NOTES TO THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 31 DECEMBER

1

Principal accounting policies

The group and company financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB), the AC 500 standards as issued by the Accounting Practices Board, and the requirements of the South African Companies Act, 1973, as amended.

The financial statements are presented in SA rand, the functional currency of Nedbank Group Limited, and are rounded to the nearest million rands. The statements are prepared on the accrual and historical-cost basis of accounting, except for:

• non-current assets and disposal groups held for sale, which are all stated at the lower of the carrying amount and the fair value less costs to sell;
• employee benefit liabilities, valued using the projected-unit credit method; and
• the following assets and liabilities, which are stated at their fair value:
  • financial assets and financial liabilities classified as at fair value through profit or loss;
  • financial assets classified as available for sale; and
  • investment properties and owner-occupied properties.

The financial information disclosed in the consolidated financial statements comprises that of the parent company, Nedbank Group Limited, together with its subsidiaries, including certain special-purpose entities (SPEs) and associates, presented as a single entity.

Subsidiary undertakings and special-purpose entities
Subsidiary undertakings are those entities, including unincorporated entities such as trusts and partnerships that are controlled by the group. The group financial statements include the assets, liabilities and results of the company plus subsidiaries, including SPEs controlled by the group from the date of acquisition until the date the group ceases to control the subsidiary. Subsidiary undertakings are consolidated when they are considered to be material to the financial statements of the group.

Control is defined as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Control is presumed to exist when the group owns, directly or indirectly through subsidiaries, more than half of the voting power of an entity, unless, in exceptional circumstances, it can clearly be demonstrated that such ownership does not constitute control. The existence and effect of potential voting rights that are currently exercisable or convertible, including potential voting rights held by other entities, are taken into account when assessing whether the group has control.

Subsidiaries include SPEs that are created to accomplish a narrow and well-defined objective, which may take the form of a company, corporation, trust, partnership or other unincorporated entity. The assessment of whether control exists over SPEs is based on the substance of the relationship between the group and the SPE. SPEs in which the group holds half or less of the voting rights, but which recontrolled by the group by retaining the majority of risks or benefits, are consolidated in the group financial statements.

Intragroup balances, transactions, income and expenses, and profits and losses are eliminated in preparation of the group financial statements. Unrealised losses are not eliminated to the extent that they provide objective evidence of impairment.

The group reassesses the consolidation requirements on a continuous basis and any changes in the group structure are considered as they occur.

Associates
An associate is an entity, including an unincorporated entity, over which the group has the ability to exercise significant influence, but not control or joint control, through participation in the financial and operating policy decisions of the investment (that is neither a subsidiary nor an investment in a joint venture). This is generally demonstrated by the group holding in excess of 20%, but no more than 50%, of the voting rights.

The profit or loss of the associate and assets and liabilities, including goodwill identified on acquisition, net of any accumulated impairment losses, are included in the group financial statements using the equity method of accounting from the date significant influence commences until the date significant influence ceases. Where an associate has a reporting period that is different from that of the group, the results of the associate are adjusted to reflect a reporting period consistent with the group’s reporting period. The carrying amount of such investments is reduced to recognise any impairment in the value of individual investments. When the group’s share of losses exceeds the carrying amount of the associate, the carrying amount is reduced to nil, inclusive of any long-term debt outstanding. The recognition of further losses is discontinued, except to the extent that the group has incurred or guaranteed obligations in respect of the associate.

Where an entity within the group transacts with an associate of the group, unrealised profits and losses are eliminated to the extent of the group’s interest in the associate.

At each reporting date the group determines whether there is objective evidence that the investments in associates are impaired. The carrying amounts of such investments are then reduced to recognise any impairment by applying the impairment methodology described in 1.11.

Investments in associates that are held with the intention of disposing them within 12 months are accounted for and classified as non-current assets held for sale in accordance with the methodology described in 1.10.

Joint ventures
Joint ventures are those entities over which the group has joint control in terms of a contractual agreement. Jointly controlled entities are incorporated into the group financial statements using the equity method of accounting. The carrying amount of such investments is reduced to recognise any impairment in the value of individual investments, by applying the impairment methodology described 1.11. in

Where an entity within the group transacts with a joint venture of the group, unrealised profits and losses are eliminated to the extent of the group’s interest in the joint venture. When the group’s share of losses exceeds the carrying amount of the joint venture, the carrying amount is reduced to nil. The recognition of further losses is discontinued, except to the extent that the group has incurred or guaranteed obligations in respect of the joint venture.

Investments in joint ventures that are held with the intention of disposing thereof within 12 months are accounted for and non-current assets held for sale in accordance with the methodology described in 1.10.

Company
Investments in group companies are accounted for at cost less impairment losses in the company financial statements. The carrying amounts of these investments are reviewed annually and impaired when necessary by applying the impairment methodology described in 1.11.

Investments held by venture capital divisions
Where the group has an investment in an associate or joint-venture company held by a venture capital division, whose primary business is to purchase and dispose of minority stakes in entities, the investment is classified as designated at fair value through profit or loss, as the divisions are managed on a fair-value basis. Changes in fair value of these investments are recognised in non-interest revenue in profit or loss in the period in which they occur.

Acquisitions of subsidiaries (entities acquired) and businesses (assets and liabilities acquired) are accounted for using the acquisition  method. The cost of a business combination is measured as the aggregate of the fair values (at the acquisition date) of assets given, liabilities incurred or assumed, and equity instruments issued by the group in exchange for control of the acquiree.

For all transactions subsequent to 31 December 2008 acquisition-related costs are recognised in profit or loss as incurred. Prior to this date all acquisition-related costs were capitalised to the cost of the acquisition.

Where the cost of acquisition includes any asset or liability resulting from a contingent consideration arrangement, that asset or liability is measured at the acquisition date fair value. Subsequent changes in such fair values are adjusted against the cost of acquisition where they qualify as measurement period adjustments (see below). All other subsequent changes in the fair value of a contingent consideration classified as an asset or liability are accounted for in accordance with the relevant IFRSs. Changes in the fair value of a contingent consideration that have been classified as equity are not recognised.

The acquiree’s identifiable assets, liabilities and contingent liabilities that meet the conditions for recognition under IFRS 3 Business Combinations, are recognised at their fair value at the date of acquisition, except:

• deferred taxation assets or liabilities, which are recognised and measured in accordance with International Accounting Standard (IAS) 12 Income Taxes, and liabilities or assets related to employee benefit arrangements, which are recognised and measured in accordance with IAS 19 Employee Benefits;
• liabilities or equity instruments that relate to the replacement, by the group, of an acquiree’s share-based payment awards, which are measured in accordance with IFRS 2 Share-based Payments and
• assets (or disposal groups) that are classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, which are measured in accordance with that standard.

If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the group reports provisional amounts for the items for which the accounting is incomplete. Where provisional amounts were reported, these are adjusted during the measurement period (see below). Additional assets or liabilities are recognised to reflect any new information obtained about the facts and circumstances that existed at the date of acquisition, which, if known, would have affected the amounts recognised on that date.

The measurement period is the period from the date of acquisition to the date the group receives complete information about facts and circumstances that existed at the acquisition date. This measurement period is subject to a maximum of one year after the acquisition date.

Where a business combination is achieved in stages the group’s previously held interests in the acquired entity are remeasured to fair value at the acquisition date on the date the group attains control, and the resulting gain or loss, if any, is recognised in profit or loss. Amounts arising from interests in the acquiree prior to the acquisition date that have previously been recognised in other comprehensive income are reclassified to profit or loss, where such treatment would be appropriate if that interest were disposed of.

Non-controlling interests in the net assets of consolidated subsidiaries are identified separately from the group’s equity therein. The interest of non-controlling shareholders is initially measured either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets. The choice of measurement basis is made on an acquisition-by-acquisition basis. Subsequent to the acquisition, non-controlling interests consist of the amount attributed to such interests at initial recognition and the non-controlling interest’s share of changes in equity since the date of the combination.

