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Financial risk management policy

The Group’s activities are exposed to various financial risks: market risk (including foreign currency risk), credit risk, liquidity risk, and interest rate risk related to cash flows. The Group’s risk management policy centers on the uncertainty of financial markets and attempts to minimize the potential adverse effects on the Group’s profitability through the use of certain financial instruments as described below.

This note provides information on the Group’s exposure to each of the aforementioned risks, the Group’s objectives, policies and processes for managing risk, the methods used to measure these risks and any changes from the previous year.

Foreign currency risk

The Group operates in an international environment and, accordingly, is exposed to foreign currency risk, particularly relating to the US dollar and, to a lesser extent, the Mexican peso, the Russian ruble, the Chinese renminbi, the Japanese yen and the pound sterling. Foreign currency risk arises on future commercial transactions, recognized assets and liabilities and net investments in foreign operations. Foreign currency risk is managed in line with Group management guidelines, which establish, mainly, the arrangement of financial or natural hedges, ongoing monitoring of fluctuations in exchange rates and other measures designed to mitigate this risk.

In 2013, had the value of the euro increased by 10% compared to the US dollar and, as a result, compared to the rest of the foreign currencies linked to the US dollar, all other things being equal, consolidated profit after income tax would have been approximately euros 58,100 thousand lower (euros 84,591 thousand in 2012), and had the value of the euro dropped by 10%, consolidated profit after income tax would have been approximately euros 43,853 thousand higher (euros 88,141 thousand in 2012), primarily because of the translation of subsidiaries’ annual accounts expressed in currencies other than the euro and the impact of merchandise purchases in US dollars.

Credit risk

The Group is not exposed to significant concentrations of credit risk as policies are in place to cover sales to franchises and retail sales comprise the vast majority of revenue. Collections are primarily made in cash or through credit card payments.

The Group adopts prudent criteria in its investment policy the main objectives of which are to reduce the credit risk associated with investment products and the counterparty are recognized as non-current assets (see note 15) and are

generally amortized over the term of the lease contract. On certain occasions, shopping center developers or the proprietors of leased premises make contributions towards the establishment of the Group’s business in their premises.

These contributions are treated as lease incentives (see note 22) and are taken to income over the lease term. A wide variety of situations also apply to the duration of lease contracts, which generally have an initial term of between 15 and 25 years. However, legislation in certain countries or the situations in which lease contracts are typically used means the duration of contacts is sometimes shorter. In some countries, legislation or the lease contracts themselves protect the right of the lessee to terminate the contract provided that sufficient advance notice (e.g. three months) is given. In other cases, however, the Group is obliged to see out the full term of the contract, or at least a significant part thereof. Some contracts combine these obligations with get-out clauses that may only be exercised at certain times over the term of the contract (e.g. every five years or at the end of the tenth year).

Details of operating lease expenses are as follows:

2013 2012

Minimum payments 1,424,921 1,333,311

Contingent rents 239,047 205,592

1,663,967 1,538,903

Sublease income 4,676 5,960

Future minimum payments under non-cancelable operating leases are as follows:

Lease payments 2013

Less than one year One to five years Over five years

1,040,126 1,588,406 702,002

Lease payments 2012

Less than one year One to five years Over five years

floating interest rate. Group exposure to this risk is not significant for the reasons mentioned above.

The Group does not have any financial assets or liabilities designated as at fair value through profit or loss. Given the Group’s investment policy, any changes in interest rates at year-end would not significantly affect consolidated profits.

Capital management

The Group’s capital management objectives are to safeguard the Group’s ability to continue operating as a going concern so that it can continue to generate returns for shareholders, benefit other stakeholders and maintain an optimum capital structure to reduce the cost of capital. The Group manages its capital structure and makes adjustments thereto in response to changes in economic conditions. No significant changes to capital management were made during the year.

Neither the Parent nor the Inditex Group subsidiaries are subject to strict capital management criteria.

