35 Financial risk management activities

In the normal course of its operations, the group is exposed to gold price, other commodity price, foreign exchange, interest rate, liquidity, equity price and credit risks. In order to manage these risks, the group may enter into transactions which make use of both on- and off-balance sheet derivatives. The group does not acquire, hold or issue derivatives for speculative purposes. The group has developed a comprehensive risk management process to facilitate, control and monitor these risks. The board has approved and monitors this risk management process, inclusive of documented treasury policies, counterparty limits and controlling and reporting structures.

Risk management activities within the group are the ultimate responsibility of the board of directors. The chief executive officer is responsible to the board of directors for the design, implementation and monitoring of the risk management plan. The newly formed Risk and Information Integrity Committee is responsible for overseeing risk management plans and systems, and the Audit and Corporate Governance Committee oversees financial risks which include a review of treasury activities and the group’s counterparties.

The financial risk management objectives of the group are defined as follows:

• safeguarding the group’s core earnings stream from its major assets through the effective control and management of gold price risk, other commodity risk, foreign exchange risk and interest rate risk;
• effective and efficient usage of credit facilities in both the short and long term through the adoption of reliable liquidity management planning and procedures;
• ensuring that investment and hedging transactions are undertaken with creditworthy counterparties; and
• ensuring that all contracts and agreements related to risk management activities are co-ordinated, consistent throughout the group and that they comply where necessary with all relevant regulatory and statutory requirements.

Gold price risk arises from the risk of an adverse effect on current or future earnings resulting from fluctuations in the price of gold. The group has transactional foreign exchange exposures, which arise from sales or purchases by an operating unit in currencies other than the unit’s functional currency. The gold market is predominately priced in US dollars which exposes the group to the risk that fluctuations in the SA rand/US dollar, Brazilian real/US dollar, Argentinean peso/US dollar and Australian dollar/US dollar exchange rates may also have an adverse effect on current or future earnings. The group is also exposed to certain by-product commodity price risk.

During the year, the group had utilised derivatives as part of its hedging of these risks. In order to provide financial exposure to the rising spot price of gold and the potential for enhanced cash-flow generation the group completed its final tranche of the hedge buy-back programme and settled all forward gold and foreign exchange contracts that had been used by the group in the past to manage those risks. At year-end there were no net forward sales contracts (2009: 571kg), net call options sold (2009: 120,594kg) and net put options sold (2009: 27,071kg) outstanding.

The group’s cash flow hedges consist of commodity and foreign exchange forward contracts that are used to protect against exposures to variability in future commodity, foreign exchange and capital expenditure cash flows. The amounts and timing of future cash flows are projected for each portfolio of financial assets and liabilities on the basis of their contractual terms and other relevant factors, including estimates of prepayments and defaults. The contractual cash flows across all portfolios over time form the basis for identifying gains and losses on the effective portions of derivatives designated as cash flow hedges of forecast transactions. Gains and losses are initially recognised directly in other comprehensive income and reclassified to earnings as gold income or as an adjustment to depreciation expense pertaining to capital expenditure, when the forecast transactions affect the income statement.

The group does not have any cash flow hedge contracts relating to product sales as at 31 December 2010. Cash flow hedge losses pertaining to capital expenditure of $3m, R21m as at 31 December 2010 (2009: $4m, R27m) are expected to be reclassified from accumulated other comprehensive income and recognised as an adjustment to depreciation expense until 2017.

The gains and losses on ineffective portions of such derivatives are recognised in the income statement. During the year to 31 December 2010, a loss of nil (2009: $5m, R40m) was recognised on non-hedge derivatives and other commodity contracts in the income statement due to hedge ineffectiveness.

Non-hedge derivatives

The loss on non-hedge derivatives and other commodity contracts was $702m, R5,136m (2009: $1,533m, R11,934m). This is as a result of the accelerated hedge book settlement, normal realised losses on non-hedge derivatives and the revaluation of non-hedge derivatives resulting from changes in the prevailing spot gold price, exchange rates, interest rates and volatilities. In 2009, forward gold contracts previously qualifying for the normal sale exemption were included in the statement of financial position, with a change in fair value recognised in the income statement as a non-hedge derivative loss of $556m, R4,144m.

