Note 28 • Financial instruments and financial risk management
28.1 Financial risk factors
Overview
The Group has exposure to the following risks from its use of financial instruments:
• Market risk
• Credit risk
• Liquidity risk
This note presents information about the Group’s exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk, and the Group’s management of capital. Further quantative disclosures are included throughout these consolidated financial statements.
The Board of Directors has overall responsibility for the establishment and oversight of the Group’s risk management framework. The Group’s risk management policies are established to identify and analyse the risks faced by the Group, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Group’s activities.
I Market Risk
Market risk is the risk that changes in market prices, such as foreign exchange rates or interest rates will affect the Group’s income or the value of its holdings of financial instruments. The market risk management objective is to manage and control market risk exposures within acceptable parameters, while optimising the return on risk.
The Group buys and sells derivatives in the ordinary course of business, and also incurs financial liabilities, in order to manage market risks. Generally the Group seeks to apply hedge accounting in order to manage volatility in profit or loss.
(a) Foreign currency risk
Translation exposure
Translation exposure arises because the profits and losses and assets and liabilities of operating subsidiaries are reported in the respective currencies of their country of incorporation. Profits and losses and assets and liabilities in the various local currencies are translated into euros, the reporting currency. For those countries with a reporting currency other than the euro, profits and losses are translated at average exchange rates and assets and liabilities are translated at closing exchange rates. Fluctuations in exchange rates against the euro will give rise to differences. These differences are recorded as translation gains or losses in shareholders’ equity.
Transaction exposure
Currency transaction exposure arises whenever a subsidiary enters into a transaction using a currency other than its measurement currency. If the relevant exchange rates move between the date of the transaction and the date of final payment, the resulting currency balance will produce a gain or loss on exchange. Such gains or losses are included in financial income and expense.
Strategic currency exposure
Strategic currency exposure arises in countries, which are not part of the European Monetary Union (EMU), or whose currencies are not pegged to the euro. When the exchange rate of the non-EMU currencies fluctuates against the euro, it affects the gross margin in those countries, as approximately 64 percent (64 percent) of the Group’s products are sourced and produced within the EMU.
The objective of the Group is to hedge any currency transaction exposure by seeking to match revenues and costs in the same currency. However, given the geographical diversity of the Group’s operations, a significant portion of sales is generated in currencies other than those in which the majority of expenses are incurred. In circumstances where revenues and costs cannot be matched, the currency transaction exposure may be hedged by periodically adjusting prices.
The Group hedges up to 100 percent of selected currency transaction exposures by entering into a variety of forward contracts in currencies in which subsidiaries of the Group transact business, to the extent that forward contracts are available in the market at a reasonable cost.
As at 31 December 2010 there were a variety of forward exchange contracts outstanding for an amount equivalent of €9 million (€51.6 million) with maturities ranging from January to December 2011, to hedge selected currency transaction exposures. The Group does not apply hedge accounting for the variety of forward contracts amounting to €9 million at nominal value (€29.9 million) that economically hedge monetary assets and liabilities in foreign currencies, mainly intra-group. Both the changes in fair value of the forward contracts and the foreign exchange gains and losses relating to the monetary assets and liabilities are recognised in the consolidated income statements. At 31 December 2010, the fair value of these forward contracts was €0.1 million loss (€0 million).
During 2010 the Group closed in total €82.4 million (€134.5 million) forward contracts related to the above mentioned variety of forward contracts. The total net realised result on all forward contracts closed in 2010 was €0.1 million loss (€6.2 million gain).
In April 2010, the Group successfully entered into a $165 million loan in the U.S. private placement market (USD loan) and at the same time entered into a series of cross currency interest rate swaps, effectively converting USD denominated private placement loan proceeds and obligations (principal and semi annual interest) into euro denominated flows. The Group designated the USD loan as financial liability at fair value through profit and loss. Both the USD loan and related cross currency interest rate swaps are measured at fair value in the consolidated income statements.
In November 2010 the Group entered into a SEK560 million loan under the €400 million facility and a cross currency interest rate swap converting the SEK loan into a Euribor 6-month loan which allowed for a reduction in the financing costs. The SEK loan will be rolled-over for two years until November 2012 when the cross currency interest rate swap will finally mature.