Financial instruments

Merchandise and goods for resale are partly acquired from foreign suppliers in US dollars. In accordance with prevailing foreign currency risk policies, Group management arranges derivatives, mainly forward contracts, to hedge cash flow fluctuations related with exchange rates.

Occasionally the Group instruments its hedges through financial investments owned by it.

Certain Group subsidiaries are granted internal financing denominated in currencies other than the euro. In accordance with prevailing foreign currency risk policies, derivatives are arranged, mainly forward contracts and swaps, to hedge changes in fair value related with exchange rates.

Moreover, and as described in note 32.2.o, the Group applies hedge accounting to mitigate the volatility that the existence of significant foreign currency transactions would have on the consolidated income statement. Hedge accounting is used because the Group meets the requirements described in note 32.2.o on accounting policies to be able to classify financial instruments as accounting hedges. More specifically, these financial instruments have been formally designated as hedges and it has been observed that the hedges are highly affective. The expiry dates of hedging instruments have been negotiated so that they coincide with the expiry dates of the hedged items. In 2013, using hedge accounting, no significant amounts were recognized in profit or loss either in relation to gains or losses on transactions that did not risk associated with financial institutions by establishing

highly detailed analysis criteria.

Investment vehicles are rated using a selection of criteria, including, ratings from the three main rating agencies, the size of the investment vehicle, location and returns. All the investment vehicles have the maximum credit rating. In relation to the counterparty risk associated with financial institutions, the Group selects a minimum credit rating of A from the various rating agencies, a minimum TIER capital ratio pursuant to Basel III and also assesses other factors during the selection process.

Similarly, maximum limits are established for the various counterparties in order the meet the objective of ensuring diversification.

In relation to credit risk arising from commercial transactions, impairment losses are recognized for trade receivables when objective evidence exists that the Group will be unable to recover all the outstanding amounts in accordance with the original contractual conditions of the receivables. The amount of the impairment loss is the difference between the carrying amount of the asset and the present value of the estimated future cash flows, discounted at the effective interest rate. The amount of the impairment loss is recognized in the income statement. The net impairment losses recognized during the year in respect of value adjustments to the balances recorded under this caption amount to euros 574 thousand (net reversals of euros 309 thousand in 2012) and correspond to doubtful trade receivables.

At 31 January 2014 and 2013, no significant outstanding balances existed. Furthermore, based on available historical data, the Group does not consider it necessary to make valuation adjustments to receivables which are not past due. The fair value of the receivables is equal to their carrying amount.

The main financial assets of the Group are shown under Financial Instruments: other information.

Liquidity risk

The Group is not exposed to significant liquidity risk, as it maintains sufficient cash and cash equivalents to meet the outflows of normal operations. In the event the Group requires financing, either in euros or in other currencies, it reverts to loans, credit facilities or other types of financial instruments (see note 20).

Details of financial liabilities are disclosed in note 20, along with their expected maturities.

Interest rate risk

Interest rate fluctuations affect the fair value of assets and liabilities which accrue a fixed rate of interest, as well

198

annual report 2013

Other financial assets 2013 2012

Fair value of the hedging instruments 13,022 7,831

Total 13,022 7,831

Other financial liabilities 2013 2012

Fair value of the hedging instruments 21,408 54,501 Reciprocal call and put options (Notes 6 and 22) 16,931 19,417

Total 38,339 73,918

The detail of the fair value (measured as indicated in note 32.2.o) of the hedging instruments is as follows:

Approximately 60% of the cash flows associated with hedges in US dollars are expected to be generated during the six months subsequent to year-end, while the remaining 40% is expected to be generated between six months to a year. It is also likely that the impact on consolidated profit and loss will arise during these periods. Also, as part of the risk management policy, the Group designates as hedged items financial assets recognized under “Current financial investments”, since the related derivatives qualify for hedge accounting.

The fair value of the hedging instruments was calculated as described in note 32.2.o

At 31 January 2014 and 2013, the Group had arranged derivatives, basically forward contracts on future purchases in US dollars forwards to hedge intra-Group financing. The fair value of these derivatives is recognized under “Other financial assets” or “Other financial liabilities” depending on the related balance.

