The objective of the Group's financial risk management is to decrease adverse effects of changes in the financial market on the Group's results and cash flows and to ensure sufficient liquidity. Financial risks consist of market, credit and liquidity risks. The Group’s most important financial risks are exchange rate risk and counterparty risk.

The main principles of financial risk management are described in the Group’s treasury policy approved by the Company’s Board of Directors. The treasury management team is responsible for the implementation of the financial policy. The treasury operations are centralised in the Group Treasury.

Market risk

Market risk includes exchange rate risk, interest rate risk and electricity price risk. At the end of the reporting period, the Group had no investments in equities or equity funds.

Exchange rate risk

The Group's exchange rate risk consists of transaction risk and translation risk.

Transaction risk
Transaction risk arises from operational items (such as sales and purchases) and financial items (such as loans, deposits and interests) in foreign currency in the Statement of Financial Position, and from forecast future cash flows, observing the items of the upcoming 12 months.  Transaction risk is monitored and hedged actively. The largest risk in terms of value is posed by sales invoiced in US dollars. Other significant currencies are the Japanese yen, the Swedish krona, the Norwegian krona, the GB pound and the Polish zloty. As regards other currencies, no individual currency has a significant effect on the Group’s overall position.

In accordance with the Treasury Policy principles, items based on significant currencies in the Statement of Financial Position are hedged 90–105% and the forecasted cash flows over the upcoming 12 months are hedged 0–50%. Forward exchange contracts with maturities up to 12 months are used as hedging instruments. The positions of operational items are presented in the table in Note 24.1.1 of the Financial Statements 2011.

The Group has an external loan of GBP 16.4 million, whose capital and interest cash flows are fully hedged against foreign exchange risk with a cross currency swap. More details of the loan are presented in Note 24.1.3. of the Financial Statements 2011. 

The Group’s internal loans and deposits are denominated in the local currency of the subsidiary, and the most significant ones are fully hedged with currency forward contracts.

The fair value changes of the currency derivatives are recognised through profit or loss in either other operating income and expenses or finance income and expenses depending on whether, from an operational perspective, sales revenue or financial assets and liabilities has been hedged. 

Translation risk
Translation risk arises from the equity of subsidiaries that have a functional currency other than the
euro. On 31 December 2011 the equity in these subsidiaries totalled EUR 40.6 million (33.9 million in 2010). The most significant translation risk arises from the Great Britain pound. The translation position has not been hedged.

Sensitivity analysis
The effect of changes in foreign exchange rates on the Group’s results (before taxes) and equity is presented in Note No: 24.1.1 of the Financial Statements 2011 for EUR/USD exchange rates. The assumption used in the analysis is a +/- 10% change in the exchange rate (USD depreciates/appreciates by 10%) while other factors remain unchanged.

The sensitivity analysis includes only financial assets and liabilities in the Statement of Financial Position, i.e. cash and cash equivalents, trade receivables and payables, and currency derivatives. The sensitivity analysis does not provide a representative picture of the exposure to foreign exchange risk because, under the foreign exchange hedging principles, the forecast 12-month foreign currency cash flow is 0–50% hedged, and in accordance with IFRS 7, the forecast transactions are not included in the analysis. The translation position is not included in the sensitivity analysis.

Electricity price risk
The price risk refers to the risk resulting from changes in electricity market prices. The market price of electricity fluctuates greatly due to weather conditions, hydrology and emissions trading, for example. The Orion Group obtains its electricity through deliveries that are tied to the spot price in price area Finland, and is therefore exposed to electricity price fluctuation.

The electricity portfolio is managed so that it is possible to hedge the cash flow risk resulting from fluctuations in the market price of electricity and to continuously purchase electricity at the most competitive price available. The hedging instruments used are standard electricity derivative instruments that are quoted on Nord Pool. Nord Pool’s closing prices are used as levels for valuation.

Hedge accounting under IAS 39 is applied to hedging electricity price risk. In applying hedge accounting to the cash flow, the amount recognised for the hedging instrument in the fair value reserve in equity is adjusted according to IAS 39.96 so that it is the lower (in absolute figures) of the following two figures:

• the cumulative gain or loss accrued by the hedging instrument from its inception 
• the cumulative change in the fair value of expected future cash flows of the item hedged from the inception of the hedge

The remaining portion of the profit or loss accrued by the hedging instrument represents the ineffective portion of the hedge and it is recognised through profit or loss. 

A fair value valuation of EUR -0.2 million (EUR 1.9 million in 2010) for electricity hedges was recognised in the equity on 31 December 2011 (before taxes). The nominal values of the derivatives totalled EUR 6.7 million (7.4 in 2010).

