23. Financial instruments

The principal financial instruments used by the voestalpine Group consist of bank loans, bonds, borrower’s notes, and trade payables. The primary aim of the financial instruments is to fund the business activities of the Group. The Group holds various financial assets, such as trade receivables, short-term deposits, and non-current investments, which arise directly from its business activities.

The Group also uses derivative financial instruments. They mainly include interest rate swaps, forward exchange transactions, and commodity swaps. These derivative financial instruments serve to hedge interest rate and currency risks as well as risks from fluctuations in raw materials prices, which result from the business activities of the Group and its sources of financing.

In addition to ensuring the availability of the liquidity necessary for supporting the Group’s business activities and maximizing shareholder value, the primary objective of its capital management is to ensure an adequate credit rating and a satisfactory equity ratio.

The voestalpine Group manages its capital using the net financial debt to EBITDA ratio as well as the gearing ratio, i.e. the net financial debt to equity ratio. Net financial debt consists of interest-bearing loans less financing receivables, loan receivables, securities as well as cash and cash equivalents. Equity includes non-controlling interests in Group companies and the hybrid capital.

The target for the gearing ratio is 50% and may only be exceeded up to a maximum of 75% for a limited period of time. The net financial debt/EBITDA ratio may not exceed 3.0. All growth measures and capital market transactions are aligned with these ratios.

These two ratios developed as follows in the reporting period:

Financial risk management also includes raw material risk management. Financial risk management is organized centrally with respect to policy-making power, strategy determination, and target definition. The existent policies include targets, principles, duties, and responsibilities for both Group Treasury and individual Group companies. In addition, they govern matters related to pooling; money markets; credit and securities management; currency, interest rate, liquidity, and commodity price risks; and the reporting system. Group Treasury, acting as a service center, is responsible for implementation. Three organizationally separate units are responsible for closing, processing, and recording transactions, which makes sure that a six-eyes principle is followed. Policies, policy compliance, and the conformity of business processes with the internal control system (ICS) are additionally audited at regular intervals by an external auditor.

It is part of the voestalpine Group’s corporate policy to continuously monitor, quantify, and—where reasonable—hedge financial risks. The Group’s risk appetite is more on the low side. The strategy is aimed at achieving natural hedges and reducing fluctuations in cash flows and earnings. Market risks are largely hedged by means of derivative financial instruments.

To quantify interest rate risks, voestalpine AG uses both the interest rate exposure and the fair value risk as indicators. The interest rate exposure quantifies the impact of a 1% change in the market interest rate on interest income and/or interest expense. The fair value risk refers to the change in the fair values of interest-rate-sensitive items if the interest yield curve shifts simultaneously by 1%.

voestalpine AG uses the “@risk” approach to quantify currency risk. The maximum loss within one year is determined with a certainty of 95%. Risk is determined for the open position, which is defined as the budgeted quantity for the next 12 months less the quantity that has already been hedged. The variance/covariance approach is used to evaluate foreign currency risks.

Liquidity risk refers to the risk of not being able to fulfill payment obligations due to insufficient funds.

The primary instrument for controlling liquidity risks is a precise financial plan that is submitted quarterly on a revolving basis by the operating entities directly to Group Treasury of voestalpine AG. The need for funds and bank credit lines are determined based on the consolidated results.

Working capital is financed by Group Treasury. A central clearing system performs intra-Group netting daily. Entities with liquidity surpluses indirectly put these funds at the disposal of entities requiring liquidity. Group Treasury deposits any residual liquidity with its principal banks. This makes it possible to lower the borrowing volume and optimize net interest income.

Financing is carried out in the local currency of the respective borrower in order to avoid exchange rate risks or is currency hedged using cross currency swaps.

voestalpine AG carries securities and current investments as a capitalized liquidity reserve. As of March 31, 2019, freely disposable securities were EUR 182.2 million (March 31, 2018: EUR 388.1 million). Furthermore, cash and cash equivalents in the amount of EUR 485.9 million (March 31, 2018: EUR 705.8 million) are reported in the Consolidated Financial Statements.

Additionally, adequate credit lines that are callable at any time exist with domestic and foreign banks. These credit lines have not been drawn. In addition to the possibility of exhausting these financing arrangements, contractually guaranteed credit lines of EUR 700.0 million (2017/18: EUR 700.0 million) are available to bridge any economic downturns.

The sources of financing are managed pursuant to the principle that the Group must remain independent of banks. Hence financing is currently provided by approximately 20 different domestic and foreign banks. The capital market is also used as a source of financing. The following capital market transaction was effected in the business year 2017/18:

The following capital market transactions were effected in the business year 2018/19:

In April 2019, voestalpine AG successfully placed a new EUR 500.0 million corporate bond issue with a coupon of 1.75% in the capital market for general corporate funding purposes. April 10, 2019, was the value date and start of official trading of the seven-year bond (ISIN AT0000A27LQ1).

