Banco Santander SA
Annual Report 2018

Plain-text annual report

2018 Annual Report santander.com 2018 Annual Report Message from Ana Botín Message from José Antonio Álvarez Strategic overview Unless otherwise specifed, references in this annual report to other documents, including but not limited to other reports and websites, including our own, are for informational purposes only. The contents of such other documents and websites are not incorporated by reference in this annual report nor otherwise considered to be a part of it. Unless the context requires otherwise, the ‘Bank’ means Banco Santander, S.A., and ‘Santander’, the ‘Group’ and ‘Santander Group’ mean Banco Santander, S.A. and subsidiaries. 2 Annual Report 2018 Consolidated directors’ report 04. Santander vision 10. Responsible banking 106. Corporate 240. Economic 336. Risk governance and fnancial review % management 12 Our approach 22 Challenge 1: New 108 Overview of corporate governance in 2018 242 Economic, regulatory and competitive context 338 Risk management and control model business environment 112 Ownership structure 244 Group selected data 346 Risk map and risk profle 48 Challenge 2: Inclusive and 116 Shareholders. sustainable growth 70 Key metrics 78 Contribution to UN Sustainable Development Goals 80 Further information 81 Non-fnancial information Law content index Engagement and shareholders meeting 124 Board of directors 169 Management team 172 Remuneration 196 Group structure and internal governance 198 Internal control over 86 Global Reporting Initiative fnancial reporting (ICFR) (GRI) content index 208 Other corporate 103 Independent verifcation governance information report 246 Group fnancial performance 284 Business areas performance 323 Research, development and innovation (R&D&I) 325 Signifcant events since year end 326 Trend information 2019 330 Alternative performance measures (APMs) 348 Credit risk 373 Trading market risk, structural risk and liquidity risk 390 Capital risk 393 Operational risk 400 Compliance and conduct risk 411 Model risk 413 Strategic risk Auditor’s report and consolidated fnancial statements (consolidated annual accounts) 423. Auditor’s report 414 Glossary General information 435. Consolidated fnancial statements 451. Not es to the consolidated fnancial statements 659. Appendix The introduction to our 2018 consolidated directors’ report on page 2 contains important information about this document. On page 414 you will fnd a Glossary with certain acronyms and defned terms used throughout this document. Our 2018 annual report is provided in Spanish and English versions. In case of discrepancy the Spanish version prevails. 3 Message from Ana Botín Dear shareholder, During 2018, we have once again been relentless in focusing on earning the lasting loyalty of our people, customers, shareholders and communities. We have made more of what we do Simple, Personal and Fair. And we have done all we can to fulfl our purpose – to help people and businesses prosper. I want to start by thanking every single one of the Santander team for once again doing their very best, and our Board for all their support and guidance. 1.- Successful execution of our strategy delivers Growth, Proftability and Strength The benefts of our strategy are now clear: we have successfully delivered on the targets we set in 2015, generating growth, proftability and fnancial strength. First, growth. Very few European banks have been able to grow their revenues in the last three years, but Santander has delivered a +7% CAGR in revenues since year-end 2015, excluding the impact of currency depreciation. Customer revenues have reached 46 billion euros in 2018, up from 37 billion euros in 2015 on a constant currency basis and net fees have grown at a 10% CAGR over the last three years. We have done this in a sustainable way, increasing our loyal individual customer base by 43% to 18.1 million over the period; and increasing our loyal SMEs and corporates customer base by 66% to 1.7 million. This has been driven in large part by our digital and commercial transformation. We now have 32 million digital customers, up from less than 17 million in 2015. This strong Group performance is thanks to the turnaround led by our new teams over the plan period. For example, in Brazil and Mexico, our focus on earning customer loyalty has improved the RoTE from below 15% to 20%. We are now applying the same approach in the US, where we have spent the last three years laying the right foundations for future growth. Our global businesses, which allow our local banks to leverage the Group’s scale, have also powered our progress. Santander Corporate and Investment Banking can combine the strengths, expertise and relationship of our local banks with our Group’s global presence, achieving an improved cost-to-income ratio close to 40% and a RoRWA of 1.8%. Our new Wealth Management division has grown underlying attributable proft by 17% and reached a RoTE of 77% (excluding excess capital) in its frst year of operations as a global unit, demonstrating the value we are able to generate when working together. Combined, these two global platforms represent around 22% of our proft. Next, proftability. The Group remains one of the most proftable and efcient banks among its global peers. Our attributable proft has II grown from 6.0 billion euros in 2015 to 7.8 billion euros in 2018. We have an underlying RoTE of 12.1%, an improvement of +110 basis points compared to 2015, and a best-in- class cost-to-income ratio of 47.0%. Finally, strength. Thanks to this performance, we have become stronger. Santander has strengthened its capital signifcantly – adding about 18 billion euros to its Common Equity Tier 1 (CET1) ratio fully loaded since 2015, taking it from 10.1% to 11.3%, exceeding our revised target of being above 11%. We have done all this while rewarding our shareholders’ loyalty, with clear targets since 2015 of improving per share metrics. Total dividends from 2018 proft is expected to be 23 euro cents per share. Since 2015, cash dividend per share has increased by 31% (up to 0.20 euros per share), and total dividend per share has increased by 17%. When you look at the big picture, we have created signifcant shareholder value during the period, increasing tangible book value per share plus cumulative cash dividend per share by +27% (+8% CAGR) for the last three years, taking into account the scrip dividend impact. On a constant currency basis, the increase was +41% (+12% CAGR) for the same period. Santander’s market valuation is among the best of our European peers – and we have consistently been in the top quartile in terms of Total Shareholder Return over the plan period. 2.- Strengthening our foundations At the same time, we have implemented fundamental change across our organization, which has underpinned this performance. We have strengthened and reinvigorated our teams, both at headquarters and in the countries. We have also refreshed our governance and embedded a new culture, all of which bolstered the Group’s solid foundations. We have made our teams and our Board, at Group and in our main markets, more diverse and international. We have reinforced our leadership teams at Group level with high-calibre new hires for key roles in Digital or Technology and Operations, equipping our senior management with more broadly based global perspectives and expertise. Since 2015, we have built a top-class team leading our local banks, with new Country Heads for our top fve markets. Although Banco Santander leads the Bloomberg Gender-Equality Index, last year we issued guidelines to ensure that building a diversifed workforce is a priority across the Group. Our aim is to have women in 30% of leadership positions by 2025. In addition, the Board recognises the important benefts of having an appropriately balanced board composition. It has therefore adopted the aim of achieving an increased female representation on the Board between the range of 40% to 60%. “The benefts of our strategy are now clear: we have successfully delivered on the targets we set in 2015, generating growth, proftability and fnancial strength” 2015 2018 Loyal customers (mn) 13.8 19.9 Digital customers (mn) 16.6 32.0 Net fee income (%) - ~10 Cost of credit (%) Cost-to-income (%) FL CET1(%) 2015 2018 1.25 1.121 47 10.05 11.3 48 EPS (%) DPS (EUR) RoTE (%) 2015 - 2018 11.2 0.20 0.23 10.0 11.7 Underlying 2018 RoTE 12.1%. 1. 2018 fgure relates to 2015 – 2018 average 2015 (%) 2018 (%) CIB RoRWA 1.5 1.8 III “We have strengthened and reinvigorated our teams, both at headquarters and in the countries. We have also refreshed our governance and embedded a new culture, all of which bolstered the Group’s solid foundations” Scale 144 million customers worldwide Business model 100,000 of our people interact with customers each day Diversifed Contribution to underlying attributable proft 52% Europe 48% Americas IV While doing this, over the last three years, we have embedded a new culture. We want everything to be done in a Simple, Personal and Fair way, and we now measure our performance at doing this. The remuneration of our senior team is now based on how they achieve their goals, not simply what they achieve. Underpinning this, we have embedded eight corporate behaviours that we expect everyone to follow; a strong common approach to risk (RiskPro); and several programmes to ensure that people have the confidence to raise issues or concerns. These improvements build on the Group’s strong foundations. We have scale. We now serve 144 million customers worldwide (up from 121 million in 2015), representing a wide range of income groups in developed and emerging economies. Our markets have a combined population of one billion people – 200 million of whom in Latin America are “unbanked”. We are one of the top three banks in nine core countries in Europe and the Americas. This scale is integral to our business model. 100,000 of our people interact with customers each day. With 13,000 branches across our markets and the reach of our digital banking offering, we are able to leverage unprecedented customer insight to create deep and lasting relationships with them. In addition, we are diversified. In 2018, 52% of our underlying attributable profit came from European markets and 48% from the Americas, where the potential for profitable growth is significantly higher. Out of our 874 billion euros gross loans at end of 2018, 19% was in Latin America, 10% in US and 71% in Europe. This diversification, together with our scale and business model, makes us more predictable: we deliver consistent results throughout the economic cycle, generating superior value for our shareholders. Compared with our peers, who are some of the best banks in the world, Santander has had the lowest volatility in earnings per share over the last 20 years, as well as over the past four years, while we have continued to increase our profitability. This performance is also based on prudent risk management. Our long-standing approach to risk is now bolstered by our use of the latest technology. Santander Analytics has hired around 200 scientists from key technical fields (mathematics, statistics, engineering, data science), who collaborate with global experts in data analytics. We are introducing cutting-edge techniques based on artificial intelligence and machine learning to support advanced risk management. All of this has helped to improve our risk profile: the credit quality of our portfolios has shown a positive trend for over five years, both in terms of non-performing loans and cost of credit (now at pre- crisis levels). We have also proven our resilience in the 2018 ECB/ EBA stress test exercise, where Santander was the bank with the strongest capital generation among its peers in the baseline scenario, and had the least capital depletion in the stress scenario. 3.- Our focus on improving returns This brings me to the issue of capital. Over the last three years, we have taken a number of actions to bolster capital levels and improve capital allocation to enhance profitability as the European banking sector continued to face heightened capital requirements. In 2015, only 40% of our capital was invested above the cost of equity returns. Today about 90% is yielding returns above that level. In particular, the increase in our profitability in Brazil, Mexico and Spain has led to a significantly improved RoTE at a Group level. Additionally, we have made great strides improving our overall business in the US and today most of our businesses there are delivering returns above the cost of equity, we have plans to continue improving. The US as a country delivered 7.6% RoTE in 2018 (with normalized 11.3% capital level) and increased underlying profits by 42% year on year (+74% attributable profit). Over the last three years, we have focused on building the foundations for growth at SBNA – making leadership changes, fixing regulatory issues, and enhancing technology. These efforts are starting to bear fruits in terms of margin improvement and cost containment, and we are confident we will be able to generate value from our US franchise, which will accrue to the Group over the next few years. This improvement in our capital allocation and profitability has been combined with a very disciplined approach to inorganic growth over the last three years – like the acquisition of the Deutsche Bank retail franchise in Poland or BANIF in Portugal – or on the buyback of strategic businesses like Santander Asset Management. We have also had the discipline to divest non-core assets such as the Allfunds platform, Totalbank in the US, Private Banking in Italy, and a reduction of our real estate exposure in Spain by over 70% in 2018. The acquisition of Banco Popular was the largest transaction we undertook in the last three years, making us Spain’s biggest bank and strengthening our position in the strategic SMEs segment of the market. This acquisition was supplemented by the quick disposal of 51% Popular’s real estate assets. It will deliver the 13% - 14% return on investment we identified at the time of the transaction. “Over the last three years, we have taken a number of actions to bolster capital levels and improve capital allocation to enhance proftability” Brazil Spain UK SCF Mexico Chile US1 SBNA1,2 SC USA1 Portugal Poland Argentina RoTE 2018 20% 11% 9% 16% 20% 18% 8% 7% 21% 12% 10% 12% 1. Adjusted RoTE for 11.30% CET1, otherwise Santander US 4%, SC USA 13.3% 2. SBNA excluding US HoldCo “We are confdent we will be able to generate value from our US franchise, which will accrue to the Group over the next few years” V “This improvement in our capital allocation and proftability has been combined with a very disciplined approach to inorganic growth over the last 3 years” Adjusted TNAVps+cash DPS (Jan15-Dec18) +33% (CAGR 7%) Adjusted TNAVps+cash DPS Excluding FX (Jan15-Dec18) +47% (CAGR 10%) VI On top of this approach to acquisitions and disposals, we have improved, and will continue improving, our internal capital allocation in the following ways. First, we have established a target minimum threshold return per client in our CIB business as well as limiting the investment period. As a result, we have improved our RoRWA in this business from 1.5% to 1.8% in 2018. We are now implementing this methodology for the next segment, middle market corporates, in all our core countries, combining fnancial discipline with providing the best service to our loyal customers. Second, proftability and capital allocation have greater weighting in senior managers’ remuneration, as we have increased the weight of the RoTE for the bonus pool calculation. And fnally, we continually examine our balance sheet to identify non- core assets for disposal, such as real estate (including our own), equity stakes we hold in companies, or non-core IT assets. By improving our core proftability to generate a RoTE between 13-15% in the next few years (depending on where interest rates end up) and using capital more efciently, we will be able to generate more capital that can be used to re-invest in high growth proftable businesses, pay more dividends and, if necessary, increase capital bufers. 4.- A digital Santander To continue growing in a sustainable and proftable way and to accelerate execution, we will remain focused on our digital transformation. First, the transformation of our core banks (“supertankers”). Every product and service we ofer today to our customers can, and should be delivered digitally. And, in parallel, we must deliver a more efcient and better service. The digitisation of our core banks is already delivering revenue growth and continuous improvement of our cost-to-income ratio. The acceleration of our transformation will power the virtuous circle of success – as ofering a better service to our customers should increase their engagement with us, thereby increasing their loyalty, consequently growing our revenue. Second, we are changing our organization to increase speed of execution and bring the benefts of the Group to a broader set of customers – small and medium sized companies and merchants. During the frst quarter of 2019, we are launching two new global platforms, Global Trade Services and Global Merchant Services, which will report to our Brazil and Mexican CEOs and will be supported by Group teams. This will further leverage our scale across the Group – just as we have successfully done with our CIB and Wealth Management businesses. These new digital platforms are fexible, ofering Santander customers – and non-customers – an ecosystem of services, and an improved customer experience at a lower price. We will give further details on them at our Investor Day. While we future-proof our “supertankers” and build Group- wide platforms, we are also creating “speedboats”. These new ventures can compete in – and disrupt – markets that our “supertankers” cannot easily enter; they can service customers in our core banks; and they can also grow faster as autonomous businesses. Openbank is a good example. Based in Spain, it is now the single largest fully digital bank in Europe in terms of balance sheet and deposits, and one of the few to provide the full array of banking products to individuals. With around 8.3 billion euros in customer deposits (up 1.3 billion euros since last year), it has grown its mortgages 370% in the last year and primary – loyal – customers by 51% in just two years. Openbank is also the testing ground for our future technology platform, as well as other ideas and initiatives which are shared across the Group. Then there’s OnePay FX, one of the frst applications of blockchain- based technology to operate at scale anywhere in the world. It allows customers in the UK, Spain, Brazil and Poland to transfer funds more quickly and transparently than ever before. Meanwhile, in Latin American there’s Superdigital. Providing basic banking services, it is focused mainly on the unbanked population as a low-cost alternative to traditional banking. Its active customer base has grown 70% since 2016 and it has already reached breakeven with 1 million euros in EBITDA. Building global digital platforms is critical if we want our customers to see Santander as “my bank”, a bank that understands their individual needs and ofers them the products and services they want, whenever and wherever they want them. The goal is not only to serve our current customers better and attract new ones, but also to attract third parties to Santander’s platforms, to build a network, boosting innovation and making it quicker to bring new products and services to the market. Better still, thanks to our shared services and common infrastructure across the world, we can change the rules of the game in markets where we were previously sub-scale, such as the US. We are developing a culture of experimentation. We are willing to try promising ideas, accepting that some might not work; and we are ensuring that when they don’t, we stop investing. Importantly, “speedboats” and “supertankers” work independently, but far from “cannibalizing” each other, by sharing their knowledge and capabilities are accelerating our transformation, boosting our growth. “To continue growing in a sustainable and proftable way and to accelerate execution, we will remain focused on our digital transformation” VII “Doing the basics brilliantly is essential – but it is no longer enough. We need to show how our business is delivering proft with a purpose” 273,000 microentepreneurs supported in 2018 by Santander VIII 5.- A more responsible Santander Digital technology has given customers more power and choice than ever before. They don’t just expect us to deliver a great service at a great price, but want us to use our role and position in the market to help address wider challenges that society faces. Santander has always strived to do this, but now it is even more important that we are responsible in all we do. Doing the basics brilliantly is essential – but it is no longer enough. We need to show how our business is delivering proft with a purpose. All our stakeholders – our people, customers, shareholders and communities – expect no less. To achieve this, we have begun to embed new governance across the Group, including during 2018 the creation of the new Responsible Banking, Sustainability and Culture Committee of the Board, to ensure that wherever we operate, our senior management is focused on the need to be responsible in all we do and on the challenges we face. First, there is the challenge of the new business environment. Regulators, governments and society as a whole are placing increasing demands on how businesses are run, beyond compliance. So we must ensure we have the right culture, skills, governance and business practices. The second challenge is to support inclusive and sustainable growth – especially in a world where there is a rising sense of inequality, and a growing recognition of the urgent need to tackle climate change. We can address these challenges in a number of ways – such as our Universities programme, our fnancial empowerment initiatives or the fnancing we provide to renewables, which are just some examples of what we are doing. The strength of our performance overall is born out by Santander being ranked third in the world among banks – and number one in Europe – in the Dow Jones Sustainability Index. Behind that achievement are stories of how, each day, we are helping to improve people’s lives. Let me take you to Santiago Tianguistenco in Mexico. There, I met some women who told me that, in the past, banks had told them their businesses were too small for them to open an account. Now, thanks to Santander’s Tuiio fnancial empowerment programme, they can grow their family businesses. The micro-loans we ofer are small, and the default rate is extremely low. The loan is provided to a group of women, to fnance their various businesses. One woman told me she now saves four hours every day, as she no longer has to go to Mexico City to collect payments from customers. She showed me her Santander credit card, her frst ever, which she proudly displayed as a sign of her entrepreneurial status. These women – many are women – were grateful that a bank had taken an interest in them. Now let’s go south, to São Mateus just outside of São Paulo, Brazil, where I visited the Santander branch on Avenida Mateo Bei. Through Santander Prospera we ofer microcredit and other fnancial services to those on very low incomes. Half of our clients are below the poverty line and our subsidized low-interest rates loans can be for as little R$100 up to R$13,000 (around 20 to 3,000 euros). Digital technology is allowing us to help more people. For example, via Prospera, one year ago it took us 10 days to approve a loan: now it only takes us 10 seconds. In one year, we have helped 100,000 customers – the same as we have helped in the previous 10 years. As we help transform people’s lives, we are building a new business with tremendous potential. The scale of the unbanked and underserved population in markets such as Brazil or Mexico will contribute to our growth, delivering shareholder value by creating proft while fulflling our purpose as a bank. Alongside this, we obviously bank large multinationals and corporates. As a leader in project fnance, our loans help these businesses beneft society by, for example, building the largest solar power plant in Latin America. We have been recognized as the leading bank in the world by number of renewable energy projects fnanced. the benefts of economic growth. While we’re proud of what we have achieved, we’re certainly not complacent. We have plans to do more in the years ahead to deliver proft with a purpose: supporting more small businesses to create jobs; helping more people access fnance; providing more fnance for the low carbon economy; widening access to education; and fostering sustainable consumption. 6.- Looking ahead Like all businesses, we operate in a volatile global economy. In many of our markets there is increasing political uncertainty. And all this is against a backdrop of tough supervisory and regulatory requirements, especially in Europe. While the global economic expansion is weakening as a result of the resurgence of trade tensions, the growth prospects for the world economy in 2019 continue to be reasonably positive, particularly in the main markets in which we operate. Specifcally, the IMF forecasts that Spain, at 2.2%, will continue to exhibit the highest growth rate of the major European Union economies; that the United Kingdom, despite Brexit, will maintain a growth rate of 1.5%; that Brazil’s growth will accelerate from last year to 2.5%; and that Mexico will grow at 2.1%. This is responsible banking in action – helping people to realise their dreams and to create new jobs and new opportunities, sharing Against this backdrop, banking activity should grow thanks to changing demography, and more people using more fnancial services. “While the global economic expansion is weakening as a result of the resurgence of trade tensions, the growth prospects for the world economy in 2019 continue to be reasonably positive, particularly in the main markets in which we operate” IX “Santander’s aim as a bank is to be the best open fnancial services platform by acting responsibly and earning the lasting loyalty of our people, customers, shareholders and communities. We shall achieve this by being Simple, Personal and Fair in all we do” Our medium term targets 13% - 15% 11% - 12% RoTE CET1 X Countries’ GDP grows faster when the proportion of people who are in their late 20s and early 30s expands rapidly – as people in these age segments are in their most productive years, both in terms of earning and spending. This happened in the US with the “baby boomers”, and in Spain over the last 30 years. We are now seeing this trend in Latin America where the median age is the late 20s and early 30s – and there are 400 million people living in the markets in which we operate. As a result, Brazil – where we are one of the top three privately owned banks, with 42.1 million customers – is projected by PwC to become the 5th largest economy in the world by 2050. Mexico, where we are also one of the top three banks, will become the world’s 7th largest economy. Argentina, despite its current economic difculties, is expected to grow into a $2.4 trillion economy. In the medium term, we expect the Latin America economy to grow between 3-4% as per its GDP potential. On top of this, the growth in digital will spread banking in Latin America, with more digital customers who are more loyal, use more products and services, contributing to our revenue growth. As mentioned, we anticipate growth this year will not be as strong in more mature economies. Santander can counterbalance this thanks to recent acquisitions in Spain, Portugal and Poland – a country with 38 million people and high growth potential – and the continuing commercial turnaround of our businesses in the US. In the UK, where we have weathered uncertainties in the past, we are confdent we are ready to do so once again. Finally, elsewhere in Europe, Santander Consumer Finance will maintain its solid progress and best in class proftability. And the United States remains the largest and most attractive banking market in the world, with attractive margins, scale and growth. All this should allow us to keep delivering on our plans as we have done for the last strategic cycle (2015-2018), growing our revenues and our earnings per share while achieving our medium term targets of a RoTE of 13% - 15% and a CET1 Fully Loaded of 11% - 12%. I am confdent we can do this because we have scale, 144 million customers in 10 large markets, local leadership positions, and a proven business model that creates unique and deep personal relationships with our customers. And because, coupled with our diversifcation across developed and developing markets and Europe and the Americas, these deliver more predictable and proftable growth. In April we will set out our plan for the next few years. The basics of the strategy will not change – we will continue to follow the same approach that has delivered success over the past three years: a relentless focus on loyalty. But as we look to the future, we need to refect our approach to responsible banking and digital technology in our bank’s global aim. Therefore, from now on, Santander’s aim as a bank is to be the best open fnancial services platform by acting responsibly and earning the lasting loyalty of our people, customers, shareholders and communities. We shall achieve this by being Simple, Personal and Fair in all we do. By doing this, we will fulfll our purpose. I would like to end as I started: by thanking the Santander team for the commitment, energy and dedication everyone has shown over the last few years. We have shown we can rise to the challenges we face by going the extra mile for our customers, and that we have what is required for Santander to succeed in the future. Again, thank you also to our outstanding Board of Directors for their support and counsel. I am confdent that together we will continue to progress and we will achieve our goals for the next years. Our success since 2015 shows we have all we need to help more people and businesses prosper. Ana Botín Group Executive Chairman XI Message from Jose Antonio Álvarez The global economy generally remained dynamic and solid in 2018. The sustained growth in mature economies, particularly the United States, offset the turbulence in some developing countries. The trade tensions from protectionist threats, despite the agreement reached in the renegotiation of NAFTA, and the tightening of US monetary policy, with interest rate hikes, contributed to the greater uncertainty and triggered varying degrees of tensions, especially in developing markets such as Turkey, Argentina and, to a lesser extent, Brazil, which was also affected by general elections. Other factors such as the lack of agreement in the Brexit negotiations and the shaping of Italy’s fiscal policy also weighed on the markets. Therefore, and in my opinion, the instability that characterised the markets’ behaviour this year was “cyclical”, quite apart from the “structural” situation in 2011, when the European economies were in recession. As well as this macroeconomic context, there are challenges facing the international financial sector. Thanks to the transformation of our Bank over the last few years, we are well placed to manage these challenges proactively and responsibly. The factors that had the most impact on our business were: 1. In the first place, the sector’s need to digitalise its business in order to improve customer service, adapt to the multi- channel demands, particularly from younger generations, and boost productivity and transactional levels. This implies building a bank aligned with the challenges of the future. At the moment, the investments in digitalisation and to improve cybersecurity, as well as anti- fraud policies, inevitably entail higher technology costs. This is exerting more pressure on the financial sector’s short- term profitability, particularly in an environment of very low interest rates in some markets. 2. On the other hand, competition is much stiffer as a result of the entry of the so-called fintechs in providing some financial services. These companies enjoy some advantages, particularly in terms of costs (they do not have branches and do not have to renew outdated technology), and in the products and markets where they operate, as they focus on the most profitable ones and do not provide the universal service that we do. We need to end asymmetric regulations, as banks, on the one hand, and digital platforms and start-ups, on the other, XII are not competing on a level playing field, whether in terms of capital requirements, compliance or use of data. We are not an IT company, but it is our duty to use the best technology and look for the best possible solutions for the real financial challenges of our customers, providing them exactly with what they need. 3. While greater regulation over the last years helped to make the financial sector more solvent, especially in terms of capital, liquidity and governance, it should be streamlined in order to avoid excessive bureaucracy and asymmetries with other countries, such as the United States, whose regulation is more flexible. 4. Lastly, we need to progress in building a single banking market in Europe, with a single deposit guarantee fund, that does not restrict the movement of liquidity between countries, harmonises supervisory standards and practices with customers and creates a level playing field for entities throughout the Banking Union. Completing this Banking Union and building a single market would allow the financial sector to develop substantial economies of scale as in the US, improving the quality of service and costs and so profitability. In addition, we should not forget that the financial sector has to increasingly assume a more committed role with society, fostering the idea of Responsible banking and financial inclusion of the least bankarised sectors. Santander is a pioneer in this matter, as our main purpose is to help people and businesses prosper in the countries where we operate, in a way that we call “Simple, Personal and Fair”. The Group’s evolution in 2018 Results The Group generated an attributable profit of EUR 7,810 million, 18% more in euros than in 2017 and 32% in constant euros, largely because of the depreciation of the Brazilian real and the Argentine peso. Moreover, these results were hit by non- recurring charges, mainly related to integration processes in Spain, Portugal and the Corporate Centre. Underlying profit (before capital gains and provisions) was EUR 8,064 million, increasing in their respective currencies in 7 of the 10 core markets. Of note were the US, Brazil, Spain, Mexico and Portugal, which registered double-digit growth. As regards gross income, net interest income rose 9%, thanks to management of spreads and higher volumes of loans and deposits, chiefly in developing countries which, overall, recorded double-digit growth. “The Group is well placed to face the new challenges of the international fnancial sector” Growth Attributable proft EUR 7,810 Mn +32% Revenue EUR 48,424 Mn +9% All changes in the highlights of these pages exclude the exchange rate impact, unless otherwise indicated. XIII in systems and in training its employees are our greatest strengths when it comes to protection from cyberthreats. Balance sheet Lending continued to be well balanced between individuals (62%, including mortgages and consumer credit), SMEs and companies (27%) and large companies (11%). Eight of the 10 core units increased their lending, notably the developing countries (+14%). Almost all units increased customer funds. The largest rises were in Argentina (+51%), Poland (+32%), Brazil (+15%) and Chile (+8%). Regarding solvency, we again generated capital and reached our targets (FL CET1 of more than 11%). Our capital position was recognised by the European Banking Authority’s stress test exercise, in which we again achieved excellent results. We are the bank with the least capital destroyed among our peers in an adverse scenario. In liquidity, the Bank comfortably meets the regulatory ratios. Our strategy reflects prudent management as regards funding sources, wide diversification in terms of wholesale issues and a high proportion of liquid assets. Fee income (+9%) also grew, reflecting greater activity and customer loyalty, as well as the growth strategy in services and high value-added products and in areas of low consumption of capital. Fee income increased in Retail Banking and particularly in Wealth Management business. Operating expenses were 7% higher because of inflation in some countries, investments in transformation and digitalisation, greater costs in global projects and the perimeter impact. The synergies and optimisation plans are already beginning to bear fruit in some countries such as Spain, Portugal and the United States and will continue to increase over time. All of this was achieved while maintaining the Bank’s commitment to the quality of customer service. In risks, credit quality performed well. The NPL ratio and the cost of credit in the last 12 months improved, and coverage remained high. As regards non-credit risks, I would like to point out that unlike other agents entering the financial sector, Santander, as one of the world’s strongest and most solid banks, guarantees data protection and customers’ savings. Cyberrisks, for example, are increasingly global and can affect both our professional and personal lives. In this sense, the Bank´s experience and investments Sharp growth in net interest income and fee income Flat costs in real terms Good performance of the credit quality ratios Strength Fully loaded CET1 11.30% +46 bps TNAV 4.19 euros EUR +0.04 “Loans and funds increased in 8 of our core units” XIV Profitability We ended 2018 with one of the best RoTE among our peers, and a RoRWA well above that in 2017, partly due to measures to reduce the consumption of capital of our risk-weighted assets. In terms of creating shareholder value, the growth in TNAV together with the dividend per share in cash increased 8%. This good performance of the Bank’s main metrics did not feed through completely to the share price, due to external factors that hit the Eurozone and UK stock markets. Nevertheless, I am optimistic about future performance, as reflected in the reports of the main analyst units. We are one of the large international banks with the greatest number of buy recommendations. Evolution of the Group’s business units in 2018 All of this explains the consistent improvement we made during the year in profit terms and in the main metrics in almost all the countries where we do business. Before looking in detail at the main trends of the business units, I would like to recall some key aspects of the Group’s strategy. The first point is our business model through which the Bank’s more than 100,000 professionals are in daily contact with our customers, via an extensive branch network and a unique relationship model, tailored to meet the different needs. The second is our commitment to geographic diversification, which is balanced between mature and developing markets and has proved to be vital in generating recurring and foreseeable results. The third is our leadership position in most of the countries where we operate, enabling us to capture economies of scale and be the benchmark in the main markets. In this environment: Spain We completed the legal integration of Banco Popular and began to integrate the branch network. We are taking advantage of Popular’s strong position in SMEs to strengthen our market share in this segment while reducing its portfolio of real estate assets and the cost of deposits that have come from Banco Popular. In addition, we continued our digitalisation strategy, strengthening our position in mobile payments while showing a good commercial dynamic in insurance, turnover of cards and SME loans. We remained the leader in large companies and private banking. Proftability RoTE 11.7% +129 bps RoRWA 1.55% +20 bps “Our geographic diversifcation has proved to be vital in generating recurring and foreseeable results” Evolution of the business units in 2018 Spain Underlying proft EUR 1,738 Mn (+21%) XV These measures were reflected in the good performance of results: profit grew at double-digit rates, driven by customer revenue, gains on financial transactions and enhanced efficiency. Santander Consumer Finance SCF remained the leader in the European consumer finance market, with a business model based on geographic diversification, efficiency, and risk and recovery systems, enabling us to maintain NPL ratios and cost of credit at historic lows. We advanced in optimising, transforming and digitalising the area. This enabled us to increase business in almost all countries, maintain a high level of profitability and increase profit for the ninth year running. Portugal The integration of Popular’s business was completed in the fourth quarter of 2018. This process has enabled us to strengthen our position as the country’s largest privately owned bank by assets and loans in domestic business. We strengthened our business with companies, boosted customer loyalty and continued to transform the commercial model, now under the Santander brand. All of this is reflected in the good evolution of profits, thanks to net interest income and provisions and the cost of credit at very low levels. Poland In Poland, which is growing at one of the fastest rates in Europe, we completed the acquisition of the retail and SME businesses from Deutsche Bank Polska, strengthening our position as one of the country’s main banks. Also, Bank Zachodni adopted the Santander brand and modernised its branch network. We maintained our leadership in digital banking, launching new apps and platforms and consolidating business growth at double-digit rates. Good evolution of profit spurred by customer revenue. United Kingdom The UK economy saw moderate growth, uncertainty over Brexit and greater competition. In this context, the Bank worked to fully install the new ring-fence infrastructure that separates retail from wholesale banking and with minimal disruption to customers. Our strategic priorities continued to focus on customer loyalty and digital and operational excellence. We are number one in service quality. Profit was impacted by competitive pressure on revenue and on costs by regulatory and strategic projects and digital transformation. Evolution of the business units in 2018 SCF Underlying proft EUR 1,296 Mn (+4%) Portugal Underlying proft EUR 480 Mn (+10%) Poland Underlying proft EUR 298 Mn (-1%) United Kingdom Underlying proft EUR 1,362 Mn (-8%) XVI United States The United States is in a phase of the cycle ahead of other mature economies, with strong growth, a historically low unemployment rate and controlled inflation. In this environment, 2018 was a great year for our franchise, clearly reflecting the efforts made in previous years in transformation, regulatory compliance and optimising the capital structure. SH USA passed the Federal Reserve’s stress tests and received no objections to its capital plan, enabling it to normalise its dividend payment policy. We improved the trend in volumes and turned around profits, which increased more than 40% in a favourable environment for banks following the rise in interest rates and the tax reform. I am optimistic we will continue to improve profitability. Latin America, a region with higher economic growth potential, larger rises in business volumes and high bankarisation opportunities, experienced bouts of instability, due to elections in Mexico and Brazil and the depreciation of some currencies that affected the Group’s results. In this environment: Brazil Brazil enjoyed an excellent year, thanks to the increasing strength of our franchise, a strategy focused on improving the customer experience and satisfaction (we are the leader in service quality) and the good performance of volumes: lending and funds continued to grow at double-digit rates. In results, the performance was clearly diferent from that of our competitors. We reduced the gap in proftability due to the good evolution of net interest income and fee income. We reached the best level of efciency in the last fve years and the cost of credit was the lowest in seven. In less than four years, despite the deep recession of the country, the Bank doubled its profit and increased its return on capital from 12% to 20%. There is still the potential to improve our positioning. Mexico In Mexico, a country with strong growth potential, we continued to strengthen our distribution capacity by investing in technological and digital developments and transforming the branch network. We launched many products and apps in order to meet each segment’s needs. This produced a significant rise in loyal and digital customers and solid growth in business volumes. Profit grew at double-digit rates, driven by the good evolution of customer revenue and the lower cost of credit. Evolution of the business units in 2018 United States Underlying proft EUR 552 Mn (+42%) Brazil Underlying proft EUR 2,605 Mn (+22%) Mexico Underlying proft EUR 760 Mn (+14%) “Our leading position in most countries is enabling us to capture economies of scale and be the benchmark in the main markets” XVII Chile Chile remained focused on transforming the commercial network with more openings of Work Cafés (a model we have replicated in other countries) and the launch of a new branch format in the fourth quarter. We also extended the range of our specialised products such as One Pay for companies and Santander Life and Life 2.0, which offers a new kind of relationship between the Bank and our customers. In a more dynamic economic environment, we accelerated growth in business with large companies and SMEs. Attributable profit was higher, driven by the good performance of customer revenue. Argentina Macroeconomic instability led the country to renegotiate its agreement with the IMF, thereby covering the financing needs for 2018-2019. The economic programme was revamped, focusing on correcting the fiscal deficit and inflation in order to stabilise the economy. In a complicated environment, Santander Río’s business and customer revenue performed well, and we made progress in the digital transformation. We continued to be the sector’s leader. But this was not reflected in the Bank’s profit as it was hit by the peso’s sharp depreciation and the adjustment from high inflation. The units in Uruguay and Peru recorded a strong growth in profits, spurred by the rise in total income and the commercial transformation process. Global Segments Santander Corporate & Investment Banking, our wholesale banking business, focused on improving profitability and on the efficient use of capital. We maintained our leadership position in Latin America and Europe, developed the franchises in the UK and the US, and strengthened integration with the retail networks. Profit was 8% higher. We created the Wealth Management division, which integrates the businesses of private banking and asset management, at the end of 2017. In 2018 we strengthened our offer to customers in both businesses in order for them to be more global, coordinated and based on the specific needs of each client. The total contribution to the Group’s profit was EUR 1,015 million (including the fee income generated by this business), 13% more than in 2017. RoRWA was 12.1%. In 2019 the insurance business will be included in Santander Wealth Management unit, which will increase the unit’s contribution to the Group and its global synergies. Evolution of the business units in 2018 Chile Underlying proft EUR 614 Mn (+8%) Argentina Underlying proft EUR 84 Mn (-54%) SCIB Underlying proft EUR 1,705 Mn (+8%) WM Underlying proft EUR 528 Mn (+17%) XVIII Mid-term targets RoTE 13% - 15% FL CET1 11% - 12% Our objectives The focus in 2019 in the Eurozone countries where we operate will be on generating further synergies in the ongoing integration processes and gaining market share, in order to offset the expected low interest rates and slower economic growth. In the UK, and in an environment with some uncertainties, our aim is to become the best open digital bank, in order to offer operational excellence, maximise efficiency and improve customer satisfaction. Santander’s management in the United States will focus on continuing to boost profitability, drive growth in customers and business volumes and enhance efficiency. Lastly, in Latin America we want to take advantage of the greater growth potential to improve our distribution networks, while continuing to develop our growth and customer loyalty strategy At the Group level, as the Chairman has explained in her message, we met the targets we set three years ago in customer loyalty and digitalisation, results, profitability, capital and evolution of the dividend. This places us in the best starting point for attaining the new medium term goals, which will be announced at the next Investor Day. We are now in a position to advance toward our main goals: 1. As regards solvency, we are looking at a FL CET1 ratio of between 11% and 12%, a range we believe is comfortable, not only in order to face unforeseen risks, but also in terms of flexibility so as to take advantage of new growth opportunities. With this in mind, we are working on a capital- light model. 2. In terms of profitability, our aim is a RoTE of more than 13%, although our efforts are focused on reaching 15%. There are two main drivers to achieve this: • Foster cooperation via countries and business units, working transversally, sharing initiatives and developing common platforms. This will enable us to give the best value offer for our customers and generate more revenue. • Second, improve efficiency. I am convinced that the digitalisation of our traditional banks will help us to cut operating costs associated with launching new products. Moreover, we are building global processes that generate significant savings and centralising, also at the global level, the negotiation of our technological infrastructure and operation of services. XIX “Our employees are the key to our excellent results, and thanks to their engagement, dedication, passion and efort we continue to get better every day” The beginning of this phase is a new challenge for all of us, and as with the previous Strategic Plan, we will continue to work to achieve our profitability, efficiency and value creation targets in accordance with the market’s demand and our shareholders, that are sustainable over time, while we build the best open digital financial services platform for our customers, shareholders, society and our employees. I will end with some words on our employees. All of them are the key to our excellent results, and thanks to their engagement, dedication, passion and effort we continue to get better every day. José Antonio Álvarez Vice chairman and Chief executive officer XX 2018 Annual Report Strategic overview Our success is based on a clear purpose, aim and approach to business. We are building a more responsible bank Our aim as a bank To be the best open fnancial services platform, by acting responsibly and earning the lasting loyalty of our people, customers, shareholders and communities. Our how Everything we do should be Simple, Personal and Fair. Our purpose To help people and businesses prosper. k n a b e l b i s n o p s e r e r o m A XXII We want to help people and businesses prosper in a Simple, Personal and Fair way, to earn the lasting loyalty of our people, customers, shareholders and communities In our day-to-day business, we do not simply meet our legal and regulatory requirements, but we aspire to exceed people ́s expectations by being Simple, Personal and Fair in all we do. We focus on areas where, as a Group, our activity can have a major impact by helping more people and businesses prosper in an inclusive and sustainable way. XXIII By focusing on loyalty, we have met the fnancial targets we set in 2015. We have consistently delivered growth, proftability and balance sheet strength Growth Loyal customers 19.9 mn (+44%) Customer revenues EUR 45.8 bn (+24%)1 Proftability RoTE 11.7% (+171 bps) Cost-to-income 47% (-61 bps) Strength Fully loaded CET1 11.30% (+125 bps) NPL ratio 3.73% (-63 bps) 2015 vs. 2018 XXIV e c n a m r o f r e p g n o r t s A Number of core markets where the Bank is among the top 3 best banks to work for 2015 2018 3 7 Loyal customers (mn) 13.8 19.9 Digital customers (mn) 16.6 32.0 Fee income (%)2 - ~10 Cost of credit (%) 1.25 1.123 Cost-to-income (%) Growth in earnings per share (%) 48 - 47 11.2 Dividend per share (EUR) 0.20 0.234 Fully loaded CET1 (%) 10.05 11.305 RoTE (%)6 Scholarships and grants (thousand) People supported in our communities (mn) 10.0 11.7 35 1.2 1557 6.37 1. Constant euros. 2. % change (constant euros), 2018 fgure relates to 2015-2018 CAGR. 3. 2018 fgure relates to 2015-2018 average. 4. Total dividend charged to 2018 earnings is subject to approval by the 2019 AGM. 5. 2018 data applying the IFRS9 transitional arrangements. 6. Underlying 2015 RoTE: 11.0%. Underlying 2018 RoTE 12.1%. 7. Refers to cumulative activity in 2016-2018. The Bank has devised a corporate methodology reviewed by an external auditor to consistently keep track of people who have benefted from our social programmes, services and products. Note: 2015 metrics have been re-stated to refect the capital increase of July 2017. By building loyalty, and acting responsibly, we generate value for all our stakeholders People 202,713 employees more motivated and engaged employees... Communities 6.3 million people supported7 resulting in higher investment in the community... Customers 144 million make our customers more satisfed and loyal... Shareholders 4.1 million driving proftability and sustainable growth... XXV People 202,713 employees We want to be among the top three banks to work for in most of our core markets and we have already achieved this in seven of them A strong corporate culture is key to having professionals who are engaged and motivated. e l p o e P – s t n e m e v e i h c a n a l p r a e y 3 XXVI Team engagement Proud to work for Santander Motivated to go beyond their formal job responsibilities 82% 86% 81% +7pp1 +4pp1 +7pp1 Simple, Personal, Fair Diversity Evaluation and remuneration 83% Of employees feel motivated to contribute to building a bank that is Simple, Personal and Fair 55% Of the total workforce are women 1. 2015 vs. 2018. 60% what we do 40% how we do it Rewarding people for doing things in a Simple, Personal and Fair way XXVII Customers 144 million We want to be the best retail and commercial bank for our customers The number of loyal and digital customers has grown, along with customer satisfaction, generating more revenue. s r e m o t s u C – s t n e m e v e i h c a n a l p r a e y 3 XXVIII More loyal customers Growth in loyal customers (mn) Loyal customers generate: 2015 13.8 2018 19.9 +44% Higher returns Revenue per customer (EUR)1 x3.4 Lower churn Attrition rate -66% More digital customers Growth in digital customers (mn) Digital sales as % of total sales 2015 16.6 2018 32.0 x2 2015 2018 15 32 x2 More satisfaction and revenues Top 3 bank in 7 core countries for customer satisfaction2 Fee income EUR 11.5 bn +31% In constant EUR (2015-2018) Customer revenues3 EUR 45.8 bn +24% In constant EUR (2015-2018) 1. Individuals and SMEs in retail franchises. 2. Source: customer satisfaction study (customers and non-customers) audited by Stiga / Conento. 3. Net interest income + fee income. XXIX Shareholders 4.1 million We want to remain leaders in proftability and efciency We have delivered higher shareholder returns while strengthening our capital base. s r e d l o h e r a h S – s t n e m e v e i h c a n a l p r a e y 3 XXX More proftable and efcient RoTE1 (%) RoRWA (%) +171 bps +35 bps 10.0 2015 11.7 2018 1.20 1.55 2015 2018 Best-in-class efciency (47% vs. ~65% peer average) One of the most proftable banks in Europe (RoTE 186 bps above peer average) Higher returns for our shareholders Growing TNAVPS + Cash DPS by 27%2 in 2015-2018 period Statutory earnings per share (EPS) (EUR) 2015 2018 4.00 0.15 4.19 0.203 2015 EUR 0.397 2018 EUR 0.449 Increase in fully loaded CET1 capital ratio (%) 2015 10.05 2018 11.304 1. Underlying 2015 RoTE: 11.0%. Underlying 2018 RoTE 12.1%. 2. Considering the impact of the scrip dividend shares. 3. Total dividend charged to 2018 earnings is subject to approval by the 2019 AGM. 4. 2018 data applying the IFRS9 transitional arrangements. Note: 2015 metrics have been re-stated to refect the capital increase of July 2017. XXXI Communities 6.3 million people supported1 We want to help more people and businesses prosper in the communities where we operate We are the company that provides most support to higher education worldwide2. We have more than 1,200 agreements with universities and other academic institutions in 33 countries. s e i t i n u m m o C – s t n e m e v e i h c a n a l p r a e y 3 XXXII We are supporting higher education EUR 406 mn investment in universities1 155,000 university scholarships and grants awarded1 We launched the new scholarship website (www.santander-grants.com) ofering study, mobility and research opportunities to students for their academic and professional development We are promoting fnancial inclusion and entrepreneurship EUR 160 mn in microfnance loans 273,000 microentrepreneurs supported We are supporting sustainable growth Leading Global Bank in the fnancing of renewable energy projects3 6,689 megawatts (MW) fnanced. A generation capacity equivalent to the consumption of 5.7 million households 3rd bank in the world 1st bank in Europe 1. Refers to cumulative activity in 2016-2018. 2. The Fortune 500 Change the World report. 3. #1 position based on number of operations; #2 position based on volume; Source: Dealogic. XXXIII Our progress and core strengths mean we can now accelerate our transformation Scale + business model + diversifcation = predictable and proftable growth. Our scale benefts our leading local banks Unique personal relationships strengthen customer loyalty Our business model and geographical diversifcation have made us more resilient than our peers Resulting in more predictable and proftable earnings s h t g n e r t s e r o c r u O XXXIV Top bank in 6 out of our 10 Markets1 144 million customers in markets with a total population of >1bn people 100,000 people talking to our customers everyday Over 13,000 branches across all our geographies Diversifcation2 Resilient Best performer under stress 52% 48% Europe The Americas Capital depletion under EBA adverse scenario (-141 bps vs. -403 bps peer average)3 More predictable and proftable earnings Earnings have increased x4 over the last 20 years, with low volatility 1. Leadership position by market share in lending. Top bank in Spain, Poland, Argentina, Portugal, Chile and SCF. Only private sector banks in the case of Poland, Argentina and Portugal. 2. 2018 underlying attributable proft. Excluding Corporate Centre and Spain Real Estate Activity. 3. Source: EBA stress test 2018. XXXV Our progress is powered by digital transformation, which is a key to success in the new economic environment s k n a b e r o C – n o i t a m r o f s n a r t l a t i g i d r u O XXXVI The digital transformation of our core banks is focused on two customer priorities in order to continue to deliver the best customer service: Ofer all our products and services through end to end digital channels Deliver all products and services in a fast and efcient way We are transforming our core banks in fve ways: Transforming the FRONT Making all products and services available in digital channels (end-to-end) Transforming the BACK Re-engineering, digitising and automating all our processes Evolving our IT architecture and systems Our core banking system is a structural advantage Onboarding new technologies Rapid integration of new technologies into our day-to-day operations Becoming an agile data-driven organisation XXXVII Our digital transformation is already delivering results s k n a b e r o C – n o i t a m r o f s n a r t l a t i g i d r u O We have more digital customers... ...who are more engaged... x2 digital customers (32 mn in 2018 vs. 16.6 mn in 2015) 18 monthly accesses per customer to the digital channels (14 in 2015) 48% digital customers as % of active customers (30% in 2015) 68% of digital customers access us via mobile apps XXXVIII ...complete more transactions... ...and increase sales x2 more transactions in digital channels since 2015 32% digital sales as % of total (15% in 2015) 38% of digital transactions through mobile apps 15% digital sales through mobile apps XXXIX We have launched new digital businesses, which complement our banks and compete in the market s e s s e n i s u b w e N – n o i t a m r o f s n a r t l a t i g i d r u O XL One of the largest fully digital banks by balance sheet with a full suite of products and services +370% mortgages1 (front book) c.90% asset growth1 +19% deposit growth1 1st Blockchain-based retail payments solution Launched in 4 geographies simultaneously 230% growth in the monthly volumes of One Pay FX transactions from May to December 2018 c.70% active customer growth vs. 2016 (c.400 thousand) 130% revenue growth vs. 2016 Breakeven with EUR 1 mn EBITDA Financial solutions for the unbanked 1. YoY growth; digital mortgages were launched in 2017. XLI w e i v e r s a e r a s s e n i s u b d n a p u o r G XLII Our 10 core markets are ready to lead in the future by working together better, and faster By successfully completing our three-year plan, we have strengthened the Group so we can continue to grow. XLIII Spain We have undergone a signifcant transformation since 2015, resulting in stronger proftability and a strengthened balance sheet. This is thanks to customer loyalty, which has doubled, as a result of the 1l2l3 strategy; strong business growth in high-added value products (the SMEs loan book has grown by EUR 24 bn); and accelerated digital transformation. Our operations have been strengthened further by the Banco Popular acquisition. s e i h p a r g o e g y b n w o d k a e r B XLIV 2.7 million 4.8 million 10.8% 56.8% Loyal customers +163% Digital customers +96% Underlying RoTE +2.66pp C ost-to-income +0.3pp Ignacio ‘Pincho’ Ortega 2015 vs. 2018. Ignacio has been playing basketball for the last 10 years and he is a core member of the Spanish senior team and also of the Under-22s, on which he is a standout. Last summer, at age 18, he received the Most Valuable Player award in the European Under-22 Championship. He has also received the frst Sports Scholarship for students with disabilities from Fundación Universia. This will allow Ignacio to pursue his athletic career while studying International Relations at the University of Alabama, in the United States, an elite centre for wheelchair basketball. XLV Santander Consumer Finance A leading consumer business in Europe, its auto fnance and consumer businesses have grown by strengthening its digital channels. 19.4 million 15 15.9% 43.1% Active customers +2.7mn Countries Underlying RoTE +3.23pp Cost-to-income -1.6pp 2015 vs. 2018. s e i h p a r g o e g y b n w o d k a e r B XLVI Poland Customer loans and deposits up by around 50%1 since 2015 – strong organic growth and market position reinforced by the agreement to acquire the retail and private banking business of Deutsche Bank Polska. Strong focus on efciency (C/I down to below 43%) has been achieved while growing the number of digital customers by 17% since 2015. 1.8 million 2.2 million 10.3% 42.8% Loyal customers +38% Digital customers +17% Underlying RoTE -2.60pp Cost-to-income -3.7pp 1. In constant euros. 2015 vs. 2018. XLVII United Kingdom We continued to deliver shareholder value despite facing an uncertain and challenging operating environment in the UK (9% RoTE). We are well positioned to succeed, with improved customer satisfaction (Top 3) and growth in digital customers (+50% since 2015), while remaining strongly capitalised (CET1 13.2%, up 160 bps). s e i h p a r g o e g y b n w o d k a e r B XLVIII 4.4 million 5.5 million 9.3% 55.2% Loyal customers +12% Digital customers +50% Underlying RoTE -2.51pp Cost-to-income +2.6pp Jenny Evans Entrepreneurship Awards UK Jenny Evans was a winner of the 2017 Santander Universities Entrepreneurship Awards and was awarded £25,000 in seed funding, as well as two fully funded internships. She also receives mentoring from our UK CEO, Nathan Bostock. “At Jenny Kate we create beautiful textile prints inspired by nature to bring the outdoors into your life and home. Winning the Post-Revenue category was an incredible experience and has completely revolutionised my business. I’ve built a huge new network of people to work with and get advice from, gained an accountability partner, new business collaborations, had an incredible week of working on my business with CEOs and industry experts and I also gained an advisory board member – all before I won!” 2015 vs. 2018. XLIX Brazil Santander Brasil is the country’s third-largest privately owned bank and the largest foreign bank in the country. It is the leader in customer satisfaction. Since 2015, it has experienced strong growth in loyal customers and digital customers. Over the same period, its underlying attributable proft rose (+88%)1 as did its proftability (RoTE +19.8%), refecting its higher productivity and improved efciency in recent years. 1. In constant euros. s e i h p a r g o e g y b n w o d k a e r B L 5.2 million 11.4 million 19.8% 33.6% Loyal customers +65% Digital customers +158% Underlying RoTE +5.68pp Cost-to-income -6.4pp Bernadete Fentrin Creating jobs After Bernadete lost her job she rented a small shop, took the 2 sewing machines that her family had, and began to make and sell clothes. She has been a customer of Prospera for 13 years, and she now has her own house, a shop and employs 4 people. Thanks to the microcredit, she has been able to buy machinery to grow the business. Bernadete has also been part of the “Parceiros em Ação” fnancial training program. In October 2018, supported by Santander, she went to the Sao Paulo Fashion Week for the frst time. 2015 vs. 2018. LI Portugal In 2018 we became the leading privately owned bank, particularly in terms of total credit and proftability, while substantially growing the number of digital customers. In October, we completed the operational and technological integration of Banco Popular Portugal. 752 thousand 734 thousand 12.1% 47.8% Loyal customers +42% Digital customers +93% Underlying RoTE -0.47pp Cost-to-income -0.9pp 2015 vs. 2018. s e i h p a r g o e g y b n w o d k a e r B LII Chile We lead in loans, customer deposits and online banking. WorkCafé, Santander Life and Digital Onboarding have helped us become leaders in innovation and digital banking in Chile. Our RoTE has reached 18%. 668 thousand 1.1 million 18.4% 41.2% Loyal customers +19% Digital customers +18% Underlying RoTE +2.88pp Cost-to-income -1.8pp 2015 vs. 2018. LIII Mexico Our focus on loyalty and digital transformation has seen the number of loyal and digital customers grow, by 81% and x3.3 respectively, since 2015. The RoTE has expanded by more than 700 bps during the same period, reaching 20% in 2018. s e i h p a r g o e g y b n w o d k a e r B LIV 2.5 million 2.9 million 20.4% 41.5% Loyal customers +81% Digital customers x3.3 Underlying RoTE +7.16pp Cost-to-income +0.2pp Juana Edith Esparza Briones Mobility Scholarship Juana was born in the municipality of El Llano, to a very poor family. Her parents had not had the opportunity to go to school. With much efort, by both her and her family, Juana was admitted to the university, where she received a Santander Scholarship to study in the United States for four months. This opportunity changed her life and allowed her to travel abroad for the frst time. “The support I received from Santander meant a lot because it changed my life.” Juana discovered that there are no barriers, and that to get ahead all she needed was the support of someone who believed in her. 2015 vs. 2018. LV Argentina Santander Río remains the leading private bank based on four pillars: proftable growth, customer centricity, efciency and risk control. In 2018, 71% of our active customers used digital channels, and 40% are now exclusively mobile customers. 1.4 million 2.1 million 11.8% 61.9% Loyal customers +35% Digital customers +66% Underlying RoTE -20.45pp Cost-to-income +6.3pp 2015 vs. 2018. s e i h p a r g o e g y b n w o d k a e r B LVI United States Santander US underlying attributable proft grew by 42% in 2018 vs. 2017. Auto loan originations at Santander Consumer USA, Santander US’s biggest business, grew by 43% to $28.8 bn. Santander US made signifcant progress closing legacy regulatory issues in 2018. 3391 thousand 8941 thousand Loyal customers +28% Digital customers +45% 7.6%2 RoTE -0.8pp3 43.4% Cost-to-income +4.6pp 1. Only SBNA. 2. Underlying RoTE adjusted for 11.3% CET1. Otherwise Santander US 4% and SC USA 13.3%. 3. Underlying adjusted RoTE. 2015 vs. 2018. LVII Corporate & Investment Banking Corporate & Investment Banking is Santander’s global division that supports corporate and institutional clients, ofering tailored services and value-added wholesale products suited to their complexity and sophistication. 1.8% EUR 1,418 million EUR 5,807 million EUR 1,705 million RoRWA Revenue synergies1 Revenues Attributable proft +21%2 +2%2 +8%2 1. Revenue synergies from leveraging SCIB value proposition to corporates and SMEs. 2. In constant euros. 2017 vs. 2018. s e i h p a r g o e g y b n w o d k a e r B LVIII Wealth Management Operating in all our markets, Santander Private Banking and Santander Asset Management have strengthened our customer ofering by improving collaboration between our banks, driving proftability (attributable proft EUR 528 million) and growth (+17%1 YoY). EUR 329 billion Assets under management -2%2 174 thousand Private Banking Customers +2% 12.1% RoRWA +0.2pp EUR 1,015 million Proft contribution3 13% 1. Underlying proft. 2. In constant euros. 3. Including net proft and total fee income generated by this business. 2017 vs. 2018. LIX 2018 consolidated directors’ report This report has been approved unanimously by our board of directors on 26 February 2019. Our new approach to this document The presentation of our consolidated directors’ report has been improved to provide in a single, streamlined document the contents of several documents that were previously published separately and will no longer be prepared but as sections of the consolidated directors’ report. In particular, in 2017, the contents now included in this report were spread in the following documents: 2017 documents now included in the consolidated directors’ report Annual report Consolidated directors’ report Annual corporate governance report (CNMV format document) Report of the board committees Sustainability report Annual report on our directors’ remuneration (CNMV format document) santander.com The new format allows a clearer presentation of the information and, therefore, of understanding, avoids repetition and, at the same time, enhances the level of disclosure rather than reducing it. The 2018 consolidated directors’ report includes all the information requirements to comply with Spanish Law 11/2018 on non-fnancial information and diversity under the chapters Santander vision and Responsible banking. Level of auditors’ review The contents of our 2018 consolidated directors’ report have been subject, as required by applicable legislation, to diferent levels of review by our independent statutory auditors, PricewaterhouseCoopers Auditores, S.L. These diferent levels of review can be summarised as follows: PricewaterhouseCoopers Auditores, S.L. has verifed that the information in this consolidated directors’ report is consistent with that of our consolidated fnancial statements and its contents comply with applicable regulations. For further information see ‘Other information: Consolidated management report section of the Auditor’s report, on page 432 in this report. PricewaterhouseCoopers Auditores, S.L. has issued a verifcation report with a limited assurance scope on the non-fnancial and diversity information required by Spanish Law 11/2018 and included in this consolidated directors’ report. Such report is included as Independent verification report of the Responsible banking chapter. PricewaterhouseCoopers Auditores, S.L. has issued an independent reasonable assurance report on the design and effectiveness of the Group´s internal control over financial reporting which is included in section 8.6 of the Corporate governance chapter. 2 Annual Report 2018 Non-IFRS and alternative performance measures In addition to fnancial information prepared in accordance with International Financial Reporting Standards (IFRS) and derived from our consolidated fnancial statements, this consolidated directors’ report contains fnancial measures that constitute alternative performance measures (APMs) as defned in the Guidelines on Alternative Performance Measures issued by the European Securities and Markets Authority (ESMA) on 5 October 2015 and other non-IFRS measures. The fnancial measures contained in this consolidated directors’ report that qualify as APMs and non-IFRS measures have been calculated using the fnancial information from Santander Group but are not defned or detailed in the applicable fnancial reporting framework and have neither been audited nor reviewed by our auditors. We use these APMs and non-IFRS measures when planning, monitoring and evaluating our performance. We consider these APMs and non-IFRS measures to be useful metrics for management and investors to facilitate operating performance comparisons from period to period. While we believe that these APMs and non-IFRS measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute of IFRS measures. In addition, other companies, including companies in our industry, may calculate or use such measures diferently, which reduces their usefulness as comparative measures. Section 8 of the Economic and fnancial review provides further information about those APMs and non-IFRS measures. Forward-looking statements Santander cautions that this annual report contains statements that constitute “forward-looking statements” within the meaning of the US Private Securities Litigation Reform Act of 1995. Forward- looking statements may be identifed by words such as ‘expect’, ‘project’, ‘anticipate’, ‘should’, ‘intend’, ‘probability’, ‘risk’, ‘target’, ‘goal’, ‘objective’, ‘estimate’, ‘future’ and similar expressions. These forward-looking statements are found in various places throughout this annual report and include, without limitation, statements concerning our future business development and economic performance and our shareholder remuneration policy. While these forward-looking statements represent our judgment and future expectations concerning the development of our business, a number of risks, uncertainties and other important factors could cause actual developments and results to difer materially from our expectations. The following important factors, in addition to those discussed elsewhere in this consolidated fnancial statements, could afect our future results and could cause outcomes to difer materially from those anticipated in any forward-looking statement: (1) general economic or industry conditions in areas in which we have signifcant business activities or investments, including a worsening of the economic environment, increasing in the volatility of the capital markets, infation or defation, and changes in demographics, consumer spending, investment or saving habits; (2) exposure to various types of market risks, principally including interest rate risk, foreign exchange rate risk, equity price risk and risks associated with the replacement of benchmark indices; (3) potential losses associated with prepayment of our loan and investment portfolio, declines in the value of collateral securing our loan portfolio, and counterparty risk; (4) political stability in Spain, the UK, other European countries, Latin America and the US; (5) changes in laws, regulations or taxes, including changes in regulatory capital and liquidity requirements, including as a result of the UK exiting the European Union and increased regulation in light of the global fnancial crisis; (6) our ability to integrate successfully our acquisitions and the challenges inherent in diverting management’s focus and resources from other strategic opportunities and from operational matters while we integrate these acquisitions; and (7) changes in our ability to access liquidity and funding on acceptable terms, including as a result of changes in our credit spreads or a downgrade in our credit ratings or those of our more signifcant subsidiaries. Numerous factors could afect the future results of Santander and could result in those results deviating materially from those anticipated in the forward-looking statements. Other unknown or unpredictable factors could cause actual results to difer materially from those in the forward-looking statements. Forward-looking statements speak only as of the date of this annual report and are based on the knowledge, information available and views taken on such date; such knowledge, information and views may change at any time. Santander does not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Historical performance is not indicative of future results Statements as to historical performance or fnancial accretion are not intended to mean that future performance, share price or future earnings (including earnings per share) for any period will necessarily match or exceed those of any prior period. Nothing in this annual report should be construed as a proft forecast. No ofer Neither this annual report nor any of the information contained therein constitutes an ofer to sell or the solicitation of an ofer to buy any securities. 3 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Santander vision Building a responsible Santander is a retail bank with a unique Our purpose To help people and businesses prosper. Our aim as a bank To be the best open fnancial services platform by acting responsibly and earning the lasting loyalty of our people, customers, shareholders and communities. Our How: Simple | Personal | Fair In everything we do. 4 1. Our scale provides potential for organic growth. 2. Unique personal banking relationships strengthen customer loyalty. 3. Our geographic and business diversifcation and our model of subsidiaries make us more resilient under adverse circumstances. Our strengths have historically resulted in: Higher earnings predictability Our vision and our strengths are sound pillars to face potential challenges: 2018 Annual Report sponsible bank from our core strengths e business model underpinned by 3 strengths. • We maintain a leadership position in our core markets. • Collaboration across the Group results in signifcant cost Top 3 Top 5 savings and higher revenues. Auto LendingB Top bank in 6 out of our 10 core marketsA A. Market share by lending. B. Non-prime auto lending. • We serve 144 million customers in markets, with a total population of more than 1 billion people. • We have over 100,000 people talking to our customers every day in our more than 13,000 branches and contact centres. • We have a well-balanced distribution between mature and developing markets, and a good mix of products for individuals and companies. • Our model of subsidiaries, autonomous in liquidity and capital, allows the Group to mitigate the risk that the difculties of one subsidiary afect the rest. • Subsidiaries are managed by local teams providing the best customers knowledge within their markets. #1 Branch network1 Balanced diversifcationA 48% Americas 52% Europe c.97% of our profts from our 10 core markets A. Underlying attributable proft 2018, excluding Corporate Centre and Spain Real Estate Activity. For further details, see more information in sections 3 and 4 of the Economic and fnancial review chapter. Resilient proft generation throughout the cycle Group net operating incomeA (EUR billion) Over the last 20 years, earnings have increased x4 with low volatility 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 A.Net operating income = Total income-operating expenses Our strong balance sheet and our model of subsidiaries make us less vulnerable to face a potentially adverse macro environment. Our scale and best-in-class efficiency ratio mitigate potential impacts from increases in costs of doing business. We are transforming our core banks while launching innovative ventures to address challenges emerging from the new digital era. We have a clear focus on acting responsibly to meet higher expectations from our stakeholders. 1. Excluding Chinese banks and Sberbank. 5 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementWe have successfully completed our 3 year plan Strategic priorities Key metrics 2015 2018 Be the best bank to work for and have a strong internal culture. Number of core markets where the Bank is among the three leading banks to work for 3 7 People Earn the lasting loyalty of our individual and business customers. Digital transformation and operational excellence. Customers Loyal customers (mn) 13.8 19.9 Digital customers (mn) 16.6 32.0 Fee income (%)A - ~10 Shareholders Capital strength, risk management and proftability. Communities People supported in the local communities where the Group operates. Cost of credit (%) Efciency ratio (%) Growth in earnings per share (%) 1.25 1.12B 48 - 47 11.2 Dividend per share (EUR) 0.20 0.23C Fully loaded CET1 capital ratio (%) 10.05 11.30D RoTE (%)E 10.0 11.7 Scholarships (thousand) People supported in our communities (mn) 35 1.2 155F 6.3F A .% change (constant euros). 2018 fgure relates to 2015-2018 CAGR. B. 2018 fgure relates to 2015-2018 average. C. Total dividend charged to 2018 earnings is subject to the 2019 AGM approval. D. 2018 data applying IFRS 9 transitional arrangements. E. Underlying RoTE 2015: 11.0%. Underlying RoTE 2018 12.1%. F. It refers to cumulative activity in 2016-2018. Note: 2015 metrics have been re-stated to refect the capital increase of July 2017. Our new strategic plan will be announced at next Santander Investor DayA A . The information that will be made available in the Investor Day is not incorporated by reference in this annual report nor otherwise considered to be a part of it. 6 2018 Annual Report Our strategy is built around a virtuous circle based on trust: People Employees who are engaged... Team engagement Strong S|P|F cultureA 82% 75% 2015 2018 >6pp than the avg. fnancial industry 63% 63% 75% Simple Personal Fair 69% 74% 79% A key focus of our strategy is to embed a strong culture based on our values: Simple, Personal and Fair. How we do things is as important as What we do. Our employee engagement levels are above the industry average. 2015 2018 % of employees that consider Santander is Simple, Personal and Fair. Customers ...generate more loyal customers... Digital sales over total sales Loyal customers 32% x2 15% 2015 2018 Lower churn Attrition rate (%) -66% Increase in loyal customers, both individuals and businesses, has resulted in a signifcant growth in revenues, loans and customer funds. Loyal customers use more our digital channels as they hold more of our products and services and interact with us more often. Shareholders ...leading to strong fnancial results... Group customer revenues Net interest income + Net fees (constant EUR billion) 45.8 37.0 2015 2018 Earnings per share Double digit growth 11.2% (2018 vs.2017) Cash dividend per share +31% Increase since 2015 Our focus on customer loyalty is delivering results: customer revenues have increased 24% from 2015 to nearly EUR 46 billion. We have signifcantly strengthened our balance sheet in the last 4 years generating 304 basis points of capital (applying IFRS 9 transitional arragements). We have become even more resilient while growing our business and increasing dividends. Communities ...and more investment in communities. 6.3 million people supported 2016-2018 155 thousand scholarships granted 2016-2018 3rd 1st bank in the world in Europe bank Highest score among peers: 95.3 points out of 100 We 1,235 have agreements with academic institutions in 33 countries. 7,647 partnerships with social institutions and entities. We are the leading global bank fnancing renewable energy projects (#1 by number of transaccions, #2 by volume, according to Dealogic). We are delivering profts in a responsible way supporting inclusive and sustainable growth. 7 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Our balanced geographic diversifcation has been key to deliver stable and predictable growth United States Proft contributionA Customers Employees Market shareB 5% 5,220,211 17,309 3% Mexico Proft contributionA 8% Customers 16,690,402 Employees Market shareB 19,859 13% Colombia Peru Chile Proft contributionA Customers Employees Market shareB 6% 3,460,654 12,008 19% Argentina Proft contributionA 1% Customers Employees Market shareB 3,701,498 9,324 10% Brazil Proft contributionA 26% Customers 42,074,640 Employees Market shareB 46,914 9% Uruguay A. 2018 underlying proft. Excluding Corporate Centre and Spain real estate activity. For further details, see more information in sections 3 and 4 of the Economic and fnancial review chapter. B. Loans. UK: lending comprises UK mortgages (excluding social housing), consumer credit and commercial lending (excluding fnancial institutions). Poland: including Santander Consumer Finance business (SCF); US: in the states where the Group operates. SCF: Top3 in our main markets in new lending of auto loans. 8 2018 Annual Report United Kingdom Proft contributionA 13% Customers 25,519,550 Employees Market shareB 25,872 10% Portugal Proft contributionA Customers Employees Market shareB 5% 4,912,459 6,705 18% Spain Proft contributionA 17% Customers 17,290,847 Employees Market shareB 32,313 18% Santander Consumer Finance Proft contributionA 13% Customers 19,427,871 Employees Market shareB 14,865 Top 3C Poland Proft contributionA Customers Employees Market shareB 3% 4,525,138 12,515 12% Main countries Santander Consumer Finance Other countries 9 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementResponsible banking Our approach What our stakeholders tell us Challenges and opportunities Principles and governance 2018 highlights Challenge 1: New business environment Strong corporate culture A talented and motivated team Responsible business practices Risk culture Shareholder value Responsible procurement Challenge 2: Inclusive and sustainable growth Meeting the needs of everyone in society Boosting enterprise Financial empowerment Supporting higher education Community investment Tax contribution Sustainable fnance Analysis of environmental and social risks Environmental footprint Key metrics Contribution to UN Sust ainable Development Goals Further information Non-financial information Law content index Global Reporting Initiative (GRI) content index 14 16 18 20 24 28 38 42 44 46 50 52 54 56 58 60 62 66 68 70 78 80 81 86 Independent verification report 103 Consolidated non-financial information statement 10 11 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementOur approach “ By delivering on our purpose, and helping people and businesses prosper, we grow as a business and we can help society address its challenges too. Economic progress and social progress go together. The value created by our business is shared – to the beneft of all. Communities are best served by corporations that have aligned their goals to serve the long term goals of society. ” Ana Botín By being responsible, we build loyalty People Customers Shareholders Communities I´m loyal to Santander because... ... Santander treats me responsibly In our day-to-day businesses, we ensure that we do not simply meet our legal and regulatory requirements, but we exceed people´s expectations by being Simple, Personal and Fair in all we do. ... Santander acts responsibly in society We focus on areas where, as a Group, our activity can have a major impact on helping people and businesses prosper. 12 2018 Annual Report 10.4 years Average length of employment >273,000 Microbusinesses supported EUR 0.23 Dividend per share, 4.5%C vs 2017 EUR 58 million Investment in programmes and projects to support communities Helping people and businesses prosper - our performance People EUR 11,865 million Personnel costsA Customers 96% of employees with permanent contracts EUR 882,921 million Loans outstanding (net) EUR 487,695 million to households EUR 22,659 million to public administrations EUR 301,975 million to companies EUR 70,592 million to othersB Shareholders EUR 64,508 million Stock market value at year-end 2018, largest bank in the euro zone EUR 121 million Investment in universities 3,724 EUR Total shareholder remunerationC million Communities EUR 179 million Community investment Suppliers EUR 3,619 million Payments to suppliersD Tax contribution EUR 16,658 million Taxes paid and collected by Santander 10,628 Approved suppliers through our global procurement model 95% Local group’s suppliers 3,458 EUR Corporate income tax million 3,598 EUR Other own taxes paid, including social contributions million A. From Group consolidated fnancial statements. B. Including fnancial business activities and customer prepayments. C. Subject to the approval of the total dividend against the 2018 results by 2019 Annual General Meeting. D. Data refers exclusively to purchases negociated by Aquánima. 13 Our approachResponsible bankingCorporate governanceEconomic and financial reviewRisk management What our stakeholders tell us Analysing, assessing and responding to the opinions and concerns of all our stakeholders is a fundamental part of our effort to operate as a responsible bank and make all we do Simple, Personal and Fair (SPF). Engagement with all stakeholders hepls to build value Earning and keeping people’s loyalty is the key to creating lasting value. To do this, we must understand the concerns of all our stakeholders. By listening to their opinions, and measuring their perceptions of the Group, we not only identify issues, we also spot opportunities. In 2018 we conducted a survey to identify what our employees, customers and society think a responsible bank should do. These fndings helped us as we analysed what the leading environmental, social and governance analysts are telling us. 88% of participation in the global engagement survey 83% of employees believe that their colleagues behave more simple 86% of employees feel proud to work for Santander 3,879 complaints received through ethical channels 1,235 agreements 6,000 interviews to university students with universities about the perception and academic of Santander as Simple, Personal and Fair institutions People Customers Key dialogue channels for stakeholders 253 7,647 partnerships with profles and 16 millions social institutions followers in and entities social networks Communities Shareholders 14 1 million surveys to measure and monitor customer satisfaction 13,217 branches +40,000 interviews to banked population about the perception of Santander as Simple, Personal and Fair 316,094 complaints received 10,000 interviews to shareholders about the perception of Santander as Simple, Personal and Fair 166,149 queries managed by email, phone, WhatsApp and online meetings 391,926 Shareholder and investor consultations trough studies and qualitative surveys 252 meetings with shareholders 2018 Annual Report Identifying the issues that matter The materiality matrix shows the concerns Santander has identifed as most important for its stakeholders in the analysis. Santander also regularly analyses the most relevant social, environmental and ethical behaviour issues through its materiality assessment. This systematic study is conducted across the whole Group’s value chain on an annual basis, and consists of a far-reaching quantitative and qualitative analysis that uses information from both internal and external sources. Relevant aspects for the Group matrix Challenge 1 Challenge 2 New business environment Inclusive and sustainable growth e c n a v e l e R l a n r e t x E Ethical behaviour and risk management control Indirect environmental impact Talent attraction & retention Cybersecurity & data protection Strong corporate governance & management transparency Environmental footprint Incentives linked to ESG criteria Financial literacy Material concerns Products and services with social/environmental value Compliance and adaptation to regulatory changes Diversity Financial inclusion Community investment Customer satisfaction Multichannel strategy and digitalisation Transparent & fair products and services Through this analysis, we have identifed two major challenges to move towards a more responsible banking model. Internal Relevance 15 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementOur approach Challenges and opportunities Like every business, Santander operates in a world that is changing fast, creating new challenges and opportunities. Using the results of the materiality assessment, we have identified two core challenges – the challenge of the new business environment, and the challenge of inclusive and sustainable growth. Challenge 1: New business environment. Adapting to an evolving world The transformation that is happening in the world economy is unprecedented. The opening of new markets, the availability of global capital and advances in information technology and communications are changing the competitive environment of companies across the world. This new competitive framework, in a time of constant change, requires companies to assume greater responsibilities to innovate and work in new ways. Santander, like all businesses, needs a motivated, skilled workforce able to deliver what customers want, harnessing the power of new technology. Meanwhile, we face new regulations and laws. These trends create the challenge of new business environment in which we operate. Our task is to exceed our stakeholders expectations, to do the basics brilliantly, every day. Key to this is having a strong culture – a business in which all we do is Simple, Personal and Fair. For more detailed information on our strategy to tackle this challenge and turn it into an opportunity, please see section “Challenge 1: New business environment” of this chapter. 16 2018 Annual Report Challenge 2: Inclusive & sustainable growth. Helping society achieve its goals Growth should meet the needs of today’s generation, without hampering future generations’ ability to meet their own needs: a balance should always be struck between economic growth, social welfare and environmental protection. Financial institutions can deliver this by managing their own operations responsibly, and lending responsibly to help society achieve its goals. We can play a major role in helping ensure growth is both inclusive and sustainable. Inclusive: by meeting all our customers’ needs, helping entrepreneurs start companies and create jobs, strengthening local economies, improving fnancial empowerment, and supporting people get the education and training they need. Sustainable: by fnancing renewable energy, supporting smart infrastructure and technology to tackle climate change (such as agrotech and green tech). We do this while taking into account the social and environmental risks and opportunities in our operations, and actively contributing to a more balanced and inclusive economic and social system. For more detailed information on our strategy to tackle this challenge and turn it into an opportunity, please see section “Challenge 2: Inclusive & sustainable growth” of this chapter. 17 Our approachResponsible bankingCorporate governanceEconomic and financial reviewRisk management Principles and governance All our activity is guided by policies, principles and frameworks to ensure we behave responsibly in everything we do. We have redesigned and strengthened our responsible banking governance, both to ensure we are compliant and to help us manage initiatives which tackle the two challenges we have identified. Policies that support our responsible banking strategy General code of conduct Corporate culture policyA General sustainability policy Human rights policy Climate change and environmental management policy Sector policies Brings together the ethical principles and rules of conduct governing the actions of all of the Group’s staf and is the central element of the Group’s compliance programme. Establishes the guidelines and required standards to be followed ensuring a consistent culture is embedded throughout the Group. Defnes our general sustainability principles, and our voluntary commitments with our main stakeholders, lasting value. Sets out how we protect human rights in all operations, and refects the UN Guiding Principles on Business and Human Rights. Sets out Santander’s policy to protect the environment and mitigate the impact of climate change. Lays down the criteria governing the Group´s fnancial activity with the defence, energy, mining & metals and soft commodities (products such as palm oil, soy and timber) sectors. Consumer protection policyB Code of conduct in security markets   Cybersecurity policy Suppliers certifcation policyC Tax policy Conficts of interest policy Financing of political parties policy Policy on contributions for social purposes Corporate volunteering policy A. Includes employee’s diversity principles. B. Includes fnancial consumer acting principles. C. Includes principles of responsible behaviour for suppliers. Changes to policies in 2018 • Update of the general sustainability policy, to refect the current governing bodies and to improve the clarity around prohibitions and restrictions in fnancing certain customers and / or activities, as set out in its sectoral policies (energy, defence, mining & metals and soft commodities). protect the Rights of LGBTI individuals as a relevant international declaration supported by Santander. • Update of the suppliers certifcation policy to include new principles of responsible behaviour for suppliers. • Approval of global policy on induction, • Update of climate change and knowledge and development. environmental management policy to refect the current governing bodies. • Update of the human rights policy to refect the current governing bodies and to include: a reference to The Global Standard Conduct for Business to • Approval of cybersecurity policy, taking into account new risks and legislation in this feld. • Approval of contribution for social purposes policy. 18 Risk culture Our risk management and compliance model is key to ensure we operate and behave in a way that refects our values and corporate culture, and delivers our responsible banking strategy. For more information, please see ‘Risk culture’ section in this chapter. 2018 Annual Report Our approach Strategic overview and coordination Responsible banking, sustainability & culture committee (RBSCC) Assisting the board of directors in fulflling its oversight responsibilities with respect to the responsible banking strategy, sustainability and culture issues of the Group: corporate culture, ethics and conduct, the digital transformation, inclusive and sustainable growth. Culture steering This group ensures we have the right culture, skills, governance, digital and business practices to meet stakeholders’ expectations. Inclusive & sustainable banking steering To meet the challenge of inclusive and sustainable growth, this group supports small businesses to create new jobs, improving fnancial empowerment, supporting fnance the low carbon economy and fostering sustainable consumption. To drive progress on the responsible banking agenda, a new unit under the Executive Chaiman´s Ofce team has been established. Santander has appointed a Senior Advisor on Responsible Business Practices, who reports directly to the executive chairman and works with the Responsible Banking Unit. Santander subsidiaries Guiding principles have been developed for subsidiaries (and global business units) to ensure governance and implementation of its responsible banking agenda is embedded across the Group as a whole. Likewise, each subsidiary has appointed a senior responsible for the function. Group strategy metrics & targets Key initiatives proposed and agreed by the RBSCC in 2018: The new governance model for responsible banking. Approval of the guiding principles of governance and supervision in matters of responsible banking, sustainability and culture for the Group’s subsidiaries. Established lines of accountability and agreed metrics. Update of the criteria for fnancing activities related to coal, both those related to its extraction (mining) and its use as an energy source (energy). Update of the fnancing policy to sensitive sectors, to incorporate new criteria and guidelines regarding the gambling sector, and the defense. Main priorities in 2019: • Financial and social inclusion. • Responsible and sustainable products ofered. • Social and environmental risk and opportunities. • Group´s corporate culture. For more information, please see section 4.3 ‘Activity report’ in Corporate governance chapter. 19 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 2018 highlights We have built on our success by helping more people and businesses prosper, while bringing a new focus to our efforts to be a more responsible bank. We have received global recognitions for our eforts… …we strived to address the challenge of the new business environment… • Santander was ranked third in the world and frst in Europe among banks in the Dow Jones Sustainability Index. • Fortune Magazine named Santander in its 2018 Change the World list – recognising the Group among companies who “do well by doing good”. • Santander received Top Employers Europe 2018 certifcation, and ranked in the top 3 of the best fnancial institutions to work in Latin America, according to Great Place to Work. • Prospera microfnance program, was chosen as an example of good practice by the Brazilian Network of the Global Compact to reach the SDGs in 2030. • Santander X, our global community of university entrepreneurship, was chosen as an example of good practice by the Spanish Network of the Global Compact to reach the SDGs in 2030. 20 • The board approved a new policy to ensure a consistent culture is embedded throughout the Group. • New employee value proposition created, positioning Santander as an employer of choice both internally and externally. 86% of employees feel proud to work for Santander. • More than 56,000 SPF surveys were sent to customers, shareholders, investors and university students to know their perception of Santander as Simple, Personal and Fair. • New corporate diversity & inclusion principles were agreed, to consolidate our cultural transformation. • Awareness and understanding of cybersecurity was increased through comprehensive communication and education activities and launch of a new, cybersecurity policy taking into account new risk and legislation. • New suppliers certifcation policy was approved, which includes principles of responsible behaviour for suppliers. • New internal governance website was created, including a single global portal for all corporate frameworks, ensuring strong governance and consistency across the Group. Simple I Personal I Fair ...Everyone´s business 2018 Annual Report Our approach …while ensuring that we promote inclusive and sustainable growth… …and building an even more responsible bank • Santander joined United Nations Environment Programme Finance Initiative (UNEP FI) to develop the principles for responsible banking to align the sector with the SDGs and the Paris Climate Agreement. • New board committee on responsible banking, sustainability and culture was formed to drive and co-ordinate our responsible banking approach across the Group. Main SDGs where Santander’s business activities and community investments have the most impact. • CEOs of diferent international companies and UN Special Advocate launched a Private Sector Partnership for Financial Inclusion, with Santander representing the banking sector. • Santander Asset Management launched a new range of sustainable funds, which combine fnancial criteria with non-fnancial ones. • Santander Corporate & Investment Banking (SCIB) consolidated its leading position in renewable energy transactions. 6,689 MW of renewable energy fnanced, equivalent to the consumption of 5,7 million households. • 4th Universia International Rectors’ Meeting was held in Salamanca. The meeting brought together 600 rectors from 26 countries, representing 10 million university students around the world, in a discussion entitled ‘University, Society and Future’ on the challenges facing higher education. 21 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Challenge 1: New business environment To meet the challenge of the new business environment, we’re focusing on... 22 2018 Annual Report Strong corporate culture The Santander Way defnes our purpose, our aim and how we do business, by being Simple, Personal and Fair in everything we do. Talented and motivated team The more prepared and motivated our workforce is, the stronger their commitment to helping people and businesses prosper will be. Our workforce is diverse in terms of expertise and gender. Responsible business practices We develop our products and services responsibly, and aspire to deliver excellent customer service. Customer protection data is one of our main priorities. Risk culture As a bank, managing risks is an essential part of our daily business. We have a robust risk management model and risk culture to ensure we operate in a prudent and responsible way. Shareholder value We have clear and robust governance. Risks and opportunities are prudently managed; and long-term strategy is designed to safeguard the interests of our shareholders and society at large. Responsible procurement Our procurement processes are based on ethical, social and environmental criteria to ensure we operate in a sustainable way throughout our operations. 23 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Strong corporate culture The Santander Way is our strong global culture, fully aligned to our corporate strategy. It includes our purpose, our aim, and how we do business. It is the bedrock of our bank, a responsible bank. The Santander Way Simple I Personal I Fair Simple, Personal and Fair is how we do business and behave as part of our corporate culture. It embodies how all Santander's professionals think and operate, and represents what our customers expect of us as a bank. It defnes how we go about our business and take decisions, and the way we interact with customers, shareholders and the community. The entire team at Santander strives each day to make sure that all they do is Simple, Personal and Fair – a s this is the way to earn customers’ lasting loyalty – while doing all they can to fulfl our purpose, to help people and businesses prosper. as what we do is “ Just as important how we do it ” Ana Botín Simple Personal Fair We ofer an accessible service for our customers, with simple, easy-to-understand products. We use plain language and improve our processes every day. We treat our customers in an individual and personal way, ofering them the products and services that best suit their needs. We want each and every one of our employees and customers to feel unique and valued. We treat our employees and customers fairly and equally, are transparent and keep our promises. We establish good relations with our stakeholders because we understand that what is good for them is also good for Santander. Our corporate culture includes eight corporate behaviours... Show respect Truly listen Talk straight Keep promises Support people Embrace change Actively collaborate Bring passion …and a strong risk culture where everyone is personally responsible for managing their risks in their day to day work ...Everyone´s business 24 2018 Annual Report The Santander Way: governance To ensure The Santander Way is understood and embedded, we need to develop, promote and monitor the consistency and implementation of our global culture across all the markets where Santander operates. We have a culture steering governing body which meets monthly, incorporating senior members from across the Group to promote, approve, support and evaluate the implementation and progress of global and local culture initiatives in line with the board approved corporate culture policy. For more information on employee ethical channels, please see 'Risk management' chapter. For more information on supplier ethical standards, please see 'Risk management' chapter. Code of conduct The General Code of Conduct defnes the standards and principles which establish the basis for all actions to be applied by the Group employees in their day-to- day activities and is the central pillar of the Group’s compliance programme. It also covers equal opportunities and non-discrimination, respect for people, work-life balance, occupational risk prevention, environmental protection and collective rights. Santander promotes the opportunities for its employees to raise concerns and operates ethical channels, managed by the compliance and conduct function, ensuring confdentiality, an that there is no retaliation against whistle- blowers. We also ensure that our suppliers abide by our ethical standards. Corporate culture policy We have a corporate culture policy that establishes the guidelines to be followed ensuring a consistent culture is formed and embedded throughout the Group. This policy has been developed in partnership with country culture teams and key stakeholders. It is structured on three levels: Common elements: these are the backbone of our culture. They have been formed through a bottom-up process and apply to the entire Group. Mandatory global initiatives: these must be implemented across the Group, but are adapted and managed at local level. Local initiatives: these are developed by local units whilst respecting the corporate culture policy and other corporate frameworks. Further information can be found on 'Risk culture' section of this chapter. Risk culture ‘risk pro’ We have a strong risk culture known as risk pro, which defnes the way in which we understand and manage risks on a day- to-day basis. It is based on the fact that all professionals are responsible for the risks they manage. 25 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Examples of cultural iniciatives to show how we are doing Simple, Personal and Fair 1. People 2. Customers 3. Shareholders 4. Communities The Santander Way of working Diversity & inclusion Simplifed processes Transparent communications Customer experience Robust internal governance Operational excellence Risk culture Future talent support via Santander Universities programme Corporate volunteering Behaviours & leadership Cyber and data protection Employee value proposition Six key focus areas in 2018 Objectives Listening strategy Promoting an environment of openness and speaking up, improving survey execution and analytics to better understand feedback and act on it. Leadership Common leadership commitments for all people managers. Diversity & Inclusion Group Diversity & Inclusion principles providing global guidance and minimum standards. Behaviours Embedding corporate behaviours in the employee lifecycle and in our everyday activities. Global collaboration Increasing global collaboration, sharing best practices and simplifying processes. Communities To continue to help communities to prosper by fostering and supporting inclusive and social programmes. 26 2018 Annual Report Across the Group, we are embedding Simple, Personal and Fair1 By building a loyal and committed workforce, we deliver sustainable growth and fulfl our purpose Employees who are more motivated and committed... People 203 thousands employees 83% of employees believe that their colleagues behave more simple, personal and fair 82% of employees are engaged ... make our customers more satisfed and loyal... 19.9 million loyal customers (+15%) 88% customers satisfaction Customers 144 million ... which drives proftability and sustainable growth... Shareholders 4.1 million +4.5% increase of dividend per share EUR 3,724 million Total shareholder remuneration ... and results in more investment in communities. 7,647 social entities we have partnered with 1,235 agreements with academic institutions in 33 countries Communities 2.5 million people helped 1. 2018 fgures. 27 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management A talented and motivated team To win in the new business environment, and to earn and keep customers’ loyalty, we need a workforce that is both talented and motivated. And if we are to meet the needs of today’s society, our team needs to reflect society. Talent Management Successful businesses need skilled and motivated teams: a responsible business attracts the best talent and earns its loyalty. Talent management and retention is therefore one of our key human resources strategies. Each year, we implement various initiatives and programmes aimed at helping our employees grow personally and professionally, thereby enhancing their ability to serve our customers in a Simple, Personal and Fair way. Main group data Total employees (thousand) % employees with a permanent contract % employees working full time Employees joining/leaving (turnover) % of workforce promoted Average length of service (years) % coverage of collective agreements 2018 203 96.0 94.6 15.4 8.6 10.3 70.6 Programmes to identify the best talent For additional information, see ‘Key metrics’ section of this chapter. • Young Leaders. Launched in 2018, this professional development programme, has involved 280 young employees from 22 countries. Participants were chosen by their peers, and are engaged directly with our top executives, giving them the chance to develop the Group’s strategy by bringing in new ideas and perspective. • Talent valuation committees. A structured process to identify our future pontential talent. • Succession planning for leaders. Succession planning for the key positions in the Group to ensure the sustainability and management control. • Action Learning Programme Santander (ALPS). A learning programme aimed at managerial talents. ALPS develops leadership and business problem resolution skills within a collaborative environments. Management takes part as sponsors. • Digital Cellar. New methods of recruitment to understand and attract digital talent, ofering spaces to execute projects (challenges that Santander faces and wants to solve). Development and mobility programmes • Global Job Posting. Ofers all employees the chance to apply for vacant positions in other countries, companies or divisions. Since its launch in 2014, over 4,000 positions have been published globally. • Mundo Santander. Our employees can work for several months on a project in another country, promoting the exchange of best practices and broadening their global vision. Since its launch, 1,907 people in 28 diferent countries have taken part. 28 2018 Annual Report Santander, a great company to work for and ranked in the top 3 of the best fnancial institutions, thanks to the performance of our operations in Argentina, Brazil, Chile and Mexico. This 2018 Great Place to Work certifcation marks a further step forward towards our objective of becoming one of the best companies to work for. It refects the huge eforts we have been making across all countries to become a more attractive organisation that is capable of attracting and retaining the fnest talent, in turn allowing us to help people and businesses prosper while making us a more responsible bank. The talent, commitment and motivation of our 202,000 employees is the basis of our success. In 2018 Santander received Top Employers Europe 2018 certifcation which acknowledges the working conditions companies create for their employees. The Group received certifcation for Santander Spain, Poland (Bank Zachodni WBK), the UK and its Santander Consumer Finance units in Austria, Belgium, Germany, Italy, the Netherlands and Poland. Likewise, in 2018 Great Place to Work recognised Santander as one of the best fnancial institutions to work in Latin America. Santander ranked 20th in the Best Multinationals Ranking Leadership commitments We know that Leadership is fundamental to the pace of our culture change. Having great leaders helps us to change faster and make the change with more stable and lasting foundations. In 2018, more than 300 colleagues in 28 countries or units across Santander Group have contributed to identifed and defne our new leaderships commitments. In the last few years, Santander has undergone various restucturings that afected jobs and employment. Wherever this has happened, we have followed a series of steps, namely: • Participation is facilitated and negotiations take place with the employees’ legal representatives. We engage closely with employees’ legal representations. • The legal regulatory minimums for redundancy payments are exceeded. We help individuals relocate and fnd new work. • Social plans that have been presented include aid for relocation and actions to give themaximum support for the employability of those afected. 29 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Knowledge and development Continuous learning is key to help our employees adapt to a fast-paced, continuously changing work environment. In 2018 a global policy on induction, knowledge and development was developed and approved. This provides criteria for the design, review, implementation and supervision of training to: • Support the business transformation. • And supports the company’s cultural transformation under the governance standards set for the Group. Main group data Millions invested in training Investment per employee (euros) % employees trained • Encourage global talent management, Hours of training per employee facilitating innovation, knowledge transfer and sharing and identifying key employees in the various knowledge areas. % of e-learning hours Employee satisfaction (over 10) 2018 98.7 486.8 100.0 33.8 48.1 8.0 The ‘Never Stop Learning’ strategy 1 Global Knowledge campus: a training space to share knowledge and best practices. 2 Leading by Example programme: a training programme that helps leaders identify the role that they should play to implement the SPF culture. 3 Santander Business Insights: a series of conferences that combine internal and external visions to sensitise employees to the importance of certain behaviours in their daily work. Leaders Academy Experience This is a new training plan to make it easier for leaders to transform the Group, to equip them with the tools and training they need to accelerate change, and to set an example for their teams and the organisation. This consists of a four stage learning journey, one sesion held per quarter, focusing on people and an inclusive worforce, new ways of working and business models in the digital age, the “new normal” and how to be great leaders. In 2018 three conferences, 12 virtual sessions and four workshops were held. 30 For additional information, see ‘Key metrics’ section of this chapter. 2018 Annual Report Evaluation and remuneration We have a comprehensive remuneration system, based on principles approved in 2018 (see Corporate governance chapter of this annual report). It combines a fxed salary (which refects the individual’s role and level of responsibility) with short- and long-term variable remuneration. This rewards employees for their performance on the basis of merit. It refects what has been achieved (group targets and individual or team targets) and how these results are obtained (refecting behaviour and conduct such as leadership, commitment, development and risk management). In addition, the Group also ofers pension plans and other benefts such as banking products and services, life insurance and medical insurance. Fixed remuneration is determined by reference to the local markets. Remuneration levels are set according to local practices and strictly follow the collective agreements applicable in each geography and community. Variable remuneration is a form of reward for achieving the Group’s quantitative and qualitative strategic targets. Furthermore, to meet European regulations on remuneration, we have identifed 1,384 people who take decisions that may involve some risk for the Group and applies to them a deferral policy for their variable renuneration with includes deferral of between three and fve years, payment in shares (50% of variable remuneration) and potential reduction (malus) or recovery (clawback). Main initiatives developed in 2018: • Review, together with the compliance function, of the local systems of variable remuneration of sales force (linked to the quality of service and behavior with customers). • Reinforcement of the elements of risks linked to variable remuneration. For additional information regarding remuneration data see ‘Key metrics’ section of this chapter. • Adoption of the necessary methodology for a consistent analysis of the gender wage gap, including gender wage equity for the performance of the same function. For aditional information regarding board remuneration see section 6 of the Corporate governance chapter. MyContribution Our employee evaluation model is designed to reinforce the key role that the corporate culture has in driving the Group’s transformation. The model and has an impact on employees´ variable remuneration. In 2018, this model was applied to all the Group’s executives, and it has been extended to other employees in diferent geographies and in the corporate centre. In addition, for a group of managers (8,000 people from all geographies in which Santander operates), the corporate bonus schemes takes into account the achievement of strategic targets related to customer satisfaction and loyalty, risk management, the capital base and the risk-adjusted return. Remuneration therefore refects what an individual has achieved as well as how he or she has behaved. How we do it 40% • Leadership • Commitment • Development • Risk management What we do 60% • Group targets • Team targets • Individual targets 31 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Diversity & Inclusion If we are to understand modern society, we need a diverse and inclusive workforce that refects society. Managing this talent diversity in an inclusive way, refecting our values, will enable us to attract, develop and retain the best professionals and to achieve better results in a sustainable manner. We have defned our general principles on Diversity & Inclusion (D&I), with the aim of serving as an ‘umbrella’ for all local initiatives as well as setting minimum standards for countries in their action plans, which will further improve diversity and inclusion in Santander. These general principles have been incorporated into our corporate culture policy as a key enabler to consolidate the cultural transformation. % of women employed % of women in management positions Average age of the workforce % Employees with a disabilityA A. US and Mexico not included. 2018 54.5 20.5 38.8 1.7 and give direction to Group diversity and inclusion strategy. • A Global Network of D&I experts with representatives from the countries (operational team to share practices and be the transmission chain at a local level). To ensure appropriate management and promote diversity and inclusion at Group level we have created two working groups: • A Global D&I Executive Working Group with business infuencers and decision makers from diferent geographies and functions to develop Additionally, in order to foster an inclusive leadership and to help to raise awareness, we have launched a global D&I online training based on learning experiences where participants will get to explore how to shift mindset and develop new skills. In 2018 the following diversity and inclusion plans were approved to be implemented across the Group Disability • Mapping and monitoring in all geographies. Include topic at the agenda of local boards. • New programs to promote the hiring of people with diferent disabilities. Enablement • Making sure employees are aware of D&I Training & Awareness programmes. Gender • Talent selection: improve or at least mantain male/female ratio in divisions in selections for leadership positions. • Talent identifcation: increase the percentage of women in the pipeline for succession planning in order to meet 2025 commitments. • Eliminate gender pay inequality for those holding positions at the same level and department. • Scorecard refecting diverse representation for leaders. • Support women growth by cross function mentoring and development programs. • Actions to support maternity and parents. Culture+ identity • Cultural Diversity Mapping. • Continue to reinforce Flexiworking by facilitating fexibility measures that promotes a better work-life balance. • Afnity Groups. Minorities represented in diferent employees’ networks. 32 85% of employees believe Santander treats employees fairly regardless of their age, family, marital status, gender identity, expression, disability, race, colour, religion or sexual orientation. +4 vs 2017.A A. 2018 Global engagement survey Further information regarding diversity in the Group available in ‘Key metrics’ section of this chapter. 2018 Annual Report Our commitments Gender diversity 30%1 2025 Cultural diversity (Diferent educational background, experience in diferent sector, international experience, race) 2025 70% 1. In top executive positions. Gender equality Equal opportunities between men and women is a priority throughout the Group. We are promoting multiple initiatives in order to achieve efective equality between men and women at all levels. The equal pay gap compares women and men who have the same job, level and function. In Santander this is very small. The gender pay gap (GPG) takes into account aggregate data of remuneration of men and women. Here, we still have a lot to do in terms of increasing representation of women at senior management levels (where remuneration is higher and gender diversity is still low). Changing this is a priority for the Group. This is why we have established specifc diversity objectives for our top-level executives. Gender pay gap 31% Gender pay gap measures the diference in pay, regardless of the work´s nature, in an organisation, a business, an entire industry or the economy in general. GPG is calculated as the diference of the median of the compensation paid to male and female employees expressed as a percentage of the median of the male compensation. For this calculation, compensation includes base salary and variable remuneration, excluding benefts/in kind remuneration or local allowances. Reported fgures are from a study conducted in 2018 (on the basis of 90% of the workforce), based on full-year 2017 compensation data updated to include 2018 compensation projections. At the board level, 33% of members are women (December 2018). In February 2019, the board agreed to increase our current objective of women representation of 30% (which we have had since 2015) to equal presence (between 40% and 60%) in 2021. In order to address the gender pay gap, we have established a methodology based on best practices, establishing common guidelines for both the Group and local units on how to address the pay gap. Likewise, local action plans have been promoted with periodic monitoring and control plans. The bank also needs to have more diverse talent in STEM skills (Science, Technology, Engineering and Mathematics) - and to do so without harming gender diversity. Equal pay gap 3% Calculation of equal pay gap compares employees of the same job, level and function. This allows to compare like for like jobs. Factors included in the Group’s local policies which may impact compensation gap between male and female such as tenure in position, years of service, previous experience or background have not been considered to mitigate the reported fgures. Banco Santander leads the Bloomberg Gender-Equality Index made up of 230 companies from diferent sectors 95.32 points out to 100 For the second consecutive year Santander has obtained the highest score out of the 230 companies that form part of the Bloomberg Gender-Equality Index, which evaluates the performance of companies in gender equality. 33 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management       Employee experience Keeping our workforce motivated is key to ensuring their commitment and success in helping people and businesses to prosper. At Santander we do it by implementing measures that encourage listening, work-life balance and a healthy and personally fulflling environment. 1 Speaking up / active listening If we are to build a responsible bank, everyone should feel able to speak up, not just to suggest how to improve doing things, but to alert management when things go wrong, or when there is suspected malpractice. Listening Speak up Take action Global engagement survey Tracking our employees’ satisfaction via the engagement survey is fundamental for our Group, as it enables us to continue to progress towards being the best bank to work for. 2018 results show that our team is proud of working for Santander and committed to continue making a bank that is more Simple, Personal and Fair. The results also show a signifcant improvement in the perception that the Group promotes a culture that fosters diversity and which focusses on results. Important areas of improvement include the need to continue improving our processes to make them simpler and more transparent, giving the resources required to ensure the job is done as efciently as possible. Ethics channels In 2018 we have implemented several initiatives to encourage people to speak up and we have created new ways to protect confdentiality and whistleblowers’ anonymity. We have worked on a project to develop a single ethical channel, through which employees will be able to report breaches both of the Code of Conduct and our Simple, Personal and Fair corporate culture. This channel will be managed by an independent third party, in order to ensure confdentiality and the anonymity of the complaint. For further information see section 7 of Risk management chapter. 34 88% of participation +4 vs 2017 82% of employees committed +5 vs 2017 84% of employees are satisfed with Santander as a place to work. +9 vs 2017 88% of employees believe Santander acts responsibly in the way it does business +1 vs 2017 2018 Annual Report 2 New ways of working We promote the transition towards a more fexible way of working that enhances the work-life balance of our employees. Our corporate fexiworking policy, applicable to the entire Group, includes a set of measures to which each person can beneft based on their personal needs and their professional situation. These measures refer to: • How we organise the working day (fexibility and time): schedules of entry / exit, alternative confgurations to the day, regulation of vacations, guides and recommendations for the rational use of mail and meetings. • Where we work from (fexibility in space): working remotely, teleworking. In addition, through an agreement signed with the representation of workers, Santander has committed to promoting a rational management of working time and its fexible application, as well as the use of technologies that allow a better organisation of the work of our professionals and that includes the right to digital disconnection. Likewise, we are also redesigning our ofces to obtain a new work space that better encourages collaboration. 82% of employees indicate that their direct manager helps them reach a reasonable balance between personal and professional life.A 84% employees indicate that their direct manager facilitates fexibility in the work team.A A. 2018 Global engagement survey results. 3 Culture of recognition The StarMeUp initiative is a global recognition network that allows employees to appraise employees who lead by example by championing SPF behaviours. In 2018, one and a half million StarMeUp stars have already been given by Santander’s professionals to other colleagues. This is proof of how the culture of recognition is being consolidated in the Group. This year, we have reached more than 132,000 active users of StarMeUp in the Group, 11% more than the goal set during the frst months of 2018, and we have already given 689,000 stars to our colleagues. StarMeUp 1.5 million stars given by employees 35 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management 4 Volunteering Volunteering builds a strong team spirit and a sense of purpose – while also helping the communities in which we operate. Thanks to our corporate volunteering policy, employees are entitled to spend a certain number of working hours each month or year volunteering. In 2018 our legal services, in line with the strategy and culture of the Group, have launched Santander Legal Pro Bono. This challenge requires our lawyers to provide voluntary and unpaid work, using all their knowledge and professional skills to support non-proft social, cultural or educational organisations that cannot aford legal services, and whose aim is helping persons in a situation of social vulnerability. Likewise, in headquarters, throughout December, we developed ‘ideas marathons’ (related to communication and marketing, technology and systems, human resources), at which our team helped various NGOs to improve their identity and brand image, their presence on social networks and branding, as well as their organisation and analysis of data. We also helped organisations develop their support for communities – for example, so that one charity which cares for young people can help train them for the labour market. Pro Bono activities are part of the Group’s corporate social responsibility and, in particular, in the objective of creating value for the community in the long-term. In countries such as Brazil, Spain, the United States, Poland, Portugal, or the United Kingdom, our employees have also devoted working hours to promoting fnancial education and teaching people to manage their fnances in an efective and organised way. Likewise, employees also participate in numerous initiatives to improve the quality of life of people. 36 Our Group Executive Chairman Ana Botín, participating in a chariry toy collection organised in collaboration with the Spanish Red Cross in Boadilla del Monte, Madrid. +40,000 employees participating in community activities +130,000 hours devoted Banco Santander, host of the European Pro-Bono Summit 2018 The Group City hosted the European Pro-Bono and Skills-Based Volunteering Summit, the leading international congress in this feld. The gathering was attended by over 130 people from around 20 countries across fve continents, addressed by more than 35 international speakers on how to leverage employee talent and generate a positive social impact. 2018 Annual Report 5 Health and occupational risk prevention Santander has an occupational risk prevention plan available to all the employees on the corporate intranet. We are aware that one of the important aspects of motivation, commitment and real equality for our employees is the balance between personal and work life. Santander continues to promote a healthy and work-life balance, through policies and services to address the personal and family needs of our employees. Our General Code of Conduct highlights the importance of promoting a working environment that is compatible with personal and family life. In addition, within the New Ways of Working initiative, Santander has designed the new work spaces and their equipment, both from the ergonomic perspective and from the safety aspect. BeHealthy In Santander, the health of our people is the health of our company. This is why we have a commitment to be one of the healthiest companies in the world, and ofer employees health and wellness benefts, and raise awareness on this topic, through our BeHealthy programme. In 2018 we partnered with The Leadership Academy of Barcelona to launch a digital space where employees around the world can access training on the four pillars of BeHealthy: Know your numbers, Move, Eat well, and BeBalanced. In this space employees can access the fagship training programme called Sustaining Executive Performance where they can fnd the keys to achieving improved performance, both personally and at work, by through encouraging healthy habits. Also, in 2018 we signed a global agreement with an innovative company called Gympass that ofers colleagues the chance to beneft from over 40,000 afliated health and wellness centers across the globe for one membership, ofering a wide range of activities from gyms, cross-ft, dancing, yoga, pilates, among others. 3.7% Absenteeism rateA 10,367 thousand hours missed due to non- working related illnesses & accidents 0.5% Work-related illness rateB For additional data disclosure, see ‘Key metrics’ section of this chapter. A. Hours missed due to occupational accident, non-work related illness or non-work related accident for every 100 hours worked. B. Hours missed due to occupational accident involving leave for every 100 hours worked. 37 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Responsible business practices Being responsible means offering our customers products and services that are Simple, Personal and Fair. We need to do the basics brilliantly and, when things go wrong, we need to solve problems fast and learn from our mistakes. Products and services commercialisation and consumer protection Our Product Governance and Consumer Protection function, within our Compliance and Conduct area, designs the crucial elements for the appropriate management and control of marketing and consumer protection. In this context the Group has a commercialisation committee, whose objective is to prevent the inappropriate distribution of products and services and to ensure the protection of customers by validating products and services. It also has a monitoring and consumer protection committee, which monitors the products and services we already have in the market and ensures that customers‘ needs are met and their rights are protected throughout the entire product life cycle. Additionally, our corporate consumer protection policy sets out the specifc criteria to identify, organise and execute the principles of consumer protection for our customers, and also sets out the specifc criteria for the control and monitoring of compliance. Financial education Financial education is a key element in the relationship with our customers and is part of our principles of consumer protection. We are committed to promoting fnancial knowledge, educating on how to use banking services efectively and generating more confdence and security in their use. In order to structure this activity and ensure homogeneous principles of conduct across all fnancial education initiatives, we continue working on the design and development of some best practice guidelines applicable to all these initiatives, in line with the criteria of supervisors and regulators. For more detail on product governance and consumer protection see ‘Risk management’ chapter. For more information on fnancial education see ‘Community investment’ section of this chapter. Corporate consumer protection policy: principles of fnancial consumer protection Treat Customer fairly Complaints handling Consideration of special customers’ circumstances and prevention of over- indebtedness Data protection Customer-centric design of products and services Responsible pricing Financial education Transparent communication Responsible innovation Safeguarding of assets 38 2018 Annual Report Vulnerable customers The Group has worked on standards and good practices when dealing with vulnerable customers and preventing over-indebtedness. This enables us to transmit to all business units, standards of action to promote the defnition, identifcation, treatment and management of clients in special circumstances and apply solutions that suit their specifc needs, to proceed in their best interests and always ofer viable solutions. These standards and good practices will be included in a corporate guide that will establish, among other, a common defnition of vulnerable customer and prevention measures of over-indebtedness. We adapt quickly to market changes After the fnancial reform carried out in Mexico, a specifc complaints channel was created so that customers could raise their complaints about certain activity cases of the recovery agencies. In response we evaluated the treatment of customers throughout the Group in order to identify possible improvements in this process and share good practices among all business units. 39 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Operational excellence and customer satisfaction We are consistently tracking our customers’ views and their experiences with Santander. This data reveals where we can improve our services further, and helps us gauge customers’ loyalty to Santander. More than a million surveys are conducted annually. To ensure that the entire Group remains focused on the customer, customer satisfaction has been included as a metric in the variable remuneration systems of most of the Group’s employees. Customer satisfaction % satisfaction among active retail customers 95.7% 94.9% 2018 Target 89.0% 87.0% Branch Telephone Internet Mobile Customer satisfaction by countries to rank among the top 3 for customer satisfaction in main marketsA TOP competitors A. Except in US. 2018 Achievement This year, the Group is in the top 3 for customer satisfaction in seven countries 7 countries in the top 3 RANKING 5 1 2 3 3 3 3 1 9 % satisfed customersB 83.3% 79.6% 85.8% 87.1% 97.8% 97.5% 91.3% 97.0% 83.3% 88.75% ARGENTINA BRAZIL CHILE SPAIN MEXICO POLAND PORTUGAL UK US GROUP B. Internal benchmark of active individual customers’ experience and satisfaction. Data at 2018 year-end. Audited. New, redesigned branches are transforming customers’ experience With initiatives such as WorkCafé in Chile, Smart Red in Spain and the digital branch in Argentina, our new branches are transforming customer experience in nearly 1,000 locations. 40 are 20% more productive generate 96% customer satisfaction Increase brand visibility and engagement with communities 2018 Annual Report Complaints management We don’t simply aim to address complaints, but to learn from them – tackling the issues that gave rise to complaints in the frst place. The Group procedure for complaint management and analysis aims at adequately handle any complaints submitted, ensuring compliance with the local and sectoral regulations applicable, and to provide customers with the best possible service. Root-cause analysis has been reinforced with the application of Group methodologies and standards. In addition, reporting and governance in all units has been completed in order to identify recurrent or systemic incidents or problems that could generate detriment in customers, to correct their original causes. Listen We consider it essential to listen carefully to our customers´ questions, complaints and claims. Analyse Review and understand the customers’ needs. Act According to the nature of the complaints, provide innovative solutions. We listen to our customers, as their loyalty to Santander generates sustainable returns. Improve Apply the improvement globally. Type of complaints % 12 5 22 Banking procedure Loans Investments Average resolution time % 5 Resolution % Payment methods 30 65 27 3 31 Insurance Other <10 10-30 days >30 days 31 In favour of the customer 69 In favour of the Bank US Mexico In the US, the Santander complaints management team has evolved signifcantly and improved complaint management. This in turn has led to improved customer satisfaction through the development of a new methodology to identify vulnerable customers. This new development allows us to support those vulnerable customers accordingly and to provide them with a solution in keeping with their circumstances. In Mexico, we have launched a new app that allows customers to submit claims for charges not recognised for purchases made with a card. This process will reduce the time in which a clarifcation is recorded by up to 60%, and makes it possible to track any report, even if it has been initiated by other channels. The customer’s balance is not afected while the claim is being resolved. 41 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Risk culture Managing risk prudently is a cornerstone of a responsible bank. This requires clear policies, processes and lines of accountability – all backed by a strong culture that refects the fact that in a bank like Santander, everyone has a role to play in managing risk. The risk pro culture is reinforced in all the Group’s units by the following initiatives: •Employee life cycle. From the selection and hiring phases and throughout their professional career, employees are made aware of their personal responsibility for risk management. •Risk management is included in all employees’ training. The Risk Pro Banking School and Academy help defne the best strategic training goals for our professionals in accordance with Group priorities, in addition to disseminating the risk culture and developing the best talent. •Risk culture awareness, its understanding and embedding has been driven globally and locally through the various initiatives. •Communication. The conduct, best practices and initiatives that exemplify the risk culture are disseminated through various communication channels, leadership direction and individual actions. •Risk culture assessment. The Group performs a systematic and ongoing assessment of the risk culture to detect any potential areas for improvement and implement action plans. This has involved the simplifcation of global indicators used to assess the level of penetration and dissemination of the risk culture within the Group. •Governance. The risk culture and risk management are underpinned by sound internal global culture and risk management governance. •Advanced Risk Management (ARM). ARM is a refection of the importance of having a robust risk culture. For the Group, it is a priority aspect for its long-term goal for remaining a solid and sustainable bank. Our risk management and compliance model is key ensuring we operate and behave in a way that refects our values and corporate culture, and delivers our responsible banking strategy. It is based on three lines of defence: 1. business and support units, 2. risk management and compliance, 3. internal audit. The board of directors is responsible for the risk control and management, and, in particular, for setting the risk appetite for the Group. Of particular interest in the area of responsible banking are risks related to compliance, conduct, digitalisation and climate change, as well as the analysis of social, environmental and reputational risks. Risk culture as part of our corporate culture - Risk Pro1 Risk management is underpinned1 by a shared culture that ensures that all employees understand and manage the risks that are part of their daily work. Santander’s strong risk culture is one of the main reasons the Group has been able to deal with changes in the economic cycle, new customer requirements and the rise of competitiveness, and the reason why Santander has earned the trust of its employees, customers, shareholders and society as a whole. Against a backdrop of constant change, with new types of risk emerging and increasing regulatory requirements, the Group maintains an excellent level of risk management that enables it to achieve sustainable growth. This involves prudence in risk management and building a sound internal risk management culture across the whole organisation, which is understood and implemented by all employees. 1. I AM RISK in UK and US. 42 ...Everyone´s business For more information, see the Risk management chapter. 2018 Annual Report 93% of employees claim that they are able to identify and feel responsible for the risks they face in their daily work.A A. Global engagement survey 2018 Embedding risk management into the employee lifecycle Talent selection & profling • Risk within Recruitment practices • Risk included in Onboarding Inspirational Leadership • Top management engaged in risk • Alignment with The Santander Way ...Everyone´s business Reward & Recognition • 10% risk objectives included in employees performance assesments • Risk recognition Cyberrisks Cybersecurity is critical in the digital age. Cyberattacks and fraud risks pose systemic risks to fnancial services. Customers expect their data to be held securely and handled ethically. Growth and Development • Group-wide risk pro e-learning completed by 132k employees and new employees in 2017 • Increase in risk management training through Risk pro banking schools, Academies and The Santander Way training Daily work • Unique Risk Portal as a single information point • Simplifed risk policies • Ongoing awareness + understanding To address this, in 2018 we have continued to strengthen our digital defences through the new cybersecurity framework. As our employees are our frst line of defence, we have launched a new cybersecurity and IT conduct policy that provides fve simple rules to help protect employees and Santander from cybercriminals. Think before you click or reply If you suspect it, report it Be discreet online and in public Keep your passwords safe Protect your information and equipment 43 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Shareholder value Our aim is to build lasting loyalty among our more than four millions shareholders by aiming to deliver sustainable growth, predictable profits and transparency. Creating value, building loyalty Our approach is to earn the lasting loyalty and confdence of our more than 4,1 million shareholders in 170 countries. As a responsible banking, transparency and engaging with investors and shareholders is a priority. can hold virtual one-on-one meetings with the Shareholder and Investor Relations team. Shareholder remuneration In 2018 the Santander remained one of the most proftable banks in the world. We are addressing key shareholder issues as follows: • Principle of one share, and one vote and one dividend. • No defensive mechanisms in the Bylaws. • Encouragement of active and informed participation at meetings. In 2018 Santander broke its record for participation at the general shareholders’ meeting (quorum of 64.55%). • Use of new technologies to improve processes. Blockchain was used for investor voting at the 2018 annual general shareholders’ meeting. This enhanced global proxy vote transparency and increased operational efciency, security and analytics, which is benefcial for investors, issuers, agent banks and custodian banks. Meanwhile, we remain in constant communication with shareholders, sharing relevant information in a timely way whith them (as set out in our policy on communication and contact with chareholders, institutional investors and Proxy Advisors). In 2018, we launched a ‘Virtual Customer’ channel so shareholders • In a trading environment of high volatility, we have met all the fnancial targets we set, increasing shareholder remuneration to 23 cents per share in 20181. • This represents an increase of 4.5% per year of the total dividend per share, with a 9% increase in cash per share1. • In a difcult environment, the main indices and the Santander share ended lower. The Santander share was down 27.5%, while Stoxx Banks fell 28.0%. Santander’s total shareholder return was 24.3% lower. • On 31 December, Santander was the number one bank in the Eurozone and in the sixteenth- largest bank in the world by market cap - at EUR 64,508 million. • At year end, Santander had 16,236,573,942 shares outstanding and posted daily average trading of 74.7 million shares in 2018, the most liquid in Europe. 4.131 million shareholders EUR 3,724 million total remuneration1 EUR 0.23 euro/share Dividend per share: 4.5% increase vs 2017 Earnings per share: 11% increase vs 2017 Remuneration in cash1 Euros per share 2018 2017 2016 0.203 0.186 0.167 1. Total divided charged to 2018 results is subject to 2019 AGM approval Capital distribution by shareholder type Capital distribution by geographic location 1.1% 39.8% 59.1% BoardA Retail shareholders Institutional investors 1.1% 77.3% 21.6% Americas Europe Rest of the world A. Shares owned or represented by directors. For further details on shares owned and represented by directors, see ‘Tenure, committee membership and equity ownership’ in section 4.2 and subsection A.3 in section 9.2 ‘Statistical information on corporate governance required by CNMV’ in the Corporate governance chapter. For more information on shareholder transparency & remuneration, please see section 3 of the Corporate governance chapter. 44 2018 Annual Report Awards and recognitions Environmental commitment Social commitment The performance of our Shareholder and Investor Relations team was recognised by prestigious industry publications such as IR Magazine and Institutional Investor and it gained prominent positions in the Extel survey. In 2018 we have worked to reduce the carbon footprint - left as a result of the trips to and from the annual general meeting - by 52% compared to 2017. Likewise, this footprint has been ofset continuing the programme established in 2016. In collaboration with the Universia Foundation, in 2018 Santander awarded 58 Capacitas grants to shareholders and their families to support disabled people integrate into socety and fnd work. Engagement with shareholders, investors and analysts The shareholder and investor relations team had the following priorities in 2018: Maintain continuous, fuid communication as well as the dissemination of relevant information to our stakeholders, fostering a fowing dialogue. Optimise and enhance the Group’s reputation in the markets. Enhance personalised service to shareholders and seek their opinions. Facilitate the participation of shareholders at the general shareholders´ meeting. Ofer exclusive products and benefts through yosoyaccionista.santander.com website. 391,926 shareholder and investor consultations through studies and qualitative surveys 1,134 contacts with institutional investors 252 meetings with shareholders 166,149 queries managed by email, phone, WhatsApp and online meetings +1,000 communications sent using mainly digital channels 53 meetings with ESG investors and analysts Evaluation of Santander by ESG indexes and analysts Santander sustainability performance is periodically evaluated by well regarded indices and ESG analysts. These evaluations and their results are used internally to measure our performance and fnd improvement opportunities. In 2018, our results stand out in the Dow Jones Sustainability Index, where Santander ranked third bank in the world and the frst in Europe. Santander remains a constituent of the FTSE4Good Index Series. Others ESG analyst valuations1 Rating/Scoring 2018 Vs. last year 2017 = ISS-oekom MSCI Sustainalytics Vigeo Eiris C A 70 57 C BBB 68 46 Vs. Sector average > > > > Santander is also evaluated by ESG analysts such as Sustainalytics, Vigeo Eiris, ISS-oekom or MSCI. 1. Source, latest rating /scoring available at the end of reference period: Sustainalytic ESG Score relative to our peers at Nov 2018 and Dec 2017; ISS-oekom rating at Dec 2018 and Jan 2018. Vigeo Eiris ESG overall score at Dec 2018 and Dec 2016; MSCI ESG Ratings assessment (on a scale of AAA-CCC) Oct 2018 and Oct 2017. 45 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Responsible procurement Our suppliers throughout the world also have an impact on communities and the environment. So we expect our suppliers operate in an ethical way, upholding the ethical, social and sustainable standards as we do. We have a model and policy for managing our suppliers, setting out a common methodology for all countries to follow when selecting, approving and evaluating suppliers. In addition to traditional criteria such as price and quality of service, sustainability issues are included in this methodology. Where necessary, both the supplier and Santander are advised to change processes and practices. In 2018, we have strengthened the principles of responsible behaviour for suppliers, which have been included in our supplier certifcation policy. These principles establish the minimum principles that we expect from our suppliers in the areas of ethics and conduct, social matters (human rights, health and safety and diversity and inclusion) and the environment. These principles are aligned with the ten principles of the Global Compact. Likewise, we have a whistleblowing channel for suppliers, through which any supplier that provides services to Banco Santander, S.A. or its subsidiaries are able to report inappropriate conduct by Group employees which breaches the framework of the contractual relationship between the supplier and Santander. This whistleblowing channel was implemented in Argentina, Brazil, Chile, Mexico, Portugal, Spain and United Kingdom. In 2018, channels were also established in two more countries where Santander Consumer Finance operates: Germany and Italy. 1. Supplier certifcation policy In 2018, we reviewed our supplier certifcation policy, and strengthened our social and environmental criteria. According to this policy, a supplier is viewed positively if: Certifcation: • They have obtained ofcial certifcations related to quality, environment management, labour relations, prevention of occupational risks, corporate social responsibility or similar. Sustainability standards: • They have signed up to the Global Compact or have their own ethical, social and environmental principles with a periodic reporting. • They have frameworks, policies, procedures, indicator records and/ or related initiatives on environmental and social issues. Code of conduct: • They have a code of conduct and its corresponding governance (deployment, monitoring and control). 2. Risk control • We have updated the risks criteria assessment, according to the Group policies in this area, related to cyber, data privacy, business continuity, facilities and security. • In Spain, we have implemented a vendor risk assessment center in order to ensure a uniform application of our supplier certifcation, that will be implemented in other countries progressively during 2019 and 2020. Country best practices Santander Totta, certifed as a family responsible company by the Màsfamilia Foundation, recommends that its suppliers adopt measures to improve the work-life balance of its employees. 46 Santander US, committed to diversity, works with business organisations that support minorities, women and disadvantaged and local companies in their supply chain. Santander Brazil, in 2018, invited 250 suppliers to participate in the Carbon Disclosure Project Supply Chain. 2018 Annual Report Principles of Responsible Behaviour for Suppliers Ethics and conduct All actions by suppliers within the Group must be subject to the principles of transparency and honesty in any relationship they have with any public body and private individuals, and not be involved in any actions associated with bribery, infuence peddling or any form of corruption in both the public and private sectors. They shall refrain from actions such as ofering, giving or receiving commissions, gifts (with the exception of those that conform to social customs) or advantages of any kind that could be considered acts of corruption. In addition, suppliers shall take all necessary measures to avoid conficts of interest. The supplier shall avoid any relationship with Group management or any other person with decision-making or infuence in relation to a contract or transaction that they are negotiating in their capacity as suppliers for Santander. Santander also expects its suppliers to have internal ethical policies, standards or procedures that include at least compliance with local laws, anti-corruption measures and initiatives to ensure business integrity. Social Human rights: Santander expects its suppliers to work to support and respect the protection of human rights in accordance with the United Nations Universal Declaration of Human Rights, the Fundamental Conventions of the International Labour Organization and the United Nations Guiding Principles on Business and Human Rights. This means that suppliers must: • Prohibit forced labour and ill-treatment of their employees. This includes a ban on all trafcking in human beings. • Ensure the absence of child labour. • Allocate a living wage sufcient to meet the basic needs of their employees and ensure compliance with the regulations in force in the countries where they operate. • Ensure that working hours are not excessive and that the maximum working day complies with national legislation. • Respect their employees’ freedom of association. Health and safety: Suppliers must comply with health and safety requirements to provide their employees with a safe and appropriate working environment. Diversity and Inclusion: Suppliers must undertake to treat all their employees fairly and equally and not to discriminate on the basis of origin, race, sex, religion, opinion or any other personal or social condition or circumstance. Environment Banco Santander is frmly committed to environmental protection and the transition to a low carbon economy. Santander therefore invites all suppliers to join it in this commitment by: • Having a sustainability or environmental policy that is aligned with the size and operations of the company and that addresses the prevention, mitigation and control of environmental impacts. • Implementing environmental management systems. • Setting targets for reducing emissions and consumption. • Promoting continuous improvement. 47 New business environmentResponsible bankingCorporate governanceEconomic and financial reviewRisk management Challenge 2: Inclusive and sustainable growth We play a major role in supporting inclusive and sustainable growth Inclusive... by meeting customers needs, helping entrepreneurs start companies and create jobs, strengthening local economies, tacking fnancial exclusion, and supporting people to receive the education and training they need. Meeting the needs of everyone in society Boosting enterprise Financial empowerment We develop innovative, simple, and personalised solutions to respond to customers’ demands and meet the needs of everyone in society. We develop products and services designed to cater for the needs of small and medium-sized enterprises (SMEs), to help them prosper, increasing employment and sharing wealth more broadly across society. We develop products and services for the most vulnerable and hard pressed in society, giving them both access to fnancial services and the skills to manage their fnances. Support to higher education Community investment Tax contribution We have created a world leading network of universities, through which we help people access education and learn new skills. We run various social programmes to help local communities access childcare, fnancial education, art and culture. Wherever we operate, we pay our fair share in taxes, contributing to the growth and progress of the communities in which we are present. 48 2018 Annual Report Sustainable... by fnancing renewables energies, supporting smart infrastructure in the developing world, as well as agrotech and green tech. We actively support the transition to a low carbon economy. Sustainable Finance We innovate to ofer new fnancial products and services that integrate ESG criteria along three main lines: sustainable infrastructures, socially responsible investment and climate fnance. Analysis of environmental and social risks We analyse and measure the social and environmental risks of our investments, as well as the opportunities that responsible products and services can bring. Environmental footprint We measure our environmental footprint and we are committed to reducing our environmental impact in the countries in which we operate. 49 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk management Meeting the needs of everyone in society We want to be the bank of choice for all customers, including those on low incomes and from vulnerable groups, offering them the services and products they need. 1|2|3 World and other engagement strategies We ofer a wide range of simple and innovative services and products that enable every customer to manage their fnances in the best possible way. 1|2|3 World is our value proposition for individual customers in Portugal, Spain and the UK. It allows them to earn interest on their account balance and money back on spending, as well as other benefts. In Mexico, we also developed Santander Plus, the local version of 1I2I3. Santander Life, in Chile, ofers an unprecedented value proposition for the middle and low income segments. In Argentina, the range of Super Account and Infnity accounts ofers diferent solutions to meet the difering needs of our customers including unlimited movements without charge, savings on card purchases and other bonuses. Santander Bank, in the US, ofers Simply Right Checking, a simple checking account with no hassles, and no surprises. Also we ofer the Santander Basic Checking Account with no gimmicks, no minimum balance requirements, and a low, fxed monthly fee. 50 Credit to households Loans to customers at December 31, 2018, net of impairment losses Residencial Consumer loans Other purposes Total millons euros 314,017 156,116 17,562 487,695 Products & services for low income and vulnerable groups Superdigital is a platform that allows customers to open a digital payments account with which they can operate in a matter of minutes, without needing to have a bank account. It provides simplifed fnancial solutions and enables fnancial access to all users, including the unbanked and those residing in areas with little or no bank coverage. Our Community Development Finance unit lends to projects that beneft low-to moderate-income individuals and communities, primarily through afordable housing projects, whereby tenants pay below market rent, and many units are earmarked to individuals with specifc needs. We help families with problems to cope with the payment of hoysing. Since 2011, we have helped more than 140,000 families with fnancial problems to continue paying their homes, with specifc measures which include: the suspension of evictions to 9,362 families, without any eviction since November 2012; donations in payment to 13,760 families; and more than 134,100 refnancing and restructuring of 112,300 families and 21,800 companies mortgages. In addition, to facilitate access to housing, Santander has contributed 1,000 homes to the Social Housing Fund, of which 963 are for rent. On the other hand, we have in social rent other 568 houses with more afordable rents conditions for families in vulnerable situation. Santander was the frst large fnancial institution to adhere to the code of good banking practices in March 2012. All front-line and customer-facing employees are provided with additional training to help recognise and understand issues which might impact customers, particularly those customers who are dealing with (or facing) vulnerable situations. 2018 Annual Report SMART RED branches Our branches are where we interact face-to-face with our customers. As part of our digital approach, we are renovating them to create a better customer experience with an innovative and functional design to make them more comfortable. We have stripped out architectural barriers to make them accessible to all and increased the technology available to provide a more agile and personalised service. Ofces 13,217 Digital Solutions One Pay FX. Is a new blockchain-based service for international payments. It allows our customers to make international payments of up to EUR 11,000 per day, in a quick and easy way. Mobile payments. We provide all available mobile payments for credit cards. GPI Swift. This is a certifcation program for global payment solutions which speeds up, and makes it possible to track, international transactions. Digitalisation (Super Net, Super Movil, Super Wallet) that improves online and mobile banking platforms to ofer customers innovative and high-quality services. ChatBot Customer Service. This is an automated customer service solution that uses artifcial intelligence to understand and solve customer needs in real time. Mobile banking users 32 million (Users of both internet and mobile banking count as one.) Blockchain Openbank We are playing an important role in the fnancial services blockchain community. One Pay FX was the frst blockchain- based international transfer service launched for private customers in various countries. We are also a founding partner of the Enterprise Ethereum Alliance, Alastria, we.trade and Utility Settlement Coin. In 2018 Openbank, the largest digital bank by balance sheet size, increased its deposits by 19%, its number of credits by 90% and its number of customers by 8%, which already exceed one million users. We have launched new functionalities to meet our customers’ expectations, such as a robo-advisor (an automated investment service) and a service to add accounts from other banks. 51 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk managementBoosting enterprise Entrepreneurs and small businesses generate jobs and wealth that underpin inclusive societies. By helping them, we can help all society to prosper. Santander SMEs Our strategy to help SMEs refects the diferent market conditions in the countries where we operate. We aim to help all sizes of businesses, both by lending and ofering non-fnancial support - such as training and access to our networks. Our objective is not just to be an SME’s bank, but its partner as it grows. We use our scale to help SMEs fnd new customers and enter new markets. EUR 117,420 million in loans to SMEs and self employed professionals New solutions in 2018 In Mexico, Santander and the country’s Secretariat of Economy signed an agreement to make it easier for entrepreneurs and SMEs to open digital accounts using a new system which will beneft 18,000 customers in 2019 alone. In Spain, Santander launched a fully digital onboarding service for companies, which streamlines the process. You can register from a computer, mobile phone or tablet in only fve steps and with the same safety and compliance standards as the paper-based process. . Global digital solutions to boost SMEs growth Santander Trade, support for Exporters. To help companies export, we ofer them free online information about markets, partners, regulations, currencies, and much more. In addition, companies can access the entire network of the Group, as well as an exclusive community of more than three million exporting and importing business customers of Santander throughout the world. Santander Trade also ofers webinars and online seminars taught by the best experts. And it has a wide network of non-banking professionals to help companies trade globally. Santander Cash Nexus, global connectivity. This agile treasury management platform allows companies to digitise the management of liquidity, collection and payment transactions, as well as direct debits; and to centralise information through electronic channels. It combines our global service with a wide range of local services, all through a single online portal. We.trade, simplifcation of operations. In collaboration with eight other European banks and IBM, we have developed the frst trading platform for commercial clients and their banks based on blockchain. This platform ofers companies a simple interface that takes advantage of the innovation of ‘smart contracts’ and opens the door to new business opportunities. Santander won ‘Most innovative use of blockchain in the fnancial sector 2018’ award in the Blockchain Expo Europe. 52 2018 Annual Report Agreements with multilateral entities to boost fnancing to SMEs In Spain in 2018 Santander signed four new agreements with the European Investment Bank (EIB) to provide fnancing to SMEs on advantageous terms, for a total amount of EUR 875 million. In Brazil the Group also signed, with the Development Bank of Latin America, a line of credit for CAF SMEs controlled by women, for a total value of EUR 42 million. In total, in the last 3 years, the Group has signed agreements with multilaterals such as EIB, EBRD, IFC, CEB and CAF to ofer fnancing lines to SMEs in Spain, Brazil, Poland and Portugal for a total value of EUR 3,870 million. Non fnancial solutions programs for SMEs United States Business First Mexico Santander Pyme United Kingdom Santander Breakthrough Spain Santander Advance Portugal Santander Advance Chile Santander Pyme Advance Brazil Programa Avancar Argentina Santander Rio Advance We also ofer additional non fnancial solutions to boost the internationalisation, training, employment and digitalisation of SMEs. This includes basic and advanced business management courses, as well as lectures and masterclasses to improve their fnancial management skills, teaching them how to use the diferent fnancial tools and services available to them to promote and grow their businesses in an inclusive and sustainable way. 53 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk management Financial empowerment We help people get access to finance, set up or grow microbusinesses, and give them the skills to manage their finances. Financial empowerment boosted by digital technology We want to give everyone access to fnancial services, regardless of where they live, age or fnancial situation. Digital technology helps us to ofer thousands of people not just a bank account, but also education in fnancial matters. Data helps us tailor our products and services to their individual needs. What’s more, by banking online, our customers have the peace of mind that they don’t need to carry cash - and can make payments more easily. Traditional banking Digital banking Branches and ATMs Internet + Mobile banking Guaranteeing access for all segments Sparsely populated communities Low-income communities Most vulnerable groups University students Example 1: Digital solutions Example 2: Working with others Example 3: Sparsely populated regions Superdigital is a Santander platform that allows users to make deposits, withdrawals and payments without the need to have a bank account. In Mexico, Santander ofers customers the possibility of carrying out basic transactions through more than 19,000 stores such as Oxxo, 7 Eleven and others. In Spain, Santander has 526 branches and 114 agents establishments in sparsely populated regions with under 10,000 inhabitants. Products and services that meet the needs of every community We ofer microfnance services to low income and underbanked entrepreneurs to help them set up small businesses, which are the driver of economic growth and social mobility. EUR 160 million in outstanding credit to micro-entrepreneurs at the end of 2018 +273,000 micro-entrepreneurs supported in 2018 Promoting fnancial education Our objective is not merely to help people open bank accounts, but to ensure that they have the skills to manage their fnances, and can make the right choices about the products and services that suit them. +360,000 People benefted from fnancial education programmes in 2018 54 2018 Annual Report Main microfnance programmes supported by Santander 1,7 billion unbanked people in the world, of which 200 million are in Latin America. Source: World Bank Tuiio Launched in 2017, TUIIO ofers products and services specially designed for low- income and underbanked population. Prospera Santander is recognised as the leading provider of microcredits among the private banks in Brazil. Microfnance in Santander Río Since 2015, Santander has ofered productive microcredits to customers of its fnancial inclusion branches. Financial inclusion program aimed at promoting a social impact in the communities. Focus on the support and development of productive activities. Micro-loans are granted to community groups composed of at least 8 micro-entrepreneurs. Average loan: 400 euros. Average term: 4 months. Productive and oriented microfnance model. Focus on those who do not have access to the formal fnancial system. Micro-loans are granted to neighbourhood groups composed of 3 or 4 micro-entrepreneurs. 65% microcredits are received by female heads of household. Average loan: 600 euros. Average term: 7 months. Cleonice, Brazil. Since when she was a little girl, Cleonice liked to see her mother sewing. She started helping her at an early age. Today Cleonice makes clothes, has three employees, a shop and a sewing room. Prospera supported her with the renovation of her workshop and the purchase of more machines so that she could serve her customers faster. 55 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk management Supporting higher education Banco Santander is the world’s largest corporate contributor to education1. We have built a unique network of 1,235 universities worldwide, through which we support students, research and entrepreneurs. EUR 121 million to universities 1,235 agreements with universities and other academic institutions in 33 countries Main lines of action of Santander Universities 1 Education We have created the largest scholarship programme in the world fnanced by a private company, as we believe that education and people progress go hand in hand. Since 2002 we have invested more than EUR 1,700 million. 73,741 university study grants 2018 metrics 2 Entrepreneurship Santander X, aims to become the world’s largest ecosystem for university entrepreneurship, connecting entrepreneurs with the three most valuable types of resources for them: talent, clients and fnancing. This helps them turn an idea into a company. To do this we promote collaboration between universities, the business sector and entrepreneurs themselves. 20,000 university entrepreneurs supported 3 Employability Universia is a digital platform of non-fnancial services for the university ecosystem. We ofer career guidance and employment services, as we aim to be the main source of advice in the Ibero-American world for young talent management. 600,000 jobs intermediated in 7 countriesA A. Estimate 40% of the total published vacancies in 2018. Universia Foundation Through scholarships, internships and employment, the foundation helps students with disabilities fnd work and integrate into society. Meanwhile, through the foundation, we have also supported numerous initiatives to 1. According to The Fortune 2018 Change the World list. 56 raise awareness of the challenges of disability, linked to culture and sports, with which we have reached more than 130,000 people. In 2018: 603 university students with disabilities received a scholarship 153 people with disabilities were included in employment 2018 Annual Report IV Universia International Rector’s Meeting In 2018 we held IV Universia International Rector’s Meeting in Salamanca, Spain. The meeting brought together 600 rectors from 26 countries representing 10 million university students around the world to discuss ‘University, Society an Future’. The conclusions are set out in the ‘Salamanca Charter’, a document that reiterates the universities’ commitment to continue leading progress by reinventing and transforming themselves. For more information visit https://en.universiasalamanca2018. com Santander scholarship programme New Santander Scholarship website where the university community can fnd scholarships and grants for studies, mobility and research that will help them in their academic and professional development. Since its launch in july 2018, we have received more than 2.5 million visits. We are committed to a vision of the future in which inclusion, equal opportunities and sustainability, will be the priorities that guide all our decisions. Ibero-american mobility grant José Rivera Contreras, Universidad Católica de Norte, Chile Thanks to an exchange programme with Spanish universities, run by Santander, he was able to focus on environmental law at The University of Zaragoza. “Living in another country helps you to form professional connections and friendships with people from all over the world. Creating a network of contacts with people from all kinds of cultural and social backgrounds is amazing for your professional future. I have moved up a rung on the ladder thanks to the opportunity I was given by Santander.” “In the next three years more than 200,000 students will receive a Santander scholarship, achieve a practice in an SME or participate in entrepreneurship programs led by your universities and supported by Santander” Ana Botín, chaiman of Banco Santander See video For more information visit www.becas-santander.com 57 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk management Community investment We encourage inclusive and sustainable growth through initiatives and programmes that support access to education, social entrepreneurship, employability and welfare in the communities where we operate. EUR 58 million in social investment 7,647 partnerships with NGOs and social welfare institutions 2.51 million people helped Commitment to childhood education Financial education We conduct various activities that support educational projects focused in Latin America. For many years we have supported education projects in diferent countries, to provide equal opportunities for all children and support the sustainable development. We support fnancial education programmes in partnership with local organisations to raise children’s awareness of the importance of saving. This helps prepare young people for embarking on an independent life and to assist families when making basic fnancial decisions. We also run fnancial training workshops and masterclasses for our SME and self-employed professional customers to help them strengthen basic management skills. Support for social welfare We run several programmes to tackle poverty, vulnerability and social marginalisation. We also support programmes to prevent disease; and promote health and welfare programmes designed to help disabled people and their families. +600,000 children helped through programmes to support childhood education +350,000 people helped through fnancial education programmes +1 million people helped through programmes designed to tackle social exclusion 1. The Bank has devised a corporate methodology tailored to Santander’s requirements and specifc model for contributing to society. This methodology identifes a series of principles, defnitions and criteria to allow the Bank to consistently keep track of those people who have benefted from the programmes, services and products with a social and/or environmental component promoted by the Bank. This methodology has been reviewed by an external auditor. 58 2018 Annual Report Protection and dissemination of culture And we support cultural initiatives mainly through: The Santander Foundation, which supports activities in the felds of art, education and young talent, literature, the environment and science. Santander Cultural, which ofers programmes in visual arts, culture, music, education and flms. +1 million people benefted from art and culture initiatives 59 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk management Tax contribution We support the progress of the communities where we operate, through a fiscal contribution consistent with our activity in each of them. As a part of our way of understanding responsible banking, Santander pays its fair share in taxes in every jurisdiction where we operate, according to the value created by the bank. Our tax strategy, which has been approved by the Board, sets out the principles by which the entire Group operates. It is published on our website. The tax risk management and control system in the Group diferent entities must comply with the principles established in this policy, refecting the Group’s internal control model, as well as on the evaluation and certifcation processes of the controls it incorporates. Santander has been a member since 2010 of the Code of Good Tax Practices in Spain and the Code of Practice on Taxation for Banks in the United Kingdom, actively participating in cooperative compliance programs that are being developed by diferent Tax administrations. Principles of the Group’s tax strategy Fulfll obligations tributaries making a reasonable interpretation of applicable rules that address its spirit and purpose. Respect the rules on transfer prices, pursuing the adequate taxation in each jurisdiction based on the functions developed, risks assumed and benefts generated. Do not provide any kind of advice or tax planning to customers in the marketing and sale of fnancial products and services. Communicate transparently the total tax contribution of the Group, distinguishing for each jurisdiction the taxes of third-party taxes. Do not create or acquire entities domiciled in ofshore jurisdictions without the specifc authorization of the board of directors, ensuring adequate control over the presence of the Group in these territories.A A. See detailed information on of-shore entities in note 3 c) of the notes to the consolidated fnancial statements. Pursue the establishment of a cooperative relationship with the Tax administration, based on the principles of transparency and mutual trust, which allows avoid conficts and consequently minimize litigation in Courts. Tax contribution Santander contributes economically and socially to the countries in which it operates by paying all taxes borne directly by the Group (own taxes1) and collecting or withholding taxes from third parties generated through business activity, cooperating as required with the local tax authorities (taxes from third parties2). remainder being taxes collected from third parties. Therefore, for every 100 euros of gross proft earned by the Group, 35 euros correspond to taxes paid and collected, as follows: • 20 euros for the payment of taxes collected from third parties. Total taxes raised and paid by the Group in 2018 amount to EUR 16,658 million, of which EUR 7,056 million correspond to own taxes with the • 15 euros for own taxes paid directly by the Group. 1. Including net income tax payments, VAT and other non-recoverable indirect taxes, social security payments made as employer and other payroll taxes, and other taxes and levies. 2. Including net payments for salary withholdings and employee social security contributions, recoverable VAT, tax deducted at source on capital, tax on non-residents and other taxes. 60 2018 Annual Report The taxes included in each year’s income statement are largely income tax accrued in the period (EUR million 4,886 in the 2018 fnancial year, see page 440 of de consolidated annuals accounts, which represents an efective rate of 34.4% or, if the extraordinary results are discounted, EUR million 5,230, which represents a 35.4% cash rate – see note 52.c of the aforementioned report), non-recoverable VAT, social security contributions as employer, and other levies paid, regardless of the date these amounts are paid. The Group’s own taxes shown in the accompanying table are included in the cash fow statement. These magnitudes usually difer from each other, given that the date of payment established by the regulations of each country on numerous occasions does not coincide with the date of generation of the income or of the operation taxed by the tax. Thus, the efective rate that results when comparing the data on income tax paid (EUR million 3,458 according to the attached table) with the Group’s pre-tax proft is 24.4%. The payment of taxes occurs in those jurisdictions where the Group’s proft is generated. Thus, 99% of the profts obtained, taxes accrued and taxes paid correspond to the countries in which the Group carries out its activity. Total own taxes paid amounts to 50% of the proft before taxes. These own taxes include not only non-recoverable indirect taxes and contributions to public social security systems, but also other taxes that are exclusively levied on banking activities (such as bank levy in the United Kingdom, Poland and Portugal), and taxes imposed on fnancial transactions (in Brazil and Argentina among others) that have been increasing in recent years. Tax disclosure by jurisdiction EUR million Jurisdiction Spain UK Portugal Poland Germany Rest of Europe Total Europe Brazil Mexico Chile Argentina Uruguay Rest of Latin America Total Latin America United States Other TOTAL Own taxes Corporate Other own taxes paid income tax Total own Third-party taxes taxes paid Total contribution 1,765 1,032 142 407 167 553 4,066 1,468 524 263 447 115 32 1,822 447 111 134 218 -35 2,697 2,395 488 304 2,859 36 13 3,588 1,478 253 541 385 518 6,761 3,863 1,012 567 3,307 151 45 464 537 25 228 119 355 1,301 495 117 179 48 198 1,728 2,338 470 202 61 329 80 12 998 322 202 118 35 20 1,695 29 6 1,154 2,849 6,095 8,945 104 3 133 9 800 9 933 19 3,458 3,599 7,057 9,601 16,658 EUR 7,056 million in own taxes EUR 9,602 million in third-party taxes EUR 16,658 million in total contribution 61 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk management Sustainable fnance We support sustainable growth by financing renewable energy, supporting smart infrastructure and fostering research and development in new technologies. Our approach is building more balanced and inclusive economies and societies. Climate Finance We are supporting the development of renewables and the more efcient use of energy while helping our clients make the transition to a low carbon economy. At the same time, the need to take measures to adapt and mitigate Financing of renewable energies ranking1, 2 climate change presents signifcant investment opportunities, which we are ready to seize by taking positive action against climate change. 8,000 7,000 6,000 5,000 3,000 2,000 1,000 0 EUR million XX Number of projects 56 45 63 37 41 40 28 24 26 27 Bank 1 Bank 2 Banco Santander Peer 1 Peer 2 Bank 3 Peer 3 Bank 4 Bank 5 Bank 6 1. As indicated by Dealogic and Bloomberg New Energy Finance league tables for project fnancing within the Lead Arranger category. 2. Peers are considered those banks that due to their size an market capitalization are comparable to Santander. The peers' list includes: Bank of America, Barclays, BBVA, BNP Paribas, Citi, Deutsche Bank, HSBC, Intesa San Paolo, ING, ITAÚ, JP Morgan Chase, Lloyds Bank, Societe Generale, Standard Chartered, UBS, UniCredit, Wells Fargo. Santander Corporate & Investment Banking (SCIB) named project fnance bank of the year in Europe by Project Finance International SCIB was named project fnance bank of the year in Europe by PFI thanks to its extensive activity and the range of fnancing and advisory services provided during 2018, as Santander expanded its project fnance expertise through a mix of infrastructure and energy deals in Europe. Santander Corporate & Investment Banking was particularly active in the UK, funded projects in Belgium, advised others in France and was a pioneer in fnancing wind farms in Spain, Portugal and Continental Europe. 62 2018 Annual Report Finance for renewable energy and energy efciency As a major fnancier of energy production infrastructure, we understand that the banking sector has to play a particularly prominent role in the transformation of the energy sector. In recent years we have consistently increased our fnancing of renewable energy projects. Financing of renewable energy Breakdown of MW fnanced by type of renewable energy (MW fnanced) 2018 2017 2016 3,390 4,074 6,689 Wind energy 88% 2016 81% 2017 77% 2018 Solar energy OtherA 8% 2016 4% 2016 19% 2017 22% 2018 – 2017 1% 2018 In 2018, Santander participated in the fnancing of renewable energy projects, with a generation capacity equivalent to the consumption of 5.7million households.C Breakdown of renewable MW fnanced by country in 2018 3,368 MW United Kingdom 1,225 MW United States 985 MW Brazil 487 MW Bélgica 364 MW Spain 210 MW Chile 50 MW Uruguay Green bonds & ESG loans Through our Santander Corporate & Investment Banking division we act as joint bookrunner in numerous emissions of green & sustainable bonds and EGS loans. In 2018, we have participated in green bond emissions for a total value of EUR 730 millionB, and in EUR 2,017 million in ESG syndicated loans A. Include hydroelectric for 2016 and biomass for 2018. B. Information includes green, social and sustainable Bond and has been obtained from Dealogic Green Bonds League table. C. Equivalence calculated using data on the average electricity usage in households for countries in which renewable energies projects have been funded, published by the World Energy Council (2014). 63 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk management Credit lines with multilateral entities In Spain, in 2018 Santander has signed a credit line of EUR 200 million for the construction of renewable energy plants with the Development Bank of the Council of Europe. This loan is part of the “Europe 2020” plan in Spain for renewable energy. In Brazil, Santander has also signed a line of credit in 2018, in collaboration with the Development Bank of Latin America CAF, to fnance the purchase of photovoltaic equipment for a total value of USD 84 million. In Poland, Santander has signed a EUR 50 million line of credit with the European Bank for Reconstruction and Development (EBRD) to fnance energy efciency investments in local companies. Likewise, the EBRD subscribed the equivalent of EUR 36 million of subordinated debt issued in Police currency by Santander Bank Polska, with Santander’s commitment to allocate the resources to fnance residential and commercial construction with energy efciency certifcations. In 2018 we signed agreements for a total value of EUR 345 million to ofer fnancing lines for energy efciency and renewable energy projects. An in the in the last 3 years, we signed agreements fr a total value of EUR 1,080 million1 in Spain, Brazil, Poland and Peru. Financing low-emission, electric and hybrid vehicles We concentrate eforts on shifting the automotive sector towards a low-carbon economy through services such as vehicle leasing and renting, to promote the use of hybrid or electric cars in the countries where it operates. • In Spain Santander fnances a feet of 24,665 vehicles. In 2018, we fnanced 7,463 transactions. Partnering for a greener mobility We ofer an emission ofset tool in Brazil to all customers who take out a loan to fnance the purchase of a car. Since 2015 we have sponsored a bike sharing scheme in London, and more recently in Boadilla del Monte, close to our headquarters in Madrid. Funding sustainable agriculture and livestock farming We fund agricultural initiatives that promote the sustainable agricultural practices. Bunge, Santander Brasil and The Nature Conservancy have joined forces to ofer soy farmers long-term loans to expand production without clearing native habitat in the Brazilian region of Cerrado. Santander spain launched app agro: this brings farmers breaking news about agriculture, especially news related to government subsidies and information about crop prices as well as agricultural products. So far it has been downloaded 30,000 with 11,000 active users in 2018. It was voted best agro app of the spanish fnancial sector. 1. Agreements signed with EIB, EBRD, IFC, CEB, and CAF among others. 64 2018 Annual Report Socially Responsible Investment Santander Asset Management is fully committed to socially responsible investment (SRI), and is undertaking the following initiatives: • Investment. When we analyse and invest our SRI products, we combine fnancial criteria with non- fnancial criteria (ESG) to select assets. Currently we manage nine SRI funds, seven in Spain (Inveractivo Confanza, Santander Responsabilidad Solidario, Santander Solidario Dividendo Europa, the three funds of the new Santander sustainable range, and the new Santander Equality Acciones fund), one in Brazil (Fundo Ethical), and a new one in Portugal (Santander Sustentável Fund). • Training. We collaborate with universities and educational centers, organising and participating in events and training days in SRI. • Dissemination and development. We participate in initiatives and organisations to help spread SRI, and which enable diferent organisations share best practice and understanding. • Social impact investment. We work with NGOs, and indirectly with our social responsible investment products, to support initiatives which help those who are at risk of social exclusion. In addition, both Santander Pensiones SA SGFP in Spain (since 2010) and Santander Asset Management Brazil (since 2008), are signatories to the United Nations principles for responsible investment (PRI). Santander employees’ pension fund in Spain is also a signatory to this initiative, and in 2018 participated in an initiative promoted by the United Nations to require governments to do more to tackle climate change. New Santander Sostenible range Santander Sostenible is the latest innovation of Santander Asset Management. The investment process aims to identify those issuers that are best prepared to face the challenges of the future, and does so by applying an analysis of four sustainability axes: financial, environmental, social and corporate governance. It is composed of three funds: • Santander Sostenible 1 • Santander Sostenible 2  • Santander Sostenible Acciones Santander Equality Acciones Launched in 2018, this is the frst investment fund in Spain that invests in companies that promote gender equality at all levels of their operations, while also presenting good opportunities for fnancial returns. Santander Totta launches Santander Sustentável Fund The Santander Sustentável Fund follows a conservative investment policy, with the portfolio composed mainly of bonds. In addition to the usual fnancial criteria, our managers analyse the performance of around 900 companies and 90 countries, through a study of more than 100 indicators of three sustainability areas: environmental, social and corporate governance. For information on socially responsible Investment visit: www.santanderassetmanagement.es. 65 Inclusive and sustainable growthResponsible bankingCorporate governanceEconomic and financial reviewRisk managementAnalysis of environmental and social risks Within the framework of our sustainability policies, we analyse the environmental and social risks of all our project finance deals. At Santander we attach great importance to the environmental and social risks wich might result from our customers’ activities in sensitive sectors. And we respects international best practices regarding social welfare and the environment, particularly the Equator Principles, as signatory since 2009. Equator Principles In 2018, 35 projects were analysed under the Equator Principle’s scope, all within the project fnance category. The majority are included under categories B and C, which are those classifed with medium and low risk. UNEP FI pilot project on implementing the TCFD recommendations for banks In 2017 Santander – together with 15 other leading banks – joined this initiative to develop models and metrics to enable scenario-based, forward-looking assessment and disclosure of climate-related risks and opportunities. In 2018 two documents were published: the frst, guidance focusing on transition risk (Extending Our Horizons: Accessing credit risk and opportunity in a changing climate); and, second, a report that helps banks assess risks and opportunities arising from physical risk (Navigating a New Climate). Sector policies The Group has approved specifc sectoral policies that contain the criteria for analysing environmental and social risks in customers’ activities in sensitive sectors, such as defence, energy, soft commodities and mining & metals or other policies carried out in this respect. Equator Principles Project Finance Category TOTAL Sector Infrastructures Oil & gas Energy Real estate Others Region America United States Mexico Chile Colombia Peru Europe United Kingdom Italy Spain Asia Oman Kuwait Azerbaijan Arab Emirates Type Designated countries1 Non-designated countries Independent review Yes No A 4 1 3 0 0 0 0 0 0 1 0 0 0 0 1 1 1 0 0 4 4 0 B 25 2 2 16 3 2 9 3 3 0 1 6 0 2 0 0 0 1 20 5 24 1 C 6 2 0 2 2 0 3 2 0 0 0 0 1 0 0 0 0 0 4 2 6 0 1. In accordance with the defnition of designated countries included in the Equator Principles, i.e., those countries considered to have a solid framework of environmental and social governance, legislation and institucional capacity to protect their inhabitants and the environment. 66 2018 Annual Report Control and monitoring of controversial projects - Punta Catalina Design, engineering & construction of a coal- fred power plant in the Dominican Republic. The debtor is the Ministry of Finance, the Dominican Corporation of State Electric Companies being the importer. And Santander participates in the syndicated fnancing of the equipment. The due diligence processes at the outset of the project met with the energy policy in force and other environmental and social requirements. Nevertheless, the project has been controversial due to corruption issues. Santander has elevated the case to executive level for detailed follow up. In addition, Santander maintains an ongoing dialogue with the NGOs involved, having responded to their letters. The internal procedure to respond to NGOs has been applied engaging diferent relevant areas within the Group, like compliance, risk, business & sustainability amongst others. A continuous dialogue is also maintained with the syndicate regarding the environmental, social & ethical issues arising from this project. Sectorial policies update Energy policy: includes the new criteria for coal power plants. Mining & Metals policy: includes the new criteria for coal mining. Defence policy: has been updated in accordance with the EC decision regarding the exclusion criteria based on activities related to prohibited material instead of clients. Soft Commodities policy: includes its alignment with the Soft Commodities Compact, the Banking Environmental Initiative which Santander adhered in 2009, since the obligation for clients to be certifed by 2020 has been removed. 67 Inclusive and sustainable growthResponsible bankingCorporate governance Economic and financial reviewRisk management Environmental footprint We are firmly committed to contribute to the protection of the environment by reducing our own environmental footprint. We believe that measuring, reporting and reducing our environmental impact is essential not just for reasons of compliance, but if we are to earn the loyalty of all our stakeholders. Since 2001, we have been measuring our environmental footprint by quantifying energy consumption, waste and atmospheric emissions. And since 2011 the Group has implemented strict criteria through diferent energy efciency and sustainability plans to ensure its environmental impact is kept to an absolute minimum. In 2016 we launched the 2016-2018 efciency plan which compromised more than 250 initiatives with an investment of 69,8 million of euros, focusing on energy savings, saving raw materials, waste reduction, emission reduction and awareness campaigns. Looking ahead, the Bank maintains its frm commitment to the environment, and will continue to establish more ambitious objectives that will help reduce its consumption, its waste generation and its emissions in its own business operations. To do so, we are going to implement a new energy efciency and sustainability plan for the period 2019-2021. Optimization of ofce space, increase of the amount of green energy and more environmental management systems are some of the initiatives in which the countries will be working on. 2016-2018 efciency plan Electricity consumption Reducing electricity consumption in buildings -9% in G10 countries. Target Greenhouse gas emissions Reducing greenhouse gas emissions -9% in G10 countries. Paper consumption Reducing paper consumption -4% in G10 countries. 2016-2018 efciency plan targets Achievement -9% -9% -26% 100% 2016-2018 efciency plan 2011-2013 Energy Efciency Plan • Emissions of CO2: a 3.5% reduction in the frst year, and a 9% reduction up to 2013 in the G5. • Electricity consumption: a 3% reduction in the frst year in G20 countries. 2012-2015 Energy Savings Plan • Emissions of CO2: a 20% reduction of emissions in G10 countries. • Electricity consumption: a 20% reduction of electricity consumption in G10 countries. 68 Result of plans 2011 2018 36% reduction of paper 15% reduction of electricity 27% reduction of emissions 186k Number of employees (+8.6%) 202k 2018 Annual Report 2018 main highlights 100% green energy in all of the ofce buildings and branches of Santander in Germany, Spain and United Kingdom. United States and Brazil also acquire green energy for some of their facilities’ consumption. In 2018 new buildings have been certifed according to international LEED and ISO 14001 standards: • LEED GOLD certifcation in SCF Germany headquarters building at Mönchengladbach, in Santander DPC in Spain and in and new Santander Spain headquarters. • ISO 14001 certifcations in corporate buildings in City of Mexico and Querétaro in Mexico. As well as this, we have certifcations for the head ofce buildings in the main countries where santander operates. Santander considers that the implementation of an environmental management system in buildings creates a correct and environmenmtally friendly performance, while improving the building’s use. 2018 environmental footprint1 2,956,420 M3 water consumed Var. 2017-2018 (%) 2.9 379,988 T CO2 teq total emissions (market based) Var. 2017-2018 (%) -0.5 1,077 MILL. KWH total electricity 50% renewable energy -3.2 Scope 1 31,227 T CO2 teq direct emissions 16,764 T total paper consumed 86% recycled or certifed paper -16.2 Scope 2 7,656,046 KG paper and cardboard waste -14.7 223,920 T CO2teq indirect electricity emissions (market based) 364,682 T CO2 teq indirect electricity emissions (location based) 4,404,809 GJ total internal electricity consumption -2.6 Scope 3 124,840 T CO2 teq indirect emissions from employees travelling to work 1. The environmental footprint table with 2-year historical data and the consumptions and emissions per employee can be found in the ‘Key Metrics’ section. 69 Inclusive and sustainable growthResponsible bankingCorporate governance Economic and financial reviewRisk management Key Metrics Employees 1. Employees by geographies and gender1 Geographies Nº employees % men % women % graduates Spain Brazil Chile Poland Argentina Mexico Portugal UK USA SCF Other Total 30,868 45,179 11,614 12,403 9,000 19,096 6,499 18,297 16,783 12,642 20,332 202,713 54 43 46 30 50 46 55 40 42 46 49 45 46 57 54 70 50 54 45 60 58 54 51 55 73 79 42 86 23 49 55 22 15 34 31 52 1. The employee data presented is broken down according to the criteria of legal entities, and is therefore not comparable to that found in the Auditors’ report and annual consolidated accounts , which are presented by management criteria. 2. Functional distribution by gender Senior ofcers Other managers Other employees Men Women Total Men Women Total Men Women Total Continental Europe United Kingdom Latin America and other regions 913 (77.8) 260 (22.2) 1,173 6,735 (64.5) 3,711 (35.5) 10,446 26,173 (44.4) 32,759 (55.6) 58,932 107 (73.3) 39 (26.7) 146 1,309 (67.2) 640 (32.8) 1,949 9,218 (39.9) 13,862 (60.1) 23,080 523 (83.9) 100 (16.1) 623 6,427 (60.2) 4,256 (39.8) 10,683 40,729 (42.6) 54,952 (57.4) 95,681 Group total 1,543 (79.5) 399 (20.5) 1,942 14,471 (62.7) 8,607 (37.3) 23.078 76,120 (42.8) 101,573 (57.2) 177,693 3. Workforce distribution by age bracket Number and % of total aged <= 25 aged 26 - 35 aged 36 - 45 aged 46 - 50 age over 50 Continental Europe United Kingdom 2,352 (3.33) 14,715 (20.86) 27,241 (38.61) 10,739 (15.22) 15,504 (21.98) 3,964 (15.75) 7,092 (28.17) 6,470 (25.70) 2,810 (11.16) 4,839 (19.22) Latin America and other regions 11,474 (10.72) 46,233 (43.21) 29,553 (27.62) 8,637 (8.07) 11,090 (10.37) Group total 17,790 (8,78) 68,040 (33.56) 63,264 (31.21) 22,186 (10.94) 31,433 (15.51) 70 2018 Annual Report 4. Distribution by type of contract1 Permanent / Full time Men Women Continental Europe United Kingdom 32,252 (49.7) 32,604 (50.3) 9,580(53.5) 8,338 (46.5) Latin America and other regions 45,950(44.8) 56,591 (55.2) Group total 87,782 (47.4) 97,533 (52.6) Continental Europe United Kingdom Temporary / Full time Men Women 966 (33.2) 1,942 (66.8) 380 (49.5) 387 (50.5) Latin America and other regions 1,249 (46.5) 1,436 (53.5) Group total 2,595 (40.8) 3,765 (59.2) Total 64,856 17,918 102,541 185,315 Total 2,908 767 2,685 6,360 Permanent / Part-time Men Women 348 (17.3) 1,662 (82.7) 622 (9.8) 5,711 (90.2) 204 (25.6) 594 (74.4) 1,174 (12.8) 7,967 (87.2) Total 2,010 6,333 798 9,141 Temporary / Part-time Men Women 255 (32.8) 522 (67.2) 52 (33.1) 105 (66.9) 276 (28.7) 687 (71.3) 583 (30.7) 1,314 (69.3) Total 777 157 963 1,897 1. Regarding indefnite contracts, 84% corresponds to “Other employees” and the remaining 12% to “Senior ofcers” and “other managers”. Also, in relation to temporary contracts, 3.5% corresponds to “Other employees” and the remaining 0.5% to “Senior ofcers” and “other managers”. The totality of temporary contracts is in the age brackets <25 and 25-35 years. The rest of the age brackets correspond to indefnite contracts. 5. Employees who work in their home country1 % Continental Europe United Kingdom Latin America and other regions Group total 1. United States data not included. Managers Other employees 89.77 92.47 88.44 89.55 96.83 96.89 98.94 97.96 Total 96.72 96.87 98.88 97.88 6. Diferently-abled employees ratio by region1 6. Diferently-abled employees1 % Continental Europe United Kingdom Latin America and other regions Group total 1. United States and Mexico data not included. 1.24 1.61 2.09 1.73 Spain Rest of the Group 1. United States and Mexico data not included. Total Group 365 3,071 3,436 71 Key MetricsResponsible bankingCorporate governanceEconomic and financial reviewRisk management 7. Coverage of the workforce by collective agreement % Nº Employees Spain Brazil Chile Poland Argentina Mexico Portugal UK US SCF Other business units Total Group 99.94 94.13 100.00 0.00 99.00 20.05 99.40 100.00 0.00 50.22 70.31 70.61 30,848 42,529 11,614 - 8,910 3,829 6,460 18,297 - 6,349 14,295 143,131 8. Distribution of new hires by age bracket % of total Continental Europe United Kingdom Latin America and other regions Group total aged <= 25 aged 26-35 aged 36-45 aged over 45 aged > 50 23.79 47.81 33.84 33.67 44.73 28.51 44.04 41.72 23.50 13.39 15.19 16.89 4.69 4.09 3.49 3.87 3.30 6.20 3.44 3.85 9. Distribution of dismissals by gender1 Senior ofcers Other managers Managers Total Group aged <=25 aged 26-35 aged 36-45 aged 46-50 aged >50 Total Group Men 68 375 3,087 3,530 Men 382 1,071 884 395 798 3,530 Woman 26 189 3,681 3,896 Woman 492 1,310 1,028 343 723 3,896 Total 94 564 6,768 7,426 Total 874 2,381 1,912 738 1,521 7,426 1. Dismissal: unilateral termination. decided by the company. of an employment contract not subject to term expiration. The concept includes encouraged redundancies within the context of restructuring processes. 10. External turnover rate by gender1 % Continental Europe United Kingdom Latin America and other regions Group total Men 12.32 16.39 17.99 15.70 Women 12.48 14.17 17.01 15.10 Total 12.41 15.10 17.45 15.37 1. Excludes temporary leaves of absence and transfers to other Group companies. 72 2018 Annual Report 11. External turnover rate by age bracket1 % of total Continental Europe United Kingdom Latin America and other regions Group total aged <= 25 aged 26-35 aged 36-45 aged 46-50 aged over 50 40.01 35.72 25.73 29.84 16.15 15.74 17.16 16.75 8.68 8.75 13.72 11.04 7.46 6.48 15.49 10.46 14.43 10.52 21.45 16.31 Total 12.41 15.10 17.45 15.37 1. Excludes temporary leaves of absence and transfers to other Group companies. 12. Employees average remuneration by gender Euros Total remuneration (average)1 Variación 2018 vs. 2017 By gender By professional category Men 51,855 0% Women 32,900 4% Senior ofcers2 418,105 3% Others managers Other employees 87,167 -8%3 32,906 5% Total 41,522 2% 1. Data at end of 2018. The total remuneration of employees includes annual base salary, pensions and variable remuneration paid in the year. 2. Includes Group Sr. Executive VP. Executive VP and Vice President. 3. The variation includes the efect of internal reclassifcation between the category and the rest of employees carried out in diferent geographies. 4 The average remunerations for age brackets are not broken down since the employee remuneration criteria are established according to their professional category, job responsibilities and competences. In this sense, age is not a material factor in determining the remuneration of Santander Group employees for the specifcities of the fnancial sector. 13. Ratio between the Bank’s minimum annual salary and the legal minimum annual salary by country % Legal minimum wage Germany Argentina Brazil Chile US Spain Mexico Poland Portugal UK 228.49% 336.53% 183.12% 111.63% 193.02% 212.58% 130.23% 107.14% 206.90% 102.43% 14. Training 15. Hours of training by category 2018 2017 Total hours of training 6,842,825 8,016,912 % employees trained Total attendees 100.0 95.9 4,700,013 5,297,451 Hours of training per employee 33.76 39.6 Total investment in training 98,689,210 97,787,322 Investment per employee Cost per hour % female participants % of e-learning training attendees % of e-learning hours Employee satisfaction (up to 10) 486.84 14.42 54.4 90.0 48.1 8.0 483.5 12.2 54.6 48.1 93.3 8.1 Senior ofcers Managers Other employees Group total Hours 69,358 764,104 6,009,363 6,842,825 Average 35.71 33.11 33.82 33.76 16.Hours of training by gender Men Women Group total Average 34.27 33.37 33.76 73 Key MetricsResponsible bankingCorporate governanceEconomic and financial reviewRisk management 17. Absenteeism by gender and region1 % Continental Europe United Kingdom Latin America and other regions Group total Men 1.85 3.65 3.05 2.64 Women 4.36 5.14 4.22 4.40 Total 3.18 4.54 3.70 3.61 1. Hours missed due to occupational accident. non-work related illness and non-work related accident for every 100 hours worked. 18. Work-related illness rate1, 2 % Continental Europe United Kingdom Latin America and other regions Group total Men 0.07 0.01 0.66 0.36 Women 0.09 0.05 0.95 0.53 Total 0.08 0.03 0.83 0.45 1. Hours missed due to occupational accident involving leave for every 100 hours worked. 2 The frequency and severity of work accidents are not detailed due to the low value they represent. 19. Occupational health and safety No. of fatal occupational accidents Hours of absenteeism (hours not worked due to common illness and non-work accident) (millions of hours). 4 10,164,315 Customers 20. Group customers1 Million Spain Portugal UK Poland SCF Rest of Europe Total Europe Brazil Mexico Chile Argentina Rest of Latin America Rest Latin America US Total Group 17.3 4.9 25.5 4.5 19.4 0.1 71.7 42.1 16.7 3.5 3.7 0.9 66.9 5.2 143.8 1. Figures for total customers; i.e. holders of any product and service with a valid contract. Of the countries in Europe listed, Santander Consumer Finance customers are included in “Rest of Europe” except those of the UK. Canada is included in “Rest of Latin America”. 74 2018 Annual Report 21. Dialogue by channel Branches Number of branches ATMs Nº ATMs 1 Digital banking Users2 Visits Monetary transactions3 1. Santander Consumer Finance not included. 2. Counts once for users of both Internet and mobile banking. 3. Millions. 22. Customer satisfaction % satisfaction among active retail customers Spain Portugal UK Poland Brazil Mexico Chile Argentina US Total 2018 13,217 2017 11,920 38,503 35,700 32.0 6,302 1,843 25.4 4,271 1,129 2018 87.1 91.3 97.0 97.5 79.6 97.8 85.8 83.3 83.3 88.0 2017 85.5 91.4 96.0 95.9 77.9 96.4 91.6 87.1 81.8 88.0 Var. 11% 8% 26% 48% 63% 2016 85.0 91.9 96.2 96.0 74.8 94.1 95.9 87.1 84.6 87.5 Source: Corporate benchmarking of experience and satisfaction among active Retail & Commercial banking customers. Based on audited external and local studies developed by well-known vendors (IPSOS, IBOPE,GFK,TNS…) (Data at end 2017, corresponding to survey results in the second half of the year). 23. Total complaints received Spain1 Portugal United Kindom 2 Poland Brazil 3 Mexico4 Chile5 Argentina6 US SCF 2018 85,519 4,298 33,797 4,480 111,829 60,740 6,171 5,464 4,160 29,067 2017 107,103 4,275 37,746 4,785 101,589 51,895 5,526 4,372 4,041 30,126 2016 34,920 5,028 39,926 4,501 88,623 48,524 5,562 2,838 2,477 33,027 Compliance metrics according to Group criteria, homogeneous for all geographies. It may not match with other local criteria such us Financial Conduct Authority (FCA) in the United Kingdom or in Brazil. 1. Even Popular Bank complaints have been included, in Spain complaints infow has decreased due to the efects of Supreme Court Ruling related to set up mortgages fees. 2. In UK complaints volumes reduced due to the new approach of complaints management model adopted across all frontline areas, as well as improvements on complaints root cause analysis governance. 3. In Brazil complaints infows have increased mainly due to fees, charges not recognised, and direct debits. 4. In Mexico complaints are increasing mainly due to fraud cases, especially e-commerce, and debt collecting (REDECO Channel). 5. Chile shows a slight increase mainly due to fraud cases, especially online cases. 6. In Argentina Complaints volumes increased due to fees and fraud cases. 75 Key MetricsResponsible bankingCorporate governanceEconomic and financial reviewRisk management Environment and climate change 24. Environmental footprint 2016-20171 2018 2017 Var. 2017-2018 (%) Consumption Water (m3)2 Water (m3/employee) Normal electricity (millions of kwh) Green electricity (millions of kwh) Total electricity (millions of kwh) 2,956,420 2,872,853 15.24 557 462 1,019 14.68 639 473 1,112 Total internal energy consumption (GJ) 4,314,890 4,522,999 Total internal energy consumption (GJ/employee) Total paper (t) Recycled or certifed paper (t) Total paper (t/employee) Waste Paper and cardboard waste (kg)3 Paper and cardboard waste (kg/employee) Greenhouse gas emissions Direct emissions (CO2 teq)4 Indirect electricity emissions (CO2 teq)-MARKET BASED5 Indirect electricity emissions (CO 2 teq)-LOCATION BASED5 Indirect emissions from displacement of employees (CO2 teq)6 Total emissions (CO2 teq)- MARKET BASED Total emissions (CO2 teq/employee) Average number of employees 22.24 16,764 14,583 0.09 7,656,046 39.46 37,635 213,815 23.11 20,010 16,969 0.10 8,972,420 45.84 29,108 226,455 354,745 374,346 124,778 376,229 1.94 194,027 126,287 381,849 1.95 195,732 2.9 3.8 -12.8 -2.4 -8.4 -4.6 -3.8 -16.2 -14.1 -15.5 -14.7 -13.9 29.3 -5.6 -5.2 -1.2 -1.5 -0.6 -0.9 1. The scope of the information includes the main operating countries: Argentina, Brazil, Chile, Germany, Mexico, Poland, Portugal, Spain, United Kingdom and United States (excluding Puerto Rico and Miami). The data regarding Banco Popular is included in Spain and Portugal in a consolidated manner. 2. Only consumption of mains water is reported. 3. 2017 and 2018 fgures do not include waste from Argentina and Brazilian sales network. 4. T hese emissions include those arising from the direct consumption of energy (natural gas and diesel) and correspond to Scope 1 defned by the standard GHG Protocol. For the calculation of these emissions, the 2018 DEFRA emission factors have been applied for 2018 emissions and 2017 DEFRA for 2017. The variation is due to the consideration of the emissions derived from the use of own vehicles in Mexico 5. These emissions include those resulting from electricity consumption and correspond to Scope 2 defned by the standard GHG Protocol. In 2017 and 2018, IEA (International Energy Agency) 2015 emission factors were used. · I ndirect electricity emissions - Market-based: zero emissions have been considered for green electricity consumed in Germany, Brazil, Spain, UK, USA, which has meant a reduction of 140,762 tons of CO2 equivalent in 2018 and 147,892 in 2017. For the rest of the electric power consumed has been applied the emission factor of the IEA corresponding to each country. · I ndirect electricity emissions - Location-based: the emission factor of the IEA corresponding to each country has been applied for the totality of electrical energy consumed, regardless of its source of origin (renewable or non-renewable). 6. T hese emissions include the emissions generated by employees working at central services of each country as they commute to work in private car, group transport and or by train, and also includes the business travel of employees when travelling in plane or by car. Employee distribution by type of travel has been determined through surveys or other estimates. For the calculation of emissions resulting from the displacement of employees, the 2018 DEFRA conversion factors have been applied for 2018 emissions and 2017 DEFRA for 2017. · Employees commuting to work in private car has been estimated with regard solely to the number of parking bays available to employees at the head ofces of each country and the consumption mix of petrol/diesel for the vehicle feet of each country. There is no reported data for employee travel in private vehicles in Argentina, Poland or the United Kingdom because this information is not available. · The displacement of employees in group vehicles has been calculated from the average distance travelled by vehicles rented by Santander Group for the group transport of their employees in the following countries: Brazil, Germany, Mexico, Poland Consumer, Portugal, Spain, US, and within central services in Spain (CGS). · There is no reported data for business trips made by plane from Poland Geoban or for business travel made by car from Poland Geoban and USA Consumer on account of the information not being available. · Emissions deriving from the use of courier services have not been included, nor have those generated by transport of cash or from any other kind of products or services arranged or indirectly generated by the fnancial services provided. 76 2018 Annual Report 77 Key MetricsResponsible bankingCorporate governanceEconomic and financial reviewRisk managementContribution to UN Sustainable Development Goals All social agents, including companies, have a responsability to contribute to the Sustainable Development Goals (SDG) of the United Nations. We contribute directly to achieving the SDGs through our business activities and also through our community investment programmes. Main SDGs where Banco Santander’s business activities and community investments have the most weight. We support the health and well-being of our employees and the communities in which we are present • BeHealthy Program: access for employees to information and training to improve and renew healthy living habits. Access to more than 40,000 afliated health and welfare centers around the world. • Support to the community: +1 million people helped through programs designed to address social exclusion and boost the well-being of people. We invests more in support for educations than any other private company in the world. And we promote the largest private scholarship program in the world. • More than 1,200 universities with which we maintain agreements. • More than 70,000 scholarships and grants awarded to students in 2018. The largest private scholarship program in the world. Santander X, our international university entrepreneurship project, chosen as good practice by the Spanish Network of the Global Compact to achieve the SDGs in 2030. We promote a diverse and inclusive workforce that refects society and allows us to face future challenges. • New general principles on diversity and inclusion that provide global guidelines and minimum standards. We have a prepared and committed team that allows us to respond and meet the needs of customers, help entrepreneurs to create businesses and employment, and strengthen local economies. • 94.6% of employees with a fxed contract • 54.5% of women in the workforce, 20.5% of women in • 8.6% of the staf promoted. management positions. For the second consecutive year, Santander has obtained the highest score among the 230 companies that are part of the Bloomberg Gender-Equality Index. • Flexiworking: incorporates multiple conciliation initiatives. In 2018 we received the Top Employers Europe 2018 certifcation and occupied one of the frst three positions in the ranking of the best fnancial institutions to work for in Latin America in 2018, according to Great Place to Work. We develop products and services for the most vulnerable in society, giving them access to fnancial services and teaching them how to use these in an appropriate way to manage their fnances in the best possible way We fnance SMEs and self-employed professionals who boost local economies, generate wealth and create employment opportunities. • 117,420 million euros in loans to SMEs and the self-employed. • 160 million euros in loans granted at the end of 2018. • Agreements with multilateral entities such as the EIB and the CAF • More than 2,730,000 micro-entrepreneurs helped. to boost fnancing to SMEs. The Prospera microfnance program in Brazil, chosen as good practice by the Brazilian Global Compact Network to achieve the SDGs in 2030 • Global digital solutions that promote connectivity between companies, help export and ofer more innovative and simple platforms to operate. • We invest in fntechs that promote fnancial technology and facilitate access to and use of fnancial services. 78 2018 Annual Report Contribution to SDGs We promote sustainable consumption both in our own operations as well as with our clients. • Environmental footprint: 25.9% reduction in paper and 13.5% reduction in electricity from 2016 to 2018. In 2018, 53% of the energy consumed by Santander was renewable energy. We support the fght against climate change and the transition to a low carbon economy. And we commit ourselves to actively contribute to the protection of the environment. • 6,689 MW of renewable energy fnanced, equivalent to the consumption of 5.7 million households. • Environmental and social risks analysis: 35 projects fnanced • Agreements with multilaterals for the fnancing and under Equator Principles criteria. development of energy efciency projects • Responsible procurement: New principles of responsible • Financing of vehicles with low CO2, electric and hybrid emissions behavior of suppliers; 95% Local group’s suppliers • Updated sector policies with new thermal coal prohibitions. We participate actively and we are part of the main initiatives and working groups at local and international level as an important way to support SDG 17 on partnerships for the goals. • World Business Council for Sustainable Development (WBCSD). Our president, Ana Botín, is a member of the executive committee. And we participate in the WBCSD Future of Work initiative, by looking into how to adapt our own business and human resource strategy to evolve with the digital age. • Banking Environment Initiative (BEI). We participate in two climate related work streams, the Soft Commodities Compact and the new initiative Bank 2030 which aims to build a roadmap for the banking industry to 2030 seeking to increase the fnancing to low carbon activites. • UNEP Finance initiative. Together with 27 other banks, we promote the principles for responsible banking of the United Nations. We also participated along with other 15 banks in 2018 in the UNEP FI pilot project on implementing the TCFD recommendations for banks. • United Nations Global Compact. We are committed to the development of our business activity with the ten principles of the Global Compact and we extend them to our value chain, demanding our suppliers to assume and also comply with them. • CEO Partnership for Financial Inclusion. We, along with other 9 companies are part of a private sector alliance for fnancial inclusion, an initiative promoted by Queen Maxima of the Netherlands, Special Representative of the United Nations to promote Inclusive Financing for development. • Principles of Ecuador. We analyze the environmental and social risks of all our fnancing operations of projects that are under the scope of the principles of Ecuador and participate actively in the evolution of the criteria • Principles of Responsible Investment. We manage our pension funds of employees in Spain and Brazil applying criteria of responsible investment. • Others include: Wolfsberg Group; Round table on responsible soy; Sustainable livestock working group; CDP (formerly Carbon Disclosure Project); Climate Leadership Council. UNEP FI – Principles for responsible banking The Principles provide the banking industry with a single framework that embeds sustainability across all business areas. The Principles align banks with society’s goals as expressed in the Sustainable Development Goals and the Paris Climate Agreement. Transparency, accountability, governance, target setting and working with all stakeholders towards positive impacts are at the core of the Principles and will help banks increase their contribution to address global challenges. 79 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Further information This Responsible banking chapter constitues the tradictional sustainability report that the Group prepares and is one of the main tools used by the Group to report on sustainability issues. When the limitations and scope of the information, and the changes in criteria applied with respect to the to the 2017 sustainability report are signifcant, these are refected in the corresponding section of the report and the GRI Content Index. Material aspects and stakeholder involvement The Group maintains active dialogue with its stakeholders in order to identify those issues that concern them. In addition, a survey was conducted to determine the most relevant aspects to be addressed in this sustainability report. The Group also closely monitors the questionnaires and recommendations of the main sustainability indexes (Dow Jones, FTSE4Good, etc.) and the various international sustainability initiatives to which the Group is party, such as the World Business Council for Sustainable Development (WBCSD). In fagging and identifying content to be included in the report, and in addition to the materiality study conducted, the sustainability context of the Group at both the global and local level was considered. Moreover, and insofar as there was sufcient available information, the impacts both within and outside the Bank were addressed. The details of this process, as well as the results of the materiality study, can be found on section 'What our stakeholders tell us' of this document. International standards and response to legislation in preparing this Responsible banking chapter Santander has relied on internationally recognized standards such as the Global Reporting Initiative (GRI) in the preparation of its successive Sustainability Reports. This chapter has been prepared in accordance with the GRI Standards: Comprehensive option. Additionally, in this chapter detailed information is provided to respond to the Law 11/2018, which transposes to the Spanish legal order the Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-fnancial and diversity information. Scope This chapter is the ffteenth annual document that the Santander Group has published, giving account of its sustainability commitments, and refers to the period from 1 January to 31 December 2018. This report has been verifed by PricewaterhouseCoopers Auditores, S.L., and independent frm which also audited the Group´s annual fnancial statements for the year. This report also covers the Group´s relevant activities in the geographical areas in which it is present: Continental Europe, the United Kingdom, the United States and Latin America. The economic information is presented according to the defnition used by the Group for accounting purposes; the social and environmental information has been prepared according to the same defnition, wherever this is available. Data contained in this chapter covers Banco Santander SA. and subsidiaries (for more information see notes 3 and 52 to the consolidated fnancial statements and sections 3 and 4 of the economic and fnancial chapter). 80 2018 Annual Report Non-fnancial information Law content index Equivalent table of legal disclosure requirements under Spanish law 11/2018 Description of the metric/concept included in the 11/2018 Law to be disclosed Chapters/section of the Consolidated directors report where the info is available Correspondence with GRI indicators Short description of the Group’s business model (it will include its business environment, its organisation and structure, the markets in which it operates, its objectives and strategies, and the main factors and trends that may afect its future performance).  Pag. 4-9 A description of the policies that the Group applies, which will include: the due diligence procedures applied for the identifcation, assessment, prevention and mitigation of risks and signifcant impacts and of verifcation and control, including the measures in which they have been adopted):  Principles and governance. Pag. 18-19 GRI 102-1 GRI 102-2 GRI 102-3 GRI 102-4 GRI 102-6 GRI 102-7 GRI 102-14 GRI 102-15 GRI 103-2 GRI 103-3 n o i t a m r o f n I l a r e n e G . 0 The results of these policies, including key indicators of relevant non-fnancial results that allow the monitoring and evaluation of progress and that favour the comparability between companies and sectors, in accordance with national, European or international frameworks of reference used for each matter. The main risks related to these matters associated with the Group’s activities (business relationships, products or services) that may have a negative efect in these areas, and how the Group manages these risks, explaining the procedures used to detect and assess them in accordance with national, European or international frameworks of reference for each matter. It must include information about the impacts that have been detected, ofering a breakdown, in particular of the main risks in the short, medium and long term. Detailed information on the current and foreseeable effects of the activities of the company in the environment and, where appropriate, health and safety, environmental evaluation or certification procedures; the resources dedicated to the prevention of environmental risks; the application of the principle of caution, the amount of provisions and guarantees for environmental risks. Sustainable fnance. Pag. 62-69 Challenge 2: Inclusive and sustainable growth. Pag. 48-61  A talented and motivated team. Pag. 28-37 GRI 103-2 GRI 103-3 Principles and governance, Responsible Procurement, Analisis of Social &Environmental pisk management, Pag. 18-19, 46-47, 66-67   Principles and governance, Responsible procurement, Analisis of Social &Environmental Risk management, Pag. 18-19, 46-47, 66-67 GRI 102-15 GRI 102-30 Sustainable fnance. Pag. 62-69 Environmental footprint. Pag. 69 Analysis of environmental and social risks. Pag. 66-67 Provisions and guarantees for environmental risks is not a material aspect of the total provisions of Banco Santander, because the environmental risk associated with its direct activities is small. GRI 102-29 GRI 102-31 GRI 201-2 GRI 103-2 (GRI de la dimensión ambiental) GRI 102-11 GRI 102-29 GRI 102-11 - 81 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Description of the metric/concept included in the 11/2018 Law to be disclosed Chapters/section of the Consolidated directors report where the info is available Correspondence with GRI indicators Contamination: Measures to prevent, reduce or repair CO2 emissions that seriously afect the environment, taking into account any form of air pollution, including noise and light pollution. Circular economy and waste prevention and management: Waste prevention measures, waste recycling measures, waste reuse measures; other forms of waste recovery and reuse; actions againts food waste. Sustainable use of resources: Use and supply of water according to local limitations Consumption of raw materials and measures taken to improve the efciency of its use. Energy: direct and indirect consumption, measures taken to improve energy efciency, use of renewable energies Climate change: Important elements of greenhouse gas emissions generated as a business activity (including goods and services produced) Measures taken to adapt to the consequences of climate change Reduction targets voluntarily established in the medium and long term to reduce greenhouse gas emissions and means implemented for this purpose. Protection of biodiversity: Measures taken to preserve or restore biodiversity Impacts caused by the activities or operations of protected areas         - - Environmental footprint. Pag. 68-69 GRI 103-2 (GRI 302 y 305) Environmental footprint. Pag. 68-69 Environmental footprint. Pag. 68-69 Environmental footprint. Pag. 68-69 Environmental footprint. Pag. 68-69 Environmental footprint. Pag. 68-69 Sustainable fnance. Pag. 62-69 Environmental footprint. Pag. 68-69 GRI 103-2 (GRI 306) GRI 301-2 GRI 306-1 GRI 303-1 GRI 103-2 (GRI 301) GRI 301-1 GRI 301-2 GRI 103-2 (GRI 302) GRI 302-1 GRI 302-3 GRI 103-2 (GRI 305) GRI 305-1 GRI 305-2 GRI 305-3 GRI 305-4 GRI 103-2 (GRI 305) GRI 201-2 GRI 103-2 (GRI 305) Los impactos causados por las actividades directas de Banco Santader sobre la biodiversidad no son materiales debido a la actividad fnanciera desarrollada por la entidad. - 82 2018 Annual Report Description of the metric/concept included in the 11/2018 Law to be disclosed Chapters/section of the Consolidated directors report where the info is available Correspondence with GRI indicators l a i c o S . 2 Employment: Total number and distribution of employees by gender, age, country and professional classifcation Total number and distribution of contracts modes and annual average of undefned contracts, temporary contracts, and part- time contracts by: sex, age and professional classifcation.   Key Metrics. Pag. 70 Key Metrics. Pag. 71 Number of dismissals by: gender, age and professional classifcation.  Key Metrics. Pag. 72 Average remuneration and its progression broken down by gender, age and professional classifcation Salary gap and remuneration of equal or average jobs in society Average remuneration of directors and executives (including variable remuneration, allowances, compensation, payment to long-term savings forecast systems and any other payment broken down by gender) Implementation of work disconnection policies Employees with disabilities Organisation of work: Organisation of work time Number of absent hours Measures designed to facilitate work-life balance and encourage a jointly responsible use of said measures by parents Health and safety: Conditions of health and safety in the workplace Occupational accidents, in particular their frequency and severity, as well as occupational illnesses. Broken down by gender. Social relations: Organisation of social dialogue (including procedures to inform and consult staf and negotiate with them) Percentage of employees covered by collective bargaining agreements by country Balance of the collective bargaining agreements (particularly in the feld of health and safety in the workplace) Training: The policies implemented in the feld of training Total number of hours of training by professional categories. Accessibility: Universal accessibility of people Equality: Measures taken to promote equal treatment and opportunities between women and men, Equality plans (Chapter III of Organic Law 3/2007, of 22 March, for the efective equality of women and men), measures taken to promote employment, protocols against sexual and gender-based harassment, Policy against all types of discrimination and, where appropriate, integration of protocols against sexual and gender-based harassment and protocols against all types of discrimination and, where appropriate, management of diversity                  GRI 103-2 (GRI 401) GRI 102-8 GRI 405-1 GRI 102-8 GRI 405-1 GRI 401-1 GRI 405-2 GRI 103-2 (GRI 405) GRI 405-2 Key Metrics. Pag. 73 Pag. 33 Key Metrics. Pag. 73 Corporate governance chapter (pág. ) GRI 102-35 GRI 102-36 GRI 103-2 (GRI 405) A talented and motivated team. Pag. 28-37 Key metrics. Pag. 32, 71 A talented and motivated team Key Metrics. Pag. 37, 74 A talented and motivated team. Pag. 28, 72 GRI 103-2 (GRI 401) GRI 405-1 GRI 103-2 (GRI 401) GRI 403-2 GRI 103-2 (GRI 401) A talented and motivated team. Pag. 28, 72 GRI 102-41 Key Metrics. Pag. 74 What our stakeholders tell us. Pad. 14-15 Key Metrics. Pag. 28, 72 GRI content index. A talented and motivated team. Pag. 28-37 Key Metrics. Pag. 73 Challenge 2: Inclusive and sustainable growth. Pag. 32, 51. A talented and motivated team. Pag. 28-37 SMEs & job creation. Pag. 28-3 GRI 403-2 GRI 403-3 GRI 103-2 (GRI 402) GRI 102-41 GRI 403-1 GRI 403-4 GRI 103-2 (GRI 404) GRI 404-2 GRI 404-1 GRI 103-2 (GRI 405) GRI 103-2 (GRI 405 y 406) 83 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Description of the metric/concept included in the 11/2018 Law to be disclosed Chapters/section of the Consolidated directors report where the info is available Correspondence with GRI indicators Application of due diligence procedures in the feld of Human Rights i s t h g R n a m u H . 3 Prevention of the risks of Human Rights violations and, where appropriate, measures to mitigate, manage and repair any possible abuses committed Complaints about cases of human rights violations Promotion and compliance with the provisions of the fundamental conventions of the International Labour Organisation regarding respect for freedom of association and the right to collective bargaining. Measures taken to prevent corruption and bribery i t s n a g a t h g F . i 4 n o i t p u r r o c Measures to combat money laundering Contributions to non-proft foundations and entities Commitments of the company to sustainable development: The impact of the company’s activity on employment and local development The impact of the company’s activity on local towns and villages and in the country Relations maintained with the representatives of local communities and the modalities of dialogue with them Association or sponsorship actions* Outsourcing and suppliers: Inclusion of social, gender equality and environmental issues in the procurement policy y n a p m o c e h t n o n o i t a m r o f n I . 5 Consideration in relations with suppliers and subcontractors of their responsibility Supervision and audit systems and resolution thereof Consumers: Measures for the health and safety of consumers Systems for complaints received and resolution thereof Tax information: The profts obtained country by country Taxes earned on benefts paid Public grants received Any other relevant information:                    Principles and governance, Analisis of Social &Environmental Risk, Responsible Procurement. Pag. 18-19, 66-67. Principles and governance, Responsible Procurement. Analisis of Social &Environmental Risk, Pag. 18-19, 66-67. GRI content index. Risk management chapter (p.) GRI 102-16 GRI 102-17 GRI 103-2 (GRI 412) GRI 410-1 GRI 412-1 GRI 412-3 GRI 406-1 A talented and motivated team. Pag. 18-19 GRI 103-2 (406, 407, 408 y 409) Principles and governance, Risk management chapter (p.) Principles and governance, Risk management chapter (p.) GRI 102-16 GRI 102-17 GRI 103-2 (GRI 205) GRI 205-1 GRI 205-2 GRI 205-3 Community investment. Pag. 58.59 GRI 413-1 SMEs & job creation, Community investment. Pag. 52-53, 58-59 SMEs & job creation, Community investment. Pag. 52-53, 58-59 What our stakeholders tell us. Pag. 14-15 Community investment. Pag. 58-59 Responsible procurement. Pag. 46-47 Responsible procurement. Pag. 46-47 Responsible procurement. Pag. 13, 46-47 Responsible Business Practices. Pag. 38-39 Risk management chapter (p.) Responsible Business Practices. Pag. 38-41 Key metrics. Pag. 75. Risk management chapter (p.) GRI content index. GRI 103-2 (GRI 204, 308 y 414) GRI 102-9 Cadena de suministro GRI 103-2 (GRI 204, 308 y 414) GRI 204-1 GRI 308-1 GRI 414-1 GRI 103-2 (GRI 204) GRI 103-2 (GRI 416, 417 y 418) GRI 416-1 GRI 417-1 G4-FS15 GRI 102-17 GRI 103-2 (GRI 416, 417 y 418) GRI 416-2 GRI 417-2 GRI 418-1 Appendix VI in Auditor's report and annual consolidate accounts (Pág. 289) Tax contribution. Pag. 13, 61 GRI content index. GRI 103-2 (GRI 201) GRI 201-4 *NB: The data to report this indicator could be quantitative or qualitative In addition to the contents mentioned in the previous table, the consolidated non-fnancial information statement of Banco Santander includes the following contents: 102-5, 102-9, 102-10, 102-12, 102-13, 102-18, 102-19, 102-20, 102-21, 102-22, 102-23, 102-24, 102-25, 102-26, 102-27, 102-28, 102-32, 102-33, 102-34, 102-37, 102-40, 102-42, 102-43, 102-44, 102-45, 102-46, 102-47, 102-48, 102-49, 102-50, 102-51, 102-52, 102-53, 102-54, 102-55, 102-56, 201-1, 201-3, 202-1, 202-2, 203-1, 203-2, 206-1, 302-1, 302-3, 307-1, 308-2, 401-2, 402-1, 404-3, 405-2, 411-1, 414-2, 415-1, 417-3, 419-1. 84 2018 Annual Report 85 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementGlobal Reporting Initiative (GRI) content index GRI Standards: GENERAL DISCLOSURES GRI Standard Disclosure GRI 101: FOUNDATION GRI 102: GENERAL DISCLOSURES Page/Omission Review 102-1 Name of the organization P. 80 102-2 Activities, brands, products, and services P. 12-13, 18, 23-24, 25, 26-27, 48- 49, 54-55, 56 and 62-65. 102-3 Location of headquarters P. 80 102-4 Location of operations Table 20 in Key metrics from the chapter Responsinle Banking (P. 74). Annual consolidated accounts. 102-5 Ownership and legal form P. 44-45 and 708 102-6 Markets served ORGANISATIONAL PROFILE 102-7 Scale of the organization 102-8 Information on employees and other workers Table 20 in Key metrics from the Responsible Banking chapter (P. 68), P. 13, 38-39, 50-51 and 54-55. P. 13, 27, 28 and 44 and tables 1 (p. 70) y 20 (p. 72) in Key metrics P. 13, 27, 28 and 44 and tables 1 (p. 70) y 20 (p. 72) in Key metrics 102-9 Supply chain P. 46-47. 102-10 Signifcant changes to the organization and its supply chain P. 81 102-11 Precautionary Principle or approach 102-12 External initiatives 102-13 Membership of associations P. 13, 27, 28 and 44 and tables 1 (p. 70) y 20 (p. 72) in Key metrics P. 31, 40-41, 46, 50-55 and 65-66 Santander participates in industry associations representing fnancial activity in the countries where it operates, as the AEB in the case of Spain 102-14 Statement from senior decision-maker P. 12, 24 and 57. STRATEGY ETHICS AND INTEGRITY 102-15 Key impacts, risks, and opportunities P. 21, 23, 28-29 42-43, 46-47, 66- 69 and p. 214 from the annual consolidated accounts. 102-16 Values, principles, standards, and norms of behavior P. 20-21, 23, 24-25, 31 and 47. 102-17 Mechanisms for advice and concerns about ethics P. 20-21, 25-27, 34-39, 47, 54-59 and 62-66. √ √ √ √ √ √ √ √1 √ √ √ √ √ √ √ √ √ 86 2018 Annual Report GRI Standard Disclosure Page/Omission Review 102-18 Governance structure 102-19 Delegating authority 102-20 Executive-level responsibility for economic, environmental, and social topics 102-21 Consulting stakeholders on economic, environmental, and social topics P. 16-17 and Corporate Governance chapter of the annual report. P. 16-17 and Corporate Governance chapter of the annual report. P. 16-17 and Corporate Governance chapter of the annual report. P. 24-25, 32-33, 38 and 43 and Corporate Governance chapter of the annual report. Annual accounts. 102-22 Composition of the highest governance body and its committees P.17 and Corporate Governance chapter of the annual report. 102-23 Chair of the highest governance body 102-24 Nominating and selecting the highest governance body 102-25 Conficts of interest 102-26 Role of highest governance body in setting purpose, values, and strategy 102-27 Collective knowledge of highest governance body GOVERNANCE 102-28 Evaluating the highest governance body’s performance P. 125 and 108-113 from the Corporate Governance chapter of the annual report. Annual accounts P. 138-140 and 156-157 from the Corporate Governance chapter of the annual report. Annual accounts. P. 16, 45, 108, 152, 160-162 from the Corporate Governance chapter of the annual report. Annual accounts. P. 18-19, 42, 60. P. 116-160 Corporate Governance. Chapter 2 of the Regulations of the Board of Directors of Banco Santander, S.A P. 116-127 from the Corporate Governance chapter of the annual report. Annual accounts. P. 108-111, 140, 146 from the Corporate Governance chapter of the annual report.Annual accounts. 102-29 Identifying and managing economic, environmental, and social impacts P. 66. Annual accounts. 102-30 Efectiveness of risk management processes P. 18-19, 42-43 and 66-67. 102-31 Review of economic, environmental, and social topics 102-32 Highest governance body’s role in sustainability reporting Risk manegement chapter of the annual accounts. Santander´s Board approved this report on February, 26th 2019 related to 2018 period (p. 24-25 from the 2018 Annual report, and p. 108 from the Corporate Governance Chapter of the Annual Report published in 2019). 102-33 Communicating critical concerns Annual accounts. 102-34 Nature and total number of critical concerns P. 18, 42-43, 66-67. 102-35 Remuneration policies P. 31 and 33. P. 186-192 from the Corporate Governance Chapter of the Annual Report 102-36 Process for determining remuneration 102-37 Stakeholders’ involvement in remuneration P. 31 and 33. P. 180 and 224 from the Corporate Governance Chapter of the Annual Report. Report of the remuneration committee P. 31 and 33. P. 180 and 224 from the Corporate Governance Chapter of the Annual Report. Report of the risk, supervision, regulation and compliance committee 102-38 Annual total compensation ratio Confdential information 102-39 Percentage increase in annual total compensation ratio Confdential information 102-40 List of stakeholder groups P. 13-14, 26-27 and 80. 102-41 Collective bargaining agreements P. 26-27 and 54. 102-42 Identifying and selecting stakeholders P. 14-15 and 26-27. 102-43 Approach to stakeholder engagement P. 26, 40-41 and 80 and table 22 in Key Metrics (p. 73). 102-44 Key topics and concerns raised P. 14-17, 22-23 and 48-49. STAKEHOLDER ENGAGEMENT √ √ √ √ √ √ √ √ √ √ √ √ √ √ √ √ √ √ √ √ NO NO √ √ √ √ √ 87 Responsible bankingCorporate governanceEconomic and financial reviewRisk management GRI Standard Disclosure 102-45 Entities included in the consolidated fnancial statements Page/Omission P. 80. Annual accounts. 102-46 Defning report content and topic Boundaries P. 15 and 80. REPORTING PRACTICE 102-47 List of material topics 102-48 Restatements of information 102-49 Changes in reporting 102-50 Reporting period 102-51 Date of most recent report 102-52 Reporting cycle P. 15 P. 80 P. 80 P. 80 P. 80 P. 80 102-53 Contact point for questions regarding the report P. 709 102-54 Claims of reporting in accordance with the GRI Standards P. 80 102-55 GRI content index 102-56 External assurance GRI Content Index (p. 86-102). P. 80. Independent verification report. Review √ √ √ √ √ √ √ √ √ √ √ √ 88 2018 Annual Report GRI Standards: Topic-specifc diclosures Identifed material aspect Material aspect boundary GRI Standard ECONOMIC STANDARDS ECONOMIC PERFORMANCE Disclosure Page/Omission Scope Review GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (P. 87-99) 103-2 The management approach and its components P. 13 and column "Page/Omission" of the GRI 201: Economic Performance" (p. 87) 103-3 Evaluation of the management approach P. 13 and column "Page/Omission" of the GRI 201: Economic Performance" (p. 87) - - - √ √ √ 201-1 Direct economic value generated and distributed Ethical behaviour and risk management / Compliance and adapting to regulatory changes Internal and external GRI 201: ECONOMIC PERFORMANCE € million Economic value generated1 Gross income Net loss on discontinued operations Gains/(losses) on disposal of assets not classifed as non-current held for sale Gains/(losses) on disposal of assets not classifed as discontinued operations Economic value distributed Dividends3 Other administrative expenses (except taxes) Personnel expenses Income tax and other taxes2 CSR investment Economic value retained (economic value generated less economic value distributed) 2018 48,329 48,424 0 28 -123 28,711 3,292 8,489 11,865 4,886 179 19,618 Group √ 1. Gross income plus net gains on asset disposals. 2. Only includes income tax on profts accrued and taxes recognised during the period. The chapter on Community Investment provides additional information on the taxes paid. 3. In addition to the EUR 3,392 million, EUR 132 million were allocated in shares to shareholders in the framework of the shareholder compensation scheme (Santander Dividendo Election) approved by shareholders’ general meeting of 23th March 2018. According to this, the Bank has ofered the possibility of getting an amount in cash or in new shares that is equivalent to the second interim dividend for the year 2018. This fgure does not come directly from consolidated annual accounts, otherwise turning to a specifcally created detail to monitor the remuneration of the shareholder. This detail can be included at the beginning of chapter 4, “Distribution of the Bank’s results, shareholders remuneration system and beneft per share”, section a). 201-2 Financial implications and other risks and opportunities due to climate change P. 18, 49, 62-69. Table 24 in Key metrics (p. 74). 201-3 Defned beneft plan obligations and other retirement plans 201-4 Financial assistance received from government The liability for provisions for pensions and similar obligations at 2017 year- end amounted to EUR 5.558 million. Endowments and contributions to the pension funds in the 2017 fnancial year have amounted to EUR 371 million. The detail may be consulted in Auditor´s report and annual consolidated accounts. The Bank has not received signifcant subsidies or public aids during 2017. The detail may be consulted in Auditor´s report and annual consolidated accounts. Group √2 Group √ Group √ 89 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Identifed material aspect Material aspect boundary GRI Standard MARKET PRESENCE Disclosure Page/Omission Scope Review 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (P. 86-102) 103-2 The management approach and its components P. 24-25 and column “Page/Omissionn” of the GRI 201: Economic Performance (p. 90). 103-3 Evaluation of the management approach P. 24-25 and column “Page/Omissionn” of the GRI 201: Economic Performance (p. 90). - - - √ √ √ 202-1 Ratios of standard entry level wage by gender compared to local minimum wage Table 13 in Key metrics (P. 73). Group √3 202-2 Proportion of senior management hired from the local community The Group Corporate Human Resources Model aims to attarct and retain the best professionals in the countries in which it operates. Table 7 in Key  metrics (p. 71) Gruop excluding USA 103-1 Explanation of the material del tema material” del Índice de topic and its boundary contenidos GRI (P. 86-102). P. 14-15, columna “Cobertura 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 54-59. P. 54-59. 203-1 Infrastructure investments and services supported P. 56, 58-59. 203-2 Signifcant indirect economic impacts P. 56, 58-59. 103-1 Explanation of the material del tema material” del Índice de topic and its boundary contenidos GRI (P. 89-101). P. 14-15, columna “Cobertura GRI 103: ENFOQUE DE GESTIÓN 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 46-47 P. 46-47 GRI 204: PROCUREMENT PRACTICES 204-1 Proportion of spending on local suppliers P. 46-47 103-1 Explanation of the material del tema material” del Índice de topic and its boundary contenidos GRI (P. 86-102). P. 14-15, columna “Cobertura 103-2 The management approach and its components 103-3 Evaluation of the management approach 205-1 Operations assessed for risks related to corruption 205-2 Communication and training about anti-corruption policies and procedures 205-3 Confrmed incidents of corruption and actions taken P. 20-21, 23, 24-25, 31 and 47. P. 20-21, 23, 24-25, 31 and 47. Risk management chapter Group Risk management chapter Risk management chapter Group Group - - - Group Group - - - - - - Group √8 √ √ √ √ √ √ √ √ √ √ √ √ √ √ √6 GRI 103: MANAGEMENT APPROACH GRI 202: MARKET PRESENCE GRI 103: MANAGEMENT APPROACH GRI 203: INDIRECT ECONOMIC IMPACT Attracting and retaining talent / Diversity / Community investment Internal INDIRECT ECONOMIC IMPACT Community investment External PROCUREMENT PRACTICES Ethical behaviour and risk management External ANTI-CORRUPTION Ethical behaviour and risk management / Compliance and adapting to regulatory changes / Corporate governance- transparency Internal and external GRI 103: MANAGEMENT APPROACH GRI 205: ANTI- CORRUPTION 90 2018 Annual Report Identifed material aspect Material aspect boundary GRI Standard ANTI-COMPETITIVE BEHAVIOR Disclosure Page/Omission Scope Review - - - √ √ √ Group √5 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p. 86-102) GRI 103: MANAGEMENT APPROACH 103-2 The management approach and its components 103-3 Evaluation of the management approach Ethical behaviour and risk management / Compliance and adapting to regulatory changes Internal and external GRI 206: ANTI- COMPETITIVE BEHAVIOUR 206-1 Legal actions for anti- competitive behavior, anti-trust, and monopoly practices P. 20-21, 23, 24-25, 31 ,47 and column “Page/Omission” of the GRI 206: Anti-competitive Behaviour (p. 91). P. 20-21, 23, 24-25, 31 ,47 and column “Page/Omission” of the GRI 206: Anti-competitive Behaviour (p. 91). After an administrative investigation on several fnancial entities, including Banco Santander, S.A., in relation to possible collusive practices or price-fxing agreements, as well as exchange of commercially sensitive information in relation to fnancial derivative instruments used as hedge of interest rate risk for syndicated loans, on 13 February 2018, the Competition Directorate of the Spanish “National Commission for Antitrust and Markets” (CNMC) published its decision, by which it fned the Bank and another three fnancial institutions with EUR 91 million (EUR 23.9 million for the Bank) for ofering interest rate derivatives in breach of Articles 1 of the Spanish Act 15/2007 on Defence of Competition and 101 of the Treaty of Functioning of the European Union. According to the CNMC, there is evidence that there was coordination between the hedging banks/lenders to coordinate the price of the derivatives and ofer clients, in each case, a price diferent from the “market price”. This decision has been appealed before the Spanish National Court by the Bank, that has already paid the fne. The Italian Competition Authority has imposed to Banca PSA Italia a fne of € 6.077.606 as part of an investigation against the Captive Banks, Assofn and Assilea. According to the decision, the Captive Banks, Assofn and Assilea ran an unlawful cartel from 2003 to April 2017, aimed at exchanging sensitive commercial information in the car fnancing market in Italy, in order to restrict competition for the sale of fnanced cars, in violation of Article 101 TFEU. The decision will be appeal. Further information on litigation and other Group contingencies can be found in the Auditor’s Report and Annual Accounts ENVIRONMENTAL STANDARDS MATERIALS Internal environmental footprint Internal and external GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components P. 62, 63, 64, 66, 68-69. 103-3 Evaluation of the management approach 301-1 Materials used by weight or volume P. 62, 63, 64, 66, 68-69. P. 69 and table 24 de Principales métricas (P. 76). Group - - - √ √ √ √4 GRI 301: MATERIALS 301-2 Recycled input materials used The percentage of the environmentally- friendly paper consumption with respect to the total consumption is 86%. This percentage includes both recycled and certifed paper 301-3 Reclaimed products and their packaging materials Not applicable due to the type of Group fnancial activity Group √4 Group NO 91 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Identifed material aspect Material aspect boundary GRI Standard ENERGY Disclosure Page/Omission Scope Review - - - Group Group Group Group - - - √ √ √ √4 NO √4 √ √ √ √4 NO NO NO NO NO 103-1 Explanation of the material topic and its boundary P. 12-13 and column "Material aspect boundary" of GRI Content Index (p. 86-102) GRI 103: MANAGEMENT APPROACH GRI 302: ENERGY 103-2 The management approach and its components 103-3 Evaluation of the management approach 302-1 Energy consumption within the organization 302-2 Energy consumption outside of the organization P. 62, 63, 64, 66 and 68-69. P. 62, 63, 64, 66 and 68-69. P. 69 and Table 24 in Key metrics (p. 76) Group Not available 302-3 Energy intensity Table 24 in Key metrics (p. 76) 302-4 Reduction of energy consumption 302-5 Reductions in energy requirements of products and services An specifc analysis of cause and efect relation for the implemented measures and of the obtained reduction is not available Not applicable due to the type of Group fnancial activity Group NO Group NO GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-101) 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 62, 63, 64, 66 and 68-69. P. 62, 63, 64, 66 and 68-69. - - - 303-1 Water withdrawal by source P. 69 and Table 24 in Key metrics (p. 76) Group GRI 303: WATER 303-2 Water sources signifcantly Not applicable due to the type afected by withdrawal of water of Group fnancial activity 303-3 Water recycled and reused Not applicable due to the type of Group fnancial activity GRI 103: MANAGEMENT APPROACH GRI 304: BIODIVERSITY 103-1 Explanation of the material topic and its boundary Not material Not material Not material 103-2 The management approach and its components 103-3 Evaluation of the management approach 304-1 Operational sites owned, leased, managed in, or adjacent to, protected areas and areas of high biodiversity value outside protected areas 304-2 Signifcant impacts of activities, products, and services on biodiversity 304-3 Habitats protected or restored 304-4 IUCN Red List species and national conservation list species with habitats in areas afected by operations Not material Group NO Not material Not material Group NO Group NO Not material Group NO Internal environmental footprint Internal and external WATER Internal environmental footprint Internal and external BIODIVERSITY Not material Not applicable 92 2018 Annual Report √ √ √ √4 √4 √4 √4 √ √ √ NO √4 NO NO NO √ √ √ Identifed material aspect Material aspect boundary GRI Standard EMISSIONS GRI 103: MANAGEMENT APPROACH Internal environmental footprint Internal and external GRI 305: EMISSIONS Disclosure Page/Omission Scope Review 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p. 86-101) 103-2 The management approach and its components 103-3 Evaluation of the management approach 305-1 Direct (Scope 1) GHG emissions 305-2 Energy indirect (Scope 2) GHG emissions 305-3 Other indirect (Scope 3) GHG emissions P. 62, 63, 64, 66 and 68-69. P. 62, 63, 64, 66 and 68-69. P. 69 and Table 24 in Key metrics (p. 76) Group P. 69 and Table 24 in Key metrics (p. 76) Group P. 69 and Table 24 in Key metrics (p. 76) Group - - - 305-4 GHG emissions intensity Table 24 in Key metrics (p. 76) Group 305-5 Reduction of GHG emissions An specifc analysis of cause and efect relation for the implemented measures and of the obtained reduction is not available 305-6 Emissions of ozone- depleting substances (ODS) Not applicable due to the type of Group fnancial activity 305-7 Nitrogen oxides (NOX), sulfur oxides (SOX), and other signifcant air emissions Not applicable due to the type of Group fnancial activity Group NO Group NO Group NO EFFLUENTS AND WASTE Internal environmental footprint Internal and external ENVIRONMENTAL COMPLIANCE Ethical behaviour and risk management / Compliance and adapting to regulatory changes Internal and external - - - Group GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p.86-101) 103-2 The management approach and its components P. 62, 63, 64, 66 and 68-69. 103-3 Evaluation of the management approach 306-1 Water discharge by quality and destination 306-2 Waste by type and disposal method P. 62, 63, 64, 66 and 68-69. Not applicable due to the type of Group fnancial activity P. 69 and Table 24 in Key metrics (p. 76) Group GRI 306: EFFLUENTS AND WASTE 306-3 Signifcant spills 306-4 Transport of hazardous waste Not applicable due to the type of Group fnancial activity Not applicable due to the type of Group fnancial activity 306-5 Water bodies afected by water discharges and/or runof Not applicable due to the type of Group fnancial activity GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p. 86-101) 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 32-33 P. 32-33 Group Group Group - - - GRI 307: ENVIRONMENTAL COMPLIANCE 307-1 Non-compliance with environmental laws and regulations The Bank has not received fnal sanctions for this concept. In addition, information on litigation and other Group contingencies can be found in Auditors’ report and annual consolidated accounts. Group √5 SUPPLIER ENVIRONMENTAL ASSESSMENT Ethical behaviour and risk management Internal and external GRI 103: MANAGEMENT APPROACH GRI 308: SUPPLIER ENVIRONMENTAL ASSESSMENT 103-1 Explanation of the material topic and its boundary P. 14-15 and column “Material aspect boundary” of GRI Content Index (p. 86-102) 103-2 The management approach and its components 103-3 Evaluation of the management approach 308-1 New suppliers that were screened using environmental criteria 308-2 Negative environmental impacts in the supply chain and actions taken P. 46-47 P. 46-47 P. 46-47 P. 46-47 - - - √ √ √ Group √8, 9 Group √8, 9 93 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Identifed material aspect Material aspect boundary GRI Standard Disclosure Page/Omission Scope Review SOCIAL STANDARDS EMPLOYMENT Attracting and retaining talent / Diversity Internal LABOUR/MANAGEMENT RELATIONS Attracting and retaining talent / Diversity Internal OCCUPATIONAL HEALTH AND SAFETY Attracting and retaining talent / Diversity Internal GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 27-28 and 56 P. 27-28 and 56 - - - 401-1 New employee hires and employee turnover P. 27-28 and 56 and Tables 10 and 11 in Key metrics (p. 70-72) Group √ √ √ √ GRI 401: EMPLOYMENT 401-2 Benefts provided to full-time employees that are not provided to temporary or part-time employees Benefts detailed in p. 26-29 are regarding only full-time employees Group √ 401-3 Parental leave Not available Group NO GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components Column "Page/Omission" of the GRI 402: Labor/Management relations" (p. 94) 103-3 Evaluation of the management approach Column "Page/Omission" of the GRI 402: Labor/Management relations" (p. 94) - - - √ √ √ GRI 402: LABOR/ MANAGEMENT RELATIONS 402-1 Minimum notice periods regarding operational changes Santander Group has not established any minimum period to give prior notice relating to organisational changes diferent from those required by law in each country Group √ GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components P. 34 y column "Page/Omission" of the GRI 403: Occupational Safe and Safety (p. 85) 103-3 Evaluation of the management approach P. 36 y column "Page/Omission" of the GRI 403: Occupational Safe and Safety (p. 87) - - - 403-1 Workers representation in formal joint management–worker health and safety committees In Banco Santander S.A, the percentage of workforce represented in the Health and Safety Committee in 100% Banco Santander S.A. and SCF √ √ √ √ GRI 403: OCCUPATIONAL HEALTH AND SAFETY 403-2 Types of injury and rates of injury, occupational diseases, lost days, and absenteeism, and number of work-related fatalities 403-3 Workers with high incidence or high risk of diseases related to their occupation 403-4 Health and safety topics covered in formal agreements with trade unions P. 36 and Tables 17, 18 and 19 in Key metrics (p. 73) Group √1 There have not been identifed work posts with high risk of desease Group NO Formal agreements with unions take into account issues concerning the health of workers and occupational health and safety, such as health monitoring and check-ups, both periodic for all workers and for workers returning from prolonged sick leave Banco Santander S.A. and SCF √ 94 2018 Annual Report Identifed material aspect Material aspect boundary GRI Standard TRAINING AND EDUCATION Disclosure Page/Omission Scope Review Attracting and retaining talent / Diversity Internal GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components P. 26,28-29. Column "Page/Omission" of the GRI 404: Training and education (p. 95) 103-3 Evaluation of the management approach P. 26,28-29. Column “Page/Omission” of the GRI 404: Training and education (p. 95) - - - 404-1 Average hours of training per year per employee P. 30-31 and tables 14, 15 and 16 in Key metrics (p. 72-73) GRI 404: TRAINING AND EDUCATION 404-2 Programs for upgrading employee skills and transition assistance programs Banco Santander in Spain ofers programmes for skills management and lifelong learning that support the employability of their employees once they have fnished their carrers or have been afected by collective redundancies. P. 28 y 30-31 and table 14 in Key metrics (p. 72) Group Banco Santander S.A. √ √ √ √ √ 404-3 Percentage of employees receiving regular performance and career development reviews P. 28-29. Regular performance and career development reviews are received by the 100% of the employees Group √ Group NO - - - √ √ √ DIVERSITY AND EQUAL OPPORTUNITY Attracting and retaining talent / Diversity / Incentives tied to ESG criteria Internal NON-DISCRIMINATION GRI 103: MANAGEMENT APPROACH GRI 405: DIVERSITY AND EQUAL OPPORTUNITIES 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (P. 86-102). 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 32-33 P. 32-33 - - - 405-1 Diversity of governance bodies and employees P. 18-19, 25, 32-33 and Tables 1, 3 and 6 in Key metrics (p. 70-71) Group √ √ √ √ 405-2 Ratio of basic salary and remuneration of women to men P.33 Ethical behaviour and risk management / Compliance and adapting to regulatory changes Internal and external GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary P. 14-15 and column "Material aspect boundary" of GRI Content Index (P. 86-102). 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 28-29 y 56. P. 28-29 y 56. GRI 406: NON- DISCRMINATION 406-1 Incidents of discrimination and corrective actions taken Risk management chapter Group √6 FREEDOM OF ASSOCIATION AND COLLECTIVE BARGAINING Not material Not applicable CHILD LABOR Not material Not applicable GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary Not material 103-2 The management approach and its components 103-3 Evaluation of the management approach Not material Not material - - - √ √ √ GRI 407: FREEDOM OF ASSOCIATION AND COLLECTIVE BARGAINING 407-1 Operations and suppliers in which the right to freedom of association and collective bargaining may be at risk Not material Group NO GRI 103: MANAGEMENT APPROACH GRI 408: CHILD LABOR 103-1 Explanation of the material topic and its boundary Not material 103-2 The management approach and its components 103-3 Evaluation of the management approach 408-1 Operations and suppliers at signifcant risk for incidents of child labor Not material Not material Not material - - - √ √ √ Group NO 95 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Disclosure Page/Omission Scope Review Identifed material aspect Material aspect boundary GRI Standard FORCED OR COMPULSORY LABOR Not material Not applicable GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material topic and its boundary Not material 103-2 The management approach and its components 103-3 Evaluation of the management approach Not material Not material Not material GRI 409: FORCED OR COMPULSORY LABOR 409-1 Operations and suppliers at signifcant risk for incidents of forced or compulsory labor - - - √ √ √ Group NO - - - √ √ √ - - - √ √ √ Group √2, 10 GRI 103: MANAGEMENT APPROACH GRI 410: SECUTIRY PRACTICES GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components Column "Page/Omission" of the GRI 410: Security Practices (p. 96) 103-3 Evaluation of the management approach 410-1 Security personnel trained in human rights policies or procedures Column "Page/Omission" of the GRI 410: Security Practices (p. 96) Santander requires to its Safety Services suppliers during the hiring process compliance with Human Rights Regulations Banco Santander √ S.A. 103-1 Explanation of the material P. 12-13 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components P. 66 and Column "Page/Omission" of the GRI 411: Rights of Indigenous People (p. 96) 103-3 Evaluation of the management approach P. 66 and Column “Page/Omission” of the GRI 411: Rights of Indigenous People (p. 96) GRI 411: RIGHTS OF INIDGENOUS PEOPLE 411-1 Incidents of violations involving rights of indigenous people The Bank ensures, through social and environmental risk assessments in their fnancing operations under the Equator Principles, that no violations of the indigenous peoples’ rights occur in such operations. GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components Column "Page/Omission" of the GRI 412: Human Rights assessment (p. 96) 103-3 Evaluation of the management approach Column "Page/Omission" of the GRI 412: Human Rights assessment (p. 96) - - - √ √ √ 412-1 Operations that have been subject to human rights reviews or impact assessments All the Bank’s fnancing operations under the Equator Principles are subject to social and environmental risk assessments (which includes human rights aspects). In 2018, a total of 35 operations were evaluated in this respect. Group 10 √ GRI 412: HUMAN RIGHTS ASSESSMENT 412-2 Employee training on human rights policies or procedures Not available Group NO 412-3 Signifcant investment agreements and contracts that include human rights clauses or that underwent human rights screening A new supplier certifcation policy was approved in 2018. This policy includes an annex with the “principles of responsible conduct for suppliers”. These principles are mandatory for all the Bank’s suppliers and include, among others, human rights aspects. √2 SECURITY PRACTICES Ethical behaviour and risk management / Compliance and adapting to regulatory changes Internal and external RIGHTS OF INDIGENOUS PEOPLES Ethical behaviour and risk management / Compliance and adapting to regulatory changes External HUMAN RIGHTS ASSESSMENT Ethical behaviour and risk management / Compliance and adapting to regulatory changes External 96 2018 Annual Report Identifed material aspect Material aspect boundary GRI Standard LOCAL COMMUNITIES Disclosure Page/Omission Scope Review GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p.86-102) 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 54-59 and 62-63 P. 54-59 and 62-63 √ √ √ Community investment External 413-1 Operations with local community engagement, impact assessments, and development programs GRI 413: LOCAL COMMUNITIES The Santander Group has several programmes in its ten main countries aim to encourage development and participation of local communities, in which it is carried out an assessment on people helped, scholarships given through agreement with Universities, among others. Moreover, in the last years the Group has developed diferent products and services ofering social and/or environmental added value adapted to each country where Santander developes its activities. P. 54-59 y 56-57. Group √11 413-2 Operations with signifcant actual and potential negative impacts on local communities Not available Group NO SUPPLIER SOCIAL ASSESSMENT Control and management of risks, ethics and compliance Internal and external PUBLIC POLICY Ethical behaviour and risk management / Compliance and adapting to regulatory changes Internal and external CUSTOMER HEALTH SAFETY Products and services that are transparent and fair GRI 103: MANAGEMENT APPROACH GRI 414: SUPPLIER SOCIAL ASSESSMENT 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components 103-3 Evaluation of the management approach 414-1 New suppliers that were screened using social criteria 414-2 Negative social impacts in the supply chain and actions taken P. 46-47 P. 46-47 P. 46-47 P. 46-47 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) GRI 103: MANAGEMENT APPROACH 103-2 The management approach and its components 103-3 Evaluation of the management approach GRI 415: PUBLIC POLICY 415-1 Political contributions P. 20-21, 23, 24-25, 31 and 47 and column “Page/Omission” of the GRI 415: Public Policy (p. 97) P. 20-21, 23, 24-25, 31 and 47 and column “Page/Omission” of the GRI 415: Public Policy (p. 97) The vinculation, memebership or collaboration with political parties or with other kind of entities, institutions os associations with public purposes, as well as contributions or services to them, should be done in a way that can assure the personal character and that avoids any involvement of the Group, as indicated in Santander Group General Code of Conduct GRI 103: MANAGEMENT APPROACH GRI 416: CUSTOMER HEALTH AND SAFETY 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 38-41 P. 38-41 416-1 Assessment of the health and safety impacts of product and service categories 416-2 Incidents of non- compliance concerning the health and safety impacts of products and services The Commercialisation Committee evaluates potential impact of all products and services, previously they are launched onto the market. These impacts include, among others, clients security and compatibility with other products (p. 38-41) The Bank has not received fnal sanctions for this concept. In addition, information on litigation and other Group contingencies can be found in Auditors’ report and annual consolidated accounts. - - - √ √ √ Group √8 9 Group √8 9 - - - √ √ √ Group √2 - - - √ √ √ Group √ Group √5 97 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementIdentifed material aspect Material aspect boundary GRI Standard MARKETING AND LABELING Disclosure Page/Omission Scope Review GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 38-41 P. 38-41 Products and services that are transparent and fair Internal and external GRI 417: MARKETING AND LABELING 417-1 Requirements for product and service information and labeling 417-2 Incidents of non-compliance concerning product and service information and labeling 417-3 Incidents of non- compliance concerning marketing communications The Commercialisation Committee evaluates potential impact of all products and services, previously they are launched onto the market. These impacts include, among others, clients security and compatibility with other products (p. 38-41). In addition, the Bank is member of the Association for Commercial Self- Regulation (Autocontrol) assuming the ethical commitment to be responsible regarding the freedom of commercial communication A fne of 120.000 euros imposed by the Instituto Vasco de Consumo for an alleged abuse of the clause of expenses of mortgage loan contracts by the Bank. The decision has been appealed. A fne of 4.5 million euros imposed by Bank of Spain for breaches relating to the content and delivery of contractual and pre-contractual information of contracts with mortgage guarantee and in relation to the collection of commissions and roundings, by the former Banco Popular A fne of 4.5 million euros imposed by the CNMV for the undue collection of incentives derived from investments in foreign and domestic collective investment schemes by the Bank. Moreover, the information regarding litigation and the Group's other contingencies is provided in the auditor's report and annual accounts. In Spain, the Bank forms part of the Spanish Advertising Association (AEA). It is also a member of the Association for the Self- regulation of Commercial Communication, which in turn is a member of the European Advertising Standards Alliance. On November 20 2018, SC and the CFPB resolved an investigation of SC’s marketing of gap waiver coverage – a product that provides coverage for the amount of the outstanding automobile loan in the event of a total loss of the vehicle (through accident or theft) where the insurance proceeds are less than the amount owed on the vehicle at the time of the loss -- and disclosures associated with loan deferrals and extensions pursuant to a Consent Order which requires SC to (1) pay approximately $2 million in customer remediation; (2) a civil monetary penalty of $2.5 million; and waive approximately $7.2 million of balances. Information on litigation and other Group contingencies can be found in Auditors’ report and annual consolidated accounts . - - - √ √ √ Group √7 Group √5 Group √5 CUSTOMER PRIVACY Measures taken for customer satisfaction Internal and external GRI 103: MANAGEMENT APPROACH 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) 103-2 The management approach and its components 103-3 Evaluation of the management approach P. 38-41 P. 38-41 GRI 418: CUSTOMER PRIVACY 418-1 Substantiated complaints concerning breaches of customer privacy and losses of customer data The Bank has not received fnal sanctions for this concept. In addition, information on litigation and other Group contingencies can be found in Auditors’ report and annual consolidated accounts. - - - √ √ √ Group √5 98 2018 Annual Report Identifed material aspect Material aspect boundary GRI Standard SOCIOECONOMIC COMPLIANCE Disclosure Page/Omission Scope Review Products and services that are transparent and fair / Ethical behaviour and risk management Internal and external 103-1 Explanation of the material P. 14-15 and column "Material aspect topic and its boundary boundary" of GRI Content Index (p. 86-102) GRI 103: MANAGEMENT APPROACH 103-2 The management approach and its components 103-3 Evaluation of the management approach GRI 419: SOCIOECONOMIC COMPLIANCE 419-1 Non-compliance with laws and regulations in the social and economic area P. 20-21, 23, 24-25, 31 and 47.and column “Page/Omission” of the GRI 419: Socioeconomic Compliance (p. 99) P. 20-21, 23, 24-25, 31 and 47.and column “Page/Omission” of the GRI 419: Socioeconomic Compliance (p. 99) The Bank has not received fnal sanctions for this concept. In addition, information on litigation and other Group contingencies can be found in Auditors’ report and annual consolidated accounts. - - - √ √ √ Group √5 99 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementGRI Standards - fnancial services sector disclosures Identifed material aspects Material aspect boundary G4 Standard Disclosure Page/Omission Scope Review FINANCIAL SERVICES SECTOR DISCLOSURES PRODUCT PORTFOLIO FS1 FS2 FS3 FS4 FS5 FS6 FS7 FS8 Policies with specifc environmental and social components applied to business lines Procedures for assesign and screening environmental and social risks in business lines Processes for monitoring clients´ implementation of and compliance with environmental and social requirements included in agreements of transactions Process(es) for improving staf competency to implement the environmentas and social policies and procedures as applied to business lines Interactions with clients/ investees/business partners regarding environmental and social risks and opportunities Percentage of the portfolio for business lines by specifc region, size (e.g. micro/ SME/large) and by sector Moneraty value of products and services designed to deliver a specifc social beneft for each business line broken down by purpose Monetary value of products and servicies designed to deliver a specifc environmental beneft foir each business line broken down by purpose P. 18-19 Group √ P. 18-19, 38-41 and 66. Group √ P. 18-19, 38-41 and 66. Group √ To raise awareness and transmit the policies content, the Bank has continued with its employee training and awareness campaigns. The latest was a video tutorial explaining the process of adaptation for the sector-specifc policies and involving those from the Bank who are ultimately responsible for this area Group √ P. 20-21 and 45 Group √ P. 38-41 Group √ P. 50-54 Group √ P. 50-54 Group √ Ethical behaviour and risk management / Compliance and adapting to regulatory changes / Products and services that are transparent and fair / Products and servicies ofering social and environmental added value Internal and external 100 2018 Annual Report Identifed material aspects Material aspect boundary G4 Standard Disclosure Page/Omission Scope Review AUDIT Ethical behaviour and risk management / Compliance and adapting to regulatory changes Internal and external FS9 Coverage and frequency of audits to assess implementation of environmental and social policies and risk assesment procedures ACTIVE OWNERSHIP The Group’s Internal Audit Area conducts a bi-annual review of the sustainability function to assess, among other aspects, the degree of compliance with the Social and Environmental Responsibility Policies, which include both the revision of the Equator Principles and other additional procedures of risk assessment on specifc sectors. The last one was carried out in 2016 Group √ FS10 Percentage and number of companies held in the instituition´s portfolio with which the reporting organization has interacted on environmental or social issues P. 66 Group √10 FS11 Percentage of assets subject to positive and negative environmental or social screening P. 66 Group √10 Ethical behaviour and risk management / Compliance and adapting to regulatory changes / Products and services that are transparent and fair / Products and servicies ofering social and environmental added value Internal FS12 Voting policy(ies) applied to environmental or social issues for shares over which the reporting organization hold the right to vote shares pr advises on voting The Santander Group has no voting policies relating to social and/or environmental matters for entities over which acts as an advisor. The Santander Employees Pension Fund does have a policy of formal vote in relation to socuial and environmental aspects, for shareholder meetings of the entities over which it has voting rights Group √ FS13 FS14 FS15 FS16 Access points in low- populated or economically disadvantaged areas by type P. 54 Group √ Initiatives to improve access to fnancial servicies for disadvantaged people P. 48-50 and Table 21 in Key metrics (p. 75) Group √ Policies for the fair design and sale of fnancial products and servicies P. 38-41 Group √ Initiatives to enhance fnancial literacy by type of benefciary P. 38-41 Group √ 101 Responsible bankingCorporate governanceEconomic and financial reviewRisk management  The independent verification report is included in p. 103-105 of this chapter. √ Reviewed content according to described scope. NO Non reviewed content. 