Risk and capital management report and annual financial statements Standard Bank Group

Transcription

1 Risk and capital management report and annual financial statements

2 Contents Risk and capital management report 2 Annual financial statements 122 Additional information Our reports 3 Overview 12 Risk and capital reporting frameworks 17 Capital management 27 Risk appetite and stress testing 31Credit risk 63 Compliance risk 65 Country risk 68 Funding and liquidity risk 77 Market risk 91 Insurance risk 97 Operational risk 101 Business risk 102 Reputational risk 103 Restatements 105 Annexure A regulatory and legislative developments impacting the group 111 Annexure B composition of capital SBG 115 Annexure C reconciliation of audited statement of financial position and regulatory capital and reserves 116 Annexure D capital instruments: main features disclosure template 123 Directors responsibility for financial reporting 123 Group secretary s certification 124 Report of the group audit committee 126 Directors report 131 Independent auditors report 132 Statement of financial position 133 Income statement 135 Statement of other comprehensive income 136 Statement of cash flows 138 Statement of changes in equity 142 Accounting policy elections 144 Notes to the annual financial statements 258 Limited company annual financial statements 266 Annexure A subsidiaries, consolidated and unconsolidated structured entities 284 Annexure B associates and joint ventures 289 Annexure C group share incentive schemes 297 Annexure D detailed accounting policies 320 Annexure E emoluments and share incentives of directors and prescribed officers 334 Annexure F six-year review 346 Annexure G segmental statement of financial position 348 Annexure H banking activities average statement of financial position (normalised) 350 Annexure I third-party funds under management 351 Financial and other definitions 354 Acronyms and abbreviations ibc Contact details

3 Our reports Frameworks applied Assurance Cross-referencing Risk and capital management report (this report) Provides a detailed discussion of the management of strategic risks related to the group s banking and insurance operations, including capital and liquidity management and regulatory developments. Various regulations relating to financial services, including Basel III International Financial Reporting Standards (IFRS) King Report on Corporate Governance for South Africa 2009 (King Code) Selected information in the risk and capital management report forms part of the audited annual financial statements. RCM AFS Annual financial statements (this report) Sets out the full audited annual financial statements for (the group or SBG), including the report of the group audit committee (GAC). IFRS South African Companies Act 71 of 2008 (Companies Act) JSE Limited (JSE) Listings Requirements King Code KPMG Inc. and PricewaterhouseCoopers Inc. have audited the annual financial statements and expressed an unmodified opinion for the year ended 31 December. Annual integrated report Provides an integrated assessment of the group s ability to create value over time. International <IR> Framework Companies Act JSE Listings Requirements King Code South African Banks Act 94 of 1990 (Banks Act) While the annual integrated report is itself not audited, it contains information that has been extracted from the audited consolidated annual financial statements. Certain externally assured information has been extracted from the group s sustainability report. AIR Sustainability report Presents a balanced and comprehensive analysis of the group s sustainability performance in relation to issues material to the group and stakeholders. Global Reporting Initiative G4 KPMG Services Proprietary Limited have provided assurance over selected sustainability information in the 2013 sustainability report and expressed an unmodified opinion. SR Indicates that additional information is available online. Denotes text in the risk and capital management report that forms part of the group s audited financial statements. The above icons refer readers to information elsewhere in this report, or in other reports that form part of the group s suite of reporting publications. Feedback We welcome the views of our stakeholders. Please contact us at Annual.Report@standardbank.co.za with your feedback. A limited number of printed risk and capital management report and annual financial statements books are available on request. Please contact our investor relations department, using the details at the back of this report, and we will provide a copy to you. 1

4 Risk and capital management report 2 Risk and capital management report and annual financial statements

5 Overview 3 Board responsibility 3 Group risk and capital management committee 4 Risk types 4 Highlights 9 Governance framework 9 Governance committees 11 Governance documents 11 Three lines of defence model Board responsibility The group s board of directors (board) has the ultimate responsibility for the oversight of risk. For the period under review, the board is satisfied that the group s risk, compliance, treasury, capital management and group internal audit (GIA) processes generally operated effectively, that the group s business activities have been managed within the board-approved risk appetite, and that the group is adequately funded and capitalised to support the execution of the group s strategy. In the instances where the group incurred losses, breached risk appetite or was fined by its regulators, the board is satisfied that management have taken appropriate remedial action. Group risk and capital management committee The group risk and capital management committee (GRCMC) is a subcommittee of the board. It provides an independent objective oversight of risk, compliance and capital management in the group. It also reviews and assesses the adequacy and effectiveness of the group risk, compliance and capital management governance framework, and the integrity of risk controls and systems. During, the responsibility for reviewing a newly constituted information technology 3

6 Risk and capital management report Overview continued (IT) governance framework and updates on significant IT investments was transferred from the GRCMC to the group IT committee. The full terms of reference of the GRCMC can be found in the corporate governance statement on page 117 of the annual integrated report. These are considered annually by the GRCMC and approved by the board. The chairmen of the GAC, the remuneration committee and the group IT committee are members of the GRCMC. This common membership supports an integrated view of finance, IT and risk, and ensures that relevant finance and risk input is considered in the determination of levels of compensation. A total of four meetings of the GRCMC were held during, all of which were attended by our external auditors. One special meeting was held to approve the interim risk and capital management report. Attendance of each member at meetings of the GRCMC can be found in the corporate governance section on page 122 of the annual integrated report. The GRCMC considered the group s current and future risk profile relative to the group s risk appetite. The committee reported to the board following each meeting on its consideration of the risk profile of the group and any concerns it may have had. It also considered the group s exposure to country, single name obligor and sector concentration risk on an ongoing basis. Reports on the South African vehicle and asset finance portfolio, the group s recovery and resolution plan, and the group s approach to compliance with principles for effective risk data aggregation and risk reporting were considered. In addition, ongoing committee education sessions were held during the year covering risk appetite and stress testing, expert judgement in the application of risk models, cybercrime (including an on-site introduction to the cybercrime centre) and an update on the proposed implementation of the Twin Peaks model of financial regulation (Twin Peaks) as well as IFRS 9 Financial Instruments impairment requirements. At each meeting of the GRCMC, the group chief risk officer (CRO) provided the committee with an overview of the key risk issues discussed at the group risk oversight committee (GROC). An update was also given by group risk-type heads and business line CROs on the specific issues of group-level significance, as well as other relevant items in their respective areas of responsibility. In relation to capital adequacy, the committee approved the internal capital adequacy assessment process (ICAAP) and submission to the South African Reserve Bank (SARB). Capital adequacy was also assessed in light of Basel Capital Accord (Basel) III requirements which are being phased in from 2013 to Members of the GRCMC have attended and will continue to attend the risk meetings on site of the group s major subsidiaries as appropriate. Risk types The group s activities give rise to various risks. These are: credit risk (starting on page 31) compliance risk (starting on page 63) country risk (starting on page 65) funding and liquidity risk (starting on page 68) market risk (starting on page 77) insurance risk (starting on page 91) operational risk (starting on page 97) business risk (starting on page 101) reputational risk (starting on page 102). Each risk is defined within the relevant section, together with an explanation of the application of the group s risk, compliance and capital management (RCCM) governance framework to the specific risk, the approved regulatory treatment for capital requirements to be held against the specific risk in terms of Basel, and a description of the relevant portfolio characteristics both in terms of prescribed disclosure and the group s business model. Highlights Stress testing and risk appetite Year in brief Stress testing and its importance as a risk management tool has received a significant amount of attention globally in, most noticeably in the continuing implementation of regular stress testing exercises by a number of international regulators. In South Africa, the group participated in a stress testing exercise conducted by the International Monetary Fund (IMF) as part of their South African financial stability assessment programme in May. In a separate exercise groupwide macroeconomic stress testing results were submitted as part of the ICAAP. As part of the annual review of the group s recovery plan a selection of extreme scenarios were formulated and the impact quantified in order to test the effectiveness of the recovery options proposed in the recovery plan. For internal purposes the group continued to conduct stress testing at various levels throughout the organisation to give insight into the impact of a changing economic environment on the forward risk profile of the group and to identify areas of vulnerability. Risk appetite is formally reviewed on an annual basis to ensure that it remains aligned with and relevant to the group s strategy. No material changes were made in the past year. Incremental improvements were made to the group s risk appetite framework to facilitate the embedding and cascading of risk appetite throughout the organisation. 4 Risk and capital management report and annual financial statements

7 Focus areas for 2015 As volatility and risks in the global economy increase, the need to continually assess the group s forward-looking risk profile against its stated risk appetite under different global macroeconomic environments is ever-increasing. The group recognises the importance of stress testing as a management tool to provide insight and is continually: enhancing its ability to quantify the impact of different macroeconomic environments on its future financial position enhancing the efficiency of the stress testing process incrementally improving the risk appetite framework to integrate it with the stress testing framework and the integrated financial resource planning process. Capital management Year in brief The group remains capitalised well above minimum regulatory capital adequacy requirements. The SARB adopted the leverage framework that was issued by the Basel Committee on Banking Supervision (BCBS) in January, with final calibrations and adjustments expected by Formal disclosure requirements commence on 1 January 2015 and the ratio is expected to transition to a pillar 1 requirement by The group issued its debut Basel III compliant tier II issue of R2,25 billion in the fourth quarter of. Focus areas for 2015 providing an optimal capital mix for the group ensuring that the group is adequately positioned to respond to regulatory capital rules under the Basel III phase-in requirements optimising financial resource allocation, including capital and liquidity between product lines, trading desks, industry sectors and legal entities to enhance the overall group economic profit and return on equity (ROE) continuing to participate in the BCBS quantitative impact studies to assess the impact of proposed amendments to regulatory requirements. Credit risk Year in brief In a year where the macroeconomic landscape saw commodity prices tumbling, interest rate hikes and the South African rand weakening, all group credit metrics remained within risk appetite. The metrics below exclude the group s discontinued operation. Gross loans and advances increased 10% in with growth in Corporate & Investment Banking (CIB) of 18% while Personal & Business Banking s (PBB) gross loans and advances increased by 6%. The group credit loss ratio (CLR) improved to 1.00% from 1.12% in CIB improved to 0.22% from 0.41% in PBB improved to 1.41% from 1.47% with the deterioration in the South African CLR to 1.53% from 1.45% in 2013 offset by improvements in the rest of Africa. The deterioration in the South African CLR is attributable to deteriorating performance in the card, instalment sale and finance lease portfolios. Non-performing loans as a percentage of gross loans and advances (NPL %) improved to 3.2% from 3.5% with CIB and PBB both improving marginally. The PBB South Africa home loans book improved to 4.4% from 4.6% while vehicle and asset finance deteriorated to 3.4% from 2.8% and card deteriorated to 5.0% from 4.6%. In the rest of Africa the NPL ratio improved to 5.1% from 5.7%. Focus areas for 2015 refining the credit risk governance standard and supporting tools to support the group s credit risk appetite applying appropriate and responsible lending criteria to ensure prudent lending practices in line with risk appetite streamlining and enhancing of credit risk management processes to bring about additional efficiencies managing concentrations across counterparties, portfolios, industries and geographic regions proactively mitigating economic stresses already evident such as commodity stresses and electricity load shedding impact on South African corporates and small businesses assessing, modelling and implementation of IFRS 9 s expected loss credit requirements improving risk data aggregation and risk reporting practices in line with BCBS 239 requirements. 5

8 Risk and capital management report Overview Highlights continued Compliance risk Year in brief The compliance function expanded its resourcing capability to improve sanctions alert and money laundering surveillance, strengthen its business advisory role as a key second line of defence function and embed a culture of compliance in all operations. The development of structural capacity to support market conduct, especially for treating customers fairly (TCF), has received significant focus, as has the revision of key operational processes. The review of capital solvency requirements and governance structures under the solvency assessment and management (SAM) programme has been a key focus area for Liberty Holdings Limited and its subsidiaries (Liberty) in preparation of the 2016 implementation. The partnership with human capital and learning and development in developing and rolling out compulsory compliance training throughout the group was a key initiative during. In line with the group s strategic focus on Africa, the refinement of the compliance operating model and embedding of compliance risk management processes to support both business and stakeholder expectations of a universal banking group has continued. All our banking operations in Africa were visited by the central compliance function during. The chairman of the GAC led a presentation to the SARB on the group s market conduct controls and approach to the management of conduct risk. This approach recognises a clear delineation between the two pillars of conduct risk, being market integrity and conduct of business. The group continues to be subject to increased scrutiny by multiple regulators. The first joint regulatory compliance-related inspection by the SARB and the Central Bank of Kenya was undertaken on the group s Kenyan banking subsidiary. The verbal feedback provided by the SARB was positive and no material issues were raised. The SARB imposed administrative sanctions and directives to implement remedial action on various South African banks. SBSA was fined R60 million. The sanction related to the failure by SBSA to ensure that appropriate measures were in place to comply fully with the relevant provisions of the Financial Intelligence Centre Act. A programme was initiated to address the SARB findings. The SARB noted that the administrative sanctions are not an indication that the banks in question have in any way facilitated transactions involving money laundering and the financing of terrorism. Anti-money laundering headcount increased from 38 in 2013 to 53 in. A further 90 posts will be filled in The group s UK subsidiary, Standard Bank Plc (SB Plc), was fined GBP76 million (ZAR134 million at the time of settlement) by the UK regulator in January for shortcomings related to the application of its own anti-money laundering policies and procedures. Extensive remediation exercises were undertaken to address these shortcomings. The regulator made no finding that the group had handled the proceeds of crime and noted that Standard Bank and its senior management have co-operated with the authority s investigation and have taken significant steps at significant cost towards remediating the issues identified, including seeking advice and assistance from external consultants. Focus areas for 2015 The emphasis for 2015 will continue to be on meeting supervisory and legislative expectations, focusing on market conduct and initiatives to enhance data privacy risk management practices, and on fostering a culture of compliance throughout the group. Continued emphasis will be placed on both business and control functions to affirm compliance responsibilities for both the first and second line of defence functions. Measures to enhance the group s automated surveillance capability continue, and the 2015 focus will be on extending capability and coverage, particularly to the group s operations in the rest of Africa. The implications of digital compliance for both market conduct and compliance risk management processes will also be key in The approach to compliance training has been revised and there will be considerable strengthening of institutional capability during The SARB s flavours of the year topics are IFRS 9, including adequacy of current levels of credit impairments, and shadow banking, which refers to the increased disintermediation within the financial system. Shadow banking represents a business opportunity, a competitive threat and a systemic risk. Liberty will continue to monitor and actively respond to the rapid pace of change in the regulatory landscape affecting insurance and retirement savings, in particular, the 55 recommendations of the Retail Distribution Review (RDR) paper issued by the Financial Services Board (FSB). Country risk Year in brief The relative concentration of cross-border exposure to the sub-saharan region continued to increase, consistent with the group s strategic focus. Cross-border exposure to conflict areas, such as Eastern Europe, and markets experiencing adverse economic conditions, such as Ghana, has been tightly managed. Focus areas for 2015 Country risk appetite and the mitigation of country-specific risks will be proactively managed in response to a challenging global political risk and economic environment for major energy producers in particular. Risk management measures will be supplemented by continued refinement of the country risk governance framework and portfolio management tools. 6 Risk and capital management report and annual financial statements

9 Funding and liquidity risk Year in brief The group maintained its liquidity positions within the approved risk appetite statement. Appropriate liquidity buffers were held in line with regulatory, prudential and internal stress testing requirements, taking into account the global risk profile and market conditions. The group continued to advance its asset-liability management capabilities and its approach to liquidity and interest rate risk management. The group further evolved its internal liquidity risk management framework to ensure that the group has, at all times, sufficient liquidity resources to continue operating under a group-specific and industry systemic stress event. The liquidity risk technology framework was updated to support the implementation of new regulations relevant to liquidity risk management. The group also prepared for the implementation of the Basel III liquidity coverage ratio (LCR) which became a minimum requirement as of 1 January 2015 and worked closely with the SARB to finalise the availability of a committed liquidity facility to assist South African banks in meeting this ratio. The South African financial markets were disrupted temporarily during the second half of on the back of the curatorship of African Bank Limited (ABL). The group s liquidity management systems, processes and frameworks proved to be resilient in the face of these market disruptions. Funding costs for South African banks have increased as a consequence of the ABL curatorship. Focus areas for 2015 enhancing frameworks and systems to address new liquidity regulations updating and implementing funds transfer pricing methodologies across the group to accurately price and measure the internal cost of funding, taking into account, where applicable, the cost of the Basel III liquidity regulations evaluating the impact of a net stable funding ratio (NSFR) across the group and developing a transition plan for the group s liquidity risk structure and balance sheet management framework. Market risk Year in brief Trading book market risk and banking book interest rate risk remained well within approved limits. Trading book average value-at-risk (VaR) remained low as the group maintained a conservative approach to market risk. The daily profit and loss results for the year showed a profit for 247 out of 260 trading days, which is reflective of CIB s client flow model. Focus areas for 2015 The group will focus on monitoring and managing the traded market risk, banking book interest rate risk and associated hedges in the context of current market volatility, including monetary policy decisions. The implications of the proposed revised trading book and new interest rate regulations will be a continued area of focus. Insurance risk Year in brief Focus continued to be placed on the SAM programme in the group s short- and long-term insurance operations, with the introduction of a number of methodologies and embedding of policies across the business. A centralised Liberty group reinsurance function was formed and is responsible for the optimisation and monitoring of reinsurance across Liberty. Focus areas for 2015 There will be continued focus on the management of insurance risks across the group with particular emphasis on the insurance risk components of the SAM programme and ensuring readiness for implementation in This will include the cascading of risk appetite to the various business units. Operational risk Year in brief The group continued to leverage off the integrated approach to risk management, where financial crime control, information risk and operational risk management are combined into a single integrated operational risk (IOR) management unit. Progress continues to be made in terms of implementing the IOR framework to support the adoption of the advanced measurement approach (AMA). Further efforts have been focused on ensuring consistent implementation of the operational risk tools throughout the group. The group continued to see benefit in the fraud awareness initiatives that proved to be an effective deterrent mechanism. China aluminium base metals Potential losses arising from external fraud in the base metal commodity financing transaction business in China, which is part of the group s discontinued operation s results and under legal privilege, has contributed to an operational risk appetite breach at both a CIB and group level. Risk mitigation is in place, including original legal documentation to support our title over metal in port (USD40 million) as well as a strong external legal opinion supporting an insurance claim of USD129 million. As at year end, the group s insurers are yet to respond to the group s claim. Developments in this regard are being closely monitored. Focus areas for 2015 enhancing the risk profile methodology to further enable comparison with risk appetite and tolerance continuously scanning the environment for emerging threats and trends promoting continuous customer and employee awareness of financial crime fighting crime through supporting industry initiatives in the countries in which the group has a presence and through the South African Banking Risk Information Centre. The group will also further expand on its cyber security operations centre by creating a 24 hour, 7 days a week capability. 7

10 Risk and capital management report Overview Highlights continued Legal risk Year in brief There was a significant increase in litigation against certain of our businesses in Africa, all of which are being defended and none of which are expected to have a material adverse impact on the group. Legal resources were restructured and enhanced to improve the processes and controls to manage legal risks. Focus areas for 2015 The capacity of the legal resources in South Africa will continue to be enhanced to better service the transactions that originated outside of South Africa but are booked onto the South African balance sheet. Additionally, the legal network will be improved to ensure minimum and uniform standards of legal support and more efficient access groupwide to available legal expertise. Environmental and social risk Year in brief Ongoing changes in environmental legislation and regulation combined with progressively higher enforcement continues to place pressure on the screening of lending and operational activities across the global banking sector. Increasingly, central banks and other bodies are promoting codes and best practice norms which are becoming part of the regulatory framework and which build on the requirements from international finance institutions for more stringent environmental and social risk management. In South Africa, environmental legislation empowering the state to request an investigation of land to establish whether contamination exists that poses risk to human health or the environment came into effect. The Act has a number of potential risks for the banking industry in the financing of property. Risk data aggregation and risk reporting Year in brief In January 2013, the BCBS published principles for effective risk data aggregation and risk reporting. This requires global systemically important banks (G-SIBs) to comply by January 2015 or within three years of being designated a G-SIB. National regulators were encouraged to apply these principles to domestic systemically important banks (D-SIBs). In February the SARB issued guidance note 3, in which it indicated that it had accepted the BCBS principles, required banks to perform a self-assessment to establish their current level of compliance, to propose remedial plans where necessary, and to indicate the likely date of compliance with the principles. This was followed by a directive in February 2015 in which the SARB indicated that South African D-SIBs which are not part of a G-SIB group are required to comply with the principles by January South African D-SIBs which are part of a G-SIB group are required to comply with the principles within the time frame set by the G-SIB national supervisor. In response, the group initiated a multi-year project sponsored by the group management committee. Focus areas for 2015 The multi-year project will be monitored in and of itself, and in relation to the group s IT and other change programmes. We will also monitor scope clarification and guidance on compliance issued by BCBS and the SARB. Focus areas for 2015 raising environmental and social risk awareness within the group improving internal processes to manage the risk introduced by changes in environmental legislation increasing the understanding of risks and opportunities posed by climate change for the group and its clients. 8 Risk and capital management report and annual financial statements

11 Governance framework The group s approach to managing risk and capital is set out in the RCCM governance framework approved by the GRCMC. The framework has two components: governance committees governance documents such as standards, frameworks and policies. Governance committees Governance committees within the RCCM governance framework are in place at both a board and management level. They have mandates and delegated authorities that are reviewed regularly. board Executive committees Board committees Group executive committee Group management committee Group risk and capital management committee Group IT committee Group audit committee Group model approval committee Group risk oversight committee IT steering committee PBB model approval committee CIB model approval committee Direct reporting line. Indirect reporting line. 9

12 Risk and capital management report Overview Governance committees continued Board committees Board committees responsible for oversight of the RCCM comprise the GAC, the GRCMC, the group IT committee, and the group model approval committee. Key roles and responsibilities of these committees, as they relate to the RCCM, are summarised in the sections that follow. Detailed information relating to these committees can be found in the governance section on page 113 of the annual integrated report. The group risk and capital management committee The GRCMC provides independent oversight of risk, compliance and capital management across the group by: ensuring adequate and effective implementation of risk governance processes, standards, policies and frameworks ensuring that the risk strategy is executed by management in accordance with the board-approved risk appetite and risk, compliance and capital management governance framework considering the quarterly risk management report which includes detailed updates on risk types, as well as the separate updates from legal, compliance, capital and liquidity risk reporting material risk and capital management matters to the board. The group IT committee The group IT committee s purpose is to assist the board in fulfilling its corporate governance responsibilities with respect to IT and reports to the board through its chairman. The committee has the authority to review and provide guidance on matters related to the group s IT strategy, budget, operations, policies and controls, as well as oversight of significant IT investments and expenditure. The group audit committee The GAC has oversight of the group s financial position and makes recommendations to the board on all financial matters, financial risks, internal financial controls, fraud, compliance and, to the extent they impact financial reporting, IT risks. In relation to the RCCM, the GAC plays a role in assessing the adequacy and operating effectiveness of the group s internal financial controls. Minutes of the GRCMC and group IT committee meetings are tabled at the GAC meetings. In order to ensure the independence of the second line of defence functions, the chairman of the GAC, who is also a member of the GRCMC, meets with the group chief compliance officer (GCCO), the group CRO, the group financial director, the group chief audit officer and the head of IOR, who is responsible for financial crime control, without management being present. The chairman of the GAC also meets, without management being present, with the chief audit officer as the third line of defence. Group model approval committee The group model approval committee is designated by the board to discharge the regulatory responsibility of reviewing and approving the group s material risk models, as well as models used in the calculation of regulatory capital. This committee is supported by the PBB and CIB model approval subcommittees, with the models being assigned to these three committees for approval based on an assessment of the materiality of each model. Management committees Group risk oversight committee Executive management responsibility for all material risk types have been delegated by the group management committee to GROC which, in turn, assists the GRCMC in fulfilling its mandate. As is the case with the GRCMC, GROC calls for and evaluates in-depth investigations and reports based on its assessment of the risk profile and external factors. GROC delegates authority to various subcommittees which deal with specific risk types or oversight activities. Material matters are escalated to GROC through reports or feedback from each subcommittee chairman. The GROC subcommittees are as follows: CIB credit governance committee, chaired by the CIB CRO group asset and liability committee (ALCO), chaired by the group financial director group compliance committee, chaired by the GCCO group country risk management committee, chaired by the group CRO group equity risk committee (ERC), chaired by the CIB CRO group internal financial control governance committee, chaired by the group financial director group operational risk committee, chaired by the group head of IOR group regulatory and legislative oversight committee, chaired by the group chief executive group sanctions review committee, chaired by the group chief executive group stress testing and risk appetite committee, chaired by the group CRO intragroup exposure committee, chaired by the group financial director PBB credit governance committee, chaired by the PBB CRO. Group IT steering committee The purpose of the committee is to provide assurance to the group management committee and the board, through the group IT committee, that management has implemented an efficient IT governance framework that supports the effective management of resources, optimisation of costs and the mitigation of risk in a secure and sustainable manner. 10 Risk and capital management report and annual financial statements

13 Governance documents Governance documents within the RCCM governance framework comprise standards, frameworks and policies which set out the requirements for the identification, assessment, measurement, monitoring, managing and reporting of risks and effective management of capital. Governance standards and frameworks are approved by the relevant board committee. Group policies are approved by the group management committee or subcommittee, relevant GROC subcommittee, GROC itself or, where regulations require board approval, by the board or relevant board committee. Business line and legal entity policies are aligned to these group policies, and are applied within their governance structures. Three lines of defence model The group uses the three lines of defence governance model which promotes transparency, accountability and consistency through the clear identification and segregation of roles. The first line of defence is made up of the management of business lines and legal entities. The second line of defence functions provide independent oversight of risks. They have resources at the centre and embedded within the business lines. Central resources provide groupwide oversight of risks, while resources embedded within the business lines support management in ensuring that their specific risks are effectively managed as close to the source as possible. Central and embedded resources jointly oversee risks at a legal entity level. The second line of defence functions develop and implement governance standards, frameworks and policies for each material risk type to which the group is exposed. This ensures consistency in approach across the group s business lines and legal entities. Compliance with the standards and frameworks is ensured through annual self-assessments by the second line of defence and reviews by GIA. Internal audit is the third line of defence and reports to and operates under a charter from the GAC. In terms of its charter, the GIA role is to provide independent and objective assurance. GIA has the authority to independently determine the scope and extent of work to be performed. All GIA employees in the group report functionally to the group chief audit officer and operationally to management of their legal entity. 11

14 Risk and capital reporting frameworks 12 IFRS and Basel reporting frameworks 14 Reporting framework consolidation differences 15 Basel approaches adopted for regulatory capital purposes 15 Risk disclosure presentation for intercompany transactions between the group s banking and insurance operations IFRS and Basel reporting frameworks Tables in this report have been labelled to identify content disclosed in terms of IFRS or Basel reporting frameworks. The method of measurement in terms of Basel differs from the method of measurement in accordance with IFRS. The Basel amounts in this report are therefore not equal to the IFRS amounts in the annual financial statements. The table below highlights the principal differences between the IFRS and Basel reporting frameworks: Principle Basel IFRS Categorisation of exposures By Basel asset class which, under the internal ratings-based (IRB) approach, is based on homogeneous risk characteristics. By class of financial instrument, taking into account the nature of the information to be disclosed and the characteristics of the underlying financial instruments. Exposure Credit exposure, for both IRB and standardised portfolios, consists of on-balance sheet exposure, off-balance sheet exposure, securities financing exposure and derivatives exposure. These exposure values are all gross exposures before the impact of netting, collateral or expected recoveries have been taken into account. Certain revolving facilities are reported using monthly average balances, per regulatory requirements. Balances reported per the statement of financial position (SOFP) are determined according to applicable IFRS requirements. Refer to annexure D in the annual financial statements for further detail. Assets on the group s IFRS SOFP are reported net of portfolio and specific impairment provisions. Balances, per the SOFP, are reported based on month end balances. Valuation Fair value gains and losses attributable to own credit risk are excluded when calculating regulatory capital. All changes in fair value (including fair value gains and losses attributable to own credit risk) on financial liabilities that, on meeting specific criteria, have been designated to be measured at fair value as well as held-for-trading liabilities, are recognised in profit or loss. 12 Risk and capital management report and annual financial statements

15 Principle Basel IFRS Impairment of assets Impairment is based on the concepts of expected and unexpected losses. Expected losses are accounted for through the level of impairments held against the underlying exposure. Statistical modelling of expected losses is required. Unexpected losses are accounted for through holding regulatory capital in relation to the size and nature of the exposure held. The difference between the Basel and IFRS impairment values produces a shortfall if the expected loss amount under Basel exceeds total impairments under IFRS, or an excess if total impairments exceed the expected loss amount. The shortfall, if any, is to be deducted from common equity tier I (CET I) capital. Assets measured at amortised cost and debt instruments classified as available-for-sale are specifically impaired and the resulting losses recognised in the profit or loss only if: there is objective evidence of impairment resulting from one or more events that have occurred after the initial recognition of the asset, and that event has an impact on the estimated future cash flows of assets that can be reliably measured. To provide for latent losses in a portfolio of loans where the loans have not yet been individually identified as impaired, impairment for incurred but not reported losses is recognised based on historic loss patterns and estimated emergence periods. The use of statistical models is permitted, but an event of default must occur before an impairment loss can be recognised. Default Defines default as the obligor being 90 days past due on the obligation (extended to 180 days for some products). Defines objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset and that objective evidence of impairment has an impact on the asset s estimated future cash flows. Examples of objective evidence of impairment include: actual breach of contract observable data indicating that there is a measurable decrease in the estimated cash flows from a group of assets since their initial recognition due to: adverse changes in the payment status of the borrowers in the group, or a deterioration in national or local economic conditions that correlate with defaults on the assets in the group. The Basel and IFRS disclosures presented within this risk and capital management report include, unless otherwise specified, the exposures from our global markets outside Africa (GMOA) operations, which for IFRS reporting purposes have been separately classified as non-current assets and liabilities held for sale in terms of IFRS. Subsequent to year end, the group s controlling interest in its GMOA was disposed of to ICBC. 13

