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22 Financial instruments - derivatives

 
Non-current Assets /Liabilities thousands of €Fair Value HierarchyHedged underlying31-Dec-201031-Dec-2009
Notional amountFair Value AssetsFair Value LiabilitiesNotional AmountFair Value AssetsFair Value Liabilities
Interest rate derivatives        
- Interest rate Swap2Loans14.2 M169 48.8 M419 
- Interest rate Swap2Loans913.2 M 42,817692.5 M 30,270
- Interest rate Option2Loans18.8 M 1,26522.5 M 1,686
Exchange rate derivatives (financial transactions)        
- Cross Currency Swap2LoansJPY 20 bn39,902 JPY 20 bn 8,438
Total   40,07144,082 41940,394
Current Assets/ Liabilities
thousands of €
Fair Value HierarchyHedged underlying31/12/201031/12/2009
Notional amountFair Value AssetsFair Value LiabilitiesNotional amountFair Value AssetsFair Value Liabilities
Interest rate derivatives        
- Interest rate Swap2Loans11.5 M27    
- Interest rate Swap2Loans13.8 M 71   
Commodity derivates        
- Swap2Crude Oil516.650 BBL1,607 290,050 BBL1,863 
- Swap2Commodities59,900 TON2,959 230,400 TON9,866 
- Swap2Electricity formula3,037,342 MWh7,916 4,679,454 MWh35,564 
- Swap2Fuel formula22,080 MWh118 882,360 MWh2,226 
- Swap2Foreign gas hubs   1,054,080 MWh 790
- Swap2Crude Oil512,300 BBL 389241,700 BBL 1,690
- Swap2Commodities13,200 TON 765193,100 TON 8,553
- Swap2Electricity formula3,349,812 MWh 10,7476,210,055 MWh 40,450
- Swap2Fuel formula   394,200 MWh 2,490
Foreign exchange derivatives  (commercial transactions)        
- Swap2EUR/USD exchange rateUSD 6.0 M170 USD 32.0 M680 
- Swap2EUR/USD exchange rateUSD 50.5 M 1,617USD 28.6 M  660
Total   12,79613,589 50,19954,633

Derivative financial instruments classified under non-current assets amount to Euro 40,071 thousand, (Euro 419 thousand as at 31 December 2009); Euro 169 thousand refer to interest rate derivatives, and Euro 39,902 thousand refer to foreign exchange derivatives relating to financing transactions. Derivative financial instruments classified under non-current liabilities amount to Euro 44,082 thousand, (Euro 40,394 thousand as at 31 December 2009), and all refer to interest rate derivatives.

With regard to interest rate derivatives as at 31 December 2010, the Group net exposure is negative by Euro 43,913 thousand, compared with an exposure, negative as well, of Euro 31,537 thousand as at 31 December 2009. The reduction in fair value, compared with the previous year, was mainly due to the subscription of new hedging derivatives which, as at 31 December 2010, showed a negative fair value, as compared to their subscription date.Specifically, in the first half of 2010, two interest rates swaps were negotiated with leading credit institutions to hedge the fair value of fixed rate financial liabilities, for a total notional value of Euro 500 million.This decrease was partly offset by the full realisation of three derivative contracts subscribed in the previous years, which had a negative fair value as at 31 December 2009.

Conversely, the fair value on foreign exchange derivatives, as at 31 December 2010, is positive by Euro 39,902 thousand, compared with a negative value, equal to Euro 8,438 thousand, as at 31 December 2009. The significant change in fair value is mainly due to the strengthening of the Japanese Yen compared to the Euro.

Derivative financial instruments classified under current assets amount to Euro 12,797 thousand (Euro 50,199 thousand as at 31 December 2009) and represent derivative contracts which are expected to be concluded in the following year. Euro 27 thousand refers to interest rate derivatives, Euro 12,600 thousand to commodity derivatives and Euro 170 thousand to foreign exchange derivatives relating to commercial transactions.

