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Note 27 Derivatives

Accounting principles

Derivative financial instruments and hedging

Financial derivatives are initially recognised in the Consolidated statement of financial position at fair value and subsequently measured at their fair value at each reporting date, though the method of recognising the resulting gains or losses is dependent on the nature of the item being hedged. When derivative contracts are entered into, the Group designates them as either hedges of the exposure to changes in the fair value of recognised assets or liabilities (fair value hedges), hedges of forecast transactions or firm commitments (cash flow hedges), hedges of net investments in foreign entities or derivative financial instruments not meeting the hedge accounting criteria in accordance with IAS 39.

At the inception of a transaction, the Group documents the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all financial instruments designated as hedges to specific assets and liabilities or to specific firm commitments or forecast transactions. The Group also documents its assessment, both at the hedge inception and on an ongoing basis, of whether the derivatives used in hedging transactions are highly effective in offsetting changes in fair value or cash flows of hedged items.

Fair value hedges

In case of fair value hedges, the Group uses either derivatives or borrowings for this purpose. The gains and losses on hedging instruments designated and qualifying as fair value hedges, and which are highly effective, are recorded in the Consolidated income statement, along with any changes in the fair value of the hedged assets or liabilities attributable to the hedged risk.

Cash flow hedges

Changes in the fair value of derivatives designated and qualifying as cash flow hedges, and which are effective, are recognised in cash flow hedges reserve within OCI, the movements of which are disclosed in the Consolidated statement of comprehensive income. The cumulative gain or loss of a derivative deferred in equity is transferred to the Consolidated Income Statement and classified as income or expense in the same period in which the hedged item affects the Consolidated income statement. In respect of hedges of exposures to foreign currency risk of future transactions resulting in the recognition of non-financial assets, the gains and losses deferred to cash flow hedges reserve within OCI are transferred from equity to be included in the initial acquisition cost of the non-financial assets at the time of recognition. The deferred amounts are ultimately recognised in the Income Statement through depreciation over the lifetime of those non-financial assets.  The changes in the time value component of the currency options are classified as financial income and expense and not included in the hedge designation.

When a hedging instrument expires, or is sold, terminated or exercised, or has its designation revoked or no longer meets the criteria for hedge accounting under IAS 39, any cumulative gain or loss deferred in equity at that time remains in equity and is accounted for as an adjustment to income or expense when the committed or forecast transaction is ultimately recognised in the Consolidated income statement. However, if the predicted transaction is no longer expected to occur, the cumulative gain or loss reported in equity from the period when the hedge was effective is recognised in the Consolidated income statement immediately.

Net investment hedges

Hedges of net investments in foreign entities are accounted for similarly to cash flow hedges, and the Group uses either derivatives or borrowings for this purpose. If the hedging instrument is a derivative, any gain or loss thereon relating to the effective portion of the hedge is recognised in equity in CTA, as disclosed in the Consolidated statement of comprehensive income; the gain or loss relating to the ineffective portion is immediately recognised in the Consolidated income statement. In addition, exchange gains and losses arising on the translation of a borrowing that hedges such an investment are also recognised in CTA, any ineffective portion being immediately recognised in the Consolidated income statement. 

Fair value through profit and loss derivatives

Certain derivative transactions, while providing effective economic hedges under Group risk management policies, do not qualify for hedge accounting under the specific rules in IAS 39 and therefore changes in the fair value of such non-qualifying hedge instruments together with any ineffectiveness of hedge-accounted instruments are accounted for at fair value in the Consolidated income statement. Fair value changes of derivative instruments relating to sales, purchases and staff benefits are presented under operating profit and specified in Note 27 Derivatives and in Note 6 Personnel expenses. Fair value changes from all other derivatives are recognised in the Consolidated income statement under financial items.

Valuation of derivatives

Derivative financial instruments are recorded in the Statement of financial position at their fair values defined as the amount at which the instrument could be exchanged in an orderly transaction between market participants at the measurement date. The fair values of such financial items have been estimated on the following basis:

  • Currency option contract values are calculated using year-end market rates together with common option pricing models. 
  • The carrying amounts of foreign exchange forward contracts are calculated using forward exchange rates at the reporting date.
  • The fair values of interest rate swaps are calculated using a discounted cash flow analysis.
  • Commodity contract fair values are computed with reference to quoted market prices on futures exchanges or other reliable market sources.
  • The fair values of Total Return (Equity) Swaps are calculated using year-end equity prices as well as year-end interest rates.

 

Shareholders’ equity – other comprehensive income

Certain derivatives are designated as cash flow hedges and measured at fair value with the fair value movements recorded in the separate equity category of OCI: Cash Flow Hedges Reserve. The other component of OCI is the Available-for-Sale Investments Reserve representing the difference between the reporting date fair value of investments and their initial fair value at acquisition (see Note 14 Available-for-sale investments).

Cash flow hedges

In the Group the estimated net amount of unrealised cash flow hedge gain net of taxes amounted to EUR 15 (EUR loss 11) million of which a gain of EUR 14 (EUR loss 23) million related to currencies and a gain of EUR 1 (EUR gain 12) million related to commodities. The unrealised gains and losses are expected to be recycled through the Income Statement within one to three years with the longest hedging contract maturing in 2027 (2027), however the majority are expected to mature in 2018. Any hedge ineffectiveness is presented as an adjustment to sales or to materials and services, depending on the underlying exposure, totalling EUR nil (EUR loss 2) million for commodity contract hedges and EUR loss 2 (EUR nil) million for currency hedges. Derivatives used in currency cash flow hedges are mainly forward contracts and options, with swaps mainly used in commodity hedges and interest rate cash flow hedges.

