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9 Derivative financial instruments

The Group uses a variety of derivative financial instruments including swaps, options, forwards, credit derivatives and exchange-traded financial futures in its trading and hedging strategies, in line with the Group’s overall risk management strategy. The objectives include managing exposure to price, foreign currency and/or interest rate risk on planned or anticipated investment purchases, existing assets or liabilities, as well as locking in attractive investment conditions for future available funds.

The fair values represent the gross carrying value amounts at the reporting date for each class of derivative contract held or issued by the Group. The gross fair values are not an indication of credit risk, as many over-the-counter transactions are contracted and documented under ISDA master agreements or their equivalent. Management believes that such agreements provide for legally enforceable set-off in the event of default, which substantially reduces credit exposure.

Fair values and notional amounts of derivative financial instruments

As of 31 December, the fair values and notional amounts of the derivatives outstanding were as follows:

The notional amounts of derivative financial instruments give an indication of the Group’s volume of derivative activity. The fair value assets are included in “Other invested assets” and “Investments for unit-linked and with-profit business”, and the fair value liabilities are included in “Accrued expenses and other liabilities”. The fair value amounts that were not offset were nil as of 31 December 2015 and 2016.

Non-hedging activities

The Group primarily uses derivative financial instruments for risk management and trading strategies. Gains and losses of derivative financial instruments not designated as hedging instruments are recorded in “Net realised investment gains/losses — non-participating business” and “Net investment result — unit-linked and with-profit business” in the income statement. For the years ended 31 December, the gains and losses of derivative financial instruments not designated as hedging instruments were as follows:

Hedging activities

The Group designates certain derivative financial instruments as hedging instruments. The designation of derivative financial instruments is primarily used for overall portfolio and risk management strategies. As of 31 December 2015 and 2016, the following hedging relationships were outstanding:

Fair value hedges

The Group enters into foreign exchange swaps to reduce the exposure to foreign exchange volatility for certain of its issued debt positions and fixed income securities. These derivative instruments are designated as hedging instruments in qualifying fair value hedges. Gains and losses on derivative financial instruments designated as fair value hedging instruments are recorded in “Net realised investment gains/losses ― non-participating business” in the income statement. For the years ended 31 December, the gains and losses attributable to the hedged risks were as follows:

Cash flow hedges

The Group entered into a cross-currency swap to reduce the exposure to foreign exchange and interest rate volatility for a long-term debt instrument issued in the second quarter of 2016. These derivative instruments are designated as cash flow hedging instruments.

For the year ended 31 December 2016, the Group recorded a gain of USD 32 million on derivatives in accumulated other comprehensive income. For the year ended 31 December 2016, the Group reclassified a gain of USD 39 million from accumulated other comprehensive income into income.

As of 31 December 2016, the maximum length of time over which the Group hedged its exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, was six years.

The Group believes that the net gains and losses associated with cash flow hedges expected to be reclassified from accumulated other comprehensive income within the next twelve months cannot be reasonably estimated as they relate to foreign exchange volatility.

Hedges of the net investment in foreign operations

The Group designates derivative and non-derivative monetary financial instruments as hedging the foreign currency exposure of its net investment in certain foreign operations.

For the years ended 31 December 2015 and 2016, the Group recorded an accumulated net unrealised foreign currency remeasurement gain of USD 1 631 million and a gain of USD 2 448 million, respectively, in shareholders’ equity. These offset translation gains and losses on the hedged net investment.

Maximum potential loss

In consideration of the rights of set-off and the qualifying master netting arrangements with various counterparties, the maximum potential loss as of 31 December 2015 and 2016 was approximately USD 1 551 million and USD 1 679 million, respectively. The maximum potential loss is based on the positive market replacement cost assuming non-performance of all counterparties, excluding cash collateral.

Credit risk-related contingent features

Certain derivative instruments held by the Group contain provisions that require its debt to maintain an investment-grade credit rating. If the Group’s credit rating were downgraded or no longer rated, the counterparties could request immediate payment, guarantee or an ongoing full overnight collateralisation on derivative instruments in net liability positions.

The total fair value of derivative financial instruments containing credit risk-related contingent features amounted to USD 106 million and USD 107 million as of 31 December 2015 and 2016, respectively. For derivative financial instruments containing credit risk-related contingent features, the Group posted collateral of nil as of 31 December 2015 and 2016, respectively. In the event of a reduction of the Group’s credit rating to below investment grade, a fair value of USD 107 million additional collateral would have had to be posted as of 31 December 2016. The total equals the amount needed to settle the instruments immediately as of 31 December 2016.