Financial risks relate to the Company’s financial position, financing and cash flows generated by the business, including for- eign exchange risk and interest rate risk. The Company’s liquidity and capital resources are described in note 2.
Under the current financing agreements, TORM is prohibited from hedging its currency and interest rate exposures. The risks related hereto are uncovered, and as a result the entire debt is uncovered in relation to interest risk, and non-USD denominated expenses are exposed to foreign exchange risk. Any changes in interest rates and foreign exchange rates could therefore have a material adverse effect on TORM’s future performance, results of operations, cash flows and financial position. Going forward, TORM may obtain con- sent to increase the use of derivatives, and then the policies and guidelines mentioned under the various risks will still apply. FOREIGN EXCHANGE RISK
TORM uses USD as its functional currency because the majority of the Company’s transactions are denominated in USD. The foreign exchange risk is thereby limited to cash flows not denominated in USD. The primary risk relates to transactions denominated in DKK, EUR and SGD and relates to administrative and operating expenses.
The part of the Company’s expenses that are denominated in cur- rencies other than USD account for approximately 97% for admin- istrative expenses (2013: 95%), approximately 16% for operating expenses (2013: 10%) and approximately 10% for capital expendi- tures (2013: 38%).
Other significant cash flows in non-USD-related currencies occur occasionally, including certain purchase obligations denominated in JPY. No other significant cash flows in non-USD-related cur- rencies occurred in 2014.
NOTE 23 – CONTINUED
All things being equal, a change in the USD/DKK exchange rate of 10% would result in a change in profit before tax and equity as follows:
USDm 2015 2014
SENSITIVITY TO CHANGES IN THE USD/DKK EXCHANGE RATE
Effect of a change in the USD exchange rate of 10% in relation to DKK:
Change in profit before tax 5.5 7.5
Change in equity 5.5 7.5
INTEREST RATE RISK
TORM’s interest rate risk generally relates to interest-bearing mortgage debt and bank loans. All the Company’s loans for fi- nancing vessels are denominated in USD, and all are floating rate loans. Fixing interest exposure is therefore reduced to the sched- uled interest fixing of the debt.
At the end of 2014, TORM has fixed 25% (2013: 25%) of the interest exposure for 2015. The fixing is a result of the scheduled interest fixing of the debt through 31 March 2015.
All things being equal, a change in the interest rate level of 1% point on the unhedged debt will result in a change in the interest rate expenses as follows:
USDm 2015 2014
SENSITIVITY TO CHANGES IN INTEREST RATES
Effect of a change in the interest rate level of 1% point:
Change in interest rate expenses 10.4 12.4
Change in equity 10.4 12.4
TORM’s interest-bearing debt decreased from year-end 2013 to year-end 2014 by USD 324m (2013: decrease of USD 150m) to USD 1,394m (2013: USD 1,718 m).
NOTE 24
FINANCIAL INSTRUMENTS
USDm 2014 2013
CATEGORIES OF FINANCIAL ASSETS AND LIABILITIES: Loans and receivables
Freight receivables 71.8 79.7
Other receivables 4.0 12.5
Cash and cash equivalents 44.6 29.1
120.4 121.3 Available-for-sale assets
Other investments 10.9 12.3
10.9 12.3 Derivative financial instruments (assets)
Other receivables - hedge accounting 0.0 -
0.0 0.0
Financial liabilities measured at amortized cost
Mortage debt and bank loans 1,427.1 1,733.9
Finance lease liabilities 11.9 12.9
Trade payables 18.3 43.9
Other liabilities 22.8 28.6
1,480.1 1,819.3 Derivative financial instruments (liabilities)
Other liabilities - fair value through profit or loss (held-for-trading) 0.1 0.0
Other liabilities (hedge accounting) 1.7 0.0
1.8 0.0
In all material aspects, the fair value of the financial assets and liabilities above equals the carrying amount except for mortage debt and bank loans for which the fair value can be found in note 17.
