FINANCIAL INSTRUMENTS Fair value determination

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

The fair value of financial instruments is determined using either prices quoted in an active market or valuation techniques where no active market exists. Markets are deemed to be active if price quotes are easily and regularly available and reflect real and regularly occurring market

transactions on an arm's length basis.

If the market has a commonly used valuation technique applied to a financial instrument to which the fair value is not directly available, the fair value is based on a commonly used valuation technique and market quotations.

If, in rare circumstances, the valuation technique is not a commonly used technique in the market, a valuation model created for the instrument in question will be used to determine the fair value.

The valuation techniques used include recent arm’s length market transactions between

knowledgeable, willing parties, the discounted cash flow method and reference to the current fair value of another instrument that is substantially the same. The valuation techniques take account

of estimated credit risk, applicable discount rates, the possibility of premature repayment and other factors affecting the reliable measurement of the fair value of financial instruments

It is typical of illiquid instruments that their price calculated using a pricing model differs from the actual transaction price. However, the actual transaction price is the best evidence of the instrument's fair value. The Day 1 profit/loss, based on the difference between the actual transaction price and the price deriving from the pricing model, is recognised in the income statement. However, the non-recognised amount is recognised as soon as there is a genuine market price for the instrument or a commonly used pricing practice is created in the market.

Securities sale and repurchase agreements

The purchase price of securities bought under 'resell conditions' binding on both parties is recognised as a receivable under the balance sheet item determined by the counterparty. The difference between the purchase price and resale price is treated as interest income and accrued over the term of the agreement.

The selling price of securities sold under 'resell conditions' binding on both parties is recognised as a financial liability under the balance sheet item determined by the counterparty. The difference between the selling price and the repurchase price is treated as interest expenses and accrued over the term of the agreement. Securities sold under the repurchase obligation and the corresponding securities provided as maintenance margin are included in the original balance sheet item despite the agreement.

Classification and recognition

On the basis of their initial recognition, financial assets and liabilities are classified as financial assets at fair value through profit or loss, loans and other receivables, held-to-maturity

investments, available-for-sale financial assets, financial liabilities at fair value through profit or loss and other financial liabilities, in accordance with their measurement practice.

The purchase and sale of financial assets and liabilities at fair value through profit or loss, held-to-maturity investments and available-for-sale financial assets are recognised in the balance sheet on the transaction date, or the date on which the Group agrees to buy or sell the asset or liability in question. Notes and bonds classified as loans and other receivables are recognised as financial assets on the transaction date and loans granted on the date on which the customer draws down the loan.

Financial assets and liabilities are offset and the net amount reported in the balance sheet only if there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis.

Financial assets are derecognised when the contractual right to receive cash flows from the financial asset has expired or the Group has transferred all risks and rewards of ownership.

Financial liabilities are derecognised when they are extinguished, i.e. when the obligation is discharged, cancels or expires.

Financial assets and liabilities at fair value through profit or loss

Financial instruments at fair value through profit or loss include financial assets and liabilities held for trading, derivative contracts held for trading and financial assets at fair value through profit or loss at inception.

Financial assets and liabilities held for trading and derivative contracts

Assets held for trading include notes and bonds, shares and participations acquired with a view to generating profits from short-term fluctuations in market prices. Liabilities held for trading refer to the obligation to deliver securities borrowed by a short seller. Derivatives are also accounted for as held for trading unless they are designated as derivatives for effective hedging or they are

guarantee contract derivatives.

Assets and liabilities held for trading and derivative contracts are measured at fair value and any change in the fair value and any capital gains and losses, interest income and expenses as well as dividend income are recognised in the income statement.

Financial assets at fair value through profit or loss at inception

Financial assets at fair value through profit or loss at inception include financial assets which are designated as at fair value through profit or loss upon their initial recognition. These financial assets are measured at fair value and any change in their fair value and any capital gains and losses, interest income and expenses as well as dividend income are recognised in the income statement.

Financial assets recognised at fair value through profit or loss at inception comprise bonds used in the management of liquidity. In accordance with the Group's risk management principles, the Group manages these investments and assesses their performance at fair value in order to receive a true and real-time picture of investment operations. Reporting to the Group's

management is based on fair values. Since the business involves investment on a long-term basis, financial assets are presented separately from those held for trading.

