ASSET-LIABILITY MANAGEMENT FRAMEWORK

ASSET-LIABILITY MANAGEMENT FRAMEWORK

Table of Contents 1. Glossary-------------------------------------------------------------------------------------------------- 3 2. Introduction ---------------------------------------------------------------------------------------------- 9 2.1 Background------------------------------------------------------------------------------------------- 9 2.2 Asset Liability Management -------------------------------------------------------------------- 11 3. Objectives and Scope of the ALM Framework----------------------------------------------- 14 4. Asset-Liability Management Framework Policy Statement ------------------------------- 16 5. Asset-Liability Management Framework Organisation------------------------------------- 17 6. Financial Risk Management Process----------------------------------------------------------- 26 6.1 Risk Methodology --------------------------------------------------------------------------------- 26 6.2 Risk Governance---------------------------------------------------------------------------------- 27 6.3 Risk Identification --------------------------------------------------------------------------------- 28 6.4 Risk Assessment---------------------------------------------------------------------------------- 28 6.5 Risk Control & Response ----------------------------------------------------------------------- 29 6.6 Risk Monitoring & Reporting ------------------------------------------------------------------- 29 6.7 Performance Measurement -------------------------------------------------------------------- 29 6.8 Categories of Risk -------------------------------------------------------------------------------- 30 7. ALM Information Systems ------------------------------------------------------------------------- 33 8. Components of the ALM Framework ----------------------------------------------------------- 36 8.1 Strategic Framework ----------------------------------------------------------------------------- 36 8.2 Institutional or Governance Framework----------------------------------------------------- 37 8.3 Operational Framework ------------------------------------------------------------------------- 38 8.4 Analytical Framework ---------------------------------------------------------------------------- 38 8.5 Technology Framework ------------------------------------------------------------------------- 38 8.6 Strategic Framework ----------------------------------------------------------------------------- 38 8.7 Performance Measurement Framework ---------------------------------------------------- 39 8.8 Regulatory Compliance Framework---------------------------------------------------------- 39 8.9 Risk Control Framework------------------------------------------------------------------------- 39 Page 2 of 40

1. Glossary TERM DEFINITION AND DESCRIPTION Assets 1 An asset is a present economic resource, from a past event, that has probable economic benefits for the City. Asset-Liability Management The ongoing process of formulating, implementing, monitoring and revising strategies on assets and liabilities to achieve a municipality s service delivery objectives, given the City s risk tolerances and constraints Asset-Liability Management Framework An ALM framework examines the nature of the City s assets and liabilities, with the objective of reducing overall risk for the City. The risk of liabilities is measured relative to that of assets, and its objectives for managing those assets Bonds A certificate issued by a government or a private sector company promising to repay borrowed money at a fixed rate of interest at fixed times, with a final capital repayment at a specified date. 1 Source : International Accounting Standards Board Page 3 of 40

TERM DEFINITION AND DESCRIPTION Cash Management This refers to the manner in which the City administers and invests its cash. This involves relevant procedures that ensure all revenue is collected, whether by tariffs, taxation or by other revenues gained, such as grants. Municipal regulations and other relevant government legislation stipulate provisions relating to bank accounts and balances, cash and investment management policies. A contingent liability is: a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or Contingent Liability b) a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) The amount of the obligation cannot be measured with sufficient reliability. Page 4 of 40

TERM DEFINITION AND DESCRIPTION The degree of correlation between two portfolios relative to a set of scenarios is a measure reflecting the relative variation of the economic values of the portfolios over the set of scenarios. Correlation Two portfolios are said to be 100% positively correlated relative to a set of scenarios if the ratio of the economic values of the two portfolios is the same in each scenario in the set at each time period. Linear relationships between variables are often assumed in finance and economics but true interdependencies may be considerably more complex. Dynamic environment The risks to which an entity is exposed and the associated rewards are determined by internal and external factors that change over time Economic value Economic value represents the long-term inherent value of the portfolio. Economic value is based on the portfolio s future cash flows, as distinguished from values based on a specific accounting framework or funding requirements. Funding requirements and accounting-based values serve as a constraint on future cash flows. Enterprise Risk Management Enterprise risk management (ERM) is the process of planning, organizing, leading, and controlling the activities of the City in order to minimize the effects of risk on the City s attainment of service delivery objectives. Page 5 of 40

