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Note 32. Financial risk management
Financial risk management
With respect to financial risk management, the Group observes a uniform treasury policy that has been approved by the Company's Board of Directors. Compliance with this policy and developments in the Group’s financial situation are monitored by the Board’s Audit Committee. The Group Treasury is centrally responsible for obtaining financial resources for the Group, for liquidity management, relations with providers of finance, and the management of financial risks. In the main, the Group’s financial resources have been obtained through the parent company, and the Group Treasury arranges financial resources for subsidiaries in their functional currencies. For subsidiaries with significant external ownership, the Group has not guaranteed financial liabilities in excess of its ownership interest.
Foreign exchange risks
Kesko Group conducts business operations in eight countries, in addition to which it makes purchases from numerous countries. In consequence, the Group is exposed to various foreign exchange risks arising from net investments in foreign operations (translation risks) and from assets, liabilities and forecast transactions (transaction risks) denominated in foreign currencies.
The Group companies’ financial resources are arranged in their functional currencies. The parent company bears the ensuing foreign exchange risk and hedges the risk exposure using derivatives or borrowings denominated in the relevant foreign currencies. The Belarusian currency BYR is not a freely convertible currency and hedging the associated exposure to foreign exchange risk is not possible.
Translation risks
The Group is exposed to foreign currency translation risks relating to net investments in subsidiaries outside the euro zone held on the balance sheet. This balance sheet exposure has not been hedged. The hedge can be designated if equity is repatriated, or if a currency is expected to be exposed to a significant devaluation risk. The most significant translation exposures are the Swedish krona, the Russian rouble and the Norwegian krone. The exposure does not include the non-controlling interest in equity. Relative to the Group's volume of operations and the balance sheet total, the foreign currency translation risk is low.
The functional currency of the real estate companies operating in St. Petersburg and Moscow in Russia has been determined to be the euro, which is why net investments in these companies are not exposed to foreign currency translation risk, and consequently are not included in the translation exposure.
Group's translation exposure as at 31 Dec. 2015
€ million
NOK SEK RUB LTL BYR
Net investment 29.6 94.4 70.3 - 3.5
Group's translation exposure as at 31 Dec. 2014
€ million
NOK SEK RUB LTL BYR
Net investment 30.0 81.7 54.3 46.0 3.5
The following table shows how a 10% change in the Group companies’ functional currencies would affect the Group’s equity.
Sensitivity analysis, impact on equity as at 31 Dec. 2015
€ million
NOK SEK RUB LTL BYR
Change +/-10% 3.0 9.4 7.0 - 0.4
Sensitivity analysis, impact on equity as at 31 Dec. 2014
€ million
NOK SEK RUB LTL BYR
Change +/-10% 3.0 8.2 5.4 4.6 0.3
Transaction risks
International purchasing activities and foreign currency denominated financial resources arranged by the parent to subsidiaries expose the Group to transaction risks relating to several currencies. The currency-specific transaction risk exposure comprises foreign currency denominated receivables and liabilities in the balance sheet, forecast foreign currency cash flows, and foreign subsidiaries’ liabilities and receivables with respect to the parent. The risk is commercially managed by, for example, transferring exchange rate changes to selling prices, or by replacing suppliers. The remaining exposures are hedged using foreign currency derivatives. The subsidiaries report their foreign exchange exposures to the Group Treasury on a monthly basis.
In the main, the subsidiaries hedge their risk exposures with the Group Treasury, which in turn hedges risk exposures using market transactions within the limits confirmed for each currency. Intra-Group derivative contracts are allocated to the segments in segment reporting.
The Group does not apply hedge accounting in accordance with IAS 39 to the hedging of transaction risks relating to purchases and sales. In initial measurement, derivative instruments are recognised at fair value and subsequently in the financial statements, they are remeasured at fair value. The change in fair value of foreign currency derivatives used for hedging purchases and sales is recognised in other operating income or expenses.
The Group monitors the transaction risk exposure in respect of existing balances and forecast cash flows. The following table analyses the transaction exposure excluding future cash flows. The presentation does not illustrate the Group’s actual foreign exchange risk after hedgings. When forecast amounts are included in the transaction exposure, the most significant differences from the table below are in the USD and RUB exposures. As at 31 December 2015, the exposure with respect to USD was €-10.9 million, and with respect to RUB, it was €-1.9 million.