Financial assets at fair value through profit or loss also include hybrid instruments in which the fair value of an embedded derivative cannot be determined separately, and investments in associates in insurance operations made by venture capital investors.

These financial assets in the consolidated balance sheet are presented as financial assets at fair value through profit or loss or as Non-life Insurance assets.

Loans and other receivables

Financial assets classified as loans and other receivables are non-derivative financial assets with fixed or determinable payments that have been created by handing over money or services. Not quoted in an active market, loans and other receivables are carried at cost. Receivables related to insurance contracts, claims administration contracts and disposal of investments are presented within this asset class. These financial assets are shown as receivables from customers, from credit and financial institutions or as Non-life Insurance assets in the consolidated balance sheet.

Loans and other receivables are initially recognised at cost, which is the fair value of consideration given plus directly attributable transaction costs. Loans and other receivables are carried at amortised cost after their initial recognition.

Impairments of loans and other receivables are recognised on an individual or collective basis.

Impairments will be assessed and recognised on an individual basis if the debtor's total exposure is significant. In other respects, impairments are assessed and recognised on a collective basis.

Impairments are recognised as an allowance of loans in the balance sheet. Recognition of interest on the reduced amount continues after the recognition of impairment. For notes and bonds classified as loans and other receivables, the difference between the carrying amount of the note/bond and a lower recoverable amount is recognised as an impairment loss in the income statement.

Impairments are recognised and impairment losses incurred only if there is objective evidence of a debtor's reduced solvency after the initial recognition of the receivable. A receivable is impaired if the present value of estimated future cash flows – including the fair value of collateral – is lower than the aggregate carrying amount of the loan and the related unpaid interest. Estimated future cash flows are discounted at the loan's original interest rate. If the loan carries a variable interest rate, the discount rate for measuring any impairment is the current effective interest rate

determined under the agreement. The difference between the carrying amount of the loan and a lower recoverable amount is recognised as an impairment loss in the income statement.

For the purpose of a collective assessment of impairment, receivables are grouped on the basis of similar credit risk characteristics. Impairment is recognised for a group of loans and receivables if there is objective evidence that debtors' ability to pay amounts due is uncertain. The impairment to

be recognised is determined by average estimated future losses based on historical loss experience.

The loan is derecognised after the completion of debt-collection measures, or otherwise based on the management's decision. Following the derecognition, payments received are recognised as an adjustment to impairments of loans and receivables. If there is subsequent objective evidence of the debtor's improved solvency, the amount of the impairment recognised earlier will be

reassessed and any change in the recoverable amount will be recorded in the income statement.

Investments held to maturity

Investments held to maturity are non-derivative financial assets with fixed or determinable payments that the company has the positive intention and ability to hold to maturity. These investments are carried at amortised cost after their initial recognition using the effective interest method. The difference between the nominal value and the acquisition value of bonds is allocated over the residual term to maturity.

If there is objective evidence of an impaired held-to-maturity investment, this impairment will be recognised under 'Net investment income' in the income statement.

These financial assets are shown under investment assets in the consolidated balance sheet.

Available-for-sale financial assets

Available-for-sale financial assets include non-derivative assets which are not classified as the abovementioned financial assets but which may be sold before their maturity, comprising notes and bonds, shares and participations. At the time of their acquisition, available-for-sale financial assets are recognised at cost, which equals the fair value of the consideration paid plus

transaction costs directly attributable to their acquisition. Available-for-sale financial assets are measured at fair value. Any changes in their fair value are recognised in the fair value reserve under shareholders' equity, from where they, including any capital gain or loss, are transferred to the income statement when the asset is derecognised or impaired. An available-for-sale financial asset is deemed to have impaired when its issuer's credit rating has undergone a significant downgrading or the fair value of a share or participation has fallen considerably or on a long-term basis below its acquisition cost.

If a security's market value continues to fall following impairment recognition, the impairment loss will be recognised in the income statement.

Interest income related to available-for-sale financial assets are recognised under 'Net interest income' in the income statement and dividends under 'Net investment income'.

