C20 Financial Risk Management and Financial Instruments
Ericsson’s financial risk management is governed by a policy approved by the Board of Directors. The Finance Committee of the Board of Directors is responsible for overseeing the capital structure and financial management of the Company and approving certain matters (such as investments, customer finance commitments, guarantees and borrowing) and is continuously monitoring the exposure to financial risks.
Ericsson defines its managed capital as the total Company equity. For Ericsson, a robust financial position with a strong equity ratio, investment grade rating, low leverage and ample liquidity is deemed important. This provides financial flexibility and independence to operate and manage variations in working capital needs as well as to capitalize on business opportunities.
Ericsson’s overall capital structure should support the financial targets: to grow faster than the market, deliver best-in-class margins and generate a healthy cash flow. The capital structure is managed by balancing equity, debt financing and liquidity in such a way that the Company secure funding of operations at a reasonable cost of capital. Regular borrowings are complemented with committed credit facilities to give additional flexibility to manage unforeseen funding needs. Ericsson strive to finance growth, normal capital expenditures and dividends to shareholders by generating sufficient positive cash flows from operating activities.
Ericsson’s capital objectives are:
- An equity ratio above 40%
- A cash conversion rate above 70%
- To maintain a positive net cash position
- To maintain a solid investment grade rating by Moody’s and Standard & Poor’s.
|Capital objectives related information|
|Capital (SEK billion)||145||147|
|Equity ratio (percent)||52||52|
|Cash conversion rate (percent)||40||112|
|Positive net cash (SEK billion)||39.5||51.3|
|Standard & Poor’s||BBB+||BBB+|
Ericsson has a treasury function with the principal role to ensure that appropriate financing is in place through loans and committed credit facilities, to actively manage the Company’s liquidity as well as financial assets and liabilities, and to manage and control financial risk exposures in a manner consistent with underlying business risks and financial policies. Hedging activities, cash management and insurance management are largely centralized to the treasury function in Stockholm.
Ericsson also has a customer finance function with the main objective to find suitable third-party financing solutions for customers and to minimize recourse to Ericsson. To the extent customer loans are not provided directly by banks, the Parent Company provides or guarantees vendor credits. The customer finance function monitors the exposure from outstanding vendor credits and credit commitments.
Ericsson classifies financial risks as:
- Foreign exchange risk
- Interest rate risk
- Credit risk
- Liquidity and refinancing risk
- Market price risk in own and other equity instruments.
The Board of Directors has established risk limits for defined exposures to foreign exchange and interest rate risks as well as to political risks in certain countries.
For further information about accounting policies, see Note C1, “Significant Accounting Policies”.
Foreign exchange risk
Ericsson is a global company with sales mainly outside Sweden. Revenues and costs are to a large extent in currencies other than SEK and therefore the financial results of the Company are impacted by currency fluctuations.
Ericsson reports the financial accounts in SEK and movements in exchange rates between currencies will affect:
- Specific line items such as Net sales and Operating income.
- The comparability of our results between periods.
- The carrying value of assets and liabilities.
- Reported cash flows.
Net sales and Operating Income are affected by changes in foreign exchange rates from two different kinds of exposures, translation exposure and transaction exposure. In the Operating Income we are primarily exposed to transaction exposure which is partially addressed by hedging.
|Currency exposure, SEK billion|
|Exposure currency||Translation exposure||Transaction exposure||Net exposure||Net exposure, percent of total|
|Total Net sales||226.9|
|Total Net cost||–209.0|
Translation exposure relates to Sales and Cost of Sales in foreign entities when translated into SEK upon consolidation. These exposures can not be addressed by hedging, but as the Income Statement is translated using average rate (average rate gives a good approximation), the impact of volatility in foreign currency rates is reduced.