In the Beihai Mill project in Guangxi, China, the Group has hedged its exposures to the foreign currency risk of future transactions resulting in the recognition of non-financial assets. The gains and losses deferred to OCI cash flow hedges reserve are transferred from equity to be included in the initial acquisition cost of the non-financial assets at the time of recognition. During the year, the total amount removed from equity and included in the initial cost of non-financial assets amounted to EUR nil (EUR loss 4) million. At the year end, there were no hedges outstanding as the last hedges related to Beihai Mill matured during 2017.

In 2015, the Group entered into new interest rate swap derivatives with a total nominal value of EUR 150 million. The swaps have been designated as cash flow hedges of 2015 issued EUR bond notes maturing in 2025 and 2027 with hedge result being booked to Cash Flow Hedges Reserve in OCI. During 2017 the Group closed its non-hedge accounted equity swaps (TRS).

Equity accounted investments

Associate companies record hedges and pensions-related amounts directly in equity, and the Group also records its share of these amounts in equity in the “OCI of Equity Accounted Investments” classification.

OCI equity accounted investments
Year Ended 31 December
EUR million 2017 2016
Bergvik Skog AB -14 -19
Total -14 -19

Fair values of derivatives

Hedge gains and losses in financial items
Year Ended 31 December
EUR million 2017 2016
Non-qualifying Hedges
Net losses on interest rate derivatives - -4
Net gains on currency derivatives 24 30
Net Gains in Financial Items 24 26

Hedge gains and losses in operating profit
Year Ended 31 December
EUR million 2017 2016
Cash Flow Hedge Accounted
Currency hedges 9 8
Commodity contract hedges -44 3
Total -35 11
As adjustments to Sales -39 16
As adjustments to Materials and services 4 -5
Realised from OCI through Income Statement -35 11
Currency hedges ineffectiveness -2 -
Commodity contract hedge ineffectiveness - -2
Net Losses/Gains from Cash Flow Hedges -37 9
Non-qualifying Hedges
Currency hedges 15 -9
Net Gains/Losses on Non-Qualifying Hedges 15 -9
Net Hedge Losses in Operating Profit -22 -

In 2017 the Group ceased hedge accounting for one of its subsidiaries because the forecasted future transactions were no longer expected to occur. This resulted in a loss of EUR 2 (EUR loss 2) million being booked as operating profit and the loss being presented in the above table as ineffectiveness from cash flow hedges.

Fair values of derivative instruments
As at 31 December
EUR million Positive
Fair Values
Negative
Fair Values
Net Fair Values Net Fair Values
2017 2016
Cash flow hedge accounted
Currency forward contracts 19 -5 14 -9
Currency options 15 -9 6 -19
Commodity contracts 14 -13 1 15
Interest rate swaps 1 -5 -4 -7
Non-qualifying hedges
Currency forward contracts 15 -3 12 5
Commodity contracts 1 -1 - -
Equity swaps (TRS) - - - 3
Total 65 -36 29 -12
Positive and negative fair values of financial instruments are shown under Interest-bearing Receivables and Liabilities and Non-current Debt with the exception of TRS, which is shown under Operative Receivables and Liabilities.

 The presented fair values in the previous table include accrued interest and option premiums.

 

Nominal values of derivative financial instruments
As at 31 December
EUR million 2017 2016
Interest Rate Derivatives
Interest rate swaps
Maturity 6–10 years 192 181
Maturity over 10 years - 25
Total 192 206
Foreign Exchange Derivatives
Forward contracts 1 682 1 783
Currency options 1 362 1 525
Total 3 044 3 308
Commodity Derivatives
Commodity contracts 282 319
Total 282 319
Total Return Swaps
Equity swaps (TRS) - 25
Total - 25
Contractual derivatives maturity repayments gross settlement
As at 31 December 2017 As at 31 December 2016
EUR million 2018 2019+ 2017 2018+
Currency Forwards and Options: Cash Flow Hedges
Outflow 1 187 - 1 214 -
Inflow 1 205 - 1 190 -
Currency Forwards and Options: Fair Value in Income Statement
Outflow 767 86 1 053 92
Inflow 777 81 1 054 81

The above table analyses the Group’s derivative financial instruments to be settled on a gross basis into relevant maturity groupings based on the remaining contract period at the reporting date.

Contractual payments for net-settled derivative financial liabilities in the following maturity groupings were: EUR 28 (EUR 6) million within one year and EUR 4 (EUR 8) million within two to five years.

Financial impact of netting for instruments subject to an enforceable master netting agreement 2017
Not offset in the Statement of Financial Position
EUR million Gross amount of recognised financial instruments Related liabilities (-) or assets (+) subject to Master Netting Agreements Collateral received (-) or given (+) Net Exposure
Derivative assets 62 -37 - 25
Derivative liabilities -37 37 - -
Financial impact of netting for instruments subject to an enforceable master netting agreement 2016
Not offset in the Statement of Financial Position
EUR million Gross amount of recognised financial instruments Related liabilities (-) or assets (+) subject to Master Netting Agreements Collateral received (-) or given (+) Net Exposure
Derivative assets 40 -40 - -
Derivative liabilities -56 40 - -16

The Group enters into derivative transactions under master netting agreements agreed with each counterparty. In case of an unlikely credit event, such as default, all outstanding transactions under the agreements are terminated and only a single net amount per counterparty is payable for settlement of all transactions. The agreements do not meet the criteria for offsetting in the Statement of financial position because offsetting is enforceable only on the occurrence of certain future events.

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