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 minimising 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 SpA 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 SpA (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 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 2009 the Group had contracts referring to various currencies in the following notional amounts:

(local currency in thousands) Sell09 Buy09 31.12.2009 Sell08 Buy08 31.12.2008
             
Euro 144,546 55,645 200,190 140,488 29,439 169,924
US dollar 49,097 3,738 52,835 54,131 14,529 68,660
GBP 176 5,473 5,649 756 5,032 5,788
Swedish krona - 20,185 20,185 - 5,415 5,415
Canadian dollar 11,403 1,470 12,873 10,985 - 10,985
Australian dollar 3,637 37,644 41,281 - 34,072 34,072
Hong Kong Dollar 230 188 417 288 - 288

At 31 December 2009, the net fair value of derivative financial instruments was positive in the amount of about EUR 633 thousand.

Sensitivity analysis on exchange rates 

For the presentation of market risks, IFRS 7 requires a sensitivity analysis, that shows the effects of the assumed changes in the most relevant market variables on the Income Statement and equity.

Exchange rate risks arise from financial instruments (including trade receivables and payables) recorded in the Financial Statements or from highly probable cash flows 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 2009, 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:

 

  31.12.2009                               31.12.2008                             
(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 (58) 65 (157) 174
Cash Flow Reserve (5,619) 5,634 (6,566) 6,564
Translation Reserve - - - -

Compared with the same analysis performed in 2008, it results a lower exposure of the Income Statement in relation to the euro/dollar exchange rate variations, as well as a lower impact on equity. This situation is referable to the lower use of project Cash Flow hedges as a result of a reduction in the currency exposure towards the US Dollar by the Group companies.

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 stabilise the weighted average cost of capital;
  • to minimise 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 2009 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 2009 is summarised below:

  31.12.2009                           31.12.2008                      
(EUR 000) +50 bps -50 bps +50 bps -50 bps
Income Statement 1,090 (1,090) 604 (604)
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 2009 showed a considerable increase compared with 31 December 2008; this effects has arisen from the significant increase in variable-rate assets. At 31 December 2008 a simulation of a +(-) 50 basis point change shows an impact of about +(-) EUR 604 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 for endorsement facilities and for cash sufficient to meet the Group’s needs.

At 31 December 2009, the Group shows a net financial liquidity of EUR 278,861 thousand recording an improvement over 31 December 2008, when the net financial position was equal to EUR 195,870 thousand.

Liquidity analysis – amounts in thousands of euros – figures at 31 December 2009

A – Financial liabilities less derivatives Less than 1 year 1 to 5 years More than 5 years
       
Non-current liabilities      
Borrowings from third parties - 4,032 -
Borrowings from related parties - - -
Other non-current liabilities - - -
       
Current liabilities      
Trade payables to related parties 7,477 - -
Trade payables to third parties 228,599 796 -
Financial liabilities to third parties 2,905 9,634 -
Other financial liabilities 793 - -
Total A 239,774 14,462  
       
B – Negative value of derivatives      
Hedge derivatives 2,695 - -
Trading derivatives (economic hedge) 121 - -
Total B 2,816 -  -
Total A + B 242,590 14,462 -

Against borrowings for EUR 257,052 thousand financial assets are posted in these amounts:

C - Financial assets  
Cash and cash equivalents 128,541
Trade receivables – third parties 395,846
Trade receivables – related parties 130,654
Financial receivables 166,892
Positive value of derivatives 3,449
TOTAL FINANCIAL ASSETS 825,382
   
D – Credit lines 29,720
   
TOTAL C + D 855,102
   
C+D-(A+B) 612,512

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 STS 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 2009 operativity with European and non-European Government entities significantly increased. We report an increase in past-due receivables attributable to the greater volume of receivables and relating to receivables past due within one year.

31.12.2009  Government entities       Other customers         Total
(EUR 000) European Area American  Area Other European Area America Area Other  
               
- Held as guarantees 115 - 2,241 13,768 2,952 13,637 32,713
- Receivables not past due 39,584 - 26,271 138,989 5,982 13,584 224,410
- Receivables past due less than 6 months 21,163 - 1,049 19,300 1,525 3,678 46,715
- Receivables past due between 6 months and 1 year 51,725 - 8,275 12,986 - 158 73,144
- Receivables past due between 1 and 5 years 3,051 - 60 15,072 - 681 18,864
- Receivables past due more than 5 years - - - - - - -
Total 115,638 - 37,896 200,115 10,459 31,738 395,846

Movements in the provision for doubtful accounts of Group trade receivables are as follows:

(EUR 000) 2009 2008
1 January 7,127 6,832
Allocations 1,812 3,728
Reversals/Uses (1,106) (3,356)
Other changes 78 (77)
31 December 7,911 7,127

Other changes 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 S&P.

Rating class  Positive fair value
AA 34.69%
A+ 1.41%
A 63.73%
A- 0.17%
   
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.

31.12.2009 Fair value through profit or loss Loans and receivables Held to maturity Available for sale Total Fair Value
(EUR 000)            
Non-current assets            
Non-current receivables from related parties - - - - - -
Financial assets at fair value - - - - -  -
Receivables - 13,778 - - 13,778 13,778
             
Current assets            
Current receivables from related parties - 130,654 - - 130,654 130,654
Trade receivables - 395,846 - - 395,846 395,846
Financial assets at fair value - - - - -  -
Financial receivables - 166,892 - - 166,892 166,891
Other current assets                - 3,868 - - 3,868 3,868

 

31.12.2009 Fair value through profit or loss Amortised Cost Total Fair Value
(EUR 000)        
Non-current liabilities        
Non-current payables to related parties - - -  -
Non-current borrowings - 4,032 4,032 4,032
Other non-current liabilities                  -                   - - -
         
Current liabilities        
Current payables to related parties - 7,477 7,477 7,477
Trade payables - 229,395 229,395 229,395
Borrowings - 12,539 12,539 12,539
Other current liabilities - 793 793 793

For short-term financial instruments, such as trade receivables and payables, the book value represents a fair approximation of fair value.

31.12.2008 Fair value through profit or loss Loans and receivables Held to maturity Available for sale Total Fair Value
(EUR 000)            
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 - 2,882 - - 2,882 2,882