Derivative financial instruments classified under current liabilities amount to Euro 13,589 thousand (Euro 54,633 thousand as at 31 December 2009) and represent derivative contracts which are expected to be concluded in the following year. Euro 71 thousand refers to interest rate derivatives, Euro 11,901 thousand to commodity derivatives and Euro 1,617 thousand to foreign exchange derivatives relating to commercial transactions.

The remarkable reduction in the fair value of commodity derivatives, both positive and negative, compared with 31 December 2009, is mainly due to the reduction in the trading business in the electricity sector, generated by a careful policy of credit risk management that led to a more careful and prudent measurement of the related counterparties, which translated into a decrease in the opening of new positions, within a context of general economic crisis that has been lasting since 2009. The performance of the market in the gas area had a significantly smaller effect. It was characterised by much smaller price fluctuations compared to the previous year, which were the result of smaller price differentials.


The fair value of financial instruments, both on interest rates and foreign exchange rates, derives from market prices; in the absence prices quoted on active markets, the method of discounting back future cash flows is used, taking the parameters observed on the market as reference. The fair value of the commodity derivatives is calculated using input directly observable on the market. All derivative contracts entered by the Group are with leading institutional counterparties.

Interest rate and foreign exchange derivative instruments held as at 31 December 2010, subscribed in order to hedge loans, can be classed into the following two categories (figures in thousands of €):

Interest rate/foreign exchange derivatives (financial transactions)Underlying31-Dec-201031-Dec-2009
Notional amountFair Value AssetsFair Value LiabilitiesIncomeChargesNotional amountFair Value AssetsFair Value LiabilitiesIncomeCharges
- Cash Flow HedgeLoans410.7 M023,0862120,145655.6 M030,69066617,159
- Fair Value HedgeLoans649.8 M39,90220,30862,34625,597149.8 M08,43809,688
- Non Hedge AccountingLoans60.8 M1967598981,120108.2 M4191,266799888
Total  40,09844,15363,26546,862 41940,3941,46527,735

Interest rate derivatives identified as cash flow hedges show a residual notional amount of Euro 410.7 million (Euro 655.6 million as at 31 December 2009) against variable rate mortgage loans of the same amount.

Income and charges in hedge accounting associated with interest rate derivatives predominantly refer to cash flow effects, or to the recording of shares of future flows, which shall have a financial impact in the following period. As at 31 December 2010 the breakdown of net charges relating to derivatives classified as cash flow hedges, amounting to Euro 20,124 thousand, is as follows:

Cash Flow Hedges (thousand of €)Income/(Charges)
- Cash Flows realised-20,598
- Accrued Interest805
- Ineffective portion-331
Total-20,124

The increase in net financial charges compared with the same period in the previous year (see Note 13 Financial income and charges) is predominantly due to the unfavourable trend (in the context of hedges entered into) in interest rates. In 2010, the benchmark Euribor rate remained at very low levels, generating a negative effect on fixed rate hedges. It should be added that this effect was partially offset by the progressive reduction in the notional amount of some derivatives, which are being concluded or have already been concluded.

The degree of ineffectiveness of this class of interest rate derivative led to the recording of net charges totalling Euro 331 thousand in the income statement. All the hedging relationships between the aforementioned derivatives contracts and the related underlying liabilities are qualified as “Cash Flow Hedges” and involved the recording in the Group shareholders’ equity, of a specific negative reserve, amounting to Euro 12,407 million, net of the related tax effect.

Interest rate and foreign exchange derivatives identified as fair value hedges show a residual notional amount of Euro 649.8 million (Euro 149.8 million as at 31 December 2009), against loans of the same amount. In the case of loans denominated in foreign currency, the notional amount of the derivative expressed in Euro is the translation to the original exchange rate hedged. Specifically, the financial liabilities hedged comprise a bond loan in Japanese Yen with a residual notional amount of JPY 20 billion and a ten-year fixed rate bond of Euro 500 million issued in November 2009, which has been hedged starting from June 2010. These derivatives led to the recording of financial income of Euro 62,346 thousand and financial charges of Euro 25,597 thousand. In parallel, however, a fair value assessment of the underlying loan was performed, recording financial income for Euro 20,861 thousand and financial charges for Euro 46,955 thousand.