TERM DEFINITION AND DESCRIPTION Financial Management The systematic application of policies, procedures and practices to the tasks of managing, directing and controlling the financial aspects of the City s business to support the delivery of the City s stated objectives. Funds Transfer Pricing GAAP GAMAP GRAP Hedging This is the process of determining the cost of funds borrowed by one entity to another within the City. Generally Accepted Accounting Principles Generally Accepted Municipal Accounting Principles Generally Recognised Accounting Principles The overall risk of a portfolio may be reduced through hedging. Hedging plays an integral role in the ALM process. Once the risks associated with a portfolio or transaction has been identified, the existing risks can be modified to suit the entity s risk tolerances and financial objectives. Undertaking additional risks that partially or fully offset the existing risks may accomplish this goal. Liability A present obligation from a past event, settlement of which will result in an outflow of the City s economic benefits. Off-Balance Sheet Activities Transactions affecting the municipality but not appearing in the balance sheet. Contingent assets and liabilities form part of this definition. Some of the most common off balance sheet activities include operating leases, hedging contracts and debtors securitisation (with recourse). Page 6 of 40

TERM DEFINITION AND DESCRIPTION Portfolio A portfolio is a collection of assets, liabilities or both. A portfolio may consist of a single asset or liability. Only financial assets and liabilities are considered in these principles. Risk The probability of an unexpected event happening that will have a negative impact on the achievement of the City s objectives. Risk Appetite The level of risk the City is prepared to tolerate in terms of financial consequences and stakeholder impact before it takes preventative action. Risk Management A continuous, proactive and systematic process, effected by a municipality s executive authority, accounting officer, management and other personnel, applied in strategic planning and across the municipality, designed to identify potential events that may affect it and manage risks to be within its risk tolerance, to provide reasonable assurance regarding the achievement of municipal objectives Risk Management Framework Defines the manner in which risk management is conducted throughout the City. Its purpose is to embed risk management across all major practices and processes including strategic planning, policy development, financial management, asset management, resource management, information management, business continuity, fraud control and project management. Page 7 of 40

TERM DEFINITION AND DESCRIPTION Risk Types Credit risk: The risk due to the uncertainty in counterparty s ability to meet its obligations to the City. Market risk: The risk the City faces from adverse changes in the value of its assets or liabilities resulting from changes in interest (and exchange rate) Liquidity risk: The risk that the City will not be able to meet its obligations when they fall due. This also includes the risk that the City will not be able to cash its investments on time. Operational risk: The risk resulting from inadequate or failed internal processes as a result of human or system errors or external events. Scenario Analysis This is the process of estimating the expected outcome or impact after a given period of time, assuming specific changes in key input variables. Sensitivity Analysis The application of modelling, constructed to identify and measure the changes that can occur to financial, and other quantifiable, projections through varying the assumptions used to create the projections. Volatility The frequency of upwards or downward moves in the price of something (including interest rates). Yield The annual rate of return on the City s investment. Page 8 of 40

2. Introduction 2.1 Background The challenge of meeting the Millennium Development Goals (MDGs) is placing an increasing emphasis on local government as the delivery agent for key basic services including water, sanitation, primary health care, housing, economic and community development. However, the devolution of service-delivery responsibility poses significant difficulties for local government if it is not coupled with sufficient financial resources, greater autonomy and increased capacity. De-centralisation of the responsibility for service delivery to local government imposes a requirement for the municipality and its entities to make effective use of all of its financial and infrastructural resources to achieve its service delivery objectives. The Municipal Finance Management Act provides the necessary governance framework by means of which the municipality and its entities can develop its capacity for service delivery through:- IT is a paradox that the lowest level of government increasingly has to provide the most comprehensive response to the most complex developmental challenges. Yet the policy making process and institutional arrangements are often deeply flawed. To meet these challenges, cities need to be transformed from passive service providers to more proactive facilitators of infrastructure and services. But this transformation cannot occur without imparting real authority, responsibility and resources to local government through a process of empowerment. A vital component of this is strengthening the city s ability to raise resources, create and maintain infrastructure and pay for these costs over time. Professor Jeffrey Sachs of Columbia University in his contribution to the Cities Alliance Annual Report 2005 Financial management systems - which incorporate strategic planning, rigorous costing, accrual accounting and performance budgeting Page 9 of 40