Group's transaction exposure as at 31 Dec. 2015
€ million
USD SEK NOK LTL RUB BYR
Group's transaction risk -1.1 -13.2 23.9 - 7.0 -0.2
Hedging derivatives 29.4 7.1 -18.7 - -13.6
Open exposure 28.3 -6.1 5.1 - -6.6 -0.2
Group's transaction exposure as at 31 Dec. 2014
€ million
USD SEK NOK LTL RUB BYR
Group's transaction risk -5.0 29.0 28.1 13.6 11.4 0.4
Hedging derivatives 38.3 -24.5 2.8 0.0 -36.2 0.0
Hedging borrowings 0.0 0.0 -22.1 0.0 0.0 0.0
Open exposure 33.3 4.5 8.8 13.6 -24.8 0.4
A sensitivity analysis of the transaction exposure shows the impact on profit or loss of a +/-10% exchange rate change in intra-Group receivables and liabilities denominated in foreign currencies and foreign currency derivatives and borrowings used for hedging.
Sensitivity analysis, impact on pre-tax profit as at 31 Dec. 2015
€ million
USD SEK NOK LTL RUB BYR
Change +/-10% 2.8 -0.6 0.5 - -0.7 0.0
Sensitivity analysis, impact on pre-tax profit as at 31 Dec. 2014
€ million
USD SEK NOK LTL RUB BYR
Change +/-10% 3.3 0.5 0.9 1.4 -2.5 0.0
Liquidity risk
Liquidity risk management aims to maintain sufficient liquid assets and credit facilities in order to ensure the ongoing availability of sufficient financial resources for the Group’s operating activities.
The Group's solvency was excellent throughout the financial year 2015. As at 31 December 2015, liquid assets totalled €887 million (€598 million). Interest-bearing liabilities were €439 million (€499 million) and interest-bearing net debt €-448 million (€-99 million) as at 31 December 2015.
Maturities of financial liabilities and related finance costs as at 31 Dec. 2015
€ million
2016 2017 2018 2019 2020− Total Balance
sheet value
Borrowings from financial institutions 0.3 0.3 0.1 0.1 1.8 2.7 2.7
finance costs 0.0
Private Placement notes (USD)* 33.1 22.0 55.1 55.1
finance costs 2.5 1.4 1.4 0.7 6.0
Bonds 224.1 224.1 224.1
finance costs 6.2 6.2 6.2 18.6
Pension loans 2.4 2.4 2.4 1.2 8.3 8.3
finance costs 0.5 0.5 0.5 0.3 1.8
Finance lease liabilities 4.5 1.6 1.0 0.6 0.7 8.3 8.3
finance costs 0.1 0.1 0.0 0.0 0.0 0.3
Payables to K-retailers 114.5 114.5 114.5
finance costs 0.0
Other interest-bearing liabilities 26.1 26.1 26.1
finance costs 0.0
Non-current non-interest-bearing liabilities 0.7 10.6 1.7 0.8 28.5 42.2 42.2
Current non-interest-bearing liabilities
Trade payables 795.1 795.1 795.1
Accrued expenses 282.7 282.7 282.7
Other non-interest-bearing liabilities 212.6 212.6 212.6
* The cash flows of Private Placement notes and related currency and interest rate derivatives are settled on a net basis. The interest rate derivative liability related to the arrangement is presented within other interest-bearing liabilities in the balance sheet. The amount of interest-bearing liability in the balance sheet arising from this credit facility totals €50.2 million (€50.2 million).
Guarantee maturities are €15.5 million in 2016 and €2.5 million in 2018−2019.