The difference between the proceeds from the disposal of a subsidiary, the fair value of any retained investment and its carrying amount at the date of disposal, including the cumulative amount of any exchange differences recognised in the statement of changes in equity that relate to the subsidiary, is recognised as a gain or loss on the disposal of the subsidiary in the group profit or loss for the period.

All changes in the group’s interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions (transactions with owners). Any difference between the amount by which the non-controlling interests are increased or decreased and the fair value of the consideration paid or received is recognised directly in equity and attributed to the group.

This accounting policy has been adopted for all transactions subsequent to 1 January 2009. The accounting treatment for prior-period transactions has not been restated.

Goodwill
Goodwill arising on the acquisition of a subsidiary is recognised as an asset on the date that control is acquired, being the acquisition date. Goodwill is measured as the excess of the sum of the consideration transferred, the amount of any non-controlling interest in  the acquiree and the fair value of the acquirer’s previously held equity interest (if any) in the entity over the net fair value of the identifiable net assets recognised. If, after reassessment, the group’s interest in the net fair value of the acquiree’s identifiable net assets exceeds the sum of the consideration transferred plus the amount of any non-controlling interest in the acquiree and the fair value of the acquirer’s previously held equity interest (if any), this excess is recognised immediately in profit or loss as a bargain purchase gain.

Goodwill is not amortised, but is tested for impairment at least once a year. Any impairment loss is recognised immediately in profit or loss and is not subsequently reversed.

On disposal of a subsidiary the goodwill attributable to the subsidiary is included in the determination of the profit or loss on disposal.

Financial instruments, as recognised on the statement of financial position, include all financial assets and financial liabilities, including derivative instruments, but exclude investments in subsidiaries, associate companies and joint ventures (other than investments held by venture capital divisions) and employee benefit plans. Financial instruments are accounted for under IAS32 Financial Instruments: Presentation, IAS39 Financial Instruments: Recognition and Measurement and IFRS7 Financial Instruments: Disclosure.

The group does not currently apply hedge accounting. This accounting policy should be read in conjunction with the group’s categorised statement of financial position, the group’s risk management policies and note note 6.1: Valuation of financial instruments.

Initial recognition
Financial instruments are recognised on the statement of financial position when the group becomes a party to the contractual provisions of a financial instrument. All purchases of financial assets that require delivery within the timeframe established by regulation or market convention (‘regular way’ purchases) are recognised at the trade date, which is the date on which the group commits to purchase the financial asset. The liability to pay for ‘regular way’ purchases of financial  assets is recognised on the trade date, which is when the group becomes a party to the contractual provisions of the financial instrument.

Contracts that require or permit net settlement of the change in the value of the contract are not considered ‘regular way’ contracts and are treated as derivatives between the trade and settlement date of the contract.

Initial measurement
Financial instruments that are designated at initial recognition as being at fair value through profit or loss are recognised at fair value. Transaction costs, which are directly attributable to the acquisition or on issue of these financial instruments, are recognised immediately in profit and loss.

Financial instruments that are not carried at fair value through profit or loss are initially measured at fair value plus transaction costs that are directly attributable to the acquisition or issue of the financial instruments.

Where the transaction price in a non-active market is different to the fair value from other observable current market transactions in the same instrument or based on a valuation technique, the variables of which include only data from observable markets, the group defers such differences (day-one gains or losses). Day-one gains or losses are amortised on a straight-line basis over the life of the financial instrument. To the extent that the inputs determining the fair value of the instrument become observable, or on derecognition of the instrument, day-one gains or losses are recognised immediately in profit or loss.

Categories of financial instruments
Subsequent to initial recognition, financial instruments are measured at fair value or amortised cost, depending on their classification and whether fair value can be measured reliably:

• • Financial instruments at fair value through profit or loss
    Financial instruments at fair value through profit or loss consist of instruments that are held for trading and instruments that the group has designated, at initial recognition date, as at fair value through profit or loss.
    
    The group classifies instruments as held for trading if they have been acquired or incurred principally for the purpose of sale or repurchase in the near term, they are part of a portfolio of identified financial instruments for which there is evidence of a recent actual pattern of short-term profit-taking or they are derivatives. The group’s derivative transactions include foreign exchange contracts, interest rate futures, forward rate agreements, currency and interest rate swaps, and currency and interest rate options (both written and purchased).
    
    Financial instruments that the group has elected, at the initial recognition date, to designate as at fair value through profit or loss are those that meet any one of the following conditions:
  • the fair value through profit or loss designation eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on assets and liabilities on different bases;
  • the instrument forms part of a group of financial instruments that is managed and its performance is evaluated on a fair-value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to key management personnel, using a fair-value basis; or
  • a contract contains one or more embedded derivatives that require separation from the host contract or a derivative that significantly modifies the cashflows of the host contract.

  Gains or losses on financial instruments at fair value through profit or loss (excluding interest income and interest expense calculated on the amortised-cost basis relating to interest-bearing instruments that have been designated as at fair value through profit or loss) are reported in non-interest revenue in the period in which they arise. Interest income and interest expense calculated in accordance with the effective-interest-rate method are reported in interest income and expense, except for interest income and interest expense on instruments held for trading, which are recognised in non-interest revenue.

• Non-trading financial liabilities
  All financial liabilities, other than those at fair value through profit or loss, are classified as non-trading fifinancial liabilities and are measured at amortised cost. The interest expense is recorded in interest expense and similar charges.
• Held-to-maturity financial assets
  Held-to-maturity financial assets are non-derivative financial assets with fixed or determinable payments and a fixed maturity that the group has the positive intention and ability to hold to maturity, other than those that meet the definition of loans and receivables or those that were designated as at fair value through profit or loss or available for sale. Held-to-maturity financial assets are measured at amortised cost, with interest income recognised in interest and similar income. Gains or losses arising on disposal of held-to-maturity financial assets are recognised in non-interest revenue.
• Loans and receivables
  Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market,other than those financial assets classified by the group on initial recognition as at fair value through profit or loss, available for sale or loans and receivables that are held for trading.
  
  Financial assets that are classified as loans and receivables are carried at amortised cost, with interest income recognised in interest and similar income. Gains or losses arising on disposal are recognised in non-interest revenue. The majority of the group’s advances are included in the loans and receivables category.


• Available-for-sale financial assets
  Available-for-sale financial assets are non-derivative financial assets that the group has designated as available-for-sale or are not classified as (a) loans and receivables, (b) held-to-maturity investments or (c)financial assets as at fair value through profit or loss.
  
  

Available-for-sale financial assets are measured at fair value, with fair-value gains or losses recognised directly in equity, in other comprehensive income. Foreign currency translation gains or losses on monetary items, impairment losses or interest income, calculated by using the effective-interest-rate method, is reported in profit or loss.

Embedded derivatives
Derivatives in a host contract that is a financial or non-financial instrument, such as an equity conversion option in a convertible bond, are separated from the host contract when all of the following conditions are met:

• The economic characteristics and risks of the embedded derivative are not closely related to those of the host contract.
• A separate instrument with the same terms as the embedded derivative would meet the definition of a derivative.
• The combined contract is not measured at fair value, with changes in fair value recognised in profit or loss.

The host contract is accounted for:

• under IAS 39 if it is a financial instrument; and
• in accordance with other appropriate accounting standards if it is not a financial instrument.

If an embedded derivative is required to be separated from its host contract, but it is not possible separately to measure the fair value of the embedded derivative, either at acquisition or at a subsequent financial reporting date, the entire hybrid instrument is categorised as at fair value through profit or loss and measured at fair value.

Measurement basis of financial instruments
There are two bases of measurement:

• amortised cost; and
• fair value.

• Amortised cost
  The amortised cost of a financial instrument is the amount at which the financial instrument is measured on initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective-interest-rate method of any difference between the initial contractual amount and the maturity amount, less any cumulative impairment losses.
  
  The effective-interest-rate method is a method of calculating the amortised cost of financial  instrument and of allocating the interest income and expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial instrument. When calculating the effective interest rate, cashflows are estimated considering all contractual terms of the financial instrument, but future credit losses are not considered. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.

