Group’s activities are exposed to a variety of financial risks: market risk (including foreign exchange risk, fair value interest rate risk and price risk), credit risk and liquidity risk.
4.1. Market risk
a.1) Exchange rate risk
The Group has international operations and is therefore exposed to foreign exchange risk during currency transactions, relating particularly to the US Dollar (USD), Brazilian Real, Mexican Peso and Indian Rupee, as well as to other currencies. Foreign exchange risk arises from future commercial transactions, recognized assets and liabilities and net investments in foreign operations. The Group hedges net forecast flows deriving from forecast transactions in currencies other than the functional currency of the Group companies that affect the transaction.
Management has established a policy requiring Group entities to manage their risk of exchange rate of foreign currency against the functional currency. The companies are required to cover the entire exchange rate risk to which they are exposed with the Central Department of Treasury. To manage exchange rate risk that arises from future comercial transactions and recognized assets and liabilities, the Group companies use forward contracts, transacted through Group Treasury Department.
transactions performed in other currency are common (in Spain, India and Latin America principally), especially in US dollar and Euro. If at December 31, 2015 the functional currency of each country with operations in US dollars had depreciated/appreciated 10% against the US dollar keeping the other variables constant, consolidated profit after tax would have been 19,339 thousand euro lower/higher (2014: 17,850 thousand euro lower/higher), mainly as a result of the effects of revaluation/devaluation of the active or passive positions in US dollars; equity would have varied in the same magnitudes (calculated excluding the effect of theimpact of changes in fair value of derivative financial instruments).
The Group has various investments in foreign operations, whose net assets are exposed to risk of foreign currency translation. Such operations are concentrated mainly in Netherlands and Latin America (Brazil and Mexico), USA and India. Overall the Group policy is that the operations in each country are financed by debt taken in the functional currency of each country, so that risk affects only to the part corresponding to the investment capital. If investment is financed partly or wholly with borrowings to credit institutions, the Group’s policy is to take loans denominated in the functional currency. In the absence of funding, the Group’s policy is not to make coverage, except in certain cases where expected cash flows in short term by delivering dividends of the subisidiary are covered. The main exposures in foreign currenty as a result of capital investments measured from the net assets of foreign companies included in the consolidated balance and the joint ventures. 2015 Brazilian real (*) 527 Mexican peso (*) 238 Indian rupee 396 US Dollar (*) 428 Other currency (*) 244 Total 1,833
(*) Value of goodwill existing at each date not included. a.2) Price risk
The Group is not exposed to equity instrument price risk since it has no significant investments. The Group is partially exposed to market price risk in respect of raw materials, relating basically to metals and oil, which affect the price of supplies of equipment and materials manufactured in the projects executed by the Group. Generally, these effects are efficiently passed on in selling prices by all similar contractors operating in the same sector. The Group reduces and mitigates price risk by means of policies implemented by management, consisting basically of a reduction or increase in the rate of placements and the selection of currencies and countries of origin, as well as by ensuring the production or acquisition of certain raw materials at a closed price.
a.3) Cash flow and fair value interest rate risk
Interest rate risk must be analysed in relation to the two types of financing obtained by the Group:
•
Project financeThe Group participates in a number of investment projects under “Project finance” arrangements in which, among other aspects, repayments are secured only by cash flows from the respective projects; there may be, in some cases and during the construction phase, additional guarantees. In such cases, financing mainly comprises long-term, variable-rate instruments. The interest rates applicable depend on the country in which the project is located and on the currency in which the financing is issued. Financing issued at variable rates exposes the Group to cash flow interest rate risk. The Group uses interest rate swaps to convert long-term financing totally or partially to fixed interest rates.
Additionally, under certain project finance contracts the company that obtains the financing undertakes vis-à- vis the granting banks to contract the above-mentioned derivative financial instruments.
(€Million)
Referenced Euribor
Other
references (*) Total
Bank Borrowings 159 77 236
Cash and cash equivalents interet-bearing - (3) (3)
Net position 159 74 233
Portion hedged with derivative financial instruments 71% 0% 48% (*) Includes project finance related to assets held for sale.
The Group analyzes its exposure to interest rate risk dynamically. A simulation through which the Group estimates the effect on the outcome of a given interest rate change is made. For each simulation, the same variation in the interest rate for all currencies and references is used. The scenarios are performed only for liabilities that represent the most relevant interest-bearing positions. Based on the simulations performed, the impact on profit after tax increase / decrease of 100 basis points in the interest rate would mean a decrease / increase of 888 thousand euro (2014: 672 thousand euro), mainly due to higher / lower interest expense on variable rate loans; equity would have varied in the same magnitudes (calculated excluding the effect of impact of changes in fair value of derivative financial instruments).