Exposure to currency risk
The Group’s exposure for some of it’s main currencies was as follows:
|
2010
|
CLP
|
CZK
|
DKK
|
KZT
|
PLN
|
RUB
|
SEK
|
SKK
|
UAH
|
IDR
|
|
In €’000 equivalents
|
|
|
|
|
|
|
|
|
|
|
|
Intra-group trading balances
|
4,964
|
2,591
|
838
|
11,280
|
(12,889)
|
87,966
|
11,235
|
1,026
|
42,925
|
5,649
|
|
Trade receivables/(payables)
|
–
|
–
|
–
|
–
|
5,396
|
–
|
(8,425)
|
–
|
–
|
–
|
|
Gross balance sheet exposure
|
4,964
|
2,591
|
838
|
11,280
|
(7,493)
|
87,966
|
2,810
|
1,026
|
42,925
|
5,649
|
|
Forward exchange contracts
|
(2,000)
|
(1,000)
|
–
|
*(615)
|
–
|
–
|
–
|
–
|
(2,204)
|
**(565)
|
|
Net Exposure
|
2,964
|
1,591
|
838
|
10,665
|
(7,493)
|
87,966
|
2,810
|
1,026
|
40,721
|
5,084
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
CLP
|
CZK
|
DKK
|
KZT
|
PLN
|
RUB
|
SEK
|
SKK
|
UAH
|
IDR
|
|
In €’000 equivalents
|
|
|
|
|
|
|
|
|
|
|
|
Intra-group trading balances
|
4,721
|
1,212
|
1,831
|
2,572
|
(15,310)
|
57,984
|
9,684
|
703
|
13,214
|
6,951
|
|
Trade receivables/(payables)
|
–
|
–
|
–
|
–
|
5,408
|
–
|
(2,574)
|
–
|
–
|
–
|
|
Gross balance sheet exposure
|
4,721
|
1,212
|
1,831
|
2,572
|
(9,902)
|
57,984
|
7,110
|
703
|
13,214
|
6,951
|
|
Forward exchange contracts
|
(2,500)
|
(1,000)
|
(2,000)
|
*(2,441)
|
–
|
–
|
(9,400)
|
–
|
–
|
–
|
|
Net Exposure
|
2,221
|
212
|
(169)
|
131
|
(9,902)
|
57,984
|
(2,290)
|
703
|
13,214
|
6,951
|
* The Kazakhstan forward exchange contracts are € against USD.
** The Indonesian forward exchange contracts are € against USD.
The following significant exchange rates applied during the year:
|
|
Average rate
|
Reporting date rate
|
|
€
|
2010
|
2009
|
2010
|
2009
|
|
RUB
|
40.08
|
44.15
|
40.33
|
43.38
|
|
KZT
|
194.28
|
205.79
|
195.23
|
212.84
|
|
UAH
|
10.50
|
11.20
|
10.57
|
11.44
|
|
PLN
|
4.00
|
4.33
|
3.96
|
4.10
|
Sensitivity analysis
The Group trades in more than forty currencies. The Group has selected the top four sales operations and shows their impact on operating profit and equity. This analysis assumes that all other variables, in particular interest rates, the exchange rates of other currencies to the euro, the selling prices of the Oriflame entities in the countries under review, remain constant over the year. The analysis is performed on the same basis for 2009. 1 percent strengthening of the euro against the following currencies on average over the reporting year would have increased (decreased) the Group operating profit or loss and equity as shown below.
|
Effect on Group operating profit in %
|
2010
|
2009
|
|
RUB
|
(1.6%)
|
(1.5%)
|
|
UAH
|
(0.5%)
|
(0.4%)
|
|
KZT
|
(0.3%)
|
(0.3%)
|
|
PLN
|
(0.1%)
|
(0.1%)
|
|
Effect on equity in € million
|
2010
|
2009
|
|
RUB
|
(1.2)
|
(0.1)
|
|
UAH
|
0.0
|
0.2
|
|
KZT
|
(0.2)
|
(0.1)
|
|
PLN
|
(0.7)
|
(0.5)
|
(b) Interest rate risk
Hedge
In March 2009, the Group decided to hedge part of its exposure to rising interest rates until March 2010 via euro denominated interest rate swap agreements. The notional amount of the hedge as at 31 December 2009 was €105 million. The Group received the 6-month euro floating rate semi-annually and paid on average a fixed swap rate of 1.84 percent.
In 2009, the Group classified the interest rate swaps as cash flow hedge until the reimbursement of the underlying loan in December 2009. From then on the Group classified the interest rate swaps as used for trading. The fair value of outstanding interest rate swaps at 31 December 2009 was a liability of €0.2 million and nil as at 31 December 2010.
