Financial instruments

As part of its financial risk management policy the Group identifies the following risks and has adopted the following risk management objectives and methods:

Currency risk management

In 2016, the Group applied the Financial Risk Management Policy (currency and interest rate risks), which is one of the elements of the Group’s centralised Financing Model. The policy has been operated by those Group companies which are exposed to material currency and interest rate risks.

• Identification of currency risk

The Group is exposed to currency risk resulting from its net exposure to the euro and the US dollar under its sale and procurement transactions, trade receivables and payables, as well as receivables and liabilities from financing and investing activities. The Group is also exposed to the risk related to periodic episodes of strong exchange rate volatility, including the effect of EUR/USD exchange rate development on the EUR/PLN and USD/PLN exchange rates.

• Purpose of currency risk management

The purpose of currency risk management is to mitigate volatility of the Group’s cash flows in the euro and US dollar and to hedge against adverse exchange rate movements by using instruments designed to reduce currency risk exposure and its effect on the Group’s financial performance.

In accordance with the policy, the objective of currency risk management at the Group is to reduce the impact of adverse exchange rate movements on the Group’s cash flows to a level acceptable by the Group, determined in accordance with the VaR methodology.

• Level of currency hedging

The hedging level is considered optimum if up to 80% of the planned net currency exposure is hedged for a period of up to 6 months from the transaction date, up to 50% of the planned currency exposure is hedged for a period from 6 to 12 months from the transaction date, and up to 30% of the planned currency exposure is hedged for a period from 12 to 24 months from the transaction date. Using a higher currency hedging level requires approval from the Management Board following a recommendation from the Risk Committee.

• Rules of executing currency hedges

Currency hedges are executed to reduce the Group’s planned currency exposure and they are classified as cash flow hedges under hedge accounting. The amount of currency in a given transaction may not be higher than the hedged item in that currency.

To hedge exposure in the euro and US dollar the Group primarily uses natural hedging, which involves increasing future liabilities in the euro and US dollar through execution of procurement, investing and financing contracts and agreements in those currencies.

The remaining currency exposure is mitigated by executing transactions of the following types:

• currency forwards,
• currency swaps, involving temporary swaps of currencies with a bank to optimise short-term currency mismatch,
• it is also possible to execute symmetric currency collars or other symmetric combinations of longing put options and shorting call options.

Currency hedges are generally settled by physical delivery of the currency on the expiry date. The Group may enter into hedging transactions with horizons of up to 24 months if this reduces the adverse impact of exchange rate fluctuations on the cash flows, and it is possible to secure the EUR/PLN or USD/PLN exchange rate to the extent it exceeds the exchange rate planned in the budget, and up to 3 months if it is possible to hedge the exchange rate at which a commercial transaction was executed if the exchange rate was below the budgeted rate.

The Group enters into currency hedges only with banks with which it has executed framework agreements setting out comprehensive terms of execution and settlement of such transactions.

Execution of currency hedging transactions where the hedge horizon is more than 24 months or the transaction does not conform to the Financial Risk Management Policy requires approval by the Management Board based on a recommendation of the Finance Committee.

Interest rate risk management

The Group is exposed to interest rate risk related to its financial liabilities (chiefly borrowings) denominated in the złoty and the euro, which are based on variable market interest rates; and financial assets (mainly bank deposits) denominated in the złoty, which earn interest at variable and fixed market interest rates.

The objective of interest rate risk management is to optimise interest rates with a view to:

• minimising the cost of interest on debt,
• ensuring the highest available profitability of financial assets and their safe allocation.

To achieve that objective it is necessary to ensure an optimum structure and cost of project financing using proceeds from issues of securities and debt, and to provide for an optimum level of working capital. The Group primarily uses natural hedging involving the use of the same reference rate for borrowings and financial assets denominated in the złoty, and maintaining its available long-term credit facilities based on a fixed interest rate in the euro.

The remaining exposure to interest rate risk may be hedged using only the following transactions:

• forward rate agreements (FRA),
• interest rate swaps (IRS),
• cross-currency interest rate swaps (CIRS).