• Fair value
  The fair value of a financial instrument is defined as the price at which an asset or liability could be exchanged in a current transaction between knowledgeable, willing parties, other than in a forced or liquidation sale.

  The fair value of instruments that are quoted in an active market is determined using quoted prices where they represent those at which regularly and recently occurring transactions take place.

  The group uses valuation techniques to establish the fair value of instruments where quoted prices in active markets are not available.

  For a detailed discussion of the fair value of financial instruments refer to Note 6.1:Valuation of financial instruments.

Impairment of financial assets
The group assesses at each reporting date whether there is objective evidence that financial asset or group of financial assets is impaired. A financial asset or a group of financial  assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a loss event) and that loss event has (or events have) an impact on the estimated future cashflows of the financial asset or group of financial  assets that can be reliably estimated. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the group about the following loss events:

• significant financial difficulty of the issuer or obligor;;
• a breach of contract, such as a default or delinquency in interest or principal payments;
• the group granting to the borrower, for economic or legal reasons relating to the borrower’s financial difficulty, a concession that the group would not otherwise consider;
• it becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
• the disappearance of an active market for that financial  asset because of financial difficulties; or
• observable data indicating that there is a measurable decrease in the estimated future cashflows from a group of  financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including:
  
  
  • adverse changes in the payment status of borrowers in the group.
  • national or local economic conditions that correlate with defaults on the assets in the group.
• Assets carried at amortised cost
  If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity financial assets carried at amortised cost has been incurred, the amount of the impairment loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cashflows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in profit or loss.

  
  The group first assesses whether there is objective evidence of impairment individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If the group determines that there is no objective evidence of impairment for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment.
  
  If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised (such as an improvement in the debtor’s credit rating), the previously recognised impairment loss is reversed by adjusting the allowance account. The reversal may not result in a carrying amount of the financial asset that exceeds what the amortised cost would have been had the impairment not been recognised at the date on which the impairment is reversed. The amount of the reversal is recognised in profit or loss for the period.

• Available-for-sale financial assets
  When a decline in the fair value of an available-for-salefinancial asset has been recognised directly in equity, in the statement offi comprehensive income, and there is objective evidence that the asset is impaired, the cumulative loss that has been recognised directly in equity, in the statement of comprehensive income, is removed from equity and recognised in t or loss. The amount profit of the cumulative loss that is removed from equity and recognised in profit or loss is the difference between the acquisition cost (net of any principal repayment and amortisation) and current fair value, less any impairment loss on thatfinancial asset previouslyfirecognised in profit or loss. Impairment losses recognised in profit or loss for an investment in an equity instrument classified as available for sale are notreversed through profit or loss.
  
  If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed, with the amount of the reversal recognised in profit or loss for the period.
  
  
• Maximum credit risk
  Credit risk arises principally from loans and advances to clients, investment securities derivatives and irrevocable commitments to provide facilities. The maximum credit risk is typically the gross carrying amount, net of any amounts offset and impairment losses. The maximum credit exposure for loan commitments is the full amount of the commitment if the loan cannot be settled net in cash or using another financial asset.

Derecognition
The group derecognises a financial asset (or group of financial assets) or a part of a financial asset (or part of a group of  financial assets)  when, and only when:

• the contractual rights to the cashflows arising from the financial asset have expired; or
• it transfers the financial asset, including substantially all the risks and rewards of ownership of the asset; or
• it transfers the financial asset, neither retaining nor transferring substantially all the risks and rewards of ownership of the asset, but no longer retaining control of the asset.

A financial liability (or part of a financial liability) is derecognised when and only when the liability is extinguished, ie when the obligation specified in the contract is discharged, cancelled or has expired.

The difference between the carrying amount of a financial asset or financial liability (or part thereof) that is derecognised and the consideration paid or received, including any non-cash assets transferred or liabilities assumed, is recognised in non-interest revenue for the period.

Securitisations
The group securitises various consumer and commercial financial assets, generally resulting in the sale of these assets to SPEs, which in turn issue securities to investors. Interests in the securitised financial assets may be retained in the form of senior or subordinated tranches, interest-only strips or other residual interests (retained interests). Retained interests are primarily recorded in available-for-sale investment securities and carried at fair value.

Gains or losses on securitisation depend in part on the carrying amount of the transferred financial assets, allocated between the financial assets derecognised and the retained interests based on their relative fair values at the date of transfer. Gains or losses securitisation are recorded in other operating income for the period.

Offsetting financial instruments and related income
Financial assets and liabilities are offset and the net amount reported in the statement of  financial position only when the group has a legally enforceable right to set off the financial asset and financial liability and the group has an intention of settling the asset and liability on a net basis or realising the asset and settling the liability simultaneously. Income and expense items are offset only to the extent that  their related instruments have been offset in the statement of financial  position.

Collateral
Financial and non-financial assets are held as collateral in respect of recognised financial assets. Such collateral, except cash collateral, is not recognised by the group, as the group does not retain the risks and rewards of ownership, and is obliged to return such collateral to counterparties on settlement of the related obligations. Should a counterparty be unable to settle its obligations, the group takes possession of collateral or calls on other credit enhancements as full or part settlement of such amounts. These assets are recognised when the applicable recognition criteria under IFRS are met, and the group’s accounting policies are applied from the date of recognition.

Cash collateral is recognised when the group receives the cash and is reported as amounts received from depositors. Collateral is also given to counterparties under certain financial arrangements, but such assets are not derecognised where the group retains the risks and rewards of ownership. Such assets are at risk to the extent that the group is unable to fulfil its obligations to counterparties.

For a detailed discussion on collateral see here.

Sale and repurchase agreements and lending of securities
Securities sold subject to linked repurchase agreements are retained in the financial statements, as the group retains all risks and rewards of ownership of the securities. The securities are recorded as trading or investment securities and the counterparty liability is included in amounts owed to other depositors, deposits from other banks, or other money market deposits, as appropriate. Securities purchased under agreements to resell are recorded as loans and advances to other banks or clients, as appropriate. The difference between the sale and repurchase price is treated as interest and recognised over the duration of the agreements using the effective-interest-rate method. Securities lent to counterparties are also retained in the financial statements and any interest earned is recognised in profit or loss using the effective-interest-rate method.

Securities borrowed are not recognised in the financial statements, unless these are sold to third parties, in which case the purchase and sale are recorded with the gain or loss included in non-interest revenue. The obligation to return them is recorded at fair value as a trading liability.

Acceptances
Acceptances comprise undertakings by the group to pay bills of exchange drawn on clients. The group expects most acceptances be to settled simultaneously with the reimbursement from clients. Acceptances are disclosed as liabilities, with the corresponding asset recorded in the statement of financial position.

Financial guarantee contracts
Financial guarantee contracts are contracts that require the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payments when due in accordance with the terms of a debt instrument.

Issued financial guarantee contracts are recognised as insurance contracts and are measured at the best estimate of the expenditure required to settle any financial obligation as of the reporting date. Liability adequacy testing is performed to ensure that the carrying amount of the liability for issued financial guarantee contracts is sufficient. Any increase in the liability relating to guarantees is recognised in profit or loss.

Taxation expense, recognised in the statement of comprehensive income, comprises current and deferred taxation. Current or deferred taxation is recognised in profit or loss, except to the extent that it relates to items recognised directly in equity, in which case it too is recognised in equity.

Current taxation
Current taxation is the expected tax payable on the taxable income for the year, using taxation rates enacted or substantively enacted at the reporting date, and any adjustment to taxation payable in respect of previous years (prior-period tax paid).

Secondary tax on companies (STC) arises from the distribution of dividends. STC is recognised at the same time as the liability to pay the related dividend, being the date of the declaration of the dividend.

Deferred taxation
Deferred taxation is provided using the balance sheet liability method, based on temporary differences. Temporary differences are differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective taxation bases. The amount of deferred taxation provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, and is measured at the taxation rates (enacted or substantively enacted at the reporting date) that are expected to be applied to the temporary differences when they reverse.