As at 31 December 2010 the breakdown of income and charges relating to derivatives classified as fair value hedges and the related underlying liabilities was as follows:

Fair Value Hedges
(thousands of €)
IncomeChargesTotal
- Valuation of derivatives46,955-20,86126,094
- Accrued Interest1,93701,937
- Cash Flows realised13,454-4,7368,718
- Ineffective portion000
Total effect of derivatives on the income statement62,346-25,59736,749
Valuation of underlyings20,861-46,955-26,094
Total  83,207-72,55210,655

The increase in financial income and charges associated with this type of hedge reflects the changes in fair value of the financial instruments illustrated above, specifically with reference to the new derivatives subscribed and the changes in the fair value of foreign exchange derivatives (now positive, but negative in the previous year), in addition to positive final cash flows.

The remaining interest rate derivatives not in the hedge accounting have a notional residual value of Euro 60.8 million (Euro 108.2 million as at 31 December 2009); some of these contracts are the result of mirroring transactions carried out in previous years as part of a restructuring of the derivatives portfolio. The remaining contracts which, under the criteria envisaged by the international accounting standards, cannot be accounted for under hedge accounting, were however put in place for hedging purposes only.

As for incorporated derivatives, reference is made to note 30.

Commodity derivative instruments held as at 31 December 2010 can be classed into the following categories (figures in thousands of €):

Commodity/foreign exchange derivatives (commercial transactions)Underlyings31-Dec-201031-Dec-2009
Fair Value AssetsFair Value LiabilitiesIncomeChargesFair Value AssetsFair Value LiabilitiesIncomeCharges
- Cash Flow HedgeElectricity formulas003,6972,441005,0553,285
- Non Hedge AccountingCommodity transactions12,77013,51866,09964,95750,19954,633383,617367,980
Total 12,77013,51869,79667,39850,19954,633388,672371,265

Commodity derivatives recorded under hedge accounting were all closed as at 31 December 2010.

The commodity derivatives not recorded under hedge accounting also include contracts put in place substantially for hedging purposes, but which, on the basis of the strict requirements set forth by international accounting standards, cannot be formally classified under hedge accounting. In any event, these contracts generate income and charges referring to higher/lower purchase prices of raw materials and, as such, are recognised as operating costs.

On the whole, in 2010, the commodity derivatives generated Euro 69,796 thousand in income and Euro 67,398 thousand in charges, for a net gain to the income statement of Euro 2,398 thousand, compared to a net gain of Euro 17,692 thousand as at 31 December 2009. The significant change in the net effect on the income statement was linked to the change in fair value, the reasons for which are illustrated above.

Interest rate risk and currency risk on financing transactions

The Group’s financial requirements are met also by turning to outside resources in the form of debt. The cost of the various forms of borrowing can be affected by market interest rate fluctuations, with a consequent impact on the amount of the net financial charges. Equally, interest rate fluctuations also influence the market value of financial liabilities. In the case of loans denominated in foreign currency, the cost may also be affected by exchange rate fluctuations with an additional effect on net financial charges. To mitigate interest rate volatility risk and, at the same time, guarantee the correct balance between fixed rate indebtedness and variable rate indebtedness, the Group has stipulated derivatives on interest rates (Cash Flow Hedges and Fair Value Hedges) against part of its financial liabilities. At the same time, to mitigate exchange rate volatility risk, the Group has stipulated foreign exchange derivatives (Fair Value Hedges) to fully hedge loans in foreign currency.