1. Only information regarding owned employees is disclosed. 2. Only qualitative information is disclosed. 3. Not broken down by gender. 4. The scope and limitations of this indicator are described on p. 57. 5. Information is provided on accounting provisions for claims of any type and over €60,000. 6. Information is provided on the total number of complaints channels, for any reason. 7. Information about each type of products and services is not detailed. 8. Data refers exclusively to centralised purchases data in Aquánima. 9. Only total amount of approved suppliers is included. 10. Information is only provided on the number of project fnance deals of Santander’s Bank, which have been analysed regarding social and environmental risks in Equator Principles’ frame. 11. Information is provided on programmes and their direct impacts of the ten main countries of the Group, instead on centers. 102 2018 Annual Report Independent verification report Independent verification report 103 Responsible bankingCorporate governanceEconomic and financial reviewRisk management104 2018 Annual Report 105 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementCorporate governance 1 Overview of corporate governance in 2018 Redesigned corporate governance report 1.1 Refreshing the board 1.2 Ne w responsible banking, sustainability and culture committee 1.3 Achieving our 2018 priorities 1.4 C ontinued improvement in corporate governance 1.5 Priorities for 2019 2 Ownership structure 2.1 Share capital 2.2 Authority to increase capital 2.3 Signifcant shareholders 2.4 Shareholders’ agreements 2.5 Treasury shares 2.6 St ock market information 3 Shareholders. Engagement and shareholders meeting 3.1 Shareholder engagement 3.2 Shareholder rights 3.3 Dividend policy 3.4 2018 AGM 3.5 Our coming 2019 AGM 4 Board of directors 4.1 Our directors 4.2 Board composition 4.3 Board functioning and efectiveness 4.4 Audit committee activities in 2018 108 108 108 109 109 110 111 112 112 112 113 114 114 115 116 116 117 119 120 122 124 126 132 140 151 4.5 Appointments committee activities in 2018 156 4.6 Remuneration committee activities in 2018 159 4.7 Risk supervision, r egulation and compliance committee activities in 2018 162 6 Remuneration 6.1 Principles of the remuneration policy 6.2 R emuneration of directors for the performance of supervisory and collective decision-making duties: policy applied in 2018 6.3 R emuneration of directors for the performance of executive duties 6.4 Dir ectors remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders 172 172 173 175 186 6.5 Pr eparatory work and decision-making process with a description of the participation of the remuneration committee 192 6.6 R emuneration of non-director members of senior management 193 6.7 Prudentiall y signifcant disclosures document 194 7 Group structure and internal governance 7.1 Corporate Centre 7.2 Internal governance of the Group 196 196 196 8 Internal control over fnancial reporting (ICFR) 198 8.1 Control environment 8.2 Risk assessment in fnancial reporting 8.3 Control activities 8.4 Information and communication 8.5 Monitoring 8.6 External auditor report 9 Other corporate governance information 198 200 201 202 204 205 208 9.1 R econciliation to CNMV’s corporate governance report model 208 9.2 St atistical information on corporate governance required by CNMV 211 9.3 Cr oss-reference table for comply or explain in corporate governance recommendations 230 9.4 R econciliation to CNMV’s remuneration report model 231 232 239 4.8 R elated-party transactions and conficts of interest 5 Management team 167 169 9.5 St atistical information on remuneration required by CNMV 9.6 Other information of interest 106 2018 Annual Report 107 Responsible bankingCorporate governanceEconomic and financial reviewRisk management1. Overview of corporate governance in 2018 Redesigned corporate governance report On 12 June 2018, the Spanish National Securities Market Commission (CNMV) approved new formats for the annual corporate governance and remuneration reports required for listed Spanish companies and, more importantly, allowed companies to draft their reports in a free format. This welcome regulatory fexibility, together with the fresh look that we have given to this 2018 consolidated directors' report (see introduction to this report on page 2) has led to a new approach being adopted for the 2018 corporate governance report which now consists in this chapter in the consolidated directors' report. Key to understanding the changes: • In this 2018 corporate governance report, we have opted to follow a free format. • This has allowed us in this 2018 corporate governance report to merge (1) the summary content that we typically included in the annual report and (2) the legally required content for the corporate governance report proper. • With the purpose of providing a holistic view of our corporate governance practices in one single document, we have also included in this 2018 report the content that was previously set out in the reports on the activities of our board of directors’ committees (see sections 4.4 to 4.7). • This year’s report also includes (1) the annual report on directors’ remuneration that we are required to prepare and submit to a non-binding vote at our annual general shareholders’ meeting (AGM), (see section 6 'Remuneration') and, (2) our directors’ remuneration policy, (see section 6.4 'Directors remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders' at our 2019 AGM). These were published previously separately but there was signifcant overlap with the corporate governance report. • Therefore, we now publish in a single document the content that was previously included in at least fve documents covering the same subject matter. It is important to point out that the new format does not imply a reduction in the information we provide. It simply presents it in a more rational and organised manner. To achieve this, the 2018 corporate governance report does not fully diverge from its previous format: • Section 9.1 'Reconciliation to CNMV’s corporate governance report model' and section 9.4 'Reconciliation to CNMV’s remuneration report model' include cross references to where information can be found in this chapter or elsewhere in this annual report for each section of the corporate governance and remuneration reports in CNMV's prescribed format. • Moreover, we have traditionally flled in the 'comply or explain' section for all recommendations in the Spanish Corporate Governance Code for Listed Companies to establish where we comply and also the few instances where we do not comply or we comply partially. Therefore, have included in section 9.3 'Cross-reference table for comply or explain in corporate governance recommendations' a chart with cross- references showing where the information supporting each response can be found in this 2018 corporate governance chapter or elsewhere in this consolidated directors´report. 1.1 Refreshing the board Continued board composition improvement Throughout 2018, we continued to refresh and strengthen our board, refecting our strong commitment to ensuring balance and diversity. The main board changes were as follows: Mr Álvaro Cardoso de Souza was appointed as an independent director at our 2018 AGM. He flled the vacancy left by executive director Mr Matías Rodríguez Inciarte. Mr Álvaro Cardoso de Souza strengthens the international diversity of the board and brings to it his strong industry experience, which also reinforces the overall risk management and accounting skills within the board. This experience was acquired in an international environment considered strategic for our Group, as he has held diferent executive positions at Citibank and several listed companies in Brazil. • Mr Henrique de Castro has been proposed by the board of directors for election at our 2019 AGM as new independent director to fll the vacancy left by Mr Juan Miguel Villar Mir on 1 January 2019. 108 2018 Annual Report Mr Henrique de Castro brings to the board his sound experience in the technological and digital industry along with signifcant experience in the US market, which he has acquired through top positions held in companies such as Yahoo! Inc. and Google, Inc. • Mr José Antonio Álvarez, who continues as our Chief Executive Ofcer (CEO), has been appointed executive vice chairman of the board on 15 January 2019. Mr Guillermo de la Dehesa, in turn, continues as director but ceased to be vice chairman on that date. Changes Stepping down from role Increase in independent Mr Matías directors Rodríguez Inciarte de Souza Taking up role Mr Álvaro Cardoso Refreshment of independent directors Mr Juan Miguel Villar Mir Mr Henrique de Castro Refreshment of vice chairman Mr Guillermo de la Dehesa Mr José Antonio Álvarez Board committees Our board has also made changes to the composition of its committees, in order to continue strengthening their performance and support to the board in their respective areas, according to the best international practices and internal rules and regulations. The changes efected are: • Executive committee: Ms Belén Romana became a member of the committee on 1 July 2018, increasing the number of independent directors in the committee. • Appointments committee: Mr Ignacio Benjumea left the committee on 1 July 2018, diferentiating the composition of the appointments committee from the remuneration committee, in line with best practices. • Risk supervision, regulation and compliance committee: Mr Álvaro Cardoso de Souza became a member of the committee on 23 April 2018 and subsequently was appointed as its chairman on 1 October 2018. Mr Bruce Carnegie-Brown, the former chairman, left the committee on 1 January 2019, following a suitable transition period. Mr Guillermo de la Dehesa left the committee on 1 July 2018. • Innovation and technology committee: Mr Rodrigo Echenique Gordillo and Ms Esther Giménez-Salinas i Colomer left the committee on 1 July 2018. • The new responsible banking, sustainability and culture committee was established, appointing Mr Ramiro Mato García- Ansorena as chairman and Ms Ana Botín-Sanz de Sautuola y O’Shea, Ms Belén Romana García, Ms Homaira Akbari, Ms Sol Daurella Comadrán, Ms Esther Giménez-Salinas i Colomer and Mr Ignacio Benjumea Cabeza de Vaca as members. On 24 July 2018 Mr Álvaro Cardoso de Souza was appointed also member of this committee. 1.2 New responsible banking, sustainability and culture committee Our board has created a responsible banking, sustainability and culture committee to help the Group progress towards its goal of being a more responsible Bank. The committee’s purpose is to assist our board in pursuing and reviewing the corporate culture and values and to advise on its relations with the various stakeholders, especially employees, customers and communities in which our Group carries out its activities. The committee will also supervise the way in which the Group manages business responsibly and how we are helping people and businesses prosper. For further information see 'Responsible banking, sustainability and culture committee' in section 4.3 of this chapter and the 'Responsible banking' chapter. 1.3 Achieving our 2018 priorities The 2017 annual report disclosed our corporate governance goals and priorities for 2018. The following chart describes how we have delivered on each priority. 109 Overview of corporate governance in 2018Responsible bankingCorporate governanceEconomic and financial reviewRisk management 2018 goals How we have delivered Board refreshment Strengthen the composition of the board of directors, showing commitment to international diversity, especially from the strategic markets in which the Group operates, and ensure a suitable composition of the committees to improve performance of their functions and their respective areas of action. Boardroom Further improve the independence of the board by increasing the number of meetings between the independent board members and the lead independent director. Board dynamics Intensify the board’s dedication to strategic matters and, in addition to the specifc annual meeting dedicated specifcally to strategic matters, hold a meeting every six months on the progress of the strategic plan. Dedication to the supervision of emerging risks and cybersecurity will also be strengthened. Board committees Continue strengthening the functions and activities of the committees in advising and supporting the board. Responsible banking, sustainability and culture committee Establish the new responsible banking, sustainability and culture committee. Intensify the board’s involvement in the development of corporate culture and its commitment to responsible business practices in relation to diversity, inclusion and sustainability. Regulatory framework Execute the modifcations introduced in the Rules and regulations of the board, putting into practice the best operating practices of our governance bodies that arise from the new guidelines issued by the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA), and also meet the expectations of the supervisor. Throughout 2018, signifcant work has been carried out to ensure that the overall composition and skills of our board of directors and board committees are appropriate. Desired areas of experience were identifed and incorporated into board succession and recruitment planning overseen by the appointments committee. Mr Álvaro Cardoso de Souza’s appointment has further strengthened the board’s international diversity, specifcally in relation to Latin America / Brazil. Section 1.1 'Refreshing the board' describes other changes and improvements made to the composition of our board and board committees. In addition, the tenure of board members remained a key area of focus, ensuring that an appropriate balance between board refreshment and retaining continuity and stability was achieved. Our appointments committee also assessed the composition of the board committees to ensure continuity of efectiveness, skillset, experience, overall stability and appropriate distribution of workload following the creation of the responsible banking, sustainability and culture committee. The number of private meetings between independent directors and the lead independent director was increased, scheduled at regular intervals throughout the year. Our board reviews the progress of the strategic plan on a regular basis in line with the established priority, and held its annual Strategy Day in June 2018. Our board has focused closely on emerging risks, including cybersecurity risks. Our Group chief risk ofcer reports to the board on a monthly basis on all risks and the Group cybersecurity ofcer reports on cybersecurity matters on a quarterly basis. All board committee functions are under constant review to ensure that all matters reviewed by the board have been previously assessed and challenged by the appropriate board committee(s). In addition, the main issues addressed by our committees are disclosed to our board as part of the report made by the relevant committee chair to the board in each meeting. Our responsible banking, sustainability and culture committee has been set up in June 2018. See section 1.2 'New responsible banking, sustainability and culture committee'. The committee’s key areas include whistleblowing, corporate culture, disclosure of the Bank’s approach to tax and the Bank’s approach to various stakeholders; in addition to the oversight and scrutiny of how the Bank is fulflling its purpose, including tackling issues such as fnancial exclusion, providing green fnance and supporting small- and medium-sized enterprises. The committee operates in full coordination with the risk supervision, regulation and compliance committee given convergence of responsibilities. Various actions have been taken: our audit committee has carried out a fnal assessment of the external auditor’s performance in relation to the audit of the annual fnancial statements, as well as an annual assessment of the internal audit function and the performance of the head of this function. The supervisory role of our risk supervision, regulation and compliance committee has been strengthened with regard to risk and compliance functions. The composition of the appointments committee has been modifed in line with best practices. 1.4 Continued improvement in corporate governance We have a strong commitment to continuously strengthening our corporate governance framework and further improving its soundness and efectiveness in the coming years. This is key to successfully fulflling our mission of becoming a more responsible Bank in an era of disruption, and to our success in tackling the many challenges that face us in today´s digital world. That is why, on top of delivering on our 2018 priorities and the other enhancements mentioned above, we have continued to work on improvements on corporate governance: • Greater transparency. As mentioned in the 'Introduction' to this consolidated directors’ report and in the introduction of this Corporate governance chapter, in 2018 we have taken a signifcant leap forward in terms of improved disclosure in corporate governance and generally. • Further insight into the skills of our directors. In our 2017 annual report we took the step of identifying each director in our board skills matrix. In this report, we have further revised 110 2018 Annual Report the matrix, adding new skills that have become relevant to our shareholders and ourselves (such as responsible banking and sustainability, human resources, talent, culture and remuneration), covering thematic skills, horizontal skills and diversity separately and including board tenure side-by-side for a clearer and more complete view . See 'Board skills and diversity matrix' in section 4.2. In addition, we have highlighted key skills attributed to each director in their profles under section 4.1 'Our directors'. • Moving to full gender equality at board level. On 26 February 2019 our board took the signifcant step of replacing our already achieved target of 30% of women representation in our board to a gender equality target that we will seek to achieve by 2021. This new gender equality target will mean that our board will strive to have a presence of women in the board of 40% to 60%. See section 4.2 'Board composition'. • Refecting our good long-standing practices in our Rules and regulations of the board. We have in many respects gone beyond our own board rules in adopting best practices in corporate governance. From time to time, we amend our Rules and regulations of the board to embed those practices more formally. These are just the latest examples: • Refecting in our Rules and regulations of the board the full independence of our audit committee. Since 2005, we have gone beyond what our Rules and regulations of the board require by having an audit committee composed entirely of independent directors. On 26 February 2019 our board decided to build that practice into a rule by amending our Rules and regulations of the board. See section 4.3 'Board functioning and efectiveness'. • The transferring of main responsibility for corporate governance to our appointments committee. The strong oversight of our appointments committee on board efectiveness has meant that it has increasingly dealt with corporate governance-related matters beyond efectiveness. On 26 February 2019 our board, following best practices, decided to broaden the mandate of our appointments committee in corporate governance matters and has correspondingly reduced that of the risk supervision, regulation and compliance committee. In addition, given his particular involvement in corporate governance of our lead director, engagement with shareholders and appointments issues, the board has also expressly provided in the Rules and regulations of the board for his membership of the appointments committee. See 'Rules and regulations of the board' in section 4.3. 1.5 Priorities for 2019 Our board’s priorities on corporate governance for 2019 are the following: • Responsible banking will be a higher priority than ever. Our culture and corporate values are essential for long term value creation. For these purposes we will focus on: • Overseeing our business practices to ensure they are sound and responsible and how we engage with all our stakeholders. • Strong governance in decisions relating to sustainability and responsible banking, as well as transparency and disclosure of our non-fnancial information (environmental, social, prevention of corruption and bribery, ethics, etc.) will be also key for our responsible banking, sustainability and culture committee. • Strategy: in the complex environment of today´s fnancial markets, the success of the Bank requires: • The understanding that innovation and digital/technological transformation are a catalyst in our business model and strategy, turning technology challenges into opportunities. • In addition to the close monitoring of emerging and geopolitical risks. • Engagement with investors and other stakeholders, closely monitored by: • Providing tailored feedback to all of stakeholders through, among others, the leadership of the lead independent director and one-to-one meetings, and meeting their expectations with transparency and reliability. Listening and giving voice to investors will enable the Bank to deliver better long term returns. • Leveraging on the implementation of the European Union shareholders’ rights directive and other legislation to enhance and encourage stakeholder relations. • Diversity in the boardroom: a strong and unbreakable commitment with broader diversity will remain a focus for our board and our appointments committee. The updated board skills and diversity matrix mentioned above will allow any gender and/or other types of imbalance to be addressed. Diversity is not a box to be ticked but a strategy for our success. • Ongoing board refreshment with an appropriate and diverse composition of our board and board committees, in addition to a balanced tenure within the board, will remain a priority for the coming years. • Compensation efectiveness: our board and the remuneration committee will continue to focus on shaping compensation structures and schemes for our executives, according to our corporate culture and values, while driving them towards alternative performance metrics. 111 Overview of corporate governance in 2018Responsible bankingCorporate governanceEconomic and financial reviewRisk management  2. Ownership structure Broad, widely distributed and well balanced shareholder base A single class of shares No takeover defences in our Bylaws Authorised capital in line with best practices, providing the necessary fexibility 2.1 Share capital Our share capital is represented by ordinary shares with a par value of 0.50 euros each. All shares belong to the same class and carry the same rights, including as to voting and dividend. There are no outstanding bonds or securities convertible into shares, other than the contingent convertible preferred securities (CCPPS) referred to in the next section 2.2 'Authority to increase capital'. At 31 December 2018, the Bank had a share capital of EUR 8,118,286,971 represented by 16,236,573,942 shares. In 2018, the share capital was altered only once through the capital increase made on 6 November 2018 as part of the Santander scrip dividend programme. A total of 100,420,360 new shares were issued representing 0.62% of the share capital at 31 December 2018. We have a broad, widely distributed and balanced shareholder structure. At 31 December 2018, the total number of Santander shares owned or represented by shareholders was 4,131,489 and the distribution by type of investor, continent and size of shareholding was as follows: Type of investor BoardA Institutional Retail Total % of share capital 1.13% 59.11% 39.76% 100% A. Shares owned or represented by directors. For further details on shares owned and represented by directors, see 'Tenure, committee membership and equity ownership' in section 4.2 and subsection A.3 in section 9.2 'Statistical information on corporate governance required by CNMV'. Continent Europe Americas Rest of the world Total % of share capital 77.29%  21.63% 1.08% 100% Size of shareholding % of share capital 1-3,000 3,001-30,000 30,001-400,000 Over 400,000 Total 9.44% 17.19% 11.60% 61.77% 100% 2.2 Authority to increase capital Under Spanish law, the authority to increase share capital rests with the general shareholder’s meeting (GSM). However, our GSM may delegate to our board of directors the authority to approve or execute capital increases. Our Bylaws are fully aligned with Spanish law, and do not establish any diferent conditions for share capital increases. At 31 December 2018, our board of directors has been authorised by the GSM to approve or execute the following capital increases: • Authorised capital to 2021: At our 2018 AGM, our board was authorised to increase share capital on one or more occasions and at any time by up to EUR 4,034,038,395.50 (or approx. 8,000 million shares representing approximately 49.70% of the share capital at 31 December 2018). This authority was granted for three years (i.e. until 23 March 2021). The authority can be used for issuances for a cash consideration, with or without pre-emptive rights for shareholders, and for capital increases to back any convertible bonds or securities issued under the authority granted to our board by the 2015 GSM to issue convertible bonds and securities. 112 2018 Annual Report Ownership structure The issuance of shares without pre-emptive rights under this authority is capped at EUR 1,613,615,358 (20% of capital at the time of the 2018 AGM or approx. 3,227 million shares representing approximately 19.88% of the share capital at 31 December 2018). This limit applies also to capital increases to convert bonds or other convertible securities, other than contingent convertible preferred securities (which can only be converted into newly-issued shares when the CET1 ratio falls below a pre-established threshold). This authority has not been used to date except in connection with the issuances of CCPS of 8 February 2019 mentioned below. • Capital increases approved for contingent conversion of CCPS: We have issued contingent convertible preferred securities that qualify as additional tier 1 instruments for regulatory capital purposes and which would convert into newly-issued shares if the CET1 ratio fall below a pre-established threshold. Each of these issuances is therefore backed by a capital increase approved under the authority to increase capital granted by the GSM to our board in force at the time of the CCPS issuance. The following chart shows the CCPS in circulation at the time of preparing this corporate governance report, with details of the capital increases backing them. The execution of these capital increases is therefore contingent and has been delegated to the board of directors. Issues of contingent convertible preferred securities Date of issuance Nominal amount Discretionary remuneration per annum Conversion 12/03/2014 EUR 1,500 million 6.25% for the frst fve years 19/05/2014 USD 1,500 million 6.375% for the frst fve years 11/09/2014 EUR 1,500 million 6.25% for the frst seven years 25/04/2017 EUR 750 million 6.75% for the frst fve years 29/09/2017 EUR 1,000 million 5.25% for the frst six years 19/03/2018 EUR 1,500 million 4.75% for the frst seven years 08/02/2019 USD 1,200 million 7.50% for the frst fve years If, at any time, the CET1 ratio of the Bank or the Group is less than 5.125% Maximum number of shares in case of conversionA 345,622,119 228,798,047 299,401,197 207,125,103 263,852,242 416,666,666 388,349,514 A. The fgure corresponds to the maximum number of shares that could be required to cover the conversion of the relevant CCPS, calculated as the quotient (rounded of by default) of the nominal amount of the CCPS issue divided by the minimum conversion price determined for each CCPS (subject to any anti-dilution adjustments and the resulting conversion ratio). • Annual delegation to execute a capital increase (which is nearing expiry and will not be renewed): As has occurred every year in the recent past, at our 2018 AGM, our board was delegated the power to execute a capital increase with pre- emptive rights for shareholders of EUR 500 million (or 1,000 million shares). Our board has not exercised this delegated power to date and the agreement will expire on the anniversary of our 2018 AGM (i.e. 23 March 2019). Our board will not propose the same delegation of power at our 2019 AGM in line with best practices in this area and the fact that the desired fexibility to increase capital is achieved with the authorised capital referred to above, which is consistent with those best practices. 2.3 Signifcant shareholders At 31 December 2018, no shareholder of the Bank individually held more than 3% of its total share capital (which is the signifcant threshold generally established under Spanish regulations for a signifcant holding in a listed company to be disclosed)1. Our Bylaws do not include any specifc provisions for signifcant holdings. While at 31 December 2018 certain custodians appeared in our register of shareholders as holding more than 3% of our share capital, we understand that those shares were held in custody on behalf of other investors, none of which exceed that threshold individually. These custodians are State Street Bank and Trust Company (13.091%), The Bank of New York Mellon Corporation (8.853%), Chase Nominees Limited (6.695%), EC Nominees Limited (3.958%) and BNP Paribas (3.791%). In addition, BlackRock Inc. had as of that date informed CNMV of its signifcant holding of voting rights in the Bank (5.585%) but had noted in its communications that the corresponding shares were being held for the account of a number of mutual funds or other investment entities, none of which exceeded 3% individually. Throughout 2018 BlackRock Inc. informed CNMV of the following movements regarding its voting rights in the Bank: 23 April, decrease below 5%, 8 May, increase above 5%, 24 July, decrease below 5%, 3 August, increase above 5%, and 11 December, decrease below 5%. In addition, the asset manager Capital Research and Management Company notifed CNMV that on 21 March 2018 it had increased its voting rights above 3%, and on 9 August 2018 that it had decreased it below 3%. The website of CNMV contains the aforementioned notices. It should be noted that there may be some overlap in the holdings declared by the above mentioned custodians and asset manager. 1. At 31 December 2018 neither our shareholders registry nor CNMV's registry showed any shareholder resident in a tax haven with a shareholding of 1% or higher of our share capital (which is the other threshold applicable under Spanish regulations). 113 Responsible bankingCorporate governanceEconomic and financial reviewRisk management While there are currently no shareholders qualifying as a signifcant shareholder, it should be noted that our Bylaws and Rules and regulations of the board provide an appropriate system for vetting and approving related party transactions as indicated in section 4.8 'Related-party transactions and conficts of interest'. Subsection A.7 of section 9.2 'Statistical information on corporate governance required by CNMV' shows the list of parties to the shareholders´ agreement. 2.5 Treasury shares 2.4 Shareholders’ agreements In February 2006, a shareholders’ agreement was entered into by various persons linked to the Botín-Sanz de Sautuola y O’Shea family whereby a syndicate was created with respect to the Bank’s shares. CNMV was informed of the execution of this agreement and the subsequent amendments made by the parties, and this information can be found on CNMV website2. There have been no amendments in fnancial year 2018. The main provisions of the agreement are the following: Our current treasury share policy was approved by our board on 23 October 2014, following recommendations published by CNMV in this respect. The policy provides that treasury share transactions shall have the following objectives3: • To provide liquidity or a supply of securities, as applicable, in the market for the Bank’s shares, giving depth to such market and minimising possible temporary imbalances in supply and demand. • To take advantage, for the beneft of shareholders as a whole, of situations of share price weakness in relation to medium-term performance prospects. • Transfer restrictions: except when the transferee is also a party to the agreement or the Fundación Botín, any transfer of the Bank’s shares expressly included in the agreement requires prior authorisation from the syndicate meeting, which may be granted or denied freely; and The policy further establishes that treasury share transactions may not be carried out for the purpose of intervening in the free formation of prices. Therefore, it requires that: • Orders to buy should be made at a price not higher than the greater of • Voting syndicate: under the agreement, the parties undertake to syndicate and pool the voting rights attached to their shares in the Bank, so that these rights may be exercised, and, in general, the syndicate members will act towards the Bank in a concerted manner, in accordance with the instructions and indications and with the voting criteria and orientation established by the syndicate. This syndication and pooling of voting rights covers not only the shares expressly attached to the syndicate under the agreement but also any voting rights attached to other Bank shares held either directly or indirectly by the parties to the agreement, and any other voting rights assigned thereto, for as long as they hold those shares or are assigned those rights. For this purpose, representation of the syndicated shares is attributed to the chair of the syndicate, who shall be the chairman of the Fundación Botín (currently Mr Francisco Javier Botín-Sanz de Sautuola y O’Shea). Ms Ana and Mr Javier Botín- Sanz de Sautuola y O’Shea are siblings. The initial term of the agreement ends on 1 January 2056, but it will be automatically extended for further 10-year periods unless terminated by one of the parties with 6-months prior notice before the end of the initial term or the end of one of the extension periods. The agreement may only be terminated by unanimous agreement of all the syndicated shareholders. At the date of execution of the agreement, the syndicate comprised a total of 44,396,513 shares of the Bank (0.273% of its share capital at the end of 2018). In addition, as established in the shareholders’ agreement, the syndication extends, solely with respect to the exercise of the voting rights, to other Bank shares held either directly or indirectly by the parties to the agreement, or whose voting rights are attributed to them, from time to time. Accordingly, at 31 December 2018, a further 39,057,250 shares (0.241% of the Bank’s share capital at such date) were also included in the syndicate. The total number of shares subject to the shareholders’ agreement was 79,798,339, representing 0.491% of the Bank’s share capital at such date. the following two: • The price of the last trade carried out in the market by independent persons; and • The highest price contained in a buy order of the order book. • Orders to sell should be made at a price not lower than the lesser of the following two: • The price of the last trade carried out in the market by independent persons; and • The lowest price contained in a sell order of the order book. Transactions with treasury shares are carried out by the Investments and Holdings department, which is isolated as a separate area from the rest of the Bank’s activities and protected by the respective Chinese walls, preventing it from receiving any inside or relevant information. Trading in treasury shares was last authorised at our 2018 AGM. This authorisation has a validity of fve years (i.e. until 23 March 2023) and permits the acquisition of treasury shares provided that the shares held at any point in time do not exceed the legal limit provided for under the Spanish Companies Act (currently, 10% of the Bank’s share capital). The authorization further requires that acquisitions are made at a price that is not lower than the nominal value of the shares and does not exceed the last trading price in the Spanish market for a transaction in which the Bank was not acting for its own account by more than 3%. We are proposing to our 2019 AGM the renewal of this authorization. See section 3.5 'Our coming 2019 AGM'. At 31 December 2018, the Bank and its subsidiaries held 12,249,652 shares representing 0.075% of our share capital at that date (compared to 3,913,340 at 31 December 2017, representing 0.024% of our Bank’s share capital). 2. For more information about this shareholder agreement, see material facts with entry numbers 64179, 171949, 177432, 194069, 211556, 218392, 223703 and 226968 fled in CNMV on 17 February 2006, 3 June 2012, 19 November 2012, 17 October, 2013, 3 October 2014, 6 February 2015, 29 May 2015 and 29 July 2015, respectively and also can be found on the Group's website. 3. The policy focuses on the discretionary trading of treasury shares. The policy applies partially to trading of treasury shares linked to customer activities, such as market risk hedging and brokerage activities, or hedging for customers. 114 2018 Annual Report Ownership structure The following chart summarises the monthly average percentages of treasury shares between 2018 and 2017. Monthly average percentages of treasury sharesA % of the Bank’s share capital at month end January February March April May June July August September October November December 2018 0.04% 0.03% 0.02% 0.04% 0.05% 0.07% 0.07% 0.07% 0.07% 0.07% 0.07% 0.07% 2017 0.05% 0.02% 0.01% 0.01% 0.02% 0.03% 0.07% 0.10% 0.09% 0.08% 0.07% 0.05% A. Monthly average of daily positions of treasury shares. In 2018, trading of treasury shares by the Bank and its subsidiaries involved: • The purchase of 206,780,988 shares equivalent to a par value of EUR 103,4 million (cash amount of EUR 1,026.4 million) at an average purchase price of EUR 4.96 per share; • The sale of 198,444,971 shares equivalent to a par value of EUR 99.2 million (cash amount of EUR 988.3 million) at an average price of EUR 4.98 per share; and • A net loss for the Group of EUR 118,080 that has been recognised in the Group’s equity under shareholders’ equity-reserves. Stock Exchange (with trading symbol SAN). They also trade on the unsponsored Sistema Internacional de Cotizaciones of the Mexican Stock Exchange (with trading symbol SANN). From July 2018 to early 2019, the number of secondary listings was streamlined and the Bank’s shares were delisted from the Buenos Aires, Milan, Lisbon and São Paulo stock exchanges. In Mexico the Bank shares have been delisted from the Índice de Precios y Cotizaciones and listed in the above mentioned Sistema Internacional de Cotizaciones. Share price performance Markets ended 2018 much lower, after a start to the year with rises driven by the positive impact of the US’s tax reform. This positive environment, however, dissipated in the following months because of greater volatility in stock markets mainly due to: (i) the political uncertainty in Italy and Brazil; (ii) the lack of agreement over Brexit; (iii) the increase in fnancial tensions in developing countries because of the dollar’s appreciation, after the Fed raised its interest rates and the European Central Bank (ECB) continued its policy of monetary normalisation and announced the end of quantitative easing and (iv) the escalation of trade tensions between US and China and its possible impact on confdence and the global economy. Fears of slowdown in the global economy, coupled with the partial shutdown of the US government, intensifed the fall in shares in the last part of the year. In this context, the main indices and the Santander share ended lower. The Santander share was down 27.5% at EUR 3.973, while Euro Stoxx Banks and Stoxx Banks fell 33.3% and 28.0%, respectively. The Spanish market Ibex 35 benchmark index declined 15.0%, the DJ Stoxx 50 13.1% and the MSCI World Banks 19.7%. Santander’s total shareholder return was 24.3% negative. Market capitalisation and trading As of 31 December 2018, Santander was the largest bank in the eurozone by market capitalisation (EUR 64,508 million) and 16th in the world. A total of 19,040 million Santander shares were traded during 2018 for an efective value of EUR 95,501 million, the largest fgure among the shares that comprise the EuroStoxx (liquidity ratio of 118%in 20184). The following chart refects the signifcant changes in treasury stock during the year, which have been communicated to CNMV. The Santander share Total of acquired Notifcation date direct shares Total of acquired indirect shares Total % of share capitalA 04/04/2018 128,699,007 32,857,278 1.002% 29/06/2018 76,457,880 8,469,406 0.526% A. Percentage calculated with the existing share capital at the date of the notifcation. 2.6 Stock market information Markets The Bank’s shares are listed on the Spanish stock exchanges (Madrid, Barcelona, Bilbao and Valencia, with trading symbol SAN), the New York Stock Exchange (NYSE) (in the form of American Depositary Shares, 'ADS', with trading symbol SAN and where each ADS represents one share of the Bank), the London Stock Exchange (in the form of Crest Depositary Interests, 'CDI', with trading symbol BNC and where each CDI represents one share of the Bank) and the Warsaw 4. Total volume of shares traded over average number of shares in issue. Shares (million) Price (EUR) Closing price Change in the price Maximum for the period Date of maximum for the period Minimum for the period Date of minimum for the period Average for the period End-of-period market capitalisation (million) Trading Total volume of shares traded (million) Average daily volume of shares traded (million) Total cash traded (EUR million) Average daily cash traded (EUR million) 2018 2017 16,236.6 16,136.2 3.973 -27.5% 6.093 5.479 +12.3% 6.246 26/01/18 08/05/17 3.800 4.838 27/12/18 02/01/17 4.844 5.562 64.508 88.410 19,040 20,222 74.7 79.3 95,501 113,665 374.5 445.7 115 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 3. Shareholders. Engagement and shareholders meeting One share, one vote, one dividend No takeover defences in our Bylaws High participation and engagement of shareholders in our AGM 3.1 Shareholder engagement The Bank is at the forefront of the best practices in engagement with shareholders and institutional investors, focusing in earning their lasting loyalty and driving proftability and sustainable growth to their investments, in a Simple, Personal and Fair way and according to our corporate culture and values. We consider transparency is vital to gain trust among our shareholders and other stakeholders and we take a proactive approach to align our reporting and disclosure with their expectations. We engage with investors actively, fairly and transparently in the following ways: • Annual engagement through the AGM. We consider our AGM as the most important annual corporate event for our shareholders. For that reason we strive to encourage the assistance and informed participation of our shareholders wherever they are based. See 'Participation of shareholders at the GSM' in section 3.2. With that aim we have adopted measures to facilitate the participation of shareholders in the AGM. In addition to make available to them the relevant information as required by law, we answer in writing all requests that shareholders send before the AGM in connection with the agenda. See 'Right to receive information' in section 3.2. Furthermore, during the AGM the chairman informs in sufcient detail on the most relevant developments of the Group's corporate governance, occurred during the year, supplementing the written information made available in the corporate governance report, and addresses any questions that the shareholders may pose verbally during the course of the general shareholders’ meeting in connection with the matters included in the agenda. When it is impossible to satisfy the shareholder's right during the course of the meeting, and in the case of those requests made by remote attendees at the meeting, the appropriate information is provided in writing within seven days after the end of the AGM. The chairmen of the audit, appointments and remuneration committees also report to the AGM on the tasks of those committees, supplementing the committees activities annual reports which are now included in this Corporate governance chapter. We also broadcast our GSMs live on our corporate website. This allows non-attending shareholders, other investors and stakeholders in general to be fully informed of the discussions and results. The record quorum and outstanding voting results in our 2018 AGM show the importance we put on engagement through our GSMs. See section 3.4 '2018 AGM'. • Quarterly results presentations. Each quarter we hold a results presentation on the same day we disclose those results. The results presentation can be followed live, via conference call or webcast. The corresponding fnancial report and results presentation material are available that day before the market opens. During the conference call it is possible to ask questions or send them via email to: investor@gruposantander.com. Our last event has been on 30 January 2019, when the 2018 Results Presentation took place. During 2018, the frst, second and third quarter results presentations took place on 24 April, 25 July and 31 October, respectively. • Investor and strategy days. We also organise investor and strategy days. These events allow our senior management to lay out our strategy for investors and stakeholders in a broader context than what results presentations typically allow. These events also allow investors to have direct interaction with senior management and some of our directors, something we see as increasingly important as a way to further underscore the strength of our board. In line with CNMV recommendations, announcements of meetings with analysts and investors and the documentation to be used at those meetings are published in advance by the Bank. The Bank has already announced that its next investor day will take place on 3 April 2019 in London5. 5. The information that will be made available in the investor day is not incorporated by reference in this annual report nor otherwise considered to be a part of it. 116 2018 Annual Report Shareholders. Engagement and shareholders meeting • Lead independent director engagement with key investors. Our lead independent director, Mr Bruce Carnegie-Brown, maintains regular contact with investors and shareholders in Europe and North America, particularly during the months prior to our AGM, allowing us to gather their insights and to form an opinion about their concerns, especially in connection with our corporate governance. As he is also chairman of the appointments and the remuneration committees, he is well suited to provide all the perspectives on the governance of the Group and get in detail investors sentiment and views. During 2018 and early 2019 he met with 30 investors in 7 diferent cities totalling a 22% of our share capital. The contribution of our lead independent director in incorporating international best practices, developing relations with institutional investors and providing them tailored feedback is highly valued by the other directors in our annual board self- assessment. • Investor roadshows. Our Investors Relations department is in constant contact with our investors, analysts and other stakeholders, seeking direct contact to provide all-round discussion on shareholder value, on covering also improvements to governance and remuneration structures and sustainability matters. During 2018 they had 1,134 contacts with 678 diferent institutional investors. Those included roadshows, 1 on 1 and group meetings and telephone calls. The team reached 33.62% of our share capital, that is more than 50% of the capital held by institutional investors. • Shareholder and Investor Relations team. As part of our exercise of openness towards our retail shareholders, during 2018 we held 252 events where they were informed about the latest results and the Group´s strategy, as well as the evolution of the share. Our Shareholders team has personally attended to 16,943 shareholders who represent 6.55% of the Bank´s share capital in diferent roadshows and 1 on 1 group meetings. To comply with our commitment to transparency and information, our Shareholder and Investor Relations team ofers numerous attention channels. In 2018, we responded to 166,149 queries received via our shareholder helplines, mailboxes and WhatsApp and achieved a 98% recommendation score in the satisfaction surveys carried out. New in 2018, and in line with our digital transformation and Simple, Personal and Fair culture, we launched a 'Virtual Customer' channel where shareholders can hold one-on-one meetings with the Shareholder and Investor Relations team using their mobile devices. • Proxy advisors, environment, social and governance (ESG) analysts and other infuencers. We have for a long time recognised the importance and value for our investors that can be obtained by seeking an open dialogue with corporate infuencers such as proxy advisors and ESG analysts. Ensuring our priorities and messages are well understood by those players translates into better communication to the end investors that look to them for advice or counsel. • Respect of fair disclosure principles. All our interactions with investors, analysts and other stakeholders follow the principle of fair disclosure and CNMV’s guidelines in this respect. Therefore, material information on our fnancial performance and prospects and other similarly relevant information is only disclosed in the types of interaction mentioned above or in other analysts meetings for which we announce the fact that the meeting will take place and publish the documentation that will be used, according to CNMV´s recommendations regarding informational meetings with analysts, institutional investors and other stock market professionals. The purpose of other interactions is therefore to better explain the public information available to all investors and be able to directly address and understand areas of interest or concern. Our policy for communicating with shareholders, institutional investors and proxy advisors establishes the rules and applicable practices in this respect, is respectful of market abuse regulations and dispenses similar treatment to all shareholders. The policy is published on the Bank´s corporate website. 3.2 Shareholder rights Our Bylaws provide for only one class of shares (ordinary shares), granting all holders the same rights. Each Santander share entitles the holder to one vote. The Bank does not have any defensive mechanisms in the Bylaws, fully conforming to the principle of one share, one vote, one dividend. In this section we highlight certain key features available to our shareholders. No restrictions on voting rights or on the free transfer of shares in our Bylaws There are no legal or bylaw restrictions on the exercise of voting rights except for those resulting from the failure to comply with applicable regulations as indicated below. There are no non-voting or multiple-voting shares, or shares giving preferential treatment in the distribution of dividends, or shares that limit the number of votes that can be cast by a single shareholder, or quorum requirements or qualifed majorities other than those established by law. There are no restrictions on the free transfer of shares other than the legal restrictions indicated in this section. The transferability of the shares is not restricted by our Bylaws or in any other manner other than by the application of legal and regulatory provisions. Likewise, there are no bylaw restrictions on the exercise of voting rights (except where an acquisition has been made in breach of legal or regulatory provisions). Further, the Bylaws do not include any neutralisation provisions (as these are referred to in Spanish Securities Market Law), which apply in the event of a tender ofer or takeover bid. 117 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Please also note that the shareholders’ agreement referred to in section 2.4 'Shareholders' agreements' contains transfer and voting restrictions on the shares subject to that agreement. These rights must be exercised by means of a certifed notice that must be received by the Bank’s registered ofce within fve days after the publication of the notice of the call to meeting. Legal and regulatory restrictions on the acquisition of signifcant holdings These legal and regulatory provisions apply mainly because of the Bank’s presence in regulated sectors (which implies that the acquisition of signifcant holdings or infuence is subject to regulatory approval or non-objection) and its status as a listed company (which implies that a tender ofer or takeover bid for the Bank’s shares must be made for the acquisition of control and other similar transactions). The acquisition of signifcant ownership interests is regulated mainly by: • Regulation (EU) 1024/2013 of the Council of 15 October 2013, conferring specific tasks on the ECB relating to the prudential supervision of credit institutions; • Spanish Securities Markets Law; and • Law 10/2014, of 26 June, on the organisation, supervision and solvency of credit institutions (articles 16 to 23) and its implementing regulation, Spanish Royal Decree 84/2015, of 13 February. The acquisition of a signifcant stake in the Bank may also require the authorisation of other domestic and foreign regulators with supervisory powers over the Bank’s and its subsidiaries' activities and shares listings or other actions in connection with those regulators or subsidiaries. Participation of shareholders at the GSM All registered holders of shares on record at least fve days prior to the day on which a meeting is scheduled to be held are entitled to attend. The Bank allows shareholders to exercise their rights to attend, delegate and vote using remote communication systems, which also foster participation in the GSM. Another communications channel available to shareholders is the electronic shareholders’ forum. This forum, which is available on our Bank’s corporate website at the time of the meeting, allows shareholders to post supplementary proposals to the agenda announced in the call notice, along with requests for support for those proposals, initiatives aimed at reaching the percentage required to exercise any of the minority shareholder rights provided for by law, as well as ofers or requests to act as a voluntary proxy. Supplement to the meeting call Shareholders representing at least 3% of the share capital may request the publication of a supplement to the AGM call with a statement of the name of the shareholders exercising this right and of the number of shares held by them, as well as the items to be included on the agenda, attaching a rationale or substantiated proposal for resolutions concerning these items and, if appropriate, any other relevant documentation. Shareholders representing at least 3% of the share capital may also submit duly grounded resolutions concerning matters that have already been included or to be included, relating to one or more items on the agenda. 118 Right to receive information From the publication of the call to the GSM until the ffth day, inclusive, prior to the date for which the meeting has been called at frst call, shareholders may deliver written requests for information or clarifcations, or submit written questions on issues they consider to be relevant concerning the items on the meeting agenda. In addition, in the same manner and within the same period, shareholders may deliver written requests for clarifcations concerning the relevant information that the Bank has provided to CNMV since the last GSM was held or concerning the auditor’s reports. The requested information and the answers provided by the Bank are published in its corporate website. Additionally, this information right may be exercised in the meeting itself but when it is impossible to satisfy the shareholder’s right during the course of the meeting, or those requests made by remote attendees at the meeting, the appropriate information is provided in writing within seven days following after the end of the GSM. Quorum and majorities required for passing resolutions at the GSM The quorum required to hold a valid general shareholders’ meeting and the system for adopting resolutions set out in our Bylaws and in the Rules and regulations for the Bank’s GSM are the same as those set down by Spanish law. Except for specifc matters as indicated below, the quorum on frst call shall be met by the attendance of shareholders representing at least twenty fve per cent of the subscribed share capital with the right to vote. If a sufcient quorum is not available, the GSM shall be held on second call, where no minimum quorum is required. For purposes of determining the quorum, shareholders who vote by mail or through electronic means before the meeting are counted as present at the meeting, as provided by the Rules and regulations for the Bank’s GSM. Except for specifc matters as indicated below, resolutions at GSMs are passed when, with respect to the voting capital present or represented at the meeting, the number of votes in favour is higher than the number of votes against. The quorum and majorities required for Bylaws amendments, issuances of shares and bonds, structural modifcations and other signifcant resolutions provided for in applicable law are those set out below for Bylaws amendments. In addition, pursuant to the rules applying to credit institutions, the increase above 100% (up to 200%) of the ratio of the variable remuneration components over the fxed ones for executive directors and other key function holders requires a qualifed majority of two thirds if there is a quorum of more than 50% and a majority of three quarters if there is not such a quorum. Our Bylaws do not require any decisions that entail an acquisition, disposal or contribution to another company of core assets or other similar corporate transactions to be subject to the approval of the GSM, except in those cases established by law. 2018 Annual Report Shareholders. Engagement and shareholders meeting Rules governing amendments to our Bylaws The GSM has the power to decide on any amendment of the Bylaws, except for the change in the location of the registered ofce within Spain, which may be decided by the board. If the Bylaws are to be amended by the GSM, the Bank’s board or, where appropriate, the shareholders tabling the resolution, must draft the complete text of the proposed amendment along with a written report justifying the proposed change, which must be provided to shareholders with the call notice for the meeting at which the proposed amendment will be voted on. Furthermore, the call notice for the GSM must clearly set out the items to be amended, detailing the right of all shareholders to examine the full text of the proposed amendment and accompanying report at the Bank’s registered ofce, and to request that these documents be delivered or sent to them free of charge. If the shareholders are called upon to deliberate on amendments to the Bylaws, the required quorum on frst call shall be met by the attendance of shareholders representing at least ffty per cent of the subscribed share capital with the right to vote. If a sufcient quorum is not available, the GSM shall be held on second call, where at least twenty-fve per cent of the subscribed share capital with voting rights must be present. When shareholders representing less than ffty per cent of the subscribed share capital with the right to vote are in attendance, the resolutions on amendments to the Bylaws may only be validly adopted with the favourable vote of two-thirds of the share capital present in person or by proxy at the meeting. However, when shareholders representing ffty per cent or more of the subscribed share capital with the right to vote are in attendance, resolutions may be validly adopted by absolute majority. Any changes to the Bylaws involving new obligations for shareholders must have the consent of those afected. Authorisation is required under the Single Supervisory Mechanism (SSM) to amend our Bylaws. However, the following amendments are exempt from this authorisation procedure, although they must nevertheless be reported to the SSM: those intended to refect a change in registered ofce within Spain, a capital increase, additions to the wording of the Bylaws of legal or regulatory requirements of an imperative or prohibitive nature or wording changes to comply with court or administrative rulings and any other amendments which the SSM has ruled to be exempt from authorisation due to a lack of materiality in response to prior consultations submitted to it for this purpose. Corporate website Our corporate website includes the information on corporate governance as required by law. In particular, it includes (i) the key internal regulations of Banco Santander (Bylaws, Rules and regulations of the board, Rules and regulations for the GSM, etc.); (ii) information on our board of directors and its committees as well as the professional biographies of the directors and (iii) information relating to the GSMs. The route to the information on corporate governance in our corporate website is: https://www.santander.com/csgs/Satellite/ CFWCSancomQP01/es_ES/Informacion-para-accionistas- e-inversores.html?leng=en_GB. This route is included for informational purposes only. The contents of our corporate website are not incorporated by reference in this annual report or otherwise considered to be a part of it. 3.3 Dividend policy In relation to the fnancial year 2018, the board of directors intends the payment against earnings for the year to be EUR 0.23 per share, to be paid quarterly. EUR 0.065 and EUR 0.065 per share has already been paid in cash in August 2018 and February 2019, respectively, as well as EUR 0.035 per share through the Santander Scrip dividend programme (with a 76.55% acceptance rate of the payment in shares) in November 2018. The remaining EUR 0.065 per share is expected to be paid in April/May 2019, in cash as fourth dividend against the 2018 results subject to the approval of the 2019 AGM. This remuneration represents an average return of 4.75% on the share price in 2018. The dividend per share, once the fnal payment of EUR 0.065 per share is approved and made, will have increased 4.50% compared to 2017. In order to have fexibility in determining how shareholder remuneration is paid to shareholders, the board is proposing a resolution to the 2019 AGM authorizing the acquisition of shares to be held in treasury with the express possibility of executing share repurchases to reduce the number of shares in issue, should market conditions make such action advisable. Any such share repurchases may also be made in conjunction with a scrip dividend, referred to below, should such a dividend be deemed appropriate. In addition, in view of the signifcant acceptance of the scrip dividend, especially among our retail shareholders, and to allow the required fexibility to be able to take advantage of the opportunities for proftable growth in our markets, the board has decided to propose to shareholders to retain the option to use a scrip dividend. This could be combined with share repurchases to satisfy the maximum number of shareholders, institutional and retail, with the target of maximizing earnings per share. These proposals will provide the board with the required fexibility to determine whether or not to use these mechanisms, depending on the Group’s performance and its progress against the targets set. The board will announce the 2019 interim dividend after the September board of directors meeting. To align ourselves with our European peers current practice, it is the board’s intention to set a pay-out ratio of 40-50% in the mid-term, increasing it from the current pay-out ratio of 30-40%; that the proportion of dividend paid in cash is not lower than that of the last year; and, as was announced in the 2018 AGM, to make two payments against the results of 2019. The agenda for the 2019 AGM includes two proposals in this respect. See section 3.5 ‘Our coming 2019 AGM’. 119 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 3.4 2018 AGM • Record quorum of 64.55% • Corporate management of the Bank in 2017 approved with 99.22% voting in favour • 2017 annual report on directors remuneration approved with 94.42% voting in favour • Appointment and re-election of directors approved with at least 96.98% voting in favour • No opposing vote of more than 15.43% Quorum and attendance The quorum for the annual general meeting of 2018 rose to 64.55%, our highest to date. Quorum at annual general shareholders’ meetings 53.7% 54.9% 55.9% 58.8% 59.7% 57.6% 64.03% 64.55% 2011 2012 2013 2014 2015 2016 2017 2018 The breakdown of the quorum was as follows: Physically present and remote attendance 0.823% By proxy Cast by post or directly Via Internet Remote voting Cast by post Via Internet Total 44.982% 2.630% 15.735% 0.377% 64.547% Voting results and resolutions All items in the agenda were approved. The average percentage of votes in favour for proposals submitted by our board was 97.61%. The following chart summarises the resolutions approved at the 2018 AGM and the voting results: 120 2018 Annual Report Shareholders. Engagement and shareholders meeting 1. Annual accounts and corporate management 1A. Annual accounts and directors’ reports for 2017 1B. Corporate management 2017 2. Application of results 3. Appointment, re-election or ratifcation of directors 3A. Establishing the number of directors 3B. Mr Álvaro Cardoso de Souza 3C. Mr Ramiro Mato 3D. Mr Carlos Fernández 3E. Mr Ignacio Benjumea 3F. Mr Guillermo de la Dehesa 3G. Ms Sol Daurella Comadrán 3H. Ms Homaira Akbari 4. Authorisation to acquire treasury shares 5. Amendments of Bylaws Valid votes For Against Blank TotalA TotalB Abstention 99.31 99.22 99.47 99.39 99.28 99.29 98.67 97.51 96.98 98.93 98.84 98.08 0.12 0.15 0.14 0.18 0.24 0.24 0.89 2.04 2.45 0.63 0.60 1.52 0.07 0.07 0.07 0.08 0.08 0.08 0.08 0.08 0.08 0.08 0.08 0.07 99.51 99.45 99.69 99.65 99.60 99.61 99.64 99.64 99.52 99.64 99.52 99.67 64.23 64.19 64.35 64.32 64.29 64.29 64.31 64.31 64.24 64.32 64.24 64.33 0.49 0.55 0.31 0.35 0.40 0.39 0.36 0.36 0.48 0.36 0.48 0.33 5A. Regarding the board of directors 98.76 0.79 0.08 99.64 64.31 0.36 5B. Regarding the delegation of powers of the board and to board committees 5C. Relating to reporting tools 6. Delegation to the board of the power to increase share capital 7. Authorisation granted to the board to increase share capital 8. Increase in share capital via scrip dividend 9. Directors' remuneration policy 10. Maximum total annual remuneration of directors in their capacity as directors 11. Maximum ratio of fxed and variable components in the total remuneration of executive directors 12. Remuneration plans which entail the delivery of shares or share options: 12A. Deferred multiyear objectives variable remuneration plan 12B. Deferred conditional variable remuneration plan 12C. Group buy-out policy 12D. Plan for employees of Santander UK Group Holdings and other companies of the Group in the UK 13. Authorisation to implement the resolutions approved 14. Annual directors' remuneration report 15 to 28. Dismissal and removal of directorsC A. Percentage of total valid votes and abstentions. B. Percentage of the share capital at the date of the 2018 AGM. 99.34 99.38 96.30 84.16 99.10 94.22 0.20 0.16 3.30 15.43 0.51 3.61 0.08 0.08 0.07 0.07 0.07 0.08 99.62 99.63 99.67 99.67 99.68 97.92 64.30 64.31 64.34 64.33 64.34 63.21 0.38 0.37 0.33 0.33 0.32 2.08 98.24 0.95 0.08 99.28 64.08 0.72 98.31 1.20 0.08 99.60 64.14 0.40 95.65 96.90 97.59 98.86 99.40 94.42 0.00 2.32 2.31 1.60 0.66 0.18 3.74 98.54 0.08 0.08 0.08 0.09 0.07 0.08 0.00 98.05 99.29 99.28 99.60 99.66 98.25 98.54 63.29 64.09 64.08 64.29 64.33 63.42 47.73 1.95 0.71 0.72 0.40 0.34 1.75 1.46 C. Items 15 to 28, not included in the agenda, were submitted to a separate vote. Each item refers to the proposal for dismissal and removal of each director in ofce at the 2018 AGM. The full texts of the resolutions adopted at the 2018 AGM can be viewed on the Group’s corporate website and on CNMV’s website, since they were fled as a signifcant event on 23 March 2018. Shareholder communications In line with the policy for communicating with shareholders, institutional investors and proxy advisors, in 2018 Banco Santander continued to strengthen communications with, service to and contact with its shareholders and investors in the context of the 2018 AGM. Telephone service lines 9,522 queries addressed Shareholder and investor mailbox 792 e-mails replied WhatsApp 14 queries addressed 121 Responsible bankingCorporate governanceEconomic and financial reviewRisk management                 3.5 Our coming 2019 AGM The board of directors has agreed to call the 2019 annual general shareholders’ meeting on 11 or 12 April, at frst or second call respectively, with the following proposed resolutions. • Remuneration of directors. To approve the fxed annual amount of remuneration for directors in their capacity as such. For further information see section 6.4 'Directors remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders'. • Annual accounts and corporate management. To approve: • Variable remuneration. To approve a maximum ratio of • The annual accounts and the directors reports of the Bank and its consolidated Group for the fnancial year ended 31 December 2018. For further information see 'consolidated fnancial statements'. • The consolidated non-fnancial statement for the fnancial year ended 31 December 2018, which forms part of this consolidated directors' report. See 'Santander vision' and the 'Responsible banking' chapter. • The corporate management for the fnancial year ended 31 December 2018. 200% between the variable and fxed components of the total remuneration for executive directors and certain employees belonging to professional categories that have a material impact on the Group’s risk profle. For further information see section 6.4 'Directors remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders'. • Remuneration plans. To approve the implementation of remuneration plans involving the delivery of shares or share options or referenced to the value of shares. For further information see section 6.4 'Directors remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders'. • The application of results obtained during fnancial year 2018. • Annual directors’ remuneration report. To provide a consultative vote on the annual directors’ remuneration report. For further information see section 6 'Remuneration'. The related documents and information shall be available for viewing on the Bank’s corporate website (www.santander.com) as from the date of publication of the announcement of the call to meeting. Likewise, the Bank will provide a live broadcast of our 2019 AGM, as it did with the 2018 AGM. We will not remunerate the attendance at the 2019 AGM, and therefore it is not necessary to establish a general, long-term policy in this respect. Notwithstanding the above, and as has been a tradition for decades, the Bank ofers attendees of the AGM a commemorative courtesy gift. See section 3.3 'Dividend policy'. • Appointment of directors. • Set the number of directors at 15, within the maximum and the minimum established by the Bylaws. • Appointment of Mr Henrique de Castro as new independent director (see section 1.1 'Refreshing the Board') and re-election of the following board members for a three-year period: Mr Javier Botín-Sanz de Sautuola O’Shea, Mr Ramiro Mato García- Ansorena, Mr Bruce Carnegie-Brown, Mr José Antonio Álvarez Álvarez and Ms Belén Romana García. • External auditor. To re-elect the frm PricewaterhouseCoopers Auditores, S.L. (PwC), as external auditor for fnancial year 2019. See 'External auditor' in section 4.4. • Authorization to acquire treasury shares, with express provision for executing share repurchase programs. See section 3.3 'Dividend policy'. • Increase in share capital via scrip dividend. See section 3.3 'Dividend policy'. • Authority to issue convertible securities. To delegate to the board of directors the authority to issue debentures, bonds, preferred interests and other fxed-income securities or debt instruments of a similar nature that are convertible into shares of the Bank. • Authority to issue non-convertible securities. To delegate to the board of directors the authority to issue debentures, bonds, preferred interests and other fxed-income securities or debt instruments of a similar nature that are not convertible into shares of the Bank. • Remuneration policy. To approve the Bank’s directors remuneration policy for 2019, 2020 and 2021. For further information see section 6.4 'Directors remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders'. 122 2018 Annual Report 123 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4. Board of directors A committed, balanced and diverse board Efective governance • Of the 15 directors, 12 are non-executive and 3 are • Thematic committees supporting the board executive • A majority of independent directors • 33% female board members • New responsible banking, sustainability and culture committee focusing on priorities Complementarity roles: executive chairman, CEO and lead independent director 124 2018 Annual Report Board of directors 16 11 12 13 7 9 4 2 1 3 5 6 8 15 14 10 0 1. Ms Ana Botín-Sanz de Sautuola y O’Shea Group executive chairman. Executive director 0 2. Mr José Antonio Álvarez Álvarez Vice chairman6 and Chief executive ofcer (CEO) Executive director 0 3. Mr Bruce Carnegie-Brown Vice chairman and lead independent director. Non-executive director (independent) 0 4. Mr Rodrigo Echenique Gordillo Vice chairman. Executive director 0 5. Ms Homaira Akbari Non-executive director (independent) 0 6. Mr Ignacio Benjumea Cabeza de Vaca Non-executive director 0 7. Mr Javier Botín-Sanz de Sautuola y O’Shea Non-executive director 0 8. Mr Álvaro Cardoso de Souza Non-executive director (independent) 0 9. Ms Sol Daurella Comadrán Non-executive director (independent) 10. Mr Guillermo de la Dehesa Romero Non-executive director7 11. Mr Carlos Fernández González Non-executive director (independent) 12. Ms Esther Giménez-Salinas i Colomer Non-executive director (independent) 13. Mr Ramiro Mato García-Ansorena Non-executive director (independent) 14. Ms Belén Romana García Non-executive director (independent) 15. Mr Juan Miguel Villar Mir8 Non-executive director (independent) 16. Mr Jaime Pérez Renovales General secretary and secretary of the board 125 6. Mr José Antonio Álvarez was appointed vice chairman of the board on 15 January 2019 7. Mr Guillermo de la Dehesa has been vice chairman of the board until 15 January 2019. 8. Mr Juan Miguel Villar Mir left the board on 1 January 2019. Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4.1 Our directors This information is presented as at 31 December 2018. Ms Ana Botín-Sanz de Sautuola y O’Shea GROUP EXECUTIVE CHAIRMAN Executive director Joined the board in 1989. Nationality: Spanish. Born in 1960 in Santander, Spain. Education: Degree in Economics from Bryn Mawr College (Pennsylvania, United States). Experience: She joined Banco Santander after working at JP Morgan (New York, 1980-1988). In 1992 she was appointed senior executive vice president. Between 1992 and 1998 she led the expansion of Santander in Latin America. In 2002, she was appointed executive chairman of Banco Español de Crédito, S.A. Between 2010 and 2014 she was chief executive ofcer of Santander UK. In 2014 she was appointed executive chairman of Santander. Other positions of note: Member of the board of directors of The Coca-Cola Company. She is also founder and chairman of the CyD Foundation (which supports higher education) and of the Empieza por Educar Foundation (the Spanish subsidiary of the international NGO Teach for All) and she sits on the advisory board of the Massachusetts Institute of Technology (MIT). Positions in other Group companies (non-executive in all cases and director unless otherwise indicated): Santander UK plc., Santander UK Group Holdings plc., Portal Universia, S.A. (chairman) and Universia Holding, S.L. (chairman). Membership of board committees: Executive committee (chairman), innovation and technology committee (chairman), and responsible banking, sustainability and culture committee. Skills and competencies: She has an extensive international executive career in the banking sector, where she has held the highest executive positions. She has also led the transformational, strategic and cultural change in the Santander Group. In addition, she has shown an ongoing commitment to sustainable and inclusive growth, as refected in her philanthropic activities. Mr José Antonio Álvarez Álvarez VICE CHAIRMAN9 & CHIEF EXECUTIVE OFFICER Executive director Joined the board in 2015. Nationality: Spanish. Born in 1960 in León, Spain. Education: Graduate in Economics and Business Administration. MBA from the University of Chicago. Experience: He joined Santander in 2002 and was appointed senior executive vice president of the Financial Management and Investor Relations division in 2004 (Group chief fnancial ofcer). He also served as director at SAM Investments Holdings Limited, Santander Consumer Finance, S.A. and Santander Holdings US, Inc. He also sat on the supervisory boards of Santander Consumer AG, Santander Consumer Bank GmbH and Santander Bank Polska, S.A. He was also a board member of Bolsas y Mercados Españoles, S.A. (BME). Other positions of note: None. Positions in other Group companies: (non-executive in all cases and director unless otherwise indicated): Banco Santander (Brasil) S.A. Membership of board committees: Executive committee and innovation and technology committee. Skills and competencies: With a distinguished career in the banking sector, he is a highly qualifed and talented leader. He brings to the board signifcant strategic and international management expertise, in particular in relation to fnancial planning, asset management and consumer fnance. He has a strong experience with and reputation amongst key stakeholders, such as regulators and investors. 9. Mr José Antonio Álvarez was appointed vice chairman of the board on 15 January 2019. 126 2018 Annual Report Board of directors Mr Bruce Carnegie-Brown VICE CHAIRMAN LEAD INDEPENDENT DIRECTOR Non-executive director (independent) Joined the board in 2015. Nationality: British. Born in 1959 in Freetown, Sierra Leone. Education: Master of Arts in English Language and Literature from the University of Oxford. Experience: He was non-executive director of Jardine Lloyd Thompson Group plc (2016-2017), non-executive director of Santander UK Group Holding Ltd (2014-2017), non-executive director of Santander UK, plc. (2012-2017) and he held the non- executive chair of AON UK Ltd (2012-2015). He was also the founder and managing partner of the quoted private equity division of 3i Group plc., and president and chief executive ofcer of Marsh Europe, S.A. He was also lead independent director at Close Brothers Group plc. (2006-2014) and at Catlin Group Ltd (2010-2014). He previously worked at JP Morgan Chase for eighteen years and at Bank of America for four years. Other positions of note: He is currently the non-executive chairman of Moneysupermarket.com Group plc. and Lloyd’s of London. Positions in other Group companies: None. Membership of board committees: Executive committee, appointments committee (chairman), remuneration committee (chairman), innovation and technology committee and risk supervision, regulation and compliance committee (he stepped down from this committee on 1 January 2019). Skills and competencies: He has a broad insurance background and fnancial services experience (in particular, in investment banking). He also possesses signifcant international experience, having had extensive exposure to Europe (UK), Middle East and Asia. His top management experience brings to the board know how in remuneration, appointments and risk-related matters. In addition, as lead independent director, he has gained an excellent understanding of investor expectations and experience in managing relations with them and with fnancial communities. Mr Rodrigo Echenique Gordillo VICE CHAIRMAN Executive director Joined the board in 1988. Nationality: Spanish. Born in 1946 in Madrid, Spain. Education: Graduate in Law and State Attorney. Experience: From 1973 to 1976 he held several positions in the Spanish Public Administration (General Secretary of the Post and Telecommunications Ofce, Technical Advisor in the Ofce of the Spanish Prime Minister and other positions in the Spanish Tax Authority ofces in Pontevedra and Madrid). Former chief executive ofcer of Banco Santander, S.A. between 1988 and 1994. He served on the board of directors of several industrial and fnancial companies, including Ebro Azúcares y Alcoholes, S.A. and Industrias Agrícolas, S.A., and was chairman of the advisory board of Accenture, S.A. He was also non- executive chairman of NH Hotels Group, S.A., Vocento, S.A., Vallehermoso, S.A. and Merlin Properties SOCIMI, S.A. He has also been non-executive chairman of Banco Popular Español, S.A. Other positions of note: He is currently a non-executive director of Inditex, S.A. and chairman of the board of trustees and the executive committee of the Banco Santander Foundation. Positions in other Group companies: (non-executive in all cases and director unless otherwise indicated): Universia Holding, S.L., Grupo Financiero Santander México, S.A.B. de C.V., Santander Vivienda, S.A. de C.V. SOFOM, E.R. Grupo Financiero Santander México, Banco Santander (Mexico), S.A., Institución de Banca Múltiple, Grupo Financiero Santander México, Casa de Bolsa Santander, S.A. de C.V., Grupo Financiero Santander México, Santander Consumo, S.A. de C.V., SOFOM. E.R., Grupo Financiero Santander México, Banco Santander International and Portal Universia, S.A. Membership of board committees: Executive committee. Skills and competencies: His extensive experience with senior executive and other non-executive roles in various industrial and fnancial companies along with his deep knowledge on the Santander Group are very valuable for the board. In addition, his prior experience in the Spanish government provides the board with strategic insights into regulations and relations with the public sector. 127 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Ms Homaira Akbari Non-executive director (independent) Joined the board in 2016. Nationality: North-American and French. Born in 1961 in Tehran, Iran. Education: Doctorate in Experimental Particle Physics from Tufts University and MBA from Carnegie Mellon University. Experience: She was chairman and CEO of SkyBitz, Inc., managing director of TruePosition Inc., non-executive director of Covisint Corporation and US Pack Logistics LLC. and she has held various posts at Microsoft Corporation and at Thales Group. Other positions of note: She is chief executive ofcer of AKnowledge Partners, LLC. She is also a non-executive director of Gemalto NV. Landstar System, Inc. and Veolia Environment, S.A. Positions in other Group companies: None. Membership of board committees: Audit committee, innovation and technology committee and the responsible banking, sustainability and culture committee. Skills and competencies: She brings signifcant executive experience in technology-related companies. Her knowledge of the digital transformation challenges is an asset to the board. In addition, her insights, gained from her extensive international experience in a diverse range of geographies, are of particular value to our Group. Mr Ignacio Benjumea Cabeza de Vaca Non-executive director Españoles, S.A. (BME) and of the Governing Body of the Madrid Stock Exchange. Other positions of note: He is vice chairman of the board of trustees and member of the executive committee of the Financial Studies Foundation and a member of the board of trustees and the executive committee of the Banco Santander Foundation. Joined the board in 2015. Positions in other Group companies: None. Nationality: Spanish. Born in 1952 in Madrid, Spain. Education: Degree in Law from Deusto University, ICADE E-3 and State Attorney. Membership of board committees: Executive committee, remuneration committee, risk supervision, regulation and compliance committee, innovation and technology committee and responsible banking, sustainability and culture committee. Experience: Former senior executive vice president, general secretary and secretary of the board of Banco Santander, and board member, senior executive vice president, general secretary and secretary to the board of Banco Santander de Negocios, S.A. and of Santander Investment, S.A. He was also technical general secretary of the Ministry of Employment and Social Security, general secretary of Banco de Crédito Industrial, S.A. and director of Dragados, S.A., Bolsas y Mercados Skills and competencies: He brings signifcant fnancial expertise to the board, in particular in banking and capital markets. He also has a wide experience in corporate governance and regulatory matters, having served as general secretary and secretary of the board of several banking institutions and held several positions in the Spanish government. He also has a signifcant involvement in several foundations. Mr Javier Botín-Sanz de Sautuola y O’Shea Non-executive director Joined the board in 2004. Nationality: Spanish. Born in 1973 in Santander, Spain. Education: Degree in Law from the Complutense University of Madrid. Experience: Co-founder and executive director, equities division of M&B Capital Advisers. S.V., S.A. (2000-2008). Previously he was legal advisor to the International Legal Department of Banco Santander (1998-1999). 128 Other positions of note: Executive chairman of JB Capital Markets, Sociedad de Valores, S.A.U. In addition to his work in the fnancial sector, he collaborates with several non-proft organisations. Since 2014 he has been chairman of the Botín Foundation. He is also a trustee of the Princess of Girona Foundation. Positions in other Group companies: None. Membership of board committees: None. Skills and competencies: He brings to the board international and management experience, in particular in the fnancial sector. He also brings a deep knowledge of the Santander Group and its operations and strategy, acquired through his tenure as a non- executive director of the Bank. 2018 Annual Report Board of directors Mr Álvaro Cardoso de Souza Non-executive director (independent) Joined the board in 2018. Nationality: Portuguese. Born in 1948 in Guarda, Portugal. Education: Degree in Economics and Business Administration from Pontifcia Universidade Católica de Sao Paulo, Master of Business Administration (MBA-Management Program for Executives) from the University of Pittsburgh and a graduate of the Investment Banking Marketing Program from Wharton Business School. Experience: He has held various positions at the Citibank Group, including CEO of Citibank Brazil and various senior positions in the US with respect to the consumer fnance, private banking and Latin American businesses. He was a member of the board of AMBEV. S.A., Gol Linhas Aéreas, S.A. and of Duratex, S.A. He has been chairman of WorldWildlife Group (WWF) Brazil, member of the board of WWF International and chairman and member of the audit and asset management committees of FUNBIO (Fundo Brasileiro para a Biodiversidade). Other positions of note: None. Positions in other Group companies (non-executive in all cases and director unless otherwise indicated): Non-executive chairman of Banco Santander (Brasil) S.A. Membership of board committees: Risk supervision, regulation and compliance committee (chairman) and responsible banking, sustainability and culture committee. Skills and competencies: He possesses a broad international banking experience, particularly in Brazil. He has a solid understanding of strategy and risk management-related matters, acquired from his executive experience, which is key to his role as chairman of our risk supervision, regulation and compliance committee. In addition, he actively collaborates in several environmental foundations and NGOs which brings him very useful knowledge in sustainability matters. Ms Sol Daurella Comadrán Non-executive director (independent) Other positions of note: She is chairman of Coca Cola European Partners, plc., executive chairman of Olive Partners. S.A. and holds several positions at companies belonging to the Cobega Group. Joined the board in 2015. Nationality: Spanish. Born in 1966 in Barcelona, Spain. Education: Degree in Business and MBA from ESADE. Experience: She served on the board of the Círculo de Economía and also as an independent non-executive director at Banco Sabadell, S.A., Ebro Foods, S.A. and Acciona, S.A. She has also been the honorary consul general of Iceland in Barcelona since 1992. Mr Guillermo de la Dehesa Romero Non-executive director10 Joined the board in 2002. Nationality: Spanish. Born in 1941 in Madrid, Spain. Education: Government Economist and head of ofce of the Bank of Spain. Experience: Former secretary of state of Economy, secretary general of Trade, chief executive ofcer of Banco Pastor, S.A., international advisor to Goldman Sachs International, chairman of Aviva Grupo Corporativo, S.L. and non-executive chairman of Santa Lucía Vida y Pensiones, S.A. Positions in other Group companies: None. Membership of board committees: Appointments committee, remuneration committee and responsible banking, sustainability and culture committee. Skills and competencies: She brings to the board excellent skills in strategy and high-level management, acquired through her international top executive experience in listed and large privately held entities, in particular in the distribution sector. The above also provides her a vast knowledge of corporate governance matters. In addition, her experience as a trustee of various Foundations oriented to health, education and environmental matters brings the board responsible business and sustainability insights. Other positions of note: He is currently non-executive vice chairman of Amadeus IT Group, S.A., honorary chairman of the Centre for Economic Policy Research (CEPR) of London, a member of the Group of Thirty based in Washington and chairman of the board of trustees of IE Business School. Positions in other Group companies: None. Membership of board committees: Executive committee, appointments committee, remuneration committee, and innovation and technology committee. Skills and competencies: Due to his experience and education, he brings to the board strategic insights in the macroeconomic and regulatory environment and on business management, after having held top management positions as well as non-executive positions. 10. Mr Guillermo de la Dehesa has been vice chairman of the board until 15 January 2019. 129 Responsible bankingCorporate governanceEconomic and financial reviewRisk management   Mr Carlos Fernández González Non-executive director (independent) Other positions of note: He is the chairman of the board of directors of Finaccess, S.A.P.I., non-executive director of Inmobiliaria Colonial. S.A. and member of the supervisory board of AmRest Holdings, SE. Joined the board in 2015. Positions in other Group companies: None. Membership of board committees: Audit committee, appointments committee and remuneration committee. Nationality: Mexican and Spanish. Born in 1966 in Mexico City, Mexico. Education: Industrial engineer. He completed graduate studies in business administration at the Instituto Panamericano de Alta Dirección de Empresas. Skills and competencies: He possesses signifcant international experience not only in fnancial, but also in other retail businesses, where he has held top executive positions with overall responsibility for fnancial reporting and audit functions as well as human resources matters. Experience: Mr Fernández has also sat on the boards of Anheuser-Busch Companies, LLC and Televisa S.A. de C.V., among other companies. Ms Esther Giménez-Salinas i Colomer Government of Catalonia and member of the advisory board of Endesa- Catalunya. Non-executive director (independent) Joined the board in 2012. Nationality: Spanish. Born in 1949 in Barcelona, Spain. Education: PhD in Law and Psychologist by the University of Barcelona. Experience: She was chancellor of the Ramon Llull University, member of the Conference of Rectors of Spanish Universities (CRUE), member of the General Council of the Judiciary of Spain, member of the scientifc committee on criminal policy of the Council of Europe, executive vice president of the Centre for Legal Studies and Specialised Training of the Justice Department of the Other positions of note: Professor emeritus at Ramón Llull University, director of the Chair of Restorative and Social Justice at the Pere Tarrés Foundation, Special Chair of Restorative Justice Nelson Mandela of the National Human Rights Comission of Mexico, director of Aqu (quality assurance agency for the Catalan university system) and of Gawa Capital Partners, S.L. Member of the Bioethics Committee of the Government of Catalonia. Positions in other Group companies: None. Membership of board committees: Risk supervision, regulation and compliance committee and responsible banking, sustainability and culture committee. Skills and competencies: Her relevant experience in senior academic and governmental roles, for which she has a strong reputation, enhances the oversight capacities of the board. In addition, her career path brings to the board knowledge and experience in legal matters, cultural transformation and in embedding an ethical and responsible culture. Mr Ramiro Mato García-Ansorena Non-executive director (independent) (AEB) and of Bolsas y Mercados Españoles, S.A. (BME) and member of the board of trustees of the Fundación Española de Banca para Estudios Financieros (FEBEF). Joined the board in 2017. Nationality: Spanish. Born in 1952 in Madrid, Spain. Education: Degree in Economics from the Complutense University of Madrid and Management Development Programme of the Harvard Business School. Experience: He has held several positions in Banque BNP Paribas, including chairman of the BNP Paribas Group in Spain. Previously, he held several signifcant positions in Argentaria. He has been a member of the Spanish Banking Association 130 Other positions of note: None. Positions in other Group companies: None. Membership of board committees: Executive committee, audit committee, risk supervision, regulation and compliance committee and responsible banking, sustainability and culture committee (chairman). Skills and competencies: He has had an extensive career in banking and capital markets, where he has held senior executive and non- executive positions. He brings to the board signifcant expertise in top management and also in audit, risk and strategy, mainly related to the fnancial sector. In addition, he has been actively participating in the boards of trustees of several foundations aimed at enhancing education. 2018 Annual Report Board of directors Ms Belén Romana García Non-executive director (independent) Joined the board in 2015. Nationality: Spanish. Born in 1965 in Madrid, Spain. Education: Graduate in Economics and Business Administration from Universidad Autónoma de Madrid and Government Economist. Experience: She was formerly senior executive vice president of Economic Policy and senior executive vice president of the Treasury of the Ministry of Economy of the Spanish Government, as well as director of the Bank of Spain and the CNMV. She also held the position of director of the Instituto de Crédito Ofcial and of other entities on behalf of the Spanish Ministry of Economy. She served as non-executive director of Banco Español de Crédito, S.A. and Mr Juan Miguel Villar Mir11 Non-executive director (independent) Joined the board of directors in 2013 and left the board on 1 January 2019. Nationality: Spanish. Born in 1931 in Madrid, Spain. Education: Doctorate in Civil Engineering, graduate in Law with a certifcate in Industrial Organisation. Experience: He was Minister of Finance and vice president of the government for Economic Afairs from 1975 to 1976. He also acted as chairman of Grupo OHL, Electra de Viesgo, Altos Hornos de Vizcaya, Hidro Nitro Española, Empresa Nacional de Celulosa, Empresa Nacional Carbonífera del Sur, Cementos del Mr Jaime Pérez Renovales Ge neral secretary and secretary of the board He joined the Group in 2003. Nationality: Spanish. Born in 1968 in Valladolid, Spain. Education: Graduate in Law and Business Administration at Universidad Pontifcia de Comillas (ICADE E-3) and State Attorney. 11. Mr Juan Miguel Villar Mir left the board on 1 January 2019. executive chairman of Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria, S.A. (SAREB). Other positions of note: Non-executive director of Aviva plc. London and of Aviva Italia Holding SpA, and member of the advisory board of the Rafael del Pino Foundation and co-chair of the Global Board of Trustees of the Digital Future Society. Positions in other Group companies: None. Membership of board committees: Executive committee, audit committee (chairman), risk supervision, regulation and compliance committee, innovation and technology committee and responsible banking, sustainability and culture committee. Skills and competencies: Her background as a government economist and her overall, executive and non-executive, experience in the fnancial sector (in particular, in the audit committee of listed companies) support her recognition as fnancial expert and qualify her for her role as chairman of the audit committee. In addition, the relevant positions held in Spanish credit institutions in the feld of capital markets provide the board with strategic insights into fnancial regulations and Spanish government relations. Cinca, Cementos Portland Aragón, Puerto Sotogrande, Fundación COTEC and the National College of Civil Engineering. Other positions of note: He serves as chairman of Grupo Villar Mir. He is also currently Professor of Business Organisation at the Politécnica University of Madrid, a full member of the Spanish Royal Academy of Engineering and the Spanish Royal Academy of Moral and Political Sciences, an honorary member of the Spanish Royal Academy of Doctors and a supernumerary member of the Spanish Royal Academy of Economic and Financial Sciences. Positions in other Group companies: None. Membership of board committees: None. Skills and competences: He brings to the board strategic insights into Spanish government relations, due to the relevant positions that he has held. In addition, his experience as chairman and frst executive brings the board signifcant corporate governance and top management skills. Experience: He was director of the ofce of the second vice president of the Government for Economic Afairs and Minister of Economy, deputy secretary of the Presidency of the Government, chairman of the Spanish State Ofcial Gazzete and of the committee for the Public Administration Reform. Previously, he was general vice secretary and vice secretary of the board and head of legal of the Santander Group, general secretary and secretary of the board of Banco Español de Crédito, S.A. and deputy director of legal services at CNMV. Secretary of all board committees. 131 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4.2 Board composition Size At 31 December 2018, our board of directors was made up of the 15 members whose profle and background are described in the section 4.1 'Our directors' above. Our Bylaws allow for a board with a minimum of 12 and a maximum of 17 members. Composition by type of director The composition of our board of directors is balanced between executive and non-executive directors, most of whom are independent. The status of each director has been verifed by the appointments committee and submitted to our board. Our board composition 20% 20% 60% Independent non-executive directors 9/15 Executive directors 3/15 Othe external directors (non propietary and non-independent) 3/15 Diversity We believe that a diverse environment is essential to ensure that objectives are achieved and that the combination of experiences and skills in the board provides an environment where diferent views emerge and the quality of decision-making is improved. Therefore, we seek a solid balance of technical skills, experiences and perspectives in the board. As further detailed below, our policy governing the selection, suitability assessment and succession of directors promotes diversity within the board, including diversity of gender, geography, experience and knowledge, with no implicit bias that could lead to any form of discrimination on the grounds of age, disability, race or ethnic origin. This policy was amended in July 2018 in order to bring it into line with recent European legislation on the disclosure of non-fnancial and diversity information and with EBA and ESMA guidelines on suitability assessment of board members and key functions holders. The Bank applies this policy when selecting directors to fll any vacancy or looking for candidates to add or replace board members. The selection policy promotes diversity in the board of directors from diferent standpoints: • Geographical provenance or background diversity: the selection process takes into account the diversity of cultural or international educational background, especially in the main geographies where the Group is present. • Gender diversity: both the appointments committee and the board of directors are aware of the importance of fostering equal opportunities between men and women and of the appropriateness of appointing women to the board who meet the requirements of ability, suitability and efective dedication to the position of director, making a conscious efort to search for female candidates who have the required profle. Our internal policy promotes a selection of directors, that endeavours to include a sufcient number of female board members to have a balanced presence of women and men. On 26 February 2019, our board replaced the target set in 2016 by the appointments committee for the minority gender (women) from 30% in 2020 to a gender equality target in the board, which implies a presence of women in the board of 40% to 60%, to be achieved by 2021. The board has exceeded the initial target women currently comprise 33.35% of the board. Female representation on our board is well above the average for large listed companies in Europe. According to a study conducted by the European Commission with data at October 2017, the percentage of female board members at large listed companies was 28.25% for all 28 countries in the European Union and 22% for Spain. • Education and professional background: the selection of candidates ensures that they are qualifed and suitable for the overall understanding of our Group, its businesses, structure and the geographies in which it operates, both individually and collectively; that they are aligned with the Santander culture. The selection process ensures that the candidates have skills and competencies in banking and fnancial services and in other areas identifed as relevant in our board skills and diversity matrix. In this regard, knowledge acquired in an academic environment is taken into account, together with experience in the professional performance of duties. • The policy has no implicit bias that could lead to discrimination by age, race, disability and/or ethnic origin. With regard to age, there are no age limits for directors or for any position on the board, including the chairman and CEO. 132 2018 Annual Report Board of directors In 2018, the Bank placed great emphasis on ensuring a diverse composition in the board covering aspects such as gender and geographical diversity but also ensuring there is no discrimination on account of race, age or disability. We believe that such an environment is vital to ensure that our goals as a business are achieved. The combination of experience and personalities on the board provides a good range of perspectives and improves the quality of decision-making. The result of implementing these diferent diversity criteria in 2018 is described in section 1.1 'Refreshing the board'. In particular, international diversity in the board as well as the need to ensure it has a balanced and adequate composition at all times was a priority for us in 2018, as indicated in section 1.3 'Achieving our 2018 priorities'. The functioning, efectiveness and results of the execution of our diversity policy can be evidenced by the breadth of skills, experience and diversity on the board and its committees shown in the 'Board skills and diversity matrix' below. This year, as stated in section 1.4 'Continued improvement in corporate governance', we provide in the matrix more information on the skills and diversity of our board, adding new skills that have become relevant to our shareholders and for the management of the Bank, covering diversity and board tenure separately. Our strong and unbreakable commitment with broader diversity will remain a focus for our appointments committee in 2019 because, as we stated in section 1.5 'Priorities for 2019', diversity is not a box to be ticked but a strategy for our success. Board skills and diversity matrix Our board composition provides the balance of knowledge, capabilities, qualifcations, diversity and experience required to execute our long-term strategy in an evolving market environment. This balance is refected in the board´s skills matrix that has been updated in 2018 in order to make it simpler, more transparent and also meet the expectations of our investors and other stakeholders, who are demanding greater visibility on certain skills within the board. In addition, the new structure takes into account the recommendations of the new EBA and ESMA guide on the suitability assessment of board members and key functions holders, which came into efect in June 2018. To this end, and in relation to the skills matrix from last year, the key changes introduced are as follows: • We have diferentiated two groups of skills or competences: thematic skills and horizontal skills. • Regarding thematic skills, we have regrouped and renamed the skills th at we had included in the past, and added the following new categories 'HR, Culture, Talent & Remuneration' and 'Responsible Business & Sustainability'. • Regarding horizontal skills, we have included in this section skills additional to the thematic ones and which are also desirable. The skills in this section had been included in previous years and are now re-grouped under this heading, with the addition of a new skill labelled 'signifcant directorship tenure'. • In addition, we have introduced a new diversity section, including not only gender diversity but also diversity in geographical provenance and/or training or education abroad, and a new board tenure section, refecting the tenure of each directorship. These changes have transformed our board skills matrix into a more complete board skills and diversity matrix, now with more information for shareholders and investors. As last year, the skills matrix discloses the skills and competencies of each board member showing our commitment to transparency in this matter. In addition, to more clearly identify the background for this skills matrix, we have included a paragraph on skills and competencies for each director in section 4.1 'Our directors'. 133 Responsible bankingCorporate governanceEconomic and financial reviewRisk management e u q i) n n a e cm h r E i a o h g c re dc oi v R( i i n w o rdt B nn a - e e d n an g e e mp n r e r i aa ) d r Ch n o c it e dc e c ae uc ier r v i B ld ( Executive ) O z eE C r a - v B l Á n a o im n r o i ta nh A c e é c s i ov J( ) n a m r i a h c ( n í t o B a n A Board skills and diversity matrixA SKILLS AND EXPERIENCE THEMATIC SKILLS Banking (93.3%) Other fnancial services (73.3%) Accounting, auditing & fnancial literacy (93.3%) Retail (93.3%) Digital & information technology (33.3%) Risk management (86.7%) Business strategy (86.7%) Responsible business & sustainability (86.7%) Human resources, culture, talent & remuneration (93.3%) Legal (26.7%) Governance & control (93.3%) International experience HORIZONTAL SKILLS Top management (93.3%) Government, regulatory & public policy (40.0%) Academia & education (60%) Significant directorship tenure (100%) DIVERSITY Female (33.3%) Geographical provenance / international education BOARD TENURE 0 to 3 years (20%) 4 to 11 years (53.3%) 12 years or more (26.7%) A. As at 31 December 2018. Europe (93.3%) US/UK (80%) Latam (66.7%) Others (33.3%) Europe (73.3%) US/UK (46.7%) Latam (20%) Others (6.7%) B. Mr José Antonio Álvarez was appointed vice chairman of the board on 15 January 2019. C. Mr Guillermo de la Dehesa has been vice chairman of the board until 15 January 2019. D. Mr Juan Miguel Villar Mir left the board on 1 Janaury 2019. 134 2018 Annual Report Board of directors Independent Other external a z u o S e d o s o d r a C o r a v l A i r a b k A a r i a m o H z e d n á n r e F s o l r a C a l l e r u a D l o S s a n i l a S - z e n é m G r e h t s E i D r i M r a l l i V i l e u g M n a u J j a e m u n e B o i c a n g I n í t o B r e i v a J C a s e h e D a l e d o m r e l l i u G o t a M o r i m a R a n a m o R n é l e B 135 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Executive directors • Ms Ana Botín-Sanz de Sautuola y O’Shea, Group executive chairman. • Mr José Antonio Álvarez Álvarez, Group vice chairman12 and CEO. • Mr Rodrigo Echenique Gordillo, Group vice chairman. A more detailed description of their roles and duties is included in 'Group executive chairman and chief executive ofcer' in section 4.3. Independent non-executive directors • Mr Bruce Carnegie-Brown (lead independent director). • Ms Homaira Akbari. • Mr Álvaro Cardoso de Souza. • Ms Sol Daurella Comadrán. • Mr Carlos Fernández González. • Ms Esther Giménez-Salinas i Colomer. • Mr Ramiro Mato García-Ansorena. • Ms Belén Romana García. Years of service of independent directors 11.1 10.2 9.5 7.3 3.0 3.4 3.01 3.56 2011 2012 2013 2014 2015 2016 2017 2018 Other external directors • Mr Ignacio Benjumea Cabeza de Vaca. • Mr Javier Botín-Sanz de Sautuola y O’Shea. • Mr Guillermo de la Dehesa Romero13. • Mr Juan Miguel Villar Mir. He left the board on 1 January 2019. On an annual basis, the appointments committee verifes and informs the board about the category of the independent directors, taking into account all the circumstances that are pertinent to each case and, in particular, the existence of any possible signifcant business relationships that could afect their independence. This analysis is described further in section 4.5 'Appointments committee activities in 2018'. Independent non-executive directors account for 60% of our board, following best practices in corporate governance and complying with the Rules and regulations of the board that require the board to be made up predominantly of non-executive directors and have a number of independent directors that represent at least 50% of the board. At year-end 2018, the average length of service for independent non-executive directors was 3.56 years. These directors cannot be classifed as proprietary directors as they do not hold or represent shareholdings equal to or greater than the size of shareholding that qualifes as signifcant by law nor have been appointed as directors on account of their status as shareholders14. Mr Botín is a party to the shareholders' agreement referred to under section 2.4 'Shareholders agreement', to which the executive chairman is also a party. They also cannot be considered independent directors for the followings reasons: • Mr Botín and Mr de la Dehesa have both held position of director for over 12 years. • In the case of Mr Benjumea the required period has not lapsed since he ceased his professional relationship with the Bank (other than that as a director of the Bank and of Santander Spain). 12. Mr José Antonio Álvarez was appointed vice chairman of the board on 15 January 2019. 13. Mr Guillermo de la Dehesa has been vice chairman of the board until 15 January 2019. 14. The board of directors, following the proposal of the appointments committee, and after a review of practices in comparable markets and companies, resolved on 13 February 2018 to apply the legally established threshold for signifcant shareholdings (3% of share capital) to be considered as proprietary director. Since the shareholding represented by Mr Javier Botín-Sanz de Sautuola y O’Shea (0.98%) was below the referred threshold, he has ceased to meet the requirements to be considered as proprietary director, whilst not satisfying the criteria to be regarded as an independent director. As a consequence, the board of directors, following the proposal of the said committee, resolved on that date, to categorize him as other external director. 136 2018 Annual Report Board of directors 137 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementTenure, committee membership and equity ownershipA Board of directors Committees e e t t i m m o c s t n e m t n o p p A i . 3 e e t t i m m o c n o i t a r e n u m e R . 4 n o i t a l u g e r , n o i s i v r e p u s k s i R . 5 e e t t i m m o c e c n a i l p m o c d n a , i g n k n a b e l b i s n o p s e R . 7 d n a y t i l i b a n a t s u s i e e t t i m m o c e r u t l u c e e t t i m m o c y g o l o n h c e t d n a n o i t a v o n n I . 6 C e e t t i m m o c e v i t u c e x E . 1 C e e t t i m m o c t i d u A . 2 t n e d n e p e d n I e v i t u c e x E l a n r e t x e r e h t O Executive chairman Ms Ana Botín-Sanz de Sautuola y O’Shea Vice chairmanB and Chief executive ofcer Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie-BrownC C C Vice chairmen Members General secretary and secretary of the board C Chairman Mr Rodrigo Echenique Gordillo Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca Mr Javier Botín-Sanz de Sautuola y O’Shea Mr Álvaro Cardoso de Souza Ms Sol Daurella Comadrán Mr Guillermo de la Dehesa RomeroD Mr Carlos Fernández González Ms Esther Giménez- Salinas i ColomerH Mr Ramiro Mato García-Ansorena Ms Belén Romana García Mr Juan Miguel Villar MirI Total Mr Jaime Pérez Renovales C C C A. Data at 31 December 2018 except where otherwise indicated. The changes in the membership of the committee during 2018 are shown in section 1.1 'Refreshing the board'. B. Mr José Antonio Álvarez was appointed vice chairman of the board on 15 January 2019. C. Mr Bruce Carnegie-Brown left the risk supervision, regulation and compliance committee on 1 January 2019. D. Mr Guillermo de la Dehesa has been vice chairman of the board until 15 January 2019. E. For further explanation, see 'Election, refreshment and succession' in section 4.2. Indicated periods do not take into account the additional period that may apply under article 222 of the Spanish Companies Act. F. The Bank has a shareholding policy that is intended to reinforce the alignment of executive directors with the long-term interests of shareholders. This policy includes the directors’ commitment to maintain a signifcant personal investment in the Bank’s shares while they are actively performing their executive duties, equivalent to two times the amount of their annual fxed remuneration (net of taxes). A 5-year period from the approval of the policy in 2016 (or, if later, after the appointment of the director) is granted to attain the established investment level. G. Includes shares owned by Fundación Botín, of which Mr Javier Botín is the chairman, and syndicated shares, except those corresponding to Ms Ana Botín and Mr Javier Botín as they are already included within their direct or direct shareholdings. In subsection A.3 of section 9.2 ‘Statistical information on corporate governance required by CNMV’ we have adapted this information to CNMV’s format, and have therefore added all the syndicated shares as shareholding of Mr Javier Botín. See 2.4 'Shareholders’ agreements'. H Ms Esther Giménez-Salinas left the innovation and technology committee on 1 July 2018. I. Mr Juan Miguel Villar Mir left the board on 1 January 2019. 138 2018 Annual Report Board of directors Tenure Bank shareholdingF i t n e m t n o p p a t s r f f o e t a D i t n e m t n o p p a t s a l f o e t a D E e t a d d n E t c e r i D t c e r i d n I d e t n e s e r p e r s e r a h S l a t i p a c e r a h s f o % l a t o T 04/02/1989 07/04/2017 First six months of 2020 668,836 20,334,245 21,003,081 0.129% 25/11/2014 07/04/2017 First six months of 2020 1,083,149 1,083,149 0.007% 25/11/2014 18/03/2016 First six months of 2019 22,443 22,443 0.000% 07/10/1988 07/04/2017 First six months of 2020 1,039,401 14,591 1,053,992 0.006% 27/09/2016 07/04/2017 First six months of 2021 22,000 9,000 31,000 0.000% 30/06/2015 23/03/2018 First six months of 2021 3,516,698 3,516,698 0.022% 25/07/2004 23/03/2018 First six months of 2019 5,272,830 12,652,340 119,468,000G 137,393,170 0.846% 23/03/2018 23/03/2018 First six months of 2019 0 0 0 0.000% 25/11/2014 23/03/2018 First six months of 2021 143,255 456,970 600,225 0.004% 24/06/2002 23/03/2018 First six months of 2021 173 25/11/2014 23/03/2018 First six months of 2021 18,524,499 30/03/2012 07/04/2017 First six months of 2020 6,062 28/11/2017 23/03/2018 First six months of 2019 40,325 22/12/2015 07/04/2017 First six months of 2020 07/05/2013 27/03/2015 First six months of 2018 167 1,338 0 4 0 0 0 0 173 0.000% 18,524,503 0.114% 6,062 0.000% 40,325 0.000% 167 1,338 0.000% 0.000% 30,341,176 33,467,150 119,468,000 183,276,326 1.13% For further details see section 9.2 'Statistical information on corporate governance required by CNMV'. Election, refreshment and succession of directors and order of the respective appointment. Outgoing directors may be re-elected. Each appointment, re-election and ratifcation is submitted to a separate vote at the AGM. Election of directors Our directors are appointed for three-year terms, and one-third of our board is renewed each year, following the order established by the length of the service on the board, according to the date Procedures for appointing, re-electing, evaluating and removing directors Our internal policy for the selection, suitability assessment and succession of directors, stipulates the criteria concerning the quantitative and qualitative composition of our board of 139 Responsible bankingCorporate governanceEconomic and financial reviewRisk management directors, the process for reviewing its composition, the process for identifying potential candidates and the selection and appointments process. The appointment and re-election of directors corresponds to the GSM. In the event that directors vacate their ofce during the term for which they were appointed, the board of directors may provisionally designate another director, by co-option, until the shareholders, at the earliest subsequent GSM, either confrm or revoke this appointment. The proposals for appointment, re-election and ratifcation of directors, regardless of the status thereof, that the board of directors submits to the shareholders at the GSM and the decisions adopted by the board itself in cases of co-option must be preceded by the corresponding report and reasoned proposal of the appointments committee. The proposal must be accompanied by a duly substantiated report prepared by the board containing an assessment of the qualifcations, experience and merits of the proposed candidate. In cases of re-election or ratifcation of directors, this committee proposal shall contain an assessment of the work and efective dedication to the position during the last period in which the proposed director occupied the post. If the board disregards the proposal made by the appointments committee, it must give the reasons for its decision and place these reasons in the minutes for the record. Our directors must meet the specifc requirements set forth by law for credit institutions and the provisions of our Bylaws, and must formally undertake, upon taking ofce, to fulfl the obligations and duties prescribed therein and in the Rules and regulations of the board. Our directors must be persons of renowned commercial and professional integrity, and must have the knowledge and experience needed to exercise their function and be in a position to carry out the good governance of the entity. Candidates for the position of director will also be selected on the basis of their professional contribution to the board as a whole. For further information see section 4.1 'Our directors' and under 'Board skills and diversity matrix' within this section 4.2. In all cases, our board of directors shall endeavour to ensure that external or non-executive directors represent a signifcant majority over executive directors and that the number of independent directors represents at least half of all directors. Our directors shall cease to hold ofce when the term for which they were appointed elapses, unless they are re-elected, when the GSM so resolves, or when they resign (explaining the reasons for this in a letter that shall be sent to the other members of the board) or place their ofce at the disposal of the board of directors. Directors must tender their resignation to the board of directors and formally resign from their position if the board of directors, following a report from the appointments committee, deems it ft, in those cases in which they may adversely afect the operation of the board or the credit or reputation of the Bank and, in particular, if they are involved in any of the circumstances of incompatibility or prohibition provided by law. The foregoing without prejudice to the provisions of Royal Decree 84/2015, which implements Law 140 10/2014 on the organisation, supervision and solvency of credit institutions, on the honorability requirements for directors and the consequences of directors subsequently failing to meet such requirements. Directors must notify the board, as soon as possible, of those circumstances afecting them that might prejudice the credit or reputation of the Bank, and particularly the criminal cases with which they are charged. Furthermore, proprietary non-executive directors must tender their resignation when the shareholder they represent disposes of, or signifcantly reduces, its ownership interest. Finally, succession planning for the main directors is a key element of the Bank’s good governance, ensuring an orderly leadership transition whilst maintaining continuity and stability of the board. Board succession planning continues to be an area of focus for the appointment committee and the board, with appropriated and robust plans in place that are regularly revisited. In application of these procedures, in September 2018 the Bank resolved to appoint Mr Andrea Orcel as new CEO, subject to obtaining the necessary regulatory approvals, the shareholders´meeting passing the relevant resolutions on his future remuneration and to the termination of the contractual relationship with his former employer. Subsequently, due to the change on the basis upon which such decision was taken and the fact that the costs of compensating Mr Orcel for past remuneration exceeded those having been considered at the time of his appointment, the board resolved in January 2019 to leave without efect Mr Orcel’s appointment. 4.3 Board functioning and efectiveness Our Board is the highest decision-making body, focusing on the supervisory function Except in matters falling within the exclusive purview of the GSM, our board of directors is the Bank’s highest decision-making body and performs its duties with unity of purpose and independent judgement. The board’s stated policy is delegating the day-to-day management of the Bank and the implementation of its strategy to the executive bodies and the management team and focusing its activity on the general supervisory function and those functions that it cannot delegate as provided by law, the Bylaws, and the Rules and regulations of the board, which in summary are the following: • General policies and strategies (including capital and liquidity strategy, new products, activities and services; corporate governance and corporate policy and internal culture and values; risk control; remuneration policy and compliance). • Financial information and general information reported to shareholders, investors and the general public, and the processes and controls that ensure the integrity of this information. • Approval of policies for the provision of information to and for communication with shareholders, markets and public opinion, and supervision of the process of dissemination of information and communications relating to the Bank. 2018 Annual Report Board of directors • Internal audit plan and results. • Selection, succession and remuneration of directors. Rules and regulations of the board Our Rules and regulations of the board and the Bank’s Bylaws are available at www.santander.com. • Selection, succession and remuneration of senior management • Bylaws. Our Bylaws contain the basic rules and regulations that and other key positions. • Efectiveness of the Group’s corporate and internal governance system. • Signifcant corporate & investment transactions. • Call the general shareholders’ meeting. • In general, governance-related matters such as related party transactions. • Corporate governance and internal governance of the Bank and its Group, including the group-subsidiary governance model, corporate frameworks and relevant group internal regulation. Structure of the board Our board has implemented a governance structure to ensure it discharges its duties efectively. Further details of this structure are provided in the next pages of this section and it can be split into four dimensions: • Group executive chairman and chief executive ofcer who, as further explained under 'Group executive chairman and chief executive ofcer' within this section 4.3 are the top responsibles for the strategic and ordinary management of the Bank which that board is responsible for overseeing, ensuring at the same time that there is a clear separation and complementarity of their roles. apply to the composition and functioning of the board of directors and its members' duties, which are supplemented and further developed by the Rules and regulations of the board. They can be amended only by our GSM, as described in 'Rules governing amendments to our Bylaws' in section 3.2. • Rules and regulations of the board. The Rules and regulations of the board establish the rules of operation and internal organisation of our board of directors and its committees through the development of applicable legal and bylaw provisions, setting forth the principles that are to govern all action taken by the board and its committees and the rules of behaviour to be observed by its members. • Our board amended its Rules and regulations on 25 June 2018 to allow the responsible banking, sustainability and culture committee to be chaired by an independent director. In 2019, on 26 February the board amended again its Rules and regulations in order, among others: • To establish the audit committee to be composed entirely of independent directors and to strengthen its supervision functions over the non-fnancial information. • To broaden the mandate of our appointments committee in corporate governance matters taking up functions previously fell with the risk supervision, regulation and compliance committee. • To expressly provide that the lead independent director must be • A lead independent director who, as further explained under a member of the appointments committee. 'Lead independent director' within this section 4.3 is responsible for the efective coordination of non-executive directors and generally ensuring that they serve as an appropriate counter- balance to executive directors. • A board committees structure, which, as further described under 'Board committee structure', within this section 4.3, supports our board in three main areas: • In the management of the Bank by exercising decision-making powers through the executive committee. • In defning strategy in key areas, through the responsible banking, sustainability and culture committee and the innovation and technology committee. • In its supervisory functions and signifcant decision-making, through the audit, appointments, remuneration and risk supervision, regulation and compliance committees. • A board secretary, who, as further described under 'Secretary of the board', within this section 4.3 supports the board, its committees and our chairman, and is also the general secretary of the Group. • To include other minor changes in the composition and functioning of the appointments and remuneration committees anticipating the recommendations and good operating practices. Our Rules and regulations of the board meet all legal requirements and adhere to the main principles and recommendations established in the Spanish Corporate Governance Code for Listed Companies of CNMV of February 2015, the Corporate Governance Principles for Banks of the Basel Committee on Banking Supervision of July 2015, as well as the guidelines established by the EBA in 'Guidelines on internal governance under Directive 2013/36/EU' that came into force on 30 June 2018. Our rules on the audit committee also adhere to the recommendations and good operating practices established in Technical Guide 3/2017 of CNMV, on Audit Committees of Public Interest Entities, of 27 June 2017. This committee also complies with the regulations applicable in the US because of the listing of our shares as American Depositary Shares on the New York Stock Exchange and with Rule 10A-3 under the Securities Exchange Act introduced by the Sarbanes-Oxley Act of 2002 (SOx), on requirements for the audit committees of companies. 141 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementGroup executive chairman and chief executive ofcer Our Group executive chairman is Ms Ana Botín-Sanz de Sautuola y O’Shea and our chief executive ofcer is Mr José Antonio Álvarez Álvarez. Lead independent director Our board has appointed Mr Bruce Carnegie-Brown as lead independent director. The role of the lead independent director is key in our governance structure, as he oversees the proper coordination of non-executive directors and ensures that they serve as an appropriate counter- balance to the executive directors. The following chart illustrates his functions and their application in 2018: Duties Activities during 2018 Three meetings were held with non-executive directors, without executive directors being present, where they were able to voice any concerns or opinions. Leadership in the annual assessment of the chairman for the determination of her variable remuneration and for the board efectiveness annual review. See section 3.1 'Shareholder engagement'. He has chaired three meetings of the executive committee due to such absence. • Coordinate and organise meetings of non-executive directors and voice their concerns. • Direct the regular assessment of the chairman of the board of directors and coordinate her succession plan. • Contact investors and shareholders to obtain their points of view for the purpose of gathering information on their concerns, in particular, with regard to the Bank’s corporate governance. • Substitute the chairman in the event of absence under the terms set down in the Rules and regulations of the board of directors. • Request that a meeting of the board of directors be called or that new items be added to the agenda for a meeting of the board. The roles of our Group executive chairman and chief executive ofcer are clearly separated, as follows: Group executive chairman Chief executive ofcer • The chief executive ofcer is responsible for the day-to-day management of the business, with the highest executive functions. • The chief executive ofcer’s direct reports manage businesses and ordinary management support corporate divisions. • The country heads, who are the Group’s frst representatives in the countries in which it operates, also report to the chief executive ofcer. • The chairman is the highest- ranking ofcer of the Bank, and is responsible for ensuring that its Bylaws are fully complied with and that the resolutions adopted at the general shareholders’ meeting and by the board of directors are carried out. The chairman is also responsible for the overall inspection of the Bank and all its services. • The chairman is the main Group representative vis-a-vis the regulators, authorities and other major stakeholders. • The chairman’s direct reports are related to long-term strategy. • The chairman is in charge of leading succession planning of main executives of the Bank. There is a clear separation of duties between those of the Group executive chairman, the chief executive ofcer, the board, and its committees, and various checks and balances that assure proper equilibrium in the Bank’s corporate governance structure, including the following: • The board and its committees oversee and control the activities of both the Group executive chairman and the chief executive ofcer. • The lead independent director is responsible for convening and coordinating the non-executive directors, and communicating their concerns. The lead independent director also oversees the periodic process of assessing the Group executive chairman and coordinates the succession plan with the appointments committee. • The audit committee is chaired by an independent director considered to be a fnancial expert, as this term is defned in Regulation S-K of the Securities and Exchange Commission (SEC). • The Group executive chairman may not hold simultaneously the position of chief executive ofcer of the Bank. • The corporate risk, compliance and internal audit functions, as independent units, report to a committee or a member of the board of directors and have direct access to the board when they deem it appropriate. The board of directors has delegated to each of the executive chairman and the chief executive ofcer all the powers of the board except those that cannot be delegated pursuant to the law, the Bylaws and the Rules and regulations of the board. The board directly exercises those powers in the performance of its general supervisory function. 142 2018 Annual Report Board of directors Board committee structure Our board currently has seven committees and one international advisory board. For a description of the composition, functions, rules of operation and activities of: • The executive committee, the responsible banking, sustainability and culture committee, and the innovation and technology committee, see the following sections within this section 4.3. • The audit, appointments, remuneration, and the risk supervision, regulation and compliance committees, see their activities reports in sections 4.4, 4.5, 4.6 and 4.7, respectively. Voluntary committees (permitted under Bylaws) Mandatory committees (required by law and under Bylaws) Decision-making powers Support and proposal in strategic areas Supervision, information advice and proposal functions in risks, fnancial information and audit matters Executive committee Responsible banking, sustainability and culture committee Audit committee Appointments committee Innovation and technology committee Risk supervision, regulation and compliance committee Remuneration committee International advisory board (members are non-directors) Board committees External advisory board Secretary of the board Our board secretary is Mr Jaime Pérez Renovales. He assists the chairman in her duties and ensures the formal and substantive legality of all action taken by the board. He also ensures that the good governance recommendations and procedures are observed and regularly reviewed. The secretary of our board is the general secretary of the Bank, and also acts as secretary for all board committees; he does not need to be a director in order to hold this position. A report from the appointments committee is required prior to submission to the board of proposals for the appointment or removal of the secretary of the board. Our board also has a deputy secretary to the board, Mr Óscar García Maceiras, who assists the secretary and replaces him in the performance of his duties in the event of absence, inability to act or illness. Proceedings of the board Our board of directors held 12 meetings in 2018. The Rules and regulations of the board provide that it shall hold no less than nine annual ordinary meetings, and one meeting at least quarterly. In 2018, the average estimated time dedicated by each member to preparing for and participating in meetings was approximately 12 hours per meeting, with the chairman estimated to have spent double that time per meeting. The board holds its meetings in accordance with a calendar established annually and an agenda of matters to be discussed, without prejudice to any further items that may be added or any additional meetings that need to be held according to the business needs that may arise. Directors may also propose the inclusion of items on the agenda. Directors will be duly informed of any modifcations to the calendar or the agenda of matters to be discussed. Likewise, the board keeps a formal list of matters reserved to it and will prepare a plan for the distribution of those matters between the ordinary meetings established in the provisional calendar approved by the board. The relevant documentation for each meeting of the board of directors and of the diferent committees to which the directors are members, is sent to the directors four business days before the board meeting and three business days before the corresponding committee meeting. The information, which is provided to the directors via secure electronic means, is specifcally for the purpose of preparing these meetings. In the opinion of the board, that information is complete and is sent sufciently in advance. In addition, the Rules and regulations of the board of directors expressly recognise the directors’ right to request and obtain information regarding any aspect of the Bank and its subsidiaries, whether domestic or foreign, as well as the right to inspect, which allows them to examine the books, fles, documents and any other 143 Responsible bankingCorporate governanceEconomic and financial reviewRisk management records of corporate transactions, and to inspect the premises and facilities of these companies. Furthermore, directors are also entitled to request and obtain, through the secretary, such information and advice deemed necessary for the performance of their duties. The board shall meet whenever the chairman so decides, acting on her own initiative or at the request of not less than three directors. Generally, the meeting must be called 15 days in advance by the board secretary. Additionally, the lead independent director is authorised to request that a meeting of the board of directors be called or that new items be added to the agenda for a meeting that has already been called. Our directors must attend the meetings in person and shall endeavour to ensure that absences are reduced to cases of absolute necessity. However, if directors are unable to personally attend a meeting, they may grant a proxy to another director, in writing and specifcally for each meeting, to represent them for all purposes therein. Proxy is granted with instructions and non-executive directors may only be represented by another non-executive director. A director may hold more than one proxy. For more information about directors’ attendance see 'Board and committees attendance' in this section 4.3. not also members of the executive committee may attend the meetings of such executive committee at least twice a year, for which purpose they shall be called by the chairman. During the year, directors that are not members of the executive committee attended 27 of the total of 45 meetings held. Comparison of number of meetings heldA Board Executive committee Audit committee Appointments committee Remuneration committee Risk supervision, regulation and compliance committee Santander Average Spain US average UK average 12 45 13 13 11 11.1 8.5 8.4 6.3 6.3 8 - 8.4 4.6 6.2 7.3 - 5.2 4 5.2 13 13 NA 6.1 A. Source: Spencer Stuart Board Index 2018 (Spain, United States and Our board may meet in various rooms at the same time, provided that interactivity and communication among them in real time is ensured by audiovisual means or by telephone and the concurrent holding of the meeting is thereby ensured. United Kingdom). NA: Not available The chart and table below show the distribution of the approximate time dedicated to each task at the meetings held by the board in 2018 and the high rate of attendance to board and committee meetings, respectively. 2018 Approximated allocators of time 14% 19% 41% 10% 16% Business performance Risk management Internal and external audit and review of the fnancial information General policies and strategies Capital & liquidity Board meetings are validly convened when more than half of its members are present in person or by proxy. Resolutions are adopted by absolute majority of the directors attending in person or by proxy. The chairman has the casting vote in the event of a tie. The Bylaws and the Rules and regulations of the board only provide for qualifed majorities for matters in which the law prescribes a qualifed majority. The board secretary maintains the documentation relating to the board of directors and maintains a record in the minutes of the content of the meetings. The minutes of the meetings held by the board of directors and its committees include any statements made at meetings that are expressly requested to be included in them. The board and its committees may contract legal, accounting or fnancial advisers or other experts, at the Bank´s expense, to assist in the exercise of their functions. Our board is tasked with promoting and encouraging communication between the various committees, especially between the risk supervision, regulation and compliance committee and the audit committee, and also between the former and the remuneration committee and the responsible banking, sustainability and culture committee. In this regard, any director may attend and participate in, but not vote, at meetings of board committees of which they are not a member, by invitation of the chairman of the board and of the chairman of the respective committee, after having requested attendance to the chairman of the board. Furthermore, all members of the board who are 144 2018 Annual Report   Board of directors Board and committees attendance Directors Board Executive Audit Appointments Remuneration Risk supervision, regulation and compliance Committees 95% 98% 94% 96% 97% Average attendance Individual attendance Ms Ana Botín-Sanz de Sautuola y O´Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie-BrownA Mr Rodrigo Echenique GordilloB Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de VacaC Mr Javier Botín-Sanz de Sautuola y O´Shea Mr Álvaro Cardoso de SouzaD Ms Sol Daurella Comadrán Mr Guillermo de la Dehesa RomeroE Mr Carlos Fernández González Ms Esther Giménez- Salinas i ColomerF Mr Ramiro Mato García-Ansorena Ms Belén Romana GarcíaG Mr Juan Miguel Villar-MirH 96% - 12/12 12/12 12/12 12/12 12/12 42/45 - 43/45 38/45 45/45 - - - - - - 13/13 12/12 45/45 12/12 7/8 12/12 - - - 12/12 42/45 - - - - - 12/12 12/12 12/12 12/12 7/12 - 12/13 - - 45/45 13/13 23/23 13/13 - - Innovation and technology 92% - 3/3 3/3 2/3 1/2 3/3 3/3 - - - 3/3 - 2/2 - 3/3 - Responsible banking, sustainability and culture 100% - 2/2 - - - 2/2 2/2 - 2/2 2/2 - - 2/2 2/2 2/2 - - - - - - - - - - 13/13 11/11 13/13 - - - - - - 7/7 11/11 13/13 - - 12/13 12/13 12/13 - - - - - - 10/11 10/11 11/11 - - - - - 6/8 - 7/7 - 13/13 13/13 13/13 - A. Left risk supervision, regulation and compliance committee on 1 January 2019. Relinquished chairmanship of that committee on 1 October 2018. B. Left the innovation and technology committee on 1 July 2018. C. Left the appointments committee on 1 July 2018. D. Member of the board since 1 April 2018 and member of the risk supervision, regulation and compliance committee since 23 April 2018. E. Left the risk supervision, regulation and compliance committee on 1 July 2018. F. Left the innovation and technology committee on 1 July 2018. G. Member of the executive committee since 1 July 2018. H. Mr Juan Miguel Villar Mir left the board on 1 January 2019. On average, each of our directors has dedicated approximately 144 hours to board meetings. In addition, those who are members of the executive committee dedicated approximately 225 hours; members of the audit committee 130 hours; members of the appointments committee 52 hours; members of the remuneration committee 44 hours; members of the risk supervision, regulation and compliance committee 130 hours; members of the innovation and technology committee 12 hours and members of the responsible banking, sustainability and culture committee 10 hours. In all the cases, the relevant chairman is estimated to have dedicated double that time. Directors must inform the appointments committee of any professional activity or position for which they are going to be proposed, so that the time commitment to the Group can be assessed on an ongoing basis, and any possible confict of interest derived from such position can be verifed. Additionally, the annual suitability reassessment made by our appointments committee (see in section 4.5 'Appointments committee activities in 2018') allows us to keep up to date all information relating to the estimated time dedicated by directors to other positions and/or professional activities and to confrm their capacity to exercise good governance as directors of the Bank. This allows the Bank to verify compliance with applicable legal requirements regarding the maximum number of company boards to which our directors may belong at the same time (no more than one executive position and two non-executive positions, or four non-executive positions, including positions held in the same Group as a single position and not including positions held at non-proft organisations or entities that do not pursue commercial activities)15. 15. This maximum is established, as provided for in article 36 of the Rules and regulations of the board, in article 26 of Spanish Law 10/2014 on the ordering, supervision and solvency of credit institutions. This rule is further developed by articles 29 and subsequent of Royal Decree 84/2015 and by Rules 30 and subsequent of Bank of Spain Circular 2/2016. 145 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Training of directors and induction programme for new directors Given the board´s commitment to continuously improve its functioning, an ongoing training programme for the board as a whole is in place, which in 2018 consisted in fve training sessions provided by internal and external speakers. Among others the training program included items like model risk, payment services directive II (PSD2), responsible banking, cyberrisk and cybersecurity, digital transformations, anti-money laundering and risk appetite. Likewise, our board has a robust induction and development programme for new directors to develop their understanding of the Group’s business, including governance rules, where key members of the management of the Group provide detailed information on their areas of responsibility, while addressing any development needs identifed in the suitability assessment process. In 2018, Mr Ramiro Mato and Mr Álvaro Cardoso de Souza completed their respective induction programmes designed for them on the basis of their experience and the specifc induction needs identifed during their suitability assessment processes. the performance of the executive chairman, the chief executive ofcer, the lead independent director, the secretary and each director´s performance. The process was coordinated by the executive chairman and the chairman of the appointments committee. It was based on a confdential, anonymous questionnaire covering the scope referred above that was fully completed by all of our board members. The assessment process focused on the following aspects: • In relation to the board as a whole: (i) structure (size and composition; skills and competencies), (ii) organisation and functioning (planning of meetings, quality of reporting, training areas, reporting by committees) and (iii) dynamics and internal culture (formal and informal engagement). • In relation to the board committees: (i) leadership, size and composition (including skills), (ii) responsibilities and (iii) quality of reporting and timelines. In 2018, incorporating feedback from the external board efectiveness review conducted in 2017, training sessions were scheduled to take into account the board and board committees operations rhythm in order to optimise the attendance. • Individual performance of the chairman of the board, chief executive ofcer, lead independent director and general secretary. Self-assessment of the board Our board conducts a yearly assessment of its functioning and the efectiveness of its work. At least once every three years, the assessment is conducted with the assistance of an external independent consultant, whose independence is assessed by the appointments committee. Action Plan following the 2017 self-assessment In 2017 our appointments committee carried out the board self- assessment with the assistance of an external consultant. The appointments committee verifed the expert´s independence, and in particular the absence of other relevant business relationships with the Group that could impair its independence. The overall review was positive in terms of outcome and key fnding and the exercise resulted in an action plan for further improvement in board efectiveness, which focused mainly on the composition and organisation of the board, board dynamics and internal culture and the functioning of board committees, as described in section 1.3 'Achieving our 2018 priorities'. In 2018 these actions contained in the action plan were monitored by the appointments committee and were successfully completed and implemented, enhancing the board’s overall functioning and efectiveness. The status of those actions was periodically reported to the board of directors. 2018 self-assessment In 2018 and according to the Rules and regulations of the board that contemplate an annual assessment and with the assistance of external consultant every three years, the board made self- assessment internally. The scope of the assessment included the functioning of the board and all its committees, as well as • In relation to each individual director: (i) willingness to speak at the meetings, (ii) contribution and receptivity of other views, (iii) constructively challenging fellow directors and proposals and management of senior management, (iv) applying a strategic mindset to board and (v) bringing their own skills and experience to board. The results of the 2018 assessment process, after the board and the committees have discussed fndings and actions specifc to them, revealed the following: • Directors´ satisfaction with the progress the board has made to enhance its efectiveness. • The size and level of independence within the board and committees is appropriate and we have made positive enhancements to board skills through recent appointments. • The open and transparent discussions and the constructive challenge with fellow directors and senior management. • The leadership and operation of the committees is efective. • The positive overall performance of the executive chairman/ chairman of the board, CEO, lead independent director and general secretary and the high degree of confdence that directors have in these individuals´ competence to serve their roles to a high standard. • The positive assessment of all other directors refects the view that overall the board is seen as efective. As a result of the self-assessment, on 26 February 2019, our board, with the prior report of our appointments committee, approved an action plan with improvements in the following areas: 146 2018 Annual Report Board of directors • Strength the composition of the board with international Executive committee experience in countries where the Group has operations and greater technology experience, sustainability and environmental matters. • To enhance the current new director induction and development programme to incorporate visits to the Bank´s main subsidiaries, covering country-specifc macroeconomic environment, business activities and regulation. • To review the annual agenda to ensure appropriate scheduling and time allocation continues to be devoted to business strategy and to review the Bank´s major risks. • To consider whether the new responsible banking, sustainability and culture committee should meet with greater frequency and establish greater coordination with the countries, in those matters. • Continue to provide opportunities for the board to interact with executive team and strengthen relations between them. • Continue to focus on gender diversity amongst the board and senior executives. Composition Chairman Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie- Brown Category Executive Executive Independent Mr Rodrigo Echenique Gordillo Executive Members Mr Ignacio Benjumea Cabeza de Vaca Mr Guillermo de la Dehesa Romero Mr Ramiro Mato García-Ansorena Other external (neither proprietary nor independent) Other external (neither proprietary nor independent) Independent Ms Belén Romana García Independent Secretary Mr Jaime Pérez Renovales Functions Our executive committee is a basic instrument for the corporate governance of the Bank and its Group. It exercises by delegation all the powers of our board, except those which cannot be delegated pursuant to the law, the Bylaws or the Rules and regulations of the board. This allows our board to focus on its general supervisory function. Oversight of our executive committee is ensured through regular reports submitted to the board on the principal matters dealt with by the committee and by making available to all directors the minutes of its meetings and all the supporting documentation made available to it. Organisation Our board of directors determines the size and qualitative composition of the executive committee, adjusting to efciency criteria and refecting the guidelines for determining the composition of the board. The executive committee, although it does not exactly replicate the qualitative composition of the board of directors, since the presence of all executive directors must be combined with a size that allows an agile development of their functions, is aligned with having a majority of external directors, including three independent directors. The secretary of the board is also the secretary of the executive committee. Our executive committee meets as many times as it is called to meeting by its chairman or by the vice chairman in her absence. It generally meets once a week. Meetings of the executive committee are held when more than one-half of its members are present in person or by proxy. The committee adopts its resolutions by majority vote of those present in person or by proxy. In the event of a tie, the chairman of the committee has the tie-breaking vote. The committee members may grant a proxy to another member, although non-executive directors may only be represented by another non-executive director. 147 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Main activities in 2018 During 2018 the executive committee took action relating to business of the Group, the main subsidiaries, risk matters, corporate transactions and the main matters that are subsequently submitted to the full board: time per meeting. 'Board and committees attendance' in section 4.3 provides information on the attendance of executive committee members at those meetings. Responsible banking, sustainability and culture committee • Earnings: the committee was also kept up to date on Group earnings, and their impact on investors and analysts. • Business performance: the committee was kept continuously and fully informed of the performance of the Group’s various business areas, through management reports or specifc reports on determined subjects submitted. It was also informed of various projects relating to the transformation and development of the Group’s culture (Simple, Personal and Fair). • Information reported by the chairman: the chairman of our board of directors, who also chairs the executive committee, regularly reported on key aspects relating to Group management and on strategy and institutional issues. • Corporate transactions: the committee analysed and, where applicable, approved corporate transactions carried out by the Group (investments and divestments, joint ventures, capital transactions, etc.). • Banco Popular: the Banco Popular integration process and its associated risks and mitigating controls were an item that was continuously monitored by the committee. • Risks: the committee was regularly informed about the risks facing the Group and, within the framework of the risk governance model, made decisions about transactions that had to be approved by it due to their amount or relevance. • Subsidiaries: the committee received reports on the performance of the various units and, in line with current internal procedures, authorised transactions and appointments of directors of subsidiaries. • Capital and liquidity: the committee received frequent information on the performance of capital ratios and of the measures being used to optimise these ratios, in addition to reviewing regulatory plans. • Talent and culture: the committee received ongoing reports of the implementation of the corporate culture and values within the Group. Composition Chairman Mr Ramiro Mato García-Ansorena Category Independent Ms Ana Botín-Sanz de Sautuola y O’Shea Executive Mr Homaira Akbari Independent Mr Ignacio Benjumea Cabeza de Vaca Other external (neither proprietary nor independent) Members Mr Álvaro Cardoso de Souza Ms Sol Daurella Comadrán Ms Esther Gimenez- Salinas i Colomer Independent Independent Independent Ms Belén Romana García Independent Secretary Mr Jaime Pérez Renovales Functions The purpose of this committee is to assist our board of directors in fulflling its oversight responsibilities with respect to the responsible business strategy and sustainability issues of the Group, preparing and reviewing the corporate culture and values and advising on its relations with various stakeholders, especially with employees, customers and communities with which the Group carries out its activities, and in particular in the following areas: • Formulation of the corporate culture and values, including the strategy on responsible business practices and sustainability. • Formulation of the Group’s strategy on relations with stakeholders, including employees, customers and communities in which the Group develops its activities. • Corporate reputation particularly on social and environmental matters. • Assist the board in the promotion of the corporate culture and values across the Group, including liaising: • Activities with supervisors and regulatory matters: the • With the remuneration committee in the alignment of the committee was regularly informed of the initiatives and activities of supervisors and regulators, in addition to projects to ensure compliance with its recommendations and regulatory changes. Group’s remuneration programmes with the referred culture and values. • Governance Models: the committee approved the Governance Models of the newly created Wealth Management division, of Santander Universities and Universia and that of the international branches under the management responsibility of Santander Corporate & Investment Banking division. In 2018, the executive committee held 45 meetings. In 2018, the average estimated time dedicated by each member to preparing for and participating in meetings was approximately fve hours per meeting, with the chairman estimated to have spent double that • With the risk supervision, regulation and compliance committee in (i) the alignment of the risk appetite and limits of the Group with our culture and values and (ii) assessment of the Group’s non-fnancial risks. • With the appointments committee in (i) the supervision of the strategy for communication and relations with shareholders and investors, including small and medium-sized shareholders, and (ii) in the processes of communication and relations with the other stakeholders. 148 2018 Annual Report Board of directors • Liaise and coordinate with the committees of the board in relation to issues concerning responsible banking practices and sustainability and ensure that adequate and efective control processes are in place and that risks and opportunities relating to sustainability and responsibility are identifed and managed. • Report periodically to the board of directors on the Bank’s and its Group’s performance and the progress made with regard to responsible business practices and sustainability, providing advice in relation to these matters, issuing reports and implementing procedures within its area of responsibility at the request of the board of directors or its chairman. Organisation Our responsible banking, sustainability and culture committee approves an annual calendar of meetings, which provides for at least four meetings. The committee meets as many times as it is required to fulfl its responsibilities. Meetings of the committee are held when more than one-half of its members are present in person or by proxy. The committee adopts its resolutions by majority vote of those present in person or by proxy. In the event of a tie. The chairman, who shall be necessarily an independent director of the committee has the casting vote. The committee members may grant a proxy to another member, although non-executive directors may only represent another non-executive director. The committee has the power to require executives to attend its meetings under the terms stated by it. The committee, through its chairman, reports to the board of directors on its activities and work. Furthermore, the supporting documentation that is provided to the committee is made available to all directors as well as a copy of the minutes. Main activities in 2018 The main topics discussed since the committee was set up are as follows: • The new responsible banking governance model. The main priorities for the committee in 2019 are set out in page 19 of the 'Responsible banking' chapter. Since it was created in June 2018 it has met on two occasions. In 2018, the average estimated time dedicated by each member to preparing for and participating in meetings was approximately fve hours per meeting, with the chairman estimated to have spent double that time per meeting. 'Board and committees attendance' in section 4.3 provides information on the attendance of the responsible banking, sustainability and culture committee members at those meetings. Innovation and technology committee Composition Chairman Ms Ana Botín-Sanz de Sautuola y O’Shea Category Executive Members Ms Homaira Akbari Independent Mr José Antonio Álvarez Álvarez Executive Mr Ignacio Benjumea Cabeza de Vaca Mr Bruce Carnegie- Brown Mr Guillermo de la Dehesa Romero Other external (neither proprietary nor independent) Independent Other external (neither proprietary nor independent) Ms Belén Romana García Independent Secretary Mr Jaime Pérez Renovales Functions The purpose of our innovation and technology committee is to assist our board of directors in fulflling its oversight responsibilities and activities with respect to the overall role of technology in the business strategy of the Group and in matters related to the Group innovation strategy and plans as well as the trends resulting from new business models, technologies and products. In particular, it has the following functions: • The guiding principles of governance and supervision in matters of responsible banking, sustainability and culture for the Group’s subsidiaries. • Review and report on plans and activities relating to technology and innovation. • Assist the board with implementation of the framework for the • The establishment of main lines of action and monitoring Group strategic technology plan. metrics. • The review of the adequacy of the general sustainability and innovation agenda. socio-environmental policies, and analysis of potential gaps to internally regulate these topics. More specifcally, the review of the criteria for fnancing activities related to coal, both those related to its extraction (mining) and its use as an energy source. • Assist the board in the identifcation of key threats to the status quo resulting from new business models, technologies, processes, products and concepts. • Assist the board with recommendations covering the Group’s • The positioning of the Bank as a relevant player in the fnancing • Propose to the board the annual systems plan. of clean energy projects. • Assist the board in evaluating the quality of the technological service. • Assist the board in evaluating the capabilities and conditions for innovation at a Group and country level. 149 Responsible bankingCorporate governanceEconomic and financial reviewRisk management • Assist the risk supervision, regulation and compliance committee International advisory board in the supervision of technological risks and cybersecurity. Organisation Our innovation and technology committee approves an annual calendar of meetings, which provides for at least four meetings. The committee meets as many times as it is required to fulfl its responsibilities. Meetings of the committee are validly held when more than one-half of its members are present in person or by proxy. The committee adopts its resolutions by majority vote of those present in person or by proxy. In the event of a tie, the chairman of the committee has the casting vote. The committee members may grant a proxy to another member, although non-executive directors may only represent another non-executive director. The committee has the power to require executives to attend its meetings under the terms stated by it. The committee, through its chairman, reports to our board of directors on its activities and work. Furthermore, the supporting documentation that is provided to the committee is made available to all directors as well as the minutes. Main activities in 2018 During 2018 the innovation and technology committee carried out, amongst others, the following activities: • Review of the Global Technology Strategy Plan. • Review of the platform and cloud strategy. • Review of the policy on data and artifcial intelligence (machine learning) and its potential impact. Composition Positions Chairman Mr Larry Summers Ms Sheila C. Bair Mr Mike Rhodin Former Secretary of the US Treasury and president emeritus of Harvard University Former chairman of the Federal Deposit Insurance Corporation and former president of Washington College Board member of TomTom, HzO and Syncsort. Former IBM senior Vice President Members Ms Marjorie Scardino Former CEO of Pearson and director of Twitter Mr Francisco D’Souza CEO of Cognizant and director of General Electric Mr James Whitehurst Mr George Kurtz Ms Blythe Masters Chairman and CEO of Red Hat CEO and co-founder of CrowdStrike CEO of Digital Asset Holdings Secretary Mr Jaime Pérez Renovales Functions The purpose of Banco Santander’s international advisory board, which comprises external experts in economy, strategy, IT and innovation, is to provide strategic advice to the Group, with a special focus on innovation, digital transformation, cybersecurity and new technologies. It also provides views on trends in capital markets, corporate governance, brand and reputation, regulation and compliance, and global fnancial services with a customer- based approach. • Review of main digital strategies to transform the core, and accelerate the growth of new businesses. Meetings The international advisory board meets at least twice per year. • Review of metrics to measure and monitor the impact of digital transformation. In 2018, the international advisory board met twice, one in spring and one in fall. • Review of the status update for the implementation of cybersecurity within the Group, the main risks and mitigating controls. • Review of the status of OpenBank digital and technological projects. The committee met on three occasions in 2018. In 2018, the average estimated time dedicated by each member to preparing for and participating in meetings was approximately fve hours per meeting, with the chairman estimated to have spent double that time per meeting. 'Board and committees attendance' in section 4.3 provides information on the attendance of the innovation and technology committee members at those meetings. 150 2018 Annual Report Board of directors 4.4 Audit committee activities in 2018 This section constitutes the audit committee report that in previous years was issued separately and that is now provided as part of the annual corporate governance report as discussed in 'Redesigned corporate governance report' in section 1. This report was prepared by the audit committee on 21 February 2019 and approved by the board of directors on 26 February 2019. Composition Composition Category Chairman Ms Belén Romana García Independent Ms Homaira Akbari Independent Members Mr Carlos Fernández González Mr Ramiro Mato García-Ansorena Independent Independent Secretary Mr Jaime Pérez Renovales The board of directors has appointed the members of the committee bearing in mind their knowledge and experience in fnance, accounting, auditing, internal control, information technologies, business and risk management. Specifcally, Ms Belén Romana García, the committee’s chairman, is considered to be a fnancial expert, as defned in SEC Regulation S-K, based on her training and expertise in accounting, auditing and risk management, and as a result of having held various positions of responsibility at entities in which knowledge of accounting and risk management was essential. For further information about the skills, knowledge and experience of each of the committee members, see section 4.1 'Our directors' and 'Board skills and diversity matrix' in section 4.2. There have been no changes in the composition of the committee during 2018. How the committee works Our audit committee meets in accordance with an annual calendar, which includes at least four meetings, and there is an annual work plan of issues to be discussed by the committee. Meetings of the committee shall be validly held with the attendance, either present or represented, of more than half of its members, who may designate another member as proxy. Resolutions are passed by a majority vote of the attendees and the chairman has the casting vote in the event of a tie. Committee members are provided with the relevant documentation for each meeting sufciently in advance of the meeting date, thereby ensuring committee efectiveness. The committee has the power to require executives to attend its meetings, by invitation from the chairman of the committee to attend under the terms established by the committee. The post of secretary to the committee corresponds, in a non- voting capacity, to the general secretary and secretary to the board, who is also head of the Group’s Human Resources area, fostering a fuid and efcient relationship with the diferent units that are expected to collaborate with, or provide information to, the committee. The committee may contract legal, accounting or fnancial advisers or other experts, at the Bank´s expense, to assist in the exercise of its functions. Without prejudice to the fact that the committee chairman reports on the content of its meetings and its activities at each of the board of directors meetings held, all documentation distributed for its meetings and the minutes thereof are made available to all directors. External auditor Our external auditor is PricewaterhouseCoopers Auditores, S.L. (PwC) with registered ofce in Madrid, Paseo de la Castellana, no. 259 B, with Tax ID Code B-79031290 and registered in the Ofcial Registry of Auditors of Accounts (Registro Ofcial de Auditores de Cuentas) of the Accounting and Audit Institute (Instituto de Contabilidad y Auditoría de Cuentas, (ICAC)) of the Ministry for Economy with number S0242. The lead partner is Mr Alejandro Esnal, a leading audit partner for the banking sector in Spain (having audited entities such as Banco Sabadell, S.A., Unicaja and Barclays Bank Spain). Throughout his 25 years of professional career, he has led numerous projects both in Spain and New York and London, mainly in audit services, as well as in internal control environments of fnancial entities. As an audit leader for banking, he participates actively in committees and working groups of the sector and collaborates proactively with the fnancial regulation department, in matters such as the restructuring of the sector or the strengthening of banking practices. Report on the independence of the external auditor The audit committee has verifed favorably the independence of the external auditor, at its meeting of 21 February 2019 and prior to the issuance of the auditor’s report on the fnancial statements, in the terms established section 4.f) of article 529 quaterdecies of the Spanish Companies Act, and under article 17.4.c)(iii) of the Rules and regulations of the board, concluding that in the committees’ opinion there are no objective reasons for doubting the independence of the external auditor. To evaluate the independence of the external auditor, the committee has considered the information included under section 'Duties and activities in 2018' on the remuneration of the auditor for audit services and any other services and the written confrmation from the external auditor itself confrming its independence with respect to the Bank under the applicable European and Spanish legislation, the SEC rules and the rules of the Public Company Accounting Oversight Board (PCAOB). Proposed reelection of the external auditor for 2019 As indicated in section 3.5 'Our coming 2019 AGM', the board of directors, following the proposal of the audit committee, has submitted to our 2019 AGM the reelection of PwC as external auditor for 2019. 151 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Duties and activities in 2018 This section contains a summary of the audit committee’s activities in 2018, classifed in accordance with the committee’s basic duties. Duties Actions taken by the audit committee Financial statements and other fnancial information • Review the fnancial • Reviewed the individual and consolidated fnancial statements and directors´ reports for 2018 and endorsed statements and other fnancial information their content prior to their authorisation for issue by the board, and ensured compliance with legal requirements and the proper application of generally accepted accounting principles and that the external auditor issued the corresponding report with regard to the efectiveness of the Group’s system of internal control of fnancial reporting (ICFR). • Endorsed quarterly the fnancial information statements dated 31 March, 30 June, 30 September and 31 December 2018, respectively, prior to their approval by the board and their disclosure to the markets and to supervisory bodies. • Endorsed other fnancial information such as: annual corporate governance report; DRA fled with CNMV; Form 20-F with the fnancial information of 2017, fled with SEC; the half-yearly fnancial information fled with CNMV and with SEC in Form 6-K, and the Group’s interim consolidated fnancial statements specifc to Brazil. • Monitored the implementation of IFRS9 throughout the year. • Report to the board • Received information from the Group’s tax advisory unit regarding the tax policies applied, in compliance with about the tax policies applied the Code of Good Tax Practices and submitted this information for the board of directors. Relationship with the external auditor Auditing the fnancial statements • Receive information • Obtained confrmation from the external auditor that it has had full access to all information, to conduct its on the audit plan and its implementation activity. • Discussed improvements in the reporting of fnancial information resulting from changes to accounting standards, and best international practices. • Analysed the detailed information on the planning, progress and execution of the audit plan and its implementation. • Analysed the auditor’s reports for the annual fnancial statements prior to the external auditor’s report to the board of directors. • Relations with the external auditor • The external auditor attended 11 of 13 committee meetings held in 2018, serving as a channel of communication between the auditor and the board. • Met two times with the external auditor without the presence of the Bank’s executives relating to the audit work. • Assessment of the auditor’s performance • Performed an evaluation of the external auditor and how it has contributed to the integrity of the fnancial information. In this evaluation, our committee was informed by the auditor and also analysed the results of any inspections carried out by the regulators on PwC, concluding that it did not observe threats to its independence as external auditor. 152 2018 Annual Report Board of directors Duties Actions taken by the audit committee Independence PwC’s remuneration for audit and non- audit services • Monitored the remuneration of PwC; the fees for the audit and non-audit services provided to the Group that were as follows: EUR million Audits Audit-related services Tax advisory services Other services Total 2018 90.0 6.5 0.9 3.4 100.8 2017 88.1 6.7 1.3 3.1 99.2 2016 73.7 7.2 0.9 3.6 85.4 The 'Audits' heading includes fees paid for auditing the annual consolidated fnancial statements of Banco Santander and its Group; the consolidated fnancial statements on Form 20-F fled in the SEC; internal control audit (SOX) for those required entities; the audit of fnancial statements of the Bank for the Brazilian regulator; and the regulatory reports required from the auditor corresponding to the diferent locations of the Group. The 'Audit-related services' refer to aspects such as the issuance of comfort letters and other services required by other regulations in relation to aspects such as, for example, securitisation and other services provided by the external auditor. The amount of fees paid for non-audit works and the percentage they represent of all fees invoiced to the Bank and/or its group is as follows: Amount of non-audit work (EUR thousand) Amount of non-audit work as a % amount of audit work 585 0.6% Company Group companies 3,665 Total 4,250 3.6% 4.2% In 2018, the Group commissioned services from audit frms other than PwC in the amount of EUR 173.9 million (115.6 and 127.9 EUR million in 2017 and 2016, respectively). • Non-audit services. • Reviewed and updated the internal policy of the approval of non-audit services. Assess threats to the independence and the safeguard measures • Reviewed services rendered by PwC, and verifed its independence. For these purposes: • Verifed that all services rendered by the Group’s auditor, including audit and audit-related services, tax advisory services and other services detailed in the section above, meet the independence requirements set out in the applicable regulation. • Verifed the ratio of fees received during the year for non-audit and audit-related services to total fees received by the auditor for all services provided to the Group, with this ratio for 2018 standing at 4.2%. • Average fees paid to auditors in 2018 for non-audit and related services account for 15% of total fees paid as a benchmark according to available information on the leading listed companies in Spain. • Verifed the ratio of fees paid for all items relating to the services provided to the Group to total fees generated by PwC frm in 2018. Group’s total fees paid are less than 0.3% of PwC’s total revenue in the world. • Reviewed the banking transactions performed with companies related to PwC, concluding that no transactions have been carried out that compromise PwC’s independence. • External auditor • After considering the information detailed above, the committee issued the 'Report on the independence of independence report the external auditor'. Re-election of the external auditor • Re-election of the external auditor • Submitted to the board of directors the proposal to re-elect PwC as external auditors for 2019. The board submitted PwC’s re-election proposal as the Bank’s external auditors to our 2019 AGM. 153 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Duties Actions taken by the audit committee Internal audit function • Assess the • Supervised the Internal Audit function and ensured its independence and efcacy throughout 2018. performance of internal audit function • Reported on the progress of the internal audit plan, allowing the committee to have and exhaustive control on Internal Audit recommendations and ratings of the diferent units and divisions. • Representatives of the Internal Audit division attended 11 of 13 meetings held by the audit committee in 2018, one of them only with the chief audit executive without the presence of other executives or the external auditor. • Proposed the budget of Internal Audit function for 2019, ensuring that it has the material and human resources necessary to carry out its function. • Reviewed the annual audit plan for 2019 and submitted it to the board for approval. • Received regular information of the internal audit activities carried out in 2018. • Reviewed the application of the measures included in the strategic internal audit plan for the 2016-2018 period. • Reviewed and was informed about internal audit function, methodologies, ratings, recommendations and main conclusions of the internal audit work in other units and geographies. • Assessed the adequacy and efectiveness of the function when performing its mission, as well as the chief audit executive’s performance in 2018, which was reported to the remuneration committee and to the board in order to establish their variable remuneration. Internal control systems • Monitor the efcacy of internal control systems • Received information of the process of evaluating and certifying the Group’s internal control model (ICM) for 2017 and the conclusions on its efectiveness. No material weaknesses were detected at Group level in accordance with this annual evaluation process. • Reviewed the efectiveness of the Bank’s internal controls on the generation of fnancial information contained in the Group’s consolidated annual report fled in the US (Form 20-F) for 2017, as required by the Sarbanes-Oxley Act, concluding that, in its opinion, the Group maintained efective internal control over said fnancial information, in all material aspects. • Whistleblowing • Received information from the Compliance & Conduct area about the activity of the whistleblowing channel channel and the irregularities committees existing in the Group for these purposes specially in regard to issues relating to questionable fnancial and accounting practices and the process of generating fnancial information, auditing and internal controls, verifying that in 2018 there was not any claim about this issues fled through these channels. • Coordination with Risk • Joint meetings with board risk supervision, regulation and compliance committee in order to share information regarding IFRS9, IT and obsolescence risk, whistleblowing, policy on outsourcing of services and other matters. • Communications • Submitted to CNMV information requested about the compliance with the obligations related to the with regulators and supervisors composition, functions and operating of the audit committee. Related-party and corporate transactions • Creation of special- purpose vehicles or entities in countries considered tax havens • Received the justifcation of the establishment of a new company in Jersey and separate the activity in Jersey and isle of Man from the so-called Ring Fenced Bank to comply with the banking reform in UK. Finally, this company in Jersey was incorporated but it remains inactive. The committee was informed that the business in Jersey and the Isle of Man will remain within the Group in the UK, although outside Santander UK. • Approval of related party transactions • Reviewed the transactions that the Bank carried out with related parties, and ensured that they were made under the terms envisaged by law and in the Rules and regulations of the board and did not require approval from the governing bodies; otherwise, approval was duly obtained following a favourable report issued by the committee, once the agreed consideration and other terms and conditions were found to be within market parameters. No member of the board of directors, direct or indirectly, has carried out any signifcant transactions or any transaction on non-customary market conditions with the Bank. The committee has examined the information regarding related party transactions in the fnancial statements. See section 4.8 'Related-party transactions and conficts of interest'. • Transactions involving structural or corporate modifcations • Reviewed the transactions involving structural or corporate modifcations planned by the Group during 2018 previously to the submission to the board of directors, analysing their economic conditions and the accounting impact. Among others, the committee reviewed the absorbtion of Banco Popular and the efectiveness of the Bank’s internal controls concerning its integration. 154 2018 Annual Report Board of directors Duties Actions taken by the audit committee Information for the general shareholders’ meeting and corporate documentation • Shareholders information • Corporate documentation for 2017 • At our 2018 AGM, Ms Belén Romana, acting as the committee’s chairman, reported to the shareholders on the matters and activities within the purview of the audit committee. • Drafted the report of the committee for the year 2017, which includes a section dedicated to the activities carried out during the year, an analysis and assessment of the fulflment of the functions entrusted to it, and the priorities for 2018 identifed following the self-assessment carried out by our board and its committees. Time devoted to each task In 2018, the audit committee held 13 meetings. In section 4.3 'Board and committees attendance' provides information on the attendance of committee members at those meetings. The average estimated time dedicated by each member of the committee to preparing for and participating in meetings held in 2018 was approximately 10 hours per meeting, with the chairman estimated to have spent double that time per meeting. accurate documentation was provided on the topics discussed, the proper presentation of which enhanced the quality of debate among members and sound decision-making. 2019 priorities The committee’s self-assessment exercise identifed the following priorities for 2019: • Ongoing focus on the size and composition of the committee, particularly in connection with necessary accounting, fnancial, risk management and audit expertise to guarantee its efectiveness. 8% 11% 19% Financial statements • Continue working on coordination with units and Group divisions, implementing information sharing mechanisms on a regular basis. • Build up a holistic of certain key topics using ‘white books’ to ensure proper oversight and monitor the activities of units and divisions taking into account the recommendations provided by Internal Audit. • Monitor the implementation of IFRS9, made in 2018, analysing the impact of the new standard and the Bank’s adaptation process, in order to reduce implementation costs and compliance risk. External audit Internal audit Internal control systems 17% Others 45% Annual assessment of the functioning and performance of the committee and fulflment of the goals set for 2018 The committee’s efectiveness during 2018 was considered as part of the overall internal assessment of board efectiveness carried out internally this year. The committee considered the fndings and suggested actions resulting from the review and related to the audit committee. In 2018, the committee successfully addressed all the challenges put forward for the year and identifed in the 2017 activities report, especially regarding coordination with the risk supervision, regulation and compliance committee in supervising the execution of the internal audit plan which has provided a holistic view of the key internal audit risks, internal audit methodologies, ratings, recommendations and main conclusions of the internal audit work in the most relevant units. Further, the regular meetings held by the chairman of the Group audit committee with the chairmen of the audit committees of the diferent subsidiaries in main geographies during the second half of the year provided their coordination and the agreement on key issues, and also allowed sharing an overview of regulatory matters and new regulations, applied across the Group’s main geographies. As a result of this assessment, it was concluded that the committee efectively performed its functions of supporting and advising the board. This was demonstrated through holding, an appropriate number of meetings, for which sufcient and 155 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4.5 Appointments committee activities in 2018 This section constitutes the appointments committee report that in previous years was issued separately and that is now provided as part of the annual corporate governance report as discussed in 'Redesigned corporate governance report' in section 1. This report was prepared by the appointments committee on 25 February 2019 and approved by the board of directors on 26 February 2019. Composition Composition Chairman Mr Bruce Carnegie- Brown Ms Sol Daurella Comadrán Category Independent Independent Members Mr Guillermo de la Dehesa Romero Other external (neither proprietary nor independent) Mr Carlos Fernández González Independent Secretary Mr Jaime Pérez Renovales Committee members are provided with the relevant documentation for each meeting sufciently in advance of the meeting date, thereby ensuring committee efectiveness. The committee has the power to require executives to attend its meetings, by invitation from the chairman of the committee to attend under the terms established by the committee. The post of secretary to the committee corresponds, in a non- voting capacity, to the general secretary and secretary to the board, who is also head of the Group’s Human Resources area, fostering a fuid and efcient relationship with the diferent units that are expected to collaborate with, or provide information to, the committee. The committee may contract legal, accounting or fnancial advisers or other experts, at Bank´s expense, to assist in the exercise of its functions. Without prejudice to the fact that the committee chairman reports on the content of its meetings and its activities at each of the board of directors meetings held, all documentation distributed for its meetings and the minutes thereof are made available to all directors. The board of directors has appointed the members of the committee bearing in mind their knowledge, aptitude and experience in relation to the committee's mission. For further information about the skills, knowledge and experience of each of the committee members, see section 4.1 'Our directors' and 'Board skills and diversity matrix' in section 4.2. How the committee works Our appointments committee holds its meetings in accordance with an annual calendar, which includes at least four meetings, and there is an annual work plan of issues to be discussed by the committee. Meetings of the committee shall be validly held with the attendance, either present or represented, of more than half of its members, who may designate another member as proxy. Resolutions are passed by a majority vote of the attendees, either present or represented, and the chairman has the casting vote in the event of a tie. 156 2018 Annual Report Board of directors Duties and activities in 2018 This section contains a summary of the appointments committee’s activities in 2018, classifed in accordance with the committee’s basic duties. Duties Actions taken by the Appointments Committee Appointments and removal of directors and committee members • Selection and succession policy and renewal of the board and its committees • Updated the policy for the selection, suitability assessment and succession of directors in accordance with EBA and ESMA guidelines on suitability, assessment for directors and the ECB Guide to ft and proper assessments. • Appointment, re-election, ratifcation and removal of directors, and committee members • Ensured that the procedures for selecting board members guaranteed the individual and collective training of directors, fostering diversity of gender, experience and knowledge and, in partnership with an external frm, conducted the relevant analysis of the necessary competencies and skills for the position, and assessing the time and dedication required to properly perform the role. • Also assessed the composition of the board committees to ensure continuity of appropriate skillset and experience, overall stability and appropriate distribution for the better development of their duties. • Analysed the candidates presented, as well as their credentials, and assessed their skills and suitability for the position. • Took note of the resignation of Mr Juan Miguel Villar Mir as director, once his tenure expired, after requesting not to be proposed for re-election at the last AGM. • In 2018 Mr Álvaro Cardoso de Souza was appointed, Mr Ramiro Mato was ratifed, and Mr Carlos Fernández, Mr Ignacio Benjumea, Mr Guillermo de la Dehesa, Ms Sol Daurella, and Ms Homaira Akbari were re-elected. All these appointment, ratifcation and re-election were proposed to the board by the appointments committee. • Submitted a proposal to the board regarding changes in the composition of the board committees, to further strengthen their performance and support to the board in their respective areas, according to the best international practices and our internal Rules and regulations of the board (for more information see 'Board committees' in section 1.1). • Approved, upon completion of one year of their term of ofce and in accordance with the Bylaws, the re-election of members of the Santander Group’s international advisory board (for more information see 'International advisory board' in section 4.3). • In 2018, our appointments committee examined the overall composition and skills of our board of directors and board committees to ensure that they are appropriate. The committee identifed, utilising the skills matrix, the desired areas of expertise and experience profles for recruitment which informed the selection process. The committee proposed Mr Álvaro Cardoso de Souza’s appointment as member of the board who has further strengthened the board’s international diversity, specifcally in relation to Latin America / Brazil. Succession plan • Succession plan for executive • Continued the regular review of talent and succession plans from executive directors and senior directors and senior management management of the Group to ensure that they are oriented to have, at all times, sufciently qualifed personnel to allow the execution of Group´s strategic plans without interruption, safe-guard business continuity and avoid any relevant functions not being take care of. This involves identifying possible replacements for key positions, in order to provide them with appropriate training and capabilities in advance. Verifcation of the status of directors • Annual verifcation of the status of directors • Verifed the classifcations of each director (as executive, independent and other external) and submitted its proposal to the board of directors for the purpose of its confrmation or review at the AGM and in the annual corporate governance report. See section 4.2. 'Board composition'. • When assessing the independence directors, the committee has verifed that there is no signifcant business relationship between Santander Group and the companies in which they are, or have previously been, signifcant shareholders or directors and, in particular, with regard to the fnancing granted by the Santander Group to these companies. In all cases, the committee concluded that the existent relationships were not signifcant, among other reasons, as the business relationships: (i) do not generate a situation of economic dependence in the relevant companies in view of the substitutability of this fnancing for other sources of funding, either bank-based fnancing or other, (ii) are aligned with the market share of Santander Group within the relevant market, and (iii) have not reached certain comparable materiality thresholds used in other jurisdictions as reference: e.g. NYSE, Nasdaq and Canada’s Bank Act. 157 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Duties Actions taken by the Appointments Committee Periodic assessment • Annual suitability • Assessed the suitability of the members of the board, the senior management, those responsible assessment of directors and key functions holders for internal control functions and those holding key positions for the conduct of the Group’s banking business, ensuring that they demonstrate commercial and professional integrity, and have suitable knowledge and experience to perform their duties. Likewise, the committee concluded that the members of the board are capable of carrying out good governance of the Bank, and have capacity to make independent and autonomous decisions for the Group´s beneft. • Verifed that the Bank had not been informed by any director of any circumstances that, in its opinion and in opinion of the board would have justifed their dismissal as a member of the board of directors of the Bank. • Potential conficts of interest and other directors´professionals activities • Examined the information provided by the directors regarding other professional activities or positions to which they had been proposed concluding that such obligations did not interfere with the dedication required as Bank´s directors and that they were not involved in potential conficts of interest that could afect the performance of their duties. • Board self-assessment • In coordination with the executive chairman, the 2018 self-assessment was performed internally, process Senior management without the assistance of an external expert. The scope of the assessment included the board and all its committees, as well as the executive chairman, the chief executive ofcer, the lead director, the secretary and each director. See 'Self-assessment of the board' in section 4.3. • Updated and submitted the board skills and diversity matrix to the board of directors for approval. See section 4.2. 'Board skills and diversity matrix'. • Assessment of senior • The committee issued favourable opinions, among others, regarding the following appointments, executive vice chairman and other key positions agreed by the board of directors: • Mr Dirk Marzluf as the new head of the Group’s Technology and Operations Division, replacing Mr Andreu Plaza. • Mr Keiran Foad as the new chief risk ofcer (CRO) replacing Mr José María Nus Badía. • In addition, the committee reported favourably on the appointment of directors and members of senior management of the main subsidiaries of the Santander Group. • Simplifcation and homogenization of senior management positions • Informed favourably on and submitted to the board to replace the previous management titles ('director general', 'director general adjunto', 'subdirector general' and 'subdirector general adjunto') with new titles common throughout the Group, according to international standards and practices (at a corporate level: Group senior executive vice-president, Group executive vice-president and Group vice-president, and, at a subsidiary level: senior executive vice-president, executive vice-president and vice-president) Internal Governance • Oversee internal governance including Group subsidiary governance • Assessed the suitability of a number of appointments and/or re-elections to Group’s subsidiaries subject to the Group’s appointments and suitability procedure. • Reviewed and updated the key board policies in accordance with the EBA guidelines on Internal Governance such as: suitability, induction, knowledge and development, and confict of interest policies, and approval of an action plan for improvements. • The committee verifed the monitoring of guidelines of the subsidiaries with the Group - subsidiary governance model in relation to the board and board committees of structure of the subsidiaries and their duties in line with best practices. • Proposed and approved the appointment of lead Group-nominated directors to ensure that those persons representing the signifcant shareholder on subsidiary boards are suitable and fully aware of their duties and responsibilities. Information for the general shareholders’ meeting and corporate documentation • Shareholders information • At our 2018 AGM, Mr Bruce Carnegie-Brown acting as the committee’s chairman, reported to the shareholders on the matters and activities within the purview of the appointments committee. • Corporate documentation • Drafted the report of the committee for the year 2017, which includes a section dedicated to the for 2017 activities carried out during the year, an analysis and assessment of the fulflment of the functions entrusted to it, and the priorities for 2018 identifed following the self-assessment carried out by our board and its committees. 158 2018 Annual Report Board of directors Time devoted to each task In 2018, the appointments committee held 13 meetings. Section 'Board and committees attendance' in section 4.3 provides information on the attendance of committee members at those meetings. The average estimated time dedicated by each member of the committee to preparing for and participating in meetings held in 2018 was approximately four hours per meeting, with the chairman estimated to have spent double that time per meeting. 28% 11% 12% 49% Appointments and suitability assessments Board and board committee, succession planning and efectiveness Governance Senior management, succession planning and related activities Annual assessment of the functioning and performance of the committee and fulflment of the goals set for 2018 The committee’s efectiveness during 2018 was considered as part of the overall internal assessment of board efectiveness carried out internally this year. The committee considered the fndings and suggested actions resulting from the review and related to the appointments committee. In 2018, the committee successfully addressed all the challenges put forward for the year and identifed in the 2017 activities report. In particular, confrmed its leadership role in the proper composition of the board of directors achieving a broader geographical diversity as a result of the incorporation of Mr Alvaro Cardoso de Souza in 2018 and reviewing also its own composition avoiding the identity of its members with those of the remuneration committee, in line with the best practices. The self-assessment process positively rated both the composition of the committee and the very high degree of dedication among its members, as well as the chairman’s leadership. The frequency and duration of its meetings were also found to be appropriate for its proper functioning and for the performance of their duties and that sufcient and accurate documentation was provided on the topics discussed, the proper presentation of which strengthened the quality of the debates among members and sound decision-making. 2019 priorities • Cultural transformation: continue working on the Bank’s cultural transformation, ensuring the attraction and retention of the appropriate talent to cover the future needs of the business. • Diversity: continue working to strive towards gender balance and broader diversity in the Group board and the rest of the organisation. • Succession planning: regular review of succession plans of members of the board and senior management, relating to current and future strategy and potential challenges the business may face. 4.6 Remuneration committee activities for 2018 This section constitutes the remuneration committee report that in previous years was issued separately and that is now provided as part of the annual corporate governance report as discussed in 'Redesigned corporate governance report' in section 1. This report has been prepared by the remuneration committee on 25 February 2019 and approved by the board of directors on 26 February 2019. Composition Composition Category Chairman Mr Bruce Carnegie-Brown Independent Members Mr Ignacio Benjumea Cabeza de Vaca Ms Sol Daurella Comadrán Mr Guillermo de la Dehesa Romero Other external (neither proprietary nor independent) Independent Other external (neither proprietary nor independent) Ms Carlos Fernández González Independent Secretary Mr Jaime Pérez Renovales Our board of directors has appointed the members of the committee bearing in mind their knowledge, aptitude and experience in relation to the committee's mission. For further information about the skills, knowledge and experience of each of the committee members, see section 4.1 'Our directors' and 'Board skills and diversity matrix' in 4.2. There have been no changes in the composition of the committee during 2018. How the committee works Our appointments committee holds its meetings in accordance with an annual calendar, which includes at least four meetings, and there is an annual work plan of issues to be discussed by the committee. Meetings of the committee shall be validly held with the attendance, either present or represented, of more than half of its members, who may designate another member as proxy. Resolutions are passed by a majority vote of the attendees and the chairman has the casting vote in the event of a tie. • Corporate and subsidiary governance: driving the continuous improvement of corporate governance across the Group, focusing on the efective functioning of board of directors with the support of the board committees and the proper oversight and control of subsidiary transactions. Review trends, and best governance practices in corporate governance. Committee members are provided with the relevant documentation for each meeting sufciently in advance of the meeting date, ensuring committee efectiveness. The committee has the power to require executives to attend its meetings, by invitation from the chairman of the committee to attend under the terms established by the committee . 159 Responsible bankingCorporate governanceEconomic and financial reviewRisk management The post of secretary to the committee corresponds, in a non- voting capacity, to the general secretary and secretary to the board, who is also head of the Group’s Human Resources, fostering a fuid and efcient relationship with the diferent units that are expected to collaborate with, or provide information to, the committee. The committee may contract legal, accounting or fnancial advisers or other experts, at the Bank´s expense, to assist in the exercise of its functions. Without prejudice to the fact that the committee chairman reports on the content of its meetings and its activities at each of the board of directors meetings held, all documentation distributed for its meetings and the minutes thereof are made available to all directors. Duties and activities in 2018 This section contains a summary of the remuneration committee’s activities in 2018, classifed in accordance with the committee’s basic functions. Duties Action taken by the Remuneration Committee Remuneration of directors • Individual remuneration of directors in their capacity as such • Analysed the individual remuneration of directors in their capacity as such based on the positions held by the directors on the collective decision-making body, membership on and attendance at the various committees, and any other objective circumstances evaluated by the board. Submission of a proposal to the board for remuneration of the new members of the responsible banking, sustainability and culture and also to increase the remuneration of members of the board as members of the board (+2.5%) in 2018 and the annual amount for the chairman of the audit and risk committees (from EUR 50 thousand to EUR 70 thousand). The rest of the remuneration components remained unchanged. • Beneft scheme • The Remuneration Policy mentioned above provided for the elimination in 2018 of the supplemental beneft scheme for the contingencies of death and permanent disability while in ofce of serving directors provided for in the contracts of the chairman and the CEO, attributing to them an exceptional, non-cumulative supplement to the fxed remuneration. This change did not involve an increased cost to the Bank and eliminated the risk of the cost of this beneft rising in the future, completing the process of reducing risks from pension commitments (derisking). • Individual fxed remuneration for executive directors • Submitted a proposal to the board to maintain the same gross salary for the executive chairman and CEO in 2018 as in 2017, with an increase equivalent to the reduction of fxed pension contributions, without the total compensation being increased as a result of this change, as well as a proposal to increase the gross annual salary of Mr Rodrigo Echenique in consideration of the new responsibilities he assumed in relation to the integration of Banco Popular into the Santander Group. • Proposed to the board to maintain the gross annual salary for executive directors in 2019 as in the prior year. • Individual variable remuneration for executive directors • Submitted a proposal to the board, for subsequent submission to the 2018 AGM, for the approval of a maximum level of variable remuneration up to 200% of the fxed component for executive directors and persons belonging to categories of staf whose professional activities (excluding control functions) have a material impact on the risk profle of the Group (the 'Identifed Staf' or 'Material Risk Takers'). • Determined the annual variable remuneration for 2017 payable immediately and the deferred amounts, part of which are established as a maximum and are conditioned to compliance with long term objectives established for executive directors, to be approved by the board, taking into account the directors´ remuneration policy, based on the individual level of achievement of the annual performance targets and the weightings previously established by the board, and the application of the corresponding targets, scales and weightings. • As part of the directors´ remuneration policy, the committee submitted a proposal for the annual performance indicators and targets to be used for the calculation of the annual variable remuneration for 2019, to be approved by the board. In addition, for submission to the board, establishing the achievement scales for annual and multi-year performance targets and their associated weightings. • Share plans • Submitted a proposal to the board, for subsequent submission to the 2018 AGM regarding the approval of the application of remuneration plans involving the delivery of shares or share options (deferred multiyear targets variable remuneration plan, deferred and conditional variable remuneration plan, application of the Group’s buy-out policy and plan for employees of Santander UK Group Holdings plc. and other companies of the Group in the UK). • Propose the directors´ remuneration policy to the board • A proposal was submitted to the board, for subsequent submission to a binding vote at the 2018 AGM, regarding the approval of the directors´ remuneration policy for 2018, 2019 and 2020, and the committee issued the required explanatory Report regarding the directors' remuneration policy. 160 2018 Annual Report Board of directors Duties Action taken by the Remuneration Committee • Propose the • Submitted of a proposal to the board, for subsequent submission to a consultative vote at the 2018 AGM, annual directors´ remuneration Report to the board regarding the annual directors’ remuneration report. • The committee assisted the board of directors in supervising compliance with the director remuneration policy. • The committee was informed by the lead independent director about the contacts with key shareholders and proxy advisors on remuneration issues for executive directors. • Celebrated four joint sessions with the risk supervision, regulation and compliance committee in order to verify that the remuneration schemes factor in risk, capital and liquidity and that no incentives are offered to assume risk that exceeds the level tolerated by the Bank, therefore promoting and being compatible with adequate and effective risk management. Remuneration of non-director members of senior management • Remuneration • Established the basic terms of the contracts and remuneration for members of senior management in policy for senior executive vice presidents and other members of senior management terms of their fxed and variable annual remuneration, submitting to the board the corresponding proposals for approval. • Established the annual variable remuneration for 2017 payable immediately and the deferred remuneration of members of senior management to be approved by the board, based on the individual level of achievement of the annual performance targets and their weightings as previously established by the board, and the application of the corresponding targets, scales and weightings. • Established of the annual performance indicators to be used for the calculation of variable remuneration for 2019 to be approved by the board, and with the cooperation of the human resources committee, and establishment, for submission to the board, the achievement scales for the annual and multi-year performance targets and weightings. Remuneration of other executives whose activities may have a signifcant impact on the Group’s assumption of risks • Remuneration for other executives who, although not members of senior management, are identifed staf • Assist the board of directors in supervising compliance with director remuneration policies • Established the key elements of the remuneration of ‘identifed staf’. • Reviewed and updated the composition of the identifed staf in order to identify the persons within the Group who fall within the parameters established for being included in such group. • Submitted a proposal to the board, for subsequent submission to the 2018 AGM, regarding the approval of a maximum level of variable remuneration up to 200% of the fxed component for certain Group employees belonging to categories of staf whose professional activities have a material impact on the risk profle of the Bank or the Group. • Reviewed the remuneration programmes to ensure they are up-to-date, giving weight to their adaptation and performance; ensuring that directors’ remuneration is appropriate taking into account the Bank’s results, culture and risk appetite; and that no incentives are ofered to assume risk that exceeds the level tolerated by the Bank, therefore promoting adequate and being compatible with and efective risk management. • The committee informed the board of the content of the report issued by an external consultant assessing the remuneration policy, in application of the provisions of Law 10/2014, which establishes that the remuneration policy of credit institutions will be subject, at least once a year, to a central and independent internal evaluation, in order to verify whether the remuneration guidelines and procedures adopted by the board of directors in its supervisory function have been complied with. • Assisted the board in its supervision of the compliance with the remuneration policy for the directors and other members of the identifed staf, as well as with any other Group's remuneration policies. • Monitored the gender pay reporting analysis and identifed the areas for improvement. • Verifed the independence of the external consultants contracted to assist the committee in the performance of its duties. Information for the general shareholders’ meeting and corporate documentation • Shareholders information • Corporate documentation for 2017 • At our 2018 AGM, Mr Bruce Carnegie-Brown acting as the committee’s chairman, reported to the shareholders on the matters and activities within the purview of the committee during 2017. • Drafted the report of the committee for the year 2017 an analysis and assessment of the fulflment of the functions entrusted to it, and the priorities for 2018 identifed following the self-assessment carried out by our board and its committees. 161 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Time devoted to each task In 2018, the remuneration committee held 11 meetings. Section 4.3, 'Board and committees attendance' provides information on the attendance of committee members at those meetings. The average estimated time dedicated by each member of the committee to preparing for and participating in meetings held in 2018 was approximately four hours per meeting, with the chairman estimated to have spent, approximately, double that time per meeting. 10% 14% 59% 17% Remuneration of board members Remuneration of senior management and key positions Remuneration schemes and policies Others Annual assessment of the functioning and performance of the committee and fulflment of the goals set for 2018 The committee’s efectiveness during 2018 was considered as part of the overall internal assessment of board efectiveness carried out internally this year. The committee considered the fndings and suggested actions resulting from the review and related to the remuneration committee. As a result of this assessment, it was concluded that the committee efectively performed its functions of supporting, informing, proposing and advising the board. This was demonstrated to holding an appropriate number of meetings, for which sufcient and accurate documentation was provided on the topics discussed, the proper presentation of which strengthened the quality of the debates among members and sound decision-making. In 2018 the remuneration committee followed up on all organisational actions and improvements that were launched as a result of the efectiveness assessment carried out in 2017. The committee has continued to monitor the gender pay reporting analysis and to identify areas of improvement. The committee is conscious that any unjustifed gender imbalances that may be identifed within the organization must be fought. In addition, the committee continued with its work in identifying areas for potential improvement in the various Group units. The committee has celebrated joint sessions with the risk supervision, regulation and compliance committee in order to verify that the remuneration schemes factor in risk, capital and liquidity that do not incentivise assuming risks that exceed the level tolerated by the Bank and are consistent with the approved risk strategy of the Bank. Report regarding the director remuneration policy As provided for under section 2 of article 529 novodecies of the Spanish Companies Act, the remuneration committee issues this report regarding the director remuneration policy for 2019, 2020 and 2021 that the board of directors intends to submit to binding approval of the shareholders at the coming AGM as a separate item of the agenda and which is an integral part of this report. See section 6.4 'Director remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders'. 162 Considering the analysis made in the context of the elaboration of the 2018 annual report on director remuneration and its continuous supervision task in relation to remuneration policies, the remuneration committee is of the opinion that the director remuneration policy for 2019, 2020 and 2021, which is expected to be submitted to the shareholders vote and is included in section 6.4 below, conforms to the principles of the Bank’s remuneration policy and to the by-law mandated remuneration system. 2019 Priorities • Intragroup coordination: coordination with the remuneration committees of the Group subsidiaries is a priority, to monitor the adequate implementation and application of the corporate policies regarding remuneration. • Gender pay gap: The committee will continue working in analysing pay gaps that may exist due to gender or other factors, adopting solutions for unjustifed imbalances when detected. • Efective compensation: ongoing focus on shaping compensation structures and schemes to refect the Bank’s culture and continue driving these towards meritocracy and the corporate values. Review the Bank’s remuneration policies to ensure that they are aligned with international best practices, and that they foster talent attraction and retention. 4.7 Risk supervision, regulation and compliance committee activities in 2018 This section constitutes the risk supervision, regulation and compliance committee report that in previous years was issued separately and that is now provided as part of the annual corporate governance report as discussed in 'Redesigned corporate governance report' in section 1. This report was prepared by the risk supervision, regulation and compliance committee on 25 February 2019 and approved by the board of directors on 26 February 2019. Composition Composition Chairman Mr Álvaro Cardoso de Souza Mr Ignacio Benjumea Cabeza de Vaca MembersA Ms Esther Giménez Salinas i Colomer Mr Ramiro Mato García-Ansorena Category Independent Other external (neither proprietary nor independent) Independent Independent Ms Belén Romana García Independent Secretary Mr Jaime Pérez Renovales A. Mr Bruce Carnegie-Brown ceased as member of the committee on 1 January 2019. The board of directors has appointed the members of the committee bearing in mind their knowledge, aptitude and experience in relation to the committee’s mission. 2018 Annual Report Board of directors For further information the skills, knowledge and experience of each of the committee members, see section 4.1 'Our directors' and 'Board skills and diversity matrix' in 4.2. How the committee works Our appointments committee holds its meetings in accordance with an annual calendar, which includes at least four meetings, and there is an annual work plan of issues to be discussed by the committee. Meetings of the committee shall be validly held with the attendance, either present or represented, of more than half of its members, who may designate another member as proxy. Resolutions are passed by a majority vote of the attendees and the chairman has the casting vote in the event of a tie. Committee members are provided with the relevant documentation for each meeting sufciently in advance of the meeting date, thereby ensuring committee efectiveness. The committee has the power to require executives to attend its meetings, by invitation from the chairman of the committee to attend under the terms established by the committee. The post of secretary to the committee corresponds, in a non- voting capacity, to the general secretary and secretary to the board, who is also head of the Group’s Human Resources area, fostering a fuid and efcient relationship with the diferent units that are expected to collaborate with, or provide information to, the committee. The committee may contract legal, accounting or fnancial advisers or other experts, at the Bank´s expense to assist in the exercise of its functions. Without prejudice to the fact that the committee chairman reports on the content of its meetings and its activities at each of the board of directors meetings held, all documentation distributed for its meetings and the minutes thereof are made available to all directors. Duties and activities in 2018 This section contains a summary of the risk supervision, regulation and compliance committee’s activities in 2018, classifed in accordance with the committee’s basic duties. Duties Risk Actions taken by the Risk Supervision, Regulation and Compliance Committee • Assist the board in (i) • The committee carried out an overview of the Group’s risks, and specifc analyses by unit and risk type, and defning the Group’s risk policies, (ii) determining the risk appetite strategy and culture and (iii) supervising their alignment with the Group’s corporate values assessed proposals, and assessed issues and projects relating to risk management and control. • Established and proposed to the board the approval of the risk appetite (risk appetite framework or RAF and the risk appetite statement), including proposals for new metrics. Reviewed on a quarterly basis the compliance with the limits. • Received information about matters relating to the proper management and control of risks within the Group, most notably the Risk Identifcation and Assessment (RIA), the Risk Control Self-Assessment (RCSA), one of the main tools for controlling these risks. • Received regular updates on the main risks afecting the diferent (e.g. Brexit, ring fencing, hyperinfation and devaluation in Argentina) business units and subsidiaries. The chairmen of the committee and of the risk committees of the diferent main global businesses and geographies of the Group held a risk convention to obtain a holistic view of the risks within the Group. • Monitored risks derived from technological obsolescence and related to cybersecurity, including data leakage, incident and vulnerability detection, patch management, network security and access control, amongst others. The committee was informed on the status of the main IT development and projects. Oversight was coordinated with the innovation and technology board committee, with which one joint session was held. • Supervised the diferent risks associated with the main corporate transactions analysed by the Bank and the diferent mitigating measures proposed to address them. In particular, it monitored the risks associated with the integration of Banco Popular in Spain and Portugal. • The Group chief fnancial ofcer (CFO) submitted the 2018 Recovery Plan to the committee, assessing the Group’s resilience in scenarios of severe stress. The plan was submitted to the board of directors for approval. • Supervised and submitted for approval to the board of directors the risk strategy. • Supervised the alignment of the risk strategy with the 3-year strategic fnancial plan, P-21 (from 2019 to 2021), which covers, in qualitative terms and for the entire Group, the priorities and projects for the next three years and, in quantitative terms, a fnancial plan for that period. • Joint meetings with board audit committee in order to share information regarding IFRS9, cybersecurity and obsolescence risk, whistleblowing,policy on outsourcing of services and other matters. 163 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Duties Actions taken by the Risk Supervision, Regulation and Compliance Committee • Assess the activity linked to Risk Management and Control • Ensured that the pricing policy for the assets, liabilities and services ofered to customers fully takes into consideration the business model and appetite and risk strategy of the Bank. • Ascertained the risks resulting from the macroeconomic environment and economic cycles pertaining to the activities of the Bank and its Group. • Reviewed the main exposures of the Group with customers, economic sectors, geographical areas and types of risk. • Supported and assisted the board in conducting stress tests of the Bank. In particular, it assessed the scenarios and assumptions to be used in such tests, analysing the results and the measures proposed by the Risk function as a result. • Supervise the Risk • Ensured the independence and efcacy of the Risk function and that material and human resources were function duly provided. • Assessed the Risk function and the performance of the Chief risk ofcer (CRO) and shared its assessment to the remuneration committee and the board, in order to establish the variable remuneration payable to him. • Collaboration to establish rational remuneration policies and practices • Examined in conjunction with the remuneration committee whether the incentives policy envisaged in the remuneration scheme takes into account risk, capital, liquidity and the probability of proft. • Analysed in conjunction with the remuneration committee, the factors used to determine the ex-ante risk adjustment of the total variable remuneration assigned to the units, based on how previously assessed risks actually materialised. Capital and liquidity • Assist the board in approving the capital and liquidity strategies and supervise their implementation • Reviewed the annual capital self-assessment report (ICAAP) prepared by the Finance and Risks divisions in accordance with industry best practices and supervisory guidelines and submitted this report to the board for approval. Moreover, a capital plan was drawn up in accordance with the scenarios envisaged over a three-year time frame. • Endorsed the Pillar III disclosures report, which was submitted to and fnally approved by the board. The report describes various aspects of the Group’s management of capital and of risk and provides an overview of the function and management of capital; base capital and prescribed capital requirements; policies for managing the various risks undertaken by the Bank from the standpoint of capital consumption; composition of the Group’s portfolio and its credit quality, measured in terms of capital and the roll-out of advanced internal models. • Assessed the liquidity plan (ILAAP), developed in the context of the Group’s business model and submitted for approval by the board. Compliance and conduct • Supervise the Compliance • Monitored the implementation of the compliance programs and the Target Operating Model (TOM) across and Conduct function the Group. • The Group Chief compliance ofcer (CCO) attended to all committee sessions (thirteen) in 2018 to report on matters under her responsibility, including the four joint sessions held in 2018 with the audit committee, the remuneration committee and the innovation and technology committee. • Ensured the independence and efcacy of the Compliance function. • Assessed the Compliance function (including the analysis of the function’s stafng to ensure that the function has the physical and human resources needed for the performance of its work) and the performance of the CCO and shared it with to the remuneration committee and the board in order to establish her variable remuneration. 164 2018 Annual Report Board of directors Duties Actions taken by the Risk Supervision, Regulation and Compliance Committee • Supervise the efcacy of • Assessed the operation of the corporate defence model and its efcacy in preventing or mitigating criminal the Compliance policy, the General Code of Conduct, anti-money laundering and terrorist fnancing manuals, and all other sector codes and rules ofences. • Monitored the compliance with regulatory requirements regarding: • The implementation of GDPR throughout the year within the Group; analysed the main risks and mitigation plans. • The implementation of MiFID II throughout the year. • Monitored and assessed new regulations afecting the Group´s activity in the diferent jurisdictions. • Monitored key strategies and initiatives for enhancing AML management in the medium term through the application of innovative technologies. • Received an external expert’s report in line with legal obligations on the prevention of money laundering in relation to Spain entities. • Regulatory compliance reported: • Volcker's compliance programme and the results of the Group's certifcation. • The global supervision model of market abuse at the Group, highlighting its maturity, endorsed by Internal Audit. • The Bank’s treasury share trading, which complied with the applicable regulations. • Product governance and consumer protection • Reviewed and submitted to the board the annual report from the Group's customer services department, explaining its activities in 2017. • Received information about the progress of the local action plans regarding internal sales force remuneration in the Group and an overview of an initial assessment of the external sales force regarding their potential conduct risk impact. • Received an update on the status of customers’ complaints in the frst half of 2018 and action plans in place to address any defciencies and detriment to customers identifed. • Received information on some of the conclusions reached from the activities carried out by the product governance and consumer protection unit. • Supervise the whistleblower channels • Supervised the activity of the whistleblowing channel that allows Group employees to confdentially and anonymously report any breaches of external or internal rules, and submitted the conclusions achieved to the audit committee. • Reviewed and reported the measures taken in the diferent countries to promote the use of whistleblower channels and their results, in accordance with the request by the board of directors. • The Culture and Regulatory Compliance functions developed a joint proposal to create a single channel model for reporting violations of the General Code of Conduct and behaviours contrary to the values of Simple, Personal and Fair. • Communications received • Received monthly reports on the most relevant communications received from supervisory bodies in from supervisors and regulators the area of compliance and conduct, and supervised the implementation of the associated actions and measures approved. Governance • Corporate governance and • The committee assessed the suitability of the Bank’s corporate governance system, concluding that the internal governance board fulfls its mission of promoting social interest and takes stakeholders’ interests into account, thereby reporting favourably the content of the corporate governance report. • Received information on the meetings held with institutional investors to explain the main initiatives implemented by the board in the area of corporate governance. • Reported favourably on the corporate governance annual report. • Reported favourably on the proposed amendments to the Rules and regulations of the board prior to its approval by the board. 165 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Duties Actions taken by the Risk Supervision, Regulation and Compliance Committee Regulations and relations with supervisors • Regulation and relations • Monitored reports on the main issues raised up by supervisors, the status of the action plans associated with supervisors with these issues and those responsible for their implementation. • Received information about the priorities published by the European Central Bank that will guide the Single Supervisory Mechanism (SSM). Likewise, the committee was informed about the results of the Supervisory Review and Evaluation Process (SREP) carried out by the ECB and about other regulatory updates. • Received from periodic information about the macroeconomic environment and economic and political performance and the outlook in various countries, as well as with regard to the main regulatory principles, new regulations and matters being debated in the fnancial sector that could afect the Group’s activity, in addition to its position in connection with these. • The committee was informed about the updates in relation to the new interbank ofered rates (IBORS) based on alternative risk-free rates, which are being developed by the supervisors of the main jurisdictions. Information for the general shareholders’ meeting and corporate documentation • Shareholders information • Corporate documentation for 2017 • At our 2018 AGM, Mr Bruce Carnegie-Brown acting as the committee’s chairman at that moment, reported to the shareholders on the matters and activities within the purview of the appointments committee. • Drafted the activities report of the committee for the year 2017, which includes a section dedicated to the activities carried out during the year, an analysis and assessment of the fulflment of the functions entrusted to it, and the priorities for 2018 identifed following the self-assessment carried out by our board and its committees. Time devoted to each task In 2018, the risk, supervision regulation and compliance committee held 13 meetings. In section 4.3 'Board and committees attendance' provides information on the attendance of committee members at those meetings. The average estimated time dedicated by each member of the committee to preparing for and participating in meetings held in 2018 was approximately 10 hours per meeting, with the chairman estimated to have spent double that time per meeting. 5% 6% 63% Risk 16% 10% Compliance and Conduct Regulations and relations with stakeholders Capital & Liquidity Governance Annual assessment of the functioning and performance of the committee and fulflment of the goals set for 2018 The committee’s efectiveness was considered as part of the overall internal assessment of board efectiveness carried out internally in 2018. The committee considered the fndings and suggested actions resulting from the review and related to the risk, supervision regulation and compliance committee. As a result of this assessment, it was concluded that the committee efectively performed its functions of supporting and advising the board. This was demonstrated to holding an appropriate number of meetings, for which sufcient and accurate documentation was provided on the topics discussed, the proper presentation of which strengthened the quality of the debates among members and sound decision-making. In 2018, our risk supervision, regulation and compliance committee followed up on all organisational actions and improvements that were launched as a result of the assessment carried out in 2017: • It continued its collaboration with the innovation and technology board committee, holding joint meetings to allow coordinated oversight of technology and cybersecurity risk, ensuring the provision of necessary resources. • It consolidated its function of supporting and assisting to the board as a committee specialised in the control and supervision of the Risks and Compliance functions, increasing its collaboration with the audit committee in the supervision of internal audit activities; and; • It strengthened its relationship with the risk supervision, regulation and compliance committees of the main subsidiaries of the Group, through continuous communication and sharing of best practices, among the chairman of these committees. 2019 Priorities The committee has identifed the following priorities for 2019: • Ongoing focus on material risks and the potential impact of their outcomes and continuous analysis of the macroeconomic environment and early warning indicators. • Ensuring the proper coordination with other board committees, including, among others, the responsible banking, sustainability and culture committee, the remuneration committee and the audit committee, and that they are aware of the work of the committee and how it relates to their respective responsibilities. • Oversight of transformational projects (regulatory and non regulatory). 166 2018 Annual Report Board of directors 4.8 Related-party transactions and conficts of interest Related-party transactions Directors, senior management and signifcant shareholders This subsection includes the report on related-party transactions referred to in recommendation six of the Good Governance Code of Spanish Listed Companies. In accordance with the Rules and regulations of the board, the board of directors shall examine any transactions that the Bank or Group companies carry out with directors, with shareholders that own, whether individually or together with others, a signifcant interest, including shareholders represented on the board of directors of the Bank or of other Group companies, or with persons related to them. These transactions require the authorisation of the board, following a favourable report from the audit committee, except where the law provides that the approval corresponds to the GSM. Exceptionally, when so advised for reasons of urgency, related- party transactions may be authorised by the executive committee, with subsequent ratifcation by the board. Such transactions shall be evaluated in the light of the principle of equal treatment and in view of market conditions. Authorisation of the board shall not be required, however, for transactions that simultaneously meet the following three conditions: • They are carried out under contracts with basically standard terms that customarily apply to the customers contracting for the type of product or service in question. • They are entered into prices or rates generally established by the party acting as supplier of the goods or service in question or, if the transactions concern goods or services for which no rates are established under arm’s length conditions, similar to those applied to commercial relationships with customers having similar characteristics. • The amount thereof does not exceed 1% of the Bank’s annual income. During 2018, no member of the board of directors, no person represented by a director, and no company of which such persons, or persons acting in concert with them or through nominees therein, are directors, members of senior management or signifcant shareholders, to the best knowledge, has entered with the Bank into any signifcant transactions or under conditions which were not market conditions. The audit committee has verifed that all transactions completed with related parties during the year were fully compliant with the abovementioned conditions in order not to require approval from the governing bodies as mentioned in the audit committee activities report in section 4.4. 'Audit committee activities in 2 018'. Group direct risks regarding the Bank's directors and members of senior management as of 31 December 2018 in the form of loans and credits and guarantees provided in the ordinary course of business, are shown in note 5.f of the 'consolidated fnancial statements'. Their conditions are equivalent to those made under market conditions or the corresponding remuneration in kind has been attributed. In addition, the Bank also has a policy for the authorization of loans, credits, loans and guarantees to directors and members of senior management that contains the procedure established for the authorization and formalization of risk transactions of which they or their related parties are benefciaries. The policy includes general rules on maximum borrowing levels, interest rates and other conditions applicable in similar terms to those applicable to the rest of employees. According to the mentioned policy and with the regulations applicable to credit institutions, the loans, credits or guarantees to be granted to directors and senior managers of the Bank need to be authorised by the board and subsequently by the ECB. There are two exceptions: • Transactions subject to the conditions of a collective agreement agreed by the Bank and whose conditions are similar to the conditions of transactions granted to any Bank employee. • Transactions carried out under contracts whose conditions are standardised and generally applied to a large number of customers, provided that the amount granted to the benefciary or its related parties does not exceed the amount of EUR 200,000. Intra-group transactions With regard to intra-group transactions, identical rules, approval bodies and procedures apply as to transactions with customers, with mechanisms in place to monitor that such transactions are under market prices and conditions. The amounts of the transactions with other Group entities (subsidiaries, associates and multigroup entities), as well as with directors, senior management and their related parties are included in note 53 ('Related parties') in the 'consolidated fnancial statements' and note 47 ('Related parties') in the individual fnancial statements. Conficts of interests The Bank has approved standards and procedures that establish the criteria for the prevention of conficts of interest that may arise as a result of the various activities and functions carried out by the Bank, or between the Bank's interests and those of its directors and senior management. In 2018, we have approved an internal policy on conficts of interest that is a compilation of various binding documents that existed prior to that time, that provides the employees, directors and entities of the Group with criteria to prevent and manage any confict of interest that may arise as a result of their activities. Directors and senior management Our directors must adopt the measures that are necessary to prevent situations in which their interests, whether their own or through another party, may enter into confict with the corporate interest and their duties towards the Bank. 167 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Group companies The Bank is the only Santander Group company listed in Spain, so it is not necessary to have mechanisms in place to resolve possible conficts of interest with subsidiaries listed in Spain. Notwithstanding, in case of conficts of interest that may arise between a subsidiary and the Bank, the latter as the parent company must take into account the interests of all its subsidiaries and the way such interests contribute to the long term interest of the subsidiaries and the Group as a whole. Likewise, the entities of the Santander Group must take into account the interests of the Santander Group as a whole and, consequently, also examine how decisions adopted at the subsidiary level may afect the Group. The Bank, as the parent company of Santander Group, structures the governance of the Santander Group through a system as ruler that guarantees the existence of rules of governance and an adequate control system, as described in section 7 'Group structure and internal governance'. The duty to avoid conficts of interest requires directors to fulfl certain obligations such as abstaining from using the Bank’s name or their capacity as directors to unduly infuence private transactions, using corporate assets, including the confdential information of the Bank, for private purposes, taking advantage of business opportunities of the Bank, obtaining benefts or remuneration from third parties in connection with the holding of their position, except for those received merely as a sign of courtesy, carrying out activities, on their own behalf or on behalf of others, which actually or potentially entail efective competition with the Bank or which otherwise place them in a situation of permanent confict with the interests of the Bank. In any case, they must inform the board of any direct or indirect confict of interest between their own interests or those of their related parties and those of the Bank that will be disclosed in the fnancial statements. No director has communicated during the year 2018 any situation that places him in a confict of interest with the Group. However, in 2018, there were 60 occasions in which directors abstained from participating in discussions and voting on matters at the meetings of the board of directors or of its committees. The breakdown of the 60 cases is as follows: on 26 occasions the abstention was due to proposals to appoint, re-elect or remove directors, and their appointment as members of board committees or as members of other boards at Santander Group companies; on 30 occasions the matter under consideration related to remuneration or the granting of loans or credits; on 1 occasion the matter concerned the discussion of a risk transaction involving a party related to a director; and on 3 occasions the abstention concerned the annual verifcation of the status and the suitability of directors. Further, the mentioned policy of conficts of interest and the Code of Conduct in Securities Markets to which both, the directors and the senior management of the Bank have adhered to, establishes mechanisms to detect and address conficts of interest. These persons must present a statement to the Compliance function of the Bank detailing any relations they hold. This statement must be continuously updated. They must also notify the Compliance function of any situation in which a confict of interest could occur owing to their relations or due to any other reason or circumstance and they shall abstain from deciding, or where applicable, voting in situations where a confict exists and shall likewise inform about the confict to those who are to take the respective decision. Conficts of interest shall be resolved by the person holding the highest responsibility for the area involved. If several areas are afected, the resolution shall be made by the most senior ofcer in all such areas or if none of the foregoing rules are applicable, by the person appointed by the Compliance function. In the event of any doubt, the Compliance function should be consulted. The control mechanisms and the bodies in charge of resolving this type of situations are described in the Code of Conduct in Securities Markets, which is available on the Group’s corporate website. According to this code, and in relation to the Group’s shares and securities, neither directors, the senior management nor their related parties may: (i) carry out counter-transactions on securities of the Group within 30 days following each acquisition or sale thereof; or (ii) carry out transactions on Group securities in the one month preceding the announcement of quarterly, six-monthly or annual results until they are published 168 2018 Annual Report  5. Management team The table below shows the profles of the Bank’s senior management (other than the executive directors described in section 4.1 'Our directors') as of 31 December 2018. Mr Rami Aboukhair COUNTRY HEAD – SANTANDER SPAIN Mr Enrique Álvarez HEAD OF STRATEGY, CORPORATE DEVELOPMENT AND NEW BUSINESSES DEVELOPMENT – SANTANDER UK Ms Lindsey Argalas HEAD OF SANTANDER DIGITAL Mr Juan Manuel Cendoya GROUP HEAD OF COMMUNICATIONS, CORPORATE MARKETING AND RESEARCH Mr José Doncel GROUP HEAD OF ACCOUNTING AND FINANCIAL CONTROL Born in 1967. He joined the Group in 2008 as a director of Santander Insurance and head of Products and Marketing. He also served as managing director of products, marketing and customers in Banco Español de Crédito, S.A. (Banesto) and as managing director and head of Retail Banking in Santander UK. In 2015 he was appointed country head for Santander Spain and in 2017 he was named CEO of Banco Popular Español, S.A. until its merger with Banco Santander, S.A. He is currently senior executive vice president and country head of Santander Spain. Born in 1978. He joined the Group in 2015 as deputy head of strategy. He is currently senior executive vice president, and until 15 February 2019 Group head of Chairman’s Ofce and Strategy and global head of Insurance Network Banking and Responsible Banking. He is currently head of strategy corporate development and New Businesses Development in Santander UK. He is also a director of Open Digital Services, S.L., Santander Fintech Limited and Zurich Santander Insurance America, S.L. Previously he was a partner in McKinsey & Company. Born in 1968. In 2017 she joined the Group as senior executive vice president and Group head of Santander Digital. She served as principal of The Boston Consulting Group (BCG) (1998-2008). She also served as senior vice president and chief of staf to the CEO of Intuit Inc. (2008-2017). Born in 1967. He joined the Bank in July 2001 as Group senior executive vice president and head of the Communications, Corporate Marketing and Research division. In 2016 he was appointed vice chairman of the board of directors of Santander Spain and head of Institutional and Media Relations of that unit, in addition to his function as Group head of Communications, Corporate Marketing and Research. He is also a member of the board of directors of Universia. Formerly, he was head of the legal and tax department of Bankinter, S.A. Juan Manuel Cendoya is a State Attorney. Positions held in other non-Group companies: He is currently a non-executive director at Arena Media Communications Network, S.L. Born in 1961. He joined the Group in 1989 as head of accounting. He also served as head of accounting and fnancial management at Banco Español de Crédito, S.A. (Banesto) (1994-2013). In 2013 he was appointed senior executive vice president and head of the Internal Audit division. In 2014 he was appointed Group head of Accounting and Financial Control. Currently he serves as Group chief accounting ofcer. 169 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Mr Keiran Foad GROUP CHIEF RISK OFFICER Mr José Antonio García Cantera GROUP CHIEF FINANCIAL OFFICER Mr Juan Guitard GROUP CHIEF AUDIT EXECUTIVE Mr José María Linares GLOBAL HEAD OF CORPORATE & INVESTMENT BANKING Ms Mónica López-Monís GROUP CHIEF COMPLIANCE OFFICER Mr Javier Maldonado GROUP HEAD OF COSTS Born in 1968. He joined the Group in 2012 as deputy chief risk ofcer of Santander UK. He also served in various risk and corporate leadership roles at Barclays Bank, plc. (1985-2011) and as chief risk ofcer at Northern Rock, plc. In 2016 he was appointed senior executive vice president and deputy chief risk ofcer of the Bank until his appointment in 2018 as the Group chief risk ofcer. Born in 1966. He joined the Group in 2003 as senior executive vice president of global wholesale banking of Banco Español de Crédito, S.A. (Banesto). In 2006 he was appointed Banesto’s chief executive ofcer. Formerly, he was member of the executive committee of Citigroup EMEA and member of the board of directors of Citigroup Capital Markets Int, Ltd. and Citigroup Capital Markets UK. In 2012 he was appointed senior executive vice president of Global Corporate Banking. Currently he serves as Group chief fnancial ofcer. Born in 1960. He joined the Group in 1997 as head of human resources of Santander Investment, S.A. He was also General Counsel and Secretary of the board of Santander Investment, S.A. and Banco Santander de Negocios. In 2013 he was head of the Bank’s Risk division. In November 2014 he was appointed head of the Internal Audit division. Currently, he serves as Group chief audit executive. Juan Guitard is a State Attorney. Born in 1971. He served as an equity analyst in Morgan Stanley & Co. New York (1993-1994). He worked as senior vice president and senior Latin America telecom equity analyst at Oppenheimer & Co. New York (1994-1997). He also served as Director Senior Latin America TMT equity analyst at Société Générale, New York & São Paolo (1997-1999). In 1999 he joined J.P. Morgan and in 2011 was appointed as managing director and head of Global Corporate Banking at J.P. Morgan Chase & Co. (2011-2017). In 2017 he was appointed senior executive vice president of the Group and Global head of Corporate & Investment Banking. Born in 1969. She joined the Group in 2009 as general secretary and board secretary of Banco Español de Crédito, S.A. (Banesto). Formerly, she was general secretary of Aldeasa, S.A. She also served as general secretary of Bankinter, S.A. In 2015 she was appointed senior executive vice president of Santander and Group chief compliance ofcer. Mónica López-Monís is a State Attorney. Born in 1962. He joined the Group in 1995 as head of the international legal division of Banco Santander de Negocios. He was in charge of several positions in Santander UK. He was appointed senior executive vice president of Santander and head of coordination and control of regulatory projects in 2014. He currently serves as Group senior executive vice president and head of Costs. Positions held in other non-Group companies: He is non-executive director of Alawwal Bank. 170 2018 Annual Report Management team Mr Dirk Marzluf GROUP HEAD OF TECHNOLOGY AND OPERATIONS Mr Víctor Matarranz GLOBAL HEAD OF WEALTH MANAGEMENT Mr José Luis de Mora GROUP HEAD OF FINANCIAL PLANNING AND CORPORATE DEVELOPMENT Mr José María Nus RISK ADVISER TO GROUP EXECUTIVE CHAIRMAN Mr Jaime Pérez Renovales GROUP HEAD OF GENERAL SECRETARIAT AND HUMAN RESOURCES Ms Magda Salarich HEAD OF SANTANDER CONSUMER FINANCE Ms Jennifer Scardino HEAD OF GLOBAL COMMUNICATIONS. GROUP DEPUTY HEAD OF COMMUNICATIONS, CORPORATE MARKETING AND RESEARCH Born in 1970. He joined the Group in 2018 as Group senior executive vice president and Group head of IT and operations. Previously he held several positions in AXA Group, where he served as group CIO from 2013 leading the insurance group’s technology and information security transformation and co- sponsor of its digital strategy. His global roles include previous work at Accenture, Daimler Chrysler and Winterthur Group. Born in 1976. He joined the Group in 2012 as head of strategy and innovation in Santander UK. In 2014 he was appointed senior executive vice president and head of executive chairman´s ofce and strategy. Previously, he held several positions in McKinsey & Company where he became partner. Currently, he serves as senior executive vice president and Global head of Wealth Management. Born in 1966. He joined the Group in 2003. Since 2003, he has been in charge of developing the Group strategic plan and acquisitions. In 2015 he was appointed Group senior executive vice president and Group head of Financial Planning and Corporate Development. Since 15 February 2019, the strategy function has been integrated with the corporate development function. Born in 1950. He joined the Group in 1996 as executive director and chief risk ofcer of Banco Español de Crédito, S.A. (Banesto). In 2010 he was appointed executive director and chief risk ofcer of Santander UK. He also served as Group chief risk ofcer until June 2018. Formerly, he served as senior executive vice president in Argentaria and Bankinter. He currently serves as senior executive vice president and risk advisor to Group executive chairman. See profle in section 4.1. 'Our directors'. Born in 1956. She joined the Group in 2008 as senior executive vice president and head of Santander Consumer Finance. Previously, she held several positions in the automobile industry, including the position of director and executive vice president of Citroën España and head of commerce and marketing for Europe of Citroën Automobiles. Born in 1967. She joined the Group in 2011 as head of corporate communications, public policy and corporate social responsibility for Santander UK. She also held several positions in the US Securities and Exchange Commission (1993-2000). She was appointed managing director of Citigroup (2000-2011). In 2016 she was appointed senior executive vice president and head of Global Communications and Group deputy head of Communications, Corporate Marketing and Research. 171 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 6. Remuneration Sections 6.1, 6.2, 6.3, 6.4, 6.5, 6.7, 9.4 and 9.5 below constitute the annual report on directors´ remuneration that must be prepared and submitted to the consultative vote of thegeneral shareholders' meeting. This report was published in previous years separately while now it is published as part of this Corporate governance chapter, as indicated in its introduction, 'Redesigned corporate governance report'. Pursuant to the previous paragraph, this annual report on remuneration of directors has been approved by the board of directors of the Bank, in its meeting held 26 February 2019. None of the directors voted against nor abstained in relation to the approval of this report. 2. Fixed remuneration must represent a signifcant proportion of total compensation. 3. Variable remuneration must compensate for performance in terms of the achievement of agreed goals of the individual and within the framework of prudent risk management. 4. The global remuneration package and the structure thereof must be competitive, in order to appeal to and retain professionals. 5. Conficts of interest and discrimination must be avoided in decisions regarding remuneration. The text of the remuneration policy for directors in force at the date of this report is available at our corporate website. The assistance of Willis Towers Watson was sought by the remuneration committee and the board for the following purposes: 6.1 Principles of the remuneration policy Remuneration of directors in their capacity as such The individual remuneration of directors, both executive and otherwise, for the performance of supervisory and collective decision-making duties, is determined by the board of directors, within the amount set by the shareholders, based on the positions held by the directors on the collective decision-making body itself and their membership and attendance of the various committees, as well as any other objective circumstances that the board may take into account. Remuneration of directors for the performance of executive duties The most notable principles of the Bank’s remuneration policy for the performance of executive duties are as follows: 1. Remuneration must be aligned with the interests of shareholders and be focused on long-term value creation, while remaining compatible with rigorous risk management and with the Bank’s long-term strategy, values and interests. • To compare the relevant data with that on the markets and comparable entities, given the size, characteristics and activities of the Group. • To analyse and confrm the compliance of certain quantitative metrics relevant to the assessment of certain objectives. • To estimate the fair value of the variable remuneration linked to long-term objectives. Banco Santander performs an annual comparative review of the total compensation of executive directors and senior executives. The 'peer group' in 2018 comprised the following banks: Itaú, JP Morgan Chase, Bank of America, HSBC, BNP Paribas, Standard Chartered, Citi, Société Générale, ING, Barclays, Wells Fargo, BBVA, Lloyds, UBS, Intesa San Paolo, Deutsche Bank and Unicredit. 172 2018 Annual Report 6.2 Remuneration of directors for the performance of supervisory and collective decision-making duties: policy applied in 2018 A. Composition and limits As set out in Banco Santander´s Bylaws, the remuneration remuneration of directors for their status as such now consists of a fxed annual amount determined at the general shareholders’ meeting. This amount shall remain in efect until the shareholders resolve to amend it, though the board may reduce its amount in the years it considers such a reduction appropriate. The remuneration established at the general shareholders’ meeting for 2018 was EUR 6 million, with two components: (a) annual allotment and (b) attendance fees. Bylaw-stipulated emoluments earned by the board in 2018 amounted to EUR 4.6 million, which is 23% less than the amount approved at the general shareholders’ meeting. In addition, the Bank contracts a civil liability insurance policy for its directors upon customary terms that are proportionate to the circumstances of the Bank. Directors are also entitled to receive shares, share options or share-linked compensation following the approval of the general shareholders´ meeting. Directors are also entitled to receive other compensation following a proposal made by the remuneration committee and upon resolution by the board of directors, as may be deemed appropriate in consideration for the performance of other duties in the Bank, whether they are the duties of an executive director or otherwise, other than the supervisory and collective decision- making duties that they discharge in their capacity as members of the board. None of the non-executive directors has the right to receive any beneft on the occasion of their removal as such. B. Annual allotment The amounts received individually by the directors during the last two years based on the positions held on the board and their membership on the various board committees were as follows: Amount per director in euros 2018 2017 Members of the board of directors 90,000 87,500 Members of the executive committee 170,000 170,000 Members of the audit committee 40,000 40,000 Members of the appointments committee 25,000 25,000 Members of the remuneration committee 25,000 25,000 Members of the risk supervision, regulation and compliance committee Members of the responsible banking, sustainability and culture committee 40,000 40,000 15,000 - Chairman of the audit committee 70,000 50,000 Chairman of the appointments committee 50,000 50,000 Chairman of the remuneration committee 50,000 50,000 Chairman of the risk supervision, regulation and compliance committee Chairman of the responsible banking, sustainability and culture committee Lead directorA Non-executive vice chairmen 70,000 50,000 50,000 - 110,000 110,000 30,000 30,000 A. Mr Bruce Carnegie-Brown, for duties performed as part of the board and board committees, specifcally as chairman of the appointments and remuneration committees and as lead director, and for the time and dedication required to perform these duties, has been allocated minimum total annual remuneration of EUR 700,000 since 2015, including the aforementioned annual allowances and attendance fees corresponding to him. C. Attendance fees By resolution of the board, at the proposal of the remuneration committee, the amount of attendance fees applicable to meetings of the board and its committees (excluding the executive committee, for which no fees are provided) during the last two years was as follows: Attendance fees per director per meeting in euros Board of directors Audit committee and risk supervision, regulation and compliance committee Other committees (excluding executive committee) 2018 and 2017 2,600 1,700 1,500 D. Breakdown of bylaw-stipulated emoluments The total amount accrued for bylaw-stipulated emoluments and attendance fees was EUR 4,6 million in 2018 (EUR 4,7 million in 2017). The individual amount accrued for each director for these items is as follows: 173 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management Directors Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie- Brown Mr Rodrigo Echenique Gordillo Mr Guillermo de la Dehesa Romero Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca Mr Francisco Javier Botín- Sanz de Sautuola y O’SheaA Ms Sol Daurella Comadrán Mr Carlos Fernández González Ms Esther Giménez- Salinas i Colomer Ms Belén Romana García Mr Juan Miguel Villar MirC Mr Ramiro Mato García- AnsorenaD Mr Alvaro Cardoso de SouzaE Mr Matías Rodríguez InciarteF Ms Isabel Tocino BiscarolasagaF Total I I I I I I I I e v i t u c e e v i x t eu -c ne x o E N BoardG Amount in euros 2018 Annual allotment EC AC ASC RC RSRCC RBSCC Total 2017 Total bylaw- stipulated Board and emoluments and committee attendance attendance fees fees 90,000 170,000 90,000 170,000 I 383,000 170,000 90,000 170,000 N 120,000 170,000 - - - - - - - - - - 8,000 268,000 39,000 307,000 301,000 - - 260,000 34,000 294,000 301,000 25,000 25,000 40,000 - 643,000 89,000 732,000 731,400 - - - 25,000 25,000 20,000 - - 260,000 33,000 293,000 295,400 360,000 81,000 441,000 472,700 I 90,000 - 40,000 - - - 8,000 138,000 61,000 199,000 159,156 - - - 13,000 25,000 40,000 8,000 346,000 86,000 432,000 444,400 - - - - 90,000 31,000 121,000 123,900 25,000 25,000 - 8,000 148,000 67,000 215,000 206,900 40,000 25,000 25,000 - - 180,000 86,000 266,000 285,000 N 90,000 170,000 NB 90,000 90,000 90,000 90,000 - - - - - 160,000 85,000 40,000 90,000 - - 115,000 170,000 40,000 85,000 - - - - - - - - - - - - - - - - - - - 40,000 8,000 138,000 58,000 196,000 161,756 40,000 8,000 268,000 81,000 414,000 297,300 - - 90,000 18,000 108,000 170,388 40,000 8,000 373,000 39,000 450,000 36,001 27,000 5,000 117,000 31,000 148,000 - - - 275,511 417,577 4,679,389 1,763,000 1,275,000 160,000 113,000 125,000 247,000 61,000 3,744,000 872,000 4,616,000 A. All amounts received were reimbursed to Fundación Botín. B. Mr Javier Botín-Sanz de Sautuola is non-external (neither propietary nor independent) since 13 February 2018 (propietary at the beginning of 2018). C. Ceased to be a director on 1 January 2019. D. Director since 28 November 2017. E. Director since 23 March 2018. F. Ceased to be a director on 28 November 2017. G. Includes committees chairmanship and other role emoluments. P: Proprietary I: Independent N: Non-external (neither proprietary nor independent). EC: Executive committee AC: Audit committee ASC: Appointments committee RC: Remuneration committee RSRCC: Risk supervision, regulation and compliance committee. RBSCC: Responsible Banking, sustainability and culture committee. 174 2018 Annual Report 6.3 Remuneration of directors for the performance of executive duties The policy applied to the remuneration of directors in 2018 for the performance of executive duties was approved by the board of directors and submitted to a binding vote at the general shareholders’ meeting of 23 March 2018, with 94.22% of the votes in favour. The table below summarises the remuneration policy and its implementation. Type of component Policy Component Gross annual salary Fixed Variable remuneration Variable • Paid in cash on a monthly basis. • Base salary for Ana Botín and José Antonio Alvarez reviewed in 2018 to refect pension transformation (equivalent reduction of pension contribution). • Base salary for Rodrigo Echenique reviewed due to increased responsibilities. • Individual benchmark reference. • Calculated against a set of annual quantitative metrics and a qualitative assessment with input of individual performance. • 50% of each payment is made in shares subject to a one-year retention. The number of shares is determined at the time of the award. • 40% paid in 2019; 60% deferred in fve years. • 24% paid in equal parts in 2020 and 2021. • 36% paid in equal parts in 2022, 2023 and 2024 subject to the compliance with a set of long-term objectives (2018-2020). Implementation in 2018 • Ana Botin: EUR 3,176 thousand. • José Antonio Álvarez: EUR 2,541 thousand. • Rodrigo Echenique: EUR 1,800 thousand. • Pension transformation detailed in section 6.3 C. • See section 6.3 B ii) for details of annual metrics and assessment. • See section 6.3 B iv) for details of the long-term metrics. • See section 6.3 B iii) for details of the individual awards. Beneft system Fixed • Annual contribution at 22% of base salary. • Mr Echenique´s current contract does not provide for any pension beneft, without prejudice to his pension rights before he was appointed executive director. Variable • Annual contribution at 22%of the 30% of the average of the last three-years variable remuneration. Other remuneration Fixed • Includes life and accident and medical insurance, including any tax due on benefts. • Includes a fxed remuneration supplement in cash (not salary nor pensionable) as part of the elimination of the death and disability supplementary benefts. Shareholding policy N/A • 200% of the net tax amount of the annual gross basic salary. • Five years from 2016 to demonstrate the shareholding. • Until 2017, the annual contribution was 55% of the fxed and variable pensionable bases. Salary and incentive benchmark reviewed in the amount reduced in pension, with no cost increase for the Bank. • Supplementary death and disability benefts eliminated. • See section 6.3 C for details of the annual contributions and pension balance. • Life and accident annuities has been increased as a result of the elimination of the supplementary death and disability benefts. • Implementation of the fxed remuneration supplement as supplementary benefts are eliminated. • See section 6.3 C for details on the pension transformation. • No change from 2017. A. Gross annual salary The board resoled to maintain the same gross annual salary for Ms Ana Botín and Mr José Antonio Álvarez for 2018 as in 2017, although with an increase in the amount equivalent to the reduction of the fxed pension contributions in the terms described in section 6.3 C, and neither the total compensation nor the cost were increased. Until 2017, the annual fxed contributions were 55% of the gross annual salary. From 2018 onwards, the fxed contributions will be 22% of the gross annual salary. The board approved an increase in the gross annual salary of Mr Rodrigo Echenique on consideration of his new responsibilities in relation with the integration of Banco Popular into the Santander Group. His annual gross salary is EUR 1,800 thousand from January 2018. 175 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management In summary, the executive directors’ gross annual salary and fxed annual contribution to pension for 2018 and 2017 were as follows: EUR thousand Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo Mr Matías Rodríguez InciarteA 2018 Fixed annual pension contribution 699 559 Gross annual salary 3,176 2,541 1,800 Total 3,875 3,100 1,800 Total 7,517 1,258 8,775 2017 Fixed annual pension contribution 1,375 1,100 - - Total 3,875 3,100 1,500 1,568 2,475 10,043 Gross annual salary 2,500 2,000 1,500 1,568 7,568 A. Ceased to be a director on 28 November 2017. Figure includes his gross annual salary until he ceased to be a director. The portion of gross annual salary for discharging his duties as senior executive vice president from 28 November 2017 is included in the corresponding section. B. Variable remuneration i) General policy for 2018 The board approved the variable remuneration of the Group executive chairman, the chief executive ofcer and the other executive directors, at the proposal of the remuneration committee, in consideration of the approved policy: • The variable components16 of the total remuneration of executive directors in 2018 amounts to less than 200% of the fxed components, as provided by agreement at the general shareholders’ meeting of 23 March 2018. • At the request of the remuneration committee, at the beginning of 2019 the board approved the fnal amount of the incentive for 2018, based on the individual benchmark variable remuneration fgure in accordance with the following: • A group of short-term quantitative metrics measured against annual objectives. • A qualitative assessment which cannot adjust the quantitative result by more than 25 percentage points upwards or downwards. • Where applicable, an exceptional adjustment that will be supported by the substantiated evidence. • The fnal variable remuneration is adjusted based on the individual assessment of the executive director, which is carried out in accordance with the current model and taking into account their individual objectives, as well as how they are achieved, for which the management of employees, the adherence to the corporate behaviours and the development of initiatives in the communities in which the Bank operates. Individual benchmark variable remuneration Quantitavie metrics and qualitative assessmentA Individual performance Final individual variable remuneration A. Where applicable, an exceptional adjustment based on substantiated evidence The quantitative metrics and the elements of the qualitative assessment are described below. • The approved incentive is paid 50% in cash and 50% in shares17, a portion in 2019 and portion deferred and linked to multi-year targets. 40% shall be paid immediately once the fnal amount has been determined, and the remaining 60% shall be deferred in equal parts over fve years, as follows: • Payment of the amount deferred over the frst two years (24% of the total), payable in 2020 and 2021, where applicable, shall be conditional on none of the malus clauses described below being triggered. • The amount deferred over the next three years (36% of the total), payable in 2022, 2023 and 2024, where applicable, shall be conditional not only on the malus clauses not being triggered but also on the achievement of the multi-year targets described below. These objectives can only decrease the amounts and the number of deferred shares. • When the deferred amount is paid in cash, the benefciary may be paid the adjustment for infation through the date of payment. • All payments in shares are subject to a one-year retention period after being delivered. 16. As stated in the initial table of this section 6.3, contributions to below of this section of the report, contributions to the benefts systems for two executive directors include both fxed components and variable components, which become part of the total variable remuneration. 17. Since variable remuneration involves the delivery of shares of the Bank, the board of directors submitted to the shareholders at the 2018 annual general shareholders’ meeting, which so approved, the application of the third cycle of the Deferred Variable Remuneration Plan Linked to Multi-Year Targets, through which the aforementioned variable remuneration for executive directors is instrumented. 176 2018 Annual Report • The hedging of Santander shares received during the retention and deferral periods is expressly prohibited. The sale of shares is also prohibited for one year from the receipt thereof. The payment schedule of the incentive is illustrated below. Immediately following performance year 40% Deferred (malus) Long-term performance deferral 12% 12% 2019 2020 2021 12% 2022 12% 2023 12% 2024 Cash Shares Total 40% 24% 36% 100% All deferred payments, whether or not subject to long-term objectives, are subject to malus. Similarly, the incentives already paid will be subject to clawback by the Bank in the scenarios and for the period set forth in the Group’s malus and clawback policy. ii) Quantitative metrics and qualitative assessment for 2018 The variable remuneration for executive directors in 2018 factored in the quantitative metrics and qualitative factors approved by the board at the beginning of 2018 at the proposal of the remuneration committee18, which has taken into account the policy referred to in the paragraphs above and the work of the human resources committee19. The result of aggregating the quantitative and qualitative weighted results is as follows: 18. Before determining the variable remuneration of executive directors and other senior managers, the committee receives a joint report from the risk compliance, audit and fnancial control functions of the Group identifying material errors which occurred during the year and satisfying itself that this has been appropiately refected in the compensation proposals for each of these executives. Downward adjustment were made to the compensation of 68 material risk takers across the Group due to material errors, none related to the performance of executive directors or senior managers. 19. This committee was aided by members of senior management who are also responsible for diferent functions in the Group, including risk, internal audit, compliance, general secretariat and human resources, fnancial management, fnancial accounting and control. Their role in this committee consisted of analysing quantitative metrics information, undertaking a qualitative analysis, and considering whether or not to apply exceptional adjustments. This analysis included diferent matters related to risk, capital, liquidity, quality and recurrence of results, and other compliance and control matters. 177 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management Category and (weight) Customers (20%) Quantitative metrics Qualitative Metrics Assessment Weighted assessmentA Component Customer satisfaction Number of loyal customers 110.9% 11.1% 100.1% 10.0% Efective compliance with the objectives of the rules on risk conduct in respect of customers. Risks (10%) Non-performing loans ratio Cost of lending ratio 102.7% 105.1% 5.1% 5.3% Appropriate management of risk appetite and excesses recognised. Adequate management of operational risk. Capital (20%) Capital ratio (CET1) 101.9% 20.4% Efcient capital management. Return (50%) Ordinary net proft (ONP)C RoRWA: return on risk weighted assetsD 96.8% 26.6% 102.2% 23.0% Suitability of business growth compared to the previous year, considering the market environment and competitors. Sustainability and solidity of results. Efcient cost management and achievement of efciency goals. Assessment +2.4% - Strengthened governance and management of commercialization conduct as part of Santander culture. +1.2% - Improving underlying controls. No material breaches of risk appetite. +3.2% - Exceeded capital plan, through sustainable underlying actions. 0 % Results in line with expectations. Exceptional adjustment TOTAL Elements (non-exhaustive) under consideration: general control environment, compliance with internal and external regulations, prudent and efcient liquidity and capital planning management. Based on strong business performance, specifcally recognizing exceptional proft growth in a challenging international context, in particular in relation to macroeconomic conditions and monetary policy changes in 2018 in some of the main markets of the Group. Total weighted scoreB 23.5% 11.6% 23.6% 49.6% 12.3% 120.6% A. The weighted assessment is the result of multiplying the assessment of each objective by the weight of each objective. When there is more than one objective in the category and save for Note D below, the weight of each objective in the category is the same. B. Result of adding or substracting the qualitative assessment to the weighted assessment. C. For this purpose, ONP is attributed ordinary net proft, adjusted upwards or downwards for those transactions that, in the opinion of the board, have an impact outside of the performance of the directors being evaluated, whereby extraordinary proft, corporate transactions, special allowances, or accounting or legal adjustments that may occur during the year are evaluated for this purpose. D. The specifc weight of ONP in the total scorecard is 27.5% and RoRWA is 22.5%. The variable remuneration allocated to each executive director was determined by applying the aforementioned metrics to the sum of the benchmark variable remuneration of the executive directors, together with the level of compliance with individual goals and the market reference. The individual variable remuneration approved by the board are set out in the section below. It was also verifed that none of the following circumstances have occurred: • The Group’s ONP20 for 2018 was not less than 50% of that for 2017. If this had occurred, the variable remuneration would not have been greater than 50% of the benchmark incentive. iii) Determination of the individual variable remuneration for executive directors in 2018 The board approved the variable remuneration of the Group executive chairman, the chief executive ofcer and the other executive directors, at the proposal of the remuneration committee, taking into account the policy referred to in the paragraphs above and the result of the quantitative metrics and qualitative assessment set out in the section above. • The Group’s ONP has not been negative. If this had occurred, the incentive would have been zero. The variable remuneration allocated to each executive director was determined by applying the aforementioned metrics to the sum of the benchmark variable remuneration of the executive directors, together with the level of compliance with individual goals, including people management, adherence to the corporate behaviours and the implementation of initiatives for communities. 20. For this purpose, ONP is attributed ordinary net proft, adjusted upwards or downwards for those transactions that, in the opinion of the board, have an impact outside of the performance of the directors being evaluated, whereby extraordinary proft, corporate transactions, special allowances, or accounting or legal adjustments that may occur during the year are evaluated for this purpose. 