Deferred taxation is recognised in profit or loss for the period, except to the extent that it relates to a transaction that is recognised directly in equity, or a business combination that is accounted for as an acquisition. The effect on deferred taxation of any changes in taxation rates is recognised in profit or loss for the period, except to the extent that it relates to items previously charged or credited directly to equity.

Deferred tax liabilities are generally recognised for all taxable temporary differences, and deferred taxation assets are generally recognised for all deductible temporary differences to the extent that it is probable that taxable profits will be available against which those deductible temporary differences can be utilised.

Deferred taxation is not recognised for the following temporary differences: the initial recognition of goodwill; the initial recognition of assets or liabilities in a transaction that is not a business combination and that affects neither accounting nor taxable profit; and differences relating to investments in subsidiaries and jointly controlled entities to the extent that they will not reverse in the foreseeable future.

Deferred taxation assets are recognised to the extent that it is probable that future taxable income will be available against which the unutilised taxation losses and deductible temporary differences can be used. Deferred taxation assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related taxation benefits will be realised.

Deferred taxation assets are recognised for STC credits received based on the expected utilisation of these credits by group companies in the declaration of future dividends.

Deferred taxation assets and liabilities are not discounted.

Impairment testing procedures
The recoverable amount of a CGU is the higher of its fair value less cost to sell and its value in use. The fair value less cost to sell is determined by ascertaining the current market value of an asset (or the CGU) and deducting any costs related to the realisation of the asset.

In assessing value in use the expected future pretax cashflows from the CGU are discounted to their present value using a pretax discount rate that reflects current market assessments of the time value of money and the risks specific to the particular CGU.

Impairment losses relating to goodwill are not reversed and all impairment losses are recognised in capital and non-trading items for the period.

Computer software and capitalised development costs
Expenditure on research activities, undertaken with the prospect of gaining new scientific or technical knowledge and understanding, and expenditure on internally generated goodwill and brands are recognised as an expense in profit or loss for the period.

If costs can be reliably measured and future economic benefits are available, expenditure on computer software and other development activities, whereby set procedures and processes are applied to a project for the production of new or substantially improved products and processes, is capitalised if the computer software and other developed products or processes are technically and commercially feasible and the group has sufficient resources to complete development. The expenditure capitalised includes the cost of materials and directly attributable employee and other direct costs. Computer development expenditure is amortised only once the relevant software is available for use in the manner intended by management. Capitalised software is stated at cost less accumulated amortisation and impairment losses. Expenditure for the development of computers that are not yet available for use, is not amortised and is stated at cost less impairment losses.

Amortisation of computer software and development costs is charged to profit or loss on a straight-line basis over the estimated useful lives of these assets, which do not exceed five years and are reviewed annually. Subsequent expenditure relating to computer software is capitalised only when it increases the future economic benefits embodied in the specific asset, in its current condition, to which it relates. All other subsequent expenditure is recognised as an expense in the period in which it is incurred. The profit or loss on the disposal of computer software is recognised in non-trading and capital items (in profit or loss). The profit or loss on disposal is the difference between the net proceeds received and the carrying amount of the asset.

Contractual client relationships
Contractual client relationships, including the present value of in-force business in insurance businesses, acquired in a business combination are recognised at fair value at the date of acquisition. The contractual client relations have a finite useful life and are carried at cost less accumulated amortisation. The useful lives of these client relationships are reviewed on an annual basis. Amortisation is calculated using the straight-line method over the expected life of the client relationship.

Defined-benefit and defined-contribution plans have been established for eligible employees of the group, with assets held in separate trustee-administered funds.

Defined-benefit plans
Pension obligations are accounted for in accordance with IAS 19 Employee Benefits. The projected-unit credit method is used to determine the defined-benefit obligations based on actuarial assumptions, which incorporate not only the pension obligations known on the reporting date, but also information relevant to their expected future development. The discount rates used are determined based on the yields for government bonds that have maturity dates approximating the terms of the group’s obligations.

Actuarial gains and losses are accounted for using the corridor method and are not recognised in the statement of changes in equity. The portion of actuarial gains and losses that are recognised for each defined-benefit plan is the excess of the net cumulative unrecognised actuarial gains and losses at the end of the previous reporting period over the greater of 10% of the present value of the defined-benefit  obligation at that date, before deducting plan assets, and 10% of the fair value of any plan assets at that date. This is then divided by the expected average remaining working lives of the employees participating in that plan.

Where the calculation results in a benefit to the group, the recognised asset is limited to the net total of any unrecognised actuarial losses and past service costs and the present value of any future refunds from the plan or reductions in future contributions to the plan.

When the benefits of a plan are improved, the portion of the increased benefit relating to past service by employees is recognised as an expense in profit or loss on a straight-line basis over the average period until the benefits become vested. To the extent that the benefits vest immediately the expense is recognised immediately in profit or loss.

Plan assets are only offset against plan liabilities where they are assets held by long-term employee benefit funds or qualifying insurance policies. Qualifying insurance policies exclude any insurance policies held by the group’s holding or subsidiary companies.

Defined-contribution plans
Contributions in respect of defined-contribution benefits are recognised as an expense in profit or loss in the statement of comprehensive income as incurred.

Postemployment benefit plans
Certain entities within the group provide postretirement medical benefits and disability cover to eligible employees. Non-pension postemployment benefits are accounted for according to their nature, either as defined-contribution or defined-benefit plans. The expected costs of postretirement benefits that are defined-benefit plans in nature are accounted for in the same manner as in the case of defined-benefit pension plans.

Short-term employee benefits
Short-term employee benefit obligations are measured in the statement of financial  position on an undiscounted basis and are expensed as the related service is provided.

Derecognition
Items of property and equipment are derecognised on disposal or when no future economic benefits are expected from their use or disposal. The gain or loss on derecognition is recognised in profit or loss and is determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item. On derecognition any surplus in the revaluation reserve in respect of an individual item of property and equipment is transferred directly to retained earnings in the statement of changes in equity.

Compensation from third parties for items of property and equipment that were impaired, lost or given up is included in profit or loss when the compensation becomes receivable.

Non-current assets (or disposal groups) are classified as held for sale when their carrying amount will be recovered principally through sale rather than use.

The asset or disposal group must be available for immediate sale in its present condition and the sale should be highly probable, with an active programme to find a buyer and the appropriate level of management approving the sale.

Immediately before classification as held for sale, all assets and liabilities are remeasured in accordance with the group’s accounting policies. Non-current assets (or disposal groups) held for sale are measured at the lower of carrying amount and fair value less incremental directly attributable cost to sell (excluding taxation and finance charges) and are not depreciated.

Gains or losses recognised on initial classification as held for sale and subsequent remeasurement is recognised in profit or loss, regardless of whether the assets were previously measured at revalued amounts. The maximum gains that can be recognised are the cumulative impairment losses previously recognised in profit or loss. A disposal group continues to be consolidated while classified as held for sale. Income and expenses continue to be recognised in profit or loss.

Non-current assets (or disposal groups) are reclassified from held for sale to held for use if they no longer meet the held-for-sale criteria. On reclassification the non-current asset (or disposal group) is remeasured at the lower of its recoverable amount and the carrying amount that would have been recognised had the asset (or disposal group) never been classified as held for sale. Any gains or losses are recognised in profit or loss, unless the asset was carried at a revalued amount prior to classification as held for sale.

A discontinued operation is a clearly distinguishable component of the group’s business that has been disposed of or is held for sale, which:

• represents a separate major line of business or geographical area of operations;
• is part of a single coordinated plan to dispose of a major line of business or geographical area of operations; or
• is a subsidiary acquired exclusively with a view to resale.

An impairment loss is recognised in profit or loss whenever the carrying amount of an asset exceeds its recoverable amount.

The recoverable amount of an asset is the higher of its fair value less cost to sell and its value in use. The fair value less cost to sell is determined by ascertaining the current market value of an asset and deducting any costs related to the realisation of the asset.