Interest rate risk
Changes in interest rates affect the Group's cash flow and results. On 31 December 2011, the Group’s interest-bearing liabilities totalled EUR 88.7 million (EUR 110.0 million in 2010). The Group is exposed to interest rate risk associated with long-term loans raised from the European Investment Bank. On 31 December 2011, the capital of these loans with interest rates tied to the 6-month Euribor rate totalled EUR 66.1 million (77.4 in 2010). If interest rates rise in 2012 in parallel by one (1) percentage point compared with priced interest rates at the end of the reporting period, and other factors remain unchanged, the estimated interest expenses of the Group would rise by EUR 0.6 million in 2012 (before taxes).

The Group’s exposure to risks related to changes in market rates is, however, reduced by the fact that the Group’s interest-bearing investments, which on 31 December 2011 totalled EUR 70.3 million (119.6 in 2010), are invested in short-term interest-bearing instruments. If these investments were included in the afore-presented sensitivity analysis, the estimated net financial costs of the Group would increase by EUR 0.0 million in 2012.

The interest cash flow of the GBP 16.4 million floating-rate loan is hedged against rising interest rates with a cross currency swap, due to which a fixed EUR-nominated interest is paid by the Group.  

Hedge accounting of the cash flow under IAS 39 is applied to the afore-mentioned GBP-denominated loan both for currency and interest risk. Equity on 31 December 2011 includes a recognition of EUR 0.2 million (0.0 in 2010) (before taxes) in the fair value of the cross currency swap. The total nominal value of these items was EUR 19.1 million (0.0 in 2010).    

Counterparty risk

Counterparty risk is realised when a counterparty to the Group does not fulfil its contractual obligations, resulting in non-payment of funds to the Group. The maximum credit risk exposure at 31 December 2011 is the total of financial assets less carrying amounts of derivatives in financial liabilities, which totals EUR 289.8 million (294.8 in 2010). The main risks relate to trade receivables and cash and cash equivalents.

The Group Treasury Policy defines the requirements for the creditworthiness of the counterparties to financial investment transactions and derivative contracts. Limits have been set for investments and counterparties for derivative contracts on the basis of creditworthiness and solidity, and they are regularly updated and monitored. Investments are made in interest-bearing instruments with duration up to three months that are tradable in secondary markets.
 
The Group Customer Credit Policy defines the requirements for the creditworthiness of the customers. In the pharmaceutical industry trade receivables are typically generated by distributors representing different geographical areas. In certain countries, products are also sold directly to local hospitals. The Group’s 25 largest customers generated about 71% of the trade receivables. The most significant individual customers are Novartis, a marketing partner in pharmaceutical sales, and Oriola-KD Corporation, a pharmaceuticals distributor.  The trade receivables are not considered to involve significant risk. In Southern Europe, the receivables from single counter parties are not significant for the Group. Credit losses for the period recognised through profit or loss were EUR 0.8 million.

Liquidity risk

The Group seeks to maintain a good liquidity position in all conditions. In addition to cash flows from operating activities, cash and cash equivalents and money market investments, the liquidity is ensured by bank overdraft limits, EUR 75 million confirmed credit limit which is available until June 2012, and an unconfirmed commercial paper programme of EUR 100 million. No issued commercial paper is included in the Financial Statements.

The Group's interest-bearing liabilities at 31 December 2011 were EUR 88.7 million (110.0 in 2010). The contract-based repayments of the loans as well as their cash flows and finance expenses on 31 December 2011 are presented in the table of Note 24.3. of the Financial Statements 2011. The average maturity of the loans from financial institutions is 3 years 2 months. The cash flows specified in the table have not been discounted. In the estimates of the financial expenses of flexible interest-bearing liabilities, forward interest rates or average contract-based reference rates have been applied.
   
At 31 December 2011, the Group’s cash and cash equivalents and other money market investments totalled EUR 123.0 million (167.2 in 2010), thus exceeding the Group’s interest-bearing net debt. To ensure the Group’s liquidity, surplus cash is invested mainly in short-term euro-denominated interest-bearing instruments with good creditworthiness that are tradable in secondary markets. Counterparties and limits for these investments are defined in accordance with the Treasury Policy.

Management of capital structure

The financial objectives of the Group include a capital structure related goal to maintain the equity ratio, i.e. equity in proportion to total assets, at a level of at least 50%. This equity ratio is not the Company’s opinion of an optimal capital structure, but rather part of an aggregate consideration of the Company’s growth and profitability targets and dividend policy.

The covenants granted by the Company and the key figures relating to the capital structure are presented in Note 24.4. of the Financial Statements 2011.