Not designated as hedge
Exposure to higher interest rates on €195 million of the Group’s debt until June 2012, was hedged economically through interest rate cap agreements. The interest rate caps give protection against a rise of 6-month Euribor over 3.5 percent. This series of interest rate caps is also hedging the synthetic loan resulting from the SEK loan and the corresponding cross currency interest rate swap.
In April 2010, when entering into the $165 million USD loan and linked cross currency interest rate swaps, the Group effectively created a floating rate of 6-month Euribor obligation, receiving USD denominated semi annual fixed swap rate and paying 6-month Euribor plus spread under the cross currency interest rate swaps, which the Group decided to hedge economically through series of interest rate cap agreements, totalling €121.3 million. The caps protect against a rise of 6-month Euribor over 4 percent and do not qualify for hedge accounting treatment under IFRS 39, since the underlying hedged item is a derivative itself.
In November 2010, the Group decided to enter into SEK560 million loan under the €400 million credit facility, which was hedged economically by entering into a cross currency interest rate swap where the Group receives 3-month Stibor and pays the 6-month euro floating rate. This cross currency interest rate swap will mature in November 2012 and the Group will rollover SEK560 million loan until the same date.
Cash flow sensitivity analysis for variable rate instruments
A change of 100 basis points in interest rates at the reporting date would have increased (decreased) equity and profit or loss by the amounts shown below. This analysis assumes that all other variables, in particular foreign currency rates, remain constant. The analysis is performed on the same basis for 2009.
|
|
Profit or (loss)
|
Equity
|
|
|
|
|
100 bp
|
100 bp
|
100 bp
|
100 bp
|
|
Effects in €’000
|
increase
|
decrease
|
increase
|
decrease
|
|
31 December 2010
|
|
|
|
|
|
Variable rate interest-bearing liabilities
|
(1,878)
|
1,878
|
–
|
–
|
|
Interest rate caps
|
3,638
|
(2,500)
|
–
|
–
|
|
Cross currency interest rate swaps
|
1,137
|
(1,192)
|
–
|
–
|
|
Cash flow sensitivity (net)
|
2,897
|
(1,814)
|
–
|
–
|
|
|
|
|
|
|
|
31 December 2009
|
|
|
|
|
|
Variable rate interest-bearing liabilities
|
(2,720)
|
2,720
|
–
|
–
|
|
Interest rate caps
|
1,283
|
(525)
|
–
|
–
|
|
Interest rate swaps
|
1,629
|
(1,629)
|
–
|
–
|
|
Cash flow sensitivity (net)
|
192
|
566
|
–
|
–
|
II Credit risk
Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Group’s receivables from customers.
There is a credit policy in place and the exposure to credit risk is monitored on an ongoing basis. Management performs ongoing evaluations of the credit position of its consultants. Due to the nature of the direct sales industry, the Group does not have significant exposure to any individual customer. (See note 17.)
At reporting date there was no significant concentration of credit risk. The maximum exposure to credit risk is represented by the carrying amount of each financial asset in the consolidated statements of financial position:
|
€’000
|
2010
|
2009
|
|
Trade and other receivables
|
81,981
|
65,308
|
|
Cash and cash equivalents
|
86,248
|
107,213
|
|
Interest rate caps for trading
|
3,813
|
698
|
|
Forward exchange rate contracts for trading
|
98
|
244
|
|
Forward exchange rate contracts for hedging
|
–
|
531
|
|
Cross currency interest rate swaps for trading
|
7,912
|
–
|
|
|
180,052
|
173,994
|
III Liquidity risk
Liquidity risk is the risk that the Group will not be able to meet its financial obligations as they fall due. The Group’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group’s reputation.