If the fair value of impaired notes and bonds classified as available-for-sale financial assets increases subsequently and this increase can be objectively regarded as being related to an event after their impairment loss recognition, the impairment loss will be reversed and recorded in the income statement. If the fair value of an impaired share increases subsequently, this increase will be recognised in shareholders' equity.

The difference between the nominal value and the acquisition cost of fixed-rate bonds is allocated over the residual term to maturity, using the effective interest method.

These financial assets are shown as investment assets or as Non-life Insurance assets in the consolidated balance sheet.

Cash and cash equivalents

Cash and cash equivalents consist of cash and receivables from credit institutions repayable on demand.

Other financial liabilities

Other financial liabilities include financial liabilities other than those at fair value through profit or loss, comprising deposits and other liabilities to credit institutions and customers, debt securities issued to the public and other financial liabilities. Other financial liabilities are recognised in the balance sheet on the settlement date and carried at amortised cost after initial recognition.

The difference between the nominal value and the acquisition cost of fixed-rate bonds is allocated over the residual term to maturity, using the effective interest method.

In the consolidated financial statements, key personnel's shareholdings in subsidiaries are classified as financial liabilities in conformity with IAS 32, under the terms and conditions of the shareholder agreements. The portion of dividends corresponding to financial liability is treated as interest expenses.

Derivative financial instruments

A derivative instrument represents a financial instrument or another contract whose value changes as a result of changes in specific interest rates, the price of financial instruments or commodities, foreign exchange rates, price or interest-rate indices, credit ratings, credit indices or other similar underlying instruments. At the time of entering into the contract, a derivative requires only minor initial net investment and will be settled on a predetermined future date.

Interest-rate derivatives, currency derivatives, equity derivatives, commodity derivatives and credit derivatives are classified as derivative contracts measured at fair value at all times. Derivative contracts are classified as hedging derivative contracts and derivative contracts held for trading.

The difference between interest received and paid on interest-rate swaps held for trading is recorded in interest income or expenses and the corresponding interest carried forward is

recognised in other assets or other liabilities. Changes in the fair value of non-hedging derivatives are recorded under 'Net trading income' or 'Net income from Non-life Insurance'. Derivatives are carried as assets under 'Derivative contracts' when their fair value is positive and as liabilities under 'Derivative contracts' or 'Non-life Insurance liabilities' when their fair value is negative.

Embedded derivatives associated with structured bonds issued are separated from the host contract and measured at fair value in the balance sheet, and changes in the fair value of these embedded derivatives and derivatives designated as hedging instruments are recognised in interest income or expenses.

Hedge accounting

The Group's Risk Management has prepared methods and internal principles used for hedge accounting, whereby a financial instrument can be defined as a hedging instrument. Hedge accounting is used to verify that changes in the fair value of a hedging instrument fully or partially offset changes in the fair value or cash flows of a hedged item.

Contracts may not be accounted for in accordance with the hedge accounting rules if the

relationship between the hedging instrument and the related hedged item, as required by IAS 39, does not meet the criteria of the standard. Pohjola Bank plc, the Group's parent company,

concludes derivative contracts which are in fact used to hedge against financial risks but which do not fulfil these criteria.

Currently, Pohjola Bank plc applies fair value hedges to hedge against interest rate equity and foreign currency risks, involving long-term fixed-rate liabilities (own issues), individual bond and loan portfolios, as well as individual loans. The Group uses forward exchange contracts and interest-rate and currency swaps as hedging instruments. Hedging against equity and foreign currency risks applies to Non-life Insurance's equity fund investments.

The relationship between hedging and hedged instruments is formally documented, containing information on risk management principals, hedging strategy and the methods used to

demonstrate hedge effectiveness. Hedge effectiveness is tested at the inception of and during the

hedge by comparing respective changes in the fair value of the hedging and hedged instrument.

The hedge is considered effective if the changes in the fair value offset one another within a range of 80–125%.

In fair value hedge accounting, changes in the fair value of the hedging and hedged instrument are recorded under 'Net investment income' (bonds included in available-for-sale financial assets) and 'Net interest income' (loans and own issues) in the income statement or 'Net investment income from Non-life Insurance' (mutual fund investments included in available-for-sale financial assets).