178 2018 Annual Report For Ms Ana Botín and Mr José Antonio Álvarez the board resolved to maintain in 2018 the same benchmark incentive as in 2017 increased in the amount equivalent to the reduction of the variable pension contributions in the terms described in section 6.3 C, without the total compensation being increased as a result of this change. Until 2017, the annual variable contributions were 55% of the average of the last three variable remunerations amounts. From 2018, the variable contributions are 22% of the same pensionable base. This has resulted in a reduction of variable pension and an equivalent increase in the benchmark incentive of EUR 516 and 349 thousand for Ms Ana Botín and Mr José Antonio Álvarez, respectively. As a result of the aforementioned process, the review of the benchmark variable remuneration and following a proposal by the remuneration committee, the board of directors approved the following amounts for variable remuneration payable immediately and the deferred amounts not linked to long-term metrics: Immediately payable and deferred (not link to long-term objectives) variable remuneration EUR thousand 2018 In cash In sharesB Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo Mr Matías Rodríguez InciarteA Total 2,368 1,582 1,256 - 5,206 2,368 1,582 1,256 - 5,206 10,412 Total 4,736 3,164 2,512 - 2017 In cash In shares 2,192 1,466 1,142 1,117 5,918 2,192 1,466 1,142 1,117 5,918 Total 4,384 2,932 2,284 2,234 11,836 A. Ceased to be a member of the board on 28 November 2017. Figure includes his deferred bonus payable immediately, not subject to long-term objectives, until he ceases to be a director. The portion for discharging his duties from 28 November is included in the corresponding section. B. The share amounts in the foregoing table correspond to a total of 1,211 thousand shares in Banco Santander (992 in 2017). The deferred portion of the variable remuneration, which will only be received, in 2022, 2023 and 2024, if the aforementioned long- term multi-year targets are met (see section 6.3 B iv)), on condition that the benefciaries continue to be employed at the Group and provided malus and clawback clauses have not been triggered, is stated at its fair value as follows21: Deferred and linked to long-term objectives variable remuneration EUR thousand Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo Mr Matías Rodríguez InciarteA 2018 In cash In sharesB 932 623 495 - 932 623 495 - Total 2,050 2,050 Total 1,864 1,246 990 - 4,100 2017 In cash In shares 863 577 450 440 863 577 450 440 Total 1,726 1,154 900 880 2,330 2,330 4,660 A. Ceased to be a member of the board on 28 November 2017. Figure includes his bonus subject to long-term objectives for service until cessation as a director on 28 November 2017. The portion for discharging his duties from 28 November as senior executive vice president is included in the corresponding section. B. The share amounts in the foregoing table correspond to a total of 477 thousand shares in Banco Santander (391 thousand shares in 2017). The fair value has been determined at the grant date based on the valuation report of an independent expert, Willis Towers Watson. According to the design of the plan for 2018 and the levels of achievement of similar plans in comparable entities, the expert concludes that the reasonable range for estimating the initial achievement ratio is around 60% - 80%. It has been considered that the fair value is 70% of the maximum. The maximum total number (without the fair value adjustment) of shares relating to the plan (1,893 thousand shares) is within the maximum limit of 2,676 shares authorised for executive directors by the shareholders at the general shareholders’ meeting of 23 March 2018, and has been calculated on the basis of the average weighted daily volume of the average weighted listing prices of Santander shares for the 15 trading sessions prior to the Friday 21. Corresponding to the fair value of the maximum amount to be received over a total of 3 years, subject to continued service, with the exceptions envisaged, the non- applicability of malus clauses and compliance with the defned goals. Fair value was estimated at the plan award date, taking into account various possible scenarios for the diferent variables contained in the plan during the measurement periods. 179 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management (not inclusive) before 29 January 2019 (the date on which the board approved the bonus for the executive directors for 2018), which was 4.298 euros per share. iv) Multi-year targets linked to the payment of deferred amounts in 2022, 2023 and 2024 The multi-year targets linked to the payment of the deferred amounts payable in 2022, 2023 and 2024 are summarised as follows: A B C Metrics Earnings per share (EPS) growth in 2020 vs 2017 Relative Total Shareholder Return (TSR)A in 2018- 2020 within a peer group Fully loaded target common equity Tier 1 ratio (CET1)B for 2020 Weight Target and compliance scales (metrics ratios) 33% 33% 33% If EPS growth ≥ 25%, then metric ratio is 1 If EPS growth ≥ 0% but < 25%, then metric ratio is 0 – 1C If EPS growth < 0%, then metric ratio is 0 If ranking of Santander above percentile 66, then metric ratio is 1 If ranking of Santander between percentiles 33 and 66, then ratio is 0 – 1D If ranking of Santander below percentile 33, then metric ratio is 0 If CET1 is ≥ 11,30%, then metric ratio is 1 If CET1 is ≥ 11% but < 11.30%, then metric ratio is 0 – 1E If CET1 is < 11%, then metric ratio is 0 A. For this purpose, TSR refers to the diference (expressed as a percentage) between the fnal value of an investment in ordinary shares of Banco Santander and the initial value of the same investment, factoring in to the calculation of the fnal value the dividends or other similar instruments (such as the Santander Scrip Dividend Programme) received by the shareholder in relation to this investment during the corresponding period of time as if an investment had been made in more shares of the same type at the frst date on which the dividend or similar concept was payable to shareholders and the weighted average share price at that date. To calculate TSR, the average weighted daily volume of the average weighted listing prices for the ffteen trading sessions prior to 1 January 2018 (exclusive) is taken into consideration (to calculate the initial value) and that of the ffteen trading sessions prior to 1 January 2021 (exclusive) (to calculate the fnal value). The peer group comprises the following entities: Itaú, JP Morgan, Bank of America, HSBC, BNP Paribas, Standard Chartered, Citi, Société Générale, ING, Barclays, Wells Fargo, BBVA, Lloyds, UBS, Intesa San Paolo, Deutsche Bank and Unicredit. B. To verify compliance with this objective, possible increases in CET1 resulting from capital increases shall be disregarded (with the exception of those related to the Santander Scrip Dividend programme). Further, the CET1 ratio at 31 December 2020 could be adjusted to strip out the impact of any regulatory changes afecting its calculation implemented until that date. C. Linear increase in the EPS ratio based on the specifc percentage that EPS growth in 2020 represents with respect to 2017 EPS within this bracket of the scale. D. Proportional increase in the TSR ratio based on the number of positions moved up in the ranking. E. Linear increase in the CET1 coefcient as a function of the CET1 ratio in 2020 within this bracket of the scale. of the benchmark bonus in 2015. Based on that fgure, an amount of LTI amount was set for each director (the 'approved LTI amount') taking into account the performance of two indicators in 2015: (1) the earnings per share (EPS) of Santander Group in 2015 compared to the target amount for such year; and (2) the return on tangible equity (RoTE) in 2015 compared to the target for that year. The application of the compliance scales associated to these metrics resulted in an approved LTI amount of 91.50% of the (maximum) established benchmark. The maximum number of shares are set out below as per this % of the approved LTI amount. At year-end 2018, the corresponding amounts to be received by each exclusive director in relation to LTI (the accrued LTI amount) was established as follows: To determine the annual amount of the deferred portion linked to objectives corresponding to each board member in 2022, 2023 and 2024, the following formula shall be applied to each of these payments ('Final annuity') without prejudice to any adjustment deriving from the malus clauses: Final annuity = Amt. x (1/3 x A + 1/3 x B + 1/3 x C) where: • 'Amt.' is one third of the variable remuneration amount deferred conditional on performance (i.e. Amt. will be 12% of the total variable remuneration set in early 2018). • 'A' is the EPS ratio according to the scale in the table above, based on EPS growth in 2020 vs 2017. • 'B' is the TSR ratio according to the scale in the table above, according to the relative performance of the Bank’s TSR within its peer group in 2018-2020. • 'C' is the CET1 ratio according to compliance with the CET1 target for 2020 described in the table above. v) Vesting of the second cycle of the Performance Shares Plan The annual general meeting held on 27 March 2015 approved the second cycle of the performance shares plan. The accrual of this long-term incentive plan (LTI) and its amount were conditional on the performance of certain metrics of Banco Santander between 2015 and 2017, as well as compliance with the remaining conditions of the plan until the end of the accrual period (31 December 2018). The maximum benchmark LTI for executive directors was set by the board, at the proposal of the remuneration committee, at an amount equal to 20% 180 2018 Annual Report Metric Ranking of Santander’s EPS growth for the 2015-2017 period compared to a peer group of 17 credit institutions (the peer group)A Weighting 25% Target and compliance scale (metric ratio) From 1st to 5th: 1 6th: 0.875 7th: 0.75 8th: 0.625 9th 0.50 From 10th to 18th: 0 Result Position 11 in ranking Score 0% Total weighted score 0% RoTE in 2017 (%) Number of principal marketsB in which Santander is in the Top 3 of the best banks to work for in 2017 Number of principal marketsC in which Santander is in the Top 3 of the best banks on the customer satisfaction index in 2017 Retail loyal customers (million) at 31 December 2017 SME and corporate retail loyal customers (million) at 31 December 2017 Total 25% ≥ 12%:1 > 11% but < 12% 0,75 – 1B ≤ 11% 0 20% 6 or more: 1 5 or fewer: 0 10: 1 Between 6 and 9: 0.2 – 0.8B 5 or fewer: 0 ≥ 17: 1 > 15 but < 17: 0.5 – 1B ≤ 15: 0 ≥ 1.1: 1 > 1 but < 1.1: 0.5 – 1B ≤ 1: 0 15% 7.5% 7.5% 100% 11.83% 95.69% 23.92% 7 markets 100% 8 markets 60% 20% 9% 15.8 million 70% 5.25% 1.5 million 100% 7.5% 65.67% A. The peer group comprised the following entities: Wells Fargo, JP Morgan Chase, HSBC, Bank of America, Citigroup, BNP Paribas, Lloyds, UBS, BBVA, Barclays, Standard Chartered, ING, Deutsche Bank, Société Générale, Intesa San- Paolo, Itaú and Unicredito. B. Straight-line increase in the ratio based on the results within the respective bracket of the scale of each metric. C. For these purposes, the Santander Groups 'principal markets' are: Argentina, Brazil, Chile, Germany, Mexico, Poland, Portugal, Spain, the US and the UK. As a result of the aforementioned process and following a proposal by the remuneration committee, the board of directors approved the following number of shares to be paid in 2019: Number of shares Approved LTI amountA Final number of shares Ratio 187,080 65.67% 122,855 126,279 65.67% 82,927 Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo Total 406,899 93,540 65.67% 61,428 267,210 A. 91.50% of the maximum established benchmark approved at the AGM on 27 March, 2015. The shares to be delivered in 2019 to executive directors based on compliance with the related multiannual target were fully deferred at the time of the accrual until their delivery. The payment in shares is subject to a one-year retention period after being delivered. vi) Malus and clawback Accrual of the deferred amounts (whether or not linked to multi- year targets) is also conditional upon the benefciary’s continued service in the Group22, and upon none of the circumstances arising, in the period prior to each payment, that give rise to the application of malus arrangements in accordance with the section on malus and clawback clauses in the Group’s remuneration policy. Similarly, the variable remuneration already paid will be subject to clawback by the Bank in the scenarios and for the period set forth in said policy, all under the terms and conditions therein provided. The variable remuneration corresponding to 2018 is subject to clawback until the beginning of 2025. 22. When the relationship with Banco Santander or another Santander Group entity is terminated due to retirement, early retirement or pre-retirement of the benefciary, a dismissal considered by the courts to be improper, unilateral withdrawal for good cause by an employee (which includes, in any case, the situations set forth in article 10.3 of Royal Decree 1382/1985, of 1 August, governing the special relationship of senior management, for the persons subject to these rules), permanent disability or death, or as a result of an employer other than Banco Santander ceasing to belong to the Santander Group, as well as in those cases of mandatory redundancy, the right to receive shares and deferred amounts in cash and, where applicable, the amounts arising from the adjustment for infation of the deferred amounts in cash shall remain under the same conditions in force as if none of such circumstances had occurred. In the case of death, the right shall pass to the successors of the benefciary. In cases of justifed temporary leave due to temporary disability, suspension of the contract due to maternity or paternity leave, or leave to care for children or a relative, there shall be no change in the rights of the benefciary. If the benefciary goes to another Santander Group company (including through international assignment and/or expatriation), there shall be no change in the rights thereof. If the relationship is terminated by mutual agreement or because the benefciary obtains a leave not referred to in any of the preceding paragraphs, the terms of the termination or temporary leave agreement shall apply. None of the above circumstances shall give the right to receive the deferred amount in advance. If the benefciary or the successors thereof maintain the right to receive the deferred remuneration in shares and cash and, where applicable, the amounts arising from the adjustment for infation of the deferred amounts in cash, it shall be delivered within the periods and under the terms provided in the rules for the plans. 181 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management Malus and clawback clauses are triggered in situations in which there is poor fnancial performance of the Bank as a whole or a specifc division or area thereof or of the exposure generated by staf, taking into account at least the following: Category Factors Risk Capital Regulation and internal codes Conduct Signifcant failures in risk management by the Bank, or by a business or risk control unit. An increase in capital requirements at the Bank or one of its business units not planned at the time that exposure was generated. Regulatory penalties or legal convictions for events that might be attributable to the unit or staf responsible for them. Likewise, failure to comply with the Bank’s internal codes of conduct. Improper conduct, whether individual or collective. Negative efects deriving from the marketing of unsuitable products and the liability of persons or bodies making such decisions will be considered especially signifcant. The application of malus or clawback clauses for executive directors shall be determined by the board of directors, at the proposal of the remuneration committee, and cannot be proposed once the retention period related to the fnal payment in shares in accordance with the plan has elapsed in the beginning of 2025. Consequently, the board of directors, at the proposal of the remuneration committee and depending on the level of compliance with the aforementioned conditions regarding malus clauses, shall determine the specifc amount of the deferred incentive to be paid and, where applicable, the amount that could be subject to clawback. C. Main features of the beneft plans The executive directors other than Mr Rodrigo Echenique participate in the defned beneft system created in 2012, which covers the contingencies of retirement, disability and death. The Bank makes annual contributions to the beneft plans of its executive directors. In 2012 the contracts of the executive directors (and of other members of the Bank’s senior management) with defned beneft pension commitments were amended to transform them into a defned contribution system. The new system gives executive directors the right to receive benefts upon retirement23, regardless of whether or not they are active at the Bank at such time, based on contributions to the system, and replaced their previous right to receive a pension supplement in the event of retirement. In the event of pre-retirement and up until the retirement date, the executive directors other than Mr Rodrigo Echenique have the right to receive an annual allotment. In the case of Ms Ana Botín, this allotment is the sum of her fxed remuneration and the 30% of the average of the three remunerations as maximum. In the case of Mr José Antonio Álvarez, this allotment is the fixed remuneration as senior vice president. The initial balance for each of the executive directors in the new defned benefts system corresponded to the market value of the assets from which the provisions corresponding to the respective accrued obligations had materialised on the date on which the old pension commitments were transferred into the new benefts system24. Since 2013, the Bank has made annual contributions to the benefts system in favour of executive directors and senior executives, in proportion to their respective pensionable bases, until they leave the Group or until their retirement within the Group, death, or disability (including, if applicable, during pre-retirement)25. Mr Rodrigo Echenique's contract does not provide for any charge to Banco Santander regarding benefts, without prejudice to the pension rights to which Mr Echenique was entitled prior to his appointment as executive director. In application of that set forth in remuneration regulations, the contributions calculated on the basis of variable remuneration are subject to the discretionary pension benefts scheme. Under this scheme, these contributions are subject to malus and clawback clauses in accordance with the policy in place at any given time and during the same period in which variable remuneration is deferred. Furthermore, they must be invested in shares of the Bank for a period of fve years from the date of the executive director leaves the Group, regardless of whether or not they leave to retire. Once that period has elapsed, the amount invested in shares will be reinvested, along with the remainder of the cumulative balance corresponding to the executive director, or it will be paid to the executive director or to their benefciaries in the event of a contingency covered by the benefts system. The beneft plan is outsourced to Santander Seguros y Reaseguros, Compañía Aseguradora, S.A., and the economic rights of the foregoing directors under this plan belong to them regardless of whether or not they are active at the Bank at the time of their retirement, death or disability. The contracts of these directors do not provide for any severance payment in the event of termination other than as may be required by law, and, in the case of pre-retirement, to the aforementioned annual allotment. Until March 2018, the system also included a supplementary benefts scheme for cases of death (death of spouse and death of parent) and permanent disability of serving directors envisaged in the contracts of Ms Ana Botín and Mr José Antonio Álvarez. As per the director's remuneration policy approved at the 23 March 2018 general shareholder´s meeting, in 2018 the system has been changed with a focus on: • Aligning the annual contributions with practices of comparable institutions. 23. As provided in the contracts of the executive directors prior to 2012, Mr Matías Rodríguez Inciarte exercised the option to receive accrued pensions (or similar amounts) in the form of capital, i.e., in a lump sum, which means that he ceased to accrue pensions from such time, with a fxed capital amount to be received, which shall be updated at the agreed interest rate. 24.In the case of Mr Matías Rodríguez Inciarte, the initial balance corresponded to the amount that was set when, as described above, he exercised the option to receive a lump sum, and includes the interest accrued on this amount from that date. 25. In the event of Mr José Antonio Alvarez´s pre-retirement, his pensionable base in case of pre-retirement will be his fxed remuneration as senior executive vicepresident. 182 2018 Annual Report • Reduce future liabilities (derisking) of the plan by eliminating the supplementary benefts scheme in the event of death (death of spouse or parent) and permanent disability of serving directors. The balance in the benefts system corresponding to each of the executive directors at 31 December 2018 and 2017 is as follows: • No increase in total costs for the Bank. The changes to the system are the following: EUR thousand 2018 2017 Ms Ana Botín-Sanz de Sautuola y O’Shea 46,093 45.798 Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique GordilloA 16,630 16.151 13,614 13.957 76,337 75,906 2017 system 2018 system TotalA Pensionable base Fixed contribution: 55% of annual gross salary. Variable contribution: 55% of 30% of the average of their last three variable remunerations amounts. Supplementary benefts In case of death (death of spouse and death of parent) and permanent disability of Ms Ana Botín and Mr José Antonio Álvarez. Widow/widower and children under 25 entitlement to a pension supplemental to the pension which they would be entitled to receive from social security. Contributions at 22% of the respective pensionable bases. The diference between contributions has been increased by the annual gross salary in the case of fxed contributions (see 6.3 A) and in the benchmark variable remuneration in the case of the variable contribution (see 6.3 B iii)). The supplementary benefts were eliminated since 1 April 2018, increasing the sum insured in the life accident insurance and setting a fxed remuneration supplement in cash refected in 'Other remuneration'. As a result of the aforementioned changes, the provisions recognised in 2018 and 2017 for retirement pensions and supplementary benefts (death of spouse, death of parent and permanent disability) amounted to EUR 2,284 thousand (EUR 5,163 thousand in 2017), as broken down below. EUR thousand Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo Mr Matías Rodríguez Inciarte 2018 1,234 1,050 - - 2017 2,707 2,456 - - Total 2,284 5,163 A. Mr Rodrigo Echenique does not participate in the defned pensions scheme described in the preceding paragraphs. However, as an executive director and for informational purposes, this year’s table includes the rights to which he was entitled prior to his designation as such. The payments made to him in 2018 to him with respect to his participation in this plan amounted to EUR 0.9 million euros (EUR 0.9 million euros in 2017). D. Other remuneration In addition to the above, the Group has insurance policies for life, health and other contingencies for the executive directors of the Bank. This component includes the fxed supplement approved for Ms Ana Botín and Mr José Antonio Álvarez to replace the supplementary benefts in the beneft systems eliminated in 2018. It also includes the life insurance contracted so that, in case of death or disability whilst in active or at pre-retirement, the executive directors or whoever they appoint, will receive the amounts of the fxed remuneration supplement that were to be paid until their retirement date. Similarly, the executive directors are covered under the civil liability insurance policy contracted by the Bank. Note 5 of the Group´s consolidated fnancial statements provides more detailed information about other benefts received by the executive directors. E. Holding shares Following a proposal submitted by the remuneration committee, in 2016 the board of directors approved a share holding policy aimed at strengthening the alignment of executive directors with shareholders’ long-term interests. According to this policy, each executive director active on 1 January 2016 would have fve years in which to demonstrate that their personal assets include an investment in the Bank’s shares equivalent to twice the net tax amount of their gross annual salary at the same date. The shareholding policy also refects the executive directors’ commitment to maintaining a signifcant personal investment in the Bank’s shares while they are actively performing their duties within the Group. 183 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management   F. Remuneration of board members as representatives of the Bank By resolution of the executive committee, all remuneration received by the Bank’s directors who represent the Bank on the boards of directors of companies in which it has an interest and which relates to appointments made after 18 March 2002, will accrue to the Group. The directors of the Bank received no remuneration from this type of representation in 2018 or 2017, save for one of the Bank’s directors, Mr Matías Rodríguez Inciarte, who received a total of EUR 42 thousand in 2017, in his role as a non- executive director of U.C.I., S.A. G. Individual remuneration of directors for all items in 2018 The detail, by Bank director, of salary remuneration payable in the short term (or immediately) and of deferred remuneration not linked to long-term goals for 2018 and 2017 is provided below. The Note 5 to the consolidated fnancial statements contains disclosures on the shares delivered in 2018 by virtue of the deferred remuneration schemes in place in previous years, the conditions for delivery of which were met in the related years. EUR thousand 2018 Salary remuneration of executive directors 2017 Immediate payment (50% in shares) Deferred payment (50% in shares) Pension Other contribution remunerationG Total Total Total Bylaw-stipulated emoluments Board and board committees annual allotment Board and committee attendance fees 268 260 643 260 360 138 346 90 148 180 138 333 90 373 117 - - 39 34 89 33 81 61 86 31 67 86 58 81 18 77 31 - - Directors Ms Ana Botín-Sanz de Sautuola y O´Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie-Brown Mr Rodrigo Echenique Gordillo Mr Guillermo de la Dehesa Romero Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca Mr Francisco Javier Botín-Sanz de Sautuola y O´SheaA Ms Sol Daurella Comadrán Mr Carlos Fernández González Ms Esther Giménez-Salinas i Colomer Ms Belén Romana García Mr Juan Miguel Villar MirB Mr Ramiro Mato García-AnsorenaC Mr Álvaro Cardoso de SouzaD Mr Matías Rodríguez InciarteE Ms Isabel Tocino BiscarolasagaF Total 2018 Total 2017 Fixed 3,176 2,541 - 2,960 1,978 - 1,776 1,186 - 7,912 5,705 - 1,800 1,570 942 4,312 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 1,234 1,050 1,030 10,483 10,582 1,596 8,645 8,893 - - - - - - - - - - - - - - - - 732 225 4,830 - - 441 199 81 513 - - - - - - - - - - 121 215 266 196 414 108 450 148 - - 731 4,281 473 159 550 124 207 285 162 297 170 36 - 4,266 418 - 31,634 3,744 3,708 872 973 7,517 7,568 6,508 7,396 3,904 4,438 17,929 19,402 2,284 5,164 2,932 2,387 27,761 - A. All amounts received were reimboursed to Fundación Botín. B. Ceased to be a member of the board on 1 January 2019. C. Appointed director with efect from 28 November 2017. D. Appointed director with efect from 23 March 2018. E. Ceased to be a member of the board on 28 November 2017 and senior executive vice president on 2 January 2018. The remuneration for discharging his duties as senior executive vice president from 28 November is included in the corresponding section. F. Ceased to be a member of the board on 28 November 2017. G. Includes fxed income supplement (see section 6.3 D). 184 2018 Annual Report In addition, the following table provides the individual detail of the salary remuneration of executive directors linked to multi- year targets, which will only be paid if the conditions of continued service at the Group, non-applicability of the malus clauses and compliance with the defned multi-year targets are fulflled (or, as applicable, of the minimum thresholds of these, with the consequent reduction of the agreed amount at the end of the year). I. Summary of remuneration of executive directors and attributable net proft There following chart shows an overview of the compensation (short-term remuneration, deferred variable remuneration and/ or deferred variable remuneration linked to multi-year targets) of the directors performing executive duties as compared with attributable net proft. Executive directors’ total remuneration as % of attributable netproft 1,20% 1.12% 1,00% 0,80% 0,60% 0,40% 0,20% 0,00% 0.41% 0.45% 0.42% 0.42% 0.36% 0.50% 2012 2013 2014 2015 2016 2017 2018 The variable remuneration received by the executive directors is also shown below as a percentage of the cash dividends paid. Variable remuneration for all executives directors as % of cash dividends 1,40% 1,20% 1,00% 0,80% 0,60% 0,40% 0,20% 0,00% 1.17% 1.17% 1.07% 0.60% 0.56% 0.44% 0.65% 2012 2013 2014 2015 2016 2017 2018 J. Summary of link between risk, performance and reward Banco Santander's remuneration policy and its implementation in 2018 promote sound and efective risk management while supporting the business objectives. They key elements of the remuneration policy for executive directors making for alignment between risk, performance and reward in 2018 were as follows: Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo Mr Matías Rodríguez InciarteB EUR thousand 2018 (50% in shares)A 2017 (50% in shares) 1,864 1,246 990 - 1,726 1,154 900 880 Total 4,100 4,660 A Fair value of the maximum amount receivable over a total of 3 years (2022, 2023 and 2024), which was estimated at the plan award date, taking into account various possible scenarios for the diferent variables contained in the plan during the measurement periods. B. Ceased to be a member of the board on 28 November 2017 and senior executive vice president on 2 January 2018. Long-term salary remuneration between 28 November and 31 December 2017 is included in the relevant section. H. Ratio of variable to fxed components of remuneration in 2018 Shareholders at the general shareholders’ meeting of 23 March 2018 approved a maximum ratio between variable and fxed components of executive directors’ remuneration of 200%. The following table shows the percentage of the variable components of total remuneration compared to the fxed components for each executive director in 2018: Executive directors Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo For these purposes: Variable components / fxed components (%) 145% 99% 169% • The variable components of remuneration includes all items of this nature, including the portion of contributions to the benefts system that are calculated on the variable remuneration of the related director. • The fxed components of remuneration includes the other items of remuneration that each director receives for the performance of executive duties, including contributions to the benefts systems calculated on the basis of fxed remuneration and other benefts, as well as all bylaw-stipulated emoluments that the director in question is entitled to receive in his or her capacity as such. 185 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management Key words Risk, performance and reward alignment element Metrics balance The balance of quantitative metrics and qualitative assessment, including customer, risk, capital and risk related proftability, used to determine the executive directors´ variable remuneration. Financial thresholds The adjustment to variable remuneration if certain fnancial thresholds are not reached, which may limit the variable remuneration to 50% of the previous year´s amount or lead to it not being awarded at all. Long-term objectives The long-term objectives linked to the last three portions of the deferred variable remuneration. These objectives are directly associated with the absolute return to shareholders, relative performance with the peer group and to maintaining a sound capital base. Individual performance The discretion of the board to consider the individual performance of the executive directors in the award of their individual variable remuneration. Variable remuneration cap 200% of fxed remuneration. Control functions involvement The work done by the human resources committee aided by members of senior management leading control functions in relation with the analysis of quantitative metrics information and undertaking the qualitative analysis. Malus and clawback Malus can be made to unvested deferred awards and clawback can be applied to vested or paid awards in the conditions and situations set out in the Group´s remuneration policy. Payment in shares At least 50% of variable remuneration is paid in shares subject to a one-year retention period after delivery. 6.4 Directors remuneration policy for 2019, 2020 and 2021 that is submitted to a binding vote of the shareholders Principles of the remuneration policy and remuneration system A. Remuneration of directors in their capacity as such The director remuneration system is regulated by article 58 of the Bylaws of Banco Santander and article 33 of the rules and regulations of the board. No changes in the principles or composition of the remuneration of directors for the performance of supervisory and collective decision-making duties are planned in 2019, 2020 and 2021 are planned with respect to those in 2018. They are set forth in sections 6.1 and 6.2. B. Remuneration of executive directors For the performance of executive duties, executive directors shall be entitled to receive remuneration (including, if applicable, salaries, incentives, bonuses, possible severance payments for early termination from such duties, and amounts to be paid by the Bank for insurance premiums or contributions to savings schemes) which, following a proposal from the remuneration committee and by resolution of the board of directors, is deemed to be appropriate, subject to the limits of applicable law. No changes in the principles of the remuneration of executive directors for the performance of executive duties are planned in 2019, 2020 and 2021, save for the change in the peer group indicated below, with respect to those in place in 2018. They are set forth in sections 6.1 and 6.3. Banco Santander performs an annual comparative review of the total compensation of executive directors and other senior executives above. The 'peer group' will comprise in 2019 the following entities: BBVA, BNP Paribas, Citi, Credit Agricole, HSBC, ING, Itaú, Scotia Bank and Unicredit. Remuneration of directors for 2019 A. Remuneration of directors in their capacity as such In 2019, the directors, in their capacity as such, shall continue to receive remuneration for the performance of supervisory and collective decision-making duties for a collective amount of up to EUR 6 million as authorised by the shareholders at the 2018 annual general shareholders’ meeting (and again subject to approval by the shareholders at the 2019 general shareholders’ meeting), with two components: • Annual allocation; and • Attendance fees. The specifc amount payable for the above-mentioned items to each of the directors and the form of payment thereof shall be determined by the board of directors under the terms set forth in section 6.2 above. In addition, as stated in the description of the director remuneration system, in 2019 the Bank will pay the premium for the civil liability insurance for its directors, obtained upon customary market terms and proportional to the circumstances of the Bank. B. Remuneration of directors for the performance of executive duties i) Fixed components of remuneration A) Gross annual salary At the proposal of the committee, the board resolved that Ms Ana Botín, Mr José Antonio Álvarez and Mr Rodrigo Echenique would maintain their same gross annual salaries in 2019 as in 2018. B) Other fxed components of remuneration • Benefts systems: defned contribution plans26 as set out in section 'Pre-retirement and beneft plans'. 26.As stated in the section below, contributions to the benefts systems for two executive directors include both fxed components and variable components. 186 2018 Annual Report • Fixed salary supplement: the executive directors, other than Mr Rodrigo Echenique, will receive a fxed salary supplement approved in 2018 when the death and disability supplementary benefts systems was eliminated. Ms Ana Botín will receive EUR 525 thousand in 2019 for this component and Mr José Antonio Álvarez EUR 710 thousand in the same year. • Social welfare benefts: executive directors will also receive certain social welfare benefts such as life insurance premiums, medical insurance and, if applicable, the allocation of remuneration for employee loans, in accordance with the customary policy established by the Bank for senior management. Additional information is included in section 'Pre-retirement and beneft plans'. ii) Variable components of remuneration The variable remuneration policy for executive directors for 2019, which was approved by the board at the proposal of the remuneration committee, is based on the principles of the remuneration policy described in section 6.3. The variable components of the executive directors’ total remuneration for 2019 must not exceed a limit of 200% of the fxed components, although the European regulation on remuneration allows certain variable components of an exceptional nature to be excluded. A) Benchmark incentive Variable remuneration for executive directors in 2019 shall be determined based on a standard benchmark incentive conditional upon compliance with 100% of the established targets. The board of directors, at the proposal of the remuneration committee and based on market and internal contribution criteria, may review the benchmark variable remuneration. B) Setting the fnal incentive based on results for the year Based on the aforementioned benchmark standard, the 2019 variable remuneration for executive directors shall be set on the basis of the following key factors: • A group of short-term quantitative metrics measured against annual objectives. The variable remuneration of executive directors consists of a single incentive27, linked to the achievement of short-and long-term goals, structured as follows: • A qualitative assessment which cannot adjust the quantitative result by more than 25% upwards or downwards. • The fnal amount of the variable remuneration shall be determined at the start of the following year (2020) based on the benchmark amount and subject to compliance with the annual objectives described in section B) below. • An exceptional adjustment that must be supported by substantiated evidence and that may involve changes prompted by defciencies in control and/or risks, negative assessments from supervisors or unexpected material events. • 40% of the incentive shall be paid immediately once the fnal amount has been determined and the remaining 60% shall be deferred in equal parts over fve years, as follows: • The payment of the amount deferred over the frst two years (24% of the total), payable in the two following years, 2021 and 2022, shall be conditional on none of the malus clauses described in section 6.3 B vi) above being triggered. • The amount deferred over the next three years (36% of the total), payable in 2023, 2024 and 2025, shall be conditional not only on the malus clauses not being triggered but also on the executive achieving the long-term objectives described in section the D) below (deferred incentive subject to long-term performance objectives). Similarly, the incentives already paid will be subject to clawback by the Bank in the scenarios and for the period set forth in the Group’s malus and clawback policy, to which section 6.3 B vi) above refers. Exceptionally and as a result of the hiring of a new executive director, the variable remuneration of the new executive directors may include sign-on bonus and/or buyouts. 27. Likewise, and as stated in section below, contributions to the benefts systems for the executive directors include both fxed components and variable components, which become part of the total variable remuneration. 187 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management The detailed quantitative metrics, qualitative assessment factors and weightings are indicated in the following scorecard: b) 60% is paid, if applicable, in fve equal parts in 2021, 2022, 2023, 2024 and 2025, net of taxes, half in cash and half in shares, subject to the conditions stipulated in section E) below. Category and weighting metrics Quantitative Customers NPS/CSIA Number (20%) of loyal customers Qualitative assessment Efective compliance with the objectives of the rules on risk conduct in respect of customers. The last three payments shall also be conditional upon the long- term objectives described in section D) below. The portion paid in shares may not be sold until one year has elapsed from delivery thereof. Risks (10%) Non- performing loans ratio Cost of credit ratio (IFRS9) Appropriate management of risk appetite and excesses recognised. Adequate management of operational risk. ) % 0 8 s Capital Capital ratio ( r (20%) e d l o h Return Ordinary net proft Suitability of business growth e r (50%) a h S Efcient capital management. (CET1)B (ONP)C (20%) RoTE: return on tangible equityB (30%) compared to the previous year, considering the market environment and competitors. Sustainability and solidity of results. Efcient cost management and achievement of efciency goals. A. Net promoter score / customer satisfaction index. B. For this purpose, the capital ratio (CET1) and the RoTE will be adjusted upwards or downwards to refect the adjustments made to the ONP pursuant to note C. C. For this purpose, ONP is attributed ordinary net proft, adjusted upwards or downwards for those transactions that, in the opinion of the board, have an impact outside of the performance of the directors being evaluated, whereby extraordinary proft, corporate transactions, special allowances, or accounting or legal adjustments that may occur during the year are evaluated for this purpose. Lastly, and as additional conditions, in determining the incentive, it will be verifed whether or not the following circumstances have occurred: • If the Group’s ONP for 2019 is less than 50% of the ONP for 2018, the incentive would in no case exceed 50% of the benchmark incentive for 2019. • If the Group’s ONP is negative, the incentive would be zero. When determining individual bonuses, the board will also take into account whether any restrictions to the dividends policy have been imposed by supervisory authorities. C) Form of payment of the incentive Variable remuneration is paid 50% in cash and 50% in shares, one portion in 2020 and the deferred portion over fve years and subject to long-term metrics, as follows: a) 40% of the incentive is paid in 2020 net of taxes, half in cash and half in shares. D) Deferred variable remuneration subject to long-term objectives As indicated above, the amounts deferred in 2023, 2024 and 2025 shall be conditional upon, in addition to the terms described in section E) below, compliance with the Group’s long-term objectives for 2019-2021. The long-term metrics are as follows: (a) Compliance with the consolidated EPS growth target of Banco Santander in 2021 vs. 2018. The EPS ratio relating to this target is obtained as shown in the table below: EPS growth in 2021 (% vs. 2018) ≥ 15% ≥ 10% but < 15% < 10% 'EPS Ratio' 1 0 – 1A 0 A. Straight-line increase in the EPS ratio based on the specifc percentage that EPS growth in 2021 represents with respect to 2018 EPS within this bracket of the scale. In addition, total or partial compliance of this objective requires that EPS growth in 2019 and 2020 is higher than 0%. (b) Relative performance of the Bank’s total shareholder return (TSR) in 2019-2021 compared to the weighted TSR of a peer group comprising 9 credit institutions, applying the appropriate TSR ratio according to the Bank’s TSR within the peer group. Ranking of Santander TSR 'TRS Ratio' Above percentile 66 Between percentiles 33 and 66 (both inclusive) Below percentile 33 1 0 – 1A 0 A. Proportional increase in the TSR ratio based on the number of positions moved up in the ranking. TSR28 measures the return on investment for shareholders as a sum of the change in share price plus dividends and other similar items (including the Santander Scrip Dividend programme) that shareholders may receive during the period in question. 28. TSR is the diference (expressed as a percentage) between the end value of an investment in ordinary shares of Banco Santander and the initial value of the same investment, factoring in to the calculation of the fnal value the dividends or other similar instruments (such as the Santander Scrip Dividend Programme) received by the shareholder in relation to this investment during the corresponding period of time as if an investment had been made in more shares of the same type at the frst date on which the dividend or similar concept was payable to shareholders and the weighted average share price at that date. To calculate TSR, the average weighted daily volume of the average weighted listing prices for the ffteen trading sessions prior to 1 January 2019 (exclusive) is taken into consideration (to calculate the initial value) and that of the ffteen trading sessions prior to 1 January 2022 (exclusive) (to calculate the fnal value). 188 2018 Annual Report  The peer group comprises the following entities: BBVA, BNP Paribas, Citi, Credit Agricole, HSBC, ING, Itaú, Scotiabank y Unicredit. The hedging of Santander shares received during the retention and deferral periods is expressly prohibited. (c) Compliance with the Santander Group’s consolidated fully loaded target common equity tier 1 ratio (CET1) for 2021. The CET1 ratio relating to this target is obtained as described below: CET1 in 2021 ≥ 12% ≥ 11.50% but < 12% < 11.50% CET1 ratio 1 0.5 – 1A 0 A. Linear increase in the CET1 ratio based on the CET1 ratio for 2021 within this bracket of the scale. To verify compliance with this objective, possible increases in CET1 resulting from capital increases shall be disregarded (with the exception of those related to the Santander Scrip Dividend programme). Further, the CET1 ratio at 31 December 2021 could be adjusted to strip out the impact of any regulatory changes afecting its calculation implemented until that date. To determine the annual amount of the deferred variable remuneration tied to performance corresponding, if applicable, to each executive director in 2023, 2024 and 2025, the following formula shall be applied to each of these payments ('Final annuity') without prejudice to any adjustment deriving from the application of the malus policy described in section 6.3 B vi) above: Final annuity = Amt. x (1/3 x A + 1/3 x B + 1/3 x C) where: • 'Amt.' is one third of the variable remuneration amount deferred conditional on performance (i.e., Amt. will be 12% of the total incentive set in early 2020). The efect of infation on the deferred amounts in cash may be ofset. The sale of shares is also prohibited for at least one year from the receipt thereof. The remuneration committee may propose to the board adjustments in variable remuneration under exceptional circumstances due to internal or external factors, such as regulatory requirements or requests or recommendations issued by regulatory or supervisory bodies. These adjustments shall be described in detail in the corresponding report of the remuneration committee and in the annual report on director´s remuneration submitted each year to an advisory vote of the shareholders at the general shareholders’ meeting. iii) Holding shares No changes in the holding shares policy are planned with respect to the terms in place for 2018 and set forth in section 6.3 E. Remuneration of directors for 2020 and 2021 A. Remuneration of directors in their capacity as such No changes to the remuneration of directors in their capacity as such for 2020 and 2021 with respect to the remuneration described for 2019 are expected, without prejudice to the fact that shareholders at the 2020 or 2021 annual general meeting may approve an amount higher than the six million euros currently in force, or that the board may determine, within such limit, a diferent distribution thereof among directors. B. Remuneration of directors for the performance of executive duties Remuneration of executive directors shall conform to principles similar to those applied in 2019, with the diferences described below. • 'A' is the EPS ratio according to the scale in section (a) above, based on EPS growth in 2021 vs. 2018. i) Fixed components of remuneration • 'B' is the TSR ratio according to the scale in section (b) above, according to the relative performance of the TSR within its peer group in 2019-2021. • 'C' is the CET1 ratio according to compliance with the CET1 target for 2021 described in section (c) above. The estimated maximum amount to be delivered in shares to executive directors is EUR 11.5 million. E) Other terms of the incentive Accrual of the deferred amounts, including amounts linked to long-term objectives, shall also be conditional upon the benefciary’s continued service in the Group and upon none of the circumstances arising that give rise to the application of malus arrangements in accordance with the section on malus and clawback clauses in the Group’s remuneration policy, all under terms similar to those indicated for 2018. Similarly, the incentives already paid will be subject to clawback by the Bank in the scenarios and for the period set forth in said policy, all under the terms and conditions therein provided. A) Gross annual salary The annual gross fxed remuneration may be revised each year depending on the criteria approved at any given time by the remuneration committee, whereby the maximum increase for 2020 and 2021 for each executive director may not exceed 5% of their annual gross salary for the previous year. Nonetheless, this increase may be higher for one or several directors provided that, when applying the rules or requirements or supervisory recommendations that may be applicable, and if so proposed by the remuneration committee, it is appropriate to adjust their remuneration mix and, in particular, their variable remuneration in view of the functions they perform, without these increases possibly leading to an increase in the total remuneration of these directors for this reason. Should these circumstances arise, they will be described in detail in the corresponding report of the remuneration committee and in the annual report on director's remuneration submitted each year to an advisory vote at the general shareholders’ meeting. B) Other fxed components of remuneration No changes planned with respect to 2019. ii)Variable components of remuneration 189 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management The policy on variable remuneration for executive directors for 2020 and 2021 will be based on much the same principles as in 2019, following the same single-incentive scheme described above, and subject to the same rules of operation and limitations. Long-term metrics shall at least include objectives relating to value creation and return for shareholders and capital in a multi-year period of at least three years. These metrics shall be aligned with the Group’s strategic plan and refect its main priorities from its stakeholders’ perspective. A) Setting the variable remuneration Variable remuneration for 2020 and 2021 for executive directors shall be determined based on a benchmark incentive approved for each year which takes into account: These metrics may be measured at the level of the Group or of the country or business, when appropriate, and the performance thereof may be relatively compared to a peer group. • A group of short-term quantitative metrics measured against annual objectives. These metrics shall be aligned with the Group strategic plan and include, at least, shareholder return targets, risk objectives, capital and customers. The metrics may be measured at Group level, and where applicable, at division level if the executive director is responsible for managing a specifc business division. The results of each metric may be compared to both the budget established for the fnancial year as well as to growth compared to the prior year. • A qualitative assessment which cannot adjust the quantitative result by more than 25% upwards or downwards. The qualitative assessment shall be performed on the same categories as the quantitative metrics, including shareholder returns, risk and capital management and customers. • Potential exceptional adjustments that must be based on substantiated evidence and that may involve changes prompted by defciencies in control and/or risks, negative assessments from supervisors or unexpected material events. The quantitative metrics, qualitative assessment and potential extraordinary adjustments will ensure that the main objectives are considered from the perspective of diferent stakeholders, and that the importance of risk and capital management is factored in. Lastly, in determining the incentive it will be verifed whether or not the following circumstances have occurred: • If the quantitative metrics linked to proft do not reach a certain compliance threshold, the incentive may not be greater than 50% of the benchmark incentive for a given year. • If the results of the metrics linked to proft are negative, the incentive shall be zero. • When determining individual bonuses, the board will also take into account whether any restrictions to the dividends policy have been imposed by supervisory authorities. B) Form of payment of the incentive No changes in form of payment are planned with respect to the terms in place for 2019. C) Deferred variable remuneration subject to long-term objectives The last three annual payments of the deferred amount of each variable remuneration shall be conditional upon, in addition to the terms described in section E) above, compliance with the Group’s long-term objectives for at least a three-year period, compliance with which may only confrm or reduce the amounts and number of deferred shares. The portion paid in shares of the incentives may not be sold until at least one year has elapsed from delivery thereof. D) Other terms of the incentive No changes in form of payment are planned with respect to the continuity, malus and clawback terms terms in place for 2019 and that are described in section E) of the remuneration policy for 2019. Likewise, no changes are planned to the hedging prohibition or the infation-related adjustments on cash deferred amounts terms set out in the same section. iii) Holding shares The share holding policy approved in 2016 shall apply in 2020 and 2021, unless the remuneration committee, under exceptional circumstances such as regulatory requirements or requests or recommendations issued by regulatory or supervisory bodies, were to propose amendments to this policy to the board. Any potential amendments would be described in detail in the corresponding remuneration committee report and in the annual report on director´s remuneration submitted each year to an advisory vote at the general shareholders’ meeting. Terms and conditions of executive directors’ contracts The terms for the provision of services by each of the executive directors are governed by the contracts signed by each of them with the Bank, as approved by the board of directors. The basic terms and conditions of the contracts of the executive directors, besides those relating to the remuneration, are the following: A. Exclusivity and non-competition Executive directors may not enter into contracts to provide services to other companies or entities except where expressly authorised by the board of directors. In all cases, a duty of non-competition is established with respect to companies and activities similar in nature to those of the Bank and its consolidated Group. Likewise, the contracts of the executive directors provide for certain prohibitions against competition and the poaching of clients, employees and suppliers that may be enforced for two years after the termination thereof for reasons other than retirement or a breach by the Bank. The compensation to be paid by the Bank for this duty of non-competition is 80% of the fxed remuneration, 40% payable on termination of the contract and 60% at the end of the two-year period for Ms Ana Botín and Mr José Antonio Álvarez. In the case of Mr Rodrigo Echenique, the compensation to be paid is two times his fxed salary, receiving 50% on termination of the contract and 50% at the beginning of the second year of the non- competition period. 190 2018 Annual Report B. Code of Conduct There is an obligation to strictly observe the provisions of the Group’s general code and of the code of conduct in securities markets, in particular with respect to rules of confdentiality, professional ethics and conficts of interest. C. Termination The contracts are of indefnite duration and do not provide for any severance payment in the case of termination other than as may be required by law. In the event of termination of her contract by the Bank, Ms Ana Botín-Sanz de Sautuola y O’ Shea must remain available to the Bank for a period of four months to ensure a proper transition, during which period she would continue to receive her gross annual salary. D. Pre-retirement and beneft plans The contracts of the following executive directors acknowledge their right to pre-retire under the terms stated below when they have not yet reached retirement age: • Ms Ana Botín-Sanz de Sautuola will be entitled to pre-retirement in the event of leaving her post for reasons other than breach of duty. In this case, she will be entitled to an annual allotment equal to the sum of her fxed remuneration and 30% of the average amount of her last variable remunerations, to a maximum of three. This allotment shall be reduced by 8% in the event of voluntary termination prior to the age of 60. This allotment is subject to the malus and clawback provisions in place for a period of fve years. • Mr José Antonio Álvarez Álvarez will be entitled to pre-retire in the event of leaving his post for reasons other than his own free will or breach of duty In that case, he will be entitled to an annual allocation equivalent to the fxed remuneration corresponding to him as a senior manager. This allotment is subject to the malus and clawback provisions in place for a period of fve years. The executive directors, other than Mr Rodrigo Echenique, participate in the defned contribution system created in 2012, which covers the contingencies of retirement, disability and death. The Bank makes annual contributions to the beneft plans of the executive directors who participate in the beneft system. The annual contributions are calculated in proportion to the respective pensionable bases of the executive directors, and shall continue to be made until they leave the Group or until their retirement within the Group, or their death or disability (including, if applicable, during pre-retirement). The pensionable base for the purposes of the annual contributions for the executive directors is the sum of fxed remuneration plus 30% of the average of their last three variable remuneration amounts (or, in the event of Mr José Antonio Álvarez’s pre-retirement, his fxed remuneration as a senior executive vice president). The contributions will be 22% of the pensionable bases in all cases. The pension amount corresponding to contributions linked to variable remuneration will be invested in Santander shares for a period of fve years on the retirement date or, if earlier, the cessation date, and shall be paid in cash after fve years have elapsed or, if subsequent, on the retirement date. Moreover, the malus and clawback clauses corresponding to contributions linked to variable remuneration shall be applied for the same period as the bonus or incentive upon which said contributions depend. The beneft plan is outsourced to Santander Seguros y Reaseguros, Compañía Aseguradora, S.A., and the economic rights of the foregoing directors under this plan belong to them regardless of whether or not they are active at the Bank at the time of their retirement, death or disability. The contracts of these directors do not provide for any severance payment in the case of termination other than as may be required by law, and, in the case of pre- retirement, the aforementioned annual allotment. Mr Rodrigo Echenique's contract does not provide for any charge to the Bank´s regarding benefts, without prejudice to the pension rights to which Mr Echenique was entitled prior to his appointment as executive director. E. Insurance and other remuneration and benefts in kind Ms Ana Botín and Mr José Antonio Álvarez will receive the fxed remuneration supplement approved as a result of the elimination of the supplementary benefts scheme in 2018. This supplement will be paid in the same amount in 2019, 2020 and 2021 and will continue to be paid until their retirement age, even if the director is then still active. The Group has arranged life and health insurance policies for the directors. The premiums for 2019 corresponding to this insurance amount to EUR 875 thousand, which includes the standard life insurance and, in the case of Ms Ana Botín and Mr José Antonio Alvarez, the life insurance coverage for the aforementioned fxed remuneration supplement. In 2020 and 2021, these premiums could vary in the event of a change in the fxed remuneration of directors or in their actuarial circumstances. Similarly, executive directors are covered by the Bank’s civil liability insurance policy. Finally, executive directors may receive other benefts in kind (such as health insurance or employee loans) in accordance with the Bank’s general policy and the corresponding tax treatment. F. Confdentiality and return of documents A strict duty of confdentiality is established during the relationship and following termination thereof, pursuant to which executive directors must return to the Bank the documents and items related to their activities that are in their possession. G. Other terms and conditions The advance notice periods contained in the contracts with the executive directors are as follows: By decision of the Bank (months) By decision of the director (months) Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique − − − Payment clauses in place of pre-notice periods are not contemplated. 4 − − 191 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management Appointment of new executive directors The components of remuneration and basic structure of the agreements described in this remunerations policy will apply to any new director that is given executive functions, notwithstanding the possibility of amending specifc terms of agreements so that, overall, they contain conditions similar to those previously described. In particular, the total remuneration of the director for performing executive duties may not be greater than the highest remuneration received by the current executive directors of the Bank pursuant to the remuneration policy approved by the shareholders. The same rules shall apply if a director assumes new duties that said director did not previously discharge or becomes an executive director. If executive responsibilities are assumed with respect to a specifc division or country, the board of directors, at the proposal of the remuneration committee, may adapt the metrics used for the establishment and accrual of the incentive in order to take into account not just the Group but also the respective division or country. The remuneration of directors in their capacity as such, it shall be included within the maximum distributable amount set by the shareholders and to be distributed by the board of directors as described above. Additionally, if the new director comes from an entity that is not part of the Santander Group, they could be the benefciary of a buyout to ofset the loss of variable remuneration corresponding to their prior post if they have not accepted a contract with the Group or of a sign- on bonus to attract them to join Banco Santander. This compensation could be paid fully or partly in shares, subject to the delivery limits approved at the general shareholders’ meeting. Therefore, authorisation is expected to be sought at the next general shareholders’ meeting to deliver a specifed maximum number of shares as part of any hires to which the buyout regulation applies. Sign-on bonuses can only be agreed once with the new executive directors, they can be paid in cash or shares and in each case will not exceed the maximum variable remuneration awarded for all executive directors the preceding year. 6.5 Preparatory work and decision- making process with a description of the participation of the remuneration committee Section 4.6 Remuneration committee activities for 2018, details the following: • Pursuant to the Bylaws and the Rules and regulations of the board of the Bank, the duties relating to the remuneration of the directors performed by the remuneration committee. • The composition of the remuneration committee at the date of approving this report. • The number of meetings with the risk supervision, regulation and compliance committee held in 2018, including those held jointly with the risk, compliance and regulation supervision committee. • The date of the meeting when this report was approved. • The 2017 annual report on directors´ remuneration was approved by the board of directors and submitted to a binding vote at the general shareholders’ meeting of 23 March 2018, with 94.42% of the votes in favour. The detail of vote was as follows: Votes cast 10,233,121,753 98.25% Number % of totalA Votes against Votes in favour Abstentions Number % of totalA 389,585,931 9,834,835,228 182,466,168 3.74% 94.42% 1.75% A. Percentage on total valid votes and abstentions. 192 2018 Annual Report 6.6 Remuneration of non-director members of senior management At its meeting of 28 January 2019, the committee agreed to propose to the board of directors the approval of the variable remuneration for 2018 of members of senior management who are not directors. The committee’s proposal was approved by the board at its meeting of 29 January 2019. The Bank’s general remuneration policy was applied in order to determine this variable remuneration, as well as the specifcities corresponding to senior management. In general, their variable remuneration packages were calculated on the same balance of quantitative metrics and qualitative assessment used for executive directors described in section 6.3 B ii). The contracts of certain senior managers have gone through changes similar to those set out in section 6.3 C for Ms Ana Botín and Mr José Antonio Álvarez. The changes aim to align the annual contributions with practices of comparable institutions and to reduce future liabilities (derisking) by eliminating the supplementary benefts scheme in the event of death (death of spouse or parent) and permanent disability of certain with no increase in total costs for the Bank. The changes are the following: • Contributions of the pensionable bases have been reduced. The diference between contributions has been increased in the same amount in the annual gross salary. • The supplementary benefts have been eliminated since 1 January 2018. • The sum insured of the life insurance have been improved. • A fxed remuneration supplement refected in the Other remuneration element of the table below was implemented for certain senior managers. These changes have not meant an increase in total cost for the Bank. The table below shows the amounts of short-term remuneration (immediately payable) and deferred remuneration (excluding that linked to multi-year targets) for members of senior management at 31 December 2018 and 2017, excluding remuneration corresponding to the executive directors shown previously: Short-term and deferred salary remuneration EUR thousand Year 2018 2017 Number of people 18 19 Fixed 22,475 17,847 Immediately receivable variable remuneration (50% in shares)A 16,748 17,758 Deferred variable remuneration (50% in shares)B Pension contributions Other remunerationC 7,582 8,104 6,193 13,511 7,263 7,348 TotalD 60,261 64,568 A. The amount of immediate payment in shares for 2018 is of 1,936 thousand Santander shares (1,430 thousand Santander shares and 226 thousand shares of Banco Santander (México) S.A. in 2017). B. The amount of deferred shares for 2018 is of 877 thousand Santander shares. C. Includes other items of remuneration such as life insurance premiums in the amount of EUR 1,641 thousand (692 thousand in 2017), health insurance and relocation packages. D. In addition, as a result of the agreements for incorporation and ofsetting of long-term remuneration and deferred losses in previous positions, compensation amounting to EUR 4,650 thousand and 649,000 shares of Banco Santander, S.A. was agreed in 2017. This compensation will be partially subject to deferral and/or recovery in certain cases. The following table shows a breakdown of the salary remuneration linked to multi-year targets for members of senior management at 31 December 2018 and 2017. This remuneration will only be received if the terms of continued service, non- applicability of the malus clauses, and compliance with long-term goals are met in the corresponding deferral periods. 193 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management Every year, the remuneration committee reviews and, if applicable, updates the composition of the identifed staf in order to identify the persons in the organisation who fall within the aforementioned parameters. The Remuneration Policies chapter of the 2018 Pillar III disclosures report29 describes the criteria used for identifying staf and the applicable regulation for the same purpose. According to these criteria, at year-end 2018, this group comprised 1,384 executives across the Group (including executive directors and non-director senior managers) (1,255 in 2017), accounting for 0.68% of total staf (0.62% in 2017). The directors that are identifed staf other than executive directors are subject to the same remuneration standards applicable to the latter described in sections 6.1 and 6.3, except for: • The various deferral percentages and terms that apply based on their category. • The possibility that in 2018 the deferred part of the incentive of certain categories of managers is not conditional upon performance but only to the malus clause. • As occurred with the bonuses in previous years, the variable remuneration amount that is paid or deferred in shares to the executives of the Group in Brazil, Chile, Mexico, Poland, and Santander Consumer US, is delivered in shares or similar instruments of their own listed entities. In the fnancial year 2019, the board of directors will maintain its fexibility for agreeing total or partial payment in shares or similar instruments of Banco Santander and/or the respective subsidiary in the proportion it considers appropriate in each case (subject, in any event, to the maximum number of Santander shares to be delivered as agreed by shareholders at the general meeting and any regulatory restrictions applicable in each jurisdiction). The aggregate amount of the 2018 variable remuneration of identifed staf, the amounts deferred in cash and in instruments and the ratio between the variable components of remuneration to the fxed components are detailed in the remuneration policies chapter of the 2018 Pillar III disclosures report mentioned above. Thousands of euros Number of people Deferred variable remuneration subject to long-term metricsA (50% in shares)B 18 19 7,962 8,510 Year 2018 2017 A. In 2018, this corresponds to the fair value of the maximum annual payments for 2022, 2023 and 2024 of the third cycle of the deferred variable remuneration plan linked to multi-year targets. In 2017, this corresponds to the estimated fair value of the maximum annual payments for 2021, 2022 and 2023 of the second cycle of the deferred variable remuneration plan linked to multi-year targets. The fair value has been determined at the grant date based on the valuation report of an independent expert, Willis Towers Watson. Depending on the design of the plan for 2018 and the levels of achievement of similar plans in comparable entities, the expert concludes that the reasonable range for estimating the initial achievement ratio is around 60% - 80%. It has been considered that the fair value is 70% of the maximum. B. The amount of shares of the deferred variable remuneration subject to long-term metrics shown in the table above is of 921 thousand Santander shares in 2018. The long-term goals are the same as those for executive directors. They are described in section 6.3 B iv). Additionally, those senior executive vice presidents that ceased to carry out their duties in 2018 and who were not members of senior management at year-end, received salary remuneration and other remuneration relating to the cessation of their duties for a total amount of EUR 1,861 thousand during the year (EUR 5,237 thousand for those leaving their posts in 2017). Those leaving in 2017 also received long-term variable remuneration for a total of EUR 999 thousand (none in 2018). In 2018, the ratio between the variable components of remuneration to the fxed components was 103% of the total for senior managers, in all cases respecting the upper limit of 200% set by the shareholders. See note 5 of the Group’s 2017 consolidated fnancial statements for further details. 6.7 Prudentially signifcant disclosures document The board of directors is responsible for approving, at the proposal of the remuneration committee, the key elements of the remuneration of managers or employees who, while not belonging to senior management, take on risks, carry out control functions (i.e. internal audit, risk management and compliance) or who receive global remuneration that places them in the same remuneration bracket as senior management and employees who take on risk, and whose professional activities may have an important impact on the Group’s risk profle (all of these together with the senior management and the Bank’s board of directors form the so called identifed staf or material risk takers). 29. The 2018 Pillar III disclosures report is published at our corporate website. 194 2018 Annual Report 195 RemunerationResponsible bankingCorporate governanceEconomic and financial reviewRisk management 7. Group structure and internal governance The structure of the Santander Group is a model of legally independent subsidiaries whose parent is Banco Santander, S.A. The Group has registered address in the city of Santander (Cantabria, Spain) and its Corporate Centre in Boadilla del Monte (Madrid, Spain). The Group has established a Group subsidiary governance model for its main subsidiaries. Any reference to subsidiaries in this section refers to the Bank’s most signifcant subsidiaries. The key features of the Group subsidiary governance model are as follows: • The governing bodies of each subsidiary shall ensure that their company is managed rigorously and prudently, while ensuring their economic solvency and upholding the interests of their shareholders and other stakeholders. • Management of the subsidiaries is a local matter carried out by local management teams which provide extensive knowledge and experience in relation to local customers and markets, while also benefting from the synergies and advantages of belonging to the Santander Group. • The subsidiaries are subject to the regulation and supervision of their respective local authorities, without prejudice to the global supervision of the Group by the ECB. • Customer funds are secured by virtue of the deposit guarantee funds in place in the relevant country, in accordance to the applicable laws. Subsidiaries fnance themselves autonomously when it comes to both capital and liquidity. The Group’s capital and liquidity positions are coordinated by the corporate committees. Intragroup exposure is limited and transparent and any such transactions are invariably arranged under arm’s length conditions. Moreover, the Group has listed subsidiaries in certain countries, in which it always retains a controlling stake. The subsidiaries’ autonomy limits the contagion risk between the Group’s diferent units, which reduces systemic risk. Each subsidiary has its own resolution plan. 7.1 Corporate Centre The Group subsidiary governance model of Banco Santander is further complemented with a Corporate Centre that brings together Group control and support units tasked with functions relating to strategy, risks, auditing, technology, human resources, legal services, communications and marketing, among others. The Corporate Centre adds value to the Group by: • Making its governance more robust, through corporate frameworks, models, policies and procedures that allow corporate expectations to be implemented and ensure efective supervision of the Group. • Making the Group’s units more efcient by unlocking cost management synergies, economies of scale and achieving a common brand. • Sharing the best commercial practices, focusing on global connectivity, launching global commercial initiatives and fostering digitalisation. 7.2 Internal governance of the Group Santander has an internal governance framework that takes the form of a governance model, establishing a set of principles that regulate relations and the interaction that must exist between the Group and its subsidiaries on three levels: • On the governing bodies of the subsidiaries, where the Group has devised rules and procedures regulating the structure, composition, make-up and functioning of the boards and their committees (audit, appointments, remuneration and risks), in accordance with international standards and good governance practices. In addition, other rules and regulations concerning the appointment, remuneration and succession planning of members of governing bodies, in full compliance with the regulations and local supervisory criteria, are embedded. • Between the CEOs (Chief executive ofcers) and country heads of the subsidiaries and of the Group and between the ofcers and teams deemed suitable to exercise key control functions within the Group and at the subsidiaries. These ofcers and teams comprise the following: CRO (chief risk ofcer); CCO (chief 196 2018 Annual Report Group structure and internal governance compliance ofcer); CAE (chief audit executive); CFO (chief fnancial ofcer); CAO (chief accounting ofcer) and key support functions (IT, Operations, HR, General Secretary’s Ofce, Legal Services, Marketing, Communications and Strategy) as well as business functions (SCIB, Wealth Management and Digital and Innovation). In relation to CEOs, country heads and other signifcant ofce holders, the governance model establishes, among other aspects, the relevant rules and regulations to be followed in relation to their appointment, setting targets, assessment, and fxing of variable remuneration and succession planning. It also explains how Group ofcers and their counterparts at the subsidiaries should liaise and interact. Santander also has thematic frameworks (corporate frameworks) for matters considered to be important due to their impact on the Group’s risk profle, notable among which are risk, capital, liquidity, compliance, technology, auditing, accounting, fnance, strategy, human resources, cybersecurity and communications and brand, and which specify: • The way the Group exercises oversight and control over the subsidiaries. • The Group’s involvement in certain of the subsidiaries’ important decisions, as well as the subsidiaries’ involvement in the Group’s decision-making processes. The aforementioned governance model and corporate frameworks efectively make up the internal governance system and are approved by the board of directors of Banco Santander, S.A. for subsequent adherence to by the governing bodies of the subsidiaries, with due regard to any local requirements to which these subsidiaries may be subject. Both the model and the frameworks are maintained up to date on an ongoing basis through the recurring adoption of legislative changes and international best practices. They are subject to annual review by the Group board of directors. Based on the corporate frameworks, the functions included in the governance model prepare internal regulatory documents (models, policies and procedures) that are given to the Group’s subsidiaries as reference and development documentation, ensuring that they are efectively implemented and embedded at local level, and in full compliance with local law and local supervisory expectations. This approach also drives a consistency of application throughout the Group as a whole. An Internal Governance Ofce at Group level, comprising Governance expertise, and the subsidiaries’ General Secretaries are responsible for promoting the efective embedding of the Governance model and Corporate Frameworks. The extent and completeness of this activity is assessed by the Group on an annual basis with associated reporting to relevant Governing bodies. 197 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 8. Internal control over fnancial reporting (ICFR) This section describes key aspects of the internal control and risk management systems in place at Santander Group with respect to the fnancial reporting process, specifcally addressing the following aspects: • Control environment. • Risk assessment in fnancial reporting. • Control activities. • Information and communication. • Monitoring. • External auditor report. 8.1 Control environment Governance and responsible bodies Our board of directors approves the fnancial information that, due to its status as a listed company, Banco Santander must periodically make public and is responsible for overseeing and guaranteeing the integrity of the internal information and control systems, as well as the accounting and fnancial information systems. This includes operational and fnancial control and compliance with applicable legislation. Our board of directors has set up an audit committee that assists the board in supervising the fnancial reporting process and internal control systems. According to the Rules and regulations of the board, our audit committee oversees the process of preparing and presenting the mandatory fnancial information relating to the Bank and the Group, and the adequate delimitation of the consolidation perimeter and the correct application of the accounting criteria, including the related non-fnancial information, in addition to its completeness; as well as the efectiveness of the internal control systems, so that the main risks are identifed, managed and properly brought to light. 198 In addition, our audit committee discusses with the external auditor any signifcant defciencies in the internal control system that may be detected in the course of the audit and ensures that the external auditor issues a report regarding the internal control system for fnancial information. The existence of an adequate ICFR, prepared and coordinated by the non-fnancial risk control area, corresponds to the entire organisational structure with control relevance, through a direct scheme of individually assigned responsibilities. In addition, the fnancial accounting and management control units in each of the countries in which the Group operates -each led by a controller- have an important role in complying with the standard. Section below includes more information on the functions carried out by each organisational structure, the controllers and the non-fnancial risk control area. Functions Responsible, Code of Conduct, whistleblowing channel and training Functions Responsible The Group, through the corporate organisation area and the organisational units for each country/entity or business, defnes, implements and maintains the organisational structures, catalogue of job positions and size of the units. Specifcally, the corporate organisation function defnes a reference managing and staf structure, which serves as a Manual across de Group. The business and support areas channel any initiative related to their structure through these organisational units. These units are responsible for analysing, reviewing and, where appropriate, incorporating any structural modifcations into the corporate technology tools. The organisation units are responsible for identifying and defning the main functions under the responsibility of each structural unit. Based on this assignment, each of the business/support areas identifes and documents the necessary tasks and controls in its area within the Internal Control Model (ICM), based on its knowledge and understanding of its activities, processes and potential risks. 2018 Annual Report Internal control over financial reporting (ICFR) Each unit thus detects the potential risks associated with those processes, which are necessarily covered by the ICM. This detection takes place based on the knowledge and understanding that management has of the business and process. It also has to establish those responsible for the various controls, tasks and functions of the documented processes, so that all the members of the division have clearly assigned responsibilities. The purpose of this is to try to ensure, among other things, that the organisational structure provides a solid model of ICFR. With respect to the specifc process of preparing its fnancial information, the Group has defned clear lines of responsibility and authority. The process entails exhaustive planning, including, among other things, the distribution of tasks and functions, the required timeline and the various reviews to be performed by each manager. To this end, the Group has fnancial accounting and control units in each of its operating markets; these are headed up by a controller whose duties include the following: • Integrating the corporate policies defned at the Group level into their management, adapting them to local requirements. • Ensuring that the organisational structures in place are conducive to due performance of the tasks assigned, including a suitable hierarchical-functional structure. • Deploying critical procedures (control models), leveraging the Group’s corporate IT tools to this end. • Implementing the corporate accounting and management information systems, adapting them to each entity’s specifc needs as required. In order to preserve their independence, the controllers report to their country heads and to the Group’s fnancial accounting and control division. The code can be consulted on the corporate website (www.santander.com). This code is binding for all members of the Group’s governance bodies and all employees of Banco Santander, S.A., who acknowledge as much when they join the Group, notwithstanding the fact that some of these individuals are also bound by the Code of Conduct in Securities Markets and other codes of conduct specifc to the area or business in which they work. The Group provides all its employees with e-learning courses on the aforementioned general code of conduct. Moreover, the compliance department is available to address any queries with respect to its application. The general code sets out the functions of the Group’s governance bodies, units and areas required to implement the code, in addition to the compliance area. The irregularities committee, consisting of representatives from various parts of the Group, is responsible for imposing disciplinary measures for any breaches of the general code and proposing corrective actions, which may lead to labour-ofence sanctions, notwithstanding any administrative or criminal sanctions that may also result from such a breach. Whistleblowing channel Banco Santander has a whistleblowing channel, through which employees can report, confdentially and anonymously, any allegedly unlawful acts or breaches of the general code of conduct that comes to their knowledge during the course of their professional activities. In addition, through this whistleblowing channel, employees can confdentially and anonymously report irregularities in accounting or auditing matters, in accordance with SOX. When reports concerning accounting or auditing matters are received, the compliance function will report to the audit committee to resolve the issue and adopt the appropriate measures. In addition, to support the existence of adequate documentation for the Group’s internal control model, the corporate non-fnancial risk control department is responsible for establishing and reporting the work method governing the process of documenting, evaluating and certifying the internal control model that covers the ICFR system, among other regulatory and legal requirements. It also handles maintaining documentation up-to-date to adapt it to organisational and regulatory changes and, together with the general controller and management control division and, if appropriate, the representatives of the divisions and/or companies concerned, present the conclusions of the internal control model evaluation process to the audit committee. There are similar functions at each unit that report to the corporate non-fnancial risk control department. To preserve the confidentiality of communications prior to their examination by the audit committee, the procedure does not require the inclusion of personal an contact data from the sender. In addition, only certain persons in the Compliance area review the content of the communication in order to determine whether it is related to accounting or auditing matters, and, if applicable, submit it to the audit committee. Training Group employees involved in preparing and reviewing its fnancial information participate in training programmes and regular refresher courses which are specifcally designed to provide them with the knowledge required to allow them to discharge their duties properly. Code of Conduct The Group’s general Code of Conduct is approved by the Bank’s board of directors, setting out behavioural guidelines of ethical principles and rules of conduct that govern the actions of all Santander Group employees and, therefore, constitutes the central pillar of the Group compliance function. It also establishes guidelines for conduct, among other matters, in relation to accounting obligations and fnancial information. The training and refresher courses are mostly promoted by the management control and general audit division itself and are designed and overseen together with the corporate learning and career development unit which is, in turn, part of the HR department and is responsible for coordinating and imparting training across the Group. 199 Responsible bankingCorporate governanceEconomic and financial reviewRisk management These training initiatives take the form of a mixture of e-learning and onsite sessions, all of which are monitored and overseen by the aforementioned corporate unit in order to guarantee they are duly taken and that the concepts taught have been properly assimilated. The following aspects of the Group’s ICM model are worth highlighting: It is a corporate model involving the whole organisational structure through a direct scheme of responsibilities assigned individually. The training and periodic update programmes taught in 2018 have focused, among other subjects, on: risk analysis and management, accounting and fnancial statement analysis, the business, banking and fnancial environment, fnancial management, costs and budgeting, numerical skills, calculations and statistics and fnancial statement auditing, among other matters directly and indirectly related to the fnancial information process. The management of the ICM documentation is decentralised, being delegated to the Group’s various units, while its coordination and monitoring is the duty of the non-fnancial risk control department, which issues general criteria and guidelines to ensure uniformity and standardisation of the documentation of procedures, control assessment tests, criteria for the classifcation of potential weaknesses and rule changes. 59,636 employees from the Group’s entities in the various countries in which it operates were involved in these training programmes, involving over 255,500 training hours at the Corporate Centre in Spain and remotely (e-learning). In addition, each country develops its own training programme based on that developed by the parent. 8.2 Risk assessment in fnancial reporting Santander Group’s ICM is defned as the process carried out by the board of directors, senior management and the rest of the Group’s employees to provide reasonable assurance that their targets will be attained. The Group’s ICM complies with the most stringent international standards and specifcally complies with the guidelines established by the Committee of Sponsoring Organisations of the Tradeway Commission (COSO) in its most recent framework published in 2013, which addresses control targets in terms of operations efectiveness and efciency, fnancial information reliability and compliance with applicable rules and regulations. ICM documentation is implemented at the main Group companies using standard and uniform methodology such that it ensures inclusion of the appropriate controls and covers all material fnancial information risk factors. The risk identification process takes into account all classes of risk (particularly those included in the recommendations issued by the Basel Risk Committee). Its scope is greater than all of the risks directly related to the preparation of the Group’s financial information. The identifcation of potential risks that must be covered by the ICM is based on the knowledge and understanding that management have of the business and its operating processes, taking into account both criteria of relative importance and qualitative criteria associated with the type, complexity or the structure of the business itself. In addition, the Bank ensures the existence of controls covering the potential risk of error or fraud in the issuance of the fnancial information, i.e., potential errors in terms of: i) the existence of the assets, liabilities and transactions as of the corresponding date; ii) the fact that the assets are Group goods or rights and the liabilities Group obligations; iii) proper and timely recognition and correct measurement of its assets, liabilities and transactions; and iv) the correct application of the accounting rules and standards and adequate disclosures. 200 It is an extensive model with a global scope of application, which not only documents the activities relating to generation of the consolidated fnancial information, its core scope of application, but also other procedures developed by each entity’s support areas which, while not generating a direct impact on the accounting process, could cause possible losses or contingencies in the case of incidents, errors, regulatory breaches and/or fraud. It is dynamic and updated continually to mirror the reality of the Group’s business as it evolves, the risks to which it is exposed and the controls in place to mitigate these risks. It generates comprehensive documentation of all the processes falling under its scope of application and includes detailed descriptions of the transactions, evaluation criteria and checks applied to the ICM model. All of the Group companies’ ICM documentation is compiled into a corporate IT application which is accessed by employees of difering levels of responsibility in the evaluation and certifcation process of Santander Group’s internal control system. The Group has a specifc process for identifying the companies that should be included within its scope of consolidation. This is mainly monitored by the fnancial accounting and control division and the ofce of the general secretary and human resources. This procedure enables the identifcation of not just those entities over which the Group has control through voting rights from its direct or indirect holdings, but also those over which it exercises control through other channels, such as mutual funds, securitisations and other structured vehicles. This procedure analyses whether the Group has control over the entity, has rights over or is exposed to its variable returns, and whether it has the capacity to use its power to infuence the amount of such variable returns. If the procedure concludes that the Group has such control, the entity is included in the scope of consolidation, and is fully consolidated. If not, it is analysed to identify whether there is signifcant infuence or joint control. If this is the case, the entity is included in the scope of consolidation, and consolidated using the equity method. Finally, the audit committee is responsible for supervising the Bank and Group’s regulated fnancial information process and internal control system. In supervising this fnancial information, particular attention is paid to its integrity, compliance with regulatory requirements and accounting criteria, and the correct defnition of the scope of 2018 Annual Report Internal control over financial reporting (ICFR) consolidation. The internal control and risk management systems are regularly reviewed to ensure their efectiveness and adequate identifcation, management and reporting. Our Group’s chief accounting ofcer presents to be validated the Group’s fnancial information to the audit committee on a quarterly basis, at least, providing explanations of the main criteria employed for estimates, valuations and value judgements. 8.3 Control activities Procedures for reviewing and authorising the fnancial information Our audit committee by mandate of the board oversees the process of preparing and presenting the mandatory fnancial information regarding the Bank and the Group, which includes the related non-fnancial information, as well as its completeness, and reviews compliance with regulatory requirements, the appropriate delimitation of the perimeter of consolidation and the correct application of accounting criteria, ensuring that this information is permanently updated on the Bank’s website. The process of creating, reviewing and authorising the fnancial information and the description of the ICFR is documented in a corporate tool which integrates the control model into risk management, including a description of the activities, risks, tasks and the controls associated with all of the transactions that may have a material efect on the fnancial statements. This documentation covers recurrent banking transactions and one- of transactions (stock trading, property deals, etc.) and aspects related to judgements and estimates, covering the registration, assessment, presentation and disclosure of fnancial information. The information in the tools is updated to refect changes in the way of carrying out, reviewing and authorising procedures for generating fnancial information. Our audit committee also has the duty to report to the board, prior to its adoption of the corresponding decisions, regarding the fnancial information that the Group must periodically make public, ensuring that such information is prepared in accordance with the same principles and practices used to prepare the fnancial statements and is as reliable as these statements. The most signifcant aspects of the accounting close process and the review of the material judgements, estimates, measurements and projections used are as follows: • Impairment losses on certain assets; • The assumptions used in the actuarial calculation of the post- employment beneft liabilities and commitments and other obligations; • The useful life of the tangible and intangible assets; • The measurement of goodwill arising on consolidation; • The calculation of provisions and the consideration of contingent liabilities; • The fair value of certain unquoted assets and liabilities; • The recoverability of tax assets; • The fair value of the identifable assets acquired and the liabilities assumed in business combinations. The information provided to directors prior to board meetings, including information on value judgements, estimates and forecasts relating to the fnancial information, is prepared specifcally for the purposes of these meetings. To verify that the ICM is working properly and check the efectiveness of the defned functions, tasks and controls, the Group has in place an assessment and certifcation process that starts with an evaluation of the control activities by the staf responsible for them. Depending on the conclusions drawn, the next step is to certify the tasks and functions related to the generation of fnancial information so that, having analysed all such certifcations, the chief executive ofcer, the chief fnancial ofcer and the chief accounting ofcer/controller certify the efectiveness of the ICM. The annual process identifes and assesses the criticality of risks and the efectiveness of the controls identifed in the Group. The non-fnancial risk control unit prepares a report spelling out the conclusions reached as a result of the certifcation process conducted by the units, taking the following aspects into consideration: • Detail of the certifcations obtained at all levels. • Any additional certifcations considered necessary. • Specifc certifcation of all signifcant outsourced services. • The ICM design and operation tests performed by those responsible for its maintenance and/or independent experts. This report also itemises the main defciencies identifed throughout the certifcation process by any of the parties involved, indicating whether these defciencies have been properly resolved or, if not, what plans are in place to correct them in a satisfactory manner. The conclusions of these evaluation processes are presented to the audit committee by the non-fnancial risk control department, together with Accounting and Management Control division and, if appropriate, the sponsors of the divisions and/or work companies concerned, after having been presented to the risk control committee. Lastly, based on this report, the Group’s chief accounting ofcer / controller (CAO), chief fnancial ofcer (CFO) and its chief executive ofcer (CEO) certify the efectiveness of the ICM in terms of preventing or detecting errors which could have a material impact on the consolidated fnancial information. In 2018, the Group has worked to strengthen the identifcation and documentation of the most relevant controls for the Group (special monitoring controls) in order to ensure an adequate internal control system over fnancial information. Further, in order to continue strengthening the Santander Group ICM, it has been decided that from 2019 onwards the internal audit function will perform independent tests on these controls as part of its audits. 201 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Internal control policies and procedures for IT systems The Technology and Operations division issues corporate IT policies. In addition, there are specifc force majeure risk mitigation strategies in place, such as virtual data processing centres, back-up power suppliers and ofsite storage facilities. For internal control purposes, the following policies are of particular importance. The Group’s IT systems which are directly or indirectly related to the fnancial statements are confgured to ensure the correct preparation and publication of fnancial information at all times by means of a specifc internal control protocol. To this end, the entity has internal policies and procedures, which are duly updated and distributed, relating to systems security and access to the IT applications and systems based on roles and in accordance with the duties and clearances assigned to each unit/ post so as to ensure proper separation of powers. The Group’s internal policies establish that access to all systems that store or process data shall be strictly controlled, and that the level of access control required is determined by potential impact on the business. Access rights are assigned by Group experts in this area (known as authorised signatures), by roles and functions. In addition, to ensure the compliance of processes related to control and maintenance of users and profles, personnel in each area are tasked with ensuring that information is only accessed by persons who need it for their work. The Group’s methodology is designed to ensure that any new software developments and the updating and maintenance of existing programmes go through a defnition-development-testing cycle that guarantees that fnancial information is handled reliably. In this way, once software developments have been completed on the basis of the defned requirements (detailed documentation of the processes to be implemented), these developments are subjected to exhaustive testing by a specialist ‘software lab’. The Corporate Certifcation Ofce is then responsible for the complete testing cycle of the software in a pre-production environment, prior to its fnal implementation. The aforementioned ofce manages and coordinates this whole cycle, which includes: technical and functional testing, performance testing, user acceptance testing, and pilot and prototype testing as defned by the entities, prior to making the applications available to all end users. Underpinned by corporate methodology, the Group guarantees the existence of business continuity plans that ensure on-going performance of key functions in the event of disasters or other events that could halt or interrupt business operations. These plans catalogue the measures, which translate into specifc initiatives, designed to mitigate the scale and severity of IT incidents and to ensure that operations are up and running again as quickly and with as little fallout as possible. To this end, the Group has highly automated back-up systems to ensure the continuity of the most critical systems with little or no human intervention thanks to parallel redundant systems, high- availability systems and redundant communication lines. Internal control policies and procedures over outsourced activities and valuation services from independent experts The Group has established an action framework and specifc implementation policies and procedures to ensure the adequate coverage of the risks associated with subcontracting activities to third parties. The relevant processes include: • The performance of tasks relating to the initiation, recording, processing, settlement, reporting and accounting of asset valuations and transactions. • The provision of IT support in its various manifestations: software development, infrastructure maintenance, incident management, IT security and IT processing. • The provision of other material support services not directly related to the generation of fnancial information: supplier management, property management, HR management, etc. The main control procedures in place to ensure adequate coverage of the risks intrinsic to these processes are: • Relations among Group companies are documented in contracts which detail exhaustively the type and level of service provided. • All of the Group’s service providers document and validate the main processes and controls related to the services they provide. • Entities to which activities are outsourced document and validate their controls in order to ensure that the material risks associated with the outsourced services are kept within reasonable levels. The Group assesses its estimates in-house. Whenever it considers it advisable to hire the services of a third party to help with specifc matters, it does so having verifed their expertise and independence, for which procedures are in place, and having validated their methods and the reasonableness of the assumptions made. Furthermore, the Group has signed service level agreements and put in place controls to ensure the integrity and quality of information for external suppliers providing signifcant services that might impact the fnancial statements. 8.4 Information and communication Function in charge of accounting policies The Financial Accounting and Control division includes the accounting policies area, the head of which reports directly to the controller and has the following exclusive responsibilities: • Defning the accounting treatment of the transactions that constitute the Bank’s business in keeping with their economic substance and the regulations governing the fnancial system. 202 2018 Annual Report Internal control over financial reporting (ICFR) • Defning and updating the Group’s accounting policies and resolving any questions or conficts deriving from their interpretation. • Business systems: software encompassing the full product- contract-customer life cycle. • Enhancing and standardising the Group’s accounting practices. • Assisting and advising the professionals responsible for new IT developments with respect to accounting requirements and ways of presenting information for internal consumption and external distribution and on how to maintain these systems as they relate to accounting issues. The Corporate Accounting, Financial Reporting and Management Framework sets out the principles, guidelines and procedures for accounting, fnancial reporting and management that apply to all entities of the Santander Group as a key underpinning of good governance. The structure of the Group calls for stipulating uniform principles, guidelines and procedures so that each Group entity can rely on efective consolidation methods and apply uniform accounting policies. The principles set out in this Framework are appropriately implemented and specifed in the Group’s accounting policies. Accounting policies must be treated as a supplement to the fnancial and accounting standards that apply in the given jurisdiction, being their overarching objectives(i) fnancial statements and other fnancial information made available to management bodies, regulators and third parties must provide accurate and reliable information for decision-making relating to the Group, and (ii) all Group entities must be enabled to comply in a timely manner with legal duties and obligations and regulatory requirements. The Accounting Policies are subject to revision whenever the reference regulations are modifed and, at least, once a year. Additionally, on a monthly basis, the accounting policies area publishes internally a bulletin that contains any news in accounting matters, including both the new published regulations and the most relevant interpretations. These documents are stored in the accounting standards library (NIC-KEY), which is accessible to all Group units. The Financial Accounting and Control division has put in place procedures to ensure it has all the information it needs to update the accounting plan to cover the issue of new products and regulatory and accounting changes that make it necessary to adapt the plan and accounting principles and policies. The Group entities, through the heads of their operations or accounting units, maintain an on-going and fuid dialogue with the fnancial regulation and accounting processes area and with the other areas of the management control unit. Mechanisms for the preparation of fnancial information The Group’s computer applications are confgured into a management model which, using an IT system structure appropriate for a bank, is divided into several ‘layers’, which supply diferent kinds of services, including: • General information systems: these provide information to division/business unit heads. • Management systems: these produce information for business monitoring and control purposes. • Structural systems: these support the data shared and used by all the applications and services. These systems include all those related to the accounting and fnancial information. All these systems are designed and developed in accordance with the following IT architecture: • General software architecture, which defnes the design patterns and principles for all systems. • Technical architecture, including the mechanisms used in the model for design outsourcing, tool encapsulation and task automation. One of the overriding purposes of this model is to provide the Group’s IT systems with the right software infrastructure to manage all the transactions performed and their subsequent entry into the corresponding accounting registers, with the resources needed to enable access to and consultation of the various levels of supporting data. The software applications do not generate accounting entries per se; they are based on a model centred on the transaction itself and a complementary model of accounting templates that specifes the accounting entries and movements to be made for the said transaction. These accounting entries and movements are designed, authorised and maintained by the Financial Accounting and Control division. The applications execute all the transactions performed in a given day across various distribution channels (branches, internet, telephone banking, e-banking, etc.) into the ‘daily transaction register’ (DGO for its acronym in Spanish). The DGO generates the transaction accounting entries and movements on the basis of the information contained in the accounting template, uploading it directly into the accounting infrastructure application. This application carries out the other processes necessary to generate fnancial information, including: capturing and balancing the movements received, consolidating and reconciling with application balances, cross-checking the software and accounting information for accuracy, complying with the accounting allocation structural model, managing and storing auxiliary accounting data and making accounting entries for saving in the accounting system itself. Some applications do not use this process. These rely instead on their own account assistants who upload the general accounting data directly by means of account movements, so that the defnition of these accounting entries resides in the applications themselves. In order to control this process, before inputting the movements into the general accounting system, the accounting information is uploaded into a verifcation system which performs a number of controls and tests. 203 Responsible bankingCorporate governanceEconomic and financial reviewRisk management This accounting infrastructure and the aforementioned structural systems generate the processes needed to generate, disclose and store all the fnancial information required of a fnancial institution for regulatory and internal purposes, all of which under the guidance, supervision and control of the Financial Accounting and Control division. To minimise the attendant operational risks and optimise the quality of the information produced in the consolidation process, the Group has developed two IT tools which it uses in the fnancial statement consolidation process. In accordance with this, internal audit is a permanent function and independent from all other functions and units. Its mission is to provide the board of directors and senior management with independent assurances in regard to the quality and efcacy of the systems and processes of internal control, risk management (current and emerging) and governance, thereby helping to safeguard the organisation’s value, solvency and reputation. Internal audit reports to the audit committee and to the board of directors on a regular basis and at least twice a year, as an independent unit, it has direct access to the board when it deems it appropriate. The frst channels information fows between the units and the Financial Accounting and Control division, while the second performs the consolidation proper on the basis of the information provided by the former. The internal audit evaluates: • The efcacy and efciency of the processes and systems cited above; Each month, all of the entities within the Group’s scope of consolidation report their fnancial statements, in keeping with the Group’s audit plan. • Compliance with applicable legislation and requirements of supervisory bodies; • The reliability and integrity of fnancial and operating The Group’s audit plan, which is included in the consolidation application, generally contains the disclosure needed to comply with the disclosure requirements imposed on the Group by Spanish and international authorities. information; and • The integrity of capital. The consolidation application includes a module that standardises the accounting criteria applied so that the units make the accounting adjustments needed to make their fnancial statements consistent with the accounting criteria followed by the Group. Internal audit is the third line of defence, independent of the other two. The scope of its work encompasses: The next step, which is automated and standardised, is to convert the fnancial statements of the entities that do not operate in euros into the Group’s functional currency. • Separate asset pools (for example, mutual funds) managed by the entities mentioned in the previous section; and • All Group entities over which it exercises efective control; The fnancial statements of the entities comprising the scope of consolidation are subsequently aggregated. • All entities (or separate asset pools) not included in the previous points, for which there is an agreement for the Group to provide internal audit functions. The consolidation process identifes intragroup items, ensuring they are correctly eliminated. In addition, in order to ensure the quality and comprehensiveness of the information, the consolidation application is confgured to make investment-equity elimination adjustments and to eliminate intragroup transactions, which are generated automatically in keeping with the system settings and checks. Lastly, the consolidation application includes another module (the annex module) which allows all units to upload the accounting and non-accounting information not specifed in the aforementioned audit plan and which the Group deems opportune for the purpose of complying with applicable disclosure requirements. This entire process is highly automated and includes automatic controls to enable the detection of incidents in the consolidation process. The Financial Accounting and Control division also performs additional oversight and analytical controls. 8.5 Monitoring 2018 ICFR monitoring activities and results Our board has approved a corporate internal audit framework for the Santander Group, defning the global function of internal audit and how it is to be carried out. 204 This scope, subjectively defned, includes the activities, businesses and processes carried out (either directly or through outsourcing), the existing organisation and any commercial networks. In addition, and also as part of its mission, internal audit can undertake audits in other subsidiaries not included among the points above, when the Group has reserved this right as a shareholder, and in outsourced activities pursuant to the agreements reached in each case. Our audit committee supervises the Group’s internal audit function and, specifcally, must: (i) propose the selection, appointment and withdrawal of the ofcer responsible for internal audit; (ii) ensure the independence and efectiveness of the internal audit function; (iii) ensure that the internal audit function has the physical and human resources needed for the performance of its work and propose the budget for this service; (iv) receive periodic information regarding the activities thereof and review the annual activities report; (v) annually assess the function of the internal audit unit and the performance of its leading ofcer, which shall be communicated to the remuneration committee and to the board to determine the variable remuneration thereof and (vi) verify that senior management and the board take into account the conclusions and recommendations set forth in its reports. 2018 Annual Report Internal control over financial reporting (ICFR) At year-end 2018, internal audit employed 1,210 people, all dedicated exclusively to this service. Of these, 266 were based at the Corporate Centre and 944 in local units situated in the principal geographic areas in which the Group is present, all of who work exclusively at those locations. Each year, Internal Audit prepares an audit plan based on a self- assessment exercise of the risks to which the Group is exposed. Internal Audit is solely responsible for executing the plan. From the reviews carried out, audit recommendations may be prepared. These are prioritised according to their relative importance and are monitored continuously until their complete implementation. It deals with any control defciencies that might afect the reliability and accuracy of the fnancial statements. To this end, it can call in the various areas of the Group involved to provide the necessary information and clarifcations. The committee also takes stock of the potential impact of any faws detected in the fnancial information. The audit committee, as part of its remit to oversee the fnancial reporting process and the internal control systems, is responsible for discussing with the external auditors any signifcant weaknesses detected in the course of the audit. At its meeting on 21 February 2019, the audit committee considered and approved the audit plan for 2019, which was submitted to, and approved by the board at the meeting held on 26 February 2019. As part of its supervision work, our audit committee assesses the results of the work of the Internal Audit division, and can take action as necessary to correct any defciencies identifed in the fnancial information. In 2018, the efectiveness and functioning of the main elements of the internal control system and controls on information systems in the units analysed were assessed. The main objectives of the internal audit reviews were: In 2018, our audit committee was informed about the evaluation and certifcation of the ICM corresponding to tax year 2017 and drew conclusions on the efectiveness of the Group’s ICM, in compliance with CNMV ICFR and SEC Sarbanes-Oxley Law (SOX) and ICFR. • Verify compliance with sections 302, 404, 406, 407 and 806 of the Sarbanes-Oxley Act. Internal audit has maintained the 2017 ICFR rating, identifying no material defciencies in the control environment. • Check the existing governance on the information related to the internal control system over fnancial information. 8.6 External auditor report • Review the functions performed by the internal control departments and other departments, areas or divisions involved in compliance with the SOX Act. The external auditor has issued an independent reasonable assurance report on the design and efectiveness of the ICFR and the description on the ICFR that is provided in this section 8 of the annual corporate governance report. This report is included in the next pages. • Check that the SOX support documentation is updated. • Verify the efectiveness of the controls documented in the process. • Evaluate the rigour of the certifcations carried out by the diferent units, especially their consistency with any observations and recommendations set forward by Internal Audit, the auditors of the statutory accounts or the supervisory bodies themselves within the framework of their reviews. • Verify proper compliance with the recommendations made in previous audits. In 2018, the audit committee and the board of directors were kept informed of the work carried out by the Internal Audit division on its annual plan and other issues related to the audit function. The audit committee assessed whether the work of internal audit was sufcient and the results of its activity and monitored the recommendations made, particularly the most important. It also reviewed the efects of the results of this work on the fnancial information. Finally, the committee monitored the corrective actions implemented, giving priority to the most important of these. Detection and management of defciencies Our audit committee is ofcially tasked with overseeing the fnancial information process and the internal control systems. 205 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 206 2018 Annual Report Internal control over financial reporting (ICFR) 207 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 9. Other corporate governance information As indicated in the introduction of this chapter 'Redesigned corporate governance report', since 12 June 2018 (Circular 2/2018) CNMV has allowed the annual corporate governance and directors’ remuneration reports mandatory for Spanish listed companies to be drafted in a free format. We have opted to use a free format for our 2018 corporate governance report and 2018 directors’ remuneration report. for corporate governance and remuneration reports, prescribed formats, a cross reference to where this information may be found in the free format 2018 annual corporate governance report or in the other chapters of this annual report. Please note however that CNMV’s prescribed formats have changed slightly in 2018 and therefore the content for each section varies from the previous year. However, CNMV requires any issuer opting to use a free format to provide certain information in a format established by CNMV so that it can be aggregated for statistical purposes. This information is included (i) for corporate governance matters under section 9.2 'Statistical information on corporate governance required by CNMV' and also covers the section 'comply with the recommendations in the Spanish Corporate Governance Code for Listed Companies or explain' and (ii) for remuneration matters under section 9.5 'Statistical information on remuneration required by CNMV'. In addition, since some shareholders or other stakeholders may be accustomed to the prescribed formats required by CNMV, section 9.1 'Reconciliation to CNMV’s corporate governance report model' and section 9.4 'Reconciliation to CNMV’s remuneration report model' include, for each section in the CNMV’s prescribed formats Moreover, we have traditionally flled in the 'comply or explain' section for all recommendations in the Spanish Corporate Governance Code for Listed Companies to establish where we comply and also the few instances where we do not comply or we comply partially. Therefore, have included in section 9.3 'Cross- reference table for comply or explain in corporate governance recommendations' a chart with cross-references showing where the information supporting each response can be found in this 2018 corporate governance chapter or elsewhere in this consolidated directors´report. 9.1 Reconciliation to CNMV’s corporate governance report model Section in CNMV model Included in statistical report Comments A. OWNERSHIP STRUCTURE Yes Yes Yes No No No Yes Yes Yes No Yes No No Yes A.1 A.2 A.3 A.4 A.5 A.6 A.7 A.8 A.9 A.10 A.11 A.12 A.13 A.14 208 See section 2.1. See section 2.3 where we explain there are no signifcant shareholders for its own acount. See 'Tenure, committee membership and equity ownership' in section 4.2 and section 6. See section 2.3 where we explain there are no signifcant shareholders for its own acount so this section does not apply. See section 2.3 where we explain there are no signifcant shareholders for its own acount so this section does not apply. See section 2.3 where we explain there are no signifcant shareholders for its own acount so this section does not apply. See section 2.4. Not applicable. See section 2.5. See section 2.5. See section 2.1 and statistical information. See section 3.2. See section 3.2. See section 2.6. 2018 Annual Report Other corporate governance information Section in CNMV model Included in statistical report Comments B. GENERAL SHAREHOLDERS’ MEETING B.1 B.2 B.3 B.4 B.5 B.6 B.7 B.8 No No No Yes Yes Yes No No See 'Quorum and majorities required for passing resolutions at the GSM' in section 3.2. See 'Quorum and majorities required for passing resolutions at the GSM' in section 3.2. See 'Quorum and majorities required for passing resolutions at the GSM' and 'Rules governing amendments to our Bylaws' in section 3.2. None. See section 3.4. See 'Participation of shareholders at the GSM' in section 3.2. See 'Quorum and majorities required for passing resolutions at the GSM' in section 3.2. See 'Corporate website' in section 3.2. C. MANAGEMENT STRUCTURE C.1 Board of directors C.1.1 C.1.2 C.1.3 C.1.4 C.1.5 C.1.6 C.1.7 C.1.8 C.1.9 C.1.10 C.1.11 C.1.12 C.1.13 C.1.14 C.1.15 C.1.16 C.1.17 C.1.18 C.1.19 C.1.20 C.1.21 C.1.22 C.1.23 C.1.24 C.1.25 C.1.26 C.1.27 C.1.28 C.1.29 C.1.30 C.1.31 C.1.32 C.1.33 Yes Yes Yes Yes No No No No No No Yes Yes Yes Yes Yes No No No No No Yes No Yes No Yes Yes Yes No Yes No Yes Yes Yes See 'Size' in section 4.2. See 'Tenure, committee membership and equity ownership' in section 4.2. See section 2.4, 4.1 and 'Executive directors', 'Independent non-executive directors', 'Other external directors' and 'Composition by type of director' in section 4.2. See section 1.4 and'Diversity' in section 4.2. See 'Diversity' in section 4.2 and section 4.5 and regarding top excecutive positions, see 'Responsible banking' chapter. See 'Diversity' in section 4.2 and section 4.5. See section 1.4 and 'Diversity' in section 4.2. Not applicable. See section 'Group executive chairman and chief executive ofcer' and 'Executive committee' in section 4.3. See section 4.1. See section 4.1. See 'Board and committees attendance' in section 4.3. See section 6 and, additionally, note 5 c) to our 'consolidated financial statements'. See section 5 and 6. See 'Rules and regulations of the board' in section 4.3. See 'Election, refreshment and succession of directors' in section 4.2. See 'Self-assessment of the board' in section 4.3 and section 4.5. See 'Self-assessment of the board' in section 4.3. See 'Election, refreshment and succession of directors' in section 4.2. See 'Proceedings of the board' in section 4.3. Not applicable. See 'Diversity' in section 4.2. See 'Election, refreshment and succession of directors' in section 4.2. See section 4.3 'Board functioning and efectiveness'. See section 4.3 'Board functioning and efectiveness' and sections 4.4, 4.5, 4.6 and 4.7. See 'Board and committees attendance' in section 4.3. See statistical information. See 'Duties and activities in 2018' in section 4.4. See 'Secretary of the board' in section 4.3. See 3.1; 'Duties and activities in 2018' in section 4.4; and section 9.6. See 'External auditor' in section 4.4. See 'Duties and activities in 2018' in section 4.4. Not applicable. 209 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Section in CNMV model Included in statistical report Comments C.1.34 C.1.35 C.1.36 C.1.37 C.1.38 C.1.39 C.2 Board committees C.2.1 C.2.2 C.2.3 Yes Yes No No No Yes Yes Yes No See statistical information. See 'Proceedings of the board' in section 4.3. See 'Election, refreshment and succession of directors' in section 4.2. Not applicable. Not applicable. See section 6.4. and 6.7. See 'Board committees structure'; 'Executive committee'; 'Responsible banking, sustainability and culture committee' and 'Innovation and technology committee' in section 4.3 and sections 4.4, 4.5, 4.6 and 4.7. See statistical information. See 'Rules and regulations of the board' in section 4.3 and sections 4.4, 4.5, 4.6 and 4.7. D. RELATED PARTY AND INTRAGROUP TRANSACTIONS D.1 D.2 D.3 D.4 D.5 D.6 D.7 No Yes Yes Yes Yes No Yes See 'Related-party transactions' in section 4.8. Not applicable. Not applicable. See 'Related-party transactions' in section 4.8. See statistical information. Not applicable. See section 4.8 ‘Related-party transactions and conficts of interest’ . See ‘Related-party transactions and conficts of interest' in section 4.8. Not applicable. E. CONTROL AND RISK MANAGEMENT SYSTEMS E.1 E.2 E.3 E.4 E.5 E.6 F. ICFRS F.1 F.2 F.3 F.4 F.5 F.6 F7 No No No No No No No No No No No No No See chapter 'Risk management' of this consolidated directors´ report, in particular section 1 'Risk management and control model' and sections 'Risk culture' and 'Tax strategy' in the Responsible banking chapter. See chapter 'Risk management' of this consolidated directors´ report, in particular section 1.1 'Risk governance' and sections 'Risk culture' and 'Tax strategy' in the Responsible banking chapter. See chapter 'Risk management' of this consolidated directors´ report, in particular section 2 'Risk map and risk profle',and 'Responsible banking' chapter and for our capital needs, see also section 'Economic capital' in Economic and fnancial review chapter. See chapter 'Risk management' of this consolidated directors´ report, in particular section 1.3 'Management processes and tools' and sections 'Risk culture' and 'Tax strategy' in the Responsible banking chapter. See chapter 'Risk management' of this consolidated directors´ report, in particular section 2 'Risk map and risk profle', and sections 3 to 9 of such chapter for each risk. Additionally, see note 25e.i to our consolidated fnancial statements. See chapter 'Risk management' of this consolidated directors´ report, in particular section 2 'Risk map and risk profle', and sections 3 to 9 of such chapter for each risk. See section 8.1 'Control environment'. See section 8.2 'Risk assessment in fnancial reporting'. See section 8.3 'Control activities'. See section 8.4 'Information and communication'. See section 8.5 'Monitoring'. Not applicable. See section 8.6 'External auditor report'. G. DEGREE OF COMPLIANCE WITH CORPORATE GOVERNANCE RECOMMENDATIONS G Yes See 'Degree of compliance with the corporate governance recommendations' in section 9.2 and section 9.3. 210 2018 Annual Report Other corporate governance information 9.2 Statistical information on corporate governance required by CNMV Unless otherwise indicated all data as of 31 December 2018. A. OWNERSHIP STRUCTURE A.1 Complete the following table on the company’s share capital: Date of last modifcation Share capital (euros) Number of shares Number of voting rights 06/11/2018 8,118,286,971 16,236,573,942 16,236,573,942 Indicate whether diferent types of shares exist with diferent associated rights: Yes No A.2 List the direct and indirect holders of signifcant ownership interests at year-end, excluding directors: Name or corporate name of shareholder BlackRock Inc. Direct 0 Indirect 4.50% Direct Indirect voting rights 0 1.10% 5.60% % of voting rights attributed to shares % of voting rights through fnancial instruments Total % of Details of the indirect shares: Name or corporate name of the indirect shareholder Name or corporate name of the direct shareholder % of voting rights attributed to shares % of voting rights through fnancial instruments Total % of voting rights BlackRock Inc. Subsidiaries of BlackRock Inc. 4.50% 1.10% 5.60% A.3 Complete the following tables on company directors holding voting rights through company shares: Name or corporate name of director Direct Indirect Direct Indirect % of voting rights attributed to shares % of voting rights through fnancial instruments % of voting rights that may be transferred through fnancial instruments Direct Indirect Total % of voting rights Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie-Brown Mr Rodrigo Echenique Gordillo Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca Mr Javier Botín-Sanz de Sautuola y O’Shea Mr Álvaro Cardoso de Souza Ms Sol Daurella Comadrán Mr Guillermo de la Dehesa Romero Mr Carlos Fernández González Ms Esther Giménez-Salinas i Colomer Mr Ramiro Mato García Ansorena Ms Belén Romana García Mr Juan Miguel Villar Mir 0.00 0.01 0.00 0.01 0.00 0.02 0.03 0.00 0.00 0.00 0.11 0.00 0.00 0.00 0.00 0.13 0.00 0.00 0.00 0.00 0.00 0.46 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.13 0.01 0.00 0.01 0.00 0.02 0.49 0.00 0.00 0.00 0.11 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 % total voting rights held by the board of directors 0.77% 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 211 Responsible bankingCorporate governanceEconomic and financial reviewRisk management A.7 Indicate whether the company has been notifed of any shareholders’ agreements pursuant to Articles 530 and 531 of the Spanish Companies Act (LSC). Provide a brief description and list the shareholders bound by the agreement, as applicable: Yes No Parties to the shareholders’ agreement capital afected Brief description of agreement % of share Expiry date, if applicable Mr Francisco Javier Botín-Sanz de Sautuola y O’Shea (directly and through Agropecuaria El Castaño, S.L.U.) Mr Emilio Botín-Sanz de Sautuola y O’Shea (directly and through Puente San Miguel, S.L.U.) Ms Ana Botín-Sanz de Sautuola y O’Shea (directly and through CRONJE, S.L.U.) Ms Carolina Botín-Sanz de Sautuola y O’Shea (through Nueva Azil, S.L.) Ms Paloma Botín-Sanz de Sautuola y O’Shea (directly and through Bright Sky 2012, S.L.) Ms Carmen Botín-Sanz de Sautuola y O’Shea Latimer Inversiones, S.L. 0.49% Transfer restrictions and syndication of voting rights as described under section 2.4 'Shareholders’ agreements' of the Corporate governance chapter in the consolidated directors' report. 01/01/2056 Indicate whether the company is aware of the existence of any concerted actions among its shareholders. Give a brief description as applicable: Yes No Participants in the concerted action capital afected Brief description of concerted action % of share Expiry date, if applicable Mr Francisco Javier Botín-Sanz de Sautuola y O’Shea (directly and through Agropecuaria El Castaño, S.L.U.) Mr Emilio Botín-Sanz de Sautuola y O’Shea (directly and through Puente San Miguel, S.L.U.) Ms Ana Botín-Sanz de Sautuola y O’Shea (directly and through CRONJE, S.L.U.) Ms Carolina Botín-Sanz de Sautuola y O’Shea (through Nueva Azil, S.L.) Ms Paloma Botín-Sanz de Sautuola y O’Shea (directly and through Bright Sky 2012, S.L.) Ms Carmen Botín-Sanz de Sautuola y O’Shea Latimer Inversiones, S.L. 0.49% Transfer restrictions and syndication of voting rights as described under section 2.4 'Shareholders’ agreements' of the Corporate governance chapter in the consolidated directors' report. 01/01/2056 A.8 Indicate whether any individual or entity currently exercises control or could exercise control over the company in accordance with article 5 of the Spanish Securities Market Act. If so, identify them: Yes No A.9 Complete the following tables on the company’s treasury shares: (*)Through: Name or corporate name of the direct shareholder Pereda Gestión, S.A. Banco Santander Río, S.A. Total: Number of shares held directly 11,400,000 849,652 12,249,652 At year end: A.11 Estimated free foat: Number of shares held directly Number of shares held indirectly* % of total share capital Estimated free foat % 93.59% 0 12,249,652 0.07% A.14 Indicate whether the company has issued securities not traded in a regulated market of the European Union. Yes No 212 2018 Annual Report   Other corporate governance information B. GENERAL SHAREHOLDERS’ MEETING B.4 Indicate the attendance fgures for the general shareholders’ meetings held during the fscal year to which this report relates and in the two preceding fscal years: Date of General Meeting % attending in person 18/03/2016 of which free foat: 0 .86% 0.19% Date of General Meeting % attending in person 07/04/2017 of which free foat: 0.90% 0.26% Date of General Meeting 23/03/2018 of which free foat: % attending in person 0.82% 0.18% Attendance data % by proxy % remote voting Electronic means 43.46% 43.46% 0.27% 0.27% Other 13.04% 13.04% Attendance data % by proxy % remote voting Electronic means Other 47.48% 47.48% 0.37% 0.37% 15.27% 15.27% Attendance data % by proxy % remote voting Electronic means 47.61% 47.61% 0.38% 0.38% Other 15.74% 15.74% B.5 Indicate whether in the general shareholders’ meetings held during the fscal year to which this report relate there has been any matter submitted to them which, for any reason, has not been approved by the shareholders. Yes No B.6 Indicate whether the bylaws require a minimum holding of shares to attend to or to vote remotely in the general shareholders’ meeting: Yes No C. MANAGEMENT STRUCTURE C.1 Board of directors C.1.1 Maximum and minimum number of directors provided for in the Bylaws: Maximum number of directors Minimum number of directors Number of directors fxed by GSM 17 12 15 Total 57.63% 56.96% Total 64.02% 63.38% Total 64.55% 63.91% 213 Responsible bankingCorporate governanceEconomic and financial reviewRisk management       C.1.2 Complete the following table with the directors’ details: Representative Category of director Position in the board Date of frst appointment Date of last appointment Name or corporate name of director Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie- Brown Mr Rodrigo Echenique Gordillo Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca N/A N/A N/A N/A N/A N/A Mr Javier Botín-Sanz de Sautuola y O’Shea N/A Mr Álvaro Cardoso de Souza Ms Sol Daurella Comadrán Mr Guillermo de la Dehesa Romero Mr Carlos Fernández González Ms Esther Giménez- Salinas i Colomer Mr Ramiro Mato García-Ansorena Ms Belén Romana García Mr Juan Miguel Villar Mir N/A N/A N/A N/A N/A N/A N/A N/A Executive Chairman 04/02/1989 07/04/2017 Executive Non-executive independent Executive Non-executive independent Other external (neither independent nor proprietary) Other external (neither independent nor proprietary Non-executive independent Non-executive independent Other external (neither independent nor proprietary) Non-executive independent Non-executive independent Non-executive independent Non-executive independent Non-executive independent Chief executive ofcer Lead independent director Vice chairman 25/11/2014 07/04/2017 25/11/2014 18/03/2016 07/10/1988 07/04/2017 Director 27/09/2016 23/03/2018 Director 30/06/2015 23/03/2018 Director 25/07/2004 18/03/2016 Director 23/03/2018 23/03/2018 Director 25/11/2014 23/03/2018 Vice chairman 24/06/2002 23/03/2018 Director 25/11/2014 23/03/2018 Director 30/03/2012 07/04/2017 Director 28/11/2017 23/03/2018 Director 22/12/2015 07/04/2018 Director 07/05/2013 27/03/2015 Election procedure Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Vote in general Shareholders´meeting Vote in general shareholders’ meeting Vote in general shareholders’ meeting Total number of directors 15 Indicate any directors who have left during the fscal year to which this report relates, regardless of the reason (whether for resignation, removal or any other): Name or corporate name of director Category of director at the time he/her left Date of last appointment Date of leave Indicate whether he or she has left Board committees he or she was a member of before the expiry of his or her term N/A N/A N/A N/A N/A N/A 214 2018 Annual Report Other corporate governance information C.1.3 Complete the following tables for the directors in each relevant category: Executive directors Name or corporate name of director Position held in the company Profle See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. Ms Ana Botín-Sanz de Sautuola y O’Shea Group executive chairman Mr José Antonio Álvarez Álvarez CEO Mr Rodrigo Echenique Gordillo Vice chairman Total number of executive directors % of the Board Proprietary non-executive directors Name or corporate name of director Name or corporate name of signifcant shareholder represented or having proposed his or her appointment N/A N/A Profle N/A Total number of proprietary non-executive directors % of the Board 3 20% 0 0% Independent non-executive directors Name or corporate name of director Profle Mr Bruce Carnegie-Brown Ms Homaira Akbari Mr Álvaro Cardoso de Souza Ms Sol Daurella Comadrán Mr Carlos Fernández González Ms Esther Giménez- Salinas i Colomer Mr Ramiro Mato García-Ansorena Ms Belén Romana García Mr Juan Miguel Villar Mir See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. Total number of independent directors % of the Board 9 60% Identify any independent director who receives from the company or its group any amount or perk other than his or her director remuneration or who maintain or have maintained during the fscal year covered in this report a business relationship with the company or any group company, either in his or her own name or as a signifcant shareholder, director or senior manager of an entity which maintains or has maintained such a business relationship. In such a case, a reasoned statement from the Board on why the relevant director(s) is able to carry on their duties as independent director (s) shall be included. Name or corporate name of director Description of the relationship Reasoned statement Sol Daurella Comadrán Financing Juan Miguel Villar Mir Financing When assessing the annual verifcation of independent directors the appointments committee has verifed whether there are signifcant business relationships between Santander Group and the companies in which these directors are or have previously been signifcant shareholders or directors, with regard to the fnancing granted by the Santander Group to these companies. In all cases, the committee concluded that the existing relations did not have the condition of signifcant among other reasons, as the business relationships: (i) do not generate a situation of economic dependence in the relevant companies in view of the substitutability of this fnancing for other sources of funding, either bank-based fnancing or other, (ii) are aligned with the market share of Santander Group within the relevant market, and (iii) have not reached certain comparable materiality thresholds used in other jurisdictions: e.g. NYSE, Nasdaq and Canada’s Bank Act. 215 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Other non-executive directors Identify all other non-executive directors and explain why these cannot be considered proprietary or independent directors and detail their relationships with the company, its executives or shareholders: Name or corporate name of director Mr Guillermo de la Dehesa Romero Mr Ignacio Benjumea Cabeza de Vaca Reasons for not qualifying under other category He has held the position of director for more than 12 years. Entity, executive or shareholder with whom it maintains a relationship Banco Santander, S.A. As the required period has not lapsed since he ceased his professional relationship with the Bank (other tan that as a director of the Bank and of Santander Spain). Banco Santander, S.A. Mr Javier Botín-Sanz de Sautuola y O’Shea He has held the position of director for more than 12 years. Banco Santander, S.A. Profle See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. See section 4.1 'Our directors' in the Corporate governance chapter in the consolidated directors' report. Total number of other non-executive directors % of the Board 3 20% List any changes in the category of a director which have occurred during the period covered in this report. Name or corporate name of director Date of change Previous category Current category Mr Javier Botín-Sanz de Sautuola y O’Shea 13/02/ 2018 Proprietary director Other external director C.1.4 Complete the following table on the number of female directors at the end of each the past four years and their category: Number of female directors % of total directors of each category FY 2018 FY 2017 FY 2016 FY 2015 FY 2018 FY 2017 FY 2016 Executive Proprietary Independent Other external Total: 1 0 4 0 5 1 0 4 0 5 1 0 5 0 6 1 0 4 0 5 33.33% 0.00% 33.33% 0.00% 44.44% 50.00% 0.00% 33.33% 0.00% 35.71% 25.00% 0.00% 62.5% 0.00% 40.00% FY 2015 25.00% 0.00% 50.00% 0.00% 33.33% C.1.11 Identify those directors (or individuals representing the director in the case of directors who are body corporates) who hold a directorship of other non-group companies that are listed on ofcial securities markets (or who are the individuals representing a body corporate holding such a directorship), if communicated to the company: Name or corporate name of director Name of the listed company Ms Ana Botín-Sanz de Sautuola y O’Shea The Coca-Cola Company Mr Bruce Carnegie-Brown Moneysupermarket.com Group plc. Mr Rodrigo Echenique Gordillo Industria de Diseño Textil, S.A. (Inditex) Position Director Chairman Director Mr Guillermo de la Dehesa Romero Amadeus IT Group, S.A. Vice Chairman Ms Homaira Akbari Veolia Environnment, S.A. Landstar System, Inc. Gemalto N.V. Ms Sol Daurella Comadrán Coca-Cola European Partners plc. Mr Carlos Fernández González Inmobiliaria Colonial, S.A. AmRest Holdings SE Ms Belén Romana García Aviva plc. Director Director Director Chairman Director Director Director 216 2018 Annual Report Other corporate governance information C.1.12 Indicate and, if applicable explain, if the company has established rules on the maximum number of directorships its directors may hold and, if so, where they are regulated: Yes No This maximum is established, as provided for in article 30 of the Rules and regulations of the board, in article 26 of Spanish Law 10/2014 on the ordering, supervision and solvency of credit institutions. This rule is further developed by articles 29 and subsequent of Royal Decree 84/2015 and by Rules 30 and subsequent of Bank of Spain Circular 2/2016. Name or corporate name Position (s) Mr Dirk Marzluf Mr Víctor Matarranz Sanz de Madrid Mr José Luis de Mora Gil-Gallardo Mr José María Nus Badía Mr Jaime Pérez Renovales Group head of Technology and Operations Global head of Wealth Management Group head of Financial Planning and Corporate Development Risk adviser to Group executive chairman Group head of General Secretariat and Human Resources C.1.13 Identify the following items of the total remuneration of the board of directors: Ms Magda Salarich Fernández de Valderrama Head of Santander Consumer Finance Board remuneration accrued in the fscal year (EUR thousand) Amount of accumulated pension rights of current directors (EUR thousand) Amount of accumulated pension rights of former directors (EUR thousand) 28,910 76,337 70,169 Ms Jennifer Scardino Head of Global communications. Group deputy head of Communications, Corporate Marketing and Research Total remuneration accrued by the senior management (EUR thousand) 62,478 C.1.14 Identify the members of the company’s senior management who are non executive directors and indicate total remuneration they have accrued during the fscal year: Name or corporate name Position (s) C.1.15 Indicate whether any changes have been made to the board Rules and regulations during the fscal year: Yes No Mr Rami Aboukhair Hurtado Mr Enrique Álvarez Labiano Country head - Santander Spain Group head of Chairman’s Ofce and Strategy. Global head of Insurance, Network Banking and Responsible Banking Ms Lindsey Tyler Argalas Head of Santander Digital Mr Juan Manuel Cendoya Méndez de Vigo Mr José Fransisco Doncel Razola Group head of Communications, Corporate Marketing and Research Group head of Accounting and Financial Control Mr Keiran Paul Foad Group Chief Risk Ofcer Mr José Antonio García Cantera Group Chief Financial Ofcer Mr Juan Guitard Marín Group Chief Audit Executive Mr José María Linares Perou Ms Mónica López-Monís Gallego Global head of Corporate & Investment Banking Group Chief Compliance Ofcer Mr Javier Maldonado Trinchant Group head of Costs C.1.21 Indicate whether there are any specifc requirements, other than those applying to directors generally, to be appointed chairman. Yes No C.1.23 Indicate whether the bylaws or the board Rules and regulations set a limited term of ofce (or other requirements which are stricter than those provided for in the law) for independent directors diferent than the one provided for in the law. Yes No C.1.25 Indicate the number of board meetings held during the fscal year and how many times the board has met without the chairman’s attendance. Attendance will also include proxies appointed with specifc instructions. Number of board meetings Number of board meetings held without the chairman’s attendance Indicate the number of meetings held by the lead independent director with the rest of directors without the attendance or representation of any executive director. Number of meetings 12 0 3 217 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Indicate the number of meetings of the various board committees held during the fscal year. Number of meetings of the audit committee Number of meetings of the responsible banking, sustainability and culture committee Number of meetings of the innovation and technology committee Number of meetings of the appointments committee Number of meetings of the remuneration committee Number of meetings of the risk supervision, regulation and compliance committee Number of meetings of the executive committee 13 2 3 13 11 13 45 C.1.26 Indicate the number of board meetings held during the fscal year and data about the attendance of the directors. C.1.31 Indicate whether the company has changed its external audit frm during the fscal year. If so, identify the incoming audit frm and the outgoing audit frm: Yes No C.1.32 Indicate whether the audit frm performs non-audit work for the company and/or its group. If so, state the amount of fees paid for such work and the percentage they represent of all fees invoiced to the company and/or its group. Yes No Group Company companies Total Amount of non-audit work (EUR thousand) Amount of non-audit work as a % of amount of audit work 585 3,665 4,250 0.6% 3.6% 4.2% Number of meetings with at least 80% of directors being present % of votes cast by members present over total votes in the fscal year Number of board meetings with all directors being present (or represented having given specifc instructions) % of votes cast by members present at the meeting or represented with specifc instructions over total votes in the fscal year C.1.33 Indicate whether the audit report on the previous year’s fnancial statements is qualifed or includes reservations. Indicate the reasons given by the chairman of the audit committee to the shareholders in the general shareholders meeting to explain the content and scope of those reservations or qualifcations. Yes No 12 98.27% 10 100% C.1.27 Indicate whether the company´s consolidated and individual fnancial statements are certifed before they are submitted to the board for their formulation. Yes No Identify, where applicable, the person(s) who certifed the company’s individual and consolidated fnancial statements prior to their formulation by the board: Name Position Mr José Francisco Doncel Razola Group chief accounting ofcer C.1.29 Is the secretary of the board also a director? Yes No If the secretary of the board is not a director fll in the following table: C.1.34 Indicate the number of consecutive years during which the current audit frm has been auditing the fnancial statements of the company and/or its group. Likewise, indicate for how many years the current frm has been auditing the fnancial statements as a percentage of the total number of years over which the fnancial statements have been audited: Individual fnancial statements Consolidated fnancial statements Number of consecutive years 3 3 Company Group Number of years audited by current audit frm/Number of years the company’s or its Group fnancial statements have been audited (%) 8.11% 8.33% C.1.35 Indicate and if applicable explain whether there are procedures for directors to receive the information they need in sufcient time to prepare for meetings of the governing bodies: Name or corporate name of the secretary Representative Mr Jaime Pérez Renovales N/A Yes No Procedures Our Rules and regulations of the board stipulate that members of the board and committees are provided with the relevant documentation for each meeting sufciently in advance of the meeting date, thereby ensuring the confdentiality of the information. 218 2018 Annual Report Other corporate governance information C.1.39 Identify, individually in the case of directors, and in the aggregate in all other cases, and provide detailed information on, agreements between the company and its directors, executives and employees that provide indemnifcation, guarantee or golder parachute clause in the event of resignation, unfair dismissal or termination as a result of a takeover bid or other type of transaction. Number of benefciaries 17 Type of benefciary Description of the agreement: Employees The Bank has no commitments to provide severance pay to directors. A number of employees have a right to compensation equivalent to one to two years of their basic salary in the event of their contracts being terminated by the Bank in the frst two years of their contract in the event of dismissal on grounds other than their own will, retirement, disability or serious dereliction of duties. In addition, for the purposes of legal compensation, in the event of redundancy a number of employees are entitled to recognition of length of service including services provided prior to being contracted by the Bank; this would entitle them to higher compensation than they would be due based on their actual length of service with the Bank itself. Indicate whether these agreements must be reported to and/ or authorised by the governing bodies of the company or its group beyond the procedures provided for in applicable law. If applicable, specify the process applied, the situations in which they apply, and the bodies responsible for approving or communicating those agreements: Board of directors General Shareholders’ Meeting Body authorising clauses Is the general shareholders’ meeting informed of such clauses? YES NO C.2 Board committees C.2.1 Give details of all the board committees, their members and the proportion of executive, independent and other external directors. Executive committee Name Position Type Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Ignacio Benjumea Cabeza de Vaca Chairman Executive director Member Executive director Member Other external director (neither proprietary nor independent) Independent non- executive director Mr Bruce Carnegie-Brown Member Mr Guillermo de la Dehesa Romero Mr Rodrigo Echenique Gordillo Member Other external director (neither proprietary nor independent) Member Executive director Mr Ramiro Mato García-Ansorena Member Independent non- executive director Ms Belén Romana García Member Indenpendent non- executive director % of executive directors % of proprietary directors % of independent directors % of other non-executive directors 37.50% 0% 37.50% 25% Audit committee Name Position Type Ms Belén Romana García Chairman Ms Homaira Akbari Member Mr Carlos Fernández González Mr Ramiro Mato García-Ansorena Member Member Independent non- executive director Independent non- executive director Independent non- executive director Independent non- executive director % of executive directors % of proprietary directors % of independent directors % of other non-executive directors 0% 0% 100% 0% Identify those directors in the audit committee who have been appointed on the basis of their knowledge and experience in accounting, audit or both and indicate the date of appointment of the committee chairman. Name of directors with accounting or audit experience Date of appointment of the committee Chairman for that position Ms Belén Romana García Ms Homaira Akbari Mr Carlos Fernández González Mr Ramiro Mato García-Ansorena 26 April 2016 219 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Appointments committee Responsible banking, sustainability and culture committee Name Position Type Name Position Type Mr Bruce Carnegie-Brown Chairman Independent non- executive director Mr Ramiro Mato García-Ansorena Chairman Independent non- executive director Mr Guillermo de la Dehesa Romero Member Other external director (neither proprietary nor independent) Ms Sol Daurella Comadrán Member Mr Carlos Fernández González Member Independent non- executive director Independent non- executive director % of executive directors % of proprietary directors % of independent directors % of other external directors 0% 0% 75.00% 25.00% Remuneration committee Name Position Type Mr Bruce Carnegie-Brown Chairman Mr Ignacio Benjumea Cabeza de Vaca Mr Guillermo de la Dehesa Romero Member Member Ms Sol Daurella Comadrán Member Mr Carlos Fernández González Member Independent non- executive director Other external director (neither proprietary nor independent) Other external director (neither proprietary nor independent) Independent non- executive director Independent non- executive director Ms Ana Botín-Sanz de Sautuola y O’Shea Member Executive director Ms Homaira Akbari Member Mr Ignacio Benjumea Cabeza de Vaca Member Mr Álvaro Cardoso de Souza Member Ms Sol Daurella Comadrán Member Ms Esther Giménez- Salinas i Colomer Member Ms Belén Romana García Member Independent non- executive director Other external director (neither proprietary nor independent) Independent non- executive director Independent non- executive director Independent non- executive director Independent non- executive director % of executive directors % of proprietary directors % of independent directors % of other external directors 12.50% 0% 75% 12.50% Innovation and technology committee Name Position Type Ms Ana Botín-Sanz de Sautuola y O’Shea Chairman Executive director Mr José Antonio Álvarez Álvarez Member Executive director % of executive directors % of proprietary directors % of independent directors % of other external directors 0% 0% 60.00% 40.00% Mr Bruce Carnegie-Brown Member Ms Homaira Akbari Member Mr Ignacio Benjumea Cabeza de Vaca Member Risk supervision, regulation and compliance committee Name Position Type Independent non- executive director Independent non- executive director Other external director (neither proprietary nor independent) Other external director (neither proprietary nor independent) Independent non- executive director 28.57% 0% 42.86% 28.57% Mr Guillermo de la Dehesa Romero Member Ms Belén Romana García Member % of executive directors % of proprietary directors % of independent directors % of other external directors Chairman Member Independent non- executive director Independent non- executive director Other external director (neither proprietary nor independent) Independent non- executive director Independent non- executive director Independent non- executive director 0% 0% 83.33% 16.67% Mr Álvaro Cardoso de Souza Mr Bruce Carnegie-Brown Mr Ignacio Benjumea Cabeza de Vaca Ms Esther Giménez- Salinas i Colomer Mr Ramiro Mato García-Ansorena Member Member Member Ms Belén Romana García Member % of executive directors % of proprietary directors % of independent directors % of other external directors 220 2018 Annual Report Other corporate governance information C.2.2 Complete the following table on the number of female directors on the various board committees over the past four years. Number of female directors FY 2018 FY 2017 FY 2016 FY 2015 Number % Number % Number % Number % Audit committee Responsible banking, sustainability and culture committee Innovation and technology committee Appointments committee Remuneration committee Risk supervision, regulation and compliance committee Executive committee 2 5 3 1 1 2 2 50% 62.5% 42.85% 25% 20% 33.3% 25% 2 - 4 1 1 2 1 50.0% - 44.4% 20.0% 20.0% 33.3% 14.29% 2 - 3 1 2 2 2 50.0% - 33.33% 20.0% 40.0% 28.57% 25.0% 1 - 2 1 2 1 2 25.0% - 25.0% 20.0% 33.33% 14.29% 25.0% D. RELATED-PARTY AND INTRAGROUP TRANSACTIONS D.2 List any signifcant transactions, by virtue of their amount or relevance, between the company or its group of companies and the company’s signifcant shareholders: D.3 List any signifcant transactions, by virtue of their amount or relevance, between the company or its group of companies and the company’s directors or executives: Not applicable. Not applicable. D.4 List any signifcant transactions undertaken by the company with other companies in its group that are not eliminated in the process of drawing up the consolidated fnancial statements and whose subject matter and terms set them apart from the company’s ordinary trading activities. In any case, list any intragroup transactions carried out with entities in countries or territories considered to be tax havens. Corporate name of the group company Banco Santander (Brasil) S.A. (Cayman Islands Branch) Brief description of the transaction This chart shows the transactions and the results obtained by the Bank (Banco Santander, S.A.) at 31 December 2018 with Group entities resident in countries or territories that were considered tax havens Pursuant to Spanish legislation,at such date These results, and the balances indicated below, were eliminated in the consolidation process. See note 53 to the 2018 Consolidated fnancial statements for more information on of-shore entities. The amount shown on the right corresponds to positive results relating to contracting of derivatives (includes branches in New York and London of Banco Santander, S.A.) The referred derivatives had a net positive market value of EUR 96 million in the Company and covered the following transactions: • 104 Non Delivery Forwards. • 150 Swaps. • 134 Cross Currency Swaps. • 5 Options. • 62 Forex. The amount shown on the right corresponds to negative results relating to deposits with the New York branch of Banco Santander, S.A. (liability). These deposits had a principal of EUR 1,484 million at 31 December 2018. The amount shown on the right corresponds to positive results relating to deposits with the London branch of Banco Santander, S.A. (asset). These deposits had a principal of EUR 119 million at 31 December 2018. The amount shown on the right corresponds to positive results relating to fxed income securities – subordinated instruments (asset). This relates to the iinvestment in November 2018 in two subordinated instruments (Tier I Subordinated Perpetual Notes and Tier II Subordinated Notes due 2028) with an amortised cost of EUR 2,205 million as at 31 December 2018. The amount shown on the right corresponds to positive results relating to interests and commissions concerning correspondent accounts (includes Hong Kong branch of Banco Santander, S.A.) (liability). This relates to correspondent accounts with a credit balance of EUR 21 million at 31 December 2018. Amount (EUR thousand) 49,652 32,155 6,605 21,432 4 221 Responsible bankingCorporate governanceEconomic and financial reviewRisk management D.5 List any signifcant transactions, by virtue of their amount or relevance, between the company or its group and other related parties, not reported in the previous sections. Not applicable. D.7 Is more than one group company listed in Spain? Yes No G. DEGREE OF COMPLIANCE WITH THE CORPORATE GOVERNANCE RECOMMENDATIONS Indicate the degree of the company’s compliance with the recommendations of the good governance code for listed companies. Should the company not comply with any of the recommendations or comply only in part, include a detailed explanation of the reasons so that shareholders, investors and the market in general have enough information to assess the company’s behaviour. General explanations are not acceptable. 1. The bylaws of listed companies should not place an upper limit on the votes that can be cast by a single shareholder, or impose other obstacles to the takeover of the company by means of share purchases on the market. Complies Explain  2. When a parent company and a subsidiary are both listed, the two provide detailed disclosure on: a) The activity they engage in and any business dealings between them, as well as between the subsidiary and other group companies. b) The mechanisms in place to resolve possible conficts of interest. Complies Partially complies Explain  Not applicable 3. During the AGM the chairman of the board should verbally inform shareholders in sufcient detail of the most relevant aspects of the company’s corporate governance, supplementing the written information circulated in the annual corporate governance report. In particular: a) Changes taking place since the previous annual general meeting. b) The specifc reasons for the company not following a given Good Governance Code recommendation, and any alternative procedures followed in its stead. Complies Partially complies Explain 4. The company should draw up and implement a policy of communication and contacts with shareholders, institutional investors and proxy advisers that complies in full with market abuse regulations and accords equitable treatment to shareholders in the same position. This policy should be disclosed on the company’s website, complete with details of how it has been put into practice and the identities of the relevant interlocutors or those charged with its implementation. Complies Partially complies Explain 5. The board of directors should not make a proposal to the general meeting for the delegation of powers to issue shares or convertible securities without pre- emptive subscription rights for an amount exceeding 20% of capital at the time of such delegation. And that whenever the board of directors approves an issuance of shares or convertible securities without pre-emptive rights the company immediately publishes reports on its web page regarding said exclusions as referenced in applicable mercantile law. Complies Partially complies Explain Our 2018 AGM, authorised our board to increase share capital with the authority to exclude pre-emptive rights for shareholders, with a limit of 20% of the share capital. This limit applies to capital increases to convert bonds or other convertible securities, other than contingent convertible preferred securities (which can only be converted into newly-issued shares when the CET 1 ratio falls below a pre-established threshold). The Bank publishes in its website the reports relating to the exclusion of pre-emptive rights when it makes use of this authority in the terms established in the recommendation. 6. Listed companies drawing up the following reports on a voluntary or compulsory basis should publish them on their website well in advance of the AGM, even if their distribution is not obligatory: a) Report on auditor independence. b) Reviews of the operation of the audit committee and the appointments and remuneration committee. c) Audit committee report on third-party transactions. d) Report on corporate social responsibility policy. Complies Partially complies Explain 7. The company should broadcast its general meetings live on the corporate website. Complies Explain 8. The audit committee should strive to ensure that the board of directors can present the Company’s accounts to the general meeting without limitations or qualifcations in the auditor’s 222 2018 Annual Report   Other corporate governance information report. In the exceptional case that qualifcations exist, both the chairman of the audit committee and the auditors should give a clear account to shareholders of their scope and content. its employees, suppliers, clients and other stakeholders, as well as with the impact of its activities on the broader community and the natural environment. Complies Partially complies Explain Complies Partially complies Explain 9. The company should disclose its conditions and procedures for admitting share ownership, the right to attend general meetings and the exercise or delegation of voting rights, and display them permanently on its website. 13. The board of directors should have an optimal size to promote its efcient functioning and maximise participation. The recommended range is accordingly between fve and ffteen members. Such conditions and procedures should encourage shareholders to attend and exercise their rights and be applied in a non-discriminatory manner. Complies Partially complies Explain 10. When a shareholder so entitled exercises the right to supplement the agenda or submit new proposals prior to the general meeting, the company should: a) Immediately circulate the supplementary items and new proposals. b) Disclose the standard attendance card or proxy appointment or remote voting form, duly modifed so that new agenda items and alternative proposals can be voted on in the same terms as those submitted by the board of directors. c) Put all these items or alternative proposals to the vote applying the same voting rules as for those submitted by the board of directors, with particular regard to presumptions or deductions about the direction of votes. d) After the general meeting, disclose the breakdown of votes on such supplementary items or alternative proposals. Complies Partially complies Explain  Not  applicable 11. In the event that a company plans to pay for attendance at the general meeting, it should frst establish a general, long-term policy in this respect. Complies Explain 14. The board of directors should approve a director selection policy that: a) Is concrete and verifable. b) Ensures that appointment or re-election proposals are based on a prior analysis of the board’s needs. c) Favors a diversity of knowledge, experience and gender. The results of the prior analysis of board needs should be written up in the appointments committee’s explanatory report, to be published when the general meeting is convened that will ratify the appointment and re-election of each director. The director selection policy should pursue the goal of having at least 30% of total board places occupied by women directors before the year 2020. The appointments committee should carry an annual verifcation on compliance with the director selection policy and set out its fndings in the annual corporate governance report. Complies Partially complies Explain 15. Proprietary and independent directors should constitute an ample majority on the board of directors, while the number of executive directors should be the minimum practical bearing in mind the complexity of the corporate group and the ownership interests they control. Complies Partially complies Explain  Complies Partially complies Explain Not  applicable 12. The board of directors should perform its duties with unity of purpose and independent judgement, according the same treatment to all shareholders in the same position. It should be guided at all times by the company’s best interest, understood as the creation of a proftable business that promotes its sustainable success over time, while maximising its economic value. In pursuing the corporate interest, it should not only abide by laws and regulations and conduct itself according to principles of good faith, ethics and respect for commonly accepted customs and good practices, but also strive to reconcile its own interests with the legitimate interests of 16. The percentage of proprietary directors out of all non- executive directors should be no greater than the proportion between the ownership stake of the shareholders they represent and the remainder of the company’s capital. This criterion can be relaxed: a) In large cap companies where few or no equity stakes attain the legal threshold for signifcant shareholdings. b) In companies with a plurality of shareholders represented on the board but not otherwise related. Complies Explain 223 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 17. Independent directors should be at least half of all board members. However, when the company does not have a large market capitalisation, or when a large cap company has shareholders individually or concertedly controlling over 30 percent of capital, independent directors should occupy, at least, a third of board places. Complies Explain 18. Companies should disclose the following director particulars on their websites and keep them regularly updated: a) Background and professional experience. b) Directorships held in other companies, listed or otherwise, and other paid activities they engage in, of whatever nature. c) Statement of the director class to which they belong, in the case of proprietary directors indicating the shareholder they represent or have links with. d) Dates of their frst appointment as a board member and subsequent re-elections. e) Shares held in the company, and any options on the same. Complies Partially complies Explain 19. Following verifcation by the appointments committee, the annual corporate governance report should disclose the reasons for the appointment of proprietary directors at the urging of shareholders controlling less than 3 percent of capital; and explain any rejection of a formal request for a board place from shareholders whose equity stake is equal to or greater than that of others applying successfully for a proprietary directorship. Complies Partially complies Explain  Not  applicable 20. Proprietary directors should resign when the shareholders they represent dispose of their ownership interest in its entirety. If such shareholders reduce their stakes, thereby losing some of their entitlement to proprietary directors, the number of the latter should be reduced accordingly. Complies Partially complies Explain  Not  applicable 21. The board of directors should not propose the removal of independent directors before the expiry of their tenure as mandated by the bylaws, except where they fnd just cause, based on a proposal from the appointments committee. In particular, just cause will be presumed when directors take up new posts or responsibilities that prevent them allocating sufcient time to the work of a board member, or are in breach of their fduciary duties or come under one of the disqualifying grounds for classifcation as independent enumerated in the applicable legislation. The removal of independent directors may also be proposed when a takeover bid, merger or similar corporate transaction alters the company’s capital structure, provided the changes in board membership ensue from the proportionality criterion set out in recommendation 16. Complies Explain 22. Companies should establish rules obliging directors to disclose any circumstance that might harm the organisation’s name or reputation, tendering their resignation as the case may be, and, in particular, to inform the board of any criminal charges brought against them and the progress of any subsequent trial. The moment a director is indicted or tried for any of the ofences stated in company legislation, the board of directors should open an investigation and, in light of the particular circumstances, decide whether or not he or she should be called on to resign. The board should give a reasoned account of all such determinations in the annual corporate governance report. Complies Partially complies Explain 23. Directors should express their clear opposition when they feel a proposal submitted for the board’s approval might damage the corporate interest. In particular, independents and other directors not subject to potential conficts of interest should strenuously challenge any decision that could harm the interests of shareholders lacking board representation. When the board makes material or reiterated decisions about which a director has expressed serious reservations, then he or she must draw the pertinent conclusions. Directors resigning for such causes should set out their reasons in the letter referred to in the next recommendation. The terms of this recommendation also apply to the secretary of the board, even if he or she is not a director. Complies Partially complies Explain  Not  applicable 24. Directors who leave before their tenure expires, through resignation or otherwise, should state their reasons in a letter to be sent to all members of the board. Whether or not such resignation is disclosed as a material event, the motivating factors should be explained in the annual corporate governance report. Complies Partially complies Explain  Not  applicable 224 2018 Annual Report Other corporate governance information 25. The appointments committee should ensure that non-executive directors have sufcient time available to discharge their responsibilities efectively. 32. Directors should be regularly informed of movements in share ownership and of the views of major shareholders, investors and rating agencies on the company and its group. The board rules and regulations should lay down the maximum number of company boards on which directors can serve. Complies Partially complies Explain Complies Partially complies Explain 26. The board should meet with the necessary frequency to properly perform its functions, eight times a year at least, in accordance with a calendar and agendas set at the start of the year, to which each director may propose the addition of initially unscheduled items. Complies Partially complies Explain 27. Director absences should be kept to a strict minimum and quantifed in the annual corporate governance report. In the event of absence, directors should delegate their powers of representation with the appropriate instructions. Complies Partially complies Explain 28. When directors or the secretary express concerns about some proposal or, in the case of directors, about the company’s performance, and such concerns are not resolved at the meeting, they should be recorded in the minutes book if the person expressing them so requests. 33. The chairman, as the person responsible for the efcient functioning of the board of directors, in addition to the functions assigned by law and the company’s bylaws, should prepare and submit to the board a schedule of meeting dates and agendas; organise and coordinate regular evaluations of the board and, where appropriate, of the company’s chief executive ofcer; exercise leadership of the board and be accountable for its proper functioning; ensure that sufcient time is given to the discussion of strategic issues, and approve and review refresher courses for each director, when circumstances so advise. Complies Partially complies Explain 34. When a lead independent director has been appointed, the bylaws or the Rules and regulations of the board of directors should grant him or her the following powers over and above those conferred by law: to chair the board of directors in the absence of the chairman or vice chairman; to give voice to the concerns of non-executive directors; to maintain contact with investors and shareholders to hear their views and develop a balanced understanding of their concerns, especially those to do with the company’s corporate governance; and to coordinate the chairman’s succession plan. Complies Partially complies Explain  Complies Partially complies Explain  Not  applicable Not  applicable 29. The company should provide suitable channels for directors to obtain the advice they need to carry out their duties, extending if necessary to external assistance at the company’s expense. 35. The board secretary should strive to ensure that the board’s actions and decisions are informed by the governance recommendations of the Good Governance Code of relevance to the company. Complies Partially complies Explain Complies Explain 30. Regardless of the knowledge directors must possess to carry out their duties, they should also be ofered refresher programmes when circumstances so advise. 36. The board in full should conduct an annual evaluation, adopting, where necessary, an action plan to correct weakness detected in: Complies Explain Not  applicable a) The quality and efciency of the board’s operation. 31. The agendas of board meetings should clearly indicate on which points directors must arrive at a decision, so they can study the matter beforehand or obtain the information they consider appropriate. For reasons of urgency, the chairman may wish to present decisions or resolutions for board approval that were not on the meeting agenda. In such exceptional circumstances, their inclusion will require the express prior consent, duly minuted, of the majority of directors present. Complies Partially complies Explain b) The performance and membership of its committees. c) The diversity of board membership and competencies. d) The performance of the chairman of the board of directors and the company’s chief executive. e) The performance and contribution of individual directors, with particular attention to the chairmen of board committees. The evaluation of board committees should start from the reports they send to the board of directors, while that of the board itself should start from the report of the appointments committee. 225 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Every three years, the board of directors should engage an external facilitator to aid in the evaluation process. This facilitator’s independence should be verifed by the appointments committee. Any business dealings that the facilitator or members of its corporate group maintain with the company or members of its corporate group should be detailed in the annual corporate governance report. The process followed and areas evaluated should be detailed in the annual corporate governance report. Complies Partially complies Explain 37. When an executive committee exists, its membership mix by director class should resemble that of the board. The secretary of the board should also act as secretary to the executive committee. Complies Partially complies Explain  Not  applicable The secretary of the executive committee is the secretary of the board. While the distribution of categories of directors in the executive committee is not exactly the same as in the board, the Bank considers it complies with the spirit of the recommendation since the current composition refects all categories of directors, including a majority of external director and three independent directors, but retaining all executive directors to maintain the efciency in the discharge of the executive functions of the committee. s 38. The board should be kept fully informed of the matters discussed and decisions made by the executive committee. To this end, all board members should receive a copy of the committee’s minutes. Complies Partially complies Explain  Not  applicable 39. All members of the audit committee, particularly its chairman, should be appointed with regard to their knowledge and experience in accounting, auditing and risk management matters. A majority of committee seats should be held by independent directors. Complies Partially complies Explain 40. Listed companies should have a unit in charge of the interna audit function, under the supervision of the audit committee, to monitor the efectiveness of reporting and control systems. This unit should report functionally to the board’s non- executive chairman or the chairman of the audit committee. l Complies Partially complies Explain 41. The head of the unit handling the internal audit function should present an annual work programme to the audit committee, inform it directly of any incidents arising during its implementation and submit an activities report at the end of each year. Complies Partially complies Explain  Not  applicable 42. The audit committee should have the following functions over and above those legally assigned: 1. With respect to internal control and reporting systems: a) Monitor the preparation and the integrity of the fnancial information of the company and, where appropriate, the Group, checking for compliance with legal provisions, the accurate demarcation of the consolidation perimeter, and the correct application of accounting principles. b) Monitor the independence of the unit handling the internal audit function; propose the selection, appointment, re- election and removal of the head of the internal audit service; propose the service’s budget; approve its priorities and work programmes, ensuring that it focuses primarily on the main risks the company is exposed to; receive regular report-backs on its activities; and verify that senior management are acting on the fndings and recommendations of its reports. c) Establish and supervise a mechanism whereby staf can report, confdentially and, if appropriate and feasible, anonymously, any signifcant irregularities that they detect in the course of their duties, in particular fnancial or accounting irregularities. 2. With regard to the external auditor: a) Investigate the issues giving rise to the resignation of the external auditor, should this come about. b) Ensure that the remuneration of the external auditor, does not compromise its quality or independence. c) Ensure that the company notifes any change of external auditor to the CNMV as a material fact, accompanied by a statement of any disagreements arising with the outgoing auditor and if applicablen, the contents thereof. d) Ensure that the external auditor has a yearly meeting with the board in full to inform it of the work undertaken and developments in the company’s risk and accounting positions. e) Ensure that the company and the external auditor adhere to current regulations on the provisions of non-audit services, limits on the concentration of the auditor’s business and other requirements concerning auditor independence. Complies Partially complies Explain 226 2018 Annual Report Other corporate governance information 43. The audit committee should be empowered to meet with any company employee or manager, even ordering their appearance without the presence of another manager. procuring theyhave the right balance of knowledge, skills and experience for the functions they are called on to discharge. The majority of their members should be independent directors. Complies Partially complies Explain Complies Partially complies Explain 44. The audit committee should be informed of any structural changes or corporate transactions the company is planning, so the committee can analyse the operation and report to the board beforehand on its economic conditions and accounting impact and, when applicable, the exchange ratio proposed. Complies Partially complies Explain  Not  applicable 45. The risk control and management policy should identify at least: a) The diferent types of risk, fnancial and non-fnancial (including operational, technological, legal, social, environmental, political and reputational risks), the company is exposed to, with the inclusion under fnancial or economic, risks of contingent liabilities and other of- balance-sheet risks. b) The setting of the risk level that the company deems acceptable. c) Measures in place to mitigate the impact of risk events should they occur. d) The internal reporting and control systems to be used to control and manage the above risks, including contingent liabilities and of-balance-sheet risks. Complies Partially complies Explain 46. Companies should establish a risk control and management function in the charge of one of the company’s internal department or units and under the direct supervision of the audit committee or some other specialised board committee. This internal department or unit should be expressly charged with the following responsibilities: a) Ensure that risk control and management systems are functioning correctly and, specifcally, that major risks the company is exposed to are correctly identifed, managed and quantifed. b) Participate actively in the preparation of risk strategies and in key decisions about their management. c) Ensure that risk control and management systems are mitigating risks efectively in the frame of the policy drawn up by the board of directors. Complies Partially complies Explain 47. Members of the appointments and remuneration committee - or of the appointments committee and remuneration committee, if separately constituted - should be chosen 48. Large cap companies should have formed separate appointments and remuneration committees. Complies Explain Not  applicable 49. The appointments committee should consult with the company’s chairman and chief executive, especially on matters relating to executive directors. When there are vacancies on the board, any director may approach the appointments committee to propose candidates that it might consider suitable. Complies Partially complies Explain 50. The remuneration committee should operate independently and have the following functions in addition to those assigned by law: a) Propose to the board the standard conditions for senior ofcer contracts. b) Monitor compliance with the remuneration policy set by the company. c) Periodically review the remuneration policy for directors and senior ofcers, including share-based remuneration systems and their application, and ensure that their individual compensation is proportionate to the amounts paid to other directors and senior ofcers in the company. d) Ensure that conficts of interest do not undermine the independence of any external advice the committee engages. e) Verify the information on director and senior ofcers’ pay contained in corporate documents, including the annual directors’ remuneration statement. Complies Partially complies Explain 51. The remuneration committee should consult with the company’s chairman and chief executive, especially on matters relating to executive directors and senior ofcers. Complies Partially complies Explain 52. The rules regarding composition and functioning of supervision and control committees should be set out in the regulations of the board of directors and aligned with those governing legally mandatory board committees as specifed in the preceding sets of recommendations. They should include at least the following terms: a) Committees should be formed exclusively by non- executive directors, with a majority of independents. b) They should be chaired by independent directors. 227 Responsible bankingCorporate governanceEconomic and financial reviewRisk management c) The board should appoint the members of such committees with regard to the knowledge, skills and experience of its directors and each committee’s terms of reference; discuss their proposals and reports; and provide report-backs on their activities and work at the frst board plenary following each committee meeting. 54. The corporate social responsibility policy should state the principles or commitments the company will voluntarily adhere to in its dealings with stakeholder groups, specifying at least: a) The goals of its corporate social responsibility policy and the support instruments to be deployed. d) They may engage external advice, when they feel it necessary for the discharge of their functions. b) The corporate strategy with regard to sustainability, the environment and social issues. e) Meeting proceedings should be minuted and a copy made available to all board members. Complies Partially complies Explain  Not  applicable 53. The task of supervising compliance with corporate governance rules, internal codes of conduct and corporate social responsibility policy should be assigned to one board committee or split between several, which could be the audit committee, the appointments committee, the corporate social responsibility committee, where one exists, or a special committee established ad hoc by the board under its powers of self-organisation, with at the least the following functions: a) Monitor compliance with the company’s internal codes of conduct and corporate governance rules. b) Oversee the communication and relations strategy with shareholders and investors, including small and medium-sized shareholders. c) Concrete practices in matters relating to: shareholders, employees, clients, suppliers, social welfare issues, the environment, diversity, fscal responsibility, respect for human rights and the prevention of illegal conduct. d) The methods or systems for monitoring the results of the practices referred to above and identifying and managing related risks. e) The mechanisms for supervising non-fnancial risk, ethics and business conduct. f) Channels for stakeholder communication, participation and dialogue. g) Responsible communication practices that prevent the manipulation of information and protect the company’s honour and integrity. Complies Partially complies Explain c) Periodically evaluate the efectiveness of the company’s corporate governance system, to confrm that it is fulflling its mission to promote the corporate interest and catering, as appropriate, to the legitimate interests of other stakeholders. 55. The company should report on corporate social responsibility developments in its management’s report or in a separate document, using an internationally accepted methodology. Complies Partially complies Explain d) Review the company’s corporate social responsibility policy, ensuring that it is geared to value creation. e) Monitor corporate social responsibility strategy and practices and assess compliance in this respect. 56. Director remuneration should be sufcient to attract and retain directors with the desired profle and compensate the commitment, abilities and responsibility that the post demands, but not so high as to compromise the independent judgement of non-executive directors. f) Monitor and evaluate the company’s interaction with its stakeholders. Complies Explain g) Evaluate all aspects of the non-fnancial risks the company is exposed to, including operational, technological, legal, social, environmental, political and reputational risks. h) Coordinate non-fnancial and diversity reporting processes in accordance with applicable legislation and international benchmarks. Complies Partially complies Explain 57. Variable remuneration linked to the company and the director’s performance, the award of shares, options or any other right to acquire shares or to be remunerated on the basis of share price movements, and membership of long-term savings schemes such as pension plans, retirement accounts or any other retirement plan should be confned to executive directors. 228 2018 Annual Report Other corporate governance information The company may consider the share-based remuneration of non-executive directors provided they retain such shares until the end of their mandate. The above condition will not apply to any shares that the director must dispose of to defray costs related to their acquisition. Complies Partially complies Explain 58. In the case of variable awards, remuneration policies should include limits and technical safeguards to ensure they refect the professional performance of the benefciaries and not simply the general progress of the markets or the company’s sector, or circumstances of that kind. In particular, variable remuneration items should meet the following conditions: number of shares equivalent to twice their annual fxed remuneration, or to exercise the share options or other rights on shares for at least three years after their award. The above condition will not apply to any shares that the director must dispose of to defray costs related to their acquisition. Complies Partially complies Explain  Not  applicable 63. Contractual arrangements should include provisions that permit the company to reclaim variable components of remuneration when payment was out of step with the director’s actual performance or based on data subsequently found to be misstated. Complies Partially complies Explain  a) Be subject to predetermined and measurable performance criteria that factor the risk assumed to obtain a given outcome. Not  applicable 64. Termination payments should not exceed a fxed amount equivalent to two years of the director’s total annual remuneration, and should not be paid until the company confrms that he or she has met the predetermined performance criteria. Complies Partially complies Explain  Not  applicable List whether any directors voted against or abstained from voting on the approval of this Report. Yes No I declare that the information included in this statistical annex are the same and are consistent with the descriptions and information included in the annual corporate governance report published by the company. b) Promote the long-term sustainability of the company and include non-fnancial criteria that are relevant for the company’s long-term value, such as compliance with its internal rules and procedures and its risk control and management policies. c) Be focused on achieving a balance between the achivement of short, medium and long-term targets, such that performance- related pay rewards ongoing achievement, maintained over sufcient time to appreciate its contribution to long-term value creation. This will ensure that performance measurement is not based solely on one of, occasional or extraordinary events. Complies Partially complies Explain  Not  applicable 59. A major part of variable remuneration components should be deferred for a long enough period to ensure that predetermined performance criteria have efectively been met. Complies Partially complies Explain  Not  applicable 60. Remuneration linked to company earnings should bear in mind any qualifcations stated in the external auditor’s report that reduce their amount. Complies Partially complies Explain  Not  applicable 61. A major part of executive directors’ variable remuneration should be linked to the award of shares or fnancial instruments whose value is linked to the share price. Complies Partially complies Explain  Not  applicable 62. Following the award of shares, share options or other rights on shares derived from the remuneration system, directors should not be allowed to transfer a 229 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 9.3 Cross-reference table for comply or explain of corporate governance recommendations Recommendation Comply / Explain 1 2 3 4 5 Comply Not applicable Comply Comply Partially comply Comply Comply Comply Comply Comply Not applicable Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Partially comply Comply Comply Comply Comply Comply Comply 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 230 Information See section 3.2. See 'Group companies' in section 4.8. See section 3.1. See section 3.1. Our 2018 AGM, authorised our board to increase share capital with the authority to exclude pre-emptive rights for shareholders, with a limit of 20% of the share capital. This limit applies to capital increases to convert bonds or other convertible securities, other than contingent convertible preferred securities (which can only be converted into newly-issued shares when the CET 1 ratio falls below a pre-established threshold). The Bank publishes in its website the reports relating to the exclusion of pre-emptive rights when it makes use of this authority in the terms established in the recommendation. See section 2.2. See sections 4.4, 4.5, 4.6, 4.8 and 'Responsible Banking' chapter. See section 3.5. See section 4.4. See 'Participation of shareholders at the GSM' in section 3.2. See section 3.2. See section 3.5. See section 4.3. See 'Size' in section 4.2. See 'Election, refreshment and succession of directors' and 'Diversity' in section 4.2. See 'Composition by type of director'; 'Independent non-executive directors' and 'Election, refreshment and succession of directors' in section 4.2. See 'Composition by type of director' in section 4.2. See 'Composition by type of director'; 'Independent non-executive directors' and 'Election, refreshment and succession of directors' in section 4.2. See 'Corporate website' in section 3.2 and section 4.1. See 'Composition by type of director' and 'Tenure, committee membership and equity ownership' in section 4.2. See 'Election, refreshment and succession of directors' in section 4.2. See 'Election, refreshment and succession of directors' in section 4.2. See 'Election, refreshment and succession of directors' in section 4.2. See 'Election, refreshment and succession of directors' in section 4.2. See 'Election, refreshment and succession of directors' in section 4.2. See 'Board and committees attendance' in section 4.3 and in section 4.5. See 'Proceedings of the board' and 'Board and committees attendance' in section 4.3. See 'Proceedings of the board' and 'Board and committees attendance' in section 4.3. See 'Proceedings of the board' in section 4.3. See 'Proceedings of the board' in section 4.3. See 'Training of directors and induction programme for new directors' in section 4.3. See 'Rules and regulations of the board' and 'Board and committees attendance' in section 4.3. See section 3.1. See 'Proceedings of the board', 'Training of director and induction program for new directors' and 'Self-assessment of the board' in section 4.3. See 'Lead independent director' in section 4.3. See 'Secretary of the board' in section 4.3. See 'Self-assessment of the board' in section 4.3. The secretary of the executive committee is the secretary of the board. While the distribution of categories of directors in the executive committee is not exactly the same as in the board, the Bank considers it complies with the spirit of the recommendation since the current composition refects all categories of directors, including a majority of external directors and three independent directors, but retaining all executive directors to maintain the efciency in the discharge of the executive functions of the committee. See ‘Executive committee’ in section 4.3. See ‘Executive committee’ in section 4.3. See 'Composition' and 'Duties and activities in 2018' in section 4.4. See 'Duties and activities in 2018' in section 4.4. See 'Duties and activities in 2018' in section 4.4. See 'Duties and activities in 2018' in section 4.4. See 'How the committee works' in section 4.4. 2018 Annual Report Other corporate governance information Recommendation Comply / Explain Information 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply Comply See 'Duties and activities in 2018' in section 4.4. See 'Duties and activities in 2018' in section 4.4 and 'Duties and activities in 2018' in section 4.7. See 'Duties and activities in 2018' in section 4.4 and 'Duties and activities in 2018' in section 4.7. See 'Composition' in section 4.5 and 'Composition' in section 4.6. See 'Board committees structure' in section 4.3. See 'Duties and activities in 2018' in section 4.5. See 'Duties and activities in 2018' in section 4.6. See 'Duties and activities in 2018' in section 4.6. See 'Rules and regulations of the board' in section 4.3 and sections 4.4, and 4.7. See 'Responsible banking, sustainability and culture committee' in section 4.3 and 'Duties and activities in 2018' in section 4.7. See 'Responsible banking, sustainability and culture committee' in section 4.3. See chapter 'Responsible banking'. See sections 6.2 and 6.3. See sections 6.2 and 6.3. See section 6.3. See section 6.3. See section 6.3. See section 6.3. See section 6.3. See section 6.3. See sections 6.1 and 6.3. 9.4 Reconciliation to the CNMV’s remuneration report model Section in CNMV model Included in statistical report Further information elsewhere and comments A. Remuneration policy for the present fscal year No No No A.1 No • See section 6.4. • See sections 4.6 and 6.5. • See 'Summary of link between risk, performance and reward' in section 6.3. See peer group in 'Remuneration of executive directors' in section 6.4. See section 6.4. See section 6.3. A.2 A.3  A.4 B. Overall summuary of application of the remuneration policy over the last fscal year B.1 B.2  B.3 B.4 B.5  B.6 B.7 B.8 B.9 B.10 B.11 B.12 B.13 B.14 B.15 B.16 C. Breakdown of the individual remuneration of directors C C.1 a) i) See sections 6.1 and 6.3. See 'Summary of link between risk, performance and reward' in section 6.3. See sections 6.2 and 6.3. See section 6.5. See section 6.2. See 'Gross annual salary' in section 6.3. See 'Variable remuneration' in section 6.3. Not applicable. See 'Main features of the beneft plans' in section 6.3. Not applicable. See 'Terms and conditions of executive directors´ contracts' in section 6.4. No remuneration for this component. See note 5 to the consolidated fnancial statements. See 'Insurance and other remuneration and benefts in kind' in section 6.4. See 'Remuneration of board members as representatives of the Bank' in section 6.3. No remuneration for this component. No No No No No No No No No No No No No No No No See section 9.5. See section 9.5. Yes Yes 231 Responsible bankingCorporate governanceEconomic and financial reviewRisk management                                 C.1 a) ii) C.1 a) iii) C.1 a) iii) C.1 b) i) C.1 b) ii) C.1 b) iii) C.1 b) iv) C.1 c) D. Other information of interest D  Yes Yes Yes Yes No No No Yes No See section 9.5. See section 9.5. See section 9.5. See section 9.5. Not awarded. Not awarded. Not awarded. See section 9.5. See section 4.6. 9.5 Statistical information on remuneration required by CNMV B. OVERALL SUMMARY OF HOW REMUNERATION POLICY WAS APPLIED DURING THE YEAR ENDED B.4 Report on the result of consultative vote at General Shareholders´ Meeting on annual report on remuneration from previous year, indicating the number of votes against, as the case may be. Votes cast Number 10,406,887,327 % of total 99.91% Votes against Votes in favour Abstentions Number 389,585,931 9,834,835,228 182,466,168 % of votes cast 3.74% 94.42% 1.75% C. ITEMISED INDIVIDUAL REMUNERATION ACCRUED BY EACH DIRECTOR Name Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie-Brown Mr Rodrigo Echenique Gordillo Mr Guillermo de la Dehesa Romero Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca Mr Javier Botín-Sanz de Sautuola y O’Shea Ms Sol Daurella Comadrán Mr Carlos Fernández González Ms Esther Giménez-Salinas i Colomer Ms Belén Romana García Mr Juan Miguel Villar Mir Mr Ramiro Mato García Ansorena Mr Álvaro Cardoso de Souza Type Executive   Executive   Independent Executive   Other external Independent   Other external  Other external Independent   Independent   Independent Independent Independent Independent Independent 232 Period of accrual in year 2018 From 01/01/2018 to 31/12/2018  From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018  From 01/01/2018 to 31/12/2018  From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018  From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018 From 01/01/2018 to 31/12/2018  From 01/01/2018 to 31/12/2018  From 23/03/2018 to 31/12/2018  2018 Annual Report Other corporate governance information C.1 Complete the following tables on individual remuneration of each director (including the remuneration for exercising executive functions) accrued during the year. a) Remuneration from the reporting company: i) Remuneration in cash (thousand euros) Name Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie-Brown Mr Rodrigo Echenique Gordillo Mr Guillermo de la Dehesa Romero Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca Mr Javier Botín-Sanz de Sautuola y O’Shea Ms Sol Daurella Comadrán Mr Carlos Fernández González Ms Esther Giménez- Salinas i Colomer Ms Belén Romana García Mr Juan Miguel Villar Mir Mr Ramiro Mato García Ansorena Mr Álvaro Cardoso de Souza Mr Matías Rodríguez Inciarte Ms Isabel Tocino Biscarolasaga Fixed remune- Remuneration for member- Per diem ship of Board's committees ration allowances Short-term variable remuneration Long-term variable remuneration Salary Severance pay Other grounds Total year Total year 2017 2018  90  90 90   90  90 90   90  90  90  90  90  90  90  90  67  -  -  39  34  89  33  81  61  86  31  67  86  58  81  18  77  31  -  -  178  3,176  2,368  170  2,541 1,582   553  -  -  170  1,800 1,256   270  48  256  0  58  90  48  243  0  283  50  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  - -   -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  -  - -   -  -  -  -  -  -  -  -  -  -  -  -  -  -  - -  -   -  -  394  6,245 5,683  532  4,949 4,971  - -   -  -  81  -  -  -  - -   - -   -  - -  732  732 3,394   3,139 441    199  513  121 473 160 551 124  215 207 266  286 196   414   108   450   148   -  - 163 298 171 36 - 3,149 418 233 Responsible bankingCorporate governanceEconomic and financial reviewRisk management ii) Table of changes in share-based remuneration schemes and gross proft from consolidated shares or fnancial instruments Financial instruments at start of year 2018 Financial instruments granted at start of year 2018 Name Name of Plan 2nd cycle of the performance shares plan (2015) No. of instruments No. of equivalent shares 187,080 187,080 Ms Ana Botín- Sanz de Sautuola y O’Shea 1st cycle of deferred variable remuneration plan linked to multi-year targets (2016) 216,308 216,308 2nd cycle of deferred variable remuneration plan linked to multi-year targets (2017) 206,775 206,775 No. of instruments No. of equivalent shares – – – – – – 3rd cycle of deferred variable remuneration plan linked to multi-year targets (2018) - – 860,865 860,865 Financial instruments at start of year 2018 Financial instruments granted at start of year 2018 Name Name of Plan 2nd cycle of the performance shares plan (2015) No. of instruments No. of equivalent shares 126,279 126,279 Mr José Antonio Álvarez Álvarez 1st cycle of deferred variable remuneration plan linked to multi-year targets (2016) 145,998 145,998 2nd cycle of deferred variable remuneration plan linked to multi-year targets (2017) 138,283 138,283 No. of instruments No. of equivalent shares – – – – – – 3rd cycle of deferred variable remuneration plan linked to multi-year targets (2018) - – 575,268 575,268 Financial instruments at start of year 2018 Financial instruments granted at start of year 2018 Name Name of Plan 2nd cycle of the performance shares plan (2015) No. of instruments No. of equivalent shares 93,540 93,540 Mr Rodrigo Echenique Gordillo 1st cycle of deferred variable remuneration plan linked to multi-year targets (2016) 108,134 108,134 2nd cycle of deferred variable remuneration plan linked to multi-year targets (2017) 107,766 107,766 No. of instruments No. of equivalent shares – – – – – – 3rd cycle of deferred variable remuneration plan linked to multi-year targets (2018) - – 456,840 456,840 234 2018 Annual Report Other corporate governance information Financial instruments consolidated during 2018 Instruments matured but not exercised Financial instruments at end of year 2018 No. of instruments No. of equivalent shares/ handed over Price of the consolidated shares Net proft from shares handed over or consolidated fnancial instruments (EUR thousand) No. of instruments No. of shares No. of equivalent shares 122,855 122,855 4,298 528 64,225 - - - - - - - - 550,952 550,952 4,298 2,368 – – – 216,308 216,308 206,775 206,775 309,913 309,913 Financial instruments consolidated during 2018 Instruments matured but not exercised Financial instruments at end of year 2018 No. of instruments No. of equivalent shares/ handed over Price of the consolidated shares Net proft from shares handed over or consolidated fnancial instruments (EUR thousand) No. of instruments No. of shares No. of equivalent shares 82,927 82,927 4,298 357 43,352 - - - - - - - - 368,171 368,171 4,298 1,582 – – – 145,998 145,998 138,283 138,283 207,097 207,097 Financial instruments consolidated during 2018 Instruments matured but not exercised Financial instruments at end of year 2018 No. of instruments No. of equivalent shares/ handed over Price of the consolidated shares Net proft from shares handed over or consolidated fnancial instruments (EUR thousand) No. of instruments No. of shares No. of equivalent shares 61,428 61,428 4,298 264 32,112 - - - - - - - - 292,376 292,376 4,298 1,257 – – – 108,134 108,134 107,766 107,766 164,464 164,464 235 Responsible bankingCorporate governanceEconomic and financial reviewRisk management iii) Long-term saving systems Name Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo Remuneration from consolidation of rights to savings system 1,234 1,050 - Contribution over the year from the company (EUR thousand) Savings systems with consolidated economic rights Savings systems with unconsolidated economic rights Name 2018 2017 2018 2017 Amount of accumulated funds (EUR thousand) 2018 2017 Systems with Systems with consolidated unconsolidated economic rights economic rights Systems with Systems with consolidated unconsolidated economic rights economic rights Ms Ana Botín-Sanz de Sautuola y O’Shea 1,234 2,707 Mr José Antonio Álvarez Álvarez Mr Rodrigo Echenique Gordillo 1,050 2,456 - - - - - - - - 46,093 16,630 13,614 - - - 45,798 16,151 13,957 - - - iv) Details of other items (EUR thousand) Name Item Ms Ana Botín- Sanz de Sautuola y O’Shea Life and accident insurance Fixed remuneration supplement insurance Other remuneration Name Component Mr José Antonio Álvarez Álvarez Life and accident insurance Fixed remuneration supplement insurance Other remuneration Name Component Mr Rodrigo Echenique Gordillo Life and accident insurance Other remuneration Amount remune rated 237 31 368 Amount remune rated 397 76 590 Amount remune rated 121 104 236 2018 Annual Report             Other corporate governance information b) Remuneration of the company directors for seats on the boards of other group companies: i) Remuneration in cash (EUR thousand) Fixed remu- neration Per diem allowances Remuner- ation for membership of Board's committees Short-term variable remuneration Long-term variable remuneration Salary Severance pay Other grounds Total year 2018 Total year 2017 - - - - - - - - - 42 Name Mr Matías Rodríguez Inciarte ii) Table of changes in share/based remunerations schemes and gross proft from consolidated shares or fnancial instruments Not applicable iii) Long term saving systems Not applicable iv) Detail of other items (EUR thousand) Not applicable 237 Responsible bankingCorporate governanceEconomic and financial reviewRisk management c) Summary of remuneration (EUR thousand) The summary should include the amounts corresponding to all the items of remuneration included in this report that have been accrued by the director, in thousand euros. Remuneration accrued in the company Remuneration accrued in group companies n n o s d o s n t t e i t f f t o t n h a o o ar d i e sr t l d o r r e p ae i a m p pl i s o s c c s i oe u s c n mr s s s r am n r a t o o e a t o s n r r oe oh x n r G G f Tr cc i fe n u l s n m o ie t t a i r r e e nh u t o m r e o R f 8 1 0 2 l a t o T 7 1 0 2 l a t o T n n o d o t e i f t t h a o ar sr r l d o ae m i a p n l i c s o c u s e u l n s s r a r tm n a t o a s n r oe G oh n f Tr cc i s n m o s s n ie t t t f t o a n i o td r e r r e e e p p n s h o s i ut c m s o m r o e o r e r x o r G fe R f i 8 1 0 2 l a t o T 7 1 0 2 l a t o T - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 42 - 42 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Name Ms Ana Botín-Sanz de Sautuola y O’Shea Mr José Antonio Álvarez Álvarez Mr Bruce Carnegie-Brown Mr Rodrigo Echenique Gordillo Mr Guillermo de la Dehesa Romero Ms Homaira Akbari Mr Ignacio Benjumea Cabeza de Vaca Mr Javier Botín-Sanz de Sautuola y O’Shea Ms Sol Daurella Comadrán Mr Carlos Fernández González Ms Esther Giménez- Salinas i Colomer Ms Belén Romana García Mr Juan Miguel Villar Mir Mr Ramiro Mato García Ansorena Mr Álvaro Cardoso de Souza Mr Matías Rodríguez Inciarte Ms Isabel Tocino Biscarolasaga 6,245 2,896 1,234 636 11,011 10,582 4,949 1,939 1,050 1,063 9,001 8,893 732 - 3,349 1,521 441 199 513 121 215 266 196 414 108 450 148 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 732 731 225 5,095 4,281 - - - - - - - - - - - - - 441 199 473 159 513 550 121 124 215 207 266 285 196 162 414 297 108 170 450 36 148 - - - 4,266 418 Total 18,346 6,356 2,284 1,924 28,910 31,634 This annual report on remuneration has been approved by the board of directors of the company, at its meeting on 26 February 2019. State if any directors have voted against or abstained from approving this report. Sí No 238 2018 Annual Report Other corporate governance information 9.6 Other information of interest Since 2010, Banco Santander has adhered to the Code of Good Tax Practice approved by the Large Companies Forum, a body which involves large Spanish companies and the Spanish tax authority, and it complies with the contents thereof. As in previous years, and in accordance with its commitments under the aforementioned code, and in application of its compliance programme and the Group’s general Code of Conduct, the head of the tax department has reported to the audit committee on the Group’s fscal policies. On 3 November 2015, at the plenary session of the abovementioned Large Companies Forum, the introduction of an appendix to the Code of Best Tax Practices was agreed to strengthen the cooperation between the Spanish tax agency and those companies that adhere to this instrument of good tax governance, through a series of actions promoting transparency and legal security in compliance with tax obligations. In the UK the Group adheres to the Code of Practice on Taxation for Banks, since its approval in 2010 by the tax authority of said country. The Bank complies with the 'Guidelines for the release of privileged information to third parties' published by the National Securities Market Commission on 9 March 2009, which expressly indicates that fnancial institutions and rating agencies are recipients of that information. It also follows the 'Recommendations regarding informational meetings with analysts, institutional investors and other stock market professionals' published by the National Securities Market Commission on 22 December 2005. Banco Santander has joined international sustainability initiatives such as, among others, the Principles of the United Nation’s Global Compact (since 2002), the Equator Principles (since 2009), the Principles for Responsible Investment (since 2008), the Banking Environment Initiative (BEI) (since 2010), the World Business Council for Sustainable Development (since 2015), UNEP Finance Initiative (since 2008) and the CDP, formerly the Carbon Disclosure Project (since 2002). On 26 November 2018 Banco Santander, together with 27 other banks throughout the world, have published the draft of the Principles for Responsible Banking, under the UN Environment Finance Initiative (UNEP FI), to be open discuss before being formally approved by the General Assembly of United Nations in September 2019. 239 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Economic and fnancial review % 1. Economic, regulatory and competitive context 2. Group selected data 3. Group fnancial performance Situation of Santander Results Balance sheet Liquidity and funding management Capital management and adequacy. Solvency ratios 4. Business areas performance Description of businesses Summary income statement of the Group’s main business areas Geographic businesses Corporate Centre Global businesses 5. Research, development and innovation (R&D&I) 6. Signifcant events since year end 7. Trend information 2019 8. Alternative performance measures (APMs) 242 244 246 246 247 259 263 270 284 284 286 288 314 315 323 325 326 330 240 2018 Annual Report 241 Responsible bankingCorporate governanceEconomic and financial reviewRisk management1. Economic, regulatory and competitive context Santander Group developed its business in 2018 in a generally dynamic economic environment. However, as the year advanced so it became clearer that the peak of the expansive cycle had been reached and risk tended to increase, giving rise to instability in the markets. The countries where the Group conducts its business performed at a less even pace although they generally grew. – United Kingdom (GDP: +1.4% estimated in 2018 vs +1.3% in 2017). The economy lost strength at the end of 2018 because of the uncertainty over Brexit, whose ups and downs were refected in pound sterling (0.9 GBP/EUR). Infation (2.1%) eased and the unemployment rate of 4.0% was efectively full employment. The Bank of England’s base rate ended the year at 0.75%. Trade tensions, despite the agreement reached in the renegotiation of NAFTA, and the tightening of US monetary policy were the main causes of greater uncertainty, which triggered tensions of varying intensity, particularly in developing markets such as Argentina and Turkey and, to a lesser extent, in Brazil and Mexico, which were also afected by the electoral cycle during most of the year. – Brazil (GDP: +1.3% estimated in 2018 vs +1.1% in 2017). Growth picked up a little, despite the impact of the transport strike. Investment recovered after four years of falling and private consumption and exports accelerated. Infation was 3.75% in December 2018, below the central bank’s 4.5% target and the Selic rate remained at an historic low (6.5%). Other factors such as the Brexit negotiations and the shape of Italy’s fscal policy also weighed on the tone of the markets: – Eurozone (GDP: +1.8% estimated in 2018 vs +2.5% in 2017). Economic activity could not maintain the strong rhythm of 2017. Yet growth in 2018 was above the potential. The jobless rate came down to 7.9%. After the hike in infation because of energy prices, it eased at the end of the year (1.6%). – Spain (GDP: +2.5% estimated in 2018 vs +3.0% in 2017). The economy slowed in 2018, although Spain remained one of the Eurozone’s most dynamic economies. Job creation was very strong and the unemployment rate continued to fall. Infation ended the year at 1.2%. – Poland (GDP: +5.1% estimated in 2018 vs +4.8% in 2017). Notable economic growth (mainly due to consumption) and lack of imbalances. The unemployment rate was below 4% (an historic low) and infation (1.0%) remained below the central bank’s 2.5% target. The central bank held its key interest rate at 1.5%. – Portugal (GDP: +2.2% estimated in 2018 vs +2.8% in 2017). The economy slowed a little, but growth was still recorded at the end of the year. Robust domestic demand was fuelled by consumption and investment, while exports slowed down. The jobless rate was below 7% and infation ended the year at 0.7%. – Mexico (GDP: +2.0% estimated in 2018 vs +2.1% in 2017). The economy grew spurred by a recovery in investment and exports. The central bank raised its key rate by 100 bps in order to prevent the efects of the peso’s depreciation and foster moderate infation. Mexico, the US and Canada reached a new trade agreement, which has yet to be ratifed. – Chile (GDP: +4.0% estimated in 2018 vs +1.5% in 2017). The economy was strong, spurred by private consumption, investment and exports. Infation rose to 2.6% (below the 3% target) and the central bank began to normalise its monetary policy, with a rise of 25 bps in its key rate to 2.75%. – Argentina (GDP: -2.4% estimated in 2018 vs +2.9% in 2017). Thanks to fnancial aid from the IMF, the economy began to show signs of stabilising, with an easing of infation, a signifcant fscal consolidation and relative exchange rate stability. The economy shrank 2.4% in 2018 and is expected to gradually improve in 2019. - United States (GDP: +2.9% estimated in 2018 vs +2.2% in 2017). GDP grew at a faster pace and the jobless rate was down to 3.7% at the end of the year. Infationary pressures increased, aligning underlying infation with the target of the Fed, which raised interest rate by 100 bps during the year. 242 2018 Annual Report Economic, regulatory and competitive context The following table shows the exchange rates against the euro of the main currencies in which we operate in 2018 as compared to 2017: Exchange rates: 1 euro / currency parity In emerging markets interest rates and spreads are higher than in mature economies, proftability remains high even in the less favourable economic scenarios. Moreover, a strong banking sector acted as a counterweight factor during episodes of instability during the year. Average Period-end 2018 1.180 0.885 4.294 2017 1.127 0.876 3.594 2018 1.145 0.895 4.444 2017 1.199 0.887 3.973 The digital challenge, which is changing the way customers interact with banks, competition and efciency processes, continues to demand high investments and adaptation levels. The banking sector must adapt itself to the ageing process of mature economies and take advantage of the new technologies in order to increase banking services access to the growing middle class in developing economies. US dollar Pound sterling Brazilian real Mexican peso 22.688 21.291 2 2.492 23.661 Chilean peso 756.661 731.538 79 4.630 736.922 Argentine peso 31.164 18.566 43.121 22.637 Polish zloty 4.261 4.256 4.301 4.177 The regulatory agenda in 2018 showed an intensifcation of the debate on Fintechs, taxes and progress on sustainability. After closing Basel III in December 2017, analysis on the impact and implementation of these new rules started in some jurisdictions. In the current fnancial scenario, fnancial markets registered several risk aversion episodes, causing certain tension on global fnancial conditions, the dollar’s appreciation and falls in the stock market. The US economy maintained a solid pace of growth, driven by the fscal policy. The S&P 500 reached a historic peak in October, and then declined until the gains of previous months were wiped out. In the Eurozone, the ECB maintained its very expansive monetary policy, with negative interest rates that enabled relaxed fnancial conditions, despite the asset purchase programme ending in December. The Zone’s economy slowed against a backdrop of greater uncertainty, refected in a decline in German public debt yields and falls in stock markets. In the United Kingdom, the uncertainties generated by the process of withdrawal from the European Union and the negotiations of the exit conditions had a negative impact on the markets. Latin American currencies had a heterogeneous evolution during 2018, mostly depreciations. Exchange rates refected, in some cases, the uncertainty of election processes, domestic issues in other cases and, in general terms, a threatening external environment due to interest rate hikes in the US and the growing trade tension globally. The international banking environment continued to be marked by the strengthening of balance sheets by improving solvency, bolster the liquidity position and reduce unproductive assets, which resulted in a better prepared sector to confront an eventual economic downturn, such as that demonstrated by the stress tests conducted by the various supervisory bodies. Although proftability improved in most economies against a backdrop of economic expansion, it continues to be one of the sector’s main challenges, particularly in Europe, where institutions should carry out structural reforms in order to bolster proftability and the valuation that markets currently make of the banking sector. In Europe, negotiations continued on revising capital and resolution frameworks while there is an ongoing debate on completing the Banking Union. The European Stability Mechanism (ESM) will provide the common backstop to the Single Resolution Fund (SRF) and a roadmap should be drawn up for progressing on political negotiations about the European Deposit Insurance Scheme. Debates on the treatment of sovereign debt and non-performing loans are also moving forward. The fntechs debate intensifed and became more holistic. International authorities are intensifying their agenda on fntechs, including recommendations to reinforce competition policy, to update legal frameworks and to increase the monitorisation of the system, including systemic non-bank entities. The aim of the authorities is to understand and monitor developments in digital transformation in order to assess the efects they might have on competition, fnancial stability, consumer and data protection and risks such as cybersecurity and terrorism fnancing. The entrance of bigtechs into fnancial activities or their role as technology providers for the fnancial sector has opened the debate on their potential systemic signifcance and the competition dynamics in the platforms ecosystem. Taxes: in the context of a digital economy, there is an international, European and even national debate in some countries as to how tax systems should assure a fair contribution to society from all companies. Additionally, in regards to the European Financial Transaction Tax proposal, a fnal agreement was not reached among countries. Lastly, in sustainable economy, the agenda is making very signifcant progress. Authorities at an international and domestic level are taking action to promote sustainable fnance. The fnancial sector will play a signifcant role and so needs to be ready to support the transition towards a green and sustainable economy. The European Commission published in March 2018 its Action Plan on Sustainable Finance, setting an ambitious agenda and goals to 2030. The action plan sets out a comprehensive strategy to further connect fnance with sustainability. 243 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 2. Group selected data BALANCE SHEET (EUR million) Total assets Loans and advances to customers Customer deposits Total customer funds A Total equity INCOME STATEMENT (EUR million) Net interest income Total income Net operating income Proft before tax Attributable proft to the parent UNDERLYING INCOME STATEMENT D (EUR million) Net interest income Total income Net operating income Proft before tax Attributable proft to the parent EPS, PROFITABILITY AND EFFICIENCY (%) EPS (euros) E Underlying EPS (euros) D E RoE RoTE Underlying RoTE D RoA RoRWA Underlying RoRWA D Efciency ratio D 244 2018 2017 %2018/2017 1,459,271 1,444,305 882,921 780,496 980,562 107,361 848,915 777,730 985,703 106,832 1.0 4.0 0.4 (0.5) 0.5 2016 1,339,125 790,470 691,111 873,618 102,699 2018 34,341 48,424 25,645 14,201 7,810 2018 34,341 48,424 25,645 14,776 8,064 2018 0.449 0.465 8.21 11.70 12.08 0.64 1.55 1.59 47.0 2017 %2018/2017 B 34,296 48,355 25,362 12,091 6,619 0.1 0.1 1.1 17.5 18.0 2017 %2018/2017 C 34,296 48,392 25,473 13,550 7,516 0.1 0.1 0.7 9.0 7.3 2017 %2018/2017 11.2 0.6 0.404 0.463 7.14 10.41 11.82 0.58 1.35 1.48 47.4 2016 31,089 44,232 23,131 10,768 6,204 2016 31,089 43,853 22,766 11,288 6,621 2016 0.401 0.429 6.99 10.38 11.08 0.56 1.29 1.36 48.1 2018 Annual Report Group selected data 2018 11.30 11.47 3.73 67.4 2017 10.84 12.26 4.08 65.2 2018 2017 %2018/2017 4,131,489 4,029,630 16,237 3.973 64,508 0.23 4.19 0.95 2018 143,759 19,896 18,149 1,747 32,014 2.5 0.6 (27.5) (27.0) 4.5 16,136 5.479 88,410 0.22 4.15 1.32 2017 %2018/2017 133,252 17,254 15,759 1,494 25,391 7.9 15.3 15.2 16.9 26.1 2016 10.55 12.53 3.93 73.8 2016 3,928,950 14,582 4.877 72,314 0.21 4.15 1.16 2016 124,882 15,220 13,864 1,356 20,917 2018 202,713 13,217 2017 %2018/2017 202,251 13,697 0.2 (3.5) 2016 188,492 12,235 SOLVENCY AND NPL RATIOS (%) Fully loaded CET1 F Phased-in CET1 F NPL ratio NPL coverage ratio THE SHARE, MARKET CAPITALISATION AND DIVIDEND Number of shareholders Shares (millions) Share price (euros) E Market capitalisation (euros) Dividend per share (EUR million)E G Tangible book value per share (euros) E Price / Tangible book value per share (X) E CUSTOMERS (thousands) Total customers Loyal customers H Loyal retail customers Loyal SMEs & corporate customers Digital customers I OPERATING DATA Number of employees Number of branches A. Includes customer deposits, mutual funds, pension funds and managed portfolios. B. In constant euros: Net interest income: +8.7%; Total income: +9.0%; Net operating income: +11.2%; Attributable proft: +32.1%. C. In constant euros: Net interest income: +8.7%; Total income: +8.9%; Net operating income: +10.6%; Attributable proft: +18.5%. D. In addition to IFRS measures, we present non-IFRS measures including those which we refer to as underlying measures. These underlying measures allow in our view a better year-on-year comparability as they exclude items outside the ordinary course performance of our business which are grouped in the ‘management adjustment’ line and are further detailed at the end of section 3.2 and in section 8 – Alternative Performance Measures – of this chapter. E. 2016 data adjusted to capital increase of July 2017. F. 2018 data applying the IFRS9 transitional arrangements. G. Total dividend charged against the year. In 2018, subject to the Board and 2019 AGM approval. H. Active customer who receive most of their fnancial services from the Group according to the commercial segment that they belong to. Various engaged customer levels have been defned taking proftability into account. I. Every consumer of a commercial bank’s services who has logged on to their personal online banking and/or mobile banking in the last 30 days. 245 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 3. Group fnancial performance 3.1 Situation of Santander At December 2018, Santander was the largest banking group in the Eurozone by market capitalisation (EUR 64,508 million) and the 16th in the world. The Group engages in all types of activities, operations and services that are typical of the banking business in general. Its business model is focused on commercial banking products and services with the aim of meeting the needs of its 144 million customers, including individuals, private banking customers, SMEs, businesses and corporates. Santander’s strategy remained focus on customer loyalty. The number of loyal customers (19.9 million) rose by 2.6 million in the year (+15%), with individuals as well as companies rising. The number of digital customers (32.0 million) rose by 6.6 million in 2018 (+26%), underscoring the strength of our digital strategy. The Group operates through a global network of 13,217 branches, the largest excluding Chinese banks and Sberbank Group, as well as digital channels, in order to provide top-quality service and fexibility. Santander is among the top three banks in customer satisfaction in seven of its main countries. Santander has EUR 1,459,271 million assets and manages EUR 980,562 million of total customer funds across all its customer segments. It has more than four million shareholders and over 200,000 employees. Retail Banking business accounts for 87% of the Group’s total income. The Group is highly diversifed and operates mainly in 10 core units, where it maintains signifcant market shares. As described in Note 1.b to the consolidated fnancial statements, our reported results are prepared in accordance with IFRS and the analysis of our fnancial situation and performance in this consolidated directors’ report is mainly based on those IFRS results. However, to measure our performance we also use non- IFRS measures and APMs or Alternative Performance Measures. While section 8 – Alternative Pe rformance Measures of this chapter provides a more detailed view of all those measures, these are the main adjustments we make to our IFRS results when providing non-IFRS measures: - Underlying results measures. We present what we call underlying results measures which in our view allow better year- on-year comparisons as they exclude items outside the ordinary course performance of our business which are grouped in the management adjustments line, and are further detailed at the end of section 3.2 of this chapter. In addition, the results by business areas in section 4 below are presented only on an underlying basis in accordance with IFRS8, and reconciled on an aggregate basis to our IFRS consolidated results in note 52.c to the consolidated fnancial statements. - Local currency measures. We make use of certain fnancial measures in local currency to help in the assessment of our ongoing operating performance. These non-IFRS fnancial measures include the results of operations of our subsidiary banks located outside the Eurozone, excluding the impact of foreign exchange. Because changes in foreign currency exchange rates have a non-operating impact on the results, we believe that evaluating their performance on a local currency basis provides an additional and meaningful assessment of performance to both management and the company’s investors. Section 8 – Alternative Performance Measures of this chapter explains how we exclude the exchange rate impact from fnancial measures in local currency. On the other hand, certain fgures contained in this consolidated directors’ report, including fnancial information, have been subject to rounding to enhance their presentation. Accordingly, in certain instances, the sum of the numbers in a column or a row in tables contained in this consolidated directors’ report may not conform exactly to the total fgure given for that column or row. 246 2018 Annual Report Group financial performance 3.2 Results 2018 Highlights Attributable profit to the parent of EUR 7,810 million, up 18% from 2017, including EUR -254 million, of management adjustments in 2018 (EUR -897 million in 2017). Excluding the FX impact it rose 32%, as follows: • Total income increased 9% backed by the rise in loyal and digital customers, increased business volumes (loans and deposits) and management of spreads. • Operating expenses rose 7% because of higher inflation in some countries, investments in transformation and digitalisation and integration of some entities. In real terms (excluding inflation and the perimeter effect), costs decreased 0.5%. • Our efficiency ratio (47%) continued to make us one of the most efficient global banks in the world, with a slight year-on-year improvement. Credit quality continued to improve: cost of credit of 1.00% and NPL ratio of 3.73%. Seven of our ten core units grew their underlying profit year-on-year in local currency. Five of them at double-digit rates. The Group’s profitability continues to be one of the best among European banks with a RoTE of 11.7%. RoTE and RoRWA improved year-on-year. Earnings per share (EPS) were EUR 0.449, 11.2% higher than in 2017 (EUR 0.404). Summarised income statement EUR million Net interest income Net fee income (commission income minus commission expense) Gains or losses on fnancial assets and liabilities and exchange diferences (net) Dividend income Share of results of entities accounted for using the equity method Other operating income / expenses Total income Operating expenses Administrative expenses Staf costs Other general administrative expenses Depreciation and amortisation Impairment or reversal of impairment of fnancial assets not measured at fair value through proft or loss (net) o/w: net loan-loss provisions Impairment on other assets (net) Provisions or reversal of provisions Gain or losses on non fnancial assets and investments, net Negative goodwill recognised in results Gains or losses on non-current assets held for sale not classifed as discontinued operations Proft or loss before tax from continuing operations Tax expense or income from continuing operations Proft from the period from continuing operations Proft or loss after tax from discontinued operations Proft for the period Attributable proft to non-controlling interests Attributable proft to the parent Change 2017 Absolute % % excl. FX 2018 34,341 11,485 1,797 370 737 (306) 48,424 34,296 11,597 1,665 384 704 (291) 48,355 (22,779) (22,993) (20,354) (11,865) (8,489) (2,425) (20,400) (12,047) (8,353) (2,593) (8,986) (8,873) (207) (2,223) 28 67 (123) 14,201 (4,886) 9,315 — 9,315 1,505 7,810 (9,259) (9,111) (1,273) (3,058) 522 — (203) 12,091 (3,884) 8,207 — 8,207 1,588 6,619 45 (112) 132 (14) 33 (15) 69 214 46 182 (136) 168 273 238 1,066 835 (494) 67 80 2,110 (1,002) 1,108 — 1,108 (83) 1,191 0.1 (1.0) 7.9 (3.6) 4.7 5.2 0.1 (0.9) (0.2) (1.5) 1.6 (6.5) (2.9) (2.6) (83.7) (27.3) (94.6) — (39.4) 17.5 25.8 13.5 — 13.5 (5.2) 18.0 8.7 8.5 20.9 (1.0) 14.2 19.8 9.0 6.6 7.6 5.6 10.6 (0.8) 6.8 7.2 (83.4) (21.6) (94.5) — (35.9) 30.3 40.0 25.8 — 25.8 0.8 32.1 2016 31,089 10,180 2,101 413 444 5 44,232 (21,101) (18,737) (11,004) (7,733) (2,364) (9,626) (9,518) (140) (2,508) 30 22 (141) 10,768 (3,282) 7,486 — 7,486 1,282 6,204 247 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Detail of the main income statement items Total income Total income amounted to EUR 48,424 million, virtually unchanged in the year. Excluding the exchange rate impact it rose 9%. Net interest income and fee income accounted for 95% of total income, well above the average of our competitors, enabling consistent and recurring growth while limiting the impact that periods of high volatility can have on gains on financial transactions. Net interest income Net interest income in 2018 amounted to EUR 34,341 million, very similar compared to 2017. The following tables show the average balance sheet balances for each year, obtained as the average of the months in the period. We do not believe that monthly averages present trends that are materially diferent from trends that daily averages would show, as well as the interest generated. They also include, by domicile of the Group entity at which the relevant assets or liabilities are accounted for, our average balances and average interest rates obtained in 2018 and 2017. Domestic balances are those of Group entities domiciled in Spain, which refect our domestic activity, and international balances are those of Group entities domiciled outside of Spain, which refect our foreign activity. Within the latter, mature markets include Continental Europe (except Spain and Poland), the UK and the US. On the other hand, developing markets include Latin America and Poland. The average balance of interest-earning assets was EUR 1,246,189 million in 2018, 3% higher year-on-year (EUR 1,204,847 million). The increase was largely due to domestic activities, benefting from the acquisition of Banco Popular in June 2017, and mature markets, driven by the growth of Santander Consumer Finance and the US. On the other hand, developing markets decreased because of exchange rates. Average balance sheet - assets and interest income EUR million Assets Cash and deposits at central banks and loans and advances to credit institutions Domestic International - Mature markets International - Developing markets Loans and advances to customers Domestic International - Mature markets International - Developing markets Debt securities Domestic International - Mature markets International - Developing markets Hedging income Domestic International - Mature markets International - Developing markets Other interest Domestic International - Mature markets International - Developing markets Total interest-earning assets Domestic International - Mature markets International - Developing markets Other assets Assets from discontinued operations Average total assets 248 2018 2017 Average balance Interest Average rate (%) Average balance Interest Average rate (%) 192,669 2,875 1.49% 182,712 3,721 2.04% 75,250 66,326 51,093 861,327 240,845 451,034 169,448 192,193 70,746 55,173 66,274 188 342 2,345 0.25% 0.52% 4.59% 43,489 5,366 17,287 20,836 5.05% 2.23% 3.83% 12.30% 6,429 1,007 792 4,630 3.35% 1.42% 1.44% 6.99% 59,335 68,312 55,065 824,226 220,067 433,894 170,265 197,909 73,166 56,602 68,141 305 (37) (37) 379 1,227 617 407 203 119 195 3,407 0.20% 0.29% 6.19% 43,640 4,828 17,153 21,659 5.29% 2.19% 3.95% 12.72% 3.61% 1.80% 1.45% 7.35% 7,141 1,315 821 5,005 507 2 (234) 739 1,032 432 330 270 1,246,189 386,841 572,533 286,815 196,672 — 1,442,861 54,325 7,141 18,791 28,393 4.36% 1.85% 3.28% 9.90% 54,325 1,204,847 352,568 558,808 293,471 202,834 — 1,407,681 56,041 6,696 18,265 31,080 4.65% 1.90% 3.27% 10.59% 56,041 2018 Annual Report Group financial performance The average return on total interest-earning assets declined 29 bps to 4.36%. The drop was largely due to the activities conducted by our entities in developing markets, which fell 69 bps to 9.90% during the period. All balance sheet items decreased (cash and deposits from central banks and credit entities: -160 bps; Loans and advances to customers: -42 bps; Debt securities: -36 bps). The average return on total interest-earning assets from the domestic activities fell 5 bps to 1.85% (cash and due from central banks and credit entities: +5 bps; Loans and advances to customers: +4 bps; Debt securities: -38 bps). The average balance of interest-bearing liabilities was EUR 1,193,108 million in 2018, an increase of 4% year-on-year (EUR 1,147,616 million). As with the interest-earning assets, the increase was largely due to domestic activities, heavily impacted by the acquisition of Banco Popular and the mature markets. On the other hand, balances in the developing markets were afected, as well as the assets, by exchange rates. The average cost of interest-bearing liabilities fell 22 bps to 1.67%. The drop was also largely due to the activities carried out by our international entities in the developing markets, whose average cost declined 99 bps to 4.73%, mostly due to lower average interest rates on customer deposits (-115 bps) and marketable debt securities (-177 bps). The average cost of domestic activities fell 7 bps to 0.79% mainly due to the lower cost of customer deposits (-17 bps). Average balance sheet - liabilities and interest expense EUR million Liabilities and stockholders’ equity Deposits from central banks and credit institutions Domestic International - Mature markets International - Developing markets Customer deposits Domestic International - Mature markets International - Developing markets Marketable debt securities Domestic International - Mature markets International - Developing markets Other interest-bearing liabilities Domestic International - Mature markets International - Developing markets Hedging expenses Domestic International - Mature markets International - Developing markets Other interest Domestic International - Mature markets International - Developing markets Total interest-bearing liabilities Domestic International - Mature markets International - Developing markets Other liabilities Non-controlling interests Shareholders´ equity Liabilities from discontinued operations Average total liabilities and stockholders´ equity Average balance 182,268 93,873 55,992 32,403 740,469 219,194 351,034 170,241 216,720 74,029 104,501 38,190 8,159 6,102 940 1,117 Average balance 191,073 101,728 57,768 31,577 773,578 250,470 351,873 171,235 221,196 75,752 111,863 33,581 7,261 5,470 799 992 2018 Interest Average rate (%) 1.58% 0.50% 1.14% 5.86% 1.17% 0.35% 0.59% 3.56% 2.75% 2.05% 2.28% 5.86% 2.56% 1.66% 0.63% 9.07% 3,018 509 659 1,850 9,062 882 2,085 6,095 6,073 1,555 2,550 1,968 186 91 5 90 24 (83) (108) 215 1,620 485 127 1,008 1,193,108 433,420 522,303 237,385 19,984 3,440 5,318 11,226 1.67% 0.79% 1.02% 4.73% 143,798 10,884 95,071 — 1,442,861 19,984 1,147,616 393,198 512,467 241,951 155,072 12,356 92,637 — 1,407,681 2017 Interest Average rate (%) 1.24% 0.28% 0.94% 4.54% 1.50% 0.52% 0.55% 4.71% 3.07% 2.01% 2.15% 7.63% 2.43% 1.64% 0.64% 8.24% 2,261 261 529 1,471 11,074 1,140 1,919 8,015 6,651 1,489 2,248 2,914 198 100 6 92 (234) (27) (256) 49 1,795 399 92 1,304 21,745 3,362 4,538 13,845 1.89% 0.86% 0.89% 5.72% 21,745 249 Responsible bankingCorporate governanceEconomic and financial reviewRisk management The change in interest income / (expense) shown in the table below was calculated as follows: • The change in volumes, which is obtained by applying the previous period’s interest rates to the diference between the average balances of the current and previous periods. • Interest income declined EUR 1,716 million due to developing markets, which ofset the increase in domestic activity and mature markets. • Interest expense fell EUR 1,761 million also due to developing markets. • The change in interest rate, which is obtained by applying to the average balance for the previous year the diference between the rates of the current and previous periods. The performance of interest income and interest expense was the following: • As a result, net interest income increased EUR 45 million due to the net impact of increased domestic and mature market’s volumes and higher rates in developing countries, ofset by the fall in volumes in developing markets (exchange rates) and low interest rates in mature ones. Volume and proftability analysis EUR million 2018 / 2017 Increase (decrease) due to changes in Rate (715) 33 82 (830) (1,644) 76 (1,000) (720) (519) (266) (13) (240) Net variation (846) 69 147 (1,062) (151) 538 134 (823) (712) (308) (29) (375) (202) (39) 197 (360) 195 185 77 (67) (2,878) (157) (931) (1,790) (1,716) 445 526 (2,687) Interest income Volume (131) 36 65 (232) 1,493 462 1,134 (103) (193) (42) (16) (135) (202) (39) 197 (360) 195 185 77 (67) 1,162 602 1,457 (897) Cash and deposits at central banks and loans and advances to credit institutions Domestic International - Mature markets International - Developing markets Loans and advances to customers Domestic International - Mature markets International - Developing markets Debt securities Domestic International - Mature markets International - Developing markets Hedging income Domestic International - Mature markets International - Developing markets Other interest Domestic International - Mature markets International - Developing markets Total interest-earning assets Domestic International - Mature markets International - Developing markets 250 2018 Annual Report Volume and costs analysis EUR million Interest expense Deposits from central banks and credit institutions Domestic International - Mature markets International - Developing markets Customer deposits Domestic International - Mature markets International - Developing markets Marketable debt securities Domestic International - Mature markets International - Developing markets Other interest-bearing liabilities Domestic International - Mature markets International - Developing markets Hedging expenses Domestic International - Mature markets International - Developing markets Other interest Domestic International - Mature markets International - Developing markets Total interest-bearing liabilities Domestic International - Mature markets International - Developing markets Group financial performance 2018 / 2017 Increase (decrease) due to changes in Volume 45 23 60 (38) 182 147 (12) 47 133 35 422 (324) (23) (10) (2) (11) 258 (56) 148 166 (175) 86 35 (296) 420 225 651 Rate 712 225 70 417 (2,194) (405) 178 (1,967) (711) 31 (120) (622) 11 1 1 9 Net variation 757 248 130 379 (2,012) (258) 166 (1,920) (578) 66 302 (946) (12) (9) (1) (2) 258 (56) 148 166 (175) 86 35 (296) (2,181) (1,761) (147) 129 78 780 (456) (2,163) (2,619) 251 Responsible bankingCorporate governanceEconomic and financial reviewRisk managementNet interest income. Summary of volume, proftability and costs analysis EUR million Interest income Domestic International - Mature markets International - Developing markets Interest expense Domestic International - Mature markets International - Developing markets Net interest income Domestic International - Mature markets International - Developing markets 2018 / 2017 Increase (decrease) due to changes in Volume Rate Net variation 1,162 602 1,457 (897) 420 225 651 (2,878) (1,716) (157) (931) 445 526 (1,790) (2,687) (2,181) (1,761) (147) 129 78 780 (456) (2,163) (2,619) 742 377 806 (441) (697) (10) (1,060) 373 45 367 (254) (68) Net interest income remained stable, virtually unchanged in euros. Excluding the exchange rate impact, net interest income rose 9%, due to greater loans and advances to customers and customer deposit volumes, mainly in developing countries, which grew at double-digit rates in local currency volumes and spreads increased. The performance by geographic areas excluding the exchange rate impact was the following: Banco Popular’s integration; Mexico (+13%) driven by increased volumes and higher interest rates. Growth also in the US (+1%) driven by greater volumes which ofset lower spreads on loans in Santander Consumer USA and the higher cost of funding from Santander Bank; and Argentina (+52%), spurred by management of spreads in a scenario of higher interest rates, volumes and infation. • All countries grew except for the UK. Of note was: Spain (+15%), with sustained improvement of spreads driven by our strategy to reduce the cost of deposits and Banco Popular’s integration; Brazil (+16%) due to higher volumes; Portugal (+9%) partly due to • The UK decreased 4% due to pressure on spreads on new mortgages lending and lower standard variable rate (SVR) balances. Net interest income EUR million Net fee income EUR million 34,296 34,341 31,089 11,597 11,485 10,180 0%A 2018 vs 2017 -1%A 2018 vs 2017 2016 2017 2018 2016 2017 2018 A. Excluding exchange rate impact: +9%. A. Excluding exchange rate impact: +9%. 252 2018 Annual Report Net fee income EUR million Fees from services Credit and debit cards Account management Bill discounting Guarantees and other contingent liabilities Other operations Mutual and pension funds Securities and custody services Managed portfolio business Insurance Net fee income Group financial performance Change 2017 Absolute % % excl. FX 2016 2018 7,037 2,156 1,371 323 414 2,774 1,108 794 305 7,350 2,124 1,490 357 501 2,879 815 841 251 2,241 2,340 11,485 11,597 (312) 32 (120) (34) (87) (104) 293 (47) 54 (99) (112) (4.3) 1.5 (8.0) (9.5) (17.4) (3.6) 35.9 (5.6) 21.5 (4.2) (1.0) 6.3 12.6 8.7 3.9 (11.6) 3.9 41.0 1.7 34.5 4.3 8.5 6,261 1,755 1,191 284 435 2,597 757 712 201 2,249 10,180 Net fee income Net fee income amounted to EUR 11,485 million, 1% below 2017. Excluding the exchange rate impact, net fee income was 9% higher, refecting greater activity and more loyal customers, as well as the strategy of growth in services and higher value-added products and in areas of low capital consumption. By global businesses, excluding the exchange rate impact, growth in net fee income from Retail Banking (+6%) and Wealth Management (+63%), while that from Santander Corporate & Investment Banking was stable (+0.3%) in the year. By region, net fee income rose in all units, with two exceptions: SCF (-9%) due to the adaptation of insurance business to the new environment, and the US (-7%) driven by lower servicing fees at Santander Consumer USA and the New York branch. The largest increases were recorded in Argentina (+47%) spurred by greater buying and selling foreign currency activity in a volatile exchange rate environment and higher revenue from cash management; Spain (+13%) thanks to increased transactions; Brazil (+15%) with rises in almost all lines, particularly in cards, current accounts, mutual funds and insurance; and Chile (+12%) driven by income from insurance, mutual funds and cards. Gains / (losses) on fnancial assets and liabilities and exchange diferences (net) Gains / (losses) on fnancial assets and liabilities and exchange diferences (net), which account for less than 4% of total income, increased 8% to EUR 1,797 million. Excluding the exchange rate impact, they rose 21% driven by increases in Spain (sale of ALCO portfolios), Argentina (favoured by market’s volatility), and the Corporate Centre, the latter resulting from reduced hedging costs of exchange rates. In this line item, gains and losses on fnancial assets and liabilities are due to the following: trading portfolio and derivative instruments marked-to-market, including spot market foreign exchange transactions, sales of investment securities and liquidation of our corresponding hedge or other derivative positions. For further details, see note 44 to the consolidated fnancial statements. Exchange rate diferences show basically the gains / (losses) on currency dealings, the diferences that arise on translations of monetary items in foreign currencies to the functional currency, and those disclosed on non-monetary assets in foreign currency at the time of their disposal. The Group manages the currencies to which it is exposed together with the arrangement of derivative instruments and, accordingly, the changes in this line item should be analysed together with those recognised under Gains / (losses) on fnancial assets and liabilities. For further details, see note 45 to the consolidated fnancial statements. Dividend income Dividend income was EUR 370 million in 2018, 4% less than in 2017 (EUR 384 million). Excluding the exchange rate impact, it was 1% lower. Share of results of entities accounted for by the equity method The share of results of entities accounted for by the equity method were EUR 737 million in 2018, 5% higher than in 2017 (EUR 704 million). Excluding the exchange rate impact, they increased 14%, mainly driven by Spain. For further information, see notes 13 and 41 to the consolidated fnancial statements. Other operating income / (expenses) Losses on net other operating income in 2018 were EUR 306 million (losses of EUR 291 million in 2017). Included in this item are income and expenses from insurance activity, non-fnancial services, other fees and contributions to the Deposit Guarantee Fund and the Single Resolution Fund. The higher loss was due to the increased contribution of EUR 47 million to these funds. For further information, see note 46 to the consolidated fnancial statements. 253 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Operating expenses EUR million Staf costs Other administrative expenses Information technology Communications Advertising Buildings and premises Printed and ofce material Taxes (other than tax on profts) Other expenses Administrative expenses Depreciation and amortisation Operating expenses 2018 2017 Absolute % % excl. FX Change 11,865 12,047 (182) 8,489 1,550 527 646 8,353 1,257 529 757 1,846 1,798 122 557 133 583 3,240 3,296 20,354 20,400 2,425 2,593 22,779 22,993 (1.5) 1.6 23.4 (0.5) 136 294 (2) (110) (14.6) 48 (11) (26) (56) (46) (168) (214) 2.7 (8.2) (4.5) (1.7) (0.2) (6.5) (0.9) 2016 11,004 7,733 1,094 499 691 1,708 146 484 3,111 18,737 2,364 21,101 5.6 10.6 33.0 10.8 (8.1) 8.7 (1.3) 3.7 6.3 7.6 (0.8) 6.6 Operating expenses Operating expenses totalled EUR 22,779 million, 1% lower year- on-year. Administrative expenses remained almost stable, and depreciation and amortisation decreased 6%. We believe that the measures to optimise costs, as part of the ongoing integration processes mainly in Spain, Portugal and Poland, will be refected in greater synergies in the future. This evolution is enabling us to combine the investments made to enhance the customer experience with an operational efciency that continues to be the sector’s reference. Excluding the exchange rate impact, operating expenses rose 7% as a result of higher infation in some countries, investments in transformation and digitalisation, and various integration processes. The efciency ratio (cost-to-income ratio) was 47.0% in 2018, better than in 2017 (47.4%), enabling us to combine one of the sector’s best efciency ratios and be among the top three banks in customer satisfaction in seven of our core countries. In real terms (excluding infation and perimeter), costs remained fat for the second year running (-0.5% in 2018 and +0.3% in 2017). Of note by units were the lower costs in the US, Spain, SCF and Portugal. The latter three refecting the integration processes implemented. The main rises were in Mexico and Chile, due to investments in infrastructure, and in Poland, due to transformation projects and pressure on salaries. Efciency ratio (cost-to-income) % 48.1 47.4 47.0 2016 2017 2018 -0.4 pp 2018 vs 2017 Impairment or reversal of impairment of fnancial assets not measured at fair value through proft or loss (net) Impairment or reversal of impairment of fnancial assets not measured at fair value through proft or loss (net) were EUR 8,986 million in 2018, a 3% decrease (EUR 9,259 million in 2017). In this item, net loan-loss provisions was 3% lower at EUR 8,873 million. Excluding the exchange rate impact, they rose 7%, with the following detail by countries: • The largest increases were in Spain due to the acquisition of Banco Popular; SCF, because of higher releases and portfolio sales in 2017, although its cost of credit remained below the standards for this business; and Argentina due to higher provisions for individual customers and the impact of the peso’s depreciation on dollar balances. • Lastly, the US and Mexico recorded falls in the year, growth in Brazil although at a slower pace than the loan book, as well as the UK and Portugal, which maintained a low cost of credit at below 10 bps. Credit quality ratios performed well in the last twelve months. The NPL ratio improved to 3.73% from 4.08% in 2017, the coverage ratio increased to 67% from 65% a year earlier, while the cost of credit fell 7 bps to 1.00%. By countries, the NPL ratio improved in eight of our 10 core units and coverage in six. 254 2018 Annual Report Group financial performance Impairment or reversal of impairment of fnancial assets not measured at fair value through proft or loss (net) EUR million Financial assets at fair value through other comprehensive income Financial assets at amortised cost Financial assets measured at cost Financial assets available-for-sale Loans and receivables Held-to-maturity investments Impairment or reversal of impairment of fnancial assets not measured at fair value through proft or loss (net) Impairment on other assets (net) EUR million Impairment of investments in subsidiaries, joint ventures and associates, net Impairment on non-fnancial assets, net Tangible assets Intangible assets Others Impairment on other assets (net) 2018 1 8,985 2017 2016 8 10 9,241 — 52 (11) 9,557 28 8,986 9,259 9,626 2018 17 190 83 117 (10) 207 2017 13 1,260 72 1,073 115 1,273 2016 17 123 55 61 7 140 For further details, see the ‘Credit risk’ section in the Risk management chapter. For further details, see note 25 to the consolidated fnancial statements. Impairment on other assets (net) Gains or losses on non-fnancial assets and investments (net) Impairment on other assets in 2018 declined to EUR 207 million. In 2017, it was EUR 1,273 million, including impairment losses of EUR 1,073 million in intangible assets, of which EUR 799 million was related to the goodwill of Santander Consumer USA. Net gains on non-fnancial assets and investments were EUR 28 million in 2018, compared to EUR 522 million in 2017. The decrease was mainly due to the fact that in 2017 we recorded capital gains from the sale of Allfunds Bank (EUR 425 million). Provisions or reversal of provisions For further details, see note 49 to the consolidated fnancial statements. Provisions (net of reversal provisions) declined 27% in 2018, to EUR 2,223 million (EUR 3,058 million in 2017). Excluding the exchange rate impact, 22% decrease mainly due to lower provisions for legal and labour claims (trabalhistas) in Brazil and for potential customer complaints in the UK. Cost of credit % Net loan-loss provisions EUR million 9,518 1.18 1.07 1.00 9,111 8,873 -0.07 pp 2018 vs 2017 -3% A 2018 vs 2017 2016 2016 2017 2017 2018 2018 2016 2017 2018 A. Excluding exchange rate impact: +7%. 255 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Attributable proft to the parent EUR million Earnings per share Euros 7,810 6,204 6,619 0.401 0.404 0.449 +18%A 2018 vs 2017 +11% 2018 vs 2017 2016 2017 2018 2016 A 2017 2018 A. Excluding exchange rate impact: +32%. A. Adjusted to capital increase of July 2017. Negative goodwill recognised in results Attributable proft to non-controlling interests In 2018, EUR 67 million (no negative goodwill was recorded in 2017) due to the diference between the fair value of the net assets acquired with the acquisition of Deutsche Bank Polska in Poland and the transaction value. The attributable proft to non-controlling interests was EUR 1,505 million, 5% lower than in 2017. Excluding the exchange rate impact, it rose 1%. Gains or losses on non-current assets held for sale not classifed as discontinued operations This item, which includes mainly impairment of foreclosed assets recorded and the sale of properties acquired upon foreclosure, were EUR -123 million in 2018, compared to EUR -203 million in 2017. Proft before tax Proft before tax was 17% higher, at EUR 14,201 million. Excluding the exchange rate impact, it increased 30%, driven by strong customer revenue (NII+fee income), controlled costs and the improved cost of credit. Income tax Corporate income tax was EUR 4,886 million in 2018, a 26% increase from EUR 3,884 million in 2017. The efective tax rate for the Group as a whole was 34.4% compared to 32.1% in 2017. For further details, see note 28 to the consolidated fnancial statements. Attributable proft to the parent Attributable proft to the parent amounted to EUR 7,810 million, 18% higher compared to 2017 (EUR 6,619 million). Excluding the exchange rate impact, attributable proft was 32% higher year- on-year. RoE was 8.21%, RoTE 11.70% and RoRWA 1.55% (7.14%, 10.41% and 1.35% respectively in 2017). Earnings per share was EUR 0.449, a 11.2% increase compared to 2017 (EUR 0.404). RoRWA % 10.38 10.41 11.70 1.29 1.35 1.55 2016 2017 2018 2016 2017 2018 RoTE % 256 2018 Annual Report Group financial performance Underlying attributable proft to the parent iii. Impairment of equity stakes and intangible assets held by the The attributable proft to the parent recorded in 2018 and 2017 was afected by the following results (net of tax), that are outside the ordinary course performance of our business and distort the year-on-year comparison: 1. These results recorded in 2018 for EUR -254 million net of tax were related to integrations (mainly restructuring costs; EUR -280 million in Spain and EUR -40 million at the Corporate Centre, both related to Popular), and positive results for integration in Portugal (EUR 20 million) and the negative goodwill adjustment in Poland (EUR 45 million). 2. These results in 2017 had a net impact of EUR -897 million on proft, as follows: i. Sale of Santander’s stake in Allfunds Bank. The capital gains from the disposal of Santander’s 25% stake amounted to EUR 297 million (gross EUR 425 million recorded in gains/losses on disposal of non-fnancial assets and investments). ii. Restructuring costs: charge of EUR 300 million for the integration of Banco Popular and an additional charge of EUR 85 million due to the integration of the commercial networks in Germany. Group of EUR 130 million. iv. Impairment of goodwill in Santander Consumer USA of EUR 603 million. v. Net impact of the tax reform, provisions for hurricanes and other provisions in the US of EUR -76 million. For further details, see note 52.c to the consolidated fnancial statements. Excluding these results from the diferent P&L lines where they are recorded, and including them separately in the management adjustments line, underlying attributable proft to the parent rose 7% to EUR 8,064 million (EUR 7,516 million in 2017). Excluding the exchange rate impact, it was 18% higher. By units, Spain, Portugal, Brazil, Mexico and the US recorded double-digit growth, while SCF and Chile also rose. Poland remained stable while the UK and Argentina decreased, the latter afected by the high infation adjustment. 2018 Management adjustments EUR million (net of tax) 2017 Management adjustments EUR million (net of tax) -320 - 254 40 Corporate Centre integration costs 66 280 Spain integration costs 370 -897 73 US tax reform 297 Allfunds capital gains 45 Poland badwill 20 Portugal integration -1,267 130 equity stakes and intangible assets 85 Germany integration costs 300 Popular integration costs 149 US (hurricanes and other provisions) 603 goodwill (Santander Consumer USA) Positive Net Negative Positive Net Negative Attributable proft to the parent EUR million Underlying attributable proft to the parent Management adjustments Attributable proft to the parent 2018 8,064 (254) 7,810 Change 2017 Absolute % % excl. FX 7,516 (897) 6,619 548 643 1,191 7.3 (71.7) 18.0 18.5 (71.6) 2016 6,621 (417) 32.1 6,204 257 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Underlying RoTE A % Underlying RoRWA A % 11.82 12.08 11.08 1.59 1.48 1.36 2016 2017 2018 2016 2017 2018 A. Excluding management adjustments. A. Excluding management adjustments. As a result, the Group’s underlying RoTE was 12.08% compared to 11.82% in 2017, and underlying RoRWA was 1.59% in 2018 compared to 1.48% a year earlier. Below, the summarised income statement adjusted to the items outside the ordinary course performance of our business (included in the management adjustments line) as detailed in note 52.c of the consolidated fnancial statements, where the reconciliation of the aggregate underlying consolidated results of our segments to the statutory consolidated results is presented. Summarised underlying income statement EUR million Net interest income Net fee income Gains (losses) on fnancial transactions and exchange diferences Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent 2018 2017 Absolute % % excl. FX 2016 Change 34,341 11,485 1,797 801 48,424 (22,779) 25,645 (8,873) (1,996) 14,776 (5,230) 9,546 — 9,546 1,482 8,064 34,296 11,597 1,703 796 48,392 (22,918) 25,473 (9,111) (2,812) 13,550 (4,587) 8,963 — 8,963 1,447 7,516 45 (112) 94 5 32 139 172 238 816 1,226 (643) 583 — 583 35 548 0.1 (1.0) 5.5 0.6 0.1 (0.6) 0.7 (2.6) (29.0) 9.0 14.0 6.5 — 6.5 2.4 7.3 8.7 8.5 18.0 4.9 8.9 7.0 10.6 7.2 (22.1) 19.7 25.2 16.9 — 16.9 9.1 18.5 31,089 10,180 1,723 862 43,853 (21,088) 22,766 (9,518) (1,960) 11,288 (3,396) 7,892 0 7,893 1,272 6,621 258 2018 Annual Report Group financial performance 3.3 Balance sheet Balance sheet A EUR million Assets Cash, cash balances at central banks and other deposits on demand Financial assets held for trading Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss Financial assets at fair value through other comprehensive income Financial assets available-for-sale Financial assets at amortised cost Loans and receivables Investments held-to-maturity Hedging derivatives Changes in the fair value of hedged items in portfolio hedges of interest risk Investments Assets under insurance or reinsurance contracts Tangible assets Intangible assets Tax assets Other assets Non-current assets held for sale Total assets Liabilities and equity Financial liabilities held for trading Financial liabilities designated at fair value through proft or loss Financial liabilities at amortised cost Hedging derivatives Changes in the fair value of hedged items in portfolio hedges of interest rate risk Liabilities under insurance or reinsurance contracts Provisions Tax liabilities Other liabilities Liabilities associated with non-current assets held for sale Total liabilities Shareholders' equity Other comprehensive income Minority interests Total equity Total liabilities and equity 2018 113,663 92,879 10,730 57,460 121,091 946,099 8,607 1,088 7,588 324 26,157 28,560 30,251 9,348 5,426 1,459,271 70,343 68,058 1,171,630 6,363 303 765 13,225 8,135 13,088 — 1,351,910 118,613 (22,141) 10,889 107,361 1,459,271 Change 2017 110,995 125,458 Absolute 2,668 (32,579) % 2.4 (26.0) 2016 76,454 148,187 34,782 22,678 65.2 31,609 133,271 903,013 13,491 8,537 1,287 6,184 341 22,974 28,683 30,243 9,766 15,280 1,444,305 107,624 59,616 1,126,069 8,044 330 1,117 14,489 7,592 12,591 — 1,337,472 116,265 (21,776) 12,344 106,833 1,444,305 70 (199) 1,404 (17) 3,183 (123) 8 (418) (9,854) 14,966 (37,281) 8,442 45,561 (1,681) (27) (352) (1,264) 543 497 — 14,438 2,348 (365) (1,455) 528 14,966 0.8 (15.5) 22.7 (5.0) 13.9 (0.4) 0.0 (4.3) (64.5) 1.0 (34.6) 14.2 4.0 (20.9) (8.2) (31.5) (8.7) 7.2 3.9 — 1.1 2.0 1.7 (11.8) 0.5 1.0 116,774 840,004 14,468 10,377 1,481 4,836 331 23,286 29,421 27,678 8,447 5,772 1,339,125 108,765 40,263 1,044,240 8,156 448 652 14,459 8,373 11,070 — 1,236,426 105,977 (15,039) 11,761 102,699 1,339,125 A. Due to the application of IFRS9 from 1 January 2018 and the decision to not restate the fnancial statements, as permitted in the regulation, the balance sheet of December 2018 is not comparable with previous reporting periods in some items. Note 1.b to the consolidated fnancial statements includes a reconciliation of balances as of 31 December 2017 under IAS39 and the corresponding balances as of 1 January 2018 under IFRS9 where the efect of the frst application of the rule is broken down. 259 Responsible bankingCorporate governanceEconomic and financial reviewRisk management  2018 Highlights Loans and advances to customers increased 4% year-on-year. The Group uses gross loans excluding reverse repurchase agreements for the purpose of analysing the traditional retail banking loans. • The latter, excluding the exchange rate impact, grew 4%, and in eight of the ten core units, particularly in developing countries (+14%). • The loan portfolio maintained a balanced structure: individuals (45%), consumer credit (17%), SMEs and companies (27%) and SCIB (11%). Customer deposits remained stable year-on-year. The Group uses customer deposits, excluding repos, and mutual funds, excluding the exchange rate impact, for the purpose of analysing the traditional retail banking funds: • Customer funds rose 4%. with growth in eight of the ten core units (basically flat in the other two). Demand and time deposits, in particular, grew while mutual funds remained virtually unchanged because of the market environment. • The customer funds structure is also clearly diversified by product: demand deposits (61%), time deposits (22%) and investment funds (17%). The net loan-to-deposit ratio was 113% (109% in 2017) reflecting the retail nature of our balance sheet. Loans and advances to customers amounted EUR 882,921 million in December 2018, a 4% increase compared to EUR 848,915 million at the end of 2017. Gross loans and advance to customers, excluding the exchange rate impact and reverse repos, increased 4%, with the following highlights: The Group uses gross loans excluding reverse repurchase agreements for the purpose of analysing the traditional commercial banking loans. To facilitate the evaluation of the management of the Group in the period reviewed, some comments below do not take into account exchange rates, which have a negative impact on the Group as a whole of two percentage points. – Rises in eight of the ten core countries, notably all developing markets which grew 14%: Argentina (+40%), due to balances in pesos as well as the impact of the peso’s depreciation on dollar balances, Poland (+30%) partly due to the integration of the retail and SME businesses acquired from Deutsche Bank Polska, Brazil (+13%), and Mexico and Chile (+10% each). Loans and advances to customers EUR million Commercial bills Secured loans Other term loans Finance leases Receivable on demand Credit cards receivable Impaired assets 2018 2017 Absolute Change 33,301 29,287 478,068 473,936 265,696 257,441 30,758 8,794 28,511 6,721 23,083 21,809 4,014 4,132 8,255 2,247 2,073 1,274 34,218 36,280 (2,062) Gross loans and advances to customers (excl. reverse repos) 873,918 853,985 19,933 Reverse repos Gross loans and advances to customers Loan-loss allowances 32,310 18,864 13,446 906,228 872,849 33,379 23,307 23,934 (627) (2.6) 24,393 Net loans and advances to customers 882,921 848,915 34,006 4.0 790,470 260 % 13.7 0.9 3.2 7.9 30.8 5.8 (5.7) 2.3 71.3 3.8 2016 23,894 454,677 232,288 25,357 8,102 21,363 32,573 798,254 16,609 814,863 2018 Annual Report Gross loans and advances to customers (excluding reverse repos) EUR billion 798 854 874 Group financial performance Gross loans and advances to customers (excluding reverse repos) % of operating areas. December 2018 Argentina: 1% Chile: 4% Brazil: 9% Mexico: 4% US: 10% Other Americas: 1% Spain: 24% 2016 2017 2018 A. Excluding exchange rate impact: +4%. +2%A 2018 vs 2017 Other Europe: 2% Poland: 3% Portugal: 4% SCF: 11% United Kingdom: 27% – More moderate growth in the mature markets (+1%), with growth • In Spain, 70% of loans are linked to foating rates and 30% at in the US (+6%) supported by higher origination volumes at Santander Consumer USA, and growth in consumer, companies, and SCIB at Santander Bank. The UK increased slightly (+1%). – Portugal and Spain’s banking sector continued to deleverage with a credit decrease around 3%. In this context, we recorded declines. In Portugal, down 2%, because of the sale of non- productive portfolios and in Spain by 4% because of lower wholesale balances and institutions. Gross loans and advance to customers excluding reverse repos maintained a balanced structure: individuals (45%), consumer credit (17%), SMEs and companies (27%) and SCIB (11%). At 2018 year-end, 53% of total loans and advances to customers maturing in over one year, were linked to foating interest rates, while the remaining 47% was linked to fxed rates, with the following detail by country: fxed rates. • Internationally, 48% of loans are at foating rates and 52% at fxed rates. For further information on the distribution of customer loans and advances by business line, see note 10.b to the consolidated fnancial statements. Tangible assets amounted to EUR 26,157 million in December 2018, increasing EUR 3,183 million and 14% from December 2017 (EUR 22,974 million), driven by the increase recorded in the US from assets associated with leasing business. Intangible assets rose to EUR 28,560 million, of which EUR 25,466 million correspond to goodwill, which decreased EUR 303 million in the year (-1%) as a net result of an increase mainly due to the card business purchase from WiZink, S.A., ofset by the exchange rate impact. Loans and advances to customers facilities with maturities exceeding one year at year-end of 2018 EUR million Fixed Floating TOTAL Dome stic Interna tional Total Weight over the total (%) Weight over the total (%) Amount Amount 30% 255,354 52% 306,896 70% 235,646 48% 353,095 Weight over the total (%) 47% 53% Amount 51,542 117,449 168,991 100% 491,000 100% 659,991 100% 261 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Total customer funds EUR million Demand deposits Time deposits Mutual funds A Customer funds Pension funds A Managed portfolios A Repos Total customer funds A. Including managed and marketed funds. Change 2018 2017 Absolute 548,711 525,072 23,639 199,025 199,649 (624) 157,888 165,413 (7,525) 905,624 890,134 15,490 % 4.5 (0.3) (4.5) 1.7 15,393 26,785 32,760 16,166 26,393 (773) (4.8) 392 1.5 53,009 (20,249) (38.2) 2016 467,261 181,089 147,416 795,766 11,298 23,793 42,761 980,562 985,702 (5,140) (0.5) 873,618 On the liabilities side, customer deposits stood at EUR 780,496 million in December 2018, virtually unchanged (+0.4%) from December 2017 (EUR 777,730 million). The Group uses customer deposits, excluding repos, and including mutual funds (customer funds) for the purposes of analysing the traditional retail banking funds. – By units, customer funds rose in eight of the ten core units, notably in Argentina (+51%), Poland (+32%), Brazil (+15%) and Portugal and Chile (+8% each). More moderate growth of around 3%-4% in Santander Consumer Finance, Mexico and the US. Spain and the UK hardly changed, because of the sharp fall in time deposits (and savings in the UK’s case), which cancelled out the 8% growth in demand deposits in Spain and the 2% rise in current accounts in the UK. Customer funds increased 2%. Excluding the efect of exchange rate movements, which had a negative impact on the Group as a whole of two percentage points, customer funds rose 4%. The main highlights were as follows: The structure of customer funds is also clearly diferentiated by product: 61% corresponds to demand deposits, 22% to time deposits and 17% to investment funds. – The strategy continued to focus on boosting loyalty. As a result, demand deposits rose 6%, increasing in almost all units. On the other hand, time deposits rose due to the Latin American countries performance, particularly Brazil, which increased 29% as part of the strategy of replacing letras fnanceiras with customer deposits in order to optimise the cost of funds. These increases ofset the falls recorded in the UK and mainly in Spain. Mutual funds remained virtually unchanged (-0.4%) impacted by the fall in the markets. The net loan-to-deposit ratio increased slightly to 113% in December 2018, compared to 109% in December 2017. In addition to attracting customer deposits, the Group applies a strategy of maintaining a selective issuance policy in international fxed income markets, endeavouring to adapt the frequency and volume of market operations to both the structural liquidity requirements of each unit and the receptivity of each market. For more information on debt issues and maturities, see the following section on liquidity and funding management. Customer funds (excluding repos) EUR billion Customer funds (excluding repos) % of operating areas. December 2018 796 147 648 890 906 165 725 158 748 +2%A -5% +3% Total Mutual funds B Deposits excl. repos 2016 2017 2018 2018 vs 2017 Argentina: 1% Other Americas: 1% Chile: 4% Brazil: 12% Mexico: 4% US: 7% Other Europe: 1% Poland: 4% Portugal: 4% SCF: 4% Spain: 35% United Kingdom: 23% A. Excluding exchange rate impact: +4%. B. Including managed and marketed funds. 262 2018 Annual Report Group financial performance 3.4 Liquidity and funding management The Group’s liquidity remains at comfortable levels, well above regulatory requirements. Recovery in lending in most countries where the Group operates. Issuance activity prioritised medium- and long-term funding instruments expected to be TLAC/MREL eligible. The Group’s moderate encumbrance of assets continued in the structural funding sources of the balance sheet. First, we present the Group’s liquidity management, the principles on which it is based and the framework in which it is included. The efective application of these principles by all institutions comprising the Group required the development of a unique management framework built upon three essential pillars: We then look at the funding strategy developed by the Group and its subsidiaries, with particular attention on the liquidity evolution in 2018. We examine changes in the liquidity management ratios and the business and market trends that gave rise to these over the last year. The section ends with a qualitative description of the outlook for funding in 2019 for the Group and its main countries. Liquidity management in Santander Group Structural liquidity management aims to fund the Group’s recurring activity optimising maturities and costs, while avoiding taking on undesired liquidity risks. Santander’s liquidity management is based on the following principles: • Decentralised liquidity model. • Medium- and long-term funding needs must be covered by medium- and long-term instruments. • High contribution from customer deposits due to the retail nature of the balance sheet. • Diversifcation of wholesale funding sources by instruments/ investors, markets/currencies and maturities. • Limited recourse to short-term. • A solid organisational and governance model that ensures the involvement of the subsidiaries’ senior management in decision-taking and its integration into the Group’s global strategy. The decision-making process for all structural risks, including liquidity and funding risk, is carried out by Local Asset and Liability Committees (ALCO) in coordination with the Global ALCO, which is the body empowered by Banco Santander’s board in accordance with the corporate Asset and Liability Management (ALM) framework. This governance model has been reinforced as it has been included within the Santander Risk Appetite Framework. This framework meets the demands of regulators and market players emanating from the fnancial crisis to strengthen banks’ risk management and control systems. • In-depth balance sheet analysis and measurement of liquidity risk, supporting decision-taking and its control. The objective is to ensure the Group maintains adequate liquidity levels necessary to cover its short- and long-term needs with stable funding sources, optimising the impact of their costs on the income statement. The Group’s liquidity risk management processes are contained within a conservative risk appetite framework established in each geographic area in accordance with its commercial strategy. This risk appetite establishes the limits within which the subsidiaries can operate in order to achieve their strategic objectives. • Management adapted in practice to the liquidity needs of each business. Every year, based on business needs, a liquidity plan is developed which seeks to achieve: • Availability of sufcient liquidity reserves, including standing • a solid balance sheet structure, with a diversifed presence in facilities/discount windows at central banks to be used in adverse situations. the wholesale markets; • Compliance with regulatory liquidity requirements both at Group and subsidiary level, as a new factor conditioning management. • the use of liquidity bufers and limited encumbrance of assets; • compliance with both regulatory metrics and other metrics included in each entity’s risk appetite statement. Over the course of the year, all dimensions of the plan are monitored. 