RISKS CONNECTED WITH NET DEBT
In relation to a significant portion of existing loan agreements, the Group has undertaken to comply with certain covenants. Moreover, a significant part of the Group's loan agreements include cross default - cross acceleration clauses, negative pledge clauses and pari passu clauses. In the future, if the above financial covenants or other commitments provided for in existing loan agreements are not complied with, the Group may be required to repay the related debt early.
Lastly, a significant portion of the LU-VE Group's loan agreements provide for disclosure obligations on the part of the company contracting the loan on various occasions, the obligation to request prior consent in the event of new loans or particular extraordinary transactions, and the obligation not to set up new mortgages.
In order to mitigate this risk, the Group carefully monitors compliance with financial covenants, all clauses in loan agreements and disclosure requirements through formalized procedures involving the legal and finance departments. In addition, it always maintains a significant amount of cash or cash equivalents that can be liquidated in the short term and short-term lines of credit to meet any, albeit considered remote, obligations to repay medium- and long-term loans in advance.
The financial instruments in which the Group invests its available liquidity are primarily represented by capitalization policies and bond and monetary instruments, almost exclusively denominated in euros.
Capitalization policies provide for guaranteed capital and a guaranteed minimum rate of return that is not negative, as well as certain penalties in the event of early redemption.
It should also be noted that, for financial instruments in general, there are the following risks:
specific risk linked to the characteristics of the related issuer:
equity soundness of the issuer, its economic characteristics, taking into account the peculiarities of the sectors in which it operates, which affect the risk that the issuer is unable to repay the interest accrued and/or the capital invested;
the generic (or systematic) risk related to: (i) interest rate fluctuations; (ii) market price trends; and (iii) the difficulty/inability to easily monetize positions in financial assets without significantly and unfavorably influencing their price.
It cannot be excluded that in the future the value obtained from the disposal of these financial instruments may be lower than the fair value posted to the financial statements, thus generating a worsening of the net financial indebtedness. Given that recurring costs are recorded in the income statement, deriving from financial charges on outstanding loans, the returns on investments in cash and cash equivalents are uncertain and highly volatile, even negative. In any event, the Group chooses its investments with a preference for low-risk investments and carries them out with leading banks. Moreover, a careful liquidity management policy and the existence of short-term lines of credit mitigate the risk of having to make sudden and unplanned cash outflows.
The liquidity risk to which the Group might be exposed is the failure to raise sufficient funds to carry out its operations and develop its industrial and commercial activities.
The Group's liquidity is primarily provided by the resources generated or absorbed by its operating and investment activities, as well as by the maturity dates of its medium/long-term debt.
In relation to the latter aspect, the guidelines adopted by the Group in managing liquidity consist of:
maintenance of adequate medium/long-term loans compared with the level of fixed assets;
maintenance of an adequate level of short-term bank loans (both for cash and for the disposal of domestic and export receivables).
Partly thanks to the application of this policy, to date the Group has credit lines from leading Italian and international banks that are adequate for its current needs.
RISKS CONNECTED WITH INTEREST RATE TRENDS
The Group uses both short-term and, above all, medium/long-term bank borrowing, in accordance with methods and technical forms that are appropriate to its investment structure.
Exposure to interest rate risk derives from the fact that the Group holds assets and liabilities that are sensitive to changes in interest rates, which are necessary to manage liquidity and financial requirements.
In particular, the main source of exposure to this risk for the Group derives from its financial debt, almost entirely at floating rates. This risk is managed by entering into derivative contracts (primarily Interest Rate Swaps) to hedge the risk according to the Group's requirements. This hedging policy enables the Group to reduce its exposure to the risk of fluctuations in interest rates.
However, from a purely accounting point of view, these instruments, although substantially guaranteeing coverage of the above-mentioned risks, do not meet all the requirements of IFRS 9 to be designated as hedge accounting and therefore their change in Fair Value is posted to the Income Statement.
RISKS CONNECTED WITH FLUCTUATIONS IN EXCHANGE RATES
The Group is exposed to the risk of fluctuations in currency exchange rates arising from several circumstances.
(i) Firstly, the Group is exposed to exchange rate risk "of a translational nature".
Indeed, the Group prepares its consolidated financial statements in euros, while it holds controlling interests in companies that prepare their financial statements in currencies other than the euro (Polish zloty, Russian rouble, Czech krona, Swedish krona, Indian rupee, Australian dollar, Chinese yuan renminbi and US dollar). The Group is thus exposed to the risk that fluctuations in the exchange rates used to translate the financial statements of subsidiaries, originally expressed in foreign currency, may have a significant impact on the Group's results, consolidated net debt and consolidated shareholders' equity. The principal exposures are monitored, but it is not within the Group's current policies to hedge such translational foreign exchange risks.
(ii) Secondly, the Group is exposed to exchange rate risk of a "transactional nature", both for purchases of goods and materials from suppliers and for sales to customers.
In terms of purchases, the Group's principal currency of exposure is the US dollar (USD, the currency to which the cost of the main raw materials is linked). Indeed, raw materials on the reference markets are quoted in USD and the cost is converted into euros by applying the USD/Euro exchange rate of the day to the dollar quotation, thus passing on the exchange rate risk to the purchaser. Moreover, Group companies located in countries where the reference currency is not the euro (although they purchase raw materials under contracts that stipulate the euro as the currency for payment and, therefore, are exposed to the USD/Euro exchange rate risk), are also exposed to the risk of fluctuations in the euro exchange rate with respect to local currencies.
Sales are primarily denominated in euros. Moreover, although the companies Sest-LUVE Polska Sp.z.o.o., HTS and Spirotech are located in countries that do not have the euro as their reference currency, almost all their sales are made in euros and are therefore exposed to the risk of fluctuations in the euro exchange rate with respect to local currencies.
In order to protect the income statement and balance sheet items from such fluctuations and reduce the risk deriving from fluctuations in exchange rates, the Group entered into derivative financial instruments (primarily range accrual forwards and plain vanilla forwards), which are used to hedge the underlying risks. However, from a purely accounting point of view, these instruments, whilst substantially hedging the above risks, do not meet all the requirements of IFRS 9 (formerly IAS 39) in order to be designated as hedge accounting. In view of this, the Group deemed it appropriate to treat these instruments as trading transactions, and not as hedges, and consequently these instruments were measured at fair value with changes recorded in the income statement.
Certain currencies (Australian dollar, Chinese yuan, Swedish krona, Indian rupee, ruble and US dollar) in which revenues and operating costs are denominated, are also subject to natural hedging (revenues denominated in a specific currency are naturally hedged against operating costs denominated in the same currency).