Bank of Commerce Holdings
Annual Report 2017

Plain-text annual report

Annual Financial Report 2017 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report For the year ended 31 December 2017 Annual Financial Report 2017 Contents Page Board of Directors and Executives Forward Looking Statements and Notes Directors’ Report of Bank of Cyprus Holdings Public Limited Company Consolidated Financial Statements of Bank of Cyprus Holdings Group Independent Auditor’s Report to the Members of Bank of Cyprus Holdings Public Limited Company on the Consolidated Financial Statements and the Company Financial Statements Financial Statements of the Bank of Cyprus Holdings Public Limited Company Annual Corporate Governance Report Additional Risk and Capital Management Disclosures Definitions and explanations on Alternative Performance Measures Disclosures 1 2 3 25 203 212 226 266 285 BANK OF CYPRUS HOLDINGS GROUP Board of Directors and Executives as at 26 March 2018 Annual Financial Report 2017 Board of Directors of Bank of Cyprus Holdings Public Limited Company Executive Committee Prof. Dr. Josef Ackermann CHAIRMAN Maksim Goldman VICE CHAIRMAN Arne Berggren Lyn Grobler Dr. Michael Heger John Patrick Hourican Dr. Christodoulos Patsalides Michalis Spanos Ioannis Zographakis Anat Bar-Gera John Patrick Hourican CHIEF EXECUTIVE OFFICER Dr. Christodoulos Patsalides DEPUTY CHIEF EXECUTIVE OFFICER AND CHIEF OPERATING OFFICER Michalis Athanasiou CHIEF RISK OFFICER Nick Fahy CHIEF EXECUTIVE OFFICER, BANK OF CYPRUS UK Eliza Livadiotou FINANCE DIRECTOR Panicos Nicolaou DIRECTOR CORPORATE BANKING Louis Pochanis DIRECTOR INTERNATIONAL BANKING, WEALTH AND MARKETS Dr. Charis Pouangare DIRECTOR CONSUMER AND SME BANKING Nicolas Scott Smith DIRECTOR RESTRUCTURING AND RECOVERIES DIVISION Anna Sofroniou DIRECTOR REAL ESTATE MANAGEMENT UNIT Aristos Stylianou EXECUTIVE CHAIRMAN, INSURANCE BUSINESSES Company Secretary Katia Santis Legal Advisers as to matters of Irish Law Arthur Cox Legal Advisers as to matters of English and US Law Sidley Austin LLP Legal Advisers as to matters of Cypriot Law Chryssafinis & Polyviou LLC Independent Auditors Registered Office Ernst & Young Chartered Accountants Ernst & Young Building Harcourt Centre Harcourt Street Dublin 2 Ireland Arthur Cox 10 Earlsfort Terrace Dublin 2 D02 T380 Ireland 1 BANK OF CYPRUS HOLDINGS GROUP Forward Looking Statements and Notes Annual Financial Report 2017 Forward Looking Statements and Notes This document contains certain forward-looking statements which can usually be identified by terms used such as ‘expect’, ‘should be’, ‘will be’ and similar expressions or variations thereof. These forward-looking statements include, but are not limited to, statements relating to the Bank of Cyprus Holdings Public Limited Company Group (the Group) intentions, beliefs or current expectations and projections about the Group’s future results of operations, financial condition, liquidity, performance, prospects, anticipated growth, provisions, impairments, strategies and opportunities. By their nature, forward-looking statements involve risk and uncertainty because they relate to events, and depend upon circumstances, that will or may occur in the future. Factors that could cause actual business, strategy and/or results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements made by the Group include, but are not limited to: general economic and political conditions in Cyprus and other European Union (EU) Member States, interest rate and foreign exchange fluctuations, legislative, fiscal and regulatory developments and information technology, litigation and other operational risks. Should any one or more of these or other factors materialise, or should any underlying assumptions prove to be incorrect, the actual results or events could differ materially from those currently being anticipated as reflected in such forward-looking statements. The forward-looking statements made in this document are only applicable as from the date of publication of this document. Except as required by any applicable law or regulation, the Group expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained in this document to reflect any change in the Group’s expectations or any change in events, conditions or circumstances on which any statement is based. The definitions and explanations on Alternative Performance Measures Disclosures are presented in ‘Definitions and explanations on Alternative Performance Measures Disclosures’ of the Annual Financial Report 2017. The Annual Financial Report 2017 is available at the Bank of Cyprus Holdings Public Limited Company Registered Office (10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland) and on the Group’s website www.bankofcyprus.com (Investor Relations/Financial Results). 2 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 The Board of Directors submits to the shareholders of the Company their Directors’ Report together with the audited Consolidated Financial Statements (Consolidated Financial Statements) and Financial Statements of the Company for the year ended 31 December 2017. The Annual Financial Report relates to the Bank of Cyprus Holdings Public Limited Company (the Company) and together with its subsidiaries (the Group) which was listed on the London Stock Exchange (LSE) and the Cyprus Stock Exchange (CSE) as at 31 December 2017. Group reorganisation On 18 January 2017 the Company became the sole shareholder of Bank of Cyprus Public Company Ltd (BOC PCL). This reorganisation was treated as a reorganisation of an existing entity that has not changed the substance of the reporting entity. The owners of BOC PCL before the reorganisation have the same absolute and relative interests in the net assets of the Group (being the Company, BOC PCL and its subsidiaries) immediately before and after the reorganisation, since the assets and liabilities of the Group and the BOC group (being BOC PCL and its subsidiaries) are the same immediately before and after the reorganisation. Hence, the Group is considered as a continuation of the BOC group. As this transaction did not result in any change of economic substance, it also did not have any effect on the total equity of the Group. The Group’s Consolidated Financial Statements reflect the difference in the amounts of share capital, share premium and capital reduction reserves as an adjustment in equity. Activities The Company was incorporated with the intention of becoming the holding company of the Group for the purposes of the Group’s listing on the LSE. The principal activities of BOC PCL and its subsidiary companies involve the provision of banking, financial services, insurance services and management and disposal of property predominately acquired in exchange of debt. All Group companies and branches are set out in Note 50 of the Consolidated Financial Statements. The Group has established branches in Greece and Romania. Acquisitions and disposals made during the year 2017 are detailed in Notes 50 and 51 of the Consolidated Financial Statements. Operating environment in Cyprus Economic recovery in Cyprus accelerated in 2017 and the medium term outlook is favourable driven by an improving labour market, broadening investments and increasing resilience. Cyprus continues to face challenges primarily in relation to public and private indebtedness and non-performing exposures (NPEs), but while more remains to be done, considerable progress has been achieved. Real Gross Domestic Product (GDP) in Cyprus increased by 3.9% in 2017 according to the Cyprus Statistical Service, compared with a 3.4% increase the previous year. In the labour market, the unemployment rate dropped to 11% on average in the year from 13% the year before according to the Cyprus Statistical Service. Average consumer inflation was marginally positive at 0.5% after four years of deflation. In the public sector the budget surplus increased significantly and the trend in the public debt to GDP ratio appears to be reversing downwards. In the banking sector funding conditions continued to improve against a backdrop of favourable developments regarding NPEs. The growth momentum is expected to be maintained in the medium term. Real GDP is expected to grow by 3.6% in 2018 and by 2.9% in 2019, slowing towards 2.5% by 2022 according to the International Monetary Fund (IMF) (Cyprus country report, December 2017). Growth will be supported by private consumption and investment expenditures and by an improving and robust labour market. On the supply side, growth is expected to be driven by favourable developments in the tourism sector and robust performance in business services. Tourism remains robust and continues to benefit from geopolitical uncertainties in competing destinations. Tourist arrivals in 2017 reached 3.7 million persons, an all-time high, and revenues reached an estimated €2.6 billion or c.13.7% of GDP. 3 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Operating environment in Cyprus (continued) The budget surplus increased to 1.9% of GDP in 2017 according to estimates by the IMF (Cyprus country report, December 2017), from 0.5% the previous year. The budget is expected to generate sizeable surpluses in the medium term (IMF, Cyprus country report, December 2017). The debt to GDP ratio is estimated at 97.5% in 2017 according to the Cyprus Statistical Service, and it is expected to decline to 75% by 2022 also according to the IMF (Cyprus country report, December 2017). Debt remains affordable with interest charges at 2.6% of GDP in 2016-2017 compared with 3.3% of GDP in 2013 (IMF, Cyprus country report, December 2017). The government took advantage of favourable conditions in debt markets to issue a new €850 million 7-year bond in June 2017 yielding 2.8% to pre-finance borrowing needs through to end-2018, and to smooth its repayment schedule beyond 2018. In the banking sector there have been significant improvements in funding conditions and asset quality. Total deposits increased marginally by 0.8% in the year, with resident deposits increasing by 3.3%. Loan deleveraging continued in the year with total loans outstanding dropping by 7.1% and loans to residents dropping by 4.8% (according to Central Bank of Cyprus (CBC) data). Cyprus’ consistent fiscal outperformance and favourable outlook indicate a more rapid reversal in the public debt ratio and the ratio of NPEs, than previously expected. The outlook over the medium term is generally positive according to the IMF and the European Commission while the economy continues to face challenges. Upside factors relate to a longer period of low oil prices, further improvement of economic fundamentals in the euro area and stronger investment spending as property prices are stabilising and as projects in tourism, energy and public works are being implemented. Downside risks to this outlook are associated with the still high levels of NPEs and public debt ratio, and with a possible deterioration of the external environment. The Cyprus government rating has been repeatedly upgraded following the consistent outperformance in public finances and the progress achieved in the banking sector. Most recently in March 2018, S&P Global Ratings affirmed its long-term sovereign rating at BB+, only one notch below investment grade, and maintained its outlook to positive. Ιn October 2017, Fitch Ratings upgraded its Long-Term Issuer Default ratings to BB from BB- with positive outlook. In July 2017, Moody’s Investors Service upgraded the long-term issuer rating of the Cyprus sovereign to Ba3 from B1 to reflect Cyprus’ economic recovery and maintained its outlook to positive. Moody’s Investors Service reiterated its credit rating and positive outlook on the Cyprus sovereign in a February 2018 update. 4 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Financial results The main financial highlights for 2017 are set out below: Consolidated Income Statement € million Net interest income Net fee and commission income Net foreign exchange gains and net gains on other financial instruments and disposal/dissolution of subsidiaries Insurance income net of claims and commissions Net gains from revaluation and disposal of investment properties and on disposal of stock of properties Other income Total income Staff costs Other operating expenses Special levy and contribution to Single Resolution Fund (SRF) Total expenses Operating profit Provision charge Impairments of other financial and non-financial assets Provisions for litigation and regulatory matters 2017 2016 583 180 48 50 27 19 907 (228) (171) (23) (422) 485 (779) (65) (98) 686 167 48 44 6 12 963 (224) (153) (20) (397) 566 (370) (47) (18) Total provisions and impairments (942) (435) Share of profit from associates and joint ventures (Loss)/profit before tax and restructuring costs Tax Loss/(profit) attributable to non-controlling interests (Loss)/profit after tax and before restructuring costs Advisory, Voluntary Exit Plan and other restructuring costs Net gain on disposal of non-core assets (Loss)/profit after tax 9 (448) (77) 2 (523) (29) - (552) 8 139 (16) (4) 119 (114) 59 64 In the consolidated income statement, within the Consolidated Financial Statements for the year ended 31 December 2017:    Provision charge includes ‘Provisions for impairment of loans and advances to customers and other customer credit losses’ and ‘Gain on derecognition of loans and advances to customers and changes in expected cash flows’. Advisory, Voluntary Exit Plan and other restructuring costs of €29 million include €28 million presented within ‘Other operating expenses’ and €1 million presented within ‘Staff costs’ (2016: €51 million within operating expenses and €63 million within staff costs). The net gain on disposal of non-core assets for the year ended 31 December 2016 represent gains of €58 million and €3 million and losses of €2 million, presented within ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’, ‘Other income’ and ‘Income tax’ respectively. 5 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Financial results (continued) Net Interest Margin Cost to income ratio Cost to income ratio excluding special levy and contribution to Single Resolution Fund Operating profit return on average assets Basic and diluted (losses)/earnings per share attributable to the owners of the Company/BOC PCL (€ cent) 3.02% 47% 44% 2.1% (123.72) 3.47% 41% 39% 2.5% 14.27 2017 2016 Key Balance Sheet figures and ratios Gross loans (€ million) Accumulated provisions (€ million) Customer deposits (€ million) Loans to deposits ratio (net) 90+ DPD ratio 90+ DPD provisioning coverage ratio NPE ratio NPE provisioning coverage ratio Quarterly average interest earning assets (€ million) Leverage ratio Capital ratios and risk weighted assets Common Equity Tier 1 capital ratio (CET1) (transitional) CET1 (fully loaded) Total capital ratio Risk weighted assets (€ million) Balance Sheet 31 December 2017 31 December 2016 18,755 4,204 17,850 82% 37% 61% 47% 48% 19,826 10.4% 12.7% 12.2% 14.2% 17,260 20,130 4,519 16,510 95% 41% 54% 55% 41% 19,060 13.2% 14.5% 13.9% 14.6% 18,865 Capital Base Shareholders’ equity totalled €2,586 million at 31 December 2017. The CET1 ratio (transitional) stood at 12.7% at 31 December 2017, compared to 14.5% at 31 December 2016. Adjusting for deferred tax assets, the CET1 ratio on a fully-loaded basis totalled 12.2% at 31 December 2017 (2016: 13.9%). During 2017 the CET1 ratio was negatively affected by the loss for the year and the deferred tax asset phasing-in, despite the reduction in risk-weighted assets (RWAs). As at 31 December 2017 the Total Capital ratio (transitional) stood at 14.2%, above the minimum required as from 1 January 2017 of 13%, positively affected mainly by the issuance of £30 million Tier 2 Capital Loan by the UK subsidiary. The Group’s minimum phased-in CET1 capital ratio requirement for 2017 was 9.50%, comprised of a 4.50% Pillar I requirement, a 3.75% Pillar II requirement and the Capital Conservation Buffer (CCB) of 1.25% applicable for 2017. Following the Supervisory Review and Evaluation Process (SREP) performed by the European Central Bank (ECB) in 2017 and based on the confirmation received in December 2017, the Pillar II requirement applicable from 1 January 2018 has been reduced to 3.00% from 3.75%. As a result, the Group’s minimum phased-in CET1 capital ratio has been reduced to 9.375% from 9.50%, comprising of a 4.50% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018. The ECB has also provided revised lower non-public guidance for an additional Pillar II CET1 buffer. The Group CET1 ratio remains comfortably above this combined Pillar II requirement and guidance. 6 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Financial results (continued) Balance Sheet (continued) Capital Base (continued) The overall Total Capital Ratio requirement for 2017 was 13.00%, comprising of a Pillar I requirement of 8.00% (of which up to 1.50% can be in the form of Additional Tier 1 (AT1) capital and up to 2.00% in the form of Tier 2 capital), a Pillar II requirement of 3.75% (in the form of CET1), and the CCB of 1.25% applicable for 2017. Following the final 2017 SREP decision, the overall Total Capital Ratio requirement has been reduced to 12.875% from 13.00%, comprising of 8.00% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018. The Group continues to explore opportunities, subject to market conditions, to raise up to 1.5% of AT1 in the near term to further strengthen the Group’s capital base. In preparation for a potential issuance of AT1 capital instruments and following the approvals of the Cypriot courts in July 2017 and December 2017, BOC PCL proceeded with the full reduction of its capital reduction reserve, in order to eliminate the BOC PCL’s accumulated losses. The reduction of capital did not have any impact on regulatory capital or the total equity position of the BOC PCL or the Group. The retained earnings will provide the basis for the calculation of distributable items under the Capital Requirements Regulation (EU) No. 575/2013 (CRR). The CRR provides that coupons on AT1 capital instruments may only be paid out of distributable items. Distributable items for the purposes of the CRR are determined, in part, by reference to retained earnings. At 31 December 2017, BOC PCL had €0.7 billion in distributable items. The BOC PCL is currently under a dividend distribution prohibition which will continue in 2018 following the final 2017 SREP decision received in December 2017. However, based on the decision, such prohibition will not apply to the payment of coupons on any AT1 capital instruments issued by BOC PCL. Both the retained earnings and distributable items of BOC PCL will partly decrease as a result of the IFRS 9 implementation on 1 January 2018. IFRS 9 Financial Instruments The Group IFRS 9 implementation has been largely completed by 1 January 2018. The new accounting standard requires the impact on the implementation date, 1 January 2018, to be recognised through equity rather than the income statement. As a result, the impact on transition, 1 January 2018, will affect the equity of the Group and not the income statement. The Group’s IFRS 9 preliminary impact on transition, which is subject to change due to final parameter calibrations, is assessed to a decrease of shareholders’ equity of c.€300 million, and is primarily driven by credit impairment provisions. This estimated reduction in shareholders’ equity equates to a decrease in the tangible net asset value at 31 December 2017 of €0.67 per share. The Group will implement the transitional arrangements for regulatory capital purposes which result in only 5% of the estimated IFRS 9 impact affecting the capital ratios during 2018. Allowing for IFRS 9 transitional arrangements the impact is a decrease of c.9 bps on Group capital ratios. On a transitional basis and on a fully phased-in basis after the period of transition is complete, the impact of IFRS 9 is expected to be manageable and within the Group’s capital plans. Default Definition According to the European Banking Authority (EBA) guidelines that govern the CRR default definition, issued in January 2017, the default definition will gradually evolve to align with the NPE definition by 1 January 2021. The Group, in line with regulatory discussions, intends to early adopt changes that will almost align the EBA CRR definition with the NPE definition as from 1 January 2018. This will result in an increase in RWAs, equivalent to a decrease of c.40 bps on CET1 ratio and a decrease of c.50 bps on total capital ratio based on 31 December 2017 figures. 7 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Financial results (continued) Balance Sheet (continued) Funding and Liquidity At 31 December 2017, the BOC PCL’s funding from central banks totalled €930 million, which relates wholly to ECB funding, compared to funding from central banks at 31 December 2016 of €850 million, which comprised Emergency Liquidity Assistance (ELA) of €200 million and ECB funding of €650 million. The ECB funding of €930 million at the year-end comprises €830 million of funding through Targeted Longer-Term Refinancing Operations (TLTRO II) and €100 million of funding through Main Refinancing Operations (MRO). BOC PCL fully repaid ELA in January 2017. Group customer deposits totalled €17,850 million at 31 December 2017, compared to €16,510 million at 31 December 2016. Cyprus deposits stood at €15,983 million at 31 December 2017, accounting for 90% of Group customer deposits. The BOC PCL’s deposit market share in Cyprus reached 32.8% at 31 December 2017. Customer deposits accounted for 76% of total assets at 31 December 2017. The Loan to Deposit ratio (L/D) stood at 82% at 31 December 2017, compared to a high of 151% at 31 March 2014. In December 2017, the BOC PCL’s subsidiary in the UK issued a £30 million unsecured and subordinated Tier 2 Capital Loan. In January, 2017 BOC PCL accessed the debt capital markets and issued a €250 million unsecured and subordinated Tier 2 Capital Note. At 31 December 2017 the Group Liquidity Coverage Ratio (LCR) stood at 190% (compared to 49% at 31 December 2016) and was in compliance with the minimum regulatory requirement of 80% (which increased to 100% on 1 January 2018). The LCR of BOC PCL amounted to 188%. The Net Stable Funding Ratio (NSFR) was not introduced on 1 January 2018, as per expectations. The minimum requirement of NSFR will be 100%. At 31 December 2017 the Group’s NSFR, on the basis of the Basel ΙΙΙ standards, stood at 111% (compared to 95% at 31 December 2016). On 1 January 2018, the local regulatory liquidity requirements were abolished, in accordance with the CRR and in December 2017 the CBC introduced a macro-prudential measure in the form of a liquidity add-on that was imposed on top of the LCR with effect on 1 January 2018. The objective of the measure is to ensure that there will be a gradual release of the excess liquidity arising from the lower liquidity requirements under the LCR compared to the ones under the local regulatory liquidity requirements previously in place. The LCR add-on applies stricter outflow and inflow rates than those defined in the Commission Delegated Regulation (EU) 2015/61. The measure will be implemented in two stages. The first stage requires stricter outflow and inflow rates which are applicable from 1 January 2018 until 30 June 2018. The second stage requires more relaxed outflow and inflow rates compared to the initial ones and are applicable from 1 July 2018 until 31 December 2018. Specifically there will be a reduction of 50% of the LCR add-on rates on 1 July 2018. The additional liquidity requirement is expected to be implemented up to 31 December 2018. The CBC may propose to modify or extend the period of application of this macro-prudential measure depending on the results of the follow-up of the banks’ actions on how the excess liquidity is utilised. The Group and BOC PCL are currently in compliance with the LCR including the LCR add-on. Loans and loan portfolio quality Group gross loans totalled €18,755 million at 31 December 2017, compared to €20,130 million at 31 December 2016. Gross loans in Cyprus totalled €16,814 million at 31 December 2017 and accounted for 90% of Group gross loans. BOC PCL is the single largest credit provider in Cyprus with a market share of 39.2% at 31 December 2017. Gross loans in the UK amounted to €1,621 million at 31 December 2017 and accounted for 9% of Group total gross loans. New loan originations for the Group reached €2,231 million for the 2017 (of which €1,653 million were granted in Cyprus and €578 million by the UK subsidiary), exceeding new lending in 2016 by 53%. At 31 December 2017, the Group net loans and advances to customers totalled €14,602 million (2016: €15,649 million). At 31 December 2017, there were no net loans and advances to customers which were classified as held for sale in line with IFRS 5 (2016: nil). 8 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Financial results (continued) Balance Sheet (continued) Loans and loan portfolio quality (continued) Tackling the Group’s loan portfolio quality remains the top priority for the Group. The Group continues to make steady progress across all asset quality metrics and the loan restructuring activity continues. The Group has been successful in engineering restructuring solutions across the spectrum of its loan portfolio. NPEs as defined by the EBA were reduced by €2.2 billion or 20% during 2017 to €8,804 million at 31 December 2017, accounting for 46.9% of gross loans, compared to 54.8% at 31 December 2016. The provisioning coverage ratio of NPEs stood at 48% at 31 December 2017, compared to 41% at 31 December 2016. When taking into account tangible collateral at fair value, NPEs are fully covered. The 31 December 2017 NPE provisioning coverage ratio increases from 48% to 51% upon IFRS 9 first time adoption. 31 December 2017 31 December 2016 € million % of gross loans € million % of gross loans NPEs as per EBA definition 8,804 46.9% 11,034 54.8% Of which: - NPEs with forbearance measures, no arrears 1,619 8.6% 2,037 10.1% The Group has recorded significant organic NPE reductions for eleven consecutive quarters and expects the organic reduction of NPEs to continue during the coming quarters. In parallel the Group continues to be actively exploring alternative avenues to accelerate this reduction. Loans in arrears for more than 90 days (90+ DPD) were reduced by €1.4 billion or 17% in 2017. The decrease was the result of restructuring activity, debt for asset swaps and write offs. 90+ DPD stood at €6,905 million at 31 December 2017, accounting of 37% of gross loans (90+DPD ratio), compared to 41% at 31 December 2016. The provisioning coverage ratio of 90+ DPD stood at 61% at 31 December 2017, compared to 54% at 31 December 2016. When taking into account tangible collateral at fair value, 90+ DPD loans are fully covered. 90+ DPD Comprising: - Loans with arrears for over 90 days but not impaired - Impaired loans Of which: 31 December 2017 31 December 2016 € million % of gross loans € million % of gross loans 6,905 36.8% 8,309 41.3% 1,385 7.4% 1,408 7.0% 5,520 29.4% 6,901 34.3% - - Impaired with no arrears Impaired with arrears less than 90 days 402 162 2.1% 0.9% 472 91 2.3% 0.5% Real Estate Management Unit The Real Estate Management Unit (REMU) on-boarded €520 million of assets in 2017, via the execution of debt for asset swaps. The focus for REMU is increasingly shifting from on-boarding of assets resulting from debt for asset swaps towards the disposal of these assets. The Group completed disposals of €258 million in 2017. In addition in 2017 the Group disposed of a property with carrying value of €10 million, classified as investment property. As at 31 December 2017, assets held by REMU had a carrying value of €1.6 billion. 9 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Financial results (continued) Balance Sheet (continued) Real Estate Management Unit (continued) Assets held by REMU (Group) Opening balance On-boarded assets Sales Closing balance 31 December 2017 31 December 2016 € million € million 1,427 520 (258) 1,641 542 1,086 (166) 1,427 Non-core overseas exposures The remaining non-core overseas net exposures (including both on-balance sheet and off-balance sheet exposures) at 31 December are as follows: € million Greece Romania Serbia Russia 31 December 2017 31 December 2016 193 79 9 31 283 149 42 44 The Group continues its effort for further deleveraging and disposal of non-essential assets and operations in Greece, Romania and Russia. In accordance with the Group’s strategy to exit from overseas non-core operations, the operations of the branch in Romania are expected to be terminated, subject to the completion of deregistration formalities with respective authorities. Most of the remaining assets and liabilities of the branch in Romania with third parties have been transferred to other entities of the Group. In addition to the above, at 31 December 2017 there were overseas exposures of €168 million in Greece not identified as non-core exposures, since they are considered by management as exposures arising in the normal course of business. Income Statement Net interest income (NII) for 2017 amounted to €583 million down by 15% compared to €686 million a year earlier and the net interest margin (NIM) for 2017 stood at 3.02% (2016: 3.47%). Average interest earning assets for 2017 amounted to €19,301 million, down by 2% a year earlier. Non-interest income for 2017 amounted to €324 million, mainly comprising of net fee and commission income of €180 million, net insurance income of €50 million and net foreign exchange income and net gains on financial instruments and disposal/dissolution of subsidiaries of €48 million. Non-interest income for 2017 increased by 17%, largely driven by the increase in gains from REMU sales and the new and increased commission charges introduced in late 2016. Total income for 2017 amounted to €907 million, compared to €963 million for 2016 (6% decrease since last year), with the reduction reflecting mainly the 2017 reduction in NII. Total expenses for 2017 were €422 million, 54% of which related to staff costs (€228 million), 41% to other operating expenses (€171 million) and 5% to special levy and contribution to SRF (€23 million). 10 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Financial results (continued) Income Statement (continued) The 2017 annual SRF contribution of €6 million was reversed following the amendment of the Imposition of Special Credit Institution Tax Law to allow the offsetting of the SRF contribution with the special levy charge. The cost to income ratio for 2017 was 47%, compared to 41% for 2016, principally reflecting lower interest income. Operating profit for 2017 was €485 million compared to €566 million for 2016. Provisions for 2017 totalled €779 million, up by 111% compared to 2016. The elevated provisioning levels reflect changes in BOC PCL’s provisioning assumptions as a result of the Group’s reconsideration of its strategy to more actively explore other innovative strategic solutions to further accelerate balance sheet de-risking. The provisioning charge for 2017 accounted for 4.0% of gross loans. An amount of c.€500 million reflecting the one-off effect of the change in the provisioning assumptions is included in the cost of risk. At 31 December 2017, accumulated provisions, including fair value adjustment on initial recognition and provisions for off-balance sheet exposures, totalled €4,204 million (compared to €4,519 million at 31 December 2016) and accounted for 22.4% of gross loans at 31 December 2017 and 31 December 2016. Impairments of other financial and non-financial assets for the year 2017 totalled €65 million, compared to €47 million for 2016, primarily affected by impairment charges relating to legacy exposures and legacy stock of properties in Cyprus and Greece. Provisions for litigation and regulatory matters for 2017 amounted to €98 million, primarily relating to redress provisions for the UK operations and a fine imposed by the Cyprus Commission for the Protection of Competition. The tax charge for 2017 totalled €77 million compared to €16 million in 2016. The elevated tax charge of 2017 reflects the reduction of deferred tax assets by €62 million, following the increase in provisions for impairment of loans and advances to customers and evaluation of the recoverability assessment of the DTA balance. Advisory, VEP and other restructuring costs for 2017 totalled €29 million, compared to €114 million for 2016 (down by 74% compared to last year). The elevated levels in the previous year relate mainly to the Voluntary Exit Plan (VEP). Loss after tax attributable to the owners of the Company for 2017 was €552 million, compared to a profit after tax of €64 million for 2016. Going concern The Directors have made an assessment of the Group’s ability to continue as a going concern. The conditions that existed during 2017 and the developments up to the date of approval of these Consolidated Financial Statements that have been considered in the going concern assessment include, amongst others, the operating environment in Cyprus and of the Group (Note 4 of the Consolidated Financial Statements). The Directors believe that the Group is taking all necessary measures to maintain its viability and the development of its business in the current economic environment. The Directors, taking into consideration the factors described below and the uncertainties that existed at the reporting date, are satisfied that the Group has the resources to continue in business for a period of at least 12 months from the date of approval of the Consolidated Financial Statements and, therefore, the going concern principle is appropriate for the reasons set out below. 11 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Going concern (continued)        The Common Equity Tier 1 (CET1) ratio and the total capital ratio on a transitional basis stood at 12.7% and 14.2% respectively at 31 December 2017, higher than the minimum required ratios (Note 4.2.1 of the Consolidated Financial Statements). The IFRS 9 impact on a transitional and on a fully phased-in basis, after the period of transition is complete, is expected to be manageable and within the Group’s capital plan. The increasing level of Group customer deposits (increase of €1,340 million during 2017). Customer deposits stood at €17,850 million at 31 December 2017. The continuous improvement in the Group liquidity position and its liquidity ratios. Following the repayment of ELA in January 2017 (2016: €200 million), the Group achieved compliance with the LCR. The Group is also in compliance with the LCR add-on, which was introduced by the CBC as a macro-prudential measure and is applicable from 1 January 2018 (Notes 4.2.3 and 46 of the Consolidated Financial Statements). As at 31 December 2017, the Group was not in compliance with all liquidity regulatory requirements with respect to its operations in Cyprus, however, these ratios were abolished on 1 January 2018. The significant reduction of Group loans that are impaired or past due for more than 90 days (90+ DPD), which have decreased by 17% during 2017 and totalled €6,905 million at 31 December 2017 and the increase of provisions coverage to 61% compared to 54% at 31 December 2016 (Note 4.2.2 of the Consolidated Financial Statements). The Cyprus government rating has been repeatedly upgraded following the consistent outperformance in public finances and the progress achieved in the banking sector. Most recently in March 2018, S&P Global Ratings affirmed its long-term sovereign rating at BB+, only one notch below investment grade, and maintained its outlook to positive. Ιn October 2017, Fitch Ratings upgraded its Long-Term Issuer Default ratings to BB from BB- with positive outlook. In July 2017, Moody’s Investors Service upgraded the long- term issuer rating of the Cyprus sovereign to Ba3 from B1 to reflect Cyprus’ economic recovery and maintained its outlook to positive. Moody’s Investors Service reiterated its credit rating and positive outlook on the Cyprus sovereign in a February 2018 update. BOC PCL regained access to the debt capital markets in January 2017 with the issuance of a €250 million unsecured subordinated Tier 2 Capital Note. Viability statement In accordance with the requirements of the UK Corporate Governance Code 2016 (UK Code), the Directors have assessed the viability of the Group, taking account of the Group’s current position and the potential impact of the main risks that the Group is facing. The Directors have selected a three-year period for this assessment in arriving at the viability statement, which is also within the usual planning process of the Group. The Directors have assessed the prospects of the Group through a number of sources, including the latest 3 year plan of the Group, the NPE strategy, the Internal Capital Adequacy Assessment Process (ICAAP) and the Internal Liquidity Assessment Process (ILAAP) reports. The Group prepared a detailed NPE Strategy Plan for the 5 year period 2017-2021 as requested by the Single Supervisory Mechanism (SSM). The plan was approved by the Board of Directors of the Company and submitted to the SSM in March 2017. The Group is currently preparing its first annual review of its NPE Strategy Plan. The ICAAP is an annual process that demonstrates whether the Group has all the necessary procedures in place in adequately identifying, measuring and monitoring the Group’s risks and ensures that the Group holds adequate capital to support its risk profile, under both a base case and a stress case. The Group also undertakes a quarterly review of its ICAAP results considering the latest actual and forecasted information. During the quarterly review, the Group’s risk profile and risk management policies and processes are reviewed and any changes since the annual ICAAP exercise are taken into consideration. The ICAAP process demonstrates that the Group has sufficient capital under both the base and stress case scenarios to support its business and achieve its objectives having regard to its Board approved Risk Appetite and Strategy, and to meet its regulatory capital, leverage and liquidity requirements. 12 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Viability statement (continued) The Group’s ILAAP analysis demonstrates that the volume and capacity of liquidity resources available to the Group are adequate to support its business model, to achieve its strategic objectives under both the business as usual and severe stress scenarios and to meet regulatory requirements including the LCR and NSFR. The Group prepares the ICAAP and ILAAP reports annually. Both reports for year 2016 were approved by the Board of Directors and submitted to the SSM in April 2017. The current year ICAAP and ILAAP reports are in progress and are expected to be finalised and submitted to the SSM by the end of April 2018. The base case of the ICAAP report is the latest 3 year plan of the Group approved by the Board in December 2017, updated if necessary for any developments. The Directors confirm that based on their assessment of the principal risks which the Group is exposed, the most significant of which are credit risk, liquidity risk, litigation risk, market risk (arising from adverse movements in exchange rates, interest rates and security prices) and risk on changes in the fair value of property, those risks are monitored and mitigated through various control mechanisms and processes (refer to Risk management section below). Based on this, and the assessment of the Group’s prospects, the Directors have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period to 31 December 2020. Business Overview As the Cypriot operations account for 90% of gross loans and 90% of customer deposits, the Group’s financial performance is highly correlated to the economic and operating conditions in Cyprus and will consequently benefit from the country’s recovery. Most recently in October 2017, Standard and Poor’s assigned BOC PCL 'B/B' long- and short-term issuer credit ratings with positive outlook. BOC PCL currently has a long-term deposit rating from Moody’s Investors Service of Caa1 with a positive outlook and a long-term issuer default rating from Fitch Ratings Limited of B- with stable outlook. The key drivers for the ratings were the improvement in the Group’s financial fundamentals mainly in asset quality and its funding position. Tackling the Group’s loan portfolio quality is of utmost importance for the Group. During the year an internal reorganisation of the Restructuring and Recoveries Division (RRD) was implemented with the aim of boosting resources on both the Retail and Small and medium-sized enterprises (SME) portfolios of RRD in order to further improve pace and sustainability in these portfolios. Additionally, the Group has created an incremental servicing engine powered by Pepper Cyprus Limited, to support BOC PCL in resolving non- performing loans from its SME and retail portfolios. The strategic focus of the Group is to reshape its business model to grow in the core Cypriot market through prudent new lending and carefully developing the UK franchise. The Group’s capital position remains adequate and the Group expects to continue to be able to support the recovery of the Cyprus economy through the provision of new lending. Growth in new lending in Cyprus is focused on selected industries that are more in line with BOC PCL's target risk profile, such as tourism, trade, professional services, information/communication technologies, energy, education and green projects. BOC PCL is currently looking to carefully expand its UK operations, remaining consistent with the Group’s overall credit appetite and regulatory environment. With selective presence in London and Birmingham and a predominantly retail funded franchise, the UK strategy is to support its core proposition in the property market, specifically targeting the professional buy-to-let market and further expanding its mortgage business and its savings, current accounts and trade-related products for SMEs, professionals and Cypriot residents. Aiming at supporting investments by SMEs and mid-caps to boost the Cypriot economy and create new jobs for young people, BOC PCL continues to provide joint financed schemes. To this end, BOC PCL continues its partnership with the European Investment Bank (EIB), the European Investment Fund (EIF), the European Bank for Reconstruction and Development (EBRD) and the Cyprus Government. 13 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Business Overview (continued) Management is also placing emphasis on diversifying income streams by boosting fee income from international transaction services, wealth management and insurance. The Group’s insurance companies, EuroLife Ltd and General Insurance of Cyprus Ltd operating in the sectors of life and general insurance respectively, are leading players in the insurance business in Cyprus, with such businesses providing a recurring income, further diversifying the Group’s income streams. The insurance income net of insurance claims for 2017 amounted to €50 million, up by 13% during 2017, compared to €44 million for 2016, contributing to 16% of non-interest income. In order to further improve its funding structure, BOC PCL is stepping up its efforts to manage the deposit mix to ensure continued compliance with liquidity requirements, taking advantage of the increased customer confidence towards the Group, as well as improving macroeconomic conditions in Cyprus. Strategy and Outlook The Group remains on track for implementing its strategic objectives aiming to become a stronger, safer and a more focused institution capable of supporting the recovery of the Cypriot economy and delivering appropriate shareholder returns in the medium term. The key pillars of the Group’s strategy are to:       Materially reduce the level of delinquent loans Further improve the funding structure Maintain an appropriate capital position by internally generating capital Focus on the core Cyprus market and the UK operations Achieve a lean operating model Deliver value to shareholders and other stakeholders 14 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Strategy and Outlook (continued) KEY PILLARS PLAN OF ACTION 1. Materially reduce the level of delinquent loans 2. Further improve the funding structure 3. Maintain an appropriate capital position 4. Focus on core markets 5. Achieve a lean operating model 6. Deliver returns • • • • • • • • • • • • • • • Sustain momentum in restructuring Focus on terminated portfolios (in Recovery Unit) – “accelerated consensual foreclosures” Real estate management via REMU Explore alternative accelerating NPE reduction measures such as NPE sales, securitisations etc. Focus on shape and cost of deposit franchise Increase loan pool for the Additional Credit Claim framework of ECB Further diversify funding sources Internally generate capital Potential AT1 issuance Targeted lending in Cyprus into promising sectors to fund recovery New loan origination, while maintaining lending yields Revenue diversification via fee income from international business, wealth, and insurance Careful expansion of UK franchise by leveraging the UK subsidiary Implementation of digital transformation program underway, aimed at enhancing productivity distribution channels and reducing operating costs over time Deliver appropriate medium term risk- adjusted returns 15 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Strategy and Outlook (continued) The table below shows the Group’s performance against the 2018 Target and the Medium Term Guidance. Group Key Performance Indicators 1 2016 2017 NPE ratio 55% 47% 2018 Target <40% ~€2 billion organic reduction Medium-Term Guidance <25% Asset Quality NPE coverage ratio 41% 48% >50% >50% Cost of Risk (Provisioning charge)2 1.7% 4.0%2 <1.0% <1.0% Capital CET1 Ratio 14.5% 12.7% >13%3,4 >13%3,4 Total Capital Ratio 14.6% 14.2% >15%3,4 >15%3,4 Total income €963 million €907 million >€800 million Profitability Cost to Income ratio 41% 47% <50%5 Total income to grow in excess of cost5 Net fee and commission income / total income Balance Sheet Total assets 17%6 €22.2 billion 20% >20% >20% €23.6 billion ~€23 billion >€25 billion Earnings per share EPS (€ cent) 14.27 (123.72) ~407 1 The NIM and the Net Loans to Deposits (L/D) targets have been removed. A new target on Total Income has been included in the key metrics considering the focus of the Group on total revenue generation and the shift of income to other lines of the Income Statement. The L/D ratio has been removed as it is not considered representative following the efforts of the Group to comply with the LCR ratio including the LCR add-on. 2 An amount of c.€500 million reflecting the one-off effect of the change in the provisioning assumptions is included in the cost of risk. 3 Allowing for IFRS 9 transitional arrangements for regulatory capital purposes in line with European Union (EU) Regulation (2018: 5%, 2019: 15%, 2020: 30%, 2021: 50% and 2022: 75%). 4 Including the impact of the adoption of the changes aligning the EBA CRR default definition with the NPE definition. 5 Excluding the special levy and SRF contribution. 6 The net fee and commission income over total income for 2016 excludes non-recurring fees of ~€7 million. 7 The 2018 target for the earnings per share does not include the impact of any trades or any unplanned or unforeseen events. 16 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Capital base Shareholders’ equity totalled €2,586 million at 31 December 2017. The CET1 ratio (transitional) totalled 12.7% at 31 December 2017 (2016: 14.5%). Adjusting for DTA, the CET1 ratio on a fully-loaded basis totalled 12.2% at 31 December 2017 (2016: 13.9%). The Total Capital ratio (transitional), at 31 December 2017, stood at 14.2% (2016: 14.6%). Additional information on regulatory capital is disclosed in the Additional Risk and Capital Management Disclosures which form part of this Annual Report and in the Pillar 3 Disclosures Report, which is available on the Group’s website www.bankofcyprus.com (Investor Relations). Share capital As at 31 December 2017, there were 446,199,933 issued ordinary shares with a nominal value of €0.10 each. Information about the changes on the authorised and issued share capital during 2017 and 2016 is disclosed in Note 35 of the Consolidated Financial Statements. Share-based payments - share options Following the incorporation of the Company and its introduction as the new holding company of the Group in January 2017, the Long Term Incentive Plan (as approved on 24 November 2015 by the Annual General Meeting of BOC PCL) was replaced by the Share Option Plan which operates at the level of the Company. The Share Option Plan is identical to the Long Term Incentive Plan except that the number of shares in the Company to be issued pursuant to an exercise of options under the Share Option Plan should not exceed 8,922,945 ordinary shares of a nominal value of €0.10 each and the exercise price was set at €5.00 per share. The term of the options was also extended to between 4-10 years after the grant date. No share options were granted since the date of replacement of the Long Term Incentive Plan by the Share Option Plan at the level of the Company. Any shares related to the Share Option Plan carry rights with regards to control of the Company that are only exercisable directly by the employee. Treasury shares of the Company Shares of the Company held by entities controlled by the Group are deducted from equity on the purchase, sale, issue or cancellation of such shares. No gain or loss is recognised in the consolidated income statement. The life insurance subsidiary of the Group, as at 31 December 2017, held a total of 142 thousand ordinary shares of the Company of a nominal value of €0.10 each (2016: 2,889 thousand ordinary shares of BOC PCL of a nominal value of €0.10 each), as part of its financial assets which are invested for the benefit of insurance policyholders (Note 24 of the Consolidated Financial Statements). The cost of acquisition of these shares was €21,463 thousand (2016: €25,333 thousand). For additional disclosures refer to Note 35 of the Consolidated Financial Statements. 17 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Change of control There are no significant agreements to which the Company is a party and which take effect following a change of control of the Company, but the Company is party to a number of agreements that may allow the counterparties to alter or terminate the agreements following a change of control. These agreements are not deemed to be significant in terms of their potential effect on the Group as a whole. The Group also has agreements which provide for termination if, upon a change of control of the Company, the Company’s creditworthiness is materially worsened. Other information During 2017 and 2016 there were no restrictions on the transfer of the Company’s ordinary shares or securities and no restrictions on voting rights other than the provisions of the Banking Law of Cyprus which requires the CBC approval prior to acquiring shares of the Company in excess of certain thresholds and the requirements of the Directive on Insider Dealing and Market Manipulation, which relates to transactions with related parties. Shares of the Company held by the life insurance subsidiary of the Group as part of its financial assets which are invested for the benefit of insurance policyholders carry no voting rights, pursuant to the insurance law. The Company does not have any shares in issue which carry special control rights. There are no agreements between shareholders, known to the Company, which may result in restrictions on the transfer of securities or voting rights. Rights and obligations of ordinary shares In accordance with the Company’s Constitution, the rights and restrictions attaching to the ordinary shares are as follows:  subject to the right of the Company to set the record dates for the purposes of determining the identity of members entitled to notice of and/or to vote at a general meeting, the right to attend and speak at any general meeting of the Company and to exercise one vote per ordinary share at any general meeting of the Company; the right to participate pro rata in all dividends declared by the Company; and the right, in the event of the Company’s winding up, to participate pro rata in the total assets of the Company.   Shareholders holding more than 3% of the share capital of the Company As at 31 December 2017 and 15 March 2018 the following shareholders held more than 3% of the share capital of the Company: 31 December 2017 15 March 2018 Number of ordinary or Depositary Interests representing Company ordinary shares % held Number of ordinary or Depositary Interests representing Company ordinary shares % held 41,383,699 9.27% 41,383,699 9.27% 22,401,744 5.02% 22,401,744 5.02% Lamesa Holdings S.A. (affiliate of Renova Group) European Bank for Reconstruction and Development Cyprus Popular Bank Public Co Ltd 21,467,719 4.81% 21,467,719 4.81% TD Asset Management 19,365,565 4.34% 19,365,565 4.34% Senvest Management LLC 16,383,514 3.67% 16,383,514 3.67% Osome Investments Ltd 14,809,498 3.32% 14,809,498 3.32% Eaton Vance 13,708,448 3.07% 16,182,333 3.63% 18 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Dividends The Company and BOC PCL are currently under a regulatory dividend distribution prohibition and therefore no dividends were declared or paid during the years 2017 and 2016. Events after the reporting date There are no material events which occurred after the reporting date. Risk management Like other financial organisations, the Group is exposed to risks, the most significant of which are credit risk, liquidity risk, market risk (arising from adverse movements in exchange rates, interest rates and security prices) and insurance risk. The Group monitors, manages and mitigates these risks through various control mechanisms. Detailed information relating to Group risk management is set out in Notes 44 to 47 of the Consolidated Financial Statements and in the Additional Risk and Capital Management Disclosures which form part of the Annual Financial Report 2017. The Group is also exposed to litigation risk, arising from claims, investigations and regulatory matters. Further information is disclosed in Note 39 of the Consolidated Financial Statements. Additionally, the Group is exposed to the risk on changes in the fair value of property which is held either for own use or as stock of property or as investment property. Stock of property is predominately acquired in exchange of debt and is intended to be disposed of in line with the Group’s strategy. Further information is disclosed in Notes 22, 25 and 27 of the Consolidated Financial Statements. In addition, details of the significant judgements, estimates and assumptions which may have a material impact on the Group’s financial performance and position are set out in Note 5 of the Consolidated Financial Statements. Details of the financial instruments and hedging activities of the Group are set out in Notes 22 and 44 to 46 of the Consolidated Financial Statements. The Pillar 3 Disclosures Report (unaudited) of the Group required with respect to the requirements of the Capital Requirement Regulation (EU) No 575/2013 is published on the Group’s website www.bankofcyprus.com (Investor Relations). Books and significant records The measures that the Directors have taken to secure compliance with the requirements of sections 281 to 285 of the Companies Act 2014 of Ireland (Companies Act 2014), with regard to the keeping of accounting records, include the provision of appropriate resources to maintain adequate accounting records throughout the Company and the Group, including the appointment of personnel with appropriate qualifications, experience and expertise. The accounting records are maintained at the Company’s registered office at 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland and at 51 Stassinos Street, Ayia Paraskevi, Strovolos, P.O.Box 24884, 1398 Nicosia, Cyprus. Research and development The Group did not incur any expenditure in research and development for the year ended 31 December 2017. Political donations Political donations are required to be disclosed under the Electoral Act 1997 of Ireland (as amended). The Directors, on enquiry, have satisfied themselves that there were no political donations made during the year ended 31 December 2017. 19 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Relevant audit information In the case of persons who are Directors at the time this report is approved in accordance with section 330 of the Companies Act 2014:   the Directors hereby individually and collectively acknowledge, that so far as each Director is aware, there is no relevant material audit information of which the Company’s statutory auditors are unaware; and that he/she has taken all the steps that he/she ought to have taken as a Director in order to make himself/herself aware of any relevant audit information and to establish that the Company’s statutory auditors are aware of that information. Preparation of periodic reporting The Board is responsible for ensuring that the management maintains an appropriate system of internal controls which provides assurance of effective operations, internal financial controls and compliance with rules and regulations. It has the overall responsibility for the Group and approves and oversees the implementation of the Group’s strategic objectives, risk strategy and internal governance. The Group has appropriate internal control mechanisms, including sound administrative and accounting procedures, Information Technology (IT) systems and controls. The governance framework is subject to review at least once a year. Policies and procedures have been designed in accordance with the nature, scale and complexity of the Group’s operations in order to provide reasonable but not absolute assurance against material misstatements, errors, losses, fraud or breaches of laws and regulations. The Board, through the Audit Committee, conducts reviews on a frequent basis, regarding the effectiveness of the Group’s internal controls and information systems, as well as in relation to the procedures used to ensure the accuracy, completeness and validity of the information provided to investors. The reviews cover all systems of internal controls, including financial, operational and compliance controls, as well as risk management systems. The role of the Audit Committee is inter alia to ensure the financial integrity and accuracy of the Company’s financial reporting. The Group’s financial reporting process is controlled using documented accounting policies and procedures supported by instructions and guidance on reporting requirements, issued to all reporting entities within the Group in advance of each reporting period. The submission of financial information from each reporting entity is subject to sign off by the responsible financial officer. Further analytical review procedures are performed at Group level. The internal control system also ensures that the integrity of the accounting and financial reporting systems, including financial and operational controls and compliance with legal and regulatory requirements and relevant standards, is adequate. The Group has in place an effective financial statement closing process by which transactions and events reflected in the Group’s accounting records are processed to produce the financial statements, related disclosures and other financial reports. The Annual Report pre its submission to the Board is reviewed and approved by the Executive Committee. The Board, through the Audit Committee scrutinises and approves the financial statements, results announcements and the Annual Report and ensures that appropriate disclosures have been made. This governance process ensures that both management and the Board are given sufficient opportunity to challenge the Group’s financial statements and other significant disclosures before their publication. 20 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Corporate Governance Statement In April 2014 the CSE issued the 4th Edition (Revised) of the Corporate Governance Code (the CSE Code). Listed companies have an obligation to include in their Annual Financial Report, a Report by the Board of Directors on Corporate Governance. In the first part of the Report, companies should report whether they comply with the CSE Code and the extent to which they implement its principles. In the second part of the Report, companies should confirm that they have complied with the CSE Code provisions and in the event that they have not, they should give adequate explanation. The Company has also chosen to comply with the UK Corporate Governance Code 2016 published by the Financial Reporting Council in the UK (the UK Code) following the decision to proceed with a Listing on the London Stock Exchange. Regarding the first part of the Report, as a company listed on the CSE, the Company has adopted the CSE Code and implements its principles. Regarding the second part of the Report, the Company complies with the provisions of the CSE Code. Throughout the Corporate Governance Report for 2017 a narrative statement is provided on how the principles of the CSE Code have been applied. The narrative also covers principles of the UK Code and how these have been applied throughout the year. The rules governing the composition of the Board of Directors and the appointment and replacement of its members are set out in Section 1 of the Corporate Governance Report for 2017. The powers of the Board of Directors and committees of the Board with administrative, management and supervisory functions, including any powers of the Directors in relation to the issuing or buying back by the Company of its shares, are also set out in the Corporate Governance Report. Any amendment or addition to the Articles of Association of the Company is only valid if approved by a special resolution at a shareholders’ meeting. A description of the operation of the shareholder meeting, the key powers of the shareholder meeting, shareholders’ rights and the exercise of such right is contained in Section 7 of the Corporate Governance Report. Details of restrictions in voting rights and special control rights in relation to the shares of the Company are set out in the section ‘Other information’ above. Other information required to be disclosed for the purposes of the European Communities (Takeover Bids (Directive 2004/25/EC)) Regulations 2006 is contained on pages 3 to 24. In accordance with section 167 of the Companies Act 2014, the Directors confirm that a Board Audit Committee is established. Details of the Board Audit Committee’s membership and activities are included in Corporate Governance Report for 2017. The Corporate Governance Report for 2017 is included within this Annual Financial Report on pages 226 to 265. The statements and information referred in this Corporate Governance Statement are deemed to be incorporated herein. 21 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Directors’ Compliance Statement As required by section 225 of the Companies Act 2014, the Directors acknowledge that they are responsible for securing the Company’s compliance with its relevant obligations (as defined in section 225(1)). The Directors confirm that a compliance statement has been drawn up setting out the Company’s policies and that appropriate arrangements and structures have been put in place that are, in the Directors’ opinion, designed to secure material compliance with the relevant obligations. A review of those arrangements and structures has been conducted in the financial year to which this report relates. Service termination agreements The service contract of one of the executive directors in office as at 31 December 2017 includes a clause for termination, by service of four months’ notice to that effect upon the executive director, without cause but at BOC PCL’s sole discretion. In such a case, BOC PCL shall have the obligation to pay the executive director in lieu of notice for immediate termination. The terms of employment of the other executive director are mainly based on the provisions of the collective agreement in place, which provides for notice or compensation by the BOC PCL based on years of service and for a four month prior written notice by the executive director in the event of a voluntary resignation. Board of Directors The members of the Board of Directors of the Company as at the date of this Directors’ Report are listed on page 1. All Directors were members of the Board throughout the year and up to the date of this Directors’ Report except as disclosed below. Ms Lyn Grobler was appointed as member of the Board of Directors following ECB approval on 7 February 2017. On 27 April 2017 the Board of Directors decided to appoint Ms Anat Bar- Gera as member of the Board of Directors and her appointment was approved by the ECB on 27 October 2017. Messrs Wilbur L. Ross Jr. and Marios Kalochoritis resigned on 1 March 2017 and on 27 June 2017 respectively. On 23 January 2018, the Board of Directors decided to appoint Ms Paula Hadjisotiriou and Ms Maria Philippou as members of the Board of Directors. Their appointment is subject to approval by the ECB. In accordance with the Articles of Association at each annual general meeting of the Company every Director who has been in office at the completion of the most recent annual general meeting since they were last appointed or reappointed, shall retire from office and offer themselves for re-election if they wish. The remuneration of the Board of Directors is disclosed in Note 49 of the Consolidated Financial Statements. 22 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Directors’ Report Annual Financial Report 2017 Directors’ and Secretary’s interests The interest in the share capital of the Company held by each member of the Board of Directors and Company Secretary is presented in the table below: Company BOC PCL Ordinary shares or Depositary Interests representing Company ordinary shares of €0.10 each at 31 December 2017 Ordinary shares or Depositary Interests representing Company ordinary shares of €0.10 each at 1 January 2017 Ordinary shares of €0.10 each at 1 January 2017 or at the date of appointment 150,000 7,192 25,000 61,430 3,012 170 4 246,808 - - - - - 10 - 10 3,000,000 143,821 500,000 1,228,595 60,240 3,390 66 4,936,112 Non-executive directors Prof. Dr. Josef Ackermann Maksim Goldman Arne Berggren Michalis Spanos Ioannis Zographakis Executive directors Dr. Christodoulos Patsalides Company Secretary Katia Santis Apart from the interests set out above, the Board of Directors and Secretary had no other interests in the shares of the Company or its subsidiaries at 31 December 2017. Environmental and employee matters The Group’s policy on environmental and employee matters is available at www.bankofcyprus.com (Responsibility, CSR Reports). Statement of Directors’ Responsibilities The Directors are responsible for preparing the Annual Financial Report and the financial statements in accordance with International Financial Reporting Standards (IFRS) adopted by the EU and with those parts of the Companies Act 2014 applicable to companies reporting under IFRSs and, in respect of the consolidated financial statements, Article 4 of the International Accounting Standards (IAS) Regulation. Under Irish law the Directors shall not approve the financial statements unless they are satisfied that they give a true and fair view of the Group’s and Company’s assets, liabilities and financial position as at the end of the financial year and of the profit or loss of the Group and the Company for the financial year. In preparing these financial statements, the Directors are required to:  select suitable accounting policies and apply them consistently  make judgements and estimates that are reasonable and prudent  state whether the financial statements have been prepared in accordance with IFRSs as adopted by the EU and ensure that they contain the additional information required by the Companies Act 2014; and prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Company will continue in business.  23 Consolidated Financial Statements 25 BANK OF CYPRUS HOLDINGS GROUP Consolidated Financial Statements - Contents For the year ended 31 December 2017 Annual Financial Report 2017 Contents Page Consolidated Income Statement Consolidated Statement of Comprehensive Income Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to the Consolidated Financial Statements 1. Corporate information 2. Summary of significant accounting policies 2.1 Group reorganisation 2.2 Basis of preparation 2.3 Accounting policies and changes in accounting policies and disclosures 2.4 Standards and interpretations 27 28 29 30 32 33 33 33 34 34 that are issued but not yet effective 35 45 2.5 Basis of consolidation 2.6 Business combinations 45 2.7 Investments in associates and joint ventures 46 46 2.8 Foreign currency translation 47 2.9 Segmental reporting 47 2.10 Turnover 47 2.11 Revenue recognition 48 2.12 Retirement benefits 49 2.13 Tax 49 2.14 Financial instruments 2.15 Derecognition of financial assets and financial liabilities 2.16 Impairment of financial assets 2.17 Hedge accounting 2.18 Offsetting financial instruments 2.19 Cash and cash equivalents 2.20 Insurance business 2.21 Repurchase and reverse repurchase agreements 2.22 Finance leases – The Group as lessor 2.23 Operating leases 2.24 Property and equipment 2.25 Investment properties 2.26 Stock of property 2.27 Non-current assets held for sale and 52 52 54 55 55 55 56 57 57 57 58 58 discontinued operations 2.28 Intangible assets 2.29 Share capital 2.30 Treasury shares 2.31 Provisions 2.32 Financial guarantees 2.33 Comparative information 58 59 59 59 59 60 60 60 3. Going concern 4. Operating environment 61 5. Significant judgements, estimates and assumptions 64 6. Segmental analysis Interest income 7. Interest expense 8. Fee and commission income and expense 9. 10. Net foreign exchange gains 11. Net gains on financial instrument transactions and disposal/dissolution of subsidiaries 12. Insurance income net of claims and commissions 13. Other income 14. Staff costs 15. Other operating expenses 16. Provisions for impairment of financial and non- financial instruments 17. Income tax 18. Earnings per share 19. Cash, balances with central banks and loans and Page 70 77 77 77 78 78 79 80 81 87 88 89 93 advances to banks 20. Investments 21. Derivative financial instruments 22. Fair value measurement 23. Loans and advances to customers 24. Life insurance business assets attributable to 94 94 100 102 115 policyholders 115 117 119 121 122 122 123 124 125 126 127 128 130 130 131 131 136 138 139 25. Property and equipment 26. Intangible assets 27. Stock of property 28. Prepayments, accrued income and other assets 29. Non-current assets held for sale 30. Funding from central banks 31. Customer deposits 32. Insurance liabilities 33. Subordinated loan stock 34. Accruals, deferred income and other liabilities 35. Share capital 36. Dividends 37. Accumulated losses 38. Fiduciary transactions 39. Contingent liabilities and commitments 40. Net cash flow from operating activities 41. Cash and cash equivalents 42. Operating leases – The Group as lessee 43. Analysis of assets and liabilities by expected maturity 44. Risk management – Credit risk 45. Risk management – Market risk 46. Risk management – Liquidity risk and funding 47. Risk management – Insurance risk 48. Capital management 49. Related party transactions 50. Group companies 51. Acquisitions and disposals 52. Investments in associates and joint ventures 53. Country by country reporting 140 141 169 173 183 184 185 193 196 199 202 26 BANK OF CYPRUS HOLDINGS GROUP Consolidated Income Statement for the year ended 31 December 2017 Annual Financial Report 2017 Turnover Interest income Interest expense Net interest income Fee and commission income Fee and commission expense Net foreign exchange gains Net gains on financial instrument transactions and disposal/dissolution of subsidiaries Insurance income net of claims and commissions Net (losses)/gains from revaluation and disposal of investment properties Net gains on disposal of stock of property Other income Staff costs Special levy on deposits on credit institutions in Cyprus Other operating expenses Gain on derecognition of loans and advances to customers and changes in expected cash flows Provisions for impairment of loans and advances to customers and other customer credit losses Impairment of other financial instruments Impairment of non-financial instruments (Loss)/profit before share of profit from associates and joint ventures Share of profit from associates and joint ventures (Loss)/profit before tax Income tax (Loss)/profit after tax for the year Attributable to: Owners of the Company/BOC PCL Non-controlling interests (Loss)/profit for the year Notes 2017 €000 2016 €000 2.10 1,165,177 1,234,098 7 8 9 9 10 11 12 13 14 15 15 16 16 16 52 17 811,031 890,298 (228,291) (204,116) 582,740 190,577 686,182 176,865 (10,179) (10,207) 45,409 43,471 2,964 63,373 50,401 44,432 (4,061) 4,974 30,447 19,052 1,361 14,905 907,350 1,025,356 (228,212) (287,172) (22,846) (19,968) (297,979) (222,987) 358,313 495,229 173,443 63,315 (952,926) (433,609) (6,459) (58,972) (11,293) (36,220) (486,601) 77,422 8,957 (477,644) 8,194 85,616 (76,681) (18,385) (554,325) 67,231 (551,852) (2,473) (554,325) 63,656 3,575 67,231 Basic and diluted (losses)/earnings per share (€ cent) attributable to the owners of the Company/BOC PCL 18 (123.7) 14.3 27 BANK OF CYPRUS HOLDINGS GROUP Consolidated Statement of Comprehensive Income for the year ended 31 December 2017 Annual Financial Report 2017 (Loss)/profit for the year Other comprehensive income (OCI) OCI to be reclassified in the consolidated income statement in subsequent periods Foreign currency translation reserve Profit/(loss) on translation of net investments in foreign branches and subsidiaries (Loss)/profit on hedging of net investments in foreign branches and subsidiaries Transfer to the consolidated income statement on disposal/dissolution of foreign operations Available-for-sale investments Net gains from fair value changes before tax Share of net gains from fair value changes of associates Transfer to the consolidated income statement on impairment Transfer to the consolidated income statement on sale OCI not to be reclassified in the consolidated income statement in subsequent periods Property revaluation Fair value gain before tax Share of fair value gain of associates Tax Actuarial gains/(losses) on the defined benefit plans Remeasurement gains/(losses) on defined benefit plans Other comprehensive income/(loss) after tax 25 17 14 Notes 2017 €000 2016 €000 (554,325) 67,231 742 (43,763) 21 (1,166) 53,408 (104) (3,958) (528) 5,687 46,506 1,709 (37) (606) 47,572 47,044 9,319 11 (522) 8,808 842 1,677 839 (47,960) (44,602) (38,915) - - 219 219 10,819 19,627 66,671 (14,255) (14,036) (52,951) Total comprehensive (loss)/income for the year (487,654) 14,280 Attributable to: Owners of the Company/BOC PCL Non-controlling interests Total comprehensive (loss)/income for the year (485,595) (2,059) (487,654) 15,321 (1,041) 14,280 28 BANK OF CYPRUS HOLDINGS GROUP Consolidated Statement of Changes in Equity for the year ended 31 December 2017 Annual Financial Report 2017 Attributable to the owners of the Company Share capital (Note 35) Share premium (Note 35) Capital reduction reserve (Note 35) Treasury shares (Note 35) Accumulated losses (Note 37) Property revaluation reserve Revaluation reserve of available- for-sale investments Other reserves Life insurance in- force business reserve Foreign currency translation reserve Non- controlling interests Total equity Total €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 1 January 2017 892,294 552,618 1,952,486 (25,333) (544,930) 90,936 7,139 6,059 103,251 36,626 3,071,146 34,959 3,106,105 Loss for the year Other comprehensive income/(loss) after tax for the year Total comprehensive (loss)/income for the year Increase in value of in- force life insurance business Tax on increase in value of in-force life insurance business Transfer of realised profits on disposal of properties Cancellation of shares due to reorganisation (Note 2.1) Change of parent company to Bank of Cyprus Holdings Public Limited Company and issue of new shares (Note 2.1) Disposals of treasury shares Dividends paid to non- controlling interests - - - - - - (892,294) - - - - - - - - - - - - - - - - (551,852) - - 10,819 8,620 47,346 - (541,033) 8,620 47,346 - - - (2,743) 343 - - 6,678 (6,678) 21,463 - - - - - - - - - - - - - - 2,743 (343) - - - - - - (551,852) (2,473) (554,325) (528) 66,257 414 66,671 (528) (485,595) (2,059) (487,654) - - - - - - - - - - - - - (870,831) - (870,831) - 870,831 - 870,831 - - 7 - - 7 (1,750) (1,750) - - - - - - - - - - - 44,620 2,241,740 (1,952,486) (21,463) 558,420 31 December 2017 44,620 2,794,358 - - - - 3,870 (3,863) - - - - - (21,463) (527,128) 92,878 54,485 6,059 105,651 36,098 2,585,558 31,150 2,616,708 30 BANK OF CYPRUS HOLDINGS GROUP Consolidated Statement of Changes in Equity for the year ended 31 December 2017 Annual Financial Report 2017 Share capital (Note 35) Share premium (Note 35) Capital reduction reserve (Note 35) Treasury shares (Note 35) Accumulated losses (Note 37) Property revaluation reserve Revaluation reserve of available-for- sale investments Other reserves Life insurance in-force business reserve Foreign currency translation reserve Reserve of disposal group and assets held for sale Non- controlling interests Total equity Total €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 Attributable to the owners of BOC PCL 1 January 2016 892,294 552,618 1,952,486 (41,301) (601,152) 99,218 47,125 6,059 99,050 30,939 17,619 3,054,955 22,376 3,077,331 63,656 - - (14,255) 219 (39,986) 49,401 219 (39,986) Profit for the year Other comprehensive (loss)/income after tax for the year Total comprehensive income/(loss) for the year Increase in value of in- force life insurance business Tax on increase in value of in-force life insurance business Transfer of realised profits on disposal of properties Disposal of subsidiary (Note 51.4.1) Acquisition of subsidiary (Note 51.3.1) Disposals of treasury shares Change in presentation of life insurance subsidiary’s treasury shares Increase in shareholding of subsidiary Dividends paid to non- controlling interests - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - (4,680) 479 - - 8,501 (8,501) 17,619 - - - - - - - 41,301 (40,560) (25,333) 25,333 - - 129 - - - - - - - - - - - - - - - - - - - - - - - - - 4,680 (479) - - - - - - - - 5,687 5,687 - - - - - - - - - - - - - - - (17,619) - - - - - 63,656 3,575 67,231 (48,335) (4,616) (52,951) 15,321 (1,041) 14,280 - - - - - 741 - - - - - - - - - 18,753 18,753 - - 741 - - 129 (129) - (5,000) (5,000) 31 December 2016 892,294 552,618 1,952,486 (25,333) (544,930) 90,936 7,139 6,059 103,251 36,626 - 3,071,146 34,959 3,106,105 31 BANK OF CYPRUS HOLDINGS GROUP Consolidated Statement of Cash Flows for the year ended 31 December 2017 Annual Financial Report 2017 Annual Financial Report 2015 Notes 2017 €000 2016 €000 Net cash flow from operating activities 40 1,993,266 3,162,625 Cash flows from investing activities Purchases of debt securities and equity securities (402,977) (213,032) Proceeds on disposal/redemption of investments: - debt securities - equity securities Interest received from debt securities Dividend income from equity securities Dividend income from associates Proceeds on disposal of subsidiaries Purchases of property and equipment Purchases of intangible assets Proceeds on disposals of property and equipment and intangible assets Proceeds on disposals of investment properties and investment properties held for sale 91,738 466,640 1,549 19,546 683 6,621 1,580 50,143 28,084 343 4,939 26,500 25 26 (10,299) (12,096) (25,723) (16,363) 91 210 14,568 14,076 Net cash flow (used in)/from investing activities (302,623) 349,444 Cash flows from financing activities Net proceeds/(repayments) of funding from central banks 79,986 (3,602,836) Net proceeds from the issue of subordinated loan stock 280,983 - Redemption of debt securities in issue Interest on funding from central banks Proceeds from disposal of treasury shares - (712) (28) (29,656) 7 741 Dividend paid by subsidiaries to non-controlling interests (1,750) (5,000) Net cash flow from/(used in) financing activities 359,198 (3,637,463) Net increase/(decrease) in cash and cash equivalents for the year 2,049,841 (125,394) Cash and cash equivalents 1 January Foreign exchange adjustments 2,231,028 2,347,408 (638) 9,014 Net increase/(decrease) in cash and cash equivalents for the year 2,049,841 (125,394) 31 December 41 4,280,231 2,231,028 Details on non-cash transactions are presented in Note 40. 32 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 1. Corporate information Bank of Cyprus Holdings Public Limited Company (the Company) was incorporated in Ireland on 11 July 2016, as a public limited company under company number 545903 in accordance with the provisions of the Companies Act 2014 of Ireland (Companies Act 2014). The Company’s name on incorporation was Aion Cyprus Public Limited Company and on 10 August 2016 the Company changed its name to Bank of Cyprus Holdings Public Limited Company. Its registered office for the period from 11 July 2016 to 19 March 2017 was at Earlsfort Centre, Earlsfort Terrace, Dublin 2, Ireland. Since 20 March 2017 the Company’s registered office is 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland. The Company is the holding company of the Bank of Cyprus Public Company Limited (BOC PCL). The Bank of Cyprus Holdings Group (the Group) comprises the Company, its subsidiary BOC PCL and the subsidiaries of BOC PCL. The Company was incorporated with the intention of becoming the holding company of the Group for the purposes of the Group’s listing on the London Stock Exchange (LSE). The Company is tax resident in Cyprus. The principal activities of BOC PCL and its subsidiary companies (the BOC group) involve the provision of banking, financial services, insurance services and management and disposal of property predominately acquired in exchange of debt. On 13 December 2016, at an Extraordinary General Meeting of the shareholders of BOC PCL a scheme of arrangement between the Company, BOC PCL and the shareholders of BOC PCL has been approved. The scheme of arrangement which became effective on 18 January 2017 introduces the Company as the new holding company of the Group which is also the sole shareholder of BOC PCL. On 19 January 2017 the shares of the Company were admitted to listing and trading on the LSE and the Cyprus Stock Exchange (CSE). The Consolidated Financial Statements are available at the registered office of Bank of Cyprus Holdings Public Limited Company (at 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland) and on the Group’s website www.bankofcyprus.com (Investor Relations). Consolidated Financial Statements The Consolidated Financial Statements of the Company for the year ended 31 December 2017 (the Consolidated Financial Statements) were authorised for issue by a resolution of the Board of Directors on 26 March 2018. The Consolidated Financial Statements have been prepared in both, the English and the Greek language. In case of a difference or inconsistency between the two, the English version prevails. 2. 2.1 Summary of significant accounting policies Group reorganisation As described in Note 1 above, on 18 January 2017 the Company became the sole shareholder of BOC PCL. This reorganisation was treated as a reorganisation of an existing entity that has not changed the substance of the reporting entity. The owners of BOC PCL before the reorganisation have the same absolute and relative interests in the net assets of the Group immediately before and after the reorganisation, since the assets and liabilities of the Group and the BOC group are the same immediately before and after the reorganisation. Hence, the Group is considered as a continuation of BOC group. As this transaction did not result in any change of economic substance it also did not have any effect on the total equity of the Group. The Group’s Consolidated Financial Statements reflect the difference in the amounts of share capital, share premium and capital reduction reserves as an adjustment in equity. 33 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.2 Basis of preparation The Consolidated Financial Statements have been prepared on a historical cost basis, except for properties held for own use and investment properties, available-for-sale investments, derivative financial instruments and financial assets at fair value through profit or loss, that have been measured at fair value, non-current assets held for sale measured at fair value less costs to sell and stock of property measured at net realisable value where this is lower than cost. The carrying values of recognised assets and liabilities that are hedged items in fair value hedges, and otherwise carried at cost, are adjusted to record changes in fair value attributable to the risks that are being hedged. Presentation of Consolidated Financial Statements The Consolidated Financial Statements are presented in Euro (€) and all amounts are rounded to the nearest thousand, except where otherwise indicated. A comma is used to separate thousands and a dot is used to separate decimals. The Group presents its balance sheet broadly in order of liquidity. An analysis regarding expected recovery or settlement of financial assets and liabilities within twelve months after the balance sheet date and more than twelve months after the balance sheet date is presented in Note 43. Statement of compliance The Consolidated Financial Statements have been prepared in accordance with the International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU) and with those parts of the Companies Act 2014 applicable to companies reporting under IFRSs. 2.3 Accounting policies and changes in accounting policies and disclosures The Consolidated Financial Statements contain a summary of the accounting policies adopted in the preparation of the Consolidated Financial Statements in Notes 2.5 to 2.33. As described in Note 2.2, the accounting policies adopted are consistent with those of the previous financial year, except for the adoption of new and amended standards and interpretations as explained in Note 2.3.1 below. 2.3.1 New and amended standards and interpretations The Group applied for the first time certain standards and amendments, which are effective for annual periods beginning on or after 1 January 2017. The Group has not early adopted any other standard, interpretation or amendment that has been issued but is not yet effective. Although these new standards and amendments were applied for the first time in 2017, they did not have a material impact on the Consolidated Financial Statements of the Group. The nature of each new standard or amendment is described below. Amendments to IAS 12 Income Taxes: Recognition of deferred tax assets for unrealised losses The objective of the amendments is to clarify the requirements of deferred tax assets for unrealised losses in order to address diversity in practice in the application of IAS 12 Income Taxes. The specific issues where diversity in practice existed relate to the existence of a deductible temporary difference upon a decrease in fair value, to recovering an asset for more than its carrying amount, to probable future taxable profit and to combined versus separate assessment. This amendment did not have an impact on the Consolidated Financial Statements. Amendments to IAS 7: Disclosure initiative The objective of the amendments is to provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non- cash changes. The amendments specify that one way to fulfil the disclosure requirement is by providing a tabular reconciliation between the opening and closing balances in balance sheet for liabilities arising from financing activities, including changes from financing cash flows, changes arising from obtaining or losing control of subsidiaries or other businesses, the effect of changes in foreign exchange rates, changes in fair values and other changes. The Group has provided the information for the current year in Note 40. 34 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.3 Summary of significant accounting policies (continued) Accounting policies and changes in accounting policies and disclosures (continued) 2.3.1 New and amended standards and interpretations (continued) Annual Improvements IFRSs 2014-2016 Cycle The International Accounting Standards Board (IASB) has issued the Annual Improvements to IFRSs 2014-2016 Cycle which is a collection of amendments to IFRSs. These did not have an impact on the Consolidated Financial Statements. These include:  IFRS 12 Disclosure of interests in other entities: The amendments clarify that the disclosure requirements in IFRS 12, other than those of summarised financial information for subsidiaries, joint ventures and associates, apply to an entity’s interest in a subsidiary, a joint venture or an associate that is classified as held for sale, as held for distribution, or as discontinued operations in accordance with IFRS 5. 2.4 Standards and interpretations that are issued but not yet effective 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU IFRS 9 Financial Instruments IFRS 9 Financial Instruments (IFRS 9) replaces IAS 39 Financial Instruments: Recognition and Measurement and introduces new requirements for classification and measurement, impairment, and hedge accounting. IFRS 9 is effective for annual periods beginning on or after 1 January 2018 with early adoption permitted. The Group will apply IFRS 9 on 1 January 2018. The Group IFRS 9 implementation has been largely completed by 1 January 2018. The IFRS 9 project had a formalised governance process whereby the Group Chief Risk Officer (GCRO) was the project owner. The main divisions involved in the project at the highest level are the Risk Management, Finance, Information Technology (IT) and Operations. A Steering Committee was set up to monitor the project, chaired by the Group Chief Executive Officer (CEO) and comprising of members of the Executive Management team, the Chief Risk Officer (CRO), the Deputy CEO & Chief Operating Officer, the Finance Director and other representatives from Risk Management and Finance, while the Group Internal Audit Director participated as an observer. The Steering Committee was monitoring the progress of the project and was reviewing the results, key assumptions policies and methodologies and reported to the Risk and Audit Committees of the Group, which had an oversight role and provided relevant approvals. The project covered all aspects of IFRS 9. A significant part was related to the development of methodologies for the calculation of impairment of customer loans and advances based on expected credit losses (ECL), in line with the requirements of IFRS 9. This change requires significant judgement in assessing available information for the ECL. Impact of IFRS 9 The Group’s IFRS 9 preliminary impact on transition including the insurance subsidiaries of the Group, which is subject to change due to final parameter calibrations, is assessed to be a decrease of shareholders’ equity of c.€300 million and is primarily driven by credit impairment provisions. The new accounting processes, internal controls, governance framework, judgements and estimation techniques will continue to be refined and undergo validation. Transition The classification, measurement and impairment requirements are applied retrospectively by adjusting the balance sheet at the date of initial application, and as permitted by IFRS 9 the Group will not restate comparative information for prior periods. The impact on the implementation date, 1 January 2018, is therefore recognised through equity rather than the consolidated income statement. No deferred tax asset will be recognised on IFRS 9 impact upon transition. 