Maturities of financial liabilities and related finance costs as at 31 Dec. 2014
€ million
2015 2016 2017 2018 2019- Total Balance
sheet value
Borrowings from financial institutions 24.5 0.4 0.1 0.1 1.8 26.9 26.9
finance costs 1.1 0.0 0.0 0.0 0.0 1.2
Private Placement notes (USD)* 29.6 19.8 49.4 50.2
finance costs 3.1 2.2 1.3 1.3 0.6 8.5
Bonds 240.3 240.3 240.3
finance costs 6.6 6.7 6.6 6.6 26.6
Pension loans 5.8 5.8 5.8 5.8 2.9 26.3 26.1
finance costs 1.0 0.7 0.5 0.3 0.1 2.5
Finance lease liabilities 6.4 3.2 1.5 0.6 0.9 12.5 12.4
finance costs 0.2 0.1 0.0 0.0 0.0 0.4
Payables to K-retailers 119.3 119.3 119.3
finance costs 0.0
Other interest-bearing liabilities 23.3 23.3 23.3
finance costs 0.0
Non-current non-interest-bearing liabilities 1.3 7.5 1.3 0.4 0.0 10.5 10.5
Current non-interest-bearing liabilities
Trade payables 794.6 794.6 794.6
Accrued expenses 272.1 272.1 272.1
Other non-interest-bearing liabilities 217.9 217.9 217.9
The terms and conditions of the Private Placement credit facility and the committed facilities include ordinary financial covenants. The requirements of these covenants have been met. The borrowing terms include a financial covenant defining the ratio between net debt and EBITDA, which remained far from the maximum throughout the financial year. At change of control, Kesko is obligated to offer a repayment of the whole loan capital to the note holders. According to the terms and conditions of the loan facility, the change of ownership to retailers or an association of retailers does not constitute a change of control.
Payables to K-retailers consist of two types of interest-bearing liabilities by Kesko to K-retailers: retailers’ prepayments to Kesko and Kesko’s chain rebate liabilities to retailers. Chain rebates are retrospective discounts given to retailers and the terms vary from one chain to another.
At the balance sheet date, the total equivalent of undrawn committed long-term credit facilities was €100.0 million (€100.0 million). According to the terms and conditions of loan agreements, at change of control, the lenders have the right to terminate the credit facility and loan amounts possibly drawn. According to the terms and conditions of the loan facility, the change of ownership to retailers or an association of retailers does not constitute a change of control. In addition, the Group’s uncommitted financial resources available contained commercial paper programmes denominated in euros totalling an equivalent of €359 million (€359 million). In addition, in January 2016, the Group companies held a total of €416.3 million available for re-borrowing in a pension insurance company. Part of the pension insurance premiums paid annually by the Group companies are funded and the accumulated funds can be re-borrowed with a term of 1−10 years in accordance with regulations confirmed by the Ministry of Social Affairs and Health. Any amount of borrowing requires the posting of adequate collateral.
Interest rate risk on borrowings and sensitivity analysis
Changes in the interest rate level have an impact on the Group’s interest expense. The policy for hedging interest rate risk is aimed at balancing the effects of changes in the interest rate level on profit or loss for different financial periods.
The interest rate risk is centrally managed by the Group Treasury, which adjusts the duration by using interest rate contracts. The target duration is three years, which is allowed to vary between one and a half and four years. The actual duration during the financial year was 1.9 (2.4) years on average.
On 11 September 2012, Kesko Corporation issued a €250 million bond. The bond carries a fixed coupon interest at 2.75% and a maturity of six years from issuance.
On 10 June 2004, Kesko Corporation issued a USD Private Placement in a total amount of USD 120 million in the United States. The facility has three tranches with bullet repayments, of which USD 60 million was paid on 10 June 2014, USD 36 million will be due on 10 June 2016 and USD 24 million on 10 June 2019.
Kesko Corporation's USD Private Placement credit facility qualifies for hedge accounting against both foreign exchange and interest rate risk and it has been hedged by currency swaps and interest rate swaps with the same amounts and maturities as the borrowing. As a result, the borrowing is fully hedged against foreign exchange and interest rate risk. During the financial year, there was no ineffectiveness to be recorded in the income statement from this credit facility.
The sensitivity analysis for changes in interest rate level in respect of commercial paper liabilities realised during the financial year has used average balance values. At the balance sheet date of 31 December 2015, the effect of variable rate borrowings on the pre-tax profit would have been €-/+1.2 million (€-/+1.7 million), if the interest rate level had risen or fallen by 1 percentage point.