The following are the contractual maturities of financial liabilities, including estimated interest payments:
|
31 December 2010
|
Carrying
|
Contractual
|
Less than
|
1–3
|
3–5
|
More than
|
|
€’000
|
amount
|
cash flows
|
1 year
|
years
|
years
|
5 years
|
|
Non-derivative financial liabilities
|
|
|
|
|
|
|
|
Loans
|
284,564
|
(335,310)
|
(13,038)
|
(171,902)
|
(29,827)
|
(120,543)
|
|
Finance lease liabilities
|
45
|
(48)
|
(36)
|
(12)
|
–
|
–
|
|
Trade and other payables
|
101,370
|
(101,370)
|
(101,370)
|
–
|
–
|
–
|
|
Bank overdraft
|
215
|
(215)
|
(215)
|
–
|
–
|
–
|
|
|
|
|
|
|
|
|
|
Derivative financial liabilities
|
|
|
|
|
|
|
|
Forward exchange rate contracts for trading
|
199
|
(199)
|
(199)
|
–
|
–
|
–
|
|
|
|
|
|
|
|
|
|
31 December 2009
|
Carrying
|
Contractual
|
Less than
|
1–3
|
3–5
|
More than
|
|
€’000
|
amount
|
cash flows
|
1 year
|
years
|
years
|
5 years
|
|
Non-derivative financial liabilities
|
|
|
|
|
|
|
|
Loans
|
262,043
|
(283,238)
|
(50,625)
|
(232,613)
|
–
|
–
|
|
Finance lease liabilities
|
129
|
(143)
|
(108)
|
(35)
|
–
|
–
|
|
Trade and other payables
|
76,185
|
(76,185)
|
(76,185)
|
–
|
–
|
–
|
|
Bank overdraft
|
121
|
(121)
|
(121)
|
–
|
–
|
–
|
|
Derivative financial liabilities
|
|
|
|
|
|
|
|
Forward exchange rate contracts for trading
|
259
|
(259)
|
(259)
|
–
|
–
|
–
|
|
Interest rate swaps for trading
|
168
|
(168)
|
(168)
|
–
|
–
|
–
|
Cash Flow hedges
The following table indicates the periods in which the cash flows associated with derivatives that are cash flow hedges are expected to occur and to impact the profit or loss:
|
|
2010
|
|
|
|
|
|
|
2009
|
|
|
|
|
Carrying
|
Expected
|
Less than
|
1–3
|
More than
|
Carrying
|
Expected
|
Less than
|
1–3
|
More than
|
|
€’000
|
amount
|
cash flows
|
1 year
|
years
|
3 years
|
amount
|
cash flows
|
1 year
|
years
|
3 years
|
|
Forward exchange contracts
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
–
|
–
|
–
|
–
|
–
|
531
|
531
|
531
|
–
|
–
|
28.2 Capital risk management
The Board’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of the business. The Board of Directors has adopted a dividend policy to the effect that, absent changes in the Group’s operations or capital structure, Oriflame intends to distribute, over the long term, at least 50 percent of the Group’s annual profit after tax as dividends.
For the €400 million bank credit facility there is a covenant in place, which limits the distribution of Oriflame’s profits to be 60 percent of the Group’s distributable profits, whereas the distributable profits are defined as the retained earnings as of 31 December 2009 plus or minus any change in distributable profits for any period thereafter. The USD loan notes agreement dated April 20, 2010 obliges the Group to maintain consolidated net worth of €120 million at each year end for the term of the agreement. Consolidated net worth is defined in the USD loan agreement as the total assets of the Company and its subsidiaries which would be shown as assets on a consolidated balance sheet of the Group as of such time prepared in accordance with IFRS, after eliminating all amounts properly attributable to minority interests, if any, in the stock and surplus of subsidiaries; minus the total liabilities of the Company and its subsidiaries which would be shown as liabilities on a consolidated balance sheet of the Group as of such time prepared in accordance with IFRS.
No changes were made in the objectives, policies or processes for managing capital during the years ended 31 December 2010 and 31 December 2009.