During 2010, the group eliminated its gold hedge book resulting in full exposure to the prevailing gold price. The loss on scheduled hedge book maturities during 2010 was $277m, R2,073m. The loss on non-hedge derivatives includes a realised loss of $2,698m, R18,954m, relating to the final tranche of the accelerated hedge buy-back of approximately 3Moz that commenced in September 2010 and was concluded on 7 October 2010 at an average price of $1,300/oz. The realised loss mainly consists of accelerated cash settlement of non-hedge derivative positions of $2,611m, R18,333m. The final phase of hedge restructuring was funded with proceeds from the equity offering and the mandatory convertible bonds issued in September, as well as cash from internal sources and debt facilities.

During 2009, the company embarked on a hedge buy-back that resulted in the accelerated settlement of both non-hedge, forward and option gold contracts qualifying for the normal sale exemption (which permits the group to not record such amounts in its financial statements until the maturity date of the contract) under which the group had committed to deliver a specified quantity of gold at a future date in exchange for an agreed price. As a result of the accelerated settlement of the normal sale exempted contracts, all remaining contracts scheduled to mature in later periods had been determined to not meet all of the requirements necessary for them to continue to qualify for the normal sales exemption in future periods and were accounted for as non-hedge derivatives and recorded on the statement of financial position at fair value with fair value changes recognised in the income statement.

The total realised loss before taxation as a result of the hedge elimination (hedge buy-back) effected during the year was $2,698m, R18,954m (2009: $797m, R6,315m), of which $2,293m, R16,077m (2009: $217m, R1,719m) was due to the accelerated settlement of non-hedge derivatives and $405m, R2,877m (2009: $580m, R4,596m) was due to the accelerated settlement of forward gold contracts previously qualifying for the normal sale exemption.

As at 31 December 2010, AngloGold Ashanti had no outstanding commitments against future production as a result of the elimination of the hedge book. At 31 December 2009, the marked-to-market value of all derivatives, irrespective of accounting designation, making up the hedge position was negative $2.18bn, negative R16.18bn based on a gold price of $1,102 per ounce, exchange rates of $1 = R7.4350 and A$1 = $0.8967 and the market interest rates and volatilities prevailing at that date.

The table below reflects the hedge position as at 31 December 2010 and includes the effect of all accelerated non-hedge settlements undertaken during the year.

The open delta hedge position of the group at 31 December 2010 was nil (31 December 2009: 3.49Moz or 108t).

As at 31 December 2010, the group had no open forward exchange or option contracts in its currency and gold hedge position.

The mix of hedging instruments, the volume of production hedged and the tenor of the hedge book is continually reviewed in the light of changes in operational forecasts, market conditions and the group’s hedging policy.

Forward sales contracts require the future delivery of the underlying at a specified price.

A put option gives the put buyer the right, but not the obligation, to sell the underlying to the put seller at a predetermined price on a predetermined date.

A call option gives the call buyer the right, but not the obligation, to buy the underlying from the call seller at a predetermined price on a predetermined date.

Fluctuations in interest rates impact on the value of short-term cash investments and financing activities, giving rise to interest rate risk.

In the ordinary course of business, the group receives cash from the proceeds of its gold sales and is required to fund working capital requirements. This cash is managed to ensure surplus funds are invested in a manner to achieve market-related returns while minimising risks. The group is able to actively source financing at competitive rates. The counterparties are financial and banking institutions and their credit ratings are regularly monitored.

The group has sufficient undrawn borrowing facilities available to fund working capital requirements (notes 26 and 36).

⁽³⁾ Not included in the statement of financial position.

The contractual maturities of financial liabilities in SA rands can be calculated by applying the exchange rate in US dollars of $1 = R6.5701 at 31 December 2010 (2009: $1 = R7.4350).

