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Management of financial risks

The Group is exposed to financial risks associated with its operations, specifically related to these types of risks:

  • market risks, relating to exchange rate risk (operativity in foreign currencies other than the functional currency) and interest rate risk;
  • liquidity risks, relating to the availability of financial resources and access to the credit market;
  • credit risks, resulting from normal commercial transactions or financing activities.

The Group specifically monitors each of these financial risks, with the objective of promptly minimizing them, also through hedging derivatives. Below is an explanation of how the Ansaldo STS Group, based on its in-house directives, manages these types of risk.

Exchange rate risk management

As indicated in the directive “Treasury management”, the exchange rate risk management of the Ansaldo STS Group focuses on the achievement of these objectives:

  • limiting potential losses due to adverse fluctuations in the exchange rate as compared with the reporting currency of Ansaldo STS and
  • its subsidiaries. In this case losses are defined in terms of cash flow rather in accounting terms;
  • limiting estimated or real costs connected to the implementation of exchange rate risk management policies.

The exchange rate risk should be hedged only if it has a relevant impact on cash flow as compared with the reporting currency. The costs and risks connected with a hedging policy (hedge, no hedge, or partial hedge) should be acceptable both financially and commercially. These instruments may be used to hedge exchange rate risk:

  • forward foreign exchange purchases and sales: exchange rate forwards are the most widely used instruments for cash flow hedges;
  • Currency Swaps / Cross Currency Swaps: used together with exchange rate forwards, they are used to manage hedging dynamically by reducing the exchange rate risks of when cash flows occur earlier or later than expected in a currency other than the functional currency;
  • Foreign currency funding/lending: foreign currency funding and lending is used to mitigate the exchange rate risk associated with the relevant credit or debit positions with bank counterparties or Group companies.

Using funding and lending in foreign currency as a hedging instrument must always be aligned with the overall treasury management and with the overall financial position of Ansaldo STS (long and short term).
Generally the purchase and sale of foreign currency is used in the case of exotic currencies where the capital market is not considered liquid or where alternative hedging instruments are not available or are only available at high cost.

Hedging of exchange rate risk

There are three types of exchange rate risk:

  1. Economic risk:
    represented by the impact that currency fluctuations may have on capital budgeting decisions (investments, location of plants, procurement markets).
  2. Transaction risk:
    the possibility that exchange rates could change during the period between the time at which a commitment to collect or pay in foreign currency at a future date (setting price lists, establishing budgets, preparing orders, invoicing) arises and the time at which such collection or payment occurs, thereby having a positive or negative impact on the exchange rate delta.
  3. Translation risk:
    this relates to the impact that the translation of dividends or the consolidation of recognised assets and liabilities has on the financial statements of multinational companies whenever the consolidation exchange rates change from year to year.

The Ansaldo STS Group hedges transaction risks in accordance with the “Treasury Management” directive, which provides for the systematic hedging of commercial cash flows resulting from the assumption of contractual commitments of a specific nature as either buyer or seller, in order to ensure current exchange rates at the date of acquisition of long-term contracts and neutralising the effects of fluctuations in the reference exchange rates.

Cash Flow Hedge

Hedges are made at the time commercial contracts are finalised through plain vanilla instruments (swaps and forwards on foreign currencies) qualifying for hedge accounting under IAS 39. These hedges are carried as cash flow hedges. Accordingly, the changes in fair value of the hedging derivatives are recognised in a special cash flow hedge reserve once the effectiveness of the hedge is demonstrated. Should the hedges prove to be ineffective, i.e. they do not fall within the effective range of between 80-125%, changes in the fair value of the hedging instruments are immediately recognised in the income statement as financial items and the cash flow hedge reserve accumulated up until the date of the last successful effectiveness test is reversed to profit and loss.

Fair value hedges

A fair value hedge involves the hedging of an exposure to changes in the fair value of a recognised asset or liability, an irrevocable unrecognised commitment or an identified portion of such asset, liability or irrevocable commitment, attributable to a specific risk and that could affect the income statement. The Group hedges against changes in fair value with regard to the exchange rate risk for assets and liabilities.