The bond, Private Placement notes and pension loans, €287.5 million in aggregate, have fixed rates, and their effective interest cost was 3.4%. At the end of the financial year, the average rate of variable-interest-rate borrowings from financial institutions, payables to retailers and other interest-bearing liabilities was 0.1%. Most of the borrowings are euro-denominated and the Private Placement notes are USD-denominated.
Financial assets and liabilities recognised at fair value
The Group’s liquid assets have mainly been invested in the debt instruments of major Finnish companies, in certificates of deposit and deposits with banks operating in Kesko’s market area, in bonds of selected companies and in corporate bond funds. The return on these investments for 2015 was 0.3% (0.8%) and the duration was 0.7 years at the end of the financial year. The maximum credit risk is the fair value of these investments in the balance sheet at the balance sheet date. The table below analyses financial instruments carried at fair value by valuation method.
Fair value as at 31 Dec. 2015
Fair value hierarchy of financial assets and liabilities
€ million
Level 1 Level 2 Level 3 Total
Financial assets at fair value through profit or loss
Money market funds 209.6 209.6
Commercial papers 65.5 65.5
Bank certificates of deposit and deposits 93.7 93.7
Bonds 5.5 5.5
Total 215.1 159.2 374.2
Derivative financial instruments at fair value through profit or loss
Derivative financial assets 13.3 13.3
Derivative financial liabilities 8.6 8.6
Available-for-sale financial assets
Private equity funds and other shares and interests 15.3 15.3
Commercial papers (maturing in less than 3 months) 84.0 84.0
Bank certificates of deposit and deposits (maturing in less than 3 months) 108.8 108.8
Bonds and corporate bond funds 178.9 178.9
Total 178.9 192.8 15.3 387.0
Fair value as at 31 Dec. 2014
Fair value hierarchy of financial assets and liabilities
€ million
Level 1 Level 2 Level 3 Total
Financial assets at fair value through profit or loss
Money market funds 14.4 14.4
Commercial papers 103.3 103.3
Bank certificates of deposit and deposits 92.2 92.2
Bonds 9.3 9.3
Total 23.7 195.6 219.3
Derivative financial instruments at fair value through profit or loss
Derivative financial assets 31.5 31.5
Derivative financial liabilities 15.5 15.5
Available-for-sale financial assets
Private equity funds and other shares and interests 13.1 13.1
Commercial papers (maturing in less than 3 months) 98.6 98.6
Bank certificates of deposit and deposits (maturing in less than 3 months) 107.6 107.6
Bonds 65.5 65.5
Total 65.5 206.3 13.1 284.8
Level 1 instruments are traded in active markets and their fair values are directly based on quoted market prices. The fair values of level 2 instruments are derived from market data. The fair value of level 3 instruments is not based on observable market data (inputs not observable).
Changes in level 3 instruments
€ million
2015 2014
Private equity funds and other shares and interests as at 1 January 13.1 16.9
Purchases 3.3 0.6
Refunds received -2.2 -5.1
Gains and losses through profit or loss - 0.0
Changes in fair values 1.2 0.6
Private equity funds and other shares and interests as at 31 December 15.3 13.1
Level 3 includes private equity funds and other shares and interests. These investments have been classified as non-current available-for-sale financial assets. Level 3 financial assets are measured based on computations received from the companies. Gains or losses with income statement impact have not been recorded on these investments for the financial year 2015.
Interest-bearing receivables and sensitivity analysis
The objective is to invest liquidity consisting of financial assets in the money market using efficient combinations of return and risk. At regular intervals, the Group’s management approves the investment instruments and limits for each counterparty among those analysed by the Group Treasury. The risks and actual returns on investments are monitored regularly.
In the sensitivity analysis of floating rate receivables, average annual balances of invested assets have been used. The receivables include customer financing receivables, finance lease receivables, other interest-bearing receivables, and within investments, commercial papers and money market funds. The sensitivity of money market funds has been determined based on duration. If the interest rate level had changed by +/-1 percentage point, the effect of these items on the pre-tax profit would have been €+/-3.5 million (€+/-3.6 million) and €+/-2.7 million (€+/-1.1 million) on equity at the balance sheet date.
