Annual Report for the 2016 financial year Key figures (group) Income statement Net result from interest operation Result from commission business and services Result from trading operations and the fair value option Result from other ordinary activities Operating income Operating expenses in CHF million Value adjustments on participations and depreciation and amortisation of tangible fixed assets and intangible assets Changes to provisions and other value adjustments and losses Operating result Extraordinary result Taxes Group net income from operations Balance sheet (before distribution of net profit) in CHF million Total assets Mortgage loans Amounts due in respect of customer deposits in % Provisions Equity Key figures Return on equity (ROE) Cost / income ratio (CIR) 3 Common equity Tier 1 ratio (CET1) 4 Core capital ratio (Tier 1) 4 Total capital ratio 4 Leverage ratio 4 Liquidity coverage ratio (LCR) 5 Assets under management Total assets under management 2016 1,187 728 379 31 2,325 –1,441 2 –124 –8 752 2 16 –7 761 2 157,985 77,275 80,890 636 10,793 7.4 2 61.7 2 15.6 17.5 17.5 6.7 132 2015 Change 2016 / 2015 in % 2.2 8.9 15.8 –35.1 5.5 4.9 17.1 –87.3 13.3 –76.0 –10.4 5.3 2.3 5.0 0.1 8.9 3.5 1,162 668 1 328 47 1 2,204 –1,374 –106 –61 664 66 –8 722 154,410 73,623 80,820 584 10,429 7.5 62.4 15.8 16.8 17.9 7.0 128 in CHF million 264,754 257,505 2.8 Headcount / banking outlets Number Headcount after adjustment for part-time employees, as on reporting date Banking outlets 6 Profit distribution Share paid to canton to defray cost of capital Distribution to canton Distribution to municipalities Total profit distribution Additional compensation for state guarantee Additional payments from public service mandate Rating agencies Fitch Moody’s Standard & Poor’s in CHF million Rating –0.1 –21.3 10.0 10.0 7.5 6.7 –7.0 5,173 89 5,179 91 21 220 110 351 22 119 AAA Aaa AAA 26 200 100 326 21 128 AAA Aaa AAA 1 A restatement of CHF 4.3 million was undertaken due to a changed profit allocation (+ profit from the commission and service business / – other ordinary income). 2 Excludes the CHF 70 million non-recurring expense in connection with the creation of provisions for pension benefit obligations. 3 Charged: Cost / income ratio (excl. changes in default-related value adjustments and losses from interest business) 4 In accordance with the provisions for systemically important banks 5 Average for the quarter, 4th quarter 6 Including branches of Zürcher Kantonalbank Österreich AG in Salzburg and Vienna as well as six automated banks. Contents In Brief 4 Interview with Dr. Jörg Müller-Ganz, Chairman, and Martin Scholl, CEO 6 Management Report Environment and Strategy Public Service Mandate Customers Employees Analysis of Financial Statements Corporate Governance Compensation Report Financial Report Glossary Branches Contact 11 11 18 22 27 30 35 55 65 158 162 164 Section About the figures: The amounts stated in this report have been rounded. The total may vary from the sum of the individual values. The following rules apply to the tables: (0 or 0.0) Figure is smaller than 0 half the unit of account used Figure not available or not meaningful blank No data available – In Brief The bank that’s “close to you” Zürcher Kantonalbank is successfully positioning itself as a full-service bank with a regional base as well as national and international links. We are the largest can- tonal bank in Switzerland and one of the largest Swiss banks. With a market penetration of around 50 percent, we rank as the leader in retail and corporate banking in the canton of Zurich. Since the acquisition of Swisscanto in March 2015, we are also Switzerland’s third-largest fund provider. Zürcher Kantonalbank is an autonomous public-law institution of the canton of Zurich and bene- fits from a state guarantee. Our public service man- date entails providing financial services for the public and businesses, assisting the canton in the perfor- mance of its tasks in the economic, social and environ- mental arenas, and ensuring that our actions comply with the demands of environmental and social responsi- bility. Our values are: personal, competent and responsible. We are part of life in the canton of Zurich. Organisational structure of Zürcher Kantonalbank (group) Committee of the board Board of directors General management Audit Corporate Banking Institutionals & Multinationals Private Banking Products, Services & Direct Banking Finance Logistics Risk Parent Company Subsidiaries Swisscanto Holding Ltd. Zürcher Kantonalbank Finance (Guernsey) Ltd. Zürcher Kantonalbank Österreich AG 4 Zürcher Kantonalbank Annual Report 2016 Switzerland’s only AAA bank We are the only Swiss bank and the only full-service bank in the world to be given an AAA rating by Standard & Poor’s. Fitch and Moody’s also awarded us their top marks. Strong roots in the canton We are the market leader in the canton of Zurich for retail and corporate banking. We also have the densest network of auto- mated banks and branches. Our customers are increasingly con- ducting their banking trans actions via our call centres, eBanking and eBanking Mobile. Further income diversification Our economic strength is based on a highly diversified income model. As at the end of 2016, the share of commission and fee income increased by 2 percentage points to 32 percent year-on-year due to Swisscanto’s integration which was continued in 2016. Net result With a group net income of CHF 761 million, we again achieved a pleasing result in 2016. The canton of Zurich receives a dividend of CHF 351 million, of which 21 mil- lion is used to cover capital costs and 110 million goes to the municipalities. The canton also received CHF 22 million as compen- sation for the state guarantee. In Brief High level of financial stability At the end of 2016, the bank had net equity of CHF 10,793 million. The total capital ratio amounted to 17.5 percent. We are therefore one of the best capitalised banks in the world. Highly popular “Büro Züri” “Büro Züri” also opened its doors with the reopening of the head office on Bahnhofstrasse in Zurich. The 21 workplaces that the bank provides to the Zurich population free of charge are very popular. The utilisation rate is 98.5 percent on average. Important employer 5,958 people work at Zürcher Kantonalbank (group) in 5,173.3 full-time positions. With 421 traineeships in banking, IT, logistics and operational main- tenance, we are one of the largest training centres in the Zurich region. Commitment to fintechs and start-ups stepped up Since 2016, we have committed ourselves to the “Swiss Fintech Innovations” association in order to make Switzerland a leading fintech centre. In addition, we fur- ther developed our position as a leading provider of risk capital in Switzerland by participating in the “investiere.ch” investment platform. Zürcher Kantonalbank Annual Report 2016 5 Martin Scholl (left) and Dr. Jörg Müller-Ganz at the bank’s head office in Bahnhofstrasse, Zurich. “A long-term approach is in our bank’s DNA” Dr. Jörg Müller-Ganz, chairman of the board of directors and Martin Scholl, CEO, discussing the strength and future of Zürcher Kantonalbank. Interview: Pascal Ihle Dr. Müller-Ganz, in your view, which investment You advocate sustainability. Isn’t this in conflict with was particularly worthwhile in 2016? Müller-Ganz: With our multifaceted commitment to the canton and municipalities, we provide substantial and sustainable local support to our community in Zurich. This creates closeness and trust. And for you, Mr Scholl, what was your best, personal investment in the last year? Martin Scholl: More creative freedom for our employees. We discontinued the traditional employee appraisals, i. e. the target agreement, qualification and performance value in 2016. We now focus on continuous dialogue between line managers and employees. This should allow us to work more flexibly and with greater agility. Away from rigid management tools towards personal discussion – that does better justice to our fast- paced world. Was it well received? Scholl: There will always be sceptics. The positives, however, clearly predominate and there was an almost euphoric mood at times. This shows us that we are on the right path. You have both invested in trust. Is this a symbol for Zürcher Kantonalbank? Scholl: Yes. As a bank, we rely on the trust of our customers and employees. Müller-Ganz: It is more than a symbol. A good invest- ment must go beyond day-to-day politics and be sustainable. To develop trust, we must invest in security. Ultimately, the goal here is also sustainability. the short-term nature of our current day-to-day life? Scholl: No, a long-term focus is entrenched in Zürcher Kantonalbank’s DNA and differentiates us from our competitors. Our task is not to look good in the short term but to hand a fundamentally healthy bank to the next generation. This long-term perspective shapes our decisions. What were the biggest challenges in 2016? Müller-Ganz: For me, these were the dealings with the regulators, the Financial Market Supervisory Authority and the Swiss National Bank. We have to keep on showing that, although we are a systemically important institution, we have a different business model to the two major banks and we have less complexity. We are not an internationally focused financial institution but a domestic bank significant to, and in particular a stable pillar of, the Swiss financial sector. And what was the biggest surprise in 2016? Müller-Ganz: There were so many surprising events in the past year. As a company, we were well prepared for various scenarios and were able to use the opportunities. A pleasant surprise for me was the resilience of the Swiss economy. Switzerland is steaming ahead and maintaining its course despite the storms in global politics and the financial and foreign currency markets. Zürcher Kantonalbank is also steaming ahead in defiance of the Swiss franc shock. Why are the results similar from year to year? Scholl: This requires a solid financial foundation, a clear strategy that does not change every six months, consistent implementation of the strategy and, above all, loyal, excellent employees. Zürcher Kantonalbank Annual Report 2016 7 Interview What did the bank earn the most money with in 2016? Scholl: In the past year, operating income reached a historic high and reflects our solid business model with a diversified income base. The commission and service business developed extremely positively. Together with the trading portfolio, it has now established itself as a key source of revenue. Both revenue sources realised a significant increase. With a share of around half of all revenue, interest operations remain the main source of income. Interest rates are currently a hot topic in the financial world: on the one hand low investment returns and, on the other hand, negative interest rates. How is your bank handling it? Scholl: It impacts the bank’s earnings position but also customers’ behaviour. Managing the balance sheet is a challenge with negative interest rates. Money is no longer earned with customer deposits, i. e. on the lia bilities side. For this reason, one has to be disciplined in securing margins on the assets side, when lending money. Customers are looking for minimum returns at all costs and are therefore prepared to accept higher risks. As a bank, we are required to provide proper risk information. The pressure on your margins is rising. Is Zürcher Kantonalbank taking higher risks? Müller-Ganz: No. Deliberate risk management is a core task at all levels of the bank. A key issue for us is that we manage the various risks in the context of prescribed limits and only invest in line with our risk profile. Mortgages are an investment class promising surplus returns. Are you pursuing this business like your competitors? Scholl: When the first warning signs of a real estate bubble forming in Switzerland appeared four or five years ago, we decided to slow down the growth. The corrections on the real estate market came about as we expected. We expect a soft landing and are not anticipating a bubble. In the last year, our mortgages for retail customers grew in line with the market. For mortgages to companies and institutional investors such as housing cooperatives and real estate funds, we were able to take advantage of market opportunities, thereby outperforming the market. But you have a state guarantee. Müller-Ganz: That is correct. But even without taking the state guarantee into account, with our Standard & Poor’s “aa-” rating we are still the leading bank in a global comparison of assessed banks. Zürcher Kantonal- bank is the most secure full-service bank in the world, even without a state guarantee. Is a state guarantee even needed then? Müller-Ganz: The people and the parliament formalised the state guarantee 147 years ago. Since then, the issue has been revisited by the government from time to time. It was last discussed by the cantonal parliament in 2014 and confirmed with a two-thirds majority. We do everything on our end to ensure that Zürcher Kantonalbank remains the most secure full-service bank in the world – with or without a state guarantee. You are the fourth largest bank in Switzerland with total assets of almost CHF 160 billion and around 6,000 employees. Does your focus on the canton of Zurich represent a cluster risk for the bank? Müller-Ganz: Three quarters of our risk lies in the Greater Zurich Area. This is also where we generate three quarters of our profit. With that in mind, one could say there is a cluster risk. But Zurich is the financially strongest canton in Switzerland and Switzerland is one of the most competitive countries in the world. For this reason, in my view, focusing on Zurich is most cer- tainly an attractive prospect. Do you provide support to Swiss companies abroad? Scholl: Since it was founded, one of the tasks of Zürcher Kantonalbank has been to develop the economy and society in the canton. We provide support to our customers wherever they go. The more international a company is, the more international are our services. We diversify along with our customers. What do you benefit from more: the “Zurich made” or the “Swiss made” label? Scholl: You can’t have one without the other. “Zurich made” is also “Swiss made”. We find that our competitors go back to their roots in a five-year cycle and want to again be a Swiss bank. We do not have to emphasise this: we are a Swiss bank, and have been for 147 years. Our customers know that. How secure is Zürcher Kantonalbank really? Müller-Ganz: We are the most secure bank in the world. We have the highest credit rating, “AAA”, given by the three leading international rating agencies and are thus the only full-service bank that has such a rating. Products and services in banking are similar. How does Zürcher Kantonalbank differentiate itself from its competitors? Scholl: Ultimately, it is about more than just products. If someone has to make a particularly important 8 Zürcher Kantonalbank Annual Report 2016 Interview “As a bank, we rely on the trust of our customers and employees,” says Martin Scholl. financial decision, they will work with a bank that stands for certain values and with which they can identify. Then there is digitalisation. How is Zürcher Kantonalbank positioned? Scholl: Digitalisation already started long ago. 20 years ago, Zürcher Kantonalbank was three times smaller, generated a fifth of today’s profits and dealt with at least twenty times fewer transactions. We are reaching our targets today with just 25 percent more employees. That is only possible thanks to automation and the use of technology. 10 years ago, the iPhone came on the mar- ket and turned our lives upside down in terms of how we transact with banks. Of course, this is a challenge but, in the last 150 years, we have proven that we are able to change and adapt and that we also have the required stability. We built the first online bank 20 years ago already and have been able to build on this knowledge. In addition, we work closely with fintech start-ups, and learn and benefit from this collaboration. Müller-Ganz: We see the digital transformation among our customers in their day-to-day lives. Our branches are being visited less and less, the use of cash is continuous- ly decreasing and the demand for our digital services is increasing. In contrast, our customers want personal consultations and expertise when it comes to complex investment and financing issues. Two things are needed today – excellent digital and analogue service. What are the biggest challenges for you in 2017? Müller-Ganz: Strategy, structure and personnel – these are the major themes that are also on our agenda in 2017. Issues such as the impacts of digitalisation on our business model, the timely fulfilment of our public service mandate, the continuing high level of attractive- ness of Zürcher Kantonalbank as a financial services provider and employer. Scholl: One challenge must surely be the major uncertainty on the market. It is important that we are equipped to deal with all eventualities with the organisation and employees. This also helps us to deal with diversity, a second important topic. Thirdly, we must ensure that the trust that we have in our employees ultimately results in better performance of the bank. Dr. Jörg Müller-Ganz was appointed to the board of directors in 2007. He joined the committee of the board in October 2010. Martin Scholl became Chief Executive Officer in 2007. He has been a member of the executive board since 2002. Prior to that, he held various roles at the bank. Zürcher Kantonalbank Annual Report 2016 9 Management Report Environment and Strategy Our financial strength is based on our full-service banking strategy, a highly diversified income model and disciplined cost management. General economic situation Market environment As far as the economic situation is concerned, the acceleration expected in 2016 turned into a slowdown at first. Nevertheless, Switzerland gradually overcame the Swiss franc crisis. From the second half of the year onwards, China‘s growth-oriented economic policy led to a more promising economic outlook – for emerg- ing markets in particular. However, the economic outlook for the developed world also brightened in the final months. In the USA this was heightened by the infrastructure projects announced by President-elect Donald Trump. 2016 had two big political surprises in store: the British vote to leave the European Union in late June and the election of Donald Trump as the 45th President of the USA in early November. Both votes went against predictions and can be viewed as anti-establishment in nature. Following the Brexit result, the financial mar- kets calmed down after some initial turmoil. In ex- pectation of a more expansive fiscal policy, the election of Donald Trump as the new US President led to expectations of interest rate rises and resurgent inflation expectations in the USA. Towards the end of the year, this led to a global growth in yields, from historically low levels in some cases. The yield on 10-year Swiss government bonds had previously slipped further into the negative zone in the summer months. After the election of Donald Trump, it was a question of picking winners and losers in terms of countries and sectors on the stock markets. The markets ended the year up by almost 10 percent (global equities in CHF). Swiss stocks brought up the rear with a slight fall. With around 260 banks, accounting for nearly 6 percent of total value added, the financial industry is extremely important to Switzerland. However, increasing regulatory requirements, changing customers’ needs, the trend towards the standardisation of services and above all the continuing negative interest rate environment are challenges which the Swiss banks need to address. The value added created by the banks has stagnated in recent years, and growth prospects for the industry remain subdued. A tendency towards consolidation has become apparent within the banking sector, par- ticularly in private banking. This makes it all the more crucial for individual players to position themselves clearly and differentiate themselves from other banks. In this respect, potential is offered by, among other things, the continuing trend towards the digitisation of banking services. On the one hand, well-established institutions are faced with new competitors from the emerging fintech industry and, on the other hand, this offers even small regional banks the opportunity to offer their services throughout Switzerland. Vision Zürcher Kantonalbank has a clear vision: to be the bank that’s “close to you”. The bank was established in 1870 with the purpose of providing banking services for people as well as small and medium-sized enterprises in the canton of Zurich. We have remained true to this vision ever since. Being the bank that’s “close to you” means being close to our customers, not just in geograph- ical terms but also at an emotional level. In line with our philosophy of providing advice and support, we develop comprehensive financial solutions oriented Zürcher Kantonalbank Annual Report 2016 11 Management Report: Environment and Strategy around customers’ needs. In doing so we strive to offer products and services that create as much added value as possible for the environment and society at large. Another factor in this is that we generate most of our value creation in the canton of Zurich and contrib- ute to the prosperity of the region as a major employer. We enter into a committed partnership with our stake- holder groups. A good relationship with our suppliers is important to us. We foster a results-driven, responsi- ble approach on the part of our employees, in a climate of trust, openness and fairness. Our vision of being the bank that’s “close to you” is what drives us. Fig. 1: Our vision Inter nationally successful National leadership No. 1 in the Greater Zurich Area Strategy Zürcher Kantonalbank pursues a full-service banking strategy. This is directly derived from the Law on Zürcher Kantonalbank and the needs of the people and busi- nesses in the Greater Zurich Area. We offer a broad line- up of banking products and services: from financing business to investment and asset management, from payment transactions to trading and capital markets business. This breadth of business activities, combined with proximity to our customers, is what makes us unique. With our approach of offering comprehensive advice and support, we provide competent, dependa- ble support for our customers at every stage of life and in all business circumstances. Our business model is complemented by selected services in the national and international arena. Our financial strength and robustness are based on disciplined cost management and a highly diversified income model. As part of this diversification, in 2015, we acquired Swisscanto, whose successful integration continued in the year under review. Clear performance promises For each of our different customer segments – retail and commercial customers, business and corporate cus- tomers – there are specific performance promises which reflect our service philosophy. We are positioning Fig. 2: Strategy Group mission statement (including vision) Group strategy Sales Retail and Commercial Customers Private Banking Corporate Banking Financial Institutions & Multinationals Channels Core business areas Monetary Transactions Deposit-Taking Business Loans Investments & Asset Management Trading & Capital Markets Logistics Finance Risk Human Resources Functions 12 Zürcher Kantonalbank Annual Report 2016 Management Report: Environment and Strategy ourselves through the high quality of our advisory service, continuity of customer support and a com prehensive, lifetime service offer. lending to foreign banks in connection with Swiss exports. Developments in our service to our customers In order to meet the changing needs of our customers in an optimal way, we are continually developing our range of products and services and redefining our multi-channel strategy. In the year under review, five branches were modernised and given a new look as part of our programme of conversions / refurbishments in line with our design and service concept (Affoltern am Albis, Effretikon, Pfäffikon, Rüti and Zurich Wollis- hofen). In our innovation laboratory, our digital channels were also developed during the year under review, in line with technological progress and changing user needs. The innovations include fingerprint login for our eBanking Mobile service. A new feature which can be used to define personal savings goals was added to the Personal Finance Manager integrated into eBank ing. Other innovations in eBanking included the ex- pansion of selfservice features such as ordering cash from home. Monetary transactions and deposit-taking business We are the number one address in the canton of Zurich for basic banking services such as payment trans actions or savings. Just under 45 percent of Zurich residents have an account with Zürcher Kantonalbank. Our bundled solutions and individual products are tailored to the needs of our customers at every stage of life. With the sale of the hundred-thousandth “ZKB inklusiv” bundled solution in the summer of 2016, a growing number of our retail customers are using one of our “ZKB inklusiv” packages, which combine at- tractive terms with changing benefits. We want to in crease this proportion further. Loans With a market penetration of around 50 percent, we rank as the leader in retail as well as corporate banking in the canton of Zurich. Due to the canton of Zurich’s economic strength within Switzerland and our important market share, above all in the domestic lending and deposit-taking business, we were categorised as “sys temically important” by the Swiss National Bank in 2013. In terms of loans, we are the clear number one in the Greater Zurich Area. We also provide finance for medium-sized and large businesses outside of this region as a third force. In this way, we directly sup port Switzerland as a business location. We are a select counterparty in international banking and provide Investments and asset management As Switzerland’s third-largest fund provider and an important asset manager we offer private individuals, businesses and institutional customers highquality, innovative products and asset management solutions. Our compelling offer comprises a transparent invest ment advisory process, a systematic investment process with clear allocation of responsibility for performance and efficient execution. Our expertise is rounded off by our in-house equity and bond research team, which mainly analyses Swiss securities and enjoys an outstand ing reputation. A highlight of the year under review was the launch of a range of more than 40 index funds for retail customers. Also, for investment business, we now only act under the competence brand Swisscanto Invest by Zürcher Kantonalbank. We are now offering all funds, except for precious metal ETFs, under this brand. In this way, we have also strengthened our position in the investment and asset management business in the year under review. We increased the share of income derived from commissions and fees by 2 percentage points to 32 percent at the end of the year under review. Trading and capital markets Our trading operations are based on clear customer focus. Innovations are developed quickly and offered in a targeted manner in line with customer needs. In Switzerland, we are among the leading service providers in traded asset classes and in debt and equity market services. Logistics Firmly established processes within the bank are a crucial factor in the success of our full-service banking strategy. The backbone to this is an efficient logistics operation that integrates information technology, pro cessing and real estate management. Processes are constantly being optimised in order to address the trend towards standardisation of banking services. In addi tion, we are pushing forward with the digital transfor mation of the bank that’s “close to you”. The basis for this is provided through the continuous upgrading of our IT infrastructure. Finance In order to implement our strategy we ensure that the necessary financial resources are available and the regulatory requirements with regard to capital resources Zürcher Kantonalbank Annual Report 2016 13 Management Report: Environment and Strategy and liquidity are fulfilled with an additional reserve buffer. We raise the outside capital and equity necessary in order to achieve our growth targets at minimal costs. With our equity and liquidity management we ensure a risk-appropriate and economically efficient use of our financial resources. Comprehensive financial reporting forms the basis for the successful financial management of the bank. Risk management The board of directors deals on a regular basis with the bank’s risks. The basis for this is provided partly by detailed quarterly reports on credit, market and liquidity risks, compliance risks, operational risks and reputa- tion risks. The board of directors also carries out a risk assessment at least once a year. The risk manage- ment and audit committees of the board of directors investigate these matters and report on them to the board. More information about our risk and compliance organisation and the associated processes and meth- ods can be found in the “Risk report” section (p. 106 onwards). Human resources In 2016, we decided to replace our previous target and performance agreement process with the dialogue- oriented and agile “Performance & Development” approach. In doing so, we aim to ensure that manage- ment and employees use their strengths more flexibly and in a more focussed manner during the year, con- stantly align their actions with corporate strategy and thereby contribute more effectively to the success of the bank. Our employees are only able to reach their full potential if they know and understand our business model and strategy. This also promotes collaboration across all levels and areas, which has a positive effect on our culture of trust. Targets To measure the effectiveness of our strategy, we have developed a comprehensive system of targets (balanced scorecard). We measure the strategic group targets in four dimensions: finance, customers, processes and employees. We are financially successful if we achieve an appropriate level of profitability, an efficient cost structure, an optimised balance sheet and income struc- ture, a high degree of customer satisfaction along with a balanced diversification of our income streams. We measure achievement of the targets on the basis of key indicators such as cost / income ratio (CIR), total capital ratio, group rating, employee satisfaction index and customer satisfaction index. Internally, since 2015 we have measured profitability on the basis of economic profit instead of return on equity (ROE). Externally, we continue to state the ROE. The measured key indicators should lie within strategic bandwidths defined by the board of directors. In addition, we draw up a multi-year plan, which we review and revise on an annual basis in line with current conditions. Annual planning and budgeting are derived from this process. Fig. 3: Strategic targets (balanced scorecard) Finance Customers Fulfil and systematically devel- op the public service mandate Retain a high rating Generate sustainable financial success Expand market position Strengthen support and advisory services; keep customer loyalty at high level Develop brand further Processes Employees Develop core business further Manage risk Optimise logistics processes Develop skills and optimise employee placement Be an attractive employer Maintain employee satisfaction at a high level 14 Zürcher Kantonalbank Annual Report 2016 Management Report: Environment and Strategy Milestones in 2016 We are very satisfied with the figures achieved in the 2016 financial year. The return on equity amounted to 7.4 percent. The cost / income ratio was 61.7 percent. We have systematically strengthened our capital base in recent years, and at the end of 2016 had a total capital ratio of 17.5 percent. This far exceeded the regulatory required minimum of 14.7 percent (including counter cyclical buffer). It does not include the CHF 575 million in endowment capital that can still be called in from the canton of Zurich. Use of the callable endowment capital would raise the total capital ratio by 0.9 percent age point. Fig. 4: Figures achieved in 2016 Variables Return on equity (ROE) Cost / income ratio (CIR) Total capital ratio Group rating Targets 1 58 – 64 % 16 – 19 % 2016 7.4 61.7 17.5 2015 7.5 62.4 17.9 2014 7.2 61.7 16.6 AAA, Aaa AAA, Aaa AAA, Aaa AAA, Aaa Employee satisfaction 65 – 70 points Brand performance ≥ 60 points Customer satisfaction 2 Retail customers Corporate banking ≥ 75 points ≥ 75 points Private banking customers ≥ 75 points 72 66 75 83 79 72 65 75 79 75 67 61 75 79 75 1 Internally, since 2015 we have measured profitability on the basis of the economic profit. Externally, we continue to state the ROE, but without target bandwidth. 2 Survey conducted every two years; 2015 results, next survey 2017. 3 Figures for 2014 / 2015 have been recalculated due to restructuring. AAA rating awarded once again The rating agencies Standard & Poor’s, Moody’s and Fitch continue to award Zürcher Kantonalbank their highest ratings of AAA or Aaa. This makes us the only Swiss bank to be given top marks by all three rating agencies. The reasons for this include the bank’s deep roots in the Zurich region and in Switzerland, its broadly diversified business model, moderate risk profile, strong capital base and state guarantee. In the view of ratings agency Standard & Poor’s, Zürcher Kantonalbank is among the safest banks in the world. It has also rated the bank‘s “standalone credit profile” very highly at aa. This describes how safe a bank is on its own, i. e. independently of any support provided by the owner of a bank in an emergency. In the year under review, we also won Global Finance magazine‘s “Safest Bank Award” for the fifth year in a row. In this survey of the 500 largest banks, Zürcher Kantonalbank emerged in second place once more behind a German develop ment bank and is therefore regarded as the safest fullservice bank in the world. Stable growth of international business International business with retail customers, which was reorganised in 2015, is based on a taxcompliant business model focussed on a few core markets, mainly in Europe, and Swiss customers abroad. When receiv ing and investing funds from international private cus tomers, we insist on tax compliance with regard to these funds and obey the laws of the countries of origin in this respect. This lays the foundation for stable growth, based on security, competence and profession alism. The most important core markets in Europe are Germany, the UK, Italy, Spain, Austria and the Czech Republic. In terms of emerging markets, our focus is on the United Arab Emirates, Hong Kong and Singapore. Zürcher Kantonalbank Österreich AG – whose assets under management increased to about EUR 1.3 billion in 2016 – acts as a gateway to Europe. It also man aged to break even. Zürcher Kantonalbank Österreich AG operates two locations, in Salzburg and Vienna, focusing on investment advisory services and asset management. Amicable agreement reached with judicial authorities in Germany An amicable agreement was reached with the judicial authorities in North RhineWestphalia covering all German federal states for a oneoff payment of EUR 5.7 million in relation to untaxed assets of German customers. Emergency plan drawn up due to systemic importance Following the bank‘s classification as a bank of national systemic importance in 2013, we drew up an emergency plan in the year under review. In this plan we describe how the systemically important functions, which include domestic deposit and lending business as well as payment transactions, can be maintained in the event of a crisis. The emergency plan is triggered if the bank is not able to stabilise itself on its own. We set out the stabilisation measures in the stabilisation plan, which also forms part of the emergency planning for systemi cally important banks and was drawn up in 2015. Thurgauer Kantonalbank uses CIO services We also provide services to other banks in relation to investment, asset management and pensions business. This includes extensive investment research, recommendations regarding investment policy, complete portfolios and processing of mandates. The partners benefit from our expertise and from connec tion to our systems, allowing them to offer their Zürcher Kantonalbank Annual Report 2016 15 in future under the TWINT brand. Once the competition commission had approved the merger, the newly founded TWINT AG began trading in the autumn of 2016. The features of both solutions have been combined into a new offer. In 2017, users of TWINT and Paymit will be migrated to the new TWINT. The common mobile payment solution will be available to all consumers and merchants, offering versatility in application: at the till, in e-commerce, in apps, at ATMs and between individuals. Outsourcing payment transactions driven forward In future we will be processing our payment transac- tions via the bank processing centre of Swisscom. In this way, Zürcher Kantonalbank is deliberately preparing itself for future requirements with respect to payment transactions. The outsourcing of payment transactions to Swisscom has been postponed until the first half of 2017. The bank that’s “close to you” as a credible reality The behaviour of banks has been the subject of funda- mental public debate in recent years. We believe that practised corporate values constitute the basis for a trusting, long-term business relationship. Our values are: personal, competent and responsible. “Personal” because we know our customers, accompanying them through every stage of life with our comprehensive service centred on partnership. “Competent” because – through our outstanding advisory and customer service capability – we can be depended upon to meet our customers’ expectations. “Responsible” because sustainability is at the heart of what we do. Our brand promise remains the bank that’s “close to you”. This represents the essence of our brand values. We attach great importance to brand awareness and reputation. A survey conducted in the year under review showed that in many respects people in Zurich believe we fit the bill of the perfect bank. Our aim is to be considered the best bank brand in the Greater Zurich Area. We pursue this objective consistently with a wide variety of measures. Management Report: Environment and Strategy customers constantly up-to-date solutions similar to full-service banks. Since 2016, Thurgauer Kantonalbank has also used our CIO services. Involvement in the fintech scene stepped up The continuing process of digitisation of banking trans- actions and developments in the area of fintech are among the strategic core themes for the bank. With the aim of making Switzerland a leading international centre for digitisation and innovation in the financial industry, in 2016 we were closely involved in the foundation of the “Swiss Fintech Innovations” associa- tion. The main focus of the association is on attracting and supporting innovative (young) businesses and professionals in the area of fintech, achieving close and direct cooperation between business and science on fintech themes and promoting the optimal regulatory framework and technical standards. Position as provider of venture capital extended With an annual investment volume of around CHF 15 million in the form of equity and mezzanine capital, Zürcher Kantonalbank was already one of the largest providers of venture capital in Switzerland. In the year under review, we acquired a substantial minority interest in “investiere.ch”, a leading Swiss investment platform for start-ups, for a total of CHF 3.5 million in a private round of financing. This strengthens our position in the start-up and fintech arena as well as exploits opportunities for the future continued development of our other financing activities, for instance in the arena of SMEs. Cooperation entered into with China Construction Bank Zürcher Kantonalbank and China Construction Bank signed an agreement for renminbi clearing in 2016. China Construction Bank is the only bank in Switzerland that is authorised by the People’s Bank of China to conduct cross-border business with China. The agree- ment means that our corporate customers domiciled in Switzerland can make payments in renminbi. Process- ing payment transactions with Chinese companies becomes simpler, since China Construction Bank is direct- ly connected to the Chinese clearing system. This is scheduled to be implemented in the first half of 2017. Paymit and TWINT combined Mobile payment in the form of smartphone apps is becoming more and more established. During the year under review, the partners in mobile payment solutions Paymit und TWINT decided to offer a joint solution 16 Zürcher Kantonalbank Annual Report 2016 Outlook We anticipate a continued challenging environment in 2017. However, we are confident that we will again achieve pleasing results in 2017 thanks to our extremely sound foundation, balanced business model and clear strategy. In the years ahead, we aim to systematically expand our leading position as a full-service bank that is outstandingly well-positioned in strategic terms. As of January 2018, Zürcher Kantonalbank will engage in a comprehensive renewal of its investment advice. As well as the close relationship with their relationship manager, in future our customers will bene- fit more directly from the knowledge of our invest- ment experts and from the use of modern technology to draw up investment proposals, monitor portfolios and offer advice. Following a successful test phase in the year under review, 2018 will see the launch of tablet-based advice to retail customers. Personalised simulations, clear visualisations and interactive features will enhance the informative value for our customers. Due to constantly declining footfall, the bank will close eight counter locations and six agencies by 2018. These locations only offer counter services, mainly deposits and withdrawals. We are investing in innovative solutions in order to differentiate ourselves within the banking sector. Our aim is to offer customers user-friendly, transparent and secure banking services. We are constantly expanding our range of online services in order to guarantee a high level of availability. We invest more than CHF 300 million annually on operating and upgrading our IT platform. The investigation of Zürcher Kantonalbank launched by the US authorities in 2011 remains ongoing at the present time. Legal certainty, tax compliance and market access will continue to be key issues of concern to the banking industry. Great importance continues to be attached to protecting the privacy of customers. It is to be assumed that competition within the banking industry will continue to increase in the years ahead. Together with the political community, the aim must be to improve the overall framework for Switzer- land as a financial centre. Freely accessible markets, in particular within the EU, are vital for Switzerland as a small, outward-looking economy. The definition of measures to counter the growing pressure on costs will remain a matter of importance. Management Report: Environment and Strategy Zürcher Kantonalbank Annual Report 2016 17 Management Report Public Service Mandate The mandate given to their cantonal bank by the people of Zurich, which is enshrined in law, constitutes the basis of our business activities. It is our USP and we are proud of it. Zürcher Kantonalbank is an independent public-law institution of the canton of Zurich. The bases for its business activities are defined in the Cantonal Bank Law. The public service mandate enshrined in this law consists of a threefold obligation of service, support and sustainability. Three pillars of our commitment The service obligation is at the heart of the public service mandate. The purpose of this is to provide bank- ing services for the general public and companies in the canton of Zurich. Particular attention is to be paid to requirements for payment transactions and relating to investment and financing business. The services cover a wide, modern range of products and banking services, our dense network of branches, the promotion of SMEs, a special partnership with not-for-profit residential property developers and support for first-time property buyers. We also make products available to the resi- dents and businesses of Zurich that are not usually pro- vided by a conventional full-service bank. These in- clude non-cost-covering micro-loans and tenant deposit accounts. The support obligation requires the bank to support regional businesses. For instance, our financing exper- tise helps Zurich to develop further as a business location through targeted support for innovative start-ups. Through over 140 sponsorship commitments, we are helping to make the canton of Zurich sustainable and liveable. The bank fulfils the sustainability aspect through ZKB environmental loans for climate-friendly building projects and a broad range of sustainable invest- ments. In addition, we view this area as the basis of Fig. 5: Public service mandate Canton of Zurich Service Providing people and businesses with comprehensive banking services Support Assisting the canton of Zurich in the economic, social and environmental arenas Sustainability Taking account of sustainability issues in all our business areas and activities our long-term financial success, which depends on respect for the principles of sustainability and profes- sional risk management. The bank lives sustainability as an integrated business principle, and this is reflected in our products, among our employees, in our com- mitment and in our operations. High-quality sustainabili- ty and certified environmental management, embed- ded in the organisation, are therefore features of the implementation of the sustainability obligation in terms of future-proof economic, environmental and social corporate development. Compensation paid to canton and municipalities Zürcher Kantonalbank fulfils its public service mandate on the basis of a business strategy aimed at long- term continuity which is based on market-oriented prin- ciples and intended to achieve an appropriate profit. A dividend of CHF 351 million is paid to the canton. The canton uses this, in the first instance, to cover capital costs incurred for the refinancing of the endowment capital (2016: CHF 21 million). 18 Zürcher Kantonalbank Annual Report 2016 Management Report: Public Service Mandate the current financial year alone around CHF 18.7 million was invested in the network of branches. However, with the continuing advance of digitisation, the impor- tance of cash transactions over the counter, for ex- ample, has been declining for some years. Due to these changes in customer behaviour, we closed three agencies during the year under review. The public service mandate in practice The way in which the bank fulfils its public service mandate is managed and supervised as part of the cor- porate governance process. The sustainability report for 2016 shows in detail how Zürcher Kantonalbank has elevated sustainability – in all its dimensions – to an integrated business principle. Detailed information about the support mandate can be found at zkb.ch/sponsor- ing. The following comprises a selection of examples of the way in which we fulfil our public service mandate. Service Multiple contact options As “the bank that’s close to you” Zürcher Kantonalbank offers contact options on all channels, whether at one of our 81 branches, at 348 ATMs, via the electronic channels of the eBanking and eBanking Mobile servic- es or using the smartwatch app. During the year under review, 404,500 customers accessed our eBanking service (2015: 380,500). 86,200 customers conducted their banking transactions via mobile devices using our eBanking Mobile app. In addition, the bank can be contacted on various social media channels. ZKB micro-loans for start-ups As a partner of the “GO! Ziel selbstständig” (“GO!”) association, a non-profit organisation, the bank helps people to set up their own business by providing micro-loans. The micro-loans provided by the bank range from CHF 5,000 to CHF 40,000 and normally have a maximum term of three years. In 2016, we financed 24 new, small businesses with a volume of approxi- mately CHF 500,000. Of the rest, two thirds go to the canton and one third to the municipalities. In this way, Zurich’s people benefit from the success of their bank. State guarantee Zürcher Kantonalbank’s customers benefit from the state guarantee. Under the law, the canton of Zurich provides a guarantee for all the bank’s (non-subordinate) liabilities should the latter’s resources prove inade- quate. For 2016, Zürcher Kantonalbank paid the canton financial compensation of CHF 22 million for the provision of the state guarantee. This is based on an arrangement which was approved by the cantonal parliament in 2015. The changing public service mandate Society is undergoing continual change, and with it Zürcher Kantonalbank’s customer base. New technical achievements, the accelerated pace of economic life and the rapid development of means of communication also call for new answers in the financial sector. The counter at the local branch which, 20 years ago, was still the main point of contact for banking transactions, nowadays represents one of several channels via which our customers can conduct their banking transactions. For example, today one third of our customers have an eBanking agreement. One in five is already using the bank’s eBanking Mobile services. Within the past twelve months, the number of mobile logins has increased by nearly two thirds. In line with the spirit of the service mandate, the bank strives to offer its customers access to modern products and services on all desired channels. In recent years, the bank has intensively addressed the issue of digitisation and launched several new offerings including a smartwatch app, a budget tool and a mobile pay- ment solution. Over the coming years, further develop- ment steps will follow which will further improve the customer experience on the digital channels. Naturally, with regard to all electronic banking transactions, we place the utmost emphasis on security. At the same time it remains an unquestioned part of the bank’s business philosophy that the personal and confidential face-to-face service provided at the local branch locations will continue to represent a key element of any banking relationship. For this reason, during Zürcher Kantonalbank Annual Report 2016 19 Management Report: Public Service Mandate Fig. 6: Use of sponsorship funds Various (regional sponsorship, communication, reserve) 31% Society (education, culture, sport, health) 31% Environment (nature) 24% Business (career and education, business development) 14% Support SME Prize for Sustainable Businesses In January 2017, Zürcher Kantonalbank will award the seventh SME Prize for Sustainable Businesses for 2016, with prize money totalling CHF 150,000. The prize recognises exceptional sustainability efforts by small and medium-sized businesses. The jury, consisting of well- known representatives of industry, science and politics, assesses candidates based on current and future- oriented aspects in the areas of business, management, the environment and society. The main prize was awarded to Schwendimann AG from Münchenbuchsee (BE), and the second and third prizes went to Bio Partner Schweiz AG from Seon (AG) and J. Grimm AG from Oetwil am See (ZH). The special prize for micro- enterprises was awarded to Romer Holzbau AG from Benken (SG) and the special prize for extraordinary achievements went to Gammacatering AG from Hünen- berg (ZG). Zürcher Kantonalbank is convinced that sustainably managed businesses perform better in the long term and are better able to hold their own against competitors. Commitment to young people For more than a hundred years, Pro Juventute has looked after the needs and concerns of children and young people in Switzerland. A major focus of the organisation is helping to prevent young people from getting into debt: young people in Switzerland are confronted with consumption and consumerism from an early age. How they and their parents deal with this can affect these young people for the rest of their lives. Together with Pro Juventute, we are committed to organise events for parents on the theme of money and consumption, which help the parents who attend to improve their children’s financial skills and accept their responsibility for teaching them about money. “Büro Züri”: a popular place to work For over a year, the bank has offered free temporary working space at its head office in Bahnhofstrasse. The number of visitors and almost 100 percent occupancy demonstrate the positive response from the people of Zurich. Individuals and groups can reserve working space at “Büro Züri” free of charge for several hours. This offer is a gift from the bank to local resi- dents. It offers start-ups, students, entrepreneurs and business people the opportunity to press ahead with their projects and plans in a professional and relaxing atmosphere. ZKB Schiller Prize goes to Thilo Krause The ZKB Schiller Prize recognises authors who enrich and shape the Swiss literature scene with their works. Zürcher Kantonalbank has awarded the prize every year since 1979, based on the recommendations of the board of trustees of the Swiss Schiller Foundation. It is our oldest commitment to the world of literature. Through our contribution, we promote and support the literary scene in the Greater Zurich Area. The prize for 2016 was awarded to Thilo Krause for his poetry collection “Um die Dinge ganz zu lassen”. Knabenschiessen: where youth and tradition meet Since 1899, the shooting club of the City of Zurich has organised the Knabenschiessen target-shooting compe- tition. For decades, this traditional Zurich event has attracted thousands of budding marksmen and women aged 13 to 17 from all over the canton. They com- pete for three days to become the champion. Besides many rides and stalls, visitors to the fair on the Albis- gütli shooting ground can also try food from all around the world. At Knabenschiessen, the emphasis is firmly on fairness, perfection and determination – values to which we are committed as the bank that’s “close to you”. That’s why we have been supporting young people and simultaneously an ancient tradition as main sponsor for the last 25 years. Food for the mind and body: LunchKino Since 1996, LunchKino has been serving up cinematic treats in the Arthouse Le Paris cinema at lunchtime – sandwiches and soft drinks are also available in the foyer. Anyone wanting to see the latest films before their official opening should set aside some time each week to visit LunchKino. The programme runs seven days a week and changes every Thursday, showing previews of frequently award-winning international studio films. It also puts on regular special showings with famous guests and an exciting supporting programme. Through our commitment to studio and short films, we contrib- ute to the diversity of the Zurich cinema scene. 