263 Responsible bankingCorporate governanceEconomic and financial reviewRisk management The Group continues developing the ILAAP (Internal Liquidity Adequacy Assessment Process), an internal self-assessment of liquidity adequacy which must be integrated into the Group’s other risk management and strategic processes. It focuses on both quantitative and qualitative matters and is used as an input to the SREP (Supervisory Review and Evaluation Process). The ILAAP evaluates the liquidity position both in ordinary and stressed scenarios. As a result of the aforementioned process, a regulatory requirement is that once a year the Group must send the supervisor a document, approved by the board of directors, that concludes that the Group’s funding and liquidity structure remains solid in all scenarios and that the internal processes are suitable to ensure sufcient liquidity. This conclusion is the result of analysis carried out by each of the subsidiaries, following the Group’s autonomous liquidity management model. The Group has a robust structure suited to the identifcation, management, monitoring and control of liquidity risks, established through common frameworks, conservative principles, clearly defned roles and responsibilities, a consistent committee structure, efective local lines of defence and a well-coordinated corporate supervision. Additionally, frequent and detailed liquidity monitoring reports are generated for management, control, informational and steering purposes. The most relevant information is periodically sent to senior management, the executive committee and the board of directors. Over the last few years, the Group and each of its subsidiaries have developed a comprehensive special situations management framework which centralises the Group’s governance in these scenarios. Contingency funding plans are integrated within this governance model, detailing a series of actions which are feasible, pre-assessed, with an established execution timeline, categorised, prioritised and sufcient both in terms of volumes as well as timeframes to mitigate stress scenarios. or practices. All of this enables us to face 2019 from a strong starting point, with no material growth restrictions. In general terms, the funding strategies and liquidity management approaches implemented by Santander subsidiaries remain: • Maintain adequate and stable medium- and long-term wholesale funding levels. • Ensure a sufcient volume of assets which can be discounted in central banks as part of the liquidity bufer. • Liquidity generation from the commercial business. All these developments, enable Santander to enjoy a very robust funding structure today. The basic features of this are: • Customer deposits are the Group’s main source of funding, representing just over two-thirds of the Group’s net liabilities (i.e. of the liquidity balance sheet) circa 90% of loans and advances to customers as of December 2018. Moreover, these deposits are highly stable due to the fact that they mainly arise from retail client activity. This represents a slight decrease with respect to the 2017 fgure of 92%. Further detail on this variation in the liquidity evolution in 2018. Santander Group liquidity balance sheet %. December 2018 Loans and advances to customers 76% 67% Customer deposits Funding strategy and liquidity evolution in 2018 Fixed assets & other 8% 15% M/LT debt issuance 5% Securitisations and others Financial assets 16% 11% Equity and other 2% ST funding Assets Liabilities • Medium- and long-term wholesale funding accounts for more than 19% of the Group’s net funding, compared with 18% at the end of 2017, and comfortably covers the loans and advances to customers not funded by customer deposits (commercial gap). The outstanding balance of M/LT debt issuance was EUR 169,825 million in nominal terms in 2018, with a comfortable maturity profle and well balanced by instruments and markets, and a weighted average maturity of 4.6 years, slightly less than the average 5.0 years as of end 2017. Funding strategy and structure Santander’s funding activity over the last few years has focused on extending its management model to all Group subsidiaries, including new incorporations. Santander has developed a funding model based on autonomous subsidiaries responsible for covering their own liquidity needs. This structure has made it possible for Santander to take advantage of its solid retail banking business model in order to maintain comfortable liquidity positions at Group level and in its main units, even during periods of market stress. Over the last few years, it has been necessary to adapt funding strategies to refect commercial business trends, market conditions and new regulatory requirements. In 2018, Santander continued to improve in specifc aspects, with no signifcant changes in liquidity management or funding policies 264 2018 Annual Report 2016 8,515 11,981 89,568 39,513 149,578 Total 11,508 13,218 Group financial performance The distribution of this funding by instrument over the last three years and maturity profle is as follows: Medium and long term debt issuance. Santander Group A EUR million Preferred Subordinated Senior debt Covered bonds Total A. Excluding securitisations, agribusiness notes and real state credit notes. Distribution by contractual maturity. December 2018. Santander Group A 2018 11,508 13,218 98,827 46,272 2017 10,365 12,049 85,962 45,585 169,825 153,961 EUR million Preferred Subordinated Senior debt Covered bonds Total 0-1 12-24 month months months months months months 9-12 6-9 3-6 1-3 2-5 more than 5 years years — — — 580 1,704 2,879 495 100 — — 3,852 1,538 — — 3,944 1,759 — — 1,480 1,000 — — — 1,403 11,508 11,234 25,119 39,026 20,823 98,827 6,798 16,950 17,632 46,272 2,199 3,559 5,390 5,703 2,480 31,917 57,380 61,197 169,825 A. If an issuance has a put option in favour of the holder, the maturity of the put is considered rather than the contractual maturity. Note: there are no additional guarantees for any of the debt issued by the Group’s subsidiaries. In addition to the debt issuances of the medium- and long- term wholesale funding, the Bank has securitisations placed in the market, collateralised funding and other specialist funding amounting to a total of EUR 53,589 million with a maturity of 1.6 years. The following charts show the similarity of the geographic distribution of the Group’s loans and advances to customers and its medium- and long-term wholesale funding. This remained largely unchanged compared to 2017. The outstanding balance at the end of 2018 was EUR 28,754 million distributed as follows: European Commercial Paper, US Commercial Paper and domestic programmes issued by the parent bank, 39%; various certifcates of deposit and commercial paper programmes in the UK, 25%; commercial paper programmes of Santander Consumer Finance, 24% and issuance programmes in other units, 12%. Evolution of liquidity in 2018 The main aspects of liquidity in 2018 can be summarised as follows: Loans and advances to customers M/LT wholesale funding i. Basic liquidity ratios remain at comfortable levels. %. December 2018 %. December 2018 ii. We are continuing to achieve regulatory ratios ahead of Other Latin America 9% Brazil 8% Eurozone 41% Other Latin America 5% Brazil 7% Eurozone 43% US 10% Other Europe 3% United Kingdom 29% US 16% Other Europe 1% United Kingdom 28% Wholesale funding stemming from short-term issuance programmes is a residual part of the Group’s funding structure, related to treasury activities and comfortably covered by liquid assets. schedule. iii. Moderate use of encumbered assets in funding operations. i. Basic liquidity ratios remain at comfortable levels At end 2018, Santander Group recorded: • A stable credit to net assets ratio (total assets minus trading derivatives and inter-bank balances) of 76%, similar to recent years. This high level in comparison with European competitors refects the retail nature of Santander Group balance sheet. • Net loan-to-deposit ratio (LTD) of 113%, in a very comfortable level (below 120%). This stability shows a balanced growth between assets and liabilities. • The ratio of customer deposits plus medium- and long-term funding to net loans was stable at 114% at end December 2018. • Limited recourse to short-term wholesale funding. The ratio was around 2%, in line with previous years. 265 Responsible bankingCorporate governanceEconomic and financial reviewRisk management • Lastly, the Group’s structural surplus (i.e. the excess of structural funding sources - deposits, medium- and long-term funding and capital - as a percentage of structural liquidity needs - fxed assets and loans-) was an average stock of EUR 157,029 million in the year. As at 31 December 2018, the consolidated structural surplus stood at EUR 156,048 million. This consists of fxed-income assets (EUR 175,321 million), equities (EUR 12,570 million), partly ofset by short-term wholesale funding (EUR -28,754 million) and net interbank deposits (EUR -3,089 million). In relative terms, the total volume was equivalent to 13% of the Group’s net liabilities, below 2017 year-end. The table shows the evolution of the basic monitoring liquidity metrics at the Group level over the last few years: Group’s liquidity monitoring metrics % Loans A / Total assets Loans A to Deposit ratio (LTD) Customer deposits and medium and long term funding / Loans A Short term wholesale funding / Net liabilities Structural liquidity surplus (% / net liabilities) A. Loans and advances to customers. 2018 76% 113% 2017 75% 109% 2016 75% 114% 114% 115% 114% 2% 2% 3% 13% 15% 14% Having discussed the principal liquidity ratios at Group level, the following table sets out the ratios for Santander’s main units as at end 2018: The key drivers behind the evolution of the Group’s liquidity and that of its subsidiaries in 2018 (excluding the forex efect) were: • Growth in lending in most countries where the Group operates. Customer deposits also grew, except for the UK. As a result of this combined performance, the commercial gap, excluding repurchase agreement, barely generates liquidity needs. • Debt issuance momentum continued, particularly in the European units. In particular, issuances that are expected to be Minimum Requirement for Eligible Liabilities (MREL) and Total Loss Absorbing Capacity (TLAC) eligible have been prioritised. In 2018, the Group as a whole captured EUR 60,053 million of medium- and long-term funding, calculated using year-average exchange rates. In terms of instruments, medium and long-term fxed income (senior debt, covered bonds, subordinated debt and preferred shares) declined by almost 1% to EUR 37,505 million. Fewer issues of senior debt and preferred shares were ofset by greater activity in covered bonds and subordinated debt. Securitisation and structured fnance activity increased 47% compared to 2017 to EUR 20,555 million. In addition, the maturity of EUR 2,069 million of securitisations was extended. By country, the largest issuers of medium- and long-term debt were the UK, Spain and Santander Consumer Finance. Compared to 2017, Mexico and Poland increased the most in relative terms. In absolute terms, the UK recorded the largest increase since it did not resort to the Bank of England’s long-term programmes. The largest declines were in Spain, the US and Portugal, which had an unusual high issuance activity in 2017. The main issuers of securitisations were Santander Consumer Finance and Santander Consumer USA. The charts below set out in greater detail their distribution by instruments and geographic areas: Distribution by instruments and geographies %. December 2018 Main units’ liquidity metrics %. December 2018 Spain Santander Consumer Finance Poland Portugal United Kingdom Brazil Mexico Chile Argentina United States Group A. Loans and advances to customers. 266 Deposits + M/LT funding / Loans A LTD ratio Subordinated 3% Preferred 3% Covered bonds 11% 81% 261% 84% 95% 122% 104% 89% 146% 61% 149% 113% 156% 65% 123% 117% 106% 118% 120% 94% 172% 108% 114% Securitisation and other 35% Senior debt 48% Other Latin America 5% Other Europe 2% Brazil 6% United Kingdom 26% Santander Consumer Finance 13% US 29% Spain 19% 2018 Annual Report Group financial performance The weight of covered bonds issued in the year was 11% of total issuances, slightly higher than last year’s 10%. However, in contrast to 2017 when the main issuers were the UK and Portugal, in 2018 the main issuers were the UK and Spain. Of note was the return of Spain’s mortgage covered bonds to public markets, absent since 2016, as it was focused on senior non-preferred issuances. Liquidity Coverage Ratio % Parent bank Santander Consumer Finance Analysing the issuance activity over the course of the year in the main geographies and comparing it to the information presented to the market at the beginning of 2018, we can conclude the following: Poland Portugal United Kingdom • Parent bank marketed around EUR 3.0 billion of hybrid securities, in the upper range of forecasts; over EUR 6.0 billion senior non- preferred, in the lower range of forecasts; and completed its funding plan with senior preferred and mortgage covered bonds of just over EUR 2.0 billion. • Santander Consumer Finance issued senior debt of more than EUR 5.0 billion, in line with forecasts. • The UK issued more than EUR 8.0 billion of senior debt via its holding company and the bank, in the upper range of forecasts. The UK completed its funding plan by issuing around EUR 5.0 billion of covered bond securities via the bank, above forecasted levels. It is noteworthy that the UK started to carry out in 2018 its issuance plan envisaged for 2019, in order to anticipate possible tensions in the capital markets related to Brexit. • The US issued slightly more than EUR 1.0 billion of senior debt via its holding company, in the lower range of forecasted volumes. • In 2018, using year-average exchange rates, the Group issued EUR 13,544 million of MREL/TLAC eligible securities, of which EUR 10,284 million were senior non-preferred and eligible senior debt, EUR 1,500 million were AT1, and EUR 1,760 million were subordinated debt. In short, Santander Group retained its comfortable access to the diferent markets in which it operates, reinforced by new issuing units and products. In 2018, we issued debt and securitisations in 16 diferent currencies, with participation from 20 relevant issuers in 13 countries and with a weighted average maturity of 4 years, slightly below the previous year. ii. Compliance with regulatory ratios ahead of schedule Under its liquidity management model, over the last few years Santander Group has been managing the implementation, monitoring and compliance with the new liquidity requirements established under international fnancial regulations ahead of schedule. LCR (Liquidity Coverage Ratio) The regulatory requirement for this ratio in 2018 was set at 100%. As a result, the Group, both at a consolidated and subsidiary level, increased its risk appetite from 100% in 2017 to 105% in 2018. The strong short-term liquidity starting position, combined with autonomous management in all major units, enabled compliance levels of more than 100% to be maintained throughout the year, at both the consolidated and individual levels. As at end 2018, the Group’s LCR ratio stood at 158%, comfortably exceeding regulatory requirements. The following table provides detail of the LCR ratio by unit. All of them show a considerable excess over requirements: December 2018 153% 269% 151% 152% 164% 133% 174% 152% 135% 158% Brazil Mexico Chile United States Group NSFR (Net Stable Funding Ratio) The fnal defnition of the net stable funding ratio approved by the Basel Committee in October 2014, has not yet come into efect. The Basel requirement still needs to be written into the CRR, which is expected to be published in 2019. The NSFR constitutes a structural measure that aims at fostering longer-term stability by incentivising banks to adequately manage their maturity mismatches by funding long-term assets with long-term liabilities. The ratio is defned as the quotient between Available Stable Funding (ASF) and Required Stable Funding (RSF). The Available Stable Funding (ASF) comprises those sources of funding – capital and other liabilities – which can be deemed stable over a period of time of one year. The Required Stable Funding (RSF) primarily encompasses those assets than can be considered illiquid over the above-mentioned period of time, hence needing to be matched with stable sources of funding. The Group has defned a management limit of 100% at the consolidated level and for almost all of its subsidiaries. Net Stable Funding Ratio % Parent bank Santander Consumer Finance Poland Portugal United Kingdom Brazil Mexico Chile United States Group December 2018 105% 107% 131% 108% 128% 109% 130% 110% 114% 114% 267 Responsible bankingCorporate governanceEconomic and financial reviewRisk management With regards to this ratio, Santander benefts from a high weight of customer deposits, which are more stable, permanent liquidity needs deriving from commercial activity funded by medium- and long-term instruments and limited recourse to short-term funding. Taken together, this has enabled Santander to maintain a balanced liquidity structure, refected in NSFR ratios higher than 100%, both at Group and individual levels as at end December 2018. iii. Asset Encumbrance Lastly, it is worth highlighting Santander’s moderate use of assets as collateral in the structural funding sources of the balance sheet. In line with the 2014 European Banking Authority (EBA) guidelines on disclosure of encumbered and unencumbered assets, the concept of asset encumbrance includes both on-balance sheet assets pledged as collateral in operations to obtain liquidity as well as those of-balance sheet assets received and re-used for a similar purpose, in addition to other assets associated with liabilities other than for funding reasons. The following tables present the data the Group is required to report to the EBA as at end 2018. On-balance sheet encumbered assets amounted to EUR 322.2 billion, 67% of which are loans (mortgages, corporate, etc.). Of-balance sheet asset encumbrance stood at EUR 69.9 billion, mainly relating to debt securities received as collateral in reverse repurchase agreements which were then re-used. The total for the two categories was EUR 391.8 billion of encumbered assets, giving rise to a volume of associated liabilities of EUR 301.6 billion. As at end 2018, total asset encumbrance in funding operations represented 24.8% of the Group’s extended balance sheet under Group. Disclosure on asset encumbrance as at December 2018 EUR billion Assets Loans and advances Equity instruments Debt instruments Other assets Carrying amount of encumbered assets Fair value of encumbered assets Carrying amount of unencumbered assets Fair value of unencumbered assets 322.2 214.6 4.2 76.3 27.1 — — 4.2 76.3 — 1,137.1 855.0 10.7 114.8 156.6 — — 10.7 114.8 — Group. Collateral received as at December 2018 EUR billion Collateral received Loans and advances Equity instruments Debt instruments Other collateral received Own debt securities issued other than own covered bonds or ABSs Fair value of encumbered collateral received or own debt securities issued Fair value of collateral received or own debt securities issued available for encumbrance 69.6 — 2.7 65.0 1.9 — 48.9 — 6.0 42.9 — 1.4 Group. Encumbered assets / collateral received and associated liabilities EUR billion Matching liabilities, contingent liabilities or securities lent Assets, collateral received and own debt securities issued other than covered bonds and ABSs encumbered Total sources of encumbrance (carrying amount) 301.6 391.8 268 2018 Annual Report EBA criteria (total assets plus guarantees received: EUR 1,578 billion in 2018). This ratio is similar to the values reported by the Group prior to the acquisition of Banco Popular in 2017. Finally, a distinction needs to be made between the diferent natures of the sources of encumbrance, as well as their role in the Group’s funding: • 51.5% of total asset encumbrance corresponds to collateral pledged in medium- and long-term transactions (with a residual maturity of more than one year) to fund the commercial activity on the balance sheet. This results in a level of asset encumbrance known as ‘structural’ at 12.8% of the extended balance sheet, using EBA criteria. • The other 48.5% corresponds to short-term market transactions with a residual maturity of less than one year, or to collateral pledged in derivative operations whose purpose is not to fnance normal business activity of businesses but rather efcient short- term liquidity management. Rating agencies The Group’s access to wholesale fnancing markets, as well as the cost of its issuances, depends in part on the ratings granted by rating agencies. These agencies regularly review the Group’s ratings. The rating of its debt depends on a series of factors that are endogenous to the institution (business model, strategy, capital, income generation capacity, liquidity and so on) and on other, exogenous factors related to the overall economic environment, the situation in the sector, and sovereign risk in the geographic areas where it operates. In certain cases, the methodology applied by these agencies limits the rating a bank can receive to the sovereign rating assigned to the country in which it is headquartered. In 2018, four rating agencies improved their rating for Banco Santander long-term senior debt after the Spanish sovereign rating was upgraded. On 6 April 2018, S&P upgraded its rating from A- to A. On 12 April 2018, DBRS raised its rating from A to A (high), on 17 April Moody’s upgraded its rating from A3 to A2, and on 17 July Fitch raised the long-term senior debt rating from A- to A, maintaining the short- and long-term issuer rating in A-/F2, respectively. The Santander rating with all of these agencies (except Fitch) is therefore higher than the sovereign rating for the country in which it is headquartered, which clearly reflects the financial strength and diversification of the Group. On the other hand, in March and October the agencies Scope and JCR confirmed Santander credit rating at AA- and A+, respectively, and in November the agency Axesor assigned Santander an unsolicited rating of A+. At the end of 2018, the ratings with the main agencies were as follows: Rating agencies DBRS Fitch Ratings Moody's Standard & Poor's Scope JCR Japan Long term Short term Outlook A (high) R-1 (middle) A- A2 A AA- A+ F2 P-1 A-1 S-1+ — Stable Stable Stable Stable Stable Stable Group financial performance Funding outlook for 2019 Santander starts 2019 with a comfortable liquidity position and with good prospects for the year. However, some uncertainties remain, namely those related to geopolitics and financial regulation. With manageable debt maturities over the next few quarters, supported by the low weight of short-term funding and an issuance dynamic expected to be in line with recent years, the Group will manage each geographic area in order to optimise liquidity usage and to maintain a robust balance sheet structure in the units and in the Group. For the Group as a whole, moderate commercial needs are envisaged as, in most cases, the increase in lending is expected to largely be counter-balanced by increases in customer deposits. The greatest liquidity needs will stem from the largest units: Spain, the UK, Brazil and Santander Consumer Finance. In 2018, the Single Resolution Board informed Banco Santander of the MREL 2018 requirement under the existing recovery and resolution rules and which has to be met before 1 January 2020. Banco Santander already complies with this requirement. Starting from 2019, the minimum requirement established in the Capital Requirements Regulation (CRR) will apply to Santander, however resolution authorities will be able to set higher levels based on resolution considerations. Once the buffers of liabilities with loss-absorbing capacity in case of resolution have been established, whether they are considered to be capital instruments or not, the Group focus for the coming years will be on repaying the ECB and Bank of England long-term funding programmes. Priority will be given to pure funding instruments, taking into account the diversification criteria and cost efficiency. The funding plans carried out by the Group aims to ensure that we meet regulatory requirements as well as those stemming from its risk appetite framework at all times. 269 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 3.5 Capital management and adequacy. Solvency ratios1 The fully loaded CET1 ratio was 11.30%1 at the end of 2018 (+46 bps year-on-year), surpassing our public target of 11% in 2018. The fully loaded total capital ratio was 14.77% (+29 bps in the year). We continued to strengthen our active capital management culture at all levels of the organisation. Santander capital management and adequacy seeks to guarantee solvency and maximise proftability, ensuring compliance with the Group’s internal objectives as well as regulatory requirements. includes strategies to use and assign capital efciently to businesses as well as securitisations, asset sales and issuances of capital instruments (capital hybrids and subordinated debt). It is a key strategic tool for taking decisions at the local and corporate levels and enables us to set a common framework of actions, defning and standardising capital management criteria, policies, functions, metrics and processes. The function of the Group’s capital is carried out at two levels: • Regulatory capital: regulatory management stems from an analysis of the capital base, the solvency ratios under the prevailing regulatory criteria and the scenarios used for capital planning. The objective is to make the capital structure as efcient as possible both in terms of cost as well as compliance with the regulatory requirements. Active capital management • Economic capital: the economic capital model aims to guarantee that the Group adequately assigns its capital to all risks to which it is exposed as a result of its activity and risk appetite. Its purpose is to optimise value creation for the Group and its business units. The real economic measurement of capital needed for an activity, together with its return, promotes value creation optimisation by selecting those activities that maximise the return on capital. This is carried out under diferent economic scenarios, both expected as well as unlikely but plausible, and with the solvency level decided by the Group. The Group considers the following magnitudes related to the capital concept: Regulatory capital • Capital requirements: the minimum volume of own funds required by the regulator to ensure the solvency of the entity, depending on its credit, market and operational risks. • Eligible capital: the volume of own funds considered eligible by the regulator to meet capital requirements. The main elements are accounting capital and reserves. Economic capital • Self-imposed capital requirement: the minimum volume of own funds required by the Group to absorb unexpected losses resulting from current exposure to the risks assumed by the entity at a particular level of probability (this may include other risks in addition to those considered in regulatory capital). • Available capital: the volume of own funds considered eligible by the entity under its management criteria to meet its capital needs. Cost of capital The minimum return required by investors (shareholders) as remuneration for the opportunity cost and risk assumed by investing in the entity’s capital. The cost of capital represents a “cut- of rate” or “minimum return” to be achieved, enabling analysis of the activity of business units and evaluation of their efciency. Leverage ratio This is a regulatory metric that monitors the soundness and robustness of a fnancial institution by comparing the size of the entity to its capital. This ratio is calculated dividing Tier 1 capital by the leverage exposure, taking into account the size of the balance sheet with adjustments for derivatives, funding of securities operations and of-balance sheet items. Return on risk adjusted capital (RoRAC) This is the return (net of tax) on economic capital required internally. Therefore, an increase in economic capital decreases the RoRAC. For this reason, the Group requires transactions or business involving higher capital consumption to deliver higher returns. This considers the risk of the investment, and is therefore a risk adjusted measurement of returns. Using the RoRAC enables the Group to manage its business more efectively, assess the real returns on its business - adjusted for the risk assumed - and to be more efcient in its business decisions. Return on risk-weighted assets (RoRWA) This is the return (net of tax) on risk-weighted assets for a particular business. The Group uses RoRWA to establish regulatory capital allocation strategies, seeking that the maximum return. Value creation The proft generated in excess of the cost of economic capital. The Group creates value when risk adjusted returns (measured by RoRAC) exceed its cost of capital, and destroys value when the reverse occurs. This measures risk adjusted returns in absolute terms (monetary units), complementing the RoRAC approach. Expected loss This is the loss due to insolvency that the entity will sufer on average over an economic cycle. Expected loss considers insolvencies to be a cost that can be reduced by appropriate selection of loans. 1. Data calculated using the IFRS9 transitional arrangements, unless otherwise indicated. Had the IFRS9 transitional arrangement not been applied, the total impact on the fully loaded CET1 at year end would have been -27 bps. 270 2018 Annual Report Group financial performance Priorities and main activities in the Group’s capital management return on capital. The Group’s most notable capital management activities are: • Establishing solvency objectives and the capital contributions aligned with the minimum regulatory requirements and internal policies, in order to guarantee a solid level of capital, coherent with the Group’s risk profle, and an efcient use of capital to maximise shareholder value. • Developing a capital plan to meet the objectives coherent with the strategic plan. Capital planning is an essential part of executing the three-year strategic plan. • Assessing capital adequacy in order to ensure that the capital plan is coherent with the Group’s risk profle and with its risk appetite framework also in stress scenarios. • Developing the annual capital budget as part of the Group’s budgetary process. • Monitoring and controlling budget execution and drawing up action plans to correct any deviation from the budget. • A greater weight of capital in incentives. To this end, certain aspects related to capital and its proftability are taken into account in the variable pay of senior management members: – Among the metrics taken into account are the Group’s fully loaded CET1, the contribution of capital and the return on risk weighted assets (RoRWA). – Among the qualitative aspects are adequate management of regulatory changes in capital, efective capital management in business decisions, generation of sustainable capital and efective capital allocation. At the same time, we are developing a programme to continuously improve the infrastructure, processes and methodologies that support all aspects related to capital in order to further strengthen active capital management, respond more agilely to the numerous and increasing regulatory requirements and conduct all activities associated with this sphere more efciently. • Calculating capital metrics. • Drawing up internal capital reports, as well as reports for the supervisory authorities and for the market. Fully loaded CET1 % The main measures taken in 2018 are set out below: 9.65% 10.05% 10.55% 10.84% 11.30% Issuances of fnancial instruments with the legal nature of capital In March 2018, Banco Santander, S.A. issued a contingent convertible bond (CoCos) of EUR 1,500 million to strengthen its AT1 (Additional Capital Tier 1). As regards subordinated debt, during the year there were two issuances: Banco Santander, S.A. issued EUR 1,250 million and Santander Bank Polska S.A. issued EUR 229 million. These issuances bolstered the total capital ratio as they count as Tier 2 capital. Dividend policy2 The board of directors’ intention is to distribute EUR 0.23 charged to 2018’s earnings in four dividends, three of them in cash and one a scrip dividend (Santander Dividendo Elección). Greater detail in section 3.3 ‘Dividend policy’ on the Corporate governance chapter. Strengthen active capital management culture The continuous improvement in the capital ratios refects the Group’s proftable growth strategy and a culture of active management of capital at all levels of the organisation. Of note: • The strengthening of dedicated capital management teams and greater coordination between the Corporate Centre and local teams. • All countries and business units developed their individual capital plans focused on having businesses that maximise the 2014 A 2015 2016 2017 2018 A. Pro-forma taking into account the January 2015 capital increase. Evolution of capital ratios in 2018 The phased-in ratios are calculated by applying the CRR transitory schedules, while the fully-loaded ratios are calculated without applying any schedule (i.e. with the fnal regulations). On 1 January 2018 the IFRS9 came into force, which implied several accounting changes afecting the capital ratios. Santander chose to apply the phase-in using transitional arrangements, which means a fve-year transition period. Applying this criteria, the fully loaded CET1 was 11.30% at the end of December. The 46 bps increase was mainly due to proft generation and RWAs management, which led to an organic generation of 64 bps, together with the 21 bps from perimeter (mainly Blackstone and WiZink), partially ofset by the net negative impact between regulatory impacts / one-ofs (-25 bps, mainly minority interests in Santander Consumer USA and restructuring costs) as well as markets and others (-14 bps, mainly held to collect and sell portfolios and intangible assets). 2. The fnal dividend against the 2018 results is subject to approval at the Group’s 2019 annual shareholders’ meeting. 271 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 2018 74,173 (10) (42) (826) 4,518 (659) (1,010) (5,815) (2,367) 67,962 3,110 1,168 (258) 5,707 27 9,754 13,422 1,405 (3,823) (22) 27 11,009 88,725 FL CET1 performance in 2018 Regulatory capital (phased-in). Flow statement % 10.84 +0.64 +0.21 -0.39 EUR million 11.30 Capital Core Tier 1 +0.46 Dec’17 Organic generation Corporate transactions Market & other The total fully-loaded capital ratio was 14.77%, up 29 bps during the year. The fully loaded leverage ratio stood at 5.1% (5.0% in 2017). Tier 1 capital increased compared to 2017 while the exposure refects the usual movements of balance sheet volumes from business activity and from exchange rate changes. The phased-in eligible capital was EUR 88,725 million. This amount represents a total capital ratio of 14.98% and phased-in common equity tier 1 (CET1) of 11.47%. Main capital and solvency ratio EUR million Starting amount (31/12/2017) Shares issued in the year and share premium Treasury shares and own shares fnanced Reserves Attributable proft net of dividends Other retained earnings Dec’18 Minority interests Decrease/(increase) in goodwill and other intangible assets Other deductions Ending amount (31/12/2018) Additional Capital Tier 1 Starting amount (31/12/2017) AT1 eligible instruments T1 excesses - subsidiaries Residual value of intangible assets Deductions Ending amount (31/12/2018) Capital Tier 2 Starting amount (31/12/2017) T2 eligible instruments Generic funds and surplus loan-loss provisions-IRB Fully loaded Phased-in T2 excesses - subsidiaries 2018 2017 2018 2017 Deductions Common equity (CET1) 66,904 65,563 67,962 74,173 Ending amount (31/12/2018) Tier 1 75,838 73,293 77,716 77,283 Deductions from total capital Total capital 87,506 87,588 88,725 90,706 Total capital ending amount (31/12/2018) Risk-weighted assets 592,319 605,064 592,319 605,064 CET1 capital ratio 11.30% 10.84% 11.47% 12.26% T1 capital ratio 12.80% 12.11% 13.12% 12.77% Total capital ratio 14.77% 14.48% 14.98% 14.99% Leverage ratio 5.10% 5.02% 5.22% 5.28% 272 2018 Annual Report Group financial performance Total risk weighted assets comprising the denominator of capital requirements based on risk, are set out below, as well as its distribution by geographic segment. Risk weighted assets EUR million Credit risk (excluding CCR) Of which standardised approach (SA) Of which the foundation IRB (FIRB) approach Of which the advanced IRB (AIRB) approach Of which Equity IRB under the Simple risk-weight or the IMA Counterparty Risk (CCR) Of which IRB approach Of which standardised approach Of which risk exposure from contributions to default fund or central counterparties (CCP) Of which credit valuation adjustment (CVA) Settlement risk Securitisation exposure in banking book (after cap) Of which IRB approach Of which IRB supervisory formula approach (SFA) Of which standardised approach (SA) Market risk Of which standardised approach Of which internal model approach (IMA) Operational risk Of which standardised approach Amounts below the thresholds for deduction (subject to 250% risk weight) Floor adjustment Total RWAs 2018 2017 469,074 480,221 277,394 280,082 37,479 37,207 150,373 158,777 3,828 11,987 7,867 1,795 233 2,092 1 5,014 4,276 1,915 738 25,012 11,858 13,154 60,043 60,043 21,188 — 4,155 14,668 8,529 3,586 313 2,240 1 3,678 2,482 708 1,196 24,161 9,702 14,459 61,217 61,217 21,118 — Minimum capital requirements 2018 37,526 22,191 2,998 12,030 306 959 629 144 19 167 - 401 342 153 59 2,001 949 1,052 4,803 4,803 1,695 — 592,319 605,064 47,386 273 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Capital requirements by geographical distribution EUR million TOTAL 38,155 14,809 66 737 8,505 1,148 1,488 3,051 82 319 382 1,667 22,191 1,146 40 33 - - 470 5,585 8,244 3,178 730 185 38 - 22 18 2,503 1,155 212 849 94 330 144 19 167 - 401 342 59 2,001 949 1,052 4,803 4,803 1,695 - United Spain Kingdom Other Europe 9,887 5,604 2 167 3,587 410 976 959 82 120 279 408 3,160 484 - - - - 130 562 610 308 165 - - - 21 - 880 1,123 212 817 94 136 35 15 86 - 215 213 2 1,037 498 539 1,034 1,034 906 - 5,488 3,617 3 130 1,310 289 192 1,832 - 171 1 171 1,871 - - - - - 9 930 536 51 13 11 34 - 1 - 285 - - - - 59 20 4 35 - 52 47 5 207 21 186 689 689 11 - 7,532 2,953 - 179 1,492 214 242 253 - 28 100 900 4,579 11 4 3 - - 55 1,233 2,149 705 139 9 4 - - 17 251 - - - - 39 34 - 5 - 90 61 29 21 21 - 852 852 131 - Brazil 4,872 653 5 12 635 2 - - - - - - 4,194 410 22 - - - 95 950 1,961 316 141 - - - - - 299 25 - 25 - 31 22 - 9 - - - - 316 316 - 606 606 365 - Other Latam United States Rest of the world 4,580 984 7 126 848 180 78 2 - - - 1 3,589 231 13 14 - - 57 886 1,074 843 128 152 - - - - 192 7 - 7 - 45 18 - 26 - 33 21 13 411 84 326 714 714 200 - 5,043 411 - 54 356 17 - 1 - - - - 4,631 6 1 16 - - 122 997 1,791 954 142 11 - - - - 591 - - - - 12 11 - 1 - 10 - 10 9 9 - 909 909 80 - 753 586 48 68 277 36 - 5 - - 1 187 167 4 - - - - 2 27 124 - 1 2 - - - - 6 - - - - 7 2 - 4 - - - - - - - - - 2 - 47,386 13,214 6,507 8,665 6,190 5,983 6,063 762 Credit risk Of which internal rating-based (IRB) approach A - Central governments and Central BANKS - Institutions - Corporates – SME - Corporates - Specialised Lending - Corporates – Other Retail - Secured by real estate SME Retail - Secured by real estate non-SME Retail - Qualifying revolving Retail - Other SME Retail - Other non-SME Other non-credit-obligation assets Of which standardised approach (SA) Central governments or central banks Regional governments or local authorities Public sector entities Multilateral Development Banks International Organisations Institutions Corporates Retail Secured by mortgages on immovable property Exposures in default Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment Collective investments undertakings (CIU) Equity exposures Other items Of which Equity IRB Under the PD/LGD method Under internal model Under simple method Counterparty credit risk Of which mark to market method (Standardised) Of which: Risk exposure amount for contributions to the default fund of a CCP Of which: CVA Settlement risk Securitisation exposures in banking book (after cap) Of which IRB ratings-based approach (RBA) Of which Standardised approach (SA) Market risk Of which standardised approach (SA) Of which internal model approaches (IMA) Operational risk Of which Standardised Approach Amounts below the thresholds for deduction and other non-deducted investments (subject to 250% risk weight) Floor adjustment Total A. Including counterparty credit risk. 274 2018 Annual Report Group financial performance The following table presents the main changes to the capital requirements by credit risk: Economic capital Credit risk capital requirements movements A EUR million Starting amount (31/12/2017) Business movements Perimeter movements Foreign exchange movements RWAs 517,133 1,255 (4,534) (8,916) Capital requirements 41,371 100 (363) (713) Ending amount (31/12/2018) 504,938 40,395 A. Includes capital requirements of equity, securitisations and counterparty risk (excluding CVA and CCP). The changes to the capital requirements by credit risk are mainly due to business growth in Brazil, Chile and Santander Consumer, partially offset by decreases in the UK and Spain. Regarding the changes to the perimeter requirements, of note was the impact of the sale of Banco Popular’s real estate business assets to an external fund. The impact of exchange rates affected mainly Argentina and Brazil. With regards to regulatory ratios, Santander exceeds the 2019 minimum regulatory requirements by 178 bps, taking into account the surplus and shortfall in AT1 and T2 respectively. 14.98% T2 AT1 1.86% 1.65% CET1 11.47% 13.20% 2.00% T2 1.50% 0.20% 1.00% AT1 CCyB c G-SIB A 2.50% CCoB B 1.50% 4.50% Pillar 2 requirement CET1 9.70% Minimum Pillar 1 Regulatory ratios 2018 (phased-in) Regulatory requirement 2019 A. Global systemically important banks (G-SIB) bufer. B. Capital conservation bufer. C. Countercyclical bufer. In short, from a qualitative point of view, Santander has solid capital ratios, aligned with its business model, balance sheet structure and risk profle. Economic capital is the capital needed to support all the risks of our activity with a certain level of solvency. It is measured using an internally developed model. In our case, the solvency level is determined by the objective long-term rating of “A” (above the Kingdom of Spain rating), which represents a confdence level of 99.95% (higher than the regulatory level of 99.90%) to calculate the necessary capital. Santander’s economic capital model incorporates in its measurement all signifcant risks incurred by the Group in its activity (concentration risk, structural interest rate risk, business risk, pensions risk and others that are beyond the scope of regulatory Pillar 1). Furthermore, economic capital incorporates the diversifcation efect which in Santander case is key, due to the multinational nature of its activity covering many businesses, in order to appropriately determine and understand the risk profle and solvency of a group with global activity such as Santander. The fact that Santander business activity is spread across various countries via a structure of separate legal entities, with a variety of customer and product segments, exposed to diferent types of risks, means that the Group results are less vulnerable to adverse situations in one of the particular markets, portfolios, customer types or risks. The economic cycles, despite the current high level of economic globalisation, are not the same nor are the diferent countries afected with the same intensity. In this way, groups with a global presence have more stable results and are more resistant to the eventual market or portfolio crises, which translate to lower risk. In other words, Santander risk and the associated economic capital of the Group as a whole are less than the sum of the individual parts. Unlike with regulatory criteria, the Group considers certain intangible assets, such as deferred taxes, goodwill and software, to retain value, even in the hypothetical case of resolution given the geographic structure of the Group’s subsidiaries. As such, the asset is valued and its unexpected loss and capital impact are estimated. Economic capital is a key tool for internal management and development of the Group’s strategy, both from the standpoint of assessing solvency as well as risk management of portfolios and businesses. From the solvency standpoint, Santander uses its economic model, in the context of the Basel Pillar 2, for the internal capital adequacy assessment process (ICAAP). The business evolution and capital needs are planned under a central scenario and alternative stress scenarios. This ensures the Group meets its solvency objectives even in adverse scenarios. The metrics derived from economic capital enable the risk-return objectives to be assessed, the price of operations to be set based on risk and the economic viability of projects, units and business lines to be evaluated, with the overriding objective of maximising the generation of shareholder value. As a homogeneous risk measure, economic capital can be used to explain the distribution of risk throughout the Group, refecting comparable activities and diferent types of risk in a single metric. Given its relevance in internal management, the Group includes several metrics derived from economic capital, both from the 275 Responsible bankingCorporate governanceEconomic and financial reviewRisk management standpoint of capital needs and risk-return, within a conservative risk appetite framework established for the Group and for the various geographies. The distribution of economic capital among the main business areas refects the diversifed nature of the Group’s business and risk. Continental Europe represents 48% of the capital, Latin America including Brazil 24%, the UK 13% and the US 15%. The requirement for economic capital as of December 2018 amounts to EUR 69,443 million, which, compared to the available economic capital base of EUR 99,566 million, imply the existence of a capital surplus of EUR 30,123 million. The main diference compared to regulatory CET1 lies in the treatment of goodwill, other intangible assets and deferred tax assets, which we consider as additional capital requirements rather than a deduction from available capital. Reconciliation of economic and regulatory capital EUR million Excluding the operating areas, the main risks the Corporate Centre assumes are goodwill and the risk derived from the exposure to structural exchange rate risk (risk stemming from maintaining stakes in subsidiaries abroad denominated in currencies other than the euro). The beneft of diversifcation included in the economic capital model, including both the intra-risk diversifcation (similar to geographic diversifcation) as well as inter-risks, amounted to approximately 30%. 2018 59,046 57,939 2017 59,098 55,862 Distribution of economic capital needs by type of risk Net capital and issuance premiums Reserves and retained profts Valuation adjustments Minority interests Prudential flters Base economic capital available Deductions Goodwill Other intangible assets DTAs Other (23,606) (23,108) % 6,893 (706) 99,566 (32,662) (25,630) (3,014) (3,754) (264) 7,228 (453) 98,627 (33,064) (25,585) (2,952) (3,820) (707) Base regulatory (CET1 FL) capital available 66,904 65,563 Base economic capital available Economic capital required A Capital surplus 99,566 69,443 30,123 98,627 71,893 26,734 A. In order to enhance the comparison with regulatory capital, the diferences in goodwill changes are included in the required economic capital. The following charts sums up the Group’s economic capital needs at the end of 2018, by geographic area and types of risk: Market 10% Interest (ALM) 3% Operational 4% Business 5% Tangible assets 3% Other 10% Goodwill 28% Lending 37% Distribution of economic capital needs by geographic area and type of risk EUR million. December 2018 Santander Group Total requirements: 69,443 Corporate Centre 25,878 Continental Europe 20,974 United Kingdom 5,755 Latin America 10,326 United States 6,510 All risks: Goodwill: 74% Market: 13% DTA: 12% 1% Other: All risks: Credit: 57% Market: 15% Business: 7% ALM: 6% Other: 15% All risks: All risks: All risks: Credit: 51% Pensions: 27% 7% 6% Other: 9% Operational: ALM: Credit: 65% 12% 6% 6% 11% Business: Operational: ALM: Other: Credit: 61% Tangible assets: 12% Business: 7% Intangible assets: 6% Other: 14% 276 2018 Annual Report Group financial performance RoRAC and value creation Santander has been using RoRAC methodology since 1993 in order to: • Calculate the consumption of economic capital and the return on it of the Group’s business units, as well as for segments, portfolios and customers, in order to facilitate optimum allocation of capital. The following chart shows the value creation and RoRAC at the end of 2018 of the Group’s main business areas: Value creation A and RoRAC EUR million 2018 2017 • Measure management of the Group’s units through budgetary Main segments RoRAC Value creation RoRAC Value creation monitoring of capital consumption and RoRAC. • Analyse and set prices for making decisions on operations (admission) and customers (monitoring). The RoRAC methodology enables the return on operations, customers, portfolios and businesses to be compared on a like- for-like basis, identifying those that obtain a risk-adjusted return higher than the cost of the Group’s capital, thus aligning risk and business in order to maximise value creation, which is the ultimate goal of the Group’s senior management. Santander also regularly assesses the level and evolution of value creation (VC) and the risk-adjusted return (RoRAC) of the Group and its main business units. The VC is the proft generated above the cost of economic capital (EC) employed, and is calculated as follows: Value creation = consolidated proft – (average economic capital x cost of capital) The proft used is obtained by making the necessary adjustments in the consolidated proft to eliminate those factors that are outside the ordinary course performance of our business, and obtain the ordinary result that each unit obtains for its activity in the year. The minimum return on capital that a transaction must obtain is determined by the cost of capital, which is the minimum remuneration required by shareholders. This is calculated by adding to the risk-free return the premium that shareholders require to invest in Santander. This premium depends essentially on the degree of volatility in Banco Santander’s share price with respect to the market’s performance. The Group’s cost of capital in 2018 was 8.86% (compared to 8.60% in 2017). As well as reviewing the cost of capital annually, the Group’s internal management also estimates a cost of capital for each business unit, taking into account each market’s specifc features, under the philosophy of subsidiaries autonomous in capital and liquidity, in order to evaluate whether each business is capable of generating value individually. If an operation or portfolio obtains a positive return, it contributes to the Group’s profts, but it only creates shareholder value when that return exceeds the cost of capital. Continental Europe United Kingdom Latin America United States Total Group 18.1% 17.3% 35.1% 10.7% 12.6% 2,083 662 2,905 39 2,835 17.3% 18.5% 31.9% 8.1% 12.4% 1,716 839 2,563 (120) 2,739 A. The value creation was calculated with the cost of capital of each unit. The Group’s total RoRAC includes both the operative units and the Corporate Centre, refecting the total economic capital of the Group and the generated return. Capital planning and stress tests Capital stress test exercises are a key tool in the dynamic evaluation of risks and the solvency of banks. It is a forward-looking evaluation based on macroeconomic as well as idiosyncratic scenarios that are unlikely but plausible. Thus, robust planning models are required, capable of transferring the efects defned in the projected scenarios to diferent elements that infuence the Bank’s solvency. The ultimate aim of capital stress exercises is to make a complete assessment of the risks and solvency of banks, which enables possible capital requirements to be determined in the event they are needed because of banks’ failure to meet their regulatory and internal capital objectives. Internally, Santander has a defned capital stress and planning process not only to respond to various regulatory exercises but also as a key tool integrated into the Group’s management and strategy. The objective of the internal capital stress and planning process is to ensure sufcient current and future capital, including in unlikely but plausible economic scenarios. Based on the Group’s initial situation (defned by its fnancial statements, its capital base, risk parameters and regulatory as well as economic ratios), the envisaged results are estimated for diferent business environments (including severe recessions as well as expected macroeconomic environments), and the Group’s solvency ratios are obtained projected usually over a three-year period. The planning process ofers a comprehensive view of the Group’s capital for the analysed time period and in each of the defned scenarios. The analysis incorporates the regulatory capital and economic capital metrics. 277 Responsible bankingCorporate governanceEconomic and financial reviewRisk management The structure in place is detailed in the following chart: 1 2 3 4 5 Macroeconomic scenarios Forecasts of balance sheet and income statement Central and recession Idiosyncratic: based on specifc risks facing the entity Multi-year horizon Reverse stress tests Projection of volumes. Business strategy Margins and funding costs Fees and operating expenses Market shocks and operational losses Credit losses and provisions. PIT LGD and PD models IFRS9 models and migration among stages Forecasts of capital requirements Consistent with projected balance sheet Risk parameters (PD, LGD and EAD) Solvency analysis Available capital base. Profts and dividends Regulatory and legislative impacts Capital and solvency ratios Compliance with capital objectives Action plan In the event of failure to comply with internal objectives or regulatory requirements The structure presented facilitates attainment of the ultimate objective of capital planning, by turning it into an important strategic element for Santander which: • Ensures current and future solvency, including in adverse economic scenarios. • Ensures comprehensive capital management and incorporates an analysis of specifc efects, facilitating their integration into the Group’s strategic planning. • Enables a more efcient use of capital. • Supports the design of the Group’s capital management strategy. • Facilitates communication with the market and supervisors. In addition, the whole process is developed with the maximum involvement of senior management and their close supervision, under a framework that ensures that the governance is suitable and that all the elements that confgure it are subject to adequate levels of questioning, review and analysis. One of the key elements in capital planning and stress analysis exercises, due to its particular importance in projecting the income statement under defned adverse scenarios, consists of calculating the provisions that will be needed under these scenarios, mainly those that are produced to cover losses on credit portfolios. Specifcally, in order to calculate loan-loss provisions, Santander uses a methodology that ensures at all times the level of provisions covers all loan losses projected by its internal models of expected loss, based on exposure at default (EAD), probability of default (PD) and loss given default (LGD parameters). This methodology is widely accepted and is similar to that used in the 2018 EBA stress test, as well as in 2011, 2014 and 2016, and in the stress test on the Spanish banking industry in 2012. During 2018 this methodology was adapted in order to incorporate the changes of the entry into force of the international fnancial information IFRS9 regulation. The Group has models to calculate balances by stages (S1, S2, S3) as well as the migration among them and the loan-loss provisions in accordance with the new standards. 278 2018 Annual Report Group financial performance Lastly, the capital planning and stress analysis process culminates with the analysis of solvency under diferent scenarios and over a defned time period, in order to assess capital sufciency and ensure the Group meets its internally defned capital objectives as well as all regulatory requirements. In the event that the capital objectives set are not met, an action plan will be drawn up which sets out the necessary measures to be able to attain the desired minimum capital. These measures are analysed and quantifed as part of the internal exercises although it is not necessary to utilise them as the minimum capital thresholds are exceeded. This internal process of stress and capital planning is carried out transversally throughout the Group, not only at the consolidated level, but also locally in the diferent units that comprise the Group, and which use the stress process and capital planning as an internal management tool and in response to their local regulatory requirements. Santander has undergone seven stress tests since the economic crisis in 2008, in which its strength and solvency has been demonstrated in the most extreme and severe macroeconomic scenarios. All of them showed that, thanks mainly to its business model and geographic diversifcation, Banco Santander would still be capable of generating profts for its shareholders and meeting the most demanding regulatory requirements. In the frst of them run in 2010 by the Committee of European Banking Supervision, Santander was the bank with the least impact on its solvency ratio, except for those banks that benefted from not distributing dividends. In the second test, conducted by the EBA in 2011, Santander was not only in the small group of banks that improved their solvency in the stress scenario but also the one with the highest level of profts. In the stress exercises carried out by OIiver Wyman for Spanish Banks in 2012 (top down and then bottom up), Banco Santander again demonstrated its strength to face the most extreme scenarios with full solvency. It was the only bank that improved its core capital ratio, with an excess of capital over the minimum of more than EUR 25 billion. In the stress exercise conducted by the ECB in 2014, in co-operation with the EBA, Santander was the group with the least impact in the adverse scenario among its international competitors (capital surplus of around EUR 20 billion above the minimum requirement). The 2016 stress exercise, unlike previous ones, did not incorporate a minimum level of capital. It used the results as an additional variable within the Supervisory Review and Evaluation Process (SREP). Santander was the bank with the least capital destroyed among its peers. Its fully loaded CET1 capital ratio declined 199 bps (compared to the peers’ average fall of 335 bps). The results of the 2018 stress test published on 2 November, underscored that Santander was once again the bank with the least capital destroyed among its peers, improving its results compared to 2016. The fully loaded1 CET1 declined 141 bps (compared to the system’ average fall of 395 bps). The results of the various stress tests showed that the Group’s business model, based on retail banking and geographic diversifcation, enables it to robustly confront the severest international crisis scenarios. As well as the regulatory stress tests, Santander has conducted internal stress tests every year since 2008, within its capital self-evaluation process (Pillar 2). In all of them, the Group’s capacity to confront the most difcult exercises, both at the global level as well as in the countries in which it operates, has been demonstrated. EBA/ECB transparency exercise 2018 As mentioned in the previous section, the EBA released in November the results of the stress test conducted on 48 European banks. The 2018 stress test, like the previous one, did not incorporate a minimum capital threshold. The fnal results are an additional variable to be used by the ECB to defne the minimum capital requirements for each bank (within the Supervisory Review and Evaluation Process - SREP). This stress exercise presented two macroeconomic scenarios (baseline and adverse), taking as a starting point the banks’ balance sheet at the end of 2017 and a three-year time horizon, with 2020 as the end point. The adverse scenario, very unlikely to occur, sets out a strong macroeconomic and fnancial markets downturn, both in Europe and in other countries where Santander operates. For instance, for the Eurozone as a whole, the scenario implies a negative cumulative GPD growth of -2.7%, rising unemployment in 2020 to 9.7% and a cumulative fall in housing prices of 19.1% in 2020. 279 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Under the adverse scenario, Santander was the bank with the least capital destroyed among its peers and also compared to 2016. The fully loaded CET1 declined 141 bps (compared to the systems’ average fall of 395 bps) from 10.61% in 2017 to 9.20% in 2020. Under the baseline scenario, Santander is also the bank with the strongest capital generation among peers3. Fully loaded CET1 ratio - stress test adverse scenario Fully loaded CET1 ratio - stress test baseline scenario % % 10.61% 9.20% 13.87% 10.61% 141 bps - +326 bps 2017 2020 2017 2020 2017 FL CET1 vs adverse 2020 2017 FL CET1 vs baseline 2020 bps Santander P 1 P 2 P 3 P 4 P 5 P 6 P 7 P 8 P 9 P 10 P 11 P 12 P 13 P 14 System: -395 bps Peers average: -403 bps -141 -193 -219 -265 -288 -334 -341 -363 -381 -437 -533 -576 -625 -657 -694 1,208 1,164 344 Proft after tax - stress test adverse scenario EUR million Santander P 1 P 2 P 3 P 4 P 5 P 6 P 7 P 8 P 9 P 10 P 11 P 12 System: -2,636 Peers average: -5,727 -1,279 -2,891 -4,050 -4,754 -5,767 -6,416 -6,710 -7,000 -7,468 -11,244 -15,334 P 13 P 14 -15,715 bps Santander 326 233 199 196 175 System: +126 bps Peers average: +114 bps P 1 P 2 P 3 P 4 P 5 P 6 P 7 P 8 P 9 P 10 P 11 P 12 P 13 P 14 -45 -52 113 108 102 102 82 62 59 43 Moreover, Santander is also the bank generating the most profts among peers, which has not incurred a cumulative loss over the three-year horizon. In short, Santander showed the greatest resilience among European peers due to the high generation of recurring revenue and profts, underscored by its strong and diversifed business model. 3. Peers: BBVA, Intesa San Paolo, Nordea, BNP, Unicredit, Commerzbank, Société Générale, ING, Crédit Agricole, HSBC, Deutsche Bank, RBS, Barclays and Lloyds. 280 2018 Annual Report Group financial performance Recovery and Resolution Plans and Special Situations Management Framework (ii) Improve escalation procedures for the recovery indicators, reducing the time frames. This section summarises the main advances in the sphere of the Group’s crisis management. Specifcally, the main principles developed regarding Recovery Plans, Resolution Plans and the management framework governing special situations. Recovery plans Context. The ninth version of the corporate recovery plan was prepared in 2018. The most important part sets out the measures that Banco Santander would have at its disposal to survive a very severe crisis on its own. (iii) Improve Early Warning Indicators (EWIs), which are almost totally homogeneous thanks to the implementation of a corporate policy on liquidity EWIs. (iv) Analysis of Banco Popular and assessment of its implications. The main conclusions extracted from analysing the contents of the 2018 corporate plan confrm that: • There are no material interdependencies between the Group’s diferent countries The most important objectives are to test: the feasibility, efectiveness and credibility of the recovery measures identifed and the degree of suitability of the recovery indicators and their respective thresholds that if surpassed entail activating the scaling of decision-making in order to cope with stress situations. • The measures available ensure an ample recovery capacity in all the scenarios raised in the plan. Moreover, the Group’s geographic diversifcation model is a point in its favour from the recovery perspective. To this end, the corporate recovery plan sets out diferent macroeconomic and/or fnancial crisis scenarios in which idiosyncratic and/or systemic events important for the Group which could entail activating the Plan are envisaged. Moreover, the Plan has been designed with the premise that, if activated, there would be no extraordinary public aid, in accordance with article 5.3 of the Bank Recovery and Resolution Directive (BRRD). It is important to point out that the Plan should not be interpreted as an instrument independent of the rest of the structural mechanisms established to measure, manage and supervise the risk assumed by the Group. The Plan is integrated with the following tools, among others: the risk appetite framework (RAF); the risk appetite statement (RAS); the risk identifcation assessment (RIA), the business continuity management system (BCMS) and the internal processes for assessing the sufciency of capital and liquidity (ICAAP and ILAAP). The Plan is also integrated into the Group’s strategic plans. Evolution in 2018. We continued the improvement work in line with the European regulator’s requirements and expectations and the industry’s best practices. Specifcally, the following were included: • Each subsidiary has sufcient capacity to emerge by its own means from a recovery situation, which increases the strength of the Group’s model, based on subsidiaries that are autonomous in terms of capital and liquidity. • None of the subsidiaries, in the event of serious fnancial problems or solvency, can be considered as sufciently relevant to surpass the severest levels established for the recovery indicators and which could result in activating the corporate plan. • The Group has sufcient mitigation mechanisms to minimise the negative economic impact from potential damage to its reputation in diferent stress scenarios. All of these factors underscore that the Group’s model and geographic diversifcation strategy, based on a model of subsidiaries autonomous in liquidity and capital, continues to be strong from a recovery perspective. Regulation and governance. The plan was developed in accordance with the current EU regulation4. The plan also follows the non-binding recommendations made by international bodies such as the Financial Stability Board (FSB5). (i) Additional evaluation of recovery measures. Greater detail and granularity regarding intra-group interconnections and the impact these interdependencies could have on the sale of a subsidiary. As in previous versions, the Group’s Plan was presented in September to the Single Supervisory Body. As of then the EBA has six months to make formal considerations. 4. Directive 2014/59/EU (Directive of the European Union on crisis management); prevailing regulation of the European Banking Authority in matters of recovery plans (EBA/RTS/2014/11; EBA/GL/2014/06; EBA/GL/2015/02); recommendations of the European Banking Authority to the European Commission on key business lines and critical functions (EBA/op/2015/05); regulation of the European Banking Authority pending approval (EBA/CP/2015/01 on ITS templates for recovery plans); regulation of the European Banking Authority not directly related with recovery, but with signifcant implications in this sphere (EBA/GL/2015/03 on factors triggering early intervention measures); as well as Spanish regulations: Law 11/2015, on recovery and resolution of credit institutions and investment service companies and Royal Decree 1012/2015 which develops this Law. 5. FSB Elements key for efective resolution systems for fnancial institutions (15 October 2014, updating of the frst publication in October 2011), guidelines for identifying critical functions and shared critical services (15 July 2013) and guidelines on elements triggering recovery and crisis scenarios (July 15 2013). 281 Responsible bankingCorporate governanceEconomic and financial reviewRisk management The Group’s Plan comprises both the Corporate Plan (which corresponds to Banco Santander S.A.) as well as local plans for its main countries (UK, Brazil, Mexico, US, Germany, Argentina, Chile, Poland and Portugal), which are annexed to the corporate plan. It is important to mention that, except for Chile, all countries have to draw up a local plan as a local regulatory requirement as well as the corporate requirement to do so. The board of Banco Santander S.A. approved the corporate plan, though the content and relevant figures were previously presented and discussed in the Group’s main management and control committees (capital committee, global ALCO and the risk supervision, regulation and compliance committee). The local plans are approved by the corresponding local bodies and always in coordination with Santander, as they must form part of the Group’s plan (as they are annexed to the corporate plan). 2) Ensure that there are information systems that can quickly provide high quality necessary information in the event of resolution. In 2018, we concluded automating the information on liabilities that could be the object of a bail-in in the event of resolution. Furthermore, we continued working on automating the rest of the information that is delivered to the resolution authority and used for drawing up the resolution plan. The later is expected to be completed during 2019. Progress was made in the ongoing projects launched to have data repositories on: 1. Legal entities that belong to the Group. Resolution plans Santander continues to cooperate with the relevant authorities in preparing resolution plans, providing all the information they request. 2. Critical suppliers. 3. Critical infrastructure. The authorities that form part of the Crisis Management Group (CMG) maintained their decision on the strategy to follow for the resolution of the Group: the Multiple Point of Entry (MPE)6. This strategy is based on the legal and business structure with which Santander operates, organised into nine “Resolution Groups” which can be resolved independently without involving other parts of the Group. In May 2018, the Single Resolution Board (SRB) communicated the preferred resolution strategy as well as the priorities of work for improving the Group’s resolvability. Regarding this, the Group continued to advance in the projects to improve its resolvability, defning four lines of action: 1) Ensure the Group has a sufcient bufer of instruments with loss absorption capacity. During 2018, the Bank issued EUR 7.0 billion of senior non- preferred debt which absorbs losses before any senior debt. In addition, in order to avoid legal uncertainties when executing a bail-in, all MREL/TLAC issuance contracts include a clause where the holder recognises the capacity of the resolution authority bail- in to said instrument. 4. Financial contracts in accordance with article 71.7 of the BRRD. 3) Guarantee operational continuity in resolution situations. The operational continuity clauses were reinforced in the contracts with internal suppliers and the clauses to be included in external supplier contracts are being analysed. The frst stage of a survey of the main market infrastructures on which the Group depends in order to understand their policies in the event that one of the member entities of this infrastructure were to enter into resolution was concluded. A second stage is underway to analyse the infrastructure policies in the event of fnancial deterioration of the entities before they enter into resolution. Lastly, contingency plans are expected to be developed to cover an infrastructure which ceases providing service in the event of resolution. 4) Foster a culture of resolvability in the Group. Progress was made in involving senior management by raising questions regarding the resolvability of Santander to the board and the creation of a steering committee specialised in resolution issues. Special situations management framework As regards governance in crisis situations, the special situations management framework was formally approved in 2016, both in the corporation as well as in the Group’s main countries. 6. Except for what has been stated, the drawing up of resolution plans in the US corresponds to the individual entities. 282 2018 Annual Report Group financial performance This framework has a holistic nature, resulting from its application to those special events or situations of any type in which there is an exceptional situation, diferent from that expected or from those which arise from ordinary businesses management, and which could compromise the development of activity or give rise to a serious deterioration of the entity’s or the Group’s fnancial situation, as it would mean a signifcant distancing from the risk appetite and defned limits. The main elements of this framework are: 1. It defnes a series of common crisis indicators. 2. It defnes a trafc light code on the basis of the degree of deterioration or risk of deterioration of the fnancial situation consistent with the limits used in daily business as usual management. 3. It defnes a Crisis Manager director who coordinates the response to a crisis situation. 4. It identifes personnel in charge of alerting and escalating crisis events. 5. It creates a high level crisis committee backed by a technical crisis committee. In 2018, progress was made in implementing the framework in order to attain a homogeneous level of development in the Group’s main subsidiaries. Moreover, progress was also made in developing instruments to facilitate rapid and efective crisis management (e.g. automation of communications in special situations, having specifc rooms prepared for crisis management, etc.) and in strengthening the awareness and training of employees and the Group’s governance bodies involved in the escalation and management of this type of situation, mainly by preparing and conducting war games. Total Loss Absorbing Capacity (TLAC) and Minimum Required Eligible Liabilities (MREL) On 9 November 2015, the FSB published its fnal principles and term sheet containing an international standard to enhance the loss absorbing capacity of G-SIBs. The fnal standard consists of an elaboration of the principles on loss absorbing and recapitalisation capacity of G-SIBs in resolution and a term sheet setting out a proposal for the implementation of these proposals in the form of an internationally agreed standard on total loss absorbing capacity (TLAC) for G-SIBs. Once implemented in the relevant jurisdictions, these principles and terms will form a new minimum TLAC standard for G-SIBs, and in the case of G-SIBs with more than one resolution group, each resolution group within the G-SIB. The FSB will undertake a review of the technical implementation of the TLAC principles and term sheet by the end of 2019. The TLAC principles and term sheet require a minimum TLAC requirement to be determined individually for each G-SIB at the greater of (a) 16% of risk weighted assets as of 1 January 2019 and 18% as of 1 January 2022, and (b) 6% of the Basel III Tier 1 leverage ratio exposure measure as of 1 January 2019, and 6.75% as of 1 January 2022. Furthermore, BRRD provides that Member States shall ensure that institutions meet, at all times, a minimum requirement for own funds and eligible liabilities (MREL). The MREL shall be calculated as the amount of own funds and eligible liabilities expressed as a percentage of the total liabilities and own funds of the institution. The European Commission’s proposals dated 23 November 2016 to amend BRRD and CRR aimed to implement the TLAC standard and to integrate the TLAC requirement into the general MREL rules thereby avoiding duplication from the application of two parallel requirements. As mentioned above, although TLAC and MREL pursue the same regulatory objective, there are, nevertheless, some diferences between them in the way they are constructed. The European Commission is proposing to integrate the TLAC standard into the existing MREL rules and to ensure that both requirements are met with largely similar instruments, with the exception of the subordination requirement, which will be institution-specifc and determined by the resolution authority. Under these proposals, institutions such as Banco Santander would continue to be subject to an institution-specifc MREL requirement (i.e., a Pillar 2 add-on MREL Requirement), which may be higher than the requirement of the TLAC standard (which would be implemented as a Pillar 1 MREL requirement for G-SIBs). 283 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4. Business areas performance 4.1 Description of businesses The segment reporting is based on fnancial information presented to the chief operating decision maker, which excludes certain items included in the statutory results that distort year-on-year comparisons and are not considered for management reporting purposes. This fnancial information (underlying basis) is computed by adjusting reported results for the efects of certain gains and losses (e.g.: capital gains, write-downs, impairment of goodwill, etc.). These gains and losses are items that management and investors ordinarily identify and consider separately to better understand the underlying trends in the business (see also note 52.c to the Group fnancial statements). The Group has aligned the information in this operating segment section in a manner consistent with the underlying information used internally for management reporting purposes and with that presented throughout the Group’s other public documents. The Group executive committee has been determined to be the chief operating decision maker for the Group. The Group’s operating segments refect the organisational and management structures. The Group executive committee reviews the internal reporting based on these segments in order to assess performance and allocate resources. The segments are diferentiated by the geographic area where profts are earned, and by type of business. The fnancial information of each reportable segment is prepared by aggregating the fgures for the Group’s various geographic areas and business units. The information relates to both the accounting data of the units integrated in each segment and that provided by management information systems. In all cases, the same general principles as those used in the Group are applied. The businesses included in each of the business areas in this report and the accounting principles under which their results are presented here may difer from the businesses included and accounting principles applied in the fnancial information separately prepared and disclosed by our subsidiaries (some of which are publicly listed) which in name or geographical description may seem to correspond to the business areas covered in this report. Accordingly, the results of operations and trends shown for our business areas in this document may difer materially from those of such subsidiaries. During 2018, certain changes took place in the organisational structure of the Group, which led to a change in segment reporting: • Banco Popular’s fnancial results and balance sheet have been allocated to the corresponding segments. The afected segments are Spain, Portugal and Real estate activity Spain. • The Group acquired the stake of Santander Asset Management that was not already owned by the Group. Following this change in the consolidation perimeter, the Group decided to integrate the acquired Asset Management business, the International Private Banking business and the corporate unit of Private Banking, which were previously reported within the Retail Banking segment, into a new segment identifed as Wealth Management. • Additionally, there has been an adjustment to the perimeter of the Global Customer Relationship Model, between the Retail Banking segment and the Santander Corporate & Investment Banking segment, as well as other minor changes relating to the Real estate activity Spain. The Group restated the corresponding information of earlier periods to refect these changes in the structure of its internal organisation. The operating business areas are structured in two levels: Geographic businesses This primary level of segmentation, which is based on the Group’s management structure, comprises fve reportable segments: four operating areas plus the Corporate Centre. The operating areas, which include all the business activities carried on therein by the Group, are: • Continental Europe: which comprises all the business activities carried out in the region. Detailed fnancial information is provided on Spain, Portugal, Poland and Santander Consumer Finance (which incorporates all the region’s business, including the three countries mentioned herewith). • United Kingdom: includes the business activities carried out by the various Group units and branches present in the UK. 284 2018 Annual Report Business areas performance • Latin America: includes all the fnancial activities carried out by the Group through its banks and subsidiary banks in the region. Detailed information is provided on Brazil, Mexico, Chile, Argentina, Uruguay, Peru and Colombia. • The US: includes the holding company (SHUSA) and the businesses of Santander Bank, Santander Consumer USA, Banco Santander Puerto Rico, the specialised unit Banco Santander International and the New York branch. Global businesses At this secondary level of segment reporting, the Group is structured into Retail Banking, Corporate & Investment Banking, Wealth Management and Real Estate Activity Spain. • Retail Banking: this covers all customer banking businesses, including consumer fnance, except those of corporate banking, which are managed through SCIB, and asset management and private banking, which are managed by Wealth Management. The results of the hedging positions in each country are also included, conducted within the sphere of each one’s assets and liabilities committee. • Santander Corporate & Investment Banking (SCIB) (formerly Santander Global Corporate Banking): This business refects revenue from global corporate banking, investment banking and markets worldwide including treasuries managed globally (always after the appropriate distribution with Retail Banking customers), as well as equities business. • Wealth Management: Includes the asset management business (Santander Asset Management), the corporate unit of Private Banking and International Private Banking in Miami and Switzerland. • Real estate activity Spain includes loans and advances to customers and foreclosed assets of customers who are mainly involved in real estate development and who have a specialised management model and the assets of the former real estate fund (Santander Banif Inmobiliario). In addition to these operating units, which report by geographic area and businesses, the Group continues to maintain the area of Corporate Centre, that includes the centralised activities relating to equity stakes in fnancial companies, fnancial management of the structural exchange rate position, assumed within the sphere of the Group’s assets and liabilities committee, as well as management of liquidity and of shareholders’ equity via issuances. As the Group’s holding entity, this area manages all capital and reserves and allocations of capital and liquidity with the rest of businesses. It also incorporates amortisation of goodwill but not the costs related to the Group’s central services (charged to the areas), except for corporate and institutional expenses related to the Group’s functioning. As described in section 3 above, the results of our business areas presented below are provided on the basis of underlying results only and generally. Including the impact of foreign exchange rate fuctuations. However, for a better understanding of the actual changes in the performance of our business areas, we also provide and discuss the year-on-year changes to our results excluding such impact. 285 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4.2 Summary income statement of the Group’s main business areas 2018. Main items of the underlying income statement EUR million Geographic businesses Continental Europe Spain Santander Consumer Finance Poland Portugal Other United Kingdom Latin America Brazil Mexico Chile Argentina Other US Operating areas Corporate Centre Total Group Global businesses Retail Banking Santander Corporate & Investment Banking Wealth Management Real estate activity Spain Operating areas Corporate Centre Total Group Net interest income 10,107 4,360 3,723 996 858 170 4,136 15,654 9,758 2,763 1,944 768 421 5,391 35,288 (947) 34,341 32,522 2,378 420 (33) 35,288 (947) 34,341 Net fee income 4,419 2,631 798 453 377 162 1,023 5,253 3,497 756 424 448 128 859 11,554 (69) 11,485 8,946 1,512 1,097 (0) 11,554 (69) 11,485 Total income Net operating income Proft before tax Underlying attributable proft to the parent 15,881 7,894 4,610 1,488 1,344 545 5,420 21,201 13,345 3,527 2,535 1,209 585 6,949 49,452 (1,028) 48,424 42,832 5,087 1,543 (10) 49,452 (1,028) 48,424 7,604 3,414 2,625 851 702 11 2,426 13,204 8,863 2,064 1,491 460 326 3,934 27,168 (1,523) 25,645 23,577 2,982 813 (204) 27,168 (1,523) 25,645 5,501 2,325 2,140 555 688 (207) 1,926 7,971 5,203 1,230 1,121 185 232 1,117 16,515 (1,739) 14,776 13,408 2,657 797 (347) 16,515 (1,739) 14,776 3,642 1,738 1,296 298 480 (170) 1,362 4,228 2,605 760 614 84 165 552 9,785 (1,721) 8,064 7,793 1,705 528 (242) 9,785 (1,721) 8,064 Underlying attributable proft 2018. % distribution of operating areas A Geographic businesses Global businesses Other Argentina: 1% Americas: 2% Chile: 6% Spain: 17% Brazil: 26% United Kingdom: 13% Wealth Management: 5% Santander Corporate & Investment Banking: 17% Mexico: 8% SCF: 13% US: 5% Portugal: 5% Poland: 3% Other Europe: 1% A. Excluding Corporate Centre and Real estate activity Spain. 286 Retail Banking: 78% 2018 Annual Report Business areas performance 2017. Main items of the underlying income statement EUR million Geographic businesses Continental Europe Spain Santander Consumer Finance Poland Portugal Other United Kingdom Latin America Brazil Mexico Chile Argentina Other US Operating areas Corporate Centre Total Group Global businesses Retail Banking Santander Corporate & Investment Banking Wealth Management Real estate activity Spain Operating areas Corporate Centre Total Group Net interest income 9,230 3,784 3,571 928 788 160 4,363 15,984 10,078 2,601 1,907 985 413 5,569 35,146 (851) 34,296 32,339 2,442 404 (38) 35,146 (851) 34,296 Net fee income 4,167 2,333 878 443 360 153 1,003 5,494 3,640 749 391 596 117 971 11,635 (38) 11,597 9,306 1,627 700 2 11,635 (38) 11,597 Total income Net operating income Proft before tax Underlying attributable proft to the parent 14,417 6,860 4,484 1,419 1,245 409 5,716 22,519 14,273 3,460 2,523 1,747 516 6,959 49,611 (1,220) 48,392 6,754 2,820 2,506 814 630 (16) 2,855 13,799 9,193 2,078 1,498 777 252 3,761 27,170 (1,696) 25,473 42,904 23,228 5,503 1,212 (8) 49,611 (1,220) 48,392 3,474 684 (217) 27,170 (1,696) 25,473 4,899 2,002 2,083 581 574 (340) 2,184 7,497 4,612 1,134 1,059 526 165 892 15,473 (1,923) 13,550 12,555 2,712 667 (461) 15,473 (1,923) 13,550 3,202 1,439 1,254 300 435 (225) 1,498 4,297 2,544 710 586 359 97 408 9,405 (1,889) 7,516 7,456 1,780 478 (308) 9,405 (1,889) 7,516 Underlying attributable proft 2017. % distribution of operating areas A Geographic businesses Global businesses Other Argentina: 4% Americas: 1% Chile: 6% Spain: 15% Brazil: 26% United Kingdom: 16% Wealth Management: 5% Santander Corporate & Investment Banking: 18% Mexico: 7% US: 4% Poland: 3% SCF: 13% Portugal: 5% A. Excluding Corporate Centre and Real estate activity Spain. Retail Banking: 77% 287 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4.3 Geographic businesses Continental Europe 2018 Highlights Focus on three main priorities: customer loyalty, digital transformation and operational excellence. Underlying attributable proft EUR 3,642 Mn Progress in the incorporation of the new strategic business: Banco Popular in Spain and Portugal, and the retail and SME businesses acquired from Deutsche Bank Polska (DBP) in Poland. Underlying attributable profit amounts to EUR 3,642 million, 14% higher in euros and excluding the exchange rate impact, spurred by customer revenue, partly driven by Banco Popular’s integration. Strategy In an environment of historically low interest rates, the Group carried out a strategy that enabled us to improve customer loyalty, increase activity, customer revenue growth, cost control and enhance credit quality. Additionally, 2018 was a key year in Continental Europe due to the resizing that followed the new strategic business integration into the Group. In Portugal, the Bank completed the operational and technological integration of Banco Popular Portugal. After this acquisition, Santander Totta became the largest privately owned bank in terms of assets and loans and advances to customers in the domestic activity. In Spain, we strengthened our position after the acquisition of Banco Popular, whose integration is progressing as scheduled. We completed the legal integration, and the central and territorial services are already unifed. Of note, good performance of the frst joint commercial ofer (1|2|3 Profesionales account) which had accounted more than 160,000 customers by the end of the year, well above the initial target. On the other hand, progress in the management of Banco Popular’s alliances in order to recover strategic business and ease its integration, focusing on enhancing the customer experience. Of note was the sale of 49% of WiZink stake to Värde Partners, Inc and the recovering of Banco Popular card business. At the same time, we recovered its ATM business. Loyal customers Digital customers Thousands Thousands 7,693 5,805 5,223 3,974 +31% +33% 2017 2018 2017 2018 In Poland, the recently named Santander Bank Polska (former BZ WBK) strengthened its position in the country following the acquisition of the retail, SMEs and private banking business of DBP. Lastly, Continental Europe benefted from the creation of the Santander Wealth Management global unit at the end of 2017 (including Asset Management and Private Banking) in order to ofer an improved and wider range of funds. In Private Banking, we are developing a new proposition, which intends to be the leader in Europe, supported by the collaboration of the countries where the Group operates. The Group continues to be immersed in its cultural transformation in the region. Santander was awarded with the Top Employers Europe 2018 certifcation. As a result, the number of loyal customers and digital customers rose (31% and 33% respectively), increasing in all countries of this area. 288 2018 Annual Report Activity Loans and advances to customers rose almost 1%. Excluding reverse repurchase agreements and the exchange rate impact, gross loans and advances to customers increased 2% mainly driven by Santander Consumer Finance and Poland (partially due to the integration of DBP). Spain and Portugal decreased in a deleveraging market environment, where consumer loans and SMEs recorded a better evolution than large companies and institutions. Customer deposits were 5% higher year-on-year, both in euros as well as excluding repurchase agreements and the exchange rate impact, due to the increase in demand deposits in all units, which ofset lower time deposits. Of note was the performance of Spain, where demand deposits amounted to more than EUR 14,000 million (+8%, driven by the 1|2|3 loyalty strategy), while time deposits decreased more than EUR 12,000 million (-20%) due to reduction of expensive deposits (partially from Banco Popular), as part of our strategy to reduce the cost of funding. Including mutual funds (-5%), customer funds grew 3%. Results Underlying attributable proft amounted to EUR 3,642 million in the year (39% of the Group’s operating areas). Underlying RoTE was 10.64%. Compared to 2017, underlying attributable proft rose 14%, without having any exchange rate impact. The evolution of proft and the main P&L lines were afected by the integration of Banco Popular in Spain and Portugal in June 2017. By lines: • Total income increased 10%, driven by all the main items. Net interest income rose 10% with a positive evolution in all units, mainly Spain and Portugal. Net fee income was 6% higher, especially in Spain due to transactionality. The only decrease was recorded in Santander Consumer Finance due to lower income from insurance. Gains on fnancial transactions rose 47% (accounting for just 6% of total income), mainly driven by Spain’s performance. • Administrative expenses and amortisations up 8%, as Spain was very afected by Popular’s integration. The ongoing measures to optimise costs, as part of the integration process, were refected in the frst synergies. • Net loan-loss provisions were 26% higher due to the perimeter, as credit quality improved: the NPL ratio decreased 57 bps year- on-year to 5.25%, with a positive performance in all commercial units. The coverage ratio fell slightly to 52%. • Other gains (losses) and provisions recorded a loss of EUR 704 million (EUR -746 million in 2017), with an uneven performance by units. Business areas performance Continental Europe EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent % % excl. FX 2018 10,107 4,419 2017 9,230 4,167 9.5 6.1 916 625 46.4 440 15,881 394 14,417 (8,278) (7,662) 7,604 (1,399) 6,754 (1,109) 11.5 10.2 8.0 12.6 26.2 (704) (746) (5.7) 5,501 (1,461) 4,899 (1,315) 4,040 3,584 — — 4,040 397 3,584 382 3,642 3,202 12.3 11.1 12.7 — 12.7 4.1 13.7 9.8 6.2 47.0 11.8 10.4 8.3 12.9 26.4 (5.6) 12.6 11.3 13.1 — 13.1 4.2 14.1 Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds 383,020 380,080 0.8 1.0 142,813 114,966 24.2 24.2 89,030 36,012 31,011 681,887 369,730 99,728 39,918 43,429 678,122 352,548 (10.7) (9.8) (28.6) 0.6 4.9 (10.6) (9.8) (28.6) 0.7 5.1 158,761 159,794 (0.6) (0.8) 62,018 37,142 14,827 642,479 39,408 61,214 45,919 17,308 636,784 41,338 1.3 (19.1) (14.3) 0.9 (4.7) 390,794 384,088 436,913 366,351 70,562 425,301 351,282 74,020 1.7 2.7 4.3 (4.7) 1.5 (19.1) (14.2) 1.0 (4.4) 1.9 2.9 4.5 (4.5) Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 10.64 52.1 5.25 52.2 67,572 5,998 9.82 53.1 5.82 54.4 67,922 6,298 0.82 (1.0) (0.57) (2.2) (0.5) (4.8) 289 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Spain Underlying attributable proft EUR 1,738 Mn 2018 Highlights Banco Popular’s integration is progressing as scheduled: the legal integration was completed, central services and regional teams unifed, a single technological platform put in place and migration of customers has already started. Progress was made on digital transformation and the customer relationship model (4.8 million digital customers, launch of Work Café and reinforcement of Santander Personal). Strong growth in SME and companies. New lending was 17% higher and the stock increased by EUR 1,800 million year-on-year. Underlying attributable proft rose 21% in 2018, with better efciency, a cost of credit at around 30 bps and a positive impact from the incorporation of Banco Popular. Strategy In 2018, the integration of Banco Popular progressed as scheduled, the central services and regional teams unifed and a single technological platform put in place where we started the migration of customers. Progress was also made in managing of Banco Popular’s alliances in order to recover strategic businesses. Loyal customers rose 40%, with double-digit rises in the main transactional drivers: cards turnover rose 14% year-on-year; points of sale, +11% with a market share gain of 253 bps year-on- year; insurance, +30% in new protection insurance premiums and growth via digital means due to the improved process of online approvals. The SMEs and companies segment was also very dynamic: commercial activity increased 17%, largely from international business (+10%), backed by trade corridors and more stafng. In 2018 SCIB continued to be the leader in lending to large companies in Spain, according to Dealogic. Of note were the more than 80 syndicated loans. On the other hand, Santander Private Banking continued to be the market leader and it was named Best Private Bank in Spain by The Banker magazine. channels rose to c.30% in December 2018. Regarding our digital transformation, of note were the following initiatives: – Implementation of Santander Personal, our tailored remote management. We doubled our remote managers, we commercialised all our products through this channel and incorporated distinctive customer relation items, such as video calls through the app or chat with the manager. – Launch of Smartbank, new relationship model with the more than 600,000 millennial customers, ofering them tailored fnancial and non-fnancial proposals. – Launch of SO:FIA, an investment platform for the integral management of shares, mutual and pension funds. – New web for companies, fully renovated as a diferential feature in the sector: online global position, one click remittances, totally integrated payment and transfer suite, international business, pre-approved loans, etc., to strengthen our competitive advantage in SMEs. – Launch of Santander OnePay Fx, a blockchain-based Digital customers increased 51%, backed by the digital transformation, to 4.8 million and the weight of sales via digital international payment service which cuts transfer time by the same day or by the next day. Loyal customers Digital customers Thousands Thousands 2,669 1,900 4,756 3,158 +40% +51% 2017 2018 2017 2018 290 Leaders in mobile and website functionalities for retail banking (Aqmetrix Ranking) New relationship model for the millennials 2018 Annual Report Business areas performance – Boost in consumer credit thanks to increased sales in pre- approved credit via ATMs, going from a pure servicing model to a more commercial one. Spain EUR million Regarding the improvements on customer experience and attention, we continue to update the branch distribution network with new models, such as Smart Red (556 branches), and we opened the frst Work Café, which integrates co-working space, a cofee shop and bank, focusing on the customer experience and digital capabilities. Lastly, in 2018 our contract centre was awarded the CRC ORO for excellent Customer Service in Spain. Activity Loans and advances to customers decreased 6%. In gross terms, excluding reverse repurchase agreements, they fell 4% in euros compared to 2017 because of the fall in large companies and institutions, which ofset the growth in retail banking due to the rise in private banking (EUR 400 million) and SMEs and companies loans (EUR 1,800 million). Customer deposits increased 1% compared to 2017. Demand deposits rose 8%, driven by the 1|2|3 account (up EUR 5,300 million in the year), which ofset the decrease in time deposits down from 41 bps in the fourth quarter of 2017 to 20 bps in the fourth quarter of 2018. Customer funds remained stable including the 5% decrease in mutual funds. In addition, EUR 14,142 million are managed in pension funds, 6% lower than in 2017. Results Underlying attributable proft amounted to EUR 1,738 million (17% of the Group’s total operating areas) and underlying RoTE was 10.81%. Compared to 2017, underlying attributable proft was 21% higher: • Total income rose 15%, spurred by net interest income (+15%) refecting a sustained improvement of customer spreads due to the lower cost of funding. Net fee income was 13% higher, thanks to increased transactions. Of note was income from servicing, mutual funds and insurance. Gains on fnancial transactions rose 28%, favoured by the management of ALCO portfolios. • Administrative expenses and amortisations were 11% higher. However, the frst synergies from the optimisation measures carried out as part of the integration process are starting to materialise. Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage • Net loan-loss provisions rose 21%. Nevertheless, the NPL ratio Number of employees fell to 6.19% in December 2018 from 10.52% in June 2017, when Banco Popular was incorporated, and the cost of credit was just 33 bps. • Other gains (losses) and provisions increased their losses in the year, partly due to provisions related to foreclosed assets. Year-on-year growth rates of proft and the main P&L lines were impacted by the incorporation of Popular. Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 2018 4,360 2,631 560 343 7,894 2017 3,784 2,333 436 307 6,860 (4,480) (4,040) 3,414 (728) (362) 2,325 (586) 1,739 — 1,739 1 1,738 2,820 (603) (215) 2,002 (546) 1,456 — 1,456 17 1,439 206,776 220,550 117,215 91,395 60,720 32,727 16,644 434,082 255,402 93,854 24,608 35,054 8,878 417,796 16,286 76,806 36,710 26,348 451,809 252,866 100,727 26,286 43,529 11,230 434,639 17,170 209,630 218,607 315,351 253,946 61,406 316,784 251,999 64,785 10.81 56.8 6.19 45.0 32,313 4,366 10.31 58.9 6.32 46.8 33,271 4,485 % 15.2 12.8 28.4 11.8 15.1 10.9 21.1 20.7 68.3 16.1 7.3 19.4 — 19.4 (96.8) 20.8 (6.2) 28.3 (20.9) (10.9) (36.8) (3.9) 1.0 (6.8) (6.4) (19.5) (20.9) (3.9) (5.1) (4.1) (0.5) 0.8 (5.2) 0.51 (2.1) (0.13) (1.8) (2.9) (2.7) 291 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Santander Consumer Finance 2018 Highlights S CF is the European leader in consumer fnance. M ain management focuses: to remain leader in auto fnance and increase consumer fnance, s trengthening digital channels. U nderlying attributable proft rose 3% in euros and 4% year-on-year excluding the exchange r ate impact. High proftability (underlying RoTE of 16%) and cost of credit at historic lows. Underlying attributable proft EUR 1,296 Mn Strategy SCF is Europe’s consumer fnance market leader, with a presence in 15 European countries and more than 130,000 associated points- of-sale (auto dealers and shops). It also has a signifcant number of fnance agreements with auto and motorbike manufacturers and retail distribution groups. In 2018, SCF continued to gain market share, underpinned by a solid business model: highly diversifed by countries with a critical mass in key products, more efcient than competitors and a risk control and recovery system that enables to maintain high credit quality. On the other hand, we continued to sign and develop new agreements, both with retail distributors as well as producers, seeking to help them in the commercial transformation process and thus increase the value proposition for the fnal client. Management focused on: • Maximising efciency of capital, in a competitive environment characterised by the entry of new competitors, an excess of liquidity in markets and moderate GDP growth. • Remaining the leaders in auto fnance and growing consumer credit by extending agreements with the main dealers. • Strengthening digital channels and helping our partners through their digital transformation. SCF launched two core projects: the e-commerce platform, to help our partners create, manage and improve their business; and digital interaction, which optimises the relationship between agents and the customers. • The plan to integrate the retail networks of SC Germany progressed as scheduled. Of note, SCF was recognised as Top Employer Europe 2018 in Austria, Belgium, Germany, Italy, The Netherlands and Poland. Activity The stock of loans and advances to customers rose 6% compared to 2017. Gross loans excluding reverse repurchase agreements and the impact of exchange rates, also grew 6%. Almost all country units grew their business, more than 70% of lending is in countries with the highest rating and Germany and the Nordics account for 52% of the portfolio. Loans and advances to customers by geographic area December 2018 7% 4% 17% 13% 292 9% 15% 35% Germany Spain Italy France Nordic countries Poland Other 2018 Annual Report Business areas performance New lending increased 7% compared to 2017, growth in almost all countries driven by commercial agreements in several of them. Of note were the rises in France, Poland, the Nordics and Italy. Santander Consumer Finance EUR million SCF is benefting from having banking licenses in most of the countries in which it operates, enabling it to take deposits in many of them. It also has a high diversifcation of funding sources, with a good structure to access markets through securitisations and other issues. This enabled customer deposits to be a product that sets Santander apart from its competitors (above EUR 36,000 million) coupled with the high capacity to access wholesale funding. Results Underlying attributable proft was EUR 1,296 million in 2018 (13% of the Group’s total operating areas) and underlying RoTE was 15.86%. Compared to 2017, underlying attributable proft was 3% higher in euros and 4% excluding the exchange rate impact, as follows: • Total income rose 3%, driven by net interest income (+5%) due to higher volumes and lower funding costs. Net fee income declined 9%, largely due to the adaptation of insurance business to the new environment. • Administrative expenses and amortisations increased slightly (+1%) and the efciency ratio improved to 43.1%. • Net loan-loss provisions increased 36%, because of the positive impact in 2017 of the sale of foreclosed portfolios and other releases. The cost of credit remained low for this type of business (0.38%), underscoring the good performance of portfolios. The NPL ratio was 2.29%, 21 bps lower year-on-year, and the coverage ratio increased to 106% (101% in December 2017). • Other gains (losses) and provisions amounted to EUR -125 million in 2018, 21% lower than in 2017 (in that year SCF recorded provisions for possible litigation and customers’ complaints). • The largest contribution to the underlying attributable proft came from Germany (EUR 349 million), the Nordic countries (EUR 331 million) and Spain (EUR 246 million). Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 2018 3,723 798 55 34 4,610 2017 3,571 878 3 32 4,484 (1,985) (1,978) 2,506 (266) % % excl. FX 4.3 (9.1) — 6.8 2.8 0.4 4.8 35.4 4.9 (9.0) — 8.3 3.3 0.9 5.3 36.1 2,625 (360) (125) 2,140 (577) 1,564 — 1,564 268 1,296 (157) (20.4) (20.5) 2,083 (588) 1,495 — 1,495 241 1,254 2.8 (1.9) 4.6 — 4.6 10.9 3.4 3.3 (1.4) 5.2 — 5.2 10.9 4.1 95,366 90,091 5.9 6.1 6,096 4,895 24.5 24.9 3,325 31 2,890 107,708 36,579 3,220 22 3,508 101,735 35,443 3.2 44.8 (17.6) 5.9 3.2 4.0 45.2 (17.3) 6.2 3.5 24,966 23,342 7.0 7.2 31,281 771 3,520 97,117 10,591 28,694 996 3,637 92,112 9,623 9.0 (22.6) (3.2) 5.4 10.1 9.3 (22.4) (3.0) 5.7 10.5 97,707 92,431 5.7 6.0 36,531 36,531 — 35,398 35,396 2 3.2 3.2 (100.0) 3.5 3.5 (100.0) 15.86 43.1 2.29 106.4 14,865 438 16.44 44.1 2.50 101.4 15,131 546 (0.58) (1.1) (0.21) 5.0 (1.8) (19.8) 293 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Poland 2018 Highlights The Group strengthened its position in Poland with the integration of the retail and SMEs businesses acquired from Deutsche Bank Polska (DBP). BZ WBK was renamed Santander Bank Polska, S.A. Strong growth in volumes refected in market share gains in a very competitive environment. Underlying attributable proft EUR 298 Mn Third bank in customer satisfaction in Poland. Underlying attributable proft fell (-1%) both in euros and excluding the exchange rate impact, due to the sale of portfolios in 2017, the cost of rebranding in 2018 and the charges associated with the integration of DBP. Strategy The retail and SMEs businesses acquired from Deutsche Bank Polska was successfully integrated into Santander Bank Polska in November. Almost 400,000 customers were migrated. As a result, Santander Bank Polska reinforced its position as one of the largest fnancial entities in Poland. For the frst time in the Polish banking system, the legal and operating merger, as well as the branch rebranding were accomplished in just one weekend. The Bank continued its strategy to become the bank of frst choice, anticipating and responding to customer expectations. The digital transformation continued during the year with the launch of mSignature, a mobile app authorisation tool as an inexpensive and secure alternative for SMS codes. The credit card and loan after-sale services were digitised. The Santander Internet service gives customers the option to amortise the entire loan or a portion. Following the implementation of Apple Pay, which joined Google Pay, Garmin Pay, BLIK, HCE and Fitbit, already in place, Santander Bank Polska S.A. now ofers six cashless payment methods. At the end of 2017, the As I Want account was successfully launched and we already have more than one million accounts opened. It was recognised as the best account for young people in the fnancial portal money.pl. Santander Bank Polska S.A. made signifcant headway in the implementation of agile methodology in the Retail Banking division. The following four tribes were established at the end of September 2018: Multichannel, Individual Customer, Risk and Consumer Engineering. The second and third rounds are underway in order to create the next tribes. This transformation project aims to speed up the delivery of innovative solutions and efectively analyse customer technology needs. All these actions resulted in important awards for the Bank in Poland, notably Bank of the Year in Poland by The Banker and second place in the Banking Stars ranking (third in 2017). The Bank was the best in two categories: efciency and stability. Also, it obtained the maximum score in the loans to total assets ratio, net loan to deposit ratio and fee income to total revenue ratio. The Bank also recorded the largest proft, RoE and RoA. Loyal customers Digital customers Thousands Thousands 2,089 2,203 1,802 1,387 +30% +5% 2017 2018 2017 2018 Santander Bank Polska branch, Poland 294 2018 Annual Report Business areas performance At the end of 2018, Santander Bank Polska had 1.8 million loyal customers (+30%), and 2.2 million digital customers (+5%) compared to 2017. Poland EUR million Activity The increased activity in an environment of volume growth and the incorporation of DBP, resulted in higher loans and advances to customers (+27%) compared to 2017 in euros. In real terms and excluding reverse repos and the exchange rate impact, loans rose 30% backed by the target segments: SMEs (+59%), individuals (+37%, notably mortgages and cash loans), companies (+14%) and SCIB (+10%). Customer deposits increased 38% year-on-year in euros. Excluding repos (repurchase agreements) and the exchange rate impact, deposits rose 36%, with double-digit growth in those from SMEs and companies as well as individuals, partly in order to increase the liquidity bufer ahead of the acquisition of Deutsche Bank Polska. Customer funds (including mutual funds) increased 32%. Moreover, Santander Bank Polska launched the frst European Medium Term Notes (EMTN) programme with EUR 500 million Eurobonds (three-year fxed price Mid Swap +77 bps). Santander SCIB acted as sole arranger and bookrunner. Results Underlying attributable proft of EUR 298 million in the year (3% of the Group’s total operating areas), and underlying RoTE of 10.29%. Compared to 2017, underlying attributable proft decreased 1% in euros as well as excluding the exchange rate impact, driven by: • Total income increased 5%, driven by net interest income (+7%) backed by larger volumes and price management in a low interest rate environment. Net fee income rose 2%, mainly from loans, cards and foreign currency, while the gain on fnancial transactions fell 15%. • Administrative expenses and amortisations rose 5% due to transformation projects and pressure on salaries. • Net loan-loss provisions were 17% higher, partly because of the sale of a non-performing loan portfolio in the first half of 2017. The cost of credit was 0.65% (0.62% in 2017). The NPL ratio improved to 4.28% (4.57% in December 2017). • Other gains (losses) and provisions recorded the impact of rebranding charges as well as those related to DBP’s acquisition. Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent 2018 996 453 44 (4) 1,488 (636) 851 (161) (135) 555 (131) 424 — 424 126 298 2017 928 443 % % excl. FX 7.3 2.2 7.4 2.3 52 (15.4) (15.3) (3) 1,419 (605) 814 (137) 35.8 4.8 5.2 4.5 17.3 36.0 4.9 5.3 4.7 17.4 (96) 40.0 40.2 581 (148) (4.4) (11.3) (4.3) (11.2) 432 (2.0) (1.9) — 432 132 — (2.0) (4.8) — (1.9) (4.7) 300 (0.7) (0.6) Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds 28,164 22,220 26.8 30.5 3,260 1,661 96.3 102.2 10,570 534 1,140 43,669 33,417 6,786 491 1,014 32,171 24,255 55.8 8.7 12.4 35.7 37.8 60.4 12.0 15.8 39.8 41.9 2,163 952 127.2 134.0 1,789 558 809 38,736 4,933 821 523 684 27,235 4,936 29,033 22,974 35,554 31,542 4,012 27,803 23,903 3,900 117.9 6.8 18.3 42.2 (0.1) 26.4 27.9 32.0 2.9 124.4 10.0 21.8 46.5 2.9 30.1 31.7 35.9 5.9 Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 10.29 42.8 4.28 67.1 12,515 611 11.56 42.6 4.57 68.2 11,572 576 (1.27) 0.1 (0.29) (1.1) 8.1 6.1 295 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Portugal Underlying attributable proft EUR 480 Mn 2018 Highlights The operational and technological integration of Banco Popular Portugal was completed in October 2018. Santander Totta strengthened its position as the country’s largest privately owned bank by assets and domestic loans and advances to customers. The digital and commercial transformation continued, increasing sales via digital channels and boosting growth of loyal and digital customers. Underlying attributable proft rose 10% year-on-year due to the improvement of the efciency ratio and lower provisions. The NPL ratio improved signifcantly and cost of credit was just 9 bps. Strategy The ofer of products and services tailored to customer needs, focused on boosting loyalty, continued in 2018. The strategy to transform the business model spurred growth in loyal and digital customers. Of note, in addition to World 1|2|3, was the development of new digital platforms such as the app Santander Empresas, mobile real-time push notifcations and alerts for cards and accounts, card blocking services and credit card payments in instalments (PagaSimples). In personal lending, CrediSimples (loan contracting exclusively through digital channels) already accounted for 28% of new lending (with that to loyal companies gaining signifcant market share). Regarding customer funds, customer deposits grew above the market, gaining market share. The Bank launched Conta SIM, a simple and more digital account, with a basic ofer of products and services for customers at the start of their working life or with lower income. As at December 2018, Santander Totta had 752,000 loyal customers (+9% compared to 2017) and 734,000 digital customers (+32% year-on-year). Santander Totta continued to be recognised for its activity. Of note: Best Bank in Portugal by Global Finance in 2018 and by World Finance as the Best Retail Bank in Portugal. Recently, it was also awarded Best Private Bank 2019 by Global Finance and Euromoney. This commercial activity was developed during the operational and technological integration of Banco Popular, completed in October 2018. Moreover, credit rating agencies upgraded their ratings throughout the year. In October, S&P upgraded its Stand Alone Credit Profile to bbb- and Moody’s upgraded deposits and long-term debt to Baa2/P-2 and Baa3/P-3, respectively. In September S&P improved its outlook from stable to positive. DBRS upgraded in April the Bank’s long-term debt to A with stable outlook. Loyal customers Digital customers Thousands Thousands 686 752 734 558 Popular Portugal integration +9% +32% 2017 2018 2017 2018 296 2018 Annual Report Activity Loans and advances to customers remained strong in the year. The market share of new lending to companies rose to 20% (+2.7 pp compared to 2017). Regarding SMEs lending, the Bank was the market leader in PME Investe, Crescimento and Capitalizar, with a market share of 23%. New mortgage lending was also very dynamic with a market share of 22% (+0.9 pp compared to 2017). Despite this strong activity, the stock of loans and advances to customers was 1% lower, compared to 2017. Excluding reverse repurchase agreements, they fell 2% year-on-year, impacted by the sale of non-proftable portfolios. Customer deposits increased 10% year-on-year driven by demand deposits (+15%) and time deposits (+5%), which produced above-market growth in deposits, particularly in companies. On the other hand, mutual funds decreased 10% and, consequently, customer funds rose 8%. In addition, EUR 1,154 million are managed in pension funds, 2% lower than in 2017. Results Underlying attributable proft amounted to EUR 480 million in the year (5% of the Group’s total operating areas), and underlying RoTE was 12.06%. Compared to 2017, underlying attributable proft rose 10%. Its performance, and that of the main P&L line items, was afected by the impact of Banco Popular’s incorporation in June 2017, as follows: • Total income increased 8%, driven by net interest income (+9%). Net fee income was 5% higher, particularly that from insurance and mutual funds. Gains on fnancial transactions, on the other hand, declined 1% because of fewer sales of ALCO portfolios in the year. • Administrative expenses and amortisations rose (+5%), although at a slower pace than total income. As a result net operating income increased 11% and the efciency ratio improved to 48%. Business areas performance Portugal EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds • Net loan-loss provisions increased. However, the cost of credit Customer deposits C was just 0.09%. The NPL ratio improved to 5.94% from 7.51% in December 2017 and the coverage ratio stood at 50%. Mutual funds • The efective tax rate was higher, partly because of the regulatory rise in corporate tax. Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 2018 858 377 75 34 1,344 (642) 702 (32) 18 688 (205) 483 — 483 2 480 2017 788 360 76 21 1,245 (614) 630 (12) (44) 574 (136) 438 — 438 2 435 35,470 35,678 3,454 3,015 12,303 1,877 1,904 55,007 37,217 8,007 4,259 257 1,197 50,937 4,070 11,803 1,828 2,804 55,127 33,986 10,024 5,413 327 1,257 51,008 4,119 36,568 37,494 39,143 37,217 1,926 36,115 33,986 2,130 12.06 47.8 5.94 50.5 6,705 572 11.65 49.3 7.51 62.1 6,822 681 % 8.9 4.7 (1.0) 61.4 8.0 4.5 11.3 160.6 — 19.8 50.5 10.3 — 10.3 9.5 10.3 (0.6) 14.5 4.2 2.6 (32.1) (0.2) 9.5 (20.1) (21.3) (21.6) (4.8) (0.1) (1.2) (2.5) 8.4 9.5 (9.6) 0.41 (1.6) (1.57) (11.6) (1.7) (16.0) 297 Responsible bankingCorporate governanceEconomic and financial reviewRisk management United Kingdom 2018 Highlights We continued with our strategy of selective growth in a competitive and uncertain operating environment whilst actively managing costs in order to improve operational efciency and the customer experience. Underlying attributable proft EUR 1,362 Mn Good business evolution: strongest mortgage growth in the last three years in a highly competitive market, which was partially ofset by a reduction in commercial real estate exposure. Our results refect income pressures and higher regulatory, risk and control costs, as well as strategic investment in business transformation and digital enhancement. Cost of credit at just 7 bps. Strategy We remained focused on growing customer loyalty, operational and digital excellence and steady and sustainable proft growth, while being the best bank for our employees and the communities in which we operate. To this end, we continued to develop our digital proposition, and in 2018 we retained 55% of refnanced mortgage loans online, an increase of 6 pp year-on-year. We also opened 43% of current accounts and 65% of credit cards through digital channels, increases of 5 and 13 pp, respectively. We enhanced our Investment Hub platform with a Digital Investment Adviser, which ofers easy access to online investment advice from GBP 20 per month. This enables customers to invest up to a maximum of GBP 20,000 in less than 30 minutes, and also receive a personal savings recommendation. The number of digital customers reached 5.5 million, up 9% year- on-year. In addition, we launched our innovative 1I2I3 Business current account in October 2018, which ofers standout value to UK SMEs as we seek to shake up the business banking market. Also, we further developed our international proposition with 3 trade corridors established in the year. We ranked second in retail customer satisfaction, as published by the Financial Research Survey (FRS). And as reported by the Charterhouse Business Banking Survey, our Corporate customer satisfaction at 61% was 7 pp above the market average. The number of loyal retail customers continued to grow, although at a slower pace (+3%) given the high comptetition in savings products. Loyal corporate customers increased 5%, with our customer-focused and international proposition. This performance was achieved despite a very competitive UK banking environment, and one which faces major regulatory changes. Open Banking and PSD II (Payment Services Directive) will infuence customer interaction and possibly the competitive landscape. Loyal customers Digital customers Thousands Thousands Video mortgage appointment 4,239 4,387 5,033 5,500 +4% +9% 2017 2018 2017 2018 298 2018 Annual Report Business areas performance In 2018, we completed our transition to a ring-fence compliant structure, with the conclusion of the required transfers of business from Santander UK to the Santander London Branch. United Kingdom EUR million Activity Loans and advances to customers increased 6% in euros compared to 2017. Excluding reverse repurchase agreements and the exchange rate impact, they rose 1%, due to growth in mortgage loans, underpinned by our focus on customer service and retention, ofset by managed reductions in commercial real estate exposure. Customer deposits declined 9% year-on-year in euros and were 1% lower excluding repurchase agreements and the exchange rate impact. Current accounts rose 2%, ofset by the reduction in savings and time deposits as part of a management pricing strategy. Mutual funds down 11% predominately driven by negative market movements and reduced net fows this year. Results Underlying attributable proft amounted to EUR 1,362 million in 2018 (13% of the Group’s total operating areas), and underlying RoTE was 9.32%. Compared to 2017, underlying attributable proft was 9% lower in euros and 8% excluding the exchange rate impact, as follows: • Total income declined 4% due to lower net interest income (-4%) because of the competitive pressure on mortgage spreads and continued SVR (Standard Variable Rate) volumes attrition. Gains on fnancial transactions fell 29% largely due to capital gains recorded in 2017. Net fee income, on the other hand, rose 3% backed by income from asset management, partly ofset by lower fee income from SCIB. • Administrative expenses and amortisations rose 6% because of increased regulatory, risk and control costs and ongoing strategic and digital transformation investments. • Net loan-loss provisions declined 14%, with a cost of credit of just 7 bps. The NPL ratio improved to 1.05% from 1.33% in 2017, backed by our prudent approach to risk and the resilience of the UK economy. The coverage ratio rose to 33% (32% in 2017). • Other gains (losses) and provisions in the lower part of the income statement had a positive impact in the year, largely due to payment protection insurance charges in 2017 which were not repeated this year. Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds 2018 4,136 1,023 199 62 5,420 2017 4,363 1,003 % % excl. FX (5.2) 2.0 (4.3) 2.9 282 (29.4) (28.7) 68 5,716 (7.9) (5.2) (7.0) (4.3) 5.7 (2,995) (2,861) 4.7 2,426 (173) (327) 1,926 (539) 1,387 — 1,387 25 1,362 2,855 (205) (15.0) (15.3) (14.2) (14.5) (466) (30.0) (29.3) 2,184 (662) (11.8) (18.6) (11.0) (17.8) 1,523 (8.9) (8.0) — — — 1,523 25 (8.9) 0.7 1,498 (9.1) (8.0) 1.6 (8.2) 257,284 243,617 5.6 6.5 39,843 56,762 (29.8) (29.2) 29,190 13,397 9,638 349,353 210,388 26,188 24,690 9,974 361,230 230,504 11.5 (45.7) (3.4) (3.3) (8.7) 12.4 (45.3) (2.6) (2.5) (8.0) 33,430 27,833 20.1 21.1 67,556 16,583 4,181 332,137 17,216 61,112 21,167 4,310 344,926 16,304 10.5 (21.7) (3.0) (3.7) 5.6 11.5 (21.0) (2.2) (2.9) 6.5 235,753 235,783 (0.0) 0.8 206,630 199,054 7,576 210,305 201,763 8,543 (1.7) (1.3) (11.3) (0.9) (0.5) (10.6) Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 9.32 55.2 1.05 33.0 25,872 756 10.26 50.1 1.33 32.0 25,971 808 (0.94) 5.2 (0.28) 1.0 (0.4) (6.4) 299 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Latin America 2018 Highlights Loyal and digital customers increased at double-digit rates in the region, underpinned by innovation, commercial transformation and enhanced loyalty. Underlying attributable proft EUR 4,228 Mn This strategy produced double-digit growth in volumes (excluding the exchange rate impact) as well as sustainable increase in customer revenue and cost of credit improvement. Underlying attributable proft of EUR 4,228 million, 2% down year-on-year in euros, impacted by the high infation adjustment in Argentina and currency depreciation against the euro in Latin American countries. Excluding the exchange rate impact, it rose 16%. Strategy Santander is a relevant player in the main markets of Latin America. Digital technology is enabling fnancial inclusion in this market, as there are millions of people without access to banking services. Thanks to our global network, we see great potential in developing relationships to serve our customers better along natural corridors of economic opportunity – such as between Brazil and Argentina, or the US and Mexico. We continue to invest in operating systems and digital infrastructure in order to streamline processes and enhance the customer experience, launching diferential propositions. The actions conducted are detailed in each unit. In 2018, loyal customers increased 21% and digital customers 30% and both rose in all units. The efort made in the commercial transformation helped soften the impact of some instability bouts on results, stemming from the election calendar in Mexico and Brazil, the impact of some currency depreciation (mainly the Argentine peso), and the high infation adjustment in Argentina. The macroeconomic instability in Argentina during the year, caused a strong depreciation of the peso (over 40%) and year-on-year high infation (47% in December 2018). As a result, Argentina renegotiated its agreement with the IMF and modifed its economic programme, focusing on correcting the fscal defcit. The agreement enables Argentina to cover its fnancing needs for 2018-2019. The new monetary and fscal policies should lead to more stable exchange rates and lower infation. Santander carried out an infation adjustment in accordance with regulation IAS29 of EUR 239 million, as detailed on Argentina’s page. The Group continues to be immersed in its cultural transformation in the region, underscored by the several awards it received. In 2018, Santander was among the top 3 best fnancial entities to work for in Latin America in the ranking Great Place to Work. Other awards were: Bank of the Year in Latin America in 2017 and 2018 by The Banker, and Best Private Banking in 2019 by Euromoney. Loyal customers Digital customers Thousands Thousands 17,872 13,793 9,928 8,216 +21% +30% 2017 2018 2017 2018 300 2018 Annual Report Activity Loans and advances to customers rose 2% in euros compared to 2017. Gross loans and advances to customers, excluding reverse repurchase agreements and the exchange rate impact, rose 12%, with growth rates around or above 10% in all units. Customer deposits remained stable in euros. Excluding repurchase agreements and the exchange rate impact, deposits increased 15%, with rises across all units driven by both demand and time deposits. Customer funds increased 12% including mutual funds (+6%). Results Underlying attributable proft amounted to EUR 4,228 million in the year (43% of the Group’s total operating areas), and underlying RoTE was 19.12%. Compared to 2017, underlying attributable proft was 2% lower in euros. The performance was very afected by the high infation adjustment in Argentina, and by currency depreciation against the euro. Excluding the forex impact, proft rose 16%, as follows: • Total income increased 12%, backed by the main P&L line items. Good performance of the most commercial revenues, underpinned by higher volumes, management of spreads and increased loyalty. Net interest income was 15% higher and net fee income 16%, with growth in all units. Gains on fnancial transactions (which account for just 3% of total income), fell 28%, largely due to the evolution in Brazil, impacted by market conditions. • Administrative expenses and amortisations were 10% higher, mostly due to expansion and commercial transformation plans, as well as greater digitalisation of the retail network. Of note was the rise in Mexico, because of the ongoing three-year investment plan. • Net loan-loss provisions rose 7%, well below the growth rate in loans and advances to customers, and enabled the cost of credit to improve 20 bps in the year, to 2.95%. Credit quality was better: the NPL ratio improved to 4.34%, from 4.46% in December 2017, and the coverage ratio increased to 97%, 85% in December 2017. • The negative impact of other income and provisions was 39% lower, thanks to reduced provisions for legal and labour contingencies in Brazil. Business areas performance Latin America EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds 2018 15,654 5,253 2017 15,984 5,494 % % excl. FX (2.1) (4.4) 15.1 15.7 600 1,013 (40.8) (28.5) (306) 21,201 29 22,519 — (5.9) (7,996) (8,721) (8.3) 13,204 (4,567) 13,799 (4,972) (4.3) (8.2) — 11.6 9.9 12.7 7.1 (666) (1,329) (49.9) (38.8) 7,971 (2,904) 7,497 (2,386) 6.3 21.7 5,067 5,111 (0.8) — — — 5,067 840 5,111 814 (0.8) 3.2 4,228 4,297 (1.6) 150,544 147,929 60,721 56,087 59,367 14,994 17,731 303,356 142,576 57,824 14,226 17,280 293,347 143,266 1.8 8.3 2.7 5.4 2.6 3.4 (0.5) 25.3 45.3 16.1 — 16.1 14.2 16.5 11.3 20.9 9.9 9.5 13.2 12.8 9.3 48,104 39,613 21.4 30.6 37,698 36,851 10,867 276,095 27,261 34,435 36,084 11,016 264,415 28,932 9.5 2.1 (1.4) 4.4 (5.8) 157,022 153,353 2.4 197,598 126,030 71,568 194,975 120,493 74,482 1.3 4.6 (3.9) 18.4 10.9 7.6 13.9 3.0 11.9 11.8 15.3 6.1 Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 19.12 37.7 4.34 97.3 90,196 5,803 17.94 38.7 4.46 85.0 89,014 5,908 1.18 (1.0) (0.12) 12.3 1.3 (1.8) 301 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Brazil 2018 Highlights Santander Brasil is the third largest privately owned bank and the largest foreign bank in Brazil. We are leaders in customer satisfaction. In less than four years, we have succeeded in strategically repositioning retail banking, and there is still potential to improve further. Prudent risk management underscored by the growth in loans and advances to customers. Proftable market share gains, compatible with lower NPL ratio and cost of credit. Underlying attributable proft rose 2%, up 22% excluding the exchange rate impact, and proftability improved (underlying RoTE of 19.77%), refecting greater productivity and the best efciency ratio of recent years. Underlying attributable proft EUR 2,605 Mn Strategy Santander Brasil recorded, once again, historically noteworthy results evolution in 2018, outperforming its main peers and underpinned by increased business activity, higher operational efciency and enhanced credit quality. This was possible by the continued strengthening of our franchise, agile innovation and enhanced services, in order to improve customer experience and satisfaction. The year’s main actions by segments included: • Aligned with the digital strategy, we put on for the fourth year running, Santander Black Week. We increased our sales through all channels, mainly in mortgages and working capital. We also launched Select Direct and the Meus Compromissos app. • The average time for taking out a mortgage loan was cut. New mortgage lending growth more than doubled the market’s and the use of the digital channels for taking out loans increased thanks to the Webcasas tool. • New payroll lending increased 28%, notably through digital channels that increased exponentially. • We continued to be the leading bank in auto fnance, with a market share of 23.7% (+64 bps year-on-year). In Webmotors, we implemented the Cockpit tool, an innovative platform for Loyal customers Digital customers Thousands Thousands the resale of vehicles, and launched Autopago, a more secure purchase and sale solution for individuals. We also announced the acquisition of a 51% stake in LOOP, which focuses on the auto market. Moreover, Santander Brasil also created Santander Auto, a fully digital insurer, a joint venture with HDI Seguros. • In acquiring business, we maintained our focus on innovative solutions and on integrating the segment ofer within the Bank. We implemented the PoS digital, SuperGet remained strong and revenue continued to grow notably (+32% year-on-year), with a market share of 14.4% (+292 bps). • In cards, increase in revenue (+20%) and in market share. The Santander Way app continued to be one of the main tools for digitalisation and customer relationship. It is considered the best app in the fnancial market given its score in both the Apple Store and Google Play. • In companies, increased customer base and portfolio volumes. In SMEs thanks to a specialised customer attention we have reached one million customers and gained market share (+40 bps year-on-year) to 11.4%. In Corporate, boosted by the new commercial strategy, and SCIB where we also have diversifed revenue sources. 11,445 8,594 Fully digital investment platform 5,232 4,186 +25% +33% 2017 2018 2017 2018 302 Employment benefts 2018 Annual Report Business areas performance • Santander continues to hold an outstanding position in the Prospera Santander Microcredit programme, with presence in 630 locations and a loan portfolio of BRL 642 million. Brazil EUR million Moreover, in 2018 we strengthened our brand and culture, and were named one of the best companies to work for by The Great Place to Work (GPTW) ranking, for the third year running. Activity Loans and advances to customers increased 1% year-on-year in euros, highly impacted by the real’s depreciation. In gross terms (excluding reverse repos and the exchange rate impact), they increased at double-digit rates (+13%). All segments recorded growth, notably consumer fnance and SMEs. Customer deposits fell 3% year-on-year in euros, but increased 23% excluding repos and the exchange rate impact, driven by strong growth in demand deposits (+9%) and time deposits (+29%), ofsetting the reduction in letras fnanceiras. This evolution was refected in proftable market share gain on customer funds, mainly in savings and agricultural credit notes. Results Underlying attributable proft of EUR 2,605 million in 2018 (26% of the Group’s total operating areas), and underlying RoTE of 19.77%. Compared to 2017, underlying attributable proft rose 2% in euros. Excluding the exchange rate impact, it was 22% higher, with good performance in the main lines, as follows: • Total income increased 12%, driven by net interest income (+16%) due to larger volumes, and net fee income (+15%), with good performance of almost all revenue line items. Of note was the growth in cards (+16%), current accounts (+11%), mutual funds (+54%), and insurance (+13%). Gains on fnancial transactions, which have very little weight (1%) on total revenue, fell 68%, afected in part by the market environment. • Administrative expenses and amortisations rose 5%, in line with business growth. This rise, less than half of that in total income, produced the best efciency ratio of the last fve years, at 33.6%. • Net loan-loss provisions increased 4%, well below the growth in loans. All credit quality ratios improved: the cost of credit declined to 4.06% from 4.36% in 2017. The NPL ratio improved to 5.25% from 5.29% a year earlier and the coverage ratio rose to 107% from 93% in 2017. • The negative impact of other gains (losses) and provisions was 30% less, due to lower provisions for legal and labour claims (trabalhistas). • Proft before tax was 35% higher. This increase, however, did not feed through to underlying attributable proft because of the higher tax (+57%), due to the rise in the efective tax rate (end of some deductions). Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 2018 9,758 3,497 136 2017 10,078 3,640 % % excl. FX (3.2) (3.9) 15.7 14.8 510 (73.4) (68.2) (46) 13,345 46 14,273 — (6.5) (4,482) (5,080) (11.8) 8,863 (2,963) 9,193 (3,395) (3.6) (12.7) — 11.7 5.4 15.2 4.2 (697) (1,186) (41.2) (29.7) 5,203 (2,264) 4,612 (1,725) 2,940 2,887 12.8 31.2 1.8 — — — 2,940 335 2,887 343 1.8 (2.2) 2,605 2,544 2.4 70,850 70,454 37,015 34,920 40,718 6,133 11,320 166,036 68,306 38,693 5,798 11,825 161,690 70,074 0.6 6.0 5.2 5.8 (4.3) 2.7 (2.5) 29,758 23,591 26.1 21,218 24,241 7,237 150,760 15,276 20,056 23,783 7,536 145,040 16,650 5.8 1.9 (4.0) 3.9 (8.3) 75,282 74,341 1.3 110,243 57,432 52,811 106,959 52,180 54,779 3.1 10.1 (3.6) 19.77 33.6 5.25 106.9 46,914 3,438 16.91 35.6 5.29 92.6 47,135 3,465 2.86 (2.0) (0.04) 14.3 (0.5) (0.8) 34.8 56.7 21.7 — 21.7 16.8 22.3 12.5 18.6 17.7 18.3 7.1 14.9 9.0 41.1 18.3 14.0 7.4 16.3 2.6 13.3 15.3 23.1 7.8 303 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Mexico Underlying attributable proft EUR 760 Mn 2018 Highlights Strategy focused on the commercial and technological transformation, refected in greater customer attraction and increased loyalty. Boost of digital channels and multichannel innovation, enhancing our value ofer with new products and services. In volume terms, growth in loans and advances to customers, notably to companies (+12%) and SMEs (8%). In customer funds, growth continued to be driven by customer deposits from individuals and SMEs. Good trend in proft. Underlying attributable proft rose 7% year-on-year. Excluding the exchange rate impact, it was 14% higher, driven by the good performance of net interest income, fee income and loan-loss provisions. Strategy During the year, we continued with our three-year plan of investment in systems and infrastructures as part of the commercial transformation strategy, carried out to improve multichanneling, strengthen our distribution model and launch new commercial initiatives in order to attract customers and increase loyalty with more products and services. Regarding the distribution model, we are developing diferent projects such as: • Transformation and implementation of the new branch distribution model, up to 314 transformed branches, surpassing the target (300). • We also launched the new sucursal Ágil model and the Transformación Digital de Nómina programme in order to improve the customer experience and cut waiting time. Of note in digitalisation was the following: • Launch of Campaña Libertad, in order to boost digital channels and reduce transactions at the branches, freeing commercial time. • We continued to strengthen mobile functionalities with Súper Móvil, Súper Wallet and contactless payments. Moreover, we developed several initiatives to consolidate our position as the bank for SMEs. We launched the new electronic banking system for SMEs and medium size companies, becoming the frst bank in Mexico to ofer a digital account for SMEs with SAS status (Sociedad por Acciones Simplifcadas) created by the Ministry of Economy and we promoted loans to the agribusiness sector. Our commercial strategy was complemented with new products and services, such as: • The number of new generation full function ATMs reached 817, above target. Also, the CRM was strengthened. • The Santander Plus programme continued to add customer benefts related to loans, insurance and commercial alliances. Over 4.7 million customers, 55% of whom are new, have already registered two years after its launching. Loyal customers Digital customers Thousands Thousands 2,515 1,993 1,948 2,879 +26% +48% 2017 2018 2017 2018 304 2018 Annual Report Business areas performance • Hipoteca Plus, a very competitive scheme in which customers beneft if they have a close relationship with the Bank. Mexico EUR million • Súper Auto (launched in the second half of the year), for auto and motorcycle fnance through a fully digital credit origination. We have over 300 auto selling agencies afliated and a fnanced portfolio of EUR 32 million. • Select Me, a programme that supports women with solutions that facilitate their day-to-day tasks and professional development. It had over 5,400 active customers at the end of the year. • Launch of the new system IVR (Interactive Voice Response) at the Contact Centre. • The Tuiio programme ofers products and services specially designed for low-income and non bankarised population. These measures resulted in increased loyalty and digitalisation of our customer base. Loyal customers rose 26% and digital ones 48%, notably mobile banking (+61%). Activity Loans and advances to customers increased 16% in euros, compared to 2017. Gross loans and advances to customers rose 10%, excluding reverse repurchase agreements and the exchange rate impact, with focus on proftability and growth in loans to individuals (consumer credit +4%, credit cards +4% and mortgage loans +9%) as well as SMEs, companies, and large companies. Customer deposits rose 13%. Excluding repurchase agreements and the exchange rate impact, demand deposits increased 5% and time deposits 9%. Mutual funds fell 5%, and so customer funds increased 3%. Results Underlying attributable proft amounted to EUR 760 million in the year (8% of the Group’s total operating areas), and underlying RoTE was 20.35%. Compared to 2017, underlying attributable proft was 7% higher in euros. Excluding the exchange rate impact underlying attributable proft rose 14%, as follows: • Total income increased 9%, driven by net interest income (+13%), backed by larger volumes and higher interest rates. Net fee income was 8% more, largely due to credit cards, mutual funds and insurance. Gains on fnancial transactions, which have very little weight in fee income, fell 28% impacted by the volatile environment. • Administrative expenses and amortisations were 13% higher, in line with the ongoing investments. • Net loan-loss provisions dropped 2%. The cost of credit improved signifcantly to 2.75% compared to 3.08% a year ago and the NPL ratio was also better at 2.43% (2.69% in 2017). Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 150.7 8.6 12.8 5.8 (2.2) 2018 2,763 756 101 (94) 3,527 2017 2,601 749 % % excl. FX 6.2 0.9 13.2 7.5 150 (32.5) (28.0) (40) 3,460 135.3 1.9 (1,462) (1,382) 5.8 2,064 (830) 2,078 (905) (0.7) (8.2) (3) (39) (91.3) (90.8) 1,230 (255) 1,134 (230) 8.5 10.9 975 — 975 215 760 904 — 904 194 710 7.9 — 7.9 11.1 7.0 15.6 18.2 14.9 — 14.9 18.4 14.0 30,632 26,462 15.8 10.0 12,403 9,956 24.6 14,142 5,683 3,016 65,876 34,327 13,676 5,627 2,481 58,203 30,392 9,536 8,247 6,194 8,281 2,168 60,507 5,369 5,168 7,680 1,779 53,267 4,936 31,192 26,962 38,630 28,705 9,925 35,548 25,629 9,919 3.4 1.0 21.6 13.2 12.9 15.6 19.9 7.8 21.9 13.6 8.8 15.7 8.7 12.0 0.1 20.35 41.5 2.43 119.7 19,859 1,418 19.50 39.9 2.69 97.5 18,557 1,401 0.85 1.5 (0.26) 22.2 7.0 1.2 18.4 (1.7) (4.0) 15.5 7.6 7.4 9.9 13.9 2.5 15.9 8.0 3.4 10.0 3.3 6.5 (4.9) 305 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Chile Underlying attributable proft EUR 614 Mn Strategy 2018 Highlights Santander is the leading privately owned bank by assets and customers in a country whose economic growth accelerated in 2018. We continued the transformation of the branch network, driving digitalisation and increasing our value ofer with new products and services. Growth in business volumes at a faster pace in several segments. Of note, the rise in loans to companies and increase in fee-generating businesses in SCIB. Underlying attributable proft rose 5% year-on-year. Excluding the exchange rate impact, it was 8% higher, driven by net interest income and net fee income. Santander is the largest privately owned bank in Chile by assets and customers, with a marked retail and transactional focus. • We launched Superdigital ofer and signed an alliance with Amazon in order to be able to manage purchases on its platform with Santander cards. In 2018, the strategy continued to be focused on ofering an attractive proftability in a stable country, one with low risk and accelerated economic growth. GDP rose 4% (estimated) in the year (1.5% in 2017). • Promotion of Digital Onboarding, the frst fully digital platform, in order to convert non-customers into customers, while improving loyalty. The focus was on our phygital transformation, a proposition that combines the best of the digital and physical worlds, where progress was made as follows: Also, we continued ofering specialised propositions for each segment, such as: • Launch of OnePay FX for companies. • We continued opening Work Café branches and launched Work Café 2.0, a pilot project for smaller branches, and a new branch model for Select and Private Banking segments. • Under the digitalisation strategy, we launched the new 2.0 app, signifcantly improved, and Santander Wallet, the frst app for mobile payments in Chile. • Consolidation of Santander Life, as a new way to interact with the community and the customer via products aimed at the mass consumer market. We launched Life 2.0 at the end of 2018, which will provide additional benefts to customers that are already part of the programme. Improving the quality of service is still one of our main priorities, and eforts made in this matter were refected in greater customer satisfaction. Loyal customers Digital customers Thousands Thousands 1,086 1,012 622 668 +7% +7% 2017 2018 2017 2018 306 2018 Annual Report Business areas performance As a result, loyal and digital customers both increased 7% year-on- year. Chile EUR million Santander Chile is continuously striving to become the best bank for customers. Euromoney, The Banker and Latin fnance recognised these eforts naming Santander as the Best Bank in Chile. Activity Loans and advances to customers increased 2% year-on-year in euros. Excluding reverse repurchase agreements and the exchange rate impact, they rose 10%, backed by those to individuals and companies. Customer deposits fell 1% year-on-year in euros, and rose 7% excluding repurchase agreements and the exchange rate impact, refecting the strategy to improve the mix of customer funds, particularly demand deposits (+11%), driven by the Select segment. Mutual funds rose 12%. Results Underlying attributable proft of EUR 614 million in 2018 (6% of the Group’s total operating areas), and underlying RoTE of 18.39%. Compared to 2017, underlying attributable proft rose 5% in euros. Excluding the exchange rate impact it was 8% higher, as follows: • Total income rose 4%, driven by net interest income (+5%), backed by growth in volumes, higher interest rates and a better mix of customer funds. Net fee income rose 12%, underpinned by income from insurance, mutual funds and greater use of cards. Gains on fnancial transactions, on the other hand, fell 28%, due to the lower contribution of SCIB business. • Administrative expenses and amortisations increased 5%, slightly more than total income, due to investments in IT and innovation and the higher costs of the collective salary agreement. The efciency ratio remained at around 41%. • Net loan-loss provisions were 6% higher, below the growth in lending and improvement the credit quality indicators. The cost of credit remained stable (1.19% in 2018 compared to 1.21% in 2017), and the NPL ratio dropped to 4.66% (4.96% in December 2017). The coverage ratio rose to 61% (58% in 2017). • Other gains (losses) and provisions amounted to EUR 103 million due to higher income from the sale of foreclosed assets and reversal of provisions to specifc loan-loss funds. • Lastly, tax was 14% higher, afected by increased tax pressure. Proft before tax was up 9%. Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds (1,045) (1,025) 2018 1,944 424 149 19 2,535 1,491 (473) 103 1,121 (220) 901 — 901 287 614 2017 1,907 391 % % excl. FX 1.9 8.3 5.4 12.0 213 (30.1) (27.7) 12 2,523 1,498 (462) 62.3 0.5 1.9 (0.5) 2.5 67.8 3.9 5.4 3.0 6.0 23 345.6 360.9 1,059 (200) 859 — 859 273 586 5.8 10.0 4.9 — 4.9 4.9 4.9 9.5 13.7 8.5 — 8.5 8.5 8.5 37,908 37,153 2.0 10.0 4,247 4,321 (1.7) 6.0 3,106 3,164 2,486 50,911 25,908 4,143 2,789 1,949 50,355 26,043 (25.0) 13.4 27.6 1.1 (0.5) (19.2) 22.3 37.5 9.0 7.3 5,867 5,491 6.8 15.2 9,806 3,535 919 46,035 4,876 8,967 3,598 1,222 45,321 5,034 9.4 (1.8) (24.8) 1.6 (3.1) 17.9 5.9 (18.9) 9.5 4.4 39,019 38,249 2.0 10.0 33,279 25,860 7,419 33,104 25,940 7,163 0.5 (0.3) 3.6 8.4 7.5 11.7 Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 18.39 41.2 4.66 60.6 12,008 381 17.89 40.6 4.96 58.2 11,675 439 0.50 0.6 (0.30) 2.4 2.9 (13.2) 307 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Argentina Underlying attributable proft EUR 84 Mn Strategy 2018 Highlights Santander Río continued to be the leading privately owned bank in Argentina by banking business. The focus was on digital transformation, customer experience and key segments (Select and Pymes Advance), resulting in more loyal and digital customers and greater digital penetration. In 2018, the economy was afected by a shock in the balance of payments, producing a peso depreciation against the euro, a 48% hike in infation, and a 2.4% fall in GDP. By year-end, exchange rates and interest rates stabilised. Underlying attributable proft was EUR 84 million, afected by the impact of the high infation adjustment and the peso’s depreciation. Santander Río consolidated its position as Argentina’s largest privately owned bank in terms of banking business. It is also one of the leading banks in loans, deposits, means of payment, transactional services, cash management, payrolls, wealth management and insurance. The initiatives in 2018, focused on fulflling its four strategic pillars: growth, risk control, operational excellence and the customer experience, via customer loyalty and digitalisation, with new products and services. Customer value ofers were redefned with special focus on key segments. Meanwhile, the transformation process continued in order to fully digitalise our platforms and incorporate the cutting-edge technologies in order to better know customers and anticipate their needs. This strategy enabled the launch of various initiatives such as: • Development of efciency plans, such as the implementation of digital improvements, robotics in operative processes, digitalisation of attention channels, merger of the former Citibank branches, technology insourcing and negotiation with new suppliers. • Launch of the new online banking, representing a renewal towards a more digital innovation experience and closer to customers, which was well accepted, while increasing the functionalities of mobile banking. • The Remote Attention Centre for Select customers has been opened, enabling closer management of the highest value portfolio. • The frst fully digital customer journeys were implemented, which enables the opening of saving accounts in only 7 minutes. This will also be implemented in mortgages, SMEs and cards. • Launch of Santander Work Café, based on the Group’s experience in other countries. • Improvement of SuperClub points programme platform, which enables users to enjoy a more personalised experience and a simple point redemption. As a result of all the above, loyal customers rose 6% year-on-year and digital ones 7%. They already account for 47% and 71% of total active customers, respectively. On the other hand, mobile banking customers account for 40% and digital sales rose by 64%. Loyal customers Digital customers Thousands Thousands 1,340 1,423 1,957 2,094 +6% +7% 2017 2018 2017 2018 308 2018 Annual Report Business areas performance Moreover, Global Finance again chose us as the Best Digital Bank in Argentina, The Banker and Global Finance named us the Best Bank in Argentina and we were ranked one of the fve best companies to work for by GPTW. Argentina EUR million Underlying income statement 2018 Activity Loans and advances to customers fell 32% year-on-year in euros. Excluding reverse repurchase agreements and the exchange rate impact, gross loans and advances to customers were 40% higher. Customer deposits declined 14% compared to 2017 in euros. Excluding repurchase agreements and the exchange rate impact, deposits rose 64%. The Bank recorded strong year-on-year growth in peso balances, with loans increasing 18% (mainly mortgage loans, auto lending and companies) and deposits 33%. Moreover, volumes were positively impacted by dollar balances due to the impact of the peso’s depreciation. Results Underlying attributable proft amounted to EUR 84 million in the year (1% of the Group’s total operating areas), and underlying RoTE of 11.83%. Compared to 2017, underlying attributable proft was 77% lower in euros, afected by the high infation adjustment of EUR 239 million, (EUR -193 million for monetary adjustment and EUR -46 million for the exchange rates). The adjustment was made in accordance with IAS29, applied when, among other factors, the cumulative three-year infation is above or around 100%, which implies that, Argentina’s 2018 full year results and balance sheet at December 2018 are adjusted to high infation. Excluding the exchange rate impact proft fell 54%, as follows: • Total income increased 35%, spurred by net interest income (+52%) driven by greater volumes in an environment of high infation and high interest rates. Net fee income rose 47%, driven by greater foreign currency activity in a volatile exchange rate environment and income from cash management. Gains on fnancial transactions increased 125%, benefting from a volatile environment and markets. • The growth in administrative expenses and amortisations (+51%), refected investments in digitalisation projects, the automatic revision of salary agreements because of the rise in infation and the peso’s depreciation against the dollar. • Net loan-loss provisions were higher (+184%) due to the individuals’ portfolio, particularly in medium and low income segments. The cost of credit increased to 3.45% (1.85% in 2017). The NPL ratio stood at 3.17% (2.50% in December 2017) and the coverage ratio improved to 135% (100% in December 2017). • Other gains (losses) and provisions fell 5%. Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds 2017 985 596 147 % % excl. FX (22.0) (24.8) 52.5 47.0 15.2 125.3 18 1,747 — (30.8) (970) (22.8) 777 (159) (40.8) 45.4 — 35.4 51.0 15.8 184.4 (92) (51.5) (5.2) 526 (165) (64.9) (39.0) (31.4) 19.2 362 (76.7) (54.4) — 362 2 — — (76.7) (71.9) (54.4) (45.2) 359 (76.7) (54.5) 768 448 170 (177) 1,209 (749) 460 (231) (45) 185 (100) 84 — 84 1 84 5,334 7,808 (31.7) 30.1 5,096 4,766 6.9 103.7 825 6 742 12,003 8,809 138 6 732 13,449 10,235 498.9 (9.7) 1.4 (10.8) (13.9) — 72.1 93.2 70.0 64.0 848 599 41.4 169.4 422 743 307 11,130 872 206 982 244 12,266 1,183 105.0 (24.3) 26.0 (9.3) (26.3) 5,574 7,608 (26.7) 10,191 8,809 1,382 12,855 10,235 2,620 (20.7) (13.9) (47.3) 290.4 44.3 139.9 72.8 40.5 39.5 51.0 64.0 0.4 Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 11.83 61.9 3.17 135.0 9,324 468 32.02 55.5 2.50 100.1 9,277 482 (20.19) 6.4 0.67 34.9 0.5 (2.9) 309 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Uruguay Underlying attributable proft EUR 132 Mn Strategy 2018 Highlights Santander Uruguay is the leading privately owned bank in the country, focused on growing retail banking and improving efciency and the quality of service. Loans grew in target segments, products and currencies. Of note was consumer credit and cards portfolio increase. Underlying attributable proft rose 28%, 43% excluding the exchange rate impact, spurred by customer revenue. Santander continued to focus on increasing loyalty and improving customer satisfaction, where we are ranked second. We continued to advance in our digital transformation strategy: the number of digital customers increased 30% and digital penetration 58% (up from 49% in 2017). Consumer fnance companies also increased placements via digital channels. At Creditel they already account for 30% of new loans. Santander holds a relevant position in the business of families in the private sector (27% market share), and in mortgage loans (over 30% market share), thanks to the specialised centre of auto and home lending. Santander Uruguay was named Best Bank to Work for in the country and the seventh Best Company to Work for in 2018 by GPTW consulting. Activity Loans and advances to customers grew 16% year-on-year in euros. Excluding reverse repos and the exchange rate impact, they rose 25% driven by growth in the target segments, products and currencies: consumer credit and cards (+20%) and local currency portfolio (+18%). Customer deposits were 5% higher in euros compared to 2017. Excluding the exchange rate impact, they increased 13%. Peso deposits grew 12% and foreign currency ones the equivalent of 13%. Results In 2018, underlying attributable proft was EUR 132 million and underlying RoTE of 27.0%. Compared to 2017, underlying attributable proft increased 28% in euros and 43% excluding the exchange rate impact. By line items: Uruguay EUR million Underlying income statement 2018 Net interest income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Proft before tax Underlying attributable proft to the parent Balance sheet Total assets Gross loans and advances A to customers Customer funds Customer deposits B Mutual funds A. Excluding reverse repos. B. Excluding repos. % % excl. FX 2017 299 402 4.2 4.4 311 419 (187) (195) (4.0) 232 (69) 159 132 207 (54) 142 103 12.3 27.6 11.9 27.7 4,605 4,397 4.7 2,743 3,893 3,861 32 2,353 16.6 3,681 3,681 — 5.8 4.9 — 16.8 17.0 7.6 25.9 43.1 25.4 43.1 12.5 25.2 13.6 12.7 — Loyal customers Digital customers Thousands Thousands 367 282 • Total income grew 17% mainly driven by net interest income and good performance of the main revenue line items. The efciency ratio was 44.6%, 4 percentage points better than in 2017. 74 90 +22% +30% 2017 2018 2017 2018 • Despite the rise in provisions because of the entry into force of IFRS9 and other impacts, the NPL ratio remained low (3.38%) and coverage was high (112%). The cost of credit stood at 2.80%. 310 2018 Annual Report Peru Business areas performance Colombia 2018 Highlights 2018 Highlights We continued to develop our activity focused on the corporate segment, the country’s large companies and the Group’s global customers. The Bank’s rating is the highest of the country’s fnancial system, following its recent upgrade. Underlying attributable proft rose 3%, or 8% excluding the exchange rate impact, spurred by net interest income, fee income and gains on fnancial transactions. The strategy remained focused on corporates, large corporates, and SCIB customers. Strong rise in volumes in euros: loans and advances to customers rose 100% and customer deposits 41%. Underlying attributable proft of EUR 9 million in the year, 54% more than in 2017, 61% higher excluding the exchange rate impact. Underlying attributable proft EUR 41 Mn Strategy Underlying attributable proft EUR 9 Mn Strategy In 2018, Santander continued to develop its activity centred on corporate banking and the country’s large companies, as well as providing service for the Group’s global customers, boosting growth on its auto fnance company. We widened our product range and customer base in all business segments, diversifed funding sources and expanded treasury services for our customers through foreign exchange transactions, forwards and other derivatives. Moreover, we continued contributing to the development of public infrastructure, through the structuring and fnancing of ports and roads and refneries adequacy in order to comply with the highest environmental standards. We also participated in an international bond issuance of the Peruvian estate of USD 2.0 billion. Santander Peru has the highest rating (A+) of the country’s fnancial system, following the recent upgrade. Activity Loans and advances to customers increased 45% year-on-year in euros (+43% on a gross basis, excluding the exchange rate impact), and customer deposits rose 17% (+16% excluding the exchange rate impact). Results Underlying attributable proft of EUR 41 million in euros in 2018 was 3% higher year-on-year. Excluding the exchange rate impact, underlying attributable proft increased 8%. Total income grew 19% driven by good performance of net interest income, net fee income and gains on fnancial transactions, which more than ofset the higher administrative expenses and amortisations stemming from investment in corporate projects. The efciency ratio stood at 33% and the coverage ratio remained high (224%). Business activity in Colombia continued to focus on SCIB customers, large corporates and corporates. The Group continues to provide solutions in treasury, risk hedging, foreign trade and confirming, as well as developing investment banking products and supporting the country’s infrastructure plan. In order to fulfil this offer, Santander Securities Services Colombia already has all the authorisations needed to begin to offer custody services in 2019. We continued to concentrate on auto fnancing business. This will enable us to have the critical mass needed to consolidate ourselves in this market. Activity Loans and advances to customers increased 100% year-on-year in euros. Excluding the exchange rate impact they rose 107%, backed by the good performance of peso portfolios. Customer deposits rose 41% in euros and 46% excluding the exchange rate impact, driven by demand deposits and particularly time deposits. Results Underlying attributable proft of EUR 9 million in the year, 54% more than in 2017 in euros. Excluding the exchange rate impact, underlying attributable profit rose 61%, backed by total income (+67%) spurred by net interest income, net fee income and gains on financial transactions. 311 Responsible bankingCorporate governanceEconomic and financial reviewRisk management United States Underlying attributable proft EUR 552 Mn Strategy 2018 Highlights The Federal Reserve terminated the 2015 Written Agreement with Santander Holdings USA, refecting the continued regulatory improvements. SH USA also passed the Federal Reserve’s capital stress test for the second consecutive year. In volumes, loans and advances to customers increased year-on-year in dollars, both at Santander Bank (+9%) and Santander Consumer USA (+5%). Santander US’s underlying attributable proft amounted to EUR 552 million, 35% higher than in 2017, 42% higher excluding the exchange rate impact, driven by higher income from leasing and loans, lower costs and improved cost of credit. Santander US includes Santander Holdings USA (SH USA, the intermediate holding company) and its subsidiaries: Santander Bank (SBNA), which is one of the largest banks in the north- eastern United States, Santander Consumer USA, an auto fnance business based in Dallas, TX; the international private banking unit in Miami; the wholesale broker-dealer in New York and the retail and commercial bank in Puerto Rico. In 2018, Santander US achieved signifcant regulatory milestones, strengthened business performance and continued to demonstrate its commitment to the communities in which it operates. The Federal Reserve terminated its 2015 Written Agreement with SH USA, refecting SH USA’s enhancements to board oversight, governance, compliance, risk management, capital planning and liquidity risk management. Also, in June 2018 SH USA passed the Federal Reserve’s annual capital stress test for the second consecutive year. Regarding business performance, we maintained the following strategic priorities: Santander Bank: • A continued focus on improving the customer experience and product ofer across the digital and physical channels, led to growth in loyal and digital customers. In Retail Banking, loyal customers rose 12%. Digital customers increased 10%, backed by continued enhancements to the Bank’s digital capabilities. • Continued investments in Commercial Banking and SCIB contributed to consistent growth in the Bank’s loans and advances to customers booked in the year. • Improved earning asset mix to drive margin improvements. Santander Consumer USA: • Focus on dealer experience and pricing, refected in the strong growth in originations across all channels in 2018. • In addition, Santander Consumer completed its USD 200 million share repurchase programme in January 2019. • As announced in June 2018, Santander Consumer USA is in discussions with FCA (Fiat Chrysler Automobiles) regarding the future of FCA’s US fnance operations after FCA had announced its intention to establish a captive US auto fnance unit and indicated Loyal customers A Digital customers A Thousands Thousands 894 814 339 303 +12% +10% 2017 2018 2017 2018 A. Santander Bank. 312 2018 Annual Report that acquiring Santander Consumer USA’s FCA-related business was one option it would consider. These discussions cover a range of options on how to optimise the existing contract and other longer-term arrangements. While discussions continue, Santander Consumer USA and FCA continue to operate under the existing arrangements. Activity Loans and advances to customers at Santander US increased 19% in euros year-on-year in net terms. Excluding the exchange rate impact and reverse repurchase agreements, gross loans and advances to customers were 6% higher, due to: • Higher origination volumes at Santander Consumer USA and growth in consumer, companies, and SCIB at Santander Bank. On the other hand, SBNA began originating auto loans through Santander Consumer USA. • Customer deposits rose 12% in euros year-on-year. Excluding repurchase agreements and the exchange rate impact, customer deposits were 5% higher, as demand deposits fell due to the outfow of public sector balances and higher interest rates, more than ofset by the increase in time deposits. Results Underlying attributable proft in the year was EUR 552 million (5% of the Group’s total operating areas), and underlying RoTE was 4.12%. Compared to 2017, underlying attributable proft rose 35% in euros and 42% excluding the exchange rate impact, driven by strong growth in Santander Bank and Santander Consumer USA. By line items: • Total income increased 5%. Net interest income rose 1% due to higher loan volume, despite lower spreads on loans in Santander Consumer USA and higher cost of funding. Net fee income decreased 7% due to lower fees at Santander Consumer USA and the New York branch. • Gains on fnancial transactions amounted to EUR 72 million (they were close to zero in 2017). Other operating income increased 60% due to higher income from leasing. • The administrative expenses and amortisations trend continued to improve (-1%) mainly due to lower technology depreciation. • Net loan-loss provisions fell 1%. The cost of credit ratio improved to 3.27% from 3.42% in December 2017. The NPL ratio stood at 2.92% and coverage was 143%. • Other gains (losses) and provisions increased losses due to charges related to legal claims and the sale of branches in 2017. Business areas performance United States EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Pro memoria: Gross loans and advances to customers B Customer funds Customer deposits C Mutual funds 2018 5,391 859 72 628 6,949 2017 5,569 971 % % excl. FX (3.2) (11.6) 1.3 (7.4) 9 669.2 705.0 410 6,959 (3,015) (3,198) 3,934 (2,618) 3,761 (2,780) 53.1 (0.1) (5.7) 4.6 (5.8) 60.3 4.5 (1.3) 9.5 (1.4) (199) 1,117 (347) 770 — 770 218 552 (90) 122.1 132.5 892 (256) 636 — 636 228 25.2 35.5 21.1 — 21.1 (4.5) 408 35.4 31.0 41.9 26.7 — 26.7 (0.0) 41.7 85,564 71,963 18.9 13.5 16,442 13,300 23.6 13,160 4,291 15,585 135,043 57,568 13,843 3,368 11,914 114,388 51,189 (4.9) 27.4 30.8 18.1 12.5 18.0 (9.2) 21.6 24.9 12.7 7.4 16,505 15,884 3.9 (0.8) 37,564 3,098 3,798 118,532 16,511 26,176 2,503 3,437 99,189 15,199 43.5 23.8 10.5 19.5 8.6 83,696 75,389 11.0 64,239 56,064 8,176 59,329 50,962 8,367 8.3 10.0 (2.3) 37.0 18.2 5.5 14.1 3.7 6.0 3.4 5.0 (6.7) Ratios (%) and operating data Underlying RoTE Efciency ratio NPL ratio NPL coverage Number of employees Number of branches A. Includes exchange diferences. B. Excluding reverse repos. C. Excluding repos. 4.12 43.4 2.92 142.8 17,309 660 3.12 46.0 2.79 170.2 17,560 683 0.99 (2.6) 0.13 (27.4) (1.4) (3.4) 313 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 4.4 Corporate Centre 2018 Highlights Underlying attributable proft EUR -1,721 Mn The Corporate Centre’s objective is to aid the operating units by contributing value-added and carrying out the corporate function of oversight and control. It also develops functions related to fnancial and capital management. The underlying attributable loss was 9% less year-on-year, due to lower hedging costs of exchange rates. Strategy and functions The Corporate Centre contributes value to the Group in various ways: • It makes the Group’s governance more solid, through global control frameworks and supervision, and it fosters the exchange of best practices in management of costs and economies of scale. This enables us to be one of the most efcient banks in the sector. • The Corporate Centre contributes to the Group’s revenue growth, by sharing the best commercial practices, launching global commercial initiatives and accelerating the digital transformation simultaneously in a cross-cutting manner in all countries. It also coordinates the relationship with the European regulators and develops functions related to fnancial and capital management, as follows. Financial management functions: • Structural management of liquidity risk associated with funding the Group’s recurring activity, stakes of a fnancial nature and management of net liquidity related to the needs of some business units. The price at which these operations are made with other Group units is the market rate (euribor or swap) plus the premium which, in the concept of liquidity, the Group supports by immobilising funds during the term of the operation. • Interest rate risk is also actively managed in order to soften the impact of interest rate changes on net interest income, conducted via derivatives with high credit quality, higher liquidity and low capital consumption. • Strategic management of the exposure to exchange rates on equity and dynamic on the countervalue of the units’ results in euros for the next 12 months. Net investments in equity are currently covered by EUR 23,025 million (mainly Brazil, UK, Mexico, Chile, US, Poland and Norway) with diferent instruments (spot, fx, forwards). Separately from the fnancial management described here, the Corporate Centre manages all capital and reserves and its allocation to each of the units. Results Underlying attributable loss of EUR 1,721 million in 2018 down from a loss of EUR 1,889 million in 2017. The improvement was mainly due to higher gains on fnancial transactions (EUR 11 million in 2018 compared to a loss of EUR 227 million in 2017) resulting from lower costs of hedging of exchange rates. Net interest income was hit by the volume of issuances made under the funding plan, largely focused on eligible TLAC instruments and costs related to the greater liquidity bufer requirements. Administrative expenses and amortisations increased 4% as a result of two efects that ofset each other: the streamlining and simplifcation measures and the investment in global projects for the Group’s digital transformation. Lastly, other gains (losses) and provisions recorded very diferent kinds of charges: provisions, intangibles, the cost of the government’s guarantee on deferred taxes, pensions, litigation, impairment of fnancial assets, etc. Corporate Centre EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent Balance sheet Loans and advances to customers Cash, central banks and credit institutions Debt instruments Other fnancial assets Other asset accounts Total assets Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities Other liabilities accounts Total liabilities Total equity Resources Number of employees A. Includes exchange diferences. 2018 (947) (69) 11 (23) (1,028) (495) (1,523) (115) (101) (1,739) 20 (1,718) — (1,718) 2 2017 % (851) (38) (227) (104) (1,220) (476) (1,696) (45) (181) (1,923) 32 (1,890) — (1,890) (1) 11.3 82.4 — (78.1) (15.7) 3.9 (10.2) 154.9 (44.5) (9.6) (36.8) (9.1) — (9.1) — (1,721) (1,889) (8.9) 6,508 6,141 377 2,113 124,494 139,634 234 1 41,783 1,333 8,206 51,557 88,077 5,326 400 1,768 2,116 122,489 132,099 223 279 35,030 1,626 8,092 45,248 86,850 22.2 — (78.7) (0.1) 1.6 5.7 5.3 (99.8) 19.3 (18.0) 1.4 13.9 1.4 1,764 1,784 (1.1) 314 2018 Annual Report 4.5 Global businesses Retail Banking Business areas performance 2018 Highlights The Group continued to focus on customer loyalty and digital transformation, with new products and services that cover the current needs of our customers. At the end of 2018, the Group had close to 20 million loyal customers and 32 million digital customers. Underlying attributable proft of EUR 7,793 million, boosted by good dynamics of customer revenue and efciency improvement. Underlying attributable proft EUR 7,793 Mn Commercial activity As regards digital platforms and apps, of note were: Santander is immersed in a digital transformation process which rests on two main priorities to continue to deliver the best customer service. • In Poland, launch of Działalnosc.pl designed to support businesspeople and mSignature, a mobile app authorisation tool as an alternative for SMS code. The frst priority is to deliver all our products and services digitally, in order to continue strengthening the relationship with our customers. The second one is to do this in the fastest and most efcient way. • In Brazil, the Santander Way app is regarded as the best fnancial market app in the country. • The UK installed a new digital clearing system that ofers customers faster clearance of cheques. To this end, our core banks are focused on 5 key areas: • Transforming our front: to provide any product and service digitally, end to end, and adopt changes quickly. • In Mexico, Súper Wallet now incorporates payment of purchases done with rewards points. • Transforming the back: We are re-engineering, digitalising and robotising so that eventually all processes will be automated for speed and efciency. • Evolving our IT architecture and systems: progressively evolve and modernise our existing technology to provide greater fexibility to our customers. • Onboarding new technologies: analytics, robots and machine learning to our day to day operations to understand the customer needs in our front. • Finally, we are becoming an agile and data-driven organisation. We have created the Santander Agile Way to be able to deliver products and services which better respond to customer needs, with improved time to market and greater productivity. This year, 35% of our projects implemented the agile methodology. Loyal customers Digital customers Thousands Thousands 32,014 25,391 19,896 17,254 On the other hand, we are also developing new digital businesses in order to support the core banks as well as to ofer disruptive products and services: • Openbank, Santander Group’s fully digital bank, initially launched in Spain, began to be expanded to other countries. • OnePay Fx, based on blockchain and which makes it possible for retail customers in UK, Spain, Brazil and Poland to complete international transfers in the same day or by the next day. • Superdigital, a low-cost fnancial solution alternative to traditional banking, mainly focused on the unbanked population of Latin America. +15% +26% Thanks to these measures, digital customers increased 26% in 2018, which already amount to half of our active customers. Loyal customers rose 15%, with an improved experience. 2017 2018 2017 2018 315 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Results Underlying attributable proft amounted EUR 7,793 million in 2018 (78% of the Group’s operating areas). Compared to 2017, underlying attributable proft increased 5% in euros. This evolution was impacted by exchange rates. Excluding this impact, proft rose 12% as follows: • Total income increased 8%, mainly driven by net interest income and net fee income. On the other hand, gains on fnancial transactions, which have very little weight (2%) on total revenue, rose 11%. • Administrative expenses and amortisations were 6% higher due to the ongoing commercial transformation and digitalisation process. • Net loan-loss provisions increased 13% driven by greater volumes, as credit quality ratios improved and the NPL ratio had a positive performance in almost all retail units. • Other gains (losses) and provisions improved 21% mainly due to lower provisions for legal and labour claims in Brazil. • Higher tax on proft, mainly resulting from the increase in Brazil. Retail Banking EUR million Underlying income statement 2018 Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent A. Includes exchange diferences. % % excl. FX 32,522 8,946 2017 32,339 9,306 0.6 (3.9) 720 680 6.0 644 42,832 580 42,904 11.0 (0.2) (19,255) (19,677) (2.1) 23,577 (8,461) 23,228 (8,278) 1.5 2.2 8.8 6.0 11.0 15.7 8.3 5.8 10.5 13.0 (1,707) (2,394) (28.7) (20.7) 13,408 (4,329) 12,555 (3,843) 9,080 8,712 — 9,080 1,287 7,793 — 8,712 1,256 7,456 6.8 12.6 4.2 — 4.2 2.4 4.5 14.6 22.2 11.3 — 11.3 8.4 11.7 Smart Red branch, Spain Regarding our branch network, the Group has a network of 13,217 branches, making it the international bank with the largest commercial network. The Group is making progress in digitalisation, but without losing its essence as a bank. The branches will continue to be a relevant channel for customers, focusing on selling products of greater value and customer advice. Most of these branches ofer full-service banking, although the Group also has branches that ofer specialised customer care to certain segments. Because of our scale, we have unique insight into what our customers want and we are driven to create personal banking relationships thanks to our experienced team of 100,000 Santander colleagues talking to our 144 million customers. We are innovating in the way we interact with our customers, including, for example, through the conversion of traditional bank branches into new collaborative spaces focused on customer experience and digital capacities, such as the new Work Café branches (Chile, Brazil, Spain, Portugal and Argentina), the SMART branches (Spain, the UK) and Santander Ágil in Mexico. During 2018, the number of branches declined by 480 branches, mostly in Continental Europe due to integration processes in Spain, Santander Consumer Finance and Portugal. Activity Loans and advances to customers increased 3% compared to 2017 in euros. Excluding reverse repurchase agreements and the exchange rate impact, gross loans rose also 3%. Customer deposits increased slightly (+0.3%) year-on-year in euros. Excluding repurchase agreements and the exchange rate impact, customer deposits increased 3%. 316 2018 Annual Report Business areas performance Santander Corporate & Investment Banking 2018 Highlights Strategy focused on widening our product ofer, developing our franchises in the United Kingdom and the US, consolidating Continental Europe as a single business unit and implementing the Multinational Coverage Model (MNC). Strong progress on the Global Infrastructure Programme (GIP) and completion of the structure under the Banking Reform Act in the UK. The integration with the retail banking network and the enhanced ofer of value-added products to its customers, drove business growth (+21%). Underlying attributable proft was 4% lower in euros at EUR 1,705 million, 8% higher excluding the exchange rate impact, due to greater customer revenue and lower provisions. Underlying attributable proft EUR 1,705 Mn Strategy Main actions carried out in the year by lines: • Focus on capturing international business fows, increasing the connectivity among the countries where the Group operates and expanding the ofer of high value-added products (Nexus, Mercados Américas, Private Debt Mobilisation, securitisations, etc.). • We continued to develop and integrate the factory of SCIB • We are still immersed in transforming the technological and risk infrastructures (GIP) into a simplifed, scalable and digital platform. • SCIB maintained its low capital consumption business model, with a balance sheet rotation which enabled us to reduce the volume of risk-weighted assets. Also, the implementation of measures such as the Dynamic Credit Portfolio Management helped reduce net loan-loss provisions. products for retail banking customers. As a result, collaboration revenue increased 21% in the year. Activity • Progress was made on strengthening our franchises in the UK and the US, in order to accelerate their growth, by completing the structure under the Banking Reform Act in the UK, simplifying the corporate structure in the US and restructuring the Division’s risk and credit units. Main actions performed in the year by business line: • Cash management: double-digit growth in transactional business as well as in customer funds. Santander Cash Nexus was consolidated as a solid and robust solution for our customers’ regional business. We achieved a record one million transactions per month, increasing our active customer base exponentially, both in those managed by SCIB and Retail Banking. Total income breakdown Constant EUR million Total 5,000 Capital & Other Global Markets Global Debt Financing Global Transaction Banking +2%A +8% -1% -1% +3% 5,087 539 1,544 1,333 1,671 2017 2018 A. In euros: -8%. 317 Responsible bankingCorporate governanceEconomic and financial reviewRisk management • Export fnance & agency fnance: Santander consolidated its leadership as one of the world’s best banks by volume of managed assets. We also worked during the year in new origination in non-core markets where this business has a high potential. • Syndicated corporate loans: of note was the acquisition of Gemalto by Thales and Westfeld by Unibail, as well as the merger between Telecom Argentina and Cablevision. Also, support for sustainable fnancing in restructuring the assets of Enel Green Power and the loan to Generali. • Trade & working capital solutions: strong growth year-on-year due to increased international transactions among the countries where the Group operates. We consolidated our strong position in Spain, Brazil and Mexico, while expanding our business towards new markets such as the US and Asia. This growth was backed by an enhanced product range and digitalisation through platforms intended for receivables and confrming. • Debt capital markets: Santander held its signifcant position in Latin America, notably placements of sovereign bonds in euros in Mexico and Chile as well as corporate issuances and fnancial institutions such as the Brazilian Development Bank. Of note in Europe was the boost in sustainable fnancing and corporate issuances. • Structured fnancing: the Group remained the leader in Latin America and Europe. We also topped the global ranking of fnancial advice by number of operations. • Global Markets: activity decreased slightly. Nevertheless, positive evolution of sales continued, mainly in the corporate sector, maintaining a greater contribution from management of books in Argentina, the US and Asia. Loans and advances to customers rose 6% in euros compared to 2017. Excluding reverse repurchase agreements and the exchange rate impact, gross loans and advances to customers increased 12%. Customer deposits decreased 1% in euros in 2018. Excluding repurchase agreements and the exchange rate impact, they grew 19%. Ranking 2018 Source Euromoney Latin Finance Global Finance Area SCIB SCIB Award / Ranking Best Investment Bank in Mexico and Chile Best Infrastructure Bank 2017 in Mexico and Brazil Global Debt Financing Best Debt Bank Latam Infrastructure Investor Global Debt Financing Latin America Bank of the year PFI The Banker PFI Global Debt Financing Bank of the Year in Europe Global Debt Financing Deal of the Year – Bonds SSAs: Argentina’s USD 2.75 bn century bond Global Debt Financing Europe Wind Power Deal of the Year Latin Finance Global Debt Financing Best Airport Financing: Grupo Aeroportuario de la Ciudad de México (GAMC) (Green Bond) Global Capital Extel FX Extel Global Markets Global Markets Global Markets Global Markets Best Liquidity Provider N.1 Leading Brokerage Firm Spain & Portugal Best Bank N.1 Country Research: Brokerage Firm Spain & Portugal Institutional Investor Global Markets #1 Corporate Access (Research) in Mexico Institutional Investor Global Markets #1 Latin America Research Team- sector winners: Equity Strategy, Electric Utilities, Transportation Institutional Investor Global Markets #1 Equity Research in Iberian markets TFR BCR Global Transaction Banking Best Trade Bank in Latin America Global Transaction Banking Best Global Supply Chain and Receivable Finance Provider Global Finance Global Transaction Banking Best Trade and Supply Chain Finance Provider in Latam Global Transaction Banking Best Trade Finance Bank in Latam Global Transaction Banking Overall ECA Finance Deal of the Year: KNPC Clean Fuels Proyect Global Transaction Banking Americas ECA Finance Deal of the Year: Zuma Energia – Parque Eólico Reynosa Wind Farm Global Transaction Banking ECA-Backed Telecoms Deal of the Year: Verizon Communications Global Transaction Banking Women Leading Climate Finance Corporate Finance Corporate Finance European M&A – HS1 Deal of the Year – Equities: CFE’s USD 759 mn IPO GTR TXF TXF TXF MIGA IJ Global The Banker 318 2018 Annual Report Business areas performance Results Santander Corporate & Investment Banking Underlying attributable proft of EUR 1,705 million (17% of the Groups’ total operating areas), driven by the strength and diversifcation of SCIB customer revenue (89% of total revenue). Compared to 2017, underlying attributable proft fell 4%. Excluding the exchange rate impact, it rose 8%, as follows: • Total income grew because of the 8% rise in net interest income (good performance in the fourth quarter). On the other hand, net fee income remained stable. • Lower gains on fnancial transactions than in 2017 whose frst quarter was excellent. • Higher administrative expenses and amortisations associated with transformation projects. • Net loan-loss provisions were signifcantly lower, mainly in Spain, the UK, Brazil and the US. By segments, better results from global transactional banking and global debt fnancing, while income from global markets decreased. EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent A. Includes exchange diferences. % % excl. FX 2018 2,378 1,512 1,004 194 5,087 2017 2,442 1,627 (2.6) (7.1) 1,212 (17.2) 222 5,503 (12.6) (7.6) (2,105) (2,028) 3.8 7.6 0.3 (5.8) (11.1) 1.7 10.7 2,982 (217) (108) 2,657 (792) 1,865 — 1,865 160 1,705 3,474 (690) (14.2) (68.5) (3.7) (66.1) (72) 49.2 64.8 2,712 (750) (2.0) 5.6 1,962 (5.0) — — 1,962 182 (5.0) (12.2) 1,780 (4.2) 11.1 21.8 7.2 — 7.2 (2.8) 8.2 319 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Wealth Management - Asset Management and Private Banking 2018 Highlights New global business division. Underlying attributable proft EUR 528 Mn Santander Private Banking and Santander Asset Management continued strengthening their position as the reference in Spain and Latin America. Santander Private Banking, with EUR 181 billion under management, is the private banking global platform built on our strong local presence in 10 markets. Santander Asset Management, with EUR 172 billion, became the asset management priority partner for the Group banks, and a specialist in Latin American assets. Total contribution to proft (net proft + total fee income generated) amounted to EUR 1,015 million, 13% more than the estimated for 2017. • Private Banking: development of a global and connected proposition, taking advantage of Santander’s presence in over 10 countries. As a result, business collaboration volumes among countries increased 19% year-on-year, to EUR 3,727 million. Moreover, the Private Wealth (UHNW – Ultra High Net Worth) segment was launched in 2018, ofering a diferential service to the Group’s most valued customers. • In 2018, Santander Private Banking received a record amount of awards, 64 in total. Of note were Best Private Banking in Spain by The Banker, and Best Private Banking in Latin America, Spain, Portugal, Chile, Argentina and Mexico by Euromoney. We were also recognised as the best customer service in Private Wealth, as well as the best accessible technology for bankers and customers in 4 countries and Latin America by Euromoney. • Also noteworthy, Santander became the frst bank in Spain to obtain the AENOR certifcate for excellence in advisory services. Strategy The Santander Wealth Management division is the combination of two complementing businesses: • Santander Private Banking includes the private banking activity of our local banks and international private banks in order to create a single global platform and to ofer our more than 170,000 Private Banking clients the Group’s products and services, in a coordinated and homogeneous manner in all the countries where Santander operates. The goal is for a local private banking customer to become a customer in all the countries where we operate. • Santander Asset Management (SAM), the international asset manager strongly rooted in Europe and Latin America. With over 45 years history and present in more than 10 countries, it is focused on creating and managing the best products (mutual funds, pension funds, institutional mandates, alternative investments, etc.) for Santander customers and third parties. The Wealth Management division launched in its frst year the following strategic initiatives: Business performance A EUR billion and % change in constant euros 329 203 172 Total Assets Under Management Funds and investment B -SAM -Private Banking Custody of customer funds 55 81 Customer deposits 45 Customer loans 14 s/2017 -2% -2% -1% -2% -6% +6% +12% A. Total asset marketed and/or managed in 2018 and 2017. B. Total adjusted for funds from private banking, customers managed by SAM. 320 2018 Annual Report Business areas performance • Santander Asset Management (SAM) enhanced and expanded Wealth Management its product range. Of note was the investment strategy followed in Spain and Latin America, with awards to the best manager of equities in Spain by Citywire, and the best fxed income fund in its class in Latin America (Latin American Corporate Bond Fund). Also, launch of investment solutions in order to adapt to the customer needs, given the current market scenario. • Moreover, SAM is the leading entity in funds management under ESG (Environmental Social and Government) criteria, notably in Spain, with the launch of the new Santander Sostenible Acciones fund, and the award to Santander Responsabilidad Solidario as the best solidarity fund. Santander Wealth Management is making progress in digital transformation, keeping pace with the rest of the Group. Tools such as Global Private Banking SPiRIT had been implemented in Mexico, Brazil and Chile and the new Virginia customer front was launched in International Private Banking. SAM started the migration of its investment platform to the most diferential solution in the market: Aladdin. Activity Total assets under management amounted to EUR 329 billion, 2% lower than in 2017, afected by the instability in markets, which generated depreciation of assets, particularly in custody, but also in marketed investment products. In Private Banking 6% growth in customer deposits and 12% in loans and advances to customers, driven by development of Private Wealth. Results Underlying attributable proft rose 11% year-on-year to EUR 528 million, up 17% excluding the exchange rate impact. By lines: • Total income rose backed by higher net interest income (+12%) and net fee income (+63%), spurred by the increase in value- added volumes under management. • Higher administrative expenses and amortisations, partly because of the investment in the Private Wealth project. • The rise in total income and expenses was afected by the larger stake in Santander Asset Management. By units, noteworthy growth in proft in Brazil (+16%) and International Private Banking (+12%). When the total fee income generated by this business is added to net proft, the total contribution to the Group is EUR 1,015 million, 13% more than the estimated in 2017. EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent A. Includes exchange diferences. 2018 420 1,097 62 (36) 1,543 (730) 813 (9) (8) 797 (234) 563 — 563 35 528 % % excl. FX 2017 404 700 4.0 56.7 38 64.5 70 1,212 — 27.3 (528) 38.3 684 (9) 18.8 (4.9) (8) (5.3) 667 (165) 502 — 502 24 478 19.5 41.9 12.1 — 12.1 42.0 10.6 Total proft contribution A EUR 1,015 Mn +13% A.Including net proft and total fee income generated by this business 11.9 62.7 74.2 — 34.1 45.6 25.3 (1.6) (2.7) 26.0 49.5 18.3 — 18.3 54.0 16.5 321 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Real estate activity Spain Underlying attributable proft EUR -242 Mn 2018 Highlights Management continued to focus on reducing these assets. Underlying attributable loss of EUR 242 million in 2018, compared to a loss of EUR 308 million in 2017. At the end of 2018, the gross exposure in the Real Estate Activity Spain unit stood at EUR 9.3 billion and loan-losses allowances of EUR 4.6 billion (coverage of 50%). The net exposure was EUR 4.7 billion, representing just 1% of our balance sheet in Spain. Management continued to focus on reducing these assets, particularly loans and foreclosed assets. As announced after the acquisition of Banco Popular, and in order to reduce the Group’s non-performing assets to irrelevant levels, on 8 August 2017 Banco Popular signed agreements with the Blackstone fund for the acquisition by the fund of 51% of Banco Popular’s real estate business, and thus control over it. This business consists of the foreclosed real estate portfolio, non-performing loans stemming from the real estate sector and other assets related to Banco Popular’s activity and that of its subsidiaries. The transaction was closed as expected, in the first quarter of 2018, once the required regulatory authorisations were obtained, which allowed Santander to focus on the integration of Banco Popular and mitigate uncertainties regarding possible additional losses related to real estate exposure. Closing the transaction entailed the creation of a company controlled by Blackstone fund, in which Santander has a 49% stake, to which Banco Popular transferred the business comprising the aforementioned assets and 100% of the share capital of Aliseda. Additionally, during the third quarter of 2018, the Group reached agreement with a subsidiary of Cerberus Capital Management to sell 35,700 properties for EUR 1,535 million, with no material impact on profit and capital expected. This transaction is scheduled to be completed by the first quarter of 2019. This unit recorded an underlying attributable loss of EUR 242 million in 2018, compared to a loss of EUR 308 million in 2017. This performance was largely due to lower net loan-loss provisions (EUR -18 million) due to reduced provision needs and the lower negative impact of other gains (losses) and provisions (EUR -83 million), largely because of lower losses from the sale of foreclosed assets. Real estate activity Spain EUR million Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions A Other operating income Total income Administrative expenses and amortisations Net operating income Net loan-loss provisions Other gains (losses) and provisions Proft before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Underlying attributable proft to the parent A. Includes exchange diferences 2018 (33) (0) 0 23 (10) (194) (204) (70) (73) (347) 104 (243) — (243) (2) (242) Real estate exposure net value A EUR billion Real estate assets - Foreclosed - Rentals Non-performing real estate loans Assets + non-performing real estate A. Real estate activity Spain. 2017 (38) 2 (0) 29 (8) % (14.4) — — (20.3) 28.8 (209) (7.2) (217) (88) (156) (461) 138 (323) — (323) (15) (5.8) (20.4) (53.5) (24.8) (25.1) (24.6) — (24.6) (89.4) (308) (21.5) Dec-2018 3.8 2.6 1.2 0.9 4.7 322 2018 Annual Report Research, development and innovation 5. Research, development and innovation (R&D&I) Research, development and innovation activities Innovation and technological development are a strategic pillar of Santander. Our objective is to respond to the new challenges that emanate from digital transformation, focusing on operational excellence and the customer experience. Moreover, the data and information that we obtain from our new technological platforms will help us to better understand the customer journey of our clients and so be able to design a better digital profle that will enable us to generate greater confdence and increased customer loyalty. As well as the competition between banks, fnancial entities must watch out for the new competitors that have entered the fnancial system, competitors whose great competitive advantage, and thus a diferentiating factor, is their use of new technologies. Consequently, developing an adequate strategic technology plan must allow for a greater capacity to adapt to customers’ needs (products and tailored services, full availability and excellent service in all channels); enhanced processes, which ensure that the Group’s professionals attain greater reliability and productivity in the exercise of their functions, and lastly, adequate management of risks, endowing teams with the necessary infrastructure to provide support for identifying and assessing all risks, be the business, operational and reputational risks, or regulatory and compliance ones. In addition, Santander as a global systemically important bank, as well as its individual subsidiaries, is subjected to increasing regulatory demands that impact the systems’ model and the underlying technology. This makes further investments necessary in order to guarantee their compliance and legal security. The latest ranking by the European Commission (the 2018 EU Industrial R&D Investment Scoreboard, based on 2017 data) recognises, as did previous rankings, Santander’s technological efort, placing it frst among Spanish companies and the frst global bank in the study (and the only one of the 100 companies investing the most) on the basis of investment in R&D. Technological investment in 2018 in R&D&i amounted to EUR 1,468 million (3% of the Group’s total income). Technological strategy In order to respond to business needs, Santander must integrate new digital capacities, such as the agile methodologies, public and private cloud, the evolution of core systems, as well as develop technological capacities (Application Programming Interface, artifcial intelligence, robotics, blockchain, etc.) and data. The Group’s technological strategy is aligned with the global businesses, Santander Digital and the banks in the various countries. It is a solid strategy, in the benefts it provides, fexible in the face of new trends and open to the changes which they represent. To this efect, we are supported by a committed organisation experienced in relations with countries, a robust and reliable technological infrastructure and, lastly, a system of governance that articulates projects and initiatives that help to crystallise this strategy in all the countries where we operate. In order to supervise the strategy’s correct implementation, the governance model includes an inter-organisational body known as ARB (Architecture Review Board). It is responsible for sharing local and global innovation collaboratively and efciently, as well as reviewing the Group’s architecture. This forum guarantees consistent architectures, strengthens the re-use of components and bolsters the use of new technologies in order to meet changing business needs. The contribution of the T&O division is key for the Group’s commercial and digital transformation. Evolving the model is required in order to progress toward developing global products and digital services. Technology matters today, and even more so in the future. This is why Isban Global and Produban Global were integrated to create Santander Global Tech as part of the T&O division, with some 2,000 T&O professionals work in Spain, the UK, Portugal, United States, Mexico, Brazil and Chile. This integration will produce a rapid organisation with a greater technological and execution capacity. Teams will work in the portfolio of global products agreed by countries (Santander Digital and the T&O division), focusing, in particular, on quality and security. Alhambra building, Boadilla del Monte, Spain. 323 Responsible bankingCorporate governanceEconomic and financial reviewRisk management The aim of these measures is to boost customer loyalty, as well as greater confdence in the digital world. We are also taking advantage of digital opportunities such as Openbank to convert us into a supplier of an open fnancial services platform. Fintech ecosystem Lastly, Banco Santander is positioning itself in the Fintech ecosystem (fnancial technology) as an innovative bank and benchmark for the sector, which is enabling it to have an observatory for anticipating and participating in the main digital trends. In order to develop this strategy, we have Santander InnoVentures, a USD 200 million venture capital fund, tasked with identifying and rating fntech companies that help Santander to innovate in order to improve operational excellence and provide a better service to customers. The fund invests, via minority stakes, in start-ups and helps them, in turn, to create commercial and/or strategic agreements within the fnancial sector and access the Group’s whole experience. As well as contributing capital, Santander InnoVentures provides the start-ups in which it invests with scale and experience, helping them to grow and so learn and promote the introduction of new technologies for the Group’s businesses and customers. At the end of 2018, Santander InnoVentures had invested in more that 20 companies in the areas of payments, marketplace lending, e-advisory, customer risk and analysis and artifcial intelligence, among others. Technological infrastructure The Group has fve high quality data processing centres (DPCs), interconnected by a redundant system of communications. These fve pairs of DPCs are distributed in strategic countries to support and develop the Group’s activity. These centres also have traditional IT systems together with the capacities supplied by an on-premises cloud, which facilitates integrated management of the technology of the various business areas and accelerates the digital transformation and adoption of new technologies. Of note among the countries where the Group operates is Brazil because of the speed with which it has adopted cloud. Cybersecurity Santander views cybersecurity as one of the Group’s main priorities and a crucial element for supporting the Bank’s mision of ‘helping people and businesses prosper’ as well as ofering excellent digital services for our customers. We continued in 2018 to develop measures to improve cybersecurity in all the Group’s spheres. We launched training measures for our professionals to improve how they handle cyberrisk issues (set out in the chapter on Responsible banking). The Risk Management Report also details the various steps taken to measure, monitor and control risks related to cybersecurity, and their respective mitigation plans. For these reasons, we continue to invest in systems and platforms that help us to improve in this sphere. Digitalisation As well as the new technological platform, the evolution of infrastructure and the aforementioned cybersecurity measures, the Group is driving its digital transformation through various projects and initiatives developed in almost all countries. For example, Superdigital and Portal Comercial in Brazil, One Pay FX in Spain, Brazil, UK and Poland, Digital Mortgages in UK, Digitalisation (Súper Net, Súper Móvil, Súper Wallet) in Mexico, GPI Swift in Argentina and mobile payments in Spain. Details on all of them can be found in section ‘Inclusive and sustainable growth’ on the Responsible banking chapter. 324 2018 Annual Report Signifcant events since year end 6. Signifcant events since year end The following signifcant event occurred between 1 January 2019 and the date of preparation of this consolidated directors’ report: On 6 February the Group announced that it had completed the placement of preferred securities contingently convertible into newly issued ordinary shares of the Bank, excluding preemptive subscription rights and for a nominal value of USD 1,200,000,000 (EUR 1,052,000,000) (the “Issue” and the “CCPS”). The CCPS were issued at par and its remuneration has been set at 7.50% on an annual basis for the frst fve years. The payment of the remuneration of the CCPS is subject to certain conditions and to the discretion of the Bank. After that, it will be reviewed every fve years by applying a margin of 498.9 bps on the 5-year Mid-Swap Rate. 325 Responsible bankingCorporate governanceEconomic and financial reviewRisk management7. Trend information 2019 The director’s report contains certain prospective information refecting the plans, forecasts or estimates of the directors, based on assumptions that the latter consider reasonable. Users of this report should, however, take into account that such prospective information is not to be considered a guarantee of the future performance of the entity, inasmuch as said plans, forecasts or estimates are subject to numerous risks and uncertainties that mean that the entity’s future performance may not match the performance initially expected. These risks and uncertainties are described in the Risk management chapter of this report and in note 54 of the consolidated fnancial statements. The global economy slowed in 2018 and left behind the peak of this expansion, although we expect a relatively dynamic environment will be maintained. We forecast global economic growth at 3.5% in 2019 (3.7% estimate for 2018), slightly above its potential, although resulting from a less homogeneous performance by regions. Mature economies are estimated to grow 2.0% (2.3% estimate for 2018), thanks to demand policies and the strength of the labour market. Growth in both the US and the Eurozone will ease, as well as the UK in the context of Brexit. Developing economies will grow by around 4.5%, slightly below the 4.6% estimated for 2018. China’s expansive measures, adopted at the expense of a more determined correction of the imbalances, will enable the economy to gradually slow down. In Latin America, the capacity to recover or secure the credibility of economic policy will play a key role. However, we expect the recovery begun in 2017 to consolidate, with growth of around 2% in 2019, underpinned by the recovery in Brazil and Chile’s ongoing dynamism. Argentina, meanwhile, is expected to gradually recover following reforms and the improvement in market confdence. Mexico will continue to grow moderately. Mature markets are expected to withdraw monetary policy stimulus measures very slightly and conditional on the economic and fnancial performance in an uncertain environment. However, any stimulus withdrawal process will be, in any case, very gradual. Long-term interest rates are expected to increase moderately. Yield curves show diverging trends, with some fattening in the US and a greater slope in Europe expected. Interest rates in developing markets will perform diferently, particularly in Latin America where each country’s monetary policies will depend on the cyclical situation and on the evolution of actual and expected infation. In any case, the fact that the recovery is moderate and infation remains low, partly due to structural factors, suggests that interest rate movements, upward or downward, will be limited. The balance of risks in the short term is downward: the probability of a geopolitical or economic policy shock, particularly in the US and Europe, has increased, which if it happens will lead to a potentially sharper downward revision. The situation in China or unstable fnancial conditions are other risk factors. In this context, we have seen increased volatility and risk aversion. In this environment, Santander ended the year having met all of the main targets set for 2015-2018: growth, proftability and strength. The number of loyal and digital customers rose, and volumes in local currency increased. Proftability was higher and RoTE and efciency improved. Also, the capital position was strengthened, while growing cash dividend per share. Banco Santander’s solid position in 10 core markets is balanced between mature and developing economies. It has 144 million customers and the scale to continue growing, which puts the Bank in a solid position to draw on the opportunities ofered by the environment. In 2019 we will rely on the same pillars that had guided the Group in the last three years. Our aim as a bank is to be the best open fnancial services platform by acting responsibly and earning the lasting loyalty of our people, customers, shareholders and communities. The management priorities of the principal units for 2019 are set out below: 326 2018 Annual Report Trend information 2019 Spain Poland The economy is forecast to grow by around 2.1% in 2019, higher than that envisaged for the Eurozone, and infation will remain low. Lending will gradually increase as the year progresses. Economic growth is expected to be stronger in 2019 at around 4%, mainly underpinned by buoyant domestic demand driven by domestic consumption and investment. The priorities for this year are: The goals to become the reference bank for individuals and companies are: • To keep our leadership by balance sheet in Spain and complete Banco Popular’s integration, maintaining quality service and customer relationship. • Develop a new value proposition / product ofer and improve the customer experience. • Accelerate the Bank’s digital transformation towards a data- • Solid corporate culture in order to strengthen employee driven company in order to improve the customer experience. engagement and motivation in order to become one of the best banks to work for in Poland. • Keep on growing SMEs and corporate segments backed by Banco Popular’s capabilities, Santander’s high added-value services and our competitive advantage in digital banking for companies. • Increase customer revenue and obtain cost synergies related to Banco Popular’s integration. • Continue to reduce doubtful assets, leveraging on our capital light model. The Real estate activity Spain unit will continue its strategy to reduce assets and lending exposure. • Become a more agile organisation in order to increase customer loyalty and retention, by accelerating the development and launch of products and services to the market. • Enhance our position in Private Banking and Asset Management. Santander Consumer Finance (SCF) Portugal SCF seeks to take advantage of its growth potential, backed by its position in the European consumer market. The main priorities will be: GDP growth will begin to ease in 2019 to around 2%, with improved investment and exports and further deleveraging of the private and public sectors. In this scenario, the Bank’s priorities are: • Maintain the leadership position in new auto fnancing and boost growth in consumer fnance through our new digital business model and signing agreements with the main retailers. • Keep on growing organically, gaining proftable market share, reinforcing our position as the largest privately owned bank in Portugal and leveraging our position in the companies segment. • Proactive management of brand agreements and development of • Focus on growing customer funds, particularly of-balance sheet digital projects. Collaboration with fntechs. funds. • Help our partners with their transformation plans, both in the digitalisation of auto purchase and fnancing as well as in other strategic projects. • Reorganise business in Germany under the same brand, in order • Combine volume growth with low cost of credit. • Improve efciency, obtaining additional synergies from Banco Popular Portugal integration. to improve efciency and ofer better customer attention. • Progress in our digital transformation and streamlining workfow. • Maintain high proftability and efciency. 327 Responsible bankingCorporate governanceEconomic and financial reviewRisk management United Kingdom Mexico The economy is expected to grow moderately in 2019 at around 1.5%, under an ordered exit from the EU. The uncertainty over Brexit could afect growth, the value of pound sterling and thus infation. The Bank of England will adjust monetary policy regarding the impact of Brexit on demand, supply and exchange rate. Against this backdrop, Santander UK priorities are: • Become the UK’s best open digital bank in order to deliver operational excellence and maximise efciency and customer satisfaction. • Generate growth through increased loyalty across target business segments. • Achieve constant proftability with a solid balance sheet and prudent risk management. UK banking environment faces major regulatory changes. Open Banking and PSD II (Payment Services Directive) introduced new requirements in 2018, which will bring business opportunities but they also introduced a new level of risk. We expect GDP growth to drop below 2% in 2019 (2.0% estimated for 2018), still hit by the shrinking of the oil sector and some uncertainty over the economic policies. Against this backdrop, Santander Mexico’s strategy will: • Continue the retail banking transformation: attraction and loyalty drivers, enhancing our attention model and expand new businesses (Súper Auto, Private Wealth and fnancial inclusion). • Drive digitalisation, remote attention models and the customer experience, in addition to improving information systems and analysis. • Focus on attracting payrolls, drawing on our strong presence in the SMEs, companies and corporate segments. • Promote SCIB business in order to continue to be the reference in the market in value-added products. • All these measures should be refected in recurrent revenue and volume growth. Brazil Chile After returning to growth in 2017 and 2018, following one of the biggest slumps in recent decades, the economy is expected to consolidate its recovery in 2019 with growth of more than 2%, above the 1.3% estimated for 2018. The economy will remain strong in 2019 with growth forecast at 3.5%. Santander Chile’s strategy will focus on: In this environment Santander Brasil’s management focus for the coming year will be: • Become the transactional bank of excellence with the best digital platform for companies. • Increase customer satisfaction and loyalty across all business • Continue improving quality of service indicators and grow loyal segments. and digital customers. • Continuous evolution and wider ofer of disruptive products and • Signifcant growth in loans and customer funds. services, and develop digital channels. • Improve our proftability, efciency and the cost of credit. • Keep on gaining market share, with growth in loans though a suitable ofer for each customer. • Grow in a recurring and proftable way, with efciency and cost of credit improvement. 328 2018 Annual Report Trend information 2019 Argentina Santander Corporate & Investment Banking Growth is expected to stabilise in 2019 after falling in 2018, and infation to ease, in an environment of fscal adjustment and a tight monetary policy. The management priorities at Santander Río will focus on: This division will continue its business strategy: • Leverage on our customer-centric model, to drive faster penetration of our franchise and growth in retail banking business (collaboration revenue). • Continue improving our value ofer focusing on the select, SMEs • Strengthen the global value proposition, focusing on boosting the advance and mid-income segments. US, the UK and Continental Europe businesses. • Gradual transformation of the branch network to a technology- centred model, focused on improving the customer experience. • Launch Openbank, the Group’s fully digital bank. • Continue the implementation of the Global Infrastructure Programme (GIP), following the regulatory agenda, while embracing the digital transformation. • Maintain disciplined use of capital, while keeping strict cost • Action plans to generate savings and improve efciency. control. • Opening of the new building which will house the central areas, with new working spaces for boosting innovation, productivity and team work. United States Wealth Management Growth is expected to remain dynamic at around 2.5% (2.9% in 2018), driven by fscal expansion. Santander will focus on: • Continue resolving legacy regulatory issues which remain pending. • Improve the customer experience in order to increase the number of active customers. • Seize collaboration opportunities across our businesses in the country in order to drive value. • Cost management in order to continue improving efciency. In 2019 we expect to generate substantial growth, including the investments needed to continue improving our value ofer. The key management drivers will be: • Consolidate Private Wealth (UHNW) model and value ofer. • Complete the construction of our private banking global platform in order to reinforce our global proposition for greater connection, taking advantage of our presence in over 10 countries. • Consolidate the model and value ofer for institutional clients in Santander Asset Management (SAM), in coordination with Santander Corporate & Investment Banking, focusing on Latin American products and infrastructures. • Continue improving and ofering a wider range of products at SAM, developing new solutions in alternative products (private debt and private equity funds of funds) and completing the ofer through strategic agreements with top level specialised management frms. • Improve digitalisation through the implementation of Global Private Banker tools, the new front for customers, as well as the investment platform Aladdin at SAM. • In 2019, the insurance business will be included in this unit, which will focus on capturing the potential of this business for the Group in all segments where there is an opportunity. In 2018 this business made a total contribution (proft after tax and generated fees) to the Group’s proft of EUR 1.4 billion. 329 Responsible bankingCorporate governanceEconomic and financial reviewRisk management 8. Alternative performance measures (APMs) In addition to the fnancial information prepared under IFRS, this consolidated directors’ report contains fnancial measures that constitute alternative performance measures (‘APMs’) to comply with the guidelines on alternative performance measures issued by the European Securities and Markets Authority on 5 October 2015 and non-IFRS measures. The fnancial measures contained in this consolidated directors’ report that qualify as APMs and non-IFRS measures have been calculated using the fnancial information from Santander but are not defned or detailed in the applicable fnancial information framework or under IFRS and have neither been audited nor reviewed by our auditors. We use these APMs and non-IFRS measures when planning, monitoring and evaluating our performance. We consider these APMs and non-IFRS fnancial measures to be useful metrics for management and investors to facilitate operating performance comparisons from period to period. While we believe that these APMs and non- IFRS fnancial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute of IFRS measures. In addition, other companies, including companies in our industry, may calculate such measures diferently, which reduces their usefulness as comparative measures. The APMs and non-IFRS measures we use in this document can be categorised as follows: Underlying results In addition to IFRS results measures, we present some results measures which are non-IFRS measures and which we refer to as underlying measures. These underlying measures allow in our view a better year-on-year comparability as they exclude items outside the ordinary course performance of our business which are grouped in the non-IFRS line management adjustments and are further detailed at the end of section 3.2 of this chapter. In addition, the results by business areas in section 4 are presented only on an underlying basis in accordance with IFRS8. The use of this information by the Group’s Governance bodies and reconciled on an aggregate basis to our IFRS consolidated results can be found in note 52.c to our consolidated fnancial statements. Proftability and efciency ratios The purpose of the proftability and efciency ratios is to measure the ratio of proft to capital, to tangible capital, to assets and to risk weighted assets, while the efciency ratio measures how much general administrative expenses (personnel and other) and amortisation costs are needed to generate revenue. Ratio Formula Relevance of the metric RoE (Return on equity) Attributable proft to the parent Average stockholders’ equity A (excl. minority interests) This ratio measures the return that shareholders obtain on the funds invested in the entity and as such measures the Bank’s ability to pay shareholders. RoTE (Return on tangible equity) Attributable proft to the parent This is a very common indicator, used to evaluate the proftability of the company as a percentage of a its tangible equity. It’s Average stockholders’ equity A (excl. minority interests) measured as the return that shareholders receive as a percentage - intangible assets Underlying RoTE Underlying attributable proft to the parent Average stockholders’ equity A (excl. minority interests) - intangible assets RoA (Return on assets) Consolidated proft Average total assets of the funds invested in the Bank less intangible assets. This indicator measures the proftability of the tangible equity of a company arising from ordinary activities, i.e. excluding results from operations outside the ordinary course performance of our business This metric, commonly used by analysts, measures the proftability of a company as a percentage of its total assets. It is an indicator that refects the efciency of the Bank’s total funds in generating proft over a given period. RoRWA (Return on risk weighted assets) Underlying RoRWA Consolidated proft Average risk weighted assets The return adjusted for risk is an derivative of the RoA metric. The diference is that RoRWA measures proft in relation to the Group’s risk weighted assets. Underlying consolidated proft Average risk weighted assets This relates the underlying proft (excluding management adjustments) to the Group’s risk weighted assets. Efciency (Cost-to-income) Operating expenses B Total income One of the most commonly used indicators when comparing productivity of diferent fnancial entities. It measures the amount of resources used to generate the Bank’s operating income. A. Stockholders’ equity = Capital and Reserves + Accumulated other comprehensive income + Attributable proft to the parent + Dividends. B. Operating expenses = Administrative expenses + amortisations. 330 2018 Annual Report Alternative Performance Measures Proftability and efciency A B RoE Attributable proft to the parent Average stockholders' equity (excluding minority interests) RoTE Attributable proft to the parent Average stockholders' equity (excluding minority interests) (-) Average intangible assets Average stockholders' equity (excl. minority interests) - intangible assets Underlying RoTE Attributable proft to the parent (-) Management adjustments Underlying attributable proft to the parent Average stockholders' equity (excl. minority interests) - intangible assets RoA Consolidated proft Average total assets RoRWA Consolidated proft Average risk weighted assets Underlying RoRWA Consolidated proft (-) Management adjustments Underlying consolidated proft Average risk weighted assets Efciency ratio (Cost-to-income) Underlying operating expenses Operating expenses Management adjustments impact C Underlying total income Total income Management adjustments impact C 2018 8.21% 7,810 95,071 11.70% 7,810 95,071 28,331 66,740 12.08% 7,810 (254) 8,064 66,740 2017 7.14% 6,619 92,638 10.41% 6,619 92,638 29,044 63,594 11.82% 6,619 (897) 7,516 63,594 2016 6.99% 6,204 88,744 10.38% 6,204 88,744 28,973 59,771 11.08% 6,204 (417) 6,621 59,771 0.64% 9,315 1,442,861 0.58% 8,207 1,407,681 0.56% 7,486 1,337,661 1.55% 9,315 598,741 1.59% 9,315 (231) 9,546 598,741 47.0% 22,779 22,779 — 48,424 48,424 — 1.35% 8,207 606,308 1.48% 8,207 (756) 8,963 606,308 47.4% 22,918 22,993 (75) 48,392 48,355 37 1.29% 7,486 580,777 1.36% 7,486 (406) 7,892 580,777 48.1% 21,088 21,101 (13) 43,853 44,232 (379) A. Averages included in the RoE, RoTE, RoA and RoRWA denominators are calculated using 13 months’ (from December to December). B. The risk weighted assets included in the denominator of the RoRWA metric are calculated in line with the criteria laid out in the CRR (Capital Requirements Regulation). C. Following the adjustments in Note 52.c to the consolidated fnancial statements. Efciency ratio by business areas Continental Europe Spain Santander Consumer Finance Poland Portugal United Kingdom Latin America Brazil Mexico Chile Argentina US 2018 Total income 15,881 7,894 4,610 1,488 1,344 5,420 21,201 13,345 3,527 2,535 1,209 6,949 Operating expenses 8,278 4,480 1,985 636 642 2,995 7,996 4,482 1,462 1,045 749 3,015 % 52.1 56.8 43.1 42.8 47.8 55.2 37.7 33.6 41.5 41.2 61.9 43.4 2017 Total income 14,417 6,860 4,484 1,419 1,245 5,716 22,519 14,273 3,460 2,523 1,747 6,959 % 53.1 58.9 44.1 42.6 49.3 50.1 38.7 35.6 39.9 40.6 55.5 46.0 Operating expenses 7,662 4,040 1,978 605 614 2,861 8,721 5,080 1,382 1,025 970 3,198 331 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Underlying RoTE by business areas 2018 2017 Average stockholders' equity (excl. minority interests) - intangible assets Underlying attributable proft to the parent 3,642 1,738 1,296 298 480 1,362 4,228 2,605 760 614 84 552 34,228 16,070 8,169 2,893 3,983 14,620 22,111 13,173 3,733 3,340 708 13,404 % 10.64 10.81 15.86 10.29 12.06 9.32 19.12 19.77 20.35 18.39 11.83 4.12 Average stockholders' equity (excl. minority interests) - intangible assets Underlying attributable proft to the parent 3,202 1,439 1,254 300 435 1,498 4,297 2,544 710 586 359 408 32,614 13,957 7,626 2,593 3,737 14,604 23,946 15,042 3,642 3,275 1,122 13,050 % 9.82 10.31 16.44 11.56 11.65 10.26 17.94 16.91 19.50 17.89 32.02 3.12 Continental Europe Spain Santander Consumer Finance Poland Portugal United Kingdom Latin America Brazil Mexico Chile Argentina US Credit risk indicators The credit risk indicators measure the quality of the credit portfolio and the percentage of non-performing loans covered by provisions. Ratio Formula Relevance of the metric NPL ratio (Non-performing loans ratio) Non-performing loans and advances to customers, customer guarantees and customer commitments granted Total Risk A The NPL ratio is an important variable regarding fnancial institutions’ activity since it gives an indication of the level of risk the entities are exposed to. It calculates risks that are, in accounting terms, declared to be non-performing as a percentage of the total outstanding amount of customer credit and contingent liabilities. Coverage ratio Cost of Credit Provisions to cover impairment losses on loans and advances to customers, customer guarantees and customer commitments granted Non-performing loans and advances to customers, customer guarantees and customer commitments granted Loan-loss provisions over the last 12 months Average loans and advances to customers over the last 12 months The coverage ratio is a fundamental metric in the fnancial sector. It refects the level of provisions as a percentage of the non-performing assets (credit risk). Therefore it is a good indicator of the entity’s solvency against client defaults both present and future. This ratio quantifes loan-loss provisions arising from credit risk over a defned period of time for a given loan portfolio. As such, it acts as an indicator of credit quality. A. Total risk = Total loans & advances and guarantees to customers (performing and non-performing) + non-performing contingent liabilities. Credit risk NPL ratio Non-performing loans and advances to customers, customer guarantees and customer commitments granted Total risk Coverage ratio Provisions to cover impairment losses on loans and advances to customers, customer guarantees and customer commitments granted Non-performing loans and advances to customers customer guarantees and customer commitments granted Cost of credit Net loan-loss provisions over the last 12 months Average loans and advances to customers over the last 12 months 332 2018 3.73% 35,692 958,153 2017 4.08% 37,596 920,968 2016 3.93% 33,643 855,510 67.4% 65.2% 73.8% 24,061 24,529 24,835 35,692 37,596 33,643 1.00% 8,873 887,028 1.07% 9,111 853,479 1.18% 9,518 806,595 2018 Annual Report NPL ratio by business areas Alternative Performance Measures Continental Europe Spain Santander Consumer Finance Poland Portugal United Kingdom Latin America Brazil Mexico Chile Argentina US Coverage ratio by business areas Continental Europe Spain Santander Consumer Finance Poland Portugal United Kingdom Latin America Brazil Mexico Chile Argentina US 2018 Non- performing loans and advances to customers customer guarantees and customer commitments granted 22,537 14,833 2,244 1,317 2,279 2,755 7,461 4,418 822 1,925 179 2,688 Total risk 429,454 239,479 97,922 30,783 38,340 262,196 171,898 84,212 33,764 41,268 5,631 92,152 2018 Provisions to cover impairment losses on loans and advances to customers, customer guarantees and customer commitments granted Non- performing loans and advances to customers customer guarantees and customer commitments granted 11,754 6,682 2,387 883 1,151 908 7,263 4,724 984 1,166 241 3,838 22,537 14,833 2,244 1,317 2,279 2,755 7,461 4,418 822 1,925 179 2,688 % 5.25 6.19 2.29 4.28 5.94 1.05 4.34 5.25 2.43 4.66 3.17 2.92 % 52.2 45.0 106.4 67.1 50.5 33.0 97.3 106.9 119.7 60.6 135.0 142.8 % 5.82 6.32 2.50 4.57 7.51 1.33 4.46 5.29 2.69 4.96 2.50 2.79 % 54.4 46.8 101.4 68.2 62.1 32.0 85.0 92.6 97.5 58.2 100.1 170.2 2017 Non- performing loans and advances to customers customer guarantees and customer commitments granted 24,674 15,880 2,319 1,114 2,959 3,295 7,464 4,391 779 2,004 202 2,156 Total risk 424,248 251,433 92,589 24,391 39,394 247,625 167,516 83,076 28,939 40,406 8,085 77,190 2017 Provisions to cover impairment losses on loans and advances to customers, customer guarantees and customer commitments granted Non- performing loans and advances to customers customer guarantees and customer commitments granted 13,419 7,434 2,352 760 1,838 1,055 6,345 4,066 760 1,167 202 3,668 24,674 15,880 2,319 1,114 2,959 3,295 7,464 4,391 779 2,004 202 2,156 333 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Other indicators The market capitalisation indicator provides information on the volume of tangible equity per share. The loan-to-deposit ratio (LTD) identifes the relationship between net customer loans and advances and customer deposits, assessing the proportion of loans and advances granted by the Group that are funded by customer deposits. The Group also uses gross customer loan magnitudes excluding reverse repurchase agreements (repos) and customer deposits excluding repos. In order to analyse the evolution of the traditional commercial banking business of granting loans and capturing deposits, repos and reverse repos are excluded, as they are mainly treasury business products and highly volatile. Ratio Formula Relevance of the metric TNAV per share (Tangible net asset value per share) Tangible book value A Number of shares excluding treasury stock Price / tangible book value per share (X) Share price TNAV per share This is a very commonly used ratio used to measure the company’s accounting value per share having deducted the intangible assets. It is useful in evaluating the amount each shareholder would receive if the company were to enter into liquidation and had to sell all the company’s tangible assets. Is one of the most commonly used ratios by market participants for the valuation of listed companies both in absolute terms and relative to other entities. This ratio measures the relationship between the price paid for a company and its accounting equity value. LtD (Loan-to-deposit) Net loans and advances to customers Customer deposits This is an indicator of the Bank’s liquidity. It measures the total (net) loans and advances to customers as a percentage of customer funds. Loans and advances (excl. reverse repos) Gross loans and advances to customers excluding reverse repos Deposits (excl. repos) Customer deposits excluding repos In order to aid analysis of the commercial banking activity, reverse repos are excluded as they are highly volatile treasury products. In order to aid analysis of the commercial banking activity, repos are excluded as they are highly volatile treasury products. PAT + After tax fees paid to SAN (in Wealth Management) Net proft + Fees paid from Santander Asset Management to Santander, net of taxes, excluding Private Banking customers Metric to assess Wealth Management’s total contribution to Group’s profts A. Tangible book value = Stockholders’ equity - intangible assets. Other indicators TNAV (tangible book value) per share Tangible book value Number of shares excl. treasury stock A (million) Price / tangible book value per share (X) Share price (euros) A TNAV (tangible book value) per share Loan-to-deposit ratio Net loans and advances to customers Customer deposits PAT + After tax fees paid to SAN (in Wealth Management) (Constant EUR million) Proft after taxes Net fee income net of tax A. 2016 data adjusted for the capital increase in July 2017, to enable like-on-like comparisons with 2017 and 2018 data. 334 2018 4.19 67,912 16,224 0.95 3.973 4.19 113% 882,921 780,496 1,015 563 452 2017 4.15 66,985 16,132 1.32 5.479 4.15 109% 848,914 777,730 902 476 426 2016 4.15 61,517 14,825 1.16 4.797 4.15 114% 790,470 691,111 n.a. n.a. n.a. 2018 Annual Report Alternative Performance Measures Impact of exchange rate movements on proft and loss accounts Impact of exchange rate movements on the balance sheet The Group presents, at both the Group level as well as the business unit level, the real changes in the income statement as well as the changes excluding the exchange rate efect, as it considers the latter facilitates analysis, since it enables businesses movements to be identifed without taking into account the impact of converting each local currency into euros. Said variations, excluding the impact of exchange rate movements, are calculated by converting P&L lines for the diferent business units comprising the Group into our presentation currency, the euro, applying the average exchange rate for 2018 to all periods contemplated in the analysis. The average exchange rates for the main currencies in which the Group operates are set out on section Economic, regulatory and competitive context of this chapter. The Group presents, at both the Group level as well as the business unit level, the real changes in the balance sheet as well as the changes excluding the exchange rate efect for loans and advances to customers excluding reverse repos and customer funds (which comprise deposits and mutual funds) excluding repos. As with the income statement, the reason is to facilitate analysis by isolating the changes in the balance sheet that are not caused by converting each local currency into euros. These changes excluding the impact of exchange rate movements are calculated by converting loans and advances to customers excluding reverse repos and customer funds excluding repos, into our presentation currency, the euro, applying the closing exchange rate on the last working day of 2018 to all periods contemplated in the analysis. The end-of-period exchange rates for the main currencies in which the Group operates are set out on section Economic, regulatory and competitive context. 335 Responsible bankingCorporate governanceEconomic and financial reviewRisk management Risk management 1. Risk management and control model 338 5. Capital risk 1.1 Risk governance 1.2 Social and environmental risk 1.3 Management processes and tools 338 340 341 5.1 Introduction 5.2 Capital risk management 5.3 Key metrics 2. Risk map and risk profle 346 6. Operational risk 3. Credit risk 3.1 Introduction 3.2 Credit risk management 3.3 Key metrics 3.4 Detail of main geographies 3.5 Other credit risk aspects 4. T rading market risk, structural and liquidity risk 4.1 Introduction 4.2 Trading market risk management 4.3 Key metrics (trading market risk) 4.4 Struct ural balance sheet risks management 348 348 348 352 358 366 373 373 374 376 383 4.5 K ey metrics (structural balance sheet risks) 385 388 4.6 Liquidity risk management 4.7 Key metrics (liquidity risk) 388 4.8 Pension and actuarial risk management 389 6.1 Introduction 6.2 Operational risk management 6.3 Key metrics 6.4 Other aspects of control and monitoring of operational risk 7. Compliance and conduct risk 7.1 Introduction 7.2 Governance 7.3 C ompliance and conduct risk management 8. Model risk 8.1 Introduction 8.2 Model risk management 9. Strategic risk 9.1 Introduction 9.2 Strategic risk management 390 390 390 392 393 393 393 398 399 400 400 400 402 411 411 412 413 413 413 Responsible bankingCorporate governanceEconomic and financial reviewRisk management1. Risk management and control model Risk management and control is key in ensuring that we remain a robust, safe and sustainable bank aligned with the interests of our employees, customers, shareholders and society. In Santander we prioritise the execution of a forward-looking risk management. This has enabled the Group, since its foundation in 1857, to deal appropriately with changes in the economic, social and regulatory environment and continue helping people and businesses prosper. 5. Information and data management processes that allow all risks to be identifed, assessed, managed and reported at appropriate levels. 6. Risks are managed by the units that generate them. Our risk management and control model is based on the principles below, taking into account regulatory expectations, and market best practices: 1. Advanced risk management with a forward-looking approach that ensures a medium-low risk profle, based on our risk appetite framework defned by the board. These principles, combined with a series of interrelated tools and processes in the Group’s strategic planning (risk appetite, risk identifcation and assessment, scenario analysis, risk reporting framework, annual planning and budget, etc.) provide a holistic control framework across the Group. 1.1 Risk governance 2. Risk culture that applies to all employees throughout the Group. 3. Clearly defned three lines of defence model that enable us to identify, manage, control, monitor and challenge all risks. The Group has a strong governance framework, which pursues the efective control of the risk profle within the risk appetite defned by the board. 4. Autonomous subsidiaries model with robust governance based on a clear structure that separates the risk management and the risk control functions. This governance framework is underpinned by the distribution of roles among the three lines of defence, a robust structure of committees dealing with a strong relationship between the Group and its subsidiaries. Overlaid with our Group wide risk culture Risk Pro/I am Risk. 338 2018 Annual Report Lines of defence At Santander, we follow a three lines of defence control model: First line Second line Third line All business functions and business support functions that originate risks and have primary responsibility in the management of those risks. The role of these functions is to establish a management structure for the risks generated as part of their activity ensuring that these remain within approved risk limits. These are the Risk Control and Compliance and Conduct function. The role of these functions is to provide independent oversight and challenge to the risk management activities of the first line of defence. These functions ensure that risks are managed in accordance with the risk appetite, fostering a strong risk culture across our organisation. They also provide guidance, advice and expert opinion in risk-related matters. Internal Audit function. This function controls and regularly checks that the policies and procedures are adequate and effectively implemented in the management and control of all risks. The Risk Control, Compliance and Conduct, and Internal Audit functions are separated and independent and have direct access to the board of directors and/or its committees. decisions on risks assumed at the highest level, ensuring that they are within the established risk appetite limits for the Group. Risk committees structure Ultimately, the board of directors is responsible for risk management and control and, in particular, for approving and periodically reviewing the Group’s risk culture and risk appetite framework. Except for specifc topics detailed in its bylaws, the board has the capacity to delegate its faculties to other committees. This is the case of the risk supervision, regulation and compliance committee and the Group’s executive committee, which has specifc risk related responsibilities. For more information see the Corporate governance chapter, section 4.7 ‘Risk supervision, regulation and compliance committee activities in 2018’ The Group Chief Risk Ofcer (Group CRO) leads the risk function within the Group, advises and challenges the executive line and reports independently to the risk supervision, regulation and compliance committee and to the board. Other bodies that form the highest level of risk governance, with authorities delegated by the board of directors, are the executive risk committee and the risk control committee, detailed as follows: Executive risk committee (ERC) Purpose: this committee is responsible for managing all risks, within the faculties delegated by the board. The committee makes Chair: CEO. Composition: nominated executive directors and other Group senior management. The Risk, Finance and Compliance and Conduct functions, among others, are represented. The Group CRO has a veto right on the committee’s decisions. Risk control committee (RCC): Purpose: to control and oversee that risks are managed in accordance with the risk appetite approved by the board, providing a comprehensive overview of all risks. This includes identifying and monitoring both current and potential risks, and evaluating their potential impact on the Group’s risk profle. Chair: Group CRO. Composition: senior management members from the Risk, Compliance and Conduct, Financial Accounting and Management Control functions are represented, among others. Senior members of the risk function (CROs) from the Group’s units regularly take part in reporting their risk profles. Additionally, each risk factor has it´s own fora, committees and meetings to manage the risks under their control. Among others, they have the following responsibilities: • Advice the CRO and the risk control committee that risks are managed in line with the Group’s risk appetite. • Carry out and regular monitoring of each risk factor. 339 Risk management and control modelResponsible bankingCorporate governanceEconomic and financial reviewRisk management • Oversee the measures adopted to comply with the expectations of the supervisors and internal and external auditors. For certain matters, the Group may establish specifc additional governance. For example, following the UK Government decision to leave the EU, the Group and Santander UK set up separate steering committees and working groups to: i) monitor the Brexit process; ii) develop contingency plans; and iii) escalate and take decisions to minimise potential impacts on our business and customers. In the face of prolonged uncertainty, the Group and Santander UK began, in 2018, to execute the agreed contingency plans to ensure readiness for the withdrawal by the UK from the European Union. The Group’s relationship with its subsidiaries regarding risk management Alignment of units with the Group In all the subsidiaries, the management and control model follows the frameworks established by the Group’s board of directors. The local units adhere to them by their respective boards. The Group reviews and validates any local adaptations as needed. The Corporate centre participates in the relevant decision-making through their validation. This creates a recognisable and common risk management and control model across the Group. The ‘Group-subsidiary governance model and good governance practices for subsidiaries’ sets up regular interaction and functional reporting by each local CRO to the Group CRO, as well as the participation of the Group in the process of appointing, setting targets, evaluation and remuneration of local CRO’s, in order to ensure risks are adequately controlled by the Group. To strengthen the relationship between the Group and the units, various initiatives have been taken in order to develop the risk management model across the Group: • Promote collaboration to accelerate share of best practices to help solve local weaknesses strengthen current processes and boost innovation. • Talent identifcation within the risk teams, boosting international mobility (Global Risk Talent Program). • Advanced Risk Management (ARM): defnition and implementation of the risk initiatives, both Group and local, underpinning the transformation aspirations of the risk management and control model of each unit. Subsidiary committee structures The ‘Group-subsidiary governance model and good governance practices for subsidiaries’ recommends that each subsidiary should have risk committees and other executive committees, consistent with those already in place in the Group. The subsidiary governance bodies are structured taking into consideration local requirements, both regulatory and legal, as well as their specifc dimension and complexity, in a manner that is consistent with those of the parent company, as established in the internal governance framework. As part of our role to review the aggregated oversight of all risks, the Group exercises a validation and challenge role with regard to the transactions and management policies of the subsidiaries, insofar as they afect the Group’s risk profle. For more detail regarding the subsidiaries committees’ structure see chapter Corporate Governance, section 7 ‘Group structure and governance framework’. Risk culture - Risk Pro Santander has a strong risk culture known as Risk Pro implemented across the Group, which defnes the way in which we understand and manage risks on a day-to-day basis. It is based on the principle that all employees are responsible for risk management. Further information is available in the Responsible banking chapter, section ‘Risk culture’. 1.2 Social and environmental risk Social and environmental policies Santander contributes to sustainable economic growth by promoting the protection and conservation of the environment, and the protection of human rights. This principle of environmental and social responsibility embedded across the Group and decision- making processes. It is for example, refected in the environmental, social and reputational risk assessments that Santander carries out on its customers and transactions as part of its decision-making processes across the whole Group. The Group has board approved, sector specifc, environmental, social and reputational risk policies covering energy (including coal), mining and metals, soft commodities and defence that are reviewed annually to ensure they follow the best international practices and standards. The policies set out the activities where the Group will not provide fnancial products and/or services and those where Santander will conduct in-depth analysis to assess their environmental, social and reputational impacts. 340 2018 Annual Report Advances to our social and environmental policies is overseen by a working group chaired by the Group Chief Compliance Ofcer. The working group also assesses any issues with customers and transactions that fall within the scope of the policies and provides an opinion on all relevant matters to corresponding approval committees. In addition to the above, and since 2009, the Group has applied the Equator Principles to all project fnance transactions. Equator Principles reporting by Santander is available on the Responsible banking chapter, in section ‘Evaluation of environmental risk of fnancing activities’. Climate change and the Task Force on Climate-related Financial Disclosures The Task Force on Climate-related Financial Disclosures (TCFD) of the Financial Stability Board (FSB) has published a series of recommendations for corporate governance, strategy, risk management, metrics and targets in relation to climate change. The implementation of these recommendations will signifcantly transform how fnancial institutions identify investment opportunities and manage the risks associated with the changes to international economic activities that are required to address the challenge of climate change. As a result of the Paris Climate Agreement, governments and regulators across the EU and other countries, where the Group is present, are working on developing and implementing legal rules that will help meet the agreed targets and facilitate the transition to a lower emission economy. Santander is providing input into these consultations and will actively work to implement them in due course. 1.3 Management processes and tools For risk management and control purposes, the Group has defned several key processes that rely on a series of tools, as follows: Risk appetite Risk Identifcation and Assessment (RIA) Stress Test Risk Reporting Framework (RRF) Risk appetite and structure of limits In Santander we defne risk appetite as the amount and type of risks that are considered prudent to assume for implementing our business strategy in the event of unexpected circumstances. Severe scenarios that could have a negative impact on the levels of capital, liquidity, proftability and/or the share price are taken into account. The risk appetite is set by the board for the whole Group. Every main business unit sets its own risk appetite according to the adaptation of the Group methodology and its own circumstances. The boards of the subsidiaries are responsible for approving their respective risk appetite proposals once they have been reviewed and validated by the Group. The Group shares a common risk appetite model. It sets out the requirements for processes, metrics, governance bodies, controls and standards for implementation across the Group, cascading down management policies and limits to lower levels. a. Business model and fundamentals of the risk appetite The risk appetite defnition is consistent with our risk culture and business model. The main elements that defne the business model and underpin the risk appetite are: • Medium-low and predictable risk profle based on a diversifed business model, focused on retail and commercial banking with internationally diversifed activities and strong material market share, as well as a wholesale business model that is centred on customer relationships in the Group’s main markets. • Stable and recurrent earnings and shareholder remuneration policy, underpinned by sound capital and liquidity, and diversifed sources of funding. 341 Risk management and control modelResponsible bankingCorporate governanceEconomic and financial reviewRisk management • Autonomous subsidiaries that are self-sufcient in terms of capital and liquidity, minimising the use of non-operational or shell companies, and ensuring that no subsidiary has a risk profle that could jeopardise the Group’s solvency. • An independent Risk function with active involvement of senior management to reinforce a strong risk culture and a sustainable return on capital. • Global and holistic view of all risks, through extensive control and monitoring: All risks, all businesses and all countries. • Focus on products that the Group knows sufciently well and has the capacity to manage (systems, processes and resources). c. Limits structure, monitoring and control The risk appetite is formulated annually and includes a series of metrics and limits to establish in quantitative and qualitative terms the maximum risk exposure that every unit and the Group as a whole is willing to assume. Compliance with risk appetite limits is regularly monitored. Specialised control functions report the risk profle adequacy to the board and its committees, on quarterly basis. Limit breaches and non-compliance with the risk appetite are reported to the relevant governance bodies. An analysis of the causes, an estimation of the duration of the breach and corrective actions proposals are also submitted. • A conduct model that protects customers and shareholders. • Remuneration policy that aligns the individual interests of employees and executives with the risk appetite, and is consistent with the evolution of the Group’s long-term results. b. Corporate risk appetite principles The following principles govern the Group’s risk appetite in all its units: Linkage between the risk appetite limits and those of the business units and portfolios is a key element for making the risk appetite an efective risk management tool. The management policies and structure of the limits used to manage the diferent types and categories of risk have a direct relation with the principles and limits defned in the risk appetite (described in greater detail in this chapter, sections 3.2 ‘Credit risk management’, 4.2 ‘Trading market risk management’ and 4.4 ‘Structural balance sheet risks management’. • Responsibility of the board and of senior management. • Holistic risk view (Enterprise Wide Risk), risk profle backtesting and challenge. The risk appetite must consider all signifcant risks and facilitate an aggregate view of the risk profle through the use of quantitative metrics and qualitative indicators. Each risk and business area is responsible for verifying that the risk appetite limits and controls used are properly embedded in the day-to-day management. The Risk Control and Supervision function validates the resulting assessment, ensuring that limits conform to the risk appetite. • Forward-looking view. The risk appetite must consider the desirable risk profle for the short and medium term, taking into account both the most plausible circumstances and adverse/ stress scenarios. • Embedding and alignment with strategic and business plans. The risk appetite is an integral part of the strategic and business planning, and is embedded in the daily management through the transfer of the aggregated limits to those set at portfolio level, unit or business line, as well as through the key risk appetite processes. d. Risk appetite axes and key metrics The risk appetite is expressed via limits on quantitative metrics and qualitative indicators that measure the exposure or risk profle by type of risk, portfolio and segment and business line, under both current and stressed conditions. These metrics and risk appetite limits are articulated in fve axes that defne the positioning that Santander wants to adopt or maintain in the deployment of its business model, which are described as follows: • Volatility of results To limit the potential negative volatility of the results in the strategic and business plans under stressed conditions. • Coherence across the various units and a common risk language throughout the Group. The risk appetite of each unit of the Group must be coherent with that across the Group. This axis contains metrics which measure the behaviour and evolution of real or potential losses in the business. • Periodic review, backtesting and adoption of best practices and regulatory requirements. Monitoring and control mechanisms are established to ensure the risk profle is maintained, and the necessary corrective and mitigating actions are taken in the event of non-compliance. The stress tests, measure the maximum fall in results under adverse conditions with a reasonable probability of occurrence and similar by risk type (thus allowing aggregation). 342 2018 Annual Report • Solvency Addresses the maintenance of the Entity’s equity, keeping capital above regulatory requirements and market expectations. It determines the minimum level of capital the Entity requires in order to cope with potential losses under both normal and stressed conditions. This approach included in the risk appetite model is supplementary to and consistent with the capital objective approved within the Group’s capital planning process. • Liquidity The Group has developed a funding model based on autonomous subsidiaries that are responsible for maintaining their own liquidity needs. On this basis, liquidity management is conducted by each subsidiary within a corporate framework that develops its basic principles (decentralisation, equilibrium in the medium and long term funding, high weight of customer deposits, diversifcation of wholesale sources, reduced exposure to short-term fnancing, sufcient liquidity reserve) and revolves around three main pillars (governance model, balance sheet analysis and measurement of liquidity risk). Santander’s liquidity risk appetite establishes demanding objectives of liquidity positions and horizons under systemic and idiosyncratic stress scenarios (local and global). In addition, a limit is set for the net stable funding ratio (NSFR), together with a limit on the minimum liquidity coverage position. • Concentration Santander seeks to maintain a diversifed risk profle. This is achieved by virtue of Santander’s business orientation to retail banking with a high degree of international diversifcation. This axis includes, among others, the individual maximum exposure limits with customers, aggregated maximum exposure with major counterparties, and maximum exposure by activity sectors, in commercial real estate and in portfolios with a high risk profle. Customers with an internal rating lower than investment grade or equivalent, or which have excessive exposure of a certain degree, are also monitored. • Non-fnancial transversal risks This involves qualitative and quantitative metrics that help monitor exposure to non-fnancial risks. These include specifc indicators for fraud, technological risk, security and cyberrisk, money laundering prevention, regulatory compliance, product governance and customer protection. Risk identifcation and assessment (RIA) The Group carries out the identifcation and assessment of the diferent risks that it is exposed to, involving the diferent lines of defence, establishing management standards that not only meet regulatory requirements but also refect best practices in the market, and reinforce our risk culture. In 2018, the approach centred on three main areas: standards control environment review, perimeter completeness by integrating new units, together with the risk performance indicators review and their alignment with the risk appetite. In addition, the RIA exercise analyses the evolution of risks and identifes areas of improvement: • Risk performance, enabling the understanding of residual risk by risk type through a set of metrics and indicators calibrated using international standards. • Control environment assessment, measuring the degree of implementation of the target operating model, as part of our advanced risk management. • Forward-looking analysis, based on stress metrics and identifcation and/or assessment of the main threats to the strategic plan (Top risks), enabling specifc action plans to be put in place to mitigate potential impacts and monitoring these plans. Based on the periodic RIA exercise, the Group’s risk profle as of December 2018 remains as solid medium-low. Scenario analysis We analyse the impact triggered by diferent scenarios in the environment, in which the Group operates. These scenarios are expressed both in terms of macroeconomic variables, as well as other variables that may impact our risk profle. Scenario analysis is a robust and useful tool for management at all levels. It enables the Group to assess its resilience in stressed environments or scenarios, and identifes measures to reduce exposure under these scenarios. The objective is to reinforce the stability of income, capital and liquidity. The robustness and consistency of the scenario analysis exercises are based on the following pillars: • Development and integration of models that estimate the future performance of metrics (for example, credit losses), based on both historic information (internal to the Group and external from the market), and simulation models. • Inclusion of expert judgement and portfolio manager’s know- how. 343 Risk management and control modelResponsible bankingCorporate governanceEconomic and financial reviewRisk management • Challenge and backtesting of model results to ensure they are adequate. • Robust governance of the whole process, covering models, scenarios, assumptions and rationale for the results, and their impact on management. diferent frequencies and present diferent granularity levels. For more detail see Risk appetite and structure of limits in section 1.3 ‘Management processes and tools’ above mentioned and section 4.6. Liquidity risk management in this report. • Recurrent risk management in diferent processes/exercises: The application of these pillars in the European Banking Authority (EBA) stress test, executed and reported bi-annually, has enabled Santander to satisfactorily meet the defned requirements - both quantitative and qualitative - and to contribute to the excellent results obtained by the Group. For further information on the Stress test result, please refer to chapter Economic and fnancial review, in section 3.5 ‘EBA/ECB transparency exercise 2018’. Uses of scenario analysis The EBA guidelines establish that scenario analysis should be integrated in the risk management framework and in the Group’s management processes. This requires a forward looking view in risk and strategic management, capital and liquidity planning. Scenario analysis is included in the Group’s control and management framework, ensuring that any impact afecting the Group’s solvency or liquidity can be rapidly identifed and addressed. With this objective, a systematic review of exposure to the diferent types of risk is included, not only under the baseline scenario but also under various simulated adverse scenarios. Santander has a map of uses in place to strengthen the alignment of scenario analysis for each risk type, along with the continuous improvement of such uses. The goal is to reinforce the integration among the diferent regulatory and management exercises. Scenario analysis forms an integral part of several key processes of the Group: • Regulatory uses: stress test scenarios using the guidelines set by the European regulator or by each local supervisor. • Internal capital adequacy assessment (ICAAP) or liquidity assessment (ILAAP) in which, while the regulators can impose certain requirements, the Group develops its own methodology to assess its capital and liquidity levels under diferent stress scenarios to support planning and adequately managing the Group’s capital and liquidity. • Risk appetite. Contains stressed metrics on which maximum levels of losses (minimum liquidity levels) are established that the Group does not want to exceed. These exercises are related to those for capital and liquidity, although they have • Budgetary and strategic planning process, in the development of commercial risk admission policies, in the global risk analysis for senior management or in the specifc analysis regarding profle of activities or portfolios. • Identifcation of Top risks on the basis of a systematic process to identify and assess all the risks which the Group is exposed to. The Top risks are selected and a macroeconomic or idiosyncratic scenario is associated with each one, to assess their impact on the Group. • Recovery plan annually performed to establish the available tools the Group will have, to survive in the event of an extremely severe fnancial crisis. The plan sets out a series of fnancial and macroeconomic stress scenarios, with difering degrees of severity, that include idiosyncratic and/or systemic events. • IFRS9 from 1 January 2018, the processes, models and scenario analysis methodology are included in the new regulatory provision requirements. For additional details regarding scenario analysis see sections 3.2 ‘Credit risk management, 4.2 ‘Trading market risk management’ and 4.6.’Liquidity risk management’. In 2018 Santander participated in the United Nations Environmental Program Financial Initiative (UNEP FI) pilot, along with 15 banks, to implement the TCFD requirements. The initiative´s objective was to develop scenarios, models and metrics to enable a scenario- based, forward-looking assessment of climate-related risks and opportunities, as well as contributing to the working group. The Group specifcally focused on direct and indirect transition risks and their impact on its transportation sector wholesale portfolio, based on diferent scenarios provided within the UNEP FI pilot. The scenarios covered Santander exposures across all geographies, taking into consideration segmentation, sensitivities and model calibration that were selected based on our knowledge of clients. The key fnding from the pilot exercise was that the Santander wholesale portfolio clients are especially resilient to the stress test, including climate-related transition impacts, and are able to adapt to the technological change requirements with limited impact on their credit quality. The UNEP FI project has brought notable progress to climate risk assessment, but there is still room for improvement in the metrics 344 2018 Annual Report calculation. Overall, the test highlighted that more granular scenarios would need to be developed to address more sector- specifc drivers and more diverse geographical assumptions (e.g. Latin American countries). The model, as it currently stands, is a deterministic model reliant on expert judgement, so its methodology and calibration need to evolve to improve the results and make them comparable between participating banks. Risk Reporting Framework (RRF) Our reporting model has strengthened by consolidating the overall view of all risks, based on complete, precise and recurring information that allows the Group’s senior management to assess the risk profle and decide accordingly. The risk reporting taxonomy contains three types of reports received by senior management on a monthly basis: the Group risk report, the risk reports of each unit, and the reports of each of the risk factors identifed in the Group’s General risk corporate framework. This risk reporting taxonomy has the following features: • It covers all signifcant risk areas. Reports maintain the due balance between data, analysis and qualitative comments, including forward-looking measures, risk appetite information, limits and emerging risks, and they are distributed to senior management. • They are suitable for the Group’s subsidiaries structure, combining a holistic view with a deeper analysis for each risk factor. • They allow a uniform view, as each subsidiary may defne its own reports based on local criteria, in addition to an aggregate view that enables for analysis of risks based on a common defnition. 345 Risk management and control modelResponsible bankingCorporate governanceEconomic and financial reviewRisk management 2. Risk map and risk profle Credit risk Credit risk with customersA by country Other 21% US 10% Chile 4% Brazil 9% Spain 25% Portugal 4% UK 27% 3.73% Non-performing loan ratio -35 bp in 2018 1.00% Cost of creditB -7 bp in 2018 Section 3 Adequate sector and geographic diversifcation between mature and emerging markets. Consolidation of the improvement trend in the Group’s main credit indicators. A. Includes gross lending to customers, guarantees and documentary credits. B. Cost of credit calculated as the percentage of loan- loss provisions twelve months of the average lending. Trading market risk, structural and liquidity risk Section 4 — VaR — 15 day moving average — VaR, 3 year average 158% Comfortable short-term liquidity coverage ratio (LCR) +24 bp in 2018 VaR 2018 evolution EUR Million. VaR at 99%. 20 18 16 14 12 10 8 6 4 2 0 Avg. VaR of the trading activity of SCIB remains at moderately low levels, as it is focused on customer services and has geographic diversifcation. Comfortable liquidity position, based on our commercial strength and autonomous subsidiaries model, with a strong weighting of customer deposits and robust liquid asset bufers. An appropriate balance sheet structure reduces the impact of interest rates changes on net interest income and equity. n a J b e F r a M r p A y a M n u J l u J g u A p e S t c O v o N c e D Capital risk RWAC by risk type Operational 10% Market 4% 11.30% CET fully LoadedD +46 bp in 2018 CreditE 86% 346 Section 5 The main capital requirements correspond to credit risk, which is the core business of the Group, with a medium-low risk profle. In the adverse scenario of the EBA stress test of November 2018, Santander is the bank with the least CET1 fully loaded destroyed among our European peers. C. Risk Weighted Assets. D. 2018 data calculated using the IFRS9 transitional arrangements. E. Includes counterparty risk, securitisations and amounts below the thresholds for deduction. 2018 Annual Report Operational risk Net losses by operational risk categories Process management 18% Damage to physical assets 2% Section 6 Signifcant reduction in net losses compared to 2017, particularly in the Practices with Customers category. External fraud 18% Employment practices 2% Improved risk analysis due to: incorporation of new risk appetite metrics, improvements in the process of determining critical controls and greater integration of operational risk in the Group’s strategic exercises. Focus on: fraud risk mitigation, information security and cybersecurity, and supplier control. Customers and products, and business practices 60% Compliance and conduct risk Section 7 Completion of the three-year strategic program, with the implementation of a series of initiatives. Deployment of the Regulatory Radar governance in the Group and units to support the monitoring of the new regulations. Digitalisation of the main processes of corporate operations, annual compliance program, product governance, Code of conduct in the securities market and operations with reputational risk validation. Promoting online collaboration with platforms and structured spaces for the exchange of information, money laundering and terrorism fnancing alert management optimisation. Implementation of a specifc compliance program for GDPR and MiFID II in the Group’s units. Consolidation of the supervision model regarding market abuse, reporting and escalation of events. Model risk Section 8 Strategic risk Section 9 Supervisors and internal auditors focus on IRB and IMA regulatory models. The management model pursues a correct monitoring and control of strategic across the Group and its subsidiaries. A strategic project has been launched, model risk management 2.0 (MRM 2.0), to reinforce our model risk management. Potential threats that may afect the strategic objectives are identifed and assessed to take necessary mitigation actions. The following sections detail the risk profle of the Group by risk factor. This risk profle might be afected by the macroeconomic, regulatory and competitive environment in which the Group performs its activities. Further information can be found in the Economic and fnancial review chapter, section 1 ‘Economic, regulatory and competitive environment’. The fnancial information is based on the aggregation of fgures for the diferent geographical areas and business units within the Group. This information relates both to accounting data and those provided by the management information systems. In all cases, the same general principles are applied as those used in the Group. The businesses included in each of our geographical segments and the accounting principles applied may difer from those used in the fnancial information prepared and disclosed by our subsidiaries which, by name or geographical description, may appear to correspond to the business areas contemplated in this report. Therefore, the results and trends shown here for our business areas may difer signifcantly from those of such subsidiaries. The notes to the consolidated fnancial statements contain additional information regarding the Group’s risks and other relevant information regarding provisions, litigation and other matters, including tax risks and litigation. 347 Risk map and risk profileResponsible bankingCorporate governanceEconomic and financial reviewRisk management 3. Credit risk 3.1 Introduction Credit risk is the risk of fnancial loss arising from the default or credit quality deterioration of a customer or other third party, to which the Group has either directly provided credit or for which it has assumed a contractual obligation. 3.2 Credit risk management The credit risk management process consists of identifying, analysing, controlling and deciding on the credit risk incurred by the Group’s transactions. It considers a holistic view of the credit risk cycle including the transaction, customer and portfolio view. Both business and risk areas, together with the senior management participate in the management process. The identifcation of credit risk is a key component for the active management and efective control of portfolios. The identifcation and classifcation of external and internal risks in each business allows corrective and mitigating measures to be adopted. Planning Planning allows to set business targets and defne specifc action plans, within the risk appetite established by the Group. These targets are met by assigning the necessary means (models, resources, systems). Strategic commercial plans (SCPs) are a basic management and control tool for the Group’s credit portfolios. The SCPs are prepared jointly by the Commercial and Risk areas, and defne the commercial strategies, risk policies and measures/infrastructures required to meet the annual budget targets. These three factors are considered as a whole, ensuring a holistic view of the portfolio to be planned and allowing a map of all the Group’s credit portfolios to be drawn. SCP management integration provides an updated view on the credit portfolios quality, allows to measure credit risk, perform internal controls and periodic monitoring of planned strategies, anticipate deviations and identify signifcant changes in risk and its potential impact, as well as corrective actions. The SCPs approval corresponds to the risk executive committee or equivalent body of each entity previous to its validation at Group level in the corporate risk executive committee. The periodic monitoring of SCPs is carried out by the same bodies that approve and validate them. The process pursues the SCPs alignment with the capital objectives of the Group’s units. Assessment of the risk and credit rating process In order to assign a rating that refects the credit quality of the customer, the Group uses valuation and parameter estimation models in each of the segments where it operates: SCIB (Santander Corporate & Investment Banking: sovereigns, fnancial institutions and large corporates), commercial banking, institutions, SMEs and individuals. The decision models applied are based on credit rating drivers which are monitored and controlled to calibrate and precisely adjust the decisions and ratings they assign. Depending on the segment, drivers may be: 348 2018 Annual Report 1 Rating: resulting from the application of mathematical algorithms incorporating a quantitative model based on balance sheet ratios or macroeconomic variables, and a qualitative module supplemented by the analyst’s expert judgement. Used for the SCIB, commercial banking, institutions and SMEs (treated on an individual basis) segments. 2 Scoring: an automatic assessment system for credit applications. It automatically assigns an individual grade to the customer for subsequent decision-making. Parameter estimation models are obtained through econometric statistical models, internally developed, based on historical loss and default of the portfolios for which they are developed and used to calculate the economic and regulatory capital, and the IFRS9 provision of each portfolio. Periodic model monitoring and evaluation is carried out, assessing among others, the adequacy of its use, its predictive capacity, correct performance, and level of granularity. In the same way, the existence and compliance of the policies corresponding to each and every segment is verifed (these policies enable the execution of business plans defned under the approved risk appetite). The resulting ratings are regularly reviewed, incorporating the latest available fnancial and other information. The depth and frequency of the reviews are increased in the case of customers who require a more detailed monitoring or through automatic warnings in the systems. Limits, pre-classifcations and pre-approvals defnition The connection between the credit risk appetite of the Group and management of the credit portfolios is implemented through the SCPs, which defne the portfolio and new originations limits to anticipate the portfolio risk profle. The cascading down of the Group’s risk appetite framework credit risk metrics, strengthens the existing control over credit portfolios. We have processes that determine the risk that the Group is able to assume with each customer. These limits are set jointly by the business and risk areas and have to be approved by the executive risk committee (or committees to which it has delegated such authority) and refect the expected results of the business in terms of risk-return. There are diferent limit models depending on the segment: • Large corporate groups: we use a pre-classifcation model based on a system for measuring and monitoring economic capital. The result is the level of risk that the Group is willing to assume with a customer/group, in terms of Capital at risk, nominal CAP, and maximum periods according to the type of transaction (in the case of fnancial entities, limits are managed through Credit equivalent risk (CER). It includes the actual and expected risk with a customer based on its usual transactions, always within the limits defned in the risk appetite and established credit policies. • Corporates and institutions that meet certain requirements (deep knowledge, rating, etc.): we use a more simplifed pre- classifcation model through an internal limit that establishes a reference point in the level of risk to be assumed with the customer. The criteria will include, among others, repayment capacity, debt in the system and the banking pool distribution. In both cases, transactions over certain thresholds or with specifc characteristics might require the approval of a senior analyst or committee. • For individual customers and SMEs with low turnover, large volumes of credit transactions can be managed more easily with the use of automatic decision models for classifying the customer/ transaction binomial. In specifc situations where a series of requirements are met, pre-approved transactions are granted to customers or potential customers (campaigns). Mitigation actions As a general rule, from a risk admission point of view, the concession criteria are linked to the payment capacity of the borrower to comply with the total of the assumed fnancial obligations – this does not imply an impediment to requiring a higher level of real or personal guarantees. The payment capacity will be evaluated based on the funds or net cash fows from the customer´s businesses or usual sources of income, without depending on guarantors or assets given as collateral. Such guarantors or assets should always be considered, when evaluating the approval of the transaction, as a second and exceptional way of recovery in case the frst has failed. In general, a guarantee is defned as a reinforcement measure added to a credit transaction for the purpose of mitigating the loss due to a breach of the payment obligation. Mitigation techniques implementation follow the minimum requirements established in the Guarantee management policy: legal certainty (possibility of legally requiring the settlement of guarantees at all times), the lack of substantial positive correlation between the counterparty and the value of the collateral, the correct documentation of all guarantees, the availability of documentation for the methodologies used for each mitigation technique and appropriate monitoring, traceability and regular control of the goods/assets used for the guarantee. In Santander we apply several credit risk mitigation techniques on the basis, among other factors, of the type of customer and product. Some are inherent to specifc transactions (e.g. real estate guarantees) while others apply to a series of transactions (e.g. derivatives netting and collateral). The diferent mitigation techniques can be grouped into the following categories: • Personal guarantees • Guarantees from credit derivatives • Real guarantees Efective guarantees are those real and personal guarantees for which its efectiveness as a credit risk mitigant is proved and whose valuation complies with the established policies and procedures. The analysis of the efectiveness of the guarantees must take into account, among others, the necessary time for the execution and ability to enforce the guarantees. 349 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Scenario analysis As described in Scenario analysis in section 1.3 ‘Management processes and tools’, credit risk scenario analysis enables senior management to better understand the portfolio evolution in the face of market conditions and changes in the environment. It is a key tool for assessing the sufciency of capital provisions for stress scenarios. Scenario analysis is applied to all of the Group’s signifcant portfolios, usually over a 3-year horizon. The process involves the following main stages: • Defnition of benchmark scenarios, either central or most plausible scenarios (baseline), as well as less likely and more adverse economic scenarios (stress scenarios). A global stress scenario is a world crisis situation that impacts each of the countries in which the Group operates. In addition, a local stress scenario impacts in an isolated way some of the main units with a greater degree of stress than the global stress scenario. The entire process takes place within a corporate governance framework, and is adapted to the growing importance of this framework as well as market best practices, assisting the Group’s senior management in gathering knowledge for decision-making. Monitoring Monitoring business performance on a regular basis, and comparing performance against agreed plans is a key risk management activity. All customers must be monitored on an ongoing and holistic manner that enables the earliest possible detection of any incidents that may arise impacting the customer’s credit rating. Monitoring is carried out through an ongoing review of all customers, assigning a monitoring classifcation, establishing pre-defned actions associated to each classifcation and executing specifc measures (pre-defned or ad-hoc) to correct any deviations that could have a negative impact for the Group. These scenarios are defned by the Group’s Research department in coordination with each unit, using fgures published by leading international institutions as a benchmark. In this monitoring, the consideration of forecasts and transactions characteristics throughout its life, is assured. It also takes into consideration any variations that may have occurred in the classifcation and its adequacy in the moment of the review. All scenarios are backed by a rationale and are verifed and reviewed by all areas involved in the simulation process. Monitoring is carried out by local and global Risk teams, supplemented by Internal Audit. It is based on customer segmentation: • Determination of risk parameters value (probability of default, loss given default, etc.) for the scenarios defned. These parameters are established using internally developed statistical-econometric models, based on default and historical losses, in relation to historical data for macroeconomic variables taking into consideration a complete economic cycle. The forecasting models follow the same development, validation and governance cycles as other internal models of the Group. They are subject to regular backtesting and recalibration to ensure they correctly capture the relationship between macroeconomic variables and the risk parameters. • Adaptation of the projection methodology to IFRS9, with an • In the SCIB segment, monitoring, in the frst instance, is a direct function of both the commercial manager and the risk analyst, who maintain the direct relationship with the customer and manage the portfolio. This function allows that an up-to- date view of the customers’ credit quality is always available and allows anticipating situations of concern and taking the necessary actions. • In the commercial banking, institutions and SMEs with an analyst assigned, the function consists in identifying and tracking customers whose situations require closer monitoring, reviewing ratings and continuously analysing indicators. impact on the estimation of the expected loss in each of the IFRS9 stages, associated with each of the scenarios put forward, as well as with other important credit risk metrics deriving from the parameters obtained (non-performing loans, provisions, allowances, etc.). • In the individual customers, businesses and SMEs with low turnover segments monitoring is carried out through automatic alerts for the main indicators, in order to detect shifts in the performance of the loan portfolio with respect to the forecasts in strategic plans. • Analysis and rationale for the credit risk profle evolution at portfolio, segment, unit and Group levels, in diferent scenarios and compared to previous years. • Integration of management indicators to supplement the analysis of the impact caused by macroeconomic factors on risk metrics. • Likewise, the process is completed with a set of controls and backtesting that ensure the adequacy of metrics and calculations. During 2018, the Group’s Customer watch list policy was replaced with a new Santander customer assessment note monitoring system (SCAN) that will be implemented in the Group’s units during 2019. The Group’s SCAN system aims to establish the level of monitoring, policies and specifc actions for all customers with individualised treatment, based on their credit quality and their particular circumstances. Each customer is assigned a level of monitoring, and specifc risk management actions, in a dynamic manner, with a specifc manager and an established periodicity. 