Performance information - which is regular, accurate and meaningful and which through an efficient information system produces a full range of relevant financial and management reports Management mind-sets which are imbued with enterprise, initiative and responsible risk-taking in their quest for continuous performance improvement. Governance systems which are enhanced through stronger accountability arrangements, comprehensive internal controls and an integrated riskmanagement system. Managing municipal services such as water systems and road networks does not come cheap, especially when we look 10 or 20 years ahead and factor in the cost of replacing large pieces of these systems. Each year, the City commits significant resources to improve services and infrastructure for the community, incurring financial risk. Increasing demand on these services calls for sound governance processes that enable the City to minimise financial risks to their delivery and optimise available resources by considering the types of financial risks associated with both its assets and is liabilities. Financial risk is an inherent part of service delivery and, whilst it is impossible to operate in an environment devoid of risk, risks can be managed. Therefore, the City must typically bear this risk in the process of achieving its service delivery objectives. Unlike the private sector, rather than seeking to realise the greatest profit, municipal management must strive to manage financial risk in a manner that maximises the likelihood of the municipality achieving its service delivery objectives by safeguarding and optimising its assets, and exercising stringent management and control of its liabilities to minimise exposure to risk. As such, the first step in any local government financial risk management process will be to define the mission, assets and liabilities of the municipality and its entities in a quantifiable way. Page 10 of 40

Managing this financial risk therefore becomes an integral part in the effective functioning of the City. The management of these financial risks is central to the reason why the Asset Liability management Committee was established. 2.2 Asset Liability Management During the 2003/4 budget Lekgotla, the City established Asset and Liability Committee (ALCO) as an enterprise wide management vehicle, which oversees the implementation of Treasury and financial risk management policies, with the objectives of achieving sustainable and good levels of liquidity, and also increase tenure of the City s investments to match the underlying liabilities. Since its inception to present time, ALCO has been more focused on the operational activities and Treasury related issues at a high level. Subsequently, the City has embarked on a process of transforming the ALCO from an operational focused committee to a committee that is actively involved in guiding the City s strategic direction through managing the financial impact of risks, compliance with legislative Municipal guidelines and adherence to the Code of Corporate Governance. achieved through: This objective shall be The establishment of a clear and concise ALM governance framework (ALM Framework, Policy and Procedures). The establishing of a well resourced and robust ALM Unit. ALM can be described as the practice of managing an organization such that decisions on financial assets and liabilities are coordinated. This involves a continuous process of formulating, implementing, monitoring and revising strategies relating to financial assets and liabilities, in an attempt to achieve the organisation s objectives, for a given set of risk tolerances and constraints (taken from The Society of Actuaries). Page 11 of 40

Through a clear ALCO Mandate that guides the ALCO members in their roles of developing strategies, setting direction and making decisions that will lead to the preservation of public trust by ensuring those decisions positively impact future citizens at minimal risks. The strategic ALM process for the City therefore involves the development of a sound financial risk management framework that has the following characteristics: Independence: Risk monitoring and oversight, supported by analytic capacity and a governance framework, are independent of funds management operations. Risk culture: The Finance directorate strives to create a culture where risk management is highly valued, considered an integral part of all ALM and treasury management activities, and viewed as the responsibility of all staff. Risk identification: All existing and new lines of business are thoroughly reviewed on an ongoing basis to identify all material relevant risks. Risk mitigation: Credit, market, liquidity, legal, and operational risks are mitigated to the extent possible. Risk measurement: Appropriate quantitative and qualitative measures have been developed in line with policies and guidelines. Monitoring and reporting: Reports provide context and significance to managers on issues surrounding risk management and the government s overall risk position and are prepared on a regular basis. Review: Periodic review of risk management policies, procedures, and operations by internal staff as well as external, independent, experts are undertaken. Risk policies are in line with leading practices of other comparable sovereigns. Asset and Liability Management (ALM") is a component of the ERM that addresses financial risks of the City of Johannesburg and its Municipal Owned Entities (MOEs), at both strategic and operational levels. ALM will enable management to effectively deal Page 12 of 40

with associated financial risk and opportunity, enhancing capacity to build stakeholder value. By effectively implementing ALM, the City of Johannesburg will be in a position to manage more appropriately the financial impact of risks emanating from its businesses, financial markets and operational activities in such a way that the City is able to achieve its service delivery objectives in a financially sustainable manner. Page 13 of 40

3. Objectives and Scope of the ALM Framework 3.1 ALM Framework Objectives The Asset-Liability Framework will inform COJ's ALM procedures, planning and implementation. The objective of the framework is to provide direction to achieve the following: Establishment of an effective ALM environment; Providing COJ management with an integrated view of the City's balance sheet and financial risk management; Establishing roles and responsibilities for/of the various structures with regard to ALM within the City of Johannesburg; and Providing COJ management with decision support when making major investment/funding decisions 3.2 ALM Process Pillars The City s ALM framework lies on three pillars: 3.2.1 ALM Organisation Structures and responsibilities Delegation of authority Level of top management involvement 3.2.2 ALM Process Risk Methodology Risk Governance Risk Identification Page 14 of 40