Transaction exposure relates to Sales and Cost of sales in non-reporting currencies in individual group companies. Foreign exchange risk is as far as possible concentrated to Swedish group companies, primarily Ericsson AB. Sales to foreign subsidiaries are normally denominated in the functional currency of the customers and are normally denominated in USD or other foreign currency. In order to limit the exposure toward exchange rate fluctuations on future revenues and costs, committed and forecasted future sales and purchases in major currencies are hedged with 7% of 12 month forecast monthly. This corresponds to approximately 5–6 months of an average forecast.
According to Company policy, transaction exposure in subsidiaries’ balance sheets (i.e. trade receivables and payables and customer finance receivables) should be fully hedged, except for non-tradable currencies. Foreign exchange exposures in balance sheet items are hedged through offsetting balances or derivatives.
As of December 31, 2011, outstanding foreign exchange derivatives hedging transaction exposures had a net market value of SEK –0.5 (0.6) billion. The market value is partly deferred in the hedge reserve in OCI to offset the gains/losses on hedged future sales in foreign currency.
Cash flow hedges
The purpose of hedging forecasted revenues and costs is to reduce volatility in the income statement. Hedging is done by selling or buying foreign currencies against the functional currency of the hedging entity using FX forwards.
Hedging is done based on a rolling 12-month exposure forecast. Ericsson uses a layered hedging approach, where the closest quarters are hedged to a higher degree than later quarters. Each consecutive quarter is hereby hedged on several occasions and is covered by an aggregate of hedging contracts initiated at various points in time, which supports the objective of reducing volatility in the income statement from changes in foreign exchange rates.
Translation exposure in net assets
Ericsson has many subsidiaries operating outside Sweden with other functional currencies than SEK. The results and net assets of such companies are exposed to exchange rate fluctuations, which affect the consolidated income statement and balance sheet when translated to SEK. Translation risk related to forecasted results from foreign operations can not be hedged, but net assets can be addressed by hedging.
Translation exposure in foreign subsidiaries is hedged according to the following policy established by the Board of Directors:
Translation risk related to net assets in foreign subsidiaries is hedged up to 20% in selected companies. The translation differences reported in OCI during 2011 were negative, SEK 1.0 billion, including hedging loss of SEK 0.0 billion.
Interest rate risk
Ericsson is exposed to interest rate risk through market value fluctuations in certain balance sheet items and through changes in interest revenues and expenses. The net cash position was SEK 39.5 (51.3) billion at the end of 2011, consisting of cash, cash equivalents and short-term investments of SEK 80.5 (87.2) billion and interest-bearing liabilities and post-employment benefits of SEK 41.0 (35.9) billion.
Ericsson manages the interest rate risk by (i) matching fixed and floating interest rates in interest-bearing balance sheet items and (ii) avoiding significant fixed interest rate exposure in Ericsson’s net cash position. The policy is that interest-bearing assets shall have an average interest duration between 10 and 14 months, taking derivative instruments into consideration. Interest-bearing liabilities do not have a duration target as the duration of the fixed rate portion will be determined by markets conditions when liabilities are issued, Group Treasury has a mandate to deviate from the asset management benchmark given by the Board and take FX positions up to an aggregated risk of VaR SEK 45 million given a confidence level of 99% and a 1-day horizon. Previously this was divided into two mandates, one 20, to leave selected transaction exposures in subsidiaries’ balance sheets unhedged, and another 30, to deviate from asset management benchmark and take FX positions.
As of December 31, 2011, 86% (97%) of Ericsson’s interest-bearing liabilities and 77% (90%) of Ericsson’s interest-bearing assets had floating interest rates, i.e. interest periods of less than 12 months.
When managing the interest rate exposure, Ericsson uses derivative instruments, such as interest rate swaps. Derivative instruments used for converting fixed rate debt into floating rate debt are designated as fair value hedges.
Fair value hedges
The purpose of fair value hedges is to hedge the variability in the fair value of fixed-rate debt (issued bonds) from changes in the relevant benchmark yield curve for its entire term by converting fixed interest payments to a floating rate (e.g. STIBOR or LIBOR) by using interest rate swaps (IRS). The credit risk/spread is not hedged.
