Financial risk management
The Group is exposed to a number of risks relating to, for example, liquid funds, trade receivables, customer-financing receivables, payables, borrowings, commodities and derivative instruments. The risks are primarily:
- Interest-rate risk on liquid funds and borrowings
- Financing risk in relation to the Group’s capital requirements
- Foreign-exchange risk on commercial flows and net investments in foreign subsidiaries
- Commodity-price risk affecting the expenditure on raw materials and components for goods produced
- Credit risk relating to financial and commercial activities
The Board of Directors of Electrolux has approved a financial policy as well as a credit policy for the Group to manage and control these risks. (Hereinafter all policies are referred to as the Financial Policy). These risks are to be managed by, amongst others, the use of financial derivative instruments according to the limitations stated in the Financial Policy. The Financial Policy also describes the management of risks relating to pension fund assets.
The management of financial risks has largely been centralized to Group Treasury in Stockholm. Local financial issues are also managed by three regional treasury centers located in Singapore, North America, and Latin America. Measurement of risk in Group Treasury is performed by a separate risk-controlling function on a daily basis. The method used for measuring risk in the financial position is parametric Value-at-Risk (VaR). The method shows the maximum potential loss in one day with a probability of 97.5% and is based on the statistical behavior of the FX spot and interest- rate markets during the last 150 business days. To emphasize recent movements in the market, the weight of the rates decrease further away from the valuation date. By measuring the VaR risk, Group Treasury is able to monitor and follow up on the Group’s risks across a wide variety of currencies and markets. The main limitation of the method is that events not showing in the statistical data will not be reflected in the risk value. Also, due to the confidence level, there is a 2.5% risk that the loss will be larger than indicated by the risk figure. Furthermore, there are guidelines in the Group’s policies and procedures for managing operational risk relating to financial instruments by, e.g., segregation of duties and power of attorney.
Proprietary trading in currency, commodities, and interest-bearing instruments is permitted within the framework of the Financial Policy. This trading is primarily aimed at maintaining a high quality of information flow and market knowledge to contribute to the proactive management of the Group’s financial risks.
Interest-rate risk on liquid funds and borrowings
Interest-rate risk refers to the adverse effects of changes in interest rates on the Group’s income. The main factors determining this risk include the interest-fixing period.
Liquid funds
Liquid funds as defined by the Group consist of cash and cash equivalents, short-term investments, derivatives, prepaid interest expenses and accrued interest income. Electrolux goal is that the level of liquid funds including unutilized committed credit facilities shall correspond to at least 2.5% of annualized net sales. In addition, net liquid funds defined as liquid funds less short-term borrowings shall exceed zero, taking into account fluctuations arising from acquisitions, divestments, and seasonal variations. Investment of liquid funds is mainly made in interest-bearing instruments with high liquidity and with issuers with a long-term rating of at least A- as defined by Standard & Poor’s or similar.
Interest-rate risk in liquid funds
Group Treasury manages the interest-rate risk of the investments in relation to a benchmark. Any deviation from the benchmark is limited by a risk mandate. Financial derivative instruments like futures and forward-rate agreements are used to manage the interest-rate risk. The holding periods of investments are mainly short-term. The major portion of the investments is made with maturities between 0 and 3 months. A downward shift in the yield curves of one-percentage point would reduce the Group’s interest income by approximately SEK 70m (110). For more information, see Note 18.
Borrowings
The debt financing of the Group is managed by Group Treasury in order to ensure efficiency and risk control. Debt is primarily taken up at the Parent Company level and transferred to subsidiaries as internal loans or capital injections. In this process, swap instruments are used to convert the funds to the required currency. Short-term financing is also undertaken locally in subsidiaries where there are capital restrictions. The Group’s borrowings contain no terms or financial triggers for premature cancellation based on rating or other financial keyratios. For additional information, see Note 18.
Interest-rate risk in borrowings
The benchmark for the long-term loan portfolio is an average interest-fixing period of 12 months. Group Treasury can choose to deviate from this benchmark on the basis of a risk mandate established by the Board of Directors. However, the maximum average interest-fixing period is 3 years. Derivatives, such as interest-rate swap agreements, are used to manage the interest-rate risk by changing the interest from fixed to floating or vice versa. On the basis of 2011 long-term interest-bearing borrowings with an interest fixing period of 1.2 (0.9) years, a one-percentage point shift in interest rates would impact the Group’s interest expenses by approximately SEK +/–60m (60) in 2012. This calculation is based on a parallel shift of all yield curves simultaneously by one-percentage point. Electrolux acknowledges that the calculation is an approximation and does not take into consideration the fact that the interest rates on different maturities and different currencies might change differently.