In assessing value in use the expected future pretax cashflows from the asset are discounted to their present value using a pretax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For an asset the cashflows of which are largely dependent on those of other assets the recoverable amount is determined for CGU to which the asset belongs.

A previously recognised impairment loss will be reversed if the recoverable amount increases as a result of a change in the estimates used previously to determine the recoverable amount, but not to an amount higher than the carrying amount that would have been determined, net of depreciation or amortisation, had no impairment loss been recognised in prior periods.

• Onerous contracts
  A provision for onerous contracts is recognised when the expected benefits to be derived by the group from a contract are lower than the unavoidable cost of meeting the obligations under the contract.
  
  
• Restructuring
  A provision for restructuring is recognised when the group has a detailed formal plan for restructuring and has raised a valid expectation, among those parties directly affected, that the plan will be carried out, either by having begun implementation or by publicly announcing the plan’s main features. Restructuring provisions include only those costs that arise directly from restructuring that is not associated with the ongoing activities of the group.

Measurement of fair value of equity instruments granted
The equity instruments granted by the group are measured at fair value at measurement date using standard option pricing valuation models. The valuation technique is consistent with generally acceptable valuation methodologies for pricing financial instruments and incorporates all factors and assumptions that knowledgeable, willing market participants would consider in setting the price of the equity instruments. Vesting conditions, other than market conditions, are not taken into account in determining fair value. Vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount.

Share-based payment transactions with persons or entities other than employees
Transactions in which equity instruments are issued to historically disadvantaged individuals and organisations in South Africa for less than fair value are accounted for as share-based payments. Where the group has issued such instruments and expects to receive services in return for equity instruments, the share-based payments charge is spread over the related vesting (ie service) period. In instances where such goods and services could not be identified the cost has been expensed with immediate effect. The valuation techniques are consistent with those mentioned above.

• payment of cash, in the form of a dividend or redemption, is at the discretion of the group;
• the instrument does not provide for the exchange of financial instruments under conditions that are potentially unfavourable to the group;
• settlement in the group’s own equity instruments is for a fixed number of equity instruments at a fixed price; and
• the instrument represents a residual interest in the assets of the group after deducting all of its liabilities.

Consideration paid or received for equity instruments is recognised directly in equity. Equity instruments are initially measured at the proceeds received, less incremental directly attributable issue costs, net of any related income tax benefits. No gain or loss is recognised in profit or loss on the purchase, sale, issue or cancellation of the group’s equity instruments.

When the group issues a compound instrument, ie an instrument that contains a liability and an equity component, the equity component is initially measured at the residual amount after deducting from the fair value of the compound instrument the amount separately determined for the liability component. Transaction costs that relate to the issue of a compound financial instrument are allocated to the liability and equity components of the instrument in proportion to the allocation of proceeds.

Distributions to holders of equity instruments are recognised as distributions in the statement of changes in equity in the period in which they are payable. Dividends for the year that are declared after the reporting date are disclosed in the notes to the financial statements.

Leases that are not classified as finance leases are classified as operating leases. Payments made under operating leases, net of any incentives received from the lessor, are recognised in profit or loss on a straight-line basis over the term of the lease. When another systematic basis is more representative of the time pattern of the user’s benefit, then that method is used.

The group as lessor
Where assets are leased out under a finance lease arrangement, the present value of the lease payments is recognised as a receivable and included under loans and advances in the statement of financial  position. Initial direct costs are included in the initial measurement of the receivable. The difference between the gross receivable and unearned finance income is recognised under loans and advances in the statement of financial position. Finance lease income is allocated to accounting periods to reflect a constant periodic rate of return on the group’s net investment outstanding in respect of the leases.

Assets leased out under operating leases are included under property and equipment in the statement of financial position. Initial direct costs incurred in negotiating and arranging the lease are added to the carrying amount of the leased asset and recognised as an expense over the lease term on the same basis as the rental income. Leased assets are depreciated over their expected useful lives on a basis consistent with similar assets. Rental income, net of any incentives given to lessees, is recognised on a straight-line basis over the term of the lease. When another systematic basis is more representative of the time pattern of the user’s benefit, then that method is used.

Recognition of lease of land
Leases of land and buildings are classified as operating or finance leases in the same way as leases of other assets.

However, when a single lease covers both land and a building, the minimum lease payments at the inception of the lease (including any upfront payments) are allocated between the land and the building in proportion to the relative fair values of the respective leasehold interests. Any upfront premium allocated to the land element that is normally classified as an operating lease represents prepaid lease payments. These payments are amortised over the lease term in accordance with the time pattern of benefits provided. If the lease payments cannot be allocated reliably between these two elements, the entire lease is classified as a finance lease, unless it is clear that both elements are operating leases.

Interest income and expense are recognised in profit or loss using the effective-interest-rate method taking into account the expected timing and amount of cashflows. The effective-interest-rate method is a method of calculating the amortised cost of a financial asset or financial liability
(or group of financial assets or financial liabilities) and of allocating the interest income or interest expense over the relevant period. Interest income and expense include the amortisation of any discount or premium or other differences between the initial carrying amount of an interestbearing
financial instrument and its amount at maturity calculated on an effective-interest-rate basis.

• Fees and commissions
  The group earns fees and commissions from a range of services it provides to clients and these are accounted for as follows: 
• Income earned on the execution of a significant act is recognised when the significant act has been performed.
• Income earned from the provision of services is recognised as the service is rendered by reference to the stage of completion of the service.
• Income that forms an integral part of the effective interest rate of a financial instrument is recognised as an adjustment to the effective interest rate and recorded in interest income.
• Dividend income
  Dividend income is recognised when the right to receive payment is established on the ex dividend date for equity instruments and is included in dividend income under non-interest revenue.
• Net trading income
  Net trading income comprises all gains and losses from changes in the fair value of financial  assets and financial liabilities held for trading, together with the related interest, expense, costs and dividends. Interest earned while holding trading securities and interest incurred on trading liabilities are reported within non-interest revenue.
• Income from investment contracts
  Refer to 1.16 for non-interest revenue arising on investment management contracts.
• Other
  Exchange and securities trading income, from investments and net gains on the sale of investment banking assets, is recognised in profit or loss when the amount of revenue from the transaction or service can be measured reliably, it is probable that the economic benefits of the transaction or service will flow to the group and the costs associated with the transaction or service can be measured reliably.
  
  Fair-value gains or losses on financial instruments at fair value through profit or loss, including derivatives, are included in non-interest revenue. These fair-value gains or losses are determined after deducting the interest component, which is recognised separately in interest income and expense.
  
  Gains or losses on derecognition of any financial assets or financial liabilities are included in non-interest revenue.

An operating segment is a component of an entity that engages in business activities from which it may earn revenues, the operating results of which component are regularly reviewed by management to make decisions about resources to be allocated and to assess its performance, and for which financial information is available.

The group’s identification of its segments and the measurement of segment results are based on the group’s internal reporting to management. The segments have been identified according to the nature of their respective products and services and their related target markets, the detail of which can be found in the Operational Segmental Report.

The segments identified are complemented by ‘Shared Services’ and ‘Central Management’, which provide support in the areas of finance, human resources, governance and compliance, risk management and information technology.

Additional information relating to geographic areas, major clients and other performance measures is provided.

The group accounts for inter segment revenues and transfers as if the transactions were with third parties at current market prices.

Cash and cash equivalents comprise balances with a maturity of less than 90 days from the date of acquisition, including cash and balances with central banks that are not mandatory, other eligible bills and amounts due from other banks.