16 Risk and capital management report Risk and capital reporting frameworks continued Reporting framework consolidation differences In accordance with IFRS, all entities, regardless of the nature of their underlying activities, are either consolidated or equity accounted based on the extent of control or influence that the group exerts over those entities. Basel differentiates entities on the underlying activity of the entity combined with the extent of control or influence that the group exerts over those entities. The different treatments for entities for regulatory and accounting consolidation are explained in the table below. Shareholding Regulatory treatment IFRS treatment Banking, financial entity or securities firm 1 Insurance entity Standardised approach Commercial entity IRB approach <10% Aggregate of investments are compared to a threshold of 10% of the group s CET I capital. Amounts above the threshold are deducted against the corresponding component of capital and amounts below the threshold are risk-weighted. > 10% but 20% Apply the deduction method 2. Aggregate of investments in tier I and tier II instruments are deducted against the corresponding component of capital. Risk weight at no less than 100%. Risk weight up to a maximum of 1 250%. Typically treated as an investment and is measured at fair value. Where the group has significant influence over that investment, equity accounting is applied unless designated to be measured at fair value through profit or loss in terms of IFRS. > 20% but 50% Other significant shareholder: Proportionately consolidate. No other significant shareholder: apply the deduction method 2. Aggregate of investments in tier I and tier II instruments are deducted against the corresponding component of capital. Apply the deduction method 2. Aggregate of investments in tier I and tier II instruments are deducted against the corresponding component of capital. Individual investments in excess of 15% of the group s CET I, additional tier I and tier II: risk weight at 1 250%. Individual investments up to 15% of the group s CET I, additional tier I and tier II: risk weight at no less than 100%. Aggregate of investments >60% of the group s CET I, Individual investments in excess of 15% of the group s CET I, additional tier I and tier II: risk weight at 1 250%. Individual investments up to 15% of the group s CET I, additional tier I and tier II: risk weight at no less than 100%. Equity accounting (unless designated to be measured at fair value through profit or loss in terms of IFRS) applied unless there is evidence of control in which case the group consolidates the investment into its results. >50% Consolidated additional tier I and tier II: risk weight excess above 60% at 1 250%. Consolidate unless there is evidence to indicate that the group does not have control over that investment in which case equity accounting will typically be applied unless designated to be measured at fair value through profit or loss in terms of IFRS. 1 For Basel purposes, financial entities other than financial entities acquired through realisation of security in respect of previously contracted debt (held temporarily); subject to other materially different rules and regulations or non-consolidation as required by law. 2 Aggregate of investments compared to 10% of the group s CET I capital and amounts above the 10% threshold are deducted against CET I capital. Amounts not deducted are combined with mortgage servicing rights and deferred tax assets and compared to 15% of the group s CET I capital. Amounts above the 15% threshold are deducted against CET I capital and amounts below are risk-weighted at 250%. 14 Risk and capital management report and annual financial statements

17 Basel approaches adopted for regulatory capital purposes Basel provides various approaches for the calculation of regulatory capital to be held against credit, market and operational risk. In general, there are three approaches: a basic approach an intermediate approach an advanced approach. The regulators approve the approach adopted on a case-by-case basis, both at a solo regulated entity and consolidated regulated entity level. The group does not adopt advanced approaches for certain portfolios, either because these methods are not yet recognised in a particular jurisdiction or because the group has chosen, on a materiality basis, to adopt the intermediate or basic approaches. In these cases, the group nevertheless adopts practices similar to the advanced approach for its internal economic capital, risk measurement and management purposes where it is felt that these offer better information for managing risks. The approaches per risk type approved by regulators are specified in the relevant credit, market and operational risk section. Risk disclosure presentation for intercompany transactions between the group s banking and insurance operations In the ordinary course of business, both the group s banking operations and the insurance operations of its subsidiary, Liberty, enter into arm s length transactions with each other. The risks arising from these transactions are managed independently within the group s banking and insurance operations as part of each operation s risk management framework. The group s banking operations risk and capital management disclosures are predominantly regulated by both IFRS and Basel III, whereas Liberty s insurance risk disclosures are influenced by both IFRS and the FSB s planned implementation of the SAM framework with effect from 1 January The group s risk and capital management report disclosures are driven by the scope of these regulatory requirements and follow the manner in which the group s risks are managed, resulting in separately presented disclosures for the group s banking and insurance operations. Limited controls 53.6% (2013: 53.6%) of the issued ordinary shares of Liberty Holdings Limited. The nature of the arm s length transactions entered into between Liberty and the Standard Bank group s banking operations includes the following: ordinary shares: Liberty purchases the group s ordinary shares for the risk and reward of its policyholders. From an IFRS perspective these shares are accounted for by the group as treasury shares and by Liberty as a financial investment. Debt financial instruments: As part of its funding activities, the group s banking operations issue debt financial instruments which include preference shares, term deposits, debt issued by consolidated structured entities and subordinated bonds. These debt instruments are accounted for by the group s banking operations as liabilities within deposit and current accounts and subordinated debt as appropriate and are recognised by Liberty as financial investments. These intercompany transactions are eliminated by the group on consolidation. The intercompany debt financial instruments are typically measured by the group s banking operations on an amortised cost basis and by the group s insurance operations on a fair value basis. The effect of this measurement inconsistency is assessed and, where applicable, reversed on consolidation. Derivative financial instruments: In order to hedge the market risk inherent in Liberty s assets and liabilities, Liberty may enter into derivatives with the group s banking operations. These derivatives are respectively accounted for as derivative assets and liabilities by the group s banking and insurance operations and are eliminated by the group on consolidation. The table on the following page discloses the value of the transactions entered into between the group s banking and insurance operations and IFRS risk disclosure tables within which such transactions have not been eliminated. The values as included in the group s banking operation s liquidity analysis, on page 72, have not been provided as they will not be able to be meaningfully compared to the fair value of the debt instruments as the liquidity risk disclosures are prepared on an undiscounted contractual cash flow basis. The group s 31 December 2013 comparative risk disclosures have been restated for the effects of the above treatment. Refer to page 104 for further information. Intercompany transactions between Liberty and the group s banking operations have not been eliminated for the purposes of separately reporting on the banking and insurance operations risk disclosures in this risk and capital management report. 15

18 Risk and capital management report Risk and capital reporting frameworks Risk disclosure presentation for intercompany transactions between the group s banking and insurance operations continued Nature of instrument Ordinary shares Preference share assets Term deposits (including sub-ordinated bonds) Derivative liabilities Deposit and current accounts ordinary shares with a fair value of R1,8 billion. R169 million fair value. R11,6 billion fair value. R273 million fair value. R5,9 billion cash balance. Value ordinary shares with a fair value of R0,9 billion. R203 million fair value. R10 billion fair value. R403 million fair value. R3,4 billion cash balance. Maturity analysis of financial liabilities by contractual maturity Banking operation s risk disclosures Trading book VaR and stressed Interest VaR (SVaR) rate analysis sensitivity Credit exposure to debt instruments Insurance operation s risk disclosures Financial asset liquidity Interest rate exposure Currency exposure by major currency (page 72) (page 80 81) (page 82) (page 60) (page 74) (page 88) (page 88) 16 Risk and capital management report and annual financial statements

19 Capital management 17 Objectives 17 Governance 17 Capital transferability 18 Basel III capital requirements 18 Objectives of Basel III 19 Regulatory capital 19 Banking operations 25 Insurance operations 25 Economic capital 25 Risk-adjusted performance measurement 25 Cost of equity 25 Banking operations 26 Insurance operations Objectives The group s capital management function is designed to ensure that regulatory requirements are met at all times and that the group and its principal subsidiaries are capitalised in line with the group s risk appetite and target ratios, both of which are approved by the board. The capital management division within treasury and capital management (TCM) comprises: Strategic capital management function: Key responsibilities include raising capital to enable growth opportunities and to provide an optimal capital structure, advising on the dividend policy, facilitating capital allocation and risk-adjusted performance measurement (RAPM), and managing the ICAAP and capital planning process, including stress testing of capital supply and demand. Portfolio analysis and reporting function: Key responsibilities include the measurement and analysis of regulatory and economic capital, internal and external reporting and implementation of new regulatory requirements. CIB and PBB capital management functions: Key responsibilities include providing support on deal pricing, balance sheet utilisation and management of capital consumption against budgets. Regional capital management function: Key responsibilities include supporting the group s operations in the rest of Africa and outside Africa. Governance The primary management level subcommittees that oversee the risks associated with capital management are the group ALCO and its subcommittee, the group capital management committee. The principal governance documents are the capital management governance framework and the model risk governance standard. Capital transferability Subject to compliance with the corporate laws of relevant jurisdictions and appropriate motivation to and approval by exchange control authorities, no significant restrictions exist on the transfer of funds and regulatory capital within the group s banking operations. 17

20 Risk and capital management report Capital management continued Basel III capital requirements The SARB adopted the Basel III framework introduced by the BCBS from 1 January The group has been compliant with the minimum requirements from that date. The group is well positioned to comply with the requirements that are subject to phase-in rules when they become effective. Basel III aims to improve the quality of capital, increase capital levels and remove inconsistencies in the definition of capital across jurisdictions as explained in the table below. Objectives of Basel III Increased quality, quantity and consistency of capital increased focus on CET I increased capital levels. Increased risk coverage credit valuation adjustment for over-the-counter (OTC) derivatives, being the capital charge for potential mark-to-market losses associated with deterioration in counterparty creditworthiness asset value correlation, being the increased capital charge on exposures to financial institutions strengthened standards for collateral management, margin period of risk, management of general wrong-way risk and stress testing. Capital conservation buffer 2.5% CET I capital buffer by 2019 to decrease pro-cyclicality build up capital during favourable economic conditions that can be drawn on during times of stress. Pillar 2a D-SIB buffer up to 2% of pillar 2a buffer prescribed by the SARB to be held against systemic risk requirements 0 2.5% D-SIB buffer required for banks deemed by the SARB to be systemically important the sum of the two requirements is limited to 3.5% and is split over all three tiers of capital. Countercyclical buffer 0 2.5% CET I capital buffer deployed by national jurisdictions when system-wide risk builds up ensures capital adequacy takes macro-financial environment into account. Leverage ratio constrain build-up of leverage in the banking sector the ratio is calculated as tier I qualifying capital/on- and off-balance sheet exposures, as defined by the BCBS, and is measured against the SARB prescribed minimum ratio of 4%. 18 Risk and capital management report and annual financial statements

21 The graph below reflects the capital requirements and phase-in periods applicable to South Africa. SARB ratios (capital as a % of risk weighted assets) 1 effective 1 January each year (%) CET I Conservation buffer Additional tier I Tier II 1 Graph excludes countercyclical buffer and confidential bank-specific pillar 2b capital requirements, but includes maximum potential D-SIB requirement which is also bank-specific and therefore confidential. The South African D-SIB framework assesses the systemic importance of banks, controlling companies and branches of foreign banks licensed to operate in South Africa. While the D-SIB loss-absorbency requirement imposed on banks will only become effective on 1 January 2016, the SARB has advised banks of their bank-specific loss-absorbency requirements in advance of the implementation date to allow banks sufficient time to account for this requirement in their capital planning and management processes. Regulatory capital The group manages its capital levels to support business growth, maintain depositor and creditor confidence, create value for shareholders, and ensure regulatory compliance. The main regulatory requirements to be complied with are those specified in the Banks Act and related regulations which are aligned with Basel III. Banking operations Regulatory capital adequacy is measured through three risk-based ratios: CET I: ordinary share capital, share premium, retained earnings and qualifying non-controlling interest less impairments divided by total risk-weighted assets. Tier I: CET I and qualifying non-controlling interest plus perpetual, non-cumulative instruments with principal loss absorption features issued under the Basel III rules divided by total risk-weighted assets. Perpetual non-cumulative preference shares issued under Basel I and Basel II are included in tier I capital but are subject to regulatory phase-out requirements over a 10-year period, effective from 1 January Total capital adequacy: Tier I plus other items such as the general allowance for credit impairments and subordinated debt with principal loss-absorption features issued under Basel III divided by total risk-weighted assets. Subordinated debt issued under Basel I and Basel II is included in total capital but is subject to regulatory phase-out requirements, over a 10-year period effective from 1 January The ratios are measured against internal targets and regulatory minimum requirements. 19

22 Risk and capital management report Capital management Regulatory capital continued Capital adequacy 1 (%) SBG tier II instrument maturity profile () Tier I Tier II Tier III Required capital Callable date to 2011 are on a Basel II basis. Basel III implemented 1 January Risk weighted assets and capital adequacy for 2012 are on a pro forma Basel III basis. Risk-weighted assets are calculated in terms of the Banks Act and related regulations, which are aligned with Basel III. The group complied with all externally imposed capital requirements during the current and prior year. The group s CET I capital, including unappropriated profit, is R113,5 billion as at 31 December (2013: R105,8 billion). The group s tier I capital, including unappropriated profit, is R118,0 billion as at 31 December (2013: R110,8 billion) and total capital, including unappropriated profit was R142,0 billion as at 31 December (2013: R136,1 billion). The SARB adopted the leverage framework that was issued by the BCBS in January, with final calibrations expected by Formal disclosure requirements are commencing from 1 January 2015 and the ratio is expected to transition to a pillar 1 requirement by The non-risk-based leverage measure is designed to complement the Basel III risk-based capital framework. The group s leverage ratio inclusive of unappropriated profit was 6.9% as at 31 December (December 2013: 6.7%, including unappropriated profit), in excess of the minimum SARB requirement of 4%. The group has a balanced tier II subordinated debt maturity profile. During, the group issued its debut Basel III compliant tier II issue of R2,25 billion. 20 Risk and capital management report and annual financial statements

23 Basel III qualifying capital, excluding unappropriated profits Normalised ordinary shareholders equity Net IFRS adjustments (2 603) (1 929) 1 IFRS ordinary shareholders equity Qualifying non-controlling interest Less: regulatory adjustments: (27 689) (27 298) Goodwill (3 711) (3 747) Other intangible assets (net of deferred tax) (15 850) (12 933) Shortfall of provisions to expected losses (2 054) (2 667) Investments in financial, banking and insurance entities exceeding threshold (4 074) (4 705) Other (2 000) (3 246) Less: regulatory exclusions unappropriated profit (13 049) (9 328) CET I capital Qualifying perpetual preference shares Qualifying non-controlling interest profit Tier I capital Tier II subordinated debt General allowance for credit impairments Tier II capital Total regulatory capital Total capital requirement Total risk-weighted assets Restated. Refer to page

24 Risk and capital management report Capital management Regulatory capital continued Basel III risk-weighted assets and associated capital requirements Risk-weighted assets 2013 Capital requirement 1 Risk-weighted assets Capital requirement 1 Credit risk Portfolios subject to the standardised approach Corporate Sovereign Banks Retail mortgages Retail other Securitisation exposure Portfolios subject to the foundation internal ratings-based (FIRB) approach Corporate Sovereign Banks Portfolios subject to the advanced internal ratings-based (AIRB) approach Corporate Sovereign Banks Retail mortgages Qualifying retail revolving exposure (QRRE) Retail other Securitisation exposure Other assets Counterparty credit risk Portfolios subject to the standardised approach Corporate Sovereign Banks Portfolios subject to the FIRB approach Corporate Sovereign Banks Portfolios subject to the AIRB approach Corporate Sovereign Banks Footnotes on the following page. 22 Risk and capital management report and annual financial statements

25 Basel III risk-weighted assets and associated capital requirements continued Risk-weighted assets 2013 Capital requirement 1 Risk-weighted assets Capital requirement 1 Equity risk in the banking book Portfolios subject to the standardised approach 2 Unlisted Portfolios subject to the market-based approach Listed Unlisted Portfolios subject to the probability of default (PD)/loss given default (LGD) approach Market risk Portfolios subject to the standardised approach Interest rate risk Equity position risk Foreign exchange risk Commodities risk Portfolios subject to the internal models approach VaR-based approach Interest rate risk Equity position risk Foreign exchange risk Commodities risk Diversification benefit (17 228) (1 723) (22 141) (2 103) Non-VaR-based Operational risk Portfolios subject to the standardised approach Portfolios subject to the advanced measurement approach Risk-weighted assets for investments in financial entities Total risk-weighted assets/capital requirement Capital requirement at 10% (December 2013: 9.5%) excludes confidential bank-specific add-ons. 2 Portfolios on the standardised approach relate to the rest of Africa operations and, in addition, portfolios for which application to adopt the internal models approach has not been submitted, or for which an application has been submitted but approval has not been granted. 3 Retail other includes retail small and medium enterprises, vehicle and asset finance, and term lending exposures. 23

26 Risk and capital management report Capital management Regulatory capital continued Capital adequacy ratios SARB minimum regulatory requirement % Internal target ratios % Including unappropriated profits % 2013 % Excluding unappropriated profits Total capital adequacy ratio Tier I capital adequacy ratio CET I capital adequacy ratio % 2013 % Capital adequacy ratios of banking subsidiaries Host tier I regulatory requirements % Host total regulatory requirements % Tier I capital % 2013 Total capital % Tier I capital % Total capital % The Standard Bank of South Africa Group Rest of Africa CfC Stanbic Bank (Kenya) Stanbic Bank Botswana Stanbic Bank Ghana Stanbic Bank Tanzania Stanbic Bank Uganda Stanbic Bank Zambia Stanbic Bank Zimbabwe Stanbic IBTC Bank (Nigeria) Standard Bank de Angola Standard Bank Malawi Standard Bank Mauritius Standard Bank Mozambique Standard Bank Namibia Standard Bank RDC (Democratic Republic of Congo) Standard Bank Swaziland Standard Lesotho Bank Standard Bank London Holdings Limited Standard Bank Isle of Man Standard Bank Jersey Liberty Group Limited (calculated in terms of the Long-term Insurance Act) CAR times covered Represents SARB Basel III minimum capital requirements. 2 Incorporating: The Standard Bank of South Africa (SBSA). 3 Incorporating: SB Plc (United Kingdom) Standard Merchant Bank Plc (Asia) (Singapore). 24 Risk and capital management report and annual financial statements

27 Insurance operations The quarterly and annual returns submitted to the FSB in terms of the Long-term Insurance Act 52 of 1998 (Long-term Insurance Act) and the Short-term Insurance Act 53 of 1998 (Short-term Insurance Act) indicated that the capital adequacy requirements (CAR) were met throughout. Liberty Group Limited CAR ratio Statutory CAR Available statutory capital Target CAR coverage ratio (times) Actual CAR coverage ratio (times) Restated. Refer to page 103. Standard Insurance Limited (SIL) regulatory capital adequacy Actual CAR coverage ratio (times) Economic capital Economic capital adequacy is the internal basis for measuring and reporting all quantifiable risks on a consistent risk-adjusted basis. The group assesses its economic capital adequacy by measuring its risk profile under both normal and stress conditions. ICAAP considers the qualitative capital management processes within the organisation and includes the organisation s governance, risk management, capital management and financial planning standards and frameworks. Furthermore, the quantitative internal assessments of the organisation s business models are used to assess capital requirements to be held against all risks the group is or may become exposed to, in order to meet current and future needs as well as to assess the group s resilience under stressed conditions. Risk-adjusted performance measurement RAPM supports the maximisation of shareholder value by optimally managing financial resources within the board-approved risk appetite. Capital is centrally monitored and allocated, based on usage and performance, in a manner that enhances overall group economic profit and return on equity. Business units are held accountable for achieving their RAPM targets. RAPM is calculated on both regulatory and economic capital measures. Cost of equity The group s rand-based cost of equity (CoE) is estimated using the capital asset pricing model. CoE is recalibrated twice a year using the latest estimates of risk-free rate, beta and equity risk premium. The group applied a CoE of 13.2% as at 31 December (2013: 13.4%). Banking operations Economic capital by risk type at end of the period Credit risk Equity risk Market risk Operational risk Business risk Interest rate risk in the banking book (IRRBB) Economic capital requirement Available financial resources Economic capital coverage ratio (times) 1,49 1,62 1 Restated. Refer to page

28 Risk and capital management report Capital management Economic capital continued Economic capital of R88,1 billion (2013: R76,2 billion) is the amount of permanent capital that is required to support the group s banking operations economic risk profile. For potential losses arising from risk types that are statistically quantifiable, economic capital reflects the worst-case loss commensurate with a confidence level of 99.92%. Available financial resources refer to capital supply as defined by the group for economic capital purposes. It represents permanent capital (ordinary shareholders equity and perpetual preference shares) adjusted for items such as future dividend payments and insurance-related reserves. The available financial resources exceed the minimum economic capital requirement. Insurance operations The FSB plans to implement the new SAM regulatory regime on 1 January As prescribed under SAM the assessment of capital will be on an economic basis for South African life insurance entities. This will apply to Liberty Group Limited, Frank Life and STANLIB Multi-Manager. The regulatory capital will be the amount of financial resources required to protect against economic insolvency under extreme events. Liberty has completed the various SAM supervision submissions requested by the FSB in. These indicate that Liberty s capital is adequate. SIL is in the process of developing a capital model that will calculate economic capital requirements. We expect to complete this model in Risk and capital management report and annual financial statements

29 Risk appetite and stress testing Risk appetite is set, and stress testing activities are undertaken, at a group level, in business lines and at a legal entity level within the risk appetite and stress testing governance frameworks. Governance 27 Governance 27 Risk appetite 27 Risk appetite governance framework 29 Risk appetite statement 29 Stress testing 29 Stress testing governance framework The primary management level governance committee overseeing risk appetite and stress testing is the group risk appetite and stress testing committee (GSTRAC). It is chaired by the group CRO and is a subcommittee of GROC. Liberty is represented on the GSTRAC to ensure a broad level of consistency in the execution of these activities between the insurance and banking operations of the group. Within Liberty, risk appetite and stress testing are governed by the Liberty group balance sheet management committee and overseen by the Liberty group risk and control oversight committee. The principal governance documents are the risk appetite governance framework and the stress testing governance framework. Risk appetite Risk appetite governance framework The risk appetite governance framework provides guidance on the following: setting and cascading of risk appetite by group, business line and legal entity measurement and methodology governance monitoring and reporting of the risk profile. The group has adopted the following definitions, where entity refers to a business line or legal entity within the group, or the group itself: Risk appetite: An expression of the amount or type of risk an entity is generally willing to take in pursuit of its financial and strategic objectives, reflecting its capacity to sustain losses and continue to meet its obligations as they fall due, under both normal and a range of stress conditions. The metric is referred to as a risk appetite trigger. Risk tolerance: The maximum amount of risk an entity is prepared to tolerate above risk appetite. The metric is referred to as a risk tolerance limit. Risk capacity: The maximum amount of risk the entity is able to support within its available financial resources. Risk appetite statement (RAS): The documented expression of risk appetite and risk tolerance which have been approved by the entity s relevant governance committee. The RAS is reviewed and revised, if necessary, on an annual basis. 27

30 Risk and capital management report Risk appetite and stress testing Risk appetite continued Risk profile: The risk profile is defined in terms of three dimensions, namely: current risk profile or forward risk profile unstressed or stressed risk profile pre- or post-management actions. The current risk profile is the amount or type of risk the entity is currently exposed to. The unstressed forward risk profile is the forward-looking view of how the entity s risk profile is expected to evolve under expected conditions. The effectiveness of available management actions can be assessed through an analysis of pre- and post-management action risk profiles against risk appetite triggers and tolerance limits. The diagram below provides a schematic view of the three levels of risk appetite and the integral role that risk types play in the process of cascading risk appetite from dimensions such as regulatory capital, economic capital, stressed earnings and liquidity to more granular portfolio limits. Risk appetite Risk appetite dimensions (quantitative) Level 1 Regulatory capital Economic capital Stressed earnings Liquidity Level 2 Risk appetite dimensions by risk type Credit and equity Operational Market Interest rate Business Liquidity Capital demand/earnings at risk utilisation per risk type RAS Portfolio limits by risk type Level 3 Credit and equity risk e.g. Operational risk e.g. Market risk e.g. Interest rate risk e.g. Business risk e.g. Liquidity risk e.g. Loss ratio NPL % Concentrations Operational losses % to gross income Normal and SVaR limits Interest rate sensitivity Cost-to-income ratio NSFR 28 Risk and capital management report and annual financial statements

31 Risk appetite statement Executive management is responsible for recommending the group s RAS, which is then approved by the GRCMC on behalf of the board. In developing the RAS, executive management considers the group s strategy and the desired balance between risk and return. The GRCMC reviews the group s current risk profile on a quarterly basis and forward risk profile (both stressed and unstressed) at least annually. Level 1 risk appetite dimensions can be either qualitative or quantitative. Quantitative level 1 risk appetite dimensions relate to available financial resources and earnings volatility. The standardised quantitative dimensions used by the group, as well as legal entities and business lines, are: stressed earnings economic capital regulatory capital liquidity (short-term liquidity and term liquidity). Level 2 risk appetite represents the allocation of level 1 risk appetite to risk types. Specifically, the contribution of individual risk types to earnings volatility and overall capital demand (both economic and regulatory) is controlled through triggers and limits. Level 3 consists of key metrics used to monitor the portfolio. Portfolio triggers and limits are required to be broadly congruent with level 1 and level 2 triggers and limits. These metrics are regularly monitored at a risk type level and ensure proactive risk management. Stress testing Stress testing governance framework Stress testing is a key management tool within the group and is used to evaluate the sensitivity of the current and forward risk profile relative to risk appetite. Stress testing supports a number of business processes, including: strategic planning and financial budgeting the ICAAP, including capital planning and management, and the setting of capital buffers liquidity planning and management informing the setting of risk appetite triggers and risk tolerance limits identifying and proactively mitigating risks through actions such as reviewing and changing limits, limiting future and reducing current exposures, and hedging thereof facilitating the development of risk mitigation or contingency plans, including recovery plans, across a range of stressed conditions supporting communication with internal and external stakeholders. Stress testing within the group s banking and insurance operations is broadly aligned and subject to the group s stress testing governance framework which sets out the responsibilities for and approaches to stress testing activities. Stress tests are conducted at group, business line, material legal entity and risk type level. Fit-for-purpose stress testing programmes are implemented for the group s banking and insurance operations to ensure appropriate coverage of the different risks. Stress testing programme The group s stress testing programme uses one or a combination of stress testing techniques, including scenario analysis, sensitivity analysis and reverse stress testing to perform stress testing for different purposes. Routine groupwide macroeconomic stress testing Routine macroeconomic stress testing is conducted across all major risk types, on an integrated basis, for a range of economic scenarios varying in severity from mild to very severe but plausible macroeconomic shocks. The impact, after consideration of mitigating actions, on the group s income statement, SOFP and capital demand and supply of the group is measured against risk appetite. Groupwide macroeconomic stress testing for the group and SBSA is performed, as a minimum, once a year for selected scenarios that are specifically designed by a scenario working group targeting the group s risk profile, geographical presence and strategy. The results of the groupwide macroeconomic stress testing are presented at a board level for the group and SBSA in order to consider whether the group s risk profile is consistent with the group s risk appetite and to set the capital buffer. Groupwide macroeconomic stress testing results are submitted as part of the annual ICAAP. Additional stress testing Groupwide macroeconomic stress testing results are supplemented with additional ad hoc stress testing at the group, legal entity, business line, or risk type level that may be required from time-to-time for risk management or planning purposes. The purpose of this stress testing is to inform management of risks that may not yet form part of routine stress testing or where the focus is on a specific portfolio or business unit. Additional stress testing can take the form of either scenario analysis or sensitivity analysis. This type of stress testing will be performed and governed at the appropriate group, legal entity, business line, or risk type level. Examples of additional stress tests for included an interest rate increase scenario as well as various commodities-related stress tests. Supervisory stress tests Regulators may call for the group or a legal entity to run a supervisory stress test using a common scenario with prescribed assumptions and methodologies. The group participated in a stress testing exercise conducted by the IMF as part of their South African financial stability assessment programme in May. 29

32 Risk and capital management report Risk appetite and stress testing Stress testing continued Business model stress testing Business model stress testing utilises the reverse stress testing technique to explore vulnerabilities in a particular strategy or business model. The outcome does not necessarily target business or bank failure, but rather seeks to inform what could have a severe impact, given a plausible but in most cases highly improbable event within a given set of circumstances and assumptions. The purpose of business model stress testing is to identify potential vulnerabilities by: assuming the business model is severely impacted identifying potential circumstances/scenarios that could have led to this impact identifying vulnerabilities in the business model, human capital, infrastructure and control framework highlighted by the failure reviewing the existing risk mitigants supplementing risk mitigants if considered necessary. Stress testing for the recovery plan As part of the annual review of the group s recovery plan the group s procedures require the execution of stress tests in order to test the effectiveness of the recovery options proposed in the recovery plan, and to provide guidance on the selection of early warning indicators. The range of scenarios that are considered include both systemic, group-specific and combination events as well as fast- and slow-moving scenarios. Risk type stress testing Risk type stress tests apply to individual risk types. Risk type stress testing could take the form of scenario or sensitivity analysis. 30 Risk and capital management report and annual financial statements

33 Credit risk 31 Definition 31 Banking operations 31 Approach to managing credit risk 31 Governance 32 Approved regulatory capital approaches 36 Credit portfolio characteristics and metrics in terms of Basel 50 Credit portfolio characteristics and metrics in terms of IFRS 59 Insurance operations 59 Consolidated mutual funds 60 Credit exposure to debt instruments 62 Impairments 62 Reinsurance Definition Credit risk is the risk of loss arising out of the failure of counterparties to meet their financial or contractual obligations when due. Credit risk is composed of counterparty risk (including primary, pre-settlement, issuer and settlement risk) and concentration risk (single counterparty, industry, product, geographic and maturity). Banking operations Approach to managing credit risk The group s credit risk comprises mainly wholesale and retail loans and advances, together with the counterparty credit risk arising from derivative and securities financing contracts entered into with our clients and market counterparties. The group manages credit risk through: maintaining a strong culture of responsible lending and a robust risk policy and control framework identifying, assessing and measuring credit risk across the group, from the level of individual facilities up to the total portfolio defining, implementing and continually re-evaluating our risk appetite under actual and stress conditions monitoring the group s credit risk relative to limits ensuring that there is expert scrutiny and independent approval of credit risks and their mitigation. Primary responsibility for credit risk management resides with the group s business lines. This is complemented with an independent credit risk function embedded within the business units, which is in turn supported by the group risk function. Governance The primary management level governance committees overseeing credit risk are the CIB and PBB credit governance committees, the group ERC and the intragroup exposure committee (all GROC subcommittees). These committees are responsible for credit risk and credit concentration risk decision-making, and delegation thereof to credit officers and committees within defined parameters. The PBB, CIB and group model approval committees approve key aspects of rating systems and credit risk models. Regular model validation and reporting to these committees is undertaken by the central validation function that is independent of the credit risk function. 31

