UBS AG
Annual Report 2008

Plain-text annual report

annual report 2008 1 | Strategy, performance and responsibility 2 | UBS business divisions and Corporate Center 3 | Risk and treasury management 4 | Corporate governance and compensation 5 | Financial information Contents Letter to shareholders 2 5 UBS reporting at a glance 6 Other sources of information 7 Contacts 1. Strategy, performance and responsibility Financial performance 12 Strategy and structure 18 The making of UBS 20 Current market climate and industry drivers 23 Risk factors 28 29 Measurement and analysis of performance 32 UBS reporting structure 33 Accounting changes 35 Key performance indicators 38 UBS results 44 Balance sheet 47 Off-balance sheet 52 Cash flows 54 UBS employees 60 Corporate responsibility 2. UBS business divisions and Corporate Center 74 Global Wealth Management & Business Banking 77 Wealth Management International & Switzerland 83 Wealth Management US 89 Business Banking Switzerland 94 Global Asset Management Investment Bank 102 110 Corporate Center 3. Risk and treasury management 120 Risk management and control 125 Risk concentrations 128 Market risk 134 Credit risk 149 Operational risk 150 Treasury management 151 159 162 Capital management 168 Shares and capital instruments 172 UBS shares in 2008 176 Basel II Pillar 3 Liquidity and funding management Interest rate and currency management 4. Corporate governance and compensation 194 Corporate governance 195 Group structure and shareholders 197 Capital structure 199 Board of Directors 206 Group Executive Board 210 Senior leadership 211 Shareholders’ participation rights 213 Change of control and defense measures 214 Auditors 216 218 Regulation and supervision 221 Compliance with New York Stock Exchange Information policy listing standards on corporate governance 223 Compensation, shareholdings and loans 224 Compensation governance 225 2008 compensation for the Board of Directors and Group Executive Board 230 Shares, options and loans for the Board of Directors and Group Executive Board (at end of 2008) 237 Compensation principles 2009 and beyond for UBS senior executives 5. Financial information Introduction 244 245 Accounting principles 246 Critical accounting policies 251 Consolidated financial statements 263 Notes to the consolidated financial statements 371 UBS AG (Parent Bank) 371 Parent Bank review 372 Parent Bank financial statements 374 Notes to the Parent Bank financial statements 393 Additional disclosure required under SEC regulations 393 A – Introduction 394 B – Selected financial data 398 C – Information on the company 399 D – Information required by industry guide 3 1 Annual Report 2008 Letter to shareholders Dear Shareholders, UBS recorded a net loss attributable to shareholders of CHF 21.3 billion in 2008. This extremely poor result stemmed pri- marily from the results of the fixed income trading business of the Investment Bank, mainly due to losses and writedowns on exposures related to US real estate and other credit posi- tions. The loss has affected all stakeholders in UBS: in 2008, in US dollar terms, shareholders suffered a 58% fall in mar- ket capitalization, compared with the average 47% decline of the other members of the Dow Jones Banks Titans 30 In- dex; the total number of employees was reduced by 7%; and employee compensation was cut 36%. Clients have, un- derstandably, expressed to us their disappointment about our losses, while at the same time stressing their apprecia- tion for the advice and service levels they receive from their advisors. For financial markets as a whole, 2008 was an extraordi- nary year in economic and financial history: world stock markets fell 42% (the MSCI world index), interest rates reached the lowest levels ever in the US and the UK, and a major investment bank failed. Responses to the crisis includ- ed the injection of new capital into many of the world’s major financial institutions by governments. With hindsight, it is clear that UBS was not prepared for this. Our balance sheet was too large and the systems of risk control and risk management that should have limited our exposure failed. We placed too much emphasis on growth and not enough on controlling risks and costs, particularly in regards to our compensation systems, performance targets and indicators and executive governance structures. Imponderable levels of cross-subsidy and confusion about accountability result- ed from complex relationships between our business divi- sions. In 2008, we focused on addressing our structural and strategic weaknesses and on establishing the long- term financial stability of UBS. Activities centered on the key areas we identified as requiring change: corporate gov- ernance, risk management and control processes, the liquid- ity and funding framework and management compensation. As a result, 2008 saw the introduction of new organization regulations to clarify the responsibilities of the Board of Di- rectors (BoD) and the Group Executive Board (GEB), the es- tablishment of an Executive Committee (EC) to allocate and monitor the use of capital and risk in each of the business divisions, and the formation of a dedicated BoD risk commit- tee. We also merged the credit and market risk functions of the Investment Bank into a single unit led by the newly es- tablished Chief Risk Officer position and a new liquidity and funding framework was introduced that requires each busi- ness division to be charged market-based rates for funding from other UBS divisions. We will continue to make changes in 2009, including the implementation of a new compensa- tion model for senior executives that aligns compensation with the creation of sustainable results for shareholders. In addition, management compensation within business divi- sions will be based largely on divisional results and the re- sponsible and independent management of each division’s resources and balance sheet. Changes in our business divisions will play a vital role in the transformation of our firm. As announced on 10 February 2009, UBS now operates with four business divi- sions and a Corporate Center. The former Global Wealth Management & Business Banking division has been split into two business divisions: Wealth Management & Swiss Bank and Wealth Management Americas. We will continue to re- position the Investment Bank as a client-orientated and fee- and commission-earning business – in other words, the In- vestment Bank is moving away from the proprietary trading business that adversely affected our capital. A new unit has been established within the Investment Bank to manage the positions of those fixed income businesses we have decided to exit. We took active steps to increase the financial stability of UBS in 2008. The issuance of two Mandatory Convertible Notes (MCNs) and a rights issue raised CHF 34.6 billion of new capital. During the year, our total balance sheet was reduced 11% to CHF 2,015 billion, risk-weighted assets fell 19% to CHF 302.3 billion and our identified risk concentra- tions fell sharply – with these reductions assisted by an agreement made in 2008 to sell a large portfolio of illiquid securities and other positions to a fund owned and con- trolled by the Swiss National Bank. Operating expenses fell 19% and the year-end tier 1 ratio was 11.0%, compared with 9.1% for year-end 2007 under the different standards that were then applicable under Basel I. As announced on 18 February 2009, UBS settled a US cross-border case with the US Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC) by entering into a Deferred Prosecution Agree- ment (DPA) with the DOJ and a Consent Order with the SEC. As part of these agreements, we will complete our pre- viously announced exit of our US cross-border business and implement an enhanced program of internal controls to 2 3 Annual Report 2008 ensure compliance with the Qualified Intermediary Agree- ment with the Internal Revenue Service. In addition, pursu- ant to an order issued by the Swiss Financial Market Supervi- sory Authority, information was transferred to the DOJ regarding accounts of certain US clients as set forth in the DPA, who, based on evidence available to UBS, committed tax fraud or the like within the meaning of the Swiss-US Double Taxation Treaty. The total cost for the settlement of USD 780 million has been fully charged to our 2008 results. This episode makes it particularly clear that our control framework must be extremely robust and that employee in- centives must be aligned with risk management and control and the creation of long-term value for shareholders. Outlook – The recent worsening of financial conditions and UBS-specific factors have adversely affected our results, par- ticularly in the Investment Bank. Even after substantial risk reduction, our balance sheet remains exposed to illiquid and volatile markets and our earnings will therefore remain at risk for some time to come. Net new money remains positive for our Wealth Management Americas division, but this is being partially offset by net outflows in Wealth Manage- ment & Swiss Bank. Global Asset Management has also ex- perienced further net outflows. More generally, financial market conditions remain fragile as company and household cash flows continue to deterio- rate, notwithstanding the very substantial measures govern- ments are taking to ease fiscal and monetary conditions. Our near-term outlook remains extremely cautious. For 2009, we will continue to implement our program to strengthen our financial position by reducing our risk posi- tions, our overall balance sheet size, and our operating costs. Management will also focus on securing and building the firm’s core client businesses and on returning the Group as soon as possible to a sustainable level of overall profit- ability. 11 March 2009 UBS Peter Kurer Chairman Oswald J. Gruebel Group Chief Executive Officer On 26 February 2009, Oswald J. Gruebel joined UBS in the capacity of Group Chief Executive Officer, replacing Marcel Rohner. Mr. Gruebel brings to UBS his deep understanding of banking and the markets and proven management skills. He also brings a strong determination to restore the bank’s sustained profitability and regain client trust. As announced on 4 March 2009, Peter Kurer, Chairman of the UBS Board of Directors, has decided not to stand for re-election at the annual general meeting on 15 April 2009. The UBS Board of Directors is nominating Kaspar Villiger for the role of Chairman. 4 UBS reporting at a glance Annual publications Quarterly publications Annual report (SAP no. 80531) Published in both German and English, this single volume report provides a letter to shareholder and a description of: – UBS’s strategy, performance and responsibility; – the strategy and performance of the business divisions Letter to shareholders The letter provides a quarterly update from UBS’s executive management on the firm’s strategy and performance. The letter is published in English, German, French and Italian. and the Corporate Center; – risk, treasury and capital management at UBS; – corporate governance and executive compensation; and – financial information, including the financial statements. Financial report (SAP no. 80834) This report provides a detailed description of UBS’s strategy and performance for the respective quarter. It is published in English. Review (SAP no. 80530) The booklet contains key information on UBS’s strategy and fi- nancials. It is published in English, German, French and Italian. Compensation report (SAP no. 82307) Compensation of senior management and the Board of Directors (executive and non-executive members) is dis- cussed here. It is published in English and German. How to order reports The annual and quarterly publications are available in PDF format on the internet at www.ubs.com/investors/topics in the reporting section. Printed copies can be ordered from the services section of the website. Alternatively, they can be or- dered by quoting the SAP number and the language prefer- ence where applicable, from UBS AG, Information Center, P.O. Box, CH-8098 Zurich, Switzerland. 5 Annual Report 2008 Other sources of information Website The “Analysts & Investors” website at www.ubs.com/inves- tors provides the following information on UBS: financial in- formation (including SEC documents); corporate informa- tion; UBS share price charts and data; the UBS event calendar and dividend information; and the latest presentations by management for investors and financial analysts. Informa- tion on the internet is available in English and German, with some sections in French and Italian. Result presentations UBS’s quarterly results presen tations are webcast live. A play- back of the most recent presentation is downloadable at www.ubs.com/presentations. Messaging service / UBS news alert On the www.ubs.com/newsalert website, it is possible to subscribe to receive news alerts about UBS via SMS or e-mail. Messages are sent in English, German, French or Italian and it is possible to state preferences for the theme of the alerts received. Form 20-F and other submissions to the US Securities and Exchange Commission UBS files periodic reports and submits other information about UBS to the US Securities and Exchange Commission (SEC). Principal among these filings is the annual report on Form 20- F, filed pursuant to the US Securities Exchange Act of 1934. UBS’s Form 20-F filing is structured as a “wrap-around” doc- ument. Most sections of the filing can be satisfied by referring to parts of the annual report. However, there is a small amount of additional information in Form 20-F which is not presented elsewhere, and is particularly targeted at readers in the US. Readers are encouraged to refer to this additional disclosure. Any document that UBS files with the SEC is available to read and copy on the SEC’s website, www.sec.gov, or at the SEC’s public reference room at 100 F Street, N.E., Room 1580, Washington, DC, 20549. Please call the SEC by dial- ing 1-800-SEC-0330 for further information on the opera- tion of its public reference room. Much of this additional information may also be found on the UBS website at www.ubs.com/investors, and copies of documents filed with the SEC may be obtained from UBS’s Investor Rela- tions team, whose contact details are listed on the next page of this report. Corporate information The legal and commercial name of the company is UBS AG. The com- pany was formed on 29 June 1998, when Union Bank of Switzerland (founded 1862) and Swiss Bank Corporation (founded 1872) merged to form UBS. UBS AG is incorporated and domi- ciled in Switzerland and operates under Swiss Company Law and Swiss Federal Banking Law as an Aktien- gesellschaft, a corporation that has issued shares of common stock to investors. The addresses and telephone numbers of UBS’s two registered offices are: Bahnhofstrasse 45, CH-8001 Zurich, Switzerland, phone +41-44-234 1111; and Aeschenvorstadt 1, CH-4051 Basel, Switzerland, phone +41-61-288 2020. UBS AG shares are listed on the SIX Swiss Exchange (traded through its trading platform SWX Europe, formerly virt-x), on the New York Stock Exchange (NYSE) and on the Tokyo Stock Exchange (TSE). 6 Contacts Switchboards For all general queries. Investor Relations UBS’s Investor Relations team supports institutional, professional and retail investors from our offices in Zurich and New York. www.ubs.com/investors Zurich London New York Hong Kong Hotline New York Fax (Zurich) Media Relations UBS’s Media Relations team supports global media and journalists from offices in Zurich, London, New York and Hong Kong. www.ubs.com/media Zurich London New York Hong Kong Shareholder Services UBS Shareholder Services, a unit of the Company Secretary, is responsible for the registration of the global registered shares. Hotline Fax +41-44-234 1111 +44-20-7568 0000 +1-212-821 3000 +852-2971 8888 +41-44-234 4100 +1-212-882 5734 +41-44-234 3415 +41-44-234 8500 +44-20-7567 4714 +1-212-882 5857 +852-2971 8200 +41-44-235 6202 +41-44-235 3154 US Transfer Agent For all global registered share-related queries in the US. www.melloninvestor.com Calls from the US Calls outside the US Fax +866-541 9689 +1-201-680 6578 +1-201-680 4675 UBS AG Investor Relations P.O. Box CH-8098 Zurich, Switzerland sh-investorrelations@ubs.com mediarelations@ubs.com ubs-media-relations@ubs.com mediarelations-ny@ubs.com sh-mediarelations-ap@ubs.com UBS AG Shareholder Services P.O. Box CH-8098 Zurich, Switzerland sh-shareholder-services@ubs.com BNY Mellon Shareowner Services 480 Washington Boulevard Jersey City, NJ 07310, USA sh-relations@melloninvestor.com 7 Strategy, performance and responsibility Strategy and performance – UBS is a global firm providing financial services to private, corporate and institutional clients – Its strategy is to concentrate on three global core businesses – wealth management, asset management and investment banking – and retail and corporate banking services in Switzerland UBS’s strategic priorities Measures taken in 2008 Client focus UBS’s purpose is to serve clients and give them confidence in making financial decisions. Whether it serves individual, corporate or institutional clients, UBS puts their success and interests first and strives to truly understand their goals. As client needs and the financial services industry constantly evolve, UBS makes a systematic effort to capture client feedback, identify potential for improvement and adapt its offerings accordingly. Profitable growth and earnings quality UBS shareholders expect the firm to achieve profitable growth. Fulfilling this expectation requires UBS to establish sustainable earning streams based on client benefit. It therefore strives to build a strong and growing client base and to continuously develop its unique assets and capabilities. Risk and capital management Taking, managing and controlling risk is a core element of UBS’s business activities. UBS’s aim is not, therefore, to eliminate all risks, but to achieve an appropriate balance between risk and return. Risk reduction and capital measures taken in 2008 aimed at maintaining UBS’s capital strength as a source of competitive advantage. Adapting risk expo- sures to the current market environment and managing UBS’s balance sheet remain strategic priorities for the firm. In August 2008, UBS launched a comprehensive program to help the firm adjust to the new realities in the financial industry. It aims to capitalize on the strengths inherent in its leading client franchises across its business divisions, to further grow these franchises, and to address certain weaknesses in its business model that had become apparent both before and as a result of the financial crisis. A significant reduction in risk exposures has been achieved during the year. UBS reduced its risk positions very significantly during the year, including through a transaction with the Swiss National Bank. UBS also took several measures to strengthen its risk organization. The Investment Bank is in the process of reposition- ing itself toward client-driven growth, combined with a further reduction of its balance sheet and risk positions. UBS has implemented new corporate governance guidelines, actively reinforcing a clear separation of the roles and responsibilities of the Board of Directors and its committees, from those of the Group Executive Board. Senior management compensation has been re- viewed. In November 2008, UBS announced the new compensation model that is directly aligned with sustain- able value creation within each manager’s area of respon­ sibility, and incorporates a longer performance evaluation horizon. 10 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S UBS financial highlights CHF million, except where indicated Performance indicators from continuing operations Diluted earnings per share (CHF) 1 Return on equity attributable to UBS shareholders (%) 2 Cost / income ratio (%) 3 Net new money (CHF billion) 4 Group results Operating income Operating expenses Operating profit before tax (from continuing and discontinued operations) Net profit attributable to UBS shareholders Personnel (full-time equivalents) 5 Invested assets (CHF billion) UBS balance sheet and capital management Balance sheet key figures Total assets Equity attributable to UBS shareholders Market capitalization 6 BIS capital ratios 7 Tier 1 (%) Total BIS (%) Risk-weighted assets Long-term ratings Fitch, London Moody’s, New York Standard & Poor’s, New York For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 (7.75) (59.1) 753.0 (226.0) 796 28,555 (27,560) (21,292) 77,783 2,174 (2.61) (11.7) 111.0 140.6 31,721 35,463 (3,597) (5,247) 83,560 3,189 4.64 23.9 70.5 151.7 47,484 33,365 15,007 11,527 78,140 2,989 2,014,815 2,274,891 2,348,733 32,531 43,519 11.0 15.0 302,273 A+ Aa2 A+ 36,875 108,654 9.1 8 12.2 8 374,421 8 AA Aaa AA 51,037 154,222 12.2 8 15.0 8 344,015 AA+ Aa2 AA+ (197) (97) (19) (666) (306) (7) (32) (11) (12) (60) (19) 1 Refer to “Note 8 Earnings per share (EPS) and shares outstanding” in the financial statements of this report. 2 Net profit attribu table to UBS shareholders from continuing operations / average eq- uity attributable to UBS shareholders. 3 Operating expenses / operating income before credit loss expense or recovery. 4 Excludes interest and dividend income. 5 Excludes personnel from private equity (part of the Corporate Center). 6 Refer to the ”UBS shares in 2008” section of this report for 2008 for further information. 7 Refer to the “Capital management” section of this report for further information. 8 The calculation prior to 2008 is based on the Basel I approach. The 2008 results and the balance sheet in this report differ from those presented in UBS’s fourth quarter 2008 report is- sued on 10 February 2009 due to: (1) the settlement agreements with the US Department of Justice and Securities and Exchange Commission related to the US cross­border case, as described in the “Settlement regarding the US cross­border case” sidebar in the “Wealth Management International & Switzerland” section of this report; (2) the determination by the Swiss National Bank (SNB) of the 30 September 2008 valuation of approximately USD 7.8 billion of securities not yet transferred by UBS to the SNB StabFund, as described in the “Transaction with the Swiss National Bank” sidebar in the “Strategy and structure” section of this report; and (3) restatements to correct identified accounting errors related to the 2008 financial statements as described in the “Accounting changes” section of this report. The total impact of the above items on net profit after tax was negative CHF 1,595 million. 11 Strategy, performance and responsibility Strategy and structure Strategy and structure UBS is a global firm providing financial services to private, corporate and institutional clients. Its strategy is to concentrate on three global core businesses – wealth management, asset management and investment banking – and to provide retail and corporate banking services in Switzerland. By delivering valuable advice, products and services to its clients, the firm aims to generate sustainable earnings and create value for its shareholders. UBS strategy and business model UBS has crafted its business strategy to benefit from one underlying global trend: the growth of wealth. Despite the current financial crisis, the firm believes that over the long term wealth creation will continue to be a prominent charac- teristic of the world economy. UBS’s three core businesses of wealth management, asset management and investment banking are geared to take advantage of this trend. Organizationally, UBS has operated throughout 2008 as a Group with three business divisions: Global Wealth Manage- ment & Business Banking, Global Asset Management and the Investment Bank. As announced on 10 February 2009, Global Wealth Management & Business Banking has been divided into two business divisions: Wealth Management & Swiss Bank and Wealth Management Americas. Each busi- ness division is accountable for its own results, but co­oper- ates to provide a broad palette of cross­business solutions for clients. UBS considers the breadth and depth of its offer- ing to be one of its main strengths, and a key to its ability to create value for clients and shareholders. Wealth Management & Swiss Bank UBS’s wealth management business caters to high net worth and affluent individuals around the world (except those served by Wealth Management Americas) whether they are investing internationally or in their home country. UBS offers these clients a complete range of tailored advice and invest- ment services. Its Swiss Bank business provides a complete set of banking services for Swiss individual and corporate clients. Wealth Management Americas Wealth Management Americas offers sophisticated products and services specifically designed to address the needs of high net worth and affluent individuals. It includes Wealth Management US, domestic Canada, domestic Brazil and the international business booked in the United States. Global Asset Management As a worldwide asset manager, UBS offers innovative invest- ment management solutions in nearly every asset class to private, corporate and institutional clients, as well as through financial intermediaries. Investment capabilities include tra- ditional assets (for instance equities, fixed income and asset allocation), alternative and quantitative investments (multi­ manager funds, funds of hedge funds and hedge funds) and real estate. Investment Bank In the investment banking and securities businesses, UBS provides securities products and research in equities, fixed income, rates, foreign exchange and metals. It also provides advisory services as well as access to the world’s capital mar- kets for corporate, institutional, intermediary and alternative asset management clients. ➔ Refer to the “Reporting structure” and “UBS business divisions and Corporate Center” sections of this report for more information on UBS’s business divisions and the Corporate Center UBS competitive profile UBS’s current business mix is a result of many decades of development, internal growth initiatives and acquisitions. Since 1998, UBS has progressively divested non­core busi- nesses and participations, and invested in growing its core businesses and creating a balanced reach worldwide. UBS is now a leading global wealth manager: it is a mar- ket leader (by client assets) in both Europe and Asia Pacific, in sixth position in the US and one of the only firms of glob- al scale focusing on wealth management as a core business. In 2008, UBS was among the top five firms globally in merg- ers and acquisitions based on deal volume. The asset man- agement business is one of the leading active asset manag- ers globally and one of the largest mutual fund managers in Europe based on assets under management. In Switzerland, UBS is the leading firm for retail and com- mercial banking. It serves around 2.5 million individual cli- ents and 133,500 corporations, institutional investors, public entities and foundations, collectively. The bank has chosen to limit its retail and commercial banking business to the Swiss market, concentrating on domestic opportunities and growing selected market segments. 12 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S UBS corporate governance As mandated by Swiss banking law, UBS operates under a strict dual board structure comprising the Board of Directors (BoD) and the Group Executive Board (GEB). The BoD is UBS’s most senior body and is ultimately responsible for the firm’s strategy and the supervision of its executive management. The BoD sets the mid­ and long­ term strategic direction of the Group, is responsible for appointments and dismissals at top management levels and for defining the firm’s risk principles and risk capacity. A clear majority of its members are non­executive and fully inde­ pendent. The management of the business is delegated by the BoD to the GEB. Under the auspices of the Group CEO, the GEB has executive management responsibility for the Group and its businesses. It assumes overall responsibility for the de­ velopment and the implementation of the Group’s and the business divisions’ strategies and for the exploitation of synergies across the firm. The Executive Committee (EC) consists of the Group Chief Executive Officer (CEO), the Group Chief Financial Officer (CFO), the Group Chief Risk Officer (CRO) and the Group General Counsel, and is responsible for the allocation of the Group’s financial resources to the business divisions. These resources include capital, funding, and risk capacity and parameters within the limits set by the BoD. ➔ Refer to the “Corporate governance” section of this report for more information UBS’s strategic priorities Client focus UBS’s purpose is to serve clients and give them confidence in making financial decisions. Whether it serves individual, cor- porate or institutional clients, UBS puts their success and in- terests first and strives to truly understand their goals. As client needs and the financial services industry constantly evolve, UBS makes a systematic effort to capture client feed- back, identify potential for improvement and adapt its offer- ings accordingly. Profitable growth and earnings quality UBS shareholders expect the firm to achieve profitable growth. Fulfilling this expectation requires UBS to establish sustainable earning streams based on client benefit. It therefore strives to build a strong and growing client base and to continuously develop its unique assets and capabilities. In order to fulfill these requirements, UBS needs to ensure that it efficiently manages its financial resources. By making continuous efficiency improvements – that is, by looking for ways to achieve the same or a better result or service with fewer resources – UBS strives both to manage costs in a dis- ciplined manner and to optimize its spending across eco- nomic and business cycles. Risk and capital management Taking, managing and controlling risk is a core element of UBS’s business activities. UBS’s aim is not, therefore, to eliminate all risks, but to achieve an appropriate balance between risk and return. Risk reduction and capital measures taken in 2008 aimed at maintaining UBS’s capital strength as a source of competitive advantage. Adapting risk exposures to the current market environment and managing UBS’s balance sheet remain strategic priorities for the firm. ➔ Refer to the “Risk and treasury management” section of this report for more information on risk and capital management Business divisions’ franchises UBS continues to develop the platform and reach of the business divisions known since 10 February 2009 as Wealth Management & Swiss Bank and Wealth Management Americas. This includes the expansion of its global presence in international wealth management growth markets. UBS’s leading position in Switzerland, both as a wealth manager and as the largest retail bank, will remain a cornerstone of UBS’s strategy and a source of sustainable profit growth. UBS also continues to develop the platform and reach of its Global Asset Management business division. This includes focusing on developing innovative products and managing toward sustainable investment performance. The Investment Bank is in the process of repositioning itself toward client­driven growth, combined with a further reduction of its balance sheet and risk positions. This will allow the Investment Bank to build on its global coverage and distribution capability and to ensure maximum accountability for the creation of shareholder value. This repositioning in- cludes the downsizing or exiting of certain businesses. ➔ Refer to the “UBS business divisions and Corporate Center” section of this report for more information on UBS’s business divisions and the Corporate Center 13 Strategy, performance and responsibility Strategy and structure Measures taken In August 2008, UBS launched a comprehensive program to re­engineer its businesses and to adjust to the new realities in the financial industry. It aims to capitalize on the strengths inherent in its leading client franchises across its business divisions, to further grow these franchises, and to address certain weaknesses in its business model that had become apparent both before and as a result of the financial crisis. Executive governance Controls have been improved and accountability and trans- parency increased at the level of top management. One re- sult has been the creation of an Executive Committee to al- locate and continuously monitor the use of capital and risk in each of the business divisions. Other wide­ranging chang- es to the Group’s governance have been proposed and im- plemented. Refer to the “Corporate governance” section of this report for more information on corporate governance. Liquidity and funding framework The business divisions have been incentivized to manage their balance sheets with greater autonomy and responsibil- ity. A new liquidity and funding concept has been approved and is being implemented. Refer to the “Liquidity and fund- ing management” section of this report for more informa- tion on liquidity and funding. Senior management compensation Senior management compensation is now aligned to sus- tainable value creation within each manager’s area of re- sponsibility and a longer performance evaluation horizon has been introduced. UBS announced a new compensation model for senior executives in November 2008 (effective 1 January 2009). Refer to the “Compensation, sharehold- ings and loans” section of this report for more information on senior management compensation. Transformation of UBS’s wealth management business As announced on 10 February 2009, Global Wealth Manage­ ment & Business Banking has been divided into two new business divisions: Wealth Management & Swiss Bank and Wealth Management Americas. 14 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Key performance indicators: 2009 and beyond UBS uses key performance indicators (KPIs) to monitor the firm’s perfor- mance and the delivery of returns to shareholders. Until the end of 2008, UBS focused on four KPIs at the Group level, as described in the discussion of performance measures in the “Mea- surement and analysis of perfor- mance” section of this report. In response to the changing market environment, UBS conducted a detailed review of its KPI framework in 2008. The objective of this review was to adjust these indicators – which are used by the firm to evaluate its economic performance as a whole and the contribution of individual employ- ees to that performance – to more closely reflect the firm’s strategic priorities. This review focused on the identifica- tion of the key drivers of total shareholder return (TSR) – defined as the change in the share price and any dividend yield – which represents the ultimate measure of performance for UBS shareholders. However, several factors driving TSR cannot be directly influenced by UBS management, such as valuation multiples and short­term market trends. Therefore, on a day­to­day basis, UBS manage- ment measures performance in the form of profitability after the cost of equity or economic profit. Conse- quently, the KPI framework has been designed to explicitly incorporate the drivers of economic profit at the Group and business division level. UBS manages its businesses based on its KPI framework, which is used for internal performance measurement to ensure management accountability and consistency. Both Group and business division KPIs are used to determine variable compensation of executives and staff. The Group and business division KPIs shown in the table below will be disclosed beginning in first quarter 2009 and going forward. Key performance indicators Group Net profit growth Cost / income ratio Return on equity (RoE) Return on assets, gross Return on risk-weighted assets, gross FINMA leverage ratio 2 Tier 1 ratio Wealth Management & Swiss Bank Wealth Management Americas Investment Bank Global Asset Management Pre-tax profit growth Pre-tax profit growth Pre-tax profit growth Pre-tax profit growth Cost / income ratio Cost / income ratio Cost / income ratio Cost / income ratio Gross margin (RoIA) 1 Gross margin (RoIA) Gross margin (RoIA) Return on attributed equity Return on assets, gross Impaired lending portfolio 3 Value at Risk 4 Net new money rate Net new money rate Net new money rate Net new money rate Economic profit 1 For International clients segment only. RoIA: return on invested assets. 2 FINMA: Swiss Financial Market Supervisory Authority. 3 Impaired lending portfolio as a % of total lending portfolio. For Swiss clients segment only. 4 Regulatory VaR. 15 Strategy, performance and responsibility Strategy and structure Risk management in 2008 UBS entered 2008 with significant legacy risk positions which exceeded the firm’s risk bearing capacity. While UBS incurred substantial writedowns on its risk positions, it pursued an active risk reduction program through sales in 2008. Signifi- cant transactions included the sale in May of US residential mortgage­backed securities to a fund managed by Black- Rock for proceeds of USD 15 billion and the agreement reached in October with the Swiss National Bank (SNB) (see details below). UBS identified significant weaknesses in its risk manage- ment and control organization. In order to address these weaknesses, UBS launched an extensive remediation plan, which included the overhaul of its risk governance, signifi- cant changes to risk management and control personnel, as well as improvements in risk capture, risk representation and risk monitoring. Implementation of this plan is ongoing and remains a high priority for UBS. Transaction with the Swiss National Bank As announced on 16 October 2008, the Swiss National Bank (SNB) and UBS reached an agreement to transfer illiquid securities and other positions from UBS’s balance sheet to a fund owned and controlled by the SNB. From the originally agreed USD 60 billion, the trans action size has been reduced to USD 38.6 billion (including the effect of price adjustments so far totaling USD 0.7 billion). With this transaction, UBS caps future potential losses from these assets, reduces its risk­weighted assets, materially de­risks its balance sheet and is no longer exposed to the funding risk of the assets to be transferred. Transaction structure The SNB will finance the fund with a loan in the amount of 90% of the purchase price to be paid by the fund, secured by the assets of the fund. 10% of the purchase price will be financed through an equity contri­ bution by the SNB. The loan will be non­recourse to UBS and will be priced at LIBOR plus 250 basis points. The fund and loan facility will terminate in eight years, but the termination date may be extended to 10 or 12 years. The cash flow from the assets, including interest, rental income, principal repayments and proceeds from asset sales (net of expenses and working capital requirements), will be applied to service the loan until full repayment. At the closing of each asset transfer, UBS will purchase, for an amount equal to the SNB’s equity contribution on that date, an option to acquire the fund’s equity once the loan has been fully repaid. The option exercise price will be USD 1 billion plus 50% of the amount by which the equity value exceeds USD 1 billion at the time of exercise. This option will be carried on UBS’s balance sheet at its fair value. In the event of a change of control of UBS, the SNB will have the right but not the obligation to require UBS to purchase the outstanding loans at par plus accrued interest and to purchase the fund equity at 50% of its value at the time. If, upon the fund’s termination, the SNB incurs a loss on the loan it has made to the fund, the SNB will be entitled to receive 100 million UBS ordinary shares against payment of the par value of those shares (currently CHF 0.10 per share). Governance In fourth quarter 2008, the fund was established under the name SNB StabFund as a Swiss limited partnership for collective investments. Its objective is to manage the acquired positions based on fundamental value consider- ations. The SNB StabFund is owned by a general partner and a limited partner, both of which are wholly owned by the SNB. The general partner has a board of directors with five members, of which three are designated by the SNB and two by UBS. UBS acts as the investment manager of the SNB StabFund, subject to the oversight of the board of directors of the general partner which must approve certain types of decisions. The board also retains the right to remove UBS as the investment manager of the SNB StabFund. Portfolio composition and size The overall portfolio valuation of positions already transferred or still expected to be transferred to the SNB StabFund is USD 38.6 billion, as shown in the table opposite, subject to any further pricing adjustments. The SNB StabFund acquired a first tranche of 2,042 securities positions from UBS on 16 December 2008 for USD 16.4 billion. The remaining positions identified for sale to the fund are planned to be transferred in March 2009 in one or more additional transfers. The purchase price for the securities transferred to the fund on 16 December 2008 was the value of these securities as of 30 September 2008 as determined by the SNB based on a valuation conducted by third­party valuation experts. On the same basis, the SNB has since determined the purchase price to 16 Transaction with the Swiss National Bank y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S be paid for a further USD 7.8 billion in securities and other positions that have not yet been transferred to the fund. So far, the determined purchase prices for securities and other positions transferred to or to be transferred to the fund were, in the aggregate, USD 0.7 billion lower than the value UBS assigned to these positions on 30 September 2008. All of this difference is accounted for in UBS’s results for 2008. Purchase prices have not yet been determined for the other positions not yet transferred to the fund, valued at USD 14.4 billion by UBS on 30 September 2008. Any difference between the purchase prices to be determined by the SNB and the value UBS assigned to these positions will affect UBS’s results in first quarter 2009. Issuance of MCNs to the Swiss Confederation In connection with the transaction with the SNB, UBS raised CHF 6 bil­ lion of new capital in the form of mandatory convertible notes (MCNs) convertible into UBS registered shares. These were placed with the Swiss Confederation and issued on 9 December 2008. Refer to the “Capital management” section of this report and “Note 26 Capital increases and mandatory convertible notes” in the financial statements of this report for more information. Implications for UBS’s 2008 income statement The overall impact on UBS’s 2008 income statement of the SNB trans action and the placement of the mandatory convertible notes (MCNs) with the Swiss Confederation was a net charge of CHF 4.5 billion. This reflects a net loss arising from the acquisition of the equity pur- chase option, the loss referred to above arising from valuation differences determined to date on securities sold or to be sold to the SNB StabFund, losses on hedges that were subject to trading restrictions as a result of the SNB transaction, and the impact of the contingent issuance of UBS shares in connection with the transaction. The fair valuation impact of the issuance of the MCNs, as described in “Note 26 Capital increases and mandatory convertible notes” in the financial statements of this report, is also included in this total. Positions affected by the transfer to the Swiss National Bank StabFund USD billion US sub-prime US Alt-A US prime US reference-linked note program Commercial real estate Student loan-backed securities Other positions Price difference Total 1 To be determined. Valuation as of 30 September 2008 Priced Not yet priced Total 4.0 1.5 1.2 5.8 3.4 0.5 8.5 (0.7) 24.2 1.6 0.8 0.7 0.0 2.3 0.0 9.0 1 14.4 5.6 2.4 1.9 5.8 5.7 0.5 17.5 (0.7) 38.6 17 Strategy, performance and responsibility The making of UBS The making of UBS All the firms that have come to make up today’s UBS look back on a long and diverse history. Both the two Swiss pre- decessor banks and PaineWebber Group Inc. (PaineWebber) came into being in the second half of the 19th century, while S.G. Warburg’s roots go back to 1934. But it was in the 1990s when UBS’s current identity began to form. In the early 1990s, the two Swiss banks that came to form the current UBS, Swiss Bank Corporation (SBC) and Union Bank of Switzerland, were commercial banks operat- ing mainly out of Switzerland. The two banks shared a simi- lar vision: to become a world leader in wealth management and a global bulge­bracket investment bank with a strong position in global asset management, while remaining an important commercial and retail bank in Switzerland. Union Bank of Switzerland, the largest and best­capital- ized Swiss bank of its time, opted to pursue a strategy of organic growth, or expansion by internal means. In contrast, SBC, then the third­largest Swiss bank, decided to take an- other route by starting a joint venture with O’Connor, a lead- ing US derivatives firm that was fully acquired by SBC in 1992. O’Connor was noted for its young, dynamic and in- novative culture, meritocracy and its team orientation. It brought state­of­the­art risk management and derivatives technology to SBC. In 1994, SBC acquired Brinson Partners, one of the leading US­based institutional asset management firms. Both the O’Connor and Brinson deals represented fundamental steps in the development of the firm. The next major move was in 1995, when SBC acquired S.G. Warburg, the British merchant bank. The deal helped to fill SBC’s strategic gaps in corporate finance, brokerage and research and, most importantly, brought with it an institu- tional client franchise, which is still crucial to today’s equities business. The 1998 merger of Swiss Bank Corporation and Union Bank of Switzerland brought together these two leading Swiss financial institutions, creating a leading global wealth manager and improving the new firm’s chances of becoming a global bulge bracket investment bank and a leading global institutional asset manager. Still, in order to become a truly global player in invest- ment banking and wealth management, UBS needed to es- tablish a significant presence in the key US market. UBS ad- vanced towards this objective when it acquired PaineWebber in 2000. Since the acquisition of PaineWebber, UBS’s main priority has been to develop and grow organically. Smaller acquisi- tions have helped to accelerate and complement the firm’s growth. In 2006, for instance, UBS enhanced its presence in Brazil and Latin America by acquiring Brazil’s largest inde- pendent investment bank and asset manager, Banco Pac­ tual. Today, UBS has significant scale in its areas of focus, with strong positions in large, mature markets as well as a growing presence in emerging markets. ➔ Refer to www.ubs.com/history for more information 18 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 1832 Schröder Münchmeyer Hengst & Co. 1895 Phillips & Drew 1997 1986 1863 Eidgenössische Bank 1862 Bank in Winterthur 1863 Toggenburger Bank 1945 1912 Union Bank of Switzerland 1872 Aargauische Kreditanstalt 1928 Interhandel 1919 1967 1832 Dillon Read & Co. 1863 Bank in Baden 1862 Basler Handelsbank 1856 Bankverein 1882 Basler Depositenbank 1872 Basler Bankverein 1895 Basler & Zürcher Bankverein 1889 Zürcher Bankverein 1889 Schweiz. Unionbank 1915 1946 S.G. Warburg Group 1897 Swiss Bank Corporation 1945 1914 Blyth, Eastman Dillon & Co. 1919 Mitchell Hutchins, Inc. 1997 1995 1989 Brinson Partners 1994 1977 O’Connor & Associates 1992 1979 1977 ab 1998 1SS008_e 1880 Paine & Webber 1879 Jackson & Curtis 1942 Paine, Webber, Jackson & Curtis 1974 PaineWebber, Inc. 2000 19 Strategy, performance and responsibility Current market climate and industry drivers Current market climate and industry drivers The current crisis and its aftermath will have profound implications for the financial services industry and the world economy. Market crisis and economic downturn 2008 was one of the most difficult years ever for the finan- cial services industry. As the crisis deepened over the course of the year, the problems in the financial industry spread to other parts of the world economy. A precipitous drop in pric- es across most main asset classes, coupled with deleverag- ing, resulted in poorly functioning lending markets and a lack of inter­bank liquidity. Banks were forced to recapitalize, sometimes with the help of governments. Hopes that the crisis might be short­lived were dashed after the failure of one of the major US investment banks in mid­September, which resulted in very severe liquidity issues for many finan- cial institutions. Banks experienced a scarcity of equity, credit supply further contracted and numerous countries fell into recession. Recessions characterized by a simultaneous fall in prices across asset classes, an increase in consumer savings rates and contractions in lending caused by a shortage of bank capital are very rare, and have always been severe. There have in fact only been four recorded instances of such reces- sions in the past century: the “bankers’ panic” in 1907, the “great depression” in 1929–39, the Swedish economic crisis in 1992, and most recently the “lost decade” in Japan from 1990–2000. Changes in consumer demand drive capital expenditures by companies and consequently affect capital goods indus- tries, sometimes very rapidly. Even countries which have not experienced high leverage growth and significant asset price increases have been affected as investment spending and exports dropped. In particular, countries which relied on foreign capital inflows (either to the government or to the private sector) are at risk of seeing foreign investment and exports fall, which could in turn hurt the value of their currency. There were radical changes to monetary and fiscal policy during 2008. Government borrowing and spending (through “stimulus packages”, transfer payments, loans, guarantees and purchases of bank capital) increased dramatically and led to higher deficits. Central bank balance sheets expand- ed, both as a result of traditional central bank activity and through unconventional measures such as the purchase of distressed assets from financial institutions (for example, mortgage backed securities). Interest rates have fallen to his- torically low levels in most countries as central banks attempt to support private and corporate spending. Macro economic perspectives The macro economic outlook for 2009 is not positive. A modest recovery can be expected only if the measures taken by governments and central banks prove to be both effective and efficient. Few observers expect the financial services in- dustry to rebound quickly from this crisis. Market capitalization of the components of the Dow Jones Banks Titans 30 Index, 2008 versus 2007¹ USD billion 200 150 100 50 0 20 31.12.07 31.12.08 UBS 1 Source: Bloomberg. Components of the Dow Jones Banks Titans 30 Index as of 28 February 2009. 1SS012_e 200 150 100 50 0 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Stock market indices development In % (USD) 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 savings can provide opportunities for certain banks, risk aversion and the downward pressure it exerts on asset prices tend to reinforce each other. 180 140 100 60 20 MSCI World S&P 500 Dow Jones Euro STOXX Banks Source: Bloomberg Dow Jones Banks Titans 30 Index Industry drivers A number of drivers are expected to have a significant im- pact on banks’ earnings and the structure of the financial services industry in the short to medium term. The most rel- evant factors are described below. De­leveraging The current downturn is different from previous ones not only in terms of its severity and wide geographical reach, but also in terms of the de­leveraging process that lies at its heart. De­leveraging is the process through which house- holds, companies and the banks that intermediate between them simultaneously attempt to sell real and financial assets to pay back their debts. This unleashes two strong deflation- ary forces. First, there is a reduction and restructuring of banks’ bal- ance sheets, which may affect their capacity to lend money. Such a restructuring is already well under way, having start- ed in 2007 when banks began recording losses on their asset portfolios, disposing of assets and raising capital. This trend gathered pace in the course of 2008 and has continued in the early part of 2009 as several banks disclosed more losses and raised further capital. Second, household and corporate balance sheets are also in effect being restructured and reduced, depressing con- sumer and capital spending and appetite for risk. This pro- cess has just started and may last several years, as house- holds address the need to permanently increase their savings. It may be particularly long and painful in countries with his- torically low savings rates, such as the US. While debt levels are lower among non­financial corpora- tions than in previous recessions, these companies will also have to restructure their balance sheets as they face falling demand for their products and services, and funding be- comes increasingly scarce and more expensive. The process of de­leveraging is expected to have, on bal- ance, a negative impact on banks’ earnings. While increased Government intervention and re­regulation The financial crisis has sparked heavy public intervention in the global financial system. State intervention packages have included a mix of capital injections by governments, public guarantees for selected bank liabilities such as deposits and commercial paper, and maximum loss guarantees for illiquid assets held in banks’ balance sheets. Governments have in- creasingly attached conditions to the measures they have taken, providing them the opportunity to at least temporar- ily influence the business activities of certain banks. At the same time, the financial industry and its regulators are analyzing the lessons learned and implementing mea- sures to adjust their business practices and the regulatory framework. This will fundamentally impact and likely trans- form the industry. While many details of the regulatory re- sponse to the financial crisis are still to be worked out, new regulation will likely focus on ways of mitigating the nega- tive effects of the business cycle through regulatory policy, as well as on measures to increase the transparency of financial markets and to strengthen their resilience. Regulators are also likely to try to better identify and address systemic risks, for example by adapting regulatory requirements to the size and profile of certain financial institutions. Specific measures are likely to include adjustments to the following six broad areas of direct relevance to international banks: higher capital requirements and the introduction of leverage limitations; more robust liquidity buffers and risk management; management and partial reintegration of off­balance sheet exposure onto firms’ balance sheets; review of valuation and accounting practices; increased co­ operation between stronger and better­equipped super­ visors and central banks, especially from an international perspective; and alignment of compensation programs and pay levels with long­term, firm­wide profitability. Some national regulators have moved quickly, including the Swiss Financial Market Supervisory Authority (FINMA; until 31 December 2008 Swiss Federal Banking Commission), which has already defined new transitional capital require- ments for UBS and Credit Suisse. Overall, the regulatory changes prompted by the current market turmoil will have lasting effects on the industry in terms of bank size, business portfolios, controls, capital requirements, profitability and compensation. These will result in significant changes to the competitive landscape. At the product level, regulatory restrictions and greater supervision in areas such as structured products, credit default swaps, and securitization are likely to result in lower margins for banks. Enhanced transparency require- ments and disclosure standards for investment products are also likely. 21 Strategy, performance and responsibility Current market climate and industry drivers Client behavior and demand The relationship between financial firms and their clients has seen accelerating change over the past couple of years, for example with the rise of increasingly sophisticated clients (such as leveraged finance investors and hedge funds). How- ever, the corporate and institutional client segment as a whole is expected to continue requiring innovative solutions which cater to specific and unique needs, and span product groups and geographies. 2008 has marked a turning point with regard to the in- vestment behavior of many private clients, and fundamental changes in this behavior are expected in the future. Returns have been negative in most asset classes and many investors have grown suspicious of hedge funds and complex prod- ucts in general, especially as these proved to be more cor­ related with equity and credit markets than originally thought. Internal UBS research shows that private clients’ risk ap- petite is changing, moving towards more “traditional” asset classes such as equities, bonds, cash or precious metals. This trend is expected to have, on balance, a negative impact on banks’ income as it results in lower gross margins. Wealth preservation The financial crisis has already resulted in a substantial de- struction of wealth as the price of many real and financial assets has fallen from the peaks of 2007. Many investors see a risk of further wealth destruction in the current economic climate. During this phase business opportunities for the financial services industry will mostly be in the realm of value preservation rather than return maximization. Investors have reacted to the current crisis by selling assets, paying back debt and accumulating cash or deemed equivalent. History shows that investors generally need several years to return to more risky asset allocations follow- ing periods of financial distress. Therefore, capital preserva- tion is likely to remain a priority for investors and most will seek to do this by holding cash before considering a diversi- fication across a wider range of asset classes and products. On the other hand, an increase in savings by individuals, par- ticularly in countries where household saving rates have been historically low, such as the US, represents an oppor­ tunity for banks. Retirement provisions The economic crisis does not fundamentally alter the private retirement industry’s growth drivers, namely the demo- graphic shift related to falling birth rates and aging and the falling coverage provided by public pension schemes. Despite the drop in the value of their assets in 2008, private fully funded schemes will continue providing individuals with the best investment tools to accumulate wealth for retirement, and savings will continue to flow into them. The ability of public pension schemes to fund themselves over the long term may be limited as several countries are al- ready heavily indebted and running large deficits, including some driven by measures taken to help their economy in the current downturn, while demographics indicate that the ratio of workers to retirees will decrease in the foreseeable future. In some countries, particularly those which have experienced the largest destruction of accumulated wealth due to the crisis (for example, the US and UK, where pen- sion funds are comparatively more exposed to equity mar- kets than in other countries), a pick­up in individual savings rates would provide additional funds, which will partly be invested in private retirement schemes. This, combined with continued demand for specialist advice in wealth manage- ment, continues to represent an opportunity for wealth and asset managers. Corporate restructuring The corporate sector is generally better equipped to deal with the negative impact of a slowing economy than in pre- vious downturns, mostly due to a relatively lower level of debt. However, a sharp reduction in demand for goods and services across developed and emerging markets and a con- tinued lack of liquidity in credit markets will inevitably impact the corporate sector. Over the medium term, default rates are expected to rise from the historically low levels prevailing before the crisis, and further major bankruptcies are likely. The internationalization of business – particularly expansion in emerging markets – is likely to slow down as the attrac- tiveness of new markets remains subdued and cash flows previously available for expansion are used to restructure balance sheets. In such a corporate environment, most of the opportunities for the banking sector are likely to arise from simple financing requirements, balance­sheet restruc- turing and asset disposals. Emerging markets Strong growth in emerging markets has been a key feature of the boom years in the global economy prior to the crisis, and banks have benefited greatly from strong growth in these markets. Growth in emerging markets is expected to slow markedly in 2009, reflecting the increased interconnec- tions between economies in the era of globalization. Export surplus countries, including those relying on commodities exports, are most vulnerable to a further deterioration in the global economic environment, but also best placed to ben- efit from a potential recovery. Over the long term, however, banks which have built up a significant presence in emerging markets and serve a wide range of institutional and private clients are likely to continue benefiting from above­average economic growth in these countries. 22 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Strategy, performance and responsibility Risk factors Risk factors Certain risks, including those described below, can impact UBS’s ability to carry out its business strategies and directly affect its business activities, financial condition, results of operations and prospects. Because the business of a broad­ based international financial services firm such as UBS is inherently exposed to risks that only become apparent with the benefit of hindsight, risks of which UBS is not presently aware could also materially affect its business activities, financial condition, results of operations and prospects. The sequence in which the risk factors are presented below is not indicative of their likelihood of occurrence or the potential magnitude of their financial consequences. Risks related to the current market crisis UBS, like many other financial market participants, was severely affected by the financial crisis that unfolded in 2007 and worsened in 2008. The deterioration of financial mar- kets in 2008 was extremely severe by historical standards, and UBS recorded substantial losses on legacy risk positions. UBS has taken a series of measures to reduce its risk expo- sures, including the sale of up to USD 38.6 billion of illiquid and other positions to a fund owned and controlled by the Swiss National Bank (SNB) as announced in the fourth quar- ter. However, UBS continues to hold positions identified as risk concentrations (refer to the “Risk concentrations” sec- tion of this report for more information on these positions, as well as positions in other asset classes that might be neg- atively affected by the current market crisis). In addition, UBS is exposed to the general systemic and counterparty risks that are exacerbated by the ongoing market crisis and relat- ed instability of financial institutions and of the financial sys- tem as a whole. UBS holds positions which may be adversely affected by the ongoing financial crisis and economic climate As discussed in the paragraphs below on general risk fac- tors, the development of market conditions and the overall economic environment, as well as factors affecting particu- lar assets, may lead to reductions in the market or carrying value of UBS’s assets. Although UBS’s exposure to the US mortgage market (including residential sub­prime, Alt­A and prime) was reduced dramatically in 2008, UBS remains exposed to that market, albeit on a reduced scale. In addi- tion, certain of its monoline­insured positions are exposed to the US residential mortgage market as described below. The markets for most US mortgage­related securities have so far remained illiquid and it is impossible to determine whether and how long current market conditions will per- sist, or whether they will further deteriorate. UBS relies on credit protection from third parties, including monoline insurers, that may not be effective UBS’s business entails exposure to counterparty credit risk, including to monoline insurers and other providers of credit protection. UBS’s credit exposure to the monoline sector arises from over­the­counter (OTC) derivative contracts – mainly credit default swaps (CDSs) which are carried at fair value – in respect of mortgage related and “monoline­ wrapped” securities. The fair value of these CDSs – and thus UBS’s exposure to the counterparties – depends on the valu- ation and the perceived credit risk of the instrument against which protection has been bought. Monoline insurers have been very adversely affected by their exposure to US residen- tial mortgage­linked products, resulting in credit rating downgrades and the need to raise additional capital. UBS has recorded large credit valuation adjustments on its claims against monoline counterparties. If the financial condition of these counterparties or their perceived creditworthiness de- teriorates further, UBS could record further credit valuation adjustments on the CDSs bought from monoline insurers. UBS could also incur losses in connection with restructur- ings of monoline insurers, including possible losses on third party hedge protection which UBS may incur as a result of changes in the corporate structure of the insurers. UBS also trades securities issued by and derivatives related to mono- line insurers, including CDSs, and the value of these securi- ties and derivatives is subject to market volatility. UBS holds positions in asset classes that have been or might be negatively affected by the current market crisis In 2007 and 2008, UBS incurred substantial losses (realized and mark­to­market) on its holdings of securities related to the US residential mortgage market. The market dislocation that began in 2007 has been progressively felt in asset classes be- yond US residential mortgages. In 2008, UBS recorded mark- downs on other assets carried at fair value, including auction rate securities (ARS), leveraged finance commitments, com- mercial mortgages in the United States and non­US mortgage­ and asset­backed securities (ABSs). UBS has recorded and in the future could record negative fair value adjustments on these assets and on other asset classes which may be affected by the crisis in the credit markets. Such securities may also be wrapped by monoline insurers and therefore could give rise to losses if the difficulties in the monoline sector persist or in- crease (see the pre vious risk factor on monoline exposures). 23 Strategy, performance and responsibility Risk factors UBS’s inventory of ARS is likely to increase in the future as a result of its commitment to repurchase client­owned ARS, as further described in the “Risk management” section of this report. UBS is also exposed to the risk of losses and write­ downs on its leveraged finance commitments. UBS holds posi- tions related to real estate markets in countries other than the United States on which it could also suffer losses. These in- clude exposures to non­US residential and commercial real es- tate and mortgages and non­US ABS programs. For example, as described in the “Credit risk” section of this report, UBS has a very substantial Swiss mortgage portfolio which is booked in Global Wealth Management & Business Banking. UBS is also exposed to risk when it provides financing against the affect- ed asset classes such as in its prime brokerage, reverse repo and lombard lending activities. – assets UBS holds for its own account as investments or trading positions could continue to fall in value; – impairments and defaults on credit exposures and on trading and investment positions could increase, and l osses may be exacerbated by falling collateral values; and – if individual countries impose restrictions on cross­border payments or other exchange or capital controls, UBS could suffer losses from enforced default by counter­ parties, be unable to access its own assets, or be impeded in – or prevented from – managing its risks. The developments mentioned above can affect the performance of both the Group and its business units. As such, there is a risk that the carrying value of goodwill of a business unit might suffer impairments. Risk factors related to UBS’s business activity Performance in the financial services industry depends on the economic climate – negative developments can adversely affect UBS’s business activities The financial services industry prospers in conditions of economic growth, stable geopolitical conditions, capital markets that are transparent, liquid and buoyant and positive investor sentiment. An economic downturn, inflation or a severe financial crisis (as seen in 2008) can negatively affect UBS’s revenues and it may be unable to immediately adjust all of its costs to the resulting deterioration in market or business conditions. A market downturn can be precipitated by a number of factors, including geopolitical events, changes in monetary or fiscal policy, trade imbalances, natural disasters, pandemics, civil unrest, war or terrorism. Because financial markets are global and highly interconnected, even local and regional events can have widespread impact well beyond the coun- tries in which they occur. A crisis could develop, regionally or globally, as a result of disruption in emerging markets, which are particularly susceptible to macro­economic and geopoliti- cal developments, or as a result of the failure of a major mar- ket participant. As UBS’s presence and business in emerging markets increases, it becomes more exposed to these risks. Adverse and extreme developments of this kind have affected UBS’s businesses in a number of ways, and may con- tinue to have further adverse effect on the firm’s businesses: – a general reduction in business activity and market volumes affects fees, commissions and margins from market­making and customer­driven transactions and activities; – a market downturn is likely to reduce the volume and valuations of assets UBS manages on behalf of clients, reducing its asset­ and performance­based fees; – reduced market liquidity limits trading and arbitrage opportunities and impedes UBS’s ability to manage risks, impacting both trading income and performance­based fees; Due to its sizeable trading inventory, trading activities and the counterparty credit risks in many of its businesses, UBS is dependent upon its risk management and control processes to avoid or limit potential losses Controlled risk­taking is a major part of the business of a fi- nancial services firm. Credit is an integral part of many of UBS’s retail, wealth management and Investment Bank activities. This includes lending, underwriting and derivatives businesses and positions. Changes in interest rates, equity prices, foreign exchange levels and other market fluctuations can adversely affect UBS’s earnings. Some losses from risk­taking activities are inevitable but, to be successful over time, UBS must balance the risks it takes with the returns it generates. It must there- fore diligently identify, assess, manage and control its risks, not only in normal market conditions but also as they might develop under more extreme (“stressed”) conditions, when concentrations of exposure can lead to severe losses. As seen in 2008, UBS is not always able to prevent losses arising from extreme or sudden market events that are not anticipated by its risk measures and systems and affect size- able inventory positions and therefore lead to serious losses. Value at Risk (VaR), a statistical measure for market risk, is derived from historical market data, and thus, by definition, could not have predicted the losses seen in the stressed conditions in 2008. Moreover, stress loss and concentration controls, and the dimensions in which UBS aggregates risk to identify potentially highly correlated exposures, proved to be inadequate. UBS’s tools and processes for market and credit risk con- trol, including country risk, its approach to risk management and control, and the steps UBS has taken to strengthen its risk management and control framework are described in the “Risk management” section of this report. Notwithstanding such steps, UBS could suffer further losses in the future if, for example: – it does not fully identify the risks in its portfolio, in par- ticular risk concentrations and correlated risks; 24 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S – its assessment of the risks identified, or its response to negative trends, proves to be inadequate or incorrect; – markets move in ways that are unexpected – in terms of their speed, direction, severity or correlation – and UBS’s ability to manage risks in the resultant environment is therefore restricted; – third­parties to whom UBS has credit exposure or whose securities it holds for its own account are severely affect- ed by events not anticipated by UBS’s models and the bank accordingly suffers defaults and impairments be- yond the level implied by its risk assessment; or – collateral or other security provided by its counterparties proves inadequate to cover their obligations at the time of their default. UBS also manages risk on behalf of its clients in its asset and wealth management businesses. Its performance in these activities could be harmed by the same factors. If clients suffer losses or the performance of their assets held with UBS is not in line with relevant benchmarks against which clients assess investment performance, UBS may suffer reduced fee income and a decline in assets under manage- ment or withdrawal of mandates. If UBS decided to support a fund or another investment sponsored by UBS in its asset or wealth management busi- ness it might, depending on the facts and circumstances, incur charges that could increase to material levels. UBS does not currently foresee the likelihood of material losses as a result, but the possibility cannot be definitively ruled out. Investment positions – such as equity holdings made as a part of strategic initiatives and seed investments made at the inception of funds managed by UBS – may also be affected by market risk factors. These investments are often not liquid and are generally intended or required to be held beyond a normal trading horizon. They are subject to a distinct control framework (described in the “Risk and treasury manage- ment” section of this report). Deteriorations in the fair value of these positions would have a negative impact on UBS’s earnings. The valuation of certain assets relies on models. For some or all of the inputs to these models there is no observable source Where possible, UBS marks its trading book assets at their quoted market price in an active market. In the current envi- ronment, such price information is not available for certain instruments and UBS applies valuation techniques to measure such instruments. Valuation techniques use “market observ- able inputs” where available, derived from similar assets in similar and active markets, from recent transaction prices for comparable items or from other observable market data. For positions for which some or all of the reference data is not observable or has limited observability, UBS uses valuation models with non­market observable inputs. “Note 27 Fair val- ue of financial instruments” in the financial statements of this report provides detailed information on the determination of fair value from valuation techniques. There is no single market standard for valuation models in this area. Such models have inherent limitations; different assumptions and inputs would generate different results, and these differences could have a significant impact on UBS’s financial results. UBS regularly re- views and updates its valuation models to incorporate all fac- tors that market participants would consider in setting a price, including factoring in current market conditions. Judgment is an important component of this process. Changes in model inputs or in the models themselves could have a material im- pact on UBS’s financial results. Credit ratings and liquidity and funding management are critical to UBS’s ongoing performance Moody’s Investors Service, Fitch Ratings and Standard & Poor’s all lowered their long­term credit rating of UBS, on one or more times in 2008 and 2009. A further reduction in UBS’s credit rating could increase its funding costs, in par- ticular with regard to funding from wholesale unsecured sources, and reduce access to capital markets. Some of these ratings downgrades have resulted, and additional reductions in the credit ratings would result, in UBS having to make ad- ditional cash payments or post additional collateral. These events may increase UBS’s need for funding to ensure that it will always have sufficient liquidity to meet liabilities when due, while reducing its ability to obtain such funding. UBS’s credit ratings also have an impact on the performance of UBS’s businesses. Along with UBS’s capital strength and rep- utation, both of which are described in greater detail in the risk factors below, UBS’s credit ratings contribute to main- taining client and counterparty confidence in UBS. Liquidity is essential to UBS’s businesses. A substantial part of UBS’s liquidity and funding requirements are met us- ing short­term unsecured funding sources, including whole- sale and retail deposits and the regular issuance of money market securities. The volume of these funding sources has generally been stable, but may change in the future due, among other things, to general market disruptions. Any such change could occur quickly and without notice. If such a change were to occur, UBS could be forced to liquidate as- sets, in particular from its trading portfolio, to meet matur- ing liabilities or deposit withdrawals. Given the depressed prices of many asset classes in current market conditions, UBS might be forced to sell assets at discounts that could adversely affect its profitability and its business franchises. In 2008, UBS’s credit spreads increased substantially, in line with the general trend for the financial services industry. If these trends continue, or if UBS maintains substantially elevated lev- els of liquidity for an extended period of time, the combination of an increase in UBS’s borrowing costs and lower margins could have an adverse impact on the firm’s pro fitability. ➔ Refer to the “Risk and treasury management” section of this report for more information on UBS’s approach to liquidity and funding management 25 Strategy, performance and responsibility Risk factors UBS’s capital strength is important to support its client franchise UBS’s capital position measured by the BIS capital ratios is and has traditionally been strong, both in absolute terms and relative to its competitors. Capital ratios are determined by (1) risk­weighted assets (RWAs) (balance sheet, off­bal- ance sheet and other market and operational risk positions, measured and risk­weighted according to regulatory criteria) and (2) eligible capital. Both RWAs and eligible capital are subject to change. Eli- gible capital, for example, could experience a reduction in case of financial losses, acquired goodwill or as a result of foreign exchange movements. RWAs, on the other hand, will be driven by UBS’s business activities and by changes in the risk profile of these assets. They could furthermore be subject to a change in regulatory requirements or the inter- pretation thereof. For instance, substantial market volatility, a widening of credit spreads (the major driver of UBS’s VaR), a change in regulatory treatment of certain positions (includ- ing, but not limited to, the definitions of assets allocated to the trading or the banking books), stronger foreign curren- cies, increased counter­party risk or a further deterioration in the economic environment could result in a rise in RWAs or a change in capital requirements and thereby potentially reduce UBS’s capital ratios. Operational risks may affect UBS’s business All UBS’s businesses are dependent on the bank’s ability to process a large number of complex transactions across mul- tiple and diverse markets in different currencies, in addition to being subject to the many different legal and regulatory regimes of these countries. UBS’s operational risk manage- ment and control systems and processes, which are de- scribed in the “Operational risk” section of this report, are designed to ensure that the risks associated with the bank’s activities, including those arising from process error, failed execution, unauthorized trading, fraud, systems failure and failure of security and physical protection, are appropriately controlled. If these internal controls fail or prove ineffective in identifying and remedying such risks, UBS could suffer operational failures that might result in losses. Legal claims and regulatory risks and restrictions arise in the conduct of UBS’s business In the ordinary course of its business, UBS is subject to regu- latory oversight and liability risk. It is involved in a variety of other claims, disputes and legal proceedings and govern- ment investigations in jurisdictions where UBS is active, including the United States and Switzerland. These types of proceedings expose UBS to substantial monetary damages and legal defense costs, injunctive relief, criminal and civil penalties and the potential for regulatory restrictions on UBS’s businesses. The outcome of these matters cannot be predicted and they could adversely affect UBS’s future busi- ness. Currently, UBS is responding to a number of govern- ment inquiries and investigations, and is involved in a num- ber of litigations and disputes, related to the sub­prime crisis, sub­prime securities, and structured transactions involving sub­prime securities. These matters concern, among other things, UBS’s valuations, disclosures, writedowns, underwrit- ing and contractual obligations. UBS has been in active dialogue with its regulators con- cerning remedial actions that it is taking to address deficien- cies in its risk management and control, funding and certain other processes and systems. UBS will for some period be subject to increased scrutiny by the Swiss Financial Market Supervisory Authority and its other major regulators, and ac- cordingly will be subject to regulatory measures that might affect the implementation of its strategic plans. UBS recently announced that it had entered into a De- ferred Prosecution Agreement with the US Department of Justice and a Consent Order with the US Securities and Exchange Commission in connection with its cross­border private banking services provided to US private clients. The US Internal Revenue Service has issued a civil summons seek- ing information concerning UBS’s cross­border business, in- cluding records located in Switzerland, and recently filed a petition for enforcement of this summons. It is possible that this and other governmental actions will lead to changes which could affect cross­border financial services and the application of Swiss financial privacy law, and this could ad- versely affect the future profitability of UBS’s cross­border banking businesses. Following disclosure of the US cross­ border matter, moreover, it is possible that tax or regulatory authorities in various jurisdictions will focus on the cross­bor- der wealth management services provided by UBS and other financial institutions. It is premature to speculate as to the scope or effect of any such reviews. ➔ Refer to “Note 21 provisions and litigation” in the financial statements of this report for more information on legal proceedings in which UBS is involved UBS might be unable to identify or capture revenue or competitive opportunities, or retain and attract qualified employees The financial services industry is characterized by intense competition, continuous innovation, detailed (and some- times fragmented) regulation and ongoing consolidation. UBS faces competition at the level of local markets and indi- vidual business lines, and from global financial institutions comparable to UBS in their size and breadth. Barriers to entry in individual markets are being eroded by new technology. UBS expects these trends to continue and competition to increase in the future. The competitive strength and market position of UBS could be eroded if the firm is unable to identify market trends and developments, does not respond to them by devising and implementing adequate business strategies or 26 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S is unable to attract or retain the qualified people needed to carry them out. In particular, the efforts required to address the current market crisis and related challenges might diminish the attention UBS devotes to managing other risks including those arising from its competitive environment. The changes recently introduced with regard to UBS’s balance sheet management, funding framework and risk management and control, as well as the repositioning of the fixed income, currencies and commodities business, are likely to reduce the revenue contribution of certain activities that require sub- stantial funding or focus on proprietary trading. Following the losses incurred in 2008, UBS very signifi- cantly reduced the variable compensation granted to its employees for that year. It is possible that, as a result of this reduction or other factors, key employees will be attracted by competitors and decide to leave UBS, or that UBS may be less successful in attracting qualified employees. UBS’s reputation is key to its business UBS’s reputation is critical in maintaining its relationships with clients, investors, regulators and the general public. The reputation of UBS can be damaged, for instance, by miscon- duct by its employees, by activities of business partners over which UBS has limited or no control, by severe or prolonged financial losses or by uncertainty about its financial sound- ness and its reliability. This could result in client attrition in different parts of UBS’s business and could negatively impact its financial performance. Maintaining the firm’s reputation and addressing adverse reputational developments are there- fore key factors in UBS’s risk management efforts. UBS’s global presence exposes the bank to other risks, including currency fluctuation UBS operates in more than 50 countries, earns income and holds assets and liabilities in many different currencies and is subject to many different legal, tax and regulatory regimes. UBS’s ability to execute its global strategy depends on obtaining and maintaining local regulatory approvals. This includes the approval of acquisitions or other transactions and the ability to obtain and maintain the necessary licenses to operate in a local market. Changes in local tax laws or regulations and their enforcement may affect the ability or the willingness of UBS’s clients to do business with the bank, or the viability of the bank’s strategies and business model. In its financial accounts, UBS accrues taxes but the final effect of taxes on earnings is only determined after comple- tion of tax audits (which generally takes a number of years) or the expiration of statutes of limitations. In addition, changes in tax laws, judicial interpretation of tax laws or pol- icies and practices of tax authorities could have a material impact on taxes paid by UBS and cause the amount of taxes ultimately paid by UBS to differ from the amount accrued. Because UBS prepares its accounts in Swiss francs, while a substantial part of its assets, liabilities, assets under manage- ment, revenues and expenses are denominated in other cur- rencies, changes in foreign exchange rates, particularly be- tween the Swiss franc and the US dollar (US dollar income represents the major part of UBS’s non­Swiss franc income) have an effect on its reported income and shareholders’ equity. UBS’s approach to management of this currency risk is explained in the “Treasury management” section of this report. 27 Strategy, performance and responsibility Financial performance Financial performance UBS’s performance is reported in accordance with Inter national Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board. This section provides a discussion and analysis of UBS’s results for 2008, commenting on the underlying operational performance of the business, with a focus on continuing operations. UBS financial highlights CHF million, except where indicated Performance indicators from continuing operations Diluted earnings per share (CHF) 1 Return on equity attributable to UBS shareholders (%) 2 Cost / income ratio (%) 3 Net new money (CHF billion) 4 Group results Operating income Operating expenses Operating profit before tax (from continuing and discontinued operations) Net profit attributable to UBS shareholders Personnel (full-time equivalents) 5 Invested assets (CHF billion) UBS balance sheet and capital management Balance sheet key figures Total assets Equity attributable to UBS shareholders Market capitalization 6 BIS capital ratios 7 Tier 1 (%) Total BIS (%) Risk-weighted assets Long-term ratings Fitch, London Moody’s, New York Standard & Poor’s, New York As of or for the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 (7.75) (59.1) 753.0 (226.0) 796 28,555 (27,560) (21,292) 77,783 2,174 (2.61) (11.7) 111.0 140.6 31,721 35,463 (3,597) (5,247) 83,560 3,189 4.64 23.9 70.5 151.7 47,484 33,365 15,007 11,527 78,140 2,989 2,014,815 2,274,891 2,348,733 32,531 43,519 11.0 15.0 302,273 A+ Aa2 A+ 36,875 108,654 9.1 8 12.2 8 374,421 8 AA Aaa AA 51,037 154,222 12.2 8 15.0 8 344,015 AA+ Aa2 AA+ (197) (97) (19) (666) (306) (7) (32) (11) (12) (60) (19) 1 Refer to “Note 8 Earnings per share (EPS) and shares outstanding” in the financial statements of this report. 2 Net profit attribu table to UBS shareholders from continuing operations / average eq- uity attributable to UBS shareholders. 3 Operating expenses / operating income before credit loss expense or recovery. 4 Excludes interest and dividend income. 5 Excludes personnel from private equity (part of the Corporate Center). 6 Refer to the “UBS registered shares” section of this report for further information. 7 Refer to the “Capital management” section of this report for further in- formation. 8 The calculation prior to 2008 is based on the Basel I approach. 28 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Measurement and analysis of performance Key factors affecting UBS’s financial position and results of operations in 2008 – In 2008, UBS continued to be severely affected by nega- tive revenues in the Investment Bank due to trading losses on risk positions. Refer to the “Risk concentrations” sec- tion and “Note 3 Net interest and trading income” in the financial statements of this report for more information on risk positions and associated losses. – UBS recorded a significant increase in credit losses from CHF 238 million in the prior year to CHF 2,996 million. This reflects the deteriorating economic environment and impairment charges taken on reclassified financial assets in fourth quarter 2008. Refer to the “Credit risk” section of this report for more information. – On 5 March 2008, UBS issued mandatory convertible notes (MCNs) with a face value of CHF 13 billion to two investors. This transaction resulted in an accounting gain of CHF 3,860 million in first quarter 2008 and in an increase in share premium of CHF 7.0 billion. Refer to “Note 26 Capital increases and mandatory convertible notes” in the financial statements of this report for more information. – On 23 April 2008, the annual general meeting of share- holders approved a proposal that UBS strengthen its shareholders’ equity by way of an ordinary capital in- crease. The capital increase was completed in June 2008 by means of a rights offering and resulted in the issue of 760,295,181 new fully paid registered shares with a par value of CHF 0.10 each. Net proceeds from the capital increase were approximately CHF 15.6 billion. Refer to “Note 26 Capital increases and mandatory convertible notes” in the financial statements of this report for more information. – On 20 May 2008, UBS completed the sale of a portfolio of US residential mortgage­backed securities (RMBSs) for proceeds of USD 15 billion to the RMBS Opportunities Master Fund, LP, a third­party entity managed by Black- Rock, Inc. The portfolio had a notional value of approxi- mately USD 22 billion and comprised primarily Alt­A and sub­prime related assets. The fund was capitalized with approximately USD 3.75 billion in equity raised by Black- Rock from third­party investors and an eight­year amor- tizing USD 11.25 billion senior secured loan provided by UBS (balance at year­end 2008 was USD 9.2 billion). – As announced on 16 October 2008, the Swiss National Bank (SNB) and UBS have reached an agreement to trans- fer, in one or more sales, up to USD 60 billion of illiquid and other positions from UBS’s balance sheet to a sepa- rate fund entity controlled and owned by the SNB. The size of the transaction has since been reduced to USD 38.6 billion. This transaction allowed UBS to reduce its exposure to certain asset classes and potential associated losses. In parallel, UBS placed CHF 6 billion of MCNs with the Swiss Confederation on 9 December 2008. The over- all impact on UBS’s income statement of the SNB trans­ action and the placement of the MCNs with the Swiss Confederation was a net charge of CHF 4.5 billion. This reflects a net loss arising from the acquisition of the equity purchase option, a loss arising from valuation differences determined to date on securities sold or to be sold to the SNB StabFund, losses on hedges that were subject to trading restrictions as a result of the SNB transaction, and the impact of the contingent issuance of UBS shares in connection with the transaction. The fair valuation im- pact of the issuance of the MCNs, as described in “Note 26 Capital increases and mandatory convertible notes” in the financial statements of this report, is also included in this total. – In 2008, the Investment Bank recorded a gain on own credit from financial liabilities designated at fair value of CHF 2,032 million, resulting from the widening of UBS’s credit spread, which was partly offset by the effects of redemptions and repurchases of such liabilities. The cumulative own credit balance for such debt held at 31 December 2008 amounts to CHF 2,953 million. Refer to “Note 27 Fair value of financial instruments” in the fi- nancial statements of this report for more information. Financial liabilities designated at fair value are liabilities for which UBS applied the option granted by IFRS to fair value them through profit or loss, predominately issued structured products. The gain reflects an increase in the difference between the market value of UBS’s debt ac- counted for under the fair value option (which is presented on the balance sheet line “Financial liabilities designated at fair value”) and the amount it would cost UBS to issue this debt at current market terms. As a general rule, the market value of UBS’s outstanding debt de creases if UBS’s own credit spread widens and increases if UBS’s credit spread tightens. Therefore, if UBS’s credit spread were to tighten again in the future, the market value of UBS’s out- standing fair valued debt would increase accordingly, re- sulting in the reversal of some or all of the gains on own credit recorded so far, unless UBS redeems own debt be- fore maturity. – Following the auction rate securities (ARS) settlement in August 2008, Wealth Management US recorded losses of CHF 1,636 million, of which CHF 1,464 million were in- 29 Strategy, performance and responsibility Financial performance cluded in general and administrative expenses, and CHF 172 million were recognized as trading losses. Under the ARS settlement, Wealth Management US agreed to pur- chase ARS from clients at their par value. Up to fourth quarter 2008, the ARS settlement liability represented a provision. The liability was reclassified from provisions to negative replacement values in fourth quarter 2008, when ARS settlement rights, which are treated as deriva- tive instruments, were issued to and accepted by clients. Losses incurred post­reclassification represented trading losses. – As announced on 18 February 2009, UBS settled the US cross­border case with the US Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC), by entering into a deferred prosecution agreement with the DOJ and a consent order with the SEC. As part of these settlement agreements, UBS agreed to pay an amount of CHF 917 million (USD 780 million) to the United States. Refer to the “Settlement regarding the US cross­border case” sidebar in the “Wealth Management International & Switzerland” section of this report for more information. – UBS recognized an income tax benefit of CHF 6,837 mil- lion in 2008, which mainly reflects the CHF 6,126 million impact from the recognition of incremental deferred tax assets on available tax losses. The incremental deferred tax assets relate mainly to Swiss tax losses incurred during 2008 (primarily due to the writedown of investments in US subsidiaries) but was reduced by a decrease in the deferred tax assets recognized for US tax losses. Refer to “Note 22 Income taxes” in the financial statements of this report for more information. Discontinued operations As discontinued activities are no longer relevant to the man- agement of the company, UBS does not consider them to be indicative of its future potential performance and they are therefore not included in its business planning decisions. This assists in comparing UBS’s performance against that of its peers, and in the estimation of future results. In the last three years, one such item had a significant impact on UBS’s consolidated financial statements: On 23 March 2006, UBS sold its 55.6% stake in Motor­Columbus to a consortium representing Atel’s Swiss minority shareholders, EOS Hold- ing, Atel and French utility Electricité de France (EDF) for a sale price of approximately CHF 1,295 million, leading to an after­tax gain on sale of CHF 387 million. Seasonal characteristics The main businesses of UBS do not generally show signifi- cant seasonal patterns, although the Investment Bank’s rev- enues have been affected in some years by the seasonal characteristics of general financial market activity and deal flows in investment banking. Other business divisions are only slightly impacted by seasonal components, such as as- set withdrawals that tend to occur in fourth quarter and lower client activity levels related to the end­of­year holiday season. Performance measures Key performance indicators (2008) Until the end of 2008, UBS consistently assessed its per­ formance against indicators designed to measure the deliv- ery (on average and through periods of varying market con- ditions) of returns to its shareholders. At the Group level, these indicators were: after­tax return on equity; net new money; diluted earnings per share (EPS); and cost / income ratio. Business division key performance indicators (KPIs) were also used for internal performance measurement and planning as well as external reporting. ➔ A new key performance indicator framework was intro- duced in first quarter 2009 and will be used to measure performance in 2009 and forward. Refer to the “Key performance indicators: 2009 and beyond” sidebar in the “Strategy and structure” section of this report for more information Client / invested assets reporting UBS reports two distinct metrics for client funds: – Client assets are all client assets managed by or deposited with UBS, including custody­only assets and assets held for purely transactional purposes. – Invested assets is a more restrictive term and includes all client assets managed by or deposited with UBS for in- vestment purposes. Of the two, invested assets is the central measure for UBS and includes, for example, discretionary and advisory wealth management portfolios, managed institutional assets, man- aged fund assets and wealth management securities or bro- kerage accounts. It excludes all assets held for purely trans- actional and custody­only purposes as UBS only administers the assets and does not offer advice on how these assets should be invested. Non­bankable assets (for example, art collections) and deposits from third­party banks for funding or trading purposes are excluded from both measures. Net new money in a reported period is the net amount of invested assets that are entrusted to UBS by new and existing clients less those withdrawn by existing clients and clients who terminate their relationship with UBS. Negative net new money means that there are more outflows than inflows. Interest and dividend income from invested assets is not counted as net new money inflow. Market and cur- rency movements as well as fees, commissions and interest on loans charged are excluded from net new money, as are the effects resulting from any acquisition or divestment of a UBS subsidiary or business. Reclassifications between invest- 30 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Business division / business unit key performance indicators (2008) Business Business divisions and business units (excluding Corporate Center) Wealth and asset management businesses and Business Banking Switzerland Key performance indicators Cost / income ratio (%) Return on attributed equity (%) Invested assets (CHF billion) Net new money (CHF billion) Wealth and asset management businesses Gross margin on invested assets (bps) Wealth Management International & Switzerland Client advisors Revenues per advisor (CHF thousand) Definition Total operating expenses / total operating income before credit loss (expense)/recovery Performance before tax / average attributed equity Client assets managed by or deposited with UBS for investment purposes only (for further details please see “Client / invested assets reporting”) Inflow of invested assets from new clients + inflows from existing clients – outflows from existing clients – outflows due to client defection Total operating income before credit loss (expense)/recovery / average invested assets Expressed in full-time equivalents Total operating income before credit loss (expense)/recovery / average number of client advisors Net new money per advisor (CHF thousand) Net new money / average number of client advisors Wealth Management US Recurring income (CHF million) Invested assets per advisor (CHF thousand) Revenues per advisor (CHF thousand) Net new money per advisor (CHF thousand) Invested assets per advisor (CHF thousand) Average invested assets / average number of client advisors Interest, asset-based revenues for portfolio management and account-based, distribution and advisory fees (as opposed to transactional revenues) Total operating income before credit loss (expense)/recovery / average number of financial advisors Net new money / average number of financial advisors Average invested assets / average number of financial advisors Business Banking Switzerland Impaired lending portfolio as a % of total lending portfolio, gross Impaired lending portfolio, gross / total lending portfolio, gross Investment Bank Compensation ratio (%) Personnel expenses / total operating income before credit loss (expense)/recovery Impaired lending portfolio as a % of total lending portfolio, gross Impaired lending portfolio, gross / total lending portfolio, gross Average regulatory VaR (10-day, 99% confidence, based on 5 years of historical data) Value at Risk (VaR) expresses maximum potential loss measured to a 99% confidence level, over a 10-day time horizon and based on 5 years of historical data ed assets and client assets as a result of a change in the service level delivered are treated as net new money inflow or outflow. When products are managed in one business division and sold in another, they are counted in both the investment man- agement unit and the distribution unit. This results in double counting within UBS’s total invested assets as both units pro- vide an independent service to their respective client, add val- ue and generate revenues. Most double counting arises where mutual funds are managed by the Global Asset Management business division and sold by Global Wealth Management & Business Banking. Both businesses involved count these funds as invested assets. This approach is in line with both finance industry practices and UBS’s open architecture strategy and allows the firm to accurately reflect the performance of each individual business. Overall, CHF 273 billion of invested assets were double counted in 2008 (CHF 392 billion in 2007). 31 Strategy, performance and responsibility Financial performance UBS reporting structure Changes to reporting structure and presentation in 2008 Industrial Holdings reported in the Corporate Center As UBS has continuously reduced its private equity business in Industrial Holdings over the last three years to a very low level, it was decided to report these activities under the Cor- porate Center from 2008 onwards. Exiting of the municipal securities business by the Investment Bank In June 2008, UBS announced the closure of its Investment Bank’s institutional municipal securities business. This hap- pened with immediate effect and the retail operations of the municipal securities business, including secondary market activities, were transferred to Wealth Management US. A goodwill impairment charge of CHF 341 million was record- ed in second quarter 2008 in relation to the exiting of this business and was attributed to the Investment Bank. Exiting of certain commodities businesses by the Investment Bank In October 2008, UBS announced that the Investment Bank would exit the commodities business, with the exception of precious metals. This resulted in an expense of CHF 133 mil- lion in fourth quarter 2008. UBS reporting structure in 2008 Global Asset Management Investment Bank Corporate Center Global Wealth Management & Business Banking Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland 1FP002_e Industriebeteiligungen Private Equity Changes to the reporting structure in 2009 Wealth Management & Swiss Bank and Wealth Management Americas On 10 February 2009, UBS announced with immediate effect the split of Global Wealth Management & Business Banking into two divisions: Wealth Management & Swiss Bank and Wealth Management Americas. UBS will start reporting results based on this new structure with the first quarter 2009 results. Investment Bank As announced on 3 October 2008 and reiterated on 10 February 2009, the Investment Bank is being repositioned to focus on its core franchises. The fixed income, currencies and com- modities (FICC) business unit of the Investment Bank has exited several businesses including institutional municipal securities, proprietary trading, commodities (excluding precious metals, exchange­traded derivatives and indices) and real estate and securitization activities, as well as exotic structured products. The internal organization of the FICC business unit has changed to reflect this repositioning, but these changes are not expected to have an immedi- ate impact on the Investment Bank’s or UBS’s reporting structure. 32 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Accounting changes Restatements made to the financial statements 2008 This Annual Report 2008, including UBS’s Group financial statements and other information, replaces the Annual Re- port 2008 issued and filed with the US SEC on Form 20­F on 11 March 2009. UBS has restated its 2008 Group financial statements to correct identified accounting errors related to the 2008 Group financial statements included in the Annual Report 2008 issued on 11 March 2009. These errors are not mate- rial to the annual or quarterly 2008 financial statements, but related corrections would have been material to first quarter 2009 financial statements. The restatement comprises three items in excess of CHF 100 million as follows: increase in fair value of auction rate securities purchase commitments at 31 December 2008 (charge to net trading income of Wealth Management US of CHF 112 million), calculation of interest income based on the effective interest rate method for as- sets reclassified from “held­for­trading” to “loans and re- ceivables” in fourth quarter 2008 (reduction of the interest income of the Investment Bank by CHF 180 million), realiza- tion of a foreign currency translation loss deferred in share- holders’ equity due to the partial disposals of an investment in a consolidated investment fund (reduction of other in- come of Corporate Center by CHF 192 million). In addition, a number of misstatements, individually below CHF 65 mil- lion, were adjusted resulting in an increase of net profit at- tributable to UBS shareholders by CHF 79 million. The total net impact of all restated items on the 2008 results was a reduction of net profit and net profit attribut- able to UBS shareholders of CHF 405 million, and a reduc- tion of equity and equity attributable to UBS shareholders of CHF 269 million. The BIS tier 1 capital decreased by CHF 217 million, the BIS total ratio decreased by 0.1% and the BIS tier 1 ratio was not affected by the restatement. 2008 quarterly net profits attributable to UBS shareholders were reduced by the following amounts: CHF 82 million in the first quarter, CHF 37 million in the second quarter, CHF 13 million in the third quarter and CHF 273 million in the fourth quarter. over the shorter of the legal vesting period and the period from grant through to the retirement eligibility date of the employee. UBS has fully restated the two prior years (2006 and 2007), with net profit attributable to UBS shareholders declining by CHF 863 million in 2007 and declining by CHF 730 million in 2006. The net increase in compensation ex- pense was CHF 797 million for 2007 and CHF 516 million for 2006, mainly affecting the Investment Bank. Refer to “Note 1 Summary of significant accounting policies” in the finan- cial statements of this report for more information. Recognition of a defined benefit asset for the Swiss pension plan In third quarter 2008, UBS concluded that it meets the requirements of IAS 19 Employee Benefits for recognizing a defined benefit asset associated with its Swiss pension plan. Prior to this, it had been UBS policy to disclose only this amount in “Note 30 Pension and other post­employment benefit plans” in the financial statements of UBS’s annual reports. UBS concluded that recognition of an asset should also consider unrecognized net actuarial losses and past service cost as permitted by IAS 19 as this results in a better reflection of the corridor approach. At the end of third quarter 2008, the measurement of the defined benefit asset represented the total cumulative unrecognized net actuarial losses plus unrecognized past service cost plus the present value of economic benefits available in the form of refunds of the plan or reductions in future contributions to the plan. The change in accounting policy resulted in the following effects on the balance sheet for 30 September 2008, the date on which the change in policy occurred, 31 December 2007 and 31 December 2006: an increase of approximately CHF 2.1 billion in other assets, an increase of approximately CHF 0.5 billion in deferred tax liabilities and an increase of approximately CHF 1.6 billion in retained earnings. Refer to “Note 1 Summary of significant accounting policies” in the financial statements and the “Capital management” sec- tion of this report for more information. Share-based payments: revisions to International Financial Reporting Standard 2 IAS 39 Reclassification of financial instruments UBS adopted amended IFRS 2 on 1 January 2008. As a result, from 1 January 2008, UBS’s share­based awards that are not generally forfeited upon the employee leaving UBS are ex- pensed in the performance year. In contrast, share­based awards featuring stringent forfeiture rules are amortized The markets for many financial instruments began to dry up in 2007 and many instruments that previously traded in ac- tive and liquid markets ceased to trade actively by mid­2008. In an effort to address accounting concerns arising from the global credit crisis, the International Accounting Standards 33 Strategy, performance and responsibility Financial performance Board published an amendment to International Accounting Standard 39 (IAS 39 Financial Instruments: Recognition and Measurement) on 13 October 2008. Although the amendment could have been applied retro- spectively from 1 July 2008, UBS decided at the end of Octo- ber 2008 to apply the amendment prospectively with effect from 1 October 2008 following an assessment of the impli- cations on its financial statements. Subject to certain conditions being met, the amend- ments to IAS 39 permit financial assets to be reclassified out of the “held for trading” category if the firm has the intent and ability to hold them for the foreseeable future or until maturity. Eligible assets may be reclassified to the “loans and receivables” category, carried at amortized cost less impairment, or the “available­for­sale” category, carried at fair value through equity, with impairment recognized in profit or loss. Assets designated at fair value through profit or loss (“fair value option”) and derivatives may not be reclassified. Effective 1 October 2008, UBS reclassified eligible assets which it intends to hold for the foreseeable future with a fair value of CHF 17.6 billion on that date from “held for trading” to the “loans and receivables” category. In addi- tion, student loan auction rate securities (ARS) with a fair value of CHF 8.4 billion have been reclassified as of 31 De- cember 2008. In fourth quarter 2008, an impairment charge of CHF 1.3 billion was recognized as credit loss expense on reclassified financial instruments. If reclassification had not occurred, the impairment charge would not have been rec- ognized but a trading loss of CHF 4.8 billion would have been recorded in UBS’s fourth quarter income statement. In the fourth quarter, the operating profit before taxes would have been CHF 3.6 billion lower if the reclassification had not occurred. Refer to “Note 29 Measurement categories of financial assets and liabilities” in the financial statements of this report for more information on the reclassification of financial assets in 2008. Discontinuation of the adjusted expected credit loss concept In first quarter 2008, UBS ceased using the adjusted expected credit loss concept in its internal management reporting and began to book, in line with IFRS, actual credit losses (recoveries) instead. Prior year results have been restated. This change had no impact on the Group’s overall net profit. Accounting changes in 2009 IFRS 8 Operating Segments The new standard on segment reporting, IFRS 8 Operating Segments, came into force on 1 January 2009 and replaced IAS 14 Segment Reporting. The external segmental reporting is based on internal report- ing within UBS to the Group Executive Board (or, the “chief operating de­ cision maker”) which makes decisions on the allocation of resources and assesses the performance of the reportable segments. Based on the new UBS structure which was announced on 10 February 2009 and following IFRS 8 guidance, UBS will show in 2009 four reportable seg- ments. The business divisions Wealth Management & Swiss Bank, Wealth Management Americas, Global Asset Management and the Investment Bank represent one reportable segment each. The Corporate Center, which does not meet the requirements of an operating segment, will also be shown separately. In addition, the new standard requires UBS to provide descriptive information about the types of products and services from which each reportable segment derives its revenue. As UBS’s report- able segment operations are mainly financial, the total interest income and expense for all reportable segments will be presented on a net basis. Based on the present arrangement of revenue­sharing agreements, the inter­segment revenue for UBS is unlikely to be material. Going forward, the segment assets and segment liabilities will be disclosed without the intercompany balances and this basis is in line with the internal reporting. An explanation of the basis on which the segment information is prepared, and reconciliations to the amounts presented in the statement of com­ prehensive income and the statement of financial position are also required by the new standard. UBS will be providing geographical information about total operating income and total non­current assets based on the following new geographical break- down: Switzerland, UK, Rest of Europe, USA, Asia Pacific and Rest of the World. 34 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Key performance indicators Until the end of 2008, UBS focused on four key perfor- mance indicators: return on equity, diluted earnings per share, cost / income ratio and net new money. These indica- tors are designed to monitor the returns UBS delivers to shareholders and are calculated using results from continu- ing operations. Return on equity  In % Cost / income ratio In % 2006 2007 2008 2006 2007 2008 40 20 0 –20 –40 –60 25.7 23.9 (11.7) (10.9) (59.1) (58.7) RoE from continuing operations Return on equity (RoE) 800 600 400 200 0 Diluted earnings per share  CHF Net new money CHF billion 2006 2007 2008 6.00 3.00 0.00 –3.00 –6.00 –9.00 4.99 4.64 (2.61) (2.43) (7.75) (7.69) Diluted EPS from continuing operations Diluted earnings per share (EPS) 160 80 0 –80 –160 –240 Key performance indicators Return on equity (RoE) (%) 1 RoE from continuing operations (%) 1 Diluted earnings per share (EPS) (CHF) 2 Diluted EPS from continuing operations (CHF) 2 Cost / income ratio (%) 3 Net new money (CHF billion) 4 753.0 70.5 111.0 2006 151.7 2007 2008 140.6 (226.0) For the year ended 31.12.08 31.12.07 31.12.06 (58.7) (59.1) (7.69) (7.75) 753.0 (226.0) (10.9) (11.7) (2.43) (2.61) 111.0 140.6 25.7 23.9 4.99 4.64 70.5 151.7 1 Net profit attributable to UBS shareholders / average equity attributable to UBS shareholders less distributions (where applicable). 2 Refer to “Note 8 Earnings per share (EPS) and shares outstanding” in the financial statements of this report for more information on EPS calculation. 3 Operating expenses / operating income before credit loss expense or recovery. 4 Excludes interest and dividend income. 35 40 -20 -40 -60 6 3 -3 -6 -9 40 20 0 -20 -40 -60 6 3 0 -3 -6 -9 20 0 0 800 600 400 200 0 160 80 0 -80 -160 -240 Strategy, performance and responsibility Financial performance 2008 The key performance indicators show: – return on equity from continuing operations for full­year 2008 at negative 59.1%, down from negative 11.7% in 2007. The profits recorded by UBS’s wealth and asset management businesses were more than offset by sub- stantial losses in the Investment Bank. – negative diluted earnings per share from continuing op- erations of CHF 7.75, compared with negative CHF 2.61 in 2007. – a cost / income ratio of 753.0%, compared with 111.0% a year ago. – net new money at negative CHF 226.0 billion, down from positive CHF 140.6 billion in 2007. Net new money out- flows were most pronounced in the Global Wealth Man- agement & Business Banking division, which recorded to- tal net new money outflows of CHF 123.0 billion. Wealth Management International & Switzerland contributed to the majority of this total with net outflows of CHF 101.0 billion, the most significant outflows occurring in the Lat- in America, Mediterranean, Middle East & Africa regions. Wealth Management US reported net new money out- flows of CHF 10.6 billion, mainly due to net outflows in the second and third quarters. The Swiss retail business recorded net new money outflows of CHF 11.4 billion. Global Asset Management saw total net outflows of CHF 103.0 billion. Of this, outflows in institutional were CHF 55.6 billion and occurred primarily via third­party distribu- tion channels. Institutional net outflows were observed in all categories except money market funds, infrastructure and real estate. Wholesale intermediary had total net out- flows of CHF 47.4 billion, reflecting higher outflows mainly in multi­asset, equities and fixed income. Approxi- mately three­fourths of the wholesale intermediary out- flows were through UBS distribution channels. Net new money 1 CHF billion Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Wealth Management & Business Banking Institutional Wholesale intermediary Global Asset Management UBS 1 Excludes interest and dividend income. Invested assets CHF billion Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Wealth Management & Business Banking Institutional Wholesale intermediary Global Asset Management UBS 36 For the year ended 31.12.08 31.12.07 31.12.06 (101.0) (10.6) (11.4) (123.0) (55.6) (47.4) (103.0) (226.0) 125.1 26.6 4.6 156.3 (16.3) 0.6 (15.7) 140.6 97.6 15.7 1.2 114.5 29.8 7.4 37.2 151.7 31.12.08 As of 31.12.07 % change from 31.12.06 31.12.07 870 600 129 1,599 335 240 575 2,174 1,294 840 164 2,298 522 369 891 3,189 1,138 824 161 2,123 519 347 866 2,989 (33) (29) (21) (30) (36) (35) (35) (32) y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S 2007 Key performance indicators show: – return on equity from continuing operations for full­year 2007 at negative 11.7%, down from positive 23.9% in 2006. The strong results posted by UBS’s wealth and asset management businesses were more than offset by sub- stantial losses in the Investment Bank; – negative diluted earnings per share from continuing operations of CHF 2.61, compared with positive CHF 4.64 in 2006; – a cost / income ratio of 111.0%, compared with 70.5% in the prior year; – net new money at CHF 140.6 billion, down from a record in 2006 of CHF 151.7 billion. The decrease was mostly driven by full­year outflows in Global Asset Manage- ment, mainly in institutional which had net new money outflows of CHF 16.3 billion. The net new money out- flows in core / value equity mandates and, to a lesser extent, in fixed income mandates were only partly offset by net new money inflows into all other asset classes, particularly alternative and quantitative investments and money market funds. Record net new money inflows were seen in Wealth Management International & Swit- zerland, particularly in Europe and Asia Pacific. Net new money inflows of CHF 26.6 billion in Wealth Mana­ gement US reflected the recruitment of experienced advisors and reduced outflows from existing clients. The Swiss retail business recorded net new money inflows of CHF 4.6 billion. New key performance indicator framework A new key performance indicator (KPI) framework was introduced in first quarter 2009 and will be used to measure performance in 2009 and forward. Refer to the “Key perfor- mance indicators: 2009 and beyond” sidebar in the “Strategy and structure” section of this report for more information on UBS’s new KPIs. 37 Strategy, performance and responsibility Financial performance UBS results Income statement CHF million, except where indicated Continuing operations Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss expense Net fee and commission income Net trading income Other income Total operating income Cash components Share-based components Total personnel expenses General and administrative expenses Depreciation of property and equipment Impairment of goodwill Amortization of intangible assets Total operating expenses Operating profit from continuing operations before tax Tax expense Net profit from continuing operations Discontinued operations Profit from discontinued operations before tax Tax expense Net profit from discontinued operations Net profit Net profit attributable to minority interests from continuing operations from discontinued operations Net profit attributable to UBS shareholders from continuing operations from discontinued operations Earnings per share Basic earnings per share (CHF) from continuing operations from discontinued operations Diluted earnings per share (CHF) from continuing operations from discontinued operations Additional information Personnel (full-time equivalents) 1 1 Excludes personnel from private equity (part of the Corporate Center). 38 As of or for the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 65,679 (59,687) 5,992 (2,996) 2,996 22,929 (25,820) 692 796 16,356 (94) 16,262 10,498 1,241 341 213 28,555 (27,758) (6,837) (20,922) 198 1 198 109,112 (103,775) 87,401 (80,880) 5,337 (238) 5,099 30,634 (8,353) 4,341 31,721 22,342 3,173 25,515 8,429 1,243 0 276 35,463 (3,742) 1,369 (5,111) 145 (258) 403 6,521 156 6,677 25,456 13,743 1,608 47,484 21,346 2,685 24,031 7,942 1,244 0 148 33,365 14,119 2,998 11,121 888 (11) 899 (20,724) (4,708) 12,020 568 520 48 (21,292) (21,442) 150 (7.69) (7.74) 0.05 (7.69) (7.75) 0.05 539 539 0 (5,247) (5,650) 403 (2.42) (2.61) 0.19 (2.43) (2.61) 0.19 493 390 103 11,527 10,731 796 5.19 4.83 0.36 4.99 4.64 0.34 (40) (42) 12 (41) (25) (209) (84) (97) (27) (36) 25 0 (23) (19) (642) (309) 37 (51) (340) 5 (4) (306) (280) (63) (218) (197) (74) (216) (197) (74) 77,783 83,560 78,140 (7) y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S 2008 Results 2008 saw the unfolding of a global financial crisis that af- fected UBS deeply. While UBS’s wealth and asset manage- ment businesses contributed positively to UBS results despite extremely difficult conditions, losses on the Investment Bank’s risk positions were very significant and led to an over- all negative result. In 2008, UBS reported a Group net loss attributable to UBS shareholders (“attributable loss”) of CHF 21,292 million – a loss of CHF 21,442 million from continuing operations and a profit of CHF 150 million from discontinued opera- tions. In 2007, UBS recorded an attributable loss of CHF 5,247 million. Trading versus non-trading income  CHF million 2006 2007 2008 45,000 42,617 30,000 33,598 31,080 13,730 15,000 0 –15,000 –30,000 (10,658) (27,203) Net income from interest margin, treasury businesses, fees and commissions and other income Net income from trading businesses Operating income Total operating income was CHF 796 million in 2008, down from CHF 31,721 million in 2007. Net interest income at CHF 5,992 million was up 12% compared with CHF 5,337 million a year earlier. Net trading income was negative CHF 25,820 mil- lion, sharply down from negative CHF 8,353 million in 2007. As well as income from interest margin­based activities (loans and deposits), net interest income includes income earned as a result of trading activities (for example, coupon and dividend income). The dividend income component of interest income is volatile from period to period, depending on the composition of the trading portfolio. In order to pro- vide a better explanation of the movements in net interest income and net trading income, their total is analyzed below under the relevant business activities. Net income from trading businesses Net income from trading businesses dropped to negative CHF 27,203 million for full­year 2008. This compares with income of negative CHF 10,658 million in the prior year, with the decline mainly due to losses on disclosed risk con- centrations in the fixed income, currencies and commodities (FICC) area of the Investment Bank in 2008. Within FICC, trading losses were experienced in difficult markets marked by a significant increase in volatility and an extreme scarcity of liquidity which negatively affected many trades and positions. Real estate and securitization, and credit and proprietary strategies all had a significant negative impact on FICC trading revenues. These losses obscured good results in select areas, notably foreign exchange and money markets, which had a strong year with revenues up from 2007. Rates had positive revenues but were down from the prior year. Trading revenues from the equities business were down from the previous year, mainly as a result of lower revenues in derivatives, especially in Europe and Asia. Equity­linked saw negative revenues in difficult equity and credit markets. The exchange­traded derivatives business was up as it benefited from significant volatility in the market. Prime brokerage ser- vices had a solid performance but revenues were down over- all from 2007 as clients deleveraged their positions. Proprie- tary trading contributed a limited loss for the year. In 2008, the Investment Bank recorded a gain on own credit from financial liabilities designated at fair value of CHF Net interest and trading income CHF million Net interest income Net trading income Total net interest and trading income Breakdown by businesses Net income from trading businesses 1 Net income from interest margin businesses Net income from treasury activities and other Total net interest and trading income 1 Includes lending activities of the Investment Bank. For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 5,992 (25,820) (19,828) (27,203) 6,160 1,214 (19,828) 5,337 (8,353) (3,016) (10,658) 6,230 1,412 (3,016) 6,521 13,743 20,264 13,730 5,718 816 20,264 12 (209) (557) (155) (1) (14) (557) 39 45000 30000 15000 0 -15000 -30000 Strategy, performance and responsibility Financial performance 2,032 million, resulting from the widening of UBS’s credit spread, which was partly offset by the effects of redemptions and repurchases of such liabilities. Refer to “Note 27 Fair val- ue of financial instruments” in the financial statements of this report for more information. In 2007, the Investment Bank recorded a gain of CHF 659 million on own credit. Net income from interest margin businesses Net income from interest margin businesses decreased 1% to CHF 6,160 million from CHF 6,230 million. This slight de- crease was primarily due to lower income from mortgages. Net income from treasury activities and other Net income from treasury activities and other was CHF 1,214 million compared with CHF 1,412 million. Gains from the accounting treatment of the MCNs issued on 5 March 2008 and 9 December 2008 were offset by negative income from the transaction with the SNB. Credit loss expense A credit loss expense of CHF 2,996 million was recorded in full­year 2008, compared with a credit loss expense of CHF 238 million in full­year 2007. The difference mainly reflects impairment charges taken on reclassified financial assets in fourth quarter 2008 and a further deterioration of the credit environment. Net credit loss expense at Global Wealth Management & Business Banking amounted to CHF 421 million in 2008 compared with a net credit loss recovery of CHF 28 million in 2007. This result was mainly due to provisions made for lom- bard loans in 2008, particularly in the fourth quarter. The Investment Bank recorded a net credit loss expense of CHF 2,575 million in 2008, compared with a net credit loss ex- pense of CHF 266 million in 2007. This increase mainly re- flects impairment charges taken on reclassified instruments in fourth quarter 2008, of which the majority was related to leveraged finance commitments. ➔ Refer to the “Risk management and control” section of this report for more information on UBS’s risk management approach, method of credit risk measurement and the development of credit risk exposures Net fee and commission income Net fee and commission income was CHF 22,929 million, down 25% from CHF 30,634 million. Income declined in all major fee categories, as outlined below: – Underwriting fees fell 48% to CHF 1,957 million, driven by a 56% decline in equity underwriting fees and a 31% decline in debt underwriting fees. – Mergers and acquisitions and corporate finance fees fell 40% to CHF 1,662 million, in an environment of reduced market activity and lower mandated deal volumes. – Net brokerage fees fell 16% to CHF 6,445 million, mainly due to lower client transaction volumes in the wealth management businesses and the Investment Bank’s cash equities and Asian equity derivatives business. – Investment fund fees fell 25% to CHF 5,583 million due to lower asset­based fees from the asset management and wealth management businesses. – Fiduciary fees increased 1% to CHF 301 million, reflecting an increase in business volume. – Custodian fees fell 12% to CHF 1,198 million, mainly due to the lower asset base. – Portfolio and other management and advisory fees fell 21% to CHF 6,169 million mainly due to the lower asset base in the wealth management businesses and reduced performance fees in the asset management business. – Insurance­related and other fees, at CHF 317 million in 2008, decreased by 25% from a year earlier mainly due to lower commission income from life insurance products at Wealth Management US. Other income Other income decreased to CHF 692 million from CHF 4,341 million. The main driver for this change was UBS’s sale of its 20.7% stake in Julius Baer during second quarter 2007, which gave rise to the recognition in second quarter 2007 of a CHF 1,950 million pre­tax gain, attributed to the Corpo- rate Center. 2008 included a gain of CHF 168 million from the sale of a stake in Adams Street Partners in the third quar- ter and a gain of CHF 360 million on the sale of UBS’s stake in Bank of China in the fourth quarter, partly offset by losses of CHF 192 million due to currency translation differences on partial disposals of an investment in a consolidated invest- ment fund. Credit loss (expense) / recovery CHF million Global Wealth Management & Business Banking Investment Bank Investment Bank – credit losses from reclassified financial instruments UBS 40 For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 (421) (1,246) (1,329) (2,996) 28 (266) (238) 109 47 156 368 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Net fee and commission income CHF million Equity underwriting fees Debt underwriting fees Total underwriting fees Mergers and acquisitions and corporate finance fees Brokerage fees Investment fund fees Fiduciary fees Custodian fees Portfolio and other management and advisory fees Insurance-related and other fees Total securities trading and investment activity fees Credit-related fees and commissions Commission income from other services Total fee and commission income Brokerage fees paid Other Total fee and commission expense Net fee and commission income Operating expenses Total operating expenses were down 19% to CHF 28,555 mil- lion from CHF 35,463 million. The decline was mainly due to significantly lower performance­related compensation, partly offset by provisions for auction rate securities and the provi- sion made in connection with the US cross­border case. Personnel expenses Personnel expenses decreased 36% to CHF 16,262 million from CHF 25,515 million. This was primarily due to lower accruals on performance­related compensation, mainly in the Investment Bank, as well as lower salary costs due to reduced staff levels. Full­year results for 2007 included accruals for share­based compensation for performance during the year. These are not reflected in full­year 2008 as, starting in 2009, they will be am- ortized over the vesting period of these awards. Contractors’ expenses, at CHF 423 million, were down 33% from 2007. This was due to a lower number of contrac- tors employed, mainly at the Investment Bank. Insurance and social security contributions declined 45% to CHF 706 million in 2008, driven by lower performance­related compensation. Contributions to retirement benefit plans increased CHF 4 mil- lion to CHF 926 million as changes in contributions to various plans largely offset each other. At CHF 2,000 million in 2008, other personnel expenses increased 2%, mainly due to sever- ance payments relating to the reduction in staff levels. General and administrative expenses At CHF 10,498 million, general and administrative expenses increased CHF 2,069 million from CHF 8,429 million. This in- crease was mainly due to provisions related to auction rate se- For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 1,138 818 1,957 1,662 8,355 5,583 301 1,198 6,169 317 25,540 273 1,010 26,823 1,909 1,984 3,894 22,929 2,564 1,178 3,742 2,768 10,281 7,422 297 1,367 7,790 423 34,090 279 1,017 35,386 2,610 2,142 4,752 30,634 1,834 1,279 3,113 1,852 8,053 5,858 252 1,266 6,622 449 27,465 269 1,064 28,798 1,904 1,438 3,342 25,456 (56) (31) (48) (40) (19) (25) 1 (12) (21) (25) (25) (2) (1) (24) (27) (7) (18) (25) curities of CHF 1,464 million, the provision of CHF 917 million made in connection with the US cross­border case and restruc- turing charges. These offset cost reductions in all other catego- ries during 2008. In absolute terms, the largest reductions came from lower travel and entertainment expenses, reduced costs from outsourcing of IT and other services and lower marketing and public relations expenses. Depreciation, amortization and impairment of goodwill Depreciation of property and equipment declined CHF 2 mil- lion to CHF 1,241 million. Amortization of intangible assets declined to CHF 213 million from CHF 276 million. A goodwill impairment charge of CHF 341 million was recorded in second quarter 2008, relating to the Investment Bank’s exit from the municipal securities business. There was no goodwill impairment charge for full­year 2007. Income tax UBS recognized an income tax benefit in the income state- ment of CHF 6,837 million for 2008, which mainly reflects the CHF 6,126 million impact from the recognition of incre- mental deferred tax assets on available tax losses. The incremental deferred tax assets mainly relate to Swiss tax losses incurred during 2008 (primarily due to the writedown of investments in US subsidiaries) but was reduced by a de- crease in the deferred tax assets recognized for US tax losses. The Swiss tax losses can be utilized to offset taxable income in Switzerland arising in the seven years following the year in which the losses are incurred. UBS recognized a net income tax expense of CHF 1,369 million for full year 2007. 41 Strategy, performance and responsibility Financial performance 2007 Results In 2007, UBS reported a Group net loss attributable to UBS shareholders (“attributable loss”) of CHF 5,247 million – a loss of CHF 5,650 million from continuing operations and a profit of CHF 403 million from discontinued operations. In 2006, UBS recorded a Group net profit attributable to UBS shareholders (“attributable profit”) of CHF 11,527 million. Operating income Total operating income was CHF 31,721 million in 2007, down 33% from CHF 47,484 million in 2006. Net interest income at CHF 5,337 million was down 18% compared with CHF 6,521 million a year earlier. Net trading income was negative CHF 8,353 million, sharply down from positive CHF 13,743 million in 2006. Net income from trading businesses Net income from trading businesses was down significantly from a positive CHF 13,730 million in 2006 to a negative CHF 10,658 million in 2007. FICC results were very weak. The credit business in FICC delivered negative revenues, especially in proprietary strategies. Structured products results were down, especially in Europe and the US, reflect- ing the decrease in customer demand for complex deriva- tives transactions. Markdowns on leveraged finance com- mitments also had a negative impact. The result for emerging markets was helped by gains from the sale of UBS’s stake in Brazil Mercantile & Futures Exchange after demutualization. Revenues from the equities business were up, mainly as a result of very strong gains in the derivatives business in China. Equity capital markets and equity prime brokerage revenues were up in Latin America following the acquisition of Banco Pactual at the end of 2006. Exchange­traded de- rivatives profited from the acquisition of ABN AMRO’s global futures and options business towards the end of 2006. Mark­to­market gains on UBS’s stake in Bovespa, the Brazil- ian stock exchange, helped the equities result. These positive performances were partially offset by losses recorded in pro- prietary trading as all regions were impacted by the market dislocation. As a result of the widening of UBS’s credit spread in 2007, the Investment Bank recorded a gain on own credit of CHF 659 million on financial liabilities designated at fair value in net trading income. Refer to “Note 27 Fair value of financial instruments” in the financial statements of this report for more information. No gain or loss was recorded on own credit on financial liabilities designated at fair value in net trading income in 2006. Net income from interest margin businesses Net income from interest margin businesses was CHF 6,230 million, up 9% from CHF 5,718 million in 2006, reflecting an increase in spreads for Swiss franc, euro and US dollar de- posits and growth in wealth management’s collateralized lending business. Wealth Management US also benefited from increased levels of deposits. Net income from treasury activities and other At CHF 1,412 million, net income from treasury activities and other in 2007 was up CHF 596 million, or 73% higher than the CHF 816 million of 2006. The accounting treatment of interest rate swaps, which hedge the economic interest rate risk of accrual­accounted balance sheet items (for ex- ample, loans or money market and retail banking products), positively affected income. They are carried on the balance sheet at fair value and, if they qualify for cash flow hedge accounting under IAS 39, changes in fair value are recorded in equity, thereby avoiding volatility in the Group income statement. In 2007, these hedges were not fully effective, leading to a gain that was booked to UBS’s income state- ment. Higher interest income was also recorded as a result of increased yield on a slightly higher average capital base. In 2007, UBS experienced a net credit loss expense of CHF 238 million, compared to a net credit loss recovery of CHF 156 million in 2006. The market dislocations stemming from the US sub­prime mortgage market during the second half of 2007 were the main reasons for the significant in- crease, mainly in the Investment Bank. Net credit loss recovery at Global Wealth Management & Business Banking amounted to CHF 28 million in 2007 com- pared with a net credit loss recovery of CHF 109 million in 2006. The reduced level of credit loss recovery was a conse- quence of the continued reduction in the impaired lending portfolio and related allowances to a level such that recover- ies realized from work­outs continue to trend lower and no longer compensate for the ongoing need to establish new allowances. The US mortgage market dislocation had no impact on these figures. The Investment Bank realized a net credit loss expense of CHF 266 million in 2007, compared with a net credit loss recovery of CHF 47 million in 2006. This mainly relates to valuation adjustments taken in connection with the securiti- zation of certain US commercial real estate assets. Net fee and commission income In 2007, net fee and commission income was CHF 30,634 million, up 20% or CHF 5,178 million from CHF 25,456 mil- lion in 2006. Income increased in nearly all major categories, as outlined below: – Underwriting fees, at their highest level ever, were CHF 3,742 million, up 20% from 2006. Equity underwriting fees were up significantly and offset a decrease in fixed income underwriting fees. 42 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S – At CHF 2,768 million, mergers and acquisitions and cor- porate finance fees in 2007 were up significantly by 49% compared with 2006, in a brisk merger and acquisition environment. – Net brokerage fees were CHF 7,671 million in 2007, up 25% from 2006, mainly driven by higher revenues in Europe, the US and Asia, due to additional services from a new equities trading platform, and a considerable in- crease in client activity in all client segments. Addition- ally, the equity derivatives business also posted higher revenues due to increased business volume. – Investment fund fees, at their highest level ever, were CHF 7,422 million in 2007, up 27% from 2006, mainly reflecting higher asset­based fees for the wealth manage- ment businesses and higher management and perfor- mance fees at Global Asset Management. – Fiduciary fees increased 18% to CHF 297 million due to an increase in business volume. – At CHF 1,367 million, custodian fees in 2007 were up 8% compared with 2006. This increase was due to an en- larged asset base. – Portfolio and other management and advisory fees in- creased by 18% to CHF 7,790 million in 2007. The in- crease was again the result of rising invested asset levels and to a lesser extent higher management fees. – Insurance­related and other fees, at CHF 423 million in 2007, decreased by 6% from a year earlier. Other income Other income was up significantly in 2007 by CHF 2,733 million, or 170%, to CHF 4,341 million from CHF 1,608 million in 2006. This mainly related to the sale of a 20.7% stake in Julius Baer in second quarter 2007. The demutual- ization of UBS’s stake in Bovespa, the Brazilian stock ex- change, and in the Brazil Mercantile & Futures Exchange positively affected the other income line as well. In 2006 UBS recorded gains on its New York Stock Exchange mem- bership seats, which were exchanged into shares when it went public in March 2006. In the same year UBS sold its stakes in the London Stock Exchange, Babcock & Brown and EBS group. advisors. Performance­related compensation decreased, re- flecting the losses incurred in the Investment Bank. Share­ based components were up 18%, or CHF 488 million, to CHF 3,173 million from CHF 2,685 million, mainly reflect- ing accelerated amortization of deferred compensation awarded for senior managers who have left UBS. Contrac- tors’ expenses, at CHF 630 million, were CHF 192 million below 2006 levels, mainly due to the transfer of contractors into permanent staff. Insurance and social security contri- butions declined by 8% to CHF 1,290 million in 2007 com- pared with CHF 1,398 million in 2006, reflecting lower bo- nus payments. Contributions to retirement benefit plans rose 15% or CHF 120 million to CHF 922 million in 2007 as a result of both higher salaries paid and the increased staff levels. At CHF 1,958 million in 2007, other personnel ex- penses increased by CHF 390 million from 2006, mainly driven by severance payments relating to the reduction in staff levels. General and administrative expenses At CHF 8,429 million in 2007, general and administrative expenses increased 6% from CHF 7,942 million a year ago. Administration costs increased due to elevated business volumes in Latin America related to the acquisition of Banco Pactual in 2006 and higher levels of UBS staff. The increased number of employees pushed occupancy costs, as well as travel and entertainment expenditures, higher. Professional fees were up on higher legal fees and IT and other outsourcing expenses were higher in all UBS busi- nesses. This increase was only partially offset by lower pro- visions. Depreciation, amortization and impairment of goodwill Depreciation was CHF 1,243 million in 2007, almost un- changed from CHF 1,244 million in 2006. Lower deprecia- tion on IT and communication equipment was offset by higher real estate charges. At CHF 276 million, amortization of intangible assets was up 86% from CHF 148 million a year earlier, related to acquisitions made at the end of 2006, mainly Banco Pactual. There was no goodwill impairment charge in 2007 or 2006. Operating expenses Income tax Total operating expenses increased 6% to CHF 35,463 mil- lion in 2007 from CHF 33,365 million in 2006. Personnel expenses Personnel expenses increased CHF 1,484 million, or 6%, to CHF 25,515 million in 2007 from CHF 24,031 million in 2006. The rise was driven by higher salaries due to the 7% increase in personnel over the year, mainly in the wealth management businesses which added client and financial UBS recognized a tax expense in the income statement of CHF 1,369 million for 2007, compared with a tax expense for 2006 of CHF 2,998 million. The tax charge for 2007 reflects tax expenses on profits earned outside the US during the year, partially offset by US and Swiss tax benefits on the writedowns related to the US sub­prime crisis. The US tax benefits recognized arose main- ly as a result of the ability to carry back losses against US profits earned in the two prior years. 43 Strategy, performance and responsibility Financial performance Balance sheet CHF million Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Loans Financial investments available-for-sale Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and intangible assets Other assets Total assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Equity Share capital Share premium Net income recognized directly in equity, net of tax Revaluation reserve from step acquisitions, net of tax Retained earnings Equity classified as obligation to purchase own shares Treasury shares Equity attributable to UBS shareholders Equity attributable to minority interests Total equity Total liabilities and equity 44 31.12.08 31.12.07 31.12.07 % change from 32,744 64,451 122,897 224,648 271,838 40,216 854,100 12,882 340,308 5,248 6,141 892 6,706 12,935 18,811 18,793 60,907 207,063 376,928 660,182 114,190 428,217 11,765 335,864 4,966 11,953 1,979 7,234 14,538 20,312 2,014,815 2,274,891 125,628 14,063 102,561 62,431 851,864 101,546 474,774 10,196 197,254 33,965 145,762 31,621 305,887 164,788 443,539 191,853 641,892 22,150 222,077 61,496 1,974,282 2,231,065 293 25,250 (4,335) 38 14,487 (46) (3,156) 32,531 8,002 40,533 207 12,433 (1,161) 38 35,795 (74) (10,363) 36,875 6,951 43,826 2,014,815 2,274,891 74 6 (41) (40) (59) (65) 99 9 1 6 (49) (55) (7) (11) (7) (11) (14) (56) (66) (62) 92 (47) (26) (54) (11) (45) (12) 42 103 (273) 0 (60) 38 70 (12) 15 (8) (11) y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Year of maturity 2400 2050 1700 1350 1000 2008 asset development CHF billion 2,275 (462) 2,400 2,050 1,700 1,350 1,000 2,015 (236) (11) 23 426 31.12.2007 Trading portfolio Collateral trading Other assets Lending 31.12.2008 Positive replacement values 31.12.08 vs 31.12.07: UBS’s total assets stood at CHF 2,015 billion on 31 Decem- ber 2008, down from CHF 2,275 billion on 31 December 2007. These shifts were driven by deliberate reductions of CHF 462 billion in the trading portfolio and of CHF 236 bil- lion in collateral trading, led by the Investment Bank. These substantial reductions were, however, partly offset by a sig- nificant rise in replacement values (increasing to a similar ex- tent on both sides of the balance sheet as discussed under “Replacement values” below) during 2008, as market move- ments drove up positive replacement values by 99%, or CHF 426 billion, to reach CHF 854 billion at year­end. Excluding positive replacement values, UBS’s total assets dropped CHF 686 billion in 2008. Currency effects for 2008 included a strengthening of the Swiss franc against the British pound, US dollar and euro. These effects deflated the balance sheet, excluding positive replacement values, by CHF 74 billion, implying an under­ lying reduction of effectively CHF 612 billion. Excluding positive replacement values, the Investment Bank significantly reduced its balance sheet assets by CHF 664 billion during 2008, and the positions of Global Wealth Management & Business Banking and Global Asset Manage- ment remained relatively stable at CHF 291 billion and CHF 25 billion, respectively. Lending and borrowing tially offset by lower volumes from the Investment Bank prime brokerage business and from lombard lending in Global Wealth Management & Business Banking. The Swiss loan portfolio remained stable during 2008 at around CHF 163 billion. 24.5 Borrowing The reduction of the Investment Bank’s assets led to lower unsecured borrowing needs during a continued difficult market environment for term debt issuance and decreasing client deposits. Money market paper issuance was CHF 112 billion in 2008, a considerable reduction of CHF 41 bil- lion from the prior year, as UBS decreased its reliance on these funding sources (in line with the firm’s lower overall funding needs) amid a reduced access to these markets for issuers in general. Financial liabilities designated at fair value stood at CHF 102 billion on 31 December 2008, a drop of CHF 90 billion from 31 December 2007, as a lower demand for structured debt was accompanied by declining market values, in particular of equity­linked notes as major stock indices fell. Long­term debt grew CHF 16 billion to CHF 86 billion as new issues of senior straight bonds, the CHF 6 billion MCN issuance to the Swiss Confederation and around CHF 2 billion of mortgage bonds issued via the Swiss Mortgage Bond Bank combined to outweigh maturing senior straight bonds. Interbank borrowing (due to banks) was CHF 126 billion on 31 December 2008, down CHF 20 billion from 31 December 2007. Customer deposits (due to customers) amounted to CHF 475 billion on 31 Decem- ber 2008, a decrease of CHF 167 billion for the year, or CHF 134 billion, on a currency­adjusted basis. Global Wealth Management & Business Banking client deposits declined CHF 109 billion with reductions in fixed deposits, fiduciary investments and current accounts. Savings and personal accounts dropped CHF 10 billion over the course of 2008, though the last quarter recorded net inflows of CHF 3 bil- lion. Investment Bank deposits declined CHF 58 billion, mainly driven by lower business funding needs and a de- cline in the prime brokerage business. Repurchase / reverse repurchase agreements and securities borrowing / lending Lending Cash and balances with central banks was CHF 33 billion on 31 December 2008, an increase of CHF 14 billion from the prior year­end. Due from banks and loans to customers both increased CHF 4 billion, rising to CHF 64 billion and CHF 340 billion, respectively. The customer loan increase stemmed mainly from the BlackRock collateralized funding transaction (a USD 11.25 billion eight­year amortizing loan; balance on 31 December 2008 USD 9.2 billion) in second quarter 2008 and the reclassification of illiquid trading as- sets from the trading portfolio in fourth quarter 2008, par- Secured lending on the asset side of the balance sheet, the sums of cash collateral on securities borrowed and reverse repurchase agreements declined during 2008 to CHF 348 bil- lion on 31 December 2008. The CHF 236 billion decline oc- curred almost entirely in the Investment Bank, where the matched book was reduced as part of its overall balance sheet reduction (the matched book is a repurchase agree- ment portfolio comprised of assets and liabilities with equal maturities and equal value so that the market risks substan- tially cancel each other out). Furthermore, as part of the In- vestment Bank’s balance sheet reduction measures, its trad- 45 Strategy, performance and responsibility Financial performance ing short positions were reduced CHF 102 billion, which resulted in lower short­coverings via reverse repurchase agreements and securities borrowing transactions. A significant amount of trading assets are funded via re- purchase agreements, so, in addition to the matched book reduction, the yearly decrease in trading assets also contrib- uted to the drop in repurchase agreements. These reduc- tions are reflected on the liability side of the balance sheet, where repurchase agreements and securities lent against cash collateral declined CHF 221 billion, standing at CHF 117 billion on 31 December 2008. Trading portfolio Significant reductions were achieved in the trading portfolio, which declined CHF 462 billion during 2008, or CHF 445 bil- lion on a currency­adjusted basis. At the end of 2008, the trading portfolio stood at CHF 312 billion. The majority of the decrease related to the Investment Bank’s overall balance sheet reductions and occurred within the fixed income, cur- rencies and commodities (FICC) business area and the equities business area. In FICC, trading inventories in a number of ar- eas, including real estate, securitization and commodities, were substantially reduced, including USD 16.4 billion of illiq- uid assets transferred to the Swiss National Bank StabFund and approximately CHF 26 billion (represents fair values at the reclassification dates) of trading assets reclassified in fourth quarter 2008 to banking book as “Loans and receivables”. The reduction in equities inventories was mainly a result of stock market declines. Reductions occurred across all trading products, with debt instruments declining CHF 278 billion, eq- uity instruments falling CHF 130 billion, traded loans falling CHF 35 billion and precious metals falling CHF 19 billion. Replacement values The positive and the negative replacement values (RVs) of derivative instruments developed in parallel, showing con- tinued strong rises during 2008, driven by increased market valuations, while notional values declined 2% year­on­year. Positive RVs grew CHF 426 billion to CHF 854 billion in 2008, while the negative RVs of derivative instruments in- creased CHF 408 billion to CHF 852 billion. In both cases, the increases were largely driven by movements in curren- cies (for example, the weakening of the US dollar), lower interest rates and widening credit spreads. Increases oc- curred across almost all derivative products, with interest rate contracts growing by CHF 211 billion, foreign exchange contracts by CHF 123 billion and credit derivative contracts by CHF 92 billion. Shareholders’ equity On 31 December 2008, equity attributable to UBS share- holders was CHF 32.5 billion, representing a decrease of CHF 4.3 billion compared with 31 December 2007. The decline in 2008 reflects mainly the net loss attribut- able to shareholders of CHF 21.3 billion combined with oth- er losses recognized directly in equity (including foreign cur- rency translation) of CHF 3.2 billion. Refer to the “Statement of recognized income and expense” in the financial state- ments of this report for more information about the losses recognized directly in equity. These equity reductions were largely offset by UBS’s capi- tal strengthening measures taken in 2008 (see the table be- low showing the impact by equity attributable to UBS share- holders accounts). Equity attributable to UBS shareholders development CHF billion Starting balance Net loss attributable to UBS shareholders of which: amount relates to MCNs issued in March 2008 1 of which: amount relates to MCNs issued in December 2008 2 Rights issue MCNs issued in March 2008 1 MCNs issued in December 2008 2 Share-based compensation plans / sale of treasury shares Others Ending balance Share capital 0.2 Share premium 12.4 Net income recognized directly in equity (1.2) Treasury shares (10.4) Retained earnings 35.8 (21.3) 3.7 0.7 0.1 0.3 15.5 7.0 (3.6) (6.6) 0.5 25.2 7.2 (3.2) (4.3) 14.5 (3.2) Equity attributable to UBS shareholders 36.9 (21.3) 15.6 7.0 (3.6) 0.6 (2.7) 32.5 1 Of the CHF 13 billion MCN1, CHF 2.3 billion, being the outstanding coupon liability recorded in “Debt issued”. 2 Of the CHF 6 billion MCN2, a balance of CHF 8.8 billion was recorded as financial liabilities on balance sheet. 46 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Off-balance sheet Contractual obligations The table below includes contractual obligations as of 31 De- cember 2008. All contracts included in the table below, with the excep- tion of purchase obligations (those where UBS is committed to purchasing determined volumes of goods and services), are either recognized as liabilities on UBS’s balance sheet or, in the case of operating leases, disclosed in “Note 25 Operating lease commitments” in the financial statements of this report. The following liabilities are recognized on the balance sheet and excluded from the table: provisions (as disclosed in “Note 21 Provisions and litigation” in the financial state- ments of this report), current and deferred tax liabilities (re- fer to “Note 22 Income taxes” in the financial statements of this report for more information), liabilities to employees for equity participation plans, settlement and clearing accounts and amounts due to banks and customers. Within purchase obligations, the obligation to employees under the mandatory notice period is excluded (this is the period in which UBS must pay employees leaving the firm contractually­agreed salaries). Off-balance sheet arrangements In the normal course of business, UBS enters into arrange- ments that, under International Financial Reporting Stan- dards, lead to either de­recognition of financial assets and liabilities for which UBS has transferred substantially all risks and rewards, or the non­recognition of financial assets (and liabilities) received for which UBS has not assumed the re- lated risks and rewards. UBS recognizes these types of ar- rangements on the balance sheet to the extent of its involve- ment, which, for example, may be in the form of derivatives, guarantees, financing commitments or servicing rights. When UBS, through these arrangements, incurs an obli- gation or becomes entitled to an asset, it recognizes them on the balance sheet, with the resulting loss or gain re- corded in the income statement. It should be noted that in many instances the amount recognized on the balance sheet does not represent the full gain or loss potential in- herent in such arrangements. Generally, these arrange- ments either meet the financial needs of customers or offer investment opportunities through entities that are not con- trolled by UBS. Off­balance sheet arrangements include purchased and retained interests, derivatives and other involvements in non­ consolidated entities and structures. UBS has originated such structures and has acquired interests in structures set up by third parties. The following paragraphs discuss several distinct areas of off­balance sheet arrangements. Risk positions UBS’s main concentrations of risk and other relevant risk po- sitions are disclosed in detail in the audited parts of the “Risk management and control” section of this report. These posi- tions include monoline insurers, auction rate securities and leveraged finance deals. The quantitative summary about each of these risk positions includes exposures of on­ and off­balance sheet arrangements. The importance and the potential impact of such posi- tions to UBS (with respect to liquidity, capital resources or market and credit risk support), including off­balance sheet structures, are also described in the “Risk and treasury man- agement” section of this report. Liquidity facilities and similar obligations On 31 December 2008 and 31 December 2007, UBS had no significant exposure through liquidity facilities and guar- antees to structured investment vehicles, conduits and oth- er types of special purpose entities (SPEs). Losses resulting from such obligations were not significant in 2008 and 2007. Contractual obligations CHF million Long-term debt Capital lease obligations Operating leases Purchase obligations Other liabilities Total Payment due by period < 1 year 36,024 63 1,034 202 3,718 41,041 1–3 years 42,188 104 1,799 166 121 44,378 3–5 years 31,869 40 1,405 85 1,406 34,805 > 5 years 77,100 0 2,573 0 0 79,673 47 Strategy, performance and responsibility Financial performance Off-balance sheet arrangements, risks, consolidation and fair value measurements Disclosure in the annual report Contractual obligations Strategy, performance and responsibility, “Off-balance sheet” section Credit guarantees, performance guarantees, undrawn irrevocable credit facilities, and similar instruments Strategy, performance and responsibility, “Off-balance sheet” section Private equity funding commitments and equity underwriting commitments Strategy, performance and responsibility, “Off-balance sheet” section Derivative financial instruments Financial statements, “Note 23 Derivative instruments and hedge accounting” Credit derivatives Leases Financial statements, “Note 23 Derivative instruments and hedge accounting” Financial statements, “Note 25 Operating lease commitments” Non-consolidated securitization vehicles and collateralized debt obligations – non-agency transactions Strategy, performance and responsibility, “Off-balance sheet” section Support to non-consolidated investment funds Strategy, performance and responsibility, “Off-balance sheet” section Securitizations (banking book only) Risk and treasury management, “Basel II Pillar 3 disclosures” section Risk concentrations Credit risk information Market risk information Liquidity risk information Consolidation Fair value measurements, including sensitivity and level 3 impact on the income statement consolidation Risk and treasury management, “Risk concentrations” section Risk and treasury management, “Credit risk” section Risk and treasury management, “Market risk” section Risk and treasury management, “Liquidity and funding management” section Financial statements, “Critical accounting policies” section Financial statements, “Note 27 Fair value of financial instruments” Non­consolidated securitization vehicles and collateralized debt obligations UBS sponsored the creation of SPEs that facilitate the securiti- zation of acquired residential and commercial mortgage loans, other financial assets and related securities. UBS also securi- tized customers’ debt obligations in transactions involving SPEs which issued collateralized debt obligations. A typical securiti- zation transaction of this kind involved the transfer of assets into a trust or corporation in return for beneficial interests in the form of securities. Financial assets held by such trusts and corporations are no longer reported in the consolidated finan- cial statements of UBS once their risks and rewards are trans- ferred to a third­party, e. g. in a sales transaction. Refer to “Note 1 Summary of significant accounting policies” in the fi nancial statements of this report for more information about UBS’s accounting policies regarding securitization activities. Generally, UBS intended to sell the beneficial interests to third parties shortly after securitization but beginning in the second half of 2007 and continuing in 2008, certain re- tained interests could not be sold due to illiquid markets for certain instruments, mainly those linked to the US mort- gage market. The volume and size of interests held in securitization structures originated by UBS and asset­backed securities purchased from third parties declined significantly in 2008, mainly due to the following factors: – Sale and expected sale of positions to a fund owned and controlled by the Swiss National Bank (for a total volume of USD 38.6 billion). – Sale of a portfolio of US residential mortgage­backed se- curities for proceeds of USD 15 billion to the RMBS Op- portunities Master Fund, LP, a third­party entity managed by BlackRock, Inc. – Several other true sales of asset­backed securities portfo- lios to third parties without recourse. – In addition, UBS announced the repositioning of its fixed income, currencies and commodities (FICC) business around client servicing and facilitation. The repositioning includes a substantial downsizing or exiting of real estate, securitization, and proprietary trading activities. UBS’s involvements in non­consolidated securitization ve- hicles and CDOs disclosed here are typically managed on a portfolio basis alongside hedges and other offsetting finan- cial instruments. The table on the next page does not include these offsetting factors and does not represent a measure of risk. Refer to the “Risk management and control” section of this report for information on UBS’s risk positions and risks. UBS’s involvement in vehicles whose residential and com- mercial mortgage securities are backed by an agency of the US government – the Government National Mortgage As- sociation (GNMA), the Federal National Mortgage Associa- tion (FNMA), or the Federal Home Loan Mortgage Corpora- 48 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S tion (FHLMC) – is not included in the table below, due to the comprehensive involvement of the US government in these organizations and the significantly lower risk profile. The numbers in the table are different to the numbers disclosed on securitizations in the “Basel II Pillar 3” section, predominately due to different scopes (for example Pillar 3 disclosures are on banking book positions only, and the con- solidation status is different for several vehicles), and to some extent due to a different measurement basis. Consolidation of securitization vehicles and CDOs UBS continually evaluates whether triggering events require the reconsideration of the consolidation conclusions made at the inception of its involvement with securitization vehicles and CDOs. Triggering events generally include items such as major restructurings, the vesting of potential rights and the acquisition, disposition or expiration of interests. In these in- stances, SPEs may be consolidated or de­consolidated in light of the changed conditions. Starting in December 2007 and during 2008, due to adverse market conditions, various non­ consolidated vehicles in which UBS held a majority stake in super senior securities were declared to have breached default provisions pursuant to the entities’ governing documents. In these instances, various contingent decision­making rights be- came immediately vested in the super­senior class holders. As a consequence, UBS determined that, in certain instances, the rights arising from such events caused it to be in control of these entities and therefore UBS had to consolidate the af- fected entities. The consolidation had no material incremental impact on UBS’s income statement and balance sheet. Risks resulting from non-consolidated securitization vehicles and CDOs The “Risk management and control” section of this report provides detailed disclosure of UBS’s main risk concentra- tions, as well as risks associated with UBS’s involvement in consolidated and non­consolidated US mortgage securitiza- tion vehicles and CDOs. If future consolidation of additional securitization vehicles is required by accounting standards, UBS does not expect this would have a significant impact on its risk exposure, capital, financial position or results of op- erations. Positions with significant impact on the income statement are disclosed in “Note 3 Net interest and trading income” in the financial statements of this report. Non-consolidated securitization vehicles and collateralized debt obligations – non-agency transactions1 CHF billion Total SPE assets Involvements in non-consolidated SPEs held by UBS As of 31 December 2008 Originated by UBS 3 CDOs and CLOs Residential mortgage Commercial mortgage Other ABS Securitizations Residential mortgage Commercial mortgage Other ABS Total Not originated by UBS CDOs and CLOs Residential mortgage Commercial mortgage Other ABS Securitizations Residential mortgage Commercial mortgage Other ABS Total Original principal outstanding Current principal outstanding Delinquency amounts Purchased and retained interests, and loans held by UBS 2 Fair value Derivatives held by UBS Fair value Nominal value 23.1 0.0 0.5 57.3 21.2 3.8 105.9 330.8 6.7 53.1 1,259.7 555.0 301.7 2,507.0 8.8 0.0 0.5 43.1 17.3 1.1 70.8 169.5 1.3 18.6 616.5 476.1 142.8 0.5 0.0 0.0 2.3 1.4 0.1 4.3 17.1 0.0 0.7 81.6 3.7 5.5 1.1 0.1 0.0 0.0 0.2 0.0 1.4 3.4 0.6 4.8 3.5 4.2 3.4 1,424.8 108.6 19.9 0.6 (0.5) 0.1 (0.3) 0.0 0.0 (0.1) 1.9 0.1 1.2 (2.4) 0.0 0.0 0.8 4.0 0.7 0.1 12.7 0.0 5.1 22.6 8.7 0.9 3.4 29.1 0.0 2.2 44.3 1 Includes all purchased and retained interests and derivatives held by UBS which are considered involvements in non-consolidated securitization vehicles and CDOs (under IFRS). This implies for example that UBS would include an insignificant involvement in such a vehicle into the table (under “Involvements in non-consolidated SPEs held by UBS”), whereas the pool assets held by such vehicle would be included under “Total SPE assets”. The size of the pool assets of such vehicle can be very high, but relates to third parties, if UBS’s involvement is insignificant. The “Total SPE assets” include informa- tion which UBS could gather after making exhaustive efforts but excludes data which UBS was unable to receive (in sufficient quality), especially for structures originated by third parties. 2 Loans and receivables have been included in this column with a carrying value of CHF 1.0 billion for structures originated by UBS and CHF 9.9 billion for structures not originated by UBS. 3 Structures originated by UBS include transactions within the scope of US GAAP, Financial Accounting Standard 140, paragraph 17. 