9.5.1. Financial risk factors

The business conducted by the Group exposes it to the following financial risks: market risk (including: price risk, foreign exchange risk and cash flow risk related to changes in interest rates), credit risk and liquidity risk.

Financial risk management is performed at the Management Board level. There are separate organizational units which monitor exposures to the individual financial risks.

The Group is exposed to significant foreign exchange volatility risk due to its foreign currency exposure which may affect the amounts of future cash flows and the financial result. Foreign exchange risk in the Group originates from the sale of its products:

• sales denominated in EUR and USD,
• sales indexed to EUR and USD.

In connection with the signed Bond Issue Program of July 2014, as amended, the Parent Company also issued bonds denominated in USD. This curtails the FX volatility risk resulting from selling products in a natural way.

The Group has been actively managing its FX risk. The overriding objective of the Group’s policy is to mitigate the exchange risk arising from its exposure to foreign currencies. The Group has been measuring its FX risk on an ongoing basis and takes actions to mitigate the effect it has on its financial standing. FX risk is managed in the Group in accordance with the FX Risk Management Policy at the Jastrzębska Spółka Węglowa S.A. Group.

The Group has allocated the executive, decision-making, supervisory, control and analytical functions to individual organizational units (the „division of tasks” principle).

In the Group, there is a Financial Risk Committee, responsible for making key FX risk management decisions, in particular for hedging contracted and planned cash flows.

In an attempt to eliminate FX risk, in 2018, the Group concluded FX forward transactions (external), in accordance with the hedge ratios adopted by the Management Board and the Financial Risk Committee. Intra-group hedging transactions have also been concluded in the Group. The maturity of the transactions did not exceed 12 months. The Group also made small purchases of materials, services or investment assets in foreign currencies. This naturally mitigates some foreign exchange risk resulting from product sales transactions.

The Group employs cash flow hedge accounting. In principle, derivative transactions to hedge the denominated exposure with maturities exceeding six months are designated for hedge accounting. At the inception of the hedge JSW formally designates and documents the hedging relationship. Effectiveness of the hedge instruments used by the Parent Company is monitored on an ongoing basis and is subject to continuous evaluation.

In 2018, the Group designated FX Forward transactions with a nominal amount of USD 62.5 million and EUR 187.5 million for hedge accounting. As at 31 December 2018, the Group had outstanding FX Forward derivatives with a total notional amount of EUR 179.1 million and USD 66.7 million, of which EUR 98.0 million and USD 23.0 million were hedge transactions for hedge accounting purposes. Derivative transactions hedge proceeds from the sales of products and merchandise which the Group expects to receive by October 2019. The effective part of the change in the fair value of hedge derivatives in the amount of PLN (9.1) million was recognized in other comprehensive income. The ineffective part and the change in the fair value of derivatives not designated for hedge accounting has been recognized in the period’s profit or loss. As a result of realization of the hedged item in both EUR and USD, the amount of PLN (27.1) million was recognized in the financial result in the period from January to December 2018.

The tables below provide details of these derivative transactions:

Open FX transactions as at 31 December 2018 are as follows:

Open FX transactions as at 31 December 2017 are as follows:

The carrying amounts of selected items denominated in foreign currencies, following a conversion into PLN, are as follows:

The Group’s sensitivity to appreciation and depreciation of the EUR/PLN and USD/PLN exchange rates is presented in the table below. Sensitivity analysis includes only the items denominated in foreign currencies which remain open at the end of the reporting period and presents the potential change in the value of financial assets and liabilities as a result of a change in the exchange rate. The sensitivity analysis is calculated on the basis of the implied volatility published by the Reuters service as at 31 December 2018.

Analysis of sensitivity to changes of exchange rates:

When the exchange rates drop (change by -%), the sensitivity analysis produces values identical to those in the table above but with an opposite sign.

The Group’s exposure to interest rate risk concerns primarily potential changes in cash flows caused by shifts in market interest rates. The Group finances its operating and investing activities partly with external funds bearing interest at floating interest rates and invests free cash in financial assets which also in most cases bear interest at floating interest rates. The Group is exposed mainly to the risk of changes in interest rates in respect of the assets associated with the acquisition of investment certificates as well as deposits and cash. To a lesser extent, the Group is exposed to the risk of changes in interest rates in respect of its liabilities under debt securities issued, finance lease liabilities and loans and borrowings. Interest rate risk arises from the volatility of the following reference rates: WIBOR O/N, WIBOR 1M, WIBOR 3M, LIBOR 1M for EUR, EURIBOR 1M, LIBOR 1M for USD, LIBOR 3M for USD.

The items of the consolidated statement of financial position, which are exposed to changes in interest rates, are presented in the following table:

The tables below present the potential impact of a change in interest rates on net profit and other comprehensive income. The analysis only covers these positions in financial instruments, which are exposed to interest rate risk as at the last day of the reporting period. The level of changes in interest rates accepted until 31 December 2018 reflects the hypothetical change in the level of the PLN reference rate.

Analysis of sensitivity to interest rate changes:

If the interest rates change by -50 basis points, the sensitivity analysis produces values identical to those in the table above but with an opposite sign.

The Group is exposed to interest rate risk primarily in PLN and USD. With respect to EURIBOR rates, their volatility is low and foreign currencies are only a small fraction of the overall cash exposed to the risk of interest rate changes; therefore, their effect on the Group’s financial results is insignificant.