Hedging transactions are carried out predominantly with the banking system. At 31 December 2008 the Group had contracts referring to various currencies in the following notional amounts:

(EUR 000) 31.12.2008 31.12.2007
Euro 169,924 102,683
US dollar 68,660 69,653
GBP 5,788 7,109
Swedish krona 5,415 41,510
Canadian dollar 10,985 23,016
Australian dollar 34,072 35,262
Hong Kong Dollar 288 0

At 31 December 2008, the net fair value of derivative financial instruments was positive in the amount of about EUR 7,171 thousand.

Sensitivity analysis on exchange rates

For the presentation of market risks, IFRS 7 requires that a sensitivity analysis show the effects of the assumed changes in the most relevant market variables on the income statement and equity. Exchange rate risks arise in respect of financial instruments (including trade receivables and payables) that are denominated in a currency other than the functional currency. Since the US dollar is the primary foreign currency used by the Group, sensitivity analysis was performed on financial instruments denominated in dollars existing at 31 December 2008, assuming a 5% appreciation (depreciation) of the euro against the US dollar. This analysis showed that an appreciation or depreciation of the euro against the US dollar would have the following impact on the Group’s financial statements:

31.12.2008 31.12.2007
(EUR 000) +5% - appreciation of euro  against
the US dollar
-5% - depreciation
of euro against
the US dollar
+5% - appreciation
of euro against
the US dollar
-5% - depreciation
of euro against
the US dollar
Income Statement (157) 174 (2,063) 2,063
Cash Flow Reserve (6,566) 6564 (4,621) 4,868
Translation Reserve - - 343 (146)

Compared with the same analysis performed in 2007, the Group’s exposure to the US dollar has decreased as compared with the changes in the euro/dollar exchange rate. Conversely, the effects in equity were greater due to greater use of cash flow hedges.

Management of interest rate risk

The aforementioned directive states that the goal of the management of interest rate risk is to lessen the negative impact of changes in interest rates, which may affect the company’s income statement, the balance sheet and the weighted average cost of capital.
Interest rate risk management by Ansaldo STS is designed to achieve the following objectives:

  • to stabilize the weighted average cost of capital;
  • to minimize the weighted average cost of capital of Ansaldo STS over the medium to long term. To achieve this objective, interest rate
    risk management will focus on the impact of interest rates on debt funding and equity funding;
  • to optimise the profit on financial investments within a general profit-risk trade-off;
  • to limit the costs relating to the execution of interest rate risk management policies, including the direct costs tied to the use of specific instruments and indirect costs relating to the internal organisation needed to manage such risk.

In order to allow future acquisition transactions, the Group invests excess liquidity in the short term. At the same time, financial debt is mainly in the short term. The common management of short-term assets and liabilities makes the group relatively neutral to changes in long-term interest rates. In 2008 as well interest rate risk was managed without the use of interest rate derivatives.

Sensitivity analysis on interest rates

Sensitivity analysis was performed on the assets and liabilities exposed to interest rate risk, assuming a parallel and symmetric 50 basis point rise (fall) in interest rates at 31 December 2008. The impact of these scenarios on the Group’s financial statements at 31 December 2008 is summarised below:

(EUR 000) 31.12.2008 31.12.2007
+50 bps -50 bps +50 bps -50 bps
Income Statement 604 (604) 864 (864)
Reserves - - - -

These impacts are the result of greater interest income that would be produced by floating rate net financial debt in the case of interest rates greater or lower than 50 basis points respectively. The change in interest rates would have no impact on the valuation of financial instruments in the financial statements, except for amortised cost, as there are no financial assets or liabilities (not derivative) recognised at fair value through profit or loss. The derivatives subscribed by the Group are exclusively exchange rate derivatives and a change in the interest rates of the various currencies would have non-relevant impacts on the year-end Fair Value.
There are no impacts on equity, as the company has no cash flow hedges on the interest rate risk.
The results achieved at 31 December 2008 do not differ significantly from those described above at 31 December 2007. At 31 December 2007 a simulation of a +(-) 50 basis point change shows an impact of about +(-) EUR 864 thousand on the income statement.