FAIR VALUE HIERARCHY FOR FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE IN THE BALANCE SHEET
The table below shows the fair value hierarchy for financial instruments measured at fair value in the balance sheet. The financial instru- ments in question are grouped into level 1 to 3 based on the degree to which the fair value is observable:
• Level 1 fair value measurements are those derived from quoted prices (unadjusted) in active markets for identical assets or liabilities • Level 2 fair value measurements are those derived from input other than quoted prices included within Level 1 that are observable for
the asset or liability, either directly (as prices) or indirectly (derived from prices)
• Level 3 fair value measurements are those derived from valuation techniques that include input for the asset or liability that are not based on observable market data (unobservable input)
NOTE 24 – CONTINUED 2014 USDm Quoted prices (Level 1) Observable input (Level 2) Un observ- able input (Level 3) Total Available-for-sale financial assets:
Other investments - - 10.9 10.9
Derivative financial instruments (assets):
Other receivables - fair value through profit or loss (held-for-trading) - - - 0.0
Other receivables (hedge accounting) - 0.0 - 0.0
Total financial assets 0.0 0.0 10.9 10.9
Derivative financial instruments (liabilities):
Other liabilities - fair value through profit or loss (held-for-trading) - 0.1 - 0.1
Other liabilities (hedge accounting) - 1.7 - 1.7
Total financial liabilities 0.0 1.8 0.0 1.8
2013 USDm Quoted prices (Level 1) Observable input (Level 2) Unobserv- able input (Level 3) Total Available-for-sale financial assets:
Other investments 0.0 - 12.3 12.3
Derivative financial instruments (assets):
Other receivables - fair value through profit or loss (held-for-trading) - 0.0 - 0.0
Other receivables (hedge accounting) - 0.0 - 0.0
Total financial assets 0.0 0.0 12.3 12.3
Derivative financial instruments (liabilities):
Other liabilities - fair value through profit or loss (held-for-trading) - 0.0 - 0.0
Other liabilities (hedge accounting) - 0.0 - 0.0
Total financial liabilities 0.0 0.0 0.0 0.0
There were no transfers between level 1 and 2 in 2014 and 2013.
In all material aspects, the estimation of the fair market value of TORM’s unlisted shares (level 3) is based on market multiples for comparable listed companies (peer group). The peer group is selected from companies in comparable industries and is assessed as representative for the assessment of the value of the shareholding. Further- more, TORM applies an average of both a price to earnings and a price to book multiple in determining the fair market value.
Derivative financial instruments of USD 1.7m (2013: USD 0.0m) are measured at fair value based on discounted cash flow on a recurring basis. Future cash flows are esti- mated on forward curves for bunker swaps and FFAs from observable forward curves at the end of the reporting period and contract forward rates discounted at a rate that reflects the credit risk of the counterparties.
RECONCILIATION OF FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE IN THE BALANCE SHEET BASED ON LEVEL 3
USDm 2014 2013
Other investments, available-for-sale:
Balance at 1 January 12.3 12.3
Gain/loss in other comprehensive income -1.4 0.6
Transfers to/from level 3 - -0.6
Balance at 31 December 10.9 12.3
NOTE 25
RELATED PARTY TRANSACTIONS
During the financial year, TORM carried on trading with its joint ventures for a total amount of USD 1.4m (2013: USD 1.9m). Management remuneration is disclosed in note 4.
To the best of TORM’s knowledge, there have not been any other transactions with related parties during the financial year.
NOTE 26
NON-CURRENT ASSETS HELD-FOR-SALE
In November 2013, the Company entered into an agreement concerning the sale of four MR tankers. The tankers were classified as held- for-sale and presented separately in the balance sheet and included under the Tanker Segment in the segment information.
An impairment loss of USD 55m from adjusting the carrying amount of the tankers to the market value was recognized in the income statement for 2013 under “Impairment losses on tangible and intangible assets”. The vessels were delivered to the new owners in March and April 2014.
NOTE 27