34 Risk and capital management report Credit risk Banking operations continued The principal governance documents are the credit governance standard and the model risk governance standard. Approved regulatory capital approaches The group has approval from the SARB to adopt the AIRB approach for its credit portfolios in SBSA and the FIRB approach for SB Plc. The group has adopted the standardised approach for the rest of Africa portfolios and for some of its less material subsidiaries and portfolios. The group has approval from the SARB to adopt the market-based and probability of default (PD)/loss given default (LGD) approaches for material equity portfolios. Standardised approach The calculation of regulatory capital is based on a risk weighting and the net counterparty exposures after recognising a limited set of qualifying collateral. The risk weighting is based on the exposure characteristics and, in the case of corporate, bank and sovereign exposures, the external agency credit rating of the counterparty. In the case of counterparties for which there are no credit ratings available, exposures are classified as unrated for determining regulatory capital requirements. Basel: Exposure subject to the standardised approach per risk weighting Exposure Mitigation 1 Exposure after mitigation Exposure after mitigation Based on risk weights 0% 35% % Rated Unrated % % and above Rated Unrated Total Constitutes eligible financial collateral. 2 Restated. Refer to page 103. Internal ratings-based approach Introduction Under the IRB regulatory capital approaches the calculation of regulatory capital is based on an estimate of exposure at default (EAD) and a risk weighting. The risk weighting is based on asset class, and estimates of PD, LGD, and maturity. Under the AIRB approaches all the parameters need to be estimated internally, while only PD is estimated internally under the FIRB approach. EAD, LGD and maturity are regulatory-prescribed in this case. All IRB models are managed under model development and validation policies that set out the requirements for model governance structures and processes, and the technical framework within which model performance and appropriateness is maintained. The models are developed using internal historical default and recovery data. In low-default portfolios, internal data is supplemented with external benchmarks and studies. Models are assessed frequently to ensure ongoing appropriateness as business environments and strategic objectives change, and are recalibrated annually using the most recent internal data. IRB risk components Probability of default The group uses a 25-point master rating scale to quantify the credit risk for each borrower (corporate asset classes) or facility (retail asset classes), as illustrated in the table that follows. Ratings are mapped to PDs by means of calibration formulae that use historical default rates and other data from the applicable portfolio. The group distinguishes between through-the-cycle PDs and point-in-time PDs, and utilises both measures in decision-making, managing credit risk exposures and measuring impairment against credit exposures. 32 Risk and capital management report and annual financial statements

35 Relationship between the group master rating scale and external ratings Group master rating scale SARB risk bucket Moody s Investor Services Standard & Poor s Fitch Grading Credit quality 1 4 AAA to AA- Aaa, Aa1, Aa2, Aa3 AAA, AA+, AA, AA- AAA, AA+, AA, AA- Investment grade Normal monitoring 5 7 A+ to A- A1, A2, A3 A+, A, A- A+, A, A BBB+ to BBB- Baa1, Baa2, Baa3 BBB+, BBB, BBB- BBB+, BBB, BBB BB+ to B- Ba1, Ba2, Ba3, B1, B2, B3 BB+, BB, BB-, B+, B, B- BB+, BB, BB-, B+, B, B- Sub-investment grade Below B- Caa1, Caa2, Caa3, Ca CCC+, CCC, CCC- CCC+, CCC, CCC- Close monitoring Default Default C D D Default Default Loss given default LGD measures are a function of customer type, product type, seniority of loan, country of risk and level of collateralisation. LGDs are estimated based on historic recovery data per category of LGD. A downturn LGD is used in the estimation of the capital charge and reflects the anticipated recovery rates in a downturn period. Exposure at default EAD captures the impact of potential draw-downs against unutilised facilities and potential changes in counterparty credit risk positions due to changes in market prices. By using historical data, it is possible to estimate an account s average utilisation of limits when default occurs, recognising that customers may use more of their facilities as they approach default. Expected loss The expected loss provides a measure of the value of the credit losses that may reasonably be expected to occur in the portfolio. Provisions must be sufficient to cover the expected losses in the credit portfolio. In its most basic form the expected loss can be represented as: expected losses = PD x EAD x LGD. 33

36 Risk and capital management report Credit risk Banking operations continued Basel: Analysis of PDs, EADs and LGDs by risk grade under the IRB approach Average PD % Total EAD 1 EAD Corporate Sovereign Banks LGD % Exposure weighted average risk weight 2 % EAD LGD % Exposure weighted average risk weight 2 % Non-default EAD LGD % Exposure weighted average risk weight 2 % Default Total Non-default Default Total Excludes equity EAD. 2 Exposure weighted average risk weights have been weighted by the sum of the EAD within each of the PD bands. Corporate, sovereign and bank portfolios Corporate entities include large companies as well as small and medium enterprises that are managed on a relationship basis or have a combined exposure to the group of more than R7,5 million. Corporate exposures also include specialised lending (project, object and commodity finance as well as income-producing real estate), public sector entities and central counterparties. Sovereign and bank borrowers include sovereign government entities, central banks, local and provincial government entities, bank financial institutions and non-bank financial institutions. The creditworthiness of corporate (excluding specialised lending), sovereign and bank exposures is assessed based on a detailed individual assessment of the financial strength of the borrower. This quantitative analysis coupled with a detailed qualitative analysis of the entity together with expert judgement and external rating agency ratings, leads to an allocation of an internal rating to the entity. Specialised lending s creditworthiness is assessed on a transactional level, rather than on the financial strength of the borrower, as the group relies on repayment from the cash flows generated by the underlying asset. Retail portfolio Retail mortgage exposures relate to mortgage loans to individuals and are a combination of both drawn and undrawn EADs. QRRE relates to cheque accounts, credit cards and revolving personal loans and products, and include both drawn and undrawn exposures. Retail other covers other branch lending and vehicle finance for retail, retail small and retail medium enterprise portfolios. Branch lending includes both drawn and undrawn exposures, while vehicle and asset finance only has drawn exposures. Internally developed behavioural scorecards are used to measure the anticipated performance for each account. Mapping of the behaviour score to a PD is performed for each portfolio using a statistical calibration of portfolio-specific historical default experience. The behavioural scorecard PDs are used to determine the portfolio distribution on the master rating scale. Separate LGD models are used for each product portfolio and are based on historical recovery data. EAD is measured as a percentage of the credit facility limit and is based on historical averages. EAD is estimated per portfolio and per portfolio-specific segment, using internal historical data on limit utilisation. 34 Risk and capital management report and annual financial statements

37 Retail mortgages QRRE Retail other Equity EAD LGD % Exposure weighted average risk weight 2 % EAD LGD % Exposure weighted average risk weight 2 % EAD LGD % Exposure weighted average risk weight 2 % Exposure PD % Equity portfolio The market-based and PD/LGD approaches are used to model the capital requirement for equity exposure. The market-based approach includes portfolios subject to the simple risk-weight method. For the PD/LGD approach, the group s approved credit risk grade models are used together with the regulatory prescribed LGD of 90% and maturity factor of five years. Equity exposures under the simple risk-weight method 2013 Listed Unlisted Total Use of internal estimates The group s credit risk rating systems and processes differentiate and quantify credit risk across counterparties and asset classes. Internal risk parameters are used extensively in risk management and business processes, including: setting risk appetite setting limits for concentration risk and counterparty limits credit approval and monitoring pricing transactions determining portfolio impairment provisions calculating economic capital. 35

38 Risk and capital management report Credit risk Banking operations continued Credit portfolio characteristics and metrics in terms of Basel Credit portfolio analysis The credit portfolio is analysed in the tables that follow in terms of the Basel approach and asset class. Basel: Exposure by approach and asset class 1 On-balance sheet Off-balance sheet Securities financing transactions Standardised FIRB AIRB Standardised FIRB AIRB Standardised Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Retail other Total Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Retail other Total Amount before the application of any offset, mitigation or netting. 2 Restated. Refer to pages FIRB AIRB 36 Risk and capital management report and annual financial statements

39 Derivative instruments Standardised FIRB AIRB Standardised Total by approach FIRB AIRB Total FIRB EAD AIRB Gross past due but not impaired exposures Gross defaulted exposures Impairment of exposures Specific Portfolio

40 Risk and capital management report Credit risk Banking operations continued Basel: Exposure by approach and asset class (Rbn) Corporate Sovereign Banks Retail mortgages QRRE Other retail Standardised FIRB AIRB Standardised 2013 FIRB 2013 AIRB 2013 Concentration risk Concentration risk is the risk of loss arising from an excessive concentration of exposure to a single counterparty, an industry, a product, a geography, maturity, or collateral. The group s credit risk portfolio is well diversified. The bank s management approach relies on reporting of concentration risk along key dimensions, the setting of portfolio limits and stress testing. 38 Risk and capital management report and annual financial statements

41 Basel: Exposures by type of asset and industry 1 On-balance sheet Off-balance sheet Securities financing transactions Derivative instruments Total gross exposure Gross defaulted exposures Impairment of exposures Specific Agriculture Mining Manufacturing Electricity Construction Wholesale Transport Finance, real estate and other business services Private households Other Portfolio Total Agriculture Mining Manufacturing Electricity Construction Wholesale Transport Finance, real estate and other business services Private households Other Total Amount before the application of any offset, mitigation or netting. 2 Restated. Refer to page 103. Total gross exposure by industry (%) 35 Finance, real estate and other business services (2013: 36) 29 Private households (2013: 32) 12 Other (2013: 10) 6 Wholesale (2013: 6) 18 Agriculture, mining, manufacturing, electricity, construction and transport (2013: 16) 39

42 Risk and capital management report Credit risk Banking operations continued Basel: Exposures by type of asset and geographic region 1 On-balance sheet Off-balance sheet Securities financing transactions Derivative instruments Total gross exposure Gross defaulted exposures Impairment of exposures Specific South Africa Other African countries Europe Asia North America South America Other Portfolio Total South Africa Other African countries Europe Asia North America South America Other Total Amount before the application of any offset, mitigation or netting. 2 Restated. Refer to page 103. Total gross exposure by geographic region (%) 58 South Africa (2013: 61) 17 Rest of Africa (2013: 18) 25 Outside Africa (2013: 21) 40 Risk and capital management report and annual financial statements

43 Basel: Exposures by residual contractual maturity 1 Less than 1 year 1 to 5 years Greater than 5 years Total gross exposure Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Retail other Total Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Retail other Total Amount before the application of any offset, mitigation or netting. 2 Restated. Refer to pages

44 Risk and capital management report Credit risk Banking operations continued Loss analysis Actual losses The table below shows the actual losses experienced in the group s IRB exposure classes during the year ended 31 December, compared to the comparable year ended 31 December Actual losses comprise impairments as determined by IFRS, and exclude post write-off recoveries. The values displayed in the table exclude all standardised approach portfolios. Basel: Analysis of actual losses IRB exposure class Corporate Sovereign 32 Banks 53 Retail exposure Retail mortgages QRRE Other retail Total Excludes recoveries post write-off recoveries and all the standardised approach portfolios. Estimated losses versus actual losses The table on the next page provides a comparison of actual PDs, LGDs and EADs to the estimated through-the-cycle PDs, LGDs and EADs. Note that this comparison is an approximation as the PD, LGD and EAD actual and estimated parameters are different for reasons that include: Estimated PDs are determined at the beginning of the 12-month period to 31 December using calibrated regulatory models. The models are calibrated to long-run default experience to ensure stable regulatory models over an entire credit cycle and would tend to underestimate actual defaults at the top of the credit cycle and overestimate actual defaults at the bottom of the credit cycle. The actual PDs are the defaults experienced over the 12-month period. A change in the vehicle and asset finance definition of default has occurred between the 2013 and reporting periods, resulting in different PD values for other retail exposure class. LGD estimates are determined at the beginning of the 12-month cycle using the regulatory long-run average-based models that include downturn adjustments. Actual LGD values can take several years to be determined as defaulted exposures have to reach a write-off stage to allow for accurate LGD calculations. In order to determine comparable actual LGD values, all accounts that reached a write-off stage during the prior three-year period were used to determine the actual LGD values. The EAD ratio reflects estimated through-the-cycle EADs, used to derive the regulatory expected loss, as a percentage of EADs derived from the actual losses. The calculated EAD ratios are averages over the prior three-year period, to enable meaningful averages to be determined. The analysis is based only on the AIRB portfolios. The zero or low level of bank and sovereign defaults, experienced in the AIRB portfolio during the period and comparative periods, did not allow for a meaningful calculation of actual LGD and PD values for sovereign and banks values or a meaningful calculation of sovereign or bank EAD ratios. 42 Risk and capital management report and annual financial statements

45 Basel: IRB exposure class 1,2 Estimated % PD LGD 3 EAD Actual % Estimated % Actual % Estimate to actual ratio % Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Other retail Total Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Other retail Total Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Other retail Total Excludes all the standardised approach portfolios. 2 No data in the columns headed actual reflects either that no default occurred or, if there was a default, there was no loss incurred. 3 Excludes FIRB portfolios. 43

46 Risk and capital management report Credit risk Banking operations continued Credit risk mitigation Collateral, guarantees, credit derivatives and on- and off-balance sheet netting are widely used to mitigate credit risk. Credit risk mitigation policies and procedures ensure that credit risk mitigation techniques are acceptable, used consistently, valued appropriately and regularly, and meet the risk requirements of operational management for legal, practical and timely enforcement. Detailed processes and procedures are in place to guide each type of mitigation used. The main types of banking book collateral taken are: mortgage bonds over residential, commercial and industrial properties cession of book debts bonds over plant and equipment the underlying movable assets financed under leases and instalment sales. Reverse repurchase agreements are underpinned by the assets being financed. Refer to the table on page 46, Basel: Securities financing transactions. Guarantees and related legal contracts are often required, particularly in support of credit extension to groups of companies and weaker counterparties. Guarantor counterparties include banks, parent companies, shareholders and associated counterparties. Creditworthiness is established for the guarantor as for other counterparty credit approvals. For derivative transactions, the group typically uses internationally recognised and enforceable International Swaps and Derivatives Association (ISDA) agreements, with a credit support annexure, where collateral support is considered necessary. Other credit protection terms may be stipulated, such as limitations on the amount of unsecured credit exposure acceptable, collateralisation if mark-to-market credit exposure exceeds acceptable limits, and termination of the contract if certain credit events occur, for example, downgrade of the counterparty s public credit rating. Wrong-way risk arises where there is a positive correlation between counterparty default and transaction exposure, and a negative correlation between transaction exposure and the value of collateral at the point of counterparty default. This risk is addressed by taking into consideration the high correlation between the default event and exposure to the counterparty when calculating the potential exposure and security margin requirements on these transactions. To manage actual or potential portfolio risk concentrations in areas of higher credit risk and credit portfolio growth, the group implements hedging and other strategies from time-to-time. This is done at individual counterparty, sub-portfolio and portfolio levels through the use of syndication, distribution and sale of assets, asset and portfolio limit management, credit derivatives and credit protection. Exposure and mitigation by asset class (Rbn) Corporate Banks Sovereign Retail Gross exposure Gross exposure 2013 Credit risk mitigation Credit risk mitigation Risk and capital management report and annual financial statements

47 Basel: Credit risk mitigation for portfolios under the IRB approach Eligible financial collateral Other eligible IRB collateral Guarantees and credit derivatives Effects of netting agreements 1 Total credit risk mitigation Total exposure Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Retail other Total Corporate Sovereign Banks Retail exposure Retail mortgages QRRE Retail other Total Netting is not equivalent to offsetting in terms of IFRS. 2 Restated. Refer to pages Basel: Credit risk mitigation for portfolios under the standardised approach Eligible financial collateral Guarantees and credit derivatives Effects of netting agreements 1 Total credit risk mitigation Total exposure Corporate Sovereign Banks Retail exposure Total Corporate Sovereign Banks Retail exposure Total Netting is not equivalent to offsetting in terms of IFRS. 2 Restated. Refer to pages

48 Risk and capital management report Credit risk Banking operations continued Counterparty credit risk The group is exposed to counterparty credit risk through movements in the fair value of securities financing and derivative contracts. The risk amounts reflect the aggregate replacement costs that would be incurred by the group in the event of counterparties defaulting on their obligations. The group s exposure to counterparty credit risk is affected by the nature of the trades, the creditworthiness of the counterparty, and netting and collateral arrangements. Counterparty credit risk is measured in potential future exposure terms and recognised on a net basis where netting agreements are in place and are legally recognised, or otherwise on a gross basis. Exposures are generally marked-to-market daily. Cash or near cash collateral is posted where contractually provided for. Counterparty credit risk is subjected to explicit credit limits which are formulated and approved for each counterparty and economic group, with specific reference to its credit rating and other credit exposures. The tables that follow detail the group s exposure to securities financing transactions and derivatives. Basel: Securities financing transactions Exposure With master netting agreement Without master netting agreement Total Collateral Cash Commodities Debt securities Equities Total EAD Restated. Refer to page Risk and capital management report and annual financial statements

49 Basel: Derivatives exposure Noncentrally cleared Centrally cleared On behalf of clients Total exposure to CCPs Noncentrally cleared Centrally cleared On behalf of clients Total exposure to CCPs Notional principal amount 2 Interest rate products Forex and gold Equities Precious metals Other commodities Credit derivatives Protection bought Protection sold Total Netted current credit exposure (net fair value) Gross positive fair value Interest rate products Forex and gold Equities Precious metals Other commodities Credit derivatives Protection bought Protection sold Netting benefits ( ) (1 059) (5 021) (82 892) (248) (7 826) Total EAD Collateral Cash Gold 1 3 Debt securities Total Restated. Refer to page Notional principal amount for derivative assets and liabilities. 47

50 Risk and capital management report Credit risk Banking operations continued Securitisation Securitisation is a transaction whereby the credit risk associated with an exposure, or pool of exposures, is tranched and where payments to investors in the transaction are dependent upon the performance of the exposure or pool of exposures. A traditional securitisation involves the transfer of the exposures being securitised to a structured entity (SE) which issues securities. In a synthetic securitisation, the tranching is achieved by the use of credit derivatives and the exposures are not removed from the SOFP. The group uses SEs to securitise customer loans and advances that it has originated to diversify its sources of funding for asset origination, for capital efficiency purposes and to reduce risk. In addition, the group plays a secondary role as an investor in certain third party securitisation note issuances (SEs established by third parties). The SEs established by the group are: Blue Granite Investments No 1 (RF) Limited (BG 1) Blue Granite Investments No 2 (RF) Limited (BG 2) Blue Granite Investments No 3 (RF) Limited (BG 3) Blue Granite Investments No 4 (RF) Limited (BG 4) Siyakha Fund (RF) Limited (Siyakha) Blue Titanium Conduit (RF) Limited (BTC). Basel: Roles fulfilled in securitising assets Securitisation transactions Originator Investor Servicer Liquidity provider Credit enhancement provider Swap counterparty Traditional securitisations BG 1 BG 2 BG 3 BG 4 Siyakha Asset-backed commercial paper programme BTC Third party transactions Basel: Securitisation transactions Asset type Year initiated Expected close Assets securitised Rbn Assets outstanding Rbn 2013 Rbn Notes outstanding 1 Rbn 2013 Rbn Retained exposure 1,2 Traditional securitisations 17,9 8,9 10,0 9,8 11,0 5,4 5,9 BG 1 3,4 Retail mortgages ,6 1,0 1,3 1,1 1,4 1,0 1,2 BG 2 3 Retail mortgages ,8 2,0 2,1 2,2 2,3 1,2 1,2 BG 3 3 Retail mortgages ,0 1,6 1,8 1,8 2,0 1,1 1,2 BG 4 3 Retail mortgages ,1 2,7 3,0 3,0 3,4 1,2 1,4 Siyakha Retail mortgages ,4 1,6 1,8 1,7 1,9 0,9 0,9 Asset-backed commercial paper programme BTC 4 Various 2002 N/A N/A 4,1 4,3 4,1 4,3 0,7 0,3 Total N/A 17,9 13,0 14,3 13,9 15,3 6,1 6,2 1 Capital plus accrued interest. 2 Includes notes, first and second loss subordinated loans and notes held by BTC. 3 Rating agency: Moody s. 4 Rating agency: Fitch. Rbn 2013 Rbn 48 Risk and capital management report and annual financial statements

51 For originated and sponsored or administered securitisations consolidated under IFRS (that is, BG1 4, Siyakha Fund and BTC) intragroup exposures to and between these securitisations have been eliminated and the underlying assets consolidated in the relevant sections (that is, primarily retail mortgages) of the risk disclosure. Only exposures to securitisations of assets originated by third parties are disclosed below. The approach applied in the calculation of risk-weighted assets is dependent on the group s approved model for the underlying assets and the existence of a rating from an eligible external credit assessment institution. To date, the group has applied the standardised approach, ratings-based approach and standard formula approach, where relevant, in the calculation of risk-weighted assets. For local securitisations in South Africa, Moody s Investor Services and/or Fitch act as rating agencies. R4,6 billion of securitisation activities took place during the year ended 31 December (2013: R2,3 billion) (relates to the facilitation of the securitisation of third-party assets into an SE that is not consolidated by the group). The transfer of assets by the group to an SE may give rise to the full or partial derecognition of the financial assets concerned. Only in the event that derecognition is achieved are sales and any resultant gains or losses on sales recognised in the financial statements. Where the SEs are consolidated at group level, such gains or losses are eliminated. Basel: Securitised on-balance sheet exposures Retail mortgages 2013 Standardised unrated IRB Unrated Investment grade Total This includes rated securitisation exposures whose ratings are not eligible for recognition from a regulatory perspective. Retail loans Total Total Basel: Securitised off-balance sheet exposures Retail mortgages 2013 Standardised unrated IRB Unrated Investment grade Total This includes rated securitisation exposures whose ratings are not eligible for recognition from a regulatory perspective. Retail loans Total Total 49

52 Risk and capital management report Credit risk Banking operations continued Credit portfolio characteristics and metrics in terms of IFRS Analysis of loans and advances The tables on the pages that follow analyse the credit quality of loans and advances measured in terms of IFRS. Maximum exposure to credit risk Loans and advances are analysed and categorised based on credit quality using the following definitions. Performing loans Performing loans are loans which are neither past due nor specifically impaired loans. These loans are current and fully compliant with all contractual terms and conditions. Normal monitoring loans within this category are generally rated 1 to 21, and close monitoring loans are generally rated 22 to 25 using the group s master rating scale. Early arrears but not specifically impaired loans include those loans where the counterparty has failed to make contractual payments and payments are less than 90 days past due, but it is expected that the full carrying value will be recovered when considering future cash flows, including collateral. Ultimate loss is not expected but could occur if the adverse conditions persist. Non-performing loans Non-performing loans are those loans for which: the group has identified objective evidence of default, such as a breach of a material loan covenant or condition, or instalments are due and unpaid for 90 days or more. Non-performing but not specifically impaired loans are not specifically impaired due to the expected recoverability of the full carrying value when considering the recoverability of future cash flows, including collateral. Non-performing specifically impaired loans are those loans that are regarded as non-performing and for which there has been a measurable decrease in estimated future cash flows. Specifically impaired loans are further analysed into the following categories: Sub-standard: Items that show underlying well-defined weaknesses and are considered to be specifically impaired. Doubtful: Items that are not yet considered final losses due to some pending factors that may strengthen the quality of the items. Loss: Items that are considered to be uncollectible in whole or in part. The group provides fully for its anticipated loss, after taking collateral into account. 50 Risk and capital management report and annual financial statements

53 Loans 1 Performing loans Non-performing loans Neither past due nor specifically impaired loans () Early arrears but not specifically impaired loans () Nonperforming but not specifically impaired loans () Specifically impaired loans () Normal monitoring () Close monitoring () Sub-standard () Doubtful () Loss () Excluding discontinued operation s exposures which are presented separately in the table that follows. Portfolio credit impairments. Specific credit impairments. 51

54 Risk and capital management report Credit risk Banking operations continued IFRS: Maximum exposure to credit risk by credit quality Performing loans Neither past due nor specifically impaired Not specifically impaired Gross advances total Normal monitoring Close monitoring Early arrears Personal & Business Banking Mortgage loans Instalment sale and finance leases Card debtors Other loans and advances Personal unsecured lending Business lending and other Nonperforming 1 Corporate & Investment Banking Corporate loans Commercial property finance Other services (54 277) (54 279) Gross loans and advances Discontinued operation s loans and advances Less: Impairments for loans and advances (18 707) Tutuwa 2 loans and advances IFRS adjustment (1 303) Discontinued operation s loans and advances (50 026) Net loans and advances Add the following other banking activities exposures: Cash and balances with central banks Derivative assets Financial investments Trading assets Pledged assets Other financial assets Total on-balance sheet exposure of continuing operations Discontinued operation financial assets Total on-balance sheet exposure Off-balance sheet exposure Letters of credit and bankers acceptances Guarantees Irrevocable unutilised facilities Commodities and securities lending transactions Total exposure to credit risk Includes loans of R24 million that are past due but not specifically impaired. 2 Tutuwa is the group s black economic empowerment (BEE) ownership initiative. 52 Risk and capital management report and annual financial statements

55 Non-performing loans Specifically impaired loans Substandard Doubtful Loss Total Securities and expected recoveries on specifically impaired loans Net after securities and expected recoveries on specifically impaired loans Balance sheet impairments for nonperforming specifically impaired loans Gross specific impairment coverage % Total nonperforming loans Nonperforming loans %

56 Risk and capital management report Credit risk Banking operations continued IFRS: Maximum exposure to credit risk by credit quality continued Performing loans Neither past due nor specifically impaired Not specifically impaired Gross advances total Normal monitoring Close monitoring Early arrears 2013 Personal & Business Banking Mortgage loans Instalment sale and finance leases Card debtors Other loans and advances Personal unsecured lending Business lending and other Nonperforming 1 Corporate & Investment Banking Corporate loans Commercial property finance Other services (46 467) (46 467) Gross loans and advances Discontinued operation s loans and advances Less: Impairments for loans and advances (19 166) Tutuwa 2 loans and advances IFRS adjustment (1 199) Discontinued operation s loans and advances (58 838) Net loans and advances Add the following other banking activities exposures: Cash and balances with central banks Derivative assets Financial investments Trading assets Pledged assets Other financial assets Total on-balance sheet exposure of continuing operations Discontinued operation financial assets Total on-balance sheet exposure Off-balance sheet exposure Letters of credit and bankers acceptances Guarantees Irrevocable unutilised facilities Commodities and securities lending transactions Total exposure to credit risk Includes loans of R42 million that are past due but not specifically impaired. 2 Tutuwa is the group s BEE ownership initiative. 54 Risk and capital management report and annual financial statements

57 Non-performing loans Specifically impaired loans Substandard Doubtful Loss Total Securities and expected recoveries on specifically impaired loans Net after securities and expected recoveries on specifically impaired loans Balance sheet impairments for nonperforming specifically impaired loans Gross specific impairment coverage % Total nonperforming loans Nonperforming loans % (1)

58 Risk and capital management report Credit risk Banking operations continued IFRS: Ageing of loans and advances past due but not impaired Less than 31 days days days days More than 180 days Personal & Business Banking Mortgage loans Instalment sale and finance leases Card debtors Other loans and advances Personal unsecured lending Business term lending and other Corporate & Investment Banking Corporate loans Commercial property finance 1 1 Total Personal & Business Banking Mortgage loans Instalment sale and finance leases Card debtors Other loans and advances Personal unsecured lending Business term lending Corporate & Investment Banking Corporate loans Commercial property finance Total Total Renegotiated loans and advances Renegotiated loans and advances are exposures which have been refinanced, rescheduled, rolled over or otherwise modified following weaknesses in the counterparty s financial position, and where it has been judged that normal repayment under the revised conditions will likely continue after the restructure. Loans renegotiated in that would otherwise be past due or impaired comprised R4,3 billion (2013: R6,7 billion). Of this amount, R3,4 billion (2013: R2,5 billion) of mortgage loans that would otherwise be past due or impaired were restructured during. Collateral The table on the following page shows the financial effect that collateral has on the group s maximum exposure to credit risk. The table is presented according to Basel asset categories and includes collateral that may not be eligible for recognition under Basel but that management takes into consideration in the management of the group s exposures to credit risk. All on- and off-balance sheet exposures that are exposed to credit risk, including non-performing loans, have been included. Collateral includes: financial securities that have a tradable market, such as shares and other securities physical items, such as property, plant and equipment financial guarantees, suretyships and intangible assets. 56 Risk and capital management report and annual financial statements

59 Netting agreements, which do not qualify for offset under IFRS but which are nevertheless enforceable, are included as part of the group s collateral for risk management purposes. All exposures are presented before the effect of any impairment provisions. In the retail portfolio, 56% (2013: 56%) is fully collateralised. The R4 138 million (2013: R2 703 million) of retail accounts that lie within the 0% to 50% range of collateral coverage mainly comprise accounts which are either in default or legal. The total average collateral coverage for all retail mortgage exposures in the 50% to 100% collateral coverage category is 90% (2013: 90%). Of the group s total exposure, 35% (2013: 36%) is unsecured and mainly reflects exposures to well-rated corporate counterparties, bank counterparties and sovereign entities. IFRS: Collateral Total exposure Unsecured Secured exposure Netting agreements Secured exposure after netting Total collateral coverage 0% to 50% 51% 100% >100% Corporate Sovereign Banks Retail Retail mortgage Other retail Total Add: financial assets not exposed to credit risk Less: impairments for loans and advances (18 707) Less: unrecognised off-balance sheet items ( ) Less: IFRS adjustment (1 384) Total exposure Reconciliation to SOFP Cash and balances with central banks Derivative assets Trading assets Pledged assets Financial investments Loans and advances Other financial assets Discontinued operation financial assets Total