The fixed leg of the IRS is matched against the cash flows of the hedged bond. Hereby the fixed-rate bond/debt is converted into a floating-rate debt in accordance with the policy.
|OUTSTANDING DERIVATIVES 1)|
|Maturity within 3 months||557||881||581||1,086|
|Maturity between 3 and 12 months||364||393||945||505|
|Maturity 1 to 3 years||–||–||2||21|
|Total currency derivatives||921||1,274||1,528||1,613||2)|
|Of which designated in cash flow hedge relations||333||638||662||–|
|Of which designated in net investment hedge relations||–||–||–||3|
|Interest rate derivatives|
|Maturity within 3 months||–||5||6||28|
|Maturity between 3 and 12 months||324||367||76||61|
|Maturity 1 to 3 years||380||618||544||118|
|Maturity 3 to 5 years||416||815||184||34|
|Maturity more than 5 years||778||161||705||87|
|Total interest rate derivatives||1,898||3)||1,966||1,515||329||2)|
|Of which designated in fair value hedge relations||1,002||–||862||–|
|1) Some of the derivatives hedging non-current liabilities are recognized in the balance sheet as non-current derivatives due to hedge accounting.
2) Of which SEK 902 million is reported as non-current liabilities.
3) Of which SEK 816 million is reported as non-current assets.
Ericsson uses the VaR methodology to measure foreign exchange and interest rate risks in portfolios managed by Treasury. This statistical method expresses the maximum potential loss that can arise with a certain degree of probability during a certain period of time. For the VaR measurement, Ericsson has chosen a probability level of 99% and a 1-day time horizon. The daily VaR measurement uses market volatilities and correlations based on historical daily data (one year).
The average VaR calculated for 2011 was SEK 20.6 million for the combined mandates. For 2010, the interest rate mandate was SEK 20.3 million and the transaction exposure mandate was SEK 9.8 million. No VaR-limits were exceeded during 2011.
Financial credit risk
Financial instruments carry an element of risk in that counterparts may be unable to fulfill their payment obligations. This exposure arises in the investments in cash, cash equivalents, short-term Investments and from derivative positions with positive unrealized results against banks and other counterparties.
Ericsson mitigates these risks by investing cash primarily in well-rated securities such as treasury bills, government bonds, commercial papers, and mortgage covered bonds with short-term ratings of at least A-1/P-1 and long-term ratings of AAA. Separate credit limits are assigned to each counterpart in order to minimize risk concentration. We have had no sub-prime exposure in our investments. All derivative transactions are covered by ISDA netting agreements to reduce the credit risk. No credit losses were incurred during 2011, neither on external investments nor on derivative positions.
At December 31, 2011, the credit risk in financial cash instruments was equal to the instruments’ carrying value. Credit exposure in derivative instruments was SEK 2.8 (3.0) billion.
Liquidity risk is that Ericsson is unable to meet its short-term payment obligations due to insufficient or illiquid cash reserves.
Ericsson minimizes the liquidity risk by maintaining a sufficient net cash position. This is managed through centralized cash management, investments in highly liquid interest-bearing securities, and by having sufficient committed credit lines in place to meet potential funding needs. For information about contractual obligations, please see Note C31, “Contractual obligations”. The current cash position is deemed to satisfy all short-term liquidity requirements.
During 2011, cash and bank and short-term investments decreased by SEK 6.7 billion to SEK 80.5 billion.
|CASH, Cash equivalents AND SHORT-TERM INVESTMENTS|
|Remaining time to maturity|
|(SEK billion)||< 3 months||< 1 year||1–5 years||>5 years||Total|
|Type of issuer/counterpart|
|1) Of which SEK 2.8 billion relates to ST-Ericsson.|
The instruments are either classified as held for trading or as assets available for sale with maturity less than one year and therefore short-term investments. Cash, Cash Equivalents and short-term investments are mainly held in SEK unless off-set by EUR-funding.