Risk Assessment Risk Control and Response Performance Management Risk policies and procedures, Prudential limits, guidelines and auditing, Risk Monitoring and Reporting 3.3 ALM information system 3.3.1 Management information systems 3.3.2 Information availability, accuracy, adequacy and expediency. 3.4 ALM Scope The scope of the ALM process at the City shall cover the following broad areas: 3.4.1 Liquidity risk management 3.4.2 Market risk management Interest rate risk management Foreign exchange risk management 3.4.3 Funding planning 3.4.4 MOEs business planning and projections Page 15 of 40

4. Asset-Liability Management Framework Policy Statement The City of Johannesburg ( COJ ) Council is committed to an Asset and Liability Management ( ALM ) policy framework aimed at Identifying, measuring, monitoring and effectively minimising financial risks for the City. This essentially entails: Planning, Directing and Controlling, the flow, level, mix, cost and yield of municipal funds. The financial impact of all of the City of Johannesburg s risks will be managed through a structured and systematic approach, which is aligned to the ALM Policy and the City s corporate governance responsibilities. ALM will be embedded in the municipal finance and operational systems and processes, to ensure that responses to financial risks remain current and dynamic. Page 16 of 40

5. Asset-Liability Management Framework Organisation 5.1 ALM Organisation Successful implementation of the financial risk management process would require strong commitment on the part of the City s Council and senior management. The Council through ALCO has the overall responsibility for management of financial risks and should decide the risk management policy and procedures, set prudential limits, auditing, reporting and review mechanism in respect of liquidity and market risk. The Asset - Liability Committee (ALCO) consisting of the City s senior management should be responsible for ensuring adherence to the policies and limits set by the Council as well as for deciding the business strategy (on the assets and liabilities sides) in line with the City s service delivery and risk management objectives. The ALM unit consisting of operating staff should be responsible for analysing, monitoring and reporting the risk profiles to the ALCO. The staff should also prepare forecasts (simulations) showing the effects of various possible changes in market conditions related to the balance sheet and recommend the action needed to adhere to City s internal limits. The ALCO is a decision-making unit responsible for balance sheet planning from riskreturn perspective including the strategic management of liquidity and market risks. The business and risk management strategy of the City should ensure that the City operates within the limits / parameters set by the Council through ALCO. 5.2 Structure and delegation of authority The Municipal Finance Management Act 56 of 2003 prescribes risk management as the full responsibility of the COJ Council. However, the powers within this context may be Page 17 of 40

delegated to the Executive Mayor (and the Mayoral Committee). The COJ Audit and Risk Committee (established as a Section 80 committee) reports to the Mayoral Committee, and has been delegated by Council to oversee the internal audit and risk management functions of the City, hence overseeing Enterprise Risk Management (ERM) implementation. The ALM is part of the City s ERM framework and its governance structure is as follows: COUNCIL MMC ALCO ARC ALM UNIT Page 18 of 40

5.3 Roles and Responsibilities 5.3.1 Council At the top of the structure is the Council. As the legislative and executive authority of a municipality, the municipal council is held accountable by the electorate for the sound and sustainable management of the financial affairs of a municipality. As such the council has the overall governance responsibility of the fiscal and financial affairs of a municipality. The overall responsibility of financial strategies and financial risk management is delegated by Council to the ALCO. 5.3.2 MMC Roles and Responsibilities Ensures that the municipality performs its constitutional and statutory functions within the limits of the approved budget. Reports instances of potential or real non-compliance with budget process, any part of the MFMA, or in relation to any emerging or impending financial problems that may necessitate provincial intervention. Promptly responds to and initiates remedial or corrective steps proposed by the municipal manager to deal with financial problems, which may include steps to reduce spending when revenue is less than the projected, and tabling an adjustments budget 5.3.3 The Mayoral Committee on Finance and Economic Development Ensure the adoption, implementation and review of an investment policy. Ensure the adoption, implementation and review of any other policies and strategies in respect of the Finance, Economic Development and Revenue and Customer Relations Management functions of the City. Page 19 of 40