60 Risk and capital management report Credit risk Banking operations continued IFRS: Collateral continued Total exposure Unsecured exposure Secured exposure Netting agreements Secured exposure after netting 0% 50% Total collateral coverage 51% 100% >100% 2013 Corporate Sovereign Banks Retail exposure Retail mortgage Other retail Total Add: financial assets not exposed to credit risk Less: impairments for loans and advances (19 166) Less: unrecognised off-balance sheet items ( ) Less: Tutuwa and treasury shares IFRS adjustment (1 018) Total exposure Reconciliation to SOFP Cash and balances with central banks Derivative assets Trading assets Pledged assets Financial investments Loans and advances Other financial assets Discontinued operation financial assets Total on-balance sheet exposure Risk and capital management report and annual financial statements

61 Insurance operations Consolidated mutual funds Liberty invests in mutual funds and is therefore also exposed to credit risk of the underlying assets in which the mutual funds are invested. Liberty s exposure to mutual funds is classified at fund level and not at the underlying asset level and, although mutual funds are not rated, fund managers are required to invest in credit assets within the defined parameters stipulated in the fund s mandate. These rules limit the extent to which fund managers can invest in unlisted and/or unrated credit assets and generally restrict funds to the acquisition of investment grade assets. Liberty assesses the funds in which it has invested to determine whether such funds are controlled by Liberty, in which case the funds are consolidated into Liberty s results and therefore the group s results. The mutual funds, into which Liberty and the group has invested and which are defined as subsidiaries, are managed by STANLIB Limited, a wholly-owned Liberty subsidiary, and other asset managers as selected and mandated by Liberty from time to time. 59

62 Risk and capital management report Credit risk Insurance operations continued Credit exposure to debt instruments The table below provides information regarding the aggregated credit risk exposure of Liberty to debt instruments categorised by credit ratings, if available, as at 31 December. Exposure to credit risk A- and above 1 Debt instruments Investment policies Local prepayments, insurance and other receivables 52 9 Foreign prepayments, insurance and other receivables Reinsurance assets 61 Derivatives and collateral deposits Loan receivables to joint ventures and associates Cash and cash equivalents Total assets bearing credit risk Credit exposure allocation estimated attributable to: Shareholders Policyholders Non-controlling interest and third party liabilities on mutual funds Total assets bearing credit risk ,2 Debt instruments Investment policies Local prepayments, insurance and other receivables 11 Foreign prepayments, insurance and other receivables Reinsurance assets Derivatives and collateral deposits Loan receivables to joint ventures and associates Cash and cash equivalents Total assets bearing credit risk Credit exposure allocation estimated attributable to: Shareholders Policyholders Non-controlling interest and third party liabilities on mutual funds Total assets bearing credit risk 1 As reported by Liberty, refer to Liberty s annual financial statements. 2 Restated. Refer to page 104. BBB+ 60 Risk and capital management report and annual financial statements

63 BBB BBB- BB+ BB BB- and below Not rated Pooled funds Total carrying value

64 Risk and capital management report Credit risk Insurance operations continued SIL has indirect exposure to debt instruments through its asset managers. Approximately 15% of SIL s assets are in a multi-manager fund with a return objective of CPI plus 3% of which less than 50% are in debt instruments. The asset manager s mandate also stipulates capital preservation in any one year. The majority of SIL s assets are invested in cash or cash equivalent instruments. Impairments Investment credit assets are valued on a fair value basis, with credit revaluations are reported in the income statement as and when these arise. Following the curatorship of ABL and consequential devaluation of their various issued financial instruments, losses have been incurred. These have mostly been borne by policyholders in terms of investment mandates with losses on shareholder exposures amounting to R20 million. Policyholder loans are carried at amortised costs. The table below therefore only indicates the impairments raised by Liberty against these financial assets. SIL has no recognised impairments. Financial assets impaired 2013 Loans 1, 2 Gross carrying value Less: accumulated impairment (33) (39) Net carrying value Reinsurance Reinsurance is used to manage insurance risk and consequently, in the liability valuation process, reinsurance assets are raised for expected recoveries on projected claims. This does not, however, discharge liability as primary insurer. In addition, reinsurance debtors are raised for specific recoveries on claims recognised. Creditworthiness is assessed prior to the appointment of reinsurers. Financial position strength, performance, track record, relative size or ranking within the industry and credit ratings of reinsurers are taken into account when determining the allocation of business to reinsurers. Credit exposure to reinsurers is also limited through the use of several reinsurers. These reinsurers are reviewed at least annually. The group is exposed to counterparty credit risk on investment reinsurance policies as well as the underlying debt instruments supporting the valuation of the policies. To further mitigate credit exposures to reinsurers the following checks are undertaken annually as a minimum: internal credit assessment of the creditworthiness of the reinsurers analyses of reports on reinsurers claim paying abilities as assessed by reputable ratings agencies analyses of valuators certificates audits of administration processes of reinsurers to whom Liberty has larger exposures reviews and renegotiation of reinsurance agreements. 1 Loans, comprising of policy loans, are impaired when the amount of the loan exceeds the policyholder s investment balance. The fair value of loans is R1 194 million (2013: R1 091 million). The loans are recoverable through offset against policyholders investment balances at policy maturity date. 2 As reported by Liberty. Refer to Liberty annual financial statements. 62 Risk and capital management report and annual financial statements

65 Compliance risk 63 Definition 63 Approach to managing compliance risk 63 General approach 64 Approach to market conduct 64 Approach to managing money laundering and terrorist financing 64 Approach to sanctions management 64 Approach to managing regulatory change 64 Approach to occupational health and safety 64 Governance Definition Compliance risk is the risk of legal or regulatory sanction, financial loss or damage to reputation that the group may suffer as a result of its failure to comply with laws, regulations, codes of conduct and standards of good practice applicable to its financial services activities. This includes addressing new laws as well as amendments to existing laws by regulatory authorities. Approach to managing compliance risk General approach The compliance function operates independently of business as a second line of defence in terms of its mandate. The mandate is approved annually by the GAC and is drawn primarily from Regulation 49 of the Banks Act. All compliance teams report through compliance executives to the GCCO. The group s approach to managing compliance risk is proactive and premised on internationally accepted principles of compliance risk management and supervisory expectations. Compliance risk management is a core risk management activity overseen by the GCCO. The GCCO has unrestricted access to the group chief executives and to the chairman of the GAC, thereby facilitating the function s independence. A robust risk management reporting and escalation procedure requires business unit and functional area compliance heads to report on the status of compliance risk management in the group to the GCCO, who escalates significant matters to group management and both executive and independent board committees. There is a key focus on TCF and market conduct as the South African regulatory framework moves towards a Twin Peaks model of supervision. This model of regulation will create two regulators for the financial sector: a prudential regulator regulating the solvency and liquidity of the financial services sector a market conduct regulator regulating how financial services institutions conduct their business and treat their customers. The anti-money laundering and combating the financing of terrorism function includes the group sanctions desk and has expanded its human resourcing and technical surveillance capability extensively to meet the group s supervisory expectations. 63

66 Risk and capital management report Compliance risk Approach to managing compliance risk continued Employees, including senior management, are made aware of their statutory compliance responsibilities through ongoing training and awareness initiatives. Approach to market conduct Conduct risk is defined by the group as the risk that detriment is caused to the group s clients, the markets or the group itself because of inappropriate execution of business activities. We anticipate that market conduct supervision will intensify under Twin Peaks. The group has thus actively responded to TCF by assigning oversight accountability to the social and ethics committee. Responsibility for the delivery of the fairness outcomes has been delegated to executives to ensure that we drive a fairness culture from the top. Strategy and business models are being interrogated from a market conduct perspective and risk standards, policies and governance frameworks are being reviewed from a conduct risk perspective. TCF is also considered in decision-making, communication, performance, reward and recognition. This outcomes-based approach to the conduct of business casts a fresh perspective on every stage in the product life cycle, raising the standards of how we do business to benefit consumers and increasing their confidence in the financial services industry. Approach to managing money laundering and terrorist financing Legislation pertaining to money laundering and terrorist financing control imposes significant requirements in terms of customer due diligence, record keeping, staff training and the obligation to detect, prevent and report suspected money laundering and terrorist financing. The group subscribes to the principles of the Financial Action Task Force, an intergovernmental body that develops and promotes policies to combat money laundering and terrorist financing. An integrated systems approach is being followed to support surveillance and reporting responsibilities. Group minimum standards are implemented throughout the group, taking into account local jurisdictional requirements. Approach to sanctions management The group actively manages the legal, regulatory, reputational and operational risks associated with doing business in jurisdictions which, or with clients who, are subject to embargoes or sanctions imposed by competent authorities. Sanctions surveillance capability has been enhanced to manage sanctions alerts and the staff complement has been increased to meet supervisory expectations. The group sanctions review committee, supported by a sanctions desk, is responsible for providing advice on all sanctions-related matters in a fluid sanctions environment. Approach to managing regulatory change The group operates in a highly regulated industry across multiple jurisdictions and is increasingly subject to international legislation with extra-territorial reach. The group aims to embed regulatory best-practice in our operations in a way that balances the interests of various stakeholders, while supporting the long-term stability and growth in the markets where we have a presence. The group s regulatory advocacy unit assesses the impact that emerging policy and regulation will have on the business. The group s approach to regulatory advocacy is to engage with government policymakers, legislators and regulators in a proactive and constructive manner. The group regulatory and legislative oversight committee (a subcommittee of GROC) enhances regulatory risk management by proactively considering the impacts of regulatory developments on the group. Approach to occupational health and safety Any risks to the health and safety of employees resulting from hazards in the workplace or potential exposure to occupational illness are managed by the occupational health and safety team and are supported by executive management accountability structures. Training of health and safety officers and employee awareness is ongoing. Recent reporting periods have indicated a reduction in reportable incidents. Governance The primary management level governance committee overseeing compliance risk is the group compliance committee. It is chaired by the GCCO and is a subcommittee of GROC. Compliance is now also represented on the group management committee which facilitates executive awareness of compliance risk-related matters. The group compliance committee reports, through the GCCO, to both GAC and GRCMC. The principal governance document is the compliance risk governance standard. 64 Risk and capital management report and annual financial statements

67 Country risk 65 Definition 65 Approach to managing compliance risk 65 Governance 66 Approved regulatory capital approaches 66 Country risk portfolio characteristics and metrics Definition Country risk, also referred to as cross-border country risk, is the uncertainty that obligors (including the relevant sovereign, and including the obligations of group branches and subsidiaries in a country) will be able to fulfil obligations to the group given political or economic conditions in the host country. Approach to managing country risk All countries to which the group is exposed are reviewed at least annually. Internal rating models are employed to determine ratings for country, sovereign and transfer and convertibility risk. In determining the ratings, extensive use is made of the group s network of operations, country visits and external information sources. These ratings are also a key input into the group s credit rating models, with credit loan conditions and covenants linked to country risk events. The model inputs are continuously updated to reflect economic and political changes in countries. The model outputs are internal risk grades that are calibrated to a country risk grade (CR) from CR01 to CR25, as well as sovereign risk grade (SB) and transfer and convertibility risk grade (SB) from SB01 to SB25. Countries rated CR08 and higher, referred to as medium- and high-risk countries, are subject to increased analysis and monitoring. Country risk is mitigated through a number of methods, including: political and commercial risk insurance co-financing with multilateral institutions structures to mitigate transferability and convertibility risk such as collection, collateral and margining deposits outside the jurisdiction in question. Governance The primary management level governance committee overseeing this risk type is the group country risk management committee. It is chaired by the group CRO and is a subcommittee of GROC. The principal governance documents are the country risk governance standard and the model risk governance standard. 65

68 Risk and capital management report Country risk continued Approved regulatory capital approaches There are no regulatory capital requirements for country risk. Country risk is, however, incorporated into regulatory capital for credit in the IRB approaches through the country risk and transfer and convertibility risk ratings impact on credit grades. Country risk portfolio characteristics and metrics The risk distribution of cross-border country risk exposures is weighted towards European and North American low-risk countries, as well as sub-saharan African medium- and high-risk countries. Country risk exposure by region and risk grade Europe % Asia % North America % Sub- Saharan Africa % Latin America % Middle East and North Africa % Australasia % Risk grade CR01-CR CR08-CR CR12-CR CR15-CR CR18-CR CR Risk grade CR01-CR CR08-CR CR12-CR CR15-CR CR18-CR CR Total medium- and high-risk country risk exposures and total low-risk country risk exposures for the year ended 31 December amounted to USD17 billion and USD10 billion, respectively (2013: USD18 billion and USD14 billion, respectively). Medium and high risk country exposure by region (%) CR08 CR11 CR12 CR14 CR15 CR17 CR18 CR21 CR22+ Europe Asia North America Sub-Saharan Africa Latin America Middle East and North Africa Australasia 66 Risk and capital management report and annual financial statements

69 Exposure to the top five medium- and high-risk countries is shown together with comparatives in the graph that follows. These exposures are in line with the group s growth strategy focused on Africa and selected emerging markets. Top five medium and high risk country risk EAD (USDm) China Nigeria Zambia Kenya Ghana 2013 Medium and high risk country EAD concentration by country rating (%) CR08 CR09 CR10 CR11 CR12 CR13 CR14 CR15 CR16 CR17 CR18 CR19 CR20 CR21 CR

70 Funding and liquidity risk 68 Definition 68 Banking operations 68 Approach to managing liquidity risk 70 Governance 70 Liquidity characteristics and metrics 74 The group s credit ratings 74 Conduits 74 Insurance operations 74 Long-term insurance 76 Short-term insurance Definition Liquidity risk is defined as the risk that an entity, although solvent, cannot maintain or generate sufficient cash resources to meet its payment obligations in full as they fall due, or can only do so at materially disadvantageous terms. Banking operations The group s liquidity risk framework is designed to ensure the comprehensive management of liquidity risks within the group in all geographies and that regulatory, prudential as well as internal minimum requirements are met at all times. This is achieved through a combination of maintaining adequate liquidity buffers to ensure that cash flow requirements can be met and ensuring that the group s SOFP is structurally sound and supportive of the group s strategy. Liquidity risk is managed on a consistent basis across the group s banking subsidiaries, allowing for local requirements. Information relating to the year ended 31 December is based on Basel III principles, including behavioural profiling methods and assumptions, as well as phasing-in requirements where applicable. As a result, in preparation for the implementation of Basel III, liquidity policies and calculations were reviewed and updated accordingly. Approach to managing liquidity risk The nature of the group s banking and trading activities gives rise to continuous exposure to liquidity risk. Liquidity risk arises when the group, despite being solvent, cannot maintain or generate sufficient cash resources to meet its payment obligations as they fall due, or can only do so at materially disadvantageous terms. This type of event may arise where counterparties, who provide the group with short-term funding, withdraw or do not roll over that funding, or normally liquid assets become illiquid as a result of a generalised disruption in asset markets. The group manages liquidity in accordance with applicable regulations and within the group s risk appetite framework. The group s liquidity risk management governance framework supports the measurement and management of liquidity across both the corporate and retail sectors to ensure that payment obligations can be met by the group s legal entities, under both normal and stressed conditions. Liquidity risk management ensures that the group has the appropriate amount, diversification and tenor of funding and liquidity to support its asset base at all times. 68 Risk and capital management report and annual financial statements

71 The group manages liquidity risk as three interrelated pillars, which are aligned to Basel III liquidity requirements. Liquidity management categories Tactical (shorter-term) liquidity risk management Structural (long-term) liquidity risk management Contingency liquidity risk management manage intra-day liquidity positions monitor interbank and repo shortage levels monitor daily cash flow requirements manage short-term cash flows manage daily foreign currency liquidity set deposit rates in accordance with structural and contingent liquidity requirements as informed by ALCO. ensure a structurally sound balance sheet identify and manage structural liquidity mismatches determine and apply behavioural profiling manage long-term cash flows preserve a diversified funding base inform term funding requirements assess foreign currency liquidity exposures establish liquidity risk appetite ensure appropriate transfer pricing of liquidity costs ensure Basel III NSFR readiness by 1 January monitor and manage early warning liquidity indicators establish and maintain contingency funding plans undertake regular liquidity stress testing and scenario analysis convene liquidity crisis management committees, if needed set liquidity buffer levels in accordance with anticipated stress events advise diversification of liquidity buffer portfolios ensure compliance with Basel III LCR from 1 January As from 1 January 2015, the group is required to comply with the LCR, a metric introduced by the BCBS to measure a bank s ability to manage a sustained outflow of customer funds in an acute stress event over a 30-day period. The ratio is calculated by taking the group s high-quality liquid assets (HQLA) and dividing it by net cash outflows. The minimum regulatory LCR requirement effective 1 January 2015 is 60%, increasing by 10% annually to reach 100% by 1 January The group is on track to meet the minimum phased-in Basel III LCR standards and as at 31 December, exceeded the 60% minimum requirement. From 2018, the group will also be required to comply with the Basel III NSFR, a metric designed to ensure that the majority of term assets are funded by stable sources, such as capital, term borrowings or funds from stable sources. The final BCBS NSFR framework was issued in October. Basel III implementation timeline Liquidity LCR NSFR Bank disclosure starts Bank disclosure starts 60% minimum standard 70% minimum standard 80% minimum standard 90% minimum standard 100% 100% 100% 69

72 Risk and capital management report Funding and liquidity risk Banking operations continued Governance The primary governance committee overseeing liquidity risk is the group ALCO, which is chaired by the group financial director and is a subcommittee of GROC. ALCOs have been established in each of the banking subsidiaries of the group and manage in-country liquidity risk. The principal governance documents are the liquidity risk governance standard and model risk governance standard. Liquidity characteristics and metrics Contingency liquidity risk management Contingency funding plans Contingency funding plans are designed to protect stakeholder interests and maintain market confidence in the event of a liquidity crisis. The plans incorporate an early warning indicator process supported by clear crisis response strategies. Early warning indicators cover bank-specific and systemic crises and are monitored according to assigned frequencies and tolerance levels. Crisis response strategies are formulated for the relevant crisis management structures and address internal and external communications and escalation processes, liquidity generation management actions and operations, and heightened and supplementary information requirements to address the crisis event. The updating of contingency funding plans while considering budget forecasting continues to be a focus for the ALM teams across the group. The group submits its recovery plan to the SARB on an annual basis, in line with the SARB s requirement for banks to submit a recovery and resolution plan. The group s recovery plan incorporates the contingent liquidity funding plan in addition to the focus given to capital planning and business continuity planning. Liquidity stress testing and scenario analysis Stress testing and scenario analysis are based on hypothetical as well as historical events. These are conducted on the group s funding profiles and liquidity positions. The crisis impact is typically measured over a 30 calendar day period as this is considered the most crucial time horizon for a liquidity event. This measurement period is also consistent with the Basel III LCR requirements. This measure is, however, adapted to meet different regulatory environments. Internal stress testing metrics are supplemented with the regulatory Basel III LCR in monitoring the group s ability to survive severe stress scenarios. Liquidity buffer Portfolios of highly marketable liquid securities to meet prudential, regulatory and internal stress testing requirements are maintained as protection against unforeseen disruptions in cash flows. These portfolios are managed within ALCO-defined limits on the basis of diversification and liquidity. The table below provides a breakdown of the group s liquid and marketable securities as at 31 December and 31 December Eligible Basel III LCR HQLA are defined according to the BCBS January 2013 LCR and liquidity risk monitoring tools framework. Management liquidity represents unencumbered marketable securities other than eligible Basel III LCR HQLA (excluding trading assets) which would be able to provide significant sources of liquidity in a stress scenario. Total liquidity Rbn 2013 Rbn Eligible LCR HQLA 1 comprising: 174,2 129,7 Notes and coins 19,0 15,9 Cash and deposits with central banks 45,7 33,4 Government bonds and bills 97,7 70,6 Other eligible liquid assets 11,8 9,8 Management liquidity 121,9 108,8 Total liquidity 296,1 238,5 Total liquidity as a % of funding-related liabilities 25.5% 23.2% 1 Eligible LCR HQLA considers any liquidity transfer restrictions that will inhibit the transfer of HQLA across jurisdictions. Liquid assets held remain adequate to meet all internal stress testing, prudential and regulatory requirements. Anticipated on- and off-balance sheet cash flows are subjected to a variety of bank-specific and systemic stresses and scenarios to evaluate the impact of unlikely but plausible events on liquidity positions. The results are assessed against the liquidity buffer and contingency funding plans to provide assurance as to the group s ability to maintain sufficient liquidity under adverse conditions. 70 Risk and capital management report and annual financial statements

73 Structural liquidity mismatch Maturity analysis of financial liabilities using behavioural profiling With actual cash flows typically varying significantly from the contractual position, behavioural profiling is applied to assets, liabilities and off-balance sheet commitments as well as to certain liquid assets. Behavioural profiling assigns probable maturities based on historical customer behaviour. This is used to identify significant additional sources of structural liquidity in the form of core deposits, such as current and savings accounts, which exhibit stable behaviour despite being repayable on demand or at short notice. Structural liquidity mismatch analyses are performed regularly to anticipate the mismatch between payment profiles of SOFP items, in order to highlight potential risks within the group s defined liquidity risk thresholds. The graph alongside shows the group s cumulative maturity mismatch between assets and liabilities for the 0 to 12 months bucket, after applying behavioural profiling. The cumulative maturity is expressed as a percentage of the group s total funding-related liabilities. Expected aggregate cash outflows are subtracted from expected aggregate cash inflows. Limits are set internally to restrict the cumulative liquidity mismatch between expected inflows and outflows of funds in different time buckets. These mismatches are monitored on a regular basis with active management intervention if potential limit breaches are evidenced. Liquidity transfer restrictions across the group are considered as part of the prudent liquidity risk management assumptions that are followed. The behaviourally adjusted cumulative liquidity mismatch remains within the group s liquidity risk appetite. Whilst following a consistent approach to liquidity risk management in respect of the foreign currency component of the balance sheet, specific indicators are observed in order to monitor changes in market liquidity as well as the impacts on liquidity as a result of movements in exchange rates. Behaviourally adjusted cumulative liquidity mismatch 1 (%) (5) (10) (15) (20) (25) 0 7 days 0 1 month 0 3 months December December % of funding-related liabilities. 0 6 months 0 12 months Internal limit Maturity analysis of financial liabilities by contractual maturity The table that follows analyses cash flows on a contractual, undiscounted basis based on the earliest date on which the group can be required to pay (except for trading liabilities and derivative liabilities, which are presented as redeemable on demand) and will, therefore, not agree directly to the balances disclosed in the consolidated statement of financial position. Derivative liabilities are included in the maturity analysis on a contractual, undiscounted basis when contractual maturities are essential for an understanding of the derivatives future cash flows. Management considers only contractual maturities to be essential for understanding the future cash flows of derivative liabilities that are designated as hedging instruments in effective hedge accounting relationships. All other derivative liabilities, together with trading liabilities are treated as trading and are included at fair value in the redeemable on demand bucket since these positions are typically held for short periods of time. The table also includes contractual cash flows with respect to off-balance sheet items which have not yet been recorded on-balance sheet. Where cash flows are exchanged simultaneously, the net amounts have been reflected. 71

74 Risk and capital management report Funding and liquidity risk Banking operations continued Maturity analysis of financial liabilities by contractual maturity Redeemable on demand Maturing within 1 month Maturing between 1 6 months Maturing between 6 12 months Maturing after 12 months 1 Financial liabilities Derivative financial instruments Instruments settled on a net basis Instruments settled on a gross basis (17) Trading liabilities Deposit and current accounts Subordinated debt Other Total Unrecognised financial instruments Letters of credit and bankers acceptances Guarantees Irrevocable unutilised facilities Commodities and securities borrowing transactions Total , 2 Financial liabilities Derivative financial instruments Instruments settled on a net basis Instruments settled on a gross basis Trading liabilities Deposit and current accounts Subordinated debt Other Total Unrecognised financial instruments Letters of credit and bankers acceptances Guarantees Irrevocable unutilised facilities Commodities and securities borrowing transactions Total The amounts presented exclude the discontinued operation. 2 Restated. Refer to page 104. Total 72 Risk and capital management report and annual financial statements

75 Funding activities Funding markets are evaluated on an ongoing basis to ensure appropriate group funding strategies are executed depending on the market, competitive and regulatory environment. The group continued to focus on building its deposit base as a key component of the group s funding mix. Deposits sourced from South Africa and other major jurisdictions in the rest of Africa, Isle of Man and Jersey provide diversity of stable sources of funding for the group. Primary funding sources are in the form of deposits across a spectrum of retail and wholesale clients, as well as loan and debt capital markets across the group. Total funding-related liabilities grew from R1 029 billion in 2013 to R1 161 billion in. Funding diversification by product (%) Concentration risk limits are used within the group to ensure that funding diversification is maintained across products, sectors, geographic regions and counterparties. Depositor concentrations % % Single depositor Top 10 depositors Restated. Refer to page 104. A component of the group's funding strategy is to ensure that sufficient contractual term funding is raised in support of term lending and to ensure adherence to the structural mismatch tolerance limits and appetite guidelines. The group successfully accessed the longer-term funding market during raising R32,2 billion through a combination of senior and subordinated debt, and syndicated loans. Notably, SBSA issued R2,25 billion of the group s first Basel III compliant tier II instruments. 22 Call deposits (2013: 22) 21 Term deposits (2013: 21) 16 Current accounts (2013: 17) 11 Cash management deposits (2013: 12) 10 Deposits from banks and central banks (2013: 7) 8 Negotiable certificates of deposits (2013: 9) 6 Senior and subordinated debt (2013: 6) 4 Other funding (2013: 4) 2 Savings accounts (2013: 2) Funding-related liabilities composition Rbn Rbn Corporate funding Retail deposits Institutional funding Deposits from banks Non-current funding-related liabilities held for sale Government and parastatals Senior debt Subordinated debt Other liabilities to the public 3 5 Total funding-related liabilities The graph below is a representation of the market cost of liquidity, which is measured as the spread paid on the negotiable certificates of deposits (NCDs) relative to the prevailing swap curve for that tenor. The graph is based on actively-issued money market instruments by banks, namely 12- and 60-month NCDs. During the year under review, long-term funding spreads increased due to the increased supply of bank issuance in money markets and debt capital markets, and lower demand for term bank credit given the ABL curatorship. 12 and 60 month liquidity spread (bps) December 2010 December 2011 December 2012 December month liquidity spread 60-month liquidity spread December 1 Restated. Refer to page Comprises of individual and small business customers. 73

76 Risk and capital management report Funding and liquidity risk Banking operations continued The group s credit ratings The group s ability to access funding at cost-effective levels is dependent on maintaining or improving the borrowing entity s credit rating. The following table provides a summary of the major credit ratings for the group and its principal operating subsidiary, SBSA. Credit ratings Long-term SBG foreign currency issuer default rating SBSA foreign currency issuer default rating RSA sovereign foreign currency issuer rating SBG issuer rating SBSA foreign currency deposit rating RSA sovereign foreign currency rating Fitch BBB BBB BBB Moody s Baa3 Baa2 Baa2 Credit ratings for SBSA are dependent on multiple factors, including the sovereign rating, capital adequacy levels, quality of earnings, credit exposure, the credit risk governance framework and funding diversification. These parameters and their possible impact on the borrowing entity s credit rating are monitored closely and incorporated into the group s liquidity risk management and contingency planning considerations. A reduction in these ratings could have an adverse effect on the group s access to liquidity sources and funding costs, may trigger collateral calls or lead to the activation of downgrade clauses and early termination associated with certain structured deposits. Rating downgrades will reduce thresholds above which collateral must be posted with counterparties to cover the group s negative mark-to-market on derivative contracts. These are managed within the liquidity management pillar. The potential cumulative impact on additional collateral requirements is as follows: 1, 2 and 3 notch rating downgrades Impact on the group s liquidity of a collateral call linked to downgrading by December December notch notch notch Restated refer to page 104. Conduits The group provides standby liquidity facilities to two conduits, namely BTC and Thekwini Warehouse Conduit. These facilities, which totalled R4,9 billion as at 31 December (2013: R6,8 billion), had not been drawn on. The liquidity risk associated with these facilities is managed in accordance with the group s overall liquidity position and represents less than 2% of the group s total funding (2013: 2%). The liquidity facilities are included in both the group s structural liquidity mismatch as well as in liquidity risk stress testing. Insurance operations The principal risk relating to long-term insurance operations is a function of policyholder behaviour. For short-term insurance operations it is a function of the variation in actual claims and expenses from expected claims and expenses. Liquidity requirements are reviewed on a monthly basis. These requirements are also monitored on an ongoing basis as part of normal operating activities. Long-term insurance Financial, property and insurance asset liquidity , 2 % % Liquid Medium Illiquid As reported by Liberty. Refer to Liberty s annual financial statements. 2 Restated. Refer to page Liquid assets are those that are considered to be realisable within one month (for example, cash, listed equities and term deposits). 4 Medium assets are those that are considered to be realisable within six months (for example, unlisted equities and certain unlisted term deposits). 5 Illiquid assets are those that are considered to be realisable in excess of six months (for example, investment properties). 74 Risk and capital management report and annual financial statements

77 Liquidity profile of assets Assets held are predominantly liquid. However, given the quantum of investments held relative to the volumes of trading within the relevant exchanges and counterparty transactions, a substantial short-term liquidation may result in current values not being realised. It is considered highly unlikely, however, that a short-term realisation of that magnitude would occur. As is the case with all insurance companies, no maturity profile can be reliably given for investments in mutual funds, equities and non-term financial debt instruments given the volatility of equity markets and uncertain policyholder behaviour. To the extent that Liberty s liabilities profile changes or policyholders choose to disinvest, Liberty uses its own balance sheet to avoid the need to sell assets under distressed circumstances. Accordingly, Liberty retains a conservative liquid asset coverage ratio backed by investments in high quality liquid assets. During, portfolios such as the STANLIB Institutional Money Market Fund experienced liquidity pressure as a result of the ABL curatorship. It was necessary to take the extraordinary step of creating African Bank Investments Limited Retention Funds (side-pockets), in effect ring fencing the ABL assets from the balance of this money market fund. The FSB approved the industry-wide side-pockets mechanism as a way to ensure equitable treatment for all investors in affected portfolios. Maturity profiles of financial instrument liabilities in long-term insurance operations The table below summarises the maturity profile of the financial instrument liabilities in the long-term insurance operations on the remaining undiscounted contractual obligations. This will, therefore, not equal the balances disclosed in the consolidated SOFP. Policyholders liabilities under investment contracts, investment contracts with discretionary participation features (DPFs) and insurance contracts are managed according to expected and not contractual cash flows, and hence are reflected in a separate table. Maturity profile of financial instrument liabilities contractual cash flows 0 3 months months 1 5 years 6 10 years Variable At amortised cost Subordinated notes Redeemable preference shares Third-party financial liabilities arising on consolidation of mutual funds Insurance and other payables Total At amortised cost Subordinated notes Redeemable preference shares Non-controlling interests loan Third-party financial liabilities arising on consolidation of mutual funds Insurance and other payables Total months are either due within the time frame or are payable on demand. 2 No fixed maturity date, however, redeemable with a two-year notice period at the instance of the company or the holder. Total 75