The detail of “Other financial assets” and “Other financial liabilities” in the consolidated balance sheet is as follows:

Other financial assets at fair value and classification based on fair value hierarchy

Description Level Fair value 2013 Transfer to income

Transfer to income from equity

Income recognise

directly in equity Fair value 2012

OTC derivatives

Foreign exchange forwards 2 12,454 2,910 (861) 4,768 5,637

Cross currency swap 2 567 (663) (963) - 2,193

Total derivatives 13,022 2,247 (1,824) 4,768 7,831

Other financial liabilities at fair value and classification based on fair value hierarchy

Description Level Fair value 2013 Transfer to income

Transfer to income from equity

Income recognise

directly in equity Fair value 2012

OTC derivatives

Foreign exchange forwards 2 21,044 (19,783) (21,216) 8,061 53,982

Interest rate swap 2 364 (154) - - 518

Inditex’s board of directors authorized a long-term incentive plan for members of the management team and other personnel from Inditex and its Group of companies. By complying with the terms of the plan, each beneficiary is entitled to receive an incentive up to a designated maximum.

The plan started on 1 February 2013 and ends on 31 January 2016. Incentives are divided into an initial payment for the period ending 31 January 2015 and a final payment for the period ending 31 January 2016.

In order to be entitled to the initial and final payments the employees must, in addition to fulfilling the other terms and conditions provided for in the plan, remain uninterruptedly in the employ of Inditex or of any Inditex Group company in the period from 1 February 2013 to the end of each of the aforementioned periods, unless any of the cases in which early settlement occurs arises (e.g. death, retirement, permanent disability or unjustified dismissal), in which case the incentive to which the employee in question might be entitled will be paid on the basis of the length of time effectively worked from the beginning of the term of the plan as a proportion of the total duration of the plan or, in the case of the initial payment, as a proportion of the duration of the initial period.

The liability in this connection is recognized under “Provisions” in the consolidated balance sheet and the period provision is reflected under “Operating expenses” in the consolidated income statement. The impact of these obligations on the consolidated balance sheet and the consolidated income statement is not material.

The cash-settled incentive plan does not expose the Group to significant risks. There are no plan assets in this connection.

Long-term equity-settled incentive plan

The general shareholders’ meeting resolved to establish a long-term equity-settled incentive plan targeted at members of the management team and other personnel of Inditex and of its Group of companies whereby each beneficiary will be entitled, if the terms and conditions provide for in the plan are met, to receive up to the maximum number of shares designated to that beneficiary.

The plan consists of two mutually independent time periods: the first, and the only one running in 2013, started on 1 July 2013 and ends on 30 June 2016; and the second, if approved in 2014, starts on 1 July 2014 and ends on 30 June 2017.

The amount relating to this plan is recognized under “Equity” in the consolidated balance sheet and the period expense is recognized under “Operating expenses” in the consolidated income statement. The impact of these obligations on the consolidated income statement balance There were no transfers among the various hierarchical

levels (see note 32.2.o).

Financial instruments: other information

The main financial assets held by the Group, other than cash and cash equivalents and derivative financial instruments, comprise loans and receivables related to the Group’s principal activity and guarantees in relation to the lease of commercial premises, which are shown under other non-current assets. The main financial assets of the Group are as follows:

2013 2012

Cash and cash equivalents 3,846,726 3,842,918 Current financial investments 212,890 260,632

Trade receivables 145,977 150,226

Receivable due to sales to franchises 162,039 147,116

Other current receivables 61,164 50,924

Guarantees 344,302 223,734

Total 4,773,098 4,675,551

The financial liabilities of the Group mainly comprise debts and payables on commercial transactions.

The fair value of financial assets and liabilities measured at amortized cost does not differ substantially from their carrying amount, taking into account that in the majority of cases collection or payment is made in the short term. In 2013 no significant financial asset impairment losses were recognized.