Ensure the preparation of the annual operating and capital estimates for the Finance, Economic Development and Revenue and Customer Relations Departments of the City. Quarterly report to the Section 79 finance and Economic Development Committee on the implementation and execution of decisions, spending of the budget and the general activities of the Finance, Economic Development and Revenue and Customer Relations Management Departments and the municipal entities. The approval of key performance indicators and targets for the Executive Directors: Finance, Economic Development and Revenue and Customer Relations Management, the departments and municipal entities. 5.3.4 Executive Mayor: Roles and Responsibilities Ensures that borrowings cannot be used to fund operating shortfalls. Ensures that processes are in place to improve budget control and to assist in the early identification of financial problems. Takes the necessary steps to report any emerging or impending financial problems that may necessitate provincial intervention. Responds to and initiates remedial or corrective steps proposed by the City Manager to deal with financial problems. Leads the council in terms of approving budgets; approving policies imposing rates and other taxes, levies and duties and approving loans. Ensures realistic revenue and expenditure projections for future years by taking into consideration the performance of the previous years. Page 20 of 40

5.3.5 Audit and Risk Committee An audit committee is an independent advisory body appointed by a council and tasked with specific responsibilities as set out in an audit committee charter approved by a council. Legislated Duties of an Audit Committee: Section 166 of the MFMA requires the Audit and Risk Committee to advice on matters relating to the following: Internal financial control, internal audits Risk management Accounting policies Adequacy, reliability and accuracy of financial reporting and information Performance management Effective governance Legislative compliance Performance evaluation Financial Risk Management is a part of the overall risk management framework for the City. The Audit and Risk Committee has a statutory responsibility of reporting to the council on the systems of internal control and the management of financial risks. 5.3.6 Asset-Liability Management Committee (ALCO) In order that the ALCO can achieve its objectives, it needs to be empowered with a set of general and specific responsibilities which will comprise the ALCO s Mandate. Page 21 of 40

The general and specific responsibilities comprise the means by which the ALCO shall implement the City s ALM Policy. These responsibilities are covered in detail under the ALCO Mandate. 5.3.7 Asset-Liability Management Unit The asset and liability management function for the City will be supported by specialists responsible for implementing and managing the ALM process. The role of this unit will include the following: Implement and manage ALM processes across all functions of the City and its MOEs in accordance with the ALM policy; Implement the City's ALM Policy and ALM-Procedures Manuals; Recommend changes to ALM policies and procedures; Measure and report to ALCO on all financial risks of the City and its MOEs; Measure and report to ALCO on the performance and effectiveness of implemented ALM strategies; Designing funding strategies to match the desired financial asset and liability profiles Operate financial asset and liability management systems, which would assist with the financial analysis and risk modelling; Give input in the preparation of the City's budget, projections and the establishment of the overall funding plan, through balance sheet, income and cash flow forecasting for the City and MOEs Design and propose to ALCO the implementation of best-practice models for effective management of COJ's financial assets and liabilities; Perform any financial analysis as required by ALCO (i.e., scenario testing and simulations) Page 22 of 40

Recommend ALM strategies and tactics for approval by the ALCO; and Conduct research on all matters commissioned by the ALCO. 5.3.8 Treasury Management Committee The Treasury Management Committee should be in place and chaired by the City's Treasurer. This committee is responsible for managing the Treasury activities of City, which covers the areas of responsibility for funding of shortfall, investing of cash surpluses and management of financial risks. The City's Treasury function including the following: Source the most efficient financial instruments at the best price and to administer and account for such instruments within the bounds of the ALM Policy. Action specific strategies and tactics to control, mitigate, and/or manage financial market risks, in accordance with the limits and guidelines approved by the ALCO; Review regularly and recommend changes to the Treasury Policy Manual, to be reviewed by the ALCO, and approved by Council; Adhere to both the ALM policy and the Treasury Policy Manual, as prescribed by the ALCO; Utilise financial instruments and mechanisms (as approved by the ALCO) for investment and debt management purposes, with approved counterparties and within approved counterparty and instrument limits; Ensure that the funding structure of the City comply at all times with the guidelines set by the ALCO; Ensure that there is adequate liquidity to enable the City and its MOEs to meet all expected and unexpected financial commitments, in a cost effective and timely manner; Ensure that the fixed/floating mix of the debt is in accordance with the guidelines set by the ALCO; Page 23 of 40