49 Strategy, performance and responsibility Financial performance Support to non­consolidated investment funds In the ordinary course of business, UBS issues investment cer- tificates to third parties that are linked to the performance of non­consolidated investment funds. Such investment funds are originated either by UBS or by third parties. For hedging pur- poses, UBS generally invests in the funds to which its obliga- tions from the certificates are linked. Risks resulting from these contracts are considered minimal, as the full performance of the funds is passed on to third parties. The Investment Bank is involved in similar structures, such as those due to the issuance of notes, index certificates and related hedging activities. In 2008, as a result of the financial markets crisis which caused declining asset values, market illiquidity and de­le- veraging by investors, UBS supported several non­consoli- dated investment funds that it manages in its wealth and asset management businesses. UBS provided this support primarily to facilitate redemption requests of fund invest- ments by clients. Material support was provided in the form of collateralized financing, direct acquisition of fund units and purchases of assets from the funds. The support pro- vided by UBS to these investment funds was made where there are regulatory or other legal requirements or other exceptional considerations. During 2008, material support has been provided as follows: fund units were acquired in the amount of CHF 0.8 billion; assets purchased from such funds amounted to CHF 0.7 billion; and fully collateralized financing provided to the funds was CHF 2.4 billion at 31 December 2008 and decreased significantly in early 2009. Guarantees granted to third­parties in the context of these non­consolidated funds were immaterial at 31 December 2008. Losses incurred in 2008 as a result of such fund sup- port were immaterial. Acquired fund units and fund assets are generally ac- counted for as financial investments available­for­sale, and are included into the respective risk disclosures in the “Risk management and control” section of this report. Financing provided by UBS at 31 December 2008 was included in the credit risk disclosures. In 2007, UBS Global Asset Management purchased finan- cial assets, predominately US RMBS, from investment funds managed by UBS. The total loss resulting from the purchas- es, writedowns and sales amounted to approximately USD 0.1 billion in 2007, of which the majority related to transac- tions with a fund consolidated at 31 December 2007 and 2008 in UBS’s financial statements. In addition, in the ordinary course of business, UBS’s wealth and asset management businesses provide short­ term funding facilities to UBS­managed investment funds. This bridges time lags in fund unit redemptions and subscrip- tions. These bridge financings did not incur losses and are expected to be paid without significant losses. Should UBS be required to consolidate previously uncon- solidated investment funds in the future, it expects no sig- nificant impact on debt covenants, capital ratios, credit rat- ings and dividends. However, future fund support itself, depending on its size, could impact these measures. Depending on market developments in 2009 and be- yond, it is possible that UBS may decide to provide financial support to one or more of its investment funds. Such deci- sions will be taken on a case­by­case basis depending upon market and other circumstances pertaining at the time. The risks incurred by providing such support will depend on the type of support provided and the riskiness of the assets held by the fund(s) in question. If UBS were to provide ex- tensive financial support to some of its investment funds, losses incurred as a result of such support could become material. Guarantees and similar obligations UBS issues the following in the normal course of business: various forms of guarantees; commitments to extend credit; standby and other letters of credit to support its customers; commitments to enter into repurchase agreements; note is- suance facilities; and revolving underwriting facilities. With the exception of related premiums, these guarantees and similar obligations are kept off­balance sheet unless a provi- sion to cover probable losses is required. On 31 December 2008, the net exposure to credit risk for credit guarantees and similar instruments, based on IFRS numbers, was CHF 18.5 billion compared with CHF 19.3 billion one year earlier. Fee income from issuing guar- antees is not material to total revenues. Guarantees represent irrevocable assurances, subject to the satisfaction of certain conditions, that the Group will make payment in the event that customers fail to fulfill their obligations to third parties. The Group also enters into com- mitments to extend credit in the form of credit lines that are available to secure the liquidity needs of customers but have not yet been drawn on by them, the majority of which range in maturity from one month to five years. If customers fail to meet their obligations, the maximum amount at risk for the Group is the contractual amount of these instruments. The risk is similar to the risk involved in extending loan facilities and is subject to the same risk management and control framework. For the year ended 31 December 2008, the Group recognized net credit loss recoveries of CHF 18 mil- lion; and for the years ended 31 December 2007 and 2006, the Group recognized net credit loss recoveries of CHF 3 mil- lion and CHF 10 million respectively, related to obligations incurred for contingencies and commitments. Provisions rec- ognized for guarantees, documentary credits and similar in- struments were CHF 31 million at 31 December 2008 and CHF 63 million at 31 December 2007. The Group partially enters into sub­participations to miti- gate the risks from commitments and contingencies. A sub­ participation is an agreement by another party to take a share of the loss in the event that the obligation is not ful- filled by the obligor and, where applicable, to fund a part of 50 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S the credit facility. The Group retains the contractual relation- ship with the obligor, and the sub­participant has only an indirect relationship. The Group will only enter into sub­par- ticipation agreements with banks to which UBS ascribes a credit rating equal to or better than that of the obligor. Furthermore, UBS provides representations, warranties and indemnifications to third parties in connection with nu- merous transactions, such as asset securitizations. Clearinghouse and future exchange memberships UBS is a member of numerous securities and futures ex- changes and clearinghouses. In connection with some of those memberships, UBS may be required to pay a share of the financial obligations of another member who defaults, or otherwise be exposed to additional financial obligations as a result. While the membership rules vary, obligations generally would arise only if the exchange or clearinghouse had exhausted its resources. UBS considers the probability of a material loss due to such obligations to be remote. Swiss deposit insurance Swiss banking law and the deposit insurance system require Swiss banks and securities dealers to jointly guarantee an amount of up to CHF 6 billion for privileged client deposits in the event that a Swiss bank or securities dealer becomes in- solvent. For the period from 20 December 2008 to 30 June 2009, FINMA estimates UBS’s share in the deposit insurance system to be CHF 1.2 billion. The deposit insurance is a guar- antee and exposes UBS to additional risk which is not reflect- ed in the “Exposure to credit risk – UBS Group” table in the “Credit risk” section of this report. At 31 December 2008, UBS considers the probability of a material loss from its obli- gation to be remote. Private equity funding commitments and equity underwriting commitments The Group enters into commitments to fund external private equity funds and investments, which typically expire within five to ten years. The commitments generally require the Group to fund external private equity funds and investments at market value at the time the commitments are drawn. The amount committed to fund these investments at 31 Decem- ber 2008 and 31 December 2007 was CHF 0.5 billion and CHF 0.4 billion respectively. Equity underwriting commit- ments in the Investment Bank amounted to CHF 0.4 billion at 31 December 2008. Commitments 1 The table below shows the maximum committed amount of commitments. CHF million Credit guarantees and similar instruments Performance guarantees and similar instruments Documentary credits Total commitments Undrawn irrevocable credit facilities 31.12.08 Sub- participations (344) (446) (415) (1,205) (1) Gross 13,124 3,596 2,979 19,699 60,316 Net 12,780 3,150 2,564 18,494 60,315 31.12.07 Sub- participations (593) (464) (517) (1,574) (2) Gross 13,381 3,969 3,474 20,824 83,980 Net 12,788 3,505 2,957 19,250 83,978 1 Includes only credit and performance guarantees and similar instruments, documentary credits, and undrawn irrevocable credit facilities. On 31 December 2008, the commitment to repurchase auction rate securities was recognized on UBS’s balance sheet as a negative replacement value for CHF 1,140 million (USD 1,069 million). It is not included into this table. Refer to the “Exposure to auction rate securities” sidebar in the “Risk concentrations” section of this report for more information. 51 Strategy, performance and responsibility Financial performance Cash flows 2008 At 31 December 2008, the level of cash and cash equivalents rose to CHF 179.7 billion, up CHF 30.6 billion from CHF 149.1 billion at the end of 2007. Operating activities Operating activities generated a cash inflow of CHF 77.0 bil- lion in 2008 compared with a cash outflow of CHF 52.1 bil- lion in 2007. Operating cash outflows (before changes in operating assets and liabilities and income taxes paid) to- taled CHF 71.6 billion in 2008, an increase of CHF 67.9 bil- lion from 2007. Net profit decreased CHF 16.0 billion com- pared with 2007. Cash inflow of CHF 403.1 billion was generated by the net decrease in operating assets, while a cash outflow of CHF 253.6 billion was reflected in the operating liabilities. The increase in cash was used to fund the operating liabili- ties. Payments to tax authorities were CHF 0.9 billion in 2008, down CHF 2.8 billion from a year earlier. Investing activities Net cash flow used in investing activities was CHF 1.7 billion compared with an overall cash inflow of CHF 2.8 billion in 2007. The net cash outflow for investments in subsidiaries and associates was CHF 1.5 billion, compared with CHF 2.3 billion in 2007, due to the acquisitions of Caisse Centrale de Réescompte Group (CCR) and VermogensGroep and a net increase in the purchase of property and equipment of CHF 1.1 billion. The net investment of financial investments avail- able for sale was CHF 0.7 billion, whereas in 2007 the divest- ments generated cash inflows of CHF 6 billion. Disposals of subsidiaries and associates in 2008 generated a cash inflow of CHF 1.7 billion. Refer to “Note 36 Business combinations” and “Note 38 Reorganizations and disposals” in the finan- cial statements of this report for more information about UBS’s investing activities in 2008 and 2007. Financing activities In 2008, financing activities generated cash outflows of CHF 5.6 billion. This reflected the net repayment of money market paper of CHF 40.6 billion and the issuance of CHF 103.1 billion in long­term debt – the latter significantly out- pacing long­term debt repayments, which totaled CHF 92.9 billion. That outflow was partly offset by inflows attribut- able to capital issuances of CHF 23.1 billion, including CHF 15.6 billion from rights issues and CHF 7.6 billion from 52 mandatory convertible notes. In 2007, UBS had a net cash inflow of CHF 74.6 billion from financing activities. The dif- ference between the two years was mainly due to the fact that net long­term debt repayments and money market pa- per repaid, amounting to CHF 111.6 billion in 2008, were only partially compensated by the cash increase due to the capital issuances. 2007 At 31 December 2007, the level of cash and cash equivalents rose to CHF 149.1 billion, up CHF 13.0 billion from CHF 136.1 billion at the end of 2006. Operating activities Net cash flow used in operating activities was CHF 52.1 bil- lion in 2007 compared with a cash outflow of CHF 5.4 billion in 2006. Operating cash outflows (before changes in operat- ing assets and liabilities and income taxes paid) totaled CHF 3.7 billion in 2007, a decrease of CHF 18.2 billion from 2006. Net profit decreased CHF 16.7 billion compared with 2006. Cash inflow of CHF 218.9 billion was generated by the net decrease in operating assets, while a cash outflow of CHF 263.6 billion was reflected in the operating liabilities. The increase in cash was used to fund the operating liabili- ties. Payments to tax authorities were CHF 3.7 billion in 2007, up CHF 1.1 billion from a year earlier. Investing activities Investing activities generated a cash inflow of CHF 2.8 bil- lion. The net cash outflow for investments in subsidiaries and associates was CHF 2.3 billion due to the acquisitions of the branch network of McDonalds Investments and 51% of Daehan Investment Trust Management Company Ltd. and a net increase in the purchase of property and equipment of CHF 1.8 billion. The net divestment of financial investments available for sale was CHF 6.0 billion, mainly due to UBS’s sale of its 20.7% stake in Julius Baer for CHF 3.9 billion. Dis- posals of subsidiaries and associates in 2007 generated a cash inflow of CHF 0.9 billion. In 2006, the net cash inflow from investing activities was CHF 4.4 billion. Cash inflows of CHF 6.4 billion were offset by acquired new businesses worth CHF 3.5 billion. Purchases of property and equipment totaled CHF 1.8 billion and the net divestment of financial investments available for sale was CHF 1.7 billion. Disposals of subsidiaries and associates in 2006 generated a cash in- flow of CHF 1.2 billion. Financing activities In 2007, financing activities generated cash flows of CHF 74.6 billion, which was used to finance the expansion of business activities. This reflected the net issuance of money market pa- per of CHF 32.7 billion and the issuance of CHF 110.9 billion in long­term debt – the latter significantly outpacing long­ term debt repayments, which totaled CHF 62.4 billion. That inflow was partly offset by outflows attributable to net move- ments in treasury shares and own equity derivative activity (CHF 2.8 billion), and dividend payments (CHF 4.3 billion). In 2006, UBS had a net cash inflow of CHF 48.1 billion from fi- nancing activities. The difference between the two years was mainly due to the fact that net long­term debt issuance and money market paper increased CHF 26.3 billion in 2007. y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S 53 Strategy, performance and responsibility UBS employees UBS employees UBS relies on the expertise and commitment of its employees to meet clients’ needs. For employees, UBS’s wide range of businesses, global career opportunities and an open and collaborative culture offer a platform for individual success. Investing in UBS employees UBS relies on the expertise, talent and commitment of its employees to meet clients’ needs and deliver results for the firm. Engaging, developing and retaining a high­value work- force is therefore a priority, and in 2008 UBS continued to judiciously invest in its personnel. This investment will help ensure that the firm has the range of skills and experience necessary to meet client needs now and to grow the firm when market conditions improve. UBS invests in its employ- ees whether they are new hires, seasoned staff, key talent or senior managers. The graph below highlights the most im- portant factors driving the value created by UBS personnel. UBS workforce Staff levels decreased in most UBS businesses over the course of the year, with the number of people employed on 31 De- cember 2008 at 77,783, down 5,777 or 7% from year­end 2007. In 2008, UBS personnel worked in 60 countries, with about 38% of staff employed in the Americas, 34% in Swit- zerland, 15% in Europe, the Middle East & Africa and 13% in Asia Pacific. Internal job mobility encourages business innovation and individual career development. Mobility across regions in- creased slightly in 2008, with 1,285 employees moving to roles in a different region, versus 1,062 in 2007. The highest Investing in employees Gender distribution by geographical region1  On 31.12.08 Total: 30,068 10,428 5,046 26,144 7,480 40,000 30,000 20,000 11,706 10,000 18,362 0 4,441 5,987 2,088 2,958 9,385 16,759 Americas Asia Pacific Continental Europe / Middle East / Africa Switzerland 2,421 5,059 United Kingdom 1HR006_e Male Female 1 Calculated on the basis that a person (working full-time or part-time) is considered one headcount in this graph only. This accounts for the total UBS end-2008 employee number of 79,166 in this graph, which excludes staff from UBS card center, Hotel Seepark Thun, Wolfsberg and Widder Hotel. number of employees transferred from Switzerland, with 143 going to Asia Pacific, 92 going to the Americas, 63 to the UK and 57 to locations in Europe, the Middle East & Af- rica. Cross­division mobility was lower in 2008 than in 2007, with 784 employees changing divisions during the course of Staffing The right people in the right place > Recruitment > Mobility > Diversity Performance management Managing people effectively Compensation and incentives Learning and development Effectiveness and efficiency Competence and qualifications > Performance planning > Performance measurement and management > Compensation > Employee share ownership > Benefits > Talent and leadership development > Business training Retention Commitment Motivation and dedication > UBS values > Measuring employee satisfaction > Employee assistance > Employee representation 54 Value added by increasing workforce quality 1HR001_e 40000 30000 20000 10000 0 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S 100 75 50 25 0 100 75 50 25 0 Personnel Regional distribution(cid:31) In %, except where indicated 31.12.06 31.12.07 31.12.08 Total1: 78,140 83,560 77,783 9.8 16.2 39.4 34.6 11.9 16.4 38.3 12.9 15.5 37.7 33.4 33.9 On 100 75 50 25 0 Switzerland Americas Rest of Europe /Middle East / Africa Asia Pacific Business unit distribution  In %, except where indicated 31.12.06 31.12.07 31.12.08 Total1: 78,140 83,560 77,783 6.1 4.4 23.7 27.8 20.6 17.4 8.3 4.3 23.2 26.1 19.2 18.9 9.4 4.9 24.3 22.1 19.7 19.6 On 100 75 50 25 0 Wealth Management International & Switzerland Business Banking Switzerland Investment Bank Wealth Management US Global Asset Management Corporate Center 1 Total full-time equivalents. the year, versus 903 in 2007. At 238 employees, transfers from the Investment Bank to Global Wealth Management & Business Banking were most common. Recruiting staff In 2008, UBS continued to recruit staff in the key markets in which it operates, although the firm sought throughout the year to reduce personnel costs, increase personnel efficiency and improve the ratio of front­office to back­office staff. As UBS believes the long­term trends for wealth and asset man- agement remain positive, particular emphasis was placed on hiring client advisors in 2008. Among other things, a new “Fast Forward” initiative was introduced to improve the hir- ing, retention and productivity of client advisors and front­ office managers. More effective recruitment, integration, and skill and competency development processes are sup- ported by line manager coaching. To further improve the quality of all candidates, better match open jobs with the right candidate and more success- fully integrate new hires, UBS standardized its approach to sourcing, selecting and “on­boarding” new hires globally in 1HR002_e 2008. Additionally, Global Wealth Management & Business Banking launched an internal marketplace aimed at filling vacancies with internal candidates. 1 Total full-time equivalents (FTE). In regard to graduate recruitment, UBS developed a firm­wide campus recruiting strategy in 2008, creating a cross­division governance body and aligning marketing with the needs of “Generation Y” (20­ to 30­year­olds) to enhance the UBS brand within this recruitment segment. A more interactive website and focused print materials sup- port a globally consistent candidate experience. UBS also focused on enhancing relationships with target schools in 2008 through a new university relations strategy, while global sourcing efforts targeted bilingual graduates over- seas for UBS’s businesses in the Asia Pacific region. For the fourth straight year, global consultant Universum ranked 1HR003_e UBS the number one employer for business students in Switzerland. In 2008, UBS hired more than 1,100 university gradu- ates for its undergraduate and MBA training programs. The UBS apprenticeship program in Switzerland hired 304 ap- prentices in 2008, up 9% from 2007. In Global Wealth Management & Business Banking interns and graduate trainees represent approximately 1% of the workforce. In response to external market conditions, the Investment Bank instituted a graduate deferral program for 2008, in which 43 graduates postponed their start dates at UBS for up to one year to engage in community service or pursue educational opportunities. Gender distribution by employee category 1 On 31.12.08 Male Female Total Officers Non-officers Total Number 30,788 10,283 41,071 % 75.0 25.0 100.0 Number 18,337 19,758 38,095 % 48.1 51.9 100.0 49,125 30,041 79,166 62.1 37.9 100.0 1 Calculated on the basis that a person (working full-time or part-time) is considered one headcount in this table only. This accounts for the total UBS year-end 2008 employee number of 79,166 in this table. Normally, UBS expresses employee numbers in terms of full-time equivalents (FTEs), which is measured as a percentage of the standard hours normally worked by permanent full-time staff. When calculated according to FTEs, the year-end 2008 total is 77,783. 55 Strategy, performance and responsibility UBS employees Developing and sustaining a diverse workforce A workforce of people from different backgrounds, cul- tures and experiences is indispensable in today’s global business environment, in part because it can help enhance understanding of regional markets and sensitivity to cul- tural norms and labor market issues. In 2008, the UBS workforce included citizens of 153 countries. The scope of UBS’s diversity initiatives is global, with 10 regional diversity boards translating this global commitment into regional ac- tion, working with local business and HR leaders. In addi- tion, more than 20 employee networks globally help to build cross­business relationships and strengthen UBS’s in- clusive culture. Over the past six years, UBS has promoted diversity in three stages: raising basic awareness; integrating diversity into management processes such as recruiting and perfor- mance management; and ensuring that diversity ultimately becomes a self­sustaining part of the workplace culture. In 2008, efforts continued to focus on making diversity self­ sustaining by linking diversity to revenue generation. Among other initiatives, UBS invited women clients and prospects in China, Italy, Switzerland, the UK and the US to targeted events designed to help UBS build market share among this important client segment. UBS also continued its program to help professionals re- turn to work after a career break. In 2008, four such pro- grams were held in London, Philadelphia / New York, Singa- pore and Sydney. These programs have helped more than 300 professionals, primarily women, prepare to return to work over the past two years. In addition, UBS was recog- nized by Working Mother magazine as being among the 100 best companies for working mothers in the US for the sixth consecutive year. Performance management UBS believes that the foundation of good performance management is an ongoing employee­manager dialogue, with demonstrable performance as the basis for meritoc- racy. All employees therefore participate in a year­round performance management process that assesses individual achievements against specific objectives. This process sup- ports staff development, links behavior to corporate values and helps ensure that employees have the skills required to meet their clients’ needs and implement their division’s strategic goals. The performance management process the senior executives is broadly the same as for other employ- ees. Achieving specific financial targets plays a significant role, with business leadership, client leadership, people leadership and personal leadership also explicitly reviewed. Compensation and incentives On 12 August 2008, UBS announced the separation of its business groups into business divisions, with incentives for management and staff in each business division aligned di- rectly with its financial results. This is being achieved through a centrally managed change program that includes the de- velopment of revised incentive systems to reward divisional management and staff for shareholder value creation in their own division. As part of this, beginning in 2009, UBS will adopt a new compensation model for the BoD and the GEB that has a long­term focus and is more closely aligned with the creation of value for the firm. (Refer to the “Compensa- tion principles 2009 and beyond for UBS senior executives” section of this report for more information.) UBS’s compensation programs are results­oriented and market­focused. Total compensation is linked to UBS’s busi- ness objectives, and pay and incentive programs are de- signed to pay for performance. UBS’s total compensation and benefits philosophy has five guiding principles which re- quire UBS to: – use carefully selected performance measures, rigorous performance management and a strict pay­for­perfor- mance relationship to support UBS’s business strategy; – support reward opportunities by consistently communi- cating UBS’s business strategy and promoting a merito- cratic culture; – provide competitive total compensation opportunities to enable UBS to attract and retain talent; – balance compensation components to meet short­term needs while focusing on mid­ to long­term objectives; and – encourage employee share ownership to strengthen the alignment between employee and shareholder interests. Employee share ownership UBS is committed to the principle of employee share owner- ship, believing accountability for decisions and actions is en- couraged through equity­based awards that vest and / or be- come unrestricted over time. Positions with a large scope of responsibility and a significant potential impact on the firm have higher equity exposure. UBS also has stringent share ownership requirements for senior executives. A voluntary equity­based program enables employees to purchase UBS shares at fair market value and generally re- ceive two free UBS options for each share purchased. Staff with annual incentive awards above a certain threshold are awarded a component in UBS shares or notional shares in- stead of cash. Select high­performing employees are granted stock options with a strike price not less than the fair market value of the shares on the date the option is granted. 56 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S On 31 December 2008, current UBS employees held an estimated 6% of UBS shares outstanding (including approxi- mately 3% in unvested / blocked shares), based on all known share holdings from employee participation plans, personal holdings and individual retirement plans. At the end of 2008, an estimated 56% of all employees held UBS shares while 51% of all employees held UBS stock options. Leadership development UBS takes a structured approach to both talent manage- ment and leadership development, understanding that both capabilities are important factors in ensuring high­quality cli- ent service and long­term business success. In 2008, a Group­wide talent management architecture was established to align the firm’s identification and selec- tion processes for “key talent”. All levels of employees with the potential to take on substantially more senior roles in the organization than they currently have may be considered key talent. In 2008, about 4% of employees were placed in a key talent pool where they can benefit from focused investment in their career and professional development. UBS’s leadership development activities are separated into Group­wide and divisional initiatives. A new framework cre- ated in 2008 centralizes development initiatives for manag- ing directors and above within a Group­level learning organi- zation. An organizational development and culture change initiative for the GEB, GMB and managing director popula- tions, called “Leading our Future”, is being developed to en- gage and align the firm’s leadership with its vision, core val- ues, strategy and leadership principles. A new leadership and management development core curriculum will be designed to strengthen the capabilities of senior leaders in their current roles, while a key talent core curriculum will build leadership capabilities among potential future senior leaders. Initiatives for all other employees are managed within the divisions but coordinated with the Group­wide initiatives to ensure consis- tency and promote the sharing of best practices. Commitment While meeting the needs of clients is UBS’s ultimate purpose, it is the firm’s corporate values that lay the foundation for its long­term sustainable growth. These values are integrated into decision making processes, management techniques and the ways in which employees interact with each other in the daily course of business. UBS’s values are clustered into four categories: – Focus on the client: The ultimate purpose of all UBS ac- tivities is to increase client satisfaction; – Lead yourself: Each individual takes responsibility for his or her own motivation, development and success; – Lead others: Everyone can lead others by being a role model, appreciating others’ successes and supporting one another’s endeavors. Leading others is about creating a collaborative environment and developing people on the basis of meritocracy and diversity; – Act with integrity: UBS upholds the law, respects regula- tions and behaves in a principled way. UBS is self­aware and has the courage to face the truth. UBS maintains the highest ethical standards. Measuring employee perceptions Employee engagement supports workforce retention and performance. An annual employee survey assesses UBS’s corporate culture and levels of employee engagement. A The client leadership experience Launched in February 2008, this Group­wide initiative brings together senior client­facing employees from different divisions for a one­and­a­ half­day workshop designed to improve UBS’s ability to meet the diverse needs of its clients and to increase UBS’s share of business with them. Participants learn about relevant products and services in the other divisions, build cross­division partnerships and learn how to work more effectively across boundaries. Seventeen regional workshops, each focusing on a specific client segment such as family offices, hedge funds and financial institutions, or on a specific region such as Western Europe, brought nearly 500 senior client­facing participants together. Almost 400 cross­divisional client service opportunities were shared, ultimately bringing in more than USD 300 million in net new money to UBS. 57 Strategy, performance and responsibility UBS employees core set of questions across all divisions provides a compre- hensive view of employee opinions. 48,205 employees, or 60% of UBS’s employee popula- tion, participated in the survey conducted in June / July 2008. Most measures declined compared with earlier years. For ex- ample, 67% of respondents were very satisfied with UBS as a place to work (compared with 80% in 2007) and 77% reported high motivation to contribute beyond what is ex- pected of them (versus 83% in 2007). These overall satisfac- tion ratings covering the period between June 2007 and June 2008 show the continued dedication of UBS employees despite the challenges. However, the survey results also clearly revealed a perceived lack of communication from se- nior management. UBS and its business divisions take these results seriously. The GEB committed to increasing employee communication through employee events, intranet and e­mail. Additionally, dialogue with managing directors across UBS increased to ensure they had accurate, updated information about UBS to share with their teams. Employee assistance UBS is committed to being a conscientious employer. Exam- ples of this commitment can be found in the firm’s Employee Assistance Programs (EAPs) and the COACH and SOVIA pro- grams in Switzerland. EAPs are available in a number of locations globally. In the US, the program provides information, referrals and ongoing support for child care, academic services and issues sur- rounding elder care, work performance and personal con- flicts. In the UK, the program is part of a health and wellbe- ing program including onsite medical specialists, emergency childcare, counseling and referral services. In Switzerland, UBS offers professional assistance for current and retired employees, as well as family members, through its HR Social Counseling and HR Retiree Service. The COACH transfer and severance process was launched in Switzerland in 2003 to help employees displaced by a re- structuring. COACH advisors provide support and assistance in finding new jobs, working closely with UBS’s internal re- cruitment center and outside employment services. During the COACH process employees retain full salary and bene- fits, and financial assistance is available for job­related train- ing, if needed. Staff below the level of director are eligible for the new Social Partnership Agreement for employees in Switzerland (SOVIA) that became effective on 1 August 2008. SOVIA lays out the terms and conditions for implementing redundan- cies among employees whose jobs are subject to the Agree- ment on Conditions of Employment for Bank Staff. SOVIA now governs the requirements and procedures for internal hiring, job transfers, and, when needed, severance. The aim is to implement necessary job cuts and operational changes in a responsible manner, making full use of the UBS internal labor market, and to offer targeted, relevant support and career advice to these employees. 58 Employee representation The UBS Employee Forum facilitates the exchange of informa- tion between employees and management on pan­European issues that have the potential to impact the performance and prospects of UBS and, in particular, its operations in Europe. This forum fulfills EU Directive 94 / 45 on the establishment of a European Works Council. Local forums also exist in a number of locations across Europe to address local issues such as health and safety, changes to workplace conditions, pension arrange- ments and collective redundancies. The UK Employee Forum, for example, is made up of internal elected representatives for each business area and division that has employees in the UK. In Switzerland, Employee Representation Committee (ERC) representatives partner with UBS management in the annual salary negotiations and are involved in employee matters, in- cluding health and safety issues, social security and pension issues. ERC employee representatives are elected to represent the interests of employees whose work contracts are gov- erned by Swiss law and the Agreement on Conditions of Em- ployment for Bank Staff. The ERC also fosters an open dia- logue between management and employees. During late 2008 and early 2009, for example, the ERC and management jointly hosted a program called “Trust is Key”. In total, around 1,100 employees gathered in seven UBS locations across Swit- zerland for open forum events in which employees developed and proposed measures to rebuild trust and confidence in UBS. These measures can be implemented in employees’ working environments or by management. Select 2008 awards “100 Best Companies for Working Mothers in the US” (Working Mother magazine 2003–2008) “No. 1 employer of choice for business graduates in Switzerland” (Universum Switzerland 2008) “Top 100 Employers for Lesbian, Gay and Bisexual People in Britain” (Stonewall Workplace Equality Index 2008) “Best Graduate Recruitment and Development Program” (UBS EXPLORE Graduate Program) (Graduate Solutions 2008) “UBS’s learning programs: awards in three categories” (Corporate University Xchange 2008) y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S 1HR010_e 59 Strategy, performance and responsibility Corporate responsibility Corporate responsibility Corporate responsibility contributes to UBS’s goal of sustainable value creation. As a leading global financial services firm, UBS is confronted with the concerns and expectations of a wide and diverse range of stakeholders. Along with clients, investors and em- ployees, for example, various government regulators and suppliers can also be said to have a stake in the company to varying degrees. In a broader sense, the communities in which UBS has a presence are stakeholders too. UBS takes the term “corporate responsibility” to mean the process of understanding, assessing, weighing and ad- dressing the concerns and expectations of these groups. This process supports UBS in its efforts to safeguard and advance the firm’s reputation for responsible corporate conduct. In very direct ways, responsible corporate conduct helps create sustainable value for the company. The crisis faced by the financial services industry made it difficult for the firm to do as much as it would have liked to fulfill its stakeholder expectations. Still, as can be seen from the examples given below – from anti­money laundering to community development and human rights to protecting the environment – UBS continued with a wide range of important and effective corporate responsibility­related activities during 2008. Even in difficult times, UBS remains convinced that cor- porate responsibility makes good business sense. Adherence to the United Nations Global Compact initiative In 2000, UBS became one of the first companies to sign the United Nations (UN) Global Compact. This global corporate responsibility initiative unites governments, business, labor organizations and civil society, fostering adherence to 10 principles covering the areas of human rights, labor stan- dards, the environment and anti­corruption. UBS considers the initiative, which had over 5,200 corporate participants at the end of 2008, to be an important yardstick providing guidance for its key corporate responsibility initiatives and activities. In addition, by participating in the Swiss UN Global Compact network, UBS contributes actively to important corporate responsibility discussions across industrial sectors among Swiss­based companies. Labor standards and human rights UBS has well established human resources policies and prac- tices that address issues such as employment, diversity, equal opportunity and discrimination. Such policies also tackle hu- man rights issues, as do policies relating to health and safety practices. UBS’s human resources policies and practices are regularly reviewed to ensure that labor standards are re- spected. In line with the firm’s endorsement of the UN Global Compact and its underlying principles, UBS adopted a state- ment supporting basic human rights in 2006. The “UBS Statement on Human Rights” outlines important human rights issues and sets out the firm’s position on the topic. In 2008, UBS reaffirmed its commitment to human rights by supporting the UN Global Compact’s Chief Executive Officer statement, which marked the 60th anniversary of the UN’s Universal Declaration of Human Rights. In 2008, UBS contin- ued with the implementation of its human rights statement with the introduction of a responsible supply chain guide- Operational corporate responsibility at UBS Corporate responsibility Workplace Ethical business conduct Environment Community affairs > Diversity > Non-discrimination > Health and safety > UBS code > Financial crime prevention > Human rights > Supply chain > In-house ecology > Banking activities > ISO 14001 > Climate change > Charitable donations > Employee volunteering Communications, training and awareness-raising 60 1CR001_e y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S line. It also continued the development of industry sector guidelines to support the consistent identification and as- sessment of environmental and social risks in the firm’s bank- ing activities. ➔ Refer to the “UBS employees” section of this report for more information on labor standards and diversity programs ➔ Refer to the discussion on supply chain management and environmental risk management below for more informa- tion on the responsible supply chain guidelines and on industry sector guidelines Environment In 1992, UBS was one of the first signatories of the UN Envi- ronment Program’s Bank Declaration (UNEP). This act com- mitted the firm to integrating appropriate environmental measures within its activities. It has resulted in a well devel- oped global environmental management system, certified to the ISO 14001 standard, which covers both banking activi- ties and in­house operations. UBS acknowledges that cli- mate change represents one of the most significant environ- mental challenges of current times. By offering relevant products and services across businesses, UBS seeks to help clients address risks and take advantage of opportunities presented by climate change and the expected transition to a lower carbon economy. With this in mind, UBS continued in 2008 to expand its offering of climate change­related products and services and to publish dedicated research re- ports. In addition, UBS seeks to lead by example by acting to reduce its own environmental impact. To this end, in 2006 the Group Executive Board (GEB) set a target to reduce the firm’s carbon emissions through 2012 by 40% from 2004 levels. UBS continued in 2008 to make good progress to- wards achieving this target. ➔ Refer to www.ubs.com/environment for more information on UBS’s environmental policies Fighting corruption UBS has long been committed to assisting the fight against money laundering, corruption and terrorist financing. The firm employs a vigorous risk­based approach to its internal anti­money laundering (AML) process. (A “risk­ based approach” means that the processes are continually tested to prove their effectiveness against the risks they are intended to address.) In early 2008 it also issued a revised Group Policy Against Corruption, setting out its zero­toler- ance stance towards corruption and strictly prohibiting all forms of bribery by UBS and its employees, including so­ called facilitation payments. At the same time, it issued more detailed guidance papers to address the following topics: guidance for employees who have connections to public of- ficials; the hiring of political advisers; guidance on engaging intermediaries; and anti­corruption guidance in connection with corrupt activity by clients. Implementation of the policy against corruption by the business divisions is well under way, and training materials developed by the Group Money Laundering Prevention Unit (GMLPU) have formed the basis for business division training modules that raise awareness of new and revised topics. In some instances web­based training programs have also been developed. Although internal policies are an important support for UBS’s high ethical standards, in practice the major risk for the firm in relation to bribery is not so much employee be- havior as the potential misuse of UBS systems by clients to perpetrate bribery. Many firms, including UBS, continue to face the legal, regulatory and reputational risk of being used to collect, store or transfer corrupt funds. UBS’s efforts to reduce the risk of misuse of its systems to perpetrate bribery will continue in 2009 and beyond. ➔ Refer to the discussion on preventing money laundering below for more information on UBS’s AML activities External recognition The firm’s corporate responsibility work has been widely rec- ognized, and UBS has been included in many indexes that track such efforts. It has, for example, been a component of the Dow Jones Sustainability Indexes since their inception in 1999. These indexes track the financial performance of the leading sustainability­driven companies worldwide. UBS is also included in the FTSE4Good Index, which measures the performance of global companies in the areas of environ- mental sustainability, stakeholder relations and support for human rights. Corporate responsibility governance The corporate responsibility committee was established in 2001 and, as a Board of Directors (BoD) committee, it sup- ports the BoD’s efforts to safeguard and advance UBS’s repu- tation for responsible conduct. As part of the governance changes introduced by UBS in 2008, the committee’s charter was revised and updated. Under the revised charter, the committee is mandated to review and assess how UBS should meet the evolving corporate responsibility expecta- tions of its stakeholders. It also has responsibility for moni- toring the firm’s corporate responsibility policies and regu­ lations, as well as the implementation of its corporate responsibility activities and commitments. Headed by the Chairman of the BoD, the committee includes three other BoD members. A new advisory panel to the committee has also been established consisting of members of the GEB and other senior managers. The panel participates in committee meetings and implements its recommendations. Meetings are held at least twice a year, with the agenda and documen- tation prepared by the committee chair and the corporate responsibility management function of UBS’s chief commu- nication officer area. 61 Strategy, performance and responsibility Corporate responsibility The GEB is responsible for UBS’s environmental policy and nominates a Group environmental representative, a function currently held by the firm’s Chief Risk Officer. A committee, comprising both Group and divisional environmental repre- sentatives, is tasked with overseeing the implementation of UBS’s environmental policy and providing guidance to the different business divisions in their implementation of the “UBS Statement on Human Rights”. The GMLPU leads the Group’s overall efforts in all aspects of money laundering prevention, including terrorism financ- ing, sanctions and anti­bribery. It supports the Group Gen- eral Counsel and the head of compliance in their functional responsibilities by providing, in conjunction with the compli- ance functions in the business divisions, reasonable assur- ance that UBS meets relevant regulatory and professional standards in its business conduct. It also defines, where ap- propriate, uniformly applicable minimum standards for AML as a whole. The GMLPU coordinates its work via various committees and specialist networks with the core committee being the global AML committee. Regional diversity boards consider and decide on key re- gional issues, such as the regional diversity strategy and di- versity goals and measures. The boards are chaired by senior managers and are also responsible for assessing the progress made on relevant issues. UBS’s global community affairs ac- tivities are governed in a decentralized fashion. Every region has a dedicated community affairs function that coordinates charitable commitments by UBS, its senior management and employees within their region. Corporate responsibility: training and raising awareness UBS strives to increase employee awareness of its corporate responsibility processes, activities and commitments. Gener- al information is published on the firm’s intranet and in em- ployee magazines. In 2008, 2,800 employees participated in training and awareness­raising activities dealing with corpo- rate responsibility. Specific training is also given to staff working in the areas of AML and environmental manage- ment. It is mandatory for AML and compliance staff to com- plete a training program every two years, and new joiners in all UBS business divisions receive training in the issue of anti­ corruption as part of their induction process. Furthermore, in 2008, 5,232 employees participated in training on environ- mental issues, with 3,905 receiving general education on UBS’s environmental policy and programs, mostly in induc- tion training, and 1,327 employees receiving specialist train- ing targeted at their area of expertise and impact. Preventing money laundering, corruption and terrorist financing UBS takes its responsibility to preserve the integrity of the financial system, and its own operations, very seriously. The firm has developed extensive policies intended to prevent, detect and report money laundering, corruption and terror- ist financing. These policies seek to protect the firm, and its reputation, from those who may intend to legitimize their ill­gotten gains through UBS. The GMLPU leads UBS’s efforts to fight money launder- ing, corruption and the financing of terrorism. It does so by continuously assessing the threats and risks that UBS faces with respect to AML in all its businesses. It takes a risk­based approach, ensuring the firm’s policies and procedures are commensurate with those risks, and that relationships that are classified as higher risk are dealt with appropriately. The firm constantly engages with its business divisions to ensure that these policies and procedures are adapted to their busi- nesses and specific AML exposures, while also seeking to streamline and increase consistency between business divi- sions by using consistent methodologies and tools (for ex- UBS’s corporate responsibility governance process Corporate responsibility committee Agenda Documentation Proposal for action Advice Mandate for action Corporate responsibility management Corporate responsibility committee advisory panel Network of internal experts Action Investment Bank Global Wealth Management & Business Banking Global Asset Management Corporate Center 1CR002_e External experts 62 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S ample, the creation of a uniform country risk framework). UBS also seeks to ensure its employees adhere to the firm’s strict know­your­customer regulations, while at the same time not treating clients a priori as criminals or undermining their right to privacy. Employees regularly undergo training in AML­related issues and new trends, be it through online training, awareness campaigns or seminars. UBS also utilizes advanced technology to assist in the identification of trans- action patterns or unusual dealings. Over the last few years, and as a core part of its risk­based approach, UBS has been particularly vigilant about enhanc- ing controls with regard to regimes and countries with heightened risks. The need for increased vigilance has been underscored by the acknowledgement by the Financial Ac- tion Task Force (FATF) of the importance of country risk con- siderations in the risk­based approach, increasing interna- tional focus on corruption, and the need for the firm to manage its global security risk activity. As a result of these considerations, UBS has implemented a global sanctions pol- icy, ceasing all business activities with a limited number of countries. In 2008, UBS continued its engagement with the public sector and its peers to promote the development and imple- mentation of AML standards for the financial industry as a whole, thereby contributing to wider efforts against money laundering. A notable achievement in this regard was made by the Wolfsberg Group, where UBS actively contributed to the FATF’s development of its Guidance Paper on Weapons of Mass Destruction Proliferation Finance, as well as com- pleting and on 14 January 2009 publishing its own trade fi- nance principles paper. Wolfsberg Group’s work is ongoing in the area of credit cards and stored value cards, the imple- mentation of a new SWIFT message format to protect against the abuse of cover payments and a review of the Group’s 2003 paper on monitoring, screening and searching. Supply chain management In 2008, UBS spent over CHF 6.9 billion purchasing a wide range of products and services from suppliers and contrac- tors around the world. UBS has established processes to manage environmental and human rights issues in relevant areas of its supply chain such as client gifts, IT equipment and energy sourcing. In order to further incorporate these issues into procurement processes, UBS has developed a supply chain guideline, which provides Group­wide guid- ance on identifying, assessing and monitoring supplier prac- tices in the areas of human and labor rights, the environ- ment and corruption. Examples of human rights issues that have been included are avoidance of child and forced labor, non­discrimination, remuneration, hours of work, freedom of association, humane treatment, and health and safety. In 2008, the guideline was gradually applied to new contracts and contract renewals with suppliers. By the end of the year around 100 suppliers had been screened according to the guideline’s social and environmental criteria, and responsible supply chain requirements were included in the contractual arrangement with those suppliers who were awarded con- tracts. Also, some 170 procurement and sourcing officers were trained on the relevance and application of the new guidelines. Community investment UBS, together with its employees, seeks to have a positive influence on the social and environmental well­being of the local communities in which it operates. The firm does this through its community affairs program. This program encompasses activities such as direct cash donations to selected organizations, employee volunteer- ing, matched­giving schemes, in­kind donations, disaster relief efforts and / or partnerships with community groups, educational institutions and cultural organizations. UBS has dedicated teams around the world which work closely with staff at all levels to build partnerships with organizations in the communities, focusing on the key themes of “empow- erment through education” and “building a stronger com- munity”. Overall, in 2008, UBS and its affiliated foundations do- nated nearly CHF 46 million to support charitable causes. UBS employees, through their donations and volunteer ef- forts, also made significant contributions to the communities they live in. Last year, almost 9,300 employees spent 84,700 hours volunteering. UBS supports their commitment by matching their donations and offering up to two working days a year for volunteering efforts. UBS has also established a number of foundations and associations that donate money to worthy causes in Switzer- land. The association A Helping Hand from UBS Employees helps disabled and disadvantaged people lead active, inde- pendent lives. UBS encouraged this employee involvement by matching the funds raised in 2008. The UBS Cultural Foundation fosters creativity, appreciation of different forms of art, and contact between artists and society. The founda- tion provides financial support for fine arts, film, literature, music, preservation of historic buildings, archaeological proj- ects and research in history and philosophy in Switzerland. In similar fashion, the purpose of the UBS Foundation for Social Issues and Education is to support deprived communities in Switzerland in various forms. Non­profit, charitable organi- zations, projects and initiatives aiming at improving social welfare receive monetary assistance from these funds. Client foundation Besides the engagement of the firm and its employees, UBS also provides its clients with the opportunity to contribute to charitable causes. The UBS Optimus Foundation invests do- nations from UBS clients into a number of programs and 63 Strategy, performance and responsibility Corporate responsibility Examples of UBS’s global community affairs in 2008 Americas: In partnership with Northwestern University, UBS launched a program to identify and develop future leaders in the non­ profit sector. According to the Donors Forum of Chicago, the non­profit sector will see a large turnover in its local and national executive leader- ship in the next five years, with nearly 60% of executive directors set to retire. This program produced its first graduates in 2008 and four UBS fellows took classes at Northwestern and were mentored by a UBS senior executive. Asia Pacific: UBS launched the first Community Leadership Experience program at the India Service Centre in Hyderabad. This initiative aims to build the capacity of leaders from the non­profit sector using the expertise and human resources of UBS and to provide them with a platform for dialogue, discussion, sharing and learning. Modeled on UBS leadership programs, it gave 20 promising young leaders from the non­profit sector a chance to learn from UBS and external speakers about topics related to leadership, governance, strategic planning, communication and mentorship. Switzerland: Twenty employees volunteered for Procap Sport, an organization that promotes enthusi- asm for sport among people with physical or mental disabilities. Volunteers supported participants in a broad range of sports activities. In another volunteering project, 200 UBS employees successfully participated at the eighth Finance Forum charity run to aid Kispex – a service providing home care for very sick, disabled and terminally ill children. UBS employees came in first in terms of numbers of participants and donations collected. UK: UBS continues to support an independent secondary school in Hackney, newly established in 2007, through the UK government’s Academies program. A local school for students of all abilities, The Bridge Academy opened in September 2007 by welcoming 187 students, and by 2013 will cater to 1,150 students including 250 sixth formers. The school’s ambition is to create an outstanding learning environment for students, staff and the local commu- nity. The Bridge Academy exemplifies UBS’s commitment to improving the provision of education and to supporting regeneration efforts in the London Borough of Hackney. ➔ Refer to www.ubs.com/ corporateresponsibility for more information on UBS’s community affairs program organizations, focusing on the key themes of children and of medical and biological research. The projects involve close collaboration with respected partner organizations and are selected by a team of specialists within the foundation, who also closely monitor their implementation. The costs of man- aging and administering the UBS Optimus Foundation are borne by UBS, so that the full contribution of each client reaches the projects. In 2008, the UBS Optimus Foundation spent over CHF 17 million supporting 71 projects in Africa, Asia Pacific, Europe and North and South America. – seeking ways to reduce UBS’s direct environmental im- pact on air, soil and water from in­house operations, with a primary focus on reducing greenhouse gas emissions. UBS also assesses the environmental impact of its suppli- ers’ products and services; – ensuring efficient implementation of UBS’s policy through a global environmental management system certified ac- cording to ISO 14001 – the international environmental management standard; – integrating environmental considerations into internal UBS and the environment communications and training. Environmental management system Through its commitment to the environment, embodied in its environmental policy, UBS aims to create long­term value for the firm and its clients and the communities they live in. The policy is based on five principles, under which the firm is continuously: – seeking to consider environmental risks in all UBS busi- nesses, especially in lending, investment banking, advi- sory and research, and UBS’s own investments; – seeking to pursue opportunities in the financial markets for environmentally friendly products and services, such as socially responsible investments; UBS’s environmental management system covers both its banking activities and in­house operations and has been certified under the ISO 14001 standard since 1999. ISO 14001 requires that the system be audited annually and re­ certified every three years. UBS successfully passed the ex- tensive ISO 14001 recertification audit in 2008. Conducted by Société Générale de Surveillance (SGS), 24 days of audits involving 163 employees were undertaken. SGS confirmed that a well­performing environmental management sys- tem, integrated in the organization and suitable for manag- 64 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S The five principles of UBS’s environmental policy Environmental policy Environmental risk management Environmental market opportunities In-house ecology Certified environmental management system Training and communication ing environmental risks and improving environmental per- formance on a continual basis, is in place. Environmental products and services During the last ten years UBS has developed a range of products and services that meet or anticipate clients’ needs in environmental and socially responsible investments (SRI). This offering currently stretches across UBS’s businesses in wealth management, investment banking, asset manage- ment, and retail and commercial banking. It includes SRI funds, research and advisory services provided to private and institutional clients, access to the world’s capital mar- kets for renewable energy firms and, in Switzerland, “green” mortgages. Investment products and advisory In 2008, UBS continued to expand its SRI offering in response to growing demand from a number of markets, including the launch of two new SRI products, the UBS (Lux) Equity Sicav – Emerging Markets Innovators and the UBS Strategy Certificate Energy Efficiency. UBS’s SRI offering is diverse and includes products managed according to “best­in­class” practices and theme­based approaches. “Best­in­class” is an active equity management approach that is based on stock selection of companies that generate above­average envi- ronmental, social and economic performance. The “best­in­ class” offering includes a global fund and a European fund. The theme­based approach focuses investment on segment- ed climate change, water and demographics strategies. Additionally, UBS offers customized client portfolios in 1CR003_e the form of segregated mandates / institutional accounts based on “negative” screening, which excludes certain con- troversial stocks or sectors from the portfolio based on their negative social or environmental impact as perceived by the client. UBS’s global platform and investment research enable the firm to offer such tailor­made solutions. In the UK, the asset management business seeks to influence the corporate responsibility and corporate governance practices of the companies it invests in. In addition to fund management ser- vices, UBS provides stock­broking and account management services to alternative energy and SRI fund managers. Finally, UBS also offers SRI portfolio management solu- tions to selected private client segments. This offering pools internal and external SRI expertise and includes SRI­focused portfolios in Switzerland and SRI­managed accounts in the US. UBS’s open architecture approach also allows clients to invest in SRI bond, equity and microfinance products from third­party providers. In the past years UBS experienced increased client de- mand for SRI and expanded its SRI product offering, result- ing in a significant increase in UBS SRI invested assets. In 2008 these SRI invested assets decreased significantly year on year, primarily due to severe corrections in the global eq- uity markets (equities is the preferred asset class of UBS’s SRI products), but also due to asset outflows. Socially responsible investments invested assets 1 For the year ended % change from CHF billion, except where indicated UBS UBS SRI 3 products and mandates positive criteria exclusion criteria Third-party Total SRI invested assets Proportion of total invested assets (%) 4 GRI 2 31.12.08 2,174 FS11 FS11 FS11 FS11 2.12 14.05 1.85 18.03 0.83% 31.12.07 31.12.06 31.12.07 3,189 2,989 5.20 33.33 1.08 39.61 1.24% 1.84 16.17 N/A 18.01 0.60% (32) (59) (58) 72 (54) 1 All figures are based on the level of knowledge as of January 2009. 2 Global reporting initiative (GRI) (see also www.global reporting.org). FS stands for the performance indicators defined in the GRI Financial Services Sector Supplement. 3 Socially responsible investments (SRI). 4 Total SRI / UBS’s invested assets. Positive criteria: apply to the active selection of companies, focusing on how a company’s strategies, processes and products impact its financial success, the environment and society. This includes best-in-class or thematic investments. Exclusion criteria: companies or sectors are excluded based on environmental, social or ethical criteria, for example, companies involved in weapons, tobacco, gambling, or companies with high negative environmental impacts. This also includes faith-based investing consistent with principles and values of a particular religion. Third-party: UBS’s open product platform gives clients access to socially responsible investment products from third-party providers. This includes both positive and exclusion criteria, and microfinance investments. 65 Strategy, performance and responsibility Corporate responsibility Research UBS’s SRI research teams analyze emerging socio­economic and environmental trends and assess their potential impact on investment markets and companies’ share prices. Identi- fying material SRI issues is challenging. Essentially, three things help determine which environmental and social issues are critical: society’s perception of what is important; the na- ture of the competitive pressures facing firms in an industry; and how costs and benefits are (or will be) distributed be- tween stakeholders. The UBS SRI research teams were established in each of the firm’s divisions to serve their respective clients. In the Invest- ment Bank, the equity research team writes recommendations and reports for institutional investment clients on renewable energy, the carbon markets and the impact of climate change on companies in a wide range of sectors. SRI and sustainabil- ity research is provided by a dedicated team. In the asset man- agement business, an internal SRI research team manages portfolios around themes such as climate change / energy ef- ficiency, water and demographics. The SRI research team in UBS’s wealth management business conducts SRI research and provides advice to private clients on SRI investment solutions. Client interest in some aspects of SRI – for instance cli- mate change, demographics and water – has grown, and so has research coverage. The SRI teams regularly collaborate with analysts in other teams to write about emerging SRI themes, and relevant research content is regularly published by a growing number of specialists within the mainstream research effort. In 2008, for example, UBS published the re- port “Mind over Matter”, which broadly examines the issue of resources efficiency, and makes the case that higher prices for basic necessities, urbani zation, and more stringent cli- mate change policies will eventually yield benefits to those who invest in efficiency upgrades. Financing and advisory services UBS’s renewable energy investment banking business ar- ranges financing and provides strategic and financial advi- sory services for companies in the solar, wind, wave and oth- er renewable energy sectors. Since 2006, UBS has led over 30 financing transactions in these sectors, raising over USD 7 billion for renewable energy companies worldwide. In 2008, to name just one example of such a transaction, UBS acted as the joint global coordinator and joint bookrunner for the EUR 1.8 billion initial public rights offering of the wind generation company EDP Renováveis, one of the larg- est wind generation companies in the world and a subsidiary company of Portuguese utility Energias de Portugal (EDP). Carbon trading In cap and trade emissions markets, such as the EU Emissions Trading Scheme (EU ETS), companies have annual caps on the amount of emissions their facilities are allowed to pro- duce. Companies who are able to reduce their emissions be- low their cap have the ability to sell their unused quota to other companies, thereby creating an emissions market. Through the use of financial instruments, UBS is able to help clients manage their exposure to the emissions markets. UBS ETD (Exchange Traded Derivatives) is an active member of and offers execution and full service clearing on the major emission exchanges in Europe and North America for con- tracts on EU ETS allowances (EUA), UN Certified Emissions Reductions (CER), Regional Greenhouse Gas Initiative allow- ances, CCX Carbon Financial Instruments (CFI) and Nitrogen Oxide and Sulfur Dioxide. Environmental risk management UBS seeks to identify, manage and control environmental risks in its business transactions. Examples of environmental risk include the impairment of a client’s cash flow or assets by environmental factors (such as inefficient processes or property that is polluted or contaminated) or through liabil- ity risk, such as when a bank takes environmentally unsound collateral onto its own books. As environmental risks can manifest themselves across the wide variety of risks inherent in UBS’s business activities, including credit risks, liability risks and reputational risks, UBS has designed environmental pro- cedures and tools for their identification, management and control. These environmental procedures and tools are inte- grated into existing processes, such as due diligence on transactions or investments and ongoing risk management. UBS continues to develop and test internal industry sector guidelines to support the consistent identification and as- sessment of environmental and social risks in all its banking activities. The sector guidelines cover industry sectors that have a high potential for environmental and social risk and summarize industry standards for dealing with potential is- sues in the various life cycles of the sector. Not all products and services provided by UBS have the same risk potential: UBS therefore takes a risk­based ap- proach to environmental risk management and regularly an- alyzes its portfolio of products and services to assess their respective potential environmental risk potential. With its current business profile and operating environment, UBS’s potential for material risk is greater within the context of its lending and capital markets businesses, as well as its direct real estate and infrastructure investments. As a result, Global Wealth Management & Business Banking has introduced a standardized environmental risk check to identify material environmental risk in its lending to all relevant clients, includ- ing its roughly 140,000 corporate clients in Switzerland. In the Investment Bank, the environmental risk framework cov- ers all banking activities including debt and equity under- 66 writing, financial advisory services and lending. For its part, Global Asset Management has put environmental due dili- gence processes in place for its real estate and infrastructure funds. If significant potential environmental risks are identi- fied in a transaction, the risks are assessed. Wherever possi- ble, UBS seeks to engage with the client to discuss possible mitigating measures. Where this is not possible or success- ful, the firm may decline the transaction altogether. Global Wealth Management & Business Banking The business division assesses its environmental risks in a three­stage process. Client advisors complete the first screenings, looking at financial risks linked to environmen- tal aspects such as compliance with environmental legis­ lation, workplace safety, contaminated sites and natural hazards. In 2008, close to 100,000 lending transactions in Switzerland were subject to such a screening. If the risks cannot be fully ruled out during the first screening, a credit officer initiates a second screening and decides whether the risks identified are transparent enough for the credit decision to be taken. Transactions entailing significant envi- ronmental risk undergo a detailed environmental assess- ment as a third step, a service provided by the business divi- sion’s environmental risk competence center. In 2008, 32 such detailed assessments took place and 134 client advi- sors and credit officers were trained. Investment Bank The Global Environmental Risk Guidelines apply to all trans- actions, services and activities within the Investment Bank. The guidelines are supported by an environmental risk frame- work that is integrated into the business division’s due dili- gence and approval processes. Investment Bank staff identify potential environmental risks in the initial due diligence phase and alert the Investment Bank’s environmental advi- sory group (EAG) in case of significant potential risks. Assess- ments by lawyers and / or external consultants are routinely sought for certain sectors and products. The EAG works with the relevant business and control functions (80 transactions in 2008) to assess the risks, determine any mitigating mea- sures and direct further due diligence, as required. In this way the relevant senior business committee may fully con- sider the potential environmental risk in the course of its re- view of the transaction and / or client. The implementation of the environmental risk framework is supported by training and awareness­raising activities. In 2008, sector­specific training was provided to 443 bankers and support functions and high­level training to a further 107 employees. Global Asset Management The business division introduced a formal environmental risk matrix in 2004 in order to assess the reputational and envi- ronmental risks that investments made by UBS on behalf of its clients might imply. The matrix is reviewed annually for applicability and comprehensiveness and forms part of the environmental management system employed within the business division. In 2008, all properties acquired or devel- oped by Global Real Estate for its direct investment vehicles were subject to a thorough environmental due diligence pro- cess, in accordance with local regulations and internal best practice guidance. Similar processes are in operation in Infra- structure Asset Management. Environmental and CO2 footprints UBS directly impacts the environment in a number of ways: its businesses consume electricity; employees travel for busi- ness purposes and use paper and generate waste in the course of their work; and offices require heating and cooling systems. Improving the use of these resources can reduce costs and enhance environmental performance, and UBS therefore has a series of measures to efficiently manage its environmental impact. CO2 strategy and emission reduction The GEB decided in February 2006 to set a Group­wide CO2 emission reduction target of 40% below 2004 levels by 2012. UBS seeks to achieve this target by: – adopting in­house energy efficiency measures that reduce energy consumption in buildings it operates; – increasing the proportion of renewable energy used to avoid emissions at source; – offsetting and neutralizing emissions that cannot be re- duced by other means. UBS’s CO2 footprint  In tons CO2 Share of renewable energy (in %) 2004 2005 2006 2007 2008 Total: 360,502 372,184 293,169 281,705 264,197 400,000 300,000 200,000 100,000 0 45 48 34 24 23 100 75 50 25 0 emissions (oil, gas, fuels) Indirect CO ² emissions (electricity) emissions (travel incl. offsetting, paper, waste) Direct CO ² Other indirect CO ² Share of renewable energy (in %) 67 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S 98,918 111,773 31,635 36,323 219,727 225,854 230,015 218,681 41,858 34,556 31,519 26,701 1CR006_e 100 75 50 500000 437500 375000 312500 250000 187500 125000 62500 0 25 0 Strategy, performance and responsibility Corporate responsibility These measures allowed UBS to further increase the share of renewable energy it purchases, and to reduce its 2008 CO2 emissions by 27% compared with 2004, another step toward achieving the 40% reduction target by 2012. Energy consumption and energy efficiency Energy consumption represents an important environmental impact area for UBS and is the biggest contributor to its overall greenhouse gas emissions. UBS has a long track re- cord of managing its energy consumption, with the firm es- tablishing its first energy management function in the 1970s. Today, energy efficiency measures are an important compo- nent of UBS’s program for achievement of the Group­wide CO2 emission reduction target. Measures include invest- ments in energy­efficient technology and encouraging good housekeeping measures. For example, a major IT server con- solidation project has been under way since 2007 which has reduced the total number of distributed servers at UBS by 2,200. The project focused on consolidating applications sit- ting on multiple old servers to fewer, newer machines and the decommissioning of old applications. The resulting en- ergy savings of 17 GWh contributed significantly to the total of 25 GWh of savings from IT activities since 2007 (repre- senting around 3% of UBS’s global power consumption). Renewable energy In addition to its energy efficiency programs, UBS seeks to improve the energy mix it purchases by including a higher proportion of renewable energy. The percentage of renew- able energy and district heating purchases rose from 24% in 2004 to 48% in 2008. Since 2007, roughly 210 GWh or 90% of the electricity supply for UBS’s buildings in Switzerland has come from re- newable sources, such as water and solar power stations. Similarly, in the UK, UBS purchases electricity backed by 100% renewable sources for all its major buildings, repre- senting 85% of the total volume. In addition, UBS purchases renewable energy credits (RECs) in the US electricity mar- kets, which accounted for 16% of its electricity consumption in the US in 2008. Business travel and offsetting Business travel is a significant contributor to UBS’s green- house gas emissions. While the firm encourages its employ- ees to use environmentally friendly alternatives to air and road travel, for example video conferences, travel is essential for a global financial services firm that strongly believes in personalized client relationships. Therefore, since 2006, UBS has offset emissions from business­related air travel, repre- senting roughly 100,000 tons of CO2 per year, or about a quarter of its total annual CO2 emissions. Offsetting emis- sions means that UBS indirectly neutralizes its business air travel emissions by investing in third­party projects that re- duce an equivalent amount of greenhouse gas emissions. UBS selected offsetting projects in Brazil, Russia, India, Chi- na, Turkey and Germany, on the basis of their adherence to international quality standards such as the Voluntary Carbon Standard and the Gold Standard, and of their additional en- vironmental and social benefits. Paper and waste UBS continues to work towards achieving its firm­wide tar- gets for paper use and waste reduction. This includes the goal of reducing paper consumption per employee by 5% for 2009 when compared with 2006 levels. UBS also aims to have 20% of the paper it uses come from recycled sourc- es. UBS has made steady progress towards achieving these paper targets, for example by switching across Europe to a 100% recycled paper for all internal printing, and through continuing improvements in electronic distribution of client statements. At the same time, the firm seeks to improve its environmental footprint by reducing waste per employee (for example, plastic bottles or packaging) by 10% and by sending 70% of waste to recycling sites. These latter tar- gets are proving to be challenging in certain regions as they heavily rely on behavioral changes rather than technical measures or processes. UBS will continue to educate its em- ployees on environmental matters, helping them make the right choices and promoting sustainable behavior both at work and at home. ➔ Refer to www.ubs.com/environment for more information on UBS’s environmental management system Environmental indicators per full-time employee Total direct and intermediate energy Total business travel Total paper consumption Total waste Total water consumption Unit kWh / FTE Pkm / FTE kg / FTE kg / FTE m3 / FTE 2008 11,792 10,281 167 298 28.1 Trend ➙ ➙ ➚ CO2 footprint Legend: FTE = full-time employee; kWh = kilo watt hour; Pkm = person kilometer; kg = kilogram; m3 = cubic meter; t = ton t / FTE 3.07 2007 11,942 12,685 190 299 26.7 3.43 2006 12,736 12,544 188 303 26.0 3.93 68 y t i l i b i s n o p s e r d n a e c n a m r o f r e p , y g e t a r t S Environmental indicators 1 Total direct and intermediate energy consumption 7 Total direct energy consumption 8 natural gas heating oil fuels (petrol, diesel, gas) renewable energy (solar power, etc.) Total intermediate energy purchased 9 electricity from gas-fired power stations electricity from oil-fired power stations electricity from coal-fired power stations electricity from nuclear power stations electricity from hydroelectric power stations electricity from other renewable resources district heating Share of renewable energy and district heating GRI 3 Absolute normalized 4 1,016 GWh EN3 127 GWh 83.3% 12.2% 4.5% 0.03% EN4 890 GWh 11.7% 3.7% 18.4% 11.1% 25.8% 23.1% 6.2% 48% Total business travel EN29 886 m Pkm rail travel 10 road travel 10 air travel Number of flights (segments) Total paper consumption post-consumer recycled new fibers FSC 11 new fibers ECF + TCF 11 new fibers chlorine bleached Total waste valuable materials separated and recycled incinerated landfilled Total water consumption Total CO2 footprint 12 total direct CO2 emissions (GHG scope 1) 13 total indirect CO2 emissions (GHG scope 2) 13 total other indirect CO2 emissions (GHG scope 3) 13 total CO2e offsets (business air travel) 14 EN1 EN2 3.5% 0.6% 96.0% 398,369 14,403 t 16.2% 16.6% 66.8% 0.4% EN22 25,644 t 54.6% 14.3% 31.1% 2.42 m m3 264,197 t 26,490 t 204,344 t 129,364 t 96,000 t EN8 EN16 EN16 EN17 2008 2 Data quality 5 *** ** ** *** *** *** *** ** *** ** ** *** *** *** *** *** ** ** *** *** *** *** *** *** ** *** *** *** ** ** *** *** ** *** *** Trend 6 ➙ ➙ ➙ ➙ ➙ ➘ ➙ ➙ ➙ ➘ ➙ ➙ ➚ ➙ ➙ ➘ ➙ ➙ ➘ ➚ ➚ ➘ ➙ ➙ 2007 2 Absolute normalized 4 981 GWh 2006 2 Absolute normalized 4 951 GWh 130 GWh 154 GWh 83.3% 12.1% 4.6% 0.03% 85.5% 11.8% 2.7% 0.03% 851 GWh 797 GWh 12.3% 4.2% 18.6% 13.6% 25.5% 22.0% 3.8% 45% 13.2% 4.5% 21.7% 20.5% 21.4% 12.7% 6.0% 34% 1,042 m Pkm 936 m Pkm 3.3% 0.5% 96.2% 446,274 15,593 t 10.5% 10.7% 78.6% 0.2% 4.1% 0.6% 95.3% 402,629 14,013 t 6.2% 0.0% 93.8% 0.0% 24,589 t 22,631 t 56.3% 15.8% 27.9% 2.19 m m3 281,705 t 26,701 t 218,681 t 149,323 t 113,000 t 58.2% 12.7% 29.1% 1.94 m m3 293,169 t 31,519 t 230,015 t 132,635 t 101,000 t Legend: GWh = giga watt hour; Pkm = person kilometer; t = ton; m3 = cubic meter; m = million 1 All figures are based on the level of knowledge as of January 2009. 2 Reporting period: 2008 (1 July 2007–30 June 2008), 2007 (1 July 2006–30 June 2007), 2006 (1 July 2005–30 June 2006). 3 Global reporting initiative (see also www.globalreporting.org). “EN” stands for the environmental performance indicators as defined in the GRI. 4 Non-significant discrepancies from 100% are pos- sible due to roundings. 5 Specifies the estimated reliability of the aggregated data and corresponds approximately to the following uncertainty (confidence level 95%): up to 5% – ***, up to 15% – **, up to 30% – *. “Uncertainty” is the likely difference between a reported value and a real value. 6 Trend: at a *** / ** / * data quality, the respective trend is stable (➙) if the variance equals 5 / 10 / 15%, low decreasing / increasing (➘,➚) if it equals 10 / 20 / 30% and decreasing / increasing if the variance is bigger than 10 / 20 / 30% ( , ). 7 Refers to energy consumed within the operational boundaries of UBS. 8 Refers to primary energy purchased which is consumed within the operational boundaries of UBS (oil, gas, fuels). 9 Refers to energy purchased that is produced by converting primary en- ergy and consumed within the operational boundaries of UBS (electricity and district heating). 10 Rail and road travel: Switzerland only. 11 Paper produced from new fibers. “FSC” stands for Forest Stewardship Council, “ECF” for elementary chlorine free and “TCF” for totally chlorine free. 12 CO2 footprint equals total CO2 emissions (GHG scope 1, 2 and 3) minus CO2e offsets. 13 Refers to ISO 14064 and the “GHG (greenhouse gas) protocol initiative” (www.ghgprotocol.org), the international standards for CO2 reporting: Scope 1 accounts for direct CO2 emissions by UBS; Scope 2 accounts for indirect CO2 emissions associated with the generation of imported / purchased electricity, heat or steam; Scope 3 accounts for indirect CO2 emissions associated with business travel, paper consumption and waste disposal. 14 Offsets from third-party GHG reduction projects measured in CO2 equivalents (CO2e). These offsets neutralize CO2 emissions from business air travel. 69 Strategy, performance and responsibility Corporate responsibility 70 UBS business divisions and Corporate Center UBS business divisions and Corporate Center – As announced on 10 February 2009, Global Wealth Management & Business Banking has been divided into two business divisions: Wealth Management & Swiss Bank and Wealth Management Americas. – The Investment Bank underwent a detailed strategic review in 2008. The result was a repositioning of the business division, personnel and cost reductions and a refocusing of the business division’s activities and businesses. Global Wealth Management & Business Banking Wealth Management International & Switzerland recorded a pre-tax profit of CHF 3,601 million in 2008, a decrease from the record profit of CHF 6,310 million in 2007. This is partially due to a provision of CHF 917 million in connection with the US cross-border case. During this period: Net new money outflows were CHF 101.0 billion compared with inflows of CHF 125.1 billion. Invested assets declined to CHF 870 billion from CHF 1,294 billion. The gross margin on invested assets fell six basis points to 97 basis points. The cost / income ratio increased to 63.1% from 51.1%. Wealth Management US recorded a pre-tax loss of CHF 810 million in 2008, compared with a pre-tax profit of CHF 674 million in 2007. 2008 included auction rate securities-related charges of CHF 1,636 million. During this period: Net new money outflows were CHF 10.6 billion compared with inflows of CHF 26.6 billion. Invested assets declined to CHF 600 billion from CHF 840 billion. The gross margin on invested assets increased five basis points to 82 basis points. The cost / income ratio increased to 113.4% from 89.9%. Recurring income declined 8% to CHF 3,835 million. Revenues per advisor decreased to CHF 721,000 from CHF 828,000. Business Banking Switzerland recorded a pre-tax profit of CHF 2,449 million, up CHF 182 million from 2007. During this period: Net new money outflows were CHF 11.4 billion compared with inflows of CHF 4.6 billion. Invested assets declined to CHF 129 billion compared with CHF 164 billion. The cost / income ratio decreased to 51.2% from 57.7%. The loan portfolio declined 2% to CHF 143 billion. The ratio of the impaired gross lending portfolio to the total gross lending portfolio improved to 1.0% from 1.2%. UBS reporting structure in 2008 Global Asset Management Investment Bank Corporate Center Global Wealth Management & Business Banking Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland 1FP002_e Industriebeteiligungen Private Equity Performance from continuing operations before tax CHF million Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center For the year ended % change from 31.12.08 31.12.07 31.12.06 3,601 (810) 2,449 5,240 1,333 (34,300) (31) 6,310 674 2,267 9,251 1,454 (16,669) 2,222 5,197 542 2,281 8,020 1,320 5,568 (789) 31.12.07 (43) 8 (43) (8) (106) (101) Global Asset Management Investment Bank Pre-tax profit decreased 8% to CHF 1,333 million in 2008 from CHF 1,454 million in 2007. During this period: Pre-tax loss of CHF 34,300 million in 2008, compared with a pre-tax loss of CHF 16,669 million in 2007. During this period: Net new money outflows were CHF 103.0 billion compared with CHF 15.7 billion. Institutional invested assets declined to CHF 335 billion compared with CHF 522 billion. Wholesale intermediary invested assets fell to CHF 240 billion compared with CHF 369 billion. The gross margin on institutional invested assets declined six basis points to 38 basis points. The gross margin on wholesale intermediary invested assets fell six basis points to 41 basis points. The cost / income ratio was 54.1% compared with 64.5%. The cost / income ratio and compensation ratio remained not meaningful due to negative overall results in both years. Average regulatory Value at Risk (VaR) (10-day, 99% confidence, five years of historical data) was CHF 374 million compared with CHF 514 million. The ratio of the impaired gross lending portfolio to the total gross lending portfolio was 3.6%, up from 0.4%. Corporate Center The Corporate Center produced a slightly negative result of CHF 31 million in 2008 from continuing operations, compared with a gain of CHF 2,222 million in 2007. During this period, total operating income decreased to CHF 998 million from CHF 3,562 million and total operating expenses declined to CHF 1,029 million from CHF 1,340 million. UBS business divisions and Corporate Center Global Wealth Management & Business Banking Global Wealth Management & Business Banking Global Wealth Management & Business Banking is a leading global provider of financial services for wealthy clients and the leading bank for individual and corporate clients in Switzerland. Business division reporting CHF million, except where indicated Income Credit loss (expense) / recovery Total operating income Cash components Share-based components 1 Total personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses Business division performance before tax Key performance indicators Cost / income ratio (%) 2 Attributed equity and risk-weighted assets Average attributed equity (CHF billion) 3 Return on attributed equity (RoaE) (%) 4 BIS risk-weighted assets (CHF billion) 5 Return on BIS risk-weighted assets (%) 6 Goodwill and intangible assets (CHF billion) 7 Additional information Invested assets (CHF billion) Net new money (CHF billion) 8 Client assets (CHF billion) Personnel (full-time equivalents) As of or for the year ended 31.12.08 21,690 31.12.07 24,841 31.12.06 21,775 109 21,884 9,074 377 9,451 3,078 1,040 232 63 13,864 8,020 28 24,869 10,564 444 11,008 3,178 1,106 241 85 15,618 9,251 62.9 63.7 169.7 5.6 5.8 2,298 156.3 3,554 51,243 155.2 5.3 6.0 2,123 114.5 3,337 48,200 % change from 31.12.07 (13) (14) (13) (58) (15) 69 (16) 8 15 3 (43) (30) (33) (3) (421) 21,269 9,191 187 9,378 5,367 926 261 98 16,030 5,240 73.9 17.3 30.4 89.2 5.8 6.2 1,599 (123.0) 2,393 49,541 1 Includes social security contributions and expenses related to alternative investment awards. 2 Operating expenses / income. 3 Refer to the “Capital management” section of this report for more information about the equity attribution framework, which was implemented in 2008. 4 Business division performance before tax / average attributed equity. 5 BIS risk-weighted assets (RWA) are according to Basel II for 2008, and according to the Basel I framework for 2007 and 2006. 6 Business division performance before tax / average BIS RWA. 7 2007 and 2006 represent goodwill and intangible assets in excess of 4% of BIS tier 1 capital. 8 Excludes interest and dividend income. 74 Global Wealth Management & Business Banking business portfolio Incremental profitability Established international markets Corporate & retail banking in Switzerland Wealth Management Switzerland Continue earnings growth to achieve top peer profitability Wealth Management Americas y t i l i b a t fi o r P Continued investments to drive top-line growth International growth markets Achieve break-even and subsequently match peer profitability Optimize break-even targets European domestic markets Other domestic markets, including start-ups Market growth d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C Business A global branch network delivers comprehensive financial services to wealthy private individuals around the world and to private and corporate clients in Switzerland. All clients are provided with the advice, financial products and tools that fit their individual needs. Strategy The cornerstones of this business division’s strategy are: – to strengthen its global leadership in wealth management by actively investing in fast-growing markets and devel- oping a strong focus on high and ultra-high net worth clients; – to position UBS as the universal bank of choice in Switzer- land by strengthening its position across all client seg- ments, as well as developing clients across segments and therefore each client relationship to its full potential; and – to maximize risk-adjusted profits by a balanced focus on top-line growth, risk and efficiency. UBS places great emphasis on differentiating strategies for individual markets according to their profitability and growth potential. In the international markets where UBS is well established with a high market share and in Switzer- land, the focus is on maximizing productivity and profitabil- ity as the growth prospects are less high. For domestic busi- nesses within the five biggest European economies, UBS aims to increase profitability. For the key domestic US pres- ence, UBS concentrates on continuing earnings growth and achieving profitability comparable with the best of its peer group. In those international markets which have been expanding strongly (for example, Asia, Eastern Europe, Latin America and the Middle East), UBS will continue to invest actively in order to tap their long-term growth potential. In addition, within the next seven to 10 years UBS plans to establish a significant domestic presence in select markets where its business is not yet mature. Organizational structure Formed on 1 July 2005, this business division encompassed UBS’s global wealth management businesses and the Swiss corporate and retail banking unit. Throughout 2008, until the recent reorganization, it comprised the following busi- ness units: Wealth Management International & Switzerland, serving wealthy and affluent clients around the world, except domestic clients in the US; Wealth Management US, serving wealthy and affluent domestic US clients; and Business Bank- ing Switzerland, serving retail and corporate clients in Swit- zerland. Each of these business units is provided with infra- structure, products and services by the business division’s support functions, which also provide services to other UBS business divisions under a transfer pricing mechanism. On 10 February 2009, UBS announced a reorganization of its global wealth management and Swiss business banking businesses. Global Wealth Management & Business Banking has been divided into two new business divisions: Wealth Management & Swiss Bank, which comprises all wealth man- agement business booked outside the Americas plus the Swiss private and corporate client business; and Wealth Man- agement Americas, including Wealth Management US, the domestic Canadian and Brazilian businesses, as well as the international business booked in the United States. This new management structure will be the basis for the business division’s segment reporting starting with UBS’s 75 UBS business divisions and Corporate Center Global Wealth Management & Business Banking Current reporting structure (on 31 December 2008) 2BD033_e Global Wealth Management & Business Banking Business Banking Switzerland Wealth Management International & Switzerland Wealth Management US Swiss clients International clients New reporting structure (from first quarter 2009 onwards) Wealth Management & Swiss Bank Wealth Management Americas Swiss clients1 International clients 2 Full profit and loss disclosure Supplementary disclosure of revenue lines and selected key performance indicators 1 Includes “Swiss Bank” and “Corporate and Institutional Banking”. 2 Includes “Wealth Management International” and “Wealth Management Global”. ➔ Prior to publication of first quarter 2009 results, UBS will publish restated business division results on www.ubs.com/investors showing quarterly and annual results for 2007 and 2008 under the new organizational structure announced on 10 February 2009. financial report for first quarter 2009. UBS will provide sepa- rate segment reporting for Wealth Management & Swiss Bank and Wealth Management Americas. UBS has chosen to subdivide Wealth Management & Swiss Bank into Swiss and international business areas for reporting purposes (income data and key performance indicators): – “Swiss clients” will cover services provided to Swiss retail, wealth management and small businesses, as well as corporate and institutional clients. – “International clients” will encompass the international wealth management business conducted out of Switzer- land and all wealth management businesses of UBS’s other booking centers in Asia and Europe. 76 Wealth Management International & Switzerland Business description Business Wealth management solutions are delivered via this business unit’s global branch network and through financial interme- diaries. In addition to the specific wealth management prod- ucts and services outlined below, clients benefit from UBS’s entire range of resources, from asset management to estate planning and corporate finance advice. An open product platform gives clients access to a wide array of pre-screened, top-quality products from third-party providers that comple- ment UBS’s own product lines. On 31 December 2008, in- vested assets were CHF 870 billion. Organizational structure Throughout 2008, until the recent reorganization, this busi- ness unit comprised the following areas: Asia Pacific; Latin America, the Mediterranean, the Middle East and Africa; North, East and Central Europe; and Switzerland. The exten- sive wealth management branch network consisted of 5,755 client advisors, around 110 offices in Switzerland and more than 100 offices worldwide. Competitors Major competitors of this business unit include globally active wealth managers, such as the wealth management operations of Credit Suisse, HSBC and Citigroup. The busi- ness unit also competes with private banks that operate mainly within their respective domestic markets, such as Coutts in the UK, Deutsche Bank AG and Sal. Oppenheim in Germany, Unicredit in Italy, and Swiss banks focused on in- ternational clients (such as Julius Baer and Pictet). Clients and markets The following client segments are offered sophisticated products and services specifically designed to address their needs: international core affluent clients with investable as- sets of CHF 250,000 to CHF 2 million; high net worth clients with investable assets of up to CHF 5 million; private wealth management clients with investable assets of CHF 5 million to CHF 50 million; and ultra-high net worth clients with in- vestable assets of more than CHF 50 million. The business unit also provides financial intermediaries, both inside and outside Switzerland, with UBS’s wealth management solu- tions, products and services. Products and services The business unit offers expert financial advice to support clients throughout the different stages of their lives. Wealth planning advice is also given on topics such as the funding of education, gift giving, inheritance and succession. Corporate finance advice is offered to support clients in the process of disposing of corporate assets. Clients can also trade a full range of financial instruments, from single securities, such as equities and bonds, to structured products and alternative investments. The business unit also fulfills the basic banking needs of private clients with a wide variety of products, rang- Invested assets by asset class  In %, except where indicated Invested assets by currency  In %, except where indicated d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 31.12.06 31.12.07 31.12.08 Total: CHF 1,138 billion CHF 1,294 billion CHF 870 billion 7 21 18 18 14 22 7 23 18 16 13 23 6 22 15 14 17 26 On 100 75 50 25 0 Accounts, money markets , fiduciary investments Bonds UBS mutual funds Equities Other (including structured products and alternative investments) External mutual funds On 100 75 50 25 31.12.06 31.12.07 31.12.08 Total: CHF 1,138 billion CHF 1,294 billion CHF 870 billion 7 7 17 33 36 10 6 15 33 36 8 5 16 35 36 0 2BD004_e USD EUR CHF GBP Others 2BD005_e 77 100 75 50 25 0 100 75 50 25 0 UBS business divisions and Corporate Center Global Wealth Management & Business Banking Loan penetration CHF billion, except where indicated Invested assets by client domicile  In %, except where indicated On 100 75 50 25 0 31.12.06 31.12.07 31.12.08 On 31.12.08 Total: CHF 682 billion 6.5% 74 84 6.6% 8.2% 71 9.0% 4.5% 8 19 17 2BD003_e 0.0% Wealth Management International Europe 56 The Americas Asia Pacific Middle East / Africa Loans Loan penetration 2BD006_e Invested assets by client wealth  In %, except where indicated 8.999991 8.249991 7.499992 6.749993 5.999994 5.249995 4.499995 3.749996 2.999997 2.249998 1.499998 0.749999 0.000000 26 On 31.12.08 46 17 11 Total: CHF 870 billion < CHF 1 million CHF 1–5 million CHF 5–10 million > CHF 10 million 99.999962 91.666632 83.333302 74.999971 66.666641 58.333311 49.999981 41.666651 33.333321 24.999990 16.666660 8.333330 0.000000 2BD007_e ing from cash accounts and savings accounts to credit cards, mortgages and securities-backed lending. By aggregating private investment flows into institution- al-size flows, the business unit is in a position to offer its private clients access to investments that would otherwise only be available to institutional clients. Expertise is sourced either from within UBS or from the external market. Both discretionary and non-discretionary mandates are offered. Clients who opt for a discretionary mandate dele- gate the management of their assets, including investment decisions, to a team of professional portfolio managers who work according to an agreed investment strategy. Clients who prefer to be actively involved in the management of their assets can choose a non-discretionary mandate, where investment professionals provide analysis and monitoring of portfolios, together with tailor-made proposals to support investment decisions. 78 Settlement regarding the US cross-border case As announced on 18 February 2009, UBS settled the US cross-border case with the US Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC) by enter- ing into a Deferred Prosecution Agreement (DPA) with the DOJ and a Consent Order with the SEC. As part of these settlement agreements: – UBS will pay a total of USD 780 mil- lion (CHF 917 million) to the United States, USD 380 million represent- ing disgorgement of profits from maintaining the US cross-border business and USD 400 million representing US federal backup withholding tax required to be withheld by UBS, together with interest and penalties, and restitu- tion for unpaid taxes associated with certain account relationships involving fraudulent sham and nominee offshore structures and otherwise as covered by the DPA. – UBS will complete the exit of the US cross-border business out of non-SEC registered entities, as announced in July 2008, which these settlements now allow UBS to do in a lawful, orderly and expedi- tious manner. – UBS will implement and maintain an effective program of internal controls with respect to compliance with its obligations under its Qualified Intermediary Agreement (QIA) with the Internal Revenue Service (IRS) as well as a revised legal and compliance governance structure in order to strengthen independent legal and compliance controls. – Pursuant to an order issued by the Swiss Financial Market Supervisory Authority (FINMA), information has been transferred to the DOJ regarding accounts of certain US clients as set forth in the DPA, who, based on evidence available to UBS, appear to have committed tax fraud or the like within the meaning of the Swiss-US Double Taxation Treaty. Under the DPA, the DOJ has agreed that any prosecution of UBS be deferred for a period of at least 18 months, which is subject to extension under certain circumstances, such as UBS needing more time to complete the implementation of the exit of its US cross-border business. If UBS satisfies all of its obligations under the DPA, the DOJ will refrain from pursuing charges against UBS relating to the investigation of its US cross- border business. Additionally, as published by FINMA on 18 February 2009, FINMA has concluded that UBS violated the requirements for proper business conduct, and it barred UBS from providing services to US resident private clients out of non-SEC registered entities. Further, FINMA ordered UBS to enhance its control framework around its cross-border businesses and announced that the effectiveness of such a framework will be audited. The order by FINMA in support of the resolution achieved with the DOJ was instrumental in averting the imminent risk of further negative implications and uncertainties for the bank. The cost for the settlement has been fully charged to the year 2008, as reflected in this report. The settlement agreements do not resolve issues concerning the pending “John Doe” summons which the IRS served on UBS in July 2008. The summons seeks information regarding a substantial number of undisclosed accounts maintained by US persons at UBS in Switzerland, whose informa- tion is protected from disclosure by Swiss financial privacy laws. As announced on 19 February 2009, the IRS has commenced a civil action, seeking enforcement of the summons, which UBS intends to challenge. UBS believes it has substantial defenses to the enforcement of the summons and intends to vigorously contest its enforcement in the civil proceeding, as is permitted under the terms of the DPA. Objections to the enforcement of the summons are based upon US law, the terms of UBS’s QIA with the IRS, Swiss financial privacy and other laws, and the principles of international comity that require US courts to take into account foreign laws. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 79 UBS business divisions and Corporate Center Global Wealth Management & Business Banking Business performance Business unit reporting CHF million, except where indicated Income Credit loss (expense) / recovery Total operating income Cash components Share-based components 1 Total personnel expenses General and administrative expenses of which: impact from US cross-border case Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses Business unit performance before tax of which: impact from US cross-border case business unit performance before tax excluding US cross-border case Key performance indicators Invested assets (CHF billion) Net new money (CHF billion) 2 Gross margin on invested assets (bps) 3 Cost / income ratio (%) 4 Client advisors (full-time equivalents) Client advisor productivity Revenues per advisor (CHF thousand) 5 Net new money per advisor (CHF thousand) 6 Invested assets per advisor (CHF thousand) 7 International clients Income Invested assets (CHF billion) Net new money (CHF billion) 2 Gross margin on invested assets (bps) 3 Swiss clients Income Invested assets (CHF billion) Net new money (CHF billion) 2 Gross margin on invested assets (bps) 3 As of or for the year ended 31.12.07 12,893 (1) 12,892 31.12.06 10,827 1 10,828 3,704 169 3,873 1,064 1,531 95 19 6,582 6,310 6,310 1,294 125.1 103 51.1 5,774 2,999 174 3,173 885 1,479 84 10 5,631 5,197 5,197 1,138 97.6 103 52.0 4,742 2,424 23,516 234,504 2,441 22,008 236,879 9,739 1,013 115.6 101 3,154 281 9.5 111 7,907 862 90.8 101 2,920 276 6.8 110 31.12.08 10,819 (390) 10,429 3,037 75 3,112 2,001 917 1,581 97 38 6,828 3,601 (917) 4,518 870 (101.0) 97 63.1 5,755 1,824 (17,029) 187,159 8,185 682 (71.3) 94 2,634 189 (29.7) 110 % change from 31.12.07 (16) (19) (18) (56) (20) 88 3 2 100 4 (43) (28) (33) (6) 0 (25) (20) (16) (33) (7) (16) (33) (1) 1 Includes social security contributions and expenses related to alternative investment awards. 2 Excludes interest and dividend income. 3 Income / average invested assets. 4 Operating expenses / income. 5 Income / average number of client advisors. 6 Net new money / average number of client advisors. 7 Average invested assets / average number of client advisors. 80 d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C Business unit reporting (continued) CHF million, except where indicated Attributed equity and risk-weighted assets Average attributed equity (CHF billion) 1 Return on attributed equity (RoaE) (%) 2 BIS risk-weighted assets (CHF billion) 3 Return on BIS risk-weighted assets (%) 4 Goodwill and intangible assets (CHF billion) 5 Additional information Recurring income 6 Client assets (CHF billion) Personnel (full-time equivalents) As of or for the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 6.1 59.0 25.2 12.3 1.9 8,194 1,048 15,271 63.1 10.5 1.8 9,617 1,651 15,811 51.5 10.8 1.7 8,143 1,436 13,564 (15) (37) (3) 1 Refer to the “Capital management” section of this report for more information on the equity attribution framework, which was implemented in 2008. 2 Business unit performance before tax / average at- tributed equity. 3 BIS risk-weighted assets (RWA) are according to Basel II for 2008, and according to the Basel I framework for 2007 and 2006. 4 Business unit performance before tax / average BIS RWA. 5 2007 and 2006 represent goodwill and intangible assets in excess of 4% of BIS tier 1 capital. 6 Interest, asset-based revenues for portfolio management and account-based, distribution and advi- sory fees. 2008 Results Key performance indicators In 2008, net new money outflows amounted to CHF 101.0 billion, compared with inflows of CHF 125.1 billion in 2007. This occurred in the context of continuing credit market tur- bulence and its impact on the firm’s operating performance and reputation. Outflows of net new money were most pro- nounced in September and the first half of October. Invested assets, at CHF 870 billion on 31 December 2008, were down 33% from CHF 1,294 billion a year earlier, main- ly reflecting sharply lower equity markets and the strong decline of major currencies against the Swiss franc, as well as net new money outflows. The gross margin on invested assets was 97 basis points in 2008, down six basis points from a year earlier, as clients increased their allocation of lower-margin cash products. A further contributing factor was substantially lower levels of cli- ent transaction activity. Overall, recurring income made up 74 basis points of the margin in 2008, down from 77 basis points in 2007. Non-recurring income comprised 23 basis points of the margin in 2008, down 3 basis points from 2007. The cost / income ratio increased to 63.1% in 2008 from 51.1% a year earlier. This increase is primarily due to general and administrative expenses from the recognition of a provi- sion of CHF 917 million (USD 780 million) in connection with the US cross-border case (refer to the “Settlement regarding the US cross-border case” sidebar in this section for more in- formation). Excluding the impact of these costs, the cost / in- come ratio would have increased to 54.6% in 2008 from the previous year. In 2008, pre-tax profit fell 43% to CHF 3,601 million, com- pared with the record CHF 6,310 million in 2007. This is par- tially due to a provision of CHF 917 million in connection with the US cross-border case. Excluding the impact of these costs, the pre-tax result would have fallen 28%, mainly reflecting lower asset base and client transaction activity. the Operating income Total operating income in 2008 was CHF 10,429 million, down 19% from CHF 12,892 million a year earlier. Recurring income decreased 15% on lower asset-based fees. Non- recurring income fell by 20% due to lower brokerage fees, reflecting decreased client transaction activity levels. Operating expenses At CHF 6,828 million, operating expenses in 2008 were up 4% from CHF 6,582 million a year earlier. This is primarily due to a provision of CHF 917 million in connection with the US cross-border case. Excluding the impact of these costs, the op- erating expenses would have decreased 10%, mainly due to lower performance-related compensation. This resulted in lower personnel expenses, which fell 20% to CHF 3,112 mil- lion in 2008 compared with CHF 3,873 million a year earlier. General and administrative expenses, at CHF 2,001 million, were up by 88% from CHF 1,064 million a year earlier due to the abovementioned provisions related to the US cross-border case. Expenses for services from other business units, at CHF 1,581 million in 2008, were up 3% from CHF 1,531 million the previous year, mainly reflecting increased consumption of services. Depreciation was CHF 97 million in 2008, almost unchanged from CHF 95 million a year earlier. Amortization of intangible assets was CHF 38 million, up CHF 19 million from 2007 mainly reflecting an impairment charge. 81 UBS business divisions and Corporate Center Global Wealth Management & Business Banking 2007 Results Key performance indicators In 2007, net new money was a record CHF 125.1 billion, compared with CHF 97.6 billion in 2006, representing an annual growth rate of 11% of the underlying invested asset base at year-end 2006. This outstanding result reflected increases in all geographical regions throughout the year, particularly in Asia Pacific and Americas, both a result of the growth strategy. Invested assets, at CHF 1,294 billion on 31 December 2007, were up 14% from CHF 1,138 billion a year earlier, mainly reflecting the strong inflow of net new money and rising financial markets. This increase was partially offset by negative currency effects. The 7% fall of the US dollar against the Swiss franc contributed to this decrease – approximately 36% of invested assets were denominated in US dollars at the end of 2007. The gross margin on invested assets was 103 basis points in 2007, unchanged from a year earlier, as the increase in non-recurring margin following a sustained level of client ac- tivity was offset by a lower recurring margin. Overall, recur- ring income made up 77 basis points of the margin in 2007, down from 78 basis points in 2006. Non-recurring income comprised 26 basis points of the margin in 2007, up one basis point from 2006. The cost / income ratio improved to 51.1% in 2007 from 52.0% a year earlier. The cost / income ratio improved for the fifth consecutive year despite the rise in costs in pursuit of the global expansion strategy. This improvement reflected the strong rise in income due to a higher asset base and higher volumes in lombard lending, which more than offset the increase in personnel expenses (mainly headcount increase and performance-related compensation) and gen- eral and administrative expenses. In 2007, pre-tax profit, at a record CHF 6,310 million, rose 21% compared with 2006. Total operating income was up 19% in 2007, reflecting a higher asset base and increased collateralized lending volumes and more client activity. Oper- ating expenses, up 17% in 2007 from 2006, also rose as the business expanded. Operating income Total operating income in 2007 was CHF 12,892 million, up 19% from CHF 10,828 million a year earlier. This was the highest level ever, reflecting a rise in recurring as well as non- recurring revenues. Recurring income increased 18% on ris- ing asset-based fees, benefiting from strong net new money inflows. This was accentuated by higher interest income due to the expansion of lombard lending activities. Non-recur- ring income rose 22% due to higher brokerage fees, reflect- ing high client activity levels. Operating expenses At CHF 6,582 million, operating expenses in 2007 were up 17% from CHF 5,631 million a year earlier, reflecting high- er personnel expenses and general and administrative expenses as a result of ongoing business growth. Personnel expenses rose 22% to CHF 3,873 million in 2007 compared with CHF 3,173 million a year earlier, reflecting the increase in salaries due to business expansion and higher perfor- mance-related compensation. General and administrative expenses, at CHF 1,064 million, were up 20% in 2007 from CHF 885 million a year earlier due to increased expenses for travel and entertainment, premises and professional fees – all a consequence of continuous business expansion. Expenses for services from other business units, at CHF 1,531 million in 2007, were up 4% from CHF 1,479 million the previous year, mainly reflecting increased con- sumption. Depreciation was CHF 95 million in 2007, up 13% from CHF 84 million a year earlier because of contin- ued business growth. Amortization of intangible assets was CHF 19 million, up CHF 9 million from 2006. 82 Wealth Management US Business description Business Wealth Management US provides wealth management ser- vices to US private clients. On 31 December 2008, the busi- ness unit had CHF 600 billion in invested assets. Organizational structure Wealth Management US is headquartered in Weehawken, New Jersey, where most corporate and operational func- tions are located. The client-facing organization consists of the branch network in the US and Puerto Rico, with more than 8,100 financial advisors. The branch network is staffed by regional managers, market area managers, branch office managers, financial advisors and administrative support staff. Established as part of Global Wealth Management & Busi- ness Banking in 2005, the business unit continues to evolve to meet the specific needs of its client base. Key acquisitions and transactions over the last three years included: Geographical presence in key markets  – August 2006 acquisition of the private client services branch network of Piper Jaffray. – February 2007 acquisition of the McDonald Investments’ private client branch network. – October 2008 saw the Investment Bank’s municipal secu- rities operations serving private clients transfer to Wealth Management US (following UBS’s decision in June 2008 that its Investment Bank would exit the institutional mu- nicipal securities business). Legal structure In the US, the business unit operates through direct and indirect subsidiaries of UBS. Securities and operations activi- ties are conducted primarily through three registered broker- dealers: UBS Financial Services Inc., UBS Financial Services Inc. of Puerto Rico and UBS Services USA LLC. Wealth Man- agement US’s banking services include Federal Deposit Insur- ance Corporation (FDIC)-insured deposit accounts and enhanced collateralized lending services, which are conduct- ed through UBS Bank USA, a federally regulated Utah bank. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C ALASKA WASHINGTON MONTANA NORTH DAKOTA MINNESOTA OREGON IDAHO WYOMING SOUTH DAKOTA WISCONSIN NEBRASKA IOWA MICHIGAN NEW YORK NEVADA UTAH COLORADO KANSAS ILLINOIS OHIO INDIANA PENNSYLVANIA WEST VIRGINIA KENTUCKY VIRGINIA MISSOURI NEW HAMPSHIRE MASSACHUSETTS RHODE ISLAND CONNECTICUT NEW JERSEY DELAWARE MARYLAND WASHINGTON D.C. VERMONT MAINE CALIFORNIA ARIZONA NEW MEXICO OKLAHOMA ARKANSAS TENNESSEE NORTH CAROLINA SOUTH CAROLINA MISSISSIPPI ALABAMA GEORGIA TEXAS LOUISIANA HAWAII Wealth Management US offices: <5 5–15 >15 FLORIDA PUERTO RICO 83 2BD010_e UBS business divisions and Corporate Center Global Wealth Management & Business Banking Competitors Wealth Management US competes with national full-service brokerage firms, domestic and global private banks, regional broker-dealers, independent broker-dealers, registered in- vestment advisors, commercial banks, trust companies and other financial services firms offering wealth management services to US private clients. In 2008, the financial crisis trig- gered consolidation within the industry that directly impact- ed the business unit’s major competitors: Citi Global Wealth Management, Merrill Lynch Global Wealth Management, Morgan Stanley Global Wealth Management Group and Wachovia Securities. Specifically, Merrill Lynch was acquired by Bank of America, effective 1 January 2009 and Wachovia Corporation was acquired by Wells Fargo, effective 31 December 2008. In January 2009, Morgan Stanley and Citi announced an agreement to combine Morgan Stanley’s Glob- al Wealth Management Group and Citi’s Smith Barney unit into a joint venture called Morgan Stanley Smith Barney. Clients and strategy Wealth Management US is focused on the delivery of ser- vices tailored to meet the needs of four distinct client seg- ments: ultra-high net worth (more than USD 10 million in investable assets), high net worth (USD 1 million to USD 10 million in investable assets), core affluent (USD 250,000 to USD 1 million in investable assets) and the emerging affluent (up to USD 250,000 in investable assets). The business unit is committed to a number of strategic priorities, including gaining market share, achieving im- proved profitability, enhancing the client experience and at- tracting and retaining key talent. One long-term strategy is to ensure the delivery of a high- quality and consistent client experience as defined by the four steps of the “UBS Client Experience”: understanding client needs, proposing appropriate solutions, agreeing on and implementing them, and reviewing progress toward client goals. To do so, the organization is focused on imple- menting a number of organic growth initiatives, infrastruc- ture enhancements and staff development programs, all aimed at fundamentally improving the way financial advisors serve clients. In 2008, Wealth Management US expanded its services and capabilities by increasing its range of client-seg- ment specific offerings. Two additional private wealth man- agement offices were opened to service ultra-high net worth clients in Houston, Texas, and Boston, Massachusetts. With these openings, UBS has nine dedicated private wealth man- agement offices across the US, with additional offices to be opened in select markets through 2010. In June 2008, the first group of UBS wealth advisors received accreditation from a new and comprehensive development program Invested assets by asset class  In %, except where indicated Invested assets by client wealth  In %, except where indicated 31.12.06 31.12.07 31.12.08 On 31.12.08 Total: CHF 600 billion Total: CHF 824 billion CHF 840 billion CHF 600 billion 8 36 16 4 29 7 7 35 17 5 28 8 8 27 19 12 28 6 8 17 27 48 < CHF 1 million CHF 1–5 million CHF 5–10 million > CHF 10 million Accounts/money markets External mutual funds Bonds Equities UBS mutual funds Other1 1 Includes structured products and alternative investments. 2BD011_e 2BD012_e On 100 75 50 25 0 84 100 75 50 25 0  designed by UBS for advisors focused on the high net worth segment. In the first and third quarters of 2008, investment centers in New Jersey and North Carolina were opened to serve emerging affluent clients. Products and services Wealth Management US offers clients a full array of wealth management services that focus on the individual invest- ment needs of each client. Comprehensive planning sup- ports clients through the various stages of their lives, includ- ing education funding, charitable giving, tax management strategies, estate strategies, insurance, retirement, and trusts and foundations. Advisors work closely with consultants who are subject-matter experts in areas such as wealth plan- ning, asset allocation, retirement and annuities, alternative investments, structured products, and banking and lending. They also have access to Wealth Management Research con- tent to support investment decisions. Products and services are designed to meet a wide vari- ety of investment objectives including capital appreciation, income generation, diversifying portfolio concentration and tax optimization. To address the full range of clients’ investment needs, Wealth Management US offers compet- itive lending and cash management services, including the Resource Management Account (RMA) product, credit cards, FDIC-insured deposits, securities-backed lending and mortgages. Additionally, through Corporate Employee Financial Services, it provides stock option and other related services to many of the largest US corporations and their executives. The business unit’s clients have the option of transaction- based or asset-based pricing for their relationships. Clients who choose asset-based pricing have access to both discre- tionary and non-discretionary investment advisory programs. While non-discretionary advisory programs enable the client to maintain control over all transactions in the account, cli- ents with discretionary advisory programs direct investment professionals to manage a portfolio on their behalf. Depend- ing on the type of discretionary program, the client can give investment discretion to a qualified financial advisor, a team of UBS investment professionals or a third-party investment manager. Separately, mutual fund advisory programs are also offered, where a financial advisor works with the client to create a diversified portfolio of mutual funds guided by a research-driven asset allocation framework. Transaction-based pricing offers access to a broad range of transaction products, including individual securities such as equities and fixed income instruments. To complement portfolio strategies, qualified clients may take advantage of the offerings in structured products and alternative invest- ments. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 85 UBS business divisions and Corporate Center Global Wealth Management & Business Banking Business performance Business unit reporting CHF million, except where indicated Income of which: ARS settlement impact Credit loss (expense) / recovery Total operating income Cash components Share-based components 1 Total personnel expenses General and administrative expenses of which: ARS settlement impact Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses Business unit performance before tax of which: ARS settlement impact business unit performance before tax excluding ARS settlement impact Key performance indicators Invested assets (CHF billion) Net new money (CHF billion) 2 Net new money including interest and dividend income (CHF billion) 3 Gross margin on invested assets (bps) 4 Cost / income ratio (%) 5 Recurring income 6 Financial advisor productivity Revenues per advisor (CHF thousand) 7 Net new money per advisor (CHF thousand) 8 Invested assets per advisor (CHF thousand) 9 Attributed equity and risk-weighted assets Average attributed equity (CHF billion) 10 Return on attributed equity (RoaE) (%) 11 BIS risk-weighted assets (CHF billion) 12 Return on BIS risk-weighted assets (%) 13 Goodwill and intangible assets (CHF billion) 14 Additional information Client assets (CHF billion) Personnel (full-time equivalents) Financial advisors (full-time equivalents) As of or for the year ended % change from 31.12.07 6,662 31.12.06 5,863 31.12.07 (12) (2) (1) 6,660 4,352 199 4,551 976 314 79 66 5,986 674 674 840 26.6 51.5 77 89.9 4,173 5,862 3,686 153 3,839 1,073 281 74 53 5,320 542 542 824 15.7 37.9 76 90.7 3,488 828 3,305 107,719 776 2,077 101,922 18.7 3.6 4.0 917 19,347 8,248 18.3 3.0 4.3 909 18,557 7,880 (13) (13) (57) (15) 141 (24) 19 (9) 11 23 (29) (77) 6 (8) (13) (18) (31) (2) (1) 31.12.08 5,847 (172) (25) 5,821 3,806 85 3,891 2,348 1,464 238 94 60 6,631 (810) (1,636) 826 600 (10.6) 11.7 82 113.4 3,835 721 (1,307) 87,876 7.3 (11.1) 25.9 (3.8) 4.3 636 18,929 8,182 1 Includes social security contributions and expenses related to alternative investment awards. 2 Excludes interest and dividend income. 3 For purposes of comparison with US peers. 4 Income / average invested assets. 5 Operating expenses / income. 6 Interest, asset-based revenues for portfolio management and account-based, distribution and advisory fees. 7 Income / average number of financial advisors. 8 Net new money / average number of financial advisors. 9 Average invested assets / average number of financial advisors. 10 Refer to the “Capital management” section of this report for more information on the equity attribution framework, which was implemented in 2008. 11 Business unit performance before tax / average attributed equity. 12 BIS risk- weighted assets (RWA) are according to Basel II for 2008, and according to the Basel I framework for 2007 and 2006. 13 Business unit performance before tax / average BIS RWA. 14 2007 and 2006 represent goodwill and intangible assets in excess of 4% of BIS tier 1 capital. 86 d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 2008 Key performance indicators In 2008, net new money outflows amounted to CHF 10.6 billion compared with inflows of CHF 26.6 billion in 2007, with net new money outflows concentrated in the second and third quarters. This reflects the credit market turbulence and its impact on the firm’s operating performance and repu- tation, which led to an increase in financial advisor attrition and clients diversifying assets away from the firm. Net new money improved to positive levels in the fourth quarter, with its strongest inflows occurring in December after financial ad- visor recruiting and retention. Including interest and divi- dends, net new money in 2008 was CHF 11.7 billion, down from CHF 51.5 billion in 2007. Wealth Management US had CHF 600 billion in invested assets on 31 December 2008, down 29% from CHF 840 bil- lion on 31 December 2007. This was a result of declining markets over the year, net new money outflows and the neg- ative impact of currency translation. In US dollar terms, invested assets decreased 24% compared with a year earlier. The gross margin on invested assets was 82 basis points in 2008, up from 77 basis points in 2007. The increase is mainly a result of a six basis point increase in the recurring income margin to 54 basis points, while the non-recurring margin decreased one basis point to 28 basis points. The cost / income ratio increased to 113.4% in 2008 from 89.9% in 2007. Following the auction rate securities (ARS) set- tlement in August 2008, Wealth Management US recorded losses of CHF 1,636 million, of which CHF 1,464 million were included in general and administrative expenses, and CHF 172 million were recognized as trading losses. Under the ARS settle- ment, Wealth Management US agreed to purchase ARS from clients at their par value. Up to fourth quarter 2008, the ARS settlement liability represented a provision. The liability was re- classified from provisions to negative replacement values in fourth quarter 2008, when ARS settlement rights, which are treated as derivative instruments, were issued and accepted by clients. Losses incurred post-reclassification represented trading losses. Excluding ARS-related charges, the cost / income ratio improved to 85.8% due to lower expenses, including reduced performance-based compensation accruals. Refer to the “Ex- posure to auction rate securities” sidebar in the “Risk concen- tration” section of this report for more information. In 2008, recurring income was CHF 3,835 million, down 8% from CHF 4,173 million a year earlier. Excluding the impact of currency fluctuations, recurring income increased 6% in 2008, driven by growth in net interest income from increased deposit balances, while recurring fee income declined slightly due to lower asset levels. Recurring income represented 66% of total operating income in 2008, com- pared with 63% in 2007. Revenues per advisor decreased in 2008 to CHF 721,000 from CHF 828,000 in 2007. In US dollar terms, revenues per advisor were on par as higher recurring income was offset by lower transactional revenue. The number of financial advisors at 31 December 2008 was 8,182, down 66 or 1% from a year earlier. Turnover among financial advisors was concentrated among lower producing advisors, including trainees. Results For full-year 2008, Wealth Management US recorded a pre- tax loss of CHF 810 million compared with a pre-tax profit of CHF 674 million in 2007. Driving the decline were total ARS- related charges of CHF 1,636 million taken during 2008. Excluding these charges, the pre-tax result would have increased 23%. In US dollar terms and excluding ARS-related charges, the pre-tax performance would have increased 41% driven by resilient operating income growth during a chal- lenging environment, coupled with a decline in expenses, including lower performance-based compensation accruals. Operating income In 2008, total operating income was CHF 5,821 million, down 13% from CHF 6,660 million in 2007. Excluding cur- rency effects and ARS related trading losses, operating income increased 4% from 2007. The increase in operating income reflects stronger net interest income related to an increase in deposit balances, and a positive impact of the new equity attribution framework introduced in first quarter 2008, partly offset by lower transactional revenue and an increase in credit losses. Operating expenses Total operating expenses rose 11% to CHF 6,631 million in 2008 from CHF 5,986 million in 2007. Excluding ARS-related expenses, operating expenses declined 14%. In US dollar terms and excluding ARS-related expenses, operating expenses declined 1%. On this basis, personnel expenses decreased 2% driven by lower performance-based compen- sation accruals, partly offset by higher severance costs relat- ed to staff reductions. Excluding ARS-related expenses, non- (including general and administrative personnel costs expenses, depreciation and amortization expenses, and services provided to and received from other business units), rose 2% in US dollar terms due to an increase in depreciation costs, while total general and administrative expenses were essentially flat from the prior year. 87 UBS business divisions and Corporate Center Global Wealth Management & Business Banking 2007 Key performance indicators The inflow of net new money in 2007 was CHF 26.6 billion, up from CHF 15.7 billion a year earlier, reflecting reduced outflows from existing clients and the recruitment of experi- enced advisors. Including interest and dividends, net new money in 2007 was CHF 51.5 billion, up from CHF 37.9 bil- lion in 2006. Wealth Management US had CHF 840 billion in invested assets on 31 December 2007, up 2% from CHF 824 billion on 31 December 2006. This was a result of rising markets over the year, net new money inflows and the first-time inclusion of former McDonald Investments’ assets. These increases were partly offset by the negative impact of cur- rency translation. In US dollar terms, invested assets in- creased 10% compared with a year earlier. The gross margin on invested assets was 77 basis points in 2007, up from 76 basis points in 2006. The increase is mainly a result of a higher recurring income margin, while the non-recurring margin decreased. The cost / income ratio was 89.9% for 2007, compared with 90.7% in 2006. The improvement in the cost / income ratio reflects higher operating income due to strong growth in recurring income, partially offset by a rise in expenses mainly reflecting higher personnel expenses in support of growth initiatives and the integration of the McDonald Investments’ private client branch network. In 2007, recurring income was a record CHF 4,173 million, up 20% from CHF 3,488 million a year earlier. Excluding the impact of currency fluctuations, recurring income was up 23% in 2007 from 2006. This increase mainly reflects higher levels of managed account fees on a year-end record level of invested assets, higher investment advisory fees and higher net interest income. Recurring income represented 63% of operating income in 2007, compared with 60% in 2006. Revenues per advisor increased in 2007 to CHF 828,000 from CHF 776,000 in 2006 as a higher average number of financial advisors was able to produce significantly higher recurring income than a year earlier. The number of financial advisors rose 5% compared with 2006, increasing by 368 advisors to 8,248 at the end of 2007, while recurring income increased 20%. Results In 2007, Wealth Management US reported a pre-tax profit of CHF 674 million, compared with CHF 542 million in 2006. In US dollar terms, performance in 2007 was up 27% from 2006. Performance in 2007 benefited from record levels of recurring income and lower general and administrative expenses. This was partly offset by higher personnel expenses. Operating income In 2007, total operating income was CHF 6,660 million, up 14% from CHF 5,862 million in 2006. Excluding currency effects, operating income increased 16% from 2006. The increase in operating income reflected the record recurring income (driven by increased asset levels in managed account products) and increased transactional revenue. Operating expenses Total operating expenses rose 13% to CHF 5,986 million in 2007 from CHF 5,320 million in 2006. Excluding currency effects, operating expenses were 15% higher. Personnel expenses increased CHF 712 million or 19%, with higher salaries as well as share-based compensation. This reflects rising headcount due to organic growth and the McDonald Investments’ private client branch network inclu- sion. General and administrative expenses decreased 9% to CHF 976 million in 2007 from CHF 1,073 million in 2006. In US dollar terms, they fell 7%, primarily reflecting lower provi- sions compared with 2006. Services from other business units increased 12% from CHF 281 million in 2006 to CHF 314 million in 2007. Depreciation was higher due to leasehold improvements. The amortization of intangibles was CHF 66 million in 2007, up 25% from CHF 53 million, mainly due to the acquisition of the McDonald Investments’ private client branch network and the full-year impact of the acquisition of the Piper Jaffray’s private client services branch network. 88 Business Banking Switzerland Business description Business Business Banking Switzerland is UBS’s retail and commercial banking unit and the leading bank in Switzerland. At the end of 2008, business banking Switzerland had CHF 129 billion in invested assets. UBS also leads the Swiss lending and retail mortgage markets, with a total loan book of CHF 143 billion on 31 December 2008. Organizational structure Business Banking Switzerland is home to the firm’s Swiss branch network for corporate and individual clients. It is organized in eight geographical regions. The customer ser- vices network includes e-banking services, customer service centers, 1,260 automated teller machines (ATMs) and 303 branches across Switzerland. To meet the needs of private clients, which are changing in line with technological advances, Business Banking Swit- zerland pursues an integrated, multi-channel strategy. It uses technology to complement, rather than replace, the traditional physical branch network. Standard transactions can be executed using one of the electronic channels, enabling client advisors to focus on providing advice and developing financial solutions. For basic products and services, technology is used to ensure around-the-clock availability. Customer service centers exist in five locations and provide basic information and support 24 hours a day via telephone. Additionally, in 65 of the UBS branches in Switzerland, a two-zone concept has been implemented: standard transactions are executed via ATMs, while client advisors, sitting in an open plan desk area next to the ATMs, focus on giving clients value- added advice. Clients make extensive use of e-banking channels. On 31 December 2008, more than 600,000 clients had active e-banking con- tracts and more than 80% of all payment orders were made in 2008 through electronic channels. Competitors UBS’s major competitors are the banks that are active in the retail and corporate banking market in Switzerland. This group includes Credit Suisse, the country’s cantonal banks, Raiffeisen Bank, other regional or local Swiss banks and for- eign bank branches in Switzerland. Clients and products The business unit serves both retail and commercial clients, including financial institutions. Approximately 2.5 million individual Switzerland-based clients are served through over 3 million accounts, mortgag- es and other financial relationships. Through the client ser- vice networks described above, individual clients can access services such as a comprehensive selection of cash accounts, savings products, advisory services, residential mortgages, pensions and life insurance. Of the approximately 135,000 corporate clients, about 200 are major companies with operations spanning a broad range of markets and geographical regions and therefore d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C Invested assets by asset class  In %, except where indicated On 100 75 50 25 0 31.12.06 31.12.07 31.12.08 Total: CHF 161 billion CHF 164 billion CHF 129 billion 4 12 10 37 8 29 4 12 10 37 8 29 4 10 9 38 10 29 Accounts/money markets Equities Bonds Other UBS mutual funds External mutual funds 2BD015_e 89 100 75 50 25 0 UBS business divisions and Corporate Center Global Wealth Management & Business Banking require advanced financing and risk management skills as well as comprehensive access to the capital markets for funding needs; about 8,200 are large companies requiring expertise in handling complex financial transactions, includ- ing the selection and design of investment products, assis- tance in complex mergers and acquisitions or provision of structured financing; and some 126,000 are small- and medium-sized enterprises requiring local market expertise and access to a full range of products and services. In addi- tion, substantial business process support is available (rang- ing from transactional payments and securities services to the facilitation of cross-border transactions with trade finance products). Global custody services offer institutional investors the opportunity to consolidate multiple-agent bank relationships into a single, cost-efficient global custodial relationship. This simplifies their processing and administration arrangements and allows them to take advantage of other services, such as flexible consolidated performance reporting and powerful portfolio management tools. Payments, securities and custodial services are offered to more than 3,000 financial institutions worldwide. Other banks which lack UBS’s scale can also outsource their pay- ment, security or custodial services in order to benefit from UBS’s scale efficiencies. Total lending portfolio, gross On 31 December 2008, the total lending portfolio was CHF 143 billion, gross. Of this amount, mortgages comprised CHF 116 billion, with 84% being residential mortgages. Continued discipline in implementing risk-adjusted pricing has resulted in a strengthened focus of origination efforts on higher-quality exposures with an attractive risk / return rela- tionship. The introduction of this model has resulted in a clear improvement in the risk profile of the business unit’s lending portfolio. ➔ Refer to the “Credit risk” section of this report for more information on UBS’s credit portfolio. Recovery portfolio A dedicated team of recovery specialists assists clients that are unable to meet their financial obligations. Economic re- covery can be achieved through restructuring or through liq- uidation of available collateral in order to limit the financial loss on the loan. The recovery portfolio amounted to CHF 2.3 billion on 31 December 2008. Since the end of 1998, successful recovery efforts have reduced the portfolio by more than 91% and non-performing loans have decreased from CHF 14.0 billion to CHF 1.5 billion, resulting in a ratio of non-performing loans to total lending portfolio of 0.9%. Total lending portfolio by category, gross In %, except where indicated Development of UBS’s recovery portfolio, 2000–2008  CHF billion On 100 75 50 25 0 90 31.12.06 31.12.07 31.12.08 Total: CHF 143 billion CHF 145 billion CHF 143 billion 2 17 81 2 18 80 2 18 80 9 9 . 2 1 . 1 3 21 3 (9) On 25 20 15 10 0 0 . 2 1 . 1 3 1 0 . 2 1 . 1 3 2 0 . 2 1 . 1 3 3 0 . 2 1 . 1 3 4 0 . 2 1 . 1 3 5 0 . 2 1 . 1 3 6 0 . 2 1 . 1 3 7 0 . 2 1 . 1 3 8 0 . 2 1 . 1 3 2 (5) 15 1 (4.4) 12 1.3 (3.5) 8.6 0.6 (2.6) 6.4 Mortgages Commercial credits Recovery portfolio 2BD016_e 5 0 4.4 0.5 (1.6) 3.3 0.4 (1.1) 2.6 0.6 (0.7) 2.50.5(0.7) 2.3 Balance New recovery loans added Settlement of recovery loans outstanding 25 20 15 10 5 2BD017_e 0 100 75 50 25 0 Business performance Business unit reporting CHF million, except where indicated Interest income Non-interest income Income Credit loss (expense) / recovery Total operating income Cash components Share-based components 1 Total personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses Business unit performance before tax Key performance indicators Invested assets (CHF billion) Net new money (CHF billion) 2 Cost / income ratio (%) 3 Impaired lending portfolio as a % of total lending portfolio, gross Attributed equity and risk-weighted assets Average attributed equity (CHF billion) 4 Return on attributed equity (RoaE) (%) 5 BIS risk-weighted assets (CHF billion) 6 Return on BIS risk-weighted assets (%) 7 Goodwill and intangible assets (CHF billion) 8 Additional information Client assets (CHF billion) Personnel (full-time equivalents) As of or for the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C (7) (1) (5) (6) (6) (64) (8) (11) (21) 4 (16) 8 (21) 3,234 1,790 5,024 (5) 5,019 2,348 27 2,376 1,018 (893) 70 0 2,570 2,449 129 (11.4) 51.2 1.0 3.8 64.0 38.0 6.1 0.0 3,470 1,816 5,286 31 5,317 2,508 76 2,584 1,138 (739) 67 0 3,050 2,267 164 4.6 57.7 1.2 87.9 2.6 0.0 3,339 1,746 5,085 109 5,194 2,389 50 2,439 1,120 (720) 74 0 2,913 2,281 161 1.2 57.3 1.7 85.4 2.7 0.0 709 15,341 986 16,085 992 16,079 (28) (5) 1 Includes social security contributions and expenses related to alternative investment awards. 2 Excludes interest and dividend income. 3 Operating expenses / income. 4 Refer to the “Capital management” section of this report for more information about the equity attribution framework, which was implemented in 2008. 5 Business unit performance before tax / average attributed equi- ty. 6 BIS risk-weighted assets (RWA) are according to Basel II for 2008, and according to the Basel I framework for 2007 and 2006. 7 Business unit performance before tax / average BIS RWA. 8 2007 and 2006 represent goodwill and intangible assets in excess of 4% of BIS tier 1 capital. 91 UBS business divisions and Corporate Center Global Wealth Management & Business Banking 2008 Key performance indicators Net new money outflows totaled CHF 11.4 billion in 2008, compared with an inflow of CHF 4.6 billion in 2007. This was mainly due to clients’ diversification of assets and re- evaluation of banking relationships in the context of con- tinuing global market turmoil. Invested assets fell to CHF 129 billion in 2008 from CHF 164 billion a year earlier, driven by negative market develop- ments and net new money outflows. In 2008 the cost / income ratio stood at 51.2%, strongly improved from 57.7% a year earlier due to a 16% decrease in operating expenses reflecting cost-cutting measures. Business Banking Switzerland’s loan portfolio was CHF 143.0 billion on 31 December 2008, down 2% from the previous year. The key credit quality ratio of the impaired lending portfolio, gross, to the total lending portfolio, gross, improved to 1.0% compared with 1.2% in 2007. Results Pre-tax profit in 2008 was a record CHF 2,449 million, CHF 182 million, or 8% above the result achieved in 2007 due to a strong decrease in operating expenses reflecting stringent cost-cutting measures as well as higher charges paid to this business unit for services provided to other businesses. Operating income Total operating income in 2008 was CHF 5,019 million, down from 2007’s level of CHF 5,317 million. Interest income decreased 7% to CHF 3,234 million in 2008 from CHF 3,470 million in 2007. This decrease reflects lower de- posit and loan volumes as well as lower margins on mort- gages. Non-interest income decreased CHF 26 million to CHF 1,790 million in 2008 from CHF 1,816 million in 2007, reflecting the lower asset base. Credit loss, at CHF 5 million in 2008, deteriorated from credit loss recoveries of CHF 31 million in 2007. Operating expenses Operating expenses in 2008 were CHF 2,570 million, down 16% from CHF 3,050 million in 2007. Personnel expenses, at CHF 2,376 million, were down 8% from CHF 2,584 mil- lion in 2007, reflecting lower performance-related compen- sation accruals. General and administrative expenses, at CHF 1,018 million in 2008, were 11% lower than the CHF 1,138 million recorded in 2007. Net charges to other busi- ness units continued to rise for the fourth consecutive year to CHF 893 million in 2008 from CHF 739 million in 2007 because of higher consumption of services in other business- es. Depreciation in 2008 slightly increased to CHF 70 million from CHF 67 million in 2007. 92 2007 Key performance indicators Net new money was CHF 4.6 billion in 2007, CHF 3.4 billion higher than the inflow of CHF 1.2 billion in 2006. This was due to an increase in inflows from existing clients. Invested assets rose to CHF 164 billion in 2007 from CHF 161 billion a year earlier, driven by positive market develop- ments and net new money inflows. This was slightly offset by the transfer of assets to Wealth Management International & Switzerland, which occurred over the course of 2007, when UBS transferred CHF 9.2 billion in client assets from the Busi- ness Banking Switzerland business unit to the Wealth Man- agement International & Switzerland business unit, reflecting the development of client relationships. In 2006, UBS trans- ferred CHF 8.2 billion in client assets for the same reason. In 2007 the cost / income ratio was 57.7%, compared with 57.3% a year earlier. Business Banking Switzerland’s gross lending portfolio was CHF 145.5 billion on 31 December 2007, up 1% from the previous year. This positive development was also reflect- ed in the key credit quality ratio of the impaired lending portfolio, gross, to the total lending portfolio, gross, which was 1.2% compared with 1.7% in 2006. Results Pre-tax profit in 2007 was CHF 2,267 million, CHF 14 million or 1% below the result achieved in 2006, as the increase in operating expenses outpaced income growth. In 2007, interest income rose on higher volumes and margin on liabil- ities, while non-interest income rose due to higher asset- based and brokerage fees. Operating income Total operating income in 2007 was CHF 5,317 million, up from the 2006 level of CHF 5,194 million. Interest income increased 4% to CHF 3,470 million in 2007 from CHF 3,339 million in 2006. The slight increase reflects the expansion of the business unit’s loan portfolio and the higher margin on liabilities. Non-interest income increased by CHF 70 million to CHF 1,816 million in 2007 from CHF 1,746 million in 2006, reflecting a higher asset base as well as higher trading income. Credit loss recoveries were CHF 31 million in 2007, a decrease from recoveries of CHF 109 million in 2006. Operating expenses Operating expenses in 2007 were CHF 3,050 million, up 5% from CHF 2,913 million in 2006. Personnel expenses, at CHF 2,584 million, were up 6% from CHF 2,439 million in 2006 due to higher salary costs for the employee pension plan in Switzerland, related to its change from a defined benefit to a defined contribution plan. General and administrative ex- penses, at CHF 1,138 million in 2007, rose and were 2% higher than the CHF 1,120 million recorded in 2006. Net charges to other business units continued to rise to CHF 739 million in 2007 from CHF 720 million in 2006 because of higher consumption of services in other business units. De- preciation in 2007 decreased to CHF 67 million from CHF 74 million in 2006. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 93 UBS business divisions and Corporate Center Global Asset Management Global Asset Management Business description One of the world’s leading asset managers, Global Asset Management provides investment capabilities and services to private clients, financial intermediaries and institutional investors. Business This business division offers a wide range of investment capabilities and services across all major asset classes includ- ing equities, fixed income, asset allocation, currency, risk management, hedge funds, real estate, infrastructure, pri- vate equity and fund administration. Invested assets totaled CHF 575 billion on 31 December 2008, making Global Asset Management one of the largest institutional asset managers and hedge fund of funds managers in the world. This busi- ness division is also one of the largest mutual fund managers in Europe and the largest in Switzerland. Revenues and key performance indicators are reported according to two principal asset management client seg- ments: institutional (for example, corporate and public pen- sion plans, governments and their central banks) and whole- sale intermediary (for example, financial intermediaries, including Wealth Management, and selected third parties). Strategy The financial crisis of 2008 is likely to have a major adverse impact on the immediate growth prospects of the asset management industry. A key change that could depress future growth in certain areas but provide opportunities in others is increased aversion to risk among investors. Inves- tors are considering risk not only in terms of volatility and the possibility of underperformance in asset classes but also in terms of the liquidity constraints related to the ability to redeem investments as well as counterparty risks. In the longer term, however the industry outlook remains strong as fundamental drivers over the past two decades have not changed and, indeed, have now been reinforced. Strong growth has been driven by the recognition, both within government and outside, of the need for increased retirement savings as median populations age and pressures on public finances correspondingly increase. This has created a growing industry in both established markets and, more recently, the new markets of the Middle East, South America and Asia Pacific. Global Asset Management’s diversified business model will allow it to continue to service growth segments by offer- ing a wide range of products from boutique-like capabilities to various markets and distribution channels. Global Asset Management’s wide spectrum of investment capabilities puts it in a strong position to further develop a holistic range of investment solutions including liability-driven investment and retirement products. This business division is well posi- Key focus areas Investment capabilities are globally co-ordinated but with boutique-like discretion wherever possible... Equities Fixed income Alternative and quantitative investments Global real estate Global investment solutions Infrastructure and private equity Fund services Europe, Middle East & Africa Americas Asia Pacific …distribution is regionally organized… Information technology Operations Human resources Legal, compliance and risk control Financial control Strategic planning Consultant relation- ships and communi- cations ...and supported by global functions 2BD019_e 94 tioned to capture opportunities with the move towards more tangible asset classes such as infrastructure, real estate and private equity. It will also continue to drive its third-party wholesale initiative forward, particularly in Europe and the Americas. Organizational structure This business division is headquartered in London, with other main offices in Chicago, Frankfurt, Hartford, Hong Kong, New York, Paris, Rio de Janeiro, Sydney, Tokyo, Toronto and Zurich, and employs around 3,800 persons in 25 countries. Significant recent acquisitions and business transfers – In December 2006, UBS completed its acquisition of Ban- co Pactual and renamed the asset management business UBS Pactual Asset Management. It is currently the sev- enth largest asset manager in Brazil with invested assets of approximately CHF 19 billion on 31 December 2008. – In May 2007, UBS announced the closure of Dillon Read Capital Management (DRCM). The business was formed in June 2005 and officially launched in June 2006. The business had two arms – one managing existing proprie- tary assets transferred from UBS Investment Bank, the other established to manage outside investor assets. As the development of the business did not meet original expectations, it was closed in May 2007. – In July 2007, UBS purchased a 51% stake in Daehan In- vestment Trust Management Company Ltd. (DIMCO) from Hana Daetoo Securities (formerly Daehan Invest- ment & Securities Company Ltd.), a wholly owned subsid- iary of Hana Financial Group. DIMCO was renamed UBS Hana Asset Management Company Ltd. internationally and Hana UBS Asset Management in Korea and is one of the market leaders in the Korean asset management industry, with invested assets of CHF 13 billion on 31 December 2008. – In February 2008, UBS acquired 100% of the Caisse Cen- trale de Réescompte (CCR) Group in France from Com- merzbank. The businesses of the CCR Group are being combined into the asset management and wealth man- agement businesses of UBS in France. CCR Group had invested assets of CHF 4 billion on 31 December 2008. – In August 2008, UBS sold its 24.9% stake in Adams Street Partners to its remaining shareholders. The transaction closed on 6 August 2008. Competitors Global Asset Management’s competitors range from global competitors in active investments (such as Fidelity Invest- ments, AllianceBernstein Investments, BlackRock, JP Mor- gan Asset Management, Deutsche Asset Management and Goldman Sachs Asset Management) to those managed on a regional or local basis or specializing in particular asset classes. In the real estate, hedge fund, infrastructure and regional private equity investment areas, competitors tend to be specialist niche players who focus mainly on one asset class. It is likely that the current market turmoil will alter the composition of the asset management industry and its par- ticipants. Successful competitors are expected to be well- diversified, large asset managers – structured as either multi- boutiques or with a more traditional structure that can benefit from economies of scale – with access to a wide range of asset classes and a broad global distribution. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C Invested assets by client type    In %, except where indicated Institutional /wholesale intermediary revenues In %, except where indicated 31.12.06 31.12.07 31.12.08 Total: CHF 866 billion CHF 891 billion CHF 575 billion 40 60 41 59 42 58 On 100 75 50 25 0 On 100 75 50 25 0 31.12.06 31.12.07 31.12.08 Total: CHF 3,220 million CHF 4,094 million CHF 2,904 million 44 56 42 58 43 57 Institutional Wholesale intermediary 2BD020_e Institutional Wholesale intermediary 2BD021_e 95 100 75 50 25 0 100 75 50 25 0 UBS business divisions and Corporate Center Global Asset Management Products and services Investment management products and services are offered in the form of segregated, pooled and advisory mandates along with a range of more than 500 registered investment funds, exchange-traded funds and other investment vehicles across all major asset classes. – Equities offers a full spectrum of investment styles with varying risk and return objectives. It has three investment pillars with distinct strategies – core / value (portfolios managed according to a price to intrinsic value philoso- phy), growth investors (a quality global growth manager) and structured equities (strategies that employ proprie- tary analytics and quantitative methods). – Fixed income offers a diverse range of global, regional and local market-based investment strategies that cover a wide range of benchmarks. Its capabilities include “core” government and corporate bond strategies, complement- ed by extended strategies such as high-yield and emerg- ing market debt. – Alternative and quantitative investments has two primary business lines – multi-manager (or fund of funds) and sin- gle manager. The former constructs portfolios of hedge funds and other alternative investments operated by third-party managers, allowing clients diversified expo- sure to a range of hedge funds, private equity and infra- structure strategies. O’Connor is a key provider of single manager global hedge funds. – Global real estate actively manages real estate invest- ments in Asia, Europe and the US across all major sectors. Its capabilities include core, value-added and opportunis- tic strategies on a global, regional and country basis, and are offered through open and closed-end private funds, funds of funds, individually managed accounts and pub- licly traded real estate securities globally. – Global investment solutions offers asset allocation, cur- rency, risk management and advisory services. It manages a wide array of domestic, regional and global balanced portfolios, currency mandates, structured portfolios and absolute return strategies which invest in internal and ex- ternal portfolios. – Infrastructure and private equity is involved in the origina- tion and management of specialist funds that invest in infrastructure and other private assets globally. – Fund services, the global fund administration business, pro- vides professional services, including legal set up, reporting and accounting for retail and institutional investment funds, for hedge funds and for other alternative funds. Investment performance full-year 2008 The decline in almost all financial markets that began in the latter half of 2007 continued in 2008 and accelerated towards the end of the year. Investors became increasingly risk averse and sensitive to news flow thus creating very vol- atile market conditions, even in perceived lower risk sectors such as money markets. Across the asset management indus- try, this difficult environment led to a wide dispersion of in- vestment performance. Among equity strategies, a higher proportion equaled or exceeded their benchmark for 2008 than for 2007, with most strategies also improving their relative standings com- pared with peers. This notable improvement in relative per- formance followed the leadership and broader personnel changes initiated during 2007. In core / value equities, the strongest performance for the year was seen in European Invested assets by region¹ In %, except where indicated Institutional invested assets by asset class In %, except where indicated 31.12.06 31.12.07 31.12.08 Total: CHF 519 billion CHF 522 billion CHF 335 billion 31.12.06 31.12.07 31.12.08 Total: CHF 866 billion CHF 891 billion CHF 575 billion 59 10 32 54 13 33 52 10 38 On 100 75 50 25 Americas Asia Pacific Europe, Middle East & Africa 1 Assets represented are totals for the Global Asset Management business division worldwide. The regional split is based on the client servicing location. 0 2BD025_b_e On 100 75 50 25 0 96 20 21 35 18 6 23 23 29 19 6 23 20 22 22 13 2BD025_11_e Money market Fixed income Equity Multi-asset Alternatives 100 75 50 25 0 100 75 50 25 0 Investment capabilities and services  Alternative and quantitative investments Single manager hedge funds Multi-manager hedge funds Quantitative Infrastructure fund of funds Private equity fund of funds Equities Core/value Global Fixed income Global Country and regional Country and regional Sector specific Emerging markets Emerging markets Specialist High yield Growth investors Structured credit Global Liquidity /short duration Country and regional Indexed Structured equities Systematic alpha Quantitative equities Portfolio construction solutions (including passive) Global real estate Global Global investment solutions Infrastructure and private equity Global Country and regional Country and regional Private strategies Asset allocation Real estate securities Currency management Agriculture Return and risk targeted Structured portfolios Risk management and advisory services Direct infrastructure investment Listed infrastructure securities Direct private equity investment Global and regional Fund services Alternative funds Investment funds d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o 2BD024_e C and in Canadian and Australian equities. European equities performance was particularly strong in the second half of the year and, overall, sector positioning contributed positively, especially overweights to telecoms and pharmaceuticals and an underweight to materials. Global equity strategies showed distinct performance improvement during the year, despite some setbacks in the fourth quarter where a range of positive contributors were insufficient to fully offset the drag on per- formance of only modest overweights to banks and diversi- fied financials. US equity strategies had a very difficult first half, followed by a strong third quarter and a weaker fourth quarter. Contributors to performance varied quarter by quar- ter but, over the year as a whole, underweights to energy and materials were the largest detractors. Overweights to utilities and telecoms were positives, although the latter was offset by weak stock selection in the sector. Growth equities strategies posted mixed performance results with the US large cap growth and US mid cap growth strategies marginally outperforming their benchmarks while other strategies underperformed for the year. The first and second halves of the year delivered markedly different results. At the end of the second quarter, all major strategies were outperforming their respective benchmarks for the year to date. The accelerated deleveraging of the second half of the year saw an indiscriminate and broad-based sell-off in the global equity markets that put significant pressure on growth Wholesale intermediary invested assets by asset class  In %, except where indicated On 100 75 50 25 0 31.12.06 31.12.07 31.12.08 Total: CHF 347 billion CHF 369 billion CHF 240 billion 3 30 27 23 17 4 31 27 19 19 5 24 18 20 33 Money market Fixed income Equity Multi-asset Alternatives 2BD025_12_e 97 100 75 50 25 0 UBS business divisions and Corporate Center Global Asset Management stocks and more than erased the outperformance of the first half of the year. Longer-term returns from growth strategies generally remain strong. 2008 was another dramatic year for global bond mar- kets. Some easing of financial market stress was evident to- wards the end of the first quarter but this was soon reversed as the economic outlook deteriorated. Levels of stress in money markets, government and corporate bond markets increased dramatically during the third quarter, culminating with the Lehman bankruptcy in September. Despite historic levels of government and central bank intervention globally, the third quarter saw a substantial flight to quality in fixed income markets. Corporate bond yield spreads (the differ- ence in yield versus government bonds) increased substan- tially. In the fourth quarter, central banks cut rates aggres- sively and combined with falling inflation expectations, this led to substantial falls in yield in developed government bond markets. Despite the announced bank bail-out plans, yield spreads on financial sector bonds widened to record levels. A combination of these factors and our portfolio positioning led to significant underperformance of US, UK, global aggregate and absolute return strategies. The struc- tured credit exposure in some of these strategies was a fac- tor, although less so as the year progressed as a result of exposures being reduced. In contrast, European aggregate, Australian, US municipal and high yield strategies outper- formed. Money market funds continued to achieve their capital preservation objectives and Global Asset Manage- ment did not need to support its large funds, including its US 2a7, Swiss or Luxembourg money market funds. Refer to the disscusion on other types of support in the “Off-balance sheet” section of this report for more information on UBS’s support to non-consolidated funds in its wealth and asset management businesses. Multi-asset strategies, including the global securities com- posite, underperformed their benchmarks in 2008, largely as a result of asset allocation and bond selection in some of the underlying portfolios. Equity selection was mixed and cur- rency management was strongly positive. At the beginning of 2008, the asset allocation position in equities was neutral. As equity valuations became more favorable and there were clear signals that the authorities were seeking to support the financial system, exposure to equities was gradually in- creased at the expense of government bonds. This market positioning detracted from performance for the year but is expected to contribute positively in the long term. Dynamic alpha strategies posted significantly negative returns in 2008 due to the overall long exposure in equities built up over the course of the year. Positive contributions came from the po- sitioning within equity markets. Currency strategy performed very strongly across all strategies for the year. Currency strat- egy had been quite aggressively positioned against the large exchange rate misevaluations that had resulted from the popularity of carry trades (borrowing in a lower yielding cur- rency to invest in a high yielding currency). The unwinding of carry trades in more risk-averse markets meant that this strategy paid off. In alternative and quantitative investments, hedge fund performance in 2008 reflected the unprecedented market dislocations and asset price destruction that occurred glob- ally. In the multi-manager business, the vast majority of funds of funds posted losses in absolute terms as most hedge fund strategies were affected by the extreme market conditions. Among the O’Connor single manager hedge funds, perfor- mance was mixed: multi-strategy alpha was negative (but out performed many peers), while fundamental long / short neutral and currency and rates strategies were notably posi- tive for the year. Overall, invested assets in the global real estate business declined moderately against a background of falling prop- erty values and investor risk aversion. Investment perfor- mance for some of our direct real estate funds subsequently came under pressure, notably in the UK and US. In contrast, funds in certain markets, notably Germany and Switzerland, achieved positive absolute returns. Global real estate securi- ties strategies suffered in absolute terms over the year but their long-term relative performance against benchmark be- gan to see some recovery. 2008 was a significant year for the infrastructure and pri- vate equity business. The core global direct investment infra- structure fund (the UBS International Infrastructure Fund) reached its final close in October, raising USD 1.52 billion. The underlying investments are performing well, benefiting from their defensive attributes and strong underlying cash flows from operating companies. The fund itself is delivering positive absolute returns. In contrast, global infrastructure securities strategies suffered negative performance for the year, in line with the wider equities markets. The launches of complementary, regionally-focused infrastructure and pri- vate equity fund initiatives were announced during 2008 with joint venture partners Abu Dhabi Investment Company and MerchantBridge respectively. 98 Business performance Business division reporting CHF million, except where indicated Institutional fees Wholesale intermediary fees Total operating income Cash components Share-based components 2 Total personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses Business division performance before tax Key performance indicators Cost / income ratio (%) 3 Institutional Invested assets (CHF billion) of which: money market funds Net new money (CHF billion) 4 of which: money market funds Gross margin on invested assets (bps) 5 Wholesale intermediary Invested assets (CHF billion) of which: money market funds Net new money (CHF billion) 4 of which: money market funds Gross margin on invested assets (bps) 5 Attributed equity and risk-weighted assets Average attributed equity (CHF billion) 6 Return on attributed equity (RoaE) (%) 7 BIS risk-weighted assets (CHF billion) 8 Return on BIS risk-weighted assets (%) 9 Goodwill and intangible assets (CHF billion) 10 Additional information Invested assets (CHF billion) Net new money (CHF billion) 4 Personnel (full-time equivalents) As of or for the year ended % change from 31.12.07 31.12.06 31.12.07 31.12.08 1,659 1 1,246 2,904 922 4 926 434 150 29 33 1,572 1,333 2,370 1,724 4,094 1,632 224 1,856 559 153 53 19 2,640 1,454 54.1 64.5 335 42 (55.6) 6.0 38 240 80 (47.4) 15.2 41 3.0 44.4 8.5 18.9 2.2 575 (103.0) 3,786 522 32 (16.3) 6.7 44 369 70 0.6 4.8 47 3.8 49.5 2.1 891 (15.7) 3,625 d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 1,803 1,417 3,220 1,305 270 1,575 399 (105) 27 4 1,900 1,320 59.0 519 28 29.8 11.0 38 347 59 7.4 (2.5) 43 2.7 62.5 1.7 866 37.2 3,436 (30) (28) (29) (44) (98) (50) (22) (2) (45) 74 (40) (8) (36) 31 (14) (35) 14 (13) (35) 4 1 Includes a gain of CHF 168 million on the sale of a minority stake in Adams Street Partners. 2 Includes social security contributions and expenses related to alternative investment awards. 3 Operating ex- penses / income. 4 Excludes interest and dividend income. 5 Operating income / average invested assets. 6 Refer to the “Capital management” section of this report for more information on the equity attribu- tion framework, which was implemented in 2008. 7 Business division performance before tax / average attributed equity. 8 BIS risk-weighted assets (RWA) are according to Basel II for 2008, and according to the Basel I framework for 2007 and 2006. 9 Business division performance before tax / average BIS RWA. 10 2007 and 2006 represent goodwill and intangible assets in excess of 4% of BIS tier 1 capital. 