35 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 9 Financial Instruments (continued) Regulatory transitional arrangements The Group has elected to apply the EU transitional arrangements for regulatory capital purposes (EU Regulation 2017/2395) where the impact on the impairment amount from the initial application of IFRS 9 on the capital ratios will be phased-in gradually. From the date of initial application of IFRS 9 and for five years the amount of the difference in provisions that will result from the transition to the new IFRS 9 in relation to the provisions that have been recognised at 31 December 2017 in accordance with IAS 39 will be added to the capital ratios. The amount that will be added each year will decrease based on a weighting factor until the impact of IFRS 9 is fully absorbed at the end of the five-years. For the year 2018 the impact on the capital ratios will be 5% of the impact on the difference in the impairment amounts. Classification and measurement The classification and measurement of financial assets will depend on how these are managed as part of the Business Models the Group operates under and their contractual cash flow characteristics (whether the cash flows represent solely payments of principle and interest (SPPI)). These factors determine whether the financial assets are measured at amortised cost, fair value through other comprehensive income (FVOCI) or fair value through profit or loss (FVPL). The combined effect of the application of the business model and the contractual cash flow characteristics tests resulted in some differences in the population of financial assets measured at amortised cost under IAS 39 as described below. Business models are determined on the date of initial application based on fact and circumstances that existed on 1 January 2018. The Group assesses the business model at a portfolio level. The portfolio level is determined at the aggregation level that reflects how the Group manages its financial assets. Information that is considered in determining the business model includes (i) policies and objectives for the relevant portfolio, (ii) how the performance and risks of the portfolio are managed, evaluated and reported to management and (iii) the frequency, volume and timing of sales in prior periods and sales expectation for future periods, including the reasons for such sales. Where the business model is to hold financial assets to collect contractual cash flows or to collect contractual cash flows and sell, the Group assesses whether individual financial assets’ cash flows represent solely payments of principal and interest (SPPI test). For the purposes of this assessment, principal is defined as the fair value of the financial asset on initial recognition. Interest is defined as consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs (e.g. liquidity risk and administrative costs), as well as a profit margin. In assessing whether contractual cash flows are SPPI, the Group considers the terms that could change the contractual cash flows so that it would not meet the condition for SPPI, including: (i) contingent and leverage features, (ii) interest rates which are beyond the control of the Group or variable interest rate consideration, (iii) features that could modify the time value of money, (iv) prepayment and extension options, (v) non-recourse arrangements and (vi) convertible features. Financial assets are measured at amortised cost if they are held within a business model whose objective is to hold financial assets in order to collect contractual cash flows and their contractual cash flows represent SPPI. Financial assets are measured at fair value through other comprehensive income if they are held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets and their contractual cash flows represent SPPI. Financial assets managed on a fair value basis and those that are held for trading are held at fair value through profit and loss. In addition, where the contractual terms of a financial asset introduce exposure to risk or volatility that are inconsistent with a basic lending arrangement, the related financial asset will be measured at FVPL. 36 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 9 Financial Instruments (continued) Classification and measurement (continued) Equity investments are measured at fair value through profit and loss. On transition to IFRS 9 and on initial recognition thereafter, there is an option to make an irrevocable election for non traded equity investments to be measured at fair value through other comprehensive income, in which case dividends are recognised in the consolidated income statement, and subsequent fair value gains or losses are recorded in other comprehensive income and are not reclassified to profit or loss upon derecognition. Classification and measurement impact assessment Following the Group IFRS 9 implementation project, with respect to classification and measurement of financial assets and financial liabilities on 1 January 2018, the impact is as follows:        Placements with central banks, bank placements and customer loans and advances that were classified as loans and receivables and measured at amortised cost under IAS 39 will continue to be measured at amortised cost under IFRS 9 with the exception of certain customer loans and advances with carrying value of c.€390 million as at 31 December 2017 which failed the SPPI tests and as a result have been classified at FVPL and will be measured at fair value. The Group has made an irrevocable election to classify the majority equity investments that were previously classified as available-for-sale under IAS 39, in FVOCI on transition to IFRS 9. Debt and other non-equity securities that were classified as available-for-sale under IAS 39 will be measured at FVOCI under IFRS 9 with the exception of certain instruments that failed the SPPI test and will be classified as FVPL. Debt securities that were classified as loans and receivables under IAS 39 will be measured at amortised cost under IFRS 9. The equity investments that were held for trading e.g. acquired principally for the purpose of selling or repurchasing in the near term will be measured at FVPL under IFRS 9. Certain equity instruments which were classified at FVPL will be classified at FVOCI under IFRS 9 as they were not held for trading on 1 January 2018. Derivatives (assets and liabilities) will continue to be measured at FVPL under IFRS 9. All financial liabilities, other than derivatives, will be measured at amortised cost. The Group has estimated that on adoption of IFRS 9, the impact following the changes on the classification and measurement of financial assets and financial liabilities is an increase of shareholders’ equity of approximately €1 million. Impairment IFRS 9 moves away from the IAS 39 incurred loss model to a forward looking ECL model. This change requires more judgement, estimates and assumptions in considering information for current and future provisioning. The ECL model will also result in earlier recognition of credit losses and thus a higher provision charge because it includes not only credit losses already incurred, but also losses that are expected in the future. The impairment requirements apply to financial assets that are not measured at FVPL. Specifically it applies to financial assets measured at amortised cost and FVOCI, lease receivables, certain loan commitments and financial guarantee contracts. Under IFRS 9, no impairment loss is recognised on equity investments. At initial recognition, allowance (or provision in the case of commitments and guarantees) is required for ECL resulting from default events that are possible within the next 12 months (12 month ECL), unless assets are deemed as purchased or originated credit impaired (POCI). Subsequently, in the event of a significant increase in credit risk since initial recognition, a provision is required resulting from all possible default events over the expected life of the financial instrument (lifetime ECL). Financial assets which have not had a significant increase in credit risk since initial recognition and where 12- month ECL is recognised are considered to be Stage 1. Financial assets that are considered to have experienced a significant increase in credit risk since initial recognition and where lifetime losses are recognised are considered to be Stage 2. Financial assets for which there is objective evidence of impairment are considered to be in default or credit- impaired and are considered to be Stage 3. 37 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 9 Financial Instruments (continued) Impairment (continued) Purchased or originated financial assets that are credit-impaired on initial recognition include loans purchased or originated financial assets at a deep discount that reflect incurred credit losses. The reconciliation of the net carrying value on customer loans and advances measured at amortised cost under IAS 39 with those measured at amortised cost under IFRS 9 is disclosed below: Carrying value IAS 39 at 31 December 2017 Transfer to FVPL–carrying amount IFRS 9 ECL remeasurement Carrying value under IFRS 9 at 1 January 2018 €000 14,602,454 (388,972) (300,266) 13,913,216 The table below discloses the breakdown of the carrying value of customer loans and advances at amortised cost under by IFRS 9 by staging as at 1 January 2018. Stage 1 Stage 2 Stage 3 POCI Total Carrying Value under IFRS 9 €000 5,089,673 4,350,173 3,883,705 589,665 13,913,216 Key impairment concepts The impairment introduces a number of key concepts as described below. Significant increase in credit risk IFRS 9 requires that, in the event of a significant increase in credit risk, since initial recognition, the calculation basis of the loss allowance would change from 12 month ECLs to lifetime ECLs. The assessment of whether credit risk has increased significantly since initial recognition is performed at each reporting period by considering the change in the risk of default occurring over the remaining life of the financial instrument since initial recognition. The Group’s assessment usually combines a qualitative and a quantitative assessment of the loan, with the quantitative element being the primary indicator of significant increase in credit risk. Past, current, as well as forward-looking reasonable and supportable information are considered in the assessment. The Group uses the lifetime probability of default (PDs) as the primary quantitative metric in order to assess transition from Stage 1 to Stage 2 for all portfolios by considering whether the lifetime PD at the reporting date exceeds the lifetime PD at origination by an established relative threshold. For each portfolio there are specific qualitative criteria that indicate if an exposure has experienced a significant increase in its credit risk, independent of any changes in the PD. 38 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 9 Financial Instruments (continued) Impairment (continued) Significant increase in credit risk (continued) For retail exposures qualitative criteria indicating significant increase in credit risk, are considered on a loan-by- loan basis and consider among others the following:     expectations of forbearance and payment holidays, covenant breaches, credit and scorecards, events such as death, unemployment, bankruptcy, or divorce. For corporate exposures qualitative factors in addition to the ones incorporated in the PD calculation, are considered on a loan-by-loan basis and consider among others the following:    in collateral value or guarantee or significant change shareholders/directors, significant adverse changes in business, financial and/or economic conditions in which the borrower operates, expected change in loan documentation. financial support provided by The Group also considers, as a backstop criterion, that a significant increase in the credit risk occurs when contractual payments are more than 30 days past due and loans that meet this condition are classified in Stage 2. Low credit risk simplification is adopted for debt security instruments with external credit ratings that are rated as investment grade. The assessment of low credit risk is based on both the external credit rating and the internal scoring (which considers latest available information on the instrument and issuer). The combination of the two will provide an adjusted credit rating. An adjusted rating which remains investment grade is considered as having low credit risk. For debt securities which are below investment grade, the low credit risk exemption does not apply and therefore an assessment of significant credit deterioration takes place, by comparing their credit rating at origination with the credit rating on the reporting date. Financial assets (other than POCI) can be transferred between stages depending on their relative change in credit risk since initial recognition. Financial assets are transferred out of Stage 2, if their credit risk is no longer considered to be significantly increased since initial recognition based on the assessments described above. Credit impaired and definition of default Exposures that meet the non performing exposure (NPE) definition as per EBA standards are considered to be in default and hence credit-impaired and are considered to be in Stage 3 and have ECL calculated on a lifetime basis. Such loans are also considered to be in default for credit risk management purposes. According to the European Banking Authority (EBA) standards and European Central Bank’s (ECB) Guidance to Banks on NPE (which was published in March 2017), NPEs are defined as those exposures that satisfy one of the following conditions: (i) The borrower is assessed as unlikely to pay its credit obligations in full without the realisation of the collateral, regardless of the existence of any past due amount or of the number of days past due. (ii) Defaulted or impaired exposures as per the approach provided in the Capital Requirement Regulation (CRR), which would also trigger a default under specific credit adjustment, distress restructuring and obligor bankruptcy. (iii) Material exposures as set by the Central Bank of Cyprus (CBC), which are more than 90 days past due. (iv) Performing forborne exposures under probation for which additional forbearance measures are extended. Performing forborne exposures under probation that present more than 30 days past due within the (v) probation period. 39 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 9 Financial Instruments (continued) Impairment (continued) Credit impaired and definition of default (continued) When the problematic exposures of a customer that fulfil the NPE criteria set out above are greater than 20% of the gross carrying amount of all on balance sheet exposures of that customer, then the total customer exposure is classified as non-performing; otherwise only the problematic part of the exposure is classified as non-performing. Exposures cease to be considered as NPEs and in such case are transferred out of Stage 3, only when all of the following conditions are met: (i) (ii) One year has passed since the forbearance measures were extended. (iii) Following the forbearance measures and according to the post-forbearance conditions, there is no past The extension of forbearance measures does not lead to the recognition of impairment or default. due amount or concerns regarding the full repayment of the exposure. (iv) No Unlikely-to-Pay criteria exist for the debtor. (v) The debtor has made post-forbearance payments of a not-insignificant amount of capital (different capital thresholds exist according to the facility type). Forward-looking inputs IFRS 9 requires the use of reasonable and supportable information, including forward-looking information, in the calculation of ECLs. ECLs are the unbiased probability-weighted credit losses determined by evaluating a range of possible outcomes and considering future economic conditions. ECLs are calculated on the basis of weighted average of three macroeconomic scenarios, baseline, downside and upside. Scenarios impact the collection of contractual cash flows, 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. Gross Domestic Product (GDP) growth, property prices, unemployment rate, consumer inflation). This process involves consideration of a variety of external actual and forecast information (International Monetary Fund (IMF), European Commission, Economist Intelligence Unit (EIU), Moody’s Analytics) adjusted by economic expert judgement to derive the base scenario, which represents the most-likely outcome. The other scenarios represent a more pessimistic outcome and a more optimistic outcome. Predicted relationships between the key indicators and default and loss rates on the portfolios of financial assets have been developed based on analysis of historical data over the past 5 years. Inputs into measurement of ECL The Group calculates ECL using the following three components:    exposure at default (EAD), loss given default (LGD) and probability of default (PD). These parameters are derived from internally developed statistical models based on historical data that are adjusted if deemed necessary, following the internal approval processes of the Group, in order to reflect forward looking information. EAD represents the expected exposure in the event of a default. EAD methodology is differentiated in the following categories: revolving and non-revolving exposures. In case of revolving exposures all future EAD changes are recognised by a credit conversion factor parameter. For non-revolving exposures the term is based on the contractual term of the exposure and both on-balance sheet and off-balance sheet exposures are amortised in accordance with the principal contractual payment schedule of each exposure. In regards to the credit-impaired exposures, the EAD is equal to the on balance sheet amount as at the reporting date. LGD represents the likely loss if there is a default and takes into account parameters such as historical loss and/or recovery rates as well as the collateral value at the time it is expected to be realised and the time value of money. 40 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 9 Financial Instruments (continued) Impairment (continued) Inputs into measurement of ECL (continued) The structure of the LGD model considers the following:  Curing: the probability of cure model was derived based on historical observations.  Non-curing is further broken down into: (i) Collateral realisation: the collateralised part of EAD of a defaulted account could be recovered through collateral realisation. The process was considered to be either voluntary (amicable sale, debt for asset swap) or forced sale or through foreclosure and receivership. (ii) Cash recovery: calculated based on observed cash flows. PD is calculated based on statistical rating models calculated per segment level and taking into consideration each individual’s exposure rating and forward looking information based on macroeconomic inputs. ECL is discounted at the effective interest rate at initial recognition or an approximation thereof. Loan modifications and derecognition The derecognition requirements of IAS 39 were carried forward into the IFRS 9. The contractual terms of a loan may be modified following various reasons, either due to commercial renegotiations or due to distressed restructurings with a view to maximise recovery. In the event that the terms and conditions of a financial asset are renegotiated or otherwise modified, the Group considers whether the modification results in derecognition of the existing financial asset and the recognition of a new financial asset. Modifications to, and exchanges of, financial liabilities are treated as extinguishments and derecognised, when the revised terms are substantially different to the original term. A derecognition of a financial asset (or part of a financial asset) and a recognition of a new financial asset would occur where there has been a substantial modification on the revised terms to the original cash flows. Judgement is required to assess whether a change in the contractual terms is substantial enough to lead to derecognition. The Group considers a series of factors of both qualitative and quantitative nature when making such judgements on a modification in the contractual cash flows. When a substantial modification in the original financial asset is deemed to exist, then the original financial asset is derecognised and a new financial asset is recognised. In the case of a new loan an assessment is performed on whether it should be classified as Stage 1 or POCI. Write off The Group reduces the gross carrying amount of a financial asset when there is no reasonable expectation of recovering it. In such case, financial assets are written off either partially or in full. Write off refers to both contractual and non-contractual write offs. Interest revenue recognition For loans considered to be Stage 1 and 2 and are not POCI, interest revenue is calculated on the gross carrying amount using the Original Effective Interest Rate (OEIR). When a financial asset becomes credit-impaired and is, therefore, regarded as Stage 3, interest income is calculated by applying the effective interest rate to the net amortised cost of the financial asset. If the financial asset cures and is no longer credit-impaired, the Group reverts to calculating interest income on the gross carrying amount. Interest revenue on POCI financial assets is recognised using the Credit Adjusted Effective Interest Rate (CAEIR) calculated at initial recognition. The CAEIR is applied on the amortised cost of the financial asset, being the gross carrying amount of the financial asset less any loss allowance. 41 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 9 Financial Instruments (continued) Hedge accounting The Group elected, as a policy choice permitted by IFRS 9, to continue to apply hedge accounting in accordance with IAS 39. The Group will implement the amended IFRS 7 hedge disclosure requirements. IFRS 15 Revenue from contracts with customers IFRS 15 was issued in May 2014 and establishes a five-step model that will apply to revenue earned from a contract with a customer (with limited exceptions), regardless of the type of revenue transaction or the industry. The standard’s requirements will also apply to the recognition and measurement of gains and losses on the sale of some non-financial assets that are not an output of the entity’s ordinary activities (e.g., sales of property, plant and equipment or intangibles). Extensive disclosures will be required, including disaggregation of total revenue; information about performance obligations; changes in contract asset and liability account balances between periods and key judgements and estimates. Either a full retrospective application or a modified retrospective application is required for annual periods beginning on or after 1 January 2018. The Group will apply IFRS 15 on 1 January 2018. The Group has performed an assessment and does not expect this standard to have a material impact on its results and financial position. IFRS 15 Revenue from contracts with customers (clarifications) The objective of the clarifications is to clarify the IASB’s intentions when developing the requirements in IFRS 15 Revenue from contracts with customers, particularly the accounting of identifying performance obligations amending the wording of the separately identifiable principle, of principal versus agent considerations including the assessment of whether an entity is a principal or an agent as well as applications of control principle and of licensing providing additional guidance for accounting of intellectual property and royalties. The clarifications also provide additional practical expedients for entities that either apply IFRS 15 fully retrospectively or that elect to apply the modified retrospective approach. The Group will apply these clarifications on 1 January 2018. The Group has performed an assessment and does not expect these clarifications to have a material impact on its results and financial position. Annual improvements IFRSs 2014–2016 cycle The IASB has issued the Annual improvements to IFRSs 2014–2016 cycle, which is a collection of amendments to IFRSs. The amendments are effective for annual periods beginning on or after 1 January 2018 for IFRS 1 First-time adoption of IFRS and for IAS 28 Investments in associates and joint ventures. Earlier application is permitted for IAS 28 Investments in associates and joint ventures. The Group does not expect these to have any impact on its results and financial position.  IFRS 1 First-time adoption of IFRS: This improvement deletes the short-term exemptions regarding disclosures about financial instruments, employee benefits and investment entities, applicable for first time adopters. IAS 28 Investments in associates and joint ventures: The amendments clarify that the election to measure at fair value through profit or loss an investment in an associate or a joint venture that is held by an entity that is venture capital organisation, or other qualifying entity, is available for each investment in an associate or joint venture on an investment-by-investment basis, upon initial recognition.  IFRS 4 Applying IFRS 9 Financial instruments with IFRS 4 Insurance contracts (amendments) The amendments are effective for annual periods beginning on or after 1 January 2018. The amendments address concerns arising from implementing the new financial instruments standard, IFRS 9, before implementing the new insurance contracts standard that the IASB is developing to replace IFRS 4. The amendments introduce two options for entities issuing insurance contracts: a temporary exemption from applying IFRS 9 and an overlay approach, which would permit entities that issue contracts within the scope of IFRS 4 to reclassify, from profit or loss to other comprehensive income, some of the income or expenses arising from designated financial assets. Since the insurance subsidiaries of the Group have adopted IFRS 9 on 1 January 2018, these amendments do not have any impact on the results and financial position of the Group. 42 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.1 Standards and interpretations issued by the IASB and adopted by the EU (continued) IFRS 16 Leases The standard is effective for annual periods beginning on or after 1 January 2019. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, i.e. the customer (lessee) and the supplier (lessor). The new standard requires lessees to recognise most leases on their financial statements. Lessees will have a single accounting model for all leases, with certain exemptions. Lessor accounting is substantially unchanged. The Group will apply IFRS 16 on 1 January 2019. The Group is in the process of assessing the impact of this standard on its results and financial position. Existing operating lease commitments are disclosed in Note 42. 2.4.2 Standards and interpretations issued by the IASB but not yet adopted by the EU Amendment in IFRS 10 Consolidated financial statements and IAS 28 Investments in associates and joint ventures: sale or contribution of assets between an investor and its associate or joint venture The amendments address an acknowledged inconsistency between the requirements in IFRS 10 and those in IAS 28, in dealing with the sale or contribution of assets between an investor and its associate or joint venture. The main consequence of the amendments is that a full gain or loss is recognised when a transaction involves a business (as defined in IFRS 3). A partial gain or loss is recognised when a transaction involves assets that do not constitute a business. In December 2015, the IASB postponed the effective date of this amendment indefinitely pending the outcome of its research project on the equity method of accounting. The Group does not expect these amendments to have a material impact on its results and financial position. Amendments IFRS 2: Classification and measurement of share based payment transactions The amendments provide requirements on the accounting for the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments, for share-based payment transactions with a net settlement feature for withholding tax obligations and for modifications to the terms and conditions of a share- based payment that changes the classification of the transaction from cash-settled to equity-settled. The amendments are effective for annual periods beginning on or after 1 January 2018 with earlier application permitted. The Group does not expect these amendments to have a material impact on its results and financial position. IAS 40: Transfers to investment property (amendments) The amendments clarify when an entity should transfer property, including property under construction or development into, or out of investment property. The amendments state that a change in use occurs when the property meets, or ceases to meet, the definition of investment property and there is evidence of the change in use. A mere change in management’s intentions for the use of a property does not provide evidence of a change in use. The amendments are effective for annual periods beginning on or after 1 January 2018 with earlier application permitted. The Group does not expect these amendments to have a material impact on its results and financial position. Amendment to IFRS 9: Prepayment features with negative compensation The amendment allows financial assets with prepayment features that permit or require a party to a contract either to pay or receive reasonable compensation for the early termination of the contract (so that, from the perspective of the holder of the asset there may be negative compensation), to be measured at amortised cost or at fair value through other comprehensive income. The amendment is effective for annual reporting periods beginning on or after 1 January 2019 with earlier application permitted. The Group is in the process of assessing the impact of this amendment on its results and financial position. Amendments to IAS 28: Long-term interests in associates and joint ventures The amendments relate to whether the measurement, in particular impairment requirements, of long term interests in associates and joint ventures that, in substance, form part of the net investment in the associate or joint venture should be governed by IFRS 9, IAS 28 or a combination of both. The amendments clarify that an entity applies IFRS 9 before it applies IAS 28, to such long-term interests for which the equity method is not applied. In applying IFRS 9, the entity does not take account of any adjustments to the carrying amount of long-term interests that arise from applying IAS 28. The amendments are effective for annual reporting periods beginning on or after 1 January 2019 with earlier application permitted. The Group is in the process of assessing the impact of these amendments on its results and financial position. 43 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.4 Summary of significant accounting policies (continued) Standards and interpretations that are issued but not yet effective (continued) 2.4.2 Standards and interpretations issued by the IASB but not yet adopted by the EU (continued) International Financial Reporting Interpretations Committee (IFRIC) Interpretation 22: Foreign currency transactions and advance consideration The interpretation clarifies the accounting for transactions that include the receipt or payment of advance consideration in a foreign currency. The interpretation covers foreign currency transactions when an entity recognises a non-monetary asset or a non-monetary liability arising from the payment or receipt of advance consideration before the entity recognises the related asset, expense or income. The interpretation states that the date of the transaction, for the purpose of determining the exchange rate, is the date of initial recognition of the non-monetary prepayment asset or deferred income liability. If there are multiple payments or receipts in advance, then the entity must determine a date of the transactions for each payment or receipt of advance consideration. The interpretation is effective for annual periods beginning on or after 1 January 2018 with earlier application permitted. The Group does not expect this interpretation to have a material impact on its results and financial position. IFRIC Interpretation 23: Uncertainty over income tax treatments The interpretation addresses the accounting for income taxes when tax treatments involve uncertainty that affects the application of IAS 12. The interpretation provides guidance on considering uncertain tax treatments separately or together, examination by tax authorities, the appropriate method to reflect uncertainty and accounting for changes in facts and circumstances. The interpretation is effective for annual periods beginning on or after 1 January 2019 with earlier application permitted. The Group is in the process of assessing the impact of this amendment on its results and financial position. Annual improvements IFRSs 2015-2017 cycle The IASB has issued the Annual improvements to IFRSs 2015-2017 cycle, which is a collection of amendments to IFRSs. The amendments are effective for annual periods beginning on or after 1 January 2019, with early application permitted. The Group does not expect these to have material impact on its results and financial position.  IFRS 3 Business combinations: The amendments clarify that a company remeasures its previously held interest in a joint operation when it obtains control of the business. IFRS 11 Joint arrangements: The amendments clarify that a company does not remeasure its previously held interest in a joint operation when it obtains joint control of the business. IAS 12 Income taxes: The amendments clarify that a company accounts for all income tax consequences of dividend payments in the same way. IAS 23 Borrowing costs: The amendments clarify that a company treats as part of general borrowings any borrowing originally made to develop an asset when the asset is ready for its intended use or sale.    IFRS 17: Insurance Contracts The standard is effective for annual periods beginning on or after 1 January 2021 with earlier application permitted if both IFRS 15 Revenue from contracts with customers and IFRS 9 Financial instruments have also been applied. IFRS 17 Insurance contracts establishes principles for the recognition, measurement, presentation and disclosure of insurance contracts issued. It also requires similar principles to be applied to reinsurance contracts held and investment contracts with discretionary participation features issued. The objective is to ensure that entities provide relevant information in a way that faithfully represents those contracts. This information gives a basis for users of financial statements to assess the effect that contracts within the scope of IFRS 17 have on the financial position, financial performance and cash flows of an entity. The Group is in the process of assessing the impact of this standard on its results and financial position. IAS 19: Plan amendment, curtailment or settlement (amendments) The amendments are effective for annual periods beginning on or after 1 January 2019 with earlier application permitted. The amendments require entities to use updated actuarial assumptions to determine current service cost and net interest for the remainder of the annual reporting period after a plan amendment, curtailment or settlement has occurred. The amendments also clarify how the accounting for a plan amendment, curtailment or settlement affects applying the asset ceiling requirements. The Group is in the process of assessing the impact of this amendment on its results and financial position. 44 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.5 Summary of significant accounting policies (continued) Basis of consolidation The Consolidated Financial Statements comprise the Consolidated Financial Statements of the Group as at and for the year ended 31 December 2017. The financial statements of the subsidiaries are prepared as of the same reporting date as that of the Company, using consistent accounting policies. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. Control is achieved when the Group is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Specifically, the Group controls an investee if, and only if, the Group has:  power over an investee (i.e. existing rights that give it the current ability to direct the relevant activities of the investee) exposure, or rights, to variable returns from its involvement with the investee the ability to use its power over the investee to affect its returns.   Generally, there is a presumption that a majority of voting rights results in control. To support this presumption and when the Group has less than a majority of the voting rights of an investee, the Group considers all relevant facts and circumstances in assessing whether it has power over an investee including the contractual arrangement with the other vote holders, rights arising from other contractual arrangements, and the Group’s voting and potential voting rights. The Group re-assesses whether or not it controls an investee if facts indicate that there are changes to any of the three elements of control. Assets, liabilities, income and expenses of subsidiaries acquired or disposed of during the year are included in the Consolidated Financial Statements from the date of acquisition or up to the date of disposal, respectively. Profit or loss and each component of other comprehensive income (OCI) are attributed to the equity holders of the parent of the Group and to the non-controlling interests, even if this results in the non-controlling interests having a deficit balance. Non-controlling interests represent the portion of profit or loss and net assets not held by the Group, directly or indirectly. The non-controlling interests are presented separately in the consolidated income statement and within equity from the Company owners’ equity. All intra-group balances and transactions are eliminated on consolidation. A change in the ownership interest of a subsidiary, without loss of control, is accounted for as a transaction between the owners, which affects equity. As a result, no goodwill arises nor any gain/loss is recognised in the income statement from such transactions. The foreign exchange differences which relate to the share of non- controlling interests being sold/acquired are reclassified between the foreign currency reserve and non- controlling interests. 2.6 Business combinations Business combinations are accounted for using the acquisition method. The cost of an acquisition is measured as the aggregate of the consideration transferred, measured at the acquisition date fair value and the amount of any non-controlling interests in the acquiree. For each business combination the Group elects whether to measure the non-controlling interests in the acquiree at fair value or at the proportionate share of the acquiree’s identifiable net assets. Any excess of the cost of acquisition over the Group’s share of the fair values of the identifiable net assets acquired, is recognised as goodwill on the consolidated balance sheet. Where the Group’s share of the fair values of the identifiable net assets are greater than the cost of acquisition (i.e. negative goodwill), the difference is recognised directly in the consolidated income statement in the year of acquisition. Acquisition related costs are expensed as incurred and included in other operating expenses. If the business combination is achieved in stages, the previously held equity interest is remeasured at fair value and any resulting gain or loss is recognised in the consolidated income statement. When the Group acquires a business, it assesses the financial assets and liabilities assumed for appropriate classification and designation in accordance with contractual terms, economic circumstances and pertinent conditions as at the acquisition date. 45 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. 2.7 Summary of significant accounting policies (continued) Investments in associates and joint ventures An associate is an entity over which the Group has significant influence. Significant influence is the power to participate in the financial and operating policy decisions of the investee, but is not control or joint control over those policies. A joint venture is a type of joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the joint venture. Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require unanimous consent of the parties sharing control. The considerations made in determining significant influence or joint control are similar to those necessary to determine control over subsidiaries. In the Consolidated Financial Statements, the Group’s investments in associates and joint ventures are accounted for using the equity method of accounting. Under the equity method, the investment in an associate or a joint venture is carried in the consolidated balance sheet at cost plus post-acquisition changes in the Group’s share of the net assets of the associate or joint venture. The Group’s share of the results of the associate or joint venture is included in the consolidated income statement. Losses of the associate or joint venture in excess of the Group’s cost of the investment are recognised as a liability only when the Group has incurred obligations on behalf of the associate or joint venture. Goodwill relating to an associate or joint venture is included in the carrying amount of the investment and is not amortised. Any excess of the Group’s share of the net fair value of the associate’s or joint venture’s identifiable assets over the cost of the investment (i.e. negative goodwill) is included as income in the determination of the Group’s share of the associate’s or joint venture’s profit or loss in the period in which the investment is acquired. The aggregate of the Group’s share of profit or loss of an associate or a joint venture is shown on the face of the consolidated income statement outside operating profit and represents profit or loss before tax. The associated tax charge is disclosed in income tax. The Group recognises its share of any changes in the equity of the associate or the joint venture through the consolidated statement of changes in equity. Profits and losses resulting from transactions between the Group and the associate or the joint venture are eliminated to the extent of the Group’s interest in the associate or the joint venture. The financial statements of the associates or joint ventures are prepared as of the same reporting date as that of the Company, using consistent accounting policies. After application of the equity method, the Group determines whether it is necessary to recognise an impairment loss on its investments in associates or joint ventures. 2.8 Foreign currency translation The Consolidated Financial Statements are presented in Euro (€), which is the functional and presentation currency of the Company and its subsidiaries in Cyprus. Each overseas branch or subsidiary of the Group determines its own functional currency and items included in the financial statements of each entity are measured using that functional currency. The Group uses the direct method of consolidation and has elected to recycle in the consolidated statement of comprehensive income the gain or loss that arises from using this method. 46 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.8 Foreign currency translation (continued) 2.8.1 Transactions and balances Transactions in foreign currencies are recorded using the functional currency rate of exchange ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated at the functional currency rate of exchange ruling at the reporting date. All differences are taken to ‘Net foreign exchange gains/losses’ in the consolidated income statement, with the exception of differences on foreign currency liabilities that provide a hedge against the net investments in subsidiaries and overseas branches. These differences are recognised in other comprehensive income in the ‘Foreign currency translation reserve’ until the disposal or liquidation of the net investment, at which time the cumulative amount is reclassified to the consolidated income statement. Non-monetary items that are measured at historic cost in a foreign currency are translated using the exchange rates ruling as at the dates of the initial transactions. Non-monetary items measured at fair value in a foreign currency are translated using the exchange rates ruling at the date when the fair value is determined. 2.8.2 Subsidiary companies and branches At the reporting date, the assets and liabilities of subsidiaries (including special purpose entities that the Group consolidates) and branches whose functional currency is other than the Group’s presentation currency are translated into the Group’s presentation currency at the rate of exchange ruling at the reporting date, and their income statements are translated using the average exchange rates for the year. Foreign exchange differences arising on translation are recognised in other comprehensive income in the ‘Foreign currency translation reserve’. On disposal or liquidation of a subsidiary or branch, the cumulative amount of the foreign exchange differences relating to that particular overseas operation, is reclassified to the consolidated income statement as part of the profit/loss on disposal/dissolution of subsidiaries. 2.9 Segmental reporting Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker is the person or group of persons that allocate resources to and assess the performance of the operating segments. The chief operating decision-maker is the Group Executive Committee. 2.10 Turnover Group turnover comprises interest income, fee and commission income, foreign exchange gains, gross insurance premiums, gains/losses of investment properties and stock of properties, turnover of property and hotel business and other income. 2.11 Revenue recognition Revenue is recognised when it is probable that economic benefits will flow to the Group and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognised. 2.11.1 Interest income and expense For all financial instruments measured at amortised cost, interest bearing financial assets classified as available-for-sale investments or at fair value through profit or loss, interest income or expense is recognised using the effective interest method. The effective interest rate is the rate that exactly discounts the estimated future cash receipts or payments through the expected life of the financial instruments, or where appropriate a shorter period, to the carrying amount of the financial instruments. Interest income is recognised on the recoverable portion of impaired loans. The Group holds loans and advances to banks and central banks with negative interest rates. The Group discloses interest paid on these assets as interest expense. Negative interest is disclosed in Note 8. 47 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.11 Revenue recognition (continued) 2.11.1 Interest income and expense (continued) The carrying amount of a financial asset or liability is adjusted if the Group revises its estimates of payments or receipts. The adjusted carrying amount is calculated based on the original effective interest rate and the change in carrying amount is recorded in ‘Net gains on financial instrument transactions for debt securities’, or ‘Gain on derecognition of loans and advances to customers and changes in expected cash flows’ for loans and advances to customers. 2.11.2 Fee and commission income Fee and commission income is generally recognised on the basis of work done so as to match the cost of providing the service, whereas fees and commissions in respect of loans and advances are recognised using the effective interest method as part of interest income. 2.11.3 Dividend income Dividend income is recognised in the consolidated income statement when the Group’s right to receive payment is established i.e. upon approval by the general meeting of the shareholders. 2.11.4 Rental income Rental income from investment properties and stock of property is accounted for on a straight-line basis over the period of the lease and is recognised in the consolidated income statement in ‘Other income’. 2.11.5 Gains from the disposal of investment property Gains on disposal of investment property are recognised in the consolidated income statement in ‘Net (losses)/gains from revaluation and disposal of investment properties’ when the buyer accepts delivery and the transfer of risks and rewards to the buyer is completed. 2.11.6 Gains on the disposal of stock of property Net gains on disposal of stock of property are recognised in the consolidated income statement when the buyer accepts delivery and the transfer of risks and rewards to the buyer is completed. 2.12 Retirement benefits The Group operates several defined contribution and defined benefit retirement plans. Defined contribution plans The Group recognises obligations, in respect of the accounting period in the consolidated income statement. Any unpaid contributions at the reporting date are included as a liability. Defined benefit plans The cost of providing benefits for defined benefit plans is estimated separately for each plan using the Projected Unit Credit Method of actuarial valuation. The defined benefit asset or liability comprises the present value of the defined benefit obligations (using a discount rate based on high quality corporate bonds), reduced by the fair value of plan assets out of which the obligations are to be settled. Plan assets are assets that are held by a funded plan or qualifying insurance policies. Any net defined benefit surplus is limited to the present value of available refunds and reductions in future contributions to the plan. Fair value is based on market price information and in the case of quoted securities it is the published bid price. The net charge to the consolidated income statement mainly comprises the service costs and the net interest on the net defined benefit asset or liability, and is presented in staff costs. Service costs comprise current service costs, past-service costs, gains and losses or curtailments and non-routine settlements. Re- measurements, comprising actuarial gains and losses, the effect of the asset ceiling (excluding net interest), and the return on plan assets (excluding net interest), are recognised immediately on the consolidated balance sheet with a corresponding debit or credit in other comprehensive income. Re-measurements are not reclassified to profit or loss in subsequent periods. 48 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.12 Retirement benefits (continued) Defined benefit plans (continued) Actuarial gains and losses comprise experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred), as well as the effects of changes in actuarial assumptions. 2.13 Tax Current income tax and deferred tax Tax on income is provided in accordance with the fiscal regulations and rates which apply in the countries where the Group operates and is recognised as an expense in the period in which the income arises. Deferred tax is provided using the liability method. Current income tax assets and liabilities are measured at the amount expected to be recovered from or paid to the tax authorities. Current income tax and deferred tax relating to items recognised directly in equity is recognised directly in equity. Deferred tax liabilities are recognised for all taxable temporary differences between the tax basis of assets and liabilities and their carrying amounts at the reporting date, which will give rise to taxable amounts in future periods. Deferred tax liabilities are recognised for all taxable temporary differences associated with investments in subsidiary and associate companies and branches except where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. Deferred tax assets are recognised for all deductible temporary differences and carry-forward of unutilised tax losses to the extent that it is probable that taxable profit will be available, against which the deductible temporary differences and carry-forward of unutilised tax losses can be utilised. The carrying amount of deferred tax assets is reviewed at each reporting date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to utilise all or part of the deductible temporary differences or tax losses. Unrecognised deferred tax assets are reassessed at each reporting date and are recognised to the extent that it has become probable that future taxable profit will allow the deferred tax asset to be recovered. Deferred tax assets and liabilities are measured at the amount that is expected to be paid to or recovered from the tax authorities, after taking into account the tax rates and legislation that have been enacted or substantially enacted by the reporting date. Current and deferred tax assets and liabilities are offset when they arise from the same tax reporting entity and relate to the same tax authority and when the legal right to offset exists. Indirect Tax Value Added Tax (VAT) Expenses and assets are recognised net of the amount of VAT, except: • when the VAT incurred on a purchase of assets or services is not recoverable from the tax authorities, in which case, the VAT suffered is recognised as part of the cost of acquisition of the asset or as part of the expense item, as applicable. • when receivables and payables are stated with the amount of VAT charged. The amount of VAT recoverable from, or payable to the tax authorities, is included as part of receivables or payables in the consolidated balance sheet. 2.14 Financial instruments 2.14.1 Date of recognition All financial assets and liabilities are initially recognised on the trade date. Purchases or sales of financial assets, where delivery is required within a time frame established by regulations or by market convention, are also recognised on the trade date, i.e. the date that the Group commits to purchase or sell the asset. Derivatives are also recognised on a trade date basis. ‘Balances with central banks’, ‘Funding from central banks’, ‘Deposits by banks’, ‘Customer deposits’, ‘Loans and advances to banks’ and ‘Loans and advances to customers’ are recognised when cash is received by the Group or advanced to the borrowers. 49 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.14 Financial instruments (continued) 2.14.2 Initial recognition and measurement of financial instruments The classification of financial instruments on initial recognition depends on the purpose for which the financial instruments were acquired and their characteristics. All financial instruments are measured initially at their fair value plus, in the case of financial assets and liabilities not measured at fair value through profit or loss, any directly attributable incremental costs of acquisition or issue. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 2.14.3 Derivative financial instruments Derivatives are recorded at fair value and classified as assets when their fair value is positive and as liabilities when their fair value is negative. Subsequently, derivatives are measured at fair value. Revaluations of trading derivatives are included in the consolidated income statement in ‘Net foreign exchange gains’ in the case of currency derivatives and in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’ in the case of all other derivatives. Interest income and expense are included in the corresponding captions in the consolidated income statement. Derivatives embedded in other financial instruments, such as the conversion option in an acquired convertible bond, are treated as separate derivatives and recorded at fair value if their economic characteristics and risks are not closely related to those of the host contract, and the host contract is not itself measured at fair value with revaluation recognised in the consolidated income statement. The embedded derivatives separated from the host are carried at fair value, with revaluations recognised in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’ in the consolidated income statement. 2.14.4 Financial assets or financial liabilities held for trading Financial assets or financial liabilities held for trading represent assets and liabilities acquired or incurred principally for the purpose of selling or repurchasing them in the near term and are recognised in the consolidated balance sheet at fair value. Changes in the fair value are recognised in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’ in the consolidated income statement. Interest income and expense are included in the corresponding captions in the consolidated income statement according to the terms of the relevant contract, while dividend income is recognised in ‘Other income’ when the right to receive payment has been established. 2.14.5 Financial assets or financial liabilities designated upon initial recognition at fair value through profit or loss Financial assets and financial liabilities classified in this category are designated by management on initial recognition when the following criteria are met: (a) the designation eliminates or significantly reduces the inconsistency that would otherwise arise from the measurement of the assets or liabilities or the recognition of gains or losses on them on a different basis, or (b) the assets and liabilities are part of a group of financial assets, financial liabilities or both which are managed and their performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, or (c) the financial instrument contains an embedded derivative, unless the embedded derivative does not significantly modify the cash flows of the instrument or it is clear, with little or no analysis, that the embedded derivative could not be separated. These assets do not form part of the trading portfolio because no recent pattern of short-term profit taking exists. They include listed debt securities economically hedged by derivatives, and not designated for hedge accounting, as well as unlisted equities which are managed on a fair value basis. 50 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.14 Financial instruments (continued) 2.14.5 Financial assets or financial liabilities designated upon initial recognition at fair value through profit or loss (continued) Financial assets and financial liabilities designated upon initial recognition at fair value through profit or loss are recognised in the consolidated balance sheet at fair value. Changes in fair value are recognised in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’ in the consolidated income statement. Interest income and expense are included in the corresponding captions in the consolidated income statement according to the terms of the relevant contract, while dividend income is recognised in ‘Other income’ when the right to receive payment has been established. 2.14.6 Held-to-maturity investments Held-to-maturity investments are those with fixed or determinable payments and fixed maturities and which the Group has the intention and ability to hold to maturity. After initial measurement, held-to-maturity investments are subsequently measured at amortised cost using the effective interest method. Amortised cost is calculated by taking into account any discount or premium on acquisition and fees that are an integral part of the effective interest rate. The amortisation is included in ‘Interest income’ in the consolidated income statement. Losses arising from impairment of such investments are recognised in ‘Impairment of other financial instruments’ in the consolidated income statement. If, as a result of a change in intention or ability, it is no longer appropriate to classify an investment as held-to-maturity, it shall be reclassified as available-for- sale and remeasured at fair value, and the difference between its carrying amount and fair value shall be accounted for, accordingly. 2.14.7 Loans and receivables Loans and receivables are financial assets with fixed or determinable payments that are not quoted in an active market. They are not entered into with the intention of immediate or short-term resale and are not classified as ‘Trading investments’, ‘Investments available-for-sale’ or ‘Investments at fair value through profit or loss’. This accounting policy covers the captions ‘Loans and advances to banks’, ‘Reverse repurchase agreements’, ‘Loans and advances to customers’ and ‘Investments classified as loans and receivables’ in the consolidated balance sheet. After their initial recognition, loans and receivables are subsequently measured at amortised cost using the effective interest method, less any provision for impairment. The losses arising from impairment are recognised in the consolidated income statement in ‘Provisions for impairment of loans and advances and other customer credit losses’ in the case of loans and advances to customers and in ‘Impairment of other financial instruments’ for all other instruments. 2.14.8 Available-for-sale investments Available-for-sale investments are those which are designated as such or do not qualify for classification as ‘Investments at fair value through profit or loss’, ‘Investments held-to-maturity’ or ‘Loans and receivables’. These investments can be sold in response to changes in market risks or liquidity requirements and include equity securities and debt securities. After initial recognition, available-for-sale investments are measured at fair value. Unrealised gains and losses from changes in fair value are recognised directly in other comprehensive income in the ‘Available-for-sale investments’ caption. When the investment is disposed of, the cumulative gain or loss previously recognised in other comprehensive income is transferred to the consolidated income statement in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’. Where the Group holds more than one investment in the same security, they are deemed to be disposed of on a weighted average cost basis. Interest income from available-for-sale debt securities is recorded in ‘Interest income’ using the effective interest method. Dividend income from available-for-sale equity securities is recognised in the consolidated income statement in ‘Other income’ when the right to receive payment has been established. Impairment losses on available-for-sale investments are recognised in the consolidated income statement in ‘Impairment of other financial instruments’ caption. 51 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.14 Financial instruments (continued) 2.14.9 Subordinated loan stock Subordinated loan stock is initially measured at the fair value of the consideration received, net of any issue costs. It is subsequently measured at amortised cost using the effective interest method, in order to amortise the difference between the cost at inception and the redemption value, over the period to the earliest date that the Group has the right to redeem the subordinated loan stock. Interest on subordinated loan stock is included in ‘Interest expense’ in the consolidated income statement. 2.14.10 Other financial liabilities at amortised cost Other financial liabilities include ‘Customer deposits’, ‘Deposits by banks’ and ‘Funding from central banks’. Financial liabilities are recognised when the Group enters into the contractual provisions of the arrangements with counterparties, which is generally on trade date, and initially measured at fair value, which is normally the consideration received, net of directly attributable transaction costs incurred. Subsequent measurement of deposits by customers, funding from central banks and deposits by banks is at amortised cost, using the effective interest method. 2.15 Derecognition of financial assets and financial liabilities 2.15.1 Financial assets A financial asset is derecognised when: (a) the contractual rights to receive cash flows from the asset have expired, or (b) the Group has transferred its contractual rights to receive cash flows from the asset or (c) has assumed an obligation to pay the received cash flows in full to a third party and has: either (i) transferred substantially all the risks and rewards of the asset, or (ii) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Renegotiated loans A loan that is renegotiated is derecognised if the existing agreement is cancelled and a new agreement made on substantially different terms, or if the terms of an existing agreement are modified, such that the renegotiated loan is substantially a different financial instrument. 2.15.2 Financial liabilities A financial liability is derecognised when the obligation under the liability is discharged, cancelled or expired. 2.16 Impairment of financial assets 2.16.1 Loans and receivables The Group assesses at each reporting date whether there is any objective evidence that a financial asset or a group of financial assets is impaired. A financial asset or a group of financial assets is impaired if there is objective evidence of impairment as a result of one or more events that have occurred after the initial recognition of the asset (an incurred loss event) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or the group of financial assets, that can be reliably estimated. Objective evidence of impairment may include indications that the borrower or group of borrowers is experiencing significant financial difficulty, default or delinquency in interest or principal payments, the probability that the borrower might be declared bankrupt or proceed with a financial restructuring and where observable data indicate that there is a measurable decrease in the estimated future cash flows, such as changes in arrears or the economic conditions that correlate with defaults. There is objective evidence that a loan is impaired when it is probable that the Group will not be able to collect all amounts due, according to the original contract terms. For loans and advances to customers carried at amortised cost, the Group first assesses individually whether objective evidence of impairment exists for loans and advances that are individually significant. Furthermore, a collective impairment assessment is made for loans and advances that are not individually significant and for losses that have been incurred but are not yet identified relating to loans and advances that have been assessed individually and for which no provision has been made. 52 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.16 Impairment of financial assets (continued) 2.16.1 Loans and receivables (continued) Provisions for impairment of loans are determined using the incurred loss model as required by IFRSs, which requires recognition of impairment losses that arose from past events and prohibits recognition of impairment losses that could arise from future events, no matter how likely those events are. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the carrying amount of the loan and the present value of the estimated future cash flows including the cash flows which may arise from guarantees and tangible collaterals. The collectability of individually significant loans and advances is evaluated based on the customer’s overall financial condition, resources and payment record, the prospect of support from creditworthy guarantors and the realisable value of any collateral. The present value of the estimated future cash flows is calculated using the loan’s original effective interest rate. If a loan bears a variable interest rate, the discount rate used for measuring any impairment loss is the current reference rate plus the margin specified in the initial contract. For the purposes of a collective evaluation of impairment, loans are grouped based on similar credit risk characteristics taking into account the type of the loan, geographic location, past-due days and other relevant factors. Future cash flows for a group of loans and advances that are collectively evaluated for impairment are estimated on the basis of historical loss experience for loans with similar credit risk characteristics to those of the group. Historical loss experience is adjusted on the basis of current observable data to reflect the impact of current conditions that did not affect the period on which the historical loss experience is based and to remove the impact of conditions in the historical period that do not currently apply. The methodology and assumptions used for estimating future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. The carrying amount of the loan is reduced through the use of a provision account and the amount of the loss is recognised in the consolidated income statement. Loans together with the associated provisions are written off when there is no realistic prospect of future recovery. Partial write-offs, including non contractual write-offs, may also occur when it is considered that there is no realistic prospect for the recovery of the contractual cash flows. If, in a subsequent period, the amount of the estimated impairment loss decreases and the decrease is due to an event occurring after the impairment was recognised, when the creditworthiness of the customer has improved to such an extent that there is reasonable assurance that all or part of the principal and interest according to the original contract terms of the loan will be collected timely, the previously recognised impairment loss is reduced by adjusting the impairment provision account. If a previously written-off loan is subsequently recovered, any amounts previously charged are credited to ‘Provisions for impairment of loans and advances and other customer credit losses’ in the consolidated income statement. 2.16.2 Investments classified as held-to-maturity and loans and receivables For held-to-maturity investments and loans and receivables investments, the Group assesses at each reporting date whether there is objective evidence of impairment. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses not yet incurred). The carrying amount of the asset is reduced and the amount of the loss is recognised in ‘Impairment of other financial instruments’ caption in the consolidated income statement. If, in a subsequent period, the amount of the estimated impairment loss decreases because of an event occurring after the impairment was recognised, the impairment loss previously recognised is reversed and the reversal is credited to the ‘Impairment of other financial instruments’ caption in the consolidated income statement. 53 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.16 Impairment of financial assets (continued) 2.16.3 Available-for-sale investments For available-for-sale investments, the Group assesses whether there is objective evidence of impairment at each reporting date. In the case of equity securities classified as available-for-sale, objective evidence would include a significant or prolonged decrease, in the fair value of the investment below cost. Where there is evidence of impairment, the cumulative loss–measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that investment previously recognised in the consolidated income statement–is deducted from the ‘Revaluation reserve of available-for-sale investments’ in other comprehensive income and recognised in ‘Impairment of other financial instruments’ caption in the consolidated income statement. Impairment losses on equity securities are not reversed through the consolidated income statement. Increases in their fair value after impairment are recognised in the ‘Revaluation of available-for-sale investments’ in other comprehensive income. In the case of debt securities classified as available-for-sale, impairment is assessed based on the same criteria applicable to financial assets carried at amortised cost. If, in a subsequent period, the impairment loss decreases and the decrease can be objectively related to an event occurring after the impairment loss was recognised, the impairment loss previously recognised is reversed through ‘Impairment of other financial instruments’ caption in the consolidated income statement. 2.17 Hedge accounting The Group uses derivative financial instruments to hedge exposures to interest rate and foreign exchange risks and in the case of the hedge of net investments, the Group uses also non-derivative financial liabilities. The Group applies hedge accounting for transactions which meet the specified criteria. At inception of the hedging relationship, the Group formally documents the relationship between the hedged item and the hedging instrument, including the nature of the risk and the objective and strategy for undertaking the hedge. The method that will be used to assess the effectiveness both at the inception and at ongoing basis, of the hedging relationship also forms part of the Group’s documentation. At inception of the hedging relationship and at each hedge effectiveness assessment date, a formal assessment is undertaken to ensure that the hedging relationship is highly effective regarding the offsetting of the changes in fair value or the cash flows attributable to the hedged risk. A hedge is regarded as highly effective if the changes in fair value or cash flows attributable to the hedged risk of the hedging instrument and the hedged item during the period for which the hedge is designated, are expected to offset in a range of 80% to 125%. In the case of cash flow hedges where the hedged item is a forecast transaction, the Group assesses whether the transaction is highly probable and presents an exposure to variations in cash flows that could ultimately affect the consolidated income statement. 2.17.1 Fair value hedges In the case of fair value hedges that meet the criteria for hedge accounting, the change in the fair value of a hedging instrument is recognised in the consolidated income statement in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’. The change in the fair value of the hedged item attributable to the risk hedged is recorded as part of the carrying value of the hedged item and is also recognised in the consolidated income statement in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’. If the hedging instrument expires or is sold, terminated or exercised, or where the hedge no longer meets the criteria for hedge accounting, the hedging relationship is discontinued prospectively. For hedged items recorded at amortised cost, the difference between the carrying value of the hedged item on termination and the face value is amortised to the consolidated income statement, over the remaining term of the original hedge. If the hedged item is derecognised, the unamortised fair value adjustment is recognised immediately in the consolidated income statement. 54 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.17 Hedge accounting (continued) 2.17.2 Cash flow hedges In the case of cash flow hedges that meet the criteria for hedge accounting, the effective portion of the gain or loss on the hedging instrument is recognised directly in other comprehensive income in the ‘Cash flow hedge reserve’. The ineffective portion of the gain or loss on the hedging instrument is recognised in ‘Net gains on financial instrument transactions and disposal/dissolution of subsidiaries’ in the consolidated income statement. When the hedged cash flows affect the consolidated income statement, the gain or loss previously recognised in the ‘Cash flow hedge reserve’ is transferred to the consolidated income statement. 2.17.3 Hedges of net investments in foreign operations Hedges of net investments in overseas branches or subsidiaries are accounted for in a way similar to cash flow hedges. Gains or losses on the hedging instrument relating to the effective portion of the hedge are recognised in other comprehensive income while gains or losses relating to the ineffective portion are recognised in ‘Net foreign exchange gains’ in the consolidated income statement. On disposal or liquidation of an overseas branch or subsidiary, the cumulative gains or losses recognised in other comprehensive income are transferred in the consolidated income statement within profit/(loss) on disposal/dissolution of subsidiaries. 2.18 Offsetting financial instruments Financial assets and financial liabilities are offset and the net amount reported in the consolidated balance sheet if there is a currently enforceable legal right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the asset and settle the liability simultaneously. 2.19 Cash and cash equivalents Cash and cash equivalents for the purposes of the consolidated statement of cash flows consist of cash, non- obligatory balances with central banks, loans and advances to banks and other securities that are readily convertible into known amounts of cash or are repayable within three months of the date of their acquisition. 2.20 Insurance business The Group undertakes both life insurance and general insurance business and issues insurance and investment contracts. An insurance contract is a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder. Investment contracts are those contracts that transfer financial risk. Investment contracts can, however, be reclassified as insurance contracts after inception if insurance risk becomes significant. Once a contract has been classified as an insurance contract, it remains an insurance contract until expiry or until all of the rights and obligations under the contract have been fulfilled, even if the insurance risk has been significantly reduced during its term. 55 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.20 Insurance business (continued) 2.20.1 Life insurance business Premium income from unit-linked insurance contracts is recognised when received and when the units have been allocated to policyholders. Premium income from non-linked insurance contracts is recognised when due, in accordance with the terms of the relevant insurance contracts. Fees and other expenses chargeable to the long-term assurance funds in accordance with the terms of the relevant insurance contracts, as well as the cost of death cover, are recognised in a manner consistent with the recognition of the relevant insurance premiums. Claims are recorded as an expense when they are incurred. Life insurance contract liabilities are determined on the basis of an actuarial valuation and for unit-linked insurance contracts they include the fair value of units allocated to policyholders on a contract by contract basis. 2.20.2 Life insurance in-force business The Group recognises as an intangible asset the value of in-force business in respect of life insurance contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the reporting date, using appropriate economic and actuarial assumptions, similar to the calculation of the respective life insurance contract liabilities. The change in the present value is determined on a post-tax basis. For presentation purposes, the change in value is grossed up at the underlying rate of tax. 2.20.3 General insurance business Premiums are recognised in the consolidated income statement in the period in which insurance cover is provided. Unearned premiums relating to the period of risk after the reporting date are deferred to subsequent reporting periods. An increase in liabilities arising from claims is made for the estimated cost of claims notified but not settled and claims incurred but not notified at the reporting date. The increase in liabilities for the cost of claims notified but not settled is made on a case by case basis after taking into consideration all known facts, the cost of claims that have recently been settled and assumptions regarding the future development of outstanding cases. Similar statistical techniques are used to determine the increase in liabilities for claims incurred but not notified at the reporting date. 2.20.4 Investment contracts The Group offers deposit administration funds which provide a guaranteed investment return on members’ contributions. Policies are written to employees of companies, which define the benefits to be received. Any shortfalls are covered by the companies which employ the staff being insured. The Group has no liability for any actuarial deficit. 2.20.5 Liability adequacy test At each reporting date, liability adequacy tests are performed to ensure the adequacy of insurance contract liabilities. In performing these tests, current best estimates of discounted future contractual cash flows and claims, expenses and investment returns are used. Any deficiency is charged to the consolidated income statement. 2.21 Repurchase and reverse repurchase agreements Securities sold under agreements to repurchase (repos) at a specific future date are not derecognised from the consolidated balance sheet. The corresponding cash received, including accrued interest, is recognised on the consolidated balance sheet as ‘Repurchase agreements’, reflecting its economic substance as a loan to the Group. The difference between the sale price and repurchase price is treated as interest expense and is accrued over the life of the agreement using the effective interest method. Repos outstanding at the reporting date relate to agreements with financial institutions. The investments pledged as security for the repurchase agreements can be sold or repledged by the counterparty. When the counterparty has the right to sell or repledge the securities, the Group reclassifies those securities in its consolidated balance sheet to ‘Investments pledged as collateral’. 56 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.21 Repurchase and reverse repurchase agreements (continued) Securities purchased under agreements to resell (reverse repos) at a specific future date, are recorded as reverse repo transactions. The difference between the purchase and the resale price is treated as interest income and is accrued over the life of the agreement using the effective interest method. Reverse repos outstanding at the reporting date relate to agreements with banks. The investments received as security under reverse repurchase agreements can either be sold or repledged by the Group. 2.22 Finance leases–The Group as lessor Finance leases, where the Group transfers substantially all the risks and rewards incidental to ownership of the leased item to the lessee, are included in the consolidated balance sheet in ‘Loans and advances to customers’. A receivable is recognised over the lease period of an amount equal to the present value of the lease payments using the implicit rate of interest and including any guaranteed residual value. Finance income is recognised in ‘Interest income’ in the consolidated income statement. 2.23 Operating leases 2.23.1 Group as lessee Leases that do not transfer to the Group substantially all the risks and benefits incidental to ownership of the leased items are operating leases. Operating lease payments are recognised as an expense in the consolidated income statement on a straight line basis over the lease term in ‘Other operating expenses’. 2.23.2 Group as lessor Leases in which the Group does not transfer substantially all the risks and rewards of ownership of an asset are classified as operating leases. 2.24 Property and equipment Owner-occupied property is property held by the Group for use in the supply of services or for administrative purposes. Investment property is property held by the Group to earn rentals and/or for capital appreciation. If a property of the Group includes a portion that is owner-occupied and another portion that is held to earn rentals or for capital appreciation, the classification is based on whether or not these portions can be sold separately. Otherwise, the whole property is classified as owner-occupied property unless the owner-occupied portion is insignificant. The classification of property is reviewed on a regular basis to account for major changes in its use. Owner-occupied property is initially measured at cost and subsequently measured at fair value less accumulated depreciation and impairment. Valuations are carried out periodically between 3 to 5 years, depending on the property (but more frequent revaluations may be performed where there are significant and volatile movement in values), by independent, qualified valuers or by the internal qualified valuers of the Group applying a valuation model recommended by the International Valuation Standards Council. Depreciation is calculated on the revalued amount less the estimated residual value of each building on a straight line basis over its estimated useful life. Gain or losses from revaluations are recognised in other comprehensive income in ‘Property revaluation’. The ‘Property revaluation reserve’ includes revaluation of property initially used by the Group for its operations which was subsequently transferred to ‘Investment properties’. Useful life is in the range of 30 to 67 years. Freehold land is not depreciated. On disposal of freehold land and buildings, the relevant revaluation reserve balance is transferred to ‘Accumulated losses’. The cost of adapting/improving leasehold property is amortised over 5 years. Equipment is measured at cost less accumulated depreciation. Depreciation of equipment is calculated on a straight line basis over its estimated useful life of 5 to 10 years. At the reporting date, when events or changes in circumstances indicate that the carrying value may not be recovered, property and equipment is assessed for impairment. Where the recoverable amount is less than the carrying amount, equipment is written down to its recoverable amount. 57 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.25 Investment properties Investment properties comprise land and buildings that are not occupied for use by, or in the operations of the Group, nor for sale in the ordinary course of business, but are held primarily to earn rental income and capital appreciation. These buildings are substantially rented to tenants and not intended to be sold in the ordinary course of business. Investment properties are measured initially at cost, including transaction costs. Subsequent to initial recognition, investment properties are measured at fair value, as at the reporting date. Gains or losses arising from changes in the fair values of investment properties are included in ‘Net (losses)/gains from revaluation and disposal of investment properties’ in the consolidated income statement. Valuations are carried out by independent, qualified valuers or by the internal qualified valuers of the Group applying a valuation model recommended by the International Valuation Standards Council. Transfers are made to (or from) investment property only when there is a change in use. For a transfer from owner-occupied property to investment property, the Group accounts for such property in accordance with the policy described in Note 2.24 ‘Property and equipment’ up to the date of change in use. For a transfer from investment property to stock of property, the property’s deemed cost for subsequent accounting is its fair value at the date of change in use. 2.26 Stock of property The Group in its normal course of business acquires properties in exchange of debt, which are held either directly or by entities set up and controlled by the Group for the sole purpose of managing these properties with an intention to be disposed of. These properties are recognised in the Consolidated Financial Statements as ‘Stock of property’, reflecting the substance of these transactions. Stock of property is initially measured at cost and subsequently measured at the lower of cost and net realisable value. Net realisable value is the estimated selling price, less the estimated costs necessary to make the sale. If net realisable value is below the cost of the stock of property, impairment is recognised in ‘Impairment of non-financial instruments’ in the consolidated income statement. 2.27 Non-current assets held for sale and discontinued operations The Group classifies non-current assets and disposal groups as held for sale if their carrying amounts will be recovered principally through a sale or distribution rather than through continuing use. The condition is regarded as met only when the sale is highly probable and the asset or disposal group is available for immediate sale in its present condition. Actions required to complete the sale should indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Management must be committed to the sale, which should be expected to qualify for recognition as a completed sale within one year from the date of classification. Such non-current assets and disposal groups held for sale are measured at the lower of their carrying amount and fair value less costs to sell, except for those assets and liabilities that are not within the scope of the measurement requirements of IFRS 5 ‘Non-current assets held for sale and discontinued operations’ such as deferred taxes, financial instruments, investment properties measured at fair value, insurance contracts and assets and liabilities arising from employee benefits. These are measured in accordance with the Group’s relevant accounting policies described elsewhere in this note. Immediately before the initial classification as held for sale, the carrying amount of the asset (or assets and liabilities in the disposal group) is measured in accordance with applicable IFRSs. On subsequent remeasurement of a disposal group, the carrying amounts of the assets and liabilities noted above that are not within the scope of the measurement requirements of IFRS 5 are remeasured in accordance with applicable IFRSs before the fair value less costs to sell of the disposal group is determined. 58 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.27 Non-current assets held for sale and discontinued operations (continued) If fair value less costs to sell of the disposal group is below the aggregate carrying amount of all of the assets and liabilities included in the disposal group, the disposal group is written down. The impairment loss is recognised in the income statement for the year. Where an impairment loss is recognised (or reversed) for a disposal group, it is allocated between the scoped-in non–current assets using the order of allocation set out in IAS 36 and no element of the adjustment is allocated to the other assets and liabilities of the disposal group. In case that the carrying amount of scoped-in non-current assets is less than the amount by which a disposal group’s carrying amount exceeds its fair value less costs to sell, the excess is not recognised. Property and equipment and intangible assets are not depreciated or amortised once classified as held for sale. Assets and liabilities classified as held for sale are presented separately in the consolidated balance sheet. A disposal group qualifies as discontinued operation if an entity or a component of an entity has been disposed of or is classified as held for sale and a) represents a separate major line of business or geographical area of operations, b) is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations, or c) is a subsidiary acquired exclusively with a view to resale. Net loss/profit from discontinued operations includes the net total of operating profit and loss before tax from discontinued operations (including net gain or loss on sale before tax and gain or loss on measurement to fair value less cost to sell of a disposal group constituting a discontinued operation) and discontinued operations tax expense. Discontinued operations are excluded from the results of continuing operations and are presented as a single amount, as profit or loss after tax from discontinued operations in the consolidated income statement. 2.28 Intangible assets Intangible assets include among others computer software and acquired insurance portfolio customer lists. Intangible assets acquired separately are measured on initial recognition at cost. The cost of intangible assets acquired in a business combination is their fair value as at the date of acquisition. Following initial recognition, intangible assets are carried at cost less any accumulated amortisation and any accumulated impairment losses. Amortisation is calculated on a straight line basis over the estimated useful life of the assets which is 3 to 8 years for computer software. For the accounting policy of in-force life insurance business, refer to Note 2.20.2. Intangible assets are reviewed for impairment when events relating to changes to circumstances indicate that the carrying value may not be recoverable. If the carrying amount exceeds the recoverable amount then the intangible assets are written down to their recoverable amount. 2.29 Share capital Any difference between the issue price of share capital and the nominal value is recognised as share premium. The costs incurred attributable to the issue of share capital are deducted from equity. 2.30 Treasury shares Own equity instruments which are acquired by the Company or by any of its subsidiaries are presented as treasury shares at their acquisition cost. Treasury shares are deducted from equity until they are cancelled or reissued. No gain or loss is recognised in the consolidated income statement on the purchase, sale, issue or cancellation of the Company’s own equity shares. 2.31 Provisions 2.31.1 Provisions for pending litigation, claims and regulatory matters Provisions for pending litigation, claims and regulatory matters against the Group are made when: (a) there is a present obligation (legal or constructive) arising from past events, (b) the settlement of the obligation is expected to result in an outflow of resources embodying economic benefits, and (c) a reliable estimate of the amount of the obligation can be made. 59 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 2. Summary of significant accounting policies (continued) 2.31 Provisions (continued) 2.31.2 Provisions for undrawn loan commitments Provisions are made for undrawn loan commitments if it is probable that the facility will be drawn and result in the recognition of an asset at an amount less than the amount advanced. 2.32 Financial guarantees The Group issues financial guarantees to its customers, consisting of letters of credit, letters of guarantee and acceptances. Financial guarantees are initially recognised in the Consolidated Financial Statements at fair value, in ‘Accruals, deferred income and other liabilities’. Subsequently, the Group’s liability under each guarantee is measured at the higher of: (a) the amount initially recognised reduced by the cumulative amortised premium which is periodically recognised in the consolidated income statement in ‘Fee and commission income’ in accordance with the terms of the guarantee, and (b) the best estimate of the expenditure required to settle any financial obligation arising as a result of the guarantee. Any increase in the liability relating to financial guarantees is recognised in the consolidated income statement in ‘Provisions for impairment of loans and advances to customers and other customer credit losses’. The balance of the liability for financial guarantees that remains is recognised in ‘Fee and commission income’ in the consolidated income statement when the guarantee is fulfilled, cancelled or expired. 2.33 Comparative information As described in Note 2.1, the Group is considered to be a continuation of the BOC group. As a result, the Consolidated Financial Statements, including comparative amounts, were prepared as if the Group existed at the beginning of the earlier period presented in the Consolidated Financial Statements. In addition reclassifications to comparative information were made to conform to current year presentation. Specifically, special levy on deposits on credit institutions in Cyprus amounting to €19,968 thousand was reclassified from ‘Other operating expenses’ to being presented separately on the face of the consolidated income statement. Additionally, negative interest income on loans and advances to banks and central banks amounting to €3,716 thousand was reclassified from ‘Interest income’ (Note 7) to ‘Interest expense’ (Note 8). Such reclassification did not have an impact on the results for the year or equity of the Group. 3. Going concern The Directors have made an assessment of the Group’s ability to continue as a going concern. The conditions that existed during 2017 and the developments up to the date of approval of these Consolidated Financial Statements that have been considered in the going concern assessment include, amongst others, the operating environment in Cyprus and of the Group (Note 4). The Directors believe that the Group is taking all necessary measures to maintain its viability and the development of its business in the current economic environment. The Directors, taking into consideration the factors described below and the uncertainties that existed at the reporting date, are satisfied that the Group has the resources to continue in business for a period of at least 12 months from the date of approval of the Consolidated Financial Statements and, therefore, the going concern principle is appropriate for the reasons set out below.  