At 31 December 2010, the group had no open hedge and non-hedge contracts as a result of the hedge book elimination. The following were the undiscounted forecast principal cash flows arising from all derivative contracts included in the statement of financial position (cash flow hedges and non-hedges) as at 31 December 2009 based on scheduled maturity dates:

Credit risk arises from the risk that a counterparty may default or not meet its obligations timeously. The group minimises credit risk by ensuring that credit risk is spread over a number of counterparties. These counterparties are financial and banking institutions. Counterparty credit limits and exposures are reviewed by the Executive Committee. Where possible, management ensures that netting agreements are in place. No set-off is applied to the statement of financial position due to the different maturity profiles of assets and liabilities. The combined maximum credit risk exposure at the reporting date by class of derivative financial instrument is $1m, R6m (2009: $335m, R2,490m) on a contract-by-contract basis.

In addition, the group has also guaranteed the hedging commitments of several subsidiary companies as disclosed in note 34.

Credit risk exposure of all derivatives netted by counterparties amounts to nil (2009: $104m, R773m). Trade and other receivables that are past due but not impaired totalled $85m, R556m (2009: $45m, R337m). Trade and other receivables that are impaired totalled $8m, R21m (2009: $32m, R237m) and other investments that are impaired totalled $2m, R16m (2009: nil). No other financial assets are past due but not impaired.

Trade receivables mainly comprise banking institutions purchasing gold bullion. Normal market settlement terms are two working days. No impairment was recognised as the principal receivables continue to be in a sound financial position.

The group does not generally obtain collateral or other security to support financial instruments subject to credit risk, but monitors the credit standing of counterparties.

The estimated fair value of financial instruments are determined at discrete points in time based on relevant market information. The estimated fair value of the group’s financial instruments as at 31 December are as follows:

The amounts in the tables above do not necessarily agree with the totals in the notes as only financial assets and liabilities are shown.

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

The carrying amounts approximate fair value because of the short-term duration of these instruments.

The fair value of the non-current portion of trade and other receivables and trade and other payables has been calculated using market interest rates.

Listed equity investments classified as available-for-sale are carried at fair value while fixed income investments and other non-current assets are carried at amortised cost. The fair value of fixed income investments and other non-current assets has been calculated using market interest rates. The unlisted equity investment is carried at cost. There is no active market for the unlisted equity investment and fair value cannot be reliably measured.

The mandatory convertible bonds are carried at fair value. The convertible and rated bonds are carried at amortised cost and their fair values are their closing market value at the reporting date. The interest rate on the remaining borrowings is reset on a short-term floating rate basis, and accordingly the carrying amount is considered to approximate fair value.

In September 2010, the group issued mandatory convertible bonds at a coupon rate of 6% due in September 2013. The conversion of the mandatory convertible bonds into ADSs was subject to shareholder approval, which was granted in October 2010. These bonds are convertible into a variable number of shares ranging from 18,140,000 at a share price equal to or less than $43.50, to 14,511,937 at a share price equal to or greater than $54.375, each as calculated in accordance with the formula set forth in the indenture.

The mandatory convertible bonds contain certain embedded derivatives relating to change in control and anti-dilution protection provisions. The shareholders have authorised that the convertible bonds will be settled in equity and not have any cash settlement potential except if a fundamental change or conversion rate adjustment causes the number of ADSs deliverable upon conversion to exceed the number of shares reserved for such purpose, among other circumstances provided in the indenture, and therefore the group has chosen to recognise the instrument, in its entirety, at fair value. Depending on the final calculated share price on the date of conversion, the liability recognised may differ from the principal amount.

Other convertible bonds that have been issued by the group will only be settled in equity if future events, outside the group's control, result in equity settlement and thus have a potential cash settlement at maturity that will not exceed the principal amount, in those circumstances the liabilities are recognised at amortised cost.

In determining the fair value liability of the mandatory convertible bonds, the group has measured the effect based on the ex interest NYSE closing price on the reporting date. The ticker code used by the NYSE for the mandatory convertible bonds is AUPRA. The accounting policy of the group is to recognise interest expense separately from fair value adjustments in the income statement. Interest is recognised on the yield to maturity basis determined at the date of issue, which was 4.55%.