99 UBS business divisions and Corporate Center Global Asset Management 2008 Key performance indicators Net new money Net new money outflows were CHF 103.0 billion for full- year 2008, compared with outflows of CHF 15.7 billion for full-year 2007. Flows through UBS channels – namely the as- set management flows relating to Global Wealth Manage- ment & Business Banking clients – accounted for more than a third of these full year 2008 outflows and UBS reputation- al issues also impacted third-party flows. Outflows of institutional net new money were CHF 55.6 billion, up from CHF 16.3 billion. Excluding money market flows, outflows increased to CHF 61.6 billion from CHF 23.0 billion. Net outflows were reported in multi-asset, fixed in- come, equities and alternatives mandates. Outflows of wholesale intermediary net new money were CHF 47.4 billion, compared with an inflow of CHF 0.6 billion in 2007. Excluding money market flows, outflows of net new money increased to CHF 62.6 billion from CHF 4.2 billion. Out- flows were mainly reported in multi-asset, equities and fixed income funds. Invested assets Institutional invested assets were CHF 335 billion on 31 De- cember 2008, down from CHF 522 billion on 31 December 2007. This decrease reflects the negative impact of financial market developments, net new money outflows and curren- cy fluctuations. Wholesale intermediary invested assets were CHF 240 bil- lion on 31 December 2008, down from CHF 369 billion on 31 December 2007, reflecting the negative impact of finan- cial market developments and net new money outflows and, to a lesser extent, currency fluctuations. Gross margin The gross margin on institutional invested assets was 38 ba- sis points compared with 44 basis points in 2007. The de- cline in gross margin was mainly due to lower performance fees from alternative and quantitative investments and the Brazilian asset management business and to a negative as- set-mix effect from a higher proportion of money market funds to total invested assets. The gross margin on wholesale intermediary invested assets was down 6 basis points to 41 basis points, mainly due to lower performance fees from the Brazilian asset management business and a change in asset-mix to lower margin products. Cost / income ratio The cost / income ratio was 54.1% compared with 64.5% in 2007. This improvement was primarily due to the closure of Dillon Read Capital Management (DRCM) in 2007, the sale of 100 a minority stake in Adams Street Partners in 2008 and lower incentive compensation provisions combined with changes to the forfeiture provisions of future share-based awards. Results Pre-tax profit for full year 2008 was CHF 1,333 million, an 8% decrease from CHF 1,454 million in 2007. Excluding costs re- lated to the closure of DRCM in 2007 and the gain from the sale of the minority stake in Adams Street Partners in 2008, full-year pre-tax profit would have decreased CHF 501 million. Operating income Total operating income declined 29% to CHF 2,904 million from CHF 4,094 million, driven largely by a significant decline in equity market valuations and relative strengthening of the Swiss franc against the major currencies, especially the US dol- lar. Institutional revenues declined to CHF 1,659 million from CHF 2,370 million. Excluding the gain from the sale of the mi- nority stake in Adams Street Partners, institutional revenues would have declined CHF 879 million due to lower perfor- mance fees (from alternative and quantitative investments and the Brazilian asset management business) and lower manage- ment fees (from the lower average invested assets base). Wholesale intermediary revenues declined to CHF 1,246 million from CHF 1,724 million due to lower management fees (from the lower average invested assets base) and lower performance fees (from the Brazilian asset management business). Operating expenses Total operating expenses were CHF 1,572 in 2008, a 40% de- cline from CHF 2,640 million in 2007. Excluding CHF 212 mil- lion in DRCM restructuring costs in 2007, total operating ex- penses would have declined 35% or CHF 856 million. This decline mainly reflects reduced incentive based compensation accruals resulting from the lower revenues, the changes to the forfeiture provisions of future share-based awards, and the re- sults of the ongoing expenditure review, partly offset by the first time inclusion of the acquisition in France of the CCR Group and the full-year impact of the acquisition in Korea of 51% of Daehan Investment Trust Management Company Ltd. General and administrative expenses were CHF 434 million, down from CHF 559 million. The 22% decrease was due to lower provisions and lower travel and entertainment expenses, partly offset by higher IT costs, the inclusion of the acquisition in France and the full-year impact of the acquisition in Korea. Net charges from other business divisions were down slightly, decreasing by CHF 3 million to CHF 150 million. Depreciation of property and equipment at CHF 29 mil- lion was down by CHF 24 million. Excluding the impact of the DRCM restructuring costs in 2007, depreciation of prop- erty and equipment increased slightly. This was mainly due to the inclusion of the acquisition in France and the full-year impact of the acquisition in Korea. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 2007 Results Pre-tax profit increased to CHF 1,454 million from CHF 1,320 million in 2006, despite the CHF 212 million of DRCM-relat- ed closure costs in second quarter 2007. This charge partly offset the positive impacts of increased performance and management fees in all business areas and the inclusion of acquisitions in Brazil and Korea. Operating income Operating income was CHF 4,094 million, up 27% from CHF 3,220 million in 2006. Institutional revenues increased 31% to CHF 2,370 million from CHF 1,803 million in 2006. This was mainly due to higher management fees in all invest- ment areas, as well as the full-year impact of the Brazilian asset management business and the post-July impact of the Korean asset management business. These were partly off- set by higher provisions. Wholesale intermediary revenues rose 22% to CHF 1,724 million from CHF 1,417 million in 2006, reflecting higher management fees across all busi- nesses and higher performance fees, mainly from the Brazil- ian asset management business. Operating expenses A 39% increase, to CHF 2,640 million from CHF 1,900 mil- lion in 2006, primarily reflected DRCM-related closure ex- penses and increased staff levels. Personnel expenses were CHF 1,856 million, 18% above 2006, reflecting the closure of DRCM, higher staff levels as well as the inclusion of the Brazilian and Korean asset management business. General and administrative expenses increased 40% to CHF 559 mil- lion in 2007 from CHF 399 million in 2006. In addition to the DRCM closure expenses, general and administrative expens- es increased due to higher technology-related expenditure and the full-year impact of the inclusion of the Brazilian asset management business. Net charge-ins from other business units were CHF 153 million, primarily due to DRCM, com- pared with the net charge-outs to other business units of CHF 105 million a year earlier. Over the same period, depre- ciation increased by 96% to CHF 53 million, as a result of the DRCM closure. Key performance indicators Net new money Institutional net new money outflows were CHF 16.3 billion, compared with net inflows of CHF 29.8 billion in 2006. Out- flows in core / value equity mandates, and to a lesser extent in fixed income mandates, were partly offset by inflows into all other asset classes, particularly alternative and quantita- tive investments and money markets. Wholesale intermediary net new money inflows were CHF 0.6 billion, compared with inflows of CHF 7.4 billion for 2006. Inflows, mainly into multi-asset and money market funds, were partly offset by outflows from fixed income funds. Invested assets Institutional invested assets were CHF 522 billion at year end, up CHF 3 billion from 2006. The net increase was driv- en by the positive impact of financial market valuations and the inclusion of assets related to the acquisition in Korea in third quarter 2007, which were only partly offset by net new money outflows and negative currency translation impacts. Wholesale intermediary invested assets were CHF 369 billion on 31 December 2007, up CHF 22 billion from 31 December 2006. This increase was primarily due to positive financial markets valuation impacts and the inclusion of as- sets related to the acquisition of UBS Hana Asset Manage- ment in third quarter 2007, partly offset by negative cur- rency translation impacts. Gross margin The gross margin on institutional invested assets was 44 basis points, up six basis points from 2006. The increase was due to higher performance fees, mainly in alternative and quantitative investments, as well as inflows into higher mar- gin products. The gross margin on wholesale intermediary invested assets was 47 basis points, up four basis points from 2006, largely driven by higher performance fees (mainly in the Bra- zilian asset management business) as well as inflows into higher margin products. Cost / income ratio The cost / income ratio was 64.5%, an increase of 5.5 per- centage points from 2006, primarily due to the CHF 212 million charge related to the closure of DRCM in second quarter 2007. 101 UBS business divisions and Corporate Center Investment Bank Investment Bank Business description UBS is a leading investment banking and securities firm, delivering comprehensive advice and execution to clients across the world’s capital markets. Business The Investment Bank provides a broad range of products and services to corporate and institutional clients, govern- ments, financial intermediaries and alternative asset man- agers. The needs of private investors are met indirectly through working with UBS’s wealth management business- es and other private banks. Strategy The current crisis in the financial markets and the resulting dramatic changes in industry dynamics, and the losses in- curred in 2007 and 2008, require the Investment Bank to recalibrate its business in order to generate profitable and sustainable growth. A number of senior leadership changes took place within the Investment Bank in 2008: Jerker Johansson joined UBS as Chairman and Chief Executive of the Investment Bank in March 2008, Carsten Kengeter and Jeffrey Mayer were appointed co-heads of the fixed in- come, currencies and commodities (FICC) business area and Tom Daula was appointed Chief Risk Officer to oversee credit risk and market risk on a combined basis as well as operational risk. The Chairman and CEO of the Investment Bank, mem- bers of the Group Executive Board and the UBS Board of Directors have concluded a detailed strategic review. Based on this, the Investment Bank is implementing a comprehen- sive repositioning plan focused on client-driven growth, a simplified organizational structure and a de-levered and de- risked balance sheet. The FICC business area has signifi- cantly restructured to concentrate on client service, simplify its operating model, strengthen risk management and fo- cus on competitive strengths, including foreign exchange and flow businesses in credit and rates. The municipal secu- rities business and fixed income proprietary trading busi- nesses have been closed and certain commodities business- es have been sold. Real estate and securitization businesses and complex structured products have been substantially or downsized or exited. Equities will continue to leverage its global distribution platform and product expertise, while seeking further effi- ciency gains. The investment banking department will con- tinue to provide corporate and institutional clients with advi- sory services while leveraging its capital markets knowledge to both deepen long-term client relationships and gain mar- ket share. These steps will require more efficient utilization of re- sources and a continued emphasis on cost containment and workforce productivity, and will bring costs down to a more sustainable level. They are occurring in conjunction with an aggressive effort to reduce the size of the balance sheet. In addition, a new market-based funding model and robust risk framework have been implemented. However, implementa- tion of this strategy is inextricably linked to the talent and expertise within the firm. The Investment Bank will therefore continue to attract, develop and retain the best people and foster a collaborative and meritocratic culture. Announced headcount reductions have and will come predominantly from the businesses being exited or downsized. Organizational structure The Investment Bank is headquartered in London and employs approximately 17,000 people across 38 countries. It has three distinct business areas which are run functionally on a global basis: equities, FICC and the investment banking department. The investment banking department is an industry leader and provides advice on cross-border mergers and acquisitions in ad- dition to raising capital for companies and governments. Tradi- tionally one of the leaders in European corporate finance, the Investment Bank has built strong franchises in the US and Asia Pacific in recent years. An important partner for institutional clients, the Investment Bank’s market-leading equities business is complemented by its top-tier foreign exchange business and broad product capabilities across fixed income markets. Although the Investment Bank pursues a strategy of organ- ic development, its presence has been enhanced through ac- quisitions. Key acquisitions over the past three years include: – the September 2006 acquisition of the global futures and options business of ABN AMRO, which positioned UBS as a market leader in futures and options as well as a global provider of execution and clearing services. – the December 2006 acquisition of the Brazilian financial services firm Banco Pactual, which placed the Investment Bank as a leader in its field in the Brazilian market. – the April 2007 acquisition of a 20% stake in UBS Securi- ties, China. 102 Legal structure The Investment Bank operates through branches and subsid- iaries of UBS AG. Securities activities in the US are conducted through UBS Securities LLC, a registered broker-dealer. Competitors The competitive landscape changed significantly in 2008. Mar- ket dislocation led UBS and its competitors to take significant steps to strengthen their balance sheets, reduce costs and maintain client confidence. Some governments and investors also took significant stakes in select financial institutions in 2008. The Investment Bank competes against other major in- ternational players such as Bank of America / Merrill Lynch, Cit- igroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Mor- gan Chase and Morgan Stanley. Products and services Equities A leading participant in the global primary and secondary markets for equity, equity-linked and equity derivative prod- ucts, the equities business area distributes, trades, finances and clears cash equity and equity-linked products. It also structures, originates and distributes new equity and equity- linked issues and provides research on companies, industry sectors, geographical markets and macroeconomic trends. A focus on technology has led to significant improvements in business processes and client services. Investments have been made in direct market access, prime brokerage and cli- ent relationship platforms, earning UBS recognition as a market leader in the provision of a number of electronic ser- vices to clients. The business area also has a global footprint with a strong presence in many local markets. Business lines of the equities business and their functions are listed below: – Cash equities provides clients with expert advisory and execution offerings with top-tier research, corporate ac- cess and tailored investment ideas. With market-leading trading execution for single stock and portfolio trading, UBS provides capital commitment, full service and block trading, advanced electronic trading strategies and tools, state-of-the-art analytics and value-enhancing commis- sion management services. – Derivatives provides standardized products and custom- ized investment solutions to clients. In addition to prod- ucts with returns linked to equities or equity indices, it also offers derivative products linked to hedge funds, mu- tual funds, real estate and commodity indices in a variety of formats such as over-the-counter, securitized, fund- wrapped and exchange-traded. – Prime services provides integrated global services, including securities borrowing and lending, equity swaps execu- d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C Selected deals Mergers and acquisitions (M&A) Joint financial advisor, bookrunner and sponsor to Lloyds TSB Group Plc on its GBP 14.7 billion acquisition of HBOS Plc and GBP 5.5 billion capital raising Lead financial advisor, joint lead arranger and joint bookrunner to Gas Natural SDG, S.A. on its EUR 16.8 billion cash offer for Union Fenosa S.A. Lead financial advisor to Eli Lilly and Company on its USD 6.5 billion acquisition of Imclone Systems Inc. Sole financial advisor to St. George Bank Limited on its AUD 18.6 billion merger with Westpac Banking Corporation Equity capital markets Advisor and joint bookrunner on the USD 19.7 billion initial public offering (IPO) of Visa Inc. This was a landmark transaction representing the largest IPO in US history, and the second largest IPO worldwide after the USD 21.9 billion IPO for Industrial & Commercial Bank of China in 2006 Joint bookrunner on the GBP 2.2 billion rights issue for Centrica Plc, the second-largest UK equity issue in 2008 outside the financial sector Joint lead manager and joint underwriter for the fully underwritten AUD 2.6 billion entitlement offer for Wesfarmers Limited Debt capital markets Joint bookrunner on a USD 2.5 billion issue for Wells Fargo & Co, its first institutional fixed income hybrid offering since November 2006 Joint bookrunner for China Merchants Bank Co Ltd. on its USD 4.4 billion domestic lower tier 2 bond, the largest bank capital deal in Asia Pacific since 2005 and voted the Best Local Currency Bond by FinanceAsia in 2008 Joint bookrunner on a EUR 5 billion benchmark issue for KFW, the promotional bank of the Federal Republic of Germany, its first euro benchmark transaction in 2008 Joint lead arranger and joint bookrunner to Verizon Wireless on a USD 17.0 billion bridge facility to finance the acquisition of Alltel Corp. Selected awards Investment Bank No. 1 M&A Financial Advisor (ECM roles) – Thomson Reuters 2008 Corporate Broker of the Year – Acquisitions Monthly 2009 Equities Asia Pacific Equity House of the Year – International Financial Review 2003, 2005–2008 No. 1 European Equity Research Firm – Institutional Investor 2002–2009 Fixed income currencies and commodities Financial Bond House of the Year – International Financial Review 2008 No. 2 Foreign Exchange House – Euromoney 2008 103 UBS business divisions and Corporate Center Investment Bank tion, multi-asset-class prime brokerage and multi-asset- class exchange-traded derivatives execution and clearing. These services are provided to an expanding list of hedge funds, banks, asset management and commodity trading clients. – Equity research provides independent assessments of the prospects for over 3,400 companies across most industry sectors and geographical regions (corresponding to 82% of world market capitalization), as well as economic, stra- tegic and quantitative research. Fixed income, currencies and commodities The FICC business area delivers products and solutions to cor- porate, institutional and public sector clients in all major mar- kets. In response to changes in global markets and client de- mand, FICC significantly restructured at the start of 2009 to improve client service, simplify its operating model, strength- en risk management and focus on competitive strengths. The real estate and securitization business will be exited (with the exception of pass-through trading, which is now part of mac- ro, described below); certain commodities businesses (ex- cluding precious metals) have been sold, and the structured products business significantly downsized. In December 2008, a significant proportion of FICC risk positions were transferred to a fund owned and controlled by the Swiss Na- tional Bank (SNB), and further positions are planned to be transfered in March 2009. Refer to the “Transaction with the Swiss National Bank” sidebar in the “Strategy and structure” section of this report for more information on this transac- tion. In first quarter 2009 additional risk positions will be iso- lated in a specialist group whose mandate is to maximize value while conducting an orderly exit of positions. The business lines of the FICC business and their func- tions are listed below: – Macro consists of foreign exchange, money market and interest rate risk management activities. It provides a range of foreign exchange, treasury and liquidity man- agement solutions to institutional and private clients. In- terest rate activities include standardized rate-driven products and services such as interest rate derivatives trading, underwriting and trading of government and agency securities. – Credit is active in the origination, underwriting, and distri- bution of primary cash and synthetic credit transactions. It is also active in secondary trading and market-making in high yield and investment grade bonds and loans in both cash and derivative products. – Emerging markets has local market presence in Latin America through UBS Pactual, as well as in Asia and Cen- Foreign exchange: Euromoney-eligible volumes1 Cash, CCT swap, derivatives, PB rolls 2001 2002 2003 2004 2005 2006 2007 2008 40 32 24 16 8 0 15.8 32.0 32.6 14.9 11.0 11.5 12.4 12.5 11.9 22.0 16.1 13.3 9.8 3.6 4.9 5.4 Volume (USD trillion) Euromoney FX-poll market share (in %) 1 Eligible volumes not equal to reported UBS volumes. 20 16 12 8 4 0 tral and Eastern Europe, enabling it to offer local investors access to international markets and international inves- tors an opportunity for local exposure. – Client services is the global sales effort, unifying product specialist sales groups, including foreign exchange, mon- ey market, rates and emerging markets products. – Quantitative analysis provides tailored solutions for clients as well as more broadly scalable solutions for the FICC flow platforms. – Research provides investors with analysis across a selected range of issuers, products, markets and industries. Investment banking The investment banking department provides advice and a range of execution services to corporate clients, financial in- stitutions, financial sponsors, sovereign wealth funds and hedge funds. Its advisory group assists on complex transac- tions and advises on strategic reviews and corporate restruc- turing solutions, while UBS’s capital markets and leveraged finance teams arrange the execution of primary and second- ary equity, as well as investment grade and non-investment grade debt issues worldwide. With a presence in all major financial markets, coverage is based on a comprehensive ma- trix of country, sector and product banking professionals. With the goal of creating a fully integrated primary busi- ness to drive revenue growth and realize productivity gains, the global groups for equity capital markets and debt capital markets have been combined. The initial focus is on product knowledge sharing, to enable teams to provide holistic advice and innovative solutions across the entire capital structure. 104 SRBG009_e 20 15 10 5 0 40 30 20 10 0 Business performance Business division reporting CHF million, except where indicated Investment banking Advisory Capital market revenues equities fixed income, currencies and commodities Other fee income and risk management Sales and trading Equities Fixed income, currencies and commodities Total Investment Bank income Credit loss (expense) / recovery 1 Total Investment Bank operating income excluding own credit Own credit 2 Total Investment Bank operating income as reported Cash components Share-based components 3 Total personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Impairment of goodwill Amortization of intangible assets Total operating expenses Business division performance before tax Key perfomance indicators Compensation ratio (%) 4 Cost / income ratio (%) 6 Impaired lending portfolio as a % of total lending portfolio, gross Average VaR (10-day, 99% confidence, 5 years of historical data) 7 Attributed equity and risk-weighted assets Average attributed equity (CHF billion) 8 Return on attributed equity (RoaE) (%) 9 BIS risk-weighted assets (CHF billion) 10 Return on BIS risk-weighted assets (%) 11 Goodwill and intangible assets (CHF billion) 12 Additional information Personnel (full-time equivalents) d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C As of or for the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 (57) (40) (57) (65) (41) (78) (241) (42) (89) (868) 208 (42) (57) 0 22 10 (52) (37) (106) (27) 2,880 1,609 1,844 977 866 (573) (26,712) 5,184 (31,895) (23,832) (2,575) (26,407) 2,032 (24,375) 5,173 (292) 4,882 3,399 990 231 341 83 6,636 2,697 4,261 2,783 1,478 (322) (7,833) 9,004 (16,837) (1,197) (266) (1,463) 659 (804) 8,902 2,384 11,286 3,386 811 210 0 172 9,925 (34,300) 15,865 (16,669) N/A 5 N/A5 3.6 374 26.8 (128.2) 195.8 (15.8) 4.6 N/A 5 N/A 5 0.4 514 190.7 (8.7) 5.3 4,999 1,821 3,631 2,095 1,536 (453) 16,727 8,387 8,340 21,726 47 21,773 0 21,773 9,788 1,898 11,686 3,210 1,034 203 0 72 16,205 5,568 53.8 74.6 0.1 410 174.6 3.5 5.5 17,171 21,779 21,733 (21) 1 2008 includes CHF 1,329 million in credit losses from impairment charges on reclassified financial instruments. 2 Represents own credit changes of financial liabilities designated at fair value through profit or loss. The cumulative own credit gain for such debt held at 31 December 2008 amounts to CHF 2,953 million. This gain has reduced the fair value of financial liabilities designated at fair value through profit or loss recognized on UBS’s balance sheet. Refer to “Note 27 Fair value of financial instruments” in the financial statements of this report for more information. 3 Includes social secu- rity contributions and expenses related to alternative investment awards. 4 Personnel expenses / income. 5 Neither the cost / income nor the compensation ratio are meaningful due to negative rev- enues recorded in the Investment Bank. 6 Operating expenses / income. 7 Regulatory Value at Risk. In third quarter 2008, UBS changed from internal management VaR to regulatory VaR as the basis for external disclosure. Refer to the “Value at Risk developments – treatment of CVA” sidebar in the “Market risk” section of this report for more information about this change. 8 Refer to the “Capital management” section of this report for more information on the equity attribution framework, which was implemented in 2008. 9 Business division performance before tax / average attributed equi- ty. 10 BIS risk-weighted assets (RWA) are according to Basel II for 2008, and according to the Basel I framework for 2007 and 2006. 11 Business division performance before tax / average BIS RWA. 12 2007 and 2006 represent goodwill and intangible assets in excess of 4% of BIS tier 1 capital. 105 UBS business divisions and Corporate Center Investment Bank 2008 Key performance indicators As in 2007, neither the cost / income ratio nor the compen- sation ratio were meaningful in 2008 due to negative total operating income. Average regulatory Value at Risk (VaR) (10-day, 99% con- fidence, five years of historical data) decreased to CHF 374 million, down from CHF 514 million in 2007. Year-end regu- latory VaR was also lower at CHF 485 million, compared with CHF 552 million the previous year. Refer to the “Market risk” section of this report for more information on the Invest- ment Bank’s VaR. The Investment Bank’s gross lending portfolio was CHF 169 billion, up from CHF 148 billion on 31 December 2007. The ratio of the impaired gross lending portfolio to the total gross lending portfolio was 3.6% at the end of 2008, up from 0.4% at the end of 2007. Following the reclassification of certain as- sets in fourth quarter 2008, impairment charges related to these assets have been reflected in credit loss as opposed to trading, contributing to this increase. Refer to the “Credit risk” section of this report for more information on the Investment Bank’s lending portfolio and “Note 29 Measurement catego- ries of financial assets and financial liabilities” in the financial statements of this report for more information on the reclas- sification of certain assets in fourth quarter 2008. Results In 2008, the Investment Bank recorded a pre-tax loss of CHF 34,300 million compared with a pre-tax loss of CHF 16,669 million in 2007, primarily due to the losses on risk positions within the fixed income, currencies and commodities (FICC) area. For full-year 2008, equities and investment banking revenues were down from a record year in 2007. A credit loss expense of CHF 2,575 million was recorded in 2008, mainly due to impairment charges taken on reclassified financial assets, as mentioned above, compared with CHF 266 million in 2007. In 2008, the Investment Bank recorded a gain on own credit from financial liabilities designated at fair value of CHF 2,032 million, resulting from the widening of UBS’s credit spread, which was partly offset by the effects of redemptions and repurchases of such liabilities. Refer to “Note 27 Fair value of financial instruments” in the financial statements of this report for more information. Operating expenses for the Investment Bank in 2008 decreased sig- nificantly from 2007, mainly reflecting lower performance- related compensation. Operating income Total operating income in 2008 was negative CHF 24,375 million, down from negative CHF 804 million a year earlier. 106 Equities Revenues, at CHF 5,184 million in 2008, were down 42% from CHF 9,004 million in 2007. 2008 was a demanding year for equities with continued difficult market conditions impacting overall business performance. Cash equity reve- nues were marginally lower as declines in revenues across Asia Pacific and Europe were only partially offset by growth in the US. Derivatives revenues were down as market vola- tility, depressed client volumes, lack of liquidity and highly correlated markets impacted performance across all re- gions, particularly in the fourth quarter. Equity linked reve- nues were down, with most regions impacted by declines in valuations, falling equity markets and reduced liquidity. Prime brokerage services had a solid performance, but rev- enues were down overall as a strong first half performance was offset by deterioration in the second half. Exchange- traded derivatives revenues increased, as it benefited from strong first and fourth quarters driven by significant volatil- ity in the market. Proprietary trading revenues were nega- tive for the year, reflecting the significant change in market conditions. Fixed income, currencies and commodities Revenues were negative CHF 31,895 million, down from negative CHF 16,837 million a year earlier. Consequences of the global market crisis, including forced liquidations, gov- ernment bail-outs and consolidation in the banking sector, negatively affected the majority of the FICC businesses in 2008. Credit recorded losses in both client and proprietary trading as a result of the significant turbulence in the mar- kets and subsequent severe lack of liquidity. The negative emerging markets result was driven by losses in Asia Pacific. These negative effects were only partially offset by positive results in certain areas. Rates experienced a solid year, driven by derivatives and government bonds in Europe and rates de- rivatives in both Asia Pacific and the US. Foreign exchange and money markets produced a strong year as it capitalized on volatile markets and strong client flows. The short-term inter- est rate business benefited from market movements to gener- ate an exceptional result in 2008. The foreign exchange distri- bution business posted very good results across all regions, benefiting from strong client flows seeking to access liquidity in the market. Structured products posted positive revenues due to strong client interest in structured funding solutions. Investment banking Revenues of the investment banking department, at CHF 2,880 million in 2008, decreased 57% from CHF 6,636 mil- lion the previous year. Market activity slowed significantly during the year, resulting in reduced advisory revenues across all regions. Market volatility in both equity and debt markets led to lower capital markets revenues. According to data from Dealogic, UBS ended 2008 with a 5.6% market share of the global fee pool compared to 5.8% in 2007. However, UBS improved its rank from sixth in 2007 to fifth in 2008. cy costs due to real estate restructuring, and by legal provi- sions. Operating expenses Operating expenses declined by CHF 5,940 million to CHF 9,925 million in 2008, a 37% decrease from CHF 15,865 million the previous year. Personnel expenses, at CHF 4,882 million in 2008, de- creased 57% from a year earlier, driven by significantly lower performance-related compensation and lower salary costs, only partly offset by restructuring charges. Share-based com- pensation was down significantly from 2007, mainly due to lower performance-related compensation. Full-year results for 2007 included accruals for share-based compensation during the year. These are not reflected in full-year 2008 as, starting in 2009, they will be amortized over the vesting pe- riod of these awards. Charges from other business units increased to CHF 990 million in 2008 from CHF 811 million in 2007. The increase reflects the cessation of a private equity performance fee received in 2007, an IT data center restructuring fee and in- creased allocations from Global Wealth Management & Business Banking reflecting higher operating volumes. Depreciation rose 10%, to CHF 231 million in 2008 from CHF 210 million in 2007, as the real-estate restructuring charges mentioned above resulted in additional depreciation costs. Amortization of intangible assets, at CHF 83 million in 2008, was down from CHF 172 million a year earlier. A goodwill impairment charge of CHF 341 million relating to the exiting of the municipal securities business by the Invest- ment Bank was recognized in second quarter 2008. There was no goodwill impairment charge for full-year 2007. General and administrative expenses increased slightly to CHF 3,399 million in 2008 from CHF 3,386 million in 2007. Reductions in travel and entertainment and IT and other out- sourcing costs were more than offset by increases in occupan- Included in the 2008 expenses mentioned above is a re- structuring charge of CHF 737 million recorded in fourth quarter, consisting of CHF 435 million of personnel expenses and CHF 302 million of costs related to real estate. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 107 UBS business divisions and Corporate Center Investment Bank 2007 Key performance indicators Neither the cost / income ratio nor the compensation ratio was meaningful in 2007 due to negative total operating in- come. In 2006, the cost / income ratio was 74.6% and the compensation ratio 53.8%. Average regulatory Value at Risk (VaR) (10-day, 99% con- fidence, 5 years of historical data) increased to CHF 514 mil- lion, up from CHF 410 million in 2006. Year-end regulatory VaR was also higher at CHF 552 million, up from CHF 465 million the previous year. These increases reflect the signifi- cant pick-up in market volatility in the second half of 2007. Refer to the “Market risk” section of this report for more information on the Investment Bank’s VaR. The Investment Bank’s gross lending portfolio was CHF 148 billion, up from CHF 120 billion on 31 December 2006, reflecting the expanding prime brokerage and exchange- traded derivatives businesses. The gross impaired lending portfolio to total gross lending portfolio ratio rose to 0.4% in 2007 from 0.1% in 2006. Results In 2007 the Investment Bank recorded a pre-tax loss of CHF 16,669 million compared with a profit of CHF 5,568 million in 2006, primarily due to losses recorded on positions related to the US residential real estate market which more than offset the solid performance in other areas. For full-year 2007, equities posted record results with very strong cash commissions, derivatives and prime services rev- enues. The investment banking department also had a re- cord year in 2007, with all geographical regions showing double-digit growth. Operating expenses for the Investment Bank decreased from 2006, mainly reflecting lower perfor- mance-related bonus accruals and a change in the composi- tion of bonus between cash and shares. This was partially offset by higher salary and general and administrative costs, driven by increased average staff levels over the year. Operating income Total operating income in 2007 was negative CHF 804 mil- lion, down from positive CHF 21,773 million a year earlier. This change was driven by losses recorded on positions re- lated to the US residential real estate market. Operating income by segment Investment banking Revenues of the investment banking department, at CHF 6,636 million in 2007, increased 33% from CHF 4,999 million the previous year. This reflected growth in each geographical 108 region, especially in the Americas. While the advisory and eq- uity capital markets businesses reported significant gains over the prior year (up 48% and 33% respectively), the debt capital markets business declined 4% as it was impacted by challeng- ing markets in the second half of 2007. Sales and trading Revenues declined to negative CHF 7,833 million from posi- tive CHF 16,727 million, driven by negative revenues of CHF 16,837 in FICC that were only partly offset by a positive rev- enue contribution of CHF 9,004 from Equities. Equities Equities revenues, at CHF 9,004 million in 2007, were up 7% from CHF 8,387 million in 2006. Overall, cash equity reve- nues were higher, with strong volumes leading to record commissions, partially offset by greater client facilitation costs. Despite a slowdown in the second half of 2007, the derivatives business posted its highest ever results following strong growth in Asia Pacific and Europe, Middle East and Africa. The exchange-traded derivatives business rose as it benefited from a full year of ABN AMRO’s futures and op- tions revenues (ABN AMRO’s futures and options business was acquired on 30 September 2006). Prime brokerage ser- vices continued to grow as client numbers and balances in- creased. Equities proprietary trading revenues sharply de- clined compared to the prior year, related to the credit market dislocation in the US. The equity linked businesses also con- tributed lower returns compared to 2006. Fixed income, currencies and commodities FICC revenues were negative CHF 16,837 million, down from positive CHF 8,340 million a year earlier. The credit market dislocation affected most of the FICC businesses in the second half of 2007, leading to losses on mortgage-re- lated positions. Credit recorded losses in both client and pro- prietary trading in the context of extreme market disruption and low liquidity at the end of 2007. Structured products revenues were down compared to the previous year, largely driven by the negative impact of the credit dislocation. Com- modities revenues declined due to lower volumes and vola- tility, especially affecting power and gas and to a lesser ex- tent precious metals. These negative effects were only partially offset by posi- tive results in other areas. The emerging markets business result was up as full-year revenues from Banco Pactual were included. Positive results were also driven by the demutual- ization and mark-to-market gains on the stake in the Brazil Mercantile & Futures Exchange. The underlying foreign ex- change spot business saw strong increases due to higher vol- umes. The foreign exchange distribution business also post- ed very good results, stemming from all geographical regions. The rates business was up, driven by higher results in Euro- pean derivatives. Operating expenses Operating expenses declined by CHF 340 million to CHF 15,865 million in 2007, a 2% decrease from CHF 16,205 million the previous year. Personnel expenses, at CHF 11,286 million in 2007, de- creased 3% from a year earlier, reflecting lower performance- related compensation and a change in the composition of bonuses between cash and shares. This was partially offset by higher salary costs due to internal growth and acquisitions. In addition, severance payments were made for redundancies towards the end of the year. Share-based compensation was up significantly from 2006, mainly reflecting a change in the forfeiture rules of certain share-based awards. General and administrative expenses were CHF 3,386 million in 2007, up 5% from CHF 3,210 million in 2006. Professional fees were up due to higher legal-related expen- ditures in all businesses. Occupancy costs in the Americas and Asia Pacific, rent and maintenance of machines and equipment and IT and other outsourcing costs rose due to higher staff levels. Administration expenditures rose as well. This was partially offset by lower provisions compared to 2006. Charges from other business units decreased to CHF 811 million in 2007 from CHF 1,034 million in 2006. The decline reflected lower charges by Global Asset Manage- ment for management of the Investment Bank’s funds in- vested in Dillon Read Capital Management (DRCM), which were reintegrated into the Investment Bank in May 2007, and as a result of a 2007 performance-related credit from Industrial Holdings. Depreciation rose slightly, by 3%, to CHF 210 million in 2007 from CHF 203 million in 2006. This was due to addi- tional office space in the Americas and Europe. The amorti- zation of intangible assets, at CHF 172 million in 2007, was up 139% from CHF 72 million a year earlier due to the two acquisitions – Banco Pactual and ABN AMRO’s futures and options business. There was no goodwill impairment charge for either full-year 2007 or 2006. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 109 UBS business divisions and Corporate Center Corporate Center Corporate Center Description The Corporate Center partners with the business divisions to ensure that UBS operates as an effective and agile firm, responding effectively to trends in the financial industry according to a common vision and set of values. Aims and objectives The Corporate Center assists UBS in managing its businesses through provision of Group-level control in the areas of fi- nance, risk, legal and compliance. It strives to maintain an appropriate balance between risk and return in the firm’s businesses while establishing and controlling UBS’s corpo- rate governance processes, including compliance with rele- vant regulations. Each functional head in the Corporate Center has authority across UBS’s businesses for his or her area of responsibility, including the authority to issue Group- wide policies for that area, and is directly reported to by his or her business division counterpart. The Corporate Center is responsible for the following ac- tivities in UBS: financial, tax and capital management; risk control, legal and compliance activities; communicating with all UBS stakeholders; branding; and positioning the firm as an employer of choice. In addition, the Corporate Center also assumes operational responsibility for certain business units that provide shared services to the business divisions – among them the information technology infrastructure and offshoring units (including the service centers in India and Poland). Organizational structure The Corporate Center consists of operational functions plus the information technology infrastructure and Group offshoring units. It is led by the Chief Operating Officer (COO) of the Corporate Center and its operational func- tions are managed by the Corporate Center executive com- mittee. Chief Operating Officer of the Corporate Center The COO of the Corporate Center is responsible for its busi- ness planning and forecasting, as well as its human resourc- es core processes. The holder of this position is responsible for information technology infrastructure, group offshoring activities and the corporate real estate portfolio for UBS’s own use. Group Chief Financial Officer The Group Chief Financial Officer (Group CFO) is responsi- ble for ensuring transparency within the reporting of finan- cial results for both the Group and its businesses. The role also entails responsibility for the Group’s financial report- ing, planning, forecasting and controlling processes, as well as the provision of advice on financial aspects of stra- tegic plans and mergers and acquisitions transactions. Fur- ther responsibilities include overseeing UBS’s tax and trea- sury functions. In coordination with the Group General Counsel, the Group CFO defines the standards for account- ing, reporting and disclosure and, together with the Chief Executive Officer, provides external certifications under sec- tions 302 and 404 of the US Sarbanes-Oxley Act of 2002. These duties are in addition to managing relations with in- vestors and coordination of working relationships with in- ternal and external auditors. Group Chief Risk Officer The Group Chief Risk Officer (Group CRO) is responsible for the development and implementation of UBS’s risk manage- ment and control principles, including the development of appropriate control frameworks for market, credit and op- erational risks throughout the Group. The Group and busi- ness division risk functions work together to manage the fol- lowing: formulating and implementing risk policies and control processes; developing risk quantification methods; monitoring associated limits and controls; ensuring that risks are completely and consistently recorded and aggregated; and ensuring that exposures are continuously monitored, controlled and remain within approved risk profiles. Each risk officer exercises specific risk control authorities. Group General Counsel The Group General Counsel, supported by the head of Group Compliance, has Group-wide responsibility for legal and com- pliance matters and for legal and compliance policies and pro- cesses. The position is responsible for defining the strategy, goals and organizational structure of the legal function, in ad- dition to setting and monitoring the Group-wide quality stan- dards for handling the legal affairs of the Group. Supported by the head of Group Compliance, the Group General Coun- sel is responsible for ensuring that UBS meets relevant regula- tory and professional standards in the conduct of its business. Other responsibilities include supervision of the General Coun- sels of the business divisions and working closely with the Group CRO with regard to the operational risk aspects of legal 110 d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C and liability risk. Furthermore, the Group General Counsel represents UBS’s interests to policy-makers and, in close coop- eration with the Group CRO and Group CFO as appropriate, establishes Group-wide management and control processes for the Group’s relationship with regulators. Group Treasurer The Group Treasurer is responsible for the management of UBS’s financial resources and financial infrastructure. The position is responsible for Group-level governance of trea- sury processes and transactions relating to UBS’s corporate legal structure, regulatory capital, balance sheet, funding and liquidity, and non-trading currency and interest rate risk. Additional responsibilities include the issuance of poli- cies to ensure proper management and efficient co-ordina- tion of treasury processes on a Group-wide basis. The Group Treasurer manages the Group’s equity, taking into account financial ratios and regulatory capital requirements, with a view to maintaining strategic flexibility and adequate capi- talization and ratings levels. The position manages UBS’s holdings of its own shares and recommends corporate ac- tions to the Group Executive Board (GEB) and the Board of Directors (BoD). Head of Group Controlling & Accounting The Head of Group Controlling & Accounting has UBS-wide responsibility for financial control. The position is responsible for the production and analysis of accurate and objective reg- ulatory, financial and management accounts and reports. The Head of Group Controlling & Accounting communicates rel- evant financial and regulatory information to the BoD, the GEB, the audit committee, internal and external auditors and the CFOs of the business divisions. The position is also re- sponsible for operating the UBS-wide quarterly and annual SOX 302-certification process and supports the Group CFO in the Group’s planning and forecasting process. Head of Group Tax The Head of Group Tax is responsible for managing the bank’s corporate income tax affairs, in such a manner that UBS achieves sustainable tax efficiency whilst acting in com- pliance with all applicable tax laws, regulations and other requirements. Group Tax also provides tax advice to the busi- ness divisions in relation to their business activities, and acts as a control function in the review of new business initiatives and transactions requiring pre-approval. Head of Group Accounting Policy The Head of Group Accounting Policy establishes Group- wide financial accounting policies and supports the business divisions and the Corporate Center in their responsibility to implement and enforce the Group accounting policy frame- work. The position manages relations with external auditors and accounting standards bodies. Chief Communication Officer The Chief Communication Officer is responsible for manag- ing UBS’s communications with its various stakeholders. An- other key responsibility is the development of the strategy, content and positioning of communications of corporate im- portance, emphasizing transparency, consistency, speed and integrity. The Chief Communication Officer presents UBS and its businesses to the media, enhancing and protecting the firm’s reputation. To employees, the position promotes understanding of the firm’s strategies, performance and cul- ture. The Chief Communication Officer also coordinates UBS’s approach to corporate responsibility. Head of Group Strategic Advisory & Financial Communication The Head of Group Strategic Advisory & Financial Communi- cation provides independent advice to the GEB (collectively and individually) and the BoD on strategic matters and sup- ports the business divisions in the execution of their strate- gies. The position coordinates cross-business division strate- gic initiatives, drives the implementation of challenging Group strategic targets and measures progress towards goals. Additionally, it monitors the competitive environment and assesses the impact of opportunities and threats on Group strategy. The Head of Group Strategic Advisory & Fi- nancial Communication also communicates with investors, analysts and rating agencies about developments at UBS and is responsible for preparing and publishing quarterly and an- nual reports. Group Head Human Resources The Group Head Human Resources has Group-wide re- sponsibility for the management of human resources, the development of the relevant human capital strategies as well as the governance over their effective implementa- tion. This includes shaping a meritocratic culture of ambi- tion and performance, building UBS’s capacity to attract and retain high-quality, diverse and mobile talent, as well as creating an attractive and flexible work environment. The position is ultimately and directly responsible for the management of talent and development of leadership within UBS’s senior management group. Additionally, Group Human Resources is mandated to design, develop and administer global compensation programs, to oversee regional and local benefit strategies, and to establish in- novative and competitive incentive frameworks on a firm- wide basis. Chief Technology Officer The Chief Technology Officer is the head of the informa- tion technology infrastructure unit (ITI). This unit encom- passes all information technology infrastructure teams across UBS, covering management of data networks, tele- phone and other communications systems, IT security, dis- 111 UBS business divisions and Corporate Center Corporate Center tributed computing and servers, mainframes and data cen- ters, market data services, user services and desktop computing. The unit focuses on serving all UBS’s business- es in a client-driven and cost-efficient way, as well as build- ing towards a consistent technical architecture across UBS through the execution of the information technology in- frastructure strategy. Head of Group Offshoring The Head of Group Offshoring is responsible for delivering offshoring services to the business divisions at appropriate and competitive prices. The service centers, which are operated by UBS staff in India and Poland, ensure that phys- ical and technical features meet UBS risk and quality stan- dards and comply with the operational risk framework. 112 Results Corporate Center reporting CHF million, except where indicated Total operating income Cash components Share-based components 1 Total personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses 2 Performance from continuing operations before tax Performance from discontinued operations before tax Performance before tax Contributions from private equity / Industrial Holdings Total operating income Total operating expenses Operating profit from continuing operations before tax Profit from discontinued operations before tax Additional information BIS risk-weighted assets (CHF billion) 3 Personnel (full-time equivalents) 4 Personnel for the Operational Corporate Center (full-time equivalents) Personnel for ITI 5 (full-time equivalents) Personnel for Group Offshoring (full-time equivalents) d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C As of or for the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 998 1,069 7 1,076 1,299 (2,066) 720 0 1,029 (31) 198 167 22 54 (32) 155 8.8 7,285 1,572 4,066 1,646 3,562 1,244 121 1,365 1,306 (2,070) 739 0 1,340 2,222 145 2,367 689 163 526 138 10.2 6,913 1,622 4,343 948 607 1,179 140 1,319 1,255 (1,969) 782 9 1,396 (789) 888 99 313 67 246 884 11.5 4,771 1,452 3,055 264 (72) (14) (94) (21) (1) 0 (3) (23) (101) 37 (93) (97) (67) 12 5 (3) (6) 74 1 Includes social security contributions and expenses related to alternative investment awards. 2 Includes expenses for the Company Secretary, Board of Directors and Group Internal Audit. 3 BIS risk-weighted assets (RWA) are according to Basel II for 2008, and according to the Basel I framework for 2007 and 2006. 4 Personnel numbers exclude full-time equivalents from private equity (part of the Corporate Center): 1 for 2008, 3,843 for 2007, 4,241 for 2006. 5 Information Technology Infrastructure (ITI). 113 UBS business divisions and Corporate Center Corporate Center 2008 Results The Corporate Center recorded a result from continuing opera- tions of negative CHF 31 million in full-year 2008, down from a gain of CHF 2,222 million in 2007. This decline was mainly related to a charge of CHF 3.4 billion following a transaction between UBS and the Swiss National Bank (SNB) in the fourth quarter. This charge reflects a net loss arising from the acquisi- tion of the equity purchase option, and the impact of the con- tingent issuance of UBS shares in connection with the trans- action. The total charge also includes the fair valuation impact of the mandatory convertible notes (MCNs) placed with the Swiss Confederation. The call component of the MCNs will be revalued each quarter and UBS expects a corresponding fluc- tuation in the results of the Corporate Center. This fluctuation is subject to the expected volatility of the UBS share price and will continue until the conversion of the MCNs into UBS shares. The loss from the SNB transaction is reported in the Corporate Center as it benefits the whole bank and not just the Invest- ment Bank. At the 27 November 2008 extraordinary general meeting, shareholders approved for this purpose the creation of conditional capital in the maximum amount of 365 million shares. Furthermore, 2008 was impacted by losses resulting from cash flow hedge ineffectiveness, driven by the accelerat- ed amortization of gains recorded until November 2007. On the positive side, a gain of CHF 3,860 million due to the accounting treatment of the MCNs in first quarter 2008 and a gain of CHF 174 million on UBS’s sale of its stake in Bank of China in the fourth quarter assisted the 2008 result. Operating income Total operating income decreased to CHF 998 million in 2008 from CHF 3,562 million in 2007, largely driven by the above- mentioned SNB transaction and fair valuation of the MCNs in fourth quarter 2008, losses on swaps not fully eligible for hedge accounting, losses of CHF 192 million due to currency translation differences on partial disposals of an investment in a consolidated investment fund, and a gain from UBS’s sale of its stake in Bank of China. The 2007 result was driven by a gain from the sale of UBS’s 20.7% stake in Julius Baer. In ad- dition, the contribution from the former Industrial Holdings decreased to CHF 22 million in 2008, compared with CHF 689 million in 2007. Operating expenses Total operating expenses were CHF 1,029 million in 2008, down CHF 311 million from CHF 1,340 million in 2007. At CHF 1,076 million in 2008, personnel expenses were down 21% from CHF 1,365 million in 2007, which reflected lower bonus accruals and lower headcount, the latter being partly offset by growth in the Offshoring Service Center headcount. In the same period, general and administrative expenses de- creased 1% to CHF 1,299 million from CHF 1,306 million. This was related mainly to lower advertising and sponsoring costs, a partial release of provisions and lower project costs as well as decreased travel activities, and were partly offset by higher real estate restructuring provisions. Other businesses were charged CHF 2,066 million, compared with CHF 2,070 million in 2007. Depreciation decreased CHF 19 million, or 3%, to CHF 720 million as a result of management action to reduce spending on IT equipment partly offset by a fair value adjustment in corporate real estate. Information technology infrastructure In 2008, the average ITI cost per UBS employee was CHF 25,178, a CHF 1,953 decrease from CHF 27,131 the previous year. This reflects an 8% cost reduction in ITI in 2008 com- pared to 2007, reflecting ongoing cost-cutting initiatives and foreign exchange movements. Average UBS staff levels de- creased slightly to 81,382 in 2008 from 81,715 in 2007. 114 2007 Results The Corporate Center recorded a pre-tax profit from con- tinuing operations of CHF 2,222 million in full-year 2007. This improvement, up from a loss of CHF 789 million in 2006, was related mainly to the CHF 1,950 million gained from UBS’s sale of its 20.7% stake in Julius Baer. In addition, positive cash flow hedges and higher treasury income also assisted the 2007 result. While all these developments helped operating income to rise, higher levels of credit loss expenses in 2007 moderated the increase. Operating income Total operating income increased to CHF 3,562 million in 2007 from CHF 607 million in 2006. This mainly reflected the gains from UBS’s sale of its 20.7% stake in Julius Baer, positive impacts from cash flow hedges and higher treasury income. In addition, the contribution from the former Indus- trial Holdings was CHF 689 million in 2007, compared with CHF 313 million in 2006. from CHF 1,319 million in 2006, mainly reflecting the higher personnel numbers in ITI, driven by higher business demand. Accelerated amortization of share-based compensation to certain terminated employees during their employment also drove personnel costs up. In the same period, general and administrative expenses increased 4% to CHF 1,306 million from CHF 1,255 million. This was related mainly to higher ITI expenses in support of higher staff levels in the business divi- sions. The Operational Corporate Center also booked higher expenses in all areas. This was partially offset by lower provi- sions (2006 included a small portion of the provision for sub- leasing office space in the US) and advertising expenditures. Other businesses were charged CHF 2,070 million compared with CHF 1,969 million, reflecting the business-driven cost increases of ITI and the India Service Center. Depreciation of property and equipment decreased CHF 43 million, or 5%, to CHF 739 million as several software components came to the end of their depreciation cycle. Amortization of intangi- ble assets was CHF 0 million in 2007, CHF 9 million below the level a year earlier. Information technology infrastructure Operating expenses Total operating expenses were CHF 1,340 million in 2007, down CHF 56 million from CHF 1,396 million in 2006. At CHF 1,365 million in 2007, personnel expenses were up 3% In 2007, the average ITI cost per UBS employee was CHF 27,131, a CHF 941 decrease from CHF 28,072 the previous year. This reflected a 12% increase in average staff levels from 72,885 in 2006 to 81,715 in 2007, while ITI costs in- creased only 8% during this period. d n a s n o i s i v i d s s e n i s u b S B U r e t n e C e t a r o p r o C 115 Risk and treasury management Audited information according to IFRS 7 and IAS 1 Risk disclosures provided in line with the requirements of the International Financial Reporting Standard 7 (IFRS 7) Financial Instruments: Disclosures, and disclosures on capital required by the International Accounting Standard 1 (IAS 1) Financial Statements: Presentation form part of the financial statements audited by UBS’s independent registered public accounting firm Ernst & Young Ltd., Basel. This information (the audited texts, tables and graphs) is marked by a bar on the left-hand side throughout this report and is incorporated by cross-reference into the financial statements of this report. Risk management – UBS entered 2008 with significant legacy risk positions which exceeded the firm’s risk bearing capacity. Risk reduction will remain a priority for UBS until risk exposure is commensurate with the firm’s targeted risk appetite. UBS incurred substantial writedowns on its risk positions and actively reduced exposures through sales. Significant transactions included the sale in May 2008 of US residential mortgage-backed securities to a fund managed by BlackRock for proceeds of USD 15 billion and the agreement reached in October 2008 to transfer illiquid securities and other positions from UBS’s balance sheet to a fund owned and controlled by the Swiss National Bank (SNB). In order to address weaknesses identified in its risk management and control organization, UBS launched an extensive remediation plan which included: the overhaul of its risk governance; significant changes to risk management and control personnel; and improvements in risk capture, risk representation and risk monitoring. 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(cid:36)(cid:87)(cid:85)(cid:75)(cid:80)(cid:71)(cid:85)(cid:85)(cid:2)(cid:70)(cid:75)(cid:88)(cid:75)(cid:85)(cid:75)(cid:81)(cid:80)(cid:2)(cid:84)(cid:75)(cid:85)(cid:77)(cid:2)(cid:69)(cid:81)(cid:79)(cid:79)(cid:75)(cid:86)(cid:86)(cid:71)(cid:71)(cid:85) (cid:21)(cid:52)(cid:47)(cid:18)(cid:18)(cid:19)(cid:65)(cid:71) Treasury management – UBS’s treasury department is responsible for the management of the firm’s financial resources. This includes the management of: liquidity and funding; capital and balance sheet; and interest rate and currency risks arising from balance sheet and capital management responsibilities. Liquidity management Funding management Liquidity management remained challenging throughout 2008, as the financial and credit market crisis, which had its origins in the US residential mortgage market in the second half of 2007, spread and gained in intensity throughout the year. In anticipation of an extended period of market turbu- lence, UBS proactively undertook several measures, starting in 2007 and continuing in 2008, to further strengthen and safeguard its liquidity position, including adjustment of short-term funding targets and increased focus on balance sheet asset reduction. Combined with the broad diversity of its funding sources, its contingency planning processes and its global scope, these additional measures have enabled UBS to maintain a balanced asset / liability profile throughout the current market dislocation. Despite challenging market conditions in the second half of 2008, UBS was able to maintain access to funding, primarily as a result of its broadly diversified funding base. Risk-weighted assets and eligible capital In 2008, risk-weighted assets declined from CHF 374.4 billion (Basel I) to CHF 302.3 billion. In this period, eligible tier 1 capital decreased from CHF 34.1 billion to CHF 33.2 billion, reflecting the effects of losses incurred during 2008 and further negative impacts on equity, only partially offset by the positive effects from issues of capital instruments. Capital instruments The following events occurred in 2008: issuance of CHF 13 billion of mandatory convertible notes to two long-term financial investors in March; issuance of EUR 1 billion of perpetual preferred securities as hybrid tier 1 capital in April; net increase in capital of CHF 15.6 billion from the rights issue in June; and issuance of CHF 6 billion of mandatory convertible notes to the Swiss Confederation in December. Capital adequacy CHF million, except where indicated BIS tier 1 capital of which hybrid tier 1 capital BIS total capital BIS tier 1 capital ratio (%) BIS total capital ratio (%) Credit risk 1 Non-counterparty related risk Market risk Operational risk Total BIS risk-weighted assets Basel II 31.12.08 33,154 7,393 45,367 11.0 15.0 222,563 7,411 27,614 44,685 302,273 Basel I 31.12.08 35,671 7,393 46,012 9.8 12.7 326,608 8,826 27,614 N/A 363,048 31.12.07 34,101 6,387 45,797 9.1 12.2 323,345 8,966 42,110 N/A 374,421 1 Includes securitization exposures and equity exposures not part of the trading book and capital requirements for failed trades. Risk and treasury management Risk management and control Risk management and control UBS was severely affected by the financial crisis that unfolded in 2007 and worsened in 2008. UBS entered 2008 with significant legacy risk positions, particularly related to US real estate and other credit positions, which exceeded the firm’s risk bearing capacity. As reported during 2008, UBS incurred significant losses on these positions. Risk reduction will remain a priority for UBS until risk exposure is commensurate with the firm’s targeted risk appetite. UBS identified significant weaknesses in its risk management and control orga- nization, as well as limitations in its traditional market risk, credit risk, liquidity risk and funding risk mea- sures (including the interplay between these measures). As a result of these weaknesses, the firm failed to adequately assess correlated risks and risk concentrations. In order to address these weaknesses, UBS launched an extensive remediation plan, which included the overhaul of its risk governance, significant changes to risk management and control personnel, as well as improvements in risk capture, risk representation and risk monitoring. Implementation of this plan is ongoing and remains a high priority for UBS. In addition, in light of the continued dislocation in financial markets, UBS has placed less emphasis on statistical models for the identification and management of risks, and more on its stress-based measures, particularly to identify and manage those portfolios considered most at risk. Market commentary in 2008 Market conditions deteriorated progressively in 2008 culmi- nating with weak macroeconomic data in fourth quarter 2008 which confirmed the severe downturn in the global economy. Credit markets worsened considerably over the year with the market dislocation spreading from US real estate-related markets to broader asset-backed security and credit markets, especially after the market-wide liquidity concerns engendered following the collapse of a major US investment bank in September 2008. Levels of market vola- tility were high throughout the year and peaked in fourth quarter, as global deleveraging and a lack of liquidity in global markets continued to distort asset prices, reducing the effectiveness of some risk mitigation techniques. Ex- treme market moves throughout the year caused a break- down in the relationship between a number of trading posi- tions and related hedges, particularly in credit and equity markets. Hedge funds experienced significant redemptions in the second half of the year as performance suffered. In the last four months of the year, central banks and govern- ments reacted with increasing urgency to the escalating financial crisis with a series of measures which attempted to stabilize financial markets and support specific financial institutions. Summary of key developments in 2008 The important developments that took place in 2008 with regard to risk management and control include: – UBS incurred substantial writedowns on its risk positions and actively reduced exposures through sales. Significant transactions included the sale in May of US residential mort- gage-backed securities to a fund managed by BlackRock for proceeds of USD 15 billion and the agreement reached in October to transfer illiquid securities and other positions from UBS’s balance sheet to a fund owned and controlled by the SNB. From an originally agreed USD 60 billion, the size of the transaction has been reduced to USD 38.6 bil- lion. UBS will continue its program of active risk reduction. – UBS strengthened the roles and responsibilities of its Board of Directors (BoD) and executive management with regard to risk management and control. The BoD has been allocated responsibility for setting the highest-level portfolio and concentration risk measures and limits, while the Group Chief Executive Officer (Group CEO) is authorized to apply these measures and limits to specific transactions, positions and exposures. A new BoD risk committee was established to take on some of the re- sponsibilities of the former Chairman’s Office. – UBS integrated its approach to risk control by merging the market and credit risk functions of the Investment Bank into a single unit. A new Chief Risk Officer (CRO) was appointed in the Investment Bank to oversee credit risk and market risk on a combined basis as well as opera- tional risk. Several other changes to senior personnel in the Investment Bank CRO organization were also made. The Corporate Center risk function was reorganized, re- sulting in the formation of a unit to focus on the control of portfolio and concentration risks and a combined func- tion to determine methodologies to measure and assess market and credit risk. UBS also made a number of other changes to senior personnel in order to strengthen its risk management and control organization. These included 120 the appointments in the Investment Bank of a new Chief Executive Officer and new heads of Fixed Income Curren- cies and Commodities. d e t i d u A The risk assessment and management performed by the BoD is in line with the statutory requirements and so is the related disclosure in this section. – In the third quarter, the Swiss Financial Market Supervisory Authority (FINMA, until 31 December 2008 Swiss Federal Banking Commission) concluded its investigation into the causes of the significant writedowns incurred by UBS. It confirmed UBS’s own conclusions in all material aspects. UBS developed a comprehensive and detailed plan to elimi- nate the weaknesses it identified, including those related to risk management and control (for example UBS’s market and credit risk functions had failed to identify certain sig- nificant portfolio and concentration risks, and there were weaknesses identified in risk systems and infrastructure). Delivery against this plan remains broadly in line with ex- pectations and is a high priority for UBS. Risk management and control principles d e t i d u A Five key principles underpin UBS’s risk management and control framework. These principles are intended to allow the firm to achieve an appropriate balance between risk and return. The five key principles are: – Business management is accountable for risk. Business management throughout the firm is accountable for all the risks assumed or incurred by its business operations. This means that each business is responsible for the con- tinuous and active management of its risk exposures, as well as for ensuring an appropriate balance between risk and return. – Independent control of risk. A control process indepen- dent of the businesses is an integral part of UBS’s risk management and control framework. Independent risk control aims to provide an objective assessment of risk- taking activities, helping senior management align the in- terests of all stakeholders, including shareholders, clients and employees. – Disclosure of risk. Comprehensive, transparent and objec- tive risk disclosure is an essential component of the risk control process. This includes disclosure and periodic re- porting to senior management, the BoD, shareholders, regulators, rating agencies and other stakeholders. – Earnings protection. UBS aims to protect earnings by lim- iting the scope for losses and exposure to stress events. Controls and limits are applied to individual exposures and portfolios in each business, to aggregate risks across all businesses, and to major risk types relative to the firm’s risk capacity (the level of risk UBS is capable of absorbing, based on its anticipated earnings power). – Reputation protection. Protection of UBS’s reputation de- pends, among other things, on the effective manage- ment and control of the risks incurred in the course of its business. All employees should make the protection of UBS’s reputation an overriding concern. Risk management and control responsibilities Key roles and responsibilities related to risk management and control are outlined below: – The BoD has a strategic and supervisory function and is responsible for determining UBS’s fundamental approach to risk. The firm’s risk principles, risk appetite and risk ca- pacity are also determined by the BoD. A newly estab- lished BoD risk committee oversees the firm’s risk profile and the implementation of risk management and control principles. – The GEB is responsible for the implementation of risk management and control principles. Its newly established Executive Committee (EC) allocates the Group’s total risk capacity amongst the business divisions, controls the firm’s overall risk profile and approves the core risk policies. – In line with UBS’s dual board structure, the authority to control risk is split between the BoD and the Group CEO. The BoD has risk control authority for portfolio and concentration limits, while the Group CEO has risk con- trol authority for the firm’s transactions, positions and exposures. These risk control authorities, however, are partially delegated to the Group CRO and the CEOs of each business division. Risk officers in the business divisions may also be delegated certain risk control authorities depending on their experience and portfolio responsibility. – The CEO of each business division is accountable for the results and risks of his or her division as well as maintain- ing an appropriate risk management structure. – The Group CRO is responsible for the development and implementation of appropriate control frameworks for credit, market and operational risks with support from the business divisions through their CROs. In addition, risk functions within the Corporate Center support the control of portfolio and concentration risks, the determi- nation of methodologies to measure and assess risk, and the development and operation of appropriate risk infra- structure (including reporting). – The CROs of the business divisions are responsible for the independent control of risk in their respective business divisions. – The Group CFO is responsible for ensuring that UBS and its business divisions disclose their financial performance in a clear and transparent way, and that this reporting and disclosure meets all regulatory requirements and corporate governance standards. The Group CFO is also responsible for the implementation of UBS’s risk manage- ment and control frameworks in the areas of capital management, liquidity, funding and tax. 121 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control Corporate governance and risk control Independent risk control Board of Directors Board of Directors 1 Audit committee Risk committee Group Executive Board Corporate Center Group Internal Audit Risk management Group Executive Board/Executive Committee Group Chief Executive Officer Group Chief Risk Officer Group General Counsel Group Chief Financial Officer Portfolio Risk Control and Methodology Head compliance Operational risk Risk Chief Operating Officer Treasurer Tax Controlling and Accounting Accounting Policy/SOX Business division Risk Control (chief risk officers) Legal and Compliance (general counsels) Finance (chief financial officers) Business division chief executive officers Business management Operations 1 For full listing of Board of Directors committees, refer to Annex C of the Organization Regulations of UBS AG. Business division risk committees 3RM001_e d e t i d u A – The Group General Counsel is responsible for implement- ing UBS’s risk management and control principles in the areas of legal and compliance. Risk management and control framework UBS’s risk management and control principles are imple- mented via a detailed risk management and control frame- work. The framework comprises both qualitative elements such as policies and authorities, and quantitative compo- nents including limits. With the risk management and con- trols principles as its basis, the framework is continually adapted and enhanced as UBS’s businesses and the market environment evolve. There are five key components in the independent risk control framework: – Risk policies and authorities to implement the firm’s risk management and control principles (see above). These re- flect UBS’s risk capacity and risk appetite, and may be adapted to accommodate the firm’s evolving business re- quirements. – Risk identification through continuous monitoring of portfolios, assessment of risks in new businesses and complex or unusual transactions, and ongoing review of the overall risk profile in the light of market developments and external events and trends. – Risk measurement using methodologies and models which are independently verified and approved by spe- cialists in the CRO organization. Appropriate risk mea- sures are applied to portfolios and risk concentrations. Risks that are not well reflected by standard measures are subject to additional controls, which may include pre-ap- proval of transactions and specific risk limits. Models to quantify risk are generally developed by dedicated units within the business divisions and the Corporate Center. UBS requires that models addressing risks which could impact its books and records be subjected to independent verification and ongoing monitoring and control by the CRO organization. – Risk control by monitoring and enforcing compliance with risk principles, policies and limits, as well as with reg- ulatory requirements. – Transparent risk reporting to stakeholders and to man- agement at all levels, on all relevant aspects of the ap- proved risk control framework, including limits. This in- cludes daily reports on certain portfolio risk measures to senior management. Monthly and quarterly reports are also prepared by the business divisions and provide the basis for consolidated reports to the Group CRO, EC, BoD risk committee and the BoD as a whole. Periodic reporting is made publicly available for the benefit of other stakeholders. 122 UBS has control processes to deal with the establishment of new businesses or significant changes to existing busi- nesses, and the execution of complex or unusual transac- tions. These processes are designed to subject the business or transaction in question to all the necessary control func- tions – risk control, legal, compliance, treasury, finance, tax and logistics – as necessary. A key aspect of this process is to ensure that transactions are booked in a way that permits appropriate ongoing risk management, measurement, con- trol and reporting. Risk categories d e t i d u A The risks faced by UBS’s businesses can be broken down into different categories. On the most fundamental level there are business risks arising from the commercial and economic risks inherent in any business activity. It is business management’s responsibil- ity to respond to changes in the economic environment and competitive landscape. Business risks are not subject to inde- pendent risk control but are factored into the firm’s strategic planning process and the assessment of UBS’s risk appetite and overall risk exposure. Primary and operational risks which result from particular business activities are, on the other hand, subject to inde- pendent risk control. Primary risks are: – Credit risk – the risk of loss resulting from the failure of a client or counterparty to meet its contractual obligations. – Market risk – the risk of loss resulting from changes in market variables. These can be categorized as overall changes in market levels and rates (the “general” market risk component), or relative changes with respect to spe- cific companies or instruments (often referred to as the “idiosyncratic” market risk component). – Liquidity and funding risk – the risk that UBS might be un- able to meet its payment obligations when due or to bor- row funds in the market at an acceptable price to fund ac- tual or proposed commitments. Operational risk is the risk of loss resulting from inade- quate or failed internal processes, people and systems (for example failed IT systems, or fraud perpetrated by a UBS employee), or from external causes, whether deliberate, ac- cidental or natural. ➔ Refer to the “Market risk”, “Credit risk”, “Operational risk” and “ Liquidity and funding management” sections of this report for a description of the control frameworks for these risk categories Quantitative controls d e t i d u A d e t i d u A Expected loss is the loss that is expected to arise on aver- age over time in connection with an activity (for example, expected number of loan defaults under normal economic conditions). It is an inherent cost of such activity, and must be factored into business plans. Statistical loss measures, such as Value at Risk (“VaR”), estimate the amount by which actual losses in a portfolio could exceed the expected loss over a specified time horizon, measured to a specified level of confidence (probability). Stress loss is the loss that could arise from extreme events, typically beyond the confidence level of the statistical loss estimate, and is normally a scenario-based measure. These risk measures are typically applied at a portfolio level. They are complemented by controls such as targeted stress measures for concentrated exposures and vulnerable portfolios, sub-portfolios or positions. Concentration risk controls are generally applied where UBS identifies that positions in different financial instruments or different port- folios are affected by changes in the same risk factor or group of correlated factors. Such concentrations can have the potential for significant loss in the event of extreme but plausible adverse developments. Identifying such develop- ments and assessing their potential impact – in particular the danger of aggregated losses from a single event through concentrated exposures – is a critical component of the risk control process. ➔ Refer to the “Risk concentrations”, section of this report for more information on risk exposures and identified risk concentrations Qualitative controls Although measurement of risk is clearly important, not all risks are quantifiable. Due diligence, sound judgment, com- mon sense and an appreciation of a wide range of potential outcomes, including a willingness to challenge assumptions, are key components of a strong risk culture for both risk management and risk control. UBS has reinforced its qualita- tive risk controls through changes to its risk management and control organization, as described above in the sum- mary of key developments in 2008 section, as well as through education programs. Earnings-at-risk and capital-at-risk To complement its day-to-day operating controls, UBS has developed the concepts of “earnings-at-risk” and “capital- at-risk”. These are general measures designed to assess the firm’s overall ability to absorb the potential losses inherent across all its business lines and from all major sources in the current economic cycle. UBS quantifies potential future losses using three comple- mentary risk measures: expected loss, statistical loss and stress loss. Earnings-at-risk focuses on UBS’s ability to absorb losses through its current earnings. It is an integral part of the risk control process and is monitored by the BoD, the BoD risk 123 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control committee and the GEB as part of UBS’s monthly risk report- ing. The concept reflects UBS’s view that the primary re- source to absorb losses should be a firm’s earnings stream. Earnings-at-risk has three elements – risk capacity, risk expo- sure and risk appetite. Risk capacity is the level of risk UBS considers itself capa- ble of absorbing, based on its earnings power, without dam- age to its dividend paying ability, its strategic plans and, ulti- mately, its reputation and ongoing business viability. It is based on a combination of budgeted, forecast and historical revenues and costs, adjusted for variable compensation, div- idends and related taxes. Risk exposure is an estimate of potential loss based on current and prospective risk positions across major risk cate- gories – primary risks, operational risk and business risk. It builds as far as possible on the statistical loss measures used in the day-to-day operating controls, extending their time horizons where necessary, with adjustments and supple- ments determined by management to reflect known cover- age gaps. Correlations are taken into account when aggre- gating potential losses from risk positions in the various risk categories to obtain an overall estimate of the risk exposure. The risk exposure is assessed against a severe but plausible constellation of events over a one-year time horizon to a 95% confidence level – in effect to assess the impact of a “once in 20 years” event. Risk appetite is established by the BoD, who set an upper boundary on aggregate risk exposure. A comparison of risk exposure with risk capacity serves as a basis for determining if current or proposed risk limits are appropriate, and is one of the tools available to management to guide decisions on adjustments to the risk profile. It also provides an indication of UBS’s ability to pay a cash dividend out of its current year earnings. UBS’s risk exposure should not normally exceed its risk ca- pacity but in the extremely difficult market conditions that persisted throughout 2008, this relationship has not held. For 2008 as a whole, UBS recorded a large net loss, showing that the risk exposures remained greater than UBS’s risk capacity. Risk exposure remained high as a result of a lack of liquid- ity in the markets for securitized assets to which UBS had significant exposures during a large part of the year, and due to significantly increased volatility levels in global markets. The reduction in risk exposure that was achieved through sales (including transactions with BlackRock and the SNB) in addition to the significant writedowns incurred on risk posi- tions, was offset by a simultaneous decrease of risk capacity due to downward revisions of earnings expectations as a consequence of the deteriorating economic outlook. Measured risk exposure is neither an expected nor a worst case scenario and it can be significantly affected by many external factors. Based on UBS’s assessment of the various dimensions of its portfolio of risks and their potential devel- opment, management has and will continue to reduce the firm’s risk exposure to achieve an appropriate level relative to its risk capacity. However, liquidity has been and remains poor in many markets. As with any model, earnings-at-risk is heavily dependent on assumptions and estimates. Measured risk exposure must be understood in this context. During the extremely difficult market conditions that prevailed in 2008, a number of supplementary measures were added to the statistical assessment of risk exposure. For example, observ- able data were supplemented by judgments in several areas including residential and commercial real estate, US munici- pal and student loan markets, and potential defaults by monoline insurers and certain corporate loan portfolios. These supplementary measures were a result of extensive consultation between risk management and control profes- sionals and contributed materially to the overall risk expo- sure that UBS recognized in 2008. Capital-at-risk considers more extreme losses and their potential to lead to a breach of minimum regulatory capital requirements or even insolvency. Capital-at-risk is an input to the capital management process, building on the earnings- at-risk concept but assessing the potential for losses to ex- ceed earnings capacity and erode capital. For capital-at-risk, the analysis parallels that for earnings-at-risk but is measured at two higher confidence levels. The first is in relation to UBS’s minimum regulatory capital requirement and is set at a 99% confidence level or a “once in 100 years event”. The second is in relation to the solvency of UBS and is set at a confidence level exceeding 99.9%. The capital-at-risk measures of aggregate risk exposure are important considerations in the assessment of capital ad- equacy. Like earnings-at-risk, capital-at-risk also relies on day-to-day risk control measures. 124 Risk concentrations Risk concentrations d e t i d u A A concentration of risk exists where: (i) a position or group of positions in financial instruments is affected by changes in the same risk factor or group of correlated factors; and (ii) the exposure could, in the event of large but plausible adverse developments, result in significant losses. The identification of risk concentrations requires judg- ment because potential future developments cannot be predicted with certainty and may vary from period to period. In determining whether a risk concentration exists, UBS con- siders a number of elements, both individually and in combi- nation. These elements include: the shared characteristics of the instruments; the size of the position or group of posi- tions; the sensitivity of the position or group of positions to changes in risk factors and the volatility and correlations of those factors. Also important in this assessment is the liquid- ity of the markets where the instruments are traded and the availability and effectiveness of hedges, as the value of a hedge instrument may not always move in line with the posi- tion being hedged. This is referred to as basis risk. d e t i d u A port for more information on the risk categories to which UBS is exposed. UBS has also bought and may be required to buy securities and units from funds that UBS has sold to clients. Such purchases, especially of illiquid assets such as interests in hedge funds, could create a significant risk exposure for UBS. If a risk concentration is identified, it is assessed to deter- mine whether it should be reduced or mitigated, and the available means to do so are also evaluated. Identified risk concentrations are subject to increased monitoring. Identified risk concentrations Based on UBS’s assessment of its portfolios and asset classes with potential for material loss in a stress scenario relevant to the current environment, the firm believes the various expo- sures shown below can be considered risk concentrations according to the abovementioned definition. UBS has significant lending, counterparty and country risk exposures that could sustain significant losses if the current economic conditions were to persist. Refer to the “Credit risk” section of this report for more information. UBS is exposed to price risk, basis risk, credit spread risk and default risk, other idiosyncratic and correlation risks on both equities and fixed income inventories, and to country risk in many of its lending and trading activities. Refer to the “Market risk”, “Credit risk” and “Operational risk” sections of this re- It is possible that material losses could occur on asset classes, positions and hedges other than those disclosed in this section of this report, particularly if the correlations that emerge in a stressed environment differ markedly from those anticipated by UBS. d e t i d u A Exposure to monoline insurers, by rating 1 USD million, unless otherwise stated Notional amount 3 Column 1 Fair value of underlying CDOs 4 Column 2 31.12.08 Fair value of CDSs prior to credit valuation adjustment 5 Column 3 (=1–2) Credit valuation adjustment on 31.12.08 Fair value of CDSs after credit valuation adjustment Column 4 Column 5 (=3–4) Credit protection on US RMBS CDOs 2 9,111 1,695 7,415 4,659 2,756 of which: from monolines rated AAA to A on US sub-prime residential mortgage-backed securities (RMBS) CDOs high grade on US sub-prime RMBS CDOs mezzanine on other US RMBS CDOs of which: from monolines rated BBB and below on US sub-prime residential mortgage-backed securities (RMBS) CDOs high grade on US sub-prime RMBS CDOs mezzanine on other US RMBS CDOs Credit protection on other assets 2 of which: from monolines rated AAA to A of which: from monolines rated BBB and below Total 31.12.08 Total 31.12.07 (USD billion) 23 0 0 23 9,088 6,222 1,092 1,774 12,424 2,399 10,025 21,535 24.2 12 0 0 12 1,683 952 28 703 7,509 1,568 5,941 9,204 19.7 11 0 0 11 7,404 5,269 1,064 1,071 4,914 830 4,084 12,329 4.5 4 0 0 4 4,655 2,961 897 797 2,335 334 2,001 6,994 0.9 6 0 0 6 2,750 2,308 167 275 2,579 496 2,083 5,335 3.6 1 Excludes the benefit of credit protection purchased from unrelated third parties.    2 Categorization based on the lowest insurance financial strength rating assigned by external rating agencies.   3 Represents gross notional amount of credit default swaps (CDSs) purchased as credit protection. 4 Collateralized debt obligations (CDOs). 5 Credit default swaps. 125 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control d e t i d u A d e t i d u A d e t i d u A d e t i d u A Exposure to monoline insurers The vast majority of UBS’s direct exposure to monoline insur- ers arises from over-the-counter (OTC) derivative contracts, mainly credit default swaps (CDSs), purchased to hedge spe- cific positions. On 31 December 2008, the total fair value of CDS protection purchased from monoline insurers against these positions was USD 5.3 billion after cumulative credit valuation adjustments (CVAs) of USD 7.0 billion. The level of CVAs increased significantly in 2008 from USD 0.9 billion on 31 December 2007 reflecting the progressive deterioration in both the fair value of the underlying CDOs and the credit quality of the monoline insurers during the year. Exposure under CDS contracts with monoline insurers is calculated as the sum of the fair values of individual CDSs after credit valuation adjustments. This, in turn, depends on the valuation of the instruments against which protection has been bought. A positive fair value, or a valuation gain, on the CDS is recognized if the fair value of the instrument it is intended to hedge decreases. The table on the previous page shows the CDS protection bought from monoline insurers to hedge specific positions. It illustrates the notional amounts of the protection originally bought, the fair value of the underlying instruments and the fair value of the CDSs both prior to and after credit valuation adjustments taken for these contracts. Refer to “Note 27 Fair value of financial instruments” in the financial state- ments of this report for more information on CVA valuation and sensitivities. The CVA as at 31 December 2008 was ad- justed to take into account the anticipated economic impact of commuting trades with certain monolines. Other than credit protection bought on the positions de- tailed in the table on the previous page, UBS held direct derivative exposure to monolines of USD 437 million after CVAs of USD 499 million on 31 December 2008. In its trad- ing portfolio, UBS also had indirect exposure to monoline insurers through securities which they have guaranteed (“wrapped”) and which were issued primarily by US states and municipalities and US student loan programs. These Exposure to auction rate securities d e t i d u A d e t i d u A Auction rate securities held by UBS Auction rate securities (ARS) are long-term securities structured to allow frequent reset of their coupon and, at the same time, the possibility for holders to sell their investment in a periodic auction, giving the securities some of the characteristics of a short-term instrument in normal market conditions. These are typically issued by municipal entities and student loan trusts, and may be wrapped by monoline insurers. Coupons paid on ARS are determined by an auction at the beginning of each interest reset period, the intention being to allow investors to earn a market rate of interest. In the past UBS acted as broker-dealer for certain ARS programs. Although it is not obligated to do so, UBS has in the past provided liquidity, from time to time, to these markets by submitting bids to ARS auctions and acquired ARS inventory in the first half of 2008 as a result. As described in the “Changes in 2008” section of UBS’s fourth quarter report, UBS and the Swiss National Bank (SNB) agreed that UBS’s student loan ARS positions will not be sold to the SNB fund. UBS’s inventory of student loan ARS was reclassified from “held for trading” to “loans and receivables” on 31 December 2008 and the student loan ARS repurchased from clients in fourth quarter 2008 were also Auction rate securities exposure US student loan auction rate securities US municipal auction rate securities US taxable auction preferred securities US tax-exempt auction preferred securities Total Net exposures on 31.12.08 1,2 (USD million) 8,362 Net exposures on 31.12.07 1 (USD billion) 4.5 451 782 3,167 12,763 1.4 5.9 1 Net exposure represents market value of gross exposure net of short positions and hedges considered effective. 2 On 31 Decem- ber 2008, USD 4.6 billion of the US student loan auction rate securities were monoline wrapped. classified as loans and receivables. Under their new classification, all student loan ARS positions held by UBS are subject to an impairment test which includes a detailed review of the quality of the underlying collateral. In fourth quarter 2008 UBS carried out a fundamental analysis of its student loan ARS inventory as well as client positions included in the buy-back program (refer to “Maximum exposure to client auction rate securities” on the next page for more information). The majority of the collateral backing the securities is backed by Federal Family Education Loan Program (FFELP) which is reinsured by the US Department of Education. Auction preferred stocks (APS) are issued by closed-end mutual funds with an underlying portfolio of tax-exempt municipal bonds, common stock, preferred stock, or taxable debt. A closed-end fund is a publicly traded investment company registered under the Investment Company Act of 1940. The Investment Company Act of 1940 requires significant over-collateraliza- tion which benefits the APS holders. 126 Exposure to auction rate securities d e t i d u A had a net market value of approximately USD 5.5 billion on 31 December 2008. d e t i d u A Previously disclosed risk concentrations Exposure to leveraged finance deals UBS defines leveraged finance deals according to internal credit ratings, which correspond with external corporate credit ratings of BB– or worse at the point of reporting and included underwritten positions that experienced a rating downgrade in 2008. The net exposure to leveraged finance commitments held by UBS was reduced significantly in 2008 to USD 4,009 million at 31 December 2008, of which USD 3,161 million was funded. Leveraged finance exposures on 31 December 2008 are shown net of cumulative gross writ- edowns and impairment charges, as well as effective hedg- es. Exposure to leveraged finance commitments, net of ef- fective hedges, at 31 December 2007 was USD 11.4 billion, of which USD 7.4 billion was funded. The net exposure at this date, after deductions of cumulative gross markdowns, was USD 11 billion. In 2008, UBS significantly reduced its exposures to US resi dential and commercial real estate-related positions and the US reference-linked note (RLN) program. These reductions were achieved both through sales and writedowns as well as UBS’s agreement with the Swiss National Bank (SNB) in Octo- ber 2008, which allows for the transfer of illiquid securities and other positions from UBS to a fund owned and controlled by the SNB. As a result of this agreement, UBS’s residual posi- tions in these asset classes were no longer considered as con- centrations of risk. Refer to the “Strategy and structure” sec- tion of this report for more information on the SNB transaction. UBS previously reported net exposures on 31 December 2007 to US sub-prime residential mortgages of USD 27.6 billion and to US Alt-A residential mortgages of USD 26.6 billion. At the same date UBS had net exposures to US commercial real estate of USD 7.7 billion and to US RLN of USD 11.2 billion. UBS also reported in third quarter 2008 net exposures of USD 6.1 billion on 30 June 2008 and USD 2.3 billion on 30 Sep- tember 2008 to US prime residential mortgages. d e t i d u A d e t i d u A On 31 December 2008, UBS had student loan ARS positions with a carrying value totaling USD 8.4 billion, of which approximately 66% of the securities in the portfolio was backed by FFELP guaranteed collateral. On the same date, UBS had exposures to US auction preferred securities of USD 4.0 billion. Maximum exposure to client auction rate securities UBS has committed to restore liquidity to client holdings of ARS. This commitment is in line with previously announced agreements in principle with various US regulatory agencies, and the final settlements entered into with the Massachusetts Securities Division, the US Securities and Exchange Commission, and the New York Attorney General. On 7 October 2008, UBS filed a registration state- ment with the US Securities and Exchange Commission for Auction Rate Securities Rights necessary to offer clients the right to sell their ARS to UBS at par value during their buy-back period. The table below shows the maximum required repurchase amount at par of ARS, which would occur over various time periods between 31 October 2008 and 2 July 2012 according to client type and security. UBS anticipates that the maximum required repurchase d e t i d u A amount is likely to decline over time as issuers refinance their debt obligations and UBS works with issuers, industry peers and US government officials on restructuring initiatives and redemp- tion opportunities. Approximately 88% of the USD 11.8 billion student loan ARS held by clients are backed by FFELP guaranteed collat- eral. Following the start of the buy-back program in fourth quarter 2008, UBS repurchased approximately USD 0.5 billion of US student loan ARS, USD 0.2 billion of US municipal ARS, USD 0.6 billion of US taxable auction preferred securities (APS) and USD 3.2 billion of US tax exempt APS from clients. Client holdings: auction rate securities d e t i d u A Par value of maximum required Buy-back period Private clients Institutional clients USD million US student loan auction rate securities US municipal auction rate securities US taxable auction preferred securities US tax-exempt auction preferred securities Total purchase on 31.12.08 31.10.08 – 4.1.11 2.1.09 – 4.1.11 30.6.10 – 2.7.12 11,775 2,041 1,659 64 15,539 41 144 161 64 410 3,196 1,589 1,202 – 5,987 8,538 308 296 – 9,142 127 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control Market risk d e t i d u A Market risk is the risk of loss from changes in market variables. There are two broad categories of changes: general market risk factors and idiosyncratic components. General market risk factors are driven by macroeconomic, geopolitical and other market-wide considerations, independent of any instrument or single issuer or counterparty. They include such things as interest rates, the levels of equity market in dices, exchange rates, commodities (including the price of energy and metals), as well as general credit spreads. The associated volatility of these risk factors and the correlations between them are also considered to be general market risk factors. Idiosyncratic components, on the other hand, are those that cannot be explained by general market moves. Broadly they are the ele- ments of the prices of debt and equity instruments, as well as derivatives linked to them, which result from factors and events specific to individual companies or entities. d e t i d u A mitigation strategies. These strategies can expose UBS to risk as the hedge instrument and the position being hedged may not always move in parallel (often referred to as “basis risk”). Senior management and risk controllers may also give in- structions for risk to be reduced, even when limits are not exceeded, if particular positions or the general levels of expo- sure are considered inappropriate. The asset management and wealth management busi- nesses carry small trading positions, principally to support client activity. The market risk from these positions is not material to UBS as a whole. UBS has also bought and may be required to buy securities and units from funds that UBS has sold to clients, which may be exposed to market risk. These positions are managed as investment positions. Refer to the “Equity investments” section below for further information. Sources of market risk UBS takes both general and idiosyncratic market risks in its trading activities, and some non-trading businesses are also subject to general market risks. Trading Most of UBS’s trading activity is in the Investment Bank. Dur- ing 2008 it included market-making, facilitation of client busi- ness and proprietary position taking in the cash and derivative markets for equities, fixed income, interest rates, foreign exchange, energy, metals and commodities. How ever, the In- vestment Bank is being repositioned to focus primarily on client activities. In addition to the planned exit from munici- pals, proprietary trading and commodities (excluding precious metals) businesses, the Investment Bank will also largely exit its remaining real estate and securitization activities as well as the exotic structured products business. Refer to the “Invest- ment Bank” section of this report for further information. The largest contributor to market risk within the Invest- ment Bank has been the fixed income trading area. This busi- ness area has been progressively reducing risk positions. Those that remain relate to coporate and consumer credit markets, US municipal and student loan markets, as well as significantly reduced positions in asset-backed securities (in- cluding residential and commercial real estate). The relative contribution from a market risk perspective from equities, currencies and commodities has been modest compared to that seen in the fixed income trading area. d e t i d u A Trading businesses are subject to multiple market risk lim- its. Traders are required to manage their risks within these limits which in turn may involve employing hedging and risk 128 Non-trading In the Investment Bank, significant non-trading interest rate risk and all non-trading foreign exchange risks are captured, controlled and reported under the same risk management and control framework as trading risk. In the other business divisions, exposures to general market risk factors – primarily interest rates and exchange rates – also arise from non-trading activities (the largest items are the inter- est rate risks in Global Wealth Management & Business Bank- ing). These market risks are generally transferred to the Invest- ment Bank or Group Treasury, which manage the positions as part of their overall portfolios within their allocated limits. Market risks that are retained by the other business divisions are not significant relative to UBS’s overall risk, and exposures are subject to market risk measures and controls. With the exception of structural currency exposures which arise from Group Treasury’s management of consolidated capital, non- trading currency and commodity positions are subject to mar- ket risk regulatory capital and are therefore captured in VaR, although such positions do not contribute significantly to over- all VaR. Group Treasury also assumes market risk from its funding, balance sheet and capital management responsibilities. For ex- ample, it finances non-monetary balance sheet items such as bank property and equity investments in associated companies. It also manages interest rate and foreign exchange risks result- ing from the deployment of UBS’s consolidated equity, from structural foreign exchange positions and from non-Swiss franc revenues and costs. The market risk limits allocated to Group Treasury cover both the risks resulting from these responsibili- ties, and those transferred from other business divisions. ➔ Refer to the “Treasury management” section of this report for more information on Group Treasury’s risk manage- ment activities. Measuring market risk d e t i d u A UBS has two major portfolio measures of market risk – VaR and stress loss – which are common to all business divisions. They are complemented by concentration and other supple- mentary limits on portfolios, sub-portfolios, asset classes or products for specific purposes where standard limits are not considered to provide comprehensive control. They may also be applied to complex products for which not all model input parameters are observable, and which thus create challenges for valuation and risk measurement. Operational limits can take a variety of forms including values (market, nominal or notional) or risk sensitivities (a measure of expo- sure to a given risk factor such as interest rates or credit spreads). These “operational limits” are intended to address concerns about the extent of market liquidity, available op- erational capacity or valuation uncertainty, for example. Market risk limits are set for each of the business divisions and Group Treasury. The limit framework in the Investment Bank is clearly more detailed than the other divisions reflect- ing the nature of the risks it takes and the capacity in which it takes risks. Value at Risk (VaR) VaR is a statistical estimate of potential loss from adverse movements in market risk factors. A single VaR model is used for both internal limit purposes and for determining market risk regulatory capital requirements. However, the population of risk positions included in the internal manage- ment VaR measure differs from the regulatory VaR measure, largely due to required exclusions from regulatory VaR. UBS’s internal management VaR includes interest rate risk from banking book positions and credit spread sensitivities related to counterparty exposures in the OTC derivatives portfolios (referred to as credit valuation adjustment – CVA). The inclu- sion of CVA in internal management VaR resulted in a mate- rial difference between this measure and the regulatory VaR. In third quarter 2008, UBS changed its VaR disclosure and now presents both the regulatory and internal VaR. UBS measures VaR using a 10-day time horizon for regulatory and for internal purposes, while VaR backtesting is based on a 1-day time horizon (refer to the discussion on backtesting below for more information). VaR is calculated daily, based on end-of-day positions, and is not subse quently restated to reflect any retrospective adjustments to position valuations. VaR models are based on historical data and thus implicitly assume that market moves over the next 10 days or one day will follow a similar pattern to those that have oc- curred over 10-day and one-day periods in the past. UBS uses a look-back period of five years which generally cap- tures the cyclical nature of financial markets but may be slow to react to periods of heightened volatility. UBS applies these historical changes directly to current positions, a method known as historical simulation. d e t i d u A Realized market losses can differ from those implied by the VaR measure for many reasons. All VaR measures are subject to limitations and must be interpreted accordingly. The losses experienced by UBS in 2008 highlight the limita- tions of VaR as an absolute measure of risk and reinforce the need for multiple views of risk exposure. As an essential complement to VaR, UBS applies stress scenarios reflecting different combinations of market moves intended to cap- ture a range of potential stress events, and more targeted stress tests for concentrated exposures and vulnerable portfolios. VaR developments in 2008 UBS made a number of changes to its VaR model in 2008, while also changing the scope of the regulatory and internal management VaR to better reflect the underlying risks. These changes significantly inpacted the levels of VaR in 2008 com- pared with 2007, and are summarized below. – From 1 January 2008, UBS changed its approach to internal risk control for illiquid US residential mortgage-related expo- sures: US sub-prime and Alt-A residential mortgage-backed securities (RMBS); super senior RMBS collateralized debt ob- ligations (CDOs); the US reference-linked note program; and related hedges. These positions were excluded from in- ternal management VaR and related limits with new con- trols were instituted directly over the volume of remaining positions in these categories. As the regulatory capital treat- ment changed from trading book to banking book, these positions were also excluded from regulatory capital VaR. – In second quarter 2008, positions in student loan auction rate securities (ARS) were reclassified from trading book to banking book for regulatory capital purposes and ex- cluded from regulatory capital VaR and backtesting due to the illiquidity of the positions. – Enhancements to the VaR model were introduced at the end of June 2008 to increase the granularity of credit spread risk representation between single name CDS, several CDS indices and cash positions. – UBS increased the scope of its internal management VaR in third quarter 2008 to more accurately represent risk exposures and related hedges. Before these changes, certain credit hedges were included in VaR but the under- lying credit exposures were not, resulting in an inconsis- tent treatment for risk monitoring and control. UBS there- fore incorporated into its internal management VaR the impact of changes in credit spread sensitivities relating to counterparty exposures in its OTC derivatives portfolio. However, when computing regulatory capital these credit spread sensitivities are currently excluded. Refer to the “Value at Risk developments – treatment of CVA” sidebar in UBS’s third quarter 2008 financial report for more in- formation. – In fourth quarter 2008, UBS introduced additional granu- larity between certain cost of funding measures – Libor 129 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control d e t i d u A and the overnight index swap (OIS) rate. In addition, UBS excluded positions related to the asset and liability man- agement (ALM) portfolio from its regulatory VaR. The ALM desk is a treasury function within the Investment Bank which manages the funding and liquidity exposures of the Investment Bank and is not managed with trading intent. The positions related to ALM this portfolio remain in internal management VaR. d e t i d u A – UBS continues to review the performance of its VaR im- plementation and will continue to enhance its VaR model to more accurately capture the relationships between market risks associated with certain risk positions, as well as the revenue of large market movements for some trad- ing positions. Backtesting The accuracy of the VaR model is monitored by backtesting, which compares the 1-day regulatory VaR calculated on trading portfolios at close of each business day with the ac- tual revenues arising on those positions on the next business day. These backtesting revenues exclude non-trading com- ponents such as commissions and fees as well as estimated revenues from intraday trading. If backtesting revenues are negative and exceed the 1-day regulatory VaR, this results in a “backtesting exception”. VaR based on a one-day horizon provides an estimate of the range of daily mark-to-market revenues on trading d e t i d u A positions under normal market conditions similar to those experienced during the historical period used in the model. As UBS’s VaR model uses a look-back period of five years it does not respond quickly to periods of heightened volatility as experienced in 2008. When 1-day regulatory VaR is measured at a 99% confidence level, such an exception can be expected, on average, to occur on one in a hundred busi- ness days. More frequent backtesting exceptions may occur if market moves are greater than those seen in the look-back period, the frequency of large moves increases, or historical correlations and relationships between markets or variables break down (for example, in a period of extreme market dis- ruption or an extreme stress event). Backtesting exceptions are also likely to arise if the way positions are represented in VaR does not adequately capture all their differentiating char- acteristics or the relationships between them. UBS experienced 50 backtesting exceptions in 2008 com- pared with 29 backtesting exceptions in 2007. The extreme market movements in a number of risk fac- tors combined with a breakdown in traditional relationships between trading positions and their corresponding hedges (basis risk) were the primary contributors to the backtesting exceptions experienced. These results highlight the limita- tions of VaR and illustrate the need for multiple views of risk exposure such as macro and more targeted stress scenarios. Refer to the “Stress loss” section below for more informa- tion. UBS will continue improving its VaR model to better Investment Bank: backtesting revenue¹ distribution Frequency in number of days 1 January 2008–31 December 2008 Source: management accounts Investment Bank: analysis of negative backtesting revenues1 CHF million 1 January 2008–31 December 2008 Source: revenues management accounts 80 60 40 20 0 > 180 150–180 120–150 90–120 60–90 30–60 0–30 (30)–0 (60)–(30) (90)–(60) (120)–(90) (180)–(150) ) 0 0 3 ( < ) 0 5 2 ( – ) 0 0 3 ( ) 0 0 2 ( – ) 0 5 2 ( ) 0 5 1 ( – ) 0 0 2 ( ) 0 0 1 ( – ) 0 5 1 ( ) 0 5 ( – ) 0 0 1 ( 0 – ) 0 5 ( 0 5 – 0 0 0 1 – 0 5 0 5 1 – 0 0 1 0 0 2 – 0 5 1 0 5 2 – 0 0 2 0 0 3 – 0 5 2 0 0 3 > Revenues in CHF million 1 Backtesting revenues exclude non-trading revenues, such as commissions and fees, and revenues from intraday trading. (210)–(180) 3RM35_e (240)–(210) (270)–(240) (300)–(270) < (300) 130 15 10 5 0 5 10 15 20 25 30 Frequency in number of days Negative backtesting revenue less than VaR Negative backtesting revenue greater than VaR 1 Backtesting revenues exclude non-trading revenues, such as commissions and fees, and revenues from intraday trading. Analysis for loss days only. 3RM36_e -15 -10 -5 0 5 20 25 30 80 60 40 20 0 10 15 capture all relevant risks in its trading portfolio. The first histogram on the previous page shows daily backtesting revenues in the Investment Bank for the whole of 2008. In the second histogram, the daily backtesting revenues are compared with the corresponding VaR over the same 12-month period for days when backtesting revenues were negative. A positive result in this histogram represents a loss less than VaR while a negative result represents a loss greater than VaR and therefore a backtesting exception. d e t i d u A All backtesting exceptions and any exceptional revenues on the profit side of the VaR distribution are investigated. In addition all backtesting results are reported to senior business management, the Group CRO and business division CROs. Backtesting exceptions are also reported to internal and external auditors and relevant regulators. Stress loss The purpose of stress testing is to quantify exposure to ex- treme and unusual market movements. UBS’s VaR measure is based on observed historical movements and correlations, whereas its stress loss measures are informed by past events but include forward looking elements. UBS’s objectives in Investment Bank: Value-at-Risk (10-day, 99% confidence, 5 years of historical data) 1 CHF million Risk type Equities Interest rates (including credit spreads) Foreign exchange Energy, metals and commodities Diversification effect Total regulatory VaR Diversification effect (%) Management VaR 1,3 Year ended 31.12.08 Year ended 31.12.07 Min. Max. Average 31.12.08 Min. Max. Average 31.12.07 82 217 12 14 2 240 185 659 58 60 2 601 239 499 131 397 28 30 (212) 374 (36%) 316 117 544 30 22 (229) 485 (32%) 424 147 260 9 24 2 276 291 415 858 73 90 2 820 836 209 450 28 51 (225) 514 (30%) 537 164 548 21 41 (223) 552 (29%) 614 1 From 1 January 2008, excludes US residential sub-prime and Alt-A mortgage-related exposures, super senior RMBS CDOs and the US reference-linked note program, and related hedges. 2 As the minimum and maximum occur on different days for different risk types, it is not meaningful to calculate a portfolio diversification effect.    3 Includes all positions subject to internal management VaR limits (including CVAs since 3Q 2008). d e t i d u A UBS Group: Value-at-Risk (10-day, 99% confidence, 5 years of historical data) 1 CHF million Business divisions Investment Bank 1 Global Asset Management Global Wealth Management & Business Banking Corporate Center 2 Diversification effect Total regulatory VaR Diversification effect (%) Management VaR 1, 4 Year ended 31.12.08 Year ended 31.12.07 Min. Max. Average 31.12.08 240 1 1 3 3 246 246 601 7 17 93 3 609 521 374 2 4 26 (34) 373 (8%) 320 485 6 16 10 (25) 492 (5%) 459 Min. 276 2 2 1 3 273 288 Max. Average 31.12.07 820 10 5 87 3 814 833 514 4 3 18 (29) 509 (5%) 535 552 3 2 21 (29) 548 (5%) 588 1 From 1 January 2008, excludes US residential sub-prime and Alt-A mortgage-related exposures, super senior RMBS CDOs and the US reference-linked note program, and related hedges. 2 The Cor- porate Center regu latory VaR only includes FX risk of Group Treasury. 3 As the minimum and maximum occur on different days for different risk types, it is not meaningful to calculate a portfolio diver- sification effect.    4 Includes all positions subject to internal management VaR limits (including CVAs since 3Q 2008). UBS: Value-at-Risk (1-day, 99% confidence, 5 years of historical data) 1 CHF million Investment Bank UBS Regulatory VaR 2 Management VaR 3 Regulatory VaR 2 Management VaR 3 Year ended 31.12.08 Year ended 31.12.07 Min. 96 101 97 101 Max. Average 31.12.08 210 171 207 169 132 125 133 125 162 160 163 159 Min. 122 124 122 126 Max. Average 31.12.07 249 253 249 254 160 164 159 165 134 149 136 152 1 10-day and 1-day Value at Risk (VaR) results are separately calculated from underlying positions and historical market moves. They cannot be inferred from each other. From 1 January 2008, excludes US residential sub-prime and Alt-A mortgage-related exposures, super senior RMBS CDOs and the US reference-linked note program, and related hedges. 2 Backtesting is based on regulatory capital VaR. 3 Includes all positions subject to internal management VaR limits (including CVAs since 3Q 2008). 131 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control stress testing are to explore a wide range of possible out- comes, to understand vulnerabilities, and to provide a con- trol framework that is comprehensive, transparent and re- sponsive to changing market conditions. In light of the continued dislocation in financial markets, UBS has placed less emphasis on statistical models such as VaR for the identification and management of risks and more on its stress-based measures, particularly to identify and manage those portfolios considered most at risk. In 2008, UBS continued to enhance its Group-wide stress testing framework, with a particular focus on the develop- ment of a range of concrete, detailed forward-looking stress scenarios. Each scenario is based on the premise of a large initial shock occurring in one part of the financial markets, leading to a series of subsequent shocks in other markets. The scenario specifications are explicitly intended to capture the liquidity characteristics of different markets and posi- tions. More frequent review of the range of scenarios in the context of macroeconomic risk analysis has also been initiated. Standard scenarios are recalculated daily, allowing the development of stress loss exposure to be tracked and com- parisons made from one period to the next. Stress loss limits approved by the Board of Directors are applied for all busi- ness divisions. Additional requirements for stress scenario calculation capabilities are being established for all Invest- ment Bank trading systems. Specific or “targeted” stress scenarios focusing on cur- rent concerns and vulnerabilities are also used. These mea- sures are adapted to changing market conditions, as well as changes to UBS’s portfolios, sub-portfolios and positions. The choice of scenarios depends on management’s view of potential economic and market developments and their rel- evance to UBS’s risk exposures. Targeted stress measures also feed into UBS’s earnings-at-risk and capital-at-risk metrics. The VaR results beyond the 99% confidence level are an- alyzed to better understand the potential risks of the portfo- lio and to help identify risk concentrations. The results of this analysis are valuable in their own right and can also be used to formulate position-centric stress tests. Although the stan- dard scenarios incorporate generic elements of past market crises, more granular detail of specific historical events is provided by extreme VaR outcomes. The largest possible loss arising from UBS’s daily VaR simulation using five years of historical data is also monitored against limits as an addi- tional stress scenario. UBS applies country limits to all but the best-rated coun- tries, covering market as well as credit risks. This includes applying appropriate stress loss limits to emerging markets in aggregate as well as to individual emerging market coun- tries. The market moves envisaged in stress scenarios, including targeted stress scenarios, might prove to be less than the moves actually seen in a stress event, and actual events may differ significantly from those modeled in the stress scenarios. Most major financial institutions employ stress tests, but their approaches differ widely and there is no benchmark or industry standard in terms of scenarios or the way they are applied to an institution’s positions. The impact of a given stress scenario, even if measured in the same way across in- stitutions, depends entirely on the make-up of each institu- tion’s portfolio, and a scenario that is relevant to one institu- tion may have no relevance to another. Comparisons of stress results between institutions can therefore be highly misleading, and for this reason UBS, like most of its peers, does not publish quantitative stress results. Concentration limits and other controls d e t i d u A UBS applies concentration limits on exposures to general market risk factors and to single name exposures. The limits take account of variations in price volatility and market depth and liquidity. In the Investment Bank, limits are placed on exposures to individual risk factors. They are applied to general market risk factors such as interest rates, credit spreads, equity indi- ces and foreign exchange rates or groups of highly correlat- ed factors based on assumed moves in the risk factors broad- ly consistent with the terms of UBS’s VaR measure. Each limit applies to exposures arising from all instrument types in all trading businesses of the Investment Bank. The assumed moves in risk factors are updated in line with the VaR his- torical time series and the limits are reviewed annually or as necessary to reflect market conditions. The effectiveness of risk factor limits in controlling concentrations of risk depends critically upon the way risk positions are represented. If long and short positions are considered to be sensitive to the same risk factor, potential gains and losses from changes in that factor are netted. The steps UBS has taken in 2008 to enhance the granularity of risk representation in its VaR mea- sure are also relevant to its risk concentration controls as underlying relationships between risk factors are more clear- ly represented in VaR exposures. UBS also applies volume-based limits to certain portfolios and sub-portfolios. Additionally, UBS measures and limits the potential impact of increased default rates on the value of its portfolio of single name exposures. The Investment Bank carries exposure to single names, and therefore to event risk (including default risk). This risk is measured across all relevant instruments (debt and equity in physical form and from forwards, options, default swaps and other derivatives including basket securities) as the ag- gregate change in value resulting from an event affecting a single name or group. The maximum amount that could be lost if all underlying debt and equity of each name became worthless is also tracked. Positions are controlled in the con- 132 text of the liquidity of the market in which they are traded, and all material positions are monitored in light of changing market conditions and information on individual names. This form of single name exposure measure is most appropriate to corporate issuers, financial institutions and other entities, the value of whose equity and debt instru- ments is dependent on their own assets, liabilities and capi- tal resources. Exposures arising from security underwriting commit- ments are subject to the same measures and controls as secondary market positions. There are also governance pro- cesses for the commitments themselves, generally including review by a commitment committee with representation from business and control functions. Underwriting commit- ments are approved under specific delegated risk manage- ment and risk control authorities. d e t i d u A d e t i d u A lar monitoring and reporting. They are also included in earn- ings-at-risk and capital-at-risk metrics. Where investments are made as part of an ongoing busi- ness they are also subject to standard controls, including portfolio and concentration limits. Seed money and co-in- vestments in UBS-managed funds made by Global Asset Management are, for example, subject to a portfolio limit. All investments must be explained and justified, approved according to delegated authorities, and monitored and re- ported to senior management throughout their life. Private equity positions were, in the past, the major com- ponent of equity investments, but the portfolio has been managed down over recent years. Under International Financial Reporting Standards (IFRS), equity investments may be classified as “financial invest- ments available-for-sale”, “financial assets designated at fair value through profit or loss” or “investments in associates”. Other applications of market risk measures Market risk measurement tools may be selectively applied to portfolios for which the primary controls are in other forms. VaR can, for example, provide additional insight into the sen- sitivity of investment positions to market risk factors, even though some of the assumptions of VaR – in particular the relatively short time horizon – may not be representative of their full risk. The results can be used by business manage- ment and risk controllers for information purposes or to trig- ger action or review. Equity investments d e t i d u A UBS makes investments for a variety of purposes. Some are made for revenue generation or as part of strategic initia- tives, while others, such as exchange and clearing house memberships, are held in support of UBS’s business activi- ties. Investments may also be made in funds managed by UBS to fund or “seed” them at inception or to demonstrate alignment of UBS’s interests with those of investors. UBS has also bought and may be required to buy securities and units from funds that UBS has sold to clients. These include pur- chases of illiquid assets such as interests in hedge funds. UBS may make direct investments in a variety of entities or buy equity holdings in both listed and unlisted companies. Such investments tend to be illiquid. The fair values of equity investments are generally dominated by factors specific to the individual stocks, and the correlation of individual hold- ings to equity indices varies. Furthermore, equity investments are generally intended to be held for the medium- or long- term and may be subject to lock-up agreements. For these reasons, they are not directly controlled using the market risk measures applied to trading activities. They are, however, subject to controls, including pre-approval of new invest- ments by business management and risk control, and regu- Composition of equity investments At 31 December 2008, UBS held equity investments totaling CHF 3,653 million, of which CHF 1,681 million were classi- fied as “financial investments available-for-sale”, CHF 1,079 million as “financial assets designated at fair value” and CHF 892 million as “investments in associates”. Within “financial investments available-for-sale”, CHF 258 million are listed equities. At 31 December 2007, UBS held equity investments totaling CHF 7,690 million, of which CHF 3,583 million were classified as “financial investments available-for-sale”, CHF 2,128 million as “financial assets designated at fair value” and CHF 1,979 million as “investments in associ- ates”. Within “financial investments available-for-sale”, CHF 1,865 million are listed equities. In December 2008, UBS disposed of its equity stake in Bank of China through a placing of approximately 3.4 billion Bank of China Limited H-shares to institutional investors for a cash consideration of approximately CHF 887 million (HKD 6,519 million). UBS acquired the shares in 2005 in prepara- tion for Bank of China’s IPO to the international market. The investment in Bank of China was accounted for as a “finan- cial investment available-for-sale”. The disposal resulted in a gain of approximately CHF 360 million. Within the total of CHF 1,079 million “financial assets des- ignated at fair value”, CHF 1,058 million represents the assets of trust entities associated with employee compensation schemes. They are broadly offset by liabilities to plan partici- pants included in “other liabilities”. The equivalent positions at 31 December 2007 amounted to CHF 1,788 million. ➔ Refer to “Note 34 Significant subsidiaries and associates” in the financial statements of this report for details of significant associates 133 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control Credit risk d e t i d u A Credit risk is the risk of financial loss resulting from failure by a client or counterparty to meet its contractual obligations to UBS. This can be caused by factors directly related to the counterparty, such as business or management problems, or from failures in the settlement process, for example on for- eign exchange transactions where UBS has honored its obli- gation but the counterparty fails to deliver the counter-value (“settlement risk”). Alternatively, it can be triggered by eco- nomic or political difficulties in the country in which the counterparty or issuer of the security is based or where it has substantial assets (“country risk”). Sources of credit risk Credit risk is inherent in traditional banking products such as loans, commitments to lend and contingent liabilities (for ex- ample, letters of credit) as well as in “traded products”: deriva- tive contracts such as forwards, swaps and options; repur- chase agreements (repos and reverse repos); and securities borrowing and lending transactions. The risk control process- es applied to these products are fundamentally the same, al- though the accounting treatment varies, as they can be car- ried at amortized cost or fair value, depending on the type of instrument and, in some cases, the nature of the exposure. Many of the business activities of Global Wealth Manage- ment & Business Banking and the Investment Bank expose UBS to credit risk, while credit risk exposure is a less material concern to Global Asset Management. Global Wealth Man- agement & Business Banking offers private and corporate cus- tomers in Switzerland and wealth management clients inter- nationally a variety of credit products, although the majority of credit risks are well secured by financial collateral or other assets. The Investment Bank gives corporate, institutional, in- termediary and alternative asset management clients access to a full range of credit and capital markets instruments across all product classes, and engages with other professional coun- terparties in its trading and risk management activities. Credit risk control Limits and controls Concentrations of credit risk can arise if clients are engaged in similar activities, or are located in the same geographical region or have comparable economic characteristics such that their ability to meet contractual obligations would be similarly affected by changes in economic, political or other conditions. To avoid, as far as possible, undue credit risk con- centrations, UBS has established limits and operational con- trols to constrain credit exposure to individual counterparties d e t i d u A and counterparty groups. Where appropriate, it has also es- tablished industry and country limits and guidelines at port- folio and sub-portfolio levels. At the level of the individual counterparty and counter- party group, limits are established covering banking and traded products. These limits put constraints not only on the current outstanding amount but also on contingent commit- ments and the potential future exposure of traded products. Credit engagements may not be entered into without the appropriate approvals and adherence to these limits. In the Investment Bank, at a portfolio level a distinction is made between those exposures which are to be held to ma- turity (“take and hold exposures”) and those which will be held only over the short term, pending distribution or risk transfer (“temporary exposures”). Most limits and operational controls constrain the credit exposure of a sub-portfolio, but UBS also has limits that restrict the credit risk of a whole port- folio using credit risk measures such as stress loss, as described below. Such limits are applied for instance to the Investment Bank’s leveraged lending portfolio, where the impact of varia- tions in default rates and asset prices is considered, together with market liquidity and UBS’s distribution capabilities. Risk mitigation Taking collateral is the most common way to mitigate credit risk. Loans to wealth management clients (“lombard lend- ing”) are made against the pledge of sufficient eligible mar- ketable securities or cash. For real estate financing, a mort- gage over the relevant property is taken to secure the claim. The Investment Bank also takes financial collateral in the form of marketable securities in much of its over-the-counter (OTC) derivatives activities and in its securities financing busi- ness (securities lending and borrowing or repurchase and re- verse repurchase). To ensure with a high degree of certainty that the collateral value will cover the exposure, discounts (“haircuts”) are generally applied to the current market val- ue. These reflect the quality, liquidity, volatility and, in some cases, the complexity of the individual instruments. Expo- sures and collateral values are continuously monitored, and margin calls or close-out procedures are enforced, when the market value of collateral falls below a predefined trigger level. Concentrations within individual collateral portfolios and across clients are also monitored where relevant and may affect the discount applied to a specific collateral pool. The OTC derivatives business is generally conducted under bilateral master agreements, which typically allow for the close-out and netting of all transactions in the event of de- fault. UBS also has two-way collateral agreements with all major market participants, under which either party can be 134 d e t i d u A d e t i d u A required to provide collateral in the form of cash or market- able securities when exposure exceeds a predefined level. The OTC derivatives business with lower-rated counterparties is generally conducted under one-way collateral agreements where only the counterparty is required to provide UBS with cash or very liquid collateral. For certain counterparties, like hedge funds, UBS may use two-way collateral agreements. UBS has policies for netting and collateral agreements, includ- ing requiring a legal opinion that contracts are enforceable in the case of insolvency in the relevant jurisdictions. The Investment Bank also utilizes credit hedging to actively manage the credit risk of its portfolios, with the goal of reduc- ing concentrations in individual names, sectors or specific port- folios. The Investment Bank utilizes a number of different hedg- ing measures which include single name credit default swaps (CDS), index CDS, credit linked notes and total return swaps. Single name CDS are generally executed under bilateral netting and collateral agreements, with high-grade market counterpar- ties. For the purposes of monitoring against limits, UBS ob- serves strict standards. Credit hedges are only recognized as a risk mitigant if they are single name credit default swaps, total return swaps or credit linked notes. They must cover potential credit exposure increases to a high level of confidence, and of- fer protection against a wide range of credit events. Other cred- it risk mitigants such as proxy hedges (credit protection on a correlated but different name) or index CDS are not recognized for the purposes of monitoring against limits. Buying credit protection creates credit exposure against the hedge provider. The exposure to credit protection provid- ers and thus the effectiveness of credit hedges is monitored as part of the overall credit exposure against the relevant names. Where there is significant correlation between the counterparty and the hedge provider (so-called “wrong-way risk”), UBS’s policy is not to recognize any benefit in credit risk measures. Credit risk measurement Credit risk measurement is an essential component of the credit risk control framework. The measurement of credit ex- posure from a loan which is fully drawn is straightforward. By contrast, the estimation of credit exposure on a traded prod- uct, the value of which varies with changes in market vari- ables, interim cash flows and the passage of time, is more complex and requires the use of models. The assessment of portfolio risk also entails estimations of the likelihood of de- faults occurring, of the associated loss ratios if they do, and of default correlations between counterparties. UBS has developed tools to support the quantification of the credit risk of individual counterparties, applying the three generally accepted parameters: probability of default, expo- sure at default and loss given default. Models are also used to derive the portfolio risk measures expected loss, statistical loss and stress loss. Credit risk parameters Three parameters are used to measure and control individual counterparty credit risk: – The probability of default is an estimate of the likelihood of the client or counterparty defaulting on its contractual obligations. This probability is assessed using rating tools tailored to the various categories of counterparties. These categories are also calibrated to the UBS 15-class Master- scale (UBS’s proprietary credit rating scale) to ensure consistency in the quantification of default probabilities across counterparties. Besides their use for credit risk measurement, ratings are an important element in setting credit risk approval authorities. – Exposure at default is derived from the current exposure to the counterparty and its possible future development. For traded products such as OTC derivatives, the exposure at default is not a definitive number – it must be derived by modeling the range of possible outcomes. In measur- ing individual counterparty exposure against credit limits, UBS considers the maximum likely exposure measured to a high confidence level over the full life of all outstanding obligations. However, when aggregating exposures to different counterparties for portfolio risk measurement, the expected exposure to each counterparty at a given time horizon (usually one year) generated by the same model is used. – The loss given default is determined based on the likely recovery rate of defaulted claims, which is a function of the type of counterparty and any credit mitigation or sup- port (such as security or guarantee). These parameters are the basis for most internal mea- sures of credit risk. They are also key inputs to the regulatory capital calculation under the advanced Internal Rating Based approach of the new Basel Capital Accord (Basel II), which UBS adopted from 1 January 2008, when the accord came into force. ➔ Refer to the discussion on rating system design and estimation of credit risk parameters below for a more detailed description of the three credit risk parameters discussed above Expected loss Credit losses must be anticipated as an inherent cost of do- ing business. But the occurrence of credit losses is erratic in both timing and amount, and those losses that do arise usu- ally relate to transactions entered into in previous accounting periods. In order to reflect the fact that future credit losses are implicit in today’s portfolio, UBS uses the concept of “ex- pected loss”. Expected loss is a statistical concept which is used to esti- mate the annual costs that are expected to arise, on average, from positions in the current credit portfolio that become impaired. The expected loss for a given credit facility is a function of the three components described above: proba- 135 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control bility of default, exposure at default and loss given default. The expected loss figures for individual counterparties are aggregated to derive the expected credit loss for the whole portfolio. Expected loss is the basis for quantifying credit risk in all portfolios. It is an input used to value or price some prod- ucts. Expected loss is also the starting point for the measure- ment of portfolio statistical loss and stress loss. ➔ Refer to the discussion on credit loss expense below for more information Stress loss Stress loss is a scenario-based measure which complements the statistical model. It is used to assess potential loss in var- ious extreme but plausible scenarios in which it is assumed that one or more of the three key credit risk parameters de- teriorates substantially according to a pattern that is typical for the chosen scenario. Stress tests are run regularly, and on an ad hoc basis as necessary, in order to identify adverse portfolio situations, particularly risk concentrations. All sce- nario results are monitored, and for certain portfolios and segments, stress loss is subject to limits. Statistical loss UBS uses a statistical model – credit Value at Risk (“credit VaR”) – to estimate the potential loss on the portfolio over one year measured to a specified level of confidence. The shape of the modeled loss distribution is driven by system- atic default relationships amongst counterparties within and between segments. The results of this analysis provide an indication of the level of risk in the portfolio, and the way it develops over time. It is also an important input to the over- all risk measures earnings-at-risk and capital-at-risk. d e t i d u A ➔ Refer to the discussion on earnings-at-risk and capital-at- risk in the “Risk management and control” section of this report for more information Composition of credit risk – UBS Group The measures of credit risk used by UBS may differ depend- ing on the purpose for which exposures are aggregated: fi- nancial accounting under the International Financial Report- ing Standards (IFRS); determination of regulatory capital; or UBS’s own internal management view (i.e. the economic risk of the credit portfolio which reflects how that risk is man- aged by UBS). The table “Exposure to credit risk – UBS Group” below begins with the IFRS view (“maximum expo- sure to credit risk”), and shows the adjustments required to reconcile to the internal management view (“Credit expo- sure before hedges”). Exposure to credit risk – UBS Group d e t i d u A For the year ended 31.12.2008 31.12.2007 CHF million Balances with central banks Due from banks Loans Contingent claims Undrawn irrevocable credit facilities Banking products Derivative instruments Securities lending / borrowing Repurchase / reverse repurchase agreements IFRS 1 reported values Maximum exposure to credit risk 2 29,156 Adjustments: Maximum exposure to internal risk view (45,419) (68,627) (807) (3,326) (118,179) (626,448) 64,451 340,308 19,699 60,316 513,930 854,100 122,897 224,648 } Credit exposure before hedges 3 29,156 19,032 271,681 18,892 56,990 395,750 227,652 Credit exposure after hedges 4 IFRS 1 reported values Maximum exposure to credit risk 2 16,433 Credit exposure before hedges 3 16,434 Credit exposure after hedges 4 347,900 60,907 26,304 335,864 285,093 20,824 83,980 518,008 428,217 207,063 376,928 20,347 80,971 429,149 184,809 58,896 } 377,622 (300,694) 46,851 Traded products 1,201,645 (927,142) 274,503 263,677 1,012,208 243,704 237,790 Financial assets designated at fair value – debt instruments Financial Investments available-for-sale – debt intruments Trading portfolio assets – debt instruments Accrued income Other assets Irrevocable commitments to acquire ARS Other products Total at the year-end 5,153 3,567 224,862 3,238 6,189 16,571 259,580 4,116 1,383 376,928 9,200 12,874 N/A 404,501 1,975,155 (1,304,902) 670,253 611,577 1,934,717 672,853 615,412 1 International Financial Reporting Standards (IFRS). 2 These amounts are considered the best representation of “maximum exposure to credit risk” as defined by the IFRS, without taking into account  credit conversion factors for off-balance sheet positions. 3 Includes temporary exposure, before risk transfer, deduction of collateral and risk mitigation. 4 Exposure after risk transfer, deduction of allowances, provisions, credit valuation adjustments, credit default swaps and credit linked notes. 136 d e t i d u A In the tables in this section the internal management view of credit risk exposure is based on a revised measurement methodology for traded products compared with 2007. The 2007 numbers have been restated accordingly. The method- ology was refined to reflect the internal reporting methods used in the business divisions. d e t i d u A In general, the exposures shown in the tables are gross and do not reflect the benefit of security held or other risk mitigation employed, such as hedging and risk transfers. The main differences between the internal management and IFRS views of gross credit exposure are: – Cash collateral posted by UBS against negative replace- ment values of derivative instruments and other positions is reported on a gross basis for IFRS purposes. For internal management purposes these exposures are treated on a net basis after factoring in an assessment of the counter- party risk on the underlying positions. – For internal management purposes netting is applied for positive and negative replacement values with the same counterparty, where the business is conducted under a le- gally enforceable netting agreement. Under IFRS, netting is applied on a more restrictive basis. Refer to “Note 1 Sum- mary of significant accounting policies” in the financial state- ments of this report for further information on IFRS netting. – Under IFRS, securities lending / borrowing and repur- chase / reverse repurchase transactions are shown on the balance sheet as UBS’s full claim on the counterparty without recognizing the counterclaim which the counter- party has for return of cash or securities on the same transactions. By contrast, for internal risk control purpos- es, the claims on and counterclaims from each counter- party are considered on each transaction on a net basis, and further netted across transactions where such netting is considered to be legally enforceable in insolvency. – All positions that were reclassified in fourth quarter from the “held for trading” to the “loans and receivables” cate- gory are included as loans under the IFRS reported expo- sures. Refer to the “Financial performance” section and “Note 29 Measurement categories of financial assets and liabilities” in the financial statements of this report for more information. However, for the purposes of providing a breakdown of UBS’s lending portfolios, only the loan un- derwriting positions are included in the internal manage- ment view of loan exposures. All reclassified positions are d e t i d u A Gross credit exposure by UBS internal ratings – UBS Group CHF million UBS internal rating 0–1 2–3 4–5 6–8 9–13 Total 0–13 (net of past due) Defaulted Past due but not defaulted Other 1 Total 1 Includes Global Asset Management and the Corporate Center. Gross credit exposure by business division Banking products Traded products Total exposure 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 27,462 128,763 108,963 89,865 27,327 21,367 157,221 121,940 81,959 40,913 55,729 150,364 42,055 14,933 2,852 382,380 423,400 265,933 6,909 7,622 3,526 2,222 2,468 2,268 1,013 60,463 144,317 23,394 12,300 2,123 242,597 1,013 83,191 279,127 151,018 104,798 30,180 648,313 14,531 3,526 3,883 81,830 301,538 145,334 94,259 43,036 665,997 3,481 2,268 1,107 1,661 94 395,750 429,149 274,503 243,704 670,253 672,853 t n e m e g a n a m y r u s a e r t d n a k s i R Global Wealth Management & Business Banking Investment Bank Other 1 UBS 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 CHF million Balances with central banks Due from banks Loans Financial assets designated at fair value Contingent claims Undrawn irrevocable credit facilities Banking products Derivatives Securities financing transactions Traded products Total credit exposure, gross Net of impairment losses recognized 1 Includes Global Asset Management and the Corporate Center. 17,629 6,606 9,992 8,236 226,183 240,643 0 14,687 2,789 0 15,929 2,081 267,893 276,881 8,353 12,747 21,100 288,993 287,774 14,039 13,023 27,061 303,942 302,974 11,528 12,044 37,230 6,576 4,056 54,201 125,636 218,482 33,260 251,742 377,378 370,494 6,441 17,532 39,725 4,166 4,500 78,890 151,254 170,677 45,873 216,550 367,804 366,882 0 382 730 961 149 0 2,222 817 844 1,661 3,883 3,883 1 535 466 0 11 0 1,013 94 0 94 1,107 1,107 29,157 19,032 16,434 26,303 264,143 280,834 7,537 18,892 56,990 395,750 227,652 46,851 274,503 670,253 662,151 4,166 20,440 80,971 429,149 184,810 58,896 243,704 672,853 670,963 137 Risk and treasury management Risk management and control d e t i d u A d e t i d u A subject to appropriate portfolio limits and risk controls, in- cluding earnings-at-risk and capital-at-risk metrics. The redesignated assets comprised: monoline protected assets (USD 5.7 billion); US reference-linked program (USD 1.1 billion); US commercial real estate (USD 3.4 billion); lever- aged finance (USD 2.3 billion); student loan auction rate se- curities (USD 7.9 billion); and other assets (USD 2.3 billion). Exposure amounts provided were the carrying values on 31 December 2008. The exposures relating to monoline-pro- tected assets, leveraged finance and student loan auction rate securities are included in the respective asset class disclo- sures in the “Risk concentrations” section of this report. Note that under US Generally Accepted Accounting Prin- ciples (GAAP), a greater degree of netting is permitted than under IFRS for OTC derivatives replacement values and for securities lending / borrowing and repurchase / reverse repur- chase transactions. UBS’s balance sheet figures for these types of transactions are not directly comparable with those of firms which report under US GAAP. As explained in the credit risk measurement section, UBS also measures, and generally applies limits to, credit exposures to individual counterparties and counterparty groups. It also measures risk across counterparties at various portfolio and sub-portfolio levels. In these calculations UBS further consid- ers the potential development of replacement values of trad- ed products over time as market risk factors change, interim payments are made and transactions mature, all of which can significantly alter the risk exposure profile. These potential developments are not reflected in the various tables in this section, which reflect only the current exposures. The credit risk exposure reported in the table “Exposure to credit risk – UBS Group” in this section excludes UBS’s participa- tion in the deposit insurance guarantee scheme under Swiss banking law, according to which Swiss banks and securities dealers are required to jointly guarantee an amount of up to CHF 6 billion for privileged client deposits in the event that another Swiss bank or securities dealer becomes insolvent. For the period 20 December 2008 to 30 June 2009 FINMA has established UBS’s share in the deposit insurance as CHF 1,192 million. Total gross credit exposure amounted to CHF 670.3 billion on 31 December 2008, a decrease of CHF 2.6 billion since the end of the previous year. Banking products decreased by CHF 33 billion mainly driven by reductions in loans and un- drawn irrevocable commitments partially compensated by higher balances with central banks, while the traded products category increased by CHF 31 billion due to a significant increase in the derivatives line of CHF 43 billion, partially com- pensated by a reduction of CHF 12 billion for securities financ- ing transactions. The reduction in loan exposure was mainly due to a reduction in the collateralized lending activity in Global Wealth Management & Business Banking. The Invest- ment Bank continued to actively reduce credit risk. The quality of the gross unimpaired credit portfolio im- proved as the investment grade component (internal rating grades 0–5) remained at 79%. 138 The table “Gross credit exposure by business division” on the previous page shows the gross credit exposure (i. e. with- out recognition of credit hedges, collateral or other risk mit- igation) by business division. The largest contributor to gross credit exposure at CHF 291 billion is the lending portfolio (due from banks CHF 19 billion, loans CHF 264 billion, and “financial assets desig- nated at fair value” CHF 8 billion) which represents 43% of total gross credit exposure and 73% of total banking prod- ucts exposure. Within this lending portfolio, CHF 233 billion (80%) is attributable to Global Wealth Management & Busi- ness Banking. Traded products exposure is incurred predom- inantly by the Investment Bank. The sections below provide further details of products, industry and rating distributions in the business division portfolios. The property financing portfolio is diversified and limits per counterparty ensure that no single property exposure presents an undue concentration. Exposure to providers of credit protection, usually in the form of credit derivatives, is controlled by the overall credit limit for the counterparty, which is typically a high-grade fi- nancial institution. Composition of credit risk (business divisions) Global Wealth Management & Business Banking The total gross banking products exposure of Global Wealth Management & Business Banking was CHF 268 billion on 31 December 2008 down by CHF 9.0 billion or 3% from a year earlier. The high quality of the banking products expo- sure, with 64% in the investment grade category is demon- strated by the rating distribution on the next page. The intro- duction of a revised credit risk framework was aimed at improving statistical credit risk measurement and reinforcing the link between the credit assessment and pricing. This re- sulted in a decrease in counterparty rating on average by one rating class as shown in the table on the next page by the increase in category 6 sub-investment grade exposures. The distribution of the exposure across UBS’s internal rating and Global Wealth Management & Business Banking:   composition of lending portfolio, gross (excluding repurchased ARS positions) In % On 31.12.08 3 10 27 9 11 Due from banks Unsecured loans Commercial mortgages Multi-family homes Single family homes and apartments Loans secured by marketable securities 40 3RM013_e loss given default (LGD) buckets as displayed in the table on the next page shows that the majority of the exposure is from products attracting the lowest LGDs, demonstrating the con- tinued improvement in the quality of this portfolio (refer to the “UBS internal rating scale and mapping of external rat- ings” table in the “Rating system design and estimation of credit risk parameters” section for more information). Global Wealth Management & Business Banking’s gross len ding portfolio (due from banks and loans) on 31 De- cember 2008 amounted to CHF 233 billion, of which CHF 142 billion (60%) was secured by real estate and CHF 62 bil- lion (27%) by marketable securities. The pie chart on the previous page shows that exposure to real estate is well diversified, with 40% of the gross lending portfolio being secured on single family homes and apartments, which gen- erally have exhibited a low risk profile. The 11% of exposure secured by residential multi-family homes consists of rented apartment buildings. Loans and other credit engagements with individual clients, excluding mortgages, amounted to CHF 91 billion and are predominantly extended against the pledge of marketable securities. The volume of collateralized lending to private individuals decreased by CHF 16 billion or 20% from the previous year. This was mainly due to substan- tial deleveraging by clients. As of 31 December 2008 more Global Wealth Management & Business Banking: banking products, gross by UBS internal rating  As a % of Global Wealth Management & Business Banking’s banking products, gross 25 20 15 10 5 0 0 and 1 2 3 4 5 6 7 8 9 10 11 12 13 Investment grade Sub-investment grade 14 Defaulted 3RM015_e 31.12.07 31.12.08 Global Wealth Management & Business Banking: distribution of banking products exposure across UBS internal rating and loss given default (LGD) buckets t n e m e g a n a m y r u s a e r t d n a k s i R On 31.12.08 CHF million UBS internal rating Gross exposure 0–25% Loss given default (LGD) buckets 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Total non-defaulted Investment grade Sub-investment grade Defaulted 1 Total banking products 1 Includes CHF 27 million of off-balance sheet items. 13,625 5,232 39,937 34,717 25,135 51,347 44,727 18,870 16,892 9,458 1,997 2,252 155 93 264,437 169,993 94,444 3,456 267,893 88 19 37,521 26,127 20,837 45,059 40,617 16,281 14,224 6,757 1,591 2,045 119 34 211,319 129,651 81,668 26–50% 13,537 5,193 2,115 8,064 3,659 5,597 3,371 2,395 2,090 1,671 402 206 36 59 48,395 38,165 10,230 211,319 48,395 51–75% 76–100% 20 301 526 639 691 736 193 567 13 3 1 3,690 2,177 1,513 3,690 3 1 11 1,017 1 1,033 1,033 1,033 Weighted average LGD (%) 39 39 20 22 14 13 13 15 17 23 20 19 19 30 18 139 25.00 18.75 12.50 6.25 0.00 Risk and treasury management Risk management and control Business Banking Switzerland: lending portfolio, gross (excluding mortgages) by industry sector  As a % of Business Banking Switzerland lending portfolio, gross (excluding mortgages) 40 30 20 10 0 Construction Banks and financial Hotels and restaurants institutions Manufacturing Private households Public authorities Real estate and rentals Retail and wholesale Services Other 3RM017_e 31.12.07 31.12.08 than 80% of loans secured by marketable securities were attributed to business outside Switzerland, of which nearly one-third relates to Wealth Management US. The Swiss lending portfolio (excluding mortgages) within the Business Banking area amounted to CHF 23 billion, rep- resenting 9% of Global Wealth Management & Business Banking’s total gross banking products exposure. It is widely spread across industries, with the majority of exposures being to banks and financial institutions, followed by public author- ities. The increase in exposures to banks and financial institu- tions was driven by additional lending to UBS fund entities. Investment Bank A substantial majority of the Investment Bank’s gross credit exposure falls into the investment grade category (internal counterparty rating classes 0 to 5) both for gross banking products (77%) and for traded products (91%). The counter- parties are primarily banks and financial institutions, multina- tional corporate clients and sovereigns. The increase in cate- gory 3 resulted from the loan to the fund managed by BlackRock. Refer to the “Loan to BlackRock fund” sidebar for more information. Banking products exposure On 31 December 2008, the Investment Bank’s total gross credit exposure from banking products amounted to CHF 125.6 billion or CHF 79.0 billion net, taking credit hedges into account. This represents a significant reduction compared to CHF 151.3 billion gross and CHF 100.7 billion net for 2007. The exposure held for distribution also reduced significantly as a consequence of the market deterioration, which resulted in mark downs of existing commitments and a substantial re- duction in new lending. The table “Investment Bank: banking products” below shows the composition of the Investment Bank’s gross banking products exposure, the hedges and oth- er risk mitigation and the net exposure in total. As described in the discussion on risk mitigation, the Investment Bank has engaged in a substantial credit risk hedging program and on 31 December 2008 had CHF 45 billion of credit hedges in place against banking products exposure. In addition certain loans captured on an accrual basis are hedged with mark-to-market hedges. To illustrate the effects of credit hedging and other risk mitigation, the first graph on the next page shows the expo- sures by counterparty rating before and after application of risk mitigation. 40 30 20 10 0 Investment Bank: banking products On CHF million 31.12.08 Investment grade Sub- investment grade Impaired and defaul- ted loans Total Gross banking products exposure Risk transfers 1 96,244 1,710 25,280 (1,764) less: specific allowances for credit losses and loan loss provisions Net banking products exposure 97,953 23,516 54 (1,526) 2,640 4,112 125,636 31.12.07 Sub- investment grade Impaired and defaul- ted loans Investment grade 103,848 2,901 46,755 (2,864) Total 151,254 (126) 151,128 651 (37) (126) 488 (1,526) 0 0 124,110 106,749 43,891 less: credit protection bought (credit default swaps, credit-linked notes) 2 Net banking products exposure, after application of credit hedges of which: held for distribution (38,388) (6,690) (28) (45,106) (43,012) (7,391) (29) (50,432) 59,566 3,685 16,826 2,808 2,612 79,004 63,737 11,091 36,500 20,160 459 100,696 1 Risk transfers include unfunded risk participations. Risk participations are shown as a reduction in exposure to the original borrower and corresponding increase in exposure to the participant bank. 2 Notional amount of credit protection bought on net banking products exposure includes credit default swaps (CDSs) and the funded portion of structured credit protection purchased through the issu- ance of credit-linked notes (CLNs). 140 Additionally, the matrix on page 142 shows the dis- tribution of the Investment Bank’s net banking products exposure after application of risk mitigants, across UBS inter- nal rating classes and loss given default buckets. Mitigants include risk participations and single name credit default swaps. No offset is given for portfolio hedges. There is a con- centration in the 26–50% bucket where most senior secured and unsecured claims fall. Sub-investment grade exposure in aggregate was reduced by CHF 3.3 billion (21%). It should be noted that exposure distributions shown elsewhere in this section refer only to gross or net exposure and do not take recovery expectations into account (refer to the “UBS inter- nal rating scale and mapping of external ratings” table in the “Rating system design and estimation of credit risk parame- ters” section below for more information). Net banking products exposure after application of credit hedges continues to be diversified across industry sectors. At 31 December 2008, the largest exposures were to regulated banks (30%) and financial institutions (28%). The increase in bank exposures resulted from higher nostro (a bank’s current account with another bank) positions and the loan to the fund managed by BlackRock resulted in an increase in the financial institutions category. Refer to the “Loan to Black- Rock fund” sidebar for more information. Investment Bank: banking products exposure by UBS internal rating As a % of Investment Bank banking products exposure 30 20 10 0 0 and 1 2 3 4 5 6 7 8 9 10 11 12 13 Investment grade Sub-investment grade 31.12.07 Gross 31.12.07 Net after credit hedges 31.12.08 Gross 31.12.08 Net after credit hedges 14 Defaulted 3RM019_e Investment Bank: banking products exposure¹ by industry sector As a % of Investment Bank banking products exposure 30 20 10 0 Banks Chemicals Electricity, gas, water supply Financial institutions Manufacturing Mining Public authorities Retail and wholesale Transport, storage and communication Other 31.12.07 31.12.08 1 Net banking products exposure, after application of credit hedges. Investment Bank: banking products exposure¹ by geographical region As a % of Investment Bank banking products exposure 3RM021_e t n e m e g a n a m y r u s a e r t d n a k s i R 60 45 30 15 0 Switzerland Other Europe North America Latin America Asia / Pacific Africa / Middle East 31.12.07 31.12.08 1 Net banking products exposure, after application of credit hedges. 3RM021b_e 141 40 40 30 30 20 20 10 10 0 0 30.0 22.5 15.0 7.5 0.0 60 45 30 15 0 Risk and treasury management Risk management and control Investment Bank: distribution of net banking products exposure across UBS internal rating and loss given default buckets On 31.12.08 CHF million UBS internal rating 0 and 1 2 3 4 5 6 7 8 9 10 11 12 13 Total non-defaulted Investment grade Sub-investment grade Defaulted Net banking products exposure Exposure 8,291 16,292 22,223 9,068 3,692 2,254 2,321 1,419 3,811 1,682 4,430 687 221 76,391 59,566 16,826 2,612 79,004 Loss given default (LGD) buckets 0–25% 3,201 11,083 1,213 341 1,017 334 133 1,930 598 1,303 473 122 21,749 15,839 5,910 531 22,280 26–50% 8,291 10,675 9,360 6,604 2,306 732 1,499 948 1,473 707 2,705 128 99 45,528 37,237 8,291 1,520 47,048 51–75% 76–100% 776 630 943 821 427 388 285 223 293 205 82 5,073 3,169 1,903 467 5,539 1,641 1,150 307 224 78 100 53 184 85 217 3 4,042 3,321 721 95 4,137 Weighted average LGD (%) 49 45 30 35 48 32 37 34 19 34 21 23 21 39 39 26 37 36 Loan to BlackRock fund As reported in second quarter 2008, UBS sold a portfolio of US RMBSs for proceeds of USD 15 billion to the RMBS Opportunities Master Fund, LP (the “RMBS fund”), a special purpose entity managed by BlackRock, Inc. The RMBS fund was capitalized with approximately USD 3.75 billion in equity raised by BlackRock from third-party investors and an eight-year amortizing USD 11.25 billion senior secured loan provided by UBS. Since its inception, the RMBS fund has amortized the loan through monthly payments in line with UBS’s original expectations. On 31 December 2008, the loan had a balance outstanding of USD 9.2 billion. UBS does not consoli- date the RMBS fund into its balance sheet as the equity investors in the RMBS fund continue to bear and receive the majority of the risks and rewards. UBS continues to monitor the development of the RMBS fund’s performance and would reassess the consolidation status if deterioration of the underlying mortgage pools related to the RMBSs were to indicate that UBS may not fully recover the loan granted to the RMBS fund. 142 Settlement risk Settlement risk arises in transactions involving exchange of value when UBS must honor its obligation to deliver without first being able to determine that the counter-value has been received. UBS continues to reduce its actual settlement vol- ume by the same proportions as in previous years through the use of multilateral and bilateral agreements. In 2008 settlement risk on 78% of gross settlement vol- umes was eliminated through risk mitigation. The most sig- nificant source of settlement risk is foreign exchange trans- actions. UBS is a member of Continuous Linked Settlement (CLS), a foreign exchange clearing house which allows trans- actions to be settled on a delivery versus payment basis, thereby significantly reducing foreign exchange-related set- tlement risk relative to the volume of business. The propor- tion of UBS’s overall gross volumes settled through CLS in- creased to 55% during 2008 compared to 53% in 2007. In 2008 UBS’s CLS volume with other CLS settlement members was 72%, which is comparable to 2007. While the number of CLS settlement members is relatively stable, in 2008 the number of third-party participants that UBS dealt with in- creased considerably from 2007. Risk reduction by other means – primarily account to ac- count settlement and payment netting – fell correspondingly to 23% of gross volumes in 2008 compared to 26% in 2007. The avoidance of settlement risk through CLS and other means does not, of course, eliminate the credit risk on for- eign exchange transactions resulting from changes in ex- change rates prior to settlement. Such counterparty risk on forward foreign exchange transactions is measured and con- trolled as part of the overall credit risk on OTC derivatives. Country risk UBS assigns ratings to all countries to which it has exposure. Sovereign ratings express the probability of occurrence of a country risk event that would lead to impairment of UBS’s claims. The default probabilities and the mapping of external ratings of the major rating agencies are the same as for counterparty rating classes (as described under “Probability of default”). In the case of country ratings, rating classes 10 Emerging markets exposure by UBS internal rating category In % On 31.12.08 25 Investment grade Sub-investment grade 75 to 13 are designated “very high risk” while the lowest rating class 14 contains countries in outright default. For all countries rated three and below, UBS sets country risk ceilings approved by the Board of Directors or under del- egated authority. The country risk ceiling applies to all UBS’s exposures to clients, counterparties or issuers of securities from the country, and to financial investments in that coun- try. Country risk measures cover both cross-border transac- tions and investments, and local operations undertaken by all UBS branches as well as by subsidiaries in countries where the risk is material. Extension of credit, transactions in traded products and positions in securities may be denied on the basis of a country ceiling, even if exposure to the name is otherwise acceptable. From a country risk control perspective, exposures to emerging markets are considered the most relevant, there- fore additional information is provided in this section cover- ing exposure to countries that UBS groups under the emerg- ing market category. Losses due to counterparty or issuer default resulting from multiple insolvencies (“systemic risk”) or general prevention of payments by authorities (“transfer risk”) are the most signifi- cant effects of a country crisis, but for internal measurement and control of country risk UBS also considers the probable fi- nancial impact of market disruptions arising prior to, during and following a country crisis. These might take the form of a severe deterioration in the country’s debt and equity markets and asset prices, and a sharp depreciation of the currency. Emerging markets exposure by major geographical area and product type CHF million On Emerging Europe Emerging Asia Emerging America Middle East / Africa Total Temporary exposures 1 Total Banking products Traded products Financial investments Tradable assets 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 3,706 16,460 6,802 5,747 32,715 738 5,439 22,039 8,778 5,007 41,263 3,049 1,454 3,594 1,491 1,338 7,877 1,590 5,653 1,486 2,414 1,177 7,059 2,157 3,980 1,071 6,210 2,288 1,603 211 879 167 0 11,143 14,373 11,172 1,257 151 2,123 150 0 2,424 864 4,928 2,987 429 9,208 2,627 8,053 4,854 990 16,524 1 Temporary exposures are loan underwritings which are held short-term, pending syndication, sale or hedging. They are not included in the regional sub-total or overall total. 