The Common Equity Tier 1 (CET1) ratio and the total capital ratio on a transitional basis stood at 12.7% and 14.2% respectively at 31 December 2017, higher than the minimum required ratios (Note 4.2.1). The IFRS 9 impact on a transitional and on a fully phased-in basis, after the period of transition is complete, is expected to be manageable and within the Group’s capital plan. The increasing level of Group customer deposits (increase of €1,340 million during 2017). Customer deposits stood at €17,850 million at 31 December 2017. The continuous improvement in the Group liquidity position and its liquidity ratios. Following the repayment of Emergency Liquidity Assistance (ELA) in January 2017 (2016: €200 million), the Group achieved compliance with the Liquidity Coverage Ratio (LCR). The Group is also in compliance with the LCR add-on, which was introduced by the CBC as a macro-prudential measure and is applicable from 1 January 2018 (Notes 4.2.3 and 46). As at 31 December 2017, the Group was not in compliance with all liquidity regulatory requirements with respect to its operations in Cyprus, however, these ratios were abolished on 1 January 2018.    60 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 3. Going concern (continued)    The significant reduction of Group loans that are impaired or past due for more than 90 days (90+ DPD), which have decreased by 17% during 2017 and totalled €6,905 million at 31 December 2017 and the increase of provisions coverage to 61% compared to 54% at 31 December 2016 (Note 4.2.2). The Cyprus government rating has been repeatedly upgraded following the consistent outperformance in public finances and the progress achieved in the banking sector. Most recently in March 2018, S&P Global Ratings affirmed its long-term sovereign rating at BB+, only one notch below investment grade, and maintained its outlook to positive. Ιn October 2017, Fitch Ratings upgraded its Long-Term Issuer Default ratings to BB from BB- with positive outlook. In July 2017, Moody’s Investors Service upgraded the long- term issuer rating of the Cyprus sovereign to Ba3 from B1 to reflect Cyprus’ economic recovery and maintained its outlook to positive. Moody’s Investors Service reiterated its credit rating and positive outlook on the Cyprus sovereign in a February 2018 update. BOC PCL regained access to the debt capital markets in January 2017 with the issuance of a €250 million unsecured subordinated Tier 2 Capital Note. 4. 4.1 Operating environment Cyprus Economic recovery in Cyprus accelerated in 2017 and the medium term outlook is favourable driven by an improving labour market, broadening investments and increasing resilience. Cyprus continues to face challenges primarily in relation to public and private indebtedness and NPEs, but while more remains to be done, considerable progress has been achieved. Real GDP in Cyprus increased by 3.9% in 2017 according to the Cyprus Statistical Service, compared with a 3.4% increase the previous year. In the labour market, the unemployment rate dropped to 11% on average in the year from 13% the year before according to the Cyprus Statistical Service. Average consumer inflation was marginally positive at 0.5% after four years of deflation. In the public sector the budget surplus increased significantly and the trend in the public debt to GDP ratio appears to be reversing downwards. In the banking sector funding conditions continued to improve against a backdrop of favourable developments regarding NPEs. The growth momentum is expected to be maintained in the medium term. Real GDP is expected to grow by 3.6% in 2018 and by 2.9% in 2019, slowing towards 2.5% by 2022 according to the International Monetary Fund (IMF) (Cyprus country report, December 2017). Growth will be supported by private consumption and investment expenditures and by an improving and robust labour market. On the supply side, growth is expected to be driven by favourable developments in the tourism sector and robust performance in business services. Tourism remains robust and continues to benefit from geopolitical uncertainties in competing destinations. Tourist arrivals in 2017 reached 3.7 million persons, an all-time high, and revenues reached an estimated €2.6 billion or c.13.7% of GDP. The budget surplus increased to 1.9% of GDP in 2017 according to estimates by the IMF (Cyprus country report, December 2017), from 0.5% the previous year. The budget is expected to generate sizeable surpluses in the medium term (IMF, Cyprus country report, December 2017). The debt to GDP ratio is estimated at 97.5% in 2017 according to the Cyprus Statistical Service, and it is expected to decline to 75% by 2022 also according to the IMF (Cyprus country report, December 2017). Debt remains affordable with interest charges at 2.6% of GDP in 2016-2017 compared with 3.3% of GDP in 2013 (IMF, Cyprus country report, December 2017). The government took advantage of favourable conditions in debt markets to issue a new €850 million 7-year bond in June 2017 yielding 2.8% to pre-finance borrowing needs through to end-2018, and to smooth its repayment schedule beyond 2018. In the banking sector there have been significant improvements in funding conditions and asset quality. Total deposits increased marginally by 0.8% in the year, with resident deposits increasing by 3.3%. Loan deleveraging continued in the year with total loans outstanding dropping by 7.1% and loans to residents dropping by 4.8% (according to CBC data). Cyprus’ consistent fiscal outperformance and favourable outlook indicate a more rapid reversal in the public debt ratio and the ratio of NPEs, than previously expected. The outlook over the medium term is generally positive according to the IMF and the European Commission, while the economy continues to face challenges. Upside factors relate to a longer period of low oil prices, further improvement of economic fundamentals in the euro area and stronger investment spending as property prices are stabilising and as projects in tourism, energy and public works are being implemented. Downside risks to this outlook are associated with the still high levels of NPEs and public debt ratio, and with a possible deterioration of the external environment. 61 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 4. 4.1 Operating environment (continued) Cyprus (continued) The Cyprus government rating has been repeatedly upgraded following the consistent outperformance in public finances and the progress achieved in the banking sector. Most recently in March 2018, S&P Global Ratings affirmed its long-term sovereign rating at BB+, only one notch below investment grade, and maintained its outlook to positive. Ιn October 2017, Fitch Ratings upgraded its Long-Term Issuer Default ratings to BB from BB- with positive outlook. In July 2017, Moody’s Investors Service upgraded the long-term issuer rating of the Cyprus sovereign to Ba3 from B1 to reflect Cyprus’ economic recovery and maintained its outlook to positive. Moody’s Investors Service reiterated its credit rating and positive outlook on the Cyprus sovereign in a February 2018 update. 4.2 The Group 4.2.1 Regulatory capital ratios The CET1 ratio of the Group at 31 December 2017 stands at 12.7% and the total capital at 14.2% on a transitional basis. The minimum Pillar I total capital ratio requirement is 8.0% and may be met, in addition to the 4.5% CET1 requirement, with up to 1.5% of Additional Tier 1 capital and with up to 2.0% of Tier 2 capital. The Group is also subject to additional capital requirements for risks which are not covered by the Pillar I capital requirements (Pillar II add-ons). The Group’s minimum phased-in CET1 capital ratio requirement for 2017 was 9.50%, comprised of a 4.50% Pillar I requirement, a 3.75% Pillar II requirement and the Capital Conservation Buffer (CCB) of 1.25% applicable for 2017. Following the Supervisory Review and Evaluation Process (SREP) performed by the ECB in 2017 and based on the confirmation received in December 2017, the Pillar II requirement applicable from 1 January 2018, has been reduced to 3.00% from 3.75%. As a result, the Group’s minimum phased-in CET1 capital ratio has been reduced to 9.375% from 9.50%, comprising of a 4.50% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018. The ECB has also provided revised lower non-public guidance for an additional Pillar II CET1 buffer. The overall Total Capital Ratio Requirement for 2017 was 13.00%, comprising of a Pillar I requirement of 8.00% (of which up to 1.50% can be in the form of Additional Tier 1 capital and up to 2.00% in the form of Tier 2 capital), a Pillar II requirement of 3.75% (in the form of CET1), and the CCB of 1.25% applicable for 2017. Following the 2017 SREP, the overall Total Capital Ratio Requirement has been reduced to 12.875% from 13.00%, comprising of 8.00% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018. The minimum CET1 requirement including Pillar II, applicable for the year 2016 was determined by the ECB at 11.75% in November 2015 and included CCB on a fully loaded basis. The above minimum ratios apply for both, BOC PCL and the Group. In January 2017 BOC PCL issued a €250 million unsecured and subordinated Tier 2 Capital Note under BOC PCL’s EMTN Programme. The note was priced at par, with a coupon of 9.25% (Note 33). In December 2017, Bank of Cyprus UK Ltd, a 100% subsidiary of BOC PCL issued a £30 million unsecured and subordinated Tier 2 Capital Loan priced at par with a coupon of 8.00% (Note 33). The capital position of the Group and BOC PCL at 31 December 2017 exceeds both their Pillar I and their Pillar II add-on capital requirements. However, the Pillar II add-on capital requirements are a point-in-time assessment and therefore are subject to change over time. 62 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 4. 4.2 Operating environment (continued) The Group (continued) 4.2.2 Asset quality The Group’s loans that are impaired or past due for more than 90 days (90+ DPD) have decreased by 17% during 2017 and totalled €6,905 million at 31 December 2017, representing 37% of gross loans before fair value adjustment on initial recognition (Note 44). The provisioning coverage ratio improved to 61% at 31 December 2017 compared to 54% at 31 December 2016. The Group NPEs, as defined by EBA, totalled €8,804 million at 31 December 2017 and accounted for 47% of gross loans before fair value adjustment on initial recognition. The provisioning coverage ratio of NPEs totalled 48% at 31 December 2017 compared to 41% at 31 December 2016. The Group addresses the asset quality challenge through the operation of the Restructuring and Recoveries Division which is actively seeking to find innovative solutions to manage distressed exposures. The Group has been successful in engineering restructuring solutions across the spectrum of its loan portfolio. 90+ DPD have decreased by 47% since their peak of €13,003 million at 31 December 2013. NPEs have decreased by 42% since their peak of €15,175 million at 31 March 2015. 4.2.3 Liquidity Group customer deposits totalled €17,850 million at 31 December 2017 compared to €16,510 million at 31 December 2016. Customer deposits in Cyprus reached €15,983 million at 31 December 2017 and €15,043 million at 31 December 2016. Customer deposits accounted for 76% of total assets as at 31 December 2017 (compared to 74% at 31 December 2016 and a low of 48% at 31 March 2014). After repayment of the ELA in January 2017, the Group is focusing on measures to improve its liquidity position and continue to exceed the minimum requirement with respect to the LCR, which was increased to 100% from 1 January 2018 onwards. As at 31 December 2017 the LCR stood at 190% for the Group (compared to 49% at 31 December 2016) and was in compliance with the minimum regulatory requirement of 80% applicable for 2017. The Net Stable Funding Ratio (NSFR) was not introduced on 1 January 2018 as per expectations. As at 31 December 2017 the Group’s NSFR, on the basis of the Basel ΙΙΙ standards, was 111% (compared to 95% at 31 December 2016). As at 31 December 2017, BOC PCL was not in compliance with all the local regulatory liquidity requirements set by the CBC with respect to its operations in Cyprus. On 1 January 2018, the local regulatory liquidity requirements were abolished, in accordance with the CRR and in December 2017 the CBC introduced a macro- prudential measure in the form of a liquidity add-on that was imposed on top of the LCR with effect on 1 January 2018. The objective of the measure is to ensure that there will be a gradual release of the excess liquidity arising from the lower liquidity requirements under the LCR compared to the ones under the local regulatory liquidity requirements previously in place. The LCR add-on applies stricter outflow and inflow rates than those defined in the Commission Delegated Regulation (EU) 2015/61. The measure will be implemented in two stages. The first stage requires stricter outflow and inflow rates which are applicable from 1 January 2018 until 30 June 2018. The second stage requires more relaxed outflow and inflow rates compared to the initial ones and are applicable from 1 July 2018 until 31 December 2018. Specifically there will be a reduction of 50% of the LCR add-on rates on 1 July 2018. The additional liquidity requirement is expected to be implemented up to 31 December 2018. The CBC may propose to modify or extend the period of application of this macro-prudential measure depending on the results of the follow-up of the banks’ actions on how the excess liquidity is utilised. BOC PCL is currently in compliance with the LCR including the LCR add-on. ELA was fully repaid on 5 January 2017. ELA is available to solvent Euro area credit institutions and although BOC PCL has received no specific assurance, management expects that BOC PCL will continue to have access to the central bank liquidity facilities, in line with applicable rules if it were to face a ‘stress event’ that gave rise to temporary liquidity problems. If a stress event were to occur in the future, BOC PCL would seek to utilise ELA funding, assuming it has sufficient available eligible collateral at the time. 63 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 4. 4.2 Operating environment (continued) The Group (continued) 4.2.4 Pending litigation, claims and regulatory matters The management has considered the potential impact of pending litigation and claims, investigations and regulatory matters against the Group. The Group has obtained legal advice in respect of these claims. Despite the novelty of many of the claims such as the bail-in of depositors and the absorption of losses by the holders of equity and debt instruments of BOC PCL and the uncertainties inherent in a unique situation, based on the information available at present and on the basis of the law as it currently stands, management considers that the said claims as well as other pending litigation, claims and regulatory matters are unlikely to have a material adverse impact on the financial position and capital adequacy of the Group. Additional information on pending litigation, claims and regulatory matters is provided in Note 39. 5. Significant judgements, estimates and assumptions The preparation of the Consolidated Financial Statements requires the Company’s Board of Directors and management to make judgements, estimates and assumptions that can have a material impact on the amounts recognised in the Consolidated Financial Statements and the accompanying disclosures, as well as the disclosures of contingent liabilities. Uncertainty about these assumptions and estimates could result in outcomes that require a material adjustment to the carrying amount of assets or liabilities affected in future periods. The key assumptions concerning the future and other key sources of estimation of uncertainty at the reporting date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities are described below. The Group based its assumptions and estimates on parameters available when the Consolidated Financial Statements were prepared. Existing circumstances and assumptions about future developments may, however, change due to market changes or circumstances beyond the control of the Group. Such changes are reflected in the assumptions when they occur. 5.1 Provision for impairment of loans and advances to customers The Group reviews its loans and advances to customers to assess whether a provision for impairment should be recorded in the consolidated income statement. In particular, management is required to estimate the amount and timing of future cash flows in order to determine the amount of provision required and the calculation of the impairment allowance involves the use of judgement. Such estimates are based on assumptions about a number of factors and therefore actual impairment losses may differ. The carrying amount of the loan is reduced through the use of a provision account and the amount of the loss is recognised in the consolidated income statement. Loans together with the associated provisions are written off when there is no realistic prospect of future recovery. Partial write-offs, including non-contractual write-offs, may also occur when it is considered that there is no realistic prospect for the recovery of the contractual cash flows. In addition, write-offs may reflect restructuring activity with customers and are part of the terms of the agreement and subject to satisfactory performance. The Group may change certain estimates from period to period, however it is impracticable to estimate the effect of such individual estimates due to interdependencies between estimates and as the profile of the population of loans changes from period to period. A very important factor for the estimation of provisions is the timing and net recoverable amount from repossession or realisation of collaterals which mainly comprise real estate assets. Assumptions have been made about the future changes in property values, as well as the timing for the realisation of the collateral, taxes and expenses on the repossession and subsequent sale of the collateral as well as any other applicable haircuts. Indexation has been used to estimate updated market values of properties, while assumptions were made on the basis of a macroeconomic scenario for future changes in property values. During 2017, the Group, following a reconsideration of its strategy to more actively explore other innovative strategic solutions to further accelerate balance sheet de-risking, has modified certain of its provisioning assumptions and estimates. 64 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 5. Significant judgements, estimates and assumptions (continued) 5.1 Provision for impairment of loans and advances to customers (continued) At 31 December 2017 the weighted average haircut (including liquidity haircut and selling expenses) used in the collective provisions calculation is c.34% (2016: average of 10% of the current market value of the property for those collaterals for which the increase in their value is capped to zero and 10% of the projected market value of the property for those collaterals for which their value is expected to drop). The timing of recovery from real estate collaterals used in the collective provision calculation has been estimated to be on average 6 years (2016: average of 3 years except for customers in Debt Recovery, average of 6 years). For the calculation of specific provisions, the timing of recovery of collaterals as well as the haircuts used were based on the specific facts and circumstances of each case. In accordance with the Loan Impairment and Provisioning Procedures Directives of 2014 and 2015 of the CBC, the cumulative average future change in property values during the year has been capped to zero. The above assumptions are also influenced by the ongoing regulatory dialogue BOC PCL maintains with its lead regulator, the ECB, and other regulatory guidance and interpretations issued by various regulatory and industry bodies such as the ECB and EBA, which provide guidance and expectations as to relevant definitions and the treatment/classification of certain parameters/assumptions used in the estimation of provisions. Any changes in these assumptions or difference between assumptions made and actual results could result in significant changes in the amount of required provisions for impairment of loans and advances. For individually significant assets, impairment allowances are calculated on an individual basis and all relevant considerations that have a bearing on the expected future cash flows are taken into account (e.g the business prospects for the customer, the realisable value of collateral, the Group’s position relative to other claimants, the reliability of customer information and the likely cost and duration of the work-out process). The level of the impairment allowance is the difference between the value of the discounted expected future cash flows (discounted at the loan’s original effective interest rate) and its carrying amount. Subjective judgements are made in the calculation of future cash flows. Furthermore, judgements change with time as new information becomes available or as work-out strategies evolve, resulting in frequent revisions to the impairment allowance as individual decisions are taken. Changes in these estimates would result in a change in the allowances and have a direct impact on the impairment charge. In addition to provisions for impairment on an individual basis, the Group also makes collective impairment provisions. The Group adopts a formulaic approach for collective provisions, which includes assigning probabilities of default and loss given default for portfolios of loans. This methodology is subject to estimation uncertainty, partly because it is not practicable to identify losses on an individual loan basis because of the large number of loans in each portfolio. In addition, the use of historical information for probabilities of default and loss rates is supplemented with significant management judgement to assess whether current economic and credit conditions are such that the actual level of incurred losses is likely to be greater or less than that suggested by historical experience. Impairment assessment also includes off-balance sheet credit exposures represented by guarantees given and by irrevocable commitments to disburse funds. Off-balance sheet credit exposures of the individually assessed assets require assumptions on the probability, timing and amount of cash outflows; otherwise the provision is calculated on a collective basis, taking into account the probability of loss for the portfolio in which the customer is included for on-balance sheet exposures impairment assessment. The Group may change certain estimates from period to period, however it is impracticable to estimate the effect of such individual estimates due to interdependencies between estimates and as the profile of the population of off-balance sheet exposure changes from period to period. In normal circumstances, historical experience provides the most objective and relevant information from which to assess inherent loss within each portfolio. In certain circumstances, historical loss experience provides less relevant information about the incurred loss in a given portfolio at the reporting date, for example, where there have been changes in economic, regulatory or behavioural conditions such that the most recent trends in the portfolio risk factors are not fully reflected. In these circumstances, such risk factors are taken into account when calculating the appropriate levels of impairment allowances, by adjusting the provision for impairment derived solely from historical loss experience. 65 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 5. Significant judgements, estimates and assumptions (continued) 5.1 Provision for impairment of loans and advances to customers (continued) The total amount of the Group’s provision for impairment of loans and advances is inherently uncertain because it is highly sensitive to changes in economic and credit conditions across a number of geographical areas. Loans subject to collective impairment assessment whose terms have been renegotiated are no longer considered past due and are treated as up to date loans for measurement purposes. Loans subject to collective impairment assessment whose terms have been renegotiated are taken into account in determining the inputs for collective impairment calculation. Loans subject to individual impairment assessment, whose terms have been renegotiated, are subject to ongoing review to determine whether they remain impaired. The carrying amounts of loans that have been classified as renegotiated retain this classification in accordance with the rules of the relevant EBA technical standard. Economic and credit conditions within geographical areas are influenced by many factors with a high degree of interdependency so that there is no one single factor to which the Group’s loan impairment provisions as a whole are particularly sensitive. Different factors are applied in each country to reflect the local economic conditions, laws and regulations and the assumptions underlying this judgement are highly subjective. The methodology and the assumptions used in calculating impairment losses are reviewed regularly. It is possible that the actual results could be different from the assumptions made, resulting in a material adjustment to the carrying amount of loans and advances. Further details on impairment allowances and related credit information are set out in Note 44. 5.2 Fair value of investments and derivatives The best evidence of fair value is a quoted price in an actively traded market. If the market for a financial instrument is not active, a valuation technique is used. The majority of valuation techniques employed by the Group use only observable market data and so the reliability of the fair value measurement is relatively high. However, certain financial instruments are valued on the basis of valuation techniques that feature one or more significant inputs that are not observable. Valuation techniques that rely on non-observable inputs require a higher level of management judgement to calculate a fair value than those based wholly on observable inputs. Valuation techniques used to calculate fair values include comparisons with similar financial instruments for which market observable prices exist, discounted cash flow analysis and other valuation techniques commonly used by market participants. Valuation techniques incorporate assumptions that other market participants would use in their valuations, including assumptions about interest rate yield curves, exchange rates, volatilities and default rates. When valuing instruments by reference to comparable instruments, management takes into account the maturity, structure and rating of the instrument with which the position held is being compared. The Group only uses models with unobservable inputs for the valuation of certain unquoted equity investments. In these cases, estimates are made to reflect uncertainties in fair values resulting from a lack of market data inputs, for example, as a result of illiquidity in the market. Inputs into valuations based on unobservable data are inherently uncertain because there is little or no current market data available from which to determine the level at which an arm’s length transaction would occur under normal business conditions. Unobservable inputs are determined based on the best information available. Further details on the fair value of assets and liabilities are disclosed in Note 22. 5.3 Impairment of available-for-sale investments Available-for-sale investments in equity securities are impaired when there has been a significant or prolonged decline in their fair value below cost. The determination of what is significant or prolonged requires judgement by management. Management has assessed that a loss of 25% or more is considered significant, except in the cases of investment companies where higher limits are set. Prolonged has been assessed by management to be a period of 12 months or more. The factors which are evaluated include the expected volatility in share prices. In addition, impairment may be appropriate when there is evidence that significant adverse changes have taken place in the technological, market, economic or legal environment in which the investee operates. 66 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 5. Significant judgements, estimates and assumptions (continued) 5.3 Impairment of available-for-sale investments (continued) Available-for-sale investments in debt securities are impaired when there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the investment and the event (or events) has an impact on the estimated future cash flows of the investment. Such impairment review takes into account a number of factors such as the financial condition of the issuer, any breach of contract, the probability that the issuer will enter bankruptcy or other financial reorganisation, which involves a high degree of judgement, as well as changes in the fair value of individual instruments such as when their fair value at the reporting date falls below 90% of the instruments’ amortised cost. Further details on impairment of available-for-sale investments are presented in Notes 16 and 20. 5.4 Retirement benefits The cost of defined benefit pension plans is determined using actuarial valuations. The actuarial valuations involve making assumptions about discount rates, the expected rate of return on plan assets, future salary increases, mortality rates as well as future pension increases where necessary. The Group’s management sets these assumptions based on market expectations at the reporting date using its best estimates for each parameter covering the period over which the obligations are to be settled. In determining the appropriate discount rate, management considers the yield curve of high quality corporate bonds. In determining other assumptions, a certain degree of judgement is required. Future salary increases are based on expected future inflation rates for the specific country plus a margin to reflect the best possible estimate relating to parameters such as productivity, workforce maturity and promotions. The expected return on plan assets is based on the composition of each fund’s plan assets, estimating a different rate of return for each asset class. Estimates of future inflation rates on salaries and expected rates of return of plan assets represent management’s best estimates for these variables. These estimates are derived after consultation with the Group’s advisors, and involve a degree of judgement. Due to the long-term nature of these plans, such estimates are inherently uncertain. Further details on retirement benefits are disclosed in Note 14. 5.5 General insurance business The Group is engaged in the provision of general insurance services. Risks under these policies usually cover a period of 12 months. The liabilities for outstanding claims arising from insurance contracts issued by the Group are calculated based on case estimates by loss adjusters and facts known at the reporting date. With time, these estimates are reconsidered and any adjustments are recognised in the financial statements of the period in which they arise. The principal assumptions underlying the estimates for each claim are based on past experience and market trends, and take into consideration claim handling costs. Other external factors that may affect the estimate of claims, such as recent court rulings and the introduction of new legislation are also taken into consideration. Provision is also made for claims incurred but not reported (IBNR) by the reporting date. Past experience as to the number and amount of claims reported after the reporting date is taken into consideration in estimating the IBNR provision. Insurance contract liabilities are sensitive to changes in the above key assumptions. The sensitivity of certain assumptions, such as the introduction of new legislation and the rulings of certain court cases, are very difficult to quantify. Furthermore, the delays that arise between the occurrence of a claim and its subsequent notification and eventual settlement increase the uncertainty existing at the reporting date. Further information on general insurance business is disclosed in Note 12. 67 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 5. Significant judgements, estimates and assumptions (continued) 5.6 Life insurance business The Group is engaged in the provision of life insurance services. Whole life insurance plans (life plans) relate to plans associated with assets where the amount payable in the case of death is the greater of the sum insured and the value of investment units. Simple insurance or temporary term plans (term plans) relate to fixed term duration plans for protection against death. In case of death within the coverage period, the insured sum will be paid. Endowment insurance (investment plans/mortgage plans/horizon plans) refer to specific duration plans linked to investments, to create capital through systematic investment in association with death insurance coverage whereby the higher of the sum insured and the value of investment units is payable on death within the contract term. Further information on life insurance business is disclosed in Note 12. 5.6.1 Value of in-force business The value of the in-force business asset represents the present value of future profits expected to arise from the portfolio of in-force life insurance. The valuation of this asset requires assumptions to be made about future economic and operating conditions which are inherently uncertain and changes could significantly affect the value attributed to these assets. The methodology used and the key assumptions that have been made in determining the carrying value of the in-force business asset at 31 December 2017, are set out in Note 24. 5.6.2 Insurance liabilities The calculation of liabilities and the choice of assumptions regarding insurance contracts require the management of the Group to make significant estimates. The assumptions underlying the estimates for each claim are based on past experience, internal factors and conditions, as well as external factors which reflect current market prices and other published information. The assumptions and judgements are determined at the date of valuation of liabilities and are assessed systematically so that the reliability and realistic position can be ensured. Estimates for insurance contracts are made in two stages. Initially, at the start of the contract, the Group determines the assumptions regarding future deaths, voluntary terminations, investment returns and administration expenses. Subsequently, at each reporting date, an actuarial valuation is performed which assesses whether liabilities are adequate according to the most recent estimates. The assumptions with the greatest influence on the valuation of insurance liabilities are presented below: Mortality and morbidity rates Assumptions are based on standard national tables of mortality and morbidity, according to the type of contract. In addition, a study is performed based on the actual experience (actual deaths) of the insurance company for comparison purposes and if sufficient evidence exists which is statistically reliable, the results are incorporated in these tables. An increase in mortality rates will lead to a larger number of claims (or claims could occur sooner than anticipated), which will increase the expenditure and reduce profits for shareholders. Investment return and discount rate The weighted average rate of return is derived based on assets that are assumed to back liabilities, consistent with the long-term investment strategy of the Group. These estimates are based on current market returns as well as expectations about future economic and financial developments. An increase in investment returns would lead to an increase in profits for shareholders. Management expenses Assumptions are made for management fees and contract maintenance as well as for general expenses, and are based on the actual costs of the Group. An assumption is also made for the rate of increase in expenses in relation to the annual inflation rate. An increase in the level of expenses would reduce profits for shareholders. 68 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 5. Significant judgements, estimates and assumptions (continued) 5.6 Life insurance business (continued) 5.6.2 Insurance liabilities (continued) Lapses Each year an analysis of contract termination rates is performed, using actual data from the insurance company incorporation until the immediate preceding year. Rates vary according to the type and duration of the plan. According to the insurance legislation of Cyprus, no assumption is made for policy termination rates in the actuarial valuation. Further details on insurance liabilities are disclosed in Note 32. 5.7 Tax The Group operates and is therefore subject to tax in various countries. Estimates are required in determining the provision for taxes at the reporting date. The Group recognises income tax liabilities for transactions and assessments whose tax treatment is uncertain. Where the final tax is different from the amounts initially recognised in the consolidated income statement, such differences will impact the income tax expense, the tax liabilities and deferred tax assets or liabilities of the period in which the final tax is agreed with the relevant tax authorities. Deferred tax assets are recognised by the Group in respect of tax losses to the extent that it is probable that future taxable profits will be available against which the losses can be utilised. Judgement is required to determine the amount of deferred tax assets that can be recognised, based upon the likely timing and level of future taxable profits, together with future tax-planning strategies. These variables have been established on the basis of significant management judgement and are subject to uncertainty. It is possible that the actual future events could be different from the assumptions made, resulting in a material adjustment to the carrying amount of deferred tax assets. The assumptions with greater influence on deferred tax are disclosed in Note 17. 5.8 Exercise of significant influence The Group determines whether it exercises significant influence on companies in which it has shareholdings of less than 20% if other factors exist that demonstrate significant influence. In performing this assessment it considers its representation in the Board of Directors which gives rise to voting rights of more than 20% and participation in policy-making processes, including participation in decisions about dividends and other distributions. 5.9 Fair value of properties held for own use and investment properties The Group’s accounting policy for property held for own use, as well as for investment property requires that it is measured at fair value. In the case of property held for own use, valuations are carried out periodically so that the carrying value is not materially different from the fair value, whereas in the case of investment properties, the fair value is established at each reporting date. Valuations are carried out by qualified valuers by applying valuation models recommended by the Royal Institution of Chartered Surveyors and the International Valuation Standards Council. In arriving at their estimates of the fair values of properties, the valuers used their market knowledge and professional judgement and did not rely solely on historical transactional comparables, taking into consideration that there is a greater degree of uncertainty than that which exists in a more active market. Depending on the nature of the underlying asset and available market information, the determination of the fair value of property may require the use of estimates such as future cash flows from assets and discount rates applicable to those assets. All these estimates are based on local market conditions existing at the reporting date. Further information on inputs used is disclosed in Note 22. 69 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 5. Significant judgements, estimates and assumptions (continued) 5.10 Stock of property – estimation of net realisable value Stock of property is measured at the lower of cost and net realisable value. The net realisable value is determined through valuation techniques, requiring significant judgement, which take into account all available reference points such as, expert valuation reports, current market conditions, the holding period of the asset applying an appropriate illiquidity discount and any other relevant parameters. Selling expenses are always considered and deducted from the realisable value. Depending on the value of the underlying asset and available market information, the determination of costs to sell may require professional judgement which involves a large degree of uncertainly due to the relatively low level of market activity. More details on the stock of property are presented in Note 27. 5.11 Provisions The accounting policy for provisions is described in Note 2.31. Judgement is involved in determining whether a present obligation exists and in estimating the probability, timing and amount of any outflows. Provisions for pending litigations, claims and regulatory matters usually require a higher degree of judgement than other types of provisions. It is expected that the Group will continue to have a material exposure to litigation and regulatory proceedings and investigations relating to legacy issues in the medium term. The matters for which the Group determines that the probability of a future loss is more than remote will change from time to time, as will the matters as to which a reliable estimate can be made and the estimated possible loss for such matters. Actual results may prove to be significantly higher or lower than the estimate of possible loss in those matters, where an estimate was made. In addition, loss may be incurred in matters with respect to which the Group believed the probability of loss was remote. For a detailed description of the nature of uncertainties and assumptions and the effect on the amount and timing of pending litigation, claims and regulatory matters refer to Note 39. 6. Segmental analysis The Group is organised into operating segments based on the geographic location of each unit. The main geographical locations that the Group operates in, are Cyprus and the United Kingdom. In addition, the Cyprus segment is further organised into operating segments based on the line of business. The remaining Group’s activities in Greece, Romania and Russia are separate operating segments for which information is provided to management but, due to their size, have been grouped for disclosure purposes into one segment, namely ‘Other countries’. The Group’s activities in Cyprus, the United Kingdom and other countries include mainly the provision of banking, financial and insurance services, as well as the management of properties either held as stock or as investment property. Management monitors the operating results of each business segment separately for the purposes of performance assessment and resource allocation. Segment performance is evaluated based on profit after tax and non-controlling interests. Inter-segment transactions and balances are eliminated on consolidation and are made on an arm’s length basis. Operating segment disclosures are provided as presented to the Group Executive Committee. The loans and advances to customers, the customer deposits and the related income and expense are generally included in the segment where the business is originated, instead of the segment where the transaction is recorded. Loans and advances to customers which are originated in countries where the Group does not have operating entities are included in the segment where they are managed. 70 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 6. Segmental analysis (continued) 2017 Cyprus €000 United Kingdom €000 Other countries €000 Total €000 Net interest income/(expense) 547,070 39,219 (3,549) 582,740 Net fee and commission income Net foreign exchange gains/(losses) Net gains/(losses) on financial instrument transactions and disposal/dissolution of subsidiaries 172,486 45,931 6,857 358 1,055 180,398 (880) 45,409 3,020 (44) (12) 2,964 Insurance income net of claims and commissions 48,760 Net losses from revaluation and disposal of investment properties Net gains/(losses) on disposal of stock of property Other income (2,487) 31,512 17,353 - - - 1,641 50,401 (1,574) (4,061) (1,065) 30,447 10 1,689 19,052 Special levy on deposits on credit institutions (22,846) Staff costs (excluding voluntary exit plan and other termination benefits) (Note 14) Staff costs – voluntary exit plan and other termination benefits (Note 14) Other operating expenses (excluding advisory and other restructuring costs) (Note 15) Other operating expenses - advisory and other restructuring costs (Note 15) Gain on derecognition of loans and advances to customers and changes in expected cash flows (Provisions)/reversal of provisions for impairment of loans and advances to customers and other customer credit losses (Impairment)/reversal of impairment of other financial instruments Impairment of non-financial instruments 863,645 46,400 (2,695) 907,350 (203,121) (22,893) (1,654) (227,668) (544) - - - - (544) (22,846) (199,075) (58,836) (11,268) (269,179) (28,267) - (533) (28,800) 409,792 (35,329) (16,150) 358,313 173,413 30 - 173,443 (934,668) 3,222 (21,480) (952,926) (11,956) (22,267) - - - 5,497 (6,459) (36,705) (58,972) - 8,957 Share of profit from associates and joint ventures 8,957 Loss before tax Income tax Loss after tax (376,729) (32,077) (68,838) (477,644) (72,516) (1,108) (3,057) (76,681) (449,245) (33,185) (71,895) (554,325) Non-controlling interests-loss 2,473 - - 2,473 Loss after tax attributable to the owners of the Company (446,772) (33,185) (71,895) (551,852) 71 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 6. Segmental analysis (continued) 2016 Cyprus €000 United Kingdom €000 Other countries €000 Total €000 Net interest income 643,259 31,307 11,616 686,182 Net fee and commission income 159,181 6,083 1,394 166,658 Net foreign exchange gains Net gains on financial instrument transactions and disposal/dissolution of subsidiaries 28,013 63,204 Insurance income net of claims and commissions 43,713 Net gains/(losses) from revaluation and disposal of investment properties Net gains/(losses) on disposal of stock of property Other income 5,315 2,050 12,530 389 105 - - - 4 15,069 43,471 64 719 63,373 44,432 (341) 4,974 (689) 1,361 2,371 14,905 Special levy on deposits on credit institutions (19,968) - Staff costs (excluding voluntary exit plan and other termination benefits) (Note 14) Staff costs – voluntary exit plan and other termination benefits (Note 14) Other operating expenses (excluding advisory and other restructuring costs) (Note 15) Other operating expenses - advisory and other restructuring costs (Note 15) Gain on derecognition of loans and advances to customers and changes in expected cash flows (Provisions)/reversal of provisions for impairment of loans and advances to customers and other customer credit losses (Impairment)/reversal of impairment of other financial instruments Impairment of non-financial instruments 957,265 37,888 30,203 1,025,356 (207,045) (15,339) (2,041) (224,425) (62,521) (226) - - (62,747) (19,968) (130,106) (33,791) (7,548) (171,445) (48,579) (516) (2,447) (51,542) 489,046 (11,984) 18,167 495,229 63,258 57 - 63,315 (379,984) 3,281 (56,906) (433,609) (12,316) (23,087) - - - 1,023 (11,293) (13,133) (36,220) - 8,194 Share of profit from associates and joint ventures 8,194 Profit/(loss) before tax 145,111 (8,646) (50,849) 85,616 Income tax (18,230) (1,126) 971 (18,385) Profit/(loss) after tax 126,881 (9,772) (49,878) 67,231 Non-controlling interests-profit (3,575) - - (3,575) Profit/(loss) after tax attributable to the owners of BOC PCL 123,306 (9,772) (49,878) 63,656 72 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 6. Segmental analysis (continued) Analysis of total revenue Total revenue includes net interest income, net fee and commission income, net foreign exchange gains, net gains on financial instrument transactions and disposal/dissolution of subsidiaries, insurance income net of claims and commissions, net (losses)/gains from revaluation and disposal of investment properties, net gains on disposal of stock of property and other income. 2017 Cyprus €000 United Kingdom €000 Other countries €000 Total €000 Total revenue from third parties 854,203 47,550 5,597 907,350 Inter-segment revenue/(expense) 9,442 (1,150) (8,292) - Total revenue 863,645 46,400 (2,695) 907,350 2016 Total revenue from third parties 941,929 39,877 43,550 1,025,356 Inter-segment revenue/(expense) 15,336 (1,989) (13,347) - Total revenue 957,265 37,888 30,203 1,025,356 The revenue for Cyprus operating segment is further analysed in analysis by business line in this note. The revenue for other countries segment mainly relates to banking and financial services for both 2017 and 2016. Analysis of assets 2017 Assets Inter-segment assets Total assets Non-current assets 2016 Assets Inter-segment assets Total assets Non-current assets Cyprus €000 United Kingdom €000 Other countries €000 Total €000 21,712,481 2,153,672 399,847 24,266,000 1,613,297 19,601 102,418 1,735,316 (667,400) 23,598,600 20,851,999 1,658,337 754,645 23,264,981 1,348,867 13,310 147,009 1,509,186 (1,093,046) 22,171,935 Non-current assets for this purpose consist of property and equipment, intangible assets, stock of property and non-financial other assets with expected maturity of over one year. 73 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 6. Segmental analysis (continued) Analysis of liabilities 2017 Liabilities Inter-segment liabilities Total liabilities 2016 Liabilities Inter-segment liabilities Total liabilities Cyprus €000 United Kingdom €000 Other countries €000 Total €000 18,935,166 2,060,484 656,183 21,651,833 (669,941) 20,981,892 17,577,993 1,595,805 988,457 20,162,255 (1,096,425) 19,065,830 Segmental analysis of customer deposits and loans and advances to customers is presented in Notes 31 and 44, respectively. Analysis by business line In addition to monitoring operations by geographical location, management also monitors the operating results of each business line for the Cyprus segment of the Group, and such information is presented to the Group Executive Committee. Income and expenses directly associated with each business line are included in determining the line’s performance. Transfer pricing methodologies are applied between the business lines to present their results on an arm’s length basis. Total other operating income includes net foreign exchange gains, net gains on financial instrument transactions and disposal/dissolution of subsidiaries, insurance income net of claims and commissions, net (losses)/gains from revaluation and disposal of investment properties, net gains on disposal of stock of property and other income. Total other operating income, staff costs and other operating expenses incurred directly by the business lines are allocated to the business lines as incurred. Indirect other operating income and indirect other operating expenses are allocated to the head office function. Management monitors the profit/(loss) before tax of each business line. Additionally, for the purposes of the Cyprus analysis by business line, notional tax at the 12.5% Cyprus tax rate is charged/credited on profit or loss before tax of each business line and therefore any taxable and non-taxable items are excluded from this notional charge/credit. The Corporate, Small and medium-sized enterprises and Retail business lines are managing loans and advances to customers as detailed in ‘Credit risk concentration of loans and advances to customers’ (Note 44). Restructuring and recoveries is the specialised unit which was set up to tackle the Group’s loan portfolio quality and manages exposures to borrowers in distress situation through innovative solutions. International banking services specialises in the offering of banking services to the international corporate and non-resident individuals, particularly international business companies whose ownership and business activities lie outside Cyprus. Wealth management oversees the provision of institutional wealth private banking, global markets, brokerage, asset management, investment banking and depository services. Real Estate Management Unit manages properties acquired through debt-for-property swaps and properties acquired through the acquisition of certain operations of Laiki Bank in 2013, and executes exit strategies in order to monetise these assets. Insurance business line is involved in both life and general insurance business. The business line Other includes head office functions such as treasury, finance, risk management, compliance, legal, corporate affairs and human resources. Head office functions provide services to the operating segments. 74 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 6. Segmental analysis (continued) Analysis by business line (continued) 2017 Corporate €000 Small and medium- sized enterprises €000 Retail Restructuring and recoveries International banking services Wealth management REMU Insurance Other Total Cyprus €000 €000 €000 €000 €000 €000 €000 €000 Net interest income/(expense) 100,471 50,175 213,909 130,780 Net fee and commission income/(expense) Total other operating income 13,740 713 9,875 629 49,589 4,954 13,085 360 66,174 66,746 7,412 Staff costs and other operating expenses Restructuring costs–voluntary exit plan and other termination benefits Restructuring costs–other operating expenses 114,924 60,679 268,452 144,225 140,332 (11,643) (11,089) (111,604) (34,371) (25,351) - - - - - - - (16,903) - - 9,728 2,526 3,334 15,588 (4,321) - (2) (17,944) 428 (6,651) 547,070 - (4,929) 21,854 172,486 33,369 15,425 49,235 44,734 44,083 144,089 59,286 863,645 (7,695) (17,866) (201,102) (425,042) - (206) (338) (544) (6,294) - (5,068) (28,267) 103,281 49,590 156,848 92,951 114,981 11,265 1,436 26,662 (147,222) 409,792 Gain on derecognition of loans and advances to customers and changes in expected cash flows (Provisions)/reversal of provisions for impairment of loans and advances to customers and other customer credit losses Impairment of other financial instruments Impairment of non-financial instruments Share of profit from associates and joint ventures Profit/(loss) before tax 15,825 4,428 13,323 136,268 935 39 (20,940) (13,512) (48,032) (841,480) (10,666) (486) - - - - - - - - - - - - - - - - - - - - - - - - 2,595 173,413 448 (934,668) (11,956) (11,956) (21,588) (62) (617) (22,267) - - 8,957 8,957 Income tax (12,271) (5,063) (15,267) 76,533 (13,156) 98,166 40,506 122,139 (612,261) 105,250 10,818 (1,352) (20,152) 26,600 (147,795) (376,729) 2,519 (1,400) (103,059) (72,516) Profit/(loss) after tax 85,895 35,443 106,872 (535,728) 92,094 9,466 (17,633) 25,200 (250,854) (449,245) Non-controlling interests-loss Profit/(loss) after tax attributable to the owners of the Company - - - - - - - - 2,473 2,473 85,895 35,443 106,872 (535,728) 92,094 9,466 (17,633) 25,200 (248,381) (446,772) 75 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 6. Segmental analysis (continued) Analysis by business line (continued) 2016 Corporate €000 Small and medium- sized enterprises €000 Retail Restructuring and recoveries International banking services Wealth management REMU Insurance Other Total Cyprus €000 €000 €000 €000 €000 €000 €000 €000 Net interest income/(expense) 81,408 61,547 246,923 201,743 Net fee and commission income/(expense) Total other operating income 9,959 559 8,825 602 45,832 4,637 12,105 506 62,292 65,072 7,403 91,926 70,974 297,392 214,354 134,767 (11,475) (11,490) (117,175) (32,959) (23,365) 10,861 (12,757) 417 (9,175) 643,259 2,032 4,146 17,039 (4,409) - (4,366) 19,722 159,181 4,124 (8,633) 44,470 40,521 88,378 154,825 98,925 957,265 (9,253) (14,461) (132,532) (357,119) (968) (1,139) (22,930) (8,237) (4,468) (224) (97) (3,269) (21,189) (62,521) Restructuring costs–other operating expenses (18) (6) (253) (14,473) (65) (8) (4,548) - (29,208) (48,579) 79,465 58,339 157,034 158,685 106,869 12,398 (22,531) 22,791 (84,004) 489,046 3,049 4,030 11,710 41,423 1,953 859 30,083 (14,690) 7,370 (393,740) (8,006) (1,965) - - - - - - - - - - - - - - - - - - - - - (19,542) - - - - - - 234 63,258 964 (379,984) (12,316) (12,316) (3,545) (23,087) 8,194 8,194 Income tax (14,075) (5,960) (22,014) 24,204 (12,602) 112,597 47,679 176,114 (193,632) 100,816 11,292 (1,412) (42,073) 22,791 (90,473) 145,111 5,259 (2,992) 11,362 (18,230) Profit/(loss) after tax 98,522 41,719 154,100 (169,428) 88,214 9,880 (36,814) 19,799 (79,111) 126,881 Non-controlling interests-profit Profit/(loss) after tax attributable to the owners of BOC PCL - - - - - - - - (3,575) (3,575) 98,522 41,719 154,100 (169,428) 88,214 9,880 (36,814) 19,799 (82,686) 123,306 In addition loans and advances to customers and deposits of the above business lines are reported to the Group Executive Committee. Such an analysis is disclosed in Notes 44 and 31 respectively. 76 Staff costs and other operating expenses Restructuring costs–voluntary exit plan and other termination benefits Gain on derecognition of loans and advances to customers and changes in expected cash flows Reversal of provisions/(provisions) for impairment of loans and advances to customers and other customer credit losses Impairment of other financial instruments Impairment of non-financial instruments Share of profit from associates and joint ventures Profit/(loss) before tax BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 7. Interest income Loans and advances to customers Loans and advances to banks and central banks Debt securities available-for-sale Investments classified as loans and receivables Trading investments Derivative financial instruments Other investments at fair value through profit or loss 2017 €000 2016 €000 744,822 853,906 11,742 19,883 2,706 9,072 10,905 11,209 779,153 885,092 14 31,798 66 12 4,557 637 811,031 890,298 Interest income from loans and advances to customers includes interest on the recoverable amount of impaired loans and advances as defined in Note 44 amounting to €137,565 thousand (2016: €201,604 thousand). 8. Interest expense Customer deposits Funding from central banks and deposits by banks Subordinated loan stock Repurchase agreements Negative interest on loans and advances to banks and central banks Derivative financial instruments 9. Fee and commission income and expense Fee and commission income Credit-related fees and commissions Other banking commissions Mutual funds and asset management fees Brokerage commissions Other commissions 2017 €000 2016 €000 140,701 137,973 3,979 39,588 22,258 10,207 7,132 - 6,476 3,716 184,277 187,753 44,014 16,363 228,291 204,116 2017 €000 2016 €000 72,484 96,710 2,777 951 80,755 75,300 2,524 819 17,655 17,467 190,577 176,865 Mutual funds and asset management fees include income of €2,777 thousand (2016: €2,342 thousand) relating to fiduciary and other similar activities. 77 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 9. Fee and commission income and expense (continued) Fee and commission expense Banking commissions Mutual funds and asset management fees Brokerage commissions 2017 €000 2016 €000 9,860 9,825 244 75 128 254 10,179 10,207 10. Net foreign exchange gains Net foreign exchange gains comprise the conversion of monetary assets in foreign currency at the reporting date, realised exchange gains/(losses) from transactions in foreign currency settled during the year and the revaluation of foreign exchange derivatives. 11. Net gains on financial instrument transactions and disposal/dissolution of subsidiaries Trading portfolio: - equity securities - debt securities - derivative financial instruments Other investments at fair value through profit or loss: - debt securities - equity securities Net gains on disposal of available-for-sale investments: - equity securities - debt securities Net gains on disposal/repayment of loans and receivables: - debt securities Realised (losses)/gains on disposal of loans Revaluation of financial instruments designated as fair value hedges: - hedging instruments - hedged items Loss on disposal/dissolution of subsidiaries 2017 €000 2016 €000 229 62 416 (57) 660 (273) 14 998 (400) 283 1,520 2,104 58,368 22 - 8,419 (12) 64 13,219 3,889 (12,990) (3,910) (2,187) (4,101) 2,964 63,373 The loss on disposal/dissolution of subsidiaries for 2017, primarily relates to loss on disposal of Hotel New Montana SRL. In the comparative period the loss on disposal/dissolution of subsidiaries primarily related to the closure of the operations of Bank of Cyprus (Channel Islands) Ltd. 78 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 11. (continued) Net gains on financial instrument transactions and disposal/dissolution of subsidiaries In the comparative period, the gains on disposal of available-for-sale equity securities, primarily relate to the gain on sale of shares held in Visa Europe Limited following the approved purchase of Visa Europe Limited by Visa Inc and the gains on disposal of debt securities classified as loans and receivables, related to the participation of BOC PCL in the Cyprus Government buyback process of Cyprus government bonds. 12. Insurance income net of claims and commissions Income 2017 Claims and commissions Insurance income net of claims and commissions Income 2016 Claims and commissions Insurance income net of claims and commissions €000 €000 €000 €000 €000 €000 102,259 (74,110) 28,149 104,261 (80,257) 24,004 44,789 (22,537) 22,252 39,341 (18,913) 20,428 147,048 (96,647) 50,401 143,602 (99,170) 44,432 Life insurance business General insurance business Income Gross premiums Reinsurance premiums Net premiums 2017 2016 Life insurance General insurance Life insurance General insurance €000 €000 €000 €000 86,277 65,701 83,951 60,215 (14,842) (29,246) (14,671) (27,544) 71,435 36,455 69,280 32,671 Change in the provision for unearned premiums - (1,187) - (1,589) Total net earned premiums Investment income and other income 71,435 22,157 35,268 69,280 31,082 10 25,324 8 Commissions from reinsurers and other income 5,924 9,511 4,977 8,251 Change in value of in-force business before tax (Note 26) 99,516 44,789 99,581 39,341 2,743 - 4,680 - 102,259 44,789 104,261 39,341 79 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 12. Insurance income net of claims and commissions (continued) 2017 2016 Life insurance General insurance Life insurance General insurance Claims and commissions €000 €000 €000 €000 Gross payments to policyholders (54,515) (27,017) (59,168) (25,864) Reinsurers’ share of payments to policyholders 7,837 13,643 8,858 12,004 Gross change in insurance contract liabilities (16,812) (3,177) (19,346) 931 Reinsurers’ share of gross change in insurance contract liabilities Commissions paid to agents and other direct selling costs (771) (1,476) (2,017) (1,845) (9,849) (4,509) (8,584) (4,143) Changes in equalisation reserve - (1) - 4 (74,110) (22,537) (80,257) (18,913) In addition to the above, the following income and expense items related to the insurance operations have been recognised in the consolidated income statement: Net (expense)/income from non-linked insurance business assets Net (losses)/gains on financial instrument transactions and other non-linked insurance business income 2017 2016 Life insurance General insurance Life insurance General insurance €000 €000 €000 €000 (66) (192) 79 96 (78) 342 16 (31) Staff costs (5,162) (4,127) (4,560) (4,170) Staff costs – restructuring costs (206) - (1,874) (1,395) Other operating expenses (6,021) (2,683) (4,186) (2,049) 13. Other income Profit on disposal of disposal group held for sale (Note 51.4.1) Dividend income Loss on sale and write-off of property and equipment and intangible assets Rental income from investment properties Rental income from stock of property Profit from hotel and golf activities Other income 2017 €000 2016 €000 - 683 (208) 2,219 7,981 3,581 4,796 2,545 343 (67) 1,626 1,460 2,051 6,947 19,052 14,905 80 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 14. Staff costs Salaries Employer’s contributions to state social insurance Retirement benefit plan costs Restructuring costs – voluntary exit plans and other termination benefits 2017 €000 2016 €000 184,933 181,175 24,913 17,822 27,154 16,096 227,668 224,425 544 62,747 228,212 287,172 In February and June 2016 the Group proceeded with voluntary exit plans for its employees in Cyprus, the cost of which is included in staff costs and amounted to €62,521 thousand. In total, 429 employees accepted the voluntary exit plan and left the Group during the year 2016. Additionally, restructuring costs in 2016 include staff termination benefits amounting to €226 thousand related to the closure of the operations of Bank of Cyprus (Channel Islands) Ltd. During 2017 a small number of employees left the Group under the same terms of the 2016 voluntary exit plan. The cost of this exit amounts to €544 thousand. The number of persons employed by the Group as at 31 December 2017 was 4,355 (2016: 4,284). The following table shows the average number of employees (full-time equivalents) based on their geographical location: Cyprus United Kingdom Other countries 2017 2016 4,034 4,125 249 31 216 48 4,314 4,389 The following table shows the business line analysis of average employees in Cyprus for 2017 and 2016 and the Group’s other geographical locations as follows: Corporate Small and medium-sized enterprises Retail Restructuring and recoveries International banking services Wealth management REMU Insurance Other (primarily head office functions (Note 6)) Total Cyprus UK Other countries 81 2017 2016 143 108 128 111 1,407 1,475 442 329 54 28 192 1,331 4,034 249 31 485 332 65 18 188 1,323 4,125 216 48 4,314 4,389 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2017 14. Staff costs (continued) Retirement benefit plan costs In addition to the employer’s contributions to state social insurance, the Group operates plans for the provision of additional retirement benefits as described below: Defined benefit plans Defined contribution plans 2017 €000 2016 €000 1,897 15,925 17,822 406 15,690 16,096 Cyprus The main retirement plan for the Group’s permanent employees in Cyprus (84% of total Group employees) is a defined contribution plan. This plan provides for employer contributions of 9% (2016: 9%) and employee contributions of 3%-10% of the employees’ gross salaries. This plan is managed by a Committee appointed by the members. A small number of employees who do not participate in the main retirement plan, are members of a pension scheme that is closed to new entrants and may receive part or all of their retirement benefit entitlement by way of a pension for life. This plan is managed by an Administrative Committee composed of representatives of both the members and the employer. A small number of employees of Group subsidiaries in Cyprus are also members of defined benefit plans. These plans are funded with assets backing the obligations held in separate legal vehicles. Greece After the disposal of the Greek operations in 2013, a small number of employees of the Group’s Greek subsidiaries and the Greek branch of the Company continue to be members of the defined benefit plans. United Kingdom The Group’s employees in the United Kingdom (6% of total Group employees) are covered by a defined contribution plan for all current employees which provides for employee contributions of 0%-7.5% on the employees’ gross salaries and employer contributions of 7.5% plus matching contributions by the employer of up to 7.5% depending on the employee contributions. In addition, a defined benefit plan (which was closed in December 2008 to future accrual of benefits) remains for active members. Other countries The Group does not operate any retirement benefit plans in Romania and Russia. Analysis of the results of the actuarial valuations for the defined benefit plans Amounts recognised in the consolidated balance sheet Liabilities (Note 34) Assets (Note 28) 2017 €000 2016 €000 10,037 22,776 - (668) 10,037 22,108 One of the plans has a funded status surplus of €13,814 thousand (2016: €13,999 thousand) that is not recognised as an asset on the basis that the Group has no unconditional right to future economic benefits either via a refund or a reduction in future contributions. The amounts recognised in the consolidated balance sheet and the movements in the net defined benefit obligation over the years are presented below: 82 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 14. Staff costs (continued) Retirement benefit plan costs (continued) Analysis of the results of the actuarial valuations for the defined benefit plans (continued) 1 January 2017 Current service cost Losses on curtailment and settlement Net interest expense/(income) Total amount recognised in the consolidated income statement Remeasurements: - Return on plan assets, excluding amounts included in net interest expense - Actuarial loss from changes in financial assumptions - Demographic assumptions - Experience adjustments - Change in asset ceiling Total amount recognised in the consolidated OCI Exchange differences Contributions: - Employer - Plan participants Benefits paid from the plans 31 December 2017 Present value of obligation Fair value of plan assets Net amount before impact of asset ceiling Impact of minimum funding requirement/ asset ceiling Net defined benefit liability €000 €000 €000 €000 €000 102,955 (94,846) 408 1,150 2,458 4,016 - 566 (2,041) (3,950) - (5,425) (2,551) - 176 (16,271) - - (2,119) (2,119) (5,209) - - - - (5,209) 1,849 (2,447) (176) 16,271 8,109 408 1,150 339 1,897 (5,209) 566 (2,041) (3,950) - (10,634) (702) (2,447) - - 13,999 22,108 - - - - - - - - (185) (185) - - - - 408 1,150 339 1,897 (5,209) 566 (2,041) (3,950) (185) (10,819) (702) (2,447) - - 82,900 (86,677) (3,777) 13,814 10,037 83 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 14. Staff costs (continued) Retirement benefit plan costs (continued) Analysis of the results of the actuarial valuations for the defined benefit plans (continued) 1 January 2016 Current service cost Gains on curtailment and settlement Net interest expense/(income) Total amount recognised in the consolidated income statement Remeasurements: - Return on plan assets, excluding amounts included in net interest expense - Actuarial loss from changes in financial assumptions - Experience adjustments - Change in asset ceiling Total amount recognised in the consolidated OCI Exchange differences Contributions: - Employer - Plan participants Benefits paid from the plans Benefits paid directly by the employer 31 December 2016 Present value of obligation Fair value of plan assets Net amount before impact of asset ceiling Impact of minimum funding requirement/ asset ceiling Net defined benefit liability €000 €000 €000 €000 €000 94,115 (97,795) (3,680) 15,065 11,385 469 (80) 17 406 (6,357) 21,979 (301) - 15,321 (1,671) - - (72) 8,109 - - - - - - - (1,066) (1,066) - - - - - 13,999 469 (80) 17 406 (6,357) 21,979 (301) (1,066) 14,255 (1,671) (2,195) - - (72) 22,108 (2,195) (2,195) 469 (80) 2,927 3,316 - - (2,910) (2,910) - (6,357) 21,979 (301) - 21,678 (9,699) - 177 (6,560) (72) - - - (6,357) 8,028 (177) 6,560 - 102,955 (94,846) 84 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 14. Staff costs (continued) Retirement benefit plan costs (continued) Analysis of the results of the actuarial valuations for the defined benefit plans (continued) The actual return on plan assets for year 2017 was a gain of €7,328 thousand (2016: gain of €9,267 thousand). The assets of funded plans are generally held in separately administered entities, either as specific assets or as a proportion of a general fund, or as insurance contracts and are governed by local regulations and practice in each country. Pension plan assets are invested in different asset classes in order to maintain a balance between risk and return. Investments are well diversified to limit the financial effect of the failure of any individual investment. Through its defined benefit plans, the Group is exposed to a number of risks as outlined below: Interest rate risk Changes in bond yields Inflation risk Asset volatility The Group is exposed to interest rate risk due to the mismatch of the duration of assets and liabilities. A decrease in corporate bond yields will increase the liabilities, although this will be partially offset by an increase in the value of bond holdings. The Group faces inflation risk, since the liabilities are either directly (through increases in pensions) or indirectly (through wage increases) exposed to inflation risks. Investments to ensure inflation-linked returns (i.e. real returns through investments such as equities, index-linked bonds and assets whose return increase with increasing inflation) could be used for better match with the expected increases in liabilities. The liabilities are calculated using a discount rate set with reference to corporate bond yields; if assets underperform this yield, a deficit will be created. The major categories of plan assets as a percentage of total plan assets are as follows: Equity securities Debt securities Loans and advances to banks 2017 2016 48% 42% 10% 46% 44% 10% 100% 100% The assets held by the funded plans include equity securities issued by the Company, the fair value of which is as at 31 December 2017 €2,137 thousand (2016: equity securities issued by BOC PCL of fair value €2,433 thousand). The Group expects to make additional contributions to defined benefit plans of €3,055 thousand during 2018. At the end of the reporting period, the average duration of the defined benefit obligation was 19.3 years. 85 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 14. Staff costs (continued) Retirement benefit plan costs (continued) Principal actuarial assumptions used in the actuarial valuations The present value of the defined benefit obligations of the retirement plans is estimated annually using the Projected Unit Credit Method of actuarial valuation, carried out by independent actuaries. The principal actuarial assumptions used for the valuations of the retirement plans of the Group during 2017 and 2016 are set out below: Cyprus Greece UK 1.58%-1.68% 1.30%-1.90% Life expectancy for pensioners at age 65 n/a 2017 Discount rate Inflation rate Future salary increases Rate of pension increase Life expectancy for pensioners at age 60 2016 Discount rate Inflation rate Future salary increases Rate of pension increase Life expectancy for pensioners at age 60 1.75% 2.25% 2.00% 23.5 years M 29.6 years F 1.75% 2.00% 2.00% 23.5 years M 29.6 years F 1.56%-1.83% 1.50%-2.00% 1.75% 2.00% n/a n/a n/a 1.75% 2.00% n/a n/a n/a 2.55% 3.20% n/a 3.00% n/a 23.0 years M 24.5 years F 2.70% 3.30% n/a 3.15% n/a 23.9 years M 25.4 years F Life expectancy for pensioners at age 65 n/a The discount rate used in the actuarial valuations reflects the rate at which liabilities could effectively be settled and is set by reference to market yields at the reporting date in high quality corporate bonds of suitable maturity and currency. For the Group’s plans in the Eurozone (Cyprus and Greece) which comprise 17% of the defined benefit obligations, the Group adopted a full yield curve approach using AA- rated corporate bond data from the iBoxx Euro Corporates AA10+ index. For the Group’s plan in the UK which comprises 83% of the defined benefit obligations, the Group adopted a full yield curve approach using the discount rate that has been set based on the yields on AA- rated corporate bonds with duration consistent with the scheme’s liabilities. Under this approach, each future liability payment is discounted by a different discount rate that reflects its exact timing. To develop the assumptions relating to the expected rates of return on plan assets, the Group, in consultation with its actuaries, uses forward-looking assumptions for each asset class reflecting market conditions and future expectations at the reporting date. Adjustments are made annually to the expected rate of return assumption based on revised expectations of future investment performance of asset classes, changes to local legislation that may affect investment strategy, as well as changes to the target strategic asset allocation. A quantitative sensitivity analysis for significant assumptions as at 31 December 2017 and 2016 is presented below. 86 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 14. Staff costs (continued) Retirement benefit plan costs (continued) Principal actuarial assumptions used in the actuarial valuations (continued) Variable Discount rate Inflation growth rate Salary growth rate Pension growth rate 2017 2016 Change +0.5% Change -0.5% Change +0.5% Change -0.5% -11.4% 12.3% -10.0% 10.9% 9.6% 1.1% 0.1% -8.9% -1.0% -0.1% 8.7% 0.8% 0.8% -8.0% -0.7% -0.7% Plus 1 year Minus 1 year Plus 1 year Minus 1 year Life expectancy -1.5% 1.9% -1.3% 1.7% The above sensitivity analysis (with the exception of the inflation sensitivity) is based on a change in one assumption while holding all other assumptions constant. In practice this is unlikely to occur and some changes of the assumptions may be correlated. The inflation sensitivity above includes changes to any inflation-linked benefit increases. When calculating the sensitivity of the defined benefit obligation to significant assumptions, the same method has been applied as when calculating the pension liability recognised on the consolidated balance sheet. The methods and types of assumptions used in preparing the sensitivity analysis did not change compared to previous years. 15. Other operating expenses Repairs and maintenance of property and equipment and stock of property Other property-related costs Operating lease rentals for property and equipment Consultancy and other professional services fees Insurance Advertising and marketing Depreciation of property and equipment (Note 25) Amortisation of intangible assets (Note 26) Communication expenses 2017 €000 2016 €000 23,850 21,705 17,590 10,408 19,912 8,203 18,518 11,930 9,404 8,739 14,728 10,512 13,972 10,697 17,502 11,558 7,263 8,118 Provisions for pending litigation, claims and regulatory matters (Note 34) 97,537 17,840 Printing and stationery Local cash transfer expenses Contribution to depositor protection scheme Other operating expenses Advisory and other restructuring costs 87 2,964 3,056 245 3,485 2,848 329 36,823 30,888 269,179 171,445 28,800 51,542 297,979 222,987 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 15. Other operating expenses (continued) Advisory and other restructuring costs comprise mainly: (a) fees of external advisors in relation to: (i) customer loan restructuring activities which are not part of the effective interest rate, (ii) the listing on the London Stock Exchange, (iii) disposal of operations and non-core assets and (b) litigation provisions related to the operations of Laiki Bank acquired in 2013. The special tax levy on credit institutions in Cyprus (the Special Levy) is imposed on the level of deposits as at the end of the previous quarter, at the rate of 0.0375% per quarter. Following an amendment of the Imposition of Special Credit Institution Tax Law in 2017, the Single Resolution Fund contribution which is charged annually by the Single Resolution Board, is offset by the Special Levy up to the level of the total annual Special Levy charge. Consultancy and other professional services fees and advisory and other restructuring costs include fees (including taxes) to the independent auditors of the Group, for audit and other professional services provided both in Cyprus and overseas, as follows: 2017 €000 2016 €000 Audit of the financial statements of the Group and its subsidiaries 2,570 2,615 Other audit-related services Tax services Services related to the listing on the London Stock Exchange Other services 407 462 114 499 4,052 423 598 4,879 1,032 9,547 16. Provisions for impairment of financial and non-financial instruments Provisions net of reversals of provisions for impairment of loans and advances to customers and other customer credit losses Loans and advances to customers (Note 44) Financial guarantees and commitments (Note 34) Impairment/(reversal of impairment) of other financial instruments Available-for-sale equity securities Available-for-sale mutual funds Loans and advances to banks Other receivables Deposits by banks 2017 €000 2016 €000 937,939 439,761 14,987 (6,152) 952,926 433,609 63 - 839 56 7,775 13,820 (1,379) (3,869) - 447 6,459 11,293 88 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 16. Provisions for impairment of financial and non-financial instruments (continued) Impairment of non-financial instruments Property held for own use (Note 25) Stock of property (Note 27) 17. Income tax Current tax: - Cyprus - overseas Cyprus special defence contribution Deferred tax Prior years’ tax adjustments Other tax charges 2017 €000 2016 €000 8,470 50,502 58,972 - 36,220 36,220 2017 €000 2016 €000 3,174 1,827 175 67,158 2,917 1,430 4,776 1,986 212 6,657 2,668 2,086 76,681 18,385 The Group’s share of income tax charge from associates for 2017 amounts to €1,129 thousand (2016: €1,244 thousand). The increase in the deferred tax charge is primarily due to the reduction of the level of deferred tax asset by €62 million following increase in provision for impairment of loans and advances to customers and evaluation of the recoverability assessment of the deferred tax asset balance. The reconciliation between the income tax expense and the (loss)/profit before tax as estimated using the current income tax rates is set out below: (Loss)/profit before tax Income tax at the normal tax rates in Cyprus Income tax effect of: - expenses not deductible for income tax purposes income not subject to income tax - - differences between overseas income tax rates and Cyprus income tax rates - reversal of previously recognised deferred tax asset - losses on which deferred tax was not recognised Prior years’ tax adjustments Other tax charges 89 2017 €000 (477,644) (59,529) 2016 €000 85,616 10,916 22,054 14,255 (10,825) (21,566) 10,213 66,858 43,563 72,334 2,917 1,430 6,428 3,598 - 13,631 2,668 2,086 76,681 18,385 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 17. Income tax (continued) Income tax in Cyprus is calculated at the rate of 12.5% on taxable income (2016: 12.5%). For life insurance business there is a minimum income tax charge of 1.5% on gross premiums. Special defence contribution is payable on rental income at a rate of 3% (2016: 3%) and on interest income from activities outside the ordinary course of business at a rate of 30% (2016: 30%). The Group’s profits from overseas operations are taxed at the rates prevailing in the respective countries, which for 2017 were: Greece 29% (2016: 29%), Romania 16% (2016: 16%), Russia 20% (2016: 20%), UK 20% until 31 March 2017 and 19% thereafter (2016: 20%). The Group is subject to income taxes in the various jurisdictions it operates and the calculation of the Group’s income tax charge and provisions for income tax necessarily involves a degree of estimation and judgement. There are transactions and calculations for which the ultimate income tax treatment is uncertain and cannot be determined until resolution has been reached with the relevant tax authority. The Group has a number of open income tax returns with various income tax authorities and liabilities relating to these open and judgemental matters, which are based on estimates of whether additional income taxes will be due. In case the final income tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the current and deferred income tax assets and liabilities in the period in which such determination is made. The accumulated income tax losses are presented in the table below: 2017 Expiring within 5 years Expiring by the end of 2028 2016 Expiring within 5 years Total income tax losses Income tax losses for which a deferred tax asset was recognised Income tax losses for which no deferred tax asset was recognised €000 €000 €000 2,761,640 - 2,761,640 7,378,801 3,067,936 4,310,865 10,140,441 3,067,936 7,072,505 4,675,399 266,800 4,408,599 Expiring between 6 and 10 years 16,306 - 16,306 Expiring by the end of 2028 7,378,801 3,336,000 4,042,801 12,070,506 3,602,800 8,467,706 The majority of the deferred tax asset relates to the Laiki Bank income tax losses transferred to BOC PCL as a result of the acquisition of certain operations on 29 March 2013. The income tax losses were transferred under ‘The Resolution of Credit and Other Institutions Law’ which states that any accumulated tax losses of the transferring credit institution at the time of the transfer, are transferred to the acquiring credit institution and may be used by it for a period of up to 15 years from the end of the year during which the transfer took place. In the case of the BOC PCL’s acquisition of certain operations of Laiki Bank, these tax losses can be utilised up to 2028. The income tax losses transferred are still subject to review and agreement with the income tax authorities in Cyprus. The deferred tax asset recognised on these specific losses can be set off against the future profits of BOC PCL by 2028 at an income tax rate of 12.5%. Recognition of deferred tax assets on unutilised income tax losses is supported by management’s business forecasts, taking into account available information and making various assumptions on future growth rates of customer loans, deposits, funding evolution, loan impairment and pricing, and considering the recoverability of the deferred tax assets within their expiry period. 90 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 17. Income tax (continued) Τhe Group performed its assessment for the recoverability of its deferred tax asset as at 31 December 2017 taking into account the Group’s actual performance, the key objectives of the Group’s strategy as well as the macroeconomic environment in Cyprus, and the detailed financial projections up to the end of 2020 which had been also used to roll out assumptions thereafter until year 2028. The key assumptions, amongst others, include the following:       New loan originations and repayments Loan and deposit interest income/expense evolution Funding structure and associated cost Diversified income streams Level of operating expenses Level of NPEs (new defaults, curing, cost of risk) The financial projections have taken into account the key objectives of the Group’s strategy which are set out below: Further improve the funding structure Focus on the core Cyprus market and the UK operations Achieve a lean operating model  Materially reduce the level of delinquent loans     Maintain an appropriate capital position by internally generating capital  Deliver value to shareholders and other stakeholders Based on the above, management has concluded that the deferred tax asset of €383,498 thousand for the Group as at 31 December 2017 is recoverable. The income tax losses relate to the same jurisdiction to which the deferred tax asset relates. Deferred tax The net deferred tax assets arise from: Difference between capital allowances and depreciation (7,938) (7,794) 2017 €000 2016 €000 Property revaluation Investment revaluation and stock of property Unutilised income tax losses carried forward Value of in-force life insurance business Other temporary differences Net deferred tax assets (17,545) (17,038) (3,807) (3,807) 383,492 450,350 (15,093) (14,750) (1,724) (1,895) 337,385 405,066 91 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 17. Income tax (continued) Deferred tax (continued) Deferred tax assets Deferred tax liabilities Net deferred tax assets The table below sets out the geographical analysis of the deferred tax assets: Cyprus United Kingdom Deferred tax assets Deferred tax liabilities Net deferred tax assets The movement of the net deferred tax assets is set out below: 1 January 2017 €000 2016 €000 383,498 450,441 (46,113) (45,375) 337,385 405,066 2017 €000 2016 €000 383,498 450,356 - 85 383,498 450,441 (46,113) (45,375) 337,385 405,066 2017 €000 2016 €000 405,066 415,724 Deferred tax recognised in the consolidated income statement (67,158) Acquisition of subsidiary (Note 51.3.1) - (6,657) (3,807) Deferred tax recognised in the consolidated statement of comprehensive income Foreign exchange adjustments 31 December (522) 219 (1) (413) 337,385 405,066 The Group offsets income tax assets and liabilities if and only if, it has a legally enforceable right to set off current income tax assets and current income tax liabilities. 92 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 17. Income tax (continued) Deferred tax (continued) The analysis of the net deferred tax expense recognised in the consolidated income statement is set out below: Difference between capital allowances and depreciation Investment revaluation Reversal of previously recognised deferred tax assets Value of in-force life insurance business Other temporary differences 2017 €000 2016 €000 150 - 66,858 343 (193) 67,158 207 (90) 3,598 479 2,463 6,657 The analysis of the net deferred tax recognised in the consolidated statement of comprehensive income is set out below: 2017 €000 2016 €000 Timing differences on property revaluation – (expense)/income (522) 219 18. Earnings per share Basic and diluted (losses)/earnings per share attributable to the owners of the Company/BOC PCL (Loss)/profit for the year attributable to the owners of the Company/BOC PCL (€ thousand) Weighted average number of shares in issue during the year, excluding treasury shares (thousand) 2017 2016 (551,852) 63,656 446,057 446,106 Basic and diluted (losses)/earnings per share (€ cent) (123.7) 14.3 The comparative figure for weighted average number of shares has been adjusted to reflect the introduction of the Company as the new holding company of the Group (Note 2.1). 93 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 19. Cash, balances with central banks and loans and advances to banks Cash Balances with central banks Cash and balances with central banks 2017 €000 2016 €000 143,905 132,594 3,250,029 1,373,802 3,393,934 1,506,396 Loans and advances to banks 1,192,633 1,087,837 Balances with central banks include obligatory deposits for liquidity purposes as at 31 December 2017 which amount to €153,733 thousand (2016: €142,697 thousand). The credit rating analysis of balances with central banks and loans and advances to banks by independent credit rating agencies is set out in Note 44. Loans and advances to banks earn interest based on the interbank rate of the relevant term and currency. 20. Investments Investments Investments at fair value through profit or loss Investments available-for-sale Investments classified as loans and receivables 2017 €000 2016 €000 51,467 43,016 639,168 262,789 48,658 68,074 739,293 373,879 The amounts pledged as collateral under repurchase agreements with banks are shown below: Investments pledged as collateral Investments available-for-sale 2017 €000 2016 €000 290,129 299,765 All investments pledged as collateral under repurchase agreements can be sold or repledged by the counterparty. The maximum exposure to credit risk for debt securities is disclosed in Note 44 and the debt securities’ price risk sensitivity analysis is disclosed in Note 45. 94 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 20. Investments (continued) Investments at fair value through profit or loss Trading investments Other investments at fair value through profit or loss Total 2017 €000 2016 €000 2017 €000 2016 €000 2017 €000 2016 €000 Debt securities Equity securities Mutual funds 536 2,644 8,795 476 - 10,426 536 10,902 2,601 4,541 4,030 7,185 9,396 34,951 16,087 43,746 11,975 12,473 39,492 30,543 51,467 6,631 25,483 43,016 Debt securities Cyprus government Listed on the Cyprus Stock Exchange Listed on other stock exchanges Equity securities Listed on the Cyprus Stock Exchange Listed on other stock exchanges Unlisted Mutual funds Listed on other stock exchanges Unlisted 536 - 536 536 476 1 475 476 - - - - 10,426 536 10,902 10,426 - 10,427 - 10,426 536 536 475 10,902 1,965 2,159 3,945 3,102 5,910 5,261 679 - 442 - - 596 - 928 679 596 442 928 2,644 2,601 4,541 4,030 7,185 6,631 8,795 8,800 - - 8,795 8,800 - 596 34,951 16,087 34,951 8,795 9,396 34,951 16,087 43,746 16,683 25,483 The debt securities classified as other investments at fair value through profit or loss were originally classified as such, to eliminate an accounting mismatch with derivatives used to economically hedge these instruments. The unlisted mutual funds classified as other investments at fair value through profit or loss relate to investments whose underlying assets are listed on stock exchanges and are therefore presented in Level 1 hierarchy in Note 22. 95 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 20. Investments (continued) Investments available-for-sale Debt securities Equity securities (including preference shares) Mutual funds Debt securities Cyprus government French government Other governments Banks and other corporations Listed on the Cyprus Stock Exchange Listed on other stock exchanges Unlisted Geographic dispersion by country of issuer Cyprus France Other European Union countries European Financial Stability Facility and European Investment Fund Supranational organisations Other countries Equity securities Listed on the Cyprus Stock Exchange Listed on other stock exchanges Unlisted 2017 €000 2016 €000 901,734 540,592 27,176 21,683 387 279 929,297 562,554 451,071 178,520 281,979 287,324 22,462 146,222 41,887 32,861 901,734 540,592 451,071 178,520 450,163 362,072 500 - 901,734 540,592 451,571 178,520 281,979 287,324 75,573 11,443 9,058 22,980 11,823 9,365 72,110 30,580 901,734 540,592 5,750 546 20,880 27,176 4,883 430 16,370 21,683 At 31 December 2017 and 2016 there were no available-for-sale investments in debt securities which have been determined to be individually impaired. Available-for-sale mutual funds are mainly unlisted and issued in other countries. 96 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 20. Investments (continued) Investments classified as loans and receivables Debt securities Cyprus government Listed on the Cyprus Stock Exchange Geographic dispersion by country of issuer 2017 €000 2016 €000 48,658 68,074 48,658 68,074 48,658 68,074 Cyprus 48,658 68,074 At 31 December 2017 the total loans and receivables have been determined to be individually impaired (2016: €49,185 thousand). Reclassification of investments Reclassification of available-for-sale investments to loans and receivables On 1 October 2008 and 30 June 2011 the Group reclassified certain available-for-sale debt securities to investments classified as loans and receivables, in view of the fact that there was no active market for these debt securities and the Group had the intention and ability to hold these securities in the foreseeable future. 