350 2018 Annual Report In addition to customers’ credit quality monitoring, Santander establishes the control procedures needed to analyse portfolios and their performance, as well as possible deviations regarding planning or approved alert levels. The function establishes as main axes, the control by countries, business areas, management models, products, among others, facilitating early detection of specifc attention points, as well as preparing action plans to correct any deteriorations. Portfolio analysis permanently and systematically controls the evolution of credit risk with regard to budgets, limits and benchmark standards, assessing the impacts of future situations, both exogenous and resulting from strategic decisions, to establish measures to bring the risk portfolio profle and volumes within the parameters set by the Group and in line with its risk appetite. Recovery and collections management Recovery activity is a signifcant element in the Group’s risk management. This function is carried out by the Recoveries area, which defnes a global strategy and an enterprise-wide focus for recovery management. The Group has a corporate recovery management model that sets the guidelines and general lines of action to be applied in the diferent countries, taking always into account the local particularities that the recovery activity requires, such as economic environment, business model or a mixture of both. Recovery has been aligned with the socio-economic reality of the Group’s countries and diferent risk management mechanisms are used with adequate prudential criteria considering unpaid debt conditions. The Recoveries area directly manage customers, where sustained value creation is based on efective and efcient collection management. The new digital channels are becoming increasingly important in recovery management, developing new forms of customer relations. The diverse features of Santander´s customers make segmentation necessary in order to manage recoveries adequately. Mass management of large groups of customers with similar profles and products is conducted through processes with a high technological and digital component, while personalised management focuses on customers who, because of their profle, require a specifc manager and more customised management. Recovery management is divided into four phases: in arrears, non-performing loans recoveries, write-ofs recoveries and management of foreclosed assets. The management scope for the recovery function includes non- productive assets (NPAs), corresponding to the forborne portfolios, NPLs, write-of loans and foreclosed assets, where the Group may use mechanisms to rapidly reduce these assets, such as portfolios or foreclosed assets sales. Therefore, the Group is constantly seeking alternative solutions to juridical processes for collecting debt. In the write-of loans category, debt instruments are included, whether due or not, for which, after an individualised analysis, their recovery is considered remote due to a notorious and unrecoverable impairment of the solvency of the transaction or the holder. Classifcation in this category involves full or partial cancellation of the gross carrying amount of the loan and it’s derecognition, which does not mean that the Group interrupts negotiations and legal proceedings to recover its amount. The Group employs specifc policies for recovery management that include the principles of the diferent recovery strategies, while always ensuring the required rating and provisions are maintained and these policies have been updated with IFRS9 implementation, where the most signifcant change relates to the classifcation of transactions and the provisions calculation. In countries with a high exposure to real estate risk, the Group has efcient sales management instruments that enable to maximise the recovery and reduce balance sheet stock. Forborne portfolio The Group has an internal Forbearance policy which acts as a reference for the diferent local transpositions of all its subsidiaries and shares the principles established by the regulation and the applicable supervisory expectations. This policy includes the requirements arising from the implementation of IFRS9. This policy defnes forbearance as the modifcation of the payment conditions of a transaction to allow a customer who is experiencing fnancial difculties (current or foreseeable), to fulfl their payment obligations. If the modifcation was not made, it would be reasonably certain that the customer would not be able to meet their fnancial obligations. The modifcation could be made to the original transaction or through a new transaction replacing the previous one. In addition, this policy also sets down rigorous criteria for the evaluation, classifcation and monitoring of such transactions, ensuring the strictest possible care and diligence in their granting and monitoring. Therefore, the forborne transaction must be focused on recovery of the amounts due and the payment obligations must be adapted to the customer’s actual situation and, in addition losses must be recognised as soon as possible if any amounts are deemed irrecoverable. Forbearances may never be used to delay the immediate recognition of losses or to hinder the appropriate recognition of risk of default. Further, the policy defnes the classifcation criteria for the forborne transactions in order to ensure that the risks are suitably recognised, bearing in mind that they must remain classifed as non-performing or in watch-list for a prudential period of time (aligned with Regulation EU 680/2014) to attain reasonable certainty that repayment capacity can be recovered. 351 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management 2018 general performance Risk is diversifed among the main regions where the Group operates: Continental Europe (45%), United Kingdom (27%), Latin America (18%) and the United States (10%), with an adequate balance between mature and emerging markets. The evolution up to December 2018, credit risk with customers increased by 4% vs. 2017, considering the same perimeter, mainly due to the United States, United Kingdom, and Mexico. Growth in local currency was generalised across all units with the exception of Spain and Portugal. These levels of lending, together with lower non-performing loans (NPLs) of EUR 35,692 million (-5.1% vs. 2017) reduced the Group’s NPL ratio to 3.73% (-35 bp against 2017). In order to cover potential losses arising from these NPLs, in accordance with the new provision calculation in accordance with IFRS9, the Group recorded allowances for loan loss of EUR 8,873 million (-2.6% vs. December 2017), after deducting post write-of recoveries. This decrease is materialised in a reduction of the cost of credit to 1.00 % (7 bp less than the previous year). Total loan-loss allowances were EUR 24,061 million, bringing the Group’s coverage ratio to 67%, taking into consideration that 62% of the Group net customer loans are secured. It is important to bear in mind that the coverage ratio is afected downwards by the weight of mortgage portfolios (particularly in the UK and Spain), as lower provisions are required due to the existing collateral, which mitigates potential losses. The forborne portfolio stood at EUR 41,234 million at the end of December. In terms of credit quality, 49% is classifed as non- performing loans, with average coverage of 53% (26% of the total portfolio). Key fgures of forborne portfolio EUR million Performing Non-performing Total Forborne % CoverageA 2018 2017 2016 20,877 27,661 29,771 20,357 20,044 18,689 41,234 47,705 48,460 26% 24% 23% A. Total loan-loss allowances/total forborne portfolio. Regarding its evolution, the Group’s forborne portfolio decreased by 13.6% in 2018, in line with the trend of previous years. 3.3 Key metrics Changes in perimeter Banco Popular On 7 June 2017, the Group acquired Banco Popular (Popular) and its results and balance sheet were disclosed in the Banco Popular unit. In this chapter, Popular results and balance sheets, both from 2017 and 2018, are allocated to the diferent geographical areas of the Group (unless stated otherwise), mainly Spain, Portugal and Spain real estate activity. Deutsche Bank Polska In Poland, a country with one of the highest growth rates in Europe, we have concluded the acquisition of Deutsche Bank Polska retail portfolio (of approximately EUR 4,500 million), thus reinforcing our position as one of the main banks in the country. 352 2018 Annual Report The tables below show the main metrics performance related to credit risk derived from our activity with customers: Main credit risk performance metrics from our activity with customers Dec. 2018 data Credit risk with customersA (EUR million) Non-performing loans (EUR million) NPL ratio (%) Continental Europe 42 9,454 424,248 331,706 2 2,537 24,674 19,638 2018 2017 2016 2018 2017 2016 Spain 2 39,479 251,433 172,974 14,833 15,880 Santander Consumer Finance 97,922 92,589 88,061 Portugal Poland UK 3 8,340 39,394 30,540 30,783 24,391 21,902 2 62,196 247,625 255,049 Latin America 17 1,898 167,516 173,150 2,244 2,279 1,317 2,755 7,461 4,418 822 2,319 2,959 1,114 3,295 7,464 4,391 779 9,361 2,357 2,691 1,187 3,585 8,333 5,286 819 84,212 83,076 89,572 33,764 28,939 29,682 41,268 40,406 40,864 1,925 2,004 2,064 5,631 8,085 7,318 179 202 109 92,152 77,190 91,709 2,688 2,156 2,088 51,049 44,237 54,040 26,424 24,079 28,590 450 2,043 536 1,410 717 1,097 Brazil Mexico Chile Argentina US SBNA SC USA Total Group 9 58,153 920,968 855,510 3 5,692 37,596 33,643 2018 5.25 6.19 2.29 5.94 4.28 1.05 4.34 5.25 2.43 4.66 3.17 2.92 0.88 7.73 3.73 2017 5.82 6.32 2.50 7.51 4.57 1.33 4.46 5.29 2.69 4.96 2.50 2.79 1.21 5.86 4.08 Continental Europe Spain Santander Consumer Finance Portugal Poland UK Latin America Brazil Mexico Chile Argentina US SBNA SC USA Total Group Coverage ratio (%) Net ASRB provisions (EUR million) Cost of credit (%/risk)C 2018 52.2 45.0 106.4 50.5 67.1 33.0 97.3 106.9 119.7 60.6 135.0 142.8 122.1 154.6 67.4 2017 54.4 46.8 101.4 62.1 68.2 32.0 85.0 92.6 97.5 58.2 2016 60.0 48.3 109.1 63.7 61.0 32.9 87.3 93.1 103.8 59.1 100.1 142.3 2018 1 ,399 728 360 32 161 173 4 ,567 2 ,963 830 473 231 2017 1,109 603 266 12 137 205 4,972 3,395 905 462 159 2016 1,342 585 387 54 145 58 4,911 3,377 832 514 107 170.2 214.4 2 ,618 2,780 3,208 102.2 212.9 65.2 99.6 328.0 73.8 108 2,501 8 ,873 116 2,590 9,111 120 2,992 9,518 2018 0 .36 0 .33 0 .38 0 .09 0 .65 0 .07 2 .95 4 .06 2.75 1.19 3 .45 3 .27 0 .24 10 .01 1 .00 2017 0.31 0.30 0.30 0.04 0.62 0.08 3.15 4.36 3.08 1.21 1.85 3.42 0.25 9.84 1.07 A. Includes gross loans and advances to customers, guarantees and documentary credits. B. Recovered write-of assets (EUR 1,558 million). C. Cost of credit = loan-loss provisions twelve months/average lending. 2016 5.92 5.41 2.68 8.81 5.42 1.41 4.81 5.90 2.76 5.05 1.49 2.28 1.33 3.84 3.93 2016 0.44 0.37 0.47 0.18 0.70 0.02 3.37 4.89 2.86 1.43 1.72 3.68 0.23 10.72 1.18 353 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Key fgures reconciliation The 2018 consolidated fnancial statements details the customer loans portfolio, both gross and net of funds. Credit risk also includes of-balance sheet risk. The following table shows the relation between the concepts that comprise these fgures: EUR million GROSS CREDIT RISK WITH CUSTOMERSA 958,153 Breakdown Lending (loans and advances to customers) 906,215 Contingent liabilities 51,938 SECTION ON CREDIT RISK LENDING (LOANS AND ADVANCES TO CUSTOMERS) LOANS AND ADVANCES TO CUSTOMERS (GROSS) 906,215 906,228B +13 Other Lending 880,628 Held for trading portfolio 202 Fair value 25,398 BALANCE SHEET ITEMS FROM CONSOLDIATED FINANCIAL STATEMENTS Allowances -23,307 Asset: lending: loans and advances to customers 857,321 202 25,398 LOANS AND ADVANCES TO CUSTOMERS (NET) 882,921 A. Includes gross loans and advances to customers, guarantees and documentary credits. B. Before loan-loss allowances. Geographical distribution and segmentation The Group’s risk function is organised on the basis of three types of customers: • Individuals: includes all individuals, except those with a business activity. This segment is, in turn, divided into sub-segments by income levels, which enables risk management by customer type. Mortgages to individuals represent approximately 36% of the Group net customer loans. These mortgages are focused in Spain and the UK, and are mainly residential mortgages with a low risk profle, low non-performing ratios and an appropriate coverage ratio. This low risk profle produces low related losses. • SMEs, commercial banking and institutions: includes companies and individuals with business activity. It also includes public sector activities in general and private sector non-proft entities. 29% 354 • Santander Corporate & Investment Banking (SCIB): consists of corporate customers, fnancial institutions and sovereigns, comprising a closed list that is revised annually. This list is determined based on a full analysis of the company (business type, level of geographic diversifcation, product types, volume of revenues it represents for the Group, etc.). The following chart shows the distribution of credit risk on the basis of its management model (includes gross loans and advances to customers, guarantees and documentary credits): Credit risk distribution 15% 56% 85% retail and commercial banking Individuals SMEs, commercial banking and institutions SCIB 2018 Annual Report Taking into consideration the aforementioned segmentation, the geographical distribution and situation of the portfolios is shown in the following charts: EUR million Total 21% 25% 10% 4% 4% TOTAL 958,153 9% 27% Individuals 24% 15% 8% TOTAL 533,552 9% 4% 4% 922,461 883,372 821,867 Performing Non-performing loans 35,692 37,596 33,643 2018 2017 2016 516,309 510,951 469,450 Spain Brazil UK Portugal Chile US Other Spain Brazil UK Portugal Chile US Other 36% Performing Non-performing loans 17,243 18,103 13,732 2018 2017A 2016 SMEs, Commercial Banking and Institutions 13% 40% TOTAL 278,847 18% 8% 10% 6% 5% SCIB 24% 32% TOTAL 145,744 11% 2% 2% 14% 15% Spain Brazil UK Portugal Chile US Other Spain Brazil UK Portugal Chile US Other 262,272 244,749 228,303 Performing Non-performing loans 16,575 17,025 17,304 2018 2017A 2016 143,870 127,672 124,113 Performing Non-performing loans 1,874 2,468 2,607 2018 2017A 2016 A. Proxies applied for 2017 data. 355 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management The key fgures by geographical area are commented below: • In the United States4 the NPL ratio stood at 2.92% (+13% in the year) with the coverage ratio remaining at high levels, at 143%. • Continental Europe • In Spain1, the NPL ratio dropped to 6.19% (-13 bp compared to 2017), due mainly to the better performance of the portfolio, the normalisation of several restructured positions and portfolio sales. • In Portugal, recoveries and distressed portfolio sales allowed for the reduction of the non-performing loans, placing the NPL ratio at 5.94% (-157 bp vs. 2017). • In Poland, the downward trend of the NPL ratio continued, placing it at 4.28% (-29 bp vs. 2017), thanks to a proactive management of the non-performing portfolio through portfolio sales, as well as the incorporation of the new retail portfolio from Deutsche Bank. • In Santander Consumer the NPL ratio was 2.29% (-21 bp in the year), due to good overall performance of the portfolios in general, across all its geographies. • United Kingdom2 reduced its NPL ratio, standing at 1.05% (-28 bp in the year) due to the good performance of all segments in general, as well as the single names management in the Corporates portfolio. The coverage ratio remained stable at 33%, thanks to the signifcance proportion of secured loans with real guarantees. • Latin America: • Brazil3, thanks to the robustness of its risk management model, as well as the proactive policies applied in the retail portfolios, the NPL ratio decreased to 5.25% (-4 bp compared to the end of 2017). The coverage ratio was 107% (+14 pp in the year), due to the implementation of IFRS9. • Chile reduced its NPL ratio to 4.66% (-30 bp in the year) thanks to the good performance in non-performing loans, mainly in individuals, together with a signifcant growth in exposure that benefted from the country’s favourable macroeconomic situation refected in the country’s main indicators. • In Mexico the NPL ratio fell to 2.43% (-26 bp in the year), mainly due to the normalisation of the Individuals segment performance. • In Argentina the NPL ratio increased up to 3.17% (+67 bp in the year) due to the difcult economic situation of the country, which is afecting especially the Individuals segment. An action plan is already in place begin to show positive results. The coverage ratio improves to 135% due to provisions increases made in certain economic groups as a preventive measure against the country´s macroeconomic deterioration. • At Santander Bank N.A. the NPL ratio was 0.88% (-33 bp in the year), due to the proactive management of certain exposures, the favourable evolution of the macroeconomic environment, is refected in the credit risk profle improvement of the corporates portfolio and the good performance of the individual portfolio. • In SC USA the NPL ratio was 7.73%, mainly due to the maturity of those loans that were forborne in 2017 which included the support to customers afected by hurricane season. Amounts past due (performing loans) Amounts past due by three months or less represented 0.34% of total credit risk with customers. The following table shows the structure at 31 December 2018, classifed on the basis of the frst maturity: Amounts past due. Maturity detail EUR million Loans and advances to credit institutions Loans and advances to customers Public administrations Other private sector Debt instruments TOTAL Less than 1 month 1 to 2 2 to 3 months months 14 1 - 2,023 5 2,018 - 2,037 629 - 629 - 630 617 - 617 - 617 Impairment of fnancial assets The main change in determining the fnancial assets hedge due to their impairment is that the new accounting standard, IFRS9, introduces the concept of expected loss compared to the previous model of incurred loss. The IFRS9 impairment model applies to fnancial assets valued at amortised cost, debt instruments valued at fair value with changes reported in other comprehensive income, lease receivables, and commitments and guarantees given not valued at fair value. The portfolio of fnancial instruments subject to IFRS9 is divided into three categories, or stages, depending on the status of each instrument in relation to its level of credit risk. • Stage 1: fnancial instruments for which no signifcant increase in risk is identifed since its initial recognition. In this case, the impairment provision refects expected credit losses arising from defaults over the following twelve months from the reporting date. • Stage 2: if there has been a signifcant increase in risk since the date of initial recognition but the impairment event has not 1. Does not include real estate activity. Further information is available in section 3.4 ‘Detail of main geographies’ - Spain. 2. More information available in section 3.4 ‘Detail of main geographies’ - United Kingdom. 3. More information available in section 3.4 ‘Detail of main geographies’ - Brazil. 4. More information available in section 3.4 ‘Detail of main geographies’ - United States. 356 2018 Annual Report14,833 227,419 Allowances evolution according to constituent item materialised, the fnancial instrument is classifed as Stage 2. In this case, the impairment provision refects the expected losses from defaults over the residual life of the fnancial instrument 2016 - 2018 NPL evolution NPL (start of period) 37,094 33,643 37 ,596 2016 2017 2018 • Stage 3: a fnancial instrument is catalogued in this stage when Stage 3 it shows efective signs of impairment as a result of one or more events that have already occurred resulting in a loss. In this case, the amount of the impairment provision refects the expected losses for credit risk over the expected residual life of the fnancial instrument. The following table shows the credit risk exposure by each of these stages exposure by geography: Exposure by stage and by geography EUR million Stage 1 Stage 2 Stage 3 TotalA Continental Europe 373,675 20,877 22,529 417,082 Spain SCF Portugal Poland UK Latin America Brazil Mexico Chile Argentina US SBNA SC USA 199,457 90,878 34,086 28,187 243,419 154,387 74,184 31,371 37,085 5,072 73,719 47,394 17,903 13,128 4,715 1,974 1,060 12,958 9,523 5,472 1,184 2,259 381 9,927 3,021 6,470 2,241 2,279 1,312 2,755 7,461 4,418 822 1,925 179 97,833 38,340 30,559 259,132 171,370 84,074 33,378 41,268 5,631 2,684 86,330 450 50,866 2,043 26,417 Total Group 845,200 53,285 35,670 934,155 A. Excluding EUR 23,998 million from balance not subject to impairment accounting. In addition, the amount due to the impairment provision refects the expected credit risk losses over the expected residual life in those fnancial instruments Purchased or Originated Credit Impaired (POCI). The evolution of the fnancial instruments with efective signs of impairment (stage 3) are shown below: Non-performing loans evolution according to constituent item NPL not subject to impairment accounting Net entries Perimeter FX and others Write-of - - 7,362 734 1,211 - - 3 7,571 25 8,269 10 ,910 10,032 (826) 177 (318) (12,758) (13,522) (12 ,673) NPL (end of period) 33,643 37,596 35 ,692 Stage 3 NPL not subject to impairment accounting - - - - 35 ,670 22 EUR million 10,300 121 1,784 (12,673) For other assets 8,070 For impaired assets 16,459 Stage 1 and 2 8,913 Stage 3 15,148 Allowances 2017 Provision for other assets Gross provision for impaired assets and write-downs FX and other Write-of Allowances 2018 2016 - 2018 allowances evolution 2016 2017 2018 Allowances (start of period) 27,121 24,835 24,529 For impaired assets For other assets Gross provision for impaired assets and write-downs Provision for other assets FX and other Write-of 17,706 15,466 16,459 9,414 9,369 8,070 11,045 11,607 10,300 52 (625) (881) 2,490 121 1,784 (12,758) (13,522) (12,673) EUR million 37,596 10,910 (141) (12,673) Allowances (end of period) 24,835 24,529 24,061 35,692 Stage 1 and 2 Stage 3 - - - - 8,913 15,148 NPL 2017 Net entries Perimeter and FX Write-of NPL 2018A A. Includes EUR 22 million of NPL not subject to impairment accounting. 357 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management The methodology required for the quantifcation of expected loss due to credit events will be based on an unbiased and weighted consideration of the occurrence of up to fve possible future scenarios that could impact the collection of contractual cash fows, taking into account the time-value of money, all available information relevant to past events, and current conditions and projections of macroeconomic factors deemed relevant to the estimation of this amount (e.g. GDP, house pricing, unemployment rate, etc.). In estimating the parameters used for impairment provisions calculation (EAD, PD, LGD and discount rate), the Group leverages its experience in developing internal models for calculating parameters for regulatory and internal management purposes. The Group is aware of the diferences between such models and regulatory requirements for provisions. As a result, it has focused on adapting the development of its IFRS9 impairment provisions models to such requirements. • Determination of signifcant increase in risk: for the purpose of determining whether a fnancial instrument has increased its credit risk since initial recognition, proceeding with its classifcation into stage 2, the Group considers the following criteria: • Quantitative criteria: changes in the risk of a default occurring through the expected life of the fnancial instrument are analysed and quantifed with respect to its credit level in its initial recognition. For the purpose of determining if such changes are considered as signifcant, with the consequent classifcation into stage 2, each unit has defned the quantitative thresholds to consider in each of its portfolios taking into account corporate guidelines and ensuring a consistent interpretation across all geographies. • Use of present, past and future information: estimation of expected losses requires a high component of expert judgement and it must be supported by past, present and future information. Therefore, these expected loss estimates take into consideration multiple macroeconomic scenarios for which the probability is measured considering past events, current situation and future trends and macroeconomic indicators, such as GDP or unemployment rate. The Group already uses forward looking information in internal management and regulatory processes, incorporating several scenarios. In this sense, the Group has leveraged its experience in the management of such information, maintaining consistency with the information used in the other processes. • Expected life of the fnancial instrument: with the purpose of its estimation all the contractual terms have been taken into account (e.g. prepayments, duration, purchase options, etc.), being the contractual period (including extension options) the maximum period considered to measure the expected credit losses. In the case of fnancial instruments with an uncertain maturity period and a component of undrawn commitment (e.g. credit cards), expected life is estimated considering the period for which the entity is exposed to credit risk and the efectiveness of management practices mitigates such exposure. • Impairment recognition: the main change with respect to the current standard related to assets measured at fair value with changes recognised through other comprehensive income. The portion of the changes in fair value due to expected credit losses will be recorded at the current proft and loss account while the rest will be recorded in other comprehensive income. 3.4 Detail of main geographies • Qualitative criteria: in addition to the quantitative criteria United Kingdom mentioned above, the Group considers several indicators that are aligned with those used in ordinary credit risk management (e.g. over 30 days past due, forbearances, etc.). Each unit has defned these qualitative criteria for each of its portfolios, according to its particularities and policies that are currently in force. The use of these qualitative criteria is complemented with the application of expert judgement. • Default defnition: the defnition considered for impairment provisioning purposes is consistent with that used in the development of advanced models for regulatory capital requirements calculations. The Group is currently working to adapt the defnition of default under new standard (EBA Guidelines on the application of the defnition of default under Article 178 of the CRR), according to the scheduled plan. Portfolio overview Credit risk with customers in the UK amounted to EUR 262,196 million as of December 2018, which means an increase, of 6% compared to year-end 2017 (increase of 7% in local currency), and representing 27% of the Group’s total loans portfolio. The NPL ratio fell to 1.05% at the end of December (-28 bp compared to year-end 2017), thanks to the good macroeconomic environment and the application of prudent policies, within the risk appetite framework. Therefore, the amount of non-performing loans decreased by 16%, following the trend observed in previous years, thanks to the good performance of the portfolios and the management of single names in the Companies segment. 358 2018 Annual Report Santander UK portfolio is divided into the following segments: The distribution of the portfolio by type of borrower is shown in the chart below: Portfolio segmentation 10% 11% Mortgages, individuals 79% Companies Other Mortgage portfolio loan type EUR million 176,581 30,490 5% 32% 8% 34% Due to its relevance, not only for Santander UK, but also for the entire credit risk exposure of the Group, it is noteworthy the portfolio of mortgage loans to individuals, detailed below. Mortgage portfolio This portfolio at the end of December 2018 amounted to EUR 176,581 million (2.1% growth in the year). It consists of residential mortgages granted to new and existing customers, and all are frst mortgages. There are no transactions that entail second or successive liens on mortgaged properties. 44% 40% 19% 18% Stock New production Buy to let Re-mortgagers Home movers First-time buyers A. First time buyer: customers who purchase a home for the frst time. B. Home mover: customers who change houses, with or without changing the bank granting the loan. C. Remortgage: customers who switch the mortgage from another The real estate market has shown strong resilience with over 1.3% price growth in the year and a stable number of transactions. fnancial entity. D. Buy to let: houses bought for renting out. Geographically, credit exposures are predominantly concentrated in the south east area of the UK and, particularly, in the metropolitan area of London. Santander UK ofers a wide range of mortgage products that are aligned with its policies and risk limits. The characteristics of some of them are described below: Geographical concentration Dec. 18 data 11% 25% London Midlands & East Anglia North Nothern Ireland Scotland 13% South East excl. London South West, Wales & Other 31% 4% 2% 14% All properties are valued independently before each new transaction is approved, in accordance with the Group’s risk management principles. The value of the property used as collateral for mortgages that have already been granted is updated quarterly by an independent agency, using an automatic valuation system in accordance with market practices and applicable legislation. • Interest only loans (32%)5: the customer pays the interest every month and repays the capital at maturity. An appropriate repayment vehicle such as a pension plan, mutual fund, etc. is required. This is a common product in the UK market for which Santander UK applies restrictive policies in order to mitigate inherent risks. For example: a maximum loan to value (LTV) of 50%, more stringent approval criteria and assessment of payment capacity, simulating the repayment of capital and interest instead of just interest. • Flexible loans (8%): the contract for this type of loan enables the customer to modify their monthly payments or make additional drawdowns of funds up to a previously pre-established limit, under various conditions. • Buy to let (5%): buy to let mortgages (purchase of a property to rent out) account for a small percentage of the total portfolio, with approval subject to strict risk policies. In December 2017, these represented approximately 8% of total underwriting and 4% of the remaining portfolio. The good performance of the mortgage portfolio is refected in the NPL ratio, which remained moderate at 1.21% at the end of December (+8 bp regarding the previous year). Thanks to the application of prudent admission policies an afordability rate of 5. Percentage calculated for loans with total or some interest only component. 359 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management the new production is maintained at 3.24 compared to 3.16 the previous year, with a reduced volume of foreclosed properties, which in December 2018 amounted to EUR 25.2 million, 0.02% of total mortgage exposure. These policies have also allowed the simple average LTV of the portfolio to stand at 42% and the average weighted LTV at 39%. The proportion of the portfolio with LTV between 85% and 100% is at low levels, around 4%. The following charts show the LTV structure for the stock of residential mortgages as of December 2018: Loan to ValueA Credit risk by segmentA Dec. 2018 data 2018 2017 2016 Var 18/17 Total credit riskA 239,479 251,433 172,974 (4.8%) Household mortgages 60,908 62,039 46,213 (2%) Other credit for individuals 25,170 27,372 16,614 Business Portfolio 137,296 143,668 96,082 (8%) (4%) Public Administrations 16,105 18,353 14,065 (12%) A. In 2017 and 2018 B.Popular is integrated. B. Including guarantees and documentary credits. 4% 1% 9% 45% The NPL ratio for the total portfolio was 6.19%, 13 bp less than in 2017. The decrease in lending (which increased the NPL ratio by 31 bp) was ofset by the better NPL fgure (which reduced the ratio by 44 bp). This improvement was mainly due to a better performance of the credit portfolio, the cure of several restructured positions and portfolio sales. 41% <50% 50-75% 75-85% 85-100% >100% NPL and coverage ratio % A. Loan to value: relation between the amount of the loan and the 48 48 appraised value of the property. Based on indices. 47 Coverage ratio NPL 45 6.19 6.53 5.41 6.32 2015 2016 2017 2018 The more relevant portfolios are described in the following subsections. Residential mortgages Residential mortgages in Santander Spain amounted to EUR 61,453 million, representing 26% of total credit risk. 99% of which have a mortgage guarantee. The credit risk policies currently used explicitly forbid loans regarded as high risk (subprime mortgages) and establish strict requirements for credit quality, both for transactions and for customers. For example, since 2009 mortgages with a loan-to- value of more than 100% have not been allowed. Spain Portfolio overview Total credit risk (including guarantees and documentary credits) at Santander Spain (excluding the Real estate unit, which is discussed subsequently in more detail) amounted to EUR 239,479 million (25% of the Group’s total), with an adequate level of diversifcation by both product and customer segment. In a context of lower economic and credit growth, new loans continue to increase, especially in SMEs and Corporates. The total credit risk decreased by 4.8% in annual terms, mainly due to the lower fnancing to public administrations, wholesale banking and an amortisation rate even higher than the growth of new production in individuals. Within the commercial banking segment, SMEs consolidate the growth trend initiated in previous years. 360 2018 Annual Report Residential mortgagesA EUR million Gross Amount Debt to incomeA Average 28.2% Loan to valueB % 2018 2017 2016 61,453 62,571 46,858 26% 6% 10% 25% 53% Without mortgage guarantee 545 532 645 With mortgage guarantee 60,908 62,039 46,213 of which non-performing loans 2,425 2,511 1,796 Without mortgage guarantee 54 147 27 With mortgage guarantee 2,371 2,364 1,769 A. Excluding SC Spain mortgage portfolio (EUR 1,837 million in 2018 with doubtful debt of EUR 68 million). 21% DI < 30% 30% < DI < 40% DI > 40% 29% 29% LTV < 40% 40% - 60% 60% - 80% 80% - 100% > 100% The NPL ratio of mortgages granted to households to acquire a home was 3.89%, remaining at levels similar to previous years below 3.9%. A. Debt to income: relation between the annual instalments and the customer’s net income. B. Loan to value: percentage indicating the total risk/latest available house appraisal. NPL ratio, residential mortgages % 3.83 3.81 3.89 Business portfolio Credit risk assumed directly with SMEs and corporates (EUR 137,296 million) represent the main lending segment in Santander Spain (57% of the total). Most of the portfolio corresponds to customers who have been assigned an analyst to monitor them continuously throughout the risk cycle. 2016 2017 2018 The portfolio is highly diversifed, with no signifcant concentrations by activity sector. The NPL ratio for this portfolio stood at 6.36% in 2018, 49 bp lower than in 2017, due to better performance, normalisation of several restructured positions and portfolio sales. The portfolio of mortgages granted to acquire homes in Spain have characteristics that maintain its medium-low risk profle which limits the expectations of a potential additional deterioration: • Principal is repaid on all mortgages from the start. • Early repayment is common so the average life of the transaction is well below that of the contract. • High quality of collateral concentrated almost exclusively in fnancing the frst home. • Average afordability rate stood at 28%. • 83% of the portfolio has a LTV below 80%, calculated as total risk/latest available house appraisal. • All customers applying for a residential mortgage are subject to a rigorous assessment of credit risk and afordability. In evaluating the payment capacity (afordability) of a potential customer, the credit analyst must determine if the income of the customer is sufcient to meet the payment of the loan instalments taking into consideration other income that the customer may receive. In addition, the analyst must assess if the customer’s income will be stable over the term of the loan. 361 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Real estate activity The Group manages the real estate activity in Spain in a separate unit, which includes the loans from clients with activity mainly in real estate development, and who have a specialised management model, holdings in real estate companies and foreclosed assets. United States Credit risk at Santander US increased to EUR 92,1526 million at the end of December (representing 10% of the Group’s total), is made up of the following business units: In recent years the Group’s strategy has been geared towards reducing these assets, which at the end of 2018 stood at a total of 9,282 EUR billion, representing 2% of assets in Spain and less than 0.6% of Group assets. Assets decreased by 13% during 2018, with the following evolution in credit exposures and foreclosed assets (run-of): 28% 4% 3% 9% 56% Santander Bank N.A. (SBNA) Santander Consumer USA (SC USA) Santander Investment Securities (SIS) Banco Santander Puerto Rico (BSPR) Banco Santander Internacional (BSI) • Net credits amount to approximately EUR 900 million, with a 29% reduction during 2018 and with a coverage ratio of 41%. • Net real estate assets (foreclosed and rental assets) were EUR 2,617 billion, with a 9% reduction vs. 2017, and a coverage ratio of 59%. Credit and foreclosed gross exposure followed the trend begun in previous years and presents a decrease of 80% between 2008 and 2018. Additionally, the Group reached an agreement to sell properties for EUR 1,535 million. This transaction is expected to be fnalised by the frst quarter of 2019. Real estate portfolio evolution EUR million. Dec. 2018 data Gross Value Allowances Net value Foreclosed Rental assets Real estate loans 2018 9.282 4.638 4.644 2.617 1.154 873 2017 10.620 5.318 5.302 2.879 1.199 1.224 In 2018, Santander US credit lending continued to grow (+19%), after the reduction of non-core portfolios. The most signifcant increases are registered in the consumer portfolio (auto) of SBNA and SC USA, as well as in the wholesale banking business of SBNA and SIS. NPL ratio and cost of credit remain at moderate levels, 2.92% (+13 bp in the year) and 3.27% (-15 bp in the year), respectively. The performance details of Santander US main units are set out below. Santander Bank N.A. Santander Bank N.A. business is focused on retail and commercial banking (83%), of which 35% is with individuals and approximately 65% with corporates. One of the main strategic goals is to continue to enhance the wholesale banking business (17%). Lending has increased by 15% over 2018, being wholesale banking and consumer (auto) the segments with higher growth. The sale of non-core assets continues and the proportion of secured lending remains above 60%. The NPL ratio continues to decline, standing at 0.88% (-33 bp in the year) in December. This reduction is explained by a proactive management of certain exposures and the favourable macro development showed in the improvement of customer’s credit risk profle in corporates and individuals portfolios. The cost of credit remains at stable levels of 0.24% despite the increase in some segment’s coverage ratios. Non-Performing Loans Ratio (SBNA) Coverage Ratio (SBNA) Cost of credit (SBNA) % 1.17 1.33 1.21 0.88 % 114 % 122 0.23 0.25 0.24 100 102 0.13 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 6. Includes EUR 9.5 million of SH USA investment. 362 2018 Annual Report Santander Consumer USA The risk indicators for SC USA are higher than those of the other United States units and the Group, due to the nature of its business, which focuses on auto fnancing through loans and leasing (97%), seeking the optimisation of the returns associated to the risk assumed. SC USA´s lending also includes a smaller personal lending portfolio (3%). exploratory discussions cover a range of options on how to optimize the existing contract and other longer-term arrangements. While a signifcant change in the business relationship could afect SC USA’s and SH USA’s operations adversely, FCA has not delivered a notice to exercise its equity option and SC USA and FCA continue to operate under the existing arrangements. In 2018, new loan and leasing production showed growth of more than 20% and 60% regarding year-end 2017, mainly supported by the commercial relationship with the Fiat Chrysler Automobiles (FCA) group, the “Chrysler Agreement”, which dates back to 2013, maintaining the quality standards for approval. Under the Chrysler Agreement, FCA has the option to acquire, for fair market value, an equity participation in the business ofering and providing fnancial services contemplated by the Chrysler Agreement In June 2018, SC USA announced that it was in exploratory discussions with FCA regarding the future of FCA’s U.S. fnance operations after FCA had announced its intention to establish a captive U.S. auto fnance unit and indicated that acquiring SC’s FCA-related business was one option it would consider. These The NPL rate, however, increased to 7.73%, mainly due to the maturity of those loans forborne in 2017, which included the support to customers afected by hurricane season. The cost of credit, at the end of December stood at 10.01% (+17 bp in the year), due to the average investment lower growth as a result of the vintages amortisation from high production exercises (2015), partially mitigated by the increase in recoveries efciency and the positive evolution of the used car price. The coverage ratio remains at high levels, 155%. The leasing portfolio - business carried out exclusively under the FCA agreement and focused on customers with high quality credit profles- grew by 41% in the year, to EUR 13,309 million, providing stable and recurring earnings. The management and mitigation of the residual value7 remains a priority, at the end of December the mark-to-market of this vehicles stood in line with the balance sheet value. Non-performing loans ratio (SC USA) Coverage rati o (SC USA) Cost of credit (SC USA) % % % 7.73 337 328 5.86 3.66 3.84 213 155 10.97 10.72 9.84 10.01 2015 2016 2017 2018 2015 201 6 2017 2018 2015 2016 2017 2018 7. Leasing residual value: diference between the estimated residual vehicle value at the contract signature and the real vehicle value at the end of the contract. 363 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Brazil Improvement in the macro indicators with respect to the previous year, with a GDP growth owing to the increase in private consumption and frm’s investment, driven in a great measure by the reduction in interest rates (SELIC), with minimum historical levels, and the boost from exports arising from the depreciation of the Brazilian real. Additionally, expectations for the next years are optimistic, and macro indicators are expected to continue improving, with a gradual normalisation of interest rates. Credit risk in Brazil amounts to EUR 84,212 million, representing an increase of 1.4% vs. 2017 and largely due to the depreciation of the Brazilian currency, excluding the exchange rate efect, recorded growth is 13%. Santander Brazil therefore accounts for 9% of the Group’s lending. Santander Brazil is adequately diversifed and has an increasingly marked retail profle, with more than 60% of loans extended to individuals, consumer fnancing and SMEs. This increase was more pronounced in retail segments with a more conservative risk profle, within prudential framework of risk growth assumption, but at the same time boosting customer relationship and loyalty, as well as business attracted through digital channels, where an important increase has been recorded during the last year. In the individuals’ loan segment, market share has increased in proftable products. It is noteworthy the growth in payroll discount loans through the Olé Consignado brand, in addition to credit cards and the mortgage loan portfolio. At the same time, the Financiera unit has reported a stronger position than its competitors, reaching 25% of market share. In the SME segment it is noteworthy the increase of Adquirência, and to a lower extent, rural loans, which have a low risk profle. Lastly, the Corporate and SCIB portfolios, both with considerable exposures in US dollars, led more conservative growth, due to the impact of the Brazilian real deprecation against the US dollar. The leading indicators for the credit risk profle of new loans (vintages) are continuously tracked. These are shown below, confrming the Group’s resilience and prudence in risk management operates. The vintages show transactions over 30 days in arrears at three and six months respectively from their origination date, in order to anticipate any possible portfolio deterioration. This enables the Group to defne corrective actions if any deviations from expected results are detected. As it can be observed in the following chart, Over30 ratio vintages have been kept at historically low levels, in spite of the strong portfolio growth, thanks to proactive risk management as well as the appropriate measures taken to improve performance. Vintages. Over 30A ratio evolution at 3 and 6 months from each vintage % Individuals 3.9 3.2 3.1 2.7 3.9 3.7 3.3 3.5 3.5 3.1 3.0 2.7 2.7 2.7 2.6 1.5 1.6 1.2 1.3 1.9 1.6 1.8 1.6 1.4 1.3 1.4 1.3 1.2 1.1 1.2 1.3 1.4 1.3 SMEs 3.7 1.9 3.0 1.5 2.5 1.4 2.1 2.1 2.1 1.8 1.0 1.1 1.0 1.0 2.9 1.4 2.3 2.4 2.2 2.5 2.4 1.0 1.1 1.1 1.3 1.3 2.0 1.2 2.4 1.1 1.0 1.2 1.0 5 1 c e D 6 1 r a M 6 1 n u J 6 1 p e S 6 1 c e D 7 1 r a M 7 1 n u J 7 1 p e S 7 1 c e D 8 1 n a J 8 1 b e F 8 1 r a M 8 1 r p A 8 1 y a M 8 1 n u J 8 1 l u J 8 1 g u A 8 1 p e S 5 1 c e D 6 1 r a M 6 1 n u J 6 1 p e S 6 1 c e D 7 1 r a M 7 1 n u J 7 1 p e S 7 1 c e D 8 1 n a J 8 1 b e F 8 1 r a M 8 1 r p A 8 1 y a M 8 1 n u J 8 1 l u J 8 1 g u A 8 1 p e S A. Ratio calculated as the total value of loans more than 30 days in arrears in the payment over the total vintage amount. B. Months on Book. Over30 Mob6B Over30 Mob3B 364 2018 Annual Report The NPL ratio stood at 5.25% as of December 2018 (-4 bp compared to the year-end of 2017). This good performance was due to the preventive risk management of the portfolio, the normalisation of the corporates and SCIB portfolios, and due to a solid growth in proftable segments. Santander Brazil, thanks to a solid culture and advanced risk management, continues improving its credit metrics. Its impairment rate on the lending portfolio, known locally as ‘Over 90 ratio’, stood at 3.1% in December 2018 (-0.1 pp vs. year-end 2017), below the average for private Brazilian banks. Over 90 ratio total 4.09% 3.88% 2.91% 3.20% 3.10% 2.90% 4 1 Q 2 4 1 Q 3 4 1 Q 4 5 1 Q 1 5 1 Q 2 5 1 Q 3 5 1 Q 4 6 1 Q 1 6 1 Q 2 6 1 Q 3 6 1 Q 4 7 1 Q 1 7 1 Q 2 7 1 Q 3 7 1 Q 4 8 1 Q 1 8 1 Q 2 8 1 Q 3 8 1 Q 4 Santander System Private Banking In general terms, and taking into account the evolution of recent years, the downward trend in the cost of credit continues, which stands at 4.06% at the end of December (-30 bp compared to the end of 2017), thanks to the proactive risk management, the improvements applied in the rating models in the SME portfolio, and the good overall performance in all portfolios. The coverage ratio stands at 107% (+14 pp vs. end of 2017), due to the implementation of IFRS9, which is comfortable level. Non-performing loans ratio Coverage ratio % % Cost of credit % 5.98 5.90 5.05 5.29 5.25 95 107 93 93 84 4.84 4.89 4.50 4.36 4.06 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 365 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management 3.5 Other credit risk aspects Credit risk by activity in the fnancial markets This section covers credit risk generated in treasury activities with customers, mainly with credit institutions. Transactions are undertaken through money market fnancial products with diferent fnancial institutions and through counterparty risk products which serve the Group’s customer’s needs. According to regulation (EU) 575/2013, counterparty credit risk is the risk that a client in a transaction could default before the defnitive settlement of the cash fows of the transaction. It includes the following types of transactions: derivative instruments, transactions with repurchase commitment, stock and commodities lending, transactions with deferred settlement and fnancing of guarantees. There are two methodologies for measuring this exposure: (i) mark-to-market (MtM) methodology (replacement value of derivatives) plus potential future exposure (add-on) and (ii) the calculation of exposure using Montecarlo simulation for some countries and products. The capital at risk or unexpected loss is also calculated, i.e. the loss which, once the expected loss has been subtracted, constitutes the economic capital, net of guarantees and recoveries. After markets close, exposures are re-calculated by adjusting all transactions to their new time frame, adjusting the potential future exposure and applying mitigation measures (netting, collateral, etc.), so that the exposures can be controlled directly against the limits approved by senior management. Risk control is performed through an integrated system and in real time, enabling the exposure limit available with any counterparty, product and maturity and in any of Santander’s subsidiaries to be known at any time. Exposures in counterparty risk: over the counter (OTC) transactions and organised markets (OM) As of December 2018, total exposure on the basis of management criteria in terms of positive market value after applying netting agreements and collateral for counterparty risk activities was EUR 14,699 million (net exposure of EUR 33,500 million). Counterparty risk: exposure in terms of market value and credit risk equivalent, including mitigation efectA EUR million 2018 2017 2016 Market value, netting efectB 29,626 31,162 34,998 Collateral received 14,927 16,293 18,164 Market value with netting efect and collateralC Netting efectD 14,699 14,869 16,834 33,500 32,876 44,554 A. Figures under internal risk management criteria. Listed derivatives have a market value of zero. No collateral is received for these types of transactions. B. Market value used to include the efects of mitigation agreements so as to calculate exposure for counterparty risk. C. Considering the mitigation of netting agreements and having deducted the collateral received. D. CRE (credit risk equivalent): net value of replacement plus the maximum potential value, minus collateral received. In the following table the distribution is shown, both in nominal and market value terms, of the Group’s diferent products that generate counterparty credit risk. This risk, is mainly concentrated in interest and exchange rate hedging instruments: 366 2018 Annual Report Counterparty risk: Distribution by nominal risk and gross market valueA EUR million 2018 2017 2016 Nominal Market value Nominal Market value Nominal Market value Positive Negative Positive Negative Positive Negative CDS protection boughtB CDS protection sold Total credit derivatives Equity forwards Equity options Spot equities Equity swaps Equities - ETF 13,498 8,966 22,464 1,080 15,695 240 7 123 130 256 467 - (187) (5) (192) (43) (443) - 18,134 12,097 30,231 733 36 266 302 4 (95) - 23,323 19,032 (95) 42,355 - 133 10,572 770 (2,841) 15,154 - - - 13,937 1,329 (227) 25,264 859 (554) 32,090 899 (1,127) 26,088 - - Total equity derivatives 63,042 2,951 (1,840) 62,657 1,633 (3,395) Fixed income forwards 6,766 110 (45) 8,660 89 (13) Fixed income options Spot fxed income Fixed income - ETF 3,161 - - 11 - Total fxed income derivatives 9,927 121 (14) - (59) - - - - - - - - - 83 339 422 48 448 - 631 - (383) (33) (416) - (426) - (461) - 1,127 (888) 37 (83) 5 5 - (2) (2) - 234 15,388 36,512 67,421 6,357 483 5,159 349 8,660 89 (13) 12,348 48 (88) Spot and term exchange rates 167,729 2,854 (2,461) 128,914 2,604 (3,870) 150,095 3,250 (6,588) Exchange rate options 46,288 296 (707) 37,140 Other exchange rate derivatives 719 9 (12) 963 256 23 (343) (17) 31,362 606 479 7 (624) (27) Exchange rate swaps 562,719 18,584 (16,918) 488,671 18,264 (15,892) 510,405 25,753 (24,175) Exchange rate - organised markets 4,186 - - 1,404 - - 824 - - Total exchange rate derivatives 781,641 21,743 (20,098) 657,092 21,147 (20,122) 693,292 29,489 (31,413) Asset swaps Call money swaps Interest rate structures 8,607 1,196 (1,475) 22,736 1,194 (817) 22,948 1,178 (758) 878,103 81,336 4,563 4,785 (5,708) 4,180 (4,477) 376,596 2,544 (2,301) 223,005 2,006 (1,581) 977 23 (594) 7,406 2,321 (39) 370,433 41 (593) (106) Forward rate agreements - FRAs 308,111 29 (28) 190,476 IRS 3,507,802 73,597 (73,237) 3,219,369 71,346 (75,391) 3,182,305 92,268 (92,873) Other interest rate derivatives 143,029 1,906 (1,484) 185,925 2,816 (2,113) 210,061 3,762 (2,985) Interest rate - ETF 73,418 3 (2) 127,288 - - 117,080 - - Total interest rate derivatives 5,000,406 86,079 (86,411) 4,126,570 78,900 (81,255) 4,133,238 101,576 (98,896) Commodities Commodities - ETF Total commodity derivatives - 2 2 - - - - - - 221 124 345 - - - - - - 539 47 586 108 - 108 (5) - (5) Total OTC derivatives 5,767,787 110,123 (107,471) 4,730,651 102,071 (104,880) 4,794,429 132,770 (131,706) Total derivatives organised marketsC Repos 109,695 902 (1,129) 154,904 - - 154,812 - - 149,006 2,352 (2,466) 165,082 2,322 (2,363) 122,035 2,374 (2,435) Securities lending 43,675 12,425 (22,272) 54,923 15,469 (16,580) 33,547 9,449 (4,124) Total counterparty risk 6,070,163 125,802 (133,338) 5,105,560 119,862 (123,823) 5,104,823 144,593 (138,265) A. Figures under internal risk management criteria. B. Credit derivatives acquired including hedging of loans. C. Refers to transactions involving listed derivatives (proprietary portfolio). Listed derivatives have a market value of zero. No collateral is received for these types of transactions. 367 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management The Group’s derivatives transactions focus on terms of less than fve years, repos and securities loans maturing in less than one year, as the following chart shows: Counterparty risk: Distribution of nominal by maturityA EUR millio. Dec. 2018 data Credit derivativesB Equity derivatives Fixed income derivatives Exchange rate derivatives Interest rate derivatives Commodity derivatives Total OTC derivatives Total derivatives organised marketsC Repos Securities lending Total counterparty risk Up to 1 year Up to 5 years Up to 10 years More than 10 years 35% 46% 88% 54% 31% 100% 34% 53% 92% 99% 36% 61% 46% 11% 28% 42% 0% 40% 43% 8% 1% 39% 3% 8% 1% 13% 19% 0% 18% 4% 0% 0% 17% 1% 0% 0% 5% 9% 0% 8% 0% 0% 0% 8% Total 22,464 63,042 9,927 781,641 5,000,407 2 5,767,787 109,695 149,006 43,675 6,070,163 A. Figures under internal risk management criteria. B. Credit derivatives acquired including hedging of loans. C. Refers to transactions involving listed derivatives (proprietary portfolio). Listed derivatives have a market value of zero. No collateral is received for these types of transactions. From the customer perspective, counterparty credit risk exposure is concentrated in those clients with high credit quality (90.2% counterparty risk with a rating equal or higher than A), and mainly with fnancial institutions (25%) and clearing houses (69%). Distribution of counterparty risk by customer rating (in nominal terms)A Dec. 2018 data Rating AAA AA A BBB BB B Other % 0.80% 11.15% 78.20% 7.78% 2.03% 0.03% 0.01% A. Ratings based on internally defned equivalences between internal ratings and credit agency ratings. Counterparty risk by customer segment Dec. 2018 data 3% 2% 1% 25% 69% Clearing houses Financial Institutions Corporates/Project Finance Commercial banking/Individuals Sovereign/supranational Transactions with clearing houses and fnancial institutions are carried out under netting and collateral agreements, and constant eforts are made to ensure that all other transactions are covered under this type of agreement. Generally, the collateral agreements that the Group signs are bilateral with few exceptions, mainly with multilateral institutions and securitisation funds, in which the agreements are unilateral in favour of the customer. Collateral is used for of reducing counterparty risk. These are a series of instruments with a certain economic value and high liquidity that are deposited/transferred by a counterparty in favour of another in order to guarantee/reduce the credit risk of the counterparty that could result from portfolios of derivatives with cross-risk between them. The transactions subject to the collateral agreement are regularly valued (normally daily) applying the parameters defned in the contract so that a collateral amount is obtained (usually cash or securities), which is to be paid to or received from the counterparty. 368 2018 Annual Report The collateral received by the Group under the diferent types of collateral agreements (CSA, OSLA, ISMA, GMRA, etc.) amounted to EUR 14,927 million (of which EUR 11,588 million related to collateral received by derivatives), mostly cash (78.7%), the rest of the collateral types are subject to strict policies of quality regarding the issuer type and its rating, debt seniority and haircuts applied. In geographical terms, the collateral received is distributed as shown in the following chart: Collateral received. Geographical distribution Dec. 2018 data 2% 4% 3% 17% 74% Spain UK Mexico Brazil Other As a consequence of the risk associated with the credit exposure that is taken on with each counterparty, the Group includes a valuation adjustment for over the counter (OTC) derivatives due to the risk associated with credit exposure assumed with each counterparty, i.e. a Credit Valuation Adjustment (CVA), and a valuation adjustment due to the risk relating to the Group itself assumed by counterparties on OTC derivatives, i.e. Debt Valuation Adjustment (DVA). As of December 2018, there were CVAs of EUR 350.8 million (+8.8% compared to December 2017) and DVAs of EUR 261.4 million (+19% compared with 2017). The defnition and methodology for calculating the CVA and DVA are set out in ‘Credit Valuation Adjustment (CVA) and Debt Valuation Adjustment (DVA)’ in this chapter. Counterparty risk, organised markets and clearing houses The Group’s policies seek to anticipate, wherever possible, the implementation of measures resulting from new regulations regarding transactions with OTC derivatives, repos and securities lending, whether settled through clearing houses or traded bilaterally. In recent years, there has been a gradual standardisation of OTC transactions in order to conduct clearing and settlement of all new trading transactions through clearing houses, as required by the recent regulation and to foster internal use of electronic execution systems. Furthermore, the Group actively manages transactions not settled through clearing houses and seeks to optimise their volume, given the spread and capital requirements under new regulations. With regards to organised markets, regulatory credit exposure has been calculated for such transactions since 2014 and the entry into force of the new CRD IV (Capital Requirements Directive) and CRR, transposing the Basel III principles for calculating capital, even though counterparty risk management does not consider credit risk on such transactions. The following tables show the weighting of trades settled through clearing houses as a portion of total counterparty risk at December 2018: Distribution of counterparty risk by settlement channel and product typeA Nominal in EUR million Credit derivatives Equity derivatives Fixed income derivatives Exchange rate derivatives Interest rate derivatives Commodity derivatives Repos Securities lending General total CCPB Organised marketsC % Nominal Bilateral Nominal 18,233 30,813 % 81.2% 48.9% 9,927 100.0% 744,713 974,732 - 95.3% 19.5% - Nominal 4,231 139 - 32,742 3,952,257 - 18.8% 0.2% - 4.2% 79.0% - 107,514 72.2% 41,492 27.8% 43,675 100.0% - - 1,929,607 4,030,861 109,695 % - - - 32,090 50.9% - - 4,186 73,418 2 - - 100.0% - - Total 22,464 63,042 9,927 781,641 2 149,006 43,675 6,070,163 1.5% 5,000,406 A. Figures under internal risk management criteria. B. Central counterparties (CCP). C. Refers to transactions involving listed derivatives (proprietary portfolio). Listed derivatives have a market value of zero. No collateral is received for these types of transactions. 369 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Distribution of risk settled by CCP and organised markets, by productA Nominal in EUR million The board, via the risk appetite framework, determines the maximum levels of concentration, as detailed in Risk appetite and structure of limits in section 1.3 ‘Management processes and tools’. Credit derivatives Equity derivatives 2018 4,231 2017 2,524 2016 3,916 32,229 26,088 36,568 Fixed income derivatives - - Exchange rate derivatives 36,928 1,592 349 1,419 Interest rate derivatives 4,025,674 2,950,796 2,732,103 Commodity derivatives 2 124 47 Repos Securities lending General total 41,492 64,086 29,763 - - 4 4,140,556 3,045,210 2,804,170 A. Figures under internal risk management criteria. Of-balance sheet credit risk The of-balance sheet risk corresponding to funding and guarantee commitments with wholesale customers was EUR 96,007 million, with the following distribution by products: Of balance sheet exposure EUR million. Dec. 2018 data Product FundingA Technical guarantees Financial and commercial guarantees Trade fnanceB Maturity < 1 year 1-3 years 3-5 years >5 years Total 12,639 20,849 28,715 4,222 66,425 7,680 2,384 1,742 4,838 16,644 6,084 3,033 1,606 1,178 11,901 861 139 31 6 1,037 General total 27,264 26,405 32,094 10,244 96,007 A. Mainly including committed bilateral and syndicated credit lines. B. Including primarily stand-by letters of credit. Credit derivatives activity The Group uses credit derivatives to cover loans, our customer’s business in fnancial markets and within its trading activities. The volume of this activity is small compared to the total assets of the Group and, moreover, is subject to a solid environment of internal controls and operational risk minimisation. Concentration risk Concentration risk control is a vital part of management. The Group continuously monitors the degree of concentration of its credit risk portfolios using various criteria: geographical areas and countries, economic sectors and groups of customers. In line with these maximum levels and limits, the executive risk committee establishes the risk policies and reviews the appropriate exposure levels for the adequate management of the degree of concentration in Santander’s credit risk portfolios. As indicated in the key metrics section of this chapter, in geographical terms, credit risk with customers is diversifed in the main markets where the Group operates (United Kingdom 27%, Spain 25%, United States 10%, Brazil 9%, etc.). In terms of diversifcation by sector, approximately 56% of the Group’s credit risk corresponds to individual customers, who, due to their inherent nature, are highly diverse. In addition, the lending portfolio is well distributed, with no signifcant concentrations in specifc sectors. The following chart shows the distribution at the end of the year: Diversifcation by economic sectorA Agriculture, livestock, forestry and fshing 2% Extractive industries 2% Manufacturing industry 14% Electricity, gas and water production and distribution 5% Construction 9% Trade and repairs 17% Transport and storage 5% Hotels and restaurants 3% Information and communications 3% Financial and insurance activities 8% Real estate activities 10% Professional, scientifc and technical activities 4% Administrative activities 3% Public administration 7% Other social services 3% Other services 5% A. Excluding individuals and reverse repos. The Group is subject to the regulation on large risks contained in the CRR, according to which the exposure contracted by an entity with a customer or group of customers linked among themselves will be considered a large exposure when its value is equal or greater than 10% of eligible capital. In addition, in order to limit large exposures, no entity can assume exposures exceeding 25% of its eligible capital with a single customer or group of linked customers, after taking into account the credit risk reduction efect contained in the regulation. Having applied the risk mitigation techniques, no groups triggered these thresholds at the end of December. Regulatory credit exposure with the 20 largest groups within the scope of large risks represented 4.47% of the outstanding credit risk with customers (lending to customers plus of-balance sheet risks) as of December 2018. 370 2018 Annual Report According to the management Group criteria, local sovereign exposure in currencies other than the ofcial currency of the country of issuance is not very signifcant (EUR 8,901 million, 3.5% of total sovereign risk), and exposure to non-local sovereign issuers involving cross-border8 risk is even less signifcant (EUR 3,906 million, 1.5% of total sovereign risk). Sovereign exposure in Latin America is mostly in local currency, and is recognised in the local accounts and concentrated in short- term maturities with lower interest rate risk and higher liquidity. In general, over the past few years, total exposure to sovereign risk has remained at adequate levels to support the regulatory and strategic reasons driving this portfolio. The investment strategy for sovereign risk also takes into account the credit quality of each country when setting the maximum exposure limits. The following table shows percentage exposure by rating levels9: AAA AA A BBB Lower than BBB 2018 11% 20% 31% 13% 25% 2017 13% 19% 29% 14% 25% 2016 16% 17% 29% 8% 30% The Group’s Risk division works closely with the Financial division to actively manage credit portfolios. Its activities include reducing the concentration of exposures through various techniques, such as using credit derivatives and securitisations to optimise the risk- return relationship for the whole portfolio. Country risk Country risk is a component of credit risk in all cross-border credit transactions arising from circumstances other than the usual business risks. The main elements involved are sovereign risk, transfer risk and other risks that afect international fnancial activity (wars, natural disasters, balance of payments crises, etc.). The Group takes into account these three elements of country risk in the calculation of provisions, through its loss forecasting models and considering the additional risk arising from cross-border transactions. As of 31 December 2018, the provisionable exposure due to country risk was EUR 285 million (EUR 184 million in 2017). At year-end 2018, total provisions stood at EUR 25 million, compared to EUR 37 million at the end of the previous period. The variation of the exposure is mainly due to new investments for institutional support, having calibrated the coverages under the new national and international regulation. The principles of country risk management continued to follow criteria of maximum prudence; country risk is assumed very selectively in transactions that are clearly proftable for the Group, and which enhance the global relationship with our customers. Sovereign risk including vis-à-vis the rest of public administrations As a general criteria in the Group, sovereign risk is that contracted in transactions with a central bank (including the regulatory cash reserve requirement), issuer risk with the Treasury (public debt portfolio) and that arise from transactions with public institutions with the following features: their funds only come from the state’s budgeted income and the activities are of a non-commercial nature. These criteria, historically used by the Group, difer in some respects from that applied by the European Banking Authority (EBA) for its regular stress exercises. The main diferences are that the EBA’s criterion does not include deposits with central banks, exposures with insurance companies, indirect exposures via guarantees and other instruments. On the other hand, the EBA does include public administrations in general (including regional and local bodies), not only the central state sector. 8. Countries that are not considered as “low risk” by Bank of Spain. 9. Internal ratings are applied. 371 Credit RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management During 2018 a new regulatory report was implemented, Sovereign COREP, for which its perimeter is based on the regulatory classifcation of counterparties. Exposure at year-end 2018 is shown in the table below (EUR million): 2018 Portfolio Financial assets held for trading and Financial assets designated as FV with changes in results Financial assets at fair value through other comprehensive income Financial assets at amortised cost Non-trading fnancial assets mandatorily at fair value through proft or loss Total net direct exposure 1,143 (43) (204) - - 503 1,013 2,015 - 426 1,839 3,320 160 103 - 27,078 4,794 - - - 953 1,190 9,203 84 6,138 20,540 4,279 1,596 340 5,688 21,419 4,002 465 - - 1,322 8,666 11 245 2,113 3,782 2,816 20 450 534 - - - - - - - - - 5 893 - - - - 49,640 8,753 261 - - 2,778 10,869 11,229 329 8,682 27,054 10,415 1,776 893 6,222 10,275 81,883 45,845 898 138,901 Spain Portugal Italy Greece Ireland Rest Eurozone UK Poland Rest of Europe US Brazil Mexico Chile Rest of America Rest of the world Total 372 2018 Annual Report 4. Trading market risk, structural and liquidity risk 4.1 Introduction The perimeter of activities subject to market risk involves transactions where patrimonial risk is assumed as a consequence of variations in market factors. Thus they include trading risks and also structural risks, which are also afected by market shifts. This risk arises from changes in risk factors - interest rates, infation rates, exchange rates, stock prices, credit spreads, commodity prices and the volatility of each of these elements - as well as from the liquidity risk of the various products and markets in which the Group operates, and balance sheet liquidity risk. • Interest rate risk is the possibility that changes in interest rates could adversely afect the value of a fnancial instrument, a portfolio or the Group as a whole. It afects loans, deposits, debt securities, most assets and liabilities in the trading books and derivatives, among others. • Equity risk is the sensitivity of the value of positions in equities to adverse movements in market prices or expectations of future dividends. Among other instruments, this afects positions in shares, stock market indices, convertible bonds and derivatives using shares as the underlying asset (put, call, equity swaps, etc.). • Credit spread risk is the risk or sensitivity of the value of positions in fxed income securities or in credit derivatives to movements in credit spread curves or in recovery rates associated with issuers and specifc types of debt. The spread is the diference between fnancial instruments listed with a margin over other benchmark instruments, mainly the interest rate risk of Government bonds and interbank interest rates. • Commodities price risk is the risk derived from the efect of potential changes in commodities prices. The Group’s exposure to this risk is not signifcant and is concentrated in derivative transactions on commodities with customers. • Infation rate risk is the possibility that changes in infation • Volatility risk is the risk or sensitivity of the value of a portfolio rates could adversely afect the value of a fnancial instrument, a portfolio or the Group as a whole. It afects instruments such as loans, debt securities and derivatives, where the return is linked to infation or to a change in the actual rate. • Exchange rate risk is the sensitivity of the value of a position in a currency other than the base currency to a movement in exchange rates. Hence, a long or open position in a foreign currency will produce a loss if that currency depreciates against the base currency. Among the exposures afected by this risk are the Group’s investments in subsidiaries in non-euro currencies, as well as any foreign currency transactions. to changes in the volatility of risk factors: interest rates, exchange rates, shares, credit spreads and commodities. This risk is incurred by all fnancial instruments where volatility is a variable in the valuation model. The most signifcant case is the fnancial options portfolio. All these market risks can be partly or fully mitigated by using options, futures, forwards and swaps. 373 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management In addition, other types of market risk require more complex hedging. For example: 4.2 Trading market risk management • Correlation risk. Sensitivity of the portfolio to changes in the relationship between risk factors (correlation), either of the same type (for example, two exchange rates) or diferent types (for example, an interest rate and the price of a commodity). • Market liquidity risk. Risk when a Group entity or the Group as a whole cannot reverse or close a position in time without having an impact on the market price or the cost of the transaction. Market liquidity risk can be caused by a reduction in the number of market makers or institutional investors, the execution of a large volume of transactions, or market instability. It increases as a result of the concentration of certain products and currencies. • Prepayment or cancellation risk. When the contractual relationship in certain transactions explicitly or implicitly allows the possibility of early cancellation without negotiation before maturity, there is a risk that the cash fows may have to be reinvested at a potentially lower interest rate. This mainly afects mortgage loans and mortgage securities. System for controlling limits Setting trading market risk limits is a dynamic process, determined by the Group’s predefned risk appetite levels (as described in Risk appetite and structure of limits in section 1.3 ‘Management processes and tools’). This process is part of an annual limits plan defned by the Group’s senior management, involving every Group’s entity. The market risk limits are established based on diferent metrics and are intended to cover all activities subject to market risk from many perspectives, applying a conservative approach. The main ones are: • Value at Risk (VaR) and Stressed VaR limits. • Limits of equivalent and/or nominal positions. • Interest rate sensitivity limits. • Vega limits. • Underwriting risk. This occurs as a result of an entity’s • Delivery risk limits for short positions in securities (fxed income involvement in underwriting a placement of securities or another type of debt, assuming the risk of partially owning the issue or the loan due to non-placement of all of it among potential buyers. In addition to the above market risks, balance sheet liquidity risk must also be considered. Unlike market liquidity risk, balance sheet liquidity risk is defned as the possibility of not meeting payment obligations on time, or doing so at excessive cost. Among the losses caused by this risk are losses due to forced sales of assets or margin impacts due to the mismatch between expected cash infows and outfows. On the other hand, pension and actuarial risks also depend on shifts in market factors, which are described in more detail, in this chapter. The Group has projects under way for compliance with obligations related to the Basel Committee’s Fundamental Review of the Trading Book, and for compliance with EBA guidelines on balance sheet interest rate risk. The objective of these projects is to have the best tools for control and management of market risks available to both managers and control units, all within a governance framework that is appropriate for the models used and the reporting of risk metrics. These projects allow meeting the requirements related to regulatory demands in these risk factors. and securities). • Limits to constrain the volume of efective losses, and protect results generated during the period: • Loss trigger. • Stop loss. • Credit limits: • Total exposure limit. • Jump to default by issuer limit. • Others. • Limits for origination transactions. These general limits are complemented by other sub-limits to establish a sufciently granular limits framework for the efective control of the market risk factors to which the Group is exposed in its trading activities. Positions are monitored on a daily basis globally and for each unit at desk level, as well as with an exhaustive control of changes to portfolios and trading desks, so as to identify any incidents that might need immediate correction, and thus comply with the Volcker Rule. Three categories of limits are established based on the scope of approval and control: global approval and control limits, global approval limits with local control, and local approval and local control limits. The limits are requested by the business executive 374 2018 Annual Report of each country/entity, considering the particular nature of the business in order to achieve the established budget targets, seeking consistency between the limits and the risk/return ratio. The limits are approved by the corresponding risk bodies. Business units must comply with the approved limits at all times. In the event of a limit being exceeded, the local business executives have to explain, in writing and on the same day, the reasons for the excess and the action plan to correct the situation, which in general might consist of reducing the position until it reaches the defned limits or setting out the strategy that justifes an increase in the limits. If the business unit fails to respond to the breach within three days, the global business executives will be asked to set out the actions to be taken in order to make the adjustment to the existing limits. If this situation lasts for ten days as of the frst excess, senior risk management will be informed so that a decision can be taken: the risk takers could be required to reduce the levels of risk assumed. Methodologies a) Value at Risk (VaR) The standard methodology Santander applies to trading activities is Value at Risk (VaR), which measures the maximum expected loss with a certain confdence level and time frame. The standard for historic simulation is a confdence level of 99% and a time frame of one day. Statistical adjustments are applied enabling the most recent developments afecting the levels of risk assumed to be incorporated efciently and on a timely manner. A time frame of two years or at least 520 days from the reference date of the VaR calculation is used. Two fgures are calculated every day: one applying an exponential decay factor that allocates less weight to the observations furthest away in time and another with the same weight for all observations. The higher of the two is reported as the VaR. Simultaneously the Value at Earnings (VaE) is calculated, which measures the maximum potential gain with a certain level of confdence and time frame, applying the same methodology as for VaR. VaR by historic simulation has many advantages as a risk metric (it sums up in a single number the market risk of a portfolio, it is based on market movements that really occurred without the need to make assumptions of functions forms or correlations between market factors, etc.), but it also has its limitations. Some limitations are intrinsic to the VaR metrics, regardless of the methodology used in their calculation, including: • The VaR calculation is calibrated at a certain level of confdence, which does not indicate the levels of possible losses beyond it. • There are some products in the portfolio with a liquidity horizon greater than that specifed in the VaR model. • VaR is a static analysis of the portfolio risk, and the situation could change signifcantly during the following day, although the likelihood of this occurring is very low. Using the historic simulation methodology also has its limitations: • High sensitivity to the historic window used. • Inability to capture plausible events that would have signifcant impact, if these do not occur in the historic window used. • The existence of valuation parameters with no market input (such as correlations, dividend and recovery rate). • Slow adjustment to new volatilities and correlations, if the most recent data receives the same weight as the oldest data. Some of these limitations are overcome by using Stressed VaR and expected shortfall, calculating VaR with exponential decay and applying conservative valuation adjustments. Furthermore, as previously stated, the Group regularly conducts analysis and backtesting of the VaR calculation model accuracy. b) Stressed VaR (sVaR) and expected shortfall (ES) In addition to standard VaR, Stressed VaR is calculated daily for the main portfolios. The calculation methodology is the same as for VaR, with the two following exceptions: • The historical observation period for the factors: when calculating stressed VaR a window of 260 observations is used, rather than 520 for VaR. However, this is not the most recent data: rather, the data used is from a continuous period of stress for the portfolio in question. This is determined for each major portfolio by analysing the history of a subset of market risk factors selected based on expert judgement and the most signifcant positions in the books. • Unlike VaR, stressed VaR is obtained using the percentile with uniform weighting, not the higher of the percentiles with exponential and uniform weightings. Moreover, the expected shortfall is also calculated by estimating the expected value of the potential loss when this is higher than the level set by VaR. Unlike VaR, ES has the advantages of capturing the risk of large losses with low probability (tail risk) and being a sub-additive metric10. The Basel Committee considers that ES with a 97.5% confdence interval delivers a similar level of risk to VaR at a 99% confdence interval. ES is calculated by applying uniform weights to all observations. 10. According to the fnancial literature, subaddivity is a desirable property for a coherent risk metric. This property establishes that f(a+b) is less than or equal to f(a)+f(b). Intuitively, it assumes that the more instruments and risk factors there are in a portfolio, the lower the risks, because of the benefts of diversifcation. Whilst VaR only ofers this property for some distributions, ES always does so. 375 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management c) Scenario analysis The Group uses other metrics in addition to VaR, providing it greater control over the risks it faces in the markets where it is active. These measures include scenario analysis, which consists in defning alternative behaviours for various fnancial variables and obtaining the impact on results of applying these to activities. These scenarios may replicate events that occurred in the past (such as a crisis) or determine plausible alternatives that are unrelated to past events. non-compliance and ratings migration that are not adequately captured in VaR, through changes in the corresponding credit spreads. This metric is essentially applied to fxed-income bonds, both public and private, derivatives on bonds (forwards, options, etc.) and credit derivatives (credit default swaps, asset backed securities, etc.). IRC is calculated using direct measurements of loss distribution tails at an appropriate percentile (99.9%), over a one year horizon. The Montecarlo methodology is used, applying one million simulations. The potential impact on earnings of applying diferent stress scenarios is regularly calculated and analysed, particularly for trading portfolios, considering the same risk factor assumptions. Three scenarios are defned, as a minimum: plausible, severe and extreme. Taken together with VaR, these reveal a much more complete spectrum of the risk profle. f) Credit Valuation Adjustment (CVA) and Debt Valuation Adjustment (DVA) The Group incorporates CVA and DVA when calculating the results of trading portfolios. The CVA is a valuation adjustment of over the-counter (OTC) derivatives, as a result of the risk associated with the credit exposure assumed by each counterparty. A number of trigger thresholds have also been established for global scenarios, based on their historical results and the capital associated with the portfolio in question. When these triggers are activated, the portfolio managers are notifed so they can take appropriate action. The results of the global stress exercises, and any breaches of the trigger thresholds, are reviewed regularly, and reported to senior management, when this is considered appropriate. d) Analysis of positions, sensitivities and results Positions are used to quantify the net volume of the market securities for the transactions in the portfolio, grouped by main risk factor, considering the delta value of any futures or options. All risk positions can be expressed in the base currency of the local unit and the currency used for standardising information. Changes in positions are monitored on a daily basis to detect any incidents, so they can be corrected immediately. Measurements of market risk sensitivity estimate the variation (sensitivity) of the market value of an instrument or portfolio to any change in a risk factor. The sensitivity of the value of an instrument to changes in market factors can be obtained using analytical approximations through partial derivatives or through a complete revaluation of the portfolio. Furthermore, the daily formulation of the income statement by the Risk area is an excellent indicator of existing risks, as it allows to identify the impact of changes in fnancial variables on portfolios. e) Derivatives activities and credit management Also noteworthy is the control of derivative activities and credit management which, because of its atypical nature, is conducted daily with specifc measures. First, the sensitivities to price movements of the underlying asset (delta and gamma), volatility (vega) and time (theta) are controlled. Second, measures such as the sensitivity to the spread, jump-to-default, concentrations of positions by level of rating, etc., are reviewed systematically. With regard to the credit risk inherent to trading portfolios, and in line with the recommendations of the Basel Committee and prevailing regulations, a further metric is also calculated: the incremental risk charge (IRC). This seeks to cover the risks of It is calculated by taking into account the potential exposures with each counterparty in each future maturity. The CVA for a particular counterparty is the sum of the CVA for all maturities. For its calculation, the following inputs are considered: • Expected exposure: including, for each operation the current market value (MTM) as well as the potential future risk (add-on) to each maturity. Mitigating factors such as collateral and netting agreements are taken into account, as well as a time decay factor for derivatives with partial interim payments. • Loss given default: the percentage of fnal loss assumed in case of default/non-payment of the counterparty. • Probability of default: for cases in which there is no market information (spread curve traded through CDS, etc.), general proxies generated on the basis of same sector companies with listed CDSs for the same sector and the counterparty’s external rating. • Discount factor curve. The Debt Valuation Adjustment (DVA) is a valuation adjustment similar to the CVA, but in this case as a result of the Group’s risk that counterparties assume in OTC derivatives. 4.3 Key metrics (trading market risk) Risk levels in trading activity have stayed at historically low levels in 2018, in a complex environment marked by uncertainty arising from low interest rates and Brexit in Europe, and geopolitical risks in Latin America units (elections in the main geographies during the year). The exposure levels in trading portfolios are lower compared to previous years in all risk factors. Risks of trading activities arise mainly from activities with customers in non-complex instruments, concentrated in hedging of interest rate and exchange rate risks. Contribution to overall risk of proprietary positions in trading portfolios is substantially lower than in previous years. 376 2018 Annual Report In 2018, a low level of consumption has been seen of limits established for trading activities, which are set in a manner that is consistent with the risk appetite defned in the Group for this type of activity. Lower risk levels are also evident even under stressed scenarios, as seen in the loss results in the stress tests regularly carried out to assess any risks not refected in the usual metrics to control and monitor trading risks. VaR during 2018 fuctuated between EUR 16.6 million and EUR 6.4 million. The most signifcant changes were related to variations in exchange and interest rate exposures and also market volatility. The average VaR in 2018 was EUR 9.7 million, slightly lower than in the two previous years (EUR 21.5 million in 2017 and EUR 18.3 million in 2016). VaR analysis During the year, the Group maintained its strategy of concentrating its trading activity on customer business, minimising, where possible, the exposure to directional risk in net terms and maintaining geographic and risk factor diversifcation. This is refected in the Value at Risk (VaR) of the SCIB trading book, which, despite the volatility in the markets, particularly in interest rates and exchange rates, decreased slightly from its average path over the last three years, ending December at EUR 11.3 million11. The following histogram shows the distribution of risk in VaR terms from 2016 to 2018. The accumulation of days with levels of between EUR 12 million and EUR 32 million (95%) is shown. Values higher than EUR 32 million (3%) largely occur in periods afected by temporary spikes in volatility, mainly in the Brazilian real against the US dollar and also in Brazilian interest rates. VaR histogram VaR at 99% over a one day horizon. Number of days (%) in each range from 2016 to 2018 VaR 2016-2018 EUR million. VaR at 99% over a one day horizon. MAX (63.2) — VaR — 15 day moving average — VaR, 3 year average 30.5% 26.1% 21.5% 11% 6.3% 2.6% 1.9% 7 < 2 1 7 1 2 2 7 2 2 3 7 3 2 4 7 4 7 4 > 0.0% 0.0% 0.1% 70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 MIN (6.3) VaR in EUR million. 6 1 0 2 n a J 6 1 0 2 r a M 6 1 0 2 y a M 6 1 0 2 n u J 6 1 0 2 p e S 6 1 0 2 v o N 7 1 0 2 n a J 7 1 0 2 r a M 7 1 0 2 y a M 7 1 0 2 l u J 7 1 0 2 p e S 7 1 0 2 v o N 8 1 0 2 n a J 8 1 0 2 r a M 8 1 0 2 y a M 8 1 0 2 l u J 8 1 0 2 p e S 8 1 0 2 v o N 11. Value at Risk. The defnition and calculation methodology for VaR is set out in section 4.2 ‘Trading market risk management’. In addition to the trading activity of SCIB, there are other positions catalogued for accounting purposes. The total VaR of trading of this accounting perimeter was EUR 11.1 million. 377 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Risk per factor The following table displays the average and latest VaR values at 99% by risk factor over the last three years, the lowest and highest values in 2018 and the expected shortfall at 97.5% at the close of December 2018: VaR statistics and Expected Shortfall by risk factor 12,13 EUR million, VaR at 99% and ES at 97.5% with one day time horizon 2018 VaR (99%) ES (97.5%) 2017 VaR 2016 VaR Min Average 6.4 (3.3) 5.9 0.8 1.6 1.0 0.0 3.3 (3.2) 3.2 0.4 0.4 2.2 0.0 5.0 (0.7) 4.9 0.5 1.3 0.5 0.1 0.6 0.0 0.1 0.2 (0.0) 0.0 0.2 0.0 9.7 (9.3) 9.4 2.4 3.9 3.4 0.0 5.7 (6.3) 4.9 1.1 1.7 4.3 0.0 8.7 (5.0) 7.7 2.3 3.4 1.6 (0.5) 1.5 0.1 0.5 1.0 (0.3) 0.3 0.9 0.0 Max 16.6 (18.7) 15.5 6.3 11.4 13.0 0.4 11.5 (11.0) 8.7 2.1 6.5 12.6 0.0 20.9 (12.2) 12.8 5.6 12.1 3.2 (1.6) 3.1 0.8 1.7 1.8 (0.5) 0.6 1.8 0.1 Latest Latest Average Latest Average Latest 11.3 (11.5) 9.7 2.8 6.2 4.1 0.0 6.3 (7.8) 5.7 1.2 2.1 5.1 0.0 12.0 (4.7) 8.0 2.7 5.3 1.8 (0.3) 1.8 0.0 0.3 0.5 (0.1) 0.1 0.5 0.1 12.4 (10.0) 9.5 3.0 5.7 4.2 0.0 6.4 (7.3) 5.5 1.0 2.1 5.0 0.0 11.1 (5.5) 7.9 3.0 5.0 1.8 (0.2) 1.7 0.0 0.3 0.5 (0.2) 0.1 0.5 0.1 21.5 (8.0) 16.2 3.0 6.6 3.6 0.0 7.0 (6.1) 6.1 1.1 2.1 3.7 0.0 20.1 (3.7) 15.1 3.3 5.5 2.1 (0.6) 2.0 0.2 0.5 0.4 (0.1) 0.1 0.4 0.0 10.2 (7.6) 7.9 1.9 3.3 4.6 0.0 6.4 (6.0) 5.7 0.5 1.4 4.7 0.0 8.4 (4.1) 7.5 1.9 3.1 1.2 (0.4) 1.2 0.0 0.4 0.2 (0.1) 0.0 0.2 0.0 18.3 (10.3) 15.5 1.9 6.9 4.2 0.1 9.0 (9.1) 8.2 1.6 4.1 4.1 0.1 13.7 (3.6) 11.4 1.4 4.5 1.3 (0.5) 1.3 0.1 0.4 0.6 (0.1) 0.1 0.5 0.0 17.9 (9.6) 17.9 1.4 4.8 3.3 0.1 9.4 (7.6) 9.1 1.5 3.0 3.4 0.1 13.5 (2.7) 13.0 0.8 2.4 2.7 (0.6) 2.7 0.0 0.5 0.5 (0.1) 0.1 0.5 0.0 Total Diversifcation efect g n i Interest rate d a r t l Equities a t o T Exchange rate Credit spread Commodities Total Diversifcation efect e Interest rate p o r u E Equities Exchange rate Credit spread Commodities Total a c Diversifcation efect i r e m Interest rate A i Equities n t a L Exchange rate Total i a s Diversifcation efect A d n Interest rate a S U Equities Exchange rate Total s e i t v Diversifcation efect i i t c a l a b o l G Interest rate Equities Exchange rate 12.The VaR of global activities includes transactions that are not assigned to any particular country. 13. In Latin America, the United States and Asia, VaR levels are not shown separately for credit spreads and commodities, because of their limited or zero materiality. 378 2018 Annual Report At the end of December, VaR increased slightly by EUR 1.1 million compared to year-end 2017, decreasing average VaR by EUR 11.8 million. By risk factor, average VaR decreased in all factors, although the reduction of the credit spread was smaller. By geographical area, it declined in all areas except in that of Global Activities, where it slightly increased, although it remained at a low level. The Group calculates and evaluates three types of backtesting: • ‘Clean’ backtesting: the daily VaR is compared with the results obtained without taking into account the intraday results or changes in the portfolio’s positions. This method compares the efectiveness of the individual models used to assess and measure the risks of positions. • Backtesting on complete results: daily VaR is compared with the day’s net results, including the results of intraday transactions and those generated by fees and commissions. • Backtesting on complete results without mark-ups or fees: the daily VaR is compared to the day’s net results from intraday transactions but excluding those generated by mark-ups and fees. This method aims to give an idea of the intraday risk assumed by Group treasuries. For the frst case and for the total portfolio, there were three exceptions of Value at Earnings (VaE) at 99% in 2018 (day on which daily proft was higher than VaE) on 21 and 30 August and 8 October, caused by strong shifts in the exchange rates of emerging economies. The defnition and calculation methodology for VaE is set out in section 4.2 ‘Trading market risk management’ in this chapter. There were also three exceptions to VaR at 99% (day on which the daily loss was higher than the VaR) on the 29 May, due to the rise in market volatility caused by political instability in Europe, and on 15 and 29 October due to the strong variations in the exchange rates and interest rates in Brazil and Mexico motivated by the general elections volatility. The number of exceptions which occurred is consistent with the assumptions specifed in the VaR calculation model. The evolution of VaR by risk factor has, in general, been stable over the last few years, decreasing somewhat in 2018, in line with the above fgures. The temporary rises in VaR for various factors are due more too temporary increases in the volatility of market prices than to signifcant changes in positions. Historical VaR by risk factor EUR million. VaR at 99% with one day time horizon (15-day moving average) — VaR interest rate 30 — VaR credit spread — VaR equity — VaR commodities — VaR exchange rate 25 20 15 10 5 0 6 1 0 2 n a J 6 1 0 2 r p A 6 1 0 2 l u J 6 1 0 2 t c O 7 1 0 2 n a J 7 1 0 2 r p A 7 1 0 2 l u J 7 1 0 2 t c O 8 1 0 2 n a J 8 1 0 2 r p A 8 1 0 2 l u J 8 1 0 2 t c O Gauging and backtesting measures Actual losses can difer from those forecast by VaR for various reasons related to the limitations of this metric. This is set out in detail in Methodologies in section 4.2 ‘Trading market risk management’. The Group regularly analyses and contrasts the accuracy of the VaR calculation model in order to confrm its reliability. The most important test consists of backtesting exercises, analysed at the local and global levels and in all cases with the same methodology. Backtesting consists of comparing forecast VaR measurements, with a certain level of confdence and time frame, with actual losses obtained in the same time frame. This enables anomalies in the VaR model of the portfolio in question to be detected (for example, shortcomings in the parameterisation of the valuation models of certain instruments, not very adequate proxies, etc.). 379 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Backtesting of trading portfolios: daily results vs. VaR for previous day EUR million 60 28 -5 -38 -70 — Clean P&L — VaE 99% — VaE 95% — VaR 99% — VaR 95% 6 1 0 2 n a J 6 1 0 2 b e F 6 1 0 2 r a M 6 1 0 2 r p A 6 1 0 2 y a M 6 1 0 2 n u J 6 1 0 2 l u J 6 1 0 2 g u A 6 1 0 2 p e S 6 1 0 2 t c O 6 1 0 2 v o N 6 1 0 2 c e D 7 1 0 2 n a J 7 1 0 2 b e F 7 1 0 2 r a M 7 1 0 2 r p A 7 1 0 2 y a M 7 1 0 2 n u J 7 1 0 2 l u J 7 1 0 2 g u A 7 1 0 2 p e S 7 1 0 2 t c O 7 1 0 2 v o N 7 1 0 2 c e D 8 1 0 2 n a J 8 1 0 2 b e F 8 1 0 2 r a M 8 1 0 2 r p A 8 1 0 2 y a M 8 1 0 2 n u J 8 1 0 2 l u J 8 1 0 2 g u A 8 1 0 2 p e S 8 1 0 2 t c O 8 1 0 2 v o N 8 1 0 2 c e D Derivatives risk management Derivatives activity is mainly focused on commercialisation of investment products and on hedging risks for our customers. Management is focused on ensuring that the net risk opened is the lowest possible. These transactions include options on equities, fxed income and exchange rates. The units where this activity mainly takes place are: Spain, Brazil, the UK and Mexico. The following chart shows the VaR Vega14 performance of structured derivatives business over the last three years. It fuctuated at around an average of EUR 3 million. In general, the periods with higher VaR levels are related to episodes of signifcant rises in volatility in the markets. During 2016, a number of diferent events pushed up market volatility (Brexit, general elections in Spain and the United States, political-economic situation in Brazil, constitutional referendum in Italy). In 2017 and 2018 these events have been less volatile, other than in a few isolated instances, which has meant lowered risk and lower VaR Vega. Change in risk over time (VaR) of structured derivatives EUR million. VaR Vega at a 99% over a one day horizon 16 14 12 10 8 6 4 2 0 — 15 day moving average — VaR Vega 6 1 0 2 n a J 6 1 0 2 r p A 6 1 0 2 l u J 6 1 0 2 t c O 7 1 0 2 n a J 7 1 0 2 r p A 7 1 0 2 l u J 7 1 0 2 t c O 8 1 0 2 n a J 8 1 0 2 r p A 8 1 0 2 l u J 8 1 0 2 t c O 14. Vega, a Greek term, means here the sensitivity of the value of a portfolio to changes in the price of market volatility. 380 2018 Annual Report Regarding the VaR by risk factor, on average, the exposure was concentrated, in this order: equities, exchange rates and interest rates. This is shown in the table below: Financial derivatives. Risk (VaR) by risk factor EUR million. VaR at a 99% over a one day horizon Total VaR Vega Diversifcation efect VaR interest rate VaR equities VaR exchange rate VaR commodities 2018 2017 2016 Minimum Average Maximum Latest Average Latest Average Latest 1.0 (0.7) 0.6 0.6 0.5 0.0 1.8 (1.4) 0.9 1.2 1.1 0.0 4.7 (2.8) 4.9 2.7 2.3 0.0 1.1 (1.4) 0.9 1.0 0.6 0.0 2.3 (1.5) 1.3 1.5 0.9 0.0 2.5 (0.6) 0.7 1.4 1.0 0.0 4.0 (2.4) 3.6 1.7 1.1 0.0 2.5 (2.3) 2.6 1.3 0.9 0.0 The average risk in 2018 (EUR 1.8 million) is lower than in 2017 and 2016, for the reasons explained above. • The availability in the market of observable data (inputs) needed to apply this valuation model. The Group continues to have a very limited exposure to instruments or complex structured assets, a management culture for which prudence in risk management is one of its hallmarks in risk management. In both cases, the exposure has reduced comparing with the previous year, for which the Group has: • Hedge funds: the total exposure is not signifcant (EUR 28 million at close of December 2018) and is all indirect, acting as counterparty in derivatives transactions. The risk with this type of counterparty is analysed case by case, establishing percentages of collateralisation on the basis of the features and assets of each fund. • Monolines: exposure to bond insurance companies as of December 2018 was EUR 24 million, all of it indirect, by virtue of the guarantee provided by this type of entity for various fnancing or traditional securitisation transactions. The exposure in this case is to double default, as the primary underlying assets are of high credit quality. The Group’s policy for approving new transactions related to these products remains very prudent and conservative. It is subject to strict supervision by the Group’s senior management. Before approving a new transaction, product or underlying asset, the Risk division verifes: • The existence of an appropriate valuation model to monitor the value of each exposure: mark-to-market, mark-to-model or mark-to-liquidity. And provided these two conditions are always met: • The availability of adequate systems, duly adapted to calculate and monitor every day the results, positions and risks of new transactions. • The degree of liquidity of the product or underlying asset, in order to make possible their coverage when deemed appropriate. Scenario analysis Various stress scenarios were calculated and analysed regularly in 2018 (at least monthly) at the local and global levels for all the trading portfolios and using the same risk factor assumptions. Maximum volatility scenario (worst case) This scenario is given particular attention as it combines historic movements of risk factors with an ad-hoc analysis in order to reject very unlikely combinations of variations (for example, sharp falls in stock markets together with a decline in volatility). A historic volatility equivalent to six standard deviations is applied. The scenario is defned by taking for each risk factor the movement which represents the largest potential loss in the portfolio, rejecting the most unlikely combinations in economic-fnancial terms. At the end of December, that scenario implied, for the global portfolio, interest rate rises in Latin American markets and falls in core markets, stock market falls, depreciation of all currencies against the euro, and increased credit spreads and volatility. The results for this scenario as of the end of December 2018 are shown in the following table: 381 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Stress scenario: maximum volatility (worst case) EUR million. Dec. 2018 data Total trading Europe Latin America US Global activities Asia Interest rate Equities Exchange rate Credit spread Commodities (18.9) (7.9) (2.1) (8.5) (0.2) (0.2) (13.1) (3.8) (9.3) - - - (29.4) (9.2) (15.8) (3.8) (0.2) (0.4) (12.9) (11.1) (0.1) - (1.7) - - - - - - - Total (74.3) (32.0) (27.3) (12.3) (2.1) (0.6) The stress test shows that the economic loss sufered by the Group in its trading portfolios, in terms of the mark-to-market (MtM) result, would be EUR 74.3 million, if the stress movements defned in the scenario materialised in the market. This loss would be concentrated in Europe (in the following order: credit spread, exchange rate, interest rate and equities) and in Latin America (in the following order: exchange rate, equities, interest rate and credit spread). Other global stress scenarios ‘Abrupt crisis’: an ad-hoc scenario with sharp market movements. Rise in interest rate curves, sharp falls in stock markets, strong appreciation of the dollar against other currencies, rise in volatility and in credit spreads. ‘Subprime crisis’: historic scenario of the US mortgage crisis. The objective of the analysis was to capture the impact on results of the reduction in liquidity in the markets. Two time horizons were used (one day and 10 days), and in both cases there were falls in stock markets and in interest rates in core markets and rises in emerging markets, and appreciation of the US dollar against other currencies. ‘Plausible Forward Looking Scenario’: a hypothetical plausible scenario defned at local level in market risk units, based on the portfolio positions and their expert judgement regarding short- term changes in market variables which can have a negative impact on such positions. ‘EBA adverse scenario’: the scenario proposed by the EBA in April 2014 as part of the EBA 2014 EU-Wide Stress Test and updated in January 2016. It was initially conceived as an adverse scenario proposed by European banks thinking in terms of a 2014-2016 time horizon and subsequently updated to the 2016-2018 time horizon. It refects the systemic threats which are considered to be the most serious threats to the stability of the banking sector in the European Union. Analysis of reverse stress tests, which are based on establishing a predefned result (unfeasibility of a business model or possible insolvency) and subsequently the risk factor scenarios and movements which could cause that situation are identifed. On a monthly basis, a stress test assessment report is performed containing explanations of the main results variations for the diferent scenarios and units. An early warning mechanism has also been established so that when the loss for a scenario is high in historic terms and/or in terms of the capital consumed by the portfolio in question, the relevant business executive is informed. The results of these monthly global scenarios for the last three years are shown in the following table: Stress test results. Comparison of 2016-2018 scenarios (annual averages) EUR million 2016 2017 2018 Worst case Abrupt crisis Plausible Fwd Looking Crisis 07-08 1d Crisis 07-08 10d EBA Adverse 100 50 0 -50 -100 -150 -200 -250 382 2018 Annual Report Also, other stress scenarios are carried out on a quarterly basis, such as the reverse stress test, scenarios of illiquidity and concentration with regard to Additional valuation adjustments (AVAs), and IRC. Linkage with balance sheet items Below are the balance sheet items in the Group’s consolidated position that are subject to market risk, distinguishing the positions whose main risk metric is the VaR from those where monitoring is carried out with other metrics. Relation of risk metrics with balances in Group’s consolidated position EUR million. Dec. 2018 data Assets subject to market risk Cash, cash balances at central banks and other deposits on demand Financial assets held for trading Non-trading financial assets mandatorily at fair value through profit or loss Financial assets designated at fair value through profit or loss Financial assets at fair value through other comprehensive income Financial assets measured at amortised cost Hedging derivatives Changes in the fair value of hedged items in portfolio hedges of interest risk Other assets Total assets Liabilities subject to market risk Financial liabilities held for trading Financial liabilities designated at fair value through profit or loss Financial liabilities at amortised cost Hedging derivatives Changes in the fair value hedged items in portfolio hedges of interest rate risk Other liabilities Total liabilities Total equity 4.4 Structural balance sheet risks management System for controlling limits As already stated for the market risk in trading, under the annual limits plan framework, limits are set for balance sheet structural risks, responding to the Group’s risk appetite level. Main market risk metrics Balance sheet amount VaR Other Main risk factors for 'Other' balance 113,663 92,879 10,730 57,460 121,091 946,099 92,140 9,327 56,584 113,663 739 1,403 876 121,091 946,099 Interest rate Interest rate; credit spread Interest rate; equities Interest rate Interest rate; credit spread Interest rate 8,607 8,586 21 Interest rate; exchange rates 1,088 107,654 1,459,271 1,088 Interest rate 70,343 70,054 68,058 67,909 289 149 Interest rate; credit spread Interest rate 1,171,630 1,171,630 Interest rate; credit spread 6 303 Interest rate; exchange rates Interest rate 6,363 6,357 303 35,213 1,351,910 107,361 • Limit on the sensitivity of net interest income in 1 year. • Limit on the sensitivity of equity value. • Structural exchange rate risk: • Net position in each currency (for results hedging positions). The main limits are: • Balance sheet structural interest rate risk: In the event one of these limits or their sub limits is exceeded, the risk management executives must explain the reasons and facilitate the actions to correct it. 383 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk managementMethodologies a) Structural interest rate risk The Group analyses the sensitivity of its net interest income and equity value to changes in interest rates. This sensitivity arises from diferences in maturity dates and interest rate repricing gaps in the various balance sheet items. Taking into consideration the balance-sheet interest rate position and the market situation and outlook, the necessary fnancial actions are adopted to align this position with that desired by the Group. These measures can range from opening positions on markets to the defnition of the interest rate features of commercialised products. The metrics used by the Group to control interest rate risk in these activities are the repricing gap, the sensitivity of net interest margin and market value of equity to changes in interest rates, the duration of capital and value at risk (VaR) for economic capital calculation purposes. b) Interest rate gap on assets and liabilities This is the basic concept for identifying the Group’s interest rate risk profle and it measures the diference between the volume of sensitive assets and liabilities on and of balance sheet that re-price (i.e. that mature or are subject to rate revisions) at certain times (called, buckets). This provides an immediate approximation of the sensitivity of the entity’s balance sheet and its net interest income and equity value to changes in interest rates. f) Pre-payment treatment for certain assets The pre-payment issue mainly afects fxed-rate mortgages in units where the relevant interest rate curves for the balance sheet are at low levels. This risk is modelled in these units, and this can also be applied, with some modifcations, to assets without defned maturity (credit card businesses and similar). The usual techniques used to value options cannot be applied directly because of the complexity of the factors that determine borrower pre-payments. As a result, the models for assessing options must be combined with empirical statistical models that seek to capture pre-payment performance. Some of the factors conditioning this performance are: • Interest rate: the diferential between fxed rates on the mortgage and the market rate at which it could be refnanced, net of cancellation and opening costs. • Seasoning: refects the existing trend of lower prepayments at the beginning of the transaction’s life-cycle, which then increase and stabilises as time goes by. • Seasonality: redemptions or early cancellations tend to take place at specifc dates. • Burnout: decreasing trend in the speed of pre-payment as the instrument’s maturity approaches, which includes: a) Age: defnes low rates of pre-payment. c) Net interest income (NII) sensitivity This is a key measure of the proftability of balance sheet management. It is calculated as the diference which arises in the net interest income during a certain period of time due to a parallel movement in interest rates. The standard period for measuring net interest income sensitivity is one year. b) Cash pooling: defnes those loans that have already overcome various waves of interest rate falls as more stable. In other words, when a loan portfolio has passed one or more cycles of downward rates and thus high levels of pre-payment, the ‘surviving’ loans have a signifcantly lower pre-payment probability. d) Economic value of equity (EVE) sensitivity This measures the interest rate risk implicit in equity value (which for the purposes of interest rate risk is defned as the diference between the net current value of assets and the net current value of liabilities outstanding), based on the impact that a change in interest rates would have on those current values. e) Treatment of liabilities without defned maturity In the corporate model, the total volume of the balances of accounts without maturity is divided between stable and unstable balances which are obtained from a model that is based on the relationship between balances and their own moving averages. From this simplifed model, the monthly cash fows are obtained and used to calculate NII and EVE sensitivities. c) Other: geographic mobility, demographic, social and available income factors, etc. The series of econometric relationships that seek to capture the impact of all these factors is the probability of pre-payment of a loan or pool of loans and is denominated the pre-payment model. g) Value at Risk (VaR) For balance sheet activity and investment portfolios, this is defned as the 99% percentile of the distribution function of losses in equity value, calculated based on the current market value of positions and returns over the last two years, at a particular level of statistical confdence over a certain time horizon. As with trading portfolios, a time frame of two years or at least 520 days from the reference date of the VaR calculation is used. This model requires a variety of inputs: • Parameters inherent in the product. • Performance parameters of the client (in this case analysis of historic data is combined with the expert business view). • Market data. • Historic data of the portfolio. 384 2018 Annual Report The Group is working on implementing the guidelines published by the EBA on management of interest rate risk in the banking book (Irrbb), published in July 2018 and applicable in 2019. Net interest income sensitivity % of total 7% h) Structural foreign exchange rate risk/hedging of results These activities are monitored via position measurements, VaR and results, on a monthly basis. 29% i) Structural equity risk These activities are monitored via position measurements, VaR and results, on a monthly basis. 31% Parent Bank Poland US UK Other 8% 4.5 Key metrics (structural balance sheet risks) The market risk profle inherent in the Group’s balance sheet, in relation to its asset volumes and shareholders’ funds, as well as the budgeted net interest income margin, remained moderate in 2018, in line with previous years. The interest rate risk originated by commercial banking in each unit is transferred to its management – through an internal risk transfer system – to the local Financial division, which is responsible for the subsidiary’s structural risk management generated by interest rate fuctuations. The Group’s usual practice is to measure interest rate risk by using statistical models, relying on mitigation strategies of structural risk using interest rate instruments, such as fxed income bond portfolios and derivative instruments to maintain the risk profle at levels that are appropriate to the risk appetite approved by senior management. Structural interest rate risk Europe and United States The main balance sheets, the Parent, the UK and the US, in mature markets and in a low interest rate setting, usually show positive sensitivities to interest rates in economic value of equity and net interest income. Exposure levels in all countries are moderate in relation to the annual budget and capital levels. At the end of December 2018, risk on net interest income over one year , measured as sensitivity to parallel changes in the worst case scenario of ±100 basis points, was concentrated in the euro, at EUR 269 million, the pound sterling, at EUR 203 million, the US dollar, with EUR 130 million, and the Polish zloty, at EUR 53 million. 25% Other: Portugal and SCF. At the same date, the most signifcant risk in economic value of equity, measured as its sensitivity to parallel changes in the worst case scenario of ±100 basis points, was concentrated in the euro interest rate curve, at EUR 5,043 million, the pound sterling, with EUR 605 million, the Polish zloty, at EUR 62 million and the US dollar, at EUR 19 million. Economic value of equity sensitivity % of total 4% 4% 11% Parent Bank UK US Other 81% Other: Poland, Portugal and SCF. Latin America Latin American balance sheets are usually positioned for interest rate cuts for both economic value and net interest income, except for net interest income in Mexico, where liquidity excess is invested in the short term in the local currency. In 2018, exposure levels in all countries were moderate in relation to the annual budget and capital levels. At the end of December, risk on net interest income over one year, measured as sensitivity to parallel changes in the worst case scenario of ±100 basis points, was concentrated in three countries: Brazil (EUR 45 million), Chile (EUR 35 million) and Mexico (EUR 12 million), as shown in the chart below: 385 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Net interest income sensitivity % of total 12% 43% Brazil Chile Mexico Other 11% 34% Other: Argentina, Peru and Uruguay. Risk to the economic value of equity over one year, measured as sensitivity to parallel ± 100 basis point movements in the worst case scenario, was also concentrated in Brazil (EUR 419 million), Chile (EUR 219 million) and Mexico (EUR 172 million). Economic value of equity sensitivity % of total 3% 21% Brazil Chile Mexico Other 50% Balance sheet structural interest rate risk (VaR)A EUR million. VaR at a 99% over a one day horizon 2018 Minimum Average Maximum Latest Structural interest rate VaRA Diversifcation efect Europe and US Latin America 301.3 (49.5) 282.2 68.5 337.1 482.5 (113.2) (182.5) 340.2 110.1 535.2 129.7 319.5 (71.5) 319.1 72.0 2017 Minimum Average Maximum Latest Structural interest rate VaRA 280.9 373.9 459.6 459.6 Diversifcation efect (198.6) (230.3) (256.5) (169.1) Europe and US Latin America 362.6 116.9 433.6 170.6 517.8 198.4 511.8 116.9 2016 Minimum Average Maximum Latest Structural interest rate VaRA 242.5 340.6 405.8 327.2 Diversifcation efect (129.2) (271.0) (294.3) (288.6) Europe and US Latin America 157.7 214.0 376.8 234.9 449.3 250.8 365.0 250.8 26% A. Includes credit spread VaR on ALCO portfolios Other: Argentina, Peru and Uruguay. Balance sheet structural interest rate VaR In addition to sensitivities to interest rate movements (in which, assessments of ±100 bp movements are complemented by assessments of +/-25 bp, +/-50 bp and +/-75 bp movements to give a fuller understanding of risk in countries with very low rates), the Group also uses other methods to monitor structural balance sheet risk from interest rates movements: these include scenario analysis and VaR calculations, applying a similar methodology to that used for trading portfolios. The table below shows the average, minimum, maximum and year-end values of structural interest rate risk VaR over the last three years: Structural interest rate risk, measured in terms of VaR at one-day and at 99%, averaged EUR 337.1 million in 2018. It is important to note the high level of diversifcation between the balance sheets of Europe and United States and those of Latin America. Structural foreign exchange rate risk/hedging of results Structural exchange rate risk arises from Group transactions in foreign currencies, mainly related to permanent fnancial investments, results and the hedging of both. This management is dynamic and seeks to limit the impact on the core capital ratio from foreign exchange rates movements. In 2018, hedging levels of the core capital ratio for foreign exchange rate risk were maintained near 100%. 386 2018 Annual Report At the end of 2018, the largest exposures of permanent investments (with their potential impact on equity) were, in the following order, in Brazilian reais, US dollars, UK pounds sterling, Chilean pesos, Mexican pesos and Polish zlotys. The Group hedges some of these positions of a permanent nature with foreign exchange-rate derivatives. In addition, the fnancial area is responsible for managing foreign exchange rate risk for the Group’s expected results and dividends in units where the base currency is not the euro. Structural equity risk The Group maintains equity positions in its banking book in addition to those of the trading portfolio. These positions are maintained as equity instruments or as equity stakes, depending on the percentage or control. Among other sectors, to a lesser extent, are for example real estate activities or public administrations. Structural equity positions are exposed to market risk. VaR is calculated for these positions using market price data series or proxies. As of the end of December 2018, the VaR at 99% with a one day time frame was EUR 180.1 million (EUR 261.6 and EUR 323 million at the end of 2017 and 2016, respectively). Structural VaR A standardised metric such as VaR can be used for monitoring total market risk for the banking book, excluding the trading activity of SCIB (the VaR evolution for this activity is described in section 4.3 ‘Key metrics (trading market risk’), distinguishing between fxed income (considering both interest rates and credit spreads on ALCO portfolios), exchange rates and equities. The equity portfolio available for the banking book at the end of December 2018 was diversifed in securities in various countries, mainly Spain, China, Morocco, Netherlands and Poland. Most of the portfolio is invested in fnancial activities and insurance sectors. In general, structural VaR is not high in terms of the Group’s volume of assets or equity. Structural VaR EUR million. VaR at a 99% over a one day horizon 2018 2017 2016 Minimum Average Maximum 568.5 799.4 Latest 556.8 Average Latest Average Latest 878.0 815.7 869.3 922.1 Structural VaR Diversifcation efect VaR Interest RateA VaR Exchange Rate VaR Equities 485.0 (319.7) 301.3 323.3 180.1 A. Includes credit spread VaR on ALCO portfolios. (325.0) (355.4) (267.7) (337.3) (376.8) (323.4) (316.6) 337.1 338.9 217.6 482.5 386.2 286.1 319.5 324.9 180.1 373.9 546.9 294.5 459.6 471.2 261.6 340.6 603.4 248.7 327.2 588.5 323.0 387 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management 4.6 Liquidity risk management Methodologies The Group measures liquidity risk using a range of tools and metrics that account for the risk factors identifed within this risk. Liquidity bufer The bufer is a portion of the total liquidity available to an entity to deal with potential withdrawals of funds (liquidity outfows) that may arise as a result of periods of stress. Specifcally, a bufer consists of a set of unencumbered liquid resources that are available for immediate use and capable of generating liquidity promptly, without incurring any loss or excessive discount. The Group uses the liquidity bufer as a tool that forms part of the calculation of most liquidity metrics and is also a metric in its own, with specifed limits for each entity. Liquidity coverage ratio (LCR) LCR has a regulatory defnition. It is intended to reinforce the short-term resistance of banks’ liquidity risk profle by ensuring that they have available sufcient high-quality liquid assets to withstand a stress scenario (idiosyncratic stress or market stress) of considerable severity for thirty calendar days. Wholesale liquidity metric This metric takes the form of a liquidity horizon assuming non- renewable wholesale fnancing outfows; it measures the number of days the entity would survive using its liquid assets to cover that loss of liquidity. The Group uses this fgure as an internal short- term liquidity metric which also reduces the risk of dependence on wholesale funding. Net stable funding ratio (NSFR) NSFR is one of the metrics used by the Group to measure long-term liquidity risk. It is a regulatory metric defned as the coefcient of the available amount of stable funding and the required amount of stable funding. This metric requires banks to maintain a stable funding profle in relation to the composition of their assets and of-balance sheet activities. Structural funding ratio The structural funding ratio measures the volume of structural funding sources used by the entity in relation to all assets regarded as structural. This internal metric is used by each Group unit to measure long-term liquidity risk. It is intended to limit recourse to short-term wholesale funding and encourage the use of medium- and long-term instruments to fund requirements arising from the Group’s core business. Asset encumbrance metrics The Group uses at least two types of metric to measure asset encumbrance risk: (i) the asset encumbrance ratio, which calculates the proportion of total encumbered assets, which are unavailable for obtaining funds, to the entity’s total assets; and (ii) the structural asset encumbrance ratio, which measures the proportion of assets encumbered by reason of structural funding transactions (mainly long-term collateralised issues and funding from central banks). Other liquidity indicators Aside from traditional liquidity risk measurement tools for short- term risk and long-term or funding risk, the Group has constructed a range of additional liquidity indicators that supplement the conventional toolset and measure other liquidity risk factors not otherwise covered. Most of these indicators are concentration metrics, such as concentration on the fve largest counterparties from a liabilities point of view, or concentration of fnancing by time to maturity. Liquidity scenario analysis The Group uses four standard scenarios as liquidity stress tests: (i) an idiosyncratic scenario featuring events that adversely afect the Group alone; (ii) a local market scenario, which considers events having serious adverse efects on the fnancial system or real economy of the Group’s base country; (iii) a global market scenario, which considers events having serious adverse efects on the global fnancial system; and (iv) a combined scenario, coupling idiosyncratic events with severe (local and global) market events arising simultaneously and interactively. The Group uses the outcomes of the stress scenarios in combination with other tools to determine risk appetite and support business decision-making. Liquidity early warning indicators (EWIs) The system of liquidity EWIs comprises quantitative and qualitative indicators that enable us to foresee liquidity stress situations and potential weaknesses in the Group entities’ funding and liquidity structure. EWIs are both external (environmental), relating to market fnancial variables, or internal, relating to the Group’s own actions. 4.7 Key metrics (liquidity risk) The Group has a strong liquidity and fnancing position based on a decentralised liquidity model, where each of the Group’s units is autonomous in managing its liquidity and maintains large bufers of highly liquid assets. As a rule, short-term liquidity metrics, LCR remains stable, with regulatory ratios above the threshold (the minimum required in 2018 is 100%). The Group has an efective management of its liquidity bufers to face the challenge of maintaining a proper liquidity profle (regulatory limits) while protecting the proftability of our balance sheet. Furthermore, most of Santander’s units maintain sound balance sheet structures, with a stable fnancing structure based on a broad customer deposit base, which covers structural needs, with low dependence on short-term funding and liquidity metrics well above regulatory requirements, both locally and at Group level, and within the limits defned on the risk appetite framework. 388 2018 Annual Report A distinction is made between the following actuarial risks: Risk of life liability: risk of loss in the value of life assurance liabilities caused by fuctuations in risk factors that afect these liabilities: • Mortality/longevity risk: risk of loss due to changes in the value of liabilities as a result of changes in the estimate of the probability of death/survival of insureds. • Morbidity risk: risk of loss due to changes in the value of liabilities as a result of changes in the estimate of the probability of disability/incapacity of insureds. • Redemption/fall risk: risk of loss due to changes in the value of liabilities as a result of the early termination of the contract or changes in the policyholders’ exercise of rights with regard to redemption, extraordinary contributions and/or paid up options. • Expense risk: risk of loss due to changes in the value of liabilities arising from adverse variances in expected expenses. • Catastrophe risk: losses caused by the occurrence of catastrophic events that increase the entity’s life liabilities. Risk of non-life liability: risk of loss from the change in the value of the non-life insurance liability caused by fuctuations in risk factors that afect these liabilities: • Premium risk: loss derived from the insufciency of premiums to cover the disasters that might occur. • Reserve risk: loss derived from the insufciency of reserves for disasters, already incurred but not settled, including costs for management of these disasters. • Catastrophe risk: losses caused by catastrophic events that increase the Group’s non-life liability. Hence, for long-term liquidity, the regulatory metric NSFR remains above 100% for the Group’s core units and for the consolidated ratio. As to structural assets encumbrance risk, i.e. the risk of facing an excess of assets bearing charges or encumbrances in connection with fnancing transactions and other market operations, the Group-level risk is in line with our European peers, where the main sources of encumbrance are collateralised debt issuances (securitisations and covered bonds) and collateralised funding facilities provided by central banks. The soundness of Santander units’ balance sheets is also demonstrated under stress scenarios constructed in accordance with uniform corporate criteria across the Group. All units would survive the worst case scenario for at least 45 days, meeting liquidity requirements with their liquid asset bufers alone. For more detail regarding liquidity metrics, see the Economic and fnancial review chapter, section 3.4 ‘Liquidity and funding management’. 4.8 Pension and actuarial risk management Pension risk In managing the risk associated with the defned beneft employee pension funds, the Group assumes the fnancial, market, credit and liquidity risks incurred in connection with the fund’s assets and investments and the actuarial risks arising from the fund’s liabilities, i.e. the pension obligations to its employees. The aim pursued by the Group in pensions risk control and management is primarily to identify, measure, follow up, control, mitigate and report this risk. The Group’s priority is to therefore identify and mitigate all clusters of pension’s risk. This is why the methodology used by the Group estimates every year the combined losses in assets and liabilities under a defned stress scenario from changes in interest rates, infation, stocks markets and real estate prices, as well as credit and operational risk. Actuarial risk Actuarial risk arises due to biometric changes in the life expectancy of those with life insurance, from the unexpected increase in the compensation envisaged in non-life insurance and, in any case, from unexpected changes in the performance of insurance takers in the exercise of the options envisaged in the contracts. 389 Trading market risk, structural and liquidity riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management 5. Capital risk Planning 3 year plan Budget Capital adequacy Implementation and monitoring Capital measurement Reporting and disclosure Supervision of capital planning and adequacy exercises The review by the risk function of capital planning and adequacy exercises ensure that capital is consistent with the established risk appetite and risk profle. It has the following fundamental objectives: • Ensure that all relevant risks to which the Group is subject, in the course of its activity, are monitored. • Review the methodologies and assumptions used in these planning processes are appropriate. • Verify that results are reasonable and consistent with the business strategy, the macroeconomic environment and the variables of the system. • Assess the consistency between diferent tests, especially those which use base and stressed scenarios. 5.1 Introduction The Group defnes capital risk as the risk of lacking sufcient capital, in quantitative or qualitative terms, to fulfl its business objectives, regulatory requirements, or market expectations. 5.2 Capital risk management The capital risk function, as second line of defence carries out the control and supervision of the capital activities developed by the frst line of defence, which independently challenges mainly through the following processes: • Supervision of capital planning and adequacy exercises through a review of all their components (balance sheet, proft and loss account, risk-weighted assets and available capital). • Ongoing supervision of measurement of the Group’s regulatory capital by identifying the key metrics for the calculation, setting tolerance levels for identifed metrics and reviewing their consumption and the consistency of the calculations, including single transactions with a capital impact. The function is designed to carry out full and regular monitoring of capital risk by verifying that capital is sufcient and adequately covered in accordance with the Group’s risk profle. Capital risk control is part of the general corporate risk framework, which brings together a range of processes, such as capital planning and adequacy and the subsequent budget execution and monitoring, alongside the ongoing measurement of capital and the reporting and disclosure of capital data, as described below: 390 2018 Annual Report This function is implemented in phases, according to the following scheme: If deemed necessary, a discussion of them will be proposed in the relevant frst-line (capital committee) and second-line committees (risk control committee). Defnition of scope Qualitative analysis Quantitative analysis Conclusion and disclosure Defnition of scope The process of supervision of capital planning and adequacy begins with the preparation of the materiality proposal, which will identify the local units whose importance is representative for the Group in terms of risk-weighted assets. In addition, other units, businesses or portfolios may be included, even if their materiality does not make them very representative, if deemed appropriate to be analysed due to their impact on the Group’s strategy, compliance with the global plan or due to their timely relevance. Ongoing supervision of capital measurement Ongoing supervision of the measurement of the Group’s regulatory capital, ensuring an appropriate capital risk profle, is another capital risk control function. For this purpose, the Group conducts qualitative analysis of the regulatory and supervisory framework and an ongoing review of capital metrics and specifed thresholds. Moreover, ongoing monitoring of compliance with the capital risk appetite is conducted aiming to maintain capital above the regulatory requirements and market demands. To fulfl this function, the following phases have been established, in accordance with the process described below: Qualitative analysis In this phase, the overall quality of the qualitative forecasts process is assessed, and includes a review of the following aspects: Defnition of metrics and thresholds Preliminary analysis Measurement and assessment Conclusions and disclosure • Models used in the generation of forecasts and scenarios, scope, metrics covered and so on. • Documentation available and provided in the generation process. Defnition of metrics and thresholds A set of metrics and thresholds that are used in the supervision process and provide the capital risk monitoring and control view are specifed on an annual basis. • The quality of the information included in the forecasts, the integrity of the data, the controls applied, the recommendations issued by Internal Audit, etc. The metrics consist of: • Primary metrics: these cover capital ratios and its components in numerator and denominator at the highest level, in addition to the transformation ratio, the EAD and expected loss. • Secondary metrics: these include a greater breakdown than the above (credit RWA’s under the Basel category or the basis on which market RWA’s are calculated). • Supplementary metrics: these allow for a more detailed analysis than the above. Thresholds are set in certain metrics which, if breached, trigger a more detailed analysis and an explanation of the causes of the breach. The metrics, their thresholds and the sources of information used are outlined in the internal ‘Guidelines of Metrics of Capital Measurement Control’. • Governance of the process, committees in which the forecasts have been presented and reviewed, approval by areas prior to fnal approval. Quantitative analysis The defned metrics and components that afect projections of risk weighted assets (RWA), available capital, pre-provision net revenue (PPNR) and of provisions are quantitatively assessed. The tests conducted include analysis of volumes, trends, reasonableness and cross-checks against the development of macroeconomic variables and historic data series. This phase calls for the involvement and appropriate coordination of all subsidiaries within the scope of the process, to conduct analysis of local projections, which in turn underpin Group-level projections. Conclusions and disclosure Based on the outcomes from the capital planning and adequacy phases, the Group conducts a fnal assessment, at least encompassing the scope of analysis, the weaknesses and the areas for improvement detected in the course of the supervision process, reporting to senior management in accordance with the established governance. 391 Capital RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Preliminary analysis At this phase of the control process, the qualitative issues, such as process governance and regulatory framework are analysed. In addition, the steps taken in connection with capital to fulfl recommendations and instructions issued by supervisory authorities and by internal audit function are examined. Measurement assessment Based on the information provided, the capital risk function analyses the metrics defned in the process, according to the following procedure: • Review of primary and secondary metrics to detect variations that exceed the defned thresholds, and where they do, perform a detailed analysis of the causes and analysing supplementary metrics. • If the origin of the incidence lies in a specifc unit or corporate area, more detailed information is requested. • Incidences found must be duly explained in terms of their causes (change in volumes, changes in the profle, one-ofs, BAU initiatives, capital actions, etc.) and discussed with the unit or corporate function involved, and with the regulatory capital and pensions function. Conclusions and disclosure The report with the conclusions is discussed by the governance body responsible for capital risk control and risk forecasting and is distributed to the regulatory capital and pensions function. If deemed necessary, the report will be proposed for discussion in the relevant frst line (Capital committee) and second-line committees (Risk control committee). Oversight of signifcant risk transfer assessment In addition, capital risk carries out the supervision of signifcant risk transfer (SRT) of securitisations. This process is a prior step and a fundamental requirement for the execution of securitisations that have SRT. 5.3 Key metrics For more detail see chapter Economic and fnancial review, section 3.5 ‘Capital management and adequacy. Solvency ratios’. 392 2018 Annual Report 6. Operational risk 6.1 Introduction Following the Basel framework, the Group defnes operational risk (OR) as the risk of losses arising from defects or failures in its internal processes, people, systems or external events, thus covering risk categories such as fraud, technological, cyber, legal and conduct risk. Mitigation plans have been promoted on aspects with special relevance (fraud, data and cybersecurity and suppliers control, among others), focused on both the implementation of corrective actions and the adequate monitoring and management of projects under development. In addition, contingency and business continuity plans have been improved, as well as in terms of crisis management. Operational risk is inherent to all products, activities, processes and systems and is generated in all business and support areas. For this reason, all employees are responsible for managing and controlling the operational risks generated in their sphere of action. 6.2 Operational risk management In the Group, OR is managed in accordance with the following phases: The Group’s goal in terms of OR management and control is focused on identifying, evaluating and mitigating sources of risk, regardless of whether they have materialised or not. The analysis of OR exposure contributes to the establish risk management priorities. It is worth mentioning the risk analysis improvement carried out in 2018 through different initiatives such as data quality enrichment, the incorporation of additional risk appetite metrics and improvements in the process of determining, identifying and evaluating critical theoretical controls together with a greater integration of operational risk within the Group’s strategic planning. Risk identifcation, measurement and assessment model A series of quantitative and qualitative corporate techniques and tools have been defned by the Group to identify, measure and assess operational risk. These are combined to produce a diagnosis on the basis of the risks identifed and an assessment of each area or local unit, through their measurement and evaluation. The quantitative analysis of this risk is carried out mainly with tools that record and quantify the level of potential losses associated with operational risk events. The qualitative analysis seek to assess aspects of exposure and hedge (including the control environment) 393 Operational RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management The most important operational risk tools used by the Group are the following: • Internal events database. The objective is to capture the Group’s operational risk events. This is not restricted by thresholds (i.e. there are no exclusions for reasons of amount), and includes those events with impact on the fnancial statements or proft and loss account and those with no such impact. Internal databases are supplemented by the signifcant events escalation process, which allows to inform and alert senior management the key operational risk events arising across the Group on a timely basis. • Operational risk control self-assessment (RCSA). A qualitative process that seeks, using the criteria and experience of a pool of experts in each function, to determine the main operational risks for each function, the control environment and their allocation to the diferent functions on the Group. The goal of RCSA is to identify and assess the material operational risks that could prevent business or support units from achieving their objective. Once they are assessed, mitigation actions are identifed if the risk levels prove to be above the tolerable profle. The Group also elaborates risk assessments for specifc sources of operational risk, enabling a more granular and transversal identifcation of potential risks. These are applied in particular to technological risks, fraud and factors that could lead to regulatory non-compliance, and areas that are exposed to money laundering and terrorism fnancing risks. The two latter areas, together with the conduct risks factor, are set out in greater detail in section 7.3 ‘Compliance and conduct risk management’, in this chapter’. • External event database15. The external database provides quantitative and qualitative information, allowing for a more detailed and structured analysis of relevant events that have occurred in the sector, the comparison of the profle of losses with the industry, both locally and globally and the appropriate preparation for the RCSA exercise and scenario analysis. • Analysis of OR scenarios. The objective is to identify potential events with a very low probability of occurrence, but which could result in a very high loss for the Group. The potential efects are assessed and extra controls and mitigating actions are identifed to reduce the likelihood of high economic impact. Expert opinion is obtained from the business lines and risk and control managers. • Corporate indicators system. These are diferent types of statistics and parameters that provide information on an institution’s risk exposure and control environment. The most signifcant indicators regarding the level of risk of the diferent factors are part of the metrics on which operational risk appetite is built. • Internal Audit and regulatory recommendations. These provide relevant information on inherent risk due to internal and external factors, enabling weaknesses in the existing controls to be identifed. • Customer complaints. The Group’s increasing systemisation of the monitoring of complaints and their root causes also provides relevant information for identifying and measuring risk levels. In this regard, the compliance and conduct function prepares a detailed analysis, as set out in section 7.3 ‘Compliance and conduct risk management’ in this chapter. • Other specifc instruments. These enable a more detailed analysis of technology risk, such as control of critical system incidents and cybersecurity events. • Internal data model. Application of statistical models is used to capture the Group’s risk profle, mainly based on information collected from the internal loss database, external data and scenarios. The main application of the model is to help determine economic capital and estimate expected and stressed losses, as a tool for specifying operational risk appetite. The risk profle is part of the non-fnancial risks risk appetite, and is structured as follows: • A general statement setting out that Santander is, on principle, averse to operational risk events that could lead to fnancial loss, fraud and operational, technological, legal and regulatory breaches, conduct problems or damage to its reputation. • General metrics of expected loss, stressed losses and overdue Internal Audit recommendations. • An additional statement is included for the more relevant risk factors, together with a number of forward-looking monitoring metrics. Specifcally, on the following: internal and external fraud, technological, cyber, legal, anti-money laundering, commercialisation of products, regulatory compliance and supplier management risk. Model implementation and initiatives Almost all the Group’s units are now incorporated into the OR model with a high degree of homogeneity. The main activities and global initiatives adopted in 2018 for efective operational risk management are: • Continuous enhancement of available information, especially the internal loss database, key to ensure the integration of all instruments and be able to perform an information cross- analysis. • Evolution and improvement of the objective qualifcation methodology for the evaluation and reporting of the main risks (Top risks) that include risk exposure, control and regulatory 15. Santander participates in international consortiums such as the ORX (Operational Risk Exchange). 394 2018 Annual Report environment and take into account the actual and forecasted elements. This methodology provides a more detailed process for fnal determination of the risk level and trend. It encourages prioritisation in risk management and the defnition of specifc mitigation plans, while supporting periodic risk communication to senior management. • Incorporation of additional risk appetite metrics related to internal fraud within the market operations scope and the cybersecurity risk. • Process improvements for the determination, identifcation and assessment of critical theoretical controls, with the aim of strengthening and homogenizing the control environment in the Group. • Greater integration of operational risk in the Group’s strategic plan, by including information regarding the potential exposure of operational risk for the next three years as well as the estimated level of losses. • Mitigation plans fostering for aspects of particular relevance (fraud, information security and cybersecurity in the widest sense, control of suppliers, among others): control of both, implementation of corrective measures and projects under development. • Improvements to contingency, business continuity and, in general, crisis management plans (initiative linked to the recovery and resolution plans), also providing coverage to emerging risks (cyber). • Fostering the control of risk associated with technology (control and supervision of the IT systems design, infrastructure management and applications development). For the suppliers control previously mentioned, the Group, as part of its digitalisation strategy, aims to ofer its customers the best solutions and products available in the market, which in many cases entail an increase in the outsourcing activities or the employment of third party services. This aspect, together with the intensive use of new technologies such as the cloud, the increase of cyber related risks and an increase in regulatory pressure in this area, make it necessary to reinforce procedures and controls to ensure that the risks arising from hiring suppliers are known and managed appropriately. In this regard, in 2018 a new version of the corporate reference model was approved, and progress has been made in defning and implementing policies, procedures and tools in the Group’s entities in order to reinforce its implementation and to ensure that adequate coverage is given to the current regulatory requirements regarding the General data protection regulation (GDPR) anticipating new requirements contemplated in the new EBA regulations related to outsourcing as well as agreements with third parties. In 2018, the eforts have been mainly aimed at: • Establishment of the vendor risk assessment centre (VRAC) function within the purchasing of the Group’s entity responsible for purchases, with the aim of making suppliers’ evaluation more efcient and homogenised. To ensure that related risks are adequately covered, and homologation process is executed before the service is provided. In addition, VRAC should help to defne and monitor the mitigation plans, and to reinforce those controls needed for the risks associated with services provider to acceptable levels according to the Group’s risk appetite. • Controls have been reinforced in the diferent phases of the model to ensure that services that involve access or processing of sensitive data, including personal data, are correctly identifed and classifed. Specifcally: • Policies have been developed to defne the criteria for data classifcation according to its sensitivity level and to establish the minimum protection requirements that must be observed for each confdentiality level (including those established by GDPR). • Development of specifc questionnaires to evaluate supplier’s controls against these requirements, and clauses that must be included in contracts with suppliers that process or store confdential information. • Establishment of a specifc escalation and governance procedure for services approval that involve the treatment or storage, by the provider, of data considered to be particularly sensitive. • During 2018, progress has been made with those providers identifed as critical in the recovery and resolution plans, aiming to include clauses that ensure the continuity of the services provided in case it was necessary to activate those plans. • The escalation policy has been revised to ensure that the essential outsourcing functions and the highest risk services are reviewed and approved in the appropriate forums and that the relevant incidents associated with suppliers that provide these services are escalated in time and manner for its review and decision-making. • Indicators and dashboard defnition and monitoring concerning the model implementation. • Review and enhancing quality of data of inventories of relevant services and associated suppliers. • Progress in the implementation of a management system that automates the diferent phases of the supplier management cycle to achieve enhanced process control and higher information quality. • Training and awareness raising of risks associated with suppliers and other third parties. 395 Operational RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management The Group continues to work on the implementation and consolidation of the model, reinforcing and standardising the activities to be carried out throughout the management cycle of suppliers and third parties. Operational risk information system The Group’s corporate information system for operational risk, named Heracles, supports operational risk management tools, providing information for reporting functions and needs at both local and Group levels. Heracles main goal is to improve decision- making in the OR management process throughout the Group. This is achieved by ensuring that those responsible for risks in every part of the Group have a complete view of the risk, and the supporting information they need, when needed. This complete and timely view of risk is obtained as a result of the integration of several programs, such as risk and control assessment, scenarios, events and metrics with a common set of taxonomies, and methodological standards. The result of this integration is a more precise risk profle and a signifcant improvement in efciency by avoiding redundant eforts and duplicities. After the incorporation of the thematic evaluation and scenarios modules, in 2018 improvements have been made to strengthen the integration between the diferent modules and simplify the system fow. Likewise, progress has been done to improve reporting capabilities in complying with the Risk Data Aggregation regulation. In order to achieve the latter goal, a reference technological architecture has been developed, providing solutions for information gathering, single database feeding (golden source) and the generation of operational risk reports. The most signifcant mitigation actions have been focused on improving the security of customers in their usual operations, the management of external fraud, as well as continuous improvements of processes and technology, sale of products management and adequate provision of services. Regarding the fraud reduction, the main specifc actions were the following: Card fraud: • Generalisation of the use of Chip & Pin (operation with PIN-cards, which require the signing of the transaction with a numeric code), both in ATMs and in physical stores, with advanced authentication mechanisms in the communication between the ATM and the point-of-sale and the Group’s systems. • Card protection against electronic commerce fraud attacks (which is still the fastest-growing fraud pattern in the industry): • Implementation of a secure e-commerce standard (3DSecure) via two-step authentication based on one-time passwords. • Innovative solutions based on mobile applications that let users deactivate cards for e-commerce use. • Issue of virtual cards using dynamic authentication passwords. • Use in Brazil of a biometric authentication system in ATMs and branch cashier desks. Customers can use this new system to withdraw cash from ATMs using their fngerprint to sign of their transactions. • Integration of monitoring and fraud detection tools with other systems, internally and externally, to enhance suspicious activity detection capabilities. In addition, further advances have been carried out by the Group regarding data supply automation from the local units’ systems of record. • Reinforced ATM security by incorporating physical protection elements and anti-skimming, as well as improvements in the logical security of the devices. Mitigation actions In line with the model, the Group monitors those mitigation actions related with the main risk sources which have been identifed through the internal OR management tools (internal event database, indicators, self-assessment, scenarios, audit recommendations, etc.) and other external information sources (external events and industry reports). Active mitigation management has become even more important in 2018, in which both the frst line of defence and the OR control function intervene, establishing an additional control through specialised business and support functions. Furthermore, the Group has continued to promote the preventive implementation of policies and procedures for OR management and control. Online/mobile banking fraud: • Validations of online banking transactions through a second security factor based on one-time use passwords. Evolution of technology, depending on the geographic area (for example, based on image codes -QR codes - generated from data for the transaction). • Enhanced online banking security by introducing a transaction risk scoring system that requests further authentication when a given security threshold is breached. • Implementation of specifc protection measures for mobile banking, such as identifcation and registration of customer devices (Device Id). 396 2018 Annual Report • Monitor e-banking platform’s security to avoid attacks on the systems. Cybersecurity and data security plans: Throughout the year, Santander continued paying full attention to cybersecurity risks, which afect all companies and institutions, including those in the fnancial sector. This situation is a cause of concern for all entities and regulators, prompting the implementation of preventive actions to be prepared for any attack of this kind. Santander has continued to develop its cybersecurity internal regulation with the defnition of a set of policies that reinforce the Global cybersecurity framework, aligned with international best practices. In relation to second line internal regulation, it should be noted that in July 2018 the executive risk committee approved a new version of the cyber supervision and control model, incorporating the technological risk within its scope. The Group is involved in an ambitious program to transform cybersecurity in order to strengthen detection, response and protection mechanisms. Innovation and continuous improvement in cybersecurity is key to address current and emerging threats, and it is a priority for Santander. Also, observation and analytical assessment of the events in the sector and in other industries enables Santander to update and adapt its models for emerging threats. Other relevant mitigating actions: The Group has established mitigation actions in order to optimise management processes according to our customer’s needs. With regard to mitigation measures relating to customer practices, products and business, Santander is involved in continuous improvement and implementation of corporate policies on aspects such as the selling of products and services and prevention of money laundering and terrorism fnancing, as described in section 7.3 ‘Compliance and conduct risk management’, in this chapter. Also related with the same category of operational risk, within the continuous process carried out in Brazil to improve the internal processes and products ofered, in order to provide a better service to our customers and, thereby, reduce the volume of incidents and legal claims, it is noteworthy the creation of joint and multidisciplinary working groups for the identifcation, defnition and implementation of mitigation actions, as well as monitoring of their efectiveness. Business continuity plan The Group has a Business Continuity Management System (BCMS), to guarantee the continuity of the business processes of its entities in the event of a disaster or serious incident. surem ent- C a e M Impact analysis o u s u n ti n o i m p rovementofthe b u sin e s s Defnition of continuity strategy c o n t i n u i t y a nisatio n Or g BMCS Policy overn a n c e G y t i u n i t n o c Training and maintenance testing s s e sin u b improvementofthe M e a Development of crisis management procedures ntin o u ous surement-C The basic goal is to: • Minimise the potential damage on people, and adverse fnancial and business impacts for the Group, caused by the interruption of normal business activities • Reduce the operational efects of a disaster, providing pre- defned and fexible guidelines and procedures to be used to re- launch and recover processes. • Restart time-sensitive business operations and associated support functions, in order to achieve business continuity, stable profts and planned growth. • Protect the public image of, and confdence in, the Group. • Meet the Group’s obligations to its employees, customers, shareholders and other stakeholders. In 2018, the Group continued to advance in implementing and continuously improving its business continuity management system. The new model has been implemented in all countries and the defnition and implementation of cybersecurity scenarios has been pursued. Furthermore, several crisis simulation exercises have been carried out, coordinated between the local units and the corporation, involving the Group’s various crisis management committees and senior management. The Group has also updated the corporate application that is used to register and store the Group’s continuity plans to allow for associating the economic functions set by the European Banking Union´s resolution authority, the SRB. 397 Operational RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management   6.3 Key metrics Net losses (including both incurred loss and net provisions) by Basel16 risk category over the last three years is as follows: Distribution of net losses by operational risk category17 (% s/total) 80% 70% 60% 50% 40% 30% 20% 10% 0% 60% 2016 2017 2018 18% 18% 0% I - Internal fraud II - External fraud 2% 2% 0,3% III - Employment practices and workplace safety IV - Practices with customers and products, and business practices V - Damage to physical assets VI - Business disruption and system failures VII - Execution, delivery and process management In relative terms, the losses in the category of customers, products and business practices decrease regarding the previous year, although for external fraud has increased. The net losses by geography are presented in the following chart: Net losses by country Brazil 45% Spain 15% Mexico 5% Others 9% UK 14% US 12% Employee’s litigation in Brazil is managed as personnel expenses. It is not included in the operational fgures since they are considered, from a point of view of management view, as part of the entity’s personnel cost. The Group’s governing bodies perform a continuous monitoring of the levels of expenditure as well as of the measures designed for their reduction. According to the Basel Operational risk framework, these expenses are reporting according to the applicable categorisation. In 2018, the most signifcant losses by category and geography correspond to litigation in Brazil where a set of actions is in place to improve customer service (gathered in a complete mitigation plan, as described in section 6.2 ‘Operational risk management’ in this chapter). On the other hand, in 2018 the volume of losses in the UK and the US has decreased due to the reduction in provisions that cover cases of product commercialisation, regulatory inspections and processes failures. Regarding external fraud, the main concentration risk is still related to the fraudulent use of debit and credit cards, with a signifcant rise in fraud in non-physical card. The forecast for next year is for this trend to continue, with an intensifcation of the activity of fraudsters in payment transactions and electronic commerce. 16. The Basel categories incorporate risks which are detailed in section 7”Compliance and conduct risk”. 17. Includes losses from the B. Popular and other perimeter changes. 398 2018 Annual Report 6.4 Other aspects of control and monitoring of operational risk Analysis and monitoring of controls in market operations Due to the specifc nature and complexity of fnancial markets, the Group considers it necessary to continuously improve operational control procedures to keep them in line with new regulations and best practices in the market, with a focus on: • Adapting the control model to new regulatory requirements, such as MiFID II, EMIR, PRIIPS, IFRS9 and GDPR, among others. • Constant improvement with the monitoring of global standards on controls related to market activity. These include those that mitigate the risk of unauthorised trading and that are measured periodically through a specifc risk appetite metric for this issue. • Strengthening business continuity plans by incorporating – among other improvements – new scenarios refecting new risks in the industry. • Reinforcing controls ensuring appropriate functional separation in market operations systems. • Improvements in the tool to control the communications that occur in the treasury desks. • Identifcation of all risks in the Group that can be hedged with insurance, including identifcation of new insurance coverage for risks already identifed in the market. • Establishment and implementation of criteria to quantify the insurable risk, backed by loss analysis and the scenarios that enable the Group’s level of exposure to each risk to be determined. • Analysis of coverage available in the insurance market, as well as preliminary design of the conditions that best suit the identifed and assessed needs. • Technical assessment of the protection provided by the policy, its costs and retention level that the Group is assuming (franchises and other elements borne by the insured) in order to evaluate and decide about its formalisation regarding those risks that should be covered. • Negotiating with suppliers and contract allocation in accordance with the procedures established by the Group. • Monitoring of incidents declared in the policies, as well as of those not declared or not recovered due to an incorrect declaration, establishing protocols for action and specifc monitoring forums. • Analysis of the adequacy of the Group’s policies for the risks • Intensifed scrutiny of markets-related suppliers, given the critical nature of this topic in view of market trends in online trading. covered, taking appropriate corrective measures for any shortcomings detected. • Incorporation of new controls on algorithmic trading following the best practices of the industry and the requirements of MiFID II. • Close cooperation between local operational risk executives and local insurance coordinators to strengthen operational risk mitigation. For more information on issues relating to regulatory compliance in markets, refer to section 7.3 ‘Regulatory compliance’. Lastly, it is important to note that the business is also undertaking a global transformation that involves modernising its technology platforms and operational processes. This will allow, among other objectives, for reinforcing the control model and reduce the operational risk associated with the business. Insurance’s role in operational risk management The Group regards insurance as a key element in the management of operational risk. In 2018, we have continued to develop procedures with the goal of achieving better coordination between the diferent functions involved in the management cycle of insurance policies used to mitigate operational risk. Once the functional relationship between the own insurance and operational risk control areas is established, the primary goal is to inform the diferent frst line risk management areas of adequate guidelines for efective management of insurable risk. The following activities are particularly important: • Active involvement of both areas in the own insurance forum, the Group’s highest technical body for defning coverage strategies and contracting insurance, (replicated in each geography to monitor the activities mentioned in this section), the claim monitoring forum, and the Corporate operational risk committee. Our own insurance area is a permanent member of diferent forums/committees of the Group related to risk management (damage to physical assets, fraud, scenarios, management of special situations, etc.), thereby increasing its interaction with other Group functions and its capacity to appropriately identify and evaluate the insurable risks and optimise the protection of the income statement. 399 Operational RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management 7. Compliance and conduct risk 7.1 Introduction The Compliance and Conduct function fosters the Group´s adherence to the rules, supervisory requirements, and principles and values of good conduct, by setting standards, advising and reporting in the interest of employees, customers, shareholders and the community as a whole. This function addresses all matters related to: • Regulatory compliance. • Prevention of money laundering and terrorism fnancing. • Governance of products and consumer protection. • Reputational risk. Under the current confguration of the three lines of defence at the Group, compliance and conduct is an independent second-line control function organisationally under the Group CRO, reporting directly and regularly to the board of directors and its committees, through the Group Chief Compliance Ofcer (Group CRO). This confguration is aligned with the requirements of banking regulation and with the expectations of supervisors. centre, towards the end of 2018, thus achieving a Compliance and Conduct function that is on par with the best standards in the fnancial industry. The Group sets out in its risk appetite framework its zero tolerance for Compliance and Conduct risks, with the clear goal of minimising the probability of any economic, regulatory or reputational impact occurring within the Group. Compliance and Conduct risk is manged through a homogeneous process in units, by establishing a common methodology and taxonomy, according to the standards of the Risk function, which consists of setting a series of Compliance and Conduct risk indicators and assessment matrices which are prepared for each local unit, as well as qualitative statements. During 2018, the Compliance and Conduct function has taken part in the annual formulation of the risk appetite, with the objective of verifying that the current model is suitable for measuring the function’s risk appetite. The corporate thresholds of two of the indicators were adjusted, reducing them, and the calculation of another was reformulated in order to provide a more accurate picture and align it with the strategy of the function and its risk tolerance. The relevant committees approved the adjustments and these were sent to the diferent local units. The Group’s goal is to minimise the probability of non-compliance events and to identify, assess, report and quickly resolve any irregularities that may occur. 7.2 Governance In accordance with the mandate entrusted to the Compliance and Conduct function improvements were made, in 2018, in the strategic compliance programme. In the two previous years, the scope and objectives of the Compliance and Conduct target operation model (TOM) were defned, and the initiative was implemented in the Group’s local units and at the Corporate The Group CRO reports to the Group’s governing and management bodies. This is independent of the Risk function’s other reporting to the governance and management bodies of all Group risks, which also includes compliance and conduct risks. The following are the compliance and conduct corporate committees, each of which has a corresponding local replica: 400 2018 Annual Report Group Compliance & Conduct – committees landscape Board of directors Risk supervision, regulation and compliance committee See the Corporate governance chapter, section 4.7 – Risk supervision, regulation and compliance committee activities in 2018 d n a e c n a i l p m o C s e e t t i m m o c t c u d n o C Tier I Compliance committee (Monthly) Regulatory compliance committee Tier II Commercialisation committee Monitoring and consumer prot. committee Anti money laundering committee Reputational risk forum (Quarterly) (Monthly) (Fortnightly) (Quarterly) (Quarterly) Regulatory compliance Governance of products and consumer protection Anti-money laundering and terrorism financing Reputational risk Control and supervision of regulatory compliance risk events related to employees, organisational aspects, international markets, developing policies and rules and ensuring compliance by units. Management, control and supervision of governance of products and services in the Group, and risks relating to commercialisation conduct with customers, consumer protection, and fiduciary risk for financial instruments, developing specific policies and regulations in this regard. Management, control and supervision of the application of the anti- money laundering and terrorism financing framework, coordinating analysis of local and Group information to identify new risks that that could result in domestic or international sanctions. Analysis of new suppliers and participants in corporate transactions for approval and ensuring units comply with the rules and policies established in this regard. Defines, controls and oversees the reputational risk model through prevention and early detection of risks and events and mitigation of any potential impact on the Group’s reputation or any impairment to how the Group is perceived by stakeholders (customers, shareholders, investors, employees, public opinion and the wider community). The corporate compliance and conduct committee is the high- level collegiate body of the compliance and conduct function, bringing together the objectives of the committees referred to below. Its main functions are as follows: • Setting up and assessing corrective actions when risks of this kind are detected in the Group, either due to weaknesses in the existing management and controls management, or due to emerging new risks. • Proposing updates and modifcations to the General compliance framework and corporate function frameworks for ultimate approval by the board of directors. • Monitoring new issued regulations or those modifed, and establishing their scope of application in the Group, and, if necessary, defning adaptation or mitigation actions. • Reviewing signifcant compliance and conduct risk events and situations, the measures adopted and their efectiveness, and proposing that they be escalated or transferred, whenever the case may be. 401 Compliance and conduct RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management The regulatory compliance committee is a collegiate governance body whose main functions are the following: The anti-money laundering/terrorism fnancing committee (AML/TF) is the collegiate body in this feld, and its main duties are as follows: • Specifying the Group CRO regulatory compliance risk control model based on common regulations applicable to several countries. • Defning the AML/TF risk control model in the Group. • Creating reference models for the development of the AML/TF • Deciding on signifcant regulatory compliance issues that might framework and its implementing regulation. pose a risk to the Group. • Interpreting the General Code of Conduct and specialised codes, and making proposals for their improvement. • Monitoring projects for improvement and transformation plans for AML/TF and, where appropriate, setting in motion supporting or corrective actions. The corporate commercialisation committee is the collegiate governance body for the approval of products and services. It has the following key functions: The reputational risk forum is the body created to support the diferent governing bodies of the Group in the supervision and control of reputational risk, ensuring its proper management and understanding. Its main functions are: • Validating new products or services proposed by the parent company or by any subsidiary/Group local unit, prior to their launch. • Establishing the commercialisation risk control model, including risk assessment indicators, and proposing the commercialisation and consumer protection risk appetite to the Compliance committee. • Establishing interpretative criteria and approving the reference models to develop the corporate commercialisation framework, and its rules, and to validate the local adaptations of those models. • Assessing and deciding on signifcant commercialisation issues that might pose a risk for the Group. The monitoring and consumer protection committee is the collegiate governance body for the monitoring of products and services, and the assessment of customer protection issues. It has the following key functions: • Monitoring the commercialisation of products and services by country and by product type, reviewing all the available information and focusing on products and services under special monitoring, and costs of conduct, compensation to customers, sanctions, etc. • Monitoring the common claim measurement and reporting methodology, based on root cause analysis, and the quality and sufciency of the information obtained. • Establishing and assessing how efective corrective measures can be when risks are detected in the governance of products and consumer protection. • Identifying, managing and reporting preventively on the problems, events, signifcant situations and best practices in commercialisation and consumer protection in a transversal manner. • Monitoring and continuous supervision of risks and reputational events, verifying if the profle of this risk is within the limits of the group’s appetite. • Developing action plans to reduce the impact of this risk and monitor them. • Reviewing and preparing reports and other documentation of reputational risk presented to the diferent governing bodies of the Group. 7.3 Compliance and conduct risk management The frst line of defence has the primary responsibility for managing compliance and conduct risks together with the business units where such risks originate, as well as the Compliance and Conduct function. This is performed either directly or through assigning compliance and conduct activities or tasks. The Compliance and Conduct function is responsible for setting up, fostering and ensuring that the local units adhere to the corporate frameworks, policies and standards applied throughout the Group. Compliance and Conduct continue to make progress in the development and design of the function’s regulatory tree and in the supervision of local units’ degree of adherence to it. The Corporate centre has the necessary components to ensure ongoing control and oversight of the compliance and conduct model, establishing robust systems of governance and systematic reporting and interaction with the local units in accordance with the Group’s subsidiary governance model. Additional detail regarding the Group’s governance model is available in the Corporate governance chapter, section 7 ‘Group structure and governance framework’. 402 2018 Annual Report Furthermore, Internal Audit - as third line of defence function - performs the tests and audits necessary to verify that adequate controls and oversight mechanisms are being applied, and that the Group’s rules and procedures are being followed. Corporate frameworks for the Compliance and Conduct function are the following: • General compliance framework. • Assessment of AML/TF on the units considered as obliged entities in this matter (or equivalent) in the Group. This annual self-assessment exercise is carried out by the business units and the local AML/TF prevention ofcers, under the supervision of the Corporate centre AML/TF prevention function. The common methodology adopted by the Group for the above mentioned assessments can be broadly summarised in a three phase process: • Products and services commercialisation and consumer 1. Assessment of unit’s inherent risk (deriving from its activity). protection framework. 2. Assessment of control environment (as a mitigating factor of the • Anti-money laundering and terrorism fnancing framework. inherent risk). The General Code of Conduct (GCC) enshrines the ethical principles and rules of conduct that govern the actions of all the Group’s employees. It is supplemented in certain matters by the rules found in other codes and their internal rules and regulations. 3. Calculation of net residual risk (derived from the combination of the two previous point’s measures according to a predefned scale). Where appropriate, and depending on the result obtained, the corresponding action plans are defned. In 2018, the main geographies consolidated the reputational risk model that contains the main elements for risk management and identifes the most signifcant sources of this type of risk. It establishes a preventive approach for its correct management and determines the functions involved in the management and control of this risk and its governance bodies. Transversal corporate projects In accordance with the organisational principles defned in the Group Compliance and Conduct TOM, transversal functions support specialised vertical functions, providing them with methodologies and resources, management systems and information and support in executing multidisciplinary projects. One of the key pillars of all the corporate functions is monitoring the units’ deployment of models. For this purpose, a methodology that enables the following has been defned: • To acquire an objective knowledge of the TOM’s degree of implementation in each one of the units. • Regularly follow up on progress in deploying the TOM. • Be used as a source for joint identifcation (Group-units) of the annual work plans defned every year. The Compliance and Conduct function oversees the efective implementation and monitoring of the General Code of Conduct under the supervision of the compliance committee and of the risk supervision, regulation and compliance committee. The GCC establishes the following: • Compliance functions and responsibilities. • The rules governing the consequences of non-compliance with it. • A whistleblowing channel for the submission and processing of reports of allegedly irregular conduct. During 2018, the Compliance and Conduct function has carried out several risk assessments in coordination with the Risk function, notably: • A regulatory compliance assessment focused on the Group’s main local units. This exercise is carried out annually, following a bottom-up process, where the frst line of defence of the local units identify the inherent risk of those rules and regulations that apply to them. First, an assessment is made on the consistency of the controls that mitigate such inherent risk, and then the residual risk in each of these obligations is determined. Action plans are established and followed by both the local and corporate compliance functions. • Conduct assessment in products and services with a scope of 17 geographies of the Group and 26 legal entities, where the frst line of defence functions evaluate the main risks of conduct in commercialisation, the suitability of the controls that mitigate said risks and establish action plans in those cases where risk assessments exceed the defned risk appetite. 403 Compliance and conduct RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Horizontal teams support vertical teams by leading execution and coordination of generalist activities, among them: Group CCO Key transversal functions • Promote the relationship of Compliance and Conduct functions among the Corporate centre and the diferent units. • Coordinate the defnition and monitoring of the annual compliance programs. • Provide methodologies, resources, systems and management information and support in the execution of multidisciplinary projects. • Jointly with the vertical functions, follow-up of the deployment of the models by the units. • Lead the digitalisation of processes. • Set up common report templates, combining qualitative and quantitative metrics. • Coordinates the creation of the regulations global repository and manages the Regulatory Radar Governance aimed at assigning regulatory implementation responsibilities. • Promote thematic fora and workshops, identify and promote the execution of the annual training programs, and prepare a biannual magazine. • Participate in the appointment and setting of the CCO´s objectives. of controls in each local unit. Further, it has established a set of risk indicators that will be regularly reported to both local governing bodies and to Corporate centre teams. • Concerning management information, a common compliance and conduct risk reporting template was deployed in 2018 in the Group’s units, with minimum content specifed by the Corporate centre and common chapters, risk dimensions by family and combining quantitative metrics and expert qualitative analysis, to which units may add local information if relevant. At year-end 2018, virtually all of the Group’s main units have adopted this new form of reporting. • The Regulatory Radar function has consolidated its role, which develops and coordinates the creation and administration of the global repository of rules and regulations, through a multidisciplinary process in which the diferent functions participate, and manages the regulatory radar governance aimed at assigning regulations implementation responsibilities and the appropriate monitoring. • The Group strengthened best practices sharing and cooperation between the Corporate centre and the local units. Thematic forums and workshops were organised on reputational risk, corporate defence, the GDPR, product governance and consumer protection, anti-money laundering and countering terrorism fnancing. • In addition to the traditional training – mandatory or not – for which the function is responsible, a biannual review of compliance and conduct and awareness-raising actions are now carried out through the Group’s internal networks. Regulatory compliance•• Product governance and customer protection Reputational risk AML/ATF Governance, planning and consolidation Coordination with units Compliance processes and information systems • Digitalisation of processes and continuous improvement. Having defned the function’s process map and documented its main activities, the Group completed in 2018 the automation of processes in fnancial intelligence, corporate actions, annual compliance programme, product governance, the Code of Conduct in Securities Markets, and acceptance of reputational risk transactions. The design phases were also completed in two new processes, namely management of committees and internal governance bodies, and the development of regulatory components. • On-line collaboration with units is improving, favouring platforms and structured spaces for information exchange, such as the compliance portal and the Verum platform for assessing the maturity of the compliance model. • Access to external information sources to enhance compliance control processes (regulatory sources, online media, stakeholder perceptions, etc.). • Management information and analytical environments, leveraging new big data and multidimensional reporting capabilities to enhance generation and distribution of compliance and conduct management reports and optimise the response to money laundering and terrorism fnancing alerts. • Global programme of MiFID II implementation. With the coming into force of MiFID II regulation in January 2018, the Group has provided the necessary support to local units afected by the regulation. The project’s main focus of attention in 2018 has been the development and efective implementation of a robust control model. Accordingly, the compliance and conduct function in the Corporate centre has defned a theoretical control framework and supervised the transposition and implementation 404 2018 Annual Report Regulatory Compliance The Regulatory Compliance area is responsible for controlling and supervising regulatory risk related to employees, organisational aspects, international markets and securities markets, developing policies and rules and ensuring compliance by units. The internal procedure on the use and functioning of the Corporate centre’s whistleblowing channel was updated in 2018, in order to: • Allow employees to make anonymous reports if they wish. • Reinforce the internal procedure for the anonymous The following functions are in place for adequate control and management of regulatory compliance risks: communication of violations regarding anti-money laundering by employees, senior management or agents. • Application and interpretation of the General Code of Conduct and other codes and rules and regulations that implement it, including management of the corporate defence model and the Group’s whistleblowing channel. • Broadening the scope to include those accounting or audit practices, in accordance with the Sarbanes-Oxley Act. The compliance function reports periodically to the audit committee on this type of complaints. • Development and application of policies and rules aimed at preventing market abuse. Types of complaints received in 2018 • Control and supervision of application of regulation related to: (i) markets, with respect to MiFID II, EMIR, Dodd-Frank Act and the Volcker Rule and (ii) the organisation, in the competencies of GDPR, FATCA and CRS. 195 93 290 44 289 2,968 Labour relations Fraud Confict of interest and corruption Products and fnancial services commercialisation AML and terrorism fnancing and sanctions Others • Disclosure of relevant Group information (material facts). The most relevant areas of the regulatory compliance function are described below: A. Employees The objective - based on the General Code of Conduct - is to establish standards for the prevention of criminal risks and conficts of interest and from a regulatory perspective, to cooperate with other areas in setting up guidelines for remuneration and dealings with suppliers. The prevention of criminal risks aims to minimise the impact of the potential criminal responsibility of legal entities for any crimes committed on their account or for their beneft by their directors or representatives and by employees as a result of a lack of control. The Group has in place a corporate defence model, which is a specifc compliance programme designed to implement awareness-raising activities as to the main criminal risks across the Bank. The Group has 14 whistleblowing channels available to all employees in all its main markets. They can access these through email, web site and app. Complaints that originated a disciplinary procedure 3,879 1,423 Complaints receivedA Disciplinary measuresB A. Consolidated data of the Top 10 local units and the Corporate centre, which includes the complaints received in all their whistleblowing channels, which are not comparable between each other. B. This fgure does not include the disciplinary measures from UK, as it is not available. 405 Compliance and conduct RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management B. Market abuse Regulatory Compliance activity in 2018 focused on the implementation of corporate tools for market abuse risk management in the main geographies: Code of Conduct in Securities Markets (CCSM) CodCon tool Monitoring of personal account dealing and material non-public information Implemented in 2018 • Mexico • Chile Monitoring transactions of SCIB Markets activity and ALM in fnancial markets Implemented in 2018: Mexico, Chile, Brazil, Santander London Branch and the UK. Global Surveillance tool Management and control in 2018 Management and control in 2018 • Approximately 13,200 person subject to the Code of Conduct in Securities Markets. • Approximately 11,000 personal account transactions of senior managers and employees. • Approximately 800 projects with potential material and non-public information. As a result of the analysis by the locals and corporate teams of alerts generated by the tool, cases of potential market abuse have already been detected and properly escalated in accordance with the governance established in each geography. The implementation of corporate policies, procedures and tools in the Group’s main countries has succeeded in establishing a global oversight model that allows a better understanding of the situation of these units with regard to market abuse risk, mainly through indicators reported by local compliance teams. C. Market regulations Regulatory compliance carries out the risk management of the main market regulations that afect the Group. The most relevant actions carried out during 2018 are detailed below: Dodd-Frank Title VII An in-depth review of the Swap Dealer Compliance Programme regarding the Dodd-Frank Tittle VII regulation was carried out in 2018, successfully strengthening internal controls and monitoring. Relevant information Regulatory compliance is responsible for disclosing relevant Group information to the markets. Banco Santander made public 48 material facts during the year, which are available on the Group’s web site and the CNMV’s web site. Volcker Rule With respect to the US Volcker Rule, oversight has continued of compliance with this regulation, which limits proprietary trading to very specifc cases that the Group controls by means of a compliance programme. This programme was satisfactorily implemented in 2018 in entities originating from the acquisition of Banco Popular. MiFID II During 2018, the Regulatory Compliance function has worked together with the MiFID II Corporate’s PMO, as well as with the diferent units in the defnition and implementation of a MiFID II control framework for each local unit, that will allow to supervise compliance with the regulation. At the end of 2018, a country supervision manual for MiFID II was approved, which establishes the relationship model for the local units with the Regulatory Compliance function at a corporate level. Its main aspects are: internal policies and procedures, control framework and KPI reporting to the corporation, second line of defence testing exercise and training programs. 406 2018 Annual Report D. Data management The main actions carried out by regulatory compliance related to data management by the Group during 2018 are detailed below: GDPR FATCA and CRS The new requirements of the European GDPR were enforced on 25 May 2018. The regulatory compliance function has performed a key role in mobilizing and raising awareness among the Group units subject to the regulation. It has led a number of corporate initiatives aimed at ensuring the efective protection of the rights of data subjects. These initiatives include the approval of a new corporate data protection policy, the design and implementation of a governance model based on Data Protection Ofcers and a control and oversight programme. It has also raised awareness among the staf through diferent training initiatives and other activities such as courses, workshops and the publication of supporting documentation in the form of guidelines and operating criteria. Product governance and consumer protection The product governance and customer protection mission is to ensure that the Group acts in the best interest of its customers by complying with regulations and the entity’s values and principles. Ensures that decisions are made and action plans are defned and monitored when necessary. Reports to senior management and statutory bodies. Oversees the design and execution of controls throughout the commercialisation and customer relationship process. Applies corporate risk assessment methodologies, such as management indicators and self- assessments. Identifes risks through: customer’s voice, regulatory guidelines, industry practices, supervisor and auditor opinions, and learning from internal/external events. Ensure that customer service, post sale systems and processes facilitate fair treatment of customers, as well as adequate detection and management of possible deterioration of products and services. Monitor and report Principles Control Assess AGEMENT N A M C U L T U R E Governance Identify Customers Postsale and servicing PROCESES Sales practices Product design Oversee the sale process to the adequate target market, with proper commercial treatment and transparency of information, as well as that sales force training and compensation systems encourage performance in the best interest of the customer. Further, and within the regulatory framework on automatic exchange of tax information between countries (FATCA and CRS), the following management areas stood out for their importance in 2018: • Fulflment of reporting obligations to the local authorities in due time and form across all units. • Periodic certifcation and certifcation of the preexisting accounts of Group units. • Approval of new corporate policies on this matter. To establish the corporate framework for the commercialisation of products and services and consumer protection and the policies that develop it, defning the principles of conduct and risk management throughout the commercialisation process and the relationship with the retail customer. To promote an appropriate culture with a Simple, Personal and Fair approach, for action in the customers´ best interest. To establish and manage: i) the Commercialisation committee; ii) the Monitoring and customer protection committee; iii) the Fiduciary risk sub-committee; and iv) the customer voice forums, which ensure that appropriate standards of conduct are applied. Ensure that products are designed to meet the characteristics and needs of customers, with an appropriate balance of risks, costs and proftability. 407 Compliance and conduct RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Main product governance and consumer protection activities in 2018 Governance strengthening Product and services validation • Implementation of corporate consumer protection and fduciary risk management policies in the Group’s units. • Development together with the Santander Digital team of a new “agile” procedure for the approval of innovative concept tests with impact on customers. • Defnition of good practices regarding sales force remuneration and monitoring of the implementation. • Supervision of the implementation of the corporate custody procedure, having been presented to the executive risk committee for validation the new custody fles of diferent Group units. • Creation of the corporate forum for the supervision of the analysis of the voice of clients, root cause and defnition of improvement plans. Proposals analysed by the Ofce of product governance: 359 Products validated in Corporate Ofce 51 Structured Prod. (Sna. Internation. Products Plc.) 58 New products presented at CCCA 141 Units enquiries 109 A. Of these proposals, one was not validated and others were modifed in the process prior to the celebration of the Committee. Proposals analysed by fduciary risk subcommittee: 743 Structured Other (policies, ETFs, funds focus list…) 73 products Retail Banking 37 Private Banking products 81 Savings/ Investment insurance 26 Collective investment undertakings and discretionary profled portfolios 526 Sales, post-sale and servicing conduct monitoring 25 sessions in 2018 of the monitoring and consumer protection committee, covering: • The marketing of products and services by country and type of product with focus on: those in special monitoring, regulatory and supervisory environment, events and conduct costs and risk analysis through indicators. • Performance, exposure in portfolios and results for customers and compliance with mandates for products with fduciary risk managed by the Group units or whose management is delegated to third parties. • Customer complaints, their management (28 countries, 36 business units and 9 CIB branches) and action plans to mitigate customer detriment. • The degree of control and volume of the 51 providers (42 of them external to Santander) that provide custody services for the Group’s own positions or customers positions. Continuous improvement of products and processes of action with customers The conduct risk management model, and specially the customer’s voice, allows the customer risk identifcation, measurement and monitoring for the conduct risk mitigation and continuous improvement (retro alimentation) of the product design, sale processes and services delivery. Events, sector practices and regulations Data base As a consequence of MiFID II, improvements are implemented in commercialisation models beyond regulatory requirements. Transformation plans in remuneration of the sales force following good practices of regulators and the diferent geographies of the Group. Customer’s voice Business monitoring First line self assessment Risk and Control Self Assessment Innovation in investment products: increased focus on digital initiatives in the product approval process and through the follow-up of the customer’s voice. Investment products adequacy in Europe: corporate project for the implementation of a control model in the frst and second line of defence. Management indicators Early cancellation: increase in disclosure requirements in the cross sale and action plans to improve the root cause analysis through the retention channels. Investment and pension funds performance: review of product defnition and/ or its investment policies in case of detecting possible management deterioration or deviations regarding product competitiveness. Refusal of insurance claims: the approval requires that the documentation for customers clearly includes the coverage exclusion. Customer complaints Due to product cancellation barriers: new products analysis so that they can be cancelled using the same channels as the ones used for hiring new products and, if this is not the case, prioritise the necessary developments so it becomes a reality. Due to interests in revolving credit cards: analysis on the approval of the applicable interest rate and comparison with a normal credit card and, in case it is more expensive, establishment of measures so that customers use them as a revolving credit card. Launch of thematic reviews on root cause of complaints: fraud, mortgages and recovery processes. 408 2018 Annual Report Anti-money laundering and countering terrorism fnancing One of the Group’s strategic objectives is to maintain advanced and efcient anti-money laundering and countering terrorism fnancing systems, constantly adapted to international regulations, with the capacity to confront the development of new techniques by criminal organisations. In addition, given that these standards and those adopted by the Group are mandatory, their correct implementation and application must be overseen. To do so, continuous work is carried out on the diferent Group entities, including monitoring of the training of Group employees. The main activity data in 2018 is as follows: As a part of the second line of defence, the AML/TF function ensure that risks are managed in accordance with the risk appetite defned by the Group and promote a strong risk culture through the organisation. AML/TF Corporate function is responsible for supervising and coordination the AML/TF systems of the Group subsidiaries, branches and business areas, requiring the adoption of the necessary programmes, measures and enhancements. The Anti-money laundering and countering terrorism fnancing policy in the Group is based on three main pillars: the highest international standards, their adaptation and compliance through global policies and technology systems that can enable such compliance. High international standards (FATF, EU, OFAC, Wolfsberg Group, etc.) AML/TF Framework and Policies Technology Systems During 2018, the Group has actively worked in the review of its internal regulations, strengthening management policies and placing a special focus on optimisation of systems, enhancing their efectiveness and considering and developing new technologies that are becoming available. From the AML/TF global function, a relevant transformation projects have been addressed, highlighting the continuous improvement of supporting tools and risk management platforms, such as the one used for automation and improvement of adverse media identifcation and management processes, extending its scope to other units/areas within the Group (Banco Santander México and SCIB Boadilla), or updating the corporate money laundering and terrorism fnancing risks and controls self- assessment (RCSA ML/TF), being aligned with the rest of the RCSA methodologies in the Compliance function. 169 Subsidiaries reviewed 208,410 Investigations carried out 57,193 Disclosures to authorities 169,941 Employees trained The Group has training plans in place at both local and corporate level, in order to cover all employees. Specifc training plans are also in place for the most sensitive areas from the perspective of anti-money laundering and countering terrorism fnancing. Reputational risk In 2018, the Group made signifcant progress on implementing the corporate reputational risk model, consolidating its main features in the Group’s most signifcant geographies. The specifc characteristics of reputational risk, which originate in a vast number of sources, require a single approach and control model that is diferent from those of other risks. The reputational risk management requires for a global interaction with both frst and second lines of defence functions responsible for the relationship with stakeholders in order to ensure a consolidated oversight of the risk, efciently supported on the current control frameworks. The aim is for reputational risk to be integrated into both business and support activities, and internal processes, thus allowing the risk control and oversight functions to integrate them in their activities. The reputational risk model is accordingly based on a prominently preventive approach to risk management and control, and also on efective processes for identifcation and management of early warnings of events and risks, and subsequent monitoring and management of both events and detected risks. 409 Compliance and conduct RiskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Key actions in 2018: • Redesign of the Reputational risk forum with an executive focus that ensures adequate procedures for the identifcation, assessment, reporting and escalating of risks and reputational events, with the presence of all the frst lines that manage relevant stakeholders. • Implementation consolidation of the model in the Group’s various geographies. • Review and consolidation of policies relating to specifc sectors (mining, soft commodities, defence and energy). • Coordination with all corporate and local units to implement socio-environmental policies. • In conjunction with the relevant functions, development of other reputational risk-related policies, such as fnancing policy for sensitive sectors. • Defnition and reporting of risk appetite metrics. The launch of a new process of identifcation, assessment, reporting and subsequent monitoring of the main reputational risks that afect the Group in diferent geographies. The frst reporting processes have already been carried out with this new methodology, which integrates other frst lines (such as the Communications area) in a more tangible manner. 410 2018 Annual Report 8. Model risk 8.1 Introduction The Group has far-reaching experience in the use of models to help making all kinds of decisions, with particular relevance for risk management decisions. A model is defned as a system, approach or quantitative method that applies theories, techniques or statistical, economic, fnancial or mathematical hypotheses to transform input data into quantitative estimates. The models are simplifed representations of real world relationships between characteristics, values and observed assumptions. This simplifcation allows the Group to focus attention on specifc aspects which are considered to be most important for applying a given model. The use of models entails model risk, defned as the potential negative consequences arising from decisions based on the results of wrong, inadequate or incorrectly used models. According to this defnition, the sources of model risk are as follows: • The model itself, due to the utilisation of incorrect or incomplete data, or due to the modelling method used and its implementation in systems. Model risk management and control functions are performed in the Corporate centre and in each of the Group’s main subsidiaries. To ensure adequate model risk management there are a set of policies and procedures which establish the principles, responsibilities and processes to follow during the model’s life cycle detailing aspects related to organisation, governance, model management and model validation, among others. The supervision and control of model risk is proportional to the importance of each model. In this sense, a concept of tiering is defned as the attribute used to synthesise the model´s level of importance or model signifcance, from which the intensity of the risk management processes that must be followed is determined. At the end of 2017, we launched a strategic plan, model risk management 2.0 (MRM 2.0), as an anticipatory measure to reinforce the model risk management, revising each of the model governance phases and conveniently addressing new supervisors expectations set out in the 2018 ECB Guide on internal models. MRM 2.0, currently underway, involves 3 phases (2018, 2019 and 2020) and includes 10 initiatives organised around 4 pillars: • Key elements: Initiatives related to governance, risk appetite, management scope and risk policies. • Incorrect use of the model. • Processes: Initiatives related to the models life cycle phases. The materialisation of model risk may cause fnancial losses, erroneous commercial and strategic decision-making or damage to the Group’s transactions • Communication: Internal and external communication (monitoring, reports, training, etc.). • Model Risk Facilitators: infrastructure, tools and resources. The Group has been working towards the defnition, management and control of model risk for several years. In 2015, a specifc area was established within the Risk division to control this risk. 411 Model riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management 8.2 Model risk management Model risk management and control is structured around a set of processes regarded as the model life cycle. The defnition of the model life cycle phases in the Group is outlined as follows: Identifcation As soon as a model is identifed, it is necessary to ensure that it is included in the model risk control perimeter. One key feature for a proper model risk management is to have a complete and exhaustive inventory of the models used. The Group has a centralised inventory, created on the basis of a uniform taxonomy for all models used at the diferent business units. The inventory contains all relevant information of each model, which allows for a proper monitoring according to their relevance and the tier criteria. The inventory enables transversal analyses of information (by geographic area, types of model, importance, etc.), thereby facilitating strategic decision-making in connection with models. The validation scope includes not only more theoretical or methodological aspects, but also the IT systems and the data quality that models rely upon for their efective functioning. In general, it includes all relevant aspects of management in general (controls, reporting, uses, senior management involvement etc.). The internal corporate validation environment is fully aligned with the internal validation criteria of advanced models produced by the fnancial regulators with authority over the Group. This maintains the criterion of a separation of functions between units developing and using the models (frst line of defence), internal validation units (second line of defence) and Internal Audit (third line) which, as the last layer of control, is responsible for reviewing the efectiveness of the function and its compliance with internal and external policies and procedures, and issuing an opinion on its level of efective independence. The internal validation function is executed in a decentralised manner through fve validation units. The coordination and harmonisation of the validation practices and processes is ensured through a specifc initiative, which has been reinforced within the MRM 2.0 project. Planning It is an internal annual exercise, approved by the local units’ governance bodies and validated in the Corporate centre, which aims to establish a strategic action plan for all models included in the scope of management of the model risk function. It identifes the needs for resources related to the models that are going to be developed, revised and implemented during the year. One of these pillars is the consistency analysis process carried out by the validation units, which includes the review of the issued recommendations, the severity thereof and the rating assigned. In this way it acts as an important point of control of the consistency and comparability of the validation works. The validation works are only concluded once this phase of consistency has been completed. Development This is the model’s construction phase, based on the needs established in the model plan and with the information provided by the specialists for that purpose. The development must take place using common standards for the Group, and which are defned by the Corporate centre. This ensures the quality of the models used for decision-making purposes. Internal validation Independent validation of models is not only a regulatory requirement in certain cases, but it is also a key feature for proper management and control of the Group’s model risk. Hence, there is a specialised unit, autonomous from developers and users, which draws up technical opinions on the suitability of internal models, and sets out conclusions concerning their robustness, utility and efectiveness. The validation opinion is expressed through a rating which summarises the model risk associated with it. The internal validation process covers all models within the model risk control scope, ranging from those used in the risk function (credit, market, structural or operational risk models, capital models, economic and regulatory models, provisions models, stress tests, etc.) to models used in functions that support decision-making. Approval Before being deployed and therefore used, each model must be submitted for approval to the corresponding governance bodies. Deployment and use This is the phase during which the newly developed model is implemented in the system in which it will be used. As noted, above, this implementation phase is another possible source of model risk. It is therefore essential that tests are conducted by technical units and the model owners to certify that the model has been implemented pursuant to the methodological defnition and functions as expected. Monitoring and control Models have to be regularly reviewed to ensure their correct performance and that they are suitable for their purpose. Otherwise, they must be adapted or redesigned. Also, control teams have to ensure that the model risk is managed in accordance with the principles and rules set out in the model risk framework and related internal regulations. 412 2018 Annual Report 9. Strategic risk 9.1 Introduction 9.2 Strategic risk management Strategic risk is the risk of loss or harm arising from strategic decisions or poor implementation of decisions afecting the long- term interests of the Group’s main stakeholders, or inability to adapt to changes in the environment. The Group’s business model must be taken into account, as a key factor on which strategic risk pivots. It has to be viable and sustainable; therefore it has to be able to generate results in accordance with the Group’s targets, every year and at least during the following three years, as well as being consistent with the long-term view. Within strategic risk, three main components are diferentiated: For Santander, strategic risk is considered to be a transversal risk, and counts with a strategic risk control and management model which is used as a reference by the Group subsidiaries. This model encompasses the procedure and necessary tools for the correct risk monitoring and control: • Long-term strategic plan and three-year plan: the strategic risk function, with the support of diferent areas of the Risk division, monitors and challenges, in an independent way, the risk management activities performed by the strategy function, adding an integrated section, although independent, to the long-term strategic plan and three-year fnancial plan (Risk assessment). Business model risk: the risk associated with the Group’s 1 business model. This includes, among others, the risk of it being obsolescent, irrelevant, and/or losing value, and so not being able to deliver the expected results. This risk is caused by both external and internal factors. 2 Strategy design risk: the risk associated with the strategy set out in the Group’s fve-year strategic plan, including the risk that the strategic plan may not be adequate per sé, or due to its assumptions, and thus the Group will not be able to deliver on its unexpected results. 3 Strategy execution risk: the risk associated with executing long-term strategic plans and three-year plans. The risks to be taken into account include both the internal and external factors described above, the inability to react to changes in the business environment, and, lastly, risks associated with corporate development transactions. • Corporate development transactions: the Strategic risk function, with the support of diferent areas of the Risk division, ensures that the corporate development transactions consider an adequate risk assessment and its impact on both Santander’s risk profle and risk appetite. • Top risks: the Group identifes, evaluates and monitors those risks that have a signifcant impact on its results, liquidity or capital that might involve undesirable concentrations afecting the entity’s fnancial health. It consists of two main categories: i) macroeconomic and geopolitical and ii) idiosyncratic (competitive environment and customers, regulatory environment and internal factors). • Strategic risk report: is a report executed jointly by the strategy function and strategic risk, as a combined tool for the monitoring and assessment of the Group’s strategy, as well as associated risks. This report is presented to the board of directors and contains: strategy execution, strategic projects, corporate development transactions, business model performance, main threats (top risks) and risk profle. 413 Strategic riskResponsible bankingCorporate governanceEconomic and financial reviewRisk management Glossary 2018 AGM 2019 AGM Our annual general shareholders’ meeting held on 23 March 2018 Our annual general shareholders’ meeting that has been called for 11 or 12 April 2019, at frst or second call respectively Active customer Those customers who comply with balance, income and/or transactionality demanded minimums defned according to the business area AGM ALCO AML AORM ARM ASF ASR AT1 ATF ATM AVAs Annual General Shareholders´ meeting Asset-Liability Committee Anti -money laundering Advance Operational Risk Management Advance Risk Management Available Stable Funding Recovered write-of assets (Activos en suspenso recuperados) Additional Tier 1 Anti-terrorist fnancing Automated teller machine Additional Valuation Adjustments Banco Popular/Popular Banco Popular Español, S.A., a bank whose share capital was acquired by Banco Santander, S.A. on 7 June 2017 and was merged into Santander in September 2018 BAU Business as usual Basel or Basel Committee The Basel Committee on Banking Supervision Business Continuity Management System basis points Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions and investment frms, as amended from time to time Banco Santander International Banco Santander Puerto Rico Compliance and Conduct Development Bank of Latin America Compound annual growth rate Maximum nominal amount of a risk operation, excluding market transactions Chief Compliance Ofcer Capital Conservation Bufer Central Counterparties Contingent Convertible Preferred Securities Code of Conduct in Securities Markets Credit Default Swaps BCMS bps BRRD BSI BSPR C&C CAF CAGR CAP CCO CCoB CCP CCPS CCSM CDS 414 2018 Annual Report CEB CEO CER CET 1 CNMV Council of Europe Development Bank Chief Executive Ofcer Credit equivalent risk Core equity tier 1 Spanish National Securities Market Commission (Comisión Nacional del Mercado de Valores) Corporate Centre Our headquarters in Boadilla and business segment as described in section 4.1 ‘Description of businesses’ in the Economic and fnancial review chapter. Corporation All the governing bodies, organisational structures and employees entrusted by Banco Santander, S.A. to exercise oversight and control across the entire Group, including those functions typically associated with the relationship between a parent company and its subsidiaries. COSO Committee of Sponsoring Organisations of the Tradeway Commission CRD IV package The prudential framework established by the CRD and CRR currently in force CRE CRO CRR CRS CSA CVA D&I DI Credit Risk Equivalent Chief Risk Ofcer Regulation (EU) 575/2013 on prudential requirements for credit institutions and investment frms, as amended from time to time The Common Reporting Standard approved by the OECD Council on 15 July 2014 Credit Support Annex Credit Valuation Adjustment Diversity & inclusion Debt to Income Digital customers Every consumer of a commercial bank’s services who has logged on to their personal online banking and/or mobile banking in the last 30 days. Dodd-Frank Act The US Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 DRA DVA EAD EBA EBRD ECB EIB EMIR EP EPS Documento de Registro de Acciones or Share Registration Document Debt Valuation Adjustment Exposure at Default European Banking Authority European Bank for Reconstruction and Development European Central Bank European Investment Bank Regulation (EU) 648/2012 on OTC derivatives, central counterparties and trade repositories, as amended from time to time Equator Principles Earnings Per Share 415 Resposible BankingCorporate governance reportEconomic and financial reviewRisk Management ReportERC ES ESG ESMA ETF EU EVE EWIs FATCA FATF FCA FED Executive Risk Committee Expected Shortfall Environmental Social and Governance European Securities and Markets Authority Exchange Traded Funds European Union Economic Value of Equity Early Warning Indicators Foreign Account Tax Compliance Act Financial Action Task Force Fiat Chrysler Automobiles Federal Reserve FL CET1 Common Equity tier 1 fully loaded / Fully loaded CET1 Forward Rate Agreements Foreign Exchange Group Chief Compliance Ofcer Group Chief Risk Ofcer Gross Domestic Product General Data Protection Regulation Global Master Repurchase Agreement Gender pay gap Great Place to Work Global Reporting Initiative Global Systematically Important Banks General shareholders’ meeting Human Resource Internal Capital Adequacy Assessment Process Spanish Instituto de Contabilidad y Auditoría de Cuentas Internal control over fnancial reporting Internal control model International Finance Corporation International Financial Reporting Standards (IFRS) as adopted in the EU pursuant to Regulation (EC) 1606/2002 on the application of international accounting standards, as amended from time to time International Financial Reporting Standards FRA FX GCCO GCRO GDP GDPR GMRA GPG GPTW GRI G-SIB GSM HR ICAAP ICAC ICFR ICM IFC IFRS IFRS9 416 2018 Annual ReportILAAP IMF IRC IRRBB ISMA IT LCR LGD Internal Liquidity Adequacy Assessment Process International Monetary Fund Incremental Risk Charge Interest Rate Risk in the Banking Book International Securities Market Association Information technology Liquidity Coverage Ratio Loss Given Default Loyal customers Active customer who receive most of their fnancial services from the Group according to the commercial segment that they belong to. Various engaged customer levels have been defned taking proftability into account. LTV MiFID 2 MREL MRM MtM NAFTA NGO NII NPAs NPLs NSFR NYSE OFAC OM ONP OR ORX OSLA OTC P&L PD Loan to Value Markets in Financial Instruments Directive. Minimum requirement for own funds and eligible liabilities which is required to be met under the BRRD Model Risk Management Mark-to-Markets North American Free Trade Agreeement Non-governmental organisation Net Interest Income Non-productive assets Non-performing loans Net stable funding ratio New York Stock Exchange Ofce of Foreign Assets Control Organised Markets Ordinary net proft Operational risk Operational Risk Exchange Overseas Securities Lender’s Agreement Over the counter Proft and Loss Probability of Default 417 Resposible BankingCorporate governance reportEconomic and financial reviewRisk Management Report People supported in our communities The Bank has devised a corporate methodology tailored to Santander’s requirements and specifc model for contributing to society. This methodology identifes a series of principles, defnitions and criteria to allow the Bank to consistently keep track of those people who have benefted from the programmes, services and products with a social and/or environmental component promoted by the Bank. This methodology has been reviewed by an external auditor. PMO POCI POS PPNR PRI PRIIPS PSD2 PwC R&D&i RAF RAS RBSCC RCC RCSA RDA RIA RoA RoE RoRAC RoRWA RoTE RSF RRF RWAs S&P 500 SAM Project management ofce Purchased or Originated Credit Impaired Point of sale Pre-Provisions Net Revenue Principles for responsible Investment Regulation 1286/2014 on key information documents for packaged retail and insurance-based investment products, as amended from time to time Payment Services Directive II PricewaterhouseCoopers Auditores, S.L. Research, development and innovation Risk appetite framework Risk Appetite Statement Responsible banking, sustainability and culture committee Risk Control Committee Risk control self-assessment Risk Data Aggregation Risk Identifcation and Assessment Return on assets Return on equity Return on risk adjusted capital Return on risk weighted assets Return on tangible equity Required Stable Funding Risk Reporting Framework Risk weighted assets The S&P 500 index maintained by S&P Dow Jones Indices LLC Santander Asset Management Santander Consumer US Santander Consumer USA Holdings Inc. Santander Bank N.A. Santander Customer Assessment Note Santander Consumer Finance Santander Corporate & Investment Banking SBNA SCAN SCF SCIB 418 2018 Annual ReportSCPs SCUSA SDG SEC SHUSA SIS SMEs SOX Strategic commercial plans Santander Consumer US Sustainable Development Goals Securities and Exchanges Commission Santander Holdings USA, Inc. Santander Investment Securities Small or medium enterprises Sarbanes-Oxley Act of 2002 Spanish Companies Act Spanish companies act approved by Royal Decree Law 1/2010, as amended from time to time Spanish Securities Markets Spanish securities markets act approved by Royal Decree Law 4/2015, as amended from time to time SPF SRB SREP SRF SRI SRT SSM STEM T2 TCFD TLAC TF TNC TOM TSR UHNW UK UN SDG UNEP FI US VaE VaR Simple, Personal and Fair European Single Resolution Board Supervisory Review and Evaluation Proccess Single Resolution Fund Socially Responsible Investment Signifcant Risk Transfer Single Supervisory Mechanism, the system of banking supervision in Europe. It comprises the ECB and the national supervisory authorities of the participating countries. Science, Technology, Engineering and Mathematics Tier 2 Task Force on Climate-related Financial Disclosures The total loss absorption capacity requirement which is required to be met under the CRD V package Terrorist fnancing The Nature Conservancy Target Operational Model Total Shareholder Return Ultra High Net Worth United Kingdom United Nations Sustainable Development Goals United Nations Environmental Program Financial Initiative United States of America Value at Earnings Value at Risk Volcker Rule Section 619 of the Dodd-Frank Act VRAC WBCSD Wolfsberg group Vendor Risk Assessment Centre World Business Council for Sustainable Development Association of thirteen global banks which aims to develop frameworks and guidance for the management of fnancial crime risks 419 Resposible BankingCorporate governance reportEconomic and financial reviewRisk Management Report Auditors’ report and consolidated annual accounts Auditors’ report Consolidated annual accounts Consolidated balance sheets as of 31 december 2018, 2017 and 2016 Consolidated income statements for the years ended 31 december 2018, 2017 and 2016 Consolidated statements of recognised income and expense for the years ended 31 december 2018, 2017 and 2016 Consolidated statements of changes in total equity for the years ended 31 december 2018, 2017 and 2016 Consolidated statements of cash fows for the years ended 31 december 2018, 2017 and 2016 Notes to the consolidated annual accounts 1. Introduction, basis of presentation of the consolidated fnancial statements (consolidated annual accounts) and other information 2. Accounting policies 3. Santander Group 4. Distribution of the Bank’s proft, shareholder remuneration scheme and earnings per share 5. Remuneration and other benefts paid to the Bank’s directors and senior managers 6. Loans and advances to central banks and credit institutions 7. Debt instruments 8. Equity instruments 9. Trading Derivatives (assets and liabilities) and short positions 10. Loans and advances to customers 11. Trading derivatives 12. Non-current assets 423 435 436 440 442 444 450 451 452 464 500 505 506 521 522 524 525 526 531 532 420 532 534 13. Investments 14. Insurance contracts linked to pensions 15. Liabilities and assets under insurance contracts and reinsurance assets 534 535 16. Tangible assets 538 17. Intangible assets – Goodwill 540 18. Intangible assets - Other intangible assets 19. Other assets 541 20. Deposits from central banks and credit institutions 542 542 21. Customer deposits 543 22. Marketable debt securities 547 23. Subordinated liabilities 548 24. Other fnancial liabilities 549 25. Provisions 561 26. Other liabilities 561 27. Tax matters 567 28. Non-controlling interests 568 29. Other comprehensive income 572 30. Shareholders’ equity 572 31. Issued capital 574 32. Share premium 574 33. Accumulated retained earnings 575 34. Other equity instruments and own shares 575 35. Memorandum items 576 36. Hedging derivatives 590 37. Discontinued operations 590 38. Interest income 590 39. Interest expense 40. Dividend income 591 41. Income from companies accounted for using the equity method 42. Commission income 43. Commission expense 44. Gains or losses on fnancial assets and liabilities 591 591 592 592 2018 Auditors’ report and consolidated annual accounts 45. Exchange diferences, net 46. Other operating income and expenses 47. Staf costs 48. Other general administrative expenses 49. Gains or losses on non fnancial assets, net 50. Gains or losses on non-current assets held for sale not classifed as discontinued operations 51. Other disclosures 52. Geographical and business segment reporting 53. Related parties 54. Risk management 55. Explanation added for translation to English Appendix Appendix I. Subsidiaries of Banco Santander, S.A. Appendix II. Societies of which the Group owns more than 5%, entities associated with Grupo Santander and jointly controlled entities Appendix III. Issuing subsidiaries of shares and preference shares Appendix IV. Notifcations of acquisitions and disposals of investments in 2018 Appendix V. Other information on the Group’s banks Appendix VI. Annual banking report 593 594 594 599 600 600 601 613 627 628 658 659 660 686 694 694 695 701 421 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 422 2018 Auditors’ report and consolidated annual accountsAuditors’ report 423 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 424 2018 Auditors’ report and consolidated annual accounts425 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix426 2018 Auditors’ report and consolidated annual accounts427 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix428 2018 Auditors’ report and consolidated annual accounts429 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix430 2018 Auditors’ report and consolidated annual accounts431 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix432 2018 Auditors’ report and consolidated annual accounts433 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix434 2018 Auditors’ report and consolidated annual accountsConsolidated annual accounts 435 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendixTranslation of the consolidated annual accounts originally issued in Spanish and prepared in accordance with the regulatory fnancial reporting framework applicable to the Group in Spain (see Notes 1 and 55). In the event of a discrepancy, the Spanish-language version prevails. Santander Group CONSOLIDATED BALANCE SHEETS AS OF 31 DECEMBER 2018, 2017 AND 2016 Million of euros Assets* CASH, CASH BALANCES AT CENTRAL BANKS AND OTHER DEPOSITS ON DEMAND FINANCIAL ASSETS HELD FOR TRADING Derivatives Equity instruments Debt instruments Loans and advances Central banks Credit institutions Customers Memorandum items: lent or delivered as guarantee with disposal or pledge rights NON-TRADING FINANCIAL ASSETS MANDATORILY AT FAIR VALUE THROUGH PROFIT OR LOSS Equity instruments Debt instruments Loans and advances Central banks Credit institutions Customers Memorandum items: lent or delivered as guarantee with disposal or pledge rights FINANCIAL ASSETS DESIGNATED AT FAIR VALUE THROUGH PROFIT OR LOSS Equity instruments Debt instruments Loans and advances Central banks Credit institutions Customers Memorandum items: lent or delivered as guarantee with disposal or pledge rights FINANCIAL ASSETS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME Equity instruments Debt instruments Loans and advances Central banks Credit institutions Customers Memorandum items: lent or delivered as guarantee with disposal or pledge rights FINANCIAL ASSETS AVAILABLE-FOR-SALE Equity instruments Debt instruments Memorandum items: lent or delivered as guarantee with disposal or pledge rights 2018 113,663 92,879 55,939 8,938 27,800 202 - - 202 23,495 10,730 3,260 5,587 1,883 - 2 1,881 - 57,460 3,222 54,238 9,226 23,097 21,915 6,477 121,091 2,671 116,819 1,601 - - 1,601 35,558 Note 9 and 11 8 7 6 6 10 8 7 6 6 10 8 7 6 6 10 8 7 6 6 10 8 7 2017** 110,995 125,458 57,243 21,353 36,351 10,511 - 1,696 8,815 50,891 2016** 76,454 148,187 72,043 14,497 48,922 12,725 - 3,221 9,504 38,145 34,782 933 3,485 30,364 - 9,889 20,475 5,766 31,609 546 3,398 27,665 - 10,069 17,596 2,025 133,271 4,790 128,481 43,079 116,774 5,487 111,287 23,980 436 2018 Auditors’ report and consolidated annual accounts FINANCIAL ASSETS AT AMORTISED COST Debt instruments Loans and advances Central banks Credit institutions Customers Memorandum items: lent or delivered as guarantee with disposal or pledge rights LOANS AND RECEIVABLES Debt instruments Loans and advances Central banks Credit institutions Customers Memorandum items: lent or delivered as guarantee with disposal or pledge rights INVESTMENTS HELD-TO-MATURITY Memorandum items: lent or delivered as guarantee with disposal or pledge rights HEDGING DERIVATIVES CHANGES IN THE FAIR VALUE OF HEDGED ITEMS IN PORTFOLIO HEDGES OF INTEREST RISK INVESTMENTS Joint ventures entities Associated entities ASSETS UNDER INSURANCE OR REINSURANCE CONTRACTS TANGIBLE ASSETS Property, plant and equipment For own-use Leased out under an operating lease Investment property Of which leased out under an operating lease Memorandum items:acquired in lease INTANGIBLE ASSETS Goodwill Other intangible assets TAX ASSETS Current tax assets Deferred tax assets OTHER ASSETS Insurance contracts linked to pensions Inventories Other NON-CURRENT ASSETS HELD FOR SALE TOTAL ASSETS Note 2018 2017** 2016** 946,099 37,696 908,403 15,601 35,480 857,322 18,271 8,607 1,088 7,588 979 6,609 324 26,157 24,594 8,150 16,444 1,563 1,195 98 28,560 25,466 3,094 30,251 6,993 23,258 9,348 210 147 8,991 5,426 7 6 6 10 7 6 6 10 7 36 36 13 15 16 16 17 18 27 14 19 12 903,013 840,004 17,543 13,237 885,470 826,767 26,278 39,567 27,973 35,424 819,625 763,370 8,147 13,491 6,996 8,537 1,287 6,184 1,987 4,197 341 22,974 20,650 8,279 12,371 2,324 1,332 96 28,683 25,769 2,914 30,243 7,033 23,210 9,766 239 1,964 7,563 15,280 7,994 14,468 2,489 10,377 1,481 4,836 1,594 3,242 331 23,286 20,770 7,860 12,910 2,516 1,567 115 29,421 26,724 2,697 27,678 6,414 21,264 8,447 269 1,116 7,062 5,772 1,459,271 1,444,305 1,339,125 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** Presented for comparison purposes only (Note 1.d). The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated balance sheet as of 31 December 2018. 437 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix CONSOLIDATED BALANCE SHEETS AS OF 31 DECEMBER 2018, 2017 AND 2016 Million of euros LIABILITIES* FINANCIAL LIABILITIES HELD FOR TRADING Derivatives Short positions Deposits Central banks Credit institutions Customers Marketable debt securities Other fnancial liabilities FINANCIAL LIABILITIES DESIGNATED AT FAIR VALUE THROUGH PROFIT OR LOSS Deposits Central banks Credit institutions Customers Marketable debt securities Other fnancial liabilities Memorandum items:subordinated liabilities FINANCIAL LIABILITIES AT AMORTISED COST Deposits Central banks Credit institutions Customers Marketable debt securities Other fnancial liabilities Memorandum items:subordinated liabilities HEDGING DERIVATIVES CHANGES IN THE FAIR VALUE OF HEDGED ITEMS IN PORTFOLIO HEDGES OF INTEREST RATE RISK LIABILITIES UNDER INSURANCE OR REINSURANCE CONTRACTS PROVISIONS Pensions and other post-retirement obligations Other long term employee benefts Taxes and other legal contingencies Contingent liabilities and commitments Other provisions TAX LIABILITIES Current tax liabilities Deferred tax liabilities OTHER LIABILITIES LIABILITIES ASSOCIATED WITH NON-CURRENT ASSETS HELD FOR SALE Note 2018 2017** 2016** 70,343 107,624 108,765 9 9 20 20 21 22 24 20 20 21 22 24 23 20 20 21 22 24 23 36 36 15 25 27 26 55,341 15,002 - - - - - - 68,058 65,304 14,816 10,891 39,597 2,305 449 - 57,892 20,979 28,753 282 292 74,369 23,005 11,391 1,351 44 28,179 9,996 - - - - 59,616 40,263 55,971 8,860 18,166 37,472 9,112 5,015 28,945 23,345 3,056 589 - 2,791 - - 1,171,630 1,126,069 1,044,240 903,101 883,320 791,646 72,523 89,679 71,414 44,112 91,300 89,764 740,899 720,606 657,770 244,314 214,910 226,078 24,215 23,820 6,363 303 765 27,839 21,510 8,044 330 1,117 26,516 19,902 8,156 448 652 13,225 14,489 14,459 5,558 1,239 3,174 779 2,475 8,135 2,567 5,568 6,345 1,686 3,181 617 2,660 7,592 2,755 4,837 13,088 12,591 - - 6,576 1,712 2,994 459 2,718 8,373 2,679 5,694 11,070 - TOTAL LIABILITIES 1,351,910 1,337,472 1,236,426 438 2018 Auditors’ report and consolidated annual accounts SHAREHOLDERS´ EQUITY CAPITAL Called up paid capital Unpaid capital which has been called up Memorandum items: uncalled up capital SHARE PREMIUM EQUITY INSTRUMENTS ISSUED OTHER THAN CAPITAL Equity component of the compound fnancial instrument Other equity instruments issued OTHER EQUITY ACCUMULATED RETAINED EARNINGS REVALUATION RESERVES OTHER RESERVES Reserves or accumulated losses in joint ventures investments Others (-) OWN SHARES PROFIT ATTRIBUTABLE TO SHAREHOLDERS OF THE PARENT (-) INTERIM DIVIDENDS OTHER COMPREHENSIVE INCOME ITEMS NOT RECLASSIFIED TO PROFIT OR LOSS ITEMS THAT MAY BE RECLASSIFIED TO PROFIT OR LOSS NON-CONTROLLING INTEREST Other comprehensive income Other items EQUITY* TOTAL LIABILITIES AND EQUITY MEMORANDUM ITEMS: OFF BALANCE SHEET AMOUNTS Loans commitment granted Financial guarantees granted Other commitments granted Note 2018 2017** 2016** 30 31 118,613 116,265 105,977 8,118 8,118 - - 8,068 8,068 - - 7,291 7,291 - - 32 50,993 51,053 44,912 565 - 565 234 525 - 525 216 - - - 240 56,756 53,437 49,953 - - (3,567) (1,602) 917 724 - (949) 466 (4,484) (2,326) (1,415) (59) 7,810 (22) 6,619 (7) 6,204 34 33 33 33 34 4 (2,237) (2,029) (1,667) 29 29 28 35 (22,141) (21,776) (15,039) (2,936) (4,034) (3,933) (19,205) (17,742) (11,106) 10,889 (1,292) 12,181 12,344 (1,436) 13,780 11,761 (853) 12,614 107,361 106,833 102,699 1,459,271 1,444,305 1,339,125 218,083 207,671 202,097 11,723 74,389 14,499 64,917 17,244 57,055 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** Presented for comparison purposes only (Note 1.d). The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated balance sheet as of 31 December 2018. 439 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix CONSOLIDATED INCOME STATEMENTS FOR THE YEARS ENDED 31 DECEMBER 2018, 2017 AND 2016 Million of euros * Interest income Financial assets at fair value through other comprehensive income Financial assets at amortised cost Other interest income Interest expense Interest income / (charges) Dividend income Income from companies accounted for using the equity method Commission income Commission expense Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net Financial assets at amortised cost Other fnancial assets and liabilities Gain or losses on fnancial assets and liabilities held for trading, net Reclassifcation of fnancial assets at fair value through other comprehensive income Reclassifcation of fnancial assets at amortised cost Other gains (losses) Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss Reclassifcation of fnancial assets at fair value through other comprehensive income Reclassifcation of fnancial assets at amortised cost Other gains (losses) Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net Gain or losses from hedge accounting, net Exchange diferences, net Other operating income Other operating expenses Income from assets under insurance and reinsurance contracts Expenses from liabilities under insurance and reinsurance contracts Total income Administrative expenses Staf costs Other general administrative expenses Depreciation and amortisation cost Provisions or reversal of provisions, net Note 38 (Debit) Credit 2018 54,325 4,481 47,560 2,284 2017** 56,041 4,384 2016** 55,156 4,522 49,096 48,084 2,561 2,550 39 (19,984) (21,745) (24,067) 34,341 34,296 31,089 384 704 14,579 (2,982) 413 444 12,943 (2,763) 404 869 1,252 2,456 40 13 and 41 42 43 44 44 370 737 14,664 (3,179) 604 39 565 1,515 - - 1,515 44 331 - - 331 (57) 83 (679) 1,643 (85) (11) 105 1,618 426 (23) (1,627) 1,919 (2,000) (1,966) (1,977) 3,175 2,546 1,900 (3,124) (2,489) (1,837) 48,424 48,355 44,232 (20,354) (20,400) (18,737) (11,865) (12,047) (11,004) (8,489) (2,425) (2,223) (8,353) (2,593) (3,058) (7,733) (2,364) (2,508) 44 44 45 46 46 46 46 47 48 16 and 18 25 440 2018 Auditors’ report and consolidated annual accountsImpairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes Financial assets at fair value through other comprehensive income Financial assets at amortised cost Financial assets measured at cost Financial assets available-for-sale Loans and receivables Held-to-maturity investments Impairment or reversal of impairment of investments in subsidiaries, joint ventures and associates, net Impairment or reversal of impairment on non-fnancial assets, net Tangible assets Intangible assets Others Gain or losses on non-fnancial assets and investments, net Negative goodwill recognised in results Gains or losses on non-current assets held for sale not classifed as discontinued operations Operating proft/(loss) before tax Tax expense or income from continuing operations Proft from continuing operations Proft or loss after tax from discontinued operations Proft for the year Proft attributable to non-controlling interests Proft attributable to the parent Earnings per share Basic Diluted (Debit) Credit Note 2018 2017** 2016** (8,986) (9,259) (9,626) (1) 10 (8,985) (8) (10) (52) 11 (9,241) (9,557) - (28) 10 17 and 18 16 17 and 18 49 50 (17) (190) (83) (117) 10 28 67 (123) 14,201 (13) (1,260) (72) (1,073) (115) 522 - (203) 12,091 27 (4,886) (3,884) 9,315 8,207 37 28 4 4 - 9,315 1,505 7,810 0.449 0.448 - 8,207 1,588 6,619 0.404 0.403 * See further detail regarding the impacts of the entry into force of IFRS9 as of 1 January 2018 (Note 1.b). ** Presented for comparison purposes only (Note 1.d). The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated income statement for the year ended 31 December 2018. (17) (123) (55) (61) (7) 30 22 (141) 10,768 (3,282) 7,486 - 7,486 1,282 6,204 0.401 0.399 441 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix CONSOLIDATED STATEMENTS OF RECOGNISED INCOME AND EXPENSE FOR THE YEARS ENDED 31 DECEMBER 2018, 2017 AND 2016 Million of euros * CONSOLIDATED PROFIT FOR THE YEAR OTHER RECOGNISED INCOME AND EXPENSE Items that will not be reclassifed to proft or loss Actuarial gains and losses on defned beneft pension plans Non-current assets held for sale Other recognised income and expense of investments in subsidiaries, joint ventures and associates Changes in the fair value of equity instruments measured at fair value through other comprehensive income Gains or losses resulting from the accounting for hedges of equity instruments measured at fair value through other comprehensive income, net Changes in the fair value of equity instruments measured at fair value through other comprehensive income (hedged item) Changes in the fair value of equity instruments measured at fair value through other comprehensive income (hedging instrument) Changes in the fair value of fnancial liabilities at fair value through proft or loss attributable to changes in credit risk Income tax relating to items that will not be reclassifed Items that may be reclassifed to proft or loss Hedges of net investments in foreign operations (efective portion) Revaluation gains (losses) Amounts transferred to income statement Other reclassifcations Exchanges diferences Revaluation gains (losses) Amounts transferred to income statement Other reclassifcations Cash fow hedges (efective portion) Revaluation gains (losses) Amounts transferred to income statement Transferred to initial carrying amount of hedged items Other reclassifcations Financial assets available-for-sale Revaluation gains (losses) Amounts transferred to income statement Other reclassifcations Hedging instruments (items not designated) Revaluation gains (losses) Amounts transferred to income statement Other reclassifcations Debt instruments at fair value with changes in other comprehensive income Revaluation gains (losses) Amounts transferred to income statement Other reclassifcations Non-current assets held for sale Revaluation gains (losses) Amounts transferred to income statement Other reclassifcations Share of other recognised income and expense of investments Income tax relating to items that may be reclassifed to proft or loss Total recognised income and expenses for the year Attributable to non-controlling interests Attributable to the parent Note 29 2018 9,315 (1,899) 332 618 - 2017** 8,207 (7,320) (88) (157) - 2016** 7,486 (303) (806) (1,172) - 1 1 (1) 36 (174) 29 36 36 36 29 36 29 - - - 109 (222) (2,231) (2) (2) - - (1,874) (1,874) - - 174 491 (317) - - - - - - (591) (29) (562) - - - - - (77) 139 7,416 1,396 6,020 68 (7,232) 614 614 - - (8,014) (8,014) - - (441) 501 (942) - - 683 1,137 (454) - - - - - (70) (4) 887 1,005 (118) 367 503 (1,329) (1,330) 1 - 676 682 (6) - 495 6,231 (5,736) - - 1,326 2,192 (866) - - - - - 80 (745) 7,183 1,656 5,527 * See further detail regarding the impacts of the entry into force of IFRS9 as of 1 January 2018 (Note 1.b). ** Presented for comparison purposes only (Note 1.d). The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated statement of recognised income and expense for the year ended 31 December 2018. 442 2018 Auditors’ report and consolidated annual accounts 443 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendixCONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY FOR THE YEARS ENDED 31 DECEMBER 2018, 2017 AND 2016 Million of euros Share premium Equity instruments (not capital) issued Other equity nstruments i A ccumulated retained earnings * Balance as of 31-12-17** Adjustments due to errors Adjustments due to changes in accounting policies Capital 8,068 - - 51,053 - - Opening balance as of 01-01-18** 8,068 51,053 Total recognised income and expense Other changes in equity Issuance of ordinary shares Issuance of preferred shares Issuance of other fnancial instruments Maturity of other fnancial instruments Conversion of fnancial liabilities into equity Capital reduction Dividends Purchase of equity instruments Disposal of equity instruments Transfer from equity to liabilities Transfer from liabilities to equity Transfers between equity items Increases (decreases) due to business combinations Share-based payment Others increases or (-) decreases of the equity - 50 50 - - - - - - - - - - - - - - - (60) (60) - - - - - - - - - - - - - - Balance as of 31-12-18 8,118 50,993 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** Presented for comparison purposes only (Note 1.d). 525 - - 525 - 40 - - - - - - - - - - - - - - 40 565 216 53,437 - - 216 - 18 - - - - - - - - - - - - - (74) 92 234 - - 53,437 - 3,319 - - - - - - (968) - - - - 4,287 - - - 56,756 The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated statement of changes in total equity for the year ended 31 December 2018. 444 2018 Auditors’ report and consolidated annual accounts Revaluation reserves - - - - - - - - - - - - - - - - - - - - - - Other reserves (1,602) - (1,473) (3,075) - (492) 10 - - - - - - - - - - 303 59 - (864) (3,567) Proft attributable to shareholders of the parent (-) Own shares (-) Interim dividends Other comprehensive income Other comprehensive income Others items Total (22) 6,619 (2,029) (21,776) (1,436) 13,780 106,833 Non-Controlling interest - - (22) - (37) - - - - - - - (1,026) 989 - - - - - - - - 6,619 7,810 (6,619) - - - - - - - - - - - - - (2,029) - (208) - - - - - - (2,237) - - - - (6,619) 2,029 - - - - - - - 1,425 (20,351) (1,790) - 253 (1,183) (109) - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - (1,545) (1,340) 12,235 105,493 1,505 7,416 (1,559) (5,548) - - - - - - - - - - - - (687) (3,892) - - - - - (660) 17 (229) (1,026) 989 - - - (601) (57) (961) (59) 7,810 (2,237) (22,141) (1,292) 12,181 107,361 445 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY FOR THE YEARS ENDED 31 DECEMBER 2018, 2017 AND 2016 Million of euros. Share premium Equity instruments (not capital) issued Other equity nstruments i A ccumulated retained earnings * Balance as of 31-12-16* Adjustments due to errors Adjustments due to changes in accounting policies Capital 7,291 - - 44,912 - - Opening balance as of 01-01-17* 7,291 44,912 Total recognised income and expense Other changes in equity Issuance of ordinary shares Issuance of preferred shares Issuance of other fnancial instruments Maturity of other fnancial instruments Conversion of fnancial liabilities into equity Capital reduction Dividends Purchase of equity instruments Disposal of equity instruments Transfer from equity to liabilities Transfer from liabilities to equity Transfers between equity items Increases (decreases) due to business combinations Share-based payment Others increases or (-) decreases of the equity - 777 777 - 6,141 6,141 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 525 - - 525 - - - - - - - - - - - - 240 49,953 - - 240 - (24) - - - - - - - - - - - - - (72) 48 216 - - 49,953 - 3,484 - - - - - - (802) - - - - 4,286 - - - 53,437 Balance as of 31-12-17* 8,068 51,053 525 * Presented for comparison purposes only (Note 1.d). The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated statement of changes in total equity for the year ended 31 December 2018. 446 2018 Auditors’ report and consolidated annual accounts Revaluation reserves - - - - - - - - - - - - - - - - - - - - - - Other reserves (949) - - (949) - (653) 6 - - - - - - - 26 - - 251 - - (936) (1,602) Proft attributable to shareholders of the parent (-) Own shares (-) Interim dividends Other comprehensive income Other comprehensive income Others items Total Non-Controlling interest (7) - - (7) - (15) - - - - - - - (1,309) 1,294 - - - - - - 6,204 (1,667) (15,039) (853) 12,614 102,699 - - 6,204 6,619 (6,204) - - - - - - - - - - - - - (1,667) - (362) - - - - - - (2,029) - - - - (6,204) 1,667 - - - - - - - - (15,039) (6,737) - - (853) (583) - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 12,614 102,699 1,588 (422) 543 - 592 - - 887 3,247 7,467 - 1,117 - - (10) (10) (665) (3,496) - - - - - (1,309) 1,320 - - - (39) 24 (39) (48) (867) (1,755) (22) 6,619 (2,029) (21,776) (1,436) 13,780 106,833 447 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY FOR THE YEARS ENDED 31 DECEMBER 2018, 2017 AND 2016 Million of euros Share premium Equity instruments not capital) issued ( Other equity nstruments i A ccumulated retained earnings * Balance as of 31-12-15* Adjustments due to errors Adjustments due to changes in accounting policies Capital 7,217 - - 45,001 - - Opening balance as of 01-01-16* 7,217 45,001 Total recognised income and expense Other changes in equity Issuance of ordinary shares Issuance of preferred shares Issuance of other fnancial instruments Maturity of other fnancial instruments Conversion of fnancial liabilities into equity Capital reduction Dividends Purchase of equity instruments Disposal of equity instruments Transfer from equity to liabilities Transfer from liabilities to equity Transfers between equity items Increases (decreases) due to business combinations Share-based payment Others increases or (-) decreases of the equity - 74 74 - - - - - - - - - - - - - - - (89) (89) - - - - - - - - - - - - - - Balance as of 31-12-16* 7,291 44,912 * Presented for comparison purposes only (Note 1.d). - - - - - - - - - - - - - - - - - - - - - - 214 46,429 - - 214 - 26 - - - - - - - - - - - - - (79) 105 240 - - 46,429 - 3,524 - - - - - - (722) - - - - 4,246 - - - 49,953 The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated statement of changes in total equity for the year ended 31 December 2018. 448 2018 Auditors’ report and consolidated annual accounts Revaluation reserves - - - - - - - - - - - - - - - - - - - - - - Other reserves (669) - - (669) - (280) 15 - - - - - - - 15 - - 174 - - (484) (949) Proft attributable to shareholders of the parent (-) Own shares (-) Interim dividends Other comprehensive income Other comprehensive income Others items Total (210) 5,966 (1,546) (14,362) (1,227) 11,940 98,753 Non-Controlling interest - - - - (1,546) (14,362) - - (210) - 203 - - - - - - - (1,380) 1,583 - - - - - - - - 5,966 6,204 (5,966) - - - - - - - - - - - - (121) - - - - - - (1,667) - - - - (5,966) 1,546 - - - - - - - - (1,227) 374 - - - - - - - - - - - - - - - - - - - - 11,940 98,753 1,282 7,183 (608) (3,237) 534 534 - - - - - - - - (22) (22) (800) (3,189) - - - - - (197) - (123) (1,380) 1,598 - - - (197) (79) (502) (677) - - - - - - - - - - - - - - - - (7) 6,204 (1,667) (15,039) (853) 12,614 102,699 449 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED 31 DECEMBER 2018, 2017 AND 2016 Million of euros * A. CASH FLOWS FROM OPERATING ACTIVITIES Proft for the year Adjustments made to obtain the cash fows from operating activities Depreciation and amortisation cost Other adjustments Net increase/(decrease) in operating assets Financial assets held-for-trading Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets at fair value through proft or loss Financial assets at fair value through other comprehensive income Financial assets available-for-sale Financial assets at amortised cost Loans and receivables Other operating assets Net increase/(decrease) in operating liabilities Financial liabilities held-for-trading Financial liabilities designated at fair value through proft or loss Financial liabilities at amortised cost Other operating liabilities Income tax recovered/(paid) B. CASH FLOWS FROM INVESTING ACTIVITIES Payments Tangible assets Intangible assets Investments Subsidiaries and other business units Non-current assets held for sale and associated liabilities Held-to-maturity investments Other payments related to investing activities Proceeds Tangible assets Intangible assets Investments Subsidiaries and other business units Non-current assets held for sale and associated liabilities Held-to-maturity investments Other proceeds related to investing activities C. CASH FLOW FROM FINANCING ACTIVITIES Payments Dividends Subordinated liabilities Redemption of own equity instruments Acquisition of own equity instruments Other payments related to fnancing activities Proceeds Subordinated liabilities Issuance of own equity instruments Disposal of own equity instruments Other proceeds related to fnancing activities D. EFFECT OF FOREIGN EXCHANGE RATE DIFFERENCES E. NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS F. CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR G. CASH AND CASH EQUIVALENTS AT END OF THE YEAR COMPONENTS OF CASH AND CASH EQUIVALENTS AT END OF THE YEAR Cash Cash equivalents at central banks Other fnancial assets Less: Bank overdrafts refundable on demand TOTAL CASH AND CASH EQUIVALENTS AT END OF THE YEAR In which: restricted cash Note 16 18 13 16 18 13 12 4 23 23 2018 3,416 9,315 21,714 2,425 19,289 51,550 (31,656) 5,795 16,275 (2,091) 61,345 1,882 27,279 (36,315) 8,312 60,730 (5,448) (3,342) 3,148 12,936 10,726 1,469 11 730 - - 16,084 3,670 - 2,327 431 9,656 - (3,301) 7,573 3,118 2,504 - 1,026 925 4,272 3,283 - 989 - (595) 2,668 110,995 113,663 10,370 89,005 14,288 - 113,663 - 2017** 40,188 8,207 23,927 2,593 21,334 18,349 (18,114) 2016** 21,823 7,486 22,032 2,364 19,668 17,966 6,234 3,085 (12,882) 2,494 (7,688) 32,379 (1,495) 30,540 1,933 19,906 12,006 (3,305) (4,137) (4,008) 10,134 7,450 1,538 8 838 - 300 - 6,126 3,211 - 883 263 1,382 387 - 4,206 7,783 2,665 2,007 - 1,309 1,802 11,989 2,994 7,072 1,331 592 (5,845) 34,541 76,454 110,995 8,583 87,430 14,982 - 110,995 - 27,938 4,364 13,143 8,032 (13,450) 21,765 (3,204) (2,872) (13,764) 18,204 6,572 1,768 48 474 - 9,342 - 4,440 2,608 - 459 94 1,147 132 - (5,745) 9,744 2,309 5,112 - 1,380 943 3,999 2,395 - 1,604 - (3,611) (1,297) 77,751 76,454 8,413 54,637 13,404 - 76,454 - * See further detail regarding the impacts of the entry into force of IFRS9 as of 1 January 2018 (Note 1.b). ** Presented for comparison purposes only (Note 1.d). The accompanying Notes 1 to 55 and Appendices are an integral part of the consolidated statement of cash fows for the year ended 31 December 2018. 450 2018 Auditors’ report and consolidated annual accounts Notes to the consolidated annual accounts 451 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendixTranslation of the consolidated annual accounts originally issued in Spanish and prepared in accordance with the regulatory fnancial reporting framework applicable to the Group in Spain (see Notes 1 and 55). In the event of a discrepancy, the Spanish-language version prevails. Banco Santander, S.A. and Companies composing Santander Group Notes to the consolidated fnancial statements (consolidated annual accounts) for the year ended 31 December 2018 1. Introduction, basis of presentation of the consolidated fnancial statements (consolidated annual accounts) and other information a) Introduction Banco Santander, S.A. (“the Bank” or “Banco Santander”) is a private-law entity subject to the rules and regulations applicable to banks operating in Spain. The Bylaws and other public information on the Bank can be consulted at its registered ofce at Paseo de Pereda 9-12, Santander. In addition to the operations carried on directly by it, the Bank is the head of a group of subsidiaries that engage in various business activities and which compose, together with it, Santander Group (“the Group”). Therefore, the Bank is obliged to prepare, in addition to its own separate fnancial statements, the Group’s consolidated fnancial statements, which also include the interests in joint ventures and investments in associates. At 31 December 2018, the Group consisted of 719 subsidiaries of Banco Santander, S.A. In addition, other 170 companies are associates of the Group, joint ventures or companies of which the Group holds more than 5% (excluding the Group companies of negligible interest with respect to the fair presentation that the annual accounts must express). The Group’s consolidated fnancial statements for 2016 were approved by the shareholders at the Bank’s annual general meeting on 7 April 2017. The Group’s consolidated fnancial statements for 2017 were approved by the shareholders at the Bank’s annual general meeting on 23 March 2018. The 2018 consolidated fnancial statements of the Group, the fnancial statements of the Bank and of substantially all the Group companies have not been approved yet by their shareholders at the respective annual general meetings. However, the Bank’s board of directors considers that the aforementioned fnancial statements will be approved without any signifcant changes. b) Basis of presentation of the consolidated annual accounts Under Regulation (EC) no. 1606/2002 of the European Parliament and of the Council of 19 July 2002 all companies governed by the law of an EU Member State and whose securities are admitted to trading on a regulated market of any Member State must prepare their consolidated fnancial statements for the years beginning on or after 1 January 2005 in conformity with the International Financial Reporting Standards (“IFRSs”) previously adopted by the European Union (“EU-IFRSs”). In order to adapt the accounting system of Spanish credit institutions to the new standards, the Bank of Spain issued Circular 4/2004, of 22 December on Public and Confdential Financial Reporting Rules and Formats, which was repealed on 1 January 2018 by the Circular 4/2017 issued by the Bank of Spain on 27 November 2017 and subsequent modifcations. The Group’s consolidated fnancial statements for 2018 were authorised by the Bank’s directors (at the board meeting on 26 February 2019) in accordance with International Financial Reporting Standards as adopted by the European Union and with Bank of Spain Circular 4/2017 and subsequent modifcations, and Spanish corporate and commercial law applicable to the Group, using the basis of consolidation, accounting policies and measurement bases set forth in Note 2, accordingly, they present fairly the Group’s equity and fnancial position at 31 December 2018 and the consolidated results of its operations and the consolidated cash fows in 2018. These consolidated fnancial statements were prepared from the accounting records kept by the Bank and by the other Group entities, and include the adjustments and reclassifcations required to unify the accounting policies and measurement bases applied by the Group. The notes to the consolidated fnancial statements contain supplementary information to that presented in the consolidated balance sheet, consolidated income statement, consolidated statement of recognised income and expense, consolidated statement of changes in total equity and consolidated statement of cash fows. The notes provide, in a clear, relevant, reliable and comparable manner, narrative descriptions and breakdowns of these statements. Adoption of new standards and interpretations issued The following modifcations came into force and were adopted by the European Union in 2018: • IFRS9 Financial instruments On 1 January 2018, IFRS9 Financial instruments entered into force. IFRS9 establishes the requirements for recognition and measurement of both fnancial instruments and certain types of non-fnancial-purchase contracts. The aforementioned requirements should be applied retrospectively, adjusting the opening balance at 1 January 2018, not requiring restatement of the comparative fnancial statements. The adoption of IFRS9 has resulted in changes in the Groups’ accounting policies for the recognition, classifcation and measurement of fnancial assets and liabilities and fnancial assets impairment. IFRS9 also signifcantly modifes other standards related to fnancial instruments such as IFRS7 “Financial instruments: disclosure”. Additionally, IFRS9 includes new hedge accounting requirements which have a twofold objective: to simplify current requirements, and to bring hedge accounting in line with risk management, 452 2018 Auditors’ report and consolidated annual accounts allowing to be a greater variety of derivative fnancial instruments which may be considered to be hedging instruments. Furthermore, additional breakdowns are required providing useful information regarding the efect which hedge accounting has on fnancial statements and also on the entity’s risk management strategy. The treatment of macro-hedges is being developed as a separate project under IFRS9. Entities have the option of continuing to apply IAS39 with respect to accounting hedges until the project has been completed. According to the analysis performed until now, the Group applies IAS39 in hedge accounting. For breakdowns of the notes, according to the regulations in force, the amendments relating to IFRS7 have only been applied to the current period. The breakdowns of the comparative information period notes maintain the breakdowns made in the previous period. The following breakdowns relate to the impact of the adoption of IFRS9 in the Group: a) Classifcation and measurement of fnancial instruments The following table shows a comparison between IAS39 as of 31 December 2017 and IFRS9 as of 1 January 2018 of the reclassifed fnancial instruments in accordance with the new requirements of IFRS9 regarding classifcation and measurement (without impairment), as well as its book value: IAS39 IFRS9 Balance Portfolio Equity instruments Financial assets available for sale (including those that were valued at cost at December) Loans and receivables Debt instruments Financial assets available for sale 2,154 1,537 457 96 Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets at fair value through other comprehensive income Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets at fair value through other comprehensive income Non-trading fnancial assets mandatorily at fair value through proft or loss 6,589 Financial assets at amortised cost 203 Financial assets held for trading Financial assets at fair value through proft or loss 199 Non-trading fnancial assets mandatorily at fair value through proft or loss Investments held-to-maturity 13,491 Financial assets at amortised cost Loans and advances Loans and receivables Loans and receivables Financial assets held for trading Financial assets at fair value through proft or loss Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets at fair value through proft or loss Financial assets at fair value through other comprehensive income 10,179 1,069 43 1,152 Financial assets at amortised cost Derivatives Derivatives – hedging accounting (liabilities) 10 Derivatives - fnancial liabilities held for trading Book value (Million ofeuros) Portfolio Book value (Million of euros) 1,651 533 1,497 486 96 6,704 203 199 13,491 611 9,577 1,107 1,102 10 453 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix b) Reconciliation of impairment provisions from IAS39 to IFRS9 The following table shows a comparison between IAS39 as of 31 December 2017 and IFRS9 as of 1 January 2018 of the impairment provisions of the fnancial instruments in accordance with the new requirements of IFRS9: Million of euros Financial assets at amortised cost Loans and advances Debt instruments Financial assets at fair value through other comprehensive income Debt instruments Commitments and guarantees granted Total IAS39 31/12/2017 Impairment impact IFRS9 01-01-2018 24,682 23,952 730 - - 617 25,299 1,974 2,002 (28) 2 2 197 2,173 26,656 25,954 702 2 2 814 27,472 Additionally, there is an impairment impact on Investments in joint ventures and associates of EUR 34 million. c) Balance sheet reconciliation from IAS39 to IFRS9 The following table shows in detail the reconciliation the consolidated balance sheet under IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 distinguishing between the impacts due to classifcation and measurement and due to impairment once adopted IFRS9: 454 2018 Auditors’ report and consolidated annual accounts ASSETS (Million of euros) Cash, cash balances at central banks and other deposits on demand Financial assets held for trading Derivatives Equity instruments Debt instruments Loans and advances Non-trading fnancial assets mandatorily at fair value through proft or loss Equity instruments Debt instruments Loans and advances Financial assets designated at fair value through proft or loss Equity instruments Debt instruments Loans and advances Financial assets at fair value through other comprehensive income Equity instruments Debt instruments Loans and advances Financial assets available-for-sale Equity instruments Debt instruments Financial assets at amortised cost Debt instruments Loans and advances Loans and receivables Debt instruments Loans and advances Investments held to maturity Investments Other assets** TOTAL ASSETS IAS39 31/12/2017 Naming modifcations* Classifcation and measurement impact Impairment impact IFRS9 01-01-2018 110,995 125,458 57,243 21,353 36,351 10,511 34,782 933 3,485 30,364 133,271 4,790 128,481 903,013 17,543 885,470 13,491 6,184 117,111 1,444,305 - - - - - - 933 933 - - (933) (933) - - 124,229 2,636 121,593 - (124,229) (2,636) (121,593) 889,779 a 15,557 b 874,222 (889,779) a (15,557) (874,222) - - - - - 160 - - 203 (43) 4,054 c 1,651 1,792 611 8,226 - (199) 8,425 a 2,126 533 486 1,107 (9,042) (2,154) c (6,888) b 21,297 20,195 b 1,102 (13,242) (1,994) c (11,248) a c (13,491) b - 6 94 - - - - - - - - - - - - - - (2) - (2) - - - - (1,982)d 20 (2,002) 8 8 - - (34) 680 e (1,330) 110,995 125,618 57,243 21,353 36,554 10,468 4,987 2,584 1,792 611 42,075 3,286 38,789 126,353 3,169 122,077 1,107 909,094 35,772 873,322 - 6,150 117,797 1,443,069 * Due to the entry into force of Bank of Spain Circular 4/2017. ** Includes Hedging derivatives, Changes in the fair value of hedged items in portfolio hedges of interest risk, Assets under insurance or reinsurance contracts, Tangible assets, Intangible assets, Tax assets, Other assets and Non-current assets held for sale. a. The amount of the item Loans and receivables at 31 December 2017 is reclassifed into Financial assets at amortised cost. Nevertheless, the Group maintained a portfolio of loans and receivables for an approximate amount of EUR 8,600 million, which relate mainly to Brazil, which was designated at amortised cost; as a result of the initial implementation of IFRS9 this portfolio has been designated as fair value and fnally it has been reclassifed as ‘Financial assets designated at fair value through proft or loss’. b. Instruments classifed as Investments held to maturity at 31 December 2017 have been reclassifed into Financial assets available-for-sale because of the initial implementation of IFRS9. Additionally, after the review of the business model of cash fow portfolio in diferent locations, the group has identifed certain groups of assets classifed at 31 December 2017 as Financial assets available-for-sale, which relate mainly to Mexico, Brazil and Consumer Finance business, whose management is oriented towards the maintenance of fnancial instruments in a portfolio until maturity end; because of that, this asset group has been reclassifed as Financial assets at amortised cost. c. The Group has reclassifed in Non-trading fnancial assets mandatory at fair value through proft or loss those fnancial instruments which have not comply with the SPPI test (solely payments of principal and interest) classifed at 31 December 2017 mainly in Loans and receivables and Financial assets available for sale, which relate mainly to the UK, Spain and Poland. d. It corresponds to the increase in provisions for impairment of the value of the assets included in the item Financial assets at amortised cos derived from the change in accounting policy. e. This corresponds with increase on provisions for the tax efect referred in section d. 455 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix             LIABILITIES (Million of euros) Financial liabilities held for trading Derivatives Short positions Deposits Marketable debt securities Other fnancial liabilities Financial liabilities designated at fair value through proft or loss Deposits Marketable debt securities Other fnancial liabilities Financial liabilities at amortised cost Deposits Marketable debt securities Other fnancial liabilities Hedging derivatives Changes in the fair value of hedged items in portfolio hedges of interest rate risk Provisions Contingent liabilities and commitments Other provisions* Other liabilities** TOTAL LIABILITIES IAS39 31/12/2017 Naming modifcations Classifcation and measurement impact Impairment impact IFRS9 01-01-2018 107,624 57,892 20,979 28,753 - - 59,616 55,971 3,056 589 1,126,069 883,320 214,910 27,839 8,044 330 14,489 617 13,872 21,300 1,337,472 - - - - - - - - - - - - - - - - - - - - - 10 10 - - - - - - - - - - - - (10) - - - - 41 41 - - - - - - - - - - - - - - - - 197 197 - (3) 194 107,634 57,902 20,979 28,753 - - 59,616 55,971 3,056 589 1,126,069 883,320 214,910 27,839 8,034 330 14,686 814 13,872 21,338 1,337,707 * Includes Pensions and other post-retirements obligations, Other long-term employee benefts, Taxes and other legal contingencies and Other provisions (including guarantees and other contingent liabilities). ** Includes Liabilities under insurance or reinsurance contracts, Tax liabilities, Other liabilities and Liabilities associated with non-current assets held for sale. 456 2018 Auditors’ report and consolidated annual accounts IAS39 31/12/2017 Naming modifcations* Classifcation and measurement impact Impairment impact IFRS9 01-01-2018 91 (1,401) 114,955 - - - - - - - - - - - - 8,068 51,053 525 216 53,437 - 91 (1,401) (2,912) EQUITY (Million of euros) Shareholders’ equity Capital Share premium Equity instruments issued other than capital Other equity Accumulated retained earnings Revaluation reserves Other reserves Own shares Proft attributable to shareholders of the parent Interim dividends Other comprehensive income Items not reclassifed to proft or loss Actuarial gains or losses on defned beneft pension plans Non-current assets held for sale Share in other income and expenses recognised in investments in joint ventures and associates Other valuation adjustments Changes in the fair value of equity instruments measured at fair value with changes in other comprehensive income Inefcacy of fair value hedges of equity instruments measured at fair value with changes in other comprehensive income Changes in the fair value of fnancial liabilities at fair value through proft or loss attributable to changes in credit risk Items that may be reclassifed to proft or loss Hedge of net investment in foreign operations (efective portion) Exchange diferences Hedging derivatives. Cash fow hedges (efective portion) Changes in the fair value of debt instruments measured at fair value with changes in other comprehensive income Hedging instruments (items not designated) Financial assets available for sale Debt instruments Equity instruments Non-current assets held for sale Share in other income and expenses recognised in investments in joint ventures and associates Non controlling interests Other comprehensive income Other elements EQUITY TOTAL EQUITY AND LIABILITIES * Due to the entry into force of Bank of Spain Circular 4/2017. 116,265 8,068 51,053 525 216 53,437 - (1,602) (22) 6,619 (2,029) (21,776) (4,034) (4,033) - (1) - (17,742) (4,311) (15,430) 152 2,068 1,154 914 - (221) 12,344 (1,436) 13,780 106,833 1,444,305 - - - - - - - - - - - - 919 - - 5 - - - - (53) (152) - - (5) - 914 (141) - - (919) - - - 1,154 - (2,068) (1,154) (914) - (5) - - - - - - (6) 99 - - - 99 - - - - - - 15 3 12 53 94 - - - - - - - - - - - - - - - - - - - - - - - (123) - (123) (22) 6,619 (2,029) (21,829) (3,267) (4,033) - (1) 773 - (6) (18,562) (4,311) (15,430) 152 1,253 - - (226) 12,236 (1,433) 13,669 (1,524) 105,362 (1,330) 1,443,069 457 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix                   The Group has chosen to apply a progressive 5-year transition period in accordance with Regulation (EU) 2017/2395 of the European Parliament and of the Council amending Regulation (EU) 575/2013 as regards transitional provisions to mitigate the impact of the introduction of IFRS9 on shareholders’ equity. If the transitional provision of IFRS 9 had not been applied, the total impact of the fully loaded CET1 ratio on 31 December 2018 would be -27 b.p. • IFRS15 Revenue from Contracts with Customers (efective for annual reporting periods beginning on or after 1 January 2018) - the new standard on the recognition of revenue from contracts with customers. It supersedes the following standards and interpretations previous in force: IAS18, Revenue; IAS11, Construction Contracts; IFRIC 13, Customer Loyalty Programs; IFRIC 15, Agreements for the Construction of Real Estate; IFRIC 18, Transfers of Assets from Customers; and SIC-31, Revenue-Barter Transactions Involving Advertising Services. Under IFRS15, an entity recognises revenue in accordance with the core principle of the standard by applying the following fve steps: identify the contract(s) with a customer; identify the performance obligations in the contract; determine the transaction price; allocate the transaction price to the performance obligations identifed in the contract; and recognise revenue when as the entity satisfes a performance obligation. • Clarifcations to IFRS15 income coming from contracts with clients. Given that IFRS15 does not apply to fnancial instruments and other contractual rights or obligations under the scope of IFRS9, no signifcant efects derived from the application of the aforementioned Accounting Standard and its clarifcations in the Group’s consolidated fnancial statements. • Modifcation to IFRS4 “Insurance contracts” applying IFRS9 “Financial Instruments” (efective for annual reporting periods beginning on or after 1 January 2018). The purpose of the amendment is to give all companies that issue insurance contracts the option to recognize in other comprehensive income, instead of proft or loss, the volatility that could arise when applying IFRS9, for new contracts before the adoption of the insurance standard and give companies whose activities are mostly insurance-related an optional temporary exemption from the application of IFRS9 until the year 2021. Entities that defer the application of IFRS9 will continue to apply the existing norm of Financial Instruments IAS39. The deferral of the aforementioned accounting standard did not apply because of non-compliance with the conditions required for it. • Modifcation to the IFRS2 Classifcation and measurement of share-based payment transactions – The amendments address the following areas: (a) Accounting for the efects that the requirements for the consolidation of the grant have in cash– settled share-based payment transactions, (b) Classifcation of share–based payment transactions with net settlement features for the tax withholding obligations; and (c) Accounting for modifcations of share-based payment transactions terms and conditions from cash-settled to equity-settled payment transactions. • Modifcation of IAS40 Transfers of investment properties; changes are made to the existing requirements or provide with some additional guidance on the implementation of such requirements. • Improvements to IFRS Cycle 2014-2016 - introduce minor amendments to IFRS1, referring to the elimination of short-term exemptions for entities adopting IFRS for the frst time, and IAS28, related to the valuation of an investment in an associated or a joint venture at fair value. Minor amendments to IFRS12 regarding this cycle came into force for the years beginning on 1 January 2017. • Interpretation to IFRIC 22 on Foreign currency transactions and advance considerations – When an entity reports a payment of advance consideration in order to recognise the profts associated to the income statement, it shall recognise both the consideration received as a non-monetary liability (deferred income or contract liabilities) in the statement of fnancial position at the exchange rate obtained according to the IAS21 The efects of changes in foreign exchange rates. When the deferred incomes are subsequently recognised in the income statement as incomes, the issue is raised on whether its measurement should refect: the amount at which the deferred income was originally recognised, namely, when the consideration was originally received; or the consideration amount received is translated to the existing exchange rate on the date when the non-monetary element is generated as income in the income statement, generating an exchange gain or loss that refects the diference between the amount of the consideration translated (i) to the exchange rate in force in the moment of its receipt and (ii) to the exchange rate I force when it is recognised in the income statement as a proft or loss. The application of the aforementioned accounting standards did not have any material efects of the Group´s consolidated fnancial statements. Also, at the date of preparation of these consolidated fnancial statements, the following amendments with an efective date subsequent to 31 December 2018 were in force: • IFRS16 Leases substitutes IAS17, IFRIC (International Financial Reporting Interpretation Committee) 4, SIC (Standard Interpretations Committee)-15 and SIC-27. It was adopted by the European Union on 31 October 2017 through the Regulation (EU) 2017/1986. • IFRS16 (efective for annual periods beginning on or after 1 January 2019, with an early adoption option that the Group has not applied) establishes the principles for the recognition, measurement, presentation and breakdown of lease contracts, with the objective of reporting information that faithfully represents the lease transactions. IFRS16 provides a single 458 2018 Auditors’ report and consolidated annual accounts accounting model for the lessee, whereby the lessee must recognise the assets by right of use and the corresponding lease liabilities of all the lease contracts, unless the lease term is 12 months or less or the underlying asset is of low value. Transition The criteria established by the Standard for the registration of the lease contracts will be applied in a retrospective modifed way adjusting the opening balance on the frst day of application (1st of January 2019). The Group, has decided to apply the practical solution allowed by the Standard of not evaluating in the frst application of the contracts are or contain a lease (under the new defnition), and therefore, the IFRS16 will only apply to those contracts that were previously identifed as lease contracts. The Group has estimated an impact due to the frst standard adoption on the ordinary capital ratio (Common Equity Tier 1 – CET 1) fully loaded of -20 b.p. Likewise, it is estimated that assets with the right to use will be approximately recognised by an amount of EUR 6.7 thousand million. The main causes of this impact are the requirements of registration of the asset with the right to use derived from all the lease contracts active during the frst application. Thus, the impact being greater for the Groups leased properties. The following are the main policies, estimates and criteria for the application of IFRS16 currently defned by the Group for its practical adoption: • Lease term: in general, the lease term of each contract will adopted in a homogenous way in all the units of the Group, and at the same time, to the particularities of each unit. Thus, the Group has worked since 2017 in the analysis and identifcation of the contracts afected by the Standard, as well as the defnition of the main technical criteria that afects the accounting of the lease contracts. With respect to the structure of the project´s governance, the Group has established a periodic meeting of the direction of the project, and a team in charge of granting the participation of the responsible teams and coordination with all the geographies. Main steps and milestones of the project In relation to the entry of this new Standard, the Group reported in the interim condensed fnancial statements as of 30 June 2018 the progress to that date of the implementation plan of the same. The Group has prepared the accounting policy and a methodological framework that has been the benchmark for the development of the implementation carried out in the diferent local units. The internal regulation has been approved under the relevant corporate bodies before the entry into force of the Standard. Likewise, the corporate development of the control model over the registration process of the lease contracts is complete, both in transition and once the Standard is applied. The proposed model includes a reference design of the controls to be employed in the new developments made for the implementation of the Standard. coincide with the initial term established. With regard to property contracts, in certain cases the possible consideration of exercising extension or early cancellation options has been evaluated, based mainly on market factors specifc to each asset in each geography. • IFRIC 23: The uncertainty over income tax treatment; - (mandatory for annual periods starting from January 1, 2019) it applies to the tax gain or loss determination, tax bases, efects of tax laws, taxes and interest rates, when there is uncertainty about taxes treatment according to IAS12. • Discount rate: taking into account that the Group has opted to apply the modifed standard retrospectively, the discount rate used in transition will be the lessee’s incremental borrowing rate at this date. For these purposes, the entity has calculated this incremental interest rate taking as a reference the quoted debt instruments issued by the Group. In this regard, the Group has estimated diferent interest rate curves based on the currency and economic environment in which the contracts are located. • Practical exemptions in transition: the Group has considered the practical solutions defned in paragraph C10 of the standard in the application of the modifed retrospective method. This application was made on a contract-by-contract basis, and none of the exemptions were generally applied. Strategy of implementation of the IFRS16 and governance The Group established a global project and multidisciplinary with the objective of adapting its processes to the new Standard of accounting of the lease contracts, granting that said processes are • Modifcation of IFRS9 Financial instruments - (mandatory for annual periods starting from January 1, 2019) a clarifcation has been published on the treatment of certain prepayment options in relation to the evaluation of contractual fows of principal and interest of fnancial instruments. • Modifcation of IAS28 Investments in associates and joint ventures - (mandatory for annual periods starting from January 1, 2019). The amendments clarify the accounting for long-term interests in an associate or joint venture, which in substance form part of the net investment in the associate or joint venture, but to which equity accounting is not applied. Entities must account for such interests under IFRS9 Financial instruments before applying the loss allocation and impairment requirements in IAS28 Investments in associates and joint ventures. 