Ensure that inherent market risks are identified and quantified prior to execution of all treasury transactions; Ensure that market risk identification and quantification methodologies prescribed by the ALCO are adhered to; and Ensure that confirmations, settlements and accounting of all treasury transactions are properly carried out at all times. 5.3.9 Municipal-Owned Entities (MOE) Finance Committees The MOE Finance Committees will perform the following functions in relation to financial risk management: Report to ALCO on a quarterly basis, on the balance sheet risks for the MOE; this risk shall include but not limited to various inflationary effects on key expense drivers such as: o Commodity price inflation o CPIX Disclose to ALCO all operational risks that have material financial risk impact on the overall City s balance sheet. Oversee the implementation of ALM strategies at MOE level, and monitor the performance of those strategies on a regular basis; Improve the MOEs financial risk management readiness or awareness through effective and efficient reporting, training programs, risk-based performance measurements and incentives; Oversee the implementation and integration of financial management and ALM systems, and data management capabilities across the MOE, to ensure adequate support for financial risk management Perform cashflow projections and forward the projections to the ALM unit. Cashflow projections shall be performed at two levels: Page 24 of 40

- Daily for monthly - Monthly for annually on a rolling budget method Page 25 of 40

6. Financial Risk Management Process Principles of risk management The major principles of the City of Johannesburg ALM risk management framework are listed below: Independence: Risk monitoring and oversight, supported by analytic capacity and a governance framework, are independent of funds management operations. Risk culture: The Finance directorate strives to create a culture where risk management is highly valued, considered an integral part of all ALM and treasury management activities, and viewed as the responsibility of all staff. Risk identification: All existing and new lines of business are thoroughly reviewed on an ongoing basis to identify all material relevant risks. Risk mitigation: Credit, market, liquidity, legal, and operational risks are mitigated to the extent possible. Risk measurement: Appropriate quantitative and qualitative measures have been developed in line with policies and guidelines. Monitoring and reporting: Reports provide context and significance to managers on issues surrounding risk management and the City s overall risk position and are prepared on a regular basis. Review: Periodic review of risk management policies, procedures, and operations by internal staff as well as external, independent, experts are undertaken. Risk policies are in line with leading practices of other comparable municipalities. A brief summary of the risk management process has been outlined below. The same process will be adopted for the ALM Policy, and a procedure manual will be developed to assist in ensuring the successful implementation of the City's ALM process. 6.1 Risk Methodology The ALM methodology of COJ consists of the following interrelated components: internal environment, objective setting, risk identification, risk assessment, risk control Page 26 of 40

and response, risk monitoring and reporting, and risk performance measurement. These components are derived from 'best practice' with respect to ALM governance. The diagram below outlines the components of the ALM process. Risk Governance Organisational context Risk management context I N T E R N A L E N V I R O N M E N T Risk identification What can happen? How can it happen? Risk assessment Measuring likelihood Measuring impact Establish the level of risk Assess risk Risk control and response Identify treatment options (strategy) Evaluate treatment options Implement recommendations Risk monitoring and reporting Exposure evaluated against risk appetite and tolerance limits Over Limit: Yes NO Appropriate risk reporting Informed management decisions E X T E R N A L E N V I R O N M E N T Performance Measures 6.2 Risk Governance The internal environment encompasses the tone of an institution, influencing the risk consciousness of its people and is the basis for all other components of ERM, providing discipline and structure. Internal environment factors include the institution's risk management philosophy; its risk appetite; oversight by the Council, the integrity, ethical values and competency of the entity's people; and the way management assigns authority and responsibility and organises and develops the company's employees. Page 27 of 40

Risk appetite is established by Council and overseen by the ALCO, and is the amount of risk exposure, or potential adverse impact from an event that COJ and its MOEs are willing to accept or retain. While operational, business/commercial and financial market risks cannot be completely eliminated, they can be minimised through effective management and transfer. Objectives are set at a strategic level establishing a basis for operations, reporting and compliance objectives. COJ faces a variety of risks from external and internal sources, and a pre-condition to effective risk identification, risk assessment and risk response, is the establishment of risk management objectives. These objectives must be aligned with COJ's risk appetite, which drives risk tolerance levels for the entire institution. 6.3 Risk Identification Risk identification entails compiling a detailed list and concise description of all strategic, operational, business/commercial and market risks that COJ and its MOEs may be exposed to in the foreseeable future that would threaten the achievement of the City's overall objectives, both in the long term and short term. 6.4 Risk Assessment All identified risk exposures are to be assessed and prioritised in terms of the approved risk methodology. Risk assessment allows the City to consider the extent to which potential events have an impact on the achievement of its objectives. COJ management assesses events from two perspectives, likelihood and impact, and uses a combination of qualitative and quantitative methods. Risks are assessed on both inherent and residual basis. Page 28 of 40