20 Zürcher Kantonalbank Annual Report 2016 Management Report: Public Service Mandate 4,206 employees took advantage of discounted ZVV Bonus Passes or Z Bonus Passes (for travel from a different canton). Almost 300 employees made use of our mobility scheme for business trips. Zürcher Kantonalbank also constantly reviews and expands its mobility offer. Discount for SMEs when leasing low-emission commercial vehicles In 2015 and 2016, we conducted an environmental campaign among SMEs. This was aimed at promoting low-emission commercial vehicles with discounts on leasing. The vehicles either had to comply with the Euro 6 standard, have electric or hybrid drive or run on biogas or natural gas. Financing was provided by the reimbursement of the federal CO2 incentive tax. With 120 agreements encompassing a total volume of CHF 26.7 million, the funds flowed back into the Swiss economy for the benefit of sustainability. 100 % green power “naturemade star” Ever since 2006, Zürcher Kantonalbank has been one of the few businesses in Switzerland to meet all of its power requirements from green power with the “naturemade star” label. This mainly comes from Swiss hydroelectric power as well as solar and wind power as well as biomass. “naturemade star” power plants fulfil strict environmental requirements so that flora and fauna around the power plant are affected as little as possible. For every kilowatt hour of hydroelectric power sold, one cent is collected in a fund. This finances ecological improvements in the area around the power stations, such as the renaturalisation of embank- ments or regeneration of old rivers. Sustainability ESG factors integrated into the investment process Through an innovative approach, since 2016, we have consistently integrated ESG factors (ESG: Environmental, Social, Governance) into conventional financial analysis. This helps us make better investment decisions. In this way, material risks are identified which have not yet been factored into the evaluation. This gives convention- al financial analysis an extra dimension. For this pur- pose, we have developed a database which supplies the portfolio manager or analysts with the key ESG inform ation at the touch of a button. In order to continue to develop our service in future and reflect on it regularly, we set up the external “Zürcher Kantonalbank Investment Sustainability Committee” in 2016. We also increased the scope of its advisory mandate to include the integra- tion of ESG criteria in the investment process. We appreciate the independent assessment of the broad range of experts of future developments, our sus tainable investments and the integration of ESG in the investment process. The investment sustainability committee meets about four times a year. Range of fairtrade gold expanded In 2015, we became the first bank in the world to launch the sale of fairtrade certified gold ingots from 1 to 10 g. The ingots carry the “Fairtrade Max Havelaar” label. In response to a doubling of sales compared with the previous year, we added a special Christmas edition to the range in 2016. Fairtrade gold ingots are about 5 to 6 percent more expensive than conventional gold. As of 2016, when fairtrade gold is sold to the bank, the fairtrade premium is refunded to our customers. The certification brings various advantages to those in- volved: due to the mandatory legalisation of the mines, the rights of the miners are protected. Formalised business relationships and a guaranteed minimum price provide financial security. The fairtrade premiums also make possible investments in community projects. Stricter safety regulations protect people and the local environment. Eco-friendly travel New forms of mobility are constantly gaining in popu larity. Holistic and sustainable approaches are increasing- ly coming to the fore. In line with our sustainability mandate, our bank has also been committed to sustain- able mobility concepts for a long time. Accordingly, for the second time, in 2016, the bank gave all employ- ees and retirees an SBB rail voucher entitling them to a discount on a HalfFare or GA travelcard. In 2016, Zürcher Kantonalbank Annual Report 2016 21 Management Report Customers With comprehensive advice and a modern product and service portfolio, we are a reliable partner for our customers at every stage of life and in all business circumstances. Advice and support Comprehensive advice and support Zürcher Kantonalbank helps people and businesses across generations. For us it is vital to offer our custom ers solutions that are tailored to their individual re quirements in all life circumstances. We want to offer a constant, first-class quality of advice and support, and meet the ever more demanding needs of our customers. We conduct regular surveys to monitor the satisfaction of our customers every year, including the year under review. The customer loyalty indices obtained reach the defined targets in all customer segments, or even ex ceed them by several index points (see p. 15). We have therefore managed to increase customer loyalty significantly from an already high level. As far as advice to retail customers is concerned, in 2016 the focus lay on developing investment solutions in a low interest environment, attractive financing vari ants and holistic pensions solutions. We have signifi cantly expanded our advice on financial planning to prepare customers for the “third age”. Through the launch of the “Meine Vorsorge” (My Pension) brochure, we have strengthened our market presence in the areas of pensions, estate planning and tax. One in every two residents of Zurich is a customer of Zürcher Kantonalbank. At the end of 2016, we had 872,100 relationships with retail customers. That makes us the leading financial services provider in the canton of Zurich for business with retail customers. In business with our corporate clients, our focus was on providing advice in the area of cash management. We assist our customers with specific services in issues relating to the liquidity of their companies. Our goal was to identify optimisation potentials along the financial value creation chain, in particular in the subsegments of information management, liquidity management, payment transactions and risk manage ment. With 53,300 customer relationships. we are also the clear number one for companies in the Greater Zurich Area. As a dependable partner to businesses in the canton, with the extensive array of services of fered by a full-service bank, we have the necessary basis on which to retain this leading position. We have a particularly close affinity to SMEs. Around half of all Zurich-based SMEs rely on the services of the bank that’s “close to you”. We are also an important partner for major national and international companies with registered offices in Switzerland as well as a select coun terparty in the global interbank market. At the end of 2016, assets under management for retail customers and companies at the parent company level amounted to CHF 187.4 billion (2015: CHF 182.3 billion). Proximity to customers through multiple contact options Closeness to our customers is important to us. We also create proximity through the multiple modern contact options available to our customers. Zürcher Kantonal bank maintains the densest ATM and branch network in the canton of Zurich. Both retail and corporate custom ers continue to use their local branch as an important point of contact for advice. In 2016, our branch sales pro- fessionals held around 162,000 face-to-face consulta tions in branch on the core businesses of invest ments and asset management, loans and on the themes of pensions, estate planning and tax. In the year un der review, five more branches (Affoltern am Albis, Effretikon, Pfäffikon, Rüti and Wollishofen) were refurbished. They now match our new, uniform design 22 Zürcher Kantonalbank Annual Report 2016 Management Report: Customers and service concept, which offers a higher standard of service in an attractive environment. Besides day-to-day business, the active dialogue with SMEs, our close relationships with industry and its organisations as well as numerous partnerships and awards to promote SMEs are evidence of our commit- ment in the canton of Zurich and the customer pro ximity that is lived daily. Online channels and mobile services continue to grow in significance as a complement to traditional branch operations. To meet this growing demand, we have been pursuing a multichannel strategy for many years, offering our customers alternative ways of carrying out their banking transactions. For instance, they can obtain advice from our support centre for retail and corporate customers by telephone or via video conference. During the year under review, our support centre handled about 730,000 calls. In addition, cus- tomers can carry out their transactions via our eBanking or eBanking Mobile services and our smartwatch app. Our customers can use the Personal Finance Manager – an eBanking feature that gives them a comprehensive, fast and clear overview of their finances – to define new personal savings goals. In association with partners, since 2015, Zürcher Kantonalbank has offered its cus- tomers the mobile payment solution Paymit. In 2016, the companies involved decided to offer the previously separate mobile payment solutions Paymit and TWINT jointly in future under the TWINT name. Both private individuals and merchants will benefit from extended functionality in future. Across all channels, we place emphasis on the greatest security and a brand experience that puts the needs of our customers at the centre. Loans Mortgages The trend of slower growth in property prices seen in recent years continued in 2016. In a market with declining immigration and stable building activity, con- tinuing low interest rates for mortgage holders still led to solid demand for real estate. In this environment, the bank’s mortgage receivables increased by CHF 3.7 billion to CHF 77,3 billion in the year under review. This equates to an increase of 5 percent, whereas the market as a whole (just banks, excluding mortgage investment companies and insurers) grew by just 2.4 percent in the year under review. Due to the contin- uing low interest environment, longterm fixed rate mortgages in particular experienced the strongest growth over the year as a whole. The share of fixed rate mortgages with a tenyear term increased from 13 percent in December 2015 to 19 percent at the end of 2016. The share of fixedrate mortgages (includ- ing ZKB starter mortgages and fixed advances) in the total mortgage portfolio was 90 percent at the end of the year. As market leader in the canton of Zurich, we place great emphasis on quality in all loans issued. Fig. 7: Mortgage receivables (in CHF billion) 2016 2015 2014 77.3 73.6 71.4 0 10 20 30 40 50 60 70 80 Many 1960s buildings, whether houses or apartment blocks, are now in their second redevelopment cycle and show potential for renovation. The energy consump- tion of the properties can also be significantly reduced in the course of renovation. Since, for us, sustainability means combining successful business activity with social and environmental responsibility, we support our customers in this process. Through our market leading environmental loans, we promote energyefficient construction and renovation. Customers benefit from an interestrate reduction of up to 0.8 percent com- pared to the indicative rate of the selected ZKB fixedrate mortgage for up to five years. In the year under review, we have once again boosted the area of energyefficient renovation in particular. We started promoting specif- ic indepth surveys by GEAK surveyors (GEAK stands for Gebäudeausweis der Kantone – cantonal building Zürcher Kantonalbank Annual Report 2016 23 Management Report: Customers energy certificate) and the implementation of energy- saving measures. The total volume of ZKB environmental loans amounted to roughly CHF 1.16 billion in the year under review. New loans were up by 28.2 % compared with the previous year. Due to an increase of loans maturing by 64.4 %, the total volume fell by 4.8 % compared to the previous year. In line with our public service mandate, we have also supported first-time property buyers with the ZKB starter mortgage for over 30 years. As a leg-up, we grant them a reduced interest rate in comparison with the normal ZKB fixed-rate mortgage. In 2016, the volume of ZKB starter mortgages amounted to CHF 4.4 billion. This represents growth of 15 percent compared to the previous year. Business financing Thanks to a constant and proven lending policy, we are able to make a key contribution to the supply of credit to SMEs in the canton of Zurich and to large business- es on a Swiss-wide scale at the same time as controlling and diversifying risk. A model-based and systematic credit assessment process and decentralised decision- making authority for standard transactions allows us to incorporate local expertise into credit decisions and to take individual factors into account. In our commu- nications with our customers, we therefore place great importance on transparency in credit decisions. The ratings are supplemented by a calculation of the maxi- mum debt capacity and the sustainability of debt levels. In dialogue with customers, the focus is primarily on value drivers and the strategy of the company as well as the free cash flow achievable in the long term. With a substantial part of its GDP derived from exports, Switzerland is a leading exporting nation. Con- sequently, our corporate customers with cross-border activities require services such as export finance, docu- mentary credits and guarantees, interest rate and currency hedging, international payment transactions and market information. Zürcher Kantonalbank has proved to be a dependable partner for these companies in this respect. For this purpose, we maintain an international network of correspondents and have our own representative offices in Singapore, Mumbai, Beijing and São Paulo. One of the tasks of these offices is to support the trade and export finance business with banks and Swiss exporters and importers. The four representative offices do not conduct their own busi- ness; instead they provide us with local expertise on the most important export markets of our corporate customers as well as risk assessment information. In 2016, a year characterised by the continuing strength of the Swiss franc and modest economic growth, Zürcher Kantonalbank once again stood side by side with Swiss companies as a dependable partner. Our credit exposure to companies increased to CHF 24.5 billi- on (+ 6.5 percent) in the year under review. Dependa- bility and fairness towards customers who are in financial difficulty are also important to us. Provided future prospects are intact, we can offer flexible solutions. Technological competition demands constant innovation on the part of Zurich as a business location as well as Zurich-based SMEs. With the Swiss Federal Institute of Technology in Zurich, the University of Zurich, the Zurich University of Applied Sciences and the Zurich University of the Arts, the prerequisites for corpo- rate start-ups in the Greater Zurich Area are excellent. To meet the associated financing needs, our “Pioneer” initiative – which supports innovative start-ups with venture capital on a targeted basis – was launched in 2005. Since then, as part of its public service man- date, Zürcher Kantonalbank has invested approximately CHF 115 million in venture capital in 185 companies from the “Information Technology, Communication and Micro Technology”, “Life Sciences and Medical Tech- nology”, “Automation, Sensors and Materials” and “Cleantech” sectors. The current Pioneer portfolio com- prises around 110 start-ups. In the year under review, 27 promising start-ups were recapitalised with venture capital in the amount of CHF 9.5 million. Fig. 8: Composition of the Pioneer start-up portfolio IT, communications, microelectronics 45% Life sciences, medical technology 31% Automation, sensors, materials 18% Cleantech 6% In the year under review, Zürcher Kantonalbank ac- quired a substantial minority interest in “investiere.ch” the leading Swiss investment platform for start-ups. This strengthened our position in the start-up and fin- tech arena. We are also partners to the technology parks Technopark Zurich, Technopark Winterthur, Bio- Technopark Schlieren, and the start-up centres Blue Lion in Zurich, Runway of the Zurich University of Applied Sciences (ZHAW) and Grow in Wädenswil. Jointly with the Swiss Federal Institute of Technology in Zurich and the canton of Zurich, we established the sponsor- 24 Zürcher Kantonalbank Annual Report 2016 ship of the Swiss Innovation Park that will be started in Dübendorf. With the renowned ZKB Technopark “Pioneer Award”, which in 2016 went to Nomoko AG for the development of a new form of camera technology, the bank fosters particularly innovative business ideas. Start-ups in traditional sectors are part of our normal financing operations. In the year under review, we provided finance of CHF 48.4 million to 64 company start-ups. We also work closely with the “GO! Ziel selbstständig” association, helping people to become entrepreneurs with ZKB micro-loans. At the other end of the business cycle, succession planning, we also take care of the needs of SMEs. Not least due to demographic developments, numerous SMEs currently face generational change. Through its comprehensive range of services, the bank provides them with guidance on these issues too. In the year under review, we fulfilled this responsible role in the protection of companies and jobs with 48 consulting mandates and 28 acquisition financings. Zürcher Kantonalbank ensures that small and micro-businesses also receive comprehensive advice and support, as well as a broad range of services on fair terms. That includes almost 4,500 micro-loans of less than CHF 200,000 for SMEs. Capital goods leasing is becoming increasingly important here. For SMEs and the agriculture sector in particular, this represents an attractive, liquidity-preserving alternative to a traditional investment loan. Zürcher Kantonalbank is a leader in the leasing business in the agricultural sector throughout Switzerland. Overall, in the joint distribution network with a large number of other cantonal banks, 2,815 lease agreements with a volume of CHF 227 million were concluded in the year under review. Fig. 9: Corporate customers by number of employees Micro-businesses and small businesses 95% Medium-sized companies 4% Large companies 2% Management Report: Customers Investments and asset management Investment policy The Chief Investment Officer is responsible for the definition and comprehensive communication of the investment policy for retail customers. Thanks to a clear investment philosophy and skilful tactical asset allocation, the assets we manage are aligned with the current market situation in an optimal and broadly diversified manner. Zürcher Kantonalbank’s invest- ment process is built on a risk-based approach and de- signed to exploit earnings potential at every stage, in the context of the customer’s personal ability to bear risk. This involves a high degree of modularity, as this allows portfolios to be personalised to the optimal de- gree and composed transparently according to spe- cific customer requirements. The Investment Solutions team of 50 economists, portfolio managers, mathe- maticians and investment specialists is dedicated to this. In the year under review, the media regularly asked their opinion on global focus issues, in particular the economic slowdown in China and turmoil on the stock markets at the start of the year, the UK referen- dum on leaving the European Union, the monetary policy of the central banks as well as negative interest rates and, of course, the US presidential election and its effect on the financial markets. Our equity and bond research division mostly pro- vides recommendations and ratings throughout Switzer- land on blue chips as well as smaller and medium- sized listed Swiss companies. It is one of Switzerland’s leading research houses for both equities and bonds. In addition, Zürcher Kantonalbank also supports plat- forms with events, such as roadshows and investor meetings, that promote information exchange between investors as well as smaller and medium-sized Swiss firms. With a comprehensive line-up, we offer attractive products and services for both private and institutional clients. The asset management business in particular has achieved positive performance in recent years. In the year under review, a pleasing number of new custom- ers was gained in asset management mandates. When managing portfolios professionally, a clear investment process and risk management are included, covering all asset classes. For private clients, the mandates are implemented with active and passive core investments. They are combined with complementary satellite investments depending on their form. For institutional investors, Zürcher Kantonalbank Annual Report 2016 25 postponement of interest rate hikes in the USA and communications from the European Central Bank also had a significant impact on the stock markets. In this environment, investors carried out more frequent reviews of their strategy and adapted their portfolios accord- ingly. Investors in the structured products business favoured yield optimisation and participation products. In terms of sales of all listed products, Zürcher Kantonal- bank is among the most important providers on the Swiss market. The pleasing trading result in the second half of the year was also achieved on a broadly di- versified basis, with contributions from currency, money market and bond trading in particular, under highly volatile market conditions following the unexpected result of the US presidential elections. Zürcher Kantonalbank can look back on another highly successful year on the Swiss capital market. It was lead manager for the issue of a total of 48 bonds on the capital market worth CHF 8,735 million. A further 23 transactions were carried out for the Mortgage Bond Institution of the Swiss Cantonal Banks, worth CHF 7,381 million. The bank acted as lead manager for a total of 19 equity transactions for companies listed on the SIX Swiss Exchange, representing more than 30 percent of all corresponding business. This included advising Walliser Kantonalbank on the introduction of a modern capital structure in four transaction steps. Besides successful equity offerings (accelerated book- buildings), Zürcher Kantonalbank also assisted Investis Holding SA with its IPO. There were numerous share buybacks as well (from smaller companies to blue chips). The picture is completed by six transactions as lead manager in the over-the-counter segment, in which the capital increase of CHF 171 million for Repower AG deserves particular mention. Management Report: Customers their implementation can be active, passive, rule- based and long-term. In addition, individual investment plans are available for professional clients. Asset Management Zürcher Kantonalbank offers a comprehensive line-up of active, indexed and thematic investment fund and asset management solutions. At the end of 2016, assets under management amounted to CHF 133.2 billion. Index-linked funds business and institutional and private asset management mandates were growth drivers. In the year under review, we followed up the acquisi- tion of Swisscanto, which took place in 2015, with the implementation of a new uniform presence. In the investment business, we now act under the compe- tence brand “Swisscanto Invest by Zürcher Kantonal- bank”. We offer all funds, except for precious metal ETFs, under the new brand. Another highlight was the launch of our range of index funds for private clients. Under the motto “100 % Swiss Made Asset Management”, we made over 40 index funds available to the public. In the year under review, our core tasks – the man- agement of assets and customer support – were accompanied by the search for innovative investment solutions for our customers. In the low interest envi- ronment, taking advantage of alternative risk premiums represents an essential supplement to our traditional services. With the launch of our new investment group “Swisscanto AST Hypotheken”, we made a new in- strument available to occupational pension funds which meets their need for added value and broader diver- sification. Trading and capital markets The trading strategy of Zürcher Kantonalbank is based on a clear customer focus. In the year under review, income from trading operations was 16 percent above the result for the previous year at CHF 379 million. The market risks in the trading book (value-at-risk) amounted to CHF 11 million on average and were slightly lower than the previous year. The first half of the year was initially dominated by macroeconomic factors such as falling interest rates, volatile stock markets and associated reticence on the part of investors. From the spring onwards, discussions focussed on a possible UK exit from the EU, or Brexit. This was also reflected in customer activities. Following the Brexit vote, the pound lost ground against the US dollar in July, before eventually stabilising in August. It fell again in the autumn. Yields on Swiss government bonds reached a new all-time low. The 26 Zürcher Kantonalbank Annual Report 2016 Management Report Employees To allow our employees to fulfil their potential even more successfully in an increasingly dynamic environment, Zürcher Kantonalbank is exploring new ways of management and working together. Zürcher Kantonalbank is built on a corporate culture based on closeness, responsibility and competence. In 2016, senior management decided to allow managers and employees greater freedom. Since it no longer reflects our dynamic environment and the challenges this involves, the annual process of defining objecti- ves and appraising performance has been replaced by the dialogue-oriented and agile “Performance & Development” (P & D) approach. A range of tools have been developed in relation to P & D, to facilitate a modern, dialogue-based management culture. Unless indicated otherwise, the figures and informa- tion below relate to the parent company (excluding subsidiaries and their subsidiaries). Headcount In 2016, the group’s headcount increased by 0.65 per- cent from 5,138.1 to 5,173.3 full-time positions on an annual average. Of these, 23.4 are full-time positions filled by employees employed on a temporary basis. There are 348 employees in training. Fig. 10: Group headcount (FTE) as at 31 December 2016 6,000 5,000 4,000 5,068 4,818 4,844 5,179 5,173 3,000 2,000 1,000 0 2012 2013 2014 2015 2016 Staff development With 421 traineeships, we are one of the largest training institutions in the canton of Zurich, offering training in the working worlds of banking, information tech- nology, logistics and general administration. In the year under review, 99 trainees started their training with us. For the first time in five years, all examination candi- dates from Zürcher Kantonalbank obtained their certifi- cate of proficiency. This fills us with pride and confirms that we look after our students well in every respect. Every student is supported by a supervisor throughout their training, who, besides providing practical train- ing, also places great emphasis on personal support. Our corporate culture underpinned by trust is an important factor for the trainees. Our young employees know about the bank’s sound foundation and that they have a good chance of continuing to be employed after completing their training. More than 80 percent of those trainees who completed their apprenticeships last year will continue their career with us. Development Development – whether internal or external – plays an important role in maintaining and developing competence. We invested CHF 10.7 million in training and development in the year under review. During the year, 556 employees took advantage of external development opportunities. The internal training offer furthers our employees’ personal development. The offering ranges from seminars about digital learning media to individual coaching sessions. For each individual employee, 2.4 internal development days were used. In the year under review, 80 high- achieving employees with potential were also given Zürcher Kantonalbank Annual Report 2016 27 positive working atmosphere. The staff asso ciation took part in a variety of projects in 2016, including the “ZaZu” (future payment transactions) project. The staff association also takes part in negotiations regarding salaries and additional benefits. In all, 41 percent of our employees are members of the association. Five board members head the association. The delegates’ assembly had 39 delegates in the year under review. Employee benefits Our employees are compensated according to the total compensation approach. This compensation consists of a base salary, variable compensation based on the performance of the group, as well as statuto- ry allo w ances and additional voluntary benefits. Please see the compensation report from page 55 onwards. Pension institutions in Switzerland are facing major challenges in guaranteeing pension payments on a sustainable basis. Zürcher Kantonalbank’s pension fund is no exception. Therefore, the management commit- tee of Zürcher Kantonalbank’s pension fund has decided to introduce a package of measures from 1 July 2017 to ensure the long-term maintenance of a solid level of benefits. This includes increasing contributions and raising the normal retirement age from 62 to 64, as well as reducing the technical interest rate from 3 to 2 per- cent and a corresponding reduction in the conversion rate. Transitional solutions are proposed for employees born from 1964 onwards. Zürcher Kantonalbank will fund these solutions to the extent of around CHF 70 million. In the year under review, the bank’s pension fund covered 5,365 active insured persons and 2,067 retirees. As at 31 December 2016, it managed assets of approximately CHF 3.71 billion with a coverage ratio of 112.8 percent (not tested). For further infor- mation on occupational pensions and employee benefits, please see Note 13, page 88. Management Report: Employees the opportunity to develop their career and personal goals through systematic development programmes. Employer commitment Work / life balance We have a wide offering in terms of work / life balance. This ranges from flexible working arrangements to financial support for childcare, reserved crèche places and holiday clubs to tailor-made advice on matters relating to caring for elderly relatives or home nursing care, for instance when needing to find a solution for parents needing care. The aim is to assist and support our employees in different situations in their lives. Our maternity plan, which ensures optimal support for mothers-to-be from the start of pregnancy onwards, is working well. Health promotion Healthcare and health promotion are important con- cerns for us. Together with our external partners, we constantly review and develop the offering. In Novem- ber, we shared our experiences with our advisers regarding external support in order to identify areas for action. The “Friendly Work Space” also means that we are committed to maintaining a high standard of systematic health management in the workplace. We presented our approach at the national conference on health management in the workplace and led a symposium on the theme of “Healthier thanks to Friend- ly Work Space”. In the last year, we also entered into a partnership with the Compasso association, the infor- mation portal for employers focussed on early detecti- on and intervention and occupational reintegration. We want to identify health problems among our emplo- yees at an early stage, in order to put in place the neces- sary measures promptly. Our financially supported healthcare offer was taken up by 179 employees. A further 128 employees took advantage of the mobile health check-ups offered for the second time at major locations. Staff association Zürcher Kantonalbank’s staff association was founded on 11 November 1916 and celebrated its centenary during the year under review. One hundred years later, the original aims still remain relevant: the staff asso cia- tion represents the social, financial and legal interests of all employees, seeks socially and financially sus tain- able solutions in partnership with management, pro- motes cooperative collaboration and helps to create a 28 Zürcher Kantonalbank Annual Report 2016 Management Report: Employees Fig. 11: GRI key figures 1 Employees Employment (parent company) Number of employees (full-time equivalent) Turnover rate Creation of new jobs Health and occupational safety (parent company) Lost days per employee as a result of sickness or occupational and non-occupational accidents Number % % 2016 4,910 5.9 0.6 2015 4,879 6.8 3.7 2014 4,704 7.7 0.6 2013 4,673 7.7 –5.0 2012 4,917 6.5 –0.7 Days / Employee 7.1 7 6.1 6.5 6.4 Continuing education and training (parent company) Internal education and training time per employee Hours / Employee Percentage of employees on external courses Diversity and equal opportunities (parent company) Percentage of women in total workforce Percentage of women in middle management Percentage of women in senior management % % % % 20.5 11.3 37.7 34.2 11.2 19.3 13.4 38.1 33.2 10.6 14.2 14.6 38.5 33.2 10.2 12.6 14.3 39.1 32.8 9.8 16.0 17.3 39.3 32.1 9.5 1 The annual report of Zürcher Kantonalbank adheres to the sustainability reporting guidelines of the Global Reporting Initiative (GRI). The bank publishes a separate sustainability report on its website at www.zkb.ch/sustainability. Zürcher Kantonalbank Annual Report 2016 29 Management Report Analysis of financial statements Management summary Fig. 12: Income structure of Zürcher Kantonalbank (in %) 2016 51 2015 53 2014 59 2013 53 2012 54 32 30 26 25 0 20 40 60 16 15 27 12 16 18 80 1 2 2 5 3 100 Result from interest operations Net commission and fee income Result from trading operations Other ordinary result Development of the operating result On the whole, the operating result increased by 13 per- cent to CHF 752 million in financial year 2016. Results exceeded expectations in particular in the commission and fees business and trading operations. The increase in income exceeds the higher expenses by far. The lower requirement for provisions also had a positive effect. Fig. 13: Performance of operating profit (in CHF million) Operating profit 2015 664 Net interest Commissions Trading Other income Operating expenses Depreciation Provisions Operating profit 2016 +25 +60 +52 –17 – 67 –18 +53 752 0 200 400 600 800 1,000 Increase in group net income from operations and operating result Zürcher Kantonalbank achieved a group net income from operations of CHF 761 million in financial year 2016, 5 percent, or CHF 38 million, higher than in the previous financial year. The operating result amounted to CHF 752 million. It increased by 13 percent, or CHF 88 million, compared to the previous year. Scope of consolidation With the parent company, Zürcher Kantonalbank, the group is the largest cantonal bank in Switzerland. It is positioned as a full-service bank with a regional anchor- ing and national presence. Its primary focus is on customers in the Greater Zurich Area. Furthermore, the broadly diversified group includes Swisscanto Holding Ltd., which is primarily active in the asset management business via its subsidiaries, Zürcher Kantonalbank Finance (Guernsey) Ltd., which focuses on issuing struc- tured investment products, and Zürcher Kantonalbank Österreich AG, which operates international onshore private banking. Please see Note 7 (p. 86) for detailed information on the participation structure. Analysis of the income situation Broad diversification of operating income Operating income in the reporting year increased by around 5 percent and amounted to CHF 2,325 million in the year under review. This mainly comprised income from the interest business (51 percent), commission and fees (32 percent) and income from trading operations (16 percent), and is therefore broad-based. As commis- sion and fees, and income from trading operations performed well, it was possible to improve diversifica- tion further. Not least, this is due to the successful integration of Swisscanto. 30 Zürcher Kantonalbank Annual Report 2016 Management Report: Analysis of financial statements Disclosures on significant compo- nents of the income statement Interest operations The negative interest rate environment remained a major challenge in the year under review. Zürcher Kanto nalbank realised a net result from interest operation of CHF 1,187 million (2015: CHF 1,162 million) thereby exceeding expect ations. This result includes an expense for defaultrelated value adjustments and losses from interest business of CHF 12 million (2015: income of CHF 3 million). The Swiss National Bank charged the bank negative interest rates of CHF 83 million in 2016. Zürcher Kantonalbank passed on the negative interest rates differen tiated on the interbank market and to the credit balances of certain major customers. Retail customers were not charged negative interest rates. Commission and service business Result includes earnings from the securities and invest- ment business, the credit business, the other service business as well as the commission expense. The large increase in results from the commission and service business of 9 percent, or CHF 60 million, to CHF 728 mil- lion is primarily due to the investment business. The latter mainly benefited from significant additional earn- ings in the fund and asset management business. Securities trading and investment activities Zürcher Kantonalbank focuses its trading activities on the customer business. Net income from trading opera- tions increased from CHF 328 million to CHF 379 mil- lion thanks to increased customer activity. Market risks in the trading book (valueatrisk with a 10day hold- ing period) decreased and amounted to CHF 11 million on average (2015: CHF 17 million). The low risk fig- ures for trading reflect the customeroriented strategy. Operating expenses For the purpose of a sustainable human resources policy, the board of directors at the end of 2016 decided that the bank would bear the costs of financing the transitional solutions required due to the realignment of the pension fund as a result of the changed environ- ment (see p. 28). For this reason, a provision for pension benefit obligations was made in the amount of 70 million in the year under review, which was recog- nised under personnel expenses. Excluding this non recurring expense, personnel expenses amounted to CHF 1,009 million (2015: CHF 947 million). The in- crease in personnel expenses is due both to higher variable salary components as well as the inclusion of Swisscanto for a full year (previous year: nine months). General and administrative expenses increased slightly by 1 percent to CHF 433 million. In accordance with the Law on Zürcher Kantonalbank, compensation has been paid for the state guarantee. In 2016 the canton received around CHF 22 million (2015: CHF 21 million), which was charged to general and administrative expenses. Fig. 14: Fiveyear comparison of operating expenses (in CHF million) 2016 1009 2015 947 2014 816 2013 851 2012 870 433 427 375 390 396 1,441 1,374 1,191 1,241 1,266 0 200 400 600 800 1,000 1,200 1,400 1,600 Personnel expenses Other operating expenses Depreciations and provisions expenditure Value adjustments on participations as well as amor tisation of tangible fixed assets and intangible assets in the year under review amounted to CHF 124 million (2015: CHF 106 million). The higher depreciation require- ment is substantially due to a price decline in a listed participation in the first half of the year. The partial ap- preciations in value in the second half of the year were recognised in extraordinary income in line with accounting provisions. Zürcher Kantonalbank assesses default risks as well as all other identifiable risks on a constant basis, where necessary creating corresponding allowances and provisions. The change in the item “Value adjustments for default risks and losses from interest operations” is a component of net interest income. Further information can be found in the section “Interest operations”. The net expense in the income statement item “Changes to provisions and other value adjustments and losses” amounted to CHF 8 million (2015: CHF 61 million). Extraordinary income statement items Nonrecurring and nonoperating income is deemed to be extraordinary income. Extraordinary result amounted to CHF 16 million in 2016 (2015: CHF 66 mil- lion). The higher result in the previous year was mainly due to real estate disposals and appreciations in the value of participations. The tax expense amounted to CHF 7 million (2015: CHF 8 million). Zürcher Kantonalbank Annual Report 2016 31 Management Report: Analysis of financial statements Analysis of the financial and capital position Disclosures on significant components of the balance sheet Credit risks, risks in the investment portfolio, interest rate risks in the balance sheet and liquidity and refinanc- ing risks are described and analysed in the risk report (p. 115 onwards). Balance sheet expansion Total assets increased by CHF 3.6 billion, or 2 percent, and amounted to CHF 158.0 billion on 31 December 2016. The increase is largely due to higher holdings of liquid assets and mortgage loans. On the liabilities side, the increase is due to the securities financing business as well as bonds and covered bonds. More than half the balance sheet was made up of amounts due in respect of customer deposits as well as mortgage loans and amounts due from customers. Liquidity and financial investments Liquid assets consisted mainly of deposits with the Swiss National Bank and totalled CHF 35.3 billion at the end of the year under review (2015: CHF 32.5 billion). These deposits serve to meet Zürcher Kantonalbank’s part icularly high liquidity rules as a systemically impor- tant bank. Furthermore, Zürcher Kantonalbank’s financial investments include extremely high quality fixed- interest securities, which are likewise used for statutorily prescribed liquidity maintenance. The volume at the end of the year under review amounted to CHF 4.2 billion (end of 2015: CHF 4.3 billion). Zürcher Kantonalbank’s comfortable liquidity situation is manifested in the liquidity coverage ratio (LCR) of 132 percent (2015: 128 percent). Amounts due from and liabilities to banks and from securities financing transactions The interbank and securities financing business is used inter alia for short and medium-term liquidity manage- ment. Compared to the previous year, there was a slight decrease in amounts due from banks (2016: CHF 5.4 billion) and amounts due to banks (2016: CHF 34.1 billion). Amounts due from securities financing transactions amounted to CHF 14.9 billion (2015: CHF 15.0 billion) and liabilities to CHF 5.1 billion (2015: CHF 3.0 billion). Amounts due from customers This line item includes all amounts due from non-banks that do not require disclosure under another item. The balance decreased slightly from CHF 7.7 billion to CHF 7.5 billion at the end of 2016. Mortgage loans Mortgage loans increased by CHF 3.7 billion, or 5 per- cent. The volume at the end of 2016 amounted to CHF 77.3 billion. Loan quality remains Zürcher Kantonal- bank’s top priority. Therefore, in view of the latent risk of changes in interest rates, the bank continues to calculate the customer’s ability to afford a property on the basis of a theoretical mortgage interest rate of 5 percent. Trading portfolio assets and derivative instruments The trading activities of Zürcher Kantonalbank contin- ue to be based on a clear customer focus. The composi- tion of trading portfolio assets and other financial 32 Zürcher Kantonalbank Annual Report 2016 instruments at fair value is shown in the financial report in Note 3 (p. 83), the replacement values of the derivative financial instruments in Note 4 (p. 84). Participations, tangible fixed assets and intangible 2015 2,425 assets In the previous year, Zürcher Kantonalbank completed the acquisition of the Swisscanto Group. In addition to the purchase price, the sellers may also receive varia- ble purchase price components in the years 2016 to 2018. These depend in particular on the contribution to earnings of the individual sellers, but also on the general market development and the success of the product range. In 2016, a variable purchase price component in the amount of around CHF 63 million was paid out with a corresponding impact on goodwill. Furthermore, under the item “Non-consolidated partici- pations”, investments were made in the TWINT AG joint-venture (CHF 4 million) and Pfandbriefzentrale der schweizerischen Kantonalbanken AG (capital increase of CHF 22 million) in the year under review. Significant non-consolidated participations, including the share of capital and voting rights, are disclosed in Note 7 (p. 86) of the Financial Report. Tangible fixed assets consist of properties in use and other tangible assets. Investments in tangible fixed assets amounted to CHF 39 million. Further information on the participations, tangible fixed assets and intangible assets can be found in the Financial Report in Notes 6 to 9 (pp. 85 – 87). Amounts due in respect of customer deposits The amounts due in respect of customer deposits con- tain the holdings in savings accounts and other cus- tomer accounts currently and over time. The volume at the end of the year under review remained almost unchanged at CHF 80.9 billion (2015: CHF 80.8 billion). Cash bonds, bond issues and central mortgage institution loans The monies due were replaced in full by issues. Addi- tional capital was also taken up. Refinancing with longer-term deposits increased significantly by CHF 2.3 billion to CHF 17.9 billion at the end of 2016. Balance sheet net equity At group level, net equity comprises corporate capital, retained earnings reserve and foreign currency trans lation reserves as well as group net income. Thanks to internally generated funds, in particular, Zürcher Kantonalbank has increased the net equity by CHF 2.0 billion since 2012. Management Report: Analysis of financial statements Fig. 15: Composition and development of net equity (in CHF million) 2016 2,425 7,678 7,282 2014 1,925 6,914 2013 1,925 6,485 2012 1,925 6,266 691 10,793 722 10,429 647 797 594 9,487 9,208 8,784 0 2,000 4,000 6,000 8,000 10,000 12,000 Corporate capital Profit reserve incl. foreign currency translation reserve Group net income The corporate capital consists exclusively of endow- ment capital. This is made available to the bank by the canton of Zurich for an unlimited term as equity. The endowment capital ceiling approved by the canton- al parliament in 2014 amounts to CHF 3.0 billion. Compared to the beginning of the year, the endowment capital amounted still to CHF 2.425 billion at the end of the financial year. A further strengthening of the equity within the scope of the unused CHF 575 million lies within the competence and responsibility of the board of directors. The retained earnings reserve including currency translation reserve amounted to CHF 7.7 billion at the end of the financial year. Together with the group net income, the reported equity before distribu- tion of net profit amounted to CHF 10.8 billion at the end of 2016. Assets under management At the end of 2016, assets under management amount- ed to CHF 264.8 billion (2015: CHF 257.5 billion). The net new money inflow of managed assets amounted to CHF 8.0 billion (2015: net new money outflow of CHF 2.5 billion). Further information can be found in Note 31 (p. 100). Zürcher Kantonalbank Annual Report 2016 33 Corporate Governance We are conscious of our responsibility towards the canton of Zurich and manage the bank in a prudent, transparent manner. Basic principles Zürcher Kantonalbank is conscious of its responsibility towards the canton of Zurich. That includes being in constant, open and transparent dialogue with our stakeholder groups. In particular, we are accountable to the canton of Zurich, its residents and the cantonal parliament, which is ultimately responsible for the super- vision of the bank. Even though there is no legal requirement to do so, the bank essentially complies with the corporate governance principles of Art. 663b bis of the Swiss Code of Obligations and the Corporate Governance Directives issued by the SIX Swiss Ex- change on 1 January 2016. It also complies with the Swiss Code of Best Practice for Corporate Govern- ance issued by economiesuisse on 29 February 2016, insofar as this is possible for a public-law institution. Unless otherwise specified, the information is applicable as at 31 December 2016. Structure and ownership Zürcher Kantonalbank is a public-law institution of the canton of Zurich. The interests and strategy of the canton are set out in the Law on Zürcher Kantonalbank of 28 September 1997, version dated 1 January 2015. The annual report includes information on the company structure (p. 4), information on ownership (p. 147), companies included in the scope of consolidation (pp. 30 and 72) and changes in equity (p. 70). Board of directors and committee of the board The board of directors consists of 13 members elected by the cantonal parliament for four years, including the three full-time members of the committee of the board. For the current legislative period, beginning on 1 July 2015 until the end of June 2019, the board of directors is made up of the following persons: Dr. Jörg Müller-Ganz Chairman János Blum Deputy Chairman Bruno Dobler Deputy Chairman since 01.07.2011 since 01.07.2011 since 01.07.2011 Amr Abdelaziz Member of the board of directors since 01.07.2015 René Huber Member of the board of directors since 01.11.2014 Hans Kaufmann Member of the board of directors since 24.10.2011 Henrich Kisker Member of the board of directors since 01.07.2015 Mark Roth Peter Ruff Member of the board of directors since 01.09.2013 Member of the board of directors since 01.07.2011 Walter Schoch Member of the board of directors since 01.07.2015 Anita Sigg Member of the board of directors since 01.07.2011 Rolf Walther Member of the board of directors since 01.10.2010 Stefan Wirth Member of the board of directors since 01.07.2011 All members of the board of directors are Swiss nation- als residents in the canton of Zurich. No member has ever served on the bank’s executive board. None of the part-time members of the board of directors has sig- nificant business connections with the bank as defined in the SIX directives. The committee of the board is an independent body. Its members are subject to the same rules as all employees of Zürcher Kantonalbank, except for the provisions of the regulations approved by the cantonal parliament governing the compensation of the members of the board of directors of Zürcher Kantonalbank dated 25 November 2004. Zürcher Kantonalbank Annual Report 2016 35 Corporate Governance The duties of the board of directors and committee of the board are set out in sections 15 and 16 of the Law on Zürcher Kantonalbank, sections 29, 30 and 33 of the bank’s organisational regulations of 23 June 2011 and other specific regulations. As laid down in section 14, paragraph 3, of the Law on Zürcher Kantonalbank, members of the board of directors may not work for any other bank; nor may they be a member of the canton al government, cantonal parliament or highest cantonal courts. In addition, members of the board of directors are not permitted to work for the tax authorities. The cantonal parliament of Zurich elects the mem bers of the board of directors and the committee of the board for a four-year term of office. In electing the members, it focuses on personal characteristics such as assertiveness, credibility and integrity, suitability with regard to banking expertise (knowledge and experience in the areas of corporate strategy, banking, finance and controlling, information technology, human resource management, risk management, leadership and organi sation, law and corporate governance in the public sector, experience in politics and public offices), regula tory requirements and proportional political rep resentation. The professional criteria for each individual member of the board of directors are reviewed by external specialists on a regular basis. Members are eligible for re-election. There are no restrictions on periods of office for members of the committee of the board. For the other members of the board of direc tors, the total period of office may not exceed twelve years. The term of office ends at the latest on the member’s 70th birthday. If members of the committee of the board reach their 65th birthday during their term of office, their time in office ends when their term of office expires. Internal organisational structure Board of directors Key responsibilities of the board of directors: It p sets out the principles of the corporate strategy, mission statement, business strategy and organisational structure p approves the risk policy, risk strategy and bank-wide risk and global limits and approves any equity investments p is responsible for establishing and closing branches and for establishing subsidiaries p is responsible for setting up an internal controls system (ICS) p determines the group and financial planning p draws up guidelines on human resources policy as part of the bank’s overall strategy p is informed quarterly on risk concentration in accordance with Article 95, paragraph 1 of the Ordinance on Capital Adequacy and Risk Diversification for Banks and Securities Dealers p is informed of the reporting on country limits p approves the detailed quarterly reports from the executive board p is regularly informed by the executive board of all relevant aspects of risk management p approves unsecured loans in excess of CHF 1 billion p is regularly informed of loans under the jurisdiction of the committee of the board p approves the annual planning, annual financial statements and the annual report including the compensation report p is responsible for hiring and dismissing the members of the executive board and their deputies, branch managers at senior level, and the chief inspector and deputy chief inspector p decides on the annual distribution of profit to the canton and municipalities Fig. 16: Corporate governance at the board of directors level Financial Market Supervisory Authority (FINMA) Cantonal parliament Supervisory committee on commercial undertakings AWU External audit Committee of the board Board of directors Inspectorate (audit) Audit committee Risk management committee Compensation and personnel committee IT committee 36 Zürcher Kantonalbank Annual Report 2016 Corporate Governance The board of directors bears ultimate responsibility for the management of the bank and for the supervision of the individuals entrusted with its operational manage- ment (section 15 of the Law on Zürcher Kantonalbank). Its key responsibilities in accordance with legal and regulatory requirements are listed on page 36. The board of directors attends to the group strate- gy in an annual cycle. It analyses strengths and weak- nesses, opportunities and risks for Zürcher Kantonalbank, along with the associated strategic risks. This also in- cludes related planning, controlling and reporting activi- ties. Regular discussions are held on risk management, risk reporting and the supervisory report by auditors Ernst & Young as well as measures and reporting related to the public service mandate and sustainability. The board of directors took decisions on credit and limit ap- plications in addition to other transactions within its remit. It informed itself of the effects of geopolitical events and the situations on the financial markets, in particular seeking guidance on the prevailing foreign exchange and interest rate situations, and continued to pursue the developments regarding the taxation trea- ty with the USA and other countries. In the year under review, the board of directors dealt on an in-depth basis with the emergency plan required due to systemic importance and sought guidance on further develop- ments relating to the regulatory requirements. This also included safeguarding liquidity and dealing with exception regulations. It closely oversaw the integra- tion activities of Swisscanto in the group as well as the activities and consequences relating to payment trans actions outsourcing. Furthermore, in the year under re- view, it dealt with international business, approved modifications to the parent company’s compensation model and handled the consequences of adjustments to Zürcher Kantonalbank’s employee pensions. The board of directors underwent a Board Effectiveness Re- view, overseen by external experts, to optimise its functioning. In the year under review, the board of directors appointed five new branch managers, a new Deputy CFO and the Head of Institutionals & Multinationals. Ten regular meetings were held; they were also attend- ed by some or all members of the executive board as well as the chief inspector. Representatives of Ernst & Young attended 3 meetings. The board of directors also held a twoday retreat to discuss strategic issues. Subsequent to the meetings of the board of directors, it regularly dealt in-depth with individual topics such as trading activity or aspects of group management by holding workshops. Two members of the board of directors also made visits to ten branches and five specialist units. Board of directors committees Four committees assist the board of directors in its decisions by providing preliminary advice: p Audit committee p Risk management committee p Compensation and personnel committee p IT committee To assist in the preparation of its resolutions, the board of directors has various committees: audit, risk manage- ment, compensation and personnel, and IT. The com mittees have no decisionmaking powers; instead they have a preliminary consultative function, make proposals, and meet as often as business requires. Infor- mation on the work of the committees is presented at every meeting of the board of directors. Twice a year, the committee chairmen hold a joint coordination meeting with the committee of the board. Where possi- ble, subjects concerning the various committees are dealt with at joint meetings coordinated by the commit- tee of the board. In addition, minutes of the individu- al committees are submitted to all members of the board of directors. Committee of the board Key responsibilities of the committee of the board: It p prepares topics relating to strategy and corporate culture for submission to the board of directors p scrutinises the decisions of the executive board and is responsible for its direct supervision p monitors the execution of resolutions passed by the board of directors p approves unsecured loans in excess of CHF 75 million p decides on the purchase and sale of real estate in addition to renovations and new building projects in accordance with the delineation of powers laid down by the board of directors p approves the payment of accounts for building projects authorised by the board of directors p takes decisions on providing assistance to business, social and cultural institutions p decides on the bank’s membership of, and representation in, organisations p is informed of the reporting on country limits p is informed of new credit transactions that fall under the jurisdiction of the executive board p is informed of the course of business at subsidiaries p is responsible for hiring and dismissing members of senior management, as well as their promotion p reviews the legal, tax and compliance reports on a half-yearly basis p is regularly informed of major risk positions p deals with pressing matters that fall under the responsibilities of the board of directors and subsequently obtains the board’s approval p in the event of escalation decides on transactions with particular business policy risks, conflicts of interest and particular effects on reputation p regularly monitors the quality and effectiveness of the fulfilment of the public service mandate Zürcher Kantonalbank Annual Report 2016 37 Corporate Governance The committee of the board is an executive body in its own right alongside the board of directors. Section 16 of the Law on Zürcher Kantonalbank states that the committee of the board is responsible for the direct supervision of the executive board. In this context, the committee monitored the implementation of deci- sions of the board of directors and compliance with statutory and regulatory requirements. Within the frame- work of such statutory and regulatory requirements, it took decisions on various operational and electoral matters. The committee of the board also made pre parations for the discussion of the public service man- date on the board of directors and in this connection is also responsible for sustainability issues. Jörg Müller-Ganz is chairman; János Blum and Bruno Dobler are the deputy chairmen. Anita Sigg and Rolf Walther have been elected as substitute members of the committee of the board. In addition to addressing strategic, planning, organi- sational and human resources questions as well as issues concerning corporate culture, the committee of the board, in accordance with statutory and regulatory com- petencies, dealt at its weekly meetings in the year under review with credit and limit transactions within its area of responsibility following the applicable regula- tions, as well as transactions involving potential reputa- tion risk. Members of the executive board, the chief inspector and representatives of the specialist units were also invited to attend on a regular basis. The commit- tee of the board met several times in its function as a strategic committee for the board of directors. In addition, it continuously dealt with current geopolitical and national events and their possible effects on the markets and the bank. The committee of the board kept itself up to date on the consequences of the low interest rate policy and regulatory changes. It monitored the progress of Swisscanto’s integration and develop- ments of important bank projects, obtained guidance on the performance results of asset management mandates and was continuously involved with the activi- ties relating to the tax dispute with the USA. In addi- tion, it dealt with succession planning for key individuals at the bank. Besides deciding on any immediate measures on the basis of objections in audit reports, the committee of the board closely oversaw implementation of regulatory requirements and, on behalf of the board of directors, discussed requests from the Financial Markets Supervi- sory Authority, FINMA, as well as those from the cantonal parliament. The committee of the board main- tained contact with FINMA, in particular also in the context of developing regulation of equity for systemi- cally important banks with a domestic focus. In order to better promote the interests of Zürcher Kantonalbank among important decisionmakers in politics and busi- ness, it established close collaboration with the newly established Public Affairs specialist unit. It also decided on sponsorship commitments under the public service mandate. It cooperated with the board committees in preparing the substantive decisions and personnel decisions as well as the basic principles for the statu tory and strategic adjustment requirement on behalf of the board of directors and ensured their swift implemen- tation. The committee of the board represented Zürcher Kantonalbank in the course of regular discus- sions between the bank chairmen in the context of the Association of Swiss Cantonal Banks and various representation events in culture, politics, environ- ment and business. In accordance with an agreed time- table, the members of the committee of the board visited all market areas and specialist units, subsidiary companies and branches. Audit committee The audit committee supports the board of directors in its supervisory and control functions in accordance with section 15a of the Law on Zürcher Kantonalbank, section 32 of the organisational regulations of Zürcher Kantonalbank and FINMA Circular 2008 / 24 on monitor- ing and internal control systems for banks. Within its remit, it prepares specialist resolutions of the full board of directors and, in this regard, is responsible in par ticular for critically analysing the published annual and interim financial statements of the parent company and group. In addition, the audit committee assesses the functionality of the internal control system in particular also with respect to compliance with standards. The audit committee comprised Mark Roth (chair- man), Amr Abdelaziz, René Huber, Hans Kaufmann and Henrich Kisker as at 31 December 2016. The chief inspector, Walter Seif, attends all meetings of the audit committee as a permanent guest. The audit committee held a total of twelve meetings lasting several hours in 2016. All meetings with agen- da items relating to financial planning, management and reporting were attended by the CFO. In relation to specific subject matter, the meetings were also attended on a regular basis by the external auditors, the CEO, CRO and Head of Legal, Tax & Compliance. Depending on their importance, various agenda items were discussed with the committee of the board, the risk management committee or jointly. The relevant management decision-makers were also involved in the discussions on a regular basis. 38 Zürcher Kantonalbank Annual Report 2016 Corporate Governance At each meeting, attention focused on financial repor- ting (monthly, quarterly, half-yearly and annual reporting including disclosures) as well as the handling of the external and internal audit reports. A total of 51 internal and 29 external audit reports were discussed. This also comprised assessment of the appropriateness of measures taken by the entities audited, the ap- proval of internal audit reports, as well as reporting by internal audit on the effective implementation of the measures decided. At several meetings and at the annual workshop organised by internal audit, advice was provided about key changes in the risk profile as well as the conse- quent setting of audit objectives for internal and exter- nal auditing. Particular attention was paid to the sys tematic, total coverage of the regulatory audit universe on a multiyear cycle by internal and external auditing. Other important activities and those required by the regulator in the year under review included: p analysis and assessment of reporting on the structure and effectiveness of the internal control system for all business units and subsidiaries of the bank p discussion of the quarterly reports by Legal, Tax & Compliance and a forward-looking assessment of statutory and regulatory developments p treatment of the annual assessment of compliance risks based on the compliance risk inventory and related risk-oriented activities undertaken and planned by the Compliance function p critical assessment of the report on the regulatory audit and the report on the accounting audit p assessment of the performance of the internal auditors p assessment of the performance and remuneration of the external auditors In relation to financial control, the audit committee dealt with the bank’s financial strategic parameters in the year under review. The audit committee paid special attention to an appropriate risk element when measuring profitability. Furthermore, the bank’s finan- cial value added was assessed and compared with other banks on the basis of the CFO’s annual benchmarking study. Other important topics for the audit committee in the year under review were: p the systemic importance of the bank, the conse quences derived accordingly as well as the stabilisation and emergency plan p business performance and multiyear financial planning p current challenges in the funds and investment business On a regular basis, the chairman of the audit committee discusses the regulatory and accounting audit with the external auditors’ partner responsible as well as with the chief inspector and CFO. He is responsible for determining the audit committee’s annual targets and its systematic, thorough and critical selfassessment. He also briefs the board of directors on an eventrelated basis about the committee’s activities as well as current issues and challenges. Compensation and personnel committee The compensation and personnel committee assists the board of directors in connection with human re sources strategy, as well as personnel and compensation policy. It assists the board of directors by providing preliminary advice and issuing recommendations on these matters. As at 31 December 2016, the com p ensation and personnel committee comprised Peter Ruff (chairman), Amr Abdelaziz, Bruno Dobler, Anita Sigg and Stefan Wirth. The compensation and personnel committee met on 10 occasions in the year under review, with all meetings attended by the Head of Human Resources or his deputy. Depending on the topic, the CEO, CFO, Head of the Institutionals & Multinationals business unit and other representatives of the specialist units partici- pated in the meetings. The committee also conducted a workshop in which the challenges for the human resources strategy and policy arising from the demo- graphic changes and other condition risks relating to human resources policy topics were discussed. The members of the compensation and personnel com- mittee attended a meeting of the audit committee in connection with the compensation report. As is normally the case, the compensation and per sonnel committee was informed about the implementa- tion of the human resources strategy, in particular about issues of promotion, disciplinary cases, dismissals, as well as staff training and development. For the annual report it verified the compensation report and discussed executive board compensation, the bonus for trading staff, the implementation of the bankwide salary and bonus system as well as the parameters for the 2016 deferred component. On behalf of the board of directors, the personnel committee reviewed a change to the parent company’s compensation system model and dealt indepth with the subsidiaries’ com pensation systems, in particular those of Swisscanto. It also obtained guidance regarding the salary trends on the market and committed itself to the process of integrating Swisscanto’s employees. The compensa- tion and personnel committee provided preliminary advice to the board of directors regarding applications for branch manager appointments, new appointments Zürcher Kantonalbank Annual Report 2016 39 Corporate Governance for the Deputy CFO and the Head of Institutionals & Multinationals and was briefed about succession arrange- ments for key individuals. In the year under review, the compensation and personnel committee also dealt with measures relating to the advancement of women. Another focal point in the year under review was Zürcher Kantonalbank’s pension fund solution; the board of directors received preliminary advice in this regard. Furthermore, the personnel committee re- viewed how employees were handled during change management processes in the context of the payment transactions project. Due to the new focus of ZKB’s performance management, the compensation and per- sonnel committee also dealt with the abolition of the MbO, performance value and employee appraisal and obtained information on and discussed the new “Performance and Development” tool. Risk management committee The risk management committee assists the board of directors in relation to the supervision of the bank’s risk management and compliance with regulatory require- ments regarding the management of risk. It prepares the relevant business for the board of directors. As at 31 December 2016, this committee comprised Rolf Walther (chairman), János Blum, René Huber, Hans Kaufmann and Anita Sigg. The risk management committee has a preliminary consultative role on behalf of the board of directors. It evaluates the quality, adequateness and effectiveness of the processes and procedures for identifying, as sessing, limiting, controlling and monitoring risks. It is informed of standard reports, stress scenarios and risk reports on a regular basis. The quarterly report by the Chief Risk Officer, giving an account of credit, market, liquidity, operating, compliance and reputation risks, is an important tool for the committee in terms of performing its role, although indepth evaluation of compliance risks falls within the remit of the audit committee. It also takes note of changes relevant to risk, especially in the mortgage business, international risks, deterioration in the economic situation and risks in other business areas. The risk management committee keeps itself informed of credit exposures and limits on a periodic basis, in particular on the credit and limit transactions within the remit of the board of directors. The risk management committee provides prelimi- nary advice on strategic credit and limit applications and other matters within the remit of the board of direc- tors from a risk perspective, receives annual reports on the adequateness and effectiveness of internal controls in the business units together with the audit committee, evaluates the completeness of the risk inventory and submits recommendations concerning risk policy para meters and strategic risks to the board of directors. The risk management committee also discusses the find- ings in the riskrelevant audit reports and notes the minutes of the operating risk subcommittee. The risk management committee held 10 meetings in the year under review, which were attended by the Chief Risk Officer or the Head of Risk Controlling and the Head of Audit. It also met once for a workshop held on the topic of condition risks. Depending on the subject matter, other representatives of the specialist areas also attended the meetings. A further two meetings took place in the context of the meetings of the audit committee. In the year under review, the commit- tee dealt in detail with the effects of the negative interest rate on asset and liability management. The committee also kept itself up to date on the impend- ing introduction of the “Internal Ratings Based” approach. It also promptly obtained guidance on the measures taken and effects of the United Kingdom’s decision to leave the EU. The continuing banking crisis in Europe (Italy, Austria, etc.) was also focused on regularly. The committee also informed itself on the developments and measures taken regarding cyber risks in the context of operational risks. With respect to country risks, it followed international developments, in particular those in Turkey after the military coup, in the United States after the elections, in Brazil and in other countries. The committee also paid particular attention to specific industries in Switzerland such as the electricity industry. In addition, it received regular reports on liquidity risk management, concentration risks, exposures to central counterparties and exception to-policy transactions. IT committee The IT committee assists the board of directors in determining and monitoring the IT strategy. It advises the board of directors on all issues relating to inform ation technology, including telematics, of the entire bank and provides it with relevant recommendations. For this purpose, it forms a picture of IT’s contribution to the bank’s performance. Furthermore, it assesses the costs and investment framework for IT by considering the potential effects on current and future courses of action as well as business risks. Finally, it assesses the functionality of the management of IT risks with an impact on IT-related investment risks. In 2016, the IT committee comprised Walter Schoch (chairman), Henrich Kisker, Jörg MüllerGanz and Stefan Wirth. The IT committee held five regular meetings 40 Zürcher Kantonalbank Annual Report 2016 Corporate Governance and one extraordinary meeting in the year under review; all were attended by the Head of Logistics. guidelines and structures its procedures in accordance with recognised international auditing standards. The IT committee discussed a total of 15 audit re- ports with relevance to IT. It was informed on a regular basis about the completion status of relevant findings of the auditors. The IT committee dealt with the 2015 IT annual report and on a quarterly basis with the stra tegic IT report. The chairman of the IT committee in the board of directors was informed in this respect. These reports include the key indicators for IT as well as the status of the most important IT programmes. In this re- spect, the committee obtained guidance on the most important programmes in the portfolio from individuals directly responsible for them. In addition, IT planning was dealt with in several meetings. The IT committee was shown how financial resources are prioritised in accordance with the bank’s strategic guidelines. The IT committee dealt on a regular basis with IT security matters and risk management. It received reports on, for instance, the threat situation and security roadmap, the restoration of data as well as security tests by means of covert attacks on the IT systems. For the purpose of a general orientation on import ant IT matters, the committee dealt with the IT architec- ture, technological innovations and data management. Further focal points were Zürcher Kantonalbank’s takeover of Swisscanto, payment transactions of the future as well as the customer interface program projects. In addition, the IT committee was informed about further strategic IT projects. Audit Audit is responsible for the group’s internal auditing. It is led by Walter Seif and has 49.5 employees (FTE). In organisational terms, Audit reports directly to the board of directors and is independent of the executive board. It assists the board of directors and its committees in fulfilling their supervisory and control tasks by using a systematic, riskoriented approach to evaluate the effectiveness of risk management, controls, as well as management, performance and monitoring processes, and submit recommendations for optimisation. Audit also examines compliance with the regulatory provisions, internal directives and guidelines in all areas of the business. To perform its audit role, Audit has unlimited rights of inspection, information and access within the bank and group companies. Audit is not bound by any directives in substantive terms and generally reports to the audit committee, the committee of the board (which can take immediate measures), the CEO, the relevant members of the executive board and other managers. Audit pursues stringent quality Auditors Under the Law on Zürcher Kantonalbank, the cantonal parliament appoints the external auditors for a two year period. The external auditors must be recognised by the Swiss Financial Market Supervisory Authority (FINMA). On 25 April 2016, the cantonal parliament confirmed the appointment of Ernst & Young as auditors for 2017 and 2018. Rolf Walker is the auditorincharge for the accounting audit. As second auditorincharge, Dr Andreas Blumer is responsible for the regulatory audit. In the year under review, Ernst & Young charged CHF 5.1 million (2015: CHF 3.8 million) for regulato- ry audits (basic and additional audits), the audit of the annual financial statements of the bank and group companies as well as the consolidated financial state- ments. Ernst & Young charged CHF 9,000 (2015: CHF 14,000) for additional consulting services and CHF 2,500 (2015: CHF 24,000) for auditrelated services. Furthermore, Ernst & Young charged CHF 2.8 million (2015: CHF 1.9 million) for auditing collective capital investments via group companies. External Audit works together with Audit and, to the extent permitted, bases its work on theirs. Cantonal parliamentary committee Responsibility for the ultimate supervision of Zürcher Kantonalbank lies with the cantonal parliament. Its tasks are laid down in section 11 of the Law on Zürcher Kantonalbank. In addition to the election of the mem- bers of the board of directors and committee of the board, these tasks include approving guidelines for the fulfilment of the public service mandate, as well as regulations governing the compensation paid to mem- bers of the board of directors and inspecting the annual financial statements and annual report of the bank, as well as discharging the governing bodies. The cantonal parliament of Zurich has charged the com- mittee on commercial undertakings with ultimate supervision in accordance with section 12 of the Law on Zürcher Kantonalbank. This standing, supervisory cantonal parliamentary committee inspects the minutes of the board of directors and, depending on the mat- ter concerned, obtains information from the chairman, committee of the board, members of the board of directors, the Chief Executive Officer, other members of the executive board or representatives of the auditors with regard to the direction and results of the bank’s business activities and important events. As at Zürcher Kantonalbank Annual Report 2016 41 Corporate Governance 31 December2016,thiscantonalparliamentarycom mitteecomprisedthefollowingmembers: astheannualreport(includingthesustainabilityreport), whichalsoaccountsforthepublicservicemandate. Publicservicemandate Aspartofthestrategyprocess,theboardofdirectors, committeeoftheboardandexecutiveboarddealona regularbasiswiththesubjectofthepublicservice mandate.Theyensurethatthestatutoryparametersand strategicallydefinedtargetsaremet.Thecommittee of theboardisassignedspecialresponsibilityforcontrol andmonitoring(sections9and10oftheGuidelines for theFulfilmentofthePublicServiceMandate).The centralbodyistheinternalspecialistcommitteefor the publicservicemandate,whichismanagedbythe HeadofCorporateResponsibility.Itadvisesandsup ports thebank’sgoverningbodiesandbusinessunitson allaspectsofthepublicservicemandateandreports annuallyonthefulfilmentofthemandatetothe super visorycommitteeofthecantonalparliament. Allbusinessunitsarerepresentedonthesteering committeeforthepublicservicemandatebyamanager withresponsibilityfortherelevantarea.Thespecialist areaofthepublicservicemandateispartofCorporate Development.Itcoordinatesplanning,implementation andreportingofthepublicservicemandateandallasso ciatedactivities.Italsopreparesthebusinessofthe steeringcommitteeforthepublicservicemandate. Vari ousspecialistareaswithintheindividualbusinessunits assistwiththeachievementofobjectives. BeatBloch,Zurich,CSP BeatHuber,Buchs,SVP Chairman DeputyChairman AndréBender,Oberengstringen,SVP Memberofthecommittee ReinhardFürst,IllnauEffretikon,SVP Memberofthecommittee NikGugger,Winterthur,EVP AstridGut,Wallisellen,BDP BeatHabegger,Zurich,FDP RolandMunz,Zurich,SP MartinRomer,Dietikon,FDP Memberofthecommittee Memberofthecommittee Memberofthecommittee Memberofthecommittee Memberofthecommittee HansW.Wiesner,Bonstetten,GLP Memberofthecommittee EvaMariaWürth,Zurich,SP Memberofthecommittee Information and control instruments Theboardofdirectorsandcommitteeoftheboard are briefedonaregularbasisonthecourseofbusiness and themainactivitiesoftheexecutiveboardaswell as onsignificantdevelopments.Attheinvitationofthe committeeoftheboard,membersoftheexecutive boardattendallmeetingsoftheboardofdirectorsto informitsmembersoncurrentissuesandareinvolved in thestrategyandplanning.Thecommitteeofthe boardscrutinisesallminutesofthemeetingsofthe ex ecutiveboard,businessunitsandcommittees.If re quired,theremainingmembersoftheboardofdirectors requestadditionalinformationontherelevantmin utes. Atleastonceeveryquarter,theboardofdirectors receivesadetailedbriefingonthecourseofbusiness, developmentsinkeyriskcategories(includingcompliance risks),aswellasonthestatusofimportantprojects. The monitoringofreputationriskisalsoincluded. A re portproducedbythelegal,taxandcomplianceunitis submittedtotheboardofdirectorsandexecutiveboard everyyear,pursuanttom.n.112FINMACircular08/24. Theantimoneylaunderingunitalsoreportstoit. Moreover,ZürcherKantonalbankhasanAuditunitthat reportsdirectlytotheboardofdirectorsandisinde pendentoftheexecutiveboard.TheAuditunitassists theboardofdirectorsandcommitteeoftheboard in fulfillingtheirsupervisoryandcontroltasks,andhas unlimitedrightsofinspectionandinformationwithin the bank.Itreportstotheauditcommitteeandthe com mitteeoftheboard,andasrequired,butatleast once peryear,totheboardofdirectors.Thesupervisory committeeofthecantonalparliamentofZurichon commercialundertakingsmonitorsthefulfilmentofthe publicservicemandateinaccordancewithsection12 of theLawonZürcherKantonalbank.Thisisprimarily basedonanannualfocusreport,thethemeofwhich changesannuallydependingonAWU’srequestsaswell 42 Zürcher Kantonalbank Annual Report 2016 Executive board Areas of responsibility Corporate Governance Details of the responsibilities of the committee of the board, board of directors, executive board and auditors are laid down in the Law on Zürcher Kantonalbank of 28 September 1997 (sections 15 to 18) and the organisa tional regulations of the Zürcher Kantonalbank group of 23 June 2011 (sections 29 to 37 and section 39). Management contracts No management contracts as defined in annex 4.4 of the SIX Swiss Exchange Corporate Governance Directive have been concluded by the group and its subsidiaries with any third parties. Communication policy Zürcher Kantonalbank pursues a transparent commun ication policy towards its stakeholder groups. The most important communication tools are the compre hensive annual report, sustainability report, half- yearly report and press conferences. The 2016 annual results were announced on 10 February 2017, and the annual report is to be discussed in the cantonal parlia ment on 15 May 2017. The bank’s half-yearly results are expected to be published at the end of August 2017. The executive board of Zürcher Kantonalbank has eight members. It is headed by Martin Scholl (Chief Executive Officer, CEO). Under section 17 of the Law on Zürcher Kantonalbank, the executive board is responsible for managing the bank’s operations. The members of the executive board perform an advisory role on the board of directors and the committee of the board. The executive board is responsible for business as well as human resources matters where they concern the management of the bank. With the exception of Audit, it is responsible for the appointment and dismissal of senior executives. The executive board is responsible for those func tions laid down by law. The organisational structure is laid down in the regulations regarding the executive board (group and parent company) of 23 June 2011. Sections 8 to 10 of the regulations govern their joint areas of responsibility. Under section 11 of the regula tions, the Chief Executive Officer is entrusted with the following tasks: managing the executive board, im plementing the group mission statement and group strategy, organisation and management guidelines, as well as representing the executive board outside the bank, coordinating the business activities of the execu tive board, and ensuring that the duties assigned by the board of directors and the committee of the board are carried out. The Chief Executive Officer reports to the committee of the board / board of directors. He has a right of veto on bank policy and strategic matters. Subject to the responsibilities of the board of directors and the committee of the board, the individual mem bers of the executive board report to the CEO. Members of the executive board All members of the executive board are Swiss nationals. Compensation, profit-sharing and loans are listed on page 63 of the compensation report. As at 31 December 2016, the executive board comprised the following members: Martin Scholl Christoph Weber Heinz Kunz Chief Executive Officer Member of the Executive Board since 2002 Head of Private Banking, Deputy Chief Executive Officer Member of the Executive Board since 2008 Dr. Stephanino Isele Head of Institutionals & Multinationals Head of Corporate Banking Member of the Executive Board since 2010 Member of the Executive Board since 2014 Daniel Previdoli Rudolf Sigg Roger Müller Dr. Jürg Bühlmann Head of Products, Services & Direct Banking Member of the Executive Board since 2007 Chief Financial Officer Chief Risk Officer Head of Logistics Member of the Executive Board since 2008 Member of the Executive Board since 2014 Member of the Executive Board since 2012 Further information about the individual members of the executive board can be found on pages 50 to 53. Zürcher Kantonalbank Annual Report 2016 43 Corporate Governance Committee of the board Jörg Müller-Ganz Dr. oec. University of St. Gallen; Swiss / German national; born in 1961 Chairman Main appointments: Member of the Board of Trustees of Innovations- park Zurich, Zurich Zoo, Zurich and ETH Foundation, Zurich; Board of Directors of Technopark Immobilien AG, Zurich and Opo Oeschger AG, Kloten Jörg Müller-Ganz, who holds a doctorate in economics from the Uni- versity of St. Gallen, was appointed to the board of directors in 2007. He joined the committee of the board in October 2010. From 1992 to 2010 he was consultant, CEO and partner at the Helbling Group. He also lectured on the subject of corporate finance at various universities. Prior to that, he worked at Bank Vontobel and Credit Suisse. He is a member of the IT committee. He was appointed chairman of the board of directors of Opo Oeschger AG, Kloten, in 2015. János Blum Dr. sc. math. ETH Zurich and lic. oec. University of St. Gallen; Swiss / Hungarian national; born in 1957 Deputy Chairman Main appointments: Chairman of the management committee / employer representative of the Zürcher Kantonalbank pension fund, Zurich; chairman of the Board of Trustees / employer representative of Zürcher Kantonalbank’s Marienburg foundation, Zurich; member of the Boards of Trustees of the Center for Corporate Responsibility and Sustainability at the University of Zurich, Zurich; and Chance, Zurich; shareholder of Blum Real GmbH, Hungary A mathematician (Dr. sc. math. ETH) and economist (lic. oec. University of St. Gallen), János Blum was elected to the board of directors in 2002 and to the committee of the board in 2011. From 1989 until 2011, he worked as an actuarial mathematician. Following various roles with Swiss Re, he was appointed chief actuary at Zurich Re, followed by Allianz Risk Transfer. He went on to work for Milliman AG and as partner for Prime Re Solutions AG, which specialises in business consult- ing in the insurance and finance sectors. Since 2015, he has been chairman of the board of trustees / employer representative of Zürcher Kantonalbank’s pension fund and Marienburg foundation, Zurich as well as a member of the risk management committee, which he chaired from 2003 until 2011. Dr. János Blum is shareholder of Blum Real GmbH, Hungary. 44 Zürcher Kantonalbank Annual Report 2016 Corporate Governance Bruno Dobler Executive MBA University of St. Gallen; Swiss national; born in 1952 Deputy Chairman Main appointments: Chairman of the Board of Trustees of SanArena, Zurich; member of the Board of Trustees of Excellence Foundation, Zurich; member of the advisory boards of the University of Zurich, Department of Economics, Zurich, and Umwelt Arena, Spreitenbach; member of the Board of Directors of B+D Beteiligungen, Eglisau; member of the Aviation Experts Group Bruno Dobler (Executive MBA University of St. Gallen) was elected to the committee of the board in 2011. After completing his banking apprenticeship and before studying to become an airline pilot, he trained with the former Union Bank of Switzerland for five years. In 1979 and 1985 he set up two airlines, which he managed as chair- man and CEO. From 2006 to 2008, he was CEO of Helvetic Airways and from 2008 to 2011 of Toggenburg Bergbahnen AG. He was a can tonal parliament member from 1995 to 2003. Bruno Dobler is chairman of the board of trustees of SanArena, Zurich and a mem- ber of the compensation and personnel committee of Zürcher Kantonal bank. He is a member of the board of directors of B+D Beteiligungen, Eglisau, and a member of the Aviation Experts Group, and a member of the advisory boards of Umwelt Arena, Spreitenbach, and the University of Zurich, Department of Economics, Zurich. Zürcher Kantonalbank Annual Report 2016 45 Corporate Governance Board of directors 46 Zürcher Kantonalbank Annual Report 2016 Amr Abdelaziz Lawyer; Swiss / Egyptian national; born in 1977 Member of the board of directors Main appointments: none Amr Abdelaziz studied law at the University of Zurich and completed a postgraduate degree in European law (LL. M.) from the College of Europe. He was appointed to the board of directors in 2015. From 2007 until 2015, he worked as a lawyer for the CMS of Erlach Poncet AG, Zurich specialising in cartel investigations. He manages his own law firm in Zurich today. He is a member of the audit committee and the compensation and personnel committee of Zürcher Kantonalbank. René Huber Swiss certified banking expert; Swiss national; born in 1956 Member of the board of directors Main appointments: Mayor of the Kloten political municipality since 2006; chairman of the Board of Directors of the Glatt Valley transport authority (Verkehrsbetriebe Glattal AG), Glattbrugg since 2011; Member of the Board of Directors of Seitzmeir Immobilien AG, Zurich, since 2016 René Huber has been a member of the board of directors since 1 November 2014. Until October 2014, he was a senior private clients adviser at UBS AG in Kloten. Prior to that, he served in various roles at UBS AG. He is a substitute member of the management committee (as employer representative) of Zürcher Kantonalbank’s pension fund and a member of the audit committee and risk management committee of Zürcher Kantonalbank. Hans Kaufmann lic. oec. publ. University of Zurich; Swiss national; born in 1948 Member of the board of directors Main appointments: Chairman of the board of directors of Kaufmann Research AG, Wettswil Hans Kaufmann joined the board of directors in 2011. From 1999 to May 2014 he was a national councillor for the SVP in the canton of Zurich. He began his professional career as a financial analyst with Zürcher Kantonalbank. In 1980 he moved to the private bank Julius Bär, where he was initially head of equity research and later chief economist for Switzerland. In 1999, Hans Kaufmann became a self-employed business consultant. He is a member of the manage- ment committee of Zürcher Kantonalbank’s pension fund and employ- er representative, a member of the audit committee and a member of the risk management committee. Corporate Governance Henrich Kisker Swiss certified accountant; Swiss / German national; born in 1955 Member of the board of directors Main appointments: Member of the Board of Directors of the group companies of Senior plc, Rickmansworth (UK); delegate of the Boards of Directors of NF Technology Holding AG, Zurich, Schmid & Partner Engineering AG, Zurich and ZMT Zurich MedTech AG, Zurich Henrich Kisker is a Swiss certified accountant. He was appointed to the board of directors in 2015. Since 1992, he has worked for Senior plc, London, UK, as Director of Tax and Treasury, and Senior Invest- ments GmbH, Schaffhausen, as managing director. Between 1989 and 1992 he worked as lead auditor for Arthur Andersen AG, Zurich. He is a member of the audit committee and the IT committee. Mark Roth Swiss certified accountant; Swiss national; born in 1974 Member of the board of directors Main appointments: Member of the Boards of Directors of Budliger Treuhand AG, Zurich, and Treuhandgesellschaft Hebeisen Kälin AG, Zurich, both since 2014 Mark Roth has been a member of the board of directors since 2013. From 2011 to 2014 he was a financial delegate in the general man- agement of the SP in the City of Zurich. He has been a member of the management board and head of auditing at Budliger Treuhand AG in Zurich since 2009. He had previously worked for Itema (Switzerland) Ltd. in Rüti with Ernst & Young, Zurich. Mark Roth is the chairman of the audit committee. Peter Ruff dipl. Ing. FH; Swiss national; born in 1956 Member of the board of directors Main appointments: Chairman of the Board of Trustees of Grüningen Botanical Garden, Grüningen; member of the Board of Directors of Exploris AG, Zurich; shareholder of Unimex GmbH, Zug; member of the Board of Directors of Ruf Group, Schlieren Peter Ruff joined the board of directors in 2011. Having trained as an engineer, he has been the owner and CEO of Exploris AG – which special ises in diagnostic solutions and data analysis in the healthcare industry – since 2002. He is also a member of the Board of Directors and co owner of Ruf Group, an information technology business. He has been a member of the management committee of the pension fund of Zürcher Kantonalbank / employer representative since 2015. Peter Ruff chairs the compensation and personnel committee of Zürcher Kantonalbank. Zürcher Kantonalbank Annual Report 2016 47 Corporate Governance 48 Zürcher Kantonalbank Annual Report 2016 Walter Schoch grad. electrical engineer, dipl. El. Ing. FH Technikum Winterthur; Master of Arts in Theology at the University of Lampeter, United Kingdom; Switzerland; born in 1956 Member of the board of directors Main appointments: Vice chairman of the Board of Trustees of SanArena, Zurich; member of the Board of Trustees of Grüningen Botanical Garden, Grüningen; chairman of the Supervisory Board, Höhere Fachschule, Uster An engineer and theologian, Walter Schoch was elected to the board of directors in 2015. He was a member of the cantonal parliament from 2007 to 2015. Walter Schoch serves as a magistrate for the municipali- ties of Bauma, Wila and Wildberg. After working for BBC Oerlikon as project manager (1982 to 1983) and Imeth AG, Wetzikon, as technical director (1983 to 1987), he worked for Swisscom AG, Zurich, from 1987 to 2003 as key account manager, senior project manager and divisional director. In 2005, Walter Schoch began his studies at the University of Lampeter in the UK, while continuing to head the MEOS Media department at MEOS Svizzera. From 2007 to 2010 he ran the Winterthur office of the Swiss Mission Fellowship. He chairs the IT committee. Anita Sigg lic. oec. publ.; Swiss national; born in 1966 Member of the board of directors Main appointments: Member of the awards committee of Sustainable Harvest Switzerland, Zurich; member of the Board of Trustees of Ökopolis foundation, Zurich Anita Sigg has been a member of the board of directors since 2011. Since 2003, she has been a lecturer and project manager, and is currently head at the Centre for Banking and Finance at Zurich University of Applied Sciences in Winterthur. An economist, she is also a trustee of the Ökopolis foundation. She previously held various senior roles with Zürcher Kantonalbank at the Corporate Centre and in market control. Anita Sigg is a member of the risk management committee and the compensation and personnel committee of Zürcher Kantonalbank. Corporate Governance Rolf Walther Graduate in business management; Swiss national; born in 1951 Member of the board of directors Main appointments: Chairman of the Board of Directors and CEO of Walther Beratungen AG, Zurich; member of the Board of Trustees of Wildnispark, Zurich Rolf Walther, an economist and self-employed businessman, was elect- ed to the board of directors in 2010. Prior to becoming an entrepreneur, he held various positions with UBS over a period of 29 years. From 2003 to 2010 he was a member of the cantonal parliament. He is chairman of the Herrenbergli Residential Home and Care Centre for the Elderly Cooperative. He is a member of the board of trustees of Wildnispark Zurich. Since 2015 he has been a substitute member of the management committee of Zürcher Kantonalbank’s pension fund and employer representative, as well as chairman of the risk management committee. Stefan Wirth dipl. Ing. ETH / BWI; Swiss national; born in 1961 Member of the board of directors Main appointments: none Stefan Wirth has been a member of the board of directors since 2011. A mechanical engineer and business administrator, he headed up software development at Credit Suisse Asset Management until 2003. He is an independent IT and organisational consultant, and implements projects for various banks in his role as project manager and business engineer. Stefan Wirth is a member of the IT committee as well as the compensation and personnel committee of Zürcher Kantonalbank. Walter Seif Swiss certified accountant, graduate in business management; Swiss / UK national; born in 1962 Head of Audit Main appointments: Chairman of the Internal Audit Association of the Swiss Cantonal Banks; member of the board of the Institute of Internal Auditing Switzerland (IIAS) Walter Seif took over as chief inspector, Head of Inspectorate (Audit) on 1 January 2015. He joined Zürcher Kantonalbank in April 2014. He previously worked in various internal audit roles at a major bank over a period of 23 years, eight of which were spent in London. Zürcher Kantonalbank Annual Report 2016 49 Audit Martin Scholl Swiss certified banking expert; Swiss national; born in 1961 Chief Executive Officer (CEO) Main appointments: Member of the Board of Directors of the Swiss Bankers Association, Basel; member of the Board of Directors of the Association of Swiss Cantonal Banks, Basel; member of the board of economiesuisse, Zurich Martin Scholl became Chief Executive Officer in 2007. He has been a member of the executive board since 2002. Martin Scholl was Head of Corporate Banking until 2005, before being appointed Head of Retail Banking in 2006. After completing his apprenticeship in banking at Zürcher Kantonalbank, he was employed in various roles. In 2001 he led the credit management department, and from 1996 to 2001 was head of sales to small and medium-sized enterprises. Martin Scholl is a member of the Board of Directors of the Swiss Bankers Association; deputy chairman of the Association of Swiss Cantonal Banks, Basel; member of the board of Zürcher Volkswirtschaftliche Gesellschaft, Zurich; member of the board of economiesuisse, Zurich; member of the Board of Directors of Venture Incubator AG, Zug; member of the Board of Trustees of the FCZ Museum foundation, Zurich. Christoph Weber Swiss certified banking expert; Swiss national; born in 1959 Head of Private Banking, Deputy CEO Main appointments: Chairman of the supervisory board of Zürcher Kantonalbank Österreich AG, Salzburg Christoph Weber was appointed Head of Private Banking and a member of the executive board in 2008. Prior to that he was Head of Private Banking North and a member of the executive board at Banca del Gottardo. From 2000 to 2006, Christoph Weber was a member of the executive board of AAM Privatbank AG, where he was head of sales to institutional and private customers, and a member of the management of Basellandschaftliche Kantonalbank (BLKB). Christoph Weber is chairman of the supervisory board of Zürcher Kantonalbank Österreich AG, Salzburg. Corporate Governance Executive board 50 Zürcher Kantonalbank Annual Report 2016 Corporate Governance Jürg Bühlmann Dr. oec. publ.; Swiss national; born in 1967 Head of Logistics Main appointments: Member of the Board of Directors of SIX Group Jürg Bühlmann was appointed Head of Logistics and a member of the executive board in 2012. Jürg Bühlmann studied business management at the University of Zurich, where he gained a doctorate. His initial role with Zürcher Kantonalbank was in Controlling. In 2002 he moved to the Logistics / IT unit. In the years that followed, he headed up strategic IT projects and managed a sub-area of IT. Dr. Jürg Bühlmann has been Head of Real Estate, which is part of Logistics, since 2011. Stephanino Isele Dr. oec. publ.; Swiss national; born in 1962 Head of Institutionals & Multinationals Main appointments: Member of the Board of Directors of Swisscanto Holding Ltd. and Swisscanto Swiss Red Cross Charity Fund (SICAV), Zurich; member of the Regulatory Board of SIX Swiss Exchange AG, Zurich; member of the advisory board of Zurich University’s Depart- ment of Banking and Finance (IBF); member of the Board of Trustees of the Swiss Finance Institute, Zurich Dr. Stephanino Isele took on the role of Head of Institutionals & Multinationals on 1 April 2014. He joined Zürcher Kantonalbank on 1 January 2008 as Head of Trading, Sales & Capital Markets. He previously held various national and international roles at J.P. Morgan & Co. and at Morgan Stanley in London, latterly as COO, for equity derivatives. He has been a member of the board of directors of Swiss- canto Holding Ltd. and Swisscanto Swiss Red Cross Charity Fund (SICAV) since 2015. He is a member of the Regulatory Board of SIX Swiss Exchange AG, Zurich, member of the advisory board of Zurich University’s Department of Banking and Finance (IBF); member of the Board of Trustees of the Swiss Finance Institute, Zurich. Zürcher Kantonalbank Annual Report 2016 51 Heinz Kunz Swiss certified banking expert; Swiss national; born in 1961 Head of Corporate Banking Main appointments: Chairman of the Board of Directors of Swisscanto Pensions Ltd., Zurich; member of the Board of Directors of Swisscanto Holding Ltd.; member of the Board of Trustees of Berufslehr-Verbund (BVZ), Zurich; member of the Board of Directors of the Deposit Protec- tion of Banks and Securities Dealers Association, Basel Heinz Kunz became Head of Corporate Banking at the end of 2010. He was previously deputy head of the unit, where he was responsible for key account management for corporate customers. Following the completion of his banking traineeship, Heinz Kunz held various roles with Zürcher Kantonalbank. They included Head of Corporate Banking for the Unterland region, and from 2001 Head of Sales for Business and Corporate Customers. Since 2016, Heinz Kunz has been chairman of the Board of Directors of Swisscanto Holding Ltd. Since 2015, Heinz Kunz has been chairman of the Board of Directors of Swisscanto Pensions Ltd., Zurich. Heinz Kunz represents the Association of Swiss Cantonal Banks (ASCB) as chairman of the Swiss Bankers Association management committee for Retail Banking and is a member of the Board of Directors of the Deposit Protection of Banks and Securities Dealers Association (esisuisse), Basel; chairman of the Board of Directors of Gasthof Gyrenbad AG, Turbenthal; member of the Board of Trustees of Berufslehr-Verbund (BVZ), Zurich. Roger Müller Swiss certified banking expert; Swiss national; born in 1962 Chief Risk Officer (CRO) Main appointments: none Roger Müller became Chief Risk Officer on 1 January 2014. From 2008 until his appointment as a member of the executive board, he was Head of the Credit Office and Deputy Chief Risk Officer. He has held a wide variety of roles within the bank since 1978. Focal points have included commercial lending and corporate banking. From 2000, he headed up credit office analysis for corporate clients. Corporate Governance 52 Zürcher Kantonalbank Annual Report 2016 Corporate Governance Daniel Previdoli lic. rer. pol.; Swiss national; born in 1962 Head of Products, Services & Direct Banking Main appointments: Chairman of the Board of Directors of Swisscanto Fund Management Company Ltd., Zurich, member of the Boards of Directors of Swisscanto Holding Ltd., Zurich, Aduno Holding AG, Zurich, Viseca Card Services SA, Zurich and Homegate AG, Zurich; deputy chairman of the Greater Zurich Area Foundation Board, Zurich Daniel Previdoli has been a member of the executive board since 2007. He became Head of Products, Services & Direct Banking on 1 October 2014 after leading the Retail Banking business unit. Prior to that he spent 11 years with UBS, where he was Head of Recovery Management Primaries between 1996 and 2002 before being appointed Head of Retail and Corporate Banking for the Zurich region. From 1987 until 1996 Daniel Previdoli served at Credit Suisse, where he held various positions both in Switzerland and abroad. Since 2016, he has been chairman of the Board of Directors of TWINT AG, Zurich. Rudolf Sigg Swiss certified banking expert; Swiss certified federal accountant and controller; Swiss national; born in 1961 Chief Financial Officer (CFO) Main appointments: Chairman of the Board of Directors of Swisscanto Holding Ltd., Zurich; member of the Board of Directors of Mortgage Bond Institution of the Swiss Cantonal Banks, Zurich; member of the management committee / employer representative of Zürcher Kantonal- bank’s pension fund, Zurich; chairman of the Zürcher Kantonalbank Freizügigkeitsstiftung and Vorsorgestiftung Sparen 3 foundations for vested pension capital and savings respectively, both in Zurich; member of the Board of Trustees / employer representative of Zürcher Kantonal- bank’s Marienburg foundation Rudolf Sigg has been a member of the executive board since 2008. He heads the Finance business unit. Previously, he had been Head of Controlling & Accounting and had overall responsibility for Controlling – which also included Central Risk Controlling in 2000 – over a period of 12 years. Rudolf Sigg has been with Zürcher Kantonalbank since 1977. He is chairman of the Board of Directors of Swisscanto Holding Ltd., Zurich and a member of the Board of Directors of Mortgage Bond Institution of the Swiss Cantonal Banks, Zurich. Zürcher Kantonalbank Annual Report 2016 53 Compensation Report 54 Zürcher Kantonalbank Annual Report 2016 Compensation Report Our compensation model is performance-based