The Group may enter into a transaction to hedge interest rate risk if it is ensured that the expected cost of the underlying instrument is limited. Execution of such a transaction requires approval by the Risk Committee. Execution of an interest rate hedging transaction must be approved by the Management Board if its hedge horizon is more than 12 months or if the transaction does not conform to the Financial Risk Management Policy.

Price risk management

As there are no adequate financial instruments hedging the price risk related to the Group’s key raw materials and products, or no significant correlation between the price of such hedging instruments and contract prices of the raw materials and products has been confirmed, the Group does not intend to use such instruments to hedge price volatility. The Group intends to mitigate the risk of price volatility using natural hedging, which involves linking the largest possible part of its procurement and sales volumes (in particular of phenol, benzene, caprolactam and polyamide, used in its production chain) under framework contracts with changes in ICIS prices for a given raw material.

Credit risk management

The Group has a credit risk management policy in place, which has been adopted by all key companies of the Group in which such risk exists.

• Identified credit risks

The Group’s credit risk is related to:

• placements of cash and cash equivalents with banks;
• granting trade credit to trading partners in the ordinary course of business.
• Purpose of credit risk management

To mitigation the risk of loss of financial assets, including loans, receivables, cash and cash equivalents.

• Limits for cash allocation and trade credits

1. The total amount of placements of cash or other financial assets by any Group company should not exceed:
   - PLN 100m – with the Group’s strategic bank with a low credit risk and high creditworthiness,
   - PLN 50m – with a bank important for the Group’s operations, with a low credit risk and high creditworthiness,
   - PLN 10m – with other financial institutions with no greater than moderate credit risk and at least good creditworthiness.
2. The total amount of trade credit granted to trading partners by any Group company should not exceed:
   - the amount of insured trade credit,
   - the market value of security provided by the customer,
   - the trade credit limit determined by the Group company based on assessment of the trading partner’s financial condition.
   - Rules of credit risk management
3. Execution of transactions involving placement of cash and cash equivalents
   - Group companies make cash placements following selection of the highest interest rate quotations received from at least three banks, taking into account allocation limits, except for overnight deposits, which may be placed with the bank at which the account balance shows a financial surplus.
   - Exceeding the allocation limit and/or placement of a deposit with a term of more than one year requires approval by the Management Board member in charge of finance or the President of the Grupa Azoty Management Board.
2. Trade credit
   - The Group determines trade credit limits based on requests received from teams responsible for execution of a sale transaction.
   - A trade credit limit does not require a separate approval if it is insured or relevant security is provided by a bank or other institution with high creditworthiness.
   - In other cases, a trade credit limit decision requires approval by the Corporate Finance Department (for limits of up to PLN 350 thousand), the Credit Risk Committee (up to PLN 2.5m) or the Management Board member in charge of finance or the President of the Grupa Azoty Management Board (over PLN 2.5m).

In the case of actual or threatened insolvency, as a result of which an impairment loss is recognised, a Group company should immediately initiate an amicable recovery procedure, or collection or enforcement proceedings to recover the threatened financial asset or relevant security.

Receivables insurance agreements

As part of trade credit risk management, the Group cooperates with leading insurance companies, taking advantage of diversification and competition between insurers by accessing specialist knowledge on financial condition of the insured trading partners and having the ability to adjust the amount of the trade credits it offers to the limits provided by individual insurers to entities which are also customers of the Group companies.

The parent (with Grupa Azoty SIARKOPOL and Zakłady Azotowe Chorzów S.A. as co-insured) and Grupa Azoty KĘDZIERZYN signed uniform global trade receivables insurance agreements with KUKE, expiring in July 2017. Grupa Azoty PUŁAWY signed a receivables insurance agreement on the same terms with EULER HERMES, expiring in January 2017, and after the reporting date it signed a new insurance agreement with the same insurer, valid until 2018. Grupa Azoty POLICE executed a global insurance agreement with ATRADIUS, based on the uniform terms of insurance, valid until November 2017.