•
Bank BorrowingsThe Group’s interest-rate risk arises mainly from long-term borrowings. Borrowings and Senior Notes issued at variable rates expose the Group to cash flow interest rate risk. Fixed-interest borrowings expose the Group to fair value interest rate risk. A large part of the Group’s borrowings are obtained at variable rates, the main reference rate being the Euribor. The Group policies consist in the use of interest rate swaps to convert long- term financing to fix interest rates.
The variable rate risk exposure at each period is as follows: (€Million)
Referenced Euribor Other
references Total
Bank Borrowings 499 188 687
Cash and cash equivalents interest-bearing
(71) (95) (166)
Net position 428 93 521
Portion hedged with derivative financial instruments 54% 0% 39%
The Group analyses exposure to interest rate risk in a dynamic manner. A number of scenarios are simulated taking into consideration refinancing, renewal of current positions, alternative financing, existence of variable- rate investments (in this sense, very short-term interest-bearing placements are treated as being exposed to variable interest rates) and existing hedges. Base don these scenarios, the Group calculates the effect on the outcome of a given interest rate change. For each simulation, the same variation in the interest rate for all currencies is used. The scenarios are performed only for liabilities that represent the most relevant interest- bearing positions. Based on the simulations performed, the impact on profit after tax of an increase / decrease of 100 basis points in the interest rate would mean a decrease / increase of 729 thousand euro (2014: 1,640 thousand euro), mainly due to higher / lower interest expense on variable rate loans; equity would have varied in the same magnitudes (calculated excluding the effect of impact of changes in fair value of derivative financial instruments).
The Group manages credit risk in relation to the following groups of financial assets:
• Derivative financial instruments and balances included under Cash and cash equivalents and financial assets at fair value through profit or loss.
• Balances related to trade and other receivables.
Derivative financial instruments and bank transactions included in cash and cash equivalents and financial assets at fair value through profit or loss are contracted with reputable financial institutions that obtain high credit ratings.
In relation to the assessment of credit risk in respect of derivative financial instruments and bank transactions included in cash and cash equivalents and financial assets at fair value through profit or loss, Group management applies the following procedures:
• Credit Default Swap (CDS). When CDSs quoted in the market exist, credit risk is quantified on the basis of the market quotation. The CDS is the additional premium that an investor is prepared to pay to cover a credit position. The quantification of the risk is therefore equal to this premium.
• Credit Spread on issues of bonds. When quoted bonds on various financial markets exist, the quantification of the credit risk can be obtained as the differential between the internal rate of return (yield) on the bonds and the risk free rate.
• Comparable. If it is not possible to obtain the quantification of the risk by applying the above two methodologies, the use of comparable is generally accepted, that is, companies or bonds issued by companies in the same sector are used as a reference.
In connection with the balances of trade and other receivables, a high proportion of them (54.20% and 56.27% at 31 December 2015 and 2014, respectively) are related to operations with national and international public entities, which the Group believes that the credit risk is very limited. In relation to private sector clients, a significant portion of the balances are related to companies with high credit ratings and with which there is no history of default. Global position of customers and receivables is periodically monitored as well as an individual analysis of the most significant exposures.
4.3. Liquidity risk
Prudent liquidity risk management implies maintaining sufficient cash and marketable securities, the availability of funding through an adequate amount of comited credit facilities and the ability to close out market positions. Given the dynamic nature of the underlying business, the Group’s Treasury Department aims to maintain flexibility in funding by the availability of committed credit lines.
It is noteworthy that, in relation to various investment projects (“Project finance”) in which the Company participates, they are characterized by the fact that the repayment of the financing arranged is mainly guaranteed by the cash flow of the respective projects. In theses cases, the Group’s policy to cover the liquidity risks state that these loans are taken long-term and structured on the basis of expected cash flows for each of the projects. In implementing this policy, the 74.51% of the funding allocated to projects taken at 31 December 2015 (2014: 93.98%) has a maturity greater than one year, there is any funding taken at 31 December 2015 (2014: 17.23%) is longer than 4 years maturity.
Regarding the rest of the Group’s liquidity position, the Management monitors the forecast liquidity reserve of the Group based on expected cash flows.
The liquidity risk management is carried out jointly and centrally by Group’s Treasury. This management includes both treasury management of Group’s recurrent operative (analysis and monitoring of debt maturities and credit collection, renewal and contracting of credit facilities, management of available credit lines, temporary placement of surplus cash) as the management of necessary funds to undertake planned investments.