Management of liquidity risk

In order to support efficient management of liquidity and contribute to the growth in its businesses, the Ansaldo STS Group has established a set of tools to optimise the management of financial resources. This objective was achieved by centralising treasury operations (cash pooling contracts with Group companies) and maintaining an active presence on financial markets to obtain adequate short and medium-term credit lines. Within this context Ansaldo STS has obtained short and long-term credit lines and guarantees sufficient to meet the Group’s needs. At 31 December 2007 the Group had a net financial position of EUR 195,870 thousand, an increase over 31 December 2007 (EUR 184,521 thousand).

Liquidity analysis – amounts in thousands of euros – figures at 31 December 2008

A – Financial liabilities less derivatives Less than 1 year 1 to 5 years More than 5 years
Non-current liabilities
Trade payables from third parties - 5,747
Trade payables to related parties - -
Other non-current liabilities - 1,356
Current liabilities
Borrowings to related parties 24,404 -
Trade payables from third parties 189,645 333
Financial liabilities to third partie 9,278 -
Other financial liabilities 6,956 -
Total A 230.283 7,436
B – Negative value of derivatives
Hedge derivatives 302 376
Trading derivatives (economic hedge) 72 -
Total B 374 376
Total A + B 230,657 7,812

Against borrowings for EUR 238,469 thousand fi nancial assets are posted in these amounts:

C - Financial assets
Cash and cash equivalents 71,536
Trade receivables – third parties 281,405
Financial receivables to related parties 88,609
Financial receivables 139,509
Positive value of derivatives 7,922
Total financial assets 588,981
D – Credit lines 49,263
Total C + D 638,244
C+D-(A+B) 399,775

The Group has a net credit position and has available liquidity to self-finance and does not have to use banks to finance its own activity. The Group has a relatively little exposure to the tensions of the liquidity market which marked the final part of the year.

Credit risk management

The Group is not exposed to significant credit risk, both as regards the counterparties of its commercial transactions and for financing and investing activities. Its primary customers are, in fact, government entities or off-shoots of such entities, concentrated in the euro area, the United States and Southeast Asia. The typical customer rating of the Ansaldo Group is therefore medium/high. Despite this, in the case of contracts with customers/counterparties with which the Group does not ordinarily do business, the customers’ solvency is assessed at the time of the offer to highlight any future credit risks.
The nature of Ansaldo’s customers means that collection times are longer (in some countries significantly longer) than in other businesses, creating significant outstanding past due positions. The following table shows the composition of receivables: at 31 December 2008 operativity with European Government entities significantly increased. Outstanding receivables slightly rose as compared with the previous year. In particular, outstanding receivables due for more than 5 years fell by 24%, receivables due for less than 5 years, but more than one year fell by 9%, and receivables due for less than one year fell by 18%.

31.12.2008 Government entities Other customers
(EUR 000) Europe Americas Other Europe Americas Other Total
- Held as guarantees 3,159 - - 2,560 - 13,118 18,837
- Receivables not past due 30,353 - 588 142,475 - 9,648 183,064
- Receivables past due less than 6 months 4,758 - 401 13,014 13,898 20,039 52,110
- Receivables past due between 6 months and 1 year 632 - - 10,722 - 128 11,482
- Receivables past due between 1 and 5 years 355 - 3 13,604 - 467 14,429
- Receivables past due more than 5 years - - - 129 - 1,354 1,483
Total 39,257 - 992 182,504 13,898 44,754 281,405

Movements in the provision for bad debts of group trade receivables are as follows::

(EUR 000) 2008 2007
1 January 6,832 6,679
Allocations 3,728 667
Transfers/Uses (3,356) (411)
Other changes (77) (103)
31 December 7,127 6,832

Other movements include the exchange rate differences generated upon the consolidation of foreign subsidiaries.

In relation with the credit risk originated from the positive value of derivatives, the counterparties of derivative contracts are mainly financial institutions. The table below breaks down the positive value of derivatives by the counterparty’s rating class.


The ratings below were provided by Fitch

Rating classe Positive fair value
AA 1%
AA- 27%
A 67%
BBB 5%
Total positive fair value 100%

Classification and fair value of financial assets and liabilities  

The table below gives a breakdown of the Group financial assets and liabilities by the accounting categories under IAS 39.  
Financial liabilities are all recognised on the amortised cost method, since the Group did not use the Fair Value Option.  
Derivatives are analysed separately. 

