Currency risks Interest rate risks Credit risks Liquidity risks Operational risks of operating activities Operation interruptions or failures Legislative operational risks
Based on the risk evaluation, the risk catalogue also includes the risk management scenario.
Catastrophic
Effect/impact
Management Removal
Major or
Moderate Acceptance transfer
Minor and management
Insignificant Acceptance
Management scenario
Probability Low,
infrequent Not very likely Possible Probable Almost certain
RISKS RELATED TO THE ENVIRONMENT AND THE INDUSTRY IN WHICH THE GROUP IS ACTIVE
Some of the identified risks are directly related to the environment or the industry in which we are active. Our results depend to a considerable extent on the macroeconomic situation in respec- tive key markets in which we conduct our activities. Our performance is especially affected by factors like the GDP in individual markets and fluctuations thereof, inflation rate, exchange rates, interest rates, transport costs, fuel prices, unemployment rate, changes in purchasing power of consumers, and the fiscal and monetary policy in the countries where we are active. Unfavourable changes of the general macroeconomic situation in the EU or globally can result in a drop of de- mand for our products and services, which in turn can cause a decrease in our revenue and have a negative impact on our financial position. Moreover, instability or disturbances in financial mar- kets, which may in particular stem from the macroeconomic environment, can restrict access to external sources of financing. Such restrictions of access to external financing or increase of the costs thereof may affect our ability to efficiently carry out our investment projects and strategies. Macroeconomic situation can also increase the risk of insolvency of our customers, which may lead to problems in collection of receivables or debt, and loss of key customers. Such unfavour- able circumstances may have a material adverse effect on our operations, financial statements, financial position, and our development potential.
The largest cost component is the cost of raw and processed materials, which is exposed to volatility of commodity prices in commodity and non-commodity markets. Raw material price volatility is further aggravated by the fluctuations in the exchange rate of US dollar relative to the Group's functional currency (the euro). In order to alleviate the risk of changes in raw material prices we employ relevant risk mitigation instruments, especially long-term contractual relation- ships with our key suppliers, and, to a lesser extent, futures contracts. Monitoring the trends in raw material prices and expectations in supply chains, and a wide supplier chain are the key controls employed to mitigate the risks in this field to acceptable levels.
FINANCIAL RISKS
We are exposed to many financial risks that include especially the following: credit risk, li- quidity risk, currency risk, risk of change in interest rates, and other risks related to changes in market terms and conditions. Following is an account of the key financial risks and the measures for their management. For more explanations regarding financial risks, please see the Financial Report part of the Annual Report, chapter Financial Instruments and Fi- nancial Risks.
CURRENCY RISKS
As our operations are broadly internationalized, we are exposed to the risk of changes in exchange rates. Namely, a change in the exchange rate between a particular currency and the Group's functional value (the euro) could result in a decrease of economic benefits for the Group. The currency risk pertains mainly to our business activities in the markets of Russia, Serbia, Australia, Great Britain, the Czech Republic, Poland, Hungary, Croatia, Ukraine, and all US dollar markets.
In these currencies, the Group balance sheet reports an excess of assets over liabilities, which is treated as a long currency position. Key accounting categories constituting a cur- rency position include trade receivables (from end users) and trade payables (to suppliers).
The exception is the US dollar for which we have an excess of liabilities over assets as the purchases from the dollar markets exceed our sales in this currency. To a lesser extent, the exposure of financial position is related to our debt in local currencies.
In 2014, the Group adopted the Currency Risk Management Policy which, inter alia, specifies the following:
• methodology of currency risk exposure measurement; • powers and responsibilities in currency risk management; • methods and required scope of currency risk management
hedging;
• acceptable currency risk hedging instruments; • acceptable currency risk hedging partners; and
• method for evaluating the performance of currency risk management.
In addition to natural currency risk hedging with internal tech- niques that involve adjusting the purchasing and sales in re- spective currencies, taking out loans in the currencies with as- set exposure, and other internal mechanisms, we also actively hedge our currency risks. Thus, we regularly and continuous- ly, on a 12-month basis, take out acceptable currency hedging instruments .The level of such hedging normally includes 60 to 80 percent of the planned cash flow. Hedging with short- term forward exchange contracts is based on planned cash flows in each currency. Required level of hedging was defined based on the ratio between the effect of each currency on the Group performance (operations volume) and probability of a change in the exchange rate (currency volatility).