459 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Lastly, at the date of preparation of these consolidated fnancial statements, the following standards which efectively come into force after 31 December 2018 had not yet been adopted by the European Union: • IFRS17 Insurance contracts; it is a new integrated accounting standard for insurance contracts, which includes recognition, measurement, presentation and disclosure. • Modifcation of IFRS Cycle 2015 - 2017- introduces minor amendments to IFRS3, IFRS11, IAS12 and IAS23. • Modifcation of IAS19 Benefts to employees – amendments, reductions and agreements on defned beneft plans are introduced. • Modifcation of IFRS conceptual framework: The IFRS Framework, which sets out the fundamental concepts of fnancial reporting, is amended. The revised Framework includes: a new chapter about measurement; guidance on fnancial reporting; improved defnitions, in particular the defnition of liabilities; and clarifcations such as management functions, prudence and measurement uncertainty in fnancial reporting. It will apply from 1 January 2020. • Modifcation of IFRS3 Business combinations - amendments are introduced. The amendments are intended to assist entities to determine whether a transaction should be accounted for as a business combination or as an asset acquisition. IFRS3 continues to adopt a market participant’s perspective to determine whether an acquired set of activities and assets is a business. The amendments are mainly due to: clarify the minimum requirements for a business; remove the assessment of whether market participants are capable of replacing any missing elements; add guidance to help entities assess whether an acquired process is substantive; narrow the defnitions of a business and of outputs; and introduce an optional fair value concentration test. • Modifcation of IAS1 and IAS8 - A new defnition of material is incorporated. The amendments clarify the accounting treatment for sales or the contribution of assets between an investor and its associates or joint ventures. They confrm that the accounting treatment depends on whether the non-monetary assets sold or contributed to an associate or joint venture constitute a “business” (as defned in IFRS3, Business combination). The Group is currently analysing the possible efects of these new standards and interpretations. All accounting policies and measurement bases with a material efect on the consolidated fnancial statements for 2018 were applied in their preparation. c) Use of critical estimates The consolidated results and the determination of consolidated equity are sensitive to the accounting policies, measurement bases and estimates used by the directors of the Bank in preparing the consolidated fnancial statements. The main accounting policies and measurement bases are set forth in Note 2. In the consolidated fnancial statements estimates were occasionally made by the senior management of the Bank and of the consolidated entities in order to quantify certain of the assets, liabilities, income, expenses and obligations reported herein. These estimates, which were made on the basis of the best information available, relate basically to the following: • The impairment losses on certain assets: it applies to fnancial assets at fair value through other comprehensive income, fnancial assets at amortised cost, non-current assets held for sale, investments, tangible assets and intangible assets (see Notes 6, 7, 8, 10, 12, 13, 16, 17 and 18); • The assumptions used in the actuarial calculation of the post- employment beneft liabilities and commitments and other obligations (see Note 25); • The useful life of the tangible and intangible assets (see Notes 16 and 18); • The measurement of goodwill arising on consolidation (see Note 17); • The calculation of provisions and the consideration of contingent liabilities (see Note 25); • The fair value of certain unquoted assets and liabilities (see Notes 6, 7, 8, 9, 10, 11, 20, 21 and 22); • The recoverability of deferred tax assets (see Note 27); and • The fair value of the identifable assets acquired and the liabilities assumed in business combinations (see Note 3). Although these estimates were made on the basis of the best information available at 2018 year-end, future events might make it necessary to change these estimates (upwards or downwards) in coming years. Changes in accounting estimates would be applied prospectively, recognising the efects of the change in estimates in the related consolidated income statement. d) Information relating to 2017 and 2016 In July 2014, the IASB published IFRS9, which was adopted with the subsequent amendments by the Group on 1 January 2018. As permitted by the regulation itself, the Group has chosen not to re- classify the comparative fnancial statements without having re- classifed under these criteria the information relating to the years ended 31 December 2017 and 2016 so that it is not comparative. However, Note 1.b includes a reconciliation of balances as of 31 December 2017 under IAS39 and the corresponding balances as of 1 January 2018 under IFRS9 where the efect of the frst application of the rule is broken down. 460 2018 Auditors’ report and consolidated annual accounts Similarly, to adapt the accounting system of Spanish credit institutions to the changes related to IFRS15 and IFRS9, on 6 December 2017, Circular 4/2017, of 27 November, of the Bank of Spain, was published, which repeals Circular 4/2004, of December 22, for those years beginning as of 1 January 2018. The adoption of this Circular has modifed the breakdown and presentation of certain headings in the fnancial statements, to adapt them to the aforementioned IFRS9. Information corresponding to the years ended 31 December 2017 and 2016, has not been restated under this Circular. On 2018, the Group changed the accounting policy for recognition of non-controlling interests in equity stake reduction transactions without loss of control. In accordance with international fnancial reporting standards, the goodwill associated with these transactions must be kept on balance. The non-controlling interests resulting from the equity stake reduction can be accounted for by their participation in the identifable net assets or by attributing the goodwill associated with the participation sold. In this sense, the Group has chosen to account for the non-controlling interests by its participation in net assets. The application of the accounting policy change, without impact on net equity, was made on 1 January 2018. The information in Note 4 relating to the ordinary shares outstanding of 2016 period has been recasted, in order to be presented in a comparative manner due to the capital increase described in Note 31.a. Therefore, the information for the years 2017 and 2016 contained in these notes to the consolidated fnancial statements is presented with the information relating to 2018 for comparative purposes only, except as mentioned above in relation to the application of IFRS9, the application of the new requirements of IFRS7 (see note 1.b) and the non-recast of the aforementioned two years balances due to Argentina’s hyperinfation efect (see note 1.h). Additionally, the impact of the acquisition of Banco Popular Español, S.A.U. (See Note 3) is not refected in the comparative of the fgures, mainly in the balance sheet, corresponding to the year 2016. In order to interpret the changes in the balances with respect to 31 December 2018, it is necessary to take into consideration the exchange rate efect arising from the volume of foreign currency balances held by the Group in view of its geographic diversity (see Note 51.b) and the impact of the appreciation/depreciation of the various currencies against the euro in 2018, based on the exchange rates at the end of 2018: Mexican peso (5.20%), US dollar (4.74%), Brazilian real (-10.60%), Argentine peso (-47.50%), sterling pound (-0.82%), Chilean peso (-7.26%), and Polish zloty (-2.89%); as well as the evolution of the comparable average exchange rates: Mexican peso (-6.16%), US dollar (-4.46%), Brazilian real (-16.30%), Argentine peso (-40.43%), sterling pound (-0.96%), Chilean peso (-3.32%) and Polish zloty (-0.10%). e) Capital management i. Regulatory and economic capital The Group’s capital management is performed at regulatory and economic levels. The aim is to secure the Group’s solvency and guarantee its economic capital adequacy and its compliance with regulatory requirements, as well as an efcient use of capital. To this end, the regulatory and economic capital fgures and their associated metrics RORWA (return on risk-weighted assets), RORAC (return on risk-adjusted capital) and value creation of each business unit- are generated, analysed and reported to the relevant governing bodies on a regular basis. Within the framework of the internal capital adequacy assessment process (Pillar II of the Basel Capital Accord), the Group uses an economic capital measurement model with the objective of ensuring that there is sufcient capital available to support all the risks of its activity in various economic scenarios, with the solvency levels agreed upon by the Group; at the same time the Group assesses, also in the various scenarios, whether it meets the regulatory capital ratio requirements. In order to adequately manage the Group’s capital, it is essential to estimate and analyse future needs, in anticipation of the various phases of the business cycle. Projections of regulatory and economic capital are made based on the budgetary information (balance sheet, income statement, etc.) and the macroeconomic scenarios defned by the Group’s economic research service. These estimates are used by the Group as a reference when planning the management actions (issues, securitisations, etc.) required to achieve its capital targets. In addition, certain stress scenarios are simulated in order to assess the availability of capital in adverse situations. These scenarios are based on sharp fuctuations in macroeconomic variables (GDP, interest rates, housing prices, etc.) that mirror historical crisis that could happen again or plausible but unlikely stress situations. Following is a brief description of the regulatory capital framework to which the Group is subject. On 26 June 2013 the Basel III legal framework was included in European law through Directive 2013/36 (CRD IV), repealing Directives 2006/48 and 2006/49, and through Regulation 575/2013 on prudential requirements for credit institutions and investment frms (CRR). The CRD IV was transposed into Spanish legislation through Law 10/2014 on the regulation, supervision and capital adequacy of credit institutions, and its subsequent implementing regulations contained in Royal Decree-Law 84/2015 and Bank of Spain Circular 2/2016, was completed the adaptation to the Spanish law. The CRR came into force immediately, establishes a phase-in that will permit a progressive adaptation to the new requirements in the European Union. These phase-in arrangements were incorporated into Spanish regulations through the approval of Royal Decree-Law 14/2013 and Bank of Spain Circular 2/2014. They 461 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix afect both the new deductions and the issues and items of own funds which cease to be eligible as such under this new regulation. In March 2016, the European Central Bank published Regulation 2016/445/UE that modifes some of the phase-in dates applicable to Group, especially deferred tax assets calendar. The capital bufers provided for in CRD IV are also subject to phase-in; they are applicable for the frst time in 2016 and must be fully implemented by 2019. The review of the existing capital regulatory framework (CRR/ CRD IV) by European governing bodies is being fnalised. The new framework (CRR II/CRDV), which is expected to be approved at the beginning of 2019, incorporates diferent Basel standards such as the Fundamental Review of the Trading Book for Market Risk, the Net Stable Funding Ratio for liquidity risk, the SA-CCR for the calculation of the EAD for counterparty risk or the interest rate risk in the Banking Book (IRRBB). It also introduces modifcations related to the treatment of central counterparties, MDA, Pillar 2, leverage ratio and Pillar 3 among others. The most relevant initiative is the implementation of the TLAC Term Sheet established at international level by the FSB (Financial Stability Board) within the European capital framework, called MREL (Minimum requirement of Eligible Liabilities) in such a way that systemic entities will have to comply with the requirements of MREL in Pillar 1. Within this package of modifcations, the modifcation of the Resolution Directive (BRRD) is also included, replacing it with the BRRD II where MREL requirements are established for Pillar 2 for all resolution entities, whether systemic or not, where the resolution authority will decide on a case-by- case basis the requirements. The Single Resolution Board’s MREL policy for 2017 was based on a step-by-step approach to achieve the MREL target level within several years, and non-compliance could result in the consideration that the entity cannot be resolved. In relation to the subordination requirement, the Single Resolution Board considered that entities of global systemic importance (G-SIIs) have to meet, as a minimum, a level of subordination equal to 13.5% of the RWA plus the combined bufer requirement. In 2018 the SRB has set target requirements for MREL at a consolidated level based on the 2017 policy. These objectives are established for each resolution group, either in MPE (Multiple Point of Entry) strategies as in the case of the Group, or in SPE (Single Point of Entry) strategies. At 31 December 2018 the Group met the minimum capital requirements established by current legislation (See Note 54). ii. Plan for the roll-out of advanced approaches and authorisation from the supervisory authorities The Group continues adopting, over the next few years, the advanced internal ratings-based (AIRB) approach under Basel II for substantially all its banks, until the percentage of exposure of the loan portfolio covered by this approach exceeds 90%. The commitment assumed before the supervisor still implies the adoption of advanced models within the ten key markets where Santander Group operates. Accordingly, the Group continued in 2018 with the project for the progressive implementation of the technology platforms and methodological improvements required for the roll-out of the AIRB approach for regulatory capital calculation purposes at the various Group units. The Group has obtained authorisation from the supervisory authorities to use the AIRB approach for the calculation of regulatory capital requirements for credit risk for the Parent and the main subsidiaries in Spain, the United Kingdom and Portugal, as well as for certain portfolios in Germany, Mexico, Brazil, Chile, the Nordic countries (Norway, Sweden and Finland), France and the United States. During 2018, approval was obtained for the sovereign portfolios, Institutions (FIRB method) and specialised fnancing (Slotting) in Chile, mortgages and most revolving portfolio of Santander Consumer Germany as well as the portfolios of dealers of PSA France and PSA UK (FIRB method). As regards the other risks explicitly addressed under Basel Pillar I, the Group is authorised to use its internal model for market risk for its treasury trading activities in the UK, Spain, Chile, Portugal and Mexico. For the purpose of calculating regulatory capital for operational risk, the Group uses the standardised approach provided for the CRR. On 2018 the European Central Bank authorised the use of the Alternative Standardised Approach to calculate the capital requirements at consolidated level in Banco Santander México, S.A., Institucion de Banca Múltiple, Grupo Financiero Santander México, in addition to the approval obtained in 2016 in Brazil. f) Environmental impact In view of the business activities carried on by the Group entities, the Group does not have any environmental liability, expenses, assets, provisions or contingencies that might be material with respect to its consolidated equity, fnancial position or results. Therefore, no specifc disclosures relating to environmental issues are included in these consolidated fnancial statements. g) Events after the reporting period On 6 February the Group announced that it had completed the placement of preferred securities contingently convertible into newly issued ordinary shares of the Bank, excluding preemptive subscription rights and for a nominal value of USD 1,200,000,000 (EUR 1,052,000,000) (the “Issue” and the “CCPS”). The CCPS were issued at par and its remuneration has been set at 7.50% on an annual basis for the frst fve years. The payment of the remuneration of the CCPS is subject to certain conditions and to the discretion of the Bank. After that, it will be reviewed every fve years by applying a margin of 498.9 basis points on the 5-year Mid-Swap Rate. h) Other information Argentina The economic situation in Argentina in recent years, which led to the signing of an agreement with the International Monetary Fund for the granting of a loan of USD 57,000 million, has had an impact 462 2018 Auditors’ report and consolidated annual accounts on the country’s main economic indicators, especially infation data, which at the end of the year amounts to 47.64%, being accumulated infation in the last three years 147%. In this sense, the Group has reviewed the macroeconomic indicators that afect Argentina’s economy and from this review has concluded the need to apply to these consolidated fnancial statements the accounting standard IAS29 for hyperinfationary economies to its activity in Argentina. This fact has meant: • Adjustment of the historical cost of non-monetary assets and liabilities and the various items of equity of these companies from their date of acquisition or inclusion in the consolidated statement of fnancial position to the end of the year to refect the changes in purchasing power of the currency caused by infation, according to the ofcial indexes published by the “Federación Argentina de Consejos Profesionales de Ciencias Económicas (FCPCE)”. These indices result from combining the National Consumer Price Index with the internal wholesale price index. • The cumulative impact corresponding to previous years has been refected in the equity at the beginning of 2018. • All components of the fnancial statements of the Argentine companies have been translated at the closing exchange rate, which at 31 December, 2018 was 43.12 Argentine peso. • The diferent components of the consolidated income statement and consolidated statement of cash fows have been adjusted for the infation index since their generation, with a balancing entry in fnancial results and a reconciling item in the statement of cash fows, respectively. • At 1 January 2018, an amount of EUR 1,716 million corresponding to the exchange losses in 2017 and prior years has been reclassifed in the total statement of changes in equity from Other comprehensive income - Exchange diferences to Other reserves. At this date, a credit to Other reserves was registered for EUR 131 million due to the non-monetary assets revaluation. Also, EUR -398 million were recognised under Other reserves during 2018, including EUR 104 million due to non-monetary assets revaluation. The comparative fgures for 2017 and 2016 have not been modifed, in accordance with IAS21. The impact on results, both by the adjustment of the fgures in the consolidated income statement at the year-end exchange rate, and by the adjustment of the fnancial loss corresponding to the impact of the infation of the year on the net monetary assets, as well as the efect on the CET1, is immaterial for the Group. UK Referendum On June 23, 2016, the UK held a referendum (the UK European Union Referendum) on its membership of the European Union, in which a majority voted for the UK to leave the European Union. Immediately following the result, the UK and global stock and foreign exchange markets commenced a period of signifcant volatility, including a steep devaluation of the pound sterling. There remains signifcant uncertainty relating to the UK’s exit from, and future relationship with, the European Union and the basis of the UK’s future trading relationship with the rest of the world. On March 29, 2017, the UK Prime Minister gave notice under Article 50(2) of the Treaty on European Union of the UK’s intention to withdraw from the European Union. The delivery of the Article 50(2) notice triggered a two year period of negotiation to determine the terms on which the UK will exit the EU and the framework for the UK’s future relationship with the European Union. Unless extended, the UK’s European Union membership will cease after this two year period. There is a possibility that the UK’s European Union membership ends at such time without reaching any agreement on the terms of its relationship with the European Union going forward. Currently this agreement is pending to be ratifed by the parliament of the United Kingdom. The outcome of Brexit remains unclear, however, a UK exit from the European Union with a no-deal continues to remain a possibility and the consensus view is that this would have a negative impact on the UK economy, afecting its growth prospects. While the longer term efects of the UK’s imminent departure from the European Union are difcult to predict, there is short term political and economic uncertainty. Santander UK is subject to substantial European Union-derived regulation and oversight. Although legislation has now been passed transferring the European Union acquis into UK law, there remains signifcant uncertainty regarding the respective legal and regulatory environments, in which Santander UK and its subsidiaries will operate when the UK is no longer a member of the European Union, and the basis on which cross-border fnancial business will take place after the UK leaves the European Union. Operationally, Santander UK and other fnancial institutions may no longer be able to rely on the European passporting framework for fnancial services, and it is unclear what alternative regime may be in place following the UK’s departure from the European Union. This uncertainty, and any actions taken as a result of this uncertainty, as well as new or amended rules, may have a signifcant impact on the operating results, proftability and business of the Group. The aforementioned political events in the UK, along with any further changes in government structure and policies, may lead to further market volatility and changes to the fscal, monetary and regulatory landscape in which Santander UK operates and could have a material adverse efect on us, including our ability to access capital and liquidity on fnancial terms acceptable to us and, more generally, on our operating results, fnancial condition and prospects. The Group, with the best estimate at the date of approval of these consolidated fnancial statements, has considered such circumstances in its evaluation of the diferent items afected in the consolidated fnancial statements, mainly in the recoverability of the cash generating unit that underpins Santander UK goodwill. 463 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 2. Accounting policies The accounting policies applied in preparing the consolidated fnancial statements were as follows: a) Foreign currency transactions i. Presentation currency The Bank’s functional and presentation currency is the euro. Also, the presentation currency of the Group is the euro. ii. Translation of foreign currency balances Foreign currency balances are translated to euros in two consecutive stages: • Translation of foreign currency to the functional currency (currency of the main economic environment in which the entity operates); and • Translation to euros of the balances held in the functional currencies of entities whose functional currency is not the euro. Translation of foreign currency to the functional currency Foreign currency transactions performed by consolidated entities (or entities accounted for using the equity method) not located in European Monetary Union (“EMU”) countries are initially recognised in their respective currencies. Monetary items in foreign currency are subsequently translated to their functional currencies using the closing rate. Furthermore: • Non-monetary items measured at historical cost are translated to the functional currency at the exchange rate at the date of acquisition. • Non-monetary items measured at fair value are translated at the exchange rate at the date when the fair value was determined. • Income and expenses are translated at the average exchange rates for the year for all the transactions performed during the year. When applying this criterion, the Group considers whether there have been signifcant changes in the exchange rates in the year which, in view of their materiality with respect to the consolidated fnancial statements taken as a whole, would make it necessary to use the exchange rates at the transaction date rather than the aforementioned average exchange rates. • The balances arising from non-hedging forward foreign currency/ foreign currency and foreign currency/euro purchase and sale transactions are translated at the closing rates prevailing in the forward foreign currency market for the related maturity. Translation of functional currencies to euros The balances in the fnancial statements of consolidated entities (or entities accounted for using the equity method) whose functional currency is not the euro are translated to euros as follows: • Assets and liabilities, at the closing rates. • Income and expenses, at the average exchange rates for the year. • Equity items, at the historical exchange rates. iii. Recognition of exchange diferences The exchange diferences arising on the translation of foreign currency balances to the functional currency are generally recognised at their net amount under Exchange diferences in the consolidated income statement, except for exchange diferences arising on fnancial instruments at fair value through proft or loss, which are recognised in the consolidated income statement without distinguishing them from other changes in fair value, and for exchange diferences arising on non-monetary items measured at fair value through equity, which are recognised under Other comprehensive income–Items that may be reclassifed to proft or loss–Exchange diferences (See note 29). The exchange diferences arising on the translation to euros of the fnancial statements denominated in functional currencies other than the euro are recognised in Other comprehensive income–Items that may be reclassifed to proft or loss–Exchange diferences in the consolidated balance sheet, whereas those arising on the translation to euros of the fnancial statements of entities accounted for using the equity method are recognised in equity under Other comprehensive income–Items that may be reclassifed to proft or loss and Items not reclassifed to proft or loss–Other recognised income and expense of investments in subsidiaries, joint ventures and associates (See note 29), until the related item is derecognised, at which time they are recognised in proft or loss. Exchange diferences arising on actuarial gains or losses when converting to euros the fnancial statements denominated in the functional currencies of entities whose functional currency is diferent from the euro are recognised under equity–Other comprehensive income–Items not reclassifed to proft or loss– Actuarial gains or (-) losses on defned beneft pension plans (See note 29). iv. Entities located in hyperinfationary economies Exchange diferences arising on the translation to the Group´s presentation currency of fnancial statements denominated in functional currencies other than euro of countries with high 464 2018 Auditors’ report and consolidated annual accounts infation rates are recorded in the consolidated statement of changes in total equity - Other reserves. Million of euros At 31 December 2018 the economic situation in Argentina which led to the review by the Group of the macroeconomic indicators that afect Argentina’s economy and from this review the Group has concluded the need to apply to these annual fnancial statements the accounting standard IAS29 for hyperinfationary economies to its activity in Argentina (See note 1.h). v. Exposure to foreign currency risk The Group hedges a portion of its long-term foreign currency positions using foreign exchange derivative fnancial instruments (see Note 36). Also, the Group manages foreign currency risk dynamically by hedging its short-term position (with a potential impact on proft or loss) in order to limit the impact of currency depreciations while optimising the cost of fnancing the hedges. The following tables show the sensitivity of the consolidated income statement and consolidated equity to changes in exchange positions arising from investments in Group companies with currencies other than the euro and their results, due to percentage changes of 1% in the various foreign currencies in which the Group maintains signifcant balances. The estimated efect on the consolidated equity attributable to the Group and on consolidated proft of a 1% appreciation of the euro against the corresponding currency is as follows: Million of euros Efect on consolidated equity Efect on consolidated proft Currency US dollar 2018 2017 2016 2018 2017 2016 (162.3) (157.9) (187.1) (4.1) (1.4) (4.5) Chilean peso (22.9) (29.0) (27.9) (5.1) (1.8) (4.2) Pound sterling (171.2) (176.6) (184.9) (4.5) (3.1) (10.0) Mexican peso (18.3) (16.0) (16.2) (1.7) (1.2) (5.4) Brazilian real (85.6) (93.1) (122.3) (5.6) (6.5) (6.3) Polish zloty (36.2) (34.5) (31.5) (4.2) (1.5) (3.3) Argentine peso (7.8) (7.4) (9.0) (0.6) (3.5) (3.3) Similarly, the estimated efect on the Group’s consolidated equity and on consolidated proft of a 1% depreciation of the euro against the corresponding currency is as follows: Efect on consolidated equity Efect on consolidated proft 2018 2017 2016 2018 2017 2016 Currency US dollar 165.6 161.1 190.8 Chilean peso 23.4 29.6 28.4 Pound sterling 174.7 180.2 188.7 Mexican peso 18.6 16.3 16.5 Brazilian real 87.4 95.0 124.7 Polish zloty 36.9 35.2 32.1 Argentine peso 8.0 7.6 9.2 4.2 5.2 4.6 1.8 5.7 4.2 0.6 1.5 1.8 3.2 1.2 6.6 1.5 3.6 4.5 4.3 10.2 5.5 6.5 3.3 3.3 The foregoing data were obtained as follows: a) Efect on consolidated equity: in accordance with the accounting policy detailed in Note 2.a.iii, the exchange diferences arising on the translation to euros of the fnancial statements in the functional currencies of the Group entities whose functional currency is not the euro are recognised in consolidated equity. The possible efect that a change in the exchange rates of the related currency would have on the Group’s consolidated equity was therefore determined by applying the aforementioned change to the net value of each unit’s assets and liabilities -including, where appropriate, the related goodwill- and by taking into consideration the ofsetting efect of the hedges of net investments in foreign operations. b) Efect on consolidated proft: the efect was determined by applying the fuctuations in the average exchange rates used for the year, as indicated in Note 2.a.ii, to translate to euros the income and expenses of the consolidated entities whose functional currency is not the euro, taking into consideration, where appropriate, the ofsetting efect of the various hedging transactions in place. The estimates used to obtain the foregoing data were performed considering the efects of the exchange rate fuctuations in isolation from the efect of the performance of other variables whose changes would afect equity and proft or loss, such as variations in the interest rates of the reference currencies or other market factors. Accordingly, all variables other than the exchange rate fuctuations were kept constant with respect to their positions at 31 December 2018, 2017 and 2016. b) Basis of consolidation i. Subsidiaries Subsidiaries are defned as entities over which the Bank has the capacity to exercise control. The Bank controls an entity when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to afect those returns through its power over the investee. 465 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The fnancial statements of the subsidiaries are fully consolidated with those of the Bank. Accordingly, all balances and efects of the transactions between consolidated companies are eliminated on consolidation. iii. Associates Associates are entities over which the Bank is in a position to exercise signifcant infuence, but not control or joint control. It is presumed that the Bank exercises signifcant infuence if it holds 20% or more of the voting power of the investee. On acquisition of control of a subsidiary, its assets, liabilities and contingent liabilities are recognised at their acquisition-date fair values. Any positive diferences between the acquisition cost and the fair values of the identifable net assets acquired are recognised as goodwill (See Note 17). Negative diferences are recognised in proft or loss on the date of acquisition. Additionally, the share of third parties of the Group’s equity is presented under Non-controlling interests in the consolidated balance sheet (See Note 28). Their share of the proft for the year is presented under Proft attributable to non-controlling interests in the consolidated income statement. The results of subsidiaries acquired during the year are included in the consolidated income statement from the date of acquisition to year-end. Similarly, the results of subsidiaries for which control is lost during the year are included in the consolidated income statement from the beginning of the year to the date of disposal. At 31 December 2018 the Group controlled the following company in which it held an ownership interest of less than 50% of the share capital, Luri 1, S.A. apart from structured consolidated entities. The percentage ownership interest in the aforementioned company is 36% (See Appendix I). Although the Group holds less than half the voting power, it manages and, as a result, exercises control over this entity. The company´s corporate purpose for the entity is the acquisition of real estate and other general operations relating thereto, including rental, and the purchase and sale of properties; the company object of the latter entity is the provision of payment services. The impact of the consolidation of this company on the Group’s consolidated fnancial statements is immaterial. The Appendices contain signifcant information on the subsidiaries. ii. Interests in joint ventures Joint ventures are deemed to be entities that are not subsidiaries but which are jointly controlled by two or more unrelated entities. This is evidenced by contractual arrangements whereby two or more parties have interests in entities so that decisions about the relevant activities require the unanimous consent of all the parties sharing control. In the consolidated fnancial statements, investments in joint ventures are accounted for using the equity method, i.e. at the Group’s share of net assets of the investee, after taking into account the dividends received therefrom and other equity eliminations. The profts and losses resulting from transactions with a joint venture are eliminated to the extent of the Group’s interest therein. The Appendices contain signifcant information on the joint ventures. In the consolidated fnancial statements, investments in associates are accounted for using the equity method, i.e. at the Group’s share of net assets of the investee, after taking into account the dividends received therefrom and other equity eliminations. The profts and losses resulting from transactions with an associate are eliminated to the extent of the Group’s interest in the associate. There are certain investments in entities which, although the Group owns 20% or more of their voting power, are not considered to be associates because the Group is not in a position to exercise signifcant infuence over them. These investments are not signifcant for the Group. There are also certain investments in associates where the Group owns less than 20% of the voting rights, as it is determined that it has the capacity to exercise signifcant infuence over them. The impact of these companies is immaterial in the Group’s consolidated fnancial statements. The Appendices contain signifcant information on the associates. iv. Structured entities When the Group incorporates entities, or holds ownership interests therein, to enable its customers to access certain investments, or for the transfer of risks or other purposes (also called structured entities since the voting or similar power is not a key factor in deciding who controls the entity), the Group determines, using internal criteria and procedures and taking into consideration the applicable legislation, whether control (as defned above) exists and, therefore, whether these entities should be consolidated. Specifcally, for those entities to which this policy applies (mainly investment funds and pension funds), the Group analyses the following factors: • Percentage of ownership held by the Group; 20% is established as the general threshold. • Identifcation of the fund manager, and verifcation as to whether it is a company controlled by the Group since this could afect the Group’s ability to direct the relevant activities. • Existence of agreements between investors that might require decisions to be taken jointly by the investors, rather than by the fund manager. • Existence of currently exercisable removal rights (possibility of removing the manager from his position), since the existence of such rights might limit the manager’s power over the fund, and it may be concluded that the manager is acting as an agent of the investors. 466 2018 Auditors’ report and consolidated annual accounts • Analysis of the fund manager’s remuneration regime, taking into consideration that a remuneration regime that is proportionate to the service rendered does not, generally, create exposure of such importance as to indicate that the manager is acting as the principal. Conversely, if the remuneration regime is not proportionate to the service rendered, this might give rise to an exposure that would lead the Group to a diferent conclusion. vi. Changes in the levels of ownership interests in subsidiaries Acquisitions and disposals not giving rise to a change in control are recognised as equity transactions, and no gain or loss is recognised in the income statement and the initially recognised goodwill is not remeasured. The diference between the consideration transferred or received and the decrease or increase in non-controlling interests, respectively, is recognised in reserves. These structured entities also include the securitisation special purpose vehicles (“SPV”), which are consolidated in the case of the SPVs over which, being exposed to variable yield, it is considered that the Group continues to exercise control. The exposure associated with unconsolidated structured entities are not material with respect to the Group’s consolidated fnancial statements. v. Business combinations A business combination is the bringing together of two or more separate entities or economic units into one single entity or group of entities. Business combinations whereby the Group obtains control over an entity or a business are recognised for accounting purposes as follows: • The Group measures the cost of the business combination, which is normally the consideration transferred, defned as the acquisition-date fair values of the assets transferred, the liabilities incurred to the former owners of the acquiree and the equity instruments issued, if any, by the acquirer. In cases where the amount of the consideration to be transferred has not been defnitively established at the acquisition date, but rather depends on future events, any contingent consideration is recognised as part of the consideration transferred and measured at its acquisition-date fair value. Moreover, acquisition-related costs do not for these purposes form part of the cost of the business combination. • The fair values of the assets, liabilities and contingent liabilities of the acquired entity or business, including any intangible assets identifed in the business combination which might not have been recognised by the acquiree, are estimated and recognised in the consolidated balance sheet; the Group also estimates the amount of any non-controlling interests and the fair value of the previously held equity interest in the acquiree. • Any positive diference between the aforementioned items is recognised as discussed in Note 2.m. Any negative diference is recognised under negative goodwill recognised in the consolidated income statement. Goodwill is only calculated and recognised once, when control of a business or an entity is obtained. Similarly, when control over a subsidiary is lost, the assets, liabilities and non-controlling interests and any other items recognised in Other Comprehensive income of that company are derecognised from the consolidated balance sheet, and the fair value of the consideration received and of any remaining equity interest is recognised. The diference between these amounts is recognised in proft or loss. vii. Acquisitions and disposals Note 3 provides information on the most signifcant acquisitions and disposals in the last three years. c) Defnitions and classifcation of fnancial instruments i. Defnitions A fnancial instrument is any contract that gives rise to a fnancial asset of one entity and a fnancial liability or equity instrument of another entity. An equity instrument is a contract that evidences a residual interest in the assets of the issuing entity after deducting all of its liabilities. A fnancial derivative is a fnancial instrument whose value changes in response to the change in an observable market variable (such as an interest rate, foreign exchange rate, fnancial instrument price, market index or credit rating), whose initial investment is very small compared with other fnancial instruments with a similar response to changes in market factors, and which is generally settled at a future date. Hybrid fnancial instruments are contracts that simultaneously include a non-derivative host contract together with a derivative, known as an embedded derivative, that is not separately transferable and has the efect that some of the cash fows of the hybrid contract vary in a way similar to a stand-alone derivative. Compound fnancial instruments are contracts that simultaneously create for their issuer a fnancial liability and an own equity instrument (such as convertible bonds, which entitle their holders to convert them into equity instruments of the issuer). The preference shares contingently convertible into ordinary shares eligible as Additional Tier 1 capital (“CCPSs”) -perpetual shares, which may be repurchased by the issuer in certain circumstances, the interest on which is discretionary, and would 467 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix convert into a variable number of newly issued ordinary shares if the capital ratio of the Bank or its consolidated group falls below a given percentage (trigger event), as those two terms are defned in the related issue prospectuses- are recognised for accounting purposes by the Group as compound instruments. The liability component refects the issuer’s obligation to deliver a variable number of shares and the equity component refects the issuer’s discretion in relation to the payment of the related coupons. In order to efect the initial allocation, the Group estimates the fair value of the liability as the amount that would have to be delivered if the trigger event were to occur immediately and, accordingly, the equity component, calculated as the residual amount, is zero. In view of the aforementioned discretionary nature of the payment of the coupons, they are deducted directly from equity. Capital perpetual preference shares (“CPPSs”), with the possibility of purchase by the issuer in certain circumstances, whose remuneration is discretionary, and which will be amortised permanently, totally or partially, in the event that the Bank or its consolidated group submits a capital ratio lesser than a certain percentage (trigger event), as defned in the corresponding prospectuses, are accounted for by the Group as equity instruments. The following transactions are not treated for accounting purposes as fnancial instruments: • Investments in associates and joint ventures (see Note 13). • Rights and obligations under employee beneft plans (see Note 25). • Rights and obligations under insurance contracts (see Note 15). • Contracts and obligations relating to employee remuneration • The risks that afect the performance of the business model (and the fnancial assets held in the business model) and, specifcally, the way in which these risks are managed. • How business managers are remunerated. • The frequency and volume of sales in previous years, as well as expectations of future sales. The analysis of the characteristics of the contractual fows of fnancial assets requires an assessment of the congruence of these fows with a basic loan agreement. Contractual cash fows that are only principal and interest payments on the outstanding principal amount meet this requirement. Depending on these factors, the asset can be measured at amortised cost, at fair value with changes in other comprehensive income, or at fair value with changes through proft and loss. IFRS9 also establishes an option to designate an instrument at fair value with changes in proft or loss, under certain conditions. The Group uses the following criteria for the classifcation of fnancial debt instruments: • Amortised cost: fnancial instruments under a business model whose objective is to collect principal and interest fows, over which there is no signifcant unjustifed sales and fair value is not a key element in the management of these assets and contractual conditions they give rise to cash fows on specifc dates, which are only payments of principal and interest on the outstanding principal amount. In this sense, unjustifed sales are considered to be those other than those related to an increase in the credit risk of the asset, unanticipated funding needs (stress case scenarios). Additionally, the characteristics of its contractual fows represent substantially a “basic fnancing agreement”. based on own equity instruments (see Note 34). • Fair value with changes in other comprehensive income: fnancial ii. Classifcation of fnancial assets for measurement purposes Financial assets are initially classifed into the various categories used for management and measurement purposes, unless they have to be presented as Non-current assets held for sale or they relate to Cash, cash balances at central banks and other deposits on demand, Changes in the fair value of hedged items in portfolio hedges of interest rate risk (asset side), Hedging derivatives and Investments, which are reported separately. Classifcation of fnancial instruments: the classifcation criteria for fnancial assets depends on the business model for their management and the characteristics of their contractual fows. The Group’s business models refer to the way in which it manages its fnancial assets to generate cash fows. In defning these models, the Group takes into account the following factors: • How key management staf are assessed and reported on the performance of the business model and the fnancial assets held in the business model. instruments held in a business model whose objective is to collect principal and interest cash fows and the sale of these assets, where fair value is a key factor in their management. Additionally, the contractual cash fow characteristics substantially represent a “basic fnancing agreement”. • Fair value with changes in proft or loss: fnancial instruments included in a business model whose objective is not obtained through the above mentioned models, where fair value is a key factor in managing of these assets, and fnancial instruments whose contractual cash fow characteristics do not substantially represent a “basic fnancing agreement”. In this section it can be enclosed the portfolios classifed under “Financial assets held for trading”, “Non-trading fnancial assets mandatorily at fair value through proft or loss” and “Financial assets at fair value through proft or loss”. Equity instruments will be classifed at fair value under IFRS9, with changes in proft or loss, unless the Group decides, for non- trading assets, to classify them at fair value with changes in other 468 2018 Auditors’ report and consolidated annual accounts comprehensive income (irrevocably) in the initial moment. The Group has generally apllied this option to the equity instruments classifed as “Available-for-sale” at 31 December 2017 under IAS39. In general, the Group has aplied this option in the case of equity instruments classifed under “Available for Sale” at 31 December 2017 under IAS39. Until 31 December 2017, the Group applied IAS39, under which the following three categories existed that are not applicable under IFRS9 (See note 1.b): • Financial assets available-for-sale: this category includes debt instruments not classifed as Held-to-maturity investments, Loans and receivables or Financial assets at fair value through proft or loss, and equity instruments issued by entities other than subsidiaries, associates and joint ventures, provided that such instruments have not been classifed as Financial assets held for trading or as Financial assets designated at fair value through proft or loss. • Credit institutions: credit of any nature, including deposits and money market transactions, in the name of credit institutions. • Customers: includes the remaining credit, including money market transactions through central counterparties. • Debt instruments: bonds and other securities that represent a debt for their issuer, that generate an interest return, and that are in the form of certifcates or book entries. • Equity instruments: fnancial instruments issued by other entities, such as shares, which have the nature of equity instruments for the issuer, other than investments in subsidiaries, joint ventures or associates. Investment fund units are included in this item. • Derivatives: includes the fair value in favour of the Group of derivatives which do not form part of hedge accounting, including embedded derivatives separated from hybrid fnancial instruments. • Loans and receivables: this category includes the investment • Changes in the fair value of hedged items in portfolio hedges of arising from ordinary lending activities, such as the cash amounts of loans drawn down and not yet repaid by customers or the deposits placed with other institutions, whatever the legal instrument, unquoted debt securities and receivables from the purchasers of goods, or the users of services, constituting part of the Group’s business. • Investments held-to-maturity: this category includes debt instruments with fxed maturity and with fxed or determinable payments, for which the Group has both the intention and proven ability to hold to maturity. iii. Classifcation of fnancial assets for presentation purposes Financial assets are classifed by nature into the following items in the consolidated balance sheet: • Cash, cash balances at Central Banks and other deposits on demand: cash balances and balances receivable on demand relating to deposits with central banks and credit institutions. • Loans and advances: includes the debit balances of all credit and loans granted by the Group, other than those represented by securities, as well as fnance lease receivables and other debit balances of a fnancial nature in favour of the Group, such as cheques drawn on credit institutions, balances receivable from clearing houses and settlement agencies for transactions on the stock exchange and organised markets, bonds given in cash, capital calls, fees and commissions receivable for fnancial guarantees and debit balances arising from transactions not originating in banking transactions and services, such as the collection of rentals and similar items. They are classifed, on the basis of the institutional sector to which the debtor belongs, into: • Central banks: credit of any nature, including deposits and money market transactions received from the Bank of Spain or other central banks. interest rate risk: this item is the balancing entry for the amounts credited to the consolidated income statement in respect of the measurement of the portfolios of fnancial instruments which are efectively hedged against interest rate risk through fair value hedging derivatives. • Hedging derivatives: Includes the fair value in favour of the Group of derivatives, including embedded derivatives separated from hybrid fnancial instruments, designated as hedging instruments in hedge accounting. iv. Classifcation of fnancial liabilities for measurement purposes Financial liabilities are initially classifed into the various categories used for management and measurement purposes, unless they have to be presented as Liabilities associated with non-current assets held for sale or they relate to Hedging derivatives or Changes in the fair value of hedged items in portfolio hedges of interest rate risk (liability side), which are reported separately. IAS39 fnancial liabilities classifcation and measurement criteria remains substantially unchanged under IFRS9. Nevertheless, in most cases, the changes in the fair value of fnancial liabilities designated at fair value with changes recognised through proft or loss for the year, due to the entity credit risk, are classifed under other comprehensive income. Financial liabilities are included for measurement purposes in one of the following categories: • Financial liabilities held for trading (at fair value through proft or loss): this category includes fnancial liabilities incurred for the purpose of generating a proft in the near term from fuctuations in their prices, fnancial derivatives not designated as hedging 469 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix instruments, and fnancial liabilities arising from the outright sale of fnancial assets acquired under reverse repurchase agreements (“reverse repos”) or borrowed (short positions). • Financial liabilities designated at fair value through proft or loss: fnancial liabilities are included in this category when they provide more relevant information, either because this eliminates or signifcantly reduces recognition or measurement inconsistencies (accounting mismatches) that would otherwise arise from measuring assets or liabilities or recognising the gains or losses on them on diferent bases, or because a group of fnancial liabilities or fnancial assets and liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided on that basis to the Group’s key management personnel. Liabilities may only be included in this category on the date when they are incurred or originated. • Financial liabilities at amortised cost: fnancial liabilities, irrespective of their instrumentation and maturity, not included in any of the above-mentioned categories which arise from the ordinary borrowing activities carried on by fnancial institutions. v. Classifcation of fnancial liabilities for presentation purposes Financial liabilities are classifed by nature into the following items in the consolidated balance sheet: • Deposits: includes all repayable balances received in cash by the Group, other than those instrumented as marketable securities and those having the substance of subordinated liabilities (amount of the loans received, which for credit priority purposes are after common creditors), except for the debt instruments . This item also includes cash bonds and cash consignments received the amount of which may be invested without restriction. Deposits are classifed on the basis of the creditor’s institutional sector into: • Central banks: deposits of any nature, including credit received and money market transactions received from the Bank of Spain or other central banks. • Credit institutions: deposits of any nature, including credit received and money market transactions in the name of credit institutions. • Customer: includes the remaining deposits, including money market transactions through central counterparties. • Marketable debt securities: includes the amount of bonds and other debt represented by marketable securities, other than those having the substance of subordinated liabilities (amount of the loans received, which for credit priority purposes are after common creditors, and includes the amount of the fnancial instruments issued by the Group which, having the legal nature of capital, do not meet the requirements to qualify as equity, such as certain preferred shares issued). This item includes the component that has the consideration of fnancial liability of the securities issued that are compound fnancial instruments. • Derivatives: includes the fair value, with a negative balance for the Group, of derivatives, including embedded derivatives separated from the host contract, which do not form part of hedge accounting. • Short positions: includes the amount of fnancial liabilities arising from the outright sale of fnancial assets acquired under reverse repurchase agreements or borrowed. • Other fnancial liabilities: includes the amount of payment obligations having the nature of fnancial liabilities not included in other items, and liabilities under fnancial guarantee contracts, unless they have been classifed as non-performing. • Changes in the fair value of hedged items in portfolio hedges of interest rate risk: this item is the balancing entry for the amounts charged to the consolidated income statement in respect of the measurement of the portfolios of fnancial instruments which are efectively hedged against interest rate risk through fair value hedging derivatives. • Hedging derivatives: includes the fair value of the Group’s liability in respect of derivatives, including embedded derivatives separated from hybrid fnancial instruments, designated as hedging instruments in hedge accounting. d) Measurement of fnancial assets and liabilities and recognition of fair value changes In general, fnancial assets and liabilities are initially recognised at fair value which, in the absence of evidence to the contrary, is deemed to be the transaction price. Financial instruments not measured at fair value through proft or loss are adjusted by the transaction costs. Financial assets and liabilities are subsequently measured at each year-end as follows: i. Measurement of fnancial assets Financial assets are measured at fair value are valued mainly at their fair value without deducting any transaction cost for their sale. The fair value of a fnancial instrument on a given date is taken to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market 470 2018 Auditors’ report and consolidated annual accounts The efective interest rate is the discount rate that exactly matches the carrying amount of a fnancial instrument to all its estimated cash fows of all kinds over its remaining life. For fxed rate fnancial instruments, the efective interest rate coincides with the contractual interest rate established on the acquisition date plus, where applicable, the fees and transaction costs that, because of their nature, form part of their fnancial return. In the case of foating rate fnancial instruments, the efective interest rate coincides with the rate of return prevailing in all connections until the next benchmark interest reset date. Equity instruments and contracts related with these instruments are measured at fair value. However, in certain circumstances the Group estimates cost value as a suitable estimate of the fair value. This can happen if the recent event available information is not enough to measure the fair value or if there is a broad range of possible measures and the cost value represents the best estimates of fair value within this range. The amounts at which the fnancial assets are recognised represent, in all material respects, the Group’s maximum exposure to credit risk at each reporting date. Also, the Group has received collateral and other credit enhancements to mitigate its exposure to credit risk, which consist mainly of mortgage guarantees, cash collateral, equity instruments and personal security, assets leased out under fnance lease and full-service lease agreements, assets acquired under repurchase agreements, securities loans and credit derivatives. ii. Measurement of fnancial liabilities In general, fnancial liabilities are measured at amortised cost, as defned above, except for those included under Financial liabilities held for trading and Financial liabilities designated at fair value through proft or loss and fnancial liabilities designated as hedged items (or hedging instruments) in fair value hedges, which are measured at fair value. iii. Valuation techniques The following table shows a summary of the fair values, at the end of 2018, 2017 and 2016, of the fnancial assets and liabilities indicated below, classifed on the basis of the various measurement methods used by the Group to determine their fair value: participants. The most objective and common reference for the fair value of a fnancial instrument is the price that would be paid for it on an active, transparent and deep market (quoted price or market price). At 31 December 2018 there were no signifcant investments in quoted fnancial instruments that had ceased to be recognised at their quoted price because their market could not be deemed to be assets. If there is no market price for a given fnancial instrument, its fair value is estimated on the basis of the price established in recent transactions involving similar instruments and, in the absence thereof, of valuation techniques commonly used by the international fnancial community, taking into account the specifc features of the instrument to be measured and, particularly, the various types of risk associated with it. All derivatives are recognised in the balance sheet at fair value from the trade date. If the fair value is positive, they are recognised as an asset and if the fair value is negative, they are recognised as a liability. The fair value on the trade date is deemed, in the absence of evidence to the contrary, to be the transaction price. The changes in the fair value of derivatives from the trade date are recognised in Gains/losses on fnancial assets and liabilities held for trading (net) in the consolidated income statement. Specifcally, the fair value of fnancial derivatives traded in organised markets included in the portfolios of fnancial assets or liabilities held for trading is deemed to be their daily quoted price and if, for exceptional reasons, the quoted price cannot be determined on a given date, these fnancial derivatives are measured using methods similar to those used to measure OTC derivatives. The fair value of OTC derivatives is taken to be the sum of the future cash fows arising from the instrument, discounted to present value at the date of measurement (present value or theoretical close) using valuation techniques commonly used by the fnancial markets: net present value (NPV), option pricing models and other methods. The amount of debt securities and loans and advances under a business model whose objective is to collect the principal and interest fows are valued at their amortised cost, using the efective interest rate method in their determination. Amortised cost refers to the acquisition cost of a corrected fnancial asset or liability (more or less, as the case may be) for repayments of principal and the part systematically charged to the consolidated income statement of the diference between the initial cost and the corresponding reimbursement value at expiration. In the case of fnancial assets, the amortised cost includes, in addition, the corrections to their value due to the impairment. In the loans and advances covered in fair value hedging transactions, the changes that occur in their fair value related to the risk or the risks covered in these hedging transactions are recorded. 471 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros Financial assets held for trading Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss Financial assets at fair value through other comprehensive income Financial assets available-for-sale** Hedging derivatives (assets) Financial liabilities held for trading Financial liabilities designated at fair value through proft or loss Hedging derivatives (liabilities) Liabilities under insurance contracts 2018* 2017 2016 Published price quotations in active markets (Level 1) Internal models (Level 2 and 3) Total Published price quotations in active markets (Level 1) Internal models (Level 2 and 3) Total Published price quotations in active markets (Level 1) Internal models (Level 2 and 3) Total 37,108 55,771 92,879 58,215 67,243 125,458 64,259 83,928 148,187 1,835 8,895 10,730 3,102 54,358 57,460 3,823 30,959 34,782 3,220 28,389 31,609 103,590 17,501 121,091 113,258 18,802 132,060 89,563 25,862 115,425 - 8,607 8,607 - 8,537 8,537 216 10,161 10,377 16,104 54,239 70,343 21,828 85,796 107,624 20,906 87,859 108,765 987 67,071 68,058 769 58,847 59,616 5 - 6,358 6,363 765 765 8 - 8,036 8,044 1,117 1,117 - 9 - 40,263 40,263 8,147 8,156 652 652 * See further detail regarding the impacts of the entry into force of IFRS9 as of 1 January 2018 (Note 1.b). ** In addition to the fnancial instruments measured at fair value shown in the foregoing table, at 31 December 2017 and 2016, the Group held equity instruments classifed as Financial assets available-for-sale and carried at cost amounting to EUR 1,211 million and EUR 1,349 million, respectively (see Note 51.c). The fnancial instruments at fair value determined on the basis of published price quotations in active markets (Level 1) include government debt securities, private-sector debt securities, derivatives traded in organised markets, securitised assets, shares, short positions and fxed-income securities issued. In cases where price quotations cannot be observed, management makes its best estimate of the price that the market would set, using its own internal models. In most cases, these internal models use data based on observable market parameters as signifcant inputs (Level 2) and, in cases, they use signifcant inputs not observable in market data (Level 3). In order to make these estimates, various techniques are employed, including the extrapolation of observable market data. The best evidence of the fair value of a fnancial instrument on initial recognition is the transaction price, unless the fair value of the instrument can be obtained from other market transactions performed with the same or similar instruments or can be measured by using a valuation technique in which the variables used include only observable market data, mainly interest rates. The Group has developed a formal process for the systematic valuation and management of fnancial instruments, which has been implemented worldwide across all the Group’s units. The governance scheme for this process distributes responsibilities between two independent divisions: Treasury (development, marketing and daily management of fnancial products and market data) and Risk (on a periodic basis, validation of pricing models and market data, computation of risk metrics, new transaction approval policies, management of market risk and implementation of fair value adjustment policies). The approval of new products follows a sequence of steps (request, development, validation, integration in corporate systems and quality assurance) before the product is brought into production. This process ensures that pricing systems have been properly reviewed and are stable before they are used. The following subsections set forth the most important products and families of derivatives, and the related valuation techniques and inputs, by asset class: 472 2018 Auditors’ report and consolidated annual accounts market quotes of European and American-style vanilla call and put options. Various interpolation and extrapolation techniques are used to obtain continuous volatility for illiquid stocks. Dividends are usually estimated for the mid and long term. Correlations are implied, when possible, from market quotes of correlation- dependent products. In all other cases, proxies are used for correlations between benchmark underlyings or correlations are obtained from historical data. The inputs of foreign exchange models include the yield curve for each currency, the spot foreign exchange rate, the implied volatilities and the correlation among assets of this class. Volatilities are obtained from European call and put options which are quoted in markets as of-the-money, risk reversal or butterfy options. Illiquid currency pairs are usually handled by using the data of the liquid pairs from which the illiquid currency can be derived. For more exotic products, unobservable model parameters may be estimated by ftting to reference prices provided by other non-quoted market sources. Credit The most common instrument in this asset class is the credit default swap (CDS), which is used to hedge credit exposure to third parties. In addition, models for frst-to-default (FTD), n-to- default (NTD) and single-tranche collateralised debt obligation (CDO) products are also available. These products are valued with standard industry models, which estimate the probability of default of a single issuer (for CDS) or the joint probability of default of more than one issuer for FTD, NTD and CDO. Valuation inputs are the yield curve, the CDS spread curve and the recovery rate. For indices and important individual issuers, the CDS spread curve is obtained in the market. For less liquid issuers, this spread curve is estimated using proxies or other credit-dependent instruments. Recovery rates are usually set to standard values. For listed single-tranche CDO, the correlation of joint default of several issuers is implied from the market. For FTD, NTD and bespoke CDO, the correlation is estimated from proxies or historical data when no other option is available. Valuation adjustment for counterparty risk or default risk The Credit valuation adjustment (CVA) is a valuation adjustment to OTC derivatives as a result of the risk associated with the credit exposure assumed to each counterparty. Fixed income and infation The fxed income asset class includes basic instruments such as interest rate forwards, interest rate swaps and cross currency swaps, which are valued using the net present value of the estimated future cash fows discounted taking into account basis swap and cross currency spreads determined on the basis of the payment frequency and currency of each leg of the derivative. Vanilla options, including caps, foors and swaptions, are priced using the Black-Scholes model, which is one of the benchmark industry models. More exotic derivatives are priced using more complex models which are generally accepted as standard across institutions. These pricing models are fed with observable market data such as deposit interest rates, futures rates, cross currency swap and constant maturity swap rates, and basis spreads, on the basis of which diferent yield curves, depending on the payment frequency, and discounting curves are calculated for each currency. In the case of options, implied volatilities are also used as model inputs. These volatilities are observable in the market for cap and foor options and swaptions, and interpolation and extrapolation of volatilities from the quoted ranges are carried out using generally accepted industry models. The pricing of more exotic derivatives may require the use of non-observable data or parameters, such as correlation (among interest rates and cross-asset), mean reversion rates and prepayment rates, which are usually defned from historical data or through calibration. Infation-related assets include zero-coupon or year-on-year infation-linked bonds and swaps, valued with the present value method using forward estimation and discounting. Derivatives on infation indices are priced using standard or more complex bespoke models, as appropriate. Valuation inputs of these models consider infation-linked swap spreads observable in the market and estimations of infation seasonality, on the basis of which a forward infation curve is calculated. Also, implied volatilities taken from zero-coupon and year-on-year infation options are also inputs for the pricing of more complex derivatives. Equity and foreign exchange The most important products in these asset classes are forward and futures contracts; they also include vanilla, listed and OTC (Over-The-Counter) derivatives on single underlying assets and baskets of assets. Vanilla options are priced using the standard Black-Scholes model and more exotic derivatives involving forward returns, average performance, or digital, barrier or callable features are priced using generally accepted industry models or bespoke models, as appropriate. For derivatives on illiquid stocks, hedging takes into account the liquidity constraints in models. The inputs of equity models consider yield curves, spot prices, dividends, asset funding costs (repo margin spreads), implied volatilities, correlation among equity stocks and indices, and cross-asset correlation. Implied volatilities are obtained from 473 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The CVA is calculated taking into account potential exposure to each counterparty in each future period. The CVA for a specifc counterparty is equal to the sum of the CVA for all the periods. The following inputs are used to calculate the CVA: • Expected exposure: including for each transaction the mark- to-market (MtM) value plus an add-on for the potential future exposure for each period. Mitigating factors such as collateral and netting agreements are taken into account, as well as a temporary impairment factor for derivatives with interim payments. • Loss Given Default: percentage of fnal loss assumed in a counterparty credit event/default. • Probability of default: for cases where there is no market information (the CDS quoted spread curve, etc.), proxies based on companies holding exchange-listed CDS, in the same industry and with the same external rating as the counterparty, are used. • Discount factor curve. The debit valuation adjustment (DVA) is a valuation adjustment similar to the CVA but, in this case, it arises as a result of the Group’s own risk assumed by its counterparties in OTC derivatives. The CVA at 31 December 2018 amounted to EUR 351 million (8.8% compared to 31 December 2017) and DVA amounted to EUR 261 million (18.9% compared to 31 December 2017). The variations are due to the fact that credit spreads for the most liquid maturities have been increased in percentages over 30%. In addition, the Group amounts the funding fair value adjustment (FFVA) is calculated by applying future market funding spreads to the expected future funding exposure of any uncollateralised component of the OTC derivative portfolio. This includes the uncollateralised component of collateralised derivatives in addition to derivatives that are fully uncollateralised. The expected future funding exposure is calculated by a simulation methodology, where available. The FFVA impact is not material for the consolidated fnancial statements as of 31 December 2018, 2017 and 2016. As a result of the frst application of IFRS9, the exposure at 1 January 2018, in level 3 fnancial instruments, has increased by EUR 2,183 million, mainly for loans and receivables, arising from new requirements regarding the classifcation and measurement of amortised cost items at other fair value items whose value is calculated using unobservable market inputs (see note 1.b). In addition, the Group has reclassifed in 2018 to level 3 the market value of certain transactions of bonds, long-term repos and derivatives for an approximate amount of EUR 1,300 million, the reason for this classifcation has been mainly due to lack of liquidity in certain signifcant inputs in the fair value of the aforementioned fnancial instruments. In addition, during 2016 the Group carried out a review of its fnancial instruments valuation processes with the purpose of increasing the observability of certain inputs and parameters used in its valuation techniques. As a result of this review, it started to receive prices of interest rate derivatives with the option of a clear type of discount for EUR and USD and correlations between pairs of shares to services of consensus pricing, which has allowed to incorporate the inputs obtained directly or inferred from instrument prices, in their internal valuation processes. As a consequence, those non-observable inputs (the parameter of the reversion to the average of the interest rates and the correlations between shares, respectively) used in the valuation of interest rate derivatives with the option of cancelling type EUR and USD and derivatives on Stock baskets had become measurable and considered observable parameters, and therefore, these products were reclassifed from Level 3 to Level 2. During 2018, 2017 and 2016 the Group has not carried out signifcant reclassifcations of fnancial instruments between levels except the changes disclosed in the level 3 table. Valuation adjustments due to model risk The valuation models described above do not involve a signifcant level of subjectivity, since they can be adjusted and recalibrated, where appropriate, through internal calculation of the fair value and subsequent comparison with the related actively traded price. However, valuation adjustments may be necessary when market quoted prices are not available for comparison purposes. The sources of risk are associated with uncertain model parameters, illiquid underlying issuers, and poor quality market data or missing risk factors (sometimes the best available option is to use limited models with controllable risk). In these situations, the Group calculates and applies valuation adjustments in accordance with common industry practice. The main sources of model risk are described below: • In the fxed income markets, the sources of model risk include bond index correlations, basis spread modelling, the risk of calibrating model parameters and the treatment of near-zero or negative interest rates. Other sources of risk arise from the estimation of market data, such as volatilities or yield curves, whether used for estimation or cash fow discounting purposes. • In the equity markets, the sources of model risk include forward skew modelling, the impact of stochastic interest rates, correlation and multi-curve modelling. Other sources of risk arise from managing hedges of digital callable and barrier option payments. Also worthy of consideration as sources of risk are the estimation of market data such as dividends and correlation for quanto and composite basket options. 474 2018 Auditors’ report and consolidated annual accounts • For specifc fnancial instruments relating to home mortgage loans secured by fnancial institutions in the UK (which are regulated and partially fnanced by the Government) and property asset derivatives, the main input is the Halifax House Price Index (HPI). In these cases, risk assumptions include estimations of the future growth and the volatility of the HPI, the mortality rate and the implied credit spreads. • Infation markets are exposed to model risk resulting from uncertainty around modelling the correlation structure among various CPI rates. Another source of risk may arise from the bid- ofer spread of infation-linked swaps. • The currency markets are exposed to model risk resulting from forward skew modelling and the impact of stochastic interest rate and correlation modelling for multi-asset instruments. Risk may also arise from market data, due to the existence of specifc illiquid foreign exchange pairs. • The most important source of model risk for credit derivatives relates to the estimation of the correlation between the probabilities of default of diferent underlying issuers. For illiquid underlying issuers, the CDS spread may not be well defned. 475 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Set forth below are the fnancial instruments at fair value whose measurement was based on internal models (Levels 2 and 3) at 31 December 2018, 2017 and 2016: Million of euros Fair values calculated using internal models at 31/12/18** * ASSETS: Financial assets held for trading Credit institutions Customers*** Debt and equity instruments Derivatives Swaps Level 2 Level 3 Valuation techniques Main assumptions 140,659 4,473 55,033 738 - 205 314 54,514 44,423 - Present value method Yield curves, FX market prices - Present value method Yield curves, FX market prices 153 Present value method Yield curves, HPI, FX market prices 585 185 Present value method, Gaussian Copula**** Yield curves, FX market prices, HPI, Basis, Liquidity Exchange rate options 617 2 Black-Scholes Model Yield curves, Volatility surfaces, FX market prices, Liquidity Interest rate options Interest rate futures Index and securities options Other Hedging derivatives Swaps Interest rate options Other 3,778 - 1,118 4,578 8,586 7,704 20 862 149 Black's Model, multifactorial advanced models interest rate Yield curves, Volatility surfaces, FX market prices, Liquidity - Present value method Yield curves, FX market prices 198 Black-Scholes Model Yield curves, Volatility surfaces, FX & EQ market prices, Dividends, Correlation, Liquidity, HPI 51 Present value method, Advanced stochastic volatility models and other Yield curves, Volatility surfaces, FX and EQ market prices, Dividends, Correlation, Liquidity, Others 21 21 Present value method FX market prices, Yield curves, Basis - Black's Model - Present value method, Advanced stochastic volatility models and other FX market prices, Yield curves, Volatility surfaces Yield curves, Volatility surfaces, FX market prices, Credit, Liquidity, Others Non-trading fnancial assets mandatorily at fair value through proft or loss 7,492 1,403 Equity instruments 985 462 Present value method Market price, Interest rates curves, Dividends and Others Debt instruments Loans and receivables*** 5,085 1,422 481 Present value method Interest rates curves 460 Present value method, swap asset model & CDS Interest rates curves and Credit curves Financial assets designated at fair value through proft or loss 53,482 876 Central banks Credit institutions Customers Debt instruments 9,226 22,897 21,355 - Present value method Interest rates curves, FX market prices 201 Present value method Interest rates curves, FX market prices 560 Present value method Interest rates curves, FX market prices, HPI 4 115 Present value method Interest rates curves, FX market prices Financial assets at fair value through other comprehensive income 16,066 1,435 Equity instruments 455 581 Present value method Market price, Interest rates curves, Dividends and Others Debt instruments Loans and receivables Financial assets available for sale Debt instruments 14,699 912 165 Present value method Interest rates curves, FX market prices 689 Present value method Interest rates curves, FX market prices and Credit curves 476 2018 Auditors’ report and consolidated annual accounts Million of euros * LIABILITIES Financial liabilities held for trading Central banks Credit institutions Customers Derivatives Swaps Fair values calculated using internal models at 31/12/18** Level 2 Level 3 Valuation techniques Main assumptions 127,991 53,950 442 289 - - - 53,950 43,489 - Present value method Yield curves, FX market prices - Present value method Yield curves, FX market prices - Present value method Yield curves, FX market prices 289 111 Present value method, Gaussian Copula**** Yield curves, FX market prices, Basis, Liquidity, HPI Exchange rate options 610 7 Black-Scholes Model Interest rate options 4,411 26 Black's Model, multifactorial advanced models interest rate Yield curves, Volatility surfaces, FX market prices, Liquidity Yield curves, Volatility surfaces, FX market prices, Liquidity Index and securities options 1,233 143 Black-Scholes Model Yield curves, FX market prices Interest rate and equity futures 7 - Black's Model Yield curves, Volatility surfaces, FX & EQ market prices, Dividends, Correlation, Liquidity, HPI Other 4,200 2 Present value method, Advanced stochastic volatility models and other Yield curves, Volatility surfaces, FX & EQ market prices, Dividends, Correlation, Liquidity, HPI Short positions - - Present value method Yield curves ,FX & EQ market prices, Equity Hedging derivatives Swaps Interest rate options Other 6,352 5,868 158 326 6 6 Present value method Yield curves ,FX & EQ market prices, Basis - Black's Model - Present value method, Advanced stochastic volatility models and other Yield curves , Volatility surfaces, FX market prices, Liquidity Yield curves , Volatility surfaces, FX market prices, Liquidity, Other Financial liabilities designated at fair value through proft or loss 66,924 147 Present value method Yield curves, FX market prices Liabilities under insurance contracts 765 - 477 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros ASSETS: Financial assets held for trading Credit institutions Customers*** Debt and equity instruments Derivatives Swaps Exchange rate options Interest rate options Interest rate futures Index and securities options Other Hedging derivatives Swaps Interest rate options Other Financial assets designated at fair value through proft or loss Credit institutions Customers***** Debt and equity instruments Financial assets available-for-sale Debt and equity instruments Fair values calculated using internal models at 31/12/17** Fair values calculated using internal models at 31/12/16** Level 2 Level 3 Level 2 Level 3 Valuation techniques 124,178 66,806 1,696 8,815 335 55,960 44,766 463 4,747 2 1,257 4,725 8,519 7,896 13 610 1,363 437 - - 32 405 189 5 162 - 5 44 18 18 - - 146,991 83,587 3,220 9,504 798 70,065 53,499 524 5,349 1,447 1,725 7,521 10,134 9,737 13 384 1,349 341 - Present value method - Present value method 40 Present value method 301 55 Present value method, Gaussian Copula**** 2 Black-Scholes Model 173 Black's Model, Heath- Jarrow- Morton Model - Present value method 26 Black-Scholes Model 45 Present value method, Monte Carlo simulation and others 27 27 Present value method - Black's Model - N/A 30,677 282 28,064 325 9,889 20,403 385 18,176 18,176 - 72 210 626 626 10,069 17,521 474 25,206 25,206 - Present value method 74 Present value method 251 Present value method 656 656 Present value method 478 2018 Auditors’ report and consolidated annual accountsMillion of euros LIABILITIES: Financial liabilities held for trading Central banks Credit institutions Customers Derivatives Swaps Exchange rate options Interest rate options Index and securities options Interest rate and equity futures Other Short positions Hedging derivatives Swaps Interest rate options Other Financial liabilities designated at fair value through proft or loss Liabilities under insurance contracts Fair values calculated using internal models at 31/12/17** Fair values calculated using internal models at 31/12/16** Level 2 Level 3 Level 2 Level 3 Valuation techniques 153,600 85,614 282 292 28,179 56,860 45,041 497 5,402 1,527 1 4,392 1 8,029 7,573 287 169 58,840 1,117 196 182 - - - 182 100 9 19 41 - 13 - 7 7 - - 7 - 136,835 87,790 1,351 44 9,996 73,481 57,103 413 6,485 1,672 1,443 6,365 2,918 8,138 6,676 10 1,452 86 69 - Present value method - Present value method - Present value method 69 1 Present value method, Gaussian Copula**** - Black-Scholes Model 21 Black’s Model, Heath- Jarrow- Morton Model 46 Black-Scholes Model - Método del valor presente 1 Present value method, Monte Carlo simulation and others - Present value method 9 9 Present value method - Black’s Model - N/A 40,255 8 Present value method 652 - See Note 15 * ** See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (See Note 1.b) Level 2 internal models use data based on observable market parameters, while level 3 internal models use signifcant non-observable inputs in market data. *** Includes mainly short-term loans and reverse repurchase agreements with corporate customers (mainly brokerage and investment companies). **** Includes credit risk derivatives with a net fair value of EUR 0 million at 31 December 2018 (31 December 2017 and 2016: net fair value of EUR 0 million and EUR -1 million, respectively). These assets and liabilities are measured using the Standard Gaussian Copula Model. ***** Includes home mortgage loans to fnancial institutions in the UK (which are regulated and partly fnanced by the Government). The fair value of these loans was obtained using observable market variables, including current market transactions with similar amounts and collateral facilitated by the UK Housing Association. Since the Government is involved in these fnancial institutions, the credit risk spreads have remained stable and are homogeneous in this sector. The results arising from the valuation model are checked against current market transactions. 479 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Level 3 fnancial instruments Set forth below are the Group’s main fnancial instruments measured using unobservable market data as signifcant inputs of the internal models (Level 3): • Derivatives on volatility of long-term interest rates (more than 30 years) where volatility is not observable in the market at the indicated term. • Equity volatility derivatives, specifcally indices and equities, • Instruments in Santander UK’s portfolio (loans, debt instruments where volatility is not observable in the long term. • HTC&S (Hold to collect and sale) syndicated loans classifed in the fair value category with changes in other comprehensive income, where the cost of liquidity is not directly observable in the market, as well as the prepayment option in favour of the borrower. The measurements obtained using the internal models might have been diferent if other methods or assumptions had been used with respect to interest rate risk, to credit risk, market risk and foreign currency risk spreads, or to their related correlations and volatilities. Nevertheless, the Bank’s directors consider that the fair value of the fnancial assets and liabilities recognised in the consolidated balance sheet and the gains and losses arising from these fnancial instruments are reasonable. The net amount recognised in proft and loss in 2018 arising from models whose signifcant inputs are unobservable market data (Level 3) amounted to EUR 10 million proft (EUR 116 million loss in 2017 and EUR 60 million proft in 2016). The table below shows the efect, at 31 December 2018 on the fair value of the main fnancial instruments classifed as Level 3 of a reasonable change in the assumptions used in the valuation. This efect was determined by applying the probable valuation ranges of the main unobservable inputs detailed in the following table: and derivatives) linked to the House Price Index (HPI). Even if the valuation techniques used for these instruments may be the same as those used to value similar products (present value in the case of loans and debt instruments, and the Black-Scholes model for derivatives), the main factors used in the valuation of these instruments are the HPI spot rate, the growth and volatility thereof, and the mortality rates, which are not always observable in the market and, accordingly, these instruments are considered illiquid. • HPI spot rate: for some instruments the NSA HPI spot rate, which is directly observable and published on a monthly basis, is used. For other instruments where regional HPI rates must be used (published quarterly), adjustments are made to refect the diferent composition of the rates and adapt them to the regional composition of Santander UK’s portfolio. • HPI growth rate: this is not always directly observable in the market, especially for long maturities, and is estimated in accordance with existing quoted prices. To refect the uncertainty implicit in these estimates, adjustments are made based on an analysis of the historical volatility of the HPI, incorporating reversion to the mean. • HPI volatility: the long-term volatility is not directly observable in the market but is estimated on the basis of shorter-term quoted prices and by making an adjustment to refect the existing uncertainty, based on the standard deviation of historical volatility over various time periods. • Mortality rates: these are based on published ofcial tables and adjusted to refect the composition of the customer portfolio for this type of product at Santander UK. • Callable interest rate derivatives (Bermudan-style options) where the main unobservable input is mean reversion of interest rates. • Trading derivatives on interest rates, taking as an underlying asset titling and with the amortization rate (CPR, Conditional prepayment rate) as unobservable main entry. • Derivatives from trading on infation in Spain, where volatility is not observable in the market. 480 2018 Auditors’ report and consolidated annual accounts Portfolio/Instrument* Impacts (Million of euros) (Level 3) Valuation technique Financial assets held for trading Main unobservable inputs Range Weighted average Unfavourable scenario Favourable scenario Trading derivatives Present value method Curves on TAB indices** Long-term rates MXN a a a a Present value method, Modifed Black-Scholes Model HPI forward growth rate 0%-5% 2.7% Interest Rate Curves, FX Market Prices HPI spot rate CPR n/a n/a 783*** n/a (0.3) - (24.0) (7.8) (163.2) 0.3 - 20.7 7.8 (84.4) Long-term FX volatility 11%-17% 14.75% (34.4) 5.0 Financial assets at fair value through other comprehensive income Debt instruments and equity holdings Present value method, others Present value method, others Present value method, others Contingencies for litigation Late payment and prepayment rate capital cost long-term proft growth rate Interest Rate Curves, FX Market Prices and Credit Curves 0%-100% 29% a a a a (23.8) (6.6) 9.7 6.6 1.8 (1.8) Local Volatility Long term volatility n/a 34.0% 244.9 (313.8) Non-trading fnancial assets mandatorily at fair value through proft or loss Credit to customers Debt instruments and equity instruments Weighted average by probability (according to forecast mortality rates) of European HPI options, using the Black-Scholes model HPI forward growth rate HPI spot rate TD Black Spain volatility Modelo Asset Swap & CDS Cvx. Adj (SLN) Model - Interest Rate Curves and Credit Long term volatility n/a n/a n/a n/a 4.7% 7.7% 8.0% 0%-5% 2.8% (6.2) 5.0 783*** (11.2) 11.2 Financial liabilities held for trading Trading derivatives Present value method, modifed Black-Scholes Model HPI forward growth rate 0%-5% 2.6% Discounted fows denominated in diferent currencies HPI spot rate Curves on TAB indices** Long-term rates MXN 722*** a IRS TIIE 3bp X-CCY MXN/ USD 4bp n/a a Bid Ofer Spread IRS TIIE 2bp - 6bp X-CCY USD/ MXN 3bp - 10bp Hedging derivatives (liabilities) Advanced models of local and stochastic volatility Correlation between the price of shares Advanced multi-factor interest rate models Mean reversion of interest rates 55%-75% 65% n/a n/a 0.0001-0.03 0.01**** - b - b Financial liabilities designated at fair value through proft or loss - - - - * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** TAB: “Tasa Activa Bancaria” (Active Bank Rate). Average interest rates on 30, 90, 180 and 360-day deposits published by the Chilean Association of Banks and Financial Institutions (ABIF) in nominal currency (Chilean peso) and in real terms, adjusted for infation (in Chilean unit of account (Unidad de Fomento - UF)). *** There are national and regional HPIs. The HPI spot value is the weighted average of the indices that correspond to the positions of each portfolio. The impact reported is in response to a 10% shift. **** Theoretical average value of the parameter. The change made for the favourable scenario is from 0.0001 to 0.03. An unfavourable scenario was not considered as there was no margin for downward movement from the parameter’s current level. a. The exercise was performed for the unobservable inputs described in the column “Main unobservable inputs” under probable scenarios. The weighted average range and value used is not shown because this exercise has been carried out jointly for diferent inputs or variants of them (for example, the TAB input are vector-term curves, for which there are also nominal and indexed curves to infation), it is not possible to break down the result in an isolated manner by type of input. In the case of the TAB curve, the result is reported before movements of +/- 100 bp for the joint sensitivity of this index in CLP (Chilean peso) and UF. The same applies for interest rates in MXN (Mexican peso). b. The Group calculates the potential impact on the measurement of each instrument on a joint basis, regardless of whether the individual value is positive (assets) or negative (liabilities), and discloses the joint efect associated with the related instruments classifed on the asset side of the consolidated balance sheet. 481 2.2 (11.5) (19.8) 4.4 (121.2) 105.1 (5.4) (4.9) - (1.2) 5.8 4.8 - 1.2 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix               31/12/2018 Fair value calculated using internal models (Level 3) 738 153 585 185 2 149 198 51 21 21 876 201 560 115 Level reclassifcations Other 312 (20) 141 171 4 - 8 195 (36) - - 699 202 497 - (4) (16) (4) (1) (2) (7) (2) - - 53 - 57 (4) 31 (36) 1,403 - 1 30 (59) (2) 25 460 481 462 - - - - - - - - - - - - - - - - - - (269) (269) 147 1,189 (93) (96) 1,435 4,473 - - - - - - - - - - - 161 161 28 - 10 128 (5) - - - 161 (9) (9) (3) - (1) (5) - - - - (9) 289 289 111 7 26 143 2 6 6 147 442 Lastly, the changes in the fnancial instruments classifed as Level 3 in 2018, 2017 and 2016 were as follows: 01-01-2018* Fair value calculated using internal models (Level 3) Purchases/ Issuances Sales/ Amortization Settlements Changes Changes in fair value recognised in proft or loss Changes in fair value recognised in proft or loss Million of euros Financial assets held for trading Debt instruments and equity instruments Trading derivatives Swaps Exchange rate options Interest rate options Index and securities options Other Hedging derivatives (Assets) Swaps Financial assets at fair value through proft or loss Credit entities Loans and advances to customers Debt instruments Non-trading fnancial assets mandatorily at fair value through proft or loss Loans and advances to customers Debt instruments Equity instruments Financial assets at fair value through other comprehensive income TOTAL ASSETS Financial liabilities held for trading Trading derivatives Swaps Exchange rate options Interest rate options Index and securities options Others Hedging derivatives (Liabilities) Swaps Financial liabilities designated at fair value through proft or loss TOTAL LIABILITIES 437 32 405 189 5 162 5 44 18 18 - - - - 1,365 465 518 382 1,726 3,546 182 182 100 9 19 41 13 7 7 7 196 85 22 63 - - - 41 22 - - 105 - - 105 66 56 - 10 162 418 41 41 - - - 41 - - - 140 181 (26) (6) (20) (8) - (3) (1) (8) - - - - - - (30) (22) (7) (1) (238) (294) (95) (95) (7) - (1) (87) - - - - (95) (34) (34) - - - - - - - - - - - - (5) - - (5) - (39) - - - - - - - - - - - (16) 2 (18) 4 (2) (16) (35) 31 3 3 19 (1) 6 14 12 20 (29) 21 - 18 9 9 (7) (2) (1) 25 (6) (1) (1) - 8 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 482 2018 Auditors’ report and consolidated annual accounts 2016 Fair value calculated using internal models (Level 3) 341 40 301 55 2 173 26 45 27 27 325 74 237 14 45 (21) - 45 1 5 - - 39 - - - - - - (7) (14) (6) - - (1) (7) (2) (2) (9) (2) (7) - 656 1,349 1 46 (239) (271) 69 69 1 - 21 46 1 9 9 8 86 33 33 - 21 - - 12 - - - 33 (3) (3) - - - (3) - - - - (3) Million of euros Financial assets held for trading Debt and equity instruments Derivatives Swaps Exchange rate options Interest rate options Index and securities options Other Hedging derivatives (Assets) Swaps Financial assets designated at fair value through proft or loss Loans and advances to customers Debt instruments Equity instruments Financial assets available-for-sale TOTAL ASSETS Financial liabilities held for trading Derivatives Swaps Exchange rate options Interest rate options Index and securities options Other Hedging derivatives (Liabilities) Swaps Financial liabilities designated at fair value through proft or loss TOTAL LIABILITIES Changes Purchases Sales Issuances Settlements Changes in fair value recognised in proft or loss Changes in fair value recognised in equity Level reclassifcations Other 2017 Fair value calculated using internal models (Level 3) - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - (5) (5) - - - - - - - - - - - (129) (1) (128) (59) (2) (11) (18) (38) (7) (7) (20) 3 (21) (2) - (156) (38) (38) (26) (11) (2) - 1 (2) (2) - (40) - - - - - - - - - - - - - - 59 59 - - - - - - - - - - - 200 - 200 200 - - - - - - - - - - (6) 194 126 126 126 - - - - - - 1 - 1 (2) - - (2) 5 - - (14) (3) (10) (1) 160 147 (5) (5) (1) (1) - (2) (1) - - - 126 (1) (6) 437 32 405 189 5 162 5 44 18 18 282 72 199 11 626 1,363 182 182 100 9 19 41 13 7 7 7 196 483 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 2015 Fair value calculated using internal models (Level 3) Purchases Changes Sales Issuances Changes in fair value recognised in Settlements proft or loss Changes in fair value recognised in equity Level reclassifcations Other 950 43 907 54 - 619 120 114 18 18 514 81 283 150 - - - - - - - - - - - - - - (157) (5) (152) - - (52) (30) (70) (4) (4) (7) - (7) - 999 2,481 37 37 (263) (431) 302 302 1 194 107 - 11 11 11 324 - - - - - - - - - - (34) (34) - (19) (15) - (3) (3) - (37) - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - (104) - - (104) (28) (132) - - - - - - - - - - 52 3 49 (3) 2 39 (3) 14 13 13 6 5 1 - - 71 10 10 - 1 8 1 1 1 - 11 2016 Fair value calculated using internal models (Level 3) 341 40 301 55 2 173 26 45 27 27 325 74 237 14 - - - - - - - - - - - - - - (489) (15) - (489) - - (433) (1) (14) 4 - - (56) - (5) (13) - - - - (2) (82) - - (2) (12) (40) (30) (11) (11) (29) (520) (49) (146) 656 1,349 - - - - - - - - - - (199) (199) - (10) (10) - (155) - (44) - (10) - - - - - - (199) (3) (13) 69 69 1 21 46 1 9 9 8 86 Million of euros Financial assets held for trading Debt and equity instruments Derivatives Swaps Exchange rate options Interest rate options Index and securities options Other Hedging derivatives (Assets) Swaps Financial assets designated at fair value through proft or loss Loans and advances to customers Debt instruments Equity instruments Financial assets available-for-sale TOTAL ASSETS Financial liabilities held for trading Derivatives Swaps Interest rate options Index and securities options Other Hedging derivatives (Liabilities) Swaps Financial liabilities designated at fair value through proft or loss TOTAL LIABILITIES 484 2018 Auditors’ report and consolidated annual accounts iv. Recognition of fair value changes As a general rule, changes in the carrying amount of fnancial assets and liabilities are recognised in the consolidated income statement. A distinction is made between the changes resulting from the accrual of interest and similar items, (which are recognised under Interest income or Interest expense, as appropriate), and those arising for other reasons, which are recognised at their net amount under Gains/losses on fnancial assets and liabilities. Adjustments due to changes in fair value arising from: • Financial assets at fair value with changes in other comprehensive income are recorded temporarily, in the case of debt instruments in other comprehensive income - Elements that can be reclassifed to proft or loss - Financial assets at fair value with changes in other comprehensive income, while in the case of equity instruments are recorded in other comprehensive income - Elements that will not be reclassifed to line item - Changes in the fair value of equity instruments valued at fair value with changes in other comprehensive income. Exchange diferences on debt instruments measured at fair value with changes in other comprehensive income are recognised under Exchange Diferences, net of the consolidated income statement. Exchange diferences on equity instruments, in which the irrevocable option of being measured at fair value with changes in other comprehensive income has been chosen, are recognised in Other comprehensive income - Items that will not be reclassifed to proft or loss - Changes in the fair value of equity instruments measured at fair value with changes in other comprehensive income. • Items charged or credited to Items that may be reclassifed to proft or loss – Financial assets at fair value through other comprehensive income and Other comprehensive income – Items that may be reclassifed to proft or loss – Exchange diferences in equity remain in the Group’s consolidated equity until the asset giving rise to them is impaired or derecognised, at which time they are recognised in the consolidated income statement. • Unrealised gains on Financial assets classifed as Non-current A derivative qualifes for hedge accounting if all the following conditions are met: 1. The derivative hedges one of the following three types of exposure: a. Changes in the fair value of assets and liabilities due to fuctuations, among others, in the interest rate and/or exchange rate to which the position or balance to be hedged is subject (fair value hedge); b. Changes in the estimated cash fows arising from fnancial assets and liabilities, commitments and highly probable forecast transactions (cash fow hedge); c. The net investment in a foreign operation (hedge of a net investment in a foreign operation). 2. It is efective in ofsetting exposure inherent in the hedged item or position throughout the expected term of the hedge, which means that: a. At the date of arrangement the hedge is expected, under normal conditions, to be highly efective (prospective efectiveness). b. There is sufcient evidence that the hedge was actually efective during the whole life of the hedged item or position (retrospective efectiveness). To this end, the Group checks that the results of the hedge were within a range of 80% to 125% of the results of the hedged item. 3. There must be adequate documentation evidencing the specifc designation of the fnancial derivative to hedge certain balances or transactions and how this hedge was expected to be achieved and measured, provided that this is consistent with the Group’s management of own risks. The changes in value of fnancial instruments qualifying for hedge accounting are recognised as follows: assets held for sale because they form part of a disposal group or a discontinued operation are recognised in Other comprehensive income under Items that may be reclassifed to proft or loss – Non-current assets held for sale. a. In fair value hedges, the gains or losses arising on both the hedging instruments and the hedged items attributable to the type of risk being hedged are recognised directly in the consolidated income statement. v. Hedging transactions The consolidated entities use fnancial derivatives for the following purposes: i) to facilitate these instruments to customers who request them in the management of their market and credit risks; ii) to use these derivatives in the management of the risks of the Group entities’ own positions and assets and liabilities (hedging derivatives); and iii) to obtain gains from changes in the prices of these derivatives (derivatives). Financial derivatives that do not qualify for hedge accounting are treated for accounting purposes as trading derivatives. In fair value hedges of interest rate risk on a portfolio of fnancial instruments, the gains or losses that arise on measuring the hedging instruments are recognised directly in the consolidated income statement, whereas the gains or losses due to changes in the fair value of the hedged amount (attributable to the hedged risk) are recognised in the consolidated income statement with a balancing entry under Changes in the fair value of hedged items in portfolio hedges of interest rate risk on the asset or liability side of the balance sheet, as appropriate. 485 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix b. In cash fow hedges, the efective portion of the change in value of the hedging instrument is recognised temporarily in Other comprehensive income – under Items that may be reclassifed to proft or loss – Hedging derivatives – Cash fow hedges (efective portion) until the forecast transactions occur, when it is recognised in the consolidated income statement, unless, if the forecast transactions result in the recognition of non-fnancial assets or liabilities, it is included in the cost of the non-fnancial asset or liability. c. In hedges of a net investment in a foreign operation, the gains or losses attributable to the portion of the hedging instruments qualifying as an efective hedge are recognised temporarily in Other comprehensive income under Items that may be reclassifed to proft or loss – Hedges of net investments in foreign operations until the gains or losses – on the hedged item are recognised in proft or loss. d. The inefective portion of the gains or losses on the hedging instruments of cash fow hedges and hedges of a net investment in a foreign operation is recognised directly under Gains/losses on fnancial assets and liabilities (net) in the consolidated income statement, in Gains or losses from hedge accounting, net. If a derivative designated as a hedge no longer meets the requirements described above due to expiration, inefectiveness or for any other reason, the derivative is classifed for accounting purposes as a trading derivative. When fair value hedge accounting is discontinued, the adjustments previously recognised on the hedged item are amortised to proft or loss at the efective interest rate recalculated at the date of hedge discontinuation. The adjustments must be fully amortised at maturity. When cash fow hedge accounting is discontinued, any cumulative gain or loss on the hedging instrument recognised in equity under other comprehensive income - Items that may be reclassifed to proft or loss (from the period when the hedge was efective) remains in this equity item until the forecast transaction occurs, at which time it is recognised in proft or loss, unless the transaction is no longer expected to occur, in which case the cumulative gain or loss is recognised immediately in proft or loss. vi. Derivatives embedded in hybrid fnancial instruments Derivatives embedded in other fnancial instruments or in other host contracts are accounted for separately as derivatives if their risks and characteristics are not closely related to those of the host contracts, provided that the host contracts are not classifed as fnancial assets/liabilities designated at fair value through proft or loss or as Financial assets/liabilities held for trading. e) Derecognition of fnancial assets and liabilities The accounting treatment of transfers of fnancial assets depends on the extent to which the risks and rewards associated with the transferred assets are transferred to third parties: 1. If the Group transfers substantially all the risks and rewards to third parties unconditional sale of fnancial assets, sale of fnancial assets under an agreement to repurchase them at their fair value at the date of repurchase, sale of fnancial assets with a purchased call option or written put option that is deeply out of the money, securitisation of assets in which the transferor does not retain a subordinated debt or grant any credit enhancement to the new holders, and other similar cases-, the transferred fnancial asset is derecognised and any rights or obligations retained or created in the transfer are recognised simultaneously. 2. If the Group retains substantially all the risks and rewards associated with the transferred fnancial asset -sale of fnancial assets under an agreement to repurchase them at a fxed price or at the sale price plus interest, a securities lending agreement in which the borrower undertakes to return the same or similar assets, and other similar cases-, the transferred fnancial asset is not derecognised and continues to be measured by the same criteria as those used before the transfer. However, the following items are recognised: a. An associated fnancial liability, which is recognised for an amount equal to the consideration received and is subsequently measured at amortised cost, unless it meets the requirements for classifcation under Financial liabilities designated at fair value through proft or loss. b. The income from the transferred fnancial asset not derecognised and any expense incurred on the new fnancial liability, without ofsetting. 3. If the Group neither transfers nor retains substantially all the risks and rewards associated with the transferred fnancial asset -sale of fnancial assets with a purchased call option or written put option that is not deeply in or out of the money, securitisation of assets in which the transferor retains a subordinated debt or other type of credit enhancement for a portion of the transferred asset, and other similar cases- the following distinction is made: a. If the transferor does not retain control of the transferred fnancial asset, the asset is derecognised and any rights or obligations retained or created in the transfer are recognised. b. If the transferor retains control of the transferred fnancial asset, it continues to recognise it for an amount equal to its exposure to changes in value and recognises a fnancial liability associated with the transferred fnancial asset. The net carrying amount of the transferred asset and the associated liability is the amortised cost of the rights and obligations retained, if the transferred asset is measured at amortised cost, or the fair value of the rights and obligations retained, if the transferred asset is measured at fair value. Accordingly, fnancial assets are only derecognised when the rights to the cash fows they generate have expired or when substantially all the inherent risks and rewards have been transferred to third parties. Similarly, fnancial liabilities are only derecognised when the obligations they generate have been extinguished or when they are acquired with the intention either to cancel them or to resell them. 486 2018 Auditors’ report and consolidated annual accounts f) Ofsetting of fnancial instruments Financial asset and liability balances are ofset, i.e. reported in the consolidated balance sheet at their net amount, only if the Group entities currently have a legally enforceable right to set of the recognised amounts and intend either to settle on a net basis, or to realise the asset and settle the liability simultaneously. Following is the detail of fnancial assets and liabilities that were ofset in the consolidated balance sheets as of 31 December 2018, 2017 and 2016: Assets Derivatives Reverse repurchase agreements Total Assets Derivatives Reverse repurchase agreements Total Assets Derivatives Reverse repurchase agreements Total 56,701 160,441 (7,145) (45,105) 31 December 2016 Million of euros 31 December 2018 Million of euros Gross amount of fnancial liabilities ofset in the balance sheet Net amount of fnancial assets presented in the balance sheet Gross amount of fnancial assets 31 December 2018 Million of euros Gross amount of fnancial liabilities ofset in the balance sheet Net amount of fnancial assets presented in the balance sheet Liabilities Gross amount of fnancial assets 107,055 (42,509) 64,546 Derivatives 104,213 (42,509) 61,704 79,114 (4,031) 75,083 Reverse repurchase agreements 82,201 (4,031) 186,169 (46,540) 139,629 Total 186,414 (46,540) 78,170 139,874 31 December 2017 Million of euros Gross amount of fnancial liabilities ofset in the balance sheet Net amount of fnancial assets presented in the balance sheet Gross amount of fnancial assets 31 December 2017 Million of euros Gross amount of fnancial liabilities ofset in the balance sheet Net amount of fnancial assets presented in the balance sheet Liabilities Gross amount of fnancial assets 103,740 (37,960) 65,780 Derivatives 103,896 (37,960) 65,936 Reverse repurchase agreements 49,556 115,336 Total 110,953 214,849 (7,145) (45,105) 103,808 169,744 Gross amount of fnancial liabilities ofset in the balance sheet Net amount of fnancial assets presented in the balance sheet Gross amount of fnancial assets Liabilities Gross amount of fnancial assets 31 December 2016 Million of euros Gross amount of fnancial liabilities ofset in the balance sheet Net amount of fnancial assets presented in the balance sheet 127,679 (45,259) 82,420 Derivatives 127,784 (45,259) 82,525 53,159 (2,213) 50,946 Reverse repurchase agreements 180,838 (47,472) 133,366 Total 82,543 210,327 (2,213) (47,472) 80,330 162,855 487 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Also, at 31 December 2018 the Group has ofset other items amounting to EUR 1,445 million (31 December 2017 and 2016: EUR 1,645 million and EUR 1,742 million, respectively). At 31 December 2018 the balance sheet shows the amounts EUR 128,637 million (2017: EUR 97,017 million and 2016: EUR 110,445 million) on derivatives and repos as assets and EUR 130,969 million (2017: EUR 153,566 million and 2016: EUR 137,097 million) on derivatives and repos as liabilities that are subject to netting and collateral arrangements. g) Impairment of fnancial assets i. Defnition The Group associates an impairment in the value to fnancial assets measured at amortised cost, debt instruments measured at fair value with changes in other comprehensive income, lease receivables and commitments and guarantees granted that are not measured at fair value. The impairment for expected credit losses is recorded with a charge to the consolidated income statement for the period in which the impairment arises. In the event of occurrence, the recoveries of previously recognised impairment losses are recorded in the consolidated income statement for the period in which the impairment no longer exists or is reduced. In the case of purchased or originated credit-impaired assets, the Group only recognizes at the reporting date the changes in the expected credit losses during the life of the asset since the initial recognition as a credit loss. In the case of assets measured at fair value with changes in other comprehensive income, the changes in the fair value due to expected credit losses are charged in the consolidated income statement of the year where the change happened, refecting the rest of the valuation in other comprehensive income. As a rule, the expected credit loss is estimated as the diference between the contractual cash fows to be recovered and the expected cash fows discounted using the original efective interest rate. In the case of purchased or originated credit-impaired assets, this diference is discounted using the efective interest rate adjusted by credit rating. Depending on the classifcation of fnancial instruments, which is mentioned in the following sections, the expected credit losses may be along 12 months or during the life of the fnancial instrument: • 12-month expected credit losses: arising from the potential default events, as defned in the following sections that are estimated to be likely to occur within the 12 months following the reporting date. These losses will be associated with fnancial assets classifed as “normal risk” as defned in the following sections. • Expected credit losses over the life of the fnancial instrument: arising from the potential default events that are estimated to be likely to occur throughout the life of the fnancial instruments. These losses are associated with fnancial assets classifed as “normal risk under watchlist” or “doubtful risk”. With the purpose of estimating the expected life of the fnancial instrument all the contractual terms have been taken into account (e.g. prepayments, duration, purchase options, etc.), being the contractual period (including extension options) the maximum period considered to measure the expected credit losses. In the case of fnancial instruments with an uncertain maturity period and a component of undrawn commitment (e.g.: credit cards), the expected life is estimated through quantitative analyses to determine the period during which the entity is exposed to credit risk, also considering the efectiveness of management procedures that mitigate such exposure (e.g. the ability to unilaterally cancel such fnancial instruments, etc.). The following constitute efective guarantees: a) Mortgage guarantees on housing as long as they are frst duly constituted and registered in favour of the entity. The properties include: i. Buildings and building elements, distinguishing among: • Houses; • Ofces, stores and multi-purpose premises; • Rest of buildings such as non-multi-purpose premises and hotels. ii. Urban and developable ordered land. iii. Rest of properties that classify as: buildings and building elements under construction, such as property development in progress and halted development, and the rest of land types, such as rustic lands. b) Collateral guarantees on fnancial instruments in the form of cash deposits and debt securities issued by creditworthy issuers. c) Other types of real guarantees, including properties received in guarantee and second and subsequent mortgages on properties, as long as the entity demonstrates its efectiveness. When assessing the efectiveness of the second and subsequent mortgages on properties the entity will implement particularly restrictive criteria. It will take into account, among others, whether the previous charges are in favour of the entity itself or not and the relationship between the risk guaranteed by them and the property value. d) Personal guarantees, as well as the incorporation of new owners, covering the entire amount of the fnancial instruments and implying direct and joint liability to the entity of persons or other entities whose solvency is sufciently proven to ensure the repayment of the loan on the agreed terms. 488 2018 Auditors’ report and consolidated annual accounts ii. Financial instruments presentation For the purposes of estimating the impairment amount, and in accordance with its internal policies, the Group classifes its fnancial instruments (fnancial assets, commitments and guarantees) measured at amortised cost or fair value through other comprehensive income in one of the following categories: • Normal Risk (“Stage 1”): includes all instruments that do not meet the requirements to be classifed in the rest of the categories. • Normal risk under watchlist (“Stage 2”): includes all instruments that, without meeting the criteria for classifcation as doubtful or default risk, have experienced signifcant increases in credit risk since initial recognition. In order to determine whether a fnancial instrument has increased its credit risk since initial recognition and is to be classifed in Stage 2, the Group considers the following criteria: balances for a client which overdue amount more than 90 days past due is greater than 20% of the loan receivable balance. These instruments may be reclassifed to other categories if, as a result of the collection of part of the past due balances, the reasons for their classifcation in Stage 3 do not remain and the client does not have balances more than 90 days past due in other loans. • Doubtful risk for reasons other than non-performing loans: this category includes doubtful recovery fnancial instruments that are not more than 90 days past due. The Group considers that a fnancial instrument to be doubtful for reasons other than delinquency when one or more combined events have occurred with a negative impact on the estimated future cash fows of the fnancial instrument. To this end, the following indicators, among others, are considered: Quantitative criteria Qualitative criteria Changes in the risk of a default occurring through the expected life of the fnancial instrument are analysed and quantifed with respect to its credit level in its initial recognition. With the purpose of determining if such changes are considered as signifcant, with the consequent classifcation into stage 2, each Group unit has defned the quantitative thresholds to consider in each of its portfolios taking into account corporate guidelines ensuring a consistent interpretation in all units. In addition to the quantitative criteria indicated, various indicators are used that are aligned with those used by the Group in the normal management of credit risk. Irregular positions of more than 30 days and renewals (see Note 54.c) are common criteria in all Group units. In addition, each unit can defne other qualitative indicators, for each of its portfolios, according to the particularities and normal management practices in line with the policies currently in force (e.g. use of management alerts, etc.). The use of these qualitative criteria is complemented with the use of an expert judgement, under the corresponding governance. In the case of forbearances, instruments classifed as “normal risk under watchlist” may be generally reclassifed to “normal risk” in the following circumstances: at least two years have elapsed from the date of reclassifcation to that category or from its forbearance date, the client has paid the accrued principal and interest balance, and the client has no other instruments with more than 30 days past due balances. • Doubtful Risk (“Stage 3”): includes fnancial instruments, overdue or not, in which, without meeting the circumstances to classify them in the category of default risk, there are reasonable doubts about their total repayment (principal and interests) by the client in the terms contractually agreed. Likewise, of-balance- sheet exposures whose payment is probable and their recovery doubtful are considered in Stage 3. Within this category, two situations are diferentiated: a) Negative net equity or decrease because of losses of the client’s net equity by at least 50% during the last fnancial year. b) Continued losses or signifcant decrease in revenue or, in general, in the client’s recurring cash fows. c) Generalised delay in payments or insufcient cash fows to service debts. d) Signifcantly inadequate economic or fnancial structure or inability to obtain additional fnancing by the client. e) Existence of an internal or external credit rating showing that the client is in default. f) Existence of overdue customer commitments with a signifcant amount to public institutions or employees. These fnancial instruments may be reclassifed to other categories if, as a result of an individualised study, reasonable doubts do not remain about the total repayment under the contractually agreed terms and the client does not have balances with more than 90 days past due. In the case of forbearances, instruments classifed as doubtful risk may be reclassifed to the category of ‘normal risk under watchlist’ when the following circumstances are present: a minimum period of one year has elapsed from the forbearance date, the client has paid the accrued principal and interest amounts, and the client has no other loan balance with more than 90 days past due. • Default Risk: includes all fnancial assets, or part of them, for which, after an individualised analysis, their recovery is considered remote due to a notorious and irrecoverable deterioration of their solvency. • Doubtful risk for non-performing loans: fnancial instruments, irrespective of the client and guarantee, with balances more than 90 days past due for principal, interest or expenses contractually agreed. This category also includes all loan In any case, except in the case of fnancial instruments with collateral covering more than 10% of the balance of the loan, the Group considers as a general rule the following as a remote recovery: the loans of clients who are in the liquidation phase 489 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix of bankruptcy proceedings, doubtful balances due to non- performing loans older than four years in this category and doubtful balances due to non-performing loans whose portion not covered by collateral has been maintained with 100% credit risk coverage for more than two years. A fnancial asset amount is maintained in the balance sheet until they are considered as a “default risk”, either all or a part of it, and the write-of is registered against the balance sheet. In the case of operations that have only been partially derecognised, for forgiveness reasons or because part of the total balance is considered unrecoverable, the remaining amount shall be fully classifed in the category of “doubtful risk”, except where duly justifed. The classifcation of a fnancial asset, or part of it, as a ‘default risk’ does not involve the disruption of negotiations and legal proceedings to recover the amount. iii. Impairment valuation assessment The Group has policies, methods and procedures in place to hedge its credit risk, both due to the insolvency attributable to counterparties and its residence in a specifc country. These policies, methods and procedures are applied in the concession, study and documentation of fnancial assets, commitments and guarantees, as well as in the identifcation of their impairment and in the calculation of the amounts needed to cover their credit risk. The asset impairment model in IFRS9 applies to fnancial assets measured at amortised cost, debt instruments at fair value with changes in other comprehensive income, lease receivables and commitments and guarantees granted that are not measured at fair value. The impairment represents the best estimation of the fnancial assets expected credit losses at the balance sheet date, assessed both individually and collectively. • Individually: for the purposes of estimating the provisions for credit risk arising from the insolvency of a fnancial instrument, the Group individually assesses impairment by estimating the expected credit losses on those fnancial instruments that are considered to be signifcant and with sufcient information to make such an estimate. Therefore, this classifcation mostly includes wholesale banking customers - Corporations, specialised fnancing - as well as some of the largest companies – Chartered and real estate developers - from retail banking. The individually assessed impairment estimate is equal to the diference between the gross carrying amount of the fnancial instrument and the estimated value of the expected cash fows receivable discounted using the original efective interest rate of the transaction. The estimate of these cash fows takes into account all available information on the fnancial asset and the efective guarantees associated with that asset. • Collectively: the Group also assesses impairment by estimating the expected credit losses collectively in cases where they are not assessed on an individual basis. This includes, for example, loans with individuals, sole proprietors or businesses in retail banking subject to a standardised risk management. For the purposes of the collective assessment of expected credit losses, the Group has consistent and reliable internal models. For the development of these models, instruments with similar credit risk characteristics that are indicative of the debtors’ capacity to pay are considered. The credit risk characteristics used to group the instruments are, among others: type of instrument, debtor’s sector of activity, geographical area of activity, type of guarantee, aging of past due balanes and any other factor relevant to estimating the future cash fows. The Group performs retrospective and monitoring tests to evaluate the reasonableness of the collective estimate. On the other hand, the methodology required to estimate the expected credit loss due to credit events is based on an unbiased and weighted consideration by the probability of occurrence of a series of scenarios, considering a range of three to fve possible future scenarios, depending on the characteristics of each unit, which could have an impact on the collection of contractual cash fows, always taking into account the time value of money, as well as all available and relevant information on past events, current conditions and forecasts of the evolution of macroeconomic factors that are shown to be relevant for the estimation of this amount (for example: GDP (Gross Domestic Product), housing price, unemployment rate, etc.). For the estimation of the parameters used in the estimation of impairment provisions (EAD (Exposure at Default), PD (Probability of Default), LGD (Loss Given Default)), the Group based its experience in developing internal models for the estimation of parameters both in the regulatory area and for management purposes, adapting the development of the impairment provision models under IFRS9. • Exposure at default: is the amount of estimated risk incurred at the time of the counterparty’s analysis. • Probability of default: is the estimated probability that the counterparty will default on its principal and/or interest payment obligations. • Loss given default: is the estimate of the severity of the loss incurred in the event of non-compliance. It depends mainly on the updating of the guarantees associated with the operation and the future cash fows that are expected to be recovered. The defnition of default implemented by the Group for the purpose of calculating the impairment provision models is based 490 2018 Auditors’ report and consolidated annual accounts on the defnition in Article 178 of Regulation 575/2013 of the European Union (CRR), which is fully aligned with the requirements of IFRS9, which considers that a “default” exists in relation to a specifc customer/contract when at least one of the following circumstances exists: the entity considers that there are reasonable doubts about the payment of all its credit obligations or that the customer/contract is in an irregular situation for more than 90 days with respect to any signifcant credit obligation. In addition, the Group considers the risk generated in all cross- border transactions due to circumstances other than the usual commercial risk of insolvency (sovereign risk, transfer risk or risks arising from international fnancial activity, such as wars, natural catastrophes, balance of payments crisis, etc.). IFRS9 includes a series of practical solutions that can be implemented by entities, with the aim of facilitating its implementation. However, in order to achieve a complete and high-level implementation of the standard, and following the best practices of the industry, the Group does not apply these practical solutions in a generalised manner: • Rebuttable presumption that the credit risk has increased signifcantly, when payments are more than 30 days past due: this threshold is used as an additional, but not primary, indicator of signifcant risk increase. Additionally, there may be cases in the Group where its use has been rebutted as a result of studies that show a low correlation of the signifcant risk increase with this past due threshold. • Assets with low credit risk at the reporting date: the Group assesses the existence of signifcant risk increase in all its fnancial instruments. This information is provided in more detail in Note 54.c (Credit risk). h) Repurchase agreements and reverse repurchase agreements Purchases (sales) of fnancial instruments under a non-optional resale (repurchase) agreement at a fxed price (repos) are recognised in the consolidated balance sheet as fnancing granted (received), based on the nature of the debtor (creditor), under Loans and advances with central banks, Loans and advances to credit institutions or Loans and advances to customers (Deposits from central banks, Deposits from credit institutions or Customer deposits). Diferences between the purchase and sale prices are recognised as interest over the contract term. i) Non-current assets and Liabilities associated with non-current assets held for sale Non-current assets held for sale includes the carrying amount of individual items, disposal groups or items forming part of a business unit earmarked for disposal (discontinued operations), whose sale in their present condition is highly likely to be completed within one year from the reporting date. Therefore, the recovery of the carrying amount of these items -which can be of a fnancial nature or otherwise- will foreseeably be efected through the proceeds from their disposal. Specifcally, property or other non-current assets received by the consolidated entities as total or partial settlement of their debtors’ payment obligations to them are deemed to be Non-current assets held for sale, unless the consolidated entities have decided to make continuing use of these assets. In this connection, for the purpose of its consideration in the initial recognition of these assets, the Group obtains, at the foreclosure date, the fair value of the related asset through a request for appraisal by external appraisal agencies. The Group has in place a corporate policy that ensures the professional competence and the independence and objectivity of the external appraisal agencies, in accordance with the regulations, which require appraisal agencies to meet independence, neutrality and credibility requirements, so that the use of their estimates does not reduce the reliability of its valuations. This policy establishes that all the appraisal companies and agencies with which the Group works in Spain should be registered in the Ofcial Register of the Bank of Spain and that the appraisals performed by them should follow the methodology established in Ministry of Economy Order ECO/805/2003, of 27 March. The main appraisal companies and agencies with which the Group worked in Spain in 2018 are as follows: Eurovaloraciones, S.A., Ibertasa, S.A., Tinsa Tasaciones Inmobiliarias, S.A.U., Krata, S.A. y Valtenic, S.A. Also, this policy establishes that the various subsidiaries abroad work with appraisal companies that have recent experience in the area and the type of asset under appraisal and meet the independence requirements established in the corporate policy. They should verify, inter alia, that the appraisal company is not a party related to the Group and that its billings to the Group in the last twelve months do not exceed 15% of the appraisal company’s total billings. Liabilities associated with non-current assets held for sale includes the balances payable arising from the assets held for sale or disposal groups and from discontinued operations. Non-current assets and disposal groups of items that have been classifed as held for sale are generally recognised at the date of their allocation to this category and are subsequently valued at the lower of their fair value less costs to sell or its book value. Non-current assets and disposal groups of items that are classifed as held for sale are not amortised as long as they remain in this category. At 31 December 2018 the fair value less costs to sell of non-current assets held for sale exceeded their carrying amount by EUR 471 million; however, in accordance with the accounting standards, this unrealised gain could not be recognised. The valuation of the portfolio of non-current assets held for sale has been made in compliance with the requirements of International Financial Reporting Standards in relation to the estimate of the fair value of tangible assets and the value-in-use of fnancial assets. 491 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The value of the portfolio is determined as the sum of the values of the individual elements that compose the portfolio, without considering any total or batch grouping in order to correct the individual values. In the case of real estate assets foreclosed in Spain, which represent 86.5% of the Group’s total non-current assets held for sale, the valuation of the portfolio is carried out by applying the following models: j) Assets under insurance or reinsurance contracts and liabilities under insurance or reinsurance contracts Insurance contracts involve the transfer of a certain quantifable risk in exchange for a periodic or one-of premium. The efects on the Group’s cash fows will arise from a deviation in the payments forecast and/or an insufciency in the premium set. The Group controls its insurance risk as follows: • By applying a strict methodology in the launch of products and in • Market Value Model used in the valuation of fnished residential the assignment of value thereto. properties (housing and parkings) and buildings of a tertiary nature (ofces, commercial premises and multipurpose buildings). The current market value of real estate is based on automated valuations obtained by comparison of peers distinguishing by location and typology of the property. In addition, for individual signifcant assets, complete individual valuations are performed. Valuations made using this method are considered as Level 2. • Market Value Model according to the Evolution of Market Values issued in the valuation of property developments in progress. The current market value of the properties is estimated on the basis of complete individual valuations of third parties, calculated from the values of feasibility studies and development costs of the promotion, as well as selling expenses, distinguishing by location and typology of the property. The valuation of real estate assets under construction is made considering the current situation of the property and not considering the fnal value of the property. Valuations made using this method are considered as Level 3. • Market Value Model according to the Statistical Evolution of Lands Values (Methodology used in the valuation of lands). A statistical update method is used, taking as reference the indexes published by the Ministry of Development applied to the latest individual valuations (appraisals) carried out by independent valuation companies and agencies. Valuations made using this method are considered as Level 2. • By using deterministic and stochastic actuarial models for measuring commitments. • By using reinsurance as a risk mitigation technique as part of the credit quality guidelines in line with the Group’s general risk policy. • By establishing an operating framework for credit risks. • By actively managing asset and liability matching. • By applying security measures in processes. Reinsurance assets includes the amounts that the consolidated entities are entitled to receive for reinsurance contracts with third parties and, specifcally, the reinsurer’s share of the technical provisions recorded by the consolidated insurance entities. At least once a year these assets are reviewed to ascertain whether they are impaired (i.e. there is objective evidence, as a result of an event that occurred after initial recognition of the reinsurance asset, that the Group may not receive all amounts due to it under the terms of the contract and the amount that will not be received can be reliably measured), and any impairment loss is recognised in the consolidated income statement and the assets are written down. In addition, in relation to the previously mentioned valuations, less costs to sell, are contrasted with the sales experience of each type of asset in order to confrm that there is no signifcant diference between the sale price and the valuation. Liabilities under insurance contracts includes the technical provisions recorded by the consolidated entities to cover claims arising from insurance contracts in force at year-end. Impairment losses on an asset or disposal group arising from a reduction in its carrying amount to its fair value (less costs to sell) are recognised under Gains or (losses) on non-current assets held for sale not classifed as discontinued operations in the consolidated income statement. The gains on a non-current asset held for sale resulting from subsequent increases in fair value (less costs to sell) increase its carrying amount and are recognised in the consolidated income statement up to an amount equal to the impairment losses previously recognised. Insurers’ results relating to their insurance business are recognised, according to their nature, under the related consolidated income statement items. In accordance with standard accounting practice in the insurance industry, the consolidated insurance entities credit to the income statement the amounts of the premiums written and charge to income the cost of the claims incurred on fnal settlement thereof. Insurance entities are therefore required to accrue at period-end the unearned revenues credited to their income statements and the accrued costs not charged to income. At least at each reporting date the Group assesses whether the insurance contract liabilities recognised in the consolidated 492 2018 Auditors’ report and consolidated annual accounts balance sheet are adequate. For this purpose, it calculates the diference between the following amounts: • Current estimates of future cash fows under the insurance contracts of the consolidated entities. These estimates include all contractual cash fows and any related cash fows, such as claims handling costs; and • The carrying amount recognised in the consolidated balance sheet of its insurance contract liabilities (See Note 15), less any related deferred acquisition costs or related intangible assets, such as the amount paid to acquire, in the event of purchase by the entity, the economic rights held by a broker deriving from policies in the entity’s portfolio. If the calculation results in a positive amount, this defciency is charged to the consolidated income statement. When unrealised gains or losses on assets of the Group’s insurance companies afect the measurement of liabilities under insurance contracts and/or the related deferred acquisition costs and/or the related intangible assets, these gains or losses are recognised directly in equity. The corresponding adjustment in the liabilities under insurance contracts (or in the deferred acquisition costs or in intangible assets) is also recognised in equity. The most signifcant items forming part of the technical provisions (see Note 15) are detailed below: • Non-life insurance provisions: i) Provision for unearned premiums: relates to the portion of the premiums received at year-end that is allocable to the period from the reporting date to the end of the policy cover period. ii) Provisions for unexpired risks: this supplements the provision for unearned premiums to the extent that the amount of the latter is not sufcient to refect all the assessed risks and expenses to be covered by the insurance companies in the policy period not elapsed at the reporting date. • Life insurance provisions: represent the value of the net obligations acquired vis-à-vis life insurance policyholders. These provisions include: i) Provision for unearned premiums and unexpired risks: this relates to the portion of the premiums received at year-end that is allocable to the period from the reporting date to the end of the policy cover period. • Provision for claims outstanding: this refects the total obligations outstanding arising from claims incurred prior to the reporting date. This provision is calculated as the diference between the total estimated or certain cost of the claims not yet reported, settled or paid and all the amounts already paid in relation to such claims. • Provision for bonuses and rebates: this provision includes the amount of the bonuses accruing to policyholders, insureds or benefciaries and that of any premiums to be returned to policyholders or insureds, to the extent that such amounts have not been assigned at the reporting date. These amounts are calculated on the basis of the conditions of the related individual policies. • Technical provisions for life insurance policies where the investment risk is borne by the policyholders: these provisions are calculated on the basis of the indices established as a reference to determine the economic value of the policyholders’ rights. k) Tangible assets Tangible assets includes the amount of buildings, land, furniture, vehicles, computer hardware and other fxtures owned by the consolidated entities or acquired under fnance leases. Tangible assets are classifed by use as follows: i. Property, plant and equipment for own use Property, plant and equipment for own use – including tangible assets received by the consolidated entities in full or partial satisfaction of fnancial assets representing receivables from third parties which are intended to be held for continuing use and tangible assets acquired under fnance leases– are presented at acquisition cost, less the related accumulated depreciation and any estimated impairment losses (carrying amount higher than recoverable amount). Depreciation is calculated, using the straight-line method, on the basis of the acquisition cost of the assets less their residual value. The land on which the buildings and other structures stand has an indefnite life and, therefore, is not depreciated. The period tangible asset depreciation charge is recognised in the consolidated income statement and is calculated using the following depreciation rates (based on the average years of estimated useful life of the various assets): ii) Mathematical provisions: these relate to the value of the Buildings for own use insurance companies’ obligations, net of the policyholders’ obligations. These provisions are calculated on a policy-by- policy basis using an individual capitalisation system, taking as a basis for the calculation the premium accrued in the year, and in accordance with the technical bases of each type of insurance updated, where appropriate, by the local mortality tables. Furniture Fixtures Ofce and IT equipment Leasehold improvements Average annual rate 2.0% 7.7% 7.0% 25.0% 7.0% 493 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The consolidated entities assess at the reporting date whether there is any indication that an asset may be impaired (i.e. its carrying amount exceeds its recoverable amount). If this is the case, the carrying amount of the asset is reduced to its recoverable amount and future depreciation charges are adjusted in proportion to the revised carrying amount and to the new remaining useful life (if the useful life has to be re-estimated). Similarly, if there is an indication of a recovery in the value of a tangible asset, the consolidated entities recognise the reversal of the impairment loss recognised in prior periods and adjust the future depreciation charges accordingly. In no circumstances may the reversal of an impairment loss on an asset raise its carrying amount above that which it would have if no impairment losses had been recognised in prior years. The estimated useful lives of the items of property, plant and equipment for own use are reviewed at least at the end of the reporting period with a view to detecting signifcant changes therein. If changes are detected, the useful lives of the assets are adjusted by correcting the depreciation charge to be recognised in the consolidated income statement in future years on the basis of the new useful lives. Upkeep and maintenance expenses relating to property, plant and equipment for own use are recognised as an expense in the period in which they are incurred, since they do not increase the useful lives of the assets. on specifc information on actual transactions and frm ofers, current prices are obtained for cash sales of those properties. The valuations performed using this approach are considered as Level 2 valuations. In the income capitalisation approach, the cash fows estimated to be obtained over the useful life of the property are discounted taking into account factors that may infuence the amount and actual obtainment thereof, such as: (i) the payments that are normally received on comparable properties; (ii) current and probable future occupancy; (iii) the current or foreseeable default rate on payments. The valuations performed using this approach are considered as Level 3 valuations, since signifcant unobservable inputs are used, such as current and probable future occupancy and/or the current or foreseeable default rate on payments. iii. Assets leased out under an operating lease Property, plant and equipment - Leased out under an operating lease refects the amount of the tangible assets, other than land and buildings, leased out by the Group under an operating lease. The criteria used to recognise the acquisition cost of assets leased out under operating leases, to calculate their depreciation and their respective estimated useful lives and to recognise the impairment losses thereon are consistent with those described in relation to property, plant and equipment for own use. l) Accounting for leases ii. Investment property Investment property refects the net values of the land, buildings and other structures held either to earn rentals or for obtaining profts by sales due to future increase in market prices. i. Finance leases Finance leases are leases that transfer substantially all the risks and rewards incidental to ownership of the leased asset to the lessee. The criteria used to recognise the acquisition cost of investment property, to calculate its depreciation and its estimated useful life and to recognise any impairment losses thereon are consistent with those described in relation to property, plant and equipment for own use. In order to evaluate the possible impairment the Group determines periodically the fair value of its investment property so that, at the end of the reporting period, the fair value refects the market conditions of the investment property at that date. This fair value is determined annually, taking as benchmarks the valuations performed by independent experts. The methodology used to determine the fair value of investment property is selected based on the status of the asset in question; thus, for properties earmarked for lease, the valuations are performed using the sales comparison approach, whereas for leased properties the valuations are made primarily using the income capitalisation approach and, exceptionally, the sales comparison approach. In the sales comparison approach, the property market segment for comparable properties is analysed, inter alia, and, based When the consolidated entities act as the lessors of an asset, the sum of the present value of the lease payments receivable from the lessee, including the exercise price of the lessee’s purchase option at the end of the lease term when such exercise price is sufciently below fair value at the option date such that it is reasonably certain that the option will be exercised, is recognised as lending to third parties and is therefore included under Loans and receivables in the consolidated balance sheet. When the consolidated entities act as the lessees, they present the cost of the leased assets in the consolidated balance sheet, based on the nature of the leased asset, and, simultaneously, recognise a liability for the same amount (which is the lower of the fair value of the leased asset and the sum of the present value of the lease payments payable to the lessor plus, if appropriate, the exercise price of the purchase option). The depreciation policy for these assets is consistent with that for property, plant and equipment for own use. In both cases, the fnance income and fnance charges arising under fnance lease agreements are credited and debited, respectively, to interest and similar income and Interest expense and similar charges in the consolidated income statement so as to produce a constant rate of return over the lease term. 494 2018 Auditors’ report and consolidated annual accounts ii. Operating leases In operating leases, ownership of the leased asset and substantially all the risks and rewards incidental thereto remain with the lessor. When the consolidated entities act as the lessors, they present the acquisition cost of the leased assets under Tangible assets (See Note 16). The depreciation policy for these assets is consistent with that for similar items of property, plant and equipment for own use, and income from operating leases is recognised on a straight- line basis under Other operating income in the consolidated income statement. When the consolidated entities act as the lessees, the lease expenses, including any incentives granted by the lessor, are charged on a straight-line basis to Other general administrative expenses in their consolidated income statements. The present value calculated applying IAS17 as of 31 December 2018 of the future payments committed by the Group for existing non-cancellable operating lease agreements amounts to EUR 8,699 million, of which EUR 739 million is payable within one year, EUR 2,472 million between one and fve years and EUR 5,488 million in more than fve years. iii. Sale and leaseback transactions In sale and leaseback transactions where the sale is at fair value and the leaseback is an operating lease, any proft or loss is recognised at the time of sale. In the case of fnance leasebacks, any proft or loss is amortised over the lease term. In accordance with IAS17, in determining whether a sale and leaseback transaction results in an operating lease, the Group should analyse, inter alia, whether at the inception of the lease there are purchase options whose terms and conditions make it reasonably certain that they will be exercised, and to whom the gains or losses from the fuctuations in the fair value of the residual value of the related asset will accrue. m) Intangible assets Intangible assets are identifable non-monetary assets (separable from other assets) without physical substance which arise as a result of a legal transaction or which are developed internally by the consolidated entities. Only assets whose cost can be estimated reliably and from which the consolidated entities consider it probable that future economic benefts will be generated are recognised. Intangible assets are recognised initially at acquisition or production cost and are subsequently measured at cost less any accumulated amortisation and any accumulated impairment losses. i. Goodwill Any excess of the cost of the investments in the consolidated entities and entities accounted for using the equity method over the corresponding underlying carrying amounts acquired, adjusted at the date of frst-time consolidation, is allocated as follows: • If it is attributable to specifc assets and liabilities of the companies acquired, by increasing the value of the assets (or reducing the value of the liabilities) whose fair values were higher (lower) than the carrying amounts at which they had been recognised in the acquired entities’ balance sheets. • If it is attributable to specifc intangible assets, by recognising it explicitly in the consolidated balance sheet provided that the fair value of these assets within twelve months following the date of acquisition can be measured reliably. • The remaining amount is recognised as goodwill, which is allocated to one or more cash-generating units (a cash- generating unit is the smallest identifable group of assets that, as a result of continuing operation, generates cash infows that are largely independent of the cash infows from other assets or groups of assets). The cash-generating units represent the Group’s geographical and/or business segments. Goodwill (only recognised when it has been acquired by consideration) represents, therefore, a payment made by the acquirer in anticipation of future economic benefts from assets of the acquired entity that are not capable of being individually identifed and separately recognised. At the end of each annual reporting period or whenever there is any indication of impairment goodwill is reviewed for impairment (i.e. a reduction in its recoverable amount to below its carrying amount) and, if there is any impairment, the goodwill is written down with a charge to Impairment or reversal of impairment on non-fnancial assets, net - Intangible assets in the consolidated income statement. An impairment loss recognised for goodwill is not reversed in a subsequent period. ii. Other intangible assets Other intangible assets includes the amount of identifable intangible assets (such as purchased customer lists and computer software). Other intangible assets can have an indefnite useful life -when, based on an analysis of all the relevant factors, it is concluded that there is no foreseeable limit to the period over which the asset is expected to generate net cash infows for the consolidated entities- or a fnite useful life, in all other cases. Intangible assets with indefnite useful lives are not amortised, but rather at the end of each reporting period or whenever there is any indication of impairment the consolidated entities review the remaining useful lives of the assets in order to determine whether they continue to be indefnite and, if this is not the case, to take the appropriate steps. 495 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Intangible assets with fnite useful lives are amortised over those useful lives using methods similar to those used to depreciate tangible assets. The intangible asset amortisation charge is recognised under Depreciation and amortisation cost in the consolidated income statement. In both cases the consolidated entities recognise any impairment loss on the carrying amount of these assets with a charge to Impairment or reversal of impairment on non-fnancial assets, net - Intangible assets in the consolidated income statement. The criteria used to recognise the impairment losses on these assets and, where applicable, the reversal of impairment losses recognised in prior years are similar to those used for tangible assets (See Note 2.k). Internally developed computer software Internally developed computer software is recognised as an intangible asset if, among other requisites (basically the Group’s ability to use or sell it), it can be identifed and its ability to generate future economic benefts can be demonstrated. Expenditure on research activities is recognised as an expense in the year in which it is incurred and cannot be subsequently capitalised. n) Other assets Other assets in the consolidated balance sheet includes the amount of assets not recorded in other items, the breakdown being as follows: • Inventories: this item includes the amount of assets, other than fnancial instruments, that are held for sale in the ordinary course of business, that are in the process of production, construction or development for such purpose, or that are to be consumed in the production process or in the provision of services. Inventories include land and other property held for sale in the property development business. Inventories are measured at the lower of cost and net realisable value, which is the estimated selling price of the inventories in the ordinary course of business, less the estimated costs of completion and the estimated costs required to make the sale. Any write-downs of inventories -such as those due to damage, obsolescence or reduction of selling price- to net realisable value and other impairment losses are recognised as expenses for the year in which the impairment or loss occurs. Subsequent reversals are recognised in the consolidated income statement for the year in which they occur. The carrying amount of inventories is derecognised and recognised as an expense in the period in which the revenue from their sale is recognised. • Other: this item includes the balance of all prepayments and accrued income (excluding accrued interest, fees and commissions), the net amount of the diference between pension plan obligations and the value of the plan assets with a balance in the entity’s favour, when this net amount is to be reported in the consolidated balance sheet, and the amount of any other assets not included in other items. 496 o) Other liabilities Other liabilities includes the balance of all accrued expenses and deferred income, excluding accrued interest, and the amount of any other liabilities not included in other categories. p) Provisions and contingent assets and liabilities When preparing the fnancial statements of the consolidated entities, the Bank’s directors made a distinction between: • Provisions: credit balances covering present obligations at the reporting date arising from past events which could give rise to a loss for the consolidated entities, which is considered to be likely to occur and certain as to its nature but uncertain as to its amount and/or timing. • Contingent liabilities: possible obligations that arise from past events and whose existence will be confrmed only by the occurrence or non-occurrence of one or more future events not wholly within the control of the consolidated entities. They include the present obligations of the consolidated entities when it is not probable that an outfow of resources embodying economic benefts will be required to settle them. The Group does not recognise the contingent liability. The Group will disclose a contingent liability, unless the possibility of an outfow of resources embodying economic benefts is remote. • Contingent assets: possible assets that arise from past events and whose existence is conditional on, and will be confrmed only by, the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Group. Contingent assets are not recognised in the consolidated balance sheet or in the consolidated income statement, but rather are disclosed in the notes, provided that it is probable that these assets will give rise to an increase in resources embodying economic benefts. The Group’s consolidated fnancial statements include all the material provisions with respect to which it is considered that it is more likely than not the obligation will have to be settled. In accordance with accounting standards, contingent liabilities must not be recognised in the consolidated fnancial statements, but must rather be disclosed in the notes. Provisions, which are quantifed on the basis of the best information available on the consequences of the event giving rise to them and are reviewed and adjusted at the end of each year, are used to cater for the specifc obligations for which they were originally recognised. Provisions are fully or partially reversed when such obligations cease to exist or are reduced. Provisions are classifed according to the obligations covered as follows (See Note 25): • Provision for pensions and similar obligations: includes the amount of all the provisions made to cover post-employment benefts, including obligations to pre-retirees and similar obligations. • Provisions for contingent liabilities and commitments: include the amount of the provisions made to cover contingent liabilities -defned as those transactions in which the Group guarantees 2018 Auditors’ report and consolidated annual accounts the obligations of a third party, arising as a result of fnancial guarantees granted or contracts of another kind- and contingent commitments -defned as irrevocable commitments that may give rise to the recognition of fnancial assets. • Provisions for taxes and other legal contingencies and Other provisions: include the amount of the provisions recognised to cover tax and legal contingencies and litigation and the other provisions recognised by the consolidated entities. Other provisions includes, inter alia, any provisions for restructuring costs and environmental measures. q) Court proceedings and/or claims in process At the end of 2018 certain court proceedings and claims were in process against the consolidated entities arising from the ordinary course of their operations (see Note 25). r) Own equity instruments Own equity instruments are those meeting both of the following conditions: • The instruments do not include any contractual obligation When the requirements stipulated in the remuneration agreement include external market conditions (such as equity instruments reaching a certain quoted price), the amount ultimately to be recognised in equity will depend on the other conditions being met by the employees (normally length of service requirements), irrespective of whether the market conditions are satisfed. If the conditions of the agreement are met but the external market conditions are not satisfed, the amounts previously recognised in equity are not reversed, even if the employees do not exercise their right to receive the equity instruments. t) Recognition of income and expenses The most signifcant criteria used by the Group to recognise its income and expenses are summarised as follows: i. Interest income, interest expenses and similar items Interest income, interest expenses and similar items are generally recognised on an accrual basis using the efective interest method. Dividends received from other companies are recognised as income when the consolidated entities’ right to receive them arises. for the issuer: (i) to deliver cash or another fnancial asset to a third party; or (ii) to exchange fnancial assets or fnancial liabilities with a third party under conditions that are potentially unfavourable to the issuer. ii. Commissions, fees and similar items Fee and commission income and expenses are recognised in the consolidated income statement using criteria that vary according to their nature. The main criteria are as follows: • The instruments will or may be settled in the issuer’s own equity instruments and are: (i) a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments; or (ii) a derivative that will be settled by the issuer through the exchange of a fxed amount of cash or another fnancial asset for a fxed number of its own equity instruments. • Fee and commission income and expenses relating to fnancial assets and fnancial liabilities measured at fair value through proft or loss are recognised when paid. • Those arising from transactions or services that are performed over a period of time are recognised over the life of these transactions or services. Transactions involving own equity instruments, including their issuance and cancellation, are charged directly to equity. • Those relating to services provided in a single act are recognised when the single act is carried out. Changes in the value of instruments classifed as own equity instruments are not recognised in the consolidated fnancial statements. Consideration received or paid in exchange for such instruments, including the coupons on preference shares contingently convertible into ordinary shares and the coupons associated with CCPP, is directly added to or deducted from equity. s) Equity-instrument-based employee remuneration Own equity instruments delivered to employees in consideration for their services, if the instruments are delivered once the specifc period of service has ended, are recognised as an expense for services (with the corresponding increase in equity) as the services are rendered by employees during the service period. At the grant date the services received (and the related increase in equity) are measured at the fair value of the equity instruments granted. If the equity instruments granted are vested immediately, the Group recognises in full, at the grant date, the expense for the services received. iii. Non-fnance income and expenses They are recognised for accounting purposes when the good is delivered or the non-fnancial service is rendered. To determine the amount and timing of recognition, a fve-step model is followed: identifcation of the contract with the customer, identifcation of the separate obligations of the contract, determination of the transaction price, distribution of the transaction price among the identifed obligations and fnally recording of income as the obligations are satisfed. iv. Deferred collections and payments These are recognised for accounting purposes at the amount resulting from discounting the expected cash fows at market rates. v. Loan arrangement fees Loan arrangement fees, mainly loan origination, application and information fees, are accrued and recognised in income over the term of the loan. 497 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix u) Financial guarantees Financial guarantees are defned as contracts whereby an entity undertakes to make specifc payments on behalf of a third party if the latter fails to do so, irrespective of the various legal forms they may have, such as guarantees, insurance policies or credit derivatives. The Group initially recognises the fnancial guarantees provided on the liability side of the consolidated balance sheet at fair value, which is generally the present value of the fees, commissions and interest receivable from these contracts over the term thereof, and simultaneously the Group recognises the amount of the fees, commissions and similar interest received at the inception of the transactions and a credit on the asset side of the consolidated balance sheet for the present value of the fees, commissions and interest outstanding. Financial guarantees, regardless of the guarantor, instrumentation or other circumstances, are reviewed periodically so as to determine the credit risk to which they are exposed and, if appropriate, to consider whether a provision is required. The credit risk is determined by application of criteria similar to those established for quantifying impairment losses on debt instruments carried at amortised cost (described in Note 2.g above). The provisions made for these transactions are recognised under Provisions - Provisions for commitments and guarantees given in the consolidated balance sheet (See Note 25). These provisions are recognised and reversed with a charge or credit, respectively, to Provisions or reversal of provisions, net, in the consolidated income statement. If a specifc provision is required for fnancial guarantees, the related unearned commissions recognised under Financial liabilities at amortised cost - Other fnancial liabilities in the consolidated balance sheet are reclassifed to the appropriate provision. v) Assets under management and investment and pension funds managed by the Group Assets owned by third parties and managed by the consolidated entities are not presented on the face of the consolidated balance sheet. Management fees are included in Fee and commission income in the consolidated income statement. The investment funds and pension funds managed by the consolidated entities are not presented on the face of the Group’s consolidated balance sheet since the related assets are owned by third parties. The fees and commissions earned in the year for the services rendered by the Group entities to these funds (asset management and custody services) are recognised under Fee and commission income in the consolidated income statement. Note 2.b.iv describes the internal criteria and procedures used to determine whether control exists over the structured entities, which include, inter alia, investment funds and pension funds. w) Post-employment benefts Under the collective agreements currently in force and other arrangements, the Spanish banks included in the Group and certain other Spanish and foreign consolidated entities have undertaken to supplement the public social security system benefts accruing to certain employees, and to their benefciary right holders, for retirement, permanent disability or death, and the post- employment welfare benefts. The Group’s post-employment obligations to its employees are deemed to be defned contribution plans when the Group makes pre-determined contributions (recognised under Staf costs in the consolidated income statement) to a separate entity and will have no legal or efective obligation to make further contributions if the separate entity cannot pay the employee benefts relating to the service rendered in the current and prior periods. Post- employment obligations that do not meet the aforementioned conditions are classifed as defned beneft plans (See Note 25). Defned contribution plans The contributions made in this connection in each year are recognised under Staf costs in the consolidated income statement. The amounts not yet contributed at each year-end are recognised, at their present value, under Provisions - Provision for pensions and similar obligations on the liability side of the consolidated balance sheet. Defned beneft plans The Group recognises under Provisions - Provision for pensions and similar obligations on the liability side of the consolidated balance sheet (or under Other assets on the asset side, as appropriate) the present value of its defned beneft post-employment obligations, net of the fair value of the plan assets. Plan assets are defned as those that will be directly used to settle obligations and that meet the following conditions: • They are not owned by the consolidated entities, but by a legally separate third party that is not a party related to the Group. • They are only available to pay or fund post-employment benefts and they cannot be returned to the consolidated entities unless the assets remaining in the plan are sufcient to meet all the beneft obligations of the plan and of the entity to current and former employees, or they are returned to reimburse employee benefts already paid by the Group. If the Group can look to an insurer to pay part or all of the expenditure required to settle a defned beneft obligation, and it is practically certain that said insurer will reimburse some or all of the expenditure required to settle that obligation, but the insurance policy does not qualify as a plan asset, the Group recognises its right to reimbursement -which, in all other respects, is treated as a plan asset- under Insurance contracts linked to pensions on the asset side of the consolidated balance sheet. 498 2018 Auditors’ report and consolidated annual accounts Post-employment benefts are recognised as follows: • Current service cost, (the increase in the present value of the obligations resulting from employee service in the current period), is recognised under Staf costs. • The past service cost, which arises from changes to existing post-employment benefts or from the introduction of new benefts and includes the cost of reductions, is recognised under Provisions or reversal of provisions. • Any gain or loss arising from a liquidation of the plan is included in the Provisions or reversion of provisions. • Net interest on the net defned beneft liability (asset), i.e. the change during the period in the net defned beneft liability (asset) that arises from the passage of time, is recognised under Interest expense and similar charges (Interest and similar income if it constitutes income) in the consolidated income statement. The remeasurement of the net defned beneft liability (asset) is recognised in Other comprehensive income under Items not reclassifed to proft or loss and includes: • Actuarial gains and losses generated in the year, arising from the diferences between the previous actuarial assumptions and what has actually occurred and from the efects of changes in actuarial assumptions. • The return on plan assets, excluding amounts included in net interest on the net defned beneft liability (asset). • Any change in the efect of the asset ceiling, excluding amounts included in net interest on the net defned beneft liability (asset). x) Other long-term employee benefts Other long-term employee benefts, defned as obligations to pre-retirees -taken to be those who have ceased to render services at the entity but who, without being legally retired, continue to have economic rights vis-à-vis the entity until they acquire the legal status of retiree-, long-service bonuses, obligations for death of spouse or disability before retirement that depend on the employee’s length of service at the entity and other similar items, are treated for accounting purposes, where applicable, as established above for defned beneft post-employment plans, except that actuarial gains and losses are recognised under Provisions or reversal of provisions, net, in the consolidated income statement (see Note 25). y) Termination benefts Termination benefts are recognised when there is a detailed formal plan identifying the basic changes to be made, provided that implementation of the plan has begun, its main features have been publicly announced or objective facts concerning its implementation have been disclosed. z) Income tax The expense for Spanish income tax and other similar taxes applicable to the foreign consolidated entities is recognised in the consolidated income statement, except when it results from a transaction recognised directly in equity, in which case the tax efect is also recognised in equity. The current income tax expense is calculated as the sum of the current tax resulting from application of the appropriate tax rate to the taxable proft for the year (net of any deductions allowable for tax purposes), and of the changes in deferred tax assets and liabilities recognised in the consolidated income statement. Deferred tax assets and liabilities include temporary diferences, which are identifed as the amounts expected to be payable or recoverable on diferences between the carrying amounts of assets and liabilities and their related tax bases, and tax loss and tax credit carryforwards. These amounts are measured at the tax rates that are expected to apply in the period when the asset is realised or the liability is settled. Tax assets includes the amount of all tax assets, which are broken down into current -amounts of tax to be recovered within the next twelve months- and deferred -amounts of tax to be recovered in future years, including those arising from tax loss or tax credit carryforwards. Tax liabilities includes the amount of all tax liabilities (except provisions for taxes), which are broken down into current -the amount payable in respect of the income tax on the taxable proft for the year and other taxes in the next twelve months- and deferred -the amount of income tax payable in future years. Deferred tax liabilities are recognised in respect of taxable temporary diferences associated with investments in subsidiaries, associates or joint ventures, except when the Group is able to control the timing of the reversal of the temporary diference and, in addition, it is probable that the temporary diference will not reverse in the foreseeable future. Deferred tax assets are only recognised for temporary diferences to the extent that it is considered probable that the consolidated entities will have sufcient future taxable profts against which the deferred tax assets can be utilised, and the deferred tax assets do not arise from the initial recognition (except in a business combination) of other assets and liabilities in a transaction that afects neither taxable proft nor accounting proft. Other deferred tax assets (tax loss and tax credit carryforwards) are only recognised if it is considered probable that the consolidated entities will have sufcient future taxable profts against which they can be utilised. Income and expenses recognised directly in equity are accounted for as temporary diferences. 499 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The deferred tax assets and liabilities are reassessed at the reporting date in order to ascertain whether any adjustments need to be made on the basis of the fndings of the analyses performed. b. Income and expense recognised in the year: includes, in aggregate form, the total of the aforementioned items recognised in the consolidated statement of recognised income and expense. aa) Residual maturity periods and average interest rates The analysis of the maturities of the balances of certain items in the consolidated balance sheet and the average interest rates at the end of the reporting periods is provided in Note 51. ab) Consolidated statement of recognised income and expense This statement presents the income and expenses generated by the Group as a result of its business activity in the year, and a distinction is made between the income and expenses recognised in the consolidated income statement for the year and the other income and expenses recognised directly in consolidated equity. Accordingly, this statement presents: a. Consolidated proft for the year. c. Other changes in equity: includes the remaining items recognised in equity, including, inter alia, increases and decreases in capital, distribution of proft, transactions involving own equity instruments, equity-instrument-based payments, transfers between equity items and any other increases or decreases in consolidated equity. ad) Consolidated statement of cash fows The following terms are used in the consolidated statements of cash fows with the meanings specifed: • Cash fows: infows and outfows of cash and cash equivalents, which are short-term, highly liquid investments that are subject to an insignifcant risk of changes in value, irrespective of the portfolio in which they are classifed. b. The net amount of the income and expenses recognised in Other comprehensive income under items that will not be reclassifed to proft or loss. The Group classifes as cash and cash equivalents the balances recognised under Cash, cash balances at central banks and other deposits on demand in the consolidated balance sheet. c. The net amount of the income and expenses recognised in Other comprehensive income under items that may be reclassifed subsequently to proft or loss. • Operating activities: the principal revenue-producing activities of credit institutions and other activities that are not investing or fnancing activities. d. The income tax incurred in respect of the items indicated in b) and c) above, except for the valuation adjustments arising from investments in associates or joint ventures accounted for using the equity method, which are presented net. e. Total consolidated recognised income and expense, calculated as the sum of a) to d) above, presenting separately the amount attributable to the parent company and the amount relating to non-controlling interests. The statement presents the items separately by nature, grouping together items that, in accordance with the applicable accounting standards, will not be reclassifed subsequently to proft and loss since the requirements established by the corresponding accounting standards are met. ac) Statement of changes in total equity This statement presents all the changes in equity, including those arising from changes in accounting policies and from the correction of errors. Accordingly, this statement presents a reconciliation of the carrying amount at the beginning and end of the year of all the consolidated equity items, and the changes are grouped together on the basis of their nature into the following items: a. Adjustments due to changes in accounting policies and to errors: include the changes in consolidated equity arising as a result of the retrospective restatement of the balances in the consolidated fnancial statements, distinguishing between those resulting from changes in accounting policies and those relating to the correction of errors. • Investing activities: the acquisition and disposal of long-term assets and other investments not included in cash and cash equivalents. • Financing activities: activities that result in changes in the size and composition of the equity and liabilities that are not operating activities. During 2018 the Group received interest amounting to EUR 50,685 million and paid interest amounting to EUR 19,927 million. Also, dividends received and paid by the Group are detailed in Notes 4, 28 and 40, including dividends paid to minority interests (non-controlling interests). 3. Santander Group a) Banco Santander, S.A. and international Group structure The growth of the Group in the last decades has led the Bank to also act, in practice, as a holding entity of the shares of the various companies in its Group, and its results are becoming progressively less representative of the performance and earnings of the Group. Therefore, each year the Bank determines the amount of the dividends to be distributed to its shareholders on the basis of the consolidated net proft, while maintaining the Group’s traditionally high level of capitalisation and taking into account that the transactions of the Bank and of the rest of the Group are managed on a consolidated basis (notwithstanding the allocation to each company of the related net worth efect). 500 2018 Auditors’ report and consolidated annual accounts At the international level, the various banks and other subsidiaries, joint ventures and associates of the Group are integrated in a corporate structure comprising various holding companies which are the ultimate shareholders of the banks and subsidiaries abroad. The purpose of this structure, all of which is controlled by the Bank, is to optimise the international organisation from the strategic, economic, fnancial and tax standpoints, since it makes it possible to defne the most appropriate units to be entrusted with acquiring, selling or holding stakes in other international entities, the most appropriate fnancing method for these transactions and the most appropriate means of remitting the profts obtained by the Group’s various operating units to Spain. The Appendices provide relevant data on the consolidated Group companies and on the companies accounted for using the equity method. b) Acquisitions and disposals Following is a summary of the main acquisitions and disposals of ownership interests in the share capital of other entities and other signifcant corporate transactions performed by the Group in the last three years: i. Sale of the 49% stake in Wizink Once the relevant regulatory authorizations had been obtained, on 6 November 2018 the operations related to the agreement reached with entities managed by Värde Partners, Inc (“Varde) and with WiZink Bank, S.A. (“WiZink”) communicated by the Group on 26 March 2018 by virtue of which: i. Banco Santander, S.A. sold its 49% stake in WiZink to Varde for EUR 1,043 million, with no signifcant impact on the Group’s results and, ii. Banco Santander, S.A. and Banco Santander Totta, S.A. acquired the business of credit and debit cards marketed by Grupo Banco Popular in Spain and Portugal that WiZink had acquired in 2014 and 2016. As a result of this transaction, the Group paid a total of EUR 681 million, receiving net assets worth EUR 306 million (mainly customer loans worth EUR 315 million), with the business combination generating a goodwill of EUR 375 million, which will be managed by the businesses in Spain. together with Banco Santander, S.A., had reached an agreement with Deutsche Bank, A.G. for the acquisition (through a carve out) of the retail and private banking business of Deutsche Bank Polska S.A., excluding the foreign currency mortgage portfolio and the CIB (Corporate & Investment Banking) business, and including the asset management company DB Securities, S.A. (Poland). In November 2018, once the regulatory authorisations had been received and approved by the general shareholders’ meetings of Santander Bank Polska S.A. and Deutsche Bank Polska S.A., the acquisition of EUR 298 million in cash and newly issued shares of Santander Bank Polska S.A. subscribed in full by Deutsche Bank, A.G. was closed. As a result of this transaction, the Group has acquired net assets worth EUR 365 million, mainly loans and deposits to customers and credit institutions amounting to EUR 4,304 million and EUR 4,025 million, respectively, and negative value adjustments amounting to 82 million euros (mainly under line “Loans”). The diference between the fair value of the net assets acquired and the transaction value resulted in a gain of EUR 67 million which was recognised under “Negative Goodwill Recognised in Income” in the Group’s consolidated income statement. iii. Acquisition of Banco Popular Español, S.A.U. On 7 June 2017 (the acquisition date), as part of its growth strategy in the markets where it is present, the Group communicated the acquisition of 100% of the share capital of Banco Popular Español, S.A.U. (merged with Banco Santander, see Note 3.b)v) as a result of a competitive sale process organised in the framework of a resolution scheme adopted by the Single Resolution Board (“SRB”) and executed by the FROB, Spanish single resolution board, in accordance with Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 May 2014, and Law 11/2015, of June 18, for the recovery and resolution of credit institutions and investment frms. As part of the execution of the resolution: • All the shares of Banco Popular outstanding at the closing of market on 7 June 2017 and all the shares resulting from the conversion of the regulatory capital instruments Additional Tier 1 issued by Banco Popular have been converted into undisposed reserves. With these transactions, the Group resumed Grupo Banco Popular’s debit and credit card business, which improves the commercial strategy and facilitates Grupo Banco Popular’s integration process. • All the regulatory capital instruments Tier 2 issued by Banco Popular have been converted into newly issued shares of Banco Popular, all of which have been acquired for a total consideration of one euro by the Group. ii. Acquisition of the retail banking and private banking business of Deutsche Bank Polska S.A. On 14 December 2017 the Group announced that its subsidiary Santander Bank Polska S.A. (previously Bank Zachodni WBK S.A.) The transaction was approved by all the applicable regulatory and antitrust authorities in the territories where Banco Popular operated. 501 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix In accordance with IFRS3, the Group measured the identifable assets acquired and liabilities assumed at fair value. The detail of this fair value of the identifable assets acquired and liabilities assumed at the business combination date was as follows: As of 7 June 2017 Cash and balances with central banks Financial assets available-for-sale Deposits from credit institutions Loans and receivables* Investments Intangible assets* Tax assets* Non-current assets held for sale* Other assets Total assets Deposits from central banks Deposits from credit institutions Customer deposits Marketable debt securities and other fnancial liabilities Provisions*** Other liabilities Total liabilities** Net assets Purchase consideration Goodwill Million of euros 1,861 18,974 2,971 82,057 1,815 133 3,945 6,531 6,259 124,546 28,845 14,094 62,270 12,919 1,816 4,850 124,794 (248) - 248 * The main fair value adjustments were the following: • Loans and receivables: in the estimation of their fair value, impairment have been considered for an approximate amount of EUR 3,239 million, considering, among others, the sale process carried out by the Bank. • Foreclosed assets: the valuation, considering the sale process carried out by the company, has meant a reduction in the value of EUR 3,806 million, approximately. • Intangible assets: includes value reductions amounting to approximately of EUR 2,469 million, mainly recorded under the “Intangible assets - goodwill”. • Deferred tax assets: mainly corresponds to the reduction of the value of negative tax bases and deductions for an approximate amount of EUR 1,711 million. ** After the initial analysis and the conversion of the subordinated debt, the best estimation is there is no signifcant impact between fair value and previous carrying amount of the fnancial liabilities. *** As a result of the resolution of Banco Popular, it includes the estimated cost of EUR 680 million relating to the potential compensation to the shareholders of Banco Popular of which EUR 535 million have been applied to the fdelity action. The Group during 2018, closed their assessment exercise of the assets acquired and liabilities assumed at fair value, without any modifcation with respect to what was recorded in 2017. 502 iv. Sale agreement of Banco Popular’s real estate business In relation with Banco Popular’s real estate business, on 8 August 2017, the Group announced the agreement with a Blackstone fund for the acquisition by the fund of 51% of, and hence the assignment of control over, part of Banco Popular’s real estate business (the “Business”), which comprises a portfolio of foreclosed properties, real estate companies, non-performing loans relating to the sector and other assets related to these activities owned by Banco Popular and its afliates (including deferred tax assets allocated to specifc real estate companies which are part of the transferred portfolio) registered on certain specifed dates (31 March 2017 or 30 April 2017). The agreements were entered following the European Commission’s unconditional authorization of the acquisition of Banco Popular Español, S.A.U. by Banco Santander, S.A. for the purposes of competition law. The transaction closed on 22 March 2018 following receipt of the required regulatory authorizations and other usual conditions in this type of transactions. The transaction has consisted of the creation of various companies, being the parent company Project Quasar Investments 2017, S.L., in which Banco Santander, S.A. maintains 49% of the share capital and Blackstone the remaining 51%, and to which Banco Popular and some subsidiaries has transferred the business constituted by the indicated assets, and its participation in the capital of Aliseda Real Estate Management Services, S.L. The value attributed to the contributed assets is approximately 10,000 million euros, of which approximately 70% was fnanced with third party bank debt. After the contribution to the vehicle by its shareholders of the necessary liquidity for the transaction of the business, the 49% stake in the capital of the vehicles was recorded in the consolidated balance sheet of the Group for EUR 1,701 million in the “Investments in joint ventures and associates - entities” section, without signifcant impact in the Group´s income statement. v. Merger by absorption of Banco Santander, S.A. with Banco Popular Español, S.A.U. On 23 April 2018 the boards of directors of Banco Santander, S.A. and Banco Popular Español, S.A.U. agreed to approve and sign the merger project by absorption of Banco Popular Español, S.A.U. by Banco Santander, S.A. On 28 September 2018 the merger certifcate of Banco Popular Español, S.A.U. by Banco Santander, S.A. was registered in the Mercantile Registry of Cantabria. After the merger, Banco Santander, S.A. has acquired, by universal succession, all the rights and obligations of Banco Popular Español, S.A.U., including those that have been acquired from Banco Pastor, S.A.U. and Popular Banca Privada, S.A.U., by virtue of the merger of Banco Pastor, S.A.U. and Popular Banca Privada, S.A.U. with Banco Popular Español, S.A.U. that was also approved on 23 April 2018 by the respective board of directors. This transaction has no impact on the Group’s income statement. vi. Agreement with Aegeon Group as partner for several insurance services On 3 July 2018, the Group announced that it had reached an agreement with the Aegon Group, pursuant to which it will be the partner in Spain for the life-insurance business and several branches of general insurance. Given such agreement, and the perimeter under which it will be materialised, are subject to various conditions including the termination of the current 2018 Auditors’ report and consolidated annual accounts alliance between Banco Popular and its current partner, it is not possible to estimate when these transactions will be closed. These transactions are not expected to have a signifcant impact on the Group’s income statement. vii. Agreement with Santander Asset Management a) Acquisition 50% SAM Investment Holdings Limited On 16 November 2016, after the agreement with Unicredit Group on 27 July 2016 to integrate Santander Asset Management, and Pioneer Investments was abandoned, the Group announced that it had reached an agreement with Warburg Pincus (“WP”) and General Atlantic (“GA”) under which Santander acquired 50% of SAM Investment Holdings Limited., at 22 December 2017. The Group disbursed a total amount of EUR 545 million and assumed fnancing of EUR 439 million, with the business combination generating a goodwill of EUR 1,173 million and EUR 320 million of “intangible assets - contracts and relationships with customers” identifed in the purchase price allocation, without other value adjustments to net assets of the business. Likewise, the market valuation of the previous participation held did not have an impact on the Group’s income statement. Considering that the main activity of the business is asset management, the main part of its activity are recorded of balance sheet. The main net assets acquired, in addition to the aforementioned intangible assets, were net deposits in credit institutions (EUR 181 million) and net tax assets (EUR 176 million). Given their nature, the fair value of these assets and liabilities do not difer from the book value recorded. The Group has closed its assessment exercise of assets acquired and liabilities assumed at fair value during the year 2018 without modifcation with respect to what was recorded at the end of 2017. b) Sale participation Allfunds Bank, S.A. As part of the transaction, which consists in the acquisition of 50% of SAM Investment Holdings Limited, that was not owned by the Group, Santander, WP and GA agreed to explore diferent alternatives for the sale of its stake in Allfunds Bank, S.A. (“Allfunds Bank”), including a possible sale or a public ofering. On 7 March 2017, the Bank announced that together with our partners in Allfunds Bank we had reached an agreement for the sale of 100% of Allfunds Bank to funds afliated with Hellman & Friedman, a leading private equity investor, and GIC, Singapore’s sovereign wealth fund. On 21 November 2017 the Group announced the closing of the sale by the Bank and its partners of 100% of Allfunds Bank’s capital, obtaining an amount of EUR 501 million from the sale of its 25% stake in Allfunds Bank, resulting in gains net of tax of EUR 297 million, which were recognised as “Gains or losses on disposal of non-fnancial assets and investments, net”, within the statement of proft or loss. viii. Purchase of the shares to DDFS LLC in Santander Consumer USA Holdings Inc. (SCUSA) On 2 July 2015, the Group announced that it had reached an agreement to purchase the 9.65% ownership interest held by DDFS LLC in SCUSA. On 15 November 2017, after having agreed on some modifcations to the original agreement and having obtained the required regulatory authorizations, the Group completed the acquisition of the aforementioned 9.65% of SCUSA shares for a total sum of USD 942 million (EUR 800 million), which have caused a decrease of EUR 492 million in the non-controlling interests balance and another reduction to reserves of EUR 307 million. ix. Agreement with Banque PSA Finance The Group, through its subsidiary Santander Consumer Finance, S.A., and Banque PSA Finance, the vehicle fnancing unit of the PSA Peugeot Citroën Group, entered into an agreement in 2014 for the transaction of the vehicle and insurance fnancing business in twelve European countries. Pursuant to the terms of the agreement, the Group will fnance this business, under certain circumstances and conditions, from the date on which the transaction is completed. In January 2015 the related regulatory authorisations to commence activities in France and the United Kingdom were obtained and, accordingly, on 2 and 3 February 2015 the Group acquired 50% of Société Financière de Banque – SOFIB ( actually PSA Banque France) and PSA Finance UK Limited for EUR 462 million and EUR 148 million, respectively. On 1 May 2015, PSA Insurance Europe Limited and PSA Life Insurance Europe Limited (both insurance companies with registered ofce in Malta) were incorporated, in which the Group contributed 50% of the share capital, amounting to EUR 23 million. On 3 August the Group acquired a full ownership interest in PSA Gestão - Comércio E Aluguer de Veiculos, S.A. (actually Santander Consumer Services,S.A. and a company with registered ofce in Portugal) and the loan portfolio of the Portuguese branch of Banque PSA Finance for EUR 10 million and EUR 25 million, respectively. On 1 October, PSA Financial Services Spain, E.F.C., S.A. (a company with registered ofce in Spain) was incorporated, in which the Group contributed EUR 181 million (50% of the share capital). (This company owns the 100% of the share capital of PSA Finanse Suisse which is domiciled in Switzerland). During 2016, the agreement obtained the necessary authorizations, by the regulators, to start activities in the rest of the countries covered by the framework agreement (Italy, the Netherlands, Austria, Belgium, Germany, Brazil and Poland). The Group’s disbursement during 2016 amounted to EUR 464 million to reach a 50% stake in the capital of each of the structures created in each geography, with the exception of PSA fnance Arrendamento Mercantil SA (actually Distribuidora de Títulos e Valores Mobiliários S.A.) where 100% of capital is acquired. During 2016 the new businesses acquired have contributed EUR 79 million to the Group’s proft. Had the business combination taken place on 1 January 2016, the proft contributed to the Group in 2016 would have been approximately EUR 118 million. x. Metrovacesa agreement - Merlin On 21 June 2016, Banco Santander hereby reached an agreement with Merlin Properties, SOCIMI, S.A., together with the other shareholders of Metrovacesa, S.A., for the integration in Merlin group, following the total spin-of of Metrovacesa, S.A., of Metrovacesa, S.A. property rental asset business in Merlin Properties, SOCIMI, S.A. and Metrovacesa, S.A. residential rental business in Metrovacesa, S.A. current subsidiary, Testa Residencial SOCIMI, S.A. (before, Testa Residencial, S.L.) The other assets of 503 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Metrovacesa, S.A. not integrated in Merlin group as a result of the integration, consisting of a residual group of land assets for development and subsequent lease, will be transferred to a newly created company wholly owned by the current shareholders of Metrovacesa, S.A. On 15 September 2016, the general meeting of shareholders of Merlin Properties, SOCIMI, S.A. and Metrovacesa, S.A. took place and the transaction was approved. Subsequently, on 20 October 2016, the deed of total division of Metrovacesa, S.A. was granted in favour of the mentioned companies, and such deed was fled in the Commercial Register on 26 October 2016. As a result of the integration, Santander Group has increased its participation to 21.95% of the equity capital of Merlin Properties, SOCIMI, S.A., 46.21% of direct participation in the equity capital of Testa Residential, SOCIMI, S.A. and 70.27% in Metrovacesa Promoción y Arrendamiento, S.A. The main impacts on the consolidated Group’s balance of this division have been; decrease of EUR 3,800 million in real estate investment (see Note 16), decrease of EUR 621 million under minority interests (see Note 28) and an increase in the heading of investments in joint ventures and associates participation of the businesses received in the associates Merlín Properties and Testa Residencial, of EUR: 1,168 and 307 million, respectively. (See Note 13.a). c) Of-shore entities According to current Spanish regulation, Santander has entities in 4 of-shore territories: Jersey, Guernsey, Isle of Man and Cayman Islands. These four jurisdictions comply with OECD standards in terms of transparency and exchange of information for tax purposes. Santander have 4 subsidiaries and 4 operative branches in of-shore territories: these are governed by the tax regimes of those territories. Santander also has 4 subsidiaries in of-shore territories, of which 3 are tax resident in the UK and 1 tax resident in Spain, to whose tax regimes they are subjected. The Group has no presence in any of the 5 territories included in the European Union’s current blacklist according to the last update of November 2018, neither in non-cooperative territories for tax purposes as defned by the OECD in July 2017. I) Subsidiaries in of-shore territories. At the reporting date, the Group has 4 subsidiaries resident in of-shore territories, two in Jersey, Whitewick Limited (inactive company) and Abbey National International Limited, and one in the Isle of Man, ALIL Services Limited. These subsidiaries contributed a proft of approximately EUR 0.2 million to the Group’s consolidated proft in 2018. In addition, during 2018, a new company domiciled in Jersey was created, named Santander International Limited, subsidiary of Santander UK Group Holdings plc, in order to make possible the separation of business imposed by the banking reform in the United Kingdom (“Ring-fence”) that came into force on January 1, 2019, although this company will be liquidated in the near future. II) Of-shore branches. Also, the Group has 4 operative of-shore branches: 2 in the Cayman Islands, 1 in the Isle of Man and 1 in Jersey. These branches report to, consolidate their balance sheets and income statements and are taxed with, their respective foreign headquarters (Cayman Islands) or in the territories where they are located (Jersey and Isle of Man). Additionally, as a result of complying with the Ring- Fence regulation in the UK mentioned in the previous point, there is another branch in Jersey of Santander UK plc, which is currently not operative and will be closed in early 2019. The aforementioned entities have a total of 144 employees as of December 2018. III) Subsidiaries in of-shore territories that are tax resident in the UK and Spain. As indicated, the Group also has 4 subsidiaries constituted in of- shore territories that are not considered to be of-shore entities, since 3 of them are tax residents in the UK and, therefore, subject to UK tax law during the period and operate exclusively from the UK (one of these subsidiaries is expected to be liquidated in 2019). Also, since April 2018, the fourth subsidiary has ceased to be a resident for tax purposes in the UK to become a tax resident in Spain. IV) Other of-shore investments. The Group manages from Brazil a segregated portfolio company called Santander Brazil Global Investment Fund SPC in the Cayman Islands, and manages from the United Kingdom a protected cell company in Guernsey called Guaranteed Investment Products 1 PCC Limited. The Group also has, directly or indirectly, few fnancial investments located in tax havens including Olivant Limited in Guernsey, entity whose liquidation or sale is expected to be carried out soon. V) OECD. The Group has no presence in non-cooperative territories for tax purposes as defned by the OECD in July 2017. In this sense it should be noted that Jersey, Guernsey, Isle of Man and Cayman Islands, comply with OECD standards in terms of transparency and exchange of information for tax purposes. VI) The European Union. On 5 December, 2017, the European Commission published some lists of non-cooperative jurisdictions for tax purposes (where there is no member state of the European Union): blacklist, gray list and territories which have received a grace period. Throughout 2018, the European Commission has updated these lists. Currently the EU blacklist is composed of 5 jurisdictions in which the Group has no presence. These jurisdictions have not committed, or have not done it sufciently, to comply with a series of measures in relation to fscal transparency, corporate tax, or the respect of the principles of the OECD to avoid the erosion of the tax bases and the transfer of benefts (better known by the English term anti-BEPS). 504 2018 Auditors’ report and consolidated annual accounts On the contrary there are 63 jurisdictions in the gray list that have committed, in a way considered sufcient, to correct their legal frameworks to align them with international standards and whose implementation will be monitored by the EU. Among others, this list includes the 4 jurisdictions in which the Group has presence and are of-shore territories in accordance with current Spanish legislation (Jersey, Guernsey, Isle of Man and Cayman Islands). Additionally, Hong Kong, Bahamas, Switzerland, Uruguay and Panama are included in the gray list, although according to the current Spanish legislation are not of-shore territories and, as disclosed before, have committed to modify their legislation, as for example implementing the Common Reporting Standards (CRS), developed by the OECD, as an automatic information exchange system between jurisdictions. The Group has 2 subsidiaries and 1 branch located in Hong Kong, 6 subsidiaries (1 of them in liquidation and 1 tax resident in the USA) and 2 branches in Bahamas (1 of them in process of closure), 6 subsidiaries in Switzerland, 12 subsidiaries in Uruguay (6 of which are in liquidation) and 1 subsidiary in Panama with reduced activity that has already received authorization from the Superintendency of Banks of Panama for its voluntary liquidation. At present, Spain has in force Double Taxation Agreements with exchange of information clause with Hong Kong, Switzerland, Uruguay and Panama, as well as Tax Information Exchange Agreement with Bahamas. VII) Impact of forthcoming changes to Spain’s tax law. On October 23, 2018, the Spanish Government published the Draft Law on measures to prevent and fght against tax fraud, which expands the concept of tax haven, including not only the countries and territories that were already considered as such, but also other tax regimes that are determined as harmful in a regulatory manner. In addition, new criteria are regulated for inclusion in the list of tax havens. As long as the list of countries and territories and harmful tax regimes that are considered tax havens are not determined by regulation, the former list of tax havens established in Royal Decree 1080/1991, of 5th July, will continue in force. The Group has established appropriate procedures and controls (risk management, supervision, verifcation and review plans and periodic reports) to prevent reputational, tax and legal risk at these entities. Also, the Group has continued to implement its policy of reducing the number of these of-shore units. The fnancial statements of the Group’s of-shore units are audited by PwC (PricewaterhouseCoopers) member frms in 2018 and 2017. 4. Distribution of the Bank’s proft, shareholder remuneration scheme and earnings per share a) Distribution of the Bank’s proft and shareholder remuneration scheme The distribution of the Bank’s net proft for 2018 that the board of directors will propose for approval by the shareholders at the annual general meeting is as follows: Million of euros First and third interim dividends and fnal dividend 3,160 Acquisition, with a waiver of exercise, of bonus share rights from the shareholders which, under the Santander Dividendo Elección scrip dividend scheme, opted to receive in cash remuneration equivalent to the second interim dividend Of which: Approved at 31 December 2018* Final dividend To voluntary reserves Net proft for the year 132 3,292 2,237 1,055 9 3,301 * Recognised under Shareholders’ equity – Interim dividends. In addition to the EUR 3,292 million indicated above, EUR 432 million in shares were allocated to the remuneration of shareholders under the shareholder remuneration scheme (Santander Dividendo Elección) approved by the shareholders at the annual general meeting held on 23 March 2018, whereby the Bank ofered shareholders the possibility to opt to receive an amount equivalent to the second interim dividend out of 2018 proft in cash or new shares. A remuneration of EUR 0.23 per share, charged to the 2018 annual period, will be proposed by the board of directors to the shareholders at the annual general meeting. b) Earnings per share from continuing and discontinued operations i. Basic earnings per share Basic earnings per share are calculated by dividing the net proft attributable to the Group (adjusted by the after-tax amount of the remuneration of contingently convertible preference shares recognised in equity - See Note 23) and the capital perpetual preference shares, if applicable, by the weighted average number of ordinary shares outstanding during the year, excluding the average number of treasury shares held in the year. 505 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Accordingly: Proft attributable to the parent (million of euros) Remuneration of contingently convertible preference shares (CCP) (million of euros) (Note 23) Of which: Proft or Loss from discontinued operations (non controlling interest net) (million of euros) Proft or Loss from continuing operations (net of non-controlling interests and CCP) (million of euros) Weighted average number of shares outstanding Adjusted number of shares Basic earnings per share (euros) Basic earnings per share from discontinued operations (euros) Basic earnings per share from continuing operations (euros) 2018 2017 2016 7,810 6,619 6,204 (560) 7,250 (395) 6,224 (334) 5,870 - - - 7,250 6,224 5,870 16,150,090,739 15,394,458,789 14,656,359,963 16,150,090,739 15,394,458,789 14,656,359,963 0.449 0.404 0.401 0.000 0.000 0.000 0.449 0.404 0.401 ii. Diluted earnings per share Diluted earnings per share are calculated by dividing the net proft attributable to the Group (adjusted by the after-tax amount of the remuneration of contingently convertible preference shares recognised in equity - See Note 23) and the capital perpetual preference shares, if applicable, by the weighted average number of ordinary shares outstanding during the year, excluding the average number of treasury shares and adjusted for all the dilutive efects inherent to potential ordinary shares (share options, and convertible debt instruments). Accordingly, diluted earnings per share were determined as follows: Proft attributable to the parent (million of euros) Remuneration of contingently convertible preference shares (CCP) (million of euros) (Note 23) Of which: Proft (Loss) from discontinued operations (net of non- controlling interests) (million of euros) Proft from continuing operations (net of non-controlling interests and CCP) (million of euros) Weighted average number of shares outstanding Dilutive efect of options/rights on shares Adjusted number of shares Diluted earnings per share (euros) Diluted earnings per share from discontinued operations (euros) Diluted earnings per share from continuing operations (euros) 2018 2017 2016 7,810 6,619 6,204 (560) 7,250 (395) 6,224 (334) 5,870 - - - 7,250 6,224 5,870 16,15 0,090,739 15,394,458,789 14,656,359,963 4 2,873,078 50,962,887 45,754,981 16,1 92,963,817 15,445,421,676 14,702,114,944 0.448 0.403 0.399 0.000 0.000 0.000 0.448 0.403 0.399 The capital increase in 2017 (See Note 31.a) had an impact on the basic and diluted earnings per share of the previous years due to the alteration in the number of shares outstanding. Due to this fact, the information relating to the 2016 period has been recasted according to the applicable legislation. 5. Remuneration and other benefts paid to the Bank’s directors and senior managers The following section contains qualitative and quantitative disclosures on the remuneration paid to the members of the Board of Directors -both executive and non-executive directors- and senior managers for 2018 and 2017: 506 2018 Auditors’ report and consolidated annual accounts a) Remuneration of Directors i. Bylaw-stipulated emoluments The annual General Meeting held on 22 March, 2013 approved an amendment to the Bylaws, whereby the remuneration of directors in their capacity as board members became an annual fxed amount determined by the annual General Meeting. This amount shall remain in efect unless the shareholders resolve to change it at a general meeting. However, the Board of Directors may elect to reduce the amount in any years in which it deems such action justifed. The remuneration established by the Annual General Meeting for the years 2018 and 2017, was EUR 6 million, with two components: (a) an annual emolument and (b) attendance fees. The specifc amount payable for the above-mentioned items to each of the directors is determined by the Board of Directors. For such purpose, it takes into consideration the positions held by each director on the Board, their membership of the Board and the board committees and their attendance of the meetings thereof, and any other objective circumstances considered by the Board. The total bylaw-stipulated emoluments earned by the Directors in 2018 amounted to EUR 4.6 million (EUR 4.7 million in 2017). Annual emolument The amounts received individually by the directors in 2018 and 2017 based on the positions held by them on the board and their membership of the Board committees were as follows: Euros 2018 2017 Members of the board of directors 9 0,000 87,500 Members of the executive committee 17 0,000 170,000 Members of the audit committee 4 0,000 40,000 Members of the appointments committee 2 5,000 25,000 Members of the remuneration committee 2 5,000 25,000 Attendance fees The directors receive fees for attending board and committee meetings, excluding executive committee meetings, since no attendance fees are received for this committee. By resolution of the board of directors, at the proposal of the remuneration committee, the fees for attending board and committee meetings - excluding, as aforementioned, executive committee meetings - were as follows: Meeting attendance fees Euros Board of directors 2018 2017 2,600 2,600 Audit committee and risk supervision, regulation and compliance oversight committee 1,700 1,700 Other committees (except the executive committee) 1,500 1,500 ii. Salaries The executive directors receive salaries. In accordance with the policy approved by the annual general meeting, salaries are composed of a fxed annual remuneration and a variable one consisting of a unique incentive, which is based on a deferred variable remuneration linked to multi-year objectives, which establishes the following payment scheme: • 40% of the variable remuneration amount, determined at year- end on the basis of the achievement of the established objectives, is paid immediately. • The remaining 60% is deferred over fve years, as the case may be, in fve portions provided that the conditions of permanence of the Group and non-concurrence of the malus clauses are met, taking into account the following accrual scheme. Members of the risk supervision, regulation and compliance oversight committee 4 0,000 40,000 and 2021) is not subject to the long-term objectives. • The accrual of the frst and second portion (payment in 2020 Members of the responsible banking, sustainability and culture committe Chairman of the audit committee 5,000 1 - 7 0,000 50,000 Chairman of the appointments committee 5 0,000 50,000 Chairman of the remuneration committee 5 0,000 50,000 Chairman of the risk, regulation and compliance oversight committee Chairman of the responsible banking, sustainability and culture committee Lead director* Non-executive deputy chairman 7 0,000 50,000 5 0,000 - 11 0,000 110,000 3 0,000 30,000 * Mr. Bruce Carnegie-Brown, for duties performed as part of the board and board committees, specifcally as chairman of the appointments and remuneration committees and as lead director, and for the time and dedication required to perform these duties, has been allocated minimum total annual remuneration of EUR 700,000 since 2015, including the aforementioned annual allowances and attendance fees corresponding to him. • The accrual of the third, fourth, and ffth portion (payment in 2022, 2023 and 2024), is linked to certain objectives related to the period 2018-2020 and the metrics and scales associated with these objectives. The fulflment of the objective determines the percentage to be paid of the deferred amount in these three annuities, being the maximum amount determined at the end of the 2018 when the total variable remuneration is approved. • In accordance with current remuneration policies, the amounts already paid will be settled to a possible recovery (clawback) by the Bank during the period set out in the policy in force each moment. The immediate payment (or short-term) as well as each deferred payment, whether subject or not to long-term, goals will be settled 50% in cash and the remaining 50% in Santander shares. 507 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix iii. Detail by director The detail, by Bank director, of the short-term (immediate) and deferred (not subject to long-term goals) remuneration for 2018 and 2017 is provided below: Thousand of euros Bylaw-stipulated emoluments Annual emolument 2018 2017 Short-term and deferred (not subject to long-term goals) salaries of executive directors n o i t a l u , e g g e e n r i , e e t t i n o i s i t i e t k e t t i em cm n s n t o n a m e v te i e l a r m m p e e e r mg t t e p o t t t i n c n i u o m m u s t o c mm k pm d d sn p u e o i o A Ac R c Ra d nn a a b m y s o et n im e c o c t b n s h sa d a s n i d m a u n m s e te eo t c A fc F ibo c n ne o r a p t t s s l e u u Rs i s r e v o d e x i i l l i i i i i Variable – immediate payment Deferred variable s e h h r s a s a h a s c c n n n I I I s e r a h s n I 7 i n o i t u b r n t o n i o t a c r n e o n r i eu l s a n m a h t t e t o o e P Or T T l l a t o T e e t t i e v i 6 t m d u r c em a o x o B Ec 90 90 90 170 170 170 120 170 383 170 90 170 90 90 90 90 - - - - - - - - - - - - - - - 25 25 - - - 25 25 13 25 - 25 - 25 40 25 25 - 160 85 40 90 90 115 85 - - - - 170 - - - - 40 40 - - - - - - - - - - - - - - - - - - - Ms. Ana Botín- Sanz de Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez Mr. Rodrigo Echenique Gordillo Mr. Guillermo de la Dehesa Romero Mr. Bruce Carnegie-Brown Mr. Ignacio Benjumea Cabeza de Vaca Mr. Francisco Javier Botín-Sanz de Sautuola y O’Shea1 Ms. Sol Daurella Comadrán Mr. Carlos Fernández González Ms. Esther Giménez-Salinas i Colomer Ms. Belén Romana García Mr. Juan Miguel Villar Mir Ms. Homaira Akbari Mr. Ramiro Mato García Ansorena2 Mr. Alvaro Cardoso de Souza3 Mr. Matías Rodríguez Inciarte4 Ms. Isabel Tocino Biscarolasaga5 - - - 20 40 40 - - - 40 40 - - 40 27 - - 8 39 3,176 1,480 1,480 888 888 7,912 1,234 1,030 10,483 10,582 - - - - 8 - 8 - 8 8 - 8 8 5 - - 34 2,541 989 989 593 593 5,705 1,050 1,596 8,645 8,893 33 1,800 785 785 471 471 4,312 81 89 86 31 67 86 58 81 18 61 77 31 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 225 4,830 4,281 - - 441 732 473 731 81 513 550 - - - - - - - - - - - 121 215 124 207 266 285 196 414 108 199 450 148 - - 162 297 170 159 36 - 4,266 418 Total 2018 Total 2017 1,763 1,675 1,275 1,345 160 160 113 125 125 123 247 280 61 - 872 7,517 3,254 3,254 1,952 1,952 17,929 2,284 2,932 27,761 973 7,568 3,698 3,698 2,219 2,219 19,402 5,164 2,387 31,634 1. All the amounts received were repaid to the Fundación Marcelino Botín. 2. Director since 28 November 2017 3. Director since 23 March 2018 4. Ceased to be a member of the Board on 28 November, 2017. This table shows the remuneration information until his ceased as a member of the board. The remuneration information for his performance as executive vice president since 28 November 2017 is included in the corresponding section. 5. Ceased to be a member of the board on 28 November, 2017. 6.Includes committee chairmanship and other roles emoluments. 7. Includes, inter alia, the life and medical insurance costs borne by the Group relating to Bank directors as well as a fxed supplement approved as part of the beneft systems transformation of the Executive Directors Ms. Ana Botín and Mr. José Antonio Álvarez. 508 2018 Auditors’ report and consolidated annual accounts on or after March 18, 2002 accrues to the Group. In 2018 and 2017 the Bank’s directors did not receive any remuneration in respect of these representative duties. Mr. Matías Rodríguez Inciarte received EUR 42 thousand as non- executive director of U.C.I., S.A. in 2017. c) Post-employment and other long-term benefts The executive directors other than Mr. Rodrigo Echenique participate in the defned beneft system created in 2012, which covers the contingencies of retirement, disability and death. The Bank makes annual contributions to the beneft plans of its executive directors. In 2012, the contracts of the executive directors (and the other members of the Bank’s senior management) with defned beneft pension commitments were amended to transform them into a defned contribution system. The new system gives executive directors the right to receive benefts upon retirement, regardless of whether or not they are active at the Bank at such time, based on contributions to the system, and replaced their previous right to receive a pension supplement in the event of retirement1. In the event of pre-retirement and up until the retirement date, Ms. Ana Botín and Mr. José Antonio Álvarez have the right to receive an annual allotment. The initial balance for each of the executive directors in the new defned benefts system corresponded to the market value of the assets from which the provisions corresponding to the respective accrued obligations had materialised on the date on which the old pension commitments were transferred into the new benefts system2. Since 2013, the Bank has made annual contributions to the benefts system in favour of executive directors and senior executives, in proportion to their respective pensionable bases, until they leave the Group or until their retirement within the Group, death, or disability (including, if applicable, during pre-retirement). No contributions will be made with respect to executive directors or senior executives who exercised the option to receive their pension rights as capital prior to the transformation of the defned benefts pension commitments into the current defned forecast contribution system as set out in footnote 2 below. Mr. Rodrigo Echenique’s contract does not provide for any charge to Banco Santander regarding benefts, without prejudice to the pension rights to which Mr. Echenique was entitled prior to his appointment as executive director. Following is the detail, by executive director, of the linked to multiannual objectives salaries at their fair value, which will only be received if the conditions of continued service, non-applicability of “malus” clauses and, full achievement of the objectives established (or, as the case may be, of the minimum thresholds thereof, with the consequent reduction of the agreed-upon amount in the end of the year) in the terms described in Note 47. Thousand of euros 2018 2017 Variable subject to Long-term objectives2 In cash In shares Total Total2 932 623 495 - 932 1,864 1,726 623 1,246 1,154 495 990 900 - - 880 Ms. Ana Botín-Sanz de Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez Mr. Rodrigo Echenique Gordillo Mr. Matías Rodríguez Inciarte1 Total 2,050 2,050 4,100 4,660 1. Ceased to be a member of the board on 28 November, 2017. The remuneration information for his performance as executive vice president is included in the corresponding section. 2. Corresponds with the fair value of the maximum amount they are entitled to in a total of 3 years: 2022, 2023 and 2024, subject to conditions of continued service, with the exceptions provided, and to the non- applicability of “malus” clauses and achievement of the objectives established. The fair value has been determined at the grant date based on the valuation report of an independent expert, Willis Towers Watson. According to the design of the plan for 2018 and the levels of achievement of similar plans in comparable entities, the expert concludes that the reasonable range for estimating the initial achievement ratio is around 60% - 80%. It has been considered that the fair value is 70% of the maximum (see Note 47). Note 5.e) below includes disclosures on the shares delivered by virtue of the deferred remuneration schemes in place in previous years the conditions for delivery which were met in the corresponding years, and on the maximum number of shares receivable in future years in connection with the aforementioned 2018 and 2017 variable remuneration plans. b) Remuneration of the Board members as representatives of the Bank By resolution of the executive committee, all the remuneration received by the Bank’s directors who represent the Bank on the Boards of Directors of listed companies in which the Bank has a stake, paid by those companies and relating to appointments made 1. As provided in the contracts of the executive directors prior to 2012, Mr. Matías Rodríguez Inciarte exercised the option to receive accrued pensions (or similar amounts) in the form of capital, i.e., in a lump sum, which means that he ceased to accrue pensions from such time, with a fxed capital amount to be received, which shall be updated at the agreed interest rate. 2. In the case of Mr. Matías Rodríguez Inciarte, the initial balance corresponded to the amount that was set when, as described above, he exercised the option to receive a lump sum, and includes the interest accrued on this amount from that date. 509 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The beneft plan is outsourced to Santander Seguros y Reaseguros, Compañía Aseguradora, S.A., and the economic rights of the foregoing directors under this plan belong to them regardless of whether or not they are active at the Bank at the time of their retirement, death or disability. The contracts of these directors do not provide for any severance payment in the event of termination other than as may be required by law. increased in the corresponding amount with no increase in total costs for the Bank. • The death and disability supplementary benefts have been eliminated since 1 April 2018. A fxed remuneration supplement (included in other remuneration in section a.iii in this note) was implemented the same date In accordance with the provisions of the remuneration regulations, contributions made that are calculated on variable remuneration are subject to the discretionary pension benefts regime. Under this regime, these contributions are subject to malus clauses and clawback according to the policy in force at any time and during the same period in which the variable remuneration is deferred. Likewise, they must be invested in Bank shares for a period of fve years from the date of the termination of executive directors in the Group, whether or not as a result of retirement. After that period, the amount invested in shares will be invested together with the remainder of the accumulated balance of the executive director, or will be paid to him or her benefciaries had there been any contingency covered by the forecasting system. Until March 2018, the system also included a supplementary benefts scheme for cases of death (death of spouse and death of parent) and permanent disability of serving directors envisaged in the contracts of Ms. Ana Botín and Mr. José Antonio Álvarez. This beneft gave the widow/widower and any children under the age of 25 in the event of death, or the director in case of disability, the right to a pension supplemental to the pension they would have been entitled to receive from social security up to an annual maximum amount equal to their respective pensionable bases, as indicated above in connection with pre-retirement (in Mr. Álvarez’s case, referring to his fxed remuneration as chief executive ofcer), with certain deductions. As per the director´s remuneration policy approved at the 23 March 2018 general shareholder´s meeting, in 2018 the system has been changed with a focus on: • Aligning the annual contributions with practices of comparable institutions. • Reducing future liabilities by eliminating the supplementary benefts scheme in the event of death (death of spouse or parent) and permanent disability of serving directors. • No increase in total costs for the Bank. The changes to the system in 2018 are the following: • Fixed and variable pension contributions have been reduced to 22% of the respective pensionable bases. The gross annual salaries and the benchmark variable remuneration have been • The total amount insured for life and accident insurance has been increased. The provisions recognised in 2018 and 2017 for retirement pensions and supplementary benefts (surviving spouse and child benefts, and permanent disability) were as follows: Thousand of euros Ms. Ana Botín-Sanz de Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez 2018 1,234 1,050 2,284 2017 2,707 2,456 5,163 Following is a detail of the balances relating to each of the executive directors under the welfare system at 31 December 2018 and 2017: Thousand of euros Ms. Ana Botín-Sanz de Sautuola y O’Shea1 46,093 45,798 2018 2017 Mr. José Antonio Álvarez Álvarez Mr. Rodrigo Echenique Gordillo2 Mr. Matías Rodríguez Inciarte3 16,630 16,151 13,614 13,957 - - 76,337 75,906 1. Includes the amounts relating to the period of provision of services at Banesto, externalised with another insurance company. 2. Executive director since 16 January, 2015 Mr. Rodrigo Echenique Gordillo doesn´t participate in the pension system and the right to the bank to make contributions in its favour in this regard. The amount at 31 December, 2018 and 2017, corresponds to him prior to his appointment as executive director in January 2015. 3. Ceased to be a member of the Board on 28 November, 2017, retained their pension rights as of 31 December, 2017 amounted to EUR 48,750 thousand. The payments made during 2018 to the members of the Board entitled to post-employment benefts amount to EUR 0.9 million (EUR 0.9 million in 2017). 510 2018 Auditors’ report and consolidated annual accounts d) Insurance The Group has taken out life insurance policies for the Bank’s directors, who will be entitled to receive benefts if they are declared disabled; in the event of death, the benefts will be payable to their heirs. The premiums paid by the Group are included in the Other remuneration column of the table shown in Note 5.a.iii above. Also, the following table provides information on the sums insured for the Bank’s executive directors: Insured capital Thousand of euros Ms. Ana Botín-Sanz de Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez Mr. Rodrigo Echenique Gordillo 1 Mr. Matías Rodríguez Inciarte 2018 22,710 19,694 5,400 - 2017 7,500 6,000 4,500 - 47,804 18,000 1. Ceased to be member of the board on 28 November, 2017. The insured capital at 31 December, 2017 amounted to EUR 5,131 thousand. The insured capital has changed for in 2018 as Ms. Ana Botín and Mr. José Antonio Alvarez as part of the pension transformation set out in Note 5.c) above, that has encompassed the elimination of the supplementary benefts and the increase of the life insurance annuities. During years 2018 and 2017, the Group has disbursed a total amount of EUR 10.1 and 10.5 million, respectively, for the payment of civil-liability insurance premiums. These premiums correspond to several civil-liability insurance policies that hedge, among others, directors, senior executives and other managers and employees of the Group and the Bank itself as well as its subsidiaries, in light of certain types of potential claims, for which it is not possible to disaggregate or individualize the amount that correspond to the directors and executives. At December 31, 2018 and 2017, there were no obligations in this connection to other directors. e) Deferred variable remuneration systems The following information relates to the maximum number of shares to which the executive directors are entitled at the beginning and end of 2018 and 2017 due to their participation in the deferred variable remuneration systems, which instrumented a portion of their variable remuneration relating to 2018 and prior years, as well as on the deliveries, whether shares or cash, made to them in 2018 and 2017 where the conditions for the receipt thereof had been met (see Note 47): i) Deferred conditional variable remuneration plan From 2011 to 2015, the bonuses of executive directors and certain executives (including senior management) and employees who assume risk, who perform control functions or receive an overall remuneration that puts them on the same remuneration level as senior executives and employees who assume risk (all of whom are referred to as identifed staf) have been approved by the Board of Directors and instrumented, respectively, through various cycles of the deferred conditional variable remuneration plan. Application of these cycles, insofar as they entail the delivery of shares to the plan benefciaries, was authorized by the related Annual General Meetings. The purpose of these plans is to defer a portion of the bonus of the plan benefciaries (60% in the case of executive directors) over a period of fve years (three years for the plans approved up to 2014) for it to be paid, where appropriate, in cash and in Santander shares; the other portion of the bonus is also to be paid in cash and Santander shares, upon commencement of the cycles, in accordance with the rules set forth below. In addition to the requirement that the benefciary remains in Santander Group’s employ, the accrual of the deferred remuneration is conditional upon none of the following circumstances existing -in the opinion of the Board of Directors following a proposal of the remuneration committee- in relation to the corresponding year in the period prior to each of the deliveries: (i) poor fnancial performance of the Group; (ii) breach by the benefciary of internal regulations, including, in particular, those relating to risks; (iii) material restatement of the Group’s consolidated fnancial statements, except when it is required pursuant to a change in accounting standards; or (iv) signifcant changes in the Group’s economic capital or its risk profle. All the foregoing shall in each case be governed by the rules of the relevant plan cycle. On each delivery, the benefciaries will be paid an amount in cash equal to the dividends paid for the amount deferred in shares and the interest on the amount deferred in cash. If the Santander Dividendo Elección scrip dividend scheme is applied, payment will based on the price ofered by the Bank for the bonus share rights corresponding to those shares. The maximum number of shares to be delivered is calculated taking into account the daily volume-weighted average prices for the 15 trading sessions prior to the date on which the Board of Directors approves the bonus for the Bank’s Executive Directors for each year. This plan and the Performance Shares (ILP) plan described below have been integrated for the executive directors and other senior managers in the deferred variable compensation plan linked to multiannual objectives, in the terms approved by the General Meeting of Shareholders held on 18 March, 2016. 511 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix ii) Performance shares plans (ILP) The annual general meeting held on 27 March 2015 approved the second cycle of the performance shares plan. The accrual of this long-term incentive plan (LTI) and its amount are conditional on the performance of certain metrics of Banco Santander between 2015 and 2017, as well as compliance with the remaining conditions of the plan until the end of the accrual period (31 December 2018). The maximum benchmark LTI in number of shares for executive directors was set by the board at the end of 2015. At year-end 2018, the corresponding amounts to be received by each exclusive director in relation to LTI (the accrued LTI amount) was established taking into account the performance of the following indicators: (1) ranking of Santander´s earning per share growth for the 2015-2017 period compared to a peer group of 17 credit institutions; (2) ROTE in 2017; (3) number of principal markets in which Santander is in the Top 3 of the best banks to work for in 2017; (4) number of principal markets in which Santander is in the Top 3 of the best banks on the customer satisfaction index in 2017; (5) retail loyal clients at 31 December 2017; and (6) SME and corporate loyal clients at 31 December 2017. The overall compliance of the plan was assessed by the Board at the 65.67%. As a result of the aforementioned process and following a proposal by the remuneration committee, the board of directors approved the following number of shares to be paid in 2019: Number of shares Approved maximum LTI amount1 Final number of shares Ratio 187,070 65.67% 122,849 126,279 65.67% 82,927 93,540 65.67% 61,428 Ms. Ana Botín-Sanz de Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez Mr. Rodrigo Echenique Gordillo Total 406,899 267,204 1. 91.50% of the maximum established benchmark approved at the AGM on 27 March 2015. With regards to the ILP of 2014 (see Note 47), in both 2017 and 2018, the position achieved in the Total Return for the Shareholders has not been such that determines the accrual of the second and third thirds. Therefore, the plan has expired. iii) Deferred variable compensation plan linked to multiannual objectives In 2016, with the aim of simplifying the remuneration structure, improving risk adjustment before and increasing the incidence of long-term objectives, the bonus plan (deferred and conditioned variable compensation plan) and ILP were replaced by one single plan, the deferred multiyear objectives variable remuneration plan. The variable remuneration of executive directors and certain executives (including senior management) corresponding to 2018 has been approved by the Board of Directors and implemented through the third cycle of the deferred variable remuneration plan linked to multi-year objectives. The application of the plan, thus far as it entails the delivery of shares to the benefciaries, was authorized by the annual General Meeting of Shareholders. As indicated in section a.ii of this Note, 60% of the variable remuneration amount is deferred for fve years (three years for certain benefciaries, not including executive directors), for their payment, where appropriate by ffth parties provided that the conditions of permanence in the group and non-concurrence of the clauses malus are met, according to the following accrual scheme: • The accrual of the frst and second parts (instalments in 2020 and 2021) is not subject to the fulflment of long-term objectives. • The accrual of the third, fourth and ffth parts is linked to the fulflment of certain objectives related to the period 2018-2020 and the metrics and scales associated with those objectives. These objectives are: • the growth of consolidated earnings per share in 2020 compared to 2017; • the relative performance of the Bank’s total shareholder return (RTA) in the period 2018-2020 in relation to the weighted RTAs of a reference group of 17 credit institutions; • compliance with the fully loaded ordinary level 1 capital objective for the year 2020; Compliance with the above objectives determines the percentage to be applied to the deferred amount in these three annuities, the maximum being the amount determined at the end of the year 2018 when the total variable remuneration is approved. Both the immediate (short-term) and each of the deferred (long- term and conditioned) portions are paid 50% in cash and the remaining 50% in Santander shares. The accrual of deferred amounts (whether or not subject to performance measures) is conditioned, in addition to the permanence of the benefciary in the Group, to the fact that during the period prior to each of the deliveries, none of the circumstances giving rise to the malus clause as set out in the Group’s remuneration policy in its chapter related to malus and clawback. Likewise, the already paid amounts of the incentive will be subject to its possible recovery (clawback) by the Bank in the cases and during the term foreseen in said policy, always in the terms and conditions that are foreseen in it. The application of malus and clawback is activated in cases in which there is poor fnancial performance of the entity as a whole or of a specifc division or area of the entity or of the exposures generated by the personnel, and at least the following factors must be considered: (i) Signifcant failures in risk management committed by the entity, or by a business unit or risk control. 512 2018 Auditors’ report and consolidated annual accounts (ii) The increase sufered by the entity or by a business unit of its capital needs, not foreseen at the time of generation of the exposures. (iii) Regulatory sanctions or judicial sentences from events that could be attributable to the unit or the personnel responsible for those. Also, the breach of internal codes of conduct of the entity. (iv) Irregular conduct, whether individual or collective. The negative efects derived from the marketing of inappropriate products and the responsibilities of the people or bodies that made those decisions will be specially considered. The maximum number of shares to be delivered is calculated by taking into account the weighted average daily volume of weighted average prices for the ffteen trading sessions prior to the previous Friday (excluded) the date on which the bonus is agreed by the board of executive directors of the Bank. iv) Shares assigned by deferred variable remuneration plans The following table shows the number of Santander shares assigned to each executive director and pending delivery as of 1 January, 2017, 31 December, 2017 and 2018, as well as the gross shares that were delivered to them in 2017 and 2018, either in the form of an immediate payment or a deferred payment. In this case after having been appraised by the board, at the proposal of the remuneration committee that the corresponding one-ffth (one third until 2014) of each plan had accrued. They bring cause of each of the plans through which the variable remunerations of deferred conditional variable remuneration plans in 2013, 2014 and 2015 and of the deferred conditional and linked to multiannual objectives 2018, 2017 and 2016. In order to mitigate the dilutive efect (and, therefore, not linked to the performance of the Group) of the capital increase with preferential subscription rights of the Bank that took place on July 2017 in certain cycles of the deferred compensation and long term incentive plans, the increase in the number of shares to be delivered to its benefciaries was approved, considering for this a valuation of preferential subscription rights equivalent to their theoretical value, EUR 0.1047 per right. The efect of increasing the number of shares is detailed in the corresponding column of the table below. 513 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Share-based variable remuneration Maximum number of shares to be delivered at anuary 1, 2017 J Shares delivered in 2017 (immediate payment 2016 variable remuneration) Shares delivered in 2017 (deferred payment 2014 variable remuneration) Shares delivered in 2017 (deferred payment 2013 variable remuneration) Shares delivered in 2017 (deferred payment 2012 variable remuneration) Shares arising from the capital increase of July 2017 (33,120) (19,561) (34,547) (87,228) (60,814) (26,242) (46,363) (133,419) 33,120 19,561 34,547 87,228 121,630 52,484 92,725 266,839 317,300 210,914 156,233 216,671 901,118 592,043 399,607 295,972 352,455 (63,460) (42,183) (31,247) (43,334) (180,224) (236,817) (159,843) (118,389) (140,982) 1,640,077 (656,031) 905 390 690 1,985 3,777 2,511 1,860 2,579 10,727 5,286 3,568 2,643 3,147 14,644 2013 variable remuneration Ms. Ana Botín-Sanz Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez2 Mr. Matías Rodríguez Inciarte 2014 variable remuneration Ms. Ana Botín-Sanz Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez2 Mr. Matías Rodríguez Inciarte 3 2015 variable remuneration Ms. Ana Botín-Sanz Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez2 Mr. Rodrigo Echenique Gordillo Mr. Matías Rodríguez Inciarte 2016 variable remuneration Ms. Ana Botín-Sanz Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez2 Mr. Rodrigo Echenique Gordillo Mr. Matías Rodríguez Inciarte 2017 variable remuneration Ms. Ana Botín-Sanz Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez2 Mr. Rodrigo Echenique Gordillo Mr. Matías Rodríguez Inciarte3 2018 variable remuneration Ms. Ana Botín-Sanz Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez 2 Mr. Rodrigo Echenique Gordillo 1. For each director, 40% of the shares indicated correspond to the short-term variable (or immediate payment). The remaining 60% is deferred for delivery, where appropriate, by ffths in the next fve years, the last three being subject to the fulflment of multiannual objectives. 2. Maximum number of shares resulting from their participation in the corresponding plans during their stage as general manager. 3. Ceased to be a member of the Board on 28 November, 2017. The shares corresponding to his variable remuneration between 28 November 28, 2017 and 2 January, 2018 as executive vice president are included in Note 5.g. 4. In addition, Mr. Ignacio Benjumea Cabeza de Vaca maintains the right to a maximum of 106,113 shares arising from his participation in the corresponding plans during his term as executive vice president. 514 2018 Auditors’ report and consolidated annual accounts Variable remuneration 2017 (maximum number of shares to be delivered) Maximum number of shares to be delivered at December 31, 2017 Shares delivered in 2018 (immediate payment 2016 variable remuneration) Shares delivered in 2018 (deferred payment 2015 variable remuneration) Shares delivered in 2018 (deferred payment 2014 variable remuneration) Shares delivered in 2018 (deferred payment 2013 variable remuneration) Variable remuneration 2018 (maximum number of shares to be delivered)1 Maximum number of shares to be delivered at December 31, 20184 (61,721) (26,632) (47,052) (135,405) (64,404) (42,811) (31,712) (43,979) (182,906) 61,721 26,632 47,052 135,405 257,617 171,242 126,846 175,916 731,621 360,512 243,332 180,226 214,620 998,690 574,375 384,118 299,346 292,771 574,375 384,118 299,346 292,771 (72,102) (48,667) (36,046) (42,924) (199,739) (229,750) (153,647) (119,738) (117,108) 1,550,610 1,550,610 (620,243) 193,213 128,431 95,134 131,937 548,715 288,410 194,665 144,180 171,696 798,951 344,625 230,471 179,608 175,662 930,366 860,865 575,268 456,840 860,865 575,268 456,840 1,892,973 1,892,973 515 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Also, the table below show the cash delivered in 2018 and 2017, by way of either immediate payment or deferred payment, in the latter case once the Board had determined, at the proposal of the remuneration committee that one-third relating to each plan had accrued: Thousand of euros Ms. Ana Botín-Sanz de Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez1 Mr. Rodrigo Echenique Gordillo Mr. Matías Rodríguez Inciarte2 2018 2017 Cash paid (immediate payment 2017 variable remuneration) Cash paid (deferred payments from 2016, 2015 and 2014 variable remuneration) Cash paid (immediate payment 2016 variable remuneration) Cash paid (one- third of deferred payment 2015, 2014 and 2013 variable remuneration) 1,370 916 714 - 3,000 947 574 305 - 1,826 1,205 814 603 718 3,339 825 461 124 690 2,099 1. Includes paid cash corresponding to his participation in the corresponding plans during the time as executive vice president. 2. Ceased to be a member of the Board on 28 November 2017. The cash paid corresponding to his variable remuneration between 28 November 2017 and 2 January 2018 as executive vice president is included in Note 5.g. v) Information on former members of the Board of Directors Following is information on the maximum number of shares to which former members of the Board of Directors who ceased in ofce prior to January 1, 2017 are entitled for their participation in the various deferred variable remuneration systems, which instrumented a portion of their variable remuneration relating to the years in which they were Executive Directors. Also set forth below is information on the deliveries, whether shares or cash, made in 2018 and 2017 to former board members, upon achievement of the conditions for the receipt thereof (see Note 47): Maximum number of shares to be delivered1 Deferred conditional variable remuneration plan (2014) Deferred conditional variable remuneration plan (2015) Plan performance shares (ILP 2015) Deferred conditional variable remuneration plan (2016) Number of shares delivered Deferred conditional variable remuneration plan (2013) Deferred conditional variable remuneration plan (2014) Deferred conditional variable remuneration plan (2015) Deferred conditional variable remuneration plan (2016) 2018 - 50,604 33,785 - 2018 - 101,537 16,868 - 2017 101,537 67,472 51,447 - 2017 80,718 100,049 16,621 - 1. At the proposal of the remuneration committee, the board of directors approved adjusting the maximum number of shares to mitigate the dilutive efect of the capital increase with pre-emptive subscription rights of July 2017 as described in iv) below. The actions derived from this adjustment are 3,233 shares. At year-end 2018, the overall compliance of the 2015 LTI Plan was assessed by the Board at the 65.67%. In addition, EUR 685 thousand and EUR 1,224 thousand relating to the deferred portion payable in cash of the aforementioned plans were paid each in 2018 and 2017. 516 2018 Auditors’ report and consolidated annual accounts f) Loans The Group’s direct risk exposure to the Bank’s directors and the guarantees provided for them are detailed below. These transactions were made on terms equivalent to those that prevail in arm’s-length transactions or the related compensation in kind was recognised: Thousand of euros Ms. Ana Botín-Sanz de Sautuola y O’Shea Mr. José Antonio Álvarez Álvarez Mr. Bruce Carnegie-Brown Mr. Matías Rodríguez Inciarte1 Mr. Rodrigo Echenique Gordillo Mr. Javier Botín-Sanz de Sautuola y O’Shea Ms. Sol Daurella Comadran Mr. Carlos Fernandez Gonzalez Ms. Esther Gimenez-Salinas i Colomer Mr. Ignacio Benjumea Cabeza de Vaca Ms. Belén Romana García Mr. Guillermo de la Dehesa Romero 2018 Loans and 2017 Loans and credits Guarantees Total credits Guarantees Total 18 8 - - 29 15 53 12 1 - 21 21 178 - - - - - - - - - - - - - 18 8 - - 29 15 53 12 1 - 21 21 178 10 9 - - 22 17 27 - - - 3 - 88 - - - - - - - - - - - - - 10 9 - - 22 17 27 - - - 3 - 88 1. Ceased to be a board director on 28 November 2017. On 31 December 2017, to loans and credits amounted to EUR 13 thousand. g) Senior managers The table below includes the amounts relating to the short- term remuneration of the members of senior management at 31 December, 2018 and those at 31 December, 2017, excluding the remuneration of the executive directors, which is detailed above:: Thousand of euros Year 2018 2017 Number of persons 18 19 Fixed 22,475 17,847 Short-term salaries and deferred remuneration Variable remuneration (bonus) - Immediate payment Deferred variable remuneration In cash In shares2 In cash In shares Pensions Other remuneration1 Total3 8,374 8,879 8,374 8,879 3,791 4,052 3,791 4,052 6,193 13,511 7,263 60,261 7,348 64,568 1. Includes other remuneration items such as life insurance premiums and localization aids totalling EUR 1,641 thousand (2017: EUR 692 thousand). 2. The amount of the immediate payment in shares for 2018 relates to Santander shares 1,936,037 (2017:1,430,143 Santander shares and 225,564 shares of Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México. 3. Additionally, and as a result of the incorporation and compensation agreements of long-term and deferred compensation lost in previous jobs, compensations were agreed in 2017 for the amount of EUR 4,650 thousand and 648,457 shares of Banco Santander, S.A. These compensations are partially subject to deferral and / or recovery in certain cases. Also, the detail of the breakdown of the linked to multiannual objective salaries of the members of senior management at 31 December, 2018 and 2017 is provided below. These remuneration payments shall be received, as the case may be, in the corresponding deferral periods upon achievement of the conditions stipulated for each payment (see Note 47): 517 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Thousand of euros Number of shares delivered Variable remuneration subject to long-term objectives1 Year 2018 2017 Number of people Cash payment Share payment Total 18 19 3,981 4,255 3,981 7,962 4,255 8,510 1. Relates in 2018 with the fair value of the maximum annual amounts for years 2022, 2023 and 2024 of the third cycle of the deferred conditional variable remuneration plan (2021, 2022 and 2023 for the frst cycle of the deferred variable compensation plan linked to annual objectives for the year 2017). Also, executive vice presidents who retired in 2018 and, therefore, were not members of senior management at year-end, received in 2018 salaries and other remuneration relating to their retirement amounting to EUR 1.861 thousand (EUR 5,237 thousand in 2017), however, the right to obtain variable remuneration subject to long-term objectives has not been generated as part of the senior management ( 2017: EUR 999 thousand). Other than Executive directors the average total remuneration awarded in 2018 to women senior managers is 0.7% higher than the average remuneration of men senior managers. Following is a detail of the maximum number of Santander shares that the members of senior management at each plan grant date (excluding executive directors) were entitled to receive at 31 December, 2018 and 2017 relating to the deferred portion under the various plans then in force (see Note 47): Maximum number of shares to be delivered1 Deferred conditional variable remuneration plan (2014) Deferred conditional variable remuneration plan (2015) 2018 2017 - 323,424 705,075 1,296,424 Performance shares plan ILP (2015) 515,456 1,050,087 Deferred conditional variable remuneration plan and linked to objectives (2016) Deferred conditional variable remuneration plan and linked to objectives (2017) Deferred conditional variable remuneration plan and linked to objectives (2018) 1,079,654 1,854,495 1,434,047 1,779,302 2,192,901 - 1. At the proposal of the remuneration committee, the board of directors approved adjusting the maximum number of shares to mitigate the dilutive efect of the capital increase with pre-emptive subscription rights of July 2017 as described in iv) below. The actions derived from this adjustment are 66,339 shares. In 2018 and 2017, since the conditions established in the corresponding deferred share-based remuneration schemes for prior years had been met, in addition to the payment of the related cash amounts, the following number of Santander shares was delivered to the executive vice presidents: Deferred conditional variable remuneration plan (2013) Deferred conditional variable remuneration plan (2014) Deferred conditional variable remuneration plan (2015) 2018 2017 - 226,766 248,963 318,690 261,109 349,725 Deferred conditional variable remuneration plan and linked to objectives (2016) 258,350 - As indicated in Note 5.c above, the senior managers participate in the defned beneft system created in 2012, which covers the contingencies of retirement, disability and death. The Bank makes annual contributions to the beneft plans of its senior managers. In 2012, the contracts of the senior managers with defned beneft pension commitments were amended to transform them into a defned contribution system. The system, which is outsourced to Santander Seguros y Reaseguros, Compañía Aseguradora, S.A., gives senior managers the right to receive benefts upon retirement, regardless of whether or not they are active at the Bank at such time, based on contributions to the system, and replaced their previous right to receive a pension supplement in the event of retirement. In the event of pre-retirement, and up to the retirement date, senior managers appointed prior to September 2015 are entitled to receive an annual allowance. In addition, in application of the provisions of the remuneration regulations, from 2016 (inclusive), a discretionary pension beneft component of at least 15% of the total has been included in contributions to the pension system. Under the regime corresponding to these discretionary benefts, the contributions made that are calculated on variable remunerations are subject to malus and clawback clauses according to the policy in force at each moment and during the same period in which the variable remuneration is deferred. Likewise, the annual contributions calculated on variable remunerations must be invested in Bank shares for a period of fve years from the date of the cessation of senior management in the Group, whether or not as a result of retirement. After that period, the amount invested in shares will be invested together with the rest of the accumulated balance of the senior manager, or he will be paid to him or her benefciaries if there were any contingency covered by the forecasting system. The contracts of certain senior managers have gone through the changes set out in note 5.c. for executive directors. The changes, aiming at aligning the annual contributions with practices of comparable institutions and reducing future liabilities by eliminating the supplementary benefts scheme in the event of death (death of spouse or parent) and permanent disability of certain with no increase in total costs for the Bank, are the following: • Contributions of the pensionable bases have been reduced. Gross annual salaries have been increased in the corresponding amount with no increases in total costs for the Bank. 518 2018 Auditors’ report and consolidated annual accounts • The death and disability supplementary benefts have been eliminated since 1 January 2018. A fxed remuneration supplement (included in other remuneration in the table above) was implemented on the same date. i) Pre-retirement and retirement The following executive directors will be entitled to take pre- retirement in the event of termination, if they have not yet reached the age of retirement, on the terms indicated below: Ms. Ana Botín-Sanz de Sautuola y O’Shea will be entitled to take pre-retirement in the event of termination for reasons other than breach. In such case, she will be entitled to an annual emolument equivalent to her fxed remuneration plus 30% of the average of her latest amounts of variable remuneration, up to a maximum of three. This emolument would be reduced by up to 8% in the event of voluntary retirement before the age of 60. This assignment will be subject to malus and clawback conditions in efect for a period of 5 years. Mr. José Antonio Álvarez Álvarez will be entitled to take pre-retirement in the event of termination for reasons other than his own free will or breach. In such case, he will be entitled to an annual emolument equivalent to the fxed remuneration corresponding to him as executive vice president. This assignment will be subject to malus and clawback conditions in efect for a period of 5 years. j) Contract termination The executive directors and senior executives have indefnite-term employment contracts. Executive directors or senior executives whose contracts are terminated voluntarily or due to breach of duties are not entitled to receive any economic compensation. If the Bank terminates the contract for any other reason, they will be entitled to the corresponding legally-stipulated termination beneft, without prejudice to the compensation that corresponds to the non-competition obligations, as detailed in the remuneration policy of the directors. If the Bank were to terminate her contract, Ms. Ana Botín-Sanz de Sautuola y O’Shea would have to remain at the Bank’s disposal for a period of four months in order to ensure an adequate transition, and would receive her fxed salary during that period. Other non-director members of the Group’s senior management, other than those whose contracts were amended in 2012 as indicated above, have contracts which entitle them, in certain circumstances, to an extraordinary contribution to their welfare system in the event of termination for reasons other than voluntary redundancy, retirement, disability or serious breach of duties. These benefts are recognised as a provision for pensions and similar obligations and as a staf cost only when the employment relationship between the Bank and its executives is terminated before the normal retirement date. • The sum insured for the life and accident insurance has been increased. All the above without an increase in total cost for the Bank. The balance as of 31 December, 2018 in the pension system for those who were part of senior management during the year amounted to EUR: 66.5 million (EUR: 118.7 million in 31 December, 2017). The net charge to income corresponding to pension and supplementary benefts for widows, orphans and permanent invalidity amounted to EUR 6.4 million in 2018 (EUR: 14.5 in 31 December, 2017). In 2018 and 2017 there is no payments in the form of a single payment of the annual voluntary pre-retirement allowance. Additionally, the capital insured by life and accident insurance at 31 December, 2018 of this group amounts to EUR 133.3 million (EUR: 53.6 million at 31 December, 2017). h) Post-employment benefts to former Directors and former executive vice presidents The post-employment benefts and settlements paid in 2018 to former directors of the Bank, other than those detailed in note 5.c amounted to EUR 13.8 million (2017: EUR 26.2 million). Also, the post-employment benefts and settlements paid in 2018 to former executive vice presidents amounted to EUR 63 million (2017: EUR 17.7 million). Contributions to insurance policies that hedge pensions and complementary widowhood, orphanhood and permanent disability benefts to previous members of the Bank’s Management Board, amounted to EUR 0.5 million in 2018 (EUR 0.5 million in 2017). Likewise, contributions to insurance policies that hedge pensions and complementary widowhood, orphanhood and permanent disability benefts for previous managing directors amounted to EUR 5.4 million in 2018 (EUR 5.5 million in 2017). In 2018 a period provision of EUR 0.08 million (release of EUR 0.5 million in 2017) was recognised in the consolidated income statement in connection with the Group’s pension and similar obligations to former directors of the Bank (including insurance premiums for supplementary surviving spouse/child and permanent disability benefts), and no period provision was recognised in relation to former executive vice presidents (2017: a period provision of EUR 5.6 million was recognised). In addition, Provisions – Pension Fund and similar obligations in the consolidated balance sheet as at 31 December, 2018 included EUR 70.2 million in respect of the post-employment beneft obligations to former Directors of the Bank (31 December, 2017: EUR 81.8 million) and EUR 179 million corresponding to former executive vice presidents (2017: EUR 195.8 million). 519 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix k) Information on investments held by the directors in other companies and conficts of interest None of the members of the board of directors or persons related to them perform, as independent professionals or as employees, activities that involve efective competition, be it present or potential, with the activities of Banco Santander, S.A., or that, in any other way, place the directors in an ongoing confict with the interests of Banco Santander, S.A. Without prejudice to the foregoing, following is a detail of the declarations by the directors with respect to their equity interests in companies not related to the Group whose object is banking, fnancing or lending; and of the management or governing functions, if any, that the directors discharge thereat. Administrator Ms. Ana Botín-Sanz de Sautuola y O’Shea Mr. Bruce Neil Carnegie-Brown Denomination Bankinter, S.A.1 Moneysupermarket.com Group plc Lloyd’s of London Ltd Mr. Rodrigo Echenique Gordillo Mitsubishi UFJ Financial Group1 Number of shares Functions 5,000,000 - 30,000 - 17,500 President2 President2 - - Mr. Guillermo de la Dehesa Romero Goldman, Sachs & Co. (The Goldman Sachs Group, Inc.) 19,546 Mr. Javier Botín-Sanz de Sautuola y O’Shea Bankinter, S.A. JB Capital Markets Sociedad de Valores, S.A. Ms. Esther Giménez-Salinas i Colomer Gawa Capital Partners, S.L. Mr. Ramiro Mato García-Ansorena BNP Paribas España, S.A. 6,929,853 2,077,198 - President - Manager ofcer2 13,806 - committees or in Group companies or related to them; on 30 occasions it was about retributive aspects or the granting of loans or credits; on 1 occasion when investment or fnancing proposals or other risk operations were discussed in favour of companies related to diferent directors and on 3 occasions the abstention occurred in relation to the annual verifcation of the directors’ nature. 1. Indirect ownership. 2. Non-executive. With regard to situations of confict of interest, as stipulated in Article 40 of the rules and regulations of the Board, the directors must notify the board of any direct or indirect confict with the interests of the Bank in which they or persons related thereto may be involved. The director involved shall refrain from taking part in discussions or voting on any resolutions or decisions in which the director or any persons related thereto may have a confict of interest. Accordingly, the related party transactions carried out during the fnancial year met the conditions established in the regulations of the board of directors so as not to require a prior favourable report from the audit committee and subsequent authorisation from the board of directors. In addition, during the 2018 fnancial year there were 60 occasions in which, in accordance with the provisions of article 36.1 (b) (iii) of the Regulations of the Board, the directors have abstained from intervening and voting in the deliberation of matters in the sessions of the board of directors or its committees. The breakdown of the 60 cases is as follows: on 26 occasions they were due to proposals for the appointment, re-election or resignation of directors, as well as the appointment of members of board 520 2018 Auditors’ report and consolidated annual accounts 6. Loans and advances to central banks and credit institutions The detail, by classifcation, type and currency, of Loans and advances to central banks and credit institutions in the consolidated balance sheets is as follows: Million of euros CENTRAL BANKS Classifcation: Financial assets held for trading Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss Financial assets designated at fair value through other comprehensive income Financial assets at amortised cost Loans and receivables Type: Time deposits Reverse repurchase agreements Impaired assets Valuation adjustments for impairment CREDIT INSTITUTIONS Classifcation: Financial assets held for trading Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss Financial assets designated at fair value through other comprehensive income Financial assets at amortised cost Loans and receivables Type: Time deposits Reverse repurchase agreements Non-loans advances Impaired assets Valuation adjustments for impairment Currency: Euro Pound sterling US dollar Brazilian real Other currencies TOTAL * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 2018* 2017 2016 - - 9,226 - 15,601 24,827 15,601 9,226 - - - - 26,278 26,278 17,359 8,919 - - - - 27,973 27,973 14,445 13,528 - - 24,827 26,278 27,973 - 2 23,097 - 35,480 58,579 10,759 33,547 14,283 2 (12) 58,579 24,801 4,073 19,238 28,310 6,984 83,406 1,696 3,221 9,889 10,069 39,567 51,152 8,169 21,765 21,232 4 (18) 51,152 23,286 5,582 15,325 28,140 5,097 77,430 35,424 48,714 6,577 20,867 21,281 4 (15) 48,714 24,278 4,337 11,996 32,013 4,063 76,687 521 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The loans and advances classifed under Financial assets designated at fair value through proft or loss consist of assets of Spanish and foreign institutions acquired under reverse repurchase agreements. The loans and advances to credit institutions classifed under Financial assets at amortised cost (IFRS9) and Loans and receivables (IAS39) are mainly time accounts and deposits. Note 51 contains a detail of the residual maturity periods of Financial assets at amortised cost (IFRS9) and Loans and receivables (IAS39) and of the related average interest rates. At 31 December 2018 the exposure and the loan loss provision by impairment stage of assets accounted for under IFRS9 amounts to EUR 51,090 million and EUR 12 million in stage 1, EUR 1 million without loan loss provision in stage 2, and EUR 2 million without loan loss provision in stage 3. 7. Debt instruments a) Detail The detail, by classifcation, type and currency, of Debt instruments in the consolidated balance sheets is as follows: Million of euros Classifcation: Financial assets held for trading Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss Financial assets designated at fair value through other comprehensive income Financial assets available-for-sale Financial assets at amortised cost Loans and receivables Held-to-maturity investments Type: Spanish government debt securities** Foreign government debt securities Issued by fnancial institutions Other fxed-income securities Impaired fnancial assets Impairment losses Currency: Euro** Pound sterling US dollar Brazilian real Other currencies Total gross Impairment losses * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** The increase in 2017 corresponds mainly to Banco Popular acquisition. 522 2018* 2017 2016 27,800 5,587 3,222 116,819 37,696 191,124 50,488 99,959 10,574 29,868 870 (635) 191,124 76,513 19,153 22,864 40,871 32,358 191,759 (635) 191,124 36,351 48,922 3,485 3,398 128,481 111,287 17,543 13,491 199,351 59,186 99,424 12,155 28,299 1,017 (730) 199,351 93,250 16,203 25,191 39,233 26,204 200,081 (730) 199,351 13,237 14,468 191,312 45,696 103,070 16,874 25,397 773 (498) 191,312 73,791 16,106 31,401 43,370 27,142 191,810 (498) 191,312 2018 Auditors’ report and consolidated annual accounts At 31 December 2018 the exposure by impairment stage of the book assets under IFRS9 amounted to EUR 154,164 million in stage 1, EUR 117 million in stage 2, and EUR 870 million in stage 3, respectively. b) Breakdown The breakdown, by origin of the issuer, of Debt instruments at 31 December 2018, 2017 and 2016, net of impairment losses, is as follows: Million of euros 2018 2017 2016 Private fxed- income Public fxed- income Total % Private fxed- income Public fxed- income Total % Private fxed- income Public fxed- income Total % Spain 4,748 50,488 55,236 28.90% 5,272 59,186 64,458 32.33% 6,153 45,696 51,849 27.10% United Kingdom 5,615 9,512 15,127 7.91% 4,339 10,717 15,056 7.55% 3,531 11,910 15,441 8.07% Portugal 3,663 6,943 10,606 5.55% 3,972 7,892 11,864 5.95% 4,068 7,689 11,757 6.15% Italy* 857 3,134 3,991 2.09% Ireland** 4,543 2 4,545 2.38% 1,287 3,147 2 3,149 1.58% 7,171 8,458 4.24% 1,035 3,547 4,582 2.40% 518 707 - 518 0.27% 6,265 6,972 3.64% 683 10,489 11,172 5.85% 772 6,619 7,391 3.71% Poland Other European countries United States Brazil Mexico Chile Other American countries Rest of the world 6,101 1,518 7,619 3.99% 7,195 1,733 8,928 4.48% 7,203 1,736 8,939 4.67% 6,833 10,362 17,195 9.00% 7,986 11,670 19,656 9.86% 10,559 13,058 23,617 12.34% 5,285 36,583 41,868 21.91% 4,729 34,940 39,669 19.90% 5,364 39,770 45,134 23.59% 520 11,325 11,845 6.20% 79 2,729 2,808 1.47% 461 62 9,478 9,939 4.99% 587 10,628 11,215 5.86% 4,071 4,133 2.07% 1,315 3,643 4,958 2.59% 1,111 1,375 2,486 1.30% 755 913 1,668 0.84% 782 1,262 2,044 1.07% 639 5,987 6,626 3.47% 764 4,218 4,982 2.50% 724 3,562 4,286 2.24% 40,677 150,447 191,124 100% 40,741 158,610 199,351 100% 42,546 148,766 191,312 100% * Of the exposure in Italy, EUR 1,855 million corresponds to bonds sold in forward. ** Includes mainly UK securities issued by Irish vehicles with underlying risk UK. The detail, by issuer rating, of Debt instruments at 31 December 2018, 2017 and 2016 is as follows: Million of euros 2018 2017 2016 Private fxed- income Public fxed- income Total % Private fxed- income Public fxed- income Total % Private fxed- income Public fxed- income Total % 18,901 834 19,735 10.33% 16,239 924 17,163 8.61% 18,916 1,008 19,924 10.41% 2,715 20,966 23,681 12.39% 2,714 23,522 26,236 13.16% 1,632 29,639 31,271 16.35% 3,464 69,392 72,856 38.12% 4,373 8,037 12,410 6.23% 2,928 3,285 6,213 3.25% 5,093 21,837 26,930 14.09% 6,449 91,012 97,461 48.89% 7,579 66,955 74,534 38.96% AAA AA A BBB Below BBB 668 37,412 38,080 19.92% 2,393 35,109 37,502 18.81% 4,751 47,872 52,623 27.51% Unrated 9,836 6 9,842 5.15% 8,573 6 8,579 4.30% 6,740 7 6,747 3.53% 40,677 150,447 191,124 100% 40,741 158,610 199,351 100% 42,546 148,766 191,312 100% 523 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The distribution of the exposure by rating level of the previous table has been afected by the diferent ratings reviews of the sovereign issuers that have occurred in recent years. Thus, the principal changes in 2018 have been Spain and Poland which went from BBB+ to A-. Likewise, the main revisions during 2017 were Portugal that went from BB+ to BBB- and Chile from AA- to A+. During 2016 United Kingdom went from AAA to AA, Poland went from A to BBB, and Argentina that did not have a rating went to B-. The detail, by type of fnancial instrument, of Private fxed-income securities at 31 December 2018, 2017 and 2016, net of impairment losses, is as follows: Million of euros At 31 December 2018 the loan loss provision by impairment stage of the assets accounted for under IFRS9 amounted to EUR 30 million in stage 1, EUR 9 million in stage 2, and EUR 596 million in stage 3. 