78 Risk and capital management report Funding and liquidity risk Insurance operations continued Liquidity risks arising from long-term insurance obligations to policyholders The following table indicates liquidity needs with respect to expected cash flows required to meet obligations arising under investment contracts, investment contracts with DPFs and insurance contracts. All the cash flows are shown gross of reinsurance on an undiscounted basis. Expected cash flows long-term insurance contracts Within 1 year 1 5 years 6 10 years years Over 20 years Effect of discounting cash flows Investment contracts (1 544) Investment with DPF Insurance contracts (77 377) Total (78 921) Investment contracts (380) Investment with DPF Insurance contracts (58 696) Total (59 076) Total The table below shows the cash surrender value for long-term insurance policyholders liabilities. The rand amount payable on surrender, on contracts which provide a surrender value, is closely related to the carrying value. For the majority of unit-linked contracts the surrender value adjusts to the respective realisation values as surrender instructions are executed. Therefore the impact of market risk adjustments on surrender lies largely with the policyholder. Cash surrender value for policyholders liabilities Carrying value 2013 Surrender value Carrying value Surrender value Investment contracts Investment contracts with DPF Insurance contracts Total policyholders liabilities Liquidity requirements associated with issuance of subordinated debt The FSB s approval of Liberty s issuance of subordinated debt, namely R3,5 billion callable capital bonds, includes a requirement to hold qualifying liquid assets in a manner prescribed by the FSB. As at 31 December and 2013, this requirement has been met and attested to by the statutory actuary of Liberty. Short-term insurance SIL manages its liquidity risk in accordance with its risk appetite statement. This covers monitoring available liquid assets against immediate expenses, and includes the impact of unexpected losses from several catastrophic events. SIL manages liquidity risk on a stand-alone basis with no reliance on the group to provide contingent funding. 76 Risk and capital management report and annual financial statements

79 Market risk 77 Definition 77 Banking operations 77 Governance 77 Approved regulatory capital approaches 78 Trading book market risk 81 Interest rate risk in the banking book 83 Equity risk in the banking book 84 Foreign currency risk 85 Own equity-linked transactions 86 Insurance operations 86 Long-term insurance 90 Short-term insurance Definition Market risk is the risk of a change in the market value, actual or effective earnings, or future cash flows of a portfolio of financial instruments, including commodities, caused by adverse movements in market variables such as equity, bond and commodity prices, currency exchange and interest rates, credit spreads, recovery rates, correlations and implied volatilities in all of these variables. The group s key market risks are: trading book market risk IRRBB equity risk in the banking book foreign currency risk own equity-linked transactions. Banking operations Governance The governance management level committees overseeing market risk are group ALCO, which is chaired by the group financial director, and the group equity risk committee, which is chaired by the CIB CRO. Both are subcommittees of GROC. The principal governance documents are the market risk governance standard and the model risk governance standard. Approved regulatory capital approaches The group has approval from the SARB to adopt the internal models approach for most asset classes and across most market variables. For material equity portfolios, the group has approval from the SARB to adopt either the market-based or PD/LGD approach. There are no regulatory capital requirements for IRRBB, structural foreign exchange exposures or own equity-linked transactions. 77

80 Risk and capital management report Market risk Banking operations continued Trading book market risk Definition Trading book market risk is represented by financial instruments, including commodities, held in the trading book, arising out of normal global market s trading activity. Approach to managing market risk in the trading book The group s policy is that all trading activities are undertaken within the group s global markets operations. The market risk functions are independent of trading operations and are accountable to the relevant legal entity ALCOs. ALCOs have a reporting line into group ALCO, a subcommittee of GROC. All VaR and SVaR limits require prior approval from the respective entity ALCOs. The market risk functions have the authority to set these limits at a lower level. Market risk teams are responsible for identifying, measuring, managing, monitoring and reporting market risk as outlined in the market risk governance standard. Exposures and excesses are monitored and reported daily. Where breaches in limits and triggers occur, actions are taken by market risk functions to bring exposures back in line with approved market risk appetite, with such breaches being reported to management and entity ALCOs. Measurement The techniques used to measure and control trading book market risk and trading volatility include VaR and SVaR, stop-loss triggers, stress tests, backtesting and specific business unit and product controls. VaR and SVaR The group uses the historical VaR and SVaR approach to quantify market risk under normal and stressed conditions. For risk management purposes VaR is based on 251 days of unweighted recent historical data, a holding period of one day and a confidence level of 95%. The historical VaR results are calculated in four steps: Calculate 250 daily market price movements based on 251 days historical data. Calculate hypothetical daily profit or loss for each day using these daily market price movements. Aggregate all hypothetical profits or losses for day one across all positions, giving daily hypothetical profit or loss, and then repeat for all other days. VaR is the 95th percentile selected from the 250 days of daily hypothetical total profit or loss. Daily losses exceeding the VaR are likely to occur, on average, 13 times in every 250 days. SVaR uses a similar methodology to VaR, but is based on a period of financial stress and assumes a 10-day holding period and a 99% confidence interval. Where the group has received internal model approval, the market risk regulatory capital requirement is based on VaR and SVaR, both of which use a confidence level of 99% and a 10-day holding period. Limitations of historical VaR are acknowledged globally and include: The use of historical data as a proxy for estimating future events may not encompass all potential events, particularly those which are extreme in nature. The use of a one-day holding period assumes that all positions can be liquidated or the risk offset in one day. This will usually not fully reflect the market risk arising at times of severe illiquidity, when a one-day holding period may be insufficient to liquidate or hedge all positions fully. The use of a 95% confidence level, by definition, does not take into account losses that might occur beyond this level of confidence. VaR is calculated on the basis of exposures outstanding at the close of business and, therefore, does not necessarily reflect intra-day exposures. VaR is unlikely to reflect loss potential on exposures that only arise under significant market moves. Trading book credit risk Credit issuer risk is assumed in the trading book by virtue of normal trading activity, and managed according to the market risk governance standard. These exposures arise from, inter alia, trading in debt securities issued by corporate and government entities as well as trading derivative transactions with other banks and corporate clients. The credit spread risk is incorporated into the daily price movements used to compute VaR and SVaR mentioned above. The VaR models used for credit risk are only intended to capture the risk presented by historical day-to-day market movements, and therefore do not take into account instantaneous or jump to default risk. Issuer risk is incorporated in the standardised approach interest rate risk charge for SBSA and in the regulatory approved incremental risk charge (non-var-based model) for Standard Bank Plc. The largest single issuer risk exposure is to the SA Sovereign with an EAD of R million (2013: R8 933 million). Stop-loss triggers Stop-loss triggers are used to protect the profitability of the trading desks, and are monitored by market risk on a daily basis. The triggers constrain cumulative or daily trading losses through acting as a prompt to a review or close-out positions. Stress tests Stress testing provides an indication of the potential losses that could occur under extreme but plausible market conditions, including where longer holding periods may be required to exit positions. Stress tests comprise individual market risk factor testing, combinations of market factors per trading desk and combinations of trading desks using a range of historical, hypothetical and Monte Carlo simulations. Daily losses experienced during the year ended 31 December did not exceed the maximum tolerable losses as represented by the group s stress scenario limits. 78 Risk and capital management report and annual financial statements

81 Backtesting The group backtests its VaR models to verify the predictive ability of the VaR calculations and ensure the appropriateness of the models within the inherent limitations of VaR. Backtesting compares the daily hypothetical profit and losses under the one-day buy and hold assumption to the prior day s calculated VaR. In addition, VaR is tested by changing various model parameters, such as confidence intervals and observation periods to test the effectiveness of hedges and risk-mitigation instruments. Refer to the graph below for the results of the group s backtesting for the year ended 31 December. The drop in oil prices caused currencies and interest rates of oil producing countries to be volatile in December, giving rise to an increase in backtesting exceptions. Regulators categorise a VaR model as green, amber or red and assign regulatory capital multipliers based on this categorisation. A green model is consistent with a satisfactory VaR model and is achieved for models that have four or less backtesting exceptions in a 12-month period. All the group s approved models were assigned green status for the year ended 31 December (2013: green). Eleven exceptions occurred during the year ended December (December 2013: 8) for 95% VaR and 1 exception (December 2013: 2) for 99% VaR. Backtesting: Hypothetical profit/loss of trading units and VaR global () (20) (40) (60) (80) (100) (120) January December Hypothetical profit/loss 95% VaR (including diversification benefits) 99% VaR (including diversification benefits) 1 Includes outside Africa global market. Backtesting: Hypothetical profit/loss of trading units and VaR outside Africa () (20) (40) (60) (80) (100) January December Hypothetical profit/loss 95% VaR (including diversification benefits) 99% VaR (including diversification benefits) 79

82 Risk and capital management report Market risk Banking operations continued Backtesting: Hypothetical profit/loss of trading units and VaR Africa () (20) (40) (60) (80) (100) January December Hypothetical profit/loss 95% VaR (including diversification benefits) 99% VaR (including diversification benefits) Specific business unit and product controls Other market risk limits and controls specific to individual business units include permissible instruments, concentration of exposures, gap limits, maximum tenor, stop-loss triggers, price validation and balance sheet substantiation. Trading book portfolio characteristics VaR for the period under review Trading book market risk exposures arise mainly from residual exposures from client transactions and limited trading for the group s own account. In general, the group s trading desks have run similar levels of market risk throughout the year when compared to Trading book normal VaR analysis by market variable Maximum 1 Minimum 1 Normal VaR Average Closing Commodities risk 19,8 8,4 13,3 14,2 Foreign exchange risk 18,6 5,3 10,2 17,8 Equity position risk 18,2 2,5 8,6 6,1 Debt securities 55,0 23,6 36,2 27,5 Diversification benefits 2 (27,5) (25,6) Aggregate 52,0 27,9 40,8 40, Commodities risk 28,4 7,7 14,4 9,5 Foreign exchange risk 20,3 6,9 10,9 10,9 Equity position risk 21,7 7,5 15,7 9,8 Debt securities 61,7 32,3 42,8 37,3 Diversification benefits 2 (37,9) (29,6) Aggregate 64,7 32,8 45,8 37,8 1 The maximum and minimum VaR figures reported for each market variable do not necessarily occur on the same day. As a result, the aggregate VaR will not equal the sum of the individual market VaR values, and it is inappropriate to ascribe a diversification effect to VaR when these values may occur on different dates. 2 Diversification benefit is the benefit of measuring the VaR of the trading portfolio as a whole, that is, the difference between the sum of the individual VaRs and the VaR of the whole trading portfolio. 80 Risk and capital management report and annual financial statements

83 Trading book stressed VaR analysis Maximum Minimum Stressed VaR Average Closing Pre-diversification 722,0 703,1 Aggregate 676,2 286,1 436,9 409, Pre-diversification 670,5 787,8 Aggregate 642,7 268,5 396,7 475,7 Analysis of trading profit The graph below shows the distribution of daily profit and losses for the period. It captures trading volatility and shows the number of days in which the group s trading-related revenues fell within particular ranges. The distribution is skewed favourably to the profit side. For the year ended 31 December, trading profit was positive for 247 out of 260 days (2013: 245 out of 259 days) on an aggregated global basis. Distribution of daily trading income () Frequency of days <(40) (40) (30) (20) (10) >130 Global Africa Outside Africa Interest rate risk in the banking book Definition This risk results from the different repricing characteristics of banking book assets and liabilities. IRRBB is further divided into the following sub-risk types: Repricing risk: timing differences in the maturity (fixed rate) and repricing (floating rate) of assets and liabilities. Yield curve risk: shifts in the yield curve that have adverse effects on the group s income or underlying economic value. Basis risk: hedge price not moving in line with the price of the hedged position. Examples include bonds/swap basis, futures/underlying basis and prime/johannesburg Interbank Agreed Rate (JIBAR) basis. Optionality risk: options embedded in bank asset and liability portfolios, providing the holder with the right, but not the obligation, to buy, sell, or in some manner alter the cash flow of an instrument or financial contract. Endowment risk: exposure arising from the net differential between interest rate insensitive assets such as non-earning assets, interest rate insensitive liabilities such as non-paying liabilities and equity. 81

84 Risk and capital management report Market risk Banking operations continued Approach to managing IRRBB Banking book-related market risk exposure principally involves managing the potential adverse effect of interest rate movements on banking book earnings (net interest income and banking book mark-to-market profit or loss) and the economic value of equity. The group s approach to managing IRRBB is governed by applicable regulations and is influenced by the competitive environment in which the group operates. The group s TCM team monitors banking book interest rate risk operating under the oversight of group ALCO. Measurement The analytical techniques used to quantify IRRBB include both earnings- and valuation-based measures. The analysis takes account of embedded optionality such as loan prepayments and accounts where the account behaviour differs from the contractual position. The results obtained from forward-looking dynamic scenario analyses, as well as Monte Carlo simulations, assist in developing optimal hedging strategies on a risk-adjusted return basis. Desired changes to a particular interest rate risk profile are achieved through the restructuring of on-balance sheet repricing or maturity profiles, or through derivative overlays. Limits Interest rate risk limits are set in relation to changes in forecast banking book earnings and the economic value of equity. The economic value of equity sensitivity is calculated as the net present value of aggregate asset cash flows less the net present value of aggregate liability cash flows. All assets, liabilities and derivative instruments are allocated to gap intervals based on either their repricing or maturity characteristics. Assets and liabilities for which no identifiable contractual repricing or maturity dates exist are allocated to gap intervals based on behavioural profiling. Hedging of endowment risk IRRBB is predominantly the consequence of endowment exposures, being the net effect of non-rate sensitive assets less non-rate sensitive liabilities and equity. The endowment risk is hedged using liquid instruments as and when it is considered opportune. Where permissible, hedge accounting is adopted using the derivatives designated as hedging instruments. Following meetings of the monetary policy committees, or notable market developments, the interest rate view is formulated through ALCO processes. Non-endowment IRRBB (repricing, yield curve, basis and optionality) is managed within the treasury and the global markets portfolios. Banking book interest rate exposure characteristics The table below indicates the rand equivalent sensitivity of the group s banking book earnings (net interest income and banking book mark-to-market profit or loss) and other comprehensive income (OCI) given a parallel yield curve shock. A floor of 0% is applied to all interest rates under the decreasing interest rate scenario resulting in asymmetric rate shocks in low-rate environments. Hedging transactions are taken into account while other variables are kept constant. Assuming no management intervention, a downward 100 basis point parallel interest rate shock across all foreign currency yield curves and a 200 basis point parallel interest rate shock across rand yield curves, would decrease the forecast 12-month net interest income on 31 December by R2,6 billion (2013: R2,7 billion). Interest rate sensitivity analysis 1 ZAR USD GBP Euro Other Total Increase in basis points Sensitivity of annual net interest income (11) Sensitivity of OCI 18 (74) (3) (149) (208) Decrease in basis points Sensitivity of annual net interest income (2 170) (103) (1) 1 (349) (2 622) Sensitivity of OCI (18) Increase in basis points Sensitivity of annual net interest income (1) Sensitivity of OCI (5) 9 (8) (172) (176) Decrease in basis points Sensitivity of annual net interest income (2 136) (199) 1 (368) (2 702) Sensitivity of OCI 5 (9) Before tax. 82 Risk and capital management report and annual financial statements

85 Equity risk in the banking book Definition Equity risk is defined as the risk of loss arising from a decline in the value of an equity or equity-type instrument held on the banking book, whether caused by deterioration in the underlying operating asset performance, net asset value, enterprise value of the issuing entity, or by a decline in the market price of the equity or instrument itself. Though issuer risk in respect of tradable equity instruments constitutes equity risk, such traded issuer risk is managed under the trading book market risk framework. Approach to managing equity risk in the banking book Equity risk relates to all transactions and investments subject to approval by the ERC, in terms of that committee s mandate, and includes debt, quasi-debt and other instruments that are considered to be of an equity nature. Equity risk excludes strategic investments by the group in subsidiaries, associates and joint ventures (other than those originated by the strategic investments and alliances business unit) deployed in delivering the group s business and service offerings unless the group financial director and group CRO deem such investments to be subject to the consideration and approval by the ERC. Governance committees The ERC is constituted as a subcommittee of GROC and operates under delegated authority from that committee, with additional reporting accountability to the CIB equity governance committee closed session. GROC grants the ERC authority to approve equity risk transactions to be held on the banking book and to manage such equity risk in accordance with the provisions of the group equity risk governance standard and associated policies. This includes the authority to: exercise such powers as are necessary to discharge its responsibilities in terms of this mandate seek independent advice at the group s expense, and investigate matters within its mandate delegate authority to a combination of ERC voting members based on the investment size. Equity banking book price risk sensitivity analysis The table below illustrates the market risk sensitivity for all non-trading equity investments assuming a 10% shift in the fair value. The analysis is shown before tax. Market risk sensitivity of non-trading equity investments 10% reduction Fair value 10% increase Equity securities listed and unlisted Impact on profit or loss (200) 200 Impact on OCI (20) Equity securities listed and unlisted Impact on profit or loss (284) 284 Impact on OCI (22) 22 Banking book equity portfolio characteristics Basel equity positions in the banking book Fair value Listed Unlisted Total Restated. Refer to page Banking book equity exposures are equity investments which comprise listed and unlisted private equity and strategic investments, and do not form part of the trading book. 83

86 Risk and capital management report Market risk Banking operations continued Foreign currency risk Definition The group s primary non-trading-related exposures to foreign currency risk arise as a result of the translation effect on the group s net assets in foreign operations, intragroup foreign-denominated debt and foreign-denominated cash exposures and accruals. Approach to managing foreign currency risk The group foreign currency management committee, a subcommittee of the group capital management committee, manages the risk according to existing legislation, South African exchange control regulations and accounting parameters. It takes into account naturally offsetting risk positions and manages the group s residual risk by means of forward exchange contracts, currency swaps and option contracts. Hedging is undertaken in such a way that it does not constrain normal operational activities. In particular, for banking entities outside of the South African common monetary area, the need for capital to fluctuate with risk-weighted assets is taken into account. The repositioning of the currency profile, which is coordinated at a group level, is a controlled process based on underlying economic views of the relative strength of currencies. The group does not ordinarily hold open exposures of any significance with respect to the banking book. Gains or losses on derivatives that have been designated as either net investment or cash flow hedging relationships are reported directly in OCI, with all other gains and losses on derivatives being reported in profit or loss. Foreign currency risk sensitivity analysis The table that follows reflects the expected financial impact, in rand equivalent, resulting from a 10% (2013: 10%) shock to foreign currency risk exposures, against ZAR. The sensitivity analysis is based on net open foreign currency exposures arising from designated net investment hedges, other derivative financial instruments, foreign-denominated cash balances and accruals and intragroup foreign-denominated debt. The sensitivity analysis reflects the sensitivity to equity and profit or loss on the group s foreign-denominated exposures other than those trading positions for which sensitivity has been included in the trading book VaR analysis. As indicated below, the impact of a 10% (2013: 10%) depreciation in foreign currency rates on the OCI and profit or loss of the group before tax is a R1 231 million gain (2013: R414 million gain). Foreign currency risk sensitivity in ZAR equivalents USD Euro GBP Naira Other Total Total net long/(short) position (5 786) (5 238) 998 (962) (1 322) (12 310) Sensitivity % Impact on OCI 578 (97) Impact on profit or loss 524 (2) (1) Total net long/(short) position (5 267) (244) (2 388) (3 921) Sensitivity % Impact on OCI 524 (260) Impact on profit or loss (136) 3 (1) (12) (146) 84 Risk and capital management report and annual financial statements

87 Own equity-linked transactions Definition The group has exposure to changes in its share price arising from its equity-linked remuneration contractual commitments. Details of the group s equity-linked share incentive schemes have been set out in annexure C of the annual financial statements. The group s remuneration report can be found in the annual integrated report on pages 133 to 161. Depending on the nature of the group s equity-linked share schemes, the group is exposed to either income statement risk or net asset value through equity risk (NAV risk) due to changes in its own share price as follows: Income statement risk arises as a result of losses being recognised in the group s income statement as a result of increases in the price of the group s share price on cash-settled share schemes above the award price. NAV risk arises as a result of the group settling an equity-linked share scheme at a higher price than the price at which the share incentive was awarded to the group s employees. The group s accounting policies for the accounting for the equity-linked share incentive schemes has been set out in annexure D of the annual financial statements. Refer to annexure C of the annual financial statements for details regarding the number of units outstanding at the end of the year together with the extent to which those outstanding units have been hedged. The following table summarises the group s most material share schemes together with an explanation of which risk (where applicable) the share scheme exposes the group to, and why, and an indication as to whether the share schemes are hedged: Share scheme Risk to the group Explanation Hedged Equity growth scheme (EGS) and the group share incentive scheme (GSIS) N/A The EGS and GSIS are equity-settled share schemes that are settled through the issuance of new shares. Accordingly, the group is not required to incur any cash flow in settling the share schemes and hence is not exposed to any risk as a result of changes in its own share price. No Quanto stock unit scheme (Quanto) Income statement risk The Quanto is a cash-settled share scheme. Increases in the group s share price result in losses being recognised in the income statement. Yes Deferred bonus scheme (DBS) and performance reward plan (PRP) NAV risk The DBS and PRP are equity-settled share schemes that are settled through the purchase of shares from the external market. Accordingly, increases in the group s share price above the grant price will result in losses being recognised in the group s equity. Yes Refer to annexure C in the annual financial statements for details regarding the number of units outstanding at the end of the year. 85

88 Risk and capital management report Market risk Banking operations continued Approach to managing own equity-linked transactions The ALCOs of the respective group entities that issue the equitylinked transactions approve hedges of the group s share price risk with quarterly reporting to group ALCO which is chaired by the group finance director. Hedging is undertaken taking into account a number of considerations which include expected share price levels based on investment analyst reports; the value of the issued share scheme awards; the cost of hedging; and the ability to hedge taking into account the nature of the share scheme and applicable legislative requirements. Hedging instruments typically include equity forwards and equity options. Hedge accounting in terms of IFRS is applied to the extent that the hedge accounting requirements are complied with. Hedges are only transacted outside of the group s closed periods which are in effect from 1 June until the publication of the group s interim results; 1 December until the publication of the group s year end results; and any period where the group is trading under a cautionary announcement. Insurance operations Long-term insurance Market risk management and reporting processes continue to mature. For management purposes, Liberty s market risk remains split into three main categories: Market risks to which Liberty wishes to maintain exposure on a long-term strategic basis: These include market risks arising from assets backing shareholder funds as well as from a 90/10 fee exposure. In aggregate, this is referred to as the shareholder investment portfolio and is managed by Liberty Financial Solutions (LibFin) Investments. Market risks to which Liberty does not wish to maintain exposure on a long-term strategic basis as these are not expected to provide adequate return on economic capital over time: This includes the asset-liability mismatch risk arising from Liberty s interest rate exposure to annuity business, and the mismatch risk arising from embedded derivatives, including policyholders investment guarantees. It also includes market risk arising from negative rand reserves, which represents the present value of future charges less the present value of future expenses and risk claims. In aggregate, this is referred to as the asset liability management portfolio and is managed by LibFin Markets. Market risks to which Liberty does not wish to maintain exposure but which Liberty is unable to adequately and/or economically mitigate through hedging: In certain instances, these market risks are second order risks resulting from, for example, liquidity risks or reputational risks. Whilst these risks cannot necessarily be hedged, they are identified and measured as far as possible and, where applicable, are taken into account for the purposes of assessing risk appetite and overall sensitivity to changes in the market. LibFin is responsible for managing Liberty s aggregate market risks, including exposures arising from shareholder funds and asset-liability mismatches, in terms of its delegated authority and within set limits. STANLIB, and other external asset managers remain responsible for managing the investment risks within their investment mandates. An independent market risk team provides oversight of the effectiveness of market risk management processes and reports on the status of market risk management to the relevant governance committees. Liberty, via STANLIB, invests in various instruments for the benefit of policyholders as well as other third parties. In doing so, the market risk associated with such investments is for the risk of those investors. During the course of, certain of these investment portfolios did experience market disruption caused by the curatorship of ABL. The resultant market risk impact (devaluation of the assets) has been attributed to these portfolios and communicated to policyholders. The impact on portfolio performance was, however, muted due to prescribed limits to concentration risk within mandates. Shareholder investment portfolio Liberty recognises the importance of investing its capital base in a diversified portfolio of financial assets. The market risk arising from this shareholder fund exposure is modelled and managed together with the 90/10 fee exposure that exposes shareholders to 10% of the returns on a defined portion of assets backing unit-linked liabilities. The Liberty board approves the long-term asset mix of this investment portfolio assuming a strategic asset allocation methodology with a long-term investment horizon. The typical asset classes included in this portfolio are equity, fixed income, property and cash, in both local and foreign currency. STANLIB and other asset managers are mandated by LibFin Investments to manage the underlying assets in this portfolio. Tactical asset allocation is performed by STANLIB within their mandate. This is similar to the way in which an asset manager would invest on behalf of a client with a long-term investment horizon. On a through-the-cycle basis, this conservative, diversified portfolio was constructed to maximise after-tax returns for a level of risk consistent with Liberty s risk appetite. In the short term, market movements will contribute to some earnings volatility. The diversified nature of the portfolio should, however, shield against significant earnings volatility. Market risk exposure from management fee revenues, other than exposure to the 90/10 fee exposure, is not currently managed as part of the shareholder investment portfolio. Asset liability management portfolio Liberty has a number of market risk exposures arising from asset-liability mismatches to which it does not wish to be exposed on a long-term strategic basis. As a result, it has chosen to mitigate these risks through a dedicated ongoing hedging programme. 86 Risk and capital management report and annual financial statements

89 The decision to hedge these risks is based on the following factors: The assumption that these market risks would result in Liberty operating outside its risk appetite. There is a liquid tradable market in which to hedge these risks. The capital-intensive nature of these market risks, particularly in an economic capital framework, which over time could potentially reduce shareholders returns on capital unless actively managed. Some of the market risks, for example, those that arise from selling investment guarantees, are asymmetric in nature and could compromise Liberty s solvency under severe market conditions. This is due to current regulatory capital rules requiring available capital to be impaired for IFRS mark-to-market changes on such instruments. The exposures which are included in this hedging programme include the following: embedded derivatives provided in contracted policies, for example, minimum investment return guarantees and guaranteed annuity options the interest rate exposure from writing annuities and guaranteed investment products. However, credit risk on the backing assets is not hedged and serves as a diversified source of revenue for Liberty guaranteed index trackers negative rand reserves. Exposure to financial, property and insurance assets The table below summarises Liberty s exposure to financial, property and insurance assets. This exposure has been split into the relevant market risk categories and then attributed to the effective holders of the risk. Exposure to financial, property and insurance assets by risk category Total financial, property and insurance assets Policyholder long-term marketrelated liabilities Other long-term policyholder liabilities 1 Attributable to Ordinary shareholders of Liberty Noncontrolling interests Third-party financial liabilities arising on consolidation of mutual funds 2,3,6 Equity price (5 676) Interest rate Property price (891) Mixed portfolios (2 954) Reinsurance assets Total Percentage (%) , 3, Equity price (6 126) Interest rate Property price (1 100) Mixed portfolios (2 732) Reinsurance assets Total Percentage (%) Negative exposure to the various risk categories can occur in Other policyholder liabilities since the present value of future inflow can exceed the present value of future benefits and expenses resulting in a negative liability. The group offsets these negative liabilities against policyholders market-related liabilities. The policyholders market risk exposure, however, remains unchanged. Hence, shareholders bear all the risks of shorting assets backing the policyholder market-related liabilities by the amount of these negative liabilities. 2 The group has a 54% interest in Liberty and therefore shares in 54% of this exposure. 3 As reported by Liberty, refer to Liberty s annual financial statements. 4 Mixed portfolios are subject to a combination of equity price, interest rate and property price risks depending on each portfolio s construction. A substantial portion of the mixed portfolios will be subject to equity price and interest rate risk. The exact proportion is practically difficult to accurately calculate given the number of mutual funds and hedge funds contained in the group portfolios. 5 Reinsurance assets are claims against reinsurers outstanding at the reporting date. They are not subject to market risk other than time value of money (interest rate) for the periods to settlement. 6 The risk category exposures have been refined to categorise equity price and interest rate risk to property price risk where the invested entity only has exposure to investment properties. The 2013 comparatives have been adjusted on the same basis. 87

90 Risk and capital management report Market risk Insurance operations continued Interest rate risk The table on the right gives additional detail on financial instrument assets and liabilities and their specific interest rate exposure. Due to practical considerations, interest rate risk details contained in investments in non-subsidiary mutual funds are not provided. Accounts receivable and accounts payable, where settlement is expected within 90 days, are not included in the analysis. The effect of interest rate risk on these balances is not considered significant given the short-term duration of the underlying cash flows. Interest rate exposure Financial instrument liabilities Carrying value Exposed to cash flow interest rate risk Exposed to fair value interest rate risk Financial instrument assets Carrying value Exposed to cash flow interest rate risk Exposed to fair value interest rate risk Based on information as reported by Liberty. Refer to Liberty s annual financial statements. 2 Restated. Refer to page 104. Foreign currency risk Offshore assets are held in policyholders portfolios to match the corresponding liabilities. Liberty is exposed to currency risk through minimum investment return guarantees issued on contracts invested in offshore portfolios and related mismatches, as well as through the 90/10 fee exposure and management fees. In addition, some of the shareholder capital base is invested in offshore assets. The gross exposure to financial instruments expressed in rand (converted at closing rates) at 31 December is R62 billion (2013: R57 billion). It is not practical to isolate accurately any detailed currency risk contained in investments in mutual funds and investment policies which are priced in rand and are not subsidiaries. The implied currency exposure to mutual funds and investment policies, however, is not material to Liberty. The table below segregates the currency exposure by major currency at 31 December. Currency exposure by major currency 1 GBP USD Euro Japanese Yen Swiss Franc Other Foreign currency risk () Gross exposure in foreign currency (m) Derivative protection in foreign currency (m) (7) (16) (449) (807) (11) (34) Net exposure in foreign currency (m) Based on information as reported by Liberty. Refer to Liberty s annual financial statements. 2 Restated. Refer to page Risk and capital management report and annual financial statements