2

STANDARDS AND INTERPRETATIONS

• IFRS 9 Financial Instruments
  The IASB has issued IFRS 9 Financial Instruments, which is the first step in its project to replace IAS 39 Financial Instruments: Recognition and Measurement, in its entirety. The project has three main phases:
  • Phase I: Classification and measurement of financial instruments;
  • Phase II: Amortised cost and impairment of financial assets; and
  • Phase III: Hedge accounting.
  IFRS 9, as currently issued, includes requirements for the classification and measurement of financial  assets and liabilities, derecognition requirements and additional disclosure requirements. The main requirements include the following:
  • Financial assets are to be classified and measured based on the business model for managing the financial asset and the cashflow characteristics of the financial asset. There are two measurement approaches, namely fair value and amortised cost. The financial asset is carried at amortised cost if it is the business model of the entity to hold that asset for the purpose of collecting contractual cashflows and if those cashflows comprise principal repayments and interest. All other financial assets are carried at fair value.
  • A financial asset that would otherwise be at amortised cost may only be designated as at fair value through profit or loss if such a designation reduces an accounting mismatch.
  • The classification and measurement of financial liabilities include requirements similar to those contained in the existing standard IAS 39 Financial Instruments: Recognition and Measurement.
  • For financial liabilities designated as at fair value through profit or loss a further requirement is that all changes in the fair value of financial liabilities attributable to credit risk be transferred to other comprehensive income with no recycling through profit or loss on disposal.
  • The requirements for derecognition are similar to those contained in the existing standard IAS 39 Financial Instruments: Recognition and Measurement, with certain additional disclosure requirements. Management does not anticipate these requirements to have a significant impact on the group’s financial statements.

IFRS 9 is effective for the group for the year commencing 1 January 2013. However, the IASB adopted a phased approach for the release of IFRS 9, with the requirements for the classification and measurement of financial assets having been released in 2009 and the requirements for the classification and measurement of financial  liabilities and derecognition having been released in 2010. Accordingly, the requirements released in 2010 cannot be early-adopted without the simultaneous adoption of the 2009 requirements. However, the requirements released in 2009 may be separately early-adopted.

The IASB intends to expand IFRS 9 in 2011 to address the requirements for the offsetting of financial assets and financial liabilities, impairment of financial assets carried at amortised cost and hedge accounting.

The implementation of IFRS 9 is anticipated to have a significant impact on the group’s financial statements. The group is evaluating the impact of the standard.

Revised standards
The following revisions to IFRS have not been early-adopted by the group:

• IFRS 7 Financial Instruments: Disclosure
  The following amendments were made to this standard during the year:
  • Clarification of certain qualitative and quantitative disclosures relating to the nature and extent of risks. The amendment is effective for the group for the year commencing 1 January 2011.
  • Additional disclosure requirements relating to the transfer of financial assets. This amendment is effective for the group for the year commencing 1 January 2012.
  These amendments address disclosure in the annual financial statements and will therefore not affect the financial position of the group. 
• IFRS 3 Business Combinations
  The amendment clarifies the measurement of non-controlling interests and provides additional guidance on unreplaced and voluntarily replaced share-based payment awards.
  
  The amendment is effective for the group for the year commencing 1 January 2011 and is not expected to have a significant impact on the group.
• IAS 12 Income Taxes
  The amendment provides a practical approach for measuring deferred taxation liabilities and deferred taxation assets when investment property is measured using the fair-value model in IAS 40 Investment Property. The amendment is effective for the group for the year commencing on or after 1 January 2012 and is not expected to have a significant impact on the group.
• IAS 24 Related-party Disclosures
  The amendment provides exemptions from certain disclosure requirements in respect of government-related entities and clarifies the definition of a related party. The amendment is effective for the group for the year commencing 1 January 2011.
  
  This amendment addresses disclosure in the annual financial statements and will therefore not affect the financial position of the group. Furthermore, the revisions to the disclosures are not expected to have a significant effect on the group.
• Annual improvement project
  As part of its third annual improvement project the IASB has issued its 2010 edition of annual improvements. The annual improvement project aims to clarify and improve the accounting standards.
  
  The improvements include those involving terminology or editorial changes, with minimal effect on recognition and measurement.
  
  There are no significant changes in the improvement of the current year that will affect the group and the improvement is effective for the group commencing 1 January 2011.

Interpretations
The following interpretations of existing standards are not yet effective and have not been early-adopted by the group:

• IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments
  The interpretation addresses divergent accounting by entities issuing equity instruments to extinguish all or part of a financial liability (often referred to as ‘debt for equity swaps’). The interpretation concludes that the issue of equity instruments to extinguish an obligation constitutes consideration paid.
  
  The consideration should be measured at the fair value of the equity instruments issued, unless that fair value is not readily determinable, in which case the equity instruments should be measured at the fair value of the obligation extinguished. Any difference between the fair value of the equity instruments issued and the carrying value of the liability extinguished is recognised in profit or loss. 
  
  If the issue of equity instruments is to settle a portion of a financial  liability, the entity should assess whether a part of the consideration relates to a renegotiation of the portion of the liability that remains outstanding.
  
  The adoption of this standard is not expected to have a material impact on the group’s annual financial statements. 
  
  The standard is effective for the group for the year commencing 1 January 2011.

• Amendments to IFRS 2 Group-settled Arrangements
  The amendment provides additional guidance on the accounting for share-based payment transactions among group entities. The most significant change is that the entity receiving the goods or services will recognise the transaction as an equity-settled share-based payment transaction only if the awards granted are its own equity instruments or if it has no obligation to settle the transaction. In all other circumstances the entity will measure the transaction as a cash-settled share-based payment.
  
  The scope of IFRS 2 has also been amended to clarify that the standard applies to all share-based payment transactions, irrespective of whether or not the goods or services received under the share-based payment transaction can be individually identified.
  
  The adoption of the amendments to the standard did not have an effect on the group’s financial statements.


• Amendments to IAS 32 Classification of Rights Issues
  The amendment states that rights, options and warrants – otherwise meeting the definition of equity instruments in IAS 32.11 – issued to acquire a fixed number of an entity’s own non-derivative equity instruments for a fixed amount in any currency are classified as equity instruments, provided the offer is made pro rata to all existing owners of the same class of the entity’s own non-derivative equity instruments.
  
  The amendment was early-adopted and did not have a significant effect on the group’s financial statements.
• Amendments to IFRIC 14 Prepayment of a Minimum Funding Requirement
  The interpretation was amended to remedy an unintended consequence of IFRIC 14, where entities are, in some circumstances, not permitted to recognise prepayments of minimum funding contributions as an asset.
  
  The amendment was early-adopted and did not have a significant effect on the group’s financial statements.
• Annual improvement project
  As part of its second annual improvement project, the IASB issued its 2009 edition of annual improvements. The annual improvement project aimed to clarify and improve the accounting standards.
  
  These improvements included those involving terminology or editorial changes with minimal effect on recognition and measurement.
  
  No significant changes were made to the group financial statements for the revisions that were effective for the year commencing 1 January 2010.

3

KEY ASSUMPTIONS CONCERNING THE FUTURE AND KEY SOURCES OF ESTIMATION

• Evaluation of whether or not activities should be considered research activities or development activities.
• Assumptions about future market conditions, client demand and other developments.
• Assessment of whether completing an asset is technically feasible. The term ‘technical feasibility’ is not defined in the accounting standards, and therefore requires a group-specific and necessarily judgemental approach.
• Evaluation of the future ability to use or sell the intangible asset arising from the development and the assessment of probability of future benefits from sale or use.
• Evaluation of whether or not a cost is directly or indirectly attributable to an intangible asset and whether or not a cost is necessary  for completing a development.

• Determining the useful life of an intangible asset, based on estimates regarding the period over which the intangible asset is expected  to produce economic benefits to the group.
  


• Determining the appropriate amortisation method. Accounting standards require that the straight-line method be used, unless management can reliably determine the pattern in which the future economic benefits of the asset are expected to be consumed by the group.
  

4

CAPITAL MANAGEMENT

5

Consolidated statement of financial position - categories of financial instruments

6

FAIR-VALUE MEASUREMENT

Background
Information obtained from the valuation of financial  instruments is used by the group to assess the performance of the business and, in particular, provide assurance that the risk and return measures that the business has taken are accurate and complete. It is important that the valuation of financial instruments accurately represent the financial position of the group while complying with the requirements of the applicable accounting standards.

