Financial risks
Financial instruments
Financial risks are referring to financial instruments. Alfa Laval has the following instruments: cash and bank, deposits, trade receivables, bank loans, trade payables and a limited number of derivative instruments to hedge primarily currency rates or interests, but also the price of metals and electricity. These include currency forward contracts, currency options, interest-rate swaps, metal forward contracts and electricity futures. See Notes 12 and 13 for more information on these financial instruments.
Financial policy
In order to control and limit the financial risks, the Board of the Group has established a financial policy. The Group has an aversive attitude toward financial risks. This is expressed in the policy. It establishes the distribution of responsibility between the local companies and the central finance function in Alfa Laval Treasury International AB, what financial risks the Group can accept and how the risks should be limited.
Price risk
There are three different types of price risks: currency risk, interest risk and market risk. See below.
Currency risk
Due to the Alfa Laval Group’s international business activities and geographical spread the Group is exposed to currency risks. The exchange rate movements in the major currencies for the Group during the last years are presented to the right (SEK/ foreign currency):
Currency risk is divided into transaction exposure that relates to exchange rate fluctuations that affects the currency flows that arise due to the business activities and translation exposure that relates to the translation of the subsidiaries’ balance sheets from local currency to SEK.
Transaction exposure
During 2008 Alfa Laval’s sales to countries outside Sweden amounted to 96.5 (96.0) (95.7) percent of total sales.
Alfa Laval’s local sales companies normally sell in domestic currency to local end customers and have their local cost base in local currency. Exports from production and logistical centres to other Group companies are invoiced in the exporting companies’ domestic currencies, except for Sweden, Denmark and UK where the exports are denominated in EUR.
The Group is principally exposed to currency risk from potential changes in contracted and projected flows of payments and receipts. The objective of foreign exchange risk management is to reduce the impact of foreign exchange movements on the Group’s income and financial position.
The Group normally has natural risk coverage through the sale as well as costs in local currencies. The financial policy states that the local companies are responsible for identifying and hedging exchange rate exposures on all commercial flows via Alfa Laval Treasury International. Contract based exposures must be fully hedged. In addition, the balance of projected flows the next 12 months must be hedged to at least 50 percent. The remaining part of the projected flows can be partially hedged after conferring with the Group’s central finance function. Alfa Laval Treasury International can add to or reduce the total hedging initiated by the local companies in the
currencies that Alfa Laval has commercial exposure up to but not exceeding 100 percent of one year’s commercial exposure for each currency.
The Group’s net transaction exposure in different currencies before and after derivatives during 2008 has amounted to:
This is a reflection of the fact that a substantial part of the production within the Group is located in Sweden and Denmark with costs denominated in local currencies.
Currency contracts for projected flows are entered into continuously during the year with 12 months maximum duration. For contract based exposures the derivatives follow the duration of the underlying contract. This means that the company experiences the effects from the market currency rate movements with a varying degree of delay
If the currency rates between SEK and the most important foreign currencies are changed by +/- 10 % it has the following effect on operating income, if no hedging measures are taken:
Exchange rate change against SEK 2008     2007   2006  
               
In SEK millions +10% -10% +10%   -10% +10% -10%
Effect on operating income              
without hedging measure              
USD 443 -443 274   -274 161 -161
EUR 163 -163 87   -87 125 -125
CAD 42 -42 24   -24 27 -27
NOK 33 -33 20   -20 15 -15
DKK -128 128 -79   79 -136 136
JPY -119 119 -60   60 20 -20
Total 45 -45 42   -42 39 -39
Total 479 -479 308   -308 251 -251
Outstanding currency forward contracts and currency options for the Group amounted to the following at the end of the year:
In millions   2008     2007     2006  
  Original     Original     Original    
Outflows currency   SEK currency   SEK currency   SEK
EUR -360   -3,965 -242   -2,294 -118   -1,065
USD -740   -5,775 -656   -4,250 -593   -4,073
DKK -93   -137 -398   -505 -685   -830
CAD -32   -205 -29   -194 -7   -41
NOK -   - -12   -14 -40   -43
GBP -2   -23 -3   -41 0   0
Other     -115     -82     -70
Total     -10,220     -7 380     -6 122
In millions   2008     2007     2006  
  Original     Original     Original    
Inflows currency   SEK currency   SEK currency   SEK
SEK 8,689   8,689 5,937   5,937 5,444   5,444
JPY 11,493   995 18,415   1,056 14,311   827
INR 1,153   186 -   - -   -
NOK 70   77 -   - -   -
SGD 7   35 18   80 18   80
GBP -   - -   - 2   25
Other     19     106     3
Total     10,001     7,179     6,379
Translation exposure
When the subsidiaries’ balance sheets in local currency are translated into SEK a translation difference arises that is due to the current year being translated at a different closing rate than last year and that the income statement is translated at the average rate during the year whereas the balance sheet is translated at the closing rate at December 31. The translation differences are reported in the equity capital. The translation exposure consists of the risk that the translation difference represents in relation to changes in the equity capital. The risk is largest for the currencies where the Group has the largest net assets and where the exchange rate movements against SEK are largest. The Group’s net assets or liabilities for the major currencies are distributed as follows:
The translation differences are a central responsibility and are managed by distributing the loans on different currencies based on the net assets in each currency and through currency forward contracts. Loans taken in the same currency as there are net assets in the Group, decrease these net assets and thereby decrease the translation exposure.
These hedges of net investments in foreign operations work in the following way. Exchange gains and losses on loans denominated in foreign currencies that finance acquisitions of foreign subsidiaries are transferred to equity as foreign currency translation adjustments if the loans act as a hedge to the acquired net assets. In equity they offset the translation adjustments resulting from the consolidation of the foreign subsidiaries. In the Group, net exchange differences of SEK -468 (13) (55) million relating to debts in foreign currencies have been charged to equity as hedges of net investments in foreign operations. The loans that hedge net investments in foreign operations are denominated in EUR and USD since these foreign currencies have the largest impact on the balance sheet. Since the Group uses part of its cash flows to amortise the loans in order to improve the financial net, the extent of this hedge tends to decrease over time.
Interest risk
By interest risk is meant how changes in the interest level affect the financial net of the Group and how the value of financial instruments vary due to changes in market interest rates. The Group attempts to manage interest-rate risk by matching fixed interest periods of financial assets and liabilities and through the use of derivative financial instruments such as interest-rate swaps.
The financial policy states that the interest rate risk and duration are measured by each main currency. The minimum interest duration for the loans should be 10 months and the maximum interest duration should be 24 months according to the policy.
The senior credit facility and the bilateral term loan accrue interest at floating
Jan 06