The contractual principal amount of the mandatory convertible bonds is $789m, provided the calculated share price of the group is within the range of $43.50 to $54.375. If the calculated share price is below $43.50, the group will recognise a gain on the principal amount and above $54.375 a loss. As at 31 December 2010, the actual share price was $49.23.

The total fair value of the mandatory convertible bonds on 15 September 2010 (date of issue) amounted to $819m. A bond issue discount of $30m was recognised in special items in the income statement. The mandatory convertible bonds were issued by AngloGold Ashanti Holdings Finance plc, a finance company wholly owned by AngloGold Ashanti Limited. AngloGold Ashanti Limited has fully and unconditionally guaranteed the mandatory subordinated convertible bonds issued by AngloGold Ashanti Holdings Finance plc. There are no significant restrictions on the ability of AngloGold Ashanti Limited to obtain funds from its subsidiaries by dividend or loan. 

The fair value of derivatives are estimated based on ruling market prices, volatilities, interest rates and credit risk as at 31 December 2010 and includes all derivatives carried in the statement of financial position.

The group uses the Black-Scholes option pricing formula to value option contracts. One of the inputs into the model is the level of volatility. These volatility levels are themselves not exchange traded. The group uses volatility inputs supplied by leading market participants (international banks).

At 31 December 2010, the group had no open derivative positions in its hedge book. The impact of credit risk adjustment totalled $150m, R1,113m at 31 December 2009.

The group uses the following hierarchy for determining and disclosing the fair value of financial instruments:

Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities;

Level 2: inputs other than quoted prices included in level 1 that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices); and

Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs).

The following table sets out the group’s financial assets and liabilities measured at fair value by level within the fair value hierarchy as at 31 December:

A principal part of the group’s management of risk is to monitor the sensitivity of derivative positions in the hedge book to changes in the underlying factors,viz. commodity price, foreign exchange rate and interest rates under varying scenarios. There are no open hedge positions as a result of the hedge book elimination during 2010. Additionally, the group’s management of risk is to monitor the sensitivity of the convertible bonds to changes in the AngloGold Ashanti Limited’s share price and warrants on shares.

The following table discloses the approximate sensitivities of the US dollar’s marked-to-market value of the hedge book, warrants on shares and the convertible bonds to key underlying factors at 31 December 2010 (actual changes in the timing and amount of the following variables may differ from the assumed changes below).

IR represents interest rate.

⁽⁴⁾ Change in B2Gold Corporation share price (+) of spot (+C$0.1) and change in share price (–) of spot (–C$0.1).

The sensitivity analysis in SA rands can be calculated by applying the exchange rate in US dollars of $1 = R6.5701 at 31 December 2010 (2009: $1 = R7.4350).

"The mandatory convertible bond valuation is primarily linked to the AngloGold Ashanti Limited share price traded on the NYSE and fluctuates with reference to the NYSE share price and market interest rates. A change of $1 in the AngloGold Ashanti Limited share price will generally impact the value of the mandatory convertible bond price in a stable interest environment by $0.83.

The group also monitors interest rate risk on other financial assets and liabilities.

The following table shows the approximate interest rate sensitivities of other financial assets and liabilities at 31 December 2010 (actual changes in the timing and amount of the following variables may differ from the assumed changes below). As the sensitivity is the same (linear) for both increases and decreases in interest rates only absolute numbers are presented.

The sensitivity analysis in SA rands can be calculated by applying the exchange rate in US dollars of $1 = R6.5701 at 31 December 2010 (2009: $1 = R7.4350).

⁽⁵⁾ This is the only interest rate risk for the company.

Foreign exchange risk arises on financial instruments that are denominated in a foreign currency.

The following table discloses the approximate foreign exchange risk sensitivities of borrowings at 31 December 2010 (actual changes in the timing and amount of the following variables may differ from the assumed changes below).

The borrowings total in the denominated currency will not be influenced by a movement in its exchange rate.