Annual Report 1999 - Kemira

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
26. MANAGEMENT OF FINANCIAL RISKS
The Group’s Treasury functions are managed
on a centralized basis. Treasury Management
functions as an internal bank via which the
subsidiaries handle all their borrowing, investment
and hedging needs. Treasury Management
also sees to the investment of liquid
funds, the management of interest rate and
foreign exchange risk as well as the maintenance
of cash pools. The policy of Kemira’s
Treasury operations is approved by the company’s
Board of Directors. In addition, the
Management Board confirms an action plan
for treasury operations each year. The objective
of financial risk management is to protect
the company from unfavourable changes occurring
in the financial markets and thus to
contribute to safeguarding the company’s
earnings trend and its shareholders’ equity.
The company employs various financial instruments,
such as forward rate agreements,
options and futures, within the framework of
the limits which have been set. Only such instruments
are used whose market values and
risks can be tracked continually and reliably
within the company’s risk management system.
Derivative instruments are used only for
hedging purposes, not for speculative gain.
Foreign exchange risk
The introduction of the euro has reduced the
Group’s currency flow exposure. The majority
of the Group’s production in the euro
zone is also sold within the area. Currency
flow risk nevertheless arises from net currency
flows in other currencies than the home
currency, both within and outside of the
euro zone. Also, the translation into euro of
the result and balance sheet items of companies
outside of the euro zone causes currency
risk.
Currency flow exposure is hedged selectively
in such a way that already assured foreign currency
flows are hedged completely and a part
of the forecast cash flows are hedged, to an increasing
extent, the more probable it is that the
flow will materialize. The basic guideline is
that a minimum of 30% of the foreign currency
flow that is forecast for the next 12 months
must be hedged. Each subsidiary is separately
responsible for taking its own hedging decisions.
The hedging undertaken by the subsidiaries
is supplemented, according to the
Group’s needs, by means of Group-level hedging
measures that are carried out by Group
Treasury and for which the limit set for 1999
was EUR 35 million. On a monthly basis, an
average of about EUR 14 million of this limit
was in use. As part of this position, measures
are taken to ensure that both external and internal
borrowing and lending in foreign currency
are nearly fully in balance. Hedging
measures at the Group level had limits relating
to both the nominal value and the market value,
and the actual figures were tracked daily.
In future the monitoring of currency flow exposure
will be changed because as a rule 50 %
of the net foreign currency flow that is forecast
for the next twelve months will be hedged.
This includes both hedging orders submitted
by subsidiaries and hedging at the group level.
Treasury Management has an authorisation to diverge
by +/- EUR 100 million from this 50 % level.
The hedging of this forecast cash flow must
nevertheless always be a minimum of 30 % and a
maximum of 100 %. Use of the limits are tracked
daily. In 1999 the total volume of all external foreign
exchange contracts and options was about
EUR 4000 million. This figure includes transactions
made both on behalf of subsidiaries and at
the group level.
The Group strives to hedge balance sheet risk by
keeping foreign currency-denominated liabilities
in balance, currency by currency, with the asset
items in the balance sheet. The foreign currencydenominated
shareholders’ equity items of subsidiaries
are hedged against foreign exchange
fluctuations in accordance with the so-called equity
hedging method by means of long-term foreign
currency-denominated loans as well as by
forward rate agreements and currency swaps. Because
euro interest rates are clearly lower than,
say, the interest rates for the US dollar and the
British pound, balance sheet hedging by means
of foreign currency loans results in a substantial
cost, which is taken into account when taking decisions
regarding hedging. In hedging balance
sheet risk, the equity ratio was monitored such
that if a change of +/- 2.5% in the foreign exchange
rates caused a one percentage point
change in the equity ratio, hedging measures had
to be undertaken. For 2000, the new range of
fluctuation for changes in foreign exchange rates
is +/- 5 %, which may cause a max. 1.5 persentage
point change in the equity ratio. In practice
this means that in the balance sheet the value of
unhedged shareholders’ equity could be a maximum
of EUR 500 million in 1999, whereas in future
this limit will be EUR 375 million. The degree
of hedging of shareholders’ equity in currencies
outside the euro area was about 25% at the
end of 1999. The largest unhedged exposures are
in Swedish kronor and British pounds.
Interest rate risk
In accordance with the Group’s risk management
policy, the objective is to hedge against
significant interest rate risks. In order to manage
interest rate risks, the Group’s borrowing and investments
are spread out between fixed and variable
interest rate instruments. In addition, interest
rate swaps and forward rate agreements are
used actively, as are other derivatives. A maximum
of 50% of the Group’s long-term liabilities
can be fixed-rate borrowings. At the end of
1999, 28% of the Group’s entire loan portfolio
consisted of fixed-interest borrowings. Pension
loans are considered to be variable-interest
loans. Treasury Management also monitors the
duration of the loan portfolio as well as its sensitivity
to changes in the interest rate curve. The
average duration of the entire loan portfolio at
the end of 1999 was about 16 months, with the
duration for pension loans set at one year. In
2000 the duration of the loan portfolio can very
in a range of 6 - 24 months. In 1999 a change of
one percentage point in the interest rate curve
was allowed to cause a maximum change of
EUR 13.5 million in the market value of the asset/liability
portfolio. During 1999 a change of
one percentage point would have led on aver-
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