Currency risk management is centralized. A currency risk man- agement council was also appointed. The parent company is signing currency risk hedging instruments both on its behalf and on behalf of other Group companies, transferring them contractually to the companies locally exposed to such risk. To a limited extend, the subsidiaries sign instruments in local mar- kets as well, while the parent company provides support and credit limits with acceptable hedging partners. By employing the centralized approach to currency risk management we can come closer to optimum effects of currency risk hedging.
CREDIT RISKS
Our operations extend over a number of geographical regions and as a result, the Group has many customers from around the globe. While they are mostly legal persons, our customers also include natural persons in the retail segment. As a general rule, we only work with customers with suitable credit rating which we regularly monitor. In addition, we have defined clear rules regard- ing credit limit approval for each customer. To this end, we adopt- ed the revised receivables management policy which defines the receivables management processes, responsible persons, and acceptable credit risk management or insurance instruments. This policy, adopted at the Group level, also provides a mandato- ry framework for the receivables management rules and policies adopted and integrated into their processes by our subsidiaries. Simultaneously, we are implementing at all companies in the business segment Home the credit risk management information module, in order to automate the process of monitoring and col- lection of receivables and credit limits, which in turn will lead to a lower share of overdue or delinquent receivables, and to gradual increase of the share of insured receivables.
Changing macroeconomic environment affects our business partners as it can cause instant changes in their credit rating, liquidity or solvency. Therefore, there is still some probability of payment delinquency on the part of our customers or even de- fault, despite the receivables management process in place at the Group. Considering the fact that our Group involves a highly diversified sales model with little concentration of receivables on individual customers or a group of customers related through mutual equity ownership, we find the Group's credit risk moder- ate. No single customer or a group of customers related through mutual equity ownership represents 10 percent or more of the Group's total sales, and exposure to a particular customer or group of customers does not represent 10 percent of the Group's total receivables.
All customers whose receivables exceed EUR 5,000 are included in the credit rating control process that also includes insuring the receivables with acceptable insurance instruments. Consistently with the receivables management policy, the following accept- able insurance instruments have been defined:
• receivables insurance by credit insurance companies; • receivables insurance with bank guarantees and letters of
credit;
• factoring without recourse;
• exceptionally, subject to special approval, pledge or mortgage
At the end of 2014, 61.6% of total Group trade receivables were insured with acceptable insurance instruments, which is 5.6 percentage points better than at the end of the preced- ing period. The share of insured receivables in the business segment Home is 64.7%, or 5.9 percentage points more than at the end of 2013. Most trade receivables are insured by SID - Prva kreditna zavarovalnica. A part of the receivables is also insured by credit insurance companies in respective lo- cal markets, and by other acceptable insurance instruments. It should be added that no insurance is required from a minor share of customers, confirmed in a special procedure, due to their excellent credit rating which we are regularly monitor- ing. In case of some trade receivables with no insurance, we have offsetting transactions, i.e. our customers are also our suppliers. Moreover, there are many small customers who are highly dispersed, leaving the credit risk regarding each individual customer very low.
We are carefully monitoring the credit risk in other business segments as well. Short-term surplus of funds and cash in commercial bank accounts is allocated in compliance with our corporate policies that also include the methodology of deter- mining acceptable financial partners or parties. These policies also specify the methodology of determining the acceptable financial partners in signing derivative financial instruments.
LIQUIDITY RISKS
Liquidity risk is the risk that the Group will fail to meet com- mitments in stipulated period of time due to the lack of avail- able funds.
Liquidity depends on efficient cash management and invest- ment dynamics. At the Group, we actively manage the liquid- ity risk by centralized monitoring and balancing the liquidity of our assets (especially receivables and inventories), liabili- ties, and cash flows from operating and investing activities. Cash management for the entire Group is centralized and supported by cash flow planning and daily monitoring soft- ware. A lot of attention is paid to drawing up and monitoring of the cash flow plan. Successful liquidity planning allows us optimum management of any short-term surpluses or defi- cits of liquid assets.