A maturity analysis of all liabilities existent as of the reporting date is presented below:

As estimated as of the reporting date, the following (prospective) interest expense corresponds to these existent liabilities:

Credit risk refers to financial losses that may occur due to non-fulfillment of contractual obligations by individual business partners.

The management of credit risks from investment and derivative transactions is governed by internal guidelines. All investment and derivative transactions are limited for each counterparty, with the size of the limit being contingent on the bank’s rating.

For the most part, cash and cash equivalents are deposited with banks whose credit ratings are good. They are generally invested for the short term. The associated credit risk thus is secondary.

The credit risk associated with derivative financial instruments is limited to transactions with a positive fair value and, in this case, to the amount of the fair value. As a result, solely the positive fair value of the derivative transactions is counted against the limit. Derivatives are closed exclusively based on standardized master agreements for financial futures transactions.

The credit risk of the underlying transactions is minimized to a large degree through a large number of credit insurances and bankable securities (guarantees, letters of credit). The default risk related to the Group’s remaining own risk is managed by way of defined credit assessment, risk evaluation, risk classification, and credit monitoring processes. The credit risk of the counterparties to financial contracts is managed by monitoring the given counterparties’ credit ratings and changes in their credit default swap (CDS) levels on a daily basis.

Depending on both the customer structure and the line of business, financial assets are deemed to have been defaulted when they are more than 180 days past due or when it is no longer certain that they will be paid in full absent collateral sales.

Receivables are classified as financial assets with impaired credit ratings when specific indicators of impairment are present (in particular, substantial financial difficulties on the part of the debtor, default or late payments, heightened risk of insolvency). Receivables are written off (derecognized) when they become uncollectible (especially when the counterparty becomes insolvent). A write-up to the amortized cost is made if the reasons for the write-down no longer exist.

The maximum theoretical default risk equals the amount at which the receivables are recognized in the statement of financial position.

The expected loss rates are determined based on historical default rates in the past five years.

As most of the receivables are insured, the risk of bad debt losses may be considered minor. There is no concentration of default risks, because the customer portfolio is well diversified.

The gross carrying amounts and allowances for trade receivables and contract assets are as follows:

The loss allowances for trade receivables and contract assets that are credit impaired have developed as follows:

In the business year 2018/19, the portfolio value adjustments were not affected by any significant individual loss allowances.

As of the reporting date, receivables of EUR 1,480.3 million were neither past due nor impaired.

The age structure of receivables that are past due but not yet impaired is presented below:

The following individual loss allowances were recognized for the voestalpine Group’s receivables during the reporting period:

The largest currency position in the Group arises from raw materials purchases in USD; however, the global business activities of the voestalpine Group also give rise to currency exposures in various other currencies.

Cash inflows and outflows in the respective currencies are offset thanks to the implementation of rolling multi-currency netting. The natural hedge created in this way mitigates risk. The use of derivative hedging instruments is another possibility. voestalpine AG hedges budgeted foreign currency payments over the next 12 months. Longer-term hedging occurs only for contracted projects. The hedging ratio is between 25% and 100%. The further in the future the cash flow lies, the lower the hedging ratio.

The net requirement for USD in the voestalpine Group was USD 615.3 million in the business year 2018/19. The decrease compared to the previous year (USD 933.8 million) was due primarily to a reduction in the volume of raw materials purchases. The remaining foreign currency exposure, resulting primarily from exports to the “non-eurozone” and raw material purchases, is significantly lower than the USD risk.

Based on the Value-at-Risk (VaR) calculation, as of March 31, 2019, the risks for all open positions for the upcoming business year are as follows:

Foreign currency Portfolio 2018/19

Taking into account the correlations between the different currencies, the resulting portfolio risk for the voestalpine Group is EUR 70.2 million (March 31, 2018: EUR 57.7 million).

voestalpine AG differentiates between cash flow risks (the risk that interest expenses or interest income will undergo a detrimental change) for variable-interest financial instruments and the present value risk for fixed-interest financial instruments. The positions shown include all interest-rate-sensitive financial instruments (loans, money market, issued and purchased securities as well as interest rate derivatives).

The primary objective of interest rate management is to optimize the interest expense subject to risk considerations. In order to achieve a natural hedge for interest-bearing positions, the modified duration of assets is closely linked to the modified duration of liabilities.

The variable-interest positions on the liabilities side significantly exceed the positions on the assets side, so that a 1% increase in the money market rate increases the interest expense by EUR 14.2 million (2017/18: EUR 8.8 million).

The weighted average interest rate for asset positions is 0.61% (2017/18: 0.42%) with a duration of 0.40 years (2017/18: 0.70 years)—including money market investments—and 1.78% (2017/18: 1.82%) for liability positions with a duration of 2.01 years (2017/18: 1.77 years).