143 3RM022_e t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control The potential financial impact of severe emerging mar- kets crises is assessed by stress testing. This entails identify- ing countries that might be subject to a potential crisis event and determining potential loss and making conservative as- sumptions about potential recovery rates depending on the types of transaction involved and their economic importance to the affected countries. Country risk exposure Exposure to emerging market countries amounted to CHF 32.7 billion on 31 December 2008, compared with CHF 41.3 billion on 31 December 2007. Of this amount, CHF 24.6 bil- lion or 75% was to investment grade countries based on UBS’s internal ratings-based approach. The reduction of CHF 8.5 billion in total emerging markets exposure arose to a large extent in Asia. The pie chart on the previous page shows UBS’s emerging market country exposures (excluding those which are tem- porary exposures) on 31 December 2008, based on the main country rating categories. The table on the previous page analyzes emerging market country exposures by major geo- graphical area and product type on 31 December 2008 compared with 31 December 2007. Temporary exposures arising from loan underwriting in these markets are shown separately in the table. Impairment and default – distressed claims d e t i d u A UBS has a number of classifications for distressed claims. A loan carried at amortized cost is considered to be “past due” when a significant payment has been missed. Any claim, re- gardless of accounting treatment, is classified as “impaired” if UBS considers it probable that a loss will result on that claim due to the obligor’s inability to meet its obligations according to the contractual terms, and after realization of any available collateral. “Obligations” in this context include interest pay- ments, principal repayments or other payments due, for ex- ample under an OTC derivative contract or a guarantee. The recognition of impairment in the financial statements depends on the accounting treatment of the claim. For prod- ucts carried at amortized cost, impairment is recognized through the creation of an allowance or provision, which is charged to the income statement as credit loss expense. For products recorded at fair value such as derivatives, impair- ment is recognized through a credit valuation adjustment, which is charged to the income statement through the “Net trading income” line. UBS has policies and processes to ensure that the carrying values of impaired claims are determined in compliance with IFRS on a consistent and fair basis, especially for those im- paired claims for which no market estimate or benchmark for the likely recovery value is available. The credit controls ap- plied to valuation and workout are the same for both amor- tized cost and fair-valued credit products. Each case is assessed d e t i d u A on its merits, and the workout strategy and estimation of cash flows considered recoverable are independently approved. Credit officers monitor derivative counterparties for de- fault or impairment using generally the same principles and processes as used for loans. In the event that a derivatives counterparty defaults on its obligations a specific credit valu- ation adjustment (CVA) is established by the credit officer. Portfolios of claims carried at amortized cost with similar credit risk characteristics are also assessed for collective im- pairment. A portfolio is considered impaired on a collective basis if there is objective evidence to suggest that it contains impaired obligations but the individual impaired items can- not yet be identified. Portfolios considered impaired on a collective basis are not included in the totals of impaired loans in the tables shown in the discussion of the composi- tion of credit risk for business divisions in the “Credit risk” section of this report. The assessment of collective impairment differs depend- ing on the nature of the underlying obligations. In UBS’s re- tail businesses, where delayed payments are routinely seen, UBS typically reviews individual positions for impairment only after they have been in arrears for a certain time. To cover the time lag between the occurrence of an impairment event and its identification, collective loan loss allowances are established, based on the expected loss measured for the portfolio over the average period between trigger events and their identification for individual impairments. Collective loan loss allowances of this kind are not required for corpo- rate and investment banking businesses because individual counterparties and exposures are continuously monitored and impairment events are identified at an early stage. Additionally, for all portfolios, UBS assesses each quarter – or on an ad hoc basis if necessary – whether there have been any previously unforeseen developments which might result in impairments that cannot be immediately identified individually. Such events could be stress situations such as a natural disaster or a country crisis, or they could result from structural changes in, for example, the legal or regulatory en- vironment. To determine whether an event-driven collective impairment exists, a set of global economic drivers is regularly assessed for the most vulnerable countries and, on a case- by- case basis, the impact of specific potential impairment events since the last assessment is reviewed. Again, the expected loss parameters of the affected sub-portfolios are the starting point for determining the collective impairment, adjusted as necessary to reflect the severity of the event in question. Past due but not impaired loans Past due but not impaired loans have suffered missed pay- ments but are not considered impaired because UBS expects ultimately to collect all amounts due under the contractual terms of the loans or with equivalent value. Compared with 31 December 2007, the past due expo- sure decreased CHF 0.5 billion at 31 December 2008. 144 Past due but not impaired loans d e t i d u A CHF million 1–10 days 11–30 days 31–60 days 61–90 days > 90 days Total On 31.12.08 31.12.07 522 89 272 331 547 1,761 515 1,381 74 36 262 2,268 Impaired loans, allowances and provisions The table below shows that allowances and provisions for credit losses increased 184%, to CHF 2,927 million on 31 December 2008 from CHF 1,031 million on 31 December 2007. Refer to “Note 9b Due from banks and loans” in the financial statements of this report for more information on the changes in allowances and provisions for credit losses during the year. The gross impaired lending portfolio increased signifi- cantly to CHF 9,145 million on 31 December 2008 from CHF 2,392 million on 31 December 2007. This was largely driven by the reclassification of certain financial instruments, some of which carried impairments, in addition to various real estate-related positions that were also considered im- paired during the year. Refer to “Note 29 measurement d e t i d u A categories of financial assets and liabilities” in the financial statements and the “Financial performance” sections of this report for more information. The ratio of the impaired lending portfolio to the total lending portfolio (both measured gross) deteriorated to 2.2% on 31 December 2008 from 0.6% on 31 December 2007. Loans or receivables with a carrying amount of CHF 224 million and CHF 126 million were reclassified from impaired to performing during 2008 and 2007 respectively. This reclassifi- cation was made either because the loans had been renegoti- ated and the new terms and conditions met normal market criteria for the quality of the obligor and type of loan, or be- cause there had been an improvement in the financial posi- tion of the obligor, enabling it to repay any past due amounts Allowances and provisions for credit losses 1 CHF million On Due from banks Loans Total lending portfolio, gross 3 Allowances for credit losses Total lending portfolio, net Impaired lending portfolio, gross Estimated liquidation proceeds of collateral for impaired loans Impaired lending portfolio, net of collateral Allocated allowances for impaired lending portfolio Other allowances and provisions Total allowances and provisions for credit losses in lending portfolio Allowances and provisions for credit losses outside of lending portfolio Ratios Allowances and provisions as a % of total lending portfolio, gross Impaired lending portfolio as a % of total lending portfolio, gross Allocated allowances as a % of impaired lending portfolio, gross Allocated allowances as a % of impaired lending portfolio, net of collateral Global Wealth Management & Business Banking Investment Bank Other 2 UBS 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 6,606 230,684 237,290 8,237 240,641 248,878 57,485 111,798 169,282 52,164 95,760 147,924 (1,195) (908) (1,733) (123) 382 730 1,113 0 534 466 1,000 64,473 343,213 407,685 60,935 336,867 397,802 0 (2,927) (1,031) 236,095 247,970 167,550 147,801 1,113 1,000 404,758 396,771 2,998 1,820 6,147 (1,594) 1,404 1,171 24 1,195 24 0.5 1.3 39.1 83.4 (740) 1,080 874 34 908 60 0.4 0.7 48.0 80.9 (2,336) 3,811 1,733 0 1,733 119 1.0 3.6 28.2 45.5 572 (364) 208 123 0 123 73 0.1 0.4 21.5 59.1 0 0 0 0 0 0 0 0.0 0.0 0.0 0.0 0 0 0 0 0 0 0 0.0 0.0 0.0 0.0 9,145 2,392 (3,930) 5,215 2,904 24 (1,104) 1,288 997 34 2,927 1,031 143 133 0.7 2.2 31.8 55.7 0.3 0.6 41.7 77.4 145 1 Figures reflect IFRS reported values.    2 Includes Global Asset Management and the Corporate Center. 3 Excludes loans designated at fair value. t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Risk management and control d e t i d u A d e t i d u A Impaired assets by type of financial instrument CHF million Impaired loans Impaired contingent claims Defaulted derivatives contracts Defaulted securities financing transactions Total 31.12.08 Total 31.12.07 such that future principal and interest are deemed to be fully collectible in accordance with the original contractual terms. Collateral held against the impaired loans portfolio con- sists in most cases of real estate. It is UBS policy to dispose of foreclosed real estate as soon as practicable. The carrying amount of foreclosed property recorded in the balance sheet under “Other assets” at the end of 2008 and 2007 amount- ed to CHF 280 million and CHF 122 million respectively. UBS seeks to liquidate collateral in the form of financial assets in the most expeditious manner, at prices considered fair. This may require that it purchases assets for its own ac- count, where permitted by law, pending orderly liquidation. The table “Impaired assets by type of financial instru- ment” above includes not only impaired loans, but also im- paired off-balance sheet claims and defaulted derivatives and repurchase / reverse repurchase contracts, which are subject to the same workout and recovery processes. The impaired assets of CHF 15.7 billion increased signifi- cantly as a consequence of the market turbulence in 2008. After deducting allocated specific allowances, provisions and credit valuation adjustments of CHF 7.2 billion and the estimated liquidation proceeds of collateral of CHF 3.9 billion, net impaired assets amounted to CHF 4.5 billion in 2008. Credit loss expense UBS’s financial statements are prepared in accordance with IFRS. Under IFRS the credit loss expense charged to the in- come statement in any period is the sum of net allowances and direct write-offs minus recoveries arising in that period, i.e. the credit losses actually experienced. In 2008, UBS experienced a net credit loss expense of CHF 2,996 million, of which CHF 1,329 million was due to impair- ment charges taken on reclassified financial instruments in the Investment Bank. This was mainly due to an impairment charge taken against a client in the petrochemical industry, excluding any benefit from hedges. In comparison, UBS re- corded a net credit loss expense of CHF 238 million in 2007. The Investment Bank recorded a net credit loss expense of CHF 2,575 million for 2008, compared with a net credit loss expense of CHF 266 million in 2007. Excluding the credit loss expense from reclassified financial instruments of CHF 1,329 146 Estimated liquidation proceeds of collateral (3,930) (3,930) (1,104) Specific  allowances, provisions and credit valuation adjustments (2,916) (20) (4,205) (111) (7,252) (1,914) Net impaired exposure 2,299 21 1,958 198 4,476 390 Impaired exposure 9,145 41 6,163 309 15,658 3,408 million, the credit loss expense amounted to CHF 1,246 mil- lion, mainly driven by new allowances on securities financing transactions, real estate loan positions and asset backed se- curities as a consequence of the deteriorations in the finan- cial markets. Global Wealth Management & Business Banking reported a net credit loss expense of CHF 370 million for 2008, com- pared with a CHF 28 million net credit loss recovery for 2007. This significant increase in credit loss expenses was mainly due to collateral shortfalls against lombard lending resulting from the turmoil in the financial markets in the fourth quarter of 2008 with sharp moves in securities prices and an unprece- dented decrease in the liquidity of certain asset categories. Rating system design and estimation of credit risk parameters Probability of default UBS assesses the likelihood of default of individual counter- parties using rating tools tailored to the various counterparty segments. Probability of default is summarized in the UBS internal rating scale and mapping of external ratings (Mas- terscale), shown on the next page, which segments clients into 15 rating classes (0 to 14), one of which is reserved for default. The UBS Masterscale reflects not only an ordinal ranking of counterparties, but also the range of default probabilities defined for each rating class. Also, in order to ensure consistency in determining default probabilities, all rating tools must be calibrated to the common Masterscale. This approach means that clients migrate between rating classes as UBS’s assessment of their probability of default changes. The performance of rating tools, including their predictive power with regard to default events, is regularly validated and model parameters are adjusted as necessary. External ratings, where available, are used to benchmark UBS’s internal default risk assessment. The ratings of the ma- jor rating agencies shown in the table are linked to the inter- nal rating classes based on the long-term average one-year default rates for each external grade. Observed defaults per agency rating category vary from year to year, especially over an economic cycle, and therefore UBS does not expect the actual number of defaults in its equivalent rating band in any d e t i d u A UBS internal rating scale and mapping of external ratings UBS Rating Description Moody’s Investor Services equivalent Standard & Poor’s equivalent 0 and 1 Investment grade Aaa Aa1 to Aa3 A1 to A3 AAA AA+ to AA– A+ to A– 2 3 4 5 6 7 8 9 10 11 12 13 14 Sub-investment grade Baa1 to Baa2 BBB+ to BBB Baa3 Ba1 Ba2 Ba2 Ba3 B1 B2 B3 BBB– BB+ BB BB BB– B+ B B– Defaulted Caa to C D CCC to C D given period to equal the rating agency average. UBS moni- tors the long-term average default rates associated with ex- ternal rating classes. If these long-term averages were ob- served to have changed in a material and permanent way, their mapping to the Masterscale would be adjusted. At the Investment Bank, rating tools are differentiated by broad segments. Current segments include banks, sovereigns, corporates, funds, hedge funds, commercial real estate and several more specialized businesses. The design of these tools follows a common approach. The selection and combination of relevant criteria (financial ratios and qualitative factors) are determined through a structured analysis by credit officers with expert knowledge of each segment, supported by statis- tical modeling techniques where sufficient data are available. The Swiss banking portfolio includes exposures to both large and small- to medium-sized enterprises, and the rating tools vary accordingly. For segments where sufficient default data are available, rating tool development is primarily based on statistical models. Typically, these “score cards” consist of eight to 12 criteria combining financial ratios with qualitative and behavioral factors which have proven good indicators of default in the past, are accepted by credit officers and are easy to apply. For smaller risk segments with few observed defaults the approach relies more on judgment and exper- tise, similar to that applied at the Investment Bank. For the Swiss commercial real estate segment and for lombard lend- ing, which is part of the retail segment, the probability of default is derived from simulation of potential changes in the value of the collateral and the probability that it will fall be- low the loan amount. Default expectations for the Swiss residential mortgage segment are based on the internal default and loss history, where the major differentiating factor is the loan-to-value ratio (i.e. the amount of the outstanding obligation ex- pressed as a percentage of the value of the collateral). Exposure at default Exposure at default represents the amounts UBS expects to be owed at the time of default. For outstanding loans, the exposure at default is the drawn amount or face value. For loan commitments and for contingent liabilities, it includes any amount already drawn plus any additional amount which is expected to be drawn at the time of default, should it occur. This calculation is based on a “credit conversion factor” – a fixed percentage per product type derived from historical experience of drawings under commitments by counterparties within the year prior to their default. For traded products, the estimation of exposure at de- fault is more complex, since the current value of a contract or portfolio of contracts can change significantly over time and may, at the time of a future default, be considerably higher or lower than the current value. For repurchase and reverse repurchase agreements and for securities borrow- ing and lending transactions, the net amount which could be owed to or by UBS is assessed, taking into account the impact of market moves over the time it would take to close out all transactions (“closeout exposure”). For ex- change-traded derivatives (ETDs), the exposure at default is derived from the difference between the initial margin and the current variation margin. Exposure at default on OTC derivative transactions is determined by modeling the po- tential evolution of the replacement value of the portfolio of trades with each counterparty over the lifetime of all transactions (“potential credit exposure”), taking into ac- count legally enforceable closeout netting agreements where applicable. For traded products, excluding ETDs, the exposure at de- fault is derived from a Monte Carlo simulation (a statistical technique involving a large number of simulations) of poten- tial market moves in all relevant risk factors, such as interest rates and exchange rates, based on estimated correlations between the risk factors. This ensures a scenario-consistent estimation of market value across all traded products at counterparty and portfolio level. The randomly simulated sets of risk factors are then used as inputs to product- specific valuation models to generate valuation paths, taking into account the impact of maturing contracts and changing col- lateral values. The resultant distribution of future valuation paths sup- ports various exposure measures. All portfolio risk measures are based on the expected exposure profile. By contrast, in controlling individual counterparty exposures UBS limits the potential “worst case” exposure over the full tenor of all transactions, and therefore applies the limits to the “maxi- mum likely exposure” generated by the same simulations, measured to a specified high confidence level. Cases where there is material correlation between the factors driving a counterparty’s credit quality and the factors driving the future path of traded products exposure (“wrong- 147 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Treasury management way risk”) require special treatment. In such cases, the po- tential credit exposure generated by the standard model is overridden by a calculation from a customized exposure model that explicitly takes this correlation into account. For portfolios where this risk is inherently present, for instance for the hedge funds portfolio, UBS has established special controls to capture these wrong-way risks. d e t i d u A The performance of exposure models is monitored by backtesting and benchmarking whereby model outcomes are compared against actual outcomes, based on UBS’s in- ternal as well as external historical experience. Loss given default Loss given default or loss severity represents UBS’s expecta- tion of the extent of loss on a claim should default occur. It is expressed as a percentage loss per unit of exposure and typically varies by type of counterparty, type and seniority of claim and the availability of collateral or other credit mitiga- tion. Loss given default estimates cover loss of principal, in- terest and other amounts due (including workout costs), and also consider the costs of carrying the impaired position dur- ing the workout process. At the Investment Bank loss given default estimates are based on expert assessment of the risk drivers (country, indus- try, legal structure, collateral and seniority), supported by em- pirical evidence from internal loss data and external bench- mark information where available. In the Swiss portfolio, loss given default differs by counterparty and collateral type and is statistically estimated using internal loss data. For the residen- tial mortgage portfolio, a further differentiation is derived by statistical simulation based on loan-to-value ratios. Debt investments Debt investments classified for IFRS as “financial investments available-for-sale” can be broadly categorized as money market instruments and debt securities, which are mainly held for statutory, regulatory or liquidity reasons. Debt in- vestments also include non-performing loans, which were purchased in the secondary market by the Investment Bank. The risk control framework applied to debt instruments classified as “Financial investments available-for-sale” varies depending on the nature of the instruments and the pur- pose for which they are held. Where applicable, debt investments are reflected in re- ports to senior management of consolidated credit expo- sures and in “large exposure” reports to FINMA. Composition of debt investments On 31 December 2008, debt financial investments classified as “Financial investments available-for-sale” consisted of money market paper of CHF 2,165 million and other debt investments of CHF 1,402 million. The increase in money market instruments is due to UK Treasury Gilts held in UBS Ltd. At 31 December 2007, the equivalent positions were CHF 349 million money market instruments and CHF 1,034 mil- lion other debt investments. 148 Operational risk Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems (for example failed IT systems, or fraud perpetrated by a UBS employee), or from external causes, whether deliberate, accidental or natural. It is inherent in all of UBS’s activities. Operational risks are monitored and, to the extent possible, controlled and mitigated. UBS’s approach to operational risk is not de- signed to eliminate risk altogether but, rather, to contain risks within levels deemed acceptable by senior manage- ment. The Group Chief Risk Officer (Group CRO), supported by the Group Head of Operational Risk, is responsible for the effective design of the operational risk framework. Operational risk framework All UBS functions, whether business, control or logistics functions, must manage the operational risks that arise from their activities. Operational risks are pervasive, as a failure in one area may have a potential impact on several other areas. Each business division has therefore established a cross-func- tional body to actively manage operational risk as part of its governance structure. To ensure the integrity of risk management decisions, each business division also has an Operational Risk Control unit, the head of which reports functionally to the Group Head of Operational Risk. The primary remit of these units is to confirm the effective implementation of the operational risk framework and to perform independent oversight of the design and conclusions regarding operating effectiveness reached by management. The foundation of the operational risk framework is that all functions have adequately defined their roles and responsibili- ties. The functions can then collectively ensure that there is adequate segregation of duties, complete coverage of risks and clear accountability. From this analysis, they develop con- trol objectives and standards to manage UBS’s tangible and intangible assets, based on the types of operational risk events that might arise, ranging from daily reconciliation problems to potentially severe events such as fraud. UBS recognizes that it cannot eliminate all risks, because errors and accidents will al- ways happen, and that even where it is possible to eliminate certain risks it is not always cost effective to do so. The functions use their controls to monitor compliance and assess their operating effectiveness in several ways, including self-certification by staff, tracking of a wide range of metrics (for example, the number and characteristics of client com- plaints, deal cancellations and corrections, unreconciled items on cash and customer accounts, and systems failures), and the analysis of internal and external audit findings. As major financial and non-financial operational risk events occur, UBS assesses their causes and the implications for its control framework. This includes events affecting third parties that are relevant to the firm’s business, provided that sufficient information is publicly available. The totality of this information is reviewed by functional managers to assess their operational risk exposure and the actions needed to address specific issues. These issues are formally captured in a risk inventory, which forms the basis of operational risk reporting to senior management. Regular reports are provided both within the business divisions and to the Group CRO to allow senior management to assess the overall operational risk profile of the firm. Operational risk measurement UBS has developed a model for the quantification of opera- tional risk which meets the regulatory capital standard spec- ified by the Basel II Advanced Measurement Approach (AMA). The model has two main components: – The historical component is based on UBS’s own internal losses and is used primarily to determine the expected loss portion of the capital requirement. UBS has been col- lecting operational risk event data (both profits and loss- es) since 2002. – The scenario component is used primarily to determine the unexpected loss portion of the capital requirement. It is based on a set of generic scenarios that represent cat- egories of operational risks which UBS is exposed to. The scenarios themselves are generated from an analysis of internal and external event information, the current busi- ness environment and UBS’s own internal control environ- ment. The scenarios are reviewed at least annually by ex- perts to ensure their validity and may be updated based on material new information or events. During 2008, sce- narios were adjusted for a number of industry-wide events including unauthorized trading losses and disputes over client practices. UBS calculates its operational risk regulatory capital re- quirement using the AMA model for the consolidated Group and the parent bank in accordance with the requirements of FINMA. For regulated subsidiaries the standardized ap- proaches are adopted as agreed with local regulators. Cur- rently, UBS does not reflect mitigation through insurance in its AMA model. 149 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Treasury management Treasury management UBS’s treasury department is responsible for the management of the firm’s financial resources. This includes the management of: liquidity and funding; capital and balance sheet; and interest rate and currency risks aris- ing from balance sheet and capital management responsibilities. UBS aims to maintain sound capital ratios at all times – to ensure strong external credit ratings and to remain one of the best-capitalized firms in the international financial sector. UBS: funding by currency  In % As of 31.12.08 UBS: funding by product type  In % As of 31.12.08 Retail savings/deposits Demand deposits Fiduciary 14 Time deposits Long-term debt Securities lending 6 Repurchase agreements Interbank 17 Money market paper 3CM003_e 15 15 11 10 CHF EUR USD 22 Other 48 UBS: BIS capital ratios¹ In % Basel I Basel II 18 15 12 9 6 4 0 Q 1 4 0 Q 2 4 0 Q 3 4 0 Q 4 5 0 Q 1 5 0 Q 2 5 0 Q 3 5 0 Q 4 6 0 Q 1 6 0 Q 2 6 0 Q 3 6 0 Q 4 7 0 Q 1 7 0 Q 2 7 0 Q 3 7 0 Q 4 8 0 Q 1 8 0 Q 2 8 0 Q 3 8 0 Q 4 14.2 13.9 13.9 14.1 13.4 12.8 12.5 12.1 12.3 11.9 14.2 12.6 14.5 14.5 12.8 13.3 13.3 11.6 15.5 14.8 15.0 15.0 15.8 12.6 12.7 12.2 12.0 12.7 13.9 11.0 16.2 15.0 15.0 12.2 11.1 12.2 11.0 11.0 9.1 7.4 BIS tier 1 capital ratio BIS total capital ratio 1 Prior to and including 4Q07 the capital ratios above are based on Basel I capital regulations, thereafter on Basel II rules. 12 10 1 19 3CM004_e 3CM010_e 150 11.25 11.25 7.50 7.50 3.75 3.75 15.00 15.00 0.00 0.00 Liquidity and funding management d e t i d u A UBS defines liquidity risk as the risk of being unable to raise funds to meet payment obligations when they fall due. Funding risk is the risk of being unable, on an ongoing basis, to borrow funds in the market at an acceptable price to fund actual or proposed commitments and thereby support UBS’s current business and desired strategy. Liquidity and funding are not the same, but they are closely related. Both are finite resources that are critical for a financial institution. Liquidity must be continuously managed to ensure that the firm can survive a crisis, whether it is a general market event, a localized difficulty affecting a smaller number of in- stitutions, or a problem unique to an individual firm. An in- stitution that is unable to meet its liabilities when they fall due may collapse, even though it is not insolvent, because it is unable to borrow sufficient funds on an unsecured basis, or does not have sufficient good quality assets to borrow against or liquid assets to sell to raise immediate cash. Market liquidity overview: 2008 The financial and credit market crisis, which had its origins in the US residential mortgage market in the second half of 2007, spread and gained in intensity throughout 2008, as a broader economic crisis developed and pointed towards a severe global downturn. A precipitous fall in trading volumes in some previously highly liquid markets accompanied a sharp reduction in asset market values. After the failure of one of the major US investment banks in mid-September, the tenor of the interbank lending market was dramatically reduced. Although other short-term funding remained avail- able at this time, it was largely limited to tenors within one month, while in secured funding markets certain assets were subjected to significantly higher haircuts and in some cases were no longer accepted as collateral. Access to other lon- ger-term wholesale funds was also severely constrained, as the level of credit spreads surged, and companies’ financing costs reached new heights. In an attempt to contain the sustained and growing crisis, which resulted in significant bank failures or forced restruc- turings of several major financial institutions throughout the year, central banks and governments were induced to inter- vene on a large scale to support both specific institutions and the global financial system as a whole. These public sector initiatives included a series of restructurings, recapitalizations – both direct and indirect – and the introduction, then subse- quent expansion, of broad-based credit and liquidity support facilities. New policies were implemented in many major economies to permit direct government investment in banks, loan and bank debt guarantees, as well as the provision of large volumes of additional liquidity to their financial systems via extraordinary financing facilities. Certain major banks be- came majority-owned by their governments. Several coun- tries announced that they would insure all domestic bank de- posits and others substantially increased the insurance protection for their deposits and bank debts, pressuring the deposits and debts of banks covered by weaker protection schemes. In the fourth quarter, the Swiss government an- nounced a number of steps to support its banking system, including a strengthening of the country’s bank deposit insur- ance scheme and a willingness to guarantee interbank liabili- ties if and when deemed necessary. Throughout most of the fourth quarter, public bond market issuance was largely lim- ited to banks whose debt was government-guaranteed. UBS’s response to the ongoing crisis Despite the very challenging conditions, UBS maintained its access to funding at all times, primarily as a result of its broadly diversified funding base. In addition, in anticipation of an extended period of market turbulence, UBS proactively undertook several measures starting in 2007 and continuing in 2008 to further strengthen and safeguard its liquidity po- sition. Short-term funding targets were adjusted, and in- creased focus was placed on asset reduction. Combined with the broad diversity of its funding sources, its contin- gency planning processes and its global scope, these addi- tional measures have enabled UBS to maintain a balanced asset / liability profile. UBS also maintains a substantial multi- currency portfolio of unencumbered high-quality short-term assets and has available and unutilized collateralized liquidity facilities at several major central banks. Like many other major financial institutions, UBS saw de- creased access to wholesale term funding and a decline in client deposits during 2008. This was counterbalanced by ongoing asset reductions – mostly in the Investment Bank – which reduced UBS’s overall funding needs. As part of these asset reductions, the trading portfolio was pared back by CHF 462 billion compared with year-end 2007. The transaction with the SNB, which was announced in fourth quarter 2008, further bolsters the firm’s liquidity and funding position by reducing overall funding requirements. Liquidity and funding risk management framework A new liquidity and funding risk management framework was approved by the Board of Directors (BoD) of UBS in 2008. This new framework outlines the principles, roles and responsibilities, models, methodologies and tools UBS uses 151 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Treasury management to manage liquidity and funding risk. The framework de- scribes a target state; many of these measures have already been, or are in the process of being implemented. The ben- efits of the new framework are the following: – First, sustainable profits will be achieved through alloca- tion of the real costs of funding to the business that gen- erates the funding requirement. There will be no more cross-subsidization of one business division by another, allowing an unbiased and more accurate view of the firm’s profitability. – Second, liquidity and funding risk are being reduced as UBS limits the size of its balance sheet, funds illiquid as- sets long-term and reduces reliance on short-term unse- cured funding. – Finally, UBS is establishing best practice liquidity and fund- ing risk management processes. The new framework is designed to keep the firm in line with industry best prac- tice, and prepare it for further changes in regulatory re- quirements and oversight. The approach taken by UBS will proceed in parallel: tacti- cally addressing a number of key initiatives in the short term, while developing the framework into a target liquidity and funding model to be strategically integrated into each busi- ness division, region and entity within the Group. Liquidity approach d e t i d u A UBS’s approach to liquidity management, which covers all branches and subsidiaries, aims to ensure that it will always have sufficient liquidity to meet liabilities when due, under both normal and stressed conditions, without incurring un- acceptable losses or risking sustained damage to its various business franchises. Central to the integrated framework is an assessment of all material, known and expected cash flows and the level of high-grade collateral that could be used to raise additional funding. It entails both careful monitoring and control of the daily liquidity position, and regular liquidity stress testing. Limits are set at Group level by the BoD risk committee, while the Executive Committee of the Group Executive Board (GEB) is responsible for the allocation of resources to the business divisions and sets limits for each of the business divisions. These limits are monitored by Group Treasury, who reports the results and trends on a regular basis to the BoD risk com- mittee and the Executive Committee of the GEB. Contin- gency plans for a liquidity crisis are incorporated into UBS’s wider crisis management process. The liquidity position and asset and liability profile are con- tinuously tracked. This involves monitoring the balance sheet contractual and behavioral maturity profiles and projecting and modeling the liquidity exposures of the firm under a variety of potential scenarios – encompassing both normal and stressed market conditions. UBS considers the possibility that its access to markets could be impacted by a stress event d e t i d u A affecting some part of its business or, in the extreme case, if it was to suffer a severe rating downgrade combined with a period of general market uncertainty. The results are factored into the overall contingency plans of UBS. UBS’s major sources of liquidity are channeled through entities that are fully consolidated. d e t i d u A Liquidity management UBS manages its liquidity position in order to be able to ride out a crisis without damaging the ongoing viability of its business. This is complemented by the firm’s funding risk management which aims to achieve the optimal liability structure to finance its businesses cost-efficiently and reli- ably. The long-term stability and security of UBS’s funding in turn helps protect its liquidity position in the event of a UBS- specific crisis. The firm’s business activities generate asset and liability portfolios which are intrinsically highly diversified with re- spect to market, product and currency. This reduces UBS’s exposure to individual funding sources, and also provides a broad range of investment opportunities, which in turn re- duces liquidity risk. UBS adopts a centralized approach to liquidity and fund- ing management to exploit these advantages to the full. The liquidity and funding process is undertaken jointly by Group Treasury and the foreign exchange and money market (FX&MM) unit within the Investment Bank’s fixed income, currencies and commodities (FICC) business area. Group Treasury establishes a comprehensive control framework, while FX&MM undertakes operational cash and collateral management within the established parameters. This centralization permits close control of both UBS’s global cash position and its stock of highly liquid securities. The central treasury process also ensures that the firm’s gen- eral access to wholesale cash markets is concentrated in FX&MM. Funds raised externally are largely channeled into FX&MM including the proceeds of debt securities issued by UBS, an activity for which Group Treasury is responsible. FX&MM in turn meets all internal demands for funding by channeling funds from units generating surplus cash to those requiring finance. In this way, UBS reduces its external borrowing and use of available credit lines, and presents a consistent and coordinated face to the market. d e t i d u A Liquidity modeling and contingency planning For the purpose of monitoring its liquidity situation, UBS em- ploys the following main measures: – A cash ladder, which is used by FX&MM to manage the firm’s funding requirements on a daily basis within limits that are set by the BoD risk committee and controlled by Group Treasury. This cumulative cash ladder shows the daily liquidity position – the net cumulative funding re- quirement for a specific day – projected for each business day from the current day forward six months. 152 d e t i d u A – A contractual maturity gap analysis of UBS’s assets and liabilities. – A behavioral maturity gap analysis under an assumed se- vere liquidity crisis scenario. d e t i d u A – A cash capital model which measures the amount of sta- ble funding in relation to the amount and composition of its assets. The breakdown of the contractual maturity of UBS’s as- sets and liabilities serves as a starting point for stress testing analyses. One such breakdown is shown in the “Maturity analysis” table at the end of this section. This maturity analy- sis is an accounting view. It does not fully represent a liquid- ity risk management perspective, which would also include behavioral stress analyses and a more detailed breakdown of asset and liability types. The aforementioned liquidity crisis scenario combines a firm-specific crisis with market disruption and focuses on a time horizon starting with overnight and extending up to one year. This UBS-specific scenario envisages large draw- downs on otherwise stable client deposits, an inability to re- new or replace maturing unsecured wholesale funding and limited capacity to generate liquidity from trading assets. Li- quidity crisis scenario analysis supports the liquidity manage- ment process so that immediate corrective measures, such as the use of a liquidity buffer to absorb potential sudden li- quidity shortfalls, can be put into effect. d e t i d u A Since a liquidity crisis could have a myriad of causes, UBS focuses on a scenario that encompasses all potential stress effects across all markets, currencies and products. The assessment includes the likelihood of maturing assets and liabilities being rolled over in a UBS-specific crisis within an otherwise stressed market environment, and gauges the extent to which the potential crisis-induced shortfall could be covered by available funding. This would be raised on a secured basis against available collateral, which includes se- curities eligible for pledging at the major central banks, or by selling liquid inventory. In both cases UBS applies crisis-level discounts to the value of the assets. It assumes that it would be generally unable to renew any of the Group’s wholesale unsecured debt, including all its maturing money market pa- per (outstanding volume CHF 112 billion on 31 December 2008) and that no contingency funding could be raised on an unsecured basis. Since liquidity needs may also result from commitments and contingencies, including credit lines extended to secure the liquidity needs of customers, UBS regularly monitors undrawn committed credit facilities and other latent liquidity risks and factors these potential liquid- ity outflows into the scenario analysis. Particular emphasis is placed on potential drawdowns of committed credit lines. verse movements in the replacement value of its over-the-coun- ter (OTC) derivative transactions which are subject to collateral arrangements and includes potential outflows in its crisis sce- nario. Given the diversity of UBS’s derivatives business and that of its counterparties, there is not necessarily a direct correlation between the factors influencing net replacement values with each counterparty and a firm-specific crisis scenario. Liquidity limits and controls Liquidity and funding limits are set by senior management, taking into consideration UBS’s business model and strategy, the prevailing market conditions and the firm’s tolerance for risk. Structural limits focus on the composition and profile of the balance sheet, while supplementary limits are designed to drive the utilization and allocation of funding resources. The supplementary limits, which consist of three categories – operational, funding and regulatory – are monitored and performance is regularly communicated to senior manage- ment. Operational limits focus on structural liquidity risk for terms from intra-day out to one year including stress testing, while funding limits focus on the liability mix. The principles underlying UBS’s limit framework aim to maximize and sus- tain the value of its business franchise and appropriately bal- ance the asset / liability structure in light of prevailing market conditions. Group Treasury is responsible for the control and oversight of the liquidity and funding limits. To complement and support the limit framework, region- al teams monitor the markets in which UBS operates for po- tential threats and regularly report any significant findings to Group Treasury. d e t i d u A UBS has also developed detailed contingency plans for li- quidity crisis management, the cornerstone of which is the Group’s substantial liquidity reserves, including a large multi- currency portfolio of unencumbered high-quality and short- term assets as well as available and unutilized liquidity facili- ties at several major central banks. The liquidity contingency plan is an integral part of the global crisis management concept, which covers all types of crisis events. Its implementation falls under the responsibility of a core crisis team with representatives from Group Treasury, from FX&MM and from related areas including the functions responsible for payments and settlements, market and credit risk control, collateral and margin management, and informa- tion technology and infrastructure. FX&MM’s centralized glob- al management model lends itself naturally to efficient liquidity crisis management. Should a crisis require contingency fund- ing measures to be invoked, Group Treasury takes responsibil- ity for coordinating liquidity generation together with repre- sentatives from FX&MM and the relevant business areas. If UBS’s credit rating were to be downgraded, “rating trig- ger” clauses, especially in derivative contracts, could result in an immediate cash outflow due to the unwinding of derivative positions, or the need to deliver additional collateral. UBS also analyzes the potential impact on its net liquidity position of ad- UBS manages its relationships with the major central banks as part of its general policy, which is to base contin- gency plans on having sufficient liquidity reserves at its dis- posal and to raise contingency funding on a secured basis against provision of collateral. 153 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Treasury management Funding UBS’s domestic retail and global wealth management busi- nesses continue to be valuable, cost-efficient and reliable sources of funding. These businesses contributed CHF 340 billion, or 72% of the CHF 475 billion total customer depos- its shown in the UBS asset funding diagram below. Com- pared with the CHF 340 billion of net loans as of 31 Decem- ber 2008, customer deposits provided 140% coverage. In terms of secured funding, i.e. repurchase agreements and securities lent against cash collateral received, UBS borrows less cash on a collateralized basis than it lends, leading to a surplus of net securities sourced (and rehypothecable) – shown as the CHF 231 billion cash-equivalent surplus in the diagram below. Furthermore, through the establishment of short-, medium- and long-term funding programs in Europe, the US and Asia, UBS can provide specialized investments to its customers through which it can efficiently raise funds globally from both institutional and private investors, mini- mizing its dependence on any particular source. A maturity breakdown of UBS’s long-term straight debt portfolio of CHF 58 billion is shown further below. Through broad diversification of its funding sources (by market, product and currency), UBS maintains a well- balanced portfolio of liabilities, which generates a stable flow of financing and provides protection in the event of market disruptions. This, together with its centralized fund- ing management, enables UBS to efficiently fund its busi- ness activities. UBS asset funding Net replacement values (RVs) As of 31.12.08 Cash, balances with central banks and due from banks Loans Due to Banks Time deposits 140% coverage Demand deposits Trading portfolio assets Cash collateral on securities borrowed and reverse repurchase agreements Other assets (including net RVs) Assets CHF 231 billion surplus s r e m o t s u c o t e u D Retail savings/deposits Fiduciary Long-term debt and financial liabilities designated at fair value Money market paper issued Trading portfolio liabilities Cash collateral on securities lent and repurchase agreements Other liabilities Equity Liabilities and equity Funding approach Medium- and long-term funding activities are planned by assessing the overall funding profile of the balance sheet, taking due account of the effective maturity of the asset base and the amount of maturing debt that will have to be 154 replaced. The ability to continue to fund ongoing business activities through periods of difficult market conditions is also factored in. Prior to the outbreak of the current crisis, at the beginning of 2007, UBS decided to further strength- en its funding profile through public issuance of senior, straight, long-term debt and to thereby enhance the overall diversification of its funding sources. Despite the persistent turbulence prevailing in the capital markets throughout the year, UBS raised CHF 24 billion of proceeds through public senior debt issuance during 2008 (compared with CHF 15 billion during 2007). Two recent examples of this funding diversification effort were the inaugural Samurai domestic Japanese Yen issuance (totaling JPY 91.5 billion) in June 2008 and the approximately CHF 2 billion Swiss covered bond (Pfandbrief) issuance via the Swiss Mortgage Bond Bank in December 2008. In addition, the extraordinary capital strengthening mea- sures implemented during 2008 in response to the losses incurred during the current crisis – such as the CHF 13.0 bil- lion mandatory convertible notes (MCNs) issued in March 2008, the EUR 1 billion proceeds from the issue of perpetual preferred securities in April 2008, the net proceeds from the June 2008 rights issue of CHF 15.6 billion and the issue of CHF 6.0 billion MCNs to the Swiss Confederation in Decem- ber 2008 – contributed funding to UBS. ➔ Refer to the “Shares and capital instruments” section of this report for more information about capital instruments To ensure that a well-balanced and diversified liability structure is preserved, Group Treasury routinely monitors UBS’s funding status and reports its findings on a monthly basis to the GEB. A key measure employed among UBS’s main analysis tools is an assessment of its “cash capital“. This concept is designed to ensure that illiquid assets are be- ing financed by long-term sources of funding. UBS seeks to run a cash capital surplus (i.e. an excess of cash capital supply over cash capital consumption). The cash capital supply consists of long-term sources of funds: unse- cured funding with remaining time to maturity of at least one year; shareholders’ equity; and core deposits (the por- tion of customer deposits deemed to have a “behavioral“ maturity of at least one year). Cash capital consumption re- flects the illiquid portion of the assets, which is defined as the portion of assets that could only be transformed into cash by sale or secured funding in more than one year. In the case of secured funding, the illiquid portion is the difference (the “haircut“) between the carrying value of an asset on the balance sheet and its effective cash value when given as col- 3CM014c_e lateral. The potential funding needs that could arise from off-balance sheet exposures, such as undrawn committed credit lines that UBS has sold, are also included in the total cash capital consumption. UBS also regularly monitors its main funding portfolios for any concentration risks – including an assessment by in- dividual counterparty. 1200 900 600 300 0 UBS: funding by product and currency In % Securities lending Repurchase agreements Interbank Money market paper Retail savings / deposits Demand deposits Fiduciary Time deposits Long-term debt 1 Total 1 Including financial liabilities designated at fair value. All currencies CHF EUR USD Others 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 31.12.08 31.12.07 1.4 10.1 12.4 11.0 9.9 13.8 6.0 17.0 18.4 2.1 19.9 9.5 9.9 7.1 11.7 6.0 16.9 17.0 0.0 0.9 0.8 0.3 6.0 2.8 0.3 1.6 2.7 0.0 1.5 0.5 0.3 4.6 2.2 0.3 2.3 1.4 0.4 1.6 4.9 1.0 1.0 2.8 2.0 2.9 5.9 0.2 2.5 1.8 0.9 0.8 2.4 1.8 1.9 4.7 0.6 6.6 4.9 8.5 3.0 6.5 3.0 9.1 5.0 1.5 12.2 4.5 7.3 1.6 5.3 3.1 9.5 6.2 0.4 1.0 1.8 1.2 0.0 1.7 0.7 3.5 4.8 0.4 3.7 2.8 1.3 – 1.8 0.8 3.1 4.7 100.0 100.0 15.3 13.2 22.4 17.0 47.2 51.2 15.1 18.6 Funding position and diversification UBS continues to maintain a balanced portfolio of liabilities that is broadly diversified by market, product and currency. The vast product offerings and global scope of the firm’s business activities are the primary reasons for funding stabil- ity. Funding is provided through numerous short-, medium-, and long-term funding programs in Europe, the US and Asia, which provide specialized investments to institutional and private clients. UBS’s domestic retail and global wealth man- agement businesses are also a valuable source of funding. The overall composition of UBS’s funding sources, as il- lustrated in the graphs below, has remained stable. These sources amount to CHF 1,016 billion on the balance sheet comprising repurchase agreements, securities lending against cash collateral received, due from banks, money market pa- per issued, due to customers and long-term debt (including financial liabilities at fair value). In terms of currencies, 48% of these funds are denominated in US dollars, while 22% are in euros and 15% in Swiss francs. The proportion of funding raised on a secured basis, pri- marily through repurchase agreements (and to a lesser ex- tent through cash collateral received for securities lent), has dropped to 11% from 22% since year-end 2007, primarily due to continued asset reductions (in particular trading as- sets and reverse repurchases / securities borrowed that were financed through repurchase agreements). UBS’s unsecured funding base remains well diversified. At year-end 2008, savings and demand deposits amounted to 24% of UBS’s funding sources, up from 19% a year earlier. The proportion of funding raised through long-term debt was stable, accounting for 18% of funding sources (up slightly from 17% a year ago), as was the proportion of money market paper, which was likewise marginally higher, at 11% (up from 10%). Compared with year-end 2007, the proportion of funding from time deposits remained con- stant, at 17%, as did fiduciary deposits, at 6%. The relative share of short-term interbank borrowing was 12%, up from 9% a year earlier. UBS, like many other major financial institutions, experi- enced decreased access to medium- and longer-term funds in the wholesale debt markets during 2008. Moreover, UBS did not raise any public long-term debt during fourth quarter 2008 as public issuance was practically limited to banks with govern- ment-guaranteed debt. While this contributed to a shortening of the maturity profile of UBS’s debt issued during 2008, this was compensated by UBS’s sale of a significant volume of il- liquid positions during the year (to the fund managed by Black Rock, the SNB StabFund and to the market in general). t n e m e g a n a m y r u s a e r t d n a k s i R UBS: funding by currency  In % As of 31.12.08 UBS: funding by product type  In % As of 31.12.08 15 15 11 10 CHF EUR USD 22 Other 48 12 10 1 19 3CM004_e Retail savings/deposits Demand deposits Fiduciary 14 Time deposits Long-term debt Securities lending 6 Repurchase agreements Interbank 17 Money market paper 3CM003_e 155 Risk and treasury management Treasury management Credit ratings As of 31.12.08 Long-term rating Short-term rating Financial strength rating / Individual Moody’s Standard & Poor’s Fitch Ratings Rating Outlook Aa2 P–1 B– stable stable stable Rating A+ A–1 Outlook stable stable Rating Outlook A+ F1+ B / C stable stable stable 1 1 Fitch’s Individual rating was changed to C, rating watch negative, on 21 January 2009. UBS Ratings The table above summarizes UBS’s long- and short-term debt ratings as of 31 December 2008 (refer to the “Credit ratings” sidebar). Maturity breakdown of long-term straight debt portfolio The graph below shows a contractual maturity breakdown of the portion of UBS’s long-term debt portfolio consisting of straight debt (and therefore excluding all structured debt, which is predominately booked as “financial liabilities desig- nated at fair value”). This amounted to CHF 55 billion on 31 December 2008, and is accounted for on the balance sheet as part of the CHF 197 billion shown on the “Debt is- sued” line (which in addition includes money market paper issued and the December 2008 MCN issuance). UBS’s long- term straight debt portfolio is composed of CHF 42 billion of senior debt (including both publicly and privately placed notes and bonds as well as Swiss cash bonds) and CHF 13 billion of subordinated debt. CHF 5 billion, or 9%, of the positions mature during 2009. Long-term straight debt – contractual maturities CHF billion As of 31.12.08 23.0 24.5 2009 2010 2011 2012–13 2014–18 2019–28 after 2028 Year of maturity 3CM004c_e Senior debt Subordinated debt 24 18 12 6 0 156 19.200001 14.400001 9.600000 4.800000 0.000000 Maturity analysis d e t i d u A CHF billion Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets 1 Trading portfolio assets pledged as collateral 1 Positive replacement values 1 Financial assets designated at fair value 2 Loans Financial investments available-for-sale Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and other intangible assets Other assets Total 31.12.08 Total 31.12.07 Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities 1 Negative replacement values 1 Financial liabilities designated at fair value 3 Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total 31.12.08 Total 31.12.07 Off-balance sheet Undrawn irrevocable facilities 4 On-demand and trading instruments Instruments at cost and at fair value / level 1 Instruments at fair value / level 2 Instruments at fair value / level 3 Due within 1 month Due between 1 and 3 months Due between 3 and 12 months Due between 1 and 5 years Due after 5 years 32.7 54.6 77.8 28.0 128.1 25.4 5.1 1.1 71.4 0.0 0.0 0.0 0.0 0.0 0.0 424.1 676.4 55.1 12.6 8.6 33.9 4.9 0.0 208.6 0.0 0.0 13.1 336.7 501.9 0.0 0.0 0.0 0.0 128.4 13.2 811.2 0.1 0.0 0.5 0.0 0.0 0.0 0.0 0.0 953.5 787.5 0.0 0.0 0.0 27.5 812.0 0.0 0.0 0.0 0.0 0.0 839.5 465.0 0.0 0.0 0.0 0.0 15.3 1.6 37.8 0.0 0.0 1.1 0.0 0.0 0.0 0.0 0.0 55.9 75.7 0.0 0.0 0.0 1.0 35.0 0.0 0.0 0.0 0.0 0.0 36.0 16.8 0.0 5.3 43.7 179.6 0.0 0.0 0.0 1.5 0.0 1.1 1.4 8.7 0.0 0.0 0.0 0.5 0.0 1.4 0.0 6.8 0.0 0.0 0.0 1.0 0.0 1.7 0.0 0.8 0.0 0.0 0.0 4.0 0.0 0.4 0.0 0.7 0.0 0.0 0.0 4.7 71.8 33.1 32.6 80.5 50.9 1.4 6.1 0.0 0.0 0.0 18.8 328.2 438.5 52.3 1.5 82.6 0.0 0.0 0.6 206.1 10.2 83.6 20.9 457.8 671.4 0.8 0.0 0.0 0.0 0.0 0.0 45.5 80.9 12.2 0.0 5.7 0.0 0.0 7.8 34.3 0.0 20.7 0.0 80.6 190.7 0.2 0.0 0.0 0.0 0.0 0.0 42.1 76.1 4.9 0.0 5.1 0.0 0.0 20.7 16.2 0.0 13.9 0.0 60.7 0.1 0.0 0.0 0.0 0.0 0.0 87.1 79.9 0.8 0.0 0.3 0.0 0.0 37.2 0.5 0.0 37.1 0.0 75.9 1.1 0.0 0.9 6.7 12.9 0.0 78.3 59.8 0.4 0.0 0.3 0.0 0.0 35.3 9.1 0.0 41.9 0.0 87.0 167.8 106.5 111.0 2,231.1 Total 32.7 64.5 122.9 224.6 271.8 40.2 854.1 12.9 340.3 5.2 6.1 0.9 6.7 12.9 18.8 2,014.8 2,274.9 125.6 14.1 102.6 62.4 851.9 101.5 474.8 10.2 197.3 34.0 1,974.3 t n e m e g a n a m y r u s a e r t d n a k s i R 59.9 0.0 0.0 0.2 0.0 0.1 0.1 0.0 60.3 1 Trading and derivative positions are presented in the first three columns of the table: “Instruments at cost and fair value / Level 1,” “Instruments at fair value / Level 2” and “Instruments at fair value /  Level 3.” Management believes that such presentation most accurately reflects the short-term nature of trading activities. The contractual maturity of the instruments may, however, extend over signifi- cantly longer periods. The breakdown of these positions into the fair value measurement categories of levels 1, 2 and 3 indicates the liquidity of the markets in which the financial instruments are traded  and the availability of market observable inputs to measure these instruments (refer to “Note 27 Fair value of financial instruments” in the financial statements of this report). Contractual maturities of  trading portfolio liabilities are: CHF 61.2 billion due within one month; and CHF 1.2 billion due between one month and one year.    2 The contractual redemption amount at maturity of financial assets  designated at fair value approximates the carrying value as of 31 December 2008 and 31 December 2007. 3 Non-trading and non-derivative financial liabilities are categorized based on the earliest  date on which UBS can be required to pay. 4 Excludes commitments from contingent claims (credit guarantees, performance guarantees and similar instruments, and documentary credits) of CHF 18,494 million and commitments to acquire auction rate securities (ARS) of CHF 16,571 million on 31 December 2008. Refer to the “Exposure to auction rate securities” sidebar in the “Risk concentra- tions” section of this report for more information. 157 Risk and treasury management Treasury management Credit ratings Despite a 2008 full-year loss of slightly above CHF 20 billion, UBS maintained a sound and strong capital position as it believes that this is a key part of its value proposition for both clients and investors. In July 2008, Moody’s Investors Service downgraded from “B” to “B–” the bank financial strength rating (BFSR) and from “Aa1” to “Aa2” the senior debt and deposit ratings of UBS AG, with a stable outlook for both ratings. In its comments, the agency said: “This downgrade reflects the chal- lenges still facing the bank’s manage- ment team to return UBS to a position of stability following the losses in its investment banking division. The bank’s financial performance and risk management since the onset of the financial crisis have been below the level expected of a B (BFSR) / Aa1 (deposit & debt) rated bank.” Moody’s further said that “the bank has initiated many changes to senior management, risk management, and, more recently, corporate governance, but it is not yet clear whether these changes will be effective considering the complexity of the task. Moody’s considers the core wealth manage- ment franchise to be resilient, and although the bank’s high profile difficulties have led to some outflows of assets under management, Moody’s considers that the bank’s franchise has not been permanently affected.” In October 2008, Moody’s affirmed both the ratings of UBS AG and the stable outlook. In December 2008, Standard & Poor’s Ratings Services (S&P’s) lowered its long-term counterparty credit rating on UBS AG to “A+” from “AA–”, following S&P’s global review of major mature-market financial institutions. The agency commented that the “rating actions on UBS reflect changes in our view of the level of risk associ- ated with the range of activities 158 pursued by major financial institutions. Moreover, we view the current downturn as being potentially longer and deeper than we had previously considered. Therefore, for UBS and most of its peers, we view asset quality as likely to weaken materially more than we had previously believed. In addition, the downgrade of the counterparty credit ratings on UBS reflects the outstanding challenges we believe it faces, which include: restoring its reputation, particularly among private banking clients; completing the repositioning of the investment bank; resolving regulatory and legal cases, particularly the US governmental investigation into cross-border private banking services provided to US clients; and managing down risk concentrations not included in the transaction with the SNB, particularly the exposure to monoline bond insurers. The ratings on UBS recognize both the Group’s intrinsic credit profile and extraordinary external support from the Swiss government and the SNB. Specifically, the long-term issuer credit rating incorporates a two-notch uplift from UBS’s stand- alone credit profile in recognition of the significantly beneficial external support provided to it. We expect that additional external support would be extended, if required, reflecting UBS’s high systemic importance within Switzerland.” S&P’s further commented that the ratings on UBS remain underpinned by a number of factors: “the asset-gathering businesses remain strongly cash-generative; having started earlier than most peers, UBS appears more advanced in deleveraging and managing costs in its investment bank; UBS appears committed to a strong regulatory capital position, and its recent CHF 6 billion issue of mandatory convertible notes (MCNs) to the Swiss Confederation offsets the dilutive effect on the tier 1 ratio of the SNB transaction; UBS’s funding and liquidity position has, in our view, remained relatively robust, and is further enhanced by the cash received from the SNB transaction.” In February 2009, S&P’s affirmed the ratings of UBS AG and the stable outlook. In October 2008, Fitch Ratings downgraded UBS AG’s long-term issuer default ratings (IDRs) from “AA–” to “A+” and UBS’s individual rating from “B” to “B / C”, comment- ing: “the stable outlooks and affirma- tion of the short-term IDRs reflect Fitch’s belief that the measures taken to de-risk and recapitalize the bank should enable UBS to draw a line under the problems that have taken their toll over the past 15 months. Nevertheless, management faces challenges in reshaping the investment bank and delivering stable and sustainable earnings in difficult market conditions with a refocused, lower-risk strategy.” In January 2009, Fitch Ratings downgraded UBS AG’s individual rating to “C” from “B / C” and placed it on rating watch negative (RWN), while the bank’s long-term IDR and short-term IDR have been affirmed at “A+” and “F1+” respectively. On 5 March 2009, Fitch Ratings affirmed the long-term and short- term IDRs of UBS AG (UBS) at “A+” and “F1+” respectively. The IDR outlooks are stable, reflecting Fitch’s view of continued official support being available. The agency has downgraded UBS’s individual rating to “D” from “C” reflecting Fitch’s concerns over the medium-term earnings outlook for the bank amid persistently challenging market conditions, and the impact of ongoing reputational and litigation issues on the stability of UBS’s key private banking and wealth manage- ment franchise. The rating watch negative (RWN) on the individual rating has been removed. Interest rate and currency management Management of non-trading interest rate risk d e t i d u A UBS’s largest non-trading interest rate exposures arise with- in the Global Wealth Management & Business Banking business division. These risks are transferred from the origi- nating business into one of two centralized interest rate risk management units: Group Treasury or the Investment Bank’s foreign exchange and money market (FX&MM) unit. These units manage the risks on an integrated basis, ex- ploiting the full netting potential across risks from different sources. Risks from fixed-maturity, short-term Swiss franc and all non-Swiss franc transactions are generally transferred to FX&MM. Risks from Swiss franc transactions with fixed ma- turities greater than one year are transferred to Group Trea- sury by individual back-to-back transactions. These fixed-rate products do not contain embedded options such as early prepayment that would allow customers to prepay at par. All prepayments are therefore subject to market-based unwind- ing costs. Current and savings accounts and many other retail prod- ucts of Global Wealth Management & Business Banking have no contractual maturity date or direct market-linked rate, and therefore their interest rate risk cannot be trans- ferred by simple back-to-back transactions. Instead, they are transferred on a pooled basis via “replicating” portfolios. A replicating portfolio is a series of loans or deposits at market rates and fixed terms between the originating business unit and Group Treasury, structured to approximate, on average, the interest rate cash flow and repricing behavior of the pooled client transactions. The portfolios are rebalanced monthly. Their structure and parameters are based on long- term market observations and client behavior, and are regu- larly reviewed and adjusted as necessary. The originating business units are thus immunized as far as possible against market interest rate movements, but retain and manage their product margin. A significant amount of interest rate risk also arises from the financing of non-monetary related balance sheet items, such as the financing of bank property and equity invest- ments in associated companies. These risks are generally transferred to Group Treasury through replicating portfolios which, in this case, are designed to approximate the funding profile mandated by senior management. Group Treasury manages its residual open interest rate exposures, taking advantage of any offsets that arise be- tween positions from different sources, within its approved market risk limits (Value at Risk (VaR) and stress loss). The preferred risk management instrument is interest rate swaps, d e t i d u A for which there is a liquid and flexible market. All transac- tions are executed via the Investment Bank – Group Treasury does not directly access the external market. ➔ Refer to the “Market risk” section of this report for further details on UBS’s market risk measures and controls d e t i d u A Market risk arising from management of consolidated capital UBS is required, by international banking regulations (Bank for International Settlements regulations), to hold a mini- mum level of capital against assets and other exposures (risk- weighted assets). The relationship between UBS’s capital and its risk-weighted assets, the BIS tier 1 ratio, is monitored by regulators and analysts and is a key indicator of its financial strength. The majority of UBS’s capital and many of its assets are denominated in Swiss francs, but the Group also holds risk- weighted assets and some eligible capital in other curren- cies, primarily US dollar, euro, UK sterling and Brazilian real. Any significant depreciation of the Swiss franc against these currencies would adversely impact the Group’s BIS tier 1 ra- tio. Group Treasury’s mandate is therefore to minimize ad- verse currency impacts on this ratio and to generate an in- come flow from the capital. This mandate determines a currency, tenor and product mix – a target profile – against which Group Treasury manages the Group’s capital. On an overall Group basis, Group Treasury’s target profile is based on a currency mix which broadly reflects the cur- rency distribution of the consolidated risk-weighted assets, using products and tenors which generate the desired in- come stream. As the Swiss franc depreciates (or appreciates) against these currencies, the consolidated risk-weighted as- sets increase (or decrease) relative to UBS’s capital. These currency fluctuations also lead to translation gains (or losses) on consolidation, which are recorded through equity. Thus, UBS’s consolidated equity rises or falls in line with the fluc- tuations in the risk-weighted assets, protecting the tier 1 ra- tio. The capital of the parent bank itself is held predomi- nantly in Swiss francs in order to avoid any significant effects of currency fluctuations on its standalone financial results. The capital of the parent bank and its subsidiaries is placed in the form of interest-bearing cash deposits inter- nally within the Group, primarily with the Investment Bank’s FX&MM unit. Where necessary, Group Treasury also executes derivatives (mainly interest rate swaps) through the Invest- ment Bank’s trading desks to achieve the target profile. FX&MM and the derivative trading units manage the resul- tant cash and market risk positions as part of their normal 159 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Treasury management d e t i d u A business activities and, in the case of FX&MM, within the ap- proved liquidity and funding risk framework. d e t i d u A ➔ Refer to the “Liquidity and funding management” section of this report for details on UBS’s liquidity and funding risk framework d e t i d u A For the purposes of measuring and managing Group Trea- sury’s market risk position, the Group’s consolidated equity is represented in the treasury book by replicating portfolios (lia- bilities) with the target currency and interest rate profile. The interest rate positions created by Group Treasury’s deposits with FX&MM or other units, and the associated derivatives, generally offset the interest rate risk of the replicating portfo- lios. Any mismatches between the two are managed, togeth- er with other non-trading interest rate risk positions, within Group Treasury’s market risk limits (VaR and stress loss). The structural foreign currency exposures are controlled by senior management but are not subject to internal market risk limits and are not included in Group Treasury’s reported VaR. Group Treasury interest rate risk development In measuring Group Treasury’s interest rate risk – expressed as VaR – both the representation of the consolidated equity (replicating portfolios) and the deployment of the equity de- scribed above are included in the calculations. On 31 December 2008, UBS’s consolidated equity was de- ployed as follows: in Swiss francs (including most of the capi- tal of the parent bank) with an average duration of approxi- mately three years and an interest rate sensitivity of CHF 7.9 million per basis point; in US dollars with an average duration of approximately four years and a sensitivity of CHF 8.0 million per basis point; in euro with an average duration of approxi- mately three years and a sensitivity of CHF 0.7 million per basis point; and in UK sterling with a duration of approximately three years and a sensitivity of CHF 0.4 million per basis point. The interest rate sensitivity of these positions is directly related to the chosen duration – targeting significantly shorter ma- turities would reduce the apparent interest rate sensitivity but would lead to greater fluctuations in interest income. Corporate currency management UBS’s corporate currency management activities are de- signed to reduce the impact of adverse currency fluctuations on its reported financial results, given regulatory constraints. UBS specifically focuses on three principal areas of currency risk management: match funding / investment of non-Swiss franc assets / liabilities; sell-down of non-Swiss franc profit and loss; and selective hedging of anticipated non-Swiss franc profit and loss. Group Treasury: Value-at-Risk (10-day, 99% confidence, 5 years of historical data) CHF million Interest rates Foreign exchange Diversification effect Total management VaR Year ended 31.12.08 Year ended 31.12.07 Min. Max. Average 31.12.08 Min. Max. Average 31.12.07 8 3 1 10 54 93 1 97 19 26 (10) 34 26 10 (14) 28 9 1 1 10 55 87 1 92 17 18 (10) 25 54 21 (14) 61 1 As the minimum and maximum occur on different days for different risk types, it is not meaningful to calculate a portfolio diversification effect. 160 d e t i d u A Match funding and investment of non-Swiss franc assets and liabilities As far as it is practical and efficient to do so, UBS follows the principle of matching the currency of its assets with the cur- rency of the liabilities which fund them – thus a US dollar asset is typically funded in US dollars, a euro liability is offset by an asset in euros, etc. This avoids profits and losses arising from retranslation at the prevailing exchange rates to the Swiss franc at each quarter end. Sell-down of reported profits and losses For accounting purposes, reported profits and losses are translated each month from the original transaction cur- rencies into Swiss francs at the exchange rate prevailing at the end of the month. Group Treasury centralizes profits or losses in foreign currencies that arise in the parent bank, and sells or buys them for Swiss francs in order to eliminate earnings volatility which would arise from retranslation at different exchange rates of previously reported non-Swiss franc profits and losses. Other UBS operating entities fol- low a similar monthly sell-down process into their own re- porting currencies. Profits retained in operating entities d e t i d u A with a reporting currency other than the Swiss franc are managed as part of UBS’s consolidated equity, as described earlier. Hedging of anticipated future reported profits and losses The monthly sell-down process cannot protect UBS’s earn- ings from swings caused by a sustained depreciation against the Swiss franc of one of the main currencies in which UBS earns net revenues or by an appreciation of one in which it incurs significant net costs. The firm’s corporate currency management executes a dynamic and cost-efficient rollover hedge strategy on a por- tion of the profits or losses that UBS anticipates for the next three months, on a rolling one-month basis. Although intended to hedge future earnings, these trans- actions are considered open currency positions. They are therefore subject to internal market risk VaR and stress loss limits. In public segmental reporting, the profits and losses aris- ing from the hedge strategy are shown as Corporate Center items, while the business division results are fully exposed to exchange rate fluctuations. t n e m e g a n a m y r u s a e r t d n a k s i R 161 Risk and treasury management Treasury management Capital management d e t i d u A d e t i d u A d e t i d u A Sufficient capital must be in place to support business activi- ties, according to both UBS’s own internal assessment and the requirements of its regulators, in particular its lead regulator the Swiss Financial Market Supervisory Authority (FINMA; un- til 31 December 2008 Swiss Federal Banking Commission). UBS aims to maintain sound capital ratios at all times, and it therefore considers not only the current situation but also projected developments in both its capital base and capital requirements. The main tools by which UBS manages the supply side of its capital ratios are active management of shares, capital instruments and dividend payments. Capital adequacy management Ensuring compliance with minimum regulatory capital re- quirements and targeted capital ratios is central to capital adequacy management. In this ongoing process, UBS man- ages towards tier 1 and total capital target ratios. In the tar- get setting process UBS takes into account the regulatory minimum capital requirements, regulators’ expectations that UBS holds additional capital above minimum requirements, UBS’s internal assessment of aggregate risk exposure in terms of capital-at-risk (refer to “Earnings-at-risk and capi- tal-at-risk” in the “Risk management and control” section of this report), the views of rating agencies, and comparison with peer institutions considering UBS’s business mix and market presence. Regulatory requirements On 1 January 2008, UBS adopted the Basel II capital frame- work of the Basel Committee on Banking Supervision of the Bank for International Settlements (BIS). (Refer to the “Gen- eral description of risk exposure measures and capital re- quirements” in the “Basel II Pillar 3” section of this report for details regarding UBS’s implementation of Basel II.) The intro- duction of Basel II led to a decrease in UBS’s overall capital requirements, as measured by risk-weighted assets (RWA). Eligible capital calculations have also been modified by the introduction of new deductions from tier 1 capital and total capital, resulting in lower eligible capital. To allow for comparability, published RWA are determined according to the rules of the BIS Basel II framework. UBS’s regulatory capital requirements are based on the regulations of FINMA, which lead to higher risk-weighted assets com- pared with BIS guidelines (refer to the additional capital management disclosure in the “Basel II Pillar 3” section of this report). Eligible capital is the same under BIS guidelines and FINMA regulations. In 2008, UBS complied with all externally imposed capital requirements. Developments As publicly announced, in fourth quarter 2008 FINMA en- hanced the capital requirements under Basel II, Pillar 2, for UBS and Credit Suisse. The new regulatory measures will have to be implemented progressively until full applicability on 1 January 2013. First, FINMA will increase the capital buffer (the regula- tory excess capital expected to be held over and above the regulatory minimum requirement) from 20% to 50%–100% over the cycle. At the same time, FINMA will allow for en- larged recognition of hybrid capital. Second, FINMA will introduce a minimum leverage ratio, defining the minimum amount of tier 1 capital required for a given balance sheet size. For this calculation, the IFRS bal- ance sheet is adjusted for a number of factors: replacement values determined according to the rules of IFRS are substi- tuted by the corresponding values under Swiss Generally Ac- cepted Accounting Principles (Swiss GAAP), allowing for in- creased recognition of netting benefits, similar to US GAAP. Moreover, the Swiss loan book, certain cash and balances with central banks and specified reverse repurchase agree- ments where the repurchase price is payable in Swiss francs will be excluded from the balance sheet. Furthermore, a number of adjustments will be made to avoid double-count- ing of assets that are already deducted from tier 1 capital, most notably goodwill and intangible assets. FINMA will re- quire a minimum leverage ratio of 3% on Group level, with an expectation that the ratio will be well above the minimum requirements in normal times. The table on the next page shows the calculation of the FINMA consolidated leverage ratio as of 31 December 2008. In January 2009, the Basel Committee on Banking Super- vision issued consultative documents on proposed revisions to the Basel II market risk framework. Broadly, the committee aims to address perceived shortcomings of the current Value at Risk (VaR) framework, most notably by enhancing capital re- quirements to incorporate effects of “stressed VaR” and by introducing new capital charges for price risks that are incre- mental to any default and event risks already captured by VaR models used by banks. Furthermore, the Basel Committee also plans to update – for regulatory capital purposes – the prudent valuation guidance for illiquid positions accounted for at fair value. It is envisaged that the revised requirements will have to be implemented by the end of 2009 and 2010, respectively. Finally, in January 2009 the Basel Committee issued a consultative document on further enhancements to the Ba- 162 sel II framework, with revised requirements for securitization exposures and, in particular, higher risk weights for re-secu- ritization positions. Capital ratios The BIS ratios compare the amount of eligible capital (in total and tier 1) with the total of risk-weighted assets. At year-end 2008, the BIS tier 1 ratio amounted to 11.0% and the total capital ratio to 15.0%, compared with 9.1% and 12.2%, respectively, under Basel I rules at year- end 2007. In this period, risk-weighted assets declined from CHF 374.4 billion (Basel I) to CHF 302.3 billion, while tier 1 capital decreased from CHF 34.1 billion to CHF 33.2 billion. Eligible capital and capital ratios were restated following a change in accounting policy on pension and other post- retirement benefit plans (refer to “Note 30 Pension and oth- er post-retirement benefit plans” in the financial statements of this report for more information). Due to this restatement, tier 1 capital and total capital increased by approximately CHF 1.6 billion and the corresponding capital ratios by 40 basis points at year-end 2007. Capital requirements d e t i d u A UBS’s capital requirements are generally based on its consoli- dated financial statements in accordance with IFRS. Under IFRS, subsidiaries and special purpose entities that are directly or indirectly controlled by UBS must be consolidated, where- as for regulatory capital purposes, different consolidation principles apply. For example, subsidiaries that are not active in the banking and finance business are excluded. ➔ Refer to the additional capital management disclosure in UBS: BIS capital ratios¹ In % Basel I Basel II 18 15 12 9 6 4 0 Q 1 4 0 Q 2 4 0 Q 3 4 0 Q 4 5 0 Q 1 5 0 Q 2 5 0 Q 3 5 0 Q 4 6 0 Q 1 6 0 Q 2 6 0 Q 3 6 0 Q 4 7 0 Q 1 7 0 Q 2 7 0 Q 3 7 0 Q 4 8 0 Q 1 8 0 Q 2 8 0 Q 3 8 0 Q 4 14.2 13.9 13.9 14.1 13.4 12.8 12.5 12.1 12.3 11.9 14.2 12.6 14.5 14.5 12.8 13.3 13.3 11.6 15.5 14.8 15.0 15.0 15.8 12.6 12.7 12.2 12.0 12.7 13.9 11.0 16.2 15.0 15.0 12.2 11.1 12.2 11.0 11.0 9.1 7.4 BIS tier 1 capital ratio BIS total capital ratio 1 Prior to and including 4Q07 the capital ratios above are based on Basel I capital regulations, thereafter on Basel II rules. On 31 December 2008 risk-weighted assets were CHF 302.3 billion, compared with CHF 374.4 billion (Basel I) at year-end 2007. Figures by component are as follows: Credit risk Risk-weighted assets for credit risk amounted to CHF 222.6 billion at 31 December 2008, compared with CHF 323.3 bil- lion under Basel I on 31 December 2007. The introduction of Basel II led to considerably lower risk-weighted assets for cred- it risk. However, the impact on individual business divisions varied: Global Wealth Management & Business Banking saw lower risk-weighted assets for customer loans, mortgages and lombard lending, while the Investment Bank was subject to higher capital requirements for over-the-counter (OTC) deriva- tives and repo-style transactions (i.e. repurchase / reverse re- purchase and securities, lending and borrowing transactions). ➔ Refer to the “Credit risk” section of this report for more the “Basel II Pillar 3” section of this report information 3CM010_e t n e m e g a n a m y r u s a e r t d n a k s i R FINMA1 adjusted assets for leverage ratio calculation CHF billion, except where indicated Total assets (IFRS) 2 prior to deductions Less: difference between IFRS and Swiss GAAP positive replacement values 3 Less: loans to Swiss clients (excluding banks) Less: cash and balances with central banks Less: Other 4 Total adjusted assets FINMA consolidated leverage ratio (%) Average fourth quarter 2008 2,212 (653) (165) (27) (20) 1,347 2.46 1 Swiss Financial Market Supervisory Authority (FINMA). 2 International Financial Reporting Standards. 3 The netting difference is disclosed in the «Off-balance sheet» section of this report. 4 Refer to the “Capital components” table for more information on deductions of assets from tier 1 capital. 163 11.25 11.25 7.50 7.50 3.75 3.75 15.00 15.00 0.00 0.00 Risk and treasury management Treasury management Non-counterparty related assets Risk-weighted assets for non-counterparty related assets amounted to CHF 7.4 billion at 31 December 2008, com- pared with CHF 9.0 billion under Basel I on 31 December 2007. d e t i d u A Market risk In 2008, risk-weighted assets for market risk decreased by CHF 14.5 billion to CHF 27.6 billion on 31 December 2008, due to lower regulatory VaR. The decrease resulted primarily from the transfer of certain illiquid assets from the trading book to the banking book on 1 January 2008 and was par- tially offset by increases in VaR following higher market vola- tility and enhancements made to the VaR model. ➔ Refer to the “Market risk” section of this report for further information Operational risk The new Basel II capital requirement for operational risk amounted to risk-weighted assets of CHF 44.7 billion on 31 December 2008. ➔ Refer to the “Operational risk” section of this report for further information Eligible capital d e t i d u A The capital available to support risk-weighted assets – eligi- ble capital – consists of tier 1 and tier 2 capital. Tier 1 capital is required to be at least 4% of risk-weighted assets and to- tal capital (tier 1 plus tier 2) at least 8%. To determine eligi- ble tier 1 and total capital, adjustments have to be made to shareholders’ equity as defined under IFRS, most notably by deducting goodwill and investments in unconsolidated enti- ties engaged in banking and financial activities. Tier 1 capital / UBS shares On 31 December 2008, the regulatory eligible tier 1 capital was CHF 33.2 billion, down CHF 0.9 billion compared with year-end 2007. This is the net effect of: CHF 21.3 billion in losses incurred during 2008; reversal for capital purposes of CHF 4.5 billion gains recognized under IFRS related to the accounting for the mandatory convertible notes (MCNs) is- sued in March and December 2008 (refer to the “IFRS equity to BIS tier 1 capital” section below for more information); CHF 3.8 billion reductions of capital related to own shares; CHF 2.9 billion losses recognized directly in equity; addition- al deductions of CHF 2.6 billion for intangible assets and other Basel II deductions; and the reversal of CHF 2.3 billion of gains on own credit for capital purposes. These negative effects were compensated by the issue of CHF 13.0 billion MCNs on 5 March 2008, proceeds of EUR 1.0 billion from the issuance of perpetual preferred securities on 11 April 2008, the net proceeds from the rights issue of CHF 15.6 bil- lion on 17 June 2008, and the issuance of CHF 6.0 billion MCNs on 9 December 2008. Hybrid tier 1 capital Hybrid tier 1 instruments are perpetual instruments that can only be redeemed if they are called by the issuer. The payment of interest is subject to compliance with minimum capital ratios and any payment missed is non-cumulative. As of 31 December 2008, UBS’s hybrid tier 1 instruments amounted to CHF 7.4 billion. Under IFRS, these instruments are accounted for as equity attributable to minority inter- ests. Tier 2 capital Tier 2 capital consists mainly of subordinated long-term debt that ranks senior to both UBS shares and hybrid tier 1 instru- Capital adequacy CHF million, except where indicated BIS tier 1 capital of which hybrid tier 1 capital BIS total capital BIS tier 1 capital ratio (%) BIS total capital ratio (%) Credit risk 1 Non-counterparty related risk Market risk Operational risk Total BIS risk-weighted assets Basel II 31.12.08 33,154 7,393 45,367 11.0 15.0 222,563 7,411 27,614 44,685 302,273 Basel I 31.12.08 35,671 7,393 46,012 9.8 12.7 326,608 8,826 27,614 N/A 363,048 31.12.07 34,101 6,387 45,797 9.1 12.2 323,345 8,966 42,110 N/A 374,421 1 Includes securitization exposures and equity exposures not part of the trading book and capital requirements for failed trades. 164 d e t i d u A ments but is subordinated to all senior obligations of UBS. Tier 2 capital accounted for CHF 12.2 billion in total capital as of year-end 2008. ➔ Refer to the “Shares and capital instruments” section of this report for details about UBS’s issuance of capital securities during 2008, including hybrid tier 1 instruments and tier 1 instruments Intragroup transfer of capital UBS enters into intragroup transactions in order to manage funding and capital of individual UBS entities. As at 31 De- cember 2008, UBS was not aware of any material restric- tions, or other major impediments, concerning the transfer of funds or regulatory capital within the Group apart from those which apply to these entities by way of local laws and regulations. IFRS equity to BIS tier 1 capital The key adjustments made to IFRS equity attributable to shareholders to determine tier 1 eligible capital result from: – An increase in IFRS share premium of CHF 7.0 billion and retained earnings of CHF 3.8 billion from the rec- ognition of CHF 13.0 billion MCNs issued in March 2008, versus an increase of tier 1 capital (recognized in BIS share premium) by CHF 13.0 billion. Refer to “Note 26 Capital increases and mandatory convertible notes” in the financial statements of this report for more infor- mation. – The different treatment of MCNs placed with the Swiss Confederation in December 2008 for IFRS and regulatory capital purposes: IFRS equity attributable to UBS share- holders decreased overall by CHF 2.9 billion, which re- flects the net effect of a reduction to share premium of CHF 3.6 billion and a positive impact on retained earnings of CHF 0.7 billion. In contrast, tier 1 capital increased by CHF 6.0 billion. Refer to “Note 26 Capital increases and mandatory convertible notes” in the financial statements of this report for more information. – A negative impact on BIS share premium of CHF 0.9 bil- lion from adjustments for the recognition of interest pay- ments on both MCNs for capital purposes. – The inability to recognize, for tier 1 capital, fair value changes recorded directly in equity under IFRS from finan- cial investments available-for-sale and cash flow hedges (reduction of CHF 1.3 billion). – Further corrections in retained earnings for gains on own credit of CHF 3.0 billion relating to the application of the fair value option under International Accounting Stan- dard (IAS) 39 for capital adequacy purposes. Capital components d e t i d u A CHF million Core capital prior to deductions of which: paid-in share capital of which: share premium, retained earnings, currency translation differences and other elements of which: non-innovative capital instruments of which: innovative capital instruments Less: treasury shares / deduction for own shares 1 Less: goodwill & intangible assets 3 Less: other Basel II deductions 4 Total eligible tier 1 capital Upper tier 2 capital Lower tier 2 capital Less: other Basel I deductions 5 Less: other Basel II deductions 4 Total eligible capital Basel II 31.12.08 48,758 293 41,072 1,810 5,583 (1,488) 2 (12,950) (1,167) 33,154 1,090 12,290 N/A (1,167) 45,367 Basel I 31.12.08 48,758 293 41,072 1,810 5,583 (1,488) (11,600) N/A 35,671 69 12,290 (2,018) N/A 46,012 31.12.07 51,437 207 44,842 340 6,047 (4,133) (13,203) 34,101 301 13,770 (2,375) 45,797 1 Consists of: i) net long position in own shares held for trading purposes; ii) own shares bought for cancellation (second trading line) and for unvested or upcoming share awards; iii) other treasury share  positions net of delta-weighted obligations out of employee stock options granted prior to August 2006. 2 Netting of own shares with share-based payment obligations is subject to a grandfathering agreement with the Swiss Financial Market Supervisory Authority. 3 Includes under Basel I only goodwill and the portion of intangible assets exceeding 4% of tier 1 capital. 4 Positions to be de- ducted as 50% from tier 1 and 50% from total capital mainly consist of: net long position of non-consolidated participations in the finance sector, first loss positions from securitization exposures, excess  of expected losses above general provisions (AIRB), expected loss for equities (simple risk weight method). 5 Consists of the net long position of non-consolidated participations in the finance sector  and first loss positions from securitization exposures. 165 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Treasury management – Removing minority interests of entities not consolidated for regulatory capital purposes, causing a further reduc- tion of regulatory capital by CHF 0.5 billion. – A positive adjustment of CHF 1.7 billion primarily for the ability to net, for capital purposes, treasury shares held as hedges against obligations from employee stock options granted prior to August 2006. Equity attribution framework In first quarter 2008, UBS implemented a new framework for attributing equity capital to its businesses. This reflects UBS’s overarching objectives of maintaining a strong capital base and guiding businesses towards activities with the best balance among profit potential, risk and capital usage. In this framework, the Group Executive Board (GEB) attributes equity to the businesses after considering their risk expo- sure, asset size, goodwill and intangible assets. The design of the equity attribution framework enables UBS to: – Calculate and assess return on attributed equity (RoaE) in each of its businesses. With effect from first quarter 2008, RoaE and return on BIS risk-weighted assets (RoRWA) are disclosed for all business groups and units and replace the previously disclosed “return on allocated regulatory capi- tal” measure. – Integrate Group-wide capital management activities with those at business group and business unit level. – Measure performance in a consistent manner across busi- ness divisions and business units. – Make better comparisons between the Group’s business- es and those of competitors. The framework operates as follows: First, each business is attributed an amount of equity equal to the average book value of goodwill and intangible assets, as reported for that business division or business unit according to IFRS. Next, the GEB considers a number of factors that drive required capi- tal, including: – Equity requirements based on aggregated risk exposure, including the potential for losses exceeding UBS’s earn- ings capacity as defined by the firm’s “capital-at-risk” concept. – Regulatory capital requirements which are based on risk- weighted asset usage of the businesses and also take into account the different market standards for tier 1 ratios associated with “pure-play” competitors of each of the businesses. – The asset size of the businesses. After reviewing the results of this formulaic approach, the GEB makes adjustments to the final tangible equity at- tribution to reflect the amount of equity it believes is ap- propriate for each business. This assessment is based on the d e t i d u A Reconciliation of International Financial Reporting Standards equity to BIS tier 1 capital CHF million Share capital Share premium Net income recognized directly in equity, net of tax Revaluation reserve from step acquisitions, net of tax Retained earnings Equity classified as obligation to purchase own shares Equity attributable to minority interests Treasury shares / deduction for own shares Mandatory convertible notes (MCNs) to the Swiss Confederation Total equity / gross tier 1 including MCNs and hybrid tier 1 instruments Less: goodwill, intangible assets and other Basel II deduction items Eligible tier 1 capital IFRS 1 view 293 25,250 (4,335) 38 14,487 (46) 8,002 (3,156) 0 3 40,533 31.12.08 Basel II Reconciliation items Basel I BIS view BIS view 0 8,500 (1,265) 0 (7,716) 46 (495) 1,668 2 6,000 6,738 293 33,750 (5,600) 38 6,771 0 7,507 (1,488) 6,000 47,271 (14,117) 4 33,154 293 33,750 (5,600) 38 6,771 0 7,507 (1,488) 6,000 47,271 (11,600) 5 35,671 1 International Financial Reporting Standards (IFRS). 2 Generally, treasury shares are fully deducted from equity under IFRS, whereas for capital adequacy purposes only the following positions in own shares are deducted: i) net long position in own shares held for trading purposes; ii) own shares bought for cancellation (second trading line) and for unvested or upcoming share awards; and iii) other  treasury share positions net of delta-weighted obligations out of employee stock options granted prior to August 2006, subject to an interim agreement with the Swiss Financial Market Supervisory Authority. 3 Under IFRS, the recognition of the MCNs to the Swiss Confederation reduced the share premium CHF 3.6 billion and increased retained earnings CHF 0.7 billion. 4 “Other Basel II deduc- tion items” includes primarily 50% of the deductions for net long position of non-consolidated participations in the finance sector, first loss positions from securitization exposures, excess of expected  losses above general provisions (AIRB), expected loss for equities (simple risk weight method). 5 Equals to goodwill and the intangible assets exceeding 4% of tier 1 capital. 166 expectations of the business’s clients and the business envi- ronment, including allowing for sufficient capital to sup- port the business’s underlying risks and sustain extreme stress scenarios. The amount of equity attributed to all the businesses corresponds to the amount that UBS believes is required to maintain a strong capital base and support its businesses adequately. If the total equity attributed to the businesses differs from the Group’s actual equity during a particular period, the surplus or deficit is shown in the Cor- porate Center. As reflected in the table below, during 2008, the amount of average equity attributed to the Investment Bank was re- duced by CHF 2 billion due to lower risk exposures. In the fourth quarter, the average equity attributed to Global Wealth Management & Business Banking grew by CHF 1 bil- lion, mainly reflecting actual and projected increases in capi- tal needs for operational risks in Wealth Management US. Global Asset Management’s average attributed equity was CHF 3 billion during 2008. In the table below, equity attributable to UBS sharehold- ers includes the CHF 13 billion nominal value of the MCNs issued in March 2008. However, the CHF 6 billion nominal value of the MCNs issued in December 2008 will be included in this figure only when the notes will be converted or if cer- tain other conditions are met which make it appropriate to include the December 2008 MCNs in equity. t n e m e g a n a m y r u s a e r t d n a k s i R Average equity attributed CHF billion Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Equity attributable to UBS shareholders 2008 6.1 7.3 3.8 17.3 3.0 26.8 (10.7) 36.3 4Q08 3Q08 6.0 8.3 3.7 18.0 3.0 26.0 (7.5) 39.5 5.9 7.6 3.5 17.0 3.0 26.0 0.2 46.2 2Q08 6.2 6.8 4.0 17.0 3.0 27.0 (15.0) 32.0 1Q08 6.3 6.6 4.1 17.0 3.0 28.0 (20.5) 27.5 167 Risk and treasury management Treasury management Shares and capital instruments Shares UBS shares and tier 1 capital The majority of UBS’s tier 1 capital comprises share premi- um and retained earnings attributed to UBS shareholders. As of 31 December 2008, total IFRS equity attributable to UBS shareholders amounted to CHF 32,531 million and was represented by a total of 2,932,580,549 issued UBS shares, of which 61,903,121 (2.1%) were held by UBS. Each outstanding share has a par value of CHF 0.10 and entitles the holder to one vote at the shareholders’ meeting and to a proportionate share of the dividend that is distrib- uted. There are no preferential rights for shareholders and no other classes of shares are issued by the parent bank (UBS AG) directly. In 2008, as part of UBS’s shareholder-approved recapital- ization measures, the outstanding shares were increased by a total of 859,033,205 reflecting mainly the issuance of newly created shares for the stock dividend (98,698,754 shares) and for the capital increase by means of a rights of- fering (760,295,181 shares). For the stock dividend, each share held on 25 April 2008 was allocated one entitlement. Twenty of those entitlements gave the holder the right to receive one UBS share for free on 19 May 2008. For the sub- sequent capital increase by means of a rights offering, share- holders were allotted one subscription right per share held on 26 May 2008. For every 20 of those rights, shareholders were entitled to buy seven shares at CHF 21.00 on 17 June 2008. As a result of the latter rights offering, a net total of CHF 15.6 billion of new capital was received. At the time of issuance this was equal to an increase of approximately 4.8% in UBS’s tier 1 ratio. Shares Number of shares Balance at the beginning of the year Issue of shares for stock dividend Issue of shares for capital increase (rights offering) Issue of shares for employee options Balance at the end of the year Shareholder-approved issuance of shares Authorized capital Stock dividend 2007 (not used) Conditional capital March 2008 MCNs December 2008 MCNs Employee equity participation plans of UBS AG Employee stock ownership plan of former PaineWebber 1 Mandatory convertible notes. 168 For the year ended 31.12.08 2,073,547,344 98,698,754 760,295,181 39,270 2,932,580,549 Maximum number of shares to be issued Year approved by shareholder general meeting % of shares issued (including MCNs 1) 31.12.08 5,001,246 277,750,000 365,000,000 149,994,296 100,415 2008 2008 2008 2006 2000 13.99 7.77 10.21 4.20 0.00 Holding of UBS shares UBS holds its own shares for three main purposes: Group Treasury holds shares to cover employee share and option programs; it repurchases shares on a second trading line, where they are earmarked for cancellation purposes (the lat- ter activity is temporarily suspended); and the Investment Bank holds shares, to a limited extent, for trading purposes where it engages in market-making activities in UBS shares and related derivative products. The holding of treasury shares on 31 December 2008 decreased to 61,903,121 or 2.1% of shares issued, from 158,105,524 or 7.6% on the same date one year prior. In 2008, a total of 3.7 million employee options were ex- ercised and an additional 63.0 million new options were granted. As of 31 December 2008, UBS was holding approx- imately 48.9 million shares in Group Treasury and an addi- tional 150 million unissued shares in conditional share capi- tal that can be used to cover future employee option exercises, of which a total of 236 million were outstanding on 31 December 2008. At year-end 2008, the shares avail- able covered all exercisable employee options. The presentation in the table below shows the purchase of UBS shares by Group Treasury under buy-back programs at the stock exchange and does not include activities of the Investment Bank in UBS shares. Treasury shares held by the Investment Bank The Investment Bank, acting as liquidity provider to the equity index futures market and as a market maker in UBS shares and derivatives, has issued derivatives linked to UBS stock. Most of these instruments are classified as cash-set- tled derivatives and are held for trading purposes only. To hedge the economic exposure, a limited number of UBS shares are held by the Investment Bank. t n e m e g a n a m y r u s a e r t d n a k s i R Share buy-back programs Program Announcement Beginning Expiration Cancellation 2000/2001 2001/2002 2002/2003 2002/2003 2003/2004 2004/2005 2005/2006 2006/2007 2007/2010 5 14.12.99 17.1.00 22.2.01 14.2.01 9.10.02 18.2.03 10.2.04 8.2.05 14.2.06 13.2.07 5.3.01 6.3.02 11.10.02 6.3.03 8.3.04 8.3.05 8.3.06 8.3.07 2.3.01 5.3.02 8.10.02 5.3.03 5.3.04 7.3.05 7.3.06 7.3.07 8.3.10 13.7.01 5.7.02 10.7.03 10.7.03 30.6.04 8.7.05 13.7.06 29.6.07 Maximum volume (in CHF billion) Maximum volume (in millions of shares) Amount (CHF billion) Total shares purchased Average price (in CHF) Unutilized volume (CHF billion) Unutilized volume (in millions of shares) 4.0 5.0 5.0 3.0 5.0 6.0 5.0 5.0 210.5 3 4.0 2.3 5.0 0.5 4.5 3.5 4.0 2.4 2.6 4 110,530,698 1, 2 36.18 1, 2 39.73 2 36.92 2 32.04 2 37.97 2 44.36 2 54.26 2 73.14 2 71.41 4 57,637,380 2 135,400,000 2 16,540,160 2 118,964,000 2 79,870,188 2 74,200,000 2 33,020,000 2 36,400,000 4 0 2.7 0 2.5 0.5 2.5 1.0 2.6 174.1 3 1 Restated to reflect 3:1 stock split on 16 July 2001.    2 Restated to reflect 2:1 stock split on 10 July 2006.    3 The 2007/2010 program was approved for a maximum of 210,527,328 shares, equal to 10% of the outstanding shares on 31 December 2006. On 31 December 2007, the unutilized number of shares (174.1 million) multiplied by the prevailing market price of UBS shares of CHF 52.40 per share equaled an unutilized volume of approximately CHF 9.1 billion. 4 In 2007, 36,400,000 shares were repurchased under the 2007/2010 program for CHF 2.6 billion (at an average price of CHF 71.41 per share). On 10 December 2007 the UBS Board of Directors communicated its decision that these shares will not be cancelled but will be rededicated as a measure to strengthen UBS’s capital. 5 This program is currently suspended. 169 Risk and treasury management Treasury management Capital instruments Mandatory convertible notes As part of the measures taken to strengthen its capital base in 2008, UBS issued two mandatory convertible notes (MCNs), with principal amounts of CHF 13 billion (MCN1) and CHF 6 billion (MCN2) respectively, in private placements to large institutional investors and the Swiss Confederation. To allow for the delivery of shares upon conversion of the MCNs, separate extraordinary general meetings of UBS shareholders were held on 27 February and 27 November 2008 to approve the creation of conditional capital for this purpose. The shareholders approved a maximum number of 277.8 million UBS shares to be delivered under the first is- sued MCN and 365 million UBS shares to be delivered under the second MCN. The initial investors in the MCNs are al- lowed to sell or transfer the instruments without restrictions to other investors. The share capital will be increased upon voluntary or mandatory conversion of the MCNs. The future mandatory capital increase allows the full proceeds to be counted as tier 1 capital for regulatory capital purposes from the date of issuance. MCNs are a special type of equity-linked security that will never be redeemed in cash but rather, upon maturity or ear- ly conversion, will automatically convert into shares of the note issuer or an affiliated company. The number of shares to be delivered depends on the conversion price, and will vary according to the precise terms (see below). The MCNs issued by UBS contain provisions allowing early conversion at the option either of the holders or of UBS. Throughout the lifetime of the MCNs, the holders will re- ceive an annual coupon based on the nominal value of the MCNs. This annual coupon not only reflects the cost of capi- tal but also compensates the noteholders for the value of options embedded in the structure, for instance for bearing the risk of a share price deterioration before conversion if the share price falls below the reference price described below, and for the fact that MCN holders only participate in the benefit of an increasing share price once the share price ex- ceeds 117% of the reference price. The MCNs can be con- verted at the earliest after a period of six months has elapsed following their issuance and they must be converted at the latest by maturity of the notes. As of year end, holders of the March 2008 MCNs (or MCN1) are expected to receive in aggregate a fixed number of 270.4 million UBS shares at conversion or settlement inde- pendently of the UBS share price development, whereas un- der the terms of the second issuance (the December 2008 MCNs or MCN2) holders will receive a variable number of shares. At or below a UBS share price of CHF 18.21, the De- cember 2008 MCNs will be converted into a maximum of 329.4 million UBS shares. Should the UBS share price rise above this level, the holders would receive a lower number of shares and the minimum would be reached with a share price of CHF 21.31. Thereafter, a further increase in price leads to an incremental increase in shares delivered, provided however that the total number of shares to be issued will not exceed the maximum number of shares (see the graphs on the next page). Hybrid tier 1 capital Hybrid tier 1 instruments represent innovative and non-inno- vative perpetual instruments and made up approximately 21.5% of adjusted core capital on 31 December 2008. They are accounted for under minority interests in the IFRS equity. In 2008, UBS raised EUR 1 billion of capital preferred securi- ties issued by UBS Capital Securities (Jersey) Ltd. The instru- ment bears an 8.836% coupon and is callable in 2013. As of 31 December 2008, UBS had issued a total of CHF 7,393 million of such instruments in various currencies. Hybrid tier 1 instruments are perpetual instruments which can only be redeemed if they are called by the issuer. If such a call is not exercised at the respective call date, the terms might include a change from fixed to floating coupon payments and, in the case of innovative instruments only, a limited step-up of the interest rate. Non-innovative instruments do not have a step- up of the interest rate and are therefore viewed as having a higher equity characteristic for regulatory capital purposes. The instruments are issued either through trusts or subsidiar- ies of UBS and rank senior to UBS shares in dissolution. Pay- ments under the instruments are subject to adherence to minimum capital ratios by UBS. Any payment missed is non- cumulative. Tier 2 capital The major element in tier 2 capital consists of subordinated long-term debt. Tier 2 instruments have been issued in vari- ous currencies and with a range of maturities across capital markets globally. They accounted for CHF 12,290 million in total capital as of year-end 2008. Tier 2 instruments rank senior to both UBS shares and to hybrid tier 1 instruments but are subordinated to all senior obligations of UBS. Distributions to shareholders The decision whether to pay a dividend and the level of the dividend are dependent on UBS’s targeted capital ratios and its cash flow generation. The decision on dividend payments is proposed by the Board of Directors (BoD) to the sharehold- ers and is subject to their approval at the annual general meeting. The BoD has decided not to propose any dividend for the financial year 2008. Distribution to shareholders in 2008 – stock dividend At the extraordinary general meeting of 27 February 2008, the shareholders approved distribution of a stock dividend offering the opportunity to obtain sale proceeds comparable with the cash dividend paid in previous years. One entitle- 170 ment was allocated to each share outstanding after the close of business on the record date of 25 April 2008. Twenty en- titlements gave the holder the right to receive one additional UBS share for free. This stock dividend was tax-efficient for many sharehold- ers resident in Switzerland and those in many other coun- tries. Unlike a cash dividend, where the Swiss withholding tax of 35% is deducted from the gross amount payable, the stock dividend was allocated to shareholders without deduc- tion of Swiss withholding tax. Compared with the cash dividend, a stock dividend is also more beneficial for UBS’s (tier 1) capital base. Cash dividend payments are deducted from the firm’s net profits and retained earnings, which are major components of its core (tier 1) capi- tal. In contrast, by issuing new shares in lieu of a dividend cash payment, the level of UBS’s (tier 1) capital base is maintained. Conversion price and number of shares MCN 1 MCN 2 Coupon 9% 12.50% Amount (CHF billion) 13.0 6.0 Issuance date Conversion period / maturity 5.3.08 9.12.08 6.9.08 9.6.09 5.3.10 9.6.11 Conversion price per UBS share (CHF) 48.07 1 18.21 2 21.31 2 additional shares if above 21.31 Conversion into numbers of UBS shares 270,438,942 329,447,681 281,579,096 3 1 Adjusted for dilution effects on the capital increase. 2 Conversion price between CHF 18.21 and CHF 21.31 (rounded) results in a variable number of shares between 329,447,681 and 281,579,096. 3 Approxi mately CHF 48 million countervalue in additional UBS shares per CHF 1 increase in the UBS share price. Number of shares to be delivered Number of shares in million Value of shares Value in CHF million 340 320 300 280 260 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 18,000 14,000 10,000 6,000 2,000 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 t n e m e g a n a m y r u s a e r t d n a k s i R UBS share price (CHF) UBS share price (CHF) MCN1 MCN2 3CM029_a_e MCN1 MCN2 3CM029_b_e Number of shares to be delivered Number of shares in million Value of shares Value in CHF million 610 590 570 550 530 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 30,000 23,000 16,000 9,000 2,000 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 UBS share price (CHF) UBS share price (CHF) MCN1 +MCN2 3CM029_c_e MCN1 +MCN2 3CM029_d_e 171 18000 14800 11600 8400 5200 2000 30000 24400 18800 13200 7600 2000 340 324 308 292 276 260 610 594 578 562 546 530 Risk and treasury management Treasury management UBS shares in 2008 UBS share price versus Dow Jones Banks Titans 30 Index In % 1 January 2006–31 December 2008 Source: Bloomberg 150 100 50 0 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 UBS registered shares (CHF) Dow Jones Banks Titans 30 Index (CHF) Note: For current share price refer to: www.ubs.com/quotes 3CM022_e UBS shares are listed on the SIX Swiss Exchange (traded on SWX Europe), the New York Stock Exchange and the Tokyo Stock Exchange. ➔ Refer to the “Capital structure“ section of this report for more information on UBS shares including par value, type and rights of security 2008 saw the unfolding of a global financial crisis and a marked global economic slowdown, with falling prices in nearly every asset class. Concerns that the deterioration in the US housing market seen in 2007 would spread to the general consumer area materialized as consumer confidence reached new lows and several western economies fell into recession. Government central banks and regulators joined forces in a global policy response to stabilize and provide li- quidity to a financial system that, in the opinion of many, nearly collapsed in the second part of the year. Capital injec- tions, the partial or full nationalization of several financial institutions and sharp reductions in interest rates did not, however, restore confidence and liquidity in the short term and credit markets remained paralyzed for most of 2008. Emerging markets suffered and commodities prices saw a sharp reversal and falling prices in the second half of 2008. Corporate earnings deteriorated at a fast pace during 2008 and entire segments of the economy entered 2009 with a very uncertain outlook. Worldwide stock markets dropped significantly during the year, with the financial sec- tor most hit: the Dow Jones Banks Titans 30 Index dropped 58%, the MSCI World index closed down 42%, the Dow Jones Industrial Average closed down 34% and the S&P 500 closed down 38%. Market capitalization  CHF billion 2001 2002 2003 2004 2005 2006 2007 20081 154 132 109 105 104 95 79 Ticker symbols Trading exchange SWX Europe New York Stock Exchange Tokyo Stock Exchange Bloomberg Reuters UBSN VX UBS US 8657 JP UBSN.VX UBS.N 8657.T Security identification codes ISIN 44 CH0024899483 2.489.948 CINS H89231 33 8 1 Market capitalization calculated based on the total UBS ordinary shares issued times the UBS share price at period end. The total UBS ordinary shares as at 31 December 2008 does not reflect the 270.4 million UBS shares and the maximum of 329.4 million UBS shares to be issued through the conversion of mandatory convertible notes in the future. Refer to “Note 8 Earnings per share (EPS) and shares outstanding” in the financial statements of this report for details on shares outstanding for EPS. Valoren Cusip 3CM023_e 160 120 80 40 0 172 150.0 112.5 75.0 37.5 0.0 160 120 80 40 0 First quarter 2008 Fourth quarter 2008 2008 continued in the same vein as the closing months of 2007, with growing concerns over contagion from real es- tate losses to the real economy. At the end of January, UBS pre-announced its fourth quarter 2007 results as a loss of CHF 12.5 billion. In March, UBS’s peer Bear Stearns ap- proached bankruptcy as it suffered a liquidity crisis in the wake of speculation over growing losses. This put further pressure on industry stock prices as the quarter ended. The global banking sector and the broader global indices de- clined by 13% and 10% respectively, while UBS underper- formed the market with its shares declining 45%. Second quarter 2008 The Bear Stearns bankruptcy and acquisition by JPMorgan announced in March proved somewhat purgative for the markets in the second quarter, which remained steady as expectations of a deep global recession were tempered. In the banking sector, however, reported losses mounted lead- ing to capital-raising by a number of large international banks including UBS. Alongside the pre-anouncement of the first quarter results, a rights issue to raise approximately CHF 15 billion was announced together with a number of measures to reduce risks and costs and stabilize per formance. UBS performed in line with the global banking sector, down 16% in the quarter while the broader indices remained gen- erally flat. Third quarter 2008 The third quarter of 2008 proved to be one of the most tu- multuous in banking history. The collapse of Lehman Brothers in September triggered a series of banking failures and gov- ernment rescues which brought the global banking system close to breaking point. Despite posting modest losses for the second quarter in August, UBS shares declined 14% in the quarter and underperformed the global banking sector, down 2% in the wake of the failure of Lehman Brothers. The fourth quarter commenced with persistent concerted ef- forts by central banks to maintain liquidity and, shortly after- wards, a series of government-led programs to stabilize the banking system. As the prospect of a deep global recession loomed, central banks united to deliver their first ever coordi- nated rate cut. UBS announced a further material risk reduction of its balance sheet through the transfer of risk assets to the Swiss National Bank as well as further strengthening its capital base through the issue of CHF 6 billion in mandatory convertible notes to the Swiss Confederation. UBS reported a modest prof- it for the third quarter. Market volatility remained extreme with a slew of profit warnings and losses reported across the banking sector. UBS shares closed the quarter down 20%, outperform- ing the global banking sector which fell 41% as well as the broader indices which declined by more than 20% on average. Over the course of 2008 UBS shares declined 68%, un- derperforming the global banking sector (down 58%), the MSCI and the S&P (down 42% and 38% respectively). Share liquidity During 2008, daily average volume in UBS shares on SWX Europe was 28.5 million shares. On the New York Stock Exchange (NYSE), it was 2.1 million shares. Because of the greater volume on SWX Europe, trading of UBS shares there is expected to remain the main factor determining the movement in UBS’s share price. During the hours in which both SWX Europe and NYSE are simultaneously open for trading (currently 3:30 p.m. to 5:30 p.m. Central European Time), price differences are like- ly to be arbitraged away by professional market-makers. The NYSE price will therefore typically be expected to depend on both the SWX Europe price and the prevailing US dol- lar / Swiss franc exchange rate. When SWX Europe is closed for trading, traded volumes will typically be lower. However, the specialist firm making a market in UBS shares on the NYSE, Van der Moolen, is required to facilitate sufficient liquidity and an orderly market in UBS shares. t n e m e g a n a m y r u s a e r t d n a k s i R 173 Risk and treasury management Treasury management UBS share data Registered shares Total ordinary shares issued Treasury shares Weighted average shares (for basic EPS 1 calculations) Weighted average shares (for diluted EPS calculations) CHF EPS Basic EPS Basic EPS from continuing operations Diluted EPS Diluted EPS from continuing operations 1 Earning per share. UBS shares and market capitalization 31.12.08 As of 31.12.07 31.12.06 2,932,580,549 2,073,547,344 2,105,273,286 61,903,121 158,105,524 164,475,699 2,769,575,922 2,165,301,597 2,221,591,786 2,770,727,478 2,166,768,923 2,309,834,516 For the year ended 31.12.08 31.12.07 31.12.06 (7.69) (7.74) (7.69) (7.75) (2.42) (2.61) (2.43) (2.61) 5.19 4.83 4.99 4.64 31.12.08 As of 31.12.07 % change from 31.12.06 31.12.07 Share price (CHF) 1 Market capitalization (CHF million) 2 1 Historical share price adjusted for the rights issue and stock dividend. 2 Market capitalization calculated based on the total UBS ordinary shares issued times the UBS share price at period end. The total UBS ordinary shares as at 31 December 2008 does not reflect the 270.4 million UBS shares and the maximum of 329.4 million UBS shares to be issued through the conversion of mandatory  convertible notes in the future. Refer to “Note 8 Earnings per share (EPS) and shares outstanding” in the financial statements of this report for details on shares outstanding for EPS.  154,222 108,654 43,519 14.84 65.86 46.60 (68) (60) Source: Bloomberg 31.12.08 7,174,486 28,584 539,856 2,134 For the year ended 31.12.07 4,079,863 16,451 304,446 1,213 31.12.06 2,731,841 10,884 214,912 853 Source: Reuters Trading volumes 1000 shares SWX total (SWX Europe) SWX daily average (SWX Europe) NYSE total NYSE daily average 174 Stock exchange prices1 SIX Swiss Exchange New York Stock Exchange High (CHF) Low (CHF) Period end (CHF) High (USD) Low (USD) Period end (USD) 2008 Fourth quarter 2008 December November October Third quarter 2008 September August July Second quarter 2008 June May April First quarter 2008 March February January 2007 Fourth quarter 2007 Third quarter 2007 Second quarter 2007 First quarter 2007 2006 Fourth quarter 2006 Third quarter 2006 Second quarter 2006 First quarter 2006 2005 Fourth quarter 2005 Third quarter 2005 Second quarter 2005 First quarter 2005 2004 Fourth quarter 2004 Third quarter 2004 Second quarter 2004 First quarter 2004 45.98 24.00 16.28 19.90 24.00 25.76 25.76 24.40 24.44 35.11 27.14 35.11 34.48 45.98 30.65 41.16 45.98 71.95 61.05 66.88 71.55 71.95 71.06 71.06 66.52 66.97 64.05 56.39 56.39 49.84 45.68 46.70 43.76 42.81 40.68 43.76 43.14 10.67 10.67 12.63 10.67 14.20 15.18 15.18 19.43 17.52 20.96 20.96 24.60 25.44 21.52 21.52 30.10 33.65 42.69 42.69 53.67 63.72 59.76 53.23 62.88 53.23 54.31 55.60 41.19 46.52 43.60 41.37 41.19 35.52 37.09 35.52 39.06 37.40 14.84 14.84 14.84 15.15 19.35 18.46 18.46 24.14 20.38 21.44 21.44 25.10 32.68 25.67 25.67 30.56 39.42 46.60 46.60 55.67 65.46 64.21 65.86 65.86 66.52 59.32 63.39 55.38 55.38 48.69 44.27 44.71 42.21 42.21 38.91 39.06 41.65 46.40 21.30 14.30 17.85 21.30 23.07 22.59 22.17 23.07 36.02 25.72 35.21 36.02 46.40 32.24 42.42 46.40 66.26 58.01 62.34 66.26 64.30 63.39 63.39 59.77 61.70 55.55 49.30 49.30 43.49 43.06 45.10 42.29 42.29 36.28 38.09 39.70 8.33 8.33 10.89 8.33 12.28 12.22 12.22 18.62 17.90 20.41 20.41 23.58 30.87 22.33 22.33 32.20 38.05 43.50 43.50 49.84 58.73 55.40 48.34 58.50 48.34 49.36 48.66 38.47 40.73 38.55 38.47 39.61 32.31 34.94 32.31 34.05 33.35 1 Historical share price adjusted for the rights issue and stock dividend 2008. t n e m e g a n a m y r u s a e r t d n a k s i R 14.30 14.30 14.30 12.74 16.90 17.54 17.54 21.89 19.39 20.66 20.66 23.66 33.59 28.80 28.80 32.34 41.29 46.00 46.00 53.25 60.01 59.43 60.33 60.33 59.31 54.85 54.99 47.58 47.58 42.75 38.93 42.20 41.92 41.92 35.17 35.53 37.25 175 Risk and treasury management Basel II Pillar 3 Basel II Pillar 3 UBS publishes Basel II Pillar 3 disclosures on a semi-annual basis. Year-end disclosures are contained within this report. Disclosure elements not covered in the “Risk management and control” and “Treasury management” sections are shown below. Introduction On 1 January 2008, UBS adopted the revised capital frame- work of the Basel Committee on Banking Supervision – Basel II – which introduced new and amended capital requirements for the different risk types and revised the calculation of eli- gible capital. The aim of Basel II Pillar 3 is to encourage market disci- pline by allowing market participants to assess key pieces of information regarding the capital adequacy of banks via a set of disclosure requirements. This section presents UBS’s Basel II Pillar 3 disclosures as of 31 December 2008 and consists mainly of quantitative disclo- sures complemented with explanatory text where needed. ➔ Qualitative disclosures related to the bank’s risk manage- ment and control, definitions and risk exposures as well as capital management can be found in the “Risk manage- ment and control” and “Treasury management” sections of this report Overview of disclosures The following table provides an overview of UBS’s Basel II Pillar 3 disclosures: Basel II Pillar 3 requirement Disclosure in the annual report Capital structure Capital adequacy “Capital management” section of this report “Capital management” and “Basel II Pillar 3” sections of this report Risk management objectives, policies and methodologies (qualitative disclosures) “Risk management and control” section of this report Credit risk Investment positions Market risk Securitization Operational risk “Basel II Pillar 3” section of this report “Basel II Pillar 3” section of this report “Risk management and control” section of this report “Basel II Pillar 3” section of this report “Risk management and control” section of this report General description of risk exposure measures and capital requirements Measures of risk exposure may differ depending on the purpose for which exposures are calculated: financial accounting under International Financial Reporting Stan- dards (IFRS) determination of regulatory capital, or UBS’s internal management. UBS’s Basel II Pillar 3 disclosures are based on the measures of risk exposure that are used to calculate the regulatory capital that is required to underpin those risks. Under the advanced Internal Ratings Based (IRB) approach applied by UBS for the majority of its businesses, credit risk weights are determined by reference to internal counterpar- ty ratings and loss-given default estimates. UBS uses internal models, approved by FINMA, to measure the credit risk ex- posures to third parties on over-the-counter derivatives and repurchase-style (repo-style) transactions. For a subset of its credit portfolio, UBS applies the standardized approach (SA- BIS), based on external ratings. Securitization exposures in the banking book are treated under the Ratings Based Approach (RBA), applying risk- 176 Detailed segmentation of required capital CHF million Credit risk Sovereigns Banks Corporates Residential mortgages Other retail Failed trades from non-delivery-versus-payment (non-DvP) transactions Securitization exposures Non-counterparty related risk Equity exposures outside trading book Settlement risk Market risk Operational risk Total BIS risk weighted assets Additional risk-weighted assets according to FINMA regulations 7 Total FINMA 8 risk weighted assets Basel II 31.12.08 Advanced 156,187 1 9,393 Standardized 52,309 2 803 23,924 104,180 13,150 5,510 30 6,202 7,646 4 27,614 5 44,685 6 242,334 4,286 43,882 3 1,499 1,833 7 7,411 219 59,939 Total 208,496 10,196 28,209 148,062 14,650 7,342 37 6,202 7,411 7,646 219 27,614 44,685 302,273 32,620 334,893 9 t n e m e g a n a m y r u s a e r t d n a k s i R 1 Advanced Internal Ratings Based approach (AIRB). 2 BIS defined standardized approach.    3 RWA for corporate exposures under the standardized approach include lombard loans from Wealth Management International & Switzerland and certain traded products, primarily relating to derivatives, from the Investment Bank. 4 Simple risk weight method. 5 Value-at-Risk approach. 6 Advanced measurement approach (AMA). 7 Reflects an additional charge of 10% on risk-weighted assets (RWA) for credit risk for exposures treated under the standardized approach, a FINMA surcharge of 200% for RWA of non-counterparty  related assets and additional FINMA capital requirements for market risk. 8 Swiss Financial Market Supervisory Authority (FINMA). 9 On 31 December 2008, the FINMA tier 1 ratio amounted to 9.9% and the FINMA total capital ratio to 13.5%. Taking into account the effects from the transitional provisions of the capital floor, which require that during the year 2008 Basel II capital requirements had to amount to at least  90% of Basel I capital requirements, FINMA RWA would have increased CHF 67.7 billion, resulting in a FINMA tier 1 ratio of 8.2% and a FINMA total capital ratio of 11.3%. weights based on external ratings. Non-counterparty related assets such as UBS premises, other properties and equip- ment require capital underpinning according to prescribed regulatory risk weights. For market risk positions, UBS derives its regulatory capi- tal requirement from its internal Value-at-Risk (VaR) model, which is approved by FINMA. UBS has developed a model to quantify operational risk, which meets the regulatory capital standard under the Basel II Advanced Measurement Approach (AMA). Basel II requires deduction of some positions from eligible capital, most notably goodwill, intangible assets (excluding software), net long positions in non-consolidated participa- tions in financial institutions and certain positions in securiti- zation exposures. The naming conventions for the “Exposure segments” used in the following tables are based on the BIS rules and differ from those under Swiss and EU regulations. “Sover- eigns” under the BIS naming convention equate to “Central governments and central banks” as used under the Swiss and EU regulations. Similarly “Banks” equate to “Institu- tions” and “Residential mortgages” equate to “Claims se- cured on residential real estate”. Additional capital management disclosures Although UBS determines published risk-weighted assets (RWA) according to the Basel II Capital Accord (BIS guide- lines), the calculation of UBS’s regulatory capital requirement is based on the regulations of FINMA, leading to higher RWA. Generally, the scope of consolidation for purposes of cal- culating these regulatory capital requirements follows the IFRS consolidation rules for subsidiaries directly or indirectly controlled by UBS AG which are active in the banking and finance business, but excludes subsidiaries in other sectors. The significant operating subsidiary companies in the Group consolidated for IFRS purposes are listed in “Note 34 Signifi- cant subsidiaries and associates” in the financial statements of this report. More specifically, the main differences in the basis of consolidation for IFRS and regulatory capital pur- poses relate to the following entity types and apply regard- less of UBS’s level of control: – Real estate and commercial companies as well as collec- tive investment schemes are not consolidated for regula- tory capital purposes but are risk-weighted. – Insurance companies are not consolidated for regulatory capital purposes but are deducted from capital. – Securitization vehicles are not consolidated for regulatory capital purposes but are treated under the securitization framework. – Joint ventures that are controlled by two ventures are fully consolidated for regulatory capital purposes, whereas they are valued under equity method accounting for IFRS. The “Detailed segmentation of required capital” table above provides a granular breakdown of UBS’s capital requirements. 177 Risk and treasury management Basel II Pillar 3 Credit risk UBS’s Pillar 3 disclosure presents the details on the parame- ters and input data used in its regulatory capital calculation. Although the parameters applied under the advanced IRB approach are generally determined using the same method- ologies, data and systems as UBS uses for internal risk quan- tification, there are nevertheless several differences due to regulatory floors, multipliers, eligibility criteria and exposure definitions that cause the figures presented in this section to deviate from the information disclosed within the “Risk management and control” section of this report. The regula- tory capital calculation of credit risk exposure also differs from that required under IFRS. The Probability of Default (PD) and Loss Given Default (LGD) estimates applied in the regulatory capital calculation are the same as those used for internal risk quantification, with the regulatory prescribed exceptions of a PD floor of 0.03% for non-sovereign exposures, an LGD floor of 10% for residential mortgages and a downturn LGD addressing a potential worsening of the economic cycle. However, be- cause the regulatory exposure definitions are different from the internally applied exposure definitions for traded prod- ucts, the rating and LGD distributions presented in this sec- tion deviate from the information presented in the “Risk management and control” section of this report. For banking products, there are no differences in the Ex- posure at Default (EAD) calculation between the regulatory and the internal management views. However, due to some differences in the scope of consolidation and segmentation, the regulatory exposure reported for Pillar 3 purposes differs from the internal management view of credit exposures which is reported in the “Risk management and control” section of this report. The regulatory exposure for traded products is predomi- nantly calculated on the same systems using the same mod- els that are used for internal risk quantification. However, whereas in the “Risk management and control” section of this report the maximum likely exposure is shown, this sec- tion reports the respective regulatory exposure measures. For securities financing exposures, this is the Close-Out VaR measure as defined in paragraphs 178 to 181 of the Basel II framework. For derivative exposures, UBS has received ap- proval from FINMA to apply the Effective Expected Positive Exposure (EPE) as defined in Annex 4 to the Basel II frame- work. For a minor part of the portfolio, UBS also applies the Comprehensive Approach or the Current Exposure Method. In the tables in this section, the regulatory net credit ex- posure shows the Basel II EAD after all collateral, netting and other eligible risk mitigants have been applied as specified by the relevant regulation. Certain Pillar 3 tables also require a regulatory gross credit exposure view, which differs for bank- Derivation of risk-weighted assets CHF million Cash and balances with central banks Due from banks Loans Financial assets designated at fair value Off-balance sheet 4 Banking products Derivatives Securities financing Traded products Trading portfolio assets Financial investments available-for-sale 5 Accrued income and prepaid expenses Other assets Other products Total 31.12.08 Exposure Less: regulatory  credit risk offsets and adjustments 1 (70) (5,125) (21,117) (6,153) (581) (33,046) (68) 26 (28) (70) (33,116) Regulatory gross credit exposure 22,872 33,884 295,395 11,803 45,589 409,542 190,047 63,825 253,872 32,916 3,027 5,011 10,696 51,650 715,064 Regulatory net credit exposure 22,802 28,759 274,278 5,649 45,008 376,496 190,047 63,825 253,872 32,848 3,027 5,036 10,668 51,579 681,947 Average regulatory risk-weighting 2 Risk-weighted assets 3 6% 25% 24% 20% 34% 24% 42% 16% 35% 40% 15% 93% 82% 53% 31% 1,349 7,066 66,547 1,123 15,105 91,191 79,663 10,404 90,067 13,255 467 4,665 8,814 27,201 208,459 1 Regulatory credit risk offsets and adjustments mainly include margin accounts for derivatives. 2 The derivation of risk-weighted assets (RWA) is based on the various credit risk parameters of the advanced Internal ratings-based approach and the standardized approach respectively. 3 Failed trades are excluded (RWA of CHF 37 million). 4 Includes contingent claims and undrawn irrevocable credit facilities. 5 Financial investments available-for-sale exclude equity positions. 178 ing products in that cash balances in margin accounts are not offset with the corresponding traded products expo- sures. This section also presents information on impaired and defaulted assets in a segmentation which is consistent with the regulatory capital calculation. The table “Derivation of risk-weighted assets” on the previous page shows the derivation of risk-weighted assets from the regulatory gross credit exposure. Regulatory gross credit exposure by geographical region Africa / Middle East Total regulatory gross credit exposure Total regulatory net exposure CHF million Cash and balances with central banks Due from banks Loans Financial assets designated at fair value Off-balance sheet Banking products Derivatives Securities financing Traded products Switzer- land 6,015 898 163,351 73 6,000 Other Europe 8,957 15,253 31,579 2,317 10,533 North America 1 2,309 12,512 76,661 9,144 25,791 176,337 68,639 126,417 10,659 16,645 79,629 18,033 80,127 26,030 Latin America 35 126 Asia / Pacific 5,555 4,648 5,312 15,251 24 905 6,402 1,468 124 219 1,884 27,556 15,423 2,931 448 3,242 25 475 4,190 2,740 62 27,304 97,662 106,157 1,592 18,354 2,803 Trading portfolio assets Financial investments available-for-sale 2 Accrued income and prepaid expenses Other assets Other products 48 30 464 4,593 5,135 12,485 17,977 2,226 1,429 1,852 570 2,797 3,736 17,992 25,080 658 8 82 145 893 1,542 3 218 363 2,126 Total regulatory gross credit exposure 31.12.08 208,777 184,294 257,654 8,887 48,037 1 North America includes the Caribbean. 2 Financial investments available-for-sale exclude equity positions. 206 190 20 6 422 7,415 22,872 33,884 295,395 11,803 45,589 409,542 190,047 63,825 253,872 32,916 3,027 5,011 10,696 51,650 715,064 22,802 28,759 274,278 5,649 45,008 376,496 190,047 63,825 253,872 32,848 3,027 5,036 10,668 51,579 681,947 Regulatory gross credit exposure by counterparty type CHF million Private individuals Corporates 1 Public entities (including sovereigns and central banks) Banks and multilateral institutions Total regulatory gross credit exposure Total regulatory net exposure 22,402 758 8,430 29 1,057 32,675 27,929 5,256 33,185 21,168 2,304 30 265 23,767 470 33,127 5,290 1,623 40,510 45,555 26,229 71,784 448 181 205 3,280 4,114 22,872 33,884 295,395 11,803 45,589 409,542 190,047 63,825 253,872 32,916 3,027 5,011 10,696 51,650 22,802 28,759 274,278 5,649 45,008 376,496 190,047 63,825 253,872 32,848 3,027 5,036 10,668 51,579 157,265 2,905 160,170 1,422 882 2,304 5 742 1,795 2,542 129,701 6,484 40,003 176,188 115,140 31,458 146,598 11,301 536 4,033 5,356 21,226 Cash and balances with central banks Due from banks Loans Financial assets designated at fair value Off-balance sheet Banking products Derivatives Securities financing Traded products Trading portfolio assets Financial investments available-for-sale 2 Accrued income and prepaid expenses Other assets Other products Total regulatory gross credit exposure 31.12.08 165,016 344,012 89,627 116,408 715,064 681,947 1 Includes corporates and non-banks financial institutions.    2 Financial investments available-for-sale exclude equity positions. 179 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Basel II Pillar 3 The “Regulatory gross credit exposure by geographical re- gion” table on the previous page provides a breakdown of UBS’s portfolio by major types of credit exposure according to classes of financial instruments and also by geographical regions. The latter distribution is based on the legal domicile of the customer. The table “Regulatory gross credit exposure by counter- party type” on the previous page provides a breakdown of UBS’s portfolio by major types of credit exposure according to classes of financial instruments and also by counterparty type. The classification of counterparty type applied here is also used for the grouping of the balance sheet. Refer to the financial statements in this report for more information. The counterparty type is different from the Basel II defined expo- sure segments used in certain other tables in this section. The “Regulatory gross credit exposure by residual contrac- tual maturity” table on the next page provides a breakdown of UBS’s portfolio by major types of credit exposure according to classes of financial instruments and also by maturity. The latter distribution is based on the residual contractual tenor. The “Regulatory gross credit exposure covered by guar- antees and credit derivatives” table on the next page provides a breakdown of collateral information, showing exposures covered by guarantees and those covered by credit deriva- tives, according to Basel II defined exposure segments. These are defined as follows: – Corporates: consists of all exposures that do not fit into any of the other exposure segments below. Mostly, it includes private commercial entities such as corporations, partnerships or proprietorships, insurance companies, funds, exchanges and clearing houses. – Sovereigns (“Central governments and central banks” under Swiss and EU regulations): consists of exposures relating to sovereign states and their central banks, the Bank for International Settlement (BIS), the International Monetary Fund (IMF), the European Union including the European Central Bank and eligible multilateral develop- ment banks (MDB). – Banks (“Institutions” under Swiss and EU regulations): consists of exposures towards banks, i. e. legal entities holding a banking license. It also includes those securities firms that are subject to supervisory and regulatory ar- rangements comparable to those applied to banks ac- cording to the Basel II Revised Framework, including, in particular, risk-based capital requirements. Basel II also defines this regulatory exposure segment such that it con- tains exposures to public sector entities with tax raising power or whose liabilities are fully guaranteed by a public entity. – Residential mortgages (“Claims secured on residential real estate” under Swiss and EU regulations): consists of residential mortgages, regardless of exposure size, if the obligor owns and occupies or rents out the mortgaged property. – Other retail: consists of exposures to small businesses, private clients and other retail customers without mort- gage financing. Notably, this includes the lombard loan portfolio. The collateral amounts in the table reflect the values used for determining regulatory capital. However, UBS has en- gaged in a substantial credit hedging program to reduce concentrated exposure to individual names or sectors or in specific portfolios, which is not fully reflected in the regula- tory numbers in this section. The “Derivation of regulatory net credit exposure” table on the next page provides a derivation of the regulatory net credit exposure from the regulatory gross credit exposure ac- cording to the advanced IRB approach and the Standardized approach. The table also provides a breakdown according to Basel II defined exposure segments. 180 Regulatory gross credit exposure by residual contractual maturity CHF million Cash and balances with central banks Due from banks Loans Financial assets designated at fair value Off-balance sheet Banking products Derivatives Securities financing Traded products Trading portfolio assets Financial investments available-for-sale 2 Accrued income and prepaid expenses Other assets Other products Total regulatory gross credit exposure 31.12.08 Due in 1 year or less Due over 1–5 years Due over 5 years 377 44,905 4,664 1,859 51,805 69,412 719 70,131 3,043 621 2,240 118,100 2,677 10,541 1,638 78,699 3,987 32,112 133,559 116,436 47,130 8 47,138 7,891 94 73,386 17,511 90,897 21,051 2,312 85 23,448 247,904 Total regulatory gross credit exposure 22,872 33,884 Total regulatory net credit exposure 22,802 28,759 295,395 274,278 11,803 45,589 409,542 190,047 63,825 253,872 32,916 3,027 5,011 10,696 51,650 5,649 45,008 376,496 190,047 63,825 253,872 32,848 3,027 5,036 10,668 51,579 Other 1 22,872 29,629 53,690 475 1,077 107,743 120 45,586 45,706 931 5,011 10,611 16,553 7,985 3,664 171,558 125,600 170,001 715,064 681,947 t n e m e g a n a m y r u s a e r t d n a k s i R 1 Includes positions without an agreed residual contractual maturity, for example loans without a fixed term, on which notice of termination has not been given.    2 Financial investments available-for- sale exclude equity positions. Regulatory gross credit exposure covered by guarantees and credit derivatives CHF million Exposure segment Corporates Sovereigns Banks Residential mortgages Other retail Total regulatory gross credit exposure 31.12.08 1 Includes guarantees and stand-by-letters of credit provided by third-parties, mainly banks. Derivation of regulatory net credit exposure CHF million Total regulatory gross credit exposure Less: regulatory credit risk offsets and adjustments 2 Total regulatory net credit exposure Breakdown of the regulatory net credit exposure by exposure segment Corporates Sovereigns Banks Residential mortgages Other retail Total regulatory net credit exposure 1 Internal ratings-based. 2 Regulatory credit risk offsets and adjustments mainly include margin accounts for derivatives. Total regulatory gross credit exposure Of which: exposure  covered by guarantees 1 Of which: exposure  covered by credit derivatives 338,370 71,953 121,776 118,703 64,262 715,064 28,156 6 206 3,373 183 563 13 169 4,302 28,368 Advanced IRB 1 approach Standardized approach 618,333 (26,226) 592,107 237,704 45,270 130,493 116,539 62,101 592,107 96,731 (6,891) 89,841 48,618 24,818 11,979 2,001 2,424 89,841 Total 31.12.08 715,064 (33,116) 681,947 286,321 70,089 142,473 118,540 64,525 681,947 181 Risk and treasury management Basel II Pillar 3 Advanced IRB approach The upper part of the table “Advanced internal ratings-based approach: regulatory net credit exposure by UBS-internal rat- ing” below provides a breakdown of the regulatory net credit exposure of UBS’s credit portfolio using the advanced IRB approach according to UBS-internal rating classes. The middle part of the table “Advanced IRB approach: exposure-weighted average loss given default by UBS-inter- nal rating” provides a breakdown of the net exposure- weighted average loss given default for UBS’s credit portfolio exposures calculated using the advanced IRB approach, according to UBS-internal rating classes. The lower part of the table “Advanced IRB approach: ex- posure-weighted average risk-weight by UBS-internal rat- ing” provides a breakdown of the net exposure-weighted average risk-weight for UBS’s credit portfolio exposures cal- culated using the advanced IRB approach according to UBS- internal rating classes. Advanced internal ratings-based approach: regulatory net credit exposure by UBS-internal rating Investment grade Sub-investment grade Defaulted 1 UBS-internal rating CHF million Regulatory net credit exposure-weighted average PD Exposure segment Corporates Sovereigns Banks Residential mortgages Other retail Total 31.12.08 0 / 1 2 / 3 4 / 5 6 – 8 9 –13 0.011% 0.064% 0.269% 0.929% 5.376% 19,978 30,321 11,390 3 102,563 14,730 89,216 6,803 47,797 47,706 86 27,330 51,922 7,039 43,562 88 1,748 52,723 4,529 61,691 261,108 134,083 102,651 17,694 37 509 4,883 1,807 24,929 6,202 8 299 206 928 7,644 1 Values of defaulted derivative contracts are based on replacement values, including “add-ons” used in the calculation of regulatory capital. Total regulatory net credit exposure 31.12.08 0.484% 237,704 45,270 130,493 116,539 62,101 592,107 Advanced internal ratings-based approach: exposure-weighted average loss given default by UBS-internal rating CHF million 0 / 1 2 / 3 4 / 5 6 – 8 9 –13 UBS-internal rating Investment grade Sub-investment grade Regulatory net credit exposure-weighted average LGD 1 (%) 31.12.08 Regulatory net credit exposure-weighted average LGD (%) Corporates Sovereigns Banks Residential mortgages Other retail Average 31.12.08 1 Loss given default. 24 26 22 10 25 33 61 25 10 15 28 42 36 32 10 22 26 34 37 36 11 13 21 32 20 15 11 15 26 35 37 26 11 16 26 Advanced internal ratings-based approach: exposure-weighted average risk-weight by UBS-internal rating CHF million 0 / 1 2 / 3 4 / 5 6 – 8 9 –13 UBS-internal rating Investment grade Sub-investment grade Regulatory net credit exposure-weighted average risk-weight (%) 31.12.08 Regulatory net credit exposure-weighted average risk-weight (%) Corporates Sovereigns Banks Residential mortgages Other retail Average 31.12.08 182 11 5 9 1 8 14 47 11 2 3 13 53 38 29 5 15 28 61 69 100 13 16 35 108 81 125 30 30 87 39 19 17 10 8 24 Standardized approach The standardized approach is generally applied where it is not possible – usually for technical reasons – to use the ad- vanced IRB approach and / or where an exemption from the advanced IRB has been granted by FINMA. The standardized approach requires banks to use risk assessments prepared by External Credit Assessment Institutions (ECAI) or Export Credit Agencies to determine the risk weightings applied to rated counterparties. ECAI risk assessments are used by UBS to determine the risk weightings for the following classes of exposure: – Central governments and central banks; – Regional governments and local authorities; – Multilateral development banks; – Institutions; and – Corporates. UBS has selected three FINMA-recognized external credit assessment institutions for this purpose - Moody’s Investors Service, Standard and Poor’s Ratings Group and Fitch Group. The mapping of external ratings to the standardized ap- proach risk weights is determined by FINMA and published on its website. The “Regulatory gross and net credit exposure by risk weight under the standardized approach” table below pro- vides a breakdown of the regulatory gross and net credit exposure by risk-weight for UBS’s credit portfolio exposures treated under the standardized approach, according to Basel II defined exposure segments. The “Eligible financial collateral recognized under stan- dardized approach” table below provides a breakdown of the financial collateral, which is eligible for recognition in the regulatory capital calculation under the standardized ap- proach, according to Basel II defined exposure segments. Regulatory gross and net credit exposure by risk weight under the standardized approach1 Total exposure CHF million 0% >0% – 35% 36% – 75% 76% – 100% 150% 31.12.08 Regulatory gross credit exposure Corporates Sovereigns Banks Residential mortgages Other retail Total 31.12.08 Regulatory net credit exposure 2 Corporates Sovereigns Banks Residential mortgages Other retail Total 31.12.08 23,884 6,538 149 8,086 23,884 14,773 23,884 6,538 149 7,478 23,884 14,165 671 26 4,492 1,068 2,476 8,732 671 26 3,425 1,004 2,424 7,550 44,840 825 1,068 997 1,602 1 8 47,731 1,612 39,807 758 1,068 997 1,602 1 8 42,630 1,611 53,651 24,885 13,654 2,065 2,476 96,731 48,618 24,818 11,979 2,001 2,424 89,841 1 The risk-weights are based on regulatory values or external ratings. 2 For traded products, the regulatory gross credit exposure is equal to the regulatory net credit exposure. Eligible financial collateral recognized under standardized approach CHF million Exposure segment Corporates Sovereigns Banks Residential mortgages Other retail Total 31.12.08 Regulatory net credit exposure under standardized approach Eligible financial collateral recognized in capital calculation1 48,618 24,818 11,979 2,001 2,424 89,841 8,911 1,148 5,942 64 648 16,713 1 The eligible financial collateral reflects the impact of the application of regulatory haircuts. For traded products, it is the difference between the International Financial Reporting Standards’ reported  values and the regulatory net credit exposure. 183 t n e m e g a n a m y r u s a e r t d n a k s i R Risk and treasury management Basel II Pillar 3 Impairment, default and credit loss The “Impaired assets by geographical region” table below provides a breakdown of credit exposures arising from im- paired assets and allowances / provisions by geographical region, based on the legal domicile of the customer. Im- paired asset exposures include loans, off-balance sheet claims, securities financing transactions and derivative con- tracts. The “Impaired assets by exposure segment” table on the next page shows a breakdown of credit exposures arising from impaired assets and allowances / provisions according to Basel II defined exposure segments. Impaired asset expo- sures include loans, off-balance sheet claims, securities fi- nancing transactions, and derivative contracts. The “Changes in allowances, provisions and specific credit valuation adjustments” table on the next page pro- vides a breakdown of movements in the specific and collec- tive allowances and provisions for impaired assets, including changes in the credit valuation allowance for derivatives. The “Total credit loss at year-end 2008” table on the next page provides a breakdown of the credit loss amount charged against UBS’s income statement in 2008 according to Basel II defined exposure segments of the advanced IRB approach. Impaired assets by geographical region CHF million Switzerland Other Europe North America 2 Latin America Asia / Pacific Africa / Middle East Total 31.12.08 Regulatory gross credit exposure 208,777 184,294 257,654 8,887 48,037 7,415 715,064 Impaired assets 1 1,534 2,334 10,053 206 1,387 145 15,658 Specific  allowances, provisions and credit valuation adjustments Exposure net of specific  allowances, provisions and credit valuation adjustments (849) (1,138) (4,808) (56) (361) (41) (7,252) 684 1,196 5,245 150 1,027 104 8,406 Total allowances, provisions and specific credit valuation adjustments (873) (1,138) (4,808) (56) (361) (41) (7,275) Collective allowances and provisions (23) (23) 1 Values of defaulted derivative contracts (CHF 6,048 million) are based on replacement values and do not include “add-ons” used in the calculation of regulatory capital. 2 North America includes the Caribbean. 184 Impaired assets by exposure segment CHF million Corporates Sovereigns Banks Residential mortgages Other retail Not allocated segment 4 Total 31.12.08 Regulatory gross credit exposure Of which impaired assets 1 Specific  allowances, provisions and credit valuation adjustments Collective allowances and provisions 2 338,370 71,953 121,776 118,703 64,262 13,855 (6,777) 16 139 352 1,296 (12) (20) (103) (340) 715,064 15,658 (7,252) (23) (23) Total allowances, provisions and specific credit valuation adjust- ments2 (6,777) (12) (20) (103) (340) (23) Write-offs 3 (714) (2) (122) (30) (7,275) (868) 1 Values of defaulted derivative contracts (CHF 6,048 million) are based on replacement values and do not include “add-ons” used in the calculation of regulatory capital. 2 Collective credit valuation adjustments of CHF 6.1 billion are partially included in the upper tier 2 capital and therefore not included in this table. 3 The write-offs refer to the period from 1 January 2008 to 31 December 2008. 4 Collective loan loss allowances and provisions are not allocated to individual counterparties and thus also not to exposure segments. Changes in allowances, provisions and specific credit valuation adjustments CHF million Balance at the beginning of 2008 Write-offs Recoveries (on written-off positions) Increase / (decrease) in credit loss allowances, provisions and specific credit valuation adjustments1 Foreign currency translations and other adjustments Transfers Balance at year-end 2008 Specific allowances  and provisions for banking products and securities financing 1,130 (868) 44 3,006 (42) (223) 3,047 Specific credit  valuation adjustments for derivatives 818 4,550 (825) (337) 4,205 Total specific  allowances, provisions and credit valuation adjustments 1,948 (868) 44 7,556 (867) (561) 7,252 Collective allowances and provisions 2 34 (11) 23 Total 1,981 (868) 44 7,545 (867) (561) 7,276 1 Total credit loss (credit loss expense and changes in specific credit valuation adjustments).    2 Collective credit valuation adjustments of CHF 6.1 billion are partially included in the upper tier 2 capital and therefore not included in this table. t n e m e g a n a m y r u s a e r t d n a k s i R Total credit loss at year-end 2008 CHF million Corporates 1 Sovereigns Banks Residential mortgages Other retail Not specified 2 Total Credit loss expense Specific credit valuation  adjustmens for defaulted derivates Total credit loss 2,564 114 (1) 342 (24) 2,996 4,117 433 4,550 1 Includes credit losses from reclassified financial instruments, which amounted to CHF 1,329 million.    2 Includes collective loan loss allowances and provisions. 6,681 547 (1) 342 (24) 7,545 185 Risk and treasury management Basel II Pillar 3 Other credit risk tables The “Credit exposure of derivatives instruments” table be- low provides an overview of UBS’s credit exposures arising from derivatives. Exposures are provided based on the bal- ance sheet carrying values of derivatives as well as regulatory net credit exposures. The net balance sheet credit exposure differs from the regulatory net credit exposures because of differences in valuation methods and the netting and collat- eral deductions used for accounting and regulatory capital purposes. Specifically, net current credit exposure is derived from gross positive replacement values, whereas regulatory net credit exposures is calculated using UBS internal credit valuation models. The “Credit derivatives” table below provides an over- view of UBS’s credit derivative portfolio by product group using notional values. The table also provides a breakdown of credit derivative positions used to risk manage UBS’s own credit portfolio (banking book for regulatory purposes) and those arising through intermediation activities (trading book for regulatory capital purposes). Credit exposure of derivative instruments CHF million Gross positive replacement values Netting benefits recognized1 Collateral held Net current credit exposure Regulatory net credit exposure (total counterparty credit risk) 2 of which treated with internal models (effective expected positive exposure (EPE)) 2 of which treated with supervisory approaches (current exposure method) 2 Breakdown of the collateral held Cash collateral Securities collateral and debt instruments collateral (excluding equity) Equity instruments collateral Other collateral Total collateral held 31.12.08 860,943 (651,756) (51,765) 157,422 190,047 164,707 25,340 46,967 4,246 121 430 51,765 1 Derivatives exposure based on accounting definition (consolidation scope for capital) measured as gross positive replacement values with netting benefits from negative replacement values with the  same counterparty. 2 Derivatives exposure is defined as regulatory net credit risk exposure. Credit derivatives Notional amounts, CHF million Credit default swaps Total return swaps Total 31.12.08 Regulatory banking book Regulatory trading book Total Protection bought 26,297 26,297 Protection sold 1,030 1,166 2,196 Total 27,326 1,166 28,492 Protection bought Protection sold Total 31.12.08 2,120,407 1,469,723 3,590,130 3,617,457 15,060 7,819 22,879 24,044 2,135,468 1,477,542 3,613,009 3,641,502 1 Notional amounts of credit derivatives are based on accounting definitions and do not include any netting benefits. For capital underpinning of the counterparty credit risk of derivative positions, the  effective expected positive exposure (or current exposure method) is taken. 186 Investment positions The “Equities disclosure for banking book positions” table below provides an overview of UBS equity investments held in the banking book for regulatory capital purposes. The cal- culation of equity investment exposure for financial account- ing under IFRS differs from that required for regulatory capi- tal purposes. The table illustrates these two measures of exposure as well as the key differences between them. The IFRS view differs from the regulatory capital view pri- marily due to: (i) differences in the basis of valuation, that is IFRS is based on “fair value accounting” whereas the “lower of cost or market value” (LOCOM) and “cost less impairment” is used for regulatory capital purposes; (ii) positions that may be treated under a different framework for regulatory capital purposes, for example tradable assets treated under Market Risk VaR; and (iii) differences in the scope of consolidation for IFRS, for example, special purpose entities consolidated for IFRS but not for regulatory capital purposes. Also disclosed in the table are realized and unrealized gains and losses. There were no unrealized gains and losses that were not recognized either on the balance sheet or in the statement of income relating to “available for sale” invest- ments designated at fair value. In addition there was no sig- nificant disparity between the share prices of investment posi- tions held in publicly quoted entities and their fair value. Equities disclosure for banking book positions CHF million Equity investments Financial investments available-for-sale Financial assets designated at fair value Investments in associates Total equity investments under IFRS Realized gains and (losses), net Unrealized gains and (losses), net Consolidation scope adjustment Capital view adjustments Total equity exposure regulatory capital view under BIS of which: to be risk weighted publicly traded privately held of which: deducted from equity Capital requirement Total simple risk weight method Unrealized gains included in tier 2 t n e m e g a n a m y r u s a e r t d n a k s i R Book value 31.12.08 1,681 1,079 892 3,653 815 421 (80) 405 3,978 1,423 1,681 874 612 69 187 Risk and treasury management Basel II Pillar 3 Securitization Sources and control of risks resulting from securitization structures Historically UBS was involved in many aspects of the origina- tion of securitization structures. This ranged from warehous- ing assets as principal and for clients, the creation of securi- tization vehicles, as well as underwriting, market-making and managing securitized assets. UBS retained securitization exposures in the form of senior or subordinated tranches (including first loss positions) and interest only strips. UBS also purchased third-party securitization positions as part of its trading activities. UBS has not, however, provided any ma- terial liquidity facilities for securitization structures and has not acted as a sponsor of securitization schemes to purchase exposures from third-party entities. UBS significantly reduced its exposures to securitization related assets in 2008 through a combination of asset sales and writedowns. As announced in October 2008 and Febru- ary 2009, UBS is repositioning its Investment Bank to focus primarily on client activities. As part of this repositioning, the Investment Bank will largely exit its real estate and securitiza- tion activities. Refer to the “Investment Bank” section of this report for more information. Remaining positions at 31 De- cember 2008 that are treated under the securitization frame- work for regulatory capital purposes include the global refer- ence-linked note programs. These positions are subject to appropriate portfolio limits and risk controls. During 2008, UBS acquired student loan auction rate se- curities (ARS) from its provision of liquidity to these markets by submitting bids to ARS auctions and from its commit- ment to restore liquidity to client holdings of ARS. Refer to the “Exposure to auction rate securities” sidebar in the “Risk management and control” section of this report for more information. For regulatory capital purposes, expo- sures from these positions are also treated as securitizations and are subject to appropriate portfolio limits and risk controls. Regulatory treatment of securitization UBS generally treated exposures from securitization posi- tions under market risk regulatory capital and any remaining securitization exposures that are still subject to this treat- ment do not form part of this disclosure. Exposures from the global reference-linked note programs and certain originat- ed traditional securitizations were treated under the securiti- zation approach for regulatory capital and are therefore in- cluded in this disclosure. In first quarter 2008 certain securitization exposures relat- ing to illiquid US real estate positions (specifically super se- nior US RMBS CDOs, sub prime and Alt A RMBS, and related hedges) were excluded from internal management and reg- ulatory VaR and were therefore no longer treated under market risk regulatory capital. Refer to “VaR developments in 2008” in the “Risk management and control” section of this report for more information. These positions are treated under the standardized approach as agreed with FINMA and are therefore not included in this disclosure. UBS generally applies the Ratings Based Approach to se- curitization exposures in the banking book using Moody’s, Standard & Poor’s and Fitch’s Ratings for all securitization exposures. Unrated tranches for which no rating can be in- ferred are deducted from eligible capital. Under the Ratings Based Approach the amount of capital is capped at the cap- ital requirement that would be assessed against the underly- ing assets had they not been securitized. On 31 December 2008 such exposures mainly included the student loan ARS positions (including purchase commitments) and the global reference-linked note programs. Interest rate or foreign currency derivatives with securiti- zation vehicles are treated under the advanced Internal Rat- ings Based approach. Accounting Policies For IFRS purposes, UBS treats originated securitized expo- sures as sales, i.e. they are derecognized from UBS’s balance sheet provided that specific derecognition criteria are met and UBS does not consolidate the transferee (as described in “Note 1 Summary of significant accounting policies” in the financial statements of this report). A gain or loss on sale is recognized when the exposures are derecognized. Deriva- tives used for synthetic securitizations are accounted for in line with the abovementioned note. Securitization positions that are classified as trading as- sets for IFRS purposes are valued at fair value as described in “Note 27 Fair value of financial instruments” in the financial statements of this report. Securitization positions that have been redesignated from trading assets to loans and receiv- ables are valued at cost less impairment as described in “Note 1 Summary of significant accounting policies” in the financial statements of this report. Good practice guidelines On 18 December 2008 the European Banking Federation, the London Investment Banking Association, the European Savings Banks Group and the European Association of Public Banks and Funding Agencies published the “Industry good practice guidelines on Pillar 3 disclosure requirement for se- curitization”. UBS is in compliance with material aspects of these guidelines. 