97 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 20. Investments (continued) Reclassification of investments (continued) The tables below present the debt securities reclassified by the Group, by date of reclassification. 31 December 2017 31 December 2016 Year 2017 Reclassification date Carrying and fair value on reclassification date Carrying value Fair value Carrying value Fair value Additional profit in the consolidated income statement had the debt securities not been reclassified Additional gain in other comprehensive income had the debt securities not been reclassified Effective interest rate on reclassification date €000 €000 €000 €000 €000 €000 €000 Reclassification of available-for-sale investments to: - loans and receivables 1 October 2008 49,800 48,658 55,104 49,185 50,329 - 6,446 4.6%-4.7% 98 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 20. Investments (continued) Reclassification of investments (continued) 31 December 2016 31 December 2015 Year 2016 Reclassification date Carrying and fair value on reclassification date Carrying value Fair value Carrying value Fair value Additional profit in the consolidated income statement had the debt securities not been reclassified Additional gain in other comprehensive income had the debt securities not been reclassified Effective interest rate on reclassification date €000 €000 €000 €000 €000 €000 €000 Reclassification of available-for-sale investments to: - loans and receivables 1 October 2008 49,800 49,185 50,329 48,021 50,232 - 1,144 4.6%-4.7% 99 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 21. Derivative financial instruments The contract amount and fair value of the derivative financial instruments is set out below: Contract amount 2017 Fair value Assets Liabilities Contract amount 2016 Fair value Assets Liabilities €000 €000 €000 €000 €000 €000 33,259 99 114 43,820 794 589 Trading derivatives Forward exchange rate contracts Currency swaps 1,419,915 1,103 14,082 1,774,916 15,875 Interest rate swaps 69,022 Currency options 396 216 18 873 402 230,874 7,986 480 85 8,215 1,901 198 1,522,592 1,436 15,471 2,057,596 17,234 10,903 Derivatives qualifying for hedge accounting Fair value hedges - interest rate swaps Net investments – forward exchange rate contracts 1,171,424 16,315 35,420 418,293 87 37,463 61,012 276 1 178,605 3,514 259 Total 2,755,028 18,027 50,892 2,654,494 20,835 48,625 1,232,436 16,591 35,421 596,898 3,601 37,722 The use of derivatives is an integral part of the Group’s activities. Derivatives are used to manage the Group’s own exposure to fluctuations in interest rates, exchange rates and equity price indices. Derivatives are also sold to customers as risk management products. Forward exchange rate contracts are irrevocable agreements to buy or sell a specified quantity of foreign currency on a specified future date at an agreed rate. Currency swaps include simple currency swaps and cross-currency swaps. Simple currency swaps involve the exchange of two currencies at the current market rate and the commitment to re-exchange them at a specified rate upon maturity of the swap. Cross-currency swaps are interest rate swaps in which the cash flows are in different currencies. Interest rate swaps are contractual agreements between two parties to exchange fixed rate and floating rate interest, by means of periodic payments, based upon a notional principal amount and the interest rates defined in the contract. Currency options are contracts that grant the holder the right, but not the obligation, to buy or sell currency at a specified exchange rate during a specified period of time. 100 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 21. Derivative financial instruments (continued) Interest rate, currency and equity options provide the buyer with the right but not the obligation, to either purchase or sell the underlying values at a specified price or level on or before a specified date. Interest rate caps/floors protect the holder from fluctuations of interest rates above or below a specified interest rate for a specified period of time. The credit exposure of derivative financial instruments represents the cost to replace these contracts at the reporting date. The exposure arising from these transactions is managed as part of the Group’s credit risk management process for credit facilities granted to customers and financial institutions. The contract amount of certain types of derivative financial instruments provides a basis for comparison with other instruments recognised on the consolidated balance sheet, but does not necessarily indicate the amounts of future cash flows involved or the current fair value of the instruments and, consequently, does not indicate the Group’s exposure to credit or market risk. The fair value of the derivatives can be either positive (asset) or negative (liability) as a result of fluctuations in market interest rates, foreign exchange rates or equity price indices, in accordance with the terms of the relevant contract. The aggregate net fair value of derivatives may fluctuate significantly over time. Hedge accounting The Group applies fair value hedge accounting using derivatives when the required criteria for hedge accounting are met. The Group also uses derivatives for economic hedging (hedging the changes in interest rates, exchange rates or other risks) which do not meet the criteria for hedge accounting. As a result, these derivatives are accounted for as trading derivatives and the gains or losses arising from revaluation are recognised in the consolidated income statement. Changes in the fair value of derivatives designated as fair value hedges and the fair value of the item in relation to the risk being hedged are recognised in the consolidated income statement. Fair value hedges The Group uses interest rate swaps to hedge the interest rate risk arising as a result of the possible adverse movement in the fair value of fixed rate available-for-sale debt securities and fixed rate customer loans and deposits. Hedges of net investments The Group’s consolidated balance sheet is affected by foreign exchange differences between the Euro and all non-Euro functional currencies of overseas subsidiaries and branches and other foreign operations. The Group hedges its structural currency risk when it considers that the cost of such hedging is within an acceptable range (in relation to the underlying risk). This hedging is effected by financing with borrowings in the same currency as the functional currency of the overseas subsidiaries and branches, as well as overseas associates and joint ventures and forward exchange rate contracts. As at 31 December 2017, deposits and forward exchange rate contracts amounting to €142,273 thousand and €61,012 thousand respectively (2016: €100,756 thousand and €178,605 thousand respectively) have been designated as hedging instruments and have given rise to a loss of €1,166 thousand (2016: gain of €53,408 thousand) which was recognised in the ‘Foreign currency translation reserve’ in the consolidated statement of comprehensive income, against the profit or loss from the retranslation of the net assets of the overseas subsidiaries and branches. 101 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement The following table presents the carrying value and fair value of the Group’s financial assets and liabilities. Financial assets 2017 2016 Carrying value Fair value €000 €000 Carrying value €000 Fair value €000 Cash and balances with central banks 3,393,934 3,393,934 1,506,396 1,506,396 Loans and advances to banks 1,192,633 1,191,617 1,087,837 1,092,964 Investments at fair value through profit or loss 51,467 51,467 43,016 43,016 Investments available-for-sale 929,297 929,297 562,554 562,554 Investments classified as loans and receivables 48,658 55,104 68,074 69,451 Derivative financial assets 18,027 18,027 20,835 20,835 Loans and advances to customers 14,602,454 15,385,385 15,649,401 16,791,164 Life insurance business assets attributable to policyholders 504,848 504,848 485,633 485,633 Other assets 107,875 107,875 131,811 131,811 20,849,193 21,637,554 19,555,557 20,703,824 Financial liabilities Funding from central banks and deposits by banks 1,425,308 1,425,308 1,284,800 1,284,800 Repurchase agreements 257,322 281,951 257,367 292,752 Derivative financial liabilities 50,892 50,892 48,625 48,625 Customer deposits 17,849,919 17,875,239 16,509,741 16,492,715 Subordinated loan stock 302,288 334,783 - - Other liabilities 176,646 176,646 168,422 168,422 20,062,375 20,144,819 18,268,955 18,287,314 The fair value of financial assets and liabilities in the above table is as at the reporting date and does not represent any expectations about their future value. The Group uses the following hierarchy for determining and disclosing fair value: Level 1: investments valued using quoted prices in active markets. Level 2: investments valued using models for which all inputs that have a significant effect on fair value are market observable. Level 3: investments valued using models for which inputs that have a significant effect on fair value are not based on observable market data. For assets and liabilities that are recognised in the Consolidated Financial Statements at fair value, the Group determines whether transfers have occurred between levels in the hierarchy by re-assessing categorisation at the end of each reporting period. 102 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement (continued) The following is a description of the determination of fair value for financial instruments and non-financial assets which are recorded at fair value on a recurring and on a non-recurring basis and for financial instruments and non-financial assets which are not measured at fair value but for which fair value is disclosed, using valuation techniques. These incorporate the Group’s estimate of assumptions that a market participant would make when valuing the instruments. Derivative financial instruments Derivative financial instruments valued using a valuation technique with market observable inputs are mainly interest rate swaps, currency swaps, currency rate options, forward foreign exchange rate contracts, equity options and interest rate collars. The most frequently applied valuation techniques include forward pricing and swap models, using present value calculations. The models incorporate various inputs including the credit quality of counterparties, foreign exchange spot and forward rates and interest rate curves. Credit Valuation Adjustments (CVA) and Debit Valuation Adjustments (DVA) The CVA and DVA are incorporated into derivative valuations to reflect the impact on fair value of counterparty risk and BOC PCL’s own credit quality respectively. The Group calculates the CVA by applying the PD of the counterparty, conditional on the non-default of the Group, to the Group’s expected positive exposure to the counterparty and multiplying the result by the loss expected in the event of default. Conversely, the Group calculates the DVA by applying its own PD, conditional on the non-default of the counterparty, to the expected positive exposure of the counterparty to Group and multiplying the result by the loss expected in the event of default. Both calculations are performed over the life of the potential exposure. The expected exposure of derivatives is calculated as per the CRR and takes into account the netting agreements where they exist. A standard LGD assumption in line with industry norms is adopted. Alternative LGD assumptions may be adopted when both the nature of the exposure and the available data support this. The Group does not hold any significant derivative instruments which are valued using a valuation technique with significant non-market observable inputs. Investments available-for-sale and other investments at fair value through profit or loss Available-for-sale investments and other investments at fair value through profit or loss which are valued using a valuation technique or pricing models, primarily consist of unquoted equity securities and debt securities. These assets are valued using valuation models which sometimes only incorporate market observable data and at other times use both observable and non-observable data. The rest of the investments are valued using quoted prices in active markets. Loans and advances to customers The fair value of loans and advances to customers is based on the present value of expected future cash flows. Future cash flows have been based on the future expected loss rate per loan portfolio, taking into account expectations for the credit quality of the borrowers. The discount rate includes components that capture the risk free rate per currency, funding cost, servicing cost and the cost of capital, considering the risk weight of each loan. Customer deposits The fair value of customer deposits is determined by calculating the present value of future cash flows. The discount rate takes into account current market rates and the credit profile of BOC PCL. The fair value of deposits repayable on demand and deposits protected by the Deposit Protection Guarantee Scheme are approximated by their carrying values. Repurchase agreements Repurchase agreements are collateralised bank takings. Given that the collateral provided by the Group is greater than the amount borrowed, the fair value calculation of these repurchase agreements only takes into account the time value of money. 103 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement (continued) Loans and advances to banks Loans and advances to banks with maturity over one year are discounted using an appropriate risk free rate plus the credit spread of each counterparty. For short-term lending, the fair value is approximated by the carrying value. Deposits by banks Since almost all deposits by banks are very short-term, the fair value is an approximation of the carrying value. Subordinated loan stock The current issue of BOC PCL is liquid with quoted prices in an active market. The fair value of the capital loan stock issued by Bank of Cyprus UK Ltd is determined using market observable models (Level 2). Investment properties The fair value of investment properties is determined using valuations performed by external, accredited, independent valuers and internal accredited valuers. Further information on the techniques applied is disclosed in the remainder of this note. Property and equipment The freehold land and buildings consist of offices and other commercial properties. The fair value of the properties is determined using valuations performed by external, accredited, independent valuers and internal accredited valuers. Further information on the techniques applied is disclosed in the remainder of this note. Model inputs for valuation Observable inputs to the models for the valuation of unquoted equity and debt securities include, where applicable, current and expected market interest rates, market expected default rates, market implied country and counterparty credit risk and market liquidity discounts. 104 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement (continued) Model inputs for valuation (continued) The following table presents the fair value measurement hierarchy of the Group’s assets and liabilities recorded at fair value or for which fair value is disclosed, by level of the fair value hierarchy: 2017 Assets measured at fair value Investment properties Residential Offices and other commercial properties Manufacturing and industrial properties Hotels Land (fields and plots) Investment properties held for sale Offices and other commercial properties Freehold property Offices and other commercial properties Trading derivatives Forward exchange rate contracts Currency swaps Interest rate swaps Currency options Derivatives qualifying for hedge accounting Fair value hedges-interest rate swaps Net investments-forward exchange rate contracts Investments at fair value through profit or loss Trading investments Other investments at fair value through profit or loss Investments available-for-sale Other financial assets not measured at fair value Loans and advances to banks Loans and receivables-investments Loans and advances to customers Level 1 €000 Level 2 €000 Level 3 €000 Total €000 - - - - - - - - - - - - - - - - 11,345 38,896 50,241 907,360 957,601 - - - - - - - 338 2,752 477 2,124 13,955 19,646 338 2,752 477 2,124 13,955 19,646 6,500 6,500 16,332 239,559 255,891 99 1,103 216 18 1,436 16,315 276 16,591 - 500 500 42 - - - - - - - - 630 96 726 99 1,103 216 18 1,436 16,315 276 16,591 11,975 39,492 51,467 21,895 929,297 34,901 288,326 1,280,828 - - - - 1,191,617 55,104 - - 1,191,617 55,104 - 15,385,385 15,385,385 1,246,721 15,385,385 16,632,106 For available-for-sale equity securities categorised as Level 3, for one investment with a carrying amount of €11,228 thousand, a change in the conversion factor by 10% would result in a change in the value of the equity securities by €1,123 thousand. For additional disclosures on sensitivity analysis of equity securities refer to Note 45. 105 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement (continued) Model inputs for valuation (continued) 2017 Liabilities measured at fair value Trading derivatives Forward exchange rate contracts Currency swaps Interest rate swaps Currency options Derivatives qualifying for hedge accounting Fair value hedges-interest rate swaps Net investments-forward exchange rate contracts Other financial liabilities not measured at fair value Deposits by banks Repurchase agreements Customer deposits Subordinated loan stock Level 1 Level 2 Level 3 €000 €000 €000 Total €000 - - - - - - - - - - - - 114 14,082 873 402 15,471 35,420 1 35,421 50,892 495,308 281,951 - - - - - - - - - - 114 14,082 873 402 15,471 35,420 1 35,421 50,892 495,308 281,951 - 17,875,239 17,875,239 300,980 33,803 - 334,783 300,980 811,062 17,875,239 18,987,281 106 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement (continued) Model inputs for valuation (continued) 2016 Assets measured at fair value Investment properties Offices and other commercial properties Manufacturing and industrial Land (fields and plots) Investment properties held for sale Offices and other commercial properties Hotels Freehold property Offices and other commercial properties Trading derivatives Forward exchange rate contracts Currency swaps Interest rate swaps Currency options Derivatives qualifying for hedge accounting Fair value hedges-interest rate swaps Net investments-forward exchange rate contracts Level 1 €000 Level 2 €000 Level 3 €000 Total €000 - - - - - - - - - - - - - - - - - - - - 346 - 346 20,548 2,791 14,720 38,059 3,071 7,994 20,548 2,791 14,720 38,059 3,417 7,994 11,065 11,411 10,340 246,215 256,555 794 15,875 480 85 17,234 87 3,514 3,601 11,176 - - - - - - - - 686 178 864 794 15,875 480 85 17,234 87 3,514 3,601 12,473 30,543 43,016 Investments at fair value through profit or loss Trading investments Other investments at fair value through profit or loss 11,787 - 19,189 11,176 Investments available-for-sale Other financial assets not measured at fair value Loans and advances to banks Loans and receivables-investments Loans and advances to customers 30,976 545,898 576,874 41 16,615 562,554 42,738 312,818 932,430 - - - - 1,092,964 69,451 - - 1,092,964 69,451 - 16,791,164 16,791,164 1,162,415 16,791,164 17,953,579 For available-for-sale equity securities categorised as Level 3, for one investment with a carrying amount of €8,740 thousand, a change in the conversion factor by 10% would result in a change in the value of the equity securities by €874 thousand. For additional disclosures on sensitivity analysis of equity securities refer to Note 45. 107 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement (continued) Model inputs for valuation (continued) 2016 Liabilities measured at fair value Trading derivatives Forward exchange rate contracts Currency swaps Interest rate swaps Currency options Derivatives qualifying for hedge accounting Fair value hedges-interest rate swaps Net investments-forward exchange rate contracts Other financial liabilities not measured at fair value Deposits by banks Repurchase agreements Customer deposits Level 1 Level 2 Level 3 €000 €000 €000 Total €000 - - - - - - - - - - - - - 589 8,215 1,901 198 10,903 37,463 259 37,722 48,625 434,786 292,752 - - - - - - - - - - - 589 8,215 1,901 198 10,903 37,463 259 37,722 48,625 434,786 292,752 - 16,492,715 16,492,715 727,538 16,492,715 17,220,253 The cash and balances with central banks and the funding from central banks are financial instruments whose carrying value is a reasonable approximation of fair value, because they are mostly short-term in nature or are repriced to current market rates frequently. Other assets and other liabilities are of a financial nature and their carrying value is a close approximation of fair value. Disclosures for life insurance business assets attributable to policyholders by level are disclosed in Note 24. During the years 2017 and 2016 there were no significant transfers between Level 1 and Level 2. 108 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 22. Fair value measurement (continued) Movements in Level 3 financial instruments measured at fair value Transfers from Level 3 to Level 2 occur when the market for some securities becomes more liquid, which eliminates the need for the previously required significant unobservable valuation inputs. Following a transfer to Level 2 the instruments are valued using valuation models incorporating observable market inputs. Transfers into Level 3 reflect changes in market conditions as a result of which instruments become less liquid. Therefore, the Group requires significant unobservable inputs to calculate their fair value. The movement in Level 3 assets which are measured at fair value is presented below: 2017 2016 Investment properties Investment properties held for sale Own use properties Financial instruments Investment properties Investment properties held for sale Own use properties Own use properties held for sale Financial instruments €000 €000 €000 €000 €000 €000 €000 €000 €000 1 January Additions Acquisition of subsidiary (Note 51.3.1) 38,059 11,065 246,215 17,479 34,628 15,018 227,945 25,400 4,273 - - - 724 - 2,114 - - - 2,107 19,952 10 - 55,253 13,867 - Disposals (12,248) (10,864) (689) (612) (3,480) (395) - - - (6,500) 6,500 Transfers from investment properties to own use properties Transfers from/(to) stock of property (Note 27) Transfers (to)/from non-current assets held for sale Net gains from fair value changes recognised in the consolidated statement of other comprehensive income Depreciation charge for the year Impairment charge for the year (Note 16) Revaluation (losses)/gains Foreign exchange adjustments 31 December - - - (3,309) (234) 19,646 - - - - - - - - - - - - - - - 1,482 (442) - - - - 2,740 5,738 (2,652) (8,470) - - - - - - (1,371) - - (2,404) - - (25,410) (51,937) - - - - - - - - - - - - 485 - - - (189) 17,479 1,280 - - 395 129 - (201) (78) (631) 447 (31) (14) 6,500 239,559 22,621 38,059 11,065 246,215 109 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 Annual Financial Report 2015 22. Fair value measurement (continued) Valuation policy and sensitivity analysis Investment properties, investment properties held for sale and own use properties The valuation technique mainly applied by the Group is the market comparable approach, adjusted for market and property specific conditions. In certain cases, the Group also utilises the income capitalisation approach. The key inputs used for the valuations of the investment properties, investment properties held for sale and own use properties are presented in the tables below. 110 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 22. Fair value measurement (continued) Valuation policy and sensitivity analysis (continued) Analysis of investment properties and investment properties held for sale Type and country 2017 Residential €000 Estimated rental value per m2 per annum Rent growth per annum Estimated building cost per m2 Yield Estimated fair value per m2 Estimated land value per m2 Land Building area Age of building m2 m2 Years Russia 338 n/a n/a €225-€2,326 n/a €51-€2,326 €9-€11 570-1,573 102-384 7 Offices and other commercial properties Cyprus Russia Manufacturing and industrial Russia Hotels Russia Land (fields and plots) Cyprus Total 8,830 €54-€353 422 9,252 n/a n/a n/a n/a 4%-6% €1,339-€7,059 €1,053 1,591 68-4,788 14-34 €210-€410 n/a €88-€124 €9-€73 2,588-2,773 649-1,644 8 477 n/a n/a €20-€176 n/a €7-€176 €5-€24 5,220-29,538 304-8,874 8-29 2,124 n/a n/a €361 n/a €361 n/a n/a 5,946 12 13,955 26,146 n/a n/a €1,000-€1,200 n/a n/a €279-€1,028 2,316-21,053 n/a n/a 111 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 22. Fair value measurement (continued) Valuation policy and sensitivity analysis (continued) Analysis of own use properties Estimated rental value per m2 per annum Type and country 2017 Offices and other commercial properties €000 Cyprus Romania UK Total Rent growth per annum Estimated building cost per m2 Yield Estimated fair value per m2 Estimated land value per m2 Land Building area Age of building €821-€1,895 5%-6% €19-€6,557 €70-€3,381 390-598,767 122-11,109 11-77 m2 m2 Years n/a n/a 660 2,284 10 173-1,740 173-1,689 Refurnished in 2009 236,268 €26-€277 3,291 n/a n/a n/a n/a 9% n/a 16,332 €214-€777 0%-6% n/a 5%-7% €3,260-€16,959 255,891 112 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 22. Fair value measurement (continued) Valuation policy and sensitivity analysis (continued) Analysis of investment properties and investment properties held for sale Estimated rental value per m2 per annum Type and country 2016 Offices and other commercial properties €000 Rent growth per annum Estimated building cost per m2 Yield Estimated fair value per m2 Estimated land value per m2 Land Building area Age of building m2 m2 Years Cyprus UK Russia Manufacturing and industrial Russia Hotels 23,266 €54-€353 n/a €821-€1,130 4%-6% €1,060-€7,059 €80-€1,053 1,591-30,001 68-7,078 6-33 346 353 23,965 €97 n/a n/a n/a n/a n/a n/a n/a n/a €133 n/a n/a n/a 304 2,773 1,644 87 13 2,791 n/a n/a n/a n/a €55-€380 €10-€282 570-3,639 259-998 6-9 Romania 7,994 n/a n/a n/a 9% n/a n/a 10,337 16,642 42 Land (fields and plots) Cyprus Total 14,720 49,470 n/a n/a €900 n/a n/a €272-€750 4,627-21,053 n/a n/a 113 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 22. Fair value measurement (continued) Valuation policy and sensitivity analysis (continued) Analysis of own use properties Estimated rental value per m2 per annum Type and country 2016 Offices and other commercial properties €000 Rent growth per annum Estimated building cost per m2 Yield Estimated fair value per m2 Estimated land value per m2 Land Building area Age of building m2 m2 Years Cyprus Romania UK Total 242,792 €27-€434 3,423 n/a n/a n/a n/a 9% n/a €588-€2,102 5%-6% €566-€8,860 €139-€3,381 390-53,155 94-10,985 n/a n/a 660 2,284 173-1,740 173-1,689 9-37 9 Re-furnished in 2009 10,340 €141-€524 0%-6% n/a 5%-7% €2,460-€12,715 256,555 114 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 22. Fair value measurement (continued) Valuation policy and sensitivity analysis (continued) Sensitivity analysis Most of the Group’s property valuations have been classified as Level 3. Significant increases/decreases in estimated values per square meter for properties valued with the comparable approach or significant increases/decreases in estimated rental values or yields for properties valued with the income capitalisation approach would result in a significantly higher/lower fair value of the properties. 23. Loans and advances to customers 2017 €000 2016 €000 Gross loans and advances to customers 18,086,230 19,201,642 Provisions for impairment of loans and advances to customers (Note 44) (3,483,776) (3,552,241) 14,602,454 15,649,401 Loans and advances to customers pledged as collateral are disclosed in Note 46. Additional analysis and information regarding credit risk and analysis of the provisions for impairment of loans and advances to customers are set out in Note 44. 24. Life insurance business assets attributable to policyholders Equity securities Debt securities Mutual funds Mortgages and other loans Bank deposits Property 2017 €000 2016 €000 1,171 8,298 60,847 56,389 402,240 367,096 1,139 1,489 39,451 52,361 504,848 485,633 13,830 13,900 518,678 499,533 Financial assets of life insurance business attributable to policyholders are classified as investments at fair value through profit or loss. In addition to the above assets, the life insurance subsidiary of the Group holds shares of the Company, as part of the assets attributable to policyholders with a carrying value as at 31 December 2017 of €350 thousand (2016: €404 thousand). Such shares are presented in the Consolidated Financial Statements as treasury shares (Note 35). 115 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 24. Life insurance business assets attributable to policyholders (continued) The analysis of the financial assets of life insurance business attributable to policyholders measured at fair value by level, is presented below: 2017 Equity securities Debt securities Mutual funds Mortgages and other loans 2016 Equity securities Debt securities Mutual funds Mortgages and other loans Level 1 Level 2 Level 3 €000 €000 €000 Total €000 1,171 - 34,282 26,565 401,384 1,139 - - - - 1,171 60,847 856 402,240 - 1,139 437,976 26,565 856 465,397 7,090 - 1,208 31,886 24,503 367,096 1,489 - - - - - 8,298 56,389 367,096 1,489 407,561 24,503 1,208 433,272 Bank deposits are financial instruments whose carrying amount is a reasonable approximation of fair value, because they are short-term in nature or are repriced to current market rates frequently. The movement of financial assets classified as Level 3 is presented below: 1 January Unrealised losses recognised in the consolidated income statement 31 December 2017 €000 2016 €000 1,208 (352) 856 1,436 (228) 1,208 During years 2017 and 2016 there were no significant transfers between Level 1 and Level 2. 116 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 25. Property and equipment 2017 Property Equipment €000 €000 Total €000 Net book value at 1 January 258,552 22,341 280,893 Additions Revaluation Transfers from stock of property (Note 27) Transfers from investment property (Note 22) Disposals and write-offs 1,843 9,319 129 395 (35) 8,456 10,299 - - - 9,319 129 395 (242) (277) Depreciation charge for the year (3,983) (7,947) (11,930) Impairment charge for the year (8,470) - (8,470) Foreign exchange adjustments (390) (154) (544) Net book value at 31 December 257,360 22,454 279,814 1 January 2017 Cost or valuation Accumulated depreciation Net book value 31 December 2017 Cost or valuation Accumulated depreciation Net book value 298,743 152,838 451,581 (40,191) (130,497) (170,688) 258,552 22,341 280,893 293,664 149,263 442,927 (36,304) (126,809) (163,113) 257,360 22,454 279,814 117 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 25. Property and equipment (continued) 2016 Property Equipment €000 €000 Total €000 Net book value at 1 January 242,941 21,392 264,333 Acquisition of subsidiary (Note 51.3.1) Additions Transfers to stock of property (Note 27) Transfers from intangible assets (Note 26) Disposals and write-offs Disposal of subsidiary (Note 51.4.1) 19,952 2,572 (1,371) - (80) - 356 20,308 9,524 12,096 - (1,371) 456 (184) (952) 456 (264) (952) Depreciation charge for the year (3,692) (7,866) (11,558) Foreign exchange adjustments (1,770) (385) (2,155) Net book value at 31 December 258,552 22,341 280,893 1 January 2016 Cost or valuation Accumulated depreciation Net book value 31 December 2016 Cost or valuation Accumulated depreciation Net book value The net book value of the Group’s property comprises: Freehold property Improvements on leasehold property 278,285 147,602 425,887 (35,344) (126,210) (161,554) 242,941 21,392 264,333 298,743 152,838 451,581 (40,191) (130,497) (170,688) 258,552 22,341 280,893 2017 €000 2016 €000 255,891 256,555 1,469 1,997 257,360 258,552 Freehold property includes land amounting to €92,471 thousand (2016: €92,818 thousand) for which no depreciation is charged. 118 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 25. Property and equipment (continued) The Group’s policy is to revalue its properties periodically (between 3 to 5 years) but more frequent revaluations may be performed where there are significant and volatile movements in values. The Group performed revaluations as at 31 December 2017. As a result, a net gain on revaluation of €9,319 thousand (2016: nil) was recognised in the consolidated statement of comprehensive income and an impairment loss of €8,470 thousand (2016: nil) was recognised in the consolidated income statement for the year ended 31 December 2017. The valuations at year end were carried out by independent qualified valuers, on the basis of market value using observable prices and/or recent market transactions depending on the location of the property. Details on valuation techniques and inputs are presented in Note 22. As at 31 December 2017 and 2016 there are charges against freehold property of the Group with carrying value €20,850 thousand (2016: €21,134 thousand). The net book value of freehold property, on a cost less accumulated depreciation basis, as at 31 December 2017 would have amounted to €194,446 thousand (2016: €190,241 thousand). 26. Intangible assets 2017 Computer software In-force life insurance business Total €000 €000 €000 Net book value at 1 January 28,959 118,004 146,963 Additions Increase in value of in-force life insurance business (Note 12) Disposals and write-offs Amortisation charge for the year Foreign exchange adjustments 25,723 - 25,723 - 2,743 2,743 (22) (9,404) (51) - - - (22) (9,404) (51) Net book value at 31 December 45,205 120,747 165,952 1 January 2017 Cost 144,898 118,004 262,902 Accumulated amortisation and impairment (115,939) - (115,939) Net book value 28,959 118,004 146,963 31 December 2017 Cost 169,612 120,747 290,359 Accumulated amortisation and impairment (124,407) - (124,407) Net book value 45,205 120,747 165,952 119 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 26. Intangible assets (continued) 2016 Computer software In-force life insurance business Total €000 €000 €000 Net book value at 1 January 20,464 113,324 133,788 Additions Transfers to equipment (Note 25) Increase in value of in-force life insurance business (Note 12) Disposals and write-offs Amortisation charge for the year Foreign exchange adjustments 16,363 (456) - - 16,363 (456) - 4,680 4,680 (13) (7,263) (136) - - - (13) (7,263) (136) Net book value at 31 December 28,959 118,004 146,963 1 January 2016 Cost 130,151 113,324 243,475 Accumulated amortisation and impairment (109,687) - (109,687) Net book value 20,464 113,324 133,788 31 December 2016 Cost 144,898 118,004 262,902 Accumulated amortisation and impairment (115,939) - (115,939) Net book value 28,959 118,004 146,963 Valuation of in-force life insurance business The actuarial assumptions made to determine the value of in-force life insurance business relate to future mortality, redemptions, level of administration and selling expenses and investment returns. The main assumptions used in determining the value of the in-force business are: Discount rate (after tax) Return on investments Expense inflation 2017 2016 10.0% 10.0% 5.0% 4.0% 5.0% 4.0% 120 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 27. Stock of property The carrying value of stock is determined as the lower of cost and net realisable value. Impairment is recognised if the net realisable value is below cost. During 2017 an impairment loss of €50,502 thousand (2016: €36,220 thousand) was recognised in ‘Impairment of non-financial instruments’ in the consolidated income statement. At 31 December 2017, stock of €418,559 thousand (2016: €608,985 thousand) is carried at net realisable value which is the fair value less costs to sell. The stock of property includes residential properties, offices and other commercial properties, manufacturing and industrial properties, hotels, land (fields and plots) and properties under construction. There is no stock of property pledged as collateral for central bank funding facilities under Eurosystem monetary policy operations and ELA (2016: €22,055 thousand). The carrying value of the stock of property is analysed in the tables below: Net book value at 1 January Acquisition of subsidiaries (Note 51.3) Additions Disposals Transfers (to)/from own use properties (Note 25) Impairment (Note 16) Foreign exchange adjustments Net book value at 31 December 2017 €000 2016 €000 1,427,272 515,858 - 75,632 523,061 1,010,059 (257,662) (139,316) (129) 1,371 (50,502) (36,220) (618) (112) 1,641,422 1,427,272 Additions during 2017 include cost of construction of €3,404 thousand (2016: nil). Analysis by type and country Cyprus Greece Romania 2017 Residential properties Offices and other commercial properties Manufacturing and industrial properties Hotels Land (fields and plots) Properties under construction Total €000 €000 €000 €000 146,214 288,282 112,890 77,820 836,543 56,992 29,057 38,882 33,427 493 6,402 - 189 175,460 9,138 336,302 498 146,815 - 78,313 4,595 847,540 - 56,992 Total 1,518,741 108,261 14,420 1,641,422 121 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 27. Stock of property (continued) Analysis by type and country Cyprus Greece Romania 2016 €000 €000 €000 Total €000 Residential properties 90,308 Offices and other commercial properties 256,152 Manufacturing and industrial properties Hotels Land (fields and plots) Properties under construction 81,572 74,578 739,058 791 36,810 55,676 53,735 544 5,732 - 9,641 136,759 12,340 324,168 511 135,818 - 75,122 9,824 754,614 - 791 Total 1,242,459 152,497 32,316 1,427,272 28. Prepayments, accrued income and other assets Receivables relating to disposal of operations Reinsurers’ share of insurance contract liabilities (Note 32) Taxes refundable Debtors Prepaid expenses Retirement benefit plan assets (Note 14) Other assets 2017 €000 2016 €000 36,282 48,000 25,647 24,121 1,391 - 57,056 49,973 33,582 24,571 1,765 668 93,066 102,296 228,507 269,911 As at 31 December 2017 and 2016, the receivables relating to disposal of operations related to the disposal of the Ukrainian operations during 2014. In 2017 the settlement terms of the deferred consideration, the related interest rate and the collaterals were amended. The deferred consideration is due to be paid to the Group under a repayment programme which has been extended from June 2019 to December 2022. The receivable is fully secured. During 2017, a reversal of impairment of €1,379 thousand was recognised in relation to other assets (2016: reversal of impairment loss of €3,869 thousand) (Note 16). 29. Non-current assets held for sale Non-current assets held for sale: - investment properties 2017 €000 2016 €000 6,500 11,411 122 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 29. Non-current assets held for sale (continued) Investment properties The investment properties classified as held for sale are properties which management is committed to sell and has proceeded with an active programme to complete this plan. The disposals are expected to take place within 12 months from the date of classification. Investment properties classified as held for sale are measured at fair value. The results of the fair value changes are presented within ‘Net (losses)/gains from revaluation and disposal of investment properties’ in the consolidated income statement and are within the Cyprus operating segment for investment properties in Cyprus and in the Other countries operating segment for Greek, UK and Romanian investment properties. An analysis of investment properties held for sale by country and key valuation inputs are disclosed in Note 22. 30. Funding from central banks Funding from central banks comprises funding from the ECB under Eurosystem monetary policy operations and ELA from the CBC, as set out in the table below: Emergency Liquidity Assistance (ELA) Main Refinancing Operations (MRO) Longer-Term Refinancing Operations (LTRO) 2017 €000 2016 €000 - 200,014 100,000 - - 50,000 Targeted Longer-Term Refinancing Operations (TLTRO) 830,000 600,000 930,000 850,014 In December 2016, BOC PCL borrowed an amount of €600 million through the new series of TLTRO (TLTRO II) announced by the ECB in March 2016 and an amount of €50 million through the LTRO. In March 2017, the €50 million borrowed through the LTRO matured and €40 million was re-borrowed, which matured in June 2017 and was re-borrowed through a new LTRO. This was repaid in September 2017. In March 2017, BOC PCL raised an additional €230 million funding from ECB, through TLTRO II. In April 2017, an additional €40 million was borrowed through the MRO of which €10 million was repaid in May 2017 and the remaining €30 million was repaid in August 2017. In December 2017 an amount of €100 million was borrowed through the MRO. As at 31 December 2017, ECB funding was at €930 million of which €100 million was from the weekly MRO and €830 million was from the 4-year TLTRO II. The interest rate applied to TLTRO II will be fixed for each operation at the rate applied in the MRO prevailing at the time of allotment and is subject to a lower rate for counterparties whose eligible net lending in the pre- specified period exceeds their benchmark. This lower rate will be linked to the interest rate on the deposit facility prevailing at the time of the allotment of each operation. ELA funding was repaid in full by BOC PCL on 5 January 2017. Details on encumbered assets related to the above funding facilities are disclosed in Note 46. 123 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 31. Customer deposits By type of deposit Demand Savings Time or notice By geographical area Cyprus United Kingdom Romania By currency Euro US Dollar British Pound Russian Rouble Romanian Lei Swiss Franc Other currencies By customer sector 2017 Corporate SMEs Retail Restructuring – Corporate – SMEs Recoveries International banking services Wealth management 2016 Corporate SMEs Retail Restructuring – Corporate – SMEs Recoveries International banking services Wealth management 2017 €000 2016 €000 6,313,244 1,536,576 10,000,099 17,849,919 6,182,096 1,061,786 9,265,859 16,509,741 15,982,905 1,867,014 - 17,849,919 15,043,362 1,464,651 1,728 16,509,741 13,829,991 1,743,513 2,110,265 49,788 42 14,943 101,377 17,849,919 12,397,828 2,201,980 1,690,118 92,472 1,669 18,087 107,587 16,509,741 Romania Total €000 €000 1,559,263 - 867,476 - - 10,306,361 145,084 - 40,743 - 6,615 - 4,163,384 - 760,993 - - 17,849,919 Cyprus €000 1,529,521 665,940 8,670,625 145,084 40,743 6,615 4,163,384 760,993 15,982,905 United Kingdom €000 29,742 201,536 1,635,736 - - - - - 1,867,014 1,184,681 566,172 7,778,136 53,457 204,166 1,207,028 1,446 178 104 1,239,584 770,516 8,985,268 192,442 27,685 11,176 4,494,755 788,315 - - - - - - - - - - 192,442 27,685 11,176 4,494,755 788,315 15,043,362 1,464,651 1,728 16,509,741 Deposits by geographical area are based on the originator country of the deposit. 124 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 32. Insurance liabilities 2017 Reinsurers’ share Net Gross 2016 Reinsurers’ share €000 €000 €000 €000 Net €000 Gross €000 546,887 (27,608) 519,279 530,075 (28,379) 501,696 24,151 (8,879) 15,272 22,690 (8,605) 14,085 Life insurance Life insurance contract liabilities General insurance Provision for unearned premiums Other liabilities Claims outstanding 34,076 (11,513) 22,563 31,009 (12,989) 18,020 Unexpired risks reserve Equalisation reserve General insurance contract liabilities 314 20 - - 314 20 204 19 - - 204 19 58,561 (20,392) 38,169 53,922 (21,594) 32,328 605,448 (48,000) 557,448 583,997 (49,973) 534,024 Reinsurance balances receivable are included in ‘Prepayments, accrued income and other assets’ (Note 28). Life insurance contract liabilities The movement of life insurance contract liabilities and reinsurance assets during the year is analysed as follows: Gross €000 2017 Reinsurers’ share €000 Net €000 Gross €000 2016 Reinsurers’ share €000 Net €000 1 January 530,075 (28,379) 501,696 510,729 (30,396) 480,333 New business Change in existing business 31 December 9,367 (1,173) 8,194 8,389 (1,150) 7,239 7,445 1,944 9,389 10,957 3,167 14,124 546,887 (27,608) 519,279 530,075 (28,379) 501,696 General insurance contract liabilities The movement in general insurance contract liabilities and reinsurance assets for the year is analysed as follows: Gross 2017 Reinsurers’ share Net Gross 2016 Reinsurers’ share Net €000 €000 €000 €000 €000 €000 Premium income 65,701 (29,246) 22,690 (8,605) 14,085 36,455 24,029 60,215 (11,533) (27,544) 12,496 32,671 Earned premiums (64,240) 28,972 (35,268) (61,554) 30,472 (31,082) 31 December 24,151 (8,879) 15,272 22,690 (8,605) 14,085 125 Liabilities for unearned premiums 1 January BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 32. Insurance liabilities (continued) General insurance contract liabilities (continued) The provisions for unearned insurance and reinsurance premiums represent the portion of premiums that relate to risks that have not yet expired at the reporting date. Claims outstanding €000 Gross 2017 Reinsurers’ share €000 Net €000 Gross €000 2016 Reinsurers’ share €000 Net €000 1 January Amount paid for claims settled in the period Increase in liabilities arising from claims 31 December Reported claims Incurred but not reported 31,009 (12,989) 18,020 32,083 (14,834) 17,249 (27,017) 13,643 (13,374) (25,864) 12,004 (13,860) 30,084 (12,167) 17,917 24,790 (10,159) 14,631 34,076 (11,513) 32,202 (10,704) 22,563 21,498 31,009 (12,989) 29,188 (12,178) 18,020 17,010 1,874 (809) 1,065 1,821 (811) 1,010 34,076 (11,513) 22,563 31,009 (12,989) 18,020 33. Subordinated loan stock Subordinated Tier 2 Capital Note Subordinated Tier 2 Capital Loan Contractual interest rate 2017 €000 2016 €000 9.25% up to 19 January 2022 8.00% up to 21 December 2022 268,485 33,803 302,288 - - - BOC PCL maintains a Euro Medium Term Note (ΕΜΤΝ) Programme with an aggregate nominal amount up to €4,000 million. In January 2017, BOC PCL issued a €250 million unsecured and subordinated Tier 2 Capital Note (Note) under BOC PCL’s EMTN Programme. The Note was priced at par with a coupon of 9.25% per annum payable annually up to 19 January 2022 and then a rate at the then prevailing 5-year swap rate plus a margin of 9.176% per annum up to 19 January 2027, payable annually. The Note matures on 19 January 2027. BOC PCL has the option to redeem the Note early on 19 January 2022, subject to applicable regulatory consents. The Note is listed on the Luxembourg Stock Exchange’s Euro Multilateral Trading Facility (MTF) market. In December 2017, Bank of Cyprus UK Ltd, a 100% subsidiary of BOC PCL issued a £30 million unsecured and subordinated Tier 2 Capital Loan (Loan), priced at par. The Loan has a coupon of 8.00% up to 21 December 2022 and then a rate at the then prevailing 5-year swap rate plus a margin of 6.99% per annum, up to 21 December 2027, payable semi-annually, in June and December. The Loan matures on 21 December 2027. Bank of Cyprus UK Ltd has the option to redeem the Loan early on 21 December 2022, subject to meeting the notice conditions. 126 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 34. Accruals, deferred income and other liabilities 2017 €000 2016 €000 Income tax payable and related provisions Special defence contribution payable Retirement benefit plans liabilities (Note 14) 25,467 5,891 10,037 Provisions for pending litigation, claims and regulatory matters (Note 39) 133,318 Provisions for financial guarantees and commitments (Notes 16 and 39) Liabilities for investment-linked contracts under administration Accrued expenses and other provisions Deferred income Items in the course of settlement Other liabilities 51,987 7,873 60,078 9,439 72,241 68,271 25,599 5,719 22,776 48,882 38,196 5,458 58,761 7,379 49,522 73,633 444,602 335,925 Provisions for pending litigation, claims and regulatory matters The movement for the year in the provisions for pending litigation, claims and regulatory matters is as follows: 1 January Increase of provisions (Note 15) Utilisation of provisions Release of provisions (Note 15) Foreign exchange adjustments 31 December 2017 €000 48,882 98,757 (12,640) (1,220) (461) 133,318 2016 €000 34,749 30,890 (7,931) (7,924) (902) 48,882 The provisions for pending litigation, claims and regulatory matters are analysed as follows: Pending litigation or claims Regulatory matters 31 December 2017 €000 62,646 70,672 133,318 2016 €000 25,234 23,648 48,882 The increase of provisions for regulatory matters during the six months ended 31 December 2017 mainly relates to increase in provision recognised on UK regulatory matters as detailed in Note 39.2.2. The increase of provisions for pending litigation and claims during the six months ended 31 December 2017 mainly relates to increase in provision recognised on investigations and litigations relating to securities issued by BOC PCL as detailed in Note 39.2.1. The increase of provisions during the year 2016 of €22,966 thousand includes an amount of €5,126 thousand which is classified in advisory and other restructuring costs in other operating expenses (Note 15). The provisions for pending litigation, claims and regulatory matters do not include insurance claims arising in the ordinary course of business of the Group’s insurance subsidiaries as these are included in ‘Insurance liabilities’ (Note 32). Further details on the pending litigations, claims and regulatory matters are disclosed in Note 39. 127 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 35. Share capital Company 2017 BOC PCL 2016 Number of shares (thousand) €000 Number of shares (thousand) €000 Authorised Ordinary shares of €0.10 each 10,000,000 1,000,000 47,677,593 4,767,759 Issued 1 January 8,922,945 892,294 8,922,945 892,294 Cancellation of shares due to reorganisation (8,922,945) (892,294) 446,200 44,620 446,200 44,620 8,922,945 892,294 - - - - Issue of shares 31 December Authorised and issued share capital 2017 The Extraordinary General Meeting (EGM) of the shareholders of BOC PCL held on 13 December 2016 approved a scheme of arrangement between the Company, BOC PCL and its shareholders. The scheme of arrangement introduced the Company as the new holding company of the Group. Additionally the EGM authorised the directors of BOC PCL to take all actions necessary or appropriate to carry the scheme of arrangement into effect. The scheme of arrangement was sanctioned by the District Court of Nicosia on 21 December 2016. Following the submission of the Court Order to the Registrar of Companies and the registration, by the latter, of the reduction of capital, the scheme of arrangement became effective on 18 January 2017. As a result on the same date, the authorised share capital of BOC PCL which amounted to €4,767,759,272.00 divided into 47,677,592,720 ordinary shares with a nominal value of €0.10 each was reduced to €3,875,464,818.70 divided into 38,754,648,453.30 ordinary shares with a nominal value of €0.10 each and its issued share capital which amounted to €892,294,453.30 divided into 8,922,944,533 ordinary shares with a nominal value of €0.10 each was reduced to nil by cancelling all the shares comprising the issued share capital of BOC PCL (the Existing Shares) resulting in the creation of a capital reduction reserve in the accounts of BOC PCL, equal to the aggregate nominal value of the Existing Shares so cancelled, and which shall be retained as a non-distributable capital reserve in accordance with the provisions of subsection (e) of section 64 of the Cyprus Companies Law, Cap. 113 (the Reduction of Capital). Following the reduction of the share capital of BOC PCL, the authorised share capital was increased to €4,767,759,272 divided into 47,677,592,720 ordinary shares with a nominal value of €0.10 each through the creation of 8,922,944,533 ordinary shares with a nominal value of €0.10 each, each of which have the same rights and rank pari passu with the existing ordinary shares of BOC PCL. Also, the reserve arising in the books of account of BOC PCL as a result of the cancellation of the Existing Shares was applied in paying up in full at par 8,922,944,533 new ordinary shares with a nominal value of €0.10 each in the capital of BOC PCL, which were issued and allotted, credited as fully paid, to the Company or its nominee(s) in accordance with the scheme of arrangement. As mentioned above, all of the shares comprising the issued share capital of BOC PCL were cancelled and BOC PCL issued and allotted 8,922,944,533 new ordinary shares of nominal value €0.10 each, credited as fully paid to the Company; and the Company issued and allotted new shares (New Shares) and procured the issue of Depositary Interests representing New Shares, in accordance with the terms of the scheme of arrangement. Each one New Share or one Depositary Interest represents one New Share for each individual holding of 20 Existing Shares. As a result, the Company issued 446,199,933 ordinary shares with a nominal value of €0.10 each. 2016 There were no changes to the issued share capital during the year 2016. All issued ordinary shares carry the same rights. 128 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 35. Share capital (continued) Share premium reserve 2017 As a result of the implementation of the scheme of arrangement, the share premium reserve was created amounting to the difference between the nominal value of the shares issued pursuant to the terms of the scheme of arrangement and the net asset value of BOC PCL. 2016 The share premium reserve was maintained pursuant to the provisions of section 55 of the Cyprus Companies Law, Cap. 113 and was not available for distribution to equity holders in the form of a dividend. The share premium as at 31 December 2016 was created in 2014 and 2015 by the issuance of 4,167,234 thousand shares of a nominal value of €0.10 each of a subscription price of €0.24 each, and was reduced by the relevant transaction costs of €30,794 thousand. Reorganisation of the Group Following the reorganisation of the Group on 18 January 2017 the Company became the sole shareholder of BOC PCL and consequently the new parent of the Group. This transaction did not result in any change of economic substance and hence did not have any effect on the total equity of the Group. The Group financial results reflect the difference of €558,420 thousand in the amounts of share capital, share premium and capital reduction reserves as an adjustment in equity. As these Consolidated Financial Statements are a continuation of the consolidated financial statements of the BOC group for the year ended 31 December 2016, the components of equity for the year then ended reflect the capital structure of BOC PCL and following the reorganisation these components of equity reflect the capital structure of the Company. Capital reduction reserve 2016 The capital reduction reserve was maintained pursuant to the provisions of section 55 of the Cyprus Companies Law, Cap. 113 and was not available for distribution to equity holders in the form of a dividend. The capital reduction reserve was created upon the reduction of the nominal value of ordinary shares from €1.00 each to €0.10 each in 2014. The reduction in capital amounted to €4,280,140 thousand, of which an amount of €2,327,654 thousand was applied against accumulated losses and an amount of €1,952,486 thousand was credited to the capital reduction reserve. Treasury shares of the Company Shares of the Company held by entities controlled by the Group are deducted from equity on the purchase, sale, issue or cancellation of such shares. No gain or loss is recognised in the consolidated income statement. During 2016 all treasury shares other than those held by the life insurance subsidiary of the Group were disposed of. Following the restructuring of the Group and the introduction of the Company as the new holding company of the Group, the shares held by the life insurance subsidiary were cancelled and New Shares of the Company were issued. The life insurance subsidiary of the Group, as at 31 December 2017, held a total of 142 thousand ordinary shares of the Company of a nominal value of €0.10 each (2016: 2,889 thousand ordinary shares of BOC PCL of a nominal value of €0.10 each), as part of its financial assets which are invested for the benefit of insurance policyholders. The cost of acquisition of these shares was €21,463 thousand (2016: €25,333 thousand). 129 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 35. Share capital (continued) Treasury shares of the Company (continued) The movement in treasury shares for the years ended 31 December 2017 and 2016 are as follows: 1 January Disposals of treasury shares Company BOC PCL 2017 2016 Number of shares (thousand) Number of shares (thousand) 2,889 5,136 (45) (5,136) Cancellation of shares due to reorganisation (Note 2.1) (2,844) Change of parent company to Bank of Cyprus Holdings Public Limited Company and issue of new shares (Note 2.1) Change in presentation of life insurance subsidiary’s treasury shares 31 December 142 - 142 - - 2,889 2,889 The treasury shares represent 0.03% of the total issued share capital of the Company (2016: 0.03% of the issued share capital of BOC PCL). The Company did not provide financial assistance permitted by section 82 of the Companies Act 2014 for the purchase of its shares. Share-based payments - share options Following the incorporation of the Company and its introduction as the new holding company of the Group in January 2017, the Long Term Incentive Plan (as approved on 24 November 2015 by the Annual General Meeting of BOC PCL) was replaced by the Share Option Plan which operates at the level of the Company. The Share Option Plan is identical to the Long Term Incentive Plan except that the number of shares in the Company to be issued pursuant to an exercise of options under the Share Option Plan should not exceed 8,922,945 ordinary shares of a nominal value of €0.10 each and the exercise price was set at €5.00 per share. The term of the options was also extended to between 4-10 years after the grant date. No share options were granted since the date of replacement of the Long Term Incentive Plan by the Share Option Plan at the level of the Company. 36. Dividends The Company and BOC PCL are currently under a regulatory dividend distribution prohibition and therefore no dividends were declared or paid during years 2017 and 2016. 37. Accumulated losses For the purpose of dividend distribution, retained earnings determined at the Company level, are the only distributable reserve. Companies, tax resident in Cyprus, which do not distribute at least 70% of their profits after tax as defined by the Special Defence Contribution Law during the two years after the end of the year of assessment to which the profits refer, will be deemed to have distributed this amount as dividend. Special defence contribution at 17% is payable on such deemed dividend distribution to the extent that the shareholders of the Company (individuals who are domiciled in Cyprus and companies) at the end of the period of two years from the end of the year of assessment to which the profits refer, are directly or indirectly Cyprus tax residents. Deemed distribution does not apply in respect of profits that are directly or indirectly attributable to shareholders that are non-Cyprus tax residents and individual shareholders who are not domiciled in Cyprus. The amount of this deemed dividend distribution is reduced by any actual dividend paid out of the profits of the relevant year. 130 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 37. Accumulated losses (continued) This special defence contribution is paid by the company on account of the shareholders. During 2017 and 2016 no deemed dividend distribution was paid by the Company and by BOC PCL. 38. Fiduciary transactions The Group offers fund management and custody services that result in holding or investing financial assets on behalf of its customers. The Group is not liable to its customers for any default by other banks or organisations. The assets under management and custody are not included in the consolidated balance sheet of the Group unless they are placed with the Group. Total assets under management and custody at 31 December 2017 amounted to €1,120,817 thousand (2016: €1,054,210 thousand). 39. Contingent liabilities and commitments As part of the services provided to its customers, the Group enters into various irrevocable commitments and contingent liabilities. These consist of financial guarantees, letters of credit and other undrawn commitments to lend. Even though these obligations may not be recognised on the consolidated balance sheet, they do contain credit risk and are therefore part of the overall credit risk exposure of the Group (Note 44). 39.1 Capital commitments Capital commitments for the acquisition of property, equipment and intangible assets as at 31 December 2017 amount to €38,306 thousand (2016: €14,830 thousand). 39.2 Pending litigation, claims and regulatory matters The Group in the ordinary course of business is subject to enquiries and examinations, requests for information, audits, investigations and legal and other proceedings by regulators, governmental and other public bodies, actual and threatened, relating to the suitability and adequacy of advice given to clients or the absence of advice, lending and pricing practices, selling and disclosure requirements, record keeping, filings and a variety of other matters. In addition, as a result of the deterioration of the Cypriot economy and banking sector in 2012 and the subsequent restructuring of BOC PCL in 2013 as a result of the Bail-in Decrees, BOC PCL is subject to a large number of proceedings and investigations that either precede, or result from the events that occurred during the period of the Bail-in Decrees. Most ongoing investigations and proceedings of significance relate to matters arising during the period prior to the issue of the Bail-in Decrees. Apart from what is described below, the Group considers that none of these matters is material, either individually or in aggregate. The Group has not disclosed an estimate of the potential financial effect on its contingent liabilities arising from these matters where it is not practicable to do so because it is too early or the outcome is too uncertain or, in cases where it is practicable, where disclosure could prejudice conduct of the matters. Provisions have been recognised for those cases where the Group is able to estimate probable losses. Where an individual provision is material, the fact that a provision has been made is stated. Any provision recognised does not constitute an admission of wrongdoing or legal liability. While the outcome of these matters is inherently uncertain, management believes that, based on the information available to it, appropriate provisions have been made in respect of legal proceedings and regulatory matters as at 31 December 2017 and hence it is not believed that such matters, when concluded, will have a material impact upon the financial position of the Group. Further information is disclosed in Note 34. 39.2.1 Pending litigation and claims Investigations and litigation relating to securities issued by BOC PCL A number of institutional and retail customers have filed various separate actions against BOC PCL alleging that BOC PCL is guilty of misselling in relation to securities issued by BOC PCL between 2007 and 2011. Remedies sought include the return of the money investors paid for these securities. Claims are currently pending before the courts in Cyprus and in Greece, as well as the decisions and fines imposed upon BOC PCL in related matters by Cyprus Securities and Exchange Commission (CySEC) and/or Hellenic Capital Market Commission (HCMC). The bonds and capital securities in respect of which claims have been brought are the following: 2007 Capital Securities, 2008 Convertible Bonds, 2009 Convertible Capital Securities (CCS) and 2011 Convertible Enhanced Capital Securities (CECS). 131 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 39. Contingent liabilities and commitments (continued) 39.2 Pending litigation, claims and regulatory matters (continued) 39.2.1 Pending litigation and claims (continued) Investigations and litigation relating to securities issued by BOC PCL (continued) BOC PCL is defending these claims, particularly with respect to institutional investors and retail purchasers who received investment advice from independent investment advisors. In the case of retail investors, if it can be documented that the relevant BOC PCL officers 'persuaded' them to proceed with the purchase and/or purported to offer 'investment advice', BOC PCL may face significant difficulties. To date, a number of cases have been tried in Greece. BOC PCL has appealed against any such cases which were not ruled in its favour. The resolution of the claims brought in the courts of Greece is expected to take a number of years. Also a small number of cases are being heard in Cyprus. No judgement has yet been issued. Provision has been made based on management's best estimate of probable outflows and based on advice of legal counsel. Bail-in related litigation Depositors A number of the BOC PCL's depositors, who allege that they were adversely affected by the bail-in, filed claims against BOC PCL and other parties (such as the CBC and the Ministry of Finance of Cyprus) on the grounds that, inter alia, the ‘Resolution Law of 2013’ and the Bail-in Decrees were in conflict with the Constitution of the Republic of Cyprus and the European Convention on Human Rights. They are seeking damages for their alleged losses resulting from the bail-in of their deposits. BOC PCL is defending these actions. Shareholders Numerous claims were filed by shareholders in 2013 (some of whom were shareholders of BOC PCL) against the Government and the CBC before the Supreme Court in relation to the dilution of their shareholding as a result of the recapitalisation pursuant to the Resolution Law and the Bail-in Decrees issued thereunder. These proceedings sought the cancellation and setting aside of the Bail-in Decrees as unconstitutional and/or unlawful and/or irregular. BOC PCL appeared in these proceedings as an interested party to support the position that the cases should be adjudicated upon in the context of private law. The Supreme Court ruled in these cases in October 2014 that the proceedings fall within private and public law and thus fall within the jurisdiction of the District Courts. As at the present date, both the Resolution Law and the Bail-in Decrees have not been annulled by a court of law and thus remain legally valid and in effect. A number of actions for damages have been filed and are still being filed with the District Courts of Cyprus. Claims based on set-off Certain claims have been filed by customers against BOC PCL alleging that the implementation of the bail-in under the Bail-in Decrees was not carried out correctly in relation to them and, in particular, that their rights of set-off were not properly respected. BOC PCL intends to contest such claims. Laiki Bank depositors and shareholders BOC PCL has been joined as a defendant with regards to certain claims which have been brought against Laiki Bank by its depositors, shareholders and holders of debt securities. These claims have been brought on grounds similar to the claims brought by BOC PCL’s bailed-in depositors and shareholders as described above. BOC PCL, inter alia, maintains the position that it should not be a party to these proceedings. Implementation of Decrees Occasionally, other claims are brought against BOC PCL in respect of the implementation of the Decrees issued following the adoption of the Resolution Law (as regards the way and methodology whereby such Decrees have been implemented). Legal position of the Group All above claims are being vigorously disputed by the Group, in close consultation with the appropriate state and governmental authorities. The position of the Group is that the Resolution Law and the Decrees take precedence over all other laws. As matters now stand, both the Resolution Law and the Decrees issued thereunder are constitutional and lawful, in that they were properly enacted and have not so far been annulled by any court. 132 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 39. Contingent liabilities and commitments (continued) 39.2 Pending litigation, claims and regulatory matters (continued) 39.2.1 Pending litigation and claims (continued) Provident fund case In December 2015, the Bank of Cyprus Employees Provident Fund (the Provident Fund) filed an action against BOC PCL claiming €70 million allegedly owed as part of BOC PCL's contribution by virtue of an agreement with the union dated 31 December 2011. Based on facts currently known, it is not practicable at this time for BOC PCL to predict the resolution of this matter, including the timing or any possible impact on BOC PCL, however at this stage the Group does not expect a material impact on its financial position. Employment litigation Former senior officers of BOC PCL have instituted a total of three claims for unfair dismissal and for Provident Fund entitlements against BOC PCL and Trustees of the Provident Fund. As at the present date one case had been dismissed as filed out of time, but the plaintiff has subsequently filed a civil action in the District Court on the same grounds as the previous case which was filed in the Labour Disputes Court. The Group does not consider that these cases will have a material impact upon its financial position. Swiss Francs loans litigation in Cyprus and UK A number of actions have been instituted against BOC PCL by borrowers who obtained loans in foreign currencies (mainly Swiss Francs). The central allegation in these cases is that BOC PCL misled these borrowers and/or misrepresented matters, in violation of applicable law. BOC PCL intends to contest such proceedings. The Group does not expect that these actions will have a material impact upon its financial position. UK property lending claims BOC PCL is the defendant in certain proceedings alleging that BOC PCL is legally responsible for allegedly, inter alia, advancing and misselling loans for the purchase by UK nationals of property in Cyprus. The proceedings in the United Kingdom are currently stayed in order for the parties to have time to negotiate possible settlements. General criminal investigations and proceedings The Attorney General and the Cypriot Police (the Police) are conducting various investigations and inquiries following and relating to the financial crisis which culminated in March 2013. BOC PCL is cooperating fully with the Attorney General and the Police and is providing all information requested of it. Based on the currently available information, the Group is of the view that any further investigations or claims resulting from these investigations will not have a material impact on its financial position. The Attorney General had filed a criminal case against BOC PCL and five former members of the Board of Directors for alleged market manipulation offences referring to the non-publication in a timely manner of the increased capital shortfall of BOC PCL in 2012. On 14 December 2017, the Court found BOC PCL and its former Chief Executive Officer guilty only in relation to the one charge regarding market manipulation and acquitted all accused of all remaining charges. On 5 January 2018 the Court imposed a fine of €120,000 on BOC PCL and a prison sentence of two and a half years on Mr. Andreas Eliades. BOC PCL has filed an appeal against both the decision and the fine imposed on it. The Attorney General had also filed a separate criminal case against BOC PCL and six former members of the Board of Directors of BOC PCL for alleged market manipulation offences referring to the non-disclosure of the purchase of the Greek Government Bonds during a specified period. On 18 December 2017, the Criminal Court dismissed the proceedings against the accused following a ruling by the Supreme Court (first instance jurisdiction) which rendered the charges void ab initio. The Attorney General has filed an appeal against the first instance ruling of the Supreme Court. In January 2017 the Attorney General has filed a criminal case against a number of current and former officers of BOC PCL relating to the reclassification of Greek Government Bonds in April 2010. No charges were instituted against BOC PCL in this case. The hearing of this case has not yet commenced. 133 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 39. Contingent liabilities and commitments (continued) 39.2 Pending litigation, claims and regulatory matters (continued) 39.2.2 Provisions for regulatory matters The Hellenic Capital Market Commission (HCMC) Investigation The HCMC is currently in the process of investigating matters concerning the Group's investment in Greek Government Bonds from 2009 to 2011, including, inter-alia, related non-disclosure of material information in BOC PCL's CCS and CECS and rights issue prospectus (tracking the investigation carried out by CySEC in 2013), Greek government bonds' reclassification, ELA disclosures and allegations by some Greek Government Bond investors regarding BOC PCL's non-compliance with Markets in Financial Instruments Directive (MiFID) in respect of investors' direct investments in Greek Government Bonds. A specific estimate of the outcome of the investigations or of the amount of possible fines cannot be given at this stage, though it is not expected that any resulting liability or damages will have a material impact on the financial position of the Group. The Cyprus Securities and Exchange Commission (CySEC) Investigations The only pending CySEC investigation against BOC PCL concerns possible price manipulation attributable to BOC PCL for the period from 1 November 2009 to 30 June 2010 post the investment in Banca Transylvania. This is now pending for decision by the CySEC’s Board. It is not expected that any resulting liability or fine will have a material impact on the financial position of the Group. Additionally, in late 2014 CySEC completed an investigation into the value of goodwill in CB Uniastrum Bank LLC disclosed in the interim financial statements of the Group in 2012. In October 2016, CySEC issued a decision, concluding that BOC PCL was in breach of certain laws regarding disclosure in accordance, inter alia, with the Market Manipulation (Market Abuse) Law of 2005 and has imposed an administrative fine upon BOC PCL of €25 thousand. CySEC also imposed higher fines upon certain former members of the Board of Directors and former management of BOC PCL. BOC PCL filed a recourse before the Administrative Court against the decisions of CySEC and the fine imposed upon BOC PCL. In March 2017, CySEC filed a legal action against BOC PCL, claiming the amount of €25 thousand imposed as a fine. In 2015, CySEC carried out an investigation into the reclassification of Greek Government Bonds in April 2010, which was also completed in 2016 with no findings being communicated to BOC PCL. On 1 December 2017 CySEC imposed a series of fines totaling €595 thousand upon BOC PCL and ten of its former directors for failing to adequately provide for doubtful debts in 2011. The fine imposed upon BOC PCL amounts to €15 thousand and BOC PCL has filed a recourse against the decision and fine before the Administrative Court. Commission for the Protection of Competition Investigation In April 2014, following an investigation which began in 2010, the Cypriot Commission for the Protection of Competition (the CPC) issued a statement of objections, alleging violations of Cypriot and EU competition law relating to the activities and/or omissions in respect of card payment transactions by, among others, BOC PCL and JCC Payment Systems Ltd (JCC), a card-processing business currently 75% owned by BOC PCL. There was also an allegation concerning BOC PCL's arrangements with American Express, namely that such exclusive arrangements violated Cypriot and EU competition law. On both matters, the CPC has concluded that BOC PCL (in common with other banks and JCC) has breached the relevant provisions of the applicable law for the protection of competition. In May 2017 the CPC imposed a fine of €18 million upon BOC PCL and BOC PCL filed a recourse against the decision and the fine. The payment of the fine has been stayed pending the final outcome of the recourse. 134 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 39. Contingent liabilities and commitments (continued) 39.2 Pending litigation, claims and regulatory matters (continued) 39.2.2 Provisions for regulatory matters (continued) UK regulatory matters During 2016 and 2017 the BOC group recognised losses of €57,540 thousand on a conduct principle issue. The provision outstanding as at 31 December 2017 is €46,962 thousand (2016: €17,368 thousand). The level of the provision represents the best estimate of all probable outflows arising from customer redress based on information available to management. Management continues to reassess the adequacy of the provision, as well as the assumptions underlying the calculations based upon experience and other relevant factors prevailing at the time. 39.3 Other contingent liabilities The Group, as part of its disposal process of certain of its operations, has provided various representations, warranties and indemnities to the buyers. These relate to, among other things, the ownership of the loans, the validity of the liens, tax exposures and other matters agreed with the buyers. As a result, the Group may be obliged to compensate the buyers in the event of a valid claim by the buyers with respect to the above representations, warranties and indemnities. A provision has been made, based on management’s best estimate of probable outflows, where it was assessed that such an outflow is probable. 135 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 40. Net cash flow from operating activities (Loss)/profit before tax Adjustments for: Provisions for impairment of loans and advances to customers and other customer credit losses and gain on derecognition and changes in expected cash flows Depreciation of property and equipment Amortisation of intangible assets Impairment of property held for own use Impairment of other financial instruments Profit upon disposal of disposal groups held for sale and discontinued operations Amortisation of discounts/premiums, catch-up adjustment on debt securities and interest on debt securities Loss on sale and write-offs of property and equipment and intangible assets Net losses/(gains) on disposal of investment properties and investment properties held for sale Net losses/(gains) from revaluation of investment properties and investment properties held for sale Dividend income Net gains on disposal of available-for-sale investments in equity securities Net gains on disposal of available-for-sale investments and investments classified as loans and receivables in debt securities Share of profit from associates and joint ventures Loss from revaluation of debt securities designated as fair value hedges Loss on disposal/dissolution of subsidiaries Net gains on disposal of stock of property Impairment of stock of property Interest on funding from central banks Interest on subordinated loan stock Change in value of in-force life insurance business Change in: Loans and advances to banks Deposits by banks Obligatory balances with central banks Customer deposits Value of in-force life insurance policies and liabilities Loans and advances to customers Other assets Accrued income and prepaid expenses Other liabilities Accrued expenses and deferred income Derivative financial instruments Investments at fair value through profit or loss Repurchase agreements Proceeds on disposals of stock of property Tax received/(paid) Net cash flow from operating activities 136 2017 €000 2016 €000 (477,644) 85,616 779,483 370,294 11,930 9,404 8,470 6,459 - 11,558 7,263 - 11,293 (2,545) (22,669) (22,764) 208 752 3,309 (683) 67 (3,934) (1,040) (343) (1,520) (58,368) (2,104) (8,957) 14,150 2,187 (30,447) 50,502 28 22,258 (2,743) 362,373 60,130 60,522 (11,036) (8,441) (8,194) 16,466 4,101 (1,361) 36,220 29,656 - (4,680) 460,864 53,890 193,096 (19,890) 1,340,178 2,329,060 2,306 (227,629) 28,424 374 91,673 3,377 5,075 (8,451) (7,058) 57,958 20,039 (354) 52,698 (1,530) (12,586) 7,769 (45) (110,784) 280,365 140,677 1,987,636 3,163,849 5,630 (1,224) 1,993,266 3,162,625 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 40. Net cash flow from operating activities (continued) Non-cash transactions 2017 Acquisition of Nicosia Mall Holdings (NMH) Limited During the year ended 31 December 2017 the Group acquired a 51% interest in the share capital of Nicosia Mall Holdings (NMH) Limited as part of the restructuring of its debt. The acquisition did not include any cash consideration. Further information is disclosed in Note 51.1.1. Closure of the operations of Bank of Cyprus branch in Romania In accordance with the Group’s strategy to exit from overseas non-core operations, the operations of the branch in Romania are expected to be terminated, subject to the completion of deregistration formalities with respective authorities during 2018. Most of the remaining assets and liabilities of the branch in Romania with third parties have been transferred to others entities of the Group. Repossession of collaterals During the year ended 31 December 2017, the Group acquired stock of property by taking possession of collaterals held as security for loans and advances to customers of €519,657 thousand (2016: €1,010,059 thousand) (Note 27). 2016 Acquisition of S.Z. Eliades Leisure Ltd During the year ended 31 December 2016 the Group acquired a 70% interest in the share capital of S.Z. Eliades Leisure Ltd in exchange for the settlement of the majority of the borrowing due from S.Z. Eliades Leisure Ltd to the Company, as part of the restructuring of its debt. The acquisition did not include any cash consideration. Further information is disclosed in Note 51.3.1. Sale of shares held in Visa Europe Limited During the year ended 31 December 2016 the Group sold its shares held in Visa Europe Limited following the purchase of Visa Europe Limited by Visa Inc. The transaction in addition to the cash paid, involved the granting of preferred stock in Visa Inc. with a carrying value of approximately €8 million and a deferred cash component of a carrying value of approximately €4 million. Closure of the operations of Bank of Cyprus (Channel Islands) Ltd As part of the Group’s strategy of focusing on its core businesses and markets, the Group decided the closure of the operations of Bank of Cyprus (Channel Islands) Ltd and the relocation of its business to other Group locations mainly Cyprus and the UK. Net cash flow from operating activities – interest and dividends Interest paid Interest received Dividends received 2017 €000 2016 €000 (194,666) (200,266) 782,476 1,018,010 683 343 588,493 818,087 137 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 40. Net cash flow from operating activities (continued) Changes in liabilities arising from financing activities 1 January 2017 Cash flows Foreign exchange adjustments Other non-cash movements 31 December 2017 41. Cash and cash equivalents Cash and cash equivalents comprise: Funding from central banks Subordinated loan stock Total €000 €000 €000 850,014 - 850,014 79,986 280,983 360,969 - - (680) (680) 21,985 21,985 930,000 302,288 1,232,288 2017 €000 2016 €000 Cash and non-obligatory balances with central banks 3,240,201 1,363,699 Loans and advances to banks with original maturity less than three months 1,040,030 867,329 4,280,231 2,231,028 Analysis of cash and balances with central banks and loans and advances to banks 2017 €000 2016 €000 Cash and non-obligatory balances with central banks 3,240,201 1,363,699 Obligatory balances with central banks 153,733 142,697 Total cash and balances with central banks (Note 19) 3,393,934 1,506,396 Loans and advances to banks with original maturity less than three months Other restricted loans and advances to banks Other loans and advances to banks 1,040,030 867,329 117,273 136,398 35,330 84,110 Total loans and advances to banks (Note 19) 1,192,633 1,087,837 Restricted loans and advances to banks include collaterals under derivative transactions of €59,997 thousand (2016: €55,017 thousand) which are not immediately available for use by the Group, but are released once the transactions are terminated. 138 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 42. Operating leases – The Group as lessee The total future minimum lease payments under non-cancellable operating leases at 31 December 2017 and 2016 are presented below: Within one year Between one and five years After five years The above mainly relate to property leases for the Group’s branches and offices. 2017 €000 2016 €000 1,850 2,663 62 4,575 1,452 3,296 282 5,030 139 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 43. Analysis of assets and liabilities by expected maturity Less than one year 2017 Over one year 2016 Total Less than one year Over one year Total Assets €000 €000 €000 €000 €000 €000 Cash and balances with central banks Loans and advances to banks Derivative financial assets 3,241,396 152,538 3,393,934 1,364,949 141,447 1,506,396 1,094,918 97,715 1,192,633 953,160 134,677 1,087,837 1,495 16,532 18,027 20,590 245 20,835 Investments 39,050 990,372 1,029,422 76,415 597,229 673,644 Loans and advances to customers Life insurance business assets attributable to policyholders Prepayments, accrued income and other assets 3,642,968 10,959,486 14,602,454 5,546,601 10,102,800 15,649,401 20,317 498,361 518,678 19,510 480,023 499,533 98,196 130,311 228,507 110,968 158,943 269,911 Stock of property 441,800 1,199,622 1,641,422 457,104 970,168 1,427,272 Property, equipment and intangible assets Investment properties Investments in associates and joint ventures 13 445,753 445,766 21 427,835 427,856 - - 19,646 19,646 118,113 118,113 - - 38,059 38,059 109,339 109,339 Deferred tax assets 26,000 357,498 383,498 2,970 447,471 450,441 Non-current assets held for sale Liabilities 6,500 - 6,500 11,411 - 11,411 8,612,653 14,985,947 23,598,600 8,563,699 13,608,236 22,171,935 Deposits by banks 360,277 135,031 495,308 354,778 80,008 434,786 Funding from central banks 100,000 830,000 930,000 250,014 600,000 850,014 Repurchase agreements - 257,322 257,322 - 257,367 257,367 Derivative financial liabilities 15,205 35,687 50,892 9,434 39,191 48,625 Customer deposits 4,786,907 13,063,012 17,849,919 5,367,559 11,142,182 16,509,741 Insurance liabilities 89,689 515,759 605,448 86,002 497,995 583,997 Accruals, deferred income and other liabilities Subordinated loan stock Deferred tax liabilities 283,754 160,848 444,602 273,332 62,593 335,925 - - 302,288 302,288 46,113 46,113 - 17 - - 45,358 45,375 5,635,832 15,346,060 20,981,892 6,341,136 12,724,694 19,065,830 The main assumptions used in determining the expected maturity of assets and liabilities are set out below. The investments are classified in the relevant time band based on expectations as to their realisation. In most cases this is the maturity date, unless there is an indication that the maturity will be prolonged or there is an intention to sell, roll or replace the security with a similar one. The latter would be the case where there is secured borrowing, requiring the pledging of bonds and these bonds mature before the maturity of the secured borrowing. The maturity of bonds is then extended to cover the period of the secured borrowing. 140 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 43. Analysis of assets and liabilities by expected maturity (continued) Trading investments are classified in the ‘less than one year’ time band. Performing loans and advances to customers in Cyprus are classified based on the contractual repayment schedule. Overdraft accounts are classified in the ‘over one year’ time band. The impaired loans as defined in Note 44, net of specific and collective provisions, and the loans which are past due for more than 90 days, are classified in the ‘over one year’ time band except from expected receipts which are included within time bands, according to historic amounts of receipts in the last months. Stock of property is classified in the relevant time band based on expectations as to its realisation. The ELA funding which forms part of the funding from central banks has been included in the ‘less than one year’ time band as at 31 December 2016, since it was expected to be repaid within one year. Funding under ELA has a contractual maturity of less than one year. A percentage of customer deposits in Cyprus maturing within one year is transferred in the ‘over one year’ time band, based on the observed behavioural analysis. In the United Kingdom deposits are classified on the basis of contractual maturities. The expected maturity of all prepayments, accrued income and other assets and accruals, deferred income and other liabilities is the same as their contractual maturity. If they don’t have a contractual maturity, the expected maturity is based on the timing the asset is expected to be realised and the liability is expected to be settled. 44. Risk management – Credit risk In the ordinary course of its business the Group is exposed to credit risk which is monitored through various control mechanisms across all Group entities in order to prevent undue risk concentrations and to price credit facilities and products on a risk-adjusted basis. Credit risk is the risk that arises from the possible failure of one or more customers to meet their obligations towards the Group. The Credit Risk Management Department sets the Group’s credit disbursement policies and monitors compliance with credit risk policy applicable to each business line and the quality of the Group’s loans and advances portfolio through the timely assessment of problematic customers. The credit exposures from related accounts are aggregated and monitored on a consolidated basis. Credit Risk Management Department, safeguards the effective management of credit risk at all stages of the credit cycle, monitors the quality of decisions and processes and ensures that the credit sanctioning function is being properly managed. The credit policies are combined with the methods used for the assessment of the customers’ creditworthiness (credit rating and credit scoring systems). The loan portfolio is analysed on the basis of assessments about the customers’ creditworthiness, their economic sector of activity and the country in which they operate. The credit risk exposure of the Group is diversified both geographically and across the various sectors of the economy. The Credit Risk Management Department determines the prohibited/high risk/dangerous sectors of the economy and sets out stricter policy rules for these sectors, according to their level of riskiness. The Group’s significant judgements, estimates and assumptions regarding the determination of the level of provisions for impairment are described in Note 5.1. The Market Risk department assesses the credit risk relating to investments in liquid assets (mainly loans and advances to banks and debt securities) and submits its recommendations for limits to be set for banks and countries to the ALCO for approval. 141 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Maximum exposure to credit risk and collateral and other credit enhancements The Group’s maximum exposure to credit risk is analysed by geographic area as follows: On-balance sheet Cyprus Greece Russia United Kingdom Romania Off-balance sheet Cyprus Greece United Kingdom Romania Total on and off-balance sheet Cyprus Greece Russia United Kingdom Romania 2017 €000 2016 €000 17,974,887 17,067,617 46,754 57,314 27,819 40,974 2,056,334 1,602,229 64,152 165,093 20,169,946 18,933,227 2,934,269 2,738,382 72,752 112,596 31,471 16,327 848 397 3,039,340 2,867,702 20,909,156 19,805,999 119,506 169,910 27,819 40,974 2,087,805 1,618,556 65,000 165,490 23,209,286 21,800,929 142 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Maximum exposure to credit risk and collateral and other credit enhancements (continued) The Group offers guarantee facilities to its customers under which the Group may be required to make payments on their behalf and enters into commitments to extend credit lines to secure their liquidity needs. Letters of credit and guarantee (including standby letters of credit) commit the Group to make payments on behalf of customers in the event of a specific act, generally related to the import or export of goods. Such commitments expose the Group to risks similar to those of loans and advances and are therefore monitored by the same policies and control processes. Loans and advances to customers The Credit Risk Management Department determines the amount and type of collateral and other credit enhancements required for the granting of new loans to customers. The main types of collateral obtained by the Group are mortgages on real estate, cash collateral/blocked deposits, bank guarantees, government guarantees, pledges of equity securities and debt instruments of public companies, fixed and floating charges over corporate assets, assignment of life insurance policies, assignment of rights on certain contracts and personal and corporate guarantees. The Group’s management regularly monitors the changes in the market value of the collateral and, where necessary, requests the pledging of additional collateral in accordance with the relevant agreement. Other financial instruments Collateral held as security for financial assets other than loans and advances is determined by the nature of the financial instrument. Debt securities and other eligible bills are generally unsecured with the exception of asset-backed securities and similar instruments, which are secured by pools of financial assets. In addition, some debt securities are government-guaranteed. The Group has chosen the ISDA Master Agreement for documenting its derivatives activity. It provides the contractual framework within which dealing activity across a full range of over-the-counter (OTC) products is conducted and contractually binds both parties to apply close-out netting across all outstanding transactions covered by an agreement, if either party defaults. In most cases the parties execute a Credit Support Annex (CSA) in conjunction with the ISDA Master Agreement. Under a CSA, the collateral is passed between the parties in order to mitigate the market contingent counterparty risk inherent in their open positions. Settlement risk arises in any situation where a payment in cash or securities is made in the expectation of a corresponding receipt in securities or cash. The Group sets daily settlement limits for each counterparty. Settlement risk is mitigated when transactions are effected via established payment systems or on a delivery upon payment basis. The table below presents the maximum exposure to credit risk, the tangible and measurable collateral and credit enhancements held and the net exposure to credit risk, that is the exposure after taking into account the impairment loss and tangible and measurable collateral and credit enhancements held. Personal guarantees are an additional form of collateral, but are not included in the information below since it is impracticable to estimate their fair value. The fair value of the collateral presented in the tables below is capped to the carrying value of the loans and advances to customers. 