and in line with the market. It is based on the longterm, financial interests of the bank. Basic principles Zürcher Kantonalbank complies with the corporate governance principles of the Swiss Code of Obligations, the Corporate Governance Directives issued by the SIX Swiss Exchange concerning information on corporate governance, and the Swiss Code of Best Practice for Corporate Governance, insofar as this is possible and appropriate as a public-law institution. As laid down in the SIX directives, the variable compensation is assigned to the financial year in which it is actually incurred. Total personnel expenses include all cash compensation and deferred components, changes in their value, as well as employer contributions to the pension fund; employer contributions to AHV (old-age and survivors’ insurance) and other mandatory social security contributions are also included. The compensation guidelines are set out in the personnel and compensation regulations issued by the board of directors for Zürcher Kantonalbank and apply through- out the group. The procedures for determining comp ensation are structured and documented by the group companies. This compensation report refers to the Zürcher Kanto nalbank parent company. The compensa- tion paid by the consolidated subsidiaries also fulfils the relevant re quirements in an appropriate manner. Competences Responsibility for the ultimate supervision of Zürcher Kantonalbank lies with the Zurich cantonal parliament In accordance with the Law on Zürcher Kantonalbank. It is also responsible for approving the regulations regarding compensation for members of the board of directors. The board of directors issues regulations governing the compensation of the members of the board of directors; these regulations are subject to approval by the cantonal parliament. Fig. 17: Competences and responsibilities Competences Body responsible p Setting up or amending p Board of directors, on compensation plans p Determining total amount of variable compensation p Compensation for committee of board of directors and other members of board of directors recommendation of compensation and personnel committee p Board of directors, on recommendation of compensation and personnel committee p Cantonal parliament, based on proposal of board of directors p Compensation for CEO p Board of directors, based on proposal of committee of board of directors p Compensation for members p Board of directors, based on of executive board proposal of committee of board of directors p Compensation for Head of Audit p Board of directors, based on p Compensation for senior management proposal of committee of board of directors p Executive board The board of directors furthermore issues personnel and compensation regulations for Zürcher Kantonalbank in accordance with Swiss Financial Market Authority (FINMA) requirements set out in circular 2010/01 “Com- pensation Systems”. It is responsible for the implementa- tion of these regulations, both at the parent company and at the relevant subsidiaries in Switzerland and abroad that are subject to consolidation (under manda- tory foreign requirements). The compensation and personnel committee assists the board of directors with compensation policy issues. It prepares the relevant business for the board of directors, gives its view on compensation issues that fall within the remit of the Zürcher Kantonalbank Annual Report 2016 55 Compensation Report committee of the board and board of directors, and reviews the market conformity of compensation for the bank as a whole. The compensation and personnel committee has the following duties and powers for determining compensation policy: p To make recommendations to the board of directors on the strategic and human resource policy principles of the pension funds from the employer’s viewpoint p To make recommendations on principles concerning compensation for members of the executive board and Audit, as well as any profit-sharing and benefit programmes p To evaluate the bank’s compensation system, specific- ally with regard to its sustainability and the avoidance of false incentives In the year under review, the compensation and personnel committee took part in six meetings discuss- ing compensation at Zürcher Kantonalbank. Compensation policy Zürcher Kantonalbank’s compensation policy is based on the bank’s business strategy, objectives and values. It takes into account the long-term financial interests of the bank and supports solid and effective risk manage- ment. The board of directors brings together the inter- ests of the canton of Zurich and the interests of Zürcher Kantonalbank and its employees. The compensation policy is also aimed at attracting and retaining highly qualified employees in the long term. With our compen- sation policy, we recognise outstanding performance and motivate employees to continue their professional development. Compensation is closely coordinated with the group’s strategy. This is based on Zürcher Kanto- nalbank’s performance promises to its customers and the canton, as well as the preservation of its good reputation. Therefore, the compensation system at Zürcher Kantonalbank does not create any incentives to take inappropriate risks that might negatively affect the bank’s stability. Variable compensation is sustainable and geared towards the long-term financial success of Zürcher Kantonalbank and its risk profile. At each in- dividual level, employees therefore have key targets that are linked to Zürcher Kantonalbank’s successful long- term performance and take account of the risks entered into. Principles of compensation Zürcher Kantonalbank’s compensation practice is based on the following objectives: p Recruiting employees who pursue their goals fairly and with integrity, in accordance with the group strategy p Motivating employees to create lasting added value while taking account of the risks p Promoting a performance-led environment for the benefit of the bank as a whole – one that recognises and rewards performance p Ensuring that variable compensation is adjusted for risk and only income that is sustainable in the long term is included p Competitive, balanced compensation for comparable jobs that reflects successful long-term performance The compensation approach for management is aimed at encouraging close cooperation and ensuring that all actions are undertaken in the interests of the bank as a whole, as well as its integrated business and risk model. For the purpose of efficient risk monitoring, the Legal, Tax & Compliance, Risk, Finance and Human Resources specialist areas must be able to perform their control and escalation tasks independently. Compensa- tion for these functions is therefore set separately to the organisational units with responsibility for income. The overall compensation for these functions ensures that they are attractive to qualified, experienced people. Zürcher Kantonalbank’s base salary is oriented to- wards the standard median values for the industry. Base- salary levels are usually reviewed on an annual basis. Variable compensation is a central element of compen- sation practice and offers flexibility for adjustment in the event of a change in the business situation. The amount of the compensation depends on the group’s results, the employee’s position and individual per- formance. The bank aims to compensate its employees in line with the market. The bank conducts annual market comparisons in cooperation with Willis Towers Watson, SwissICT, Kienbaum and other specialist con- sultancy firms. Zürcher Kantonalbank therefore measures itself against other Swiss financial institutions. For senior managers, additional compensation parameters obtained from these market comparisons are scaled on the basis of criteria such as size of the organ- isation, number of employees, hierarchy, depth of organ- isation, geographical reach and internationality. Addi- tional appropriate parameters are used if necessary. All compensation (honoraria, attendance fees and similar compensation) for delegation and representation on 56 Zürcher Kantonalbank Annual Report 2016 Compensation Report behalf of the bank must be surrendered to Zürcher Kantonalbank. Any reimbursed expenses are retained by the appointee. Employees’ variable compensation is not, or only partially, paid out at the bank’s discretion if the employee has violated contractual, risk or compli- ance requirements before the date of the intended pay- ment or if the bank has sustained losses due to the activity. Moreover, such employees are deemed “bad leavers” under compensation models and their entitle- ment to any deferred compensation lapses. Breaches of laws, codes of conduct, directives or internal rules can in addition lead to disciplinary meas- ures. These may be supplemented with the reduction or forfeiture of variable compensation and / or a deferred element and similar elements of compensation. In the event of ongoing investigations or suspicion of mis conduct that could lead to disciplinary measures, Zürcher Kantonalbank is entitled to delay payment of varia- ble compensation and / or deferred compensation and similar elements of compensation until the matter has been definitively clarified or the relevant sanction decided. Under the “bad leaver” rule, the longterm deferred component as well as the deferred element at risk may lapse in full if Zürcher Kantonalbank parts company with the employee for specific reasons. This may be the case if employees have committed a breach of contract or have caused material or nonmate- rial damages as a result of their activities or the rela tionship of trust between them and the bank has suf- fered lasting damage as a result of their conduct. Agreed payments such as guaranteed bonuses or bonus buyouts in connection with the conclusion of an employment contract are termed signon compensa- tion. Zürcher Kantonalbank pursues a policy whereby such compensation is agreed on only an exceptional basis and only in individually justified instances. Payments agreed in connection with the termination of an em- ployment relationship are termed severance compensa- tion. Zürcher Kantonalbank’s employment contracts do not contain any preagreed severance compensation or notice periods that differ from the general terms and conditions of employment. Signon and severance compensation must be approved by the committee of the board on the basis of clear decisionmaking pro cesses. The signon and severance compensation agreed in the year under review is shown in Figure 18. Compensation groups Board of directors Compensation for members of the board of directors is based on the regulations governing the compensation of members of the board of directors of Zürcher Kantonalbank, as approved by the cantonal parliament of Zurich on 25 November 2004. For parttime mem- bers of the board of directors, it comprises a fixed annual salary plus compensation for each membership of a committee and an expense allowance. An attendance fee is paid for meetings, visits to specialist units and branch offices, as well as training and development events. No variable compensation is paid to the members of the board of directors. Committee of the board As full-time members of the board of directors, the members of the committee of the board receive an expense allowance, in addition to all the benefits designated for all Zürcher Kantonalbank employees in the relevant regulations. The chairman receives an additional allowance of 10 percent of his annual base salary. No variable compensation is paid to the members of the committee of the board. Audit In view of Audit’s special function, the Head of Audit and employees at the second most senior level of management who report directly to him do not receive any variable compensation. Their entire compensation takes the form of a fixed annual salary. Fig. 18: 2016 Agreed signon and severance compensation (in CHF) Total signon payments – of which key risk-takers Total severance compensation – of which key risk-takers Total compensation No. of employees Total Paid in 2016 Amounts due in 2017 or later 2 0 0 0 2 50,000 0 0 0 50,000 0 0 0 0 0 50,000 0 0 0 50,000 Zürcher Kantonalbank Annual Report 2016 57 Compensation Report Executive board Compensation for the members of the executive board is based on Zürcher Kantonalbank’s overall compensa- tion policy. A variable element is paid depending on the group’s result. Part of the variable compensation is deferred as a long-term component (LZA). Senior management Senior management has a sustained influence on the bank’s business operations (risks, image, etc.), on its group’s result and therefore on the implementation of the strategy. Senior managers make up approxi mately one percent of the total headcount. As with the executive board, variable compensation is provided in addition to the base salary; this variable compensation is linked to the group’s result and individual perfor- mance. Part of the variable compensation is deferred as in the case of the executive board. Other management and employees In principle, all the bank’s employees are entitled to a variable element of compensation for good perfor- mance. For selected employees in the trading, sales and capital markets area, a separate compensation model applies. Part of the variable compensation is deferred and exposed to future risk development. In accord- ance with the supervisory recommendations, the group of key risk-takers subject to the rules for deferred variable compensation is formed from the compensation groups. Key risk-takers are: p Executive board p Senior management with a substantial influence on the resources of the business and / or risk profile p Selected employees in the trading, sales and capital markets area who exceed a defined threshold in relation to variable compensation A total of 91 employees are defined as key risktakers; in the year under review, nine of them were active members of the executive board. Components of compensation In its compensation policy, Zürcher Kantonalbank uses the total compensation approach, which comprises the following compensation components: Fig. 19: Components of compensation Base salary Contractually agreed, paid out on a regular basis Variable compensation Variable component of salary that is contingent on result and performance Deferred component Long-term, deferred element of compensation based on sustainable success of the business Statutory allowances and additional benefits Child and training allowances, family allowances (Agreement on Conditions of Employment for Bank Staff), allowances under the Labour Law, expense allowances, allowance for years of service, etc. The base salary, variable compensation and deferred components are explained in greater detail below. Base salary Zürcher Kantonalbank’s base salary is generally orient- ed towards the standard median values for the industry. The results of the salary comparisons help provide a basis for the setting of individual salaries. Base salary levels are decided in accordance with position, ex perience and skills, and take account of individual sustain able performance. Adjustments are made to reflect market conditions, affordability, individual performance and the overall financial position of Zürcher Kantonal- bank. Variable compensation The bank’s total pool for variable compensation is based on the group’s result with capital and risk costs being taken into account. The operating income of trade less risk and capital costs is decisive for determining the variable compensation for trade. The amount of the allocation of the variable compensation depends on the employee’s position and individual performance. Variable compensation is decided by the bank. At its discretion, the variable compensation may be for- feited in full following inadequate performance or a poor business result. Variable compensation is re- duced or forfeited at the bank’s own discretion if, prior to the time of the envisaged payout, the employee has committed a breach of contract, the bank has in- curred considerable losses as a result of the employee’s activity or the employee is serving his / her notice. Thresholds for the deferred compensation components are based on the risk profile of the bank as a whole. 58 Zürcher Kantonalbank Annual Report 2016 Fig. 20: Variable compensation at a glance Variable compensation Long-term deferred component Deferral at risk Recipient Due Permanent employees Immediate Executive board, senior management Transferred after 3 years Certain employees in the trading and capital markets area Transfer in equal shares over 2 years 1 Taking capital and risk costs into account. Yes Yes Yes Long-term deferred component For members of the executive board and senior manage- ment, part of the variable compensation is deferred as a long-term component for three years. For each series of deferred component, the targets to be achieved are specified in advance and apply for the entire term. The value of the deferred component at the end of this term is based on the achievement of targets related to the level of sustainable profit. The maximum value of the deferred component is 1.5 times the original amount, the minimum being 0.5 times. Should there be a negative internal net income over the three-year period, the value of the deferred compensation is reduced to zero. Deferral at risk For selected employees in the trading, sales and capital markets area with a significant influence on the bank’s results and risk profile, a portion of the variable compen- sation in excess of a specific amount is deferred and exposed to risk for a two-year period. The functions of CEO and Head of Human Resources for the bank as a whole, which are independent of the trading, sales and capital markets area, may impose a penalty, i. e. a reduction or forfeiture of the deferred amount at risk at the individual person level, particularly in the case of: p significant financial losses at the level of department, desk or individual p reputational damage or other actions that may be detrimental to Zürcher Kantonalbank, such as activities that breach regulations and result or may result in sanctions by the Swiss Financial Market Supervisory Authority p activities that may result in significant customer migrations or inappropriate risk-taking outside of the ordinary risk processes Compensation Report Forfeiture clause Performance, penalty clause Dependent on individual performance in event of misconduct. Amount of cash sum paid out on due date depends on development of sustainable profit and adherence to values framework. Performance -related 1 Yes Yes Amount of cash sum paid out on due date depends on whether a penalty has been imposed. Yes Risk consideration Risk-adjusted variable compensation pool Two different methods are used for the risk adjustment of the variable compensation pools. The variable compensation pool of the bank as a whole is based on the overall group result after adjusting for risk costs. Risk costs take into account standard risk costs as well as the cost of risk capital or cost of equity. The model for standard risk costs is based on the default rates over an entire economic cycle. This evens out the annual default risk costs, which would other- wise be irregular. By taking account of standard risk costs, risk costs arising as a result of current business volumes are therefore included in the annual accounts under the model. Management decisions to focus on specific products or markets are therefore covered by cor- responding risk costs on a timely basis. Thanks to this procedure, the basis for calculating the variable compen- sation pool is oriented towards the bank’s sustainable development. A standard market interest rate on the entire equity is used for the compensation of equity. The calculation process for the variable compensa- tion pool of the trading area is based on the adjusted result for the trading, sales and capital markets area. This is likewise adjusted for the default and market risk costs of the individual trading desks. The calculation is based firstly on the standard risk costs for default risks and secondly on the cost of risk capital in accor- dance with internal models for default as well as mar- ket risks (internal capital-at-risk models). The capital-at- risk approach is used to determine the internally required capital that is tied up for a year on account of market and default risks on trading activities. The maximum risk capital available for trading activities is allocated by the board of directors on an annual basis. This takes account of the bank’s strategic direction and capital planning for the coming years. The risk capital allocated in this way is charged to the result for Zürcher Kantonalbank Annual Report 2016 59 Compensation Report Fig. 21: Risk overview Risk adjustments made prior to the allocation of variable compensation Quantitative p Cost of equity p Risk costs p Special factors Explicit Risk adjustments made following the allocation of variable compensation p Deferred components of compensation p Conduct-based adjustment (penalty or forfeiture) Qualitative p Employee appraisal p Reporting by internal control units Implicit p Sustainable profit the trading, sales and capital markets area using a standard market interest rate. Determining the variable compensation of key risk-takers Included in the performance appraisal of key risk-takers are risk aspects, any breaches of internal or external directives and guidelines or misconduct that may impact negatively on the reputation of the bank as well as ongoing disciplinary proceedings. The individual perfor- mance of a key risk-taker is discussed on a continuous basis with the respective supervisor. During the process of allocating and paying variable compensation ele- ments for key risk-takers in the trading, sales and capital markets area, the independent control functions of legal, tax and compliance, risk management and human resources are consulted. Setting variable compensation The variable compensation of key risk-takers can account for a large element of their overall compensation and varies from year to year depending on the performance of the group and the individual performance appraisal. As stated above under “Competences and responsibili- ties” (p. 55), the board of directors decides the comp- ensation of the members of the executive board based on the proposals of the committee of the board. The executive board decides the compensation of key risk-takers from senior management at the request of the respective member of the executive board after assessing individual performance. The Head of Institu- tionals and Multinationals decides the compensation of key risk-takers in the trading, sales and capital markets area based on the proposals of the head of that organi- sational unit. Risk adjustment in relation to deferred compensation Deferred components of compensation are subject to further risk adjustment. They may lapse in full or in part if negative business developments or other prede- fined conditions occur (see “Long-term deferred component” (p. 59) and “Deferral at risk” (p. 59) for further details on the possibilities of a reduction). 60 Zürcher Kantonalbank Annual Report 2016 Compensation Report Compensation for members of the board of directors Compensation for members of the board of directors is based on the regulations governing the compensation of members of the board of directors of Zürcher Kantonalbank, as approved by the cantonal parliament of Zurich on 25 November 2004. For part-time mem- bers of the board of directors, it comprises a fixed annual compensation of CHF 18,000 plus CHF 6,000 compen- sation for each membership of a committee. An annual expense allowance of CHF 6,000 is also provided. A fixed attendance fee of CHF 700 per day and CHF 350 per half-day is paid for meetings. These rates are also paid for visits to branch offices and specialist units as well as for necessary role-related courses and further training. As full-time members of the board of directors, the members of the committee of the board have, since 1994, received an annual base salary of CHF 311,500 in addition to all the benefits designated for all employ- ees in the relevant regulations. The chairman receives an additional allowance of 10 percent of his annual base salary. The full-time members of the board of directors are paid an annual allowance of CHF 14,000 each. The full-time members of the board of directors are insured within the scope of the bank’s directive on pension funds. No variable compensation is paid to the members of the board of directors. Under the disclo- sure guidelines, the compensation paid to the members of the board of directors is reported individually. Total expenses in relation to the board of directors were slightly lower. No other additional compensation or benefits in kind were paid to current or former mem- bers of the board of directors or related parties during the year under review. There are no unusual commit- ments between Zürcher Kantonalbank and the members of the board of directors or related parties. The part-time members of the board of directors and related parties are granted loans only on normal market terms. The members of the board of directors and related parties received no other fees or pay- ments for additional services rendered to the Zürcher Kantonalbank group or any of its subsidiaries during the year under review. Compensation in 2016 Total personnel expenses in respect of the full-time- equivalent headcount of 4,910 (2015: 4,879) amounted to CHF 965.1 million (parent company). Included in this figure, for a full financial year for the first time, are the costs for employees who were integrated into the parent company following the takeover of Swisscanto in 2015. Along with the higher variable compensation expenses, personnel expenses increased by 8 percent. The social security expenses also include payments to the bank’s pension fund. All variable elements of compensation are assigned to the financial year in which they are actually incurred. Fig. 22: Personnel expenses in 2016 (parent company) in CHF million Base salaries 1 Total amount of variable compensation Social insurance Other personnel expenses 2 Total personnel expenses 2016 2015 527.4 234.6 170.7 3 32.4 508.4 193.6 159.4 31.0 965.1 3 892.4 1 Fixed compensation for permanent employees and temporary staff, governing bodies as well as compensation for loss of income and payroll-related costs. 2 In particular costs for training, staff support, recruitment and premiums. 3 Excludes the CHF 70 million non-recurring personnel expense in connection with the creation of provisions for pension benefit obligations. In the course of its annual review of base salaries, Zürcher Kantonalbank decided to raise base salaries for 2016 by CHF 5.0 million (+ 1.0 percent) compared with the previous year. The increase in base salaries was used primarily to bring employees closer to industry levels as well as to provide a greater reward to employees who have assumed more responsibility or shown outstand- ing performance. Total variable compensation increased by CHF 41 million. The total amount of deferred com- pensation was CHF 13.9 million. Fig. 23: Details of variable compensation (parent company) No. of employees 1 2016 in CHF million No. of employees 1 2015 in CHF million 4,910 234.6 4,879 193.6 91 13.9 86 9.9 2 0.1 – 0 1 – 0 0 Total amount of variable compensation p of which deferred compensation p of which agreed sign-on and severance compensation p of which other charges and credits recognised in the income statement from compensation in previous years 1 Full-time equivalents. Zürcher Kantonalbank Annual Report 2016 61 Compensation Report Compensation for members of the executive board Total compensation for the individual members of the executive board takes account of their performance in the relevant areas of responsibility. Total compensa- tion for the executive board in 2016 amounted to CHF 12,705,215 (2015: CHF 12,329,523). The highest sum paid to a member of the executive board during the year under review was CHF 1,858,205 in salary and variable compensation, together with CHF 211,892 in pension payments and other remuneration, and was paid to Martin Scholl, CEO (2015: CHF 1,924,392). In addition, deferred components amounting to CHF 2,213,750 (2015: CHF 2,118,813) were set aside for the members of the executive board; provided specific conditions are met, these will be paid out in three years’ time. The members of the executive board and related parties received no other fees or payments for additional services rendered to the Zürcher Kantonalbank group or any of its subsidiaries during the year under review. Total loans and mort- gage lending to the executive board members amount- ed to CHF 10,798,500 (of which CHF 9,881,500 on employee terms). No loans on unusual terms were granted to related parties of the executive board. 62 Zürcher Kantonalbank Annual Report 2016 Compensation Report Fig. 24: Compensation and loans for members of the board of directors (in CHF) Committee of the board Dr. Jörg Müller-Ganz János Blum Bruno Dobler Year 2016 2015 2016 2015 2016 2015 Other members of the board of directors Amr Abdelaziz (since 1.7.2015) Thomas Heilmann (until 30.6.2015) René Huber Hans Kaufmann Henrich Kisker (since 1.7.2015) Mark Roth Peter Ruff Walter Schoch (since 1.7.2015) Anita Sigg 3 Prof. Dr. Hans Sigg (until 30.6.2015) Liliane Waldner (until 30.6.2015) Rolf Walther Stefan Wirth Total Total 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 Annual compensation Attendance fee Expense allowance 1 Employer contributions Benefits in kind 2 to pillar 2 Total 342,650 342,650 311,500 311,500 311,500 311,500 30,000 15,000 0 12,000 30,000 27,000 30,000 30,000 30,000 15,000 24,000 27,000 24,000 24,000 24,000 12,000 30,000 30,000 0 – – – – – – 28,700 11,550 0 29,750 27,650 23,100 26,950 29,750 24,150 11,550 33,250 28,000 32,200 26,250 26,250 15,050 23,800 19,950 0 12,000 11,900 0 12,000 24,000 24,000 30,000 30,000 0 18,900 27,650 33,250 23,450 24,500 14,040 14,040 14,040 14,040 14,040 14,040 6,000 3,000 0 3,000 6,000 6,000 6,000 6,000 6,000 3,000 6,000 6,000 6,000 6,000 6,000 3,000 6,000 6,000 0 3,000 0 3,000 6,000 6,000 6,000 6,000 8,610 9,350 6,860 6,850 0 200 94,084 94,084 87,698 87,698 73,091 73,091 459,385 460,125 420,098 420,088 398,631 398,831 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 64,700 29,550 0 44,750 63,650 56,100 62,950 65,750 60,150 29,550 63,250 61,000 62,200 56,250 56,250 30,050 59,800 55,950 0 26,900 0 33,900 57,650 63,250 59,450 60,500 Loans as at 31.12. 1,300,000 1,300,000 1,790,000 1,790,000 980,000 984,000 0 0 0 0 10,640,000 500,000 1,065,000 800,000 0 0 0 0 0 0 0 70,000 2,252,000 2,258,000 0 0 0 0 0 0 0 1,241,651 1,235,651 274,050 283,500 102,120 102,120 15,470 16,400 254,873 254,873 1,888,164 18,027,000 1,892,544 7,702,000 1 For the members of the committee of the board, CHF 40 is attributable to rounding differences due to monthly payments. 2 Benefits in kind: child, training and family allowances (Agreement on Conditions of Employment for Bank Staff), loyalty bonuses, medical check-ups, contribution to tram / rail season tickets. 3 Loans: reduced community of heirs of Anita Sigg-Meyer: CHF 1,700,000, Anita Sigg alone: CHF 552,000. Zürcher Kantonalbank Annual Report 2016 63 Financial Report Contents Group Group income statement Group balance sheet Group cash flow statement Group statement of changes in equity Notes to the group financial statements a) Profile b) Accounting and valuation policies c) Explanations of risk management d) Explanation of the methods used for identifying default risks and determining the need for value adjustments e) Explanations of the valuation of collateral f) Explanations on the bank’s business policy regarding the use of derivative financial instruments and the use of hedge accounting g) Explanations of material events occuring after the balance sheet date i) Information on the balance sheet j) Information on off-balance-sheet transactions k) Information on the income statement l) Risk report m) Multi-year comparison Report of the statutory auditor on the consolidated financial statements Parent company Parent company financial statements Income statement Appropriation of profit Balance sheet Statement of changes in equity 66 67 68 70 71 72 78 78 79 80 81 82 99 101 106 128 130 134 135 136 137 138 Notes to the parent company’s financial statements b) Accounting and valuation policies i) Information on the balance sheet j) Information on off-balance-sheet transactions k) Information on the income statement Pawnbroking agency operated by Zürcher Kantonalbank Report of the statutory auditor on the financial statements 139 140 149 150 153 154 About the figures: The amounts stated in this report have been rounded. The total may therefore vary from the sum of the individual values. The following rules apply to the tables: 0 (0 or 0.0) Figure that is smaller than half the unit of account used Figure not available or not meaningful blank No data available – Zürcher Kantonalbank Annual Report 2016 65 Financial Report Group income statement in CHF million Note 2016 2015 Change Change in % Result from interest operations Interest and discount income Interest and dividend income from financial investments Interest expense Gross result from interest operations Changes in value adjustments for default risk and losses from interest operations Subtotal net result from interest operations Result from commission business and services Commission income from securities and investment activities Commission income from lending activities Commission income from other services Commission expense Subtotal result from commission business and services Result from trading operations and the fair value option 32 Other result from ordinary activities Result from the disposal of financial investments Income from participations – of which from equity-consolidated participations – of which from other non-consolidated participations Result from real estate Other ordinary income Other ordinary expense Subtotal other result from ordinary activities Operating income Operating expenses Personnel expenses General and administrative expenses Subtotal operating expenses Value adjustments on participations and depreciation and amortisation of tangible fixed assets and intangible assets Changes to provisions and other value adjustments and losses Operating result Extraordinary income Extraordinary expenses Taxes Group net income Non-recurring personnel expense in connection with the creation of provisions for pension benefit obligations Group net income from operations 1,453 58 –311 1,199 –12 1,187 763 55 134 –225 728 379 1 14 3 11 10 9 –3 31 1,396 64 –301 1,159 3 1,162 692 55 1 112 –190 668 328 10 28 3 25 7 9 1 –8 47 34 35 36 36 39 2,325 2,204 –1,079 –433 –1,511 –124 –8 682 17 –1 –7 691 70 761 –947 –427 –1,374 –106 –61 664 67 –0 –8 722 722 57 –6 –10 41 –15 25 71 0 23 –34 60 52 –9 –15 –1 –14 3 0 4 –17 120 –132 –6 –137 –18 53 18 –49 –1 1 –32 70 38 4.1 –9.4 3.3 3.5 – 2.2 10.3 0.7 20.2 18.0 8.9 15.8 –90.4 –52.0 –15.5 –56.7 41.0 0.2 –55.9 –35.1 5.5 13.9 1.3 10.0 17.1 –87.3 2.7 –74.2 – –10.4 –4.4 – 5.3 1 A restatement of CHF 4.3 million was undertaken due to a changed profit allocation (+ profit from commission income from the lending business / – other ordinary income). 66 Zürcher Kantonalbank Annual Report 2016 Group balance sheet before distribution of net profit, as at 31 December Note 2016 2015 Change in CHF million Assets Liquid Assets Amounts due from banks Amounts due from securities financing transactions Amounts due from customers Mortgage loans Trading portfolio assets Positive replacement values of derivative financial instruments Other financial instruments at fair value Financial investments Accrued income and prepaid expenses Non-consolidated participations Tangible fixed assets Intangible assets Other assets Total assets Total subordinated claims – of which subject to mandatory conversion and / or debt waiver Liabilities Amounts due to banks Liabilities from securities financing transactions Amounts due in respect of customer deposits Trading portfolio liabilities Negative replacement values of derivative financial instruments 1 2 2 3 4 3 5 6, 7 8 9 10 1 3 4 Liabilities from other financial instruments at fair value 3, 14 Cash bonds Bond issues Central mortgage institution loans Accrued expenses and deferred income Other liabilities Provisions Bank’s capital Retained earnings reserve Foreign currency translation reserves Group net income Equity Total liabilities Total subordinated liabilities – of which subject to mandatory conversion and / or debt waiver Off-balance-sheet transactions Contingent liabilities Irrevocable commitments Obligations to pay up shares and make further contributions Credit commitments 15 15 15 10 16 21 21 21 21 21 2, 28 2 2 29 35,336 5,364 14,889 7,509 77,275 9,472 1,933 20 4,156 360 179 804 168 520 32,497 6,011 14,966 7,673 73,623 10,226 2,897 220 4,320 294 161 860 124 538 157,985 154,410 181 44 34,137 5,084 80,890 2,656 1,551 3,100 235 9,329 8,384 683 506 636 2,425 7,686 –8 691 10,793 157,985 1,298 1,298 4,483 7,506 233 291 8 34,803 2,991 80,820 2,110 2,067 4,163 269 7,669 7,716 578 211 584 2,425 7,290 –8 722 10,429 154,410 1,310 1,310 3,851 7,478 147 2,839 –648 –77 –164 3,652 –754 –963 –200 –164 66 18 –56 44 –18 3,575 –110 35 –665 2,093 69 546 –516 –1,063 –34 1,660 668 105 295 52 396 –0 –32 364 3,575 –13 –13 631 28 86 Financial Report Change in % 8.7 –10.8 –0.5 –2.1 5.0 –7.4 –33.3 –90.9 –3.8 22.5 11.2 –6.5 35.4 –3.3 2.3 –37.8 427.0 –1.9 70.0 0.1 25.9 –24.9 –25.5 –12.6 21.7 8.7 18.1 139.6 8.9 5.4 5.5 –4.4 3.5 2.3 –1.0 –1.0 16.4 0.4 58.6 Zürcher Kantonalbank Annual Report 2016 67 Financial Report Group cash flow statement in CHF million Cash inflow 2016 Cash outflow 2016 Cash inflow 2015 Cash outflow 2015 Cash flow from operating activities (internal financing): Income for the period under review Value adjustments on participations and depreciation and amortisation of tangible fixed assets and intangible assets Provisions and other value adjustments Changes in value adjustments for default risks and losses Accrued income and prepaid expenses Accrued expenses and deferred income Other items Dividend for previous year Balance Cash flow from equity transactions: Share / participation / endowment capital, etc. Recognised in reserves Balance Cash flow from transactions in respect of non-consolidated participations, tangible fixed assets and intangible assets: Non-consolidated participations Real estate Other tangible fixed assets Intangible assets Mortgages on own real estate Balance Cash flow from banking business: Medium and long-term business (> 1 year): Amounts due to banks Amounts due in respect of customer deposits Liabilities from other financial instruments at fair value Cash bonds Bonds Central mortgage institution loans Loan of central issuing institutions Other obligations (other liabilities) Amounts due from banks Amounts due from customers Mortgage loans Other financial instruments at fair value Financial investments Other accounts receivables (other assets) 691 124 123 61 105 0 579 0 0 10 1 0 45 3,433 1,818 295 139 18 722 106 130 51 15 154 0 719 500 21 500 20 21 0 0 503 5 2,213 1,243 68 88 71 54 66 7 326 0 0 26 21 18 68 123 1,109 257 74 81 1,749 1,150 4 3,655 365 382 84 71 22 280 21 213 30 138 341 982 154 115 2,380 491 48 2,281 200 42 (continued on page 69) 68 Zürcher Kantonalbank Annual Report 2016 Group cash flow statement (continued) in CHF million Cash inflow 2016 Cash outflow 2016 Cash inflow 2015 Cash outflow 2015 Financial Report Cash flow from banking business: Short-term business: Amounts due to banks Liabilities from securities financing transactions Amounts due in respect of customer deposits Trading portfolio liabilities Negative replacement values of derivative financial instruments Liabilities from other financial instruments at fair value Amounts due from banks Amounts due from securities financing transactions Amounts due from customers Trading portfolio assets Positive replacement values of derivative financial instruments Other financial instruments at fair value Financial investments Liquidity: Liquid Assets Balance 6,876 237 1,006 198 1,063 779 444 2,093 327 546 509 77 164 733 963 200 529 516 990 2,839 456 618 112 620 927 251 392 493 5,433 879 Zürcher Kantonalbank Annual Report 2016 69 Financial Report Group statement of changes in equity in CHF million Bank’s capital Profit reserves Group net income Foreign currency translation reserve Total equity Total equity as at 01.01.2015 Opening amount Impact of restatement Capital increase Capital decrease Increase in scope of capital consolidation Decrease in scope of capital consolidation Other contributions / other capital paid in Reclassifications Currency translation effect Distribution of profit Revaluation adjustments not affecting net income Other allocations to (transfers from) the reserves for general banking risks Other allocations to (transfers from) the other reserves Group net income Total equity as at 31.12.2015 1,925 7,566 –4 9,487 500 21 –280 –18 2,425 7,290 722 722 500 21 –3 –280 –18 722 10,429 –3 –8 in CHF million Bank’s capital Profit reserves Group net income Foreign currency translation reserve Total equity Total equity as at 01.01.2016 Opening amount Impact of restatement Capital increase Capital decrease Increase in scope of capital consolidation Decrease in scope of capital consolidation Other contributions / other capital paid in Reclassifications Currency translation effect Distribution of profit Revaluation adjustments not affecting net income Other allocations to (transfers from) the reserves for general banking risks Other allocations to (transfers from) the other reserves Group net income Total equity as at 31.12.2015 2,425 8,012 –8 10,429 –326 0 2,425 7,686 691 691 –0 –8 –0 –326 0 691 10,793 70 Zürcher Kantonalbank Annual Report 2016 Financial Report Outsourcing Zürcher Kantonalbank outsourced contract initiation for the conclusion of online mortgages via a portal as a “significant service” as defined in FINMA Circular 2008 / 7 (“Outsourcing by banks”) to Homegate AG, Zurich. Furthermore, Zürcher Kantonalbank out- sourced the digitalisation of paper-based structured payment orders (ZKB Quickpay) to Swisscom (Schweiz) AG, Ittigen. Notes a) Profile Zürcher Kantonalbank has been at the service of its customers for more than 140 years. It has established a leading financial market position in particular in the Greater Zurich Area since the bank was founded in 1870. The bank continuously develops itself further in order to meet the ever-changing needs of our customers as best as possible. Broad diversification With the parent company, Zürcher Kantonalbank, the group is the largest cantonal bank in Switzerland. It is positioned as a full-service bank with a regional anchoring and its primary focus is on customers in the Greater Zurich Area. To a limited extent, the bank also conducts business in the rest of Switzerland and abroad. Zürcher Kantonalbank is an independent public -law institution of the canton of Zurich with headquarters in Zurich and offers its customers the densest branch network in the Greater Zurich Area. The bank’s public service mandate requires it to contribute to address- ing economic and social issues in the canton of Zurich and to support environmentally sustainable develop- ment in the region. Furthermore, the broadly diversified group includes Swisscanto Holding Ltd. with its sub- sidiaries (Swisscanto Fund Management Company Ltd, Swisscanto Pensions Ltd., Swisscanto Funds Centre Ltd. and Swisscanto Asset Management International SA), which are primarily active in the asset management business, Zürcher Kantonalbank Finance (Guernsey) Ltd., which focuses on issuing structured investment prod- ucts and Zürcher Kantonalbank Österreich AG, which operates international onshore private banking. Please see Note 7 (p. 86) for detailed information on the participation structure. Zürcher Kantonalbank Annual Report 2016 71 Financial Report Note b) Accounting and valuation policies Changes in accounting and valuation principles No material changes in accounting and valuation principles were recorded in the year under review. Period of consolidation The period of consolidation corresponds to the calendar year. General principles The group financial statements of the Zürcher Kantonal- bank group are prepared in accordance with the Listing Rules of the Swiss Exchange and with the accounting rules for banks, securities dealers, financial groups and conglomerates (ARB). The group financial statements provide a true and fair view of the group’s financial posi- tion, results of operations and cash flows. Scope of consolidation The consolidated financial statements comprise the accounts of the parent company and the directly and indirectly owned significant subsidiaries in which the bank has a participation of more than 50 percent of the voting capital or which it controls in another way. The group financial statements are prepared in accordance with the principle of substance-over-form. The individual accounts of the group companies are included on the basis of uniform accounting standards that are applied throughout the group. Method of consolidation Capital is consolidated in accordance with the purchase method. This involves offsetting the group companies’ equity capital at the time of acquisition or at the time of formation against the book value of the parent com- pany’s interest. Please refer to the section on Intangible assets (p. 76) for details of the treatment of any good- will. All the assets and liabilities as well as expenses and income of the subsidiaries to be consolidated are included in the group financial statements. Intragroup transactions and unrealised gains are eliminated on consolidation. Recognition of transactions All business transactions are recorded and measured in accordance with recorded principles on the day they occur. Foreign exchange and precious metal spot and forward transactions concluded but not yet executed are booked in accordance with the settlement-day prin- ciple. These transactions are stated between trade and settlement date (value date) at replacement value under the corresponding position (positive or negative replacement values of derivative financial instruments). Securities and options transactions are recognised in the balance sheet as of the transaction day. Balance sheet fixed-term transactions are booked as of the settlement day. Foreign exchange conversion Transactions in foreign currency are converted at the corresponding daily rate. Assets and liabilities in foreign currency, with the exception of banknotes, are calcu- lated at the average rate as at the balance sheet date. The bid rates on the balance sheet date are applied for foreign banknotes. Exchange gains and losses are recognised under “results from trading activities and the fair value option”. The annual financial statements of Zürcher Kantonalbank Österreich AG are prepared in euros. The assets and liabilities are converted at the rate on the balance sheet date, and income and expenses at the average exchange rate for the year. The difference between these exchange rates is reported directly in equity as foreign currency translation effect under the item “foreign currency translation reserve”. Fig. 1: Foreign currency conversion rates 2016 2015 Rates on balance sheet date Annual average rates Rates on balance sheet date Annual average rates USD EUR 1.0164 1.0720 0.9873 1.0892 1.0010 1.0874 0.9645 1.0640 72 Zürcher Kantonalbank Annual Report 2016 Offsetting assets and liabilities In principle, no offsetting takes place except in the following cases. Claims and liabilities are offset if all the conditions below are met: p claims and liabilities arise from the same type of transactions with the same counterparty, p have the same or earlier maturity for the claim, p are in the same currency, and p cannot result in a counterparty risk. Holdings of own bonds and cash bonds are offset against the corresponding liability positions. Furthermore, positive and negative changes in book value with no income effect are offset in the compensation account. For over-the-counter transactions, the positive and negative replacement values of derivative instruments as well as the related cash collaterals are offset (netting). For this purpose, a relevant bilateral agreement with the affected counterparties must be in place. This agree- ment must be proven to be recognised and legally enforceable. Liquid assets Besides the cash balances in Swiss francs and foreign banknotes, the sight deposits with the Swiss National Bank are primarily included in this position. These items are carried at nominal value. Amounts due from and to banks Unless stated otherwise in a different position, amounts due from and to banks including bills of exchange drawn on the bank and money market instruments without the character of securities are stated in this position. These items are carried at nominal value. Redis- counted transactions in bills of exchange and money market instruments are shown net at year-end. Appropriate allowances are created for default risks on existing positions and directly deducted from assets (see also section “Value adjustments for default risks, provisions and losses from interest operations”, p. 74). Financial Report Amounts due from and liabilities from securities financing transactions The amounts due from securities financing transactions include reverse repo transactions which are treated as advances against collateral in the form of securities. This underscores the financing nature of the transactions. The securities are transferred in the same way as if they had been pledged as collateral for the loan. Reim- bursement claims in the context of securities borrowing, which arise from cash collaterals for the borrowed, non-monetary values, are also included. Repo transactions in the sense of a collateralised refinancing are entered in the balance sheet under liabili- ties from securities financing transactions. Within the framework of securities lending, Zürcher Kantonalbank lends non-monetary assets, such as securities, on its own account and at its own risk (principal status). The redemption obligation for cash deposits received is also shown here. The bank conducts lending and bor- rowing transactions within the framework of trading transactions. Loan transactions involving securities or money market paper not collateralised with cash are not recognised in the balance sheet but reported in the Notes. Amounts due from customers, mortgage loans and amounts due in respect of customer deposits These items are carried at nominal value. Book claims in precious metals are stated at market values. Appropriate allowances are created for default risks on existing positions and directly deducted from assets (see the next section). Default risks on credit limits granted but not utilised on the balance sheet date are accounted for by means of provisions (see “Provisions”, p. 77). Leasing arrangements are reported in the balance sheet under loans, at their nominal value (or property value) less accumulated amortisation plus instalments due but not paid, interest on arrears and fees. The element of the leasing instalment representing the interest for the period in question is reported under interest income. The remaining amount of the leasing instalment repre- sents the repayment element and reduces the claim amount. Comments on the valuation of collateral for loans can be found in section e), under “Valuation of collateral” (p. 79). Zürcher Kantonalbank Annual Report 2016 73 Trading portfolio assets and liabilities Trading positions including money market paper held in the context of the trading business are carried at fair value. This is defined as the amount for which mutually independent, knowledgeable business partners would exchange an asset or repay a debt. This corresponds to the price set on a price-efficient and liquid market or determined on the basis of a valuation model. If – in exceptional cases – fair value cannot be calculated, positions are accounted for and valued at the lower of cost or market. Valuation differences are recognised in the income statement. Interest and dividend income on securities trading portfolios are credited to the item “result from trading activities and the fair value option”. The refi- nancing result for the securities trading portfolio is calcu- lated by offsetting result from trading activities against net interest. With the exception of the physical precious metal portfolios accounted for under financial invest- ments, all other precious metals that are physical and held in account form are accounted for as trading activities and at fair value. Short positions are also accounted for at fair value and stated under the item “trading portfolio liabilities”. Financial Report Value adjustments for default risks, provisions and losses from interest operations Loss risks on existing exposures are allowed for by appropriate value adjustments. They are formed via the item “changes in value adjustments for default risks and losses from interest operations” and deducted directly from the asset affected. The amount of the allowance is determined on a systematic basis that takes account of the risks of Zürcher Kantonalbank’s portfolio. The bank considers loans / receivables to be impaired if there are indications that the debtor will not be able to meet his future liabilities, but at the latest when the contractually defined amortisations, interest and commission payments are due for 90 days or more. The corresponding interest and commission is provided for in full. Impaired loans / receivables are valued on an individu- al basis. Individual allowances for credit risks are established in accordance with the following principles: p Claims are valued individually on the basis of the borrower’s financial situation and the realisable value of any collateral. p As soon as the expected payments to repay a loan are no longer assured, a value adjustment is estab- lished for the probable credit default (book value less estimated recoverable amount). p Exposures rated as impaired are subjected to a credit rating test at least twice a year. If necessary, an appropriate value adjustment is formed or existing ones adjusted to the current circumstances. Value adjustments for impaired loans are reversed if there is reasonable assurance of timely collection of interest and principal in accordance with the contractual terms of the claim agreement. In the event of small risks in homogenously composed credit portfolios, the need for an allowance is assessed collectively (collec- tive individual value adjustments). Zürcher Kantonalbank does not set up a collective value adjustment for inherent risks because the method used to determine an individual allowance ensures the correct valuation of a loan. Country-specific risks in connection with loans / receivables are accounted for separately. Among other factors, country assessments of various rating agen- cies are taken into account. Such value adjustments take into account any existing collateral as well as existing individual value adjustments and are reviewed at least every six months. If all or part of a claim is deemed uncollectible or forgiven, it is written off accordingly. 