Credit and counterparty risk
The divisions' business entities are responsible for the management of the credit risk associated with amounts due from customers. The Group has a credit policy and its implementation is controlled. The aim is to ensure the collection of receivables by carefully assessing customers’ creditworthiness, by specifying customer credit terms and collateral requirements, by effective credit control and credit insurances, as applicable. In Finland, the main part of the Group’s business activities is carried out in cooperation with retailers. According to retailer agreements, retailers shall arrange overdraft facilities to be held as collateral for their trade payables by the relevant Kesko subsidiary.
The Group companies apply a uniform practice to measuring past due receivables. A receivable is written down when there is objective evidence of impairment. The ageing analysis of trade receivables as at 31 December was as follows:
Ageing analysis of trade receivables
€ million
2015 2014
Trade receivables fully performing 540.7 536.2
1−7 days past due trade receivables 9.9 12.3
8−30 days past due trade receivables 11.4 12.1
31−60 days past due trade receivables 5.2 4.3
over 60 days past due trade receivables 14.4 19.2
Total 581.7 584.2
Within trade receivables, €331.9 million (€332.9 million) were from chain retailers and €1.9 million (€2.4 million) were credit card receivables. The collateral for chain retailer receivables is an overdraft facility granted by a Kesko associate, Vähittäiskaupan Takaus Oy, with the maximum always limited to the realisable value of the countersecurity from the K-retailer's company and its entrepreneur to Vähittäiskaupan Takaus Oy. At the end of the financial year, the aggregate value of countersecurities was €171.1 million (€160.1 million). In addition, the collateral for receivables includes other collaterals, such as business mortgages and other pledged assets.
Trade receivables include an impairment charge to a total of €17.2 million (€21.5 million) monitored on a separate allowance account. The original balance sheet value of these trade receivables was €21.9 million (€28.2 million). The aggregate amount of credit losses and impairments recognised in the profit for the financial year was €3.7 million (€6.0 million).
The amount of receivables with renegotiated terms totalled €3.2 million (€2.7 million).
Financial credit risk
Financial instruments involve the risk of non-performance by counterparties. Kesko enters into foreign currency and other derivative contracts only with creditworthy banks. Liquid funds are invested, in accordance with limits set annually for each counterparty, in instruments with good creditworthiness. Company and bank-specific euro and time limits are set for money market investments. These limits are reviewed during the year depending on the market situation.
Commodity risks and their sensitivity analysis
The Group uses electricity derivatives for the purpose of balancing out energy costs. The electricity price risk is assessed for five-year periods. The changes in the fair values of derivatives hedging the price of electricity supplied during the financial year are recognised within adjustments to purchases. Hedge accounting is applied to contracts hedging future purchases. The effective portion of derivatives that qualify for hedge accounting is recognised in the revaluation reserve of equity and the ineffective portion in the income statement within other operating income or expenses. The change in the revaluation reserve recognised in equity is presented in the statement of comprehensive income under revaluation of cash flow hedge.
At the end of the year, the ineffective portion of derivatives hedging the price risk of electricity was €-2.9 million (€-1.6 million).
As at the balance sheet date, a total quantity of 464,832 MWH (731,976 MWH) of electricity had been purchased with electricity derivatives and 245,520 MWH under fixed price purchase agreements. The 1–12 month hedging level was 66% (87%), the 13–24 month level was 60% (65%), the 25–36 month level was 38% (45%), and the 37–48 month level was 4% (24%).
The sensitivity analysis of electricity derivatives assumed that derivatives maturing in less than 12 months have an impact on profit. If the market price of electricity derivatives changed by -/+20% from the balance sheet date 31 December 2015, it would contribute €-/+0.7 million (€-/+1.6 million) to the 2016 income statement and €-/+1.1 million (€-/+2.7 million) to equity. The impact has been calculated before tax.
Derivatives
Fair values of derivative contracts
€ million
31 Dec. 2015
Positive
fair value (balance sheet value)
31 Dec. 2015
Negative
fair value (balance sheet value)
31 Dec. 2014
Positive
fair value (balance sheet value)
31 Dec. 2014
Negative
fair value (balance sheet value)
Interest rate derivatives 0.0 -0.5
Foreign currency derivatives 13.3 -1.4 * 31.5 -9.6
Electricity derivatives -7.2 0.1 -5.4
Notional principal amounts of derivative contracts
€ million
31 Dec. 2015 Notional principal amount 31 Dec. 2014 Notional principal amount
Interest rate derivatives 100.4 * 101.1
Foreign currency derivatives 287.6 * 378.4
Electricity derivatives 9.4 21.4
* The derivative contracts include interest rate swaps relating to a foreign currency borrowing facility with a gross notional principal amount of €100.4 million and a fair value of €0.0 million (€-0.5 million), and currency swaps with a notional principal amount of €50.2 million and a fair value of €4.9 million (€-0.8 million).