The net present value (NPV) risk determined using the Value-at-Risk calculation for March 31, 2019, is equal to EUR 0.0 million (March 31, 2018: EUR 0.3 million) for positions on the assets side, given a 1% change in the interest rate, and EUR 88.7 million (March 31, 2018: EUR 30.5 million) for positions on the liabilities side. Therefore, in the event of a 1% drop in the interest rate, voestalpine AG would have an imputed (unrecognized) net present value loss of EUR 88.7 million (March 31, 2018: EUR 30.2 million).

The asset positions include EUR 129.6 million (March 31, 2018: EUR 337.0 million) in investments in the V54 fund of funds. One hundred percent of the fund assets are invested in euro or cash bonds and money market securities of the two sub-funds (V101 and V103) as well as in various special funds, as follows:

In addition to the investment fund, there are also securities exposures in the amount of EUR 64.3 million (March 31, 2018: EUR 55.6 million).

In the business year 2018/19, the V54 fund of funds posted gains of 0.47% (2017/18: 0.44%).

In the business year 2018/19, hedge accounting in accordance with IFRS 9 (2017/18: in accordance with IAS 39) was used to hedge foreign currency cash flows, interest-bearing receivables and liabilities, and raw materials purchase agreements. In this connection, all transactions related to foreign currency and interest rate hedges are hedged in toto. Solely the commodity index component is hedged in connection with raw materials procurement contracts. A hedging ratio of 100% is stipulated in this connection. The hedges are cash flow hedges. Hedge accounting is only applied to a portion of the completed hedge transactions.

The following derivative financial instruments are classified as cash flow hedges:

The hedging volume is as follows:

The following underlying transactions were hedged:

The cash flow hedge reserve developed as follows:

The following derivative financial instruments are measured at fair value. The associated gains/losses are posted in the income statement:

Derivatives designated as cash flow hedges have the following effects on cash flows and the profit or loss for the period:

The nominal amounts are allocated to the aforementioned maturity buckets as follows:

The item “Other” in the category “Financial assets measured at fair value through profit or loss” contains securities measured using the fair value option. The carrying amount of the financial assets represents a reasonable approximation of the fair value.

The financial liabilities measured at amortized cost, excluding bonds issued, fall under Level 2. Valuation is performed according to the discounted cash flow method, whereby the input parameters for the calculation of the market values are the foreign exchange rates, interest rates, and credit spreads observable on the market. Using the input parameters, the fair values are calculated by discounting estimated future cash flows at market interest rates.

Bonds issued are measured using Level 1 inputs based on the quoted price as of the reporting date.

The carrying amounts of trade and other payables are an appropriate approximation of the fair value.

The table below analyzes regular fair value measurements of financial assets and financial liabilities. These measurements are based on a fair value hierarchy that categorizes the inputs included in the valuation methods used to measure fair value into three levels. The three levels are defined as follows:

The derivative transactions (Level 2) are measured using the discounted cash flow method by determining the value that would be realized if the hedging position were closed out (liquidation method). The observable currency exchange rates and raw materials prices as well as interest rates are the input for the calculation of fair values. Fair values are calculated based on the inputs by discounting expected future cash flows at market interest rates.

The voestalpine Group recognizes reclassifications between different levels of the fair value hierarchy as of the end of the reporting period in which the change occurred. There were no reclassifications in the business years 2017/18 or 2018/19.

The table below presents the reconciliation of Level 3 financial assets measured at fair value between the opening balance and the closing balance, as follows:

Level 3 includes the investment in Energie AG Oberösterreich that is measured at fair value. The fair value of this entity can be reliably determined based on the valuation report that is prepared once a year for Energie AG Oberösterreich as a whole, taking into account all relevant information.

Significant sensitivities in the determination of the fair values may result from changes in the underlying market data of comparable entities and the input factors used to determine the net present value (particularly discount rates, long-term forecasts, plan data, etc.).

The receivables in this portfolio are sold monthly on a rolling basis as part of the Group’s factoring programs. The measurement gains or losses allocable to this portfolio are of secondary significance.

The credit risk associated with a particular debtor is the most important factor in the fair value determination of the portfolio entitled, “Trade and other receivables held for factoring.” Any increase/decrease by 1% in the established default rates thus would change the fair value of this portfolio at most in the same amount; as a rule, however, the fair value change is disproportionately low, because credit insurance has been purchased for significant portions of the portfolio.

The table below shows the net gains and losses on financial instruments, broken down by measurement category:

In the business year 2017/18, net profit in the amount of EUR 10.3 million was recognized through profit or loss for financial instruments that are measured using the fair value option.

Total interest income and total interest expense for financial assets and financial liabilities that were not measured at fair value through profit or loss are as follows:

The impairment loss on financial instruments measured at AC is EUR 13.4 million (2017/18: EUR 7.4 million), and the reversals of loss allowances are EUR 3.7 million (2017/18: EUR 8.2 million).