74 Zürcher Kantonalbank Annual Report 2016 Financial Report Positive and negative replacement values of derivative financial instruments Derivative financial instruments are valued at fair value and, in principle, represent trading activities. Com- ments on the business policy parameters for the use of derivative financial instruments and explanations in connection with the application of hedge accounting can be found under section f) (p. 80). Replacement values of derivative financial instruments from customer transactions resulting from contracts traded over- the- counter (bank as agent) are, in principle, accounted for. Exchange-traded contracts from customer trans- actions are accounted for if no daily margining takes place. Replacement values from trading activities are accounted for under “Positive replacement values of derivative financial instruments” on the asset side or the item “Negative replacement values of derivative financial instruments” on the liability side. Valuation gains are recognised through income in the item “Result from trading activities and the fair value option”. Hedging transactions are also valued at fair value. An exception are the derivative financial instruments used to hedge interest rate risk within the scope of asset and liability management. In this case, value changes are recognised in the compensation account not affecting net income. The net balance of this compensation account is included in “Other assets” or “Other liabili- ties”. If the gains from the hedging transaction exceed those from the hedged underlying transaction, the hedge is considered ineffective. The excess part of the derivative instrument is treated like a trading transaction. Please see the statements in the section “Offsetting assets and liabilities” (p. 73) with respect to the recognition of netting agreements for derivative financial instruments. Other financial instruments at fair value or liabilities from other financial instruments at fair value Structured products with own debenture components issued by the bank are valued as a whole at fair value (no bifurcation of the derivative from the underlying instrument) provided that the following conditions have been met on a cumulative basis: a) The financial instruments are valued at fair value and are subject to risk management corresponding to that for trading activities. This should be based on a documented risk management and investment strate- gy which ensures correct recording, measuring and limitation of the various risks. b) There is an economic hedging relationship between the financial instruments on the asset side and those on the liability side that is largely neutralised in terms of income by the fair value valuation (avoidance of an accounting mismatch). c) Any impact of a change in own creditworthiness on the fair value is neutralised and does not affect the income statement where it arises. The amounts are accounted for under “Liabilities from other financial instruments at fair value”. Investments by subsidiaries managed in the trading book and con- nected to self-issued structured products are stated at fair value. The accounting takes place in “Other finan- cial instruments at fair value”. Financial investments The item includes money market securities which are not held in the context of trading business. Accounting takes place at nominal value taking a discount provi- sion into account. Fixed-income securities held to matu- rity are valued in accordance with the accrual method (at acquisition cost with amortisation of the premium or discount over the maturity). Realised gains from sales prior to maturity are amortised to maturity. The lower of cost or market rule is applied in the case of value losses resulting from changes in credit standing. Fixed-interest securities with no intention to hold until maturity are also recorded based on the same rule. Shares and other equity securities that, irrespective of the share of voting rights, are also booked under this item provided that they were not acquired as a perma- nent investment. Real estate taken over from the credit business and intended for disposal is also valued at the lower of cost or market (acquisition cost or conservatively esti- mated lower liquidation value). Non-realised losses and market-related revaluations up to the original cost of the securities components are stated under “Other ordinary expenses” or “Other ordinary income”. Realised gains or losses of the securities components from the sale of financial invest- ments are booked under “Results from the disposal of financial investments”. Unrealised and realised gains in foreign currency components are booked under “Results from foreign exchange trading”. Non-consolidated participations Shares and other equity securities are considered as participations regardless of the share of voting rights held, provided they have been acquired as a perma- nent investment. Participations with voting rights of up to 20 percent are valued at lower of cost or market. Participations are subject to an impairment review, con- ducted at least once a year. Non-consolidated par- Zürcher Kantonalbank Annual Report 2016 75 Financial Report ticipations with voting rights of between 20 percent and 49.9 percent, together with the non-material (from an accounting perspective) majority participation in Zürcher Kantonalbank Representações Ltda. are stated in accordance with the equity method in proportion to the equity held on the balance sheet date. The propor- tionate net income is recognised in the group income statement on the basis of equity valuation as par- ticipation income. Tangible fixed assets Bank premises, including installations and fittings in rented properties, are carried at historical cost plus major investments and amortised on a straight-line basis over their estimated useful life. Other properties acquired as a long-term investment are also carried at the lower of cost less straight-line amortisation or capitalised value. The remaining tangible fixed assets comprise IT systems and equipment, furniture, vehi- cles and machinery. Smaller investments are charged in full to other operating expenses in the year of acquisi- tion. Larger investments are capitalised and amortised in full over their estimated useful life on the basis of business criteria or, in the case of acquired data process- ing programs, generally over twelve months. Fig. 2: Estimated useful life for depreciation purposes (in years): Country Bank premises and other properties – Shell – Building envelope Installations (fitting out, technical installations) Fittings in rented properties IT systems and equipment Acquired IT programmes Furniture / vehicles / machines no depreciation max. 80 max. 30 max. 25 remaining duration of rental agreement * 2 to max. 5 max. 1 max. 5 * In the case of rental agreements with an option to extend, depreciation is extended to the option date should the investment be made with the intention of taking up the option. An impairment test of all tangible fixed assets is under- taken on a regular basis. An asset is subject to impair- ment if its book value exceeds the realisable value. In the real estate sector, the realisable value is determined by a property valuer. For other tangible fixed assets, the realisable value is equivalent to the economic value, which is defined according to business criteria. Intangible assets Goodwill If the purchase cost of an acquisition is greater than the net assets valued in accordance with standard groupwide accounting principles, the remaining amount is capitalised as goodwill. This goodwill is written off over the estimated useful life on a straight-line basis. The amortisation period is generally five years, from the date of acceptance, but a maximum of 10 years, in justi- fied instances. If the recoverability of goodwill is no longer ensured on the balance sheet date (impairment), an impairment is recognised. Other intangible assets The other intangible assets include purchased software licences. Smaller investments are charged in full to other operating expenses in the year of acquisition. Larger investments are capitalised and normally fully amortised over 12 months. 76 Zürcher Kantonalbank Annual Report 2016 Financial Report Taxes As an independent public-law institution, Zürcher Kantonalbank is exempt from taxes on its income and capital under cantonal law (§61) and federal law on direct taxation (§56). The subsidiary Zürcher Kantonalbank Finance (Guernsey) Ltd. is a finance company under Companies Law in Guernsey. In terms of tax law, as of 1 January 2008 the company is deemed to be resident and is liable to pay tax. As it does not perform any banking activi- ties that are subject to income tax or any other regulated transactions that are subject to tax, Zürcher Kantonal- bank Finance (Guernsey) Ltd. pays only a fixed “validation fee”, which is included in other operating expenses. Zürcher Kantonalbank Finance (Guernsey) Ltd. is not liable for any federal, cantonal or municipal taxes in Switzerland. The Swisscanto companies are liable for cantonal and federal taxes or the tax regimens of Luxembourg or the United Kingdom in accordance with their domicile. Zürcher Kantonalbank Österreich AG is subject to Austrian corporation tax. Its taxable income is taxed at a fixed rate of 25 percent. The tax implications of time differences between the balance sheet values reported in the group financial statements and the tax values in the individual accounts are reported as deferred tax claims or liabilities. Deferred tax claims from loss carry-forwards are cap- italised where it is likely that sufficient taxable profits will be generated within the statutory time limits, against which these differences / corresponding loss carry- forwards may be offset. Changes in deferred taxes are stated in the income statement via the taxes item. Provisions Loss risks in connection with off-balance-sheet trans- actions (e. g. credit limits confirmed but not utilised) as well as other identifiable and foreseeable risks as of the balance sheet date are accounted for by means of appropriate, operationally necessary provisions. Formation and dissolution takes place via the posi- tion “Changes to provisions and other value adjust- ments and losses”. Profit reserves The group’s self-generated funds are recognised under retained earnings reserves. This item also includes the reserves for general banking risks separately disclosed by the parent company. Pension funds An annual evaluation is performed to assess whether, from the group’s perspective, an economic benefit or economic obligation arises for the bank or the group as a result of a pension fund. The determination is based on agreements and annual financial statements of the pension funds, which, in Switzerland, are prepared according to Swiss GAAP FER 26. Other calculations showing the financial situation and existing surplus / shortfall for each pension fund in accordance with actual circumstances are also taken into account. Zürcher Kantonalbank has no liabilities that extend beyond the regulatory foundations. The employer contribution reserve is capitalised in the “Other assets” item. Additions and withdrawals are included in “Personnel expenses”. Please see Note 13 (p. 88) for additional infor mation. Contingent liabilities, irrevocable commitments, obligations to pay up shares and make further contributions, credit commitments and fiduciary investments Off-balance-sheet transactions are reported at nominal value. Appropriate provisions are set aside for identi- fiable risks in accordance with the principle of prudence. Irrevocable commitments also include forward com- mitment mortgages. Zürcher Kantonalbank Annual Report 2016 77 Financial Report Note c) Explanations of risk management For explanations on risk management in general and the treatment of the interest rate risk, other market risks and credit risks specifically, please refer to the state- ments in section l) “Risk report” (p. 106). Note d) Explanation of the methods used for identifying default risks and determing the need for value adjustments The methods used in connection with the identification of default risks and the determination of value adjust- ments can be seen under accounting and valuation principles on page 74. Further information can also be found in section l) Risk report in the “Credit risks” paragraph (p. 115). 78 Zürcher Kantonalbank Annual Report 2016 Financial Report Notes e) Explanation of the valuation of collateral conditions may require an adjustment to the valuation intervals or portfoliospecific, extraordinary revaluations. The maximum permitted loan for the financed property is based on the class of collateral. The class of collateral reflects the expected volatility of the value of the real estate or the usability of the real estate. It is determined by the type of property (e. g. singlefamily house, commercial property), the type of use (owner occupied, rented) and other propertyspecific criteria (e. g. position, size of property). Other collateral Other collateral includes account balances, marketable securities as well as other readily realisable assets (precious metals, fiduciary investments, claims from life insurance policies, etc.). To the extent possible, lending values are based on market values. Other collateral is subject to the deduction of specified margins. These take into account the likelihood of fluctuations in value and concentration risks within the coverage. The valuation of collateral for loans is specified in com- prehensive internal regulations. They define the methods, procedures and competencies. These rules are contin ually monitored and aligned with regulatory requirements and market changes. The bank distinguishes between mortgage claims in the form of secured loans and ready realisable collateral. Collateral secured by mortgage Zürcher Kantonalbank uses recognised estimation methods appropriate to the type of property for the evaluation of collateral secured by mortgage. The lower of cost or market principle is applied; accordingly, the lower of estimated value or purchase price is taken as the lending basis. This corresponds to the guidelines for the audit, evaluation and completion of mortgage secured loans issued by the Swiss Bankers Association. The key evaluation factors for a property assess- ment are: p Land (macro and micro position, area) p Building (construction standard, condition, room concept, sustainability) p Type of use (private, commercial, communal) p Legal regulations p Situation under substantive law and contractual agreements (rights, encumbrances) p Income from rented properties Modelbased evaluation processes are used in the first instance in the financing of singlefamily houses and apartments. In the bank’s internal hedonic model, the estimated value is determined based on the characteristics of the property to be valued and with the assistance of the data from similar market transactions. Depending on the type of property, customer and complexity, Zürcher Kantonalbank also makes use of expert estimations. The assessment criteria, the valua- tion procedures and methods to be used and the required valuation skills of experts are set out in the bank’s internal regulations. The valuation of collateral secured by mortgages are reviewed on a regular basis. The frequency depends on the type of property. Special developments in the real estate market or macro economic framework Zürcher Kantonalbank Annual Report 2016 79 Financial Report Notes f) Explanation of the bank’s business policy regarding the use of derivative financial instruments and the use of hedge accounting Use of derivative financial instruments The business with derivative financial instruments requires observing financial policy requirements. It may be conducted for the purposes of proprietary and customer trading as well as for hedging, and contains both over-the-counter (OTC) as well as exchange - traded transactions. Derivative financial instruments may only be estab- lished on underlyings that fulfil the following conditions: p Pricing is generally undertaken via an exchange, another organised exchange or according to recog- nised, transparent regulations determined in advance. p The prices are published. p The underlying instrument may only be physically delivered for participation rights, bonds, fund units and precious metals. Comments in connection with the application of hedge accounting Hedge accounting is a balance sheet accounting of collateral relationships. It intends to reduce the volatility of the profit values or equity capital stated and adjust it to the economic risk. The Zürcher Kantonalbank Group applies hedge accounting to limit the interest rate risk in connection with balance sheet structure management. In this process, there is both a cash value and an income pros- pect consideration. For further details of the processes and methods, please refer to the corresponding para- graph and section I) Risk report (p. 123). Contractually-agreed customer transactions, finan- cial investments as well as debt financing in the banking book qualify as underlying transactions to be hedged. For the underlying instrument, a distinction is made be- tween direct and indirect transactions. For direct transactions, Treasury has a direct influence on the tim- ing and terms of the underlying instrument (purchase of financial investments, bond issues). Indirect transac- tions are understood to be all the transactions con- cluded by sales and transferred to Treasury for managing the interest risks. For direct transactions, the profit and loss (P & L) of individual transactions is taken into account, whilst for direct transactions only the market value of the positions, based on changed market conditions (in particular the interest curve), are included in profit and loss. Appropriate derivative financial instruments (mainly interest swaps) are used for hedging purposes. For each hedging relationship, a review is undertaken to determine whether they meet the conditions for the application of hedge accounting (e. g. the hedging transactions must be concluded with an external counterparty). All hedging transactions are treated as direct trans- actions. Zürcher Kantonalbank hedges the underlying transaction by means of a macro hedge. It optimises the total exposure on the basis of key rate sensitivities while adhering to the risk policy requirements. The P & L of the hedging transactions has an opposite direction to the P & L of the underlying transactions and indicates the economic risk assumption and cover. The hedge effectiveness is measured every six months as of the balance sheet date at the end of June and the end of December. It is based on the effects on the P & L arising from the interest exposures of the underlying transactions and the hedging transactions. Speci- fically, the P & L of the hedging transaction is compared to the P & L of the hedging transaction as of the balance sheet date. The cumulative absolute amounts from the monthly P & L of the underlying and hedging transactions are compared for the aggregate view of the hedge effec- tiveness over the 6-month horizon. The hedge is regarded as effective as long as the P & L of the hedging transactions does not exceed the P & L of the underly- ing transactions. If the P & L of the hedging transactions, accumulated over six months, exceeds the P & L of the underlying transactions, the excessive part of the hedge is regarded as ineffective. The transactions responsible for the ineffectiveness of the hedge are then identified in the hedging portfolio. These transactions are derec- 80 Zürcher Kantonalbank Annual Report 2016 Financial Report ognised from the hedging portfolio and allocated to the trading activities. This is carried out until the hedge is effective in the period under review. No ineffectiveness was recorded in the year under review. Notes g) Explanation of material events occurring after the balance sheet date No significant events affecting the financial position, results of operations and cash flows of the group occurred between the balance sheet date and the date on which the group financial statements were prepared. Zürcher Kantonalbank Annual Report 2016 81 Financial Report Note i) Information on the balance sheet 1 Breakdown of securities financing transactions in CHF million 2016 2015 Book value of cash collateral due to bank for securities borrowed and in connection with reverse repurchase agreements Book value of cash collateral due from bank for securities lent and in connection with repurchase agreements Book value of securities lent in connection with securities lending or delivered as collateral in connection with securities borrowing as well as securities in own portfolio transferred in connection with repurchase agreements – of which with unrestricted rights to resell or pledge Fair value of securities received and serving as collateral in connection with securities lending or securities borrowed in connection with securities borrowing as well as securities received in connection with reverse repurchase agreements with an unrestricted right to resell or repledge – of which repledged securities – of which resold securities 14,889 5,084 3,325 3,325 43,457 358 31,662 14,966 2,991 1,830 1,830 34,760 292 24,525 2 Overview of collateral for loans and off-balance-sheet transactions, as well as impaired loans Overview by collateral Type of collateral in CHF million Secured by mortgage Other collateral Unsecured Total Loans (before netting with value adjustments) Amounts due from customers Mortgage loans – Residential property – Office and business premises – Trade and industrial property – Other Total mortgage loans Total lendings (before netting value adjustments) 2016 Total lendings (before netting value adjustments) 2015 Total lendings (after netting value adjustments) 2016 Total lendings (after netting value adjustments) 2015 Off-balance-sheet Contingent liabilities Irrevocable commitments Obligations to pay up shares and make further contributions Credit commitments Total off-balance-sheet transactions 2016 Total off-balance-sheet transactions 2015 82 Zürcher Kantonalbank Annual Report 2016 72 925 6,626 7,623 64,061 8,607 2,361 2,296 77,325 77,397 73,757 77,347 73,708 59 1,131 1,190 1,289 64,061 8,607 2,361 2,296 77,325 84,948 81,453 84,785 81,296 4,483 7,506 233 12,222 11,476 925 886 920 884 1,969 49 2,017 1,743 6,626 6,811 6,518 6,705 2,455 6,327 233 9,015 8,444 (continued on page 83) 2 Overview of collateral for loans and off-balance-sheet transactions, as well as impaired loans Financial Report (continued) Information on impaired loans in CHF million Impaired loans 2016 2015 Gross debt Estimated yield from collateral Net debt Individual allowances 1 468 466 285 282 183 184 169 162 1 Individual allowances of 100 percent of the net amount outstanding are normally formed. Individual rates of adjustment may apply in the case of major positions. 3 Trading portfolios and other financial instruments at fair value in CHF million Assets Debt securities, money market securities / transactions – of which listed 1 Equity securities Precious metals and commodities Other trading portfolio assets Total trading portfolio assets Debt securities Structured products Other Total other financial instruments at fair value Total assets – of which determined using a valuation model – of which securities eligible for repo transactions in accordance with liquidity requirements 1 Listed = traded on a recognised exchange. in CHF million Trading portfolio liabilities Debt securities, money market securities / transactions – of which listed 1 Equity securities Precious metals and commodities Other trading liabilities Total trading portfolio liabilities Debt securities Structured products Other Total other financial instruments at fair value Total liabilities – of which determined using a valuation model 1 Listed = traded on a recognised exchange. 2016 5,468 5,314 2,472 1,532 9,472 20 20 9,492 20 1,616 2016 2,644 2,589 12 0 0 2,656 3,100 3,100 5,756 3,100 2015 5,524 5,284 2,773 1,929 10,226 220 220 10,446 516 1,784 2015 2,085 2,074 17 9 2,110 4,163 4,163 6,273 4,460 Zürcher Kantonalbank Annual Report 2016 83 Financial Report 4 Derivative instruments (assets and liabilities) in CHF million Positive replacement values Negative replacement values Contract volume Positive replacement values Negative replacement values Contract volume Trading instruments Hedging instruments 500 255,140 5,390 6,687 0 557 1,000 23,164 267,717 557 1,000 23,164 Interest rate instruments Forward contracts including FRAs Swaps Futures Options (OTC) Options (traded) Total Foreign exchange / precious metals Forward contracts Combined interest rate / currency swaps Futures Options (OTC) Options (traded) Total Equity securities / indices Forward contracts Swaps Futures Options (OTC) Options (traded) Total Credit derivatives Credit default swaps Total return swaps First-to-default swaps Other credit derivatives Total Others 1 Forward contracts Swaps Futures Options (OTC) Options (traded) Total Total before netting 2016 – of which, determined using a valuation model 2015 – of which, determined using a valuation model 6,150 185 0 6,335 2,962 608 279 1 3,851 1 163 105 270 2 2 4 2 2 10,460 10,460 9,700 9,700 0 5,274 110 0 5,385 2,839 1,001 77 1 297,707 4,495 27 11,889 180 3,918 314,298 7 54 133 193 3 0 3 2 0 3 9,501 9,501 8,847 8,847 212 112 1,231 6,195 7,750 433 136 569 269 47 2 318 590,652 – 459,646 – 85 85 530 2,269 530 2,269 642 642 748 748 1,530 1,530 1,933 1,933 25,433 – 30,380 – Total after netting agreements Positive replacement values (accumulated) Negative replacement values (accumulated) 2016 2015 1,933 2,897 1,551 2,067 (continued on page 85) 84 Zürcher Kantonalbank Annual Report 2016 Financial Report 4 Derivative instruments (assets and liabilities) (continued) Breakdown by counterparty in CHF million Positive replacement values (after netting agreements) 2016 1 Includes commodities and hybrid derivatives. Central clearing houses Banks and securities dealers Other customers 68 575 1,290 The contract volume shows the amount of underlying on which a derivative is based or the notional amount underlying the derivative in accordance with the requirements of FINMA Circular 15 / 1, irrespective of whether the derivative is traded long or short. The contract volume is determined differently depending on the type of contract and does not permit any direct conclusions to be drawn about the risk exposure. 5 Financial investments in CHF million Debt securities – of which intended to be held to maturity – of which not intended to be held to maturity (available for sale) Equity securities – of which qualified participations 1 Precious metals Real estate 2 Total financial investments – of which securities eligible for repo transactions in accordance with liquidity requirements 1 At least 10 percent of the capital or voting rights. 2 The insurance value of real estate included in financial investments amounted to CHF 1 million. Book value Fair value 2016 2015 2016 2015 3,927 3,927 4,146 4,146 4,145 4,145 4,372 4,372 10 12 21 23 217 1 4,156 3,817 162 1 4,320 4,021 217 1 4,385 4,030 162 1 4,558 4,243 Counterparties by rating in CHF million Moody’s Standard & Poor’s, Fitch Debt securities: book values 2016 Aaa – Aa3 Aaa – AA– A1 – A3 A+ – A– Baa1 – Baa3 BBB+ – BBB– Ba1 – Ba3 Lower than Ba3 BB+ – B– Lower than B – No rating No rating 3,530 69 329 All but CHF 2.5 million of debt instruments without a rating fulfil the conditions for high-quality liquid assets (HQLA) according to the Liquidity Ordinance (LiqV). If two or more ratings exist with different risk weightings, those ratings which correspond to the two lowest risk weightings are taken into consideration and the higher of the two risk weightings is used. As a first priority the issue rating is used and as a second priority, the issuer rating. 6 Presentation of non-consolidated participations Accumu- lated value adjustments and changes in book value (valuation using equity method) Book value at end 2015 Reclassifica- tions Additions Disposals (incl. any for- eign currency differences) Value adjustments Changes in book value in the case of participation values using the equity method / depreciation reversals Book value at end 2016 Market value at end 2016 in CHF million Acquisition cost Participations valued using the equity method – with market value – without market value 30 –13 17 Other participations – with market value – without market value Total participations 1 56 93 179 –5 –18 56 88 161 26 26 –0 –0 –1 –11 –2 –15 1 4 1 7 17 48 113 179 48 48 1 No significant impairments and appreciation due to (partial) omission of an impairment to be recorded. Zürcher Kantonalbank Annual Report 2016 85 Financial Report 7 Disclosures on companies in which the bank holds a permanent direct or indirect significant participation Company name Domicile Business activity Currency of corporate capital Company capital in CHF million Zürcher Kantonalbank capital ratio in % Zürcher Kantonalbank voting rights in % Held directly Held indirectly Fully consolidated holdings Zürcher Kantonalbank Finance (Guernsey) Ltd. Guernsey Financial services Swisscanto Holding Ltd. 1 Zurich Participations Swisscanto Fund Management Company Ltd. Swisscanto Pensions Ltd. Zurich Zurich Fund management Financial services Swisscanto Fund Centre Ltd. London Financial services Swisscanto Asset Management International SA Luxembourg Fund management Zürcher Kantonalbank Österreich AG Salzburg Financial services CHF CHF CHF CHF CHF CHF EUR Reported under non-consolidated participations: 2 – of which using the equity method 1 24 5 1 15 0 6 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Technopark Immobilien AG Zurich Project planning, construction, maintenance CHF 40 33.3 33.3 – of which other non-consolidated participations Pfandbriefzentrale der schweizerischen Kantonalbanken AG Zurich Pfandbrief institution Aduno Holding AG 4 Zurich Participations CHF CHF 1,625 3 25 17.8 14.7 17.8 14.7 Not fully consolidated subsidiaries Zürcher Kantonalbank Representações Ltda. 5 São Paulo Representative office BRL 0 100.0 100.0 x x x x x x x x x x x 1 Swisscanto Holding Ltd. holds 100 percent of the shares in Swisscanto Fund Management Company Ltd., Swisscanto Pensions Ltd., Swisscanto Fund Centre Ltd. and Swisscanto Asset Management International SA. 2 All non-consolidated participations with a ratio higher than 10 percent are shown. In addition, the share of the participations in the corporate capital must amount to more than CHF 2 million or the book value to more than CHF 15 million. 3 Of which CHF 325 million has been paid up 4 Requirement to surrender shares when new shareholders are admitted in accordance with the shareholder agreement. 5 Total assets in CHF thousand (2015: 292, 2014: 326); net income in CHF thousand (2015: 14, 2014: 38). 8 Presentation of tangible fixed assets Acquisition cost Accumulated depreciation Book value at end 2015 Change of scope of consolidation Additions Disposals Depreciation Book value End 2016 1,508 –689 8 0 –6 –0 199 –160 818 2 0 39 21 –10 18 –1 –64 –0 –0 –20 766 2 36 in CHF million Bank buildings Other real estate Proprietary or separately acquired software Other tangible fixed assets Tangible assests acquired under finance leases – of which bank buildings – of which other real estate – of which other tangible fixed assets Total tangible fixed assets 1,716 –856 860 39 –11 –84 804 The insurance value of real estate included in tangible fixed assets amounted to CHF 1,471 million. The insurance value of other tangible fixed assets amounted to CHF 553 million. (continued on page 87) 86 Zürcher Kantonalbank Annual Report 2016 Financial Report 31.12.2016 31.12.2015 0 0 0 0 0 0 8 Presentation of tangible fixed assets (continued) in CHF million Operating leases Leasing commitments not recognised in the balance sheet Due up to 12 months Due between 12 months and 5 years Due after more than 5 years Total of leasing commitments not recognised in the balance sheet – of which callable within 1 year 9 Presentation of intangible assets in CHF million Goodwill Patents Licences Other intangible assets Cost value Accumulated depreciation Book value at end 2015 Reclassifica- tions 149 –28 121 38 –35 3 Total intangible assets 186 –62 124 Additions Disposals consolidation Amortisation Appreciation Changes in scope of 63 5 0 68 –0 –0 –19 –5 –0 –25 Book value at end 2016 165 3 168 10 Other assets and liabilities in CHF million Compensation account Deferred income tax as recognised as assets Amount recognised as assets due to employer contribution reserves Amount recognised as assets relating to other assets from pension schemes Badwill Settlement accounts Indirect taxes Other Total Other assets Other liabilities 2016 315 9 1 46 118 31 520 2015 413 9 1 5 70 39 538 2016 2015 355 44 108 506 111 33 68 211 11 Assets pledged or assigned to secure own commitments, and assets under reservation of ownership in CHF million Pledged / assigned assets Amounts due from banks Amounts due from customers Mortgage loans Trading portfolio assets Financial investments Total pledged / assigned assets No assets are subject to reservation of ownership. 2016 Effective commitment 2,189 1,643 9,642 50 2015 Effective commitment 1,851 2,031 8,873 124 5 Book value 1,865 2,051 10,101 124 5 Book value 2,212 1,692 10,101 50 16 14,072 13,524 14,145 12,884 Instruments serving as security where, in connection with securities financing, the right of resale or pledging has been granted are shown in Note 1 (p. 82). Zürcher Kantonalbank Annual Report 2016 87 Financial Report 12 Liabilities relating to own pension schemes and number and nature of equity instruments of the bank held by own pension schemes in CHF million 2016 2015 Change Liabilities to own pension schemes from balance-sheet transactions Amounts due in respect of customer deposits Cash bonds Negative replacement values of derivative financial instruments Accrued expenses and deferred income Total Own pension schemes do not hold any of the bank’s equity instruments. 104 11 0 115 144 0 0 145 –40 11 –0 –30 13 Information on pension schemes The Zürcher Kantonalbank pension schemes is a public-law institution and is a separate legal entity. The purpose of the pension scheme is to insure the bank’s employees against the economic consequences of age, death and disability. The pension schemes pension plan comprises three different pension vehicles. The annuity plan insures the basic salary (annual salary) according to the combined defined benefit / defined contribution principle 1. The capital plan insures any variable, qualify- ing AHV compensation (bonus) that is paid out. The capital plan is also based on a combined defined benefit / defined contribution principle. The third vehicle – the supplementary account – enables insured individu- als to pre- finance the benefits that will be lost upon early retirement between the ages of 58 and 62. The premiums required for these plans constitute a component of personnel expenses. Contributions to th annuity and capital plans are funded jointly by the insured individual and the bank. The supplementary account is funded exclusively by the insured individuals. For the senior management of affiliated employers, an additional plan is operated in the form of a separate trust. Structured on a defined contribution basis, this scheme insures the element of the base salary in excess of a specific minimum amount. The senior management plan is funded jointly by insured individuals and the bank. The following employers are affiliated to Zürcher Kantonalbank’s pension scheme: p Zürcher Kantonalbank’s Grüningen Botanical Garden Trust p Zürcher Kantonalbank pension fund p Zürcher Kantonalbank’s SanArena Trust p Swisscanto Fund Management Company Ltd. (since 1 January 2016) p Swisscanto Pensions Ltd. (since 1 January 2016) p Zürcher Kantonalbank Occupational pension provision for the employees of the Austrian subsidiary is outsourced to a collective scheme governed by Austrian law. The pension plan is structured on a defined contribution basis. The employees of subsidiary Zürcher Kantonalbank Finance (Guernsey) Ltd. are not affiliated to any pension scheme. 1 Retirement benefits are based on the individually accumulated savings assets, while death and disability benefits are calculated as a percentage of the insured salary. Disability pensions are paid for life, with recalculation of the pension taking place upon reaching normal retirement age. 88 Zürcher Kantonalbank Annual Report 2016 Financial Report Fig. 3: Coverage ratio pursuant to Article 44 BVV2 in % Zürcher Kantonalbank pension scheme Zürcher Kantonalbank trust for senior management Swisscanto pension scheme Coverage ratio as at 31.12.2016 (not audited) Coverage ratio as at 31.12.2015 (audited) 113 110 n / a 1 111 111 115 1 As of 1 January 2016, employees of Swisscanto Fund Management Company Ltd. and Swisscanto Pensions Ltd. are insured under the Zürcher Kantonalbank Pension Scheme. Affiliation with the Swisscanto Flex Collective Foundation was announced at the end of 2015. Swisscanto Funds Centre Ltd. in London has set up a pension plan for all employees. The plan is managed by an outside partner. The assets of the insured persons are invested with a leading pension provider. The savings contributions are fully financed by the employer. The risks are comprehensively covered by insurance companies. assets, is managed by an insurance company. The savings contributions are fully financed by the employer. The risks are comprehensively covered by the insurance company. The office in Germany is a member of the pension scheme for the banking industry. The employ- ees can save tax-free contributions for retirement, with the employer paying part of the contributions. Swisscanto Asset Management International SA in Luxembourg has set up a pension scheme for all em- ployees. The plan, including the investment of employee There is no possibility of shortfall or surplus for pension solutions in other countries as the investment risk is fully borne by the employee. Zürcher Kantonalbank Annual Report 2016 89 Financial Report 13A Employer contribution reserve (ECR) in CHF million 31.12.2016 31.12.2016 31.12.2016 31.12.2015 2016 2015 Nominal value Waiver of use Net amount Net amount Influence of ECR on personnel expenses Influence of ECR on personnel expenses Zürcher Kantonalbank pension scheme Total 1 1 1 1 1 1 –0 –0 –0 –0 13B Economic benefit / economic obligations and the pension expenses in CHF million 31.12.2016 2016 2015 2016 2016 2016 2015 Overfunding / underfunding Economic interest of the financial group Change in economic interest Contributions paid Pension expenses in personnel expenses Employer-funded fund / employer-funded pension fund Pension plans without overfunding / underfunding Pension plans with overfunding Pension plans with shortfall Pension schemes without own assets Total 1 Including the creation of provisions for pension benefit obligations amounting to CHF 70 million. 183 1 183 1 108 183 183 108 14 Issued structured products Underlying risk of the embedded derivative Valued as a whole Valued separately Book value Total Booked in trading portfolio Booked in other financial instruments at fair value Value of the host instrument Value of the derivative 148 2,463 159 56 145 129 3,100 4,163 148 2,463 159 56 145 129 3,100 4,163 in CHF million Interest rate instruments Equity securities Foreign currencies Commodities / Precious metals Loans Real estate Hybrid instruments Total 2016 Total 2015 With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC 90 Zürcher Kantonalbank Annual Report 2016 Financial Report 15 Presentation of bonds outstanding and mandatory convertible bonds (incl. cash bonds and central mortgage institution loans) Cash bonds in CHF million 31.12.2016 31.12.2015 Maturity structure in CHF million Cash bonds Outstanding amount Weighted average interest rate 235 269 2019 28 0.97 1.23 2021 33 2020 16 Maturities 2017 – 2026 2016 – 2025 after 2021 84 Total 235 2017 45 2018 30 Bonds and mandatory convertible bonds in CHF million Outstanding amount Weighted average interest rate Maturities 31.12.2016 (Issuer: Zürcher Kantonalbank) – of which non-subordinated – of which subordinated without PONV clause 1 – of which subordinated with PONV clause 31.12.2015 (Issuer: Zürcher Kantonalbank) – of which non-subordinated – of which subordinated without PONV clause – of which subordinated with PONV clause 9,329 8,031 1,298 7,669 6,358 1,310 1.03 2.79 1.37 2.80 2017 – 2044 2025 – perpetual 2016 – 2044 2025 – perpetual Maturity structure in CHF million Bond issues 1 Point of non-viability (PONV). 2017 1,326 2018 816 2019 114 2020 519 2021 1,052 after 2021 5,501 Total 9,329 Central mortgage institution loans in CHF million 31.12.2016 31.12.2015 Maturity structure in CHF million Central mortgage institution loans 1 Outstanding amount Weighted average interest rate 8,384 7,716 0.79 0.97 Maturities 2017 – 2030 2016 – 2030 2017 516 2018 1,126 2019 742 2020 962 2021 after 2021 Total 794 4,244 8,384 1 Pfandbriefzentrale der schweizerischen Kantonalbanken AG loans. Zürcher Kantonalbank Annual Report 2016 91 Financial Report 16 Presentation of value adjustments and provisions and changes therein during the current year in CHF million Provisions for deferred taxes Provisions for pension benefit obligations 1 Provisions for credit risks Provisions for other business risks 2 Provisions for restructuring 3 Other provisions 4 Total provisions Value adjustments for default risks and country risks – of which value adjustments for default risks from impaired loans 5 – of which value adjustments for latent risks Changes in scope of consoli dation Appropriate usage and reversals As at end of 2015 Reclassifica tions Currency differences Past due interest, recoveries New creations charged to income Releases to income Balance at end 2016 0 147 221 10 206 584 162 162 –10 –2 –9 –7 –28 –5 –5 0 70 47 1 1 119 58 58 –0 –41 –2 –0 –1 –43 –49 –49 0 70 144 221 0 201 636 169 169 2 2 4 –0 –0 3 3 1 In line with a sustainable human resources policy, the board of directors decided in December 2016 that the bank would assume certain costs for the financing of transitional solutions in connection with the realignment of the pension fund to the changed environment. In the year under review, provision for pension liabilities amounting to CHF 70 million was made under personnel expenses. 2 Provisions for other business risks relate to provisions for settlement risks, for example, which cover identifiable risks as at the balance sheet date. 3 Provisions for restructuring were made in connection with the acquisition of the Swisscanto group and comprise personnel measures and various integration costs. 4 Other provisions primarily consist of provisions for litigation and provisions for employees’ holiday credits. 5 Default risks consist primarily of counterparty risks, the values of which are generally adjusted by 100 percent of the net amount outstanding. Individual rates of adjustment may apply in the case of major positions. Recoveries from amounts due derecognised in previous periods are reported directly via changes in value adjustments for default risk and losses from interest operations (2016: CHF 3 million / 2015: CHF 5 million). Zürcher Kantonalbank is aware that the United States Department of Justice (DOJ) and United States Internal Revenue Service (IRS) are investigating Zürcher Kantonalbank’s cross-border business with US customers. The Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks launched by the United States Department of Justice on 29 August 2013 was declared to have ended by the DOJ at the end of 2016. It was aimed at banks that were not the subject of an investigation by the DOJ as at 29 August 2013. It therefore did not apply to Zürcher Kantonalbank, which has been under investigation since September 2011. The bank is continuing to cooperate with the relevant authorities on this matter. It is working towards an agreement. The timing of the conclusion of this process remains uncertain. Zürcher Kantonalbank evaluates all its risks on a constant basis, including in this connection, where necessary, taking corresponding measures in terms of risk provisioning. All assessments are associated with a great deal of uncertainty. For more details on the management of credit risks, operational risks as well as legal and compliance risks, please refer to section I) of the risk report. 17 Presentation of the bank’s capital The disclosure pursuant to the accounting guidelines for banks (AGB) is only made by the parent company (p. 146). 18 Number and value of equity securities or options on equity securities held by all executives and directors and by employees, and disclosures on any employee participation schemes Neither Zürcher Kantonalbank nor its subsidiaries have employee participation schemes. 92 Zürcher Kantonalbank Annual Report 2016 Financial Report 19 Amounts due from and due to related parties Amounts due from Amounts due to in CHF million 2016 2015 Holders of qualified participations: Group companies Affiliated companies Transactions with members of governing bodies Other related parties 4 547 18 11 0 421 16 2016 592 1,629 28 2015 472 1,859 30 Affiliated companies are public cantonal corporations or semi-public enterprises in which the canton holds significant participations. On- and off-balance-sheet transactions with related persons are, with the exception of loans granted to members of the bank’s governing bodies, conducted at usual market conditions. Loans to the bank’s governing bodies are granted occasionally on employee terms. Primarily the usual balance sheet banking business was involved, i. e. it was mainly amounts due from and due to customers. The totals above also include securities items and amounts outstanding from transactions in derivatives (positive and negative replacement values). The off-balance-sheet transactions with related parties in the amount of CHF 205 million (2015: CHF 181 million) primarily include irrevocable loan commitments and other contingent liabilities. 20 Disclosure of holders of significant participations The disclosure pursuant to the accounting guidelines for banks (AGB) is only made by the parent company (p. 147). 21 Disclosure of own shares and composition of equity capital in CHF million Bank’s capital Profit reserves Foreign currency translation reserves Group net income Total equity The bank does not hold any capital shares of its own. 2016 2,425 7,686 –8 691 10,793 2015 2,425 7,290 –8 722 10,429 22 Disclosures in accordance with the Ordinance against Excessive Compensation with respect of Listed Stock Corporations and Article 663c para. 3 CO for banks whose equity securities are listed. The disclosure pursuant to the accounting guidelines for banks (AGB) is only made by the parent company (p. 148). Zürcher Kantonalbank Annual Report 2016 93 Financial Report 23 Maturity structure of financial instruments in CHF million at sight cancellable Due within 3 months between 3 and 12 months between 1 and 5 years after 5 years no maturity Total Assets / financial instruments Cash Amounts due from banks Amounts due from securities financing transactions Amounts due from customers Mortgage loans Trading portfolio assets Positive replacement values of derivative financial instruments Other financial instruments at fair value Financial investments Total assets / financial instruments 2016 Total assets / financial instruments 2015 Debt capital / financial instruments Amounts due to banks 35,336 1,974 185 127 9,472 1,933 20 227 49,274 48,149 0 1,325 1,584 407 74 4,539 995 719 9,868 2,642 8,699 481 773 2,065 849 8,263 36,156 23,312 16 22,550 24,687 197 11,299 11,178 1,683 40,311 38,154 2,032 26,267 25,197 6,253 5,067 1 1 1 2,292 4 27,157 3,515 570 600 Liabilities from securities financing transactions 1,429 Amounts due in respect of customer deposits 22,333 51,630 3,655 4,437 1,183 272 1,035 Trading portfolio liabilities Negative replacement values of derivative financial instruments Liabilities from other financial instruments at fair value 2,656 1,551 3,100 Cash bonds Bond issues Central mortgage institution loans Total debt capital / financial instruments 2016 Total debt capital / financial instruments 2015 1,298 15 783 219 29 543 297 107 2,502 3,624 84 4,204 4,244 31,932 54,361 36,265 5,567 7,075 10,166 33,674 49,371 34,212 8,986 7,293 9,072 35,336 5,364 14,889 7,509 77,275 9,472 1,933 20 4,156 155,954 152,434 34,137 5,084 80,890 2,656 1,551 3,100 235 9,329 8,384 145,366 142,607 94 Zürcher Kantonalbank Annual Report 2016 24 Assets, liabilities and off-balance-sheet positions by domestic and foreign origin – domicile principle Financial Report in CHF million Assets Liquid assets Amounts due from banks Amounts due from securities financing transactions Amounts due from customers Mortgage loans Trading portfolio assets Positive replacement values of derivative financial instruments Other financial instruments at fair value Financial investments Accrued income and prepaid expenses Non-consolidated participations Tangible fixed assets Intangible assets Other assets Total assets Liabilities Amounts due to banks Liabilities from securities financing transactions Amounts due in respect of customer deposits Trading portfolio liabilities Negative replacement values of derivative financial instruments Liabilities from other financial instruments at fair value Cash bonds Bond issues Central mortgage institution loans Accrued expenses and deferred income Other liabilities Provisions Bank’s capital Retained earnings reserve Foreign currency translation reserves Group net income Total liabilities Off-balance-sheet transactions Contingent liabilities Irrevocable commitments Obligations to pay up shares and make further contributions Credit commitments 2016 Domestic Foreign Domestic 35,284 1,403 7,009 5,870 77,275 4,767 1,503 2,422 310 177 799 168 511 53 3,961 7,880 1,640 1 4,705 430 20 1,734 50 1 4 0 9 32,487 1,538 7,436 6,174 73,622 5,226 1,884 2,381 255 160 855 124 528 2015 Foreign 10 4,473 7,530 1,499 1 5,000 1,013 220 1,939 39 1 5 0 10 137,497 20,488 132,671 21,739 2,430 24 75,146 734 735 1,581 235 9,329 8,384 635 506 634 2,425 7,584 –8 674 111,047 1,455 6,603 232 31,707 5,060 5,744 1,922 816 1,519 48 1 2 102 17 46,938 3,027 903 1 2,912 24 75,899 774 743 2,725 269 7,669 7,716 555 210 583 2,425 7,229 –8 735 110,461 1,411 6,501 146 31,890 2,967 4,921 1,336 1,324 1,438 23 1 1 60 –13 43,948 2,440 977 1 Zürcher Kantonalbank Annual Report 2016 95 Financial Report 25 A Assets by country or group of countries Switzerland Rest of Europe – of which Germany – of which France – of which United Kingdom – of which Guernsey Americas – of which USA Asia and Oceania Africa Total assets 25 B Liabilities by country or group of countries Switzerland Rest of Europe – of which Germany – of which France – of which United Kingdom – of which Guernsey Americas – of which USA Asia and Oceania Africa Total liabilities 2016 2015 in CHF million Share in % in CHF million Share in % 137,497 13,382 2,331 911 4,077 120 5,167 3,953 1,889 49 87.0 8.5 1.5 0.6 2.6 0.1 3.3 2.5 1.2 0.0 132,671 14,327 3,354 870 3,893 64 5,386 4,148 1,988 38 85.9 9.3 2.2 0.6 2.5 0.0 3.5 2.7 1.3 0.0 157,985 100.0 154,410 100.0 2016 2015 in CHF million Share in % in CHF million Share in % 111,047 25,239 4,223 2,384 5,459 2,094 9,858 4,082 10,766 1,075 157,985 70.3 16.0 2.7 1.5 3.5 1.3 6.2 2.6 6.8 0.7 100.0 110,461 22,178 5,192 1,436 4,330 2,053 8,671 4,033 11,773 1,326 154,410 71.5 14.4 3.4 0.9 2.8 1.3 5.6 2.6 7.6 0.9 100.0 25 C Contingent liabilities, irrevocable commitments, obligations to pay up shares and make further contributions by countries or group of countries 2016 2015 in CHF million Share in % in CHF million Share in % 8,291 3,061 67 3 1,753 915 475 94 380 15 67.8 25.0 0.5 0.0 14.3 7.5 3.9 0.8 3.1 0.1 8,058 2,554 77 0 187 1,782 530 32 295 39 70.2 22.3 0.7 0.0 1.6 15.5 4.6 0.3 2.6 0.3 12,222 100.0 11,476 100.0 Switzerland Rest of Europe – of which Germany – of which France – of which United Kingdom – of which Guernsey Americas – of which USA Asia and Oceania Africa Total 96 Zürcher Kantonalbank Annual Report 2016 Financial Report 26 Breakdown of total foreign assets by credit rating of country groups (risk domicile view) Rating class of ZKB’s own country rating Moody’s A B C D E F G Total Aaa / Aa1 / Aa2 / Aa3 A1 / A2 / A3 Baa1 / Baa2 / Baa3 Ba1 / Ba2 Ba3 B1 / B2 / B3 Caa1 / Caa2 / Caa3 / Ca / C 31.12.2016 Net foreign exposure 31.12.2015 Net foreign exposure in CHF million Share in % in CHF million Share in % 12,353 84.9 11,605 83.4 641 816 634 75 25 4 4.4 5.6 4.4 0.5 0.2 0.0 747 973 538 32 11 9 5.4 7.0 3.9 0.2 0.1 0.1 14,547 100.0 13,916 100.0 For explanations regarding the rating system please refer to section l) of the risk report (p. 116). Zürcher Kantonalbank Annual Report 2016 97 Financial Report 27 Balance sheet by currencies Currencies converted into CHF million CHF USD EUR ROW Total in CHF million Assets Liquid assets Amounts due from banks Amounts due from securities financing transactions Amounts due from customers Mortgage loans Trading portfolio assets Positive replacement values of derivative financial instruments Other financial instruments at fair value Financial investments Accrued income and prepaid expenses Non-consolidated participations Tangible fixed assets Intangible assets Other assets 35,209 1,053 5,330 5,518 77,139 6,318 1,594 20 3,240 260 178 801 168 496 9 3,361 4,592 870 122 1,770 94 97 65 1 2 Total assets shown in balance sheet 137,324 10,982 103,640 240,964 109,715 120,697 114 723 4,749 974 14 925 227 820 26 0 3 0 11 8,585 76,529 85,114 4,456 4,244 3,886 212 877 659 531 21 1 1 –19 –8 1 4 227 219 147 459 19 0 9 0 11 1,094 18,927 20,021 2,891 851 59 8 18 11 0 35,336 5,364 14,889 7,509 77,275 9,472 1,933 20 4,156 360 179 804 168 520 157,985 308,812 466,796 34,137 5,084 80,890 2,656 1,551 3,100 235 9,329 8,384 683 506 636 2,425 7,686 –8 691 24,808 14,862 3,837 157,985 95,407 120,214 482 –624 71,588 86,450 –1,336 532 16,029 19,866 155 337 308,985 466,969 –173 355 18,887 678 3,359 1,235 216 339 63 30 7,903 162 72,794 1,150 451 2,084 235 8,798 8,384 589 476 635 2,425 7,705 689 114,478 125,961 240,439 525 110 Delivery entitlements from spot exchange, forward forex, forex option and precious metal transactions Total assets Liabilities Amounts due to banks Liabilities from securities financing transactions Amounts due in respect of customer deposits Trading portfolio liabilities Negative replacement values of derivative financial instruments Liabilities from other financial instruments at fair value Cash bonds Bond issues Central mortgage institution loans Accrued expenses and deferred income Other liabilities Provisions Bank’s capital Retained earnings reserve Foreign currency translation reserves Group net income Total balance sheet liabilities Delivery obligations from spot exchange, forward forex, forex option and precious metal transactions Total liabilities Net position per currency in 2016 Net position per currency in 2015 98 Zürcher Kantonalbank Annual Report 2016 Financial Report Note j) Information on off-balance-sheet items The following gives more detailed information on off-balance-sheet positions, as well as assets under management and other liabilities not included in the balance sheet. 