Credit risk in the Group is concentrated in the following areas:

• trade receivables,
• cash and bank term deposits,
• derivaties.

Credit risk identified in trade receivables is related to their concentration and timely service and credibility of buyers. Sales are made to a limited number of buyers and therefore there is a concentration of risk associated with trade receivables.

In 2018, the ArcelorMittal Group and companies with the State Treasury in the shareholding structure still remain the principal buyers, responsible for respectively 33.4% and 16.1% of all trade receivables as at 31 December 2018. Both the ArcelorMittal Group and companies with the State Treasury as a shareholder decreased their share in trade receivables in 2018, as compared to the previous year. In 2017, the share held by the ArcelorMittal Group in trade receivables was 34.9% while the share of receivables from companies with the State Treasury as a shareholder represented 17.2% of all trade receivables in that period.

The Group operates on a volatile market and is exposed to the risk of uncollectible receivables. This risk is mitigated by the fact that most of the Group’s clients are large steel conglomerates with solid market position, or local commercial power plants. The Group does not require any security interest from buyers with a strong market position, considering the strategic nature of the cooperation and the ability to assess their financial documents. Other offtakers must put forward security, such as an irrevocable letter of credit or a blank promissory note. The clients who are unable to submit the security satisfactory to the Group can make a purchase against prepayment or have their amounts due insured by insurance companies.

As at 31 December 2018, 11.5% of the Group’s trade receivables was insured, 6.5% was secured by blank promissory notes and 13.3% was secured by letters of credit (as at 31 December 2017: 8.3% of the Group’s trade receivables was insured, 12.2% was secured by blank promissory notes and 8.5% was secured by letters of credit).

Taking into account the above security interest and the history of cooperation with the customers, the risk of uncollectible receivables is deemed to be very low.

The credit risk pertaining to cash and cash equivalents is limited because the Group invests its cash in banks with an established market position. The selection of financial institutions in which cash is deposited is also driven by the conditions ensuing from the signed Bond Issue Program.

Concentration of financial resources in banks:

This information covers the cash presented in Note 7.6. and Note 7.9.

In connection with the conservative selection of banks with which Group entities cooperate, the current level of risk may be estimated as low.

The Group selects cooperating banks for concluding forward transactions following similar principles as in the case of time deposits of available cash. In accordance with the FX Risk Management Policy in the Group, the Group hedges FX risk, among others by benefiting from natural hedges and entering into hedging transactions with banks and subsidiaries. To minimize the risk associated with execution of hedging transactions, the Group cooperates exclusively with highly credible banks. To diversify the risk associated with the execution of hedging transactions, the Financial Risk Committee at the Jastrzębska Spółka Węglowa S.A. Group defines the maximum concentration level for derivative transactions (the maximum nominal amount of transactions open at a single bank). The process of hedging exchange risk is monitored on an ongoing basis. The highest concentration level in one bank as at 31 December 2018 was 67% of the permissible limit.

According to the Group’s assessment, the maximum exposure to credit risk on the final day of the reporting period is the full carrying amount of trade receivables without the fair value of security accepted, cash and cash equivalents and financial assets in the form of bank term deposits.

In connection with the high capital expenditures incurred and the strong dependence of cash flows on coal and coke sale prices, in periods of bad economic conditions the Group is exposed to liquidity risk. Currently, owing to a significant improvement in the Group’s financial position, including an improvement in liquidity, as well as the repayment of a portion of liabilities on account of the bond issue, this risk has been curtailed.

The current market conditions enable generation of positive cash flows at the operational level, resulting in a high level of available cash. Moreover, within the framework of its strategic activities, the Parent Company will maintain the Stabilization Fund, the role of which will be to provide a safety cushion in times of economic downturn when it will be necessary to incur expenditures not fully covered by cash inflows. With this in mind, a Cooperation Agreement was signed with TFI Energia S.A. (formerly PGE Towarzystwo Funduszy Inwestycyjnych S.A.), under which JSW established the JSW Stabilization Closed-End Investment Fund (JSW Stabilization FIZ). On 18 January 2018 an issue of Series A Investment Certificates totaling PLN 1.5 billion was completed. Additionally, on 17 December 2018, the issue of Series B Investment Certificates for the amount of PLN 300.0 million was completed.

The Group also intends to maintain the proper financing structure by keeping an appropriate level of long-term financing sources.

The Group’s process of liquidity risk management calls for effective monitoring and reporting of the liquidity position, among others, to take preventive measures in the event of a threat to liquidity and maintaining an appropriate (minimum) level of cash available for service of current payments.

Additionally, in order to achieve more effective management of current liquidity, the Group has in place a cash management system named Physical Cash Pooling (PCP).

According to the signed agreements as at 31 December 2018, the Group had available and unused overdraft and working capital loan limits totaling PLN 0.8 million (as at 31 December 2017: PLN 0.9 million).

The table below contains an analysis of the Group’s financial liabilities by age group, distributed according to time to contractual maturity on the last day of the reporting period. The amounts presented in the table represent undiscounted contractual cash flows. The balances of trade liabilities and other financial liabilities maturing within 12 months are recognized at their carrying amounts, since the impact of discounting is not significant in terms of value.