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between knowledgeable, willing parties. Underlying the definition of fair value is a presumption that an entity is a going concern without any intention or need to liquidate, to curtail materially the scale of its operations or to undertake a transaction on adverse terms. Fair value is not, therefore, the amount that an entity would receive or pay in a forced transaction, involuntary liquidation or distressed sale.

• Validation and approval
  The business unit entering into the transaction is responsible for the initial determination and recording of the fair value of the transaction. There are formalised review protocols for the independent review and validation of fair values separate from the business unit entering into the transaction. These include, but are not limited to:
  • daily controls over the profit or loss recorded by trading and treasury front office traders;
  • specific controls to ensure consistent pricing policies and procedures are adhered to; and
  • independent valuation of structures, products and trades; and
  • periodic review of all elements of the modelling process
  
  

  The validation of pricing and valuation methodologies is verified by a specialist team that is part of the group’s risk management function and that is independent of all the business units. A specific area of focus is the marking-to-model of illiquid and/or complex financial instruments.

  The review of the modeling process includes approval of model revisions, vetting of model inputs, review of model results and more specifically the verification of risk calculations. All valuation techniques are validated and reviewed by qualified senior staff and are calibrated and back-tested for validity by using prices from any observable current market transaction in the same instrument (ie without modification or repackaging) or based on any observable market data. The group obtains market data consistently in the same market where the instrument was originated or purchased.

  If the fair-value calculation deviates from the quoted market value due to inaccurate observed market data, these deviations in the valuation are documented and presented at a review committee, which is independent of both the business unit and the specialist team, for approval. The committee will need to consider both the regulatory and accounting requirements in arriving at an opinion on whether the deviation is acceptable.

  The group refines and modifies its valuation techniques as markets and products develop and as the pricing for individual products becomes more or less readily available. While the group believes its valuation techniques are appropriate and consistent with other market participants, the use of different methodologies or assumptions may result in different estimates of fair value at the different reporting dates.

• Stress testing and sensitivity measures
  Comprehensive stress testing is conducted by the group, in which the following, at a minimum, is considered:
  • anticipated future projected trading positions;
  • historical events;
  • scenario testing to evaluate plausible future events; and
  • specific testing to supplement the value-at-risk methodology (ie one-day holding period and 99% confidence interval).
  
  

  For further discussion in respect of stress testing and sensitivity measures refer to note 6.6 of the annual financial statements.

• Quoted price
  A financial instrument is regarded as quoted in an active market if quoted prices are readily available from an exchange, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis. The appropriate quoted market price for an asset held or a liability to be issued is usually the current bid price and, for an asset to be acquired or a liability held, the asking price.
  
  The objective of determining fair value is to arrive at the transaction price of an instrument on the measurement date (ie without  modifying or repackaging the instrument) in the most advantageous active market to which the business has immediate access.
  
  The existence of published price quotations in an active market is the best evidence of fair value and, when they exist, they are used to measure the financial asset or financial liability. A market is considered to be active if transactions occur with sufficient volume and frequency to provide pricing information on an ongoing basis.
  
  These quoted prices would generally be classified as level 1 in terms of the fair-value hierarchy prescribed by IFRS 7 Financial Instruments: Disclosure.
• Valuation technique
  If the market for a financial instrument is not active, the group establishes fair value by using a valuation technique. These valuation techniques may include:
  • using recent arm’s length market transactions between knowledgeable, willing parties;
  • reference to the current fair value of another instrument that is substantially of the same nature;
  • reference to the value of the net asset of the underlying business;
  • earning multiples;
  • discounted-cashflow analysis; and
  • various option-pricing models.

  If there is a valuation technique that is commonly used by market participants to price the financial instrument and that technique has been demonstrated to provide reasonable estimates of prices obtained in actual market transactions, the group will use that technique.
  
  The objective of using a valuation technique is to establish what the transaction price would have been on the measurement date in an arm’s length exchange and motivated by normal business considerations. In applying valuation techniques, the group uses estimates and assumptions that are consistent with available information about the estimates and assumptions that market participants would use in setting a price for the financial instrument.
  
  Fair value is therefore estimated on the basis of the results of a valuation technique that makes maximum use of market inputs and relies as little as possible on entity-specific inputs. A valuation technique would be expected to arrive at a realistic estimate of the fair value if:

  • it reasonably reflects how the market could be expected to price the instrument; and
  • the inputs to the valuation technique reasonably represent market expectations and measures of the risk-return factors inherent in the financial instrument.

  Therefore, a valuation technique:

  • will incorporate all relevant factors that market participants would consider in determining a price; and
  • is consistent with accepted economic methodologies for pricing financial instruments.

  If a published price quotation in an active market does not exist for a financial instrument in its entirety, but active markets exist for its component parts, fair value is determined on the basis of the relevant market prices for the various component parts.

  If a rate (rather than a price) is quoted in an active market, the group uses that market-quoted rate as an input into a valuation technique to determine fair value. If the market-quoted rate does not include credit risk or other factors that market participants would include in valuing the instrument, the group adjusts for these factors.

  Valuation techniques applied by the group would generally be classified as level 2 or level 3 in terms of the fairvalue hierarchy prescribed by IFRS 7 Financial Instruments: Disclosure. The determination of whether an instrument is classified as level 2 or level 3 is dependent on the degree of observable inputs versus unobservable inputs used in determining the fair value.

• prices or quotes from exchange or listed markets in which there are sufficient liquidity and activity;
• proxy observable market data that is proven to be highly correlated and has a logical, economic relationship with the instrument that is being valued; and
• other direct and indirect market inputs that are observable in the marketplace.

Data is considered by the group to be ‘observable’ if the data is:

• prices or quotes from exchange or listed markets in which there are sufficient liquidity and activity;
• readily available;
• regularly distributed;
• from multiple independent sources;
• transparent; and
• not proprietary.

• reliable;
• based on consensus within reasonable narrow, observable ranges;
• provided by sources that are actively involved in the relevant market; and
• supported by actual market transactions.

It is not intended to imply that all of the above characteristics must be present to conclude that the evidence qualifies as observable market data. Judgement is applied based on the strength and quality of the available evidence.

• Discount rate: Where discounted cashflow techniques are used, estimated future cashflows are based on management’s best estimates and the discount rate used is a market rate at the reporting date for an instrument with similar terms and conditions.
• The time value of money: The business may use well-accepted and readily observable general interest rates, such as the Johannesburg Interbank Agreed Rate (South Africa), London Interbank Offered Rate (United Kingdom) or an appropriate swap rate, as the benchmark rate to derive the present value of a future cashflow.
• Credit risk: Credit risk is the risk of loss associated with a counterparty’s failure or inability to fulfil its contractual obligations. The valuation of the relevant financial instrument takes into account the effect of credit risk on fair value by including an appropriate adjustment for the risk taken.
• Foreign currency exchange prices: Active currency exchange markets exist for most major currencies, and prices are quoted daily on  various trading platforms and in financial publications.
• Commodity prices: Observable market prices are available for those commodities that are actively traded on exchanges in South Africa, London, New York and Chicago, as well as on other commercial exchanges.
• Equity prices: Prices (and indices of prices) of traded equity instruments are readily observable on JSE Limited or any other recognised international exchange. Present value techniques may be used to estimate the current market price of equity instruments for which there are no observable prices.
• Volatility: Measures of the volatility of actively traded items can be reasonably estimated by the implied volatility in current  market prices. The shape and skew of the volatility curve is derived from a combination of observed trades and doubles in the market. In the absence of an active market, a methodology to derive these volatilities from observable market data will be developed and utilised.
• Recovery rates/Loss given default (LGD): These are used as an input to valuation models as an indicator of the severity of losses on default. Recovery rates are primarily sourced from market data providers or inferred from observable credit spreads.  
• Prepayment risk and surrender risk: Expected repayment patterns for financial assets and expected surrender patterns for financial liabilities can be estimated on the basis of historical data.
• Servicing costs: If the cost of servicing a financial asset or financial liability is significant and other market participants would face comparable costs, the issuer would consider them in determining the fair value of that financial asset or financial liability.
• Dividends: Consistent consensus dividend forecasts adjusted for internal investment analysts’ projections can be applied to each share. Forecasts are usually available for the current year plus one additional year. Thereafter, a constant growth rate would be applied to the specific dates into the future for each individual share.
• Inception profit (day-one gain or loss): The best evidence of the fair value of a financial instrument at initial recognition is the transaction price (ie the fair value of the consideration given or received), unless the fair value of that instrument is evidenced by comparison with other observable current market transactions in the same instrument (ie without modification or repackaging) or based on a valuation technique, the variables of which include data from observable markets only.