28 Contingent liabilities and contingent assets in CHF million Guarantees to secure credits and similar Performance guarantees and similar Irrevocable commitments arising from documentary letters of credit Other contingent liabilities Total contingent liabilities Contingent assets arising from tax losses carried forward Other contingent assets Total contingent assets 2016 437 3,299 746 4,483 2015 416 2,904 531 3,851 In connection with the completed acquisition of Swisscanto Holding Ltd., a fixed purchase price was paid to the sellers in March 2015 and a variable purchase price in October 2016. The purchase contract provides for the possibility of two further variable purchase price payments in 2017 and 2018. Their amount depends on the contribution to results of the individual sellers, general market conditions and the income from the product range. The actual annual share of the purchase price cannot fall below zero. The two variable pur- chase price payments – payable in October 2017 until October 2018 – are not quantifiable at the current time. They are based on the principle whereby the gen- eration of higher net income with the sellers results in higher variable purchase price payments. 29 Credit commitments There are no credit commitments as of 31 December 2016 and 31 December 2015. 30 Fiduciary transactions in CHF million Fiduciary investments with third-party companies Fiduciary investments with linked companies Fiduciary loans Fiduciary transactions arising from securities lending and securities borrowing (conducted out in the bank’s own name for the account of customers) Other fiduciary transactions Total 2016 243 2015 205 243 205 Zürcher Kantonalbank Annual Report 2016 99 Financial Report 31 Breakdown of managed assets and presentation of their development a) Breakdown of managed assets in CHF million Type of customer assets Assets in collective investment schemes managed by Zürcher Kantonalbank Assets under discretionary asset management agreements 1 Other customer assets 1 Total customer assets (including double counting) 2 – of which double counting 3 2016 2015 75,939 57,303 131,512 264,754 38,658 73,884 53,905 129,716 257,505 30,838 1 Assets with a Private Portfolio Consulting (PPC) mandate (approximately CHF 500 million) are now shown under “Other managed assets” (previously “Assets under discretionary asset management agreements”). A PPC mandate offers a more intensive form of advice with additional services compared with a classic advisory mandate. The previous year has been restated. 2 The managed customer assets shown include all customer assets of an investment nature held with Zürcher Kantonalbank, as well as customer assets held with third-party banks and which are managed by Zürcher Kantonalbank. In addition, passive products from corporate customers, which have no investment character, are also shown as managed assets. This does not include assets held with Zürcher Kantonalbank but managed by third parties (custody-only). Assets of banks and significant investment fund companies (including collective pension fund foundations, investment trusts, employee benefits foundations and pension funds) for which Zürcher Kantonalbank acts exclusively as custodian bank are treated as custody-only. 3 Correction of value for previous year by CHF 5.8 billion in view of Swisscanto collective investment schemes. b) Presentation of the development of managed assets in CHF million 2016 2015 1 Total managed assets (including double counting assets) at beginning + / – net new money inflow or net new money outflow 2 + / – price gains / losses, interest, dividends and currency gains / losses + / – other effects Total managed assets (including double counting) at end 257,505 7,953 6,430 –7,134 3 264,754 208,674 –2,502 –903 52,235 4 257,505 1 Following a change in the segmentation of business partners as well as deposits, the figures for the previous year were adjusted. 2 The net new money inflow / outflow corresponds to the development of managed customer assets adjusted for fluctuations in prices and exchange rates, interest and dividend payments, fees and expenses charged to customers, and reclassification of assets. Changes due to acquisitions / disposals of subsidiaries are not included. The interest billed to loan customers is included in the change in net new money inflow / outflow. 3 The restructuring of a major mandate led to a reduction in eligible portfolios, without an actual outflow of assets. The CHF 7.1 billion reduction in assets is therefore shown under “Other effects”. 4 For the most part other effects for 2015 reflect the acquisition of Swisscanto Holding Ltd. 100 Zürcher Kantonalbank Annual Report 2016 Financial Report Note k) Information on the income statement In this section, individual income statement items are broken down in detail and the components of the return on equity explained. 32 Breakdown of the result from trading activities and the fair value option a) Breakdown by business area (in accordance with the organisation of the bank or financial group) in CHF million Result from foreign exchange, banknotes and precious metals Result from bonds, interest rate and credit derivatives Result from trading in equities and structured products Result from other trading activities 1 Total 2016 133 144 48 54 379 2015 120 114 54 39 328 b) Breakdown by underlying risk and based on the use of the fair value option in CHF million Result from foreign exchange, banknotes and precious metals Result from bonds, interest rate and credit derivatives Result from trading in equities and structured products Result from other trading activities Total – of which from fair value option on assets – of which from fair value option on liabilities 2016 133 144 48 54 379 –0 –54 Trading result from: Foreign ex- change and banknotes Precious metals Securities lending and borrowing Bonds, interest rate and credit derivatives Equities and equity derivatives Commod- ities and commodity derivatives Other products 2 113 –0 7 120 –4 20 –5 –0 15 –3 58 58 142 –1 –3 138 –0 –5 2 50 –1 52 –40 –2 –0 –2 –6 –1 –1 4 1 Other trading activities includes results from securities lending and borrowing as well as positions for which the executive board and Asset Management are responsible. 2 Trading income from other products includes hybrid products and real estate derivatives. Zürcher Kantonalbank Annual Report 2016 101 Financial Report 33 Disclosure of material refinancing income in the interest and discount income item as well as material negative interest During the 2016 financial year a refinancing income of CHF –12.1 million (previous year CHF –1.9 million) was included in the interest and discount income item. Negative interest on lending business is shown as a reduction in the interest and discount income. Negative interest on deposit-taking business is shown a reduction in interest expenses. in CHF million Negative interest on lending business (reduction in the interest and discount income) Negative interest on deposit-taking business (reduction in interest expenses) 34 Personnel expenses in CHF million Compensation for governing bodies and personnel – of which alternative forms of variable compensation AHV, IV, ALV and other social security contributions Changes in book value for economic benefits and obligations arising from pension schemes Other personnel expenses Total 1 Including the creation of provisions for pension liabilities amounting to CHF 70 million. 35 General and administrative expenses in CHF million Occupancy expense Expense for information and communications technology Expenses for vehicles, equipment, furniture and other fixtures, as well as operating lease expenses Auditors’ fees – of which for financial and regulatory audits – of which for other services Other operating expenses – of which as compensation for state guarantee Total 2016 148 117 2016 796 249 1 33 1,079 2016 35 172 2 8 8 0 215 22 433 2015 114 82 2015 745 169 32 947 2015 50 172 2 6 5 0 197 21 427 102 Zürcher Kantonalbank Annual Report 2016 36 Explanations regarding material losses, extraordinary income and expenses, as well as value adjustments and provisions no longer required Financial Report in CHF million Extraordinary income Reversal of impairment on other participations Income from sale of other real estate / bank premises Income from sale of participations Other Total Extraordinary expenses Losses from sale of other real estate / bank premises Expenses incurred outride of the reporting period Loss from the sale of participations Other Total 2016 2015 5 9 2 1 17 0 1 1 21 38 3 6 67 0 0 0 In the financial year, no material freed-up allowances and provisions were recorded. 37 Disclosure of and reasons for revaluations of participations and tangible fixed assets up to acquisition cost at maximum in CHF million Participation CLS Group Holdings AG SWIFT Technopark Winterthur AG Valiant Holding AG Total Domicile Lucerne La Hulpe Winterthur Lucerne 2016 2015 1 0 1 3 0 17 20 Appreciation is applied to non-listed participations in accordance with the mean value method and, for listed participations, in accordance with the market value method. Zürcher Kantonalbank Annual Report 2016 103 Financial Report 38 Income statement broken down according to domestic and foreign origin, according to the principle in CHF million Result from interest operations Interest and discount income Interest and dividend income from financial investments Interest expense Gross result from interest operations Changes in value adjustments of default risk and losses from interest operations Subtotal net result from interest operations Result from commission business and services Commission income from securities and investment activities Commission income from lending activities Commission income from other services Commission expense Subtotal result from commission and business services Result from trading operations and the fair value option Other ordinary activities Result from disposal of financial investments Participation income, total group – of which from equity-consolidated participations – of which from other non-consolidated participations Result from real estate Other ordinary income Other ordinary expense Subtotal other result from ordinary activites Operating expenses Personnel expenses General and administrative expenses Subtotal operating expenses Value adjustments on participations and depreciation and amortisation of tangible fixed assets and intangible assets Changes to provisions and other value adjustments and losses Operating result Extraordinary income Extraordinary expenses Change in reserves for general banking risks Taxes Group net income Domestic 2016 Foreign Domestic 2015 Foreign 1,452 58 –311 1,199 –12 1,187 616 55 132 –170 633 357 1 14 3 11 10 9 –3 30 –1,062 –422 –1,484 –123 –7 594 17 –1 –6 604 0 0 –0 0 0 0 147 0 3 –55 95 22 0 0 0 0 0 0 –16 –11 –27 –1 –1 88 0 –0 –1 87 1,395 64 –300 1,159 3 1,162 557 55 1 112 –141 583 307 10 28 3 25 7 9 1 –7 47 –931 –418 –1,349 –105 –61 585 67 –0 –3 648 0 0 –1 –0 –0 –0 135 0 0 –50 85 20 0 0 0 0 0 –0 0 –15 –9 –25 –1 –0 79 0 –5 75 1 A restatement of CHF 4.3 million was undertaken due to a changed profit allocation (+ Commission income from lending activities / – Other ordinary income). 104 Zürcher Kantonalbank Annual Report 2016 Financial Report 39 Presentation of current taxes, deferred taxes and disclosure of the tax rate in CHF million 2016 2015 Creation of provisions for deferred taxes Reversal of provisions for deferred taxes Capitalisation of deferred taxes on loss carryforwards Expense for current income and capital taxes Total –0 0 –0 –7 –7 –0 0 0 –9 –8 Unrecognised reductions on tax loss carryforwards and on tax credits which, under the prudence principle, are not entered in the balance sheet. Hypothetical, deferred income taxes calculated at theoretical tax rates on revalued investments not relevant for tax purposes. Figures in tables: minus = expense; plus = income. As Zürcher Kantonalbank is exempt from direct taxes, no weighted average interest rate is disclosed. 40 Disclosures and explanations of the earnings per equity security in the case of listed banks Zürcher Kantonalbank has no listed equity-type security. 41 Components of ROE in % Return on equity (ROE) in CHF million Relevant net income for calculating ROE Group net income from operations 1 Total Relevant average equity 2 for calculating ROE Average corporate capital Average other equity components Total 1 Excludes the CHF 70 million non-recurring expense in connection with the creation of provisions for pension benefit obligations. 2 Average corporate capital and other equity components are calculated on a monthly basis. 2016 7.4 761 761 2,425 7,869 10,294 2015 7.5 722 722 2,175 7,495 9,670 Zürcher Kantonalbank Annual Report 2016 105 Financial Report Note f) Risk report Risk profile In view of continuing negative Swiss franc interest rates, asset and liability management remains a challenge. The high interest rate sensitivity in the banking book in the long term primarily takes into account the risk of a protracted period of low interest rates. As far as the lending business is concerned, the volume of mortgages increased by nearly 5 percent to CHF 77.3 billion, with lending policy remaining the same. Real estate financing for retail customers account- ed for CHF 57 billion of this. There were no material changes in the rating structure of the various credit portfolios. Except for event-driven movements such as after the Brexit result in June, there was little volatility in the value-at-risk for the trading book for 2016. The low risk figures for trading reflect the strategy of focussing on customer business in this area. The key figures for both short-term and structural liquidity risks indicate a comfortable liquidity situation for Zürcher Kantonalbank. Among operational risks, the management of cyber risks continues to demand particular attention. The legal and reputation risks in the cross-border financial services business are a focal point in the management o compliance risks, together with adapting to changes to the regulatory framework for financial services providers. Internal controls system Zürcher Kantonalbank’s internal controls system covers all control structures and processes, which at all levels of the institution constitute the basis for the achievement of the bank’s business policy objectives, the protection of the bank’s credit rating and reputation, compliance with legal and ethical norms, as well as the reliability of financial reporting. The internal controls system in- volves not only retrospective checks but also planning and management activities. The following are key features of the internal controls system: p the risk policy parameters of the board of directors for safeguarding the bank’s credit rating and reputation, p systematic risk analysis and periodic monitoring of the appropriateness and effectiveness of internal controls by the executive board and board of directors, p the bank’s established processes for risk management and compliance with applicable standards and p the systematic process to ensure the appropriateness and effectiveness of internal controls by the individual business units and processes. Principles of risk management The objective of risk management is to support the bank in generating added value whilst retaining a first- class credit rating and reputation. Zürcher Kantonal- bank’s approach to risk management is based on the following principles: p Risk culture: the bank fosters a risk culture that is geared towards responsible behaviour. Risk managers bear responsibility for profits and losses generated on the risks entered into. In addition, they bear primary responsibility for identifying transactions and struc- tures with particular business policy risks, conflicts of interest or particular effects on the bank’s reputation. p Separation of functions: for significant risks and to avoid conflicts of interest, the bank has established control processes that are independent of manage- ment. p Risk identification and monitoring: the bank only enters into transactions if the risks are in accordance with its business strategy and can be appropriately identified, managed and monitored. p Risk and return: in relation to all transactions, the bank seeks to achieve a balanced relationship between risk and return. Assessment of the risk / return profile takes account of quantifiable as well as non-quantifiable risks. p Transparency: risk reporting and disclosure are guided by high industry standards in terms of objectivity, scope, transparency and timeliness. These principles constitute the basis for determining the organisational structure and detailed group-wide risk management framework. 106 Zürcher Kantonalbank Annual Report 2016 Financial Report Executive board The executive board approves the provisions for iden- tifying, assessing, measuring, limiting and monitoring risk. It provides the board of directors with periodic reports on the overall bank risks and compliance with the risk policy parameters. The executive board also informs the board of directors of measurement methods and models as well as their consequences for risk management. The executive board is also responsible for approving matters with particular business policy risks, conflicts of interest or particular effects on the reputa- tion of Zürcher Kantonalbank, unless they are assigned to another officer-holder in regulatory terms. Conflicts committee The members of the executive board represented on the conflicts committee take decisions on matters with particular business policy risks. The escalation body of the conflicts committee is the committee of the board. Risk committee The risk committee assists the executive board with formulating risk management processes. Decisions of the risk committee are taken on the basis of respon- sibilities delegated by the members of the executive board represented on the risk committee. The risk managers represented on four separate sub-committees (credit, trading, treasury and operational risk) and members of the risk and compliance organisation pro- vide preliminary advice on the risk committee’s busi- ness and formulate proposals for it. In a crisis situation, individual crisis management teams reporting to the risk committee ensure that necessary and appropriate measures are defined and implemented. Principles of compliance policy The objective of compliance is to ensure that Zürcher Kantonalbank conducts its business operations in accordance with legal and ethical norms. The principles of the compliance policy are as follows: relevant legal and ethical norms; anchoring ethical and performance - related basic values in a code of conduct; duty of all employees and members of the governing bodies to comply with the laws, regulations, internal rules, industry standards, codes of conduct with correspond- ing sanctions for violations of the rules; special re- porting procedure for identified violations of the rules for employees (whistle-blowing); primary responsi- bility of the executive board for compliance; annual assessment of the compliance risk based on the risk inventory with corresponding activity plan, as well as independence of the compliance function. The most important principle of all is that Zürcher Kantonalbank conducts its banking operations in accordance with the statutory and regulatory provisions as well as recog- nised professional and ethical principles within the banking industry. Risk and compliance organisation Zürcher Kantonalbank’s risk management line organi- sation is based on the Three Lines of Defence model. In organisational terms, the risk acceptance and risk management functions (1st Line of Defence), on the one hand, and preventive risk management (2nd Line of Defence) and risk control (3rd Line of Defence) on the other, are separated at executive-board level (Fig. 4, p. 108). Board of directors and committee of the board The board of directors approves the principles of risk management and compliance, code of conduct, risk acceptance and additional risk policy parameters. The board of directors is also responsible for the monitoring and regular examination of the appropriate- ness and effectiveness of internal controls, including the risk and compliance organisation. The board of directors approves matters involving major financial exposure and / or having particular effects on the group’s reputation in key areas. The committee of the board approves limits and dis- cusses matters involving particular business policy risks, where they lie outside the remit of the executive board and do not fall within the remit of the board of directors. The risk management and audit commit- tees support the board of directors in its tasks. Zürcher Kantonalbank Annual Report 2016 107 Financial Report Fig. 4: Risk and compliance organisation Line organisation Committees Board of directors and committee of the board Risk management committee Audit committee Executive board CRO CEO Risk and compliance functions CEO CRO EB 1st LoD * CRO CEO CFO CRO EB Products, Services & Direct Banking EB Private Banking EB Institutionals & Multinationals General counsel General counsel 2 General counsel 2 General counsel 2 Risk control Preventative risk management 3. LoD* 2. LoD* Risk management independently of individual case Preventative management of compliance risk in individual cases Representatives of CRO line International Business Management, Product management Investments & pensions Risk managers Risk managers 1. LoD* Representative of risk manager 1 Escalation body is the committee of the board. 2 General Counsel has right of escalation to the committee of the board at any time. * Line of Defence. International committee The international committee is tasked with defining the business policy parameters for matters with an international dimension, as well as corresponding monitoring and reporting. CRO line The Chief Risk Officer (CRO) is a member of the executive board and manages the Risk unit. He has a right of intervention that permits measures to be assigned to the risk managers if required by the risk situation or to protect the bank. Risk control (3rd Line of Defence) is responsible for identifying and monitoring risks at portfolio level, monitoring compliance with the risk policy parameters and integrated risk reporting to the executive board and board of directors. The risk control function is respon sible for defining methods of risk measurement, parts of the acceptance procedure for new products and valuation methods, model validation, as well as execution and quality assurance in relation to the risk measure ment implemented. Preventative risk management (2nd Line of Defence) is responsible for analysis and examination of transac tions prior to conclusion in the context of existing deline ations of power and mandatory consultations, the definition of parameters at individual transaction level, the continuous local monitoring of risks and the training of risk managers. 108 Zürcher Kantonalbank Annual Report 2016 Conflicts committee 1Risk committeeInternational committeeCRO lineCompliance line Financial Report Compliance line The general counsel reports directly to the CEO and manages the legal, tax and compliance unit. As a member of the risk, conflicts and international commit- tees, he has a right of escalation to the committee of the board. He also enjoys direct access to the committee of the board at all times. The compliance function as 3rd Line of Defence has the following duties: examining on an annual basis the compliance risk inventory and preparing the annual activity plan with key focal points relating to the management of compliance risk, formulating propos- als and if necessary implementing defined monitoring and control duties in the context of post-deal control, defining the risk management tools and implementing risk control measures independently of the individual case such as editing directives in the context of the im- plementation of new directives and staging training events. The compliance function as 2nd Line of Defence is primarily responsible for providing forward-looking legal advice with the objective of avoiding or minimising individual identified risks and threats arising due to legal parameters. Legal advice is provided in the context of existing mandatory consultations, as a pre-deal consultation or on request. Risk managers The risk managers (1st Line of Defence) bear responsi- bility for profits and losses generated on the risks entered into. They are responsible for the continuous, active management of risks and for constant compliance with the risk policy parameters, relevant laws, ordinances and standards. The sales units are responsible for credit risks as risk managers and the trading and capital markets unit for market risks in the trading book. Inter- est risks in the banking book and liquidity risks are managed partly by treasury in the finance business unit and partly by the trading and capital markets unit. All units of the bank are responsible for managing operational and compliance risks. Risk reporting Risk controlling reports on a quarterly basis in the con- text of integrated risk reporting to the executive board and board of directors on the development of the risk profile, on material internal and external events, and on findings from monitoring activities. Quarterly reports are supplemented by special analysis of significant themes. Besides quarterly reporting, various reports are produced for the individual types of risk; in terms of the frequency with which they are published and group of recipients, they are tailored to the individual risks and ensure the provision of comprehensive, objective and transparent information for decision-makers and supervisory bodies. The compliance function also reports directly to the board of directors once a year. Regulatory capital adequacy and liquidity requirements The following sections contain, amongst other matters, key points from the quantitative disclosure in accordance with FINMA Circular 2016 / 1. The complete disclosure reports, including qualitative information, are available at zkb.ch/disclosures. Eligible and required capital Weighted capital adequacy requirements Under Basel III, a selection of different approaches is available to banks for the calculation of capital adequacy requirements for credit, market and operational risks. By contrast, calculation of the required capital for credit risks is performed in accordance with the international standard approach (SA-BIS). The model-based approach is used for market risks, combined with the standard approach (SA-BIS) for specific interest rate risks, and the basic indicator approach (BIA) for operational risk. The capital requirements for systemically important institutions basically consist of capital adequacy require- ments for the bank to continue its activities (going concern) and additional loss-absorbing measures (gone concern). The total requirement for the continuation of the bank’s activities consists of a base requirement and additional requirements, calculated on an annual basis according to market share and total exposure. At the present time, requirements for additional loss- absorbing measures only apply to global systemically important banks (G-SIB) and are therefore not rele- vant to Zürcher Kantonalbank as a domestic systemically important institution (D-SIB). As at 31 December 2016, the capital adequacy requirement for Zürcher Kantonalbank as a domestic systemically important institution is 14.0 percent of risk-weighted assets, for both the parent company and the group, according to the individual decree issued by the Swiss Financial Market Supervisory Authority (FINMA). The countercyclical capital buffer on mort- gages secured on residential properties in Switzerland increased the requirement by a further CHF 453 mil- lion, or 0.7 percent, to 14.7 percent. As at 31 December 2016, the minimum required capital for the group amounted to CHF 5,279 million (2015: CHF 5,035 million) against eligible capital of CHF 11,564 million (2015: CHF 11,293 million) (Fig. 5). The minimum required capital was therefore Zürcher Kantonalbank Annual Report 2016 109 Financial Report Fig. 5: Minimum disclosure in CHF million (unless indicated otherwise) 1 Minimum capital based on risk-based requirements 2 3 4 5 6 7 8 9 Eligible capital – of which common equity Tier 1 (CET1) – of which Tier 1 capital (T1) Risk-weighted assets (RWA) CET1 ratio (Common equity Tier 1 capital as a percentage of RWA) 1 Tier 1 capital ratio (Tier 1 capital as a percentage of RWA) 1 Total capital ratio (as a percentage of RWA) 1 Countercyclical capital buffer (as a percentage of RWA) 10 CET1 target ratio (as a percentage) according to Annex 8 to the Swiss Capital Adequacy Ordinance (CAO) plus countercyclical capital buffer 2 11 T1 target ratio (as a percentage) according to Annex 8 to the Swiss Capital Adequacy Ordinance (CAO) plus countercyclical capital buffer 2 12 Total capital target ratio (as a percentage) according to Annex 8 to the Swiss Capital Adequacy Ordinance (CAO) plus countercyclical capital buffer 2 13 Basel III Leverage Ratio (Tier 1 capital as a percentage of total exposure) 14 Total exposure 15 Liquidity coverage ratio (LCR) as a percentage in the 4th quarter 3 16 17 LCR numerator: total high quality liquid assets (HQLA) LCR denominator: total net outflows of funds 18 Liquidity coverage ratio (LCR) as a percentage in the 3rd quarter 3 19 20 LCR numerator: total high quality liquid assets (HQLA) LCR denominator: total net outflows of funds 21 Liquidity coverage ratio (LCR) as a percentage in the 2nd quarter 3 22 23 LCR numerator: total high quality liquid assets (HQLA) LCR denominator: total net outflows of funds 24 Liquidity coverage ratio (LCR) as a percentage in the 1st quarter 3 25 26 LCR numerator: total high quality liquid assets (HQLA) LCR denominator: total net outflows of funds Group Parent Company 4 31.12.2016 31.12.2016 5,279 11,564 10,266 10,849 65,987 15.6 16.4 17.5 0.7 10.7 13.7 14.7 6.3 171,618 132 40,976 31,151 125 40,482 32,331 116 34,302 29,673 119 34,821 29,290 5,259 11,362 10,064 10,647 65,731 15.3 16.2 17.3 0.7 10.7 13.7 14.7 6.2 171,254 131 40,943 31,230 125 40,459 32,396 115 34,239 29,808 118 34,752 29,370 1 Figures for capital are net values in accordance with the definitive Basel III provisions. Zürcher Kantonalbank chose not to make use of the transitional provisions under Art. 140 –142 CAO, which allow a gradual introduction of the new rules. The figures are calculated in accordance with the provisions of the CAO for non-systematically important banks. 2 In accordance with the decree issued by FINMA in August 2014, Zürcher Kantonalbank’s CET1 target ratio is 10.0 %, the T1 target ratio 13.0 % and the total capital target ratio 14.0 %, each plus the countercyclical buffer of 0.7 %. 3 Based on monthly averages. 4 The parent company’s capital is calculated on a solo consolidated basis since 31 December 2012. Under Art. 10 para. 3 CAO, FINMA can allow a bank to consolidate group companies operating in the financial sector at individual institution level (solo consolidation) on account of their particularly close relationship to the bank. FINMA has ruled that Zürcher Kantonalbank may consolidate the subsidiary Zürcher Kantonalbank Finance (Guernsey) Ltd. on a solo basis under the individual institution provisions as of 2012. Fig. 6a: Required minimum capital (group) in CHF million Remarks 31.12.2016 SA-BIS 31.12.2015 SA-BIS Credit risks (using standard approach) including CVA 1 4,561 4,296 – of which price risks relating to equity-type securities in the banking book Non-counterparty-related risks (using standard approach) Market risks – of which market risks (using model-based approach) 2, 4 – of which market risks on interest rate instruments (specific market risks) 3, 4 Operational risks (using basic indicator approach) Required minimum capital Total risk-weighted assets 12.5 x minimum capital 29 64 326 163 163 327 5,279 65,987 25 69 353 214 139 318 5,035 62,942 1 The capital adequacy requirements for the risk of possible value adjustments due to counterparty credit risk on derivatives (CVA risk) are calculated in accordance with the standard approach and amounted to CHF 194 million as at 31 December 2016 (CHF 198 million as at 31 December 2015). 2 Excludes specific interest rate risks; aggregate value-at-risk (VaR) from average for the 60 immediately preceding trading days and stress-based VaR from average for the 12 immediately preceding weeks. 3 Specific risks due to interest rates (from interest rate instruments, options and credit derivatives). 4 The values for the two lines were reversed in error in the 2015 Annual Report. 110 Zürcher Kantonalbank Annual Report 2016 Fig. 6b: Risk-based capital requirement based on capital ratios for systemically important banks Financial Report in CHF million Basis of assessment Risk-weighted assets (RWA) Risk-based capital requirements (going concern) based on capital ratios Total 1 – of which CET1: minimum – of which CET1: capital buffer – of which CET1: countercyclical capital buffer – of which CET1: additional capital Pillar 2 – of which Additional Tier 1: minimum – of which Additional Tier 1: capital buffer – of which Additional Tier 1: additional capital Pillar 2 Eligible capital (going concern) 2,3 Core capital – of which CET1 – of which CET1 to cover the Additional Tier 1 requirements – of which Additional Tier 1 High-Trigger CoCos – of which Additional Tier 1 Low-Trigger CoCos – of which Tier 2 High-Trigger CoCos – of which Tier 2 Low-Trigger CoCos Group 31.12.2016 Transitional rules Rules as from 2020 CHF 65,987 CHF 65,987 As a percentage of RWA CHF As a percentage of RWA CHF 9,691 4,075 1,287 453 1,237 1,204 528 907 14.7 6.2 2.0 0.7 1.9 1.8 0.8 1.4 As a percentage of RWA CHF 11,564 8,924 1,342 583 17.5 13.5 2.0 0.9 714 1.1 9,889 2,969 2,679 453 950 2,310 528 CHF 10,849 8,012 2,254 583 – – 15.0 4.5 4.1 0.7 1.4 3.5 0.8 As a percent age of RWA 16.4 12.1 3.4 0.9 – – Risk-based requirements for additional loss-absorbing measures (gone concern) based on capital ratios 4 As a percentage of RWA CHF As a percentage of RWA CHF Total (net) Eligible additional loss-absorbing measures (gone concern) Total – of which bail-in bonds – of which CET1, used to meet gone concern requirements – of which Additional Tier 1, used to meet gone concern requirements As a percentage of RWA CHF As a percentage of RWA CHF 1 Capital requirements are calculated as a percentage of risk-weighted assets. In accordance with the decree issued by FINMA in August 2014, Zürcher Kantonalbank’s CET1 target ratio is 10.0 %, the T1 target ratio 13.0 % and the total capital target ratio 14.0 %, each plus the countercyclical buffer of 0.7 %. 2 Figures for capital are net values in accordance with the definitive Basel III provisions. Zürcher Kantonalbank chose not to make use of the transitional provisions under Art. 140 – 142 CAO, which allow a gradual introduction of the new rules. 3 In accordance with the transitional provisions for the amendment of the CAO of 11 May 2016 (Art. 148b CAO) regarding the quality of capital for systemically important banks, low-trigger Tier 2 capital can be included in the core capital until the first capital call, but not later than 31 December 2019. 4 There are currently no gone concern capital requirements for D-SIB (Domestic Systemically Important Banks). CHF 244 million more than in the previous year (Fig. 6a). The increase in required capital for credit risks is mainly connected with the growth in mortgage-backed loans and higher credit equivalents for derivative and repo transactions. The requirements for market risks were slightly lower than in the previous year, while those for operational risks were slightly higher. The eligible capital of Zürcher Kantonalbank increased in the 2016 financial year, mainly due to retained earnings. The total capital ratio of 17.5 percent (2015: 17.9 percent) and the common equity Tier 1 capital ratio of 15.6 percent (2015: 15.8 percent) based on required minimum capital reflect Zürcher Kantonal- bank’s solid equity base. Zürcher Kantonalbank Annual Report 2016 111 Financial Report Unweighted capital adequacy requirements (leverage ratio) The unweighted capital adequacy requirement (leverage ratio) is 3.4 percent according to the individual decree issued by FINMA. The systemi cally relevant leverage ratio of 6.7 percent far exceeds the requirements, highlighting the strength of Zürcher Kantonalbank’s capital base, even under the unweighted capital adequacy requirements. Fig. 7: Unweighted capital adequacy requirements based on the leverage ratio for systemically important banks in CHF million Basis of assessment Total exposure (leverage ratio denominator, LRD) Unweighted capital adequacy requirements (going concern) based on the leverage ratio Total 1 – of which CET1: minimum – of which CET1: capital buffer – of which CET1: additional capital Pillar 2 – of which Additional Tier 1: minimum – of which Additional Tier 1: additional capital Pillar 2 Eligible capital (going concern) 2, 3 Core capital – of which CET1 – of which CET1 to cover the Additional Tier 1 requirements – of which Additional Tier 1 High-Trigger CoCos 4 – of which Additional Tier 1 Low-Trigger CoCos – of which Tier 2 High-Trigger CoCos – of which Tier 2 Low-Trigger CoCos 4 Unweighted requirements for additional loss-absorbing measures (gone concern) based on leverage ratio 5 Total (net) Eligible additional loss-absorbing measures (gone concern) Total – of which bail-in bonds – of which CET1, used to meet gone concern requirements – of which Additional Tier 1, used to meet gone concern requirements Group 31.12.2016 Transitional rules Rules as from 2020 CHF 171,618 CHF 171,618 As a percentage of LRD CHF As a percentage of LRD CHF 5,766 3,947 0 172 1,201 446 3.4 2.3 0.0 0.1 0.7 0.3 7,723 2,574 2,574 2,574 4.5 1.5 1.5 1.5 As a percentage of LRD CHF As a percentage of LRD CHF 11,467 8,924 1,342 583 6.7 5.2 0.8 0.3 618 0.4 10,849 8,012 2,254 583 – – 6.3 4.7 1.3 0.3 – – As a percentage of LRD CHF As a percentage of LRD CHF As a percentage of LRD CHF As a percentage of LRD CHF 1 Capital requirements are calculated as a percentage of total exposure. In accordance with the decree issued by FINMA in August 2014, the unweighted capital requirement is 3.4 %. 2 Figures for capital are net values in accordance with the definitive Basel III provisions. Zürcher Kantonalbank chose not to make use of the transitional provisions under Art. 140 – 142 CAO, which allow a gradual introduction of the new rules. 3 In accordance with the transitional provisions for the amendment of the CAO of 11 May 2016 (Art. 148b CAO) regarding the quality of capital for systemically important banks, low-trigger Tier 2 capital can be included in the core capital until the first capital call, but not later than 31 December 2019. 4 The eligible capital in the unweighted capital ratio which can be covered by AT 1 and during the transitional period by AT 2 is restricted to 0.7 % in 2016 (Art. 148c CAO). 5 There are currently no gone concern capital requirements for D-SIB (Domestic Systemically Important Banks). 112 Zürcher Kantonalbank Annual Report 2016 Financial Report Fig. 8: Risk capital assigned by board of directors, by risk category Financial investments and participations 3% Real estate 3% Asset liability management 14% Trading operations 5% Credit risks 61% Operational risks 14% Market risks 25% Capital allocation in internal risk management Zürcher Kantonalbank employs a capital-at-risk appro- ach to control risks. The board of directors specifies the maximum risk capital and assigns this capital to the credit, market and operational risk categories. The models are based on a time horizon of one year and a maxi- mum default probability of 0.1 percent per year. The risk capital for market and credit risks is allotted to the individual organisational units, and the cost of capital is charged to the units. In the case of operational risks, there is no internal allocation of the cost of capital. Of the CHF 11,293 million in eligible capital at the end of 2015, CHF 4,480 million was allocated to the risk business in 2016. The percentage breakdown of the capital allocated by risk category is shown in Figure 8. Regulatory requirements regarding liquidity In 2016, Zürcher Kantonalbank’s liquidity coverage ratio (LCR) remained stable, far above the minimum level of 100 percent required under the regulations. Fig. 9: Liquidity coverage ratio (LCR) in CHF million Q1 2016 1 Q2 2016 1 Q3 2016 1 Q4 2016 1 Q4 2015 1 High quality liquid assets (HQLA) 2 – of which Level 1 – of which Level 2 Net outflow of funds Liquidity coverage ratio (LCR) 34,821 32,046 2,775 29,290 119 % 34,302 31,487 2,815 29,673 116 % 40,482 37,550 2,932 32,331 125 % 40,976 37,773 3,203 31,151 132 % 36,101 33,663 2,439 28,188 128 % 1 Monthly averages; based on the values shown in the monthly liquidity statement. 2 Allowing for the unwinding / settlement mechanism in accordance with FINMA Circular 2015 / 2 – Liquidity Risks for Banks (Annex 1). Zürcher Kantonalbank Annual Report 2016 113 Financial Report Risk categories Zürcher Kantonalbank’s risk strategy is based on the risk categorisation illustrated in Figure 10. strategies successfully. Strategic risks are managed in the context of the bank’s strategy process. Systemic risks Systemic risk is where an institution suffers damage due to negative developments in the financial system that are beyond its control. Systemic risks cannot be independently limited and controlled by a single institu- tion. Systemic risks are managed in conjunction with the Swiss National Bank (SNB), Swiss Financial Market Supervisory Authority (FINMA) and, if necessary, the Federal Council. The SNB and FINMA are responsible for establishing adequate processes for managing systemic risks. Reputation risks Reputation risks involve damage to Zürcher Kantonal- bank’s image and brand value. As reputation risks can potentially arise as a result of any of the bank’s business operations, they are controlled chiefly by ensuring competency, integrity and reliability on a bank - wide basis. This is a multi-layered task that embraces the bank’s entire range of operational and strategic man- agement tools. The findings of continuous media monitoring and periodic reputation monitoring are also important to Zürcher Kantonalbank’s management of reputation risk. Strategic risks Strategic risks include the risk of pursuing a strategy that is inappropriate against the backdrop of relevant factors of influence but also the risk of not implementing Other risks The definition of risk categories as well as the strategy, processes and organisation of risk management are described in the following sections. Fig. 10: Risk categories Responsible: Swiss National Bank, Swiss Financial Market Supervisory Authority, Federal Council (National Council, Council of States) Board of directors, executive board according to allocation of roles, risk management Systemic risks Strategic risks Reputation risks Credit risks Market risks Liquidity risks Operational risks Compliance risks Handled by: Banking Act, Banking Ordinance, Emergency Organisation of the Swiss National Bank Bank-wide Strategy, Balanced Scorecard, Strategic Controlling Reputation risk = derived risk Risk policy parameters, laws / regulations / norms 114 Zürcher Kantonalbank Annual Report 2016 Financial Report Credit risks Loans, promises of payment and trading business involve credit risks. Credit risk is the risk whereby payments due from a debtor are not met or are not met on time. Strategy, organisation and processes The strategy for managing credit risks is set out in the internal lending policy, which is reviewed and updated by the risk organisation in an annual, structured process, and approved by the executive board. The principles defined in the lending policy include the measurement and management of risks based on uniform, binding objectives and instruments, acceptance of risks based on objective, business-related criteria, in proportion to the bank’s risk capacity, together with sustainable manage- ment of the quality of the credit portfolio. The bank adopts a risk and cost-based pricing policy, with transparent credit decisions and a selective, quality-oriented strategy for the acquisition of financing business. Particular attention is also paid to environmen- tal and social risks in the credit assessment process. In recognition of the total commitment of owners, higher risks are also accepted on occasions for SMEs from the Greater Zurich Area. Based on the Three Lines of Defence model, the preventative risk management and risk control functions are separated from risk management at executive board level. Preventative risk management is responsi- ble for setting parameters for the lending policy, analysing and examining transactions in the context of existing delineations of power, continuous local monitoring of risks and the training of risk managers. Risk control, as the 3rd Line of Defence, is responsible for monitoring risks and risk reporting at portfolio level, as well as defining methods of risk management. Credit risks are managed and controlled at individual exposure level by means of detailed parameters and areas of responsibility within the credit process, whilst at portfolio level they are managed and controlled by limiting risk capital for the credit business in accordance with the capital-at-risk approach. Another key control element in credit risk management is risk-adjusted pric- ing, which includes expected losses (standard risk costs) as well as the cost of the risk capital to be retained in order to cover unexpected losses. Expected losses are determined on the basis of the probability of default (PD), assumptions regarding the level of exposure at default (EAD) and the estimated loss given default (LGD). Rating models specific to individu- al segments are used to determine default probabilities. The rating system for retail and corporate customers as well as banks combines statistical procedures with many years of practical experience in the credit business and incorporates both qualitative and quantitative elements. Country ratings are in principle based on the ratings of external agencies (country ceiling ratings and sovereign default ratings). A credit portfolio model is used as the basis for the modelling of unexpected losses. Besides default probabilities, exposures in the event of default and loss rates – in particular the correlations between debtors – are significant for the modelling of unexpected losses. In principle, the model covers balance sheet and off-balance-sheet items. For the valuation of collateral for loans, in particular the calculation of market and collateral values, the corresponding methods, procedure and responsibilities are specified in an extensive set of internal rules. These rules are continually monitored and aligned with regulatory requirements and market changes. For the valuation of mortgage collateral, the bank uses recog- nised estimation methods that are tailored to the type of property. This includes the use of hedonic mod- els, income capitalisation approaches and expert appraisals. The models used as well as the individual valuations are reviewed on a regular basis. The maxi- mum loan-to-value ratio for mortgages is based on the marketability of the collateral and influenced by fac- tors such as location and type of property (house or commercial property, for example). Marketable col- lateral (securities, precious metals, account balances, for example) is in principle valued at current market prices. Other collateral is subject to the deduction of specified margins. These margins differ primarily depending on the marketable collateral’s susceptibility to fluctuations in value. Limits are used to minimise credit exposures. In addition to the limits at counterparty and counterparty group level, limits are placed on sub-portfolios – for instance for foreign exposures. All credit and contingent exposures are valued each day, while exposures from trading business are valued on a real-time basis. In the case of trading business, pre-deal checks can be undertaken to examine and ensure adherence to coun- terparty limits. Any breaches of the limits are report- ed promptly to the officer responsible. An early-warning system is used to identify negative developments and communicate them to the officers responsible. The rating of corporate customers is in principle reviewed once a year on the basis of the annual financial state- ments. A supplementary review of ratings, limits and exposures in retail and corporate customer business is undertaken using risk-oriented criteria. Ratings, limits and exposures in the banking sector are reviewed peri- Zürcher Kantonalbank Annual Report 2016 115 Settlement risk A settlement risk arises in the case of transactions with mutual payment and delivery obligations, where Zürcher Kantonalbank must meet its obligations without being able to ensure that counterpayment is also being made. Settlement risk can occur in relation to foreign ex change transactions, securities lending and borrowing (SLB) and OTC repo transactions as well as transac tions involving different payment systems and time zones in the interbank sector. Zürcher Kantonalbank’s mem bership of the CLS Bank International Ltd. joint venture a clearing centre for settlement of foreign exchange transactions on a “delivery versus payment” basis helps ensure that a substantial element of the settlement risk arising as a result of foreign exchange trading is eliminated. Risk concentration Zürcher Kantonalbank uses an internal, systemsbased method for monitoring risk concentration. Besides measurement for the purpose of preparing regulatory reports, risk concentration is restricted at product and customer level using benchmarks that are reflected in the corresponding powers of authorisation. Inter nal risk concentration reporting includes information on product, sector and individual position concentrations. Due to the bank’s anchoring within the Greater Zurich Area, the biggest risk concentration in the credit portfolio takes the form of geographical concentration risk. Risk profile The following sections provide information about the most important subportfolios of the credit exposures of Zürcher Kantonalbank on the basis of various criteria. Figure 11 illustrates credit exposures by counterparty group in accordance with Basel III. Financial Report odically and on an extraordinary basis in the event of a deterioration in the credit rating of a particular institution. Value adjustments As part of their risk management role, the bank’s relationship managers constantly monitor all positions in the credit portfolio to identify any signs of deprecia tion. Should any signs be found, a standardised impair ment test is used to determine whether a loan should be classed as impaired. Impaired loans are those where the borrower is unlikely to be able to meet his future obligations. Where it appears that the bank will be una ble to collect all amounts due on a claim, the bank makes an allowance for the unsecured part of the loan, based on creditworthiness. In determining the re quired allowance, mortgage collateral (including valua tion discounts, settlement and holding costs) and marketable collateral (freely tradable securities such as deposits, precious metals, fiduciary investments, etc.) are included at current realisable value. In particular, the recoverability of other security (e.g. leased assets, letter of comfort) has to be demonstrated. Authority for the approval of the creation of new individual allowances rests with the risk managers. Above a certain amount, the approval of the risk organisation is also required. Loans on which interest and corresponding commis sion have not been received in full 90 days after be coming due, and therefore classified as non-performing, are deemed to be impaired and fully adjusted. Al though general allowances are made for overdrafts of up to CHF 30,000 and interest outstanding for more than 90 days and the corresponding commission, indi vidual allowances are the norm. A central, specialised unit handles impaired positions across all customer segments. This unit steers the positions through the stabilisation and resolution pro cess, with regular review of the adjustment require ment for existing allowances. Country risks The country risk of individual exposures is determined on the basis of the risk domicile where this is not identical to the domicile of the borrower, in accordance with the Swiss Bankers Association’s guidelines on the management of country risk. In the case of secured exposures, the risk domicile is determined by taking into account the domicile of the collateral. The risks for each country, total country risks and total country risks outside the best rating category (bank inhouse rating categories B to G) are subject to limits, adher ence to which is monitored on a constant basis. 116 Zürcher Kantonalbank Annual Report 2016 Financial Report Fig. 11: Group credit exposure breakdown by counterparty group Credit exposure 1 in CHF million Balance sheet items Due from banks Due from securities financing transactions Due from customers Mortgages Positive replacement value Other financial instruments valued at fair value Debt securities in financial investments Deferred items Other assets 5 Total as at 31.12.2016 Total as at 31.12.2015 Off-balance-sheet items Contingent liabilities Irrevocable commitments 6 Obligations to pay up shares and make further contributions Credit commitments Total as at 31.12.2016 Total as at 31.12.2015 Central governments and central banks Banks and securities dealers Other institutions 2 Companies Retail customers and small businesses 3 Other positions 4 Total 15 204 2 83 572 116 992 1,232 6 3 9 8 5,348 8,831 0 594 20 696 2,800 993 44 128 1 3,054 4,382 4,830 465 2,026 70,606 575 1,140 1,528 209 15,488 16,013 5,105 5,195 14,260 15,375 73,416 69,834 0 107 1,795 88 360 80 2,431 2,297 5,364 14,889 7,509 77,275 1,933 20 4,145 360 196 111,692 109,946 1,227 100 83 317 2,804 5,102 339 1,901 24 82 4,483 7,506 233 233 1,327 1,171 400 407 7,906 7,877 2,240 1,786 340 227 12,222 11,477 1 The counterparty groups correspond to those in the Capital Adequacy Ordinance (CAO). Cash, non-counterparty-related assets and exposure with equity-type characteristics are not stated under credit exposure. 