8. Equity instruments a) Breakdown The detail, by classifcation and type, of Equity instruments in the consolidated balance sheets is as follows: Million of euros 2018* 2017 2016 2018 2017 2016 Classifcation: Financial assets held for trading 8,938 21,353 14,497 Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss 3,260 933 546 Financial assets designated at fair value through other comprehensive income 2,671 Financial assets available-for-sale 4,790 5,487 1 4,869 27,076 20,530 Type: Shares of Spanish companies 3,448 4,199 3,098 Shares of foreign companies 9,107 20,448 15,342 Investment fund shares 2,314 2,429 2,090 1 4,869 27,076 20,530 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). Note 29 contains a detail of the Other comprehensive income, recognised in equity, on Financial assets designated at fair value through other comprehensive income (IFRS9) and Financial assets available-for-sale, and also the related impairment losses (IAS39). Securitised mortgage bonds 2,942 2,458 1,584 Other asset-backed bonds 9,805 5,992 2,803 Floating rate debt Fixed rate debt Total 13,721 13,756 11,818 1 4,209 18,535 26,341 40,677 40,741 42,546 c) Impairment losses The changes in the impairment losses on Debt instruments are summarised below: Million of euros Balance at beginning of year Net impairment losses for the year** Of which: Impairment losses charged to income Impairment losses reversed with a credit to income Exchange diferences and other items Balance at end of year Of which: 2018* 704 2017 498 2016 291 43 348 380 138 386 423 (95) (38) (43) (112) 635 (116) 730 (172) 498 By geographical location of risk: European Union Latin America 22 613 30 700 40 458 ** Of which: Loans and advances Financial assets at amortised cost Financial assets available for sale Financial assets designated at fair value through other comprehensive income 348 405 - (25) 43 - * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 524 2018 Auditors’ report and consolidated annual accountsb) Changes The changes in Financial assets at fair value through other comprehensive income (IFRS9), and Financial assets available-for- sale (IAS39) were as follows: 9. Trading Derivatives (assets and liabilities) and short positions Million of euros Balance at beginning of the year Net additions (disposals) Of which: Visa Europe, Ltd. Valuation adjustment and other items 2018* 2017 2016 3,169 (324) 5,487 4,849 (331) (294) - - (263) (174) (366) 932 Balance at end of year 2,671 4,790 5,487 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). Visa Europe, Ltd. On 21 June 2016 the Group disposed its Visa Europe, Ltd. stake, classifed as available for sale, obtaining a gain net of taxes of EUR 227 million (see Note 44 Gains or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net). c) Notifcations of acquisitions of investments The notifcations of the acquisitions and disposals of holdings in investees made by the Bank in 2018, in compliance with Article 155 of the Spanish Limited Liability Companies Law and Article 125 of Spanish Securities Market Law 24/1998, are listed in Appendix IV. a) Trading Derivatives The detail, by type of inherent risk, of the fair value of the trading derivatives arranged by the Group is as follows (see Note 11): Million of euros 2018 2017 2016 Debit Debit Credit balance balance balance Credit Credit balance balance balance Debit Interest rate risk Currency risk 36,087 36,487 38,030 37,582 47,884 48,124 16,912 17,025 16,320 18,014 21,087 23,500 Price risk 2,828 1,673 2,167 2,040 2,599 2,402 Other risks 112 156 726 256 473 343 55,939 55,341 57,243 57,892 72,043 74,369 b) Short positions Following is a breakdown of the short positions (liabilities): Million of euros Borrowed securities: Debt instruments Of which: Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México Santander UK plc Equity instruments Of which: 2018 2017 2016 1,213 2,447 2,250 1,213 - 1,087 890 1,557 1,671 930 1,319 1,142 991 103 Santander UK plc Banco Santander, S.A. - 1,500 987 98 Short sales: Debt instruments Of which: 12,702 16,861 19,613 Banco Santander, S.A. 5,336 8,621 7,472 Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México 26 46 Banco Santander (Brasil) S.A. 7,300 8,188 1,872 9,197 15,002 20,979 23,005 525 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 10. Loans and advances to customers Million of euros a) Detail The detail, by classifcation, of Loans and advances to customers in the consolidated balance sheets is as follows: Million of euros Financial assets held for trading** 202 8,815 9,504 2018* 2017 2016 Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss 1,881 Loan type and status: Commercial credit Secured loans 2018 2017 2016 33,301 29,287 23,894 4 78,068 473,936 454,677 Reverse repurchase agreements 32,310 18,864 16,609 Other term loans Finance leases 2 65,696 257,441 232,288 30,758 28,511 25,357 Receivable on demand 8,794 6,721 8,102 Credit cards receivables 23,083 21,809 21,363 21,915 20,475 17,596 Impaired assets 34,218 36,280 32,573 Financial assets at fair value through other comprehensive income 1,601 Financial assets at amortised cost 857,322 Loans and receivables 819,625 763,370 Of which: Impairment losses (23,307) (23,934) (24,393) 882,921 848,915 790,470 Geographical area: Spain 9 06,228 872,849 814,863 215,764 227,446 161,372 European Union (excluding Spain) 411,550 390,536 379,666 United States and Puerto Rico 89,325 75,777 87,318 Other OECD countries 82,607 74,463 74,157 Latin America (non-OECD) 87,406 88,302 93,207 Loans and advances to customers disregarding impairment losses 906,228 872,849 814,863 Rest of the world 19,576 16,325 19,143 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** The decrease refects the run-down of UK’s trading business due to the banking reform (Ring-fencing). Interest rate formula: Fixed rate Floating rate 9 06,228 872,849 814,863 4 97,365 447,788 417,448 4 08,863 425,061 397,415 9 06,228 872,849 814,863 Note 51 contains a detail of the residual maturity periods of fnancial assets at amortised cost (IFRS9) and loans and receivables (IAS39) and of the related average interest rates. Note 54 shows the Group’s total exposure, by origin of the issuer. There are no loans and advances to customers for material amounts without fxed maturity dates. b) Breakdown Following is a breakdown, by loan type and status, geographical area of residence and interest rate formula, of the loans and advances to customers of the Group, which refect the Group’s exposure to credit risk in its core business, disregarding impairment losses: At 31 December 2018, 2017 and 2016 the Group had granted loans amounting to EUR 13,615, 16,470 and 14,127 million to Spanish public sector agencies which had a rating at 31 December 2018 of A (ratings of BBB at 31 December 2017 and 2016), and EUR 10,952, 18,577 and 16,483 million to the public sector in other countries (at 31 December 2018, the breakdown of this amount by issuer rating was as follows: 13.8% AAA, 12.2% AA, 3.2% A, 58.3% BBB and 12.5% below BBB). Without considering the Public Administrations, the amount of the loans and advances at 31 December 2018 amounts to EUR 881,661 million, of which, EUR 847,443 million euros are classifed as non- performing. The above-mentioned ratings were obtained by converting the internal ratings awarded to customers by the Group (See Note 54) into the external ratings classifcation established by Standard & Poor’s, in order to make them more readily comparable. 526 2018 Auditors’ report and consolidated annual accountsFollowing is a detail, by activity, of the loans to customers at 31 December 2018, net of impairment losses: Million of euros Net exposure Loan-to-value ratio*** Secured loans Total Without collateral Of which: Of which: other property collateral collateral More than 40% and less than or equal to 60% More than 60% and less than or equal to 80% More than 80% and less than or equal to 100% Less than or equal to 40% Public sector 22,659 21,480 279 900 114 86 125 699 More than 100% 155 53,155 15,929 864 36,362 684 388 196 35,663 295 301,975 173,482 68,555 59,938 24,752 21,090 17,244 38,514 26,893 Other fnancial institutions (fnancial business activity) Non-fnancial corporations and individual entrepreneurs (non-fnancial business activity) (broken down by purpose) Of which: Construction and property development Civil engineering construction Large companies 156,666 104,023 18,949 33,694 24,641 3,248 1,884 1,803 20,855 525 1,902 920 8,300 138 5,766 6,224 306 6,671 4,208 157 2,126 368 1,899 476 6,657 19,022 14,527 SMEs and individual entrepreneurs Households – other (broken down by purpose) Of which: Residential Consumer loans Other purposes 117,420 65,772 28,226 23,422 10,548 7,889 6,222 16,998 9,991 487,695 115,997 321,119 50,579 83,889 104,266 103,496 46,296 33,751 314,017 1,682 311,513 822 77,643 97,815 98,240 32,361 6,276 156,116 109,810 17,562 4,505 2,387 7,219 43,919 5,838 3,406 2,840 4,709 1,742 3,225 2,031 8,766 26,200 5,169 1,275 Total* 865,484 326,888 390,817 147,779 109,439 125,830 121,061 121,172 61,094 Memorandum item Refnanced and restructured transactions** 30,527 6,278 14,032 10,217 3,328 3,422 3,210 3,541 10,748 * In addition, the Group has granted advances to customers amounting to EUR 17,437 million, bringing the total of loans and advances to EUR 882,921 million. ** Includes the net balance of the impairment of the accumulated value or accumulated losses in the fair value due to credit risk. *** The ratio is the carrying amount of the transactions at 31 December 2018 provided by the latest available appraisal value of the collateral. Note 54 contains information relating to the restructured/ refnanced loan book. Following is the movement of the gross exposure broken down by impairment stage of loans and advances to customers recognised under “Financial assets at amortised cost” and “Financial assets 527 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix at fair value through other comprehensive income” under IFRS9 during 2018: Million of euros Stage 1 Stage 2 Stage 3 Total 746,654 60,304 35,477 842,435 (31,234) 31,234 (3,980) 3,980 (13,998) 13,998 21,795 (21,795) 4,103 (4,103) 835 (835) - - - - - - Balance at beginning of the year* Impairment losses charged to income for the year Of which: Impairment losses charged to proft or loss Impairment losses reversed with a credit to proft or loss Change of perimeter Write-of of impaired balances against recorded impairment allowance Exchange diferences and other changes** Balance at end of the year Which correspond to: Impaired assets Other assets Of which: 2018 2017 2016 25,936 24,393 26,517 10,501 10,513 10,734 17,850 19,006 17,081 (7,349) - (8,493) - (6,347) (136) (12,673) (13,522) (12,758) (457) 23,307 2,550 23,934 36 24,393 14,906 8,401 16,207 7,727 15,331 9,062 Individually calculated Collective calculated 4,905 18,402 5,311 18,623 6,097 18,296 79,727 (5,265) (1,997) 72,465 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 - - (12,673) (12,673) January 2018 (Note 1.b). ** In 2017, mainly includes the balances from the acquisition of Banco (17,968) (2,400) (386) (20,754) Popular Español, S.A.U. Million of euros Balance at the beginning of year Movements Transfers Transfer to Stage 2 from Stage 1 Transfer to Stage 3 from Stage 1 Transfer to Stage 3 from Stage 2 Transfer to Stage 1 from Stage 2 Transfer to Stage 2 from Stage 3 Transfer to Stage 1 from Stage 3 Net changes on fnancial assets Write-ofs Exchange diferences and others Exposure as of 31 December 2018 795,829 52,183 33,461 881,473 At 31 December 2018, the Group had EUR 757 million (1 January 2018: EUR 803 million) in purchased credit-impaired assets, which relate mainly to the business combinations carried out by the Group. c) Impairment losses on loans and advances to customers at amortised cost and at fair value through other comprehensive income The changes in the impairment losses on the assets making up the balances of fnancial assets at amortised cost and at fair value through other comprehensive income - Loans and advances - Customers: 528 In addition, provisions for debt securities amounting to EUR 43 million (31 December 2017: EUR 348 million; 31 December 2016: EUR 405 million) and written-of assets recoveries have been recorded in the year amounting to EUR 1,558 million. (31 December 2017: EUR 1,620 million; 31 December 2016: EUR 1,582 million). With this, the impairment recorded in Financial assets at amortised cost amounts EUR 8,986 million (31 December 2017: EUR 9,241 million; 31 December 2016: EUR 9,557 million). Following is the movement of loan loss provision broken down by impairment stage of loans and advances to customers recognised under “Financial assets at amortised cost” under IFRS9 during 2018: Million of euros Loss allowance as of 1 January 2018 Transfers Transfer from Stage 2 to Stage 1 Transfer from Stage 3 to Stage 1 Transfer from Stage 3 to Stage 2 Transfer from Stage 1 to Stage 2 Transfer from Stage 2 to Stage 3 Transfer from Stage 1 to Stage 3 Net changes of the exposure and modifcations in the credit risk Write-ofs FX and other movements Carrying amount as of 31 December 2018 Stage 1 Stage 2 Stage 3 Total 4,350 5,079 16,507 25,936 (1,173) 3,854 2,681 (279) 1,264 985 (1,971) 4,529 2,558 438 (1,656) (1,218) 435 (1,264) (829) 84 (173) (89) 304 (961) 7,070 6,413 - - (12,673) (12,673) (66) (37) (354) (457) 3,658 4,743 14,906 23,307 2018 Auditors’ report and consolidated annual accountsd) Impaired assets and assets with unpaid past-due amounts The detail of the changes in the balance of the fnancial assets classifed as Financial assets at amortised cost – Customers (IFRS9) and Loans and receivables - Loans and advances to customers (IAS39) considered to be impaired due to credit risk is as follows: Million of euros 2018 2017 2016 Balance at beginning of year 36,280 32,573 36,133 Net additions 10,821 8,409 7,393 Written-of assets (12,673) (13,522) (12,758) Changes in the scope of consolidation Exchange diferences and other 177 (387) 9,618 (798) 661 1,144 Balance at end of year 34,218 36,280 32,573 This amount, after deducting the related allowances, represents the Group’s best estimate of the discounted value of the fows that are expected to be recovered from the impaired assets. At 31 December 2018, the Group’s written-of assets totalled EUR 47,751 million (31 December 2017: EUR 43,508 million; 31 December 2016: EUR 40,473 million). Following is a detail of the fnancial assets classifed as Financial assets at amortised cost (IFRS9) and Loans and receivables to costumers (IFRS39) and considered to be impaired due to credit risk at 31 December 2018, classifed by geographical location of risk and by age of the oldest past-due amount: Million of euros Spain European Union (excluding Spain) United States and Puerto Rico Other OECD countries Latin America (non-OECD) With no past-due balances or less than 90 days past due 5,671 2,940 1,906 1,414 1,221 13,152 780 1,213 531 498 1,145 4,167 With balances past due by 90 to 180 days 180 to 270 days 270 days to 1 year More than 1 year 551 577 30 143 782 656 519 31 162 561 8,724 2,662 178 520 803 Total 16,382 7,911 2,676 2,737 4,512 2,083 1,929 12,887 34,218 529 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix     The detail at 31 December 2017 is as follows: Million of euros Spain European Union (excluding Spain) United States and Puerto Rico Other OECD countries Latin America (non-OECD) The detail at 31 December 2016 is as follows: Million of euros Spain European Union (excluding Spain) United States and Puerto Rico Other OECD countries Latin America (non-OECD) With no past-due balances or less than 90 days past due 6,012 2,023 1,221 1,523 945 11,724 With no past-due balances or less than 90 days past due 4,845 2,648 805 1,601 1,242 11,141 Set forth below for each class of impaired asset are the gross amount, associated allowances and information relating to the collateral and/or other credit enhancements obtained at 31 December 2018: Million of euros Without associated real collateral With real estate collateral Gross Allowance recognised amount 13,250 16,228 (8,636) (4,408) With other collateral 4,740 (1,862) Total 34,218 (14,906) Estimated collateral value * - 11,653 1,913 13,566 * Including the estimated value of the collateral associated with each loan. Accordingly, any other cash fows that may be obtained, such as those arising from borrowers’ personal guarantees, are not included. 530 With balances past due by 90 to 180 days 180 to 270 days 270 days to 1 year More than 1 year 938 1,526 641 563 1,309 4,977 793 811 42 166 709 814 558 50 128 578 9,643 3,829 192 378 888 Total 18,200 8,747 2,146 2,758 4,429 2,521 2,128 14,930 36,280 With balances past due by 90 to 180 days 180 to 270 days 270 days to 1 year More than 1 year 508 1,783 833 481 1,059 4,664 360 877 38 145 1,131 2,551 625 654 61 158 677 2,175 7,009 3,262 242 474 1,055 12,042 Total 13,347 9,224 1,979 2,859 5,164 32,573 When classifying assets in the previous table, the main factors considered by the Group to determine whether an asset has become impaired are the existence of amounts past due -assets impaired due to arrears- or other circumstances may be arise which will not result in all contractual cash fow being recovered, such as a deterioration of the borrower’s fnancial situation, the worsening of its capacity to generate funds or difculties experienced by it in accessing credit. Past-due amounts receivable In addition, at 31 December 2018, there were assets with amounts receivable that were past due by 90 days or less, the detail of which, by age of the oldest past-due amount, is as follows: Million of euros Loans and advances to customers Of which Public Sector Total Less than 1 month 2,023 5 2,023 1 to 2 months 2 to 3 months 629 - 629 617 - 617 e) Securitisation Loans and advances to customers includes, inter alia, the securitised loans transferred to third parties on which the Group 2018 Auditors’ report and consolidated annual accounts         securitisations performed, and the balance shown as derecognised for those years relates to securitisations performed in prior years. The loans derecognised include assets of Santander Bank, National Association amounting to approximately EUR 35 million at 31 December 2018 (31 December 2017: EUR 113 million; 31 December 2016: EUR 324 million) that were sold, prior to this company’s inclusion in the Group, on the secondary market for multifamily loans, and over which control was transferred and substantially all the associated risks and rewards were not retained. The loans retained on the face of the balance sheet include the loans associated with securitisations in which the Group retains a subordinated debt and/or grants any manner of credit enhancements to the new holders. The loans transferred through securitisation are mainly mortgage loans, loans to companies and consumer loans. has retained the risks and rewards, albeit partially, and which therefore, in accordance with the applicable accounting standards, cannot be derecognised. The breakdown of the securitised loans, by type of original fnancial instrument, and of the securitised loans derecognised because the stipulated requirements were met (See Note 2.e) is shown below. Note 22 details the liabilities associated with these securitisation transactions. Million of euros Derecognised Of which 2018 2017 2016 47 241 477 Securitised mortgage assets* 47 241 477 Retained on the balance sheet 88,767 91,208 100,675 Of which Securitised mortgage assets 33,900 36,844 44,311 Of which: UK assets 13,519 15,694 20,969 Other securitised assets 54,867 54,364 56,364 Total 88,814 91,449 101,152 * Of which EUR 35 million correspond to the amount of Multifamily loans of Santander Bank, National Association. Securitisation is used as a tool for the management of regulatory capital and as a means of diversifying the Group’s liquidity sources. In 2018, 2017 and 2016 the Group did not derecognise any of the 11. Trading derivatives The detail of the notional amounts and the market values of the trading derivatives held by the Group in 2018, 2017 and 2016 is as follows: Million of euros Trading derivatives: Interest rate risk Forward rate agreements Interest rate swaps Options, futures and other derivatives Credit risk Credit default swaps Foreign currency risk 2018 2017 2016 Notional amount Market value Notional amount Market value Notional amount Market value 308,340 4,197,246 543,138 (1) 115 190,553 3,312,025 (514) 540,424 (15) 974 (511) 370,244 3,092,360 (64) 804 565,635 (980) 18,889 33 25,136 68 38,827 37 Foreign currency purchases and sales Foreign currency options Currency swaps Securities and commodities derivatives and other Total 275,449 54,215 334,524 59,932 5,791,733 301 2 (416) 1,078 598 236,805 43,488 295,753 70,325 4,714,509 (29) (37) (1,628) 529 (649) 259,336 36,965 321,316 76,523 1,102 112 (3,627) 290 4,761,206 (2,326) 531 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 12. Non-current assets 13. Investments The detail of Non-current assets held for sale in the consolidated balance sheets is as follows: a) Breakdown The detail, by company, of Investments is as follows: Million of euros Tangible assets Of which: Million of euros 2018 2017 2016 2018 2017 2016 5,424 11,661 5,743 Associated entities Project Quasar Investment 2017 S.L. 1,701 - - Foreclosed assets 5,334 11,566 5,640 Merlin Properties, SOCIMI, S.A. 1,358 1,242 1,168 Of which: property assets in Spain 4,488 10,533 4,902 Metrovacesa, S.A. 1,255 - - Other tangible assets held for sale Other assets* Total** 90 2 95 3,619 103 29 Testa Residencial, SOCIMI, S.A. Companies Zurich Santander 961 988 1,011 5,426 15,280 5,772 Allianz Popular, S.L. Companies Santander Insurance Other companies Joint Ventures entities Wizink Bank, S.A. - 431 392 511 651 438 358 520 307 - 325 431 6,609 4,197 3,242 - 1,017 - Unión de Créditos Inmobiliarios, S.A., EFC 202 207 177 Santander Generales Seguros y Reaseguros, S.A. y Santander Vida Seguros y Reaseguros, S.A. (former Aegon Santander Seguros) SAM Investment Holdings Limited* Other companies 163 186 - - 614 577 197 525 695 979 1,987 1,594 * SAM Investment Holdings Limited became part of the Group in 2017. Of the entities included above, at 31 December 2018, the entity Merlin Properties, SOCIMI, S.A, Metrovacesa S.A. and Compañía Española de Viviendas en Alquiler, S.A. are the only listed companies. * In 2017 include, mainly, Banco Popular Español, S.A.U. assets under the sale of the real estate business to Blackstone (see Note 3). ** In March 2018, the agreement for the operation of Popular’s real estate business with Blackstone has materialised (see Note 3). At 31 December 2018, the allowances recognised for the total non-current assets held for sale represented 49% (2017: 50% without considering the assets of Banco Popular Español, S.A.U. sold on March 2018 and 2016: 51%). The charges recorded in those years amounted to EUR 320 million, EUR 347 million and EUR 241 million, respectively, and the recoveries during these exercises are amounted to EUR 61 million, EUR 41 million and EUR 29 million, respectively. Without taking into consideration the Blackstone agreement already mentioned in Note 2, during 2018 the Group sold, for EUR 1,578 million, foreclosed assets with a gross carrying amount of EUR 2,190 million, for which provisions totalling EUR 736 million had been recognised. These sales gave rise to gains of EUR 124 million. In addition, other tangible assets were sold for EUR 117 million, giving rise to a gain of EUR 12 million. 532 2018 Auditors’ report and consolidated annual accounts b) Changes The changes in the investments were as followed: Million of euros Following is a summary of the fnancial information for 2018 on the main associates and joint ventures (obtained from the information available at the date of preparation of the fnancial statements): 2018* 6,150 2017 4,836 2016 3,251  Million of euros Balance at beginning of year Acquisitions (disposals) of companies and capital increases (reductions) Of which: Wizink Bank, S.A. Allianz Popular, S.L. Changes in the consolidation method (Note 3) Of which: Quasar Metrovacesa Efect of equity accounting Dividends paid and reimbursements of share premium Exchange diferences and other changes Balance at end of year (1,761) 1,893 (72) (1,033) - 1,017 438 - - 2,967 (582) 1,457 1,701 1,255 737 - - - - 704 444 (404) (376) (305) (101) 7,588 (291) 6,184 61 4,836 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). c) Impairment losses In 2018, 2017 and 2016 there was no evidence of material impairment on the Group’s investments. d) Other information Following is a summary of the fnancial information on the companies accounted for using the equity method (obtained from the information available at the date of preparation of the fnancial statements): Million of euros Total assets Total liabilities Net assets Group's share of net assets Goodwill Of which: Companies Zurich Santander Wizink Bank, S.A. Allianz Popular, S.L. Companies Santander Insurance Total Group share Total income Total proft Group's share of proft 2018 2017 2016 74,765 (58,153) 16,612 63,093 (51,242) 11,851 55,791 (45,623) 10,168 6,157 1,431 4,194 1,990 3,381 1,455 526 - 347 205 7,588 12,174 1,867 737 526 553 347 205 6,184 12,536 1,699 704 526 - - 205 4,836 11,766 984 444 Total assets Total liabilities Total income Total proft 21,934 20,324 4,301 334 12,105 11,701 351 7 Joint Ventures entities Of which: Unión de Créditos Inmobiliarios, S.A., EFC Santander Generales Seguros y Reaseguros, S.A. y Santander Vida Seguros y Reaseguros, S.A. (former Aegon Santander Seguros) Of which: Companies Santander Zurich Allianz Popular, S.L. Companies Santander Insurance Associated entities 52,831 37,829 7,873 132 84 122 15 1,533 402 113 13,805 12,915 4,143 3,238 3,028 113 2,276 1,899 822 77 Total 74,765 58,153 12,174 1,867 533 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix  14. Insurance contracts linked to pensions The detail of Insurance contracts linked to pensions in the consolidated balance sheets is as follows: Million of euros Assets relating to insurance contracts covering post-employment beneft plan obligations: Banco Santander, S.A. 2018 2017 2016 210 210 239 239 269 269 15. Liabilities and assets under insurance contracts and reinsurance assets The detail of Liabilities under insurance contracts and reinsurance assets in the consolidated balance sheets (See Note 2.j) is as follows: reinsurance Reinsurance Total (balance ceded payable) 2018 2017 2016 Direct insurance and reinsurance assumed Reinsurance ceded Total (balance payable) Direct insurance and reinsurance assumed Reinsurance ceded Total (balance payable) 52 227 140 87 397 20 69 765 (47) (163) (127) (36) (86) (9) (19) (324) 5 64 13 51 311 11 50 441 50 483 100 383 423 29 132 1.117 (41) (151) 9 332 (96) 4 (55) 328 (115) 308 (11) (23) (341) 18 109 776 Direct insurance and assumed 61 159 76 83 358 19 55 652 (46) (138) (76) (62) 15 21 - 21 (98) 260 (8) 11 (41) (331) 14 321 Million of euros Technical provisions for: Unearned premiums and unexpired risks Life insurance Unearned premiums and risks Mathematical provisions Claims outstanding Bonuses and rebates Other technical provisions 534 2018 Auditors’ report and consolidated annual accounts 16. Tangible assets a) Changes The changes in Tangible assets in the consolidated balance sheets were as follows: Million of euros For own use Leased out under an operating lease Investment property Total Cost: Balances at 1 January 2016 Additions / disposals (net) due to change in the scope of consolidation* Additions / disposals (net) Transfers, exchange diferences and other items Balances at 31 December 2016 Additions / disposals (net) due to change in the scope of consolidation Additions / disposals (net) Transfers, exchange diferences and other items Balances at 31 December 2017 Additions / disposals (net) due to change in the scope of consolidation Additions / disposals (net) Transfers, exchange diferences and other items Balances at 31 December 2018 Accumulated depreciation: Balances at 1 January 2016 Disposals due to change in the scope of Consolidation Disposals Charge for the year Transfers, exchange diferences and other items Balances at 31 December 2016 Disposals due to change in the scope of Consolidation Disposals Charge for the year Transfers, exchange diferences and other items Balances at 31 December 2017 Disposals due to change in the scope of consolidation Disposals Charge for the year Transfers, exchange diferences and other items Balances at 31 December 2018 17,442 (17) 763 (76) 18,112 1,740 781 (1,357) 19,276 34 589 (1,164) 18,735 14,921 287 2,380 650 18,238 205 2,445 (2,215) 18,673 44 5,545 825 25,087 (9,448) (3,376) 5 311 (1,079) - (10,211) - 478 (1,165) (22) (10,920) (12) 629 (1,159) 938 (10,524) (3) 457 - (2,247) (5,169) - 639 - (1,574) (6,104) (34) 413 - (2,679) (8,404) 7,345 39,708 (4,278) (64) 462 3,465 - (100) (223) 3,142 (630) (182) 48 2,378 (284) 121 29 (10) (53) (197) - 8 (25) 25 (189) - 17 (13) (14) (4,008) 3,079 1,036 39,815 1,945 3,126 (3,795) 41,091 (552) 5,952 (291) 46,200 (13,108) 123 797 (1,089) (2,300) (15,577) - 1,125 (1,190) (1,571) (17,213) (46) 1,059 (1,172) (1,755) (199) (19,127) 535 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendixMillion of euros Impairment losses: Balances at 1 January 2016 Impairment charge for the year Releases Disposals due to change in the scope of Consolidation Exchange diferences and other Balances at 31 December 2016 Impairment charge for the year Releases Disposals due to change in the scope of Consolidation Exchange diferences and other Balances at 31 December 2017 Impairment charge for the year Releases Disposals due to change in the scope of Consolidation Exchange diferences and other Balances at 31 December 2018 Tangible assets, net: Balances at 31 December 2016* Balances at 31 December 2017 Balances at 31 December 2018 For own use Leased out under an operating lease Investment property (1,076) (62) 60 309 17 (752) (21) 3 (1) 142 (629) (8) 5 - 16 Total (1,280) (117) 62 310 73 (952) (79) 7 (3) 123 (904) (94) 11 - 71 (159) (43) 1 - 42 (159) (42) - (2) 5 (198) (56) - - 15 (239) (616) (916) (45) (12) 1 1 14 (41) (16) 4 - (24) (77) (30) 6 - 40 (61) 7,860 8,279 8,150 12,910 12,371 16,444 2,516 2,324 1,563 23,286 22,974 26,157 * The decreases in 2016 in Tangible assets - Investment property was due to the separation and deconsolidation of Metrovacesa, S.A. (See Note 3). 536 2018 Auditors’ report and consolidated annual accounts Cost 5,713 5,225 6,963 211 18,112 5,892 5,608 7,213 563 19,276 6,127 5,605 6,686 317 18,735 Accumulated depreciation Impairment losses Carrying amount (1,967) (4,161) (4,023) (60) (10,211) (2,014) (4,422) (4,391) (93) (10,920) (2,056) (4,455) (3,946) (67) (10,524) (41) - - - (41) (77) - - - (77) (61) - - - (61) 3,705 1,064 2,940 151 7,860 3,801 1,186 2,822 470 8,279 4,010 1,150 2,740 250 8,150 b) Tangible assets for own use The detail, by class of asset, of Tangible assets - For own use in the consolidated balance sheets is as follows: Million of euros Land and buildings IT equipment and fxtures Furniture and vehicles Construction in progress and other items Balances at 31 December 2016 Land and buildings IT equipment and fxtures Furniture and vehicles Construction in progress and other items Balances at 31 December 2017 Land and buildings IT equipment and fxtures Furniture and vehicles Construction in progress and other items Balances at 31 December 2018 The carrying amount at 31 December 2018 in the foregoing table includes the following approximate amounts EUR 5,390 million (31 December 2017: EUR 5,455 million; 31 December 2016: EUR 5,906 million) relating to property, plant and equipment owned by Group entities and branches located abroad. c) Investment property The fair value of investment property at 31 December 2018 amounted to EUR 1,825 million (2017: EUR 2,435 million; 2016: EUR 2,583 million). A comparison of the fair value of investment property at 31 December 2018, with the net book value shows gross unrealised gains of EUR 262 million (2017: EUR 128 million and 2016: EUR 67 million), attributed completely to the group. The rental income earned from investment property and the direct costs related both to investment properties that generated rental income in 2018, 2017 and 2016 and to investment properties that did not generate rental income in those years are not material in the context of the consolidated fnancial statements. 537 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 17. Intangible assets – Goodwill The detail of goodwill, based on the cash-generating units giving rise thereto, is as follows: Million of euros Santander UK Banco Santander (Brasil) Santander Bank Polska Santander Consumer USA Santander Bank, National Association Santander Consumer Germany SAM Investment Holdings Limited Santander Portugal Santander España* Banco Santander - Chile Santander Consumer Nordics Grupo Financiero Santander (Mexico) Other companies Total goodwill 2018 8,307 4,459 2,402 2,102 1,793 1,217 1,173 1,040 1,023 627 502 434 387 2017 2016 8,375 8,679 4,988 2,473 2,007 1,712 1,217 1,173 5,769 2,342 3,182 1,948 1,217 - 1,040 1,040 648 676 518 413 529 371 704 537 449 486 25,466 25,769 26,724 * Includes mainly goodwill arising from purchases of Popular’s network and Wizink’s card business. The changes in goodwill were as follows: Million of euros Balance at beginning of year 25,769 26,724 26,960 2018 2017 2016 The Group has goodwill generated by cash-generating units located in non-euro currency countries (mainly the UK, Brazil, the United States, Poland, Chile, Norway, Sweden and Mexico) and, therefore, this gives rise to exchange diferences on the translation to euros, at closing rates, of the amounts of goodwill denominated in foreign currencies. Accordingly, in 2018 there was an increase in goodwill, mainly due to the purchase of the card businesses from Wizink Bank, S.A. (the increase in 2017 is due to the purchase of Banco Popular Español, S.A.U) and a decreased by EUR 556 million (EUR 1,704 and 185 million in 2017 y 2016) due to exchange diferences which, pursuant to current standards, were recognised with a debit to Other comprehensive income - Items that may be reclassifed to proft or loss - Exchange diferences in other comprehensive income in the consolidated statement of recognised income and expense (see Note 29.d). At least once per year (or whenever there is any indication of impairment), the Group reviews goodwill for impairment (i.e. a potential reduction in its recoverable value to below its carrying amount). The frst step that must be taken in order to perform this analysis is the identifcation of the cash-generating units, i.e. the Group’s smallest identifable groups of assets that generate cash infows that are largely independent of the cash infows from other assets or groups of assets. The amount to be recovered of each cash-generating unit is determined taking into consideration the carrying amount (including any fair value adjustment arising on the business combination) of all the assets and liabilities of all the independent legal entities composing the cash-generating unit, together with the related goodwill. The amount to be recovered of the cash-generating unit is compared with its recoverable amount in order to determine whether there is any impairment. Additions (Note 3) 383 1,644 - - - (50) - (2) The Group’s directors assess the existence of any indication that might be considered to be evidence of impairment of the cash-generating unit by reviewing information including the following: (i) certain macroeconomic variables that might afect its investments (population data, political situation, economic situation -including banking concentration level-, among others) and (ii) various microeconomic variables comparing the investments of the Group with the fnancial services industry of the country in which the cash-generating unit carries on most of its business activities (balance sheet composition, total funds under management, results, efciency ratio, capital adequacy ratio, return on equity, among others). Regardless of whether there is any indication of impairment, every year the Group calculates the recoverable amount of each cash-generating unit to which goodwill has been allocated and, to this end, it uses price quotations, if available, market references (multiples), internal estimates and appraisals performed by independent experts. Of which: SAM Investment Holdings Limited Santander España Impairment losses Of which: Santander Consumer USA Disposals or changes in scope of consolidation Exchange diferences and other items - 375 - - 1,173 248 (899) (799) (130) - (556) (1,700) (184) Balance at end of year 25,466 25,769 26,724 538 2018 Auditors’ report and consolidated annual accounts Firstly, the Group determines the recoverable amount by calculating the fair value of each cash-generating unit on the basis of the quoted price of the cash-generating units, if available, and of the Price Earnings Ratio of comparable local entities. In addition, the Group performs estimates of the recoverable amounts of certain cash-generating units by calculating their value in use using discounted cash fow projections. The main assumptions used in this calculation are: (i) earnings projections based on the fnancial budgets approved by the Group’s directors which cover between three and fve year period (unless a longer time horizon can be justifed), (ii) discount rates determined as the cost of capital taking into account the risk-free rate of return plus a risk premium in line with the market and the business in which the units operate and (iii) constant growth rates used in order to extrapolate earnings in perpetuity which do not exceed the long-term average growth rate for the market in which the cash- generating unit in question operates. The cash fow projections used by Group management to obtain the values in use are based on the fnancial budgets approved by both local management of the related local units and the Group’s directors. The Group’s budgetary estimation process is common for all the cash-generating units. The local management teams prepare their budgets using the following key assumptions: a) Microeconomic variables of the cash-generating unit: management takes into consideration the current balance sheet structure, the product mix on ofer and the business decisions taken by local management in this regard. b) Macroeconomic variables: growth is estimated on the basis of the changing environment, taking into consideration expected GDP growth in the unit’s geographical location and forecast trends in interest and exchange rates. These data, which are based on external information sources, are provided by the Group’s economic research service. Projected period Discount rate* Nominal perpetual growth rate 5 years 8.4% 2.5% 3 years 11.1% 1.5% 3 years 10.6% 3.8% 5 years 8.5% 2.5% 5 years 5 years 9.6% 9.6% 2.5% 2.0% 5 years 9.2% 2.5% Santander UK Santander Consumer USA Santander Bank, National Association Santander Consumer Germany SAM Investment Holdings Limited Santander Portugal Santander Consumer Nordics * Post-tax discount rate. Given the degree of uncertainty of these assumptions, the Group performs a sensitivity analysis thereof using reasonable changes in the key assumptions on which the recoverable amount of the cash-generating units is based in order to confrm whether their recoverable amount still exceeds their carrying amount. The sensitivity analysis involved adjusting the discount rate by +/- 50 basis points and the perpetuity growth rate by +/-50 basis points. Following the sensitivity analysis performed, the value in use of all the cash-generating units still exceeds their recoverable amount, albeit: • In the case of Santander Consumer USA, the Group recognised in 2017 a goodwill impairment amounting to EUR (799) million. The mentioned impairment was estimated considering the decrease in the entity’s proft in contrast with the forecasts carried out in the previous years, derived from a change in the long term business strategy. • As disclosed in note 1.h, the recent political events as c) Past performance variables: in addition, management takes into consideration in the projection the diference (both positive and negative) between the cash-generating unit’s past performance and that of the market. consequence of UK intention to leave the European Union are producing economic volatility that has unfavourably afected the assumptions included in the Santander UK value in use estimate. This value is close to the recoverable amount. Following is a detail of the main assumptions used in determining the recoverable amount, at 2018 year-end, of the most signifcant cash-generating units which were valued using the discounted cash fow method: The recoverable amount of Santander Bank Polska (former Bank Zachodni WBK S.A.), Banco Santander - Chile, Grupo Financiero Santander (México) and Banco Santander (Brasil) was calculated as the fair values of the aforementioned cash-generating units obtained from the market prices of their shares at year-end. This value exceeded the recoverable amount. Based on the above, and in accordance with the estimates, forecasts and sensibility analysis available for the managers of the Bank, during 2018 the Group has not recognised goodwill impairment losses within Impairment losses on other assets (net) - Goodwill and other intangible assets caption (EUR 899 and 50 million during 2017 and 2016, respectively). 539 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 18. Intangible assets - Other intangible assets The detail of Intangible assets - Other intangible assets in the consolidated balance sheets and of the changes therein in 2018, 2017, and 2016 is as follows: Estimated useful life 31 December 2017 Net additions and disposals Change in scope of consolidation Amortisation and impairment Application of amortisation and impairment Exchange diferences and other 31 December 2018 35 - 6,945 1,560 (5,386) (4,721) (665) (240) - - 1,468 1 - - - - - - - 1 12 (1) (1) - - - - (1,253) (1,153) (100) (117) (118) 1 2,914 1,469 12 (1,370) - 1 36 (1,102) (50) 1,035 985 50 117 - - - (178) (13) 173 147 26 86 - - 69 7,134 1,510 (5,432) (4,743) (689) (154) - - 3,094 Estimated useful life 31 December 2016 Net additions and disposals Change in scope of consolidation Amortisation and impairment Application of amortisation and impairment Exchange diferences and other 31 December 2017 39 - - 6,558 1,245 (4,848) (4,240) (608) (297) - 1,470 68 - - - - - 42 436 (64) (14) (50) - - 2,697 1,538 414 - - - (1,403) (1,310) (93) (174) (174) (1,577) - (4) 35 (679) (126) 694 627 67 111 - - (446) (63) 235 216 19 120 - (158) 6,945 1,560 (5,386) (4,721) (665) (240) - 2,914 IT developments 3-7 years Million of euros With indefnite useful life: Brand names With fnite useful life: Other Accumulated amortisation Development Other Impairment losses Of which: addition liberation Million of euros With indefnite useful life: Brand names With fnite useful life: IT developments 3-7 years Other Accumulated amortisation Development Other Impairment losses Of which: addition 540 2018 Auditors’ report and consolidated annual accounts Million of euros With indefnite useful life: Brand names With fnite useful life: IT developments 3-7 years Other Accumulated amortisation Development Other Impairment losses Of which: addition Estimated useful life 31 December 2015 Net additions and disposals Change in scope of Application of amortisation Amortisation consolidation and impairment and impairment Exchange diferences and other 31 December 2016 49 1 5,411 1,306 (3,873) (3,353) (520) (423) - 1,726 41 - - - - - - - (124) - - - - - - - - (1,275) (1,168) (107) (11) (11) 2,470 1,768 (124) (1,286) (11) - 39 (890) - 716 716 - 185 - - 311 22 (416) (435) 19 (48) - (131) 6,558 1,245 (4,848) (4,240) (608) (297) - 2,697 In 2018, 2017 and 2016, impairment losses of EUR 117, EUR 174 and EUR 11 million, respectively, were recognised under Impairment or reversal of impairment on non-fnancial assets, net – intangible assets. This impairment losses related mainly to the decline in or loss of the recoverable value of certain computer systems and applications as a result of the processes initiated by the Group to adapt to the various regulatory changes and to transform or integrate businesses. 19. Other assets The detail of Other assets is as follows: Million of euros Transactions in transit Net pension plan assets (Note 25) 2018 143 1,015 2017 2016 206 604 431 521 Prepayments and accrued income 3,089 2,326 2,232 Other 4,744 4,427 3,878 8,991 7,563 7,062 541 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 20. Deposits from central banks and credit institutions Note 51 contains a detail of the residual maturity periods of fnancial liabilities at amortised cost and of the related average interest rates. The detail, by classifcation, counterparty, type and currency, of Deposits from central banks and Deposits from credit institutions in the consolidated balance sheets is as follows: 21. Customer deposits 2018 2017 2016 The detail, by classifcation, geographical area and type, of Customer deposits is as follows: Million of euros CENTRAL BANKS Classifcation: Financial liabilities held for trading - 282 1,351 Financial liabilities designated at fair value through proft or loss 14,816 8,860 9,112 Financial liabilities at amortised cost Type: 72,523 71,414 44,112 87,339 80,556 54,575 Deposits on demand 5 5 5 Time deposits 82,797 78,801 46,278 Reverse repurchase agreements 4,537 1,750 8,292 87,339 80,556 54,575 Million of euros Classifcation: Financial liabilities held for trading* 2018 2017 2016 - 28,179 9,996 Financial liabilities designated at fair value through proft or loss. 39,597 28,945 23,345 Financial liabilities at amortised cost Geographical area: Spain 740,899 720,606 657,770 780,496 777,730 691,111 267,210 260,181 181,888 European Union (excluding Spain) 309,615 318,580 295,059 United States and Puerto Rico 53,843 50,771 63,429 Other OECD countries 67,462 62,980 62,761 Latin America (non-OECD) 82,343 84,752 87,519 CREDIT INSTITUTIONS Classifcation: Financial liabilities held for trading Financial liabilities designated at fair value through proft or loss Financial liabilities at amortised cost Type: - 292 44 Rest of the world 23 466 455 780,496 777,730 691,111 10,891 18,166 5,015 Type: 89,679 91,300 89,764 100,570 109,758 94,823 Demand deposits- Current accounts Savings accounts 346,345 328,217 279,494 196,493 189,845 180,611 Other demand deposits 5,873 7,010 7,156 Deposits on demand 6,154 6,444 4,220 Time deposits 53,421 54,159 61,321 Reverse repurchase agreements 40,873 49,049 29,277 Time deposits- Fixed-term deposits and other term deposits Subordinated deposits 122 106 5 Home-purchase savings accounts 100,570 109,758 94,823 Discount deposits 195,540 195,285 176,581 40 3 45 3 50 448 Currency: Euro Pound sterling US dollar Brazilian real Other currencies TOTAL 97,323 119,606 74,746 19,301 14,820 12,237 45,848 33,259 40,514 18,657 16,485 16,537 Hybrid fnancial liabilities 3,419 4,295 3,986 Subordinated liabilities 23 21 24 Repurchase agreements 32,760 53,009 42,761 780,496 777,730 691,111 * The decrease refects the run-down of UK’s trading business due to the 6,780 6,144 5,364 banking reform (Ring-fencing). 187,909 190,314 149,398 Note 51 contains a detail of the residual maturity periods of fnancial liabilities at amortised cost and of the related average interest rates. The increase in Deposits from central banks measured at amortised cost mainly relates to the Grupo Banco Popular acquisition in 2017 and the Group’s participation in the last years in the European Central Bank’s targeted longer-term refnancing operations (LTRO (Long-Term Refnancing Operation) and TLTROs (Targeted Long-Term Refnancing Operation)) which amounts to EUR 55,382 million at 31 December 2018. 542 2018 Auditors’ report and consolidated annual accounts 22. Marketable debt securities a) Breakdown The detail, by classifcation and type, of Marketable debt securities is as follows: Million of euros Classifcation: 2018 2017 2016 Financial liabilities held for trading - - - Financial liabilities designated at fair value through proft or loss Financial liabilities at amortised cost Type: Bonds and debentures outstanding Subordinated Notes and other securities 2,305 3,056 2,791 244,314 214,910 226,078 246,619 217,966 228,869 195,498 176,719 183,278 23,676 21,382 27,445 19,865 19,873 25,718 246,619 217,966 228,869 The breakdown of book value by maturity of the subordinated liabilities and Bonds and debentures outstanding at 31 December 2018: Million of euros Subordinated Liabilities Covered bonds Other bonds and debentures Total bonds and debentures outstanding Total bonds and debentures outstanding and subordinated liabilities Within 1 year 1 to 3 years 3 to 5 years 580 16,009 21,492 37,501 129 29,105 41,858 70,963 1,341 12,287 24,873 37,160 More than 5 years 21,626 28,035 21,839 Total 23,676 85,436 110,062 49,874 195,498 38,081 71,092 38,501 71,500 219,174 Note 51 contains a detail of the residual maturity periods of fnancial liabilities at amortised cost and of the related average interest rates in those years. b) Bonds and debentures outstanding The detail, by currency of issue, of Bonds and debentures outstanding is as follows: Currency of issue Euro US dollar Pound sterling Brazilian real Chilean peso Other currencies Balance at end of year Million of euros 2017 83,321 48,688 13,279 17,309 5,876 8,246 176,719 2018 85,479 62,021 16,616 15,778 6,460 9,144 195,498 31 December 2018 Outstanding issue amount in foreign currency (Million) Annual interest rate (%) 85,479 71,014 1.25% 3.14% 14,864 2.40% 70,117 5.53% 5,133,310 5.00% 2016 77,231 48,134 15,098 27,152 6,592 9,070 183,278 543 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The changes in Bonds and debentures outstanding were as follows: Million of euros Balance at beginning of year Net inclusion of entities in the Group Of which: Banco Santander, S.A. (Group Banco Popular) Banca PSA Italia S.P.A. PSA Bank Deutschland GmbH Issues Of which: Banco Santander (Brasil) S.A. Santander Consumer USA Holdings Inc. Grupo Santander UK Banco Santander, S.A. * Santander Consumer Finance, S.A. Banco Santander - Chile. Santander Consumer Bank A.S. Santander Holdings USA, Inc. PSA Banque France Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México Santander Consumer Bank AG PSA Financial Services Spain, EFC, SA SCF Rahoituspalvelut KIMI VI DAC Auto ABS French Lease Master Compartiment 2016 Banco Santander Totta, S.A. Redemptions and repurchases Of which: Banco Santander (Brasil) S.A. Santander Consumer USA Holdings Inc. Santander Group UK Banco Santander, S.A.* Santander Consumer Finance, S.A. Santander Consumer Bank AS Santander Holdings USA, Inc. Banca PSA Italia S.p.A. Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México Santander International Products, Plc. Banco Santander- Chile Banco Santander Totta, S.A. Santander Bank, National Association Exchange diferences and other movements Balance at year-end * As of 31 December 2017 and 2016, issuer entities were included. 544 2018 176,719 - - - - 2017 183,278 11,426 11,426 - - 2016 182,073 1,009 - 500 497 68,306 62,260 57,012 16,422 15,627 14,984 7,683 3,605 1,483 1,342 1,210 716 560 - - - - - 16,732 11,242 7,625 10,712 2,508 579 1,117 4,133 1,032 118 749 - 635 - 1,999 7,699 11,699 12,815 6,385 4,567 3,363 1,537 2,798 - 1,840 - 726 - 635 - (48,319) (66,871) (59,036) (14,802) (11,939) (6,800) (4,752) (2,366) (1,268) (903) (600) (579) (491) (204) (41) - (1,208) 195,498 (23,187) (10,264) (13,303) (9,956) (1,618) (337) (759) - (224) (310) (1,442) (998) (886) (13,374) 176,719 (7,579) (11,166) (13,163) (12,837) (4,117) (710) (1,786) - (1,453) (332) (516) (856) - 2,219 183,278 2018 Auditors’ report and consolidated annual accounts c) Notes and other securities These notes were issued basically by Santander Consumer Finance, S.A.; Santander UK plc; Banco Santander México, S.A. Institución de Banca Múltiple, Grupo Financiero Santander México and Banco Santander, S.A. The fair value of the guarantees received by the Group (fnancial and non-fnancial assets) which the Group is authorised to sell or pledge even if the owner of the guarantee has not defaulted is scantly material taking into account the Consolidated fnancial statements as a whole. d) Guarantees Set forth below is information on the liabilities secured by fnancial assets: Million of euros 2018 2017 2016 Asset-backed securities 38,140 32,505 38,825 Of which, mortgage- backed securities 5,197 4,034 8,561 Other mortgage securities 46,026 52,497 44,616 Of which: mortgage-backed bonds 22,023 23,907 16,965 Territorial covered bond 1,270 1,270 592 85,436 86,272 84,033 The main characteristics of the assets securing the aforementioned fnancial liabilities are as follows: 1. Asset-backed securities: a. Mortgage-backed securities- these securities are secured by securitised mortgage assets (see Note 10.e) with average maturities of more than ten years that must: be a frst mortgage for acquisition of principal or second residence, be current in payments, have a loan-to-value ratio below 80% and have a liability insurance policy in force covering at least the appraisal value. The value of the fnancial liabilities broken down in the foregoing table is lower than the balance of the assets securing them - securitised assets retained on the balance sheet - mainly because the Group repurchases a portion of the bonds issued, and in such cases they are not recognised on the liability side of the consolidated balance sheet. b. Other asset - backed securities - including asset-backed securities and notes issued by special-purpose vehicles secured mainly by mortgage loans that do not meet the foregoing requirements and other loans (mainly personal loans with average maturities of fve years and loans to SMEs with average maturities of seven years). 2. Other mortgage securities include mainly: (i) mortgage-backed bonds with average maturities of more than ten years that are secured by a portfolio of mortgage loans and credits (included in secured loans - see Note 10.b) which must: not be classifed as of procedural stage; have available appraisals performed by specialised entities; have a loan-to-value (LTV) ratio below 80% in the case of home loans and below 60% for loans for other assets and have sufcient liability insurance, (ii) other debt securities issued as part of the Group’s liquidity strategy in the UK, mainly covered bonds in the UK secured by mortgage loans and other assets. e) Spanish mortgage-market issues The members of the board of directors hereby state that the Group entities operating in the Spanish mortgage-market issues area have established and implemented specifc policies and procedures to cover all activities carried on and guarantee strict compliance with mortgage-market regulations applicable to these activities as provided for in Royal Decree 716/2009, of 24 April implementing certain provisions of Mortgage Market Law 2/1981, of 25 March, and, by application thereof, in Bank of Spain Circulars 7/2010 and 5/2011, and other fnancial and mortgage system regulations. Also, fnancial management defnes the Group entities’ funding strategy. The risk policies applicable to mortgage market transactions envisage maximum loan-to-value (LTV) ratios, and specifc policies are also in place adapted to each mortgage product, which occasionally require the application of stricter limits. The Bank’s general policies in this respect require the repayment capacity of each potential customer (the efort ratio in loan approval) to be analysed using specifc indicators that must be met. This analysis must determine whether each customer’s income is sufcient to meet the repayments of the loan requested. In addition, the analysis of each customer must include a conclusion on the stability over time of the customer’s income considered with respect to the life of the loan. The aforementioned indicator used to measure the repayment capacity (efort ratio) of each potential customer takes into account mainly the relationship between the potential debt and the income generated, considering on the one hand the monthly repayments of the loan requested and other transactions and, on the other, the monthly salary income and duly supported income. The Group entities have specialised document comparison procedures and tools for verifying customer information and solvency (see Note 54). The Group entities’ procedures envisage that each mortgage originated in the mortgage market must be individually valued by an appraisal company not related to the Group. In accordance with Article 5 of Mortgage Market Law 41/2007, any appraisal company approved by the Bank of Spain may issue valid appraisal reports. However, as permitted by this same article, the Group entities perform several checks and select, from among these companies, a small group with which they enter into cooperation agreements with special conditions and automated control mechanisms. The Group’s internal regulations specify, in detail, each of the internally approved companies, as well as the approval requirements and procedures and the controls established to uphold them. In this connection, the regulations establish the functions of an appraisal company committee on which the various areas of the Group related to these companies are represented. The aim of the committee is 545 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix to regulate and adapt the internal regulations and the activities of the appraisal companies to the current market and business situation (See note 2.i). Basically, the companies wishing to cooperate with the Group must have a signifcant level of activity in the mortgage market in the area in which they operate, they must pass a preliminary screening process based on criteria of independence, technical capacity and solvency -in order to ascertain the continuity of their business- and, lastly, they must pass a series of tests prior to obtaining defnitive approval. In order to comply in full with the legislation, any appraisal provided by the customer is reviewed, irrespective of which appraisal company issues it, to check that the requirements, procedures and methods used to prepare it are formally adapted to the valued asset pursuant to current legislation and that the values reported are customary in the market. The information required by Bank of Spain Circulars 7/2010 and 5/2011, by application of Royal Decree 716/2009, of April 24 is as follows: Million of euros 2018 2017 2016 Face value of the outstanding mortgage loans and credits that support the issuance of mortgage- backed and mortgage bonds pursuant to Royal Decree 716/2009 (excluding securitised bonds) Of which: Loans eligible to cover issues of mortgage-backed securities Transfers of assets retained on balance sheet: mortgage- backed certifcates and other securitised mortgage assets 85,610 91,094 56,871 60,195 59,422 38,426 15,807 18,202 19,509 Mortgage-backed bonds The mortgage-backed bonds (“cédulas hipotecarias”) issued by the Group entities are securities the principal and interest of which are specifcally secured by mortgages, there being no need for registration in the property register, by mortgage on all those that at any time are recorded in favour of the issuer and are not afected by the issuance of mortgage bonds and / or are subject to mortgage participations, and / or mortgage transfer certifcates, and, if they exist, by substitution assets eligible to be hedged and for the economic fows generated by derivative fnancial instruments linked to each issue, and without prejudice to the issuer’s unlimited liability. The mortgage bonds include the credit right of its holder against the issuing entity, guaranteeing in the manner provided for in the previous paragraph, and involve the execution to claim from the issuer the payment after due date. The holders of these securities are recognised as preferred creditors, singularly privileged, with the preference, included in number 3º of article 1,923 of the Spanish Civil Code against any other creditor, in relation with the entire group of loans and mortgage loans registered in favour of the issuer, except those that act as coverage for mortgage bonds and / or are subject to mortgage participations and / or mortgage transfer certifcates. In the event of insolvency, the holders of mortgage-backed bonds will enjoy the special privilege established in Article 90.1.1 of Insolvency Law 22/2003, of 9 July. Without prejudice to the foregoing, in accordance with Article 84.2.7 of the Insolvency Law, during the insolvency proceedings, the payments relating to the repayment of the principal and interest of the bonds issued and outstanding at the date of the insolvency fling will be settled up to the amount of the income received by the insolvent party from the mortgage loans and credits and, where appropriate, from the replacement assets backing the bonds and from the cash fows generated by the fnancial instruments associated with the issues (Final Provision 19 of the Insolvency Law). If, due to a timing mismatch, the income received by the insolvent party is insufcient to meet the payments described in the preceding paragraph, the insolvency managers must settle them by realising the replacement assets set aside to cover the issue and, if this is not sufcient, they must obtain fnancing to meet the mandated payments to the holders of the mortgage-backed bonds, and the fnance provider must be subrogated to the position of the bond-holders. In the event that the measure indicated in Article 155.3 of the Insolvency Law were to be adopted, the payments to all holders of the mortgage-backed bonds issued would be made on a pro-rata basis, irrespective of the issue dates of the bonds. The outstanding mortgage-backed bonds issued by the Group totalled EUR 22,023 million at 31 December 2018 (all of which were denominated in euros), of which EUR 21,523 million were issued by Banco Santander, S.A. and EUR 500 million were issued by Santander Consumer Finance, S.A. The issues outstanding at 31 December 2018 and 2017 are detailed in the separate fnancial statements of each of these companies. Mortgage-backed bond issuers have an early redemption option solely for the purpose of complying with the limits on the volume of outstanding mortgage-backed bonds stipulated by mortgage market regulations. None of the mortgage-backed bonds issued by the Group entities had replacement assets assigned to them. 546 2018 Auditors’ report and consolidated annual accounts 23. Subordinated liabilities a) Breakdown The detail, by currency of issue, of Subordinated liabilities in the consolidated balance sheets is as follows: Currency of issue Euro US dollar Pound sterling Brazilian real Other currencies Balance at end of year Of which, preference shares Of which, preference participations 31 December 2018 Outstanding issue amount in foreign currency (million) Annual interest rate (%) 14,001 8,946 562 - 3.89% 5.30% 8.92% - Million of euros 2017 11,240 8,008 874 131 1,257 21,510 404 8,369 2018 14,001 7,813 628 - 1,378 23,820 345 9,717 2016 8,044 9,349 949 136 1,424 19,902 413 6,916 Note 51 contains a detail of the residual maturity periods of subordinated liabilities at each year-end and of the related average interest rates in each year. b) Changes The changes in Subordinated liabilities in the last three years were as follows: Million of euros Balance at beginning of year Net inclusion of entities in the Group (Note 3) Of which: Banco Santander, S.A. (Grupo Banco Popular) Placements Of which: Banco Santander, S.A.* Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México Santander Bank Polska S.A. PSA Banque France Net redemptions and repurchases** Of which: Banco Santander, S.A.* Santander UK plc Santander Holdings USA, Inc. Santander Bank, National Association Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México Banco Santander (Brasil) S.A. Santander Consumer Finance, S.A. Exchange diferences and other movements Balance at end of year 2018 2017 2016 21,510 19,902 21,153 - 11 - - 3,283 11 2,994 - 2,395 2,750 2,894 2,328 281 235 - (1,259) (401) (313) (195) - - 78 (870) (453) (60) (72) 59 - - (2,812) (1,976) (51) - (163) (285) - (125) (62) - - - - - (716) (70) 286 23,820 (527) 21,510 (834) 19,902 * As of 31 December 2017 and 2016, issuer entities were included. ** The balance relating to issuances, redemptions and repurchases (EUR 2,024 million), together with the interest paid in remuneration of these issuances including PPCC (EUR 1,245 million), is included in the cash fow from fnancing activities. c) Other disclosures This item includes the preference shares (participaciones preferentes) and other fnancial instruments issued by the consolidated companies which, although equity for legal purposes, do not meet the requirements for classifcation as equity (preference shares). The preference shares do not carry any voting rights and are non- cumulative. They were subscribed to by non-Group third parties and, except for the shares of Santander UK plc referred to below, are redeemable at the discretion of the issuer, based on the terms and conditions of each issue. At 31 December 2018, Santander UK plc had a GBP 2,041 million subordinated issue which is convertible (having acquired the Group GBP 900 million), at Santander UK plc’s option, into preference shares of Santander UK plc, at a price of GBP 1 per share. For the purposes of payment priority, preference shares (participaciones preferentes) are junior to all general creditors and to subordinated deposits. The remuneration of these securities, which have no voting rights, is conditional upon the obtainment of sufcient distributable proft and upon the limits imposed by Spanish banking regulations on equity. The other issues are subordinated and, therefore, for the purposes of payment priority, they are junior to all general creditors of the issuers. At 31 December 2018, the following issues were convertible into Bank shares: On 5 March, 8 May and 2 September 2014, Banco Santander, S.A. announced that its executive committee had resolved to launch three issues of preference shares contingently convertible into newly issued ordinary shares of the Bank (“CCPSs”) for a nominal amount of EUR 1,500 million, USD 1,500 million and EUR 1,500 million, respectively. The interest on the CCPSs, payment of which is subject to certain conditions and is discretionary, was set at 6.25% per annum for the frst fve years (to be repriced thereafter by applying a 541 basis-point spread to the 5-year Mid-Swap Rate) for the March issue, at 6.375% per annum for the frst fve years (to be repriced thereafter by applying a 478.8 basis-point spread to the 5-year Mid-Swap Rate) for the May issue and at 6.25% per annum 547 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix On 20 April 2018, Santander Bank Polska S.A. carried out an issue of subordinated obligations for a term of ten years and with an option to amortize the ffth anniversary of the issue date, for an amount of EUR 1,000 million Polish zlotys. The issue accrues a foating interest of Wibor (6M) + 160 basic points payable semiannually. On 1 October 2018, Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México it issued a subordinated debt for a term of ten years for a nominal amount of 1,300 million US dollars and at an interest rate of 5.95%, the group having acquired 75% of the issue. The accrued interests from the subordinated liabilities during 2018 amounted to EUR 770 million (EUR 966 million and EUR 945 million during 2017 and 2016, respectively). Interests from the “CCPS” during 2018 amounted to EUR 560 million (EUR 395 million and EUR 334 million in 2017 and 2016, respectively). 24. Other fnancial liabilities The detail of Other fnancial liabilities in the consolidated balance sheets is as follows: Million of euros Trade payables Clearing houses Tax collection accounts: 2018 1,323 434 2017 1,559 767 2016 1,230 676 Public Institutions 3,968 3,212 2,790 Factoring accounts payable 263 290 180 Unsettled fnancial transactions 3,373 6,375 7,418 Other fnancial liabilities 15,303 16,225 14,222 24,664 28,428 26,516 Note 51 contains a detail of the residual maturity periods of other fnancial liabilities at each year-end. for the frst seven years (to be repriced every fve years thereafter by applying a 564 basis-point spread to the 5-year Mid-Swap Rate) for the September issue. On 25 March, 28 May, and 30 September 2014, the Bank of Spain confrmed that the CCPSs were eligible as Additional Tier 1 capital under the new European capital requirements of Regulation (EU) No 575/2013. The CCPSs are perpetual, although they may be redeemed early in certain circumstances and would convert into newly issued ordinary shares of Banco Santander if the Common Equity Tier 1 ratio of the Bank or its consolidated group fell below 5.125%, calculated in accordance with Regulation (EU) No 575/2013. The CCPSs are traded on the Global Exchange Market of the Irish Stock Exchange. Furthermore, on 29 January 2014 Banco Santander (Brasil) S.A. launched an issue of Tier 1 perpetual subordinated notes for a nominal amount of USD 1,248 million, of which the Group has acquired 89.6%. The notes are perpetual and would convert into ordinary shares of Banco Santander (Brasil) S.A. if the common equity Tier 1 ratio, calculated as established by the Central Bank of Brazil, were to fall below 5.125%. On 30 December 2016 Grupo Financiero Santander México, S.A.B. of C.V. made an issue of perpetual subordinated notes for a nominal amount of USD 500 million of which the Group has acquired 88.2%. Perpetual obligations are automatically converted into shares when the Regulatory Capital Index (CET1) is equal to or less than 5.125% at the conversion price. On 25 April, and 29 September 2017, Banco Santander, S.A. issued preferred shares contingently convertible in newly issued common shares of the Bank (the “CCPP”), for a nominal amount of 750 million euros, and 1,000 million euros, respectively. The remuneration of the CCPPs, whose payment is subject to certain conditions and is also discretionary, was fxed at 6.75% annually for the frst fve years (being reviewed thereafter by applying a margin of 680.3 basis points over the 5-year Mid-Swap Rate) for the issue paid out in April, and at 5.25% annually for the frst six years (reviewed thereafter by applying a margin of 499.9 basis points over the 5-year Mid-Swap Rate) for the issue paid out in September. On 8 February 2018, Banco Santander, S.A. carried out an issue of subordinated obligations for a term of ten years, amounting to EUR1,250 million. The issue accrues an annual interest of 2.125% payable annually. On 19 March, 2018, Banco Santander, S.A. carried out an issue of contingently convertible preferred shares in common shares of the newly issued Bank (the “PPCC”), for a nominal amount of EUR 1,500 million. The remuneration of the CCPPs, whose payment is subject to certain conditions and is also discretionary, was fxed at an annual 4.75%, payable quarterly, for the frst seven years (being revised thereafter applying a margin of 410 basis points over the type Mid-swap). 548 2018 Auditors’ report and consolidated annual accounts 25. Provisions a) Breakdown The detail of Provisions in the consolidated balance sheets is as follows: Million of euros Provision for pensions and other obligations post-employments Other long term employee benefts Provisions for taxes and other legal contingencies Provisions for contingent liabilities and commitments (Note 2) Other provisions Provisions b) Changes The changes in Provisions in the last three years were as follows: Million of euros 2018 5,558 1,239 3,174 779 2,475 13,225 2017 6,345 1,686 3,181 617 2,660 14,489 2016 6,576 1,712 2,994 459 2,718 14,459 2018 2017 2016 i p s e* s i t t i ln be m a i l g s nt of le n r - s t e e n h s b oa t pl e o e r r ot oy fn o f t e s m sp s s n nm n n n e m igm o oy o o io i e sno r s s s c ei l m i i i i v v v v p t ho ond o o m r on r re r r Pe Pt Pca Op r o f t i t l i l g s nt of e n r - s e t e n s h b o a t pl o e p e r r r ot oy o n f f e s s m n n oy o so l i l v p a t om o T s n o s c ei v o r r Pe Pt Pca Op o l p m e s vm vt o r re s e s i t t i ln be m a i l t f i t m s n n e igm o sno r ond on r h t i i i i i i i l s n a l p g s n t of e n r - e t e s h b o t p o e e r r r ot oy o f f s s s n n n oy o o so s l i ei l v v p a ho t o rm o r Pe Pt Pca Op T s e s i t t i ln be m a i l t f i t s m n n e gm o sno r c i vt ond on r o l p m e s i m i v o r r e n e m t i i i i i l a t o T 6,3 45 1 ,6 86 814 5,841 14,68 6 6,576 1,712 459 5,712 14,459 6,356 1,916 618 5,604 14,494 - - - (30 ) (3 0) 59 184 146 1,365 1,754 11 8 (4) 13 28 38 251 (49) 2,25 3 2,4 93 237 293 (49) 2,863 3,344 227 368 (40) 2,235 2,790 165 78 21 6 - - - - 18 6 84 175 82 (2 05) 7 (2 12) 224 227 (3) (49) 455 (504) 2,25 3 2,2 23 (20) 4,61 2 5,3 01 (2,359 ) (3,07 8) 2 (22) - - - - 198 88 (49) 606 2,863 3,058 3,855 4,727 (655) (992) (1,669) 170 73 (16) 24 (40) 31 8 329 377 (48) - - - - 201 81 (40) 2,235 2,508 226 3,024 3,651 (266) (789) (1,143) (7) (4 82) - - (3 32) (6 25) - (2) (3 68) - - - - - - - - - - - - - - - - - ( 7) (7) (48 2) 369 (95 7) (355) (498) - (260) ( 2) - (36 8) (273) - - - - - - - - - - - - (7) (3) 369 1,275 - - (853) (367) (603) (260) (20) - (1) (273) (852) - - - - - - - - - - - - - - - - (3) 1,275 (970) (20) (1) (852) (2) (2,149) (2,151) (3) (2,548 ) (2,55 1) - (3) (2,997) (3,000) - 23 6 264 264 - - - - - - - Balances at beginning of year Incorporation of Group companies, net Additions charged to income: Interest expense(Note 39) Staf costs (Note 47) Provisions or reversion of provisions Addition Release Other additions arising from insurance contracts linked to pensions Changes in value recognised in equity Payments to pensioners and pre- retirees with a charge to internal provisions Benefts paid due to settlements Insurance premiums paid Payments to external funds Amounts used Transfer, exchange diferences and other changes Balances at end of year 66 3 (73) 17 133 4 43 (1) (5) 64 (1,102) (1,044) (50) 23 (113) 9 (131) 5,5 58 ,239 1 779 5,6 49 13,225 6,345 1,686 617 5,841 14,489 6,576 1,712 459 5,712 14,459 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 549 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix c) Provision for pensions and other obligations post – employments and Other long term employee benefts The detail of Provisions for pensions and similar obligations is as follows: Million of euros Provisions for post-employment plans - Spanish entities Provisions for other similar obligations - Spanish entities 2018 2017 2016 3,930 4,274 4,701 1,189 1,643 1,664 Of which: pre-retirements 1,172 1,630 1,644 Provisions for post-employment plans – United Kingdom Provisions for post-employment plans - Other subsidiaries Provisions for other similar obligations - Other subsidiaries Provision for pensions and other obligations post –employments and Other long term employee benefts 130 323 306 1,498 1,748 1,569 50 43 48 6,797 8,031 8,288 Of which: defned benefts 6,791 8,026 8,277 i. Spanish entities - Post-employment plans and other similar obligations At 31 December 2018, 2017 and 2016, the Spanish entities had post-employment beneft obligations under defned contribution and defned beneft plans. In addition, in various years some of the consolidated entities ofered certain of their employees the possibility of taking pre-retirement and, therefore, provisions are recognised each year for the obligations to employees taking pre- retirement -in terms of salaries and other employee beneft costs- from the date of their pre-retirement to the agreed end date. In 2017, in parallel and simultaneously, Banco Santander and Banco Popular Español, S.A.U. reached an agreement with the workers’ representatives to implement a pre-retirement and incentivised retirement plan, which welcomed 1,715 employees during 2018, being the provision set up to cover these commitments of EUR 209 million. In 2017 and 2016 the provisions accounted for beneft plans and contribution commitments were EUR 248 and 361 million respectively. In October 2017, the Bank and the workers’ representatives reached an agreement for the elimination and compensation of certain passive rights arising from extra-covenant improvement agreements. The efect of the settlement of the mentioned commitments is shown in the tables included below in the “beneft paid for settlement” line. The expenses incurred by the Spanish companies in respect of contributions to defned contribution plans amounted to EUR 87 million in 2018 (2017: EUR 90 million; 2016: EUR 93 million). The amount of the defned beneft obligations was determined on the basis of the work performed by independent actuaries using the following actuarial techniques: 1. Valuation method: projected unit credit method, which sees each period of service as giving rise to an additional unit of beneft entitlement and measures each unit separately. 2. Actuarial assumptions used: unbiased and mutually compatible. Specifcally, the most signifcant actuarial assumptions used in the calculations were as follows: Post-employment plans Other similar obligations Annual discount rate 2018 1.55% 2017 1.40% and 1.38% B. Popular 2016 1.50% 2018 1.55% 2017 1.40% 2016 1.50% Mortality tables PERM/F-2000 PERM/F-2000 PERM/F-2000 PERM/F-2000 PERM/F-2000 PERM/F-2000 Cumulative annual CPI growth Annual salary increase rate Annual social security pension increase rate 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 2.00%* B. Popular 1.75% in 2018 and Rest B. Santander 1.25% 2.00%* N/A N/A N/A 1.00% 1.00% 1.00% N/A N/A N/A Annual beneft increase rate N/A N/A N/A From 0% to 1.50% From 0% to 1.50% From 0% to 1.50% * Corresponds to the Group’s defned-beneft obligations. 550 2018 Auditors’ report and consolidated annual accounts The discount rate used for the fows was determined by reference to high-quality corporate bonds (at least AA in euros) with terms consistent with those of the obligations. Any changes in the main assumptions could afect the calculation of the obligations. At 31 December 2018, if the discount rate used had been decreased or increased by 50 basis points, there would have been an increase or decrease in the present value of the post-employment obligations of +5.33% (-50 b.p) to -4.88% (+50 b.p.), respectively, and an increase or decrease in the present value of the long-term obligations of +1.11% (-50 b.p.) to -1.09% (+50 b.p.), respectively. These changes would be ofset in part by increases or decreases in the fair value of the assets and insurance contracts linked to pensions. 3. The estimated retirement age of each employee is the frst at which the employee is entitled to retire or the agreed-upon age, as appropriate. The fair value of insurance contracts was determined as the present value of the related payment obligations, taking into account the following assumptions: Expected rate of return on plan assets Expected rate of return on reimbursement rights Post-employment plans Other similar obligations 2018 2017 2016 2018 2017 2016 1.55% 1.40% 1.55% 1.40% 1.50% 1.50% 1.55% 1.40% N/A N/A N/A N/A The funding status of the defned beneft obligations in 2018 and the four preceding years is as follows: Million of euros Post-employment plans Other similar obligations 2018 2017 2016 2015 2014 2018 2017 2016 2015 2014 Present value of the obligations: To current employees Vested obligations to retired employees To pre-retirees employees Long-service bonuses and other benefts 60 138 50 48 62 5,332 5,662 4,423 4,551 4,708 - - - - - - - - - - Other 35 112 383 380 307 - - - - - - - - - - 1,187 1,647 1,644 1,801 2,220 17 - 13 - 13 - 12 - 13 4 Less - Fair value of plan assets 1,500 1,640 157 157 167 15 17 - - - Provisions - Provisions for pensions 3,927 4,272 4,699 4,822 4,910 1,189 1,643 1,657 1,813 2,237 5,427 5,912 4,856 4,979 5,077 1,204 1,660 1,657 1,813 2,237 Of which: Internal provisions for pensions 3,720 4,036 4,432 4,524 4,565 1,189 1,642 1,657 1,813 2,237 Insurance contracts linked to pensions (Note 14) Unrecognised net assets for pensions 210 238 269 299 345 (3) (2) (2) (1) - - - 1 - - - - - - - 551 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The amounts recognised in the consolidated income statements in relation to the aforementioned defned beneft obligations are as follows: Million of euros Current service cost Interest cost (net) Expected return on insurance contracts linked to pensions Provisions or reversion of provisions Actuarial (gains)/losses recognised in the year Past service cost Pre-retirement cost Other Post-employment plans Other similar obligations 2018 2017 2016 2018 2017 2016 18 73 (4) - 3 1 (4) 87 16 79 (4) - - - (2) 89 11 91 (5) - 6 6 (21) 88 1 18 - 7 5 208 - 239 1 21 - 13 - 248 - 283 1 27 - 6 - 355 (1) 388 In addition, in 2018 Other comprehensive income – Items not reclassifed to proft or loss – Actuarial gains or (-) losses on defned beneft pension plans decreased by EUR 65 million with respect to defned beneft obligations (increased 2017: EUR 41 million; increased 2016: EUR 141 million). The changes in the present value of the accrued defned beneft obligations were as follows: Million of euros Present value of the obligations at beginning of year Incorporation of Group companies, net Current service cost Interest cost Pre-retirement cost Efect of curtailment/settlement Benefts paid Benefts paid due to settlements Past service cost Actuarial (gains)/losses Demographic actuarial (gains)/losses Financial actuarial (gains)/losses Exchange diferences and other items Present value of the obligations at end of year Post-employment plans Other similar obligations 2018 5,912 (36) 18 99 1 (4) (423) - 3 (145) (21) (124) 2 5,427 2017 4,856 1,563 16 94 - (2) (388) (260) - 57 (7) 64 (24) 5,912 2016 4,979 - 11 95 6 (21) (353) - 6 136 15 121 (3) 4,856 2018 1,660 - 1 18 208 - (617) - 5 6 (3) 9 (77) 1,204 2017 1,657 202 1 21 248 - 2016 1,813 - 1 27 355 - (490) (570) - - 13 10 3 8 - - 6 (1) 7 25 1,660 1,657 552 2018 Auditors’ report and consolidated annual accounts The changes in the fair value of plan assets and of insurance contracts linked to pensions were as follows: Plan assets Million of euros Post-employment plans Other similar obligations Fair value of plan assets at beginning of year Incorporation of Group companies, net Expected return on plan assets Benefts paid Contributions/(surrenders) Actuarial gains/(losses) Exchange diferences and other items 2018 1,640 - 26 (115) 21 (73) 1 2017 157 1,507 15 (58) 3 24 (8) Fair value of plan assets at end of year 1,500 1,640 Insurance contracts linked to pensions Million of euros 2016 157 - 4 (8) 9 (2) (3) 157 2018 2017 2016 17 - - (2) - (1) 1 15 - 18 - (1) - - - 17 - - - - - - - - Fair value of insurance contracts linked to pensions at beginning of year Incorporation of Group companies, net Expected return on insurance contracts linked to pensions Benefts paid Paid premiums Actuarial gains/(losses) Fair value of insurance contracts linked to pensions at end of year Post-employment plans Other similar obligations 2018 2017 2016 2018 2017 2016 238 269 299 - 4 (27) 2 (7) 210 - 4 (29) 1 (7) 238 - 5 (32) - (3) 269 1 - - (1) - - - - 2 - (1) - - 1 - - - - - - - In view of the conversion of the defned-beneft obligations to defned-contribution obligations, the Group has not made material current contributions in Spain in 2018 to fund its defned-beneft pension obligations. The plan assets and the insurance contracts linked to pensions are instrumented mainly through insurance policies. ii. United Kingdom At the end of each of the last three years, the businesses in the United Kingdom had post-employment beneft obligations under defned contribution and defned beneft plans. The expenses incurred in respect of contributions to defned contribution plans amounted to EUR 93 million in 2018 (2017: EUR 82 million; 2016: EUR 81 million). The following table shows the estimated benefts payable at 31 December 2018 for the next ten years: Million of euros 2019 2020 2021 2022 2023 2024 to 2028 792 662 569 486 425 1,604 The amount of the defned beneft obligations was determined on the basis of the work performed by independent actuaries using the following actuarial techniques: 1. Valuation method: projected unit credit method, which sees each period of service as giving rise to an additional unit of beneft entitlement and measures each unit separately. 553 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 2. Actuarial assumptions used: unbiased and mutually compatible. Specifcally, the most signifcant actuarial assumptions used in the calculations were as follows: The amounts recognised in the consolidated income statements in relation to the aforementioned defned beneft obligations are as follows: 2018 2017 2016 Million of euros Annual discount rate 2.90% 2.49% 2.79% Mortality tables 108/86 S2 Light 108/86 S2 Light 116/98 S1 Light TMC Current service cost Interest cost (net) 2018 2017 2016 31 (6) 25 36 (6) 30 31 (22) 9 Cumulative annual CPI growth Annual salary increase rate Annual pension increase rate 3.22% 1.00% 2.94% 3.15% 1.00% 2.94% 3.12% 1.00% 2.92% The discount rate used for the fows was determined by reference to high-quality corporate bonds (at least AA in pounds sterling) that coincide with the terms of the obligations. Any changes in the main assumptions could afect the calculation of the obligations. At 31 December 2018, if the discount rate used had been decreased or increased by 50 basis points, there would have been an increase or decrease in the present value of the obligations of +9.80% (-50 b.p.) and -8.74% (+50 b.p.), respectively. If the infation assumption had been increased or decreased by 50 basis points, there would have been an increase or decrease in the present value of the obligations of +6.57% (+50 b.p.) and -6.31% (-50 b.p.), respectively. These changes would be ofset in part by increases or decreases in the fair value of the assets. The funding status of the defned beneft obligations in 2018 and the four preceding years is as follows: In addition, in 2018 Other comprehensive income – Items not reclassifed to proft or loss – Actuarial gains or (-) losses on defned beneft pension plans decreased by EUR 481 million with respect to defned beneft obligations (2017: increase of EUR 121 million; 2016: increase of EUR 621 million). The changes in the present value of the accrued defned beneft obligations were as follows: Million of euros Present value of the obligations at beginning of year Current service cost Interest cost Benefts paid Contributions made by employees Past service cost 2018 2017 2016 13,056 12,955 12,271 31 320 36 347 31 407 (489) (445) (332) 24 - 20 - 20 - Million of euros Present value of the obligations Less- 2018 2017 2016 2015 2014 Demographic actuarial (gains)/losses (21) (184) (59) Actuarial (gains)/losses (766) 602 2,315 12,079 13,056 12,955 12,271 11,959 Financial actuarial (gains)/losses (745) 786 2,374 Exchange diferences and other items (97) (459) (1,757) Present value of the obligations at end of year 12,079 13,056 12,955 Fair value of plan assets 12,887 13,239 13,118 12,880 12,108 Provisions - Provisions for pensions Of which: Internal provisions for pensions (808) (183) (163) (609) (149) The changes in the fair value of the plan assets were as follows: 130 323 306 150 256 Million of euros Net assets for pensions (938) (506) (469) (759) (405) Fair value of plan assets at beginning of year 2018 2017 2016 13,239 13,118 12,880 Expected return on plan assets 326 353 429 Benefts paid Contributions Actuarial gains/(losses) (489) (445) (332) 209 208 304 (285) 481 1,694 Exchange diferences and other items (113) (476) (1,857) Fair value of plan assets at end of year 12,887 13,239 13,118 554 2018 Auditors’ report and consolidated annual accounts In 2019 the Group expects to make current contributions to fund these obligations for amounts similar to those made in 2018. The main categories of plan assets as a percentage of total plan assets are as follows: Equity instruments Debt instruments Properties Other 2018 17% 50% 10% 23% 2017 20% 46% 13% 21% 2016 25% 49% 12% 14% The following table shows the estimated benefts payable at 31 December 2018 for the next ten years: Million of euros 2019 2020 2021 2022 2023 2024 to 2028 297 301 321 345 363 2,127 iii. Other foreign subsidiaries Certain of the consolidated foreign entities have acquired commitments to their employees similar to post-employment benefts. At 31 December 2018, 2017 and 2016, these entities had defned- contribution and defned-beneft post-employment beneft obligations. The expenses incurred in respect of contributions to defned contribution plans amounted to EUR 107 million in 2018 (2017: EUR 99 million; 2016: EUR 92 million). The actuarial assumptions used by these entities (discount rates, mortality tables and cumulative annual CPI growth) are consistent with the economic and social conditions prevailing in the countries in which they are located. Specifcally, the discount rate used for the fows was determined by reference to high-quality corporate bonds, except in the case of Brazil where there is no extensive corporate bond market and, accordingly the discount rate was determined by reference to the series B bonds issued by the Brazilian National Treasury Secretariat for a term coinciding with that of the obligations. In Brazil the discount rate used was between 9.11% and 9.26%, the CPI 4% and the mortality table the AT-2000. Any changes in the main assumptions could afect the calculation of the obligations. At 31 December 2018, if the discount rate used had been decreased or increased by 50 basis points, there would have been an increase or decrease in the present value of the obligations of +5.25% (-50 b.p.) and -4.80% (+50 b.p.), respectively. These changes would be ofset in part by increases or decreases in the fair value of the assets. The funding status of the obligations similar to post-employment benefts and other long-term benefts in 2018 and the four preceding years is as follows: Million of euros Present value of the obligations Less- Of which: with a charge to the participants Fair value of plan assets Provisions - Provisions for pensions Of which: Internal provisions for pensions Net assets for pensions Unrecognised net assets for pensions 2018 9,116 167 7,743 1,206 1,541 (77) (258) Of which: business in Brazil 6,649 167 6,046 436 756 (62) (258) 2017 9,534 193 7,927 1,414 1,787 (98) (275) 2016 9,876 153 8,445 1,278 1,613 (52) (283) 2015 8,337 133 7,008 1,196 1,478 (28) (254) 2014 10,324 151 8,458 1,715 1,999 (8) (276) 555 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The amounts recognised in the consolidated income statements in relation to these obligations are as follows: The changes in the present value of the accrued obligations were as follows: Million of euros Million of euros Present value of the obligations at beginning of year Incorporation of Group companies, net Current service cost Interest cost Pre-retirement cost 2018 2017 2016 9,534 9,876 8,337 36 34 646 (6) 165 35 807 - 171 38 802 (9) (37) Efect of curtailment/settlement (199) (19) Benefts paid (634) (716) (690) Benefts paid due to settlements Contributions made by employees Past service cost Actuarial (gains)/losses Demographic actuarial (gains)/losses Financial actuarial (gains)/losses - 5 3 390 (59) 449 (24) (1,352) 6 3 8 18 404 1,269 (140) 544 439 830 Exchange diferences and other items (693) (1,003) 1,321 Present value of the obligations at end of year 9,116 9,534 9,876 The changes in the fair value of the plan assets were as follows: Million of euros Fair value of plan assets at beginning of year Incorporation of Group companies, net Expected return on plan assets Benefts paid 2018 2017 2016 7,927 8,445 7,008 - 573 166 732 154 732 (602) (683) (637) Benefts paid due to settlements - (24) (1,328) Contributions Actuarial gains/(losses) 199 308 94 203 559 687 Exchange diferences and other items (662) (1,006) 1,270 Fair value of plan assets at end of year 7,743 7,927 8,445 In 2019 the Group expects to make contributions to fund these obligations for amounts similar to those made in 2018. Current service cost Interest cost (net) Provisions or reversion of provisions Actuarial (gains)/losses recognised in the year Past service cost Pre-retirement cost Other 2018 2017 2016 34 101 5 3 (6) (203) (66) 35 104 1 3 - (19) 124 38 105 (9) 18 (9) (37) 106 In addition, in 2018 Other comprehensive income – Items not reclassifed to proft or loss – Actuarial gains or (-) losses on defned beneft pension plans increased by EUR 64 million with respect to defned beneft obligations (increased EUR 207 million and increased EUR 513 million in 2017 and 2016, respectively). In December 2011, the fnancial entities of Portugal, including Banco Santander Totta, S.A. made a partial transfer of the pension commitments to the Social Security. Consequently, Banco Santander Totta, S.A. carried out the transfer of the corresponding assets and liabilities and the current value of the net commitments of the fair value of the corresponding assets of the plan, as of 31 December 2011, under Provisions - Funds for pensions and similar obligations. In 2016, the collective bargaining agreement of the banking sector was approved, consolidating the sharing of responsibility for the pension commitments between the State and the banks. On the other hand, in 2016 the Group in Brazil updated the recognition of its obligations of certain health benefts in the terms stipulated in the regulation that develops them and that establishes the coverage of this beneft in equal proportion between the sponsor and partners. The efect of this liquidation, together with that of the businesses in Portugal, is shown in the following tables under the heading “benefts paid due to settlements”. In June 2018, the Group in Brazil reached an agreement with the labour unions to modify the scheme of contributions to certain health benefts, which implied a reduction in commitments amounting to 186 million euros, shown in the following tables under the heading “Efect to curtailment/settlement”. 556 2018 Auditors’ report and consolidated annual accounts The main categories of plan assets as a percentage of total plan assets are as follows: legal contingencies and Other provisions. The types of provision were determined by grouping together items of a similar nature: Equity instruments Debt instruments Properties Other 2018 7% 83% 1% 9% 2017 6% 84% 3% 7% 2016 7% 88% 1% 4% Million of euros Provisions for taxes Provisions for employment- related proceedings (Brazil) 2018 2017 2016 864 1,006 1,074 859 868 915 Provisions for other legal proceedings 1,451 1,307 1,005 Provision for customer remediation 652 885 685 The following table shows the estimated benefts payable at 31 December 2018 for the next ten years: Million of euros 2019 2020 2021 2022 2023 2024 to 2028 593 603 612 629 644 3,429 d) Provisions for taxes and other legal contingencies and Other provisions Provisions - Provisions for taxes and other legal contingencies and Provisions - Other provisions, which include, inter alia, provisions for restructuring costs and tax-related and non-tax-related proceedings, were estimated using prudent calculation procedures in keeping with the uncertainty inherent to the obligations covered. The defnitive date of the outfow of resources embodying economic benefts for the Group depends on each obligation. In certain cases, these obligations have no fxed settlement period and, in other cases, depend on the legal proceedings in progress. The detail, by geographical area, of Provisions for taxes and other legal contingencies and Other provisions is as follows: Million of euros Regulatory framework- related provisions Provision for restructuring Other 105 492 101 360 253 472 1,226 1,314 1,308 5,649 5,841 5,712 Relevant information is set forth below in relation to each type of provision shown in the preceding table: The provisions for taxes include provisions for tax-related proceedings. The provisions for employment-related proceedings (Brazil) relate to claims fled by trade unions, associations, the prosecutor’s ofce and ex-employees claiming employment rights to which, in their view, they are entitled, particularly the payment of overtime and other employment rights, including litigation concerning retirement benefts. The number and nature of these proceedings, which are common for banks in Brazil, justify the classifcation of these provisions in a separate category or as a separate type from the rest. The Group calculates the provisions associated with these claims in accordance with past experience of payments made in relation to claims for similar items. When claims do not fall within these categories, a case-by-case assessment is performed and the amount of the provision is calculated in accordance with the status of each proceeding and the risk assessment carried out by the legal advisers. 2018 2017 2016 Recognised by Spanish companies 1,647 1,666 1,148 Recognised by other EU companies 1,044 1,127 1,300 Recognised by other companies 2,958 3,048 3,264 The provisions for other legal proceedings include provisions for court, arbitration or administrative proceedings (other than those included in other categories or types of provisions disclosed separately) brought against Santander Group companies. Of which: Brazil 2,496 2,504 2,715 5,649 5,841 5,712 The provisions for customer remediation include mainly the estimated cost of payments to remedy errors relating to the sale of certain products in the UK and the estimated amount related Set forth below is the detail, by type of provision, of the balance at 31 December 2018, 2017 and 2016 of Provisions for taxes and other 557 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendixto the foor clauses of Banco Popular Español, S.A.U. To calculate the provision for customer remediation, the best estimate of the provision made by management is used, which is based on the estimated number of claims to be received and, of these, the number that will be accepted, as well as the estimated average payment per case. The regulatory framework-related provisions include mainly the provisions relating to the FSCS (Financial Services Compensation Scheme), the Bank Levy in the UK and in Poland the provision related to the Banking Tax. The provisions for restructuring include only the costs arising from restructuring processes carried out by the various Group companies. Qualitative information on the main litigation is provided in Note 25.e to the consolidated fnancial statements. Our general policy is to record provisions for tax and legal proceedings in which we assess the chances of loss to be probable and we do not record provisions when the chances of loss are possible or remote. We determine the amounts to be provided for as our best estimate of the expenditure required to settle the corresponding claim based, among other factors, on a case-by- case analysis of the facts and the legal opinion of internal and external counsel or by considering the historical average amount of the loss incurred in claims of the same nature. The defnitive date of the outfow of resources embodying economic benefts for the Group depends on each obligation. In certain cases, the obligations do not have a fxed settlement term and, in others, they depend on legal proceedings in progress. The main movements during the 2018 of the breakdown provisions are shown below: Regarding the provisions arising from civil contingencies and legal nature, Brazil provides in the period EUR 359 million (2017: EUR 355 million, 2016: EUR 201 million) due to civil contingencies and EUR 288 million (2017: EUR 505 million, 2016: EUR 395 million) arising from employment related claims. This increase was partially ofset by the use of available provisions of which EUR 299 million (2017: EUR 388 million, 2016: EUR 284 million) were related to payments of employment-related claims and EUR 191 million (2017: EUR 203 million, 2016: EUR 239 million) due to civil contingencies. Regarding the provisions arising for customer remediation, EUR 16 million (2017: EUR 164 million, 2016: EUR 179 million) are released, and EUR 128 million (2017: EUR 106 million, 2016: EUR 173 million) are used in United Kingdom. On the other hand, in Banco Popular. S.A.U., an amount of EUR 119 million (2017: EUR 223 million) has been used in the year from foor clauses. Regarding the provisions constituted by regulatory framework, EUR 73 million have been charged (2017: EUR 106 million; 2016: EUR 173 million) and EUR 88 million have been used during 2018 (2017: EUR 151 million; 2016: EUR 169 million) in United Kingdom (Bank Levy and FSCS). In addition, EUR 100 million have been provisioned and paid in Poland. Regarding the provisions for restructuring process, a further provision of EUR 290 million (2017: EUR 425 million; 2016: EUR 244 million) was registered in Spain. This increase was partially ofset by the use of EUR 179 million (2017: EUR 162 million; 2016: EUR 206 million). e) Litigation and other matters i. Tax-related litigation At 31 December 2018 the main tax-related proceedings concerning the Group were as follows: • Legal actions fled by Banco Santander (Brasil) S.A. and certain Group companies in Brazil challenging the increase in the rate of Brazilian social contribution tax on net income from 9% to 15% stipulated by Interim Measure 413/2008, ratifed by Law 11.727/2008, a provision having been recognised for the amount of the estimated loss. Due to recent unfavourable decisions of the courts, the Group in Brazil has withdrawn their actions and paid the amount claimed, using the existing provision. • Legal actions fled by Banco Santander (Brasil) S.A. and other Group entities to avoid the application of Law 9.718/98, which modifes the basis to calculate PIS and COFINS social contribution, extending it to all the entities income, and not only to the income from the provision of services. In relation of Banco Santander (Brasil) S.A. process, in May 2015 the Federal Supreme Court (FSC) admitted the extraordinary appeal fled by the Federal Union regarding PIS, and dismissed the extraordinary appeal lodged by the Brazilian Public Prosecutor’s Ofce regarding COFINS contribution, confrming the decision of Federal Regional Court favourable to Banco Santander (Brasil) S.A.. The appeals fled by the other entities before the Federal Supreme Court, both for PIS and COFINS, are still pending. The risk is classifed as possible and there is a provision for the amount of the estimated loss. • Banco Santander (Brasil) S.A. and other Group companies in Brazil have appealed against the assessments issued by the Brazilian tax authorities questioning the deduction of loan losses in their income tax returns (IRPJ and CSLL) in relation to diferent administrative processes of the years 1998, 2001, 2005 and 2006 on the ground that the requirements under the applicable legislation were not met. The appeals are pending decision in CARF. No provision was recognised in connection with the amount considered to be a contingent liability. • Banco Santander (Brasil) S.A. and other Group companies in Brazil are involved in administrative and legal proceedings against several municipalities that demand payment of the Service Tax on certain items of income from transactions not classifed as provisions of services. There are several cases in diferent judicial instances. No provision was recognised in connection with the amount considered to be a contingent liability.” 558 2018 Auditors’ report and consolidated annual accounts • Banco Santander (Brasil) S.A. and other Group companies in Brazil are involved in administrative and legal proceedings against the tax authorities in connection with the taxation for social security purposes of certain items which are not considered to be employee remuneration. There are several cases in diferent judicial instances. A provision was recognised in connection with the amount of the estimated loss. • In May 2003 the Brazilian tax authorities issued separate infringement notices against Santander Distribuidora de Títulos e Valores Mobiliarios Ltda. (DTVM, currently Santander Brasil Tecnologia S.A.) and Banco Santander (Brasil) S.A. in relation to the Provisional Tax on Financial Movements (CPMF) of the years 2000, 2001 and part of 2002. In July 2015, after the unfavourable decision of CARF, both entities appealed at Federal Justice in a single proceeding. There is a provision recognised for the estimated loss. • In December 2010 the Brazilian tax authorities issued an infringement notice against Santander Seguros S.A. (Brazil), currently Zurich Santander Brasil Seguros e Previdência S.A., as the successor by merger to ABN AMRO Brasil dois Participações S.A., in relation to income tax (IRPJ and CSLL) for 2005, questioning the tax treatment applied to a sale of shares of Real Seguros, S.A. Actually it is appealed before the CARF. As the former parent of Santander Seguros S.A. (Brasil), Banco Santander (Brasil) S.A. is liable in the event of any adverse outcome of this proceeding. No provision was recognised in connection with this proceeding as it is considered to be a contingent liability. • In November 2014 the Brazilian tax authorities issued an infringement notice against Banco Santander (Brasil) S.A. in relation to corporate income tax (IRPJ and CSLL) for 2009 questioning the tax-deductibility of the amortization of the goodwill of Banco ABN AMRO Real S.A. performed prior to the absorption of this bank by Banco Santander (Brasil) S.A., but accepting the amortization performed after the merger. Actually it is appealed before the Higher Chamber of CARF. No provision was recognised in connection with this proceeding as it was considered to be a contingent liability. • Banco Santander (Brasil) S.A. has also appealed against infringement notices issued by the tax authorities questioning the tax deductibility of the amortization of the goodwill arising on the acquisition of Banco Comercial e de Investimento Sudameris S.A from years 2007 to 2012. No provision was recognised in connection with this matter as it was considered to be a contingent liability. • Banco Santander (Brazil) S.A. and other companies of the Group in Brazil are undergoing administrative and judicial procedures against Brazilian tax authorities for not admitting tax compensation with credits derived from other tax concepts, not having registered a provision for such amount since it is considered to be a contingent liability. • Banco Santander (Brasil) S.A. is involved in appeals in relation to infringement notices initiated by tax authorities regarding the ofsetting of tax losses in the CSLL (‘Social Contribution on Net Income’) of year 2009. The appeal is pending decision in CARF. A provision was recognised in connection with the amount of the estimated loss. • Legal action brought by Sovereign Bancorp, Inc. (currently Santander Holdings USA, Inc.) claiming its right to take a foreign tax credit for taxes paid outside the United States in fscal years 2003 to 2005 as well as the related issuance and fnancing costs. On 17 July 2018, the District Court fnally ruled against Santander Holdings USA, Inc. Final resolution is anticipated within the coming months, with no efect on income, as it is fully provisioned. • Banco Santander has appealed before European Courts the Decisions 2011/5/CE of 28 October 2009, and 2011/282/UE of 12 January 2011 of the European Commission, ruling that the deduction regulated pursuant to Article 12.5 of the Corporate Income Tax Law constituted illegal State aid. On November 2018 the General Court confrmed these Decisions but these judgements have been appealed at the Court of justice of the European Union. The Group has not recognised provisions for these suits since they are considered to be a contingent liability. At the date of approval of these consolidated fnancial statements certain other less signifcant tax-related proceedings were also in progress. ii. Non-tax-related proceedings At 31 December 2018, the main non-tax-related proceedings concerning the Group were as follows: • Payment Protection Insurance (PPI): claims associated with the sale by Santander UK plc of payment protection insurance or PPI to its customers. As of 31 December 2018, the remaining provision for PPI redress and related costs amounted to GBP 246 million (EUR 275 million) and GBP 356 million (EUR 406 million) as of 31 December 2017. This provision represents management’s best estimate of Santander UK plc future liability in respect of mis-selling of PPI policies and is based on recent claims experience and consideration of the FCA Consultation paper CP18/33 (Regular premium PPI complaints and recurring non- disclosure of commission – feedback on CP18/18, fnal guidance, and consultation on proposed mailing requirements) issued on 7 November 2018. It has been calculated using key assumptions such as the estimated number of customer complaints received, the number of rejected misselling claims that will be in scope for Plevin v Paragon Personal Finance Limited [2014] UKSC 61 redress, and the determination of liability with respect to a specifc portfolio of claims. The provision will be subject to continuous review, taking into account the impact of any further claims received and FCA guidance. • Delforca: dispute arising from equity swaps entered into by Gaesco (now Delforca 2008, S.A.) on shares of Inmobiliaria Colonial. The bank is claiming to Delforca a total of EUR 66 million from the liquidation of the swaps. Two arbitration proceedings were instigated before the Spanish Court of Arbitration with an outcome of two awards in favour of the Bank. However, these two arbitration awards were annulled for procedural issues. Mobiliaria Monesa (Delforca’s parent company) has commenced a civil proceeding against the Bank claiming damages which, as of date have not been determined. The proceeding has been stayed because the jurisdiction of the Court has been challenged. Within insolvency proceedings before the Commercial Court, both 559 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Delforca and Mobiliaria Monesa have instigated a claim against the Bank seeking the recovery of EUR 56.8 million that the Bank received from the liquidation of the swap. The Bank has not recognised any provisions in this connection. • Former employees of Banco do Estado de São Paulo S.A., Santander Banespa, Cia. de Arrendamiento Mercantil: the claim was fled in 1998 by the association of retired Banespa employees (AFABESP) requesting the payment of a half-yearly bonus envisaged in the entity’s Bylaws in the event that the entity obtained a proft and that the distribution of this proft were approved by the Board of Directors. The bonus was not paid in 1994 and 1995 since the bank did not make a proft and partial payments were made from 1996 to 2000, as agreed by the Board of Directors and the relevant clause was eliminated in 2001. The Regional and the High Employment Court ordered the bank to pay this half-yearly bonus since the event until nowadays. The Bank fled an appeal which awaits judgment before the Federal Supreme Court (STF). The Bank has not recognised any provisions in this connection. • “Planos Económicos”: like the rest of the banking system in Brasil, Santander Brasil has been the target of customer complaints and collective civil suits stemming from legislative changes and its application to bank deposits, fundamentally (‘economic plans’). At the end of 2017, there was an agreement between regulatory entities and the Brazilian Federation of Banks (Febraban), already homologated by the Supremo Tribunal Federal, with the purpose of closing the lawsuits. Discussions focused on specifying the amount to be paid to each afected client according to the balance in their notebook at the time of the Plan. Finally, the total value of the payments will depend on the number of endorsements they have made and the number of savers who have demonstrated the existence of the account and its balance on the date the indexes were changed. In November 2018, the STF ordered the suspension of all economic plan processes for two years from February 2018. The provisions recorded for the economic plan processes are considered sufcient. • CNMC: after an administrative investigation on several fnancial entities, including Banco Santander, S.A., in relation to possible collusive practices or price-fxing agreements, as well as exchange of commercially sensitive information in relation to fnancial derivative instruments used as hedge of interest rate risk for syndicated loans, on 13 February 2018, the Competition Directorate of the Spanish “National Commission for Antitrust and Markets” (CNMC) published its decision, by which it fned the Bank and another three fnancial institutions with EUR 91 million (EUR 23.9 million for the Bank) for ofering interest rate derivatives in breach of Articles 1 of the Spanish Act 15/2007 on Defence of Competition and 101 of the Treaty of Functioning of the European Union. According to the CNMC, there is evidence that there was coordination between the hedging banks/lenders to coordinate the price of the derivatives and ofer clients, in each case, a price diferent from the “market price”. This decision has been appealed before the Spanish National Court by the Bank, that has already paid the fne. • Floor clauses (“cláusulas suelo”): As a consequence of the acquisition of Banco Popular, S.A.U, the Group has been exposed to a material number of transactions with foor clauses. The so-called “foor clauses” or minimum clauses are those under which the borrower accepts a minimum interest rate to be paid to the lender, regardless of the applicable reference interest rate. Banco Popular Español, S.A.U. included “foor clauses” in certain asset transactions with customers. In relation to this type of clauses, and after several rulings made by the Court of Justice of the European Union and the Spanish Supreme Court, and the extrajudicial process established by the Spanish Royal Decree- Law 1/2017, of January 2, Banco Popular Español, S.A.U. made extraordinary provisions that were updated in order to cover the efect of the potential return of the excess interest charged for the application of the foor clauses between the contract date of the corresponding mortgage loans and May 2013. The Group considered that the maximum risk associated with the foor clauses applied in its contracts with consumers, in the most severe and not probable scenario, would amount to approximately EUR 900 million, as initially measured and without considering the returns performed. For this matter, after the purchase of Banco Popular Español, S.A.U., EUR 357 million provisions have been used by the Group (EUR 238 million in 2017 and EUR 119 million in 2018) mainly for refunds as a result of the extrajudicial process mentioned above. As of December 31, 2018, the amount of the Group’s provisions in relation to this matter amounts to EUR 104 million which covers the probable risk. • Banco Popular´s acquisition: considering the declaration setting out the resolution of Banco Popular Español, S.A.U., the redemption and conversion of its capital instruments and the subsequent transfer to Banco Santander, S.A. of the shares resulting from this conversion in exercise of the resolution instrument involving the sale of the institution’s business, in the application accordance with the single resolution framework regulation referred to in Note 3, some investors have fled claims against the EU’s Single Resolution Board decision, the FROB’s resolution executed in accordance to the aforementioned decision, and claims have been fled and may be fled in the future against Banco Popular Español, S.A.U., Banco Santander, S.A. or other Santander Group companies deriving from or related to the acquisition of Banco Popular Español, S.A.U. There are also criminal investigations in progress led by the Spanish National Court in connection with Banco Popular Español, S.A.U., although not with its acquisition. On 15 January 2019, the Spanish National Court, applying article 130.2 of the Spanish Criminal Code, declared the Bank the successor entity to Banco Popular Español, S.A.U. (following the merger of the Bank and Banco Popular Español, S.A.U.on 28 September 2018), and, as a result, determined that the Bank assumed the role of the party being investigated in the criminal proceeding. The Bank has resorted this decision. At this time it is not possible to foresee the total number of demands and additional claims that could be put forth by the former shareholders, nor their economic implications (particularly considering that the resolution decision in application of the new laws is unprecedented in Spain or any other Member State of the European Union and that possible future claims might not specify any specifc amount, allege new legal interpretations or involve a large number of parties). The estimated cost of the potential compensation to the shareholders of Banco Popular Español, S.A.U. has been accounted for as disclosed in Note 3 of the consolidated fnancial statements. 560 2018 Auditors’ report and consolidated annual accounts • German shares investigation: the Cologne Public Prosecution Ofce is conducting an investigation against the Bank, and other group entities based in UK - Santander UK plc, Abbey National Treasury Services plc and Cater Allen International Limited -, in relation to a particular type of tax dividend linked transactions known as cum-ex transactions. The Group is cooperating with the German authorities. As the investigations are at preliminary stage, the results and the efects for the Group, which may potentially include the imposition of fnancial penalties, cannot be anticipated. The Bank has not recognised any provisions in this connection. • Attorneys General Investigation of auto loan securitisation transactions and fair lending practices: in October 2014, May 2015, July 2015 and February 2017, Santander Consumer USA Inc. (SC) received subpoenas and/or Civil Investigative Demands (CIDs) from the Attorneys General of the U.S. states of California, Illinois, Oregon, New Jersey, Maryland and Washington under the authority of each state’s consumer protection statutes. SC was informed that these states serve on behalf of a group of 32 state Attorneys General. The subpoenas contain broad requests for information and the production of documents related to SC’s underwriting, securitization, the recovery eforts servicing and collection of nonprime vehicle loans. SC has responded to these requests within the deadlines specifed in the CIDs and has otherwise cooperated with the Attorneys General with respect to this matter. The provisions recorded for this investigation are considered sufcient. • Financial Industry Regulatory Authority (“FINRA”) Puerto Rico Arbitrations: as of 31 December 2018, Santander Securities LLC (SSLLC) had received 589 FINRA arbitration cases related to Puerto Rico bonds and Puerto Rico closed-end funds (CEFs). The statements of claims allege, among other things, fraud, negligence, breach of fduciary duty, breach of contract of the acquirers, unsuitability, over-concentration of the investments and defect to supervise. There were 420 arbitration cases that remained pending as of 31 December 2018. The provisions recorded for these matters are considered sufcient. As a result of various legal, economic and market factors impacting or that could impact of the value Puerto Rico bonds and CEFs, it is possible that additional arbitration claims and/or increased claim amounts may be asserted against SSLLC in future periods. The Bank and the other Group companies are subject to claims and, therefore, are party to certain legal proceedings incidental to the normal course of their business (including those in connection with lending activities, relationships with employees and other commercial or tax matters). With the information available to it, the Group considers that, at 31 December 2018, it had reliably estimated the obligations associated with each proceeding and had recognised, where necessary, sufcient provisions to cover reasonably any liabilities that may arise as a result of these tax and legal risks. It also believes that any liability arising from such claims and proceedings will not have, overall, a material adverse efect on the Group’s business, fnancial position or results of operations. 26. Other liabilities The detail of Other liabilities in the consolidated balance sheets is as follows: Million of euros Transactions in transit Accrued expenses and deferred income Other 27. Tax matters 2018 803 6,621 5,664 13,088 2017 811 6,790 4,990 12,591 2016 994 6,507 3,569 11,070 a) Consolidated Tax Group Pursuant to current legislation, the Consolidated Tax Group includes Banco Santander, S.A. (as the parent) and the Spanish subsidiaries that meet the requirements provided for in Spanish legislation regulating the taxation of the consolidated profts of corporate groups (as the controlled entities). On 1 January 2018 those entities that were part of the Consolidated Tax Group which parent company was Banco Popular Español, S.A.U., and that meet the requirements have been integrated in the aforementioned Consolidate Tax Group. The other Group companies fle income tax returns in accordance with the tax regulations applicable to them. b) Years open for review by the tax authorities In 2018 the conformity and non-conformity acts relating to the fnancial years 2009 to 2011 were formalised. The adjustments signed in conformity had no signifcant impact on results and, in relation to the concepts signed in disconformity both in this year and in previous years that have been appealed, Banco Santander, S.A., as the Parent of the Consolidated Tax Group, considers, in accordance with the advice of its external lawyers, that the adjustments made should not have a signifcant impact on the consolidated fnancial statements, and there are sound arguments as proof in the appeals pending or to be fled against them. Consequently, no provision has been recorded for this concept. Following the completion of these actions for 2009 to 2011, subsequent years up to and including 2018 are subject to review. At the date of approval of these accounts, the beginning of VAT proceedings for periods not yet prescribed up to and including 2016 have been notifed. Likewise, in 2018 the partial actions relating to corporate income tax for 2016 of the Consolidated Tax Group of which Banco Popular Español, S.A.U. was the parent were completed, and a certifcate of conformity was drawn up confrming the tax return fled by the taxpayer. In relation to this Consolidated Tax Group, the years 2010 to 2017 inclusive are subject to review. The other entities have the corresponding years open for review, pursuant to their respective tax regulations. 561 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix d) Tax recognised in equity In addition to the income tax recognised in the consolidated income statement, the Group recognised the following amounts in consolidated equity in 2018, 2017 and 2016: Million of euros Other comprehensive income Items not reclassifed to proft or loss Actuarial gains or (-) losses on defned beneft pension plans Changes in the fair value of equity instruments measured at fair value through other comprehensive income Financial liabilities at fair value with changes in results attributed to changes in credit risk Items that may be reclassifed to proft or loss Cash fow hedges Changes in the fair value of debt instruments through other comprehensive income Financial assets available for sale Debt instruments Equity instruments Other recognised income and expense of investments in subsidiaries, joint ventures and associates 2018* 2017 2016 (225) (199) 60 60 364 364 - (26) 124 (50) 167 - (694) 108 (136) (97) (366) 269 (552) (368) (184) 7 (101) (11) 60 (6) (330) e) Deferred taxes Tax assets in the consolidated balance sheets includes debit balances with the Public Treasury relating to deferred tax assets. Tax liabilities includes the liability for the Group’s various deferred tax liabilities. On 26 June 2013, the Basel III legal framework was included in European law through Directive 2013/36 (CRD IV) and Regulation 575/2013 on prudential requirements for credit institutions and investment frms (CRR), directly applicable in every member state as from 1 January 2014, albeit with a gradual timetable with respect to the application of, and compliance with, various requirements. This legislation establishes that deferred tax assets, the use of which relies on future profts being obtained, must be deducted from regulatory capital. Because of the possible diferent interpretations which can be made of the tax regulations, the outcome of the tax audits of the years reviewed and of the open years might give rise to contingent tax liabilities which cannot be objectively quantifed. However, the Group’s tax advisers consider that it is unlikely that such tax liabilities will arise, and that in any event the tax charge arising therefrom would not materially afect the Group’s consolidated fnancial statements. c) Reconciliation The reconciliation of the income tax expense calculated at the tax rate applicable in Spain (30%) to the income tax expense recognised and the detail of the efective tax rate are as follows: Million of euros 2018 2017 2016 Consolidated proft (loss) before tax: From continuing operations 14,201 12,091 10,768 From discontinued operations - - - Income tax at tax rate applicable in Spain (30%) By the efect of application of the various tax rates applicable in each country* Of which: Brazil United Kingdom United States Chile 14,201 12,091 10,768 4,260 3,628 3,230 509 539 312 719 (99) (57) (35) 656 (78) 68 (48) 396 (63) 94 (54) Efect of deduction of goodwill in Brazil Efect of reassessment of deferred taxes Permanent diferences** - - 338 (282) 374 (20) 77 Current income tax 4,886 3,884 3,282 Efective tax rate Of which: 34,40% 32,12% 30,48% Continuing operations 4,886 3,884 3,282 Discontinued operations (Note 37) - - - Of which: Current taxes Deferred taxes 4,763 3,777 123 107 1,493 1,789 Taxes paid in the year 3,342 4,137 2,872 * Calculated by applying the diference between the tax rate applicable in Spain and the tax rate applicable in each jurisdiction to the proft or loss contributed to the Group by the entities which operate in each jurisdiction. ** Including the recognition of tax credits in Portugal in 2018. 562 Efect of proft or loss of associates and joint ventures (221) (211) (133) Total (164) (184) 2018 (Note 1.b). * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 Auditors’ report and consolidated annual accounts In this regard, pursuant to Basel III, in recent years several countries have amended their tax regimes with respect to certain deferred tax assets so that they may continue to be considered regulatory capital since their use does not rely on the future profts of the entities that generate them (referred to hereinafter as “monetizable tax assets”). Italy had a very similar regime to that described above, which was introduced by Decree-Law no. 225, of 29 December 2010, and amended by Law no. 10, of 26 February 2011. In addition, in 2013 in Brazil, by means of Provisional Measure no. 608, of 28 February 2013 and, in Spain, through Royal Decree- Law 14/2013, of 29 November confrmed by Law 27/2014, of 27 November tax regimes were established whereby certain deferred tax assets (arising from provisions to allowances for loan losses in Brazil and provisions to allowances for loan losses, provisions to allowances for foreclosed assets and provisions for pension and pre-retirement obligations in Spain) may be converted into tax receivables in specifc circumstances. As a result, their use does not rely on the entities obtaining future profts and, accordingly, they are exempt from deduction from regulatory capital. In 2015 Spain completed its regulations on monetizable tax assets with the introduction of a fnancial contribution which will involve the payment of 1.5% for maintaining the right to monetise which will be applied to the portion of the deferred tax assets that qualify under the legal requirements as monetizable assets generated prior to 2016. In a similar manner, Italy, by decree of 3 May 2016 has introduced a fee of 1.5% annually to maintain the monetizable of part of the deferred tax assets. The detail of deferred tax assets, by classifcation as monetizable or non-monetizable assets, and of deferred tax liabilities at 31 December 2018, 2017 and 2016 is as follows: Million of euros Tax assets: Tax losses and tax credits Temporary diferences Of which: Non-deductible provisions Valuation of fnancial instruments Loan losses Pensions Valuation of tangible and intangible assets Tax liabilities: Temporary diferences Of which: Valuation of fnancial instruments Valuation of tangible and intangible assets Investments in Group companies * Not deductible from regulatory capital. 2018 2017 2016 Monetizable* ** Other Monetizable* ** Other Monetizable * 10,866 12,392 11,046 12,164 - 10,866 4,276 8,116 - 4,457 11,046 7,707 - - 7,279 3,587 - - - - - - 2,613 609 1,308 632 1,215 5,568 5,568 1,168 1,503 880 - - 2,336 530 7,461 1,159 3,585 723 - - - - - - 1,077 4,837 4,837 1,207 1,256 808 9,649 - 9,649 - - 6,082 3,567 - - - - - - Other 11,615 4,934 6,681 1,645 1,042 940 641 537 5,694 5,694 1,105 1,916 1,265 ** Banco Popular Español, S.A.U. requested the conversion of part of its monetizable assets in 2017 (EUR 486 million which were approved in 2018) and in 2018 (EUR 995 million pending resolution) given the circumstances of the aforementioned regulations are applied. 563 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The Group only recognises deferred tax assets for temporary diferences or tax loss and tax credit carryforwards where it is considered probable that the consolidated entities that generated them will have sufcient future taxable profts against which they can be utilised. Brazil The deferred tax assets recognised in Brazil total EUR 5,869 million, of which EUR 3,249 million were for monetizable temporary diferences, EUR 2,392 million for other temporary diferences and EUR 228 million for tax losses and credits. The deferred tax assets and liabilities are reassessed at the reporting date in order to ascertain whether any adjustments need to be made on the basis of the fndings of the analyses performed. The Group estimates that the recognised deferred tax assets for temporary diferences, tax losses and credits will be recovered in approximately 10 years. United States The deferred tax assets recognised in the United States total EUR 1,209 million, of which EUR 512 million were for temporary diferences and EUR 697 million for tax losses and credits. The Group estimates that the recognised deferred tax assets for temporary diferences will be recovered before 2028. The recognised tax loss and tax credit carryforwards will be recovered before 2029. These analyses take into account, inter alia: (i) the results generated by the various entities in prior years, (ii) each entity or tax group’s projected earnings, (iii) the estimated reversal of the various temporary diferences, based on their nature, and (iv) the period and limits established by the legislation of each country for the recovery of the various deferred tax assets, thereby concluding on each entity or tax group’s ability to recover its recognised deferred tax assets. The projected earnings used in these analyses are based on the fnancial budgets approved by the Group’s directors for the various entities applying constant growth rates not exceeding the average long-term growth rate for the market in which the consolidated entities operate, in order to estimate the earnings for subsequent years considered in the analyses. Relevant information is set forth below for the main countries which have recognised deferred tax assets: Spain The deferred tax assets recognised at the Consolidated Tax Group total EUR 12,987 million, of which EUR 7,422 million were for monetizable temporary diferences with the right to conversion into a credit against the Public Finance, EUR 2,465 million for other temporary diferences and EUR 3,100 million for tax losses and credits. The Group estimates that the recognised deferred tax assets for temporary diferences will be recovered in a maximum period of 15 years. This period would also apply to the recovery of the recognised tax loss and tax credit carryforwards. 564 2018 Auditors’ report and consolidated annual accounts The changes in Tax assets - Deferred and Tax liabilities - Deferred in the last three years were as follows: Million of euros Deferred tax assets Tax losses and tax credits Temporary diferences Of which: monetizable Deferred tax liabilities Temporary diferences Million of euros Deferred tax assets Tax losses and tax credits Temporary diferences Of which: monetizable Deferred tax liabilities Temporary diferences Million of euros Deferred tax assets Tax losses and tax credits Temporary diferences Of which: monetizable Deferred tax liabilities Temporary diferences Balances at 31 December 2017 IFRS9 Adoption impact (Balance at 1 January 2018) 23,210 4,457 18,753 11,046 (4,837) (4,837) 18,373 680 - 680 273 - - 680 Foreign currency balance translation diferences and other (Charge)/ credit to asset and liability valuation items adjustments (807) 1 (808) (843) (114) (114) (921) 149 - 149 - (315) (315) (166) (Charge)/ credit to income 241 (128) 369 390 (364) (364) (123) Acquisitions Balances at 31 for the December 2018 year (net) (215) (54) (161) - 62 62 23,258 4,276 18,982 10,866 (5,568) (5,568) (153) 17,690 Balances at 31 December 2016 (Charge)/ credit to income Foreign currency balance translation diferences and other (Charge)/ credit to asset and liability valuation items adjustments 21,264 4,934 16,330 9,649 (5,694) (5,694) 15,570 (675) (279) (396) (185) 568 568 (107) (756) (205) (551) (455) 414 414 (342) (1) - (1) - 19 19 18 Acquisitions for the year (net) Balances at 31 December 2017 3,378 23,210 7 3,371 2,037 (144) (144) 3,234 4,457 18,753 11,046 (4,837) (4,837) 18,373 Balances at 31 December 2015 (Charge)/ credit to income Foreign currency balance translation diferences and other (Charge)/ credit to asset and liability valuation items adjustments Acquisitions for the year (net) Balances at 31 December 2016 22,045 4,808 17,237 8,887 (5,565) (5,565) 16,480 (1,311) 194 (1,505) 49 (478) (478) 1,355 110 1,245 713 98 98 (1,789) 1,453 (551) - (551) - (26) (26) (577) (274) (178) (96) - 277 277 3 21,264 4,934 16,330 9,649 (5,694) (5,694) 15,570 565 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Also, the Group did not recognise deferred tax assets relating to tax losses, tax credits for investments and other incentives amounting to approximately EUR 5,500 million, the use of which EUR 450 million is subject, among other requirements, to time limits. of credits for monetizable deferred tax assets; And negative tax bases and (iv) the limitation of the application of deductions to avoid double taxation, all this makes provision for an increase in the amount of taxes payable in Spain in the coming years by the consolidated tax group. f) Tax reforms The following signifcant tax reforms were approved in 2018 and previous years: The Tax Cuts and Jobs Act (the 2017 Act) was approved in the United States on 22 December 2017. The main amendments introduced in this tax regulation afected the US corporate tax rates, some business-related exclusions and deductions and credits. Likewise, this amendment entailed an international tax impact for many companies that operate internationally. The main impact is derived from the decrease in the federal tax rate that was reduced from 35% to 21%, which afected both the amount and estimation of the recoverability of deferred tax assets and liabilities during 2017 as well as the proft after tax from 2018. The estimated impact on the Group, arisen from the afected subsidiaries, which was already recorded as of 31 December 2017, did not represent a signifcant amount in the attributable proft. On 29 December 2017, Law No. 27430 on the reform of the Argentine tax system was published, whose main measures entered into force on 1 January 2018, therefore it had no efect on the Group’s accounts in 2017. Among other measures, it is established a gradual reduction of the income tax from the 35% applicable until 2017, to 30% in 2018 and 2019, and up to 25% in 2020 and ahead, which is complemented by a dividend withholding of 7% for those distributed with a charge to 2018 and 2019 fnancial years, and 13% if distributed with a charge to 2020 onwards. On December 2016, the Royal Decree-Law 3-2016 was approved in Spain under which the following tax measures were adopted, among others,: (i) The limit for the integration of deferred monetizable tax assets, as well as for set-of for the negative tax was reduced( the limit was reduced from 70% to 25% of the tax base), (ii) this regulation set out a new limit of 50% of the tax rate for the application of deductions in order to avoid double taxation, (iii) this regulation also set out the compulsory impairment reversion for deductible participations in previous years by one ffths independently from the recovery of the participated, and (iv) the regulation included the non-deductibility of the losses generated from the transmission of participations performed from 1 January 2017. The efects of this reform for the consolidated tax Group were: (i) the consolidation in 2016 of deferred tax assets for impairment of non-deductible participations, in a non signifcant amount; (ii) the integration in 2016 tax base and the next four fscal years of a minimum reversal of the impairment of investments in shares that were tax deductible in years prior to 2013, that has no an adverse efect on the accounts, since there are no legal restrictions on the availability of shares; (iii) the slowdown in the consumption In the United Kingdom, a progressive reduction was approved in 2016 regarding the tax rate of the Corporate Tax, from 20% to 17%. The applicable rate from 1 April 2017 is of 19%, and it will be 17% from 1 April 2020. Also in 2015, a surcharge of 8% on the standard income tax rate for bank profts was approved. This surcharge applies from 1 January 2016. In addition, from 2015 customer remediation payments are no longer considered to be tax-deductible. In Poland, the introduction of a tax on certain bank assets at a monthly rate of 0.0366%, which comes into force in 2016, was approved. In Brazil, in 2015, there was also an increase for insurance and fnancial companies and in the rate of the Brazilian social contribution tax on net income (CSL) from 15% to 20% (applicable from 1 September 2015 to 31 December 2018).Since 1 January 2019, the tax rate is 15% again, as a result of which the income tax rate (25%) plus the CSL rate total 40% for those companies. As a result of the tax reform approved in Chile in 2012, the applicable tax rate gradually increased from 20% to 27% from 2018 onwards. g) Other information In compliance with the disclosure requirement established in the Listing Rules Instrument 2005 published by the UK Financial Conduct Authority, it is hereby stated that shareholders of the Bank resident in the United Kingdom will be entitled to a tax credit for taxes paid abroad in respect of withholdings that the Bank has to pay on the dividends to be paid to such shareholders if the total income of the dividend exceeds the amount of exempt dividends of GBP 2,000 for the year 2018/19. The shareholders of the Bank resident in the United Kingdom who hold their ownership interest in the Bank through Santander Nominee Service will be informed directly of the amount thus withheld and of any other data they may require to complete their tax returns in the United Kingdom. The other shareholders of the Bank resident in the United Kingdom should contact their bank or securities broker. Banco Santander, S.A. is part of the Large Business Forum and has adhered since 2010 to the Code of Good Tax Practices in Spain. Also Santander UK is a member of the HMRC’s Code of Practice on Taxation in the United Kingdom, actively participating in both cases in the cooperative compliance programs being developed by these Tax Administrations. 566 2018 Auditors’ report and consolidated annual accounts 28. Non-controlling interests Non-controlling interests include the net amount of the equity of subsidiaries attributable to equity instruments that do not belong, directly or indirectly, to the Bank, including the portion attributed to them of proft for the year. a) Breakdown The detail, by Group company, of Equity - Non-controlling interests is as follows: Million of euros 2018 2017 2016 Santander Consumer USA Holdings Inc. 1,652 1,479 1,963 Santander Bank Polska S.A. 1,538 1,901 1,653 Grupo PSA 1,409 1,305 1,149 Banco Santander (Brasil) S.A. 1,114 1,489 1,784 Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México 1,093 1,056 1,069 Banco Santander - Chile 1,085 1,209 1,204 Grupo Metrovacesa Other companies* - 836 449 1,493 1,481 1,208 9,384 10,756 10,479 Proft/(Loss) for the year attributable to non-controlling interests 1,505 1,588 1,282 Of which: Banco Santander (Brasil) S.A. Banco Santander (Chile) S.A. Grupo PSA Santander Consumer USA Holdings Inc. Banco Santander México, S.A. Institución de Banca Múltiple, Grupo Financiero Santander México Santander Bank Polska S.A. Other companies 292 279 232 288 264 206 194 215 171 218 368 256 216 173 95 194 160 108 190 148 108 10,889 12,344 11,761 * Includes a Santander UK plc issuance of perpetual equity instruments of EUR 1,280 million in 2018 (EUR 1,290 million and EUR 753 million in 2017 and 2016, respectively). b) Changes The changes in Non-controlling interests are summarised as follows: Million of euros 2018* 2017 2016 Balance at the end of the previous year 12,344 11,761 10,713 Efect of changes in accounting policies** (1,292) - - Balance at beginning of year 11,052 11,761 10,713 Other comprehensive income Exchange diferences Cash fow hedge Available for sale equity Available for sale fxed income Changes in the fair value of equity instruments Changes in the fair value of debt instruments Other Other (109) (583) (135) (653) (1) (12) 40 (1) (11) (2) 71 12 (54) 1,166 374 360 45 (30) 38 (39) 674 Proft attributable to non- controlling interests 1,505 1,588 1,282 Modifcation of participation rates (65) (819) (28) Change of perimeter (660) (39) (197) Dividends paid to minority shareholders (687) (665) (800) Changes in capital and others concepts (147) 1,101 417 Balance at end of year 10,889 12,344 11,761 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** See change in consolidated statements of changes in total equity. During 2016, there was a decrease of EUR 621 million in Non - controlling interests due to the transaction of Metrovacesa, S.A. (See Note 3). Additionally, during the year 2016, the Group incorporated the remaining geographies included in the PSA framework agreement (Netherlands, Belgium, Italy, Germany, Brazil and Poland) (see Note 3), generating an increase in the balance of Non - controlling interests of EUR 410 million. During the year 2017, the Group completed the acquisition of 9.65% of shares of Santander Consumer USA Holdings Inc (See Note 3), which resulted in a reduction of EUR 492 million in the balance of Non - controlling interests. 567 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix In 2018 there was a loss of control over Metrovacesa, S.A. in the Group, which has led to a decrease of EUR 826 million in the balance of Minority interests (see Note 3). The foregoing changes are shown in the consolidated statement of changes in total equity. c) Other information The fnancial information on the subsidiaries with signifcant non- controlling interests at 31 December 2018 is summarised below: Million of euros* Total assets Total liabilities Net assets Total income Total proft Banco Santander (Brasil) S.A. Banco Santander - Chile Grupo Financiero Santander México, S.A.B de C.V. Santander Bank Polska S.A. Santander Consumer USA Holdings Inc. 166,036 150,760 15,276 13,345 2,940 50,911 46,035 4,876 2,535 901 65,876 60,507 5,369 3,527 975 43,669 38,736 4,933 1,488 424 38,526 32,340 6,186 4,215 710 * Information prepared in accordance with the segment reporting criteria described in Note 52 and, therefore, it may not coincide with the information published separately by each entity. • Other reclassifcations: includes the amount of the transfers made in the year between the various valuation adjustment items. The amounts of these items are recognised gross, including the amount of the Other comprehensive income relating to non- controlling interests, and the corresponding tax efect is presented under a separate item, except in the case of entities accounted for using the equity method, the amounts for which are presented net of the tax efect. 29. Other comprehensive income The balances of Other comprehensive income include the amounts, net of the related tax efect, of the adjustments to assets and liabilities recognised in equity through the consolidated statement of recognised income and expense. The amounts arising from subsidiaries are presented, on a line by line basis, in the appropriate items according to their nature. Respect to items that may be reclassifed to proft or loss, the consolidated statement of recognised income and expense includes changes in other comprehensive income as follows: • Revaluation gains (losses): includes the amount of the income, net of the expenses incurred in the year, recognised directly in equity. The amounts recognised in equity in the year remain under this item, even if in the same year they are transferred to the income statement or to the initial carrying amount of the assets or liabilities or are reclassifed to another line item. • Amounts transferred to income statement: includes the amount of the revaluation gains and losses previously recognised in equity, even in the same year, which are recognised in the income statement. • Amounts transferred to initial carrying amount of hedged items: includes the amount of the revaluation gains and losses previously recognised in equity, even in the same year, which are recognised in the initial carrying amount of assets or liabilities as a result of cash fow hedges. 568 2018 Auditors’ report and consolidated annual accounts a) Breakdown of Other comprehensive income - Items that will not be reclassifed in results and Items that can be classifed in results Million of euros Other comprehensive income Items that will not be reclassifed to proft or loss Actuarial gains and losses on defned beneft pension plans Non-current assets held for sale Share in other income and expenses recognised in investments, joint ventures and associates Other valuation adjustments Changes in the fair value of equity instruments measured at fair value with changes in other comprehensive income Inefciency of fair value hedges of equity instruments measured at fair value with changes in other comprehensive income Changes in the fair value of equity instruments measured at fair value with changes in other comprehensive income (hedged item) Changes in the fair value of equity instruments measured at fair value with changes in other comprehensive income (hedging instrument) Changes in the fair value of fnancial liabilities measured at fair value through proft or loss attributable to changes in credit risk Items that may be reclassifed to proft or loss Hedges of net investments in foreign operations (efective portion) Exchange diferences Cash fow hedges (efective portion) Changes in the fair value of debt instruments measured at fair value with changes in other comprehensive income Hedging instruments (items not designated) Financial assets available for sale Debt instruments Equity instruments Non-current assets held for sale Share in other income and expenses recognised in investments, joint ventures and associates 31/12/2018 (IFRS9)* 31/12/2017 (IAS39) 31/12/2016 (IAS39) (22,141) (2,936) (3,609) - 1 - 597 - - - 75 (19,205) (4,312) (15,730) 277 828 - - (268) (21,776) (4,034) (4,033) - (1) - (15,039) (3,933) (3,931) - (2) - (17,742) (4,311) (15,430) 152 2,068 1,154 914 - (221) (11,106) (4,925) (8,070) 469 1,571 423 1,148 - (151) * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). b) Other comprehensive income- Items not reclassifed to proft or loss – Actuarial gains or (-) losses on defned beneft pension plans Other comprehensive income – Items not reclassifed to proft or loss – Actuarial gains or (-) losses on defned beneft pension plans include the actuarial gains and losses and the return on plan assets, less the administrative expenses and taxes inherent to the plan, and any change in the efect of the asset ceiling, excluding amounts included in net interest on the net defned beneft liability (asset). Its variation is shown in the consolidated statement of income and expense. The provisions against equity in 2018 amounted to EUR 618 million - See Note 25.b -, with the following breakdown: • Decrease of EUR 65 million in the accumulates actuarial losses relating to the Group´s entities in Spain, mainly due to the evolution experienced by the discount rate - increase from 1.40% to 1.55%. • Decrease of EUR 481 million in the cumulative actuarial losses relating to the Group´s businesses in the UK, mainly due to the evolution experienced by the discount rate - increase from 2.49% to 2.90%. • Increase of EUR 95 million in accumulated actuarial losses corresponding to the Group’s business in Brazil, mainly due to the reduction in the discount rate (from 9.53% to 9.11% in pension benefts and 9.65% to 9.26% in medical benefts), as well as variations in the other hypotheses. 569 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The other modifcation in accumulated actuarial proft or losses is a decrease of EUR 167 million as a result of exchange rate and other efects, mainly in Brazil (depreciation of the real). c) Other comprehensive income - Items that will not be reclassifed in results - Changes in the fair value of equity instruments measured at fair value with changes in other comprehensive income Includes the net amount of unrealised fair value changes of equity instruments at fair value with changes in other comprehensive income. The following is a breakdown of the composition of the balance as of 31 December 2018 (IFRS9) under “Other comprehensive income” - Items that will not be reclassifed to proft or loss - Changes in the fair value of equity instruments measured at fair value with changes in other global result depending on the geographical origin of the issuer: Million of euros Equity instruments Domestic Spain International Rest of Europe United States Latin America and rest Of which: Publicly listed Non publicly listed Capital gains by valuation Capital losses by valuation Net gains/losses by valuation Fair value 31/12/18* 20 160 9 708 897 818 79 (216) (76) - (8) (300) (18) (282) (196) 84 9 700 597 800 (203) 417 652 42 1,560 2,671 1,943 728 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). d) Other comprehensive income - Items that may be reclassifed to proft or loss - Hedge of net investments in foreign operations (efective portion) and exchange diferences The changes in 2018 refect the negative efect of the depreciation of large part of the currencies, mainly the Brazilian real and pound sterling, whereas the changes in 2017 refect the negative efect of the sharp depreciation of the Brazilian real and the US dollar. Of the change in the balance in these years, a loss of EUR 556, 1,704 and 185 million in 2018, 2017 and 2016 relate to the measurement of goodwill. The detail, by country is as follows: Million of euros Net balance at end of year (20,042) (19,741) (12,995) 2018 2017 2016 Of which: Brazilian Real Pound Sterling Mexican Peso Argentine Peso* Chilean Peso US Dollar Other (12,950) (11,056) (8,435) (3,924) (3,732) (2,996) (2,312) (2,230) (1,908) - (1,684) (1,309) (1,238) 1,330 (948) (866) 555 (728) (614) 2,849 (582) * In 2018, due to the application of IAS29 for hyperinfationary economies, they have been transferred to Other Reserves (see Note 33). 570 2018 Auditors’ report and consolidated annual accounts e) Other comprehensive income -Items that may be reclassifed to proft or loss - Hedging derivatives – Cash fow hedges (Efective portion) Other comprehensive income – Items that may be reclassifed to proft or loss - Cash fow hedges includes the gains or losses attributable to hedging instruments that qualify as efective hedges. These amounts will remain under this heading until they are recognised in the consolidated income statement in the periods in which the hedged items af1ect it (See Note 11). f) Other comprehensive income - Items that may be reclassifed to proft or loss – Changes in the fair value of debt instruments measured at fair value with changes in other comprehensive income (IFRS9) and available-for-sale (IAS39) Includes the net amount of unrealised changes in the fair value of assets classifed as Changes in the fair value of debt instruments measured at fair value with changes in other comprehensive income (IFRS9) and Financial assets available-for-sale (IAS39) (See Notes 7 and 8). The breakdown, by type of instrument and geographical origin of the issuer, of Other comprehensive income – Items that may be reclassifed to proft or loss - Changes in the fair value of debt instruments measured at fair value with changes in other comprehensive income (IFRS9) and Financial assets available-for- sale (IAS39) at 31 December 2018, 2017 and 2016 is as follows: Million of euros 31 December 2018* 31 December 2017 31 December 2016 n o i t a u l a v e R i s n a g n o i t a u l a v e R s e s s o l n o i t a u l a v e r t e N ) s e s s o l ( / s n a g i n o i t a u l a v e R i s n a g n o i t a u l a v e R s e s s o l e u l a v r i a F n o i t a u l a v e r t e N ) s e s s o l ( / s n a g i n o i t a u l a v e R i s n a g n o i t a u l a v e R s e s s o l e u l a v r i a F n o i t a u l a v e r t e N ) s e s s o l ( / s n a g i e u l a v r i a F 326 373 (3) (55) 323 318 38,550 17,494 660 306 (25) (24) 635 282 48,217 20,244 610 50 (26) (170) 584 32,729 (120) 16,879 448 (117) 331 42,599 404 (129) 275 39,132 167 (163) 4 35,996 37 (178) (141) 19,777 90 (128) (38) 20,888 1,184 (353) 831 118,420 1,460 (306) 1,154 128,481 117 944 (162) (521) (45) 25,683 423 111,287 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 5 166 14 744 929 828 101 (2) (2) (5) (6) (15) (5) (10) 3 1,373 48 (5) 43 1,309 164 9 738 914 823 91 979 560 1,878 4,790 2,900 1,890 284 21 811 1,164 999 165 (4) - (7) (16) (11) (5) 280 21 1,016 772 804 2,390 1,148 5,487 988 160 3,200 2,287 2,389 (321) 2,068 133,271 2,108 (537) 1,571 116,774 Debt instruments Government debt securities and debt Instruments issued by central banks Spain Rest of Europe Latin America and rest of the world Private-sector debt securities Equity instruments Domestic Spain International Rest of Europe United States Latin America and rest of the world Of which: Listed Unlisted * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 571 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix       At the end of 2017 and 2016 the Group assessed whether there is any objective evidence that the instruments classifed Changes in the fair value of debt and equity instruments measured at fair value with changes in other comprehensive income and Financial assets available-for-sale (IAS39) (debt securities and equity instruments) were impaired. This assessment included but was not limited to an analysis of the following information: i) the issuer’s economic and fnancial position, the existence of default or late payment, analysis of the issuer’s solvency, the evolution of its business, short-term projections, trends observed with respect to its earnings and, if applicable, its dividend distribution policy; ii) market-related information such as changes in the general economic situation, changes in the issuer’s sector which might afect its ability to pay; iii) changes in the fair value of the security analysed, analysis of the origins of such changes - whether they are intrinsic or the result of the general uncertainty concerning the economy or the country - and iv) independent analysts’ reports and forecasts and other independent market information. As of 1 January 2018, with the entry into force of IFRS9, the Group estimates the expected losses on debt instruments measured at fair value with changes in other comprehensive income. These losses are recorded with a charge to the consolidated income statement for the period. At the end of the years 2018, 2017 and 2016, the Group recorded under Impairment or reversal of impairment on fnancial assets not measured at fair value through proft or loss, net due to modifcation of the consolidated income statement, in the line of fnancial assets at fair value with changes in other comprehensive income (IFRS9) a provision of EUR 1 million in 2018, and in the line of available-for-sale fnancial assets (IAS39) a provision of EUR 10 million in equity instruments in 2017, and a reversal of provision of EUR 25 million and a provision of EUR 14 million in debt and equity instruments, respectively, in 2016. Until 31 December 2017, in the case of quoted equity instruments, when the changes in the fair value of the instrument under analysis were assessed, the duration and signifcance of the fall in its market price below cost for the Group was taken into account. As a general rule, for these purposes the Group considers a signifcant fall to be a 40% drop in the value of the asset or a continued fall over a period of 18 months. Nevertheless, it should be noted that the Group assessed, on a case-by-case basis, each of the securities that have sufered losses, and monitors the performance of their prices, recognising an impairment loss as soon as it is considered that the recoverable amount could be afected, even though the price may not have fallen by the percentage or for the duration mentioned above. If, after the above assessment has been carried out, the Group considers that the presence of one or more of these factors could afect recovery of the cost of the asset, an impairment loss was recognised in the income statement for the amount of the loss registered in equity under Other comprehensive income – Items that may be reclassifed to proft or loss – Items not reclassifed to proft or loss – Other Valuation adjustments. Also, where the Group was not intend and/or is not able to hold the investment for a sufcient amount of time to recover the cost, the instrument was written down to its fair value. As of January 1 2018, with the entry into force of IFRS9, no impairment analysis is performed of equity instruments recognised under Other comprehensive income. IFRS9 eliminates the need to carry out the impairment estimate on this class of equity instruments and the reclassifcation to proft and loss on the disposal of these assets. g) Other comprehensive income - Items that may be reclassifed to proft or loss and Items not reclassifed to proft or loss - Other recognised income and expense of investments in subsidiaries, joint ventures and associates The changes in other comprehensive income - Entities accounted for using the equity method were as follows: Million of euros Balance at beginning of year Revaluation gains/(losses) Net amounts transferred to proft or loss 2018 (222) (65) 2017 (153) (84) 2016 (232) 79 20 15 - Balance at end of year (267) (222) (153) Of which: Zurich Santander Insurance América, S.L. (159) (145) (84) 30. Shareholders’ equity The changes in Shareholders’ equity are presented in the consolidated statement of changes in total equity. Signifcant information on certain items of Shareholders’ equity and the changes therein in 2018 is set forth below. 31. Issued capital a) Changes At 31 December 2015 the Bank’s share capital consisted of 14,434,492,579 shares with a total par value of EUR 7,217 million. On 4 November 2016, a capital increase of EUR 74 million was made, through which the Santander Dividendo Elección scrip dividend scheme took place, whereby 147,848,122 shares were issued (1.02% of the share capital). At 31 December 2016 the Bank’s share capital consisted of 14,582,340,701 shares with a total par value of EUR 7,291 million. As a result of the acquisition of Banco Popular Español, S.A.U. described in Note 3, and in order to strengthen and optimize the Bank’s equity structure to provide adequate coverage of the acquisition, the Group, on 3 July 2017, reported on the agreement of the executive committee of Banco Santander, S.A. to increase the capital of the Bank by EUR 729 million by issuing and putting into circulation 1,458,232,745 new ordinary shares of the same 572 2018 Auditors’ report and consolidated annual accountsclass and series as the shares currently in circulation and with preferential subscription rights for the shareholders. The issue of new shares was carried out at a nominal value of ffty euro cents (EUR 0.50) plus a premium of EUR 4.35 per share, so the total issue rate of the new shares was EUR 4.85 per share and the total efective amount of the capital increase (including nominal and premium) of EUR 7,072 million. Each outstanding share had been granted a preferential subscription right during the preferential subscription period that took place from 6 to 20 July 2017, where 10 preferential subscription rights were required to subscribe 1 new share. On 7 November 2017, a capital increase of EUR 48 million was made, through which the Santander Dividendo Elección scrip dividend scheme took place, whereby 95,580,136 shares were issued (0.6% of the share capital). At 31 December 2017 the Bank’s share capital consisted of 16,136,153,582 shares with a total par value of EUR 8,068 million. On 7 November 2018, a capital increase of EUR 50 million was made, through which the Santander Dividendo Elección scrip dividend scheme took place, whereby 100,420,360 shares were issued (0.62% of the share capital). Therefore, the Bank’s new capital consists of EUR 8,118 million at 31 December 2018, represented by 16,236,573,942 shares of EUR 0.50 of nominal value each one and all of them from a unique class and series. The Bank’s shares are listed on the Spanish Stock Market Interconnection System and on the New York, London, Mexico and Warsaw Stock Exchanges, and all of them have the same features and rights. Santander shares are listed on the London Stock Exchange under Crest Depository Interest (CDI’s), each CDI representing one Bank’s share. They are also listed on the New York Stock Exchange under American Depositary Receipts (BDRs), each BDR representing one share. During 2018 and the beginning of 2019 the number of markets where the Bank is listed has been reduced; the Bank’s shares has been delisted from Buenos Aires, Milan, Lisboa and Sao Paulo’s markets. At 31 December 2018, the only shareholders listed in the Bank’s shareholders register with ownership interests of more than 3%1 were State Street Bank & Trust Company (13.09%), The Bank of New York Mellon Corporation (8.85%), Chase Nominees Ltd. (6.69%), EC Nominees Limited (3.96%) and BNP Paribas (3.79%). However, the Bank considers that these ownership interests are held in custody on behalf of third parties and that none of them, as far as the Bank is aware, has an ownership interest of more than 3% of the Bank’s share capital2 or voting power. As of 31 December 2018, the shareholders of the Bank did not have owners of shares resident in tax havens with a participation of more than 1% of the share capital. (1) The threshold stipulated in Royal Decree 1362/2007 of 19 October, which implemented the Spanish Securities Market Act 24/1988 of 28 July defning the concept of signifcant holding. (2) The website of the Comisión Nacional del Mercado de Valores (www. cnmv.es) contains a notice of signifcant holding published by Blackrock, Inc. on 09 August 2017, in which it notifes an indirect holding in the voting rights attributable to Bank shares of 5.585%, plus a further stake of 0.158% held through fnancial instruments. During 2018, Blackrock Inc. informed the Spanish CNMV of the following movements regarding its voting rights in the Bank: 23 April 2018, reduction below 5%, and 8 May 2018, increase above 5%. However, according to the Bank’s shareholder register, Blackrock, Inc did not hold more than 3% of the voting rights on that date, or on 31 December 2018. b) Other considerations The shareholders at the annual general meeting of 18 March 2016 also resolved to increase the Bank’s capital by a par value of EUR 500 million and granted the board the broadest powers to set the date and establish the terms and conditions of this capital increase within one year from the date of the aforementioned annual general meeting. If the board does not exercise the powers delegated to it within the period established by the annual general meeting, these powers will be rendered null and void. In addition, the ordinary general meeting of shareholders of 7 April 2017 also agreed to delegate to the board of directors the broadest powers so that, within one year from the date of the meeting, it can indicate the date and set the conditions for a capital increase with the issuance of new shares, for an amount of EUR 500 million. The capital increase will have no value or efect if, within the period of one year, the board of directors does not exercise the powers delegated to it. Likewise, the additional capital authorised by the ordinary general meeting of shareholders on 7 April 2017 is not more than EUR 3,645,585,175. The term available to the Bank’s administrators to execute and carry out capital increases up to that limit ends on 7 April 2020. The agreement grants the board the power to totally or partially exclude the pre-emptive subscription right under the terms of article 506 of the Capital Companies Law, although this power is limited to EUR 1,458,234,070. At 23 March 2018, the ordinary general meeting of shareholders also agreed to delegate to the board of directors the broadest power to execute the capital increase agreement adopted by the shareholders meeting and the authorization to the Board of directors to increase it. At 31 December 2018 the shares of the following companies were listed on ofcial stock markets: Banco Santander Río, S.A.; Grupo Financiero Santander México, S.A. de C.V.; Banco Santander - Chile; Cartera Mobiliaria, S.A., SICAV; Santander Chile Holding S.A.; Banco Santander (Brasil) S.A., Santander Bank Polska S.A. (former Bank Zachodni WBK S.A.) and Santander Consumer USA Holdings Inc. At 31 December 2018 the number of Bank shares owned by third parties and managed by Group management companies (mainly portfolio, collective investment undertaking and pension fund managers) or jointly managed was 63 million shares, which represented 0.39% of the Bank’s share capital. In addition, the 573 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix number of Bank shares owned by third parties and received as security was 212 million shares (equal to 1.30% of the Bank’s share capital). b) Breakdown The detail of Accumulated retained earnings and Reserves of entities accounted for using the equity method is as follows: At 31 December 2018 the capital increases in progress at Group companies and the additional capital authorised by their shareholders at the respective general meetings were not material at Group level (See Appendix V). 32. Share premium Share premium includes the amount paid up by the Bank’s shareholders in capital issues in excess of the par value. The Spanish Limited Liability Companies Law expressly permits the use of the share premium account balance to increase capital at the entities at which it is recognised and does not establish any specifc restrictions as to its use. The reduction of EUR 74 million in 2016 is the result for the capital increases arising from the Santander Dividendo Elección scrip dividend scheme. The increase in the balance of Share premium in 2017 is the result of the capital increase of EUR 6,343 million approved on 3 July 2017 (See note 31.a) and the reduction of EUR 48 million is due the capital increases charge to reserve arising from the Santander Diviendo Elección program. The decrease produced in 2018 is a consequence of the reduction of EUR 50 million to cope with the capital increase as a result of the Santander Dividendo Elección program. Also, in 2018, 2017 and 2016 an amount of EUR 10 million was transferred from the Share premium account to the Legal reserve (2017: EUR 154 million; 2016: EUR 15 million) (See note 33.b.i). 33. Accumulated retained earnings a) Defnitions The balance of Equity - Accumulated gains and Other reserves includes the net amount of the accumulated results (profts or losses) recognised in previous years through the consolidated income statement which in the proft distribution were allocated in equity, the expenses of own equity instrument issues, the diferences between the amount for which the treasury shares are sold and their acquisition price, as well as the net amount of the results accumulated in previous years, generated by the result of non-current assets held for sale, recognised through the consolidated income statement. Million of euros Restricted reserves Legal reserve Own shares Revaluation reserve Royal Decree-Law 7/1996 Reserve for retired capital Unrestricted reserves Voluntary reserves* Consolidation reserves attributable to the Bank Reserves of subsidiaries Reserves of entities accounted for using the equity method 2018 2017 2016 2 ,580 2,880 2,686 1,624 902 1,614 1,212 1,459 1,173 43 11 43 11 43 11 12 ,100 11,368 11,285 5,737 6,904 7,192 6 ,363 4,464 4,093 37 ,593 36,862 34,568 917 725 465 53,190 51,835 49,004 * In accordance with the commercial regulations in force in Spain. i. Legal reserve Under the Consolidated Spanish Limited Liability Companies Law, 10% of net proft for each year must be transferred to the legal reserve. These transfers must be made until the balance of this reserve reaches 20% of the share capital. The legal reserve can be used to increase capital provided that the remaining reserve balance does not fall below 10% of the increased share capital amount. In 2018 the Bank transferred EUR 10 million from the Share premium account to the Legal reserve (2017: EUR 154 million; 2016: EUR 15 million). Consequently, once again, after the capital increases described in Note 31 had been carried out, the balance of the Legal reserve reached 20% of the share capital, and at 31 December 2018 the Legal reserve was of the stipulated level. ii. Reserve for treasury shares Pursuant to the Consolidated Spanish Limited Liability Companies Law, a restricted reserve has been recognised for an amount equal to the carrying amount of the Bank shares owned by subsidiaries. The balance of this reserve will become unrestricted when the circumstances that made it necessary to record it cease to exist. Additionally, this reserve covers the outstanding balance of loans granted by the Group secured by Bank shares and the amount equivalent to loans granted by Group companies to third parties for the acquisition of treasury shares plus the own treasury shares amount. iii. Revaluation reserve Royal Decree Law 7/1996, of 7 June The balance of Revaluation reserve Royal Decree-Law 7/1996 can be used, free of tax, to increase share capital. From 1 January 2007, the balance of this account can be taken to unrestricted reserves, provided that the monetary surplus has been realised. The surplus will be deemed to have been realised in respect of the portion on 574 2018 Auditors’ report and consolidated annual accounts which depreciation has been taken for accounting purposes or when the revalued assets have been transferred or derecognised. b) Own shares Shareholders’ equity - Own shares includes the amount of own equity instruments held by all the Group entities. If the balance of this reserve were used in a manner other than that provided for in Royal Decree-Law 7/1996, of 7 June, it would be subject to taxation. iv. Reserves of subsidiaries The detail, by company, of Reserves of subsidiaries, based on the companies’ contribution to the Group (considering the efect of consolidation adjustments) is as follows: Million of euros Banco Santander (Brasil) S.A. (Grupo Consolidado) Grupo Santander UK Grupo Santander Holdings USA Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México Banco Santander - Chile Grupo Santander Consumer Finance Banco Santander Totta, S.A. (Grupo Consolidado) Santander Bank Polska S.A. Santander Seguros y Reaseguros, Compañía Aseguradora, S.A. Banco Santander (Suisse) SA Santander Investment, S.A. Banco Santander Río S.A. Cartera Mobiliaria, S.A., SICAV Exchange diferences, consolidation adjustments and other companies* Of wich, restricted 2018 2017 2016 10,755 9,874 8,993 8,207 4,260 7,724 4,150 6,887 4,091 3,436 2,963 2,841 2,729 1,387 714 369 208 (82) - 3,229 2,764 2,465 2,821 1,093 638 381 202 1,639 - 3,255 2,630 2,027 2,593 967 824 354 349 1,326 377 (194) (118) (105) 37,593 36,862 34,568 2,964 2,777 2,730 * Includes the charge relating to cumulative exchange diferences in the transition to International Financial Reporting Standards. 34. Other equity instruments and own shares a) Equity instruments issued not capital and other equity instruments Other equity instruments includes the equity component of compound fnancial instruments, the increase in equity due to personnel remuneration, and other items not recognised in other “Shareholders’ equity” items. On 8 September 2017, Banco Santander issued contingent redeemable perpetual bonds (the “Fidelity Bonds”) amounting to EUR 981 million nominal value - EUR 686 million fair value- of those in the power of third parties an amount amounting to EUR 549 million. On 31 December 2018 amounted to EUR 565 million. Aditionally, at 31 December 2018 the Group had other equity instruments amounting to EUR 234 million. Transactions involving own equity instruments, including their issuance and cancellation, are recognised directly in equity, and no proft or loss may be recognised on these transactions. The costs of any transaction involving own equity instruments are deducted directly from equity, net of any related tax efect. On 21 October 2013 and 23 October 2014 the Bank’s board of directors amended the regulation of its treasury share policy in order to take into account the criteria recommended by the CNMV, establishing limits on average daily purchase trading and time limits. Also, a maximum price per share was set for purchase orders and a minimum price per share for sale orders. The Bank’s shares owned by the consolidated companies accounted for 0.075% of issued share capital at 31 December 2018 (31 December 2017: 0.024%; 31 December 2016: 0.010%). The average purchase price of the Bank’s shares in 2018 was EUR 4.96 per share and the average selling price was EUR 4.98 per share. The efect on equity, net of tax, arising from the purchase and sale of Bank shares was of EUR 0 million in 2018 (2017: EUR 26 million; 2016: EUR 15 million). 35. Memorandum items Memorandum items relates to balances representing rights, obligations and other legal situations that in the future may have an impact on net assets, as well as any other balances needed to refect all transactions performed by the consolidated entities although they may not impinge on their net assets. a) Guarantees and contingent commitments granted Contingent liabilities includes all transactions under which an entity guarantees the obligations of a third party and which result from fnancial guarantees granted by the entity or from other types of contract. The detail is as follows: Million of euros 31/12/18 31/12/17 31/12/16 Loans commitment granted 218,083 207,671 202,097 Of which doubtful 298 81 8 Financial guarantees granted 11,723 14,499 17,244 Of which doubtful 181 254 1,070 Financial guarantees 11,557 14,287 17,244 Credit derivatives sold 166 212 - Other commitments granted 74,389 64,917 57,055 Of which doubtful 983 992 - Technical guarantees 35,154 30,273 23,684 Other 39,235 34,644 33,371 575 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix ii) Non-managed marketed funds At 31 December 2018 there are non-managed marketed funds totalling EUR 42,211 million (31 December 2017: EUR 41,398 million; 31 December 2016: EUR 23,247 million). c) Third-party securities held in custody At 31 December 2018 the Group held in custody debt securities and equity instruments totalling EUR 940,650 million (31 December 2017: EUR 997,061 million; 31 December 2016 EUR 965,648 million) entrusted to it by third parties. 36. Hedging derivatives The Group, within its fnancial risk management strategy, and in order to reduce asymmetries in the accounting treatment of its operations, enters into hedging derivatives on interest, exchange rate, credit risk or variation of stock prices, depending on the nature of the risk covered. Based on its objective, the Group classifes its hedges in the following categories: • Cash fow hedges: cover the exposure to the variation of the cash fows associated with an asset, liability or a highly probable forecast transaction. This cover the variable-rate issues in foreign currencies, fxed-rate issues in non-local currency, variable-rate interbank fnancing and variable-rate assets (bonds, commercial loans, mortgages, etc.). • Fair value hedges: cover the exposure to the variation in the fair value of assets or liabilities, attributable to an identifed and hedged risk. This covers the interest risk of assets or liabilities (bonds, loans, bills, issues, deposits, etc.) with coupons or fxed interest rates, interests in entities, issues in foreign currencies and deposits or other fxed rate liabilities. • Hedging of net investments abroad: cover the exchange rate risk of the investments in subsidiaries domiciled in a country with a diferent currency from the functional one of the Group. The following table contains details of the hedging instruments used in the Group’s hedging strategies as of 31 December 2018: The breakdown as at 31 December 2018 of the exposures and the provision fund (see note 25) out of balance sheet by impairment stage under IFRS9 is EUR 297,409 million and EUR 382 million in stage 1, EUR 5,324 million and EUR 132 million in stage 2 and EUR 1,462 million and EUR 265 million in stage 3, respectively. Additionally, the Group had provisions for guarantees and commitments granted for an amount of EUR 617 and 459 million and a doubtful exposure amounting to EUR 1,327 and 1,078 million, as at 31 December 2017 and 2016, respectively. A signifcant portion of these guarantees will expire without any payment obligation materialising for the consolidated entities and, therefore, the aggregate balance of these commitments cannot be considered as an actual future need for fnancing or liquidity to be provided by the Group to third parties. Income from guarantee instruments is recognised under Fee and commission income in the consolidated income statements and is calculated by applying the rate established in the related contract to the nominal amount of the guarantee. i. Loan commitments granted Loan commitments granted: frm commitments of grating of credit under predefned terms and conditions, except for those that comply with the defnition of derivatives as these can be settled in cash or through the delivery of issuance of another fnancial instrument. They include stand-by credit lines and long-term deposits. ii. Financial guarantees granted Financial guarantees includes, inter alia, fnancial guarantee contracts such as fnancial bank guarantees, credit derivatives sold, and risks arising from derivatives arranged for the account of third parties. iii. Other commitments granted Other contingent liabilities include all commitments that could give rise to the recognition of fnancial assets not included in the above items, such as technical guarantees and guarantees for the import and export of goods and services. b) Memorandum items i) Of-balance-sheet funds under management The detail of of-balance-sheet funds managed by the Group and by joint ventures is as follows: Million of euros Investment funds Pension funds 2018 2017 2016 127,564 135,749 129,930 11,160 11,566 11,298 Assets under management 19,131 19,259 18,032 157,855 166,574 159,260 576 2018 Auditors’ report and consolidated annual accounts  Million of euros Fair value hedges: Interest rate risk Equity swap Future interest rate Interest rate swap Call money swap Currency swap Infation swap Swaption Collar Floor Exchange rate risk Fx forward Interest rate and exchange rate risk Interest rate swap Call money swap Currency swap Infation risk Call money swap Currency swap Credit risk CDS Cash fow hedges: Interest rate risk Fx forward Future interest rate Interest rate swap Currency swap Floor Exchange rate risk Future FX and c/v term FV FX forward Future interest rate Interest rate swap Currency swap Floor Deposits borrowed Interest rate and exchange rate risk Interest rate swap Currency swap Infation risk FX forward Currency swap Equity risk Option Other risk Future FX and c/v term RF Hedges of net investments in foreign operations: Exchange rate risk FX forward 2018 Carrying amount Changes in fair value used for calculating hedge Notional Value Assets Liabilities inefectiveness Balance sheet line items 3,451 2,648 (5,114) (4,616) - - (2) - 2,345 (4,168) 178,719 163,241 109 7,702 129,217 19,579 4,957 - 51 15 1,611 3,019 3,019 12,237 3,022 20 9,195 168 64 104 54 54 170 121 - 6 1 5 11 11 792 143 - 649 - - - - - 118,400 38,229 4,865 307 49 127 33,956 2,350 1,747 38,457 4,955 3,283 4,946 1,055 23,904 314 - 34,383 12,572 21,811 6,318 414 5,904 77 77 936 936 21,688 21,688 21,688 - - 240 57 10 971 - 186 - 10 775 - - 3,542 20 3,522 45 - 45 - - - - 291 291 291 (250) (45) - (6) - (145) (1) (1) (493) (20) - (473) (4) (3) (1) - - (976) (229) (1) - (202) (26) - (568) - (15) - (5) (548) - - (124) (97) (27) (30) (9) (21) (4) (4) (21) (21) (273) (273) (273) 96 56 - Hedging derivatives (126) Hedging derivatives 321 Hedging derivatives (32) Hedging derivatives (17) Hedging derivatives 9 Hedging derivatives - Hedging derivatives - Hedging derivatives (99) Hedging derivatives 3 3 Hedging derivatives 42 (15) Hedging derivatives - Hedging derivatives 57 Hedging derivatives (5) (3) Hedging derivatives (2) Hedging derivatives - - Hedging derivatives (28) 203 (1) Hedging derivatives 29 Hedging derivatives 159 Hedging derivatives 11 Hedging derivatives 5 Hedging derivatives (878) (697) Hedging derivatives (36) Hedging derivatives (12) Hedging derivatives 8 Hedging derivatives (142) Hedging derivatives - Hedging derivatives 1 Deposits 665 (7) Hedging derivatives 672 Hedging derivatives 11 (1) Hedging derivatives 12 Hedging derivatives (8) (8) Hedging derivatives (21) (21) Hedging derivatives (1) (1) (1) Hedging derivatives 318,807 8,607 (6,363) 67 577 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix              Considering the main contributions of hedging within the Group, the main types of hedgings that are being carried are in Santander UK Group, Banco Santander, S.A., Consumer Group, Banco Santander Mexico and Banco Santander Brazil that are detailed below. Santander UK Group enters into derivatives to provide customers with risk management solutions and to manage and hedge the Group’s own risks. Within fair value hedges, Santander UK Group has portfolios of assets and liabilities at fxed rate that are exposed to changes in fair value due to changes in market interest rates. These positions are managed by contracting mainly Interest Rate Swaps. Efectiveness is assessed by comparing the changes in the fair value of these portfolios generated by the hedged risk with the changes in the fair value of the derivatives contracted. Santander UK Group also has access to international markets to obtain fnancing by issuing fxed-rate debt in its functional currency and other currencies. As such, they are exposed to changes in interest rates and exchange rates, mainly in EUR and USD. This risk is mitigated with Cross Currency Swaps and Interest Rate Swaps in which they pay a fxed rate and receive a variable rate. Efectiveness is evaluated using linear regression techniques to compare changes in the fair value of the debt at interest and exchange rates with changes in the fair value of Interest Rate Swaps or Cross Currency Swaps. Within the cash fow hedges, Santander UK Group has portfolios of assets and liabilities at variable rates, normally at SONIA or LIBOR. To mitigate this risk of variability in market rates, it contracts Interest Rate Swaps. As Santander UK Group obtains fnancing in the international markets, it assumes a signifcant exposure to currency risk mainly USD and EUR. In addition, it also has debt securities for liquidity purposes that assume exposure in foreign moneys, mainly JPY. To manage this exchange rate risk, Spot, Forward and Cross Currency Swap are contracted to match the cash fow profle and the maturity of the estimated interest and principal repayments of the hedged item. Efectiveness, is assessed by comparing changes in the fair value of the derivatives with changes in the fair value of the hedged item attributable to the hedged risk by applying a hypothetical derivative method using linear regression techniques. In addition, within the hedges that cover equity risk, Santander UK Group ofers employees the opportunity to purchase shares of the Bank at a discount under the Sharesave scheme, exposing the bank to share price risk. As such, options are purchased allowing them to purchase shares at a pre-set price. Banco Santander, S.A. covers the risks of its balance sheet in a variety of ways. On the one hand, documented as fair value hedges, it covers the interest rate, foreign currency and credit risk of fxed-income portfolios at a fxed rate (REPOs are included in this category). Resulting, in an exposure to changes in their fair value due to variations in market conditions based on the various risks hedged, which has an impact on the Bank’s income statement. To mitigate these risks, the Bank contracts derivatives, mainly Interest rate Swaps, Cap&Floors, Forex Forward and Credit Default Swaps. On the other hand, the interest and exchange rate risk of loans granted to corporate clients at a fxed rate is generally covered. These coverages, are carried out through Interest Rate Swaps and Cross Currency Swaps. In addition, the Bank manages the interest and exchange risk of debt issues in their various categories (issuing covered bonds, perpetual, subordinated and senior bond) and in diferent currencies, denominated at fxed rates, and therefore subject to changes in their fair value. These issues are covered through Interest Rate Swaps and Cross Currency Swaps. The Bank’s methodology for measuring the efectiveness of this type of coverage is based on comparing the markets value of the hedged items (based on the objective risk of the hedge) and of the hedging instruments in order to analyse whether the changes in the market value of the hedged items are ofset by the market value of the hedging instruments, thereby mitigating the hedged risk. Prospectively, the same analysis is performed, measuring the theoretical market values in the event of parallel variations in the market curves of a positive basis point. Finally, the Bank also manages and hedges the interest rate risk of its mortgage portfolio and various variable rate issues in cash fow hedges, which hedge the exposure of fows due to the risk of variations in interest curves, which may have an impact on the income statement. These hedges are made through mainly Interest Rate Swaps. The hypothetical derivative methodology is used to measure the efectiveness of these cash fow hedges, in order to determine the level of risk compensation based on the comparison of the discounted net cash fows of the hedging instruments and the hedged items. Consumer Group entities mainly have loans portfolios at fxed interest rates and are therefore, exposed to changes in fair value due to movements in market interest rates. The entities manage this risk by contracting Interest Rate Swaps in which they pay a fxed rate and receive a variable rate. Interest rate risk is the only one hedged and, therefore, other risks, such as credit risk, are managed but not hedged by the entities. The interest rate risk component is determined as the change in fair value of fxed rate loans arising solely from changes in a reference rate. This strategy is designated as a fair value hedge and its efectiveness is assessed by comparing changes in the fair value of loans attributable to changes in reference interest rates with changes in the fair value of interest rate swaps. In addition, in order to access international markets with the aim of obtaining sources of fnancing, some Consumer Group´s entities issue fxed rate debt in their own currency and in other currencies that difer from their functional currency. Therefore, they are exposed to changes in both interest rates and exchange rates, which they mitigate with derivatives (Interest Rate Swaps, Fx Forward and Cross Currency Swaps) in which they receive a fxed interest rate and pay a variable interest rate, implemented with a fair value hedge. 578 2018 Auditors’ report and consolidated annual accounts The cash fow hedges of the Santander Group´s entities hedge the foreign currency risk of loans and fnancing. Its efectiveness is assessed by comparing through lineal regression the changes in the fair value of the bonds to the changes in fair value of the derivatives. Finally, it has hedges of net investments abroad to hedge the foreign exchange risk of the shareholding in NOK and CNY currencies. Banco Santander Mexico has mainly long-term loan portfolios at fxed interest rates, portfolios of short-term deposits in local currency, portfolios of Mexican Government bonds and corporate bonds in currencies other than the local currency and are therefore exposed to changes in fair value due to movements in market interest rates, as well as these latter portfolios also to variations in exchange rates. The entity manages this risk by contracting derivatives (Interest Rate Swaps or Cross Currency Swaps) in which they pay a fxed rate and receive a variable rate. The interest rate is hedged and the exchange risk, if applicable, too. Thus, other risks, such as credit risk, are managed but not hedged by the entities. The interest rate risk component is determined as the change in the fair value of fxed rate loans arising solely from changes in a reference rate. This strategy is designated as a fair value hedge and its efectiveness is assessed by comparing changes in the fair value of loans attributable to changes in benchmark interest rates with changes in the fair value of interest rate swaps. Regarding cash fow hedges, Banco Santander Mexico has a portfolio of unsecured bonds issued at a variable rate in its local currency, which it manages with an Interest Rate Swap in which it receives a variable rate and pays a fxed rate. On the other hand, it also has diferent items in currencies other than the local currency: unsecured foating rate bonds, commercial bank loans at variable rates, fxed rate issues, Mexican and Brazilian government bonds at fxed rates and loans received in USD from other banks. In all these portfolios, the Bank is exposed to exchange rate variations, which it mitigates by contracting Cross Currency Swaps or FX Forward. Banco Santander Brazil has, on the one hand, fxed-rate government bond portfolios and, therefore, they are exposed to changes in fair value due to movements in market interest rates. The entity manages this risk by contracting derivatives (Interest Rate Swaps or Futures) in which they pay a fxed rate and receive a variable rate. The interest rate risk is the only one hedged and consequently other risks, such as credit risk, are managed but not hedged by the entity. This strategy is designated as a fair value hedge and its efectiveness is evaluated by comparing by linear regression the changes in the fair value of the bonds with the changes in the fair value of the derivatives. On the other hand, as part of the fair value hedge strategy, it has corporate loans in diferent currencies than the local one and is therefore exposed to changes in fair value due to exchange rates. This risk is mitigated by contracting Cross Currency Swaps. Its efectiveness is evaluated by comparing changes in the fair value of loans attributable to changes in benchmark interest rates with changes in the fair value of derivatives. Finally, it also has a portfolio of long-term Corporate Bonds with infation-indexed rates. With reference to what it has been mentioned before, they are exposed to variations in market value due to variations in market infation rates. In order to achieve its mitigation, they contract futures in which they pay the indexed infation and receive variable interest rates. In the hedge of cash fows, Banco Santander Brazil has portfolios of loans and government bonds in diferent currency than the entity´s functional currency and, therefore, it is subject to the risk of changes in currency rates. This exposure will be mitigated by hiring cross currency swaps and futures. Its efectiveness is assessed by comparing changes in fair value of loans and bonds to changes in fair value of such derivatives. Finally, they have a portfolio of variable rate government bonds, so they are exposed to changes in the value due to changes in interest rates. In order to mitigate these changes, a future is hired in which a variable rate is paid and a fxed rate is received. Its efectiveness is assessed by comparing changes in the fair value loans and bonds to changes in the fair value of the futures. In any case, in the event of inefectiveness in fair value or cash fow hedges, the entity mainly considers the following causes: • Possible economic events afecting the entity (e.g.: default), • For movements and possible market-related diferences in the collateralized and non-collateralized curves used in the valuation of derivatives and hedged items, respectively. • Possible diferences between the nominal value, settlement/ price dates and credit risk of the hedged item and the hedging element. Regarding net foreign investments hedges, basically, they are allocated in Banco Santander, S.A. and Santander Consumer Finance Group. The Group assumes, as a priority objective in risk management, to minimize – up to a determined limit set up by the responsible for the fnancial management of the Group- the impact on the calculation of the capital ratio of their permanent investments included within the consolidation perimeter of the Group, and whose shares are legally named in a diferent currency than the holding has. For this purpose, fnancial instruments (generally derivatives) on exchange rates are hired, that allow mitigating the impact on the capital ratio of changes in the forward exchange rate. The Group hedges the risk, mainly, for the following currencies: BRL, CLP, MXN, CAD, COP, CNY, GBP, CHF, NOK, USD and PLN. The instruments used to hedge the risk of these investments are Forex Swaps, Forex Forward and buys/sells of spot currencies. In the case of this type of hedge, the inefectiveness scenarios are considered to be of low probability, given that the hedging instrument is designated considering the determined position and the spot rate at which it is found. 579 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The following table sets out the maturity profle of the hedging instruments used in the Group’s non-dynamic hedging strategies:  Million of euros Up to one month One to three months Three months to one year One year to fve years More than fve years 31 December 2018 Fair value hedges: Interest rate risk Equity swap Future interest rate Interest rate swap Call money swap Currency swap Swaption Collar Floor Exchange rate risk Fx forward Interest rate and exchange rate risk Interest rate swap Call money swap Currency swap Infation risk Call money swap Currency swap Credit risk CDS Cash fow hedges: Interest rate risk Fx forward Future interest rate Interest rate swap Currency swap Floor Exchange rate risk Future FX and c/v term FV FX forward Future interest rate Interest rate swap Currency swap Floor Interest rate and exchange rate risk Interest rate swap Currency swap Infation risk FX forward Currency swap Equity risk Option Other risk Future FX and c/v term RF Hedges of net investments in foreign operations: Exchange rate risk FX forward 580 9,377 8,436 - 668 7,672 96 - - - - 17 17 924 445 - 479 - - - - - 18,684 2,079 49 2 2,028 - - 16,166 4,955 1,423 4,946 - 4,842 - - - - 439 - 439 - - - - 555 555 555 17,989 12,519 27 2,012 10,213 267 - - - - 1,855 1,855 3,615 1,462 - 2,153 - - - - - 6,994 2,607 - - 2,161 446 - 3,478 - - - - 3,478 - 8 8 - 524 121 403 - - 377 377 777 777 777 28,616 25,760 23,773 21,987 46 981 18,423 1,823 714 - - - 1,147 1,147 639 35 - 604 - - - - - 16,954 6,971 - - 5,957 839 175 5,896 - 47 - - 5,535 314 2,921 898 2,023 566 156 410 41 41 559 559 11,067 11,067 11,067 51,794 Total 178,719 163,241 109 7,702 129,217 19,579 4,957 51 15 1,611 3,019 3,019 12,237 3,022 20 9,195 168 64 104 54 54 118,400 38,229 49 127 33,956 2,350 1,747 38,457 4,955 3,283 4,946 1,055 23,904 314 34,383 12,572 21,811 6,318 414 5,904 77 77 936 936 49,039 46,310 - 1,391 32,407 10,426 1,875 - 15 196 - - 2,556 370 20 2,166 168 64 104 5 5 12,821 552 - - 217 335 - 933 - - - - 933 - 9,524 3,210 6,314 1,812 - 1,812 - - - - 78,541 73,989 36 2,650 60,502 6,967 2,368 51 - 1,415 - - 4,503 710 - 3,793 - - - 49 49 62,947 26,020 - 125 23,593 730 1,572 11,984 - 1,813 - 1,055 9,116 - 21,930 8,456 13,474 2,977 137 2,840 36 36 - - 9,289 9,289 9,289 - - - 21,688 21,688 21,688 150,777 61,860 318,807 2018 Auditors’ report and consolidated annual accounts        Additionally, the profle information of maturities and the price/ average rate for the most representative geographies is shown: Santander UK Group 31 December 2018 Million of euros Up to one month One to three months Three months to one year One year to fve years More than fve years Total 16,333 44,166 17,498 94,288 Fair value hedges Interest rate risk Interest rate instruments Nominal Average fxed interest rate (%) GBP Average fxed interest rate (%) USD Average fxed interest rate (%) EUR Interest rate and foreign exchange rate risk Exchange rate instruments Nominal Average GBP/EUR exchange rate Average GBP/USD exchange rate Average fxed interest rate (%) USD Average fxed interest rate (%) EUR Cash fow hedges Interest rate risk Interest rate instruments Nominal Average fxed interest rate (%) GBP Foreign exchange risk Exchange rate instruments Nominal Average GBP/JPY exchange rate Average GBP/EUR exchange rate Average GBP/USD exchange rate Interest rate and foreign exchange rate risk Exchange rate instruments Nominal Average GBP/EUR exchange rate Average GBP/USD exchange rate Average fxed interest rate (%) GBP 6,888 0.633 (0.223) 1.513 877 - 1.580 - 3.615 9,403 0.788 0.670 1.314 2,894 - 1.332 - 2.500 1.057 0.911 1.337 - - - - - 1.586 1.085 2.684 1,331 1.183 1.511 3.888 2.375 - - 1,917 0.726 2,225 0.733 3,466 1.334 4,378 - - 1.304 - - - - 2,853 147.215 - 1.307 - - - - 3,310 7,132 146.372 145.319 1.280 1.310 2,859 1.252 1.633 2.340 1.135 1.305 21,288 1.271 1.545 2.660 2.849 1.261 2.179 585 1.168 - 3.923 7.950 - - - - - - 5,687 7,608 17,673 9,495 33,642 1.217 1.511 2.900 581 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix      Banco Santander, S.A. Fair value hedges Interest rate risk Interest rate instruments Nominal Average fixed interest rate (%) GBP Average fixed interest rate (%) EUR Average fixed interest rate (%) CHF Average fixed interest rate (%) USD Foreign exchange risk Exchange rate instruments Nominal Interest rate and foreign exchange rate risk Exchange rate instruments Nominal Average fixed interest rate (%) AUD/EUR Average fixed interest rate (%)CZK/EUR Average fixed interest rate (%)EUR/COP Average fixed interest rate (%)HKD/EUR Average fixed interest rate (%)JPY/EUR Average fixed interest rate (%)NOK/EUR Average fixed interest rate (%)USD/COP Average AUD/EUR exchange rate Average CZK/EUR exchange rate Average EUR/GBP exchange rate Average EUR/COP exchange rate Average EUR/MXN exchange rate Average HKD/EUR exchange rate Average JPY/EUR exchange rate Average MXN/EUR exchange rate Average NOK/EUR exchange rate Average USD/BRL exchange rate Average USD/COP exchange rate Credit Risk Credit risk instruments Nominal Cash flow hedges Interest rate risk Interest rate instruments Nominal Average fixed interest rate (%) EUR Hedges of net investments in foreign operations Exchange rate instruments Exchange rate instruments Nominal Average BRL/EUR exchange rate Average CLP/EUR exchange rate Average CNY/EUR exchange rate Average COP/EUR exchange rate Average GBP/EUR exchange rate Average MXN/EUR exchange rate Average PLN/EUR exchange rate 582 31 December 2018 Million of euros Up to one month Three One to three months to one year months One year to five years More than five years Total 500 - 3.75 - - 665 - 0.63 - - 425 - 2.06 - 1.38 12,987 - 1.81 0.76 3.43 22,030 7.08 3.20 1.04 4.11 36,602 - 1,825 771 - - 2,596 41 - - - - - - 6.13 - - - - - - - - - - - - 1,942 - 373 4.46 - - - - 22.98 - 461 - - - - - - 6.71 - - 1.145 - - - - - - - 0.0003 - - - 120 - - 7.54 - - - - - - - 0.0003 - - - - - 0.269 0.0003 - - - 3,656 2,085 4.00 0.86 - 2.52 0.64 - 9.47 1.499 25.407 - - - 8.718 132.014 14.696 - - - 951 4.80 - - - 1.28 3.61 - 1.499 26.030 - - - - 125.883 - 9.606 - 0.0003 49 5 54 6,130 0.51 20 0.55 8,092 20,746 497 - 766.01 - 3,728.01 0.91 - - 10,587 4.46 768.25 8.14 3,685.80 0.89 24.51 4.38 9,289 4.73 795.10 - - - 24,50 4,26 - - - - - - - - 2018 Auditors’ report and consolidated annual accounts     Consumer Group Fair value hedges Interest rate risk Interest rate instruments Nominal Average fixed interest rate (%) EUR Average fixed interest rate (%) CHF Foreign exchange risk Exchange rate instruments Nominal Average DKK/EUR exchange rate Average NOK/EUR exchange rate Average CHF/EUR exchange rate Interest rate and foreign exchange rate risk Exchange rate instruments Nominal Average SEK/EUR exchange rate Average DKK/EUR exchange rate Average fixed interest rate (%) SEK Average fixed interest rate (%) DKK Cash flow hedges Interest rate risk Interest rate instruments Nominal Average fixed interest rate (%) EUR Foreign exchange risk Exchange rate instruments Nominal Average SEK/EUR exchange rate Average NOK/EUR exchange rate Average CHF/EUR exchange rate Average CAD/EUR exchange rate Average DKK/EUR exchange rate Average PLN/EUR exchange rate Average USD/EUR exchange rate Average JPY/EUR exchange rate 31 December 2018 Million of euros Up to one month Three One to three months to one year months One year to five More than five years years 253 (0.197) (0.659) 17 134.135 - - - - - - - 85 0.183 339 0.101 0.108 0.896 0.654 0.134 - - - 672 (0.125) (0.696) 3,488 (0.036) (0.679) 6,883 (0.065) (0.561) 30 - - 376 134.109 103.232 878.624 887.218 240 - 0.134 - 0.002 339 0.104 0.134 0.008 0.003 - - - - 448 - 0.134 - 0.004 99 0.183 313 0.183 423 0.183 557 0.098 0.108 0.859 0.658 0.134 - - - 2,368 0.099 0.108 0.870 0.652 0.134 0.234 0.897 0.008 1,061 0.099 0.108 0.900 0.656 - 0.233 - 0.008 - - - 63 (0.113) - - - - - - - - - - - - - - - - - - - - - - - - Total 11,359 423 1,027 920 4,325 943 583 Hedges of net investments in foreign operations Foreign exchange risk Exchange rate instruments Nominal 181 282 480 Average NOK/EUR exchange rate 103.751 103.538 102.963 Average CNY/EUR exchange rate - - 121.796 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix                  Banco Santander México Fair value hedges Interest rate risk Interest rate instruments Nominal Average fixed interest rate (%) MXN Average fixed interest rate (%) USD Interest rate and foreign exchange rate Exchange and interest rate instruments Nominal Average EUR/MXN exchange rate Average GBP/MXN exchange rate Average USD/MXN exchange rate Average MXV/MXN exchange rate Average fixed interest rate (%) USD Average fixed interest rate (%) EUR Average fixed interest rate (%) GBP Cash flow hedges Interest rate risk Interest rate instruments Nominal Average fixed interest rate (%) MXN Foreign exchange risk Exchange rate instruments Nominal Average EUR/MXN exchange rate Average GBP/MXN exchange rate Average USD/MXN exchange rate Average BRL/MXN exchange rate 31 December 2018 Million of euros Up to one month Three One to three months to one year months One year to five More than five years years - - - - - - - - - - - - - 1 5.180 - - - - - - - - - - - 346 6.907 1.465 41 - - 13.920 5.059 8.000 - - - - 1,415 - - 18.729 5.863 44 - - 20.289 - 56 16.679 - 17.918 5.732 80 5.593 1.465 282 20.470 24.870 13.920 5.059 3.980 2.420 - 178 7.258 2,719 18.932 23.127 16.443 5.736 - - - 1,009 21.890 25.310 18.390 5.059 4.125 2.750 6.750 - - 103 18.688 25.947 18.508 - Total 427 1,332 178 4,337 584 2018 Auditors’ report and consolidated annual accounts                  Banco Santander Brazil Fair value hedges Interest rate risk Interest rate instruments Nominal Average fxed interest rate (%) BRL Foreign exchange rate risk and other Exchange rate instruments Nominal Average USD/BRL exchange rate Cash fow hedges Interest rate risk Interest rate instruments Nominal Average fxed interest rate (%) BRL Foreign exchange risk and other Exchange rate instruments Nominal Average USD/BRL exchange rate 31 December 2018 Million of euros Up to one month Three One to three months to one year months One year to fve More than fve years years 668 9.500 6 3.247 2,045 6.967 - 6.937 3,529 10.055 1,378 10.030 15 3.303 36 3.551 316 3.642 38 3.265 3,877 6.500 2,997 6.500 3,030 6.500 119 6.500 - - - - 8 26 3.716 3.648 - - 238 3.135 Total 7,620 411 10,023 272 585 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix                  The following table contains details of the hedged exposures covered by the Group’s hedging strategies of 31 December 2018: Million of euros 31 December 2018 Carrying amount of hedged items Accumulated amount of fair value adjustments on the hedged item Change in fair value Cash flow hedge/currency of hedged item for translation reserve ineffectiveness Continuing Discontinued hedges assessment hedges (20) (74) (39) (35) 18 (186) 35 3 170 (40) (3) 8 (11) 53 16 (31) 67 1 - 4 1 3 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Assets Liabilities Assets Liabilities Balance sheet line item Cash flow hedges: 110,669 46,830 1,915 (1,765) Interest rate risk 104,393 39,251 1,886 (1,478) Deposits 5,922 1,195 Bond Repo Loans of securities Liquidity facilities Issuances assurance Securitisation Equity instruments Exchange rate risk Deposits Bonds Interest and Exchange rate risk Borrowed deposits Bonds Securitisation Repos CLO Inflation risk Deposits Bonds Credit risk Bonds 27,235 21,759 13,874 53,397 3,965 - - - 3,378 1,614 1,764 2,776 751 1,591 - 434 - 68 - 68 54 54 561 175 232 2,013 13,316 - - - - 7,474 - 3,571 3,358 99 446 105 105 - - - 279 792 25 742 48 - - - 5 9 (4) 21 19 2 - - - 3 - 3 - - 1 Deposits and loans and advances (791) Debt instruments (16) Other assets - Loans and advances (2) Loans and advances (12) Other assets/liabilities (658) Other assets/liabilities - Equity instruments - - Deposits and loans and advances - Debt instruments (287) - Deposits and loans and advances (26) Debt instruments (262) Other assets/liabilities 1 Other assets/liabilities - Other assets/liabilities 1 1 Deposits and loans and advances - Debt instruments - - Debt instruments 586 2018 Auditors’ report and consolidated annual accounts    Million of euros 31 December 2018 Carrying amount of hedged items Accumulated amount of fair value adjustments on the hedged item Assets Liabilities Assets Liabilities Balance sheet line item Change in fair value of hedged item for inefectiveness assessment Cash fow hedge/currency translation reserve Continuing hedges Discontinued hedges Cash fow hedges Interest rate risk Firm commitment Deposits Government bonds Liquidity facilities Seconday market loans Senior securitization Exchange rate risk Deposits Bonds Secondary market loans Senior titulisation CLO Interest and Exchange rate risk Deposits Bonds Securitisation Infation risk Deposits Bonds Liquidity facilities Equity risk Highly likely scheduled transactions Other risks Bonds Net foreign investments hedges Exchange rate risk Firm commitment Equity instruments Other assets/liabilities Deposits and loans and advances Debt instruments Loans and advances Other assets/liabilities Other assets/liabilities Other assets/liabilities Deposits and loans and advances Loans and advances Other assets/liabilities Other assets/liabilities Deposits and loans and advances Debt instruments Other assets/liabilities Deposits and loans and advances Debt instruments Loans and advances Other assets/liabilities Other assets/liabilities 792 792 13 779 - - - - 10 10 - 10 - - - Other assets/liabilities - Equity instruments (432) (52) (24) (26) (13) 8 4 (1) (416) 83 (309) (179) (11) - 4 7 (13) 10 15 25 (3) (7) 17 17 - - - - - - 447 131 (75) 47 92 65 2 - (23) (8) (16) (21) 21 1 341 2 (9) 348 22 25 (3) - (4) (4) (20) (20) - - - - (10) (12) - - - (12) - - 2 - 2 - - - - - - - - - - - - - - - - - - - 111,461 46,830 1,925 (1,765) (452) 447 (10) The cumulative amount of adjustments of the fair value hedging instruments that remain in the balance for covered items that are no longer adjusted by proft and loss of coverage as of 31 December 2018 is EUR 71 million euros. 587 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix             The net impact of the coverages are shown in the following table: Million of euros 2018 Reclassified amount of reserves to the income statement due to: Cover transaction affecting the Line of the income statement that includes reclassified items income statement 553   39   (24) Interest margin (4) Interest margin 17 Interest margin/ Gains or losses of financial assets/liabilities 47 Interest margin/ Gains or losses of financial assets/liabilities 3 Interest margin - Interest margin -   Ineffective coverage Earnings/ (losses) recognised in another recognised Line of the income cumulative overall result statement of cash flows the ineffectiveness income in the statement that includes 75 (18) (24) Gains or losses of financial assets/liabilities (61) Gains or losses of financial assets/liabilities 1 Gains or losses of financial assets/liabilities 46 Gains or losses of financial assets/liabilities 12 Gains or losses of financial assets/liabilities 8 Gains or losses of financial assets/liabilities 95 39 Gains or losses of financial assets/liabilities 8 Gains or losses of financial assets/liabilities 49 Gains or losses of financial assets/liabilities (1) Gains or losses of financial assets/liabilities (2) (2) Gains or losses of financial assets/liabilities 8 (4) - Gains or losses of financial assets/liabilities (21) Gains or losses of financial assets/liabilities 2 Gains or losses of financial assets/liabilities 16 Gains or losses of financial assets/liabilities - Gains or losses of financial assets/liabilities - Gains or losses of financial assets/liabilities (1) Gains or losses of financial assets/liabilities 200 193 (2) 50 104 85 2 (46) - Fair value hedges Interest rate risk Deposits Bonds Repo Loans of fixed- income securities Liquidity lines Securitisations Risk of interest rate and exchange rate Deposits Bonds Securitisations CLO Other Risks Securitisations Cash flow hedges Risk of interest rate Firm Commitment Deposits Bonds Loans secondary markets Liquidity lines Repo Securitisations 588 2018 Auditors’ report and consolidated annual accounts                                   Earnings/ (losses) recognised in another cumulative overall result (20) (25) (25) - 5 24 1 45 1 (4) 48 11 14 (3) (8) (8) (21) (21) - - - - Risk of Exchange rate Deposits Asset bonds Repo Loans secondary markets Securitisations CLO Risk of interest rate and exchange rate Deposits Bonds Securitisations Risk of infation Deposits Asset bonds Risk of equity Highly probable planned transactions Other risks Bonds Coverage of net investment abroad Risk of Exchange rate Equity instruments Million of euros 2018 Reclassifed amount of reserves to the income statement due to: Line of the income statement that includes the inefectiveness of cash fows Cover transaction afecting the income statement Line of the income statement that includes reclassifed items Inefective coverage recognised in the income statement (688) (698) Gains or losses of fnancial assets/liabilities 43 Gains or losses of fnancial assets/liabilities - Gains or losses of fnancial assets/liabilities 4 Gains or losses of fnancial assets/liabilities (37) Gains or losses of fnancial assets/liabilities - Gains or losses of fnancial assets/liabilities (457) (563) Interest margin/ Gains or losses of fnancial assets/liabilities 89 Interest margin/ Gains or losses of fnancial assets/liabilities (3) Gains or losses of fnancial assets/liabilities 48 Interest margin/ Gains or losses of fnancial assets/liabilities (36) Interest margin/ Gains or losses of fnancial assets/liabilities 8 Interest margin/ Gains or losses of fnancial assets/liabilities 700 967 743 Gains or losses of fnancial assets/liabilities 447 Gains or losses of fnancial assets/liabilities 778 Interest margin 571 Interest margin/ Gains or losses of fnancial assets/liabilities (490) Gains or losses of fnancial assets/liabilities (382) Interest margin/ Gains or losses of fnancial assets/liabilities - - Gains or losses of fnancial assets/liabilities - Gains or losses of fnancial assets/liabilities - - Gains or losses of fnancial assets/liabilities - - Gains or losses of fnancial assets/liabilities - - - - Gains or losses of fnancial assets/liabilities 4 3 Interest margin 1 Interest margin - - - - - - - - 200 83 553 589 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix     The following table shows a reconciliation of each component of equity and an analysis of other comprehensive income in relation to hedge accounting: Million of euros Balance at beginning of year Cash fow hedges Risks of interest rate Amounts transferred to income statements Other reclassifcations Risks of exchange rate Amounts transferred to income statements Other reclassifcations Risks of interest rate and exchange rate Amounts transferred to income statements Other reclassifcations Risk of infation Amounts transferred to income statements Other reclassifcations Risk of equity Amounts transferred to income statements Other reclassifcations Other risks Amounts transferred to income statements Other reclassifcations Minorities Taxes Balance at end of year 37. Discontinued operations No operations were discontinued in 2018, 2017 or 2016. 2018 152 193 (37) 230 (20) 457 (477) 45 (967) 1,012 11 (4) 15 (8) - (8) (21) - (21) (25) (50) 277 38. Interest income Interest and similar income in the consolidated income statement comprises the interest accruing in the year on all fnancial assets with an implicit or explicit return, calculated by applying the efective interest method, irrespective of measurement at fair value; and the rectifcations of income as a result of hedge accounting. Interest is recognised gross, without deducting any tax withheld at source. The detail of the main interest and similar income items earned in 2018, 2017 and 2016 is as follows: Million of euros Loans and advances, central banks Loans and advances, credit institutions Debt instruments 2018 1,320 2017 2016 1,881 2,090 1,555 1,840 2,388 6,429 7,141 6,927 Loans and advances, customers 43,489 43,640 42,578 Other interest 1,532 1,539 1,173 54,325 56,041 55,156 Most of the interest and similar income was generated by the Group’s fnancial assets that are measured either at amortised cost or at fair value through Other comprehensive income. 39. Interest expense Interest expense and similar charges in the consolidated income statement includes the interest accruing in the year on all fnancial liabilities with an implicit or explicit return, including remuneration in kind, calculated by applying the efective interest method, irrespective of measurement at fair value; the rectifcations of cost as a result of hedge accounting; and the interest cost attributable to provisions recorded for pensions. The detail of the main items of interest expense and similar charges accrued in 2018, 2017 and 2016 is as follows: Million of euros Central banks deposits 2018 2017 2016 421 216 127 Credit institution deposits 2,597 2,045 1,988 Customer deposits 9,062 11,074 12,886 Debt securities issued and subordinated liabilities 6,073 6,651 7,767 Marketable debt securities 5,303 5,685 6,822 Subordinated liabilities (Note 23) Provisions for pensions (Note 25) Other interest 770 186 966 198 945 201 1,645 1,561 1,098 19,984 21,745 24,067 Most of the interest expense and similar charges was generated by the Group’s fnancial liabilities that are measured at amortised cost. 590 2018 Auditors’ report and consolidated annual accounts40. Dividend income 42. Commission income Dividend income includes the dividends and payments on equity instruments out of profts generated by investees after the acquisition of the equity interest. The detail of Income from dividends as follows: Million of euros Commission income comprises the amount of all fees and commissions accruing in favour of the Group in the year, except those that form an integral part of the efective interest rate on fnancial instruments. The detail of Fee and commission income is as follows: 2018* 2017 2016 Million of euros Dividend income classifed as: Financial assets held for trading 241 234 217 Coming from collection and payment services: Non-trading fnancial assets mandatorily at fair value through proft or loss 23 Financial assets available-for-sale 150 196 Financial assets at fair value through other comprehensive income 106 370 384 413 * See further detail regarding the impacts of the entry into force of IFRS9 as of 1 January 2018 (Note 1.b). Bills Demand accounts Cards Orders Cheques and other Coming from non-banking fnancial products: Investment funds Pension funds Insurance 41. Income from companies accounted for using the equity method Income from companies accounted for using the equity method comprises the amount of proft or loss attributable to the Group generated during the year by associates and joint ventures. The detail of Income from companies accounted for using the equity method is as follows: Million of euros Coming from Securities services: Securities underwriting and placement Securities trading Administration and custody Asset management Other: Foreign exchange 2018 2017 2016 Financial guarantees 2018 2017 2016 334 368 ,371 1 1,490 295 1,191 ,514 3 3,515 2,972 475 138 449 154 431 133 ,832 5 5,976 5,022 ,024 1 124 751 92 696 86 2 ,433 2,517 2,428 ,581 3 3,360 3,210 283 251 458 305 374 302 359 251 282 287 297 201 ,297 1 1,286 1,067 546 549 291 471 559 283 353 505 286 Zurich Santander Insurance América, S.L. Wizink Bank, S.A. Allianz Popular, S.L. Companhia de Crédito, Financiamento e Investimento RCI Brasil SAM Investment Holdings Limited Other entities 194 56 45 21 - 421 737 241 36 15 19 87 306 704 223 Commitment fees Other fees and commissions 2 ,568 2,644 2,500 3,954 3,957 3,644 14,664 14,579 12,943 - - 12 79 130 444 591 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix43. Commission expense Commission expense shows the amount of all fees and commissions paid or payable by the Group in the year, except those that form an integral part of the efective interest rate on fnancial instruments. a) Breakdown The detail, by origin, of Gains/losses on fnancial assets and liability: Million of euros 2018* 2017 2016 42 49 47 Of which: debt instruments Gains or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net (IFRS9) Financial assets at amortised cost Other fnancial assets and liabilities Of which: debt instruments Of which: equity instruments Gains or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net (IAS39) Of which fnancial assets available for sale Of which: equity instruments Gains or losses on fnancial assets and liabilities held for trading, net** 604 39 565 563 404 869 472 316 156 861 464 397 1,515 1,252 2,456 Gains or losses on non-trading fnancial assets and liabilities mandatory at fair value through proft or loss 331 Gains or losses on fnancial assets and liabilities measured at fair value through proft or loss, net** Gains or losses from hedge accounting, net (57) (85) 426 83 (11) (23) 2,476 1,560 3,728 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** Includes the net result obtained by transactions with debt securities, equity instruments, derivatives and short positions included in this portfolio when the Group jointly manages its risk in these instruments. As explained in Note 45, the above breakdown should be analysed in conjunction with the exchange diferences, net: Million of euros Exchange diferences, net 2018 (679) 2017 105 2016 (1,627) The detail of Fee and commission expense is as follows: Million of euros Commissions assigned to third parties Cards By collection and return of efects Other fees assigned Other commissions paid Brokerage fees on lending and deposit transactions Sales of insurance and pension funds Other fees and commissions 2018 2017 2016 1,972 1,358 11 603 1,207 1,831 1,391 12 428 1,151 1,639 1,217 11 411 1,124 232 933 205 897 204 873 3,179 2,982 2,763 44. Gains or losses on fnancial assets and liabilities Gains/losses on fnancial assets and liabilities includes the amount of the Other comprehensive income of fnancial instruments, except those attributable to interest accrued as a result of application of the efective interest method and to allowances, and the gains or losses obtained from the sale and purchase thereof. 592 2018 Auditors’ report and consolidated annual accounts b) Financial assets and liabilities at fair value through proft or loss The detail of the amount of the asset balances is as follows: At 31 December 2018, the amount of the change in the fair value of fnancial liabilities at fair value through proft or loss attributable to changes in their credit risk during the year is not material. Million of euros 2018 2017 2016 45. Exchange diferences, net Exchange diferences shows basically the gains or losses on currency dealings, the diferences that arise on translations of monetary items in foreign currencies to the functional currency, and those disclosed on non-monetary assets in foreign currency at the time of their disposal. The Group manages the currencies to which it is exposed together with the arrangement of derivative instruments and, accordingly, the changes in this line item should be analysed together with those recognised under Gains/losses on fnancial assets and liabilities (see Note 44). Loans and receivables: 56,323 40,875 40,390 Central banks 9,226 - - Credit institutions 23,099 11,585 13,290 Customers Debt instruments Equity instruments Derivatives 23,998 29,290 27,100 36,609 39,836 52,320 12,198 22,286 15,043 55,939 57,243 72,043 161,069 160,240 179,796 The Group mitigates and reduces this exposure as follows: • With respect to derivatives, the Group has entered into framework agreements with a large number of credit institutions and customers for the netting-of of asset positions and the provision of collateral for non-payment. At 31 December 2018 the actual credit risk exposure of the derivatives was EUR 33,289 million. • Loans and advances to credit institutions and Loans and advances to customers included reverse repos amounting to EUR 33,837 million at 31 December 2018. Also, mortgage-backed assets totalled EUR 1,334 million. • Debt instruments include EUR 27,720 million of Spanish and foreign government securities. At 31 December 2018 the amount of the change in the year in the fair value of fnancial assets at fair value through proft or loss attributable to variations in their credit risk (spread) was not material. The detail of the amount of the liability balances is as follows: Million of euros Deposits 65,304 84,724 48,863 2018 2017 2016 Central banks Credit institutions Customer Marketable debt securities Short positions Derivatives Other fnancial liabilities 14,816 10,891 39,597 2,305 15,002 55,341 449 9,142 10,463 18,458 57,124 3,056 5,059 33,341 2,791 20,979 23,005 57,892 74,369 589 - 138,401 167,240 149,028 593 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 46. Other operating income and expenses 47. Staf costs Other operating income and Other operating expenses in the consolidated income statements include: a) Breakdown The detail of Staf costs is as follows: Million of euros Million of euros 2018 2017 2016 Insurance activity 51 57 63 Wages and salaries Income from insurance and reinsurance contracts issued Of which: 3,175 2,546 1,900 Social Security costs Additions to provisions for defned beneft pension plans (Note 25) Insurance and reinsurance premium income 3,011 2,350 1,709 Contributions to defned contribution pension funds Reinsurance income (Note 15) 164 196 191 Other staf costs 2018 2017 8,824 8,879 1,412 1,440 2016 8,133 1,291 84 88 81 287 271 266 1,258 1,369 1,233 11,865 12,047 11,004 b) Headcount The average number of employees in the Group, by professional category, was as follows: Average number of employees 2018 2017 2016 The Bank: Senior management* 22 64 Other line personnel 30,339 21,327 Clerical staf** General services personnel** Rest of Spain Santander UK plc Banco Santander (Brasil) S.A. Other companies*** - - 30,421 7,944 18,757 46,645 98,062 76 20,291 1,904 13 22,284 6,925 19,428 - - 21,391 12,703 19,079 46,210 48,052 96,349 94,946 201,829 195,732 191,635 * During 2018, categories of deputy assistant executive vice president and above were erased. ** During 2017, clerical staf and general services personnel categories were erased considering all the staf in the aforementioned categories on the other line personnel category. *** Does not include staf afected by discontinued operations. The number of employees, at the end of 2018, 2017 and 2016, was 202,713, 202,251 and 188,492, respectively. Expenses of insurance and reinsurance contracts Of which: Claims paid,other insurance- related expenses and net provisions for insurance contract liabilities Reinsurance premiums paid Other operating income Non- fnancial services Other operating income (3,124) (2,489) (1,837) (2,883) (2,249) (1,574) (241) 1,643 367 1,276 (240) 1,618 472 1,146 (263) 1,919 698 1,221 Other operating expense (2,000) (1,966) (1,977) Non-fnancial services (270) (302) (518) Other operating expense: (1,730) (1,664) (1,459) Of which, credit institutions deposit guarantee fund and single resolution fund (895) (306) (848) (291) (711) 5 Most of the Bank’s insurance activity is carried on in life insurance. 594 2018 Auditors’ report and consolidated annual accounts The functional breakdown (fnal employment), by gender, at 31 December 2018 is as follows: Functional breakdown by gender Continental Europe Latin America and Others United Kingdom Senior executives Other executives Other personnel Men 913 523 107 1,543 Women 260 100 39 399 Men 6,735 6,427 1,309 14,471 Women 3,711 4,256 640 8,607 Men 26,173 40,729 9,218 76,120 Women 32,759 54,952 13,862 101,573 The same information, expressed in percentage terms at 31 December 2018, is as follows: Functional breakdown by gender Continental Europe Latin America and Others United Kingdom Senior executives Other executives Other personnel Men 78% 84% 73% 79% Women 22% 16% 27% 21% Men 64% 60% 67% 63% Women 36% 40% 33% 37% Men 44% 43% 40% 43% Women 56% 57% 60% 57% The labour relations between employees and the various Group companies are governed by the related collective agreements or similar regulations. c) Share-based payments The main share-based payments granted by the Group in force at 31 December 2018, 2017 and 2016 are described below. The number of employees in the Group with disabilities, distributed by professional categories, at 31 December 2018, is as follows: Average number of employees* Senior management Other management Other staf 2018 6 64 3,366 3,436 * An employee with disabilities is considered to be a person who is recognised by the State or the company in each jurisdiction where the Group operates and that entitles them to receive direct monetary assistance, or other types of aid such as, for example, reduction of their taxes. In the case of Spain, employees with disabilities have been considered to be those with a degree of disabilities greater than or equal to 33%. The amount does not include employees in the United States. The number of Group employees with disabilities at 2017 and 2016, was 3,289 and 2,941, respectively, (not including the United States). Likewise, the average number of employees of Banco Santander, S.A. with disabilities, equal to or greater than 33%, during 2018 was 241 (209 and 216 employees during 2017 and 2016). At the end of fscal year 2018, there were 304 employees (211 and 213 employees at 31 December 2017 and 2016). i. Bank The variable remuneration policy for the Bank’s executive directors and certain executive personnel of the Bank and of other Group companies includes Bank share-based payments, the implementation of which requires, in conformity with the law and the Bank’s Bylaws, specifc resolutions to be adopted by the general meeting. Were it necessary or advisable for legal, regulatory or other similar reasons, the delivery mechanisms described below may be adapted in specifc cases without altering the maximum number of shares linked to the plan or the essential conditions to which the delivery thereof is subject. These adaptations may involve replacing the delivery of shares with the delivery of cash amounts of an equal value. The plans that include share-based payments are as follows: (i) deferred conditional delivery share plan; (ii) deferred conditional variable remuneration plan, (iii) performance share plan and (iv) Deferred variable compensation plan linked to multiannual objectives. The characteristics of the plans are set forth below: 595 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Description Plan`s benefciaries Conditions Calculation Base The purpose of this plan is to defer a portion of the variable remuneration of the benefciaries over a period of three years for it to be paid in Santander shares. Group executives or employees whose variable remuneration or annual bonus for 2013 exceeded, in general, EUR 0.3 million (gross) In addittion to that of the benefciary remaining in the Group’s employ, that none of the following circumstances should occur in the period prior to each deliveries: (i) Poor fnancial performance of the Group; (ii) breach by the benefciary of internal regulations, including, in particular, those relating to risks; material restatement of the Group’s consolidated fnancial statements, except when it is required pursuant to a change in accounting standards; or (iii) (iv) Signifcant changes in the Group’s economic capital or risk profle. The amount in shares is calculated based on the tranches of the following scale:: • 300 thousand euros or less 0% deferred • 300 to 600 thousand euros 20% deferred • More than 600 thousand euros 30% deferred. Deferral period: 3 years. The purpose of these cycles is to defer a portion of the variable remuneration of the benefciaries over a period of three years for the third (2013), fourth (2014), sixth (2016) cycles, and over three or fve years for the ffth (2015), seventh (2017) and eigth (2018) cycles, for it to be paid, where appropriate, in cash and in Santander shares; the other portion of the variable remuneration is also to be paid in cash and Santander shares, upon commencement of the cycles, in accordance with the rules set forth below. Executive directors and certain executives (including senior management) and employees who assume risk, who perform control functions or receive an overall remuneration which puts them on the same remuneration level as senior executives and employees who assume risks (Fifth, fourth and third cycle) In the case of the seventh, sixth and eigth cycle, the benefciares are Material Risk Takers (Identifed staf) that are not benefciaries of the Deferred Multiyear Objectives Variable Remuneration Plan. For the third, fourth, ffth and sixth cycles (2013 to 2016), the accrual of deferred compensation is conditioned, in addition to the requirement that the benefciary remains in the Group’s employ, with the exceptions included in the plan regulations upon none of the following circumstances existing during the period prior to each of the deliveries, pursuant to the provisions set forth in each case in the plan regulations: (i) (ii) breach by the benefciary of internal regulations, including, in particular, those relating to risks; material restatement of the Group’s consolidated fnancial statements, except when it is required pursuant to a change in accounting standards; or Poor fnancial performance of the Group; (iii) (iv) Signifcant changes in the Group’s economic capital or risk profle In the case of the seventh and eight cycles (2017 and 2018), the accrual of deferred compensation is conditioned, in addition to the permanence of the benefciary in the Group, with the exceptions contained in the plan’s regulations, to no assumptions in which there is a poor performance of the entity as a whole or of a specifc division or area of the entity or of the exposures generated by the personnel, and at least the following factors must be considered: signifcant failures in risk management (i) committed by the entity , or by a business unit or risk control unit; the increase sufered by the entity or by a business unit of its capital needs, not foreseen at the time of generation of the exposures; (iii) Regulatory sanctions or judicial sentences for (ii) events that could be attributable to the unit or the personnel responsible for those. Also, the breach of internal codes of conduct of the entity; and (iv) Irregular behaviours, whether individual or collective, considering in particular the negative efects derived from the marketing of inappropriat products and the responsibilities of the persons or bodies that made those decisions. e Paid half in cash and half in shares Third cycle (2013), 3 years deferral: • Executive directors: 40% and 60% immediate and deferred payments, respectively. • Division directors and other executives of the Group with a similar profle: 50% and 50% immediate and deferred payments, respectively. • Other Executives part of the Identifed Staf: 40% and 60%, immediate and deferred payments, respectively. Fourth and ffth cycles (2014 and 2015, respectively): • Executive directors and members of the Identifed Staf with total variable remuneration higher than 2.6 million euros: 40% paid immediately and 60% deferred over 5 years (3 years in fourth cycle). • Division managers, country heads, other executives of the Group with a similar profle and members of the Identifed Staf with total variable remuneration between 1.7 million euros (1.8 million in fourth cycle) and 2.6 million euros: 50% paid immediately and 50% deferred over5 years (3 years in fourth cycle) • Other benefciaries: 60% paid immediately and 40% deferred over 3 years. Sixth cycle (2016): • 60% of bonus will be paid immediately and 40% deferred over a three year period. Seventh and eight cycle (2017 and 2018): • Executive Directors and members of identifed staf with target total variable remuneration higher or equal to 2.7 million euros: 40% paid immediately and 60% deferred over 5 years • Executive Directors and members of identifed staf with total Variable remuneration between 1.7 million euros and 2.7 million euros: 50% paid immediately and 50% paid over 5 years. • Other benefciaries: 60% paid immediately and 40% deferred over 3 years. Deferred variable remuneration systems (i) Deferred and conditional variable remuneration plan (2013) (ii) Deferred conditional variable remuneration plan (2013, 2014, 2015, 2016, 2017 and 2018) 596 2018 Auditors’ report and consolidated annual accounts Deferred variable remuneration systems (iii) Performance share plan (2014 and 2015) (iv) Deferred Multiyear Objectives Variable Remuneration Plan (2016, 2017 and 2018) Description Plan`s benefciaries Conditions Calculation Base The purpose is to instrument a portion of the variable remuneration of the executive directors and other members of the Identifed Staf, consisting of a long- term incentive (ILP) in shares based on the Bank’s performance over a multiannual period. In addition, the second cycle (2015) also applies to other Bank employees not included in the Identifed Staf or Material Risk Takers, in respect of whom it is deemed appropriate that the potential delivery of Bank shares be included in their remuneration package in order to better align the employee’s interests with those of the Bank. The aim is simplifying the remuneration structure, improving the ex ante risk adjustment and increasing the impact of the long- term objectives on the Group’s most relevant roles. The purpose of these cycles is to defer a portion of the variable remuneration of the benefciaries over a period of three or fve years, for it to be paid, where appropriate, in cash and in Santander shares; the other portion of the variable remuneration is also to be paid in cash and Santander shares, upon commencement of the cycles, in accordance with the rules set forth below. The accrual of the last third of the deferral (in the case of 3 years deferral) of the last three ffths (in the case of 5 years deferral) is also subject to long-term objectives. Executive Directors and senior managers Other Material Risk Takers or Identifed Staf Other benefciaries in the case only of the second cycle. In addition to the requirement that the benefciary remains in the Group’s employ, with the exceptions included in the plan regulations, the delivery of shares to be paid on the ILP payment date based on compliance with the related multiannual target is conditional upon none of the following circumstances existing during the period prior to each of the: (i) Poor fnancial performance of the Group; (ii) breach by the benefciary of internal regulations, including, in particular, those relating to risks; (iii) material restatement of the Group’s consolidated fnancial statements, except when it is required pursuant to a change in accounting standards; or (iv) signifcant changes in the Group’s economic capital or risk profle For the second cycle (2015), based on the maximum benchmark value (20%), at the proposal of the remuneration committee, the Board of Directors will set the maximum number of shares, the value in euros of which is called the “Agreed-upon Amount of the ILP”, taking into account (i) the Group’s earnings per share (EPS) and (ii) the Group’s return on tangible equity (RoTE for 2015 with respect to those budgeted for the year. First cycle (2014): • Relative Total Shareholder Return (TSR) measured against a group of 15 comparable institutions (the “peer group”) in the periods 2014- 2015; 2014-2016; and 2014-2017. Second cycle (2015), the basis of calculation is the fulflment of the following objectives: • Relative performance of the earning per share growth (EPS) growth of the Santander Group for the 2015- 2017 period compared to a peer group of 17 credit institutions. • ROTE • of the Santander Group for fnancial year 2017 • Employee satisfaction, measured by whether or not the corresponding Group company is included in the “Top 3” of the best banks to work for. ) • number of principal markets in which Santander is in the Top 3 of the best banks on the customer satisfaction index in 2017 • retail loyal clients • SME and corporate loyal clients Executive directors and certain executives (Including top management) of the Group’s frst lines of responsibility. In 2016 (frst cycle), the accrual is conditioned, in addition to the permanence of the benefciary in the Group, with the exceptions contained in the plan’s regulations tha none of The following circumstances during the period prior to each of the deliveries in the terms set forth in each case in the plan’s regulations: (i) Poor performance of the Group; (ii) breach by the benefciary of the internal regulations, including in particular that relating to risks; (iii) material restatement of the Group’s consolidated fnancial statements, except when appropriate under a change in accounting regulations; Or (iv) Signifcant changes in the Group’s economic capital or risk profle. In 2017 and 2018 (second and third cycles), the accrual is conditioned, in addition to the benefciary permanence in the Group, with the exceptions contained in the plan’s regulations, to the non-occurrence of instances of poor fnancial performance from the entity as a whole or of a specifc division or area thereof or of the exposures generated by the personnel, at least the following factors must be considered: (i) Signifcant failures in risk management committed (ii) by the entity, or by a business unit or risk control unit; the increase sufered by the entity or by a business unit of its capital needs, not foreseen at the time of generation of the exposures; (iii) Regulatory sanctions or court rulings for events that could be attributable to the unit or the personnel responsible for those. Also, the breach of internal codes of conduct of the entity; and (iv) Irregular behaviours, whether individual or collective, considering in particular negative efects derived from the marketing of inappropriate products and responsibilities of persons or bodies that made those decisions. Paid half in cash and half in shares. The maximum number of shares to be delivered is calculated by taking into account the weighted average daily volume of weighted average prices for the ffteen trading sessions prior to the previous Friday (excluding) on the date on which the board decides the bonus for the Executive directors of the Bank. First cycle (2016): • Executive directors and members of the Identifed Staf with total variable remuneration higher than or equal to 2.7 million euros: 40% paid immediately and 60% deferred over a 5 year period. • Senior managers, country heads of contries representing at least 1% of the Group´s capital and other members of the identifed sfaf whose total variable remuneration is between 1.7 million and 2.7 million euros: 50% paid immediately and 50% deferred over a5 year period. • Other benefciaries: 60% paid immediately and 40% deferred over a 3 year period. The second and third cycles (2017 and 2018, respectively) are under the same deferral rules, save for the variable remuneration considered is target and not the actual award. In 2016 the metrics for the deferred portion subject to long-term objectives are: • Earnings per share (EPS) growth in 2018 over 2015. • Relative Total Shareholder Return (TSR) measured against a group of credit institutions. • Compliance with the fully-loaded common equity tier 1 (“CET1”) ratio target for fnancial year 2018. • Compliance with Santander Group’s underlying return on risk-weighted assets (“RoRWA”) growth target for fnancial year 2018 compared to fnancial year 2015. In 2017 (second cycle) and 2018 (third cycle) the metrics for the deferred portion subject to long-term objectives are: • EPS growth in 2019 over 2016 and in 2020 over 2017, for each respective cycle • Relative Total Shareholder Return (TSR) measured against a group of 17 credit institutions.in the periods 2017- 2019 and 2018.-2019, respectively. • Compliance with the fully-loaded common equity tier 1 (“CET1”) ratio target for fnancial years 2019 and 2020, respectively. 597 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix ii. Santander UK plc The long-term incentive plans on shares of the Bank granted by management of Santander UK plc to its employees are as follows: Number of shares (in thousand) Exercise price in pounds sterling* Year granted Employee group Number of persons** Date of commencement of exercise period Date of expiry of exercise period Plans outstanding at 01/01/16 Options granted (Sharesave) Options exercised 24,762 17,296 (338) Options cancelled (net) or not exercised (12,804) Plans outstanding at 31/12/16 Options granted (Sharesave) Options exercised Options cancelled (net) or not exercised Plans outstanding at 31/12/17 Options granted (Sharesave) Options exercised Options cancelled (net) or not exercised Plans outstanding at 31/12/18 28,916 3,916 (1,918) (3,713) 27,201 6,210 (3,340) (3,233) 26,838 4.91 2016 Employments 7,024 01/11/16 01/11/16 3.67 3.51 4.02 2017 Employments 4,260 01/11/17 01/11/17 3.77 3.40 01/11/19 01/11/21 01/11/20 01/11/22 3.46 2018 Employments 4,880 01/11/18 01/11/21 01/11/18 01/11/23 3.16 3.76 * At December 31, 2018, 2017, 2016 and 2015, the euro/pound sterling exchange rate was EUR 1.11790 GBP 1; EUR 1.12710 GBP 1, EUR 1.16798 GBP 1 and EUR 1.36249 GBP 1, respectively. ** Number of accounts/contracts. A single employee may have more than one account/contract. In 2008 the Group launched a voluntary savings scheme for Santander UK employees (Sharesave Scheme) whereby employees who join the scheme in 2016, 2017 and 2018 see deducted between GBP 5 and GBP 500 from their net monthly pay over a period of three or fve years. When this period has ended, the employees may use the amount saved to exercise options on shares of the Bank at an exercise price calculated by reducing by up to 20% the average purchase and sale prices of the Bank shares in the three trading sessions prior to the approval of the scheme by the UK tax authorities (HMRC). This approval must be received within 21 to 41 days following the publication of the Group’s results for the frst half of the year. This scheme was approved by the Board of Directors, at the proposal of the appointments and remuneration committee, and, since it involved the delivery of Bank shares, its application was authorized by the Annual General Meeting held on 21 June 2008. Also, the scheme was authorized by the UK tax authorities (HMRC) and commenced in September 2008. In subsequent years, at the Annual General Meetings held on 19 June, 2009, 11 June, 2010, 17 June, 2011, 28 March, 2012, 22 March, 2013, 28 March, 2014, 27 March, 2015, 18 March, 2016, 7 April, 2017, and 23 March, 2018, respectively, the shareholders approved the application of schemes previously approved by the board and with similar features to the scheme approved in 2008. iii. Fair value The fair value of the performance share plans was calculated as follows: a) Deferred variable compensation plan linked to multi-year objectives 2016, 2017 and 2018: The fair value of the plan has been determined, at the grant date, based on the valuation report of an independent expert, Willis Towers Watson. According to the design of the plan for 2016, 2017 and 2018 and the levels of achievement of similar plans in comparable entities, the expert concludes that the reasonable range for estimating the initial achievement ratio is around 60% - 80%. It has been considered that the fair value is 70% of the maximum. b) 2015 Performance share plan: The fair value of this plan was calculated at the grant date based on a valuation report by an independent expert. On the basis of the design of the plan for 2015 and the levels of achievement of similar plans at comparable entities, the expert concluded that the reasonable range for estimating the initial achievement coefcient was approximately 60% to 80% and, accordingly, the fair value was considered to be 70% of the maximum. Therefore, as the maximum level was determined as being 91.50%, the fair value is 64.05% of the maximum amount. 598 2018 Auditors’ report and consolidated annual accounts c) Performance share plans 2014: 48. Other general administrative expenses • It was assumed that the benefciaries will not leave the Group’s employ during the term of each plan. a) Breakdown The detail of Other general administrative expenses is as follows: Million of euros Property, fxtures and supplies Technology and systems Technical reports Advertising Taxes other than income tax Communications Surveillance and cash courier services Per diems and travel expenses Insurance premiums Other administrative expenses 2018 1,968 1,550 707 646 557 527 405 225 76 2017 1,931 1,257 759 757 583 529 443 217 78 1,828 8,489 1,799 8,353 2016 1,853 1,095 768 691 484 499 389 232 69 1,653 7,733 b) Technical reports and other Technical reports includes the fees paid by the various Group companies (detailed in the accompanying Appendices) for the services provided by their respective auditors, the detail being as follows: Million of euros Audit fees Audit-related fees Tax fees 2017 2016 All other fees 2018 90.0 6.5 0.9 3.4 2017 88.1 6.7 1.3 3.1 2016 73.7 7.2 0.9 3.6 • The fair value of the Bank’s relative TSR position was calculated, on the grant date, on the basis of the report of an independent expert whose assessment was carried out using a Monte Carlo valuation model to perform 10,000 simulations to determine the TSR of each of the companies in the benchmark group, taking into account the variables set forth below. The results (each of which represents the delivery of a number of shares) are classifed in decreasing order by calculating the weighted average and discounting the amount at the risk-free interest rate. Expected volatility* Annual dividend yield based on last few years Risk-free interest rate (Treasury Bond yield (zero coupon) over the period of the plan) PI14 51.35% 6.06% 4.073% * Calculated on the basis of historical volatility over the corresponding period (three years). The application of the simulation model resulted in a percentage value of 55.39% for Plan l-14. Since this valuation refers to a market condition, it cannot be adjusted after the grant date. d) Santander UK Sharesave plans: The fair value of each option granted by Santander UK was estimated at the grant date using a European/American Partial Diferential Equation model with the following assumptions: Risk-free interest rate Dividend increase 2018 1.27%- 1.40% 5.6%- 6.12% 0.89%- 1.08% 5.48%- 5.51% 0.31%- 0.41% 5.92%- 6.21% Implied volatility of underlying shares based on expected life of the options 23.99%- 24.17% 26.16%- 26.31% 31.39%- 32.00% Expected life of options granted 3 and 5 years 3 and 5 years 3 and 5 years Total 100.8 99.2 85.4 The Audit fees heading includes audit fees for the Banco Santander, S.A. individual and consolidated fnancial statements, as the case may be, of the companies forming part of the Group, the integrated audits prepared for the annual report flling in the Form 20-F required by the U.S. Securities and Exchange Commission (SEC) for those entities currently required to do so, the internal control audit (SOX) for those required entities, the audit of the consolidated fnancial statements as of 30 June and limited quarterly consolidated reviews for the Brazilian regulator as of 31 March, 30 June and 30 September and the regulatory reports required by the auditor corresponding to the diferent locations of the Santander Group. The main concepts included in Audit-related fees correspond to aspects such as the issuance of Comfort letters, or other reviews required by diferent regulations in relation to aspects such as, for example, Securitization. The services commissioned from the Group’s auditors meet the independence requirements stipulated by the Audit Law, the US SEC rules and the Public Company Accounting Oversight Board (PCAOB), applicable to the Group, and they did not involve in any 599 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 50. Gains or losses on non-current assets held for sale not classifed as discontinued operations The detail of Gains/(losses) on non-current assets held for sale not classifed as discontinued operations is as follows: Million of euros Net balance Tangible assets Impairment (Note 12) Gain (loss) on sale (Note 12) Other gains and other losses 2018 (123) 2017 (195) (259) (306) 136 - 111 (8) 2016 (141) (212) 71 - (123) (203) (141) case the performance of any work that is incompatible with the audit function. Lastly, the Group commissioned services from audit frms other than PwC amounting to EUR 173.9 million in 2018 (2017: EUR 115.6 million; 2016: EUR 127.9 million, respectively). The “Audit Fees” caption includes the fees corresponding to the audit for the year, regardless of the date on which the audit was completed. In the event of subsequent adjustments, which will not be signifcant in any case, and for purposes of comparison, they are presented in this note in the year to which the audit relates. The rest of the services are presented according to the date of their approval by the Audit Committee. c) Number of branches The number of ofces at 31 December 2018 and 2017 is as follow: Number of branches Spain Group Group 2018 4,427 8,790 13,217 2017 4,546 9,151 13,697 49. Gains or losses on non fnancial assets, net The detail of Gains/(losses) on disposal of assets not classifed as non-current assets held for sale is as follow: Million of euros Gains: Tangible and intangible assets Investments Of which: Allfunds Bank, S.A. (Note 3) Losses: Tangible and intangible assets Investments 2018 2017 2016 124 2 - 126 (92) (6) (98) 28 134 443 425 577 (43) (12) (55) 522 131 30 - 161 (116) (15) (131) 30 600 2018 Auditors’ report and consolidated annual accounts 51. Other disclosures a) Residual maturity periods and average interest rates The detail, by maturity, of the balances of certain items in the consolidated balance sheet is as follows: 31 December 2018* Million of euros On demand Within 1 month 1 to 3 months 3 to 12 months 1 to 3 years 3 to 5 years More than 5 years Average interest rate Total 113,663 - - - - - - 113,663 0.61% 1,886 487 1,399 1,399 6,023 6,022 1 1 3,329 3,328 1 1 12,873 19,432 10,705 64,172 118,420 12,830 19,415 10,661 64,076 116,819 3.13% 43 43 17 17 44 44 96 96 1,601 1,601 1.41% 46,247 56,818 71,627 102,036 134,697 107,921 426,753 946,099 16 1,534 1,319 6,646 2,474 1,783 23,924 37,696 3.33% Assets: Cash, cash balances at Central Banks and other deposits on demand Financial assets at fair value through other comprehensive income Debt instruments Loans and advances Customers Financial assets at amortised cost Debt instruments Loans and advances 46,231 55,284 70,308 95,390 132,223 106,138 402,829 908,403 Central banks Credits institutions Customers Liabilities: Financial liabilities at amortised cost Deposits Central banks - 23 - 4 - - 15,574 15,601 5,389 6,711 6,003 5,314 947 1,024 35,480 4.63% 1.66% 49,872 63,597 89,383 126,909 105,191 386,231 857,322 4.97% 10,092 36,139 161,796 62,841 74,956 114,909 154,129 118,626 490,925 1,178,182 4.20% 545,284 87,782 93,293 127,522 182,670 56,927 78,152 1,171,630 536,134 74,440 67,406 91,958 107,459 18,833 6,871 903,101 Credit institutions 15,341 13,413 24,724 16,384 8,759 Customer deposits 520,489 58,897 40,053 75,067 34,267 304 2,130 2,629 507 64,433 2,520 6,412 9,901 - 72,523 0.39% 4,646 89,679 2,225 740,899 2.19% 1.19% Marketable debt securities** Other fnancial liabilities 237 8,913 11,347 1,995 18,817 7,070 33,536 71,805 37,919 70,653 244,314 2.59% 2,028 3,406 175 628 24,215 545,284 87,782 93,293 127,522 182,670 56,927 78,152 1,171,630 1.48% Diference (assets less liabilities) (383,488) (24,941) (18,337) (12,613) (28,541) 61,699 412,773 6,552 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** Includes promissory notes, certifcates of deposit and other short-term debt issues. The Group’s net borrowing position with the ECB was EUR 11,882 million at 31 December 2018, mainly because in last period the Group borrowed funds under the ECB’s targeted longer-term refnancing operations (LTRO, TLTRO) programme. (See note 20). 601 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 31 December 2017 Million of euros On demand Within 1 month 1 to 3 months 3 to 12 months 1 to 3 years 3 to 5 years More than 5 years Average interest rate Total 110,995 - - - - - - 110,995 0.53% 326 326 2,467 2,467 1,646 1,646 11,497 22,447 11,497 22,447 11,164 11,164 78,934 128,481 78,934 128,481 4.34% Assets: Cash, cash balances at central banks and other deposits on demand Financial assets available-for-sale Debt instruments Loans and receivables 57,000 58,686 53,218 96,689 119,541 112,786 405,093 903,013 Debt instruments 249 1,381 997 2,073 2,317 1,656 8,870 17,543 3.06% Loans and advances 56,751 57,305 52,221 94,616 117,224 111,130 396,223 885,470 Central banks Credits institutions Customers Held-to-maturity investments - 18,242 38,509 - 3,948 4,198 1,446 3,445 4,811 5,708 - 5,694 - 939 16,073 1,341 26,278 39,567 49,159 47,330 84,097 111,530 110,191 378,809 819,625 - - 1,902 122 294 11,173 13,491 168,321 61,153 54,864 110,088 142,110 124,244 495,200 1,155,980 Liabilities: Financial liabilities at amortised cost Deposits Central banks Credit institutions Customer deposits Marketable debt securities* Other financial liabilities Difference (assets less liabilities) 537,604 527,499 450 20,870 506,179 105 10,000 537,604 681 13,350 52,636 11,638 9,634 2,015 15,263 42,047 11,927 3,909 75,161 75,161 87,939 130,672 136,487 59,325 66,667 100,658 81,169 83,542 39,719 22,565 5,247 11,907 74,664 1,126,069 8,283 883,320 - 4,663 3,620 71,414 91,300 720,606 2,715 42,988 25,406 6,501 72,537 31,680 29,286 54,202 43,395 64,357 214,910 728 1,116 428 2,024 27,839 87,939 130,672 136,487 83,542 74,664 1,126,069 1.98% (369,283) (14,008) (33,075) (20,584) 5,623 40,702 420,536 29,911 5.10% 1.26% 5.44% 1.52% 4.61% 0.24% 2.40% 2.00% 2.56% * Includes promissory notes, certificates of deposit and other short-term debt issues. 602 2018 Auditors’ report and consolidated annual accounts31 December 2016 Million of euros On demand Within 1 month 1 to 3 months 3 to 12 months 1 to 3 years 3 to 5 years More than 5 years Average interest rate Total 76,454 - - - - - - 76,454 0.98% 200 200 5,986 5,986 2,007 2,007 5,442 23,574 5,442 23,574 13,900 13,900 60,178 111,287 60,178 111,287 4.33% Assets: Cash, cash balances at central banks and other deposits on demand Financial assets available-for-sale Debt instruments Loans and receivables 52,512 48,420 56,725 85,521 113,387 93,816 389,623 840,004 Debt instruments 248 1,628 708 2,246 2,125 1,918 4,364 13,237 6.31% Loans and advances 52,264 46,792 56,017 83,275 111,262 91,898 385,259 826,767 Central banks Credits institutions Customers Held-to-maturity investments - 941 11,499 1,117 - 23 14,393 27,973 16,632 35,632 - 4,938 2,210 2,220 4,435 1,268 3,721 35,424 40,913 42,308 79,938 106,827 90,607 367,145 763,370 - - 123 2,075 342 11,928 14,468 129,166 54,406 58,732 91,086 139,036 108,058 461,729 1,042,213 Liabilities: Financial liabilities at amortised cost Deposits Central banks 480,075 95,583 67,282 125,774 115,591 69,467 90,468 1,044,240 471,494 79,446 42,583 86,006 69,775 34,505 7,837 791,646 422 2,007 633 101 20,027 20,922 - 44,112 Credit institutions 16,649 16,357 10,603 23,313 13,540 Customer deposits 454,423 61,082 Marketable debt securities* Other fnancial liabilities 642 7,939 12,861 3,276 31,347 14,225 10,474 62,592 36,208 5,560 8,023 3,742 89,764 4,095 657,770 39,465 43,985 34,520 80,380 226,078 303 1,831 442 2,251 26,516 6.54% 1.96% 5.79% 1.70% 5.12% 0.26% 3.97% 2.25% 3.68% Diference (assets less liabilities) (350,909) (41,177) (8,550) (34,688) 23,445 38,591 371,261 (2,027) 480,075 95,583 67,282 125,774 115,591 69,467 90,468 1,044,240 2.57% * Includes promissory notes, certifcates of deposit and other short-term debt issues. 603 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The detail of the undiscounted contractual maturities of the existing financial liabilities at amortised cost at 31 December 2018 is as follows: Financial liabilities at amortised cost Deposits Central banks Credit institutions Customer Marketable debt securities Other financial liabilities 31 December 2018* Million of euros On demand Within 1 month 1 to 3 3 to 12 months months 1 to 3 years 3 to 5 years More than 5 years Total 532,915 304 15,257 517,354 296 8,913 74,320 2,126 13,413 58,781 11,243 1,995 67,169 91,766 106,935 18,439 6,540 898,084 2,624 896 64,424 24,698 16,288 8,552 39,847 74,582 33,959 2,520 6,085 9,834 - 4,427 2,113 17,359 33,443 7,070 2,028 71,431 3,406 37,409 69,352 175 628 72,894 88,720 736,470 240,533 24,215 542,124 87,558 91,598 127,237 181,772 56,023 76,520 1,162,832 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 31 December 2017 Million of euros On demand Within 1 month 1 to 3 3 to 12 months months 1 to 3 years 3 to 5 years Financial liabilities at amortised cost Deposits Central banks Credit institutions Customer Marketable debt securities Other financial liabilities 526,059 451 20,378 505,230 1,486 10,001 537,546 57,490 2,018 14,903 40,569 11,735 3,908 73,133 89,249 99,780 64,977 23,801 2,719 13,035 24,807 27,138 6,348 52,413 72,254 31,491 32,365 15,385 5,123 11,857 - 4,553 3,604 11,387 28,412 52,989 42,888 63,648 9,634 728 1,116 428 2,024 71,512 89,147 717,418 212,545 27,839 110,270 128,920 119,082 75,681 73,829 1,118,461 31 December 2016 Million of euros On demand Within 1 month 1 to 3 3 to 12 months months 1 to 3 years 3 to 5 years Financial liabilities at amortised cost Deposits Central banks Credit institutions Customer Marketable debt securities Other financial liabilities 467,529 422 16,676 450,431 623 7,939 95,231 2,006 15,789 77,436 13,582 3,645 49,246 68,830 66,255 633 101 20,021 15,500 20,057 12,364 33,113 48,672 33,870 34,781 20,916 5,517 8,348 - 3,736 4,029 12,705 38,119 42,201 34,022 78,094 10,097 305 1,837 442 2,251 44,099 89,639 655,899 219,346 26,516 476,091 112,458 72,048 107,254 110,293 69,245 88,110 1,035,499 604 More than 5 years Total 8,157 878,077 More than 5 years Total 7,765 789,637 2018 Auditors’ report and consolidated annual accounts                                                                                    Below is a breakdown of contractual maturities for the rest of fnancial assets and liabilities as of 31 December 2018: Million of euros at 31 December 2018* FINANCIAL ASSETS Financial assets held for trading Derivatives Equity instruments Debt instruments Loans and advances Credits institutions Customers Non-trading fnancial assets mandatorily at fair value through proft or loss Debt instruments Loans and advances Central banks Credit institutions Customers Financial assets designated at fair value through proft or loss Equity instruments Debt instruments Loans and advances Central banks Credits institutions Customers Financial assets at fair value through other comprehensive income Equity instruments Hedging derivatives Within 1 1 to 3 months months 3 to 12 months 1 to 3 years 3 to 5 years More than 5 years Total 4,512 3,564 2,691 3,165 - - 6,793 899 - 22,084 15,189 - 19,350 14,098 - 1,821 399 5,894 6,895 5,252 - - - - - - 21,598 13,045 604 7 20,994 13,038 1,211 5,433 14,587 4,131 5,196 3,474 3,215 346 - 1,876 1,339 - 2 - 20 326 - - 1,337 326 - - - - - - - 5,625 304 5,321 2,582 778 1,961 17 - - 17 - - 17 - - - - - 5,215 727 4,488 - 1,327 3,161 125 - - 125 - - 125 - - 609 166 474 2,167 36,576 19,897 8,938 7,539 202 - 202 7,912 1,232 6,680 - 1,695 4,985 7,025 3,260 3,689 76 - - 76 2,671 2,671 4,234 92,879 55,939 8,938 27,800 202 - 202 57,460 3,222 54,238 9,226 23,097 21,915 10,730 3,260 5,587 1,883 - 2 1,881 2,671 2,671 8,607 868 1,088 - - - 4,065 348 3,717 - 579 3,138 2 - 2 - - - - - - 957 59 Changes in the fair value of hedged items in portfolio hedges of interest rate risk 106 7 20 28 TOTAL FINANCIAL ASSETS 30,040 17,128 12,929 29,619 24,433 59,286 173,435 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 605 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros at 31 December 2018* FINANCIAL LIABILITIES Financial liabilities held for trading Derivatives Shorts positions Deposits Central banks Credits institutions Customers Marketable debt securities Other financial liabilities Financial liabilities designated at fair value through profit or loss Deposits Central banks Credits institutions Customers Marketable debt securities Other financial liabilities Hedging derivatives Changes in the fair value of hedged items in portfolio hedges of interest rate risk Within 1 months 1 to 3 months 3 to 12 months 1 to 3 years 3 to 5 More than 5 years years Total 10,473 2,897 7,576 3,351 2,874 477 1,104 822 282 16,123 14,323 1,800 16,457 14,956 1,501 22,835 19,469 3,366 70,343 55,341 15,002 - - - - - - 29,574 29,522 9,804 8,809 10,909 13 39 485 3 - - - - - - 7,017 6,947 4,940 949 1,058 70 - 144 5 - - - - - - 864 627 72 271 284 237 - 321 23 - - - - - - 1,497 531 - 188 343 556 410 362 64 - - - - - - 999 455 - 229 226 544 - 651 - - - - - - 28,107 27,222 - 445 26,777 885 - 4,400 - - - - - - 68,058 65,304 14,816 10,891 39,597 2,305 449 6,363 60 148 303 TOTAL FINANCIAL LIABILITIES 40,535 10,517 2,312 18,046 18,167 55,490 145,067 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). Million of euros at 31 December 2018* Within 1 1 to 3 months months 3 to 12 months 1 to 3 years 3 to 5 years More than 5 years Total Memorandum items Loans commitment granted Financial guarantees granted Other commitments granted 71,860 12,436 22,749 2,100 58,431 1,737 1,486 4,437 6,174 35,632 1,728 2,650 MEMORANDUM ITEMS 132,391 15,659 33,360 40,010 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). 43,205 1,029 3,503 47,737 32,201 218,083 692 2,145 11,723 74,389 35,038 304,195 In the Group’s experience, no outflows of cash or other financial assets take place prior to the contractual maturity date that might affect the information broken down above. 606 2018 Auditors’ report and consolidated annual accountsb) Equivalent euro value of assets and liabilities The detail of the main foreign currency balances in the consolidated balance sheet, based on the nature of the related items, is as follows: Equivalent value in million of euros Cash, cash balances at central banks and other deposits on demand Financial assets/liabilities held for trading Non-trading fnancial assets mandatorily at fair value through proft or loss Other fnancial assets/liabilities at fair value through proft or loss Financial assets/liabilities available-for-sale Financial assets at fair value through other comprehensive income Financial assets at amortised cost Loans and receivables Investments held-to-maturity Investments Tangible assets Intangible assets Financial liabilities at amortised cost Liabilities under insurance contracts Other 2018* 2017 2016 Assets Liabilities Assets Liabilities Assets Liabilities 61,372 56,217 8,231 - 40,989 - 32,244 35,997 67,926 598,629 1,189 19,903 23,016 - - 24,506 893,233 - - - - - 694,362 29 20,567 791,944 67,025 82,004 - 76,459 60,423 100,083 - 70,958 7,322 65,691 553,301 11,490 1,121 15,971 23,499 - - 23,695 851,119 21,766 - - - - - - 6,965 68,370 571,829 12,272 1,308 16,957 26,338 16,667 - - - - - - 638,680 58 20,989 757,952 - - 678,542 61 27,961 23,169 892,506 789,397 * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). c) Fair value of fnancial assets and liabilities not measured at fair value The fnancial assets owned by the Group are measured at fair value in the accompanying consolidated balance sheet, except for cash, cash balances at central banks and other deposits on demand, loans and advances at amortised cost (IFRS9) and the loans and receivables, held-to-maturity investments, equity instruments whose market value cannot be estimated reliably and derivatives that have these instruments as their underlyings and are settled by delivery thereof (IAS39). Similarly, the Group’s fnancial liabilities -except for fnancial liabilities held for trading, those measured at fair value and derivatives other than those having as their underlying equity instruments whose market value cannot be estimated reliably- are measured at amortised cost in the accompanying consolidated balance sheet. 607 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Following is a comparison of the carrying amounts of the Group’s fnancial instruments measured at other than fair value and their respective fair values at year-end: i) Financial assets measured at other than fair value Million of euros 2018 2017 2016 Assets Loans and advances Debt instruments i g t n n u y ro r m a Ca e u r il a a F v 1 l e v e L 2 l e v e L 3 l e v e L i t n u g n y ro r r a a Ca F e u m il a v 1 l e v e L 2 l e v e L 3 l e v e L i g t n n u e y o u r r r m il a a a Ca F v 1 l e v e L 2 l e v e L 3 l e v e L 908,403 914,013 - 88,091 825,922 885,470 895,645 - 141,839 753,806 826,767 833,819 - 127,224 706,595 37,696 38,095 20,898 11,246 5,951 31,034 31,094 10,994 13,688 6,412 27,705 27,417 11,529 11,678 4,210 946,099 952,108 20,898 99,337 831,873 916,504 926,739 10,994 155,527 760,218 854,472 861,236 11,529 138,902 710,805 ii) Financial liabilities measured at other than fair value Million of euros 2018 2017 2016 i g t n n u y ro r m a Ca e u r il a a F v 1 l e v e L 2 l e v e L 3 l e v e L Liabilities i t n u g n e y ro u r m il a a Ca v r a F 1 l e v e L 2 l e v e L 3 l e v e L i g t n n u y ro r am Ca e u r il a a F v 1 l e v e L 2 l e v e L 3 l e v e L Deposits 903,101 902,680 - 302,414 600,266 883,320 883,880 - 177,147 706,733 791,646 792,172 - 90,271 701,901 Debt instruments and other fnancial liabilities 268,529 271,226 72,945 143,153 55,128 242,749 248,891 52,896 139,301 56,694 252,594 255,758 43,306 186,356 26,096 1,171,630 1,173,906 72,945 445,567 655,394 1,126,069 1,132,771 52,896 316,448 763,427 1,044,240 1,047,930 43,306 276,627 727,997 The main valuation methods and inputs used in the estimates at 31 December 2018 of the fair values of the fnancial assets and liabilities in the foregoing table were as follows: • Loans and receivables: the fair value was estimated using the present value method. The estimates were made considering factors such as the expected maturity of the portfolio, market interest rates, spreads on newly approved transactions or market spreads -when available-. • Held-to-maturity investments: the fair value was calculated based on market prices for these instruments. • Financial liabilities at amortised cost: i) Deposits: the fair value of short term deposits was taken to be their carrying amount. Factors such as the expected maturity of the transactions and the Group’s current cost of funding in similar transactions are consider for the estimation of long term deposits fair value. It had been used also current rates ofered for deposits of similar remaining maturities. ii) Marketable debt securities and subordinated liabilities: the fair value was calculated based on market prices for these instruments -when available- or by the present value method using market interest rates and spreads, as well as using any signifcant input which is not observable with market data if applicable. The fair value of cash, cash balances at central banks and other deposits on demand was taken to be their carrying amount since they are mainly short-term balances. In addition, at 31 December 2017 and 2016, equity instruments amounting to EUR 1,211 million and EUR 1,349 million, respectively, (See note 2.d) recognised as Financial assets available-for-sale (IAS39) were measured at cost in the consolidated balance sheet because it was not possible to estimate their fair value reliably, since they related to investments in entities not listed on organised markets and, consequently, the non-observable inputs were signifcant. 608 2018 Auditors’ report and consolidated annual accounts d) Exposure of the Group to Europe’s peripheral countries The detail at 31 December 2018, 2017 and 2016, by type of fnancial instrument, of the Group’s sovereign risk exposure to Europe’s peripheral countries and of the short positions held with them, taking into consideration the criteria established by the European Banking Authority (EBA) (See note 54) is as follows: Sovereign risk by country of issuer/borrower at 31 December 2018** Million of euros* Debt instruments MtM Derivatives**** Financial assets held for trading and fnancial assets designated at fair value through proft or loss Financial assets at fair value through other Short comprehensive income positions Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets at amortised Loans and advances to cost customers*** Total net direct exposure Direct Indirect risk risk (CDS)s Spain Portugal Italy Ireland 3,601 (2,458) 72 477 - (115) (681) - 27,078 4,794 - - - - - - 7,804 13,615 49,640 407 277 385 - 3,725 8,753 80 - 261 - - 87 2 - - - - * ** See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). Information prepared under EBA standards. Also, there are government debt instruments on insurance companies balance sheets amounting to EUR 13,364 million (of which EUR 11,529 million, EUR 1,415 million, EUR 418 million and EUR 2 million relate to Spain, Portugal, Italy and Ireland, respectively) and of-balance-sheet exposure other than derivatives – contingent liabilities and commitments– amounting to EUR 5,622 million (of which EUR 4,870 million, EUR 366 million and EUR 386 million to Spain, Portugal and Italy, respectively). *** Presented without taking into account the valuation adjustments recognised (EUR 34 million). **** “Other than CDSs” refers to the exposure to derivatives based on the location of the counterparty, irrespective of the location of the underlying. “CDSs” refers to the exposure to CDSs based on the location of the underlying. Sovereign risk by country of issuer/borrower at 31 December 2017* Million of euros Debt instruments Financial assets at fair value through other Short comprehensive income positions Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets held for trading and fnancial assets designated at fair value through proft or loss Financial assets at amortised Total net direct cost customers*** exposure**** Loans and advances to MtM Derivatives*** Direct Indirect risk risk (CDS)s Spain Portugal Italy 6,940 (2,012) 208 1,962 (155) (483) 37,748 5,220 4,613 1,585 232 - 1,906 3 - 16,470 3,309 16 62,637 (21) 8,817 6,108 - (5) - - 5 * Information prepared under EBA standards. Also, there are government debt securities on insurance companies’ balance sheets amounting to EUR 11,673 million (of which EUR 10,079 million, EUR 1,163 million and EUR 431 million relate to Spain, Portugal and Italy, respectively) and of-balance-sheet exposure other than derivatives – contingent liabilities and commitments– amounting to EUR 3,596 million (EUR 3,010 million, EUR 146 million and EUR 440 million to Spain, Portugal and Italy, respectively). ** Presented without taking into account the Other comprehensive income recognised (EUR 31 million). *** “Other than CDSs” refers to the exposure to derivatives based on the location of the counterparty, irrespective of the location of the underlying. “CDSs” refers to the exposure to CDSs based on the location of the underlying. **** EUR 19,601 million were included within the direct exposures of the balance sheet mainly from debt securities of Grupo Banco Popular. 609 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix  Sovereign risk by country of issuer/borrower at 31 December 2016* Million of euros Debt instruments MtM Derivatives*** Financial assets held for trading and fnancial assets designated at fair value through Short proft or loss positions Spain Portugal Italy 8,943 (4,086) 154 2,211 (212) (758) Financial assets available- for-sale 23,415 5,982 492 Loans and receivables 1,516 214 - Held-to- maturity Loans and Total net direct investments customers** exposure advances to Other than CDSs Indirect risk (CDS)s 1,978 14,127 45,893 (176) 4 - 930 7 7,072 1,952 - (2) - - 2 * Information prepared under EBA standards. Also, there are government debt securities on insurance companies’ balance sheets amounting to EUR 10,502 million (of which EUR 9,456 million, EUR 717 million and EUR 329 million relate to Spain, Portugal and Italy, respectively) and of-balance-sheet exposure other than derivatives – contingent liabilities and commitments– amounting to EUR 5,449 million (EUR 5,349 million, EUR 91 million and EUR 9 million to Spain, Portugal and Italy, respectively). ** Presented without taking into account the Other comprehensive income recognised (EUR 27 million). *** Other than CDSs refers to the exposure to derivatives based on the location of the counterparty, irrespective of the location of the underlying. CDSs refers to the exposure to CDSs based on the location of the underlying. The detail of the Group’s other exposure to other counterparties (private sector, central banks and other public entities that are not considered to be sovereign risks) in the aforementioned countries at 31 December 2018, 2017 and 2016 is as follows: Exposure to other counterparties by country of issuer/borrower at 31 December 2018**** Million of euros* Debt instruments MtM Derivatives*** Financial assets held for Balances with central banks 42,655 1,369 51 - - Spain Portugal Italy Greece Ireland trading and Financial assets at fair value fnancial through other assets repurchase designated comprehensive income agreements at FVTPL Reverse 8,117 - 6,296 - - 412 11 84 - 21 1,760 90 635 - 1,093 Non-trading fnancial assets mandatorily at fair value through proft or loss 320 - - - 16 Financial assets at Loans and Total net amortised advances to cost customers** exposure direct Other than CDSs CDSs 202,149 258,075 3,880 (6) 33,596 38,887 1,132 10,830 17,896 80 80 25 10,633 11,788 253 28 127 - - - - 2,662 3,821 - - * See reconciliation of IAS39 as of 31 December 2017 to IFRS9 as of 1 January 2018 (Note 1.b). ** Also, the Group has of-balance-sheet exposure other than derivatives -contingent liabilities and commitments- amounting to EUR 76,691 million, EUR 8,158 million, EUR 5,193 million, EUR 200 million and EUR 850 million to counterparties in Spain, Portugal, Italy, Greece and Ireland, respectively. *** Presented without taking into account valuation adjustments or impairment corrections (EUR 9,385 million). **** “Other than CDSs” refers to the exposure to derivatives based on the location of the counterparty, irrespective of the location of the underlying. “CDSs” refers to the exposure to CDSs based on the location of the underlying. 610 2018 Auditors’ report and consolidated annual accounts Exposure to other counterparties by country of issuer/borrower at 31 December 2017* Million of euros Debt instruments Balances with central banks 36,091 761 17 - - Spain Portugal Italy Greece Ireland Financial assets held for trading and fnancial assets Reverse designated at fair value through proft or loss repurchase agreements Financial assets available- for-sale Loans and receivables Investments held-to- maturity Loans and advances to customers* Total net direct Other exposure**** than CDSs CDSs Derivatives*** 6,932 178 2,416 - - 623 160 438 - 20 4,784 764 1,010 - 476 2,880 4,007 - - 584 - 210,976 262,286 2,299 106 - - - 35,650 10,015 56 1,981 41,626 13,896 56 3,061 1,416 211 30 79 2 - 5 - - * Also, the Group has of-balance-sheet exposure other than derivatives -contingent liabilities and commitments- amounting to EUR 81,072 million, EUR 8,936 million, EUR 4,310 million, EUR 200 million and EUR 714 million, of which Grupo Banco Popular EUR 15,460 million, to counterparties in Spain, Portugal, Italy, Greece and Ireland, respectively. ** Presented excluding Other comprehensive income and impairment losses recognised (EUR 10,653 million of which around EUR 3,986 of Grupo Banco Popular). *** “Other than CDSs” refers to the exposure to derivatives based on the location of the counterparty, irrespective of the location of the underlying. “CDSs” refers to the exposure to CDSs based on the location of the underlying. **** EUR 83,625 million were included within the direct exposures of the balance sheet mainly from debt securities of Grupo Banco Popular. Exposure to other counterparties by country of issuer/borrower at 31 December 2016* Million of euros Debt instruments Financial assets held for trading and fnancial assets Reverse designated at fair value through proft or loss repurchase agreements Financial assets available- for-sale Balances with central banks 9,640 8,550 1,223 4,663 655 26 - - - - - - 84 818 - 45 426 732 - 396 Spain Portugal Italy Greece Ireland Derivatives*** Loans and receivables Investments held-to- maturity Loans and advances to customers** Total net direct exposure Other than CDSs 711 3,936 - - 77 - 240 - - - 147,246 172,033 2,977 28,809 34,150 1,600 6,992 8,568 161 34 47 1,503 690 47 985 CDSs (16) - 6 - - * Also, the Group has of-balance-sheet exposure other than derivatives -contingent liabilities and commitments- amounting to EUR 64,522 million, EUR 6,993 million, EUR 3,364 million, EUR 268 million and EUR 369 million to counterparties in Spain, Portugal, Italy, Greece and Ireland, respectively. ** Presented excluding Other comprehensive income and impairment losses recognised (EUR 8,692 million). *** “Other than CDSs” refers to the exposure to derivatives based on the location of the counterparty, irrespective of the location of the underlying. “CDSs” refers to the exposure to CDSs based on the location of the underlying. 611 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Following is certain information on the notional amount of the CDSs at 31 December 2018, 2017 and 2016 detailed in the foregoing tables: Notional amount Bought - 151 26 - - 205 Sold - 382 26 - 265 75 Notional amount Bought - 324 25 1 25 225 Sold - 499 128 1 450 201 Notional amount Bought - 534 28 - 78 317 Sold - 751 290 6 503 362 Net - (231) - - (265) 130 Net - (175) (103) - (425) 24 Net - (217) (262) (6) (425) (45) Fair value Bought - (2) - - - (5) Sold - (4) - - - 5 Net - (6) - - - - Fair value Bought Sold Net - (3) (1) - - (3) Fair value Bought - (3) 1 - - (1) - 5 1 - 5 8 Sold - (13) (1) - 2 7 - 2 - - 5 5 Net - (16) - - 2 6 31/12/18 Million of euros Spain Sovereign Other Portugal Sovereign Other Italy Sovereign Other 31/12/17 Million of euros Spain Sovereign Other Portugal Sovereign Other Italy Sovereign Other 31/12/16 Million of euros Spain Sovereign Other Portugal Sovereign Other Italy Sovereign Other 612 2018 Auditors’ report and consolidated annual accountsThe Continental Europe area encompasses all the business activities carried on in the region. The United Kingdom area includes the business activities carried on by the various Group units and branches with a presence in the UK. The Latin America area includes all the fnancial activities carried on by the Group through its banks and subsidiaries in the region. The United States area includes the holding company (SHUSA) and the businesses of Santander Bank, National Association, Santander Consumer USA Holdings Inc., Banco Santander Puerto Rico, Banco Santander International’s specialised unit and the New York branch. The Group has considered the aggregation criteria of IFRS8 for purposes of identifying these reportable geographical segments. The corporate centre segment includes the centralised management business relating to fnancial investments, fnancial management of the structural currency position, within the remit of the Group’s corporate asset and liability management committee, and management of liquidity and equity through issues. With regard to the balance sheet, due to the required segregation of the various business units (included in a single consolidated balance sheet), the amounts lent and borrowed between the units are shown as increases in the assets and liabilities of each business. These amounts relating to intra-Group liquidity are eliminated and are shown in the Intra-Group eliminations column in the table below in order to reconcile the amounts contributed by each business unit to the consolidated Group’s balance sheet. There are no customers located in any of the areas that generate income exceeding 10% of Total income. 52. Geographical and business segment reporting The segment reporting is based on fnancial information presented to the chief operating decision maker, which excludes certain items included in the statutory results that distort year-on-year comparisons and are not considered for management reporting purposes. This fnancial information (“underlying basis”) is computed by adjusting reported results for the efects of certain gains and losses (e.g.: capital gains, write-downs, etc.) These gains and losses are items that management and investors ordinarily identify and consider separately to understand better the underlying trends in the business. The Group has aligned the information in this operating segment Note in a manner consistent with the underlying information used internally for management reporting purposes and with that presented throughout the Group’s other public documents. The Group executive committee has been determined to be the chief operating decision maker for the Group. The Group’s operating segments refect its organisational and management structures. The Group executive committee reviews the Group’s internal reporting based around these segments in order to assess performance and allocate resources. The segments are diferentiated by the geographical area where profts are earned and by type of business. The fnancial information of each reportable segment is prepared by aggregating the fgures for the Group’s various geographic areas and business units. a) Geographical segments This primary level of segmentation, which is based on the Group’s management structure, comprises fve reportable segments: four operating areas plus the corporate centre. The operating areas, which include all the business activities carried on therein by the Group, are: Continental Europe, the United Kingdom, Latin America and the United States, based on the location of the Group’s assets. 