Financial risk management
The information below is from the Annual Report 2019.
Foreign exchange risk
Foreign exchange exposures are monitored at the Business level, hedged at company level against the Group Treasury and then netted and covered externally at Group level by the Group Treasury. All material fixed sales and purchase contracts, including both future cash flows and related accounts receivable and payable, are hedged. The estimated future commercial exposures are evaluated by the Businesses, and the level of hedging is decided by the Board of Management. Hedge accounting in accordance with IFRS 9 is applied to most of the hedges of these exposures. The hedges cover such time periods that both the prices and costs can be adjusted to new exchange rates. These periods vary among Group companies from one month to two years. The Group also hedges its position of the statement of financial position, which includes cash balances, loans/deposits as well as other receivables and payables denominated in foreign currencies.
As field service work is invoiced in local currencies, there is some foreign exchange changes related volatility in the Group’s turnover. However the effect to the profitability is limited as the related costs are in the same currency. Spare part sales are based on euro price list and related purchases in non-euro currencies are hedged, so effect from foreign currency rate changes to spare part sales in minimal. As both Marine and Energy Business project/hardware sales/purchases as well as estimated currency exposures from long-term agreements are hedged, the Group does not expect significant gains/losses from foreign exchange rate changes in 2020 related to its operations excluding internal financing.
Fixed sales and purchase contracts are usually hedged by using foreign exchange forwards to offset currency spot rate related changes to the value of the underlying cash flows. As the aim is to hedge and apply hedge accounting (cash flow hedging) only to the foreign exchange spot risk, all interest rate/hedge timing related gains/losses are booked directly into the financial items. As the underlying cash flows can have long maturities, the related hedges can be done with shorter maturities and they can be rolled over when needed, so that at the maturity the total currency rate related gains/losses from these hedges are expected to fully offset the related gains/losses from the underlying cash flows. Because the hedge relation is based on matching critical terms (except the timing), the hedge ratio is 1:1. A cancellation or reduction of sales/purchase value of an order can cause adjustment to the related hedge and any related gains/losses will be immediately recognised in the statement of income.
As external hedges are typically done on short maturities (up to 1 year) and only high credit quality (A- minimum rating requirement) counterparties are utilised, counterparty credit risk is expected to have minimal effect on hedge valuations. Due to some underlying hedged cash flows having longer maturities than related hedges the change in present value of the hedge and underlying cash flow does not always fully offset each other during the lifetime of a hedge. This ineffectiveness is calculated on quarterly basis and will be booked on Group level in financial items.
The instruments, and their nominal values, used to hedge the Group’s foreign exchange exposures are listed in Note 30. Derivative financial instruments.
Since Wärtsilä has subsidiaries and joint ventures outside the euro zone, the Group’s equity, goodwill and purchase price allocations are sensitive to exchange rate fluctuations. At the end of 2019, the net assets of Wärtsilä’s foreign subsidiaries and joint ventures outside the euro zone totalled EUR 1,041million (979). In addition, goodwill and purchase price allocations from acquisitions nominated in foreign currencies amounted to EUR 926 million (932). In 2019, the translation differences recognised in OCI mainly come from changes in GBP exchange rate.
In 2019, EUR 4 million (-14) fair value adjustments related to cash flow hedges were recognised in equity. EUR 19 million (-8) of the fair value adjustments were transferred from equity to the statement of income as net sales or operating expenses during 2019. In 2019, the result from ineffective portion of the cash flow hedges or gain/loss from cancelled projects was EUR -5 million (-2), which was booked in financial items and specified in Note 11. Financial income and expenses.
Approximately 67% (67) of sales and 59% (65) of operating costs in 2019 were denominated in euros, and approximately 20% (21) of sales and 10% (8) of operating costs were denominated in US dollars. The remainder were split between several currencies. The Group’s profits and competitiveness are also indirectly affected by the home currencies of its main competitors: USD, GBP, JPY and KRW.
As Wärtsilä's operations are global they often involve currency risks. The largest operative currency positions (excluding financing) open as of 31 December 2019 by currency pair are listed below.