28.3 Fair value estimation
The fair values of financial assets and liabilities, together with the carrying amounts shown in the consolidated statements of financial position are as follows:
|
|
31 December 2010
|
|
31 December 2009
|
|
|
€’000
|
Carrying amount
|
Fair value
|
Carrying amount
|
Fair value
|
|
Financial assets carried at amortised cost
|
|
|
|
|
|
Trade and other receivables
|
81,981
|
81,981
|
65,308
|
65,308
|
|
Cash and cash equivalents
|
86,248
|
86,248
|
107,213
|
107,213
|
|
Total loans and receivables
|
168,229
|
168,229
|
172,521
|
172,521
|
|
Total financial assets carried at amortised cost
|
168,229
|
168,229
|
172,521
|
172,521
|
|
|
|
|
|
|
|
Financial assets carried at fair value
|
|
|
|
|
|
Cross currency interest rate swaps for trading
|
7,912
|
7,912
|
–
|
–
|
|
Interest rate caps for trading
|
3,813
|
3,813
|
698
|
698
|
|
Forward exchange rate contracts for trading
|
98
|
98
|
244
|
244
|
|
Total derivatives for trading
|
11,823
|
11,823
|
942
|
942
|
|
Forward exchange rate contracts for hedging
|
–
|
–
|
531
|
531
|
|
Total derivatives for hedging
|
–
|
–
|
531
|
531
|
|
Total derivative financial assets
|
11,823
|
11,823
|
1,473
|
1,473
|
|
Total financial assets carried at fair value
|
11,823
|
11,823
|
1,473
|
1,473
|
|
|
|
|
|
|
|
|
31 December 2010
|
|
31 December 2009
|
|
|
€’000
|
Carrying amount
|
Fair value
|
Carrying amount
|
Fair value
|
|
Financial liabilities carried at amortised cost
|
|
|
|
|
|
Loans
|
(158,095)
|
(159,809)
|
(262,043)
|
(269,544)
|
|
Trade and other payables
|
(101,370)
|
(101,370)
|
(252,311)
|
(252,311)
|
|
Finance lease liabilities
|
(45)
|
(47)
|
(129)
|
(140)
|
|
Bank overdrafts
|
(215)
|
(215)
|
(121)
|
(121)
|
|
Total financial liabilities carried at amortised cost
|
(259,725)
|
(261,441)
|
(514,604)
|
(522,116)
|
|
|
|
|
|
|
|
Financial liabilities carried at fair value
|
|
|
|
|
|
USD loan
|
(126,470)
|
(126,470)
|
–
|
–
|
|
Total designated as such upon initial recognition
|
(126,470)
|
(126,470)
|
–
|
–
|
|
Forward exchange rate contracts for trading
|
(199)
|
(199)
|
(259)
|
(259)
|
|
Interest rate swaps for trading
|
–
|
–
|
(168)
|
(168)
|
|
Total derivatives for trading
|
(199)
|
(199)
|
(427)
|
(427)
|
|
Total derivative financial liabilities
|
(199)
|
(199)
|
(427)
|
(427)
|
|
Total financial liabilities carried at fair value
|
(126,669)
|
(126,669)
|
(427)
|
(427)
|
|
Unrecognised loss
|
|
(1,716)
|
|
(7,512)
|
Trade and other receivables
The fair value of trade and other receivables is equal to carrying value given its short-term nature.
Trade and other payables
The fair value of trade and other payables is equal to carrying value given its short-term nature.
Derivative financial assets and liabilities
The fair value of forward exchange contracts, interest rate swaps and cross currency interest rate swaps are based on their market quotes. Those quotes are tested for reasonableness by discounting estimated future cash flows based on the terms and maturity of each contract and using market interest rates for a similar instrument at the reporting date. The fair value of interest rate caps is the estimated amount which the Group would receive or pay when unwinding the caps at the reporting date.
Financial liabilities at amortised costs
Fair value is calculated based on the present value of future principal and interest cash flows, discounted at the forward market rate of interest at the reporting date.
Financial liabilities carried at fair value designated as such upon initial recognition
The fair value of the USD loan is calculated by discounting the cash flows associated to the loan schedule for the life of the loan at the market interest rates prevailing for such type and currency of loan as of the reporting date. No changes in the credit risks were done for this calculation as there have been no changes in the financial condition of the Group since the inception of the USD loan.
The difference between the USD loan carrying amount and the amount the Group would be contractually required to pay at maturity to the holders of the obligation amounts to €5.1 million (gain) at the reporting date.
Note 28.4 Fair value hierarchy
The table below analyses financial instruments carried at fair value, by valuation method. The different levels have been defined as follows:
Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities
Level 2: inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e., as prices) or indirectly (i.e., derived from prices)
Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs)
|
€’000
|
Level 1
|
Level 2
|
Level 3
|
Total
|
|
31 December 2010
|
|
|
|
|
|
USD loan
|
–
|
(126,470)
|
–
|
(126,470)
|
|
Derivative financial assets
|
–
|
11,823
|
–
|
11,823
|
|
Derivative financial liabilities
|
–
|
(199)
|
–
|
(199)
|
|
|
–
|
(114,846)
|
–
|
(114,846)
|
|
|
|
|
|
|
|
€’000
|
Level 1
|
Level 2
|
Level 3
|
Total
|
|
31 December 2009
|
|
|
|
|
|
Derivative financial assets
|
–
|
1,473
|
–
|
1,473
|
|
Derivative financial liabilities
|
–
|
(427)
|
–
|
(427)
|
|
|
–
|
1,046
|
–
|
1,046
|