188 Securitization activity during 2008 The first table below shows exposures that have been secu- ritized by UBS via a traditional securitization during the year. It also shows any gains or losses recognized on sales into these traditional securitization structures for regulatory capi- tal purposes. The exposure values disclosed are based on the transaction date and were accounted for at fair value pre- securitization (the resulting gain or loss is not significant). UBS retained securitization positions for all traditional secu- ritization made in 2008. No synthetic securitizations oc- curred during 2008. Total outstanding exposures securitized – synthetic securitizations The second table below provides a breakdown of the inven- tory of the total outstanding exposures that have been secu- ritized by UBS via synthetic securitizations prior to 2008 as part of its global reference linked note program. Historically, UBS retained securitization positions from its synthetic secu- ritizations. The exposure values disclosed are calculated on the basis of their regulatory exposure value. Due to the trans- fer of assets to the SNB fund, however, UBS no longer holds securitization positions of all synthetic securitizations. Amount of impaired / past due assets securitized – synthetic securitizations The third table below provides a breakdown of the inventory of outstanding impaired or past due exposures that have been securitized by UBS via a synthetic securitization. The exposure values are based on the amounts referenced in the transaction and are included into the below disclosure once a credit event has occurred. Securitization activity during 2008 – traditional securitizations CHF million For year ended Residential mortgages Commercial mortgages Other Total Total outstanding exposures – synthetic securitizations CHF million For year ended Residential mortgages Commercial mortgages Other 1 Total Amount of exposures securitized Recognized gain or loss on sale 31.12.08 31.12.08 577 964 0 1,541 (13) 13 0 0 Amount of exposures securitized 31.12.08 433 596 9,657 10,686 t n e m e g a n a m y r u s a e r t d n a k s i R 1 Contains securitization structures comprising various exposure types, e.g. residential mortgages, commercial mortgages, credit card receivables and trading receivables. Amount of impaired / past due assets securitized – synthetic securitizations CHF million For year ended Residential mortgages Commercial mortgages Other Total Amount of exposures impaired / past due 31.12.08 22 0 190 212 189 Risk and treasury management Basel II Pillar 3 Losses recognized on originated transactions in 2008 The table below provides a breakdown of losses recognized by UBS on securitization tranches purchased or retained that result from a securitization originated by UBS, after taking into account the offsetting effects of any credit protection that is an eligible risk mitigation instrument for the retained or repurchased tranche. UBS partially reports such exposures on a fair value and partially on a cost less impairment basis. These losses mainly include losses related to the global refer- ence-linked note program. Securitization exposures retained or purchased The table below provides a breakdown of securitization ex- posures purchased or retained by UBS, irrespective of its role in the securitization transaction. The exposure values dis- closed are calculated on the basis of their regulatory expo- sure value. Capital charge for securitization exposures retained or purchased The table below provides a breakdown of securitization ex- posures purchased or retained by UBS, irrespective of its role in the securitization transaction as well as a breakdown of the related capital requirement. Losses recognized on originated transactions in 2008 CHF million For year ended Residential mortgages Commercial mortgages Other Total Securitization exposures retained or purchased Exposure type CHF million For year ended Residential mortgages Commercial mortgages Other 1 Total Amounts of losses recognized 31.12.08 789 153 291 1,233 Exposure amount 31.12.08 592 583 33,960 35,135 1 Contains securitization structures comprising various exposure types, for example, residential mortgages, commercial mortgages, credit card receivables and trading receivables. Includes also student loan auction rate securities positions (including purchase commitments). Capital charge for securitization exposures retained or purchased Exposure amount Capital charge CHF million > 0–20% > 20–35% > 35–50% > 50–75% > 75–100% > 100–150% > 150–250% > 250–300% > 300–350% > 350–375% > 375–400% > 400–625% > 625–1250% Deducted from capital Total 190 31.12.08 32,576 464 253 321 1,181 – 24 – – – – 10 – 306 35,135 332 13 11 19 100 – 5 – – – – 4 13 306 803 Corporate governance and compensation Information according to articles 663b bis and 663c (paragraph three) of the Swiss Code of Obligations Disclosures provided in line with the requirements of articles 663b bis and 663c (paragraph three) of the Swiss Code of Obligations’ “Supplementary disclosures for companies whose shares are listed on a stock exchange: compensations and participations” are also included in the audited financial statements of this report. This information is marked by a bar on the left-hand side throughout this section. Corporate governance – UBS implemented new corporate governance guidelines in 2008, actively reinforcing a clear separation of the roles and responsibilities of the Board of Directors and its committees from those of the Group Executive Board The firm believes that shareholder interests are served by good corporate governance. At the extraordinary general meetings (EGM) held in 2008, shareholders approved the following: On 27 February, shareholders approved the creation of a maximum of CHF 10,370,000 in authorized capital, allowing the distribution of a stock dividend. Shareholders also approved the creation of conditional capital allowing two financial investors to subscribe to an issue of CHF 13 billion of mandatory convertible notes (MCNs). On 27 November, shareholders approved the creation of conditional share capital for the issuance of MCNs in the amount of CHF 6 billion to the Swiss Confederation. The dual-board structure achieves a clear separation of power: The Board of Directors (BoD) is responsible for the firm’s strategic direction as well as the monitoring and supervision of the business. All members are independent with the exception of its full-time Chairman. Dissolution of the Chairman’s Office in 2008 streamlined the management process, with its duties and responsibilities spread amongst existing and newly established committees. The Group Executive Board is responsible for the executive management of the firm and must account to the BoD for the firm’s financial results. It is led by the Group Chief Executive Officer and supported by the newly established Executive Committee. The following events strengthened UBS’s leadership capacity during 2008: The position of senior independent director was established to facilitate direct communication between shareholders and the BoD, as well as between BoD members and their Chairman. The term of office for all BoD members was reduced to one year. This was approved at the annual general meeting held in April and is effective for all elections and re-elections held from 2008 onwards. Compensation, shareholdings and loans – UBS’s compensation principles for senior executives were extensively reviewed in 2008 – New compensation principles are effective from 2009 onwards Compensation for 2008 Total senior executive compensation decreased 77% in 2008. No incentive award or discretionary stock options were granted to the Chairman and executive members of the Board of Directors nor to the members of the Group Executive Board in reflection of UBS’s negative financial performance for the year. Compensation principles 2009 These will align compensation with the creation of sustain- able shareholder returns through sound risk taking; promote a performance-driven culture with a long-term view to results and shareholder interests; and support the firm’s focused business strategy. These principles include a “malus” system for cash awards as well as performance conditions for equity awards. A non-binding vote on executive compensation will be held at the annual general meeting to be held in April 2009. Compensation authorities Recipients Compensation recommendations developed by Approved by Communicated by Chairman of the BoD Chairman of the HRCC 1 Group CEO Chairman of the BoD Members of the GEB Group CEO Independent BoD members (remuneration system and fees) Chairman of the BoD / HRCC 1 The human resources and compensation committee. HRCC HRCC HRCC BoD HRCC HRCC Group CEO Chairman of the BoD Corporate governance and compensation Corporate governance Corporate governance The corporate governance principles of UBS are designed to lead the firm towards sustainable growth and protect the interests of its shareholders, as well as to create value for shareholders and stakeholders. UBS uses the term “corporate governance” to refer to the organizational structure and operational practices of its leadership and management. UBS is subject to, and fully complies with, the following reg- ulatory requirements regarding corporate governance: the SIX Swiss Exchange’s (SIX) “Directive on Information Relating to Corporate Governance”; the Swiss Code of Obligations (CO) articles 663b bis and 663c (paragraph three) regarding transparency of compensation paid to members of the Board of Directors (BoD) and senior management; and the stan- dards established in the Swiss Code of Best Practice for Corporate Governance, including the appendix on executive compensation. In addition, as UBS is listed on the New York Stock Ex- change (NYSE) as a foreign listed company, the firm must meet all corporate governance standards applicable to for- eign listed companies. UBS meets these standards, and ad- ditionally complies with the majority of NYSE standards for US domestic issuers. This section of UBS’s annual report provides the informa- tion required by the following regulatory requirements: – The SIX “Directive on Information Relating to Cor- porate Governance”, with regard to: Group structure and shareholders; capital structure; BoD; Group Ex- ecutive Board (GEB); compensation, shareholdings and loans; shareholders’ participation rights; change of control and defense measures; auditors and informa- tion policy. – Articles 663b bis and 663c (paragraph three) of the CO “Supplementary disclosures for companies whose shares are listed on a stock exchange: compensations and par- ticipations”, with regard to share and option ownership and loans. – The NYSE “Corporate Governance Listing Standards” with regard to foreign listed companies, independence of directors, BoD committees and differences from the NYSE standards applicable to US domestic issuers. In addition to the regulatory requirements mentioned above, this section of the report also summarizes the regula- tory and supervisory environment of UBS in its principal loca- tions, and provides a list of all members of UBS’s senior lead- ership, including the vice chairmen of the business divisions. Updates have been made to the sections discussing the BoD, GEB and compensation, shareholdings and loans. These up- dates follow an overhaul of the “Organization Regulations of UBS AG” (“organization regulations”), which was con- ducted by the BoD following the annual general meeting, and the findings of the review of the executive governance structure conducted in late 2008. 194 Group structure and shareholders UBS Group legal entity structure d e t i d u A all shares issued on 31 December 2008, compared with 7.99% at year-end 2007 and 8.81% at year-end 2006. Under Swiss company law, UBS is organized as a limited company, a corporation that has issued shares of common stock to investors. UBS AG is the parent company of the UBS Group (Group). The legal entity structure of UBS is designed to support its businesses within an efficient legal, tax, regulatory and funding framework. Neither the business divisions of UBS nor its Corporate Center are separate legal entities: they primarily operate out of the parent bank, UBS AG, through its branches worldwide. This structure is designed to capital- ize on the increased business opportunities and cost effi- ciencies offered by the use of a single legal platform and to enable the flexible and efficient use of capital. Where it is neither possible nor efficient to operate out of the parent bank, businesses operate through local subsidiaries. Instan- ces of this are usually due to local legal, tax or regulatory rules or a result of additional legal entities joining the Group through acquisition. Operational Group structure On 31 December 2008, the operational structure of the Group comprised the Corporate Center and the three busi- ness divisions: Global Wealth Management & Business Banking, Global Asset Management and the Investment Bank. In this report, performance is reported according to this structure. However, on 10 February 2009, UBS an- nounced that Global Wealth Management & Business Bank- ing had been divided into two new business divisions: Wealth Management & Swiss Bank and Wealth Manage- ment Americas. Refer to the “Strategy and structure” sec- tion of this report for more information on the restructuring of the business divisions. Listed and non-listed companies belonging to the Group (consolidated entities) The Group includes a number of subsidiaries, none of which, however, are listed companies. ➔ Refer to “Note 34 Significant subsidiaries and associates” in the financial statements of this report for details of significant operating subsidiary companies of the Group Significant shareholders d e t i d u A Chase Nominees Ltd., London, acting in its capacity as a nominee for other investors, was registered with 7.19% of DTC (Cede & Co.), New York, The Depository Trust Com- pany, a US securities clearing organization, was registered as a shareholder for a large number of beneficial owners with 9.89% of all shares issued on 31 December 2008 (14.15% on 31 December 2007). According to UBS’s “Regulation on the Registration of Shares”, voting rights of nominees are restricted to 5%, but clearing and settlement organizations are exempt from this restriction. On 31 December 2008, no other shareholder had reported holding 3% or more of all voting rights. Ownership of UBS shares is widely spread. The tables on the next page provide information about the distribution of UBS sharehold- ers by category and geography. This information relates only to registered shareholders and cannot be assumed to be rep- resentative of the entire UBS investor base. Only sharehold- ers registered in the share register as “shareholders with vot- ing rights” are entitled to exercise voting rights. Under the Swiss Stock Exchange Act, anyone holding shares in a company listed in Switzerland, or derivative rights related to shares of such a company, has to notify the com- pany and the stock exchange if the holding attains, falls below or exceeds one of the following thresholds: 3, 5, 10, 15, 20, 25, 33 1/3, 50, or 66 2⁄3% of the voting rights, wheth- er they are exercisable or not. The detailed disclosure re- quirements and the methodology for calculating the thresh- olds are defined in the “Ordinance of the Swiss Financial Market Supervisory Authority on Stock Exchanges and Se- curities Trading” (disclosure of shareholdings). In particular, the ordinance prohibits the netting of so-called acquisition positions (i.e. in particular shares, conversion rights and ac- quisition rights or obligations) with disposal positions (i.e. rights or obligations to sell). It further requires that each such position be calculated separately and reported as soon as it reaches a threshold. In addition to the notification requirements according to Swiss law, as of 16 May 2008, shareholders of UBS also have notification obligations with regard to major shareholdings in shares of UBS under the German Securities Trading Act (Wert- papierhandelsgesetz, WpHG). These obligations arise due to the fact that UBS has chosen Germany as its home member state within the meaning of the European Union’s “Prospectus Directive”. The obligations came into force with the first filing of the listing application for the new shares created as a result of the stock dividend by UBS on SWX Europe, a regulated mar- ket in the EU. According to the WpHG, anyone whose share- holding in UBS attains, exceeds or falls below the thresholds of 3, 5, 10, 15, 20, 25, 30, 50 or 75% of the voting rights has to 195 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance notify, without undue delay, such change simultaneously to UBS and the German Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht; BaFin). The detailed disclosure requirements and the methodology for calculating the thresh- olds are defined in paragraphs 21 et seq. of the WpHG. sisted mainly of 8.91% of voting rights attached to employee options, 9.22% of voting rights attached to the mandatory convertible notes issued by UBS in March 2008 and 11.23% of voting rights attached to the mandatory convertible notes is- sued by UBS in December 2008. At year-end 2008, UBS held a stake of UBS registered shares corresponding to less than 3% of the total share capital of UBS AG. At the same time, UBS had disposal positions relating to 891,230,556 voting rights of UBS AG and these corresponded to 30.39% of the total voting rights of UBS AG. These con- Cross shareholdings UBS has no cross shareholdings in excess of a reciprocal 5% of capital or voting rights with any other company. Distribution of UBS shares On 31 December 2008 Number of shares registered 1–100 101–1,000 1,001–10,000 10,001–100,000 100,001–1,000,000 1,000,001–5,000,000 5,000,001–29,325,805 (1%) 1–2% 2–3% 3–4% 4–5% Over 5% Total registered Unregistered 2 Total shares issued Shareholders registered Shares registered Number % of shares issued Number 39,458 200,945 92,559 6,280 500 99 31 1 3 0 0 2 1 339,878 % 11.6 59.1 27.2 1.9 0.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2,279,778 89,228,454 242,151,755 145,370,413 148,881,546 200,105,606 324,972,121 38,551,136 202,408,105 0 0 500,789,047 100.0 1,894,737,961 1,037,842,588 2,932,580,549 3 0.1 3.0 8.2 5.0 5.1 6.8 11.1 1.3 6.9 0.0 0.0 17.1 64.6 35.4 100.0 1 On 31 December 2008, DTC (Cede & Co.), New York, the US securities clearing organization, was registered with 9.89% of all shares issued. Chase Nominees Ltd., London, was entered as a trustee / nominee holding 7.19% of all shares issued. 2 Shares not entered in the share register on 31 December 2008. 3 211,917,438 registered shares do not carry voting rights. Shareholders: type and geographical distribution Shareholders Shares Number 330,226 9,063 589 % 97.1 2.7 0.2 Number 460,037,591 433,384,170 1,001,316,200 1,037,842,588 % 15.7 14.8 34.1 35.4 339,878 100.0 2,932,580,549 100.0 310,284 20,060 2,505 7,029 91.3 5.9 0.7 2.1 802,619,576 625,650,671 400,179,323 66,288,391 1,037,842,588 27.4 21.3 13.6 2.3 35.4 339,878 100.0 2,932,580,549 100.0 On 31 December 2008 Individual shareholders Legal entities Nominees, fiduciaries Unregistered Total Switzerland Europe North America Other countries Unregistered Total 196 Capital structure Capital Under Swiss company law, shareholders must approve in a shareholders’ meeting any increase in the total number of is- sued shares, which may arise from an ordinary share capital increase or the creation of conditional or authorized capital. At year-end 2008, 2,932,580,549 shares were issued with a par value of CHF 0.10 each, leading to ordinary share capital of CHF 293,258,054.90 (including shares issued for the capital increase out of authorized and conditional capital in 2008). Conditional share capital At year-end 2008, conditional share capital of CHF 15,009,471.10 was available to settle employee option exer- cises, corresponding to a maximum of 150,094,711 shares. Conditional capital was created in 2000 in connection with the acquisition of PaineWebber Group Inc. (PaineWeb- ber) to cover option rights previously granted by PaineWeb- ber to its employees. Additionally, at the annual general meeting (AGM) held in 2006, shareholders approved condi- tional capital in the amount of 150 million UBS shares to be used for employee option grants limited to a period of three years. Options under both plans are exercisable at any time between their vesting and the expiry date. Shareholders’ pre-emptive rights are excluded. In 2008, options with re- spect to 39,270 shares were exercised under the PaineWeb- ber option plans, and 4,653 options expired without being exercised. No options were settled with conditional capital shares in 2008 under the UBS employee stock option plans. At the extraordinary general meeting (EGM) held on 27 February 2008, UBS shareholders approved the creation of conditional capital through the issuance of 277,750,000 shares to satisfy the settlement in shares of CHF 13 billion in mandatory convertible notes (MCNs) with maturity 5 March 2010 placed with two financial investors. At the 27 November 2008 EGM, UBS shareholders ap- proved the creation of conditional capital through the issu- ance of 365,000,000 shares to satisfy the settlement in shares of CHF 6 billion in MCNs with maturity 9 June 2011 issued to the Swiss Confederation. Authorized share capital At the 27 February 2008 EGM, UBS shareholders approved the creation of authorized capital for a maximum amount of CHF 10,370,000 or 103,700,000 new shares (approximately 5% of the issued share capital at year-end 2007). A total of 98,698,754 new shares were issued on the basis of entitle- ments alloted. The authorized capital created was used to replace the cash dividend for the financial year 2007 with a stock dividend paid in 2008. Changes of shareholders’ equity According to International Financial Reporting Standards (IFRS), equity attributable to UBS shareholders amounted to CHF 32.5 billion on 31 December 2008. ➔ Refer to the “Statement of changes in equity” in the financial statements of this report for more information on changes in shareholders’ equity over the last three years Shares, participation and bonus certificates, capital securities UBS shares are issued in registered form, traded and settled as so-called global registered shares. Each registered share has a par value of CHF 0.10 and carries one vote. Voting rights may, however, only be exercised if the holder expressly declares that he or she acquired these shares in his or her own name and for his or her own account. Global registered shares provide direct and equal ownership for all sharehold- ers, irrespective of the country and stock exchange in which they are traded. Refer to the “Shareholders’ participation rights” section of this report for more information. On 31 December 2008, 1,682,820,523 shares carried voting rights, 211,917,438 shares were entered in the share register without voting rights, and 1,037,842,588 shares were not registered. All 2,932,580,549 shares were fully Ordinary share capital On 31 December 2007 Issue of shares for stock dividend Issue of shares for capital increase (rights offering) Issue of shares out of employee options exercised from conditional capital On 31 December 2008 Share capital in CHF Number of shares 207,354,734 2,073,547,344 9,869,875 76,029,518 3,927 98,698,754 760,295,181 39,270 293,258,055 2,932,580,549 Par value in CHF 0.10 0.10 0.10 0.10 0.10 197 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance paid up and eligible for dividends. There are no preferential rights for shareholders. UBS did not issue any participation certificates or bonus certificates in 2008. In 2008, UBS Capital Securities (Jersey) Ltd. raised EUR 1 billion hybrid tier 1 capital in the form of preferred securi- ties. Additionally, UBS increased an existing CHF 350 million subordinated bond issue maturing in 2017 by CHF 50 million. At year-end 2008, UBS had outstanding CHF 7,393 million in preferred securities, which count as hybrid tier 1 capital under regulatory rules. Outstanding tier 2 capital securities accounted for CHF 12,290 million in total capital on 31 De- cember 2008. Limitation on transferability and nominee registration UBS does not apply any restrictions or limitations on the transferability of its shares. Shares registered in the share register with voting rights may be voted without any restric- tions, according to the provisions of the “Articles of Associa- tion of UBS AG” (which require an express declaration of beneficial ownership). UBS has special provisions for the registration of fiducia- ries and nominees. Fiduciaries and nominees are entered in the share register with voting rights up to a total of 5% of all shares issued, if they agree to disclose, upon request from the firm, beneficial owners holding 0.3% or more of all UBS shares. An exception to the 5% rule exists for securities clearing organizations such as The Depository Trust Compa- ny in New York. Convertible bonds and options On 31 December 2008, there were 236 million employee options outstanding, of which 124 million were exercisable. UBS satisfies share delivery obligations under its option- based participation plans either by purchasing UBS shares in the market on grant date or shortly thereafter, or through the issuance of new shares out of conditional capital. At ex- ercise, shares held in treasury or newly issued shares are de- livered to the employee against receipt of the strike price. On 31 December 2008, UBS held approximately 48.9 million shares in treasury and an additional 150 million unissued shares in conditional share capital, which were available to be used for future employee option exercises. The shares available cover all vested (i.e. exercisable) employee options. The Investment Bank, acting as liquidity provider to the equity futures market and as a market-maker in UBS shares and derivatives, issues derivatives linked to UBS stock. Most of these instruments are classified as cash-settled derivatives and are held for trading purposes only. To hedge the eco- nomic exposure, a limited number of UBS shares are held by the Investment Bank. On 5 March 2008, UBS issued CHF 13 billion of MCNs as approved at the 27 February 2008 EGM. The notes were placed with two financial investors (Government of Singa- pore Investment Corporation and one other investor) and will pay a coupon of 9% until conversion into UBS shares, which must take place on or before a date two years after issuance. The MCNs contain market-standard provisions al- lowing for early conversion at the option of either UBS or the MCN holders. Early conversion is only possible from the date six months after issuance of the MCNs. The conversion of the MCNs is expected to increase the number of shares is- sued by 270,438,942, reflecting adjustments due to the or- dinary capital increase approved by UBS shareholders at the 23 April 2008 AGM, subject to no further dilutive events oc- curring until conversion. The terms of the MCNs contain standard market provisions for the adjustment of the con- version price if any dilutive events occur between issuance and maturity, such as capital increases at a discount, divi- dends in cash or in specie in excess of CHF 2.05 per share per financial year, and similar events. On 9 December 2008, in order to enable UBS to retain a strong tier 1 capital ratio after giving effect to the transac- tion with the Swiss National Bank, UBS issued CHF 6 billion of MCNs, following the 27 November 2008 EGM. The notes were placed with the Swiss Confederation and have a matu- rity date 30 months after the issue date (i.e. 9 June 2011). Until maturity of the MCNs, the holders will receive an an- nual coupon of 12.5% of their nominal value. The conver- sion of the MCNs is expected to increase the number of shares issued by 9.3%, depending on the development of the UBS share price and the absence of dilutive events (such as any dividend payments). The terms of the MCNs contain standard market provisions allowing for early conversion at the option of either UBS or MCN holders and for the adjust- ment of the conversion price if any dilutive events occur be- tween issuance and maturity. ➔ Refer to the discussion on shares and capital instruments in the “Treasury management” section of this report for more information on the MCNs 198 Board of Directors The Board of Directors (BoD) is ultimately responsible for the firm’s strategy and the supervision of its executive management. It also approves the financial statements for issue. Shareholders elect each member of the BoD, which in turn appoints its Chairman, at least one vice chairman and the members of its various committees. Members of the Board of Directors This section provides information on the composition of the BoD on 31 December 2008. It shows each member’s func- tions in UBS, nationality, year of initial appointment to the BoD and current term of office, professional history and edu- cation, date of birth and other activities and functions, such as mandates on boards of important corporations, organiza- tions and foundations, permanent functions for important interest groups and official functions and political mandates. At the annual general meeting (AGM) held on 23 April 2008, Peter R. Voser and Lawrence A. Weinbach were re- elected as their term of office expired. Marcel Ospel did not stand for re-election. Peter Kurer and David Sidwell were elected to their first term on the BoD, and Peter Kurer re- placed Marcel Ospel as full-time Chairman of the BoD. Steph- an Haeringer, Rolf Meyer, Peter Spuhler and Lawrence A. Weinbach tendered their resignations effective 2 October 2008. At the extraordinary general meeting (EGM) held on 2 Oc- tober 2008, Sally Bott, Rainer-Marc Frey, Bruno Gehrig and William G. Parrett were elected to the BoD for the first time. On 31 December 2008, with the exception of its executive Chairman, Peter Kurer, all members of the BoD were consid- ered independent by the BoD. As announced on 4 March 2009, Peter Kurer has decided not to stand for re-election at the AGM on 15 April 2009. The UBS BoD is nominating Kaspar Villiger as a candidate for the role of Chairman. Peter Kurer Address Function(s) in UBS UBS AG Bahnhofstrasse 45 CH-8098 Zurich Chairman of the Board of Directors (BoD) / chair of the corporate responsibility committee / chair of the strategy committee Nationality Year of initial appointment Swiss 2008 Current term of office runs until 2009 Sergio Marchionne Address Function(s) in UBS Nationality Fiat S.p.A. Via Nizza 250 I-10126 Turin Independent vice chairman and senior independent director / member of the gover- nance and nominating committee / member of the strategy committee Canadian and Italian Year of initial appointment 2007 Current term of office runs until 2010 Professional history, education and date of birth Peter Kurer was elected to the BoD at the annual general meeting (AGM) held in 2008 and thereafter appointed Chairman of the BoD. He chairs the corporate responsibility committee and the strategy com- mittee. Mr. Kurer had served as Group General Counsel of UBS since 2001, when he joined the firm. He also served as a member of UBS’s Group Executive Board (GEB) from 2002 until his election to the BoD in April 2008. Between 1991 and 2001, Mr. Kurer was a partner at the law firm Homburger AG in Zurich. Between 1980 and 1990, he was with the Zurich office of Baker & McKenzie law firm, first as associate and later as partner. He was a law clerk at the District Court of Zurich from 1977 to 1979. Mr. Kurer graduated as doctor iuris from the University of Zurich and was admitted as attorney-at-law at the Zurich Bar. He holds an LL.M. from the University of Chicago. He was born on 28 June 1949. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Peter Kurer is a member of the board of Avenir Suisse as well as a member of the visiting committee of the University of Chicago’s Law School. He is also a member of the board of trustees of a foundation which acts as an advisory board to the University of St. Gallen’s program for law and economics, and a member of the committee of continuing education, Executive School of Management, Technology and Law, University of St. Gallen. Professional history, education and date of birth Sergio Marchionne serves as Chief Executive Officer (CEO) of Fiat S.p.A., Turin, and Fiat Group Automobiles. Mr. Marchionne began his professional career in 1983 as a chartered accountant and tax specialist for Deloitte & Touche in Canada. Two years later, he became Group controller and then director of corporate development at Lawson Mardon Group of Toronto. In 1989 and 1990, he served as executive vice presi- dent of Glenex Industries. In the following two years Mr. Marchionne acted as vice president of finance and Chief Financial Officer (CFO) at Acklands Ltd. He returned to Lawson Mardon Group in 1992 as vice president of legal and corporate development and CFO. The company was acquired by Alusuisse Lonza in 1994. After the acquisition, having become CEO in 1996, he held various positions of increasing respon- sibility until 2000. Upon completion of the merger of Alusuisse with Alcan, he acted as CEO and Chairman of the spin-off Lonza Group Ltd. until 2002. In 2002, Mr. Marchionne was appointed CEO of the Société Générale de Surveillance (SGS) Group of Geneva. He has been a member of the supervisory board of Fiat S.p.A. since 2003 and has served as CEO of the company since June 2004. Mr. Marchionne studied phi- losophy at the University of Toronto (Canada), business at the University of Windsor (Canada) and law at Osgoode Hall Law School in Toronto (Canada) and is a lawyer and chartered accountant. He was born on 17 June 1952. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Sergio Marchionne is Chairman of SGS and a member of the BoD of Philip Morris International Inc., New York. He is also a member of Acea (European Automobile Manufacturers Association) and Chairman of CNH Case New Holland Global N.V. 199 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance Ernesto Bertarelli Address Function(s) in UBS Bemido SA Avenue Giuseppe- Motta 31–33 PO Box 145 CH-1211 Geneva 20 Member of the gover- nance and nominating committee / member of the human resources and compensation committee Nationality Year of initial appointment Swiss 2002 Current term of office runs until 2009 Sally Bott Address Function(s) in UBS BP p.l.c. 1 St. James’s Square GB-London SW1Y 4PD Member of the human resources and compensa- tion committee / member of the corporate responsibility committee Nationality American (US) Year of initial appointment 2008 Current term of office runs until 2009 Rainer-Marc Frey Address Function(s) in UBS Horizon21 Poststrasse 4 CH-8808 Pfaeffikon Member of the risk committee / member of the strategy committee Nationality Year of initial appointment Swiss 2008 Current term of office runs until 2009 Bruno Gehrig Address Function(s) in UBS Swiss Life General-Guisan-Quai 40 Postfach CH-8022 Zurich Member of the audit committee Nationality Year of initial appointment Swiss 2008 Current term of office runs until 2009 Professional history, education and date of birth Ernesto Bertarelli was CEO of Serono International SA, Geneva, between 1996 and 2007. The company was sold to Merck KGaA, Germany, on 5 January 2007. He started his career with Serono in 1985 and held several positions in sales and marketing. Prior to his appointment as CEO, he served for five years as deputy CEO. Mr. Bertarelli was also the vice chairman of the BoD of Serono SA, Coinsins (Switzerland) and the Chairman of SeroMer Biotech SA, Chéserex (Switzerland), until 5 January 2007. Mr. Bertarelli holds a Bachelor of Science from Babson College, Boston and an MBA from Harvard University. He was born on 22 September 1965. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Ernesto Bertarelli is Chairman of Team Alinghi SA (winner of the America’s Cup 2003 and 2007), Ecublens (Switzerland), and of Alinghi Holdings Ltd. Jersey. He is the Chairman of Kedge Capital Partners Ltd., Jersey and of Kedge Capital Holdings (Jersey) Ltd., Switzerland. He was awarded two extraordinary na- tional honors: the Légion d’honneur by President Chirac of France, and the Cavaliere di Gran Croce by Carlo Azeglio Ciampi, former President of the Italian Republic. He is a member of the strategic advisory board of Ecole Polytechnique Fédérale de Lausanne (EPFL) and holds various board mandates in profes- sional organizations of the biotech and pharmaceutical industries. Professional history, education and date of birth Sally Bott serves as Group HR Director of BP plc, which she joined in early 2005, and is a member of its Group Executive Committee. Ms. Bott spent most of her career in financial services. Between 2000 and 2005, she was a Managing Director at Marsh & McLennan, a US-based global risk and insurance ser- vices business, and head of global HR for Marsh, Inc. She was at Barclays Bank from 1994 to 2000, first as BZW HR director and then Group HR director from 1997 to 2000. In 1970, she joined Citibank out of college as a research analyst in the economics department. She was credit trained and in the Finance Function. She joined HR in 1978 and worked as a HR director in most of the wholesale bank and invest- ment banking businesses during the next 15 years. She was the Global HR Director of the wholesale bank from 1990 to 1993. Ms. Bott has a BS in economics from Manhattanville College, USA. She was born on 11 November 1949. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Sally Bott is a member of the board of the Royal College of Music in London and the Carter Burden Center for the Aged in NYC. Professional history, education and date of birth Rainer-Marc Frey is the founder and Chairman of Horizon21, an investment management company which takes long-term investment views on various megatrends in the investment management industry. In 1992, he founded RMF Investment Group (RMF), one of the first hedge fund groups in Europe, and became CEO. RMF was acquired by Man Group Plc in 2002. Between 2002 and 2004, he held a number of senior roles within Man Group Plc and was the largest individual shareholder. From 1989 to 1992, prior to founding RMF, Mr. Frey served as a director at Salomon Brothers Inc. in Zurich, Frankfurt and London, where he was involved mainly with equity derivatives. Between 1987 and 1989, he worked for Merrill Lynch Inc. covering equity, fixed income and swaps markets. He holds a degree in economics from the University of St. Gallen. Mr. Frey was born on 10 January 1963. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Rainer-Marc Frey is a member of the BoD of DKSH Group, Zurich, and a member of the advisory board of Invision Private Equity AG, Zug. He is a member of the BoD of the Frey Charitable Foundation, Freienbach. Professional history, education and date of birth Bruno Gehrig has been Chairman of Swiss Life Holding since 2003 and will resign on 7 May 2009 from this position. Between 1996 and 2003, he served at the Swiss National Bank, starting as a member of the governing board and becoming vice chairman in 2000. From 1992 to 1996, he was a professor of banking and finance at the University of St. Gallen and concurrently served as a member of the Swiss Federal Banking Commission (FINMA since 1 January 2009). Between 1989 and 1991, he held the posi- tion of CEO at Cantrade Private Banking Group. Mr. Gehrig worked for the former Union Bank of Switzerland (UBS) between 1981 and 1989, where he started as chief economist before assuming re- sponsibility for securities sales and trading. He studied economics at the University of Berne, where he also did his PhD studies. He completed postgraduate studies at the University of Rochester, New York. He was assistant professor at the University of Berne and received his Dr. h.c. from the University of Rochester, New York. Mr. Gehrig was born on 26 December 1946. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Bruno Gehrig is the vice chairman of the BoD of Roche Holding AG, Basel, and the Chairman of the Swiss Air Transport Foundation, Zug. 200 Gabrielle Kaufmann-Kohler Address Function(s) in UBS Lévy Kaufmann-Kohler 3-5, rue du Conseil-Général CH-1205 Geneva Chair of the governance and nominating committee / member of the corporate responsi- bility committee Nationality Year of initial appointment Swiss 2006 Current term of office runs until 2009 Professional history, education and date of birth Gabrielle Kaufmann-Kohler has been arbitrator and partner with Lévy Kaufmann-Kohler since 1 January 2008, and a professor of private international law, including international arbitration, at the University of Geneva Law School since 1997. Between 1996 and 2007, she worked as a practicing attorney at the Schellenberg Wittmer law firm, Geneva, where she was a partner. Ms. Kaufmann-Kohler was adjunct professor for private international law at the University of Geneva Law School from 1993 to 1996. From 1985 to 1995, she was with Baker & McKenzie law firm, first as associate and then as partner. She is a member of the Geneva Bar (since 1976) and of the New York State Bar (since 1981) and is known worldwide for her expertise in international arbitration. In 1980, she worked for the UBS New York Branch as a legal advisor. Ms. Kaufmann-Kohler completed her legal studies at the University of Geneva in 1977 and received her doctorate from the University of Basel in 1979. She was born on 3 November 1952. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Gabrielle Kaufmann-Kohler is a member of the board of the American Arbitration Association. Helmut Panke Address Function(s) in UBS BMW AG Petuelring 130 D-80788 Munich Member of the human resources and compensa- tion commit tee / member of the risk committee Nationality Year of initial appointment German 2004 Current term of office runs until 2010 William G. Parrett Address Function(s) in UBS Nationality 433 Country Club Rd. W. New Canaan, Ct. 06840 USA Member of the audit committee American (US) Year of initial appointment 2008 Current term of office runs until 2009 David Sidwell Address Function(s) in UBS Apartment 26-O 25 Central Park West New York N.Y. 10023 USA Chair of the risk committee / member of the corporate responsi- bility committee Nationality American (US) and British Year of initial appointment 2008 Current term of office runs until 2009 Professional history, education and date of birth Between 2002 and 2006, Helmut Panke was Chairman of the board of management of BMW AG, Munich. In 1982, he joined as head of planning and controlling in the research and development divi- sion. He subsequently assumed management functions in corporate planning, organization and corpo- rate strategy. Before his appointment as Chairman, he was a member of BMW’s board of management from 1996. Between 1993 and 1996, he was Chairman and CEO of BMW Holding Corporation in the US. Mr. Panke graduated from the University of Munich with a PhD in physics and was assigned to the University of Munich and the Swiss Institute for Nuclear Research before joining McKinsey & Co in Dusseldorf and Munich as a consultant. He was born on 31 August 1946. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Helmut Panke is a member of the BoD of Microsoft Corporation, Redmond, WA (USA) and is also a member of the supervisory board of Bayer AG (Germany). He is a member of the BoD of the American Chamber of Commerce in Germany and a member of the international advisory board for Dubai International Capital’s “Global Strategic Equities Fund”. Professional history, education and date of birth William G. Parrett served his entire career with Deloitte Touche Tohmatsu, a global organization of member firms that operates with 160,000 people in nearly 140 countries. He was CEO from 2003 until his retirement in 2007. Between 1999 and 2003, he was a managing partner of Deloitte & Touche USA LLP and served on Deloitte’s Global Executive Committee. Mr. Parrett founded the US National Financial Services Industry Group (1995) and the Global Financial Services Industry Group (1997) of Deloitte, both of which he led as Chairman. In his 40 years of experience in professional services, Mr. Parrett served public, private, governmental, and state-owned clients worldwide in order to help Deloitte achieve supe- rior financial performance and growth. Mr. Parrett has a Bachelors degree in accounting from St. Francis College, New York, and is a certified public accountant. He was born on 4 June 1945. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: William Parrett is an independent director of Eastman Kodak Co., Blackstone Group LP, and Thermo Fisher Scientific Inc., USA. He is also the Chairman of the BoD of the United States Council for International Business and of United Way of America, a member of the board of trustees of Carnegie Hall, and a member of the Executive Committee of the International Chamber of Commerce. Professional history, education and date of birth David Sidwell was executive vice president and CFO of Morgan Stanley in New York between March 2004 and October 2007. Before joining Morgan Stanley he was with JPMorgan Chase & Co. He joined JPMorgan Chase & Co. in 1984 in New York where he held a number of different positions during his 20 years of service, including controller and CFO of the Investment Bank. Prior to this he was with PricewaterhouseCoopers LLP in both London and New York. Mr. Sidwell graduated from Cambridge University in England and is a chartered accountant qualifying in the Institute of Chartered Accountants in England and Wales. He was born on 28 March 1953. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: David Sidwell is a director of the Federal National Mortgage Association Fannie Mae. He is a trustee of the International Accounting Standards Committee Foundation, London and the Chairman of the BoD of Village Care of New York, a not-for-profit organization, as well as director of the National Council on Aging. 201 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance Peter R. Voser Address Function(s) in UBS Royal Dutch Shell plc 2501 AN NL-The Hague Chair of the audit committee / member of the strategy committee Nationality Year of initial appointment Swiss 2005 Current term of office runs until 2009 Joerg Wolle Address Function(s) in UBS Nationality DKSH Holding AG Wiesenstrasse 8 CH-8034 Zurich Chair of the human resources and compensa- tion committee / member of the governance and nominating committee German and Swiss Year of initial appointment 2006 Current term of office runs until 2009 Professional history, education and date of birth Peter R. Voser has been CFO and an executive BoD member of Royal Dutch Shell plc in London since 2004. Between 2002 and 2004, he was CFO of Asea Brown Boveri (ABB) in Switzerland. Between 1982 and 2002, he worked for the Royal Dutch / Shell Group, holding various assignments in Switzerland, the UK, Argentina and Chile. Mr. Voser graduated from the University of Applied Sciences, Zurich. He was born on 29 August 1958. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Mr. Voser is a member of the BoD of the Swiss Federal Auditor Oversight Authority. Professional history, education and date of birth Joerg Wolle has been president and CEO of DKSH Holding Ltd. since 2002. From 2000 until the merger with Diethelm Keller in 2002, he was president and CEO of SiberHegner Holding AG. He completed his studies in engineering in 1983 and received his doctorate in 1987 from the Technical University of Chemnitz in Germany. Mr. Wolle was born on 19 April 1957. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Joerg Wolle is a member of the BoD of Diethelm Keller Holding Ltd., Zurich. He is also the Chairman of the BoD of BURU Holding Ltd., Cham, and a member of the BoD of OAV (German Asia-Pacific Business Association), Hamburg. Elections and terms of office Organizational structure In accordance with the new article 19 (paragraph one) of the “Articles of Association of UBS AG” approved at the 23 April 2008 AGM, all BoD members are to be elected on an indi- vidual basis for a one-year term of office. As a result, by 2010 at the latest, shareholders must confirm the entire membership of the BoD on a yearly basis at the AGM. BoD members are normally expected to serve for a mini- mum of three years. No BoD member can continue to serve beyond the AGM held in the calendar year following his or her sixty-fifth birthday. The BoD may, in exceptional circum- stances, propose to the AGM that a BoD member be re- elected despite having reached this age limit. However, no BoD member may hold office beyond the age of 70. The boxes on the previous pages list the following for all BoD members: year of first appointment to the BoD and the expiry of their current mandate. Organizational principles The BoD has ultimate responsibility for the mid- and long- term strategic direction of the UBS Group (Group), for ap- pointments and dismissals at top management level and for the definition of the firm’s risk principles and risk capacity. Following each AGM, the BoD meets to elect or appoint its Chairman, one or more vice chairmen, the senior indepen- dent director and the members and chairs of its committees. The BoD appoints a company secretary who acts as secretary to the BoD and its committees. There were significant changes to the organizational structure of the BoD in 2008, including the dissolution of the Chairman’s Office as of 1 July 2008, which was composed of the Chairman and the vice chairman / vice chairmen. The du- ties and responsibilities of the former Chairman’s Office were allocated to a number of BoD committees, including the new risk committee and the new strategy committee. In ad- dition, the duties and responsibilities of the governance and nominating committee (formerly the nominating committee) and the human resources and compensation committee (formerly the compensation committee) have been expand- ed. The duties and responsibilities of the committees of the BoD are described below. Moreover, the position of a senior independent director has been established and is currently held by Sergio Marchionne, in addition to his role as the firm’s vice chairman. According to the Articles of Association, the BoD meets as often as business requires, but at least six times a year. A 202 total of 47 meetings were held in 2008, of which 17 includ- ed Group Executive Board (GEB) members, 26 were without GEB participation, and four were independent BoD meetings held without the presence of its Chairman. On average, 91% of BoD members were present at BoD meetings and 83% at the BoD meetings without GEB participation. Each committee chair provides the BoD with regular up- dates on the current activities of his or her committee and on important committee issues. At least once per year, the BoD reviews its own perfor- mance as well as the performance of each of its committees. This review is based on an assessment conducted by the gov- ernance and nominating committee and seeks to determine whether the BoD and its committees are functioning effec- tively and efficiently. The BoD is organized as follows: Chairman’s Office UBS had a Chairman’s Office until 30 June 2008. Since then, the duties and responsibilities of the dissolved Chairman’s Office have been allocated to a number of BoD committees. Audit committee The audit committee comprises at least three independent BoD members, with all members having been determined by the BoD as being fully independent and financially literate. Peter R. Voser, the committee’s chair, as well as the other two members, have accounting and financial management expertise and are “financial experts” according to the rules established by the US Sarbanes-Oxley Act of 2002. The committee operates under the audit committee char- ter, as described in the “Organization Regulations of UBS AG” (organization regulations) and its annexes. The commit- tee does not itself perform audits, but supervises the work of the auditors. Its primary responsibility is to assist the BoD in: (i) monitoring the integrity of the financial statements of UBS and compliance with legal and regulatory requirements; and (ii) reviewing the organization and efficiency of internal con- trols and financial reporting processes. On behalf of the BoD, the committee monitors the qualification, independence and performance of UBS’s external auditors and their lead partners. It prepares proposals for the BoD regarding the appointment or removal of UBS’s external auditors. The BoD then submits these proposals to the AGM. The committee also reviews the financial statements of UBS and UBS Group, and makes proposals as to whether the annual financial statements of UBS and UBS Group should be submitted to the AGM for approval. On 31 December 2008, Peter R. Voser chaired the commit- tee with Bruno Gehrig and William G. Parrett as its additional members. The committee met six times in 2008, with the head of Group Internal Audit, the representatives of the external auditors, the Group Chief Financial Officer (CFO), the head of Group Controlling and Accounting and the head of Group Ac- counting Policy participating. The six meetings included regu- lar separate sessions with these representatives. In addition, the Group General Counsel attended one meeting. A special session was organized with the Group CFO to discuss the an- nual financial results. Participation at the meetings averaged 94% and all were held with external auditors present. The committee reports back to the BoD about its discus- sions with UBS’s external auditors. Once per year, the lead partners take part in a BoD meeting, presenting the long- form report of UBS’s external auditors, as required by the Swiss Financial Market Supervisory Authority (until 31 De- cember 2008, Swiss Federal Banking Commission). Corporate responsibility committee The corporate responsibility committee supports the BoD in fulfilling its duty to safeguard and advance the Group’s repu- tation for responsible corporate conduct and to assess devel- opments in stakeholder expectations and their possible con- sequences for UBS. The committee comprises at least three BoD members and, on 31 December 2008, Peter Kurer chaired the committee with Sally Bott, Gabrielle Kaufmann- Kohler and David Sidwell as its additional members. The committee is advised and supported by a number of senior business representatives. The committee met twice in 2008, with an average participation of 63%. ➔ Refer to the “Corporate responsibility” section of this report for more information on corporate responsibility Governance and nominating committee The governance and nominating committee supports the BoD in fulfilling its duty to establish best practices in corpo- rate governance across the Group, to conduct a self-assess- ment of the full BoD, in consultation with the Chairman of the BoD, to establish and maintain a process for appointing new BoD members and to manage the succession of the Group Chief Executive Officer (Group CEO). The committee comprises at least three independent BoD members and, on 31 December 2008, Gabrielle Kaufmann-Kohler chaired the committee with Ernesto Bertarelli, Sergio Marchionne and Joerg Wolle as its additional members. In 2008, 14 meetings were held with an average participation of 95%. Of these 14 meetings, eight were held with external advisors. Human resources and compensation committee The human resources and compensation committee has the following functions: (i) to support the BoD in fulfilling its duty to set guidelines on compensation and benefits; (ii) to approve the total individual compensation for the Chairman of the BoD, the non-independent BoD members and the GEB members; (iii) together with the Chairman of the BoD, to provide the BoD with a proposal for total individual com- pensation for the independent BoD members; and (iv) to scrutinize the performance of the executives and supervise 203 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance and approve the succession planning for all executives (other than the Group CEO). The human resources and compen- sation committee also reviews the compensation disclosure included in this report. The committee operates under the human resources and compensation committee charter, as described in the organization regulations and its annexes. The Group CEO must provide this committee with an an- nual report on the effectiveness of UBS’s human resources polices and suggest modifications and supply regular up- dates regarding the results of employee and executive sur- veys and leadership processes. The committee comprises at least three independent BoD members and, on 31 December 2008, Joerg Wolle chaired the committee with Sally Bott, Helmut Panke and Ernesto Bertarelli as its additional members. Eight meetings were held in 2008, with an average participation of 93%. Of those meetings, four were held with external advisors. ➔ Refer to the “Compensation, shareholdings and loans” section of this report for more information on the BoD human resources and compensation committee’s decision-making procedures Risk committee The risk committee became effective on 1 July 2008 and took over many responsibilities of the former Chairman’s Of- fice. The function of the committee is to support the BoD in fulfilling its duty to supervise and to set appropriate risk management and control principles in the areas of: (i) risk management and control, including credit, market and op- erational risk; (ii) treasury and capital management, includ- ing funding and liquidity; and (iii) balance sheet manage- ment, including in each case any consequent reputational risk. For these purposes, the committee will receive all rele- vant information from the GEB. The Group CEO, the Group CFO, the Group CRO and the Executive Committee are re- sponsible for assessing and managing the risks of the Group and are ultimately accountable to the BoD with regard to their activities. The committee comprises at least three independent BoD members and, on 31 December 2008, David Sidwell chaired the committee with Rainer-Marc Frey and Helmut Panke as its additional members. The committee has met eight times since its formation on 1 July 2008, with an average participa- tion of 87%. Three of these meetings were held with exter- nal advisors. A special session was held with the Governing Board of the Swiss National Bank, and will continue to be held on an annual basis. Strategy committee The strategy committee became effective on 1 July 2008. The functions of the strategy committee are: (i) to work with the Group CEO to initiate, at least once per year, a review of the firm’s strategy and its implementation by the GEB, with a view to submitting presentations to the BoD to facilitate its decisions on the Group’s strategy; (ii) to monitor the imple- mentation of the Group’s current strategy and report results to the BoD; (iii) to consider, in conjunction with the risk com- mittee, the Group’s strategy to deal with anticipated or exist- ing high-level risks; and (iv) to validate the Group’s current strategy with external experts where the committee consid- ers such external advice to be appropriate. The committee comprises at least three independent BoD members and, on 31 December 2008, Peter Kurer chaired the committee with Rainer-Marc Frey, Sergio Marchionne and Peter R. Voser as its additional members. All members were present at the six committee meetings held in 2008, with one meeting held as a strategy seminar and external advisors present at two. Roles and responsibilities of the Chairman of the Board of Directors Peter Kurer, the Chairman, has entered into a full-time em- ployment contract with UBS in connection with his service on the BoD and is entitled to receive pension benefits upon retirement. He assumes clearly defined management respon- sibilities. The Chairman takes a leading role in mid- and long-term strategic planning, the selection and supervision of the Group CEO and the GEB members, mid-term succession planning and developing and shaping compensation princi- ples. In addition, the Chairman actively supports major client and transaction initiatives. As leader of the BoD, the Chairman is responsible for en- suring that the BoD is effective and correctly balances its focus between its strategic and supervisory functions. In ad- dition, the Chairman presides over the AGMs and EGMs and works with the committee chairs to coordinate the work of all committees. Together with the Group CEO, the Chairman is responsible for ensuring effective communication with shareholders and other stakeholders, including government officials and regulators. This is in addition to establishing and maintaining a close working relationship with the Group CEO and the other GEB members, providing advice and sup- port while respecting the fact that day-to-day management responsibility is delegated to the GEB. Roles and responsibilities of the senior independent director At least once per year, the senior independent director orga- nizes and leads a meeting of the independent BoD members without the presence of the Chairman. The senior indepen- dent director reports to the Chairman of the BoD on the evaluation of the Chairman’s performance. The senior inde- pendent director acts as a contact point for shareholders wishing to engage in discussions with an independent BoD member. 204 Important business connections of independent members of the Board of Directors with UBS UBS, as a global financial services provider and a major bank in Switzerland, has business relationships with many large companies including those in which UBS BoD members as- sume management or independent board responsibilities. The nature of the relationships between UBS and companies whose chair or chief executive is a member of UBS’s BoD is not considered to compromise the BoD members’ capacity for independent judgment. Furthermore, no independent BoD member has personal business relationships with UBS that could compromise his or her independence. All relationships and transactions with UBS BoD members and their affiliated companies are conducted in the ordinary course of business and are on the same terms as those pre- vailing at the time for comparable transactions with non-af- filiated persons. Checks and balances: Board of Directors and Group Executive Board Effective 1 July 2008, the separation of responsibilities be- tween the BoD and executive management has been clari- fied. The BoD has a clear strategy-setting responsibility and will supervise and monitor the business, whereas the GEB, headed by the Group CEO, has executive management re- sponsibility. UBS operates under a strict dual board structure, as mandated by Swiss banking law. The functions of Chair- man of the BoD and Group CEO are assigned to two differ- ent people, thus ensuring a separation of powers. This struc- ture establishes checks and balances and preserves the institutional independence of the BoD from the day-to-day management of the firm, for which responsibility is delegat- ed to the GEB under the leadership of the Group CEO. No member of one board may be a member of the other. Supervision and control of executive management re- mains with the BoD. The authorities and responsibilities of the two bodies are governed by the “Articles of Association of UBS AG” and “Organization Regulations of UBS AG”, including the latter document’s “Annex B - Responsibilities and authorities”. ➔ Refer to www.ubs.com/governance for more details on checks and balances for the BoD and GEB Information and control instruments vis-à-vis the Group Executive Board The BoD is kept informed of the activities of the GEB in vari- ous ways. The minutes of the GEB meetings are made avail- able to the BoD members. At BoD meetings, the Group CEO and the GEB members regularly update the BoD on impor- tant issues. At BoD meetings, BoD members may request from BoD or GEB members any information about any matters con- cerning UBS that they require to fulfill their duties. Outside meetings, BoD members may request information from oth- er BoD members and GEB members, in which case such re- quests must be approved by the Chairman of the BoD. Group Internal Audit monitors the compliance of busi- ness activities with legal and regulatory requirements and all internal regulations, policies and guidelines. This internal au- dit organization, which is independent from management, reports significant findings to the Chairman of the BoD, the risk committee and the audit committee. For the first time in February 2008, UBS’s internal compli- ance function provided an annual compliance report to the BoD. This report is required by sections 109 and 112 of circular 08 / 24 of the Swiss Financial Market Supervisory Authority on the supervision and internal controls at banks. ➔ Refer to the “Risk management and control” section of this report for more information n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 205 Corporate governance and compensation Corporate governance Group Executive Board UBS operates under a strict dual board structure, as man- dated by Swiss banking law. The management of the busi- ness is delegated by the Board of Directors (BoD) to the Group Executive Board (GEB). Members of the Group Executive Board on 28 February 2009 The text in the boxes below provides information on the composition of the GEB on 28 February 2009. It shows each member’s function in UBS, nationality, year of initial appoint- ment to the GEB, professional history and education, date of birth and other activities and functions, such as mandates on boards of important corporations, organizations and founda- tions, permanent functions for important interest groups as well as official functions and political mandates. Changes in 2008 On 23 April 2008, Peter Kurer stepped down as Group General Counsel (Group GC) and was replaced by Markus U. Diethelm on 1 September 2008. In the meantime, David Aufhauser, Neil Stocks and Bernhard Schmid acted as inter- im co-General Counsels while Peter Kurer retained an overall supervisory role over the team of the three General Coun- sels. This was accepted by the Swiss Financial Market Super- visory Authority as a transitional arrangement. On 1 September 2008, Marco Suter stepped down as Group Chief Financial Officer (Group CFO) and John Cryan replaced him as Group CFO. On 4 November 2008, Joe Scoby stepped down as Group Chief Risk Officer (Group CRO) and Philip J. Lofts replaced him as Group CRO. On 12 November 2008, Marten Hoekstra assumed the duties on an interim basis of Raoul Weil, Chairman and Chief Executive Officer (CEO) of Global Wealth Management & Business Banking, who relinquished his duties on that date. Currently Raoul Weil is a member of the GEB but does not hold a function. Changes in 2009 Francesco Morra and Juerg Zeltner have been appointed as CEOs of Wealth Management & Swiss Bank and as CEO Swit- zerland and CEO Wealth Management Global, respectively. They assumed their roles on 10 February 2009 and became members of the GEB at this date. As CEO Switzerland, Fran- cesco Morra will head the wealth management business for domestic Swiss wealth management and private clients. As CEO Wealth Management Global, Juerg Zeltner will lead all UBS domestic wealth management businesses outside of Switzerland and the Americas. Marten Hoekstra heads the business division Wealth Management Americas and no lon- ger assumes the role of deputy Chairman and CEO of Global Wealth Management & Business Banking. Oswald J. Gruebel was named Group CEO on 26 February 2009, replacing Marcel Rohner who stepped down as Group CEO on that date. Oswald J. Gruebel 1 Address Function(s) in UBS UBS AG Bahnhofstrasse 45 CH-8098 Zurich Group Chief Executive Officer Nationality Year of initial appointment German 2009 1 Oswald J. Gruebel was named Group CEO on 26 February 2009, replacing Marcel Rohner who stepped down as Group CEO on that date. Professional history, education and date of birth Oswald J. Gruebel was named UBS Group Chief Executive Officer (Group CEO) on 26 February 2009. Before joining UBS he was the CEO of Credit Suisse Group and of Credit Suisse and stepped down from this role in May 2007. He was CEO of Credit Suisse Financial Services from 2002 to 2004 and was addi- tionally Co-CEO of Credit Suisse Group from 2003 until 2004. Mr. Gruebel was a member of the Credit Suisse Group Executive Board (GEB) between 1997 and 2001 and again from 2002 to 2007. From 1991 until 1997 he was member of the Executive Board of Credit Suisse, responsible for equities, fixed income, global foreign exchange, money markets and asset/liability management in Zurich. Before that he was a member of the GEB, Financière Credit Suisse First Boston in Zug. In 1970 Mr. Gruebel joined White Weld Securities and became its CEO in 1978. From 1961 to 1970 he worked for Deutsche Bank AG. He was born on 23 November 1943. 206 John Cryan Address Function(s) in UBS UBS AG Bahnhofstrasse 45 CH-8098 Zurich Group Chief Financial Officer (Group CFO) Professional history, education and date of birth John Cryan, formerly global head of the financial institutions group at UBS’s Investment Bank, was ap- pointed Group CFO in September 2008. As an alumnus of Arthur Andersen & Co, Mr. Cryan joined S.G. Warburg in London in 1987. Since 1992, he has specialized in providing strategic and financial advice to a wide range of companies in the financial services sector globally. In recent months, he has played an active role in advising UBS’s Board of Directors (BoD) and Group Executive Board (GEB) on issues related to the current financial crisis. Mr. Cryan graduated in 1981 and holds an MA Hons from the University of Cambridge. He was born on 16 December 1960. Nationality Year of initial appointment British 2008 Markus U. Diethelm Address UBS AG Bahnhofstrasse 45 CH-8098 Zurich Function(s) in UBS Group General Counsel Nationality Year of initial appointment Swiss 2008 John A. Fraser Address Function(s) in UBS Nationality UBS AG Bahnhofstrasse 45 CH-8098 Zurich Chairman and CEO Global Asset Management Australian Year of initial appointment 2002 Marten Hoekstra Address Function(s) in UBS UBS AG Bahnhofstrasse 45 CH-8098 Zurich Deputy CEO Global Wealth Management & Business Banking and Head Wealth Management US Nationality American (US) Year of initial appointment 2008 Professional history, education and date of birth Markus U. Diethelm was appointed Group General Counsel of UBS on 1 September 2008. From 1998 to 2008, he worked for Swiss Re. He started his career in 1983 with Bär & Karrer, a Zurich law firm. In 1988, he joined Paul, Weiss, Rifkind, Wharton & Garrison in New York as a foreign associate. As of 1989, he practiced with New York’s Shearman & Sterling, specializing in mergers and acquisitions. In 1992 he joined the Los Angeles-based law firm Gibson, Dunn & Crutcher, focusing on corporate matters, securities transactions, liti- gation and regulatory investigations while operating out of the firm’s Brussels and Paris offices. He joined Swiss Re in 1998 as Group Chief Legal Officer and was appointed to its GEB effective 1 January 2007. Mr. Diethelm holds a law degree from the University of Zurich and a Masters degree and PhD from the law school at Stanford University. He is a qualified attorney-at-law in Switzerland and admitted to the New York Bar. He was born on 22 October 1957. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Markus U. Diethelm is the Chairman of the legal committee of the Swiss American Chamber of Commerce. Professional history, education and date of birth John A. Fraser was appointed Chairman and CEO of the Global Asset Management division in late 2001. Prior to that, he was President and COO of UBS Asset Management and Head of Asia Pacific. In 208, he became Chairman of UBS Saudi Arabia. From 1994 to 1998, he was Executive Chairman and CEO of The Australia Funds Management business. Before joining UBS, Mr. Fraser spent over 20 years in various positions at the Australian Treasury, including two international postings to Washington D.C., first, at the International Monetary Fund and, second, as Minister (Economic) at the Australian Embassy. From 1990 to 1993, he was Deputy Secretary (Economic) of the Australian Treasury from 1990 to 1993. Mr. Fraser graduated from Monash University in Australia in 1972 and holds a first-class honors degree in econom- ics. He was born on 8 August 1951. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: John A. Fraser is a member of the Board of Governors of the Marymount International School at Kingston- upon-Thames in the UK. Professional history, education and date of birth On 12 November 2008, Marten Hoekstra assumed the duties of Raoul Weil, as Chairman and CEO Global Wealth Management & Business Banking, on an interim basis. He was appointed head of Wealth Management US in July 2005 and Deputy CEO Global Wealth Management & Business Banking in November 2007. Between 2001 and 2005, he assumed different management roles in Global Wealth Management & Business Banking, including head of market strategy and development, and in July 2002 became a member of the Group Managing Board. Previously, from 1983 to 2000, he held various roles with PaineWebber, including that of financial advisor. Mr. Hoekstra graduated with a BA in political science from the University of North Dakota and received his MBA from the Kellogg Graduate School of Management at Northwestern University. He was born on 21 May 1961. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Marten Hoekstra is a member of the BoD of Prisoner Fellowship Ministries and of the Zurich International School Foundation, both non-profit organizations. He is also a member of the BoD of the Securities Industry & Financial Markets Association (SIFMA). n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 207 Corporate governance and compensation Corporate governance Jerker Johansson Address Function(s) in UBS Nationality UBS AG Bahnhofstrasse 45 CH-8098 Zurich Chairman and CEO of the UBS Investment Bank Swedish Year of initial appointment 2008 Professional history, education and date of birth Jerker Johansson joined UBS and was named Chairman and CEO of the UBS Investment Bank on 13 February 2008. Previously he was vice chairman of Morgan Stanley Europe, and a member of its management committee. From 2005 to 2007, he was head of Morgan Stanley’s institutional equity divi- sion. In 2005, he was also named co-head of the combined sales and trading business, consisting of the institutional equity division and the fixed income division. In 2007, he became co-head of sales and trad- ing with responsibility for clients and services, continuing his responsibility for prime brokerage and be- coming solely responsible for the sales and trading side of capital markets. Mr. Johansson joined Morgan Stanley in 1985 as a summer associate and held various positions including head of equity capital markets Europe before being promoted in 1997 to COO, institutional equity division Europe. He was also a mem- ber of the European management committee. From 2002 to 2005, he was head of the institutional eq- uity division in Europe. Before joining Morgan Stanley, Mr. Johansson was part of Bankers Trust’s Graduate Training Program, and also worked for Chase Manhattan Bank. He holds a Masters degree in economics from Stockholm University and an MBA from Stanford. He was born on 19 May 1956. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Jerker Johansson is a member of the Stanford Business School advisory board, a trustee of Tower Hamlets Educational Business Partnership and a Business Leader at Community Links, London. Philip J. Lofts Address UBS AG Bahnhofstrasse 45 CH-8098 Zurich Professional history, education and date of birth Philip J. Lofts, formerly deputy Group CRO and Group risk Group chief operating officer, was appointed Group CRO as of November 2008. He has been with UBS for over 20 years. In 2008, he became Group risk chief operating officer after having previously been Group chief credit officer for three years. Before this, Mr. Lofts worked for the Investment Bank in a number of business and risk control positions in Europe, Asia Pacific and the US. He was born on 9 April 1962. Function(s) in UBS Group CRO Nationality Year of initial appointment British 2008 Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Mr. Lofts is a member of the foundation board of the University of Connecticut. Francesco Morra Address Function(s) in UBS Nationality UBS AG Bahnhofstrasse 45 CH-8098 Zurich CEO Switzerland Swiss and Italian Year of initial appointment 2009 1 1 Appointed on 10 February 2009. Walter H. Stuerzinger Address UBS AG Bahnhofstrasse 45 CH-8098 Zurich Function(s) in UBS COO Corporate Center Nationality Year of initial appointment Swiss 2005 Rory Tapner Address Function(s) in UBS UBS AG Bahnhofstrasse 45 CH-8098 Zurich Chairman and CEO Asia Pacific Nationality Year of initial appointment British 2006 208 Professional history, education and date of birth Francesco Morra was appointed CEO Switzerland and became a member of the GEB in February 2009. In November 2007, he was appointed Head of Wealth Management Western Europe, Mediterranean, Middle East & Africa. In addition, as of September 2008, he was also responsible for the business unit Latin America, Caribbean & Canada. Francesco Morra joined UBS in 2005 as Head of Wealth Management Italy and as a member of the Group Managing Board. Before joining UBS, he held various management positions at The Boston Consulting Group Inc. between 1992 and 2005. He holds a PhD in economics from the University of St. Gallen (Switzerland). He was born on 31 August 1967. Professional history, education and date of birth Walter H. Stuerzinger was appointed COO Corporate Center in October 2007. Prior to that, he was Group CRO from 2001 until 2007 and head of Group Internal Audit from 1998 until 2001. Before the merger with SBC, he was head of Group Internal Audit at the former Union Bank of Switzerland. Previously he worked with Credit Suisse on various assignments in the controlling and auditing areas. Mr. Stuerzinger holds a Swiss banking diploma and is a member of the Institute of Chartered Accountants. He was born on 6 July 1955. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Walter H. Stuerzinger is a member of the foundation board of the UBS Pension Fund. Professional history, education and date of birth Rory Tapner was appointed Chairman and CEO Asia Pacific in May 2004. Previously he was Joint Global Head of Investment Banking. From 1983 to 1998 he was with S.G. Warburg and Warburg Dillon Read as global head of equity capital markets, joint head of UK corporate finance and head of the UK capital markets team. He was also a member of the Warburg Dillon Read executive board. Mr. Tapner has a law degree from Kings College, London University and went to Lancaster Gate Law School. Mr. Tapner was born on 30 September 1959. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Rory Tapner is the treasurer and Chairman of the financial committee of Council of Kings College, London University. Alexander Wilmot-Sitwell Address Function(s) in UBS UBS AG Bahnhofstrasse 45 CH-8098 Zurich Joint Global Head of Investment Banking, Chairman and CEO of UBS Group Europe, Middle East & Africa Nationality Year of initial appointment British 2008 Robert Wolf Address Function(s) in UBS Nationality UBS AG Bahnhofstrasse 45 CH-8098 Zurich Chairman and CEO of UBS Group Americas, President of the UBS Investment Bank American (US) Year of initial appointment 2008 Juerg Zeltner Address Function(s) in UBS UBS AG Bahnhofstrasse 45 CH-8098 Zurich CEO Wealth Management Global Nationality Year of initial appointment 1 Appointed on 10 February 2009. Swiss 2009 1 Professional history, education and date of birth In January 2008, Alexander Wilmot-Sitwell became Joint Global Head of Investment Banking and Chairman and CEO of UBS Group Europe, Middle East & Africa. In 2006, Mr. Wilmot-Sitwell became a member of the Group managing board. He joined the firm in 1996 as head of corporate finance in South Africa and moved to London in 1998 as head of UK investment banking. Prior to joining Warburg Dillon Read, he was head of corporate finance at SBC Warburg in South Africa, SBC Warburg. Mr. Wilmot-Sitwell graduated from Bristol University with a degree in modern history. He was born on 16 March 1961. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Alexander Wilmot-Sitwell is vice president of the “Save the Children Fund”, London. Professional history, education and date of birth Robert Wolf was appointed President of the UBS Investment Bank in 2007 and was COO of the UBS Investment Bank from 2004 to 2008. Since 2006, he has also served as Chairman and CEO of UBS Group Americas. Prior to this, Mr. Wolf served as global head of fixed income from 2002 to 2004 and held the position of global head of credit trading, research & distribution from 1998 to 2001. He joined the firm in 1994, after spending approximately 10 years at Salomon Brothers in fixed income. Mr. Wolf graduated from the Wharton School at the University of Pennsylvania with a Bachelors of Science in economics in 1984. He was born on 8 March 1962. Other activities and functions Mandates on boards of important corporations, organizations and foundations or interest groups: Robert Wolf is a member of the undergraduate executive board of Wharton School, of the athletics board of overseers of UPENN and of the Financial Services Round Table. Mr. Wolf is a member of the Council on Foreign Relations and of the committee encouraging corporate philanthropy. He is in the executive leadership council of the Multiple Myeloma Research Foundation, Norwalk, CT, and on the board of trustees of the Children’s Aid Society, New York. Professional history, education and date of birth Juerg Zeltner was appointed CEO Wealth Management Global and became a member of the GEB in February 2009. In November 2007, he was appointed Head of Wealth Management North, East & Central Europe and became a member of the Group Managing Board in the same year. From 2005 to 2008, he was CEO of UBS Deutschland AG, Frankfurt and became CEO of all UBS business in Benelux, Germany and Central Europe in 2007. Prior to that, he held various management positions in the Private Banking Division of UBS. Between 1987 and 1998, Juerg Zeltner was with SBC in various roles within the Private and Corporate Client Division in Bern, New York and Zurich. He graduated from the School of Economics and Business Administration in Bern and completed the Advanced Management Program at Harvard Business School. He was born on 4 May 1967. Establishment of the Executive Committee Responsibilities, authorities and organizational principles of the GEB The Executive Committee (EC) was established on 1 Janu- ary 2009. The EC consists of the Group CEO, the Group CFO, the Group CRO and the Group GC. Under the leader- ship of the Group CEO, the EC is responsible for the alloca- tion of the UBS Group’s financial resources to the business divisions – i.e. the capital, the terms and availability of funding and the risk capacity and parameters, in each case within the limits set by the BoD. Additionally, the EC sets the performance targets of the business divisions and then monitors and evaluates them. Under the auspices of the Group CEO, the EC prepares proposals for approval by the BoD and supports the BoD in its decision-making process. The EC has overall responsibility for implementing UBS’s risk management and control principles, allocating risk ca- pacity to the business divisions and controlling the firm’s overall risk profile. Under the leadership of the Group CEO, the GEB has executive management responsibility for the Group and its business. The GEB assumes overall responsibility for the development and implementation of strategies for the Group and business divi- sions. The GEB, in particular the Group CEO, is responsible for the implementation and results of the firm’s business strate- gies. The GEB plays a key role in defining the human resources policy and the compensation principles of the Group. ➔ Refer to the “Organization Regulations of UBS AG”, which are available at www.ubs.com/governance, for more information on the authorities of the GEB Management contracts UBS has not entered into management contracts with any third parties. 209 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance Senior leadership The Group Managing Board (GMB) comprises members of business division and Corporate Center management and individuals assuming special Group functions. In the first half of 2009, the GMB will be dissolved and replaced by a new group of senior leaders reflecting the responsibilities at Group, divisional and regional levels. 210 Shareholders’ participation rights UBS is committed to shareholder participation in its decision- making process and aims to make such participation as easy as possible. More than 300,000 directly registered share- holders, as well as some 90,000 US shareholders registered via nominee companies, regularly receive written informa- tion about the firm’s activities and performance and are per- sonally invited to shareholder meetings. Refer to the “Infor- mation policy” section of this report for further information on these documents. Relationships with shareholders UBS fully subscribes to the principle of equal treatment of all shareholders, who range from large investment institutions to individual investors, and regularly informs them about the development of the company of which they are co-owners. The annual general meeting (AGM) offers shareholders the opportunity to raise any questions regarding the devel- opment of the company and the events of the year under review. Members of the Board of Directors (BoD) and Group Executive Board (GEB), as well as the internal and external auditors, are present to answer these questions. Voting rights, restrictions and representation UBS places no restrictions on share ownership and voting rights. Nominee companies and trustees, which normally represent a large number of individual shareholders, may hold an unlimited number of shares, but voting rights are limited to a maximum of 5% of outstanding UBS shares in order to avoid the risk of unknown shareholders with large stakes being entered in the share register. Securities clearing organizations, such as The Depository Trust Company in New York, are not subject to the 5% voting limit. In order to be recorded in the share register with voting rights, shareholders must confirm that they acquired UBS shares in their own name and for their own account. Nomi- nee companies and trustees are required to sign an agree- ment with UBS confirming their willingness to disclose to the company, upon its request, individual beneficial owners holding more than 0.3% of all issued shares. All shareholders registered with voting rights are entitled to participate in shareholder meetings. If they do not wish to attend in person, they can issue instructions to accept, reject or abstain on each individual item on the meeting agenda either by giving instructions to an independent proxy desig- nated by UBS (as required under Swiss company law) or by appointing UBS, another bank or another registered share- holder of their choice to vote on their behalf. Nominee com- panies normally submit the proxy material to the beneficial owners and transmit the collected votes to UBS. Statutory quorums Shareholder resolutions, the election and re-election of members of the BoD and the appointment of the Group and statutory auditors are decided at the AGM by an abso- lute majority of the votes cast, excluding blank and invalid ballots. Swiss company law requires that for certain specific issues a majority of two-thirds of the votes represented at the meeting vote in favor of the resolution. These issues in- clude, among others, the introduction of voting shares, the introduction of restrictions on the transferability of regis- tered shares, conditional and authorized capital increases, and restrictions or exclusion of shareholders’ pre-emptive rights. The “Articles of Association of UBS AG” also require a two-thirds majority of votes represented for any change to its provisions regarding the number of BoD members and any decision to remove one-fourth or more of the members of the BoD. Votes and elections are normally conducted electronically to ascertain clearly the exact number of votes cast. Voting by a show of hands remains possible if a clear majority is pre- dictable. Shareholders representing at least 3% of the votes represented may still request, however, that a vote or elec- tion take place electronically or by written ballot. In order to allow shareholders to clearly express their views on all indi- vidual topics, each item on the agenda is put to vote sepa- rately and BoD elections are made on a person-by-person basis. Convocation of general meetings of shareholders The AGM normally takes place in April each year, but in any case within six months of the close of the financial year. A personal invitation including a detailed agenda and explana- tion of each motion is sent to every registered shareholder at least 20 days ahead of the scheduled meeting. The meeting agenda is also published in various Swiss and international newspapers and on the internet at www.ubs.com/agm. Extraordinary general meetings (EGMs) may be convened whenever the BoD or the statutory auditors consider it nec- essary. Shareholders individually or jointly representing at least 10% of the share capital may, at any time, ask in writ- ing that an EGM be convened to deal with a specific issue put forward by them. Such a request may also be brought forward during the AGM. 211 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance Placing of items on the agenda mulates an opinion on the proposals, which is published to- gether with the motions. Shareholders individually or jointly representing shares with an aggregate par value of CHF 62,500 may submit proposals for matters to be placed on the agenda for consideration at the shareholders’ meeting. UBS publishes the deadline for submitting such proposals in the Swiss Official Gazette of Commerce and on its website (www.ubs.com/agm). Requests for items to be placed on the agenda must include the actual motions to be put forward, together with a short explanation, if necessary. The BoD for- Registrations in the share register The general rules for being entered with voting rights in the Swiss or US share registers of UBS also apply before general meetings of shareholders. There is no “closing of the share reg- ister” in the days ahead of the meeting. Registrations, including the transfer of voting rights, are processed for as long as techni- cally possible, normally until two days before the meeting. 212 Change of control and defense measures UBS refrains from restrictions that would hinder develop- ments initiated in or supported by the financial markets. It also does not have any specific defenses in place to prevent hostile takeovers. Duty to make an offer An investor who acquires more than 33 1⁄3% of all voting rights (directly, indirectly or in concert with third parties), whether they are exercisable or not, has to submit a take- over offer for all shares outstanding, according to Swiss stock exchange law. UBS has not elected to change or opt out of this rule. Clauses on changes of control The service agreements and employment contracts of the Chairman of the Board of Directors (BoD) and of the mem- bers of the Group Executive Board (GEB) and the Group Managing Board (GMB) do not generally contain clauses triggered by a change of control. For 2008, employment contracts contain employment notice periods of 12 months for GEB members and six to 12 months for GMB members, depending on local market practice. From 2009, employ- ment contracts for GEB members will have a reduced notice period of six months. During this notice period they are en- titled to salary and pro rata discretionary incentive awards. The human resources and compensation committee of the BoD may, however, accelerate the vesting of restricted shares and amend the vesting date or lapse date of options for all employees in case of a change of control. n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 213 Corporate governance and compensation Corporate governance Auditors Audit is an integral part of corporate governance. While retain- ing their independence, the external auditors and Group Inter- nal Audit closely coordinate their work. The risk committee, the audit committee and ultimately the Board of Directors (BoD) supervise the adequacy of audit work. External, independent auditors At the annual general meeting (AGM) in 2008, Ernst & Young Ltd., Basel, (Ernst & Young) were re-elected as auditors for the UBS Group (Group) for a further one-year term of office. Ernst & Young assume all auditing functions according to laws, regulatory requests and the “Articles of Association of UBS AG”. The Ernst & Young lead partners in charge of the UBS audit are Andrew McIntyre and Andreas Blumer (since 2005 and 2004, respectively). Ernst & Young will be proposed for re-election at the AGM in 2009. At the AGM in 2006, BDO Visura, Zurich, was appointed as special auditor for a three-year term of office. The special auditors provide audit opinions in connection with capital increases independently from the Group auditors. BDO Vi- sura will be proposed for re-election at the AGM in 2009. Fees paid to external independent auditors The fees (including expenses) paid by UBS to its auditors are listed in the following table. In addition, Ernst & Young re- ceived CHF 31,561,000 in 2008 (CHF 31,050,000 in 2007) for audit and tax work performed on behalf of UBS invest- ment funds, many of which have independent fund boards or trustees. Audit work includes all services necessary to perform the audit in accordance with applicable laws and generally ac- cepted auditing principles as well as other assurance ser- vices that generally only the principal auditor can provide. This includes statutory and regulatory audits, attest servic- es, and reviews of documents to be filed with regulatory bodies. Audit-related work comprises assurance and related ser- vices that are traditionally performed by the principal audi- tors, such as letters of comfort, internal control reviews, at- testation services related to financial reporting, consultation concerning financial accounting and reporting standards as well as investment performance reports. Tax work performed by Ernst & Young’s tax division encompasses routine preparation of draft original and amended tax returns, general tax planning and advice on tax compliance matters. Other services are approved on an exceptional basis only. In 2007 and 2008, they mainly comprised on-call advisory services. Pre-approval procedures and policies To ensure their independence, all services provided by Ernst & Young have to be pre-approved by the audit committee of the BoD. A pre-approval may be granted either for a specific mandate or in the form of a general pre-approval authoriz- ing a limited and well-defined type and amount of services. The audit committee has delegated pre-approval authority to its chair; hence the Group Chief Financial Officer submits all proposals for services by Ernst & Young to the chair of the Fees paid to external auditors UBS paid the following fees (including expenses) to its external auditors Ernst & Young Ltd.: In CHF thousand Audit Global audit fees Additional services classified as audit (services required by law or statute, including work of a non-recurring nature mandated by regulators) Total audit Non-audit Audit-related fees Tax advisory Other Total non-audit 214 For the year ended 31.12.08 31.12.07 45,848 9,918 55,766 8,430 504 1,246 10,180 49,000 12,718 61,718 9,779 1,892 1,699 13,370 audit committee for approval. At each quarterly meeting, the committee is informed of the approvals granted by its chair. Group Internal Audit With 331 staff members worldwide at 31 December 2008, Group Internal Audit supports the BoD and its committees by independently assessing the effectiveness of UBS’s system of internal controls and the firm’s compliance with statutory, le- gal and regulatory requirements. All key issues raised by Group Internal Audit are communicated to the management responsible, to the Group Chief Executive Officer (Group CEO) and to the Chairman of the BoD via formal audit reports. In addition, the BoD’s risk and audit committees are regularly informed about important issues. Group Internal Audit closely cooperates with internal and external legal advisors and risk control units on investigations into major control issues. To maximize its independence from management, the head of Group Internal Audit, Ian Overton, reports directly to the Chairman of the BoD and to the risk committee. Group Internal Audit has unrestricted access to all accounts, books and records and must be provided with all information and data needed to fulfill its auditing duties. The risk committee may order special audits to be conducted. BoD members, BoD committees or the Group CEO may submit requests for such audits to the risk committee. Coordination and close cooperation with the auditors en- hance the efficiency of Group Internal Audit’s work. n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 215 Corporate governance and compensation Corporate governance Information policy UBS provides regular information to its shareholders and to the financial community. Financial results will be published as follows First quarter Second quarter Third quarter Fourth quarter 5 May 2009 4 August 2009 3 November 2009 9 February 2010 The annual general meeting of shareholders will take place as follows 2009 2010 15 April 2009 14 April 2010 UBS meets with institutional investors worldwide throughout the year. It regularly holds results presentations, special inves- tor seminars, road shows, individual and group meetings. Where possible, meetings involve senior management as well as members of the investor relations team. UBS makes use of diverse technologies such as webcasting, audio links and cross-location video-conferencing to widen its audience and maintain contact with shareholders around the world. Once a year, unless they explicitly choose not to, registered shareholders receive a summary of UBS’s annual report in the form of an annual review. It provides an overview of the firm and its activities during the year as well as key financial infor- mation. Each quarter, shareholders are mailed a brief update on the firm’s quarterly financial performance. Shareholders can also request UBS’s complete financial reports, produced on a quarterly and annual basis, free of charge. To ensure fair access to and dissemination of its financial information, UBS makes its publications available to all shareholders at the same time. ➔ Refer to www.ubs.com/investors for a complete set of published reporting documents, access to recent webcasts and a selection of senior management industry conference presentations Financial disclosure principles Based on discussions with analysts and investors, UBS be- lieves that the market rewards companies that provide clear, consistent and informative disclosure about their business. Therefore, UBS aims to communicate its strategy and results in a manner that allows shareholders and investors to gain a full and accurate understanding of how the company works, what its growth prospects are and what risks the strategy and results might entail. Feedback from analysts and inves- tors is continually assessed and, where relevant, reflected in the firm’s quarterly and annual reports. To continue to achieve these goals, UBS applies the following principles in its financial reporting and disclosure: – Transparency in disclosure enhances understanding of the economic drivers and, as with the provision of detailed business results, builds trust and credibility. – Consistency in disclosure within each reporting period and between reporting periods. – Simplicity in disclosure allows readers to gain the appro- priate level of understanding of the performance of the firm’s businesses. – Relevance in disclosure avoids information overload by focusing on what is relevant to UBS’s stakeholders or re- quired by regulation or statute. – Best practice in line with industry norms, leading the way to improved standards where possible. Financial reporting policies UBS reports its results after the end of every quarter, includ- ing a breakdown of results by business divisions and exten- sive disclosures relating to credit and market risk. UBS’s financial statements are prepared according to In- ternational Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board. Refer to “Note 1 Summary of significant accounting policies” in the financial statements of this report for a detailed explanation of the basis of UBS’s accounting. UBS is committed to maintaining the transparency of its reported results and to ensuring that analysts and investors can make meaningful comparisons with previous periods. If there is a major reorganization of its business divisions, or if changes to accounting standards or interpretations lead to a material change in the Group’s reported results, UBS’s results are restated for previous periods when required by applica- ble accounting standards to show how they would have been reported according to the new basis and provide clear explanations of all relevant changes. Prior to publication of first quarter 2009 results, UBS will publish restated business division results on www.ubs.com/investors showing quarter- ly and annual results for 2007 and 2008 under the new or- ganizational structure announced on 10 February 2009. US regulatory disclosure requirements As a reporting company under the US federal securities laws (a foreign private issuer), UBS must file or submit certain re- ports and other information, including certain financial re- 216 In accordance with Section 404 of the US Sarbanes-Oxley Act of 2002, the management of UBS is responsible for es- tablishing and maintaining adequate internal control over financial reporting. The financial statements of this report contain management’s assessment of the effectiveness of in- ternal control over financial reporting as of the time of the report’s publication. The external auditors’ report on this as- sessment is also included. ports, with the US Securities and Exchange Commission (SEC). UBS files an annual report on Form 20-F with the SEC, and submits to the SEC its quarterly financial reporting un- der cover of Form 6-K. As of the end of the period covered by this annual report, an evaluation was carried out under the supervision of man- agement, including the Group Chief Executive Officer (CEO) and Group Chief Financial Officer (CFO), of the effectiveness of UBS’s disclosure controls and procedures (as defined in Rule 13a–15e) under the US Securities Exchange Act of 1934. Based upon that evaluation, the Group CEO and Group CFO concluded that these disclosure controls and procedures were effective as of the end of the period cov- ered by this annual report. No significant changes were made in UBS’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. ➔ These reports and filings, as well as materials sent to shareholders in connection with annual and extraordinary general meetings, are all available at www.ubs.com/investors n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 217 Corporate governance and compensation Corporate governance Regulation and supervision As a Swiss-registered company, UBS’s home country regula- tor is the Swiss Financial Market Supervisory Authority (FIN- MA). However, UBS’s operations are global and are therefore regulated and supervised by the relevant authorities in each of the jurisdictions in which it conducts business. This section describes the regulation and supervision of UBS’s business in Switzerland, the firm’s home market. The regulatory and su- pervisory environments in the US and the UK, UBS’s next two largest areas of operations, are also discussed. Regulation and supervision in Switzerland FINMA, the successor organization of the Swiss Federal Bank- ing Commission (SFBC), commenced operations on 1 January 2009. On that date, the Federal Act on the Swiss Financial Mar- ket Supervisory Authority, which the Swiss Parliament approved on 22 June 2007, went into full legal force. The effect of the Act is to merge three bodies – the Swiss Federal Banking Com- mission (SFBC), the Federal Office of Private Insurance, and the Anti-Money Laundering Control Authority – into FINMA. In ad- dition to a new organizational framework which will also im- pact supervisory activity, the Act streamlines and harmonizes the sanctions regime applicable to financial institutions. Swiss federal legislation The legislation most relevant to UBS is that enacted by the Swiss Parliament and the Swiss Federal Council. In this respect, UBS is regulated by the Swiss Federal Law relating to Banks and Savings Banks of 8 November 1934, as amended, and the related Implementing Ordinance of 17 May 1972, as amended, which are together known as the Federal Banking Law. Depending on the license obtained un- der this law, banks in Switzerland may engage in a full range of financial services activities, including commercial banking, investment banking and asset management. Banking groups may also engage in insurance activities, but these must be undertaken through a separate subsidiary. The Federal Bank- ing Law establishes a framework for supervision by FINMA. Switzerland implemented the internationally agreed capi- tal adequacy rules of the Basel Capital Accord (Basel II) by means of the Capital Adequacy Ordinance of 29 September 2006 and subsequent FINMA circulars. Switzerland imposes a more differentiated and tighter regime than the interna- tionally agreed rules, including more stringent risk weights. ➔ Refer to the “Capital management” section of this report for more details about capital requirements requirements issued at the end of 2008 increased the risk-based buffer and complemented it with a leverage ratio requirement, i.e. a minimum ratio of capital and balance sheet. The Federal Act of 10 October 1997 on the Prevention of Money Laundering in the Financial Sector (Anti-Money Laun- dering Act, AMLA) lays down a common standard for due diligence obligations for the whole financial sector which must be met in order to prevent money laundering. In its capacity as a securities broker, UBS is governed by the Swiss Federal Law on Stock Exchanges and Securities Trading of 24 March 1995, as amended. FINMA is the com- petent supervisory authority. Regulation by FINMA FINMA is strongly involved in the shaping of the legislative frame- work for banks, especially through the following mechanisms: – First, FINMA has substantial influence on the drafting of Swiss federal legislation (for example, the specific ordi- nance concerning the prevention of money laundering of 18 December 2002, as amended). – On a more technical level, FINMA is empowered to issue circulars, 44 of which are presently effective. These in- clude, for example, FINMA circular 08 / 38 on market be- havior and FINMA circular 08 / 24 on supervision and in- ternal controls at banks. Self-regulation by the SIX Swiss Exchange and the Swiss Bankers Association Certain aspects of securities brokering, such as the organi- zation of trading, are subject to self-regulation through the SIX Swiss Exchange (SIX), under the overall supervision of FINMA. Examples are: – the Listing Regulations of 24 January 1996, as amended, and the General Conditions dated 7 September 2007 (the Listing Regulations are currently under review and amend- ments may go into force on 1 July 2009); and – the Directive on the Disclosure of Management Trans- actions of 1 July 2005. FINMA also officially endorses self-regulatory guidelines issued by the banking industry (through the Swiss Bankers Association), making them an integral part of banking regu- lation. Examples are: – Agreement on the Swiss banks’ code of conduct with re- gard to the exercise of due diligence, 2008. – Directives on the independence of financial research, 2008. – Guidelines on the simplified prospectus for structured products, 2007. Capital requirements for the two large banks, UBS and Cred- it Suisse, exceed the Swiss minimum due to a mandatory capital buffer under Pillar 2 of Basel II. The revised decree on capital – Agreement of Swiss Banks on Deposit Insurance, 2005. – Guidelines on the handling of dormant accounts, custody accounts and safe-deposit boxes held in Swiss banks, 2000. 218 Two-tier system of supervision and direct supervision of UBS and Credit Suisse Generally, supervision in Switzerland is based on a division of tasks between FINMA and a number of authorized audit firms. Under this two-tier supervisory system, FINMA has the responsibility for overall supervision and enforcement mea- sures while the authorized audit firms carry out official du- ties on behalf of and subject to sanctions imposed by FIN- MA. The responsibility of external auditors encompasses the audit of financial statements, the reviewing of banks’ com- pliance with all prudential requirements and on-site audits. Due to their major role in the Swiss financial system, FINMA subjects UBS and Credit Suisse to its direct supervi- sion. The regime of direct supervision is regulated by the FINMA 08 / 9 circular on the supervision of large banking groups. Supervisory tools include an intensive schedule of meetings with bank management and provision of manage- ment information encompassing all control and business areas, direct audits (on-site examinations), on-site visits to the banks’ operations in foreign jurisdictions and coordinat- ed action and exchange with important host supervisors. FINMA assigns to each of the two large banking groups a team responsible for monitoring their risk situation on an ongoing basis. The analyses produced by these supervisory teams are combined and supplemented with those of two cross-institutional specialist groups focusing on specific as- pects of investment banking, wealth management and asset management. Disclosures to the Swiss National Bank While Switzerland’s banks are primarily supervised by FINMA, compliance with liquidity rules is monitored by the Swiss National Bank (SNB). The SNB also takes a direct interest in the stress testing practice of both big banks. Liquidity regula- tion is currently being reformed. Regulation and supervision in the US Banking regulation UBS’s operations in the US are subject to a variety of regula- tory regimes. It maintains branches in California, Connecti- cut, Illinois, New York and Florida. UBS’s branches located in California, New York and Florida are federally licensed by the Office of the Comptroller of the Currency. US branches lo- cated in Connecticut and Illinois are licensed by the state banking authority of the state in which the branch is located. Each US branch is subject to regulation and examination by its licensing authority. UBS also maintains state and federally chartered trust companies and other limited purpose banks, which are regulated by state regulators or the Office of the Comptroller of the Currency. In addition, the Board of Gov- ernors of the Federal Reserve System exercises examination and regulatory authority over UBS’s state-licensed US branch- es. Only the deposits of UBS’s subsidiary bank located in the state of Utah are insured by the Federal Deposit Insurance Corporation. The regulation of the firm’s US branches and subsidiaries imposes restrictions on the activities of those branches and subsidiaries, as well as prudential restrictions, such as limits on extensions of credit to a single borrower, including UBS subsidiaries and affiliates. The licensing authority of each US branch has the author- ity, in certain circumstances, to take possession of the busi- ness and property of UBS located in the state of the office it licenses. Such circumstances generally include violations of law, unsafe business practices and insolvency. As long as UBS maintains one or more federal branches, the Office of the Comptroller of the Currency also has the authority to take possession of the US operations of UBS AG under simi- lar circumstances, and this federal power may pre-empt the state insolvency regimes that would otherwise be applicable to UBS’s state-licensed branches. As a result, if the Office of the Comptroller of the Currency exercised its authority over the US branches of UBS AG pursuant to federal law in the event of a UBS insolvency, all of UBS’s US assets would most likely be applied first to satisfy creditors of its US branches as a group, and then made available for application pursuant to any Swiss insolvency proceeding. In addition to the direct regulation of its US banking of- fices, UBS is subjected to oversight regulation by the Board of Governors of the Federal Reserve System under various laws (including the International Banking Act of 1978 and the Bank Holding Company Act of 1956) because it operates US branches. On 10 April 2000, UBS AG was designated a “financial holding company” under the Bank Holding Com- pany Act of 1956. Financial holding companies may engage in a broader spectrum of activities than bank holding com- panies or foreign banking organizations that are not finan- cial holding companies, including underwriting and dealing in securities. To maintain its financial holding company sta- tus, (1) UBS, its US subsidiary federally chartered trust com- pany and its US subsidiary bank located in Utah are required to meet certain capital ratios, (2) UBS’s US branches, its US subsidiary federally chartered trust company, and its US sub- sidiary bank located in Utah are required to meet certain ex- amination ratings, and (3) UBS’s subsidiary bank in Utah is required to maintain a rating of at least “satisfactory” unter the Community Reinvestment Act of 1997. A major focus of US governmental policy relating to financial institutions in recent years has been aimed at fighting money laundering and terrorist financing. Regulations applicable to UBS and its subsidiaries impose obligations to maintain appropriate poli- cies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing could have serious consequences for the firm, both in legal terms and in terms of its reputation. 219 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Corporate governance US regulation of other US operations In the US, UBS Securities LLC and UBS Financial Services Inc., as well as UBS’s other US-registered broker-dealer entities, are subject to regulations that cover all aspects of the securi- ties business, including: sales methods; trade practices among broker-dealers; use and safekeeping of customers’ funds and securities; capital structure; record-keeping; the financing of customers’ purchases; and the conduct of direc- tors, officers and employees. These entities are regulated by a number of different gov- ernment agencies and self-regulatory organizations, includ- ing the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Depending upon the specific nature of a broker-dealer’s business, it may also be regulated by some or all of the New York Stock Ex- change (NYSE), the Municipal Securities Rulemaking Board, the US Department of the Treasury, the Commodities Futures Trading Commission and other exchanges of which it may be a member. In addition, the US states, provinces and ter- ritories have local securities commissions that regulate and monitor activities in the interest of investor protection. These regulators have a variety of sanctions available, including the authority to conduct administrative proceedings that can re- sult in censure, fines, the issuance of cease-and-desist orders or the suspension or expulsion of the broker-dealer or its di- rectors, officers or employees. Created in July 2007 through the consolidation of the Na- tional Association of Securities Dealers (NASD) and the mem- ber regulation, enforcement and arbitration functions of the NYSE, FINRA is dedicated to investor protection and market integrity through effective and efficient regulation and com- plementary compliance and technology-based services. FINRA covers a broad spectrum of securities businesses, in- cluding: registering and educating industry participants; exam- ining securities firms; writing rules; enforcing those rules and the federal securities laws; informing and educating the invest- ing public; providing trade reporting and other industry utili- ties; and administering a dispute resolution forum for investors and registered firms. It also performs market regulation under contract for the NASDAQ Stock Market, the American Stock Exchange and the Chicago Climate Exchange. Regulation and supervision in the UK UBS’s operations in the UK are regulated by the Financial Services Authority (FSA), which establishes a regime of rules and guidance governing all relevant aspects of financial ser- vices businesses. The FSA has established a risk-based approach to supervi- sion and has a wide variety of supervisory tools available to it, including regular risk assessments, on-site inspections (which may relate to an industry-wide theme or be firm-spe- cific) and the ability to commission reports by skilled persons (who may be the firm’s auditors, IT specialists, lawyers or other consultants as appropriate). The FSA also has an ex- tremely wide set of sanctions which it may impose under the Financial Services and Markets Act 2000, broadly similar to those available to US regulators. Some of UBS’s subsidiaries and affiliates are also regulat- ed by the London Stock Exchange and other UK securities and commodities exchanges of which UBS is a member. The business is also subject to the requirements of the UK Panel on Takeovers and Mergers where relevant. Financial services regulation in the UK is conducted in ac- cordance with European Union directives which require, among other things, compliance with certain capital ade- quacy standards, customer protection requirements and conduct of business rules (such as MiFID). These directives apply throughout the European Union and are reflected in the regulatory regimes of the various member states. The standards, rules and requirements established under these directives are broadly comparable in scope and purpose to the regulatory capital and customer protection requirements imposed under applicable US law. 220 Compliance with New York Stock Exchange listing standards on corporate governance As a Swiss company listed on the New York Stock Exchange (NYSE), UBS complies with the NYSE corporate governance standards for foreign private issuers. In addition, UBS has voluntarily adopted the majority of NYSE governance rules for US companies. Independence of directors Based on the listing standards of the NYSE, UBS’s BoD has es- tablished specific criteria for defining the independence of its external members. Each external director has to personally confirm his or her compliance with the criteria, which are pub- lished on the firm’s website under www.ubs.com/governance. All current external members have been confirmed by the BoD as having no material relationship with UBS, either directly or as a partner, controlling shareholder or executive officer of a company that has a relationship with UBS. These members are: Ernesto Bertarelli, Sally Bott, Rainer-Marc Frey, Bruno Gehrig, Gabrielle Kaufmann-Kohler, Sergio Marchionne, Helmut Panke, William G. Parrett, David Sidwell, Peter R. Voser and Joerg Wolle. Each of them has also met all other BoD and NYSE re- quirements with respect to independence, with the exception of Ernesto Bertarelli. He does not satisfy one of the indepen- dence requirements because UBS holds the basic sponsorship rights to Team Alinghi and Ernesto Bertarelli is the owner of Team Alinghi SA. Otherwise he fully satisfies the NYSE indepen- dence requirements. The BoD considers that UBS’s compensa- tion for these basic sponsorship rights to Team Alinghi does not impair Ernesto Bertarelli’s independence in any way. The NYSE has more stringent independence requirements for members of audit committees. All three members of UBS’s audit committee are external BoD members who, in addition to satisfying the above criteria, do not: receive, di- rectly or indirectly, any consulting, advisory or other compen- satory fees from UBS other than in their capacity as directors; hold, directly or indirectly, UBS shares in excess of 5% of the outstanding capital; or serve on the audit committees of more than two other public companies. These members are Peter R. Voser, William G. Parrett and Bruno Gehrig and all three have been determined by the BoD as financially literate and “financial experts” according to the definitions estab- lished by the US Sarbanes-Oxley Act of 2002. The NYSE guidelines allow for an exemption for audit committee mem- bers to sit on more than three audit committees, provided that all members of the BoD determine that the candidate has the time and the availability to fulfill his or her obliga- tions. Considering the credentials of William G. Parrett, and the fact that he has retired from his executive functions, the BoD granted this exemption. Board of Directors and its committees UBS operates under a strict dual board structure mandated by Swiss banking law. No member of the Group Executive Board (GEB) may also be a member of the BoD and vice versa. This structure ensures the institutional independence of the entire BoD from the day-to-day management. UBS has estab- lished committees for the following BoD mandates: audit; human resources and compensation; governance and nomi- nating; risk; strategy and corporate responsibility. Refer to the “Board of Directors” section of this report for further in- formation on these committees – including their mandates, responsibilities and authorities – as well as their activities dur- ing 2008. In addition, the BoD elects at least one vice chair- man who must be independent and who acts as the senior independent director. Sergio Marchionne has assumed this role. The BoD may elect another vice chairman who need not be independent, but has not done so at this time. More details about the vice chairman function can be found in the “Organization Regulations of UBS AG” and its annexes, which are published on www.ubs.com/governance. The BoD has adopted organization regulations that consti- tute UBS’s corporate governance guidelines, which include all matters required by the NYSE rules. The BoD has also adopted a “Code of Business Conduct and Ethics” with an addendum for principal executive, financial and accounting officers or controllers, as required by the US Sarbanes-Oxley Act. Both the organization regulations and the “Code of Business Conduct and Ethics” are available on the UBS website at www.ubs. com/governance. In addition, the audit committee has estab- lished rules for the handling of complaints related to accounting and auditing matters in addition to the internal policies on “Whistleblowing Protection for Employees” and on “Compli- ance with Attorney Standards of Professional Conduct”. Differences from corporate governance standards relevant to US listed companies According to the NYSE listing standards on corporate gover- nance, foreign private issuers have to disclose any significant ways in which their corporate governance practices differ from those to be followed by domestic companies. Responsibility of the audit committee for appointment, compensation, retention and oversight of the independent auditors UBS’s audit committee has been assigned all the abovemen- tioned responsibilities, except for appointment of the inde- pendent auditors, which is required to be voted upon by shareholders as per Swiss company law. The audit commit- 221 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Compensation, shareholdings and loans tee assesses the performance and qualification of the exter- nal auditors and submits its proposal for appointment, re- appointment or removal to the full BoD, which brings this proposal to the shareholders for vote at annual general meetings (AGM). Discussion of risk assessment and risk management policies by the audit committee In accordance with UBS’s organization regulations, the BoD risk committee has the authority to define the firm’s risk principles and risk capacity. The committee is responsible for monitoring UBS’s adherence to those risk principles and for monitoring whether business and control units run appropri- ate systems for the management and control of risks. Assistance by audit committee of the internal audit function Both the Chairman and risk committee of the BoD have the responsibility for and authority to supervise the internal audit function. Responsibility of the human resources and compensation committee for oversight of management and evaluation by the Board of Directors Performance evaluations of UBS’s senior management, com- prising the Group Chief Executive Officer and the members of the GEB, are completed by the Chairman of the BoD and the human resources and compensation committee and reported to the full BoD. All BoD committees perform a self-assessment of their activities and report back to the full BoD. The BoD has direct responsibility and authority to evaluate its own perfor- mance, without preparation by a BoD committee. Proxy statement reports of the audit and human resources and compensation committees Under Swiss company law, all reports addressed to share- holders are provided and signed by the full BoD, which has ultimate responsibility vis-à-vis shareholders. The commit- tees submit their reports to the full BoD. Shareholders’ votes on equity compensation plans Swiss company law authorizes the BoD to approve compen- sation plans. Though Swiss law does not allocate such au- thority to the AGM, it requires that Swiss companies deter- mine capital in their articles of association and therefore each increase of capital is required to be submitted for share- holders’ approval. This means that, if equity-based compen- sation plans result in a need for a capital increase, AGM ap- proval is mandatory. If, however, shares for such plans are purchased in the market, shareholders do not have the au- thority to vote on their approval. 222 Compensation, shareholdings and loans The principles of compensation for UBS senior executives are designed to align their interests with those of shareholders – the creation of long-term value and sustainable shareholder returns. These principles are established by the human resources and compensation committee of the Board of Directors. Letter from the human resources and compensation committee of the Board of Directors Dear shareholders, The global financial services industry is facing challenges of a magnitude not seen for decades. These challenges had a clear and widespread impact on the industry in 2008 and UBS and its peers were no exception. Executive compen- sation is always a high-profile issue and, during 2008, this was debated by the public, media and regulators to a greater extent than ever before. During 2008, UBS was very proactive in addressing the current issues surround- ing executive compensation. The UBS Board of Directors (BoD) established a new human resources and compensa- tion committee in July 2008. This committee is responsible for the supervision of executive performance, the structure of employment agree- ments for senior executives and succession planning for members of the BoD and the Group Executive Board (GEB). Shortly after its creation, the committee commissioned an extensive review of all incentive systems used throughout the UBS Group (Group). The review was accelerated following UBS’s transaction with the Swiss National Bank in October and the principles of UBS’s new compensation model were published the following month for implementation in 2009. In parallel with this review, UBS held extensive discussions with the Swiss Financial Market Supervisory Authority (FINMA) on a range of compensation matters, including the new compensa- tion model and the amount of variable compensation to be paid to employees for 2008. Although the financial services industry is facing a difficult period, competition for the very best talent remains fierce and competitive pay remains a vital tool in attracting and retaining executives. Variable compensation, in both a cash and equity form, remains a core component of UBS’s new compensation model, though the final amount awarded to executives depends on their achievement of performance targets linked to long- term, risk-adjusted value creation. As part of this change, awards granted under the performance equity plan will be directly linked to company perfor- mance for an initial period of three years. In addition, executives will be required to keep a minimum of 75% of all shares awarded to them (after taxes) for a further five years. To strengthen this clear and direct link between shareholder value and compensation expense, UBS has announced the implementation of a three-year deferral period and a bonus- malus, or “claw-back”, structure for all executive cash awards for 2009 and beyond. The firm explicitly sought to “alter the UBS corporate culture” through its design of the new compensation model. All members of the human resources and compensation committee strongly believe the new compensation model will play a central role in the firm’s future success. Furthermore, due to its explicit goals for long-term value creation, the model inherently considers and promotes the best interests of both shareholders and the Group alike. Given its commitment to shareholder input, the BoD will introduce a non-binding vote on the principles of executive compensation for senior executives at its annual general meeting for 2009. Materials relating to this vote are located in the “Compensation prin- ciples 2009 and beyond for UBS senior executives” section of this report. Please consider the relevant documentation and take part in implementing this pioneering approach to executive compensation practices. Joerg Wolle Chair of the human resources and compensation committee 223 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Compensation, shareholdings and loans Compensation governance Human resources and compensation committee The human resources and compensation committee is com- posed of four independent members of the Board of Direc- tors (BoD). On 31 December 2008, the members were Joerg Wolle (committee chair), Ernesto Bertarelli, Sally Bott and Helmut Panke. The following external advisors supported the committee in 2008: Hostettler & Partner with regard to the design of UBS’s new senior executive compensation pro- gram, PricewaterhouseCoopers for the design of the perfor- mance equity plan and Towers Perrin for market data. Authorities and responsibilities UBS is committed to the highest standards of corporate gov- ernance. The human resources and compensation commit- tee is responsible for reviewing UBS’s principles on total compensation and benefits for submission to the BoD. Ad- ditionally, on behalf of the BoD, the committee oversees five key areas of responsibility: – reviewing and approving the design of the total compen- sation framework, including compensation programs and plans; – determining the relationship between pay and perfor- mance; – approving base salaries and annual incentive awards for senior executives; – reviewing and approving individual employment agree- ments; and – reviewing and approving the terms and conditions for GEB members who relinquish their positions. Authorities for compensation-related decisions are gov- erned by the “Organization Regulations of UBS AG”, “An- nex B – Responsibilities and authorities”, and “Annex C – Charter for the committees of the Board of Directors of UBS AG”. The structure is shown below. Grant policy and decision-making process The committee decides the target amount of variable cash and equity compensation to be awarded to each senior ex- ecutive based on Group, business division and individual per- formance, combined with market data. Individual performance is assessed formally each year by measuring achievement against pre-defined personal objec- tives. Personal objectives will be focused on areas such as the following: contribution to Group and business division re- sults; exceptional contributions to cross-business co-opera- tion; strategic leadership skills and potential; outstanding professional and technical expertise; commitment to UBS; adherence to corporate values and principles; active risk management and the creation of shareholder value. The 2009 non-binding vote on executive compensation UBS places value upon the opinions of its shareholders. At the annual general meeting (AGM) to be held in April 2009, the firm will provide shareholders with an opportunity to ex- press their views through a vote on the compensation prin- ciples for senior executives for 2009 and beyond. Refer to the “Compensation principles 2009 and beyond for UBS se- nior executives” section of this report for the relevant mate- rials. As the ultimate decision on executive compensation is legally within the powers of the BoD, such a vote is non- binding and advisory in nature. UBS believes that this vote presents an innovative and sensible means of including shareholder participation in compensation matters. Compensation authorities Recipients Compensation recommendations developed by Approved by Communicated by Chairman of the BoD Chairman of the HRCC 1 Group CEO Chairman of the BoD Members of the GEB Group CEO Independent BoD members (remuneration system and fees) Chairman of the BoD / HRCC 1 The human resources and compensation committee. HRCC HRCC HRCC BoD HRCC HRCC Group CEO Chairman of the BoD 224 2008 compensation for the Board of Directors and Group Executive Board Board of Directors remuneration Chairman of the Board of Directors and executive members of the Board of Directors The new compensation model was not yet applicable in 2008 and the Chairman of the Board of Directors (BoD) was therefore eligible, in principle, to receive a variable incentive award fully dependent on the Group’s financial performance. However, as announced in the compensation report published on 17 No- vember 2008, the human resources and compensation commit- tee decided against granting any variable compensation award to the Chairman of the BoD for 2008. The total compensation awarded to the Chairman of the BoD, Peter Kurer, for the 2008 financial year was CHF 1,565,647. This amount made him the highest-paid member of the BoD for 2008 and consisted of eight months salary as Chairman of the BoD. This amount does not include the four months of salary he received as a member of the Group Executive Board (GEB). Under both the new and old compensation models, the decision process to determine the overall compensation of the Chairman of the BoD includes an annual performance assessment by the full BoD and the human resources and compensation committee. Pay levels for comparable func- tions outside of UBS are also taken into account. Remuneration for former executive members and the former Chairman of the Board of Directors Marcel Ospel, former Chairman of the BoD, did not stand for re-election at the AGM of 23 April 2008. Stephan Haeringer, former executive vice chairman of the BoD, retired from the BoD on 2 October 2008. Marco Suter, formerly an executive member of the BoD, stepped down from the BoD on 1 October 2007 and thereafter acted as Group Chief Financial Officer (Group CFO) and as a member of the GEB until his stepping down from this role on 31 August 2008. While Marcel Ospel has retired from UBS as of April 2008, Stephan Haeringer and Marco Suter agreed with UBS to continue their services for UBS until their termination dates of 30 September 2009 and 31 August 2009 respectively. All three persons were contractually entitled to receive a base salary, a payment based on their average remuneration over the last three years and certain employment benefits until the expiry of their 12-month notice period. For the fiscal years 2007 and 2008, Marcel Ospel, Stephan Haeringer and Marco Suter did not receive any incentive awards. Furthermore, on 25 November 2008, Marcel Ospel, Stephan Haeringer and Marco Suter announced that they vol- untarily relinquished substantial parts of the payments to which they were entitled during their periods of employment with UBS. The total amount waived or repaid was CHF 33 million. The remaining contractual obligations to all three former BoD members, consisting of those due in 2008 and those upcoming in 2009, net of the CHF 33 million voluntarily waived or repaid, amounted to CHF 10 million. This amount has been fully accrued in 2008 and is reflected in the firm’s 2008 income statement. Of this amount, CHF 2.3 million was for Marcel Ospel, CHF 3.9 million for Stephan Haeringer and CHF 3.8 million for Marco Suter. Independent members of the Board of Directors Reflecting their independent status, the remuneration of in- dependent members of the BoD includes no variable compo- nent and is therefore not dependent on the financial perfor- mance of the UBS Group (Group). Fees for independent d e t i d u A Compensation details and additional information for executive members of the BoD CHF, except where indicated a Name, function 1 Peter Kurer, Chairman Marcel Ospel, Chairman Stephan Haeringer, Executive Vice Chairman Marco Suter, Executive Vice Chairman For the year ended 2008 2007 2008 2007 2008 2007 2008 2007 Base salary 1,333,333 666,667 2,000,000 1,125,000 1,500,000 1,125,000 Annual incentive award (cash) 0 0 0 0 0 0 Annual incentive award (shares – fair value) b 0 Discretionary award (options – fair value) c 0 Benefits in kind d 58,267 Contributions to retirement benefits plans e 174,047 Total 1,565,647 0 0 0 0 0 0 0 0 0 0 80,755 307,310 108,846 111,808 87,023 834,445 261,069 2,568,379 195,802 1,429,648 261,069 1,872,877 70,820 155,252 1,351,072 1 2008: Peter Kurer was the only executive member in office on 31 December; Marcel Ospel did not stand for re-election in April 2008 and Stephan Haeringer stepped down during the year as a member of the BoD. Both their payments are pro-rata for the four respective nine-month periods served in their functions. 2007: Marco Suter stepped down during the year as a member of the BoD. His 2007 payment was pro-rata for the nine-month period served as Executive Vice Chairman. 225 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Compensation, shareholdings and loans d e t i d u A Remuneration details and additional information for independent members of the BoD CHF, except where indicated a & e c n a n r e v o G e e t t i m m o c g n i t a n m o n i e e t t i m m o c e t a r o p r o C y t i l i b i s n o p s e r e e t t i m m o c e e t t i m m o c y g e t a r t S k s i R e t t i e For the period AGM to AGM m m o c Base fee Committee retainer(s) Benefits in kind Additional payments e e t t i m m o c t i d u A & R H M M M M C M M C n o i t a s n e p m o c M M M M C M M C Name, function 1 Ernesto Bertarelli, member Sally Bott, member 2 Rainer-Marc Frey, member 2 Bruno Gehrig, member 2 Gabrielle Kaufmann- Kohler, member Sergio Marchionne, senior independent director, vice chairman Rolf A. Meyer, member 2 Helmut Panke, member William G. Parrett, member 2 David Sidwell, member Peter Spuhler, member 2 Peter R. Voser, member Lawrence A. Weinbach, member 2 Joerg Wolle, member Total 2008 Total 2007 M M C M M C M M M M M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 200,000 150,000 75,000 2007/2008 M M 2008/2009 162,500 150,000 2007/2008 2008/2009 162,500 100,000 2007/2008 2008/2009 325,000 2007/2008 325,000 M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 2007/2008 325,000 M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 2007/2008 250,000 250,000 200,000 200,000 150,000 650,000 300,000 250,000 100,000 M C 2008/2009 325,000 450,000 2007/2008 2008/2009 162,500 2007/2008 325,000 M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 2007/2008 325,000 2008/2009 325,000 2007/2008 325,000 0 200,000 400,000 300,000 100,000 600,000 300,000 150,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Share percent- age 3 100 Number of shares 4,5 51,596 100 50 14,677 12,280 Total 525,000 475,000 237,500 312,500 50 16,158 262,500 50 13,572 575,000 0 575,000 250,000 6 775,000 525,000 312,500 975,000 625,000 575,000 262,500 50 50 100 100 50 50 50 50 50 29,731 9,349 76,228 16,226 16,158 15,853 32,316 9,349 13,572 775,000 50 40,072 100 100 50 50 50 50 50 100 15,945 16,226 37,487 10,162 13,572 15,040 32,316 14,677 162,500 525,000 725,000 625,000 262,500 925,000 625,000 475,000 6,437,500 5,675,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Legend: C = Chairman of the respective committee; M = Member of the respective committee 1 There were 11 independent BoD members in office on 31 December 2008. David Sidwell was appointed at the AGM on 23 April 2008 and Rolf A. Meyer, Peter Spuhler and Lawrence A. Weinbach stepped down from the BoD at the EGM on 2 October 2008. Sally Bott, Rainer-Marc Frey, Bruno Gehrig and Bill G. Parrett were appointed at the EGM on 2 October 2008. 2 Remunerations is for six months only, as such members either stepped down or were appointed on 2 October 2008. 3 Fees are paid 50% in cash and 50% in restricted UBS shares. However, independent BoD members can elect to have 100% of their remuneration paid in restricted UBS shares. 4 For 2008, shares valued at CHF 11.38 (average price of UBS shares at SWX Europe over the last 10 trading days of February 2009), attributed with a price discount of 15%, discount price CHF 9.67. The shares are blocked for four years. For 2007, shares valued at CHF 36.15 (average price of UBS shares at SWX Europe over the last 10 trading days of February 2008), attributed with a price discount of 15%, discount price CHF 30.75. The shares are blocked for four years. 5 Number of shares is reduced in case of the 100% election to deduct social security contribu- tion. All remuneration payments are submitted to social security contribution/taxes at source. 6 This payment is associated with the newly created function of a senior independent director. In addition, one-off cash payments were made to the chair of the risk committee (CHF 500,000), the governance and nominating committee (CHF 300,000) and the human resources and compensation committee (CHF 200,000). These payments reflect the substantial workload of setting up the new risk committee, and expanding the mandate of the governance and nominating committee and the human resources and compensation committee. Total payments to all members of the BoD d e t i d u A CHF, except where indicated a Aggregate of all members of the BoD Aggregate of all members of the BoD 226 For the year ended 2008 2007 Total 10,267,240 11,467,328 members are reviewed annually by the Chairman of the BoD and the human resources and compensation committee for approval by the BoD. None of the independent members of the BoD has any contract with UBS providing for benefits upon the termination of their term of office at the BoD. The BoD substantially reduced the fees payable to members of its committees for 2008. This decision was made following consideration of market practice in comparable global finan- cial services and other relevant companies in Switzerland. The table on the prior page shows remuneration for indepen- dent members of the BoD between the 2008 and 2009 AGMs. Group Executive Board compensation In 2008, total compensation for members of the GEB was reduced significantly from the prior year. The reduction oc- curred because, due to the overall negative Group result, no variable compensation was granted to GEB members for the performance year 2008. The total compensation for the highest-paid member of the GEB, Marcel Rohner, amounted to CHF 1,814,702 for the financial year 2008. Base salary Base salaries are established to be appropriate for the role of each senior executive on an individual basis. Base salaries con- sist of a fixed amount of compensation and any adjustments are limited to significant changes in job responsibility. Due to the variability of annual incentive awards, the ratio of base salary to total compensation can vary significantly from year to year. Since no variable incentive awards were paid for the financial year 2008, base salaries for senior executives and employers contribution to retirement benefit plans amounted to 93.7% of total compensation compared with 20.6% in 2007. The remainder of 6.3% reflects benefits in kind. Benefits In order to help attract and retain the best employees in each local market where it operates, UBS provides employee ben- efits that are competitive within each of these markets. Changes, terminations and the introduction of new benefits are governed by the procedures contained in the “Organiza- tion Regulations of UBS AG”. UBS considers benefits to be a supplemental element of total compensation and the bene- fits offered may vary substantially from location to location. Generally there are no special benefits for senior execu- tives; they receive the same benefits as all other employees in the location and business where they work. In Switzerland, senior UBS executives share the same re- tirement plan benefits as all other employees. The firm’s gen- eral pension plan is made up of two defined contribution elements: one plan covering base salary and the other cover- ing variable compensation. Outside Switzerland, senior UBS executives participate in appropriately-designed local pension plans (in which other employees also participate) which do not provide special pro- visions for senior executives. In the US, senior executives can choose to participate in a 401K-defined contribution plan which is open to all employees. In addition, some executives participate in legacy defined benefit plans which were avail- able to other employees but are no longer available to new hires. In the UK, senior executives either participate in a pen- sion plan operated on a defined contribution basis or partici- pate in a legacy defined benefit plan which was open to all employees but is closed to participation for new hires. No special pension schemes are offered to senior executives. ➔ Refer to “Note 30 Pension and other post-retirement benefit plans” in the financial statements of this report for details on the various retirement benefit plans established in Switzerland and other major markets d e t i d u A Total compensation for all members of the GEB CHF, except where indicated a Name, function For the year ended Base salary Annual incentive award (cash) Annual incentive award (shares; fair value) b Discretionary award (options; fair value) c Marcel Rohner, Group Chief Executive Officer (highest-paid) 2008 Rory Tapner, Chairman & CEO Asia Pacific (highest-paid) Aggregate of all members of the GEB who were in office on 31 December 2008 1 Aggregate of all members of the GEB who were in office on 31 December 2007 1 Aggregate of all members of the GEB who stepped down during 2008 2 Aggregate of all members of the GEB who stepped down during 2007 2 2007 2008 2007 2008 2007 1,500,000 0 0 1,291,960 4,501,900 4,501,904 7,815,943 0 0 6,995,885 15,305,667 15,305,708 1,614,871 0 0 2,511,947 23,042,376 6,750,036 0 0 0 0 0 0 Contributions to retirement benefits plans e Benefits in kind d Total 161,768 152,934 1,814,702 10,256 900 10,306,920 457,652 817,315 9,090,911 532,706 912,974 39,052,939 234,838 258,423 2,108,132 406,567 275,635 32,986,561 1 Number and distribution to senior executives: 2008: 12 GEB members in office on 31 December. 2007: eight GEB members in office on 31 December. 2 Number and distribution of senior executives: 2008: includes four months in office as a GEB member for Peter Kurer, eight months in office for Marco Suter and 10 months for Joe Scoby. 2007: includes nine months in office for Huw Jenkins and Clive Standish and six months for Peter Wuffli. 227 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Corporate governance and compensation Compensation, shareholdings and loans Cash and equity incentives “Pay for performance” is the guiding principle of the UBS executive compensation policy. As discussed above, the hu- man resources and compensation committee decided not to grant any variable cash or equity compensation to GEB members for 2008. This decision recognizes the overall poor performance of the Group and the failure to achieve key performance targets despite some highly successful busi- nesses within each of the business divisions. price of CHF 28.10, as well as a cash amount of CHF 370,000. In line with market practice, these awards were granted as a replacement for compensation and benefits forfeited from their previous employment as a result of joining UBS. Employment contracts There were no material changes to employment agreements for existing GEB members during 2008 and the 12-month no- tice period remained unchanged for the financial year 2008. Replacement of forfeited awards for former employer compensation Jerker Johansson and Markus Diethelm joined UBS during 2008. In total, they were granted 574,432 shares with a grant date fair market value of CHF 10.7 million, 700,000 options with a strike price of CHF 36.46 and 7,420 options with a strike Compensation to former members of the Board of Directors and Group Executive Board Compensation and benefits in kind paid to former members of the BoD and the GEB reflect legacy agreements still hon- ored by UBS. d e t i d u A Compensation paid to former members of the BoD and GEB1 CHF, except where indicated a Name, function Georges Blum, former member of the BoD (Swiss Bank Corporation) Franz Galliker, former member of the BoD (Swiss Bank Corporation) Walter G. Frehner, former member of the BoD (Swiss Bank Corporation) Hans (Liliane) Strasser, former member of the BoD (Swiss Bank Corporation) Robert Studer, former member of the BoD (Union Bank of Switzerland) Alberto Togni, former member of the BoD (UBS) Philippe de Weck, former member of the BoD (Union Bank of Switzerland) Aggregate of all former members of the GEB 2 Aggregate of all former members of the BoD and GEB For the year ended Compensation 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 Benefits in kind Total 101,579 101,579 90,803 69,596 62,174 74,663 73,061 32,673 42,311 126,208 260,162 427,949 502,478 109,703 129,701 171,180 257,791 90,803 69,596 62,174 74,663 73,061 32,673 42,311 126,208 260,162 746,410 820,879 109,703 129,701 171,180 257,791 318,461 318,401 0 0 318,461 318,401 1,113,551 1,418,481 1,432,012 1,736,882 1 Compensation or remuneration that is connected with the former members’ activity on the BoD or GEB, or that is not at market conditions. 2 Includes two former GEB members. 228 d e t i d u A Explanations of compensation details for executive members of the BoD and members of the GEB: a. Local currencies are converted into CHF using the exchange rates as detailed in “Note 39 Currency translation rates” in the financial statements of this report. b. Values per share at grant: CHF 36.15 / USD 33.55 for shares granted in 2008 related to the performance year 2007. CHF prices are the average price of UBS shares at SWX Europe over the last 10 trading days of February, and USD prices are the average price of UBS shares at the NYSE over the last 10 trading days of February in the year in which they are granted. c. No options were granted in 2009 for the performance year 2008. d. Benefits in kind – car leasing, company car allowance, staff discount on banking products and services, health and welfare benefits and gen- eral expense allowances – are all valued at market price. e. Swiss senior executives participate in the same pension plan as all other employees. Under this plan, employees receive a company contribution to the plan which covers compensation up to CHF 820,800. The retirement benefits consist of a pension, a bridging pension and a one-off payout of accumulated capital. Employees must also contribute to the plan. This figure excludes the mandatory employer’s social security contributions (AHV, ALV) but includes the portion attributed to the employer’s portion of the legal BVG requirement. The employee contribu- tion is included in the base salary and annual incentive award components. In both the US and the UK, senior executives participate in the same plans as all other employees. In the US there are two different plans, one of which operates on a cash balance basis, which entitles the participant to receive a company contribution based on compensation limited to USD 250,000. This plan is no longer available to new hires. US senior executives may also participate in the UBS 401K-defined contribution plan (open to all employees), which provides a company matching contribution for employee contributions. In the UK, senior executives par- ticipate in either the principal pension plan, which is limited to an earnings cap of GBP 100,000, or a grandfathered defined benefit plan which provides a pension on retirement based on career average base salary (uncapped). n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 229 Corporate governance and compensation Compensation, shareholdings and loans Shares, options and loans for the Board of Directors and Group Executive Board (at end of 2008) d e t i d u A Share and option ownership of members of the BoD at 31 December 2007/2008 Name, function 1 Peter Kurer, Chairman For the year ended 2008 Number of shares held 416,088 Voting rights in % 0.025 Number of options held 372,995 Potentially conferred voting rights in % 2 0.022 2007 292,762 0.026 350,000 0.031 Type and quantity of options 3 85 256 95 913 95 913 95 913 xxx: xxxv: xli: xlv: xxx: xxxv: xli: xlv: 80 000 90 000 90 000 90 000 Sergio Marchionne, senior independent director, vice chairman Ernesto Bertarelli, member Sally Bott, member Rainer-Marc Frey, member Bruno Gehrig, member Gabrielle Kaufmann-Kohler, member Helmut Panke, member William G. Parrett, member David Sidwell, member Peter R. Voser, member Joerg Wolle, member 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 87,926 45,800 89,434 48,411 1 0 3,000 18,713 3,303 31,971 13,206 4,000 1 30,823 11,580 41,509 7,709 0.005 0.004 0.005 0.004 0.000 0.000 0.000 0.001 0.000 0.002 0.001 0.000 0.000 0.002 0.001 0.002 0.001 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 1 This table includes vested, unvested, blocked and unblocked shares and options held by members of the BoD including related parties. 2 No conversion rights are outstanding. 3 Refer to “Note 31 Equity participation and other compensation plans” in the financial statements of this report for more information. Group Executive Board Senior executive share ownership policy Share ownership policies are in place to ensure that the in- terests of management are aligned with those of sharehold- ers. Up to and including 2008, senior executives were re- quired to accumulate and hold UBS shares with an aggregate value of five times the amount of the last three years’ aver- age cash component of their total compensation (base salary plus cash incentive award). Due to changes in the compen- sation model, the share ownership policy will be changed from 2009 onwards (refer to the “Compensation principles 2009 and beyond for UBS senior executives” section of this report for more information). Senior executives are not per- mitted to enter into any transaction which hedges, mitigates or otherwise transfers the risk of price movements of un- vested UBS shares, notional shares or stock options granted under UBS compensation plans. 230 d e t i d u A Share and option ownership of members of the GEB at 31 December 2007/2008 Name, function 1 Marcel Rohner, Group Chief Executive Officer For the year ended 2008 Number of shares held 711,366 Voting rights in % 0.042 Number of options held 1,055,043 Potentially conferred voting rights in % 2 0.063 2007 501,846 0.044 990,000 0.088 John Cryan, Group Chief Financial Officer 2008 235,929 0.014 382,673 0.023 Markus U. Diethelm, Group General Counsel John A. Fraser, Chairman and CEO Global Asset Management 2007 2008 2007 2008 112,245 0.007 0 583,812 0.035 1,144,808 0.000 0.068 2007 461,764 0.041 1,074,232 0.095 Marten Hoekstra, Deputy CEO Global Wealth Management & Business Banking and Head Wealth Management US 2008 245,397 0.015 684,168 0.041 Type and quantity of options 3 31,971 213,140 277,082 319,710 213,140 xxv: xxx: xxxv: xli: xlv: xxv: xxx: xxxv: xli: xlv: v: vi: vii: xii: xiii: xiv: xvii: xviii: xix: xxi: xxii: xxiii: xxvii: xxviii: xxix: xxxii: xxxiii: xxxiv: xxxviii: xxxix: xl: xlii: xliii: xliv: xlvi : i: viii: xv: xx: xxxi: xxxvi: xli: xlv: i: viii: xv: xx: xxxi: xxxvi: xli: xlv: ii: iii: iv: ix: x: xi: xxvi: xxxi: xxxvi: xli: xlv: xlvii: 30,000 200,000 260,000 300,000 200,000 21,362 20,731 20,725 5,454 5,294 5,292 23,626 23,620 23,612 5,526 5,524 5,524 17,072 17,068 17,063 14,210 14,210 14,207 5,330 5,328 5,326 17,762 17,762 17,760 53,285 0 56,013 76,380 127,884 127,884 170,512 202,483 213,140 170,512 52,560 71,672 120,000 120,000 160,000 190,000 200,000 160,000 8,679 8,421 8,421 8,823 12,825 8,561 42,628 53,285 53,285 85,256 154,931 239,053 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Jerker Johansson, Chairman and CEO Investment Bank 2007 2008 2007 521,544 0.031 753,410 0.045 xlviii: xlix: 745,990 7,420 1 This table includes vested and unvested shares and options held by members of the GEB including related parties. 2 No conversion rights are outstanding. 3 Refer to “Note 31 Equity participation and other compensation plans” in the financial statements of this report for more information. 231 Corporate governance and compensation Compensation, shareholdings and loans d e t i d u A Share and option ownership of members of the GEB on 31 December 2007/2008 (continued) Name, function 1 Philip J. Lofts, Group Chief Risk Officer For the year ended 2008 Number of shares held 186,434 Voting rights in % 0.011 Number of options held 577,723 Potentially conferred voting rights in % 2 0.034 Walter Stuerzinger, Chief Operating Officer, Corporate Center 2007 2008 296,886 0.018 372,995 0.022 2007 209,442 0.019 350,000 0.031 Rory Tapner, Chairman and CEO Asia Pacific 2008 827,809 0.049 1,379,533 0.082 Raoul Weil, Chairman and CEO Global Wealth Management & Business Banking, relinquished his duties on an interim basis Alexander Wilmot-Sitwell, Chairman and CEO, UBS Group EMEA and Joint Global Head IB Department Robert Wolf, Chairman and CEO, UBS Group Americas / President Investment Bank 2007 514,365 0.046 1,294,486 0.115 2008 315,698 0.019 432,409 0.026 2007 212,934 0.019 405,752 0.036 2008 304,655 0.018 353,807 0.021 827,307 0.049 948,473 0.056 2007 2008 2007 Type and quantity of options 3 v: vi: vii: xii: xiii: xiv: xvii: xviii: xix: xxi: xxii: xxiii: xxvii: xxviii: xxix: xxxv: xli: xlv: xlvii: xvi: xxx: xxxv: xli: xlv: xvi: xxx: xxxv: xli: xlv: vii: xv: xxiv: xxx: xxxv: xli: xlv: vii: xv: xxiv: xxx: xxxv: xli: xlv: xv: xxxv: xli: xlv: xv: xxxv: xli: xlv: xxxiv: xxxvii: xxxviii: xxxix: xl: xlv: xlvii: xx: xxxi: xxxvi: xli: xlv: xlvii: 11,445 11,104 11,098 1,240 5,464 1,199 9,985 9,980 9,974 1,833 1,830 1,830 35,524 35,524 35,521 117,090 117,227 85,256 74,599 31,971 63,942 85,256 95,913 95,913 30,000 60,000 80,000 90,000 90,000 281,862 213,140 213,140 170,512 159,855 170,512 170,512 264,486 200,000 200,000 160,000 150,000 160,000 160,000 53,285 102,281 127,884 148,959 50,000 95,976 120,000 139,776 53,282 2,130 35,524 35,524 35,521 106,570 85,256 287,739 213,140 127,884 106,570 106,570 106,570 1 This table includes vested and unvested shares and options held by members of the GEB including related parties. 2 No conversion rights are outstanding. 3 Refer to “Note 31 Equity participation and other compensation plans” in the financial statements of this report for more information. 232 d e t i d u A d e t i d u A Total of all blocked and unblocked shares held by non-executive members of the BoD 1 Total Of which non-restricted Of which blocked until Shares held on 31 December 2008 307,378 177,027 Shares held on 31 December 2007 296,533 134,808 1 Includes related parties. No individual board member holds 1% or more of all shares issued. 2009 12,126 2008 30,602 2010 13,592 2009 43,096 2011 30,193 2010 35,874 2012 74,440 2011 52,153 Total of all vested and unvested shares held by the executive members of the BoD and members of the GEB1 Shares held on 31 December 2008 5,585,170 2,977,807 1,058,881 595,638 461,376 319,776 171,692 Total Of which vested Of which vesting 2009 2010 2011 2012 2013 Shares held on 31 December 2007 6,396,479 3,831,550 796,533 653,726 526,425 362,709 225,536 2008 2009 2010 2011 2012 1 Includes related parties. No individual BoD or GEB member holds 1% or more of all shares issued. n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 233 Corporate governance and compensation Compensation, shareholdings and loans Vested and unvested options held by independent members of the BoD and by members of the GEB on 31 December 2007 / 2008 d e t i d u A Type Number of options Year of grant Vesting date Expiry date Subscription ratio 56,013 8,679 8,421 8,421 32,807 31,835 313,685 76,380 8,823 12,825 8,561 6,694 10,758 6,491 394,309 31,971 33,611 33,600 33,586 415,623 7,359 7,354 7,354 213,140 31,971 42,628 52,596 52,592 52,584 532,850 436,937 14,210 14,210 67,489 837,477 383,652 2,130 40,854 40,852 40,847 1,332,125 17,762 17,762 17,760 1,348,276 53,285 505,478 745,990 7,420 2001 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2003 2003 2003 2003 2003 2003 2003 2003 2003 2003 2004 2004 2004 2004 2004 2005 2005 2005 2005 2005 2005 2006 2006 2006 2006 2007 2007 2007 2007 2008 2008 2008 2008 20.02.2004 31.01.2002 31.01.2004 31.01.2005 31.01.2003 31.01.2004 31.01.2005 31.01.2005 28.02.2002 29.02.2004 28.02.2005 28.02.2003 28.02.2004 28.02.2005 28.06.2005 28.06.2005 01.03.2004 01.03.2005 01.03.2006 31.01.2006 01.03.2004 01.03.2005 01.03.2006 31.01.2006 31.01.2006 31.01.2006 01.03.2005 01.03.2006 01.03.2007 28.02.2007 01.03.2007 01.03.2006 01.03.2007 01.03.2008 01.03.2008 01.03.2008 04.03.2007 01.03.2007 01.03.2008 01.03.2009 01.03.2009 01.03.2008 01.03.2009 01.03.2010 01.03.2010 01.03.2011 01.03.2011 01.03.2011 01.03.2011 20.02.2009 31.07.2012 31.07.2012 31.07.2012 31.01.2012 31.01.2012 31.01.2012 31.01.2012 28.08.2012 28.08.2012 28.08.2012 28.02.2012 28.02.2012 28.02.2012 28.06.2012 28.12.2012 31.01.2013 31.01.2013 31.01.2013 31.01.2013 28.02.2013 28.02.2013 28.02.2013 31.01.2013 31.07.2013 31.07.2013 27.02.2014 27.02.2014 27.02.2014 27.02.2014 27.02.2014 28.02.2015 28.02.2015 28.02.2015 28.02.2015 28.02.2015 04.03.2015 28.02.2016 28.02.2016 28.02.2016 28.02.2016 28.02.2017 28.02.2017 28.02.2017 28.02.2017 28.02.2018 28.03.2018 07.04.2018 06.06.2018 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 i ii iii iv v vi vii viii ix x xi xii xiii xiv xv xvi xvii xviii xix xx xxi xxii xxiii xxiv xxv xxvi xxvii xxviii xxix xxx xxxi xxxii xxxiii xxxiv xxxv xxxvi xxxvii xxxviii xxxix xl xli xlii xliii xliv xlv xlvi xlvii xlviii xlix 234 Strike price CHF 46.92 USD 21.24 USD 21.24 USD 21.24 CHF 36.49 CHF 36.49 CHF 36.49 USD 21.24 USD 21.70 USD 21.70 USD 21.70 CHF 36.65 CHF 36.65 CHF 36.65 CHF 37.90 CHF 37.90 CHF 27.81 CHF 27.81 CHF 27.81 USD 22.53 CHF 26.39 CHF 26.39 CHF 26.39 CHF 30.50 CHF 30.50 USD 22.53 CHF 44.32 CHF 44.32 CHF 44.32 CHF 48.69 USD 38.13 CHF 47.58 CHF 47.58 CHF 47.58 CHF 52.32 USD 44.81 CHF 47.89 CHF 65.97 CHF 65.97 CHF 65.97 CHF 72.57 CHF 67.00 CHF 67.00 CHF 67.00 CHF 73.67 CHF 32.45 CHF 35.66 CHF 36.46 CHF 28.10 Transactions in 2008 In accordance with applicable rules and regulations, man- agement transactions in UBS shares by members of the Board of Directors (BoD) and the Group Executive Board (GEB) are publicly disclosed. On 16 May 2008, persons close- ly associated with them also have such reporting obligations. Transactions which require reporting are those involving all types of financial instruments whose price is primarily influ- enced by UBS shares. As a consequence of the issuance of new UBS shares in connection with the stock dividend ap- proved by the extraordinary general meeting on 27 February 2008, the grandfathering of Swiss rules ended on 16 May 2008, and the EU requirements (paragraph 15a of the Ger- man Securities Trading Act) regarding the reporting of man- agement transactions are now applicable. From 1 January to 15 May 2008, four purchases were disclosed with a total value of CHF 5,525,205, as well as two sales with a total value of CHF 847,332. Individuals’ names and transactions made by closely associated persons were not required to be disclosed. From 16 May until 31 December 2008, seven share pur- chases were disclosed with a total value of CHF 5,022,563 and USD 27,228, as well as three share sales with a total value of CHF 18,302,528 and USD 757,457 – of which CHF 17,736,100 were due to a single sale. Such disclosures contained the indi- viduals’ names. There were no share purchases or sales made by closely associated persons. Due to the capital increase with a rights issue in June 2008, there were 29 exercises of subscription rights with a total value of CHF 27,447,987, seven purchases of subscription rights with a total amount of CHF 54,430 and 24 sales of subscrip- tion rights with a total value of CHF 3,076,438 and USD 52. These disclosures contained the individuals’ names. Two close- ly associated parties exercised subscription rights, one sold subscription rights. Until 2008, UBS executives generally received a majority of their compensation in UBS shares or options. For this rea- son, management transactions, in general, see sales out- weighing purchases. Blackout periods and synchronized dates for unblocking or vesting of shares or options granted as compensation may lead to transactions being concentrat- ed in short time periods. n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 235 Corporate governance and compensation Compensation, shareholdings and loans Loans As a global financial services provider and major Swiss do- mestic bank, UBS typically has business relationships with many large companies. Members of UBS’s BoD often as- sume management or independent board responsibilities in many of these companies. Moreover, the granting of loans to both individuals and companies is part of UBS’s ordinary business. The members of UBS’s BoD and GEB are granted loans, fixed advances and mortgages at arm’s length market terms. In 2008, loans granted to companies related to seven inde- pendent members of the BoD amounted to CHF 667.3 million, including guarantees, contingent liabilities and unused com- mitted credit facilities. Refer to “Note 32 Related parties” in the financial statements of this report for more information. Loans granted to former members of the Board of Directors and to the Group Executive Board In 2008, all loans granted to former members of the BoD and GEB, or to their related parties, were on at arm’s length market terms. Loans granted to members of the BoD at 31 December 2007/2008 CHF, except where indicated a Name, function 1 Peter Kurer, Chairman 2 Sergio Marchionne, Senior Independent Director, Vice Chairman Ernesto Bertarelli, member Sally Bott, member Rainer-Marc Frey, member Bruno Gehrig, member 2 Gabrielle Kaufmann-Kohler, member Helmut Panke, member William G. Parrett, member 2 David Sidwell, member Peter R. Voser, member Joerg Wolle, member For the year ended 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 Secured loans 1,261,000 0 0 0 0 0 0 798,000 0 0 0 0 1,167,659 0 0 0 0 0 Aggregate of all members of the BoD 3,226,659 Other loans granted 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 No loans have been granted to related parties of the members of the BoD at conditions not customary in the market. 2 Secured loans granted prior to their election to the BoD. Loans granted to members of the GEB at 31 December 2007/2008 CHF, except where indicated a Name, function 1 Markus U. Diethelm, Group General Counsel Joe Scoby, Group Chief Risk Officer 3 Aggregate of all members of the GEB 4 Aggregate of all members of the GEB For the year ended 2008 2007 2008 2007 Secured loans 3,900,000 0 7,740,562 3,487,000 Other loans granted 2 0 3,145,796 0 3,145,796 Total 1,261,000 0 0 0 0 0 0 798,000 0 0 0 0 1,167,659 0 0 0 0 0 3,226,659 Total 3,900,000 3,145,796 7,740,562 6,632,796 1 No loans have been granted to related parties of the members of the GEB at conditions not customary in the market. 2 Guarantees. 3 Joe Scoby stepped down as Group Chief Risk Officer on 4 November 2008. 4 Including those members of the GEB who stepped down during 2008. 236 d e t i d u A d e t i d u A Advisory vote Compensation principles 2009 and beyond for UBS senior executives During 2008, the UBS Board of Directors (BoD) reviewed the incentive systems of the UBS Group (Group) and examined their level of alignment with the firm’s values and long-term orientation. Towards the end of the year, UBS announced that a new compensation model would apply from 2009 onwards. At the annual general meeting (AGM) to be held in 2009, shareholders will be invited to participate in an advisory vote on the principles of this new compensation model. This section of this report outlines these principles and explains how the new model will apply to the Chairman of the BoD, independent BoD members and Group Executive Board (GEB) members. Compensation policy The Chairman of the UBS BoD receives a fixed base salary that comprises cash and a pre-determined, fixed number of shares. 1 The Chairman is not entitled to any variable compensation. The independent BoD members receive fixed remunera- tion fees. Independent BoD members are not entitled to any variable compensation. Compensation for members of the GEB comprises a fixed salary, variable cash compensation and variable equity com- pensation. Variable compensation awarded to GEB members: – is based on long-term performance: Variable compensa- tion remains an important component of the new model, but it is based on clear, long-term performance measures that take business risk into account. Two variable compen- sation schemes – one in cash (“cash balance plan”), one in equity (“performance equity plan”) – have been defined for the members of the GEB. The results of the senior ex- ecutive’s business division will be a key factor in determin- ing the amount of variable cash compensation to be awarded. In unprofitable years no new variable cash com- pensation will be paid. In the performance equity plan, the final number of shares that each senior executive will re- ceive can be determined only after three years, and will be based on achievement against two performance measures: economic profit and relative total shareholder return. – addresses risk management: Pay that depends upon long- term performance increases risk awareness. Economic profit used to determine vesting of the performance eq- uity plan is a market-recognized standard for measuring risk-adjusted profit taking into account the cost of equity capital, while the new cash plan no longer pays out im- mediately, but holds compensation at risk, subject to fu- ture business performance. – incorporates a “malus” system: A maximum of one-third of a senior executive’s variable cash incentive will be paid out at the beginning of the following year. Should certain mate- rial adverse events occur, a “malus” or negative award may be applied to the cash balance plan. Separately, the perfor- mance equity plan will deliver between zero and two times each senior executive’s target award. Failure to achieve threshold economic profit targets or a reasonable level of total shareholder return can result in a share delivery that is considerably below target or even zero. Compensation components Chairman of the Board of Directors From January 2009, the Chairman of the BoD receives a fixed base salary comprising cash and a pre-determined fixed number of UBS shares. These shares vest after four years and are subject to a “malus” in loss-making years over the vest- ing period. This compensation package does not include any variable, performance-dependent component, but does keep the Chairman’s pay aligned with long-term, sustainable value creation through its share component. Independent members of the Board of Directors The independent members of the BoD receive fixed remu- neration only. Fees are paid 50% in cash and 50% in blocked Compensation structure Element of compensation Chairman of the BoD Independent members of BoD Members of the GEB Fixed pay Base salary in cash and a fixed number of restricted share awards Fixed fee (min. 50%; max. 100% in restricted share awards) Base salary in cash Variable cash compensation Variable equity compensation No No No No Cash balance plan Performance equity plan Share retention policy Yes (vesting four years after grant) Yes (blocked for 4 years) Yes 1 Pending Kaspar Villiger’s election as Chairman of the BoD this renumeration structure would not be applicable to him (but rather a fixed base salary only). 