6.5 Risk Control & Response A decision as to whether or not to terminate, transfer, tolerate or treat the relevant risk must, at all times be made. In considering their response, COJ management assesses the effect on risk likelihood and impact, as well as cost versus benefit, selecting a response that brings residual risk within desired risk tolerances. COJ management identifies and implements controls, mitigations and interventions to mitigate the risks. This will include the identification of the risk owner, actions required and due dates thereof, and evaluating the effectiveness of the controls, further. 6.6 Risk Monitoring & Reporting All risk exposures will continually / periodically be evaluated against risk appetite and tolerance limits. Risk monitoring is aimed at improving the current stage of risk management from basic to advance in terms of risk governance, risk assessments, risk quantification, risk reporting and risk control optimisation. Risk reporting will involve the production of appropriate risk reports to enable and enhance informed decision-making by management and where necessary, the Council. 6.7 Performance Measurement Risk management's performance will be measured and monitored through the following performance management activities: Monitoring of progress made by management with the implementation of the ALM methodology; Monitoring of key risk indicators; Monitoring of loss and incident data; Progress made with risk mitigation action plans; and Page 29 of 40

Annual quality assurance review of ALM performance by the Internal Audit function, which must also report on its review to the Audit and Risk Committee. 6.8 Categories of Risk The diagram represents a generic view of the risks covered under a traditional ALM process. Operational (Key considerations) Suppliers Service delivery Employee issues Fraud Projects Natural events IT Fire Strategic (Key considerations) Technology The economy Consumer needs Legal: Contracts, litigations and intellectual property Asset and liability management (ALM) management Compliance (Key considerations) Tax requirements Environmental legislation Accounting standards Internal Controls Ethics Financial (Key considerations) Exchange rates Interest rates Liquidity Profitability Credit Page 30 of 40

As the risk environment is so varied and complex, business managers and risk practitioners normally place different types of risk into convenient categories. This process of risk categorisation is also driven by the fact that many risks require highly specialised knowledge and expertise to understand them. The main categories of risk for CoJ are as follows: 6.8.1 Market Risk This is the risk that the value of a financial position or portfolio will decline due to adverse movements in market rates such as interest rates, foreign exchange rates, equity prices and commodity prices. Market risk can be subdivided into interest rate risk, foreign exchange risk and commodity price risk. Interest rate risk is the most relevant risk for the City s treasury while commodity price risk will be prevalent in the MOEs. 6.8.2 Liquidity risk management Liquidity risk is the risk that there will be inadequate funds available to meet payment obligations as they become due, alternatively, to fund asset growth including the seizing of acquisition opportunities or that this can only be done at materially disadvantageous terms. The liquidity risk policy ensures that the City has available or has access to sufficient funds to meet these obligations. 6.8.3 Operational Risk This is the risk of loss resulting from failed internal processes, people, systems, and external events. Operational risks include the risks relating to health, safety, business continuity, accidents, incidents, insurable risks and the risk of non-compliance with any statutory requirements of central, provincial or local government, including regulations imposed by the regulatory agencies. Page 31 of 40

The ALM process for the City and its MOEs will focus on the strategic and tactical management of financial risk as outlined under the risk categories. Page 32 of 40

7. ALM Information Systems ALM has to be supported by a management philosophy which clearly specifies the risk policies and procedures, limits and guidelines. This framework needs to be built on sound methodology with necessary information system as back up. Thus, Information is the key to the ALM process. There are various methods prevalent world-wide for measuring risks. These range from easy-to-comprehend and simple `Gap analysis to extremely sophisticated and dataintensive `Simulation methods. However, the central element for the entire ALM exercise is the availability of timely, adequate and accurate information. Creating value in COJ s decision-making processes requires more than attaching a piece of software to a system. Government s silos must not inhibit information flows. Efforts must be made to verify that accurate information exists the first time it is captured. Plans must exist to proactively seek out people who can use the information. Investments are needed in analytical tools and education for employees. Having the right information at the right time to make the right decisions means a new culture it means viewing information as a part of an Information Value Chain. The figure below describes this value chain Page 33 of 40