613 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The condensed balance sheets and income statements of the various geographical segments are as follows: Million of euros (Condensed) balance sheet Total Assets Loans and advances to customers Cash, balances at central banks and credit institutions and other deposits on demand Debt instruments Other financial assets* Other asset accounts** Total Liabilities Customer deposits Central banks and credit institutions Marketable debt securities Other financial liabilities*** Other liabilities accounts**** Total Equity Other customer funds under management Investment funds Pension funds Assets under management Other non-managed marketed Customer funds 2018 Continental Europe United Kingdom Latin America United States Corporate centre Intra-Group eliminations Total 681,887 383,020 349,353 257,284 303,356 135,043 139,634 (150,002) 1,459,271 150,544 85,564 6,509 - 882,921 142,813 89,030 36,012 31,012 642,479 369,730 158,762 62,018 37,142 14,827 39,408 69,219 48,030 11,062 10,127 28,555 39,843 29,190 13,398 9,638 332,137 210,388 33,429 67,556 16,583 4,181 17,216 7,672 7,576 - 96 - 60,721 59,367 14,994 17,730 16,442 13,160 4,292 15,585 276,095 118,532 142,576 48,103 37,698 36,851 10,867 27,261 78,194 71,439 98 6,657 57,568 16,504 37,564 3,098 3,798 16,511 2,763 512 - 2,251 128 13,528 6,141 377 2,112 124,495 51,557 234 1 41,783 1,333 8,206 88,077 7 7 - - - (68,891) 197,069 - - (81,111) 191,124 70,808 117,349 (68,890) 1,351,910 - 780,496 (68,890) 187,909 - - - 246,619 95,007 41,879 (81,112) 107,361 - - - - - 157,855 127,564 11,160 19,131 42,211 * ** Including Trading derivatives and Equity instruments. Including Hedging derivatives, Changes in the fair value of hedged items in portfolio hedges of interest risk, Non-current assets held for sale, Assets under insurance or reinsurance contracts, tangible assets, intangible assets, tax assets, other assets and non-current assets held for sale. *** Including Trading derivatives, Short positions and Other financial liabilities. **** Including Hedging derivatives, Changes in the fair value of hedged items in portfolio hedges of interest risk, Liabilities under insurance or reinsurance contracts, provisions, tax liabilities, other liabilities and liabilities associated with non-current assets held for sale. 614 2018 Auditors’ report and consolidated annual accountsMillion of euros 2017 (Condensed) balance sheet Continental Europe United Kingdom Latin America United States Corporate centre Intra-Group eliminations Total Total Assets 678,122 361,230 293,347 114,388 132,099 (134,881) 1,444,305 Loans and advances to customers 380,081 243,616 147,929 71,963 5,326 - 848,915 Cash, balances at central banks and credit institutions and other deposits on demand Debt instruments Other fnancial assets* Other asset accounts** Total Liabilities Customer deposits 114,965 99,728 39,918 43,430 56,762 26,188 24,690 9,974 56,087 57,824 14,226 17,281 13,300 13,843 3,368 11,914 636,784 344,926 264,415 99,189 352,549 230,504 143,266 400 1,768 2,117 122,488 45,247 222 279 35,029 1,625 8,092 (53,089) 188,425 - 199,351 84,319 (81,792) 123,295 (53,089) 1,337,472 - 777,730 (53,089) 190,314 - - - 217,966 107,299 44,163 39,613 34,435 36,085 11,016 51,189 15,884 26,176 2,503 3,437 28,932 15,199 86,852 (81,792) 106,833 80,732 74,435 - 2,871 452 - 6,297 2,419 47 13,561 - - - - - - - - - - 166,574 135,749 11,566 19,259 41,398 Central banks and credit institutions 159,794 Marketable debt securities Other fnancial liabilities*** Other liabilities accounts**** Total Equity Other customer funds under management Investment funds Pension funds Assets under management Other non-managed marketed Customer funds 61,214 45,919 17,308 41,338 74,314 52,319 11,566 10,429 27,790 27,833 61,112 21,167 4,310 16,304 8,657 8,543 - 114 - * ** Including Trading derivatives and Equity instruments. Including Hedging derivatives, Changes in the fair value of hedged items in portfolio hedges of interest risk, Non-current assets held for sale, Assets under insurance or reinsurance contracts, tangible assets, intangible assets, tax assets, other assets and non-current assets held for sale. *** Including Trading derivatives, Short positions and Other fnancial liabilities. **** Including Hedging derivatives, Changes in the fair value of hedged items in portfolio hedges of interest risk, Liabilities under insurance or reinsurance contracts, provisions, tax liabilities, other liabilities and liabilities associated with non-current assets held for sale. 615 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros 2016 (Condensed) balance sheet Continental Europe United Kingdom Latin America United States Corporate centre Intra-Group eliminations Total Total Assets 520,134 354,960 320,768 137,391 132,154 (126,282) 1,339,125 Loans and advances to customers 297,214 251,251 152,187 85,389 4,429 - 790,470 Cash, balances at central banks and credit institutions and other deposits on demand Debt instruments Other fnancial assets* Other asset accounts** Total Liabilities Customer deposits Central banks and credit institutions Marketable debt securities Other fnancial liabilities*** Other liabilities accounts**** Total Equity Other customer funds under management Investment funds Pension funds Assets under management Other non-managed marketed Customer funds 77,232 80,639 40,689 24,360 36,643 28,045 26,819 12,202 67,400 63,314 18,696 19,171 16,970 17,940 3,566 13,526 486,644 337,945 291,454 120,741 2,640 1,374 2,803 120,908 47,387 857 552 30,921 2,633 12,424 (47,744) - - 153,141 191,312 92,573 (78,538) 111,629 (47,745) 1,236,426 - 691,111 (47,745) 149,398 - - - 228,869 123,890 43,158 143,747 64,460 47,585 47,436 41,395 11,291 22,264 26,340 2,907 4,770 29,314 16,650 84,767 (78,537) 102,699 81,034 74,554 - 3,828 701 - 6,480 3,127 - - - - 448 14,999 10 - - - - - 159,260 129,930 11,298 18,032 23,247 269,934 105,152 53,064 49,042 9,452 33,490 65,834 46,229 11,298 8,307 7,790 212,113 21,590 71,108 27,913 5,221 17,015 8,564 8,446 - 118 - * ** Including Trading derivatives and Equity instruments. Including Hedging derivatives, Changes in the fair value of hedged items in portfolio hedges of interest risk, Non-current assets held for sale, Assets under insurance or reinsurance contracts, tangible assets, intangible assets, tax assets, other assets and non-current assets held for sale. *** Including Trading derivatives, Short positions and Other fnancial liabilities. **** Including Hedging derivatives, Changes in the fair value of hedged items in portfolio hedges of interest risk, Liabilities under insurance or reinsurance contracts, provisions, tax liabilities, other liabilities and liabilities associated with non-current assets held for sale. 616 2018 Auditors’ report and consolidated annual accounts The condensed income statements for the geographical segments are as follows: Million of euros (Condensed) Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Attributable proft to the parent Continental Europe 10,107 4,419 915 441 2018 United Kingdom 4,136 1,023 199 62 Latin America United States Corporate centre 15,654 5,391 (947) 5,253 600 (306) 859 72 627 (69) 11 (23) Total 34,341 11,485 1,797 801 15,882 5,420 21,201 6,949 (1,028) 48,424 (8,279) 7,603 (1,399) (703) 5,501 (1,461) 4,040 - 4,040 397 3,643 (2,995) 2,425 (173) (326) 1,926 (539) 1,387 - 1,387 25 1,362 (7,995) 13,206 (4,567) (667) 7,972 (2,904) 5,068 - 5,068 840 4,228 (3,015) 3,934 (2,618) (199) 1,117 (347) 770 - 770 218 552 (495) (1,523) (116) (100) (1,739) 21 (1,718) - (1,718) 3 (1,721) (22,779) 25,645 (8,873) (1,995) 14,777 (5,230) 9,547 - 9,547 1,483 8,064 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement – reclassifcation of fnancial assets at amortised cost. Additionally, includes a release of EUR 113 million mainly corresponding to the results by commitments and contingent risks includes in the line of the statutory income statement of provisions or reversal of provisions. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except a release EUR 113 million mainly corresponding to the results by commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. 617 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros 2017 (Condensed) Underlying income statement Continental Europe United Kingdom Latin America United States Corporate centre Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Attributable proft to the parent 9,230 4,167 626 394 14,417 (7,661) 6,756 (1,109) (746) 4,901 (1,316) 3,585 - 3,585 383 3,202 4,364 1,003 282 67 15,984 5,569 5,494 1,014 30 971 9 410 (851) (38) (227) (104) Total 34,296 11,597 1,704 797 5,716 22,522 6,959 (1,220) 48,394 (2,862) 2,854 (205) (465) 2,184 (661) 1,523 - 1,523 25 1,498 (8,720) 13,802 (4,972) (1,330) 7,500 (2,386) 5,114 - 5,114 817 4,297 (3,198) 3,761 (2,780) (90) 891 (256) 635 - 635 227 408 (476) (1,696) (45) (182) (1,923) 31 (1,892) - (1,892) (3) (1,889) (22,917) 25,477 (9,111) (2,813) 13,553 (4,588) 8,965 - 8,965 1,449 7,516 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** NeNet loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement – reclassifcation of fnancial assets at amortised cost. Additionally, includes a release of EUR 50 million mainly corresponding to the results by commitments and contingent risks includes in the line of the statutory income statement of provisions or reversal of provisions. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except a release of EUR 50 million mainly corresponding to the results by commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. 618 2018 Auditors’ report and consolidated annual accounts Million of euros 2016 (Condensed) Underlying income statement Continental Europe United Kingdom Latin America United States Corporate centre Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Attributable proft to the parent 8,161 3,497 818 330 4,405 1,031 319 61 13,345 4,581 806 32 12,806 5,816 18,764 (6,781) 6,025 (1,342) (671) 4,012 (1,083) 2,929 - 2,929 330 2,599 (2,967) 2,849 (58) (340) 2,451 (735) 1,716 - 1,716 36 1,680 (7,692) 11,072 (4,911) (785) 5,376 (1,362) 4,014 - 4,014 628 3,386 5,917 1,102 22 492 7,533 (3,197) 4,336 (3,208) (90) 1,038 (357) 681 - 681 286 395 (739) (31) (242) (53) Total 31,089 10,180 1,723 862 (1,065) 43,854 (450) (1,515) 1 (74) (1,588) 141 (1,447) - (1,447) (8) (1,439) (21,087) 22,767 (9,518) (1,960) 11,289 (3,396) 7,893 - 7,893 1,272 6,621 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement – reclassifcation of fnancial assets at amortised cost. Additionally, includes a release of EUR 108 million mainly corresponding to the results by commitments and contingent risks includes in the line of the statutory income statement of provisions or reversal of provisions. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except a release of EUR 108 million mainly corresponding to the results by commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. 619 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Santander Corporate and Investment Banking (SCIB): This business refects the revenues from global corporate banking, investment banking and markets worldwide including treasuries managed globally (always after the appropriate distribution with Retail Banking customers), as well as equities business. Wealth Management: Includes the asset management business (Santander Asset Management, S.A., S.G.I.I.C.), the corporate unit of Private Banking and International Private Banking in Miami and Switzerland. The Real Estate Activity Spain includes the loans and foreclosed assets of customers who are mainly involved in real estate development and who have a specialised management model and the assets of the former real estate fund (Santander Banif inmobiliario). Although the Real Estate Operations in Spain and the Wealth Management business segments do not meet the quantitative thresholds defned in IFRS8, such segments are considered reportable by the Group and separately disclosed because the Group management believes that information about these segments is useful to users of the fnancial statements. There are no customers in any of the business segments that generate income exceeding 10% of Total income. b) Business segments At this secondary level of segment reporting, the Group is structured into Retail Banking, Santander Corporate and Investment Banking, Wealth Management and Real Estate Activity Spain; the sum of these segments is equal to that of the primary geographical reportable segments and total fgures for the Group are obtained by adding the data for the corporate centre. During the year 2018, certain changes took place in the organizational structure of the Group, which led to a change in the secondary level of segment reporting: • The Group acquired the remaining stake of SAM Investment Holdings Limited that was not owned by the Group, as explained in Note 3. Following this change in the consolidation perimeter, the Group has decided to integrate the acquired asset management business, the International Private Banking business and the corporate unit of Private Banking, which were previously reported within the Commercial Banking segment, into a new segment identifed as Wealth Management. The Group has restated the corresponding information for earlier periods to refect these changes in the structure of its internal organization and reporting. • Additionally, there has been an adjustment into the Global Customer Relationship Model’s perimeter between the Retail Banking segment and the Corporate and Investment Banking segment and other minor changes relating to the Real Estate Activity Spain. Finally the Group has decided to rename certain of its business segments. Accordingly, the Commercial Banking unit is now called Retail Banking; and the segment previously reported as Santander Global Corporate Banking is now called Santander Corporate & Investment Banking. Considering the aforementioned information, the business segments are now conformed as follows: Retail Banking (formerly Commercial Banking): This covers all customer banking businesses, including consumer fnance, except those of corporate banking, which are managed through the SCIB, and asset management and private banking, which are managed by Wealth Management. The results of the hedging positions in each country are also included, conducted within the sphere of each one’s Assets and Liabilities Committee. 620 2018 Auditors’ report and consolidated annual accounts The condensed income statements are as follows: Million of euros (Condensed) Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Attributable proft to the parent Retail Banking 32,523 8,945 720 645 42,833 (19,256) 23,577 (8,461) (1,707) 13,409 (4,329) 9,080 - 9,080 1,287 7,793 2018 Corporate & Investment Banking Wealth Real Estate Management Activity in Spain Corporate centre (33) (947) 2,378 1,512 1,004 193 5,087 (2,105) 2,982 (217) (108) 2,657 (792) 1,865 - 1,865 160 1,705 420 1,097 62 (37) 1,542 (729) 813 (9) (7) 797 (234) 563 - 563 35 528 Total 34,341 11,485 1,797 801 (69) 11 (23) (1,028) 48,424 (495) (22,779) (1,523) (116) (100) 25,645 (8,873) (1,995) (1,739) 14,777 21 (5,230) (1,718) 9,547 - (1,718) 3 - 9,547 1,483 (1,721) 8,064 - - 23 (10) (194) (204) (70) (73) (347) 104 (243) - (243) (2) (241) * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement. Additionally, includes a release of EUR 112 million mainly corresponding to the results by commitments and contingent risks included in the line provisions or reversal of provisions,net of the statutory income statement. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except a release of EUR 112 million mainly corresponding to the results by commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. 621 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros (Condensed) Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Attributable proft to the parent 2017 Corporate & Investment Banking M 2,442 1,627 1,212 222 5,503 Retail Banking 32,339 9,306 681 580 42,906 (19,677) (2,028) 23,229 (8,278) (2,395) 12,556 (3,843) 8,713 - 8,713 1,258 7,455 3,475 (690) (72) 2,713 (750) 1,963 - 1,963 183 1,780 Wealth anagement Activ Real Estate ity in Spain 404 700 38 70 1,212 (528) 684 (9) (8) 667 (165) 502 - 502 24 478 (38) 2 - 29 (7) (208) (215) (88) (157) (460) 139 (321) - (321) (13) (308) Corporate centre (851) (38) (227) (104) Total 34,296 11,597 1,704 797 (1,220) 48,394 (476) (22,917) (1,696) (46) (181) (1,923) 25,477 (9,111) (2,813) 13,553 31 (4,588) (1,892) 8,965 - (1,892) (3) (1,889) - 8,965 1,449 7,516 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement. Additionally, includes a release of EUR 50 million mainly corresponding to the results by commitments and contingent risks included in the line provisions or reversal of provisions,net of the statutory income statement. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except a release of EUR 50 million mainly corresponding to the results by commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. 622 2018 Auditors’ report and consolidated annual accounts Million of euros (Condensed) Underlying income statement Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Proft from continuing operations Net proft from discontinued operations Consolidated proft Non-controlling interests Attributable proft to the parent 2016 Corporate & Investment Banking 2,528 1,407 1,256 289 5,480 Retail Banking 28,914 8,206 668 536 38,324 (18,036) (1,917) 20,288 (8,673) (1,682) 9,933 (2,734) 7,199 - 7,199 1,089 6,110 3,563 (658) (76) 2,829 (787) 2,042 - 2,042 174 1,868 Wealth Management Real Estate Activity in Spain Corporate centre 429 597 32 18 1,076 (473) 603 (22) (5) 576 (153) 423 - 423 14 409 (1,065) 43,854 (450) (21,087) (43) 1 9 72 39 (211) (172) (167) (122) (461) 137 (324) - (739) (31) (242) (53) (1,515) 2 (75) (1,588) 141 (1,447) - (324) (1,447) 3 (8) (327) (1,439) Total 31,089 10,180 1,723 862 22,767 (9,518) (1,960) 11,289 (3,396) 7,893 - 7,893 1,272 6,621 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement. Additionally, includes a release of EUR 108 million mainly corresponding to the results by commitments and contingent risks included in the line provisions or reversal of provisions,net of the statutory income statement. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except a release of EUR 108 million mainly corresponding to the results by commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. 623 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix c) Reconciliations of reportable segment results The tables below reconcile the underlying basis results to the statutory results for each of the periods presented as required by IFRS8. For the purposes of these reconciliations, all material reconciling items are separately identifed and described. The Group’s assets and liabilities for management reporting purposes do not difer from the statutory reported fgures and therefore are not reconciled. Million of euros Reconciliation of underlying results to statutory results Underlying results Adjustments Statutory results 2018 Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Consolidated proft Non-controlling interests Attributable proft to the parent 34,341 11,485 1,797 801 48,424 (22,779) 25,645 (8,873) (1,995) 14,777 (5,230) 9,547 1,483 8,064 - - - - - - - - (576) (576) 344 (232) 22 (254) 34,341 11,485 1,797 801 48,424 (22,779) 25,645 (8,873) (2,571) 14,201 (4,886) 9,315 1,505 7,810 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement – reclassifcation of fnancial assets at amortised cost. Additionally, includes a release of EUR 113 million mainly corresponding to the results by commitments and contingent risks includes in the line of the statutory income statement of provisions or reversal of provisions. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except for a release of 113 million euros mainly corresponding to results from commitments and contingent risks, Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. Explanation of adjustments: • Restructuring costs: The net impact of EUR -300 million on • Negative goodwill in Poland: The negative goodwill of EUR 45 Proft attributable to the Parent, relates to restructuring costs in connection with the integration of Banco Popular Español, S.A.U., as follows EUR -280 million in Spain, EUR -40 million in corporate centre and EUR 20 million in Portugal. The corresponding gross impacts are refected on the “Other gains (losses) and provisions” line above. million, relates to the acquisition of the the banking and private banking business of Deutsche Bank Polska, S.A. 624 2018 Auditors’ report and consolidated annual accounts Million of euros 2017 Reconciliation of underlying results to statutory results Underlying results Adjustments Statutory results Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Proft for the period Non-controlling interests Proft attributable to the parent 34,296 11,597 1,704 797 48,394 (22,917) 25,477 (9,111) (2,813) 13,553 (4,588) 8,965 1,449 7,516 - - (39) - (39) (76) (115) (98) (1,249) (1,462) 704 (758) 139 (897) 34,296 11,597 1,665 797 48,355 (22,993) 25,362 (9,209) (4,062) 12,091 (3,884) 8,207 1,588 6,619 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement – reclassifcation of fnancial assets at amortised cost. Additionally, includes a release of EUR 50 million mainly corresponding to the results by commitments and contingent risks includes in the line of the statutory income statement of provisions or reversal of provisions. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except for a release of 50 million euros mainly corresponding to results from commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. Explanation of adjustments • Allfunds Bank, S.A. sale: corresponds to the sale by the Bank and its partners of 100% of Allfunds Bank, S.A. capital, obtaining an amount of EUR 501 million from the sale of its 25% stake in Allfunds Bank, S.A., resulting in gains of EUR 425 million recognised in “Other gains (losses) and provisions” and of EUR 297 million net of tax. • Restructuring Costs and equity impairments: relates to the charge of EUR -425 million on “Other gains (losses) and provisions” (EUR -300 million net of tax) for the integration of Banco Popular Español, S.A.U. into the group and an additional charge of EUR -125 million on “Other gains (losses) and provisions” (EUR -85 million after tax efect) mainly related to commercial networks in Germany. During 2017, an additional impairment on equity investment and intangible assets held by the Group has been accounted for a value of EUR -130 million on “Other gains (losses) and provisions”, with no tax efect. • Goodwill Impairment: impairment of goodwill associated with Santander Consumer USA Holdings, inc. This impairment had a gross impact of EUR -899 million on “Other gains (losses) and provisions” line (EUR -603 million in Proft attributable to the parent). • US Tax Reform and other impairments: the adjustment primarily corresponds to net impacts of the tax reform in the United States together with other expenses related to provisions for hurricanes and other provisions in the year 2017. The net impact of these adjustments in Proft attributable to the parent adds EUR -76 million. 625 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros 2016 Reconciliation of underlying results to statutory results Underlying results Adjustments Statutory results Net interest income Net fee income Gains (losses) on fnancial transactions* Other operating income** Total income Administrative expenses, depreciation and amortisation Net operating income*** Net loan-loss provisions**** Other gains (losses) and provisions***** Operating proft/(loss) before tax Tax on proft Consolidated proft Non-controlling interests Attributable proft to the parent 31,089 10,180 1,723 862 43,854 (21,087) 22,767 (9,518) (1,960) 11,289 (3,396) 7,893 1,272 6,621 - - 378 - 378 (14) 364 - (885) (521) 114 (407) 10 (417) 31,089 10,180 2,101 862 44,232 (21,101) 23,131 (9,518) (2,845) 10,768 (3,282) 7,486 1,282 6,204 * ** Gains (losses) on fnancial transactions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Gain or losses on fnancial assets and liabilities not measured at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities held for trading, net, Gains or losses on non-trading fnancial assets and liabilities mandatorily at fair value through proft or loss, net, Gain or losses on fnancial assets and liabilities measured at fair value through proft or loss, net, Gain or losses from hedge accounting, net and Exchange diferences, net. Other operating income includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Dividend income; Income from companies accounted for using the equity method, Other operating income, Other operating expenses, Income from assets under insurance or reinsurance contracts and Expenses from liabilities under insurance or reinsurance contracts. *** Net Operating Income is used for the Group’s internal reporting and management reporting purposes but is not a line item in the statutory consolidated income statement. **** Net loan-loss provisions refers to Impairment or reversal of impairment at fnancial assets not measured at fair value through proft or loss and net gains and losses from changes line item in the statutory income statement – reclassifcation of fnancial assets at amortised cost. Additionally, includes a release of EUR 108 million mainly corresponding to the results by commitments and contingent risks includes in the line of the statutory income statement of provisions or reversal of provisions. ***** Other gains (losses) and provisions includes the following line items in the statutory income statement, which are presented net for internal reporting and management reporting purposes: Provisions or reversal of provisions except a release of 108 million euros mainly corresponding to results from commitments and contingent risks; Impairment of investments in joint ventures and associates, net; Impairment on non-fnancial assets, net; Gains or losses on non-fnancial assets, net; Negative goodwill recognised in results and Gains or losses on non-current assets held for sale not classifed as discontinued operations. • VISA Europe Equity Gains: on 21 June 2016 the Group disposed its Visa Europe, Ltd. stake, classifed as available for sale, obtaining a gross gain of EUR 380 million recognised in “Other gains (losses) and provisions” (impact of EUR 227 million net of taxes). Explanation of adjustments • PPI United Kingdom: during 2016, the group accounted for provisions to cover eventual claims related to payment protection insurance (PPI). These provisions had an impact of EUR -139 million on “Other gains (losses) and provisions” (EUR -137 million in Proft attributable to the parent). • Restructuring costs: refects the impacts of the restructuring costs faced by the Group during the year 2016, mainly relating to the acceptance of pre-retirement and voluntary redundancy ofers in Spain with an impact of EUR -662 million on “Other gains (losses) and provisions” (EUR -475 million in Proft attributable to the parent). 626 2018 Auditors’ report and consolidated annual accounts 53. Related parties The parties related to the Group are deemed to include, in addition to its subsidiaries, associates and joint ventures, the Bank’s key management personnel (the members of its board of directors and the executive vice presidents, together with their close family members) and the entities over which the key management personnel may exercise signifcant infuence or control. Following below is the balance sheet balances and amounts of the Group’s income statement corresponding to operations with the parties related to it, distinguishing between associates and joint ventures, members of the Bank’s board of directors, the Bank’s executive vice presidents, and other related parties. Related-party transactions were made on terms equivalent to those that prevail in arm’s-length transactions or, when this was not the case, the related compensation in kind was recognise. Million of euros 2018 2017 2016 s f f o o s d s e t r s n r t r aie ea o o r bo i c t u t m bc od e s n e e r n s e hi M a A td v j s t n e d e i v s ie t r u p c e e c x i Ev d e t a l e r s e t r t s n e ai s io r e c u ei od t t h s n r n t a s e a Op A v j f o s r e bo m e M f o d s r ar o t bc e e r hi td s t n e d e i v s ie t r u p c e e c x i Ev d e t a l e r s e t r t s n e ai s io r e c u ei od t t h s n r n t a s e a Op A v j 30 256 6,048 - - 472 21 300 5,884 - - 223 30 256 21 279 Assets: Loans and advances: credit institutions Loans and advances: customers Debt instruments Others Liabilities: Financial liabilities: credit institutions Financial liabilities: customers Marketable debt securities Others Income statement: Interest income Interest expense Gains/losses on fnancial assets and liabilities and others Commission income Commission expense Other: Contingent liabilities and others Contingent commitments Derivative fnancial instruments 7,202 704 6,142 295 61 1,650 8 1,596 8 38 993 73 (3) 82 853 (12) 4,707 21 393 4,293 - - - - - 19 - 19 - - - - - - - - 9 7 1 1 - - 12 - 12 - - - - - - - - 3 1 2 - - - 363 - 363 - - 31 14 (1) - 18 - 5,081 473 22 748 309 414 4 21 1,020 57 (3) 302 735 (71) In addition to the detail provided above, there were insurance contracts linked to pensions amounting to EUR 210 million at 31 December 2018 (31 December 2017: EUR 239 million; 31 December 2016: EUR 269 million). - - - - - 19 - 19 - - - - - - - - 7 6 1 - - - 14 - 14 - - - - - - - - 3 1 2 - 782 3,881 508 64 210 6 301 3,574 597 4,146 352 60 185 19 17 4,110 5,209 452 - 824 155 669 - - 609 67 (15) 15 561 (19) 21 - 63 - 63 - - 14 8 - - 6 - f f o o d s rs r e r ao bo t m bc e e e r hi M td - - - - - 27 - 27 - - - - - - - - 1 - 1 - s t n e d e i v s ie t r u p c ee c x i Ev d e t a l e r s e r ei t h r t a Op 22 307 - - 22 286 - - 21 - 10 124 - - 10 124 - - - - - - - - 3 - 3 - - - 13 10 (1) - 4 - 846 139 417 290 627 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 54. Risk management In addition, the Group considers the following risks: a) Cornerstones of the risk function The risk management and control model is based on the principles below: • Operational risk: is defned as the risk of loss due to the inadequacy or failure of internal processes, people and systems, or due to external events. This defnition includes legal risk. • Advanced risk management policy, with a forward-looking • Compliance risk and conduct: is that which arises from practices, approach that allows the Group to maintain a medium-low risk profle, through a risk appetite defned by the board. processes or behaviours that are not adequate or that do not comply with internal regulations, legality or supervisory requirements. • Risk culture that applies to all employees throughout the Group. • Clearly defned three lines of defence model that enable us to identify, manage, control, monitor and challenge all risks. • Autonomous subsidiaries model with robust governance based on a clear structure that separates the risk management and the risk control functions. • Information and data management processes that allow all risks to be identifed, assessed, managed and reported at appropriate levels. • Risks are managed by the units that generate them. • Reputational risk: is defned as the risk of a current or potential negative economic impact due to a reduction in the perception of the Group by employees, customers, shareholders/investors and society in general. • Model risk: is the risk of loss arising from inaccurate predictions that may lead the Group to make sub-optimal decisions, or from the inappropriate use of a model. • Strategic risk: the risk of loss or damage arising from strategic decisions or their poor implementation, which afect the long- term interests of our main stakeholders, or of an inability to adapt to the changing environment These principles are aligned with the Group’s strategy and business model, taking into account the requirements of regulators and supervisors, as well as the best market practices. 2. Risk governance The Group has a strong governance framework, which pursues the efective control of the risk profle, within the risk appetite defned by the board. The Board is responsible for approving the general risk control and management policy, including tax risks. 1. Main risks of the group’s fnancial instruments The main risk categories in which the Group has its most signifcant current and/or potential exposures, thus facilitating the identifcation thereof, includes the following: • Credit risk: risk of fnancial loss arising from the default or credit quality deterioration of a customer or other third party, to which the Santander Group has either directly provided credit or for which it has assumed a contractual obligation. • Market risk: risk incurred as a result of changes in market factors that afect the value of positions in the trading book. • Trading risk • Structural risk. • Liquidity risk: risk of the Group does not have the liquid fnancial assets necessary to meet its obligations at maturity, or can only obtain them at a high cost. • Capital risk: risk of Santander Group not having an adequate amount or quality of capital to meet its internal business objectives, regulatory requirements or market expectations. This governance framework is underpinned by the distribution of roles among the three lines of defence, a robust structure of committees and a strong relationship between the Group and its subsidiaries. 2.1. Lines of defence At Banco Santander, we follow a three lines of defence control model: • The frst line of defence is all business functions and business support functions that originate risks and have primary responsibility in the management of those risks. The role of these functions is to establish a management structure for the risks generated as part of their activity ensuring that these remain within approved risk limits. • The second line of defence is risk Control and Compliance and Conduct function. The role of these functions is to provide independent oversight and challenge to the risk management activities of the frst line of defence. • The third line of defence: Internal Audit function. This function controls and regularly checks that the policies, and procedures are adequate and efectively implemented in the management and control of all risks The risk control, compliance and conduct, and internal audit functions are have direct access to the board of directors and/or its committees. 628 2018 Auditors’ report and consolidated annual accounts 2.2. Risk committee structure Ultimately, the board of directors is responsible for risk management and control and, in particular, for approving and periodically reviewing the Group’s risk culture and risk appetite framework. Except for specifc topics detailed in its bylaws, the board has the capacity to delegate its faculties to other committees. This is the case of the risk supervision, regulation and compliance committee and the Group’s Executive committee, which has specifc risk related responsibilities. The Group Chief Risk Ofcer (Group CRO) leads the risk function within the Group, advises and challenges the executive line and reports independently to the risk supervision, regulation and compliance committee and to the board. Other bodies that form the highest level of risk governance, with authorities delegated by the board of directors, are the executive risk committee and the risk control committee, detailed below: Risk control committee (CCR): To control and ensure that risks are managed in accordance with the risk appetite approved by the board, providing a comprehensive overview of all risks. This includes identifying and monitoring both current and potential risks, and evaluating their potential impact on the Group’s risk profle. This committee is chaired by the Group Chief Risk Ofcer (Group CRO). Additionally, each risk factor has its own fora, committees and meetings to manage the risks under their control. Among others, they have the following responsibilities: • Advice the CRO and the risk control committee that risks are managed in line with the Group’s risk appetite. • Carrying out complete and regular monitoring of each risk factor. • Oversee the measures adopted to comply with the expectations of the supervisors and internal and external auditors. Executive risk committee (ERC): This committee is responsible for managing all risks, within the powers delegated by the board. The committee makes decisions on risks assumed at the highest level, ensuring that they are within the established risk appetite limits for the Group. This committee is chaired by the Chief executive ofcer and it is composed with nominated executive directors and other Group´s senior management. The Risk, Finance and Compliance and Conduct functions, among others, are represented. The Group CRO has a veto right on the committee’s decisions. 2.3. The Group’s relationship with subsidiaries regarding risk management Alignment of units with the Group In all the subsidiaries, the management and control model follows the frameworks established by the Group’s board of directors. The local units adhere to them by their respective boards. The Group reviews and validates any local adaptations as needed. Corporate centre participates in the relevant decision-making through their validation. Subsidiary committee structures The “Group-subsidiary governance model and good governance practices for subsidiaries” recommends that each subsidiary should have Risk committees and other executive committees, consistent with those already in place in the Group. The subsidiary governance bodies are structured taking into consideration local requirements, both regulatory and legal, as well as their specifc dimension and complexity, in a manner that is consistent with those of the parent company, as established in the internal governance framework. 3. Management processes and tools 3.1. Risk appetite and structure of limits The Group defnes the risk appetite as the amount and type of risks that are considered prudent to assume for implementing our business strategy in the event of unexpected circumstances. Severe scenarios that could have a negative impact on the levels of capital, liquidity, proftability and/or the share price are taken into account. The risk appetite is set by the board for the whole Group. Every main business unit sets its own risk appetite according to the adaptation of the Group methodology and its own circumstances. The boards of the subsidiaries are responsible for approving their respective risk appetite proposals once they have been reviewed and validated by the Group. The Group shares a common risk appetite model. It sets out the requirements for processes, metrics, governance bodies, controls and standards for implementation across the Group, cascading down management policies and limits to lower levels. Corporate risk appetite principles The following principles govern the Santander Group’s risk appetite in all its units: • Responsibility of the board and of senior management. • Holistic risk view (Enterprise Wide Risk), risk profle backtesting and challenge. The risk appetite must consider all signifcant risks and facilitate an aggregate view of the risk profle through the use of quantitative metrics and qualitative indicators. 629 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix • Forward-looking view. The risk appetite must consider the • The maximum levels of concentration that the Group considers desirable risk profle for the short and medium term, taking into account both the most plausible circumstances and adverse/ stress scenarios. reasonable to admit. • Non-fnancial transversal risks • Embedding and alignment with strategic and business plans. The risk appetite is an integral part of the strategic and business planning, and is embedded in the daily management through the transfer of the aggregated limits to those set at portfolio level, unit or business line, as well as through the key risk appetite processes. 3.2. Risk identifcation and assessment (RIA) The Group carries out the identifcation and assessment of the diferent risks that is exposed to, involving the diferent lines of defence, establishing management standards that not only meet regulatory requirements but also refect best practices in the market, and reinforce our risk culture. • Coherence across the various units and a common risk language throughout the Group. The risk appetite of each unit of the Group must be coherent with that across the Group. • Periodic review, backtesting and adoption of best practices and regulatory requirements. Monitoring and control mechanisms are established to ensure the risk profle is maintained, and the necessary corrective and mitigating actions are taken in the event of non-compliance. Limits, monitoring and control structure The risk appetite is formulated annually and includes a series of metrics and limits to establish in quantitative and qualitative terms the maximum risk exposure that every unit and the Group as a whole is willing to assume. Compliance with risk appetite limits is regularly monitored. Specialised control functions report the risk profle adequacy to the board and its committees, on quarterly basis. Limit breaches and non-compliance with the risk appetite are reported to the relevant governance bodies. An analysis of the causes, an estimation of the duration of the breach and corrective actions proposals are also submitted. Linkage between the risk appetite limits and those of the business units and portfolios is a key element for making the risk appetite an efective risk management tool. Pillars of the risk appetite The risk appetite is expressed via limits on quantitative metrics and qualitative indicators that measure the exposure or risk profle by type of risk, portfolio and, segment and business line, under both current and stressed conditions. These metrics and risk appetite limits are articulated in fve axes that defne the positioning that Santander wants to adopt or maintain in the deployment of its business model, described as follows: • The volatility in the income statement that the Group is willing to accept. • The solvency position that the Group wants to maintain. • The minimum liquidity position that the Group wants to have. In 2018, the approach centred on three main areas: standards control environment review, perimeter completeness by integrating new units, together with the risk performance indicators review and their alignment with the risk appetite. In addition the RIA exercise analyses the evolution of risks and identifes areas of improvement: • Risk performance, enabling the understanding of residual risk by risk type through a set of metrics and indicators calibrated using international standards. • Control environment assessment, measuring the degree of implementation of the target operating model, as part of our advanced risk management. • Forward-looking analysis, based on stress metrics and identifcation and/or assessment of the main threats to the strategic plan (Top risks), enabling specifc action plans to be put in place to mitigate potential impacts and monitoring these plans. Based on the periodic RIA exercise, the Group’s risk profle as of December 2018 remains as solid medium-low. 3.3. Scenario analysis We analyse the impact triggered by diferent scenarios in the environment, in which the Group operates. These scenarios are expressed both in terms of macroeconomic variables, as well as other variables that may impact our risk profle. Scenario analysis is a robust and useful tool for management at all levels. It enables the Group to assess its resilience in stressed environments or scenarios, and identifes measures to reduce exposure under these scenarios. The objective is to reinforce the stability of income, capital and liquidity. The robustness and consistency of the scenario analysis exercises are based on the following pillars: • Development and integration of models that estimate the future performance of metrics (for example, credit losses), based on both historic information (internal to the Group and external from the market), and simulation models. 630 2018 Auditors’ report and consolidated annual accounts • Inclusion of expert judgement and portfolio manager’s know- how. • Challenge and backtesting of model results to ensure they are adequate. • Robust governance of the whole process, covering models, scenarios, assumptions and rationale for the results, and their impact on management. Scenario analysis forms an integral part of several key processes of the Group: The risk reporting taxonomy, contains three types of reports received by senior management on a monthly basis: the Group risk report, the risk reports of each unit, and the reports of each of the risk factors identifed in the Group’s risk map. b) Credit risk 1. Introduction to the credit risk treatment Credit risk is the risk of fnancial loss arising from the default or credit quality deterioration of a customer or other third party, to which the Group has either directly provided credit or for which it has assumed a contractual obligation. • Regulatory uses: stress test scenarios using the guidelines set by There are diferent limit models depending on the segment: • Large corporate groups: we use a pre-classifcation model based on a system for measuring and monitoring economic capital. The result is the level of risk that the Group is willing to assume with a customer/group, in terms of Capital at Risk, nominal CAP, and maximum periods according to the type of transaction (in the case of fnancial entities, limits are managed through Credit Equivalent Risk (CER). It includes the actual and expected risk with a customer based on its usual operations, always within the limits defned in the risk appetite and established credit policies. • Corporates and institutions that meet certain requirements (deep knowledge, rating, etc.): we use a more simplifed pre- classifcation model through an internal limit that establishes a reference of the level of risk to be assumed with the customer. The criteria will include, among others, repayment capacity, debt in the system and the banking pool distribution. In both cases, transactions over certain thresholds or with specifc characteristics might require the approval of an analyst or committee. • For individual customers and SMEs with low turnover, large volumes of credit transactions can be managed more easily with the use of automatic decision models for classifying the customer/ transaction binomial. In specifc situations where a series of requirements are met, pre-approved transactions are granted to customers or potential customers (campaigns). the European regulator or by each local supervisor. • Internal capital adequacy assessment (ICAAP) or liquidity assessment (ILAAP) in which, while the regulators can impose certain requirements, the Group develops its own methodology to assess its capital and liquidity levels under diferent stress scenarios to support planning and adequately managing the Group’s capital and liquidity. • Risk appetite. Contains stressed metrics on which maximum levels of losses (minimum liquidity levels) are established that the Group does not want to exceed. These exercises are related to those for capital and liquidity, although they have diferent frequencies and present diferent granularity levels. • Recurrent risk management in diferent processes/exercises: • Budgetary and strategic planning process, in the development of business policies for risk approval, in the global risk analysis made by senior management and in specifc analysis regarding the profle of activities or portfolios. • Identifcation of Top risks on the basis of, a systematic process to identify and assess all the risks which the Group is exposed to. The Top risks are selected and a macroeconomic or idiosyncratic scenario is associated with each one, to assess their impact on the Group. • Recovery plan annually to establish the available tools the Group will have, to survive in the event of an extremely severe fnancial crisis. The plan sets out a series of fnancial and macroeconomic stress scenarios, with difering degrees of severity, that include idiosyncratic and/or systemic events. • IFRS9 from 1 January 2018, the processes, models and scenario analysis methodology are included in the new regulatory provision requirements. 3.4. Risk Reporting Framework (RRF) Our reporting model has strengthened by consolidating the overall view of all risks, based on complete, precise and recurring information that allows the Group’s senior management to assess the risk profle and decide accordingly. 631 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix 2. Main aggregates and variations Following are the main aggregates relating to credit risk arising on customer business: Main credit risk aggregates arising on customer business (Management information data) Credit risk with customers* (million of euros) Non-performing loans NPL ratio (%) 2018 2017 2016 2018 2017 2016 2018 2017 2016 Continental Europe Spain Santander Consumer Finance Portugal Poland UK Latin América Brazil Mexico Chile Argentina US Santander Bank, National Association Santander Consumer USA Group Total 429,454 239,479 97,922 38,340 30,783 262,196 171,898 84,212 33,764 41,268 5,631 92,152 51,049 26,424 424,248 331,706 22,537 24,674 19,638 251,433 172,974 14,833 15,880 92,589 32,816 24,391 88,061 30,540 21,902 2,244 2,319 2,279 2,959 1,317 1,114 247,625 255,049 2,755 3,295 167,516 173,150 83,076 28,939 89,572 29,682 7,461 4,418 822 7,464 4,391 9,361 2,357 2,691 1,187 3,585 8,333 5,286 779 819 40,406 40,864 1,925 2,004 2,064 8,085 77,190 44,237 24,079 7,318 91,709 54,040 28,590 179 202 109 2,688 2,156 2,088 450 536 717 2,043 1,410 1,097 958,153 920,968 855,510 35,692 37,596 33,643 5.25 6.19 2.29 5.94 4.28 1.05 4.34 5.25 2.43 4.66 3.17 2.92 0.88 7.73 3.73 5.82 6.32 2.50 7.51 4.57 1.33 4.46 5.29 2.69 4.96 2.50 2.79 1.21 5.86 4.08 5.92 5.41 2.68 8.81 5.42 1.41 4.81 5.90 2.76 5.05 1.49 2.28 1.33 3.84 3.93 * Includes gross lending to customers, guarantees and documentary credits. Risk is diversifed among the main regions where the Group operates: Continental Europe (45%), United Kingdom (27%), Latin America (18%) and the United States (10%), with an adequate balance between mature and emerging markets. The evolution up to December 2018, credit risk with customers increased by 4% vs. 2017, considering the same perimeter, mainly due to the United States, United Kingdom, and Mexico. Growth in local currency was generalised across all units with the exception of Spain and Portugal. These levels of lending, together with lower non-performing loans (NPLs) of EUR 35,692 million (-5.1% vs. 2017) reduced the Group’s NPL ratio to 3.73% (-35 bp against 2017). In order to cover potential losses arising from these NPLs, in accordance with the new provision calculation in accordance with IFRS9, the Group recorded allowances for loan loss of EUR 8,873 million (-2.6% vs. December 2017), after deducting post write-of recoveries. This decrease is materialised in a reduction of the cost of credit to 1.00 % (7 bp less than the previous year). Information on the estimation of impairment losses The Group estimates the impairment losses by calculating the expected loss at 12 months or for the entire life of the transaction, based on the stage in which each fnancial asset is classifed in accordance with IFRS9. Then, considering the most relevant units of the group (United Kingdom, Spain, United States, Brazil, as well as Chile, Mexico, Portugal, Poland, Argentina and the Group Santander Consumer Finance) representing about 95% of the total of the Group’s provisions, the detail of the exhibition and the impairment losses associated with each of the stages as of 31 December 2018 is shown. In addition, depending on the current credit quality of the transactions, the exposure is divided into three grades (investment, speculation and default): Exposure and impairment losses by stage Million of euros Credit Quality* Stage 1 Stage 2 Stage 3 Total Investment grade 685,507 7,176 Speculation grade 222,495 47,439 - - 692,683 269,935 Default - - 30,795 30,795 Total Risk** 908,002 54,616 30,795 993,412 Impairment losses 3,823 4,644 12,504 20,970 * Detail of credit quality ratings calculated for Group management purposes. ** Amortised cost assets + Loans and advances + loan commitments granted. 632 2018 Auditors’ report and consolidated annual accounts The other units up to the total Group amounts contributed EUR 151,906, 700 and 1,743 million of exposure, and impairment losses of EUR 152, 163 and 1,145 million, in stage 1, stage 2 and stage 3, respectively. The rest of the balance, considering the fnancial instruments not included before, amounts to EUR 242,867 million, mostly classifed in stage 1. In addition, at 31 December 2018, the Group had EUR 757 million (1 January 2018: EUR 803 million) of purchased credit-impaired assets, which relate mainly to the business combinations carried out by the Group. The Group monitors the evolution of credit risk provisions, in collaboration with the main geographies, by carrying out sensitivity analyses considering variations in the scenarios macroeconomic variables and their main variables (such as interest rate, house price growth, unemployment rate or GDP growth) that have an impact on the distribution of fnancial assets in the diferent stages and the calculation of credit risk provisions. Aditionally, based on similar macroeconomic scenarios, the Group also performs stress tests and sensitivity analysis in a current basis, such as ICAAP, strategic plans, budgets and recovery and resolution plans. In this sense, a prospective view of the sensitivity of each of the Group’s loan portfolio is created in relation to the possible desviation from base scenario, considering both the macroeconomic developments in diferent scenarios and the three year evolution of the business. These tests include potentially adverse and favourable scenarios. The classifcation of transactions into the diferent stages of IFRS9 is carried out in accordance with the provisions of the risk management policies of the diferent Group´s units, which are consistent with the risk management policies prepared by Banco Santander Group. In order to determine the classifcation in stage 2, the Group assesses whether there has been a signifcant increase in credit risk (SICR) since the initial recognition of transactions, considering a series of common principles throughout the Group that guarantee that all fnancial instruments are subject to this assessment, which considers the particularities of each portfolio and type of product on the basis of various quantitative and qualitative indicators. Furthermore, transactions are subject to the expert judgment of analysts, which is implemented in accordance with approved governance. 3. Detail of the main geographical areas Following is the risk information related to the most relevant geographies in exposure and credit risk allowances. In addition, for the Santander Corporate & Investment Banking perimeter, transactions and balances are included in each geography. 3.1. United Kingdom Credit risk with customers in the UK amounted to EUR 262,196 million as of December 2018, which means an increase, in local currency, of 6% compared to year end 2017 (and 7% in local currency), and representing 27% of the Group’s total loan portfolio. Mortgage portfolio This portfolio at the end of December amounted to EUR 176,581 million. It consists of residential mortgages granted to new and existing customers, and all are frst mortgages. There are no transactions that entail second or successive liens on mortgaged properties. All properties are valued independently before each new transaction is approved, in accordance with the Group’s risk management principles. The value of the property used as collateral for mortgages that have already been granted is updated quarterly by an independent agency, using an automatic valuation system in accordance with market practices and applicable legislation. Information on the estimation of impairment losses Following is the detail of the Santander UK exposure and impairment losses associated with each of the stages at 31 December 2018. In addition, depending on the current credit quality of the operations, the exposure is divided into three grades (investment, speculation and default): Exposure and impairment losses by stage Million of euros Credit Quality* Stage 1 Stage 2 Stage 3 Total Investment grade 225,929 1,900 Speculation grade 34,655 11,514 - - 227,829 46,169 Default - - 2,795 2,795 Total Exposure** 260,584 13,415 2,795 276,793 Impairment losses 224 335 335 894 * Detail of credit quality ratings calculated for Group management purposes. ** Amortised cost assets + Loans and advances + loan commitments granted. 633 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix For the estimation of expected losses, prospective information is taken into account. Specifcally, Santander UK considers fve prospective macroeconomic scenarios, which are updated periodically over a 5-year time horizon. The evolution projected for the next fve years of the main macroeconomic indicators used by Santander UK to estimate expected losses is presented below: Pessimistic scenario 2 Pessimistic scenario 1 Base scenario Optimistic scenario 1 Optimistic scenario 2 2019 -2023 Magnitudes Interest rate Unemployment rate Housing price change GDP growth 2.3% 8.6% -9.5% 0.3% Each of the macroeconomic scenarios is associated with a given probability of occurrence. In terms of allocation, Santander UK associates the highest weighting with the Base Scenario, while it associates the lowest weightings with the most extreme or acid scenarios. In addition, at 31 December 2018, the weights used by Santander UK refect the future prospects of the British economy in relation to its current political and economic position so that higher weights are assigned for negative scenarios: 1.5% 4.3% 2.0% 1.6% 1.3% 3.8% 2.3% 2.1% 1.0% 2.8% 3.4% 2.5% 2.5% 6.9% -2.0% 0.7% 3.2. Spain Portfolio overview Total credit risk (including guarantees and documentary credits) at Santander Spain (excluding the Real estate unit, which is discussed subsequently in more detail) amounted to EUR 239,479 million (25% of the Group’s total), with an adequate level of diversifcation by both product and customer segment. Pessimistic scenario 2 Pessimistic scenario 1 Base scenario Optimistic scenario 1 Optimistic scenario 2 10% 30% 40% 15% 5% The NPL ratio for the total portfolio was 6.19%, 13 bp less than in 2017. The decrease in lending (which increased the NPL ratio by 13 bp) was ofset by the improved NPL fgure (which reduced the ratio by 22 bp). This improvement was mainly due to an improved performance of the credit portfolio, the cure of several restructured loans and the sale of loan portfolios. The coverage rate stood at 45%. In relation to the determination of classifcation in Stage 2, the quantitative criteria applied by Santander UK is based on identifying whether any increase in PD for the expected life of the transaction is greater than both an absolute and a relative threshold. The relative threshold established is common to all portfolios and a transaction is considered to exceed this threshold when the PD for the entire life of the transaction doubles with respect to the PD at the time of initial recognition. The absolute threshold, on the other hand, is diferent for each portfolio depending on the characteristics of the transactions. In addition, for each portfolio, a series of specifc qualitative criteria is defned to indicate that the exposure has had a signifcant increase in credit risk, regardless of the evolution of its PD since the time of initial recognition. Santander UK, among other criteria, considers that an operation presents a signifcant increase in risk when it presents irregular positions for more than 30 days. These criteria depend on the risk management practices of each portfolio. Information on the estimation of impairment losses Following is the detail of the Santander Spain exposure and impairment losses associated with each of the stages at 31 December 2018. In addition, depending on the current credit quality of the operations, the exposure is divided into three grades (Investment, speculation and default): Exposure and impairment losses per stage Million of euros Credit Quality* Stage 1 Stage 2 Stage 3 Total Investment grade 171,266 289 Speculation grade 25,108 12,603 - - 171,555 37,711 Default - - 14,941 14,941 Total Exposure** 196,374 12,892 14,941 224,207 Impairment losses 366 768 5,565 6,699 * Detail of credit quality calculated for the purposes of Grupo Santander’s management. ** Amortised cost assets + Loans and advances + loan commitments granted. 634 2018 Auditors’ report and consolidated annual accounts The remaining business units to reach the entire portfolio in Spain contribute another EUR 125,544, EUR 66 and EUR 1,657 million of exposure, and impairment losses in the amount of EUR 132, EUR 48 and EUR 957 million, in stage 1, stage 2 and stage 3, respectively. For the estimation of the expected losses, the prospective information is taken into account. Specifcally, Santander Spain considers three prospective macroeconomic scenarios, which are updated periodically, during a time horizon of 5 years. The projected evolution for the next fve years of the main macroeconomic indicators used by Santander Spain for estimating expected losses is presented below: Magnitudes Interest rate Unemployment rate Housing price change GDP growth 2019-2023 Pessimistic scenario Base scenario Optimistic scenario 0.3% 0.7% 1.2% 15.3% 12.3% 10.8% 0.5% 1.1% 2.2% 1.8% 3.8% 2.6% Portfolio of home purchase loans to families Residential mortgages in Spain, including Santander Consumer Finance business, amounted to EUR 63,290 million, representing 25% of total credit risk. 99.14% of which have a mortgage guarantee. Million of euros Home purchase loans to families Without mortgage guarantee With mortgage guarantee 31/12/18 Gross amount Of which: non-performing 63,290 545 62,745 2,493 54 2,439 The portfolio of mortgages granted to acquire homes in Spain have characteristics that maintain its medium-low risk profle which limits the expectations of a potential additional deterioration: • Principal is repaid on all mortgages from the start. • Early repayment is common so the average life of the transaction is well below that of the contract. Each one of the macroeconomic scenarios is associated with a given probability of occurrence. As for its allocation, Santander Spain associates the Base scenario with the highest weight, while associating the lower weights to the most extreme scenarios: • High quality of collateral concentrated almost exclusively in fnancing the frst home. • Average afordability rate stood at 28%. • 83% of the portfolio has a LTV below 80%, calculated as total risk/latest available house appraisal. Breakdown of the credit with mortgage guarantee to households for house acquisition, according to the percentage that the total risk represents on the amount of the latest available valuation (loan to value). Pessimistic scenario Base scenario Optimistic scenario 30% 40% 30% In relation to the determination of the classifcation in stage 2, the quantitative criteria applied by Santander Spain are based on identifying whether any increase in PD for the entire expected life of the operation is greater than an absolute threshold. The threshold established for each portfolio is diferent depending on the characteristics of the transactions, and a transaction is considered to exceed this threshold when the PD for the entire life of the transaction increases by up to a quarter with respect to the PD it had at the time of initial recognition. In addition, for each portfolio, a series of specifc qualitative criteria are defned that indicate that the exposure has had a signifcant increase in credit risk, regardless of the evolution of its PD since the time of initial recognition. Santander Spain, among other criteria, considers that an operation presents a signifcant increase in risk when it presents positions past due for more than 30 days. These criteria depend on the risk management practices of each portfolio. 635 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million of euros Gross amount Of which: watchlist /non-performing More than 60% and equal to 40% less than 60% less than 80% More than 40% and Less than or More than 80% and less than or More than 100% equal to 100% 15,393 239 18,448 366 18,484 584 6,408 479 4,012 771 Total 62,745 2,439 31/12/18 Loan to value ratio Credit policies limit the maximum loan to value to 80% for first residence mortgages and 79.77% in the case of second home mortgages. Companies portfolio Credit risk assumed directly with SMEs and Corporates (EUR 147,634 million) is the main lending segment in Spain, including Santander Consumer Finance business (60% of the total). Most of the portfolio (90%) corresponds to customers who have been assigned an analyst to monitor them continuously throughout the risk cycle. The portfolio is broadly diversified without significant concentrations by activity sector. Real estate activity The Group manages the real estate activity in Spain in a separate unit, which includes the loans from clients with activity mainly in real estate development, and who have a specialised management model, holdings in real estate companies and foreclosed assets. The NPL ratio of this portfolio ended the year at 27.58% (compared with 29.96% at December 2017) due to the decrease of non- performing assets in the troubled loan portfolio and, in particular, to the sharp reduction in lending in this segment. The table below shows the distribution of the portfolio. The coverage ratio of the real estate doubtful exposure in Spain stands at 35.27%. Million of euros Financing for construction and property development recognised by the Group’s credit institutions (including land) (business in Spain) Of which:watchlist/ non-performing Memorandum items: Written-off assets 31/12/18 Gross amount Excess over collateral value Specific allowance 4,812 1,327 3,675 834 393 532 468 In recent years the Group’s strategy has been geared towards reducing these assets. The changes in gross property development loans to customers were as follows: Memorandum items: data from the public consolidated balance sheet Million of euros Million of euros Balance at beginning of year Foreclosed assets Banco Popular (perimeter) Reductions* Written-off assets Balance at end of year 31/12/18 31/12/17 31/12/16 6,472 (100) - 5,515 (27) 2,934 7,388 (28) - (1,267) (1,620) (1,415) (293) 4,812 (330) 6,472 (430) 5,515 * Includes portfolio sales, cash recoveries and third-party subrogations and new production. Total loans and advances to customers excluding the Public sector (business in Spain) Total consolidated assets (Total business) (Book value) Impairment losses and credit risk allowances. Coverage for unimpaired assets (business in Spain) 31/12/18 Carrying amount 223,921 1,459,271 1,244 636 2018 Auditors’ report and consolidated annual accountsAt year-end, the concentration of this portfolio was as follows: Million of euros 1. Without mortgage guarantee 2. With mortgage guarantee 2.1 Completed buildings 2.1.1 Residential 2.1.2 Other 2.2 Buildings and other constructions under construction 2.2.1 Residential 2.2.2 Other 2.3 Land 2.3.1 Developed consolidated land 2.3.2 Other land Total Loans: gross amount 31/12/18 379 4,433 2,691 1,328 1,363 1,071 609 462 671 480 191 4,812 Policies and strategies in place for the management of these risks The policies in force for the management of this portfolio, which are reviewed and approved on a regular basis by the Group’s senior management, are currently geared towards reducing and securing the outstanding exposure, albeit without neglecting any viable new business that may be identifed. In order to manage this credit exposure, the Group has specialised teams that not only form part of the risk areas but also supplement the management of this exposure and cover the entire life cycle of these transactions: commercial management, legal procedures and potential recovery management. As has already been disclosed in this section, the Group’s anticipatory management of these risks enabled it to signifcantly reduce its exposure, and it has a granular, geographically diversifed portfolio in which the fnancing of second residences accounts for a very small proportion of the total. Mortgage lending on non-urban land represents a low percentage of mortgage exposure to land, while the remainder relates to land already classifed as urban or approved for development. The signifcant reduction of exposure in the case of residential fnancing projects in which the construction work has already been completed was based on various actions. As well as the specialised marketing channels already in existence, campaigns were carried out with the support of specifc teams of managers for this function who, in the case of the Santander network, were directly supervised by the recoveries business area. These campaigns, which involved the direct management of the projects with property developers and purchasers, reducing sale prices and adapting the lending conditions to the buyers’ needs, enabled loans already in force to be subrogated. These subrogations enable the Group to diversify its risk in a business segment that displays a clearly lower non-performing loans ratio. In the case of construction-phase projects that are experiencing difculties of any kind, the policy adopted is to ensure completion of the construction work so as to obtain completed buildings that can be sold in the market. To achieve this aim, the projects are analysed on a case-by-case basis in order to adopt the most efective series of measures for each case (structured payments to suppliers to ensure completion of the work, specifc schedules for drawing down amounts, etc.). The loan approval processes are managed by specialist teams which, working in direct coordination with the sales teams, have a set of clearly defned policies and criteria: • Property developers with a robust solvency profle and a proven track record in the market. • Medium-high level projects, conducting to contracted demand and signifcant cities. • Strict criteria regarding the specifc parameters of the transactions: exclusive fnancing for the construction cost, high percentages of accredited sales, principal residence fnancing, etc. • Support of fnancing of government-subsidised housing, with accredited sales percentages. • Restricted fnancing of land purchases dealt with exceptional nature. In addition to the permanent control performed by its risk monitoring teams, the Group has a specialist technical unit that monitors and controls this portfolio with regard to the stage of completion of construction work, planning compliance and sales control, and validates and controls progress billing payments. The Group has created a set of specifc tools for this function. All mortgage distributions, amounts drawn down of any kind, changes made to the grace periods, etc. are authorised on a centralised basis. Foreclosed properties At 31 December 2018, the net balance of these assets amounted to EUR 5,226 million (gross amount: EUR 10,333 million; recognised allowance: EUR 5,107 million, of which EUR 3,142 million related to impairment after the foreclosure date). 637 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix In addition, the Group holds an ownership interest in Project Quasar investments 2017, S.L. (See Note 3.b) for EUR 1,701 million. The changes in foreclosed properties were as follows: The following table shows the detail of the assets foreclosed by the businesses in Spain at the end of 2018: Million of euros Property assets arising from fnancing provided to construction and property development companies Of which: Completed buildings Residential Other Buildings under construction Residential Other Land Developed land Other land Property assets from home purchase mortgage loans to households Other foreclosed property assets Total property assets In recent years, the Group has considered foreclosure to be a more efcient method for resolving cases of default than legal proceedings. The Group initially recognises foreclosed assets at the lower of the carrying amount of the debt (net of provisions) and the fair value of the foreclosed asset (less estimated costs to sell).Subsequent to initial recognition, the assets are measured at the lower of fair value (less costs to sell) and the amount initially recognised. The fair value of this type of assets is determined by the Group’s directors based on evidence obtained from qualifed valuers or evidence of recent transactions. The management of real estate assets on the balance sheet is carried out through companies specializing in the sale of real estate that is complemented by the structure of the commercial network. The sale is realised with levels of price reduction in line with the market situation. 3. Includes EUR 9,5 million of Santander Consumer USA Holdings Inc. 638 1,992 796 1,196 168 159 9 1,616 619 997 1,165 285 5,226 2016 1.3 (1.3) - 31/12/18 Gross carrying amount Valuation adjustments Of which: impairment losses on assets since time of foreclosure Carrying amount 7,909 4,133 2,733 3,776 3,194 1,247 1,947 299 287 12 4,416 1,616 2,800 2,016 408 10,333 1,202 451 751 131 128 3 2,800 997 1,803 851 123 5,107 706 211 495 81 81 - 1,946 597 1,349 357 52 3,142 Gross additions Disposals Diference Thousand of Million of euros 2018 0.8 (1.8) (1.0) 2017* 1.4 (1.9) (0.5) * Without considering the Blackstone transaction (See Note 3). 3.3. United States Credit risk at Santander Consumer Holding USA, Inc, increased to EUR 92,1523 million at the end of December (representing 10% of the Group’s total), is made up of the following business units: Santander Bank, National Association Business is focused on retail and commercial banking (83%), of which 35% is with individuals and approximately 65% with corporates. One of the main strategic goals is to continue to enhance the wholesale banking business (17%). The NPL ratio continues to decline, standing at 0.88% (-33 bp in the year) in December. This reduction is explained by a proactive management of certain exposures and the favourable macro development showed in the improvement of customer’s credit risk profle in corporates and individuals portfolios. The cost of credit remains at stable levels of 0.24% despite the increase in some segment’s coverage ratios. 2018 Auditors’ report and consolidated annual accounts In relation to the determination of Stage 2 classifcation, the quantitative criteria applied at Santander Bank, National Association are based on identifying whether any increase in PD for the expected life of the transaction is greater than a series of absolute thresholds. Each portfolio has a set of thresholds in accordance with the characteristics and credit risk profle of the products composing it, and a transaction is considered to exceed these thresholds when the PD for the entire life of the transaction increases by up to double with respect to that which it had at the time of initial recognition. In addition, Santander Bank, National Association also assesses the risk of its operations by comparing the FICO (Fair Isaac Corporation) rating of each of them at the present time with respect to the one they had at the time of their recognition, establishing a diferent absolute threshold for each portfolio according to their characteristics. Additionally, for each portfolio, a series of specifc qualitative criteria are defned, which indicate that the exposure has had a signifcant increase in credit risk, regardless of the evolution of its PD since the initial recognition. Santander Bank, National Association, among other criteria, considers that a transaction presents a signifcant increase in risk when it has irregular positions for more than 30 days. These criteria depend on the risk management practices of each portfolio Santander Consumer USA Holdings Inc. (SC USA) The risk indicators for Santander Consumer USA Holdings Inc. are higher than those of the other United States units, due to the nature of its business, which focuses on auto fnancing through loans and leasing (97%), seeking the optimisation of the returns associated to the risk assumed. Santander Consumer USA Holdings Inc.´s lending also includes a smaller personal lending portfolio (3%). The NPL rate, however, increased to 7.73%, mainly due to the maturity of those loans forborne in 2017 (hurricanes). The cost of credit, at the end of December stood at 10.01% (+17 bp in the year), due to the average investment lower growth as a result of the vintages amortisation from high production exercises (2015), partially mitigated by the increase in recoveries efciency and the positive evolution of the used car price. The coverage ratio remains at high levels, 155%. Information on the estimation of impairment losses Following is a detail of the exposure and impairment losses associated with each of the stages at 31 December 2018 of Santnader Bank, National Association. In addition, depending on the current credit quality of the operations, the exposure is divided into three grades (Investment, speculation and default): Exposure and impairment loss by stage Million of euros Credit quality* Stage 1 Stage 2 Stage 3 Investment grade 5,149 - Speculation grade 60,391 3,784 Default - - Total Exposure** 65,540 3,784 Impairment losses 233 204 - - 448 448 105 Total 5,149 64,175 448 69,772 542 * Detail of credit quality ratings calculated for Group management purposes. ** Amortised cost assets + Loans and advances + loan commitments granted. For the estimation of expected losses, prospective information is taken into account. Specifcally, Santander Bank, National Association considers three prospective macroeconomic scenarios, which are updated periodically over a 5-year time horizon. The evolution projected for the next fve years of the main macroeconomic indicators used Santander Bank, National Association to estimate expected losses is presented below: Magnitudes Interest rate Unemployment rate House price change GDP growth 2019-2023 Unfavourable scenario Base scenario Favourable scenario 1.3% 6.9% 2.2% 1.5% 2.8% 4.2% 3.9% 2.1% 3.6% 3.9% 3.9% 2.8% Each of the macroeconomic scenarios is associated with a given probability of occurrence. As for its allocation, Santander Bank, National Association associates the highest weighting to the Base scenario, while associates the lowest weightings to the most extreme scenarios: Unfavourable scenario Base scenario Favourable scenario 20% 60% 20% 639 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Information on the estimation of impairment losses Following is the detail of Santander Consumer USA Holdings Inc. exposure and impairment losses associated with each of the stages at 31 December 2018. In addition, depending on the current credit quality of the operations, the exposure is divided into three grades (Investment, speculation and default): Exposure and impairment losses by stage Million of euros Credit Quality* Stage 1 Stage 2 Stage 3 Investment grade 224 - Speculation grade Default 20,313 6,600 - - Total Exposure** 20,537 6,600 - - 2,218 2,218 Total 224 26,913 2,218 29,355 Impairment losses 824 1,720 667 3,211 * Detail of credit quality ratings calculated for Group management purposes. ** Amortised cost assets + Loans and advances + loan commitments granted. In relation to the methodology used to calculate impairment losses, Santander Consumer USA Holdings Inc. uses a method for calculating expected losses based on the use of risk parameters: EAD (Exposure at Default), PD (Probability of Default) and LGD (Loss Given Default). The expected loss of an operation is the result of adding the estimated monthly expected losses of the same during its entire life, unless the operation is classifed in Stage 1 (on those used for the Santander Corporate Investment Banking portfolios see section 3.5) which will correspond to the sum of the estimated monthly expected losses during the following 12 months. In general, there is an inverse relationship between credit quality of transactions and projections of impairment losses so that transactions with better credit quality require a lower expected loss. Credit quality of transactions, refected in the internal rating associated with each transaction or the client, shown in the likelihood of default of the transactions. For the estimation of expected losses, prospective information should be taken into account. Specifcally, Santander Consumer USA Holdings Inc. considers three prospective macroeconomic scenarios, periodically updated over a 5-year time horizon. The evolution projected for the next fve years of the main macroeconomic indicators used by in Santander Consumer USA Holdings Inc in the estimation of expected losses is shown below: Magnitudes Interest rate Unemployment rate House price change GDP Growth 2019-2023 Unfavourable scenario Base scenario Favourable scenario 1.3% 6.9% 2.2% 1.5% 2.8% 4.2% 3.9% 2.1% 3.6% 3.9% 3.9% 2.8% Each of the macroeconomic scenarios is associated with a given probability of occurrence. Santander Consumer USA Holdings Inc. associates the highest weighting to the Base scenario, whereas it associates the lowest weightings to the most extreme or acid scenarios: Unfavourable scenario Base scenario Favourable scenario 20% 60% 20% In relation to the classifcation measurement in Stage 2, the quantitative criteria applied by the entity are based on identifying whether any increase in PD for the expected life of the transaction exceeds a series of absolute thresholds. Each portfolio has a set of thresholds in accordance with the characteristics and credit risk profle of the products in the portfolio, considering that one transaction exceeds these thresholds when the PD for the entire life of the transaction doubles it in comparison to the one that had at the beginning. In addition, the entity also assesses the risk of its transactions by comparing the FICO (Fair Isaac Corporation) rating of each of them at the current period, in comparison to what they had at the beginning, establishing diferent absolute thresholds for each portfolio depending on its characteristics. Additionally, for each portfolio, a series of specifc qualitative criteria are defned, which indicate that the exposure has had a signifcant increase in credit risk, regardless of the evolution of its PD since the initial recognition. The entity among other criteria, considers that a transaction presents a signifcant increase in risk when it has irregular positions for more than 30 days. These criteria depend on the risk management practices of each portfolio. 3.4. Brazil Credit risk in Brazil amounts to EUR 82,212 million, representing an increase of 1.4% vs. 2017 due to the depreciation of the Brazilian currency, excluding the exchange rate efect, recorded growth is 13%. Santander Brazil therefore accounts for 9% of the Group’s credit lending. Santander Brazil is adequately diversifed and has an increasingly marked retail profle, with more than 60% of loans extended to individuals, consumer fnancing and SMEs. 640 2018 Auditors’ report and consolidated annual accounts Information on the estimation of impairment losses The Santander Brazil exposure’s detail and impairment losses associated with each of the stages at 31 December 2018 is presented. In addition, depending on the current credit quality of the operations, the exposure is divided into three grades (Investment, speculation and default): Exposure and impairment losses Million of euros Credit Quality* Stage 1 Stage 2 Stage 3 Total Investment grade 51,150 472 Speculation grade 56,884 5,334 - - 51,622 62,218 Default - - 4,223 4,223 Total Exposure** 108,034 5,806 4,223 118,063 Impairment losses 997 768 2,889 4,654 * Detail of credit quality ratings calculated for Group management purposes. ** Amortised cost assets + Loans and advances + loan commitments granted. For the estimation of expected losses, prospective information is taken into account. Particularly, Santander Brazil considers three prospective macroeconomic scenarios, periodically updated, over a time horizon of 5 years. The evolution projected for the next fve years of the main macroeconomic indicators used to estimate the expected losses in Santander Brazil is as follows: Magnitudes Interest rate Unemployment rate Housing price growth rate GDP Growth 2019-2023 Pessimistic scenario Base scenario Optimistic scenario 11.0% 16.3% -1.4% -1.2% 7.7% 9.9% 4.2% 2.4% 6.0% 8.6% 5.9% 3.5% Each macroeconomic scenario is associated with a determined likehood of occurrence. Regarding its assignation, Brazil links the highest weight to the base scenario whilst links the lowest weights to the most extreme scenarios: Pessimistic scenario Base scenario Optimistic scenario 10% 80% 10% With respect to the determination of the classifcation in Stage 2, the quantitative criteria that are applied are based on identifying whether any increase in the PD for all the expected life of the operation is higher than an absolute threshold. Santander Brazil, for the purposes of a better integration in its portfolio management, has adapted the rating of the operations to PD thresholds, setting out diferent thresholds for each portfolio according to the characteristics of the operations. In addition, for every portfolio, a set of specifc qualitative criteria are defned to indicate that the exposure to credit risk has signifcantly risen, regardless of the evolution of its PD since the initial recognition. Santander Brazil, among other criteria, considers that an operations involves a signifcant increase in risk when it presents irregular positions for more than 30 days, but in Real State, Consigned and Financial portfolios, where, due to their particular attributes, they use a 60 days threshold. Such criteria depend upon each portfolio’s risk management practices. 3.5. Santander Corporate & Investment Banking The detail of exposure and impairment losses presented for the main geographies includes the portfolios of Santander Corporate & Investment Banking. In this sense, due to the type of customers managed in these portfolios, large multinational companies, the Group uses its own credit risk models. These models are common to diferent geographies using their own macroeconomic scenarios. The average projected evolution for the next years of the GDP projected for the next few years is presented, which has been used for the estimation of the expected losses, together with the weighting of each scenario: Pessimistic scenario Base scenario Optimistic scenario Global GDP Growth 2.7% 3.6% 4.2% Each macroeconomic scenarios is associated with a determined likehood of occurrence. As for its allocation, Santander Corporate & Investment Banking associates the highest weight with the Base Scenario, while associating the lower weights with the more extreme scenarios. Escenario desfavourable Escenario base Escenario favourable 20% 60% 20% 641 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The board, via the risk appetite framework, determines the maximum levels of concentration. In line with these maximum levels and limits, the executive risk committee establishes the risk policies and reviews the appropriate exposure levels for the adequate management of the degree of concentration in Santander’s credit risk portfolios. The Group is subject to the regulation on large risks contained in the CRR, according to which the exposure contracted by an entity with a customer or group of customers linked among themselves will be considered a large exposure when its value is equal or greater than 10% of eligible capital. In addition, in order to limit large exposures, no entity can assume exposures exceeding 25% of its eligible capital with a single customer or group of linked customers, after taking into account the credit risk reduction efect contained in the regulation. Having applied the risk mitigation techniques, no groups triggered these thresholds at the end of December. Regulatory credit exposure with the 20 largest groups within the scope of large risks represented 4.47% of the outstanding credit risk with customers (lending to customers plus of-balance sheet risks) as of December 2018. The detail, by activity and geographical area of the counterparty, of the concentration of the Group’s risk at 31 December 2018 is as follows: 4. Other credit risk aspects 4.1. Credit risk by activity in the fnancial markets This section covers credit risk generated in treasury activities with customers, mainly with credit institutions. Transactions are undertaken through money market fnancial products with diferent fnancial institutions and through counterparty risk products which serve the Group’s customer’s needs. According to regulation (EU) 575/2013, counterparty credit risk is the risk that a client in a transaction could default before the defnitive settlement of the cash fows of the transaction. It includes the following types of transactions: derivative instruments, transactions with repurchase commitment, stock and commodities lending, operations with deferred settlement and fnancing of guarantees. There are two methodologies for measuring this exposure: (i) mark-to-market (MtM) methodology (replacement value of derivatives) plus potential future exposure (add-on) and (ii) the calculation of exposure using Monte Carlo simulation for some countries and products. The capital at risk or unexpected loss is also calculated, i.e. the loss which, once the expected loss has been subtracted, constitutes the economic capital, net of guarantees and recoveries. After markets close, exposures are re-calculated by adjusting all transactions to their new time frame, adjusting the potential future exposure and applying mitigation measures (netting, collateral, etc.), so that the exposures can be controlled directly against the limits approved by senior management. Risk control is performed through an integrated system and in real time, enabling the exposure limit available with any counterparty, product and maturity and in any of Santander’s subsidiaries to be known at any time. 4.2. Concentration risk Concentration risk control is a vital part of management. The Group continuously monitors the degree of concentration of its credit risk portfolios using various criteria: geographical areas and countries, economic sectors and groups of customers. 642 2018 Auditors’ report and consolidated annual accounts Million of euros Central banks and Credit institutions Public sector Of which: Central government Other central government Other fnancial institutions (fnancial business activity) Non-fnancial companies and individual entrepeneurs (non-fnancial business activity) (broken down by purpose) Of which: Construction and property development Civil engineering construction Large companies SMEs and individual entrepreneurs Households – other (broken down by purpose) Of which: Residential Consumer loans Other purposes Total* 31/12/18 Other EU countries 94,532 38,112 34,497 3,615 54,473 Spain 60,562 64,528 53,060 11,468 16,378 Total 244,523 177,207 157,656 19,551 102,985 America 75,460 67,943 63,490 4,453 25,751 Rest of the world 13,969 6,624 6,609 15 6,383 383,708 126,503 117,261 126,098 13,846 27,699 5,606 220,192 130,211 491,836 314,048 156,806 20,982 5,578 3,352 56,547 61,026 89,407 62,232 18,065 9,110 4,674 1,642 72,406 38,539 17,311 595 78,850 29,342 276,667 116,686 210,218 64,258 2,191 40,696 68,872 7,118 136 17 12,389 1,304 9,076 902 5,611 2,563 1,400,259 357,378 581,045 411,938 49,898 * For the purposes of this table, the defnition of risk includes the following items in the public balance sheet: Loans and advances to credit institutions, Loans and advances to Central Banks, Loans and advances to Customers, Debt Instruments, Equity Instruments, trading Derivatives, Hedging derivatives, Investments and fnancial guarantees given. 4.3. Sovereign risk and exposure to other public sector entities As a general criteria in the Group, sovereign risk is that related to transactions with a central bank (including the regulatory cash reserve requirement), Treasury issuances risk (public debt portfolio) and that related to transactions with public institutions with the following features: their funds only come from the state’s budgeted income and the activities are of a non-commercial nature. These criteria, historically used by the Group, difer in some respects from that applied by the European Banking Authority (EBA) for its regular stress exercises. The main diferences are that the EBA’s criterion does not include deposits with central banks, exposures with insurance companies, indirect exposures via guarantees and other instruments. On the other hand, the EBA does include public administrations in general (including regional and local bodies), not only the central state sector. According to the management Group criteria, local sovereign exposure in currencies other than the ofcial currency of the country of issuance is not very signifcant (EUR 8,901 million, 3.5% of total sovereign risk), and exposure to non-local sovereign issuers involving cross-border risk is even less signifcant (EUR 3,906 million, 1.5% of total sovereign risk). Sovereign exposure in Latin America is mostly in local currency, and is recognised in the local accounts and concentrated in short- term maturities with lower interest rate risk and higher liquidity. 643 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The exposure in the table below is disclosed following the latest amendments of the regulatory reporting framework carried out by the EBA, which entered into force in 2018: Million of euros 31/12/2018 Portfolio Financial assets at amortised cost Non-trading fnancial assets mandatorily at fair value through proft or loss 21,419 4,002 465 - - 1,322 8,666 11 245 2,113 3,782 2,816 20 450 534 - - - - - - - - - 5 893 - - - - Total net direct exposure 49,640 8,753 261 - - 2,778 10,869 11,229 329 8,682 27,054 10,415 1,776 893 6,222 45,845 898 138,901 prepared jointly by the commercial and risks areas, and defne the commercial strategies, risk policies and measures/infrastructures required to meet the annual budget targets. These three factors are considered as a whole, ensuring a holistic view of the portfolio to be planned and allowing a map of all the Group’s credit portfolios to be drawn. SCP management integration provides at all times an updated view on the credit portfolios quality, allows to measure credit risk, perform internal controls and periodic monitoring of planned strategies, anticipate deviations and identify signifcant changes in risk and its potential impact, as well as the application of corrective actions. The SCPs approval corresponds to the risk executive committee or equivalent body of each entity previous to its validation at Group level in the corporate risk executive committee. The periodic monitoring of SCPs is carried out by the same bodies that approve and validate them. The process pursues the SCPs alignment with the capital objectives of the Group’s units. Country Spain Portugal Italy Greece Ireland Rest of eurozone United Kingdom Poland Rest of Europe United States Brazil Mexico Chile Other American countries Rest of the world Total Financial assets designated at fair Financial assets at fair value through value through other comprehensive income proft or loss 1,143 (43) (204) - - 503 1,013 2,015 - 426 1,839 3,320 160 103 - 10,275 27,078 4,794 - - - 953 1,190 9,203 84 6,138 20,540 4,279 1,596 340 5,688 81,883 5. Credit risk management The credit risk management process consists of identifying, analysing, controlling and deciding on the credit risk incurred by the Group’s operations. It considers a holistic view of the credit risk cycle including transaction, customer and portfolio view. Both business and risk areas, together with the senior management participate in the management process. The identifcation of credit risk is a key component for the active management and efective control of portfolios. The identifcation and classifcation of external and internal risks in each business allows corrective and mitigating measures to be adopted. 5.1. Planning Identifcation Planning allows to set business targets and defne specifc action plans, within the risk appetite established by the Group. These targets are met by assigning the necessary means (models, resources, systems). Strategic commercial plans Strategic commercial plans (SCPs) are a basic management and control tool for the Group’s credit portfolios. The SCPs are 644 2018 Auditors’ report and consolidated annual accounts Scenario analysis Credit risk scenario analysis enables senior management to better understand the portfolio evolution in the face of market conditions and changes in the environment. It is a key tool for assessing the sufciency of capital provisions for stress scenarios. Scenario analysis is applied to all of the Group’s signifcant portfolios, usually over a 3-year horizon. The process involves the following main stages: • Defnition of benchmark scenarios, either central or most plausible scenarios (baseline), as well as less likely and more adverse economic scenarios (stress scenarios). A global stress scenario is a world crisis situation that impacts each of the countries in which the Group operates. In addition, a local stress scenario impacts in an isolated way some of the main units with a greater degree of stress than the global stress scenario. • Determination of risk parameters value (probability of default, loss given default, etc.) for the scenarios defned. These parameters are established using internally developed statistical- econometric models, based on default and historical losses, in relation to historical data for macroeconomic variables taking into consideration a complete economic cycle. • Adaptation of the projection methodology to IFRS9, with an impact on the estimation of the expected loss in each of the IFRS9 stages, associated with each of the scenarios put forward, as well as with other important credit risk metrics deriving from the parameters obtained (non-performing loans, provisions, allowances, etc.). • Analysis and rationale for the credit risk profle evolution at portfolio, segment, unit and Group levels, in diferent scenarios and compared to previous years. • Integration of management indicators to supplement the analysis of the impact caused by macroeconomic factors on risk metrics. • Likewise, the process is completed with a set of controls and backtesting that ensure the adequacy of metrics and calculations. In order to assign a rating that refects the credit quality of the customer, the Group uses valuation and parameter estimation models in each of the segments where it operates: SCIB (Santander Corporate & Investment Banking: sovereigns, fnancial institutions and large corporates), commercial banking, institutions, SMEs and individuals. The decision models applied are based on credit rating drivers which are monitored and controlled in order to calibrate and precisely adjust the decisions and ratings they assign. Depending on the segment, drivers may be: • Rating: resulting from the application of mathematical algorithms incorporating a quantitative model based on balance sheet ratios or macroeconomic variables, and a qualitative module supplemented by the analyst’s expert judgement. Used for the SCIB, commercial banking, institutions and SMEs (treated on an individual basis) segments. • Scoring: an automatic assessment system for credit applications. It automatically assigns an individual grade to the customer for subsequent decision making. Parameter estimation models are obtained through econometric statistical models, internally developed, based on historical loss and default of the portfolios for which they are developed and used to calculate the economic and regulatory capital of each portfolio. Periodic model monitoring and evaluation is carried out, assessing among others, the adequacy of its use, its predictive capacity, correct performance, and level of granularity. In the same way, the existence and compliance of the policies corresponding to each and every segment is verifed (these policies enable the execution of business plans defned under the approved risk appetite). The resulting ratings are regularly reviewed, incorporating the latest available fnancial information and experience in the development of banking relations. The depth and frequency of the reviews are increased in the case of customers who require a more detailed monitoring or through automatic warnings in the systems. The entire process takes place within a corporate governance framework, and is adapted to the growing importance of this framework as well as market best practices, assisting the Group’s senior management in gathering knowledge for decision making. 5.2 Assessment of the risk and credit rating process The connection between the credit risk appetite of the Group and management of the credit portfolios is implemented through the SCPs, which defne the portfolio and new originations limits in order to anticipate the portfolio risk profle. The transposition and cascading down of the Group’s risk appetite framework credit risk metrics, strengthens the existing control over credit portfolios. 5.3. Limits, pre-classifcations and pre-approvals defnition There are diferent limit models depending on the segment: • Large corporate groups: we use a pre-classifcation model based on a system for measuring and monitoring economic capital. The result is the level of risk that the Group is willing to assume with a customer/group, in terms of Capital at Risk, nominal CAP, and maximum periods according to the type of transaction (in the case of fnancial entities, limits are managed through Credit Equivalent Risk (CER). It includes the actual and expected risk with a customer based on its usual operations, always within the limits defned in the risk appetite and established credit policies. The Group has processes that determine the risk that each customer is able to assume. These limits are set jointly by the business and risks areas and have to be approved by the Executive risk committee (or committees in which it has delegated such authority) and refect the expected results of the business in terms of risk-return. 645 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix • Corporates and institutions that meet certain requirements (deep knowledge, rating, etc.): we use a more simplifed pre- classifcation model through an internal limit that establishes a reference of the level of risk to be assumed with the customer. The criteria will include, among others, repayment capacity, debt in the system and the banking pool distribution. Efective guarantees are those real and personal guarantees for which its efectiveness as a credit risk mitigant is proved and whose valuation complies with the established policies and procedures. The analysis of the efectiveness of the guarantees must take into account, among others, the necessary time for the execution and ability to enforce the guarantees. In both cases, transactions over certain thresholds or with specifc characteristics might require the approval of an analyst or committee. 5.5. Monitoring / Anticipation Monitoring business performance on a regular basis, and comparing performance against agreed plans is a key risk management activity. • For individual customers and SMEs with low turnover, large volumes of credit transactions can be managed more easily with the use of automatic decision models for classifying the customer/ transaction binomial. In specifc situations where a series of requirements are met, pre-approved transactions are granted to customers or potential customers (campaigns). 5.4. Transaction decision-making As a general rule, from a risk admission point of view, the concession criteria are linked to the payment capacity of the borrower to comply, in time and form, with the total of the assumed fnancial obligations – this does not imply an impediment to requiring a higher level of real or personal guarantees. The payment capacity will be evaluated based on the funds or net cash fows from the customer´s businesses or usual sources of income, without depending on guarantors or assets given as collateral. Such guarantors or assets should always be considered, when evaluating the approval of the transaction, as a second and exceptional way of recovery in case the frst has failed. In general, a guarantee is defned as a reinforcement measure added to a credit transaction for the purpose of mitigating the loss due to a breach of the payment obligation. Mitigation techniques implementation follows the minimum requirements established in the guarantee management policy: legal certainty (possibility of legally requiring the settlement of guarantees at all times), the lack of substantial positive correlation between the counterparty and the value of the collateral, the correct documentation of all guarantees, the availability of documentation for the methodologies used for each mitigation technique and appropriate monitoring, traceability and regular control of the goods/assets used for the guarantee. In Santander we apply several credit risk mitigation techniques on the basis, among other factors, of the type of customer and product. Some are inherent to specifc transactions (e.g. real estate guarantees) while others apply to a series of transactions (e.g. derivatives netting and collateral). The diferent mitigation techniques can be grouped into the following categories: • Personal guarantees • Guarantees from credit derivatives • Real guarantees All customers must be monitored on an ongoing and holistic manner that enables the earliest possible detection of any incidents that may arise impacting the customer’s credit rating. Monitoring is carried out through an ongoing review of all customers, assigning a monitoring classifcation, establishing pre-defned actions associated to each classifcation and executing specifc measures (pre-defned or ad-hoc) to correct any deviations that could have a negative impact for the Group. In this monitoring, the consideration of forecasts and transactions characteristics throughout its life, is assured. It also takes into consideration any variations that may have occurred in the classifcation and its adequacy in the moment of the review. Monitoring is carried out by local and global Risk teams, supplemented by Internal Audit. It is based on customer segmentation: • In the SCIB segment, monitoring, in the frst instance, is a direct function of both the commercial manager and the risk analyst, who maintain the direct relationship with the customer and manage the portfolio. This function ensures that an up-to- date view of the customers’ credit quality is always available and allows anticipating situations of concern and taking the necessary actions. • In the commercial banking, institutions and SMEs with an analyst assigned, the function consists in identifying and tracking customers whose situations require closer monitoring, reviewing ratings and continuously analysing indicators. • In the individual customers, businesses and SMEs with low turnover segments monitoring is carried out through automatic alerts for the main indicators, in order to detect shifts in the performance of the loan portfolio with respect to the forecasts in strategic plans. 5.6. Recovery and collections management Recovery activity is a signifcant element in the Group’s risk management. This function is carried out by the Recoveries area, which defnes a global strategy and an enterprise-wide focus for recovery management. The Group has a corporate recovery management model that sets the guidelines and general lines of action to be applied in the diferent countries, taking always into account the local particularities that the recovery activity requires, such as economic environment, business model or a mixture of both. 646 2018 Auditors’ report and consolidated annual accounts must be recognised as soon as possible if any amounts are deemed irrecoverable. Forbearances may never be used to delay the immediate recognition of losses or to hinder the appropriate recognition of risk of default. Further, the policy defnes the classifcation criteria for the forborne transactions in order to ensure that the risks are suitably recognised, bearing in mind that they must remain classifed as non-performing or in watch-list for a prudential period of time (aligned with Regulation EU 680/2014) to attain reasonable certainty that repayment capacity can be recovered. The forborne portfolio stood at EUR 41,234 million at the end of December. In terms of credit quality, 49% is classifed as non- performing loans, with average coverage of 53% (26% of the total portfolio). The following terms are used in Bank of Spain Circular 4/2017 of Bank of Spain with the meanings specifed: • Refnancing transaction: transaction that is granted or used, for reasons relating to current or foreseeable fnancial difculties of the borrower, to repay one or more of the transactions granted to it, or through which the payments on such transactions are brought fully or partially up to date, in order to enable the borrowers of the cancelled or refnanced transactions to repay their debt (principal and interest) because they are unable, or might foreseeably become unable, to comply with the conditions thereof in due time and form. • Restructured transaction: transaction with respect to which, for economic or legal reasons relating to current or foreseeable fnancial difculties of the borrower, the fnancial terms and conditions are modifed in order to facilitate the payment of the debt (principal and interest) because the borrower is unable, or might foreseeably become unable, to comply with the aforementioned terms and conditions in due time and form, even if such modifcation is envisaged in the agreement. Recovery has been aligned with the socio-economic reality of the Group’s countries and diferent risk management mechanisms are used with adequate prudential criteria considering unpaid debt conditions. The diverse features of Santander´s customers make segmentation necessary in order to manage recoveries adequately. Mass management of large groups of customers with similar profles and products is conducted through processes with a high technological and digital component, while personalised management focuses on customers who, because of their profle, require a specifc manager and more customised management. Recovery management is divided into four stages: irregularity or early non-payment, non-performing loans recoveries, write-ofs recoveries and management of foreclosed assets. The management scope for the recovery function includes non- productive assets (NPAs), corresponding to the forborne portfolios, NPLs, write-of loans and foreclosed assets, where the Group may use mechanisms to rapidly reduce these assets, such as portfolios or foreclosed assets sales. Therefore, the Group is constantly seeking alternative solutions to juridical processes for collecting debt. In the write-of loans category, debt instruments are included, whether due or not, for which, after an individualised analysis, their recovery is considered remote due to a notorious and unrecoverable impairment of the solvency of the transaction or the holder. Classifcation in this category involves full cancellation of the gross carrying amount of the loan and it’s derecognition, which does not mean that the Group interrupts negotiations and legal proceedings to recover its amount. Forborne loan portfolio The Group has a corporate forbearance policy which acts as a reference for the diferent local transpositions of all its subsidiaries. These share the general principles established by the Bank of Spain and the EBA. This policy includes the requirements arising from the implementation of IFRS9. This policy defnes forbearance as the modifcation of the payment conditions of a transaction to allow a customer who is experiencing fnancial difculties (current or foreseeable), to fulfl their payment obligations. If the modifcation was not made, it would be reasonably certain that the customer would not be able to meet their fnancial obligations. The modifcation could be made to the original transaction or through a new transaction replacing the previous one. In addition, this policy also sets down rigorous criteria for the evaluation, classifcation and monitoring of such transactions, ensuring the strictest possible care and diligence in their granting and follow up. Therefore, the forbearance transaction must be focused on recovery of the amounts due, the payment obligations must be adapted to the customer’s actual situation and losses 647 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix CURRENT REFINANCING AND RESTRUCTURING BALANCES Amounts in million of euros, except number of transactions that are in units Without real guarantee With real guarantee Total Maximum amount of the actual collateral that can be considered Number of transactions Gross amount Number of transactions Gross amount Real estate guarantee Rest of real guarantees - 37 265 - 76 11 - 16 135 - 18 38 - 11 16 - 4 15 187,192 7,383 44,452 13,039 8,116 1,321 426 1,578,622 313 3,476 1,889 824,591 1,932 17,193 1,600 7,905 1,766,116 10,946 869,194 30,288 16,048 30 4,016 5,356 Impairment of accumulated value or accumulated losses in fair value due to credit risk - 6 10 6,339 620 4,352 10,707 - - - - - - - Credit entities Public sector Other fnancial institutions and: individual shareholder Non-fnancial institutions and individual shareholder Of which: fnancing for constructions and property development Other warehouses Total Financing classifed as non- current assets and disposable groups of items that have been classifed as held for sale The transactions presented in the foregoing tables were classifed at 31 December 2018 by nature, as follows: The table below shows the changes in 2018 in the forborne loan portfolio: • Non-performing: Operations that rest on an inadequate payment scheme will be classifed within the non-performing category, regardless they include contract clauses that delay the repayment of the operation throughout regular payments or present amounts written of the balance sheet for being considered irrecoverable. • Performing: Operations not classifable as non-performing will be classifed within this category. Operations will also will be classifed as normal if they have been reclassifed from the non-performing category for complying with the specifc criteria detailed below: Million of euros Beginning balance Refnancing and restructuring of the period Memorandum item: impact recorded in the income statement for the period Debt repayment Foreclosure Derecognised from the consolidated balance sheet a) A period of a year must have expired from the refnancing or Others variations restructuring date. Balance at end of year 2018 36,164 2017 37,365 10,191 12,675 2,659 (11,126) (731) (3,660) (311) 30,527 2,406 (9,107) (950) (5,334) 1,515 36,164 b) The owner must have paid for the accrued amounts of the capital and interests, thus reducing the rearranged capital amount, from the date when the restructuring of refnancing operation was formalised. c) The owner must not have any other operation with amounts past due by more than 90 days on the date of the reclassifcation to the normal risk category. 51% of the forborne loan transactions are classifed as other than non-performing. Particularly noteworthy are the level of existing guarantees (52% of transactions are secured by collateral) and the coverage provided by specifc allowances (representing 26% of the total forborne loan portfolio and 42% of the non-performing portfolio). 648 2018 Auditors’ report and consolidated annual accounts 2018 Without real guarantee With real guarantee Of which: Non-performing/Doubtful Maximum amount of the actual collateral that can be considered Number of transactions Gross amount Number of transactions Gross amount Real estate guarantee Rest of real guarantees - 13 110 - 7 3 - 9 75 - 4 16 - 4 9 - - - 121,445 4,669 26,122 8,156 5,058 689 328 874,840 996,408 245 1,668 6,347 1,369 181,469 207,675 1,329 5,834 14,010 1,038 3,505 8,576 28 823 1,512 Impairment of accumulated value or accumulated losses in fair value due to credit risk - 2 9 5,851 594 2,772 8,634 - - - - - - - c) Trading market risk, structural and liquidity risk • Infation rate risk is the possibility that changes in infation rates 1. Activities subject to market risk and types of market risk The perimeter of activities subject to market risk involves operations where patrimonial risk is assumed as a consequence of variations in market factors. Thus they include trading risks and also structural risks, which are also afected by market shifts. This risk arises from changes in risk factors - interest rates, infation rates, exchange rates, stock prices, credit spreads, commodity prices and the volatility of each of these elements - as well as from the liquidity risk of the various products and markets in which the Group operates, and balance sheet liquidity risk: • Interest rate risk is the possibility that changes in interest rates could adversely afect the value of a fnancial instrument, a portfolio or the Group as a whole. It afects loans, deposits, debt securities, most assets and liabilities in the trading books and derivatives, among others. could adversely afect the value of a fnancial instrument, a portfolio or the Group as a whole. It afects instruments such as loans, debt securities and derivatives, where the return is linked to infation or to a change in the actual rate. • Exchange rate risk is the sensitivity of the value of a position in a currency other than the base currency to a movement in exchange rates. Hence, a long or open position in a foreign currency will produce a loss if that currency depreciates against the base currency. Among the exposures afected by this risk are the Group’s investments in subsidiaries in non-euro currencies, as well as any foreign currency transactions. • Equity risk is the sensitivity of the value of positions in equities to adverse movements in market prices or expectations of future dividends. Among other instruments, this afects positions in shares, stock market indices, convertible bonds and derivatives using shares as the underlying asset (put, call, equity swaps, etc.). 649 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix • Credit spread risk is the risk or sensitivity of the value of positions in fxed income securities or in credit derivatives to movements in credit spread curves or in recovery rates associated with issuers and specifc types of debt. The spread is the diference between fnancial instruments listed with a margin over other benchmark instruments, mainly the interest rate risk of Government bonds and interbank interest rates. • Commodities price risk is the risk derived from the efect of potential changes in commodities prices. The Group’s exposure to this risk is not signifcant and is concentrated in derivative transactions on commodities with customers. • Volatility risk is the risk or sensitivity of the value of a portfolio to changes in the volatility of risk factors: interest rates, exchange rates, shares, credit spreads and commodities. This risk is incurred by all fnancial instruments where volatility is a variable in the valuation model. The most signifcant case is the fnancial options portfolio. All these market risks can be partly or fully mitigated by using options, futures, forwards and swaps. In addition to the above market risks, balance sheet liquidity risk must also be considered. Unlike market liquidity risk, balance sheet liquidity risk is defned as the possibility of not meeting payment obligations on time, or doing so at excessive cost. Among the losses caused by this risk are losses due to forced sales of assets or margin impacts due to the mismatch between expected cash infows and outfows. 1. Trading market risk management The Group’s trading risk profle remained moderately low in 2018, in line with previous years, due to the fact that the Group’s activity has traditionally focused on providing services to its customers, with only limited exposure to complex structured assets, as well as geographic diversifcation and risk factors. The standard methodology Santander Group applies to trading activities is Value at Risk (VaR), which measures the maximum expected loss with a certain confdence level and time frame. The standard for historic simulation is a confdence level of 99% and a time frame of one day. Statistical adjustments are applied enabling the most recent developments afecting the levels of risk assumed to be incorporated efciently and on a timely manner. A time frame of two years or at least 520 days from the reference date of the VaR calculation is used. Two fgures are calculated every day: one applying an exponential decay factor that accords less weight to the observations furthest away in time and another with the same weight for all observations. The higher of the two is reported as the VaR. The detail of the metrics risk related to the Group’s balance sheet items as of 31 December 2018 is as follows: 650 2018 Auditors’ report and consolidated annual accounts Assets subject to market risk Cash, cash balances at central banks and other deposits on demand Financial assets held for trading Non-trading fnancial assets mandatorily at fair value through proft or loss Financial assets designated at fair value through proft or loss Financial assets designated at fair value through other comprehensive income Financial assets at amortised cost Main market risk metric Balance sheet amount VaR Others Main risk factor for “Other” balance 113,663 92,879 - 113,663 Interest rate 92,140 739 Interest rate, spread 10,730 9,327 1,403 Interest rate, Equity market 57,460 56,584 876 Interest rate 121,091 946,099 - - 121,091 Interest rate, spread 946,099 Interest rate Hedging derivatives 8,607 8,586 21 Interest rate, exchange rate Changes in the fair value of hedged items in portfolio hedges of interest risk Other assets Total Assets Liabilities subject to market risk Financial liabilities held for trading Financial liabilities designated at fair value through proft or loss 1,088 107,654 1,459,271 - - 1,088 Interest rate - - 70,343 70,054 289 Interest rate, spread 68,058 67,909 149 Interest rate Financial liabilities at amortised cost 1,171,630 - 1,171,630 Interest rate, spread Hedging derivatives 6,363 6,357 6 Interest rate, exchange rate Changes in the fair value of hedged items in portfolio hedges of interest rate risk Other liabilities Total liabilities Equity 303 35,213 1,351,910 107,361 - - 303 Interest rate - VaR during 2018 fuctuated between EUR 16.6 million and EUR 6.4 million (2017: 9.7 and 63.2). The most signifcant changes were related to variations in exchange and interest rate exposures and also market volatility. The average VaR in 2018 was EUR 9.7 million, slightly lower than in the two previous years (EUR 21.5 million in 2017). The following table shows the average and latest values of Var at 99% by risk factor in the last three years as well as the minimum and maximum values. 651 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Total VaR trading (Derivatives: VaR risk per factor of risk) Million of euros. Structural VaR 99% with a temporary horizon one day Total Diversifcation efect Interest rate Equities Exchange rate Credit spread Commodities 2018 Average 9.7 (9.3) 9.4 2.4 3.9 3.4 0.0 Max 16.6 (18.7) 15.5 6.3 11.4 13.0 0.4 Latest 11.3 (11.5) 9.7 2.8 6.2 4.1 0.0 Min 6.4 (3.3) 5.9 0.8 1.6 1.0 0.0 2017 2016 Average Latest Average Latest 21.5 (8.0) 16.2 3.0 6.6 3.6 0.0 10.2 (7.6) 7.9 1.9 3.3 4.6 0.0 18.3 (10.3) 15.5 1.9 6.9 4.2 0.1 17.9 (9.6) 17.9 1.4 4.8 3.3 0.1 The Group continues to have a very limited exposure to instruments or complex structured assets, a management culture for which prudence in risk management is one of its hallmarks in risk management. In both cases, the exposure has reduced comparing with the previous year, for which the Group has: • Hedge funds: the total exposure is not signifcant (EUR 28 million at close of December 2018) and is all indirect, acting as counterparty in derivatives transactions. The risk with this type of counterparty is analysed case by case, establishing percentages of collateralisation on the basis of the features and assets of each fund. • Monolines: exposure to bond insurance companies as of December 2018 was EUR 24 million, all of it indirect, by virtue of the guarantee provided by this type of entity for various fnancing or traditional securitisation transactions. The exposure in this case is to double default, as the primary underlying assets are of high credit quality. The Group’s policy for approving new transactions related to these products remains very prudent and conservative. It is subject to strict supervision by the Group’s senior management. Before approving a new transaction, product or underlying asset, the Risk division verifes: • The existence of an appropriate valuation model to monitor the value of each exposure: mark-to-market, mark-to-model or mark-to-liquidity. • The availability in the market of observable data (inputs) needed to apply this valuation model. And provided these two conditions are met: • The availability of adequate systems, duly adapted to calculate and monitor every day the results, positions and risks of new transactions. • The degree of liquidity of the product or underlying asset, in order to make possible their coverage when deemed appropriate. Calibration and test measures Actual losses can difer from those forecast by VaR for various reasons related to the limitations of this metric which are detailed later in the section of methodologies. The Group regularly analyses and contrasts the accuracy of the VaR calculation model in order to confrm its reliability. The most important test consists of backtesting exercises, analysed at the local and global levels and in all cases with the same methodology. Backtesting consists of comparing forecast VaR measurements, with a certain level of confdence and time frame, with actual losses obtained in the same time frame. This enables anomalies in the VaR model of the portfolio in question to be detected (for example, shortcomings in the parameterisation of the valuation models of certain instruments, not very adequate proxies, etc.). The Group calculates and evaluates three types of backtesting: • “Clean” backtesting: the daily VaR is compared with the results obtained without taking into account intraday results or changes in the portfolio’s positions. This method compares the efectiveness of the individual models used to assess and measure the risks of positions. • Backtesting on complete results: daily VaR is compared with the day’s net results, including the results of intraday transactions and those generated by fees and commissions. • Backtesting on complete results without mark-ups or fees: the daily VaR is compared to the day’s net results from intraday transactions but excluding those generated by mark-ups and fees. This method aims to give an idea of the intraday risk assumed by Group treasuries. For the frst case and for the total portfolio, there were three exceptions of Value at Earnings (VaE) at 99% in 2018 (day on which daily proft was higher than VaE) on 21 and 30 August and 8 October, caused by strong shifts in the exchange rates of emerging economies. 652 2018 Auditors’ report and consolidated annual accounts There were also one exception to VaR at 99% (day on which the daily loss was higher than the VaR) on the 29 May, due to the rise in market volatility caused by political instability in Europe, and on 15 and 29 October due to the strong variations in the exchange rates and interest rates in Brazil and Mexico motivated by the general elections volatility. The number of exceptions which occurred is consistent with the assumptions specifed in the VaR calculation model. 2. Structural balance sheet risks 2.1. Main aggregates and variations The market risk profle inherent in Grupo Santander’s balance sheet, in relation to its asset volumes and shareholders’ funds, as well as the budgeted fnancial margin, remained moderate in 2018, in line with previous years. Structural VaR A standardised metric such as VaR can be used for monitoring total market risk for the banking book, excluding the trading activity of SCIB, distinguishing between fxed income (considering both interest rates and credit spreads on ALCO portfolios), exchange rates and equities. In general the structural VaR is not signifcant according to the assets amounts or capital of the Group: Structural VaR Million of euros. Structural VaR 99% with a temporary horizon one day 2018 2017 2016 Structural VaR Min Average 485.0 568.5 Max 799.4 Latest 556.8 Average 878.0 Latest 815.7 Average 869.3 Latest 922.1 Diversifcation efect (319.7) (325.0) (355.4) (267.7) (337.3) (376.8) (323.4) (316.6) VaR interest rate* VaR exchange rate VaR equities 301.3 323.3 180.1 337.1 338.9 217.6 482.5 386.2 286.1 319.5 324.9 180.1 373.9 546.9 294.5 459.6 471.2 261.6 340.6 603.4 248.7 327.2 588.5 323.0 * Includes credit spread VaR on ALCO portfolios. Structural interest rate risk • Latin America • Europe and the United States The main balance sheets, the Parent, United Kingdom and United States, in mature markets and in a low interest rate setting, usually show positive sensitivities to interest rates in economic value of equity and net interest income. Exposure levels in all countries are moderate in relation to the annual budget and capital levels. At the end of December 2018, risk on net interest income over one year , measured as sensitivity to parallel changes in the worst case scenario of ±100 basis points, was concentrated in the euro, at EUR 269 million, the pound sterling, at EUR 203 million, the US dollar, with EUR 130million, and the Polish zloty, at EUR 53 million. Latin American balance sheets are usually positioned for interest rate cuts for both economic value and net interest income, except for net interest income in Mexico, where liquidity excess is invested in the short term in the local currency. In 2018, exposure levels in all countries were moderate in relation to the annual budget and capital levels. At the end of December, risk on net interest income over one year, measured as sensitivity to parallel changes in the worst case scenario of ±100 basis points, was concentrated in three countries: Brazil (EUR 45 million), Chile (EUR 35 million) and Mexico (EUR 12 million). 653 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Risk to the economic value of equity over one year, measured as sensitivity to parallel ± 100 basis point movements in the worst case scenario, was also concentrated in Brazil (EUR 419 million), Chile (EUR 219 million) and Mexico (EUR 172 million). • VaR of on-balance-sheet structural interest rate risk In addition to sensitivities to interest rate movements (in which, assessments of ±100 bp movements are complemented by assessments of +/-25 bp, +/-50 bp and +/-75 bp movements to give a fuller understanding of risk in countries with very low rates), the Group also uses other methods to monitor structural balance sheet risk from interest rates movements: these include scenario analysis and VaR calculations, applying a similar methodology to that used for trading portfolios. Structural interest rate risk, measured in terms of VaR at one-day and at 99%, averaged EUR 352.5 million in September 2018. It is important to note the high level of diversifcation between the balance sheets of Europe and United States and those of Latin America. Structural foreign currency risk/hedges of results Structural exchange rate risk arises from Group transactions in foreign currencies, mainly related to permanent fnancial investments, results and the hedging of both. This management is dynamic and seeks to limit the impact on the core capital ratio from exchange rates movements. In 2018, hedging levels of the core capital ratio for foreign exchange rate risk were maintained near 100%. At the end of 2018, the largest exposures of permanent investments (with their potential impact on equity) were, in the following order, in Brazilian real, US dollars, UK pounds sterling, Chilean pesos, Mexican pesos and Polish zlotys. The Group hedges some of these positions of a permanent nature with foreign exchange-rate derivatives. In addition, the fnancial area is responsible for managing foreign exchange rate risk for the Group’s expected results and dividends in units where the base currency is not the euro. Structural equity risk The Group maintains equity positions in its banking book in addition to those of the trading portfolio. These positions are maintained as equity instruments or as investments, depending on the percentage or control. The equity portfolio available for the banking book at the end of December 2018 was diversifed in securities in various countries, mainly Spain, China, Morocco, Netherlands and Poland. Most of the portfolio is invested in fnancial activities and insurance sectors. Among other sectors, to a lesser extent, are for example real estate activities or public administration. Structural equity positions are exposed to market risk. VaR is calculated for these positions using market price data series or proxies. As of the end of December 2018, the VaR at 99% with a one day time frame was EUR 180.1 million (EUR 261.6 and EUR 323 million at the end of 2017 and 2016, respectively). 2.2. Methodologies Structural interest rate risk The Group analyses the sensitivity of its net interest income and equity value to changes in interest rates. This sensitivity arises from diferences in maturity dates and interest rate repricing gaps in the various balance sheet items. Taking into consideration the balance-sheet interest rate position and the market situation and outlook, the necessary fnancial actions are adopted to align this position with that desired by the Group. These measures can range from opening positions on markets to the defnition of the interest rate features of commercialised products. The metrics used by the Group to control interest rate risk in these activities are the repricing gap, the sensitivity of net interest margin and market value of equity to changes in interest rates, the duration of capital and value at risk (VaR) for economic capital calculation purposes. Structural exchange-rate risk/hedging of results These activities are monitored via position measurements, VaR and results, on a daily basis. Structural equity risk These activities are monitored via position measurements, VaR and results, on a monthly basis. 3. Liquidity risk Structural liquidity management aims to fund the Group’s recurring activity optimising maturities and costs, while avoiding taking on undesired liquidity risks. Santander’s liquidity management is based on the following principles: • Decentralised liquidity model. • Medium- and long-term funding needs must be covered by medium- and long-term instruments. 654 2018 Auditors’ report and consolidated annual accounts • High contribution from customer deposits due to the retail nature • A solid balance sheet structure, with a diversifed presence in the of the balance sheet. wholesale markets; • Diversifcation of wholesale funding sources by instruments/ • The use of liquidity bufers and limited encumbrance of assets; investors, markets/currencies and maturities. • Limited recourse to short-term. • Compliance with both regulatory metrics and other metrics included in each entity’s risk appetite statement. • Availability of sufcient liquidity reserves, including standing facilities/discount windows at central banks to be used in adverse situations. Over the course of the year, all dimensions of the plan are monitored. The Group continues developing the ILAAP (Internal Liquidity Adequacy Assessment Process), an internal self-assessment of liquidity adequacy which must be integrated into the Group’s other risk management and strategic processes. It focuses on both quantitative and qualitative matters and is used as an input to the SREP (Supervisory Review and Evaluation Process). The ILAAP evaluates the liquidity position both in ordinary and stressed scenarios. iii. Asset encumbrance It is important to note the Group’s moderate use of assets as security for structural balance-sheet funding sources. Following the guidelines laid down by the European Banking Authority (EBA) in 2014, the concept of asset encumbrance includes both on-balance-sheet assets provided as security in transactions to obtain liquidity and of-balance-sheet assets that have been received and re-used for the same purpose, as well as other assets associated with liabilities for reasons other than funding. • Compliance with regulatory liquidity requirements both at Group and subsidiary level, as a new factor conditioning management. The efective application of these principles by all institutions comprising the Group required the development of a unique management framework built upon three essential pillars: A solid organisational and governance model that ensures the involvement of the subsidiaries’ senior management in decision- taking and its integration into the Group’s global strategy. The decision-making process for all structural risks, including liquidity and funding risk, is carried out by Local Asset and Liability Committees (ALCO) in coordination with the Global ALCO, which is the body empowered by Banco Santander’s board in accordance with the corporate Asset and Liability Management (ALM) framework. This governance model has been reinforced as it has been included within the Santander Risk Appetite Framework. This framework meets the demands of regulators and market players emanating from the fnancial crisis to strengthen banks’ risk management and control systems. In-depth balance sheet analysis and measurement of liquidity risk, supporting decision-taking and its control. The objective is to ensure the Group maintains adequate liquidity levels necessary to cover its short- and long-term needs with stable funding sources, optimising the impact of their costs on the income statement. The Group’s liquidity risk management processes are contained within a conservative risk appetite framework established in each geographic area in accordance with its commercial strategy. This risk appetite establishes the limits within which the subsidiaries can operate in order to achieve their strategic objectives. Management adapted in practice to the liquidity needs of each business. Every year, based on business needs, a liquidity plan is developed which seeks to achieve: 655 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix The residual maturities of the liabilities associated with the assets and guarantees received and committed are presented below, as of 31 of December of 2018 (thousand of million of euros). Residual maturities of the liabilities Committed assets Guarantees received >3months Unmatured <=1month <=3months <=12months >1month >1year <=2years >2years <=3years 3years <=5years 5years <=10years >10years TOTAL 28.5 53.7 24.6 15.8 11.9 10.7 29.0 78.6 55.4 28.1 20.4 16.5 322.2 10.3 1.8 1.8 1.7 1.8 1.1 69.6 The reported Group information as required by the EBA at 2018 year-end is as follows: On-balance-sheet encumbered assets Thousand of million of euros Loans and advances Equity instruments Debt securities Other assets Total assets Carrying amount of encumbered assets Fair Value of encumbered assets Fair Value of non- encumbered assets Carrying amount of non-encumbered assets 214.6 4.2 76.3 27.1 322.2 4.2 76.3 855.0 10.7 114.8 156.6 1,137.1 10.7 114.8 Encumbrance of collateral received Thousand of million of euros Encumbered assets and collateral received and matching liabilities Thousand of million of euros Fair value of encumbered collateral received or own debt securities issued Fair value of collateral received or own debt securities issued available for encumbrance 69.6 - 2.7 65.0 1.9 48.9 - 6.0 42.9 - - 1.4 Matching liabilities, contingent liabilities or securities lent Assets, collateral received and own debt securities issued other than covered bonds and ABSs encumbered Total sources of encumbrance (carrying amount) 301.6 391.8 On-balance-sheet encumbered assets amounted to EUR 322.2 thousand million, of which 67% are loans (mortgage loans, corporate loans, etc.). Of-balance-sheet encumbered assets amounted to EUR 69.6 thousand million, relating mostly to debt securities received as security in asset purchase transactions and re-used. Taken together, these two categories represent a total of EUR 391.8 thousand million of encumbered assets, which give rise to EUR 301.6 thousand million matching liabilities. Collateral received Loans and advances Equity instruments Debt securities Other collateral received Own debt securities issued other than own covered bonds or ABSs 656 2018 Auditors’ report and consolidated annual accounts   As of December 2018, total asset encumbrance in funding operations represented 24.8% of the Group’s extended balance sheet under EBA criteria (total assets plus guarantees received: EUR 1.5878 thousand million as of December 2018). This percentage is similar to the values presented by the Group before the acquisition of Banco Popular Español, S.A.U. in 2017. Regulatory capital In 2018, the solvency target set was achieved. Santander’s CET1 fully loaded ratio stood at 11.30% at the close of the year, demonstrating its organic capacity to generate capital. The key regulatory capital fgures are indicated below: Reconciliation of accounting capital with regulatory capital Lastly, regard should be had to the diferent sources of encumbrance and the role they play in the Group’s funding: Million of euros • 51.5 % of total encumbered assets relate to security provided in medium- and long-term fnancing transactions (with residual maturity of more than one year) to fund the commercial balance- sheet activity. This places the level of asset encumbrance in “structural” funding transactions at 12.8 % of the expanded balance sheet under EBA standards. • The other 48.5 % relate to transactions in the short-term market (with residual maturity of less than one year) or to security provided in derivative transactions whose purpose is not to fund the ordinary business activity but rather to ensure efcient short- term liquidity management. d) Capital risk The capital risk function, as second line of defence carries out the control and supervision of the capital activities developed by the frst line of defence, which independently challenges mainly through the following processes: • Supervision of capital planning and adequacy exercises through a review of all their components (balance sheet, proft and loss account, risk-weighted assets and available capital). • Ongoing supervision of measurement of the Group’s regulatory capital by identifying the key metrics for the calculation, setting tolerance levels for identifed metrics and reviewing their consumption and the consistency of the calculations, including single transactions with a capital impact. The function is designed to carry out full and regular monitoring of capital risk by verifying that capital is sufcient and adequately covered in accordance with the Group’s risk profle. The Group commands a sound solvency position, above the levels required by regulators and by the European Central bank. At 1 March 2019, at a consolidated level, the Group must maintain a minimum capital ratio of 9.70% of CET1 fully loaded (4.5% being the requirement for Pillar I, 1.5% being the requirement for Pillar 2R (requirement), 2.5% being the requirement for capital conservation bufer, 1% being the requirement for G-SIB and 0.20% being the requirement for anti-cyclical capital bufer). Santander Group must also maintain a minimum capital ratio of 1.5% of Tier 1 fully loaded and a minimum total ratio of 13.20% fully loaded. Subscribed capital Share premium account Reserves Treasury shares Attributable proft Approved dividend Shareholders’ equity on public balance sheet Valuation adjustments Non- controlling interests 2018 8,118 50,993 53,988 (59) 7,810 2017 8,068 51,053 52,577 (22) 6,619 (2,237) (2,029) 118,613 116,265 (22,141) (21,777) 10,889 12,344 Total Equity on public balance sheet 107,361 106,832 Goodwill and intangible assets (28,644) (28,537) Eligible preference shares and participating securities Accrued dividend Other adjustments* Tier 1 (Phase-in) 9,754 (1,055) 7,635 (968) (9,700) (7,679) 77,716 77,283 * Fundamentally for non-computable non-controlling interests and deductions and reasonable flters in compliance with CRR. The following table shows the Phase-in capital coefcients and a detail of the eligible internal resources of the Group: Capital coefcients Level 1 ordinary eligible capital (million of euros) Level 1 additional eligible capital (million of euros) 2018 2017 67,962 74,173 9,754 3,110 Level 2 eligible capital (million of euros) 11,009 13,422 Risk-weighted assets (million of euros) 592,319 605,064 Level 1 ordinary capital coefcient (CET 1) 11.47% 12.26% Level 1 additional capital coefcient (AT1) 1.65% 0.51% Level 1 capital coefcient (Tier 1) Level 2 capital coefcient (Tier 2) Total capital coefcient 13.12% 12.77% 1.86% 2.22% 14.98% 14.99% 657 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Eligible capital Million of euros Eligible capital Common Equity Tier 1 Capital (-) Treasure shares and own shares fnanced Share Premium Reserves Other retained earnings Minority interests Proft net of dividends Deductions Goodwill and intangible assets Others Additional Tier 1 Eligible instruments AT1 T1- excesses-subsidiaries Residual value of dividends Others Tier 2 Elegible instruments T2 Gen. funds and surplus loans loss prov. IRB T2-excesses- subsidiaries Others 2018 2017 67,962 8,118 (64) 50,993 55,036 74,173 8,068 (22) 51,053 52,241 (23,022) (22,363) 6,981 4,518 7,991 3,621 (34,598) (26,416) (28,644) (22,829) (5,954) (3,586) 9,754 9,666 88 - - 11,009 11,306 - (297) - 3,110 8,498 347 (5,707) (27) 13,422 9,901 3,823 (275) (27) Total eligible capital 88,725 90,706 Note: Santander Bank and its afliates had not taken part in any State aid programmes. Leverage ratio The leverage ratio has been defned within the regulatory framework of Basel III as a measure of the capital required by fnancial institutions not sensitive to risk. The Group performs the calculation as stipulated in CRD IV and its subsequent amendment in EU Regulation no. 573/2013 of 17 January 2015, which was aimed at harmonising calculation criteria with those specifed in the BCBS “Basel III leverage ratio framework” and “Disclosure requirements” documents. • Inclusion of net value of derivatives (gains and losses are netted with the same counterparty, minus collaterals if they comply with certain criteria) plus a charge for the future potential exposure. • A charge for the potential risk of security funding transactions. • Lastly, it includes a charge for the risk of credit derivative swaps (CDS). The European Commission’s proposals to modify CRR and CRD IV on 23 November 2016, foresee a mandatory requirement of a 3% leverage ratio for Tier 1 capital, which would be added to the own funds requirements in the article 92 of the CRR. The proposals for the Commission’s modifcation also point to the possibility of introducing a bufer of leverage ratio for global systemic entities in the future. Million of euros Leverage Level 1 Capital Exposure Leverage Ratio 31/12/2018 31/12/2017 77,716 77,283 1,489,094 1,463,090 5.22% 5.28% Global systemically important banks The Group is one of 30 banks designated as global systemically important banks (G-SIBs). The designation as a systemically important entity is based on the measurement set by regulators (the FSB and BCBS), based on 5 criteria (size, cross-jurisdictional activity, interconnectedness with other fnancial institutions, substitutability and complexity). This defnition means it has to fulfl certain additional requirements, which consist mainly of a capital bufer (1%), in TLAC requirements (total loss absorbing capacity), that we have to publish relevant information more frequently than other banks, greater regulatory requirements for internal control bodies, special supervision and drawing up of special reports to be submitted to supervisors. The fact that Grupo Santander has to comply with these requirements makes it a more solid bank than its domestic rivals. This ratio is calculated as Tier 1 capital divided by leverage exposure. Exposure is calculated as the sum of the following items: 55. Explanation added for translation to English • Accounting assets, excluding derivatives and items treated as deductions from Tier 1 capital (for example, the balance of loans is included, but not that of goodwill). These consolidated fnancial statements are presented on the basis of the regulatory fnancial reporting framework applicable to the Group in Spain (see Note 1.b). • Of-balance-sheet items (mainly guarantees, unused credit limits granted and documentary credits) weighted using credit conversion factors. 658 2018 Auditors’ report and consolidated annual accounts Appendix 659 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix% of ownership held by the Bank % of voting powerk Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount 0.00% 100.00% 100.00% 100.00% Real estate 53 A & L CF (Guernsey) Limited n Guernsey 0.00% 100.00% 100.00% 100.00% Leasing Appendix I Subsidiaries of Banco Santander, S.A.1 Company 2 & 3 Triton Limited Location United Kingdom A & L CF December (1) Limited j A & L CF June (2) Limited e A & L CF June (3) Limited e A & L CF March (5) Limited d A & L CF September (4) Limited f Abbey Business Services (India) Private Limited d Abbey Covered Bonds (Holdings) Limited Abbey Covered Bonds (LM) Limited Abbey Covered Bonds LLP Abbey National Beta Investments Limited Abbey National Business Ofce Equipment Leasing Limited Abbey National International Limited Abbey National Nominees Limited Abbey National PLP (UK) Limited Abbey National Property Investments United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom India United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom Abbey National Treasury Services Investments Limited United Kingdom Abbey National Treasury Services Overseas Holdings Abbey National Treasury Services plc Abbey National UK Investments Abbey Stockbrokers (Nominees) Limited Abbey Stockbrokers Limited United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Holding company - b - - Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation - b - - Securitisation (291) 35 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Leasing Jersey 0.00% 100.00% 100.00% 100.00% Banking 0.00% 100.00% 100.00% 100.00% Securities company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Banking 366 0.00% 100.00% 100.00% 100.00% Finance 0.00% 100.00% 100.00% 0.00% 100.00% 100.00% company 100.00% Securities company 100.00% Securities company 0 0 0 0 0 0 9 2 19 0 0 0 0 0 5 0 0 522 0 0 7 0 0 0 (1) 0 0 0 0 0 0 0 0 0 0 5 0 12 21 0 0 0 11 0 0 0 0 0 0 0 0 0 0 0 0 6 0 0 155 0 0 376 0 0 0 Ablasa Participaciones, S.L. Spain 18.94% 81.06% 100.00% 100.00% Holding 299 (115) 454 company Administración de Bancos Latinoamericanos Santander, S.L. Spain 24.11% 75.89% 100.00% 100.00% Holding 2,542 (9) 1,863 company Aevis Europa, S.L. AFB SAM Holdings, S.L. Spain Spain 96.34% 0.00% 96.34% 96.34% Cards 1.00% 99.00% 100.00% 100.00% Holding 1 116 0 0 1 113 company 660 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Afsa S.A. Location Direct Indirect Year 2018 Year 2017 Activity Chile 0.00% 100.00% 100.00% 100.00% Fund management company ALIL Services Limited Isle of Man 0.00% 100.00% 100.00% 100.00% Services Aliseda Participaciones Inmobiliarias, S.L. i Spain 0.00% 0.00% 0.00% 100.00% Real estate Aliseda Real Estate, S.A. Spain 100.00% 0.00% 100.00% 100.00% Real estate Aljardi SGPS, Lda. Portugal 0.00% 100.00% 100.00% 100.00% Holding Million eurosa Capital + reserves Net results Carrying amount 4 3 - 0 0 - 5 3 - 48 1,209 (20) (6) 32 1,148 United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0 0 0 0 0 0 0.00% 100.00% 100.00% 100.00% Finance (227) company 0 0 0 0 0 0 0 Spain 100.00% 0.00% 100.00% 100.00% Real estate 36 (97) Alliance & Leicester Cash Solutions Limited Alliance & Leicester Commercial Bank Limited Alliance & Leicester Investments (Derivatives) Limited Alliance & Leicester Investments (No.2) Limited Alliance & Leicester Investments Limited Alliance & Leicester Limited Alliance & Leicester Personal Finance Limited Altamira Santander Real Estate, S.A. Amazonia Trade Limited AN (123) Limited United Kingdom United Kingdom 100.00% 0.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Holding company Andaluza de Inversiones, S.A. Spain 0.00% 100.00% 100.00% 100.00% Holding company ANITCO Limited Aquanima Brasil Ltda. Aquanima Chile S.A. Aquanima México S. de R.L. de C.V. United Kingdom Brazil Chile 0.00% 100.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% E-commerce 0.00% 100.00% 100.00% 100.00% Services Mexico 0.00% 100.00% 100.00% 100.00% E-commerce Aquanima S.A. Argentina 0.00% 100.00% 100.00% 100.00% Services Arcaz - Sociedade Imobiliária Portugal Portuguesa, Lda. r 0.00% 99.90% 100.00% 100.00% Inactive Argenline S.A. j o Uruguay 0.00% 100.00% 100.00% Asto Digital Limited Athena Corporation Limited Atlantes Azor No. 1 Atlantes Azor No. 2 Atlantes Mortgage No. 2 Atlantes Mortgage No. 3 Atlantes Mortgage No. 4 Atlantes Mortgage No. 5 Atlantes Mortgage No. 7 United Kingdom United Kingdom Portugal Portugal Portugal Portugal Portugal Portugal Portugal Atlantes Mortgage No.1 FTC Portugal Atlantes Mortgage No.1 plc Ireland 0.00% 100.00% 100.00% 0.00% 100.00% 100.00% - - - - - - - - - b b b b b b b b b - - - - - - - - - 100.00% Finance company 100.00% Finance company - Financial services - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation 0 0 92 0 3 2 2 0 3 0 40 0 0 0 0 0 0 0 0 25 0 0 0 0 0 0 1 0 1 0 0 (13) (2) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 27 0 0 0 2 0 0 0 27 0 0 0 0 0 0 0 0 0 0 661 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Atual Serviços de Recuperação de Créditos e Meios Digitais S.A. Brazil 0.00% 89.85% 100.00% 100.00% Financial services 61 - - - - - - - - - - - - - b b b b b b b b b b b b b - - - - - - - - - - - - - - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation 0.00% 79.52% 100.00% 100.00% Technology services 99.99% 99.99% 99.99% 0.01% 100.00% 100.00% Renting 0.01% 100.00% 100.00% Renting 0.01% 100.00% 100.00% Renting 100.00% 0.00% 100.00% 100.00% Renting France France Italy Spain Spain Switzerland United Kingdom United Kingdom United Kingdom United Kingdom Brazil Spain Spain Spain Spain Spain 99.97% 0.03% 100.00% 100.00% Renting 99.00% 1.00% 100.00% 100.00% Air transport 100.00% 0.00% 100.00% 100.00% Renting 99.99% 99.99% 0.01% 100.00% 100.00% Renting 0.01% 100.00% 100.00% Renting 99.00% 1.00% 100.00% - Renting 99.99% 0.01% 100.00% 100.00% Renting 99.00% 1.00% 100.00% 100.00% Air transport 99.99% 0.01% 100.00% 100.00% Renting 0 0 0 0 0 0 0 0 0 0 0 0 1 3 44 10 36 8 82 4 0 13 10 2 43 2 26 4 0 0 0 0 0 0 0 0 0 0 0 0 (6) 0 4 5 2 0 0 (1) 0 3 1 0 0 2 3 54 0 0 0 0 0 0 0 0 0 0 0 0 0 3 28 6 25 8 63 4 1 9 11 2 26 3 19 0.00% 89.85% 100.00% 100.00% Finance 312 204 443 company 0.00% 50.00% 50.00% 50.00% Banking 0.00% 89.85% 100.00% 100.00% Banking 100.00% 0.00% 100.00% 100.00% Banking Paraguay 0.00% 99.33% 99.33% 99.33% Banking 297 942 14 0 37 45 0 0 123 848 9 0 Portugal 0.00% 100.00% 100.00% 100.00% Banking 1,088 (4) 1,085 Auto ABS DFP Master Compartment France 2013 Auto ABS French Lease Master Compartiment 2016 France France Auto ABS French Leases 2018 France Auto ABS French Loans Master Auto ABS French LT Leases Master Auto ABS Italian Loans 2018-1 S.R.L. Auto ABS Spanish Loans 2016, Fondo de Titulización Auto ABS Spanish Loans 2018-1, Fondo de Titulización Auto ABS Swiss Leases 2013 Gmbh Auto ABS UK Loans 2017 Holdings Limited Auto ABS UK Loans 2017 Plc Auto ABS UK Loans Holdings Limited Auto ABS UK Loans PLC Auttar HUT Processamento de Dados Ltda. Aviación Antares, A.I.E. Aviación Británica, A.I.E. Aviación Centaurus, A.I.E. Aviación Comillas, S.L. Unipersonal Aviación Intercontinental, A.I.E. Aviación Laredo, S.L. Aviación Oyambre, S.L. Unipersonal Aviación RC II, A.I.E. Aviación Real, A.I.E. Aviación Santillana S.L. Aviación Scorpius, A.I.E. Aviación Suances, S.L. Aviación Tritón, A.I.E. Aymoré Crédito, Financiamento e Investimento S.A. Banca PSA Italia S.p.A. Banco Bandepe S.A. Banco de Albacete, S.A. Banco de Asunción, S.A. en liquidación voluntaria j Banco Madesant - Sociedade Unipessoal, S.A. 662 Spain Spain Spain Spain Spain Spain Spain Spain Brazil Italy Brazil Spain 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Banco Olé Bonsucesso Consignado S.A. Brazil 0.00% 53.91% 60.00% 60.00% Banking Banco PSA Finance Brasil S.A. Brazil 0.00% 44.93% 50.00% 50.00% Finance company Banco S3 México, S.A., Institución de Banca Múltiple Mexico 0.00% 100.00% 100.00% 100.00% Credit institution Banco Santander - Chile Chile 0.00% 67.12% 67.18% 67.18% Banking Banco Santander (Brasil) S.A. Brazil 13.94% 75.92% 90.44% 90.24% Banking Banco Santander (México), S.A., Institución de Banca Múltiple, Grupo Financiero Santander México como Fiduciaria del Fideicomiso 100740 Banco Santander (México), S.A., Institución de Banca Múltiple, Grupo Financiero Santander México como Fiduciaria del Fideicomiso 2002114 Banco Santander (México), S.A., Institución de Banca Múltiple, Grupo Financiero Santander México como Fiduciaria del Fideicomiso GFSSLPT Banco Santander (Panamá), S.A. j Mexico 0.00% 75.13% 100.00% 100.00% Finance company Mexico 0.00% 76.48% 100.00% 100.00% Holding company Mexico 0.00% 77.83% 100.00% 100.00% Finance company Panama 0.00% 100.00% 100.00% 100.00% Banking Banco Santander (Suisse) SA Switzerland 0.00% 100.00% 100.00% 100.00% Banking Portugal 0.00% 100.00% 100.00% 100.00% Banking Colombia 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Banking Banco Santander Consumer Portugal, S.A. Banco Santander de Negocios Colombia S.A. Banco Santander International Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México United States Mexico Million eurosa Capital + reserves Net results Carrying amount 183 66 49 3,555 12,858 38 13 5 37 1,093 166 95 874 78 153 8 7 31 72 745 2,738 14 3,220 10,112 39 1 1 0 36 24 2 98 8 5 31 820 128 101 972 0.00% 75.13% 75.17% 99.99% Banking 4,727 853 4,193 Banco Santander Perú S.A. Peru 99.00% 1.00% 100.00% 100.00% Banking Banco Santander Puerto Rico Puerto Rico 0.00% 100.00% 100.00% 100.00% Banking Banco Santander Río S.A. Argentina 0.00% 99.30% 99.25% 99.20% Banking Banco Santander Totta, S.A. Portugal 0.00% 99.86% 99.96% 99.96% Banking Banco Santander, S.A. Uruguay 97.75% 2.25% 100.00% 100.00% Banking Banif International Bank, Ltd j Bahamas 0.00% 99.86% 100.00% 100.00% Banking Bansa Santander S.A. Chile 0.00% 100.00% 100.00% 100.00% Real estate BCLF 2013-1 B.V. The Netherlands - b - - Securitisation BEN Benefícios e Serviços S.A. Brazil 0.00% 89.85% 100.00% Besaya ECA Designated Activity Company i Bilkreditt 3 Designated Activity Company j Bilkreditt 4 Designated Activity Company j Bilkreditt 5 Designated Activity Companyj Bilkreditt 6 Designated Activity Company Ireland 0.00% 0.00% 0.00% Ireland Ireland Ireland Ireland - - - - b b b b - - - - - Payment services - Finance company - Securitisation - Securitisation - Securitisation - Securitisation 160 787 761 2,922 346 0 22 0 10 - 0 0 0 0 22 50 247 467 72 0 3 0 0 - 0 0 0 0 121 836 411 3,415 191 0 25 0 9 - 0 0 0 0 663 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Bilkreditt 7 Designated Activity Company Location Ireland Direct Indirect Year 2018 Year 2017 Activity - b - - Securitisation BPE Financiaciones, S.A. Spain 90.00% 10.00% 100.00% 100.00% Finance company BPE Representaçoes y Participaçoes, Ltda. j BPP Asesores S.A. j BPV Promotora de Vendas e Cobrança Ltda. Brazil 100.00% 0.00% 100.00% 100.00% Finance company Argentina 100.00% 0.00% 100.00% 100.00% Finance company Brazil 0.00% 53.91% 100.00% 100.00% Finance company BRS Investments S.A. Argentina 0.00% 100.00% 100.00% 100.00% Finance company Caja de Emisiones con Garantía de Anualidades Debidas por el Estado, S.A. Spain 62.87% 0.00% 62.87% 62.87% Finance company Cántabra de Inversiones, S.A. Spain 100.00% 0.00% 100.00% 100.00% Holding company Cántabro Catalana de Inversiones, S.A. Capital Street Delaware LP Capital Street Holdings, LLC Capital Street REIT Holdings, LLC United States United States United States Spain 100.00% 0.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Holding company Capital Street S.A. Luxembourg 0.00% 100.00% 100.00% 100.00% Finance Carfax (Guernsey) Limited n Guernsey 0.00% 100.00% 100.00% 100.00% company Insurance brokerage Carfnco Financial Group Inc. Canada 96.42% 0.00% 96.42% 96.42% Holding company Carfnco Inc. Canada 0.00% 96.42% 100.00% 100.00% Finance Casa de Bolsa Santander, S.A. de C.V., Grupo Financiero Santander México Mexico 0.00% 99.97% 99.97% company 99.97% Securities company Cater Allen Holdings Limited United 0.00% 100.00% 100.00% 100.00% Holding 0.00% 100.00% 100.00% company 100.00% Securities company Million eurosa Capital + reserves Net results Carrying amount 0 1 0 0 2 23 0 30 306 0 14 0 0 0 0 1 16 0 0 1 0 0 1 73 0 (15) 38 3 0 0 267 0 14 0 0 57 42 50 0 0 0 0 0 6 3 0 0 0 0 75 42 53 0 0 0.00% 100.00% 100.00% 100.00% Holding 1,151 21 1.172 company 0.00% 100.00% 100.00% 100.00% Banking 485 67 249 0.00% 100.00% 100.00% 100.00% Holding 0.00% 100.00% 100.00% company 100.00% Advisory services 0.00% 69.71% 100.00% 100.00% Leasing 0.00% 75.13% 100.00% 100.00% Non proft institute 0.00% 100.00% 100.00% 100.00% Aircraft rental 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company - b - - Securitisation 0 0 14 1 (54) (21) (18) 0 21 0 0 (12) 0 (7) 35 24 0 (13) 0 0 1 1 0 0 0 0 0 Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United States Mexico Spain United States United States United States United States Cater Allen International Limited Cater Allen Limited Cater Allen Lloyd's Holdings Limited Cater Allen Syndicate Management Limited CCAP Auto Lease Ltd. Centro de Capacitación Santander, A.C. Certidesa, S.L. Chrysler Capital Auto Funding I LLC Chrysler Capital Auto Funding II LLC Chrysler Capital Auto Receivables LLC Chrysler Capital Auto Receivables Trust 2016-A 664 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Chrysler Capital Master Auto United States Receivables Funding 2 LLC Chrysler Capital Master Auto United States Receivables Funding LLC 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company France 0.00% 50.00% 100.00% 100.00% Banking France 0.00% 50.00% 100.00% 100.00% Finance company Argentina 0.00% 100.00% 100.00% - Services Spain 0.00% 100.00% 100.00% - Services Million eurosa Capital + reserves Net results Carrying amount 106 90 363 20 0 0 (171) (3) 141 11 0 0 Portugal 86.28% 13.72% 100.00% 100.00% Real estate 132 (132) United States 0.00% 69.71% 100.00% 100.00% Securitisation Uruguay 100.00% 0.00% 100.00% 100.00% Services Ireland 100.00% 0.00% 100.00% 100.00% Reinsurances Digital Procurement Holdings N.V. The Netherlands 0.00% 100.00% 100.00% 100.00% Holding company Diners Club Spain, S.A. Spain 75.00% 0.00% 75.00% 75.00% Cards Dirección Estratega, S.C. Mexico 0.00% 100.00% 100.00% 100.00% Services 0.00% 100.00% 100.00% 100.00% Real estate 0 0 9 5 10 0 (10) (2) 14 (15) (20) (31) (57) (63) (83) (69) development - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation (130) - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation (68) (66) 0 0 0 0 0 0 0 2 0 0 8 15 9 15 15 34 48 55 50 97 42 48 (34) (81) (96) - - - - - - - - - - - - - - - b b b b b b b b b b b b b b b - - - - - - - - - - - - - - - Compagnie Generale de Credit Aux Particuliers - Credipar S.A. Compagnie Pour la Location de Vehicules - CLV Comunidad Laboral Trabajando Argentina S.A. Comunidad Laboral Trabajando Iberica, S.L. Unipersonal Consulteam Consultores de Gestão, Lda. Consumer Lending Receivables LLC Crawfall S.A. g j Darep Designated Activity Company Dirgenfn, S.L., en liquidación j Spain Drive Auto Receivables Trust 2015-A Drive Auto Receivables Trust 2015-B Drive Auto Receivables Trust 2015-C Drive Auto Receivables Trust 2015-D Drive Auto Receivables Trust 2016-A Drive Auto Receivables Trust 2016-B Drive Auto Receivables Trust 2016-C Drive Auto Receivables Trust 2017-1 Drive Auto Receivables Trust 2017-2 Drive Auto Receivables Trust 2017-3 Drive Auto Receivables Trust 2017-A Drive Auto Receivables Trust 2017-B Drive Auto Receivables Trust 2018-1 Drive Auto Receivables Trust 2018-2 Drive Auto Receivables Trust 2018-3 United States United States United States United States United States United States United States United States United States United States United States United States United States United States United States 0 0 428 26 0 0 2 0 0 7 1 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 665 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Drive Auto Receivables Trust 2018-4 Drive Auto Receivables Trust 2018-5 Drive Auto Receivables Trust 2019-1 EDT FTPYME Pastor 3 Fondo de Titulización de Activos United States United States United States Spain - - - - b b b b - - - - - Securitisation - Securitisation - Inactive - Securitisation Electrolyser, S.A. de C.V. Mexico 0.00% 75.13% 100.00% 100.00% Services Entidad de Desarrollo a la Pequeña y Micro Empresa Santander Consumo Perú S.A. Peru 55.00% 0.00% 55.00% 55.00% Finance company Erestone S.A.S. Esfera Fidelidade S.A. Evidence Previdência S.A. France Brazil Brazil 0.00% 90.00% 90.00% 90.00% Real estate 0.00% 89.85% 100.00% - Services 0.00% 89.85% 100.00% 100.00% Holding company Million eurosa Capital + reserves Net results Carrying amount 0 0 0 0 0 20 1 2 64 2 9 (116) 24 0 0 0 3 0 0 (17) 1 2 0 0 0 0 0 13 1 2 42 2 4 Finance Professional Services, S.A.S. Financeira El Corte Inglés, Portugal, S.F.C., S.A. Financiera El Corte Inglés, E.F.C., S.A. France 0.00% 100.00% 100.00% 100.00% Services Portugal 0.00% 51.00% 100.00% 100.00% Finance company Spain 0.00% 51.00% 51.00% 51.00% Finance 214 66 140 company Finsantusa, S.L. Unipersonal Spain 0.00% 100.00% 100.00% 100.00% Holding 3,785 (9) 1,020 0.00% 100.00% 100.00% 100.00% Leasing company 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Advisory services 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Finance 0.00% 100.00% 100.00% - - - - - - - - b b b b b b b b - - - - - - - - company - Investment fund - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation 0 0 0 0 0 0 5 27 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 4 0 0 0 0 0 0 0 0 0 First National Motor Business Limited First National Motor Contracts Limited First National Motor Facilities Limited First National Motor Finance Limited First National Motor Leasing Limited First National Motor plc First National Tricity Finance Limited Fondo de Inversión Privado Renta Terrenos I j Fondo de Titulización de Activos PYMES Santander 9 Fondo de Titulización de Activos RMBS Santander 1 Fondo de Titulización de Activos RMBS Santander 2 Fondo de Titulización de Activos RMBS Santander 3 Fondo de Titulización de Activos Santander 2 Fondo de Titulización de Activos Santander Consumer Spain Auto 2014-1 United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom Chile Spain Spain Spain Spain Spain Spain Fondo de Titulización de Activos Santander Empresas 1 Spain Fondo de Titulización de Activos Santander Empresas 2 Spain 666 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Fondo de Titulización de Activos Santander Empresas 3 Spain Spain Spain Spain Spain Spain Spain Spain Spain Spain Spain Spain Fondo de Titulización de Activos Santander Hipotecario 7 Fondo de Titulización de Activos Santander Hipotecario 8 Fondo de Titulización de Activos Santander Hipotecario 9 Fondo de Titulización PYMES Santander 13 Fondo de Titulización PYMES Santander 14 Fondo de Titulización RMBS Santander 4 Fondo de Titulización RMBS Santander 5 Fondo de Titulización Santander Consumer Spain Auto 2016-1 Fondo de Titulización Santander Consumer Spain Auto 2016-2 Fondo de Titulización Santander Consumo 2 Fondo de Titulización Santander Financiación 1 Fondos Santander, S.A. Administradora de Fondos de Inversión (en liquidación) j - - - - - - - - - - - - b b b b b b b b b b b b - - - - - - - - - - - - - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation Uruguay 0.00% 100.00% 100.00% 100.00% Fund management company Fortensky Trading, Ltd. Ireland 0.00% 100.00% 100.00% 100.00% Finance Fosse (Master Issuer) Holdings Limited United Kingdom - b - - Securitisation company Fosse Funding (No.1) Limited United 0.00% 100.00% 100.00% 100.00% Securitisation Fosse Master Issuer PLC Fosse PECOH Limited Fosse Trustee (UK) Limited FTPYME Banesto 2, Fondo de Titulización de Activos FTPYME Santander 2 Fondo de Titulización de Activos Fundo de Investimentos em Direitos Creditórios Multisegmentos NPL Ipanema V – Não padronizado s Fundo de Investimentos em Direitos Creditórios Multisegmentos NPL Ipanema VI – Não padronizado s Gamma, Sociedade Financeira de Titularização de Créditos, S.A. Kingdom United Kingdom United Kingdom United Kingdom Spain Spain Brazil Brazil 0.00% 100.00% 100.00% 100.00% Securitisation - b - - Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation - - - - b b b b - - - - - Securitisation - Securitisation - - Investment fund Investment fund Portugal 0.00% 99.86% 100.00% 100.00% Securitisation GC FTPYME Pastor 4 Fondo de Titulización de Activos Spain - b - - Securitisation 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 (5) (2) 0 0 0 0 0 18 7 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 (1) 4 0 0 0 0 0 3 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 8 0 667 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million eurosa Capital + reserves Net results Carrying amount Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Location Mexico Direct Indirect Year 2018 Year 2017 Activity 0.00% 100.00% 100.00% 100.00% Services Chile 0.00% 100.00% 100.00% 100.00% Internet Company Gesban México Servicios Administrativos Globales, S.A. de C.V. Gesban Santander Servicios Profesionales Contables Limitada Gesban Servicios Administrativos Globales, S.L. Spain Gesban UK Limited United Kingdom 99.99% 0.01% 100.00% 100.00% Services 0.00% 100.00% 100.00% 100.00% Payments and collections services Spain 0.00% 100.00% 100.00% 100.00% Electricity production Peru 0.00% 100.00% 100.00% 100.00% Holding company Spain 96.34% 0.00% 96.34% 96.34% Securities and real estate management 35.00% 65.00% 100.00% 100.00% Real estate 1 0 4 1 1 0 5 3 0.00% 79.52% 88.50% 88.50% Payment services 379 0.00% 100.00% 100.00% - Inactive - - - - - b b b b b - - - - - - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation 0.00% 100.00% 100.00% 100.00% Holding company 0 0 0 0 0 0 1 0 0 0 0 0 0 0 0 1 0 0 0 12 16 1 109 5 388 0 0 0 0 0 0 0 0 0 0 0 0 0 0 99.11% 0.89% 100.00% 100.00% Holding 2,669 269 2,817 Mexico 100.00% 0.00% 100.00% company - Holding company 3,902 335 4,001 United States United States Spain Portugal Ireland Portugal Ireland Portugal Spain 0.00% 56.88% 56.88% 81.90% Holding company 0.00% 56.88% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Automotive - - - - - b b b b b - - - - - - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation 0.00% 100.00% 100.00% 100.00% Renting 32 32 2 (48) 1 (39) (4) 0 1 110 65 (1) (1) 0 2 (5) (2) (3) 0 0 (9) (6) 29 17 2 0 0 0 0 0 1 511 719 Holbah II Limited Bahamas 0.00% 100.00% 100.00% 100.00% Holding company Holbah Santander, S.L. Unipersonal Spain 0.00% 100.00% 100.00% 100.00% Holding company 668 Spain Brazil Spain Italy Italy Italy Italy Italy Spain Spain Gestión de Instalaciones Fotovoltaicas, S.L. Unipersonal Gestora de Procesos S.A. en liquidación j Gestora Patrimonial Calle Francisco Sancha 12, S.L. Gestora Popular, S.A. Getnet Adquirência e Serviços para Meios de Pagamento S.A. Global Galantis, S.A. Golden Bar (Securitisation) S.r.l. Golden Bar Stand Alone 2014-1 Golden Bar Stand Alone 2015-1 Golden Bar Stand Alone 2016-1 Golden Bar Stand Alone 2018-1 Green Energy Holding Company, S.L. Grupo Empresarial Santander, S.L. Grupo Financiero Santander México, S.A. de C.V. GTS El Centro Equity Holdings, LLC c GTS El Centro Project Holdings, LLC c Guaranty Car, S.A. Unipersonal Hipototta No. 4 FTC Hipototta No. 4 plc Hipototta No. 5 FTC Hipototta No. 5 plc Hipototta No.13 Hispamer Renting, S.A. Unipersonal 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 Company Holmes Funding Limited Holmes Holdings Limited Holmes Master Issuer plc Holmes Trustees Limited Holneth B.V. HQ Mobile Limited g Ibérica de Compras Corporativas, S.L. Location United Kingdom United Kingdom United Kingdom United Kingdom The Netherlands United Kingdom Spain Independence Community Bank Corp. Ingeniería de Software Bancario HUB Chile Limitada Inmo Francia 2, S.A. Inmobiliaria Viagracia, S.A. Insurance Funding Solutions Limited Integry Tecnologia e Serviços A H U Ltda. United States Chile Spain Spain United Kingdom Brazil % of ownership held by the Bank % of voting powerk Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount 0.00% 100.00% 100.00% 100.00% Securitisation (41) - b - - Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation 0 3 0 0.00% 100.00% 100.00% 100.00% Holding 401 3,710 66 3,775 0.00% 100.00% 100.00% company - Internet technology 97.17% 2.83% 100.00% 100.00% E-commerce 0.00% 100.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% It services 100.00% 0.00% 100.00% 100.00% Real estate 100.00% 0.00% 100.00% 100.00% Real estate 0.00% 100.00% 100.00% 0.00% 79.52% 100.00% 100.00% Finance company 100.00% Technology services 100.00% Holding company Interfnance Holanda B.V. The Netherlands 100.00% 0.00% 100.00% Intermediacion y Servicios Tecnológicos, S.A. Inversiones Capital Global, S.A. Unipersonal Inversiones Inmobiliarias Alprosa, S.L. Inversiones Inmobiliarias Cedaceros, S.A. Inversiones Inmobiliarias Gercebio, S.A. Inversiones Inmobiliarias Inagua, S.A. i Inversiones Inverjota, SICAV, S.A., en liquidación j i Inversiones Marítimas del Mediterráneo, S.A. Investigaciones Pedreña, A.I.E. Spain 99.50% 0.50% 100.00% 100.00% Services Spain 100.00% 0.00% 100.00% 100.00% Holding company Spain 94.33% 5.67% 100.00% 100.00% Real estate Spain 99.50% 0.50% 100.00% 100.00% Real estate Spain 97.80% 2.20% 100.00% 100.00% Real estate Spain Spain 0.00% 0.00% 0.00% 100.00% Real estate 0.00% 0.00% 0.00% - Investment company Spain 100.00% 0.00% 100.00% 100.00% Inactive Spain 99.00% 1.00% 100.00% - Research and development Isban México, S.A. de C.V. Mexico 0.00% 75.13% 100.00% 100.00% It services Isla de los Buques, S.A. Spain 99.98% 0.02% 100.00% 100.00% Finance company Spain 76.79% 19.55% 96.35% 96.35% Chemistry La Unión Resinera Española, S.A., en liquidación j Langton Funding (No.1) Limited Langton Mortgages Trustee (UK) Limited Langton PECOH Limited Langton Securities (2008-1) plc United Kingdom United Kingdom United Kingdom United Kingdom 0.00% 100.00% 100.00% 100.00% Securitisation (20) (43) 0.00% 100.00% 100.00% 100.00% Securitisation - b - - Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation 0 0 0 0 0 1 3 0 (5) 0 4 0 (2) 0 0 0 0 316 10 6 1 0 7 0 0 0 1 20 54 63 0 13 0 2 (10) 365 (1) 393 0 0 - - (2) 0 4 0 0 0 0 - - 4 0 30 1 0 0 0 0 0 669 2 7 26 54 85 0 16 0 2 328 415 (29) (11) - - 15 0 36 1 0 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Langton Securities (2010-1) PLC Langton Securities (2010-2) PLC Langton Securities Holdings Limited Location United Kingdom United Kingdom United Kingdom Direct Indirect Year 2018 Year 2017 Activity 0.00% 100.00% 100.00% 100.00% Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation - b - - Securitisation Laparanza, S.A. Spain 61.59% 0.00% 61.59% 61.59% Agricultural Liquidity Limited Luri 1, S.A. m Luri 4, S.A. Unipersonal, en liquidación j i United Kingdom Spain Spain 0.00% 100.00% 100.00% 100.00% Factoring holding 36.00% 0.00% 0.00% 0.00% 36.00% 31.00% Real estate 0.00% 100.00% Real estate Million eurosa Capital + reserves Net results Carrying amount 0 0 0 28 1 15 - 1 0 0 0 0 (3) - 0 0 0 16 0 5 - Luri 6, S.A. Unipersonal Spain 100.00% 0.00% 100.00% 100.00% Real estate investment 1,315 10 1,405 MAC No. 1 Limited Manberor, S.A. Master Red Europa, S.L. Mata Alta, S.L. Merciver, S.L. United Kingdom Spain Spain Spain Spain - b - - Mortgage credit 0 company 97.80% 2.20% 100.00% 100.00% Real estate (90) 96.34% 0.00% 96.34% 96.34% Cards 0.00% 61.59% 100.00% 100.00% Real estate 99.90% 0.10% 100.00% 100.00% Financial advisory 0 0 0 0 0 3 0 (1) 0 0 0 0 0 0 (2) 0 3 1 2 0 0 0 0 (1) 9 0 0 1 0 1 0 0 0 0 0 0 0 0 0 0 0 49 21 17 3 4 1 0 93 274 1 0 1 33 0 0 0 0 0 0 0 0 0 0 16 22 20 3 4 1 1 94 336 Merlion Aviation One Designated Activity Company Ireland 51.00% 0.00% 51.00% 51.00% Renting Moneybit, S.L. Spain 100.00% 0.00% 100.00% 100.00% Services Mortgage Engine Limited United Kingdom 0.00% 100.00% 100.00% 100.00% Financial services Motor 2015-1 Holdings Limited United - b - - Securitisation Motor 2015-1 PLC Motor 2016-1 Holdings Limited Motor 2016-1 PLC Motor 2016-1M Ltd j Kingdom United Kingdom United Kingdom United Kingdom United Kingdom Motor 2017-1 Holdings Limited United Motor 2017-1 PLC Kingdom United Kingdom 0.00% 100.00% 100.00% 100.00% Securitisation - b - - Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation - - b b - - - Securitisation - Securitisation 0.00% 100.00% 100.00% 100.00% Securitisation Naviera Mirambel, S.L. Spain 0.00% 100.00% 100.00% 100.00% Finance company Naviera Trans Gas, A.I.E. Naviera Trans Iron, S.L. Naviera Trans Ore, A.I.E. Naviera Trans Wind, S.L. Spain Spain Spain Spain 99.99% 0.01% 100.00% 100.00% Renting 100.00% 0.00% 100.00% 100.00% Leasing 99.99% 99.99% 0.01% 100.00% 100.00% Renting 0.01% 100.00% 100.00% Renting Naviera Transcantábrica, S.L. Spain 100.00% 0.00% 100.00% 100.00% Leasing Naviera Transchem, S.L. Unipersonal Newcomar, S.L., en liquidación j Spain 100.00% 0.00% 100.00% 100.00% Leasing Spain 40.00% 40.00% 80.00% 80.00% Real estate Norbest AS Norway 7.94% 92.06% 100.00% 100.00% Securities Novimovest – Fundo de Investimento Imobiliário Portugal 0.00% 79.65% 79.76% 79.51% investment Investment fund 670 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company NW Services CO. Olé Tecnologia Ltda. Open Bank, S.A. Open Digital Market, S.L. Open Digital Services, S.L. Operadora de Carteras Gamma, S.A.P.I. de C.V. Optimal Investment Services SA Location Direct Indirect Year 2018 Year 2017 Activity United States Brazil Spain Spain Spain 0.00% 100.00% 100.00% 100.00% E-commerce 0.00% 53.91% 100.00% 100.00% It services 100.00% 0.00% 100.00% 100.00% Banking 0.00% 100.00% 100.00% - Services 99.97% 0.03% 100.00% 100.00% Services Mexico 100.00% 0.00% 100.00% 100.00% Holding company Switzerland 100.00% 0.00% 100.00% 100.00% Fund management company 0.00% 54.18% 51.25% 51.25% Fund Optimal Multiadvisors Ireland Ireland Plc / Optimal Strategic US Equity Ireland Euro Fund i Optimal Multiadvisors Ireland Ireland Plc / Optimal Strategic US Equity Ireland US Dollar Fund i 0.00% 44.08% 51.57% Optimal Multiadvisors Ltd / Optimal Strategic US Equity Series (consolidado) i Bahamas 0.00% 55.86% 56.34% Parasant SA Switzerland 100.00% 0.00% 100.00% management company 51.62% Fund management company 56.10% Fund management company 100.00% Holding company Million eurosa Capital + reserves Net results Carrying amount 4 0 206 0 38 7 24 4 5 45 0 1 5 0 (58) 0 (1) 0 0 1 2 0 210 0 0 22 23 0 0 0 1,097 (89) 904 Pastor Vida, S.A. de Seguros y Reaseguros i PBD Germany Auto 2018 UG (haftungsbeschränkt) PBE Companies, LLC PECOH Limited United States United Kingdom Spain 0.00% 0.00% 0.00% 100.00% Insurance Germany - b - - Securitisation - 0 0.00% 100.00% 100.00% 100.00% Real estate 109 0.00% 100.00% 100.00% 100.00% Securitisation Pereda Gestión, S.A. Spain 99.99% 0.01% 100.00% 100.00% Holding company Phoenix C1 Aviation Designated Activity Company Ireland 51.00% 0.00% 51.00% 51.00% Renting Pingham International, S.A. Uruguay 0.00% 100.00% 100.00% 100.00% Services Popular Bolsa S.V., S.A. Spain 100.00% 0.00% 100.00% Popular Capital, S.A. Spain 90.00% 10.00% 100.00% 100.00% Securities company 100.00% Finance company Popular de Participaciones Financieras, S.A. i Spain 0.00% 0.00% 0.00% 100.00% Venture capital Popular de Renting, S.A. i Spain 0.00% 0.00% 0.00% 100.00% Renting Popular Gestão de Activos, S.A. Popular Gestión Privada S.G.I.I.C., S.A. Portugal 100.00% 0.00% 100.00% Spain 0.00% 100.00% 100.00% 100.00% Management of funds and portfolios 100.00% Management of funds and portfolios Popular Operaciones, S.A. Spain 100.00% 0.00% 100.00% 100.00% Finance company Popular Seguros - Companhia Portugal de Seguros S.A. 0.00% 99.90% 100.00% 84.07% Insurance Portal Universia Argentina S.A. Portal Universia Portugal, Prestação de Serviços de Informática, S.A. Argentina 0.00% 75.75% 75.75% 75.75% Internet Portugal 0.00% 100.00% 100.00% 100.00% Internet Premier Credit S.A.S. Colombia 0.00% 100.00% 100.00% 100.00% Financial advisory 0 51 3 0 6 (2) - - 1 7 0 9 0 0 1 - 0 1 0 (9) 2 0 1 0 - - 0 1 0 0 0 (1) 0 - 0 110 0 4 0 0 6 0 - - 1 7 0 7 0 0 1 671 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Prime 16 – Fundo de Investimentos Imobiliário Brazil 0.00% 89.85% 100.00% 100.00% Investment fund Primestar Servicing, S.A. Portugal 20.00% 79.89% 100.00% 80.00% Real estate Produban Brasil Tecnologia Ltda. Brazil 0.00% 100.00% 100.00% - Technology services PSA Bank Deutschland GmbH Germany 0.00% 50.00% 50.00% 50.00% Banking PSA Banque France PSA Consumer Finance Polska Sp. z o.o. France Poland 0.00% 50.00% 50.00% 50.00% Banking 0.00% 40.24% 100.00% 100.00% Finance company PSA Finance Belux S.A. Belgium 0.00% 50.00% 50.00% 50.00% Finance company PSA Finance Polska Sp. z o.o. Poland 0.00% 40.24% 50.00% 50.00% Finance company PSA Finance Suisse, S.A. Switzerland 0.00% 50.00% 100.00% 100.00% Leasing PSA Finance UK Limited PSA Financial Services Nederland B.V. PSA Financial Services Spain, E.F.C., S.A. United Kingdom The Netherlands 0.00% 50.00% 50.00% 50.00% Finance company 0.00% 50.00% 50.00% 50.00% Finance company Spain 0.00% 50.00% 50.00% 50.00% Finance company PSA Renting Italia S.p.A. Italy 0.00% 50.00% 100.00% - Renting PSRT 2018-A Punta Lima, LLC Recovery Team, S.L. Unipersonal Retop S.A. f United States United States Spain - b - - Securitisation 0.00% 100.00% 100.00% 100.00% Leasing 100.00% 0.00% 100.00% 100.00% Finance company Uruguay 100.00% 0.00% 100.00% 100.00% Finance company Return Capital Serviços de Recuperação de Créditos S.A. Brazil 0.00% 62.90% 70.00% 70.00% Collection services Return Gestão de Recursos S.A. Riobank International (Uruguay) SAIFE j Roc Aviation One Designated Activity Company Roc Shipping One Designated Activity Company Brazil 0.00% 62.90% 100.00% 100.00% Fund management company Uruguay 0.00% 100.00% 100.00% 100.00% Banking Ireland 100.00% 0.00% 100.00% 100.00% Renting Ireland 51.00% 0.00% 51.00% 51.00% Renting Rojo Entretenimento S.A. Brazil 0.00% 85.00% 94.60% 94.60% Services SAM Asset Management, S.A. de C.V., Sociedad Operadora de Fondos de Inversión Mexico 0.00% 100.00% 100.00% 100.00% Fund management company SAM Brasil Participações S.A. Brazil 1.00% 99.00% 100.00% 100.00% Holding company SAM Finance Lux S.à r.l. Luxembourg 0.00% 100.00% 100.00% 100.00% Management SAM Investment Holdings Limited u SAM UK Investment Holdings Limited Sancap Investimentos e Participações S.A. Saninv - Gestão e Investimentos, Sociedade Unipessoal, S.A. Jersey 0.00% 100.00% 100.00% 100.00% Holding company United Kingdom Brazil 0.00% 89.85% 100.00% 100.00% Holding company company Portugal 0.00% 100.00% 100.00% 100.00% Portfolio management Santander (CF Trustee Property Nominee) Limited United Kingdom 0.00% 100.00% 100.00% 100.00% Services 672 Million eurosa Capital + reserves Net results Carrying amount 99 1 3 428 1,093 1 100 30 34 288 60 410 6 0 19 5 11 0 0 0 (2) (1) 28 3 33 4 982 (8) 80 0 1 44 116 0 17 4 7 55 13 55 2 57 (2) 9 21 1 0 0 (1) (1) 1 16 3 0 2 1 219 463 0 42 11 15 123 20 174 3 0 17 11 63 1 0 0 0 0 25 161 38 2 105 1,551 117 0 0 11 0 0 88 0 0 92.38% 7.62% 100.00% 100.00% Holding 1,093 511 1,665 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 Company Santander (CF Trustee) Limited d Location United Kingdom Santander (UK) Group Pension Schemes Trustees Limited d United Kingdom % of ownership held by the Bank % of voting powerk Direct Indirect Year 2018 Year 2017 Activity 0.00% 100.00% 100.00% 100.00% Asset management 0.00% 100.00% 100.00% 100.00% Asset Million eurosa Capital + reserves Net results Carrying amount Santander Agente de Valores Limitada Santander Ahorro Inmobiliario 1, S.A. Santander Ahorro Inmobiliario 2, S.A. Chile 0.00% 67.44% 100.00% Spain 97.95% 0.58% 98.53% Spain 99.13% 0.78% 99.91% management 100.00% Securities company 98.54% Real estate investment 99.91% Real estate investment Santander Asset Finance (December) Limited United Kingdom 0.00% 100.00% 100.00% 100.00% Leasing Santander Asset Finance plc United 0.00% 100.00% 100.00% 100.00% Leasing Kingdom Santander Asset Management - Sociedade Gestora de Fundos de Investimento Mobiliário, S.A. Santander Asset Management Chile S.A. Santander Asset Management Luxembourg, S.A. Santander Asset Management S.A. Administradora General de Fondos Portugal 100.00% 0.00% 100.00% 100.00% Fund management company Chile 0.01% 99.94% 100.00% 100.00% Securities investment Luxembourg 0.00% 100.00% 100.00% 100.00% Fund management company Chile 0.00% 100.00% 100.00% 100.00% Fund management company Santander Asset Management UK Holdings Limited United Kingdom Santander Asset Management UK Limited United Kingdom 0.00% 100.00% 100.00% 100.00% Holding 278 0.00% 100.00% 100.00% company 100.00% Management of funds and portfolios Santander Asset Management, LLC Santander Asset Management, S.A., S.G.I.I.C. Santander Back-Ofces Globales Mayoristas, S.A. Santander Banca de Inversión Colombia, S.A.S. Puerto Rico 0.00% 100.00% 100.00% 100.00% Management Spain 0.00% 100.00% 100.00% 100.00% Fund management company Spain 100.00% 0.00% 100.00% 100.00% Services Colombia 0.00% 100.00% 100.00% 100.00% Financial services 0 0 51 23 23 54 216 27 (6) 4 27 37 3 22 4 1 0 0 13 (1) 0 9 19 1 0 1 0 0 43 21 23 0 162 27 0 0 10 132 14 25 2 55 1 0 186 201 5 167 1 1 Santander BanCorp Puerto Rico 0.00% 100.00% 100.00% 100.00% Holding 927 56 983 company Santander Bank & Trust Ltd. Bahamas 0.00% 100.00% 100.00% 100.00% Banking Santander Bank Polska S.A. Poland 67.47% 0.00% 67.47% 69.34% Banking Santander Bank, National Association Santander Brasil Administradora de Consórcio Ltda. Santander Brasil Asset Management Distribuidora de Títulos e Valores Mobiliários S.A. Santander Brasil Gestão de Recursos Ltda. Santander Brasil Tecnologia S.A. United States Brazil 0.00% 100.00% 100.00% 100.00% Banking 0.00% 89.85% 100.00% 100.00% Services Brazil 0.00% 100.00% 100.00% 100.00% Securities investment Brazil 0.00% 100.00% 100.00% 100.00% Real estate investment Brazil 0.00% 89.85% 100.00% 100.00% It services Santander Brasil, EFC, S.A. Spain 0.00% 89.85% 100.00% 100.00% Finance company Santander Capital Desarrollo, SGEIC, S.A. Unipersonal Spain 100.00% 0.00% 100.00% 100.00% Venture capital 796 5,043 11,364 39 33 465 32 763 11 (5) 504 346 403 4,312 11,708 32 64 2 35 66 (2) 9 (1) 576 27 714 8 673 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Santander Capital Structuring, S.A. de C.V. Location Mexico Direct Indirect Year 2018 Year 2017 Activity 0.00% 100.00% 100.00% 100.00% Trade Santander Capitalização S.A. Brazil 0.00% 89.85% 100.00% 100.00% Insurance Santander Cards Ireland Limited Santander Cards Limited Santander Cards UK Limited Ireland 0.00% 100.00% 100.00% 100.00% Cards United Kingdom United Kingdom 0.00% 100.00% 100.00% 100.00% Cards 0.00% 100.00% 100.00% 100.00% Finance company Million eurosa Capital + reserves Net results Carrying amount 8 46 (8) 93 149 2 29 0 0 (1) 0 65 0 93 106 Santander Chile Holding S.A. Chile 22.11% 77.72% 99.84% 99.84% Holding 1,390 265 1,393 company Santander Consulting (Beijing) Co., Ltd. China 0.00% 100.00% 100.00% 100.00% Advisory Santander Consumer (UK) plc United 0.00% 100.00% 100.00% 100.00% Finance Kingdom company 7 465 (63) (35) 1 4 106 291 (42) 69 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance 16 (31) company 0.00% 69.71% 100.00% 100.00% Finance 323 73 company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 61 20 24 46 50 (14) (18) (29) (17) 30 23 8 0 1 (2) 23 29 8 19 9 11 31 21 10 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 United States United States United States United States United States United States United States United States United States United States United States United States United States United States United States United States Santander Consumer ABS Funding 3 LLC Santander Consumer Auto Receivables Funding 2013-B2 LLC Santander Consumer Auto Receivables Funding 2013-B3 LLC Santander Consumer Auto Receivables Funding 2013-L1 LLC Santander Consumer Auto Receivables Funding 2014-L1 LLC Santander Consumer Auto Receivables Funding 2015-L1 LLC Santander Consumer Auto Receivables Funding 2015-L2 LLC Santander Consumer Auto Receivables Funding 2015-L3 LLC Santander Consumer Auto Receivables Funding 2015-L4 LLC Santander Consumer Auto Receivables Funding 2016-B1 LLC Santander Consumer Auto Receivables Funding 2016-B2 LLC Santander Consumer Auto Receivables Funding 2016-B3 LLC Santander Consumer Auto Receivables Funding 2016-B4 LLC Santander Consumer Auto Receivables Funding 2016-L1 LLC Santander Consumer Auto Receivables Funding 2016-L2 LLC Santander Consumer Auto Receivables Funding 2016-L3 LLC 674 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Santander Consumer Auto Receivables Funding 2016-L4 LLC Santander Consumer Auto Receivables Funding 2017-L1 LLC Santander Consumer Auto Receivables Funding 2017-L2 LLC Santander Consumer Auto Receivables Funding 2017-L3 LLC Santander Consumer Auto Receivables Funding 2017-L4 LLC Santander Consumer Auto Receivables Funding 2018-L1 LLC Santander Consumer Auto Receivables Funding 2018-L2 LLC Santander Consumer Auto Receivables Funding 2018-L3 LLC Santander Consumer Auto Receivables Funding 2018-L4 LLC Santander Consumer Auto Receivables Funding 2018-L5 LLC United States United States United States United States United States United States United States United States United States United States 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 9 8 3 2 0.00% 69.71% 100.00% 100.00% Finance 54 company 0.00% 69.71% 100.00% 100.00% Finance 0.00% 69.71% 100.00% 0.00% 69.71% 100.00% 0.00% 69.71% 100.00% 0.00% 69.71% 100.00% company - Finance company - Finance company - Finance company - Finance company Santander Consumer Bank Belgium 0.00% 100.00% 100.00% 100.00% Banking Santander Consumer Bank AG Germany 0.00% 100.00% 100.00% 100.00% Banking Santander Consumer Bank AS Norway 0.00% 100.00% 100.00% 100.00% Finance company Santander Consumer Bank GmbH Santander Consumer Bank S.A. Santander Consumer Bank S.p.A. Santander Consumer Banque S.A. Santander Consumer Chile S.A. Austria 0.00% 100.00% 100.00% 100.00% Banking Poland 0.00% 80.48% 100.00% 100.00% Banking Italy 0.00% 100.00% 100.00% 100.00% Banking France 0.00% 100.00% 100.00% 100.00% Banking Chile 51.00% 0.00% 51.00% 51.00% Finance company Santander Consumer Credit Services Limited Santander Consumer Finance Benelux B.V. United Kingdom The Netherlands Santander Consumer Finance Global Services, S.L. Spain 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Technology services Finland 0.00% 100.00% 100.00% 100.00% Finance company 0 0 0 0 0 1,166 3,063 1,910 334 637 737 491 59 (35) 126 5 205 10 11 8 12 11 71 19 28 24 19 0 0 0 0 0 0 0 0 0 0 28 463 262 1,170 4,820 1,996 43 363 130 506 79 26 14 0 24 0 55 603 490 15 0 190 5 130 Santander Consumer Finance Oy Santander Consumer Finance, S.A. Santander Consumer Finanse Sp. z o.o. Santander Consumer Holding Austria GmbH Santander Consumer Holding GmbH Spain 75.00% 25.00% 100.00% 100.00% Banking 10,154 560 7,327 Poland 0.00% 80.48% 100.00% 100.00% Services Austria 0.00% 100.00% 100.00% 100.00% Holding company 15 364 0 21 13 518 Germany 0.00% 100.00% 100.00% 100.00% Holding 4,784 284 5,827 company 675 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Santander Consumer International Puerto Rico LLC Santander Consumer Leasing GmbH Santander Consumer Mediación Operador de Banca-Seguros Vinculado, S.L. Santander Consumer Multirent Sp. z o.o. Santander Consumer Operations Services GmbH Santander Consumer Receivables 10 LLC Santander Consumer Receivables 11 LLC Santander Consumer Receivables 3 LLC Santander Consumer Receivables 7 LLC Santander Consumer Receivables Funding LLC Santander Consumer Renting, S.L. Santander Consumer Services GmbH Santander Consumer Services, S.A. Santander Consumer Technology Services GmbH Puerto Rico 0.00% 69.71% 100.00% 100.00% Services Germany 0.00% 100.00% 100.00% 100.00% Leasing Spain 0.00% 94.61% 100.00% 100.00% Insurance intermediary Poland 0.00% 80.48% 100.00% 100.00% Leasing Germany 0.00% 100.00% 100.00% 100.00% Services United States United States United States United States United States Spain 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 69.71% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Leasing Austria 0.00% 100.00% 100.00% 100.00% Services Portugal 0.00% 100.00% 100.00% 100.00% Finance company Germany 0.00% 100.00% 100.00% 100.00% It services Million eurosa Capital + reserves Net results Carrying amount 6 20 1 23 9 712 233 213 301 0 36 0 6 12 2 40 0 2 0 27 (2) 60 68 0 1 0 2 2 5 101 0 5 18 0 0 0 0 0 39 0 5 24 Santander Consumer USA Holdings Inc. United States Santander Consumer USA Inc. United States 0.00% 69.71% 69.71% 68.12% Holding 5,330 800 4,805 company 0.00% 69.71% 100.00% 100.00% Finance 4,860 (85) 3,329 company Spain 0.00% 100.00% 100.00% 100.00% Finance company Mexico 0.00% 75.13% 100.00% 100.00% Cards Chile Chile 0.00% 67.20% 100.00% 100.00% Insurance brokerage 0.00% 83.23% 100.00% Brazil 0.00% 89.85% 100.00% 100.00% Securities company 100.00% Securities company 488 597 84 54 127 90 505 155 566 2 2 58 46 15 120 Brazil 0.00% 89.85% 100.00% 100.00% Holding 497 82 518 company Spain 81.00% 19.00% 100.00% 100.00% Fund management company United States United States United States United States 0.00% 69.71% 100.00% 100.00% Finance - - - b b b - - - company - Securitisation - Securitisation - Securitisation 5 1 71 50 66 2 0 20 16 25 2 0 0 0 0 Santander Consumer, EFC, S.A. Santander Consumo, S.A. de C.V., S.O.F.O.M., E.R., Grupo Financiero Santander México Santander Corredora de Seguros Limitada Santander Corredores de Bolsa Limitada Santander Corretora de Câmbio e Valores Mobiliários S.A. Santander Corretora de Seguros, Investimentos e Serviços S.A. Santander de Titulización S.G.F.T., S.A. Santander Drive Auto Receivables LLC Santander Drive Auto Receivables Trust 2014-4 Santander Drive Auto Receivables Trust 2014-5 Santander Drive Auto Receivables Trust 2015-1 676 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Santander Drive Auto Receivables Trust 2015-2 Santander Drive Auto Receivables Trust 2015-3 Santander Drive Auto Receivables Trust 2015-4 Santander Drive Auto Receivables Trust 2015-5 Santander Drive Auto Receivables Trust 2016-1 Santander Drive Auto Receivables Trust 2016-2 Santander Drive Auto Receivables Trust 2016-3 Santander Drive Auto Receivables Trust 2017-1 Santander Drive Auto Receivables Trust 2017-2 Santander Drive Auto Receivables Trust 2017-3 Santander Drive Auto Receivables Trust 2018-1 Santander Drive Auto Receivables Trust 2018-2 Santander Drive Auto Receivables Trust 2018-3 Santander Drive Auto Receivables Trust 2018-4 Santander Drive Auto Receivables Trust 2018-5 Santander Energías Renovables I, S.C.R., S.A. United States United States United States United States United States United States United States United States United States United States United States United States United States United States United States Spain - - - - - - - - - - - - - - - b b b b b b b b b b b b b b b - - - - - - - - - - - - - - - - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation 59.66% 0.00% 59.66% 59.66% Venture capital Santander Equity Investments Limited United Kingdom 0.00% 100.00% 100.00% Spain 100.00% 0.00% 100.00% 100.00% Finance company 100.00% Payment services Santander España Merchant Services, Entidad de Pago, S.L. Unipersonal Santander Estates Limited Santander F24 S.A. United Kingdom Poland 0.00% 100.00% 100.00% 100.00% Real estate 0.00% 67.47% 100.00% 100.00% Finance company Santander Factoring S.A. Chile 0.00% 99.84% 100.00% 100.00% Factoring Santander Factoring Sp. z o.o. Poland 0.00% 67.47% 100.00% 100.00% Financial services Santander Factoring y Confrming, S.A., E.F.C. Spain 100.00% 0.00% 100.00% 100.00% Factoring Santander FI Hedge Strategies Ireland 0.00% 89.85% 100.00% 100.00% Investment company Santander Finance 2012-1 LLC United States 0.00% 100.00% 100.00% Santander Financial Exchanges Limited Santander Financial Services, Inc. United Kingdom 100.00% 0.00% 100.00% Puerto Rico 0.00% 100.00% 100.00% Santander Finanse Sp. z o.o. Poland 0.00% 67.47% 100.00% Santander Fintech Limited United Kingdom 100.00% 0.00% 100.00% 100.00% Financial services 100.00% Finance company 100.00% Finance company 100.00% Financial services 100.00% Finance company 53 35 24 26 (2) (9) (29) (52) (74) (86) 0 0 0 0 0 11 43 204 4 0 42 14 220 473 2 0 166 49 84 24 22 28 25 30 43 59 55 69 71 (41) (58) (69) (66) (88) 0 6 4 0 0 1 4 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 6 45 180 0 0 43 1 96 126 (197) 247 0 0 (4) 8 68 2 0 162 20 87 677 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Spain 0.00% 100.00% 100.00% 100.00% Fund 5 (2) 3 Santander Fund Administration, S.A. Unipersonal Santander Fundo de Investimento Amazonas Multimercado Crédito Privado Investimento no Exterior o Santander Fundo de Investimento Diamantina Multimercado Crédito Privado Investimento no Exterior g Santander Fundo de Investimento Financial Curto Prazo e Santander Fundo de Investimento Guarujá Multimercado Crédito Privado Investimento no Exterior d Santander Fundo de Investimento SBAC Referenciado di Crédito Privado h Santander Fundo de Investimento Unix Multimercado Crédito Privado o Santander GBM Secured Financing Designated Activity Company i Santander Gestión de Recaudación y Cobranzas Ltda. Brazil 0.00% 89.85% 100.00% 100.00% Brazil 0.00% 89.85% 100.00% 100.00% Brazil 0.00% 89.85% 100.00% 100.00% Brazil 0.00% 89.85% 100.00% 100.00% Brazil 0.00% 85.75% 100.00% 100.00% Brazil 0.00% 89.85% 100.00% 100.00% management company Investment fund Investment fund Investment fund Investment fund Investment fund Investment fund Ireland 0.00% 0.00% 0.00% - Securitisation Chile 0.00% 99.84% 100.00% 100.00% Financial services Santander Global Consumer Finance Limited United Kingdom 0.00% 100.00% 100.00% 100.00% Finance company Santander Global Facilities, S.A. de C.V. Santander Global Facilities, S.L. Santander Global Operations, S.A. Santander Global Property, S.L. Santander Global Services, S.A. j Mexico 100.00% 0.00% 100.00% 100.00% Real estate management Spain 100.00% 0.00% 100.00% 100.00% Real estate Spain 100.00% 0.00% 100.00% 100.00% Services Spain 97.34% 2.66% 100.00% 100.00% Securities investment Uruguay 0.00% 100.00% 100.00% 100.00% Services Santander Global Sport, S.A. Spain 100.00% 0.00% 100.00% 100.00% Sports activity Spain 100.00% 0.00% 100.00% - It services United Kingdom Brazil Spain Spain Spain 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 89.85% 100.00% - - - b b b - - - - Investment fund - Securitisation - Securitisation - Securitisation Santander Global Technology, S.L. Santander Guarantee Company Santander Hermes Multimercado Crédito Privado Infraestructura Fundo de Investimento t Santander Hipotecario 1 Fondo de Titulización de Activos Santander Hipotecario 2 Fondo de Titulización de Activos Santander Hipotecario 3 Fondo de Titulización de Activos 678 123 17 141 406 23 392 1,124 155 0 69 18 104 712 33 694 77 - 5 6 95 268 34 258 0 24 391 4 - 0 0 0 7 - 1 1 2 79 - 5 6 96 (25) 250 29 (5) 0 (6) 83 0 - 0 0 0 24 255 0 19 346 3 - 0 0 0 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Santander Holding Imobiliária S.A. Santander Holding Internacional, S.A. Brazil 0.00% 89.85% 100.00% 100.00% Real estate 5 (1) 4 Spain 99.95% 0.05% 100.00% 100.00% Holding 3,651 1 2,463 company Santander Holdings USA, Inc. United States 100.00% 0.00% 100.00% 100.00% Holding 17,842 618 12,392 company Santander Inclusión Financiera, S.A. de C.V., S.O.F.O.M., E.R., Grupo Financiero Santander México Santander Insurance Agency, Inc. Santander Insurance Agency, U.S., LLC Santander Insurance Services UK Limited Santander Intermediación Correduría de Seguros, S.A. Santander International Limited Santander International Products, Plc. u Mexico 0.00% 75.13% 100.00% 100.00% Finance 12 (5) Puerto Rico 0.00% 100.00% 100.00% 100.00% company Insurance brokerage United States United Kingdom 0.00% 100.00% 100.00% 100.00% Insurance 100.00% 0.00% 100.00% 100.00% Asset Spain 100.00% 0.00% 100.00% 100.00% management Insurance brokerage Jersey 0.00% 100.00% 100.00% - Finance company Ireland 99.99% 0.01% 100.00% 100.00% Finance company 7 1 39 19 0 1 1 0 1 1 0 0 5 8 1 40 18 0 0 Santander Inversiones S.A. Chile 0.00% 100.00% 100.00% 100.00% Holding 1,448 204 1,032 Santander Investment Bank Limited Santander Investment Chile Limitada Bahamas 0.00% 100.00% 100.00% 100.00% Banking company Chile 0.00% 100.00% 100.00% Santander Investment I, S.A. Spain 100.00% 0.00% 100.00% 100.00% Finance company 100.00% Holding company Santander Investment Limited Bahamas 0.00% 100.00% 100.00% 100.00% Inactive Santander Investment Securities Inc. United States 0.00% 100.00% 100.00% 100.00% Securities company Santander Investment, S.A. Spain 100.00% 0.00% 100.00% 100.00% Banking Santander Inwestycje Sp. z o.o. Santander ISA Managers Limited Poland 0.00% 67.47% 100.00% United Kingdom 0.00% 100.00% 100.00% 100.00% Securities company 100.00% Management of funds and portfolios Santander Lease, S.A., E.F.C. Spain 70.00% 30.00% 100.00% 100.00% Leasing Ireland - b - - Securitisation Santander Leasing Poland Securitization 01 Designated Activity Company Santander Leasing S.A. Santander Leasing S.A. Arrendamento Mercantil Santander Leasing, LLC Santander Lending Limited Santander Mediación Operador de Banca- Seguros Vinculado, S.A. Poland Brazil United States United Kingdom 0.00% 67.47% 100.00% 100.00% Leasing 0.00% 89.85% 99.99% 99.99% Leasing 0.00% 100.00% 100.00% 100.00% Leasing 0.00% 100.00% 100.00% 100.00% Mortgage credit 221 Spain 96.70% 3.30% 100.00% 100.00% company Insurance intermediary Santander Merchant S.A. Argentina 0.00% 100.00% 100.00% 100.00% Finance Santander Mortgage Holdings Limited United Kingdom 0.00% 100.00% 100.00% company - Financial services Santander Operaciones España, S.L. Spain 100.00% 0.00% 100.00% 100.00% Services 954 543 219 0 402 191 9 14 90 0 130 1,305 13 5 0 0 18 (8) 899 16 0 0 14 0 0 8 14 0 4 73 (7) 5 5 0 0 0 321 27 0 416 186 7 6 35 0 30 1,163 7 225 2 2 0 18 679 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Santander Paraty Qif PLC Ireland 0.00% 89.85% 100.00% 100.00% Investment fund Santander Pensiones, S.A., E.G.F.P. Santander Pensões - Sociedade Gestora de Fundos de Pensões, S.A. Spain 0.00% 100.00% 100.00% Portugal 100.00% 0.00% 100.00% Santander Prime Auto Issuance Notes 2018-A Designated Activity Company Ireland Santander Prime Auto Issuance Notes 2018-B Designated Activity Company Ireland Santander Prime Auto Issuance Notes 2018-C Designated Activity Company Ireland Santander Prime Auto Issuance Notes 2018-D Designated Activity Company Ireland Santander Prime Auto Issuance Notes 2018-E Designated Activity Company Ireland - - - - - b b b b b - - - - - 100.00% Pension fund management company 100.00% Pension fund management company - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation Santander Private Banking Gestión, S.A., S.G.I.I.C. Santander Private Banking s.p.a. in Liquidazione j Spain 100.00% 0.00% 100.00% 100.00% Fund management company Italy 100.00% 0.00% 100.00% 100.00% Finance company Santander Private Banking UK Limited United Kingdom Santander Private Real Estate Advisory & Management, S.A. Spain 0.00% 100.00% 100.00% 100.00% Real estate 99.99% 0.01% 100.00% 100.00% Real estate Santander Private Real Estate Advisory, S.A. Santander Real Estate, S.G.I.I.C., S.A. Santander Retail Auto Lease Funding LLC Santander Retail Auto Lease Trust 2017-A Santander Retail Auto Lease Trust 2018-A Santander Río Asset Management Gerente de Fondos Comunes de Inversión S.A. Spain 100.00% 0.00% 100.00% 100.00% Real estate Spain 100.00% 0.00% 100.00% 100.00% Fund management company United States United States United States 0.00% 69.71% 100.00% 100.00% Securitisation - - b b - - - Securitisation - Securitisation Argentina 0.00% 100.00% 100.00% 100.00% Fund management company 100.00% Advisory services Santander Río Servicios S.A. Argentina 0.00% 99.97% 100.00% Santander Río Trust S.A. Argentina 0.00% 99.97% 100.00% 100.00% Services Santander Río Valores S.A. Argentina 0.00% 99.34% 100.00% 100.00% Securities company Santander S.A. Sociedad Securitizadora Santander Secretariat Services Limited Santander Securities LLC United Kingdom United States Chile 0.00% 67.24% 100.00% 100.00% Fund management company 0.00% 100.00% 100.00% 100.00% Holding 0.00% 100.00% 100.00% Santander Securities S.A. Poland 0.00% 67.47% 100.00% 680 Million eurosa Capital + reserves Net results Carrying amount 473 (197) 248 14 19 118 4 0 0 0 0 0 52 39 285 5 11 118 0 55 0 1 0 0 3 1 0 0 29 17 4 7 2 9 (6) 1 0 1 0 0 16 59 3 0 0 1 0 0 4 0 0 0 0 0 35 33 389 4 12 118 0 0 0 3 0 0 4 1 0 company 100.00% Securities company - Securities company 136 10 (110) 0 26 3 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Santander Securities Services Brasil Distribuidora de Títulos e Valores Mobiliários S.A. Brazil 0.00% 100.00% 100.00% 100.00% Securities 207 19 213 investment Santander Securities Services Brasil Participações S.A. Brazil 0.00% 100.00% 100.00% 100.00% Holding company Colombia 0.00% 100.00% 100.00% 100.00% Finance company 223 10 21 (1) 272 11 Santander Securities Services Colombia S.A. Sociedad Fiduciaria Santander Securities Services, S.A. Unipersonal Santander Seguros y Reaseguros, Compañía Aseguradora, S.A. Santander Servicios Corporativos, S.A. de C.V. Santander Servicios Especializados, S.A. de C.V. Santander Speedboats Holding Company, S.L. Santander Technology USA, LLC Santander Tecnología Argentina S.A. Santander Tecnología España, S.L. Santander Totta Seguros, Companhia de Seguros de Vida, S.A. Spain 0.00% 100.00% 100.00% 100.00% Banking 512 52 372 Spain 100.00% 0.00% 100.00% 100.00% Insurance 1,169 132 1,188 Mexico 0.00% 75.14% 100.00% 100.00% Services Mexico 0.00% 75.13% 100.00% Spain 99.97% 0.03% 100.00% 100.00% Financial services - Holding company 5 2 0 1 0 0 5 1 0 United States 0.00% 100.00% 100.00% 100.00% It services 138 (29) 109 Argentina 0.00% 99.34% 100.00% 100.00% It services Spain 100.00% 0.00% 100.00% 100.00% It services Portugal 0.00% 99.90% 100.00% 100.00% Insurance 2 35 93 1 5 18 3 35 47 Santander Totta, SGPS, S.A. Portugal 0.00% 99.90% 99.90% 99.90% Holding 3,357 630 3,923 Poland 50.00% 33.74% 100.00% 100.00% Fund company management company Hong-Kong 0.00% 100.00% 100.00% 100.00% Inactive 4 17 0 44 39 0 0 16 0 - b - - Charitable services 77.67% 22.33% 100.00% 100.00% Finance 13,492 1,400 20,327 company 100.00% 0.00% 100.00% 100.00% Finance company 0.00% 100.00% 100.00% 100.00% Services 49 17 0 3 45 17 0.00% 100.00% 100.00% 100.00% Banking 14,361 2,291 14,559 0.00% 100.00% 100.00% 100.00% It services 0.00% 75.13% 100.00% 100.00% Finance company 6 330 Mexico - b - - Securitisation 5 10 22 0 6 260 0 Santander Towarzystwo Funduszy Inwestycyjnych S.A. Santander Trade Services Limited Santander UK Foundation Limited Santander UK Group Holdings plc Santander UK Investments Santander UK Operations Limited Santander UK plc Santander UK Technology Limited Santander Vivienda, S.A. de C.V., S.O.F.O.M., E.R., Grupo Financiero Santander México Santander Vivienda, S.A. de C.V., S.O.F.O.M., E.R., Grupo Financiero Santander México como Fiduciaria del Fideicomiso Bursa United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom Mexico Santusa Holding, S.L. Spain 69.76% 30.24% 100.00% 100.00% Holding 6,903 718 6,460 SC Austria Finance 2013-1 S.A. Luxembourg SC Germany Auto 2013-2 UG (haftungsbeschränkt) j Germany - - b b - - company - Securitisation - Securitisation 0 0 0 0 0 0 681 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix % of ownership held by the Bank % of voting powerk Direct Indirect Year 2018 Year 2017 Activity Million eurosa Capital + reserves Net results Carrying amount Subsidiaries of Banco Santander, S.A.1 Company SC Germany Auto 2014-1 UG (haftungsbeschränkt) j SC Germany Auto 2014-2 UG (haftungsbeschränkt) SC Germany Auto 2016-1 UG (haftungsbeschränkt) SC Germany Auto 2016-2 UG (haftungsbeschränkt) SC Germany Auto 2017-1 UG (haftungsbeschränkt) SC Germany Auto 2018-1 UG (haftungsbeschränkt) Location Germany Germany Germany Germany Germany Germany SC Germany Consumer 2013-1 UG (haftungsbeschränkt) j Germany SC Germany Consumer 2014-1 UG (haftungsbeschränkt) Germany SC Germany Consumer 2015-1 UG (haftungsbeschränkt) Germany SC Germany Consumer 2016-1 UG (haftungsbeschränkt) Germany SC Germany Consumer 2017-1 UG (haftungsbeschränkt) Germany SC Germany Consumer 2018-1 UG (haftungsbeschränkt) Germany SC Germany Vehicles 2013-1 UG (haftungsbeschränkt) Germany SC Germany Vehicles 2015-1 UG (haftungsbeschränkt) Germany SC Poland Consumer 15-1 Sp. z.o.o. SC Poland Consumer 16-1 Sp. z o.o. SCF Ajoneuvohallinto I Limited SCF Ajoneuvohallinto II Limited SCF Ajoneuvohallinto KIMI VI Limited SCF Ajoneuvohallinto VII Limited Poland Poland Ireland Ireland Ireland Ireland - - - - - - - - - - - - - - - - - - - - b b b b b b b b b b b b b b b b b b b b - - - - - - - - - - - - - - - - - - - - - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation SCF Eastside Locks GP Limited United 0.00% 100.00% 100.00% 100.00% Real estate SCF Rahoituspalvelut I Designated Activity Company Kingdom Ireland SCF Rahoituspalvelut II Designated Activity Company Ireland SCF Rahoituspalvelut KIMI VI Designated Activity Company Ireland SCF Rahoituspalvelut VII Designated Activity Company Ireland SCFI Ajoneuvohallinto Limited j Ireland SCFI Rahoituspalvelut Designated Activity Company j Ireland Secucor Finance 2013-I Designated Activity Company q Ireland - - - - - - - b b b b b b b - - - - - - - management - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation (1) Services and Promotions Delaware Corp. United States 0.00% 100.00% 100.00% 100.00% Holding company 682 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 59 0 0 0 0 0 0 0 0 0 0 0 (16) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 3 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 62 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Services and Promotions Miami LLC Servicio de Alarmas Controladas por Ordenador, S.A. Servicios Corporativos Seguros Serfn, S.A. de C.V. j Servicios de Cobranza, Recuperación y Seguimiento, S.A. de C.V. United States Spain 0.00% 100.00% 100.00% 100.00% Real estate 99.99% 0.01% 100.00% 100.00% Security Mexico 0.00% 85.30% 100.00% 100.00% Services Mexico 0.00% 85.00% 85.00% 85.00% Finance company Sheppards Moneybrokers Limited United Kingdom 0.00% 100.00% 100.00% 100.00% Advisory services Million eurosa Capital + reserves Net results Carrying amount 50 1 0 30 0 88 (6) - 1 36 32 0 36 125 127 3 0 0 1 0 8 53 1 0 7 0 307 (7) 73 0 - 2 27 (1) 0 1 3 4 0 - 1 59 17 0 37 128 130 49 0 0 0 49 0 31 8 0 5 0 0 56 4 0 0 1 0 2 0 10 10 0 0 0 0 0 Shiloh III Wind Project, LLC SI Distribuidora de Títulos e Valores Mobiliários S.A. Silk Finance No. 4 Sobrinos de José Pastor Inversiones, S.A. i Sociedad Integral de Valoraciones Automatizadas, S.A. Socur, S.A. f Sol Orchard Imperial 1 LLC c Solarlaser Limited Sovereign Community Development Company Sovereign Delaware Investment Corporation United States Brazil Portugal Spain United States United Kingdom United States United States Sovereign Lease Holdings, LLC United States Sovereign REIT Holdings, Inc. United States Sovereign Securities Corporation, LLC United States 0.00% 100.00% 100.00% 100.00% Electricity 298 production 0.00% 89.85% 100.00% 100.00% Leasing - b - - Securitisation 0.00% 0.00% 0.00% 100.00% Holding company Spain 100.00% 0.00% 100.00% 100.00% Appraisals Uruguay 100.00% 0.00% 100.00% 100.00% Finance company 0.00% 56.88% 100.00% 100.00% Electricity production 0.00% 100.00% 100.00% 100.00% Real estate 0.00% 100.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Holding 0.00% 100.00% 100.00% company 100.00% Financial services 0.00% 100.00% 100.00% 100.00% Inactive company 0.00% 100.00% 100.00% 100.00% Holding 7,006 154 7,160 Sovereign Spirit Limited n Bermudas 0.00% 100.00% 100.00% 100.00% Leasing Sterrebeeck B.V. The Netherlands 100.00% 0.00% 100.00% 100.00% Holding 4,481 643 11,093 company Suleyado 2003, S.L. Unipersonal Super Pagamentos e Administração de Meios Eletrônicos S.A. Superdigital Holding Company, S.L. Suzuki Servicios Financieros, S.L. Spain 0.00% 100.00% 100.00% 100.00% Securities Brazil 0.00% 89.85% 100.00% Spain 99.97% 0.03% 100.00% investment 100.00% Payment services - Holding company Spain 0.00% 51.00% 51.00% 51.00% Intermediation Svensk Autofnans WH 1 Designated Activity Company Ireland - b - - Securitisation Swesant SA Switzerland 0.00% 100.00% 100.00% 100.00% Holding company Portugal 0.00% 99.86% 100.00% 100.00% Holding company Taxagest Sociedade Gestora de Participações Sociais, S.A. Teatinos Siglo XXI Inversiones S.A. Chile 50.00% 50.00% 100.00% 100.00% Holding 3,090 273 2,524 company 683 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company The Alliance & Leicester Corporation Limited The Best Specialty Cofee, S.L. Unipersonal Tikgi Aviation One Designated Activity Company Location United Kingdom Direct Indirect Year 2018 Year 2017 Activity 0.00% 100.00% 100.00% 100.00% Real estate Spain 100.00% 0.00% 100.00% 100.00% Restaurants Ireland 100.00% 0.00% 100.00% - Renting Time Retail Finance Limited j United Kingdom Tonopah Solar I, LLC TOPSAM, S.A de C.V. United States Mexico 0.00% 100.00% 100.00% 100.00% Services 0.00% 100.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Fund Toque Fale Serviços de Telemarketing Ltda. Tornquist Asesores de Seguros S.A. j Totta (Ireland), PLC h Totta Urbe - Empresa de Administração e Construções, S.A. Trabajando.com Colombia Consultoría S.A.S. Trabajando.com México, S.A. de C.V. management company Brazil 0.00% 79.52% 100.00% 100.00% Telemarketing Argentina 0.00% 99.99% 99.99% 99.99% Advisory services Ireland 0.00% 99.86% 100.00% 100.00% Finance company Portugal 0.00% 99.86% 100.00% 100.00% Real estate Colombia 0.00% 100.00% 100.00% - Services Mexico 0.00% 100.00% 100.00% - Services Trabajando.com Perú S.A.C. Peru 0.00% 100.00% 100.00% Brazil 0.00% 100.00% 100.00% - Services - Services Portugal 0.00% 100.00% 100.00% - Services Trade Maps 3 Ireland Limited Ireland Trans Rotor Limited United Kingdom Hong-Kong - - b b - - - Securitisation - Securitisation 100.00% 0.00% 100.00% 100.00% Renting Transolver Finance EFC, S.A. Spain 0.00% 51.00% 51.00% 51.00% Leasing Tuttle and Son Limited Universia Brasil S.A. Universia Chile S.A. United Kingdom Brazil Chile 0.00% 100.00% 100.00% 100.00% Payments and collections services 0.00% 100.00% 100.00% 100.00% Internet 0.00% 86.84% 86.84% 86.72% Internet Universia Colombia S.A.S. Colombia 0.00% 100.00% 100.00% 100.00% Internet Universia España Red de Universidades, S.A. Spain 0.00% 89.45% 89.45% 89.45% Internet Trabalhando.com Brasil Consultoria Ltda. Trabalhandopontocom Portugal - Sociedade Unipessoal, Lda. c j Trade Maps 3 Hong Kong Limited Million eurosa Capital + reserves Net results Carrying amount 13 1 0 0 32 2 1 0 450 30 1 0 0 3 0 0 0 16 45 0 0 0 0 1 0 0 (1) 0 13 0 0 0 (22) 10 1 0 0 7 (4) 0 0 0 0 0 0 0 2 7 0 0 0 0 0 1 1 0 450 0 0 0 0 0 0 0 0 15 17 0 0 0 0 2 Universia Holding, S.L. Spain 100.00% 0.00% 100.00% 100.00% Holding 22 (7) 21 company Universia México, S.A. de C.V. Mexico 0.00% 100.00% 100.00% 100.00% Internet Universia Perú, S.A. Universia Uruguay, S.A. W.N.P.H. Gestão e Investimentos Sociedade Unipessoal, S.A. Peru Uruguay Portugal 0.00% 96.51% 96.51% 96.51% Internet 0.00% 100.00% 100.00% 100.00% Internet 0.00% 100.00% 100.00% 100.00% Portfolio management 0 0 0 0 Wallcesa, S.A. Spain 100.00% 0.00% 100.00% 100.00% Securities (942) Wave Holdco, S.L. Spain 100.00% 0.00% 100.00% investment - Holding company 41 0 0 0 0 0 0 0 0 0 0 0 33 684 2018 Auditors’ report and consolidated annual accounts Subsidiaries of Banco Santander, S.A.1 % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Wave SME Holdings Limited United 0.00% 100.00% 100.00% 100.00% Holding Wave SME Technology Limited Waypoint Insurance Group, Inc. Whitewick Limited Kingdom United Kingdom United States Jersey WIM Servicios Corporativos, Mexico S.A. de C.V. company 0.00% 100.00% 100.00% 100.00% Technology services 0.00% 100.00% 100.00% 100.00% Holding company 0.00% 100.00% 100.00% 100.00% Inactive 0.00% 100.00% 100.00% 100.00% Advisory WTW Shipping Designated Activity Company Ireland 100.00% 0.00% 100.00% 100.00% Leasing Million eurosa Capital + reserves Net results Carrying amount 0 0 9 0 0 11 0 0 0 0 0 1 0 0 9 0 0 9 a. Amount per provisional books of each company as of the date of publication of these annexes, generally referred to 31 December 2018 without considering, where appropriate, the interest dividends that has been made in the year. In the carrying amount (net cost of provision), the Group´s ownership percentage has been applied to the number of each of the holders, without considering the impairment of goodwill incurred in the consolidation process. The Data from foreign companies are converted in to euros at the exchange rate at the end of the period. b. Companies over which efective control is exercised. c. Data from the latest approved fnancial statement as at 31 December 2017. d. Data from the latest approved fnancial statement as at 31 March 2018. e. Data from the latest approved fnancial statement as at 30 June 2018. f. Data from the latest approved fnancial statement as at 30 September 2018. g. Data from the latest approved fnancial statement as at 31 July 2018. h. Data from the latest approved fnancial statement as at 30 November 2018. i. Company in process of merger or liquidation. Pending of being registered. j. Company in liquidation at 31 December 2018. k. Pursuant to Article 3 of Royal Decree 1159/2010, of 17 September approving the rules for the preparation of consolidated fnancial statements, in order to determine voting power, the voting power relating to subsidiaries or to other persons acting in their own name but on behalf of Group companies was added to the voting power directly held by the Parent. For these purposes, the number of votes corresponding to the Parent in relation to companies over which it exercises indirect control is the number corresponding to each subsidiary holding a direct ownership interest in such companies. l. Data from the latest fnancial statement as at 31 December 2016. m. See note 2.b.i n. Company resident in the UK for tax purposes. o. Data from the latest approved fnancial statement as at 28 February 2018. p. Data from the latest approved fnancial statement as at 31 May 2018. q. Data from the latest approved fnancial statement as at 31 January 2018. r. Data from the latest available approved fnancial statement as at 31 December 2004. s. Data from the latest approved fnancial statement as at 31 October 2018. t. Newly incorporated society, without approval of the fnancial statements. u. Company resident in Spain for tax purposes. 1. Companies issuing shares and preference shares are listed in annex III, together with other relevant information. 685 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Appendix II Societies of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity 3E1 Sp. z o.o b Poland 0.00% 12.89% 21.60% 21.60% Electricity production Type of company - Administrador Financiero de Transantiago S.A. Aegon Santander Portugal Não Vida - Companhia de Seguros, S.A. Aegon Santander Portugal Vida - Companhia de Seguros Vida, S.A. Chile 0.00% 13.42% 20.00% 20.00% Payments and Associated collections services Portugal 0.00% 48.95% 49.00% 49.00% Insurance Portugal 0.00% 48.95% 49.00% 49.00% Insurance Jointly controlled Jointly controlled Million eurosa Capital + Assets reserves Net results 0 70 33 (2) 19 14 2 4 3 99 19 12 Aeroplan - Sociedade Portugal Construtora de Aeroportos, Lda. e 0.00% 19.97% 20.00% 20.00% Inactive - 0 0 Spain 36.78% 0.00% 36.78% 36.78% Food Associated 24 (40) Aguas de Fuensanta, S.A. e Alawwal Bank (consolidado) b Alcuter 2, S.L. k Allianz Popular, S.L. (Consolidado) Anekis, S.A. Spain Spain Spain Arena Communications Spain Network, S.L. b Attijariwafa Bank Société Anonyme (consolidado) b Autopistas del Sol S.A. b Aviva Powszechne Towarzystwo Emerytalne Aviva Santander S.A. b Aviva Towarzystwo Ubezpieczeń na Życie S.A. b Banco Hyundai Capital Brasil S.A. Saudi Arabia 0.00% 11.16% 11.16% 11.16% Banking 23,746 2,916 318 - - 37.23% 0.00% 37.23% 37.23% Technical services - 40.00% 0.00% 40.00% 40.00% Insurance Associated 3,238 24.75% 24.75% 49.50% 49.50% Advertising Associated 20.00% 0.00% 20.00% 20.00% Advertising Associated 2 10 - 98 2 4 - 113 (1) 10 Morocco 0.00% 5.11% 5.11% 5.26% Banking Argentina 0.00% 14.17% 14.17% 14.17% Motorway concession Poland 0.00% 6.75% 10.00% 10.00% Pension fund management company Poland 0.00% 6.75% 10.00% 10.00% Insurance - - - - 43,401 4,035 601 28 120 2 114 5 24 3,716 350 132 Brazil 0.00% 44.93% 50.00% - Finance company Banco RCI Brasil S.A. Brazil 0.00% 35.84% 39.89% 39.89% Leasing Jointly controlled Jointly controlled 48 22 2,572 234 Bank of Beijing Consumer Finance Company China 0.00% 20.00% 20.00% 20.00% Finance company Associated 584 94 Bank of Shanghai Co., China Ltd. (consolidado) b 6.50% 0.00% 6.50% 6.48% Banking - 229,555 16,775 1,948 Benim - Sociedade Imobiliária, S.A. b Portugal 0.00% 25.77% 25.81% 25.81% Real estate Associated Câmara Interbancária Brazil de Pagamentos - CIP 0.00% 15.82% 17.61% - Payments and collections services - 11 122 Cantabria Capital, SGEIC, S.A. Spain 50.00% 0.00% 50.00% 50.00% Management of Associated 0 venture capital 7 54 0 0 23 0 686 0 0 0 50 7 2018 Auditors’ report and consolidated annual accountsSocieties of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Portugal 0.00% 49.98% 49.98% 49.98% Real estate services Chile 0.00% 22.37% 33.33% 33.33% Payments and Associated collections services Spain 0.00% 49.00% 49.00% 49.00% Technology Associated Type of company Jointly controlled Million eurosa Capital + Assets reserves Net results 1 9 3 0 6 2 0 1 0 CCPT - ComprarCasa, Rede Serviços Imobiliários, S.A. Centro de Compensación Automatizado S.A. Centro para el Desarrollo, Investigación y Aplicación de Nuevas Tecnologías, S.A. b CNP Santander Insurance Europe Designated Activity Company CNP Santander Insurance Life Designated Activity Company CNP Santander Insurance Services Ireland Limited Cobranza Amigable, S.A.P.I. de C.V. Comder Contraparte Central S.A Companhia Promotora UCI Compañia Española de Financiación de Desarrollo, Cofdes, S.A., SME b Compañía Española de Seguros de Crédito a la Exportación, S.A., Compañía de Seguros y Reaseguros (consolidado) b Compañía Española de Viviendas en Alquiler, S.A. Compañía para los Desarrollos Inmobiliarios de la Ciudad de Hispalis, S.L., en liquidación l e Ireland 49.00% 0.00% 49.00% 49.00% Insurance brokerage Associated 886 96 31 Ireland 49.00% 0.00% 49.00% 49.00% Insurance brokerage Associated 1,426 203 45 Ireland 49.00% 0.00% 49.00% 49.00% Services Associated Mexico 0.00% 33.78% 39.74% 39.74% Collection services Jointly controlled 8 7 Chile 0.00% 7.54% 11.23% 11.23% Financial services Associated 28 Brazil 0.00% 25.00% 25.00% 25.00% Financial services Jointly controlled 1 2 0 14 (1) Spain 20.18% 0.00% 20.18% - Finance company - 129 116 1 0 1 0 9 Spain 23.33% 0.55% 23.88% 21.08% Credit insurance - 803 361 23 Spain 24.07% 0.00% 24.07% 24.07% Real estate Associated 466 271 33 Spain 21.98% 0.00% 21.98% 21.98% Real estate development 38 (238) (86) - - - - - Condesa Tubos, S.L. b Spain 36.21% 0.00% 36.21% 30.61% Services Corkfoc Cortiças, S.A. b Portugal 0.00% 27.54% 27.58% - Cork industry Corridor Texas Holdings LLC (consolidado) b United States 0.00% 29.47% 29.47% 32.61% Holding company Eko Energy Sp. z o.o b Poland 0.00% 13.13% 22.00% 22.00% Electricity production 162 3 205 0 Euro Automatic Cash Entidad de Pago, S.L. FAFER- Empreendimentos Urbanísticos e de Construção, S.A. b e Spain 50.00% 0.00% 50.00% 50.00% Payment services Associated 99 Portugal 0.00% 36.57% 36.62% 36.62% Real estate - 0 32 20 197 4 74 1 (6) 0 (3) (4) (18) 0 687 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Million eurosa Capital + Assets reserves Net results 0 0 0 87,042 4,007 297 Societies of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity FC2Egestión, S.L. Spain 50.00% 0.00% 50.00% 50.00% Environmental management Federal Home Loan Bank of Pittsburgh b Federal Reserve Bank of Boston b FIDC RCI Brasil I – Financiamento de Veículos c FIDC RN Brasil – Financiamento de Veículos United States United States Brazil Brazil Fondo de Titulización Spain de Activos UCI 11 Fondo de Titulización Spain de Activos UCI 14 Fondo de Titulización Spain de Activos UCI 15 Fondo de Titulización Spain de Activos UCI 16 Fondo de Titulización Spain de Activos UCI 17 Fondo de Titulización Spain de Activos, RMBS Prado I Fondo de Titulización Spain Hipotecaria UCI 10 Fondo de Titulización Spain Hipotecaria UCI 12 Fondo de Titulización, Spain RMBS Prado II Fondo de Titulización, Spain RMBS Prado III Fondo de Titulización, Spain RMBS Prado IV Fondo de Titulización, Spain RMBS Prado V Fondo de Titulización, Spain RMBS Prado VI 0.00% 6.33% 6.33% 6.33% Banking 0.00% 30.09% 30.09% 30.44% Banking - - - - - - - - - - - - - - - (h) (h) (h) (h) (h) (h) (h) (h) (h) (h) (h) (h) (h) (h) (h) - - - - - - - - - - - - - - - - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation - Securitisation Fortune Auto Finance Co., Ltd China 0.00% 50.00% 50.00% 50.00% Finance company Type of company Jointly controlled - - Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled 87,860 1,516 142 38 166 71 180 487 576 800 676 366 105 255 454 375 369 398 427 0 0 0 0 0 0 0 0 0 0 0 0 0 2,083 219 Friedrichstrasse, S.L. Spain 35.00% 0.00% 35.00% 35.00% Real estate Associated Gestora de Inteligência Brazil de Crédito S.A. 0.00% 17.97% 20.00% 20.00% Collection services Jointly controlled 0 76 Gire S.A. Argentina 0.00% 57.92% 58.33% 58.33% Payments and Associated 118 0 73 14 collections services Grupo Financiero Ve Por Más, S.A. de C.V. (consolidado) Mexico 24.99% 0.00% 24.99% 24.99% Financial services Associated 2,589 211 HCUK Auto Funding 2016-1 Ltd e United Kingdom HCUK Auto Funding 2017-1 Ltd United Kingdom - - (h) (h) - - - Securitisation - Securitisation Jointly controlled Jointly controlled 0 168 0 0 688 22 9 11 0 0 0 0 0 0 0 0 0 0 0 0 0 49 0 (6) 17 2 0 0 2018 Auditors’ report and consolidated annual accounts Societies of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity - (h) - - Securitisation 0.00% 22.37% 22.37% - Real estate - Type of company Jointly controlled Million eurosa Capital + Assets reserves Net results 615 15 0 15 0 0 HCUK Auto Funding 2017-2 Ltd United Kingdom Healthy Neighborhoods Equity Fund I LP b United States Hyundai Capital UK Limited United Kingdom 0.00% 50.01% 50.01% 50.01% Finance company Jointly controlled 3,206 155 36 Imperial Holding S.C.A. e i Luxembourg 0.00% 36.36% 36.36% 36.36% Securities investment Imperial Management Luxembourg S.à r.l. m e 0.00% 40.20% 40.20% 40.20% Holding company Inbond Inversiones 2014, S.L. b Spain 40.00% 0.00% 40.00% 40.00% Financial studies Indice Iberoamericano Spain de Investigación y Conocimiento, A.I.E. 0.00% 51.00% 51.00% 51.00% Information system - - Jointly controlled Jointly controlled 0 0 (113) 0 225 225 0 0 1 2 (3) (1) Inmo Alemania Gestión de Activos Inmobiliarios, S.A. Spain 0.00% 20.00% 20.00% 20.00% Holding company - 40 19 Inverlur Aguilas I, S.L. Spain 50.00% 0.00% 50.00% 50.00% Real estate Inverlur Aguilas II, S.L. Spain 50.00% 0.00% 50.00% 50.00% Real estate Jointly controlled Jointly controlled Inversiones en Resorts Spain Mediterráneos, S.L. e 0.00% 43.28% 43.28% 43.28% Real estate Associated Spain 25.42% 0.00% 25.42% 25.42% Venture capital - 0 1 0 26 0 1 (2) 22 0.00% 49.00% 49.00% 49.00% Securities and real Associated 326 326 estate investment 0.00% 49.00% 49.00% 49.00% Securities and real Associated 429 319 estate investment 0.00% 14.23% 21.09% 21.09% Trade 0.00% 10.60% 4.99% 4.99% Holding company 0.00% 69.40% 4.43% 4.43% Holding company Canada 0.00% 7.67% 4.99% 4.99% Holding company Mauritania 0.00% 69.52% 4.43% 4.43% Holding company Canada Brazil 0.00% 96.45% 4.99% 4.99% Holding company 0.00% 32.08% 35.70% - Business services - - - - - - Jointly controlled Jointly controlled 2 2 82 68 1 129 8 1 (4) 2 74 60 2 133 7 0 Luri 3, S.A. Spain 10.00% 0.00% 10.00% 10.00% Real estate Lusimovest Fundo de Investimento Imobiliário Portugal 0.00% 25.73% 25.77% 25.77% Investment fund Associated 106 98 Chile Chile Poland United States Canada Inversiones Ibersuizas, S.A. b Inversiones ZS América Dos Ltda Inversiones ZS América SpA Invico S.A. b J.C. Flowers I L.P. b J.C. Flowers II-A L.P. (consolidado) b JCF AIV P L.P. b JCF BIN II-A d Jupiter III L.P. b Loop Gestão de Pátios S.A. Massachusetts United Business Development States Corp. (consolidado) b MB Capital Fund IV, LLC b Merlin Properties, SOCIMI, S.A. (consolidado) b United States Spain 0.00% 21.60% 21.60% 21.60% Finance company - 0.00% 23.94% 23.94% 23.94% Finance company - 66 15 9 9 16.88% 5.60% 22.48% 22.57% Real estate Associated 12,005 4,623 1,100 689 3 0 0 (1) 4 62 65 0 (1) 8 9 (1) (4) (1) 0 2 (1) 1 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Metrovacesa, S.A. (consolidado) b New PEL S.à r.l. b NIB Special Investors IV-A LP b NIB Special Investors IV-B LP b Niuco 15, S.L. k Norchem Holdings e Negócios S.A. Nowotna Farma Wiatrowa Sp. z o.o b Odc Ambievo Tecnologia e Inovacao Ambiental, Industria e Comercio de Insumos Naturais S.A. Olivant Limited (consolidado) m POLFUND - Fundusz Poręczeń Kredytowych S.A. Prisma Medios de Pago S.A. Procapital - Investimentos Imobiliários, S.A. b e 69 49 15 - 28 18 98 4 68 42 13 - 21 11 11 4 0 0 19 0 1 20 60 13 0 7 2 - 1 0 0 0 0 0 0 4 0 1 1 24 0 Societies of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Type of company Million eurosa Capital + Assets reserves Net results Spain 31.94% 17.46% 49.40% 71.45% Real estate Associated 2,547 2,397 (39) development Luxembourg 0.00% 7.67% 0.00% 0.00% Holding company Canada 0.00% 99.55% 4.99% 4.99% Holding company Canada 0.00% 93.42% 4.99% 4.99% Holding company - - - Spain Brazil 37.23% 0.00% 37.23% - Technical services - 0.00% 19.54% 29.00% 29.00% Holding company Associated Norchem Participações Brazil e Consultoria S.A. 0.00% 44.93% 50.00% 50.00% Securities company Jointly controlled Poland 0.00% 12.96% 21.73% 21.60% Electricity production Brazil 0.00% 18.14% 20.19% 20.19% Technology - - Guernsey 0.00% 10.39% 10.39% 10.39% Holding company - 18 14 Operadora de Activos Mexico Alfa, S.A. De C.V. e Operadora de Activos Mexico Beta, S.A. de C.V. Operadora de Tarjetas Chile de Crédito Nexus S.A. 0.00% 49.98% 49.98% 49.98% Finance company Associated 0.00% 49.99% 49.99% 49.99% Finance company Associated 0.00% 8.66% 12.90% 12.90% Cards Associated Parque Solar Páramo, S.L. Spain 92.00% 0.00% 25.00% 25.00% Electricity production Jointly controlled Payever GmbH Germany 0.00% 10.00% 10.00% 10.00% Software Associated Poland 0.00% 33.74% 50.00% 50.00% Management Associated 0 0 44 30 2 25 Argentina 0.00% 18.39% 18.52% 17.47% Business services Associated 440 Portugal 0.00% 39.96% 40.00% 40.00% Real estate - 4 Project Quasar Investments 2017, S.L. Spain 49.00% 0.00% 49.00% - Finance company Associated 11,571 2,926 1,023 PSA Corretora de Seguros e Serviços Ltda. PSA Insurance Europe Limited PSA Life Insurance Europe Limited Brazil 0.00% 44.93% 50.00% 50.00% Insurance Malta 0.00% 50.00% 50.00% 50.00% Insurance Malta 0.00% 50.00% 50.00% 50.00% Insurance Jointly controlled Jointly controlled Jointly controlled PSA UK Number 1 plc United 0.00% 50.00% 50.00% 50.00% Leasing Associated Kingdom Chile Spain 0.00% 22.44% 33.43% 33.43% Services 20.00% 0.08% 20.08% 20.00% Cards Spain 0.00% 50.00% 50.00% 50.00% Services Associated Associated Jointly controlled Redbanc S.A. Redsys Servicios de Procesamiento, S.L.b Retama Real Estate, S.A. 690 1 0 158 51 72 5 26 137 9 5 10 41 0 12 8 0 1 9 45 (40) (2) 2018 Auditors’ report and consolidated annual accounts Societies of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Type of company Million eurosa Capital + Assets reserves Net results Rías Redbanc, S.A. Uruguay 0.00% 25.00% 25.00% 25.00% Services - Saite, S.A. Spain 50.00% 0.00% 50.00% 50.00% Real estate Jointly controlled Santander Auto S.A. Brazil 0.00% 44.93% 50.00% - Insurance Associated 3 29 3 Poland 0.00% 33.06% 49.00% 49.00% Insurance Associated 239 Santander Aviva Towarzystwo Ubezpieczeń na Życie S.A. Santander Aviva Towarzystwo Ubezpieczeń S.A. Santander Generales Seguros y Reaseguros, S.A. Santander Vida Seguros y Reaseguros, S.A. Saturn Japan II Sub C.V. b Saturn Japan III Sub C.V. b Sepacon 31, S.L. k Servicios de Infraestructura de Mercado OTC S.A SIBS SGPS, S.A. b Sistemas Técnicos de Encofrados, S.A. (consolidado) b Sociedad Conjunta para la Emisión y Gestión de Medios de Pago, E.F.C., S.A. Sociedad de Garantía Recíproca de Santander, S.G.R. b Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria, S.A. b Sociedad Española de Sistemas de Pago, S.L. b Sociedad Interbancaria de Depósitos de Valores S.A. Solar Energy Capital Europe S.à r.l. (consolidado) b Poland 0.00% 33.06% 49.00% 49.00% Insurance Associated 142 37 Spain 0.00% 49.00% 49.00% 49.00% Insurance Spain 0.00% 49.00% 49.00% 49.00% Insurance 355 74 322 89 29 The Netherlands The Netherlands Spain Chile 0.00% 69.30% 0.00% 0.00% Holding company 0.00% 72.72% 0.00% 0.00% Holding company 37.23% 0.00% 37.23% 37.23% Technical services - 0.00% 7.55% 11.25% 11.25% Services Associated 36 35 171 171 - 32 - 14 Jointly controlled Jointly controlled - - Portugal 0.00% 16.54% 16.56% 16.56% Portfolio - 176 95 management Sistema de Tarjetas y Medios de Pago, S.A. Spain 18.11% 0.00% 18.11% - Payment services Associated 377 Spain 27.15% 0.00% 27.15% 25.15% Building materials - 66 Spain 42.50% 0.00% 42.50% 42.50% Payment services Jointly controlled 105 29 Spain 25.50% 0.23% 25.73% 25.50% Financial services - 16 11 Spain 22.21% 0.00% 22.21% 22.22% Financial services - 40,145 2,620 (565) Spain 22.24% 0.00% 22.24% 22.24% Payment services - Chile 0.00% 19.66% 29.29% 29.29% Custody Associated Luxembourg 0.00% 33.33% 33.33% 33.33% Holding company Jointly controlled 10 6 11 6 5 1 Stephens Ranch Wind Energy Holdco LLC (consolidado) b United States Syntheo Limited United Kingdom 0.00% 28.80% 28.80% 28.80% Electricity - 248 246 production 0.00% 50.00% 50.00% 50.00% Payment services Jointly controlled 3 4 1 18 3 12 4 2 0 2 0 13 16 8 1 0 - 1 25 0 (16) 1 0 1 1 0 (5) (1) 691 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Societies of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Type of company Million eurosa Capital + Assets reserves Net results Tbforte Segurança e Transporte de Valores Ltda. Tbnet Comércio, Locação e Administração Ltda. Tecnologia Bancária S.A. Teka Industrial, S.A. (consolidado) b Testa Residencial, SOCIMI, S.A. (consolidado) b The OneLife Holding S.à r.l. (consolidado) b Brazil 0.00% 17.80% 19.81% 19.81% Security Associated 87 84 (16) Brazil 0.00% 17.80% 19.81% 19.81% Telecommunications Associated 71 86 (16) Brazil 0.00% 17.80% 19.81% 19.81% Atm Associated 433 106 (13) Spain 0.00% 9.42% 9.42% 9.42% Household appliances - 571 154 Spain 0.79% 17.64% 18.43% 38.74% Real estate Associated 2,356 1,324 Luxembourg 0.00% 5.90% 0.00% 0.00% Holding company - 5,398 44 (5) 70 6 Tonopah Solar Energy Holdings I, LLC (consolidado) United States 0.00% 26.80% 26.80% 26.80% Holding company Jointly controlled 547 190 (49) Chile 0.00% 33.33% 33.33% 33.33% Services Associated 2 0.00% 16.78% 25.00% 25.00% Cards Associated 1,138 50.00% 0.00% 50.00% 50.00% Holding company Grecia 0.00% 50.00% 50.00% 50.00% Financial services UCI Holding Brasil Ltda Brazil 0.00% 50.00% 50.00% 50.00% Holding company Portugal 0.00% 50.00% 50.00% 50.00% Insurance brokerage Spain 0.00% 50.00% 50.00% 50.00% Real estate services Portugal 0.00% 21.83% 21.86% 21.86% Finance company Associated 347 87 Unión de Créditos Inmobiliarios, S.A., EFC Spain Uro Property Holdings Spain SOCIMI, S.A. b 0.00% 50.00% 50.00% 50.00% Mortgage credit company Jointly controlled 12,343 386 14.95% 0.00% 14.95% 14.95% Real estate - 1,636 201 VCFS Germany GmbH Germany 0.00% 50.00% 50.00% 50.00% Marketing Venda de Veículos Fundo de Investimento em Direitos Creditórios c Brazil - (h) - - Securitisation Webmotors S.A. Brazil 0.00% 62.90% 70.00% 70.00% Services Jointly controlled Jointly controlled Jointly controlled 0 136 0 62 44 24 10 Brazil 0.00% 48.79% 48.79% 48.79% Insurance Associated 12,455 605 232 Brazil 0.00% 48.79% 48.79% 48.79% Insurance Associated 176 (2) Spain 0.00% 49.00% 49.00% 49.00% Holding company Associated 1,096 936 42 159 Zurich Santander Brasil Seguros e Previdência S.A. Zurich Santander Brasil Seguros S.A. Zurich Santander Holding (Spain), S.L. 692 Trabajando.com Chile S.A. Transbank S.A. U.C.I., S.A. UCI Hellas Credit and Loan Receivables Servicing Company S.A. Chile Spain UCI Mediação de Seguros Unipessoal, Lda. UCI Servicios para Profesionales Inmobiliarios, S.A. Unicre-Instituição Financeira de Crédito, S.A. (1) 73 72 0 0 0 0 Jointly controlled Jointly controlled Jointly controlled Jointly controlled Jointly controlled 291 1 2 0 2 0 16 (2) 0 0 0 0 20 11 23 0 5 2018 Auditors’ report and consolidated annual accounts Societies of which the Group owns more than 5%g, entities associated with Grupo Santander and jointly controlled entities % of ownership held by the Bank % of voting powerk Company Location Direct Indirect Year 2018 Year 2017 Activity Type of company Million eurosa Capital + Assets reserves Net results Zurich Santander Holding Dos (Spain), S.L. Spain 0.00% 49.00% 49.00% 49.00% Holding company Associated 547 384 163 Zurich Santander Insurance América, S.L. Spain 49.00% 0.00% 49.00% 49.00% Holding company Associated 1,874 1,510 361 Zurich Santander Seguros Argentina S.A. j Zurich Santander Seguros de Vida Chile S.A. Zurich Santander Seguros Generales Chile S.A. Zurich Santander Seguros México, S.A. Zurich Santander Seguros Uruguay, S.A. Argentina 0.00% 49.00% 49.00% 49.00% Insurance Associated 36 7 9 Chile 0.00% 49.00% 49.00% 49.00% Insurance Associated 249 33 46 Chile 0.00% 49.00% 49.00% 49.00% Insurance Associated 184 37 Mexico 0.00% 49.00% 49.00% 49.00% Insurance Associated 498 Uruguay 0.00% 49.00% 49.00% 49.00% Insurance Associated 18 38 9 13 92 2 a. Amount per provisional books of each company as of the date of publication of these annexes, generally referred to 31 December 2018, unless stated otherwise because the Annual Accounts are pending to be formulated. The data from foreign companies are converted into euros at the exchange rate at the end of the period. b. Data from the latest approved fnancial statements as at 31 December 2017. c. Data from the latest approved fnancial statements as at 31 May 2018. d. Data from the latest available approved fnancial statements as at 30 September 2017. e. Company in liquidation to 31 December 2018. f. Pursuant to Article 3 of Royal Decree 1159/2010, of 17 September approving the rules for the preparation of consolidated fnancial statements, in order to determine voting power, the voting power relating to subsidiaries or to other persons acting in their own name but on behalf of Group companies was added to the voting power directly held by the Parent, For these purposes, the number of votes corresponding to the Parent in relation to companies over which it exercises indirect control is the number corresponding to each subsidiary holding a direct ownership interest in such companies. g. Excluding the Group companies listed in Appendix I and those of negligible interest with respect to the fair presentation that the consolidated fnancial statements must express (pursuant to Article 48 of the Spanish Commercial Code and Article 260 of the Spanish Limited Liability Companies Law). h. Companies over which the non-subsidiary investee of the Group exercises efective control i. Data from the latest available approved fnancial statements as at 31 October 2016. j. Data from the latest available approved fnancial statements as at 30 June 2018. k. Recent create company without approved fnancial statements available. l. Data from the latest approved fnancial statements as at 30 November 2016. m. Data from the latest approved fnancial statements as at 31 December 2016. 693 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Appendix III Issuing subsidiaries of shares and preference shares % of ownership held by the Bank Million of eurosa Direct Indirect Activity Capital Reservations Cost of preferred Net results Company Emisora Santander Spain, S.A. Unipersonal Location Spain 100.00% 0.00% Finance company Santander UK (Structured Solutions) Limited United Kingdom 0.00% 100.00% Finance company 2 0 0 0 0 0 75 0 0 40 Sovereign Real Estate Investment Trust United States 0.00% 100.00% Finance 5,005 (3,115) company a. Amounts per provisional books of each company as at 31 December 2018, converted into euros (in the case of foreign companies) at the year-end exchange rates. Appendix IV Notifcations of acquisitions and disposals of investments in 2018 (Article 155 of the Spanish Limited Liability Companies Law and Article 125 of the Spanish Securities Market Law). COMMUNICATION OF SIGNIFICANT SHARES MADE TO CNMV DURING 2018: On the 29-01-2018, the communication made by Banco Santander, S.A. was registered in the CNMV. They informed that the Group´s shares in NYESA VALORES CORPORACIÓN had decreased to 6.407% (<10%) on the 18.01.2018. NOTE: After the increase in share capital executed by NYESA, the percentage of Banco Santander, S.A. (given Banco Popular Español, S.A.U) in this company has fallen from 13.223% to 6.407%, exceeding the 10% threshold. On the 12-02-2018, the communication made by Banco Santander, S.A., was registered in the CNMV, where they informed that the Group’s shares in METROVACESA, S.A. had increase to 53.311% (51.497% of the voting rights attributed to shares and 1.814% of the voting rights through fnancial instruments) (>50%) on the 06.02.2018 as a result of the company’s admission to the Stock Exchange. On the 23-03-2018, the communication made by Banco Santander, S.A. was registered in the CNMV, where they informed that the Group’s shares in METROVACESA, S.A. dropped to 49.362% (<50%) on the 22.03.2018. On the 28-03-2018, the communication made by Banco Santander, S.A. was registered in the CNMV, where they informed that the Group’s shares in NYESA VALORES CORPORACIÓN had decreased to 4.468% (<5%) on the 21.03.2018. 694 On the 02-04-2018, the communication made by Banco Santander, S.A. was registered in the CNMV, where they informed that the Group’s shares in NYESA VALORES CORPORACIÓN had decreased to 2.939% (<3%) on the 28.03.2018. On the 04-10-2018, the communication made by Banco Santander, S.A. was registered in the CNMV, in which it was reported that the purpose of this communication was to update the information referring to the Banco Santander’s, S.A stock options in ABENGOA, S.A., after the merger by absorption of Banco Popular Español, S.A.U. by Banco Santander, S.A. As a result of the merger, the shares held by Banco Popular Español, S.A.U. became direct shares of Banco Santander, S.A. Therefore, Banco Santander’s shares in ABENGOA, S.A. amounted to 4.975% on the 28.09.2018. On the 04-10-2018, the communication made by Banco Santander, S.A. was registered in the CNMV, informing that the purpose of this communication was to update the information referring to the Banco Santander’s, S.A stock options in METROVACESA, S.A., after the merger by absorption of Banco Popular Español, S.A.U. by Banco Santander, S.A. As a result of the merger, the shares held by Banco Popular Español, S.A.U. became direct shares of Banco Santander, S.A. Therefore, Banco Santander’s shares in METROVACESA, S.A. amounted to 49.362% on the 28.09.2018. On the 04-10-2018, the communication made by Banco Santander, S.A. was registered in the CNMV, informing that the purpose of this communication was to update the information referring to the Banco Santander’s, S.A stock options in COMPAÑIA ESPAÑOLA DE VIVIENDAS EN ALQUILER, S.A. (CEVASA), after the merger by absorption of Banco Popular Español, S.A.U. by Banco Santander, S.A. As a result of the merger, the shares held by Banco Popular Español, S.A.U. became direct shares of Banco Santander, S.A. Therefore, Banco Santander’s shares in CEVASA, S.A. amounted to 24.068% on the 28.09.2018. On the 30-10-2018, the communication made by Banco Santander, S.A., BANCO BILBAO VIZCAYA ARGENTARIA, S.A., BANKIA, S.A., CAIXABANK, S.A., KUTXABANK, S.A., LIBERBANK, S.A., and BANCO DE SABADELL, S.A., (concerted action) in which it was reported 2018 Auditors’ report and consolidated annual accounts that Group Santander’s S.A stake in GENERAL DE ALQUILER DE MAQUINARIA, S.A., was 63.045% on the 28.09.2018. NOTE: Update of the information on a concerted action of the Entities included in this Parasocial Agreement, with the sole purpose of updating the information existing in the CNMV on the participation of the Entities members of the Concerted Action in GAM as a result of the merger by absorption of BANCO POPULAR ESPAÑOL, S.A.U by Banco Santander, S.A. Appendix V Other information on the Group’s banks A) Following is certain information on the share capital of the Group’s main banks based on their total assets. 1. Santander UK plc a) Number of fnancial equity instruments held by the Group. At 31 December 2018, the Company was a subsidiary of Banco Santander, S.A. and Santusa Holding, S.L. On 12 November 2004 Banco Santander, S.A. acquired the then entire issued ordinary share capital of 1,485,893,636 Ordinary shares of 10p. each. On 12 October 2008 a further 10 billion Ordinary shares of 10p. each were issued to Banco Santander, S.A. and an additional 12,631,375,230 Ordinary shares of 10p. each were issued to Banco Santander, S.A. on 9 January on 2009. On 3 August 2010, 6,934,500,000 ordinary shares of 10p. each were issued to Santusa Holding, S.L. With efect from 10 January 2014, Santander UK Group Holdings Limited, a subsidiary of Banco Santander, S.A. and Santusa Holding S.L., became the benefcial owner of 31,051,768,866 of 10p. each, being the entire issued Ordinary share capital of the Company, by virtue of a share exchange agreement between Santander UK Group Holdings Limited, Banco Santander, S.A. and Santusa Holding, S.L. Santander UK Group Holdings Limited became the legal owner of the entire issued Ordinary share capital of the Company on 1 April 2014 and on 25 March 2015 became a public limited company and changed its name from Santander UK Group Holdings Limited to Santander UK Group Holdings plc. In addition to this, there are 325,000,000 Non-Cumulative Non-Redeemable 10.375% and 8.625% Sterling Preference Shares of GBP 1.00 each and 13,780 Series A Fixed (6.222%)/Floating Rate Non-Cumulative Callable Preference Shares of GBP 1.00 each. The legal and benefcial title to the entire issued Preference share capital is held by third parties and is not held by Banco Santander, S.A. b) Capital increases in progress At 31 December 2018, there were no approved capital increases. c) Share capital authorised by the shareholders at the general meeting The shareholders at the Annual General Meeting held on 28 March 2018 resolved to unconditionally authorise the company to carry out the following repurchases of share capital: (1) To buy back its own 8.625% Sterling Preference shares on the following terms: (a) The Company may buy back up to 125,000,000 8.625% Sterling Preference shares; (b) The lowest price which the Company can pay for 8.625% Sterling Preference shares is 75% of the average of the market values of the preference shares for fve business days before the purchase is made; and (c) The highest price (not including expenses) which the Company can pay for each 8.625% Sterling Preference share is 125% of the average of the market values of the preference shares for fve business days before the purchase is made. This authority began on 28 March 2018 and will end on the conclusion of the next Annual General Meeting of the Company. The Company may agree, before this authorisation ends, to buy back its own 8.625% Sterling Preference shares even though the purchase may be completed after this authorisation ends. (2) To buy back its own 10.375% Sterling Preference shares on the following terms: (a) The Company may buy up to 200,000,000 10.375% Sterling Preference shares; (b) The lowest price which the Company can pay for 10.375% Sterling Preference shares is 75% of the average of the market values of the preference shares for fve business days before the purchase is made; and (c) The highest price (not including expenses) which the Company can pay for each 10.375% Sterling Preference share is 125% of the average of the market values of the preference shares for fve business days before the purchase is made. This authority began on 28 March 2018 and will end on the conclusion of the next Annual General Meeting of the Company. The Company may agree, before this authorisation ends, to buy back its own 10.375% Sterling Preference shares even though the purchase may be completed after this authorisation ends. (3) To buy back its own Series A Fixed (6.222%)/ Floating Rate Non-Cumulative Callable Preference Shares on the following terms: (a) The Company may buy up to 13.780 Series A Fixed(6.222%)/ Floating Rate Non-Cumulative Callable Preference Shares; (b) The lowest price which the Company can pay for Series A Fixed(6.222%)/Floating Rate Non-Cumulative Callable Preference Shares is 75% of the average of the market values of the preference shares for fve business days before the purchase is made; and (c) The highest price (not including expenses) which the Company can pay for each Series A Fixed (6.222%)/Floating Rate Non- Cumulative Callable Preference Shares is 125% of the average of the market values of the preference shares for fve business days before the purchase is made. This authority began on 28 March 2018 and will end on the conclusion of the next Annual General Meeting of the Company. The Company may agree, before this authorisation ends, to buy back its own Series A Fixed (6.222%)/Floating Rate Non-Cumulative 695 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix Callable Preference Shares even though the purchase may be completed after this authorisation ends. g) Quoted equity instruments Not applicable. d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights 3. Banco Santander (Brasil) S.A. Not applicable. e) Specifc circumstances that restrict the availability of reserves Not applicable. f) Non-Group entities which hold, directly or through subsidiaries, 10% or more of equity Not applicable. g) Quoted equity instruments The preference share capital of Santander UK plc is traded on the London Stock Exchange under the following details: • 10.375% Sterling Preference – ISIN: GB0000064393 a) Number of fnancial equity instruments held by the Group The Group holds 3,440,170,512 ordinary shares and 3,273,507,089 preference shares through Banco Santander, S.A. and its subsidiaries Sterrebeeck B.V., Grupo Empresarial Santander, S.L., Banco Santander, S.A. and Banco Madesant – Sociedade Unipessoal, S.A. The shares composing the share capital of Banco Santander (Brasil) S.A. have no par value and there are no pending payments. At 2018 year-end, the bank’s treasury shares consisted of 13,316,502 ordinary shares and 13,316,502 preferred shares, with a total of 26,633,004 shares. In accordance with current Bylaws (Article 5.7), the preference shares do not confer voting rights on their holders, except under the following circumstances: • 8.625% Sterling Preference – ISIN: GB0000044221 a) In the event of transformation, merger, consolidation or spin-of • Series A Fixed (6.222%) / Floating Rate Non-Cumulative Callable Preference Shares – ISIN: XS0502105454 2. Abbey National Treasury Services plc a) Number of fnancial equity instruments held by the Group The Group holds ordinary shares amounting to GBP 249,998,000 through Santander UK Group Holdings plc (249,998,000 ordinary shares with a par value of GBP 1 each). The Group also holds 1,000 tracker shares (shares without voting rights but with preferential dividend rights) amounting to GBP 1,000 and 1,000 B tracker shares amounting to GBP 1,000 through Santander UK Group Holdings plc, both with a par value of GBP 1 each. b) Capital increases in progress No approved capital increases are in progress. c) Capital authorised by the shareholders at the general meeting Not applicable. d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights Not applicable. e) Specifc circumstances that restrict the availability of reserves Not applicable. f) Non-Group entities which hold, directly or through subsidiaries, 10% or more of equity Not applicable. of the company. b) In the event of approval of agreements between the company and the shareholders, either directly, through third parties or other companies in which the shareholders hold a stake, provided that, due to legal or bylaw provisions, they are submitted to a general meeting. c) In the event of an assessment of the assets used to increase the company’s share capital. The General Assembly may, at any moment decide to convert the preference shares into ordinary shares, establishing a reason for the conversion. However, the preference shares do have the following advantages (Article 5.6): a) Their dividends are 10% higher than those distributed to ordinary shares. b) Priority in the dividends distribution. c) Participation, on the same terms as ordinary shares, in capital increases resulting from the reserves and profts capitalization and in the distribution of bonus shares arising from the capitalization of retained earnings, reserves or any other funds. d) Priority in the reimbursement of capital in the event company’s dissolution. e) In the event of a public ofering due to a change in control of the company, the holders of preferred shares are guaranteed the right to sell the shares at the same price paid for the block of shares transferred as part of the change of control, i.e. they are treated the same as shareholders with voting rights. 696 2018 Auditors’ report and consolidated annual accounts b) Capital increases in progress No approved capital increases are in progress. b) Capital increases in progress At 31 December 2018 there were no approved capital increases. c) Capital authorised by the shareholders at the general meeting The company is authorised to increase share capital, subject to approval by the Board of Directors, up to a limit of 9,090,909,090 ordinary shares or preferred shares, and without need to maintain any ratio between any of the diferent classes of shares, provided they remain within the limits of the maximum number of preferred shares provided in Law. As of 31 December 2018, the share capital consists of 7,498,531,051 shares (3,818,695,031 ordinary shares and 3,679,836,020 preferred shares). d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights At the general meeting held on 21 December 2016 the shareholders approved the rules relating to the deferred remuneration plans for the directors, management and other employees of the company and of companies under its control. Shares delivery is linked to achievement of certain targets. e) Specifc circumstances that restrict reserves availability The only restriction on the availability of Banco Santander (Brasil) S.A.’s reserves is connected to the requirement for the legal reserve formation (restricted reserves), which can only be used to ofset losses or to increase capital. The legal reserve requirement is set-forth in Article 193 of the Brazilian Corporations Law, which establishes that before allocating profts to any other purpose, 5% of profts must be transferred to the legal reserve, which must not exceed 20% of the company’s share capital. c) Capital authorised by the shareholders at the general meeting Not applicable. d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights Not applicable. e) Specifc circumstances that restrict the availability of reserves Not applicable. f) Non-Group entities which hold, directly or through subsidiaries, 10% or more of equity Not applicable. g) Quoted equity instruments Not applicable. 5. Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México a) Number of fnancial instruments of capital held by the group. In 2018 the merger process of Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México, as merging Company, with GRUPO FINANCIERO SANTANDER MEXICO, S.A.B. DE C.V., as merged Company was fnalised, as well as the Constitution of the new GRUPO FINANCIERO SANTANDER MEXICO, S.A. DE C.V.; the parent group through Grupo Financiero Santander Mexico, S.A. de C.V. (the ‘fnancial group’) and Santander Global Facilities, S.A. de C.V. (Mexico), own 5,087,801,602 shares which constitute the 74.97% of the share capital of the Bank. f) Non-Group entities which hold, directly or through subsidiaries, 10% or more of equity Not applicable. b) Capital increases in course. There aren´t any. g) Listed capital instruments All the shares are listed on the São Paulo Stock Exchange (BM&FBOVESPA; B3 – Brasil, Bolsa, Balcão) and the shares deposit certifcates (American Depositary Receipts - ADR) are listed on the New York Stock Exchange (NYSE). 4. Santander Bank, National Association a) Number of fnancial equity instruments held by the Group At 31 December 2018, the Group held 530,391,043 ordinary shares that carry the same voting and dividend acquisition rights over Santander Holdings USA, Inc. (SHUSA). This holding company and Independence Community Bank Corp. (ICBC) hold 1,237 ordinary shares with a par value of USD 1 each, which carry the same voting rights. These shares constitute all the share capital of Santander Bank, National Association (SBNA). SHUSA holds an 80.84% ownership interest in SBNA, and the remaining 19.16% belongs to ICBC. ICBC is wholly owned by SHUSA. There is no shareholders’ meeting for the ordinary shares of SBNA. c) Capital authorised by the Shareholders Meeting. The a capital stock of the Society is 28,117,661,554.00 mexican pesos (twenty eight thousand one hundred seventeen million six hundred sixty one thousand fve hundred ffty four Mexican pesos) represented by a total of 7,436,994,357 (seven thousand four hundred thirty six million nine hundred ninety four thousand three hundred ffty seven) stocks with a nominal value of 3.780782962 mexican pesos (three Mexican pesos 780782962/1000000000) each one; divided in 3,796,120,213 (three thousand seven hundred ninety six million one hundred and twenty thousand two hundred and thirteen) stocks of “F” Series and 3,640,874,144 (three thousand six hundred and forty million eight hundred seventy four thousand on hundred forty four) stocks of “B” Series. The capital stock is constituted as follows: 697 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix • Paid-in and subscribed capital of the Society is 25,660,152,629.00 mexican pesos (twenty fve thousand six hundred sixty million one hundred ffty two thousand six hundred twenty nine Mexican pesos) represented by a total of 6,786,994,357 (six thousand seven hundred eighty six million nine hundred ninety four thousand three hundred and ffty seven) stocks with a nominal value of 3.780782962 mexican pesos (three Mexican pesos 780782962/1000000000) each one; divided in 3,464,309,145 (three thousand four hundred sixty four million three hundred and nine thousand one hundred forty fve) stocks of “F” Series and 3,322,685,212 (three thousand three hundred twenty two million six hundred eighty fve thousand two hundred and twelve) stocks of “B” Series. • The authorised capital stock of the Society is 2,457,508,925.00 mexican pesos., Two thousand four hundred ffty seven million fve hundred and eight thousand nine hundred and twenty fve Mexican pesos), represented by a total of 650,000,000 (six hundred and ffty million) stocks with a nominal value of 3.780782962 mexican pesos (three Mexican pesos 780782962/1000000000) each one; divided in 331,811,068 (three hundred thirty one million eight hundred eleven thousand and sixty eight) would correspond to the “F” series and 318,188,932 (three hundred eighteen million one hundred eighty eight thousand nine hundred and thirty two) to “B” Series are kept in the treasury of the Society. d) Rights incorporated into parts of founder, bonds or debt, convertible obligations and securities or similar rights. (i) The Board of Directors on its meeting held on October 22, 2015, was updated regarding the situation of the debt issuance of Banco Santander Mexico, S.A. Institución de Banca Múltiple, Grupo Financiero Santander Mexico, which had been previously ratifed in the session held on October 17, 2013, in order to issue debt for the amount of 6,500 million dollars in local or international markets, for a maximum period of 15 years, senior or subordinated debt and includes debt instruments qualifying for purposes of capital in accordance with the legislation in force, which can be implemented individually or through several issue programs. The approved debt issuance of Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México is currently composed as follows: Instrument Type Term Amount Available Broadcast program of bank bonds and certifcates of deposit of money in term Revolving 19-feb-21 55,000 million Mexican pesos Private banking structured bonds Act Not Revolving* 19-apr-32 20,000 million Mexican pesos Structured bonds without public ofering 16-feb-32 Senior Bonds Not Revolving 09-nov-22 Not Revolving 30-jan-24 10,000 million me Mexican xican pesos 1.000 thousand million american dollars 77.09 thousand million American dollars **Carry out the call at 30 January 2019. Not Revolving perpetual 500 million American dollars Not Revolving 1-oct-2028 1,300 millon American dollars Capital Notes (Tier 2 capital)** Capital Notes AT1 Capital Notes (Tier 2 capital) * The issuance of structured private banking bonds isn’t revolving. Once placed the amount laid down in the corresponding brochure a new certifcate is issued by the authorised amount. 698 $35,514 million mexican pesos Con t.c. fx according to Banxico 10/jan/ 2019 $4,936 million mexican pesos $10,000 million mexican pesos N/A N/A N/A N/A 2018 Auditors’ report and consolidated annual accounts   (ii) The Board of Directors on its meeting held on January 27, 2011 approved the general conditions for the senior debt issue in international markets. On October 18, 2012 such issue was approved for the amount of 500 and 1000 million american dollars, for a term of 5 to 10 years. The issue was approved with the objective of obtaining resources to fnance the increase in business assets and the liquidity of the Bank. Under these agreements adopted by the Board of Directors, the debt was issued for an amount of 1,000 million american dollars on November 9, 2012. (iii) On December 27, 2013 Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México issued subordinated notes (subordinated notes 2013) for a total amount of 1.300.000.000 american dollars, in accordance with the capital requirements established in the Basilea III criteria for complementary capital/ Tier 2 at a rate of 5,95% with redemption date of January, 30 2024. The controlling shareholder, Banco Santander, S.A., agreed to buy 975.000.000 american dollars of such notes which correspond to the 75% of the notes. Such notes were ofered through a private ofering only to qualifed institutional buyers, in accordance with Rule 144A of the U.S. Securities Act of 1933 and it´s modifcations, and outside the U.S. under the Regulation S of the Market Law. The issue was approved with the objective of increase the efciency of the capital of the Institution, and to adequate its capital profle to its main peers, as well as to increase the cost efectiveness of resources with the same capital strength and capacity for growth in risk-weighted assets. (iv) On the General Shareholder´s meeting, held on May 14, 2012, it was approved to ratify the agreement adopted by the Extraordinary Shareholder´s meeting held on 17 March 2009, in which it was agreed to create a collective credit for the amount of 1,000,000,000 american dollars through the issue of subordinated, non-preferential, non-guaranteed and non- convertible obligations. So far the issue has not been made. (v) The Board of Director on its meeting held on October 27, 2016 approved the issuance in Mexico of debt up to 500 million of American dollars or its equivalent in Mexican pesos. The Ordinary and Extraordinary Shareholder´s meeting held on December 5, 2016, approved to issue a fnancial instrument that comply with the requirements of regulatory capital established in Basilea III, which was considered as not fundamental basic capital, for up to 500 million american dollars. On December 29, 2016 Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México, made an overseas private ofering of subordinate, non- preferred, perpetual and convertible obligations representing the share capital by a total amount of 500,000,000 american dollars, which had the character of a ‘ mirror emission ‘(back- to-back), as a guarantee of liquidity of subordinate obligations not preferential, perpetual and convertible into shares, issued by Grupo Financiero Santander Mexico. (vi) As a result of the corporate restructure which included among others the merger of Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México, as a merging party with Grupo Financiero Santander Mexico as merged Company the subordinated obligations referred to in paragraph (v), were acquired in its entirety by Banco Santander México, S.A., Institución de Banca Múltiple, Grupo Financiero Santander México; therefore the subordinate obligations of Banco Santander Mexico became extinct by confusion of rights and obligations, since the Bank as a merging party met the quality of debtor and creditor in these instruments at the moment that the merger was fnalised. Based on the above the subordinate obligations issued by Grupo Financiero Santander Mexico, which were acquired by various investors, will continue to be in force on behalf of its owners and managed by Banco Santander Mexico, preserving substantially the terms and conditions in which they were issued. (vii) On September 20, 2018 Banco Santander México, S.A., Institución de Banca Múltiple Grupo Financiero Santander México. issued and placed equity instruments, subordinated, preferential, and not convertible into shares, governed by foreign law representative of the complementary part of the net capital of Banco Santander (Tier 2 subordinated preferred capital notes), for the amount of 1,300,000,000.00 american dollars (the “instruments”), whose resources were used mainly for the acquisition of the 94.07% of the 2013 subordinated notes. The amount issued of 1,300,000,000.00 american dollars covers in full the sum of the repurchase of the subordinated notes 2013, for 1,222,907,000.00 american dollars. With respect to the 77,093,000.00 american dollars that remained in force, shall be paid in advance of January 30, 2019, which has been authorised by the Bank of Mexico. ** Regarding, the acquisition of the subordinated notes 2013: (a) the acquired total amount was 1,222,907,000.00 american dollars (nominal value), at a price of 1,010.50 american dollars and (b) the amount acquired Banco Santander, S.A. (Spain), was a nominal 1,078,094,000.00 american dollars. With respect of the issue of the instruments the total amount distributed to Banco Santander, S.A. (Spain), was 75% of the emission; which means that the settled amount is was 975,000,000.00 american dollars. The General Extraordinary Shareholder´s Meeting was held on September 10, 2018 where among other subjects, it was approved to ratify the limit for the issuance of up to 6,500 million 699 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix American dollars debt to a maximum period of 15 years, senior or subordinate, in local markets and/or international markets, instrumented individually or through broadcast programs, which was previously authorised by the Board of Directors on its meeting held on April 26 of 2018. e) Specifc circumstances that restrict the availability of reserves. According to the Law of Financial Institutions, general dispositions applicable to fnancial institutions, General Corporations law and the bylaws, the Bank has to constitute or increase its capital reserves to ensure the solvency to protect the payments system and the public savings. The Bank increases its legal reserve annually accordingly to the results obtained in the fscal year (benefts). The Bank must constitute the diferent reserves established in the legal provisions applicable to fnancial institutions, which are determined according to the qualifcation granted to credits and they are released when the credit rating improves, or when it is settled. f) Entities outside the Group which own, directly or through subsidiaries, a stake equal to or greater than 10% of the equity. Not applicable. g) Equity instruments admitted to trading. Not applicable. 6. Banco Santander Totta, S.A a) Number of equity instruments held by the Group The Group holds 1,256,179,958 ordinary shares through its subsidiaries: Santander Totta, SGPS, S.A. with 1,241,172,043 shares, Taxagest Sociedade Gestora de Participações Sociais, S.A. with 14,593,315 shares, and Banco Santander Totta, S.A. with 407,130 treasury shares, all of which have a par value of EUR 1 each and identical voting and dividend rights and are subscribed and paid in full. b) Capital increases in progress At 31 December 2018, there were no approved capital increases. c) Capital authorised by the shareholders at the general meeting Not applicable. d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights Not applicable. e) Specifc circumstances that restrict the availability of reserves Under Article 296 of the Portuguese Companies’ Code, the legal and merger reserves can only be used to ofset losses or to increase capital. Non-current asset revaluation reserves are regulated by Decree- Law 31/98, under which losses can be ofset or capital increased by the amounts for which the underlying asset is depreciated, amortised or sold. f) Non-Group entities which hold, directly or through subsidiaries, 10% or more of equity Not applicable. g) Quoted equity instruments Not applicable. 7. Santander Consumer Bank AG a) Number of fnancial equity instruments held by the Group At 31 December 2018, through Santander Consumer Holding GmbH, the Group held 30,002 ordinary shares with a par value of EUR 1,000 each, all of which carry the same voting rights. b) Capital increases in progress Not applicable. c) Capital authorised by the shareholders at the general meeting Not applicable. d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights Not applicable. e) Specifc circumstances that restrict the availability of reserves Not applicable. f) Non-Group entities which hold, directly or through subsidiaries, 10% or more of equity Not applicable. g) Quoted equity instruments Not applicable. 8. Banco Santander - Chile a) Number of equity instruments held by the Group The Group holds a 67.18% ownership interest in its subsidiary in Chile corresponding to 126,593,017,845 ordinary shares of Banco Santander - Chile through its subsidiaries: Santander Chile Holding S.A. with 66,822,519,695 ordinary shares, Teatinos Siglo XXI Inversiones S.A., with 59,770,481,573 ordinary shares and Santander Inversiones S.A. with 16,577 fully subscribed and paid ordinary shares that carry the same voting and dividend rights. b) Capital increases in progress At 31 December 2018, there were no approved capital increases. 700 2018 Auditors’ report and consolidated annual accounts c) Capital authorised by the shareholders at the general meeting Share capital at 31 December 2018 amounted to CLP 891,302,881,691. d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights Not applicable. e) Specifc circumstances that restrict the availability of reserves Remittances to foreign investors in relation to investments made under the Statute of Foreign Investment (Decree-Law 600/1974) and the amendments thereto require the prior authorisation of the foreign investment committee. f) Non-Group entities which hold, directly or through subsidiaries, 10% or more of equity Not applicable. g) Quoted equity instruments All the shares are listed on the Chilean stock exchanges and, through American Depositary Receipts (ADRs), on the New York Stock Exchange (NYSE). 9. Santander Bank Polska S.A. (formerly Bank Zachodni WBK S.A.) a) Number of fnancial equity instruments held by the Group At 31 December, 2018, Banco Santander, S.A. held 68,880,774 ordinary shares with a par value of PLN 10 each, all of which carry the same voting rights. b) Capital increases in progress At 31 December, 2018, there were no approved capital increases. c) Capital authorised by the shareholders at the general meeting At the extraordinary general meeting held on 29 May 2018 passed the resolution regarding the demerger of Deutsche Bank Polska S.A. As a result of this demerger share capital of Santander Bank Polska was increased by PLN 27,548,240 through issuance of 2,754,824 ordinary bearer shares series N with a nominal value of PLN 10 (ten zlotys) each. The share capital increase took place on 9 November 2018. d) Rights on founder’s shares, “rights” bonds, convertible debentures and similar securities or rights At the general meeting held on 17 May 2017, the shareholders resolved to approve the “Incentive Scheme VI” as an initiative to attract, motivate and retain the bank’s employees. Delivery of the shares is tied to the achievement of certain targets in the years from 2017 to 2019. The bank considers that the exercise of these rights might give rise to the issuance of no more than 250,000 shares. e) Specifc circumstances that restrict the availability of reserves Not applicable. f) Non-Group entities, which hold, directly or through subsidiaries, 10% or more of equity Not applicable. g) Quoted equity instruments All the shares of Santander Bank Polska S.A. are listed on the Warsaw Stock Exchange. B) The restrictions on the ability to access or use the assets and settle the liabilities of the Group, as required under paragraph 13 of IFRS12, are described below. In certain jurisdictions, restrictions have been established on the distribution of dividends on the basis of the new, much more stringent capital adequacy regulations. However, there is currently no evidence of any practical or legal impediment to the transfer of funds by Group subsidiaries to the Parent in the form of dividends, loans or advances, repatriation of capital or any other means. Appendix VI Annual banking report The Group’s total tax contribution in 2018 (taxes incurred directly by the Group and the collection of taxes incurred by third parties generated in the course of its economic activities) exceeded EUR 16,600 million of which more than EUR 7,000 million correspond to own taxes (Corporate income tax, non-recoverable VAT and other indirect taxes, payments to the Social Security on behalf of the employer and other taxes on payroll and other taxes and levies). This annual banking report was prepared in compliance with Article 89 of Directive 2013/36/EU of the European Parliament and of the Council, of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment frms, and its transposition into Spanish law pursuant to Article 87 of Law 10/2014, of 26 June on the regulation, supervision and capital adequacy of credit institutions. Following is a detail of the criteria used to prepare the annual banking report for 2018: a) Name(s), nature of activities and geographical location The aforementioned information is available in Appendices I and III to the Group’s consolidated fnancial statements, which contain details of the companies operating in each jurisdiction, including, among other information, their name(s), geographical location and the nature of their activities. 701 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix As can be seen in the aforementioned Appendices, the main activity carried on by the Group in the various jurisdictions in which it operates is commercial banking. The Group operates mainly in ten markets through a model of subsidiaries that are autonomous in capital and liquidity terms, which has clear strategic and regulatory advantages, since it limits the risk of contagion between Group units, imposes a double layer of global and local oversight and facilitates crisis management and resolution. The number of Group ofces totals 13,217 (the largest commercial network of any international bank) and these ofces provide our customers with all their basic fnancial needs. b) Turnover and income before tax For the purposes of this report, turnover is considered to be gross income, and gross proft or loss before tax, both as defned and presented in the consolidated income statement that forms part of the Group’s consolidated fnancial statements. c) Number of employees on a full time equivalent basis The data on employees on a full time equivalent basis were obtained from the average headcount of each jurisdiction. The foregoing amounts form part of the cash fow statement and therefore difer from the income tax expense recognised in the consolidated income statement (EUR 4,886 million in 2018, representing an efective rate of 34.4% or, if extraordinary results are discounted, EUR 5,230 million which represents an efective rate of 35.4% (see note 52.c)). This is so because the tax regulations of each country establish: • The time at which taxes must be paid and, normally, there is a timing mismatch between the dates of payment and the date of generation of the income bearing the tax. • Its own criteria for calculating the tax and establishes temporary or permanent restrictions on expense deduction, exemptions, relief or deferrals of certain income, thereby generating the related diferences between the accounting proft (or loss) and taxable proft (or tax loss) which is ultimately taxed; tax loss carryforwards from prior years, tax credits and/or relief, etc. must also be added to this. Also, in certain cases special regimes are established, such as the tax consolidation of companies in the same jurisdiction, etc. d) Tax on proft or loss In the absence of specifc criteria, the amount of taxes actually paid in respect of those taxes whose efect is recognised under “Income Tax” in the consolidated income statement (EUR 3,458 million in 2018, with an efective tax rate of 24.4%) has been included. e) Public subsidies received In the context of the disclosures required by current legislation, this term was interpreted to mean any aid or subsidy in line with the European Commission’s State Aid Guide and, in such context, the Group companies did not receive public subsidies in 2018. Taxes efectively paid in the year by each of the companies in each jurisdiction include: • Supplementary payments relating to income tax returns, normally for prior years. • Advances, prepayments, withholdings made or borne in respect of tax on proft or loss for the year. Given their scantly representative amount, it was decided that taxes borne abroad would be included in the jurisdiction of the company that bore them. • Refunds collected in the year with respect to returns for prior years that resulted in a refund. • Where appropriate, the tax payable arising from tax assessments and litigation relating to these taxes. 702 2018 Auditors’ report and consolidated annual accounts The detail of the information for 2018 is as follows: 2018 Turnover (million of euros) Employees Gross proft or loss before tax (million of euros) Tax on proft or loss (million of euros) Jurisdiction Germany Argentina Austria Bahamas Belgium Brazil1 Canada Chile China Colombia Spain2 United States Denmark Finland France Ireland Isle of Man Cayman Islands Italy Jersey Luxemburg Malta Mexico3 Norway The Netherlands Panama Paraguay Peru Poland Portugal4 Puerto Rico United Kingdom Singapore Sweden Switzerland Uruguay 1,377 1,203 171 9 104 13,211 52 2,568 95 26 7,644 6,764 177 112 575 108 1 (1) 421 1 39 10 4,562 8,939 349 44 212 44,151 200 11,565 219 169 38,227 15,616 236 171 939 2 57 - 830 76 - - 3,584 19,295 317 96 1 - 70 1,885 1,398 247 5,472 4 161 106 416 508 295 6 - 166 14,930 7,294 963 24,772 10 324 233 1,609 196,969 457 190 83 (1) 64 5,343 10 1,198 28 2 106 1,144 89 69 343 (20) 1 (1) 183 1 33 10 1,218 171 42 - - 42 817 376 (20) 1,922 1 106 29 165 14,201 119 118 33 - 15 998 3 202 3 3 464 29 5 14 63 - - - 63 1 - - 322 55 78 - - 8 228 25 9 537 - 21 7 35 3,458 Consolidated Group total 48,424 1.Including the information relating to a branch in the Cayman Islands the profts of which are taxed in full in Brazil. The contribution of this branch proft before tax from continuing operations 2018 is EUR 613 million. 2. Includes the corporate centre. In Tax on proft or loss, it includes EUR 116 million of monetizable deferred taxes converted form Banco Popular Español, S.A.U. 3. Including the information on a branch in the Bahamas the profts of which are taxed in full in Mexico. In 2018 the contribution of this branch to operating proft before tax from continuing operations was EUR - 2 million. 4. Including the information relating to the branch, closed on 31 December, in the UK and is taxed both in the UK and in Portugal. In 2018 the contribution of this branch to proft before tax from continuing operations was EUR 32 million. At 31 December 2018, the Group’s return on assets (ROA) was 0.64%. 703 Auditors’ reportConsolidated annual accountsNotes to the consolidated annual accountsAppendix PAGE INTENTIONALLY LEFT BLANK IN THE ENGLISH VERSION. IN THE SPANISH VERSION PAGES 704 TO 707 CONTAIN THE SIGNATURE PAGES TO THE BANCO SANTANDER, S.A. 2018 CONSOLIDATED DIRECTORS’ REPORT AND CONSOLIDATED FINANCIAL STATEMENTS IN THE FORM REQUIRED UNDER SPANISH LAW. 704 Annual Report 2018 Resposible Banking Corporate governance report Economic and financial review Risk Management Report PAGE INTENTIONALLY LEFT BLANK IN THE ENGLISH VERSION. IN THE SPANISH VERSION PAGES 704 TO 707 CONTAIN THE SIGNATURE PAGES TO THE BANCO SANTANDER, S.A. 2018 CONSOLIDATED DIRECTORS’ REPORT AND CONSOLIDATED FINANCIAL STATEMENTS IN THE FORM REQUIRED UNDER SPANISH LAW. 705 PAGE INTENTIONALLY LEFT BLANK IN THE ENGLISH VERSION. IN THE SPANISH VERSION PAGES 704 TO 707 CONTAIN THE SIGNATURE PAGES TO THE BANCO SANTANDER, S.A. 2018 CONSOLIDATED DIRECTORS’ REPORT AND CONSOLIDATED FINANCIAL STATEMENTS IN THE FORM REQUIRED UNDER SPANISH LAW. 706 Annual Report 2018 Resposible Banking Corporate governance report Economic and financial review Risk Management Report PAGE INTENTIONALLY LEFT BLANK IN THE ENGLISH VERSION. IN THE SPANISH VERSION PAGES 704 TO 707 CONTAIN THE SIGNATURE PAGES TO THE BANCO SANTANDER, S.A. 2018 CONSOLIDATED DIRECTORS’ REPORT AND CONSOLIDATED FINANCIAL STATEMENTS IN THE FORM REQUIRED UNDER SPANISH LAW. 707 General information Corporate information Banco Santander, S.A. is a Spanish bank, incorporated as sociedad anónima in Spain and is the parent company of Grupo Santander. Banco Santander, S.A. operates under the commercial name Santander. The Bank’s Legal Entity Identifer (LEI) is 5493006QMFDDMYWIAM13 and its Spanish tax identifcation number is A-390000013. The Bank is registered with the Companies Registry of Cantabria, and its Bylaws have been adapted to the Spanish Companies Act by means of the notarial deed instrument executed in Santander on 29 July 2011 before the notary Juan de Dios Valenzuela García, under number 1209 of his book and fled with the Companies Registry of Cantabria in volume 1006 of the archive, folio 28, page number S-1960, entry 2038. The Bank is also registered in the Ofcial registry of entities of Bank of Spain with code number 0049. The Bank’s registered ofce is at: Paseo de Pereda, 9-12 39004 Santander Spain The Bank’s principal executive ofces are located at: Santander Group City Avda. de Cantabria s/n 28660 Boadilla del Monte Madrid Spain Telephone: (+34) 91 259 65 20 Corporate history The Bank was established in the city of Santander by public deed before the notary José Dou Martínez on 3 March 1856, which was later ratifed and amended in part by a second public deed dated 21 March 1857 executed before the notary José María Olarán. The Bank commenced operations upon incorporation on 20 August 1857 and, according to article 4 of the Bylaws, its duration shall be for an indefnite period. It was transformed into a credit corporation (sociedad anónima de crédito) by public deed, executed before notary Ignacio Pérez, on 14 January 1875 and registered in the Companies Registry Book of the Government’s Trade Promotion Section in the province of Santander. The Bank amended its Bylaws to conform to the Spanish public companies act of 1989 by means of a public deed executed in Santander on 8 June 1992 before the notary José María de Prada Díez and recorded in his notarial record book under number 1316. On 15 January 1999, the boards of directors of Santander and Banco Central Hispanoamericano, S.A. agreed to merge Banco Central Hispanoamericano, S.A. into Santander, and to change Banco Santander’s name to Banco Santander Central Hispano, S.A. The shareholders of Santander and Banco Central Hispanoamericano, S.A. approved the merger on 6 March 1999, at their respective general meetings and the merger became efective in April 1999. The Bank’s general shareholders’ meeting held on 23 June 2007 approved the proposal to change back the name of the Bank to Banco Santander, S.A. As indicated above, the Bank brought its Bylaws into line with the Spanish Companies Act by means of a public deed executed in Santander on 29 July 2011. The Bank’s general shareholders’ meeting held on 22 March 2013 approved the merger by absorption of Banco Español de Crédito, S.A. On 7 June 2017, Santander acquired the entire share capital of Banco Popular Español, S.A. in an auction in connection with a resolution plan adopted by the European Single Resolution Board (the European banking resolution authority) and executed by the FROB (the Spanish banking resolution authority) following a determination by the European Central Bank that Banco Popular was failing or likely to fail, in accordance with Regulation (EU) 806/2014 establishing a framework for the recovery and resolution of credit institutions and investment frms. On 24 April 2018, the Bank announced that the boards of directors of Banco Santander, S.A. and Banco Popular Español, S.A.U. had agreed to an absorption of Banco Popular by Banco Santander. The legal absorption was efective on 28 September 2018. Annual Report 2018 Shareholder and investor relations Santander Group City Pereda, 2ª planta Avda. de Cantabria, s/n 28660 Boadilla del Monte Madrid Spain Telephone: (+34) 91 259 65 14 investor@gruposantander.com Hard copies of the Bank’s annual report can be requested by shareholders free of charge at the address and phone number indicated above. Media enquiries Santander Group City Arrecife, 2ª planta Avda. de Cantabria, s/n 28660 Boadilla del Monte Madrid Spain Telephone: (+34) 91 289 52 11 comunicacion@gruposantander.com Customer service department Calle Princesa, 25 Edifcio Hexágono, 2ª planta 28008 Madrid Spain Telephone: (+34) 91 759 48 36 atenclie@gruposantander.com Banking Ombudsman in Spain (Defensor del cliente en España) Mr José Luis Gómez-Dégano Apartado de Correos 14019 28080 Madrid Spain ©February 2019, Banco Santander, S.A. All rights reserved. Photographs: Miguel Sánchez Moñita, Lucía M. Diz, Javier Vázquez and Jaime Boira Production: MRM-Mccann Sprintfnal Legal deposit: M-7729-2019 All customers, shareholders and the general public can use Santander’s ofcial social network channels in all the countries in which the Group operates. Resposible BankingCorporate governance reportEconomic and financial reviewRisk Management Report 

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