143 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Maximum exposure to credit risk and collateral and other credit enhancements (continued) 2017 Maximum exposure to credit risk Fair value of collateral and credit enhancements held by the Group Cash Securities Letters of credit/ guarantee Property Other Surplus collateral Net collateral Net exposure to credit risk €000 €000 €000 €000 €000 €000 €000 €000 €000 Balances with central banks (Note 19) 3,250,029 Loans and advances to banks (Note 19) 1,192,633 Trading investments - debt securities (Note 20) Debt securities classified as available- for-sale and loans and receivables (Note 20) Derivative financial instruments (Note 21) Loans and advances to customers (Note 23) Debtors (Note 28) Reinsurers’ share of insurance contract liabilities (Note 28) Other assets - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 3,250,029 1,192,633 536 950,392 18,027 536 950,392 18,027 14,602,454 339,050 275,111 258,848 21,803,417 747,362 (10,369,288) 13,054,500 1,547,954 24,121 48,000 83,754 - - - - - - - - 37,798 - - - - - - - - - - 24,121 48,000 (1,516) 36,282 47,472 On-balance sheet total 20,169,946 339,050 275,111 296,646 21,803,417 747,362 (10,370,804) 13,090,782 7,079,164 Contingent liabilities Acceptances and endorsements 8,367 813 Guarantees Commitments 768,165 85,099 - 464 - 9,817 79 (4,056) 6,653 1,714 3,736 153,756 11,405 - - 254,460 513,705 9,372 20,258 Documentary credits 29,630 1,139 7 190 7,550 486 Undrawn formal stand-by facilities, credit lines and other commitments to lend 2,233,178 38,132 5,563 1,543 402,309 36,266 (19,699) 464,114 1,769,064 Off-balance sheet total 3,039,340 125,183 6,034 5,469 573,432 48,236 (23,755) 734,599 2,304,741 Total credit risk exposure 23,209,286 464,233 281,145 302,115 22,376,849 795,598 (10,394,559) 13,825,381 9,383,905 144 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Maximum exposure to credit risk and collateral and other credit enhancements (continued) 2016 Maximum exposure to credit risk Fair value of collateral and credit enhancements held by the Group Cash Securities Letters of credit/ guarantee Property Other Surplus collateral Net collateral Net exposure to credit risk €000 €000 €000 €000 €000 €000 €000 €000 €000 Balances with central banks (Note 19) 1,373,802 Loans and advances to banks (Note 19) 1,087,837 Trading investments - debt securities (Note 20) Debt securities at fair value through profit or loss (Note 20) Debt securities classified as available- for-sale and loans and receivables (Note 20) Derivative financial instruments (Note 21) Loans and advances to customers (Note 23) Debtors (Note 28) Reinsurers’ share of insurance contract liabilities (Note 28) Other assets - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 1,373,802 1,087,837 476 10,426 608,666 20,835 476 10,426 608,666 20,835 15,649,401 345,827 335,599 305,202 22,250,801 501,500 (9,949,923) 13,789,006 1,860,395 24,571 49,973 107,240 - - - - - - - - 59,656 - - - - - - - - - - 24,571 49,973 (967) 58,689 48,551 On-balance sheet total 18,933,227 345,827 335,599 364,858 22,250,801 501,500 (9,950,890) 13,847,695 5,085,532 Contingent liabilities Acceptances and endorsements 7,606 375 - - 9,524 13 (4,090) 5,822 1,784 Guarantees Commitments 797,269 69,720 1,326 5,529 164,880 6,222 (210) 247,467 549,802 Documentary credits 27,636 10,837 15 102 8,112 297 - 19,363 8,273 Undrawn formal stand-by facilities, credit lines and other commitments to lend 2,035,191 31,449 1,050 2,221 329,280 16,158 (19,705) 360,453 1,674,738 Off-balance sheet total 2,867,702 112,381 2,391 7,852 511,796 22,690 (24,005) 633,105 2,234,597 Total credit risk exposure 21,800,929 458,208 337,990 372,710 22,762,597 524,190 (9,974,895) 14,480,800 7,320,129 145 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit risk concentration of loans and advances to customers There are restrictions on loan concentrations which are imposed by the Banking Law in Cyprus, the relevant CBC Directives and CRR. According to these restrictions, banks are prohibited from lending more than 25% of the capital base to a single customer group. The Group’s risk appetite statement imposes stricter concentration limits and the Group is taking actions to run down those exposures which are in excess of the internal limits over time. In addition to the above, the Group’s overseas subsidiaries must comply with guidelines for large exposures as set by the regulatory authorities of the countries in which they operate. BOC PCL categorises its loans using the following customer sectors:  Retail – all personal customers and small businesses with facilities from BOC PCL of up to €260 thousand, excluding professional property loans;  SME – any company or group of companies (including personal and housing loans to the directors or shareholders of a company) with facilities with BOC PCL in the range of €260 thousand to €6 million and a maximum annual credit turnover of €10 million; and  Corporate – any company or group of companies (including personal and housing loans to the directors or shareholders of a company) with available credit lines with BOC PCL in excess of an aggregate principal amount of €6 million or having a minimum annual credit turnover of €10 million. In addition, Bank of Cyprus UK Ltd defines corporate loans as loans over €1 million. SME loans are loans less than €1 million and retail loans relate to individuals. Fair value adjustment on initial recognition The fair value adjustment on initial recognition relates to the loans and advances to customers acquired as part of the acquisition of certain operations of Laiki Bank in 2013 and originated credit impaired loans. In accordance with the provisions of IFRS 3, this adjustment has decreased the gross balance of loans and advances to customers. However, for IFRS 7 disclosure purposes as well as for credit risk monitoring, the aforementioned adjustment is not presented within the gross balances of loans and advances. 146 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit risk concentration of loans and advances to customers (continued) Geographical and industry concentrations of Group loans and advances to customers are presented below: 2017 Cyprus Greece United Kingdom Romania Russia Total Fair value adjustment on initial recognition Gross loans after fair value adjustment on initial recognition By economic activity €000 €000 €000 €000 €000 €000 €000 €000 Trade Manufacturing Hotels and catering Construction Real estate Private individuals Professional and other services Other sectors By customer sector Corporate SMEs Retail - housing - consumer, credit cards and other International banking services Wealth management 1,969,360 630,101 1,283,512 2,310,057 1,760,498 6,677,670 1,181,920 1,000,434 - - - - 13,859 6,468 103,808 3,398 15,003 1,339,680 214 - 338 97,992 54,616 1,231 8,925 7,416 6,208 12,236 80,930 87 9,223 35,552 49,322 2,041,466 (71,636) 1,969,830 20,567 664,552 (19,968) 644,584 - 1,393,528 (47,257) 1,346,271 11,764 2,337,455 (144,899) 2,192,556 1 - 3,196,112 (89,647) 3,106,465 6,775,963 (195,686) 6,580,277 62,325 1,308,084 (61,954) 1,246,130 - 1,037,555 (37,438) 1,000,117 16,813,552 15,555 1,621,052 160,577 143,979 18,754,715 (668,485) 18,086,230 7,100,987 15,341 1,295,710 153,694 133,701 8,699,433 (333,740) 8,365,693 3,254,742 4,097,800 2,049,335 256,554 54,134 - - 214 - - 238,509 6,801 10,278 3,510,330 (121,514) 3,388,816 72,856 13,977 - - - 82 - - - - - - 4,170,656 (88,799) 4,081,857 2,063,608 (116,752) 1,946,856 256,554 54,134 (3,005) (4,675) 253,549 49,459 16,813,552 15,555 1,621,052 160,577 143,979 18,754,715 (668,485) 18,086,230 147 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit risk concentration of loans and advances to customers (continued) 2017 Cyprus Greece United Kingdom Romania Russia Total Fair value adjustment on initial recognition By business line €000 €000 €000 €000 €000 €000 €000 Gross loans after fair value adjustment on initial recognition €000 3,321,730 15,341 1,293,304 - - 214 238,509 72,856 13,977 Corporate SMEs Retail - housing - consumer, credit cards and other Restructuring - major corporate - corporate - SMEs - retail housing - retail other Recoveries - corporate - SMEs - retail housing - retail other International banking services Wealth management 1,219,350 3,007,487 1,085,146 1,292,607 777,460 1,085,221 437,892 226,623 1,709,190 950,171 652,421 737,566 256,554 54,134 96,498 6,801 - 82 33,860 - - - - - - - - - 2,406 23,336 - - - - - - - - - - 133,701 4,860,574 (83,251) 4,777,323 10,278 1,474,938 (14,566) 1,460,372 - - - - - - - - - - - - - 3,080,343 (30,274) 3,050,069 1,099,419 (14,348) 1,085,071 1,326,467 (55,850) 1,270,617 777,460 (15,303) 762,157 1,085,221 (37,096) 1,048,125 437,892 226,623 (6,319) (8,037) 431,573 218,586 1,734,932 (179,336) 1,555,596 950,171 (69,852) 652,421 (52,206) 737,566 (94,367) 256,554 54,134 (3,005) (4,675) 880,319 600,215 643,199 253,549 49,459 - - - - - - - - - - - Restructuring major corporate business line includes customers with exposures over €100.000 thousand, whereas restructuring corporate business line includes customers with exposures between €6.000 thousand and €100.000 thousand. 16,813,552 15,555 1,621,052 160,577 143,979 18,754,715 (668,485) 18,086,230 148 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit risk concentration of loans and advances to customers (continued) 2016 Cyprus Greece United Kingdom Romania Russia Total Fair value adjustment on initial recognition Gross loans after fair value adjustment on initial recognition By economic activity €000 €000 €000 €000 €000 €000 €000 €000 Trade Manufacturing Hotels and catering Construction Real estate Private individuals Professional and other services Other sectors By customer sector Corporate SMEs Retail - housing - consumer, credit cards and other International banking services Wealth management 2,044,324 658,811 1,302,543 2,874,331 2,022,559 6,980,383 1,332,250 1,054,255 - - - - 13,964 7,133 112,773 11,141 55,100 2,124,529 (87,576) 2,036,953 7,735 3,263 25,396 699,075 (25,734) 673,341 - 1,418,579 (62,665) 1,355,914 3,181 75,918 12,793 2,966,223 (210,436) 2,755,787 19,599 1,056,924 200,825 6,934 3,306,841 (114,140) 3,192,701 214 - 337 45,557 54,865 1,361 3,093 12,458 32,927 - 7,029,247 (227,057) 6,802,190 97,148 1,496,721 (80,501) 1,416,220 - 1,088,880 (120,344) 968,536 18,269,456 20,150 1,295,758 347,360 197,371 20,130,095 (928,453) 19,201,642 7,517,473 19,936 1,040,941 334,440 179,293 9,092,083 (481,340) 8,610,743 4,100,298 4,202,358 2,064,802 321,571 62,954 - - 214 - - 222,337 12,641 11,144 4,346,420 (202,240) 4,144,180 13,314 19,166 - - 100 179 - - - 4,215,772 (100,509) 4,115,263 6,934 2,091,295 (135,350) 1,955,945 - - 321,571 62,954 (3,619) (5,395) 317,952 57,559 18,269,456 20,150 1,295,758 347,360 197,371 20,130,095 (928,453) 19,201,642 149 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit risk concentration of loans and advances to customers (continued) 2016 Cyprus Greece United Kingdom Romania Russia Total Fair value adjustment on initial recognition By business line €000 €000 €000 €000 €000 €000 €000 Gross loans after fair value adjustment on initial recognition €000 Corporate SMEs Retail - housing - consumer, credit cards and other Restructuring - major corporate - corporate - SMEs Recoveries - corporate - SMEs - retail housing - retail other International banking services Wealth management 2,557,653 19,936 1,036,331 237,203 165,592 4,016,715 (71,064) 3,945,651 1,377,837 3,531,293 1,317,434 2,080,586 1,014,853 1,219,572 1,864,381 1,502,889 671,065 747,368 321,571 62,954 - - 214 - - - - - - - - - 222,337 12,442 11,144 1,623,760 (29,071) 1,594,689 13,314 17,617 - - - 100 179 33,947 - - - - - - - 3,544,707 (40,640) 3,504,067 1,335,444 (26,435) 1,309,009 2,114,533 (156,190) 1,958,343 1,014,853 (22,795) 992,058 1,219,572 (50,393) 1,169,179 4,610 63,290 13,701 1,945,982 (231,291) 1,714,691 - - 1,549 - - 199 - - - - - - 1,503,088 (122,776) 1,380,312 671,065 (59,869) 6,934 755,851 (108,915) - - 321,571 62,954 (3,619) (5,395) 611,196 646,936 317,952 57,559 18,269,456 20,150 1,295,758 347,360 197,371 20,130,095 (928,453) 19,201,642 The loans and advances to customers in Cyprus include lending exposures to Greek entities granted by the Company in Cyprus in its normal course of business with a carrying value of €69,616 thousand (2016: €82,154 thousand) and lending exposures in Cyprus with collaterals in Greece with a carrying value of €98,660 thousand (2016: €106,968 thousand). Additionally as at 31 December 2017, the loans and advances to customers in Cyprus include lending exposures to Serbian entities or with collaterals in Serbia with a carrying value of €15,000 thousand (2016: €9,700 thousand). 150 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Currency concentration of loans and advances to customers 2017 Euro US Dollar British Pound Russian Rouble Romanian Lei Swiss Franc Other currencies 2016 Euro US Dollar British Pound Russian Rouble Romanian Lei Swiss Franc Other currencies Cyprus Greece United Kingdom Romania Russia Total Fair value adjustment on initial recognition Gross loans after fair value adjustment on initial recognition €000 €000 €000 €000 €000 €000 €000 €000 16,000,016 15,555 16,050 159,518 16,053 16,207,192 (649,671) 15,557,521 228,660 74,707 229 - 451,883 58,057 - - - - - - 424 1,599,844 - - 2,128 2,606 - 92 - 967 - - 42,550 271,634 (525) 271,109 - 1,674,643 (423) 1,674,220 85,376 85,605 967 (1) - 85,604 967 454,011 (14,525) 439,486 60,663 (3,340) 57,323 16,813,552 15,555 1,621,052 160,577 143,979 18,754,715 (668,485) 18,086,230 17,563,760 20,150 149,235 38,907 103 - 471,167 46,284 - - - - - - 229 490 1,276,658 - - 7,570 10,811 345,931 16,079 17,946,149 (882,038) 17,064,111 - 88 - 1,341 - - 73,457 223,182 (10,281) 212,901 - 1,315,653 (538) 1,315,115 107,835 107,938 1,341 (1) - 107,937 1,341 478,737 (31,170) 447,567 57,095 (4,425) 52,670 18,269,456 20,150 1,295,758 347,360 197,371 20,130,095 (928,453) 19,201,642 151 - - - - - - BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit quality of loans and advances to customers The following table presents the credit quality of the Group’s loans and advances to customers: 2017 Fair value adjustment on initial recognition Gross loans before fair value adjustment on initial recognition Gross loans after fair value adjustment on initial recognition Gross loans before fair value adjustment on initial recognition 2016 Fair value adjustment on initial recognition Gross loans after fair value adjustment on initial recognition €000 €000 €000 €000 €000 €000 11,149,969 (140,405) 11,009,564 10,990,773 (166,185) 10,824,588 2,084,694 (29,554) 2,055,140 2,238,127 (38,743) 2,199,384 Neither past due nor impaired Past due but not impaired Impaired 5,520,052 (498,526) 5,021,526 6,901,195 (723,525) 6,177,670 18,754,715 (668,485) 18,086,230 20,130,095 (928,453) 19,201,642 Past due loans are those with delayed payments or in excess of authorised credit limits. Impaired loans are those for which a provision for impairment has been recognised on an individual basis or for which incurred losses exist at their initial recognition or customers in Debt Recovery. During the year ended 31 December 2017 the total gross amount of non-contractual write-offs recorded by the Group amounted to €466,248 thousand (2016: €517,694 thousand). The remaining gross loan balance of these customers as at 31 December 2017 was €326,636 thousand (2016: €305,591 thousand), of which €23,090 thousand (2016: €19,651 thousand) were past due for more than 90 days but not impaired and €230,832 thousand (2016: €130,964 thousand) were impaired. Loans and advances to customers that are neither past due nor impaired The credit quality of loans and advances to customers that were neither past due nor impaired is monitored by the Group using internal systems. The table below presents the credit risk quality of loans and advances to customers that were neither past due nor impaired. 2017 Cyprus United Kingdom Romania 2016 Cyprus Greece United Kingdom Romania Russia Grade 1 Grade 2 Grade 3 €000 €000 €000 Total €000 7,031,123 1,384,121 1,158,512 9,573,756 1,503,234 48,975 22,812 1,575,021 978 - 214 1,192 8,535,335 1,433,096 1,181,538 11,149,969 6,127,350 1,751,332 1,802,957 9,681,639 - - 214 214 1,187,130 53,838 10,011 1,250,979 56,857 - 348 - 693 43 57,898 43 7,371,337 1,805,518 1,813,918 10,990,773 152 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit quality of loans and advances to customers (continued) Loans and advances to customers that are neither past due nor impaired (continued) Loans and advances to customers that were neither past due nor in excess of their limit during the last twelve months, are classified as Grade 1. Loans and advances to customers that were past due or in excess of their limit for up to 30 consecutive days during the first half of the year or for up to 15 consecutive days during the second half of the year, are classified as Grade 2. Loans and advances to customers that were past due or in excess of their limit for more than 30 consecutive days during the first half of the year or for more than 15 consecutive days during the second half of the year, are classified as Grade 3. Loans and advances to customers that are past due but not impaired Past due analysis: - up to 30 days - 31 to 90 days - 91 to 180 days - 181 to 365 days - over one year 2017 €000 2016 €000 438,538 455,394 261,453 375,161 124,484 128,675 252,034 140,714 1,008,185 1,138,183 2,084,694 2,238,127 The fair value of the collateral that the Group holds (to the extent that it mitigates credit risk) in respect of loans and advances to customers that are past due but not impaired as at 31 December 2017 is €1,688,623 thousand (2016: €1,762,528 thousand). The fair value of the collateral is capped to the gross carrying value of the loans and advances to customers. Impaired loans and advances to customers Cyprus Greece Russia United Kingdom Romania 2017 2016 Gross loans and advances Fair value of collateral Gross loans and advances Fair value of collateral €000 €000 €000 €000 5,213,278 3,297,980 6,384,503 3,953,086 15,555 7,041 19,936 143,979 34,847 196,144 6,447 19,932 12,041 17,962 87,381 7,213 140,793 20,385 288,571 54,436 5,520,052 3,380,185 6,901,195 4,120,078 153 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit quality of loans and advances to customers (continued) Impaired loans and advances to customers (continued) The fair value of the collateral presented above has been computed based on the extent that the collateral mitigates credit risk and has been capped to the gross carrying value of the loans and advances to customers. Impaired: - no arrears - up to 30 days - 31 to 90 days - 91 to 180 days - 181 to 365 days - over one year 2017 €000 2016 €000 401,933 471,855 141,329 20,880 26,340 73,073 62,119 29,201 49,572 51,438 4,856,497 6,237,010 5,520,052 6,901,195 Provision for impairment of loans and advances to customers The movement in provisions for impairment of loans and advances is as follows: 2017 1 January Cyprus €000 United Kingdom €000 Other countries €000 Total €000 3,170,161 10,782 371,298 3,552,241 Transfer between geographical areas 23 Transfer upon acquisition of property through a restructuring activity Foreign exchange and other adjustments Applied in writing off impaired loans and advances Interest accrued on impaired loans and advances Collection of loans and advances previously written off (12,792) (23) - - - - (12,792) 77,234 (183) (7,059) 69,992 (831,708) (117) (138,684) (970,509) (97,951) (2) (1,406) (99,359) 5,975 287 2 6,264 Charge for the year (Note 16) 925,161 (3,222) 16,000 937,939 31 December 3,236,103 7,522 240,151 3,483,776 Individual impairment 2,367,205 4,751 227,739 2,599,695 Collective impairment 868,898 2,771 12,412 884,081 154 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Provision for impairment of loans and advances to customers (continued) 2016 1 January Dissolution of subsidiaries Acquisition of subsidiary Foreign exchange and other adjustments Applied in writing off impaired loans and advances Interest accrued on impaired loans and advances Collection of loans and advances previously written off Cyprus United Kingdom Other countries Total €000 €000 €000 €000 3,731,750 39,394 422,289 4,193,433 - (6,154) (8,577) - - - (6,154) (8,577) 113,109 (2,232) 16,725 127,602 (923,723) (16,945) (114,597) (1,055,265) (138,603) 1,872 - - (1,909) (140,512) 81 1,953 Charge for the year (Note 16) 394,333 (3,281) 48,709 439,761 31 December 3,170,161 10,782 371,298 3,552,241 Individual impairment 2,779,379 7,788 370,623 3,157,790 Collective impairment 390,782 2,994 675 394,451 The above table does not include the fair value adjustments on initial recognition of loans acquired from Laiki Bank and provisions for impairment on financial guarantees and commitments which are part of ‘Accruals, deferred income and other liabilities’ (Note 34). Assumptions have been made about the future changes in property values, as well as the timing for the realisation of the collateral, taxes and expenses on the repossession and subsequent sale of the collateral as well as any other applicable haircuts. Indexation has been used to estimate updated market values of properties, while assumptions were made on the basis of a macroeconomic scenario for future changes in property values. During 2017, the Group, following a reconsideration of its strategy, to more actively explore other innovative strategic solutions to further accelerate balance sheet de-risking, has modified certain of its provisioning assumptions and estimates. At 31 December 2017 the weighted average haircut (including liquidity haircut and selling expenses) used in the collective provisions calculation is c.34% (2016: average of 10% of the current market value of the property for those collaterals for which the increase in their value is capped to zero and 10% of the projected market value of the property for those collaterals for which their value is expected to drop). The timing of recovery from real estate collaterals used in the collective provision calculation has been estimated to be on average 6 years (2016: average of 3 years except for customers in Debt Recovery, average of 6 years). For the calculation of specific provisions, the timing of recovery of collaterals as well as the haircuts used were based on the specific facts and circumstances of each case. In accordance with the Loan Impairment and Provisioning Procedures Directives of 2014 and 2015 of the CBC, the cumulative average future change in property values during the year has been capped to zero. The above assumptions are also influenced by the ongoing regulatory dialogue BOC PCL maintains with its lead regulator, the ECB, and other regulatory guidance and interpretations issued by various regulatory and industry bodies such as the ECB and EBA, which provide guidance and expectations as to relevant definitions and the treatment/classification of certain parameters/assumptions used in the estimation of provisions. 155 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Provision for impairment of loans and advances to customers (continued) Any changes in these assumptions or difference between assumptions made and actual results could result in significant changes in the amount of required provisions for impairment of loans and advances. Sensitivity analysis The Group has performed sensitivity analysis on certain of the loan impairment assumptions relating to the loan portfolio in Cyprus with reference date 31 December 2017. The impact on the provisions for impairment of loans and advances is presented below: Change in provisions assumptions: Increase/(decrease) on provisions for impairment of loans and advances €000 Increase the timing of recovery from collaterals by 1 year for all customers 120,700 Decrease the timing of recovery from collaterals by 1 year for all customers (121,875) Increase haircuts by 5% on all customers Decrease haircuts by 5% on all customers Increase the average expected recovery period by 1 year and decrease of haircuts by 5% on all customers Decrease the average expected recovery period by 1 year and increase haircuts by 5% on all customers 179,447 (169,291) (47,199) 59,748 Collateral and other credit enhancements obtained The carrying value of assets obtained during 2017 and 2016 by taking possession of collateral held as security, was as follows: Residential property Commercial and other property 2017 €000 2016 €000 77,932 85,171 444,536 1,000,533 522,468 1,085,704 The total carrying value of the assets obtained over the years by taking possession of collateral held as security for customer loans and advances and held by the Group as at 31 December 2017 amounted to €1,611,091 thousand (2016: €1,395,127 thousand including an amount of €3,072 thousand relating to commercial and other property which were classified as held for sale). The disposals of repossessed assets during 2017 amounted to €247,030 thousand (2016: €129,002 thousand). 156 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Forbearance Forbearance measures occur in situations in which the borrower is considered to be unable to meet the terms and conditions of the contract due to financial difficulties. Taking into consideration these difficulties, the Group decides to modify the terms and conditions of the contract to provide the borrower the ability to service the debt or refinance the contract, either partially or fully. The practice of extending forbearance measures constitutes a grant of a concession whether temporarily or permanently to that borrower. A concession may involve restructuring the contractual terms of a debt or payment in some form other than cash, such as an arrangement whereby the borrower transfers collateral pledged to the Group. As such, it constitutes an objective indicator that requires assessing whether impairment is needed. Modifications of loans and advances that do not affect payment arrangements, such as restructuring of collateral or security arrangements are not regarded as sufficient to indicate impairment as by themselves they do not necessarily indicate credit distress affecting payment ability. Rescheduled loans and advances are those facilities for which the Group has modified the repayment programme (provision of a grace period, suspension of the obligation to repay one or more instalments, reduction in the instalment amount and/or elimination of overdue instalments relating to capital or interest) and current accounts/overdrafts for which the credit limit has been increased with the sole purpose of covering an excess. For an account to qualify for rescheduling it must meet certain criteria including that the client’s business must be considered to be viable. The extent to which the Group reschedules accounts that are eligible under its existing policies may vary depending on its view of the prevailing economic conditions and other factors which may change from year to year. In addition, exceptions to policies and practices may be made in specific situations in response to legal or regulatory agreements or orders. Forbearance activities may include measures that restructure the borrower's business (operational restructuring) and/or measures that restructure the borrower’s financing (financial restructuring). Restructuring options may be of a short or long-term nature or combination thereof. The Group has developed and deployed restructuring solutions, which are suitable for the borrower and acceptable for the Group. Short-term restructuring solutions are defined as restructured repayment solutions of duration of less than two years. In the case of loans for the construction of commercial property and project finance, a short-term solution may not exceed one year. Short-term restructuring solutions can include the following:  Interest only: during a defined short-term period, only interest is paid on credit facilities and no principal repayment is made. Reduced payments: decrease of the amount of repayment instalments over a defined short-term period in order to accommodate the borrower’s new cash flow position. Arrears and/or interest capitalisation: the capitalisation of arrears and/or of accrued interest arrears to the principal; that is forbearance of the arrears and addition of any unpaid interest to the outstanding principal balance for repayment under a rescheduled program. Grace period: an agreement allowing the borrower a defined delay in fulfilling the repayment obligations usually with regard to the principal.    157 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Forbearance (continued) Long-term restructuring solutions can include the following:  Interest rate reduction: permanent or temporary reduction of interest rate (fixed or variable) into a fair and sustainable rate. Extension of maturity: extension of the maturity of the loan which allows a reduction in instalment amounts by spreading the repayments over a longer period. Discounted Sale (Sale by agreement/assisted sale): when BOC PCL and the borrower agree to voluntarily dispose of the secured asset(s) to partially or fully repay the debt. Rescheduling of payments: the existing contractual repayment schedule is adjusted to a new sustainable repayment program based on a realistic, current and forecasted, assessment of the cash flow generation of the borrower. Conversion of currency: the aim should be to align the currency of the debt to the currency of the cash flows. Alteration of contract conditions/covenants: when BOC PCL discharges the borrower of covenants or conditions included in a loan agreement. New loan facilities: new loan facilities may be granted during a restructuring agreement, which may entail the pledge of additional security and in the case of inter-creditor arrangements the introduction of covenants in order to compensate for the additional risk incurred by the Group in providing a new financing to a distressed borrower. Debt consolidation: the combination of multiple exposures into a single loan or limited number of loans. Debt/asset swaps: agreement between the Group and the borrower to voluntarily dispose of the secured asset to partially or fully repay the debt. The asset may be acquired by the Group and any residual debt may be restructured within an appropriate repayment schedule in line with the borrower’s reassessed repayment ability. Partial or total debt forgiveness: this corresponds to BOC PCL forfeiting the right to legally recover part or the whole of the amount of debt outstanding by the borrower. The Group applies the debt forgiveness solution only as a last resort and in remote cases having taken into consideration the ability of the borrower to repay the remaining debt in the agreed timeframe and the moral hazard. Debt forgiveness (write-off) and restructuring: this corresponds to BOC PCL forfeiting the right to legally recover part of the amount of debt outstanding by the borrower. Rollover: consists of modifying the maturity date, providing for the same interest for the extended period of time granted for repayment. Split and freeze: the customer’s debt is split into sustainable and unsustainable parts. The sustainable part is restructured and continues to operate. The unsustainable part is ‘frozen’ for the restructured duration of the sustainable part. At the maturity of the restructuring, the frozen part is either forgiven pro-rata (based on the actual repayment of the sustainable part) or restructured. Debt/equity swaps: partial set-off of the debt and obtaining of an equivalent amount of equity by the Group, with the remaining debt right-sized to the cash flows of the borrower to allow repayment to the Group from repayment on the re-sized debt and from the eventual sale of the equity stake in the business. This solution is used only in exceptional cases and only where all other efforts for restructuring are exhausted and after ensuring compliance with the banking law.              In addition, the following solutions can be used: a) Additional security: when additional liens on unencumbered assets are obtained as additional security from the borrower in order to compensate for the higher risk exposure and as part of the restructuring process. b) Capture surplus cash: aims at securing cash flows, which may currently not be unencumbered and/or not pledged by BOC PCL. Surplus cash may be obtained, for example, from higher cash flows from operations, as well as from disposal of collaterals, or unencumbered assets. Rescheduled loans and advances to customers The below tables present the Group’s rescheduled loans and advances to customers by industry sector, geography and credit quality classification, as well as impairment provisions and tangible collateral held for rescheduled loans. 158 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) 2017 1 January Cyprus Greece Russia €000 €000 €000 United Kingdom €000 Romania €000 Total €000 7,401,870 337 83,893 90,323 78,881 7,655,304 New loans and advances rescheduled in the year 402,521 Assets no longer classified as rescheduled (including repayments) (1,326,918) Applied in writing off rescheduled loans and advances (461,468) Interest accrued on rescheduled loans and advances Foreign exchange adjustments 278,858 (21,917) - - - 1 - - 89 3,424 406,034 (7,998) (79,147) (52,034) (1,466,097) - - (2) 16 (13,076) (474,546) 1,381 280,256 (5,300) (1,393) (327) (28,937) 31 December 2016 1 January 6,272,946 338 70,595 9,886 18,249 6,372,014 8,391,624 24,865 138,376 116,232 119,185 8,790,282 New loans and advances rescheduled in the year 900,616 - - 54,780 340 955,736 Assets no longer classified as rescheduled (including repayments) Applied in writing off rescheduled loans and advances Interest accrued on rescheduled loans and advances Foreign exchange adjustments 31 December (1,504,769) (97) (77,308) (68,305) (42,843) (1,693,322) (715,713) (24,871) 326,260 3,852 7,401,870 440 - 337 - - (255) 557 (189) (741,028) 2,392 329,649 22,825 (12,686) (4) 13,987 83,893 90,323 78,881 7,655,304 The classification as rescheduled loans is discontinued when all EBA criteria for the discontinuation of the classification as forborne exposure are met. These are set out in the ECB Guidance to Banks on Non-Performing Loans. 159 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) Credit quality 2017 Neither past due nor impaired Past due but not impaired Impaired 2016 Neither past due nor impaired Past due but not impaired Impaired Cyprus Greece Russia €000 €000 €000 United Kingdom €000 Romania €000 Total €000 3,158,894 1,218,160 1,895,892 6,272,946 4,021,923 1,212,177 2,167,770 7,401,870 - - 338 338 - - 337 337 - - 70,595 5,383 2,354 2,149 79 3,164,356 - 1,220,514 18,170 1,987,144 70,595 9,886 18,249 6,372,014 - 671 83,222 85,722 85 4,107,730 2,509 2,092 225 1,215,582 78,571 2,331,992 83,893 90,323 78,881 7,655,304 160 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) Fair value of collateral 2017 Neither past due nor impaired Past due but not impaired Impaired 2016 Neither past due nor impaired Past due but not impaired Impaired Cyprus €000 2,818,937 1,020,063 1,437,734 5,276,734 3,772,578 1,021,347 1,828,036 6,621,961 Russia United Kingdom Romania €000 €000 €000 Total €000 - - 14,500 14,500 - 671 47,740 48,411 5,345 2,353 1,131 8,829 85,661 2,504 1,974 93 - 2,824,375 1,022,416 9,948 1,463,313 10,041 5,310,104 80 182 3,858,319 1,024,704 22,060 1,899,810 90,139 22,322 6,782,833 The fair value of collateral presented above has been computed based on the extent that the collateral mitigates credit risk. 161 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) Credit risk concentration 2017 By economic activity Trade Manufacturing Hotels and catering Construction Real estate Private individuals Professional and other services Other sectors By customer sector Corporate SMEs Retail - housing - consumer, credit cards and other International banking services Wealth management Cyprus €000 607,700 201,377 429,520 1,222,591 862,508 2,221,465 359,970 367,815 6,272,946 2,923,699 1,310,652 1,430,760 552,908 53,103 1,824 Greece €000 Russia United Kingdom Romania €000 €000 €000 31,237 12,314 - 8,212 - - 18,832 - 445 44 2,242 - 4,837 1,593 725 - Total €000 640,095 213,857 431,762 713 122 - 11,933 1,242,736 5,401 872,746 - 80 - 2,223,058 379,607 368,153 70,595 9,886 18,249 6,372,014 65,925 4,670 - - - - 3,867 4,549 - 1,470 - - 18,249 3,012,078 - - - - - 1,319,871 1,430,760 554,378 53,103 1,824 - - - - - - - 338 338 338 - - - - - 6,272,946 338 70,595 9,886 18,249 6,372,014 162 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) Credit risk concentration (continued) 2017 By business line Corporate SMEs Retail - housing - consumer, credit cards and other Restructuring - major corporate - corporate - SMEs - retail housing - retail other Recoveries - corporate - SMEs - retail housing - retail other International banking services Wealth management Cyprus €000 Greece €000 Russia United Kingdom Romania €000 €000 €000 Total €000 795,714 344,957 958,415 290,308 934,096 624,602 739,537 301,111 122,749 569,287 226,158 171,234 139,851 53,103 1,824 338 - - - - - - - - - - - - - - 65,925 4,670 - - - - - - - - - - - - - 3,867 4,549 - 1,470 14,637 880,481 - - - 354,176 958,415 291,778 - - - - - - - - - - - 79 934,175 - - - - 624,602 739,537 301,111 122,749 3,533 572,820 - - - - - 226,158 171,234 139,851 53,103 1,824 6,272,946 338 70,595 9,886 18,249 6,372,014 163 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) Credit risk concentration (continued) 2016 By economic activity Trade Manufacturing Hotels and catering Construction Real estate Private individuals Professional and other services Other sectors By customer sector Corporate SMEs Retail - housing - consumer, credit cards and other International banking services Wealth management Cyprus €000 668,305 214,248 619,259 1,539,773 1,047,280 2,515,157 446,946 350,902 7,401,870 3,418,231 1,675,528 1,661,487 567,426 74,704 4,494 Greece €000 Russia United Kingdom Romania €000 €000 €000 35,229 16,347 - 8,934 - - 23,383 - 261 - 12,139 176 69,426 996 7,325 - Total €000 705,419 231,858 634,647 1,624 1,263 3,249 25,175 1,574,058 47,192 1,163,898 60 - 318 2,516,213 477,654 351,557 83,893 90,323 78,881 7,655,304 78,488 5,405 74,987 14,501 77,556 3,649,599 1,265 1,696,699 - - - - - 835 - - - 60 - - 1,661,487 568,321 74,704 4,494 - - - - - - - 337 337 337 - - - - - 7,401,870 337 83,893 90,323 78,881 7,655,304 164 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) Credit risk concentration (continued) 2016 By business line Corporate SMEs Retail - housing - consumer, credit cards and other Restructuring - major corporate - corporate - SMEs Recoveries - corporate - SMEs - retail housing - retail other International banking services Wealth management Cyprus €000 Greece €000 Russia United Kingdom Romania €000 €000 €000 Total €000 711,872 464,163 1,494,123 449,107 1,371,448 790,600 815,597 544,311 395,768 167,364 118,319 74,704 4,494 337 - - - - - - - - - - - - 78,488 5,405 - - - - - - - - - - - 74,987 14,501 - 835 - - - - - - - - - 77,391 1,265 943,075 485,334 - 60 1,494,123 450,002 165 1,371,613 - - - - - - - - 790,600 815,597 544,311 395,768 167,364 118,319 74,704 4,494 7,401,870 337 83,893 90,323 78,881 7,655,304 165 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 44. Risk management – Credit risk (continued) Rescheduled loans and advances to customers (continued) Provisions for impairment 2017 Individual impairment Collective impairment 2016 Individual impairment Collective impairment Cyprus €000 797,975 594,075 1,392,050 899,178 200,069 1,099,247 Greece €000 Russia United Kingdom Romania €000 €000 €000 Total €000 338 - 338 337 - 337 56,094 - 56,094 65,297 359 65,656 1,054 242 1,296 1,855 365 2,220 10,078 865,539 - 594,317 10,078 1,459,856 59,791 1,026,458 2 200,795 59,793 1,227,253 166 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit quality of Group assets exposed to credit risk other than loans and advances to customers - analysis by rating agency designation Balances with central banks and loans and advances to banks Balances with central banks and loans and advances to banks are analysed by Moody’s Investors Service rating as follows: Aaa – Aa3 A1 – A3 Baa1 – Baa3 Ba1 – Ba3 B1 – B3 Caa - C Unrated Other receivables from banks 2017 €000 2016 €000 745,330 785,002 560,059 249,693 132,610 2,870,600 41,860 37,067 655 1,137,717 18,399 14,410 58,406 154,805 56,603 41,085 4,442,662 2,461,639 Band Ba1-Ba3 above includes an amount of €152,538 thousand which mainly relates to obligatory deposits for liquidity purposes with the CBC. As at 31 December 2017, bank balances with carrying value of €33,004 thousand are impaired (2016: €78,725 thousand), with cumulative impairment loss of €24,998 thousand (2016: €55,655 thousand). 167 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 44. Risk management – Credit risk (continued) Credit quality of Group assets exposed to credit risk other than loans and advances to customers - analysis by rating agency designation (continued) Debt securities Investments in debt securities are analysed by Moody’s Investors Service rating, their issuer and classification, as follows: Aaa – Aa3 Baa1 – Baa3 Ba1 – Ba3 B1 – B3 Caa – C Unrated Issued by: - Cyprus government - other governments - banks and other corporations Classified as: - trading investments - investments at fair value through profit or loss - available-for-sale investments - investments classified as loans and receivables 2017 €000 2016 €000 437,857 349,565 12,306 12,507 500,265 - - - 500 257,495 1 - 950,928 619,568 500,265 257,496 304,441 329,211 146,222 32,861 950,928 619,568 536 476 - 10,426 901,734 540,592 48,658 68,074 950,928 619,568 168 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 45. Risk management – Market risk Market risk is the risk of loss from adverse changes in market prices - namely from changes in interest rates, exchange rates and security prices. The Market Risk department is responsible for monitoring the risk resulting from such changes with the objective to minimise the impact on earnings and capital. The department also monitors liquidity risk and credit risk with counterparties and countries. It is also responsible for monitoring compliance with the various market risk policies and procedures. Interest rate risk Interest rate risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in market interest rates. It arises as a result of timing differences on the repricing of assets, liabilities and off balance sheet items. Interest rate risk is measured using interest rate sensitivity gap analysis where the difference between assets and liabilities repricing in each time band is calculated separately for each currency. Interest rate risk is managed through a Year 1 Interest Rate Effect (IRE) limit on the maximum reduction of net interest income under the various interest rate shock scenarios. Limits are set as a percentage of the Group capital and as a percentage of the net interest income (when positive) and are allocated to the various banking units of the Group. In the case of Cyprus, there are different limits for Euro and foreign currencies. Sensitivity analysis The table below sets out the impact on the Group’s net interest income, over a one-year period, from reasonably possible parallel changes in the interest rates of the main currencies: Parallel change in interest rates ((increase)/decrease in net interest income) 2017 +1.6% for Russian Rouble +0.6% for Euro, US Dollar and British Pound +0.4% for Swiss Franc +0.2% for Japanese Yen +0.6% for all other currencies -1.7% for Russian Rouble -0.6% for Euro, US Dollar and British Pound -0.3% for Swiss Franc -0.2% for Japanese Yen -0.6% for all other currencies 2016 +2% for Russian Rouble +1% for US Dollar +0.5% for all other currencies -4% for Russian Rouble -0.5% for all other currencies Euro US Dollar British Pound Other currencies Total €000 €000 €000 €000 €000 24,280 190 13,720 605 38,795 (28,459) (1,428) (2,749) (1,333) (33,969) 17,269 15,950 5,081 (43) 38,257 (21,479) (8,089) (3,057) (438) (33,063) 169 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 45. Risk management – Market risk (continued) Interest rate risk (continued) Sensitivity analysis (continued) In addition to the above fluctuations in net interest income, interest rate changes can result in fluctuations in the fair value of investments at fair value through profit or loss (including investments held for trading) and in the fair value of derivative financial instruments. The equity of the Group is also affected by changes in market interest rates. The impact on the Group’s equity arises from changes in the fair value of fixed rate debt securities classified as available-for-sale (unless impaired). The sensitivity analysis is based on the assumption of a parallel shift of the yield curve. The table below sets out the impact on the Group’s profit/loss before tax and equity as a result of reasonably possible changes in the interest rates of the major currencies. Change in interest rates 2017 +0.4% for Swiss Franc +0.2% for Japanese Yen +0.6% for all other currencies -0.3% for Swiss Franc -0.2% for Japanese Yen -0.6% for all other currencies 2016 +2% for Russian Rouble +1% for US Dollar +0.5% for all other currencies -4% for Russian Rouble -0.5% for all other currencies Currency risk Impact on profit/loss before tax Impact on equity €000 €000 364 (3,155) (364) 3,155 1,347 (1,764) (1,347) 1,734 Currency risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. In order to manage currency risk, the ALCO has approved open position limits for the total foreign exchange position limits. The foreign exchange position limits are lower than those prescribed by the CBC. These limits are managed by Treasury and monitored daily by market risk officers in all the banking units of the Group, who report the overnight foreign currency position of each unit to Market Risk daily. The Group does not maintain a currency trading book. The table below sets out the Group’s currency risk resulting from the financial instruments that it holds. The analysis assumes reasonably possible changes in the exchange rates of major currencies against the Euro, based mainly on historical price fluctuations. The impact on profit/loss after tax includes the change in net interest income that arises from the change of currency rate. The impact on equity arises from the hedging instruments that are used to hedge part of the net assets of the subsidiaries whose functional currency is not the Euro. The net assets of foreign operations are also revalued and affect equity, but their impact is not taken into account in the above sensitivity analysis as the above relates only to financial instruments which have a direct impact either on profit/loss after tax or on equity. 170 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 45. Risk management – Market risk (continued) Currency risk (continued) 2017 US Dollar Russian Rouble Romanian Lei Swiss Franc British Pound Japanese Yen Other currencies US Dollar Russian Rouble Romanian Lei Swiss Franc British Pound Japanese Yen Other currencies 2016 US Dollar Russian Rouble Romanian Lei Swiss Franc British Pound Japanese Yen Other currencies US Dollar Russian Rouble Romanian Lei Swiss Franc British Pound Japanese Yen Other currencies Change in foreign exchange rate Impact on profit/loss after tax Impact on equity % €000 €000 1,110 2,714 (419) 3,803 868 195 (18) (908) (1,628) 343 (2,535) (578) (160) 14 1,935 2,645 - 6,629 1,017 307 173 (1,584) (1,587) - (4,419) (678) (251) (142) - 22,323 (407) - (34,079) - - - (13,394) 333 - 22,719 - - - 18,828 4,459 - (19,358) - - - (11,297) (3,648) - 12,905 - - +10 +25 +10 +20 +20 +10 +10 -10 -25 -10 -20 -20 -10 -10 +10 +25 +10 +20 +20 +10 +10 -10 -25 -10 -20 -20 -10 -10 171 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 45. Risk management – Market risk (continued) Price risk Equity securities price risk The risk of loss from changes in the price of equity securities arises when there is an unfavourable change in the prices of equity securities held by the Group as investments. Investments in equities are outside the Group’s risk appetite. The Group monitors the current portfolio mostly acquired by the Group as part of the acquisition of certain operations of Laiki Bank, with the objective to gradually liquidate all positions for which there is a market. Equity securities may also be acquired in the context of delinquent loan workouts and are disposed of by the Group as soon as practicable. Changes in the prices of equity securities that are classified as investments at fair value through profit or loss, affect the results of the Group, whereas changes in the value of equity securities classified as available-for-sale affect the equity of the Group (if not impaired). The table below shows the impact on the profit/loss before tax and on equity of the Group from a change in the price of the equity securities held, as a result of reasonably possible changes in the relevant stock exchange indices. 2017 Cyprus stock exchange Athens exchange Other stock exchanges and non listed Cyprus stock exchange Athens exchange Other stock exchanges and non listed 2016 Cyprus stock exchange Athens exchange Other stock exchanges and non listed Cyprus stock exchange Athens exchange Other stock exchanges and non listed Change in index % Impact on profit/loss before tax €000 Impact on equity €000 +25 +25 +20 -25 -25 -20 +25 +35 +20 -25 -35 -20 1,477 - 1,144 (1,483) (5) (1,390) 1,313 - 858 (1,567) (30) (858) 1,288 99 4,206 (1,282) (93) (3,960) 1,049 95 2,122 (795) (67) (2,122) Debt securities price risk Debt securities price risk is the risk of loss as a result of adverse changes in the prices of debt securities held by the Group. Debt security prices change as the credit risk of the issuer changes and/or as the interest rate changes for fixed rate securities. The Group invests a significant part of its liquid assets in debt securities issued mostly by governments. The average Moody’s Investors Service rating of the debt securities portfolio of the Group as at 31 December 2017 was Baa1 (2016: Baa1). The average rating excluding the Cyprus Government bonds for 31 December 2017 was Aa1 (2016: Aa2). Changes in the prices of debt securities classified as investments at fair value through profit or loss, affect the profit or loss of the Group, whereas changes in the value of debt securities classified as available-for-sale affect the equity of the Group (if not impaired). 172 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 45. Risk management – Market risk (continued) Price risk (continued) Debt securities price risk (continued) The table below indicates how the profit/loss before tax and equity of the Group will be affected from reasonably possible changes in the price of the debt securities held, based on observations of changes in credit risk over the past years. Change in market prices 2017 +3% for A3 and above rated bonds +10% for below A3 rated bonds -3% for A3 and above rated bonds -10% for below A3 rated bonds 2016 +6.5% -6.5% Impact on profit/loss before tax Impact on equity €000 €000 1,385 13,038 607 45,667 (1,385) (13,038) (607) (45,667) 2,861 34,776 (2,861) (34,776) 46. Risk management – Liquidity risk and funding Liquidity risk is the risk that the Group is unable to fully or promptly meet current and future payment obligations as and when they fall due. This risk includes the possibility that the Group may have to raise funding at high cost or sell assets at a discount to fully and promptly satisfy its obligations. It reflects the potential mismatch between incoming and outgoing payments, taking into account unexpected delays in repayment or unexpectedly high payment outflows. Liquidity risk involves both the risk of unexpected increases in the cost of funding of the portfolio of assets and the risk of being unable to liquidate a position in a timely manner on reasonable terms. In order to limit this risk, management aims to achieve diversified funding sources in addition to the Group’s core deposit base, and has adopted a policy of managing assets with liquidity in mind and monitoring cash flows and liquidity on a daily basis. The Group has developed internal control processes and contingency plans for managing liquidity risk. Management and structure The Board of Directors sets the Group’s Liquidity Risk Appetite being the level of risk at which the Group should operate. The Board of Directors, through its Risk Committee, approves the Liquidity Policy Statement and reviews almost at every meeting the liquidity position of the Group. Information on inflows/outflows is also provided. The ALCO is responsible for setting the policies for the effective management and monitoring of liquidity across the Group. Bank of Cyprus UK Ltd ALCO is responsible for monitoring the liquidity position of the unit and ensuring compliance with the approved policies and regulatory requirements. 173 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Management and structure (continued) Group Treasury is responsible for liquidity management at Group level and for overseeing the operations of Bank of Cyprus UK Ltd, to ensure compliance with internal and regulatory liquidity policies and provide direction as to the actions to be taken regarding liquidity needs. Every unit is responsible for managing its liquidity and targets to finance its own needs. Group Treasury assesses on a continuous basis, and informs ALCO at regular time intervals, the adequacy of the liquid assets and takes the necessary actions to enhance the Group’s liquidity position. Liquidity is also monitored daily by Market Risk, which is an independent department responsible to monitor compliance at the level of individual units, as well as at Group level, with both internal policies and limits, and with the limits set by the regulatory authorities in the countries where the Group operates. Market Risk reports to ALCO the regulatory liquidity position of the various units of the Group, at least monthly. It also provides the results of various stress tests to ALCO at least quarterly. Liquidity is monitored and managed on an ongoing basis through: (i) (ii) (iii) Risk appetite: established Group Risk Appetite together with the appropriate limits for the management of all risks including liquidity risk. Liquidity policy: sets the responsibilities for managing liquidity risk as well as the framework, limits and stress test assumptions. Liquidity limits: a number of internal and regulatory limits are monitored on a daily, monthly and quarterly basis. Where applicable, a traffic light system (RAG) has been introduced for the ratios, in order to raise flags when the ratios deteriorate. (iv) Early warning indicators: monitoring of a range of indicators for early signs of liquidity risk in the market or specific to the Group. These are designed to immediately identify the emergence of increased liquidity risk to maximise the time available to execute appropriate mitigating actions. Liquidity Contingency Plan: maintenance of a Liquidity Contingency Plan (LCP) which is designed to provide a framework where a liquidity stress could be effectively managed. The LCP provides a communication plan and includes management actions to respond to liquidity stresses. (v) (vi) Recovery Plan: the Group has developed a Recovery Plan (RP). The key objectives of the RP are to set the key Recovery and Early Warning indicators, so as to monitor these consistently and to set in advance a range or recovery options to enable the Group to be adequately prepared to respond to stressed conditions and restore the Group’s position. Monitoring process Daily The daily monitoring of cash flows and highly liquid assets is important to safeguard and ensure the uninterrupted operations of the Group’s activities. Market Risk prepares a report for submission to the CBC and ECB/Single Supervisory Mechanism (SSM), indicating the opening and closing liquidity position, net customer movements and other movements analysed by the main currencies. In addition, Group Treasury monitors daily and intraday the customer inflows and outflows in the main currencies used by the Group. Since May 2016, Market Risk also prepares daily stress testing for bank-specific, market wide and combined scenarios. The requirement is to have sufficient liquidity buffer to enable BOC PCL to survive a two-week stress period, and adequate capacity to raise funding under a three month period, under all scenarios. The liquidity buffer is made up of: Banknotes, CBC balances (excluding the Minimum Reserve Requirements (MRR)), nostro current accounts, money market placements up to the stress horizon, available ECB credit line and market value net of haircut of eligible unencumbered/available bonds. Most of these are High Quality Liquid Assets (HQLA) as per the LCR definitions and/or ECB Eligible bonds and excludes domestic issues of Cyprus Government Bonds. The designing of the stress tests followed best practice guidance and was based on the liquidity risk drivers which are recognised internationally by both the Prudential Regulation Authority (PRA) and EBA SREP. The stress tests assumptions are included in the Group Liquidity Policy which is reviewed on an annual basis and approved by the Board. However, whenever it is considered appropriate to amend the assumptions during the year, approval is requested by ALCO and the Board Risk Committee. The main items shocked in the different scenarios are: deposit outflows, wholesale funding, loan repayments, off-balance sheet commitments, marketable securities and cash collateral for derivatives and repos. 174 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Monitoring process (continued) Weekly Market Risk prepares a weekly report of Euro and foreign currency liquidity mismatch, which also discloses the level of liquidity ratios which is submitted to the CBC. Monthly Market Risk prepares reports monitoring compliance with internal and regulatory liquidity ratios, for all banking units and for the Group and submits them to the ALCO, the Executive Committee and the Board Risk Committee. It also calculates the expected flows under a stress scenario and compares them with the projected available liquidity buffer in order to calculate the survival days. The fixed deposit renewal rates and deposits by tenor are also presented to the ALCO. Market Risk reports the LCR and Additional Liquidity Monitoring Metrics (ALMM) to the CBC/ECB monthly. Group Treasury prepares a liquidity report which is submitted to the ALCO on a monthly basis. The report indicates the liquidity position of BOC PCL and the Group, data on monthly customer flows, as well as other important developments related to liquidity. Quarterly The results of the stress testing scenarios prepared daily are reported to ALCO and the Board Risk Committee quarterly. Moreover, Market Risk reports the NSFR, Leverage Ratio to the CBC/ECB quarterly and various other liquidity reports, included in the short-term exercise of the SSM per the SREP guidelines. Annually The Group prepares on an annual basis its report on ILAAP. As part of the Group’s procedures for monitoring and managing liquidity risk, there is a Group LCP for handling liquidity difficulties. The LCP details the steps to be taken in the event that liquidity problems arise, which escalate to a special meeting of the extended ALCO. The LCP sets out the members of this Committee and a series of the possible actions that can be taken. This LCP, as well as the Group’s Liquidity Policy, is reviewed by ALCO at least annually, during the ILAAP review. The ALCO submits the updated Liquidity Policy with its recommendations to the Board through the Board Risk Committee for approval. The approved Liquidity Policy is notified to the SSM. Liquidity ratios The Group LCR presented in the table below, is calculated based on the Delegated Regulation (EU) 2015/61. It is designed to establish a minimum level of high-quality liquid assets sufficient to meet an acute stress lasting for 30 calendar days. During 2017 the minimum requirement was 80% and increased to 100% on 1 January 2018. The Group LCR is calculated monthly by Market Risk and sent to CBC/ECB 15 days after the month end. Following ELA repayment in January 2017, BOC PCL has been concentrating its efforts in increasing liquid assets and thus improving its LCR. The Group’s LCR ratio was as follows: End of reporting period Average monthly ratio Highest monthly ratio Lowest monthly ratio 2017 % 2016 % 190 120 190 58 49 5 49 0 175 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Liquidity ratios (continued) As at 31 December 2017, the Group is in compliance with its regulatory liquidity requirement with respect to the LCR. As at 31 December 2017, BOC PCL was not in compliance with all of the local regulatory liquidity requirements (which were abolished on 1 January 2018 as per Article 412(5) of EU Regulation No 575/2013) with respect to its operations in Cyprus. More specifically, BOC PCL was in compliance with the CBC EUR stock ratio and the CBC EUR 0-30 days mismatch ratio, but was not in compliance with the rest of the local regulatory liquidity requirements. In December 2017, the CBC introduced a macroprudential measure in the form of a liquidity add-on that was imposed on top of the LCR and which became effective on 1 January 2018. The objective of the measure is to ensure that there will be a gradual release of the excess liquidity arising from the lower liquidity requirements under the LCR compared to the ones under the local regulatory liquidity requirements previously in place. The add-on applies stricter outflow and inflow rates on some of the parameters used in the calculation of the LCR than the ones defined in the Commission Delegated Regulation (EU) 2015/61 as well as additional liquidity requirements in the form of outflow rates on other items that are not subject to any outflow rates as per the Regulation. The measure will be implemented in two stages. The first stage requires stricter outflow and inflow rates which are applicable from 1 January 2018 until 30 June 2018. The second stage requires more relaxed outflow and inflow rates compared to the initial ones, and are applicable from 1 July 2018 until 31 December 2018. Specifically, there will be a reduction of 50% of the LCR add-on rates on 1 July 2018. The additional liquidity requirement is expected to be implemented up to 31 December 2018. The CBC may propose to modify or extend the period of application of this macroprudential measure depending on the results of the follow-up of the banks’ actions on how the excess liquidity is utilised. As at 31 December 2017, the Group and BOC PCL were in compliance with the LCR add-on implemented on 1 January 2018. As at 31 December 2017 and 2016 Bank of Cyprus UK Ltd was in compliance with its regulatory liquidity requirements. Main sources of funding During the year 2017, the Group’s main sources of funding were its deposit base and central bank funding, through the Eurosystem monetary policy operations. ELA was fully repaid on 5 January 2017 (31 December 2016: €200 million). The liquidity received from central banks is subject to the relevant regulations and requires qualifying assets as collateral. The funding via Eurosystem monetary policy operations ranges from short term to long term. As at 31 December 2017, ECB funding was at €930 million of which €100 million was from the weekly MRO and €830 million was from the 4-year TLTRO II. In January 2017, BOC PCL issued a €250 million unsecured and subordinated Tier 2 Capital Note under BOC PCL’s EMTN Programme. Further information is disclosed in Note 33. Funding to subsidiaries The funding provided by BOC PCL to its subsidiaries for liquidity purposes is repayable as per the terms of the respective agreements. BOC PCL’s subsidiary Bank of Cyprus UK Ltd cannot place funds with the Group in excess of maximum limits set by the local regulator. Any new funding to subsidiaries requires approval from the ECB and the CBC. The subsidiaries may proceed with dividend distributions in the form of cash to BOC PCL, provided that they are not in breach of their regulatory capital and liquidity requirements. Certain subsidiaries have a recommendation from their regulator to avoid any dividend distribution at this point in time. 176 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Collateral requirements The carrying values of the Group’s encumbered assets as at 31 December 2017 and 2016 are summarised below: Cash and other liquid assets Investments Loans and advances Property 2017 €000 2016 €000 120,525 139,975 317,167 359,813 3,137,586 2,853,511 - 93,574 3,575,278 3,446,873 Cash is mainly used to cover collateral required for (i) derivatives and repurchase transactions and (ii) trade finance transactions and guarantees issued. It is also used as part of the supplementary assets for the covered bond. Investments are mainly used as collateral for repurchase transactions with commercial banks as well as supplementary assets for the covered bond. Loans and advances indicated as encumbered as at 31 December 2017 and 2016 are mainly used as collateral for funding from the Central Banks (ECB, CBC and Bank of England), the covered bond and government deposits. As at 31 December 2017 no loans and advances to customers or property were pledged as collateral for ELA (2016: €787 million). Loans and advances to customers include mortgage loans of a nominal amount €1,001 million (2016: €1,002 million) in Cyprus, pledged as collateral for the covered bond issued by BOC PCL in 2011 under the Covered Bond Programme. Furthermore housing loans of a nominal amount €1,273 million (2016: €765 million) in Cyprus are pledged as collateral for the funding from the ECB (Note 30). At 31 December 2017, loans of a nominal amount of €715 million in Cyprus are pledged as collateral for deposits of the Republic of Cyprus (2016: nil). At 31 December 2017 BOC PCL’s subsidiary Bank of Cyprus UK Ltd has pledged €161 million (2016: €244 million) of loans and advances to customers with the Funding for Lending Scheme (FLS) of the Bank of England. As at 31 December 2017 the subsidiary had drawn down Treasury bills of €82 million (2016: €29 million) under the FLS. These Treasury bills are not recorded on the consolidated balance sheet as ownership remains with the Bank of England. BOC PCL maintains a Covered Bond Programme set up under the Cyprus Covered Bonds legislation and the Covered Bonds Directive of the CBC. Under the Covered Bond Programme, BOC PCL has in issue covered bonds of €650 million secured by residential mortgages originated in Cyprus. The covered bonds have a maturity date of 12 December 2018, bear interest of 3 months Euribor plus 3.25% on a quarterly basis and are traded on the Luxemburg Bourse. The covered bonds have a Conditional Pass-Through structure. All the bonds are held by BOC PCL. The credit rating of the covered bonds was upgraded to an investment grade rating and the covered bond has become eligible collateral for the Eurosystem credit operations. As from 2 October 2015, it has been placed as collateral for accessing funding from the ECB. The credit ratings of the Republic of Cyprus by the main credit rating agencies continue to be below investment grade. As a result, the ECB does not include Cyprus Government Bonds in its asset purchase programme, or as eligible collateral for Eurosystem monetary operations. 177 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Analysis of financial assets and liabilities based on remaining contractual maturity The analysis of the Group’s financial assets and liabilities based on the remaining contractual maturity at 31 December is based on undiscounted cash flows, analysed in time bands according to the number of days remaining from 31 December to the contractual maturity date. Financial assets The analysis of financial assets does not include any interest receivable cash flows. Financial assets have a much longer duration than financial liabilities and non-discounted interest receivable cash flows are higher than non-discounted interest payable cash flows (based on remaining contractual maturity). As a result, non- discounted cash inflows from interest receivable would have greatly exceeded non-discounted cash outflows on interest payable, thus artificially improving liquidity. Current accounts, overdrafts and amounts in arrears are included within the first maturity time band which reflects their contractual maturity. All other loans and advances to customers are analysed according to their contractual repayment schedule. Loans and advances to banks are analysed in the time bands according to the number of days remaining from 31 December, until their contractual maturity date. Amounts placed as collateral (primarily for derivatives and loans) are assigned to different time bands based on either their maturity (in the case of loans), or proportionally according to the maturities of derivatives (where the collateral had no fixed maturity). Financial assets with no contractual maturity (such as equity securities) are included in the ‘over five years’ time band, unless classified as at fair value through profit or loss, in which case they are included in the ‘up to one month’ time band. The investments are classified in the relevant time band according to their contractual maturity. Financial liabilities All financial liabilities for the repayment of which notice is required, are included in the relevant time bands as if notice had been given on 31 December, despite the fact that the Group expects that the majority of its customers will not demand repayment of such liabilities on the earliest possible date. Fixed deposits are classified in time bands based on their contractual maturity. Although customers may demand repayment of time deposits (subject to penalties depending on the type of the deposit account), the Group has the discretion not to accept such early termination of deposits. Subordinated loan stock is classified in the relevant time band according to the remaining contractual maturity, ignoring the call date. The amounts presented in the table below are not equal to the amounts presented on the balance sheet, since the table below presents all cash flows (including interest to maturity) on an undiscounted basis. Derivative financial instruments Derivative financial instruments were classified according to whether the settlement of cash flows occurs on a net or gross basis. For net settled derivatives, after offset of receivable and payable amounts, the fair value of the derivatives is included in financial assets or in financial liabilities in the time band corresponding to the remaining maturity of the derivative. Gross settled derivatives or net settled derivatives that are hedging instruments in cash flow hedges are presented in a separate table and the corresponding cash flows are classified accordingly in the time bands which relate to the number of days until their receipt or payment. Commitments and contingent liabilities The limits of loans and advances are commitments to provide credit to customers. The limits are granted for predetermined periods and can be cancelled by the Group after giving relevant notice to the customers. Usually the customers do not fully utilise the limits granted to them. 178 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Analysis of financial assets and liabilities based on remaining contractual maturity (continued) 2017 Financial assets Cash and balances with central banks Loans and advances to banks Investments at fair value through profit or loss Loans and advances to customers Fair value of net settled derivative assets Non-trading investments On demand and up to one month Between one and three months Between three months and one year Between one and five years Over five years Total €000 €000 €000 €000 €000 €000 3,321,403 29,667 34,371 8,493 - 3,393,934 1,053,565 4,775 3,573 110,476 20,244 1,192,633 46,389 4,541 - 47 490 51,467 4,273,947 269,251 852,799 3,933,785 5,272,672 14,602,454 1,414 69 11 16,369 164 18,027 20,464 - 10,480 609,319 337,692 977,955 Other assets 26,618 13,420 7,821 53,864 6,152 107,875 Total financial assets 8,743,800 321,723 909,055 4,732,353 5,637,414 20,344,345 Financial liabilities Deposits by banks 196,211 140,361 26,145 460 141,554 504,731 Funding from central banks Repurchase agreements 100,000 - - - - - 830,000 - 930,000 267,524 10,908 278,432 Customer deposits 9,595,209 3,173,297 4,530,788 641,855 5,320 17,946,469 Subordinated loan stock Fair value of net settled derivative liabilities Other liabilities Total undiscounted financial liabilities 23,125 - - 126,303 362,125 511,553 14,039 992 252 23,789 11,898 50,970 87,689 16,666 29,929 4,820 2,410 141,514 10,016,273 3,331,316 4,587,114 1,894,751 534,215 20,363,669 179 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Analysis of financial assets and liabilities based on remaining contractual maturity (continued) 2016 Financial assets Cash and balances with central banks Loans and advances to banks Investments at fair value through profit or loss Loans and advances to customers Fair value of net settled derivative assets Non-trading investments On demand and up to one month Between one and three months Between three months and one year Between one and five years Over five years Total €000 €000 €000 €000 €000 €000 1,446,851 26,372 29,157 4,016 - 1,506,396 871,306 13,630 14,660 172,674 15,567 1,087,837 27,971 8,740 1,686 4,069 550 43,016 6,064,296 258,139 687,253 3,627,733 5,011,980 15,649,401 17,829 2,701 59 159 87 20,835 7,941 6,453 42,008 335,288 238,938 630,628 Other assets 28,761 8,955 19,477 67,944 6,674 131,811 Total financial assets 8,464,955 324,990 794,300 4,211,883 5,273,796 19,069,924 Financial liabilities Deposits by banks 309,922 6,312 32,731 6,704 83,812 439,481 Funding from central banks Repurchase agreements 200,014 50,000 - - - - 600,000 - 850,014 285,838 9,188 295,026 Customer deposits 8,750,919 3,113,258 3,396,832 1,343,667 4,193 16,608,869 Fair value of net settled derivative liabilities Other liabilities Total undiscounted financial liabilities 7,955 1,010 53 31,687 7,504 48,209 95,719 16,430 31,974 4,591 2,296 151,010 9,364,529 3,187,010 3,461,590 2,272,487 106,993 18,392,609 180 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Analysis of financial assets and liabilities based on remaining contractual maturity (continued) On demand and up to one month Between one and three months Between three months and one year Between one and five years Over five years Total €000 €000 €000 €000 €000 €000 403,689 6,552 1,966 (402,221) (6,465) (1,956) 1,468 87 10 919,721 181,629 1,106 (933,009) (182,582) (1,107) (13,288) (953) (1) - - - - - - - - - 412,207 (410,642) 1,565 - 1,102,456 - (1,116,698) - (14,242) 2,849 4,155 1,363 - - 8,367 132,897 134,166 242,944 167,153 91,005 768,165 2017 Gross settled derivatives Financial assets Contractual amounts receivable Contractual amounts payable Financial liabilities Contractual amounts receivable Contractual amounts payable Contingent liabilities and commitments Contingent liabilities Acceptances and endorsements Guarantees Commitments Documentary credits 3,382 5,447 17,931 505 2,365 29,630 Undrawn formal standby facilities, credit lines and other commitments to lend 2,215,856 17,322 - - - 2,233,178 2,354,984 161,090 262,238 167,658 93,370 3,039,340 181 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 46. Risk management – Liquidity risk and funding (continued) Analysis of financial assets and liabilities based on remaining contractual maturity (continued) On demand and up to one month Between one and three months Between three months and one year Between one and five years Over five years Total €000 €000 €000 €000 €000 €000 669,186 164,669 1,531 (652,202) (161,871) (1,497) 16,984 2,798 34 1,060,998 188,662 1,498 (1,070,866) (190,401) (1,526) (9,868) (1,739) (28) - - - - - - - - - 835,386 (815,570) 19,816 - 1,251,158 - (1,262,793) - (11,635) 3,983 2,483 1,140 - - 7,606 160,531 153,096 242,952 152,890 87,800 797,269 2016 Gross settled derivatives Financial assets Contractual amounts receivable Contractual amounts payable Financial liabilities Contractual amounts receivable Contractual amounts payable Contingent liabilities and commitments Contingent liabilities Acceptances and endorsements Guarantees Commitments Documentary credits 4,649 6,824 14,190 287 1,686 27,636 Undrawn formal standby facilities, credit lines and other commitments to lend 2,020,254 14,937 - - - 2,035,191 2,189,417 177,340 258,282 153,177 89,486 2,867,702 182 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 47. Risk management – Insurance risk Insurance risk is the risk that an insured event under an insurance contract occurs and the uncertainty of the amount and the timing of the resulting claim. By the very nature of an insurance contract, this risk is random and therefore unpredictable. For a portfolio of insurance contracts where the theory of probability is applied to pricing and provisioning, the principal risk that the Group faces is that the actual claims and benefit payments will exceed the carrying amount of insurance liabilities. This could occur because the frequency or severity of claims and benefits are greater than estimated. Insurance events are random and the actual volume and cost of claims and benefits will vary from year to year compared to the estimate established using statistical or actuarial techniques. The above risk exposure is mitigated by the Group through the diversification across a large portfolio of insurance contracts. The variability of risks is also reduced by careful selection and implementation of underwriting strategy guidelines, as well as the use of reinsurance arrangements. Although the Group has reinsurance arrangements, it is not relieved of its direct obligations to policyholders and is thus exposed to credit risk with respect to ceded insurance, to the extent that any reinsurer is unable to meet the obligations assumed under such reinsurance arrangements. For that reason, the creditworthiness of reinsurers is evaluated by considering their solvency and credit rating. Life insurance contracts The main factors that could affect the overall frequency of claims are epidemics, major lifestyle changes and natural disasters. The underwriting strategy and risk assessment is designed to ensure that risks are well diversified in terms of type of risk and level of insured benefits. This is largely achieved through the use of medical screening in order to ensure that pricing takes account of the current medical conditions and family medical history and through the regular review of actual claims and product pricing. The Group has the right to decline policy applications, it can impose additional charges and it has the right to reject the payment of fraudulent claims. The most significant risks relating to accident and health insurance contracts result from lifestyle changes and from climate and environmental changes. The risks are mitigated by the careful use of strategic selection and risk-taking at the underwriting stage and by thorough investigation for possible fraudulent claims. The Group uses an analysis based on its embedded value which provides a comprehensive framework for the evaluation and management of risks faced, the understanding of earnings volatility and operational planning. The table below shows the sensitivity of the embedded value to assumption changes that substantially affect the results. Change in embedded value Change in interest rates +0.25% Change in expenses +10% Change in lapsation rates +10% Change in mortality rates +10% 2017 €000 2016 €000 271 84 (2,014) (2,482) (1,069) (690) (6,272) (6,519) The variables above are not linear. In each sensitivity calculation for changes in key economic variables, all other assumptions remain unchanged except when they are directly affected by the revised economic conditions. Changes to key non–economic variables do not incorporate management actions that could be taken to mitigate effects, nor do they take account of consequential changes in policyholder behaviour. In each sensitivity calculation all other assumptions are therefore unchanged. Some of the sensitivity scenarios shown in respect of changes to both economic and non–economic variables may have a consequential effect on the valuation basis when a product is valued on an active basis which is updated to reflect current economic conditions. 183 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 47. Risk management – Insurance risk (continued) Life insurance contracts (continued) While the magnitude of these sensitivities will, to a large extent, reflect the size of closing embedded value, each variable will have a different impact on different components of the embedded value. In addition, other factors such as the intrinsic cost and time value of options and guarantees, the proportion of investments between equities and bonds and the type of business written, including for example, the extent of with–profit business versus non–profit business and to the extent to which the latter is invested in matching assets, will also have a significant impact on sensitivities. General insurance contracts General insurance business is concentrated in Cyprus and the main claims during 2017 and 2016 related to fire and natural forces and other damage to property, motor vehicle liability and general liability. Risks under these policies are usually covered for a period of 12 months, with the exception of the goods in transit class that covers shorter periods and the contractors all risks class that covers longer periods. The liabilities for outstanding claims arising from insurance contracts issued by the Group are calculated based on experts’ estimates and facts known at the balance sheet date. With time, these estimates are reconsidered and any adjustments are recognised in the financial statements of the period in which they arise. The principal assumptions underlying the estimates for each claim are based on past experience and market trends and take into consideration claims handling costs, inflation and claim numbers for each accident year. Also external factors that may affect the estimate of claims, such as recent court rulings and the introduction of new legislation are taken into consideration. The insurance contract liabilities are sensitive to changes in the above key assumptions. The sensitivity of certain assumptions, such as the introduction of new legislation and the rulings of court cases, is very difficult to be quantified. Furthermore, the delays that arise between the occurrence of a claim and its subsequent notification and eventual settlement increase the uncertainty over the cost of claims at the reporting date. The risk of a general insurance contract occurs from the uncertainty of the amount and time of presentation of the claim. Therefore the level of risk is determined by the frequency of such claims, the severity and the evolution of claims from one period to the next. The main risks for the general insurance business arise from major catastrophic events like natural disasters. These risks vary depending on location, type and nature. The variability of risks is mitigated by the diversification of risk of loss to a large portfolio of insurance contracts, as a more diversified portfolio is less likely to be affected by changes in any subset of the portfolio. The Group’s exposure to insurance risks from general insurance contracts is also mitigated by the following measures: adherence to strict underwriting policies, strict review of all claims occurring, immediate review and processing of claims to minimise the possibility of negative developments in the future, and use of effective reinsurance arrangements in order to minimise the impact of risks, especially for catastrophic events. 48. Capital management The primary objective of the Group’s capital management is to ensure compliance with the relevant regulatory capital requirements and to maintain strong credit ratings and healthy capital adequacy ratios in order to support its business and maximise shareholders’ value. The Group follows the EU Regulations, primarily the CRR and CRD IV and any other decisions or circulars issued by the regulators, ECB and CBC with respect to the capital adequacy calculations. The Group and BOC PCL have complied with the minimum capital requirements (Pillar I and Pillar II). The overseas banking subsidiary, Bank of Cyprus UK Ltd, complies with the minimum regulatory capital requirements, including those set by the local regulator in the UK. The insurance subsidiaries of the Group comply with the requirements of the Superintendent of Insurance including the minimum solvency ratios. The regulated investment firms of the Group comply with the regulatory capital requirements of the CySEC laws and regulations. The Pillar 3 Disclosures Report (unaudited) of the Group required with respect to the requirements of the Capital Requirement Regulation (EU) No 575/2013 is published on the Group’s website www.bankofcyprus.com (Investor Relations). 184 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. Related party transactions Related parties of the Group include associates and joint ventures, key management personnel, Board of Directors and their connected persons. (a) Transactions with subsidiary The Company is the holding company of the Group. The Company enters into transactions with its subsidiary in the normal course of business. Balances and transactions between the Company and its subsidiaries are disclosed in Note 14 of the Company’s financial statements. Transactions with the subsidiaries have been eliminated on consolidation. (b) Associates and joint ventures The Group provides to and receives from its associates and joint ventures certain banking and financial services. These are not material to the Group and all the transactions are made on normal business terms as for comparable transactions with customers of a similar standing. Additional information is disclosed in Note 52 of these Consolidated Financial Statements. (c) Compensation of the Board of Directors and key management personnel The following disclosures are made in accordance with the provisions of IAS 24 Related Party Disclosures and sections 305 and 306 of the Companies Act 2014, in respect of the compensation of the Board of Directors and key management personnel. Fees and emoluments of members of the Board of Directors and other key management personnel Director emoluments Executives Salaries and other short term benefits Employer’s contributions Retirement benefit plan costs Non-executives Fees Total directors’ emoluments 2017 €000 2016 €000 2,300 1,848 91 202 110 168 2,593 2,126 882 3,475 861 2,987 Other key management personnel emoluments Salaries and other short term benefits 3,150 3,144 Termination benefits Employer’s contributions Retirement benefit plan costs Total other key management personnel emoluments Total - 202 189 3,541 7,016 397 190 158 3,889 6,876 Fees and benefits are included for the period that they serve as members of the Board of Directors. The retirement benefit plan costs relate to contributions paid for defined contribution plan. The termination benefits relate to compensation paid during 2016 to members of the Executive Committee who left the Group under the voluntary exit plan. 185 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. Related party transactions (continued) (c) Compensation of the Board of Directors and key management personnel (continued) Fees and emoluments of members of the Board of Directors and other key management personnel (continued) Executive Directors The salaries and other short term benefits of the Executive Directors are analysed as follows: John Patrick Hourican (Chief Executive Officer) Christodoulos Patsalides (Deputy Chief Executive Officer and Chief Operating Officer) 2017 €000 2016 €000 2,104 1,652 196 196 2,300 1,848 The retirement benefit plan costs for 2017 amounting to €202 thousand (2016: €168 thousand) relate to: Mr John Patrick Hourican €184 thousand (2016: €150 thousand) and Dr Christodoulos Patsalides €18 thousand (2016: €18 thousand). Non-executive Directors Josef Ackermann Wilbur L. Ross Jr. Arne Berggren Maksim Goldman Michalis Spanos Ioannis Zographakis Marios Kalochoritis Michael Heger Lyn Grobler Anat Bar-Gera 2017 €000 2016 €000 150 20 115 120 100 135 45 110 72 15 882 150 120 115 120 100 115 90 51 - - 861 The fees of the non-executive Directors include fees as members of the Board of Directors of the Company and its subsidiaries, as well as of committees of the Board of Directors. Other key management personnel The other key management personnel emoluments include the remuneration of the members of the Executive Committee since the date of their appointment to the Committee and other members of the management team who report directly to the Chief Executive Officer or to the Deputy Chief Executive Officer and Chief Operating Officer. 186 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. Related party transactions (continued) (d) Transactions with Directors and key management personnel The table below shows the deposits and other credit balances held by the directors and their connected persons, who were in office during the year: Deposits as at 31 December: - members of the Board of Directors and other key management personnel - connected persons Interest expense on deposits for the year 2017 €000 2016 €000 2,737 3,088 5,825 64 2,981 3,559 6,540 69 The above table does not include year-end balances for members of the Board of Directors and their connected persons who resigned during the year. Interest expense is disclosed for the period during which they were members of the Board of Directors or served as key management personnel. Loans to Directors The following information is presented in accordance with the Companies Act 2014. For the purposes of the Companies Acts disclosures, ‘Directors’ means the current Board of Directors of the Company and any past directors who were members of the Board of Directors of the Company during the relevant period. All transactions with members of the Board of Directors and their connected persons are made on normal business terms as for comparable transactions, including interest rates, with customers of a similar credit standing. A number of loans and advances have been extended to other key management personnel on the same terms as those applicable to the rest of the Group’s employees and their connected persons on the same terms as those of customers. Connected persons include spouses, minor children and companies in which directors/other key management personnel, hold directly or indirectly, at least 20% of the voting shares in a general meeting, or act as executive director or exercise control of the entities in any way. Additional to members of the Board of Directors, related parties include entities providing key management personnel services to the Group. Directors: There were 12 Directors in office during the year (2016: 10 Directors), 4 of whom availed of credit facilities (2016: 4 Directors). The balances outstanding are disclosed below. Key management personnel: There were 13 key management personnel in office during the year (2016: 18 key management personnel), 11 of whom availed of credit facilities (2016: 16 key management personnel). Ten of the key management personnel who availed of credit facilities had balances outstanding at 31 December 2017 (2016:10 key management personnel). Where no amount is shown in the tables below, this indicates a credit balance, a balance of nil, or a balance of less than €500. The value of arrangements at the beginning and end of the current and preceding financial years as stated below in accordance with section 307 of the Companies Act 2014, expressed as a percentage of the net assets of the Group at the beginning and end of the current and preceding financial years is less than 1%. Details of transactions with key management personnel, and their connected persons where indicated, for the years ended 31 December 2017 and 2016 are as follows: 187 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. Related party transactions (continued) (d) Transactions with Directors and key management personnel (continued) Loans to Directors (continued) Current Directors Balance as at 1 January Amounts advanced during the year Amounts repaid during the year Balance as at 31 December €000 €000 €000 €000 Aggregate maximum amount outstanding during the year €000 Unused credit facilities €000 263 46 309 300 55 355 - 1 - - - - - - n/a - n/a n/a n/a n/a n/a n/a n/a 33 n/a 49 n/a n/a n/a n/a n/a n/a n/a n/a n/a 238 23 261 263 46 309 2 - - - - - - 261 56 317 300 59 359 4 5 5 2 28 - - 34 34 - 19 19 9 11 10 10 - - - 1 Christodoulos Patsalides 2017 Loans Overdrafts/credit cards 2016 Loans Overdrafts/credit cards Michael Spanos 2017 Overdrafts/credit cards 2016 Overdrafts/credit cards Ioannis Zographakis 2017 Overdrafts/credit cards 2016 Overdrafts/credit cards John Patrick Hourican 2017 Overdrafts/credit cards 2016 Overdrafts/credit cards Former Directors Marios Kalochoritis 2016 Overdrafts/credit cards The balances included in the table above include principal and interest. Also, amounts advanced and repaid are not shown for overdraft and credit card facilities as these are revolving in nature. The aggregate maximum amount outstanding includes credit card exposures at the maximum statement balance. No other Directors had any loan facilities or overdraft/credit card balances with the Group during the year ended 31 December 2017 (2016: nil). No impairment charges or provisions have been recognised during the year ended 31 December 2017 and 2016 in respect of the above loans and facilities. All interest that has fallen due on these loans or facilities has been paid. Former Directors who resigned/retired during the year 2017 or 2016 had no other credit facilities with the Group. 