237 n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C Advisory vote Corporate governance and compensation Compensation, shareholdings and loans UBS shares. However, members can elect to have 100% of their remuneration paid in blocked UBS shares. These shares are attributed with a price discount of 15% and restricted from sale for four years from the date they are granted. Group Executive Board Members of the GEB are entitled to a fixed salary. In addi- tion, they may receive variable compensation under either the cash balance plan or the performance equity plan or a combination of both (these plans are discussed below). Base salary Members of the GEB receive a fixed base salary that is deter- mined according to the skills, experience and knowledge they bring to their role in the relevant market segment. Cash balance plan The cash balance plan rewards long-term profitability by link- ing variable cash compensation to sustained business perfor- mance. The plan allows for a maximum of one-third of a se- nior executive’s variable cash incentive to be paid out at the beginning of the following year, with the entire cash incen- tive in question to be paid out over a three-year period. As such, the plan provides a multi-year reflection of performance and compensation. This is designed to ensure that the finan- cial impact of decisions and actions taken in one period im- pacts the variable compensation over a longer period of time. The system is significantly strengthened through inclusion of a bonus - malus system, which allows for the application of a “malus” or negative award to the balance of variable com- pensation. Circumstances in which this could occur include: incurring of a financial loss; material restatement of the Group’s financial statements; substantial underachievement of individual performance targets; or the taking of excessive risk or causing of harm to UBS. If a senior executive leaves UBS, the cash balance will be kept at risk for the remaining life of the plan in order to capture any tail risk events. Performance equity plan The performance equity plan is forward-looking and depen- dent on results produced over a three-year time period. At the start of each performance period, senior executives are ad- vised of a potential quantity of restricted performance shares that, subject to the achievement of pre-defined business tar- gets, is expected to vest after three years. A final decision on the actual number of shares that will vest and transfer to the senior executive is only possible after the end of the three-year period, depending upon the level of performance achieved. If UBS’s performance over the three-year period is below target, the number of shares that vest is reduced and may be zero. Should UBS’s performance over the three-year period be above target, the actual number of shares may be adjusted up to two times the original target. Performance measurement for the first award will begin in 2009, with the first possible vesting in 2012. Performance shares are not eligible for divi- dends during the three-year measurement period. The final number of shares that will actually vest depends on cumulative achievement against two performance metrics: – Economic profit (EP) is an internal measure for value cre- ation that reflects both profitability and the equity re- quired to support business risk. It is calculated by sub- tracting the cost of equity capital from the annual net profit attributable to UBS shareholders. EP is only realized when the return on capital achieved is greater than the firm’s cost of capital. In order to offset accounting entries which distort the economic perspective, the EP calcula- tion is adjusted for items not reflected in business perfor- mance. The three-year EP targets for the performance equity plan are based on the UBS strategic business plan and analyst expectations. Threshold, target and stretch performance goals have been defined for the 2009 – 2011 performance period based on expected EP perfor- mance and consideration of the expected market value associated with those EP performance levels. However, the human resources and compensation committee may revise the performance target if an exceptional event oc- curs that makes this either necessary or advisable. – Total shareholder return (TSR) is an external measurement of value creation that measures the total return on a UBS share, i.e. both the dividend yield and the capital appre- ciation of the share price. UBS measures TSR over a three- year period relative to banking industry performance as Performance Equity Plan: basic design year 1 year 2 year 3 year 4 year 5 year 6 year 7 year 8 Performance period: 3 years Grant year 1 Vesting year 4 Share retention period ¹ # Performance shares (# performance shares xvesting multiple [0% –200%] ²= # vested UBS shares) 1 Refer to the description of UBS’s share retention policy for the Chairman of the BoD and GEB members shown in this section of this report. 2 Cumulative EP- and TSR-driven vesting multiple (min. 0%; max. 200%). 238 4CP025_e Advisory vote Historic TSR ranking Performance period UBS TSR # peer companies 1 UBS rank / 1.4.99–1.4.02 1.4.00–1.4.03 1.4.01–1.4.04 1.4.02–1.4.05 1.4.03–1.4.06 1.4.04–1.4.07 1.4.05–1.4.08 4% (4%) 6% 10% 39% 18% (14%) 16 / 27 11 / 27 9 / 28 9 / 30 10 / 30 19 / 30 28 / 30 Vesting matrix 3 years’ cumulative EP < Threshold¹ 0% Threshold Target Stretch 100% 200% 1 Current constituents of the Dow Jones Banks Titans 30 Index. Under- performance Median- performance Out- performance TSR performance: rank within Dow Jones Banks Titans 30 Index 4CP026_e 1 But limited vesting if TSR rank 1–10. indicated by the components of the Dow Jones Banks Ti- tans 30 Index©. This global index comprises the top 30 companies in the banking sector, as defined by Dow Jones, and has been chosen for its relevance to UBS (banking), for transparency (known listed companies), for sector coverage (30 leading global banks assessed by market capitalization, revenues, and net profit) and for independence (managed by Dow Jones). For greater transparency and consistent with best practice, the TSR for all companies in the index will be measured in a com- mon currency (Swiss franc). Cumulative EP is the primary and most important perfor- mance measure, with relative TSR performance able to ei- ther increase or reduce the award indicated by the EP achievement. Both performance conditions will be pre-de- fined for each three-year performance period. A shortfall in value creation during the performance period, as measured by cumulative EP and relative TSR performance, may result in a “malus” or the vesting of shares below target (this could be as low as zero). However, in case of outperformance against both the EP target and the TSR index, the actual numbers of shares may be adjusted up to two times the orig- inal target award. If a senior executive leaves UBS before the vesting of an award, the quantity of shares received will be pro-rated to the actual service period as well as being depen- dent upon the full three-year performance conditions. Awards may be forfeited under certain circumstances. Employment contracts All GEB members will receive new employment agreements during 2009, under which notice periods will be reduced from 12 months to six months. Furthermore, any discretion- ary variable compensation paid to senior executives who leave UBS will, as per the new employment agreements, be based on Group, business division and personal perfor- mance. Any amounts paid would be pro-rated to the end of the notice period and would use only variable cash compen- sation as a basis. Furthermore, any payments would gener- ally be made under the cash balance plan, with two-thirds of any variable cash award being kept “at risk” for the remain- der of the three-year performance cycle in order to capture any tail risk events. “Golden parachutes” (in the sense of ex gratia payments made to senior executives due to termina- tion of employment) do not exist at UBS. n o i t a s n e p m o c d n a e c n a n r e v o g e t a r o p r o C 239 Advisory vote Corporate governance and compensation Compensation, shareholdings and loans Share retention policy Effective 1 January 2009, the Chairman of the BoD and all GEB members are required to retain 75% of all vested shares (after payment of taxes) during their time in office and for a period of eight years from the date of grant. This rule ap- plies for all mandatory share-based compensation plans, in- cluding the performance equity plan. For example, perfor- mance equity plan shares granted in 2009 will continue to be restricted after vesting until 2017 unless the executive leaves UBS. All shares granted to independent members of the BoD are blocked for a period of four years from the date of grant. Share retention policy year 1 year 2 year 3 year 4 year 5 year 6 year 7 year 8 Restricted share awards Blocked shares Share retention policy Performance period Share retention policy Chairman of the BoD Independent members of the BoD Members of the GEB 4CP029_e 240 Financial information Financial information Table of contents 244 245 246 Introduction Accounting principles Critical accounting policies 251 Consolidated financial statements 251 Management’s report on internal control 302 17 Other assets over financial reporting Report of independent registered public accounting firm on internal control over financial reporting Report of the statutory auditor and the independent registered public accounting firm on the consolidated finan- cial statements Income statement Balance sheet Statement of changes in equity Statement of recognized income and expense Statement of cash flows Notes to the consolidated financial statements 1 Summary of significant accounting policies 2a Segment reporting 2b Segment reporting by geographic location Income statement notes 3 Net interest and trading income 4 Net fee and commission income 5 Other income 6 Personnel expenses 7 General and administrative expenses 8 Earnings per share (EPS) and shares outstanding Balance sheet notes: assets 9a Due from banks and loans 9b Allowances and provisions for credit losses 10 Securities borrowing, securities lending, repurchase and reverse repurchase agreements 11 Trading portfolio 12 Financial assets designated at fair value 13 Financial investments available-for-sale 14 Investments in associates 15 Property and equipment 16 Goodwill and intangible assets 252 254 256 257 258 260 261 263 263 281 288 289 289 291 291 292 292 293 294 294 295 295 296 297 298 298 299 300 303 303 303 305 306 310 312 319 319 319 321 321 322 330 Balance sheet notes: liabilities 18 Due to banks and customers 19 Financial liabilities designated at fair value and debt issued 20 Other liabilities 21 Provisions and litigation 22 Income taxes 23 Derivative instruments and hedge accounting Off-balance sheet-information 24 Pledgeable off-balance-sheet securities 25 Operating lease commitments Additional information 26 Capital increases and mandatory convertible notes 27 Fair value of financial instruments 28 Pledged assets and transferred financial assets which do not qualify for derecognition 331 29 Measurement categories of financial assets 333 339 344 347 347 351 352 356 358 360 360 362 and financial liabilities 30 Pension and other post-employment benefit plans 31 Equity participation and other compensation plans 32 Related parties 33 Post-balance-sheet events 34 Significant subsidiaries and associates 35 Invested assets and net new money 36 Business combinations 37 Discontinued operations 38 Reorganizations and disposals 39 Currency translation rates 40 Swiss banking law requirements 41 Supplemental guarantor information required under SEC rules 242 371 UBS AG (Parent Bank) 393 Additional disclosure required under SEC regulations 371 Parent Bank review 393 A – Introduction 372 372 373 373 374 374 376 376 376 377 377 377 378 379 379 379 379 380 380 380 380 381 381 382 383 383 384 385 386 388 389 389 390 392 Parent Bank financial statements Income statement Balance sheet Statement of appropriation of retained earnings Notes to the Parent Bank financial statements Accounting policies Additional income statement information Net trading income Extraordinary income and expenses Additional balance sheet information Allowances and provisions Statement of shareholders’ equity Share capital Off-balance sheet and other information Assets pledged or assigned as security for own obligations and assets subject to reservation of title Commitments and contingent liabilities Derivative instruments Fiduciary transactions Due to UBS pension plans Personnel Significant shareholders Corporate governance and compensation report Compensation details and additional information for executive members of the Board of Directors Remuneration details and additional information for independent members of the Board of Directors Total payments to all members of the Board of Directors Total compensation for all members of the Group Executive Board Share and option ownership of members of the Board of Directors Compensation paid to former members of the Board of Directors and Group Executive Board Share and option ownership of members of the Group Executive Board Vested and unvested options held by independent members of the Board and by members of the Group Executive Board Loans granted to members of the Board of Directors Loans granted to members of the Group Executive Board Report of the statutory auditor on the financial statements Confirmation of the auditors concerning conditional capital increase 394 395 396 397 397 398 398 399 399 399 401 403 404 405 406 407 408 409 410 411 412 413 B – Selected financial data Key figures Income statement data Balance sheet data Ratio of earnings to fixed charges C – Information on the company Property, plant and equipment D – Information required by industry guide 3 Selected statistical information Average balances and interest rates Analysis of changes in interest income and expense Deposits Short-term borrowings Contractual maturities of investments in debt instruments, available-for-sale Due from banks and loans (gross) Due from banks and loan maturities (gross) Impaired and non-performing loans Cross-border outstandings Summary of movements in allowances and provisions for credit losses Allocation of the allowances and provisions for credit losses Due from banks and loans by industry sector (gross) Loss history statistics n o i t a m r o f n i l a i c n a n i F 243 Financial information Introduction Financial information 2008 This comprises the audited consolidated financial statements of UBS Group for 2008, 2007 and 2006, prepared according to International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). It also includes the audited financial statements of UBS AG (the Parent Bank) for 2008 and 2007, prepared according to Swiss banking law. Additional disclosure required by Swiss and US regulations is included where appropriate. 244 Accounting principles UBS’s consolidated Financial Statements have been prepared in accordance with International Financial Reporting Stan- dards (IFRS) as issued by the International Accounting Stan- dards Board (IASB) and stated in Swiss francs (CHF). Until 2006, UBS also reconciled its Financial Statements to US Generally Accepted Accounting Principles (US GAAP). Except where clearly identified, all of UBS’s financial infor- mation presented in this document is presented on a con- solidated basis under IFRS. Pages 371 to 392 contain the fi- nancial statements for the UBS AG Parent Bank – the Swiss company, including branches worldwide, which owns all the UBS companies, directly or indirectly. The Parent Bank’s fi- nancial statements are prepared in order to meet Swiss regu- latory requirements and in compliance with Swiss Banking Law. Except in those pages, or where otherwise explicitly stated, all references to “UBS” refer to the UBS Group and not to the Parent Bank. Pages 393 to 413 include additional disclosures required under SEC rules. All references to 2008, 2007 and 2006 refer to the UBS Group and the Parent Bank’s fiscal years ended 31 December 2008, 2007 and 2006. The Financial Statements for the UBS Group and the Parent Bank have been audited by Ernst & Young Ltd. An explanation of the critical accounting policies applied in the preparation of UBS’s Financial Statements is provided in the next section. The basis of UBS’s accounting is described in Note 1 to the Financial Statements. The UBS Group financial statements 2008 included in this Annual Report 2008 replace the Group financial state- ments 2008 included in the Annual Report 2008 issued and filed with the US SEC on Form 20-F on 11 March 2009. Re- fer to Note 1b to the financial statements of this report for details. n o i t a m r o f n i l a i c n a n i F 245 Financial information Critical accounting policies Basis of preparation and selection of policies UBS prepares its Financial Statements in accordance with IFRS as issued by the International Accounting Standards Board. The application of certain of these accounting prin- ciples requires considerable judgment based upon esti- mates and assumptions that involve significant uncertainty at the time they are made. Changes in assumptions may have a significant impact on the Financial Statements in the periods where assumptions are changed. Accounting treat- ments where significant assumptions and estimates are used are discussed in this section, as a guide to understand- ing how their application affects the reported results. A broader and more detailed description of the accounting policies UBS employs is shown in Note 1 to the Financial Statements. The application of assumptions and estimates means that any selection of different assumptions would cause the re- ported results to differ. UBS believes that the assumptions it has made are appropriate, and that UBS’s Financial State- ments therefore present the financial position and results fairly, in all material respects. The alternative outcomes dis- cussed below are presented solely to assist the reader in understanding UBS’s Financial Statements, and are not in- tended to suggest that other assumptions would be more appropriate. Many of the judgments UBS makes when applying ac- counting principles depend on an assumption, which UBS believes to be correct, that UBS maintains sufficient liquid- ity to hold positions or investments until a particular trading strategy matures – i. e. that UBS does not need to realize positions at unfavorable prices in order to fund immediate cash needs. Liquidity is discussed in more detail in the “Liquidity and funding management” section of this re- port. Fair value of financial instruments Financial assets and financial liabilities in UBS’s trading port- folio, financial assets and liabilities designated at fair value, derivative instruments, and financial assets available-for-sale are recorded at fair value on the balance sheet. Changes in the fair value of these financial instruments are recorded in Net trading income in the income statement, except for fi- nancial assets available-for-sale, for which changes in fair value are recorded directly in equity until realized or the as- sets are considered impaired. Key judgments affecting this accounting policy relate to how UBS determines fair value for such assets and liabilities. Where no active market exists, or where quoted prices are not otherwise available, UBS determines fair value using valuation techniques. In these cases, fair values are esti mated from observable data in respect of similar financial instru- ments, using models to estimate the present value of expec- ted future cash flows or other valuation techniques, using inputs existing at the balance sheet dates. If available, mar- ket observable inputs are applied to valuation models (level 2). In cases where market observable inputs are not available for all significant valuation parameters, they are estimated based on appropriate assumptions (level 3). At 31 December 2008, financial assets categorized as level 2 amounted to CHF 965 billion (31 December 2007: CHF 799 billion) and those categories as level 3 amounted to CHF 57 billion (31 December 2007: CHF 76 billion). At 31 December 2008, financial liabilities categorized as level 2 amounted to CHF 931 billion (31 December 2007: CHF 615 billion) and level 3 to CHF 46 billion (31 December 2007: CHF 59 billion). Valuation models are used primarily to value derivatives transacted in the over-the-counter market, including credit derivatives, unlisted equity and debt securities (including those with embedded derivatives), and other debt instru- ments for which markets were or have become illiquid in 2008. All valuation models are validated before they are used as a basis for financial reporting, and periodically reviewed thereafter, by qualified personnel independent of the area that created the model. Wherever possible, UBS compares valuations derived from models with prices of similar financial instruments, and with actual values when realized, in order to further validate and calibrate UBS’s models. A variety of factors are incorporated in UBS’s models, in- cluding actual or estimated market prices and rates, such as time value and volatility, and market depth and liquidity. Where available, UBS uses market observable prices and rates derived from market verifiable data. Where such fac- tors are not market observable, changes in assumptions could affect the reported fair value of financial instruments. UBS generally applies its models consistently from one peri- od to the next, ensuring comparability and continuity of val- uations over time. However, models are changed or adapted to market developments in situations where peviously used models have limitations and are assessed to be inadequate. Estimating fair value inherently involves a signi ficant degree of judgment. Management therefore establishes valuation ad- justments to cover the risks associated with the estimation of unobservable input parameters and the assumptions within the models themselves. Valuation adjustments are also made to reflect such elements as deteriorating creditworthiness (in- 246 cluding country-specific risks), concentrations in specific types of instruments and market risk factors (interest rates, curren- cies, etc.), and market depth and liquidity. Although a signifi- cant degree of judgment is, in some cases, required in estab- lishing fair values, management believes that the fair values recorded in the balance sheet and the changes in fair values recorded in the income statement are reflective of the underly- ing economics, based on UBS’s established fair value and mod- el governance policies and the related controls and proce dural safeguards UBS employs. For a description of the valuations of UBS’s positions related to the US student loan auction rate se- curities, monolines, leveraged finance transactions, US and non-US reference linked notes, US commercial mortgage backed securities and other instruments which were deter- mined relevant for specific disclosure refer to Note 27. Uncertainties associated with the use of model-based valuations (both level 2 and level 3) are predominantly ad- dressed through the use of model reserves. These reserves reflect the amounts that UBS estimates are appropriate to deduct from the valuations produced directly by the models to reflect uncertainties in the relevant modeling assumptions and inputs used. In arriving at these estimates, UBS considers the range of market practice and how it believes other mar- ket participants would assess these uncertainties. Model reserves are periodically reassessed in light of information from market transactions, pricing utilities, and other relevant sources. The level of these model reserves is, nevertheless, to a large extent a matter of judgment. To estimate the potential effect on the Financial State- ments from the use of alternative valuation techniques or assumptions, UBS makes use of the model reserve amounts described above, by scaling the level of the model reserves higher and lower, to assess the impact on valuation of in- creasing or decreasing the amount of model-related uncer- tainty considered. The potential effect of using reasonably possible alter native valuation assumptions has been quantified as follows: – Scaling the model reserve amounts upward in line with less favorable assumptions would reduce fair value by ap- proximately CHF 2.5 billion at 31 December 2008, by approximately CHF 2.7 billion at 31 December 2007 and approximately CHF 1.0 billion at 31 December 2006. – Scaling the model reserve amounts downward in line with more favorable assumptions would increase fair value by approximately CHF 1.4 billion at 31 December 2008, ap- proximately CHF 2.2 billion at 31 December 2007, and ap- proximately CHF 1.0 billion at 31 December 2006. Refer to Note 27 for additional sensitivity information for se- ve ral relevant products. Goodwill impairment test The ongoing crisis in the financial markets dramatically changed industry dynamics and the related decrease in mar- ket capitalization of UBS made it necessary to monitor close- ly whether there was indication that goodwill allocated to its cash-generating units was impaired. At 31 December 2008, equity attributable to UBS shareholders stood at CHF 33 bil- lion. UBS’s market capitalization, excluding the shares to be issued upon conversion of the MCNs, amounted to CHF 44 billion at 31 December 2008. On the basis of the impairment testing methodology described in Note 16, UBS concluded that the year-end 2008 balances of goodwill allocated to all its segments remain recoverable. Goodwill allocated to the Investment Bank at 31 December 2008 amounted to CHF 4.3 billion (CHF 5.2 billion at 31 December 2007), to Wealth Management US CHF 3.7 billion, Wealth Management Inter- national & Switzerland CHF 1.6 billion and Global Asset Man- agement CHF 2.0 billion. The assessment of the goodwill in the Investment Bank, which is most affected by the financial market crises, was a key focus. In its review of the year-end 2008 goodwill balance, UBS considered the performance outlook of its Investment Bank division and the underlying business operations to resolve whether the recoverable amount for this unit covers its car- rying amount. Based on the estimated cash flows the Invest- ment Bank will generate from its businesses, discounted back to their present value using a discount rate that reflects the risk profile of the Investment Bank’s activities, UBS con- cluded that goodwill allocated to the Investment Bank re- mained recoverable on 31 December 2008. The conclusion was reached on the basis of the forecast results of those activities which management expects to generate positive cash flows in future years. The forecasts are based on an ex- pectation that the economic environment will gradually im- prove over the next three years and reach an average growth level thereafter. The fair value obtained from the model cal- culation was subject to a stress test by decreasing forecast cash flows by one third and at the same time increasing the discount rate by 3.5 percentage points to 16.5%. The stress value covered the book value of the Investment Bank. How- ever, if the conditions in the financial markets and banking industry further deteriorate and turn out to be worse than anticipated in UBS’s performance forecasts, the goodwill car- ried in the Investment Bank business division may need to be impaired in future periods. The same model is applied to all segments carrying good- will. It is most sensitive to changes in the forecast earnings available to shareholders in year one to five, the estimated 247 n o i t a m r o f n i l a i c n a n i F Financial information return on equity, the underlying equity, the cost of equity and to changes in the long-term growth rate. The applied long-term growth rate is based on long-term risk-free inter- est rates. Earnings available to share holders are estimated based on forecast results, business ini tiatives and planned capital investments and returns to shareholders. Valuation parameters used within the Group’s impairment test model are linked to external market in formation, where applicable. Management believes that reasonable changes in key as- sumptions used to determine the recoverable amounts of all segments will not result in an impairment situation. Reclassification of financial instruments The International Accounting Standards Board published an amendment to International Accounting Standard 39 (IAS 39 Financial Instruments: Recognition and Measurement) on 13 October 2008, under which eligible financial assets, sub- ject to certain conditions being met, may be reclassified out of the “held for trading” category if the firm has the intent and ability to hold them for the foreseeable future or until maturity. Although the amendment could have been applied retro- spectively from 1 July 2008, UBS decided at the end of Octo- ber 2008 to apply the amendment with effect from 1 October 2008 following an assessment of the implications on its finan- cial statements. Effective 1 October 2008, UBS reclassified eligible assets which it intends to hold for the foreseeable future with a fair value of CHF 17.6 billion on that date from “held for trad- ing” to the “loans and receivables” category. In addition, student loan auction rate securities (ARS) with a fair value of CHF 8.4 billion have been reclassified as of 31 December 2008. In fourth quarter 2008, an impairment charge of CHF 1.3 billion was recognized as credit loss expense on reclassi- fied financial instruments. If reclassification had not oc- curred, the impairment charge would not have been recog- nized but an additional trading loss of CHF 4.8 billion would have been recorded in UBS’s fourth quarter income state- ment. Net interest income after reclassification increased by CHF 0.1 billion. Refer to Note 29 for details. Consolidation of Special Purpose Entities UBS sponsors the formation of Special Purpose Entities (SPEs) primarily to allow clients to hold investments in sepa- rate legal entities, to allow clients to jointly invest in alter- native assets, for asset securitization transactions and for buying or selling credit protection. In accordance with IFRS, UBS does not consolidate SPEs that it does not control. In order to determine whether UBS control an SPE or not, UBS has to make judgments about risks and rewards and assess the ability to make operational decisions for the SPE in question. In many instances, elements are present that, considered in isolation, indicate control or lack of control over an SPE, but when considered together make it difficult to reach a clear conclusion. When assessing whether UBS has to consolidate an SPE it evaluates a range of factors, including whether (a) the activities of the SPE are being conducted on UBS’s behalf according to its specific business needs so that UBS obtains the benefits from the SPE’s op- erations, or (b) UBS has decision-making powers to obtain the majority of the benefits of the activities of the SPE, or UBS has delegated these decision-making powers by set- ting up an autopilot mechanism, or (c) UBS has the rights to obtain the majority of the benefits of the activities of an SPE and therefore may be exposed to risks arising from the ac- tivities of the SPE, or (d) UBS retains the majority of the re- sidual or ownership risks related to the SPE or its assets in order to obtain the benefits from its activities. UBS consoli- dates a SPE if its assessment of the relevant factors indi- cates that UBS controls the SPE. SPEs used to allow clients to hold investments are struc- tures that allow one or more clients to invest in an asset or set of assets, which are generally purchased by the SPE in the open market and not transferred from UBS. The risks and rewards of the assets held by the SPE reside with the clients. Typically, UBS will receive service and commission fees for creation of the SPE, or because it acts as investment man- ager, custodian or in some other function. Many of these SPEs are single-investor or family trusts while others allow a broad number of investors to invest in a diversified asset base through a single share or certificate. These latter SPEs range from mutual funds to trusts investing in real estate. The majority of UBS’s SPEs are created for client investment purposes and are not consolidated. However, UBS consoli- dates investment funds in cases where it provides or have a moral obligation to provide financial support to a fund. In these instances UBS generally assumes the majority or a sig- nificant portion of the risks of the fund, which, combined with UBS’s role as investment manager, makes the party that can exercise control over the entity. SPEs used to allow clients to jointly invest in alternative assets, e. g. feeder funds, for which generally no active markets exist, are often in the form of limited partnerships. Investors are the limited partners and contribute all or the majority of the capital, whereas UBS serves as the general partner. In that capacity, UBS is the investment manager and 248 have sole discretion over investment and other administra- tive decisions, but have no or only a nominal amount of cap- ital invested. UBS typically receives service and commission fees for UBS’s services as general partner but do not, or only to a minor extent, participate in the risks and rewards of the vehicle, which reside with the limited partners. In most in- stances, limited partnerships are not consolidated under IFRS because UBS’s legal and contractual rights and obligations indicate that UBS does not have the power to govern the financial and operating policies of these entities and concur- rently do not have the objective of obtaining benefits from its activities through such power. SPEs used for securitization. SPEs for securitization are created when UBS has assets (for example, a portfolio of loans) which it sells to an SPE, and the SPE in turn sells inter- ests in the assets as securities to investors. Consolidation of these SPEs depends mainly on whether UBS retains the ma- jority of the benefits or risks of the assets in the SPE. UBS does not consolidate SPEs for securitization if it has no control over the assets and no longer retain any signifi- cant ex posure (for gain or loss) to the income or investment returns on the assets sold to the SPE or the proceeds of their liquidation. This type of SPE is a bankruptcy remote entity – if UBS were to go bankrupt the holders of the secu- rities would clearly be owners of the asset, while if the SPE were to go bankrupt the securities holders would have no recourse to UBS. SPEs for credit protection are set up to allow UBS to sell the credit risk on portfolios, which may or may not be held by UBS, to investors. They exist primarily to allow UBS to have a single counterparty (the SPE), which sells credit pro- tection to it. The SPE in turn has investors who provide it with capital and participate in the risks and rewards of the credit events that it insures. UBS generally consolidates SPEs used for credit protection. Equity compensation IFRS 2 requires that shares and share options awarded to employees are recognized as compensation expense based on their fair value at grant date. In valuing share awards, the employee’s entitlement to receive dividends during the vest- ing period and post-vesting sale and hedge restrictions and non-vesting conditions are taken into account. The share op- tions UBS issue to its employees have features that make them incomparable to options on UBS’s shares traded in ac- tive markets. Accordingly, UBS cannot determine fair value by reference to a quoted market price, but UBS rather esti- mates it using an option valuation model. The model, a Monte Carlo simulation, requires inputs such as interest rates, expected dividends, volatility measures and specific employee exercise behavior patterns based on statistical data. Some of the model inputs UBS uses are not market ob- servable and have to be estimated or derived from available data. Use of different estimates would produce different op- tion values, which in turn would result in higher or lower compensation expense recognized. Several recognized models for the valuation of options exist but none can be singled out as the best or most correct. The model UBS applys has been selected because it is able to handle some of the specific features included in the options granted to UBS’s employees. If UBS was to use a different model, the option values produced would be different, even if it used the same inputs. Using both different inputs and a different valuation model could have a significant impact on the fair value of employee share options, which could be either higher or lower than the values produced by the model UBS applys and the inputs it has used. On 1 January 2008, UBS adopted an amendment to IFRS 2 Share-based Payment: Vesting Conditions and Cancel- lations and restated the two comparative prior years. The amended standard no longer considers non-compete condi- tions to establish a service requirement in order to earn the share-based awards. Accordingly, UBS changed its expense recognition for compensation awards that contain non-com- pete conditions from the stated vesting period to the period over which the employee is required to provide active service in order to earn the award. Post-vesting sale and hedge re- strictions and other non-vesting conditions are considered when determining the fair value of an award at grant date. The adoption of these IFRS 2 amendments had the effect that the compensation expense for share and option awards containing non-compete provisions was recognized retro- spectively in the year for which the award was granted. Ad- ditional compensation expense of CHF 797 million was rec- ognized for 2007 and CHF 516 million for 2006. In 2008, management decided that most of the share-based awards to be granted in March 2009 for the year 2008 will be for- feited if the employee terminates employment with UBS prior to vesting and eliminated the non-compete conditions. Compensation expense for these awards will be recognized over the stated vesting period that commences on 1 March 2009. The adoption of the amendments to IFRS 2 and the large reduction in variable compensation for 2008 resulting in a small number of share grants related to 2008 signifi- cantly reduced share-based compensation expense for 2008. 249 n o i t a m r o f n i l a i c n a n i F Financial information Further information on UBS equity compensation plans is disclosed in Note 1a) 22) and Note 31 to the Financial State- ments. Deferred taxes Deferred tax assets arise from a variety of sources, the most significant being: a) tax losses that can be carried forward to be utilized against profits in future years; and b) expenses recognized in the books but disallowed in the tax return un- til the associated cash flow occurs. UBS records a valuation allowance to reduce its deferred tax assets to the amount which can be recognized in line with the relevant accounting standards. The level of deferred tax asset recognition is influenced by management’s assess- ment of UBS’s future profitability profile. At each balance sheet date, existing assessments are reviewed and, if neces- sary, revised to reflect changed circumstances. In a situation where recent losses have been incurred, the relevant ac- counting standards require convincing evidence that there will be sufficient future profitability. At 31 December 2008, recognized deferred tax assets amount to CHF 8.9 billion. Recognized deferred tax assets include an amount related to tax loss carry-forwards of CHF 8.1 billion, mainly relating to tax losses incurred in UBS AG, Switzerland, that can be utilized to offset taxable in- come in Switzerland in future years. The losses mainly re- sulted from the write-down of investments in US subsi diaries. At 31 December 2007, recognized deferred tax assets amounted to CHF 3.2 billion. Swiss tax losses can be carried forward for seven years. The deferred tax assets recognized at 31 December 2008 have been based on future profitability assumptions over a five year horizon. The level of assets recognized may, however, need to be adjusted in the future in the event of changes to those profitability assumptions. Refer to Note 22 for further details. 250 Financial information Consolidated financial statements Consolidated financial statements Management’s report on internal control over financial reporting The Board of Directors and management of UBS AG (UBS) are responsible for establishing and maintaining adequate internal control over financial reporting. UBS’s internal con- trol over financial reporting is designed to provide reason- able assurance regarding the preparation and fair presenta- tion of published financial statements in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board. UBS’s internal control over financial reporting includes those policies and procedures that: – Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispo- sitions of assets; – Provide reasonable assurance that transactions are re- corded as necessary to permit preparation and fair pre- sentation of financial statements, and that receipts and expenditures of the company are being made only in ac- cordance with authorizations of UBS management; and – Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or dis- position of the company’s assets that could have a mate- rial effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become in- adequate because of changes in conditions, or that the de- gree of compliance with the policies or procedures may de- teriorate. UBS management assessed the effectiveness of UBS’s internal control over financial reporting as of 31 December 2008 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment, management believes that, as of 31 Decem- ber 31 2008, UBS’s internal control over financial reporting was effective. The effectiveness of UBS’s internal control over financial reporting as of 31 December 2008 has been audited by Ernst & Young Ltd, UBS’s independent registered public accounting firm, as stated in their report appearing on pages 252 to 253, which expressed an unqualified opinion on the effec- tiveness of UBS’s internal control over financial reporting as of 31 December 2008. n o i t a m r o f n i l a i c n a n i F 251 Financial information Consolidated financial statements 252 n o i t a m r o f n i l a i c n a n i F 253 Financial information Consolidated financial statements 254 n o i t a m r o f n i l a i c n a n i F 255 Financial information Consolidated financial statements Income statement CHF million, except per share data Note 31.12.08 31.12.07 31.12.06 31.12.07 For the year ended % change from 3 3 3 4 3 5 6 7 15 16, 38 22 37 22 8 8 65,679 (59,687) 5,992 (2,996) 2,996 22,929 (25,820) 692 796 16,262 10,498 1,241 341 213 28,555 (27,758) (6,837) (20,922) 198 1 198 109,112 (103,775) 87,401 (80,880) 5,337 (238) 5,099 30,634 (8,353) 4,341 31,721 25,515 8,429 1,243 0 276 35,463 (3,742) 1,369 (5,111) 145 (258) 403 6,521 156 6,677 25,456 13,743 1,608 47,484 24,031 7,942 1,244 0 148 33,365 14,119 2,998 11,121 888 (11) 899 (20,724) (4,708) 12,020 568 520 48 (21,292) (21,442) 150 (7.69) (7.74) 0.05 (7.69) (7.75) 0.05 539 539 0 (5,247) (5,650) 403 (2.42) (2.61) 0.19 (2.43) (2.61) 0.19 493 390 103 11,527 10,731 796 5.19 4.83 0.36 4.99 4.64 0.34 (40) (42) 12 (41) (25) (209) (84) (97) (36) 25 0 (23) (19) (642) (309) 37 (51) (340) 5 (4) (306) (280) (63) (218) (197) (74) (216) (197) (74) Continuing operations Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss expense Net fee and commission income Net trading income Other income Total operating income Personnel expenses General and administrative expenses Depreciation of property and equipment Impairment of goodwill Amortization of intangible assets Total operating expenses Operating profit from continuing operations before tax Tax expense Net profit from continuing operations Discontinued operations Profit from discontinued operations before tax Tax expense Net profit from discontinued operations Net profit Net profit attributable to minority interests from continuing operations from discontinued operations Net profit attributable to UBS shareholders from continuing operations from discontinued operations Earnings per share Basic earnings per share (CHF) from continuing operations from discontinued operations Diluted earnings per share (CHF) from continuing operations from discontinued operations 256 Balance sheet CHF million Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Loans Financial investments available-for-sale Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and intangible assets Other assets Total assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Equity Share capital Share premium Net income recognized directly in equity, net of tax Revaluation reserve from step acquisitions, net of tax Retained earnings Equity classified as obligation to purchase own shares Treasury shares Equity attributable to UBS shareholders Equity attributable to minority interests Total equity Total liabilities and equity Note 31.12.08 31.12.07 31.12.07 % change from 9 10 10 11 11 23 12 9 13 14 15 16 17, 22 18 10 10 11 23 19 18 19 20, 21, 22 32,744 64,451 122,897 224,648 271,838 40,216 854,100 12,882 340,308 5,248 6,141 892 6,706 12,935 18,811 18,793 60,907 207,063 376,928 660,182 114,190 428,217 11,765 335,864 4,966 11,953 1,979 7,234 14,538 20,312 2,014,815 2,274,891 125,628 14,063 102,561 62,431 851,864 101,546 474,774 10,196 197,254 33,965 145,762 31,621 305,887 164,788 443,539 191,853 641,892 22,150 222,077 61,496 1,974,282 2,231,065 293 25,250 (4,335) 38 14,487 (46) (3,156) 32,531 8,002 40,533 207 12,433 (1,161) 38 35,795 (74) (10,363) 36,875 6,951 43,826 2,014,815 2,274,891 74 6 (41) (40) (59) (65) 99 9 1 6 (49) (55) (7) (11) (7) (11) (14) (56) (66) (62) 92 (47) (26) (54) (11) (45) (12) 42 103 (273) 0 (60) 38 70 (12) 15 (8) (11) 257 n o i t a m r o f n i l a i c n a n i F Financial information Consolidated financial statements Statement of changes in equity CHF million Share capital Balance at the beginning of the year Issue of share capital Capital repayment by par value reduction Cancellation of second trading line treasury shares Balance at the end of the year attributable to UBS shareholders Share premium Balance at the beginning of the year Change in accounting policy Premium on shares issued and warrants exercised Net premium / (discount) on treasury share and own equity derivative activity Employee share and share option plans Tax benefits from deferred compensation awards Transaction costs related to share issuances, net of tax Balance at the end of the year attributable to UBS shareholders Balance at the end of the year attributable to minority interests Balance at the end of the year Net income recognized directly in equity, net of tax Foreign currency translation Balance at the beginning of the year Change in accounting policy Movements during the year Subtotal – balance at the end of the year attributable to UBS shareholders 1 Balance at the end of the year attributable to minority interests Subtotal – balance at the end of the year Net unrealized gains / (losses) on financial investments available-for-sale, net of tax Balance at the beginning of the year Net unrealized gains / (losses) on financial investments available-for-sale Impairment charges reclassified to the income statement Realized gains reclassified to the income statement Realized losses reclassified to the income statement Subtotal – balance at the end of the year attributable to UBS shareholders Balance at the end of the year attributable to minority interests Subtotal – balance at the end of the year Changes in fair value of derivative instruments designated as cash flow hedges, net of tax Balance at the beginning of the year Net unrealized gains / (losses) on the revaluation of cash flow hedges Net realized (gains) / losses reclassified to the income statement Subtotal – balance at the end of the year attributable to UBS shareholders Balance at the end of the year attributable to minority interests Subtotal – balance at the end of the year Net income recognized directly in equity, net of tax – attributable to UBS shareholders Net income recognized directly in equity – attributable to minority interests Balance at the end of the year Revaluation reserve from step acquisitions, net of tax Balance at the beginning of the year Movements during the year Balance at the end of the year attributable to UBS shareholders For the year ended 31.12.08 31.12.07 31.12.06 207 86 0 0 293 8,884 3,549 20,003 (4,626) (1,961) (176) (423) 25,250 417 25,667 (2,627) 27 (3,709) (6,309) (1,095) (7,404) 1,471 (648) 42 (524) 6 347 2 349 (32) 1,780 (121) 1,627 0 1,627 (4,335) (1,093) (5,428) 38 0 38 211 0 0 (4) 207 9,870 2,770 12 (560) 898 (557) 0 12,433 556 12,989 (1,618) 4 (986) (2,600) (480) (3,080) 2,876 1,213 14 (2,638) 6 1,471 32 1,503 (443) 239 172 (32) 0 (32) (1,161) (448) (1,609) 38 0 38 871 1 (631) (30) 211 9,992 2,325 46 (271) (56) 604 0 12,640 461 13,101 (432) (14) (1,168) (1,614) (208) (1,822) 931 2,574 19 (649) 1 2,876 30 2,906 (681) 1 237 (443) 0 (443) 819 (178) 641 101 (63) 38 1 Net of CHF (17) million, CHF 39 million and CHF 83 million of related taxes for the years ended 31.12.08, 31.12.07 and 31.12.06 respectively. 258 Statement of changes in equity (continued) CHF million Retained earnings Balance at the beginning of the year Change in accounting policy Net profit attributable to UBS shareholders for the year Dividends paid 1 Cancellation of second trading line treasury shares Balance at the end of the year attributable to UBS shareholders Balance at the end of the year attributable to minority interests Balance at the end of the year Equity classified as obligation to purchase own shares Balance at the beginning of the year Movements during the year Balance at the end of the year attributable to UBS shareholders Treasury shares Balance at the beginning of the year Acquisitions Disposals Cancellation of second trading line treasury shares Balance at the end of the year attributable to UBS shareholders Minority interests – preferred securities Total equity attributable to UBS shareholders Total equity attributable to minority interests Total equity 1 Stock dividend of 20-for-1 was distributed in April 2008, cash dividends of CHF 2.20 per share and CHF 1.60 per share were paid on 23 April 2007 and 24 April 2006 respectively. Additional information: Equity attributable to minority interests CHF million Balance at the beginning of the year Issuance of preferred securities Other increases Decreases and dividend payments Foreign currency translation Minority interest in net profit Balance at the end of the year 31.12.08 6,951 1,618 12 (532) (615) 568 8,002 For the year ended 31.12.07 6,089 996 101 (502) (272) 539 6,951 For the year ended 31.12.08 31.12.07 31.12.06 38,081 (2,286) (21,292) (16) 0 14,487 234 14,721 (74) 28 (46) (10,363) (367) 7,574 0 (3,156) 8,444 32,531 8,002 40,533 49,151 (1,423) (5,247) (4,275) (2,411) 35,795 16 35,811 (185) 111 (74) (10,214) (7,169) 4,605 2,415 (10,363) 6,827 36,875 6,951 43,826 44,105 (693) 11,527 (3,214) (3,997) 47,728 (25) 47,703 (133) (52) (185) (10,739) (8,314) 4,812 4,027 (10,214) 5,831 51,037 6,089 57,126 31.12.06 7,619 1,219 131 (3,191) (182) 493 6,089 n o i t a m r o f n i l a i c n a n i F 259 Financial information Consolidated financial statements Statement of changes in equity (continued) Number of shares Shares issued Balance at the beginning of the year Issuance of share capital Cancellation of second trading line treasury shares Balance at the end of the year Treasury shares Balance at the beginning of the year Acquisitions Disposals Cancellation of second trading line treasury shares Balance at the end of the year For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 2,073,547,344 2,105,273,286 2,177,265,044 859,033,205 1,294,058 2,208,242 (33,020,000) (74,200,000) 2,932,580,549 2,073,547,344 2,105,273,286 158,105,524 13,398,118 (109,600,521) 164,475,699 102,074,942 (75,425,117) (33,020,000) 208,519,748 117,160,339 (87,004,388) (74,200,000) 61,903,121 158,105,524 164,475,699 (2) 100 41 (4) (87) (45) 100 (61) On 31 December 2008, a maximum of 100,415 shares can be issued against the future exercise of options from former Pain- eWebber employee option plans. These shares are shown as conditional share capital in the UBS AG (Parent Bank) disclo- sure. During 2006, shareholders approved the creation of con- ditional capital of up to a maximum of 150 million shares to fund UBS's employee share option programs. In 2008 and 2007, zero and 5,704 shares had been issued under this pro- gram. The remaining conditional capital to fund UBS’s employ- ee share option programs amounts to 149,994,296 shares. On 27 February 2008 the extraordinary general meeting of shareholders approved the creation of a maximum of CHF 10,370,000 in authorized capital, allowing the distri- bution of a stock dividend. Additionally, on 23 April 2008, the Annual General Meeting of shareholders (AGM) ap- proved a capital increase that resulted in the issuance of 760,295,181 fully paid registered shares. In addition dur- ing 2008, shareholders approved the creation of condi- tional capital in a maximum amount of 642,750,000 shares for the two issuances of mandatory convertible notes (MCNs). For further information refer to “Note 26 Capital increases and mandatory convertible notes” in the finan cial statements. All issued shares are fully paid. Statement of recognized income and expense 31.12.08 Attributable to UBS Share- holders Minority interests Total 31.12.07 Attributable to UBS Share- holders Minority interests 31.12.06 Attributable to UBS Share- holders Minority interests Total (1,465) (30) (1,495) (1,825) 0 2,180 541 2 0 (1,823) 2,610 541 332 9 0 Total 2,619 332 (615) (4,307) (1,025) (272) (1,297) (1,251) (182) (1,433) 0 (196) 329 0 329 (676) (645) (3,818) 568 (20,724) (77) (24,542) (1,980) (5,247) (7,227) (270) (2,250) 1,015 539 269 (4,708) 11,527 (6,958) 12,542 0 (173) 493 320 (676) 842 12,020 12,862 2,180 (3,692) (196) (3,173) (21,292) (24,465) For the year ended CHF million Net unrealized gains / (losses) on financial investments available-for-sale, before tax Changes in fair value of derivative instruments designated as cash flow hedges, before tax Foreign currency translation Tax on items transferred to / (from) equity Net income recognized directly in equity, net of tax Net income recognized in the income statement Total recognized income and expense 260 Statement of cash flows CHF million Cash flow from / (used in) operating activities Net profit Adjustments to reconcile net profit to cash flow from / (used in) operating activities Non-cash items included in net profit and other adjustments: 31.12.08 For the year ended 31.12.07 31.12.06 (20,724) (4,708) 12,020 Depreciation of property and equipment Impairment / amortization of goodwill and intangible assets Credit loss expense (recovery) Share of net profits of associates Deferred tax expense / (benefit) Net loss / (gain) from investing activities Net loss / (gain) from financing activities Net (increase) / decrease in operating assets: Net due from / to banks Reverse repurchase agreements and cash collateral on securities borrowed Trading portfolio, net replacement values and financial assets designated at fair value Loans / due to customers Accrued income, prepaid expenses and other assets Net increase / (decrease) in operating liabilities: Repurchase agreements, cash collateral on securities lent Accrued expenses and other liabilities Income taxes paid Net cash flow from / (used in) operating activities Cash flow from / (used in) investing activities Investments in subsidiaries and associates Disposal of subsidiaries and associates Purchase of property and equipment Disposal of property and equipment Net (investment in) / divestment of financial investments available-for-sale Net cash flow from / (used in) investing activities Cash flow from / (used in) financing activities Net money market paper issued / (repaid) Net movements in treasury shares and own equity derivative activity Capital issuance Capital repayment by par value reduction Dividends paid Issuance of long-term debt, including financial liabilities designated at fair value Repayment of long-term debt, including financial liabilities designated at fair value Increase in minority interests 1 Dividends paid to / decrease in minority interests Net cash flow from / (used in) financing activities Effects of exchange rate differences Net increase / (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of the year Cash and cash equivalents, at the end of the year Cash and cash equivalents comprise: Cash and balances with central banks Money market paper 2 Due from banks with original maturity of less than three months Total 1,241 554 2,996 6 (7,020) (797) (47,906) (16,588) 236,497 350,099 (174,443) 7,512 (220,935) (32,625) (887) 76,980 (1,502) 1,686 (1,217) 69 (712) (1,676) (40,637) 623 23,135 0 0 103,087 (92,894) 1,661 (532) (5,557) (39,186) 30,561 149,105 179,666 32,744 86,732 60,190 179,666 1,253 282 238 (120) (371) (4,085) 3,779 (60,762) 173,433 60,729 47,955 (2,408) (271,060) 7,430 (3,663) (52,078) (2,337) 885 (1,910) 134 5,981 2,753 32,672 (2,771) 0 0 (4,275) 110,874 (62,407) 1,094 (619) 74,568 (12,228) 13,015 136,090 149,105 18,793 77,215 53,097 149,105 1,325 196 (156) (117) (303) (2,092) 3,659 80,269 (61,382) (177,087) 64,029 (4,263) 66,370 14,755 (2,607) (5,384) 2,856 1,154 (1,793) 499 1,723 4,439 16,921 (3,179) 1 (631) (3,214) 97,675 (59,740) 1,331 (1,072) 48,092 (2,099) 45,048 91,042 136,090 3,495 87,144 45,451 136,090 1 Includes issuance of preferred securities of CHF 1,617 million, CHF 996 million and CHF 1,219 million for the years ended 31 December 2008, 31 December 2007 and 31 December 2006 respectively. 2 Money market paper is included in the balance sheet under Trading portfolio assets and Financial investments available-for-sale. CHF 3,853 million, CHF 3,364 million and CHF 7,183 million were pledged at 31 December 2008, 31 December 2007 and 31 December 2006 respectively. 261 n o i t a m r o f n i l a i c n a n i F Financial information Consolidated financial statements Statement of cash flows (continued) CHF million Additional information Cash received as interest Cash paid as interest Cash received as dividends on equities (incl. Associates, see Note 14) Significant non-cash investing and financing activities Private equity investments, deconsolidation Property and equipment Goodwill and intangible assets Minority interests Motor-Columbus, deconsolidation Financial investments available-for-sale Property and equipment Goodwill and intangible assets Debt issued Minority interests Acquisition of ABN AMRO’s Global Futures and Options Business Property and equipment Goodwill and intangible assets Acquisition of Banco Pactual Financial investments available-for-sale Property and equipment Goodwill and intangible assets Debt issued Acquisition of Piper Jaffray Goodwill and intangible assets Acquisition of McDonald Investments branch network Property and equipment Goodwill and intangible assets Acquisition of Daehan Investment Trust Management Company Property and equipment Goodwill and intangible assets Minority interests Acquisition of Caisse Centrale de Réescompte Group (CCR) Property and equipment Goodwill and intangible assets Debt issued Acquisition of VermogensGroep Property and equipment Goodwill and intangible assets 262 For the year ended 31.12.08 31.12.07 31.12.06 79,805 76,109 4,839 264 62 178 2,229 951 718 2,057 13 428 36 9 2,218 1,496 605 68,239 61,681 2,779 33 22 103,828 97,358 5,313 24 3 262 2 224 60 5 405 114 2 173 Financial information Notes to the consolidated financial statements Notes to the consolidated financial statements Note 1 Summary of significant accounting policies a) Significant accounting policies 1) Basis of accounting UBS AG and subsidiaries (“UBS” or the “Group”) provide a broad range of financial services including advisory services, underwriting, financing, market making, asset management and brokerage on a global level, and retail banking in Swit- zerland. The Group was formed on 29 June 1998 when Swiss Bank Corporation and Union Bank of Switzerland merged. The merger was accounted for using the uniting of interests method of accounting. The consolidated financial statements of UBS (the “Finan- cial Statements”) are prepared in accordance with Interna- tional Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB), and stated in Swiss francs (CHF), the currency of Switzerland where UBS AG is incorporated. On 5 March 2009, the Board of Directors approved them for issue. Disclosures under IFRS 7 Financial Instruments: Disclosures about the nature and extent of risks and Capital disclosures under IAS 1 Presentation of Financial Statements have been included in the audited parts of the “Risk and treasury man- agement” section. 2) Use of estimates in the preparation of Financial Statements In preparing the Financial Statements, management is re- quired to make estimates and assumptions that affect re- ported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Use of available information and application of judgment are inherent in the formation of estimates. Actual results in the future could differ from such estimates, and the differences may be material to the Finan- cial Statements. 3) Subsidiaries, associates and jointly controlled entities The Financial Statements comprise those of the parent com- pany (UBS AG) and its subsidiaries including certain special purpose entities, presented as a single economic entity. The effects of intra-group transactions are eliminated in prepar- ing the Financial Statements. Subsidiaries including special purpose entities that are directly or indirectly controlled by the Group are consolidated. UBS controls an entity if it has the power to govern the financial and operating policies so as to obtain benefits from the entity’s activities. Subsidiaries acquired are consolidated from the date control is trans- ferred to the Group. Subsidiaries to be divested are consoli- dated up to the date of disposal (i. e. loss of control). Equity attributable to minority interests is presented in the consolidated balance sheet within equity, separately from equity attributable to UBS shareholders. Net profit attributable to mi- nority interests is shown separately in the income statement. The Group sponsors the formation of entities, which may or may not be directly or indirectly owned subsidiaries, for the purpose of asset securitization transactions and structured debt issuance, and to accomplish certain narrow and well de- fined objectives. These companies may acquire assets directly or indirectly from UBS or its affiliates. Some of these compa- nies are bankruptcy-remote entities whose assets are not avail- able to satisfy the claims of creditors of the Group or any of its subsidiaries. Such companies are consolidated in the Group’s Financial Statements when the substance of the relationship between the Group and the company indicates that the com- pany is controlled by the Group. UBS also has employee ben- efit trusts that are used in connection with share-based pay- ment arrangements and deferred com pensation schemes. Pursuant to the criteria set out in SIC 12 Consolidation – Spe- cial Purpose Entities, an interpretation of IAS 27, UBS consoli- dates these trusts if it controls such entities. Investments in associates in which UBS has a significant in- fluence are accounted for under the equity method of ac- counting. Significant influence is normally evidenced when UBS owns 20% or more of a company’s voting rights. Invest- ments in associates are initially recorded at cost, and the carry- ing amount is increased or decreased to recognize the Group’s share of the investee’s net profit or loss (including net profit or loss recognized directly in equity) after the date of acquisition. Interests in jointly controlled entities, in which UBS and one or more third parties have joint control, are accounted for un- der the equity method. A jointly controlled entity is subject to a contractual agreement between UBS and one or more third parties, which establishes joint control over its economic ac- tivities. Interests in such entities are reflected under Invest- ments in associates on the balance sheet and the related dis- closures are included in the disclosures for associates. UBS holds certain interests in jointly controlled real estate entities. Assets and liabilities of subsidiaries, investments in asso- ciates and interests in jointly controlled entities are classified as “held for sale” if their carrying amount will be recovered principally through a sale transaction rather than through continuing use – see parts 17) and 26). Major lines of busi- ness and subsidiaries that were acquired exclusively with the intent for resale are presented as discontinued operations 263 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements in the income statement in the period when the sale oc- curred or it becomes highly probable that a sale will occur within 12 months – see part 26). 4) Recognition and derecognition of financial instruments UBS recognizes financial instruments on its balance sheet when the Group becomes a party to the contractual provi- sions of the instrument. UBS enters into transactions where it transfers financial as- sets recognized on its balance sheet but retains either all risks and rewards of the transferred financial assets or a portion of them. If all or substantially all risks and rewards are retained, the transferred financial assets are not derecognized from the balance sheet. Transfers of financial assets with retention of all or substantially all risks and rewards include, for example, se- curities lending and repurchase transactions described in this Note under parts 12) and 13). They further include transac- tions where financial assets are sold to a third party with a concurrent total rate of return swap on the transferred assets to retain all their risks and rewards. These types of transac- tions are accounted for as secured financing transactions. In transactions where substantially all of the risks and rewards of ownership of a financial asset are neither retained nor trans- ferred, UBS derecognizes the financial asset if control over the asset is lost. The rights and obligations retained in the transfer are recognized separately as assets and liabilities as appropriate. In transfers where control over the financial asset is retained, the Group continues to recognize the asset to the extent of its con- tinuing involvement, determined by the extent to which it is ex- posed to changes in the value of the transferred asset. Examples of such transactions are transfers of financial assets involving guarantees, writing put options, acquiring call options, or spe- cific types of swaps linked to the performance of the asset. UBS removes a financial liability from its balance sheet when it is extinguished, i. e. when the obligation specified in the contract is discharged or cancelled or expires. Assets held in an agency or fiduciary capacity are not assets of the Group and are not reported in the balance sheet, pro- vided the recognition criteria of IFRS are not satisfied. 5) Determination of fair value For an overview of financial assets and financial liabilities ac- counted for at fair value, refer to the IAS 39 measurement categories presented in Note 29: financial assets and finan- cial liabilities held for trading (including derivatives), financial assets and financial liabilities designated at fair value through profit or loss, and financial investments available-for-sale. For details on the determination of fair value, including those on fair value measurements for US student loan auction rate securities, monolines, leveraged finance transactions, US and non-US reference linked notes, US commercial mort- gage backed securities and other instruments which were determined relevant for specific disclosure refer to Note 27. For financial instruments traded in active markets, the determination of fair values of financial assets and financial lia- bilities is based on quoted market prices or dealer price quota- tions. For all other financial instruments, fair value is determined using valuation techniques. Valuation techniques include net present value techniques, the discounted cash flow method, comparison to similar instruments for which market observable prices exist and valuation models. UBS uses widely recognized valuation models for determining fair values of non-standard- ized financial instruments of lower complexity like options or interest rate and currency swaps. For these financial instru- ments, inputs into models are generally market observable. For more complex instruments, UBS uses internally devel- oped models, which are usually based on valuation methods and techniques generally recognized as standard within the industry. Valuation models are used primarily to value deriva- tives transacted in the over-the-counter market, including credit derivatives, unlisted equity and debt securities (in cluding those with embedded derivatives), and other debt instruments for which markets were or have become illiquid in 2008. Some of the inputs to these models may not be market ob- servable and are therefore estimated based on assumptions. The impact on Net profit of financial instrument valuations reflecting non-market observable inputs (level 3 profit and loss) is disclosed in Note 27. When entering into a transaction where model inputs are not market observable, the financial instrument is initially recognized at the transaction price, which is generally the best indicator of fair value. This may dif- fer from the value obtained from the valuation model. The timing of the recognition in income of this initial difference in fair value (“Deferred day 1 profit or loss”) depends on the in- dividual facts and circumstances of each transaction but is never later than when the market data become observable. Refer to Note 27 for details on deferred day 1 profit or loss. The output of a model is always an estimate or approxima- tion of a value that cannot be determined with certainty, and valuation techniques employed may not fully reflect all factors relevant to the positions UBS holds. Valuations are therefore adjusted, where appropriate, to allow for additional factors including model risks, liquidity risk and counterparty credit risk. Based on the established fair value and model gover- nance policies and related controls and procedures applied, management believes that these valuation adjustments are necessary and appropriate to fairly state the values of financial instruments carried at fair value on the balance sheet. A breakdown of fair values of financial instruments mea- sured on the basis of quoted market prices in active markets (level 1), valuation techniques reflecting market observable in- puts (level 2), and valuation techniques reflecting significant non-market-observable inputs (level 3) is provided in Note 27. 6) Trading portfolio assets and liabilities Trading portfolio assets consist of debt instruments (including those in the form of securities, money market paper, traded corporate and bank loans), equity instruments (including 264 those in the form of securities), precious metals and other commodities owned by the Group (“long” positions). Trading portfolio liabilities consist of obligations to deliver financial in- struments such as debt and equity instruments which the Group has sold to third parties but does not own (“short” positions). The trading portfolio includes non-derivative finan- cial instruments (including those with embedded derivatives) and commodities. Financial instruments which are considered derivatives in their entirety are presented on balance sheet as Positive and Negative replacement values, refer to part 14). The trading portfolio is carried at fair value. Gains and losses realized on disposal or redemption and unrealized gains and losses from changes in the fair value of trading portfolio assets and liabilities are reported as Net trading in- come. Interest and dividend income and expense on trading portfolio assets or liabilities are included in Interest and divi- dend income or Interest and dividend expense. An acquired non-derivative financial asset or liability is classified at acquisition as held for trading and presented in the trading portfolio, if it is (a) acquired or incurred princi- pally for the purpose of selling or repurchasing it in the near term; or (b) part of a portfolio of identified financial instru- ments that are managed together and for which there is evi- dence of a recent actual pattern of short-term profit-taking. The Group uses settlement date accounting when recording trading financial asset transactions. From the date the purchase transaction is entered into (trade date), UBS recognizes any un- realized profits and losses arising from revaluing that contract to fair value in Net trading income. The corresponding receivable or payable is presented on the balance sheet as a positive or nega- tive replacement value. When the transaction is consummated (settlement date), a resulting financial asset is recognized on the balance sheet at the fair value of the consideration given or re- ceived plus or minus the change in fair value of the contract since the trade date. When the Group becomes party to a sales con- tract of a financial asset classified in its trading portfolio, unreal- ized profits and losses are no longer recognized from the date the sales transaction is entered into (trade date) and it derecog- nizes the asset on the day of its transfer (settlement date). Trading portfolio assets transferred to external parties that do not qualify for derecognition (see part 4)) are reclas- sified on UBS‘s balance sheet from Trading portfolio assets to Trading portfolio assets pledged as collateral, if the transfer- ee has received the right to sell or repledge them. Following an amendment to IAS 39 in 2008 (refer to Note 1b and Note 29), subject to certain conditions being met, financial assets may be reclassified out of the “held for trading” category to the “loans and receivables” category if the firm has the intent and ability to hold them for the foreseeable future or until ma- turity. UBS has applied this option in fourth quarter 2008 and reclassified several illiquid financial instrument positions to the category “loans and receivables”, which requires these instru- ments are no longer fair valued through profit or loss but rather accounted for at amortized cost less impairment. 7) Financial assets and Financial liabilities designated at fair value through profit or loss (“Fair Value Option”) A financial instrument may only be designated at fair value through profit or loss at inception and this designation can- not subsequently be changed. Financial assets and financial liabilities designated at fair value are presented in separate lines on the face of the balance sheet. The conditions for applying the fair value option are met on the basis that a) they are hybrid instruments which consist of a debt host and an embedded derivative component, or b) they are items that are part of a portfolio which is risk managed on a fair value basis and reported to senior management on that basis, or c) the application of the fair value option reduces or elimi- nates an accounting mismatch that would otherwise arise. Hybrid instruments which fall under criterion a) above include i) bonds and compound debt liabilities issued, ii) com- pound debt liabilities – OTC, and iii) hybrid financial assets from reverse repurchase agreements. Bonds and compound debt liabilities issued and OTC generally include embedded de- rivative components which refer to an underlying, e. g. equity price, interest rate, commodities price or index. UBS has desig- nated most of its issued hybrid debt instruments as Financial liabilities designated at fair value through profit or loss. Besides hybrid instruments, the fair value option is also applied to certain loans and loan commitments which are substantially hedged with credit derivatives. The application of the fair value option to these instruments reduces an ac- counting mismatch, as loans would have been otherwise accounted for at amortized cost or as financial investments available-for-sale (refer to part 8)), whereas the hedging credit protection is accounted for as a derivative instrument at fair value through profit or loss. Loan commitments other than onerous loan commitments are only recognized on bal- ance sheet if the fair value option has been applied. UBS has also applied the fair value option to a hedge fund investment which is part of a portfolio managed on a fair value basis. Fair value changes related to financial instru- ments designated at fair value through profit or loss are recognized in Net trading income. Interest income and interest expense on financial assets and liabilities designated at fair value through profit or loss are included in Interest income on financial assets designat- ed at fair value or Interest on financial liabilities designated at fair value. Refer to Note 3. UBS applies the same recognition and derecognition prin- ciples to financial instruments designated at fair value as for financial instruments held for trading (refer to parts 4) and 6)). 8) Financial investments available-for-sale Financial investments available-for-sale are non-derivative fi- nancial assets that are not classified as held for trading, des- 265 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements ignated at fair value through profit or loss, or loans and re- ceivables. They are recognized on a settlement date basis. Financial investments available-for-sale include strategic equity investments as well as instruments that, in manage- ment’s opinion, may be sold in response to or in anticipation of needs for liquidity or changes in interest rates, foreign exchange rates or equity prices. Financial investments avail- able-for-sale consist mainly of equity instruments, including certain private equity investments. In addition, certain debt instruments and non-performing loans acquired in the secondary market are classified as financial investments available-for-sale. Financial investments available-for-sale are carried at fair value. Lock-in periods for equity investments are considered when determining fair value. Unrealized gains or losses are reported in Equity, net of applicable income taxes, until such investments are sold, collected or otherwise disposed of, or until any such investment is determined to be impaired. On disposal of an investment, the accumulated unrealized gain or loss included in Equity is transferred to Net profit for the period and reported in Other income. Gains and losses on disposal are determined using the average cost method. Interest and dividend income on financial investments available-for-sale are included in Interest and dividend in- come from financial investments available-for-sale. If a financial investment available-for-sale is determined to be impaired, the cumulative unrealized loss previously rec- ognized in Equity is included in Net profit for the period and reported in Other income. UBS assesses at each balance sheet date whether there is objective evidence that a finan- cial investment available-for-sale is impaired. In case of such evidence, it is considered impaired if its cost exceeds the re- coverable amount. The recoverable amount for a quoted fi- nancial investment available-for-sale is determined by refer- ence to the market price. A quoted financial investment available-for-sale is considered impaired if objective evidence indicates that the decline in market price has reached such a level that recovery of the cost value cannot be reasonably expected within the foreseeable future. For a non-quoted financial investment available-for-sale (debt and equity in- struments), the recoverable amount is determined by apply- ing recognized valuation techniques. The standard method applied for non-quoted equity instruments is based on the multiple of earnings observed in the market for comparable companies. Management may adjust valuations determined in this way based on its judgment. For non-quoted debt in- struments, UBS typically determines the recoverable amount by applying the discounted cash flow method. After the recognition of impairment on a financial invest- ment available-for-sale, a) increases in fair value of equity instruments are reported in Equity and b) increases in fair value of debt instruments up to original cost are recognized in Other income, provided the fair value increase has been triggered by a specific event (as defined by IFRS). 9) Loans and receivables For an overview of financial assets and financial liabilities accounted for as “loans and receivables”, refer to the IAS 39 measurement categories presented in Note 29. Loans include loans originated by the Group where money is provided directly to the borrower, participation in a loan from another lender and purchased loans that are not quot- ed in an active market and for which no intention of im- mediate or short-term resale exists. Originated and pur- chased loans that are intended to be sold in the short term are generally recorded as Trading portfolio assets. Certain purchased non-performing loans are recognized as financial investments available-for-sale. In addition, in fourth quarter 2008, UBS has reclassified certain debt financial assets from the category “held-for-trading” to “loans and receivables”, mainly due to illiquid markets for these instruments (refer to Note 1b and Note 29). At 31 December 2008, a significant portion of auction rate securities, including those acquired by UBS from clients was classified as “loans and receviables”. Refer to Note 9. Loans are recognized when cash is advanced to borrow- ers. They are initially recorded at fair value, which is the cash given to originate or purchase the loan, plus any transaction costs, and are subsequently measured at amortized cost using the effective interest rate method. Interest on loans is included in Interest earned on loans and advances and is recognized on an accrual basis. Fees and di- rect costs relating to loan origination, refinancing or restruc- turing and to loan commitments are deferred and amortized to Interest earned on loans and advances over the life of the loan using the straight-line method which approximates the effective interest rate method. Fees received for commitments that are not expected to result in a loan are included in Credit- related fees and commissions over the commitment period. Loan syndication fees where UBS does not retain a portion of the syndicated loan are credited to commission income. Commitments Letters of credit, guarantees and similar instruments commit UBS to make payments on behalf of third parties under spe- cific circumstances. These instruments, as well as undrawn irrevocable credit facilities, carry credit risk and are included in the exposure to credit risk table, in the audited “Credit risk” section of Risk and treasury management, with their gross maximum exposure to credit risk. 10) Allowance and provision for credit losses An allowance or provision for credit losses is established if there is objective evidence that the Group will be unable to collect all amounts due on a claim according to the original contractual terms or the equivalent value. A “claim” means a loan or receivable carried at amortized cost, or a commit- ment such as a letter of credit, a guarantee, a commitment to extend credit or other credit products. 266 An allowance for credit losses is reported as a reduction of the carrying value of a claim on the balance sheet. For an off-balance sheet item, such as a commitment, a provision for credit loss is reported in Other liabilities. Additions to al- lowances and provisions for credit losses are made through Credit loss expense. Allowances and provisions for credit losses are evaluated at a counterparty-specific level and collectively based on the following principles: Counterparty-specific: A claim is considered impaired when management determines that it is probable that the Group will not be able to collect all amounts due according to the original contractual terms or the equivalent value. Individual credit exposures are evaluated based on the borrower’s character, overall financial condition, resources and payment record; the prospects for support from any fi- nancially responsible guarantors; and, where applicable, the realizable value of any collateral. The estimated recoverable amount is the present value, using the loan’s original effective interest rate, of expected future cash flows, including amounts that may result from restructuring or the liquidation of collateral. Impairment is measured and allowances for credit losses are established for the difference between the carrying amount and the esti- mated recoverable amount. Upon impairment, the accrual of interest income based on the original terms of the claim is discontinued, but the increase of the present value of impaired claims due to the passage of time is reported as Interest income. All impaired claims are generally reviewed and analyzed at least annually. Any subsequent changes to the amounts and timing of the expected future cash flows compared with the prior estimates result in a change in the allowance for credit losses and are charged or credited to Credit loss expense. An allowance for impairment is reversed only when the credit quality has improved to such an extent that there is reasonable assurance of timely collection of principal and in- terest in accordance with the original contractual terms of the claim or equivalent value. A write-off is made when all or part of a claim is deemed uncollectible or forgiven. Write-offs are charged against pre- viously established allowances for credit losses or directly to Credit loss expense and reduce the principal amount of a claim. Recoveries in part or in full of amounts previously writ- ten off are credited to Credit loss expense. A loan is classified as non-performing when the payment of interest, principal or fees is overdue by more than 90 days and there is no firm evidence that it will be made good by later payments or the liquidation of collateral, insolvency proceedings have commenced against the firm, or when ob- ligations have been restructured on concessionary terms. Collectively: All loans for which no impairment is identi- fied on a counterparty-specific level are grouped into sub- portfolios with similar credit risk characteristics to collectively assess whether impairment exists within a portfolio. Allow- ances from collective assessment of impairment are recog- nized as Credit loss expense and result in an offset to the aggregated loan position. As the allowance cannot be allo- cated to individual loans, the loans are not considered to be impaired and interest is accrued on each loan according to its contractual terms. 11) Securitizations UBS securitizes various financial assets, which generally results in the sale of these assets to special purpose entities, which in turn issue securities to investors. UBS’s involvement in securiti- zation structures significantly declined in 2008. UBS applies the policies set out in part 3) in determining whether the re- spective special purpose entity must be consolidated and those set out in part 4) in determining whether derecognition of transferred financial assets is appropriate. The following statements mainly apply to financial asset transfers which are considered true sales to non-consolidated entities. Interests in the securitized financial assets may be retained in the form of senior or subordinated tranches, interest-only strips or other residual interests (“retained interests”). Re- tained interests are primarily recorded in Trading portfolio assets and carried at fair value. Gains or losses on securitiza- tion are recognized in Net trading income, which is gener- ally when the derecognition criteria are satisfied. Typically, the Group seeks to exit its risk in retained interests shortly after close of the securitization. Synthetic securitization structures typically involve derivative financial instruments for which the principles set out in part 14) apply. Purchased asset-backed securities (ABS), including mortgage-backed securities (MBS), originated by third parties are recognized as financial assets held for trading, or in a minority of cases, as Financial investments available-for-sale. In 2008, certain il- liquid ABS were reclassified to the category “loans and re- ceivables” and several student loan auction rate securities, which are considered securitized instruments, are classified as loans and receivables after acquiring them from clients. UBS acted as structurer and placement agent in various MBS and other ABS securitizations. In such capacity, UBS purchased collateral on its own behalf or on behalf of cus- tomers during the period prior to securitization. UBS typi- cally sold the collateral into designated trusts at the close of the securitization and underwrites the offerings to inves- tors. UBS earns fees for its placement and structuring ser- vices. Consistent with the valuation of similar inventory, fair value of retained tranches is initially and subsequently de- termined using market price quotations where available or internal pricing models that utilize variables such as yield curves, prepayment speeds, default rates, loss severity, in- terest rate volatilities and spreads. The assumptions used for pricing are based on observable transactions in similar secu- rities and are verified by external pricing sources, where available. 267 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements 12) Securities borrowing and lending Securities borrowing and securities lending transactions are generally entered into on a collateralized basis. In such trans- actions, UBS typically lends or borrows securities in exchange for securities or cash collateral. Additionally, UBS borrows securities from its clients’ custody accounts in exchange for a fee. The majority of securities lending and borrowing agreements involve shares, and the remainder typically in- volve bonds and notes. The transactions are conducted un- der standard agreements employed by financial market par- ticipants and are undertaken with counterparties subject to UBS’s normal credit risk control processes. UBS monitors the market value of the securities received or delivered on a dai- ly basis and requests or provides additional collateral or re- turns or recalls surplus collateral in accordance with the un- derlying agreements. The securities which have been transferred, whether in a borrowing / lending transaction or as collateral, are not recog- nized on or derecognized from the balance sheet unless the risks and rewards of ownership are also transferred. In such transactions where UBS transfers owned securities and where the borrower is granted the right to sell or repledge them, the securities are reclassified on the balance sheet from Trading portfolio assets to Trading portfolio assets pledged as collat- eral. Cash collateral received is recognized with a correspond- ing obligation to return it (Cash collateral on securities lent). Cash collateral delivered is derecognized with a correspond- ing receivable reflecting UBS’s right to receive it back (Cash collateral on securities borrowed). Securities received in a lending or borrowing transaction are disclosed as off-balance sheet items if UBS has the right to resell or repledge them, with securities that UBS has actually resold or repledged also disclosed separately (see Note 24). Additionally, the sale of securities received in a borrowing or lending transaction trig- gers the recognition of a trading liability (short sale). Consideration exchanged in financing transactions (i. e. interest received or paid) is recognized on an accrual basis and recorded as Interest income or Interest expense. 13) Repurchase and reverse repurchase transactions Securities purchased under agreements to resell (Reverse re- purchase agreements) and securities sold under agreements to repurchase (Repurchase agreements) are generally treated as collateralized financing transactions. Nearly all repurchase and reverse repurchase agreements involve debt instru- ments, such as bonds, notes or money market paper. The transactions are conducted under standard agreements em- ployed by financial market participants and are undertaken with counterparties subject to UBS’s normal credit risk con- trol processes. UBS monitors the market value of the securi- ties received or delivered on a daily basis and requests or provides additional collateral or returns or recalls surplus col- lateral in accordance with the underlying agreements. In a reverse repurchase agreement, the cash delivered is derecognized and a corresponding receivable, including ac- crued interest, is recorded in the balance sheet line Reverse repurchase agreements, recognizing UBS’s right to receive it back. In a Repurchase agreement, the cash received is recog- nized and a corresponding obligation, including accrued interest, is recorded in the balance sheet line Repurchase agreements. Securities received under reverse repurchase agreements and securities delivered under repurchase agree- ments are not recognized on or derecognized from the bal- ance sheet, unless the risks and rewards of ownership are ob- tained or relinquished. In repurchase agreements where UBS transfers owned securities and where the recipient is granted the right to resell or repledge them, the securities are reclassi- fied in the balance sheet from Trading portfolio assets to Trad- ing portfolio assets pledged as collateral. Securities received in a reverse repurchase agreement are disclosed as off-balance sheet items if UBS has the right to resell or repledge them, with securities that UBS has actually resold or repledged also disclosed separately (see Note 24). Additionally, the sale of securities received in reverse repurchase transactions triggers the recognition of a trading liability (short sale). Interest earned on reverse repurchase agreements and interest incurred on repurchase agreements is recognized as interest income or interest expense over the life of each agreement. The Group offsets reverse repurchase agreements and re- purchase agreements with the same counterparty, maturity, currency and Central Securities Depository (CSD) for transac- tions covered by legally enforceable master netting agree- ments when net or simultaneous settlement is intended. 14) Derivative instruments and hedge accounting All derivative instruments are carried at fair value on the bal- ance sheet and are reported as Positive replacement values or Negative replacement values. Where the Group enters into derivatives for trading purposes, realized and unrealized gains and losses are recognized in Net trading income. Credit losses incurred on over-the-counter (OTC) deriva- tives are also reported in Net trading income. Hedge accounting The Group also uses derivative instruments as part of its asset and liability management activities to manage expo- sures to interest rate, foreign currency and credit risks, in- cluding exposures arising from forecast transactions. The Group applies either fair value or cash flow hedge account- ing when transactions meet the specified criteria to obtain hedge accounting treatment. At the time a financial instrument is designated as a hedge, the Group formally documents the relationship be- tween the hedging instrument(s) and hedged item(s), includ- ing the risk management objectives and strategy in under- taking the hedge transaction, together with the methods that will be used to assess the effectiveness of the hedging 268 relationship. Accordingly, the Group assesses, both at the inception of the hedge and on an ongoing basis, whether the hedging derivatives have been “highly effective” in off- setting changes in the fair value or cash flows of the hedged items. UBS regards a hedge as highly effective only if the fol- lowing criteria are met: a) at inception of the hedge and throughout its life, the hedge is expected to be highly effec- tive in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, and b) actual results of the hedge are within a range of 80% to 125%. In the case of hedging a forecast transaction, the transaction must have a high probability of occurring and must present an exposure to variations in cash flows that could ultimately affect the reported net profit or loss. The Group discontinues hedge accounting when it determines that a derivative is not, or has ceased to be, highly effective as a hedge; when the de- rivative expires or is sold, terminated or exercised; when the hedged item matures, is sold or repaid; or when a forecast transaction is no longer deemed highly probable. Hedge ineffectiveness represents the amount by which the changes in the fair value of the hedging derivative differ from changes in the fair value of the hedged item or the amount by which changes in the present value of cash flows of the hedging derivative differ from changes (or expected changes) in the present value of cash flows of the hedged item. Such ineffectiveness is recorded in current period earn- ings in Net trading income. Fair value hedges For qualifying fair value hedges, the change in fair value of the hedging derivative is recognized in the income state- ment. Those changes in fair value of the hedged item that are attributable to the risks hedged with the derivative in- strument are reflected in an adjustment to the carrying value of the hedged item, which is also recognized in the income statement. The fair value change of the hedged item in a portfolio hedge of interest rate risks is reported separately from the hedged portfolio in Other assets or Other liabilities as appropriate. If the hedge relationship is terminated for reasons other than the derecognition of the hedged item, the difference between the carrying value of the hedged item at that point and the value at which it would have been carried had the hedge never existed (the “unamortized fair value adjustment”) is, in the case of interest-bearing instru- ments, amortized to the income statement over the remain- ing term of the original hedge, while for non-interest-bear- ing instruments that amount is immediately recognized in earnings. If the hedged item is derecognized, e. g. due to sale or repayment, the unamortized fair value adjustment is recognized immediately in profit or loss. Cash flow hedges A fair value gain or loss associated with the effective portion of a derivative designated as a cash flow hedge is recognized initially in Equity. When the cash flows that the derivative is hedging materialize, resulting in income or expense, then the associated gain or loss on the hedging derivative is simul- taneously transferred from Equity to the corresponding in- come or expense line item. If a cash flow hedge for a forecast transaction is deemed to be no longer effective, or if the hedge relationship is ter- minated, the cumulative gain or loss on the hedging deriva- tive previously reported in Equity remains there until the committed or forecast transaction occurs or is no longer expected to occur, at which point it is transferred to profit or loss. Economic hedges which do not qualify for hedge accounting Derivative instruments which are transacted as economic hedges but do not qualify for hedge accounting are treated in the same way as derivative instruments used for trading purposes, i. e. realized and unrealized gains and losses are recognized in Net trading income except that, in certain cases, the forward points on short duration foreign ex- change contracts are reported in Net interest income. Ad- ditionally, the Group has entered into economic hedges of credit risk within the loan portfolio using credit default swaps to which it cannot apply hedge accounting. In the event that the Group recognizes an impairment on a loan that is economically hedged in this way, the impairment is recognized in Credit loss expense, whereas any gain on the credit default swap is recorded in Net trading income. See Note 23 for additional information. Where UBS designates an economically hedged item at fair value through profit or loss, all fair value changes, including impairments, on both the hedged item and the hedging instrument are reflected in Net trading income (refer to part 7)). Credit losses in- curred on over-the-counter (OTC) derivatives are reported in Net trading income. Embedded derivatives A derivative may be embedded in a “host contract”. Such combinations are known as hybrid instruments and arise predominantly from the issuance of certain structured debt instruments. If the host contract is not carried at fair value with changes in fair value reported in the income statement, the embedded derivative is generally required to be sepa- rated from the host contract and accounted for as a stand- alone derivative instrument at fair value through profit or loss if the economic characteristics and risks of the embed- ded derivative are not closely related to the economic char- acteristics and risks of the host contract, and is the embed- ded derivative actually meets the definition of a derivative. Bifurcated embedded derivatives are presented on the same balance sheet line as the host contract, and are shown in Note 29 in the “Held for trading” category, reflecting the measurement and recognition principles applied. Typically, UBS applies the fair value option to hybrid in- 269 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements struments (see part 7)), in which case bifurcation of an em- bedded derivative component is not required. statement costs are recognized in profit and loss through depreciation of the capitalized leasehold improvements over their estimated useful life. 15) Cash and cash equivalents Cash and cash equivalents consist of Cash and balances with central banks, balances included in Due from banks with original maturity of less than three months, and Money mar- ket paper included in Trading portfolio assets and Financial investments available-for-sale. 16) Physical commodities Physical commodities (precious metals, base metals, energy and other commodities) held by UBS as a result of its broker- trader activities are accounted for at fair value less costs to sell and recognized within the Trading portfolio. Changes in fair value less costs to sell are recorded in Net trading income. 17) Property and equipment Property and equipment includes own-used properties, in- vestment properties, leasehold improvements, IT, software and communication, plant and manufacturing equipment, and other machines and equipment. With the exception of investment properties, Property and equipment is carried at cost, less accumulated deprecia- tion and accumulated impairment losses, and is periodically reviewed for impairment. The useful life of property and equipment is estimated on the basis of the economic utiliza- tion of the asset. Classification for own-used property Own-used property is defined as property held by the Group for use in the supply of services or for administrative pur- poses, whereas investment property is defined as property held to earn rental income and / or for capital appreciation. If a property of the Group includes a portion that is own-used and another portion that is held to earn rental income or for capital appreciation, the classification is based on whether or not these portions can be sold separately. If the portions of the property can be sold separately, they are separately ac- counted for as own-used property and investment property. If the portions cannot be sold separately, the whole property is classified as own-used property unless the portion used by the Group is minor. The classification of property is reviewed on a regular basis to account for major changes in its usage. Leasehold improvements Leasehold improvements are investments made to custom- ize buildings and offices occupied under operating lease contracts to make them suitable for the intended purpose. The present value of estimated reinstatement costs to bring a leased property into its original condition at the end of the lease, if required, is capitalized as part of the total leasehold improvements costs. At the same time, a corresponding lia- bility is recognized to reflect the obligation incurred. Rein- Software Software development costs are capitalized when they meet certain criteria relating to identifiability, it is probable that future economic benefits will flow to the enterprise, and the cost can be measured reliably. Internally developed software meeting these criteria and purchased software are classified within IT, software and communication. Property and equipment is depreciated on a straight-line basis over its estimated useful life as follows: Properties, excluding land Leasehold improvements Other machines and equipment IT, software and communication Not exceeding 50 years Residual lease term, but not exceeding 10 years Not exceeding 10 years Not exceeding 5 years Property held for sale Non-current property formerly own-used or leased to third parties under an operating lease and equipment the Group has decided to sell and for which the sale within 12 months is highly probable are classified as non-current assets held for sale and recorded in Other assets. Upon classification as held for sale, they are no longer depreciated and are carried at the lower of book value or net realizable value. Foreclosed properties and other properties classified as current assets are included in Properties held for sale and recorded in Other assets. They are carried at the lower of book value and net realizable value. Investment property Investment property is carried at fair value with changes in fair value recognized in the income statement in the period of change. UBS employs internal real estate experts to determine the fair value of investment property by applying recognized valuation techniques. In cases where prices of recent market transactions of comparable properties are available, fair value is determined by reference to these transactions. 18) Goodwill and intangible assets Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of net identifiable assets of the acquired entity at the date of acquisition. Goodwill is not amortized; it is tested yearly for impairment, and, additionally, when a reasonable indication of impair- ment exists. The impairment test is conducted at the seg- ment level as reported in Note 2a. The segment has been determined as the cash-generating unit for impairment testing purposes as this is the level at which the perfor- mance of investments is reviewed and assessed by manage- ment. Refer to Note 16 for details. 270 Intangible assets comprise separately identifiable intangi- ble items arising from business combinations and certain pur- chased trademarks and similar items. Intangible assets are recognized at cost. The cost of an intangible asset acquired in a business combination is its fair value at the date of acquisi- tion. Intangible assets with a definite useful life are amortized using the straight-line method over their estimated useful economic life, generally not exceeding 20 years. Intangible assets with an indefinite useful life are not amortized. Gener- ally all identified intangible assets of UBS have a definite use- ful life. At each balance sheet date, intangible assets are re- viewed for indications of impairment or changes in estimated future benefits. If such indications exist, the intangible assets are analyzed to assess whether their carrying amount is fully recoverable. An impairment loss is recognized if the carrying amount exceeds the recoverable amount. Intangible assets are classified into two categories: a) in- frastructure, and b) customer relationships, contractual rights and other. Infrastructure consists of an intangible asset rec- ognized in connection with the acquisition of PaineWebber Group, Inc. Customer relationships, contractual rights and other includes mainly intangible assets for client relation- ships, non-compete agreements, favorable contracts, propri- etary software, trademarks and trade names acquired in busi- ness combinations. 19) Income taxes Income tax payable on profits is recognized as an expense based on the applicable tax laws in each jurisdiction in the period in which profits arise. The tax effects of income tax losses available for carry forward are recognized as a de- ferred tax asset if it is probable that future taxable profit will be available against which those losses can be utilized. Deferred tax liabilities are recognized for temporary dif- ferences between the carrying amounts of assets and liabi- lities in the balance sheet and their amounts as measured for tax purposes, which will result in taxable amounts in future periods. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future periods, but only to the extent it is probable that sufficient taxable profits will be available against which these differ- ences can be utilized. Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the period in which the asset will be realized or the liability will be settled based on enacted rates. Tax assets and liabilities of the same type (current or de- ferred) are offset when they arise from the same tax report- ing group, they relate to the same tax authority, the legal right to offset exists, and they are intended to be settled net or realized simultaneously. Current and deferred taxes are recognized as income tax benefit or expense except for current and deferred taxes recognized (i) upon the acquisition of a subsidiary, (ii) for un- realized gains or losses on financial investments available- for-sale, for changes in fair value of derivative instruments designated as cash flow hedges, and for certain foreign cur- rency translations of foreign operations, (iii) for certain tax benefits on deferred compensation awards, and (iv) for gains and losses on the sale of treasury shares. Deferred taxes rec- ognized in a business combination (item (i)) are considered when determining goodwill. Items (ii), (iii) and (iv) are re- corded in Net income recognized directly in equity. 20) Debt issued Short-term debt Short-term money market paper issued is initially measured at fair value, which is the consideration received, net of transaction costs incurred. Subsequent measurement is at amortized cost, using the effective interest rate method to amortize cost at inception to the redemption value over the life of the debt. Long-term senior and subordinated debt without embedded derivative Issued debt instruments without embedded derivatives are accounted for at amortized cost. However, it is the Group’s policy to apply fair value hedge accounting to its fixed-rate debt instruments when the interest rate risk is managed on a mark-to-market basis. When fair value hedge accounting is applied to fixed-rate debt instruments, the carrying values of debt issues are adjusted for changes in fair value related to the hedged exposure rather than carried at amortized cost – refer to part 14) for further discussion. Long-term debt with embedded derivative (related to UBS AG shares) Debt instruments with embedded derivatives that are related to UBS AG shares (e. g. mandatory convertible notes) are separated into a liability and an equity component at issue date if they require physical settlement. When the hybrid debt instrument is issued, a portion of the net proceeds is allocated to the debt component based on its fair value. The determination of fair value is generally based on quoted market prices for UBS debt instruments with comparable terms. The debt component is subsequently measured at amortized cost or at fair value through profit or loss, if the fair value option is applied. The remaining amount of the net proceeds is allocated to the equity component and reported in Share premium. Subsequent changes in fair value of the separated equity component are not recognized. However, if the hybrid debt instrument or the embedded derivative re- lated to UBS AG shares is to be cash settled or if it contains a settlement alternative, then the separated derivative is accounted for as a freestanding derivative, with changes in fair value recorded in Net trading income unless the entire hybrid debt instrument is designated at fair value through profit or loss (“Fair Value Option”) – refer to part 7). 271 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Other long-term debt with embedded derivative (not related to UBS AG shares) Debt instruments with embedded derivatives that are related to non-UBS AG equity instruments, foreign exchange, credit instruments or indices are considered structured debt instru- ments. UBS has designated most of its structured debt in- struments at fair value through profit or loss (“Fair Value Option”) – see part 7). If such instruments have not been designated at fair value through profit or loss, the embed- ded derivative is separated from the host contract and ac- counted for as a standalone derivative if the criteria for sepa- ration are met. The host contract is subsequently measured at amortized cost. The fair value option is not applied to cer- tain hybrid instruments which contain bifurcatable embed- ded derivatives with references to foreign exchange rates and precious metal prices and which are not hedged by de- rivative instruments. Those hybrids are still subject to bifurca- tion of the embedded derivative. Bonds issued by UBS held as a result of market making activities or deliberate purchases in the market are treated as redemption of debt. A gain or loss on redemption is recorded depending on whether the repurchase price of the bond is lower or higher than its carrying value. A subsequent sale of own bonds in the market is treated as a reissuance of debt. Interest expense on debt instruments is included in Inter- est on debt issued. 21) Post-employment benefits UBS sponsors a number of post-employment benefit plans for its employees worldwide which include both defined benefit and defined contribution plans and other retirement benefits such as post-employment medical benefits. Contri- butions to defined contribution plans are expensed when employees have rendered services in exchange for such con- tributions, generally in the year of contribution. UBS uses the projected unit credit method to determine the present value of its defined benefit obligations and the related current service cost and, where applicable, past ser- vice cost. The principal actuarial assumptions used are set out in Note 30. UBS recognizes a portion of its actuarial gains and losses as income or expense if the net cumulative unrecognized actu- arial gains and losses at the end of the previous reporting period are outside the corridor defined as the greater of: a) 10% of present value of the defined benefit obligation at that date (before deducting the fair value of plan assets); and b) 10% of the fair value of any plan assets at that date. The unrecognized actuarial gains and losses exceeding the greater of these two values are recognized in the income statement over the expected average remaining working lives of the employees participating in the plans. If the defined benefit liability is negative (i. e. a defined benefit asset) measurement of the asset is limited to the low- er of the defined benefit asset and the total of cumulative unrecognized net actuarial losses plus unrecognized past ser- vice cost plus the present value of economic benefits available in the form of refunds of the plan or reductions in future con- tributions to the plan. However, no gain is recognized solely as a result of an actuarial loss or past service cost in the cur- rent period, and no loss is recognized solely as a result of an actuarial gain in the current period. Refer also to Note 1b. UBS recognizes curtailments on its defined benefit plans when the reductions in expected future service and in the de- fined benefit obligation are 10% or more. Reductions in ex- pected future service and in the defined benefit obligation of between 5% and 10% are recognized if deemed material, and reductions of less than 5% are generally not recognized. 22) Equity participation and other compensation plans Equity participation plans UBS provides various equity participation plans to employees in the form of share plans and share option plans. UBS rec- ognizes the fair value of share and share option awards, de- termined at the date of grant, as compensation expense over the period that the employee is required to provide active services in order to earn the award. Plans containing voluntary termination non-compete provisions (i. e. good leaver clause) and no vesting conditions are considered vested in substance at the grant date because no future ser- vice is required. The related compensation expense is recog- nized during the performance year, which is generally the period prior to the grant date. The awards remain forfeitable until the legal vesting date if certain conditions are not met. Forfeiture of awards after the grant date does not result in a reversal of compensation expense as the related services have been received. Plans containing vesting conditions typ- ically have a three-year tiered vesting structure which means awards vest in one-third increments over that period. Such awards may contain provisions that shorten the required ser- vice period due to retirement eligibility. In such instances, UBS recognizes compensation expense over the shorter of the legal vesting period and the period from grant to the retirement eligibility date of the employee. Forfeiture of these awards results in a reversal of compensation expense. The fair value of share awards is equal to the average UBS share price at the date of grant adjusted for an employee’s non-entitlement to dividends during the vesting period (if applicable) and, any post-vesting sale and hedge restrictions and non-vesting conditions. The fair value of share option awards is determined by means of a Monte Carlo simulation which takes into account the specific terms and conditions under which the share options are granted. Equity settled awards are classified as equity instruments and are not remeasured subsequent to the grant date, unless an award is modified such that its fair value immediately after 272 modification exceeds its fair value immediately prior to modi- fication. Any increase in fair value resulting from a modifica- tion is recognized as compensation expense, either over the remaining service period or immediately for vested awards. Cash settled awards are classified as liabilities and re- measured to fair value at each balance sheet date as long as they are outstanding. Decreases in fair value reduce compen- sation expense, and no compensation expense, on a cumu- lative basis, is recognized for awards that expire worthless or remain unexercised. Refer to Note 1b for the adoption of IFRS 2 Share-based Payment: Vesting Conditions and Cancellations on 1 January 2008. Other compensation plans UBS sponsors other deferred compensation plans which can be in the form of fixed or variable deferred cash compensa- tion. Expense is recognized over the service period, which is the period the employee is obligated to work in order to be- come entitled to the compensation. Fixed deferred cash compensation is generally awarded in the form of sign-on bonuses and employee forgiveable loans. The grant date fair value is fixed at the grant date. Variable deferred cash compensation is generally award- ed in the form of Alternative Investment Vehicles (AIV’s). The grant date fair value is based on the fair value of the under- lying assets (i. e. money market funds, UBS and non-UBS mutual funds and other UBS sponsored funds) on grant date and is subsequently marked-to-market at each reporting date until the award is distributed. Forfeiture of these awards results in the reversal of expense. 23) Amounts due under unit-linked investment contracts UBS Global Asset Management’s financial liabilities from unit- linked contracts are presented as Other Liabilities (refer to Note 20) on the balance sheet. These contracts allow investors to invest in a pool of assets through investment units issued by a UBS subsidiary. The unit holders receive all rewards and bear all risks associated with the reference asset pool. The financial liability represents the amount due to unit holders and is equal to the fair value of the reference asset pool. 24) Provisions Provisions are recognized when UBS has a present obligation (legal or constructive) as a result of a past event, and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reli- able estimate can be made of the amount of the obligation. Provisions are reflected under Other liabilities on the balance sheet. Refer to Note 21. The majority of UBS’s provisions relate to operational risks, including litigation. When a provision is recognized, its amount needs to be estimated as the exact amount of the obligation is generally unknown. The estimate is based on all available in- formation and reflects the amount that has the highest prob- ability of being paid. UBS revises existing provisions up or down as soon as it is able to quantify the amounts more accurately. 25) Equity, treasury shares and contracts on UBS shares UBS AG shares held UBS AG shares held by the Group are classified in Equity as Trea- sury shares and accounted for at weighted average cost. The difference between the proceeds from sales of Treasury shares and their cost (net of tax, if any) is reported as Share premium. Contracts with gross physical settlement Contracts that require gross physical settlement in UBS AG shares are classified in Equity as Share premium (provided a fixed amount of shares are exchanged against a fixed amount of cash) and accounted for at cost. Upon settlement of such contracts, the difference between the proceeds received and their cost (net of tax, if any) are reported as Share premium. Contracts with net cash settlement or settlement option for counterparty Contracts on UBS AG shares that require net cash settlement or provide the counterparty with a choice of settlement are generally classified as trading instruments, with changes in fair value reported in the income statement. Physically settled written put options and forward share purchase contracts Physically settled written put options and forward share pur- chase contracts, including contracts where physical settlement is a settlement alternative, result in the recognition of a finan- cial liability. At inception of the contract, the present value of the obligation to purchase own shares in exchange for cash is transferred out of Equity and recognized as a liability. The liabil- ity is subsequently accreted, using the effective interest rate method, over the life of the contract to the nominal purchase obligation by recognizing interest expense. Upon settlement of the contract, the liability is derecognized, and the amount of equity originally recognized as a liability is reclassified within Equity to Treasury shares. The premium received for writing put options is recognized directly in Share premium. Minority interests Net profit and Equity are presented including minority inter- ests. Net profit is split into Net profit attributable to UBS shareholders and Net profit attributable to minority interests. Equity is split into Equity attributable to UBS shareholders and Equity attributable to minority interests. Trust preferred securities issued UBS has issued trust preferred securities through consolidat- ed preferred funding trusts which hold debt issued by UBS. UBS AG has fully and unconditionally guaranteed all of these securities. UBS’s obligations under these guarantees are sub- 273 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements ordinated to the prior payment in full of the deposit liabilities of UBS and all other liabilities of UBS. The trust preferred se- curities represent equity instruments which are held by third parties and treated as minority interests in UBS’s consolidated financial statements with dividends paid also reported in Equity attributable to minority interests. UBS bonds held by preferred funding trusts are eliminated in consolidation. 26) Discontinued operations and non-current assets held for sale UBS classifies individual non-current non-financial assets and disposal groups as held for sale if such assets or disposal groups are available for immediate sale in their present con- dition subject to terms that are usual and customary for sales of such assets or disposal groups, management is committed to a plan to sell such assets and is actively looking for a buy- er, the assets are being actively marketed at a reasonable sales price in relation to their fair value, the sale is expected to be completed within one year, and their sale is considered highly probable. These assets (and liabilities in the case of disposal groups) are measured at the lower of their carrying amount and fair value less costs to sell and presented in Oth- er assets and Other liabilities (see Notes 17 and 20). Netting of assets and liabilities is not permitted. UBS presents discontinued operations in a separate line in the income statement if an entity or a component of an entity has been disposed of or is classified as held for sale and a) rep- resents a separate major line of business or geograph-ical area of operations, b) is part of a single co-ordinated plan to dis- pose of a separate major line of business or geographical area of operations, or c) is a subsidiary acquired exclusively with a view to resale (e. g., certain private equity investments). Net profit from discontinued operations includes the net total of operating profit and loss before tax from operations including net gain or loss on sale before tax or measurement to fair value less costs to sell and discontinued operations tax expense. A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for finan- cial reporting purposes, from the rest of UBS’s operations and cash flows. If an entity or a component of an entity is classified as a discontinued operation, UBS restates prior periods in the income statement – see part 3). Refer to Note 37 for details. 27) Leasing UBS enters into lease contracts, predominantly of premises and equipment, as a lessor as well as a lessee. The terms and conditions of these contracts are assessed and the leas- es are classified as operating leases or finance leases ac- cording to their economic substance. When making such an assessment, the Group focuses on the following aspects: a) transfer of ownership of the asset to the lessee at the end of the lease term; b) existence of a bargain purchase option held by the lessee; c) whether the lease term is for the major part of the economic life of the asset; d) whether the present value of the minimum lease payments is sub- stantially equal to the fair value of the leased asset at incep- tion of the lease term; and e) whether the asset is of a specialized nature that only the lessee can use without major modifications being made. If one or more of the con- ditions are met, the lease is generally classified as a finance lease, while the non-existence of such conditions normally leads to a classification as an operating lease. Lease contracts classified as operating leases where UBS is the lessee are disclosed in Note 25. These contracts include non-cancellable long-term leases of office buildings in most UBS locations. Lease contracts classified as operating leases where UBS is the lessor, and finance lease contracts where UBS is the lessor or the lessee, are not material. Contractual arrangements which are not considered leases in their entirety but which include lease elements are not material to UBS. UBS recognizes a provision for a lease contract of office space, if the unavoidable costs of a contract exceed the bene- fits to be received under it, which requires that a lease contract is considered onerous it its entirety. A provision for onerous lease contracts often includes significant vacant rental space. 28) Fee income UBS earns fee income from a diverse range of services it provides to its customers. Fee income can be divided into two broad cat- egories: income earned from services that are provided over a certain period of time, for which customers are generally billed on an annual or semi-annual basis, and income earned from providing transaction-type services. Fees earned from services that are provided over a certain period of time are recognized ratably over the service period. Fees earned from providing transaction-type services are recognized when the service has been completed. Performance-linked fees or fee components are recognized when the recognition criteria are fulfilled. Loan commitment fees on lending arrangements where the initial ex- pectation is that the loan will be drawn down at some point, are deferred until the loan is drawn down, and then recognized as an adjustment to the effective yield over the life of the loan. The following fee income is predominantly earned from services that are provided over a period of time: investment fund fees, fiduciary fees, custodian fees, portfolio and other management and advisory fees, insurance-related fees, credit- related fees and commissions received up-front. Fees predom- inantly earned from providing transaction-type services include underwriting fees, corporate finance fees and brokerage fees. 29) Foreign currency translation Foreign currency transactions are initially recorded at the spot exchange rate on the date of the transaction. At the balance sheet date, all monetary assets and liabilities and non-monetary assets and liabilities measured at fair value through profit or loss are translated using the closing ex- change rate. Non-monetary assets and liabilities not mea- sured at fair value through profit or loss are translated using 274 the historical exchange rate. Realized foreign exchange dif- ferences resulting from the sale of assets or settlement of li- abilities are recognized in Net trading income. mine the revenues and expenses directly attributable to each business unit. Internal charges and transfer pricing adjustments are reflected in the performance of each business unit. Unrealized exchange rate differences on monetary assets and liabilities are recorded in Net trading income. Unrealized exchange rate differences on non-monetary financial assets held for trading and non-monetary financial assets designated at fair value through profit or loss are recognized in Net trad- ing income. Unrealized exchange rate differences on non- monetary financial investments available-for-sale are recorded directly in Equity until the asset is sold or becomes impaired. Upon consolidation, assets and liabilities of foreign enti- ties are translated at the closing exchange rate at the balance sheet date, and income and expense items are translated at the weighted average rate for the period. Differences result- ing from the use of closing and weighted average exchange rates and from revaluing a foreign entity’s net asset balance at the closing rate are recognized directly in Foreign currency translation within Equity. 30) Earnings per share (EPS) Basic earnings per share are calculated by dividing the net profit or loss for the period attributable to ordinary share- holders by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share are calculated using the same method as for basic EPS and adjusting the net profit or loss for the period attributable to ordinary shareholders and the weight- ed average number of ordinary shares outstanding to reflect the potential dilution that could occur if options, warrants, con- vertible debt securities or other contracts to issue ordinary shares were converted or exercised into ordinary shares. 31) Segment reporting In 2008, UBS’s businesses were organized on a worldwide basis into three business divisions and the Cor porate Center. Each business division is comprised of individual business units. Global Wealth Management & Business Banking consists of three business segments: Wealth Management International & Switzerland, Wealth Management US and Business Banking Switzerland. The business divisions Investment Bank and Global Asset Management constitute one segment each. In total, UBS has reported five business segments. Corporate Center includes all corporate functions and elimination items, and is not consid- ered a business segment under IFRS. The presentation of the business segments reflects UBS’s organizational structure and management responsibilities. In February 2009, UBS announced that, going forward, it will divide its business division Global Wealth Management & Business Banking into two new busi- ness divisions: Wealth Management & Swiss Bank, comprising all non-Americas wealth management businesses as well as the Swiss private and corporate client business; and the business division Wealth Management Americas. UBS’s management reporting systems and policies deter- Inter-business unit revenues and expenses: Revenue-shar- ing agreements are used to allocate external customer reve- nues to business units on a reasonable basis. Inter-business unit charges are predominantly reported in the line “Services (to) / from other business units” for both business units con- cerned. Transactions between business units are conducted at internally agreed transfer prices or at arm’s length. Corpo- rate Center expenses are allocated to the operating business units to the extent appropriate. Net interest income is allocated to the business units based on their balance sheet positions. Assets and liabili- ties of the business divisions are funded through and invested with the central treasury departments, with the net margin reflected in the results of each business unit. To complete the allocation, Corporate Center transfers interest income earned from managing UBS’s consolidated equity back to the segments based on the average equity attributed, a con- cept which was introduced in 2008. Prior to 2008, Corpo- rate Center transferred interest income earned from manag- ing UBS’s consolidated equity back to the segments based primarily on regulatory capital requirements. For detailed discussion on the equity attribution framework, refer to the “Capital management” section of the annual report. Commissions are credited to the business unit with the corresponding customer relationship, with revenue-sharing agreements for the allocation of customer revenues where several business units are involved in value creation. Segment assets and Segment liabilities: Both segment as- sets and segment liabilities are reported in the management reporting system and shown before the elimination of inter- company balances. Due to the central treasury approach, equity must be allocated to the segments. The allocation ba- sis is average equity attributed, a concept which was intro- duced in 2008 (for a detailed discussion on the equity attri- bution framework, refer to the section “Capital management” of this report). Total segment assets and total segment liabil- ities are derived by taking into account any remaining fund- ing surplus or requirements in each business division. Prior to 2008, the equity was allocated to the segments based pri- marily on regulatory capital requirements. Refer to Note 2a. 32) Netting UBS nets assets and liabilities in its balance sheet if it has a le- gally enforceable right to set off the recognized amounts and intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously. UBS nets the positive and negative replacement values of OTC interest rate swaps trans- acted with London Clearing House. The positions are netted by currency and across maturities. Furthermore, amounts in- cluded in Loans and Due to customers related to the Prime Brokerage Business have been netted, where possible. 275 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements b) Changes in accounting policies, comparability and other adjustments Effective in 2008 Restatements made to the financial statements 2008 These financial statements 2008 replace the financial state- ments 2008 included in the Annual Report 2008 issued and filed with the US SEC on Form 20-F on 11 March 2009. UBS has restated its 2008 financial statements to correct identified accounting errors related to the 2008 financial statements, predominately to the fourth quarter 2008 finan- cial statements. These errors are not material to the annual or quarterly 2008 financial statements, but related correc- tions would have been material to first quarter 2009 finan- cial statements. The restatement comprises three items in excess of CHF 100 million as follows: – The fair value of auction rate securities purchase commit- ments at 31 December 2008, which are recognized as negative replacement values on UBS’s balance sheet, was increased by CHF 112 million, resulting in a correspond- ing charge to net trading income. – For certain assets reclassified from “held-for-trading” to “loans and receivables” in fourth quarter 2008, recogni- tion of interest income based on the effective interest rate method was reduced by CHF 180 million. Other assets were reduced accordingly as of 31 December 2008. – The partial disposals of an investment in a consolidated investment fund in 2008 gave rise to the realization of the related foreign currency translation loss deferred in shareholders’ equity. This adjustment reduced other in- come for the year 2008 by CHF 192 million but did not have a net impact on UBS’s equity. In addition to the abovementioned items, a number of misstatements individually below CHF 65 million were ad- justed. The aggregate net effect of these items was an in- crease of net profit attributable to shareholders of CHF 79 million. The total net impact of all restated items on the 2008 results was a reduction of net profit and net profit at- tributable to UBS shareholders of CHF 405 million, a reduc- tion of equity and equity attributable to UBS shareholders of CHF 269 million, and a reduction of basic and diluted earn- ings per share by CHF 0.15 and CHF 0.14 respectively. There was no effect on income tax expense. Periods prior to 2008 were not affected by the restatement. 2008 quarterly net profits attributable to UBS shareholders were reduced by the following amounts: CHF 82 million in first quarter, CHF 37 million in second quarter, CHF 13 million in third quarter, and CHF 273 million in fourth quarter. In addition, guarantees and other collateral held for loans to banks and customers at 31 December 2008 disclosed in Note 9a were reduced by CHF 11,511 million to CHF 113,032 million with a corresponding increase of unsecured loans to CHF 98,003 million. In note 19, senior long-term debt at 31 December 2008 was increased by CHF 3,199 million to CHF 67,298 million, whereas subordinated long-term debt was reduced by this amount to CHF 12,769 million. In the “Risk management and control” section, chapter on credit risk, past due but not impaired loans at 31 December 2008 were reduced by CHF 1,827 million to CHF 1,761 million. These adjustments did not impact UBS’s income statement, bal- ance sheet or earnings per share. IFRS 2 Share-based Payment: Vesting Conditions and Cancellations On 1 January 2008, UBS adopted an amendment to IFRS 2 Share-based Payment: Vesting Conditions and Cancellations and fully restated the two comparative prior years. The amended standard clarifies the definition of vesting condi- tions and the accounting treatment of cancellations. Under the amended standard, UBS is required to distinguish be- tween vesting conditions (such as service and performance conditions) and non-vesting conditions. The amended standard no longer considers vesting con- ditions to include certain non-compete provisions. The impact of this change is that UBS compensation awards are expensed over the period that the employee is required to provide active services in order to earn the award. Post-vesting sale and hedge restrictions and non-vesting con- ditions are considered when determining grant date fair val- ue. The effect of the restatement on the opening balance sheet at 1 January 2006 was as follows: reduction of retained earnings by approximately CHF 2.3 billion, increase of share premium by approximately CHF 2.3 billion, increase of liabili- ties (including deferred tax liabilities) by approximately CHF 0.5 billion, and increase of deferred tax assets by approxi- mately CHF 0.5 billion. Net profit attributable to UBS share- holders declined by CHF 863 million in 2007 and by CHF 730 million in 2006. Additional compensation expenses of CHF 797 million and CHF 516 million was recognized in 2007 and 2006, respectively. These additional compensation expenses include awards granted in 2008 for the performance year 2007. The impact of the restatement on total equity as of 31 December 2007 was a decrease of CHF 366 million. Retained earnings at 31 December 2007 decreased by approximately CHF 3.9 billion, share premium increased by approximately CHF 3.5 billion, liabilities (including deferred tax liabilities) in- creased by approximately CHF 0.6 billion and deferred tax assets increased by approximately CHF 0.2 billion. The re- statement decreased basic and diluted earnings per share for the year ended 31 December 2007 by CHF 0.40 each and for the year ended 31 December 2006 by CHF 0.33 and CHF 0.31, respectively. In order to provide comparative informa- tion, these amounts also reflect the retrospective adjustments to shares outstanding in 2007 due to the capital increase and the share dividend paid in 2008. The additional compensation expense is attributable to the 276 acceleration of expenses related to share-based awards as well as for certain alternative investment vehicle awards and deferred cash compensation awards which contain non-com- pete provisions and sale and hedge restrictions that no longer qualify as vesting conditions under the amended standard. proximately CHF 0.5 billion in Deferred tax liabilities and an increase of approximately CHF 1.6 billion in Retained earn- ings. There was no material impact to the income statements or earnings per share for these periods. Reclassifications of financial instruments The International Accounting Standards Board published an amendment to International Accounting Standard 39 (IAS 39 Financial Instruments: Recognition and Measurement) on 13 October 2008, under which eligible financial assets, subject to certain conditions being met, may be reclassified out of the “held for trading” category if the firm has the intent and abil- ity to hold them for the foreseeable future or until maturity. Although the amendment could have been applied re- trospectively from 1 July 2008, UBS decided at the end of October 2008 to apply the amendment with effect from 1 October 2008 following an assessment of the implications on its financial statements. Effective 1 October 2008, UBS reclassified eligible assets which it intends to hold for the foreseeable future with a fair value of CHF 17.6 billion on that date from “held for trading” to the “loans and receivables” category. In addi- tion, student loan auction rate securities (ARS) with a fair value of CHF 8.4 billion have been reclassified as of 31 De- cember 2008. In fourth quarter 2008, an impairment charge of CHF 1.3 billion was recognized as a credit loss expense on reclas sified financial instruments. If reclassification had not occurred, the impairment charge would not have been rec- ognized but an additional trading loss of CHF 4.8 billion would have been recorded in UBS’s income statement. Net interest income after reclassification increased by CHF 0.1 billion. Refer to Note 29 for details. Recognition of a defined benefit asset for the Swiss pension plan In third quarter 2008, UBS concluded that it meets the re- quirements in IAS 19 Employee Benefits to recognize a de- fined benefit asset associated with its Swiss pension plan. Prior to this, it had been UBS policy to only disclose this amount in the Note “Pension and Other Post-Employment Benefit Plans” of UBS’s Annual Report. UBS concluded that recognition of an asset should also consider unrecognized net actuarial losses and past service costs as permitted by IAS 19 as this results in a better reflection of the corridor ap- proach. UBS considered this a change in accounting policy to be applied retrospectively as required by IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. The change in accounting policy resulted in the following effects on the balance sheets for 1 January 2007, 31 December 2007, and 30 September 2008, which is the date the change in accounting policy was effective: an increase of approxi- mately CHF 2.1 billion in Other assets, an increase of ap- Revenues from Industrial Holdings and Goods and materials purchased The income statement no longer includes the lines Revenues from Industrial Holdings and Goods and materials purchased, as the last consolidated industrial private equity investment in Industrial Holdings was sold in first quarter 2008 and is classi- fied as a discontinued operation in UBS’s income statement. Prior periods have been restated to reflect this classification. Changes to segment reporting UBS has continuously reduced its private equity business in Industrial Holdings over the last three years. The business no longer includes consolidated industrial private equity invest- ments. Starting first quarter 2008, UBS is reporting the re- maining activities from this business, mainly financial invest- ments available-for-sale, under Corporate Center. Trading portfolio assets pledged as collateral The balance sheet line Trading portfolio assets pledged as col- lateral includes financial assets held for trading which UBS has transferred to third parties with the right of rehypothecation. Financial assets held for trading which UBS has transferred to third parties without the right of rehypothecation are present- ed under Trading portfolio assets. In order to apply this pre- sentation policy consistently, financial instruments have been reclassified from Trading portfolio assets pledged as collateral to Trading portfolio assets in the amount of CHF 50.1 billion as at 31 December 2007. The reclassification did not impact the income statements or earnings per share. IFRIC 13 Customer Loyalty Programmes IFRIC 13 was issued on 28 June 2007 and is effective for annual periods beginning on or after 1 July 2008. IFRIC 13 addresses how companies that grant their customers loyalty award credits when buying goods or services should account for their obligation to provide free or discounted goods and services, if and when the customers redeem the points. IFRIC 13 requires entities to allocate some of the proceeds of the initial sale to the award credits and recognize these proceeds as revenue only when they have fulfilled their obligations to provide goods or services. This interpretation had no signifi- cant impact on UBS’s Financial Statements. IFRIC 14 The Limit on a Defined Benefit Asset Minimum Funding Requirements and their Interaction – IAS 19 IFRIC 14 was issued on 5 July 2007 and is effective for annual periods beginning on or after 1 January 2008. IFRIC 14 pro- vides guidance regarding the circumstances under which re- funds and future reductions in contributions from a defined 277 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements benefit plan can be regarded as available to an entity for the purpose of recognizing a net defined benefit asset. Addition- ally, in jurisdictions where there is both a minimum funding re- quirement and restrictions on the amounts that companies can recover from the plan, either as refunds or reductions in contri- butions, additional liabilities may need to be recognized. This interpretation had no impact on UBS’s Financial Statements. IAS 23 Borrowing Costs The IASB issued a revised version of IAS 23 on 29 March 2007. The revised Standard is effective for annual periods beginning 1 January 2009. UBS earlier adopted the revised standard early from 1 January 2008 on a prospective basis, as permitted by the Standard. The revisions require that bor- rowing costs attributable to the acquisition, construction or production of a qualifying asset be capitalized as part of the cost of that asset. The adoption of the revised standard did not have a material impact on UBS’s Financial Statements. Effective in 2007 and earlier IFRS 7 Financial Instruments: Disclosures On 1 January 2007, UBS adopted the disclosure requirements for financial instruments under IFRS 7. The new standard has no impact on recognition, measurement and presentation of financial instruments. Accordingly, the first-time adoption of IFRS 7 had no effect on Net profit and Equity. Rather, it re- quires UBS to provide disclosures in its financial statements that enable users to evaluate: a) the significance of financial instruments for the entity’s financial position and performance (refer to the notes to the Financial Statements), and b) the nature and extent of credit, market and liquidity risks arising from financial instruments (including details about concentra- tions of such risks) during the period and at the reporting date, and how UBS manages those risks (refer to the audited sections in Risk and treasury management). The disclosure principles of IFRS 7 complement the principles for recognizing, measuring and presenting financial assets and financial liabili- ties in IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement. Netting In second quarter 2007, UBS concluded that it meets the criteria to offset Positive and Negative replacement values of OTC interest rate swaps transacted with London Clearing House (LCH). Under IFRS, positions are netted by currency and across maturities. The amount of replacement values netted was CHF 35,470 million at 31 December 2006. Fur- thermore, amounts included in Loans and Due to customers related to the Prime Brokerage business have been netted. At 31 December 2006, amounts netted were CHF 14,679 million. In both cases, the application of netting had no im- pact on UBS’s income statement, Earnings per share, credit exposure and regulatory capital. Syndicated finance revenues In fourth quarter 2007, UBS revised the presentation of certain syndicated finance revenues in its income statement. Reve- nues which relate to syndicated loan commitments designated at fair value through profit or loss are now presented in Net trading income rather than as Debt underwriting fees in Net fee and commission income. Prior periods have been adjusted to conform to this presentation. The adjustments resulted in a reduction of Net fee and commission income of CHF 425 mil- lion for 2006 and a corresponding increase in Net trading in- come in this period. The change in presentation had no impact on UBS’s Net profit and Earnings per share for 2006. The adoption of the following new interpretations on 1 January 2007 had no material impact on UBS’s Financial Statements. IFRIC 7 Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies This interpretation provides guidance on how to apply the requirements of IAS 29 in a reporting period in which an en- tity (this could be a subsidiary) identifies the existence of hy- perinflation in the economy of its functional currency, when that economy was not hyperinflationary in the prior period, and the entity therefore restates its financial statements in accordance with IAS 29. UBS has no subsidiaries operating in a hyperinflationary economy. IFRIC 8 Scope of IFRS 2 This IFRIC addresses whether IFRS 2 applies to transactions in which the entity cannot identify specifically some or all of the goods or services received. The interpretation requires that IFRS 2 be applied to transactions in which goods or ser- vices are received, such as transactions in which an entity receives goods or services as consideration for equity instru- ments of the entity. This includes transactions in which the entity cannot identify specifically some or all of the goods or services received. The unidentifiable goods or services re- ceived (or to be received) should be measured as the differ- ence between the fair value of the share-based payment and the fair value of any identifiable goods or services received (or to be received). Measurement of the unidentifiable goods or services received should take place at the grant date. However, for cash-settled transactions, the liability should be remeasured at each reporting date until it is settled. IFRIC 9 Reassessment of Embedded Derivatives The interpretation clarifies that an entity should not reassess whether an embedded derivative needs to be separated from the host contract after the initial hybrid contract is rec- ognized, unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under the contract, in which case re- assessment is required. This interpretation did not have an impact on UBS’s Financial Statements. 278 IFRIC 10 Interim Financial Reporting and Impairment The new interpretation of IAS 39 and IAS 36 requires that impairment losses recognized in a previous interim period in respect of goodwill or an investment in either an equity in- strument or a financial asset carried at cost must not be re- versed at a subsequent balance sheet date. This interpreta- tion did not have an impact on UBS’s Financial Statements. IFRIC 11 IFRS 2: Group and Treasury Share Transactions IFRIC 11 provides guidance on (a) how to account for share- based payment arrangements between entities within the same group; (b) determining whether a transaction should be accounted for as equity-settled or cash-settled when an entity either chooses or is required to buy equity instru- ments (i. e. treasury shares) from another party to satisfy its obligations to its employees; and (c) determining whether a transaction should be accounted for as equity-settled or cash-settled when an entity’s employees are granted rights to equity instruments of the entity (e. g. share options), ei- ther by the entity itself or by its shareholders, and the share- holders of the entity provide the equity instruments need- ed. The interpretation requires that share-based payment transactions in which an entity receives services as consider- ation for its own equity instruments be accounted for as an equity-settled transaction. This applies regardless of wheth- er the entity chooses or is required to buy those equity in- struments from another party to satisfy its obligations to its employees under the share-based payment arrangement. IAS 39 Financial Instruments: Recognition and Measure- ment – Amendment to the Fair Value Option UBS adopted the revised IAS 39 fair value option on 1 Janu- ary 2006. On the transition date of the revised standard, 1 January 2006, UBS did not apply the fair value option to any previously recognized financial asset or financial liability for which the fair value option had not been used under the previous fair value option guidance. Staff Accounting Bulletin (SAB) 108 In response to the release of the Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 108, Con- sidering the Effects of Prior Year Misstatements when Quan- tifying Misstatements in Current Year Financial Statements, UBS elected to adopt a modified quantitative framework for assessing whether the financial statement effect of a mis- statement is material because it renders a better evaluation of those effects. This method, which UBS adopted in Decem- ber 2006, uses a dual approach for quantifying the effect of a misstatement that considers both the carryover and revers- ing effects of prior year misstatements. c) International Financial Reporting Standards and Interpretations to be adopted in 2009 and later Effective in 2009 IFRS 8 Operating Segments IFRS 8 Operating Segments is effective on 1 January 2009 and will replace IAS 14 Segment Reporting. Under the re- quirements of the new standard, UBS’s external segmental reporting will be based on the internal reporting to the Group Executive Board (or, the “chief operating decision maker”) which makes decisions on the allocation of re- sources and assesses the performance of the reportable segments. Based on the new UBS structure which was an- nounced in February 2009 and following IFRS 8 guidance, UBS will report four operating segments in 2009. The busi- ness divisions, Wealth Management & Swiss Bank, Wealth Management Americas, Global Asset Management and In- vestment Bank represent one reportable segment each. Corporate Center does not meet the requirements of an operating segment and will be shown separately. In addi- tion, the new standard requires UBS to provide descriptive information about the types of products and services from which each reportable segment derives its revenue. As UBS’s reportable segment operations are mainly financial, the to- tal interest income and expense for all reportable segments will be presented on a net basis. Based on the present ar- rangement of revenue-sharing agreements, the inter-seg- ment revenue for UBS is unlikely to be material. Going for- ward, the segment assets and segment liabilities will be disclosed without the intercompany balances which are in line with the internal reporting. An explanation of the basis on which the segment information is prepared and recon- ciliations to the amounts presented in the income statement and balance sheet are also required by the new standard. In addition, UBS will be providing geographical information about total operating income and total non-current assets based on the following new geographical breakdown, Swit- zerland, UK, Rest of Europe, USA, Asia Pacific and Rest of the World. IAS 1 (revised) Presentation of Financial Statements and IAS 32 (revised) Financial Instruments: Presentation IAS 1 (revised), Presentation of Financial Statements, was is- sued in September 2007 and is effective on 1 January 2009. The revised standard affects the presentation of owner changes in equity and of comprehensive income: UBS will continue presenting owner changes in equity in the state- ment of changes in equity, but the detailed information re- lated to non-owner changes in equity will be removed from the statement of changes in equity and presented in the statement of comprehensive income. The revised standard does not change the recognition, measurement or disclosure of specific transactions addressed in other IFRSs. 279 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements In addition, the IASB issued a further amendment to IAS 1 and an amendment to IAS 32 regarding puttable financial instruments and obligations arising on liquidation in Febru- ary 2008. The IAS 32 amendment clarifies under which cir- cumstances puttable financial instruments and obligations arising on liquidation have to be treated as equity instru- ments. The amendment is limited in scope and is restricted to the accounting for such instruments under IAS 1, IAS 32, IAS 39 and IFRS 7. The amendment to IAS 1 requires addi- tional information about puttable financial instruments and obligations arising on liquidations which have to be treated as equity instruments. UBS will adopt the two amendments on 1 January 2009. It is not expected that these amendments will have a significant impact on UBS’s Financial Statements. Amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards and IAS 27 Consolidated and Separate Financial Statements – Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate The amendments to IFRS 1 and IAS 27 were issued on 22 May 2008 and are effective for annual periods beginning on 1 July 2009 (which is 1 January 2010 for UBS) and 1 January 2009, respectively. The amendments to IFRS 1 allow a first-time adopter, at its date of transition to IFRSs in its separate finan- cial statements, to use a deemed cost to account for an in- vestment in a subsidiary, jointly controlled entity or associate. The amendments to IAS 27 remove the definition of “cost method” and require all dividends from a subsidiary, jointly controlled entity or associate to be recognized as income in the separate financial statements of the investor when the right to receive the dividend is established and provides guid- ance on the formation of a new parent entity. These amend- ments have no impact on UBS’s Financial Statements. IFRIC 15 Agreements for the Construction of Real Estate IFRIC 15 was issued on 3 July 2008 and is effective for an- nual periods beginning on or after 1 January 2009. IFRIC 15 provides guidance on the accounting for agreements for the construction of real estate where entities enter into agree- ments with buyers before construction has been completed and the timing of revenue recognition. UBS does not expect this interpretation to have a significant impact on its Finan- cial Statements. IFRIC 16 Hedges of a Net Investment in a Foreign Operation IFRIC 16 was issued on 1 October 2008 and is effective for annual periods beginning on or after 1 October 2008. IFRIC 16 provides guidance in determining which foreign exchange risks arising from net investments in foreign operations of subsidiaries, associates, joint ventures or branches qualify for hedge accounting in accordance with IAS 39 Financial In- struments: Recognition and Measurement. IFRIC 16 clarifies that net investment hedging can only be applied when the net assets of the foreign operation are recognized in the en- tity’s consolidated financial statements. UBS is currently as- sessing the impact of this interpretation on its Financial Statements. Effective in 2010, if not adopted early Amendments to IAS 39 Financial Instruments: Recognition and Measurement – Eligible Hedged Items The amendment to IAS 39 was issued on 31 July 2008 and is effective for annual periods beginning on or after 1 July 2009. The amendments provide additional guidance on the designation of a hedged item. The amendment clarifies how the existing principles underlying hedge accounting should be applied in two particular situations: a) a one-sided risk in a hedged item and b) inflation in a financial hedged item. UBS does not expect these amendments to have a significant impact on its Financial Statements. IFRIC 17 Distributions of Non-cash Assets to Owners IFRIC 17 was issued on 27 November 2008 and is effective for annual periods beginning on or after 1 July 2009. IFRIC 17 clarifies when a dividend payable should be recognized, how the dividend payable should be measured and how to account for the difference between the carrying amount of the asset distributed and the carrying amount of the divi- dend payable once the dividend payable is settled. UBS is currently assessing the impact of this interpretation on its Financial Statements. IFRIC 18 Transfers of Assets from Customers IFRIC 18 was issued on 29 January 2009 and is effective, prospectively, for transfers of assets from customers re- ceived on or after 1 July 2009. The IFRIC clarifies how to account for transfers of items of property, plant and equip- ment by entities that receive such transfers from their cus- tomers. The interpretation also applies to agreements in which an entity receives cash from a customer when that amount of cash must be used only to construct or acquire an item of property, plant and equipment and the entity must then use that item to provide the customer with on- going access to a supply of goods and / or services. UBS is currently assessing the impact of this interpretation on its Financial Statements. IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements In January 2008, the IASB issued a revised Standard of IFRS 3 Business Combinations and amendments to IAS 27 Consoli- dated and Separate Financial Statements. The most signifi- cant changes under revised IFRS 3 are as follows: − Contingent consideration will be recognized at fair value as part of the consideration transferred at the acquisition date. Currently contingent consideration is only recog- nized once it meets the probability and reliably measur- able criteria. 280 − Non-controlling interests in an acquiree will either be measured at fair value or as the non-controlling interest’s proportionate share of the fair value of net identifiable assets of the entity acquired. The option is available on a transaction-by-transaction basis. − Transaction costs incurred by the acquirer will no longer be part of the acquisition cost but will have to be ex- pensed as incurred. The revised IFRS 3 is effective for annual periods begin- ning on or after 1 July 2009 and has to be applied prospec- tively from the date of adoption to business combinations consummated after that date. Business combinations con- summated prior to that date will not be impacted. The amendments to IAS 27 reflect changes in the account- ing for non-controlling interests and deal primarily with the ac- counting for changes in ownership interests in subsidiaries after control is obtained, the accounting for the loss of control over subsidiaries, and the allocation of profit or loss to controlling and non-controlling interests in a subsidiary. IAS 27 requires that certain amendments be applied retrospectively whereas others are applied prospectively. UBS is currently assessing the impact of the Standard on its Financial Statements. The revised IFRS 3 and the amendments to IAS 27 are ef- fective for annual periods beginning on or after 1 July 2009 and must be adopted together. UBS will adopt IFRS 3 and the amendments to IAS 27 from 1 January 2010. Note 2a Segment reporting In 2008, UBS’s businesses were organized on a worldwide basis into three business divisions and a Corporate Center. The business division Global Wealth Management & Busi- ness Banking consists of three segments: Wealth Manage- ment International & Switzerland, Wealth Management US and Business Banking Switzerland. The business divisions In- vestment Bank and Global Asset Management constitute one segment each. In total, UBS reports five business seg- ments and a Corporate Center in 2008. The Corporate Cen- ter includes all corporate functions, elimination items as well as the remaining industrial holdings activities and is not con- sidered a business segment. Refer to Note 1 of this report for information about UBS’s new segment structure, effective as of first quarter 2009. Global Wealth Management & Business Banking In 2008, Global Wealth Management & Business Banking comprised three segments. Wealth Management Interna- tional & Switzerland offers a comprehensive range of prod- ucts and services individually tailored to affluent interna- tional and Swiss clients and operates from offices around the world. Wealth Management US provides wealth manage- ment services to affluent US clients through a highly trained financial advisor network. Business Banking Switzerland pro- vides individual and corporate clients in Switzerland with a complete portfolio of banking and securities services, fo- cused on customer service excellence, profitability and growth, using a multi-channel distribution. The segments share technological and physical infrastructure, and have joint departments supporting major functions such as e- commerce, financial planning and wealth management, in- vestment policy and strategy. Refer to Note 1 of this report for the changes to the structure of this business division, ef- fective first quarter 2009. Global Asset Management The business division Global Asset Management provides in- vestment products and services to institutional investors and wholesale intermediaries around the globe. Clients include corporate and public pension plans, financial institutions and advisors, central banks, charities, foundations and individual investors. Investment Bank The business division Investment Bank operates globally as a client-driven investment banking and securities business pro- viding innovative products, research, advice and complete access to the world’s capital markets for intermediaries, governments, corporate and institutional clients and other parts of UBS. Corporate Center The Corporate Center ensures that all business divisions operate as a coherent and effective whole with a common set of values and principles in such areas as risk management and control, financial reporting, marketing and communi- cations, funding, capital and balance sheet management, management of foreign currency earnings, information technology infrastructure and service centers. In addition, Corporate Center holds the remaining activities from the industrial holding business, mainly financial investments available-for-sale. 281 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 2a Segment reporting (continued) For the year ended 31 December 2008 Internal charges and transfer pricing adjustments are reflected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a business division on a reasonable basis. Transactions between business divisions are conducted at internally agreed transfer prices or at arm’s length. CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Impairment of goodwill Amortization of intangible assets 2 Total operating expenses Performance from continuing operations before tax Performance from discontinued operations before tax Performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net profit Additional information 3 Total assets Total liabilities Capital expenditure Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Wealth Management International & Switzerland Wealth Business Banking Management US Switzerland 10,819 (390) 10,429 3,112 2,001 1,581 97 0 38 6,828 3,601 3,601 5,847 (25) 5,821 3,891 2,348 238 94 0 60 6,631 (810) (810) 5,024 (5) 5,019 2,376 1,018 (893) 70 0 0 2,570 2,449 2,449 2,904 0 2,904 926 434 150 29 0 33 1,572 1,333 1,333 (21,800) (2,575) (24,375) 4,882 3,399 990 231 341 83 9,925 (34,300) (34,300) 998 0 998 1,076 1,299 (2,066) 720 0 0 1,029 (31) 198 167 UBS 3,792 (2,996) 796 16,262 10,498 0 1,241 341 213 28,555 (27,758) 198 (27,560) (6,837) 1 (20,724) 248,355 242,390 83 61,433 53,218 135 240,212 236,504 34 33,684 30,684 95 1,752,500 1,726,708 33 (321,369) (315,222) 929 2,014,815 1,974,282 1,309 1 Impairments of financial investments available-for-sale for the year ended 31 December 2008 were as follows: Global Wealth Management & Business Banking CHF 19 million; Global Asset Manage- ment CHF 22 million; Investment Bank CHF 121 million; Corporate Center CHF 40 million. 2 Refer to Note 16 of this report for further information regarding goodwill and other intangible assets by business division. 3 The funding surplus or requirement is reflected in each business division and adjusted in Corporate Center. 282 Note 2a Segment reporting (continued) For the year ended 31 December 2008 Internal charges and transfer pricing adjustments are reflected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a business division on a reasonable basis. Transactions between business divisions are conducted at internally agreed transfer prices or at arm’s length. CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Impairment of goodwill Amortization of intangible assets 2 Total operating expenses Performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net profit Additional information 3 Total assets Total liabilities Capital expenditure Performance from continuing operations before tax Performance from discontinued operations before tax Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland 10,819 (390) 10,429 3,112 2,001 1,581 97 0 38 6,828 3,601 3,601 5,847 (25) 5,821 3,891 2,348 238 94 0 60 6,631 (810) (810) 5,024 (5) 5,019 2,376 1,018 (893) 70 0 0 2,570 2,449 2,449 2,904 0 2,904 926 434 150 29 0 33 1,572 1,333 1,333 (21,800) (2,575) (24,375) 4,882 3,399 990 231 341 83 9,925 (34,300) (34,300) 998 0 998 1,076 1,299 (2,066) 720 0 0 1,029 (31) 198 167 UBS 3,792 (2,996) 796 16,262 10,498 0 1,241 341 213 28,555 (27,758) 198 (27,560) (6,837) 1 (20,724) 248,355 242,390 83 61,433 53,218 135 240,212 236,504 34 33,684 30,684 95 1,752,500 1,726,708 33 (321,369) (315,222) 929 2,014,815 1,974,282 1,309 1 Impairments of financial investments available-for-sale for the year ended 31 December 2008 were as follows: Global Wealth Management & Business Banking CHF 19 million; Global Asset Manage- ment CHF 22 million; Investment Bank CHF 121 million; Corporate Center CHF 40 million. 2 Refer to Note 16 of this report for further information regarding goodwill and other intangible assets by business division. 3 The funding surplus or requirement is reflected in each business division and adjusted in Corporate Center. n o i t a m r o f n i l a i c n a n i F 283 Financial information Notes to the consolidated financial statements Note 2a Segment reporting (continued) For the year ended 31 December 2007 Internal charges and transfer pricing adjustments are reflected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a business division on a reasonable basis. Transactions between business divisions are conducted at internally agreed transfer prices or at arm’s length. CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets 3 Total operating expenses Performance from continuing operations before tax Performance from discontinued operations before tax Performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net profit Additional information 4 Total assets Total liabilities Capital expenditure Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Wealth Management International & Switzerland Management Business Banking Switzerland Corporate Center Industrial Holdings Wealth US 6,662 (2) 6,660 4,551 976 314 79 66 5,986 674 674 12,893 (1) 12,892 3,873 1,064 1,531 95 19 6,582 6,310 6,310 5,286 31 5,317 2,584 1,138 (739) 67 0 3,050 2,267 2,267 4,094 0 4,094 1,856 559 153 53 19 2,640 1,454 1,454 (538) (266) (804) 11,286 3,386 811 210 2 172 15,865 (16,669) (16,669) 2,873 0 2,873 1,334 1,298 (2,194) 739 0 1,177 1,696 7 1,703 689 0 689 31 8 124 0 0 163 526 138 664 UBS 31,959 (238) 31,721 25,515 8,429 0 1,243 276 35,463 (3,742) 145 (3,597) 1,369 (258) (4,708) 349,849 344,662 106 71,570 66,637 254 296,199 291,001 26 51,471 49,099 319 1,984,134 1,965,773 88 (478,833) (487,766) 1,326 501 1,659 19 2,274,891 2,231,065 2,138 1 Impairments of financial investments available-for-sale for the year ended 31 December 2007 were as follows: Global Wealth Management & Business Banking CHF 11 million; Global Asset Manage- ment CHF 39 million; Investment Bank CHF 22 million; Corporate Center CHF (1) million and Industrial Holdings CHF 3 million. 2 Includes CHF 34 million for impairments of leasehold improvements and other machines and equipment. 3 Refer to Note 16 of this report for further information regarding goodwill and other intangible assets by business division. 4 The funding surplus or requirement is reflected in each business division and adjusted in Corporate Center. 