The fair values of derivatives are presented as gross amounts. Kesko has entered into netting arrangements under ISDA contracts with all counterparties engaged in transactions with derivatives. All of these contracts provide for mutual posting of collateral. The threshold level for collateral posting had not been exceeded at the balance sheet date. Analysed by counterparty, derivative financial liabilities could be set off in a total of €3.2 million.
The maximum credit risk from derivatives is the fair value of the balance sheet at the reporting date.
Cash flows from derivative contracts as at 31 Dec. 2015
€ million
2016 2017 2018 2019 2020 2021− Total
Payables
Foreign exchange forward contracts outside hedge accounting 236.1 236.1
Net settlement of payables
Interest rate derivatives
Electricity derivatives 3.4 2.7 1.1 0.1 7.2
Derivatives relating to Private Placement notes*
Foreign currency derivatives
Receivables
Foreign exchange forward contracts outside hedge accounting 243.0 243.0
Net settlement of receivables
Derivatives relating to Private Placement notes*
Foreign currency derivatives 3.2 0.1 0.1 2.0 5.4
Interest rate derivatives 0.3 0.2 0.2 0.1 0.8
* The cash flows from Private Placement notes and related foreign currency derivatives and interest rate derivatives are settled on a net basis. The debt on interest rate derivatives relating to the facility is presented in the balance sheet within 'other interest-bearing liabilities'. The balance sheet shows a total interest-bearing liability of €50.2 million (€50.2 million) relating to this credit facility.
Cash flows from derivative contracts as at 31 Dec. 2014
€ million
2015 2016 2017 2018 2019 2020− Total
Payables
Foreign exchange forward contracts outside hedge accounting 325.0 325.0
Net settlement of payables
Interest rate derivatives 0.0 0.0
Electricity derivatives 2.1 1.6 1.3 0.4 0.0 5.4
Derivatives relating to Private Placement notes*
Foreign currency derivatives 0.1 0.5 0.0 0.0 0.3 0.9
Receivables
Foreign exchange forward contracts outside hedge accounting 347.3 347.3
Net settlement of receivables
Derivatives relating to Private Placement notes*
Interest rate derivatives 0.4 0.3 0.2 0.2 0.1 1.2
Capital structure management
Kesko Group’s objectives in capital management include target rates set for the Group’s solvency and liquidity. The Group’s capital structure (equity-to-debt ratio) is optimised at the Group level. The objectives for the Group’s solvency and liquidity are set with the purpose of securing the Group’s liquidity in all market situations, enabling the implementation of capital expenditure programmes in line with the Group’s strategy, and maintaining shareholder value. A target rate has been set for the performance indicator ‘interest-bearing net debt/EBITDA’. Some of the Group’s interest-bearing liabilities include covenants, whose terms and conditions have been taken into account in the above target rate. The Group does not have a credit rating from any external credit rating institution.
The target levels for Kesko Group’s performance indicators are approved by the Board of Directors. On 26 May 2015, the Board approved, as a part of the Group's medium term financial objectives, the following values for the performance indicators: 'return on capital employed excluding non-recurring items', 'return on equity excluding non-recurring items' and 'interest-bearing net debt/EBITDA'.
Target level Level achieved in 2015 Level achieved in 2014
Return on capital employed excl. non-recurring items 14% 11.7 9.9
Return on equity excl. non-recurring items 12% 8.2 7.6
Interest-bearing net debt/EBITDA < 2.5 -1.4 -0.3
€ million 2015 2014
Interest-bearing liabilities 439.1 498.9
Liquid assets 887.2 598.0
Interest-bearing net debt -448.1 -99.2
EBITDA 331.4 346.5
Interest-bearing net debt/EBITDA -1.4 -0.3