Sensitivity Analysis

In conjecturing an instant shift of -50 basis points in the interest rate curve with respect to the interest rate effectively applied for the assessments as at 31 December 2010, at like-for-like exchange rates, the potential increase in fair value of the existing derivative financial instruments on interest rates and exchange rates would amount to roughly Euro 26.3 million. Likewise, conjecturing an instant shift of +50 basis points in the interest rate curve, there would be a potential decrease in fair value of about Euro 24.8 million.

These fair value changes would have no effect on the income statement if it were not for the potential ineffective portion of the hedge, as they refer to financial derivative instruments classified under hedge accounting. As for the effects on Shareholders’ Equity, in the event of a negative shift in the curve, the change in Cash Flow Hedge reserves would be negative for Euro 4.9 million, net of tax, while in the event of a positive shift, the change would be positive for Euro 4.7 million, net of tax.

As for derivatives designated as fair value hedges, these fair value changes would have no effect on the income statement, except for that limited to the ineffective portion of the hedge, since they are offset by a change in the fair value of the underlying liabilities being hedged, in the opposite sign.

The effects on the income statement of the fair value changes of the instruments not in hedge accounting, as they almost entirely undergo mirroring transactions, would be insignificant.

In conjecturing an instant rise of 10% in the EUR/JPY exchange rate, with no change in interest rates, the potential increase in the fair value of derivative financial instruments held as at 31 December 2010 would amount to approximately Euro 21.2 million. Likewise, an instant fall of 10% in the exchange rate would bring about a potential increase in the fair value of the instruments of around Euro 25.9 million.As these are exchange rate derivatives regarding financing transactions, fully designated as fair value hedges, these changes would have no effect on the income statement, except for that of the potentially ineffective portion of the hedge, since they are offset by a change in the fair value of the underlying liability being hedged, in the opposite sign.

Market risk and currency risk on commercial transactions

In relation to the wholesale activities carried out by the subsidiary Hera Trading Srl, the Group must handle the risks associated with the misalignment between the index-linking formulas relating to the purchase of gas and electricity and the index-linking formulas linked to the sale of said commodities, including therein fixed price contracts stipulated, as well as any exchange rate risk in the event that the commodity purchase/sale agreements are concluded in currencies other than the Euro (essentially the US dollar).

With reference to those risks, the Group objective is to lessen the risk of fluctuation in the forecast budget margins.The instruments used for handling price risk, both with regards to the price of the goods and the related Euro/Dollar exchange rate, are carried out through swap agreements, aimed at pre-establishing the effects on the sales margins irrespective of the changes in the aforementioned market conditions.

Though these transactions are substantially put in place for hedging purposes, in order to realise all possible synergies and decrease operating costs, they are concretely implemented by destructuring the indices included in the underlying contracts and reaggregating them by individual type and net external exposure. As a result, in most cases, the direct correlation of the hedging transactions with the related underlyings is lost, thereby making these transactions non-compliant with the requirements of IAS 39 for hedge accounting.

Sensitivity Analysis

In conjecturing an instant 10 dollar-per-barrel rise in the Brent price, with no change in the Euro/Dollar exchange rate, and no change in the curve of the national standard price, the potential increase in the fair value of derivative financial instruments held as at 31 December 2010 would amount to approximately Euro 9.7 million. Likewise, an instant fall in the same amount would bring about a potential decrease in the fair value of the instruments of around Euro 9.7 million.

In conjecturing an instant rise in the exchange rate of 0.05 dollars per Euro, with no change in the Brent price, and no change in the national standard price, the potential decrease in the fair value of derivative financial instruments held as at 31 December 2010 would amount to approximately Euro 5 million. Likewise, an instant fall in the same amount would bring about a potential increase in the fair value of the instruments of around Euro 5 million.

In conjecturing an instant +5 €/MWh change in the national standard price curve, with no change in the Euro/Dollar exchange rate, and no change in the Brent price, the potential increase in the fair value of derivative financial instruments held as at 31 December 2010 would amount to approximately Euro 3.8 million. On the contrary, an instant change of -5 €/MWh would bring about a potential decrease in the fair value of the instruments of around Euro 3.5 million.


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