Valuation adjustments
To determine a reliable fair value, where appropriate, the group applies certain valuation adjustments to the pricing information derived from the above sources. In making appropriate adjustments, the group considers certain adjustments to the modelled price that market participants would make when pricing that instrument. Factors that would be considered include the following:

• Own credit on financial liabilities: The carrying amount of financial liabilities held at fair value is adjusted to reflect the effect of changes in the group’s own credit spreads. As a result, the carrying value of issued bonds and subordinated-debt instruments that have been designated as at fair value through profit or loss is adjusted by reference to the movement in the appropriate spreads. The resulting gain or loss is recognised in profit and loss in the statement of other comprehensive income.
• Counterparty credit spreads: Adjustments are made to market prices when the creditworthiness of the counterparty differs from that of the assumed counterparty in the market price (or parameter).

• Other short-term securities and government and other securities
  The fair value of these instruments is based on quoted market prices from an exchange dealer, broker, industry group or pricing service, when available. When they are unavailable, the fair value is determined by reference to quoted market prices for similar instruments,  adjusted as appropriate for the specific circumstances of the instruments.
  
  Where these instruments include corporate bonds, the bonds are valued using observable active quoted prices or recently executed transactions, except where observable price quotations are not available. Where price quotations are not available, the fair value is determined based on cashflow models, where significant inputs may include yield curves and bond or single-name credit default swap spreads.
   
• Derivative financial instruments
  Derivative contracts can either be traded via an exchange or over the counter (OTC) and are valued using market standard models and quoted parameter inputs. Parameter inputs are obtained from pricing services, consensus pricing services and recently occurring transactions in active markets, whenever possible. Certain inputs may not be observable in the market directly, but can be determined from observable prices via model calibration procedures. Some inputs are not observable, but can generally be estimated from historical data or other sources.
   
• Loans and advances
  Loans and advances include mortgage loans (home loans and commercial mortgages), other asset-based loans, including collaterised debt obligations, and other secured and unsecured loans.
  
  In the absence of an observable market for these instruments, the fair value is determined by using internally developed models that are specific to the instrument and that incorporate all available observable inputs. These models involve discounting the contractual cashflows by using a credit-adjusted zero-coupon curve.
   
• Investment securities
  Investment securities include private-equity investments, listed investments and unlisted investments.
  
  The fair value of listed investments is determined with reference to quoted bid prices at the close of business on the relevant securities exchange.
  
  Where private-equity investments are involved, the exercise of judgement is required because of uncertainties inherent in estimating the fair value. The fair value of private equity is determined using appropriate valuation methodologies that, dependent on the nature of the investment, may include an analysis of the investee’s financial position and results, risk profiles and prospects, discounted-cashflow analysis, enterprise value comparisons with similar companies, price/earnings comparisons and earnings multiples. For each investment the relevant methodology is applied consistently over time and may be adjusted for changes in market conditions relative to that instrument.
  
  The fair value of unlisted investments is determined using appropriate valuation techniques that may include, but are not limited to,  discounted-cashflow analysis, net asset value calculations and directors’ valuations.
  
  
• Other assets
  Short positions or long positions in equities arise in trading activities where equity shares, not owned by the group, are sold in the market to third parties. The fair value of these instruments is determined by reference to the gross short/long position valued at the offer rate.
  
  Investments in instruments that do not have a quoted market price in an active market and the fair value of which cannot be reliably measured, as well as derivatives that are linked to and have to be settled by delivery of such unquoted equity instruments, are measured at fair value, utilising models considered to be appropriate by management.
  
  
• Amounts owed to depositors
  Amounts owed to depositors include deposits under repurchase agreements, negotiable certificates of deposit and other deposits.



These instruments incorporate all market risk factors, including a measure of the group’s credit risk relevant for that financial liability when designated as at fair value through profit or loss. The fair value of these financial liabilities is determined by discounting the contractual cashflows using a Nedbank-specific credit-adjusted yield curve that reflects the level at which the group would issue similar instruments at the reporting date. The market risk parameters are valued consistently to similar instruments held as assets.

The fair value of a financial liability with a demand feature is not less than the amount payable on demand, discounted from the first date on which the amount could be required to be paid. When the fair value of financial  liability cannot be reliably determined, the liability is recorded at the amount due.

Fair value is considered reliably measurable if:
• the variability in the range of reasonable fair-value estimates is not significant for that instrument; or
• the probabilities of the various estimates within the range can be reasonably assessed and used in estimating fair value.

• Investment contract liabilities
  The fair value of investment contract liabilities is determined by reference to the fair value of the underlying assets.

• Long-term debt instruments
  The fair value of long-term debt instruments is determined by reference to published market values on the relevant exchange.

• Complex instruments
  These instruments are valued by using internally developed models that are specific to the instrument and that have been calibrated to market prices. In less active markets data is obtained from less frequent market transactions, broker quotes and through extrapolation and interpolation techniques. Where observable prices or inputs are not available, other relevant sources of information such as historical data, fundamental analysis of the economics of the transaction and proxy information from similar transactions are used.  These models are continually reviewed and assessed to ensure that the best available data is being utilised in the determination of fair value.

• Other liabilities
  Short positions or long positions in equities arise in trading activities where equity shares, not owned by the group, are sold in the market to third parties. The fair value of these instruments is determined by reference to the gross short/long position valued at the offer rate.
  
  Where the group has assets and liabilities with offsetting market risks, it may use mid-market prices as a basis for establishing fair values for the offsetting risk positions and apply the bid or asking price to the net open position, as appropriate.

Certain financial instruments of the group are not carried at fair value. The calculation of the fair value of these financial instruments incorporates the group’s best estimate of the amount at which these financial assets could be exchanged, or financial liabilities settled, between knowledgeable, willing parties in an arm’s length transaction.

Fair values at the balance sheet date of these respective financial instruments detailed below are estimated for the purpose of disclosure as follows:

Loans and advances
Loans and advances that are not recognised at fair value principally comprise variable-rate financial assets. The interest rates on these financial assets are adjusted when the applicable benchmark interest rate changes.

Loans and advances are not actively traded in the SA market and it is therefore not possible to determine the fair value of these loans and advances using observable market prices. Due to the unique characteristics of the loans and advances book and the fact that there have been no recent transactions involving the disposals of loans and advances, there is no basis to determine a price that could be negotiated between a willing buyer and seller. The group is not currently in the position of a forced sale for the underlying loans and advances and it would therefore be inappropriate to value the loans and advances on a forced-sale basis.

For impaired loans and advances, the carrying value as determined after consideration of the group’s IAS 39 credit impairments is considered the best estimate of fair value.

The group has developed a methodology and model to determine the fair value of the gross exposures for performing loans and advances measured at amortised cost. This model incorporates the use of average interest rates and projected monthly cashflows per product type. Future cashflows are discounted using interest rates at which similar loans would be granted to borrowers with similar credit ratings and maturities. Methodologies and models are updated on a continuous basis for changes in assumptions and modelling techniques.

Future forecasts for the group’s probability of default (PD) and LGD for 2011 to 2013 (2009: for 2010 to 2012) are based on the latest available internal data and is applied to the first three years’ projected cashflows. Thereafter, PDs and LGDs are reverted to their long-run averages and are applied to the remaining projected cashflows.

The results of these fair-value calculations are summarised below:

7

Liquidity gap

8

Contractual maturity analysis for financial liabilities

9

Historical value at risk (99%, one day) by risk type

10

Interest rate repricing gap