Capital structure and credit rating
The Group defines its capital as equity stated in the balance sheet including non-controlling interests. In 2011, the Group’s capital was SEK 20,644m (20,613). The Group’s objective is to have a capital structure resulting in an efficient weighted cost of capital and sufficient credit worthiness where operating needs and the needs for potential acquisitions are considered.
To achieve and keep an efficient capital structure, the Financial Policy states that the Group’s long-term ambition is to maintain a long-term rating within a safe margin from a non-investment grade. The rating for long-term debt was changed from BBB to BBB+ in November 2010 by Standard & Poor’s.
| Rating | ||||
| Long-term debt | Outlook | Short-term debt | Short-term debt, Nordic | |
| Standard & Poor’s | BBB+ | Stable | A-2 | K-1 |
When monitoring the capital structure, the Group uses different key numbers which are consistent with methodologies used by rating agencies and banks. The Group manages the capital structure and makes adjustments to it in light of changes in economic conditions. In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, buy back own shares or issue new shares, or sell assets to reduce debt.
Financing risk
Financing risk refers to the risk that financing of the Group’s capital requirements and refinancing of existing borrowings could become more difficult or more costly. This risk can be decreased by ensuring that maturity dates are evenly distributed over time, and that total short-term borrowings do not exceed liquidity levels. The net borrowings, i.e., total borrowings less liquid funds, excluding seasonal variances, shall be long-term according to the Financial Policy. The Group’s goals for long-term borrowings include an average time to maturity of at least 2 years, and an even spread of maturities. A maximum of SEK 5,000m of the borrowings are normally allowed to mature in a 12-month period. For additional information, see Note 18.
Foreign exchange risk
Foreign exchange risk refers to the adverse effects of changes in foreign exchange rates on the Group’s income and equity. In order to manage such effects, the Group covers these risks within the framework of the Financial Policy. The Group’s overall currency exposure is managed centrally.
Transaction exposure from commercial flows
The Financial Policy stipulates the hedging of forecasted flows in foreign currencies. Taking into consideration the price-fixing periods, commercial circumstances and the competitive environment, business sectors within Electrolux can have a hedging horizon of up to 8 months of forecasted flows. Hedging horizons outside this period are subject to approval from Group Treasury. The operating units are allowed to hedge invoiced flows from 75% to 100% and forecasted flows from 60% to 80%. Group subsidiaries cover their risks in commercial currency flows mainly through the Group’s treasury centers. Group Treasury thus assumes the currency risks and covers such risks externally by the use of currency derivatives.
The Group’s geographically widespread production reduces the effects of changes in exchange rates. The remaining transaction exposure is either related to internal sales from producing entities to sales companies or external exposures from purchasing of components and input material for the production paid in foreign currency. These external imports are often priced in US dollars. The global presence of the Group, however, leads to a significant netting of the transaction exposures. For additional information on exposures and hedging, see Note 18.
Translation exposure from consolidation of entities outside Sweden
Changes in exchange rates also affect the Group’s income in connection with translation of income statements of foreign subsidiaries into Swedish krona. Electrolux does not hedge such exposure. The translation exposures arising from income statements of foreign subsidiaries are included in the sensitivity analysis mentioned below.
Foreign exchange sensitivity from transaction and translation exposure
The major currencies that Electrolux is exposed to are the US dollar, the euro, the Brazilian real, and the Australian dollar. Other significant exposures are, for example, the Russian ruble, the British pound and the Swiss franc. These currencies represent the majority of the exposures of the Group, but are, however, largely offsetting each other as different currencies represent net inflows and outflows. Taking into account all currencies of the Group, a change up or down by 10% in the value of each currency would affect the Group’s profit and loss for one year by approximately SEK +/– 330m (550), as a static calculation. The model assumes the distribution of earnings and costs effective at year-end 2011 and does not include any dynamic effects, such as changes in competitiveness or consumer behavior arising from such changes in exchange rates.