91 Property market risk Liberty is exposed to tenant default. Unlet space within its investment property portfolio will affect property values and rental income. This risk is mainly attributable to the matching of policyholders liabilities. The shareholder exposure is mainly limited to management fees and profit margins. The managed diversity of the property portfolio and the existence of multi-tenanted buildings significantly reduce the exposure to this risk. At 31 December, the proportion of unlet space in the property portfolio was 10% (2013: 6%). Property market risk also arises with respect to shareholder exposures to investment guarantees and negative rand reserves, and this risk is managed as part of the dedicated hedging programme. Liberty s exposure to property market risk at 31 December is shown below. Exposure to property market risk ,2 Investment properties Owner-occupied properties Mutual funds with >80% property exposure Gross exposure Indirect exposure through debt and equity shareholdings Attributable to non-controlling interests (3 720) (3 503) Net exposure Concentration use risk within directly held properties is summarised below: Shopping malls Office buildings Hotels South African listed property securities held via mutual fund investments Convention centre and residential property Based on information as reported by Liberty. Refer to Liberty s annual financial statements. 2 The property market risk disclosures have been enhanced to include indirect exposures in addition to direct exposures. Derivative financial instruments and risk mitigation Certain Liberty entities are party to contracts for derivative financial instruments, mainly entered into as part of the dedicated hedging strategy. These instruments are used to mitigate equity, interest rate and currency risk and include vanilla futures, options, swaps, swaptions and forward exchange contracts. Derivative financial instruments are either traded on a regulated exchange or negotiated OTC as a direct arrangement between two counterparties. Exchange instruments are margined in accordance with the exchange or clearing member s requirements and the clearing house is the counterparty to each trade. OTC instruments are only entered into with appropriately approved counterparties. Signed ISDA agreements are held with all counterparties. Sensitivity analysis The table below provides a description of risk sensitivities to various market variables. The interest rate yield curve and implied option volatility sensitivities below reflect the financial impact of an instantaneous event at the financial position date. In determining the financial impact of such an event, new asset levels are applied to both the measurement of policyholders liabilities and to long-term assumptions dependent on interest rate yield curves and implied option volatilities. The equity price and rand currency sensitivities also reflect the impact of an instantaneous event at the financial position date. However, in the calculation of the financial impact of such an event, new asset levels are only applied to the measurement of policyholders liabilities. No changes are made to long-term assumptions used in the measurement of policyholders liabilities. The market sensitivities are applied to all assets held by Liberty, not just assets backing the policyholders liabilities. Market variable Interest rate yield curve Implied option volatilities Equity prices Description of sensitivity A parallel shift in the interest rate yield curve A change in the implied short-term equity, property and interest rate option volatility assumptions A change in the local and foreign equity prices Rand exchange rates A change in the ZAR exchange rate to all applicable currencies 89

92 Risk and capital management report Market risk Insurance operations continued The table below summarises the impact of the change in the aforementioned risk variables on policyholder liabilities, and ordinary shareholders equity and attributable profit after taxation. Sensitivity analysis of risk variables 1 Change in variable % 2013 Impact on policyholders liabilities Impact on ordinary shareholder equity and attributable profit after taxation Change in variable % Impact on policyholders liabilities Impact on ordinary shareholder equity and attributable profit after taxation Market assumptions Interest rate yield curve 12 (3 638) (285) 12 (3 022) (213) (12) (12) Option price volatilities (22) (55) (20) (2) (2) (20) (74) 33 Equity prices (15) (19 077) (1 260) (15) (18 460) (1 256) Rand exchange rates 12 2 (4 373) (655) 12 2 (3 862) (627) (12) (12) Based on information as reported by Liberty. Refer to Liberty s annual financial statements. 2 Strengthening of the rand. 3 Weakening of the rand. 4 Currently option price volatilities are not hedged and consequently the analysis is performed on market data at 31 December. The sensitivities are non-linear and will be significantly impacted by the mix of future new business. Short-term insurance Market risk arises from investments in cash, corporate money market and collective investment schemes. It is not material in the group context. Management of the investment portfolio is outsourced with target returns and capital preservation as specified in the mandate. 90 Risk and capital management report and annual financial statements

93 Insurance risk Definition Insurance risk is the risk that actual future demographic and related expense experience will differ from that expected and hence that used in measuring policyholder liabilities and in pricing products. 91 Definition 91 Long-term insurance risk 91 Overview 92 Approach to managing insurance risk 92 Long-term insurance risk subtypes 94 Sensitivity analysis 95 Short-term insurance risk 95 Overview 95 Approach to the management of short-term insurance risks 95 Short-term insurance risk types Insurance risk arises due to uncertainty regarding the timing and amount of future cash flows from insurance contracts. Insurance risk applies to long-term insurance operations housed in Liberty and the short-term insurance operations housed in Liberty Africa and SIL. Insurance risk is referred to within Liberty as business risk. Long term insurance risk Overview The statutory actuaries, group business risk department and the heads of risk in the business units provide independent oversight of compliance with Liberty s risk management policies and procedures and the effectiveness of the group s insurance risk management processes. The timing of expected future cash flow is specifically influenced by assumptions on future mortality, longevity, morbidity, withdrawal and expenses made in the measurement of policyholders liabilities and in product pricing. Deviations from assumptions will result in actual cash flows being different from those expected. As such, each assumption represents a source of uncertainty. Experience investigations are conducted, at least annually, on all significant insurance risks to ascertain the extent of deviations from assumptions and their financial impacts. If the investigations indicate that these deviations are likely to persist in future, the assumptions will be adjusted accordingly for the subsequent measurement of policyholder liabilities. Insurance risks are assessed and reviewed against Liberty s risk appetite and risk target. To reduce the level of risk, mitigating actions are developed for any insurance risks that fall outside management s assessment of risk appetite. 91

94 Risk and capital management report Insurance risk Long-term insurance risk continued Approach to managing insurance risk Insurance risks are managed through processes applied prior to and on acceptance of risks and those applied once the risks are contracted. Risk management prior to and on acceptance of risks Prior to acceptance of risks in new products, inherent risks are identified, quantified and priced. Sensitivity tests are performed to obtain an understanding of the risk types and appropriateness of mitigating actions. Product design also takes account of various factors, including size and timing of fees and charges, appropriate levels of minimum premiums, commission structures and policy terms and conditions. Where applicable, an underwriting assessment is conducted to assess a new individual s risk at the point of sale. Furthermore, Liberty makes use of reinsurance to reduce its exposures to some business risks. Post implementation reviews are performed to ensure that intended outcomes are realised and to determine if any further action is required. Risk management once risks have been accepted The ongoing management of insurance risk, once the risk is contracted, is effectively the management of deviations of actual experience from the assumed best estimate of future experience. The statutory actuaries provide oversight of Liberty s insurance risk in that they are required to: report at least annually on the financial soundness of the life companies within Liberty oversee the setting of assumptions used to provide best estimate liabilities plus compulsory and discretionary margins (as described in the accounting policies) in accordance with the assumption setting policy report on the actuarial soundness of premium rates in use for new business and the profitability of the business, taking into consideration the reasonable benefit expectations of policyholders and the associated insurance and market risks. All new products and premium rates are approved through the product approval process and signed-off by the relevant statutory actuary. Second line oversight is provided by the group business risk committee (GBRC) that reports into Liberty s group control and risk oversight committee (GCROC). The following are the main duties and responsibilities of the GBRC: recommend for approval insurance risk-related policies to GCROC and ensure compliance therewith ensure that insurance risk is appropriately controlled by monitoring insurance risk triggers against agreed limits and/or procedures gain assurance that material insurance risks are being monitored and that the level of risk taken is satisfactorily in line with the Liberty risk appetite statement at all times consider any new insurance risks introduced through new product development or strategic development and how they should be managed monitor, ratify and/or escalate to GCROC all material insurance risk-related breaches or excesses highlighting the corrective action undertaken to resolve the issue monitor insurance risk regulatory requirements as they apply to the management of the group and its subsidiaries balance sheets. Reinsurance arrangements are put in place to reduce the mortality and morbidity exposure per individual and provide cover in catastrophic events. Liberty has a centralised reinsurance function which is responsible for the optimisation and monitoring of reinsurance across its business. The group performs an annual review of the reinsurance cover in line with the stated risk appetite and reinsurance strategy. Long-term insurance risk subtypes Policyholder behaviour risk Policyholder behaviour risk is the risk of adverse financial impact caused by actual policyholders behaviour deviating from expected policyholders behaviour, mainly due to: regulatory and law changes (including taxation) changes in economic conditions sales practices competitor behaviour policy conditions and practices policyholders perceptions. Policyholders behaviour risk includes a consideration of comparable risks in the asset management business. The primary policyholder behaviour risk is persistency risk. This arises when policyholders discontinue or reduce contributions, or withdraw benefits at a rate that is not in line with expectations. This behaviour results in a loss of future charges that are designed to recoup expenses and commission incurred early in the life of the contract, and to provide a return on capital. A deterioration in persistency generally gives rise to a loss. The business has continued to focus on a broad programme of initiatives to manage persistency risk and withdrawal rates on major product lines are broadly in line with expectations. 92 Risk and capital management report and annual financial statements

95 Underwritten risks Mortality and morbidity risk Mortality risk is the risk of loss arising due to actual death claims on life assurance business being higher than expected. Morbidity risk is the risk of loss arising due to policyholders health-related (disablement and dread disease) claims being higher than expected. Liberty has a range of standard processes and procedures in place to manage mortality and morbidity risk, including differentiating by the individual characteristics, right of review of premiums, underwriting at inception, medical tests, and use of experienced reinsurers and claims assessors. Liberty views mortality and morbidity risks as risks that are core to the business. These risks will be retained if they cannot be mitigated or transferred on risk-adjusted value-enhancing terms. Mortality and morbidity risk gives rise to significant economic capital requirements in particular due to potential catastrophic events. Since it is difficult to obtain reinsurance for certain catastrophic events, such as epidemics on reasonable terms, the mortality and morbidity economic capital requirements are likely to remain significant. The table below summarises the profiles of the sums assured at risk per life in terms of mortality benefits before and after reinsurance for individual and group risk business. Profile for amounts at risk for individual and group business retail and corporate 1 Sum assured at risk band (Rands) Before reinsurance After reinsurance % % and above Total and above Total Based on information as reported by Liberty. Refer to Liberty s annual financial statements. The table above demonstrates that the sums assured are spread over many lives in terms of amounts at risk, and that the exposure to individual lives has been reduced by means of reinsurance arrangements. Given the large number of assured lives, the random fluctuation in mortality claims is expected to be small, as the larger the portfolio of uncorrelated insurance risks, the smaller the relative variability around the expected outcome becomes. Catastrophe reinsurance Catastrophe reinsurance is consolidated across Liberty s life licences and is in place to reduce the risk of many claims arising from the same event. Various events are excluded from the catastrophe reinsurance (for example, epidemics and radioactive contamination). For corporate risk business, the exposure per industry class is monitored to maintain a diversified portfolio of risks and manage concentration exposure to a particular industry class. The following table splits the annual corporate risk business by industry class. Annual corporate business by industry class 1 % 2013 % Administrative/professional Retail Light manufacturing Heavy manufacturing Heavy industrial and other high risk 3 3 Total As reported by Liberty, refer to Liberty s annual financial statements. 93

96 Risk and capital management report Insurance risk Long-term insurance risk continued Longevity risk Longevity risk is the risk of loss arising due to annuitants living longer than expected. For life annuities, the loss arises as a result of Liberty s undertaking to make regular payments to annuitants for their remaining lives, and possibly to the annuitants spouses for their remaining lives. The most significant risk on these liabilities is continued medical advances and improvement in social conditions that lead to longevity improvements being better than expected. Liberty manages longevity risk by monitoring the actual longevity experience and identifying trends over time, and allowing for future mortality rates falling in the pricing of new business and the measurement of policyholders liabilities. Expense expectation, tax expectation and new business risk Expense expectation risk is the risk of adverse financial impact due to the timing or amount of administration expenses incurred, or both differing from those expected in the administration of policies, for example, the actual cost per policy differing from that assumed in the pricing or reserving basis. Tax expectation risk is the risk of losses arising due to the actual tax assessed being more than the tax expected. New business risk is the risk of adverse financial impact due to the actual volume, mix and/or quality of new business deviating from that expected in calculating expected financial outcomes. Allowance is made for expected future maintenance expenses in the measurement of policyholders liabilities utilising a cost per policy methodology. These expected expenses are dependent on estimates of the number of in-force and new business policies. As a result, the risk of expense loss arises due to expenses increasing by more than expected and the number of in-force and new business policies being less than expected. Liberty manages the expense and new business risk by: Regularly monitoring actual expenses against the budgeted expenses Regularly monitoring new business volumes and mix Regularly monitoring withdrawal rates including lapses Implementing cost control measures in the event of expenses exceeding budget or of significant unplanned reductions in the number of in-force polices. Even though expense risk does not give rise to large capital requirements, the measurement of expense risk is core to the business. The expenses that Liberty is expected to incur on policies are allowed for in product pricing. If the expenses expected to be incurred are considerably higher than those of insurers offering competing products, the ability of Liberty to sell business on a profitable basis will be impaired. This not only has capital implications, but can also affect Liberty s ability to function as a going concern in the long term. Tax expectation risk is mitigated through the implementation of Liberty s tax risk framework as well as the employment of tax experts to identify and manage tax risks. Sensitivity analysis The table below provides a description of the sensitivities that are provided on insurance risk assumptions. Insurance risk variable Assurance mortality Annuitant mortality Morbidity Withdrawals Expense per policy Description of sensitivity A level percentage change in the expected future mortality rates on assurance contracts A level percentage change in the expected future mortality rates on annuity contracts A level percentage change in the expected future morbidity rates A level percentage change in the policy withdrawal rates A level percentage change in the expected maintenance expenses Insurance risk sensitivities are applied as a proportional percentage change to the assumptions made in measuring policyholders liabilities. Over a reporting period, assets are expected to earn a return consistent with the long-term assumptions used in measuring policyholders liabilities. Each sensitivity is applied in isolation with all other assumptions left unchanged. The table on the following page summarises the impact of the change in the aforementioned risk variables on policyholders liabilities and attributable profit after taxation. 94 Risk and capital management report and annual financial statements

97 Sensitivity analysis of risk variables 1 Change in variable % 2013 Impact on policyholders liabilities Impact on ordinary shareholders equity and attributable profit after taxation Change in variable % Impact on policyholders liabilities Impact on ordinary shareholders equity and attributable profit after taxation Insurance assumptions Mortality Assured lives (189) (164) (2) (264) 190 (2) (228) 164 Annuitant longevity (251) (162) (4) 3 (334) 241 (4) 3 (217) 156 Morbidity (306) (260) (5) (425) 306 (5) (360) 259 Withdrawals (364) (339) (8) (562) 405 (8) (533) 384 Expense per policy (195) (187) (5) (271) 195 (5) (260) Based on information as reported by Liberty. Refer to Liberty s annual financial statements. 2 Annuitant life expectancy increases, i.e. annuitant mortality reduces. 3 Annuitant life expectancy reduces, i.e. annuitant mortality increases. 4 The significant increase in sensitivity impact is as a consequence of large annuity new business written during. Short-term insurance risk Overview SIL writes mainly property, motor, accident and health insurance on a countrywide basis within South Africa. Approximately 70% of the total gross written premium is property insurance which indemnifies, subject to any limits or excesses, the policyholder against loss or damage to their own property and business interruption arising from this damage. Liberty Africa writes mainly property and motor business through Liberty Kenya Holdings Limited, and medical expense business through Total Health Trust Limited in Nigeria. Approach to the management of short-term insurance risks Insurance risk is managed primarily through pricing, product design, investment strategy, risk rating and reinsurance. The principal governance document is the short-term insurance risk governance standard. Short-term insurance risk types The underwriting strategy seeks diversity to ensure a balanced portfolio and is based on a large portfolio of similar risks over a large geographical area. This strategy is cascaded down to individual underwriters through detailed underwriting authorities that set out the limits that any one underwriter can write by line size, class of business, territory and industry in order to enforce appropriate risk selection within the portfolio. The key risks associated with this product are underwriting risk, competitor risk and claims experience risk (including the variable incidence of natural disasters). Property is subject to a number of risks, including theft, fire, business interruptions and weather. For property classes of business there is a significant geographical concentration of risk so that external factors such as adverse weather conditions may adversely impact upon a large proportion of a particular geographical portion of the company s property risks. Claim inducing perils such as storms, floods, subsidence, fires, explosions and rising crime levels will occur on a regional basis, meaning that SIL has to manage its geographical risk dispersion carefully. The greatest likelihood of significant losses to the group arises from catastrophe events such as flood, storm or earthquake damage. To mitigate this risk, we buy reinsurance across a diversified panel of 38 reinsurers. 95

98 Risk and capital management report Insurance risk Short-term insurance risk continued Risk and catastrophe reinsurance The business reinsures a portion of the risks it underwrites in order to control its exposure to losses and protect capital resources. For example, excess of loss reinsurance and catastrophe reinsurance protect against major losses on high sums insured and major natural disasters, respectively. Policyholder behaviour risk Policyholder behaviour risk is the risk of loss arising due to actual policyholders discontinuing their insurance policies earlier or more frequently than expected. This may arise due to a change in economic conditions and/or inconsistent policy practices, regulatory and tax changes, selling practices and policyholder perceptions. The primary policyholder behaviour risk is persistency risk, which arises due to policyholders discontinuing insurance on short-term insurance business, where the policyholder cancels cover. This could lead to a reduction in premium income, an increase in the expense ratio and a reduction on the return on capital. Catastrophe risk The risk of adverse financial impact due to a single event or series of events of major magnitude, usually over a short period (often 72 hours), leads to a significant deviation in actual claims from the total expected claims. Claims incidence risk This is the risk of loss in excess of what has been priced for, arising from accident, fire and theft on short-term insurance business. On certain types of business, for example, third-party liability claims, the claim distribution is longer tailed. This means that the final cost of the claim is only known many years into the future. The risk here is that we reserve inadequately for this ultimate claims cost. Expense risk This is the risk of an adverse financial impact due to the timing and/or amount of expenses incurred, or both differing from those expected in administering policies, e.g. assumed in the pricing basis or actual cost per policy. The expenses that the group is expected to incur on policies are allowed for in product pricing. If the expenses expected to be incurred are considerably higher than those of insurers offering competing products, our ability to sell business on a profitable basis will be restricted. This does not only have capital implications, but can also affect the group s ability to function as a going concern in the long term. New business risk This is the risk of adverse financial impact due to the actual volume and/or quality of new business deviating from the expected volume and/or quality. Emerging risks In addition to monitoring and assessing existing risks, there also needs to be a focus on emerging risks. These are likely to take the form of a change in the quantification of one of the aforementioned risks. Examples of this include an increase in natural disasters due to climate change and/or changes in regulation. Short-term insurance operations are impacted by adverse economic conditions which could lead to lower new business take-up rates, higher than budgeted cancellation rates and fraud. The potential for fraudulent behaviour is also very high. New business and lapse rates are budgeted each year and monitored on a monthly basis. These rates are reported and compared to budget figures. 96 Risk and capital management report and annual financial statements

99 Operational risk Definition Operational risk is defined as the risk of loss suffered as a result of the inadequacy of, or a failure in, internal processes, people and/or systems or from external events. 97 Definition 97 Approach to managing operational risk 98 Insurance cover 98 Governance committees 99 Approved regulatory capital approach 99 Operational risk subtypes 99 Operational risk subtype: Model risk 99 Operational risk subtype: Tax risk 99 Operational risk subtype: Legal risk 99 Operational risk subtype: Environmental and social risk 100 Operational risk subtype: Information technology and change risk 100 Operational risk subtype: Information risk 100 Operational risk subtype: Cyber risk 100 Operational risk subtype: Financial crime risk 100 Operational risk subtype: Physical commodities Operational risk subtypes are managed and overseen by specialist functions. These subtypes include: model risk tax risk legal risk environmental and social risk information technology and change risk information risk cyber risk compliance risk (dealt with on page 63) financial crime risk physical commodities. Approach to managing operational risk Operational risk exists in the natural course of business activity. The group operational risk governance standard sets out the minimum standards for operational risk management to be adopted across the group. The governance standard seeks to ensure adequate and consistent governance, identification, assessment, monitoring, managing and reporting of operational risk to support the group s business operations. In addition, it ensures that the relevant regulatory criteria can be met by those banking entities adopting the advanced measurement approach, and those adopting the basic indicator approach or the standardised approach for regulatory capital purposes. It is not an objective to eliminate all exposure to operational risk as this would be neither commercially viable nor possible. The group s approach to managing operational risk is to adopt fit-for-purpose operational risk practices that assist business line management in understanding their inherent risk and reducing their risk profile while maximising their operational performance and efficiency. The IOR management function is independent from business line management and is part of the second line of defence reporting to the group CRO. It is responsible for the development and maintenance of the operational risk governance framework, facilitating business s adoption of the framework, oversight and reporting, as well as for challenging the risk profile. The team proactively analyses root causes, trends and emerging threats, advises on the remediation of potential control weaknesses and recommends best-practice solutions. Individual teams are dedicated to each business line and report to 97

100 Risk and capital management report Operational risk Approach to managing operational risk continued the business unit CRO. IOR also provides dedicated teams to enabling functions such as finance, IT and human capital. These teams work alongside their business areas and facilitate the adoption of the operational risk governance framework. As part of the second line of defence, they also monitor and challenge the business units and enabling functions management in respect of their operational risk profile. A central function, based at a group level, provides groupwide oversight and reporting. It is also responsible for developing and maintaining the operational risk governance framework. Business continuity management (BCM) is a process that identifies potential operational disruptions and provides a basis for planning for the mitigation of the negative impact from such disruptions. In addition, it promotes operational resilience and ensures an effective response that safeguards the interests of the group and its stakeholders. The group s BCM framework encompasses emergency response preparedness and crisis management capabilities to manage the business through a crisis to full recovery. The group s business continuity capabilities are evaluated by testing business continuity plans and conducting crisis simulations. In April, a crisis management simulation was utilised to test the group crisis management leadership team and plan. The simulation proved to be an effective mechanism to validate the group s crisis management capability and confirmed the embedding of this capability in the group s overall integrated recovery planning process. The group is fully cognisant of the risks which the prevailing electricity shortages in South Africa pose to the continuity of its SBSA services and operations and to the broader group through services provided out of South Africa. The group has completed a high-level assessment of its readiness to withstand both routine load shedding and a national grid interruption to ensure the risks are mitigated proactively. Insurance cover The group buys insurance to mitigate operational risk. This cover is reviewed on an annual basis. The group insurance committee oversees a substantial insurance programme designed to protect the group against loss resulting from its business activities. The principal insurance policies in place are the group crime, professional indemnity, and group directors and officers liability policies. In addition, the group has fixed assets and liabilities coverage in respect of office premises and business contents; third-party liability for visitors to the group s premises, and employer s liability. The group s business travel policy provides cover for group staff, whilst travelling on behalf of the group. Governance committees The primary management level governance committees overseeing operational risk, including the various subtypes, are: Governance committee Group internal financial control governance committee Group operational risk committee Group regulatory and legislative oversight committee Group and business line model approval committees Group IT steering committee IT architecture governance committee Legal executive committee Tax risk committee Governance document N/A Information risk governance standard Operational risk governance standard Operational risk governance framework Business resilience governance framework IT risk and IT change risk governance standard N/A Model risk governance standard N/A N/A Legal risk governance standard Tax risk governance standard 98 Risk and capital management report and annual financial statements

101 Approved regulatory capital approach The group has approval from the SARB to adopt the AMA for SBSA and the standardised approach for all other legal entities. The journey to migrate all countries in Africa to the AMA is underway. The group does not include insurance as a mitigant in the calculation of regulatory capital. Operational risk subtypes Operational risk subtype: Model risk Model risk arises from potential weaknesses in a model that is used in the measurement, pricing and management of risk. These weaknesses include incorrect assumptions, incomplete information, inaccurate implementation, limited model understanding, inappropriate use or inappropriate methodologies leading to incorrect conclusions by the user. The group s approach to managing model risk is based on the following principles: Fit-for-purpose governance, which includes: an approved model risk governance framework a three-lines-of-defence governance structure comprising independent model development, model validation and IA oversight functions model approval committees with board and executive management membership based on model materiality and regulatory requirements policies that define minimum standards, materiality, validation criteria, approval criteria, and roles and responsibilities. A skilled and experienced pool of technically competent staff is maintained in the development, validation and audit functions. Robust model-related processes, including: the application of best-practice modelling methodologies independent model validation in accordance with both regulatory and internal materiality assessments adequate model documentation, including the coverage of model use and limitations controlled implementation of approved models into production systems ongoing monitoring of model performance review and governance of data used as model inputs peer challenge in technical forums. Credit IRB models and operational risk AMA models are validated at initial development and at least annually thereafter by the validation function. Other models are validated at initial development and reviewed at intervals determined by materiality and performance criteria. Validation techniques test the appropriateness and effectiveness of the models, and indicate if the model is fit-for-purpose. Models are recommended by the relevant technical committee for approval or ongoing use to the relevant model approval committee. Operational risk subtype: Tax risk Tax risk is defined as any event, action or inaction in tax strategy, operations, financial reporting, or compliance that either adversely affects the group s tax or business objectives or results in an unanticipated or unacceptable level of monetary, financial statement or reputational exposure. The group s approach to tax risk is governed by the GAC-approved tax risk control framework which, in turn, is supported by policies dealing with specific aspects of tax risk such as, for example, transfer pricing, indirect taxes, withholding taxes and remuneration taxes. Operational risk subtype: Legal risk Legal risk is defined as the exposure to the adverse consequences resulting from inaccurately drafted contracts, their execution, the absence of written agreements or inadequate agreements. This includes exceeding authority as contained in a contract. It applies to the full scope of group activities and may also include the activities of third parties acting on behalf of the group. The adverse consequences are the financial losses arising from judgments or private settlements, including punitive damages. The group has processes and controls in place to manage its legal risks. Failure to manage these risks effectively could result in legal proceedings impacting the group adversely, both financially and reputationally. Operational risk subtype: Environmental and social risk Environmental risk is described as a measure of the potential threats to the environment. It combines the probability that events will cause or lead to the degradation of the environment and the magnitude of such degradation. Environmental risk includes risks related to or resulting from climate change, human activities or from natural processes that are disturbed by changes in natural cycles. Social risk is described as risks to people, their livelihoods, health and welfare, socioeconomic development, social cohesion and the ability to adapt to changing circumstances. Environmental and social risk assessment and management deals with two aspects: Risks over which the group does not have control but which have potential to impact on the group s operations and its clients. Risks over which the group has direct control. These include our immediate direct impact, such as our waste management and the use of energy and water as well as our broader impact, including risks that occur as a result of our lending or financial services activities. The group sustainability management unit develops the strategy, policy and management frameworks that enable the identification, management, monitoring and reporting of both aspects. 99

102 Risk and capital management report Operational risk Operational risk subtypes continued The group has an environmental and social risk management policy and subscribes to a number of international norms and codes, such as those of the United Nations Environment Programme Finance Initiative, the Equator Principles and the Banking Association of South Africa s code of conduct for banks. In support of these policy commitments, it has developed guidance to bankers, screening tools to assist in categorising environmental and social risk and various training programmes to assist credit evaluators, deal makers and other key individuals. Operational risk subtype: Information technology and change risk Information technology risk encompasses both IT risk and IT change risk. The group s IT risk refers to the risk associated with the use, ownership, operation, involvement, influence and adoption of IT within the group. It consists of IT-related events and conditions that could potentially impact the business. IT change risk refers to risk arising from changes, updates or alterations made to the IT infrastructure, systems or applications that could affect service reliability and availability. The group relies heavily on technology to support complex business processes and handle large volumes of critical information. As a result, a technology failure can have a crippling impact on the group s brand and reputation. The IOR IT risk function oversees compliance with the IT risk and IT change risk governance standard. Operational risk subtype: Information risk Information risk encompasses the risk of accidental or intentional unauthorised use, modification, disclosure or destruction of information resources, which would compromise the confidentiality, integrity or availability of information and which would potentially be harmful to the group s business. Additionally, it comprises of all the challenges that result from the need to control and protect the group s information. The group has adopted a risk-based approach to managing information risks. The IOR management function oversees the information risk management system, policies and practices across the group. The execution of these policies and practices is driven through a network of embedded representatives within the business lines. The head of group information risk oversees the execution in conjunction with the heads of embedded operations risk per business area. The reason for the denial of access was that the owners of the personal information declined to give consent for access to be given to the requestor. Operational risk subtype: Cyber risk Cyber risk is the risk associated with injury, damage or loss from electronic exposure that can result in an adverse impact on the group s business. This risk may arise due to the disclosure, modification, destruction or theft of information, or from the unavailability of the transaction site, systems or networks. The cyber security operations centre, within IOR, manages this risk by proactively identifying malicious activity that poses a risk to the confidentiality, integrity and availability of the group s information assets. Identification and mitigation of cyber threats includes services to deliver both the proactive immobilisation of threats that are active in the group and the identification, investigation, resolution and reporting of threats that have materialised into cyber incidents. Operational risk subtype: Financial crime risk Financial crime risk includes fraud, bribery, corruption, theft and integrity misconduct by staff, customers, suppliers, business partners and stakeholders. The group financial crime control (GFCC) function combats financial crime risk through the prevention and detection of, and response to, all financial crime incidents to mitigate economic loss, reputational risk and regulatory sanction. As is the case with the other functions within operational risk, GFCC maintains close working relationships with other risk functions, specifically compliance, legal risk and credit risk, and with other group functions such as IT, human capital, and finance. Operational risk subtype: Physical commodities A physical commodities specialist function based in Johannesburg, London, Singapore and Shanghai manages physical commodities transactions where the group takes ownership of the underlying commodity. The role of the team is to focus on the risks embedded in each trade, on a pre- and post-trade basis, and to ensure they are understood, tracked, controlled and escalated if appropriate. The team works with approved third parties who play a key role in the process and the provision of related control functions such as shipbrokers, insurers, warehouse providers and security companies. The Promotion of Access to Information Act 2 of 2000 gives effect to the constitutional right of access to information that is held by a private or public body. The following information was disclosed in terms of applicable regulations: From January to December, the group processed six (January 2013 to December 2013: 16) requests for access to information, of which two were granted, three were denied, and one is still in progress. Risk and capital management report and annual financial statements 100