31.12.2008  
(EUR 000) 
 Fair value 
through profit  or loss  
Loans
and receivables 
 Held to 
maturity 
 Available
for sale 
 Total    Fair Value 
Non-current assets              
Non-current receivables from related parties    -   -  -  -   -   - 
Financial assets at fair value    -   -  -  -     
Receivables   -  11,517  -  -  11,517  11,517  
Current assets        -  -     
Current receivables from related parties    -  230,350  -  -  230,350  230,350  
Trade receivables    -  281,405  -  -  281,405  281,405  
Financial assets at fair value    -   -  -  -     
Financial receivables    -   -  -  -     
Other current assets    31,668   2,882  -  -  34,550 34,550

 

 31.12.2008
 (EUR 000)   
Fair value through
profit or loss 
 Amortised Cost      Total    Fair Value
Non-current liabilities          
Non-current payables from related parties    -   -   -   - 
Non-current borrowings    -   5,747    5,747    5,747  
Other non-current liabilities    7,246   1,356    8,602    8,602  
Current liabilities          
Current payables from related parties    -   27,654    27,654    27,654  
Trade payables    -   189,978    189,978    189,978  
Borrowings   -   9,276    9,276    9,276  
Other current liabilities    -   77,252    77,252    77,252  

For short-term fi nancial instruments, such as trade receivables and payables, book value represents a fair approximation of fair value

 31.12.2007  (EUR 000)   Fair value  
through profit 
or loss   
Loans
and  
receivables
Held
to  maturity  
Available  for sale    Total Fair Value
Non-current assets              
Non-current receivables rom related parties    -  -   -   -   -   - 
Financial assets at fair value   -   -   -   -     
Receivables   - 15,153  -   -   15,153    15,156
Current assets    -          
Current receivables from related parties    - 199,743  -   -   199,744  199,746
Trade receivables    - 269,851  -   -   269,851    269,854
Financial assets at fair value    -  -  -   -   -   - 
Financial receivables    -  -  -   -     
Other current assets    - 24,297  -   -   24,297    24,300

 

 31.12.2007  (euro migliaia)  Fair value through 
profit or loss   
Amortised
Cost   
Total    Fair Value 
Non-current liabilities          
Non-current payables from related parties    -  -   -   
Non-current borrowings    - 6,968  6,968    6,968  
Other non-current liabilities    - 9,227  9,227    9,227  
Current liabilities          
Current payables from related parties    - 24,590  24,590    24,590  
Trade payables    - 174,725  174,725    174,725  
Borrowings   - 12,601  12,601    12,601  
Other current liabilities    - 74,300  74,300    64,958  

Derivatives

The table below provides the fair values of derivative instruments:

Fair Value at 31.12.2008 Fair Value at 31.12.2007
Assets
Interest rate swap
Trading - -
Fair value hedge - -
Cash flow hedge - -
Currency forward/swap/option
Trading - -
Fair value hedge 773 -
Cash flow hedge 7,149 211
Equity instruments (trading)
Embedded derivatives (trading)
Liabilities
Interest rate Swap
Trading - -
Fair value hedge - -
Cash flow hedge - -
Currency forward/swap/option
Trading (72) -
Fair value hedge (412) (95)
Cash flow hedge (267) (9,887)
Equity instruments (trading)
Embedded derivatives (trading)

The Group uses cash flow hedge derivatives hedging the exchange rate risk exposure for expected future transactions that are highly probable and fair value hedge derivatives hedging the exchange rate risk exposure of financial assets/liabilities recognised in the financial statements.
The negative value of trading derivatives relates to management derivatives hedging exchange rate risk that do not qualify as accounting hedges in accordance with the provisions of IAS 39. With reference to derivatives hedging exchange rate risk, the Group hedges both future receipts and payments. The table below provides the maturities of these hedged payments.

31.12.2008
Notional amount
(in thousands US$)

31.12.2007
Notional amount
(in thousands US$)
Maturity Receipts Payments Receipts Payments
Within 1 year 2,672 3,320 6,876 1,774
2 to 3 years 7,393 - - -
4 to 9 years - - - -
More than 9 years - - - -
Total 10,065 3,320 6,876 1,774