| Sensitivity analysis of major currencies | |||
| Risk | Change | Profit or loss impact 2011 | Profit or loss impact 2010 |
| Currency | |||
| BRL/SEK | –10% | –304 | –314 |
| AUD/SEK | –10% | –257 | –273 |
| GBP/SEK | –10% | –180 | –202 |
| CHF/SEK | –10% | –164 | –134 |
| RUB/SEK | –10% | –155 | –164 |
| CAD/SEK | –10% | –118 | –97 |
| DKK/SEK | –10% | –66 | –72 |
| HUF/SEK | –10% | 82 | –15 |
| EUR/SEK | –10% | 411 | 319 |
| USD/SEK | –10% | 810 | 601 |
Exposure from net investments (balance sheet exposure)
The net of assets and liabilities in foreign subsidiaries constitute a net investment in foreign currency, which generates a translation difference in connection with consolidation. This exposure can have an impact on the Group’s total comprehensive income, and on the capital structure, and is hedged according to the Financial Policy. The Financial Policy stipulates the extent to which the net investments can be hedged and also sets the benchmark for risk measurement. From January 1, 2011, the hedging policy was changed. Net investments are only hedged to ensure any of the following objectives; 1) to protect key ratios important to the Group’s credit rating, 2) financial covenants (if any), and 3) to protect net investments corresponding to financial investments such as excess liquidity. Group Treasury is allowed to deviate from the benchmark under a given risk mandate. The benchmark for hedging is set by the Audit Committee for objectives 1) and 2), and for objective 3), the benchmark is set by the Treasury Board. Hedging of the Group’s net investments is implemented within the Parent Company in Sweden.
A change up or down by 10% in the value of each currency against the Swedish krona would affect the net investment of the Group by approximately SEK +/– 2,980m (2,740), as a static calculation at year-end 2011. A similar valuation of all financial instruments used for hedging net investments would have an effect on the Group’s equity of approximately SEK +/– 0m (570). At year-end, no such instruments were outstanding.
For 2011, the hedging policy stated that the benchmark was to hedge only net investments with an equity capitalization exceeding 60%, unless the exposure of any other currency is considered too high by the Group, in which case this also should be hedged.
Commodity-price risks
Commodity-price risk is the risk that the cost of direct and indirect materials could increase as underlying commodity prices rise in global markets. The Group is exposed to fluctuations in commodity prices through agreements with suppliers, whereby the price is linked to the raw-material price on the world market. This exposure can be divided into direct commodity exposure, which refers to pure commodity exposures, and indirect commodity exposures, which is defined as exposure arising from only part of a component. Commodity-price risk is mainly managed through contracts with the suppliers. A change up or down by 10% in steel would affect the Group’s profit or loss with approximately SEK +/– 900m (900) and in plastics with approximately SEK +/– 600m (500), based on volumes in 2011.
Credit risk
Credit risk in financial activities
Exposure to credit risks arises from the investment of liquid funds, and as counterpart risks related to derivatives. In order to limit exposure to credit risk, a counterpart list has been established, which specifies the maximum permissible exposure in relation to each counterpart. The Group strives for arranging master netting agreements (ISDA) with the counterparts for derivative transactions and has established such agreements with the majority of the counterparts, i.e., if counterparty will default, assets and liabilities will be netted. To reduce the settlement risk in foreign exchange transactions made with banks, Group Treasury use Continuous Linked Settlement (CLS). CLS eliminates temporal settlement risk since both legs of a transaction are settled simultaneously.
Credit risk in trade receivables
Electrolux sells to a substantial number of customers in the form of large retailers, buying groups, independent stores, and professional users. Sales are made on the basis of normal delivery and payment terms. The Electrolux Group Credit Policy defines how credit management is to be performed in the Electrolux Group to achieve competitive and professionally performed credit sales, limited bad debts, and improved cash flow and optimized profit. On a more detailed level, it also provides a minimum level for customer and credit-risk assessment, clarification of responsibilities and the framework for credit decisions. The credit-decision process combines the parameters risk/reward, payment terms and credit protection in order to obtain as much paid sales as possible. In some markets, Electrolux uses credit insurance as a mean of protection. Credit limits that exceed SEK 300m are decided by the Board of Directors.
For many years, Electrolux has used the Electrolux Rating Model (ERM) to have a common and objective approach to credit-risk assessment that enables more standardized and systematic credit evaluations to minimize inconsistencies in decisions. The ERM is based on a risk/reward approach and is the basis for the customer assessment. The ERM consists of three different parts, Customer and Market Information, Warning Signals and a Credit Risk Rating (CR2). The risk of a customer is determined by the CR2 in which customers are classified.
There is a concentration of credit exposures on a number of customers in, primarily, USA, Latin America and Europe. For additional information, see Note 17.