Interest rate risk
Wärtsilä is exposed to interest rate risk primarily through market value changes to the net debt portfolio (price risk) and also through changes in interest rates (re-fixing on rollovers). Interest rate risk is managed by constantly monitoring the market value of the financial instruments and by using sensitivity analysis.
Interest-bearing loan capital at the end of 2019 totalled EUR 908 million (823). The average interest rate was 0.9% (1.0) and the average re-fixing time 21 months (27).
Wärtsilä spreads its interest rate risk exposure by taking both fixed and floating rate loans. The share of fixed rate loans as a proportion of the total debt can vary between 30–70%. The Board of Directors has given authorisation to temporarily increase the share of fixed loans up to 100%, and the authorisation is valid until January 2022. Wärtsilä hedges its loan portfolio by using derivative instruments such as interest rate swaps, futures and options.
Liquidity and refinancing risk
Wärtsilä ensures sufficient liquidity at all times by efficient cash management and by maintaining sufficient committed and uncommitted credit lines available. Refinancing risk is managed by having a balanced and sufficiently long loan portfolio.
The existing funding programmes include:
• Committed Revolving Credit Facilities totalling EUR 640 million (640).
• Finnish Commercial Paper programmes totalling EUR 800 million (800).
The average maturity of the non-current debt is 46 months (49) and the average maturity of the confirmed credit lines is 30 months (31). Additional information in Note 28. Financial liabilities.
At year-end, the Group had cash and cash equivalents totalling EUR 369 million (487), of which EUR 11 million is related to assets held for sale, as well as EUR 640 million (640) non-utilised committed credit facilities. Commercial Paper Programmes were not utilised on 31 December 2019 nor on 31 December 2018.
Committed Revolving Credit Facilities as well as the parent company's long-term loans include a financial covenant (solvency ratio). Solvency ratio is expected to remain clearly over the covenant level for the foreseeable future.
The responsibility for managing the credit risks associated with ordinary commercial activities lies with the Businesses and the Group companies. Major trade and project finance credit risks are minimised by transferring risks to banks, insurance companies and export credit organisations.
The credit risks related to the placement of liquid funds and to trading in financial instruments are minimised by setting explicit limits for the counterparties and by making agreements only with the most reputable domestic and international banks and financial institutions. As only high credit quality (A- minimum rating requirement) counterparties are utilised for derivative financial instruments and the transactions are done under ISDA Master Agreements, no credit losses are expected from these instruments.
The Group companies deposit the maximum amount of their liquid financial assets with the centralised treasury when local laws and central bank regulations allow it. The Group’s funds are placed in instruments with sufficient liquidity (current bank deposits or Finnish Commercial Papers) and rating (at least single-A rated instruments or other instruments approved by the Group’s CFO). These placements are constantly monitored by the Group Treasury, and Wärtsilä does not expect any future defaults from the placements.
The expected credit losses associated with investments carried at amortised cost are assessed on a forward-looking basis based on investment maturity dates and counterparty credit risk on quarterly basis. As of 31 December 2019 the expected credit loss was not material.
Aging of trade receivables
For trade receivables and receivables from revenue recognised over time in accordance with the input method, simplified approach is used and the loss allowance is measured at the estimate of the lifetime expected credit losses. Receivables from revenue recognised over time in accordance with the input method are usually covered with advance payments collected from customers. Thus, recognising credit losses based on the lifetime expected loss amounts mainly concerns trade receivables. For trade receivables not due or maximum 359 days overdue, an impairment of 0.1%–2.0% is made, depending on the aging category and the origin of the receivable. In calculating the expected credit loss rates, the Group considers historical loss rates for each category, and adjusts for forward-looking macroeconomic data. In addition to that, trade receivables more than 360 days old are assessed for impairment individually.
Equity price risk
Wärtsilä has equity investments totalling EUR 14 million (13) in power plant companies, most of which are located in developing countries and performing well according to expectations. Additional information in Note 18. Financial assets and liabilities by measurement category.
Capital risk management
Wärtsilä’s policy is to secure a strong capital base to keep the confidence of investors and creditors and for the future development of the business. The capital is defined as total equity including non-controlling interests and net interest-bearing debt. The target for Wärtsilä is to maintain gearing below 0.50 and to pay a dividend of at least 50% of earnings over the cycle.