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The Group’s exposure to currency risk derives from the differences between the geographic distribution of its manufacturing activities and the markets in which it sell products and, in limited cases, from the use of sources of funding and other financial instruments denominated in foreign currencies.
The exposure to interest rate risk arises from requirements related to the funding of operating activities, both industrial and financial, and investment of surplus liquidity. Changes in market rates of interest could have a postive or negative impact on Group profit and loss, indirectly affecting the cost of and yields on financing transactions and investments. The Group regularly assesses its exposure to interest rate and currency risk and manages those risks through the use of derivative financial instruments in accordance with the established risk management policies.
Group policy only permits derivatives to be used to manage exposure to fluctuations in exchange and interest rates connected with future cash flows or assets and liabilities. The use of derivatives for speculative purposes is not permitted.
The Group utilises derivative financial instruments designated as fair value hedges, mainly to hedge:
- the currency risk on financial instruments denominated in foreign currency;
- the interest rate risk on fixed rate loans and borrowings.
The instruments principally used for these hedges are currency swaps, forward contracts, interest rate swaps and combined interest rate and currency hedging instruments.
The Group uses derivative financial instruments as cash flow hedges for the purpose of fixing:
- the exchange rate at which forecast transactions denominated in foreign currencies will be accounted for;
- the interest paid on borrowings, both to match the fixed interest received on loans (customer financing activity), and to achieve the optimum pre-established mix of floating versus fixed rate liabilities in its funding structure.
Currency exposure on expected commercial transactions is hedged with currency swaps, forward contracts and currency options. Interest rate exposure is typically hedged with interest rate swaps and, in limited cases, forward rate agreements.
The counterparties to these agreements are leading, specialised financial institutions.