2 This group includes public authorities and institutions, the Bank for International Settlements (BIS), the International Monetary Fund (IMF), multilateral development banks and community facilities. 3 Small businesses are defined by Zürcher Kantonalbank as all companies that meet at least one of the following conditions: number of employees < 50, total assets < CHF 6 million, net sales < CHF 15 million. 4 E. g. foundations or deferred items. 5 Excludes equalising accounts for value adjustments not recognised in the income statement and deferred tax assets which rely on future profitability. 6 Irrevocable commitments are disclosed in accordance with the definition specified in the Capital Adequacy Ordinance (CAO). Due to the different measurement criteria, the total may differ from the total under the Accounting Guidelines for Banks (group balance sheet). Zürcher Kantonalbank Annual Report 2016 117 Financial Report Credit exposures by rating category Default probability ratings are assigned internally on the basis of a scale from 1 to 19. Figure 12 shows credit exposures to counterparties by rating category using S&P’s rating scale. Fig. 12: Credit exposures by rating category Rating category AAA AA A BBB BB B C D 0 10 20 30 40 50 60 End of 2016 End of 2015 Share in % Credit exposures by customer portfolio Figure 13 shows credit exposures classified in accord- ance with the bank’s internally defined customer portfolios. Fig. 13: Credit exposures by customer portfolio Private individuals Companies Banks and securities traders Financial sector excluding banks Governments and public entities in CHF million 0 20,000 40,000 60,000 secured 2016 secured 2015 unsecured 2016 unsecured 2015 Credit exposures in relation to “private individuals” consist almost entirely of mortgages and represent 53 percent (2015: 52 percent) of total credit exposures. The “corporates” portfolio consists of credit exposures in relation to customers of a commercial nature. The share of this customer group in total credit exposures is 23 percent (2015: 22 percent), 83 percent (2015: 82 percent) of which is secured by mortgage on proper- ties or cash. In the “banks and securities dealers” portfolio, the larger share of credit exposures in volume terms is in the form of collateralised transactions such as reverse repo transactions. Other credit exposures in relation to banks arise as a result of trading opera- tions and from the export financing business. Insurance companies, pension funds, financial holding compa- nies, investment fund companies and similar companies together constitute the “Financial sector excluding banks” portfolio. “Governments and public entities” – the smallest portfolio, with a share of 4 percent of the volume of credit exposures – consists of positions with central banks, central governments and public authorities and institutions. Mortgage exposure to private individuals Real estate financing for private individuals is part of Zürcher Kantonalbank’s core business. Two-thirds of mortgage exposures relate to owner-occupied residen- tial property. The remaining exposures are secured with rented residential properties or properties that are used for commercial purposes. Mortgage exposure to private individuals increased by 3.9 % in 2016. The median gross loan-to-value ratio for all properties in the private customer portfolio was 51 percent (2015: 52 percent). Unsecured credit exposure Seventy-five percent (2015: 78 percent) of unsecured credit exposure in the “corporates” portfolio relates to customers in the AAA to BBB (investment grade) rating categories. The volume of unsecured lending in the corporate customers portfolio increased slightly overall. 118 Zürcher Kantonalbank Annual Report 2016 Financial Report Impaired loans Impaired loans amounted to CHF 468 million (2015: CHF 466 million). After deduction of the estimated recoverable value of the collateral, there was a net debt of CHF 183 million (2015: CHF 184 million, see also Note 2 to the balance sheet, p. 83). Risk-weighted, impaired international loans accounted for less than 15 percent of the bank’s total risk-weighted impaired loans, and for that reason no geographical break- down is provided. Non-performing loans The nominal value of non-performing loans amounted to CHF 128 million at the end of the reporting period (2015: CHF 143 million). Loans are classified as non-per- forming when interest payments, commission, am- ortisation or the repayment of the principal have not been received in full 90 days after becoming due. This also includes claims against borrowers in liquidation, and loans with special conditions arising from a borrower’s financial standing. In addition, non-perform- ing loans are often a component of impaired loans. Allowances and provisions The volume of allowances and provisions for default risks increased by CHF 3 million to CHF 312 million in 2016 (CHF 144 million in provisions for default risks and CHF 169 million in allowances for default risks from impaired loans (see also p. 92, Note 16 to the balance sheet). Fig. 14: Unsecured credit exposures of corporate customers by rating category Rating category AAA AA A BBB BB B C D 0 500 1,000 1,500 2,000 2,500 3,000 End of 2016 End of 2015 in CHF million Fig. 15: Unsecured credit exposures of banks and securities traders by rating category Rating category AAA AA A BBB BB B C D 0 500 1,000 1,500 2,000 2,500 3,000 End of 2016 End of 2015 in CHF million In the “banks and securities traders” customer portfolio, the volume of unsecured loans in the AA and A rating categories fell slightly due to a slight decrease in money market lending and reductions in international trade finance. Rating downgrades for banks from emerging markets led to the volume shift from rating category BBB to rating category BB. Eighty-three percent (2015: 92 percent) of unsecured exposures relate to rating categories AAA to BBB (investment grade). Zürcher Kantonalbank Annual Report 2016 119 Financial Report Approach to measuring capital adequacy, account- ing for collateral and hedging instruments used Capital adequacy requirements for credit risks are calcu- lated using the international standard approach (SA- BIZ). The credit equivalent of derivatives is calculated based on the fair value method, while the financial collateral comprehensive method is used for credit risk mitigation and for calculation of the credit equivalent for repos. In accordance with the regulatory require- ments, capital is also required to cover the credit risks arising from financial investments and participa- tions. The capital required for the risk of possible value adjustments due to the counterparty risk on de- rivatives (CVA risk) is calculated in accordance with the standard approach. Under Basel III, the risk weightings of counterparties may be calculated on the basis of agency ratings. For the corporate and public-law entity categories, Zürcher Kantonalbank applies the ratings from agencies Stand- ard & Poor’s and Moody’s. In the case of the bank and sovereign sectors, Fitch ratings are also taken into account. For securities with an issue-specific rating from Standard & Poor’s and Moody’s, it is this issue rating that is used. In accordance with the Capital Adequacy Ordinance, the basis for calculating credit exposures in the case of most transactions is the reported value. In off-balance- -sheet transactions, a credit conversion factor is used. Derivative transactions are converted into a credit equiv- alent and shown after netting. Market risks Market risks comprise the risk of financial losses on own securities and derivatives as a result of changes in factors market, such as share prices, interest rates, volatilities and exchange rates, as well as issuer default. Strategy, organisation and processes Zürcher Kantonalbank pursues a strategy focussed on customer transactions for trading business. The individu- al desks hold trading mandates approved by the risk committee which set out the basic conditions in terms of the objectives pursued, instruments used for underly- ing and hedging transactions, the form of risk manage- ment and the holding period. Based on the Three Lines of Defence model, the preventative risk management and risk control functions are separated from risk management at executive board level. The responsibilities of preventative risk manage- ment, which are independent of trading and the risk control function downstream include monitoring compli- ance with risk limits and trading mandates, calculating and analysing the trading income (P&L) and risk figures as well as preventive analysis of potentially high-risk transactions. The risk organisation is also responsible for defining methods of risk measurement, their independ- ent validation and internal and external risk reporting. Market risk is measured, managed and controlled on the one hand by assigning risk capital in accordance with the capital-at-risk approach and on the other by using value-at-risk limits. It is supplemented by the periodic performance of stress tests and by the monitor- ing of market liquidity risks. The value of trading posi- tions is determined using the fair value method, where- by marking to market or marking to model, which is subject to stricter rules, is applied on a daily basis. The capital-at-risk market risk corresponds to the assigned risk capital for the market risks of trading operations on a one-year horizon and at a confi- dence level of 99.9 percent. The modelling is based on a stressed value-at-risk (Stressed-VaR). Besides general market risks, the model also takes into account issuer default risks. Using a Monte Carlo simulation, Zürcher Kantonal- bank calculates value-at-risk for a 10-day period and at a confidence level of 99 percent. The loss distribution is arrived at from the valuation of the portfolio using a large number of manufactured scenarios (full valua- tion). The necessary parameters for determining the scenarios are estimated on the basis of historical market data, whereby more recent observations for the forecasting of volatility are accorded a higher weight- ing than less recent ones. As a result, value-at-risk re- sponds rapidly to any changing volatility on the mar- kets. Value-at-risk is calculated on a daily basis for the entire trading book. The four groups of risk factors commodities, currencies, interest rates and equities are calculated and shown separately as well as on a com- bined basis (Fig. 16). The bank uses different types of scenarios for stress - testing: in matrix scenarios, all market prices and their corresponding volatilities are heavily skewed. Such a scenario might include a 30 percent general fall in equity market prices with a simultaneous 70 percent increase in market volatility. The risk of losses due to general changes in price and volatility can therefore be identified. Non-linearity or asymmetry of risks can be observed in the matrix scenarios. Zürcher Kanto nalbank identifies probability-based scenarios which are accord- ed a 0.1 percent probability of occurring in addition to the matrix scenarios. These scenarios are calculated with increased correlations between risk factors, with a view to taking into account the reduced diversification effect typically observed in an extreme situation. 120 Zürcher Kantonalbank Annual Report 2016 Financial Report validation focuses on the back-testing of the risk-factor distribution, while the qualitative validation focuses on aspects such as data quality, operation and further development of the model, as well as ongoing plau- sibility checks on the model results. In addition to the annual review of the model, risks not modelled in the value-at-risk are periodically analysed in a separate process and monitored with regard to materiality. Risk profile At year-end 2016, the value-at-risk stood at CHF 9 million (Fig. 16). Interest rate risks continue to domi- nate (Fig. 17, p. 122). On average, the value-at- risk decreased from CHF 17 million to CHF 11 million comp- ared with the previous year. The main reason for the reduction lies in a lower average interest rate exposure in 2016. The bank additionally monitors the market liquidity risk of individual portfolios. In the equity derivatives sector, the potential trading volume resulting from the hedging strategy in the case of a change in the key risk factors is compared with the total market volume. Hypothetical offsetting expenses are calculated for bonds and bond-type products, based on observed bid-ask spreads and taking into account additional pricing supple- ments / discounts. Large-scale positions are examined regularly to ensure there is sufficient liquidity; valua- tion reserves are formed if necessary, causing a reduc- tion in core capital in the context of capital adequacy. The bank performs daily back-testing for the purpose of examining the forecast accuracy of value-at-risk. Regulatory back-testing is based on comparison of value- at-risk for a holding period of one day with the back- testing result. Any breach of limits is notified to the units responsible immediately. The market risk model is validated annually on the basis of a defined process. Validation includes quantita- tive as well as qualitative aspects. The quantitative Fig. 16: Market risks in the trading book (group) Risks including volatility risks in CHF million Commodities 1 Currencies 2 Interest rates Equities Diversification Modelled total risk Total risk 3 Risks based on model approach (value-at-risk with 10-day holding period) As at 31.12.2016 Average current year 2016 Maximum Minimum As at 31.12.2015 0 1 1 0 0 1 1 4 0 1 8 9 16 6 9 2 3 8 1 3 –5 –5 –9 –3 –4 7 8 15 5 9 9 11 17 7 12 1 Excluding gold. 2 Including gold. 3 Sum of modelled total risk and risk premium for trading products not fully modelled. Zürcher Kantonalbank Annual Report 2016 121 Financial Report Fig. 17: Components of value-at-risk (in CHF million) Commodity risk Currency risk Interest rate risk Equity risk Diversification effect Total value-at-risk 0 5 10 15 Back-testing results 2016 The quality of the value-at-risk approach used is estimated by comparing the value-at-risk for a holding period of one day with the realised daily back-testing result (Fig. 18). In 2016, two breaches of the value-at-risk were recorded. In the case of a one-day holding period and 99-percent quantile, two to three breaches of the value-at-risk are expected each year. The back-testing result therefore corresponds to the statisti- cally expected figure. The first breach resulted from extraordinary market movements following the Brexit result in the UK and the second was due to a major movement in money market interest rates at the end of November. Approach to measuring capital adequacy The required capital is calculated based on the internal model-based approach approved by FINMA using value-at-risk. Capital adequacy requirements are based on the market risks in the trading book and ex- change rate, precious metals and commodity risks in the banking book. Besides the value-at-risk figures calculated daily, stress-based value-at-risk figures are also included in the calculation of required capital on a weekly basis. The total risk is also calculated using the model approach, although the value changes in risk factors are based on data that were observed in a period with significant market stress for Zürcher Kantonal- bank. By contrast, calculation of the required capital for the specific risks of interest rate instruments is per- formed in accordance with the international standard approach (SA-BIZ) valid as of 31 December 2015. Fig. 18: Comparison of back-testing results 1 and value-at-risk (in CHF million) 20 16 12 8 4 0 –4 –8 –12 –16 –20 1st quarter 2nd quarter 3rd quarter 4th quarter Back-testing results One-day value-at-risk 1 The back-testing result corresponds to the adjusted trading income used for the methodological review of the quality of the risk model. 122 Zürcher Kantonalbank Annual Report 2016 Strategy, organisation and processes for the management of market risks in the banking book margin effects to be analysed for different interest rate scenarios over a period of several years. Financial Report Risk profile The sensitivity data shown in Fig. 19 on p. 124 indicate the change in value in Swiss francs when interest rates for each maturity band fall by one basis point (0.01 per- centage points). The customer deposits contained in the hedged item are represented via replicating portfolios with average maturities of between 17 and 26 months. The interest rate sensitivity of the CHF banking book stood at CHF 8.1 million per basis point as at 31 De- cember 2016, level with the previous year. The interest rate exposure mainly serves as a strategic hedge against persistently low Swiss franc interest rates and is dominated (by more than two thirds) by the strategic interest rate risk position specified by the board of direc- tors (equity benchmark). In the event of an interest rate rise, the positive margin effects successively com- pensate for the losses in terms of the structural contribution. The increase in interest rate sensitivity in the maturity band of over five years and the reduc- tion between one and five years are mainly attributable to aging effects of hedging transactions. The euro and US dollar interest rate exposures are almost fully hedged as of the end of 2016. Interest rate risks in the balance sheet Interest rate risks are the risk that changes in market interest rates will impact negatively on Zürcher Kantonal- bank’s financial position. As well as affecting current interest income, changes in interest rates have implica- tions for future earnings. Strategy, organisation and processes The interest rate risk in the banking book is managed in strategic terms by the board of directors and in tactical terms by the CFO and treasury. The strategic interest rate risk position is specified by the board of directors on a periodic basis in the form of an investment strategy for equity (equity benchmark). The CFO and treasury manage the deviation of the interest rate risk position in the banking book from the equity benchmark within the risk limits. The Risk unit is responsible for the measurement and monitoring of risk as well as inde- pendent reporting on interest rate risk. Zürcher Kantonalbank pursues a strategy focussed on medium-term optimisation of net interest income for the management of the banking book. The interest rate risk is managed based on the market interest meth- od. For customer deposits and loans with a variable interest rate, the interest rate risk is determined by tak- ing into account the bank’s presumed future rate - setting behaviour and reviewed at least once a year. The interest rate risk takes account of the present value as well as earnings prospects. With the pres- ent value perspective, interest rate risks are managed by allocating risk capital in accordance with the capital- at-risk approach (risk horizon one year, confidence level 99.9 percent) and by using value-at-risk limits (hold- ing period 20 trading days, confidence level 99 percent). In addition, stress scenarios are simulated in order to analyse and limit the impact of extraordinary changes in the level of interest rates. As far as earnings are concerned, stress tests provide an indication of the structural contribution in the event of extraordinary changes in market interest rates with unchanged positioning over a one year period. Besides the structural contribution, with regard to earn- ings, margin effects are particularly significant for cus- tomer deposits with variable interest. This applies espe- cially in an environment of negative market interest rates for balance sheet items such as retail customer de- posits which are not affected by negative interest rates. Newly implemented monitoring tools allow such Zürcher Kantonalbank Annual Report 2016 123 Financial Report Fig. 19: Interest rate sensitivity of the banking book CHF Basis point sensitivity 1 in CHF 1,000 up to 12 months 1 to 5 years over 5 years Hedged item Hedge Total as at 31.12.2016 Total as at 31.12.2015 –30 –36 –66 200 3,902 –1,788 2,114 3,349 6,934 –879 6,055 4,509 Total 10,806 –2,703 8,103 8,058 1 Basis point sensitivity is measured as a cash value effect when the interest rate in the maturity band concerned falls by one basis point (bp). A basis point is 0.01 percentage points. Fig. 20: Value-at-risk of interest rate risk in the banking book in CHF million Value-at-risk (99 % quantile) As at 31.12.2016 As at 31.12.2015 –164 –226 The value-at-risk of the interest rate risk position of the banking book decreased due to lower volatility in interest rate markets (Fig. 20). Risks in the investment portfolio The risks in the investment portfolio comprise issuer risks on debt instruments in financial investments and market risks on equity-type securities and real estate. Interest rate risks are managed and limited as part of asset and liability management. Strategy, organisation and processes The basis of the investment portfolio is mainly opera- tional. Debt securities in financial investments form part of the bank’s liquidity buffer, participations mainly relate to companies from the financial market infrastruc- ture and the real estate position consists almost entire- ly of property in use by the bank. There are detailed parameters and competencies for the purchase of financial investments and real estate, as well as for entering into participations. The investment strategy for the financial investments managed by treasury is laid down in a directive approved by the risk committee. Only debt instruments with a first-class credit rating, eligible as high quality liquid assets (HQLA) may be purchased. The Risk unit is responsible for the measurement and monitoring of risk as well as inde- pendent reporting on investment portfolio risks. Risk is managed internally for the investment port- folio by assigning risk capital. For the determination of the risk capital for financial investments and participa- tions, Zürcher Kantonalbank uses an internal model 124 Zürcher Kantonalbank Annual Report 2016 based on a stress period for the risk factors, taking into account diversification effects, liquidity dependencies and the hedgeability of positions. For real estate owned by the bank, risk capital is allocated based on regulato- ry capital adequacy requirements. Risk profile The balance sheet value of debt securities in financial investments was CHF 3.9 billion as at 31 December 2016 (2015: CHF 4.1 billion). The portfolio consists of first- class bonds and is diversified in terms of counterparty groups and countries. The distribution by counter- party group is shown in Figure 11 (p. 117). Guarantees given by central governments in relation to debt securities of banks are in some cases not apparent. It should also be noted that, in Figure 11, due to regulato- ry requirements the exposure to central mortgage institution loans is shown in the companies counterparty group. Other positions for Financial investments and Participations can be found in Notes 5 and 6 to the balance sheet (p. 85). Approach to measuring capital adequacy The capital adequacy required for the investment portfolio is calculated using the international standard approach. Operational risks Operational risks are potential risks that arise due to the inappropriateness or failure of persons, systems, procedures or due to external events. Strategy, organisation and processes The objective of Zürcher Kantonalbank’s management of operational risk is the risk-oriented protection of people, information, services and assets within its own sphere of responsibility and maintenance and resto- ration of critical business functions in an operational emergency. The management of operational risk is therefore an essential factor in ensuring that the canton, customers, partners, the public and the regula- tor can be confident about the services provided by the bank. The assessment of operational risks takes account not only of the direct financial losses but also the consequences of a loss of customer confidence and reputation. The bank-wide inventory of operational risks constitutes the basis for the management of operational risks. Through periodic, systematic assessments, the operational risks of all the bank’s critical services and service providers are identified, assessed and docu- mented. Bank-wide security management constitutes an important component of the management of opera- tional risks, and comprises four areas of security and corresponding protection objectives: Fig. 21: Security management Security area Security protection objective Business continuity management Data security Maintaining critical business functions in the event of serious events stemming from operational risks Protecting data confidentiality, integrity and availability Personal safety Protecting people (life and limb) Protection of property Protecting physical assets The measurement of operational risks is based on an estimate of potential claims and the probability of occurrence. To calculate the operational risks, inherent risks are set against existing risk-mitigating measures. If the residual risks exceed the risk tolerance, additional risk-mitigating measures are defined. The effective- ness of the risk-mitigating measures is monitored in the context of the bank-wide internal controls system. The specialist “Operational Risk” function of the Risk unit specifies methods and provides tools for monito- ring the internal controls system. Financial Report Risk profile There was no material change in the bank’s risk profile for operating risks compared with the previous year. There were no fundamental changes in the bank’s busi- ness model or organisational structure. Zürcher Kanto- nalbank paid particular attention to the identification of operational risk scenarios in relation to cybercrime. The bank’s security management is addressing growing threat levels through continuous improvement in protective and defensive measures. Approach to measuring capital adequacy Zürcher Kantonalbank uses the basic indicator approach to determine the required capital for operational risks. Liquidity and refinancing risks Liquidity refers to the bank’s capacity to discharge its liabilities promptly and unrestrictedly. The liquidity risk is the risk that this capacity to pay will be impaired under institution or market-specific stress conditions. Refinancing refers to the procurement of funds for the financing of assets. Management of refinancing involves managing the maturity profile of assets and lia- bilities. Refinancing risk is the risk that the bank is not in a position to procure sufficient funds for the ongoing financing of its lending business on suitable terms. Strategy, organisation and processes The treasury organisational unit, which reports to the CFO, is responsible for managing the liquidity risks and refinancing of Zürcher Kantonalbank. The treasury delegates operational liquidity management to the mo- ney trading unit, which ensures the efficient use of liquidity based on internal and regulatory rules. Within the framework of risk policy parameters, the board of directors establishes the liquidity risk tolerance based on the internal model. The risk organisation oversees compliance with the rules and reports to the board of directors on this on a regular basis. The measurement, management and control of short-term liquidity risks are based both on the internal model and on the regulatory indicator, the liquidity coverage ratio (LCR). The internal model is based on a bank-specific stress scenario tailored to the character- istics of Zürcher Kantonalbank. In this scenario, substan- tial outflows of varying intensity in customer and interbank business are assumed. The result of the liquidi- ty risk measurement is an automatically produced daily report on the net liquidity position, availability of liquid assets and securities eligible for repo transac- tions in financial investments and trading business posi- tions as well as liquidity inflows and outflows under Zürcher Kantonalbank Annual Report 2016 125 Financial Report the stress scenario. As a systemically important bank, with effect from 1 January 2015, Zürcher Kantonalbank is subject to a minimum requirement of 100 percent for the LCR. Zürcher Kantonalbank uses an internal mo- del in accordance with marginal note 225 of FINMA Circular 2015 / 2 Liquidity Risks for Banks for the division of wholesale deposits into operational and non-operati- onal categories. Net outflows of funds from derivati- ves due to market changes are calculated based on a look back method in accordance with marginal note 262 of the Circular. Besides Swiss francs, which make up by far the largest part of the balance sheet of Zürcher Kantonalbank, the LCR is also monitored and periodically reported in other major currencies. The management of liquidity risks also involves an emergen- cy plan. This supports the situationally appropriate conduct of the relevant functions in a crisis. Zürcher Kantonalbank pursues a long-term refinan- cing policy, including both cost and risk aspects. Refinancing risks are managed via a deliberate diversifi- cation with regard to maturities and refinancing instruments used and markets, to limit dependence on funding sources. The treasury uses short and long- term instruments, which are placed on the domestic and international markets. The diversified refinancing base is reflected in a broad product portfolio, compri- sing customer deposits, bank deposits and capital market refinancing. Risk profile The liquidity ratios moved within a stable framework in 2016. The quarterly averages for the LCR are shown in Fig. 9 on page 113. They lie between 116 percent and 132 percent. High quality liquid assets (HQLA) amount to between CHF 34.3 billion and CHF 41 billion. These can be subdivided into Level 1 assets (cash, central bank deposits, tradeable securities) and Level 2 assets (tradeable securities with less strict criteria). The majority of Level 1 assets are held in the form of central bank deposits. The liquidity risk profile is actively managed, particularly by targeted management of fixed-term deposits and SLB and repos. The change in the LCR is driven by fluctuations in non-operational deposits and SLB and repo business with banks and major customers. Figure 22 shows a year-on-year comparison of the coverage ratio for asset-side customer business. Loans to customers amounted to CHF 90.6 billion against funds due to customers of CHF 84.6 billion as at 31 December 2016. This gives a coverage ratio of 93.3 percent. The coverage ratio has reduced slightly versus the previous year due to the increased volume of mortgages. Fig. 22: Coverage ratio customer business CHF billion / percent 100 95.3% 93.3% 80 60 40 20 0 2015 2016 Loans to customers Funds due to customers Coverage ratio 126 Zürcher Kantonalbank Annual Report 2016 Financial Report Risk profile Zürcher Kantonalbank is aware that the United States Department of Justice (DOJ) and United States Internal Revenue Service (IRS) are investigating Zürcher Kantonal- bank’s cross-border business with US customers. The Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks launched by the United States Department of Justice on 29 August 2013 was declared to have ended by the DOJ at the end of 2016. It was aimed at banks that were not the subject of an investi- gation by the DOJ as at 29 August 2013. It therefore did not apply to Zürcher Kantonalbank, which has been under investigation since September 2011. The bank is continuing to cooperate with the relevant authorities on this matter. It is working towards an agreement. The timing of the conclusion of this process remains uncer- tain. Zürcher Kantonalbank evaluates all its risks on a constant basis, including in this connection, where necessary taking corresponding measures in terms of risk provisioning. All assessments are associated with a great deal of uncertainty. Compliance and legal risks Compliance and legal risks are the risk of a breach of the rules, standards and code of conduct that can lead to legal and regulatory sanctions, financial losses or reputation damage. Zürcher Kantonalbank’s compliance function reports directly to the CEO and is indepen- dent of profit-driven business activities. It supports the executive board and employees in adhering to the legal and ethical norms applicable to them. Support generally consists of identifying, evaluating, advising, monitoring and reporting, in general terms as well as in individual cases. Processes and methods The following are the main risk control instruments used for the management of compliance and legal risks: providing the bank with information on all relevant legal requirements, providing legal advice, training and education of employees, implementation of ordinan- ces through internal bank directives, monitoring and con- trolling, making inquiries and investigating in the event of a violation of the rules, assisting and instructing civil, criminal and administrative proceedings. The duties of the compliance function include main- taining the bank-wide compliance risk inventory, deter- mining the risk management tools for compliance risks, as well as preventive management of compliance risks in individual cases. To fulfil its role, the compliance func- tion has unlimited rights of information, access and inspection. As a support function, compliance communi- cates its legal advice in the form of recommendations. It cannot issue any instructions to risk managers. Zürcher Kantonalbank Annual Report 2016 127 Financial Report Note m) Multi-year comparison Due to the application of the new accounting regulations, many figures cannot be compared with figures from previous periods, or only to a limited extent. The multi-year comparison will therefore be established again as from 2014 (based on the figures in accordance with the new accounting regulations). in CHF million Income statement Net result from interest operations Result from commission business and services Result from trading operations and the fair value option Other result from ordinary activities Operating income Operating expenses Value adjustments on participations and depreciation and amortisation of tangible fixed assets and intangible assets Changes to provisions and other value adjustments and losses Operating result Extraordinary result Taxes Group net income Balance sheet (before distribution of net profit) in CHF million Total assets Mortgage loans Amounts due in respect of customer deposits in % Provisions Equity Key figures Return on equity (ROE) Cost / income ratio (CIR) 2 Common equity Tier 1 ratio (CET1) 3 Core capital ratio (Tier 1) 3 Total capital ratio 3 Leverage ratio 3 Liquidity coverage ratio (LCR) 4 Assets under management Total assets under management 2016 1,187 728 379 31 2,325 –1,441 1 –124 –8 752 1 16 –7 761 1 2015 1,162 668 328 47 2,204 –1,374 –106 –61 664 66 –8 722 2014 1,127 526 233 43 1,929 –1,191 –93 –38 607 41 –0 647 157,985 154,410 145,872 77,275 80,890 636 10,793 7.4 1 61.7 1 15.6 17.5 17.5 6.7 132 73,623 80,820 584 10,429 7.5 62.4 15.8 16.8 17.9 7.0 128 71,349 79,969 539 9,487 7.2 61.7 14.6 15.6 16.6 5.8 – in CHF million 264,754 257,505 208,677 Headcount / banking outlets Number Headcount after adjustment for part-time employees, as at 31 December Banking outlets 5 5,173 89 5,179 91 4,844 97 (continued on page 129) 128 Zürcher Kantonalbank Annual Report 2016 Multi-year comparison (continued) Profit distribution in CHF million Share paid to canton to defray cost of capital Distribution to canton Distribution to municipalities Total profit distribution Additional compensation for state guarantee Additional payments from public service mandate Rating agencies Fitch Moody’s Standard & Poor’s Rating 2016 21 220 110 351 22 119 AAA Aaa AAA 1 Excludes the CHF 70 million non-recurring expense in connection with the creation of provisions for pension benefit obligations. 2 Charged: Cost-income ratio (excl. changes in default-related value adjustments and losses from interest business). 3 In accordance with the provisions for systemically important banks. 4 Average for the quarter, 4th quarter. 5 Including branches of Zürcher Kantonalbank Österreich AG in Salzburg and Vienna as well as automated banks. Financial Report 2015 26 200 100 326 21 128 AAA Aaa AAA 2014 34 164 82 280 – 106 AAA Aaa AAA Zürcher Kantonalbank Annual Report 2016 129 Financial Report Ernst & Young Ltd Maagplatz 1 P.O. Box CH-8010 Zurich Phone Fax www.ey.com/ch +41 58 286 31 11 +41 58 286 30 04 Report of the statutory auditor to the Cantonal Parliament of Zurich on our audit of the consolidated financial statements as of 31 December 2016 of Zurich, 2 March 2017 Report of the statutory auditor on the consolidated financial statements Mr. President Ladies and Gentlemen As statutory auditor, we have audited the consolidated financial statements of Zürcher Kantonalbank, which comprise the consolidated balance sheet, consolidated statement of income, consolidated statement of cash flows, consolidated statement of changes in equity and the notes to the consolidated financial statements (pages 66 to 127), for the year ended 31 December 2016. Board of Directors’ responsibility The Board of Directors is responsible for the preparation of the consolidated financial statements in accordance with the Swiss accounting principles for banks and the requirements of Swiss law. This responsibility includes designing, implementing and maintaining an internal control system relevant to the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. The Board of Directors is further responsible for selecting and applying appropriate accounting policies and making accounting estimates that are reasonable in the circumstances. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with Swiss law and Swiss Auditing Standards. Those standards require that we plan and perform the audit to obtain reasonable assurance whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers the internal control system relevant to the entity’s preparation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control system. An audit also includes evaluating the appropriateness of the accounting policies used and the reasonableness of accounting estimates made, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 130 Zürcher Kantonalbank Annual Report 2016 Financial Report Page 2 Opinion In our opinion, the consolidated financial statements for the year ended 31 December 2016 give a true and fair view of the financial position, the results of operations and the cash flows in accordance with the Swiss accounting principles for banks and comply with Swiss law. Report on key audit matters based on the circular 1/2015 of the Federal Audit Oversight Authority Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements of the current period. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. For each matter below, our description of how our audit addressed the matter is provided in that context. We have fulfilled the responsibilities described in the Auditor’s responsibility section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the consolidated financial statements. The results of our audit procedures, including the procedures performed to address the matters below, provide the basis for our audit opinion on the consolidated financial statements. Loans – impairment of client loans and amounts due from banks as well as determination of allowances and provisions Audit matter Zürcher Kantonalbank discloses client loans, which consist of amounts due from clients and mortgage receivables, as well as amounts due from banks at nominal value less any necessary allowances. If required, provisions are recorded for limits that are set but not used as of the balance sheet date. The need for an allowance or provision is determined on a case-by-case basis and is based on the difference between the carrying amount of a receivable, or, if greater, the limit, and the prospective recoverable amount, taking into account the counterparty risk and the net income from the use of any collateral. Determining allowances and provisions requires making estimates and assumptions, which by definition involve judgments and can vary depending on the valuation. As of 31 December 2016, Zürcher Kantonalbank discloses client loans and amounts due from banks totaling CHF 90.1 billion. Their share as a percentage of total assets amounted to 57.1% as of the reporting date. Therefore, the valuation of the impairment of client loans and the amounts due from banks as well as the determination of allowances and provisions are key audit matters. Significant accounting principles regarding client loans, amounts due from banks as well as allowances and provisions are described by Zürcher Kantonalbank on pages 73, 74, 77 and 79 as well as on pages 115 to 120 of the bank’s annual report. Furthermore, we refer to notes 2 and 16 on pages 82 and 92 in the notes to the consolidated financial statements. Zürcher Kantonalbank Annual Report 2016 131 Financial Report Page 3 Our audit response Our audit included auditing the processes and controls in connection with granting and monitoring loans as well as assessing the identification and calculation of allowances and provisions. Moreover, we performed sample tests on the impairment of selected client loans and amounts due from banks, and evaluated the compliance and implementation of significant accounting principles as well as the appropriateness of the disclosures in the notes to the consolidated financial statements. Fair value measurement of financial instruments Audit matter Fair value is defined as the amount for which an asset is exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction. This amount corresponds to the price requested in a price-efficient and liquid market or, if this is missing, to the price determined on the basis of a valuation model. Valuation models are significantly affected by the assumptions that are used, including interest, forward and swap rates, spread curves and the volatility and estimates of future cash flows. There is a significant degree of judgment involved in making these assumptions. Zürcher Kantonalbank discloses financial instruments at fair value measurement – largely in connection with client business – in different balance sheet items. As of 31 December 2016, the fair value of positive replacement values of derivative financial instruments amounts to CHF 1.9 billion, while that of the negative replacement values comes to CHF 1.6 billion. The underlying contract volume before taking into account netting agreements amounts to CHF 616.0 billion. Furthermore, as of 31 December 2016, Zürcher Kantonalbank discloses obligations that were determined using a valuation model from other financial instruments at fair value measurement totaling CHF 3.1 billion. As a result of the inherent scope of judgment and the significance of the listed balance sheet items in the consolidated financial statements of Zürcher Kantonalbank, the valuation of these items represents a key audit matter. Zürcher Kantonalbank explains the relevant accounting principles on pages 74, 75, 80, 81 as well as on pages 120 to 122 of their annual report. Furthermore, we refer to notes 3, 4 and 14 on pages 83, 84 and 90 in the notes to the consolidated financial statements We audited the processes and controls with regard to fair value measurement, the validation and application of valuation models as well as the significant assumptions on which these are based. Moreover, we assessed the assumptions made in connection with the valuation and their appropriateness on the basis of sample testing. We compared the prices considered on price-efficient and liquid markets with independent sources using sample testing. Our audit response 132 Zürcher Kantonalbank Annual Report 2016 Financial Report Page 4 Provisions for compliance and legal risks Audit matter Zürcher Kantonalbank faces a limited number of pending legal issues and process risks, for which they have determined and recognized (on the balance sheet) the provisioning need as of 31 December 2016 on the basis of the estimated amounts in dispute. We consider the assessment of the determination and completeness of provisions for compliance and legal risks to be a key audit matter, because the estimated possible costs and obligations have a significant level of uncertainty and the bank’s estimates and assessments involve significant judgments. In addition, unexpected negative developments can have a material impact on Zürcher Kantonalbank’s net assets and results of operations. The bank’s history of cross-border banking services with US clients is being investigated by the US Department of Justice and the US Internal Revenue Service. As in other areas, the bank assesses its risks on an ongoing basis here, taking appropriate risk provisioning measures where required. Zürcher Kantonalbank explains the relevant accounting principles on pages 77 and 127 of their annual report. Furthermore, we refer to note 16 on page 92 in the notes to the consolidated financial statements. Our audit response Our audit with regard to provisions for compliance and legal risks included inspecting the bank’s internal documentation and risk analyses, discussing the assumptions made in determining the provisions with those charged with governance at the bank as well as evaluating the assessments prepared by the bank’s external legal representatives on our behalf. Report on other legal requirements We confirm that we meet the legal requirements on licensing according to the Auditor Oversight Act (AOA) and independence (article 728 CO and article 11 AOA) and that there are no circumstances incompatible with our independence. In accordance with article 728a para. 1 item 3 CO and Swiss Auditing Standard 890, we confirm that an internal control system exists, which has been designed for the preparation of consolidated financial statements according to the instructions of the Board of Directors. We recommend that the consolidated financial statements submitted to you be approved. Ernst & Young Ltd Rolf Walker Licensed audit expert (Auditor in charge) Stefan Lutz Licensed audit expert Zürcher Kantonalbank Annual Report 2016 133 Financial Report Parent Company Parent company financial statements 134 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report Income statement in CHF million Note 2016 2015 Change Change in % Result from interest operations Interest and discount income Interest and dividend income from financial investments Interest expense Gross result from interest operations Changes in value adjustments for default risk and losses from interest operations Subtotal net result from interest operations Result from commission business and services Commission income from securities and investment activities Commission income from lending activities Commission income from other services Commission expense Subtotal result from commission business and services Result from trading operations and the fair value option 32 Other ordinary activities Result from disposal of financial investments Income from participations Result from real estate Other ordinary income Other ordinary expense Subtotal other result from ordinary activities Operating income Operating expenses Personnel expenses General and administrative expenses Subtotal operating expenses Value adjustments on participations and depreciation and amortisation of tangible fixed assets and intangible assets Changes to provisions and other value adjustments and losses Operating result Extraordinary income Extraordinary expenses Change in reserves for general banking risks Net income 34 35 36 36 36 1,452 57 –311 1,199 –12 1,186 573 55 102 –107 624 357 1 72 13 18 –3 102 2,269 –1,035 2 –411 –1,446 –121 –7 694 17 –6 70 3 775 1,396 64 –300 1,159 3 1,162 501 55 1 91 –83 563 303 7 127 7 11 1 –3 149 2,178 –892 –401 –1,293 –103 –60 722 62 –0 –100 684 57 –6 –11 39 –16 24 72 0 12 –23 61 53 –6 –55 6 7 1 –48 90 –143 –10 –153 –19 53 –29 –45 –5 170 91 4.1 –10.0 3.7 3.4 – 2.1 14.4 0.7 12.9 27.9 10.8 17.6 –86.2 –43.1 76.2 59.8 –19.5 –31.8 4.2 16.0 2.6 11.8 18.1 –87.9 –3.9 –72.3 – – 13.4 1 A restatement of CHF 4.3 million was undertaken due to a changed profit allocation (+ Commission income from lending activities / – Other ordinary income). 2 Includes the CHF 70 million non-recurring expense in connection with the creation of provisions for pension benefit obligations. 3 Release of reserves for general banking risks to neutralise the effect of the non-recurring personnel expense on the result. Zürcher Kantonalbank Annual Report 2016 135 Financial Report Parent Company Distribution of net profit in CHF million Net income Profit carried forward Distributable profit Distribution of net profit Profit distribution Dividends – of which share paid to canton to meet cost of capital – dividends for the benefit of the canton – dividends for the benefit of the municipalities Profit retained Allocated to reserves – allocated to voluntary retained earnings reserve New profit carried forward 2016 2015 Change Change in % 775 1 776 351 21 220 110 425 425 1 684 1 685 326 26 200 100 358 358 1 91 –0 91 24 –6 20 10 67 67 –0 13.4 –17.1 13.3 7.5 –21.3 10.0 10.0 18.7 18.7 –18.3 The distribution of profit was approved by the board of directors on 26 January 2017. Approval of the annual financial statements by the cantonal parliament is planned for 8.5.2017. 136 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report Balance sheet before distribution of net profit, as at 31 December Note 2016 2015 Change Change in % in CHF million Assets Liquid assets Amounts due from banks Amounts due from securities financing transactions Amounts due from customers Mortgage loans Trading portfolio assets Positive replacement values of derivative financial instruments Other financial instruments at fair value Financial investments Accrued income and prepaid expenses Participations Tangible fixed assets Intangible assets Other assets Total assets Total subordinated claims – of which subject to mandatory conversion and / or debt waiver Liabilities Amounts due to banks Liabilities from securities financing transactions Amounts due in respect of customer deposits Trading portfolio liabilities Negative replacement values of derivative financial instruments 1 2 2 3 4 3 5 10 1 3 4 Liabilities from other financial instruments at fair value 3, 14 Cash bonds Bond issues Central mortgage institution loans Accrued expenses and deferred income Other liabilities Provisions Reserves for general banking risks Corporate capital Statutory profit reserves Voluntary retained earnings reserve Profit carried forward Net income Equity Total liabilities Total subordinated liabilities – of which subject to mandatory conversion and / or debt waiver Off-balance-sheet transactions Contingent liabilities Irrevocable commitments Obligations to pay up shares and make further contributions Credit commitments 10 16 21 21 21 21 21 21 2 2 2 35,292 5,248 14,889 7,541 77,275 7,834 1,990 32,490 5,817 14,966 7,716 73,623 8,880 2,983 2,802 –570 –77 –175 3,652 –1,047 –994 4,041 4,177 –137 324 624 799 3 501 236 562 852 3 545 156,360 152,851 181 44 34,096 5,084 80,957 2,656 1,551 1,581 235 9,329 8,384 584 499 632 4,836 2,425 1,213 1,521 1 775 10,771 156,360 1,298 1,298 4,484 9,019 233 291 8 34,749 2,991 80,880 2,110 2,067 2,725 269 7,669 7,716 505 207 572 4,906 2,425 1,213 1,163 1 684 10,392 152,851 1,310 1,310 3,852 8,907 147 88 63 –52 –0 –44 3,509 –110 35 –653 2,093 77 546 –516 –1,144 –34 1,660 668 80 292 60 –70 358 –0 91 379 3,509 –13 –13 632 112 86 8.6 –9.8 –0.5 –2.3 5.0 –11.8 –33.3 –3.3 37.2 11.2 –6.1 –9.4 –8.1 2.3 –37.8 427.0 –1.9 70.0 0.1 25.9 –25.0 –42.0 –12.6 21.7 8.7 15.8 141.4 10.5 –1.4 30.8 –17.1 13.4 3.6 2.3 –1.0 –1.0 16.4 1.3 58.6 Zürcher Kantonalbank Annual Report 2016 137 Financial Report Parent Company Equity statement Bank’s capital Statutory profit reserves Reserves for general banking risks Voluntary retained earnings reserve Balance sheet profit Total equity 1,925 500 2,260 4,806 397 9,388 500 –34 –164 –82 100 684 10,392 –1,163 1,163 100 116 –34 –164 –82 –116 684 685 Bank’s capital Statutory profit reserves Reserves for general banking risks Voluntary retained earnings reserve Balance sheet profit Total equity 2,425 1,213 4,906 1,163 685 10,392 Total equity as at 31.12.2015 2,425 1,213 4,906 1,163 in CHF million Total equity as at 01.01.2015 Opening amount Capital increase Capital decrease Increase in scope of capital consolidation Decrease in scope of capital consolidation Other contributions / other capital paid in Acquisition of own capital shares Disposal of own capital shares Reclassifications Profit (loss) on disposal of own shares Capital costs on endowment capital Allocation to the canton from previous years profit Allocation to municipalities from previous years profit Other allocations to / withdrawals from the reserves Other allocations to (transfers from) the reserves for general banking risks Other allocations to (transfers from) the other reserves Net income in CHF million Total equity as at 01.01.2016 Opening amount Capital increase Capital decrease Increase in scope of capital consolidation Decrease in scope of capital consolidation Other contributions / other capital paid in Acquisition of own capital shares Disposal of own capital shares Reclassifications Profit (loss) on disposal of own shares Capital costs on endowment capital Allocation to the canton from previous years profit Allocation to municipalities from previous years profit Other allocations to / withdrawals from the reserves Other allocations to (transfers from) the reserves for general banking risks Other allocations to (transfers from) the other reserves Net income –26 –200 –100 –358 775 776 –26 –200 –100 –70 775 10,771 –70 358 Total equity as at 31.12.2016 2,425 1,213 4,836 1,521 138 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report Notes Parent Company Under Art. 36 of the Swiss Ordinance on Banks and Savings Banks, institutions that draw up group financial statements are exempt from disclosure of certain information in the individual financial statements. For reasons of clarity, the same numbering has been used for the required disclosure items as in the notes to the group financial statements. They are generally based on the accounting principles of the group, with the following exceptions: all partici- pations are recognised at lower of cost or market in the statutory financial statements. The goodwill from acquisition is included under participations. In the individual financial statements, the reserves for general banking risks are shown as an individual item in the balance sheet. Their formation and release is shown under changes in reserves for general banking risks. The statements with respect to the group with regard to the company profile, explanations relating to risk management, the identification of default risks and defi- nition of the need for value adjustments, valuation of coverage and explanation regarding the business policy in the use of derivative instruments as well as regard- ing the use of hedge accounting in the group also apply to the parent company. The same applies to material events occurring after the balance sheet date. Accounting and valuation policies The accounting, valuation and balance sheet reporting are based on the provisions of the Code of Obligations and Swiss banking law, the accounting guidelines for banks, securities traders, financial groups and conglom- erates according to Circular 15 / 1 issued by the Swiss Federal Financial Markets Supervisory Authority (AGB) of 28 September 1997 and the regulations based on it. The statutory financial statements of the parent compa- ny are prepared in compliance with the provisions of Art. 25 para. 1 a) BO (“Reliable assessment statutory single-entity financial statements”). Zürcher Kantonalbank Annual Report 2016 139 Parent Company Financial Report Note i) Information on the balance sheet 1 Breakdown of securities financing transactions in CHF million 2016 2015 Book value of cash collateral due to bank for securities borrowed and in connection with reverse repurchase agreements Book value of cash collateral due from bank for securities lent and in connection with repurchase agreements Book value of securities lent in connection with securities lending or delivered as collateral in connection with securities borrowing as well as securities in own portfolio transferred in connection with repurchase agreements – of which with unrestricted rights to resell or pledge Fair value of securities received and serving as collateral in connection with securities lending or securities borrowed in connection with securities borrowing as well as securities received in connection with reverse repurchase agreements with an unrestricted right to resell or repledge – of which repledged securities – of which resold securities 14,889 5,084 3,325 3,325 43,457 358 31,662 14,966 2,991 1,830 1,830 34,760 292 24,525 2 Overview of collateral for loans and off-balance-sheet transactions, as well as impaired loans Overview by collateral in CHF million Loans (before netting with value adjustments) Amounts due from customers Mortgage loans – Residential property – Office and business premises – Trade and industrial property – Other Total mortgage loans Total lendings (before netting with adjustments) 2016 Total lendings (before netting with adjustments) 2015 Total lendings (after netting with adjustments) 2016 Total lendings (after netting with adjustments) 2015 Off-balance-sheet Contingent liabilities Irrevocable commitments Obligations to pay up shares and make further contributions Credit commitments Total off-balance-sheet transactions 2016 Total off-balance-sheet transactions 2015 Type of collateral Secured by mortgage Other collateral Unsecured Total 72 874 6,709 7,655 64,061 8,607 2,361 2,296 77,325 77,397 73,757 77,347 73,708 59 1,131 1,190 1,289 64,061 8,607 2,361 2,296 77,325 84,980 81,495 84,816 81,339 4,484 9,019 233 13,737 12,907 874 838 869 837 1,969 41 2,010 1,734 6,709 6,900 6,601 6,795 2,457 7,847 233 10,537 9,884 (continued on page 141) 140 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report 2 Overview of collateral for loans and off-balance-sheet transactions, as well as impaired loans (continued) Information on impaired loans in CHF million Impaired loans 2016 2015 Gross debt Estimated yield from collateral Net debt Individual allowances 1 468 466 285 282 183 184 169 162 1 Individual allowances of 100 percent of the net amount outstanding are normally formed. Individual rates of adjustment may apply in the case of major positions. 