284 Note 2a Segment reporting (continued) For the year ended 31 December 2007 Internal charges and transfer pricing adjustments are reflected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a business division on a reasonable basis. Transactions between business divisions are conducted at internally agreed transfer prices or at arm’s length. CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets 3 Total operating expenses Performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net profit Additional information 4 Total assets Total liabilities Capital expenditure Performance from continuing operations before tax Performance from discontinued operations before tax Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Corporate Center Industrial Holdings 12,893 (1) 12,892 3,873 1,064 1,531 95 19 6,582 6,310 6,310 6,662 (2) 6,660 4,551 976 314 79 66 5,986 674 674 5,286 31 5,317 2,584 1,138 (739) 67 0 3,050 2,267 2,267 4,094 0 4,094 1,856 559 153 53 19 2,640 1,454 1,454 (538) (266) (804) 11,286 3,386 811 210 2 172 15,865 (16,669) (16,669) 2,873 0 2,873 1,334 1,298 (2,194) 739 0 1,177 1,696 7 1,703 689 0 689 31 8 124 0 0 163 526 138 664 UBS 31,959 (238) 31,721 25,515 8,429 0 1,243 276 35,463 (3,742) 145 (3,597) 1,369 (258) (4,708) 349,849 344,662 106 71,570 66,637 254 296,199 291,001 26 51,471 49,099 319 1,984,134 1,965,773 88 (478,833) (487,766) 1,326 501 1,659 19 2,274,891 2,231,065 2,138 1 Impairments of financial investments available-for-sale for the year ended 31 December 2007 were as follows: Global Wealth Management & Business Banking CHF 11 million; Global Asset Manage- ment CHF 39 million; Investment Bank CHF 22 million; Corporate Center CHF (1) million and Industrial Holdings CHF 3 million. 2 Includes CHF 34 million for impairments of leasehold improvements and other machines and equipment. 3 Refer to Note 16 of this report for further information regarding goodwill and other intangible assets by business division. 4 The funding surplus or requirement is reflected in each business division and adjusted in Corporate Center. n o i t a m r o f n i l a i c n a n i F 285 Financial information Notes to the consolidated financial statements Note 2a Segment reporting (continued) For the year ended 31 December 2006 Internal charges and transfer pricing adjustments are reflected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a business division on a reasonable basis. Transactions between business divisions are conducted at internally agreed transfer prices or at arm’s length. CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses Performance from continuing operations before tax Performance from discontinued operations before tax Performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net profit Additional information 3 Total assets Total liabilities Capital expenditure Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Wealth Management International & Switzerland Management Business Banking Switzerland Corporate Center Industrial Holdings Wealth US 5,863 (1) 5,862 3,839 1,073 281 74 53 5,320 542 542 10,827 1 10,828 3,173 885 1,479 84 10 5,631 5,197 5,197 5,085 109 5,194 2,439 1,120 (720) 74 0 2,913 2,281 2,281 3,220 0 3,220 1,575 399 (105) 27 4 1,900 1,320 1,320 21,726 47 21,773 11,686 3,210 1,034 2032 72 16,205 5,568 5,568 294 0 294 1,273 1,242 (1,978) 783 9 1,329 (1,035) 4 (1,031) 313 0 313 46 13 9 (1) 0 67 246 884 1,130 UBS 47,328 156 47,484 24,031 7,942 0 1,244 148 33,365 14,119 888 15,007 2,998 (11) 12,020 286,334 281,328 257 63,260 58,007 273 211,837 205,749 14 48,616 46,672 498 2,059,019 2,039,225 593 (322,221) (342,778) 1,385 1,888 3,404 97 2,348,733 2,291,607 3,117 1 Impairments of financial investments available-for-sale for the year ended 31 December 2006 were as follows: Global Wealth Management & Business Banking CHF 8 million; Global Asset Management CHF 1 million; Investment Bank CHF 5 million; Corporate Center CHF (2) million and Industrial Holdings CHF 23 million. 2 Includes a CHF 34 million software impairment. 3 The funding surplus or requirement is reflected in each business division and adjusted in Corporate Center. 286 Note 2a Segment reporting (continued) For the year ended 31 December 2006 Internal charges and transfer pricing adjustments are reflected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a business division on a reasonable basis. Transactions between business divisions are conducted at internally agreed transfer prices or at arm’s length. CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services (to) / from other business units Depreciation of property and equipment Amortization of intangible assets Total operating expenses Performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net profit Additional information 3 Total assets Total liabilities Capital expenditure Performance from continuing operations before tax Performance from discontinued operations before tax Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Corporate Center Industrial Holdings 10,827 1 10,828 3,173 885 1,479 84 10 5,631 5,197 5,197 5,863 (1) 5,862 3,839 1,073 281 74 53 5,320 542 542 5,085 109 5,194 2,439 1,120 (720) 74 0 2,913 2,281 2,281 3,220 0 3,220 1,575 399 (105) 27 4 1,900 1,320 1,320 21,726 47 21,773 11,686 3,210 1,034 2032 72 16,205 5,568 5,568 294 0 294 1,273 1,242 (1,978) 783 9 1,329 (1,035) 4 (1,031) 313 0 313 46 13 9 (1) 0 67 246 884 1,130 UBS 47,328 156 47,484 24,031 7,942 0 1,244 148 33,365 14,119 888 15,007 2,998 (11) 12,020 286,334 281,328 257 63,260 58,007 273 211,837 205,749 14 48,616 46,672 498 2,059,019 2,039,225 593 (322,221) (342,778) 1,385 1,888 3,404 97 2,348,733 2,291,607 3,117 1 Impairments of financial investments available-for-sale for the year ended 31 December 2006 were as follows: Global Wealth Management & Business Banking CHF 8 million; Global Asset Management CHF 1 million; Investment Bank CHF 5 million; Corporate Center CHF (2) million and Industrial Holdings CHF 23 million. 2 Includes a CHF 34 million software impairment. 3 The funding surplus or requirement is reflected in each business division and adjusted in Corporate Center. n o i t a m r o f n i l a i c n a n i F 287 Financial information Notes to the consolidated financial statements Note 2b Segment reporting by geographic location The geographic analysis of total assets is based on customer domicile, whereas operating income and capital expenditure are based on the location of the office in which the trans- actions and assets are recorded. Because of the global nature of financial markets, the Group's business is managed on an integrated basis worldwide, with a view to profitability by product line. The geographical analysis of operating income, total assets and capital expenditure is provided in order to comply with IFRS and does not reflect the way the Group is managed. Management believes that analysis by business division, as shown in Note 2a, is a more meaningful repre- sentation of the way in which the Group is managed. For the year ended 31 December 2008 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 11,564 (9,219) 6,132 1,453 (1,158) 770 (10,519) (1,321) 3,122 (284) 796 392 (36) 100 230,554 466,317 341,107 637,302 201,743 137,792 11 23 17 32 10 7 556 71 138 407 105 32 43 5 11 31 8 2 2,014,815 100 1,309 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 18,787 (1,671) 2,541 880 6,393 4,791 59 (5) 8 3 20 15 224,679 404,506 358,504 822,825 257,991 206,386 10 18 16 36 11 9 436 261 117 923 318 83 20 12 5 44 15 4 31,721 100 2,274,891 100 2,138 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 12,964 6,863 5,553 15,295 4,988 1,821 47,484 27 14 12 32 11 4 213,689 373,219 314,642 1,066,647 206,027 174,509 9 16 13 46 9 7 100 2,348,733 100 650 314 70 723 328 1,032 3,117 21 10 2 23 11 33 100 Switzerland United Kingdom Rest of Europe United States Asia Pacific Rest of the world Total For the year ended 31 December 2007 Switzerland United Kingdom Rest of Europe United States Asia Pacific Rest of the world Total For the year ended 31 December 2006 Switzerland United Kingdom Rest of Europe United States Asia Pacific Rest of the world Total 288 Income statement notes Note 3 Net interest and trading income Accounting standards require separate disclosure of net in- terest income and net trading income (see the tables on this and the next page). This required disclosure, however, does not take into account that net interest and trading income are generated by a range of different businesses. In many cases, a particular business can generate both net interest and trading income. Fixed income trading activity, for ex- ample, generates both trading profits and coupon income. UBS management therefore analyzes net interest and trad- ing income according to the businesses that drive it. The sec- ond table below (labeled Breakdown by businesses) provides information that corresponds to this management view. Net income from trading businesses includes both interest and trading income generated by the Group’s trading businesses and the Investment Bank’s lending activities. Net income from interest margin businesses comprises interest income from the Group’s loan portfolio. Net income from treasury and other activities reflects all income from the Group’s cen- tralized treasury function. CHF million Net interest and trading income Net interest income Net trading income Total net interest and trading income Breakdown by businesses Net income from trading businesses 1 Net income from interest margin businesses Net income from treasury activities and other Total net interest and trading income Net interest income 2 Interest income Interest earned on loans and advances 3 Interest earned on securities borrowed and reverse repurchase agreements Interest and dividend income from trading portfolio Interest income on financial assets designated at fair value Interest and dividend income from financial investments available-for-sale Total Interest expense Interest on amounts due to banks and customers Interest on securities lent and repurchase agreements Interest and dividend expense from trading portfolio Interest on financial liabilities designated at fair value Interest on debt issued Total Net interest income For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 5,992 (25,820) (19,828) (27,203) 6,160 1,214 (19,828) 20,213 22,521 22,397 404 145 5,337 (8,353) (3,016) (10,658) 6,230 1,412 (3,016) 21,263 48,274 39,101 298 176 65,679 109,112 18,150 16,123 9,162 7,298 8,954 59,687 5,992 29,318 40,581 15,812 7,659 10,405 103,775 5,337 6,521 13,743 20,264 13,730 5,718 816 20,264 15,266 39,771 32,211 25 128 87,401 20,024 34,021 14,533 4,757 7,545 80,880 6,521 12 (209) (557) (155) (1) (14) (557) (5) (53) (43) 36 (18) (40) (38) (60) (42) (5) (14) (42) 12 1 Includes lending activities of the Investment Bank. 2 Interest includes forward points on foreign exchange swaps used to manage short-term interest rate risk on foreign currency loans and depos- its. 3 Includes interest income on impaired loans and advances of CHF 99 million for 2008, CHF 110 million for 2007 and CHF 158 million for 2006. n o i t a m r o f n i l a i c n a n i F 289 Financial information Notes to the consolidated financial statements Note 3 Net interest and trading income (continued) Net trading income 1 CHF million Equities Fixed income Foreign exchange and other 2 Net trading income thereof net gains / (losses) from financial assets designated at fair value thereof net gains / (losses) from financial liabilities designated at fair value 3 thereof net gains / (losses) from own credit changes of financial liabilities designated at fair value 4 For the year ended % change from 31.12.08 4,694 (37,361) 6,846 (25,820) (974) 44,284 3,993 31.12.07 9,048 (20,949) 3,548 (8,353) (30) (3,779) 659 31.12.06 31.12.07 (48) (78) 93 (209) 7,064 2,755 3,924 13,743 (397) (3,659) 0 506 1 Refer to the table “Net interest and trading income” on the previous page for the Net income from trading businesses (for an explanation, read the corresponding introductory comment). 2 Includes trading from money markets, currencies and commodities. 3 Financial liabilities designated at fair value are to a large extent economically hedged with derivatives and other instruments whose change in fair value is also reported in Net trading income. 4 Refer to Note 27. Significant impacts on net trading income1 US sub-prime residential mortgage market US Alt-A residential mortgage market US prime residential mortgage market Credit valuation adjustments for monoline credit protection US commercial mortgage market US reference linked notes (RLN) Leveraged finance US student loans Subtotal Mandatory convertible notes 3 SNB transaction 4 Total For the year ended 31.12.08 For the year ended 31.12.07 USD billion CHF billion USD billion CHF billion (8.1) (7.4) (1.8) (7.6) (0.3) (2.6) (1.2) (1.6) (30.6) (8.2) (7.6) (1.9) (8.2) (0.4) (2.7) (1.3) (1.6) (31.9) 4.6 (5.2) (32.6) (14.6) (2.0) (0.8) (1.3) (16.6) (2.3) (0.9) (1.5) (18.7) 2 (21.3) 2 (21.3) 1 The positions disclosed in this table are reflected in Net trading income as shown in the table above. Includes mainly positions (previously) considered risk concentrations (refer to the section “Risk management and control”). Certain positions have been reclassified from “held for trading” to “loans and receivables” in fourth quarter 2008. Refer to Note 29. The profit or loss after reclassification resulting from these positions is included in net interest income and, if applicable, credit loss (expense) / recovery. 2 Includes only positions disclosed in the Annual Report 2007. 3 Refer to Note 26. 4 Refer to Note 38. 290 Note 4 Net fee and commission income CHF million Equity underwriting fees Debt underwriting fees Total underwriting fees M&A and corporate finance fees Brokerage fees Investment fund fees Fiduciary fees Custodian fees Portfolio and other management and advisory fees Insurance-related and other fees Total securities trading and investment activity fees Credit-related fees and commissions Commission income from other services Total fee and commission income Brokerage fees paid Other Total fee and commission expense Net fee and commission income Note 5 Other income CHF million Associates and subsidiaries Net gains from disposals of consolidated subsidiaries Net gains from disposals of investments in associates Share of net profits of associates Total Financial investments available-for-sale Net gains from disposals Impairment charges Total Net income from investments in property 3 Net gains from investment properties 4 Other income from Industrial Holdings Other Total other income For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 1,138 818 1,957 1,662 8,355 5,583 301 1,198 6,169 317 25,540 273 1,010 26,823 1,909 1,984 3,894 22,929 2,564 1,178 3,742 2,768 10,281 7,422 297 1,367 7,790 423 34,090 279 1,017 35,386 2,610 2,142 4,752 30,634 1,834 1,279 3,113 1,852 8,053 5,858 252 1,266 6,622 449 27,465 269 1,064 28,798 1,904 1,438 3,342 25,456 (56) (31) (48) (40) (19) (25) 1 (12) (21) (25) (25) (2) (1) (24) (27) (7) (18) (25) For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 (184) 199 1 (6) 9 615 1 (202) 413 88 0 0 183 692 (70) 28 145 103 3,338 2 (71) 3,267 108 31 689 143 4,341 (11) 21 106 116 921 (12) 909 61 5 313 204 1,608 (163) 611 (91) (82) (185) (87) (19) (100) (100) 28 (84) 1 Refer to Note 38 for details. 2 Includes a pre-tax gain of CHF 1,950 million from UBS’s sale of its 20.7% stake in Julius Baer. 3 Includes net rent received from third parties and net operating expenses. 4 Includes unrealized and realized gains from investment properties at fair value. n o i t a m r o f n i l a i c n a n i F 291 Financial information Notes to the consolidated financial statements Note 6 Personnel expenses CHF million Salaries and bonuses Contractors Insurance and social security contributions Contribution to retirement plans Other personnel expenses Total personnel expenses Note 7 General and administrative expenses CHF million Occupancy Rent and maintenance of IT and other equipment Telecommunications and postage Administration Marketing and public relations Travel and entertainment Professional fees Outsourcing of IT and other services Other Total general and administrative expenses 31.12.08 12,207 423 706 926 2,000 16,262 For the year ended 31.12.07 20,715 630 1,290 922 1,958 25,515 31.12.06 19,441 822 1,398 802 1,568 24,031 % change from 31.12.07 (41) (33) (45) 0 2 (36) For the year ended 31.12.08 1,516 31.12.07 1,569 31.12.06 1,415 669 888 926 408 728 1,085 1,029 3,249 1 10,498 701 948 991 585 1,029 1,106 1,233 267 8,429 648 906 781 601 934 919 1,090 648 7,942 % change from 31.12.07 (3) (5) (6) (7) (30) (29) (2) (17) 25 1 Included in the year ended 31 December 2008 is an amount of CHF 1,464 million for the expected costs associated with the repurchase of auction rate securities from clients and CHF 917 million in connection with UBS’s US cross-border case. Refer to Note 21 “Provisions and litigation” and Note 23 “Derivative instruments and hedge accounting”. 292 Note 8 Earnings per share (EPS) and shares outstanding For the year ended % change from 31.12.08 31.12.07 31.12.06 31.12.07 Basic earnings (CHF million) Net profit attributable to UBS shareholders from continuing operations from discontinued operations Diluted earnings (CHF million) Net profit attributable to UBS shareholders Less: (profit) / loss on equity derivative contracts Net profit attributable to UBS shareholders for diluted EPS from continuing operations from discontinued operations Weighted average shares outstanding Weighted average shares outstanding Potentially dilutive ordinary shares resulting from unvested exchangeable shares, options and warrants outstanding 1 Weighted average shares outstanding for diluted EPS Earnings per share (CHF) Basic from continuing operations from discontinued operations Diluted from continuing operations from discontinued operations Shares outstanding Total ordinary shares issued Second trading line treasury shares 2006 program Other treasury shares Total treasury shares Shares outstanding Retrospective adjustments for stock dividend 3 Retrospective adjustments for rights issue 2 Mandatory convertible notes and exchangeable shares 4 Shares outstanding for EPS (21,292) (21,442) 150 (21,292) (28) (21,320) (21,470) 150 (5,247) (5,650) 403 (5,247) (16) (5,263) (5,666) 403 11,527 10,731 796 11,527 (8) 11,519 10,723 796 2,769,575,922 2,165,301,597 2,221,591,786 1,151,556 2,770,727,478 1,467,326 2 2,166,768,923 88,242,730 2 2,309,834,516 (7.69) (7.74) 0.05 (7.69) (7.75) 0.05 (2.42) (2.61) 0.19 (2.43) (2.61) 0.19 5.19 4.83 0.36 4.99 4.64 0.34 (306) (280) (63) (306) (75) (305) (279) (63) 28 (22) 28 (218) (197) (74) (216) (197) (74) 31.12.08 As of 31.12.07 % change from 31.12.06 31.12.07 2,932,580,549 2,073,547,344 2,105,273,286 61,903,121 61,903,121 158,105,524 158,105,524 22,600,000 141,875,699 164,475,699 2,870,677,428 1,915,441,820 1,940,797,587 95,772,091 97,039,879 141,850,917 143,728,676 41 (61) (61) 50 600,557,453 518,711 139,561 3,471,234,881 2,153,583,539 2,181,705,703 61 1 Due to UBS’s losses, 28 million and 54 million potential ordinary shares from unexercised employee shares and options are not considered as they have an anti-dilutive effect for the years ended 31 December 2008 and 31 December 2007. Total equivalent shares outstanding on out-of-the-money options that were not dilutive for the respective periods but could potentially dilute earnings per share in the future were 283,263,330; 119,309,645; and 37,229,136 for the years ended 31 December 2008, 31 December 2007 and 31 December 2006 respectively. An additional 100 million ordinary shares related to the SNB transaction were not dilutive for the year ended 31 December 2008 but could potentially dilute earnings per share in the future. 2 Shares outstanding and potentially dilutive ordinary shares are increased by 7.053% due to the rights issue. 3 Shares outstanding are increased by 5% to reflect the 1:20 ratio of the stock dividend. 4 31 December 2008 includes 329,447,681 shares for the mandatory convertible notes issued to the Swiss Confederation in December 2008 and 270,438,942 shares for the mandatory convertible notes issued to two investors in March 2008, adjusted for the dilution effect of the rights issue; remaining amounts related to exchangeable shares (31 December 2007 and 31 December 2006 have been adjusted for the stock dividend and rights issue). n o i t a m r o f n i l a i c n a n i F 293 Financial information Notes to the consolidated financial statements Balance sheet notes: assets Note 9a Due from banks and loans (held at amortized cost) By type of exposure CHF million Banks Allowance for credit losses Net due from banks Loans Residential mortgages Commercial mortgages Other loans Debt instruments traditionally not classified as loans and receivables 1 Subtotal Allowance for credit losses of which: Debt instruments traditionally not classified as loans and receivables Net loans Net due from banks and loans (held at amortized cost) By geographical region (based on the location of the borrower) Switzerland United Kingdom Rest of Europe United States Asia Pacific Rest of the world Subtotal Allowance for credit losses Net due from banks, loans (held at amortized cost) and loans designated at fair value 2 By type of collateral Secured by real estate Collateralized by securities Guarantees and other collateral Unsecured Subtotal 31.12.08 64,473 (22) 64,451 121,811 21,270 170,099 30,033 343,213 (2,905) (1,329) 340,308 404,759 166,798 30,540 47,724 105,907 23,279 38,590 412,838 (2,927) 409,911 145,491 56,312 113,032 98,003 412,838 31.12.07 60,935 (28) 60,907 122,435 21,058 193,374 – 336,867 (1,003) – 335,864 396,771 166,435 29,796 43,966 70,962 27,843 62,916 401,918 (1,031) 400,887 145,927 96,306 79,936 79,749 401,918 Allowance for credit losses Net due from banks, loans (held at amortized cost) and loans designated at fair value 2 1 Includes student loan auction rate securities (ARS) of CHF 8.4 billion and other debt instruments of CHF 17.1 billion (before impairment) reclassified from the category “held for trading” to “loans and receivables” and ARS acquired from clients of CHF 4.5 billion. 2 Includes loans designated at fair value of CHF 5,153 million on 31 December 2008 and CHF 4,116 million on 31 December 2007. For further details refer to “Note 12 Financial Assets Designated at Fair Value”. 409,911 400,887 (2,927) (1,031) 294 Note 9b Allowances and provisions for credit losses CHF million Balance at the beginning of the year Write-offs Recoveries Increase / (decrease) in credit loss allowances and provisions Disposals Foreign currency translation and other adjustments Balance at the end of the year CHF million As a reduction of due from banks As a reduction of loans As a reduction of securities borrowed Subtotal Included in other liabilities related to provisions for contingent claims Total allowances and provisions for credit losses Specific allowances and provisions Collective loan loss allowances and provisions Total 31.12.08 Total 31.12.07 1,130 (868) 44 3,007 (223) (43) 3,047 34 0 0 (11) 0 0 23 1,164 (868) 44 2,996 (223) (43) 3,070 1,332 (321) 55 238 (131) (9) 1,164 Specific allowances and provisions Collective loan loss allowances and provisions Total 31.12.08 Total 31.12.07 22 2,882 112 3,016 31 3,047 0 23 0 23 0 23 22 2,905 112 3,039 31 3,070 28 1,003 70 1,101 63 1,164 Note 10 Securities borrowing, securities lending, repurchase and reverse repurchase agreements The Group enters into collateralized reverse repurchase and repurchase agreements and securities borrowing and securi- ties lending transactions that may result in credit exposure in the event that the counterparty to the transaction is unable to fulfill its contractual obligations. The Group controls credit risk associated with these activities by monitoring counter- party credit exposure and collateral values on a daily basis and requiring additional collateral to be deposited with or returned to the Group when deemed necessary. Balance sheet assets CHF million By counterparty Banks Customers Total Balance sheet liabilities CHF million By counterparty Banks Customers Total Cash collateral on Reverse repurchase securities borrowed 31.12.08 agreements 31.12.08 Cash collateral on securities borrowed 31.12.07 Reverse repurchase agreements 31.12.07 17,523 105,374 122,897 110,254 114,393 224,648 48,480 158,583 207,063 221,575 155,353 376,928 Cash collateral on securities lent 31.12.08 Repurchase agreements 31.12.08 Cash collateral on securities lent 31.12.07 Repurchase agreements 31.12.07 12,181 1,881 14,063 36,088 66,473 102,561 29,512 2,109 31,621 139,156 166,731 305,887 n o i t a m r o f n i l a i c n a n i F 295 Financial information Notes to the consolidated financial statements Note 11 Trading portfolio The Group trades in debt instruments (including money market paper and tradable loans), equity instruments, pre- cious metals, other commodities and derivatives to meet the financial needs of its customers and to generate revenue. Refer to Note 23 for derivative instruments. The table below represents a pure accounting view. It does not reflect hedges and other risk-mitigating factors and the amounts must therefore not be considered risk exposures. CHF million Trading portfolio assets Debt instruments Government and government agencies Switzerland United States Japan Other Banks Listed 1 Unlisted Corporates Listed 1 Unlisted Total debt instruments thereof pledged as collateral with central banks thereof pledged as collateral (excluding central banks) thereof pledged as collateral and can be repledged or resold by counterparty Equity instruments Listed 1 Unlisted Total equity instruments thereof pledged as collateral thereof can be repledged or resold by counterparty Precious metals and other commodities 2 Total trading portfolio assets Trading portfolio liabilities Debt instruments Government and government agencies Switzerland United States Japan Other Banks Listed 1 Unlisted Corporates Listed 1 Unlisted Total debt instruments Equity instruments Total trading portfolio liabilities 31.12.08 31.12.07 121 31,366 46,049 38,160 12,450 10,725 41,690 44,301 224,862 5,541 56,612 30,903 70,713 6,545 77,258 15,849 9,312 9,934 312,054 129 18,914 2,344 12,656 4,235 119 8,961 1,984 49,342 13,089 62,431 437 86,684 51,137 52,993 28,923 13,594 153,416 150,768 537,952 3,252 152,704 88,866 181,034 25,968 207,002 26,870 25,325 29,418 774,372 171 50,659 13,557 27,335 8,806 873 15,076 3,949 120,426 44,362 164,788 1 Includes financial instruments which are exchanged in representative markets, as defined by Art. 4d of the ordinance concerning capital adequacy and risk diversification for banks and securities traders (“Eigenmittelverordnung”, ERV), issued by the Swiss Financial Market Supervisory Authority (FINMA). 2 Other commodities predominantly consist of energy. 296 Note 12 Financial assets designated at fair value CHF million Loans Structured loans Reverse repurchase and securities borrowing agreements Banks Customers Other financial assets Total financial assets designated at fair value 31.12.08 4,500 653 4,321 2,329 1,079 12,882 31.12.07 3,633 483 4,289 1,232 2,128 11,765 The maximum exposure to credit loss of all items in the above table except for Other financial assets is equal to the fair value (CHF 11,803 million at 31 December 2008 and CHF 9,637 million at 31 December 2007). Other financial assets are generally comprised of equity investments and are not directly exposed to credit risk. The maximum exposure to credit loss at 31 December 2008 and 31 December 2007 is mitigated by collateral of CHF 6,335 million and CHF 5,830 million, respectively. The amount by which credit derivatives or similar instru- ments mitigate the maximum exposure to credit loss of loans and structured loans designated at fair value is as follows: CHF million Notional amount of loans and structured loans Credit derivatives related to loans and structured loans – notional amounts 1 Credit derivatives related to loans and structured loans – fair value 1 Additional Information 31.12.08 31.12.07 6,186 4,314 547 4,166 3,351 59 For the year ended Cumulative from inception until the year ended CHF million 31.12.08 31.12.07 31.12.08 31.12.07 Change in fair value of loans and structured loans designated at fair value, attributable to changes in credit risk 2 Change in fair value of credit derivatives and similar instruments which mitigate the maximum exposure to credit loss of loans and structured loans designated at fair value 2 (668) 486 (87) 58 (659) 547 (98) 59 1 Credit derivatives and similar instruments include credit default swaps, credit linked notes, total return swaps, put options, and similar instruments. These are generally used to manage credit risk when UBS has a direct credit exposure to the counterparty, which has not otherwise been collateralized. 2 Current and cumulative changes in the fair value of loans attributable to changes in their credit risk are only calculated for those loans oustanding at balance sheet date. Current and cumulative changes in the fair value of credit derivatives hedging such loans include all the derivatives which have been used to mitigate credit risk of these loans since designation at fair value. For loans reported under the fair value option, changes in fair value due to changes in the credit standing of the borrower are calculated using counterparty credit information obtained from independent market sources. n o i t a m r o f n i l a i c n a n i F 297 Financial information Notes to the consolidated financial statements Note 13 Financial investments available-for-sale CHF million Money market paper Other debt instruments Listed 1 Unlisted Total Equity instruments Listed 1 Unlisted Total Total financial investments available-for-sale Net unrealized gains (losses) – before tax Net unrealized gains (losses) – after tax 31.12.08 2,165 31.12.07 349 322 1,080 1,402 258 1,423 1,681 5,248 403 349 317 717 1,034 1,865 1,718 3,583 4,966 1,900 1,503 1 Includes financial instruments which are exchanged in representative markets, as defined by Art. 4d of the ordinance concerning capital adequacy and risk diversification for banks and securities traders (“Eigenmittelverordnung”, ERV), issued by the Swiss Financial Market Supervisory Authority (FINMA). Note 14 Investments in associates CHF million Carrying amount at the beginning of the year Additions Disposals Transfers Income Impairments Dividends paid Foreign currency translation Carrying amount at the end of the year 31.12.08 1,979 807 (1,307) (422) 12 (18) (34) (125) 892 31.12.07 1,523 1,656 (846) (367) 137 (17) (42) (65) 1,979 Significant associated companies of the Group had the following balance sheet and income statement totals on an aggre- gated basis, not adjusted for the Group's proportionate interest. Refer to Note 34 for a list of significant associates. 31.12.08 31.12.07 4,272 3,448 1,211 198 9,189 2,524 1,228 321 CHF million Assets Liabilities Revenues Net profit 298 Note 15 Property and equipment At historical cost less accumulated depreciation CHF million Historical cost Own-used properties Leasehold improve- ments IT, software and com- munication Other machines and equipment Plant and manu- facturing equipment Projects in progress 31.12.08 31.12.07 Balance at the beginning of the year 9,242 3,297 4,604 Additions Additions from acquired companies Disposals / write-offs 1 Reclassifications Foreign currency translation Balance at the end of the year Accumulated depreciation Balance at the beginning of the year Depreciation 2 Disposals / write-offs 1 Reclassifications Foreign currency translation Balance at the end of the year Net book value at the end of the year 3 196 0 (21) (28) (101) 9,289 265 1 (138) 289 (321) 3,393 5,121 1,969 332 (7) (160) (14) 5,272 4,017 312 (88) (4) (159) 2,031 1,362 334 6 (523) 84 (419) 4,086 4,022 497 (520) 0 (387) 3,612 475 885 75 0 (80) 53 (67) 867 540 100 (54) 0 (40) 546 321 29 0 0 (31) 0 2 0 27 0 (28) 0 2 0 0 666 311 0 0 (620) (40) 317 0 0 0 0 0 0 317 18,723 1,181 7 (792) (222) (945) 18,477 1,727 6 (1,008) (76) (403) 17,952 18,723 11,679 1,241 (697) (164) (598) 11,461 6,491 11,578 1,253 (873) (14) (266) 11,678 7,045 1 Includes write-offs of fully depreciated assets. 2 In 2008, amounts include CHF 103 million impairments of own-used property, CHF 13 million impairments of leasehold improvements, CHF 1 million impairments of IT, software and communication and CHF 14 million impairments of other machines and equipment. 3 Fire insurance value of property and equipment is CHF 14,166 million (2007: CHF 14,689 million). Investment properties at fair value CHF million Balance at the beginning of the year Additions Sales Revaluations Foreign currency translation Balance at the end of the year 31.12.08 31.12.07 189 37 0 (6) (5) 215 14 182 0 7 (14) 189 n o i t a m r o f n i l a i c n a n i F 299 Financial information Notes to the consolidated financial statements Note 16 Goodwill and intangible assets At 31 December 2008, the following four segments carried goodwill: Wealth Management International & Switzerland (CHF 1.6 billion), Wealth Management US (CHF 3.7 billion), Global Asset Management (CHF 2.0 billion), and Investment Bank (CHF 4.3 billion). For the purpose of testing goodwill for impairment, UBS considers each of these segments as a separate cash-generating unit, and determines the re cov- erable amount of a segment on the basis of value in use. The ongoing crisis in the financial markets dramatically changed industry dynamics, and the related decrease in mar- ket capitalization of UBS made it necessary during 2008 to review whether there was indication that goodwill allocated to its cash generating units was impaired. At 31 December 2008, equity attributable to UBS shareholders stood at CHF 33 billion. UBS’s market capitalization, excluding the impact of the issued MCNs, amounted to CHF 44 billion at 31 De- cember 2008. On the basis of the impairment testing meth- odology described below, UBS concluded that the year-end 2008 balances of goodwill allocated to all its segments re- main recoverable. Methodology for goodwill impairment testing The recoverable amount is determined using a proprietary model based on discounted cash flows, which has been adapted to give effect to the special features of the banking business and its regulatory environment. The recoverable amount is determined by estimating streams of earnings available to shareholders in the next five years, discounted to their present values. The terminal value reflecting all periods beyond the fifth year is calculated on the basis of the esti- mated individual return on equity for each segment, which is derived from the forecast fifth-year profit, the underlying equity, the cost of equity and the long-term growth rate. The recoverable amount of a segment is the sum of earnings available to shareholders from the first five years and the terminal value. In 2007, the recoverable amount was based on the discounted estimated streams of earnings determined in a rolling forecast process for the next four quarters and the terminal value. The five-year period for the cash flow projections applied in 2008 is considered a more appropriate measure, given the currently volatile market environment and the uncertainties in the short-term outlook. Assumptions The model is most sensitive to changes in the forecast earn- ings available to shareholders in years one to five, the esti- mated return on equity, the underlying equity, the cost of equity and to changes in the long-term growth rate. The ap- plied long-term growth rate is based on long-term risk-free interest rates. Earnings available to shareholders are estimat- ed based on forecast results, which takes into account busi- ness initiatives and planned capital investments, and returns to shareholders. Valuation parameters used within the Group’s impairment test model are linked to external market information, where applicable. Management believes that reasonable changes in key assumptions used to determine the recoverable amounts of all segments will not result in an impairment situation. Discount rate In % Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank 31.12.08 31.12.07 9.5 11.5 9.5 11.0 13.0 9.0 10.5 9.0 10.5 11.5 300 Investment Bank On 31 December 2008, the reassessment of the goodwill of UBS’s Investment Bank, which has been most affected by the implications of the financial market crises, was a key focus. Goodwill allocated to the Investment Bank amounted to CHF 4.3 billion at 31 December 2008 (CHF 5.2 billion at 31 December 2007). The reduction is due to an impairment of CHF 341 million of goodwill related to the US Municipal Se- curities Business, which was closed in June 2008 (refer to Note 38 for details) and foreign currency translation effects. In its review of the year-end 2008 goodwill balance, UBS considered the performance outlook of its Investment Bank division and the underlying business operations to resolve whether the recoverable amount for this unit covers its carrying amount, based on the methodology described above. On this basis, UBS concluded that goodwill allocated to the Investment Bank remains recoverable on 31 Decem- ber 2008. The conclusion was reached based on the forecast results which include those activities that are expected to generate positive cash flows in future years. The forecasts are based on an expectation that the economic environment will gradually improve over the next three years and reach an average growth level thereafter. The fair value obtained from the model calculation was subject to a stress test by decreas- ing forecast cash flows by one third and at the same time increasing the discount rate by 3.5 percentage points to 16.5%. The stress value covered the book value of the In- vestment Bank. However, if the conditions in the financial markets and banking industry further deteriorate and turn out to be worse than anticipated in UBS’s performance fore- casts, the goodwill carried in the Investment Bank business division may need to be impaired in future quarters. Recognition of any impairment of goodwill would reduce IFRS Equity attributable to UBS shareholders and Net profit but it would not impact cash flows, as well as the BIS Tier 1 capital, BIS total capital, and capital ratios of the UBS Group, as goodwill is required to be deducted from capital under the Basel II capital framework. CHF million Historical cost Balance at the beginning of the year Additions and reallocations Disposals Write-offs 1 Foreign currency translation Balance at the end of the year Accumulated amortization and impairment Balance at the beginning of the year Amortization Impairment of goodwill and intangible assets Disposals Write-offs 1 Foreign currency translation Balance at the end of the year Goodwill Total Infrastructure Intangible assets Customer relationships, contractual rights and other 12,829 495 (20) (356) (1,364) 11,585 0 0 341 0 (356) 15 0 876 0 0 0 (52) 824 315 42 0 0 0 (19) 337 487 1,619 90 (13) (116) (272) 1,308 471 152 20 (7) (116) (76) 444 864 Net book value at the end of the year 11,585 1 Represents write-offs of fully amortized intangible assets and impaired goodwill for disposed business activities. Total 31.12.08 31.12.07 2,495 15,324 15,493 90 (13) (116) (324) 2,131 786 193 20 (7) (116) (95) 781 585 (33) (472) (1,688) 13,716 786 193 361 (7) (472) (80) 781 612 (3) (175) (603) 15,324 720 282 0 (3) (175) (38) 786 1,350 12,935 14,538 n o i t a m r o f n i l a i c n a n i F 301 Financial information Notes to the consolidated financial statements Note 16 Goodwill and intangible assets (continued) The following table presents the disclosure of goodwill and intangible assets by business unit for the year ended 31 Decem- ber 2008. CHF million Goodwill Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank Corporate Center UBS Intangible assets Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank Corporate Center UBS Balance at the beginning of the year Additions and reallocations Disposals Amortization Impairment Foreign currency translation Balance at the end of the year 1,697 3,907 0 2,000 5,207 18 12,829 288 729 0 264 422 6 1,709 157 0 0 338 1 0 495 58 0 0 32 0 0 90 0 0 0 0 0 (20) (20) 0 0 0 0 0 (6) (6) 0 0 0 0 (341) 0 (341) (20) 0 0 0 0 0 (205) (228) 0 (356) (590) 1 1,648 3,678 0 1,982 4,277 0 (1,379) 11,585 (57) (43) 0 (77) (52) 0 251 626 0 186 286 0 (18) (60) 0 (33) (83) 0 (193) (20) (229) 1,350 The estimated, aggregated amortization expenses for intangible assets are as follows: CHF million Estimated, aggregated amortization expenses for: Intangible assets 168 153 145 125 103 656 1,350 Note 22 31.12.08 31.12.07 8,880 1,203 330 2,922 981 4,495 18,811 3,220 6,370 454 3,009 1,145 6,114 20,312 2009 2010 2011 2012 2013 2014 and thereafter Total Note 17 Other assets CHF million Deferred tax assets Settlement and clearing accounts VAT and other tax receivables Prepaid pension costs Properties held for sale Other receivables Total other assets 302 Balance sheet notes: liabilities Note 18 Due to banks and customers CHF million Due to banks Due to customers in savings and investment accounts Other amounts due to customers Total due to customers Total due to banks and customers Note 19 Financial liabilities designated at fair value and debt issued Financial liabilities designated at fair value CHF million Bonds and compound debt instruments issued Compound debt instruments – OTC Loan commitments 1 Total 31.12.08 125,628 100,647 374,127 474,774 600,402 31.12.07 145,762 109,128 532,764 641,892 787,654 31.12.08 92,446 7,468 1,632 101,546 31.12.07 183,143 8,251 459 191,853 1 Loan commitments recognized as Financial liabilities designated at fair value, until drawn down and recognized as loans. See Note 1a) 7) for additional information. At 31 December 2008, the contractual redemption amount at maturity of Financial liabilities designated at fair value through profit or loss was CHF 12.2 billion higher than the carrying value. At 31 December 2007, the contractual re- demption amount at maturity of such liabilities approximat- ed the carrying value. Refer to Note 1a) 7) for details. Debt issued (held at amortized cost) CHF million Short-term debt: Money market paper issued Long-term debt: Bonds Senior Subordinated Shares in bond issues of the Swiss Regional or Cantonal Bank’ Central Bond Institutions Medium-term notes Subtotal long-term debt Total 31.12.08 111,619 31.12.07 152,256 67,298 12,769 2,418 3,150 85,635 197,254 52,265 14,129 199 3,228 69,821 222,077 n o i t a m r o f n i l a i c n a n i F 303 Financial information Notes to the consolidated financial statements Note 19 Financial liabilities designated at fair value and debt issued (continued) The Group uses interest rate and foreign exchange deriva- tives to manage the risks inherent in certain debt issues (held at amortized cost). In the case of interest rate risk manage- ment, the Group applies hedge accounting as discussed in Note 1a) 14) and Note 23 – Derivative Instruments and Hedge Accounting. As a result of applying hedge account- ing, at 31 December 2008 and 31 December 2007, the car- rying value of debt issued was CHF 904 million higher and CHF 138 million higher, respectively, reflecting changes in fair value due to interest rate movements. The Group issues both CHF and non-CHF denominated fixed-rate and floating-rate debt. Subordinated debt securities are unsecured obligations of the Group that are subordinated in right of payment to all present and future senior indebtedness and certain other obligations of the Group. At 31 December 2008 and 31 De- cember 2007, the Group had CHF 12,769 million and CHF 14,129 million, respectively, in subordinated debt. Subordi- nated debt usually pays fixed interest annually or floating rate interest based on three-month or six-month London Interbank Offered Rate (LIBOR) and provides for single prin- cipal payments upon maturity. At 31 December 2008 and 31 December 2007, the Group had CHF 165,312 million and CHF 238,835 million, respec- tively, in unsubordinated debt (excluding money market pa- per, compound debt instruments – OTC and loan commit- ments designated at fair value). The following table shows the split between fixed-rate and floating-rate debt issues based on the contractual terms. However, it should be noted that the Group uses interest rate swaps to hedge many of the fixed-rate debt issues, which changes their repricing characteristics into those of floating-rate debt. Contractual maturity dates CHF million, except where indicated 2009 2010 2011 2012 2013 2014–2018 Thereafter 31.12.08 Total Total 31.12.07 UBS AG (Parent Bank) Senior debt Fixed rate Interest rates (range in %) Floating rate Subordinated debt Fixed rate Interest rates (range in %) Floating rate Subtotal Subsidiaries Senior debt Fixed rate Interest rates (range in %) Floating rate Subordinated debt Fixed rate Interest rates (range in %) Floating rate Subtotal Total 49,415 0–9.90 33,808 465 6.0–6.0 11,706 0–9.70 4,939 6,041 6,626 0–9.955 0–9.66375 3,979 6,455 10,994 0–9.75 4,683 17,170 0–9.90 7,881 1,627 103,579 155,432 0–9.75 19,255 81,000 131,714 83,688 16,645 10,020 13,081 15,677 5,665 2,745 8,875 9,789 2.375–7.375 4.5–8.75 3,820 34,536 3,820 4,340 23,627 197,274 301,275 60,092 0–9.03 3,505 2,904 0–9.0 2,548 8,459 813 0–8.375 0–8.495 2,000 1,033 377 0–9.0 783 1,010 9,348 83,003 76,863 0–9.494 0–9.829 4,303 4,277 18,449 35,792 74 6.25–6.25 74 0 63,671 5,452 147,359 22,097 10,459 20,479 1,846 1,160 5,313 13,625 101,526 14,927 16,837 39,849 37,252 298,800 0 0 112,655 413,930 The table above indicates fixed interest rate coupons ranging from 0 up to 9.955% on the Group’s bonds. The high or low coupons generally relate to structured debt issues prior to the separation of embedded derivatives. As a result, the stat- ed interest rate on such debt issues generally does not reflect the effective interest rate the Group is paying to service its debt after the embedded derivative has been separated and, where applicable, the application of hedge accounting. 304 Note 20 Other liabilities CHF million Provisions Provisions for contingent claims Current tax liabilities Deferred tax liabilities VAT and other tax payables Settlement and clearing accounts Amounts due under unit-linked investment contracts Other payables 1 Total other liabilities Note 31.12.08 31.12.07 21 9b 22 2,727 31 1,192 1,470 1,022 3,089 13,051 11,384 33,965 1,716 63 2,000 2,429 1,079 7,476 27,455 19,278 61,496 1 The most significant individual items included in other payables are third party interests of consolidated limited partnerships of CHF 3.1 billion, contingent payments for the acquisition of Pactual in 2006, and liabilities from cash-settled employee compensation plans. n o i t a m r o f n i l a i c n a n i F 305 Financial information Notes to the consolidated financial statements Note 21 Provisions and litigation CHF million Balance at the beginning of the year Additions from acquired companies Increase in provisions recognized in the income statement Release of provisions recognized in the income statement Provisions used in conformity with designated purpose Capitalized reinstatement costs Disposal of subsidiaries Reclassifications Foreign currency translation Balance at the end of the year Operational 1 298 Litigation 2,3 474 0 473 (182) (318) 0 0 0 (1) 270 1 3,069 (143) (990) 0 0 (980) (13) 1,418 Other 4 944 0 460 (203) (73) (21) 0 1 (69) 1,039 Total 31.12.08 1,716 1 4,002 (528) (1,381) (21) 0 (979) (83) 2,727 Total 31.12.07 1,703 0 742 (216) (570) 6 (16) 155 (88) 1,716 1 Includes provisions for litigation resulting from security risks and transaction processing risks. 2 Includes litigation resulting from legal, liability and compliance risks. 3 In 2008 Global Wealth Management and Business Banking made a provision of CHF 1,464 million (USD 1,363 million) for the expected costs of the repurchase of auction rate securities (ARS), including fines. In the fourth quarter, after the provision was partially applied for repurchases of ARS, an amount of CHF 968 million (USD 908 million), excluding fines, was reclassified to Negative replacement values (refer to Note 23 for details). In addition a provision of CHF 917 million (USD 780 million) was made in connection with UBS’s US cross-border case. 4 Includes reinstatement of costs for leasehold improvement which amounted to CHF 167 million on 31 December 2008 (CHF 233 million on 31 December 2007), provisions for onerous lease contracts, provisions for employee benefits (service anniversaries and sabbatical leaves) and other items. Litigation UBS Group operates in a legal and regulatory environment that exposes it to potentially significant litigation risks. As a result, UBS is involved in various disputes and legal proceed- ings, including litigation, arbitration, and regulatory and criminal investigations. Such cases are subject to many un- certainties, and their outcome is often difficult to predict, including the impact on the operations or financial state- ments, particularly in the earlier stages of a case. In certain circumstances, to avoid the expense and distraction of legal proceedings, UBS may, based on a cost-benefit analysis, enter into a settlement even though UBS denies any wrong- doing. The Group makes provisions for cases brought against it only when after seeking legal advice, in the opinion of management, it is probable that a liability exists, and the amount can be reasonably estimated. No provision is made for claims asserted against the Group that in the opinion of management are without merit and where it is not likely that UBS will be found liable. At 31 December 2008, UBS is involved in the following legal proceedings which could be material to the Group: a) Tax Shelter Investigation: In connection with a criminal in- vestigation of tax shelters, the United States Attorney’s Office for the Southern District of New York (US Attorney’s Office) continues to examine certain tax-oriented transac- tions in which UBS and others engaged between 1996 and 2000. UBS is continuing to cooperate in this investigation. b) Municipal Bond: In November 2006, UBS and others received subpoenas from the US Department of Justice, Antitrust Division, and the US Securities and Exchange Commission (SEC) seeking information relating to deriva- tive transactions entered into with municipal bond issuers and to the investment of proceeds of municipal bond issuances. Both investigations are ongoing, and UBS is cooperating. In addition, various state Attorneys General have issued subpoenas seeking similar information. In the SEC investigation, on 4 February 2008, UBS received a “Wells notice” advising that the SEC staff is considering recommending that the SEC bring a civil action against UBS AG in connection with the bidding of various finan- cial instruments associated with municipal securities. Un- der the SEC’s Wells process, UBS will have the opportu- nity to set forth reasons of law, policy or fact why such an action should not be brought. c) HealthSouth: UBS is defending itself in two putative secu- rities class actions brought in the US District Court of the Northern District of Alabama by holders of stock and bonds in HealthSouth Corp. In October 2008, UBS agreed to settle derivative litigation brought on behalf of Health- South in Alabama State Court. Due to existing insurance coverage this settlement has no impact on UBS’s result in 2008. d) Parmalat: UBS has been facing multiple proceedings arising out of the Parmalat insolvency. In June 2008, UBS settled all civil claims brought by Parmalat in its capacity as Assumptor in composition with creditors and Mr. Bondi (Extraordinary Commissioner of Parmalat S.p.A. and other Parmalat companies under extraordinary administration) for EUR 185 million. Other civil claims by third parties have automatically terminated as a result of termination of criminal proceedings in Milan (with the exception of some costs issues which are the subject of appeals to Court of Cassation) and will also do so in Parma when the time for filing an appeal expires, unless an appeal has been lodged in the meantime. 306 Note 21 Provisions and litigation (continued) e) Auction Rate Securities: UBS was sued by three state regu- latory authorities and was the subject of investigations by the SEC and other regulators, relating to the marketing and sale of Auction Rate Securities (ARS) to clients and to UBS’s role and participation in ARS auctions. UBS also has been named in several putative class actions and individual civil suits and a large number of individual arbitrations. The regulatory actions and investigations and the class actions followed the disruption in the markets for these securities and related auction failures since mid-February 2008. Plaintiffs and the regulators are generally seeking rescis- sion, i. e., for UBS to purchase the ARS that UBS sold to them at par value, as well as compensatory damages, dis- gorgement of profits and in some cases penalties. In May 2008, UBS entered into a settlement with the Massachu- setts Attorney General in which UBS agreed to buy back USD 36 million in auction rate securities that had been sold to general purpose municipal accounts but were impermis- sible investments for those accounts. On 8 August 2008, UBS entered into settlements in principle with the SEC, the New York Attorney General (NYAG) and other state agencies represented by the North American Securities Ad- ministrators Association (NASAA), including the Massa- chusetts Securities Division (MSD), whereby UBS agreed to offer to buy back ARS from eligible customers within cer- tain time frames, and to pay penalties of USD 150 million (USD 75 million to the NYAG, USD 75 million to the other states). On 2 October 2008, UBS finalized its settlement with the MSD, on 11 December 2008 with the SEC and the NYAG, and UBS is continuing to finalize agreements with the other state regulators. UBS’s offer to purchase back ARS was done by a registered securities offering effective 7 October 2008. UBS’s settlement is largely in line with similar industry regulatory settlements; however, UBS is the only firm of its major competitors that offered to purchase ARS from institutional clients before a date cer- tain. UBS’s settlement with the SEC and MSD requires UBS to offer to buy eligible ARS from eligible institutional clients by no later than 30 June 2010. Settlements with the other NASAA states are being worked out. The NYAG set- tlement does not reference a date certain, but contains language similar to other industry settlements requiring that UBS make ‘best efforts’ to provide liquidity solutions for institutional investors. The NYAG and SEC continue to investigate individuals affiliated with UBS who traded in ARS or who had responsibility for disclosures. On 7 Octo- ber 2008, the NYAG announced a settlement with the for- mer Investment Bank Global General Counsel relating to his trading of ARS allegedly in violation of New York’s Martin Act. The former Investment Bank Global General Counsel neither admitted nor denied the state’s allega- tions, but agreed to certain penalties and sanctions. f) US Cross-Border: UBS AG has been responding to a num- ber of governmental inquiries and investigations relating to its cross-border private banking services to US private clients during the years 2000–2008. In particular, the US Department of Justice (DOJ) has been examining whether certain US clients sought, with the assistance of UBS client advisors, to evade their US tax obligations by avoiding restrictions on their securities investments imposed by the Qualified Intermediary Agreement (QIA) UBS entered into with the US Internal Revenue Service (IRS) in 2001. DOJ and IRS are also have been examining whether UBS AG has been compliant with withholding obligations in rela- tion to sales of non-US securities under the Deemed Sales and Paid In US tax regulations. A former UBS AG client advisor pleaded guilty to one count of conspiracy to de- fraud the United States and the IRS in connection with providing investment and other services to a US person who is alleged to have evaded US income taxes on income earned on assets maintained in, among other places, a former UBS AG account in Switzerland. In November 2008, the CEO of Global WM&BB was indicted by a US federal grand jury sitting in the Southern District of Flori- da on one count of conspiring to defraud the IRS in viola- tion of US law. Among other things, the indictment al- leges that the CEO of Global WM&BB had involvement in the operation and maintenance of the US cross-border business while knowing that such business was being conducted in violation of certain US laws. The District At- torney for the County of New York has issued a request for information seeking information located in the US concerning UBS’s cross-border business, including any in- formation located in the US relating to clients of that business. Further, the IRS has delivered to UBS AG a no- tice concerning alleged violations of the QIA which UBS is responding to under the applicable cure process. The SEC has been examining whether Swiss-based UBS client advi- sors engaged in activities in relation to their US-domiciled clients that triggered an obligation for UBS Switzerland to register with the SEC as a broker- dealer and / or invest- ment adviser. Finally, the Swiss Financial Market Supervi- sory Authority (FINMA) investigated UBS’s cross-border servicing of US private clients under Swiss Banking Super- visory legislation. The investigations also have been fo- cused on the management supervision and control of the US cross-border business and the practices at issue. UBS has been working to respond in an appropriate and re- sponsible manner to all of these investigations in an effort to achieve a satisfactory resolution of these matters. As announced on 17 July 2008, UBS will no longer provide securities and banking services to US-resident private clients (including non-operating entities with US benefi- ciaries) except through its SEC-registered affiliates. On 307 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 21 Provisions and litigation (continued) 18 February 2009, UBS announced that it had entered into a Deferred Prosecution Agreement (DPA) with the DOJ and a Consent Order with the SEC. These agree- ments resolve the above-described criminal and regula- tory investigations by these authorities. As part of these settlement agreements, among other things: (i) UBS will pay a total of USD 780 million to the United States, USD 380 million representing disgorgement of profits from maintaining the US cross-border business and USD 400 million representing US federal backup withholding tax required to be withheld by UBS, together with interest and penalties, and restitution for unpaid taxes associated with certain account relationships involving fraudulent sham and nominee offshore structures and otherwise as covered by the DPA; (ii) UBS will complete the exit of the US cross-border business out of non-SEC registered enti- ties, as announced in July 2008, which these settlements permit UBS to do in a lawful, orderly and expeditious manner; (iii) UBS will implement and maintain an en- hanced program of internal controls with respect to com- pliance with its obligations under its Qualified Intermedi- ary (QI) Agreement with the Internal Revenue Service (IRS), as well as a revised Legal and Compliance gover- nance structure in order to strengthen independent legal and compliance controls; and (iv) pursuant to an order is- sued by FINMA, information was transferred to the DOJ regarding accounts of certain US clients as set forth in the DPA who, based on evidence available to UBS, appear to have committed tax fraud or the like within the meaning of the Swiss-US Double Taxation Treaty. Pursuant to the DPA, DOJ has agreed that any further prosecution of UBS will be deferred for a period of at least 18 months, sub- ject to extension under certain circumstances such as UBS needing more time to complete the implementation of the exit of its US cross-border business. If UBS satisfies all of its obligations under the DPA, the DOJ will refrain permanently from pursuing charges against UBS relating to the investigation of its US cross-border business. As part of the SEC resolution, the SEC filed a Complaint against UBS in Federal District Court in Washington, D.C., charging UBS with acting as an unregistered broker-deal- er and investment advisor in connection with maintaining its US cross-border business. Pursuant to the Consent Order, UBS did not admit or deny the allegations in that Complaint, and consented to the entry of a final judg- ment that provides, among other things, that: (i) UBS will pay USD 200 million to the SEC, representing disgorge- ment of profits from the US cross-border business (this amount is included within, and not in addition to, the USD 780 million UBS is paying to the United States as described above); and (ii) UBS will complete its exit of the US cross-border business and will be permanently enjoined from violating the SEC registration requirements by providing broker-dealer or investment advisory services to US persons through UBS entities not registered with the SEC. The DOJ and SEC agreements do not resolve issues con- cerning the pending “John Doe” summons which the IRS served on UBS in July 2008. In this regard, on 19 February 2009, the Civil Tax Division of the DOJ filed a civil petition for enforcement of this summons in US Federal District Court in Miami, through which it seeks an order directing UBS to produce information located in Switzerland re- garding US clients who have maintained accounts with UBS in Switzerland without providing a Form W-9. On 24 February 2009, the District Court issued a scheduling order pursuant to which a hearing will be held on 13 July 2009. The DPA preserves UBS’s ability to defend fully its rights in connection with the IRS’s enforcement effort. UBS believes that it has substantial defenses, including that complying with the summons would constitute a vio- lation of Swiss financial privacy laws, and intends to vig- orously contest the enforcement of the summons. The resolution of the summons litigation could result in the imposition of substantial fines, penalties and / or other remedies. In addition, pursuant to the DPA, should UBS fail to comply with a final US court order directing it to comply with the summons after fully exhausting all rights to appeal, the DOJ may, after certain conditions have been satisfied, choose to pursue various remedies avail- able for breach of the DPA. This may include charging UBS with conspiracy to commit tax fraud. Also on 18 February 2009, the FINMA published the re- sults of the now concluded investigation conducted by the Swiss Federal Banking Commission (SFBC). The SFBC concluded, among other things, that UBS violated the requirements for proper business conduct under Swiss banking law and issued an order barring UBS from pro- viding services to US resident private clients out of non- SEC registered entities. Further, the SFBC ordered UBS to enhance its control framework around its cross-border businesses, and announced that the effectiveness of such framework will be audited. g) Sub-prime-related Matters: UBS is responding to a number of governmental inquiries and investigations, and is in- volved in a number of litigations, arbitrations and disputes, related to the sub-prime crisis, sub-prime securities, and structured transactions involving sub-prime securities. These matters concern, among other things, UBS’s valua- tions, disclosures, write-downs, underwriting, and contrac- tual obligations. In particular, UBS has been in regular com- munication with, and responding to inquiries by FINMA, its home country consolidated regulator, as well as the SEC and the United States Attorney’s Office for the Eastern Dis- 308 Note 21 Provisions and litigation (continued) trict of New York (USAO), regarding some of these issues and others, including the role of internal control units, gov- ernance and processes around risk control and valuation of sub-prime instruments, compliance with public disclosure rules, and the business rationales for the launching and the reintegration of Dillon Read Capital Management (DRCM). While FINMA concluded its investigation in October 2008, the investigation by the SEC and the USAO are ongoing. In addition, a consolidated class action was filed against UBS and a number of senior directors and officers in the South- ern District of New York alleging securities fraud in connec- tion with the firm’s valuations and disclosures relating to sub-prime and asset-backed securities. UBS and a number of senior officers and directors have also been sued in a consolidated class action brought on behalf of holders of UBS ERISA retirement plans in which there were purchases of UBS stock. Both class actions are in their early stages. h) Madoff: In relation to the Madoff investment fraud, UBS, UBS (Luxembourg) SA and certain other UBS subsidiaries are responding to inquiries by a number of regulators, including FINMA and the Luxembourg Commission de surveillance du secteur financier (CSSF). CSSF has made inquiries concerning two third party funds established under Luxembourg law the assets of which were man- aged by Bernard L. Madoff Investment Securities LLC, and which now face severe losses. The documentation estab- lishing both funds suggests that UBS entities act in vari- ous capacities including custodian, administrator, man- ager, distributor and promoter, and that UBS employees serve as board members. On 25 February 2009, the CSSF issued a communiqué with respect to the larger of the two funds, stating that UBS (Luxembourg) SA had failed to comply with its due diligence responsibilities as custo- dian bank. The CSSF ordered UBS (Luxembourg) SA to review its infrastructure and procedures relating to its supervisory obligations as custodian bank, but did not or- der it to compensate investors. To date, very few investor claims have been filed, and most have related to unsatis- fied redemption requests delivered to these funds prior to the revelation of the Madoff scheme. Further, certain cli- ents of UBS Sauerborn (the KeyClient segment of UBS Deutschland AG) are exposed to Madoff-managed posi- tions through third party funds and funds administered by UBS Sauerborn. n o i t a m r o f n i l a i c n a n i F 309 Financial information Notes to the consolidated financial statements Note 22 Income taxes CHF million Tax expense from continuing operations Domestic Current Deferred Foreign Current Deferred Total income tax expense from continuing operations Tax expense from discontinued operations Domestic Foreign Total income tax expense from discontinued operations Total income tax expense For the year ended 31.12.08 31.12.07 31.12.06 (336) (7,282) 519 262 (6,837) 1 0 1 (6,836) 409 (25) 1,061 (76) 1,369 (258) 0 (258) 1,111 1,759 (107) 1,533 (187) 2,998 (12) 1 (11) 2,987 Of the deferred tax benefit in the income statement of CHF 7,020 million, CHF 6,126 million relates to the recognition of incremental net deferred tax assets in respect of available tax losses. The incremental deferred tax assets mainly relate to Swiss tax losses incurred during the year (primarily due to the writedown of investments in US subsidiaries). The tax benefit was reduced by a decrease in the deferred tax asset recog- nized for US tax losses. estimated basis during the year, part of which are expected to be repaid because the final tax liability for the year is an- ticipated to be less than the amounts paid. The current tax expense for 2008 is net of tax benefits related to prior years of CHF 446 million. There were also deferred tax benefits related to prior years of CHF 44 mil- lion giving total tax benefits relating to prior years of CHF 490 million. The Group made net tax payments, including domestic and foreign taxes, of CHF 887 million, CHF 3,663 million, CHF 2,607 million in 2008, 2007 and 2006 respectively. The tax payments in 2008 include installment payments paid on The components of operating profit before tax, and the differences between income tax expense reflected in the Fi- nancial Statements and the amounts calculated at the Swiss statutory rate, are as follows: CHF million Operating profit from continuing operations before tax Domestic Foreign Income taxes at Swiss statutory rate of 22% for 2008, 2007 and 2006 Increase / (decrease) resulting from: Applicable tax rates differing from Swiss statutory rate Tax effects of losses not recognized Previously unrecorded tax losses now utilized Lower taxed income Non-deductible goodwill and intangible asset amortization Other non-deductible expenses Adjustments related to prior years Change in deferred tax valuation allowance Other items 31.12.08 (27,758) 3,269 (31,027) (6,107) (7,056) 7,412 (10) (773) 160 737 (490) (692) (17) For the year ended 31.12.07 (3,742) 10,337 (14,079) (823) (3,054) 6,327 (257) (1,587) 15 227 (72) 279 314 Income tax expense from continuing operations (6,837) 1,369 31.12.06 14,119 5,503 8,616 3,106 799 21 (676) (941) 21 183 316 (192) 361 2,998 310 Note 22 Income taxes (continued) Significant components of the Group’s gross deferred income tax assets and liabilities are as follows: CHF million Deferred tax assets Compensation and benefits Tax loss carry-forwards Trading assets Other Total Valuation allowance Deferred tax assets recognized Deferred tax liabilities Compensation and benefits Property and equipment Financial investments and associates Trading assets Goodwill and intangible assets Other Deferred tax liabilities 31.12.08 31.12.07 1,534 32,834 608 258 35,234 (26,354) 8,880 111 29 206 244 289 591 3,370 10,385 163 859 14,777 (11,557) 3,220 470 175 690 498 173 424 1,470 2,429 The change in the balance of net deferred tax assets and deferred tax liabilities does not equal the deferred tax expense in those years. This is mainly due to the effects of exchange rate changes on tax assets and liabilities denom- inated in currencies other than CHF. For the above purpos- es, the valuation allowance represents amounts that are not expected to provide future benefits, either because they are offset against potential tax adjustments or due to insufficiency of future taxable income. The deferred tax as- sets recognized at 31 December 2008 were as follows: Compensation and benefits: CHF 321 million; Tax loss carry- forwards: CHF 8,126 million; Trading assets: CHF 243 million; and Other: CHF 190 million. UBS AG Switzerland and certain overseas branches and subsidiaries of the Group have deferred tax assets related to tax loss carry-forwards and other items. Because the realiza- tion of these assets is uncertain, the Group has established valuation allowances of CHF 26,354 million (CHF 11,557 million at 31 December 2007) mainly relating to US tax loss- es. For entities that incurred losses in either the current or preceding year, an amount of CHF 8,463 million is recog- nized as deferred tax assets at 31 December 2008 (CHF 2,363 million at 31 December 2007). These deferred tax as- sets mainly relate to Swiss tax losses (primarily due to the writedown of investments in US subsidiaries) and US tax losses. Swiss tax losses can be carried forward for seven years and US federal tax losses for 20 years. The agreement which UBS entered into to transfer certain illiquid securities and other positions to a fund owned and controlled by the Swiss National Bank (refer to Note 38) materially reduced the Group’s exposures to US real estate related assets and hence provided additional evidence that future US taxable profits will be available against which part of the Group’s unused US tax losses can be utilized. A deferred tax asset has been recognized in respect of that portion of the US tax losses. The deferred tax assets recognized at 31 December 2008 in respect of tax losses have been based on profitability as- sumptions over a five-year horizon. The expected future profitability is based on business plan assumptions taking into consideration uncertainties arising from the current ad- verse economic environment. If the business plan earnings and assumptions in following quarters substantially deviate from the current assumptions, the amount of existing de- ferred tax assets may need to be adjusted. The Group pro- vides for deferred income taxes on undistributed earnings of subsidiaries except to the extent that those earnings are in- definitely invested. At 31 December 2008, CHF 413 million of such earnings were treated as indefinitely invested. n o i t a m r o f n i l a i c n a n i F 311 Financial information Notes to the consolidated financial statements Note 22 Income taxes (continued) At 31 December 2008, tax losses totalling CHF 71,214 million which are not recognized as deferred tax assets are available to be offset against potential tax adjustments or future taxable income. The tax losses expire as follows: CHF million Within 1 year From 2 to 4 years After 4 years Total 31.12.08 1 19 71,195 71,214 Note 23 Derivative instruments and hedge accounting A derivative is a financial instrument, the value of which is derived from the value of another (“underlying”) financial instrument, an index or some other variable. Typically, the underlying is a share, commodity or bond price, an index value or an exchange or interest rate. The majority of derivative contracts are negotiated as to amount (“notional”), tenor and price between UBS and its counterparties, whether other professionals or customers (over-the-counter (OTC) contracts). Other derivative contracts are standardized in terms of their amounts and settlement dates and are bought and sold on organized exchanges (exchange-traded contracts). The notional amount of a derivative is generally the quan- tity of the underlying instrument on which the derivative contract is based and is the basis upon which changes in the value of the contract are measured. It provides an indication of the underlying volume of business transacted by the Group but does not provide any measure of risk. Derivative instruments are carried at fair value, shown in the balance sheet as separate totals of Positive replacement values (assets) and Negative replacement values (liabilities), except for futures and exchange-traded options with daily margining, which are presented as receivables and payables. Positive replacement values represent the cost to the Group of replacing all transactions with a fair value in the Group’s favor if all the relevant counterparties of the Group were to default at the same time, assuming transactions could be replaced instantaneously. Negative replacement values rep- resent the cost to the Group’s counterparties of replacing all their transactions with the Group with a fair value in their favor if the Group were to default. Positive and negative replacement values on different transactions are only netted if the transactions are with the same counterparty, are de- nominated in the same currency, and the cash flows will be settled on a net basis. Changes in replacement values of de- rivative instruments are recognized in the income statement unless they meet the criteria for certain hedge accounting relationships, as explained in Note 1a) 14) Derivative instru- ments and hedge accounting. Types of derivative instruments The Group uses the following derivative financial instru- ments for both trading and hedging purposes. Forwards and futures are contractual obligations to buy or sell financial instruments or commodities on a future date at a specified price. Forward contracts are tailor-made agree- ments that are transacted between counterparties on the OTC market, whereas futures are standardized contracts transacted on regulated exchanges. Swaps are transactions in which two parties exchange cash flows on a specified notional amount for a predetermined period. Most swaps are traded OTC. The major types of swap transactions undertaken by the Group are as follows: – Interest rate swap contracts generally entail the contract- ual exchange of fixed-rate and floating-rate interest pay- ments in a single currency, based on a notional amount and a reference interest rate, e. g. LIBOR. – Cross-currency swaps involve the exchange of interest payments based on two different currency principal bal- ances and reference interest rates and generally also en- tail exchange of principal amounts at the start and / or end of the contract. – Credit default swaps (CDSs) are the most common form of a credit derivative, under which the party buying pro- 312 Note 23 Derivative instruments and hedge accounting (continued) tection makes one or more payments to the party selling protection in exchange for an undertaking by the seller to make a payment to the buyer following a credit event (as defined in the contract) with respect to a third-party credit entity (as defined in the contract). Settlement following a credit event may be a net cash amount or cash in return for physical delivery of one or more obligations of the credit entity and is made regardless of whether the protection buyer has actually suffered a loss. After a credit event and settlement, the contract is terminated. – Total rate of return swaps give the total return receiver exposure to all of the cash flows and economic benefits and risks of an underlying asset, without having to own the asset, in exchange for a series of payments, often based on a reference interest rate, e. g. LIBOR. The total return payer has an equal and opposite position. – Metal swaps (precious metal swaps and base metal swaps) involve the purchase and sale of specific metals. A precious metal swap involves the purchase and sale of a specified metal with fixed notional amount and fixed price but different settlement dates. A base metal swap is the simultaneous purchase and sale of a specified met- al with same settlement dates but different pricing terms. Options are contractual agreements under which, typically, the seller (writer) grants the purchaser the right, but not the obligation, either to buy (call option) or to sell (put op- tion) by or at a set date, a specified quantity of a financial instrument or commodity at a predetermined price. The purchaser pays a premium to the seller for this right. Op- tions involving more complex payment structures are also transacted. Options may be traded OTC or on a regulated exchange and may be traded in the form of a security (war- rant). Credit derivatives UBS’s credit derivative portfolio consists of credit default swaps and total return swaps. The total notional value of protection bought and sold during 2008 was CHF 2,136 bil- lion and CHF 1,474 billion, respectively. Commitment to acquire auction rate securities In 2008, Wealth Management US recognized provisions of CHF 1,464 million, presented as general and administrative expenses in the income statement, for the expected cost of the repurchase of auction rate securities (ARSs) and related costs, including fines. The estimate of the expected cost was based on assumptions relating to the timing of the repur- chase, the restructuring of the securities as well as the fair values of such securities. In October, UBS proceeded with the implementation of the settlement agreements by registering with the US Secu- rities and Exchange Commission the offering of ARS rights (in the legal form of securities) to clients. The issued ARS rights provide eligible clients the right to sell ARS (put op- tion), while UBS stipulated a right to call ARS from clients (as well as a litigation release from institutional clients). Pur- suant to the issuance of the ARS rights, the commitment to repurchase ARS from clients was treated as a derivative. As a result, the provision, excluding fines, was reclassified to Negative replacement value. After reclassification, changes in the fair value of the commitment resulted in an addi- tional CHF 172 million loss in Net trading income. As of 31 December 2008, the fair value of the commitment rec- ognized as negative replacement value was CHF 1,140 mil- lion. Derivatives transacted for trading purposes Most of the Group’s derivative transactions relate to sales and trading activities. Sales activities include the structuring and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or expected risks. Trading activities include market making, positioning and arbi- trage activities. Market making involves quoting bid and offer prices to other market participants with the intention of gen- erating revenues based on spread and volume. Positioning means managing market risk positions with the expectation of profiting from favorable movements in prices, rates or indi- ces. Arbitrage activities involve identifying and profiting from price differentials between the same product in different mar- kets or the same economic factor in different products. Derivatives transacted for hedging purposes The Group enters into derivative transactions for the pur- poses of hedging assets, liabilities, forecast transactions, cash flows and credit exposures. The accounting treatment of hedge transactions varies according to the nature of the instrument hedged and whether the hedge qualifies as such for accounting purposes. Derivative transactions may qualify as hedges for account- ing purposes. These are described under the corresponding headings in this note. The Group’s accounting policies for derivatives designated and accounted for as hedging instru- ments are explained in Note 1a) 14) Derivative instruments and hedge accounting, where terms used in the following sections are explained. n o i t a m r o f n i l a i c n a n i F 313 Financial information Notes to the consolidated financial statements Note 23 Derivative instruments and hedge accounting (continued) The Group has entered into CDSs that provide economic hedges for credit risk exposures in the loan and traded prod- uct portfolios but do not meet the requirements for hedge accounting treatment. The Group has also entered into a limited volume of inter- est rate swaps and other interest rate derivatives (e. g. fu- tures) for day-to-day economic interest rate risk manage- ment purposes, but without applying hedge accounting. The fair value changes of such swaps are booked to Net trading income. Fair value hedges The Group’s fair value hedges principally consist of interest rate swaps that are used to protect against changes in the fair value of fixed-rate instruments (e. g. long-term-fixed rate debt issues) due to movements in market interest rates. The fair values of outstanding interest rate derivatives des- ignated as fair value hedges were a CHF 883 million net positive replacement value at 31 December 2008 and a CHF 125 million net positive replacement value at 31 De- cember 2007. Fair value hedges of interest rate risk CHF million Gains / (losses) on hedging instruments Gains / (losses) on hedged items attributable to the hedged risk Net gains / (losses) representing ineffective portions of fair value hedges For the year ended 31.12.08 31.12.07 31.12.06 778 (796) (18) 15 (11) 4 (28) 11 (17) In addition, the Group entered into a fair value hedge ac- counting relationship in 2005 using foreign exchange deriv- atives to protect a certain portion of equity investments available-for-sale from foreign currency exposure. The time value associated with the FX derivatives is excluded from the evaluation of hedge ineffectiveness. The hedging relation- ship was terminated in 2008 as a result of UBS’s disposal of its foreign currency investment, which was the hedged item in this hedge accounting relationship. The fair value of out- standing FX derivatives designated as fair value hedges at 31 December 2008 and 31 December 2007 was CHF 0 million for both years. Fair value hedges of foreign exchange risk CHF million Gains / (losses) on hedging instruments Gains / (losses) on hedged items attributable to the hedged risk Net gains / (losses) representing ineffective portions of fair value hedges For the year ended 31.12.08 31.12.07 31.12.06 0 0 0 42 (44) (2) 49 (44) 5 Fair value hedges of portfolio interest rate risk The Group also applies fair value hedge accounting of port- folio interest rate risk. The change in fair value of the hedged items is recorded separately from the hedged item on the balance sheet. The fair value of derivatives desig- nated for this hedge method at 31 December 2008 was a CHF 765 million net negative replacement value and at 31 December 2007 was a CHF 41 million net negative re- placement value. During 2008, UBS expanded the use of its method to hedge portfolio interest rate risk to include other Swiss mort- gage loan portfolios. Fair value hedge of portfolio of interest rate risk CHF million Gains / (losses) on hedging instruments Gains / (losses) on hedged items attributable to the hedged risk Net gains / (losses) representing ineffective portions of fair value hedges For the year ended 31.12.08 31.12.07 31.12.06 (644) 688 44 (37) 30 (7) (7) 7 0 314 Note 23 Derivative instruments and hedge accounting (continued) Cash flow hedges of forecast transactions The Group is exposed to variability in future interest cash flows on non-trading assets and liabilities that bear interest at variable rates or are expected to be refunded or reinvested in the future. The amounts and timing of future cash flows, representing both principal and interest flows, are projected for each portfolio of financial assets and liabilities, based on contractual terms and other relevant factors including esti- mates of prepayments and defaults. The aggregate principal balances and interest cash flows across all portfolios over time form the basis for identifying the non-trading interest rate risk of the Group, which is hedged with interest rate swaps, the maximum maturity of which is 19 years. The schedule of forecast principal balances on which the expected interest cash flows arise as of 31 December 2008 is shown below. Forecasted cash flows CHF billion Cash inflows (assets) Cash outflows (liabilities) Net cash flows < 1 year 1–3 years 3–5 years 5–10 years over 10 years 247 69 178 443 129 314 309 101 208 250 85 165 19 2 17 Gains and losses on the effective portions of derivatives des- ignated as cash flow hedges of forecast transactions are ini- tially recorded in Equity as Net income recognized directly in equity and are transferred to current period earnings when the forecast cash flows affect net profit or loss. The gains and losses on ineffective portions of such derivatives are rec- ognized immediately in the income statement. A CHF 108 million loss, a CHF 443 million gain and a CHF 36 million loss were recognized in 2008, 2007 and 2006, respectively, due to hedge ineffectiveness. As of 31 December 2008 and 2007, the fair values of outstanding derivatives designated as cash flow hedges of forecast transactions were a CHF 2,539 million net positive replacement value and a CHF 99 million net positive replace- ment value, respectively. At the end of 2008 and 2007, un- recognized income of CHF 86 million and CHF 135 million associated with de-designated hedging swaps remained de- ferred in Equity. It will be removed from Equity when the hedged cash flows have an impact on net profit or loss, or when the forecasted cash flows are no longer expected to take place. In fourth quarter 2008, due to reductions in the volume of short term financial instruments, some of the forecasted cash flows previously included in the hedge rela- tionships have been determined to no longer be expected to occur. Amounts reclassified from Net income recognized di- rectly in Equity to current period earnings due to discontinu- ation of hedge accounting were a CHF 49 million net gain in 2008, a CHF 79 million net gain in 2007 and a CHF 132 mil- lion net gain in 2006. These amounts were recorded in Net interest income. Risks of derivative instruments Derivative instruments are transacted in many trading port- folios, which generally include several types of instruments, not just derivatives. The market risk of derivatives is man- aged and controlled as an integral part of the market risk of these portfolios. The Group’s approach to market risk is de- scribed in the audited “Market risk” section of this report. Derivative instruments are transacted with many differ- ent counterparties, most of whom are also counterparties for other types of business. The credit risk of derivatives is managed and controlled in the context of the Group’s over- all credit exposure to each counterparty. The Group’s ap- proach to credit risk is described in the audited “Credit risk” section of this report. It should be noted that, although the positive replacement values shown on the balance sheet can be an important component of the Group’s credit expo- sure, the positive replacement values for a counterparty are rarely an adequate reflection of the Group’s credit exposure on its derivatives business with that counterparty. This is be- cause, on the one hand, replacement values can increase over time (“potential future exposure”), while on the other hand, exposure may be mitigated by entering into master netting agreements and bilateral collateral arrangements with counterparties. Both the exposure measures used by the Group internally to control credit risk and the capital n o i t a m r o f n i l a i c n a n i F 315 Financial information Notes to the consolidated financial statements Note 23 Derivative instruments and hedge accounting (continued) requirements imposed by regulators reflect these additional factors. The replacement values presented on UBS’s balance sheet and in the tables on the next two pages include netting in accordance with IFRS requirements (refer to Note 1), which is more restrictive than netting guidance provided by the Swiss Financial Market Supervisory Authority (FINMA). The main difference of Swiss GAAP to IFRS is that Swiss GAAP netting is generally based on close-out netting arrangements which are enforceable in case of insolvency. The impact of such netting agreements on the gross replacement values shown in the tables on the next two pages is to reduce both positive and negative replacement values by CHF 652 billion and CHF 292 billion at 31 December 2008 and 2007, respec- tively. As a result, positive replacement values after netting for UBS Group were CHF 202 billion at 31 December 2008 and CHF 136 billion at 31 December 2007. 316 Note 23 Derivative instruments and hedge accounting1 (continued) As of 31 December 2008 Term to maturity CHF billion Interest rate contracts Over-the-counter (OTC) contracts Forward contracts Swaps Options Exchange-traded contracts 4 Futures Options Total Credit derivative contracts Over-the-counter (OTC) contracts Credit default swaps Total rate of return swaps Total Foreign exchange contracts Over-the-counter (OTC) contracts Forward contracts Interest and currency swaps Options Exchange-traded contracts 4 Futures Options Total Equity / index contracts Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 4 Futures Options Total Precious metals contracts Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 4 Futures Options Within 3 months NRV 3 PRV 2 3–12 months NRV PRV 1–5 years PRV NRV over 5 years NRV PRV Total PRV Notional value Total NRV Notional value 2.1 9.5 4.0 2.2 9.9 3.7 3.8 23.6 6.6 4.1 24.3 7.0 0.3 152.1 14.3 0.4 140.5 15.7 0.0 142.9 16.5 6.2 330.0 37.4 1,544.9 9,065.4 498.4 6.7 317.6 43.0 1,584.5 22,739.9 595.5 144.8 12.6 0.8 16.4 0.8 16.6 0.5 34.5 0.5 36.0 0.1 166.8 0.1 156.7 157.4 159.5 219.8 6.4 375.1 11,334.9 1.4 307.8 8.7 368.7 25,236.4 1.4 0.5 3.4 3.9 21.0 72.1 7.5 0.3 0.4 0.7 22.8 74.5 7.6 3.4 0.2 3.6 8.4 36.2 10.0 3.5 0.1 3.6 10.6 33.8 9.1 95.4 3.1 98.4 1.6 34.9 2.1 91.2 0.5 91.7 1.1 39.2 1.8 89.8 1.6 91.4 0.1 27.1 88.2 0.5 88.8 189.1 8.3 197.4 1,856.1 31.2 1,887.2 183.3 1.5 184.8 1,754.0 12.6 1,766.7 0.1 26.5 0.0 31.2 170.3 19.7 468.1 2,047.4 610.1 34.5 173.9 18.6 485.6 1,868.4 524.8 0.2 101.0 0.3 105.2 0.0 54.6 0.0 53.5 38.7 42.1 27.2 26.6 0.2 221.5 12.8 3,138.3 0.3 227.3 1.7 6.1 2,886.5 1.9 1.7 5.0 8.6 0.8 0.5 0.1 1.3 1.6 3.2 2.0 4.8 1.8 7.4 2.2 4.7 2.0 8.5 5.2 10.0 5.3 12.1 6.7 16.0 4.8 11.7 5.6 16.1 0.7 0.6 0.6 1.3 0.1 1.4 0.1 1.9 0.5 1.3 0.2 2.0 3.2 1.2 0.5 1.8 0.0 2.3 1.4 0.8 0.4 1.5 0.0 1.9 1.2 0.8 0.2 1.7 0.9 2.9 0.0 0.2 0.3 4.0 1.2 5.5 0.1 0.2 0.3 0.4 0.9 0.0 1.0 0.0 6.4 12.9 16.1 35.3 1.8 3.8 0.1 5.8 8.2 2.4 68.5 108.9 15.3 97.9 290.5 13.1 30.6 4.7 48.4 26.1 5.7 13.5 69.9 115.2 5.7 23.0 18.7 47.4 1.7 3.7 0.3 5.7 7.1 2.4 8.4 17.9 851.9 8 1.1 40.1 106.1 18.2 110.5 275.0 14.1 35.8 0.6 9.5 60.0 19.0 6.6 0.0 86.1 111.8 16.6 Total Commodities contracts, excluding precious metals contracts Over-the-counter (OTC) contracts 2.2 0.3 1.7 0.4 3.7 1.3 Forward contracts Options Exchange-traded contracts 4 Futures Options Total Total derivative instruments 5,6 thereof commitments to repurchase auction rate securities 2.0 4.5 135.7 2.0 4.1 138.1 3.7 8.8 115.5 3.7 8.1 119.2 2.7 4.8 322.8 2.7 4.6 313.1 1.1 0.9 280.0 1.0 281.6 8.4 19.0 854.1 7 1 Bifurcated embedded derivatives are presented in the same balance sheet line as the host contract and are excluded from the table. Payables and receivables resulting from the valuation of regular way purchases and sales of financial assets between trade and settlement date are recognized as replacement values and therefore included in the table. PRVs and NRVs are categorized in the different time bands on the basis of the maximal duration of the derivative contract. 2 PRV: Positive replacement value. 3 NRV: Negative replacement value. 4 Exchange-traded products include own account trades only. 5 Total PRV and total NRV include approximately CHF 462 million and CHF 1,649 million, respectively for the option to purchase the SNB StabFund equity. Refer to Note 38. 6 Total NRVs include approximately CHF 1,058 million for the derivative component of the mandatory convertible notes issued to the Swiss Confederation in December 2008. Refer to Note 26. 7 The impact of netting agreements accepted by the Swiss Financial Market Supervisory Authority (FINMA) for capital adequacy calculations is to reduce positive replacement values to CHF 202,351 million. 8 The impact of netting agreements accepted by the FINMA for capital adequacy calculations is to reduce negative replacement values to CHF 200,055 million. 317 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 23 Derivative instruments and hedge accounting1 (continued) As of 31 December 2007 Term to maturity CHF billion Interest rate contracts Over-the-counter (OTC) contracts Forward contracts Swaps Options Exchange-traded contracts 4 Futures Options Total Credit derivative contracts Over-the-counter (OTC) contracts Credit default swaps Total rate of return swaps Total Foreign exchange contracts Over-the-counter (OTC) contracts Forward contracts Interest and currency swaps Options Exchange-traded contracts 4 Futures Options Total Equity / index contracts Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 4 Futures Options Total Precious metals contracts Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 4 Futures Options Forward contracts Options Exchange-traded contracts 4 Futures Options Total Total derivative instruments Within 3 months NRV 3 PRV 2 3–12 months NRV PRV 1–5 years PRV NRV over 5 years NRV PRV Total PRV Notional value Total NRV Notional value 0.7 4.9 0.4 0.6 6.5 0.2 0.4 0.6 0.8 5.4 0.3 0.6 7.0 0.2 0.3 0.6 0.1 7.9 0.2 0.3 8.5 6.5 0.1 6.6 0.1 8.1 0.6 0.3 9.2 6.0 0.2 6.2 8.2 26.9 4.8 8.8 28.2 4.4 2.6 15.8 5.9 2.9 13.6 5.5 0.0 52.4 3.4 0.0 55.1 4.8 77.3 15.8 69.0 17.3 0.8 142.4 19.8 759.7 12,527.7 621.9 0.9 137.6 22.9 775.1 15,835.8 783.1 0.0 55.9 0.0 59.9 93.0 86.3 367.7 39.0 163.9 14,316.0 0.9 1,705.0 50.9 162.4 19,149.9 0.9 30.9 3.2 34.1 94.4 10.9 105.3 2,509.7 56.6 2,566.3 99.6 6.6 106.2 2,662.6 131.7 2,794.3 60.9 2.5 63.3 0.9 19.4 1.3 62.5 2.8 65.3 0.6 21.9 1.3 26.8 7.9 34.7 0.0 12.5 0.1 0.0 11.6 0.1 0.1 40.0 0.1 41.4 0.0 24.2 0.0 22.0 21.6 23.9 12.5 11.7 2.4 3.1 2.0 4.2 1.7 4.7 1.0 9.1 0.6 5.4 0.7 12.1 6.1 11.6 6.2 12.4 7.9 14.3 8.7 18.9 6.5 12.5 7.2 20.0 0.5 0.5 1.0 1.0 0.9 1.1 0.7 1.1 0.2 2.0 1.6 1.2 1.0 1.8 0.0 2.9 1.9 0.9 0.5 1.7 0.0 2.2 1.8 1.0 0.1 1.2 0.2 1.5 0.0 0.2 0.1 3.5 0.3 3.9 0.1 0.1 0.2 0.2 1.1 0.1 1.2 0.1 Total Commodities contracts, excluding precious metals contracts Over-the-counter (OTC) contracts 0.1 1.1 0.1 2.1 0.2 2.2 2.4 0.5 2.4 0.5 1.6 0.9 11.7 74.5 12.1 0.1 98.4 4.8 14.5 20.8 40.0 2.4 3.6 0.4 6.4 7.0 2.4 635.0 2,457.9 759.2 1.5 0.0 3,853.6 103.1 113.5 20.5 158.6 395.7 16.8 36.6 18.5 71.9 59.0 11.4 0.4 88.7 159.5 687.2 2,414.0 747.7 10.5 4.5 3,863.9 72.7 177.9 35.1 166.9 452.6 23.1 42.5 0.2 9.5 75.3 52.5 13.5 169.9 92.6 328.5 12.3 75.3 11.3 0.1 99.0 3.9 28.9 22.4 55.1 2.2 4.0 0.4 6.6 6.9 2.8 4.5 14.3 443.56 1.6 4.5 64.4 1.5 4.3 67.8 2.3 4.8 60.6 2.3 5.1 63.3 1.0 3.8 160.0 0.7 3.5 174.8 1.2 143.2 1.3 137.6 4.9 14.2 428.25 1 Bifurcated embedded derivatives are presented in the same balance sheet line as the host contract and are excluded from the table. Payables and receivables resulting from the valuation of regular way purchases and sales of financial assets between trade and settlement date are recognized as replacement values and therefore included in the table. PRVs and NRVs are categorized in the different time bands on the basis of the maximal duration of the derivative contract. 2 PRV: Positive replacement value. 3 NRV: Negative replacement value. 4 Exchange-traded products include own account trades only. 5 The impact of netting agreements accepted by the Swiss Financial Market Supervisory Authority (FINMA) for capital adequacy calculations is to reduce positive replacement values to CHF 135,846 million. 6 The impact of netting agreements accepted by the FINMA for capital adequacy calculations is to reduce negative replacement values to CHF 151,168 million. 318 Off-balance-sheet information Note 24 Pledgeable off-balance-sheet securities The Group obtains securities which are not recorded on the balance sheet with the right to sell or repledge them as shown in the table below. CHF million Fair value of securities received which can be sold or repledged as collateral under reverse repurchase, securities borrowing and lending arrangements, derivative transactions and other transactions in unsecured borrowings thereof sold or repledged in connection with financing activities to satisfy commitments under short sale transactions in connection with derivative and other transactions 31.12.08 651,380 621,981 29,399 430,670 343,252 62,431 24,987 31.12.07 1,491,567 1,396,768 94,799 1,118,305 924,795 164,788 28,722 Note 25 Operating lease commitments At 31 December 2008, UBS was obligated under a number of non-cancellable operating leases for premises and equip- ment used primarily for banking purposes. The significant premises leases usually include renewal options and escala- tion clauses in line with general office rental market condi- tions as well as rent adjustments based on price indices. However, the lease agreements do not contain contingent rent payment clauses and purchase options. The leases also do not impose any restrictions on UBS’s ability to pay divi- dends, engage in debt financing transactions or enter into further lease agreements. The minimum commitments for non-cancellable leases of premises and equipment are presented as follows: CHF million Operating leases due 2009 2010 2011 2012 2013 2014 and thereafter Subtotal commitments for minimum payments under operating leases Less: Sublease rentals under non-cancellable leases Net commitments for minimum payments under operating leases 31.12.08 1,034 950 848 772 634 2,573 6,811 578 6,233 319 319 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 25 Operating lease commitments (continued) CHF million Gross operating lease expense from continuing operations from discontinued operations Sublease rental income from continuing operations Net operating lease expense from continuing operations from discontinued operations 31.12.08 31.12.07 31.12.06 1,215 1,215 0 50 1,165 1,165 0 1,251 1,233 18 54 1,197 1,179 18 1,170 1,137 33 56 1,114 1,081 33 Operating lease contracts include non-cancellable long-term leases of office buildings in most UBS locations. At 31 De- cember 2008, the minimum lease commitments for each of 12 office locations exceeded CHF 100 million and non- cancellable minimum lease commitments for each of two office locations in New Jersey and New York exceeded CHF 500 million. 320 Additional information Note 26 Capital increases and mandatory convertible notes Share capital increase On 23 April 2008, the Annual General Meeting of share- holders (AGM) approved a proposal that UBS strengthen its shareholders’ equity by way of an ordinary capital increase. The capital increase, completed in June 2008, was effected by granting existing shareholders rights to subscribe to seven new shares for 20 old shares at a price of CHF 21 per share. The capital increase was fully underwritten and resulted in the issue of 760,295,181 new fully paid registered shares with a par value of CHF 0.10 each. Net proceeds from the capital increase were approximately CHF 15.6 billion. The newly issued shares ranked pari passu in all respects with the existing registered shares immediately upon issue. Issuance of mandatory convertible notes (MCNs) March 2008 issuance On 9 December 2007, UBS entered into an agreement with the Government of Singapore Investment Corporation Pte Ltd and an investor from the Middle East to issue mandatory convertible notes (MCNs) with a face value of CHF 13 billion. The MCNs were issued on 5 March 2008 after the share- holders approved, at the Extraordinary General Meeting held on 27 February 2008, the creation of conditional capital in a maximum amount of 277,750,000 shares to be issued upon conversion of the MCNs. The MCNs counted as Tier 1 capital for regulatory capital purposes from the date of issue. The MCNs have a coupon of 9% per annum and are convertible into UBS shares after two years, with earlier conversion options for the investors and UBS. The terms of the MCNs initially linked conversion to the share price at the date of conversion, with the minimum conversion price set at CHF 51.48 and the maximum conversion price at CHF 60.23 per share. Conversion prices were subject to anti- dilution adjustments in the event of certain corporate actions. As a result of anti-dilution adjustments triggered by the June 2008 capital increase, the initial conversion prices were adjusted and the MCNs will be converted into a fixed num- ber of 270,438,942 shares. Under IFRS, the commitment to issue the MCNs to the two investors entered into by UBS on 9 December 2007 was subject to derivative accounting between the date the com- mitment was entered into and the date of issuance on 5 March 2008. The total change in the fair value of such commitment of approximately CHF 3,860 million was recog- nized as a gain in 2008. Pursuant to the adjustments to the conversion prices, the accounting treatment for the MCNs changed. Upon issu- ance, the MCNs had been initially treated as a compound financial instrument consisting of a debt host and an embed- ded equity component. After the adjustments to the conver- sion prices, the MCNs have been treated as an equity instru- ment, which resulted in the reclassification of CHF 12,382 million from liability to Share premium in equity. In 2008, Share premium increased by approximately CHF 6,969 mil- lion due to the MCNs and interest expense incurred was approximately CHF 126 million. As of 31 December 2008, a liability representing the present value of the 9% coupon payments due on 5 March 2009 and 2010, respectively, was recorded for approximately CHF 2,297 million. Interest at a rate of 2.78% per annum continues to be accrued on the remaining liability. December 2008 issuance On 15 October 2008, UBS entered into an agreement with the Swiss Confederation to issue mandatory convertible notes (MCNs) with a face value of CHF 6 billion. The MCNs were issued on 9 December 2008 after the shareholders approved, at the Extraordinary General Meeting held on 27 November 2008, the creation of conditional capital in a maximum amount of 365,000,000 shares to be issued upon conversion of the MCNs. The MCNs counted as Tier 1 capital for regulatory capital purposes from the date of issue. The MCNs pay a coupon of 12.5% per annum and are convertible into UBS shares after 30 months, with earlier conversion options for the note holders and UBS. Conver- sion is linked to the share price at the time of conversion, with the minimum conversion price set at CHF 18.21 and the maximum conversion price set at CHF 21.31 per share. If the share price is at or below CHF 18.21, conversion will result in the issuance of the maximum number of shares which is 329,447,681. If the share price is at or above CHF 21.31, conversion will result in issuance of a minimum number of shares of 281,579,096 plus an additional variable number of shares, provided however that the total number of shares to be issued will not exceed the maximum number of shares. If the share price is between the minimum and maximum con- version prices, the MCNs will be converted into a variable number of shares by dividing CHF 6 billion by the market price determined immediately before conversion. Conver- sion prices are subject to anti-dilution adjustments in the event of certain corporate actions. 321 321 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 26 Capital increases and mandatory convertible notes (continued) Under IFRS, the commitment to issue the MCNs entered into by UBS on 15 October 2008 was subject to derivative accounting between the date the commitment was entered into and the date of issuance. Changes in the fair value of the commitment between 15 October 2008 and 9 Decem- ber 2008 resulted in a gain of approximately CHF 329 million in 2008. The commitment was attributable to the equity component and was reclassified as a reduction to Share pre- mium upon issuance of the MCNs. Upon issuance, the MCNs were treated as a compound financial instrument consisting of a debt host and embedded equity and derivative components. The debt host was recog- nized as a liability initially measured at fair value and ac- counted for at amortized cost. The fair value of the debt host on 9 December 2008 was estimated at approximately CHF 7,733 million. At 31 December 2008, the carrying value of the liability was approximately CHF 7,740 million and inter- est expense recognized in 2008 amounted to approximately CHF 8 million. The fair value of the derivative component was determined to be approximately CHF 1,425 million, rec- ognized as a negative replacement value. Subsequent chang- es in the fair value of the derivative component resulted in a gain of approximately CHF 367 million in 2008. The equity component was attributed a fair value of approximately CHF 3,158 million, recorded in equity as a reduction to Share premium. The value of the equity component is not re- measured to fair value after 9 December 2008. Note 27 Fair value of financial instruments a) Fair value measurements Fair value is the amount for which an asset could be ex- changed, or a liability settled, between knowledgeable, will- ing parties in an arm’s length transaction. Refer to Note 1a) 5) for an overview on the determination of fair value. Determination of fair values from quoted market prices or valuation techniques CHF billion Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Financial investments available-for-sale Total assets Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Total liabilities 31.12.08 Level 1 Level 2 Level 3 128.1 25.4 5.1 1.1 2.4 162.1 33.9 4.9 38.8 128.4 13.2 811.2 11.2 1.2 965.2 27.5 812.0 91.2 930.7 15.3 1.6 37.8 0.6 1.6 57.0 1.0 35.0 10.3 46.3 Total 271.8 40.2 854.1 12.9 5.2 1,184.3 62.4 851.9 101.5 Level 1 277.2 57.4 6.8 1.8 1.2 344.4 119.9 6.6 1,015.8 126.5 31.12.07 Level 2 Level 3 330.7 48.5 407.4 10.0 2.4 799.0 44.9 420.1 149.5 614.5 52.3 8.3 14.0 1.4 75.9 16.8 42.4 59.2 Total 660.1 114.2 428.2 11.8 5.0 1,219.3 164.8 443.5 191.9 800.2 Financial instruments accounted for at fair value For trading portfolio assets and liabilities, financial assets and liabilities designated at fair value and financial investments available-for-sale which are listed or otherwise traded in an active market, for exchange-traded derivatives, and for other financial instruments for which quoted prices in an active market are available, fair value is determined directly from those quoted market prices (level 1). For financial instruments which do not have quoted mar- ket prices directly available from an active market, fair values are estimated using valuation techniques or models, based wherever possible on assumptions supported by observable market prices or rates prevailing at the balance sheet date (level 2). This is the case for the majority of OTC derivatives, and for many unlisted and listed instruments which are not traded in active markets. For some types of financial instruments, fair values can- not be obtained directly from quoted market prices, or in- directly using valuation techniques or models supported by observable market prices or rates. This is generally the case for certain complex or structured financial instruments and for private equity investments. In addition, the illiquidity of a broad range of financial instruments linked to the US res- idential mortgage market, as well as US student loan ARSs, monolines, leveraged finance and others required an ex- tended use of valuations based on partially or fully non- market observable market inputs in the second half of 2007 and 2008. In these cases, fair value is estimated indirectly 322 Note 27 Fair value of financial instruments (continued) a) Fair value measurements (continued) using valuation techniques or models for which the inputs are reasonable assumptions, based on market conditions (level 3). In its valuations, UBS uses indices, where and to the ex- tent appropriate. The most frequently applied pricing mod- els and valuation techniques include forward pricing and swap models using present value calculations, option mod- els such as the Black-Scholes model or generalizations of it, and credit models such as default rate models or credit spread models. The values derived from applying these tech- niques are significantly affected by the choice of valuation model and the underlying assumptions made concerning factors such as the amounts and timing of future cash flows, discount rates, volatility and credit risk. Accrued interest is recognized as part of the fair value of financial instruments accounted for at fair value. Lock-up periods for equity invest- ments are considered when determining fair value. Refer to the description below of the impact from UBS’s own credit movements on financial liabilities accounted for at fair value. For the deferral and recognition of day 1 profit or loss, refer to Note 27d. For a description of the valuations of UBS’s positions related to the US student loan auction rate securities (which were reclassified to “loans and receivables” per 31 December 2008), monolines, US and non-US refer- ence linked notes, and other instruments which were deter- mined relevant for specific disclosure refer to Note 27c. Reflection of counterparty credit risk in the valuation of traded debt instruments and derivative instruments UBS incorporates the counterparty credit risk inherent in over-the-counter (OTC) derivatives transactions and traded debt instruments into its fair value estimates via the credit valuation adjustment (CVA). This amount represents the es- timated market value of protection required to hedge credit risk from counterparties in UBS’s OTC derivatives portfolio and traded debt instruments, taking into account expected future exposures, collateral, and netting arrangements. The most significant component of the overall CVA is the portion related to monolines, discussed further below. issued by a riskless intermediary, relative to the market value of those obligations issued by UBS, as judged from the per- spective of the holders of those obligations. Own credit changes were calculated based on a senior long-term debt curve generated from observed external pricing for funding associated with new senior debt issued by the Group, or rel- evant secondary market transactions in senior long-term UBS debt. In the absence of issued debt, credit default swap spreads would be considered as well. Disclosures on own credit for financial liabilities designated at fair value At 31 December 2008, the own credit gain for financial lia- bilities designated at fair value still held at reporting date, predominantly issued structured products, amounts to CHF 2,032 million (year-to-date) and CHF 2,953 million (life-to- date). The life-to-date amount reduced the fair value of fi- nancial liabilities designated at fair value at 31 December 2008. Included in these amounts is the overall quantification of changes in fair value attributable to changes in UBS’s credit spread during the periods. In addition, it includes the credit effect of period changes in fair values attributable to factors other than credit spreads, including benchmark inter- est rates, prices of financial instruments issued by third par- ties, commodity prices, foreign exchange rates or index pric- es or rates (i.e. credit effect of volume changes). The year-to-date 2008 own credit profit and loss including only the change in credit spread but excluding the credit effect of volume changes was a gain of CHF 3,993 million. Reflection of market illiquidity in fair value determinations Fair value estimates incorporate the effects of illiquidity in the relevant markets. Where trading prices are observable in such markets, these prices invariably include a liquidity or risk premium relative to what could be concluded on the basis of an actuarial assessment of credit loss potential. Valu- ations based on models similarly incorporate liquidity or risk premiums either implicitly (e. g, by calibrating to market pric- es that incorporate such premiums) or explicitly. UBS’s own credit risk in the valuations of financial liabilities at fair value, including derivative liabilities The Group’s own credit changes are reflected in valuations for those financial liabilities at fair value, including derivative liabilities, where the Group’s own credit risk would be con- sidered by market participants and excludes fully collateral- ized transactions and other instruments for which it is estab- lished market practice not to include an entity-specific adjustment for own credit. This amount represents the esti- mated difference in the market value of identical obligations Valuation processes There may be uncertainty about the accuracy of a valuation, resulting from the choice of the valuation technique or mod- el used, the assumptions embedded in these models, the extent to which inputs are not market observable, or as a result of other elements affecting the valuation technique. Valuation adjustments, including model reserves, are applied to reflect these uncertainties and are deducted from the fair values produced by the models or other valuation tech- niques. All models used for valuation undergo an internal 323 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 27 Fair value of financial instruments (continued) a) Fair value measurements (continued) validation process before they are approved for use. Uncer- tainties associated with the use of model-based valuations (both level 2 and level 3) are predominantly addressed through the use of model reserves. These reserves reflect the amounts that UBS estimates are appropriate to deduct from the valuations produced directly by the models to reflect un- certainties in the relevant modeling assumptions and inputs used. Based on UBS’s established fair value and model gover- nance policies and the related controls and procedural safe- guards the Group employs, management believes the result- ing estimated fair values recorded in the balance sheet and the changes in fair values recorded in the income statement are reasonable and are the most appropriate at the balance sheet date. Financial instruments accounted for at amortized cost The following table reflects the estimated fair values for the Group’s instruments accounted for at amortized cost. Refer to Note 29 for an overview of financial assets classified as “loans and receivables” and financial liabilities accounted for at amortized cost. CHF billion Assets Loans to banks and customers Cash collateral on securities borrowed and reverse repurchase agreements Accrued income and prepaid expenses, other assets Liabilities Due to banks and customers Cash collateral on securities lent and repurchase agreements Debt issued Accrued expenses and deferred income, other liabilities 31.12.08 Carrying value Fair value 403.0 347.5 9.1 600.4 116.6 201.2 22.8 402.6 347.7 9.1 600.4 116.6 199.7 22.8 The fair values included in the table above were calculated for disclosure purposes only. The valuation techniques and assumptions described below provide a measurement of fair value of UBS’s financial instruments accounted for at amortized cost. However, because other institutions may use different methods and assumptions for their fair value esti mation, such fair value disclosures cannot necessarily be compared from one financial institution to another. UBS applies significant judgments and assumptions to arrive at these fair values, which are more holistic and less sophisti- cated than UBS’s established fair value and model gover- nance policies and processes applied for financial instru- ments accounted for at fair value, whose fair values impact UBS’s balance sheet and net profit. Debt instruments reclas- sified in fourth quarter 2008 from “held for trading” to “loans and receivables” followed the same fair value mea- surement principles and governance policies as financial in- struments accounted for at fair value. The following prin- ciples were applied when determing fair value estimates for financial instruments accounted for at amortized cost: – For short-term financial instruments with remaining maturities of one year or less, the carrying amount, which is net of credit loss allowances, is generally con- sidered a reasonable estimate of fair value. The follow- ing financial instruments accounted for at amortized cost have remaining maturities of one year or less: 100% of cash collateral on securities borrowed and re- verse repurchase agreements; 97% of loans due from banks; 61% of loans to customers; 98% of amounts due to banks and customers; 99% cash collateral on securities lent and repurchase agreements; 60% of debt issued. Refer to the chapter “Liquidity and funding management” in the “Risk and treasury management” section of this report. – The fair value of variable-interest bearing financial instru- ments accounted for at amortized cost is assumed to be approximated by their carrying amounts, which are net of credit loss allowances, and does not reflect fair value changes in the credit quality of counterparties respectively UBS’s own credit movements. – For fixed-interest bearing financial instruments with re- maining maturities above one year, fair value was estimat- ed by discounting contractual cash flows using current rates at which similar loans would be transacted to bor- rowers with similar credit ratings and/or collateral and for the same remaining maturities. These estimates generally include adjustments for counterparty credit respectively UBS’s own credit. – The fair value estimates for repurchase and reverse repur- chase agreements with variable and fixed interest rates, for all maturities, include the valuation of the interest rate component of these instrument. Credit and debit valua- 324 Note 27 Fair value of financial instruments (continued) a) Fair value measurements (continued) tion adjustments have not been included into the valua- tion due to the short-term nature of these instruments. – For loans to customers from Global Wealth Management & Business Banking, mainly reflecting the impact of the Swiss Mortgage loan portfolio with a fixed rate of interest, an excess of fair value over the carrying amount of CHF 3.0 billion was determined. This amount is largely attribut- able to the current CHF interest rate movements, which are significantly below the average levels over the last de- cade. The fair values of UBS’s Investment Bank’s loans to customers were CHF 3.4 billion below their carrying val- ues, mainly reflecting credit valuation adjustments for debt instruments reclassified from “held for trading” to “loans and receivables” in fourth quarter 2008. – For debt issued with remaining maturites greater than one year, the fair value was determined from quoted market prices, where available. Where quoted market prices were not available the fair value was derived by discounting contractual cash flows by using rates at which UBS could issue debt with similar remaining maturities. Adjustments for own credit movements have been included into fair value estimation. The fair value of loans to banks and customers measured at amortized cost at 31 December 2007 was CHF 392.3 bil- lion (carrying value: CHF 395.3 billion). The fair value of debt issued measured at amortized cost at 31 December 2007 was CHF 222.7 billion (carrying value: CHF 222.0 billion). The fair values of UBS’s fixed rate loans, long- and medi- um-term notes and bonds issued are predominantly hedged by derivative instruments. Refer to Note 23 and Note 1. The interest rate risk inherent in balance sheet positions with no specific maturity may also be hedged with derivative instru- ments based on management’s view of their average cash flow and repricing behavior. b) Fair value measurements involving significant unobservable inputs (level 3) Level 3 instruments at year-end As of 31 December 2008, financial instruments measured with valuation techniques using significant non-market ob- servable inputs (level 3) mainly include structured rates and credit trades, bespoke collateralized debt obligations (CDOs), instruments linked to the US sub-prime residential, US com- mercial and non-US real estate markets and leveraged finance instruments. Level 3 financial liabilities also include hybrid financial liabilities from structured products issuances. Material changes in level 3 instruments for the year Level 3 instruments recognized as Trading portfolio assets (including those pledged as collateral) were reduced by ap- proximately CHF 44 billion compared to 2007. The decline mainly relates to the following events and transactions: re- classifications of approximately CHF 13 billion from the IAS 39 category “held for trading” to the category “loans and receivables”, the sale of US RMBS to a fund managed by BlackRock of approximately CHF 4 billion and the sale of po- sitions (mainly products linked to US residential and com- mercial real estate markets) of approximately CHF 6 billion to the fund owned and controlled by the Swiss National Bank. The balance of approximately CHF 30 billion mainly reflects writedowns, other sales, deconsolidations, amortizations, and foreign exchange movements. The reductions were par- tially offset by net reclassifications from level 2 to level 3 of approximately CHF 9 billion as valuation inputs became less observable during 2008. Reclassifications into level 3 mainly included student loan ARS, leveraged finance deals, and US real estate products. Derivatives classified as level 3 increased at the end of 2008 by approximately CHF 24 billion (Positive replacement values) and approximately CHF 18 billion (Negative replace- ment values), predominantly driven by widening credit spreads impacting fair value of structured rates and credit trades, and bespoke CDOs. In addition, reclassifications into level 3 increased positive replacement values by approxi- mately CHF 8 billion and negative replacement values by ap- proximately CHF 8 billion as valuation inputs became less observable during 2008. The decrease of level 3 financial liabilities designated at fair value of approximately CHF 32 billion at the end of 2008 was due mainly to hybrid and other financial liabilities desig- nated at fair value of approximately CHF 15 billion which was included in level 3 as of 31 December 2007, although these financial liabilities were related to level 1 and level 2 valuations. Other factors which contributed to the decrease of level 3 financial liabilities designated at fair value during 2008 were expiries of trades, foreign exchange movements, disposals of instruments linked to the US sub-prime mort- gage market and redemptions of hybrid financial liabilities. The transfer of further level 3 instruments to the SNB fund in 2009 will lead to more reductions in level 3 trading assets, positive and negative replacement values. 325 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 27 Fair value of financial instruments (continued) b) Fair value measurements involving significant unobservable inputs (level 3) (continued) Level 3 profit or loss Total Net trading income / (loss) for the years ended 31 De- cember 2008, 31 December 2007 and 31 December 2006 was CHF (25.8) billion, CHF (8.4) billion and CHF 13.7 bil- lion, respectively, which represents the net result from a range of products traded across different business activi- ties, including the effect of the foreign currency translation of monetary assets and liabilities and including both real- ized and unrealized income. Unrealized income is deter- mined from changes in fair values, using quoted prices in active markets when available, and otherwise estimated us- ing valuation techniques with market observable and / or non-market observable inputs. Net trading income includes net losses of CHF 11.5 bil- lion, net losses of CHF 11.6 billion and net gains of CHF 0.4 billion from unrealized fair value changes of financial instru- ments for which fair value is calculated on the basis of valu- ation techniques with significant non-market observable in- puts (level 3) for the years ended 31 December 2008, 2007 and 2006. Such valuation techniques reflecting significant non-mar- ket observable inputs (level 3) include mainly models for more complex financial instruments and for financial instruments for which markets were illiquid at the balance sheet date. They require the use of reasonable assumptions and esti- mates based on market conditions at the balance sheet date. Net trading income is often generated from transactions involving several financial instruments or subject to hedging or other risk management techniques. This may result in dif- ferent portions of the transaction being priced using differ- ent methods. In many cases, the amounts estimated using valuation techniques with non-market observable inputs were offset or partially offset by changes in fair value of oth- er financial instruments or transactions, for which quoted market prices or rates were available, or on which the gain or loss has been realized. Consequently, the changes in fair value which were estimated using valuation techniques with non-market observable inputs and have been recognized in profit or loss during the period represent only a portion of Net trading income. Sensitivity information Included in the fair value of financial instruments carried at fair value on the balance sheet are those estimated in full or in part using valuation techniques based on assumptions that are not supported by market observable prices or rates. There may be uncertainty about a valuation, resulting from the choice of valuation technique or model used, the assumptions embedded in those models, the extent to which inputs are not market observable, or as a result of other ele- ments affecting the valuation technique. Valuation adjust- ments, including model reserves, are applied to reflect such uncertainties and are deducted from the fair values produced by the models or other valuation techniques. All models used for valuation undergo an internal valida- tion process before they are approved for use. Based on UBS’s established fair value and model gover- nance policies and the related controls and procedural safe- guards the Group employs, management believes the result- ing estimated fair values recorded in the balance sheet and the changes in fair values recorded in the income statement are reasonable and are the most appropriate at the balance sheet date. Uncertainties associated with the use of model-based val- uations (both level 2 and level 3) are predominantly ad- dressed through the use of model reserves. These reserves reflect the amounts that UBS estimates are appropriate to deduct from the valuations produced directly by the models to reflect uncertainties in the relevant modeling assumptions and inputs used. In arriving at these estimates, UBS considers the range of market practice and how it believes other mar- ket participants would assess these uncertainties. Model re- serves are periodically reassessed in light of information from market transactions, pricing utilities, and other relevant sources. The level of these model reserves is, nevertheless, to a large extent a matter of judgment. To estimate the potential effect on the Financial State- ments from the use of alternative valuation techniques or assumptions, UBS makes use of the model reserve amounts described above, by scaling the level of the model reserves higher and lower, to assess the impact on valuation of in- creasing or decreasing the amount of model-related uncer- tainty considered. The potential effect of using reasonably possible alterna- tive valuation assumptions has been quantified as follows: – Scaling the model reserve amounts upward in line with less favorable assumptions would reduce fair value by ap- proximately CHF 2.5 billion at 31 December 2008, by ap- proximately CHF 2.7 billion at 31 December 2007, and approximately CHF 1.0 billion at 31 December 2006. – Scaling the model reserve amounts downward in line with more favorable assumptions would increase fair value by approximately CHF 1.4 billion at 31 December 2008, by approximately CHF 2.2 billion at 31 December 2007, and approximately CHF 1.0 billion at 31 December 2006. Please refer to Note 27c below for the instrument catego- ries which are deemed to be relevant for specific sensitivity disclosure per 31 December 2008, and which are included in the sensitivity numbers provided above. 326 Note 27 Fair value of financial instruments (continued) c) Valuation techniques and inputs by product Where possible, financial instruments are marked at prices quoted in active markets. In the current market environ- ment, such price information is typically not available for all financial instruments, and UBS applies valuation techniques to measure such instruments. Valuation techniques use “market-observable inputs”, where available, derived from similar assets in similar and active markets, from recent trans- action prices for comparable items or from other observable market data. For positions where observable reference data are not available for some or all parameters, UBS calibrates the non-market-observable inputs used in its valuation mod- els based on a combination of judgment, historical experi- ence and knowledge of current market conditions. US super senior RMBS CDOs All material super senior RMBS CDO tranches still held by UBS are covered by corresponding monoline credit protection ref- erencing the specific position held by UBS. Where liquidation of the RMBS CDO is deemed imminent, valuation is based on the estimated aggregate proceeds of the liquidation (using current fair value estimates of the underlying instruments) less any estimated expenses associated with the liquidation. For the remainder of the super senior RMBS CDO population, a model that projects losses on the underlying mortgage pools and applies the implications of these projected lifetime losses through to the RMBS and then to the CDO structure is applied. The loss projection is calibrated separately for each RMBS CDO so that the model recovers the estimated market value of the underlying collateral pool. At 31 December 2007, a similar model was applied, with loss projection esti- mates calibrated such that the model valued relevant ABX market indices consistently with their observed levels in the market. The model has been adjusted in 2008 to better re- flect the prevailing market conditions and illiquidity. Credit valuation adjustments on monoline credit protection Credit valuation adjustments (CVAs) for monoline credit protec- tion are based on a methodology that uses credit default swap spreads on the monolines as a key input in determining an im- plied level of expected loss. Where a monoline has no observ- able credit default swap spread, a judgment is made on the most comparable monoline or combination of monolines and the corresponding spreads are used instead. Credit valuation adjustments are intended to achieve a fair value of the underly- ing contracts and are normally based on publicly available infor- mation. In 2008, in some cases where UBS has had knowledge of potential restructurings that may result in economic out- comes more adverse than those implied by CDS market spreads, UBS had determined to modify CVA amounts accordingly. At 31 December 2007, a similar methodology was applied. The methodology was re-calibrated in 2008 to reflect prevailing market conditions, in particular the greater prevalence of CDS trading with up-front cash exchanges and declines in potential recovery rates implied by recovery swap contract pricing. To assess the sensitivity of the CVA calculation to alterna- tive assumptions, the impact of a 10% increase in monoline credit default swap spreads (e.g. from 2,000 basis points to 2,200 basis points for a specific monoline) is considered. At 31 December 2008, such an increase would have resulted in an increase in the monoline credit valuation adjustment of ap- proximately USD 206 million (CHF 220 million). The sensitivity of the monoline credit valuation adjustment to a decrease of one percentage point in the monoline recovery rate assump- tions (e.g. from 30% to 29% for a specific monoline; condi- tional on default occurring) is estimated at USD 58 million (CHF 62 million). In addition, the credit valuation adjustments related to transactions referencing RMBS CDOs are sensitive to the es- timated market value of the underlying collateral pool. Hold- ing all other parameters constant, the sensitivity of the monoline credit valuation adjustment to a 10% adverse change in the aggregate value of the collateral pools under- lying the referenced RMBS CDOs is estimated at USD 106 million (CHF 113 million). Refer to the section “Risk management and control” for details on UBS’s exposure to monolines. Student loan auction rate securities (ARSs) Student loan ARSs held by UBS’s Investment Bank of USD 7.9 billion (CHF 8.4 billion), previously classified as “held for trading”, were reclassified to the category “loans and receiv- ables” per 31 December 2008. This implies that, going for- ward, these positions will be accounted for at amortized cost and tested for impairment, rather than being subject to fair value accounting through profit or loss. These ARS positions have been fair valued for the last time at 31 December 2008, applying the following principles. The applied method sepa- rates various factors and risks influencing fair value of ARSs and allows calibrating the result to market transactions whenever they become available. The methodology relies on four key components: (a) fundamental cash flow modeling to estimate the level and timing of potential credit losses on a given portfolio of student loans backing the ARS, (b) use of forward yields embedded in market term structure to esti- mate expected required coupon payments, c) discounted cash flow projections calibrated to observed ARS market transactions to correct for any model drift, and (d) liquidity penalties that impose a further discount to reflect market conditions. Each of these inputs is calculated and then ag- gregated in order to arrive at the fair value for each individ- 327 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 27 Fair value of financial instruments (continued) c) Valuation techniques and inputs by product (continued) ual security. At 31 December 2007, these instruments were not classified as level 3, as auctions had not failed at this time. After the failure of auctions due to lack of investor de- mand in first quarter 2008 up to third quarter 2008, UBS valued student loan ARSs by comparing them to the student loan floating rate notes (FRNs), but adopted the model de- scribed above for 31 December 2008, consistent with the belief that it provides a better and more granular approach to fair value estimation. Refer to the section “Risk management and control” for Non-US reference linked notes (Non-US RLNs) The same valuation model and the same approach to cal- culation of fair value adjustments is applied for the non-US RLN credit protection as for the US RLN credit protection de- scribed above, except spread is shocked by 10% for Euro- pean corporate names. As of 31 December 2008, the fair value of the non-US RLN credit protection is approximately USD 1,971 million (CHF 2,102 million). The fair value adjust- ments (up and down) calculated by applying the shocks de- scribed above are USD 155 million (CHF 165 million). details on UBS’s student loan ARS exposures. US reference linked notes (US RLNs) The US RLN consists of a series of transactions whereby UBS purchases credit protection, predominantly in note form, on a portfolio of fixed income assets. It is described in detail in the Annual Report 2007, “Risk, Treasury and Capital Man- agement” section, page 13. The referenced assets are com- prised of USD ABSs (primarily home equity) and/or corporate bonds and loans across all rating categories. UBS’s direct ex- posure to these assets has been reduced via transactions in- cluding the transaction with the SNB. The credit protection embodied in the RLN notes is fair valued using a market standard approach to the valuation of portfolio credit protection (Gaussian copula). This ap- proach effectively simulates correlated defaults within the portfolio, where the expected losses and defaults of the individual assets are closely linked to the observed market prices (spread levels) of those assets. Key assumptions of the model include correlations and recovery rates. UBS ap- plies fair value adjustments related to potential uncertainty in each of these parameters, which are only partly observ- able. In addition, UBS applies fair value adjustments for un- certainties associated with the use of observed spread lev- els as the primary inputs. These fair value adjustments are calculated by applying shocks to the relevant parameters and revaluing the credit protection. These shocks for correlation, recovery, and spreads are set to various levels depending on the asset type and / or region. Correlation and recovery shocks are generally in the range of 5 to 15 percentage points. Spread shocks vary more widely and also depend on whether the under lying protec- tion is funded or unfunded to reflect cash / synthetic basis effects. As of 31 December 2008, the fair value of the US RLN credit protection (pre-reserve) is approxima tely USD 3,284 million (CHF 3,502 million). The fair value adjustments calculated by applying the shocks described above are USD 299 million (CHF 319 million). Leveraged finance A significant proportion of UBS’s leveraged finance exposures have been reclassified from the category “held for trading” to the category “loans and receivables” in fourth quarter 2008. The leveraged finance exposures in the “held for trading” cat- egory at 31 December 2008 are predominantly classified as level 3. Fair value estimates for these positions rely on market knowledge and expert judgment, including judgmental deter- minations based on the terms of the relevant instrument and various other factors. These other factors may include, with- out limitation, observable pricing for other debt of the rele- vant issuer or debt of issuers of comparable credit quality, credit default swap spreads and estimated loss severity fac- tors, and prevailing interest rate levels. Option to acquire equity of the SNB StabFund Under IFRS, the option to purchase the SNB StabFund’s eq- uity is recognized on the balance sheet as a derivative at fair value with changes in fair value recognized in profit and loss. At 31 December 2008, the fair value of the call option held by UBS was approximately CHF 1,100 million. This fair value is calculated using a standard option pric- ing model, where the asset pool is treated as the underlying asset. Key assumptions relate to the level of volatility as- sumed and to the interest rate assumed. At 31 December 2008, UBS assigned a volatility of 11.3% to the underlying asset pool. Decreasing or increasing this assumption by 10% (i. e. 11.3% to 10.2% and 11.3% to 12.4%) would have decreased / increased the fair value at 31 December 2008 by approximately minus USD 156 million (CHF 166 million) / plus USD 156 million (CHF 166 million) respectively. At 31 December 2008, UBS applied an interest rate based on an assumed term funding rate for the asset pool of LIBOR + 250 bp. Decreasing or increasing this assumption by 100 bp would have decreased / increased the estimated fair value at 31 December 2008 by minus USD 246 million (CHF 262 million) / plus USD 290 million (CHF 309 million). 328 Note 27 Fair value of financial instruments (continued) c) Valuation techniques and inputs by product (continued) Derivatives embedded in MCN December issuance The MCNs issued in December 2008 include embedded eq- uity and derivative components with UBS shares as underly- ing, which are bifurcated and treated as one derivative ac- counted for at fair value with fair value changes recognized in profit or loss. Refer to Note 26 for more information. The fair value amounted to negative CHF 1,058 million at 31 De- cember 2008. A 10% reduction in UBS’s share price from CHF 14.84 to CHF 13.35, holding all other variables con- stant, would have resulted in a fair value of negative CHF 826 million, whereas an increase of UBS’s share price to CHF 16.32 would have led to a fair value of negative CHF 1,314 million. There are no impacts on UBS’s financial resources, as the embedded equity and derivative components will be set- tled in newly issued UBS shares. d) Deferred day 1 profit or loss The table reflects financial instruments for which fair value is determined using valuation models where not all inputs are market observable. Such financial instruments are ini- tially recognized at their transaction price although the val- ues obtained from the relevant valuation model on day 1 may differ. The table shows the aggregate difference yet to be recognized in profit or loss at the beginning and end of the period and a reconciliation of changes in the balance of this difference (movement of deferred day 1 profit or loss). CHF million Balance at the beginning of the year Deferred profit / (loss) on new transactions Recognized (profit) / loss in the income statement Revision to fair value estimates Foreign currency translation Balance at the end of the year For the year ended 31.12.08 31.12.07 550 588 (459) 0 (52) 627 951 1,259 (1,383) (224) (53) 550 n o i t a m r o f n i l a i c n a n i F 329 Financial information Notes to the consolidated financial statements Note 28 Pledged assets and transferred financial assets which do not qualify for derecognition Financial assets are mainly pledged in securities borrowing and lending transactions, in repurchase and reverse repur- chase transactions, under collateralized credit lines with cen- tral banks, against loans from mortgage institutions, in con- nection with derivative transactions and for security deposits relating to stock exchange and clearinghouse memberships. Pledged assets CHF million Financial assets pledged: Financial assets pledged to third parties for liabilities with and without the right of rehypothecation thereof: Financial assets pledged to third parties with right of rehypothecation Mortgage loans Other 1 Total financial assets pledged Other assets pledged Precious metals and other commodities Carrying amount 31.12.08 31.12.07 78,002 40,216 3,699 21,040 182,827 114,190 200 0 102,741 183,027 780 8,628 1 Includes financial instruments of CHF 16 billion reclassified from trading portfolio to loans and receivables. On 31 December 2007 it was presented in the line Financial assets pledged to third parties for liabilities with and without the right of rehypothecation. The following table presents details of financial assets which have been sold or otherwise transferred, but which do not qualify for derecognition. Criteria for derecognition are dis- cussed in Note 1a) 4). Transfer of financial assets which do not qualify for derecognition CHF billion Nature of transaction Securities lending agreements Repurchase agreements Other financial asset transfers Total Continued asset recognition in full – Total assets 31.12.08 31.12.07 22.0 13.1 46.6 81.7 59.7 51.3 75.9 186.9 The transactions are mostly conducted under standard agreements employed by financial market participants and are undertaken with counterparties subject to UBS’s normal credit risk control processes. The resulting credit exposures are controlled by daily monitoring and collateralization of the positions. The financial assets which continue to be recognized are typically transferred in exchange for cash or other financial assets. The associated liabilities can therefore be assumed to be approximately the carrying amount of the transferred financial assets. UBS retains substantially all risks and rewards of the trans- ferred assets in each situation of continued recognition in full. These include credit risk, settlement risk, country risk and market risk. Repurchase agreements and securities lending agree- ments are discussed in Notes 1a) 12) and 1a) 13). Other financial asset transfers include sales of financial assets while concurrently entering into a total rate of return swap with the same counterparty and sales of financial assets involving guarantees. Transferred financial assets which are subject to partial continued recognition were immaterial in 2008 and 2007. The carrying amounts of the partially recognized transferred financial assets are included in the table. 330 Note 29 Measurement categories of financial assets and financial liabilities a) Measurement categories of financial assets and financial liabilities The following table provides information about the carrying amounts of individual classes of financial instruments within the measurement categories of financial assets and financial liabilities as defined in IAS 39. Only those assets and liabilities which are deemed to be financial instruments are included in the table below, which may cause certain balances to dif- fer from those presented on the balance sheet. See the Critical accounting policies for a discussion on how fair value of financial instruments is determined. See also Note 1a) 5)–9). Financial assets Held for trading Trading portfolio assets Trading portfolio assets pledged as collateral Debt issued 1,2 Positive replacement values Total Fair value through profit or loss, other Financial assets designated at fair value Cash, loans and receivables Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Loans Accrued income and prepaid expenses Other assets Total Available-for-sale Financial investments available-for-sale Total financial assets Financial liabilities Held for trading Trading portfolio liabilities Debt issued 1 Negative replacement values Total Fair value through profit or loss, other Financial liabilities designated at fair value Amounts due under unit-linked contracts Total Financial liabilities at amortized cost Due to banks Cash collateral on securities lent Repurchase agreements Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total Total financial liabilities 1 Embedded derivatives presented on the balance sheet line Debt issued. 2 On 31 December 2007, respective amounts have been included in the line Positive replacement values. 31.12.08 31.12.07 261,904 40,216 4,152 854,100 1,160,372 630,764 114,190 428,217 1,173,171 12,882 11,765 32,744 64,451 122,897 224,648 338,520 3,238 5,901 18,793 60,907 207,063 376,928 334,367 9,200 12,874 792,399 1,020,132 5,248 1,970,901 4,966 2,210,034 62,431 185 851,864 914,480 101,546 13,051 114,597 125,628 14,063 102,561 474,774 10,012 201,221 12,765 941,024 1,970,101 164,788 74 443,539 608,401 191,853 27,455 219,308 145,762 31,621 305,887 641,892 21,665 222,003 25,302 1,394,132 2,221,841 331 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 29 Measurement categories of financial assets and financial liabilities (continued) b) Reclassification of financial assets Pursuant to the amendment to IAS 39 and IFRS 7, “Reclas- sification of Financial Assets”, UBS reclassified certain finan- cial assets out of Trading portfolio assets to Loans and re- ceivables. Although the amendment could have been applied retrospectively from 1 July 2008, UBS decided at the end of October 2008 to apply the amendment with effect from 1 October 2008 following an assessment of the implications on its financial statements. The financial assets were reclassi- fied using their fair value on the date of the reclassification which became their new cost basis at that date. The reclas- sification of these financial assets reflects UBS’s change in intent and ability to hold these financial assets for the fore- seeable future rather than for trading in the near term. The table below shows the fair values of the reclassified financial assets as of their reclassification date and their car- rying values and fair values as of 31 December 2008: CHF billion Trading portfolio assets reclassified to Loans on 1.10.08 Trading portfolio assets reclassified to Loans on 31.12.08 Total financial assets reclassified to Loans and receivables 1.10.08 31.12.08 Fair value Carrying value Fair value 17.6 17.6 15.8 8.4 24.2 12.4 8.4 20.8 Reclassified financial assets primarily relate to student loan ARSs and other debt instruments. As of the reclassification date, estimated effective interest rates on the reclassified financial assets ranged on average from 6% to 15% with expected recoverable cash flows of CHF 50.2 billion. For the years ended 31 December 2008 and 31 December 2007, fair value losses of CHF 4.1 billion and CHF 0.6 billion, prior to reclassification, were recognized in the income state- ment on the reclassified financial assets. If the financial assets had not been reclassified, the change in their fair values, after actual reclassification, would have resulted in additional fair value losses of CHF 4.8 billion in the income statement for the year ended 31 December 2008. After reclassification, the contribution of the reclassified financial assets to UBS’s income statement was an increase in Net interest income of CHF 0.1 billion, less a Credit loss expense of CHF 1.3 billion, resulting in a net negative impact on operating profit before tax of CHF 1.2 billion for the year ended 31 December 2008. 332 Note 30 Pension and other post-employment benefit plans a) Defined benefit plans The Group has established various pension plans inside and outside of Switzerland. The major plans are located in Swit- zerland, the UK, the US and Germany. Independent actuarial valuations are performed for the plans in these locations. The measurement date of these plans is 31 December for each year presented. The overall investment policy and strategy for the Group’s defined benefit pension plans is guided by the objective of achieving an investment return which, together with the contributions paid, is sufficient to maintain reasonable con- trol over the various funding risks of the plans. The invest- ment advisors appointed by plan trustees are responsible for determining the mix of asset types and target allocations which are reviewed by the plan trustees on an ongoing ba- sis. Actual asset allocation is determined by a variety of cur- rent economic and market conditions and in consideration of specific asset class risk. The expected long-term rates of return on plan assets are based on long-term expected inflation, interest rates, risk premiums and targeted asset class allocations. These esti- mates take into consideration historical asset class returns and are determined together with the plans’ investment and actuarial advisors. Swiss pension plans The pension plan of UBS covers all UBS employees in Swit- zerland and exceeds the minimum benefit requirements un- der Swiss law. The Swiss plan was amended on 1 January 2007 to change the definition of retirement benefits from a final covered salary to a retirement savings approach and on 1 January 2008 to allow employees a choice in the level of annual contributions paid by the employee. The pension plan provides benefits which are based on annual contribu- tions as a percentage of salary and accrue at an interest rate that is defined annually by the plan trustees. calculated as a percentage of covered salary and are deduct- ed monthly. The percentages deducted from salary for the full standard level of benefit coverage (including risk bene- fits) depend on age and vary between 1% and 9% of cov- ered base salary and 3% and 8% of covered variable com- pensation. The employer pays a contribution that ranges between 100% and 375% of employees’ contributions for the standard level of benefit coverage. The benefits covered include retirement benefits; disability, death and survivor pensions; and employment termination benefits. The employer contributions expected to be made in 2009 to the Swiss pension plan are CHF 520 million. UBS recognized a defined benefit asset associated with its Swiss pension plan in 2008 and restated prior periods. Refer to Note 1b). Foreign pension plans The foreign locations of UBS operate various pension plans in accordance with local regulations and practices. Among these plans are defined contribution plans as well as defined benefit plans. The locations with defined benefit plans of a material nature are in the UK, the US and Germany. The UK and the US defined benefit plans are closed to new entrants who are covered by defined contribution plans. The amounts shown for foreign plans reflect the net funded positions of the major foreign plans. The retirement plans provide benefits in the event of re- tirement, death, disability or employment termination. The plans’ retirement benefits depend on age, contributions and level of compensation. The principal plans are financed in full by the Group. The employer contributions expected to be made in 2009 to these pension plans are CHF 96 million. The funding policy for these plans is consistent with local government and tax requirements. The assumptions used in foreign plans take into account Contributions to the pension plan of UBS are paid by em- ployees and the employer. The employee contributions are local economic conditions. Refer also to Note 1a) 21). n o i t a m r o f n i l a i c n a n i F 333 Financial information Notes to the consolidated financial statements Note 30 Pension and other post-employment benefit plans (continued) a) Defined benefit plans (continued) CHF million For the year ended Swiss Foreign 31.12.08 31.12.07 31.12.06 31.12.08 31.12.07 31.12.06 Defined benefit obligation at the beginning of the year (20,877) (21,506) (20,972) (4,928) (5,207) (5,020) (336) (710) (233) 0 (288) 1,158 (25) (367) (633) (236) (414) 1,508 792 (21) (347) (611) (221) (125) (265) 723 (17) 0 0 329 (21,311) 22,181 990 (3,820) 603 233 (1,158) 0 19,029 (2,282) 4,405 0 0 2,123 2,123 (603) 603 (20,877) 21,336 1,067 (250) 584 236 (792) 0 22,181 1,304 2,123 0 (1,304) 2,123 1,953 (414) 584 (21,506) 20,229 998 447 492 221 (723) (328) 21,336 (170) 2,123 0 0 1,588 (127) 492 2,123 2,123 1,953 2,123 2,123 1,953 2,123 2,123 1,953 (63) (251) 318 148 0 0 0 0 1,134 (3,642) 4,579 282 (1,027) 194 (88) (264) 236 151 0 (54) 0 0 298 (4,928) 4,602 313 (97) 200 (76) (242) (120) 149 0 0 186 0 (84) (5,207) 4,288 283 40 66 (148) (151) (149) (1,014) 2,866 (776) 1,324 0 (288) 4,579 (349) 975 0 74 4,602 (605) 1,237 1 626 (69) 194 0 0 (203) 548 798 (250) 548 633 (97) 200 (54) 0 (56) 626 887 (261) 626 491 (103) 66 0 170 9 633 815 (182) 633 1,953 548 626 633 Service cost Interest cost Plan participant contributions Amendments Actuarial gain / (loss) Benefits paid Termination benefits Acquisitions Settlements Curtailments Foreign currency translation Defined benefit obligation at the end of the year Fair value of plan assets at the beginning of the year Expected return on plan assets Actuarial gain / (loss) Employer contributions Plan participant contributions Benefits paid Settlements Curtailments Foreign currency translation Fair value of plan assets at the end of the year Funded status Unrecognized net actuarial (gains) / losses Unrecognized past service cost Unrecognized asset (Accrued) / prepaid pension cost Movement in the net (liability) or asset (Accrued) / prepaid pension cost at the beginning of the year Net periodic pension cost Employer contributions Acquisitions Settlement Foreign currency translation (Accrued) / prepaid pension cost Amounts recognized in the balance sheet Prepaid pension cost Accrued pension liability (Accrued) / prepaid pension cost 334 Defined benefit obligation from funded plans (21,311) (20,877) 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 Note 30 Pension and other post-employment benefit plans (continued) Immediate recognition of net actuarial (gains) / losses in current period 1,826 (1,258) a) Defined benefit plans (continued) CHF million For the year ended Components of net periodic pension cost Service cost Interest cost Expected return on plan assets Amortization of unrecognized net (gains) / losses Amortization of unrecognized past service cost Immediate recognition of past service cost in current period Termination benefits Settlements Curtailments Limit of defined benefit asset Net periodic pension cost Funded and unfunded plans CHF million Plan assets Surplus / (deficit) Experience gains / (losses) on plan liabilities Experience gains / (losses) on plan assets CHF million Defined benefit obligation from funded plans Defined benefit obligation from unfunded plans Plan assets Surplus / (deficit) Experience gains / (losses) on plan liabilities Experience gains / (losses) on plan assets Swiss Foreign 31.12.08 31.12.07 31.12.06 31.12.08 31.12.07 31.12.06 336 710 (990) 0 0 367 633 (1,067) 0 0 0 25 0 (1,304) 603 414 21 0 1,304 414 19,029 (2,282) 0 (3,820) 22,181 1,304 0 (250) 63 251 (282) 37 88 264 (313) 58 76 242 (283) 68 0 69 0 97 0 103 347 611 (998) 25 125 0 0 17 0 0 127 Swiss (20,972) 20,229 (743) (20,225) 18,575 (1,650) (21,506) 21,336 (170) (265) 447 Foreign 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 (3,402) (240) 2,866 (776) 62 (1,027) (4,654) (274) 4,579 (349) (32) (97) (5,002) (205) 4,602 (605) (11) 40 (4,635) (385) 4,288 (732) (3,815) (327) 3,580 (562) n o i t a m r o f n i l a i c n a n i F 335 Financial information Notes to the consolidated financial statements Note 30 Pension and other post-employment benefit plans (continued) a) Defined benefit plans (continued) Principal weighted average actuarial assumptions used (%) Assumptions used to determine defined benefit obligations at the end of the year Swiss Foreign 31.12.08 31.12.07 31.12.06 31.12.08 31.12.07 31.12.06 Discount rate Expected rate of salary increase Rate of pension increase Assumptions used to determine net periodic pension cost for the year ended Discount rate Expected rate of return on plan assets Expected rate of salary increase Rate of pension increase Plan assets (weighted average) Actual plan asset allocation (%) Equity instruments Debt instruments Real estate Other Total Long-term target plan asset allocation (%) Equity instruments Debt instruments Real estate Other Actual return on plan assets (%) Additional details to fair value of plan assets UBS financial instruments and UBS bank accounts UBS AG shares 1 Securities lent to UBS included in plan assets Other assets used by UBS included in plan assets 3.3 2.5 0.5 3.5 4.5 2.5 0.8 26 55 13 6 100 20–48 37–63 10–20 0-5 (12.8) 782 55 0 148 6.0 4.5 1.9 5.8 7.1 4.8 2.4 46 35 3 16 100 5.8 4.8 2.4 5.2 7.0 4.6 2.1 50 38 4 8 100 5.2 4.6 2.1 5.0 6.7 4.4 1.9 53 38 4 5 100 45–48 37–38 3–7 10–12 (18.2) 49–52 38–44 4–6 1–3 4.8 49–53 37–44 4–6 1–5 7.8 3.5 2.5 0.8 3.0 5.0 2.5 0.8 38 47 11 4 100 33–51 31–50 10–19 0 3.9 336 128 9,379 111 3.0 2.5 0.8 3.0 5.0 2.5 0.8 41 45 11 3 100 33–51 31–50 10–19 0 7.2 684 193 7,169 69 1 The number of UBS AG shares was 3,734,000; 2,436,257; and 2,600,417 as of 31 December 2008, 31 December 2007 and 31 December 2006, respectively. Mortality tables and life expectancies for major plans Mortality table BVG 2000 PA 92 Dr. K. Heubeck 2005 G RP 2000 with projections Mortality table BVG 2000 PA 92 Dr. K. Heubeck 2005 G RP 2000 with projections Life expectancy at age 65 for a male member currently aged 65 31.12.07 17.8 21.9 18.9 18.3 31.12.06 31.12.08 aged 45 31.12.07 31.12.06 17.8 21.8 18.7 17.9 17.8 25.6 21.8 18.4 17.8 23.0 21.6 18.3 17.8 23.0 21.5 17.9 Life expectancy at age 65 for a female member currently aged 65 31.12.07 21.1 24.8 23.0 20.5 31.12.06 31.12.08 aged 45 31.12.07 31.12.06 21.1 24.7 22.8 20.3 21.1 26.4 25.7 20.6 21.1 25.8 25.6 20.5 21.1 25.8 25.5 20.3 31.12.08 17.8 22.7 19.0 18.4 31.12.08 21.1 24.5 23.1 20.6 Country Switzerland UK Germany US Country Switzerland UK Germany US 336 Note 30 Pension and other post-employment benefit plans (continued) b) Post-retirement medical and life plans In the US and the UK, the Group offers retiree medical benefits that contribute to the health care coverage of em- ployees and beneficiaries after retirement. In addition to re- tiree medical benefits, the Group in the US also provides retiree life insurance benefits. The UK plan is closed to new entrants. The benefit obligation in excess of fair value of plan assets for those plans amounts to CHF 159 million as of 31 December 2008 (2007: CHF 190 million; 2006: CHF 219 million) and the total accrued post-retirement cost amounts to CHF 164 million as of 31 December 2008 (2007: CHF 181 million; 2006: CHF 176 million). The net periodic post-retirement costs for the years ended 31 December 2008, 31 December 2007 and 31 December 2006 were CHF 9 million (including a curtailment gain of CHF 11 million), CHF 26 million and CHF 24 million, respectively. The employer contributions expected to be made in 2009 to the post-retirement medical and life plans are CHF 7 million. CHF million 31.12.08 31.12.07 31.12.06 Post-retirement benefit obligation at the beginning of the year Service cost Interest cost Plan participant contributions Actuarial gain / (loss) Amendments Benefits paid Curtailments Foreign currency translation Post-retirement benefit obligation at the end of the year Fair value of plan assets at the beginning of the year Employer contributions Plan participant contributions Benefits paid Fair value of plan assets at the end of the year CHF million Defined benefit obligation Plan asset Surplus / (deficit) Experience gains / (losses) on plan liabilities (190) (8) (11) (0) 14 0 7 9 20 (159) 0 6 1 (7) 0 (219) (12) (11) (1) 39 (8) 8 0 14 (216) (10) (11) (1) 1 (1) 9 0 10 (190) (219) 0 7 1 (8) 0 0 8 1 (9) 0 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 (159) 0 (159) 3 (190) 0 (190) 8 (219) 0 (219) 1 (216) 0 (216) (3) (166) 0 (166) 0 The assumed average health care cost trend rate used in de- termining post-retirement benefit expense is assumed to be 10% for 2008 and to decrease to an ultimate trend rate of 5% in 2014. On a country-by-country basis, the same dis- count rate is used for the calculation of the post-retirement benefit obligation from medical and life plans as for the de- fined benefit obligations arising from pension plans. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percentage point change in the assumed health care cost trend rates would change the US post-retirement benefit ob- ligation and the service and interest cost components of the net periodic post-retirement benefit costs as follows: CHF million Effect on total service and interest cost Effect on the post-retirement benefit obligation 1% increase 1% decrease 3 19 (2) (16) n o i t a m r o f n i l a i c n a n i F 337 Financial information Notes to the consolidated financial statements Note 30 Pension and other post-employment benefit plans (continued) c) Defined contribution plans The Group also sponsors a number of defined contribution plans primarily in the UK and the US. Certain plans permit employees to make contributions and earn matching or other contributions from the Group. The contributions to these plans recognized as expense for the years ended 31 December 2008, 31 December 2007 and 31 December 2006 were CHF 312 million, CHF 285 million and CHF 229 million, respectively. d) Related party disclosure UBS is the principal bank for the pension fund of UBS in Switzerland. In this function, UBS is engaged to execute most of the pension fund’s banking activities. These activities also include, but are not limited to, trading and securities lending and borrowing. All transactions have been executed at arm’s length conditions. The foreign UBS pension funds do not have a similar banking relationship with UBS, but they may hold and trade UBS shares and / or securities. In 2008, UBS sold to its Swiss pension fund certain bank-occupied properties for proceeds of approximately CHF 186 million and recognized a gain of approximately CHF 97 million. UBS and its Swiss pension fund entered si- multaneously into lease-back arrangements for some of the properties with 25-year lease terms and two renewal options for ten years each. At 31 December 2008 the minimum commitment towards the Swiss pension fund under the related leases is approximately CHF 41 million. The following fees and interest have been received or paid by UBS: Related party disclosure CHF million Received by UBS Fees Paid by UBS Interest Dividends and capital repayments The transaction volumes in UBS shares and other UBS securities are as follows: Transaction volumes – related parties Financial instruments bought by pension funds UBS AG shares (in thousands of shares) UBS financial instruments (nominal values in CHF million) Financial instruments sold by pension funds or matured UBS AG shares (in thousands of shares) UBS financial instruments (nominal values in CHF million) For the year ended 31.12.08 31.12.07 31.12.06 44 1 4 58 2 38 53 2 33 For the year ended 31.12.08 31.12.07 31.12.06 6,925 78 1,881 10 1,728 950 1,930 976 1,793 8 2,752 14 UBS has also leased buildings from its pension funds. The rent paid by UBS under these leases amounted to CHF 7 mil- lion in 2008, CHF 6 million in 2007 and CHF 4 million in 2006. There were no financial instruments due from UBS pen- sion plans outstanding as of 31 December 2008 (2007: CHF 0 million; 2006: CHF 120 million). The amounts due to UBS defined benefit pension plans are contained in the addition- al details to the fair value of plan assets. Furthermore, UBS defined contribution plans hold 17,866,949 UBS shares with a market value of CHF 272 million as of 31 December 2008 (2007: 14,121,239 shares with a market value of CHF 736 million; 2006: 14,158,961 shares with a market value of CHF 1,043 million). 338 Note 31 Equity participation and other compensation plans a) Plans offered UBS has established several equity participation plans to further align the interests of executives, managers and staff with the interests of shareholders. The plans are offered to eligible employees in approximately 50 countries and are designed to meet the complex legal, tax and regulatory requirements of each country in which they are offered. The explanations below provide a general description of the terms of the most significant plans offered, however specific plan rules may vary by country. Refer to Note 1a) 22) for a description of the accounting policy related to equity partici- pation and other compensation plans. Refer also to Note 1b for a description of the restatement impact of adopting IFRS 2 Share-based Payment: Vesting Conditions and Can- cellations on 1 January 2008. Equity participation plans Equity Plus Plan (Equity Plus): This voluntary plan gives eli- gible employees the opportunity to purchase UBS shares at fair market value and generally receive at no additional cost two UBS options for each share purchased, up to a maxi- mum annual limit. Share purchases can be made annually from bonus compensation and / or quarterly based on regu- lar deductions from salary. Shares purchased under Equity Plus are restricted from sale for two years from the time of purchase. The options have a strike price equal to the fair market value of a UBS share on the date the option is grant- ed, a two-year vesting period and generally expire ten years from the date of grant. The options are forfeitable in certain circumstances and are settled in equity, except in countries where this is not permitted for legal reasons. Compensation expense related to the UBS options is recognized over the shorter of the legal vesting period and the period from grant to the retirement eligibility date of the employee. Equity Ownership Plan (EOP): Selected employees receive between 10% and 45% of their annual performance-relat- ed compensation in UBS shares or notional UBS shares in- stead of cash, on a mandatory basis (on-cycle awards). Up to and including 2004, certain employees were eligible to receive a portion of their EOP award in Alternative Invest- ment Vehicles (AIVs) or UBS options. Since 2005, options have not been granted as part of EOP and awards have been generally made in UBS shares, with less than 2% be- ing made in AIVs to selected employee groups. The awards granted in UBS shares or notional UBS shares are settled in equity, except in countries where this is not permitted for legal reasons. Awards granted in the form of AIVs are settled in cash. EOP awards generally vest in one-third increments over a three-year vesting period. In certain cir- cumstances, these awards are forfeitable. Compensation expense for on-cycle awards is generally recognized during the performance year, which is generally the period prior to the grant date. During 2008, UBS granted to certain employees on-cycle EOP awards with a nine-month vesting period. Compensa- tion expense for these awards was fully recognized in 2007. Beginning with on-cycle awards granted in 2009 for the performance year 2008, compensation expense will be rec- ognized over the shorter of the legal vesting period and the period from grant to the date the employee satisfies certain retirement eligibility requirements. This change in account- ing treatment is the result of the vesting provisions being amended to require forfeiture upon voluntary termination of employment rather than upon violation of non-compete provisions. EOP awards are also granted to selected employees when joining UBS or in other special circumstances (off-cycle awards). Off-cycle awards have the same terms and condi- tions as on-cycle awards, except that the forfeiture condi- tions are more stringent. Compensation expense for off- cycle awards is generally recognized over the shorter of the legal vesting period and the period from grant to the retire- ment eligibility date of the employee. Senior Executive Equity Ownership Plan (SEEOP): Senior executives receive between 25% and 50% of their perfor- mance-related compensation in UBS shares or notional UBS shares instead of cash, on a mandatory basis. The awards granted in UBS shares or notional UBS shares are settled in equity. SEEOP awards generally vest in one-fifth increments over a five-year vesting period. These awards are forfeitable if certain conditions are not met. Compensation expense for all SEEOP awards is recognized during the performance year, which is generally the period prior to the grant date. During 2008, UBS granted to certain employees SEEOP awards with a nine-month vesting period. Compensation expense for these awards was fully recognized in 2007. Key Employee Stock Option Plan (KESOP): Key and high potential employees are granted discretionary UBS options with a strike price not less than the fair market value of a UBS share on the date the option is granted. One option gives the right to acquire one registered UBS share at the option’s strike price. The awards are settled in equity, except in countries where this is not permitted for legal reasons. Options granted prior to 2008 generally vest in one-third increments over a three-year vesting period and generally expire ten years from the grant date. Options granted from 2008 vest in full following a three-year vesting period and generally expire ten years from the grant date. These awards are generally forfeitable upon termination of employment with UBS. Compensation expense is recog- nized over the shorter of the legal vesting period and the 339 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 31 Equity participation and other compensation plans (continued) a) Plans offered (continued) period from grant to the retirement eligibility date of the employee. Senior Executive Stock Option Plan (SESOP): Senior execu- tives may be granted discretionary UBS options with a strike price set at 110% of the fair market value of a UBS share on the date the option is granted. One option gives the right to acquire one registered UBS share at the option’s strike price. The awards are settled in equity. Options vest in full follow- ing a three-year vesting period and generally expire ten years from the grant date. These awards are forfeitable if certain conditions are not met. Compensation expense for all SESOP awards is recognized during the performance year, which is generally the period prior to the grant date. Global WM&BB Partner Plus Plan (PPP): UBS grants no- tional UBS shares to certain client advisers, which vest in 20% increments 6 to 10 years after the grant date. The awards are generally settled in equity, except in countries where this is not permitted for legal reasons, and are forfeitable in certain circumstances. Compensation expense is recognized over the shorter of the legal vesting period and the period from grant to the retirement eligibility date of the employee. The first grants made under this plan were in 2007. Other compensation plans Executive Capital Accumulation Plan (ECAP): UBS sponsors a voluntary deferred compensation plan for selected eligi- ble employees. Under this plan, participants are allowed to notionally invest a portion of their cash bonus in money market funds, UBS and non-UBS mutual funds and other UBS sponsored funds. No additional company match is granted, the awards are generally not forfeitable and are settled in cash. This plan does not result in compensation expense for UBS. WMUS Partner Plus Plan: WM US sponsors a compulsory deferred compensation plan for selected eligible employees. Under this plan, UBS awards amounts based on a predefined formula during the performance year. Participants are also allowed to voluntarily contribute additional amounts earned during the year into the plan up to a percentage of UBS’s contributions. The amounts awarded earn an above-market rate of interest during a four-year period and a market rate of interest thereafter. Partner Plus awards vest in 20% incre- ments 6 to 10 years after the grant date. The UBS contribu- tions and all interest earned are forfeitable in certain circum- stances. Compensation expense is recognized over the shorter of the vesting period and the period from the perfor- mance year to the date that the employee is eligible to leave UBS and retain their award. UBS satisfies share delivery obligations under its option- based participation plans either by purchasing UBS shares in the market or through the issuance of new shares. At exer- cise, shares held in treasury or newly issued shares are deliv- ered to the employee against receipt of the strike price. As of 31 December 2008, UBS was holding approximately 49 mil- lion shares in treasury and an additional 150 million unissued shares in conditional share capital, which are available and can be used for future employee option exercises. The shares available cover all vested (i.e. exercisable) employee options. b) Effect on income statement and balance sheet The total share-based compensation expense recognized for the years ended 31 December 2008, 31 December 2007 and 31 December 2006 was negative CHF 94 million, CHF 3,173 million and CHF 2,685 million, respectively. The de- crease in compensation expense in 2008 as compared to prior years is primarily a result of UBS adopting the amend- ment to IFRS 2 Share-based Payment: Vesting Conditions and Cancellations on 1 January 2008. Furthermore, UBS amended the EOP plan rules for awards to be granted in 2009 for the year 2008 for which compensation expense related to these awards will be recognized over the vesting period rather than in the performance year. For the years ended 31 December 2008, 31 December 2007 and 31 De- cember 2006, the compensation expense recognized for share-based payments was primarily related to equity-settled plans. At 31 December 2008, total compensation expense related to non-vested awards not yet recognized in the in- come statement is CHF 648 million, which is expected to be recognized in Personnel expenses over a weighted average period of 3.2 years. Payments to participants of cash-settled share-based and AIV plans for the years ended 31 December 2008, 31 Decem- ber 2007 and 31 December 2006 were CHF 80 million, CHF 42 million and CHF 177 million, respectively. The total carry- ing amount of the liability related to these cash-settled plans amounted to CHF 207 million as of 31 December 2008. 