188 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. Related party transactions (continued) (d) Transactions with Directors and key management personnel (continued) Loans to Directors (continued) Connected persons of the Board of Directors The aggregate of loans to connected persons of Directors in office at 31 December 2017, as defined in section 220 of the Companies Act 2014, are as follows (aggregate of 1 person; 2016: 1 person): Balance as at 1 January Amounts advanced during the year Amounts repaid during the year Balance as at 31 December Aggregate maximum amount outstanding during the year 2017 €000 €000 €000 €000 €000 Persons connected to Michael Spanos Overdrafts/credit cards 5 n/a n/a 2016 Persons connected to Michael Spanos Overdrafts/credit cards 9 n/a n/a 1 5 6 16 The balances included in the table above include principal and interest. Also, amounts advanced and repaid are not shown for overdraft and credit card facilities as these are revolving in nature. The aggregate maximum amount outstanding includes credit card exposures at the maximum statement balance. No impairment charges or provisions have been recognised during the year ended 31 December 2017 and 2016 in respect of the above loans and facilities. All interest that has fallen due on these loans or facilities has been paid. 189 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. Related party transactions (continued) (d) Transactions with Directors and key management personnel (continued) Loans to Directors (continued) Key management personnel in office during the year (and their connected persons) 2017 Loans Overdrafts/credit cards 2016 Loans Overdrafts/credit cards Balance as at 1 January Amounts advanced during the year Amounts repaid during the year Balance as at 31 December Aggregate maximum amount outstanding during the year €000 €000 €000 €000 €000 2,565 389 2,954 3,348 523 3,871 147 n/a 55 n/a 241 n/a 365 n/a 2,549 335 2,884 2,565 389 2,954 2,692 491 3,183 3,809 831 4,640 The aggregate number of key management personnel during 2017 is 13 (2016: 18). The balances included in the table above are aggregated and include principal and interest. Also, amounts advanced and repaid are not shown for overdraft and credit card facilities as these are revolving in nature. The aggregate maximum amount outstanding includes credit card exposures at the maximum statement balance. No impairment charges or provisions have been recognised during the year ended 31 December 2017 and 2016 in respect of the above loans and facilities. All interest that has fallen due on these loans or facilities has been paid. 190 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. (d) Related party transactions (continued) Transactions with Directors and key management personnel (continued) Aggregate amounts outstanding at year end and additional transactions Loans and advances as at 31 December: - Board of Directors - Key management personnel Connected persons Interest income for the year Insurance premium income for the year Accruals and other liabilities as at 31 December: - balances with entity providing key management personnel services Staff costs, consultancy and restructuring expenses 2017 2016 2017 Number of persons €000 2016 €000 10 13 10 13 263 2,473 414 3,150 85 112 309 2,502 458 3,269 112 107 6,217 3,101 17,627 11,992 The above table does not include year-end balances for members of the Board of Directors and their connected persons who resigned during the year. Interest income is disclosed for the period during which they were members of the Board of Directors or served as key management personnel. In addition to loans and advances, there were contingent liabilities and commitments in respect of members of the Board of Directors and their connected persons, mainly in the form of documentary credits, guarantees and commitments to lend, amounting to €76 thousand (2016: €61 thousand). There were also contingent liabilities and commitments to other key management personnel and their connected persons amounting to €431 thousand (2016: €385 thousand). The total unsecured amount of the loans and advances and contingent liabilities and commitments to members of the Board of Directors, key management personnel and their connected persons (using forced-sale values for tangible collaterals and assigning no value to other types of collaterals) at 31 December 2017 amounted to €663 thousand (2016: €635 thousand). At 31 December 2017 the Group has a deposit of €5,419 thousand (2016: €4,614 thousand) with Piraeus Bank SA, in which Mr Arne Berggren is a non-executive Director. The Group has also provided certain indemnities to Piraeus Bank SA as part of the disposal of Kyprou Leasing SA in 2015. At 31 December 2016 the Group had an investment in Invesco Euro Short Term Bond Fund, in which Mr Wilbur L. Ross Jr. was an executive Director. The fair value of the investment at 31 December 2016 amounted to €4,047 thousand. Mr Ross resigned from the Board of Directors of the Company on 1 March 2017. During the year ended 31 December 2017 premiums of €32 thousand and claims of €17 thousand were paid between the members of the Board of Directors of the Company and their connected persons and the insurance subsidiaries of the Group and commissions amounting to €10 thousand were received by the Group for the provision of investment services. Additionally, during the year ended 31 December 2017, BOC PCL has signed an agreement to rent property owned by connected persons to the director Mr Michalis Spanos covering the period from 1 June 2017 to 31 May 2027. The monthly rental expense amounts to €4 thousand commencing from June 2018. 191 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 49. (d) Related party transactions (continued) Transactions with Directors and key management personnel (continued) Aggregate amounts outstanding at year end and additional transactions (continued) There were no other transactions during the years ended 31 December 2017 and 2016 with connected persons of the current members of the Board of Directors or with any members who resigned during the two years. 192 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 50. Group companies The main subsidiary companies and branches included in the Consolidated Financial Statements of the Group, their registered office, their activities, and the percentage held by the Company (directly or indirectly) as at 31 December 2017 are: Company Bank of Cyprus Holdings Public Limited Company Bank of Cyprus Public Company Ltd The Cyprus Investment and Securities Corporation Ltd (CISCO) General Insurance of Cyprus Ltd EuroLife Ltd Kermia Ltd Kermia Properties & Investments Ltd Cytrustees Investment Public Company Ltd LCP Holdings and Investments Public Ltd JCC Payment Systems Ltd CLR Investment Fund Public Ltd Auction Yard Ltd BOC Secretarial Company Ltd S.Z. Eliades Leisure Ltd Bank of Cyprus Public Company Ltd (branch of BOC PCL) Bank of Cyprus UK Ltd Bank of Cyprus Financial Services Ltd (formerly BOC Financial Services Ltd) BOC Asset Management Romania S.A. (formerly Cyprus Leasing S.A.) MC Investment Assets Management LLC Kyprou Finance (NL) B.V. Fortuna Astrum Ltd Activities Percentage holding (%) Holding company Commercial bank Investment banking, asset management and brokerage General insurance Life insurance Property trading and development Property trading and development Closed-end investment company Holding company Card processing transaction services Investment company Auction company Secretarial services Land development and operation of a golf resort Administration of guarantees and holding of real estate properties Commercial bank Financial advisory services Collection of the existing portfolio of receivables, including third party collections Problem asset management company Financing services Problem asset management company N/A 100 100 100 100 100 100 54 67 75 20 100 100 70 N/A 100 100 100 100 100 100 Registered office 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia Cyprus 154 Limassol Avenue, CY-2025, Strovolos, Nicosia, Cyprus 2-4 Themistokli Dervis Street, CY-1066, Nicosia, Cyprus 4 Evrou Street, CY-2003, Strovolos, Nicosia, Cyprus 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia Cyprus 154 Limassol Avenue, CY-2025 Strovolos, Nicosia, Cyprus 26 Vyronos Street, CY-1096 Nicosia, Cyprus 1 Stadiou Street, Nisou, CY-2571 Cyprus 26 Vyronos Street, CY-1096 Nicosia, Cyprus 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia Cyprus 192 Alexandras Avenue, 11521 Athens, Greece 27-31 Charlotte Street, London, W1T 1RD, United Kingdom Calea Dorobonti 187B, Sector 1, Bucharest, Romania 19-1 Zvezdnyi building, Moscow, Russia Strawinskylaan 3127, 1077 ZX Amsterdam, Netherlands Internacionalniti Brigada 69, 11104, Grad Beograd, Serbia 193 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 50. Group companies (continued) In addition to the above companies, at 31 December 2017 BOC PCL had 100% shareholding in the companies listed below whose activity is the ownership and management of immovable property: Cyprus: Timeland Properties Ltd, Cobhan Properties Ltd, Bramwell Properties Ltd, Birkdale Properties Ltd, Newington Properties Ltd, Innerwick Properties Ltd, Ramendi Properties Ltd, Ligisimo Properties Ltd, Polkima Properties Ltd, Nalmosa Properties Ltd, Smooland Properties Ltd, Emovera Properties Ltd, Estaga Properties Ltd, Skellom Properties Ltd, Blodar Properties Ltd, Spaceglowing Properties Ltd, Threefield Properties Ltd, Ecunaland Properties Ltd, Tebane Properties Ltd, Cranmer Properties Ltd, Vieman Ltd, Les Coraux Estates Ltd, Natakon Company Ltd, Oceania Ltd, Dominion Industries Ltd, Ledra Estate Ltd, EuroLife Properties Ltd, Laiki Lefkothea Center Ltd, Labancor Ltd, Steparco Ltd, Joberco Ltd, Zecomex Ltd, Domita Estates Ltd, Memdes Estates Ltd, Pamaco Platres Complex Ltd, Vameron Properties Ltd, Thryan Properties Ltd, Otoba Properties Ltd, Edoric Properties Ltd, Canosa Properties Ltd, Kernland Properties Ltd, Kimrar Properties Ltd, Jobelis Properties Ltd, Melsolia Properties Ltd, Lozzaria Properties Ltd, Koralmon Properties Ltd, Petrassimo Properties Ltd, Kedonian Properties Ltd, Lasteno Properties Ltd, Armozio Properties Ltd, Spacous Properties Ltd, Calinora Properties Ltd, Marcozaco Properties Ltd, Soluto Properties Ltd, Solomaco Properties Ltd, Linaland Properties Ltd, Andaz Properties Ltd, Unital Properties Ltd, Neraland Properties Ltd, Wingstreet Properties Ltd, Nolory Properties Ltd, Lynoco Properties Ltd, Fitrus Properties Ltd, Lisbo Properties Ltd, Mantinec Properties Ltd, Syniga Properties Ltd, Colar Properties Ltd, Irisa Properties Ltd, Bracando Properties Ltd, Provezaco Properties Ltd, Hillbay Properties Ltd, Jungax Properties Ltd, Ofraco Properties Ltd, Forenaco Properties Ltd, Hovita Properties Ltd, Badrul Properties Ltd, Belaland Properties Ltd, Citlali Properties Ltd, Astromeria Properties Ltd, Orzo Properties Ltd, Basiga Properties Ltd, Regetona Properties Ltd, Arcandello Properties Ltd, Camela Properties Ltd, Subworld Properties Ltd, Jongeling Properties Ltd, Introserve Properties Ltd, Alomco Properties Ltd, Cereas Properties Ltd, Fareland Properties Ltd, Sindelaco Properties Ltd, Barosca Properties Ltd, Fogland Properties Ltd, Tebasco Properties Ltd, Dolapo Properties Ltd, Homirova Properties Ltd, Valecross Properties Ltd, Altco Properties Ltd, Forsban Properties Ltd, Marisaco Properties Ltd, Olivero Properties Ltd, Jaselo Properties Ltd, Elosa Properties Ltd, Garveno Properties Ltd, Flona Properties Ltd, Toreva Properties Ltd, Resoma Properties Ltd, Mostero Properties Ltd, Helal Properties Ltd, Yossi Properties Ltd, Gozala Properties Ltd, Pendalo Properties Ltd, Frontyard Properties Ltd, Bascot Properties Ltd, Bonsova Properties Ltd, Nasebia Properties Ltd, Vanemar Properties Ltd, Garmozy Properties Ltd, Palmco Properties Ltd, Thermano Properties Ltd, Indene Properties Ltd, Ingane Properties Ltd, Venicous Properties Ltd, Lasmane Properties Ltd, Lorman Properties Ltd, Consoly Properties Ltd, Eracor Properties Ltd, Alomnia Properties Ltd, Rulemon Properties Ltd, Thelemic Properties Ltd, Maledico Properties Ltd, Dentorio Properties Ltd, Valioco Properties Ltd, Bascone Properties Ltd, Artozaco Properties Ltd, Elizano Properties Ltd, Letimo Properties Ltd (previously K. Athienitis Kalamon Ltd), Allodica Properties Ltd, Balasec Properties Ltd, Bendolio Properties Ltd, Carnota Properties Ltd, Desogus Properties Ltd, Diafor Properties Ltd, Kartama Properties Ltd, Nelipo Properties Ltd, Paradexia Properties Ltd, Paramina Properties Ltd, Prosilia Properties Ltd, Nouralia Properties Ltd, Resocot Properties Ltd, Soblano Properties Ltd, Talamon Properties Ltd, Weinar Properties Ltd, Zemialand Properties Ltd, Asianco Properties Ltd, Barway Properties Ltd, Cimonia Properties Ltd, Coeval Properties Ltd, Comenal Properties Ltd, Demoro Properties Ltd, Elosis Properties Ltd, Fastflow Properties Ltd, Finacap Properties Ltd, Finevo Properties Ltd, Ganina Properties Ltd, Nicosia Mall Property (NMP) Ltd (previously Gileco Properties Ltd), Intelamon Properties Ltd, Jomento Properties Ltd, Kenelyne Properties Ltd, Lancast Properties Ltd, Mazima Properties Ltd, Nesia Properties Ltd, Nigora Properties Ltd, Nivoco Properties Ltd, Pariza Properties Ltd, Primaco Properties Ltd, Riveland Properties Ltd, Rosalica Properties Ltd, Secretsky Properties Ltd, Senadaco Properties Ltd, Tasabo Properties Ltd, Unoplan Properties Ltd, Venetolio Properties Ltd and Zandexo Properties Ltd. The registered office of the above companies is at 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia, Cyprus, with the exception of EuroLife Properties Ltd whose registered office is at 4 Evrou Street, Strovolos, CY-2003 Nicosia, Cyprus and Ledra Estate Ltd which is at 2-4 Themistoklis Dervis Street, CY-1066 Nicosia, Cyprus. 194 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 50. Group companies (continued) Romania: Otherland Properties Dorobanti SRL, Battersee Real Estate SRL, Trecoda Real Estate SRL, Green Hills Properties SRL, Bocaland Properties SRL, Romaland Properties SRL, Imoreth Properties SRL, Inroda Properties SRL, Tantora Properties SRL, Zunimar Properties SRL, Allioma Properties SRL and Nikaba Properties SRL. The registered office of the companies is at Bucharest, 42-44 George Cosbuc Street, 4th Floor, 5th District, Romania. Further, at 31 December 2017 BOC PCL had 100% shareholding in Obafemi Holdings Ltd, Stamoland Properties Ltd and Gosman Properties Ltd, 51% shareholding in Nicosia Mall Management (NMM) Limited (previously Devoco Properties Limited), Nicosia Mall Finance (NMF) Limited (previously Harimo Properties Limited) and Nicosia Mall Holdings (NMH) Limited (previously NCMH Nicosia City Mall Holdings Limited) whose main activities are the holding of shares and other investments and the provision of services. The registered office of the companies is at 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia, Cyprus. At 31 December 2017 BOC PCL had 100% shareholding in the companies listed below which are reserved to accept property: Cyprus: Belvesi Properties Ltd, Tavoni Properties Ltd, Amary Properties Ltd, Hamura Properties Ltd, Meriaco Properties Ltd, Flymoon Properties Ltd, Holstone Properties Ltd, Alepar Properties Ltd, Calandomo Properties Ltd, Cramonco Properties Ltd, Bigwaive Properties Ltd, Monata Properties Ltd, Valecast Properties Ltd, Legamon Properties Ltd, Teresan Properties Ltd, Aktilo Properties Ltd, Alezia Properties Ltd, Aparno Properties Ltd, Arleta Properties Ltd, Asendo Properties Ltd, Azemo Properties Ltd, Domilas Properties Ltd, Dorfilo Properties Ltd, Enelo Properties Ltd, Gylito Properties Ltd, Kuvena Properties Ltd, Lamezoco Properties Ltd, Mikosa Properties Ltd, Noleta Properties Ltd, Nuca Properties Ltd, Odolo Properties Ltd, Orleania Properties Ltd, Prodino Properties Ltd, Racotino Properties Ltd, Ravenica Properties Ltd, Rondemio Properties Ltd, Rouena Properties Ltd, Rylico Properties Ltd, Sailoma Properties Ltd, Stormino Properties Ltd, Tolmeco Properties Ltd, Vatino Properties Ltd, Virero Properties Ltd, Volparo Properties Ltd, Wiceco Properties Ltd and Zedoma Properties Ltd. The registered office of the companies is at 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia Cyprus. Romania: Selilar Properties SRL. Its registered office is at Bucharest, 42-44 George Cosbuc Street, 4th Floor, 5th District, Romania. In addition, BOC PCL holds 100% of the following intermediate holding companies: Cyprus: Otherland Properties Ltd, Pittsburg Properties Ltd, Battersee Properties Ltd, Trecoda Properties Ltd, Bonayia Properties Ltd, Bocaland Properties Ltd, Buchuland Properties Ltd, Commonland Properties Ltd, Romaland Properties Ltd, BC Romanoland Properties Ltd, Blindingqueen Properties Ltd, Fledgego Properties Ltd, Janoland Properties Ltd, Loneland Properties Ltd, Unknownplan Properties Ltd, Frozenport Properties Ltd, Imoreth Properties Ltd, Inroda Properties Ltd, Melgred Properties Ltd, Tantora Properties Ltd, Zunimar Properties Ltd, Selilar Properties Ltd, Mirodi Properties Ltd, Nallora Properties Ltd, Nikaba Properties Ltd, Allioma Properties Ltd, Landanafield Properties Ltd and Hydrobius Properties Ltd. The registered office of the companies is at 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia Cyprus. BOC PCL also holds 100% of the following companies which are inactive: Cyprus: Laiki Bank (Nominees) Ltd, Fairford Properties Ltd, Thames Properties Ltd, Paneuropean Ltd, Philiki Ltd, Cyprialife Ltd, Imperial Life Assurance Ltd, Philiki Management Services Ltd, Nelcon Transport Co. Ltd, Ilera Properties Ltd, Weinco Properties Ltd, Calomland Properties Ltd, Lameland Properties Ltd, BOC Asset Management Ltd, Renalandia Properties Ltd, Sylvesta Properties Ltd, Crolandia Properties Ltd, Iperi Properties Ltd, Finerose Properties Ltd and Fantasio Properties Ltd. The registered office of the companies is at 51 Stassinos Street, Ayia Paraskevi, Strovolos, CY-2002, Nicosia Cyprus, except from BOC Asset Management Ltd whose registered office is at 154 Limassol Avenue, Strovolos, CY-2025, Nicosia, Cyprus. Greece: Kyprou Zois (branch of EuroLife Ltd), Kyprou Asfalistiki (branch of General Insurance of Cyprus Ltd), Kyprou Commercial SA and Kyprou Properties SA whose registered office is at 192 Alexandras Avenue, 11521, Athens, Greece. 195 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 50. Group companies (continued) Romania: Frozenport Properties SRL, Loneland Properties SRL and Melgred Properties SRL. The registered office of the companies is at Bucharest, 42-44 George Cosbuc Street, 4th floor, 5th District, Romania with the exception of Frozenport Properties SRL whose registered office is at Voluntari City, 200A Piperi Building, 1st Floor, Judet Ilfov, Romania. All Group companies are accounted for as subsidiaries using the full consolidation method. All companies listed above have share capital consisting of ordinary shares. Control over CLR Investment Fund Public Ltd (CLR) and its subsidiaries without substantial shareholding The Group considers that it exercises control over CLR and its subsidiaries (Europrofit Capital Investors Public Limited, Axxel Ventures Limited and CLR Private Equity Limited) through control of the members of the Board of Directors and is exposed to variable returns through its holding. Dissolution and disposal of subsidiaries As at 31 December 2017, the following subsidiaries were in the process of dissolution or in the process of being struck off: Samarinda Navigation Co Ltd, BOC Ventures Ltd, Salecom Ltd, Diners Club (Cyprus) Ltd, Leasing Finance LLC, Corner LLC, Omiks Finance LLC, Unknownplan Properties SRL, Bank of Cyprus (Channel Islands) Ltd, Buchuland Properties SRL, Janoland Properties SRL, Mirodi Properties SRL, Nallora Properties SRL, Pittsburg Properties SRL and Blindingqueen Properties SRL. In accordance with the Group’s strategy to exit from overseas non-core operations, the operations of the branch in Romania are expected to be terminated, subject to the completion of deregistration formalities with respective authorities. Most of the remaining assets and liabilities of the branch in Romania with third parties have been transferred to other entities of the Group. Longtail Properties Ltd, Kyprou Securities SA and Tefkros Investments Ltd were dissolved during the year ended 31 December 2017. Moonland Properties Ltd, Lepidoland Properties Ltd, Danoma Properties Ltd, Metin Properties Ltd, Jemina Properties Ltd, Flitous Properties Ltd, Belzeco Properties Ltd, Landeed Properties Ltd, Nabela Properties Ltd, Singleserve Properties Ltd, Consento Properties Ltd, Molla Properties Ltd, Lezanco Properties Ltd, Balisimo Properties Ltd, Tezia Properties Ltd, Fireford Properties Ltd, Conemia Properties Ltd, Endar Properties Ltd, Valiro Properties Ltd, Nimoland Properties Ltd, Pekiro Properties Ltd, Nerofarm Properties Ltd, Orasmo Properties Ltd, Unduma Properties Ltd, Silen Properties Ltd, Cavadino Properties Ltd, Avolo Properties Ltd, Vidalaco Properties Ltd, Warmbaths Properties Ltd, Bothwick Properties Ltd, Caruzoco Properties Ltd, Threerich Properties Ltd, Hotel New Montana SRL, Commonland Properties SRL and Fledgego Properties SRL were disposed of during the year ended 31 December 2017 as part of the Group’s strategy to dispose of repossessed properties. 51. Acquisitions and disposals 51.1 Acquisitions during 2017 51.1.1 Acquisition of Nicosia Mall Holdings (NMH) Limited In the context of the loan restructuring activities, the Group acquired on 28 September 2017 a 51% interest in the share capital of Nicosia Mall Holdings (NMH) Limited. Nicosia Mall Holdings (NMH) Limited is involved in the construction of the Nicosia Mall. The consideration for the acquisition of 51% share in Nicosia Mall Holdings (NMH) Limited amounts to €7,500 thousand which was used to reduce part of the outstanding facilities and therefore the acquisition did not include any cash consideration. The transaction was considered as an acquisition of an asset and was not treated as a business combination since the Group obtained control of an input without any process, therefore no goodwill or gain on bargain was recognised. BOC PCL has control over Nicosia Mall Holdings (NMH) Limited. The non-controlling interest is measured at the proportionate share of the identifiable net assets acquired. 196 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 51. Acquisitions and disposals (continued) 51.1 Acquisitions during 2017 (continued) 51.1.1 Acquisition of Nicosia Mall Holdings (NMH) Limited (continued) The fair value of assets and liabilities of Nicosia Mall Holdings (NMH) Limited at the date of acquisition are presented below: Assets Loans and advances to banks Stock of property Liabilities Deposits by banks Net identifiable assets acquired €000 4,011 52,758 56,769 56,769 - No cash and cash equivalents were acquired. 51.2 Disposals during 2017 There were no material disposals during the year ended 31 December 2017. 51.3 Acquisitions during 2016 51.3.1 Acquisition of S.Z. Eliades Leisure Ltd In the context of its loan restructuring activities, the Group acquired on 15 June 2016 a 70% interest in the share capital of S.Z. Eliades Leisure Ltd in exchange for the settlement of borrowings due from it of a total gross amount of €52,335 thousand. S.Z. Eliades Leisure Ltd operates in land development and the operation of a golf resort in Cyprus. The fair value of the consideration for the acquisition of the 70% share in S.Z. Eliades Leisure Ltd amounts to €43,758 thousand. The acquisition did not include any cash consideration. The Group considers that it controls S.Z. Eliades Leisure Ltd. The non-controlling interest is measured at the proportionate share of the identifiable net assets acquired. The fair value of assets and liabilities of S.Z. Eliades Leisure Ltd at the date of acquisition are presented below: Assets Property and equipment Stock of property Prepayments, accrued income and other assets Liabilities Deferred tax liability Accruals, deferred income and other liabilities Net identifiable assets acquired Less non-controlling interest Net assets acquired No cash and cash equivalents were acquired. 197 €000 20,308 48,632 580 69,520 3,807 3,202 7,009 62,511 (18,753) 43,758 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 51. Acquisitions and disposals (continued) 51.3 Acquisitions during 2016 (continued) 51.3.2 Acquisition of K. Athienitis Kalamon Ltd In the context of the loan restructuring activities of the parent company of K. Athienitis Kalamon Ltd, the Group acquired on 23 December 2016 a 100% interest in the share capital of K. Athienitis Kalamon Ltd. K. Athienitis Kalamon Ltd operates in the development and rental of immovable property. The fair value of the consideration for the acquisition of the 100% share in K. Athienitis Kalamon Ltd amounts to €4,204 thousand, which is also the cash consideration paid for the acquisition of the company. Part of the consideration paid was used to reduce the outstanding loan facilities of the parent company of K. Athienitis Kalamon Ltd. The Group considers that it controls K. Athienitis Kalamon Ltd. The fair value of assets and liabilities of K. Athienitis Kalamon Ltd at the date of acquisition are presented below: Assets Stock of property Prepayments, accrued income and other assets Liabilities Deposits by banks Accruals, deferred income and other liabilities Net identifiable assets acquired No cash and cash equivalents were acquired. 51.4 Disposal during 2016 €000 27,000 2 27,002 22,198 600 22,798 4,204 51.4.1 Disposal of Kermia Hotels Ltd and adjacent land In June 2016, the Group completed the sale of 100% of its subsidiary Kermia Hotels Ltd and adjacent land which was classified as a disposal group held for sale. The carrying value of assets and liabilities disposed of as at the date of their disposal are presented below: Assets Property and equipment Prepayments, accrued income and other assets Cash and cash equivalent Liabilities Deferred tax liability Accruals, deferred income and other liabilities Total net assets sold €000 27,130 678 1,132 28,940 3,677 1,308 4,985 23,955 The cash consideration received amounts to €26,500 thousand and the disposal resulted in a gain of €2,545 thousand (Note 13). 198 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 52. Investments in associates and joint ventures Carrying value of the investments in associates and joint ventures Percentage holdings (%) 2017 €000 2016 €000 CNP Cyprus Insurance Holdings Ltd Interfund Investments Plc Aris Capital Management LLC Rosequeens Properties Limited Rosequeens Properties SRL Tsiros (Agios Tychon) Ltd M.S. (Skyra) Vassas Ltd D.J. Karapatakis & Sons Limited Rodhagate Entertainment Ltd Fairways Automotive Holdings Ltd 49.9 23.1 30.0 33.3 33.3 50.0 15.0 7.5 7.5 45.0 Share of pre-tax profit/(loss) from associates and joint ventures CNP Cyprus Insurance Holdings Ltd Interfund Investments Plc 115,770 107,172 2,343 2,167 - - - - - - - - - - - - - - - - 118,113 109,339 2017 €000 2016 €000 8,781 176 8,957 8,228 (34) 8,194 Investments in associates CNP Cyprus Insurance Holdings Ltd As part of the acquisition of certain operations of Laiki Bank in 2013, 49.9% of CNP Cyprus Insurance Holdings Ltd, the parent company of a group of insurance companies in Cyprus and Greece, was acquired by the Group. The main financial highlights of the associate are as follows: Total assets Total liabilities 2017 €000 2016 €000 707,796 696,005 (475,794) (481,234) Net assets, including value of in-force business 232,002 214,771 199 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 52. Investments in associates and joint ventures (continued) Investments in associates (continued) CNP Cyprus Insurance Holdings Ltd (continued) CNP Cyprus Insurance Holdings Ltd holds deposits with companies within the Group amounting to €19,547 thousand. The transactions between CNP Cyprus Insurance Holdings Ltd and the Group are presented in the table below: Dividend income Interest expense paid by the Group Other expenses paid by the Group 2017 €000 2016 €000 774 139 92 6,621 197 92 Interfund Investments Plc The Group has a 23.1% interest in Interfund Investments Plc, which is a closed-end investment company in Cyprus, listed on the CSE. The market value of the investment is €1,804 thousand (2016: €1,399 thousand). During the years 2017 and 2016 there were no material transactions between the Group and the associate. Rosequeens Properties Limited and Rosequeens Properties SRL The Group effectively owns 33.3% of the share capital of Rosequeens Properties SRL which is incorporated in Romania and owns a shopping mall in Romania. The shareholding was acquired after BOC PCL took part in a public auction for the settlement of customer loan balances amounting to approximately €21 million. The Group’s share of net assets of the associate at 31 December 2017 and 2016 had nil accounting value as the net assets of the associate had a negative balance. Aris Capital Management LLC The Group’s holding in Aris Capital Management LLC of 30.0% was transferred to the Group following the acquisition of certain operations of Laiki Bank. During previous years, the Group has recognised an impairment loss of €2,078 thousand. During the years 2017 and 2016, there were no material balances or transactions between the Group and the associate. M.S. (Skyra) Vassas Ltd During the year ended 31 December 2016, in the context of its loan restructuring activities, the Group acquired a 15.0% interest in the share capital of M.S. (Skyra) Vassas Ltd. M.S. (Skyra) Vassas Ltd is the parent company of a group of companies (Skyra Vassas group) with operations in the production, processing and distribution of aggregates (crushed stone and sand) and provision of other construction materials, and services based on core products such as ready-mix concrete, asphalt and packing of aggregates. The Group considers that it exercises significant influence over the Skyra Vassas group as the Group has the power to have representation to the Board of Directors and to vote for matters relating to the relevant activities of the business. The investment is considered to be fully impaired and its value is restricted to zero. 200 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Notes to the Consolidated Financial Statements 52. Investments in associates and joint ventures (continued) Investments in associates (continued) D.J. Karapatakis & Sons Limited and Rodhagate Entertainment Ltd During the year ended 31 December 2016, in the context of its loan restructuring activities, the Group acquired a 7.5% interest in the share capital of D.J. Karapatakis & Sons Limited and Rodhagate Entertainment Ltd, operating in leisure, tourism, film and entertainment industries in Cyprus. The Group considers that it exercises significant influence over the two companies as the Group has the power to have representation to the Board of Directors and to vote for matters relating to the relevant activities of the business. The investments are considered to be fully impaired and their value is restricted to zero. Fairways Automotive Holdings Ltd During the year ended 31 December 2016, in the context of its loan restructuring activities, the Group acquired a 45.0% interest in the share capital of Fairways Automotive Holdings Ltd. Fairways Automotive Holdings Ltd is the parent company of Fairways Ltd operating in the import and trading of motor vehicles and spare parts. The Group considers that it exercises significant influence over the company. The investment is considered to be fully impaired and its value is restricted to zero. Investment in joint venture Tsiros (Agios Tychon) Ltd The Group holds a 50.0% shareholding in Tsiros (Agios Tychon) Ltd. The shareholder agreement with the other shareholder of Tsiros (Agios Tychon) Ltd stipulates a number of matters which require consent by both shareholders, therefore the Group considers that it jointly controls the company. The carrying value of Tsiros (Ayios Tychon) Ltd is restricted to zero. The percentage holdings are in ordinary shares or membership interests. 201 BANK OF CYPRUS HOLDINGS GROUP Notes to the Consolidated Financial Statements Annual Financial Report 2017 53. Country by country reporting Article 89 of CRD IV requires banks to disclose on a consolidated basis the following information for all countries where the Group operates. The table below provides information on the following items of the Group for year 2017: Country Total operating income/ (expense) Average number of employees (Loss)/profit before tax Accounting tax expense on (loss)/profit Corporation tax paid/ (refunded) Public subsidies received €000 €000 €000 €000 €000 Cyprus Russia United Kingdom Romania Greece Netherlands Total 854,714 459 48,286 1,421 2,478 (8) 4,034 (434,162) 5 249 20 6 - (4,796) 4,162 (11,169) (31,542) (137) 5,196 1,593 1,058 243 1,330 103 2,376 1,593 1,022 225 (10,924) 78 907,350 4,314 (477,644) 9,523 (5,630) - - - - - - - The activities of Group companies by geographical area are disclosed in Note 50. Total operating income/(expense): comprises net interest income, net fee and commission income, net foreign exchange gains, net gains on financial instrument transactions and disposal/dissolution of subsidiaries, insurance income net of claims and commissions, net (losses)/gains from revaluation and disposal of investment properties, net gains on disposal of stock of property and other income. Number of employees: the number of employees has been calculated as the average number of employees, on a quarterly basis, who were employed by the Group during the year ended 31 December 2017. (Loss)/profit before tax: (Loss)/profit before tax represents (losses)/profits after the deduction of inter-segment revenues/(expenses). Accounting tax expense on (loss)/profit: includes corporation tax and Cyprus special defence contribution. Deferred tax charge for the year is excluded from the above. Corporation tax paid/(refunded): includes actual payments made during 2017 for corporation tax (including insurance premium taxes) and Cyprus special defence contribution. 202 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Opinion We have audited the financial statements of Bank of Cyprus Holdings Public Limited Company (‘the Company’ or the ‘Parent Company’) and its subsidiaries (all together, ‘the Group’) for the year ended 31 December 2017, which comprise the Consolidated Income Statement, Consolidated and Parent Company Statement of Comprehensive Income, Consolidated and Parent Company Balance Sheet, Consolidated and Parent Company Statement of Changes in Equity, Consolidated and Parent Company Statement of Cash Flows and notes to the financial statements, including the Summary of significant accounting policies set out in Note 2. The financial reporting framework that has been applied in their preparation is Irish Law and International Financial Reporting Standards (‘IFRS’) as adopted by the European Union and, as regards the Company financial statements, as applied in accordance with the provisions of the Companies Act 2014. In our opinion:      the Group financial statements give a true and fair view of the assets, liabilities and financial position of the Group as at 31 December 2017 and of its loss for the year then ended; the Company financial statements give a true and fair view of the assets, liabilities and financial position of the Company as at 31 December 2017 and of its loss for the year then ended; the Group financial statements have been properly prepared in accordance with IFRS as adopted by the European Union; the Company financial statements have been properly prepared in accordance with IFRS as adopted by the European Union as applied in accordance with the provisions of the Companies Act 2014; and the Group financial statements and Company financial statements have been properly prepared in accordance with the requirements of the Companies Act 2014 and, as regards the Group financial statements, Article 4 of the IAS Regulation. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (Ireland) (‘ISAs (Ireland)’) and applicable law. Our responsibilities under those standards are further described in the Auditor's Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Group and Company in accordance with ethical requirements that are relevant to our audit of financial statements in Ireland, including the Ethical Standard as applied to public interest entities issued by the Irish Auditing and Accounting Supervisory Authority (IAASA), and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Overview of our audit approach Key audit matters Impairment provision on loans and advances to customers including IFRS 9 transition Legal and conduct provisions    Going concern  Recoverability of deferred tax assets  Valuation of stock of property Materiality  Group materiality of €22m which represents 1% of Common Equity Tier 1 Key audit matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) that we identified, including those which had the greatest effect on: the overall audit strategy, the allocation of resources in the audit; and directing the efforts of the engagement team. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. 203 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Key audit matter How our audit addressed the key audit matter Impairment provision on loans and advances to customers including IFRS 9 transition As at 31 December 2017, gross loans and to €18,086m (2016: advances amounted impairment €19,201m) and the provision amounted (2016: €3,552m). to €3,484m related The basis of the impairment provision policy is presented in the accounting policies and further analysed the consolidated financial statements. in Note 5.1 to significant. Management using judgment, Impairment provisions are calculated on a collective basis for portfolios of loans of similar credit risk characteristics and on an individual basis for loans that meet the internal definition exercises of subjective significant assumptions, when determining both the timing and the amounts of the impairment provision for loans and advances. As loans and advances comprise a large portion of the Group’s assets, and due to the significance of judgment used the individual and collective provisions, this is considered to be a key audit matter. in estimating both We have focused on the following judgments and estimates which could give rise to material misstatement or are potentially subject to management bias:    completeness and The recognition of loss events. timing of of The measurement individually assessed provisions, which is dependent on the valuation of collateral, the timing of cash flows and realisations. The measurement of modelled provisions, which is dependent upon key assumptions relating to probability of default and recovery rates. Refer to the accounting policies; and Note 44 of the consolidated financial statements. The Group is required under IAS 8 to disclose the impact of IFRS 9 adoption for accounting periods beginning on or after 1 January 2018. We consider this transition and disclosure to be a key audit matter because new models have been developed to calculate IFRS 9 impairment losses (see note 2.4.1 of the statements) and consolidated financial in respect of retail and Impairment provisions recognised commercial lending are determined by management using discounted cash flow assessments and modelling techniques that utilise customer data, historical loan performance, expected future performance and a variety of market assumptions. We focused on the assumptions underlying the calculation of modelled provisions and the discounted cash flow assessments. In obtaining sufficient audit evidence we:  Reviewed design and operating effectiveness of key controls around the end-to-end process from classification and performance monitoring and calculation of impairment provisions to the final stages of approval governance and model validation, with consideration given to susceptibility of controls to management override.  Reviewed impairment methodology to establish model parameters and performed data integrity validation checks to ensure that the inputs employed by the Group’s modelling tools in the calculation of provisions are correct.   Involved our credit risk specialists within the engagement team to test the assumptions and calculations of modelled collective provisions. The underlying logic of data preparation, transformation and related formulas for computing collective provisions was assessed via a source code review of the related IT components involved. For non-performing loans, we tested a sample of loan reviews and assessed the measurement of the provisions, involving our valuation specialists to value the collateral. We examined other cash flow assumptions where the level of provision is not dependent on collateral values. We also assessed the timing of estimated cash flows.  Evaluated and management. tested key assumptions adopted by In respect of the disclosure of the impact of IFRS 9, we obtained an understanding of and evaluated management’s process for the calculation of the transition adjustment including governance over the determination of key judgments. These included probability weighted macroeconomic scenarios, staging criteria and forward looking information. We also performed the following procedures:  Reviewed key technical papers prepared by management during the transition project as part of our assessment of the effectiveness of the implementation.  Tested the key controls developed by management for the purpose of generating the transition adjustment for both Impairment and Classification & Measurement. 204 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Key audit matter judgment is required in a number of significant areas, in particular around the calculation of Expected Credit Loss. How our audit addressed the key audit matter  Assessed the output of management’s Classification & for consistency with our Measurement workstream understanding of the Group’s business models.  With the assistance of our internal specialists, tested key IFRS 9 models developed by management where these were relevant to the calculation of the transition adjustment. We assessed the key assumptions and judgments made by management.  Reviewed management’s rationalisation of the overall calculated impact of IFRS 9 on the Balance Sheet position at 1 January 2018. We assessed the appropriateness and presentation of disclosures with relevant accounting standards and our planned audit procedures were completed without material exception. In relation to provision for pending litigation, audit focus was placed on the completeness of the exposures and the litigation provision identified by the Group and the probability of occurrence assigned to each case. In relation to the provision for conduct matters, audit focus was placed on the reliability and completeness of underlying customer data, assumptions incorporated within the provision valuations, and the completeness of the provisions recorded. In obtaining sufficient audit evidence we:  Obtained detailed assessment from the Group’s internal legal department of potential outcomes for each individual case in excess of €200k. We ensured that this assessment was endorsed by the Group’s external legal advisors in Cyprus and Greece.  Reviewed with the head of the internal legal department the list of existing and potential claims, the current progression of existing cases with a range of related outcome possibilities and the consequential exposure for the Group.  Reviewed lists of legal cases from each location and tested that sufficient provision has been recorded in the Group’s records where the exposure is assessed as probable.  Reviewed the board of directors and other committee meeting minutes for evidence of any unidentified legal cases or developments in current cases which may impact the outcome.  Reviewed regulatory correspondence for the duration of the audit period and further inquired with the compliance department about known existing circumstances or possible non-compliance with any regulatory requirements.  Reviewed working files and results reports for the assessment of customer redress provisions, prepared by the Group’s external advisors. We involved our internal specialists to 205 Legal and conduct provisions As at 31 December 2017, provision for litigation and conduct matters amounted to €133m (2016: €49m). The accounting policy is described in Note 2.31 and further analysed in Note 5.11 financial statements. the consolidated for provisions to to legal subject The Group, in the ordinary course of business, claims, various is investigations and other proceedings. It also operates in a heavily regulated environment and needs to remain constantly alert to ensure and compliance with regulations. Management reviews all existing and potential legal and conduct provisions based on the assessment of the probability of economic outflow in conjunction with the internal compliance and legal departments. the Group relevant rules from The recognition and measurement of provisions in respect of litigation, regulatory actions and customer remediation require a high level of judgment. Due to the risk that the provision for impending litigations and pending regulatory matters may be incomplete or inappropriately provided for, and the difficulty in assessing and measuring the quantum from any resulting obligations, this is considered a key audit matter. Refer to the Accounting policies; and Notes 34 financial and 39 of statements. the consolidated INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Key audit matter How our audit addressed the key audit matter Going Concern As disclosed in the Statement of Directors’ Responsibilities, Directors are required to prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Company will continue in business. The Directors have determined that the going concern principle is appropriate and that the Group is taking all necessary measures to maintain its viability and the development of its business economic environment. The Group was previously not in compliance with all regulatory requirements with respect to its operations in Cyprus. This is considered to be a key audit matter. liquidity current the in Refer to the Directors’ Report and Note 3 of the consolidated financial statements. Recoverability of Deferred Tax Assets The Group has recognised deferred tax assets of €383m (2016: €450m) in respect of tax losses available to be carried forward to future years. The basis of is presented in the accounting policies and further analysed the in Note 5.7 consolidated financial statements. recognition the to The recoverability and carrying amount of the deferred tax assets require management judgment and estimation in assessing the probability, timing and sufficiency of future taxable profits from which deductible tax temporary differences and unutilised losses can be offset, particularly when this forecasting extends beyond the normal planning cycle. This in turn is based on assess consequential losses. the assumptions around response rates and  Assessed the disclosures made against the relevant accounting standards. Our planned audit procedures were completed without material exception. Our audit procedures included evaluating the Directors’ going concern assessment in order to assess whether there are events and conditions that exist that may cast significant doubt of the Group’s ability to continue as a going concern. In obtaining sufficient audit evidence we:  Read regulator correspondence for evidence of changes in the Group’s capital and liquidity requirements.  Evaluated the progress made in relation to the funding position and compliance with minimum liquidity requirements.  Reviewed the Group’s 3 year plan approved by the Board of Directors in December 2017.  internal valuation specialists within Involved our the engagement team to review and test the inputs and assumptions embedded in forecasts, considering whether the overall forecasts are within a range of possible alternative outcomes and in line with our knowledge of the business, the operating environment in Cyprus and of the Group, the future strategy and the past performance.  Assessed whether the Group’s disclosures in relation to going concern adequately reflected the risks and uncertainties inherent to the going concern assessment. Our planned audit procedures were completed without material exception. In the performance of our audit procedures, focus was placed on assessing the key judgment inputs and assumptions underlying the profit projections such as macro-economic assumptions, business growth rates, cost reduction and restructuring initiatives. In obtaining sufficient audit evidence we:  Reviewed and tested the supporting calculations of the Group’s initial 3 year plan which formed the basis of the extended projections until 2028.  internal valuation specialists within Involved our the engagement team to review and test the inputs and assumptions embedded in forecasts, considering whether the overall forecasts are within a range of possible alternative outcomes and in line with our knowledge of the business, the 206 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Key audit matter future economic assumptions concerning conditions, and legislation governing the use of historical trading losses carried forward. performance business the light of inherent uncertainty and In significant amount of judgment and estimation required by management, we have considered future forecasts supporting the recognition of deferred tax assets to be a key audit matter. Refer to the Accounting policies and Note 17 of the consolidated financial statements. Valuation of stock of property The Group has acquired a significant number of properties as a result of restructuring agreements with customers. As at 31 December 2017, the stock of properties amounted to €1,641m (2016: €1,427m). The basis of the property valuation policy is presented in the accounting policies and further analysed the consolidated financial statements. in Note 5.10 to These properties are valued by the Group as stock of property in accordance with IAS 2. In light of the large volume of properties held and the uncertainty around market conditions when estimating the recoverable amount, we judgment based the have considered valuation inputs involved to be a key audit matter. Refer to the Accounting policies and Note 27 of the consolidated financial statements. How our audit addressed the key audit matter operating environment in Cyprus and of the Group, the future strategy and the past performance.  Compared the actual results with management profit projections and obtained explanations about significant variances to assess the accuracy of the forecasting process.  Assessed the disclosures made against the relevant accounting standards. Our planned audit procedures were completed without material exception. In the performance of our audit procedures, focus was placed on assessing the key judgment inputs and assumptions underlying the valuation of the properties held in accordance to IAS2. In obtaining sufficient audit evidence we:  Reviewed design and operating effectiveness of key controls around the end-to-end valuation process of stock of property.  Obtained management’s assessment of the net realisable value (‘NRV’) and tested whether the lower of the cost and NRV is considered as the value of the inventory as at the reporting date, in accordance with IAS 2.  Obtained the valuation reports received by the Group from independent external valuers for a sample of properties and tested that the fair value used in the calculation of the NRV was in accordance with these valuations.  For a sample of external valuation reports reviewed, we assessed the methodology and assumptions by involving our internal valuation specialists.  Compared disposal cost assumptions incorporated in the Group’s calculation of the NRV to disposals that have occurred during the year.  Performed substantive analytical review procedures, categorising the properties by type and district and comparing the change in the value of each type of property and each district over the year to the changes in Royal Institute of Chartered Surveyors (‘RICS’) indices.  Assessed the disclosures made against the relevant accounting standards. Our planned audit procedures were completed without material exception. Our application of materiality We apply the concept of materiality in planning and performing the audit, in evaluating the effect of identified misstatements on the audit and in forming our audit opinion. Materiality Materiality is the magnitude of an omission or misstatement that, individually or in the aggregate, could reasonably be expected to influence the economic decisions of the users of the financial statements. Materiality provides a basis for determining the nature and extent of our audit procedures. 207 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY We determined materiality for the Group to be €22m (2016: €27m), which is 1% (2016: 1%) of the Group’s Common Equity Tier 1 (‘CET1’). We believe that this provides us with the most appropriate performance metric on which to base our materiality calculation as we consider it to be the most relevant performance measure to the stakeholders of the Group. The Company became the sole shareholder of Bank of Cyprus Public Company Ltd (‘BOC PCL’) on 18 January 2017 and the Group is considered to be a continuation of the predecessor BOC group. Hence, the 2016 materiality comparatives displayed are those that were deployed for the audit of the predecessor BOC group. The basis for calculation remains consistent. Performance materiality Performance materiality is the threshold for application of materiality at the individual account or balance level. Performance materiality is set at an amount to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality. On the basis of our risk assessments, together with our assessment of the overall control environment, our judgment was that performance materiality should be set at 50% (2016: 50%) of our materiality, namely €11m (2016: €14m). We have set performance materiality at this level having performed our risk assessment and due to this being our first year as auditors for the new Group. Reporting threshold The reporting threshold is set as the amount below which identified misstatements are considered as being clearly trivial. We agreed with the Audit Committee that we would report to them all uncorrected audit differences in excess of €1m (2016: €1m), which is set at 5% of planning materiality, as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. Our reporting threshold amount is designated at an amount below which misstatements would not be accumulated because we expect that the accumulation of such amounts clearly would not have a material effect on the financial statements. We evaluate any uncorrected misstatements against both the quantitative measures of materiality discussed above and in light of other relevant qualitative considerations in forming our opinion. An overview of the scope of our audit report Tailoring the scope Our assessment of audit risk, our evaluation of materiality and our allocation of performance materiality determine our audit scope for each entity within the Group. Taken together, this enables us to form an opinion on the consolidated financial statements. We take into account size, risk profile, the organisation of the group and effectiveness of group-wide controls, changes in the business environment and other factors such as recent internal audit results when assessing the level of work to be performed at each component entity. In establishing the overall approach to the Group audit, we determined the type of work that needed to be performed at each operating segment and business unit by us, as the Group engagement team, or by component EY auditors operating under our instructions (‘component auditors’). Where the work was performed by component auditors, we determined the level of involvement we needed to have in their audit work to be able to conclude whether sufficient audit evidence had been obtained as a basis for our opinion on the consolidated financial statements as a whole. Having assessed the risk of material misstatement to the Group financial statements, we selected 1 full-scope and 3 specific-scope components covering locations in Cyprus, the United Kingdom and Greece, representing the principal business units of the Group. Together with additional procedures performed at the Group level, this gave us the evidence required for our opinion on the Group financial statements. Of the 4 components selected, we performed full scope audit procedures of the financial information of BOC PCL (the “full scope component”) which was selected based on its size and risk characteristics. For the remaining 3 components (“specific scope components”), we performed audit procedures on specific accounts within that component that we considered had the potential for the greatest impact on the Group financial statements because 208 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY of the size of these accounts or their risk profile. These 3 components were EuroLife Ltd, Bank of Cyprus UK Ltd and the Greek branch of BOC PCL. We also instructed component auditors for 5 other locations to perform specified procedures over accounts and disclosures that were material to the Group audit. The reporting components where we instructed or performed audit procedures accounted for 96% (2016: 120%) of the Group’s Loss before tax, 94% (2016: 92%) of the Group’s Revenue and 99% (2016: 99%) of the Group’s Total assets. The audit scope of these components may not have included testing of all significant accounts of the component but will have contributed to the coverage of significant testing for the Group. Of the remaining components, none are individually greater than 2% of the Group’s equity. For these components, we performed other procedures to respond to any other potential risks of material misstatement to the Group financial statements. Conclusions relating to principal risks, going concern and viability statement We have nothing to report in respect of the following information in the annual report, in relation to which ISAs (Ireland) require us to report to you whether we have anything material to add or draw attention to:    the disclosures in the annual report set out on notes 44 to 47 that describe the principal risks and explain how they are being managed or mitigated; the directors’ confirmation set out in the Viability statement on page 12 in the annual report that they have carried out a robust assessment of the principal risks facing the Group and the parent company, including those that would threaten its business model, future performance, solvency or liquidity; the directors’ statement set out on page 11 in the financial statements about whether the directors considered it appropriate to adopt the going concern basis of accounting in preparing the financial statements and the directors’ identification of any material uncertainties to the Group’s and the parent Company’s ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements;  whether the directors’ statement relating to going concern required under the Listing Rules in accordance with Listing Rule 9.8.6R (3) is materially inconsistent with our knowledge obtained in the audit; or  the directors’ explanation in the annual report as to how they have assessed the prospects of the Group and the parent Company, over what period they have done so and why they consider that period to be appropriate, and their statement as to whether they have a reasonable expectation that the group and the parent company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions. Other information The directors are responsible for the other information. The other information comprises the information included in the annual report other than the financial statements and our auditor’s report thereon. Our opinion on the financial statements does not cover the other information and, except to the extent otherwise explicitly stated in our report, we do not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If we identify such material inconsistencies or apparent material misstatements, we are required to determine whether there is a material misstatement in the financial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. 209 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY In this context, we also have nothing to report in regard to our responsibility to specifically address the following items in the other information and to report as uncorrected material misstatements of the other information where we conclude that those items meet the following conditions:  Fair, balanced and understandable – the statement given by the directors that they consider the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the group’s and the parent company’s performance, business model and strategy, is materially inconsistent with our knowledge obtained in the audit; or  Audit committee reporting – the report does not appropriately address matters communicated by us to the audit committee; or  Directors’ statement of compliance with the UK Corporate Governance Code – the parts of the directors’ statement required under the Listing Rules relating to the company’s compliance with the UK Corporate Governance Code containing provisions specified for review by the auditor in accordance with Listing Rule 9.8.10R (2) do not properly disclose a departure from a relevant provision of the UK Corporate Governance Code. Opinions on other matters prescribed by the Companies Act 2014 Based solely on the work undertaken in the course of the audit, we report that:   in our opinion, the information given in the directors’ report is consistent with the financial statements; and in our opinion, the directors’ report has been prepared in accordance with the Companies Act 2014. We have obtained all the information and explanations which we consider necessary for the purposes of our audit. In our opinion the accounting records of the Company were sufficient to permit the financial statements to be readily and properly audited and the Company financial statements are in agreement with the accounting records. Matters on which we are required to report by exception Based on the knowledge and understanding of the company and its environment obtained in the course of the audit, we have not identified material misstatements in the directors' report. The Companies Act 2014 requires us to report to you if, in our opinion, the disclosures of directors’ remuneration and transactions required by sections 305 to 312 of the Act are not made. We have nothing to report in this regard. Respective responsibilities Responsibilities of directors for the financial statements As explained more fully in the Statement of Directors’ Responsibilities set out on page 23, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view, and for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, the directors are responsible for assessing the parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. Auditor’s responsibilities for the audit of the financial statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor's report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (Ireland) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements. 210 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY The objectives of our audit, in respect to fraud, are; to identify and assess the risks of material misstatement of the financial statements due to fraud; to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses; and to respond appropriately to fraud or suspected fraud identified during the audit. However, the primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. Our approach was as follows:  We obtained an understanding of the legal and regulatory frameworks that are applicable to the Group and have a direct impact on the preparation of the financial statements.  We assessed the susceptibility of the Group’s financial statements to material misstatement, including how fraud might occur by holding discussions with senior management, including the Chief Executive Officer, Chief Financial Officer, Chief Risk Officer, Head of Internal Audit and Head of Legal. We also reviewed the Group’s fraud-related policies and mandates of different governance forums assessing fraud.  As part of our audit procedures, we were aware of the risk of fraud, especially in the areas of estimation and those we assessed as having the risk of management override.  Based on this understanding we designed our audit procedures to identify non-compliance with such laws and regulations. Our procedures involved inquiring of key management, reviewing the key policies and reviewing the correspondence exchanged with the Regulators. A further description of our responsibilities for the audit of the financial statements is located on the IAASA's website at: http://www.iaasa.ie/getmedia/b2389013-1cf6-458b-9b8fa98202dc9c3a/Description_of_auditors _responsibilities_for_audit.pdf. This description forms part of our auditor's report. Other matters which we are required to address We were appointed by the board of Bank of Cyprus Holdings Public Limited Company on 14 July 2016 to audit the financial statements for the year ending 31 December 2016 and subsequent financial periods. The period of total uninterrupted engagement including previous renewals and reappointments of the firm is 2 years. The non-audit services prohibited by IAASA’s Ethical Standard were not provided to the company and we remain independent of the company in conducting our audit. Our audit opinion is consistent with the additional report to the audit committee. The purpose of our audit work and to whom we owe our responsibilities Our report is made solely to the Company’s members, as a body, in accordance with section 391 of the Companies Act 2014. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report. Eoin MacManus for and on behalf of Ernst & Young Chartered Accountants and Statutory Audit Firm Office: Dublin Date: 26/03/2018 211 Financial Statements 212 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Financial Statements - Contents for the year ended 31 December 2017 Contents Statement of Comprehensive Income Balance Sheet Statement of Changes in Equity Statement of Cash Flows Page 214 215 216 217 Notes to the financial statements 218-225 213 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Statement of Comprehensive Income for the year ended 31 December 2017 2017 For the period from 11 July 2016 to 31 December 2016 Notes €000 €000 Other income Administrative and other operating expenses Finance costs Impairment of investment in subsidiary Loss before income tax Income tax 4 5 7 6 1,653 (1,602) 51 (24) (545,358) (545,331) - Loss and total comprehensive loss for the year/period (545,331) The notes on pages 218 to 225 form an integral part of these financial statements. - (20) (20) - - (20) - (20) 214 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Statement of Changes in Equity for the year ended 31 December 2017 Share capital (Note 10) Share premium (Note 10) Accumulated losses (Note 11) Total equity €000 €000 €000 €000 Issue of shares Total comprehensive loss after tax for the period Balance at 31 December 2016 Shares repurchased and cancelled 25 - 25 (25) - - - - Issue of new shares 44,620 2,794,358 - (20) (20) - - 25 (20) 5 (25) 2,838,978 Total comprehensive loss after tax for the year - - (545,331) (545,331) Balance at 31 December 2017 44,620 2,794,358 (545,351) 2,293,627 The notes on pages 218 to 225 form an integral part of these financial statements. 216 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Statement of Cash Flows for the year ended 31 December 2017 Cash flows from operating activities Loss before tax Adjustments for: Impairment of investment in subsidiary Changes in working capital: Receivables from related parties Other payables Net cash from/(used in) operating activities Cash flows from financing activities Issue of share capital Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents: At beginning of the year/period At end of the year/period 2017 For the period from 11 July 2016 to 31 December 2016 €000 €000 (545,331) (20) 545,358 27 (61) 185 151 - - 151 - 151 - (20) (25) 20 (25) 25 25 - - - The notes on pages 218 to 225 form an integral part of these financial statements. 217 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 1. Corporate information Bank of Cyprus Holdings Public Limited Company (the Company) was incorporated in Ireland on 11 July 2016 as a public limited company under company number 545903 in accordance with the provisions of the Companies Act 2014 of Ireland (Companies Act 2014). The Company’s name on incorporation was Aion Cyprus Public Limited Company and on 10 August 2016 the Company changed its name to Bank of Cyprus Holdings Public Limited Company. Its registered office for the period from 11 July 2016 to 19 March 2017 was at Earlsfort Centre, Earlsfort Terrace, Dublin 2, Ireland. Since 20 March 2017 the Company’s registered office is 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland. The Company owns 100% of the share capital of Bank of Cyprus Public Company Limited (BOC PCL) whose principal activities involve the provision of banking, financial services, insurance services and management and disposal of property predominately acquired in exchange of debt. The Board of Directors does not expect that the Company’s activities will change in the foreseeable future. The Bank of Cyprus Holdings Group (the Group) comprises the Company, its subsidiary BOC PCL and the subsidiaries of BOC PCL. The Company was incorporated with the intention of becoming the holding company of the Group for the purposes of the Group’s listing on London Stock Exchange (LSE). During the period from 11 July 2016 to 31 December 2016 the Company did not undertake any trading activity. On 18 January 2017 the Company became the sole shareholder of BOC PCL, and on 19 January 2017 the shares of the Company were admitted to listing and trading on the LSE and the Cyprus Stock Exchange (CSE). The Company is tax resident in Cyprus. The financial statements are available at the Company’s registered office (at 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland) and on the Group’s website www.bankofcyprus.com (Investor Relations). Financial statements The financial statements of Bank of Cyprus Holdings Public Limited Company for the year ended 31 December 2017 were authorised for issue by a resolution of the Board of Directors on 26 March 2018. The financial statements have been prepared in both the English and Greek language. In case of a difference or inconsistency between the two, the English version prevails. 2. Summary of significant accounting policies 2.1 Basis of preparation The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU) and with those parts of the Companies Act 2014 applicable to companies reporting under IFRSs. Presentation of financial statements The financial statements are presented in Euro (€) and all amounts are rounded to the nearest thousand, except where otherwise indicated. A comma is used to separate thousands and a dot is used to separate decimals. 2.2 Going concern The going concern assessment of the Company is consistent with the going concern assessment of the Group, a summary of which is presented in Note 3 of the consolidated financial statements of the Group for the year ended 31 December 2017. 2.3 Changes in accounting policies and disclosures The accounting policies adopted in preparing the financial statements of the Company are consistent with those adopted in preparing the consolidated financial statements of the Group, a summary of which is presented in Note 2 of the consolidated financial statements of the Group for the year ended 31 December 2017. In addition the following policies are adopted: 218 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 2. 2.3 Summary of significant accounting policies (continued) Changes in accounting policies and disclosures (continued) Investments in subsidiaries, associates and joint ventures Investments in subsidiaries, associates and joint ventures are measured at cost less impairment. The accounting policies adopted are consistent with those of the previous financial year, except for the adoption of new and amended standards and interpretations as explained in Note 2.3.1 of the consolidated financial statements of the Group for the year ended 31 December 2017. 3. Significant accounting estimates, judgements and assumptions The preparation of the financial statements requires the Company’s Board of Directors and management to make judgements, estimates and assumptions that can have a material impact on the amounts recognised in the financial statements and the accompanying disclosures, as well as the disclosures of contingent liabilities. Uncertainty about these assumptions and estimates could result in outcomes that require a material adjustment to the carrying amount of assets or liabilities affected in future periods. The Board of Directors has made the following judgements and estimations: Investments in subsidiaries The Company periodically evaluates the recoverability of investment in subsidiary whenever indicators of impairment are present. Indicators of impairment include such items as declines in revenues, earnings or cash flows or material adverse changes in the economic or political stability of a particular country, which may indicate that the carrying amount of an asset is not recoverable. If facts and circumstances indicate that investment in subsidiary may be impaired, the estimated future undiscounted cash flows associated with this subsidiary would be compared to their carrying amounts to determine if the impairment of the investment is necessary. 4. Other income Management consultancy services (Note 14(i)) Reimbursement of expenses and fees (Note 14(i)) 5. Administrative and other operating expenses Directors’ fees (Note 14(iii)) Consultancy and other professional fees (Note 14(ii)) Stock exchange fees Audit fees For the period from 11 July 2016 to 31 December 2016 €000 - - - 2017 €000 940 713 1,653 For the period from 11 July 2016 to 31 December 2016 €000 2017 €000 882 165 400 155 1,602 - - - 20 20 The consultancy and other professional fees above do not include any fees charged by the Company’s statutory auditors. The Company did not employ any staff during the year 2017 and the period from 11 July 2016 to 31 December 2016. 219 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 6. Income tax Current tax 2017 For the period from 11 July 2016 to 31 December 2016 €000 €000 - - The reconciliation between the income tax expense and the loss before tax as estimated using the current income tax rates is set out below: 2017 For the period from 11 July 2016 to 31 December 2016 €000 €000 (545,331) (68,166) - (3) 68,258 (89) (3) - - - 3 - - - - - Loss before tax Income tax at the normal tax rates in Cyprus Income tax effect of: - expenses not deductible for income tax purposes - income not subject to income tax - tax effect of losses on which deferred tax was not recognised Income tax in Cyprus is calculated at the rate of 12.5% on taxable income (2016: 12.5%). 7. Investment in subsidiary 1 January/11 July Issue of shares due to reorganisation (Note 10) Impairment of investment in subsidiary 31 December 2016 €000 2017 €000 - 2,838,978 (545,358) 2,293,620 The investment in subsidiary represents an 100% investment in the share capital of BOC PCL, a company registered in Cyprus and its activities are presented in Note 1. Its registered office is at 51 Stassinos Street, Ayia Paraskevi, Strovolos, P.O.Box 24884, 1398 Nicosia, Cyprus. 220 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 8. Bank balances 2017 €000 2016 €000 Cash at bank (Note 14(iv)) 151 - Cash at bank earns interest at 0.02% per annum. Cash at bank represents cash and cash equivalents for the purpose of statement of cash flows. 9. Receivables from related parties Receivables from related parties (Note 14 (iv)) 61 25 The above balances represent the maximum exposure to credit risk at the balance sheet date. 10. Share capital 2017 €000 2016 €000 Authorised Ordinary shares of €0.10 each Deferred ordinary shares of €1.00 each Issued and fully paid Ordinary shares of €0.10 each Deferred ordinary shares of €1.00 each 2017 2016 Number of shares (thousand) €000 Number of shares € 10,000,000 1,000,000 10,000,000,000 1,000,000,000 - - 25,000 25,000 446,200 44,620 10 1 - - 25,000 44,620 25,000 25,001 The Company did not provide financial assistance permitted by section 82 of the Companies Act 2014 for the purchase of its shares. Authorised and issued share capital 2017 The Extraordinary General Meeting (EGM) of the shareholders of BOC PCL held on 13 December 2016 approved a scheme of arrangement between the Company, BOC PCL and its shareholders. The scheme of arrangement introduced the Company as the new holding company of the Group. Additionally the EGM authorised the directors of BOC PCL to take all actions necessary or appropriate to carry the scheme of arrangement into effect. The scheme of arrangement was sanctioned by the District Court of Nicosia on 21 December 2016. 221 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 10. Share capital (continued) Authorised and issued share capital (continued) 2017 (continued) Following the submission of the Court Order to the Registrar of Companies and the Registration, by the latter, of the reduction of capital, the scheme of arrangement became effective on 18 January 2017. As a result on the same date, the authorised share capital of BOC PCL which amounted to €4,767,759,272.00 divided into 47,677,592,720 ordinary shares with a nominal value of €0.10 each was reduced to €3,875,464,818.70 divided into 38,754,648,453.30 ordinary shares with a nominal value of €0.10 each and its issued share capital which amounted to €892,294,453.30 divided into 8,922,944,533 ordinary shares with a nominal value of €0.10 each was reduced to nil by cancelling all the shares comprising the issued share capital of BOC PCL (the Existing Shares) resulting in the creation of a capital reduction reserve in the accounts of BOC PCL, equal to the aggregate nominal value of the Existing Shares so cancelled, and which shall be retained as a non-distributable capital reserve in accordance with the provisions of subsection (e) of section 64 of the Companies Law, Cap. 113 (the Reduction of Capital). Following the reduction of the share capital of BOC PCL, the authorised share capital was increased to €4,767,759,272 divided into 47,677,592,720 ordinary shares with a nominal value of €0.10 each through the creation of 8,922,944,533 ordinary shares with a nominal value of €0.10 each, each of which have the same rights and rank pari passu with the existing ordinary shares of BOC PCL. Also, the reserve arising in the books of account of BOC PCL as a result of the cancellation of the Existing Shares was applied in paying up in full at par 8,922,944,533 new ordinary shares with a nominal value of €0.10 each in the capital of BOC PCL, which were issued and allotted, credited as fully paid, to the Company or its nominee(s) in accordance with the scheme of arrangement. As mentioned above, all of the shares comprising the issued share capital of BOC PCL were cancelled and BOC PCL issued and allotted 8,922,944,533 new ordinary shares of nominal value €0.10 each, credited as fully paid to the Company; and the Company issued and allotted New Shares and procured the issue of Depositary Interests representing New Shares, in accordance with the terms of the scheme of arrangement. Each one New Share or one Depositary Interest represents one New Share for each individual holding of 20 Existing Shares. As a result, the Company issued 446,199,933 ordinary shares with a nominal value of €0.10 each. 2016 On incorporation of the Company, the Company issued 1 share of €1.00, which was converted on 4 August 2016 into 10 shares of €0.10 each. On 11 August 2016, the Company additionally issued 25,000 deferred ordinary shares of €1.00 each, which are issued free of any pre-emption rights. As at 31 December 2016 only the ordinary shares of €0.10 each carried voting rights. All issued shares are fully paid. Share premium reserve 2017 As a result of the implementation of the scheme of arrangement, the share premium reserve was created in an amount equal to the difference between the nominal value of the shares issued pursuant to the terms of the scheme of arrangement and the net asset value of BOC PCL. Share-based payments-share options On 24 November 2015, the Annual General Meeting of BOC PCL’s shareholders authorised the Board of Directors to establish and implement a Long Term Incentive Plan and allowed BOC PCL the flexibility to increase the ratio of variable remuneration relative to fixed remuneration up to a maximum of 100% of fixed remuneration for members of senior management (Shareholder Resolution). The authorised Long Term Incentive Plan involved the granting of options for the acquisition of shares to a defined group of employees of the Group and under the current terms of the Shareholder Resolution: (i) the total amount of shares that may be issued and allotted under the Long Term Incentive Plan shall not exceed 178,458,891 ordinary shares of nominal value of €0.10 each, (ii) the exercise price shall be set at €0.25 per share, (iii) the vested share options will only be able to be exercised three years after the grant date, and (iv) any share options not exercised by 31 March 2026 will lapse. 222 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 10. Share capital (continued) Share-based payments-share options (continued) The options would be designed to vest only if certain key performance conditions were met, including amongst other things, the full repayment of ELA, the lifting of dividend restrictions, the cancellation of government guarantees and the performance of eligible employees. Following the incorporation of the Company and its introduction as the new holding company of the Group in January 2017, the Long Term Incentive Plan was replaced by the Share Option Plan which operates at the level of the Company. The Share Option plan is identical to the Long Term Incentive Plan except that the number of shares in the Company to be issued pursuant to an exercise of options under the Share Option Plan should not exceed 8,922,945 ordinary shares of a nominal value of €0.10 each and the exercise price was set at €5.00 per share. The term of the options was also extended to between 4-10 years after the grant date. No share options were granted since the date of replacement of the Long Term Incentive Plan by the Share Option Plan at the level of the Company. 11. Accumulated losses For the purpose of dividend distribution, retained earnings determined at Company level, are the only distributable reserve. Companies, tax resident in Cyprus, which do not distribute at least 70% of their profits after tax as defined by the Special Defence Contribution Law during the two years after the end of the year of assessment to which the profits refer, will be deemed to have distributed this amount as dividend. Special defence contribution at 17% is payable on such deemed dividend distribution to the extent that the shareholders of the Company (individuals who are domiciled in Cyprus and companies) at the end of the period of two years from the end of the year of assessment to which the profits refer, are directly or indirectly Cyprus tax residents. Deemed distribution does not apply in respect of profits that are directly or indirectly attributable to shareholders that are non-Cyprus tax residents and individual shareholders who are not domiciled in Cyprus. The amount of this deemed dividend distribution is reduced by any actual dividend paid out of the profits of the relevant year. This special defence contribution is paid by the company on account of the shareholders. During the year 2017 and the period from 11 July 2016 to 31 December 2016 no deemed dividend distribution was paid by the Company. 12. Other payables Accruals VAT payable 2017 €000 2016 €000 30 175 205 20 - 20 Other payables are due within 12 months from the balance sheet date. 13. Fair value measurement The fair value of the financial assets and financial liabilities approximates their carrying value. 223 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 14. Related party transactions The following transactions were carried out with related parties: (i) Other income Management consultancy services Reimbursement of expenses and fees For the period from 11 July 2016 to 31 December 2016 €000 - - - 2017 €000 940 713 1,653 The above transactions were carried out between the Company and its subsidiary BOC PLC on an arm’s length basis. (ii) Administrative and other expenses Consultancy and other professional fees 2017 For the period from 11 July 2016 to 31 December 2016 €000 €000 27 - The above transactions were carried out between the Company and its subsidiary BOC PLC on an arm’s length basis. (iii) Directors’ remuneration The total directors’ fees amount to €882 thousand. These were reimbursed by BOC PCL and included in other income above. Fees are included for the period that Directors serve as members of the Board of Directors. Non-executive Directors Josef Ackermann Wilbur L. Ross Jr. Arne Berggren Maksim Goldman Michalis Spanos Ioannis Zographakis Marios Kalochoritis Michael Heger Lyn Grobler Anat Bar-Gera 2017 Period from 11 July 2016 to 31 December 2016 €000 €000 150 20 115 120 100 135 45 110 72 15 882 - - - - - - - - - - - 224 BANK OF CYPRUS HOLDINGS PUBLIC LIMITED COMPANY Notes to the Financial Statements 14. (iii) Related party transactions (continued) Directors’ remuneration (continued) The fees of the non-executive Directors include fees as members of the Board of Directors of the Company, as well as of committees of the Board of Directors. (iv) Year-end balances Receivables from related parties BOC PCL Bank balances BOC PCL 2017 €000 2016 €000 61 151 25 - The receivable from related parties relates to income outstanding from management consultancy services and reimbursement of expenses and fees. The balance at the comparative period represents the consideration received by BOC PCL on behalf of the Company in relation to the amount of share capital issued by the Company. Except as disclosed above, there were no other significant transactions with related parties of the Company and no information to be disclosed under section 307 of the Companies Act 2014 for the year 2017 and the period from 11 July 2016 to 31 December 2016. 15. Financial risk management The Company is exposed to risks the most significant of which is the liquidity risk. Liquidity risk refers to probable losses that the Company may face, in case of repayment difficulties to its cash flow obligations. The level of operational costs is low and the Company enjoys adequate liquidity. 16. Capital management The Company does not have formal policies and procedures for capital risk management. 225 Annual Corporate Governance Report 2017 226 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 Introduction Good governance contributes to the long term success of a company and creates trust and engagement between a company and its stakeholders. The Board of Directors (the ‘Board’) of the Bank of Cyprus Holdings Plc (the ‘Company’) is committed to the highest standards of corporate governance and aims to ensure on an ongoing basis that the Company is a modern, transparent, competitive and sustainable organisation. By adopting best practices in corporate governance and corporate administration, the Company achieves a dynamic and effective communication between the Board, management and shareholders, leading to the successful implementation of its strategy. A key objective of the governance framework of the Company together with its subsidiaries (the ‘Group’) is to ensure compliance with applicable legal and regulatory requirements. The Company is subject to the Code of Corporate Governance of the Cyprus Stock Exchange (the ‘CSE Code’ available on www.cse.com.cy) as well as the Directive on Governance and Management Arrangements of the Central Bank of Cyprus (the ‘CBC Directive on Governance’). The Company has also elected to comply with the UK Corporate Governance Code 2016 published by the Financial Reporting Council in the UK (the ‘UK Code’ which is available on www.frc.org.uk). Part A The Company has adopted both the CSE Code and the UK Code, has incorporated their provisions in the Group’s Corporate Governance Policy and fully implements their principles. The policy together with the Board Manual, the terms of reference of the Board committees and the practices followed by the Board and its committees, constitute important foundations for maximising shareholder value. Part B The Company confirms that it has complied with the provisions of the CSE Code throughout 2017. The Directors further consider that the Company has also complied with the provisions of the UK Code, other than as set out herein:   From 1 March 2017, following the resignation of Mr. Wilbur Ross, to 20 November 2017 and in anticipation of European Central Bank (‘the ECB’) approval for the appointment of Mr. James B. Lockhart, the Nominations & Corporate Governance Committee (‘the NCGC’) comprised of only two members, one independent and one non-independent non-executive Director. Mr Lockhart decided not to take up the appointment in order to pursue alternate business opportunities, and Mrs Grobler was appointed to the NCGC on 20 November 2017. Additionally, the Human Resources & Remuneration Committee (the ‘HRRC’) for part of the year following the resignation of Mr. Marios Kalochoritis on 27 June 2017 and until the appointment of Mrs Bar-Gera following ECB approval on 27 October 2017, comprised of only two members, both of whom were independent. Details of how the Company has applied the provisions of the CSE Code throughout 2017 are set out in this Corporate Governance Report and in the Remuneration Policy Report which follows. The narrative that follows also covers how the Company has applied the main and supporting principles and disclosure requirements set out in the UK Code. The Group considers that it has a robust governance framework with a clear organisational structure, well defined, transparent and consistent lines of responsibility and effective processes through which to identify, manage, monitor and report risks to which it is or might be exposed. It has appropriate internal control mechanisms, including sound administrative and accounting procedures, Information Technology (‘IT’) systems and controls. The Company continually monitors and reviews internally, at least once a year, its governance framework and that of its subsidiary companies (where applicable) through effective oversight. The Directors are aware that in case they have material concerns about the overall governance of the Group, these should be reported without delay to the Board and, if their concerns are not satisfactorily addressed, the Directors should report these concerns to the Central Bank of Cyprus (‘CBC’). 227 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 Introduction (continued) Part B (continued) The Board has delegated authority to committees of the Board to support its oversight of risk and control. The committees are the Group Audit Committee (‘the AC’), the Group Risk Committee (‘the RC’), the NCGC, the HRRC and the Technology Committee (‘the TC’). Details of these committees are set out in section 5 of this report. The chairperson of each committee reports on matters discussed during committee meetings to the subsequent scheduled meetings of the Board and minutes of these meetings are tabled at the Board as soon as possible for noting and/or discussion, as necessary. The committee terms of reference are reviewed annually by the relevant committees and by the Board and are available on the Group’s website www.bankofcyprus.com or by request to the Company Secretary. 1. Board of Directors The authorities of the members of the Board derive from the Articles of Association of the Company, and are specified by the CSE and UK Codes, the relevant Companies, Stock Exchange and Banking Laws and the Directives of the CBC. The role of the Board and its committees is well described and analysed in the Board Manual that has been fully revised to incorporate all additional responsibilities that emanate from the UK Code. The Board is responsible for ensuring that the management maintains an appropriate system of internal controls which provides ongoing assurance of effective operations, internal financial controls and compliance with rules and regulations. It has the overall responsibility for the Group and approves and oversees the implementation of the Group’s strategic objectives, risk strategy and internal governance. 1.1 The Role of the Board The Board’s role is to provide leadership of the Group and promote the Group’s vision, values, culture and behaviour, within a framework of prudent and effective controls, which enables risk to be assessed and managed. The Board is collectively responsible for the long-term success of the Group; it sets the Group’s strategic objectives, integrates sustainability into the way business is conducted, ensures that the necessary financial and human resources are in place for the Group to meet its objectives and reviews management performance. The Board also ensures that its obligations towards its shareholders and other stakeholders are understood and met. Furthermore, the Board has the responsibility to present a fair, balanced and understandable assessment of the Company’s position and prospects, including in relation to the annual and interim financial statements and other price-sensitive public reports and reports required by regulators and by law. There is a clear division of responsibilities at the head of the Company between the running of the Board and the executive responsibility for the running of the Company’s business. The day to day operations of the Group have been delegated to management. The Board is the decision-making body for all matters of importance because of their strategic, financial or reputational implications or consequences. Specific decisions and matters are reserved for approval by the Board and these are reviewed and updated regularly. Matters requiring Board approval are:                The Group’s long-term objectives and strategy. Overall risk policy and risk management procedures. The Group’s Risk Appetite Statement. Annual and three-year budgets and business plans. Capital expenditures for amounts over €20 million. Unusual transactions. Mergers, acquisitions and disposals of the Group’s assets for amounts over €20 million. Intra-group guarantees, indemnities and security. Directors’ conflicts of interest. The selection, appointment, re-appointment of Directors of the Company and the termination of the services of the Chief Executive Officer. Overseeing corporate governance and the succession planning. Promoting the appropriate culture, values and ethics of the Group. The establishment and oversight of policies for selecting, developing and replacing senior management and heads of internal control functions. The Remuneration Policy. The declaration of a Recovery Emergency Situation. 