Group prepares.
Such forecasts main objective in the short-term; a) strength the liquidity position of the working capital, thereby helping to ease recurrent cash tensions that currently exist in the Group's business sector and b) adapt the Group's financial structure to the current market conditions, as well as to the cash generation capacity of each of the Group's business units. Among other measures currently under analysis, which include the feasibility of redefining the current business structure in order to guarantee that each business unit indebtness that is in line with its capacity to generate operating cash, as well as the establishment of an asset disinvestment process, provided that it may be executed in a manner that contributes to the Group's best business interests As of the preparation date of these annual accounts, a Strategic Plan is being prepared, designed and communicated to the main parties involved in the process.
In order to provide more transparency and to strength the reliability of the cash flow estimates (which are the basis on which the aforementioned projections are prepared), the Group has facilitated the continuous detailed review of its projected information to an external advisor in this area, and which commenced during the second half of 2015. It is worthmentioning that during the year the aforementioned review, has experienced a general achievement of the objectives established in the different forecast prepared by the Management.
Set out below are the most relevant assumptions defined by Group Management to preparing the aforementioned forecasts, which fulfilment involves factors that may not be under the control of the Group and therefore generate a certain level of uncertainty regarding materialization:
• As previously mentioned, forecasts take into consideration the working capital of a substantial part of the bank borrowings that fall due in the short-term, particularly the credit facilities. The perception of financial agents regarding the outlook for the Group's business sector has deteriorated during the second half of 2015 due to external factors. This environment also gives rise to limited access to capital markets, which is shown in the decline in the market prices for the debt instrument issued by the Group. In order to attain its objectives, the Group expects to continue to have the confidence of financial institutions in order to renew, or replace, a significant part of the existing credit lines, which primarily consist of ordinary credit facilities, confirming facilities, factoring facilities, and bank guarantees.
• The Group's business structure may be redefined, as was mentioned previously, together with the debt level to attribute to each business unit. This restructuring requires the prior acceptance by at least a relevant part of financial creditors in line with the previously comments. The Group therefore considers that the confidence shown by financial creditors with respect to the solvency of its project is a key aspect of the success of these proposals within the framework of the ordinary negotiations currently in progress with those financial creditors.
• Finally, Group Management is considering the possibility of making significant disinvestments in 2016 in order to reduce its corporate financial debt, to the extent that such transactions may be executed in a manner that contributes to the Group's best business interests. The businesses that may be sold include the concessions, particularly those that Management expects may be assumed soon by the Group as a result of the completion of the break up with the joint business which parent company is Isolux Infrastructure Netherlands, B.V. (Notes 9 and 15). Although a significant part of those businesses are located in Brazil, which is currently undergoing serious political and economic difficulties that could negatively affect both the disinvestment period and the volume of liquidity to be obtained as a result of such a disinvestment and, possibly, the decision to execute the disinvestment, Group Management considers that those circumstances have been properly evaluated when preparing the forecasts and, therefore, will not significantly affect the plans currently being executed.
Taking into account these cash flow projections for 2016, which form part of the Strategic Plan currently being developed, the Directors consider that the Group will be in an adequate situation to allow it to fulfil its short- term obligations. Accordingly, these consolidated annual accounts have been prepared on a going concern basis
The Group’s objectives regarding managing capital are to safeguard the ability to continue as a going concern to seek a return for shareholders and benefits to other holders of equity instruments and to maintain an optimar capital structure to reduce the cost thereof.
In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends payable to shareholders, repay capital to shareholders, issue new shares or sell assets to reduce debt.
The Group monitors capital in accordance with the leverage ratio, in line with the industry practice. This index is calculated as net debt divided by total capital (excluding the projects’ position assigned). Net debt is calculated as total debt with credit institutions, the current positon of trade and other payables, as shownin the consolidated accounts, less cash and cash equivalents and financial assets at fair value through profit or loss. The capital is calculated as equity, as shown in the consolidated accounts, plus net debt.
The leverage ratios at 31 December 2015 and 2014 are as follows:
(€Million) 2015 2014
Bank Borrowings and senior notes and Trade and other payables - current 4,063 3,903 Less: Financial assets at fair value through profit or loss (13) (15)
Less: Cash and cash equivalents (169) (291)
Net debt 3,881 3,597
Equity (including Non-controlling interests, excluding hedging reserves and
cumulative translation differences) 600 615
Total Capital 4,481 4,212
Leverage ratio (Net debt / Total capital) 86.6% 85.4%