103 Business risk Business risk is the risk of loss due to operating revenues not covering operating costs. Business risk is usually caused by the following: inflexible cost structures market-driven pressures, such as decreased demand, increased competition or cost increases group-specific causes, such as a poor choice of strategy, reputational damage or the decision to absorb costs or losses to preserve reputation. The group mitigates business risk in a number of ways, including: performing extensive due diligence during the investment appraisal process, in particular for new acquisitions and joint ventures detailed analysis of the business case for, and financial, operational and reputational risk associated with, disposals the application of new product processes per business line through which the risks and mitigating controls for new and amended products and services are evaluated stakeholder management to ensure favourable outcomes from external factors beyond the group s control monitoring the profitability of product lines and customer segments maintaining tight control over the group s cost base, including the management of its cost-to-income ratio, which allows for early intervention and management action to reduce costs being alert and responsive to changes in market forces a strong focus in the budgeting process on achieving headline earnings growth while containing cost growth; contingency plans are built into the budget that allow for costs to be significantly reduced in the event that expected revenues do not materialise increasing the ratio of variable costs to fixed costs which creates flexibility to reduce costs during an economic downturn. Business risk includes strategic risk and post-employment obligation risk as follows: Strategic risk is the risk that the group s future business plans and strategies may be inadequate to prevent financial loss or protect the group s competitive position and shareholder returns. The group s business plans and strategies are discussed and approved by executive management and the board and, where appropriate, subjected to stress tests. Post-employment obligation risk arises from the requirement to contribute as an employer to an under-funded defined benefit plan. The group operates both defined contribution plans and defined benefit plans, with the majority of its employees participating in defined contribution plans. The group s defined benefit pension and healthcare provider schemes for past and certain current employees create post-employment obligations. The group mitigates these risks through independent asset managers and independent asset and liability management advisors for material funds. Potential residual risks which may impact the group are managed within the group asset and liability management process. The primary governance committee for overseeing this risk is the group ALCO which is chaired by the group financial director. 101

104 Reputational risk Reputational risk is the risk of potential or actual damage to the group s image which may impair the profitability and/or sustainability of its business. Such damage may result from a breakdown of trust, confidence or business relationships on the part of customers, counterparties, shareholders, investors or regulators that can adversely affect the group s ability to maintain existing business or generate new business relationships and continued access to sources of funding. The breakdown may arise from a number of factors or incidents such as a poor business model, continued losses and failures in risk management. Safeguarding the group s reputation is of paramount importance. There is growing emphasis on reputational risks arising from compliance breaches, as well as from ethical considerations linked to countries, clients and sectors, and environmental considerations. The breakdown may be triggered by an event or may occur gradually over time. The group s crisis management processes are designed to minimise the reputational impact of such events or developments. Crisis management teams are in place both at executive and business line level. This includes ensuring that the group s perspective is fairly represented in the media. The principal governance document is the reputational risk governance standard. The group s code of ethics is an important reference point for all staff. The group ethics officer and group chief executives are the formal custodians of the code of ethics. For more information on the group s code of ethics go to Risk and capital management report and annual financial statements 102

105 Restatements Capital management Basel III: qualifying capital, excluding unappropriated profits In accordance with IFRS the group reported, in its 2013 financial results, its GMOA as a discontinued operation in the income statement with its assets and liabilities being separately reported as non-current assets/liabilities held for sale. The group normalised its 2013 financial results and, specifically, its segment results, for the disposal of GMOA to reflect GMOA as part of its continuing operations and not as separate asset/liabilities. For purposes of comparative financial reporting purposes, the group has reversed the normalised results and presented and accounted for GMOA in accordance with IFRS. Refer to page 21. Liberty CAR ratio: The 2013 statutory CAR amount was erroneously transposed and has accordingly been restated. Refer to page 25. Economic capital Credit risk economic capital has been restated to reflect certain positions that were previously not modelled for economic capital purposes. Refer to page 25. Credit risk: Basel derivatives exposure The gross positive fair value of derivatives (GPFV) and netting benefits, reported on page 47, previously included cash collateral held on derivative liability positions. The GPFV was also previously determined after the application of offsetting risk positions. The previously reported GPFV has been restated to exclude the cash collateral and to be presented before the effects of offsetting. The netting benefit was restated to include the effects of offsetting and to exclude the cash collateral on the derivative liability positions. The restatement had no effect on the group s capital requirements. 103

106 Risk and capital management report Restatements continued These two adjustments have also been adjusted in the following tables: Exposure subject to the standardised approach per risk weighting: page 32 Exposure by approach and class: page 36 Exposures by type of asset and industry: page 39 Exposures by type of asset and geographic region: page 40 Exposures by residual contractual maturity: page 41 Credit risk mitigation for portfolios under the IRB approach: page 45 Credit risk mitigation for portfolios under the standardised approach: page 45 Central counterparties (CCP) exposure Certain Basel tables were restated to include CCP exposures in order to ensure consistent presentation across all Basel tables, where CCP was previously excluded. Refer to pages 36, 41, 45. Credit risk-based: Securities financing transactions The exposure amounts without master netting agreements were erroneously transposed. The comparative results have accordingly been restated. Liberty Refer to page 46. As noted on page 15, under Risk disclosure presentation for intercompany transactions between the group s banking and insurance operations, transactions between the group s banking and insurance operations have not been eliminated for the purposes of separately reporting on the banking and insurance operations risk disclosures in this risk report. The previously reported information has been restated to conform to this manner of presentation. Depositor concentration The underlying calculation of depositor concentration was reviewed and revised during and the comparative results have accordingly been restated. Refer to page 73. Funding-related liabilities composition The underlying calculation of funding-related liabilities composition was reviewed and revised during and the comparative results have accordingly been restated. Refer to page 73. Liquidity risk: Impact on collateral requirements of ratings downgrade The method used to calculate the impact on collateral requirements has been updated to include those contracts referencing different thresholds for different rating agencies. The comparative results have accordingly been restated. Refer to page 74. Market risk: Basel equity positions in the banking book The total banking book equity positions amount was erroneously calculated to include certain non-banking book positions. The comparative results have accordingly been restated. Refer to page 83. Refer to pages 60, 72, 74, 88. Risk and capital management report and annual financial statements 104

107 Annexure A Regulatory and legislative developments impacting the group Global South Africa Rest of Africa Basel III NSFR Large exposures Revised standardised approach for counterparty credit risk Capital requirements for banks equity investments in funds Leverage ratio Securitisation Fundamental review of the trading book Revised standardised approach for operational risk Interest rate risk in the banking book Pillar 3 disclosure requirements Loss-absorbing capacity of G-SIBs OTC derivatives Recovery and resolution planning IFRS IFRS 9 Revenue Accounting for leases Insurance contracts Twin Peaks regulatory framework Financial Markets Act TCF Protection of Personal Information Act (PoPI) Consumer credit insurance RDR Insurance SAM RDR Retirement reform TCF Consumer credit insurance Exchange control Financial crime (anti-money laundering) Capital adequacy and prudential requirements Consumer protection UK, EU and US UK s fair and effective market review UK Banking Reform Act EU recast capital requirements directive and new regulation EU markets in financial instruments recast directive and new regulation EU benchmark regulation EU financial transaction tax (FTT) EU market abuse regulation (MAR) EU 4th money laundering directive European market infrastructure regulation Dodd Frank Wall Street reform and Consumer Protection Act 105

108 Risk and capital management report Annexure A Regulatory and legislative developments impacting the group continued Global Basel III Over the past year, the BCBS has substantially completed the remaining components of Basel III. It has agreed on a globally consistent definition of the leverage ratio, issued the final standard for the NSFR and has set out its plan to address excessive variability in risk-weighted asset calculations. More details on some of the topics finalised during the past year follow below: NSFR: The final NSFR retains the structure of the January consultative proposal. The key changes introduced in the final standard published cover the required stable funding for short-term exposures to banks and other financial institutions, derivatives exposures and assets posted as initial margin for derivative contracts. Framework for measuring and controlling banks large exposures: The new framework is intended to be a common minimum standard to apply from 1 January G-SIBs exposures to other G-SIBs will be capped at 15% of tier I capital, while other individual exposures to single counterparties or groups of connected counterparties will be capped at 25%. Reporting of large exposures will be required for any exposure above 10% eligible capital. The standardised approach for measuring counterparty credit risk exposures: The new standardised approach (SA-CCR) calculation introduces significant changes to the methodology from the current non-internal model method approaches. From 1 January 2017 the SA-CCR will be used to calculate the counterparty credit risk exposure associated with OTC derivatives, exchanges traded derivatives and long settlement transactions instead of the standardised method, current exposure method, or internal model method shortcut. Capital requirements for banks' equity investments in funds: The revised framework will take effect 1 January 2017 and will apply to investments in all types of funds (e.g. hedge funds, managed funds and investment funds). Leverage ratio: The revised framework will be effective on 1 January The SARB requires banks leverage ratio to be above a 4% minimum requirement, where the leverage ratio is calculated as tier I capital divided by the sum of on-balance and off-balance sheet exposures, securities financing transactions and derivatives. Securitisation: The revisions to the securitisation framework, which will come into effect in January 2018, aims to address shortcomings in the Basel II securitisation framework and to strengthen the capital standards for securitisation exposures held in the banking book. The BCBS and Group of Twenty (G20) Financial Stability Board also released a number of consultative papers on key topics for comment during the past year. The group participated in quantitative impact studies and on industry forums to inform authorities on the potential impact of proposed regulatory guidance. The following consultation papers received focus during the past year: trading book capital requirements the revised standardised approach for measuring operational risk capital a capital requirement for interest rate risk in the banking book pillar 3 disclosure requirements adequacy of loss-absorbing capacity of G-SIBs in resolution. OTC derivatives Globally there has been a focus on increasing the transparency and regulation of OTC derivatives and to reduce the systemic risk posed by OTC derivative transactions, markets and practices. The G20 s reform programme and subsequent agreements resulted in various principles being defined for use of exchanges or electronic platforms, clearing through central counterparties, reporting to trade repositories and higher capital and margin requirements for derivatives that are not cleared centrally. Many of the G20 jurisdictions are already making good progress in implementation of the G20 agreed commitments, with most of the EU and US regulatory frameworks already effective. South African financial market participants are largely impacted only indirectly by these regulatory developments, which translates into only a reciprocating responsibility to assist our cross border counterparts in complying with their regulatory obligations. Once the South African OTC derivatives reform regulations are finalised, the impact will be direct. The South African OTC derivatives reform framework is expected to be finalised over the course of 2015/2016. Recovery and resolution planning South Africa is in the process of adopting the global Financial Stability Board standards for the effective management of institutions under severe circumstances that could affect the stability of the financial system. These guidelines require the development of recovery and resolution plans. The recovery plans for systemically important institutions proactively identifies management actions which can be adopted during periods of severe stress to ensure the survival of the entity and the sustainability of the economy within which it operates. In the event that these actions prove unsuccessful, the resolution plan sets out the approach for unwinding the entity in an orderly manner minimising the impact on its stakeholders. The group submitted its first comprehensive integrated recovery plan in July 2013 and is now maintaining and annually submitting this plan to ensure that it remains relevant with the most current view of the group s strategy, legal entity structure and financial and risk positions. The group integrated recovery plan was developed to provide a valuable tool to management and the board to manage the implications of severe stress and proactively addresses potential hurdles in effecting these actions. The group is obtaining similar benefits from planning for the stability of its subsidiaries under severe conditions. The National Treasury (NT) and regulatory authorities are in the process of defining the Resolution Framework for South Africa. It will address the globally requisite topics of resolution authority mandate, tools available under resolution such as bail-in and sale of business, and approach for cross-border cooperation with other regulators. It is anticipated that the resolution framework will be adopted in IFRS The International Accounting Standards Board (IASB) has finalised and issued a number of new accounting requirements as well as Risk and capital management report and annual financial statements 106

109 issued a number of proposed accounting changes. The most significant of these being as follows: IFRS 9 Financial Instruments The IASB has issued IFRS 9 which is the replacement for IAS 39 Financial Instruments: Recognition and Measurement (IAS 39). The effective date of IFRS 9 will be 1 January The replacement of IAS 39 was achieved through the following phases: Classification and measurement of financial assets: IFRS 9 requires financial assets to be categorised based on the group s business model for managing the financial assets and the contractual cash flow characteristics of the financial asset. The financial assets will be measured at either amortised cost or fair value according to its classification. Credit risk in financial liability measurement: IFRS 9 requires changes in the fair value of financial liabilities (that are designated at fair value) due to changes in own credit risk to be recognised in OCI as opposed to the income statement. Expected loss impairment model proposals: IFRS 9 replaces IAS 39 s incurred loss impairment requirements with an expected loss impairment model requirement. This new expected loss impairment model will require more timely recognition of expected credit losses and will be applied to financial assets measured at either amortised cost or fair value through OCI, as well as defined loan commitments. With the exception of purchased or originated credit impaired financial assets, expected credit losses are required to be measured through a loss allowance at an amount equal to either 12-month expected credit losses or full lifetime expected credit losses. A loss allowance for full lifetime expected credit losses is required for a financial instrument if the credit risk of that financial instrument has increased significantly since initial recognition as well as for certain contract assets or trade receivables. For all other financial instruments, expected credit losses are measured at an amount equal to 12-month expected credit losses. Hedge accounting requirements: IFRS 9 simplifies the existing hedge accounting requirements and will allow the group to better reflect its risk management activities in its financial statements and will provide more opportunities to apply hedge accounting. Revenue IFRS 15 Revenue from Contracts with Customers (IFRS 15) replaces the existing revenue standards and their related interpretations. IFRS 15 sets out the requirements for recognising revenue that applies to all contracts with customers (except for contracts that are within the scope of the standards on leases, insurance contracts or financial instruments). The core principle of the standard is that revenue recognised reflects the consideration to which the company expects to be entitled in exchange for the transfer of promised goods or services to the customer. The standard incorporates a five step analysis to determine the amount and timing of revenue recognition. The standard will be applied retrospectively with an effective date of 1 January Leases IFRS currently requires an entity to classify its lease arrangements as either finance or operating leases based on the terms of the underlying contract and the risks and rewards incidental to ownership of the leased assets. The IASB has released proposed changes to the accounting for leases. The proposals include changes in the manner in which leases are identified and classified. The core principle of the proposed requirements is that the lessee and lessor should recognise all rights and obligations arising from leasing arrangements on balance sheet. The most significant proposed change pertaining to the accounting treatment of operating leases is from the lessees perspective where a right of use (ROU) asset together with a liability for the future payments is to be recognised. From a South African regulatory perspective, the increase in both assets and liabilities will have an impact on the group s prudential requirements as follows: The ROU assets will attract a risk weighting of 100% for purposes of determining capital requirements in support of these assets. Given the long-term nature of the ROU assets, the ROU assets are expected to be categorised under Basel III as other assets and will attract a 100% stable funding requirement. Liabilities arising from the lease agreement will increase the group s total liabilities, resulting in a reserving requirement of 2.5% of the balance, as well as a liquid asset requirement of 5% of the balance. The liability does not contribute to the stable funding Basel III requirement. Insurance contracts The IASB s exposure draft on insurance contracts proposes a comprehensive measurement approach for all types of insurance contracts that are issued by entities (and reinsurance contracts held by entities) with a modified approach for some short-duration contracts. The comprehensive measurement approach is based on the principle that insurance contracts create a bundle of rights and obligations that work together to generate a package of cash inflows (premiums) and outflows (benefits and claims). The proposals state that an insurer applies a measurement approach utilising building blocks to this package of cash flows. The proposals and effective date are both yet to be finalised. With respect to all of the abovementioned accounting developments, the group continues to participate in industry body discussions on the new and proposed changes. The group is currently developing its adoption framework to ensure that it is positioned to adopt the requirements of the new standards on their respective effective dates in line with the standards required transition requirements. South Africa Twin Peaks regulatory framework The second draft of the Financial Sector Regulation Bill was released by NT on 12 December following public comments and engagement with stakeholders. It is expected to be tabled in Parliament in Its aim is to make the financial sector safer and better serve South Africa by providing the legislative framework for the adoption of a Twin Peaks system of regulating the financial sector. The Twin Peaks system will comprise a Prudential Authority focused on the safety and soundness of financial institutions, and a 107

110 Risk and capital management report Annexure A Regulatory and legislative developments impacting the group continued Financial Sector Conduct Authority focused on the manner in which financial institutions conduct their business and the fair treatment of financial customers. The Bill also takes steps to strengthen financial stability and crisis resolution. Once enacted the Bill will be adopted in two phases: to establish the two regulatory authorities to harmonise the various sub-sectoral legislation and align prudential and/or market conduct standards across the sector. Financial Markets Act The Financial Markets Act 19 of 2012 impacts a number of activities of corporate and investment banking. This Act regulates the functioning of the stock exchange, as well as market abuse such as insider trading and price manipulation. Draft regulations were released by the NT for OTC derivatives with specific requirements in terms of reporting, clearing, and OTC product providers. Following public comment and stakeholder engagement, the regulatory framework for OTC derivatives is expected to be finalised in Treating customers fairly The SA FSB published a roadmap for the programme TCF which outlines a framework on aspects of market conduct of financial services firms. TCF comprises six fairness outcomes and seeks to ensure that the fair treatment of customers is embedded within the culture of financial services firms. In order to meet the outcomes, the group has initiated a TCF programme, put governance structures in place and is developing suitable measures and implementing control mechanisms. While the various boards of directors of affected group entities will ensure that TCF is central to the entities ethics, values, culture and strategy, senior management owns TCF. Protection of Personal Information Act The PoPI Act provides for conditions of privacy and protection of personal information. PoPI has an extensive impact on the group, particularly in relation to the manner in which it uses information, both within South Africa and internationally. The group takes care to protect the personal information of customers and will be strengthening controls to align to PoPI s requirements. A group data privacy officer has been appointed and the group s PoPI project is progressing satisfactorily. The Banking Association of South Africa is drafting a banking code on PoPI which, if approved by the new information regulator (when established), will govern the banking industry. Consumer credit The National Credit Amendment Act includes changes in the regulation of consumer credit which have implications for several of the group s models, systems and processes. These changes include amendments to the conditions of registration to empower the Minister of Trade and Industry to prescribe codes of conduct and verify, review or remove consumer credit information. The credit information amnesty came into effect 1 April and involved the removal of certain adverse credit information from credit records at the credit bureaus. The draft Affordability Assessment Regulations outline specific steps to assess customers ability to afford credit. A programme has been initiated in PBB SA to ensure the continuation of sound credit extension within its risk appetite. Retail Distribution Review The SA FSB has released the RDR document for comment. The review centres on the insurance and investment value change, including the product providers, intermediaries and customers. It focuses on the financial advice and products sold to customers and makes proposals to address potential areas in the value chain which could result in conflicts of interest. The proposals would impact the SBSA s insurance and investment business models. A process is in place to engage with stakeholders on the document. United Kingdom, Europe and the United States Key regulatory developments in the group s operations in future are: UK Fair and Effective Market review: The UK is reviewing the fairness and effectiveness of fixed income, currency and commodity (FICC) markets, including the feasibility of a global code of conduct. The review will also extend the regulatory regime which applies to LIBOR, to a broader range of FICC benchmarks. UK Banking Reform Act: A number of measures will be phased in up to 2019, including ring fencing of deposit taking activities and measures to enhance individual accountability. The latter will include new enforceable conduct rules, applying to nearly all bank employees, reverse burden of proof for senior managers. Subsequent to any material breach in a senior managers area, they will be required to demonstrate that all reasonable steps were taken to mitigate the breach. A new criminal offence of reckless misconduct has also been adopted, relating to any senior manager actions, which results in a bank failure. EU recast capital requirements directive and new regulation: 1 January saw the implementation of Basel III across the European Union, via the capital requirements directive (CRD) and the capital requirements regulation (CRR), collectively referred to as the CRD IV package. The combined reforms have introduced new capital, leverage and liquidity requirements, whilst also introducing new concepts such as capital buffers and imposing regulatory frameworks on securitisations, derivatives trading and remuneration policies. EU Markets in Financial Instruments recast directive and new regulation: This will become effective January 2017, introducing requirements which include: all multilateral trading in financial instruments (unless qualifying as OTC), will be required to be traded on a regulated venue, and subject to pre- and post-trade transparency harmonised EU position limit regime for commodity derivatives restrictions on algorithmic trading and direct electronic access measures to harmonise EU approaches to third country equivalence regimes. EU Benchmark Regulation: The regulation is expected to become effective in 2017, establishing a legal basis for the International Organization of Securities Commissions Principles for Financial Benchmarks. Once adopted, administration of benchmarks will become a regulated activity, requiring prior regulatory approval. Use of unregulated benchmarks will be prohibited, along with any third country benchmarks, not deemed Risk and capital management report and annual financial statements 108

111 equivalent to the proposed regulation. The regulation also introduces prescriptive requirements for contributors to benchmarks. EU FTT: Once adopted, the FTT will introduce tax on financial transactions. Agreement on an EU 28 FTT has not been achievable and 11 member states (Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia) have decided to proceed with the adoption of an EU 11 FTT. EU Market Abuse Regulation: The Market Abuse Regulation will become effective in June 2016 and will extend the current market abuse regime to all financial instruments, including trading on the spot market, under certain circumstances. New offences in relation to insider dealing and market manipulation will also be introduced. EU 4th Money Laundering Directive: The directive is expected to become effective in 2016, introducing a more risk-based approach to: money laundering and terrorist financing risk assessments, at an EU, member state and an obliged entity level customer due diligence approach to third world countries. The European Market Infrastructure Regulation: This regulation has been in effect since August 2012 with further details still being phased in. It specifies requirements for central clearing, reporting to trade repositories and risk mitigation for non-centrally cleared OTC derivatives. The clearing requirement for certain specified OTC derivatives products will take effect on a phased in basis from January The group is able to support its EU counterparties in their compliance with this regulatory framework and has not experienced any disruption in trading activities with their EU counterparts. Dodd Frank Wall Street Reform and Consumer Protection Act: This came into effect in the US in July It was designed to promote the financial stability of the US economy by improving accountability and transparency in the financial system, specifically the derivative markets where US persons are the counterparty. The majority of rules have now taken effect, with only some products yet to be made available to trade on swap execution facilities, or to be made subject to mandatory clearing. Rest of Africa Continued focus on enhancing the regulatory framework in countries across Africa during resulted in an increase in the complexity and tightening of regulatory requirements. The most significant developments noted have related to exchange control, financial crime (anti-money laundering), prudential requirements (capital adequacy and liquidity) and market conduct requirements. Emphasis on local currencies being the mode of settlement and tightening of repatriation periods in countries such as Ghana, the Democratic Republic of Congo (DRC) and Angola was highlighted in developments relating to foreign exchange and exchange control with a resultant impact on cash payment procedures, pricing and the handling of imports and exports. The extent of regulations in DRC included emphasis of the Congolese franc in-country as the settlement currency for transactions, including all local charges and taxes due to the tax authority. Foreign currencies equal to or greater than USD cannot be effected, except in cities or towns where there are financial institutions, branches or points of representation; thus promoting the development of formal economy (including the banking system) and also supporting the fight against money laundering and terrorism financing. Developments relating to financial crime, specifically anti-money laundering, have included the enhancement of existing regulations and the introduction of new legislation. This has included enhanced and focused reporting of suspicious transactions, strengthening of regulatory authorities, stricter time frames for reporting and the introduction of offences for terrorist financing to give effect to international best practice measures to combat terrorist proliferation activities. Directives on capital adequacy and prudential liquidity requirements have been issued or re-enforced in a number of countries. In Mauritius guidelines on the scope and application of Basel III, eligible capital, and new measures to assess liquidity risk management were introduced. In countries such as Nigeria, measures to ensure a more prudent assessment of regulatory capital and raise the quality and loss absorbency of the capital base of banks have been introduced. Mozambique saw the introduction of requirements to publicly disclose information relating to capital structure, capital adequacy, credit risk, mitigation of credit risk, market risk, operational risk and equity stakes disclosure relating to banking books. Consumer protection measures noted in some of the countries have varied from the introduction of specific fee disclosures (in Angola, Nigeria and Lesotho) to the placement of moratoriums on fees for a period of time (in Botswana). The Bank of Mauritius proposed fairness measures for banks in Mauritius. The recommendations made are guided by the principles of fairness and rest on eight pillars of fairness, which include banking accessibility to all fair fees and charges, fair terms and condition, TCF, protecting and empowering customers and treating bankers fairly. Based on the increase in regulatory developments in, it is anticipated that these will continue on an upward trend in Impacting the group s short- and long-term insurance operations South Africa Solvency Assessment and Management The SA FSB is developing a risk-based regulatory requirement for South African insurance and reinsurance organisations, known as SAM. This new regulatory standard aims to address the adequacy of capital allocation and risk management to protect policyholders. This initiative will align the South African insurance industry with international standards. A two-phase SAM parallel run will facilitate a smooth transition to this new regulatory standard. A light phase was conducted during the second half of, with a comprehensive phase to be conducted during Insurers will need to be in a position to comply with most of the SAM requirements by 2015; however, full implementation of the SAM framework will only be effective from 1 January

112 Risk and capital management report Annexure A Regulatory and legislative developments impacting the group continued SAM requires organisations to integrate risk and capital management within the organisation. Liberty can derive certain business benefits from implementing SAM principles, such as: Increased risk transparency: Improved measurement and management of risk across all processes in the organisation will create more detailed information. Transparency of risk reporting will enable the avoidance of risks before they result in losses by taking mitigating action. Reduced capital requirements: Adoption of a sophisticated risk management approach could be rewarded by lower regulatory capital requirements. Investment to improve the risk management could, therefore, be recovered through long-term capital savings. Greater diversification of investments: Reduced capital requirements will release funds for alternative investment opportunities. Improved risk management processes will allow for investment in assets with higher risk and return, depending on risk appetite. Higher profit potential: Sophisticated capital management will enable improved capital allocation between business units to focus on higher return opportunities. Advanced risk management processes will support sensible engagement in high margin business. Communicating enhanced risk management and capital allocation arrangements as part of brand will create greater demand from customers and shareholders. Improved credit rating: This will entail increased market disclosure of risk management practices to both investors and analysts. Evidence of sophisticated risk management processes will lead to improved analyst ratings driving down capital costs. The new SAM regime will drive key changes to Liberty s business applications. These changes will predominantly lead to enhanced business capability in respect of risk-adjusted decision-making processes within Liberty. Liberty is well represented at all levels of the SA FSB s SAM industry forums through participation in the task groups and working groups, the SAM steering committee and its subcommittees. Retail Distribution Review In November, the SA FSB released a RDR discussion paper. The SA FSB has indicated that the changes will be effected in a phased manner both under the current regulatory framework (Financial Advisory and Intermediary Services (FAIS) Act 2002) and as the Twin Peaks legislative framework evolves. It is proposed than an implementation period of 12 months is provided for once proposals are finalised. RDR is broadly underpinned by the regulator s aim to implement international-standard market conduct and consumer protection frameworks in South Africa. The review is directed at addressing the complexity of financial investment and risk products and the perceived misalignment of incentives between customers, intermediaries and product providers. RDR aims to ensure that remuneration structures do not prejudice the customer and that there are level playing fields and payment structures across similar investment products. Furthermore, RDR promotes awareness among customers of how much and how their advisers are remunerated. Retirement reform The overarching objective of retirement reform is to safeguard savers and pensioners against presumed market failures in costs, access and disclosure and to mobilise additional savings. The proposed reforms aim to improve the transparency and disclosure of product offerings to encourage competition (and decrease cost) and to allow consumers to effectively compare and choose savings products. A number of retirement reform proposals have been implemented through the Taxation Laws Amendment Act 2013, the Financial Services Laws General Amendment Act 2013 and the draft Taxation Laws Amendment Bill. Some of the amendments proposed in the Taxation Laws Amendment Act 2013 have been delayed because of political pressure from the labour unions who have argued that retirement reforms must take place within the context of broader social security reform. Liberty has introduced a retirement reform regulatory project which will ensure that the organisation is compliant with the proposed reforms. Treating customers fairly Further to the original TCF documents released in 2011, in October the SA FSB has released discussion documents implementing and standardising a complaints management process; the categorisation of complaints; engagement with the Ombudsman and reporting of complaints. Liberty currently has a TCF regulatory project in place which will ensure that the organisation is adopting TCF principles. Consumer credit insurance (CCI) In July, a technical report on the CCI market in South Africa was issued by the NT. The purpose of the technical report was to conduct a review of business practices in the CCI sector and to propose mechanisms of strengthening the existing framework. The technical report will be used to finalise the policy framework with a view to regulating the CCI industry more effectively. The report highlights the following key concerns in the CCI market: lack of transparency in the total cost of credit high premiums and different pricing product differentiation limits comparison CCI cover does not meet the needs of the target market. The report proposes the following mechanisms in order to address the weaknesses in the CCI market: regulating the pricing of CCI regulating market conduct non-pricing practices protecting consumers through insurance cover for credit providers. Risk and capital management report and annual financial statements 110