3 Trading portfolios and other financial instruments at fair value in CHF million Assets Debt securities, money market securities / transactions – of which listed 1 Equity securities Precious metals and commodities Other trading portfolio assets Total trading portfolio assets Debt securities Structured products Other Total other financial instruments at fair value Total assets – of which determined using a valuation model – of which securities eligible for repo transactions in accordance with liquidity requirements 1 Listed = traded on a recognised exchange. in CHF million Trading portfolio liabilities Debt securities, money market securities / transactions – of which listed 1 Equity securities Precious metals and commodities Other trading liabilities Total trading portfolio liabilities Debt securities Structured products Other Total other financial instruments at fair value Total liabilities – of which determined using a valuation model 1 Listed = traded on a recognised exchange. 2016 3,574 3,469 2,472 1,532 256 7,834 7,834 256 1,013 2016 2,644 2,589 12 0 0 2,656 1,581 1,581 4,237 1,581 2015 3,883 3,647 2,773 1,929 296 8,880 8,880 296 1,161 2015 2,085 2,074 17 9 2,110 2,725 2,725 4,835 2,725 Zürcher Kantonalbank Annual Report 2016 141 Financial Report Parent Company 4 Derivative instruments (assets and liabilities) in CHF million Interest rate instruments Forward contracts including FRAs Swaps Futures Options (OTC) Options (traded) Total Foreign exchange / precious metals Forward contracts Combined interest rate / currency swaps Futures Options (OTC) Options (traded) Total Equity securities / indices Forward contracts Swaps Futures Options (OTC) Options (traded) Total Credit derivatives Credit default swaps Total return swaps Firsttodefault swaps Other credit derivatives Total Other 1 Forward contracts Swaps Futures Options (OTC) Options (traded) Total Total before netting 2016 – of which, determined using a valuation model 2015 – of which, determined using a valuation model Trading instruments Hedging instruments Positive replace ment value Negative replace ment value Contract volume Positive replace ment value Negative replace ment value Contract volume 6,169 185 0 6,354 2,963 608 279 1 3,851 14 220 105 340 2 2 4 3 0 3 0 5,292 110 0 500 257,359 5,390 8,720 0 557 1,000 23,164 5,403 271,970 557 1,000 23,164 2,840 1,001 81 1 297,744 4,495 27 12,405 180 85 530 2,269 3,923 314,851 85 530 2,269 9 61 133 202 3 2 5 2 1 4 558 112 1,630 6,195 8,495 447 273 719 362 47 45 454 10,552 10,552 9,830 9,830 9,537 9,537 8,891 8,891 596,488 – 462,757 – 642 642 748 748 1,530 1,530 1,933 1,933 25,433 – 30,380 – Total after netting agreements Positive replacement values (accumulated) Negative replacement values (accumulated) 2016 2015 1,990 2,983 1,551 2,067 (continued on page 143) 142 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report 4 Derivative instruments (assets and liabilities) (continued) Breakdown by counterparty in CHF million Positive replacement values (after netting agreements) 2016 1 Includes commodities and hybrid derivatives. Central clearing houses Banks and securities dealers Other customers 68 575 1,346 The contract volume shows the amount of underlying on which a derivative is based or the notional amount underlying the derivative in accordance with the requirements of FINMA Circular 15 / 1, irrespective of whether the derivative is traded long or short. The contract volume is determined differently depending on the type of contract and does not permit any direct conclusions to be drawn about the risk exposure. 5 Financial investments in CHF million Debt securities – of which intended to be held to maturity – of which not intended to be held to maturity (available for sale) Equity securities – of which qualified participations 1 Precious metals Real estate 2 Total financial investments – of which securities eligible for repo transactions in accordance with liquidity requirements 1 At least 10% of capital or votes. 2 The insurance value of real estate included in financial investments amounted to CHF 1 million. Book value Fair value 2016 2015 2016 2015 3,813 3,813 4,003 4,003 4,028 4,028 4,227 4,227 10 11 21 22 217 1 4,041 3,720 162 1 4,177 3,906 217 1 4,267 3,930 162 1 4,412 4,125 Counterparties by rating in CHF million Moody’s Standard & Poor’s, Fitch Debt securities: book values 2016 Aaa – Aa3 Aaa – AA– A1 – A3 A + – A – Baa1 – Baa3 BBB + – BBB– Ba1 – Ba3 Lower than Ba3 BB + – B– Lower than B – No rating No rating 3,422 65 325 All debt instruments without a rating fulfil the conditions of high-quality liquid assets (HQLA) according to the Liquidity Ordinance (LiqV). If two or more ratings exist with different risk weightings, those ratings which correspond to the two lowest risk weightings are taken into consideration and the higher of the two risk weightings is used. As a first priority the issue rating is used and as a second priority, the issuer rating. 10 Other assets and liabilities in CHF million Compensation account Deferred income tax as recognised as assets Amount recognised as asset due to employer contribution reserves Amount recognised as asset realting to other assets from pension schemes Badwill Settlement accounts Indirect taxes Other Total Other assets Other liabilities 2016 315 46 118 23 501 2015 413 5 68 59 545 2016 2015 355 42 102 499 111 31 65 207 Zürcher Kantonalbank Annual Report 2016 143 Financial Report Parent Company 11 Assets pledged or assigned to secure own commitments, and assets under reservation of ownership in CHF million Pledged / assigned assets Amounts due from banks Amounts due from customers Mortgage loans Trading portfolio assets Financial investments Total pledged / assigned assets No assets are subject to reservation of ownership. 2016 Effective commitment 2,189 1,643 9,642 50 2015 Effective commitment 1,851 2,031 8,873 124 Book value 1,865 2,051 10,101 124 Book value 2,212 1,692 10,101 50 14,056 13,524 14,140 12,879 Instruments serving as security where, in connection with securities financing, the right of resale or pledging has been granted are shown in Note 1 (p. 140). 12 Liabilities relating to own pension schemes and number and nature of equity instruments of the bank held by own pension schemes in CHF million 2016 2015 Change Liabilities to own pension schemes from balance-sheet transactions Amounts due in respect of customer deposits Cash bonds Negative replacement values of derivative financial instruments Accrued expenses and deferred income Total Own pension schemes do not hold any of the bank’s equity instruments. 13A Employer contribution reserve (ECR) 104 11 115 144 0 144 –40 11 –30 in CHF million 31.12.2016 31.12.2016 31.12.2016 31.12.2015 2016 2015 Nominal value Waiver of usage Net amount Net amount Influence of ECR on personnel expenses Influence of ECR on personnel expenses Zürcher Kantonalbank pension scheme Total 144 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report 13B Economic benefit / economic obligations and the pension expenses in CHF million 31.12.2016 2016 2015 2016 2016 2016 2015 Overfunding / underfunding Economic interest of the bank Change in economic interest Contributions paid Pension expenses in personnel expenses Employer-funded fund / employer-funded pension fund Pension plans without surplus / shortfall Pension plans with surplus Pension plans with shortfall Pension schemes without own assets Total 1 Including the creation of provisions for pension benefit obligations amounting to CHF 70 million. 14 Issued structured products 179 1 179 1 103 179 179 103 Underlying risk of the embedded derivative Valued as a whole Valued separately Book value Total in CHF million Interest rate instruments Equity securities Foreign currencies Commodities / precious metals Loans Real estate Hybrid instruments Total 2016 Total 2015 With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC With own debenture component (ODC) / without ODC Booked in trading portfolio Booked in other financial instruments at fair value Value of the host instrument Value of the derivative 1,455 57 53 8 8 1,581 2,725 1,455 57 53 8 8 1,581 2,725 Zürcher Kantonalbank Annual Report 2016 145 Financial Report Parent Company 16 Presentation of value adjustments and provisions, reserves for general banking risk, and changes therein during the current year in CHF million Provisions for deferred taxes Provisions for pension benefit obligations 1 Provisions for credit risks Provisions for other business risks 2 Provisions for restructuring 3 Other provisions 4 Total provisions Reserves for general banking risks 4,906 Value adjustments for default risks and country risks – of which value adjustments for default risks from impaired loans 5 – of which value adjustments for latent risks 162 162 As at end of 2015 Appropriate usage and reversals Reclassifi - cations Currency differences Past due interest, recoveries New creation charged to income statement Releases to income Balance at end 2016 147 219 3 203 572 –10 –0 –2 –6 –19 –5 –5 2 2 4 70 47 1 118 58 58 70 144 219 0 199 632 4,836 169 169 –41 –1 –0 –42 –70 –49 –49 3 3 1 In line with a sustainable human resources policy, the board of directors decided in December 2016 that the bank would assume certain costs for the financing of transitional solutions in connection with the realignment of the pension fund to the changed environment. In the year under review, provision for pension liabilities amounting to CHF 70 million was made under personnel expenses. 2 Provisions for other business risks relate to provisions for settlement risks, for example, which cover identifiable risks as at the balance sheet date. 3 Provisions for restructuring were made in connection with the acquisition of the Swisscanto group and comprise personnel measures and various integration costs. 4 Other provisions primarily consist of provisions for litigation and provisions for employees’ holiday credits. 5 Default risks consist primarily of counterparty risks, the values of which are generally adjusted by 100 percent of the net amount outstanding. Individual rates of adjustment may apply in the case of major positions. Recoveries from amounts due derecognised in previous periods are reported directly via changes in value adjustments for default risk and losses from interest operations (2016: CHF 3 million / 2015: CHF 5 million). Zürcher Kantonalbank is aware that the United States Department of Justice (DOJ) and United States Internal Revenue Service (IRS) are investigating Zürcher Kantonalbank’s cross- border business with US customers. The Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Bawnks launched by the United States Department of Justice on 29 August 2013 was declared to have ended by the DOJ at the end of 2016. It was aimed at banks that were not the subject of an investigation by the DOJ as at 29 August 2013. It therefore did not apply to Zürcher Kantonalbank, which has been under investigation since September 2011. The bank is continuing to cooperate with the relevant authorities on this matter. It is working towards an agreement. The timing of the conclusion of this process remains uncertain. Zürcher Kantonalbank evaluates all its risks on a constant basis, including in this connection, where necessary taking corresponding measures in terms of risk provisioning. All assessments are associated with a great deal of uncertainty. For more details on the management of credit risks, operational risks as well as legal and compliance risks, please refer to section I) of the risk report. 17 Presentation of the bank’s capital in CHF million Endowment capital Participation capital 1 Total bank’s capital Total nominal value 2016 Total nominal value 2015 2,425 2,425 2,425 2,425 1 By decision of the Cantonal Council of 26 May 2014, the participation capital was abolished as of 1 January 2015. At present, Zürcher Kantonalbank only has endowment capital and has no outstanding participation capital. In April 2014, the cantonal parliament increased the endowment ceiling, which has an indefinite time limit, by CHF 500 million to CHF 3,000 million. Zürcher Kantonalbank’s corporate capital consists of endowment capital, which with effect from 30 June 2015 was increased by CHF 500 million to CHF 2,425 million. If needed, the board of directors can call on the unused CHF 575 million of the endowment capital. The profit distribution takes place on the basis of the stipulations set forth in Section 26f Law on Zürcher Kantonalbank of 28 September 1997, version dated 1 January 2015 and has no direct link to the endowment capital. 146 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report 18 Number and value of equity securities or options on equity securities held by all executives and directors and by employees, and disclosures on any employee participation schemes Zürcher Kantonalbank does not have any employee participation schemes. 19 Amounts due from and due to related parties in CHF million Holders of qualified participations: Group companies Affiliated companies Transactions with members of governing bodies Other related parties Amounts due from Amounts due to 2016 4 542 547 18 2015 11 580 421 16 2016 2015 592 294 1,629 28 472 250 1,859 30 Affiliated companies are public cantonal corporations or semi-public enterprises in which the canton holds significant participations. On- and off-balance-sheet transactions with related persons are, with the exception of loans granted to members of the bank’s governing bodies, conducted at usual market conditions. Loans to the bank’s governing bodies are granted occasionally on employee terms. Primarily the usual balance sheet banking business was involved, i. e. it was mainly amounts due from and due to customers. The totals above also include securities items and amounts outstanding from transactions in derivatives (positive and negative replacement values). The off-balance-sheet transactions with related parties in the amount of CHF 1,727 million (2015: CHF 1,671 million) primarily include irrevocable loan commitments, in particular the keepwell agreement with Zürcher Kantonalbank Finance (Guernsey) Ltd., and other contingent liabilities. 20 Disclosure of holders of significant participations Zürcher Kantonalbank is an independent public-law institution of the canton of Zurich. Zürcher Kantonalbank Annual Report 2016 147 Financial Report Parent Company 21 Disclosure of own shares and composition of equity capital in CHF million Reserves for general banking risks Bank’s capital Statutory profit reserves Voluntary retained earnings reserve Profit carried forward Net income Total equity The bank does not hold any capital shares of its own. The statutory retained earnings reserve cannot be distributed. 2016 4,836 2,425 1,213 1,521 1 775 10,771 2015 4,906 2,425 1,213 1,163 1 684 10,392 In 2015 the board of directors decided on a reallocation of CHF 1,163 million from the statutory retained earnings reserves into the voluntary retained earnings reserves. 22 Disclosures in accordance with the Ordinance against Excessive Compensation with respect of Listed Stock Corporations and Article 663c para. 3 CO for banks whose equity securities are listed. These requirements are not applicable to Zürcher Kantonalbank. 26 Breakdown of total foreign assets by credit rating of country groups (risk domicile view) Rating class of ZKB’s own country rating Moody’s A B C D E F G Total Aaa / Aa1 / Aa2 / Aa3 A1 / A2 / A3 Baa1 / Baa2 / Baa3 Ba1 / Ba2 Ba3 B1 / B2 / B3 Caa1 / Caa2 / Caa3 / Ca / C 31.12.2016 Net foreign exposure 31.12.2015 Net foreign exposure in CHF million Share in % in CHF million Share in % 11,127 84.2 10,241 81.9 531 815 634 75 25 4 4.0 6.2 4.8 0.6 0.2 0.0 708 973 538 32 11 9 5.7 7.8 4.3 0.3 0.1 0.1 13,210 100.0 12,511 100.0 For explanations regarding the rating system please refer to section l) of the risk report (p. 116). 148 Zürcher Kantonalbank Annual Report 2016 Parent Company Note j) Information on off-balance-sheet items Financial Report 30 Fiduciary transactions in CHF million Fiduciary investments with third-party companies Fiduciary investments with group companies and linked companies Fiduciary loans Fiduciary transactions arising from securities lending and borrowing (in the bank’s own name for the account of customers) Other fiduciary transactions Total 31 Breakdown of managed assets and presentation of their development a) Breakdown of managed assets in CHF million Type of customer assets Assets in collective investment schemes managed by Zürcher Kantonalbank Assets under discretionary asset management agreements 1 Other customer assets 1 Total customer assets (including double counting) 2 – of which double counting 3 2016 243 2015 205 243 205 2016 2015 75,939 56,417 131,027 263,384 38,658 73,884 53,114 129,215 256,214 30,838 1 Assets with a Private Portfolio Consulting (PPC) mandate (approximately CHF 500 million) are now shown under Other managed assets (previously Assets under discretionary asset management agreements). A PPC mandate offers a more intensive form of advice with additional benefits compared with a classic advisory mandate. The previous year has been restated. 2 The managed customer assets shown include all customer assets of an investment nature held with Zürcher Kantonalbank, as well as customer assets held with third-party banks and which are managed by Zürcher Kantonalbank. Lending products for corporate customers, which do not have an investment element, are also shown as assets under management. This does not include assets held with Zürcher Kantonalbank but managed by third parties (custody-only). Assets of banks and significant investment fund companies (including collective pension fund foundations, investment trusts, employee benefits foundations and pension funds) for which Zürcher Kantonalbank acts exclusively as custodian bank are treated as custody-only. 3 Correction of value for previous year by CHF 5.8 billion in view of Swisscanto collective investment schemes b) Presentation of the development of managed assets in CHF million 2016 2015 1 Total managed assets (incl. double counting) at beginning + / – net new money inflow or net new money outflow 2 + / – price gains / losses, interest, dividends and currency gains / losses + / – other effects Total managed assets (incl. double counting) at end 256,214 7,887 6,412 –7,130 3 263,384 207,415 –2,574 –867 52,239 4 256,214 1 Following a change in the segmentation of business partners as well as deposits, the figures for the previous year were adjusted. 2 The net new money inflow / outflow corresponds to the development of managed customer assets adjusted for fluctuations in prices and exchange rates, interest and dividend payments, fees and expenses charged to customers, and reclassification of assets. Changes due to acquisitions / disposals of subsidiaries are not included. The interest billed to loan customers is included in the change in net new money inflow / outflow. 3 The restructuring of a major mandate led to a reduction in eligible portfolios, without an actual outflow of assets. The CHF 7.1 billion reduction in assets is therefore shown under Other effects. 4 For the most part, other effects for 2015 reflect the acquisition of Swisscanto Holding Ltd. Zürcher Kantonalbank Annual Report 2016 149 Financial Report Note k) Information on the income statement Parent Company 32 Breakdown of the result from trading activities and the fair value option a) Breakdown by business area (in accordance with the organisation of the bank or financial group) in CHF million Result from foreign exchange, banknotes and precious metals Result from bonds, interest rate and credit derivatives Result from trading in equities and structured products Result from other trading activities 1 Total 2016 133 144 25 54 357 2015 115 114 34 40 303 b) Breakdown by underlying risk and based on the use of the fair value option Trading result from: Foreign exchange and banknotes Precious metals Securities lending and borrowing Bonds, interest rate and credit derivatives Equities and equity derivatives Commod- ities and commodity derivatives Other products 2 in CHF million Result from foreign exchange, banknotes and precious metals Result from bonds, interest rate and credit derivatives Result from trading in equities and structured products Result from other trading activities Total – of which from fair value option on assets 2016 133 144 25 54 357 113 –0 11 124 – of which from fair value option on liabilities –12 –1 20 –5 –0 15 –0 58 58 142 –7 –3 132 –0 2 29 –1 31 –5 –2 –0 –2 –6 1 1 0 1 Other trading activities includes results from securities lending and borrowing as well as positions for which the executive board and Asset Management are responsible. 2 Trading income from other products includes hybrid products and real estate derivatives. 150 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report 33 Disclosure of material refinancing income in the interest and discount income item as well as material negative interest During the 2016 financial year a refinancing income of CHF –12.1 million (previous year CHF –1.9 million) was included in the interest and discount income item. Negative interest on lending business is shown as a reduction in the interest and discount income. Negative interest on deposit-taking business is shown as a reduction in interest expenses. in CHF million Negative interest on lending business (reduction in the interest and discount income) Negative interest on deposit-taking business (reduction in interest expenses) 34 Personnel expenses in CHF million Compensation for governing bodies and personnel – of which alternative forms of variable compensation AHV, IV, ALV and other social security contributions Changes in book value for economic benefits and obligations arising from pension schemes Other personnel expenses Total 1 Including the creation of provisions for pension benefit obligations amounting to CHF 70 million. 35 General and administrative expenses in CHF million Occupancy expense Expense for information and communications technology Expenses for vehicles, equipment, furniture and other fixtures, as well as operating lease expenses Auditors’ fees – of which for financial and regulatory audits – of which for other services Other operating expenses – of which as compensation for state guarantee Total 2016 147 117 2016 762 241 1 32 1,035 2016 32 168 1 5 5 205 22 411 2015 114 82 2015 702 159 31 892 2015 44 167 2 4 4 184 21 401 Zürcher Kantonalbank Annual Report 2016 151 Financial Report Parent Company 36 Explanations regarding material losses, extraordinary income and expenses, as well as material releases of hidden reserves, reserves for general banking risks, and value adjustments and provisions no longer required in CHF million Extraordinary income Reversal of impairment on other participations Income from sale of other real estate / bank premises Income from sale of participations Other Total Extraordinary expenses Losses from sale of other real estate / bank premises Expenses incurred outside of the reporting period Loss from the sale of participations Other Total Change in reserves for general banking risks Release of reserves for general banking risks Total 2016 2015 21 38 3 1 62 0 0 0 7 8 2 0 17 0 6 6 70 1 70 1 Release of reserves for general banking risks to neutralise the effect of the non-recurring personnel expense on the result. In the financial year, no hidden reserves or material freed-up allowances and provisions were recorded. 37 Disclosure of and reasons for revaluation of participations and tangible fixed assets up to acquisition cost at maximum in CHF million Participation Caleas AG CLS Group Holdings AG Technopark Winterthur AG Technopark Immobilien AG Valiant Holding AG Zürcher Kantonalbank Österreich AG Zürcher Kantonalbank Representações Ltda. Total Domicile Zurich Lucerne Winterthur Zurich Lucerne Salzburg São Paulo 2016 2015 0 1 1 0 2 3 0 0 17 20 Appreciation is applied to non-listed participations in accordance with the mean value method and, for listed participations, in accordance with the market value method. 39 Presentation of current taxes, deferred taxes and disclosure of the tax rate As an independent public-law institution, Zürcher Kantonalbank is exempt from taxes on its income and capital under cantonal law (Art. 61) and federal law on direct taxation (Art. 56). 152 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report Pawnbroking agency of Zürcher Kantonalbank Zürcher Kantonalbank is required to operate a pawnbroking agency (Art. 7 para. 3 of the Law on Zürcher Kantonal- bank). Since 1872, the pawnbroking agency has been granting loans in return for the depositing of pledged items. It is managed as an independent business operation in Zurich, at Zurlindenstrasse 105. The following section shows the balance sheet, income statement and loan transactions of the pawnbroking agency (in CHF 1,000). Balance sheet (before distribution of net profit) 2016 2015 in CHF 1,000 2016 2015 in CHF 1,000 Assets Cash Postal account Accounts receivable Loans Inventory Furniture, IT system Accrued interest Liabilities 228 12 227 Zürcher Kantonalbank 40 Surplus from auctions Accounts payable 6,359 6,655 Provisions 0 0 242 Reserve fund 0 Profit carried forward 264 Operating profit 5,404 5,762 225 6 140 1,029 1 36 6,841 240 9 145 942 1 87 7,186 Total assets 6,841 7,186 Total assets Income statement in CHF 1,000 Expenses Operating expenses Refinancing expenses Losses Depreciation and provisions Operating profit Total Loan transactions 2016 2015 in CHF 1,000 2016 2015 949 52 1 36 1,039 Income 958 Interest on loans Other income 56 1 87 840 200 902 200 1,102 Total 1,039 1,102 Total loans at 31.12.2015 New loans in 2016 (incl. renewals) Repayments 2016 Proceeds from auctions incl. inventory receipts Total loans at 31.12.2016 Items in CHF 1,000 Items in CHF 1,000 11,293 238 13,751 154 5,676 11,207 6,655 13,609 5,352 6,359 Zürcher Kantonalbank Annual Report 2016 153 Financial Report Parent Company Ernst & Young Ltd Maagplatz 1 P.O. Box CH-8010 Zurich Phone Fax www.ey.com/ch +41 58 286 31 11 +41 58 286 30 04 Report of the statutory auditor to the Cantonal Parliament of Zurich on our audit of the financial statements as of 31 December 2016 of Zurich, 2 March 2017 Zürcher Kantonalbank, Zurich Report of the statutory auditor on the financial statements Mr. President Ladies and Gentlemen As statutory auditor, we have audited the financial statements of Zürcher Kantonalbank, which comprise the balance sheet, income statement, statement of changes in equity and notes (pages 135 to 153), for the year ended 31 December 2016. Board of Directors’ responsibility The Board of Directors is responsible for the preparation of the financial statements in accordance with the requirements of Swiss law and the Law on Zürcher Kantonalbank. This responsibility includes designing, implementing and maintaining an internal control system relevant to the preparation of financial statements that are free from material misstatement, whether due to fraud or error. The Board of Directors is further responsible for selecting and applying appropriate accounting policies and making accounting estimates that are reasonable in the circumstances. Auditor’s responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Swiss law and Swiss Auditing Standards. Those standards require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers the internal control system relevant to the entity’s preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control system. An audit also includes evaluating the appropriateness of the accounting policies used and the reasonableness of accounting estimates made, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements for the year ended 31 December 2016 comply with Swiss law and the Law on Zürcher Kantonalbank. 154 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report Page 2 Report on key audit matters based on the circular 1/2015 of the Federal Audit Oversight Authority Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. For each matter below, our description of how our audit addressed the matter is provided in that context. We have fulfilled the responsibilities described in the Auditor’s responsibilities section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the financial statements. The results of our audit procedures, including the procedures performed to address the matters below, provide the basis for our audit opinion on the financial statements. Loans – impairment of client loans and amounts due from banks as well as determination of allowances and provisions Audit Matter Zürcher Kantonalbank discloses client loans, which consist of amounts due from clients and mortgage receivables, as well as amounts due from banks at nominal value less any necessary allowances. If required, provisions are recorded for limits that are set but not used as of the balance sheet date. The need for an allowance or provision is determined on a case-by-case basis and is based on the difference between the carrying amount of a receivable, or, if greater, the limit, and the prospective recoverable amount, taking into account the counterparty risk and the net income from the use of any collateral. Determining allowances and provisions requires making estimates and assumptions, which by definition involve judgments and can vary depending on the valuation. As of 31 December 2016, Zürcher Kantonalbank discloses client loans and amounts due from banks totaling CHF 90.1 billion. Their share as a percentage of total assets amounted to 57.6% as of the reporting date. Therefore, the valuation of the impairment of client loans and the amounts due from banks as well as the determination of allowances and provisions are key audit matters. Significant accounting principles regarding client loans, amounts due from banks as well as allowances and provisions are described by Zürcher Kantonalbank on pages 73, 74, 77 and 79 as well as on pages 115 to 120 of the bank’s annual report. Furthermore, we refer to notes 2 and 16 on pages 140, 141 and 146 in the notes to the financial statements. Our audit included auditing the processes and controls in connection with granting and monitoring loans as well as assessing the identification and calculation of allowances and provisions. Moreover, we performed sample tests on the impairment of selected client loans and amounts due from banks, and evaluated the compliance and implementation of significant accounting principles as well as the appropriateness of the disclosures in the notes to the financial statements. Our audit response Zürcher Kantonalbank Annual Report 2016 155 Financial Report Parent Company Page 3 Fair value measurement of financial instruments Audit matter Fair value is defined as the amount for which an asset is exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction. This amount corresponds to the price requested in a price-efficient and liquid market or, if this is missing, to the price determined on the basis of a valuation model. Valuation models are significantly affected by the assumptions that are used, including interest, forward and swap rates, spread curves and the volatility and estimates of future cash flows. There is a significant degree of judgment involved in making these assumptions. Zürcher Kantonalbank discloses financial instruments at fair value measurement – largely in connection with client business – in different balance sheet items. As of 31 December 2016, the fair value of positive replacement values of derivative financial instruments amounts to CHF 2.0 billion, while that of the negative replacement values comes to CHF 1.6 billion. The underlying contract volume before taking into account netting agreements amounts to CHF 621.9 billion. Furthermore, as of 31 December 2016, Zürcher Kantonalbank discloses obligations that were determined using a valuation model from other financial instruments at fair value measurement totaling CHF 1.6 billion. As a result of the inherent scope of judgment and the significance of the listed balance sheet items in the financial statements of Zürcher Kantonalbank, the valuation of these items represents a key audit matter. Zürcher Kantonalbank explains the relevant accounting principles on pages 74, 75, 80, 81 as well as on pages 120 to 122 of their annual report. Furthermore, we refer to notes 3, 4 and 14 on pages 141 to 143 and 145 in the notes to the financial statements. We audited the processes and controls with regard to fair value measurement, the validation and application of valuation models as well as the significant assumptions on which these are based. Moreover, we assessed the assumptions made in connection with the valuation and their appropriateness on the basis of sample testing. We compared the prices considered on price-efficient and liquid markets with independent sources using sample testing. Our audit response Provisions for compliance and legal risks Audit Matter Zürcher Kantonalbank faces a limited number of pending legal issues and process risks, for which they have determined and recognized (on the balance sheet) the provisioning need as of 31 December 2016 on the basis of the estimated amounts in dispute. We consider the assessment of the determination and completeness of provisions for compliance and legal risks to be a key audit matter, because the estimated possible costs and obligations have a significant level of uncertainty and the bank’s estimates and assessments involve significant judgments. In addition, unexpected negative developments can have a material impact on Zürcher Kantonalbank’s net assets and results of operations. 156 Zürcher Kantonalbank Annual Report 2016 Parent Company Financial Report Page 4 The bank’s history of cross-border banking services with US clients is being investigated by the US Department of Justice and the US Internal Revenue Service. As in other areas, the bank assesses its risks on an ongoing basis here, taking appropriate risk provisioning measures where required. Zürcher Kantonalbank explains the relevant accounting principles on pages 77 and 127 of their annual report. Furthermore, we refer to note 16 on page 146 in the notes to the financial statements. Our audit with regard to provisions for compliance and legal risks included inspecting the bank’s internal documentation and risk analyses, discussing the assumptions made in determining the provisions with those charged with governance at the bank as well as evaluating the assessments prepared by the bank’s external legal representatives on our behalf. Our audit response Report on other legal requirements We confirm that we meet the legal requirements on licensing according to the Auditor Oversight Act (AOA) and independence (article 728 CO and article 11 AOA) and that there are no circumstances incompatible with our independence. In accordance with article 728a para. 1 item 3 CO and Swiss Auditing Standard 890, we confirm that an internal control system exists, which has been designed for the preparation of financial statements according to the instructions of the Board of Directors. We further confirm that the proposed appropriation of available earnings complies with Swiss law and the Law on Zürcher Kantonalbank. We recommend that the financial statements submitted to you be approved. Ernst & Young Ltd Rolf Walker Licensed audit expert (Auditor in charge) Stefan Lutz Licensed audit expert Zürcher Kantonalbank Annual Report 2016 157 Glossary Assessment Appraisal of a project, situation or participant. Audit Audit (the inspectorate) is responsible for the group’s internal auditing. In organisation- al terms, it reports directly to the board of directors and assists the latter in fulfilling its super visory and control tasks. Basel III The reforms published by the Basel Committee for Banking Supervision in 2010, Basel III, include a further revision of the Basel Capital Accord. Besides stricter, risk-based capital require- ments with a countercyclical effect, a limit has been set on leverage for the first time (leverage ratio). A global mini- mum liquidity standard is also envisaged. Basel Committee on Banking Supervision The Basel Commit- tee on Banking Supervision was established by the Bank for International Settlements (BIS) in 1974 and is made up of repre- sentatives of central banks and supervisory authorities from 27 countries. Switzerland is repre- sented by FINMA and the SNB. The Basel Committee serves as a forum for cooperation on banking supervision issues and is the world’s most important standardsetting body for bank- ing regulation. Of particular importance is the Basel Capital Accord, also known as Basel I, Basel II and Basel III. Bid-ask spread Difference between the buying and selling price of a financial instrument or currency. Business continuity management Business continuity management ensures a company’s critical business functions are main- tained or restored in the case of internal or external events. Capital-at-Risk The maximum risk capital specified by the board of directors, it is divided between the various risk categories of credit, market and operational risk in order to limit the various business activities. Capital budgeting Planning process for determining risk capital. The available funds (risk capital) are allocated to the various investment opportunities (risk categories, risk managers). Clearing centre Financial sector institution that ensures the order- ly settlement of financial trans actions between two counterpar- ties. Sometimes known as a clearing house, it acts as a central counterparty through which financial transactions between different parties are processed. Commodity trade finance Loan financing for trade in com modities. Compliance Compliance on the one hand involves ensuring the behaviour and actions of the bank and its employees meet applicable legal and ethical standards and, on the other hand, comprises all organisation- al measures designed to prevent violations of the law and breach- es of rules and ethical norms by the bank, its governing bod- ies and its employees. Confidence level Also known as confidence interval or expectancy range. Indicates an interval for the accuracy of the estimated position of a parameter. The confidence interval is the range containing the true position of the parameter in the case of the infinite repetition of a ran- dom experiment with a specific frequency (confidence level). Core capital This term was intro- duced as part of the Basel Capital Accord (Basel III) and comprises the equity available to a company on a permanent basis in order to cover losses in its operations. Core capital primarily consists of paidup corporate capital, or endowment capital, as well as capital and profit reserves (hard core capital or common equity Tier 1). Additional Tier 1 capital, such as perpetual hybrid capital, is also included. Core capital ratio (Tier 1) This term was introduced as part of the Basel Capital Accord (Basel III) and describes the level of re- quired core capital as a percent- age of risk-weighted assets. Corporate governance Corporate governance is the totality of principles aimed at safeguarding the owner’s interests; while preserving decisionmaking pow- ers and efficiency at the high- est level of the company, these 158 Zürcher Kantonalbank Annual Report 2016 principles are intended to guar- antee transparency and provide a proper system of checks and balances. Cost / Income ratio (CIR) The ratio of cost to income is called the cost / income ratio and is a key measure of the efficiency of a participant in the financial sector. Countercyclical capital buffer The countercyclical capital buffer is a preventative capital measure within the Basel III framework to prevent overheated bank lend- ing. The level and implementa- tion timescale for the capital buffer are determined by the Federal Council at the Swiss National Bank’s request, with FINMA monitoring implementa- tion of the measure at bank level. In addition, the SNB can confine the countercyclical capital buffer to just one part of the credit market (e.g. residential mortgag- es). Creditworthiness Ability and willingness of an individual, company or country to repay its debts. CVA charge (credit valuation adjustment) Additional capital requirement for the risk of a change in counterparty credit rating in the case of OTC deriva- tives not settled via a central counterparty. Endowment capital Equity made available to Zürcher Kantonal- bank, as a public-law institution, by the canton, as owner. Exception-to-policy Procedure that deviates from internal guidelines on an exceptional basis. Fair value Fair value is the amount for which mutually independent, knowledgeable business partners would exchange an asset or repay a debt. FATCA With the “Foreign Account Tax Compliance Act”, the United States aims to prevent US taxpay- ers from minimising their taxes particularly through financial institutions located abroad. The law came into effect for financial institutions worldwide on 1 July 2014, and will be implemented in stages by 2017. FERI award FERI EuroRating Ser- vices AG selects the best invest- ment funds and fund companies across the German-speaking countries. FERI assesses quanti- tative and qualitative criteria in investment research as well as portfolio and risk management. FINMA The Swiss Financial Market Supervisory Authority (FINMA) is responsible for supervising banks, insurance companies, exchanges, securities dealers, collective investment schemes, as well as distributors and insurance bro- kers. An independent authority, it works to protect creditors, investors and policyholders, as well as the effectiveness of the financial markets. Impairment Decrease in value where the book value of an asset (participation, fixed asset or intangible asset) exceeds the re coverable amount (higher than net market value or valueinuse). Issuer Issuer of securities such as equities or bonds. Key rate sensitivity Sensitivity of the present value to a very minimal change in interest rates, e.g. effect on the present value of a portfolio of financial invest- ments due to a lowering of the market interest rate by 0.01 percent. Letter of credit The (documentary) letter of credit is an instrument guaranteeing the settlement of payment and credit transactions in connection with international trade. An importer’s bank issues a promise to pay in which it agrees to make the payment Glossary to the exporter of a good upon receipt of the documents specified in the letter of credit. Leverage ratio The leverage ratio i an unweighted equity ratio and measures a bank’s degree of indebtedness. It is calculated from the relationship between equity and the sum of all assets and various off-balance-sheet items. Liquidity A company’s ability to meet its commitments in full and on time. The Banking Act re- quires banks in Switzerland to have sufficient liquidity. The money market is central to the liquidity management of banks. The SNB provides the money market with liquidity, thereby implementing its monetary policy. Long-term deferred component An unsecured entitlement to a future allocation of a cash sum. It is deferred for a period of three years and subject to additional conditions, in particular the sustainable success of the busi- ness. Monte-Carlo simulation Stochastic process based on very frequent- ly conducted random experi- ments. The aim is to use proba- bility theory to solve problems that are difficult or impossible to solve by analysis. Negative replacement value The replacement value corresponds to the market value of outstand- ing derivative financial instru- ments. Negative replacement values constitute a financial obligation and thus a liability. Netting The term netting describes the offsetting of receivables and payables under a netting agree- ment between two counter- parties. Netting agreements must be enforceable under bankruptcy law. As a result of netting, the level of gross receivables / payables is reduced to a net position. Zürcher Kantonalbank Annual Report 2016 159 Glossary OTC transaction Transaction that takes place over the counter (OTC), i. e. not in an exchange but on a direct, individual basis between two counterparties. Positive replacement value The replacement value corresponds to the market value of outstand- ing derivative financial instru- ments. Positive replacement val- ues constitute a receivable and thus an asset. Repo (repurchase agreement) Financial transaction where the borrower agrees to transfer securities to the lender in return for an agreed sum of money and redeem them for payment plus interest at the end of the term. Return on equity (ROE) The return on equity measures the profit ability of equity and is calculated from the relationship between net profit and equity. Risk capital allocation The alloca- tion of risk capital (capital-at-risk) to the various risk categories (or risk managers) as part of the planning process. Risk-adjusted pricing Pricing where the price level depends on the level of risk entered into. Risk-weighted assets, RWA The term risk-weighted assets was introduced as part of the Basel Capital Accord (Basel III) and constitutes the central basis for measuring risk-weighted capital ratios such as the core capital ratio. The risk weighting assumes that not every position entails the same level of risk. For this reason, less risky positions require less equity to underpin them than riskier ones. SLB transactions (Securities Lend- ing and Borrowing) With SLB transactions, the lender transfers a security to a borrower to use for a fixed or indefinite, though callable period; in return, they receive a fee from the borrower. SME Small and medium-sized enterprises with fewer than 250 employees. Microbusinesses and small businesses are those with fewer than 20 employees. Companies with 20 to 249 em- ployees are considered medi- um-sized enterprises. Swiss standard approach Banks in Switzerland have so far been able to use two standard approaches to calculate risk-weighted assets: the Swiss standard approach (SA-CH) and the international standard approach (SA-BIS) for credit risks. In the course of implementing Basel III in Switzer- land, FINMA abolished the Swiss standard approach. Thus from the end of 2018, banks will only be permitted to use the interna- tional standard approach. In addition, banks can use instit- utionspecific model approach- es for credit risk based on inter- nal ratings (IRB approaches). However, these need to be ap- proved by FINMA. Systemically important banks A bank or group of banks is systemically important if it per- forms functions in the domestic lending and deposit business, as well as payment transactions that are indispensable to the Swiss economy and not substi- tutable at short notice. Other criteria such as size, risk profile and integration are also taken into account in any decision. Systemically important banks in Switzerland are subject to particularly strict requirements (“too big to fail”). Value-at-risk (VAR) The maximum loss not exceeded on a specific risk position (e. g. a securities portfolio) with a given probability (e. g. 95 percent) over a given period of time (e. g. 10 days). Volatility Fluctuation, e. g. in the price of a security. 160 Zürcher Kantonalbank Annual Report 2016 Zürcher Kantonalbank Annual Report 2016 161 Branches Regional base We have a strong local base. With 81 branches and 348 ATMs we have the densest network of ATMs and branches in the canton of Zurich. Feuerthalen Marthalen Andelfingen Rickenbach Seuzach Pfungen Winterthur-Wülflingen Oberwinterthur Winterthur Elgg Winterthur-Seen Rafz Eglisau Bülach Niederglatt Embrach Dielsdorf Rümlang Regensdorf Kloten Bassersdorf Glattbrugg Effretikon Turbenthal Dietikon Schlieren Urdorf Affoltern Seebach Oerlikon Dietlikon Wallisellen Höngg Altstetten Schwamendingen Dübendorf Albisrieden Wiedikon Prime Tower Unispital City Fällanden Neumünster Klusplatz Witikon Volketswil Russikon Fehraltorf Pfäffikon Bauma Bäretswil Wetzikon Wollishofen Maur Zumikon Uster Bonstetten-Wettswil Adliswil Thalwil Langnau a.A. Affoltern a.A. Küsnacht Erlenbach Obfelden Horgen Egg Hinwil Gossau Meilen Grüningen Wald Bubikon Rüti Männedorf Hombrechtikon Hausen a.A. Stäfa Wädenswil Station Burghalden Richterswil Samstagern 162 Zürcher Kantonalbank Annual Report 2016 Branches National and international links As Switzerland’s third-largest bank, we are active at a national and international level in selected business areas. SH ZH TG BS SO BL AG LU ZG SZ NW GL OW UR Bern BE AR AI SG GR JU FR NE VD Pully GE VS TI London Luxembourg Guernsey Vienna/Salzburg Zurich Mumbai* Beijing* Singapore* São Paulo* * Representation offices Zürcher Kantonalbank Annual Report 2016 163 Contact Should you require further information about Zürcher Kantonalbank, the following offices will be pleased to assist: Corporate Banking +41 (0)844 850 830 businessline@zkb.ch Retail Customers +41 (0)844 843 823 serviceline@zkb.ch Private Banking +41 (0)844 843 827 privatebanking@zkb.ch Financial Institutions & Multinationals +41 (0)44 292 87 00 international@zkb.ch Media +41 (0)44 292 29 79 medien@zkb.ch You can find further information at www.zkb.ch Imprint Published by Zürcher Kantonalbank, Postfach, 8010 Zurich Concept and layout Partner & Partner AG, Winterthur Photography Daniel Auf der Mauer, Zurich (Cover, pp. 6 – 9); Dominique Meienberg, Zurich (pp. 44 – 53) Translation and proofreading Xplanation AG, Zurich Print Multicolor Print AG (NZZ Mediengruppe) Print run 200 copies Copyright 2017 Zürcher Kantonalbank 164 Zürcher Kantonalbank Annual Report 2016 Disclaimer This document is for information pur- poses only and is expressly not addressed to any person who by domicile or nationality is prohibited to receive such information according to the applicable law. This document contains statements and forecasts which relate to, or could influence the future development of Zürcher Kantonalbank and its business activity. These statements and fore- casts reflect estimates and expectations at the time of preparing the report. By their nature, they are subject to un- certainty, as risks and other important factors may influence actual perfor- mance and results. This may mean that actual performance differs substantially from the estimates and expectations set out by Zürcher Kantonalbank in the Annual Report. This document is neither an offer nor a recommendation for the purchase or sale of financial instruments or financial services and does not dis- charge the recipient from their own judgement. Nor does it constitute an offer to sell or a solicitation or an invitation to subscribe to or to make an offer to buy any securities, nor does it provide a basis for any contract or obligation of any kind. The present document has not been drawn up by the “financial analysis” department as defined in the rules of the “Directives on the Independence of Financial Research” published by the Swiss Bankers Association, hence these rules do not apply to this document. This publication and the information contained herein must not be distribut- ed and / or redistributed to, used or relied upon by any person (whether individual or entity) who may be a US person under Regulation S under the US Securities Act of 1933. US persons include any US resident; any corp oration, company, partnership or other entity organised under any law of the United States; and other categories set out in Regulation S. Copyright © 2017 Zürcher Kantonalbank. All rights reserved. r e p a p d e l c y c e r % 0 0 1 n o d e t n i r P 7 1 0 2 / 3