Figure above shows that effective decision-making begins by identifying needs and capturing, updating and storing information effectively. Strategies can then be developed to verify that information is passed to the right people at the right time. Access at the right time will enable analysis; action and insight that will help promote the right decision Collecting accurate data in a timely manner will be the biggest challenge owing to the City s structure of having reportable departments such as revenue and Treasury as well as MOEs established as independent companies and ran by independent boards. These MOEs and departments do not have a uniform reporting and accounting system as that of the Core business. Data for simulation shall also come from different sources. For instance, information on financial assets and liabilities shall be obtained from Treasury Management System currently being Front Arena, while customer data shall come from different systems. For Johannesburg Water, that system is Venus. The acquisition of IPS Sendero system by the City will address the issue of data management as all the information shall be collated through its data interface of DMS. The diagram below captures the various sources of data and flows of information onto IPS Sendero for simulation: Page 34 of 40

Information Centre GL - Open Series Management Accounts report Subtotal debt Balances IPS- Sendero Treasury ALM Desk Hedging all new interest rate risk on new liabilities Management of all local bond trading Extract data and manipulate: xls into MS to flatfile into Sendero Page 35 of 40

8. Components of the ALM Framework Asset and liability Management forms an integral part of the ERM process within the City. Management of the City and each MOE must base their business decisions on a dynamic and integrated risk management system and process, driven by the City's overall strategy. The ALM process will enable COJ to manage the financial impact of risks emanating from its businesses, and the financial markets in such a way that its targeted economic returns are achieved. This process will therefore capture the financial impact of adverse consequences on the specific drivers of net operating profit and cash flow return on assets or financial objectives. The ALM framework is categorised into the following: Strategic framework; Institutional framework; Operational framework; Analytical framework; Technology framework; Information reporting framework; Performance measurement framework; Regulatory compliance framework; and Risk control framework. 8.1 Strategic Framework The Council establishes and articulates the risk appetite of the City at both the municipal and MOE levels. The amount of risk that could be taken is specified in quantifiable terms. The Council also clearly establishes the roles and responsibilities of Page 36 of 40

the ALM Unit, which should be pro-active and not reactive. The function of this unit is not merely analytical, but serves as a catalyst for formulating business strategies. 8.2 Institutional or Governance Framework The reporting structure, described in the ALM governance documents sets out the structure within which Asset Liability Management and associated financial risks are managed. The frameworks delineate roles and responsibilities of the ALCO members and the ALM Unit. Below is an overall ALM Governance structure: COUNCIL MMC ALCO ARC ALM UNIT Page 37 of 40

8.3 Operational Framework At both the municipal and MOE levels, a consistent framework will ensure that all functions are co-ordinated and work towards a common objective. ALM implementation will include adoption of new management concepts at all levels and introduction of new technologies if necessary, in order to measure and report performance and financial risks. 8.4 Analytical Framework It is important that there is consistency in the analytical methods used for the measurement of risk. Periodic reviews of the models to measure risk, confirmation of assumptions and the verification of their predictive accuracy should be carried out. Various analytical concepts (gap, simulation earnings at risk, value at risk, economic value at risk) will be used to obtain appropriate insights. 8.5 Technology Framework An ALM Framework must be supported by reliable information. This includes COJ's historical information as well as projections, historical and projected market information and collective management insights. Although much of this information is available, accessing it in the best format will be of utmost importance for the implementation of the ALM process. Existing tools, if adequate, will be used to process and produce meaningful reports. A good information system will give COJ management a complete picture of the balance sheet. 8.6 Strategic Framework The overriding objectives of this framework are to: Page 38 of 40

Provide the recipient with sufficient information to understand the risk position of COJ and its MOEs; Identify the strategic alternatives available to the institution, the risk I reward trade-offs and the responsibility for implementing; Monitor the impact of decisions; and Incorporate into the City and MOE risk registers, all financial risks identified through the ALCO process. 8.7 Performance Measurement Framework The performance of central business units, Treasury unit and MOEs must be constantly measured on a meaningful and comparable basis. Risk adjusted performance measures would provide a powerful incentive to align the performance of individuals and business units with COJ's strategic objectives. 8.8 Regulatory Compliance Framework The objective of this framework is to ensure compliance with relevant statutory and regulatory requirements of central, provincial or local government, including regulations imposed by the regulatory agencies. 8.9 Risk Control Framework This framework will identify and evaluate controls, mitigations and interventions currently in place or which have been implemented by COJ to contain the potential impact of financial risks. The risk control evaluation will follow three essential steps: Firstly, the appropriateness and adequacy of the existing controls on the corresponding financial risks, will be evaluated; Page 39 of 40

Secondly, the performance of these existing risk controls will be evaluated against the desired levels of control effectiveness; and Thirdly, a gap between existing control effectiveness and desired effectiveness will be established. This will form a basis for the revised risk control plan. Page 40 of 40