228 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. 1.1 Board of Directors (continued) The Role of the Board (continued) The appointment, replacement, transfer or removal from office of the heads of internal control functions is subject to Board approval. The appointment of individuals who may have a material impact on the risk profile of the Group is also subject to Board approval. Their appropriateness for the role is monitored on an ongoing basis. The Board is responsible for determining the nature and extent of the principal risks the Group is willing to take in achieving its strategic objectives and ensuring the maintenance of an effective risk management and oversight process across the Group. The Board approves the Group Risk Appetite Statement on an annual basis and receives regular updates on the Group’s risk environment and exposure to the Group’s material risk types through the Risk Report reviewed monthly. Detailed information relating to Group risk management is set out in Notes 44 to 47 of the Consolidated Financial Statements and the Additional Risk and Capital Management Disclosures section of the 2017 Annual Financial Report. 1.1.1 Information and Support The Board meets on a regular basis and has a formal schedule of matters for consideration which is annually reviewed. The Board receives regular reports and presentations from the Group Chief Executive Officer (‘Group CEO’) and other senior management on strategy and developments in the operations of the Group. The Board considers reports from each of the Board committees while regular reports are also provided on the Group’s risk appetite, top and emerging risks, risk management, credit exposures and the Group’s loan portfolio, asset and liability management, liquidity, litigation, compliance and reputational issues. The key areas of focus in 2017 for the Board, inter alia, were:      Group strategy and long term objectives in light of the regulatory and economic environment: Three-year financial plan.   Acquisitions and divestments.  Resolution Plan & Minimum Requirement for own funds and Eligible Liabilities (MREL).  Setting up of Shipping Centre.  Compliance with Liquidity Cover Ratio (‘LCR’).    Deposit strategy. Issue of Tier 2 Notes for Bank Of Cyprus Public Company Ltd (‘BOC PCL’). IT strategy. Risk and governance:  Approval of the Group’s Risk Appetite Statement.  Approval of Internal Capital Adequacy Assessment Process (‘ICAAP’) Report.  Approval of Internal Liquidity Adequacy Assessment Process (‘ILAAP’) Report.  Discussion of International Financial Reporting Standards 9 (‘IFRS9’) implementation progress.  Review of monthly risk reports.  Action Plan to implement Supervisory Review and Evaluation Process (SREP) recommendations.  Approval of the Group Recovery Plan.  Approval of appointments to the Board and major subsidiary boards, review of corporate governance matters and Board Performance evaluation. Directors & Officers (D & O) liability insurance. Budget and performance oversight:  Review of the monthly management accounts.  Approval of the annual budgets and capital plans.  Review of the performance of the Group’s business divisions, its major subsidiaries and business units  Review and approval of Group financial results (monthly, quarterly and annual). External environment:  Review of the banking industry outlook.  Review of the political, economic and regulatory environment of Cyprus including possible effects of Brexit on the Cyprus economy. Investors and stakeholder perspectives.  229 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. 1.1 Board of Directors (continued) The Role of the Board (continued) 1.1.1 Information and Support (continued)   Monitoring key regulatory issues affecting the Group:  Supervisory Review and Evaluation Process (‘SREP’).  Ongoing supervisory dialogue and approval of relevant responses to the Single Supervisory Mechanism (‘SSM’).  Discussion of new regulatory developments and requirements.  Key regulatory correspondence and related responses.  Legal issues/actions against the Group. Review the progress of managing non-performing exposures (‘NPE’)  Major and international corporate restructurings.  NPE strategy.  Ramping-up servicing of Retail NPEs. In early 2017 the Board approved a report on BOC UK Oversight which put forward several recommendations for better monitoring of the BOC UK subsidiary. 1.2 Composition of the Board of Directors As at 31 December 2017 the Board comprised of ten Directors: the Group Chairman who was independent on appointment, two executive Directors and seven non-executive Directors. The Board has determined six of the non-executive Directors to be independent non-executive Directors in accordance with the provisions of the UK Code and the CSE Code. On 7 February 2017 Mrs Lyn Grobler was appointed to the Board as an independent non-executive Director following approval by the ECB. In March 2017 the Board appointed Mr. James B. Lockhart III, pending the approval of the ECB, to replace Mr. Wilbur L. Ross who had resigned on 1 March 2017, following his appointment as U.S. Secretary of Commerce. However, before finalisation of his assessment, Mr. Lockhart decided not to take up the appointment in order to pursue alternate business opportunities. On June 27 2017, Mr. Marios Kalochoritis resigned from the Board to take up an appointment as Senior Advisor to the Group CEO. On 27 October 2017 Mrs Anat Bar-Gera was appointed to the Board as an independent non-executive Director following approval by the ECB. On 23 January 2018 the Board appointed two new independent non-executive Directors, Mrs Paula Hadjisotiriou and Mrs Maria Philippou pending the approval of the ECB. The names and brief biographical details including each Director’s background, experience and independent status are set out in section 4 of this report. The NCGC annually reviews the structure, size, tenure and composition of the Board (including skills, knowledge, experience, independence and diversity) to ensure that there is an appropriate mixture of skills, experience as well as gender. This includes a review of tenure and an assessment of the skills profile of the Board to ensure that the Board and committees comprise of Directors having an all-embracing perception of the Group’s activities and the risks associated with them. The Committee also ensures plans are in place for the selection, appointment and orderly succession of executive Directors and senior managers. In addition, where any appointment or resignation will alter the overall size of the Board, a review is undertaken to ensure that the composition remains appropriate. The Board considers its current size and composition appropriate to provide the broad range of skills and experience necessary to govern the business effectively while enabling full and constructive participation by all Directors given the size and operations of the Group and the time demands placed on the Directors. The Group carries out a review of the ongoing fitness and probity of Board and Executive Committee (ExCo) members on an annual basis, whereby they are required to confirm any changes in their circumstances in respect of their compliance with the CBC Directive on the Assessment of the Fitness & Probity of the members of the management body and managers of authorised credit institutions (‘CBC Fitness & Probity Directive’). Following the review of 2017, no changes were reported. The Board concluded that each of the Directors has the requisite standard of fitness, probity and financial soundness to perform his/her functions effectively. 230 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. Board of Directors (continued) 1.2 Composition of the Board of Directors (continued) Executive Directors The Group CEO and the Group Deputy CEO & Chief Operating Officer (‘DCEO & COO’) are employees of BOC PCL. The Group CEO’s termination of employment is subject to four months’ notice to be given by either party. The DCEO & COO’s employment is mainly based on the provisions of the collective agreement in place, which provides for notice or compensation by the BOC PCL based on years of service and for a four month prior written notice by the executive director in the event of a voluntary resignation. Non-Executive Directors Non-executive Directors are not Company employees and do not participate in the daily management of the Group. They are responsible for monitoring executive activity and contributing to the development of strategy. Their role is to constructively challenge the Company’s existing strategy and contribute to the development of new strategies, to scrutinize the performance of senior management in meeting agreed goals and objectives, to monitor the reporting of the performance, and to satisfy themselves on the integrity of financial information and that the systems of financial controls, compliance and risk management frameworks and the internal control framework are robust and defensible. 1.2.1 Meetings of the Board of Directors During 2017 the Board held 12 meetings. Further details on the number of the meetings of the Board and its committees and attendance by individual Directors are set out below. In March 2017 the Board held an offsite two day meeting specifically focused on strategy. Board of Directors 1/1/2017-31/12/2017 Name Josef Ackermann (Chairman) Maksim Goldman (Vice Chairman) Wilbur L. Ross (Vice-Chairman)1 Anat Bar-Gera2 Arne Berggren Lyn Grobler3 Michael Heger John P. Hourican Marios Kalochoritis4 Christodoulos Patsalides Michael Spanos Ioannis Zographakis Total meetings5 Board of Directors 12/12 12/12 0/2 1/1 12/12 11/11 12/12 12/12 8/8 12/12 11/12 12/12 12 AC HRRC NCGC RC AC & RC Joint 7/8 8/8 8/8 8 2/2 6/6 1/2 6/6 6 7/7 7/7 0/0 1/1 7 8/9 0/0 9/9 2/3 9/9 9 5/5 0/0 5/5 5/5 1/1 5/5 5 1 Resigned on 1 March 2017 2 Appointed on 27 October 2017 3 Appointed on 7 February 2017 4 Resigned on 27 June 2017 5 The number of Board meetings at BOC PCL level was 16 during the year 2017. The attendance of these meetings can be found on page 240. Agendas and papers are circulated in a timely manner prior to each meeting and all members of the Board are informed in writing of forthcoming Board meetings to allow them adequate time to review the relevant information to enable them to fully discharge their duties. The Company Secretary is closely involved in preparing the schedule of all Board and committee meetings and the agendas for these meetings, in conjunction with the Chairman, ensuring that relevant information is dispatched timely to all members of the Board. 231 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. Board of Directors (continued) 1.2 Composition of the Board of Directors (continued) 1.2.1 Meetings of the Board of Directors (continued) Under the supervision of the Chairman of the Board, the Company Secretary’s responsibilities include facilitating the flow of information within the Board and its committees, between senior management and non- executive Directors and between heads of internal control functions and non-executive Directors, as well as facilitating the induction, development and evaluation of members of the Board. All Directors have access to the advice and services of the Company Secretary and the Corporate Governance Compliance Officer (the ‘CGCO’) who can provide relevant information related to Board procedures and the CSE and UK Codes. Independent professional advice is also available to the Directors at the Group’s expense if and when required. Committees of the Board have similar access and are provided with sufficient resources to undertake their duties. All Directors have the benefit of directors’ and officers’ liability insurance in respect of legal actions against them. 1.2.2 Term of Appointment, Retirement and Re-election of Directors Non-executive Directors are appointed for an initial three-year term and are typically expected to serve two three-year terms. The Board may invite Directors to serve additional periods once their performance has been assessed as adequate. A non-executive’s term of office will not extend beyond 12 years in total and any re- appointment beyond 6 cumulative years will be subject to rigorous review and should take into account the need for progressive refreshing of the Board. According to the Articles of Association of the Company, all Directors retire each year and if eligible and assuming satisfactory performance, are subject to re-election by shareholders. The following Directors, being eligible, offered themselves for re-election and were re-elected at the Annual General Meeting (the ‘AGM’) in 2017: Josef Ackerman, Maksim Goldman, Michael Spanos, Arne Berggren, Lyn Grobler, Michael Heger, John Patrick Hourican, Christodoulos Patsalides and Ioannis Zographakis. Anat Bar-Gera and James B. Lockhart III were elected to the Board effective from the date of approval of their appointment by the ECB. The names of Directors submitted for election or re-election are accompanied by sufficient information such as biographical details and any other relevant information in the AGM documentation to enable shareholders to take an informed decision. The Board may at any time appoint any person who is willing to act as Director and who fulfils the criteria as these are determined in the Board Nominations Policy, either to fill a vacancy or as an addition to the existing Board, but the total number of Directors should not exceed 13. Any Director so appointed is subject to election at the AGM following his/her appointment. 1.2.3 Conflicts of interest The Board Manual documents procedures relating to Directors’ conflicts of interest, and sets out how these are to be identified, reported and managed to ensure that the Directors act at all times in the best interests of the Company. The Board Manual is reviewed and revised if necessary, at least annually. The Group’s Policy on Conflicts of Interest which applies to all employees and Directors sets out their duty to avoid, manage and disclose actual, potential or perceived conflicts of interest. The policy is reviewed annually and is communicated throughout the Group. The Board has adopted a Dealing Code for transactions in the Company’s securities by Persons Discharging Managerial Responsibilities (PDMRs). The Dealing Code complies with the European Market Abuse Regulation. All Directors have complied with the Dealing Code during 2017. All Directors and PDMRs have been informed about their obligations under the Dealing Code in writing. None of the Directors had, during the year or at year end, a material interest, directly or indirectly in any contract of significance with the Group (See Note 49 of the Consolidated Financial Statements). 232 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. Board of Directors (continued) 1.2 Composition of the Board of Directors (continued) 1.2.4 Time commitment The Board has determined the time commitment expected of non-executive Directors to be 35-40 days per annum. Time devoted to the Group can be considerably more when serving on Board committees. The NCGC considers, amongst others, whether a potential Director is able to devote the requisite time and attention to the Company’s affairs, prior to the Board’s approval of the individual’s appointment. The CBC Fitness and Probity Directive which incorporates the provisions on the management body of credit institutions in Article 91 of the European Capital Requirements Directive (‘CRD IV’), determines that a Director cannot hold more than one of the following combinations:   One executive directorship with two non-executive directorships Four non-executive directorships Executive or non-executive directorships held within the same group, count as a single directorship. Directorships in organisations which do not pursue predominantly commercial objectives do not count for the purposes of the above guidelines. BOC PCL has been classified as a ‘significant institution’ under the European Union (Capital Requirements) Regulation 2014. The ECB which supervises BOC PCL following the European Union Regulation 468/2014 which established the framework for cooperation within the SSM between the ECB and national competent authorities may in exceptional cases, and taking into consideration the nature and complexity of the business of the Group, authorise members of the Board to hold one additional directorship. At the time of their appointment, the CBC was the relevant competent authority to grant permission to five of the Directors to hold one additional non-executive directorship to those permitted by article 91 of the CRD IV. During the year ended 31 December 2017, all Directors were within the directorship limits set out for ‘significant institutions’. Mr. Wilbur Ross who resigned on 1 March 2017 had held five non-executive directorships at the time. The Directors hold positions on the management bodies of other companies as noted in their biographical details included in section 4 of this report. Such participation does not prevent them from devoting the necessary time and attention to their duties as members of the Board of the Company and is within the limits set by the CBC Fitness and Probity Directive. It was estimated that in 2017 each non-executive Director spent at least 38 days on board-related duties. The Board considered the time commitment of all Directors and concluded that each Director devotes the requisite time for the effective performance of his/her duties. 1.2.5 Group Chairman and Group Chief Executive Officer The respective duties of the Chairman of the Board and the Group CEO are clearly and distinctly segregated. The two roles are separate and they distinguish between the running of the Board and the executive responsibility for running the Company’s business. The terms of reference of these two roles are set out in writing in the Group Board Manual which has been approved by the Board. The Chairman ensures the effective functioning of the Board on all aspects of its role including:        Providing leadership to the Board. Ensuring that the Board determines the nature and extent of the significant risks the Group is willing to embrace in the implementation of its strategy. Ensuring that the members of the Board have sufficient time to consider strategic and other critical issues and obtain answers to any questions or concerns they may have and are not faced with unrealistic deadlines for decision making. Encouraging the active participation of members of the Board. Ensuring conflicts of interests are disclosed and members abstain from participating in the decision- making and voting on any matter on which they may have a conflict of interest. Ensuring that adequate time is allowed for discussion of complex or contentious or strategic issues and, where appropriate, arranging for informal meetings beforehand to enable thorough preparation for the Board discussion. Promoting high standards of corporate governance. 233 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. Board of Directors (continued) 1.2 Composition of the Board of Directors (continued) 1.2.5 Group Chairman and Group Chief Executive Officer (continued) The Chairman commits a substantial amount of time to the Group. There were no changes to the other significant commitments of the Chairman during the year ended 31 December 2017. During the year the Chairman and the non-executive Directors met without the executive Directors present, to discuss a range of business matters. The Group CEO is responsible:     To develop and present to the Board the strategy of the Group. To execute the approved strategy. To lead the senior management team in the day-to-day running of the business. To make decisions on all matters affecting the operations, performance and strategy of the Group’s business with the exception of those matters reserved for the Board. The Group CEO’s service contract is reviewed at least every three years. The last review took place in March 2017 and his contract was extended, on 28 March 2017, from January 2018 until December 2018. 1.2.6 Senior Independent Director The Senior Independent Director (‘SID’) is available to shareholders and Directors if they have concerns that are not resolved through normal communication channels. He provides a sounding board for the Chairman, providing support to the Chairman in delivering his objectives. He chairs an executive session of the non- executive Directors to assess the performance of the Chairman as part of the annual evaluation of Board performance provided for in the CBC Governance Directive. 1.3 Board Balance and Independence Both the CSE Code and the UK Code provide that at least 50% of the Board, excluding the Chairman, should be independent non-executive Directors, so that no individual or small group of individuals can dominate the Board’s decision-taking. The NCGC and the Board consider the independence status of each Director on appointment. In addition, the independence status of each Director is reviewed on an annual basis to ensure that the determination regarding independence remains appropriate. In 2017 the Board considered the principles relating to independence contained in the CSE Code and the UK Code, as well as the CBC Fitness and Probity Directive and concluded that the status of each Director as determined remained appropriate. The status of each Director is presented in the biographical details in section 4 of this report. Mr. Maksim Goldman is a senior executive of a corporation controlled by a significant shareholder in the Company and therefore he is not considered independent by reference to the provisions of the CBC Directive on Fitness and Probity, the CSE Code and the UK Code. The Board comprises a majority of independent non-executive Directors to ensure that no individual or small group can dominate its decision making. The Board considers that each non-executive Director brings independent challenge and judgement to the workings of the Board, through their character, objectivity and integrity. A relevant ‘Confirmation of Independence’ based on the independence criteria of provision A.2.3 of the CSE Code is signed annually by each of the independent non-executive Directors and is submitted to the Cyprus Stock Exchange together with the Corporate Governance Report. 1.3.1 Appointments to the Board The Board recognises the need to identify the best qualified and available people to serve on the Board. It is responsible for the appointment of Directors. In accordance with the Board Nominations Policy all appointments are made on merit against objective criteria (including skills and experience) with due regard for the benefits of diversity on the Board. The Board plans for its own renewal with the assistance of the NCGC which regularly reviews Board composition, tenure and succession planning. 234 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. 1.3 Board of Directors (continued) Board Balance and Independence (continued) 1.3.1 Appointments to the Board (continued) The NCGC, prior to assessing candidates, identifies the skills and experience required for the role, assesses the time commitment involved and, having regard to the formal assessment of the skills profile of the Board and succession planning, recommends the nomination to the Board. The recruitment process for non-executive Directors is supported by an experienced third party professional search firm which develops an appropriate pool of candidates and provides independent assessments of the candidates. The Group then works with that firm to shortlist candidates, conduct interviews/meetings (including meetings with members of the NCGC) and complete comprehensive due diligence. In accordance with the Board Nominations Policy, the assessment process and the due diligence process is extensive and includes self-certification confirmations of probity and financial soundness and external checks involving a review of various publicly available sources. The process also involves the NCGC satisfying itself as to the candidate’s ability to devote sufficient time to the role, independence, fitness and probity and assessing and documenting its consideration of possible conflicts of interest. The NCGC then makes recommendations to the Board. The process described above was followed in the selection of Mrs Anat Bar-Gera in April 2017. Egon Zehnder, an external search consultancy firm with no other connection to the Company, was engaged in respect of this non-executive Director appointment. Letters setting out the terms of appointment of each of the non-executive Directors, including the time commitment expected of each of them, are available on request from the Company Secretary. Directors are required to devote adequate time to the business of the Group, which includes attendance at regular meetings, training sessions and briefings and preparation time for meetings. In addition, non-executive Directors are normally required to sit on at least one committee of the Board, which involves the commitment of additional time. Certain non-executive Directors such as the SID and committee chairpersons are required to allocate additional time in fulfilling those roles. 1.3.2 Directors’ induction and ongoing development Full, formal and tailored induction programmes, with particular emphasis on risk management and internal control systems are arranged for newly appointed Directors. The programmes also entail a series of meetings with senior executives and other Directors to enable new Directors to familiarise themselves with the business, management and governance structure including the function of the Board and the role of the committees. The Company Secretary under the supervision of the Chairman develops programmes based on the Director’s individual needs. Following appointment, each Director receives a relevant package and undergoes an induction programme. Focused training of the Board is arranged in conjunction with scheduled Board meetings where information is provided to ensure that Directors receive adequate insight into a particular area through presentations by Group Businesses and briefings with senior management. Dedicated training sessions also take place on particular issues (refer to table below for 2017 training schedule) usually identified by the Directors themselves and the Company Secretary. A training schedule is prepared at the beginning of each year and Directors are expected to attend accordingly. All the members of the Board were provided on appointment with an information pack which includes, among others, the Board Manual, key legislation, directives and regulations and the Company’s Articles of Association. As demonstrated in the table below, during the year specialised training sessions with the contribution of external advisors were provided, covering issues relating to the duties and responsibilities of Board members. 235 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. Board of Directors (continued) 1.3 Board Balance and Independence (continued) 1.3.2 Directors’ induction and ongoing development (continued) Training sessions for the Board members during 2017 Name False Assurance AML Essentials Market Abuse Regulations J. Ackermann M. Goldman W. L. Ross A. Bar-Gera A. Berggren L. Grobler M. Heger J. Hourican M. Kalochoritis C. Patsalides M. Spanos Y. Zographakis √ √ N/A N/A √ √ √ √ √ √ √ √ √ √ N/A √ √ √ √ √ N/A √ √ √ √ √ N/A √ √ √ √ √ N/A √ √ √ MiFID II Board Oversight and Obligations √ √ N/A √ √ √ √ √ N/A √ √ √ The training material is distributed to all Directors regardless of attendance. In 2017 there were several e- learning sessions relating to Anti-Money Laundering, Market Abuse Directive / Market Abuse Regulation and MiFID II Directive. Directors are also offered the option of attending suitable external educational courses, events or conferences designed to provide an overview of current issues of relevance to Directors. The Company Secretary ensures all Directors are provided with relevant information on a timely basis to enable them to consider issues for decision-making and discharge of their oversight responsibilities. The Directors also have access to the advice of the Group external legal advisors and to independent professional advice, at the Group’s expense, if and when required. Board committees have similar access and are provided with sufficient resources to undertake their duties. The Directors also receive comprehensive guidance from the Company Secretary on Board procedures as well as guidance on duties and obligations by the CGCO. In the performance of their roles, executive Directors develop and refresh their skills and knowledge of the Group’s business and operations through regular interactions, meetings and briefings with senior management and through presenting on the Group’s business to investors and analysts. They remain abreast of developments affecting the financial services sector and banking by representing the Group’s interests at conferences, advisory groups and other events and meetings with regulators and other authorities. 1.3.3 Board Performance Evaluation The Board is committed to regular and at least annual evaluation of its effectiveness and that of its committees. The internal evaluation of the performance of the Board, its committees and individual members conducted in March 2017 by the CGCO, indicated a strong and diverse composition of experiences that could however, be further enhanced by appointing more members with IT background and/or cybersecurity, while at the same time striving for gender diversity. The annual Board performance evaluation report made several recommendations and an action plan for the implementation of these recommendations was set up. The assessment carried out through on-line questionnaires considered overall performance relative to the role of the Board and its committees. The outcome of the Board evaluation was considered by the NCGC and collectively discussed by the Board. Seven recommendations were made to enhance the Board process, although they were not material to the effectiveness of the Board. The Board accepted them and set up an action plan to incorporate those recommendations. Further, taking into account the evaluation report, the Board concluded that it continues to be effective and that each Director continues to make a valuable contribution to the deliberations of the Board. The Board also concluded that all the members of the Board have appropriate qualifications, broad relevant experience and continue to be effective and demonstrate continuing commitment to the role. The effectiveness of each of the four principal committees was also assessed as adequate. 236 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 1. 1.3 Board of Directors (continued) Board Balance and Independence (continued) 1.3.3 Board Performance Evaluation (continued) The SID led the process of evaluation of the Chairman’s performance based on a discussion during an executive session of the non-executives (without the Chairman). The Board concluded that the Chairman continues to lead the Board effectively, continues to make valuable contribution and demonstrates continuing commitment to the role. 1.3.4 Loans to Directors and Other Transactions Details of loans to Directors and other transactions with the Group are set out in Note 49 of the Consolidated Financial Statements for the year ended 31 December 2017. The Banking Law currently forbids the extension of any credit to independent members of the Board, but the CBC may exempt certain exposures from time to time having regard to the exceptionally low risk arising from the exposures concerned. Furthermore, any credit to be extended to non-independent members of the Board must comply with the following provisions of the Law:       be approved by a resolution of the Board carried by a majority of two-thirds of the members that participated in the relevant Board meeting and the member concerned should neither be present during the discussion nor vote on the resolution, the exposure granted should be on the same commercial terms as would apply to customers for similar exposures in the ordinary course of banking practice, the total value of exposures in respect of all members of the Board should not exceed at any time 10% of BOC PCL’s own funds, or such other lower percentage as the CBC may determine from time to time, the total value of any unsecured exposures granted to all members of the Board should not exceed at any time 1% of the BOC PCL’s own funds or such other lower percentage as the CBC may determine from time to time, the total value of exposure to any member of the Board should not exceed at any time the amount of €500,000 or such other lower amount as the CBC may determine from time to time, and no financing is permitted to any executive member of the Board that does not comply with the commercial terms or exceeds the limits that apply to all staff or such other lower amount as the CBC may determine from time to time. All members of the Board complied with the relevant provisions of the CSE Code and the Banking Law as at 31 December 2017. 2. Internal Controls The Board is responsible for the adequacy and effectiveness of the system of internal controls in the Group. This system ensures that:     The effectiveness of the governance framework is monitored and periodically assessed and appropriate steps are taken to timely address any deficiencies. The appropriate compliance framework is in place. The integrity of the accounting and financial reporting systems, including financial and operational controls and compliance with legal and supervisory requirements and relevant standards, is adequate. The appropriate information security framework for the protection of confidential information is in place. The system of internal controls has been designed in accordance with the nature, scale and complexity of the Group’s operations in order to provide reasonable but not absolute assurance against material misstatements, errors, losses, fraud or breaches of laws and regulations. 237 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 2. Internal Controls (continued) The overall internal control systems of the Group include:         A transparent organisational structure with clear reporting lines to Senior Management and the Board, Three lines of defence model for the management of risks across the Group, Board and Executive Committees with clear responsibilities, Policies and procedures, Monthly reporting by business lines to enable progress to be monitored, trends to be evaluated and variances to be acted upon, Monthly meetings of ExCo and Operating Committee (OpCo) to review performance, A Code of Conduct setting out the standards expected of all officers and employees, and A Whistleblowing Policy including processes and procedures to be followed for independent investigation of concerns raised by staff. The Board confirms that, through the AC and the RC, has conducted reviews for the year ended 31 December 2017, regarding the effectiveness of the Group’s internal control and information systems, as well as in relation to the procedures used to ensure the accuracy, completeness and validity of the information provided to investors. The reviews covered all systems of internal controls, including financial, operational and compliance controls, as well as risk management systems. In carrying out their reviews, the AC and RC receive regular business and operational risk assessments, regular reports from the Group Internal Audit Director, the Director of Group Compliance and the Group Chief Risk Officer (‘GCRO’), internal and external audit reports, as well as regulatory reports. Additionally, the Board receives a confirmation on an annual basis by the Group CEO as to the effectiveness of compliance, risk management and information security system of internal controls. The Board, through the AC and RC, has received confirmation that executive management has taken or is taking the necessary actions to remedy all weaknesses identified through the operation of the Group’s framework of internal controls. Based on the internal audit work carried out in 2017, significant steps have been made, which further strengthened the Group’s system of internal controls. In particular, progress was made in the NPE management and the arrears management process, areas which pose the most important risks for the Group. Moreover, there is still room for improvement in certain areas within the information systems and information security environment. Overall, the Board through its committees has reviewed the effectiveness of the system of internal controls of the Group for the year ended 31 December 2017 and confirms its effectiveness. The Board confirms that it is not aware of any violation of the Cyprus Securities and Stock Exchange Laws and Regulations. The Group’s financial reporting process is controlled using documented accounting policies and procedures supported by instructions and guidance on reporting requirements, issued to all reporting entities within the Group in advance of each reporting period. The submission of financial information from each reporting entity is subject to sign off by the responsible financial officer. Further analytical review procedures are performed at Group level. The internal control system also ensures that the integrity of the accounting and financial reporting systems, including financial and operational controls and compliance with legal and supervisory requirements and relevant standards, is adequate. The Group has in place an effective financial statement closing process by which transactions and events reflected in the Group’s accounting records are processed to produce the financial statements, related disclosures and other financial reports. Τhe Annual Report pre its submission to the Board is reviewed and approved by the ExCo. The Board, through the AC scrutinises and approves the financial statements, results announcements and the Annual Report and ensures that appropriate disclosures have been made. This governance process ensures that both management and the Board are given sufficient opportunity to challenge the Group’s financial statements and other significant disclosures before their publication. 238 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 2. 2.1 Internal Controls (continued) Going concern The Directors have made an assessment of the Group’s ability to continue as a going concern. The conditions that existed during 2017 and the developments up to the date of approval of the Consolidated Financial statements that have been considered in the going concern assessment include, amongst others, the operating environment in Cyprus and of the Group (Note 4 of the Consolidated Financial Statements). The Directors believe that the Group is taking all necessary measure to maintain its viability and the development of its business in the current economic environment. The Directors, taking into consideration the factors described below and the uncertainties that existed at the reporting date, are satisfied that the Group has the resources to continue in business for a period of at least 12 months from the date of approval of the Consolidated Financial Statements and therefore the going concern principle is appropriate for the reasons set out below.        The Common Equity Tier 1 (CET1) ratio and the total capital ratio on a transitional basis stood at 12.7% and 14.2% respectively at 31 December 2017, higher than the minimum required ratios (Note 4.2.1 of the Consolidated Financial Statements). The IFRS 9 impact on a transitional and on a fully phased-in basis, after the period of transition is complete, is expected to be manageable and within the Group’s capital plan. The increasing level of Group customer deposits (increase of €1,340 million during 2017). Customer deposits stood at €17,850 million at 31 December 2017. The continuous improvement in the Group liquidity position and its liquidity ratios. Following the repayment of Emergency Liquidity Assistance (‘ELA’) in January 2017 (2016: €200 million), the Group achieved compliance with the Liquidity Coverage Ratio (LCR). The Group is also in compliance with the LCR add-on, which was introduced by the CBC as a macro-prudential measure and is applicable from 1 January 2018 (Notes 4.2.3 and 46 of the Consolidated Financial Statements). As at 31 December 2017, the Group was not in compliance with all liquidity regulatory requirements with respect to its operations in Cyprus, however, these ratios were abolished on 1 January 2018. The significant reduction of Group loans that are impaired or past due for more than 90 days (90+ DPD), which have decreased by 17% during 2017 and totalled €6,905 million at 31 December 2017 and the increase of provisions coverage to 61% compared to 54% in December 2016 (Note 4.2.2 of the Consolidated Financial Statements). The Cyprus government rating has been repeatedly upgraded following the consistent outperformance in public finances and the progress achieved in the banking sector. Most recently in March 2018, S&P Global Ratings affirmed its long-term sovereign rating at BB+, only one notch below investment grade, and maintained its outlook to ‘positive’. Ιn October 2017, Fitch Ratings upgraded its Long-Term Issuer Default ratings to ‘BB’ from ‘BB-’ with positive outlook. In July 2017, Moody’s Investors Service upgraded the long-term issuer rating of the Cyprus sovereign to Ba3 from B1 to reflect Cyprus’ economic recovery and maintained its outlook to positive. Moody’s Investors Service reiterated its credit rating and positive outlook on the Cyprus sovereign in a February 2018 update. BOC PCL regained access to the debt capital markets in January 2017 with the issuance of €250 million unsecured subordinated Tier 2 Capital Note. 2.2 Group Code of Conduct and Whistleblowing Policy The Group has set out the standards that are expected from all the employees and Directors of the Group in a Code of Conduct along with guidance on how these standards should be applicable. The Group also has a Whistleblowing Policy in place for all staff, including Directors, which is in accordance with international practice. The policy is reviewed annually. Its general principles are:     Concerns in good faith, about wrongdoing or malpractice can be raised in confidence without fear of victimisation, discrimination, disadvantage or dismissal. Procedures for the reporting of any matters of concern are clearly provided. The persons concerned must be able to bypass the main channels for whistleblowing if these prove inappropriate, and use the anonymous reporting line. Disclosures are managed in a timely, consistent and professional manner. The appointment of the Chairman of the AC, an independent non-executive Director as a Whistleblowing Champion with specific responsibilities. The Board and Group CEO are committed to this policy, which encourages staff to raise concerns. 239 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 3. Other matters On 18 January 2017 the Company became the sole shareholder of BOC PCL. This reorganisation was treated as a reorganisation of an existing entity that has not changed the substance of the reporting entity. The owners of BOC PCL before the reorganisation have the same absolute and relative interests in the net assets of the Group immediately before and after the reorganisation, since the assets and liabilities of the Group and the BOC group (being BOC PCL and its subsidiaries) are the same immediately before and after the reorganisation. Hence the Group is considered a continuation of BOC group. On 19 January 2017, the Company was admitted to listing and trading on the London Stock Exchange (‘LSE’) and the CSE. A common Board and committee structure applies with the same Directors sitting on the Board of Directors of the Company and on the Board of Directors of BOC PCL and on the committees of each of the two Boards. The table below show attendance of the Directors on the meetings of BOC PCL throughout 2017. Board of Directors of BOC PCL 1/1/2017-31/12/2017 Board of Directors 16/16 16/16 0/2 3/3 16/16 15/15 16/16 16/16 9/9 16/16 15/16 16/16 16 AC HRRC NCGC RC AC & RC Joint TC 2/2 10/11 10/10 10/10 0/2 1/1 16/19 0/3 7/7 0/1 19/19 7/7 11/11 10/10 7/7 2/2 9/9 9/9 5/6 10/10 11/12 3/3 11/11 11 10 10 19/19 19 7/7 7 9/9 9 Name Josef Ackermann (Chairman) Maksim Goldman (Vice Chairman) Wilbur L. Ross (Vice-Chairman)1 Anat Bar-Gera2 Arne Berggren Lyn Grobler3 Michael Heger John P. Hourican Marios Kalochoritis4 Christodoulos Patsalides Michael Spanos Ioannis Zographakis Total meetings 1 Resigned on 1 March 2017 2 Appointed on 27 October 2017 3 Appointed on 7 February 2017 4 Resigned on 27 June 2017 3.1 Company Secretary The Board appointed Mrs Katia Santis as Company Secretary. 3.2 Group Internal Auditor The Board appointed Mr. George Zornas as Group Internal Audit Director. 3.3 Corporate Governance Compliance Officer The Board appointed Mr. Marios Skandalis as CGCO. 240 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 4. 4.1 Members of the Board of Directors Non-Executive Directors Josef Ackermann (Chairman) Born in 1948. Dr Ackermann is the former Chairman of the Management Board and the Group Executive Committee at Deutsche Bank. Dr Ackermann joined Deutsche Bank's Board of Managing Directors in 1996, where he was responsible for the investment banking division. Under his leadership, this business unit developed into one of Deutsche Bank's principal revenue sources and entered the top group of global investment banks. Prior to Deutsche Bank, Dr Ackermann was President of Schweizerische Kreditanstalt (SKA), today's Credit Suisse. Dr Ackermann has held numerous board positions including sitting on the Board of Directors at Zurich Insurance Group, Royal Dutch Shell plc, Siemens AG and EQT Holdings AB among others. Dr Ackerman also served as Vice-Chairman of the Foundation Board of the World Economic Forum. Dr Ackermann is an Honorary Fellow of the London Business School, was visiting professor in finance at the London School of Economics, and was appointed honorary professor at the Johann Wolfgang Goethe University in Frankfurt. Dr Ackermann studied economics and social sciences at the University of St. Gallen, where he earned his doctorate, and holds an honorary doctorate from the Democritus University of Thrace in Greece. Dr. Ackermann has extensive experience in the financial services industry, having spent more than 40 years in various senior strategic, investment and oversight roles in Scheizerische Kreditanstalt and Deutsche Bank. Term of Office: External Appointment: Appointed to the Board of BOC PCL in November 2014 and the Board in October 2016 Independent: On Appointment Maksim Goldman (Vice Chairman) Investor AB Renova Management AG Honorary Chairman of the St. Gallen Foundation for International Studies Honorary Senate Member of the Foundation Lindau Nobel Prize winners Meetings at Lake Constance Vice Chair and Member of the Board of Trustees of the Conference Board Committee Membership: Chairman of Governance Committee the Nominations and Corporate Born in 1971. Mr. Goldman currently serves as Director of Strategic Projects at Renova where he is responsible for coordinating the business development of various significant assets under management of the Group. Previously, Mr. Goldman served as Deputy Chief Investment Officer of Renova Group, responsible for implementing the investment policy and support of key mergers and acquisitions transactions. From 2005 to 2007 he worked as Vice President and International Legal Counsel of Sual-Holding, which was the management company for OAO ‘SUAL’, the second largest aluminium company in Russia, and also participated in the creation of UC Rusal through combination of the assets of Sual-Holding, Rusal and Glencore. From 1999 to 2005 Mr. Goldman worked as an associate at Chadbourne & Parke LLP in New York and in Moscow. Mr. Goldman holds a J.D. from the School of Law, University of California (Los Angeles). He also holds a Bachelor of Arts degree in History from the University of California (Los Angeles). Mr. Goldman has extensive experience in investments and business developments and benefits from oversight experience in a number of external directorships. 241 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 4. 4.1 Members of the Board of Directors (continued) Non-Executive Directors (continued) Maksim Goldman (Vice Chairman) (continued) Term of Office: Appointed to the Board of BOC PCL in November 2014 and the Board in October 2016 External Appointment: United Company RUSAL Plc OAO ‘Volga’ FC ‘Ural’ Independent: No Committee Membership: Member of the Risk Committee Member of the Nominations and Corporate Governance Committee Arne Berggren (Chairman of the Risk Committee) Born in 1958. Mr. Berggren has been involved in corporate and bank restructurings, working for both the private sector as well as for international organisations since the early 90s, starting with Nordea during the Swedish financial crisis. This was followed by bank crises management and bank restructuring assignments in numerous countries in Latin America, Eastern Europe and Asia, and more recently during the current financial crisis in the Baltics, Spain and Slovenia. He has been Head of Financial Restructuring and Recovery at Carnegie Investment Bank AB and Swedbank AB and as CEO of Swedcarrier AB he led the restructuring of parts of Swedish Rail. Mr Berggren has held numerous Board positions in the financial and corporate sector, including a position on the Board of Directors at LBT Varlik Yönetim AS and DUTB Ldt. He is a graduate of the University of Uppsala, Sweden. Mr. Berggren has significant experience in corporate and bank restructurings, bank crises management and risk management and has extensive experience in oversight from a number of directorships. Term of Office: Appointed to the Board of BOC PCL in November 2014 and the Board in October 2016 External Appointment: Eusticon AB Pireaus Bank Group Independent: Yes Anat Bar-Gera Committee Membership: Chairman of the Risk Committee Member of the Audit Committee Born in 1958. Since 2015, Mrs Bar-Gera is the Chairwoman of Cyverse, a leading Switzerland-based cybersecurity company established with the aim of providing access to the most advanced cybersecurity solutions coming out of Israel and the Silicon Valley. Mrs Bar-Gera is currently a member of the expert network of the World Economic Forum and a former member of the Global Agenda Council on the future of the internet, of the World Economic Forum. Prior to this and for more than 20 years, Mrs Bar-Gera co-founded, scaled and exited a number of telecom and internet international companies operating primarily across Europe and Africa. In 1988, she joined UBS in Switzerland as an Associate in the M&As department, where she initiated and executed pan-European deals especially in the high-tech area. Mrs Bar-Gera graduated from INSEAD, France with an MBA and from the Hebrew University, Israel, with a Bachelor of Laws (LL.B.). Mrs Bar-Gera has significant experience in start-ups and cybersecurity and benefits from oversight experience in a number of external directorships. 242 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 4. 4.1 Members of the Board of Directors (continued) Non-Executive Directors (continued) Anat Bar-Gera (continued) Term of Office: Appointed to the Board of BOC PCL and the Board in October 2017 Independent: Yes Lyn Grobler External Appointment: Cyverse AG Swiss Mobile Data Expert Network of the World Economic Forum Committee Membership: Member of the Human Resources and Remuneration Committee Member of the Technology Committee Born in 1964. Mrs Grobler is an experienced executive with a strong track-record in technology and IT roles. She was appointed Group Chief Information Officer (CIO) at Hyperion Insurance Group in 2016. Prior to this she was Vice President and CIO Corporate Functions at BP where she led the transformation of both the organisation and the digital landscape through introducing sustained change in process, capability and technology, having held a variety of roles across IT and global trading over 16 years. Before BP, Mrs Grobler managed large scale global technology projects and strategies within banking and trading based in both London and South Africa. Mrs Grobler has been recognised as one of the 25 most influential women in UK IT and has been shortlisted for CIO of the Year at the 2016 Women in IT awards. Mrs Grobler holds an HND in computer systems from Durban University in South Africa. Mrs Grobler has significant experience in IT and digital transformation and benefits from oversight experience in a number of external directorships. Term of Office: Appointed to the Board of BOC PCL and the Board in February 2017 Independent: Yes External Appointment: Board Intelligence Ltd Hyperion Services Ltd Howden Broking Group Committee Membership: Chairperson of the Technology Committee Member of the Nominations and Corporate Governance Committee Paula Hadjisotiriou (subject to ECB approval) Born in 1957. Mrs Hadjisotiriou is an experienced executive with a long career in senior management roles in financial institutions. She started her accountancy career at Howard, Wade & Jacob before moving to Pricewaterhouse Coopers. Following a eight-year tenor at the Latsis Group of Companies as Deputy General Manager of Internal Audit, she embarked between 1990-2015 on a career in banking, at first with Eurobank Ergasias S.A as Group Chief Financial Officer and then with National Bank of Greece as Deputy Chief Executive Officer & Chief Financial Officer. Currently Mrs Hadjisotiriou serves as an advisor to the Latsis Group of Companies in the UK. Mrs Hadjisotiriou is a Chartered Accountant and a member of the Institute of Chartered Accountants of England and Wales (ICAEW). Mrs Hadjisotiriou has significant experience in financial institutions and benefits from oversight experience in a number of external directorships. 243 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 4. 4.1 Members of the Board of Directors (continued) Non-Executive Directors (continued) Paula Hadjisotiriou (subject to ECB approval) (continued) Term of Office: External Appointment: Appointed to the Board of BOC PCL and the Board in January 2018 (subject to ECB approval) None Independent: Yes Michael Heger Committee Membership: Member of the Audit Committee (subject to ECB approval) Member of the Risk Committee (subject to ECB approval) Born in 1955. Dr Heger currently serves as the general manager of finance and investment and as an independent senior advisor for S.I.F. International Holding S.A., Luxembourg at its representative office in Vienna. Previously, during 2009-2012 he served as general manager and chief executive officer of Metal Trade Overseas AG in Zug, Switzerland. He began his career in 1980 as a manager in export finance and legal affairs for Waagner-Biro AG in Vienna, Austria. Having spent two years at Waagner-Biro AG, he moved to UniCredit Bank Austria Group, where he held various management positions from 1982 to 2002. In 2001-2002, he served as general manager and head of structured trade finance at Bank Austria AG. From 2002-2003, he served as the deputy general manager and head of International division for Raiffeisenlandesbank Niederosterreich-Wien AG. Dr Heger then joined MPH Management and Participation Holding S.A., a special purpose company for equity participation in commercial and industrial companies, financial institutions and in property developments as well as for financial and consulting services for domestic and international clients and commodity trading, as the general manager of finance and investment and head of the representative office from 2004-2009. Dr Heger holds a doctorate in law from the University of Vienna and obtained a postgraduate degree in law from the College of Europe in Bruges, Belgium. Dr Heger has extensive banking experience having spent more than 20 years in various senior positions in UniCredit Bank Austria Group and has considerable strategic knowledge of industrial and commercial companies, financial institutions and property developments. Term of Office: External Appointment: Appointed to to the Board of BOC PCL in June 2016 and the Board in October 2016 None Independent: Yes Committee Membership: Member of the Audit Committee Member of the Human Resources and Remuneration Committee Member of the Technology Committee Maria Philippou (subject to ECB approval) Born in 1975. Mrs Philippou started her career as an HR Consultant with KPMG Greece, before moving to the Lambrakis Press Group as HR Generalist. Having spent three years with Eurobank Ergasias S.A as Compensation & Benefits Manager, in 2006 she moved to the Coca Cola Company Group, progressing through various roles such as Rewards Manager and HR Business & Strategic Partner to her current position as Global Talent & Development Director. Mrs Philippou holds a degree in Business Administration from Nottingham Trent University and a Master of Science in Human Resources Management form Brunel University. Mrs Philippou is an experienced executive in human resources and brings valuable skills to the Board in people management. 244 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 4. 4.1 Members of the Board of Directors (continued) Non-Executive Directors (continued) Maria Philippou (subject to ECB approval) (continued) Term of Office: External Appointment: Appointed to the Board of BOC PCL and the Board in January 2018 (subject to ECB approval) None Independent: Yes Committee Membership: Member of the Human Resources and Remuneration Committee (subject to ECB approval) Michael Spanos (Senior Independent Director) Born in 1953. Mr. Spanos is Managing Director of M.S. Business Power Ltd, which provides consultancy services on strategic and business development (since 2008). Mr. Spanos worked at Lanitis Bros Ltd from 1981 to 2008 as Marketing Manager, General Manager and Managing Director. Between 2005 and 2009, Mr. Spanos served as Vice-Chairman of the Board of Directors of the Cyprus International Institute (Republic of Cyprus and Harvard School of Public Health). Mr. Spanos has also served on other boards, such as Coca-Cola Içecek (2012-2016), Heineken-Lanitis Cyprus Ltd (2005 to 2007), Lumiere TV Public Ltd (2000 to 2012), A. Petsas & Sons Public Ltd (2000 to 2007) and CypriaLife Insurance Ltd (1995 to 2000). Mr. Spanos is a former member of the Central Bank of Cyprus Board of Directors. Mr. Spanos holds a Master's degree in economics from North Carolina State University. Mr. Spanos as an experienced Managing Director and member of a number of Boards, has in-depth knowledge of international business, management, finance and strategic development. Term of Office: Appointed the Board of BOC PCL in November 2014 and the Board in October 2016 Independent: Yes Ioannis Zographakis External Appointment: M.S. Business Power Ltd Green Dot (Cyprus) Ltd Lanitis Bros Ltd Committee Membership: Chairman of the Human Resources and Remuneration Committee Born in 1963. Mr. Zographakis is a senior Executive with a broad and diverse international experience in the banking industry. He has worked with Citibank for over 20 years, in the USA, UK and Greece. His line/business positions and divisional/corporate responsibilities, have provided him with an extensive background in corporate governance, business restructuring, re-engineering, crisis management, separation of businesses, business strategy, profit & loss management, finance, product and segment management, operations & technology management, and dealing with various regulatory bodies and industry related organisations. He started his career in 1990 with Citibank in Greece as a Management Associate for Europe, Middle-East & Africa (EMEA). He then worked as the Deputy Treasurer and Treasurer for the Consumer Bank in Greece, before moving to the USA in 1996 as the Director of Finance for CitiMortgage. In 1997 he became the Financial Controller for Citigroup's Consumer Finance business in the US and then he served as Chief Financial Officer for the Consumer Assets Division. From 1998 until 2004 he worked in the Student Loan Corporation (SLC), a Citigroup subsidiary and a New York Stock Exchange traded company. He started as the Chief Financial Officer, became the Chief Operations Officer and in 2001 he was named the Chief Executive Officer. In 2005 he moved back to Europe as Citibank's Consumer Lending Head for EMEA and UK Retail Bank Head. 245 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 4. 4.1 Members of the Board of Directors (continued) Non-Executive Directors (continued) Ioannis Zographakis (continued) Deciding to move closer to home in 2006, he took the position as Citibank's Retail Bank Head in Greece where he stayed until 2011, before moving back to Cyprus consulting on financial services when requested. He has been a Director for the Student Loan Corporation in the US, a Director for Tiresias (Greek Credit Bureau) and the Secretary of the Audit Committee, a Director and member of the Audit Committee for Diners Club Greece, the Vice-Chairman of the Citi Insurance Brokerage Board in Greece and the Chairman of the Investments and Insurance Supervisory Committee in Citibank Greece. He holds an MBA from Carnegie Mellon University in the USA and a Bachelor’s degree in civil engineering from Imperial College in London. Mr. Zographakis has extensive experience in the banking industry, having spent more than 20 years in various senior operational and financial roles in Citibank and on the Board of a number of financial entities. Term of Office: External Appointment: Appointed to the Board of BOC PCL in September 2013 and the Board in October 2016 None Independent: Yes 4.2 Executive Directors John Patrick Hourican (Group CEO) Committee Membership: Chairman of the Audit Committee Member of the Risk Committee Member of the Technology Committee Born in 1970. Mr. Hourican served as Chief Executive of The Royal Bank of Scotland (‘RBS’) Group’s Investment Bank (Markets & International Banking) from October 2008 until February 2013. Between 2007 and 2008, he served on behalf of a consortium of banks (RBS, Fortis and Santander) as Chief Financial Officer of ABN AMRO Group and as a Member of its Managing Board. He joined RBS in 1997 as a Leveraged Finance banker. He held a variety of senior positions within RBS's wholesale banking division, notably on the division's Board as Finance Director and Chief Operating Officer. He also ran the bank’s Leveraged Finance business in Europe and Asia. Mr. Hourican started his career at Price Waterhouse and he is a Fellow of the Institute of Chartered Accountants in Ireland. He is a graduate of the National University of Ireland and Dublin City University. Mr. Hourican is an experienced Chief Executive Officer, Finance Director and Chief Operating Officer having served in various senior roles for over fifteen years with the RBS. Term of Office: Appointed to the Board of BOC PCL in December 2013 and the Board in July 2016 External Appointment: Atradius N.V. Independent: No Committee Membership: None 246 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 4. Members of the Board of Directors (continued) Christodoulos Patsalides (DCEO & COO) Born in 1962. From 1989 to 1996, Dr. Patsalides worked for the Central Bank of Cyprus in the management of Government External Debt and Foreign Exchange Reserves Department. In 1996, Dr Patsalides joined the Group where he has held a number of positions in corporate banking, treasury and private banking, among others. From December 2013 to April 2016, Dr Patsalides served as Finance Director and was responsible for finance, treasury, investor relations, economic research and procurement. In his current capacity as the DCEO & COO, he is responsible for human resources, corporate affairs, central operations, legal services, organisation and methods, information technology, business transformation and administrative operations. Dr Patsalides holds a PhD and an MSc in economics from the London School of Economics and a BSc in economics from Queen Mary College in London. Dr Patsalides is an experienced financial services professional having served in a number of senior roles in the Group including as Finance Director. Term of Office: Appointed to the Board of BOC PCL in November 2014 and the Board in July 2016 Independent: No External Appointment: Cyprus Anti-Cancer Society Committee Membership: None 247 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. Board Committees BOCH PLC Board of Directors Group Nominations & Corporate Governance Committee Group Human Resources & Remuneration Committee (NCGC) (HRRC) Group Audit Committee Group Risk Committee (AC) (RC) Non-Executive responsibility for leading the process for Board appointments and for identifying and nominating, for approval by the Board, candidates for appointment to the Board and oversight of the corporate governance arrangements of the Group Non-Executive responsibility for setting the overarching principles, parameters and governance framework of the Group's remuneration policy and the remuneration of senior executives Non-Executive responsibility for oversight of, and advice to the Board on, matters relating to financial statements and oversight of compliance function and internal audit function Non-Executive responsibility for oversight of and advice to the Board on, high level risk related matters and risk governance In order to exercise proper oversight of risk and control, the Board has delegated certain responsibilities to committees of the Board. The principal committees are the AC, the RC, the NCGC and the HRRC. The key roles of the Board committees are described above. Further information of the work of these committees follows in the section below. The terms of reference of the committees are based on the relevant provisions of the CSE and UK Codes and the CBC Governance Directive (where applicable) and are available on the Group’s website (www.bankofcyprus.com) or by request to the Company Secretary. Each committee reviews its terms of reference annually. The overall responsibility for approving and monitoring the Group’s strategy, risk appetite and policies for managing risks lies with the Board, which exercises this responsibility through two of its main committees, namely the RC and the AC. The chairperson of each committee reports on matters discussed during committee meetings to the subsequent scheduled meetings of the Board and minutes of these meetings are tabled at the Board as soon as possible for noting and/or discussion, as necessary. This linkage is important between the committees given that it is impractical for independent non-executive Directors to be members of all the committees. The Board in 2017 set up a Technology Committee to drive the digital transformation of BOC PCL. The Committee is comprised of four non-executive members and is chaired by Mrs Lyn Grobler whose extensive knowledge and experience in IT will be instrumental to the digital transformation of BOC PCL. 5.1 Nominations and Corporate Governance Committee The NCGC comprised three non-executive Directors at 31 December 2017, two of whom were independent. It is chaired by the Chairman of the Board, except when the NCGC is dealing with the appointment of a successor to the role of chairperson, and its composition is fully compliant with the CSE Code, the UK Code and the CBC Governance Directive. 248 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.1 Board Committees (continued) Nominations and Corporate Governance Committee (continued) Biographical details, including each member’s background, experience and independence status are set out in section 4 of this report. The Committee held 7 meetings in 2017. The Chairman and members of the Committee together with their attendance at meetings are shown below. The NCGC meets annually with no management present. Member attendance in 2017: NCGC meetings* in 2017: Josef Ackermann (Chairman) Wilbur L. Ross (resigned 1 March 2017) Maksim Goldman Lyn Grobler (appointed 20 November 2017) 7/7 0/0 7/7 1/1 * The number of committee meetings at BOC PCL level were 10 during 2017. The attendance of these meetings can be found on page 240. The key responsibilities of the NCGC are set out in its terms of reference, which are available on the Group’s website (www.bankofcyprus.com) and are reviewed annually and approved by the Board. The role of the Committee is to ensure that the Board is comprised of members who are best able to discharge the duties and responsibilities of Directors and to support and advise the Board in relation to:      Board recruitment (including regularly reviewing, reporting on and taking into account , when making further appointments, the composition and effectiveness of the Board), Vice-Chairperson, Director and CEO development (under the overall responsibility and supervision of the Chairperson of the Board), Chairperson development (under the overall responsibility and supervision of the SID), The ongoing evaluation of the structure, size, composition and performance of the Board, its committees and individual Directors, and Succession planning for Directors and senior management. The Committee also:   Oversees the adoption of appropriate internal policies on the assessment of the fitness & probity of members of the Group ExCo, other Senior Managers and Heads of the Internal Control Functions, and Keeps the Board’s governance arrangements under review and makes appropriate recommendations to the Board to ensure that such arrangements are consistent with best corporate governance standards and practices in place. The Committee considered the following key matters in 2017:  The Annual Corporate Governance Report. Potential conflicts of interest with Directors’ other appointments. The Group Board Nominations Policy. The Group Corporate Governance Policy. The Group Policy on Fitness & Probity of Directors, Managers and Identified Staff. The Group Board Diversity Policy. The Board Manual and terms of reference of the main committees. Governance Arrangements   Corporate Governance quarterly reports.        Compliance with the CSE Code.  Compliance with the UK Code.  Approval of the Directors’ annual training agenda.   Appointment of SpencerStuart to carry out the Board performance evaluation for 2017. Performance appraisal of the Group CEO and the DCEO & COO. 249 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.1  Board Committees (continued) Nominations and Corporate Governance Committee (continued) Appointments and Renewals  Nominations, appointments to the Board and major subsidiary boards.  Structure, size, and composition (skills, knowledge and expertise) of the Board and Board committees.  The independence of the non-executive members.  Board and individual member performance evaluation.  Effectiveness of performance of each committee.  Subsidiary Governance  Update of the Corporate Governance Guidelines for Group subsidiaries to align practice across the Group.  Review of the oversight report of Bank Of Cyprus UK Ltd (‘BOC UK’).  Review of the oversight reports of major subsidiaries and representative offices.  Approval of the Framework Agreement with BOC UK which sets out the terms and understanding between the Group and BOC UK and the responsibilities of each party. The Chairman of the Committee reported to the Board after each meeting to ensure all Directors were fully informed of the Committee’s activities. 5.1.1 Diversity The non-executive Directors have diverse skills, knowledge and extensive executive and/or non-executive experience that combine to provide independent perspective and effective board dynamics. The effectiveness of the Board depends on ensuring the right balance of Directors with banking or financial services experience and broader commercial experience. Following review in 2017, the NCGC determined that the skills profile of the Board, either academically or through professional experience was appropriate and relevant to the business of the Group including inter alia, banking, financial services, manufacturing, audit and accounting, strategy development, insurance, risk management, business experience, dealing with competent authorities, economics, legal and consultancy services, IT, cybersecurity and others. Directors bring their individual knowledge, skills and experience to bear in discussions on the major challenges facing the Group. The Group recognises the benefits of having a diverse Board and is committed to this respect. In reviewing Board composition and identifying suitable candidates, the NCGC considers the benefits of all aspects of diversity including the skills identified as relevant to the business of the Group, industry experience, nationality, gender, age and other relevant qualities in order to maintain an appropriate range and balance of skills, experience and background on the Board. The participation of Executives on the Board enhances the banking expertise of the Board and ensures that the Board is provided with direct, precise and up-to-date information about significant issues concerning the Group. During 2017, the NCGC reviewed the Board Diversity Policy (the latest version of which is available on the Group’s website (www.bankofcyprus.com)) which aims to achieve gender diversity by 2020 with appointments based on meritocracy. The Group having recognised the benefits of a diverse Board has set a target to achieve and maintain 40% female representation by the end of 2020 and a plan prepared by the Company Secretary has been approved by the NCGC describing all key intervening milestones leading to the accomplishment of this target. Following Mrs Grobler’s appointment to the Board on 7 February 2017, the Board proceeded with the appointment of Mrs Anat Bar-Gera on 27 October 2017. On January 23 2018, the Board appointed two new directors, Mrs Paula Hadjisotiriou and Mrs Maria Philippou to the Board, (both subject to ECB approval) thereby achieving diversity of 33.3%. The Code of Conduct similarly ensures equal opportunities to all members of staff and treats diversity with fairness and respect aiming to provide fair treatment for everyone at work. 250 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.2 Board Committees (continued) Human Resources and Remuneration Committee The Committee on 31 December 2017 comprised of 3 independent non-executive members from diverse backgrounds to provide a balanced and independent view on remuneration matters. The HRRC is chaired by the SID and its composition complies with the requirements of the CSE Code, the UK Code and the CBC Directive on Governance and Management Arrangements of Credit Institutions (‘CBC Governance Directive’). The Board considers that the Chairman of the Committee possesses appropriate knowledge and expertise on HR and remuneration issues. Marios Kalochoritis resigned from the Committee and the Board on 27 June 2017 and was replaced by Mrs Anat Bar-Gera on 27 October 2017. Biographical details, including each member’s background, experience and independence status are set out in section 4 of this report. The Committee held 6 meetings in 2017. The Chairman and members of the Committee together with their attendance at meetings are shown below. The Director of Human Resources is invited to attend meetings as appropriate. Member attendance in 2017: HRRC meetings* in 2017: Michael Spanos (Chairman) Marios Kalochoritis (resigned 27 June 2017) Michael Heger Anat Bar-Gera (appointed 27 October 2017) 6/6 1/2 6/6 2/2 * The number of committee meetings at BOC PCL level were 10 during 2017. The attendance of these meetings can be found on page 240. The key responsibilities of the HRRC are set out in its terms of reference, which are available on the Group’s website (www.bankofcyprus.com) and are reviewed annually and approved by the Board. The role of the Committee is:       To ensure that the Group is equipped with the human capital necessary for the achievement of its strategic goals, whose reward will be based on personal performance and Group results. To ensure that the Group is equipped with the organisational capital to be able to effect continuous improvement. To ensure that the Group is equipped with the information capital and the technology necessary to facilitate process improvements that will create a comparative advantage in the market. To propose adequate remuneration considered necessary to attract and retain high value-adding professionals. Therefore, remuneration has to be satisfactory vis-a-vis peer companies. To set the overarching principles and parameters of compensation and benefits policies across the Group and exercise oversight for such issues. To consider the remuneration arrangements of the executive Directors of the Group, other identified staff and the employee Remuneration Policy bearing in mind the European Banking Authority (‘EBA’) Guidelines on remuneration policies and practices, the CBC Governance Directive and the CSE Code. The Committee is responsible for the development and periodic review of the Group Remuneration Policy which is proposed to the Board for ratification. In addition, the Board, through the Committee, is ultimately responsible for monitoring the implementation of the Group Remuneration Policy. The Group’s aim is to align its Remuneration Policy and human resources practices, with its long term objectives, its risk tolerance, capital and liquidity availability, the interests of its shareholders and ensure that they are consistent with and promote sound and effective management of risk and do not encourage excessive risk-taking. 251 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.2 Board Committees (continued) Human Resources and Remuneration Committee (continued) In developing its Remuneration Policy, the Group takes into account the provisions that are included in the CSE Code, the CBC Directive on Governance and Management Arrangements of Credit Institutions (the ‘CBC Governance Directive’) which came into effect in August 2014 and incorporated the requirements for Remuneration Policies included in the European Capital Requirements Directive (‘CRD IV’) and the EBA Guidelines on sound remuneration policies issued in December 2015, as well as regulatory restrictions pertinent to the banking sector currently. The remuneration of non-executive Directors is determined and approved by the Board. Neither the Chairman nor any Director participates in decisions relating to their own personal remuneration. The Committee reviews and approves the content of any resolutions submitted for approval at the general meeting of the shareholders, which are prepared by the Company Secretary in cooperation with the Group’s legal advisers in accordance with Annex 3 of the CSE Code and concern possible plans for the compensation of members of the Board in the form of shares, share warrants or share options. The Committee considered the following key matters in 2017:    Annual Remuneration Policy Review  Annual review and approval of the Remuneration Policy.   The performance and remuneration of Senior Management. The remuneration of heads of control functions. Disclosures and Governance  Review of the Remuneration Policy Report in the Annual Report.  Review of the Terms of reference of the Committee. Human Resource Review  Review of the training plan of staff for the year.  Close monitor of the progress of the negotiations with the trade union with regards to the renewal of the 2017 Collective Agreement and recommendation to the Board on the approval of the renewal of 2017 Collective Agreement.  Review of the 2016 Group Staff Opinions Survey results and action plans.  Review of a proposal for a Short Term Incentive Plan (‘STIP’).  Review of the Performance Appraisal statistics.  Monitor of the BOC PCL’s head count and payroll cost evolution. The Chairman of the Committee reported to the Board after each meeting to ensure all Directors were fully informed of the Committee’s activities. Further information on the role of the Committee is presented in the Remuneration Policy Report, on page 261 of this report. 5.3 Audit Committee As at 31 December 2017, the AC comprised three independent non-executive Directors. The Board considers that the AC as a whole has a relevant mix of skills and financial/banking experience. The Board further believes that Ioannis Zographakis can be regarded as having recent and relevant financial experience for the purposes of the UK Code and can be regarded as an Audit Committee financial expert. Biographical details, including each member’s background, experience and independence status are set out in section 4 of this report. 252 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.3 Board Committees (continued) Audit Committee (continued) The Committee held 8 meetings during 2017. The Chairman and members of the Committee together with their attendance at meetings are shown below. Arne Berggren is the Chairman of the RC and Ioannis Zographakis is also a member of the RC. Michael Heger is also a member of the HRRC. Such common membership facilitates effective governance across all finance and risk issues. Agendas can be aligned and overlap of responsibilities can be avoided. Member attendance in 2017: AC meetings* in 2017 Ioannis Zographakis (Chairman) Arne Berggren Michael Heger 8/8 7/8 8/8 * The number of committee meetings at BOC PCL level were 11 during 2017. The attendance of these meetings can be found on page 240. The key responsibilities of the AC are set out in its terms of reference, which are available on the Group’s website (www.bankofcyprus.com) and are reviewed annually and approved by the Board. The role of the Committee, inter alia, is:        To oversee the system of internal controls including reviewing its effectiveness; To monitor the integrity of the Group's financial statements and related announcements; To monitor the effectiveness of the internal audit function; To advise the Board on appointment of the external auditors and be responsible for oversight and remuneration of the external auditor; To review the Group’s and Company’s financial and accounting policies and practices; To monitor the effectiveness of the Group's whistle-blowing procedures; To monitor the effectiveness of the anti-money laundering function of the Company and all other aspects of regulatory/ethics compliance; and to make recommendations to the Board on such matters. The role of the Committee is fundamental to ensuring the financial integrity and accuracy of the Company’s financial reporting. Good, open relationships between the Committee, the Finance Director, the Group Internal Audit Director and the Director of Group Compliance as well as the external auditors, are essential to adding value to the organisation. This is achieved by holding management to account for the implementation of all audit recommendations (internal and external) and inviting appropriate divisional directors to meetings to explain how they are delivering the agreed actions for which they are responsible. In addition to providing assurance within the governance and accountability structures of the Group, it is essential that the Committee contributes, delivers results and adds value to the Group. The AC considered the following key significant accounting and other related issues in its review of the financial statements for the year ended 31 December 2017. In addressing these issues, the AC considered the appropriateness of management’s judgements and estimates and where appropriate, discussed those judgements and estimates with the external auditors:  Internal Controls and Risk Management  Annual review of the effectiveness of the Group’s internal controls.  Review of monthly audit reports and internal control issues.  Review of the Annual Audit Report of the Group Internal Audit Division and major audit findings.  Review and approval of the Group Financial Crime Compliance Department (‘FCCD’) Annual Report, the Group FCCD Risk Management Report, the Regulatory & Ethics Compliance Department (‘RECD’) Annual Report.  Review of the monthly reports of the FCCD and the RECD.  Review of quarterly reports of Cybercrime and Security Incident Response Plan.  Review of the Triennial Assessment of the Group’s internal control framework. 253 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.3      Board Committees (continued) Audit Committee (continued) Year end and interim reporting. External Reporting   Review and approval of the quarterly financial results.  Review of the provisions for impairment of loans and advances.  Review of the Group’s existing accounting policies.  Approval of new and significant changes in existing policies.  Approval of IFRS9 accounting policies.  Regular update on progress and implementation of IFRS 9 accounting matters. Internal Auditors  Review of the Group Internal Audit Strategic Plan.  Approval of the revised Group Internal Audit charter.  Review of the independence of the Group Internal Audit Division and the Group Internal Audit Director.  Review of Group Internal Audit Succession Planning.  Update on the Quality Assurance and Improvement Program of the Group Internal Audit Division.  Appraisal of the Group Internal Audit Director. Compliance function  Review and approval of the FCCD Audit Plan, the FCCD Action Plan, the RECD Action Plan.  Review and approval of the Anti-Money Laundering (AML) risk appetite statement, AML Policy, Customer Acceptance Policy and Sanctions Policy.  Consideration of major compliance issues and reports submitted to it by the Group Compliance Division.  Review and approval of the various regulatory & ethics compliance policies.  Updated on important forthcoming regulatory developments.  Appraisal of the Director of Group Compliance. External Auditors  Discussion of the results of the audit of the financial statements with the external auditors.  Discussion of the IFRS provisioning parameters.  Consideration of key accounting judgements and estimates.  Appointment of the external auditors.  Approval for the rotation of the statutory auditors.  Assessment of the independence of external auditors.  Approval of audit, tax compliance and other assurance fees for the year.  Approval of permissible non-audit services assigned to the auditors. Governance  Review of revised terms of reference of the AC.  Review of group subsidiaries’ audit reports.  Approval of the Annual Corporate Governance Report.  Review of quarterly Customer Complaints Management Report. The Committee has:     Endorsed the going concern assessment for the purposes of the basis of preparation of the financial statements. Reviewed and monitored the appropriateness and completeness of the published financial statements and related announcements to shareholders of the Company and any formal announcements relating to the Group’s financial performance, including significant financial reporting judgements and estimates made by the Group. Advised the Company’s Board that the Group Annual Financial Report and financial statements, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy. Considered for disclosure all material relevant issues that have concerned management and the Group statutory auditors during the year. 254 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.3    Board Committees (continued) Audit Committee (continued) Reviewed accounting policies and practices, including approval of the critical accounting policies. Considered management’s recommendations in respect of provisions for impairment of loans and advances and any other impairment losses and charges as reported in the Group’s financial statements. Discussed key areas of judgements and estimates in the Group’s financial results with the external auditors, Ernst & Young Chartered Accountants (‘EY’); particular areas for discussion included their findings/observations as part of their audit/review of the Group’s financial statements, including inter alia, loan provisioning and impairment policies, going concern issues and the recoverability of deferred tax asset.  Loan impairment The AC considered loan impairment allowances and charges, discussing with management the basis of calculation and the reasons for significant changes. Judgements and estimates discussed included impairment of loans and advances; interest income recognition, and the disclosures relating to provisions and contingent liabilities for litigation and regulatory claims.  Deferred Tax assets The Committee discussed the extent of deferred tax assets to be recognised and in particular management’s projections for future taxable profits against which those losses may be utilised in the future. Judgement is required to determine the amount of deferred tax assets that can be recognised, based upon the likely timing and level of future taxable profits, together with future tax- planning strategies.  Going concern Further the AC considered management’s assessment of the appropriateness of preparing the financial statements of the Group on a going concern basis. The considerations assessed by the AC are set out in Note 3 of the Consolidated Financial Statements. The Committee has the responsibility for examining any significant transactions in any form, carried out by the Company and/or its subsidiary companies, where any member of the Board, CEO, senior executive officer, Secretary, auditor or large shareholder has, directly or indirectly, any significant interest. It ensures that these transactions are carried out within the framework of the Company’s normal commercial practices (at arm’s length). The Committee received regular reports from the Group Finance Director, the Group Internal Audit Director and the Director of Group Compliance. The Committee reviewed the adequacy of resources, qualifications and experience of staff in the Finance Division. Reports were submitted to the Committee on internal control matters. The Group Finance Director, the Group Internal Audit Director, the Director of Group Compliance, external auditors and other senior executives attended the Committee’s meetings. The Committee has regular discussions with the external auditors, the Group Internal Audit Director and the Director of Group Compliance and discusses issues without the presence of the management. Other responsibilities The AC and the RC liaise closely and in joint committee meetings review the appropriateness of and completeness of the system of internal controls. The AC is primarily responsible to review the manner and framework in which management ensures and monitors the adequacy of the nature, extent and effectiveness of internal controls system, including accounting control systems, thereby maintaining an effective system of internal controls. During 2017 the joint committee had an oversight role on IFRS 9 implementation and reviewed the results, key assumptions and methodologies and provided approvals where deemed necessary. 255 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.3 Board Committees (continued) Audit Committee (continued) The Board has delegated authority to the NCGC to draw up the Annual Corporate Governance Report, but the AC retains its duty to review and approve the Annual Corporate Governance Report. In addition AC has responsibility for:   Assisting the Board in meeting its obligations under relevant stock exchange listing rules and other applicable laws and regulations. Monitoring and reviewing the effectiveness of the Group’s internal audit function and its operations. The Chairman of the Committee reported to the Board after each meeting to ensure all Directors were fully informed of the Committee’s activities. 5.3.1 Internal Audit independence The Group Internal Audit and Group Compliance Divisions report directly to the Board through the AC. They are organisationally independent of units with executive functions and are not subordinated to any other unit of the Company, except the Director of Group Compliance who has a dotted reporting line to the DCEO & COO, for administration matters. The Committee’s activities included the consideration of reports submitted by the Group Internal Audit and Group Compliance Divisions. The Committee has satisfied itself that the Group Internal Audit Division was effective and adequately resourced through regular meetings held with and reports provided by the Group Internal Audit Director on internal audit issues, including the effectiveness and adequacy of resources. The Committee received reports over the course of 2017 on the activities of the internal audit function and reviewed its planned activities for the following year. Management’s responses to Group Internal Audit’s findings and recommendations were reviewed and monitored. The monthly reports issued by the Group Internal Audit Director and Director of Group Compliance enable the Committee to focus discussion on specific areas of concern and root causes and to track remediation progress over time. The Committee proposes to the Board the appointment, replacement, transfer or removal of the Group Internal Audit Director and the Director of Group Compliance. It submits a report to the Board on: a) the adequacy of the audits carried out, the conclusions and the proposals of the Group Internal Audit, and b) subjects that are related to the independence and smooth execution of audit work carried out by Group Internal Audit. The independence of the two functions as well as the independence of the Group Internal Audit Director were reviewed by the AC. 5.3.2 Arrangements relating to the external auditors The objectivity and independence of the external auditors is safeguarded and effectiveness of the external audit process assessed through monitoring of their relationship with the Group by the AC, including the monitoring of the balance between audit and permissible non-audit services. The external auditors provided written confirmation of their objectivity and independence to the Group. In addition, the external auditors do not provide internal audit services to the Group. The AC reviews annually a detailed analysis of the audit and non- audit fees relating to work done by the external auditors, to confirm their independence and refers this analysis to the Board. Additionally the Committee implemented the Policy on the provision of permissible non-audit services by the Group statutory auditors in line with the EU Directive and related regulation. The policy provides that the auditors can be engaged to provide permissible non-audit services only if the engagement has been pre-approved by the AC. 256 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.3 Board Committees (continued) Audit Committee (continued) 5.3.2 Arrangements relating to the external auditor (continued) The European Directive which updated the EU regulatory framework on statutory audits was enacted into national law in May 2017 in Cyprus and in June 2016 in Ireland. The new legislation covers mandatory audit firm rotation, additional restrictions on the provision of non-audit services, further requirements on audit committee oversight of the performance of the audit and new requirements regarding auditor reporting. The AC had oversight of the tender procedure of the Group for the provision of statutory audits as per the agreed roadmap and recommended to the Board for appointment the audit firm of PricewaterhouseCoopers (‘PwC’) for accounting periods commencing 1 January 2019. 