Refinancing risk is the risk that Ericsson is unable to refinance outstanding debt at reasonable terms and conditions, or at all, at a given point in time.
|Repayment schedule of NON-CURRENT borrowings 1)|
|Nominal amount (SEK billion)||Current maturities of long- term debt||Notes and bonds (non-current)||Liabilities to financial institutions (non-current)||Total|
|1) Excluding finance leases reported in Note C27, “Leasing”.|
Debt financing is mainly carried out through borrowing in the Swedish and international debt capital markets.
Bank financing is used for certain subsidiary funding and to obtain committed credit facilities.
|Funding programs 1)|
|Euro Medium-Term Note program (USD million)||5,000||2,878||2,122|
|Long-term Committed Credit facility (USD million)||2,000||–||2,000|
|Indian Commercial Paper program (INR million)||5,000||–||5,000|
|1) There are no financial covenants related to these programs.|
In June 2011 Ericsson was upgraded by Moody’s from Baa1 to A3 (stable). Standard & Poor’s kept the BBB+ credit rating with stable outlook. Both credit ratings are considered to be solid investment grade.
Financial instruments carried at other than fair value
The fair value of the majority of the Company’s financial instruments are determined based on quoted market prices or rates. In the following tables, carrying amounts and fair values of financial instruments that are carried in the financial statements at other than fair values are presented. Assets valued at fair value through profit or loss showed a net gain of SEK 0.7 billion. For further information about valuation principles, please see Note C1, “Significant accounting policies”.
|Financial Instruments Carried at other than Fair Value 1)|
|Book value||Fair value|
|Current part of non-current borrowings||4.3||0.8||4.3||0.8|
|Notes and bonds||17.2||20.6||17.1||20.5|
|Other borrowings non-current||4.9||5.1||4.9||5.0|
|1) Excluding finance leases reported in Note C27, “Leasing”.|
Financial instruments excluded from the tables, such as trade receivables and payables, are carried at amortized cost which is deemed to be equal to fair value. When a market price is not readily available and there is insignificant interest rate exposure affecting the value, the carrying value is considered to represent a reasonable estimate of fair value.
Market price risk in own shares and other listed equity investments
Risk related to our own share price
Ericsson is exposed to the development of its own share price through stock purchase plans for employees and synthetic share-based compensations to the Board of Directors.
Stock purchase plans for employees
The obligation to deliver shares under the stock purchase plan is covered by holding Ericsson Class B shares as treasury stock. A change in the share price will result in a change in social security charges, which represents a risk to the income statement. The cash flow exposure is fully hedged through the holding of Ericsson Class B shares as treasury stock to be sold to generate funds to cover also social security payments.
Synthetic share-based compensations to the Board of Directors
For these plans, the Company is exposed to risks in relation to own share price, both in relation to compensation expenses and social security charges. The obligation to pay compensation amounts under the synthetic share-based compensations to the Board of Directors is covered by a liability in the balance sheet.
For further information about the stock purchase plan and the synthetic share-based compensations to the Board of Directors, please see note C28, “Information Regarding Members of the Board of Directors, the Group Management and Employees”.
|Financial instruments, Book value|
|SEK billion||Customer finance||Trade receivables||Short-term investments||Cash equivalents||Borrowings||Trade payables||Other financial assets||Other current receivables||Other current liabilities||Other non-current liabilities||2011||2010|
|Assets at fair value through profit or loss||–||–||38.8||5.0||–||–||0.8||2.0||–3.2||–||43.4||58.9|
|Loans and receivables||4.2||64.5||3.1||4.1||–||–||3.3||–||–||–||79.2||70.3|
|Available for sale assets||–||–||–||–||–||–||–||–||–||–||–||–|
|Financial liabilities at amortized cost||–||–||–||–||–31.0||–25.3||–||–||–||–||–56.3||–55.8|