340 Note 31 Equity participation and other compensation plans (continued) c) UBS share awards Movements in shares granted under the equity participation plans described in Note 31a) are as follows: Forfeitable, at the beginning of the year Shares awarded during the year Distributions during the year Forfeited during the year Forfeitable, at the end of the year of which: shares vested for accounting purposes Weighted average grant date fair value CHF 66 32 61 54 53 Number of shares 31.12.08 59,102,580 90,895,594 1,2 (60,105,109) (5,156,131) 84,736,935 65,767,017 Weighted average grant date fair value CHF 58 70 55 66 66 Number of shares 31.12.07 56,141,102 30,271,820 (25,031,819) (2,278,523) 59,102,580 47,700,903 Weighted average grant date fair value CHF 46 69 43 56 58 Number of shares 31.12.06 53,725,186 26,652,070 (22,712,566) (1,523,588) 56,141,102 47,345,901 1 The number of shares awarded during the year include 4,260,681 of reinvested dividends as a result of the stock dividend, for which new shares were issued on 19 May 2008. There was no impact to the weighted average grant date fair value and no additional compensation expense was recognized. 2 As a result of the rights offering in June 2008, UBS adjusted the number of notional shares which were unvested at the date of the rights offering. This was done to prevent any dilution impact to holders of these notional shares. The total number of shares awarded during the year include an addi- tional 1,806,071 notional shares as a result of this anti-dilution adjustment. No additional compensation expense was recognized. Prior to 2008, UBS estimated the grant date fair value of shares awarded during the year by using the average UBS share price on the grant date as quoted on the SWX Europe. The grant date fair value of notional UBS shares without dividend entitlements includes a deduction for the present value of future expected dividends to be paid between grant date and distribution. The market value of shares vested was CHF 1,385 million, CHF 1,737 million, and CHF 1,587 million for the years ended 31 December 2008, 31 December 2007, and 31 December 2006, respectively. For share awards granted beginning in 2008, UBS mea- sures compensation cost based on the average market price of the UBS share on the grant date less a discount for post- vesting sale and hedge restrictions and non-vesting con- ditions, in accordance with IFRS 2 Share-based Payment: Vesting Conditions and Cancellations. The grant date fair value of notional UBS shares without dividend entitlements also includes a deduction for the present value of future expected dividends to be paid between grant date and distri- bution. The fair value of the share awards subject to post- vesting sale and hedge restrictions is discounted based upon the duration of the post-vesting restriction. The weighted average discount for share awards granted in 2008 is approximately 19% of the market price of the UBS share. Discounts for non-vesting conditions are based on the prob- ability that the non-vesting conditions will be achieved and the award will become exercisable. The fair value of share- based awards granted prior to 2008 was not discounted for post-vesting sale and hedge restrictions, as there was no dis- tinction between vesting and non-vesting conditions until the IASB amended IFRS 2 effective for UBS January 2008 Share-based Payment: Vesting Conditions and Cancellations. n o i t a m r o f n i l a i c n a n i F 341 Financial information Notes to the consolidated financial statements Note 31 Equity participation and other compensation plans (continued) d) UBS option awards Movements in options granted under the equity participation plans described in Note 31a) are as follows: Outstanding, at the beginning of the year Granted during the year Exercised during the year Forfeited during the year Expired unexercised Outstanding, at the end of the year Exercisable, at the end of the year Number of options 31.12.08 1 198,213,092 62,973,879 (3,673,657) (6,732,080) (14,725,689) 236,055,545 124,054,442 Weighted average exercise price CHF 1,2 52 30 26 52 46 47 46 Number of options 31.12.07 1 188,393,473 48,094,483 (34,331,511) (3,650,942) (292,411) 198,213,092 96,396,428 Weighted average exercise price CHF 1,2 47 67 36 62 58 52 39 Number of options 31.12.06 1 193,707,056 48,507,481 (50,279,072) (3,520,009) (21,983) 188,393,473 85,589,034 Weighted average exercise price CHF 1,2 39 67 34 52 38 47 34 1 As a result of the rights offering in June 2008, UBS adjusted the number of options and exercise price for vested and unvested employee options which were unexercised at the date of the rights offering. This was done to prevent any dilution impact to holders of these options. No additional compensation expense was recognized. This resulted in an increase to the number of options awarded in 2008 of 3,881,320 and an increase to the prior year outstanding balance of 2,400,143. 2 Some of the options in this table have exercise prices denominated in USD which have been converted into CHF at the year-end spot exchange rate for the purposes of this table. The weighted average share price at the time when the options were exercised during the year was CHF 34, CHF 72, and CHF 71 for the years ended 31 December 2008, 31 De- cember 2007, and 31 December 2006, respectively. The fol- lowing table provides additional information about option awards: Intrinsic value of options exercised during the year (CHF million) Weighted average grant date fair value of options granted (CHF) 31.12.08 31.12.07 31.12.06 29 7.53 1,046 10.43 1,660 11.63 The following table summarizes additional information about options outstanding and options exercisable at 31 Decem- ber 2008: Options outstanding Options exercisable Number of options outstanding Weighted average exercise price (CHF / USD) Aggregate intrinsic value (CHF / USD million) Weighted average remaining contractual term (years) Number of options exercisable Weighted average exercise price (CHF / USD) Aggregate intrinsic value (CHF / USD million) Weighted average remaining contractual term (years) Range of exercise price per share CHF 14.47–25.00 25.01–35.00 35.01–45.00 45.01–55.00 55.01–65.00 65.01–75.00 14.47–75.00 USD 4.74–20.00 20.01–30.00 30.01–40.00 40.01–53.50 4.74–53.50 342 9,612,902 49,437,156 27,821,969 26,011,919 5,398,949 76,929,095 195,211,990 108,301 15,864,689 9,821,977 15,048,584 40,843,551 18.31 31.08 39.23 49.18 60.31 67.85 49.32 13.49 21.60 34.03 41.40 31.86 1.7 0.0 0.0 0.0 0.0 0.0 1.7 0.3 0.0 0.0 0.0 0.3 9.8 8.3 5.9 6.0 8.0 7.7 7.5 1.2 3.7 5.3 6.2 5.0 0 8,966,563 19,023,570 22,846,437 2,208,584 30,294,459 83,339,613 108,301 15,864,689 9,821,977 14,919,862 40,714,829 0.00 28.22 40.68 48.63 61.30 66.34 51.39 13.49 21.60 34.03 41.36 31.82 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.0 0.0 0.0 0.3 4.3 4.3 5.7 7.4 7.5 5.9 1.2 3.7 5.3 6.1 5.0 Note 31 Equity participation and other compensation plans (continued) e) Valuation The fair value of options is determined by means of a Monte Carlo simulation. The simulation technique uses a mix of implied and historic volatility and specific employee exercise behavior patterns based on statistical data, taking into account the specific terms and conditions under which the options are granted, such as the vesting period, forced exer- cises during the lifetime, and gain- and time-dependent ex- ercise behavior. The expected term of each option is calcu- lated as the probability-weighted average period of the time between grant and exercise. The term structure of volatility is derived from the implied volatilities of traded UBS options in combination with the observed long-term historic share price volatility. Dividends are assumed to grow at a fixed rate over the term of the option. The fair value of options granted in 2008, 2007 and 2006 was determined using the following assumptions: Expected volatility (%) Risk-free interest rate (%) Expected dividend (CHF) Strike price (CHF) Share price (CHF) Expected volatility (%) Risk-free interest rate (%) Expected dividend (CHF) Strike price (CHF) 1 Share price (CHF) 1 1 Not adjusted for stock dividend and rights offering in 2008. Expected volatility (%) Risk-free interest rate (%) Expected dividend (CHF) Strike price (CHF) 2 Share price (CHF) 2 31.12.08 CHF awards range low range high 33.86 2.83 1.85 30.11 28.05 30.00 1.74 1.10 14.47 14.47 49.32 3.27 2.57 46.02 43.61 31.12.07 CHF awards range low range high 23.86 2.58 3.13 71.31 70.25 22.51 2.46 2.20 55.48 55.48 29.23 3.27 4.56 78.80 78.80 CHF awards 1 25.38 2.15 2.26 71.19 70.16 31.12.06 range low range high 22.51 1.96 1.76 65.13 65.13 27.18 2.68 2.83 77.33 76.25 1 Less than 1% of awards in 2006 were granted in USD. These have been combined with CHF awards for purposes of this disclosure. 2 Not adjusted for stock dividend and rights offering in 2008. n o i t a m r o f n i l a i c n a n i F 343 Financial information Notes to the consolidated financial statements Note 32 Related parties The Group defines related parties as associated companies, post-employment benefit plans for the benefit of UBS em- ployees, key management personnel, close family members of key management personnel and enterprises which are, directly or indirectly, controlled by, jointly controlled by or significantly influenced by or in which significant voting power resides with key management personnel or their close family members. Key management personnel is defined as members of the Board of Directors (BoD) and Group Execu- tive Board (GEB). This definition is based on the requirements of IAS 24 Related Party Disclosures. a) Remuneration of key management personnel The non-independent members of the BoD have top man- agement employment contracts and receive pension bene- fits upon retirement. Total remuneration of the non-inde- pendent members of the BoD and GEB including those who stepped down during 2008 is as follows: CHF million Base salaries and other cash payments Incentive awards – cash Employer’s contributions to retirement benefit plans Benefits in kind, fringe benefits (at market value) Equity compensation benefits 1 Total 31.12.08 31.12.07 31.12.06 12 0 2 1 0 15 14 38 2 2 22 78 16 107 1 2 113 239 1 Expense for shares and options granted is measured at grant date and allocated over the vesting period, generally 3 years for options and 5 years for shares. Marcel Ospel, former Chairman of the BoD, did not stand for re-election at the AGM of 23 April 2008. Stephan Haeringer, former executive vice chairman of the BoD, retired from the BoD on 2 October 2008. Marco Suter, formerly an executive member of the BoD, stepped down from the BoD on 1 Octo- ber 2007 and thereafter acted as Group Chief Financial Officer (Group CFO) and as a member of the GEB until his stepping down from this role on 31 August 2008. While Marcel Ospel has retired from UBS as of April 2008, Stephan Haeringer and Marco Suter agreed with UBS to continue their services for UBS until their termination dates of 30 Sep- tember 2009 and 31 August 2009 respectively. All three persons were contractually entitled to receive base salary, a payment based on their average remuneration over the last three years and certain employment benefits until the expiry of their 12-month notice period. For the fiscal years 2007 and 2008, Marcel Ospel, Stephan Haeringer and Marco Suter did not receive any incentive awards. Furthermore, on 25 November 2008, Marcel Ospel, Stephan Haeringer and Marco Suter announced that they voluntarily relinquished substantial parts of the payments to which they were entitled during their periods of employ- ment with UBS. The total amount waived or repaid was CHF 33 million. The remaining contractual obligations to all three former BoD members, consisting of those due in 2008 and those upcoming in 2009, net of the CHF 33 million voluntarily waived or repaid, amounted to CHF 10 million. This amount has been fully accrued in 2008 and is reflected in the firm’s 2008 income statement. Of this amount, CHF 2.3 million was for Marcel Ospel, CHF 3.9 million for Stephan Haeringer and CHF 3.8 million for Marco Suter. The independent members of the BoD do not have em- ployment or service contracts with UBS, and thus are not entitled to benefits upon termination of their service on the BoD. Payments to these individuals for their services as exter- nal board members amounted to CHF 6.4 million in 2008, CHF 5.7 million in 2007 and CHF 5.9 million in 2006. 344 Note 32 Related parties (continued) b) Equity holdings Number of stock options from equity participation plans held by non-independent members of the BoD and the GEB 1 Number of shares held by members of the BoD, GEB and parties closely linked to them 1 Further information about UBS’s equity participation plans can be found in Note 31. 31.12.08 31.12.07 31.12.06 8,458,037 5,892,548 6,828,152 6,693,012 10,886,798 7,974,724 Of the share totals above, at 31 December 2008, 31 Decem- ber 2007 and 31 December 2006, 15,878 shares, 4,852 shares and 7,146 shares respectively were held by close family members of key management personnel and 103,841 shares, 2,200,000 shares and 2,200,000 shares respectively were held by enterprises which are directly or indirectly controlled by, jointly controlled by or significantly influenced by or in which significant voting power resides with key management per- sonnel or their close family members. Further information about UBS’s equity participation plans can be found in Note 31. No member of the BoD or GEB is the beneficial owner of more than 1% of the Group’s shares at 31 December 2008. c) Loans, advances and mortgages to key management personnel Non-independent members of the BoD and GEB members have been granted loans, fixed advances and mortgages on the same terms and conditions that are available to other employees, based on terms and conditions granted to third parties adjusted for reduced credit risk. Independent BoD members are granted loans and mortgages at general mar- ket conditions. Movements in the loan, advances and mortgage balances are as follows: CHF million Balance at the beginning of the year Additions Reductions Balance at the end of the year 31.12.08 31.12.07 15 8 (12) 11 19 0 (4) 15 No unsecured loans were granted to key management personnel as of 31 December 2008 and 31 December 2007. d) Associated companies Movements in loans to associated companies are as follows: CHF million 31.12.08 31.12.07 Balance at the beginning of the year Additions Reductions Credit loss (expense) / recovery Foreign currency translation Balance at the end of the year thereof unsecured loans thereof allowances for credit losses All loans to associated companies are transacted at arm’s length. 220 171 (77) 0 (13) 301 82 3 375 60 (215) 0 0 220 56 4 345 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 32 Related parties (continued) d) Associated companies (continued) Other transactions with associated companies transacted at arm’s length are as follows: CHF million Payments to associates for goods and services received Fees received for services provided to associates Commitments and contingent liabilities to associates Note 34 provides a list of significant associates. e) Other related party transactions For the year ended or as of 31.12.08 31.12.07 31.12.06 90 6 40 87 20 33 58 79 32 During 2008 and 2007, UBS entered into transactions at arm’s length with enterprises which are directly or indirectly controlled by, jointly controlled by or significantly influenced by or in which significant voting power resides with key management personnel or their close family members. In 2008 and 2007 these companies included Aebi + Co. AG (Switzerland), AC Management SA, (Switzerland), Bertarelli Family (Switzerland), Bertarelli Investment Ltd (Jersey) (dis- solved in December 2007), DKSH Holding AG (Switzerland), Fiat Group (Italy), Kedge Capital Selected Funds Ltd. (Jersey), Lévy Kaufmann-Kohler (Switzerland), Limonares Ltd (Jersey) (dissolved in December 2007), Löwenfeld AG (Switzerland), Martown Trading Ltd. (Isle of Man), Omega Fund I Ltd (Jer- sey), Omega Fund II Ltd (Jersey), Omega Fund III Ltd (Jersey), Omega Fund IV Ltd (Jersey), Royal Dutch Shell plc (UK), SGS Société Générale de Surveillance SA (Switzerland), Stadler Rail Group (Switzerland), Team Alinghi (Switzerland), Team Alinghi (Spain) and Walo Group (Switzerland). Movements in loans to other related parties are as follows: CHF million Balance at the beginning of the year Additions Reductions Balance at the end of the year 1 31.12.08 31.12.07 31.12.06 688 206 220 674 872 301 485 688 919 34 81 872 1 In 2008 includes loans, guarantees and contingent liablitites of CHF 192 million and unused committed facilities of CHF 482 million but excludes unused uncommitted working capital facilities and unused guarantees of CHF 691 million. In 2007 includes loans, guarantees and contingent liabilities of CHF 270 million and unused committed facilities of CHF 418 million but excludes unused un- committed working capital facilities and unused guarantees of CHF 205 million. In 2006 includes loans, guarantees and contingent liabilities of CHF 128 million and unused committed facilities of CHF 744 million but excludes unused uncommitted working capital facilities and unused guarantees of CHF 173 million. Other transactions with these related parties include: CHF million Goods sold and services provided to UBS Fees received for services provided by UBS 31.12.08 31.12.07 31.12.06 1 22 8 16 8 8 As part of its sponsorship of Team Alinghi, UBS paid CHF 828,090 (EUR 538,000) in basic sponsoring fees for 2008. Team Alinghi’s controlling shareholder is UBS board member Ernesto Bertarelli. f) Additional information UBS also engages in trading and risk management activities (e. g. swaps, options, forwards) with various related parties mentioned in previous sections. These transactions may give rise to credit risk either for UBS or for a related party towards UBS. As part of its normal course of business, UBS is also a market maker in equity and debt instruments and at times may hold positions in instruments of related parties. 346 Note 33 Post-balance-sheet events On 18 February 2009, UBS announced that it settled its US cross-border case with the US Department of Justice and the US Securities and Exchange Commission. Refer to “Note 21 Provisions and litigation” for details. The Swiss National Bank (SNB) determined the purchase price to be paid for certain positions that have not yet been transferred into the fund owned and controlled by the SNB. Refer to “Note 38 Reorganizations and disposals” for details. Both events above meet the definition of an adjusting event after the reporting period as defined in IAS 10 Events after the Reporting Period and have been considered in the financial statements as of 31 December 2008. The total im- pact on net profit after tax was negative CHF 1,203 million. On 19 January 2009, UBS announced that it had entered into an agreement to acquire the commodity index business of AIG Financial Product Corp. Refer to “Note 36 Business combinations” for details. There have been no further material post-balance-sheet events which would require disclosure or adjustment to the 31 December 2008 Financial Statements. On 5 March 2009, the Board of Directors reviewed the Financial Statements and authorized them for issue. These Fi nancial Statements were submitted to the Annual General Meeting of Shareholders on 15 April 2009 for approval. Note 34 Significant subsidiaries and associates The legal entity group structure of UBS is designed to support the Group’s businesses within an efficient legal, tax, regula- tory and funding framework. Neither the business divisions of UBS (namely Investment Bank, Global Wealth Manage- ment & Business Banking and Global Asset Management) nor Corporate Center are replicated in their own individual legal entities, but rather they generally operate out of UBS AG (Parent Bank) through its Swiss and foreign branches. The Parent Bank structure allows UBS to capitalize on the advantages offered by the use of one legal platform by all the business divisions. It provides for the most cost-efficient and flexible structure and facilitates efficient allocation and use of capital, comprehensive risk management and control and straightforward funding processes. Where, usually due to local legal, tax or regulatory rules or due to additional legal entities joining the UBS Group via acquisition, it is either not possible or not efficient to operate out of the Parent Bank, then local subsidiary companies host the businesses. The significant operating subsidiary compa- nies in the Group are listed below: Share capital in millions Equity interest accumulated in % Significant subsidiaries Company Banco UBS Pactual S.A. Caisse Centrale de Réescompte CCR Actions S.A. CCR Gestion S.A. Fondcenter AG OOO UBS Bank PT UBS Securities Indonesia UBS (Bahamas) Ltd. UBS (France) S.A. Jurisdiction of incorporation Rio de Janeiro, Brazil Business division 1 IB Paris, France Paris, France Paris, France Zurich, Switzerland Moscow, Russia Jakarta, Indonesia Nassau, Bahamas Paris, France Global AM Global AM Global AM Global AM IB IB Global WM&BB Global WM&BB UBS (Grand Cayman) Limited George Town, Cayman Islands IB UBS (Italia) S.p.A. UBS (Luxembourg) S.A. UBS (Monaco) S.A. Milan, Italy Luxembourg, Luxembourg Monte Carlo, Monaco UBS Alternative and Quantitative Investments Limited London, Great Britain UBS Alternative and Quantitative Investments LLC UBS Americas Inc UBS Asesores SA UBS Bank (Canada) Delaware, USA Delaware, USA Panama, Panama Toronto, Canada Global WM&BB Global WM&BB Global WM&BB Global AM Global AM IB Global WM&BB Global WM&BB BRL EUR EUR EUR CHF RUB IDR USD EUR USD EUR CHF EUR GBP USD USD USD CAD 349.6 106.3 1.1 2.2 0.1 1,250.0 118,000.0 4.0 50.7 25.0 60.0 150.0 9.2 0.3 0.1 0.0 0.0 8.5 UBS Bank Mexico, S.A. Institucion de Banca Multiple, UBS Grupo Financiero Mexico City, Mexico IB MXN 639.4 1 Global WM&BB: Global Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, CC: Corporate Center. 100.0 100.0 100.0 100.0 100.0 100.0 98.6 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 347 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 34 Significant subsidiaries and associates (continued) Significant subsidiaries (continued) Company UBS Bank USA UBS Bank, S.A. UBS Belgium SA / NV UBS Capital (Jersey) Ltd UBS Capital B.V. UBS Card Center AG Jurisdiction of incorporation Utah, USA Madrid, Spain Brussels, Belgium St. Helier, Jersey Amsterdam, the Netherlands Business division 1 Global WM&BB Global WM&BB Global WM&BB IB IB Glattbrugg, Switzerland Global WM&BB UBS Clearing and Execution Services Limited London, Great Britain UBS Convertible Securities (Jersey) Limited UBS Derivatives Hong Kong Limited St. Helier, Jersey Hong Kong, China IB CC IB UBS Deutschland AG UBS Factoring AG UBS Fiduciaria S.p.A. UBS Finance (Cayman Islands) Ltd. UBS Finance (Curação) N.V. UBS Finance (Delaware) LLC UBS Financial Services Inc. Frankfurt am Main, Germany Global WM&BB Zurich, Switzerland Milan, Italy Global WM&BB Global WM&BB George Town, Cayman Islands Willemstad, Netherlands Antilles Delaware, USA Delaware, USA CC CC IB Global WM&BB Global WM&BB Global WM&BB Global AM Global AM Global AM Global AM Global AM Global AM CC IB Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global WM&BB Global WM&BB IB Global AM UBS Financial Services Incorporated of Puerto Rico Hato Rey, Puerto Rico UBS Fund Advisor, L.L.C. UBS Fund Holding (Luxembourg) S.A. UBS Fund Holding (Switzerland) AG UBS Fund Management (Switzerland) AG UBS Fund Services (Cayman) Ltd UBS Fund Services (Ireland) Limited Delaware, USA Luxembourg, Luxembourg Basel, Switzerland Basel, Switzerland George Town, Cayman Islands Dublin, Ireland UBS Fund Services (Luxembourg) S.A. Luxembourg, Luxembourg UBS Fund Services (Luxembourg) S.A. Poland Branch Zabierzow, Poland UBS Futures Singapore Ltd. UBS Global Asset Management (Americas) Inc UBS Global Asset Management (Australia) Ltd UBS Global Asset Management (Canada) Co Singapore, Singapore Delaware, USA Sydney, Australia Toronto, Canada UBS Global Asset Management (Deutschland) GmbH Frankfurt am Main, Germany UBS Global Asset Management (Hong Kong) Limited Hong Kong, China UBS Global Asset Management (Italia) SGR SpA UBS Global Asset Management (Japan) Ltd Milan, Italy Tokyo, Japan UBS Global Asset Management (Singapore) Ltd Singapore, Singapore UBS Global Asset Management (Taiwan) Ltd Taipei, Taiwan UBS Global Asset Management (France) S.A. Paris, France Global WM&BB UBS Global Asset Management (UK) Ltd UBS Global Asset Management (US) Inc UBS Global Asset Management Funds Ltd UBS Global Asset Management Holding Ltd UBS Global Asset Management Life Ltd UBS Global Life AG UBS Global Trust Corporation UBS Grupo Financiero, S.A. de C.V. UBS Hana Asset Management Company Ltd UBS International Holdings B.V. UBS International Inc. UBS International Life Limited UBS Investment Management Canada Inc. London, Great Britain Delaware, USA London, Great Britain London, Great Britain London, Great Britain Vaduz, Liechtenstein St. John, Canada Mexico City, Mexico Seoul, South Korea Amsterdam, the Netherlands CC New York, USA Dublin, Ireland Toronto, Canada Global WM&BB Global WM&BB Global WM&BB Share capital in millions Equity interest accumulated in % USD EUR EUR GBP EUR CHF USD CHF HKD EUR CHF EUR USD USD USD USD USD USD CHF CHF CHF USD EUR CHF PLN USD USD AUD CAD EUR EUR HKD EUR JPY SGD TWD GBP USD GBP GBP GBP CHF CAD MXN KRW EUR USD EUR CAD 1,700.0 77.2 23.0 119.0 8.9 2 0.1 50.0 50.0 880.0 176.0 5.0 0.2 0.5 0.1 37.3 2 2,005.8 2 31.0 2 0.0 42.0 18.0 1.0 5.6 1.3 2.5 0.1 39.8 2 0.0 8.0 117.0 7.7 2.3 25.0 3.1 2,200.0 4.0 340.0 68.0 23.2 2 19.0 86.0 5.0 5.0 0.1 851.8 45,000.0 6.8 44.3 2 1.0 0.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 51.0 100.0 100.0 100.0 100.0 1 Global WM&BB: Global Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, CC: Corporate Center. 2 Share capital and share premium. 348 Share capital in millions Equity interest accumulated in % Note 34 Significant subsidiaries and associates (continued) Significant subsidiaries (continued) Company UBS Investments Philippines, Inc. Jurisdiction of incorporation Makati City, Philippines UBS Italia SIM SpA UBS Leasing AG UBS Life AG UBS Life Insurance Company USA UBS Limited UBS Loan Finance LLC UBS Menkul Degerler AS UBS New Zealand Limited UBS O’Connor Limited UBS O’Connor LLC UBS Pactual Asset Management S.A. DTVM UBS Preferred Funding Company LLC I UBS Preferred Funding Company LLC II UBS Preferred Funding Company LLC IV UBS Preferred Funding Company LLC V UBS Real Estate Kapitalanlagegesellschaft mbH UBS Real Estate Securities Inc UBS Realty Investors LLC Milan, Italy Zurich, Switzerland Zurich, Switzerland California, USA London, Great Britain Delaware, USA Istanbul, Turkey Auckland, New Zealand London, Great Britain Delaware, USA Rio de Janeiro, Brazil Delaware, USA Delaware, USA Delaware, USA Delaware, USA Munich, Germany Delaware, USA Massachusetts, USA Business division 1 IB IB Global WM&BB Global WM&BB Global WM&BB IB IB IB IB Global AM Global AM Global AM CC CC CC CC Global AM IB Global AM UBS Sauerborn Private Equity Komplementär GmbH Bad Homburg, Germany Global WM&BB UBS Securities (Thailand) Ltd UBS Securities Asia Limited UBS Securities Australia Ltd UBS Securities Canada Inc UBS Securities España Sociedad de Valores SA UBS Securities France S.A. UBS Securities Hong Kong Limited UBS Securities India Private Limited UBS Securities International Limited UBS Securities Japan Ltd UBS Securities LLC UBS Securities Malaysia Sdn. Bhd. UBS Securities Philippines Inc UBS Securities Pte. Ltd. UBS Securities Pte. Ltd. Seoul Branch UBS Service Centre (India) Private Limited UBS Service Centre (Poland) Sp. z o.o. UBS Services USA LLC Bangkok, Thailand Hong Kong, China Sydney, Australia Toronto, Canada Madrid, Spain Paris, France Hong Kong, China Mumbai, India London, Great Britain George Town, Cayman Islands Delaware, USA Kuala Lumpur, Malaysia Makati City, Philippines Singapore, Singapore Seoul, South Korea Mumbai, India Krakow, Poland Delaware, USA IB IB IB IB IB IB IB IB IB IB IB IB IB IB IB CC CC Global WM&BB UBS South Africa (Proprietary) Limited Sandton, South Africa IB UBS Swiss Financial Advisers AG UBS Trustees (Bahamas) Ltd UBS Trustees (Cayman) Ltd UBS Trustees (Jersey) Ltd. UBS Trustees (Singapore) Ltd UBS UK Holding Limited UBS UK Properties Limited UBS Wealth Management (UK) Ltd UBS Wealth Management Australia Ltd UBS Trust Company National Association Vermogens Advies Holding B.V. Zurich, Switzerland Nassau, Bahamas Global WM&BB Global WM&BB George Town, Cayman Islands Global WM&BB St. Helier, Jersey Singapore, Singapore London, Great Britain London, Great Britain London, Great Britain Melbourne, Australia New York, USA Global WM&BB Global WM&BB IB IB Global WM&BB Global WM&BB Global WM&BB Amsterdam, the Netherlands Global WM&BB PHP EUR CHF CHF USD GBP USD TRY NZD GBP USD BRL USD USD USD USD EUR USD USD EUR THB HKD AUD CAD EUR EUR HKD INR GBP JPY USD MYR PHP SGD KRW INR PLN USD ZAR CHF USD USD GBP SGD GBP GBP GBP AUD USD EUR 360.0 15.1 10.0 25.0 39.3 2 63.3 16.7 30.0 7.5 8.8 1.0 73.2 0.0 0.0 0.0 0.0 7.5 950.4 2 9.3 0.0 400.0 20.0 209.8 2 10.0 15.0 22.9 430.0 668.3 18.0 60,000.0 22,205.6 2 75.0 190.0 311.5 150,000.0 1,249.6 0.1 0.1 0.0 1.5 2.0 2.0 0.0 3.3 5.0 132.0 2.5 53.9 105.0 2 0.3 1 Global WM&BB: Global Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, CC: Corporate Center. 2 Share capital and share premium. 99.4 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 51.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 349 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 34 Significant subsidiaries and associates (continued) Consolidated companies: changes in 2008 Significant new companies Caisse Centrale de Réescompte – Paris, France CCR Actions S.A. – Paris, France CCR Gestion S.A. – Paris, France UBS Convertible Securities (Jersey) Limited – St. Helier, Jersey UBS Preferred Funding Company LLC V – Delaware, USA UBS Service Center (India) Private Limited – Mumbai, India Vermogens Advies Holding B.V. – Amsterdam, the Netherlands Deconsolidated companies Significant deconsolidated companies Crédit Industriel Société Anonyme in Liquidation – Zurich, Switzerland Thesaurus Continentale Effekten-Gesellschaft in Zurich in Liquidation – Zurich, Switzerland UBS Fiduciary Trust Company – New Jersey, USA Significant associates Company SIX Group AG – Zurich, Switzerland UBS Securities Co. Limited – Beijing, China Williamsburg Edge LLC – Delaware, USA 219 West 81st LLC – Delaware, USA Reason for deconsolidation Liquidated Liquidated Sold Industry Financial Financial Real Estate Real Estate Equity interest in % 17.3 20.0 50.0 50.0 350 Note 35 Invested assets and net new money Invested assets include all client assets managed by or de- posited with UBS for investment purposes. For example, invested assets include managed fund assets, managed insti- tutional assets, discretionary and advisory wealth manage- ment portfolios, fiduciary deposits, time deposits, savings accounts and wealth management securities or brokerage accounts. All assets held for purely transactional purposes and custody-only assets, including corporate client assets held for cash management and transactional purposes, are excluded from invested assets as the Group only administers the assets and does not offer advice on how the assets should be invested. Also excluded are non-bankable assets (e. g. art collections) and deposits from third-party banks for funding or trading purposes. Discretionary assets are defined as client assets for which UBS decides how to invest them. Other invested assets are those where the client ultimately decides how the assets are invested. When a single product is created in one business division and sold in another, it is counted in both the busi- ness division that manages the investment and the one that distributes it. This results in double counting within UBS total invested assets, as both business divisions are providing a service independently to their respective clients, and both add value and generate revenue. Net new money in a period is the net amount of invested assets that are entrusted to UBS by new and existing clients less those withdrawn by existing clients and clients who ter- minate their relationship with UBS. Net new money is calculated using the direct method, by which inflows and outflows to / from invested assets are de- termined at the client level based on transactions. Interest and dividend income from invested assets is not counted as net new money inflow. Market and currency movements as well as fees, commissions and interest on loans charged are excluded from net new money, as are the effects resulting from any acquisition or divestment of a UBS subsidiary or business. Reclassifications between invested assets and cli- ent assets as a result of a change in the service level delivered are treated as net new money flows. CHF billion Fund assets managed by UBS Discretionary assets Other invested assets Total invested assets (double counts included) thereof double count thereof acquisitions (divestments) Net new money (double counts included) On or for the year ended 31.12.08 31.12.07 339 528 1,307 2,174 273 19.1 (226.0) 509 877 1,803 3,189 392 50.5 140.6 n o i t a m r o f n i l a i c n a n i F 351 Financial information Notes to the consolidated financial statements Note 36 Business combinations Business combinations completed in 2008 Caisse Centrale de Réescompte Group In February 2008, UBS completed the acquisition in France of 100% of Caisse Centrale de Réescompte Group (CCR) from Commerzbank. The cost of the business combination, includ- ing directly attributable transaction costs, amounted to ap- proximately CHF 613 million (EUR 387 million) and was paid in cash. The cost of the business combination included ap- proximately EUR 133 million for the excess capital in CCR at closing. The cost of the business combination has been allo- cated to intangible assets reflecting customer relationships of CHF 36 million (EUR 23 million), net assets of CHF 209 mil- lion (EUR 131 million) and goodwill of CHF 368 million (EUR 233 million). The business of CCR, which included EUR 13.3 billion of invested assets as of 31 December 2007 and ap- proximately 190 employees, was integrated into UBS’s asset management and wealth management businesses in France. Caisse Centrale de Réescompte Group (CCR) 2008 Book Value Step-up to fair value Fair Value CHF million Assets Intangible assets Property and equipment Goodwill All other assets Total assets Liabilities Total liabilities Net assets Total liabilities and equity 0 5 0 513 518 297 221 518 36 0 368 1 405 13 392 405 36 5 368 514 923 310 613 923 Total 36 368 On the acquisition date, intangible assets and goodwill were allocated to the divisions as follows: Caisse Centrale de Réescompte Group (CCR) 2008 Global Wealth Management & Business Banking Global Asset Management 10 37 26 331 CHF million Assets Intangible assets Goodwill 352 Note 36 Business combinations (continued) VermogensGroep In August 2008, UBS completed the acquisition of 100% of VermogensGroep, an independent Dutch wealth manager. The cost of the business combination, including directly attributable transaction costs, amounted to approximately CHF 171 million (EUR 105 million) out of which approxi- mately CHF 81 million (EUR 50 million) were paid in cash upon closing. The remaining cost of the business combina- tion is expected to be paid in installments over the next 3 years. The cost of the business combination was alloc- ated to intangible assets of CHF 49 million (EUR 30 million), net liabilities of CHF 2.1 million (EUR 1.3 million) and good- will of CHF 124 million (EUR 77 million). VermogensGroep serves wealthy private clients, foundations and institutions in the Dutch market and managed client assets of approxi- mately EUR 4 billion at the time of the transaction. Vermo- gensGroep was integrated into UBS’s wealth management business. VermogensGroep 2008 CHF million Assets Intangible assets Property and equipment Goodwill All other assets Total assets Liabilities Total liabilities Net assets Total liabilities and equity Book Value Step-up to fair value Fair Value 0 2 0 10 12 2 10 12 49 0 124 0 173 12 161 173 49 2 124 10 185 14 171 185 Acquisition announced after the balance sheet date Acquisition of the commodity index business of AIG Financial Products Corp. On 19 January 2009, UBS announced that its investment bank had entered into a binding agreement to purchase the commodity index business of AIG Financial Products Corp., including AIG’s rights to the DJ-AIG Commodity index. The purchase price for the transaction is USD 15 million, payable upon closing, and additional payments of up to USD 135 mil- lion over the following 18 months, based upon future earn- ings of the purchased business. Closing of the transaction, expected by May 2009, is subject to a number of regulatory and other conditions. No assurance can be given that any such conditions will be satisfied. n o i t a m r o f n i l a i c n a n i F 353 Financial information Notes to the consolidated financial statements Note 36 Business combinations (continued) Business combinations completed in 2007 During 2007, UBS completed two material acquisitions that were accounted for as business combinations. McDonald Investments’ branch network In February 2007, UBS completed the acquisition of the branch network of McDonald Investments, a unit of Key- Corp. The cost of the business combination consisted of CHF 269 million (USD 220 million) for the business opera- tions including directly attributable transaction costs, and of CHF 70 million (USD 58 million) for the net loans to cus- tomer portfolios of McDonald Investments, resulting in a total cash consideration paid of CHF 339 million (USD 278 million). The cost of the business combination was allocated to an intangible asset reflecting customer relationships of CHF 57 million (USD 47 million), remaining net assets of CHF 77 million (USD 63 million) including the net loans to customer portfolios, and goodwill of CHF 205 million (USD 168 million). The unit provides comprehensive wealth man- agement services to affluent and high net worth individuals, including estate planning, retirement planning and asset management, and has been integrated into Wealth Man- agement US. McDonald Investments’ branch network 2007 CHF million Assets Intangible assets Property and equipment Deferred tax assets Goodwill All other assets Total assets Liabilities Total liabilities Net assets Total liabilities and equity Book Value Step-up to fair value Fair Value 0 4 0 0 70 74 6 68 74 57 (1) 10 205 0 271 0 271 271 57 3 10 205 70 345 6 339 345 Daehan Investment Trust Management Company In July 2007, UBS completed the acquisition of 51% of Dae- han Investment Trust Management Company Ltd. (DIMCO) from Hana Daetoo Securities (formerly Daehan Investment & Securities Company Ltd.), a wholly owned subsidiary of Hana Financial Group. DIMCO was integrated into UBS’s Global Asset Management business and renamed as UBS Hana Asset Management Company Ltd. internationally, and as Hana UBS Asset Management in Korea. The estimated cost of the busi- ness combination amounted to approximately CHF 238 mil- lion (KRW 180 billion) in total and was paid in cash. The pur- chase price is subject to an earn-out clawback of up to CHF 40 million (KRW 30 billion) over the next three to five years. The acquisition costs had been allocated to intangible assets reflecting customer relationships of CHF 54 million, net assets of CHF 74 million and goodwill of CHF 170 million. On the acquisition date, equity attributable to minority interests was CHF 60 million. At closing, DIMCO managed around CHF 26.4 billion of assets (KRW 19.9 trillion). In 2008, the purchase price allocation was finalized and resulted in intangible assets of CHF 52 million and goodwill of CHF 188 million. Daehan Investment Trust Management Company 2007 CHF million Assets Intangible assets Goodwill All other assets Total assets Liabilities Total liabilities Net assets attributable to minority interests Net assets attributable to UBS shareholders Total liabilities and equity 354 Book Value Step-up to fair value Fair Value 0 0 87 87 13 36 38 87 52 188 0 240 14 22 204 240 52 188 87 327 27 58 242 327 Note 36 Business combinations (continued) Business combinations announced in 2007 Standard Chartered’s mutual funds management business in India Following the expiry of the Sale and Purchase Agreement between UBS and Standard Chartered Bank executed in January 2007, UBS announced in December 2007 that it will not proceed with its planned acquisition of Standard Char- tered Bank’s mutual funds management business in India. Acquisition of significant associates in 2007 UBS Securities In April 2007, UBS completed the acquisition of an equity stake of 20% in the newly established UBS Securities Co. Ltd. (UBSS) in China for a total consideration of approximately Pro-forma information (unaudited) CHF 369 million (RMB 2.4 billion). The cost of the acquisition consisted of cash payments of approximately CHF 324 million (RMB 2.1 billion) including transaction costs and liabilities set- tled as well as the assumption of liabilities of approximately CHF 45 million (RMB 0.3 billion). On the basis of its current rights and obligations, UBS has significant influence and ap- plies the equity method of accounting. Following approvals by Chinese regulators, UBSS commenced operations in De- cember 2006 on the basis of a comprehensive set of securities licenses. UBSS is active in both primary and secondary domes- tic equities and fixed income busi nesses, in discretionary asset management, corporate advisory and mergers and acquisi- tions services, and in wealth management. The following pro-forma information shows UBS’s total op- erating income, net profit attributable to UBS shareholders and basic earnings per share as if all of the acquisitions com- pleted in 2008 had been made as of 1 January 2007 and all acquisitions completed in 2007, had been made as of 1 Jan- uary 2006. Adjustments have been made to reflect additional amortization and depreciation of assets and liabilities, which have been assigned fair values different from their carryover bases in purchase accounting. Pro-forma information (unaudited) CHF million, except where indicated Total operating income Net profit Basic earnings per share (CHF) For the year ended 31.12.08 31.12.07 31.12.06 819 (21,286) (7.69) 31,932 (5,233) (2.42) 48,928 11,887 5.35 n o i t a m r o f n i l a i c n a n i F 355 Financial information Notes to the consolidated financial statements Note 37 Discontinued operations 2008 2006 Motor-Columbus On 23 March 2006, UBS sold its 55.6% stake in Motor- Columbus to a consortium representing Atel’s Swiss minority shareholders (EBM, EBL, the Canton of Solothurn, IB Aarau, AIL Lugano and WWZ Zug), EOS Holding and Atel, as well as to the French utility Electricité de France (EDF) following the receipt of relevant regulatory approvals by the Swiss and international authorities. In total, UBS sold 281,535 Motor- Columbus shares, at a price of CHF 4,600 per share, result- ing in a sale price of approximately CHF 1,295 million, which was fully paid in cash. A pre-tax gain on sale of CHF 364 mil- lion is reported in the Industrial Holdings segment. From 1 January to 23 March 2006, Motor-Columbus had a net profit from operations of CHF 71 million. Together with the after-tax gain on sale of CHF 387 million, the net profit from discontinued operations is CHF 458 million in 2006. Other Industrial holdings In 2006, private equity investments contributed CHF 437 mil- lion to UBS’s net profit from discontinued operations, which includes after-tax gains on sale of CHF 424 million and an after-tax operating profit of CHF 13 million. Industrial holdings In 2008, private equity investments, including the sale of one equity investment and subsequent gains on private equity investments sold in prior years, contributed CHF 155 million to UBS’s net profit from discontinued operations, which includes after-tax gains on sale of CHF 120 million and an after-tax operating profit of CHF 34 million. The cash consid- eration received for the equity investment sold in 2008 amounted to CHF 141 million. These private equity invest- ments were held within the Industrial Holdings, integrated within Corporate Center since the beginning of 2008, and were sold in line with UBS’s strategy to exit the private equity business. 2007 Industrial holdings In 2007, private equity investments, including the sale of two private equity investments as well as subsequent gains on private equity investments sold in prior years, contributed CHF 138 million to UBS’s net profit from discontinued operations, which includes after-tax gains on sale of CHF 102 million and an after-tax operating profit of CHF 36 mil- lion. The cash consideration received for the two investments sold in 2007 amounted to CHF 14 million. These private equity investments were all held within the Industrial Hold- ings segment and were sold in line with UBS’s strategy to exit the private equity business. Private banks & GAM The tax benefit on gain from sales of CHF 258 million in- cludes the release of a deferred tax liability of approximately CHF 275 million to the profit and loss account, which was recognized upon the sale of UBS’s 20.7% stake in Julius Baer in 2007. This deferred tax liability had been recognized in connection with the receipt of Julius Baer shares on the sale of Private Banks & GAM in December 2005, but was not ul- timately incurred due to the manner of realization of the Julius Baer investment. The tax expense from the recognition of the deferred tax liability was booked in discontinued op- erations in 2005, and therefore the release has also been reflected in discontinued operations. 356 Note 37 Discontinued operations (continued) CHF million Operating income Operating expenses Operating profit from discontinued operations before tax Pre-tax gain on sale Profit from discontinued operations before tax Tax expense on operating profit from discontinued operations before tax Tax expense on gain from sale Tax expense from discontinued operations Net profit from discontinued operations Net cash flows from operating activities investing activities financing activities For the year ended 31.12.08 Private Banks & GAM 1 0 0 0 44 44 0 1 1 43 0 0 0 Industrial Holdings 19 (15) 34 120 155 0 0 0 155 (1) 3 0 1 Gain resulting from a purchase price adjustment related to the sale of Private Banks & GAM in 2005. Included in Corporate Center in Note 2a. CHF million Operating income Operating expenses Operating profit from discontinued operations before tax Pre-tax gain on sale Profit from discontinued operations before tax Tax expense on operating profit from discontinued operations before tax Tax expense on gain from sale Tax expense from discontinued operations Net profit from discontinued operations Net cash flows from operating activities investing activities financing activities 1 Included in Corporate Center in Note 2a. CHF million Operating income Operating expenses Operating profit from discontinued operations before tax Pre-tax gain on sale Profit from discontinued operations before tax Tax expense on operating profit from discontinued operations before tax Tax expense on gain from sale Tax expense from discontinued operations Net profit from discontinued operations Net cash flows from operating activities investing activities financing activities 1 Pre-tax gain on sale includes CHF 4 million related to Private Banks & GAM, which is included in Corporate Center in Note 2a. For the year ended 31.12.07 Private Banks & GAM 1 0 0 0 7 7 0 (258) (258) 265 0 0 0 Industrial Holdings 394 358 36 102 138 0 0 0 138 32 (1) (42) For the year ended 31.12.06 Motor-Columbus 2,494 2,412 82 364 446 11 (23) (12) 458 1 (52) (22) Other Industrial Holdings 1 993 979 14 428 442 1 0 1 441 16 73 (88) 357 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 38 Reorganizations and disposals Reorganizations Closure of the US municipal securities business In June 2008, UBS closed its Investment Bank’s institutional municipal securities business. The retail operations of the municipal securities business, including secondary market activities, were transferred to Wealth Management US. As a result, approximately 70 employees and municipal bonds with a fair value of approximately CHF 0.4 billion (USD 0.4 billion) were transferred from the Investment Bank to Wealth Management US. In 2008, restructuring costs of CHF 56 million (USD 55 million) and a goodwill impairment loss of CHF 341 mil- lion (USD 334 million) were recognized in the income statement in relation to this closure. The restructuring costs mainly relate to termination costs for office space rental contracts and vendor contracts, and severance payments to employees. Repositioning of the investment bank In connection with the repositioning of the Investment Bank announced in October 2008, restructuring costs of approxi- mately CHF 737 million were incurred in fourth quarter 2008. These costs consisted of approximately CHF 435 million of personnel expenses, mainly severance payments and other compen sation, and approximately CHF 302 million of costs related to real estate, including impairment losses on proper- ties and equipment of CHF 100 million and costs for unused prem ises of CHF 202 million. Disposals Sale of US residential mortgage-backed securities to BlackRock fund On 20 May 2008, UBS completed the sale of a portfolio of US residential mortgage-backed securities (RMBS) for pro- ceeds of USD 15 billion to the RMBS Opportunities Master Fund, LP (the “fund”), a third-party fund managed by Black- Rock, Inc. The portfolio had a notional value of approxi- mately USD 22 billion and comprised primarily Alt-A and sub-prime related assets, and a limited amount of prime securities. Based on fair value at the time of the transaction, approximately three-quarters of the assets sold consisted of 2006 and 2007 vintages. The fund was capitalized with approximately USD 3.75 billion in equity raised by BlackRock from third-party inves- tors. The equity investors will absorb any losses sustained by the fund up to a maximum of their equity investment. UBS provided an eight-year amortizing USD 11.25 billion senior secured loan to the fund, collateralized by the RMBS assets held by the fund. The loan bears a commercial rate of inter- est with debt service being met from principal and interest received from the underlying mortgage pools. UBS does not retain any equity interest in the fund. 358 The USD 15 billion proceeds were approximately in line with the fair value of the assets recorded by UBS at 31 March 2008. Since its inception, the fund has amortized the loan through monthly payments in line with UBS’s original expec- tations. As at 31 December 2008, the loan had a balance outstanding of USD 9.2 billion. UBS does not consolidate the fund into its balance sheet as the equity investors in the fund continue to bear and receive the majority of the risks and rewards. UBS continues to monitor the development of the fund’s performance and would reassess the consolidation status if deterioration of the underlying mortgage pools re- lated to the RMBS were to indicate that UBS may not fully recover the loan granted to the fund. Sale of assets to a third-party fund controlled by the Swiss National Bank (SNB) As announced on 16 October 2008, UBS entered into an agreement with the Swiss National Bank (SNB) to trans- fer certain illiquid securities and other positions to the SNB StabFund limited partnership for collective investments (the “fund”), which is fully owned and controlled by the SNB. For each transfer of assets, the SNB finances 90% of the purchase price by providing a loan to the fund and the re- maining 10% by making an equity contribution to the fund. Upon each asset transfer, UBS purchases, for an amount equal to the SNB’s equity contribution to the fund on that date, an option to purchase the fund’s equity (all such op- tions referred to collectively as the “call option”). The exer- cise price of the call option is set at USD 1 billion plus 50% of the fund’s equity value that exceeds USD 1 billion at the time of exercise. The call option will be exercisable upon repayment in full of the loan provided by the SNB. The loan is secured by the assets of the fund and bears interest at a rate of one month LIBOR of the underlying currency plus 250 basis points. Service of the loan will be made from the cash flows generated by the fund’s assets. In the event of a change of control of UBS, the SNB has the right but not the obligation to request that UBS purchase the SNB’s loan to the fund at its outstanding principal amount plus accrued interest and the fund’s equity for 50% of its value at the time (the “put option”). If, upon termination of the fund, the SNB incurs a loss on its loan, it will be entitled to receive 100 million UBS ordinary shares, subject to anti-dilution adjustments, in exchange for payment of the par value of these shares (the “contingent share issue”). The positions are transferred to the fund at market value (net exposure) determined at 30 September 2008. The posi- tions transferred to the SNB are priced at the lower of UBS’s estimated market value as of 30 September 2008 and the Note 38 Reorganizations and disposals (continued) value determined as of that date by the SNB based on a valuation conducted by third party valuation agents. Compared with the initial announcement on 16 Octo- ber 2008, the originally agreed size of the portfolio of USD 60 billion to be transferred has been reduced. UBS has trans- ferred or identified for transfer positions totalling a market value (net exposure) of USD 38.6 billion (including the effect of price adjustments so far totalling USD 0.7 billion). Posi- tions identified for transfer include approximately USD 21.9 billion of positions pre viously disclosed as risk concentrations, primarily US real estate-related securities and assets from the US reference-linked note program (RLN), and approximately USD 17.5 billion of other positions, mainly non-US real es- tate-related securities as well as other asset-backed securi- ties, prior to the price difference of USD 0.7 billion on the positions for which the SNB already determined the pur- chase price. On 16 December 2008, UBS completed the sale of a first tranche of securities positions for approximately USD 16.4 billion consisting primarily of US and European residential and commercial mortgage-backed securities and other asset- backed securities. The remaining positions identified for sale to the fund are planned to be transferred in March 2009 in one or more additional transfers. The purchase price for the securities transferred to the fund on 16 December 2008 was the value of these securities as of 30 September 2008 as determined by the SNB based on a valuation conducted by third-party valuation experts. On the same basis, the SNB has since determined the pur- chase price to be paid for a further USD 7.8 billion of posi- tions that have not yet been transferred to the fund. So far, the determined purchase prices for positions transferred to or to be transferred to the fund were, in the aggregate, USD 0.7 billion lower than the value UBS assigned to these positions on 30 September 2008. All of this difference is accounted for in UBS’s results for 2008. Overall, the aggre- gate price difference represents approximately 3% of UBS’s market value (net exposure) for these positions and reflects the inherent judgement involved in the valuation of illiquid assets. Under IFRS, the call option is recognized on the balance sheet as a derivative at fair value with changes in fair value recognized in profit or loss. The portion of the call option al- ready purchased is reflected as Positive replacement value. The portion of the call option yet to be purchased upon fu- ture transfers is reflected as Negative replacement value to- gether with the amount payable to the SNB for such option. The put option was evaluated as a contingent liability that has been deemed remote. The contingent share issue is treated as an equity instru- ment and was recognized at fair value in equity as an in- crease to Share premium and an expense in Net trading income. The fair value of the contingent share issue was estimated at approximately CHF 607 million and will not hereafter be re-measured to fair value. Overall, the impact of the transaction on the income statement was a loss of approximately CHF 5,232 million in 2008. This reflects a net loss on the call option of approxi- mately CHF 3,511 million and the expense of approximately CHF 607 million associated with the contingent share issue as well as a CHF 771 million loss due to the recognized price difference and CHF 343 million losses on hedges that were subject to trading restrictions as a result of the transaction. The remaining market value (net exposure) of the posi- tions already transferred or still to be transferred to the fund amounts to USD 39.4 billion excluding the effect of price adjustments so far totalling USD 0.7 billion. Of these posi- tions USD 31.3 billion of market value (net exposure) repre- sents financial assets, predominantly Trading portfolio as- sets, with a corresponding balance sheet amount of USD 31.1 billion per 30 September 2008. USD 8.1 billion of mar- ket value (net exposure) relate to financial liabilities, exclu- sively Negative replacement values from derivative contracts, with a balance sheet amount of USD 10.8 billion at the same date. Market values (net exposure) represent the remaining loss potential or economic risk from a position and may dif- fer from the balance sheet carrying amount, particularly for derivative contracts which are represented on the balance sheet by replacement values. Disposal of equity interest in Adams Street Partners In August 2008, UBS Global Asset Management closed the sale of its 24.9% equity interest in Adams Street Partners (ASP) to the remaining shareholders of ASP for a cash con- sideration of approximately CHF 184 million (USD 167 mil- lion). UBS’s interest in ASP was accounted for using the equity method. The sale resulted in a gain of approximately CHF 168 million. ASP was formed in January 2001 in con- nection with a management buyout of that business from Global Asset Management, with UBS retaining the now sold 24.9% stake. Global Asset Management will continue its close collaboration with ASP under an existing sub-advisory agreement in place since 2001. Disposal of financial investment in Bank of China In December 2008, UBS disposed of its equity stake in Bank of China through a placing of approximately 3.4 billion Bank of China Limited H-shares to institutional investors for a cash consideration of approximately CHF 887 million (HKD 6,519 million). UBS acquired the shares in 2005 in prepara- tion for Bank of China’s IPO to the international market. The investment in Bank of China was accounted for as a financial investment available-for-sale. The disposal resulted in a gain of approximately CHF 360 million. 359 n o i t a m r o f n i l a i c n a n i F Financial information Notes to the consolidated financial statements Note 39 Currency translation rates The following table shows the principal rates used to translate the financial statements of foreign entities into Swiss francs: 1 USD 1 EUR 1 GBP 100 JPY Spot rate As of Average rate Year ended 31.12.08 31.12.07 31.12.08 31.12.07 31.12.06 1.07 1.49 1.56 1.17 1.13 1.65 2.25 1.02 1.06 1.58 1.96 0.98 1.22 1.65 2.31 1.02 1.25 1.58 2.31 1.08 Note 40 Swiss banking law requirements The consolidated Financial Statements of UBS are prepared in accordance with International Financial Reporting Stan- dards (IFRS). The Guidelines of the Swiss Financial Market Supervisory Authority (FINMA) require banks which present their financial statements under IFRS to provide a narrative explanation of the main differences between IFRS and Swiss GAAP (FINMA circular 08/2) and the Banking Ordinance. In- cluded in this note are the significant differences in regard to recognition and measurement between IFRS and the provi- sions of the Banking Ordinance and the Guidelines of the FINMA governing financial statement reporting pursuant to Article 23 through Article 27 of the Banking Ordinance. The differences outlined in points two through nine also apply to the Parent Bank stat utory accounts. 1. Consolidation Under IFRS, all entities which are controlled by the Group are consolidated. Under Swiss law, only entities that are active in the field of banking and finance and real estate entities are subject to consolidation. Entities which are held temporarily are gener- ally recorded as financial investments. 2. Financial investments available-for-sale Under IFRS, Financial investments available-for-sale are carried at fair value. Changes in fair value are recorded directly in Equity until an investment is sold, collected or otherwise disposed of, or until an investment is determined to be impaired. At the time an available-for-sale investment is determined to be impaired, the cumulative unrealized loss previously recognized in Equity is included in net profit or loss for the period. On disposal of a financial investment available-for-sale, the cumulative unrecognized gain or loss previously recognized in Equity is recognized in the income statement. Under Swiss law, financial investments are carried either at the lower of cost or market or at amortized cost less impairment with changes in measurement recorded in the income statement. Reductions to market value below cost and reversals of such reductions up to original cost as well as gains and losses on disposal are included in Other income. Equity investments that are considered permanent are car- ried on the balance sheet at cost less impairment with impairment losses recorded in the income statement. Perma- nent investments are classified on the balance sheet as in- vestments in associated companies. 3. Cash flow hedges The Group uses derivative instruments to hedge the expo- sure from varying cash flows. Under IFRS, when hedge accounting is applied the fair value gain or loss on the effec- tive portion of the derivative designated as a cash flow hedge is recognized in Equity. When the hedged cash flows materi- alize, the accumulated unrecognized gain or loss is realized and released to income. Under Swiss law, the effective portion of the fair value change of the derivative instrument used to hedge cash flow exposures is deferred on the balance sheet as other assets or other liabilities. The deferred amounts are released to income when the hedged cash flows mate- rialize. 4. Investment property Under IFRS, investment property is carried at fair value, with changes in fair value recognized in the income statement. Under Swiss law, investment property is carried at amor- tized cost less any accumulated depreciation less impairment losses unless the investment property is classified as held for sale. Investment property classified as held for sale is carried at the lower of cost or market. 360 Note 40 Swiss banking law requirements (continued) 5. Fair value option Under IFRS, the Group applies the fair value option to certain financial assets and financial liabilities, mainly to hybrid debt instruments. As a result, the entire hybrid instrument is ac- counted for at fair value with changes in fair value reflected in net trading income. Furthermore, UBS designated certain loans, loan commitments and fund investments as financial assets designated at fair value through profit and loss. Under Swiss accounting rules, the fair value option is not available. Hybrid instruments are bifurcated: the embedded derivative is marked to market through net trading income and the host contract is accounted for on an accrued cost basis. No own credit adjustments are booked for hybrid instruments. Generally, loans are accounted for at amortized cost less impairment, loan commitments stay off-balance sheet and fund investments are accounted for as financial investments. 6. Goodwill and intangible assets Under IFRS, goodwill acquired in a business combination is not amortized but tested annually for impairment. Intangible assets acquired in a business combination with an indefinite useful life are also not amortized but tested annually for impairment. Under Swiss law, goodwill and intangible assets with in- definite useful lives are amortized over a period not exceed- ing five years, unless a longer useful life, which may not exceed twenty years, can be justified. 7. Discontinued operations Under certain conditions, IFRS requires that non-current as- sets or disposal groups be classified as held for sale. Disposal groups that meet the criteria of discontinued operations are presented in the income statement in a single line as net income from discontinued operations. Under Swiss law, no such reclassification takes place. 8. Extraordinary income and expense Certain items of income and expense are classified as extraordinary items under Swiss law, whereas in the Group Income Statement the amounts are classified as operating income or expense or are included in net profit from discon- tinued operations, if required. 9. Netting of replacement values Under IFRS, replacement values are reported on a gross basis, unless certain restrictive requirements are met. Under Swiss law, replacement values are reported on a net basis, provid- ed the netting agreements are legally enforceable. n o i t a m r o f n i l a i c n a n i F 361 Financial information Notes to the consolidated financial statements Note 41 Supplemental guarantor information required under SEC rules Guarantee of PaineWebber securities Following the acquisition of Paine Webber Group Inc., UBS made a full and unconditional guarantee of the senior and subordinated notes and trust preferred securities (“Debt S ecurities”) of PaineWebber. Prior to the acquisition, Paine- Webber was a SEC Registrant. Upon the acquisition, Paine- Webber was merged into UBS Americas Inc., a wholly owned subsidiary of UBS. Under the guarantee, if UBS Americas Inc. fails to make any timely payment under the Debt Securities agreements, the holders of the Debt Securities or the Debt Securities trustee may demand payment from UBS without first pro- ceeding against UBS Americas Inc. UBS’s obligations under the subordinated note guarantee are subordinated to the prior payment in full of the deposit liabilities of UBS and all other liabilities of UBS. The information presented in this note is prepared in ac- cordance with IFRS and should be read in conjunction with the Consolidated Financial Statements of UBS of which this information is a part. Supplemental Guarantor Consolidating Income Statement CHF million For the year ended 31 December 2008 UBS AG Parent Bank 1 UBS Americas Inc. Subsidiaries Entries UBS Group Consolidating Operating income Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss expense Net fee and commission income Net trading income Income from subsidiaries Other income Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Impairment of goodwill Amortization of intangible assets Total operating expenses Operating profit from continuing operations before tax Tax expense Net profit from continuing operations Net profit from discontinued operations Net profit Net profit attributable to minority interests Net profit attributable to UBS shareholders 49,699 (48,686) 1,013 (861) 152 9,709 (8,129) (19,882) 2,836 (15,314) 8,738 3,918 770 0 1 13,427 (28,741) (7,407) (21,335) 43 (21,292) 0 (21,292) 21,343 (17,436) 3,907 (2,050) 1,857 7,910 (19,847) 0 1,058 (9,022) 5,169 4,604 205 341 93 10,412 (19,434) (4) (19,430) 0 (19,430) (9) (19,421) 27,354 (26,282) 1,072 (85) 987 5,310 2,156 0 (3,202) 5,251 2,355 1,976 266 0 119 4,716 535 574 (39) 155 116 577 (461) (32,717) 32,717 0 0 0 0 0 19,882 0 19,882 0 0 0 0 0 0 19,882 0 19,882 0 19,882 0 19,882 65,679 (59,687) 5,992 (2,996) 2,996 22,929 (25,820) 0 692 796 16,262 10,498 1,241 341 213 28,555 (27,758) (6,837) (20,922) 198 (20,724) 568 (21,292) 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 362 Note 41 Supplemental guarantor information required under SEC rules (continued) Supplemental guarantor consolidating balance sheet CHF million As of 31 December 2008 Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Loans Financial investments available-for-sale Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and intangible assets Other assets Total assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Equity attributable to UBS shareholders Equity attributable to minority interests Total equity Total liabilities and equity UBS AG Parent Bank 1 UBS Americas Inc. Subsidiaries Entries UBS Group Consolidating 27,030 111,563 48,874 206,087 183,303 33,445 862,459 5,120 326,548 1,237 3,684 66,255 5,093 250 15,541 332 11,490 109,783 79,178 54,973 5,240 18,215 7,755 53,774 638 2,700 58 971 9,393 3,905 5,382 192,206 16,914 145,851 50,638 1,531 293,896 12,741 35,193 3,373 2,666 50 642 3,292 6,849 0 (250,808) (52,674) (206,468) (17,076) 0 (320,470) (12,734) (75,207) 0 (2,909) (65,473) 0 0 (7,484) 32,744 64,451 122,897 224,648 271,838 40,216 854,100 12,882 340,308 5,248 6,141 892 6,706 12,935 18,811 1,896,489 358,405 771,224 (1,011,303) 2,014,815 196,723 25,248 30,988 51,034 855,005 88,505 422,688 7,417 127,408 12,598 1,817,614 78,875 0 78,875 1,896,489 68,213 32,884 140,197 17,086 16,792 1,716 70,242 2,584 2,439 4,313 356,466 (1,097) 3,036 1,939 111,500 8,605 137,844 11,387 300,537 24,059 57,051 3,104 67,407 24,538 746,032 20,226 4,966 25,192 (250,808) (52,674) (206,468) (17,076) (320,470) (12,734) (75,207) (2,909) 0 (7,484) (945,830) (65,473) 0 (65,473) 125,628 14,063 102,561 62,431 851,864 101,546 474,774 10,196 197,254 33,965 1,974,282 32,531 8,002 40,533 358,405 771,224 (1,011,303) 2,014,815 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. n o i t a m r o f n i l a i c n a n i F 363 Financial information Notes to the consolidated financial statements Note 41 Supplemental guarantor information required under SEC rules (continued) Supplemental guarantor consolidating cash flow statement CHF million For the year ended 31 December 2008 Net cash flow from / (used in) operating activities UBS AG Parent Bank 1 69,772 UBS Americas Inc. Subsidiaries UBS Group (438) 7,646 76,980 Cash flow from / (used in) investing activities Investments in subsidiaries and associates Disposal of subsidiaries and associates Purchase of property and equipment Disposal of property and equipment Net (investment in) / divestment of financial investments available-for-sale Net cash flow from / (used in) investing activities Cash flow from / (used in) financing activities Net money market paper issued / (repaid) Net movements in treasury shares and own equity derivative activity Capital issuance Issuance of long-term debt, including financial liabilities designated at fair value (1,502) 1,686 (819) 37 330 (268) (52,815) 623 23,135 91,961 0 0 (258) 27 156 (75) 0 0 (140) 5 (1,198) (1,333) 914 11,264 0 0 0 Repayment of long-term debt, including financial liabilities designated at fair value (62,822) (14,500) Increase in minority interests Dividends paid to / decrease in minority interests Net activity in investments in subsidiaries Net cash flow from / (used in) financing activities Effects of exchange rate differences Net increase / (decrease) in cash equivalents Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year Cash and cash equivalents comprise: Cash and balances with central banks Money market paper 2 Due from banks with original maturity of less than three months Total 0 0 (11,978) (11,896) (33,963) 23,645 109,110 132,755 27,030 62,777 42,948 132,755 842 (112) 21,816 8,960 442 8,889 15,532 24,421 332 19,875 4,214 24,421 (1,502) 1,686 (1,217) 69 (712) (1,676) (40,637) 623 23,135 103,087 (92,894) 1,661 (532) 0 (5,557) (39,186) 30,561 149,105 179,666 32,744 86,732 60,190 179,666 0 0 11,126 (15,572) 819 (420) (9,838) (2,621) (5,665) (1,973) 24,463 22,490 5,382 4,080 13,028 22,490 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Money market paper is included in the Balance sheet under Trading portfolio assets and Financial investments available-for-sale. CHF 3,853 million was pledged at 31 December 2008. 364 Note 41 Supplemental guarantor information required under SEC rules (continued) Supplemental guarantor consolidating income statement CHF million For the year ended 31 December 2007 UBS AG Parent Bank 1 UBS Americas Inc. Subsidiaries Consolidating Entries UBS Group Operating income Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss expense Net fee and commission income Net trading income Income from subsidiaries Other income Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of intangible assets Total operating expenses Operating profit from continuing operations before tax Tax expense Net profit from continuing operations Net profit from discontinued operations Net profit Net profit attributable to minority interests Net profit attributable to UBS shareholders 77,306 (74,689) 2,617 11 2,628 12,852 3,467 464 (4,273) 15,138 13,239 5,684 930 3 19,856 (4,718) 794 (5,512) 265 (5,247) 0 (5,247) 47,747 (46,420) 1,327 (234) 1,093 10,119 (9,932) 0 8,369 9,649 8,329 3,446 138 101 12,014 (2,365) (486) (1,879) 0 (1,879) 18 (1,897) 51,985 (50,592) 1,393 (15) 1,378 7,663 (1,888) 0 245 7,398 3,947 (701) 175 172 3,593 3,805 1,061 2,744 138 2,882 521 2,361 (67,926) 67,926 109,112 (103,775) 0 0 0 0 0 (464) 0 (464) 0 0 0 0 0 (464) 0 (464) 0 (464) 0 (464) 5,337 (238) 5,099 30,634 (8,353) 0 4,341 31,721 25,515 8,429 1,243 276 35,463 (3,742) 1,369 (5,111) 403 (4,708) 539 (5,247) 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. n o i t a m r o f n i l a i c n a n i F 365 Financial information Notes to the consolidated financial statements Note 41 Supplemental guarantor information required under SEC rules (continued) Supplemental guarantor consolidating balance sheet CHF million On 31 December 2007 Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Loans Financial investments available-for-sale Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and intangible assets Other assets Total assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Equity attributable to UBS shareholders Equity attributable to minority interests Total equity Total liabilities and equity UBS AG Parent Bank 1 UBS Americas Inc. Subsidiaries Consolidating Entries UBS Group 8,530 154,138 117,312 292,839 297,100 161,071 436,271 5,510 370,274 2,611 7,379 28,049 5,352 276 15,848 1,902,560 246,977 45,055 105,750 111,955 456,631 146,701 555,694 13,276 168,266 19,524 1,869,829 32,731 0 32,731 1,902,560 109 16,530 166,479 106,775 170,977 55,842 16,770 7,149 41,398 980 4,369 139 959 10,516 5,135 604,127 114,066 64,281 238,880 51,904 16,333 14,947 87,534 8,242 3,478 5,511 605,176 (3,373) 2,324 (1,049) 604,127 10,154 200,488 53,672 266,470 84,884 4,498 192,144 8,421 43,584 1,375 4,883 150 923 3,746 4,951 0 (310,249) (130,400) (289,156) 107,221 (107,221) (216,968) (9,315) (119,392) 0 (4,678) (26,359) 0 0 (5,622) 18,793 60,907 207,063 376,928 660,182 114,190 428,217 11,765 335,864 4,966 11,953 1,979 7,234 14,538 20,312 880,343 (1,112,139) 2,274,891 94,968 52,685 250,413 929 187,543 39,520 118,056 5,310 50,333 42,083 841,840 33,876 4,627 38,503 880,343 (310,249) (130,400) (289,156) 0 (216,968) (9,315) (119,392) (4,678) 0 (5,622) (1,085,780) (26,359) 0 (26,359) (1,112,139) 145,762 31,621 305,887 164,788 443,539 191,853 641,892 22,150 222,077 61,496 2,231,065 36,875 6,951 43,826 2,274,891 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 366 Note 41 Supplemental guarantor information required under SEC rules (continued) Supplemental guarantor consolidating cash flow statement CHF million For the year ended 31 December 2007 Net cash flow from / (used in) operating activities UBS AG Parent Bank 1 (65,749) UBS Americas Inc. 19,670 Subsidiaries (5,999) UBS Group (52,078) Cash flow from / (used in) investing activities Investments in subsidiaries and associates Disposal of subsidiaries and associates Purchase of property and equipment Disposal of property and equipment Net (investment in) / divestment of financial investments available-for-sale Net cash flow from / (used in) investing activities Cash flow from / (used in) financing activities Net money market paper issued / (repaid) Net movements in treasury shares and own equity derivative activity Dividends paid Issuance of long-term debt, including financial liabilities designated at fair value Repayment of long-term debt, including financial liabilities designated at fair value Increase in minority interests Dividends paid to / decrease in minority interests Net activity in investments in subsidiaries Net cash flow from / (used in) financing activities Effects of exchange rate differences Net increase / (decrease) in cash equivalents Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year Cash and cash equivalents comprise: Cash and balances with central banks Money market paper 2 Due from banks with original maturity of less than three months Total (2,337) 885 (1,022) 40 4,027 1,593 35,017 (2,771) (4,275) 105,197 (54,251) 0 0 871 79,788 (9,070) 6,562 102,548 109,110 8,530 60,266 40,314 109,110 0 0 (581) 28 34 (519) (1,426) 0 0 1,022 (7,022) 32 (665) (6,627) (14,686) (3,062) 1,403 14,129 15,532 109 13,202 2,221 15,532 0 0 (307) 66 1,920 1,679 (919) 0 0 4,655 (1,134) 1,062 46 5,756 9,466 (96) 5,050 19,413 24,463 10,154 3,747 10,562 24,463 (2,337) 885 (1,910) 134 5,981 2,753 32,672 (2,771) (4,275) 110,874 (62,407) 1,094 (619) 0 74,568 (12,228) 13,015 136,090 149,105 18,793 77,215 53,097 149,105 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Money market paper is included in the Balance sheet under Trading portfolio assets and Financial investments available-for-sale. CHF 3,364 million was pledged at 31 December 2007. n o i t a m r o f n i l a i c n a n i F 367 Financial information Notes to the consolidated financial statements Note 41 Supplemental guarantor information required under SEC rules (continued) Supplemental guarantor consolidating income statement CHF million For the year ended 31 December 2006 UBS AG Parent Bank 1 UBS Americas Inc. Subsidiaries Consolidating Entries UBS Group Operating income Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss expense Net fee and commission income Net trading income Income from subsidiaries Other income Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of intangible assets Total operating expenses Operating profit from continuing operations before tax Tax expense Net profit from continuing operations Net profit from discontinued operations Net profit Net profit attributable to minority interests Net profit attributable to UBS shareholders 60,057 (56,020) 4,037 167 4,204 11,646 10,306 3,086 (450) 28,792 12,480 2,805 979 14 16,278 12,514 1,499 11,015 512 11,527 0 11,527 42,667 (41,049) 1,618 (6) 1,612 8,590 1,634 0 1,637 13,473 8,287 3,362 133 83 11,865 1,608 1,018 590 0 590 527 63 39,269 (38,403) 866 (5) 861 5,220 1,803 0 421 8,305 3,264 1,775 132 51 5,222 3,083 481 2,602 387 2,989 (34) 3,023 (54,592) 54,592 87,401 (80,880) 0 0 0 0 0 (3,086) 0 (3,086) 0 0 0 0 0 (3,086) 0 (3,086) 0 (3,086) 0 (3,086) 6,521 156 6,677 25,456 13,743 0 1,608 47,484 24,031 7,942 1,244 148 33,365 14,119 2,998 11,121 899 12,020 493 11,527 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 368 Note 41 Supplemental guarantor information required under SEC rules (continued) Supplemental guarantor consolidating cash flow statement CHF million For the year ended 31 December 2006 Net cash flow from / (used in) operating activities UBS AG Parent Bank 1 UBS Americas Inc. (14,984) (2,215) Subsidiaries UBS Group 11,815 (5,384) Cash flow from / (used in) investing activities Investments in subsidiaries and associates Disposal of subsidiaries and associates Purchase of property and equipment Disposal of property and equipment Net (investment in) / divestment of financial investments available-for-sale Net cash flow from / (used in) investing activities Cash flow from / (used in) financing activities Net money market paper issued / (repaid) Net movements in treasury shares and own equity derivative activity Capital issuance Capital repayment by par value reduction Dividends paid Issuance of long-term debt, including financial liabilities designated at fair value Repayment of long-term debt, including financial liabilities designated at fair value Increase in minority interests Dividends paid to / decrease in minority interests Net activity in investments in subsidiaries Net cash flow from / (used in) financing activities Effects of exchange rate differences Net increase / (decrease) in cash equivalents Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year Cash and cash equivalents comprise: Cash and balances with central banks Money market paper 2 Due from banks with original maturity of less than three months Total 2,856 1,154 (1,292) 298 90 3,106 17,526 (3,179) 1 (631) (3,214) 79,358 (48,748) 0 0 (8,410) 32,703 406 34,000 68,548 102,548 2,660 73,431 26,457 102,548 0 0 (255) 47 433 225 0 0 (246) 154 1,200 1,108 1,039 (1,644) 0 0 0 0 10,881 (447) 85 2,441 3,229 17,228 (1,871) 598 13,531 14,129 78 11,488 2,563 14,129 0 0 0 0 7,436 (10,545) 1,246 (3,513) 5,181 (1,839) (634) 10,450 8,963 19,413 757 2,225 16,431 19,413 2,856 1,154 (1,793) 499 1,723 4,439 16,921 (3,179) 1 (631) (3,214) 97,675 (59,740) 1,331 (1,072) 0 48,092 (2,099) 45,048 91,042 136,090 3,495 87,144 45,451 136,090 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Money market paper is included in the Balance sheet under Trading portfolio assets and Financial investments available-for-sale. CHF 7,183 million was pledged at 31 December 2006. n o i t a m r o f n i l a i c n a n i F 369 Financial information Notes to the consolidated financial statements Note 41 Supplemental guarantor information required under SEC rules (continued) Guarantee of other securities UBS AG, acting through wholly-owned finance subsidiaries, issued the following trust preferred securities: USD billion, unless otherwise indicated Issuing Entity UBS Preferred Funding Trust I UBS Preferred Funding Trust II UBS Preferred Funding Trust IV UBS Preferred Funding Trust V Type of security Trust preferred securities Trust preferred securities 1 Floating rate noncumulative trust preferred securities Trust preferred securities Outstanding on 31.12.08 Date issued Interest (%) Amount October 2000 June 2001 8.622 7.247 May 2003 May 2006 one-month LIBOR + 0.7% 6.243 1.5 0.5 0.3 1.0 1 In June 2006, USD 300 million (at 7.25%) of Trust preferred securities also issued in June 2001 were redeemed. UBS AG has fully and unconditionally guaranteed these se- curities. UBS’s obligations under the trust preferred securities guarantee are subordinated to the prior payment in full of the deposit liabilities of UBS and all other liabilities of UBS. At 31 December 2008, the amount of senior liabilities of UBS to which the holders of the subordinated debt securities would be subordinated is approximately CHF 1,959 billion. 370 Financial information UBS AG (Parent Bank) UBS AG (Parent Bank) Parent Bank review Income statement The Parent Bank UBS AG net loss increased by CHF 32,238 million from a loss of CHF 4,251 million in the previous year to a loss of CHF 36,489 million. Income from investments in associated companies in- creased to CHF 3,763 million from CHF 2,592 million in 2007, mainly due to higher dividend distributions received. Personnel expenses were down to CHF 6,707 million from CHF 13,505 million in 2007, mainly due to lower accruals on performance-related compensation and recognition of a de- fined pension asset. Losses resulting from the US market had a significant im- pact on the following income statement lines: – Depreciation increased from CHF 8,660 million in 2007 to CHF 26,900 million in 2008, mainly reflecting writedowns of investments in associated US companies. – Net trading income decreased from positive CHF 2,767 million in 2007 to negative CHF 9,466 million in 2008. This mainly reflects losses in the fixed-income business and the charges associated with the SNB transaction. The decrease in Extraordinary income and increase in Extraordinary expenses are explained on page 376. Balance sheet In 2008, UBS’s overall balance sheet reduction initiatives also led to lower Parent Bank total assets. In particular UBS subsidiaries in the Americas reduced their assets and therefore their funding needs from the Parent Bank. The Parent Bank total assets stood at CHF 1,189 billion on 31 December 2008, a drop of CHF 409 billion from CHF 1,598 billion on 31 December 2007. The reductions occurred in trading balances, which declined by CHF 254 billion, interbank lending (loans and collateral trading) dropped CHF 171 billion, with customer loans and collateral trading down CHF 83 billion and oth- er assets down CHF 5 billion. These declines, however, were partially offset by higher positive replacement values of CHF 78 billion and liquid assets of CHF 19 billion. Mort- gage loans remained stable in 2008 at CHF 141 billion. The above mentioned write-downs of investments in as- sociated US companies have been offset during the year by capital injections. Interbank lending During 2008, due from banks on time declined by CHF 40 billion, predominantly due to lower funding needs of UBS bank subsidiaries in the Americas. Due from banks on de- mand declined slightly by CHF 4 billion, as lower funding to bank subsidiaries in the European Region outweighed the increase to non-UBS related banks in the Americas and Japan. In addition, interbank collateral trading declined by CHF 127 billion, with roughly two thirds attributable to lower trading volumes with UBS subsidiaries, and one third due to reductions in trading volumes with third party clients. Customer lending The customer loan drop of CHF 55 billion was mainly the result of lower funding needs of UBS subsidiaries (non- banks), predominantly in the Americas region. In addition, customer collateral trading declined CHF 28 billion, of which two thirds was attributable to third party clients in the Americas and Europe and one third to UBS sub- sidiaries in the Americas. Financial investments Compared with the previous year, the increase of CHF 10 bil- lion is mainly due to the reclassification from Trading balances in securities to Financial investments in fourth quarter 2008. n o i t a m r o f n i l a i c n a n i F 371 Financial information UBS AG (Parent Bank) Parent Bank financial statements Income statement CHF million Interest and discount income Interest and dividend income from trading portfolio Interest and dividend income from financial investments Interest expense Net interest income Credit-related fees and commissions Fee and commission income from securities and investment business Other fee and commission income Fee and commission expense Net fee and commission income Net trading income Net income from disposal of financial investments Income from investments in associated companies Income from real estate holdings Sundry income from ordinary activities Sundry ordinary expenses Other income from ordinary activities Operating income Personnel expenses General and administrative expenses Operating expenses Operating profit Depreciation and write-offs on investments in associated companies and fixed assets Allowances, provisions and losses Profit before extraordinary items and taxes Extraordinary income Extraordinary expenses Tax expense Profit / (loss) for the period 372 For the year ended % change from 31.12.08 31.12.07 31.12.07 37,825 12,014 76 (49,022) 893 208 11,668 610 (2,849) 9,637 (9,466) 176 3,763 29 3,384 (2,767) 4,584 5,648 6,707 5,822 12,528 (6,880) 26,900 3,071 (36,852) 1,002 482 157 (36,489) 58,674 19,003 58 (75,179) 2,556 205 15,468 686 (3,269) 13,090 2,767 178 2,592 27 3,352 (3,223) 2,926 21,339 13,505 5,191 18,696 2,643 8,660 2,780 (8,797) 4,665 4 115 (4,251) (36) (37) 31 (35) (65) 1 (25) (11) (13) (26) (1) 45 7 1 (14) 57 (74) (50) 12 (33) 211 10 (319) (79) 37 (758) Balance sheet CHF million Assets Liquid assets Money market paper Due from banks Due from customers Mortgage loans Trading balances in securities and precious metals Financial investments Investments in associated companies Fixed assets Accrued income and prepaid expenses Positive replacement values Other assets Total assets Total subordinated assets Total amounts receivable from Group companies Liabilities and equity Money market paper issued Due to banks Due to customers on savings and deposit accounts Other amounts due to customers Medium-term bonds Bond issues and loans from central mortgage institutions Accruals and deferred income Negative replacement values Other liabilities Allowances and provisions Share capital General statutory reserve Reserve for own shares Other reserves Profit / (loss) for the period Total liabilities and equity Total subordinated liabilities Total amounts payable to Group companies 31.12.08 31.12.07 % change from 31.12.07 27,030 62,777 355,679 191,308 141,328 158,741 11,085 22,001 5,032 3,877 201,801 8,697 8,530 60,266 527,081 274,510 141,381 412,977 1,685 21,228 5,273 7,221 124,244 13,676 1,189,356 1,598,072 3,924 435,721 52,063 292,730 61,872 388,338 3,150 143,589 7,895 193,108 14,181 2,724 293 40,910 2,877 22,115 (36,489) 1,189,356 21,228 271,434 6,293 602,667 104,878 491,102 72,303 521,189 3,228 189,023 17,368 145,445 15,576 3,970 207 8,775 9,441 19,818 (4,251) 1,598,072 21,114 330,567 217 4 (33) (30) 0 (62) 558 4 (5) (46) 62 (36) (26) (38) (28) (50) (40) (14) (25) (2) (24) (55) 33 (9) (31) 42 366 (70) 12 (758) (26) 1 (18) Statement of appropriation of retained earnings The Board of Directors proposes to the Annual General Meeting (AGM) on 15 April 2009 to approve the following appropriation: CHF million Profit / (Loss) for the financial year 2008 as per the Parent Bank's Income Statement Appropriation to other reserves Appropriation to general statutory reserves: Retained earnings Appropriation to general statutory reserves: Share premium (36,489) (22,115) (2,472) (11,901) 373 n o i t a m r o f n i l a i c n a n i F Financial information UBS AG (Parent Bank) Notes to the Parent Bank financial statements Accounting Policies The Parent Bank Financial Statements are prepared in accor- dance with Swiss Federal banking law. The accounting poli- cies are principally the same as for the Group Financial State- ments outlined in Note 1, Summary of Significant Accounting Policies. Major differences between the Swiss Federal bank- ing law requirements and International Financial Reporting Standards (IFRS) are described in Note 40 to the financial statements. The accounting policies applied for the statutory accounts of the Parent Bank are discussed below. The risk management of UBS AG is described in the context of the risk management for UBS Group. For the statutory required risk assessment refer to the “Risk and treasury manage- ment” section of this report. Treasury shares Treasury shares are own equity instruments held by an entity. Under Swiss law, treasury shares are recognized in the balance sheet as trading balances. Short positions in treasury shares are recognized in Due to banks. Treasury shares recognized as trading balances and short positions in treasury shares are measured at fair value with unrealized gains or losses from remeasurement to fair value included in the income statement. Realized gains and losses on the sale or acquisition of treasury shares are recognized in the income statement. A reserve for own shares must be created in equity equal to the cost value of the treasury shares held. The reserve for own shares is not available for distribution to shareholders. Foreign currency translation Assets and liabilities of foreign branches are translated into CHF at the spot exchange rate at the balance sheet date. Income and expense items are translated at weighted aver- age exchange rates for the period. Gains resulting from exchange differences on the translation of each of these foreign branches are credited to a provision account (other liabilities). Losses resulting from exchange differences are debited, firstly, to the aforementioned provision account until such provision is fully utilized, and, secondly, to profit and loss. Investments in associated companies Investments in associated companies are equity interests which are held for the purpose of the Parent Bank’s business activities or for strategic reasons. They include all directly held subsidiar- ies and are carried at cost less impairment, if applicable. Deferred taxes Deferred tax assets are not recognized in the Parent Bank Financial Statements. Deferred tax liabilities are recognized for all taxable temporary differences. The change in the de- ferred tax liability is recognized in profit or loss. Equity participation and other compensation plans Equity participation plans Under Swiss law, employee share awards are recognized as compensation expense and accrued over the performance year, which is generally the period prior to the grant date. Employee option awards which do not contain voluntary termination non-compete provisions are recognized as compensation expense on the grant date. If the award is performance based and contains substantive future ser- vice / vesting period, compensation expense is recognized over the performance period. Employee option awards which contain voluntary termination non-compete provi- sions (i. e. good leaver clause) are recognized as compensa- tion expense over the performance year. Equity- and cash- settled awards are classified as liabilities. The employee share option awards are remeasured to fair value at each balance sheet date. However, for employee share options that UBS intends to settle in shares from condi tional capital, there is no impact on the income statement and no liability is recog- nized. Upon exercise of employee options, cash received for payment of the strike price is credited against share capital and general statutory reserve. Other compensation plans Fixed and variable deferred cash compensation is recognized as compensation expense over the performance year. If the award is performance based and contains substantive future service / vesting period, compensation expense is recognized over the performance period. 374 Changes in accounting policies, comparability and other adjustments Equity participation plans In 2008, UBS revised the measurement methodology for the liability under employee share option awards settled with treasury shares. The measurement of the liability was previ- ously based on the higher of grant date fair value and intrin- sic value of the underlying options, whereas following the revision, it is based on fair value. This change resulted in rev- enues of CHF 1.2 billion. In 2006, UBS adopted the policy to decide at grant whether to use conditional capital or treasury shares to sat- isfy employee option delivery obligations in UBS shares. In 2008, UBS changed this policy to allow it to use treasury shares up to the number of treasury shares held, with the excess of employee option delivery obligations satisfied from conditional capital. As a result, UBS recognized an additional expense of CHF 298 million before tax in the income state- ment in 2008. Post-employment benefits In 2008, UBS concluded that it meets the requirements to recognize a defined benefit asset associated with its Swiss pension plan consistent with the consolidated financial state- ments. The change in accounting policy resulted in the fol- lowing effects on the balance sheet and income statement for 31 December 2008: an increase of approximately CHF 2.1 billion in Other assets and a corresponding decrease in Personnel expenses. Reclassification of trading securities UBS decided at the end of October to reclassify securities from “trading balances in securities and precious metals” to “financial investments” with effect from 1 October 2008. The securities have been reclassified on the basis of their fair value on the reclassification date and are now accounted for on an amortized cost basis. An impairment charge of CHF 0.3 billion was recognized on the reclassified financial in- struments. If the reclassification had not occurred, the im- pairment charge would not have been recognized but a trading loss of CHF 1.9 billion would have been recorded. n o i t a m r o f n i l a i c n a n i F 375 Financial information UBS AG (Parent Bank) Additional income statement information Net trading income CHF million Equities Fixed income Foreign exchange and other1 Total 1 Includes commodities trading income. Extraordinary income and expenses For the year ended % change from 31.12.08 31.12.07 31.12.07 3,930 (15,505) 2,109 (9,466) 7,867 (7,679) 2,579 2,767 (50) (102) (18) Extraordinary income includes a gain from the sale of the Bank of China investment of approximately CHF 360 million in 2008, whereas 2007 included a gain on the sale of UBS’s 20.7% stake in Julius Baer of CHF 3,180 million. Further, 2008 includes a release of provisions of CHF 72 million, a release on reserves on investments in subsidiaries of CHF 490 million and a writeup of investments in associated com- panies of CHF 30 million (2007: CHF 409 million). Amounts in 2007 include a release on reserves on own properties of CHF 824 million and for lapsed employee options of CHF 165 million. In 2008, extraordinary expenses include CHF 478 million related to an overstatement of trading income in 2007. Extraordinary expenses in 2007 were immaterial. 376 Additional balance sheet information Allowances and provisions CHF million Default risks (credit and country risk) Trading portfolio risks 1 Litigation risks 2 Operational risks Retirement benefit plans Deferred taxes Other 3 Total allowances and provisions Allowances deducted from assets Total provisions as per balance sheet Balance at 31.12.07 1,036 4,554 158 164 107 31 3,446 9,496 5,526 3,970 Provisions applied in accordance with their specified purpose Reclassifi cations Recoveries, doubtful interest, currency translation differences Provisions released to income New provisions charged to income Balance at 31.12.08 (481) (457) (203) (2) (2,672) (3,815) 3 (3) 187 (49) 2 (68) 72 (506) (33) (280) (14) (244) (1,077) 1,504 10,304 1,460 289 52 3 871 14,483 (47) (47) 1,556 14,858 1,078 157 94 36 1,333 19,112 16,388 2,724 1 The increase was mainly in the area of Fixed Income, Currencies and Commodities (FICC) in the Investment Bank. 2 Includes the movements of provisions for auction rate securities (ARS): provisions have been assumed by UBS AG from a subsidiary of CHF 922 million (USD 865 million), new provisions of CHF 407 million have been expensed; the provisions have been partially applied, and the residual amount of CHF 968 million was reclassified to Negative replacement values. In addition a provision of CHF 917 million (USD 780 million) was made in connection with UBS’s US cross-border case. Refer to “Note 21 Provisions and litigations”). 3 The 31 December 2008 balance includes provisions for capitalization commitments of subsidiaries that have a capital deficit of approximately CHF 592 million and provisions were applied for the writeoff of investments in subsidiaries of CHF 2,629 million. In addition, provisions for reinstatement costs for leasehold improvements, provisions for employee benefits (service anniversaries and sabbatical leaves) are mainly included in this line. Statement of shareholders’ equity CHF million As of 31.12.06 and 1.1.07 Cancellation of own shares Capital increase Increase in reserves Prior year dividend Profit / (loss) for the period Changes in reserves for own shares As of 31.12.07 and 1.1.08 Cancellation of own shares Capital increase 1 Capital increase related to MCNs Increase in reserves Prior year dividend Profit / (loss) for the period Changes in reserves for own shares Transfers 2 As of 31.12.08 General statutory reserves: Share premium General statutory reserves: Retained earnings Reserves for own shares 6,280 2,015 9,114 Share capital 211 (4) 457 2,472 23 6,303 15,911 16,223 (11,901) 26,536 (2,472) 0 207 86 293 327 9,441 (6,564) 2,877 1 Includes stock dividend. 2 Subject to approval by the Annual General Meeting on 15 April 2009. Other reserves 27,288 (2,411) (457) (4,275) (4,251) (327) 15,567 (15) (36,489) 6,564 14,373 0 Total shareholders’ equity (before distribution of profit) 44,908 (2,415) 23 (4,275) (4,251) 33,990 15,982 16,223 0 0 (36,489) 0 0 29,706 377 n o i t a m r o f n i l a i c n a n i F Financial information UBS AG (Parent Bank) Share capital As of 31.12.08 Issued and paid up Conditional share capital As of 31.12.07 Issued and paid up Conditional share capital Par value Ranking for dividends No. of shares Capital in CHF No. of shares Capital in CHF 2,932,580,549 293,258,055 2,932,580,549 293,258,055 792,844,711 79,284,471 2,073,547,344 207,354,734 2,073,547,344 207,354,734 150,138,634 15,013,863 On 31 December 2008, a maximum of 100,415 shares can be issued against the future exercise of options from former PaineWebber employee option plans. These shares are shown as conditional share capital in the UBS AG (Parent Bank) disclosure. During 2006, shareholders approved the creation of con- ditional capital of up to a maximum of 150 million shares to fund UBS’s employee share option programs. In 2007, 5,704 shares had been issued under this program. The remaining conditional capital to fund UBS’s employee share option pro- grams amounts to 149,994,296 shares. On 27 February 2008 the extraordinary general meeting of shareholders approved the creation of a maximum of CHF 10,370,000 in authorized capital, allowing the distribution of a stock dividend. Additionally, on 23 April 2008, the Annual Gen- eral Meeting of shareholders (AGM) approved a capital increase that resulted in the issuance of 760,295,181 fully paid regis- tered shares. In addition, during 2008, shareholders approved the creation of conditional capital in a maximum amount of 642,750,000 shares for the two issuances of mandatory con- vertible notes (MCNs). For further information, refer to Note 26 to the financial statements. 378 Off-balance sheet and other information Assets pledged or assigned as security for own obligations and assets subject to reservation of title CHF million Money market paper Mortgage loans Securities Other Total 31.12.08 31.12.07 Change in % Book value Effective liability Book value Effective liability Book value Effective liability 7,429 3,699 50,223 8,149 69,500 1,300 2,418 37,083 0 40,801 12,792 200 99,821 8,628 121,441 2,372 199 49,397 51,968 (42) (50) (6) (43) (45) (25) (21) Financial assets are mainly pledged in securities borrowing and lending transactions, in repurchase and reverse repurchase transactions, under collateralized credit lines with central banks, against loans from mortgage institutions, in connection with derivative transactions and for security deposits relating to stock exchange and clearinghouse memberships. Commitments and contingent liabilities CHF million Contingent liabilities Irrevocable commitments Liabilities for calls on shares and other equities Confirmed credits 31.12.08 286,451 68,660 145 2,079 31.12.07 223,105 104,784 145 2,630 % change from 31.12.07 28 (34) 0 (21) UBS AG is jointly and severally liable for the value added tax (VAT) liability of Swiss subsidiaries that belong to its VAT group. UBS has an obligation to deliver 100 million ordinary UBS shares, subject to anti dilution adjustments, in exchange for payment of the par value of these shares, if the SNB incurs a loss on its loan provided to the SNB StabFund upon termina- tion of this fund. If UBS would be required to deliver those shares, UBS intends to settle this obligation using conditional capital (subject to shareholders’ approval). Derivative instruments CHF million Interest rate contracts Credit derivative contracts Foreign exchange contracts Precious metal contracts Equity / Index contracts Commodities contracts, excluding precious metals contracts Total derivative instruments Replacement value netting Replacement values after netting 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 31.12.08 31.12.07 Notional amount CHF bn 36,476 3,712 6,005 108 473 160 46,934 PRV 1 377,307 202,357 222,178 5,804 28,502 27,055 863,203 661,402 201,801 NRV 2 370,346 187,216 229,656 5,697 36,208 25,387 854,510 661,402 193,108 PRV 1 167,334 111,898 99,494 6,363 30,400 21,181 436,670 312,426 124,244 NRV 2 164,325 116,128 99,613 6,569 49,985 21,251 457,871 312,426 145,445 Notional amount CHF bn 33,545 5,451 7,725 147 760 484 48,112 379 n o i t a m r o f n i l a i c n a n i F Financial information UBS AG (Parent Bank) Fiduciary transactions CHF million Deposits: with other banks with group banks Total Due to UBS pension plans CHF million Due to UBS pension plans and UBS debt instruments held by pension plans Securities borrowed from pension plans 31.12.08 31.12.07 % change from 31.12.07 36,452 2,738 39,190 46,074 2,186 48,260 (21) 25 (19) For the year ended % change from 31.12.08 31.12.07 31.12.07 876 0 443 9,379 98 (100) Personnel Parent Bank personnel was 40,998 on 31 December 2008 and 45,102 on 31 December 2007. Significant shareholders Chase Nominees Ltd., London, acting in its capacity as a nominee for other investors, was registered with 7.19% of all shares issued on 31 December 2008, compared with 7.99% at year-end 2007 and 8.81% at year-end 2006. DTC (Cede & Co.), New York, The Depository Trust Company, a US securities clearing organization, was registered as a shareholder for a large number of beneficial owners with 9.89% of all shares issued on 31 December 2008 (14.15% on 31 December 2007). 380 Corporate governance and compensation report Compensation details and additional information for executive members of the BoD CHF, except where indicated a Name, function 1 Peter Kurer, Chairman Marcel Ospel, Chairman Stephan Haeringer, Executive Vice Chairman Marco Suter, Executive Vice Chairman For the year ended 2008 2007 2008 2007 2008 2007 2008 2007 Base salary 1,333,333 666,667 2,000,000 1,125,000 1,500,000 1,125,000 Annual incentive award (cash) 0 0 0 0 0 0 Annual incentive award (shares – fair value) b 0 Discretionary award (options – fair value) c 0 Benefits in kind d 58,267 Contributions to retirement benefits plans e 174,047 Total 1,565,647 0 0 0 0 0 0 0 0 0 0 80,755 307,310 108,846 111,808 87,023 834,445 261,069 2,568,379 195,802 1,429,648 261,069 1,872,877 70,820 155,252 1,351,072 1 2008: Peter Kurer was the only executive member in office on 31 December; Marcel Ospel did not stand for re-election in April 2008 and Stephan Haeringer stepped down during the year as a member of the BoD. Both their payments are pro-rata for the four respective nine-month periods served in their functions. 2007: Marco Suter stepped down during the year as a member of the BoD. His 2007 payment was pro-rata for the nine-month period served as Executive Vice Chairman. Explanations of compensation details for executive members of the BoD and members of the GEB: a. Local currencies are converted into CHF using the exchange rates as detailed in “Note 39 Currency translation rates” in the financial statements of this report. b. Values per share at grant: CHF 36.15 / USD 33.55 for shares granted in 2008 related to the performance year 2007. CHF prices are the average price of UBS shares at SWX Europe over the last 10 trading days of February, and USD prices are the average price of UBS shares at the NYSE over the last 10 trading days of February in the year in which they are granted. c. No options were granted in 2009 for the performance year 2008. d. Benefits in kind – car leasing, company car allowance, staff discount on banking products and services, health and welfare benefits and gen- eral expense allowances – are all valued at market price. e. Swiss senior executives participate in the same pension plan as all other employees. Under this plan, employees receive a company contribution to the plan which covers compensation up to CHF 820,800. The retirement benefits consist of a pension, a bridging pension and a one-off payout of accumulated capital. Employees must also contribute to the plan. This figure excludes the mandatory employer’s social security contributions (AHV, ALV) but includes the portion attributed to the employer’s portion of the legal BVG requirement. The employee contribu- tion is included in the base salary and annual incentive award components. In both the US and the UK, senior executives participate in the same plans as all other employees. In the US there are two different plans, one of which operates on a cash balance basis, which entitles the participant to receive a company contribution based on compensation limited to USD 250,000. This plan is no longer available to new hires. US senior executives may also participate in the UBS 401K-defined contribution plan (open to all employees), which provides a company matching contribution for employee contributions. In the UK, senior executives par- ticipate in either the principal pension plan, which is limited to an earnings cap of GBP 100,000, or a grandfathered defined benefit plan which provides a pension on retirement based on career average base salary (uncapped). 381 n o i t a m r o f n i l a i c n a n i F Financial information UBS AG (Parent Bank) Remuneration details and additional information for independent members of the BoD CHF, except where indicated a & e c n a n r e v o G e e t t i m m o c g n i t a n m o n i e e t t i m m o c e t a r o p r o C y t i l i b i s n o p s e r e e t t i m m o c e e t t i m m o c y g e t a r t S k s i R e t t i e For the period AGM to AGM m m o c Base fee Committee retainer(s) Benefits in kind Additional payments e e t t i m m o c t i d u A & R H M M M M C M M C n o i t a s n e p m o c M M M M C M M C Name, function 1 Ernesto Bertarelli, member Sally Bott, member 2 Rainer-Marc Frey, member 2 Bruno Gehrig, member 2 Gabrielle Kaufmann- Kohler, member Sergio Marchionne, senior independent director, vice chairman Rolf A. Meyer, member 2 Helmut Panke, member William G. Parrett, member 2 David Sidwell, member Peter Spuhler, member 2 Peter R. Voser, member Lawrence A. Weinbach, member 2 Joerg Wolle, member Total 2008 Total 2007 M M C M M C M M M M M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 200,000 150,000 75,000 2007/2008 M M 2008/2009 162,500 150,000 2007/2008 2008/2009 162,500 100,000 2007/2008 2008/2009 325,000 2007/2008 325,000 M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 2007/2008 325,000 M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 2007/2008 250,000 250,000 200,000 200,000 150,000 650,000 300,000 250,000 100,000 M C 2008/2009 325,000 450,000 2007/2008 2008/2009 162,500 2007/2008 325,000 M 2008/2009 325,000 2007/2008 325,000 2008/2009 162,500 2007/2008 325,000 2008/2009 325,000 2007/2008 325,000 0 200,000 400,000 300,000 100,000 600,000 300,000 150,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Share percent- age 3 100 Number of shares 4,5 51,596 100 50 14,677 12,280 Total 525,000 475,000 237,500 312,500 50 16,158 262,500 50 13,572 575,000 0 575,000 250,000 6 775,000 525,000 312,500 975,000 625,000 575,000 262,500 50 50 100 100 50 50 50 50 50 29,731 9,349 76,228 16,226 16,158 15,853 32,316 9,349 13,572 775,000 50 40,072 100 100 50 50 50 50 50 100 15,945 16,226 37,487 10,162 13,572 15,040 32,316 14,677 162,500 525,000 725,000 625,000 262,500 925,000 625,000 475,000 6,437,500 5,675,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Legend: C = Chairman of the respective committee; M = Member of the respective committee 1 There were 11 independent BoD members in office on 31 December 2008. David Sidwell was appointed at the AGM on 23 April 2008 and Rolf A. Meyer, Peter Spuhler and Lawrence A. Weinbach stepped down from the BoD at the EGM on 2 October 2008. Sally Bott, Rainer-Marc Frey, Bruno Gehrig and Bill G. Parrett were appointed at the EGM on 2 October 2008. 2 Remunerations is for six months only, as such members either stepped down or were appointed on 2 October 2008. 3 Fees are paid 50% in cash and 50% in restricted UBS shares. However, independent BoD members can elect to have 100% of their remuneration paid in restricted UBS shares. 4 For 2008, shares valued at CHF 11.38 (average price of UBS shares at SWX Europe over the last 10 trading days of February 2009), attributed with a price discount of 15%, discount price CHF 9.67. The shares are blocked for four years. For 2007, shares valued at CHF 36.15 (average price of UBS shares at SWX Europe over the last 10 trading days of February 2008), attributed with a price discount of 15%, discount price CHF 30.75. The shares are blocked for four years. 5 Number of shares is reduced in case of the 100% election to deduct social security contribu- tion. All remuneration payments are submitted to social security contribution/taxes at source. 6 This payment is associated with the newly created function of a senior independent director. In addition, one-off cash payments were made to the chair of the risk committee (CHF 500,000), the governance and nominating committee (CHF 300,000) and the human resources and compensation committee (CHF 200,000). These payments reflect the substantial workload of setting up the new risk committee, and expanding the mandate of the governance and nominating committee and the human resources and compensation committee. 382 Total payments to all members of the BoD CHF, except where indicated a Aggregate of all members of the BoD Aggregate of all members of the BoD For the year ended 2008 2007 Total 10,267,240 11,467,328 Total compensation for all members of the GEB CHF, except where indicated a Name, function For the year ended Base salary Annual incentive award (cash) Annual incentive award (shares; fair value) b Discretionary award (options; fair value) c Marcel Rohner, Group Chief Executive Officer (highest-paid) 2008 Rory Tapner, Chairman & CEO Asia Pacific (highest-paid) Aggregate of all members of the GEB who were in office on 31 December 2008 1 Aggregate of all members of the GEB who were in office on 31 December 2007 1 Aggregate of all members of the GEB who stepped down during 2008 2 Aggregate of all members of the GEB who stepped down during 2007 2 2007 2008 2007 2008 2007 1,500,000 0 0 1,291,960 4,501,900 4,501,904 7,815,943 0 0 6,995,885 15,305,667 15,305,708 1,614,871 0 0 2,511,947 23,042,376 6,750,036 0 0 0 0 0 0 Contributions to retirement benefits plans e Benefits in kind d Total 161,768 152,934 1,814,702 10,256 900 10,306,920 457,652 817,315 9,090,911 532,706 912,974 39,052,939 234,838 258,423 2,108,132 406,567 275,635 32,986,561 1 Number and distribution to senior executives: 2008: 12 GEB members in office on 31 December. 2007: eight GEB members in office on 31 December. 2 Number and distribution of senior executives: 2008: includes four months in office as a GEB member for Peter Kurer, eight months in office for Marco Suter and 10 months for Joe Scoby. 2007: includes nine months in office for Huw Jenkins and Clive Standish and six months for Peter Wuffli. n o i t a m r o f n i l a i c n a n i F 383 Financial information UBS AG (Parent Bank) Share and option ownership of members of the BoD at 31 December 2007/2008 Name, function 1 Peter Kurer, Chairman For the year ended 2008 Number of shares held 416,088 Voting rights in % 0.025 Number of options held 372,995 Potentially conferred voting rights in % 2 0.022 2007 292,762 0.026 350,000 0.031 Type and quantity of options 3 85 256 95 913 95 913 95 913 xxx: xxxv: xli: xlv: xxx: xxxv: xli: xlv: 80 000 90 000 90 000 90 000 Sergio Marchionne, senior independent director, vice chairman Ernesto Bertarelli, member Sally Bott, member Rainer-Marc Frey, member Bruno Gehrig, member Gabrielle Kaufmann-Kohler, member Helmut Panke, member William G. Parrett, member David Sidwell, member Peter R. Voser, member Joerg Wolle, member 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 87,926 45,800 89,434 48,411 1 0 3,000 18,713 3,303 31,971 13,206 4,000 1 30,823 11,580 41,509 7,709 0.005 0.004 0.005 0.004 0.000 0.000 0.000 0.001 0.000 0.002 0.001 0.000 0.000 0.002 0.001 0.002 0.001 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 1 This table includes vested, unvested, blocked and unblocked shares and options held by members of the BoD including related parties. 2 No conversion rights are outstanding. 3 Refer to “Note 31 Equity participation and other compensation plans” in the financial statements of this report for more information. 384 Compensation paid to former members of the BoD and GEB1 CHF, except where indicated a Name, function Georges Blum, former member of the BoD (Swiss Bank Corporation) Franz Galliker, former member of the BoD (Swiss Bank Corporation) Walter G. Frehner, former member of the BoD (Swiss Bank Corporation) Hans (Liliane) Strasser, former member of the BoD (Swiss Bank Corporation) Robert Studer, former member of the BoD (Union Bank of Switzerland) Alberto Togni, former member of the BoD (UBS) Philippe de Weck, former member of the BoD (Union Bank of Switzerland) Aggregate of all former members of the GEB 2 Aggregate of all former members of the BoD and GEB For the year ended Compensation 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 Benefits in kind Total 101,579 101,579 90,803 69,596 62,174 74,663 73,061 32,673 42,311 126,208 260,162 427,949 502,478 109,703 129,701 171,180 257,791 90,803 69,596 62,174 74,663 73,061 32,673 42,311 126,208 260,162 746,410 820,879 109,703 129,701 171,180 257,791 318,461 318,401 0 0 318,461 318,401 1,113,551 1,418,481 1,432,012 1,736,882 1 Compensation or remuneration that is connected with the former members’ activity on the BoD or GEB, or that is not at market conditions. 2 Includes two former GEB members. n o i t a m r o f n i l a i c n a n i F 385 Financial information UBS AG (Parent Bank) Share and option ownership of members of the GEB at 31 December 2007/2008 Name, function 1 Marcel Rohner, Group Chief Executive Officer For the year ended 2008 Number of shares held 711,366 Voting rights in % 0.042 Number of options held 1,055,043 Potentially conferred voting rights in % 2 0.063 2007 501,846 0.044 990,000 0.088 John Cryan, Group Chief Financial Officer 2008 235,929 0.014 382,673 0.023 Markus U. Diethelm, Group General Counsel John A. Fraser, Chairman and CEO Global Asset Management 2007 2008 2007 2008 112,245 0.007 0 583,812 0.035 1,144,808 0.000 0.068 2007 461,764 0.041 1,074,232 0.095 Marten Hoekstra, Deputy CEO Global Wealth Management & Business Banking and Head Wealth Management US 2008 245,397 0.015 684,168 0.041 Type and quantity of options 3 31,971 213,140 277,082 319,710 213,140 xxv: xxx: xxxv: xli: xlv: xxv: xxx: xxxv: xli: xlv: v: vi: vii: xii: xiii: xiv: xvii: xviii: xix: xxi: xxii: xxiii: xxvii: xxviii: xxix: xxxii: xxxiii: xxxiv: xxxviii: xxxix: xl: xlii: xliii: xliv: xlvi : i: viii: xv: xx: xxxi: xxxvi: xli: xlv: i: viii: xv: xx: xxxi: xxxvi: xli: xlv: ii: iii: iv: ix: x: xi: xxvi: xxxi: xxxvi: xli: xlv: xlvii: 30,000 200,000 260,000 300,000 200,000 21,362 20,731 20,725 5,454 5,294 5,292 23,626 23,620 23,612 5,526 5,524 5,524 17,072 17,068 17,063 14,210 14,210 14,207 5,330 5,328 5,326 17,762 17,762 17,760 53,285 0 56,013 76,380 127,884 127,884 170,512 202,483 213,140 170,512 52,560 71,672 120,000 120,000 160,000 190,000 200,000 160,000 8,679 8,421 8,421 8,823 12,825 8,561 42,628 53,285 53,285 85,256 154,931 239,053 Jerker Johansson, Chairman and CEO Investment Bank 2007 2008 2007 521,544 0.031 753,410 0.045 xlviii: xlix: 745,990 7,420 1 This table includes vested and unvested shares and options held by members of the GEB including related parties. 2 No conversion rights are outstanding. 3 Refer to “Note 31 Equity participation and other compensation plans” in the financial statements of this report for more information. 386 Share and option ownership of members of the GEB on 31 December 2007/2008 (continued) Name, function 1 Philip J. Lofts, Group Chief Risk Officer For the year ended 2008 Number of shares held 186,434 Voting rights in % 0.011 Number of options held 577,723 Potentially conferred voting rights in % 2 0.034 Walter Stuerzinger, Chief Operating Officer, Corporate Center 2007 2008 296,886 0.018 372,995 0.022 2007 209,442 0.019 350,000 0.031 Rory Tapner, Chairman and CEO Asia Pacific 2008 827,809 0.049 1,379,533 0.082 Raoul Weil, Chairman and CEO Global Wealth Management & Business Banking, relinquished his duties on an interim basis Alexander Wilmot-Sitwell, Chairman and CEO, UBS Group EMEA and Joint Global Head IB Department Robert Wolf, Chairman and CEO, UBS Group Americas / President Investment Bank 2007 514,365 0.046 1,294,486 0.115 2008 315,698 0.019 432,409 0.026 2007 212,934 0.019 405,752 0.036 2008 304,655 0.018 353,807 0.021 827,307 0.049 948,473 0.056 2007 2008 2007 Type and quantity of options 3 v: vi: vii: xii: xiii: xiv: xvii: xviii: xix: xxi: xxii: xxiii: xxvii: xxviii: xxix: xxxv: xli: xlv: xlvii: xvi: xxx: xxxv: xli: xlv: xvi: xxx: xxxv: xli: xlv: vii: xv: xxiv: xxx: xxxv: xli: xlv: vii: xv: xxiv: xxx: xxxv: xli: xlv: xv: xxxv: xli: xlv: xv: xxxv: xli: xlv: xxxiv: xxxvii: xxxviii: xxxix: xl: xlv: xlvii: xx: xxxi: xxxvi: xli: xlv: xlvii: 11,445 11,104 11,098 1,240 5,464 1,199 9,985 9,980 9,974 1,833 1,830 1,830 35,524 35,524 35,521 117,090 117,227 85,256 74,599 31,971 63,942 85,256 95,913 95,913 30,000 60,000 80,000 90,000 90,000 281,862 213,140 213,140 170,512 159,855 170,512 170,512 264,486 200,000 200,000 160,000 150,000 160,000 160,000 53,285 102,281 127,884 148,959 50,000 95,976 120,000 139,776 53,282 2,130 35,524 35,524 35,521 106,570 85,256 287,739 213,140 127,884 106,570 106,570 106,570 1 This table includes vested and unvested shares and options held by members of the GEB including related parties. 2 No conversion rights are outstanding. 3 Refer to “Note 31 Equity participation and other compensation plans” in the financial statements of this report for more information. 387 n o i t a m r o f n i l a i c n a n i F Financial information UBS AG (Parent Bank) Vested and unvested options held by independent members of the BoD and by members of the GEB on 31 December 2007 / 2008 Type Number of options Year of grant Vesting date Expiry date Subscription ratio 56,013 8,679 8,421 8,421 32,807 31,835 313,685 76,380 8,823 12,825 8,561 6,694 10,758 6,491 394,309 31,971 33,611 33,600 33,586 415,623 7,359 7,354 7,354 213,140 31,971 42,628 52,596 52,592 52,584 532,850 436,937 14,210 14,210 67,489 837,477 383,652 2,130 40,854 40,852 40,847 1,332,125 17,762 17,762 17,760 1,348,276 53,285 505,478 745,990 7,420 2001 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 2003 2003 2003 2003 2003 2003 2003 2003 2003 2003 2004 2004 2004 2004 2004 2005 2005 2005 2005 2005 2005 2006 2006 2006 2006 2007 2007 2007 2007 2008 2008 2008 2008 20.02.2004 31.01.2002 31.01.2004 31.01.2005 31.01.2003 31.01.2004 31.01.2005 31.01.2005 28.02.2002 29.02.2004 28.02.2005 28.02.2003 28.02.2004 28.02.2005 28.06.2005 28.06.2005 01.03.2004 01.03.2005 01.03.2006 31.01.2006 01.03.2004 01.03.2005 01.03.2006 31.01.2006 31.01.2006 31.01.2006 01.03.2005 01.03.2006 01.03.2007 28.02.2007 01.03.2007 01.03.2006 01.03.2007 01.03.2008 01.03.2008 01.03.2008 04.03.2007 01.03.2007 01.03.2008 01.03.2009 01.03.2009 01.03.2008 01.03.2009 01.03.2010 01.03.2010 01.03.2011 01.03.2011 01.03.2011 01.03.2011 20.02.2009 31.07.2012 31.07.2012 31.07.2012 31.01.2012 31.01.2012 31.01.2012 31.01.2012 28.08.2012 28.08.2012 28.08.2012 28.02.2012 28.02.2012 28.02.2012 28.06.2012 28.12.2012 31.01.2013 31.01.2013 31.01.2013 31.01.2013 28.02.2013 28.02.2013 28.02.2013 31.01.2013 31.07.2013 31.07.2013 27.02.2014 27.02.2014 27.02.2014 27.02.2014 27.02.2014 28.02.2015 28.02.2015 28.02.2015 28.02.2015 28.02.2015 04.03.2015 28.02.2016 28.02.2016 28.02.2016 28.02.2016 28.02.2017 28.02.2017 28.02.2017 28.02.2017 28.02.2018 28.03.2018 07.04.2018 06.06.2018 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 1:1 i ii iii iv v vi vii viii ix x xi xii xiii xiv xv xvi xvii xviii xix xx xxi xxii xxiii xxiv xxv xxvi xxvii xxviii xxix xxx xxxi xxxii xxxiii xxxiv xxxv xxxvi xxxvii xxxviii xxxix xl xli xlii xliii xliv xlv xlvi xlvii xlviii xlix 388 Strike price CHF 46.92 USD 21.24 USD 21.24 USD 21.24 CHF 36.49 CHF 36.49 CHF 36.49 USD 21.24 USD 21.70 USD 21.70 USD 21.70 CHF 36.65 CHF 36.65 CHF 36.65 CHF 37.90 CHF 37.90 CHF 27.81 CHF 27.81 CHF 27.81 USD 22.53 CHF 26.39 CHF 26.39 CHF 26.39 CHF 30.50 CHF 30.50 USD 22.53 CHF 44.32 CHF 44.32 CHF 44.32 CHF 48.69 USD 38.13 CHF 47.58 CHF 47.58 CHF 47.58 CHF 52.32 USD 44.81 CHF 47.89 CHF 65.97 CHF 65.97 CHF 65.97 CHF 72.57 CHF 67.00 CHF 67.00 CHF 67.00 CHF 73.67 CHF 32.45 CHF 35.66 CHF 36.46 CHF 28.10 Loans granted to members of the BoD at 31 December 2007/2008 CHF, except where indicated a Name, function 1 Peter Kurer, Chairman 2 Sergio Marchionne, Senior Independent Director, Vice Chairman Ernesto Bertarelli, member Sally Bott, member Rainer-Marc Frey, member Bruno Gehrig, member 2 Gabrielle Kaufmann-Kohler, member Helmut Panke, member William G. Parrett, member 2 David Sidwell, member Peter R. Voser, member Joerg Wolle, member For the year ended 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 Secured loans 1,261,000 0 0 0 0 0 0 798,000 0 0 0 0 1,167,659 0 0 0 0 0 Aggregate of all members of the BoD 3,226,659 Other loans granted 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 No loans have been granted to related parties of the members of the BoD at conditions not customary in the market. 2 Secured loans granted prior to their election to the BoD. Loans granted to members of the GEB at 31 December 2007/2008 CHF, except where indicated a Name, function 1 Markus U. Diethelm, Group General Counsel Joe Scoby, Group Chief Risk Officer 3 Aggregate of all members of the GEB 4 Aggregate of all members of the GEB For the year ended 2008 2007 2008 2007 Secured loans 3,900,000 0 7,740,562 3,487,000 Other loans granted 2 0 3,145,796 0 3,145,796 Total 1,261,000 0 0 0 0 0 0 798,000 0 0 0 0 1,167,659 0 0 0 0 0 3,226,659 Total 3,900,000 3,145,796 7,740,562 6,632,796 1 No loans have been granted to related parties of the members of the GEB at conditions not customary in the market. 2 Guarantees. 3 Joe Scoby stepped down as Group Chief Risk Officer on 4 November 2008. 4 Including those members of the GEB who stepped down during 2008. n o i t a m r o f n i l a i c n a n i F 389 Financial information UBS AG (Parent Bank) 390 n o i t a m r o f n i l a i c n a n i F 391 Financial information UBS AG (Parent Bank) 392 Additional disclosure required under SEC regulations A – Introduction The following pages contain additional disclosures about UBS Group which are required under SEC regulations. UBS’s consolidated Financial Statements have been pre- pared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and are denominated in Swiss francs (CHF), the reporting currency of the Group. n o i t a m r o f n i l a i c n a n i F 393 Financial information Additional disclosure required under SEC regulations B – Selected financial data The tables below set forth, for the periods and dates indicated, information concerning the noon buying rate for the Swiss franc, expressed in United States dollars, or USD, per one Swiss franc. The noon buying rate is the rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York. On 27 February 2009 the noon buying rate was 0.8568 USD per 1 CHF. Year ended 31 December 2004 2005 2006 2007 2008 Month September 2008 October 2008 November 2008 December 2008 January 2009 February 2009 1 The average of the noon buying rates on the last business day of each full month during the relevant period. Average rate 1 (USD per 1 CHF) At period end 0.8059 0.8039 0.8034 0.8381 0.9298 0.8712 0.7606 0.8200 0.8827 0.9369 High 0.8843 0.8721 0.8396 0.9087 1.0142 High 0.9248 0.8921 0.8616 0.9602 0.9359 0.8757 Low 0.7601 0.7544 0.7575 0.7978 0.8171 Low 0.8776 0.8570 0.8172 0.8171 0.8599 0.8465 394 Key figures CHF million, except where indicated 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 For the year ended Balance sheet data Total assets Equity attributable to UBS shareholders Average equity to average assets (%) Market capitalization Shares Registered ordinary shares Treasury shares BIS capital ratios Tier 1 (%) Total BIS (%) Risk-weighted assets Invested assets (CHF billion) Personnel (full-time equivalents) Switzerland United Kingdom Rest of Europe Middle East / Africa United States Rest of Americas Asia Pacific Total Long-term ratings 2 Fitch, London Moody’s, New York Standard & Poor’s, New York 2,014,815 2,274,891 2,348,733 2,001,099 1,703,647 32,531 1.5 43,519 36,875 1.8 108,654 51,037 2.0 154,222 45,633 1.9 131,949 35,161 1.9 103,638 2,932,580,549 2,073,547,344 2,105,273,286 2,177,265,044 2,253,716,354 61,903,121 158,105,524 164,475,699 208,519,748 249,326,620 11.0 15.0 302,273 2,174 26,406 7,071 4,817 145 27,362 1,984 9,998 77,783 A+ Aa2 A+ 9.1 1 12.2 1 374,421 1 3,189 27,884 8,813 4,776 139 29,921 2,054 9,973 83,560 AA Aaa AA 12.2 1 15.0 1 344,015 1 2,989 27,022 8,243 4,338 102 29,076 1,743 7,616 78,140 AA+ Aa2 AA+ 13.3 1 14.5 1 312,532 1 2,652 26,029 7,135 3,759 112 25,999 1,137 5,398 69,569 AA+ Aa2 AA+ 12.3 1 14.1 1 266,955 1 2,217 25,990 7,180 3,461 107 25,180 1,051 4,438 67,407 AA+ Aa2 AA+ 1 The calculation prior to 2008 is based on the Basel I approach. 2 Refer to the “Credit risk” section of this report for information about the nature of these ratings. n o i t a m r o f n i l a i c n a n i F 395 Financial information Additional disclosure required under SEC regulations Income statement data CHF million, except where indicated 31.12.08 Interest income Interest expense Net interest income Credit loss (expense) / recovery Net interest income after credit loss (expense) / recovery Net fee and commission income Net trading income Other income Total operating income Total operating expenses Operating profit from continuing operations before tax Tax expense Net profit from continuing operations Net profit from discontinued operations Net profit Net profit attributable to minority interests Net profit attributable to UBS shareholders Cost / income ratio (%) 1 Per share data (CHF) Basic earnings per share 2 Diluted earnings per share 2 Operating profit before tax per share Cash dividends declared per share (CHF) 3,4 Cash dividend declared per share (USD) 3,4 Dividend payout ratio (%) 3,4 Rates of return (%) Return on equity attributable to UBS shareholders 5 Return on average equity Return on average assets 65,679 (59,687) 5,992 (2,996) 2,996 22,929 (25,820) 692 796 28,555 (27,758) (6,837) (20,922) 198 (20,724) 568 (21,292) 753.0 (7.69) (7.69) (10.02) N/A N/A N/A (58.7) (60.6) (0.9) For the year ended 31.12.07 109,112 (103,775) 31.12.06 87,401 (80,880) 31.12.05 59,286 (49,758) 5,337 (238) 5,099 30,634 (8,353) 4,341 31,721 35,463 (3,742) 1,369 (5,111) 403 (4,708) 539 (5,247) 111.0 (2.42) (2.43) (1.73) N/A N/A N/A (10.9) (10.6) (0.2) 6,521 156 6,677 25,456 13,743 1,608 47,484 33,365 14,119 2,998 11,121 899 12,020 493 11,527 70.5 5.19 4.99 6.36 2.20 1.83 42.4 25.7 24.0 0.5 9,528 375 9,903 21,184 8,248 1,135 40,470 28,533 11,937 2,270 9,667 4,526 14,193 661 13,532 71.2 5.98 5.74 5.27 1.60 1.26 26.8 36.7 34.4 0.7 31.12.04 39,228 (27,484) 11,744 241 11,985 18,310 5,098 875 36,268 26,840 9,428 2,073 7,355 629 7,984 454 7,530 74.5 3.25 3.10 4.07 1.50 1.27 46.2 23.1 21.3 0.4 1 Operating expenses / operating income before credit loss expense. 2 For EPS calculation, refer to Note 8 in the Financial Statements. 3 Additionally, in July 2006, a par value reduction of CHF 0.30 (USD 0.24) per share was distributed. Dividends are normally declared and paid in the year subsequent to the reporting period. 4 For the business year 2007 a stock dividend was distributed for which 98,698,754 new shares were issued on 19 May 2008 to UBS shareholders with an exchange ratio of 20:1. 5 Net profit attributable to UBS shareholders / average equity attributable to UBS sharehold- ers less distributions. 396 Balance sheet data CHF million Assets Total assets Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Loans Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Due to customers Debt issued Equity attributable to UBS shareholders 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 For the year ended 2,014,815 2,274,891 2,348,733 2,001,099 1,703,647 64,451 122,897 224,648 271,838 40,216 854,100 340,308 125,628 14,063 102,561 62,431 851,864 101,546 474,774 197,254 32,531 60,907 207,063 376,928 660,182 114,190 428,217 335,864 145,762 31,621 305,887 164,788 443,539 191,853 641,892 222,077 36,875 50,426 351,590 405,834 648,346 230,168 292,975 297,842 203,689 63,088 545,480 204,773 297,063 145,687 555,886 190,143 51,037 33,644 288,435 404,432 499,297 154,759 273,889 279,910 124,328 59,938 478,508 188,631 277,770 117,401 466,907 160,710 45,633 35,419 210,606 357,164 389,487 159,115 248,664 241,803 120,026 51,301 422,587 171,033 267,799 65,756 386,320 117,856 35,161 Ratio of earnings to fixed charges The following table sets forth UBS’s ratio of earnings to fixed charges on an IFRS basis for the periods indicated. The ratios are calculated based on earnings from continuing operations. Ratios of earnings to combined fixed charges and preferred stock dividend requirements are not presented as there were no preferred share dividends in any of the periods indicated. 31.12.08 0.53 31.12.07 0.96 31.12.06 1.17 31.12.05 1.23 31.12.04 1.32 For the year ended n o i t a m r o f n i l a i c n a n i F 397 Financial information Additional disclosure required under SEC regulations C – Information on the company Property, plant and equipment At 31 December 2008, UBS operated about 1,166 business and banking locations worldwide, of which about 36% were in Switzerland, 47% in the Americas, 12% in the rest of Europe, Middle East and Africa and 4% in Asia-Pacific. 36% of the business and banking locations in Switzerland were owned directly by UBS, with the remainder, along with most of UBS’s offices outside Switzerland, being held under com- mercial leases. These premises are subject to continuous maintenance and upgrading and are considered suitable and adequate for current and anticipated operations. 398 D – Information required by industry guide 3 Selected statistical information The tables below set forth selected statistical information regarding the Group’s banking operations extracted from the Financial Statements. Unless otherwise indicated, aver- age balances for the years ended 31 December 2008, 31 De- cember 2007 and 31 December 2006 are calculated from monthly data. The distinction between domestic and foreign is generally based on the booking location. For loans, this method is not significantly different from an analysis based on the domicile of the borrower. Average balances and interest rates The following table sets forth average interest-earning assets and average interest-bearing liabilities, along with the average rates, for the years ended 31 December 2008, 2007 and 2006. Average balance 31.12.08 Interest Average rate (%) Average balance 31.12.07 Interest Average rate (%) Average balance 31.12.06 Interest Average rate (%) CHF million, except where indicated Assets Due from banks Domestic Foreign Cash collateral on securities borrowed and reverse repurchase agreements Domestic Foreign Trading portfolio assets Domestic Foreign taxable Foreign non-taxable Foreign total Financial assets designated at fair value Domestic Foreign Loans Domestic Foreign 7,243 58,287 421 1,559 31,642 669,010 1,208 21,313 15,104 520 522,804 21,494 8,070 383 530,874 21,877 945 11,024 0 404 188,950 147,034 6,840 8,304 Financial investments available-for-sale Domestic Foreign taxable Foreign non-taxable Foreign total 1,599 3,370 0 3,370 Total interest-earning assets 1,665,082 72 73 73 62,591 3,088 Net interest on swaps Interest income and average interest-earning assets Non-interest-earning assets Positive replacement values Fixed assets Other Total average assets 5.8 2.7 3.8 3.2 3.4 4.1 4.7 4.1 3.7 3.6 5.6 4.5 2.2 2.2 3.8 11,784 46,049 664 2,344 31,473 977,302 11,866 861,923 5,754 1,693 46,581 696 38,206 199 867,677 38,405 588 9,114 187,073 146,040 3,930 2,934 0 2,934 0 298 6,565 9,359 66 110 110 2,295,830 106,781 2,331 5.6 5.1 5.4 4.8 5.9 4.4 3.5 4.4 3.3 3.5 6.4 1.7 3.7 3.7 4.7 10,800 29,814 587 1,490 27,147 926,575 17,976 707,432 4,438 1,333 38,393 651 31,433 127 711,870 31,560 42 2,325 0 70 181,186 105,362 5,784 6,284 4,126 3,171 0 3,171 2,020,394 28 100 0 100 86,280 1,121 5.4 5.0 4.9 4.1 3.6 4.4 2.9 4.4 3.0 3.2 5.9 0.7 3.2 3.2 4.3 1,665,082 65,679 3.9 2,295,830 109,112 4.8 2,020,394 87,401 4.3 600,073 7,091 82,357 2,354,603 373,229 7,090 82,739 2,758,888 278,733 7,445 68,894 2,375,466 n o i t a m r o f n i l a i c n a n i F 399 Financial information Additional disclosure required under SEC regulations Average balances and interest rates (continued) CHF million, except where indicated Liabilities and equity Due to banks Domestic Foreign Cash collateral on securities lent and repurchase agreements Domestic Foreign Trading portfolio liabilities Domestic Foreign Financial liabilities designated at fair value Domestic Foreign Due to customers Domestic demand deposits Domestic savings deposits Domestic time deposits Domestic total Foreign 1 Short-term debt Domestic Foreign Long-term debt Domestic Foreign 51,027 88,798 1,503 3,423 31,269 397,453 1,026 15,097 5,525 132,901 1,444 151,324 56,730 68,213 35,575 160,518 401,421 1,735 134,920 5,766 74,531 256 8,906 69 7,229 495 604 1,081 2,180 11,044 63 6,216 148 2,527 Total interest-bearing liabilities 1,638,632 59,687 Non-interest-bearing liabilities Negative replacement values Other Total liabilities Total equity Total average liabilities and equity Net interest income Net yield on interest-earning assets 605,990 67,066 2,311,688 42,915 2,354,603 1 Due to customers in foreign offices consists mainly of time deposits. Average balance 31.12.08 Interest Average rate (%) Average balance 31.12.07 Interest Average rate (%) Average balance 31.12.06 Interest Average rate (%) 2.9 3.9 3.3 3.8 4.6 6.7 4.8 4.8 0.9 0.9 3.0 1.4 2.8 3.6 4.6 2.6 3.4 3.6 60,858 146,286 2,477 8,008 47,041 752,616 1,902 38,680 5,561 328 214,326 15,484 1,503 173,162 64,568 78,775 41,056 184,399 426,130 2,228 144,546 4,235 70,079 79 7,580 736 502 1,206 2,444 16,388 98 8,643 115 1,549 2,232,970 103,775 382,115 88,191 2,703,276 55,612 2,758,888 4.1 5.5 4.0 5.1 5.9 7.2 5.3 4.4 1.1 0.6 2.9 1.3 3.8 4.4 6.0 2.7 2.2 4.6 46,544 108,885 1,583 5,261 46,224 751,617 1,589 32,432 4,408 283 202,263 14,250 58 4,699 534 392 639 1,565 11,500 115 5,934 82 1,529 80,880 1,864 127,458 70,981 86,631 28,876 186,488 314,788 1,973 110,418 3,957 57,899 1,964,786 278,903 77,304 2,320,993 54,473 2,375,466 3.4 4.8 3.4 4.3 6.4 7.0 3.1 3.7 0.8 0.5 2.2 0.8 3.7 5.8 5.4 2.1 2.6 4.1 5,992 5,337 6,521 0.4 0.2 0.3 The percentage of total average interest-earning assets at- tributable to foreign activities was 85% for 2008 (89% for 2007 and 88% for 2006). The percentage of total average interest-bearing liabilities attributable to foreign activities was 84% for 2008 (86% for 2007 and 85% for 2006). All assets and liabilities are translated into CHF at uniform month-end rates. Interest income and expense are translat- ed at monthly average rates. Average rates earned and paid on assets and liabilities can change from period to period based on the changes in interest rates in general, but are also affected by changes in the cur- rency mix included in the assets and liabilities. This is espe- cially true for foreign assets and liabilities. Tax-exempt income is not recorded on a tax-equivalent basis. For all three years presented, tax-exempt income is considered to be insignificant and the impact from such income is therefore negligible. 400 Analysis of changes in interest income and expense The following tables allocate, by categories of interest-earn- ing assets and interest-bearing liabilities, the changes in in- terest income and expense due to changes in volume and interest rates for the year ended 31 December 2008 com- pared with the year ended 31 December 2007, and for the year ended 31 December 2007 compared with the year end- ed 31 December 2006. Volume and rate variances have been calculated on movements in average balances and changes in interest rates. Changes due to a combination of volume and rates have been allocated proportionally. Refer to the appropriate section of Industry Guide 3 for a discussion of the treatment of impaired and non-performing loans. CHF million Interest income from interest-earning assets Due from banks Domestic Foreign Cash collateral on securities borrowed and reverse repurchase agreements Domestic Foreign Trading portfolio assets Domestic Foreign taxable Foreign non-taxable Foreign total Financial assets designated at fair value Domestic Foreign Loans Domestic Foreign Financial investments available-for-sale Domestic Foreign taxable Foreign non-taxable Foreign total Interest income Domestic Foreign Total interest income from interest-earning assets Net interest on swaps Total interest income 2008 compared with 2007 2007 compared with 2006 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change (254) 624 11 (1,409) (243) (785) 9 (494) (485) (14,798) (10,470) (25,268) 191 (367) (176) (14,921) (1,791) (16,712) 81 103 184 (14,840) (1,688) (16,528) 0 63 66 64 (40) 16 0 16 (28) (28,871) (28,899) 0 43 209 0 106 275 (1,119) (1,055) 46 (53) 0 (53) (595) (14,696) (15,291) 6 (37) 0 (37) (623) (43,567) (44,190) 757 (43,433) 53 812 212 2,080 (220) 6,798 38 6,836 0 204 188 2,441 (1) (8) 0 (8) 24 42 148 6,108 265 (25) 34 9 0 24 593 634 39 18 0 18 232 12,365 12,597 1,069 6,835 7,904 77 854 360 8,188 45 6,773 72 6,845 0 228 781 3,075 38 10 0 10 1,301 19,200 20,501 1,210 21,711 401 n o i t a m r o f n i l a i c n a n i F Financial information Additional disclosure required under SEC regulations Analysis of changes in interest income and expense (continued) 2008 compared with 2007 2007 compared with 2006 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change (403) (3,162) (571) (1,423) (974) (4,585) 487 1,795 (631) (245) (876) (18,113) (5,470) (23,583) (2) (5,863) (3) (961) (86) (63) (159) (308) (939) (22) (578) 41 98 (70) (715) (7) 610 (155) 165 34 44 (72) (6,578) (10) (351) (241) 102 (125) (264) (13) (35) (1,849) (2,427) (8) 880 33 978 (1,328) (29,518) (30,846) (870) (12,372) (13,242) (2,198) (41,890) (44,088) (4,405) (5,344) 4,120 407 952 285 6,205 (29) 390 32 1,190 253 149 299 701 768 (32) 866 27 (297) 1,391 10,074 11,465 894 2,747 313 6,248 45 1,234 21 2,881 202 110 567 879 4,888 (17) 2,709 33 20 2,168 20,727 22,895 28 43 74 844 (11) 1,691 (51) (39) 268 178 15 1,843 6 317 777 10,653 11,430 CHF million Interest expense on interest-bearing liabilities Due to banks Domestic Foreign Cash collateral on securities lent and repurchase agreements Domestic Foreign Trading portfolio liabilities Domestic Foreign Financial liabilities designated at fair value Domestic Foreign Due to customers Domestic demand deposits Domestic savings deposits Domestic time deposits Domestic total Foreign Short-term debt Domestic Foreign Long-term debt Domestic Foreign Interest expense Domestic Foreign Total interest expense 402 Deposits The following table analyzes average deposits and the average rates on each deposit category listed below for the years ended 31 December 2008, 2007 and 2006. The geographic allocation is based on the location of the office or branch where the deposit is made. Deposits by foreign depositors in domestic offices were CHF 51,228 million CHF 81,243 million and CHF 78,234 million at 31 December 2008, 31 December 2007 and 31 December 2006, respectively. CHF million, except where indicated 31.12.08 31.12.07 31.12.06 Average deposit Average rate (%) Average deposit Average rate (%) Average deposit Average rate (%) Banks Domestic offices Demand deposits Time deposits Total domestic offices Foreign offices Interest-bearing deposits 1 Total due to banks Customer accounts Domestic offices Demand deposits Savings deposits Time deposits Total domestic offices Foreign offices Interest-bearing deposits 1 Total due to customers 1 Mainly time deposits. 2,341 4,902 7,243 58,287 65,530 56,730 68,213 35,575 160,518 401,421 561,939 0.5 3.8 2.7 3.9 3.7 0.9 0.9 3.0 1.4 2.8 2.4 2,474 9,310 11,784 46,049 57,833 64,568 78,775 41,056 184,399 426,130 610,529 0.6 5.1 4.2 5.5 5.2 1.1 0.6 2.9 1.3 3.8 3.1 2,024 8,776 10,800 29,814 40,614 70,981 86,631 28,876 186,488 314,788 501,276 0.2 4.5 3.7 4.8 4.5 0.8 0.5 2.2 0.8 3.7 2.6 At 31 December 2008, the maturity of time deposits exceeding CHF 150,000, or an equivalent amount in other currencies, was as follows: CHF million Within 3 months 3 to 6 months 6 to 12 months 1 to 5 years Over 5 years Total time deposits Domestic 38,052 2,216 1,495 648 231 Foreign 186,590 9,387 4,617 1,532 235 42,642 202,361 n o i t a m r o f n i l a i c n a n i F 403 Financial information Additional disclosure required under SEC regulations Short-term borrowings The following table presents the period-end, average and maximum month-end outstanding amounts for short-term bor- rowings, along with the average rates and period-end rates at and for the years ended 31 December 2008, 2007 and 2006. CHF million, except where indicated 31.12.08 31.12.07 31.12.06 31.12.08 31.12.07 31.12.06 Money market paper issued Due to banks Repurchase agreements 1 31.12.07 31.12.06 31.12.08 Period-end balance Average balance Maximum month-end balance Average interest rate during the period (%) Average interest rate at period-end (%) 111,619 136,655 170,503 4.6 2.9 152,256 146,774 167,637 6.0 6.1 119,584 112,391 123,108 5.4 4.0 61,155 74,295 87,233 3.5 2.3 84,826 153,231 140,039 149,311 175,233 114,815 404,512 153,231 591,005 5.1 4.5 4.4 4.1 3.5 1.4 487,455 739,138 848,401 5.0 4.9 754,623 717,542 777,010 4.4 5.0 1 For the purpose of this disclosure, balances are presented on a gross basis. 404 Contractual maturities of investments in debt instruments available-for-sale 1,2 CHF million, except percentages 31 December 2008 3 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt instruments Total fair value CHF million, except percentages 31 December 2007 3 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt instruments Total fair value CHF million, except percentages 31 December 2006 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and official institutions Corporate debt securities Mortgage-backed securities Other debt instruments Total fair value Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 0.00 0.00 0.00 1.31 23.35 0.00 9.06 0 0 0 33 3 0 188 224 3.46 0.00 0.00 0.00 3.38 0.00 13.47 2 0 0 0 88 0 3 93 0 0 0 33 38 42 0 113 0.00 0.00 0.00 2.81 3.12 4.00 0.00 1 0 0 34 12 455 37 539 4.00 0.00 0.00 5.22 1.74 5.28 7.42 Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 0 0 0 50 50 0 14 114 0.00 0.00 0.00 1.87 5.66 0.00 4.20 2.02 0.00 0.00 2.54 4.11 0.00 12.41 2 0 0 2 44 0 216 264 0.00 0.00 0.00 4.48 0.00 4.48 0.00 0 0 0 75 0 3 0 78 1 0 0 0 0 561 0 562 4.00 0.00 0.00 0.00 0.00 5.28 0.00 Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 2.22 0.00 0.00 1.48 7.00 0.00 0.00 2 0 0 38 26 0 0 66 0 0 0 2 0 0 233 235 0.00 0.00 0.00 1.89 0.00 0.00 9.28 0.00 0.00 0.00 4.47 0.00 4.48 0.00 0 0 0 57 2 10 0 69 1 0 0 0 0 150 0 151 4.00 0.00 0.00 0.00 0.00 5.10 0.00 1 Money market paper has a contractual maturity of less than one year and is not included in the table. 2 Average yields are calculated on an amortized cost basis. 3 Debt instruments available-for-sale recognized on UBS’s balance sheet of CHF 1,402 million CHF 1,034 million for 2008 and 2007, respectively and disclosed in Note 13 include CHF 433 million and CHF 16 million of instruments without fixed maturity for 2008 and 2007, respectively. Such instruments are not reflected in the table. n o i t a m r o f n i l a i c n a n i F 405 Financial information Additional disclosure required under SEC regulations Due from banks and loans (gross) The Group’s lending portfolio is widely diversified across in- dustry sectors with no significant concentrations of credit risk. CHF 152.5 billion (37% of the total) consists of loans to thousands of private households, predominantly in Switzer- land, and mostly secured by mortgages, financial collateral or other assets. Exposure to Banks and Financial institutions amounted to CHF 174.3 billion (42% of the total). This in- cludes cash posted as collateral by UBS against negative re- placement values on derivatives or other positions, which, from a risk perspective, is not considered lending but is a key component of the measurement of counterparty risk taken in connection with the underlying products. Exposure to banks includes money market deposits with highly rated in- stitutions. Excluding Banks and Financial institutions, the largest industry sector exposure is CHF 16.3 billion (4% of the total) to Real estate and rentals. For further discussion of the loan portfolio, see the Risk and treasury management section on Credit risk. The following table illustrates the diversification of the loan portfolio among industry sectors at 31 December 2008, 2007, 2006, 2005 and 2004. The industry categories pre- sented are consistent with the classification of loans for re- porting to the Swiss Financial Market Supervisory Authority (FINMA) and Swiss National Bank. CHF million Domestic Banks 1 Construction Financial institutions Hotels and restaurants Manufacturing 2 Private households Public authorities Real estate and rentals Retail and wholesale Services 3 Other 4 Total domestic Foreign Banks 1 Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 5 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 6 Total foreign Total gross 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 1,734 1,377 8,113 1,811 4,020 119,285 4,042 12,097 4,818 6,172 3,329 1,237 1,393 5,525 1,824 3,887 121,536 4,734 11,691 5,138 6,170 3,300 561 1,535 5,542 1,957 3,643 117,852 4,972 11,356 4,569 6,758 4,345 1,407 1,816 4,213 2,044 4,134 111,549 5,494 11,792 4,808 8,088 3,119 1,406 1,943 4,332 2,269 5,485 105,160 5,460 11,466 4,908 9,110 591 166,798 166,435 163,090 158,464 152,130 63,708 2,816 448 2,995 100,779 5,026 4,394 33,242 11,094 4,240 2,515 9,816 3,894 1,073 246,040 412,838 60,333 635 624 1,888 96,370 4,678 4,509 42,828 4,172 5,056 2,239 9,294 1,752 1,105 50,124 1,321 522 951 67,676 3,006 3,177 35,031 2,175 4,360 1,815 16,436 1,528 564 32,287 2,716 295 1,637 62,344 3,784 3,431 38,283 1,686 2,707 1,257 5,593 1,419 272 34,269 366 122 745 45,095 2,758 1,695 30,237 1,228 940 1,102 8,002 762 318 235,483 401,918 188,686 351,776 157,711 316,175 127,639 279,769 1 Includes Due from banks and Loans from Industrial Holdings of CHF 27 million at 31 December 2007, CHF 93 million at 31 December 2006, CHF 728 million at 31 December 2005, CHF 909 million at 31 December 2004. 2 Includes chemicals, food and beverages. 3 Includes transportation, communication, health and social work, education and other social and personal service activities. 4 Includes mining and electricity, gas and water supply. 5 Includes food and beverages. 6 Includes hotels and restaurants. The table above also includes loans designated at fair value. 406 Due from banks and loans (gross) (continued) The following table analyzes the Group’s mortgage portfolio by geographic origin of the client and type of mortgage at 31 December 2008, 2007, 2006, 2005 and 2004. Mortgages are included in the industry categories mentioned on the previous page. CHF million Mortgages Domestic Foreign Total gross mortgages Mortgages Residential Commercial Total gross mortgages 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 134,700 8,381 143,081 121,811 21,270 143,081 135,341 8,152 143,493 122,435 21,058 143,493 134,468 10,069 144,537 124,548 19,989 144,537 130,880 15,619 146,499 127,990 18,509 146,499 124,496 12,185 136,681 117,731 18,950 136,681 Due from banks and loan maturities (gross) CHF million Domestic Banks Mortgages Other loans Total domestic Foreign Banks Mortgages Other loans Total foreign Total gross Within 1 year 1 to 5 years Over 5 years Total 1,733 52,324 23,538 77,595 60,703 5,533 116,217 182,453 260,048 1 60,308 5,224 65,533 1,671 2,249 13,112 17,032 82,565 22,068 1,530 23,598 365 599 40,511 41,475 65,073 1,734 134,700 30,292 166,726 62,739 8,381 169,840 1 240,960 407,686 1 Includes student loan auction rate securities (ARS) of CHF 8.4 billion and other debt instruments of CHF 17.1 billion reclassified from the category “held for trading” to “loans and receivables” and ARS acquired from clients of CHF 4.5 billion. At 31 December 2008, the total amount of Due from banks and Loans due after one year granted at fixed and floating rates are as follows: CHF million Fixed-rate loans Adjustable or floating-rate loans Total 1 to 5 years Over 5 years 79,225 3,340 82,565 33,479 31,594 65,073 Total 112,704 34,934 147,638 n o i t a m r o f n i l a i c n a n i F 407 Financial information Additional disclosure required under SEC regulations Impaired and non-performing loans A loan (included in Due from banks or Loans) is classified as non-performing: 1) when the payment of interest, principal or fees is overdue by more than 90 days and there is no firm evidence that they will be made good by later payments or the liquidation of collateral; 2) when insolvency proceedings have commenced; or 3) when obligations have been restructured on concessionary terms. CHF million 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 Gross interest income that would have been recorded on non-performing loans: Domestic Foreign Interest income included in Net profit for non-performing loans: Domestic Foreign 16 3 32 4 39 4 40 2 50 10 56 8 81 8 72 9 107 17 106 8 The table below provides an analysis of the Group’s non-performing loans. For further information see the Risk and treasury management section on Credit risk. CHF million Non-performing loans: Domestic Foreign Total non-performing loans UBS does not, as a matter of policy, typically restructure loans to accrue interest at rates different from the original contractual terms or reduce the principal amount of loans. For more information refer to the “Credit risk” section of this report. Instead, specific loan allowances are established as necessary. Unrecognized interest related to restructured loans was not material to the results of operations in 2008, 2007, 2006, 2005 or 2004. In addition to the non-performing loans shown above, the Group has CHF 4,442 million, CHF 911 million, CHF 710 million, CHF 1,071 million and CHF 1,144 million in “other impaired loans” for the years ended 31 December 2008, 2007, 2006, 2005 and 2004, respectively. 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 1,431 3,272 4,703 1,349 132 1,481 1,744 174 1,918 2,106 257 2,363 2,772 783 3,555 Other impaired loans are loans where the Group’s credit officers have expressed doubts as to the ability of the bor- rowers to repay the loans. For the years ended 31 December 2008, 2007, 2006, 2005 and 2004, they are loans not con- sidered “non-performing” in accordance with Swiss regula- tory guidelines. As of 31 December 2008, 31 December 2007, 31 December 2006, 31 December 2005 and 31 De- cember 2004, specific allowances of CHF 941 million, CHF 124 million, CHF 106 million, CHF 200 million, CHF 241 mil- lion, respectively, had been established against these loans. 408 Cross-border outstandings Cross-border outstandings consist of general banking prod- ucts such as loans and deposits with third parties, credit equivalents of over-the-counter (OTC) derivatives and securi- ties financing, and the market value of the inventory of debt securities. Outstandings are monitored and reported on an ongoing basis by the credit risk control organization with a dedicated country risk information system. With the excep- tion of the 33 most developed economies, these exposures are rigorously limited. The following analysis excludes Due from banks and Loans from Industrial Holdings. Claims that are secured by third-party guarantees are recorded against the guarantor’s country of domicile. Out- standings that are secured by collateral are recorded against the country where the asset could be liquidated. This follows the “Guidelines for the Management of Country Risk”, which are applicable to all banks that are supervised by the Swiss Financial Market Supervisory Authority (FINMA). The following tables list those countries for which cross- border outstandings exceeded 0.75% of total assets at 31 December 2008, 2007 and 2006. At 31 December 2008, there were no outstandings that exceeded 0.75% of total assets in any country currently facing liquidity problems that the Group expects would materially affect the country’s abil- ity to service its obligations. For more information on country exposure, see the Risk and treasury management section on Credit risk. CHF million United States Japan Germany France United Kingdom Luxembourg CHF million United States Japan Germany United Kingdom Cayman Islands France CHF million United States Japan United Kingdom Germany Banks Private Sector Public Sector Total % of total assets 31.12.08 13,869 2,093 19,098 11,469 9,599 2,883 Banks 13,110 1,761 21,384 6,624 173 10,620 Banks 7,692 2,283 11,149 15,240 71,584 13,159 10,418 7,048 8,608 17,586 14,234 38,922 6,010 6,807 2,625 0 31.12.07 99,687 54,174 35,526 25,324 20,832 20,469 4.9 2.7 1.8 1.3 1.0 1.0 Private Sector Public Sector Total % of total assets 192,049 12,883 12,354 14,647 27,715 7,075 16,545 36,717 2,249 8,552 74 4,605 31.12.06 221,704 51,361 35,988 29,823 27,963 22,300 9.8 2.3 1.6 1.3 1.2 1.0 Private Sector Public Sector Total % of total assets 208,200 8,263 16,098 8,080 22,574 30,158 559 1,574 238,466 40,704 27,806 24,894 10.2 1.7 1.2 1.1 n o i t a m r o f n i l a i c n a n i F 409 Financial information Additional disclosure required under SEC regulations Summary of movements in allowances and provisions for credit losses The following table provides an analysis of movements in allowances and provisions for credit losses. UBS writes off loans against allowances only on final settlement of bankruptcy proceedings, the sale of the underlying assets and / or in case of debt forgiveness. Under Swiss law, a creditor can continue to collect from a debtor who has emerged from bankruptcy, unless the debt has been forgiven through a formal agreement. CHF million Balance at beginning of year Domestic Write-offs Banks Construction Financial institutions Hotels and restaurants Manufacturing 1 Private households Public authorities Real estate and rentals Retail and wholesale Services 2 Other 3 Total domestic write-offs Foreign Write-offs Banks Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 4 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 5 Total foreign write-offs Total write-offs Recoveries Domestic Foreign Total recoveries Net write-offs Increase / (decrease) in credit loss allowance and provision Collective loan loss provisions Other adjustments 6 Balance at end of year Net foreign exchange Other adjustments Total adjustments 31.12.08 1,164 31.12.07 1,332 31.12.06 1,776 31.12.05 2,802 31.12.04 3,775 0 (6) (37) (3) (31) (112) 0 (10) (4) (7) 0 (210) (13) (1) 0 0 (623) (6) 0 (5) (2) 0 0 0 (7) (1) (658) (868) 43 1 44 (824) 3,007 (11) (266) 3,070 (43) (223) 7 (266) 0 (9) (8) (7) (45) (68) (1) (27) (62) (20) (21) 0 (14) (11) (16) (40) (89) 0 (44) (20) (47) (2) (268) (283) (1) 0 0 0 (15) (21) 0 (14) (2) 0 0 0 0 0 (53) (321) 52 3 55 (266) 242 (4) (140) 1,164 (9) (131) (140) (3) 0 0 0 0 (11) (1) (7) (58) 0 0 0 0 0 (80) (363) 51 11 62 (301) (108) (48) 13 1,332 10 3 13 0 (16) (14) (26) (39) (131) 0 (56) (25) (35) (4) (346) (164) 0 0 0 (50) (8) (23) (21) (22) (3) (9) 0 0 (5) (305) (651) 53 10 63 (588) (298) (76) (64) 1,776 50 (114) (64) 0 (49) (24) (101) (77) (208) 0 (109) (68) (83) (9) (728) (21) (1) (3) 0 (34) (23) (8) (8) (2) 0 0 (7) 0 (21) (128) (856) 54 5 59 (797) (216) (25) 65 2,802 2 63 65 1 Includes chemicals, food and beverages. 2 Includes transportation, communication, health and social work, education and other social and personal service activities. 3 Includes mining and electric- ity, gas and water supply. 4 Includes food and beverages. 5 Includes hotels and restaurants. 6 See the table below for details. 7 An allowance was utilized as a result of foreclosure of certain loans in return for underlying collateral received. 410 Allocation of the allowances and provisions for credit losses The following table provides an analysis of the allocation of the allowances and provisions for credit loss by industry sector and geographic location at 31 December 2008, 2007, 2006, 2005 and 2004. For a description of procedures with respect to allowances and provisions for credit losses, see the Risk and treasury management section on Credit risk. CHF million Domestic Banks Construction Financial institutions Hotels and restaurants Manufacturing 1 Private households Public authorities Real estate and rentals Retail and wholesale Services 2 Other 3 Total domestic Foreign Banks 4 Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 5 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 6 Total foreign Collective loan loss provisions 7 Total allowances and provisions for credit losses 8 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 16 39 18 8 71 121 1 50 262 78 92 756 6 960 8 2 542 25 4 233 19 208 80 19 185 0 2,291 23 3,070 10 43 52 10 113 190 1 57 247 112 76 911 18 1 1 3 112 20 0 15 20 8 4 4 1 12 219 34 1,164 10 72 61 27 155 187 3 99 311 113 107 10 91 75 49 174 262 8 168 330 196 61 10 112 82 98 224 333 9 250 363 222 188 1,145 1,424 1,891 20 4 2 8 9 37 0 26 21 4 4 7 1 6 35 5 2 16 8 57 1 30 72 3 1 27 0 8 149 38 1,332 265 86 1,775 246 4 1 15 140 112 14 48 66 5 95 32 1 (75) 704 207 2,802 1 Includes chemicals, food and beverages. 2 Includes transportation, communication, health and social work, education and other social and personal service activities. 3 Includes mining, electricity, gas and water supply. 4 Counterparty allowances and provisions only. Country provisions with banking counterparties amounting to CHF 0 million, CHF 0 million, CHF 0 million, CHF 37 million, and CHF 17 million are disclosed under Collective loan loss provisions for 2008, 2007, 2006, 2005 and 2004, respectively. 5 Includes food and beverages. 6 Includes hotels and restaurants. 7 The 2008, 2007, 2006, 2005 and 2004 amounts include CHF 0, CHF 0 million, CHF 0 million, CHF 48 million and CHF 161 million, respectively, of country provisions. 8 The 2008, 2007, 2006, 2005 and 2004 amounts include CHF 31 million, CHF 63 million, CHF 76 million, CHF 109 million, CHF 214 million, respectively, of provisions for unused commitments and contingent liabilities. n o i t a m r o f n i l a i c n a n i F 411 Financial information Additional disclosure required under SEC regulations Due from banks and loans by industry sector (gross) The following table presents the percentage of loans in each industry sector and geographic location to total loans. This table can be read in conjunction with the preceding table showing the breakdown of the allowances and provisions for credit losses by industry sectors to evaluate the credit risks in each of the categories. in % Domestic Banks 1 Construction Financial institutions Hotels and restaurants Manufacturing 2 Private households Public authorities Real estate and rentals Retail and wholesale Services 3 Other 4 Total domestic Foreign Banks 1 Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 5 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 6 Total foreign Total gross 31.12.08 31.12.07 31.12.06 31.12.05 31.12.04 0.4 0.3 2.0 0.4 1.0 28.9 1.0 2.9 1.2 1.5 0.8 40.4 15.4 0.7 0.1 0.7 24.4 1.2 1.1 8.1 2.7 1.0 0.6 2.4 0.9 0.3 0.3 0.3 1.4 0.5 1.0 30.2 1.2 2.9 1.3 1.5 0.8 41.4 15.0 0.2 0.2 0.5 24.0 1.2 1.1 10.7 1.0 1.3 0.6 2.3 0.4 0.1 0.2 0.4 1.6 0.6 1.0 33.5 1.4 3.2 1.3 1.9 1.3 46.4 14.2 0.4 0.1 0.3 19.2 0.9 0.9 10.0 0.6 1.2 0.5 4.7 0.4 0.2 0.4 0.6 1.3 0.6 1.3 35.3 1.7 3.7 1.5 2.6 1.1 50.1 10.2 0.9 0.1 0.5 19.7 1.2 1.1 12.1 0.5 0.9 0.4 1.8 0.4 0.1 0.5 0.7 1.5 0.8 2.0 37.6 2.0 4.1 1.7 3.3 0.2 54.4 12.3 0.1 0.0 0.3 16.1 1.0 0.6 10.8 0.4 0.3 0.4 2.9 0.3 0.1 59.6 100.0 58.6 100.0 53.6 100.0 49.9 100.0 45.6 100.0 1 Includes Due from banks and Loans from Industrial Holdings in the amount of CHF 0 for 2008, CHF 27 million for 2007, CHF 93 million for 2006, CHF 728 million for 2005 and CHF 909 million for 2004. 2 Includes chemicals, food and beverages. 3 Includes transportation, communication, health and social work, education and other social and personal service activities. 4 Includes mining and electricity, gas and water supply. 5 Includes food and beverages. 6 Includes hotels and restaurants. 412 Loss history statistics The following is a summary of the Group’s loan loss history (relating to Due from banks and Loans). The table below does not include loans designated at fair value. CHF million, except where indicated Gross loans 1 Impaired loans Non-performing loans Allowances and provisions for credit losses 2 Net write-offs Credit loss (expense) / recovery Ratios Impaired loans as a percentage of gross loans Non-performing loans as a percentage of gross loans Allowances and provisions for credit losses as a percentage of: Gross loans Impaired loans Non-performing loans Allocated allowances as a percentage of impaired loans 3 Allocated allowances as a percentage of non-performing loans 4 Net write-offs as a percentage of: Gross loans Average loans outstanding during the period Allowances and provisions for credit losses Allowance and provisions for credit losses as a multiple of net write-offs 31.12.08 407,685 9,145 4,703 3,070 824 (2,996) 31.12.07 397,802 2,392 1,481 1,164 266 (238) 31.12.06 349,524 2,628 1,918 1,332 301 156 2.2 1.2 0.8 33.6 65.3 31.8 41.8 0.2 0.2 26.8 3.73 0.6 0.4 0.3 48.7 78.6 41.7 58.9 0.1 0.0 22.9 4.38 0.8 0.5 0.4 50.7 69.4 46.3 58.0 0.1 0.1 22.6 4.43 31.12.05 315,210 3,434 2,363 1,776 588 375 1.1 0.7 0.6 51.7 75.2 46.4 59.0 0.2 0.1 33.1 3.02 31.12.04 279,769 4,699 3,555 2,802 797 241 1.7 1.3 1.0 59.6 78.8 51.6 61.4 0.3 0.2 28.4 3.52 1 Includes Due from banks and Loans from Industrial Holdings in the amount of CHF 0 for 2008, CHF 27 million for 2007, CHF 93 million for 2006, CHF 728 million for 2005 and CHF 909 million for 2004. 2 Includes Collective loan loss provisions. 3 Allowances relating to impaired loans only. 4 Allowances relating to non-performing loans only. n o i t a m r o f n i l a i c n a n i F 413 Cautionary Statement Regarding Forward-Looking Statements | This report contains statements that constitute “forward-looking statements”, including but not limited to statements relating to the anticipated effect of transactions described herein, risks arising from the current market crisis and other risks specific to UBS’s business, strategic initiatives, future business development and economic performance. While these forward-looking statements represent UBS’s judgments and expectations concerning the development of its business, a number of risks, uncertainties and other important factors could cause actual developments and results to differ materially from UBS’s expectations. These factors include, but are not limited to: (1) the extent and nature of future developments in the market segments that have been or may be affected by the current market crisis and their effect on UBS’s assets and exposures, including UBS’s remaining net and gross exposures related to the United States mortgage market; (2) developments affecting the availability of capital and funding to UBS and other financial institutions, including any changes in UBS’s credit spreads and ratings; (3) other market and macroeconomic developments, including movements in local and international securities markets, credit spreads, currency exchange rates and interest rates; (4) changes in internal risk control and limitations in the effectiveness of UBS’s internal processes for risk management, risk control, measurement and modeling, and of finan- cial models generally; (5) the possible consequences of efforts to enforce the US Internal Revenue Service’s “John Doe” summons and of pending or future inquiries concerning UBS’s cross-border banking businesses by tax or regulatory authorities in other jurisdictions; (6) the degree to which UBS is successful in implementing its remediation plans and strategic and organizational changes, including the recently announced cost and headcount reductions, and whether those plans and changes will have the effects an- ticipated; (7) changes in the financial position or creditworthiness of UBS’s customers, obligors and counterparties, and developments in the markets in which they operate, including possible failures resulting from the current market crisis and adverse economic environment; (8) management changes and changes to the internal or overall structure of UBS’s business divisions; (9) the occurrence of operational failures, such as fraud, unauthorized trading and systems failures; (10) legislative, governmental and regulatory developments, including the effect of more stringent capital requirements and of regulatory constraints on UBS’s activities; (11) changes in accounting standards or policies, and accounting determinations affecting the recognition of gain or loss, the valuation of goodwill and other assets or other matters; (12) changes in and the effect of com- petitive pressures, including the possible loss of key employees as a result of compensation issues or for other reasons; (13) technological developments; and (14) the impact of all such future developments on positions held by UBS, on its short-term and longer-term earnings, on the cost and availability of funding and on UBS’s capital ratios. In addition, these results could depend on other factors that we have previously indicated could adversely affect our business and financial performance which are contained in our past and future filings and reports, including those filed with the SEC. More detailed information about those factors is set forth in documents furnished by UBS and filings made by UBS with the SEC, including UBS’s Annual Report on Form 20-F for the year ended 31 December 2008. UBS is not under any obligation to (and expressly disclaims any obligation to) update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise. Rounding | Numbers presented throughout this report may not add up precisely to the totals provided in the tables. Percentages and percent changes are calculated based on rounded figures displayed in the tables and text and may not precisely reflect the percentages and percent changes that would be derived based on figures that are not rounded. Imprint | Publisher: UBS AG, P.O. Box, CH-8098 Zurich, Switzerland; CH-4002 Basel, P.O. Box, Switzerland; www.ubs.com | Language: English / German | SAP-No. 80531E-0901 © UBS 2009. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved. 

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