5.4 Risk Committee The RC is responsible for advising the Board on high-level risk related matters and risk governance and for non- executive oversight of risk management and internal controls (other than financial reporting). The RC on 31 December 2017 comprised three non-executive Directors most of whom independent. The Board considers that the RC as a whole possesses adequate knowledge, skills and expertise to fully understand and monitor the risk strategy and the risk appetite of the Group. Biographical details, including each member’s background, experience and independence status, are set out in section 4 of this report. The Committee held 9 meetings during 2017. The Chairman and members of the Committee together with their attendance at meetings are shown below. Member attendance in 2017: RC meetings* in 2017 Arne Berggren (Chairman) Maksim Goldman Marios Kalochoritis (resigned 27 June 2017) Wilbur L Ross (resigned 1 March 2017) Ioannis Zographakis 9/9 8/9 2/3 0/0 9/9 * The number of committee meetings at BOC PCL level were 19 during 2017. The attendance of these meetings can be found on page 240. To ensure coordination with the work of the AC, the Chairman of the RC, Mr. Arne Berggren, is a member of the AC and the Chairman of the AC, Mr. Ioannis Zographakis is a member of the RC. Maksim Goldman is also a member of the NCGC. Such common membership facilitates effective governance across all finance and risk issues. Agendas can be aligned and overlap of responsibilities can be avoided. The main purpose of the Committee is to review, on behalf of the Board, the aggregate risk profile of the Group, including performance against risk appetite for all risk types and to ensure that both the risk profile and risk appetite remain appropriate. Specifically it:      Advises the Board on risk appetite and alignment with strategy. Monitors the effectiveness of the Group’s risk management and internal control systems except from financial reporting and compliance internal control systems. Monitors the Group’s risk appetite and risk profile against key performance/risk indicators as set out in the Group’s Risk Appetite Statement. Identifies the potential impact of key issues and themes that may impact the risk profile of the Group. Ensures that the Group’s overall risk profile and risk appetite remain appropriate given the external environment, any key issues and themes impacting the Group and the internal control environment. 257 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.4    Board Committees (continued) Risk Committee (continued) Seeks to identify and assess future potential risks which, by virtue of their uncertainty, of low probability and unfamiliarity may not have been factored adequately into review by other Board Committees. Advises the Board on alignment of remuneration with risk appetite (through advice to the Group HRRC). Advises the Board on risks associated with proposed strategic acquisitions and disposals. The Group, like all other financial institutions, is exposed to risks, the most significant of which are credit risk, liquidity and funding risk, market risk, operational risk and property price risk. The Group monitors and manages these risks through various control mechanisms and reviews the mitigating actions proposed by management. To ensure consistency of scope and approach by subsidiary company committees, the RC has established core terms of reference to guide subsidiary companies when adopting terms of reference for the non-executive risk committees. The Committee’s endorsement is required for any proposed material changes to subsidiary company risk committee terms of reference and for appointments to such committees. Detailed information relating to Group Risk Management is set out in Notes 44 to 47 of the Consolidated Financial Statements and the Additional Risk and Capital Management Disclosures section of the 2017 Annual Financial Report. Key areas of focus for the Committee during the year were to set strategies and ensure compliance with reference to non-performing exposures management, review risk policies where necessary to comply with the changing regulatory environment and better support business needs and review the enhancements of the provisioning methodology. The Committee identified the current and potential impact of key issues and themes that have an actual or potential impact on the Group’s risk profile and performed deep dive discussions in order to better understand and provide guidance to the management. Deep-dive discussions for 2017 covered such matters as the recoveries portfolio, major corporate of Recoveries and Restructuring Division (RRD) small and medium enterprises of RRD, fraud risk management, and an analysis of the IFRS9 expected credit loss scenario impact. The Group IFRS 9 implementation has been largely completed by 1 January 2018. The IFRS 9 project had a formalised governance process whereby the GCRO was the project owner. The main divisions involved in the project at the highest level were the Risk, Finance, IT and Operations. A Steering Committee was set up to monitor the project, chaired by the Group CEO and comprising of members of the Executive Management team, the CRO, the DCEO & COO, the Finance Director and other representatives from Risk and Finance, while the Group Internal Audit Director participated as an observer. The Steering Committee was monitoring the progress of the project and was reviewing the results, key assumptions policies and methodologies and reported to the Board Risk and Audit Committees, which had an oversight role and provided approvals. The RC undertook the following key activities in 2017:      Review of risk appetite. The Committee reviewed the alignment of risk appetite and Group strategy. Regular reviews were undertaken of the Group’s risk profile against the key performance indicators set out in the Risk Appetite Statement which considered the need for any adjustment to the risk appetite. Review of the top and emerging risks. Oversight of executive risk management. Regular reports were received from the GCRO including a risk map which provides analysis of risk profiles for categories of risk identified in the Group Risk Appetite Statement. Review of Strategy Risk Assessment. Approval/recommendation for approval of a large number of restructurings and contractual or non- contractual write-offs. 258 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 5. 5.4 Board Committees (continued) Risk Committee (continued)               Framework for the implementation of ECB’s Guidance on Leveraged Transactions. Approval/recommendation for approval of special restructuring products and solutions. Approval and recommendation to the Board for approval of the 2017 Group Recovery Plan. Update on Group Regulatory/Supervisory Activity. Approval of risk-related limits. Review of the IFRS 9 Progress Report. Review of the Reputational Risk Report. Update on the Assets-Liabilities Committee meetings minutes. Review of the operational risk. The Committee received regular reports on the Group’s operational risk management framework. Review of risk management policies. Review of several regulatory issues such as ECB’s guidance on NPL Exit Criteria and leveraged transactions. Review of regulatory communication. Review of the terms of reference and Committee’s effectiveness. The Committee undertook a review of its terms of reference and of its own effectiveness. Review of risk management and internal controls. The Committee recommended to the Board the annual reports of Risk Management, Information Security, ICAAP and ILAAP. The Chairman of the Committee reported to the Board after each meeting to ensure all Directors were fully informed of the Committee’s activities. 6. Remuneration Policy Report The Remuneration Policy Report was prepared by the Board following a proposal by the HRRC in accordance with Annex 1 of the CSE Code and the UK Code. It is presented in the 2017 Annual Financial Report of the Group, after the Corporate Governance Report. The Remuneration Policy Report is presented to the AGM of shareholders for approval. Information on the remuneration of the members of the Board for the year 2017 is disclosed in Note 49 of the Consolidated Financial Statements of the Group, as well as in the Remuneration Policy Report. 7. Shareholder Relations Mrs Annita Pavlou, Manager Investor Relations Department, has been appointed by the Board as Investor Relations Officer, responsible for the communication between shareholders and the Group since 30 August 2016. Information concerning the Group is provided to shareholders, prospective investors, brokers and analysts in a prompt and unbiased manner free of charge. The Group uses its website (www.bankofcyprus.com) to provide shareholders and potential investors with recent and relevant financial information, including the annual, the mid-year financial report and quarterly results, announcements and presentations. The Investor Relations section of the Group’s website is updated with all announcements published on the LSE and CSE as these are made. It also contains contact details for the Investor Relations Department. Directors receive an investor relations update from management at all scheduled Board meetings. This update typically includes market updates, share price and valuation analysis, updates on analysts’ reports and share register analysis. One of the responsibilities of the Chairman of the Board is to ensure that the views, issues and concerns of shareholders are effectively communicated to the Board and to ensure that Directors develop an understanding of the views of major investors. The SID, Mr. Michael Spanos, is available to shareholders if they have concerns that are not resolved through the normal communication channels. All shareholders of the Company are treated on an equal basis. There are no shareholders with special control rights. Shareholders are promptly and accurately informed of any material changes regarding the Group, including its financial condition, financial results, ownership and governance. 259 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Annual Financial Report 2017 7. Shareholder Relations (continued) Under the Irish Companies Act 2014, one or more members holding at least 3% of the issued share capital of the Company, representing at least 3% of the total voting rights of all the members who have a right to vote at the meeting to which the request for inclusion of the item relates, has the right to: (a) put an item on the agenda of the AGM provided that the item has been accompanied by stated grounds justifying its inclusion or a draft resolution to be adopted; and (b) to table a draft resolution for an item on the agenda of a general meeting. Such a request must have been received by the Company at least 42 days prior to the relevant meeting. Any change or addition to the Articles of Association of the Company is only valid if approved by special resolution at a meeting of the shareholders. Major shareholders do not have different voting rights from those of other shareholders. As at 31 December 2017 the following were the major shareholders in Bank of Cyprus Holdings Public Limited Company:        Lamesa Investments Limited European Bank for Reconstruction and Development Cyprus Popular Bank Public Co Ltd TD Asset Management Senvest Management LLC Osome Investments Ltd Eaton Vance 9.27% 5.02% 4.81% 4.34% 3.67% 3.32% 3.07% In accordance with the Company’s Constitution, at the Company’s annual general meeting in 2017:    The Directors were authorised to allot shares up to an aggregate of 147,245,978 ordinary shares of €0.10 each and a further 147,245,978 ordinary shares of €0.10 each in the case of a Rights Issue (as defined in the notice for that general meeting). The Directors were authorised to issue and allot those shares as if the pre-emption provisions set out in section 1022 of the Companies Act 2014 are dis-applied in respect of:  (i) in the case of a Rights Issue, the aggregate number of ordinary shares of €0.10 each authorised to be issued pursuant to such Rights Issue (as defined in the notice for that general meeting); and (ii) 22,309,997 ordinary shares of €0.10 otherwise that (i); and  a further 22,309,997 ordinary shares of €0.10 each for specified transactions. the Directors were also authorised to issue, allot, grant options over or otherwise dispose of Additional Tier 1 (“AT1 ECNs”) and ordinary shares pursuant to the conversion or exchange of AT1 ECNS provided that this be limited to the issue, allotment, grant of options over or other disposal of ordinary shares of an aggregate nominal amount €6,662,999 and of AT1 ECNs convertible or exchangeable into ordinary shares up to such maximum aggregate nominal amount, and the pre-emption provisions set out in section 1022 of the Companies Act 2014 in respect of this authority were dis-applied. The Directors were also authorised to make purchases of up to 10% of the Company’s shares. Such purchases may be made only at price levels which the Directors considered to be in the best interests of the shareholders generally, after taking into account the Company’s overall financial position. In addition, the minimum price which may be paid for such shares shall not be less than the nominal value of the shares and the maximum price will be the higher of 105% of the average market price of such shares and the amount stipulated by Article 5(1) of the EU Market Abuse (Buyback and Stabilisation) Regulation. The authority conferred in each of the above resolutions expires on the earlier of close of business on the date of the AGM of the Company to be held in 2018 or on 30 September 2018. The AGM was held on 29 August 2017 at the Company’s headquarters. The Chairman of the Board (who is also the Chairman of the NCGC) and the Chairmen of the AC, the RC and the HRRC were present to hear the views of the shareholders and answer questions. As is the practice, all Directors of the Board at the time of the AGM attended the AGM. At the 2017 AGM, separate resolutions were proposed on each substantially separate issue and voting was conducted by poll. The results of every AGM of the Company including details of votes cast for and against on each resolution are posted on the Group’s website www.bankofcyprus.com and released to the London and Cyprus Stock Exchanges. The AGM of the Company in 2018 is scheduled to be held on 28 August 2018. 260 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Remuneration Policy Report for the year 2017 Annual Financial Report 2017 Annual Financial Report 2015 Remuneration Policy Report for the year 2017 1. Introduction In accordance with the provisions of the CSE Code published by the CSE (4th Edition (Revised) April 2014) and in particular Annex 1 of the CSE Code, the HRRC prepares the Annual Board of Directors’ Remuneration Policy Report which is ratified by the Board and submitted to the shareholders’ AGM. The Board of Directors Remuneration Policy Report for the year 2017 was ratified by the Board on 26 March 2018. The Bank of Cyprus Group’s objective to attract, develop, motivate and retain high value professionals is considered fundamental in achieving the goals and objectives of the Group and ensuring that the right people are in the right roles whilst managing the Group’s remuneration strategy and policies in a manner aligned with the Group’s shareholders. 2. Human Resources and Remuneration Committee The Committee’s primary role is to ensure that staff members contribute to sustainable growth by staying ahead of challenges and opportunities. The Group aims to review its remuneration policies and practices on an ongoing basis and amend them where necessary, with the aim of ensuring that they are consistent with and promote sound and effective risk management. Every year, the Committee proposes to the Board the Annual Remuneration Policy Report as part of the Annual Report of the Group, which is submitted to the shareholders’ AGM for approval. The Committee also reviews the related party transactions note (Note 49) of the Consolidated Financial Statements of the Group and the Remuneration Policy Report itself. 2.1 Terms of Reference of the Human Resources and Remuneration Committee The role of the Committee is:       To ensure that the Group is equipped with the human capital necessary for the achievement of its strategic goals, whose reward will be based on personal performance and Group results. To ensure that the Group is equipped with the organisational capital to be able to effect continuous improvement. To ensure that the Group is equipped with the information capital and the technology necessary to facilitate process improvements that will create a comparative advantage in the market. To propose adequate remuneration considered necessary to attract and retain high value-adding professionals. Therefore, remuneration has to be satisfactory vis-a-vis peer companies. To set the overarching principles and parameters of compensation & benefits policies across the Group and exercise oversight for such issues. To consider the remuneration arrangements of the executive Directors of the Group, other identified staff and the employee compensation policy bearing in mind the EBA Guidelines on remuneration policies and practices, the CBC Governance Directive and the CSE Code. The Committee reviews the implementation and effectiveness of the Remuneration Policy and ensures this is in compliance with the Remuneration Framework of the CBC Governance Directive. The Committee exercises oversight of negotiations with the labour union in Cyprus and provides guidance and support to management. It advises the Board on the approval of the collective agreements and reviews the framework of industrial relations and collective agreements to ensure they are relevant to best practices and conducive to good performance. 261 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Remuneration Report for the year 2017 Annual Financial Report 2017 Remuneration Policy Report for the year 2017 (continued) 2. 2.1 Human Resources and Remuneration Committee (continued) Terms of Reference of the Human Resources and Remuneration Committee (continued) It ensures that internal control functions are involved in the design, review and implementation of the Remuneration Policy and that staff members who are involved in the design, review and implementation of the Remuneration Policy and practices have relevant expertise and are capable of forming independent judgement on the suitability of the Remuneration Policy and practices, including their suitability for risk management. The Committee reviews any voluntary retirement/separation schemes for material subsidiaries in cooperation with the Group Human Resources Division (‘HRD’) and succession planning for all divisions and subsidiaries for Senior Management throughout the Group. The Committee monitors compliance with the Code of Conduct and reviews disciplinary controls and measures of the Group as presented by HRD on an annual basis. It also reviews the annual training plan as presented by HRD and approved by the Group CEO and ensures that it creates and/or develops the right competencies and behaviours that are necessary for meeting the Group’s strategic priorities. The Committee reviews and approves the content of any resolutions submitted for approval at the AGM of the shareholders, which are prepared by the Company Secretary in cooperation with the Group’s legal advisers in accordance with Annex 3 of the Code and concern possible plans for the compensation of members of the Board in the form of shares, share warrants or share options. Senior Management and other Identified Staff The Committee reviews and approves remuneration packages of Group divisional directors, senior managers and subsidiaries’ general managers, including salary, pension policy, option plans, and other types of compensation, recommended by the Group CEO or by the Chairmen of the Risk and Audit Committees (in the case of the heads of internal control functions) in consultation with the Group CEO and HRD. The Committee also reviews the performance appraisals of Group divisional directors (except heads of internal control functions). Senior managers and subsidiaries’ general managers’ appraisals are performed by the Group CEO. The Committee reviews and approves appointments, transfers and dismissals of Group divisional directors, senior managers and subsidiaries’ general managers (except heads of internal control functions), recommended by the Group CEO, and ensures that all contractual obligations are adhered to. The Chairman of the Committee is available to shareholders in the AGM to answer any questions regarding the Remuneration Policy of the Group. 3. 3.1 Governance of Group Remuneration Policy Principles of the CSE Code of Corporate Governance Companies should implement official and transparent procedures for developing policies concerning the remuneration of executive Directors and fixing the remuneration of each Board member separately. The level of remuneration should be sufficient to attract and retain talent required for the efficient operation of the Company. Part of the remuneration of executive Directors should be determined in such a way as to link rewards to corporate and individual performance. Resolution, or any other authority allowing, variable pay should be linked to performance. The Company’s Corporate Governance Report includes a statement of the Remuneration Report and relevant criteria, as well as the total remuneration of the executive and non-executive members of the Board. 262 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Remuneration Report for the year 2017 Annual Financial Report 2017 Remuneration Policy Report for the year 2017 (continued) 3. 3.2 Governance of Group Remuneration Policy (continued) EBA Guidelines The EBA Guidelines aim to ensure that an institution’s remuneration policies and practices are consistent with and promote sound and effective risk management. The Group seeks to ensure it implements remuneration policies which are in compliance with regulatory guidelines, while at the same time operating under legal and regulatory constraints. In accordance with EBA guidelines for identification of those employees whose professional activities are deemed to have a material impact on the Group’s risk profile, the Group maintains a list of these employees known as Material Risk Takers. 4. 4.1 Remuneration Remuneration of non-Executive Directors The remuneration of non-executive Directors is not linked to the profitability of the Group. It is related to the responsibilities and time devoted for Board meetings and decision-making for the governance of the Group, and for their participation in the committees of the Board and any participation in the boards of Group subsidiary companies. The shareholders’ AGM held on 29 August 2017 approved the same levels of remuneration as those approved by the shareholders’ AGM on 25 October 2016 also approving remuneration for the members and Chairperson of the Technology Committee established in February 2017. The Committee proposes fees payable to the Chairman and the Vice Chairman, while the Chairman makes recommendations for the remuneration of the non-executive Directors to the Board for approval by the AGM, considering the following factors:       Τhe time allocated and effort exerted by non-executive Directors to meetings and decision-making in the management of the Group. Τhe undertaken level of risk. Τhe increased compliance and reporting requirements. Τhe requirement not to link remuneration of non-executive Directors to the profitability of the Group. Τhe requirement that non-executive Directors do not participate in the pension schemes of the Group. Τhe requirement not to include share options as remuneration of non-executive Directors. Neither the Chairman nor any Director participates in decisions relating to their own personal remuneration. The Chairman receives annual fees of €120,000, the Vice Chairman of €80,000, the SID of €70,000 and the members of €45,000. Additionally the Group reimburses all Directors for expenses incurred in the course of their duties. The Chairmen of the Audit and Risk Committees receive annual fees of €45,000 each and members receive €25,000. The Chairmen of the HRRC, the Nominations and Corporate Governance Committee (NCGC) and the Technology Committee (TC) receive annual fees of €30,000 each. Each member of the HRRC and the TC receives €20,000 per annum, while each member of the NCGC receives €15,000 per annum. 4.2 Remuneration and Other Benefits of Executive Directors Executive Directors The Committee reviews and approves the remuneration packages vis-a-vis their performance. The Group CEO and the Group Deputy CEO & Chief Operating Officer (‘DCEO & COO’) are employees of BOC PCL. Contracts of Employment The employment contract of the Group CEO, Mr. John Patrick Hourican, has been extended up to 31 December 2018. 263 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Remuneration Report for the year 2017 Annual Financial Report 2017 Remuneration Policy Report for the year 2017 (continued) 4. 4.2 Remuneration (continued) Remuneration and Other Benefits of Executive Directors (continued) No amount of variable remuneration has been paid during 2017 and 2016. In line with the 2016 and 2017 SREP decisions, the variable pay is capped at 10% of consolidated net revenues. Service Termination Agreements The service contract of the Group CEO includes a clause for termination, by service of four months’ notice to that effect by the executive Director, without cause but at BOC PCL’s sole discretion. In such a case, BOC PCL shall have the right to pay the Director, in lieu of notice for immediate termination. The terms of employment of Dr Christodoulos Patsalides, DCEO & COO and executive member of the Board, are mainly based on the provisions of the collective agreement in place, which provides for notice or compensation by the BOC PCL based on years of service and for a four month prior written notice by the executive director in the event of a voluntary resignation. Bonus No bonus was recommended by the Company’s Board for executive Directors for 2017. Retirement Benefit Schemes The Group CEO, Mr. John Patrick Hourican, and the DCEO & COO, Dr Christodoulos Patsalides, participate in a defined contribution plan on the same basis as other employees. The main characteristics of the retirement benefit schemes are presented in Note 14 of the Consolidated Financial Statements for the year ended 2017. Share Options No share options were granted to the executive Directors during 2017. Other Benefits Other benefits provided to the executive Directors include medical fund contributions and life insurance. The Group CEO is provided with other benefits related to his relocation and residence in Cyprus. The relevant costs for the executive Directors are disclosed in Note 49 of the Consolidated Financial Statements for the year ended 2017. The Group CEO, Mr Hourican, receives and retains fees relative to his appointment as a non-executive on the Board of Atradius N.V. of €50,000. 264 BANK OF CYPRUS GROUP Annual Corporate Governance Report 2017 Remuneration Report for the year 2017 Annual Financial Report 2017 5. Information Regarding the Remuneration of Directors for Year 2017 Remuneration for participation in the Board of Directors and its Committees € Total remuneration for services € Remuneration and benefits from other Group companies € Remuneration in the form of profit and/or bonus distribution € Assessment of the value of benefits that are considered to form remuneration € Total remuneration and benefits € Annual contribution to retirement benefits € Remuneration for services* € Executive Directors John P. Hourican Christodoulos Patsalides Non-Executive Directors Josef Ackermann Maksim Goldman Wilbur L. Ross Arne Berggren Anat Bar-Gera Lyn Grobler Michael Heger Marios Kalochoritis Michael Spanos Ioannis Zographakis 2,180,370 210,835 - - 2,180,370 210,835 - - - - - - - - - - 150,000 120,000 20,000 150,000 120,000 20,000 115,000 115,000 15,245 72,158 15,245 72,158 110,000 110,000 45,000 100,000 135,000 45,000 100,000 135,000 2,391,205 882,403 3,273,608 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 2,180,370 184,500 210,835 17,550 150,000 120,000 20,000 115,000 15,245 72,158 110,000 45,000 100,000 135,000 - - - - - - - - - - 3,273,608 202,050 * Includes employers’ contributions excluding contributions to retirement benefits. 26 March 2018 265 Additional Risk and Capital Management Disclosures 2017 266 BANK OF CYPRUS HOLDINGS GROUP Annual Financial Report 2017 Additional Risk and Capital Management Disclosures (Unaudited) Mid-Year Financial Report 30 June 2015 1. Credit risk The Central Bank of Cyprus (CBC) issued to credit institutions the Loan Impairment and Provisioning Directives of 2014 and 2015 (Directive), which provides guidance to banks for loan impairment policy and procedures for provisions. The purpose of this Directive is to ensure that credit institutions have in place adequate provisioning policies and procedures for the identification of credit losses and prudent application of International Financial Reporting Standards (IFRSs) in the preparation of their financial statements. The Directive requires certain disclosures in relation to the loan portfolio quality, provisioning policy and levels of provision. The disclosures required by the Directive, in addition to those presented in Notes 2 and 44 of the Consolidated Financial Statements for the year ended 31 December 2017, are set out in the following tables. The tables disclose Non-Performing Exposures (NPEs) based on the definitions of the European Banking Authority (EBA) standards. According to the EBA standards and European Central Bank’s (ECB) Guidance to Banks on Non-Performing loans (which was published in March 2017), NPEs are defined as those exposures that satisfy one of the following conditions: (i) The debtor is assessed as unlikely to pay its credit obligations in full without the realisation of the collateral, regardless of the existence of any past due amount or of the number of days past due. (ii) Defaulted or impaired exposures as per the approach provided in the Capital Requirements Regulation (CRR) (Article 178). (iii) Material exposures (as defined below) which are more than 90 days past due. (iv) Performing forborne exposures under probation for which additional forbearance measures are (v) extended. Performing forborne exposures under probation that present more than 30 days past due within the probation period. Exposures include all on and off balance sheet exposures, except those held for trading, and are categorised as such for their entire amount without taking into account the existence of collateral. The following materiality criteria are applied:  When the problematic exposures of a customer that fulfil the NPE criteria set out above are greater than 20% of the gross carrying amount of all on balance sheet exposures of that customer, then the total customer exposure is classified as non-performing; otherwise only the problematic part of the exposure is classified as non-performing.  Material arrears/excesses are defined as follows: - Retail exposures: - Loans: Arrears amount greater than €500 or number of instalments in arrears is greater than one. - Overdrafts: Excess amount is greater than €500 or greater than 10% of the approved limit. - Exposures other than retail: Total customer arrears/excesses are greater than €1,000 or greater than 10% of the total customer funded balances. The extension of forbearance measures does not lead to the recognition of impairment or default. NPEs may cease to be considered as non-performing only when all of the following conditions are met: (i) (ii) One year has passed since the forbearance measures were extended. (iii) Following the forbearance measures and according to the post-forbearance conditions, there is no past due amount or concerns regarding the full repayment of the exposure. (iv) No unlikely-to-Pay criteria exist for the debtor. (v) The debtor has made post-forbearance payments of a not-insignificant amount of capital (different capital thresholds exist according to the facility type). 267 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 1. Credit risk (continued) The tables below present the analysis of loans and advances to customers in accordance with the EBA standards. Gross loans and advances to customers Provision for impairment and fair value adjustment on initial recognition 31 December 2017 General governments Other financial corporations Non-financial corporations Of which: Small and Medium sized Enterprises2 Of which: Commercial real estate2 Non-financial corporations by sector Construction Wholesale and retail trade Accommodation and food service activities Real estate activities Manufacturing Other sectors Households Of which: Residential mortgage loans2 Of which: Credit for consumption2 Total on-balance sheet Group gross customer loans and advances1 Of which NPEs €000 88,780 387,169 10,586,922 €000 2,618 264,809 5,187,722 Of which exposures with forbearance measures Total exposures with forbearance measures €000 4,263 202,501 4,025,293 Of which on NPEs €000 2,358 180,836 2,851,028 Total provision for impairment and fair value adjustment on initial recognition €000 2,098 97,237 2,702,685 Of which NPEs €000 1,128 95,696 2,604,430 Of which exposures with forbearance measures Total exposures with forbearance measures €000 Of which on NPEs €000 1,367 41,254 1,228,304 1,061 40,532 1,181,589 8,695,078 4,843,832 3,630,398 2,661,059 2,464,383 2,378,953 1,089,330 1,049,587 8,002,352 4,153,585 3,497,693 2,431,002 2,037,490 1,952,487 1,013,916 973,244 2,303,375 1,973,382 1,743,627 876,763 1,314,939 420,392 2,768,637 648,131 1,578,458 7,691,844 1,028,638 342,666 775,636 3,348,567 2,452,419 1,700,494 893,938 495,099 222,789 518,261 172,232 400,366 1,350,241 1,287,442 500,603 480,676 5,254,483 2,294,294 1,918,345 1,277,136 732,039 684,818 307,742 292,726 1,000,327 504,304 285,386 221,049 275,873 266,760 84,288 80,526 18,754,715 8,803,716 6,684,476 4,734,716 4,152,261 3,988,696 1,771,528 1,703,858 1 Excluding loans and advances to central banks and credit institutions. 2 The analysis shown in lines ‘non financial corporations’ and ‘households’ is non-additive across categories as certain customers could be in both categories. 268 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 1. Credit risk (continued) 31 December 2016 General governments Other financial corporations Non-financial corporations Of which: Small and Medium sized Enterprises4 Of which: Commercial real estate4 Non-financial corporations by sector Construction Wholesale and retail trade Accommodation and food service activities Real estate activities Manufacturing Other sectors Households Of which: Residential mortgage loans4 Of which: Credit for consumption4 Total on-balance sheet Gross loans and advances to customers Provision for impairment and fair value adjustment on initial recognition Group gross customer loans and advances3 Of which NPEs €000 103,626 487,262 11,590,608 €000 4,241 372,797 6,818,489 Of which exposures with forbearance measures Total exposures with forbearance measures €000 4,978 234,505 5,052,743 Of which on NPEs €000 4,073 203,512 3,738,859 Total provision for impairment and fair value adjustment on initial recognition €000 2,685 220,013 3,020,161 Of which NPEs €000 1,615 216,926 2,932,686 Of which exposures with forbearance measures Total exposures with forbearance measures €000 Of which on NPEs €000 1,861 119,703 1,211,059 1,555 119,701 1,178,127 9,398,025 6,116,979 4,306,269 3,294,185 2,642,367 2,564,855 1,030,218 998,465 8,951,533 5,535,377 4,413,488 3,252,816 2,240,852 2,168,019 1,004,617 974,143 2,921,229 2,060,864 2,242,250 1,060,451 1,334,040 705,634 2,900,224 682,641 1,691,610 7,948,599 1,438,774 394,884 976,496 3,838,722 2,803,740 1,942,888 1,009,104 445,368 262,566 664,801 165,308 473,014 1,237,835 1,168,475 334,936 317,645 5,413,446 2,601,852 2,166,098 1,469,563 603,504 551,690 192,535 179,947 1,062,416 589,843 312,853 242,723 292,588 283,181 65,865 62,917 20,130,095 11,034,249 8,095,966 5,889,332 4,480,694 4,319,702 1,667,559 1,617,028 3 Excluding loans and advances to central banks and credit institutions. 4 The analysis shown in lines ‘non financial corporations’ and ‘households’ is non-additive across categories as certain customers could be in both categories. 269 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 1. Credit risk (continued) The analysis of loans and advances to customers excluding loans and advances to general governments by year of origination is presented in the tables below for balances as at 31 December 2017 and 2016. Gross loans and advances Loans and advances to non-financial corporations Loans and advances to other financial corporations Loans and advances to households 31 December 2017 Total gross loans and advances NPEs Provision for impairment Fair value adjustment on initial recognition Total gross loans and advances NPEs Provision for impairment Fair value adjustment on initial recognition Total gross loans and advances NPEs Provision for impair- ment Fair value adjustment on initial recognition Total gross loans and advances NPEs Provision for impair- ment Fair value adjustment on initial recognition €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 Within 1 year 2,379,891 455,727 107,289 9,840 1,549,977 271,610 68,147 6,758 96,483 51,833 10,477 1– 2 years 2,295,840 682,395 177,521 47,878 1,555,447 523,726 132,007 44,841 16,786 1,260 860 2 – 3 years 1,367,972 355,367 104,329 22,357 936,550 242,123 78,848 21,630 6,575 4,349 849 - - - 733,431 132,284 28,665 3,082 723,607 157,409 44,654 3,037 424,847 108,895 24,632 727 3 – 5 years 1,232,295 533,621 224,838 45,504 688,234 277,621 130,206 26,572 86,871 61,245 27,503 9,446 457,190 194,755 67,129 9,486 5 – 7 years 1,917,537 1,084,776 454,500 103,646 1,043,082 659,485 311,725 62,497 29,465 16,023 5,703 2,722 844,990 409,268 137,072 38,427 7 – 10 years 4,852,612 2,924,240 1,215,794 227,155 2,145,083 1,557,982 773,614 128,028 107,404 98,230 17,797 1,501 2,600,125 1,268,028 424,383 97,626 More than 10 years 4,619,788 2,764,972 1,199,073 210,439 2,668,549 1,655,175 773,230 144,582 43,585 31,869 18,541 1,838 1,907,654 1,077,928 407,302 64,019 Total 18,665,935 8,801,098 3,483,344 666,819 10,586,922 5,187,722 2,267,777 434,908 387,169 264,809 81,730 15,507 7,691,844 3,348,567 1,133,837 216,404 General governments Total on balance sheet 88,780 2,618 432 1,666 18,754,715 8,803,716 3,483,776 668,485 The table includes rescheduled loans amounting to €437 million which cannot be split by origination date and are included in the ‘Within 1 year’ time band. 270 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 1. Credit risk (continued) Gross loans and advances Loans and advances to non-financial corporations Loans and advances to other financial corporations Loans and advances to households 31 December 2016 Total gross loans and advances NPEs Provision for impairment Fair value adjustment on initial recognition Total gross loans and advances NPEs Provision for impairment Fair value adjustment on initial recognition Total gross loans and advances NPEs Provision for impair- ment Fair value adjustment on initial recognition Total gross loans and advances NPEs Provision for impair- ment Fair value adjustment on initial recognition €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 €000 Within 1 year 2,613,418 956,324 105,081 50,621 1,797,382 729,022 76,321 47,403 43,695 1,179 316 - 772,341 226,123 28,444 3,218 1– 2 years 1,717,484 572,168 86,962 29,105 1,219,786 433,754 75,491 27,943 5,365 4,786 106 - 492,333 133,628 11,365 1,162 2 – 3 years 799,077 253,268 84,858 24,802 464,035 135,966 52,981 20,453 18,857 8,132 6,370 2 316,185 109,170 25,507 4,347 3 – 5 years 1,608,809 1,038,286 347,856 99,381 983,008 688,261 251,112 65,055 93,601 68,433 30,235 11,724 532,200 281,592 66,509 22,602 5 – 7 years 3,503,311 1,874,723 610,315 161,315 1,630,886 1,026,092 420,738 91,948 46,032 37,689 20,662 5,299 1,826,393 810,942 168,915 64,068 7 – 10 years 6,428,917 4,336,616 1,605,626 406,134 3,439,414 2,558,051 1,101,876 226,763 193,260 171,045 34,657 66,445 2,796,243 1,607,520 469,093 112,926 More than 10 years 3,355,453 1,998,623 710,866 155,088 2,056,097 1,247,343 461,356 100,721 86,452 81,533 32,953 11,244 1,212,904 669,747 216,557 43,123 Total 20,026,469 11,030,008 3,551,564 926,446 11,590,608 6,818,489 2,439,875 580,286 487,262 372,797 125,299 94,714 7,948,599 3,838,722 986,390 251,446 General governments Total on balance sheet 103,626 4,241 677 2,007 20,130,095 11,034,249 3,552,241 928,453 The table above includes rescheduled loans amounting to €1,049 million which cannot be split by origination date and are included in the ‘Within 1 year’ time band. 271 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 2. Liquidity risk and funding 2.1 Encumbered and unencumbered assets Asset encumbrance arises from collateral pledged against secured funding and other collateralised obligations. An asset is classified as encumbered if it has been pledged as collateral against secured funding and other collateralised obligations and, as a result, is no longer available to the Bank of Cyprus Holdings Group (the Group) for further collateral or liquidity requirements. The total encumbered assets of the Group amounted to €3,575,278 thousand as at 31 December 2017 (2016: €3,446,873 thousand). An asset is classified as unencumbered if it has not been pledged as collateral against secured funding and other collateralised obligations. Unencumbered assets are further analysed into those that are available and can be potentially pledged and those that are not readily available to be pledged. As at 31 December 2017, the Group held €14,876,355 thousand (2016: €12,608,521 thousand) of unencumbered assets that can be potentially pledged and can be used to support potential liquidity funding needs and €3,690,269 thousand (2016: €4,595,181 thousand) of unencumbered assets that are not readily available to be pledged for funding requirements in their current form. As at 31 December 2017 no loans and advances to customers or property were pledged as collateral for Emergency Liquidity Assistance (ELA) (2016: €787 million). Loans and advances to customers include mortgage loans of a nominal amount €1,001 million (2016: €1,002 million) in Cyprus, pledged as collateral for the covered bond issued by Bank of Cyprus Public Company Ltd (BOC PCL) in 2011 under the Covered Bond Programme. Furthermore housing loans of a nominal amount €1,273 million (2016: €765 million) in Cyprus are pledged as collateral for the funding from the ECB (Note 30 of the consolidated financial statements for the year ended 31 December 2017). At 31 December 2017, loans of a nominal amount of €715 million in Cyprus are pledged as collateral for deposits of the Republic of Cyprus (2016: nil). At 31 December 2017 BOC PCL’s subsidiary Bank of Cyprus UK Ltd has pledged €161 million (2016: €244 million) of loans and advances to customers with the Funding for Lending Scheme (FLS) of the Bank of England. As at 31 December 2017 the subsidiary had drawn down Treasury bills of €82 million (2016: €29 million) under the FLS. These Treasury bills are not recorded on the consolidated balance sheet as ownership remains with the Bank of England. The table below presents an analysis of the Group’s encumbered and unencumbered assets and the extent to which these assets are currently pledged for funding or other purposes. The carrying amount of such assets is disclosed below: Total €000 4,586,567 1,029,422 14,602,454 31 December 2017 Encumbered Unencumbered Pledged as collateral €000 which can potentially be pledged €000 which are not readily available to be pledged €000 Cash and bank placements Investments Loans and advances to customers Non-current assets held for sale Property 120,525 317,167 3,137,586 - - 4,135,621 694,308 8,278,614 330,421 17,947 3,186,254 - 6,500 6,500 1,767,812 149,147 1,916,959 Total on-balance sheet 3,575,278 14,876,355 3,690,269 22,141,902 31 December 2016 Cash and bank placements Investments Loans and advances to customers Non-current assets held for sale 139,975 359,813 2,853,511 - 2,092,643 298,419 8,659,324 11,065 361,615 15,412 4,136,566 2,594,233 673,644 15,649,401 346 11,411 Property 93,574 1,547,070 81,242 1,721,886 Total on-balance sheet 3,446,873 12,608,521 4,595,181 20,650,575 272 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 2. Liquidity risk and funding (continued) 2.1 Encumbered and unencumbered assets (continued) Encumbered assets primarily consist of loans and advances to customers and investments in debt securities and property. These are mainly pledged for the funding facilities of the Central Banks (ECB, CBC and Bank of England) (Note 30 of the consolidated financial statements for the year ended 31 December 2017), for the covered bond and for deposits of the Republic of Cyprus. Investments are mainly used as collateral for repurchase transactions with commercial banks as well as supplementary assets for the covered bond (Note 46 of the consolidated financial statements for the year ended 31 December 2017). Encumbered assets include cash and other liquid assets placed with banks as collateral under ISDA/GMRA agreements which are not immediately available for use by the Group but are released once the transactions are terminated. Cash is mainly used to cover collateral required for (i) derivatives and repurchase transactions and (ii) trade finance transactions and guarantees issued. It is also used as part of the supplementary assets for the covered bond. Under the Covered Bond Programme, BOC PCL has in issue covered bonds of €650 million secured by residential mortgages originated in Cyprus. The covered bonds have a maturity date of 12 December 2018, bear interest of 3 months Euribor plus 3.25% on a quarterly basis and are traded on the Luxemburg Bourse. The covered bonds have a Conditional Pass-Through structure. All the bonds are held by BOC PCL. The credit rating of the covered bonds was upgraded to an investment grade rating and the covered bond has become eligible collateral for the Eurosystem credit operations. As from 2 October 2015, it has been placed as collateral for accessing funding from the ECB. The credit ratings of the Republic of Cyprus by the main credit rating agencies continue to be below investment grade. As a result, the ECB does not include Cyprus Government Bonds in its asset purchase programme, or as eligible collateral for Eurosystem monetary operations. Unencumbered assets which can potentially be pledged include Cyprus loans and advances which are less than 90 days past due and are expected to be eligible for ELA funding, as well as loans of overseas subsidiaries and branches which are available to be pledged. Customer loans of overseas subsidiaries and branches cannot be pledged with the CBC as collateral for ELA. Moreover, for some of the overseas subsidiaries and branches, these assets are only available to be pledged for other purposes for the needs of the particular subsidiary/branch and not to provide liquidity to any other entity of the Group. Balances with central banks are reported as unencumbered and can be pledged, to the extent that there is excess available over the minimum reserve requirement. The minimum reserve requirement is reported as unencumbered not readily available to be pledged. Unencumbered assets that are not readily available to be pledged primarily consist of loans and advances which are prohibited by contract or law to be encumbered or which are over 90 days past due or for which there are pending litigations or other legal actions against the customer, a proportion of which would be suitable for use in secured funding structures but are conservatively classified as not readily available for collateral. Properties whose legal title has not been transferred in the name of the Company or the subsidiary are not considered to be readily available as collateral. Insurance assets held by Group insurance subsidiaries are not included in the table below as they are primarily due to the insurance policyholders. 273 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 2. Liquidity risk and funding (continued) 2.1 Encumbered and unencumbered assets (continued) The carrying and fair value of the encumbered and unencumbered investments of the Group as at 31 December 2017 and 2016 are as follows: 31 December 2017 Carrying value of encumbered investments Fair value of encumbered investments Carrying value of unencumbered investments Fair value of unencumbered investments €000 €000 €000 €000 Equity securities Debt securities 1,740 1,740 315,427 315,425 76,754 635,501 76,754 641,949 Total investments 317,167 317,165 712,255 718,703 31 December 2016 Equity securities Debt securities 1,562 1,562 358,251 358,454 52,514 261,317 52,514 262,491 Total investments 359,813 360,016 313,831 315,005 2.2 Liquidity regulation In addition to the liquidity ratios applicable at each banking location where the Group operates, it has to comply with provisions on the Liquidity Coverage Ratio (LCR) under CRD IV/CRR (as supplemented by the Commission Delegated Regulation (EU) No 2015/61 which prescribes the criteria for liquid assets and methods of calculation as from 1 October 2015 and the Commission Implementing Regulation (EU) No 2016/322 which prescribes supervisory reporting requirements and applied from 10 September 2016). It also monitors its position against the Net Stable Funding Ratio (NSFR) as proposed under Basel III. The LCR is designed to promote short-term resilience of a Group’s liquidity risk profile by ensuring that it has sufficient high quality liquid resources to survive an acute stress scenario lasting for 30 days. The NSFR has been developed to promote a sustainable maturity structure of assets and liabilities. The CRR requires phased-in compliance with the LCR standard as from 1 October 2015 with an initial minimum ratio of 60%, increasing to 70% on 1 January 2016, 80% on 1 January 2017 and 100% as from 1 January 2018. In October 2014, the Basel Committee on Banking Supervision proposed the methodology for calculating the NSFR. It is noted that the NSFR did not become effective on 1 January 2018 as opposed to what was expected. As at 31 December 2017 the Group was in compliance with its regulatory liquidity requirements with respect to the LCR. On the basis of the Commission Delegated Regulation (EU) 2015/61 the Group’s LCR as at 31 December 2017 was 190% (2016: 49%); on the basis of Basel standards the Group’s NSFR was 111% (2016: 95%). Following the full repayment of ELA funding on 5 January 2017, the Group has been concentrating its efforts to comply with its regulatory liquidity ratios. Furthermore, BOC PCL and Bank of Cyprus UK Ltd must comply with their local regulatory liquidity ratios. The minimum regulatory liquidity ratios for the operations in Cyprus are set by the CBC. In September 2017, the CBC proceeded with a partial relaxation of the regulatory liquidity requirements. On 1 January 2018, the local regulatory liquidity requirements were abolished, in accordance with the CRR. In December 2017, the CBC introduced a macroprudential measure in the form of a liquidity add-on that was imposed on top of the LCR with effect on 1 January 2018. The objective of the measure is to ensure that there will be a gradual release of the excess liquidity arising from the lower liquidity requirements under the LCR compared to the ones under the local regulatory liquidity requirements previously in place. 274 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 2. Liquidity risk and funding (continued) 2.2 Liquidity regulation (continued) The LCR add-on applies stricter outflow and inflow rates on some of the parameters used in the calculation of the LCR than those defined in the Commission Delegated Regulation (EU) 2015/61 as well as additional liquidity requirements in the form of outflow rates on other items that are not subject to any outflow rates as per the Regulation. The measure will be implemented in two stages. The first stage requires stricter outflow and inflow rates which are applicable from 1 January 2018 until 30 June 2018. The second stage requires more relaxed outflow and inflow rates compared to the initial ones, and are applicable from 1 July 2018 until 31 December 2018. Specifically, there will be a reduction of 50% of the LCR add-on rates on 1 July 2018. The additional liquidity requirement is expected to be implemented up to 31 December 2018. The CBC may propose to modify or extend the period of application of this macroprudential measure depending on the results of the follow-up of the banks’ actions on how the excess liquidity is utilised. As at 31 December 2017 BOC PCL was not in compliance with all the local regulatory liquidity requirements (which were abolished on 1 January 2018 as per Article 412(5) of EU Regulation No 575/2013) with respect to its operations in Cyprus. More specifically, BOC PCL was in compliance with the CBC EUR stock ratio and the CBC EUR 0-30 days mismatch ratio, but was not in compliance with the rest of the local regulatory liquidity requirements. As at 31 December 2017, the Group and BOC PCL were in compliance with LCR taking into account the imposed add-on implemented on 1 January 2018. 2.3 Liquidity reserves 31 December 2017 31 December 2016 Composition of the liquidity reserves Liquidity reserves Liquidity reserves as per LCR Delegated Reg (EU) 2015/61 LCR eligible Level 1 Level 1 Level 2A Liquidity reserves Liquidity reserves of which Delegated Reg (EU) 2015/61 LCR eligible Level 1 Cash and balances with central banks Nostro and overnight placements with banks Other placements with banks €000 €000 €000 €000 €000 3,239,985 2,896,935 - 1,361,581 1,146,015 676,431 283,735 - - - - 420,749 373,645 - - Liquid investments Available ECB Buffer 591,565 548,706 69,782 172,333 256,325 2,151 - - 124,998 - Total 4,793,867 3,445,641 69,782 2,453,306 1,402,340 Investments under Liquidity Reserve are shown at market value net of haircut (as prescribed by regulators) in order to reflect the actual liquidity value that can be obtained. Liquid investments exclude local issues of the Cyprus Government Bonds and include off balance sheet Bank of England Treasury Bills acquired by Bank of Cyprus UK Ltd through the encumbrance of customer loans with the Bank of England. Under the LCR Liquidity Reserves, all Cyprus Government Bonds are eligible for inclusion as Level 1 assets given that they are issued by a Member State in the local currency. LCR does not require liquid assets to be eligible as collateral for central bank operations and are included at market value. Under LCR, only €52 million of Bank of Cyprus UK Ltd liquid assets are included since this is the amount required to bring the Bank of Cyprus UK Ltd’s LCR ratio to 100% as per Article 8(2) of the Commission Delegated Regulation (EU) 2015/61 which requires that in the case there is no free transferability of liquid assets from a third country, the institution can only use those assets that meet the liquidity outflows of that country. The Liquidity Reserves are managed by Group Treasury. ELA was fully repaid on 5 January 2017. Following the full repayment of ELA on 5 January 2017, all ELA collateralised assets have subsequently been released. 275 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 2. Liquidity risk and funding (continued) 2.3 Liquidity reserves (continued) As at 31 December 2017, ECB funding was at €930 million, of which €100 million was from the weekly Main Refinancing Operations (MRO) and €830 million was from the 4-year Targeted Longer-Term Refinancing Operations (TLTRO II). In December 2016, BOC PCL borrowed an amount of €600 million through the new series of TLTRO (TLTRO II) announced by the ECB in March 2016 and an amount of €50 million through the LTRO. In March 2017, the €50 million borrowed through the LTRO matured and €40 million was re-borrowed, which matured in June 2017 and was re-borrowed through the new LTRO. This was repaid in September 2017. In March 2017, BOC PCL raised an additional €230 million funding from ECB, through TLTRO II. In April 2017, an additional €40 million was borrowed through the MRO of which €10 million was repaid in May 2017 and the remaining €30 million was repaid in August 2017. In December 2017 an amount of €100 million was borrowed through the MRO. In January 2017, BOC PCL issued a €250 million unsecured and subordinated Tier 2 Capital Note (Note) under BOC PCL’s EMTN Programme. The Note was priced at par with a coupon of 9.25% per annum payable annually up to 19 January 2022 and then a rate at the then prevailing 5-year swap rate plus a margin of 9.176% per annum up to 19 January 2027, payable annually. The Note matures on 19 January 2027. BOC PCL has the option to redeem the Note early on 19 January 2022, subject to applicable regulatory consents. In December 2017, Bank of Cyprus UK Ltd, a 100% subsidiary of BOC PCL issued a £30 million unsecured and subordinated Tier 2 Capital Loan (Loan), priced at par. The Loan has a coupon of 8.00% up to 21 December 2022 and then a rate at the then prevailing 5-year swap rate plus a margin of 6.99% per annum, up to 21 December 2027, payable semi-annually, in June and December. The Loan matures on 21 December 2027. Bank of Cyprus UK Ltd has the option to redeem the Loan early on 21 December 2022, subject to meeting the notice conditions. 3. Other risks 3.1 Operational risk Operational risk is defined as the risk of a direct or indirect impact loss resulting from inadequate or failed internal processes, people and systems or external events. The Group includes in this definition compliance, legal and reputational risk. The Group recognises that the control of operational risk is directly related to effective and efficient management practices and high standards of corporate governance. To that effect, the management of operational risk is geared towards maintaining a strong internal control governance framework and managing operational risk exposures through a consistent set of management processes that drive risk identification, assessment, control and monitoring. The main objectives of operational risk management within the Group are: (i) the development of operational risk awareness and culture, (ii) the provision of adequate information to the Group’s management at all levels in relation to the operational risk profile at a Company, Unit and activity level, so as to facilitate decision making for risk control activities, and (iii) the control of operational risk to ensure that operational losses do not cause material damage to the Group’s franchise and that the impact on the Group’s profitability and corporate objectives is contained. Operational risks can arise from all business lines and from all activities carried out by the Group and are thus diverse in nature. To enable effective management of all material operational risks, the operational risk management framework adopted by the Group is based on the three lines of defence model, through which risk ownership is dispersed throughout the organisation. The first line of defence comprises management and staff who have immediate responsibility of day-to-day operational risk management and own the risk. Each business unit owner is responsible for identifying and managing all the risks that arise from the unit’s activities as an integral part of their first line responsibilities. 276 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 3. Other risks (continued) 3.1 Operational risk (continued) The second line of defence comprises the risk management function whose role is to provide operational risk oversight and independent and objective challenge to the first line of defence, supported by other specialist control and support functions such as the Group Compliance, Legal, Information Technology and Information Security and Health and Safety functions. The third line of defence comprises the Internal Audit function, which provides independent assurance over the integrity and effectiveness of the risk management framework throughout the Group. During 2017, further progress has been achieved towards the ongoing enhancement of Operational Risk Management, since a new Fraud Risk Management System was deployed towards the end of the year. Implementation of this system will take place in Phases, and Phase I involves internet and mobile banking online transactions. Operational risk loss events are classified and recorded in the Group’s internal loss database (a new improved system was launched in 2016 providing for the integration of all risk-control data under the same system) to enable risk identification, corrective action and statistical analysis. During the year ended 31 December 2017, 282 loss events with gross loss equal to or greater than €1,000 each were recorded (2016: 92). The Group strives to continuously enhance its risk control culture and increase awareness of its employees on operational risk issues through ongoing staff training. The Group also maintains adequate insurance policies to cover for unexpected material operational losses. Business resilience is treated as a priority and as such the Group places significant importance on continuously enhancing the continuity arrangements for all markets in which the Group operates, to ensure timely recovery in the case of events that may cause major disruptions to the business operations. 3.2 Regulatory risk The Group’s operations are supervised by the ECB as a supervisory body for all the banks in the Eurozone area (referred to as the Single Supervisory Mechanism, SSM). The ECB exercises its supervisory responsibilities in cooperation with the national central banks which together constitute the Eurosystem, the central banking system of the Eurozone. As such, in Cyprus the ECB cooperates with the CBC, as the Company is considered as a significant credit institution for the purposes of the ECB Regulation. The overseas subsidiaries and branches of the Group are also supervised by the ECB and the national regulatory authorities in the countries where they operate. In this context, the Group is exposed to a series of regulatory and legal risks:  Legislative action and regulatory measures which may materially impact the Group and the financial and economic environment in which it operates. The Group's business and operations are subject to substantial regulation and supervision and can be negatively affected by its non-compliance with regulatory requirements and any adverse regulatory and governmental developments. The implementation of SSM recommendations as well as Supervisory Review and Evaluation Process (SREP) prudential requirements, may impact the Group and the Group’s strategy. The implementation of a more demanding and restrictive regulatory framework (including CRD IV/CRR) with respect to, amongst others, capital ratios, leverage, liquidity and disclosure requirements, notwithstanding the benefit to the financial system, poses additional risks for banks. Changes in laws or regulations might also restrict certain types of transactions, affect the Group's strategy and lead to modification of the customer charges for banking products or transactions. The Group is subject to certain regulatory and legal constraints in originating new loans, managing and restructuring existing loans and foreclosing on collateral. The Group is exposed to tax risk and failure to manage such risk may adversely impact the Group.       277 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 3. Other risks (continued) 3.2 Regulatory risk (continued) The EU Bank Recovery and Resolution Directive 2014/59/EU (BRRD) establishes a framework for the recovery and resolution of European Union (EU) credit institutions. The stated aim of the BRRD is to provide supervisory resolution authorities, with common tools and powers to address banking crises pre-emptively in order to ensure the continuity of the institution’s critical financial and economic functions whilst safeguarding financial stability and minimising taxpayers’ exposure to losses. The BRRD includes the concept of loss absorption and a minimum requirement for own funds and eligible liability (MREL). The BRRD also has significant funding implications for credit institutions, which include the establishment of pre-funded resolution funds of 1% of deposits covered under the EU Deposit Guarantee Schemes Directive (DGSD) 2014/49 to be built up by 31 December 2024. The BRRD has been implemented in Cyprus. The EU has also established a Single Resolution Mechanism (SRM), set up under the Single Resolution Mechanism Regulation No 806/2014 as part of the European Banking Union. Under the SRM, a single resolution process applies to all credit institutions supervised by the SSM. This process is co-ordinated by the Single Resolution Board (SRB). The Company is subject to the supervision of the SSM and accordingly the SRM. The SRM Regulation is closely connected with the BRRD. For credit institutions within the SSM, the SRB effectively takes on the role of the relevant national resolution authority established under the BRRD. The Company is subject to the supervision of the SRB. On 1 January 2016 the Directive 2009/138/EC of the European Parliament and of the Council and the relevant Regulations on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) came in force. Additionally on 11 April 2016 the Law on Insurance and Reinsurance Services and Other Related Issues (Law 38(I)/2016) became effective. The new legal and regulatory framework introduced significantly increased quantitative and qualitative requirements. The Insurance Companies Control Service (Ministry of Finance) supervises the required capital which should be maintained by insurance companies in order to ensure they meet the solvency requirement. Additional targets are set by the insurance subsidiaries of the Group, EuroLife Ltd and General Insurance of Cyprus Ltd, in order to maintain sound capital ratios which can support operational targets. The insurance subsidiaries of the Group manage their capital base by monitoring the coverage of solvency capital requirements on a quarterly basis using high quality own funds. Both subsidiaries are compliant with the solvency capital requirements imposed by the Insurance Companies Control Service during 2017. The Cyprus Investment and Securities Corporation Ltd (CISCO) and BOC Asset Management Ltd (BOCAM) are members of the Investor Compensation Fund (ICF) which was established pursuant to Article 59(1) and (2) of Law 144(Ι)/2007 which provides for the Provision of Investment Services, the Exercise of Investment Activities, the Operation of Regulated Markets and other Related Matters as an investor compensation fund for ICF clients other than credit institutions. The powers and functions of the ICF are regulated by the provisions of the Directive 144-2007-15 of the Cyprus Securities and Exchange Commission (CySEC) for the Continuance of the Operation and the Operation of the IF Investor Compensation Fund. Both CISCO and BOCAM are obliged to contribute annually an amount of up to 0.1% of the eligible funds and financial instruments of the member’s clients and to contribute when called upon by CySEC an extraordinary supplementary contribution, if it deems that the existing means for the payment of compensation are inadequate, particularly in the event of a liquidation procedure of a member of the ICF. The amount of the extraordinary supplementary contribution is not designated (nor capped). The EU Investor Compensation Schemes Directive 97/9/EC (the ICSD) requires member states to establish Investor Compensation Schemes (ICS) to protect investors with respect to firms carrying on investment business (which may be an investment firm or a credit institution). An ICS will typically make payouts if an investment firm or credit institution carrying on investment business fails. In Cyprus, the Investor Compensation Fund for Clients of Banks (the Fund) is governed by the establishment and operation regulations of an Investor Compensation Fund for Clients of Banks Regulations of 2004 and 2007. Such a Fund is administered by the CBC. The Company is obligated to contribute annually an amount of up to 0.001% of the eligible funds and financial instruments of the Company's clients. 278 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 3. Other risks (continued) 3.3 Intensity of competition The Group faces intense competition in the markets in which it operates in the Cyprus economy. Competition primarily originates from other commercial banks, the credit co-operative sector, branches and subsidiaries of foreign banks, and insurance companies offering savings and investment products. Following the acquisition of the operations of Laiki Bank in 2013, the Group’s market share in total loans in Cyprus increased significantly. The Group’s market share in deposits however, had dropped as a result of the recapitalisation by own means as part of the economic adjustment programme. Liquidity shortages were covered by the provision of ELA through the Eurosystem. By January 2017 the Group repaid the entire ELA as a result of substantial deleveraging and the gradual return of deposits. Following the abolition of all capital controls there were increasing deposit inflows in the banking system. During 2015 and 2016 the Group’s market share in deposits increased significantly and continued to increase in 2017 as well. The Group remains today the biggest and most systemically important local banking organisation in Cyprus. Any intensification of competition as a result of more competitive interest rates being offered on deposits and advances compared to those offered by the Group, may create pressure on Group profitability. 3.4 Litigation risk The Group may, from time to time, become involved in legal or arbitration proceedings which may affect its operations and results. Litigation risk arises from pending or potential legal proceedings against the Group (Note 39 of the consolidated financial statements for the year ended 31 December 2017) and in the event that legal issues are not properly dealt with, by the Group, resulting in the cancellation of contracts with customers thus exposing the Group to legal actions against it. 3.5 Political risk External factors which are beyond the control of the Group, such as developments in the European and the global economy, as well as political and government actions in Cyprus can affect the operations of the Group, its strategy and prospects, either directly or indirectly through their possible impact on the domestic economy. Cyprus is a small open economy with a large and expanding export sector. Exports of goods and services have been about 66% of Gross Domestic Product (GDP) in 2016 and 2017. As a result the Cyprus economy is exposed to developments outside its borders, particularly in Russia, the UK and Greece. Cyprus is also exposed to developments in the European Union and the Eurozone that may lead to a payments crisis or changes in the regulatory and supervisory framework. The exit of the UK from the EU may have consequences for both the UK and the EU and as a result Cyprus may be affected. There are close trade and investment links between Cyprus and the UK which means that the Cyprus economy is vulnerable to the impact on the UK economy of UK’s exit from the EU. The pound sterling has already depreciated sharply against the euro since the Brexit referendum in June 2016. The initial impact on the UK economy so far has been less severe than initially forecasted but the economy is slowing down with inflation on the rise because of the currency depreciation. According to the European Commission real GDP growth was 1.8% in 2017 and expected to slow down to 1.4% and 1.1% in 2018 and 2019 respectively. In an adverse scenario, it is very likely for real GDP to contract in 2018-2019. A slowdown in economic activity in the UK and outright contraction in an adverse scenario, coupled with the decline in the exchange rate of the pound against the euro, will reduce the competitiveness of Cypriot exports to the UK. Exports of goods to the UK are about 8% of total exports of goods on average in the three years to 2016. This compares to a share of about 29% on average in the three years to 2004. Cyprus’ trade has been increasingly diverting toward the euro area after accession to the EU. On the services side, particularly tourism, the UK remains a significant source country. Arrivals from the UK were 34.3% of total arrivals in 2017. This compares with a share of 36.3% in 2016 and a share near 60% about a decade ago. 279 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 3. Other risks (continued) 3.5 Political risk (continued) The UK is likely to exit the EU with a free trade agreement that entails on the one hand a host of trade barriers between it and its existing trade partners and on the other hand, the freedom to pursue free trade with other non-EU countries including the US, Japan and also China. In the transition period however, there will likely be economic setbacks both for the UK and the EU including Cyprus and mitigating actions will be required for trade diversion. Developments in other non-EU countries with which Cyprus maintains significant economic links, the unresolved Cyprus problem, and political and social unrest or escalation of military conflict in neighbouring countries and/or other overseas areas may adversely affect the Cyprus economy. Russia is an important economic partner of Cyprus both in terms of tourism and international business flows. Any developments that impact negatively on these linkages will have a negative impact on the economy and will thus affect the Group’s operations. The economic situation in Russia has been gradually improving driven by the stabilisation in oil prices, the return of foreign direct investment and booms in certain sectors, for example agriculture. These factors are helping the country pull out of recession. After dropping by 2.8% in 2015 and by 0.2% in 2016, real GDP recovered by 1.5% in 2017 and expected to increase by 1.7% in 2018 according to the IMF. Diversification of the economy and medium term growth are hindered by structural factors. Cyprus is less exposed to the crisis in Greece than it was prior to its own crisis and with the risk of a disorderly exit now remote, the outlook is considerably better. The Greek economy recovered in 2017 growing by 1.3% following a marginal drop of 0.3% during 2016 according to provisional data from the Hellenic Statistical Authority. Real GDP is expected to increase by 2.5% in each of 2018 and 2019 according to the European Commission’s Winter 2018 Interim European Economic Forecast. Greece is benefiting from the broader recovery in Europe and improvements in competitiveness achieved by structural reforms. Greece has been receiving bailout funds in recent months without significant problems or disagreements with its creditors. The country’s third bailout programme is set to end in August 2018 but it is not yet fully clear what will follow with a debt to GDP ratio of 180.8% at the end of 2016 (as per Eurostat). Greece will probably continue to need financial assistance in a form other than a bailout programme, such as for instance, a precautionary credit line. There are still unaddressed problems in Greece’s structural economy and the reform effort should continue after the country exits the bailout programme. The European Union and the Eurozone remain fragmented and there are widespread disagreements regarding the nature of future reforms. As such, the medium term will see policy inaction and the divisions at national levels will deepen. The reform agenda includes ways to deepen financial integration, mechanisms for coping with future crises and security and defense cooperation. Disagreements over these issues will tend to expose the divisions across Europe. France seeks to increase spending and financial risk sharing within the EU, while Germany focuses on a more efficient oversight of fiscal policies and the financial sectors of the member states before risk sharing can become possible. Italy remains a major source of uncertainty. The rise of a Eurosceptic government in the third largest economy in the Eurozone can be a source of instability. On monetary policy the ECB is poised to end its Quantitative Easing programme in 2018 and possibly start to raise interest rates in 2019. The ECB has been particularly cautious in tapering its Quantitative Easing programme and in tightening its monetary stance. But the recent acceleration in economic activity may lead to the end of the overly accommodative policies may be coming to an end. Given the above, the Group recognises that unforeseen political events can have negative effects on the fulfilment of contractual relationships and obligations of its customers and other counterparties, which may have a significant impact on the Group’s activities, operating results and position. 280 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 4. Capital management The primary objective of the Group’s capital management is to ensure compliance with the relevant regulatory capital requirements and to maintain strong credit ratings and healthy capital adequacy ratios in order to support its business and maximise shareholders’ value. With the exception of certain specified provisions, the CRR and Capital Requirements Directive (CRD IV) came into effect on 1 January 2014. The CRR and CRD IV transposed the new capital, liquidity and leverage standards of Basel III into the European Union’s legal framework. CRR establishes the prudential requirements for capital, liquidity and leverage for credit institutions and investment firms. It is directly applicable in all EU member states. CRD IV governs access to deposit-taking activities and internal governance arrangements including remuneration, board composition and transparency. Unlike the CRR, member states were required to transpose the CRD IV into national laws and it allowed national regulators to impose additional capital buffer requirements. CRR introduced significant changes in the prudential regulatory regime applicable to banks including amended minimum capital adequacy ratios, changes to the definition of capital and the calculation of risk weighted assets and the introduction of new measures relating to leverage, liquidity and funding. CRR permits a transitional period for certain of the enhanced capital requirements and certain other measures, which will be largely fully effective by 2019. In addition, the Regulation (EU) 2016/445 of the ECB on the exercise of options and discretions available in Union law (ECB/2016/4) provides certain transitional arrangements which supersede the national discretions unless they are stricter than the EU Regulation 2016/445. The CET1 ratio of the Group at 31 December 2017 stands at 12.7% and the total capital ratio at 14.2% on a transitional basis. The minimum Pillar I total capital requirement is 8.0% and may be met, in addition to the 4.5% CET1 requirement, with up to 1.5% by Additional Tier 1 capital and with up to 2.0% by Tier 2 capital. The Group is also subject to additional capital requirements for risks which are not covered by the Pillar I capital requirements (Pillar II add-ons). The Group’s minimum phased-in CET1 capital ratio requirement for 2017 was 9.50%, comprised of a 4.50% Pillar I requirement, a 3.75% Pillar II requirement and the Capital Conservation Buffer (CCB) of 1.25% applicable for 2017. Following the Supervisory Review and Evaluation Process (SREP) performed by the ECB in 2017 and based on the confirmation received in December 2017, the Pillar II requirement applicable from 1 January 2018, has been reduced to 3.00% from 3.75%. As a result, the Group’s minimum phased-in CET1 capital ratio has been reduced to 9.375% from 9.50%, comprising of a 4.50% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018. The ECB has also provided revised lower non-public guidance for an additional Pillar II CET1 buffer. The overall Total Capital Ratio Requirement was 13.00%, comprising of a Pillar I requirement of 8.00% (of which up to 1.50% can be in the form of Additional Tier 1 capital and up to 2.00% in the form of Tier 2 capital), a Pillar II requirement of 3.75% (in the form of CET1), and the CCB of 1.25% applicable for 2017. Following the 2017 SREP, the overall Total Capital Ratio Requirement has been reduced to 12.875% from 13.00%, comprising of 8.00% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018. The minimum CET1 requirement including Pillar II, applicable for the year 2016 was determined by the ECB at 11.75% in November 2015 and included CCB on a fully loaded basis. The above minimum ratios apply for both, BOC PCL and the Group. BOC PCL is 100% subsidiary of the Company and its principal activities are the provision of banking, financial services and management and disposal of property predominately acquired in exchange of debt. The capital position of the Group and BOC PCL at 31 December 2017 exceeds both their Pillar I and their Pillar II add-on capital requirements. However, the Pillar II add-on capital requirements are a point-in-time assessment and therefore are subject to change over time. Based on the provisions of the Macroprudential Oversight of Institutions Law of 2015 which came into force on 1 January 2016, the CBC is the designated Authority responsible for setting the macroprudential buffers that derive from the CRD IV. 281 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 4. Capital management (continued) In accordance with the provisions of the above law, the CBC sets, on a quarterly basis, the Countercyclical Capital buffer (CCyB) level in accordance with the methodology described in this law. The CCyB is effective as from 1 January 2016 and is determined for all the countries in the European Economic Area (EEA) by their local competent authorities ahead of the beginning of each quarter. The CBC has set the level of the CCyB for Cyprus at 0% for the years of 2017 and 2016. The CCyB for the Group has been calculated at 0% for the years 2017 and 2016. In accordance with the provisions of this law, the CBC is also the responsible authority for the designation of banks that are Other Systemically Important Institutions (O-SIIs) and for the setting of the O-SII buffer requirement for these systemically important banks. The Group has been designated as an O-SII and the CBC set the O-SII buffer for the Group at 2.0%. This buffer will be phased-in gradually, starting from 1 January 2019 at 0.5% and increasing by 0.5% every year thereafter, until being fully implemented (2.0%) on 1 January 2022. Following the enactment of the amendments in the Cypriot Banking Law on 3 February 2017, the Capital Conservation Buffer (CCB) is gradually phased-in at 0.625% in 2016, 1.25% in 2017, 1.875% in 2018 and is fully implemented on 1 January 2019 at 2.5%. The Bank Recovery and Resolution Directive (BRRD) requires that from January 2016 EU member states shall apply the BRRD’s provisions requiring EU credit institutions and certain investment firms to maintain a minimum requirement for own funds and eligible liabilities (MREL), subject to the provisions of the Commission Delegated Regulation (EU) 2016/1450. Although the precise calibration and ultimate designation of the Group’s MREL has not yet been finalised, BOC PCL is monitoring developments in this area very closely. The Group’s overseas banking subsidiaries comply with the regulatory capital requirements of the local regulators in the countries in which they operate. The insurance subsidiaries of the Group comply with the requirements of the Superintendent of Insurance including the minimum solvency ratio. The regulated investment firms of the Group comply with the regulatory capital requirements of the CySEC laws and regulations. 282 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 4. Capital management (continued) 4.1 Capital position The capital position of the Group and the BOC PCL under CRD IV/CRR basis (after applying the transitional arrangements) is presented below: Regulatory capital Transitional Common Equity Tier 1 (CET1)5,6 Transitional Additional Tier 1 capital (AT1) Tier 2 capital (T2) Transitional capital6 Risk weighted assets – credit risk7 regulatory total Risk weighted assets – market risk Risk weighted assets – operational risk Total risk weighted assets Group BOC PCL 31 December 2017 €000 31 December 2016 €000 31 December 2017 €000 31 December 2016 €000 2,184,152 2,727,997 2,022,949 2,727,172 - - - - 266,174 21,423 255,026 12,394 2,450,326 2,749,420 2,277,975 2,739,566 15,538,637 16,861,793 14,491,974 16,041,100 4,731 6,231 2,448 2,750 1,717,125 1,997,200 1,613,463 1,827,938 17,260,493 18,865,224 16,107,885 17,871,788 Transitional Common Equity Tier 1 ratio Transitional total capital ratio 12.7 14.2 14.5 14.6 12.6 14.1 15.3 15.3 % % % % During the year ended 31 December 2017, the CET1 was negatively affected by the loss for the year and by the phase-in of transitional adjustments, mainly deferred tax asset. The Risk-Weighted Assets (RWAs) were positively affected by the Group’s ongoing efforts for risk-weighted assets optimisation as well as of the increased provisioning. As a result of the above, the CET1 ratio decreased by 180 bps during the year. Additional information on capital management can be found in the 2017 Pillar 3 Disclosures Report on the Group’s website, www.bankofcyprus.com (Investor Relations). 5 CET1 inlcudes regulatory deductions, primarily comprising deferred tax assets and intangible assets amounting to €135,205 thousand and €88,407 thousand as at 31 December 2017 and 31 December 2016 respectively. 6 Following the Regulation (EU) 2016/445 of the ECB of 14 March 2016 on the exercise of options and discretions available in Union law (ECB/2016/4), the deferred tax asset phase-in period reduced from 10 to 5 years, with effect as from the reporting of 31 December 2016. 7 Includes Credit Valuation Adjustmnets (CVA). 283 BANK OF CYPRUS HOLDINGS GROUP Additional Risk and Capital Management Disclosures (Unaudited) Annual Financial Report 2017 5. Internal Capital Adequacy Assessment Process (ICAAP), Internal Liquidity Assessment Process (ILAAP), Pillar II and Supervisory Review and Evaluation Process (SREP) and ECB 2018 Stress Test The Group prepares the ICAAP and ILAAP reports annually. Both reports for year 2016 were approved by the Board of Directors and submitted to the SSM in April 2017. The current year ICAAP and ILAAP reports are in progress and are expected to be finalised and submitted to the SSM by the end of April 2018. The Group also undertakes a quarterly review of its ICAAP results considering the latest actual and forecasted information. During the quarterly review, the Group’s risk profile and risk management policies and processes are reviewed and any changes since the annual ICAAP exercise are taken into consideration. The ICAAP process demonstrates that the Group has sufficient capital under both the base and stress case scenarios to support its business and achieve its objectives having regard to its Board approved Risk Appetite and Strategy, and to meet its regulatory capital, leverage and liquidity requirements. A quarterly review is also performed for the ILAAP through quarterly stress tests submitted to the Assets and Liabilities Committee (ALCO) and Board Risk Committee. The Group’s ILAAP analysis demonstrates that the volume and capacity of liquidity resources available to the Group are adequate to support its business model, to achieve its strategic objectives under both the business as usual and severe stress scenarios and to meet regulatory requirements including the LCR and Net Stable Funding ratios. The ECB, as part of its supervisory role, has been conducting the SREP and onsite inspections on the Group. SREP is a holistic assessment of, amongst other things, the Group’s business model, internal governance and institution-wide control arrangements, risks to capital and adequacy of capital to cover these risks and risks to liquidity and adequacy of liquidity resources to cover these risks. The objective of the SREP is for the ECB to form an up-to-date supervisory view of the Group’s risks and viability and to form the basis for supervisory measures and dialogue with the Group. Additional capital and other requirements could be imposed on the Group as a result of these supervisory processes, including a revision of the level of Pillar II add-ons as the Pillar II add-on capital requirements are a point-in-time assessment and therefore subject to change over time. ECB 2018 Stress Test The EBA in cooperation with the European Systemic Risk Board (ESRB), initiated the 2018 EU-wide stress tests to assess the resilience of financial institutions to adverse market developments and is expected to be completed in the fourth quarter of 2018. The Group will participate in the bi-annual ECB 2018 Stress test, as in 2016. 284 BANK OF CYPRUS HOLDINGS GROUP Definitions and explanations on Alternative Performance Measures Disclosures Accumulated provisions Αccumulated provisions comprise (i) provisions for impairment of customer loans and advances to customers, (ii) the fair value adjustment on initial recognition of loans, and (iii) provisions for off-balance sheet exposures (contingent liabilities and commitments) disclosed on the balance sheet within other liabilities. Cost to Income ratio Cost-to-income ratio is calculated as the total staff costs and other operating expenses (excluding advisory and other restructuring costs) divided by total income (excluding gains/(losses) on disposals of non-core assets). Interest earning assets Interest earning assets is the sum of: cash and balances with central banks, loans and advances to banks, net loans and advances to customers, investments (excluding equities and mutual funds) and derivatives. Leverage ratio The leverage ratio is calculated as the tangible total equity to total assets as presented on the balance sheet. Loans in arrears for more than 90 days (90+ DPD) Loans in arrears for more than 90 days (90+ DPD) are defined as loans past-due for more than 90 days and loans that are impaired (impaired loans are those (i) for which a provision for impairment has been recognised on an individual basis or (ii) for which incurred losses existed at their initial recognition or (iii) customers in Debt Recovery). Loans in arrears for more than 90 days (90+ DPD) ratio Net fee and commission income over total income Loans past-due for more than 90 days (as defined) divided by loans before the deduction of accumulated provisions (as defined). Fee and commission income less fee and commission expense divided by total income (as defined), but excluding gains/(losses) on disposals of non-core assets. Net Interest Margin Net interest margin is calculated as the net interest income (annualised) divided by the average interest earning assets. Net loans to deposit ratio Net loans to deposits ratio is calculated as the net loans and advances to customers divided by customer deposits. Where applicable, loans and deposits held for sale are added to the numerator and denominator respectively. Non-performing exposures (NPEs) According to the EBA standards, a loan is considered a non-performing exposure if: (i) the debtor is assessed as unlikely to pay its credit obligations in full without the realisation of the collateral, regardless of the existence of any past due amount or of the number of days past due, or (ii) the exposures are impaired i.e. in cases where there is a specific provision, or (iii) there are material exposures which are more than 90 days past due, or (iv) there are performing forborne exposures under probation for which additional forbearance measures are extended, or (v) there are performing forborne exposures under probation that present more than 30 days past due within the probation period. The NPEs are reported before the deduction of accumulated provisions (as defined). NPE ratio NPE ratio is non-performing exposures (as defined) divided by loans before the deduction of accumulated provisions (as defined). Operating profit return on average assets Provisioning charge (cost of risk) Operating profit return on average assets is calculated as the operating profit divided by the average of total assets for the relevant period. Provisioning charge (cost of risk) is calculated as the provisions for impairment of customer loans plus the gain on derecognition of loans and advances to customers for the year divided by average customer loans before accumulated provisions (as defined). 285 BANK OF CYPRUS HOLDINGS GROUP Definitions and explanations on Alternative Performance Measures Disclosures Provisioning coverage ratio for 90+ DPD Provisioning coverage ratio for NPEs Total income Provisioning coverage ratio for 90+ DPD is calculated as the accumulated provisions (as defined) divided by 90+ DPD (as defined). Provisioning coverage ratio for NPEs is calculated as accumulated provisions (as defined) over NPEs (as defined). Comprises total of net interest income, net fee and commission income, net foreign exchange gains, net gains on financial instrument transactions and disposal/dissolution of subsidiaries, insurance income net of claims and commissions, net (losses)/gains from revaluation and disposal of investment properties, net gains on disposal of stock of property and other income. 286 

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