We have implemented a uniform and centralized approach to banking partners both in Slovenia and abroad, through which the parent company manages optimum debt of the entire Group, taking into account the aspects of extent, costs, maturity, and currency balance.
In order to diversify the financing sources, we successfully issued in 2014 for the second time short-term commercial paper in total nominal amount of EUR 35,000 thousand. Short-term is- sues of commercial paper, which we continue to employ in 2015 (the third issue of short-term commercial paper was offered in February 2015 in the nominal amount of EUR 27,000 thousand), are intended for balancing the seasonal dynamics of cash flow from operating and investing ac- tivities. These cash flows are, as a general rule, negative in the first half of the year, followed by gradual improvement throughout the rest of the calendar year. Short-term cash flow disbalance is additionally managed by taking out short-term revolving loans and credit limits on current ac- counts with commercial banks in Slovenia and abroad. At the end of the year, the liquidity reserve, consisting of unused approved credit lines, available cash and cash equivalents in accounts, and fixed-term deposits with commercial banks amounted to EUR 109,349 thousand. Liquidity re- serve is intended for short-term cash flow management and it considerably mitigates the Group's short-term liquidity risk.
The Group has in place a long-term plan for servicing its financial liabilities which is regularly up- dated. In 2014, we extensively restructured the maturity profile of our debt. This included replacing all borrowings gradually maturing in 2014 with long-term financing sources. This process included the following:
• improving the maturity profile of our financial liabilities by 23.5 percentage points – at the end of 2014, long-term financial liabilities accounted for as much as 73.5% of total financial liabilities; • issuing 5-year amortizing bond (note) GV01 in the total nominal amount of EUR 73,000 thousand,
thus diversifying the financing sources in the long-term part of our debt as well. In addition to short-term commercial paper, the issue of long-term bond provides extra assurance that other investors, besides the banks, have confidence in the Group;
• carrying out the third round of parent company capital increase from authorized capital pursuant to the Shareholders Assembly resolution dating from 2013. Consistently with the Shareholders Assembly decision, the capital increase amount was EUR 10,000 thousand, and it was carried out by means of a debt-to-equity swap;
• reducing the Group's total financial liabilities by EUR 29,807 thousand; • notably decreasing the amount of required financing for the year 2015. INTEREST RATE RISKS
Financing of the Group's current operations and its investment activities involves interest rate risk, since a good part of the loans taken out depends on the variable interest rate Euribor or other local variable reference interest rates. Interest rate risk exposure thus includes especially changes (increase) in the Euribor that are unfavourable for the Group's financial liabilities. A large part of financial liabilities involve a variable interest rate that depends on the 3-month or 6-month Euribor. The interest structure of financial assets and liabilities is not balanced as the Group has consid- erably more financial liabilities than interest-earning financial assets. In 2014, we considerably increased the amount of our financial liabilities with a fixed variable rate, which is largely the result of the issue of the GV01 bond (note) with a fixed nominal rate of 3.85% in 2014. The proceeds from the issue of the bond replaced the financial liabilities with a variable interest rate. The share of non-derivative financial liabilities with a fixed interest rate rose by 20 percentage points and amounted to 28% of total financial liabilities as at December 31, 2014. After 2014, the share of liabilities with a fixed interest rate was further increased.
As at December 31, 2014, we also held interest rate swaps in the amount of EUR 28,300 thousand. Both currency and interest rate derivatives are only signed with acceptable partners. We therefore find the risk of failure on the part of our contractual partners to fulfil their contractual obligations minimal. In 2014, variable interest rates were mostly on a downward trend. Therefore, we did not sign new derivative financial instruments intended for hedging the risk of an increase in the variable interest rate. The share of financial liabilities for which fixed interest rates were agreed or hedg- ing instruments were signed was 35% at the end of 2014. Despite the fact that we did not take out interest rate risk hedging instruments in 2014, we are regularly and continuously monitoring the financial markets in order to allow timely measures in case of macroeconomic changes.