113 Annexure B Composition of capital SBG 1 December Basel III December 2013 Basel III CET I capital Instruments and reserves CET I capital before regulatory adjustments Reference Directly issued qualifying common share capital plus related stock surplus (c) Retained earnings (d) Accumulated other comprehensive income (and other reserves) (d) Directly issued capital subject to phase out from CET I (only applicable to non-joint stock companies) Public sector capital injections grandfathered until 1 January 2018 Common share capital issued by subsidiaries and held by third parties (amount allowed in group CET I) (f) Regulatory adjustments Less: total regulatory adjustments to CET I (27 689) (27 298) Prudential valuation adjustments Goodwill (net of related tax liability) (3 711) (3 747) (b) Other intangibles other than mortgage-servicing rights (net of related tax liability) (15 850) (12 933) (b) Deferred tax assets that rely on future profitability, excluding those arising from temporary differences (net of related tax liability) (511) (1 054) (a) Cash flow hedge reserve (467) (761) Shortfall of provisions to expected losses (2 054) (2 667) Securitisation gain on sale Gains and losses due to changes in own credit risk on fair valued liabilities (195) (747) Defined benefit pension fund net assets (516) (669) Investments in own shares (if not already netted of paid-in capital on reported balance sheet) (308) Reciprocal cross-holdings in common equity Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions, where the bank does not own more than 10% of the issued share capital (amount above 10% threshold) Significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions (amount above 10% threshold) (4 074) (4 705) Mortgage servicing rights (amount above 10% threshold) Deferred tax assets arising from temporary differences (amount above 10% threshold, net of related tax liability) Amount exceeding the 15% threshold, relating to: Significant investments in the common stock of financials Mortgage servicing rights Deferred tax assets arising from temporary differences National-specific regulatory adjustments (3) (15) Regulatory adjustments applied to CET I in respect of amounts subject to pre-basel III treatment Regulatory adjustments applied to CET I due to insufficient additional tier I and tier II to cover deductions 1 Disclosure based on prescribed SARB template. All blank line items are not applicable as at 31 December and 31 December

114 Risk and capital management report Annexure B continued Composition of capital SBG 1 continued December Basel III December 2013 Basel III Additional tier I capital Instruments Additional tier I capital before regulatory adjustments Reference Directly issued qualifying additional tier I instruments plus related stock surplus, classified as: (e) Equity under applicable accounting standards (e) Liabilities under applicable accounting standards Directly issued capital instruments subject to phase out from additional tier I (e) Additional tier I instruments (and CET I instruments not included in common share capital ) issued by subsidiaries and held by third parties (amount allowed in group additional tier I), including: Instruments issued by subsidiaries subject to phase out Regulatory adjustments Total regulatory adjustments to additional tier I capital Investments in own additional tier I instruments Reciprocal cross-holdings in additional tier I instruments Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions, where the bank does not own more than 10% of the issued share capital (amount above 10% threshold) Significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions (amount above 10% threshold) National-specific regulatory adjustments: Regulatory adjustments applied to CET I in respect of amounts subject to pre-basel III treatment Regulatory adjustments applied to additional tier I due to insufficient additional tier I due to insufficient tier II to cover deductions Tier I capital Disclosure based on prescribed SARB template. All blank line items are not applicable as at 31 December and 31 December Risk and capital management report and annual financial statements 112

115 Composition of capital SBG 1 continued December Basel III December 2013 Basel III Capital and provisions Tier II capital before regulatory adjustments Directly issued qualifying tier II instruments plus related stock surplus Directly issued capital instruments subject to phase out from tier II Reference Tier II instruments (and CET I and additional tier I instruments not included in common share capital and additional tier I instruments) issued by subsidiaries and held by third parties (amount allowed in group tier II), including: (g) Instruments issued by subsidiaries subject to phase out Provisions Regulatory adjustments Total regulatory adjustments to tier II capital Investments in own tier II instruments Reciprocal cross-holdings in tier II instruments Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation, net of eligible short positions, where the bank does not own more than 10% of the issued share capital (amount above 10% threshold) Significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation (net of eligible short positions) National-specific regulatory adjustments Regulatory adjustments applied to tier II in respect of amounts subject to pre-basel III treatment Tier II capital Total capital Total risk-weighted assets Risk-weighted assets in respect of amounts subject to pre-basel III treatment Capital ratios and buffers CET I (as a percentage of risk-weighted assets) % Tier I (as a percentage of risk-weighted assets) % Total capital (as a percentage of risk-weighted assets) % Institution-specific buffer requirement (minimum CET I requirement plus capital conservation buffer plus countercyclical buffer requirements plus global systemically important banks (G-SIB) buffer requirement, expressed as a percentage of risk-weighted assets) % Capital conservation buffer requirement % Bank-specific countercyclical buffer requirement % G-SIB buffer requirement % Common equity tier I available to meet buffers (as a percentage of risk-weighted assets) % Disclosure based on prescribed SARB template. All blank line items are not applicable as at 31 December and 31 December

116 Risk and capital management report Annexure B continued Composition of capital SBG 1 continued December Basel III December 2013 Basel III National minima (if different from Basel III) National CET I minimum ratio (if different from Basel III minimum) excluding individual capital requirement (ICR) and domestic systemically important banks (D-SIB) % National tier I minimum ratio (if different from Basel III minimum) excluding ICR and D-SIB % National total capital minimum ratio (if different from Basel III minimum) excluding ICR and D-SIB % Amounts below the threshold for deductions (before risk weighting) Non-significant investments in the capital of other financials Significant investments in the capital of financials Mortgage servicing rights (net of related tax liability) Deferred tax assets arising from temporary differences (net of related tax liability) Applicable caps on the on the inclusion of provisions in tier II Provisions eligible for inclusion in tier II in respect of exposures subject to standardised approach (prior to application of cap) Cap on inclusion of provisions in tier II under standardised approach Provisions eligible for inclusion in tier II in respect of exposures subject to internal ratings-based approach (prior to application of cap) Cap for inclusion of provisions in tier II under internal ratings-based approach Capital instruments subject to phase-out arrangements (only applicable between 1 January 2013 and 1 January 2022) Current cap on CET I instruments subject to phase-out arrangements Amount excluded from CET I due to cap (excess over cap after redemptions and maturities) Current cap on additional tier I instruments subject to phase-out arrangements Amount excluded from additional tier I due to cap (excess over cap after redemptions and maturities) Current cap on tier II instruments subject to phase-out arrangements Amount excluded from tier II due to cap (excess over cap after redemptions and maturities) Reference 1 Disclosure based on prescribed SARB template. All blank line items are not applicable as at 31 December and 31 December Risk and capital management report and annual financial statements 114

117 Annexure C Reconciliation of audited statement of financial position and regulatory capital and reserves Statement of financial position Under regulatory scope of consolidation Reference 1 Assets Cash and balances with central banks Financial investments, trading and pledged assets Non-current assets held for sale Loans and advances Current tax assets 498 Deferred tax assets (a) Derivatives and other assets Interest in associates and joint ventures Investment property Goodwill and other intangible assets (b) Property and equipment Total assets Equity and liabilities Equity Equity attributable to ordinary shareholders Ordinary share capital (c) Ordinary share premium (c) Reserves (d) Preference share capital and premium (e) Non-controlling interests (f) Liabilities Derivative, trading and other liabilities Non-current liabilities held for sale Deposit and current accounts Current tax liabilities Deferred tax liabilities Policyholders liabilities Subordinated debt (g) Total equity and liabilities Reference to annexure B on preceding pages. 115

118 Risk and capital management report Annexure D Capital instruments: Main features disclosure template 1 Ordinary share capital (including share premium) Subordinated bond SBK7 Subordinated bond SBK9 Subordinated bond SBK12 Subordinated bond SBK13 Subordinated bond SBK14 Issuer SBSA SBSA SBSA SBSA SBSA SBSA Unique identifier (for example, CUSIP, ISIN or ZAG ZAG ZAG ZAG ZAG Bloomberg identifier for private placement) Governing law(s) of the instrument SA SA SA SA SA SA Regulatory treatment Transitional Basel III rules CET I Tier II Tier II Tier II Tier II Tier II Post-transitional Basel III rules CET I Tier II Tier II Tier II Tier II Tier II Eligible at solo/group/group & solo Solo Group & solo Group & solo Group & solo Group & solo Group & solo Instrument type (types to be specified by each jurisdiction) Amount recognised in regulatory capital (currency in, as of most recent reporting date) Ordinary share capital and premium Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt ZAR ZAR3 000 ZAR1 500 ZAR1 600 ZAR1 150 ZAR1 780 Par value of instrument (currency in millions) ZAR1 ZAR3 000 ZAR1 500 ZAR1 600 ZAR1 150 ZAR1 780 Accounting classification Equity attributable to ordinary shareholders Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Original date of issuance Ongoing 2005/05/ /04/ /11/ /11/ /12/01 Perpetual or dated Perpetual Dated Dated Dated Dated Dated Original maturity date N/A 2020/05/ /04/ /11/ /11/ /12/01 Issuer call subject to prior supervisory approval No Yes Yes Yes Yes Yes Optional call date, contingent call dates and redemption amount (currency in ) N/A 2015/05/24 ZAR /04/10 ZAR /11/24 ZAR /11/24 ZAR /12/01 ZAR1 780 Subsequent call dates, if applicable N/A 2015/05/24 or any interest payment date thereafter Coupons/dividends 2018/04/10 or any interest payment date thereafter 2016/11/24 or any interest payment date thereafter 2016/11/24 or any interest payment date thereafter 2017/12/01 or any interest payment date thereafter Fixed or floating dividend/coupon N/A Fixed Fixed Fixed Floating Fixed Coupon rate and any related index N/A 9.63% 8.40% 10.82% JIBAR % semi-annual semi-annual semi-annual semi-annual Existence of a dividend stopper No No No No No No Fully discretionary, partially discretionary Full discretionary Mandatory Mandatory Mandatory Mandatory Mandatory or mandatory Existence of step up or other incentive No Yes Yes Yes Yes No to redeem Non-cumulative or cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Convertible or non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Write-down feature N/A N/A N/A N/A N/A N/A Position in subordination hierarchy in liquidation (specify instrument type Most subordinated Senior unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured immediately senior to instrument) Non-compliant transitioned features No Yes Yes Yes Yes Yes If yes, specify non-compliant features N/ARegulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) (a)(i) (a)(i) (a)(i) (a)(i) (a)(i) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) (a)(iv)(d) (a)(iv)(d) (a)(iv)(d) (a)(iv)(d) (a)(iv)(h)(ii) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) (a)(iv)(h)(ii) (a)(iv)(h)(ii) (a)(iv)(h)(ii) (a)(iv)(h)(ii) 1 For related carrying values of subordinated debt, refer to note 23 in the annual financial statements. Risk and capital management report and annual financial statements 116

119 Subordinated bond SBK15 Subordinated bond SBK16 Subordinated bond SBK17 Subordinated bond SBK18 Subordinated bond SBK19 Subordinated bond SBK20 Ordinary share capital (including share premium) Cumulative preference share capital Non-cumulative preference share capital SBSA SBSA SBSA SBSA SBSA SBSA SBG SBG SBG ZAG ZAG ZAG ZAG ZAG ZAG SBK ZAE SBKP ZAE SBPP ZAE SA SA SA SA SA SA SA SA SA Tier II Tier II Tier II Tier II Tier II N/A CET I Tier II Additional tier I Tier II Tier II Tier II Tier II Tier II Tier II CET I Tier II Additional tier I Group & solo Group & solo Group & solo Group & solo Group & solo Group & solo Group Group Group Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Ordinary share capital and premium Preference share capital and share premium Preference share capital and share premium ZAR1 220 ZAR2 000 ZAR2 000 ZAR3 500 ZAR500 ZAR2 250 ZAR ZAR8 ZAR4 396 ZAR1 220 ZAR2 000 ZAR2 000 ZAR3 500 ZAR500 ZAR c ZAR1 1c Subordinated Subordinated Subordinated Subordinated Subordinated Subordinated debt debt debt debt debt debt Equity attributable to ordinary shareholders Preference share capital and share premium Preference share capital and share premium 2012/01/ /03/ /07/ /10/ /10/24 /12/02 Ongoing 1969/11/ /07/07, 2006/05/23, 2006/08/12 Dated Dated Dated Dated Dated Dated Perpetual Perpetual Perpetual 2022/01/ /03/ /07/ /10/ /10/ /12/02 N/A N/A N/A Yes Yes Yes Yes Yes Yes No No No 2017/01/23 ZAR /03/15 ZAR /07/30 ZAR /10/24 ZAR /10/24 ZAR /12/02 ZAR2 250 N/A N/A N/A 2017/01/23 or any interest payment date thereafter 2018/03/15 or any interest payment date thereafter 2019/07/30 or any interest payment date thereafter 2020/10/24 or any interest payment date thereafter 2019/10/24 or any interest payment date thereafter 2019/12/02 or any interest payment date thereafter N/A N/A N/A Floating Floating Floating Floating Floating Floating N/A Fixed Floating JIBAR JIBAR JIBAR JIBAR JIBAR JIBAR N/A 6.50% 77% of prime interest rate No No No No No No No No No Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Full discretionary Full discretionary Full discretionary No No No No No No No No No Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Cumulative Non-cumulative Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible N/A N/A N/A N/A N/A Yes N/A N/A N/A Senior unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured Non-cumulative preference shares Subordinated debt Cumulative preference shares Yes Yes Yes Yes Yes No No Yes Yes Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(h)(ii) N/A N/A No loss absorbency features at the point of non-viability No loss absorbency features at the point of non-viability 117

120 Risk and capital management report Annexure D Capital instruments continued Main features disclosure template 1 continued Issuer Subordinated bond Standard Bank Swaziland 1 Standard Bank Swaziland Limited Subordinated bond Standard Bank Swaziland 2 Standard Bank Swaziland Limited Subordinated bond Stanbic Bank Botswana 1 Stanbic Bank Botswana Limited Subordinated bond Stanbic Bank Botswana 5 Stanbic Bank Botswana Limited Subordinated bond Standard Bank Mozambique Standard Bank Mozambique Subordinated bond CfC Stanbic Bank Kenya 3 CFC Stanbic Bank Limited Unique identifier (for example, CUSIP, ISIN or SZD SZD SBBL056 SBBL057 SBM-2007 KE Bloomberg identifier for private placement) Governing law(s) of the instrument Swaziland Swaziland Botswana Botswana Mozambique Kenya Regulatory treatment Transitional Basel III rules N/A Tier II Tier II Tier II Tier II Tier II Post-transitional Basel III rules N/A Tier II Tier II Tier II Tier II Tier II Eligible at solo/group/group & solo Solo Group & solo Group & solo Group & solo Group & solo Group & solo Instrument type (types to be specified by each jurisdiction) Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Amount recognised in regulatory capital (currency in, as of most recent reporting date) ZAR50 E50 ZAR50 E50 ZAR61 BWP50 ZAR97 BWP80 ZAR88 MT260 ZAR307 KES2 402 Par value of instrument (currency in millions) ZAR50 E50 ZAR50 E50 ZAR61 BWP50 ZAR97 BWP80 ZAR88 MT260 ZAR307 KES2 402 Accounting classification Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Original date of issuance /12/ /10/ /06/ /05/ /06/ /07/07 Perpetual or dated Dated Dated Dated Dated Dated Dated Original maturity date 2024/12/ /10/ /06/ /05/ /06/ /07/07 Issuer call subject to prior supervisory approval Yes Yes Yes Yes Yes Yes Optional call date, contingent call dates and redemption amount (currency in ) Subsequent call dates, if applicable 2019/12/14 E December or any interest payment date thereafter 2015/10/14 E 50 On or after 2015/10/ /06/13 BWP 50 On or after 2016/06/13 Coupons/dividends Fixed or floating dividend/coupon Fixed Fixed Fixed margin linked to a floating base rate 2017/05/23 BWP 80 On or after 2017/05/23 Fixed margin linked to a floating base rate 91 day BoBC +150bps N/A N/A Fixed margin linked to a floating base rate WA +50bps Coupon rate and any related index 8.75% 8.1% 91 day BoBC +130bps 12.5% Existence of a dividend stopper No No No No No No Fully discretionary, partially discretionary Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory or mandatory Existence of step up or other incentive Yes Yes Yes Yes Yes Yes to redeem Non-cumulative or cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Convertible or non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Write-down feature N/A N/A N/A N/A N/A N/A Position in subordination hierarchy in liquidation (specify instrument type immediately senior to instrument) Senior/ unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured N/A N/A Fixed Senior unsecured Non-compliant transitioned features N/A Yes Yes Yes Yes Yes If yes, specify non-compliant featuresregulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) (a)(i) (a)(i) (a)(i) (a)(i) (a)(i) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) (a)(iv)(d) (a)(iv)(d) (a)(iv)(d) (a)(iv)(d) (a)(iv)(h)(ii) Regulation 38(14) Regulation 38(14) Regulation 38(14) Regulation 38(14) (a)(iv)(h)(ii) (a)(iv)(h)(ii) (a)(iv)(h)(ii) (a)(iv)(h)(ii) 1 For related carrying values of subordinated debt, refer to note 23 in the annual financial statements. Risk and capital management report and annual financial statements 118

121 Subordinated bond CfC Stanbic Bank Kenya 3 Subordinated bond CfC Stanbic Bank Kenya Subordinated bond Stanbic Bank Ghana 1 Subordinated loan Stanbic Bank Ghana 2 Subordinated loan Standard Bank Mauritius Subordinated loan Standard Bank Tanzania Subordinated loan Stanbic Bank Uganda Subordinated loan Standard Bank Angola Subordinated loan Stanbic Bank IBTC CfC Stanbic Bank Limited CfC Stanbic Bank Limited Stanbic Bank Ghana Limited Stanbic Bank Ghana Limited Standard Bank Mauritius Standard Bank Tanzania Stanbic Bank Uganda Standard Bank Angola Stanbic Bank IBTC KE KE IFC IFC Standard Bank Standard Bank SAHL Standard Bank NGSB2024S1B1 South Africa South Africa South Africa South Africa Kenya Kenya Ghanaian law Ghana Mauritius Tanzania Uganda Angola Nigeria Tier II N/A Tier II Tier II Tier II Tier II Tier II N/A N/A Tier II N/A Tier II Tier II Tier II Tier II Tier II N/A N/A Group & solo Solo Group & solo Group & solo Solo Solo Solo Solo Solo Subordinated debt Subordinated debt Subordinated debt Subordinated loan Subordinated loan Subordinated loan Subordinated loan Subordinated loan Subordinated loan ZAR12 KES98 ZAR511 KES4 000 ZAR25 GHS7 ZAR58 GHS16 ZAR289 USD25 ZAR58 TZS8 664 ZAR81 UGX ZAR347 AOA3 086 ZAR463 NGN7 309 ZAR12 KES98 ZAR511 KES4 000 ZAR25 GHS7 ZAR58 GHS16 ZAR289 USD25 ZAR58 TZS8 664 ZAR81 UGX ZAR347 AOA3 086 ZAR463 NGN7 309 Subordinated debt Subordinated debt Subordinated debt Subordinated loan Subordinated loan Subordinated loan Subordinated loan Subordinated loan Subordinated loan 2009/07/07 /12/ /01/ /03/ /12/ /12/ /10/ /05/ /04/30 Dated Dated Dated Dated Dated Dated Dated Dated Dated 2016/07/ /12/ /01/ /03/ /12/ /12/ /10/ /04/ /10/31 Yes Yes Yes Yes Yes Yes Yes Yes Yes N/A June 2020 KES /01/23 GHS7 2015/03/29 GHS /12/04 USD /12/15 TZS /10/31 UGX /04/23 AOA /05/31 NGN7 309 Fixed margin linked to a floating base rate 182 day T-bill +175 bps N/A June 2020 or any interest payment date thereafter 23 January 2017 or any interest payment date thereafter 29 March 2015 or any interest payment date thereafter Fixed Fixed Fixed margin linked to a floating base rate 5 December 2017 or any interest payment date thereafter Fixed margin linked to a floating base rate 16 December 2016 or any interest payment date thereafter Fixed margin linked to a floating base rate 1 November 2016 or any interest payment date thereafter Fixed margin linked to a floating base rate 24 April 2018 or any interest payment date thereafter Fixed margin linked to a floating base rate 1 November 2016 or any interest payment date thereafter Fixed margin linked to a floating base rate 12.95% 11.25% LIBOR + 325bps LIBOR + 300bps LIBOR + 395bps LIBOR + 376bps LIBOR + 360bps LIBOR + 360bps No No No No No No No No No Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Yes No Yes Yes Yes Yes Yes Yes Yes Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible N/A N/A N/A N/A N/A N/A N/A N/A N/A Senior unsecured Senior/ unsecured Senior unsecured Senior unsecured Yes N/A Yes Yes Yes Yes Yes N/A N/A Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(d) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(d) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(d) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(d) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(d) Regulation 38(14) (a)(iv)(h)(ii) Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(d) Regulation 38(14) (a)(iv)(h)(ii) Senior debt Senior debt Senior debt Senior debt Senior debt 119

122 Risk and capital management report Annexure D Capital disclosure continued Main features disclosure template 1 continued Subordinated loan Standard Bank Zambia Subordinated loan Stanbic Bank DRC Subordinated bond Stanbic Bank IBTC Subordinated bond Standard Bank Namibia Subordinated loan Stanbic Bank Botswana Issuer Unique identifier (for example, CUSIP, ISIN or Bloomberg identifier for private placement) Standard Bank Zambia Standard Bank South Africa Stanbic Bank DRC Standard Bank South Africa Stanbic Bank IBTC Standard Bank Namibia Stanbic Bank Botswana NGSB2024S1B1 NA000A1ZRK11 Standard Bank South Africa Governing law(s) of the instrument Zambia DRC Congo Nigeria Namibia Botswana Regulatory treatment Transitional Basel III rules Tier II N/A N/A N/A N/A Post-transitional Basel III rules Tier II N/A N/A N/A N/A Eligible at solo/group/group & solo Solo Solo Solo Solo Solo Instrument type (types to be specified by each jurisdiction) Subordinated loan Subordinated loan Subordinated debt Subordinated debt Subordinated loan Amount recognised in regulatory capital (currency in, as of most recent reporting date) ZAR174 ZMK96 ZAR35 CDF2 736 ZAR977 NGN ZAR100 NAD100 ZAR364 BWP300 Par value of instrument (currency in millions) ZAR174 ZMK96 ZAR35 CDF2 736 ZAR977 NGN ZAR100 NAD100 ZAR364 BWP300 Accounting classification Subordinated loan Subordinated loan Subordinated debt Subordinated debt Original date of issuance 2011/12/13 /06/03 /09/30 /10/23 /11/28 Perpetual or dated Dated Dated Dated Dated Dated Original maturity date 2021/12/ /06/ /09/ /10/ /11/28 Issuer call subject to prior supervisory approval Yes Yes Yes Yes Yes Optional call date, contingent call dates and redemption amount (currency in ) Subsequent call dates, if applicable Coupons/dividends Fixed or floating dividend/coupon 2016/12/13 ZMK96 14 December 2016 or any interest payment date thereafter Fixed margin linked to a floating base rate 2019/06/03 CDF June 2019 or any interest payment date thereafter Fixed margin linked to a floating base rate 2019/10/01 NGN October 2019 or any interest payment date thereafter 2019/10/23 NAD October 2019 or any interest payment date thereafter Subordinated loan 2019/11/28 BWP November or any interest payment date thereafter Fixed Fixed Fixed Coupon rate and any related index LIBOR + 385bps LIBOR + 975bps 13.25% 9.00% 10.25% Existence of a dividend stopper No No No No No Fully discretionary, partially discretionary or mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Existence of step up or other incentive to redeem Yes Yes No Yes No Non-cumulative or cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Convertible or non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Write-down feature N/A N/A N/A N/A N/A Position in subordination hierarchy in liquidation (specify instrument type immediately senior to instrument) Senior debt Senior debt Senior unsecured Senior unsecured Senior debt Non-compliant transitioned features Yes N/A N/A N/A N/A If yes, specify non-compliant features Regulation 38(14) (a)(i) Regulation 38(14) (a)(iv)(d) Regulation 38(14) (a)(iv)(h)(ii) 1 For related carrying values of subordinated debt, refer to note 23 in the annual financial statements. 2 SB Plc s subordinated debt is disclosed within non-current liabilities held for sale, a controlling interest of which was disposed of by the group on 1 February Risk and capital management report and annual financial statements 120

123 Subordinated bond SB 2 Plc 1 Subordinated bond SB 2 Plc 2 Subordinated loan Standard Bank Offshore Group Subordinated loan Standard Bank Offshore Group Subordinated loan Standard Bank Offshore Group Subordinated loan Standard Bank Offshore Group Subordinated loan Standard Bank Offshore Group Subordinated loan Standard Bank Offshore Group SB Plc SB Plc SBOG SBOG SBOG SBOG SBOG SBOG BXS BXS Standard Bank Offshore Group Standard Bank Offshore Group Standard Bank South Africa Standard Bank Group International Ltd Standard Bank Offshore Group Standard Bank Offshore Group UK UK IOM Ltd IOM Ltd Jersey Jersey Jersey Jersey Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Tier II Group & solo Group & solo Solo Solo Solo Solo Solo Solo Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt ZAR1 639 USD142 ZAR5 784 USD500 ZAR144 GBP8 ZAR54 GBP3 ZAR180 GBP10 ZAR108 GBP6 ZAR180 GBP10 ZAR198 GBP11 ZAR1 639 USD142 ZAR5 784 USD500 ZAR144 GBP8 ZAR54 GBP3 ZAR180 GBP10 ZAR108 GBP6 ZAR180 GBP10 ZAR198 GBP11 Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt Subordinated debt 2006/07/ /12/ /06/ /06/ /06/ /06/ /06/ /06/29 Perpetual Dated Dated Dated Dated Dated Dated Dated N/A 2019/12/ /06/ /06/ /06/ /06/ /06/ /06/30 Yes N/A N/A N/A N/A N/A N/A N/A 2016/07/27 N/A N/A N/A N/A N/A N/A N/A USD July 2016 or any interest payment date thereafter N/A N/A N/A N/A N/A N/A N/A Fixed until 27/07/2016 then floating Fixed Floating Floating Floating Floating Floating Floating 8.012% per annum until 27/07/2016. Then 3 month LIBOR % 8.125% per annum 25bps over LIBOR, payable 6 monthly 25bps over LIBOR, payable 3 monthly 340bps over LIBOR, payable 3 monthly 25bps over LIBOR, payable 3 monthly LIBOR + 420bps, payable 3 monthly 25bps over LIBOR, payable 3 monthly No No No No No No No No Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Mandatory Yes No No No No No No No Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-cumulative Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible Non-convertible N/A N/A N/A N/A N/A N/A N/A N/A Senior unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured Senior unsecured Yes Yes Yes Yes Yes Yes Yes N/A CRR CRR Non compliant with Basel III post transition Non compliant with Basel III post transition Non compliant with Basel III post transition Non compliant with Basel III post transition Non compliant with Basel III post transition Non compliant with Basel III post transition 121

124 AFS Annual financial statements The consolidated and separate annual financial statements were audited in terms of the Companies Act 71 of The preparation of the group s consolidated and separate annual financial statements was supervised by the group financial director, Simon Ridley, BCom (Natal), CA(SA) AMP (Oxford). A summary of these results were made publicly available on 5 March Directors responsibility for financial reporting 123 Group secretary s certification 124 Report of the group audit committee 126 Directors report 131 Independent auditors report 132 Statement of financial position 133 Income statement 135 Statement of other comprehensive income 136 Statement of cash flows 138 Statement of changes in equity 142 Accounting policy elections 144 Notes to the annual financial statements 258 Limited company annual financial statements 266 Annexure A subsidiaries, consolidated and unconsolidated structured entities 284 Annexure B associates and joint ventures 289 Annexure C group share incentive schemes 297 Annexure D detailed accounting policies 320 Annexure E emoluments and share incentives of directors and prescribed officers 334 Annexure F six-year review 346 Annexure G segmental statement of financial position 348 Annexure H banking activities average statement of financial position (normalised) 350 Annexure I third-party funds under management Risk and capital management report and annual financial statements 122

125 Directors responsibility for financial reporting In accordance with the Companies Act, the directors are responsible for the preparation of the annual financial statements. These annual financial statements conform to IFRS as issued by the IASB, and fairly present the affairs of Limited (the company) and (the group) as at 31 December, and the net income and cash flows for the year then ended. It is the responsibility of the independent auditors to report on the fair presentation of the financial statements. The directors are ultimately responsible for the internal controls of the company and the group. Management enables the directors to meet these responsibilities. Standards and systems of internal controls are designed and implemented by management to provide reasonable assurance of the integrity and reliability of the financial statements and to adequately safeguard, verify and maintain accountability for shareholder investments and company and group assets. Accounting policies, supported by judgements, estimates and assumptions in compliance with IFRS, are applied on the basis that the company and the group shall continue as a going concern. Systems and controls include the proper delegation of responsibilities within a clearly defined framework, effective accounting procedures and adequate segregation of duties. Systems and controls are monitored throughout the company and the group. Greater detail of these systems and controls, including the operation of the group s internal audit function, is provided in the corporate governance statement in the group s annual integrated report and the risk and capital management section of this report. Based on the information and explanations provided by management and the group s internal auditors, the directors are of the opinion that the internal financial controls are adequate and that the financial records may be relied upon for preparing the financial statements in accordance with IFRS and to maintain accountability for the company and the group s assets and liabilities. Nothing has come to the attention of the directors to indicate that a breakdown in the functioning of these controls, resulting in material loss to the company and the group, has occurred during the year and up to the date of this report. The directors have a reasonable expectation that the company and the group will have adequate resources to continue in operational existence and as a going concern in the financial year ahead. The annual financial statements which appear on pages 132 to 333 and specified sections of the risk and capital management report contained within pages 3 to 121 were approved by the board on 4 March 2015 and signed on its behalf by: Fred Phaswana Chairman 4 March 2015 Ben Kruger Sim Tshabalala Group chief executive Group chief executive 4 March March 2015 Group secretary s certification Compliance with the Companies Act 71 of 2008 (Companies Act) In terms of the Companies Act and for the year ended 31 December, I certify that Limited has filed all returns and notices required by the Companies Act with the Companies and Intellectual Property Commission and that all such returns and notices are true, correct and up to date. Zola Stephen Group secretary 4 March