The Group is exposed to many different financial risks in its operations. Such risks include foreign currency, credit and liquidity risks. These and other financial risks are described in more detail below. The objective of the Group's financial risk management is to decrease the negative effects of market and counterparty risks on the Group's profits and cash flows and to ensure sufficient liquidity.
The main principles for financial risk management are described in the Group Treasury Policy approved by the Board of Directors of the parent company, and the Group Treasury is responsible for its implementation. Treasury activities are centralised in the Group Treasury.
The Group is exposed to market risks related to foreign currency exchange rate, market interest rate and electricity price.
Foreign currency exchange rate risk
The Group's foreign currency exchange rate risk consists of transaction risk and translation risk.
Transaction risk arises from operational items (such as sales and purchases) and financial items (such as loans, deposits and interest flows) in foreign currency in the statement of financial position, and from forecast cash flows over the upcoming 12 months. Transaction risk is monitored and hedged actively. In accordance with the Treasury Policy, items based on significant currencies in the statement of financial position are normally hedged 90−105% and the forecast cash flows over the upcoming 12 months 0−50%. Currency derivatives with maturities up to 12 months are used as hedging instruments.
The most significant currencies for the Group’s operational items are the US dollar, Swedish krona, Polish zloty, Norwegian krona, Russian rouble, Japanese yen and British pound. As regards these currencies, no individual currency accounts for a significant portion of the overall position. The position as regards these currencies is presented in the table in Note 126.96.36.199 of the Financial Statements 2020.
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 swaps.
The fair value changes of the currency derivatives are recognised through profit and loss in either other operating income and expenses or finance income and expenses depending on whether, from an operational perspective, sales revenues or financial assets and liabilities have been hedged.
Translation risk arises from the equity of subsidiaries outside the eurozone. At 31 December 2020, the equity in these subsidiaries totalled EUR 62.2 (2019: 59.8) million. The most significant translation risk arises from the British pound. This translation position has not been hedged.
The effect of changes in foreign currency exchange rates on the Group’s results (before taxes) at the reporting date is presented for the significant currencies in the table in Note 188.8.131.52 of the Financial Statements 2020. The assumption used in the sensitivity analysis is a +/- 10% change in the exchange rates (foreign currency depreciates/appreciates by 10%) while other factors remain unchanged. In accordance with IFRS 7, the sensitivity analysis includes only the financial assets and liabilities in the statement of financial position, and so the analysis does not take into account the forecast upcoming 12-month foreign currency cash flow included in the position. The potential translation position is not taken into account in the sensitivity analysis. In case the Group is not applying hedge accounting, the changes of exchange rates are recorded directly to profit or loss in the income statement.
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 Group obtains its electricity through deliveries that are partly fixed-price contracts and partly tied to the spot price of the price area of Finland, and in the latter case is therefore exposed to electricity price fluctuation. This price risk is not hedged.
Interest rate risk
Changes in interest rates affect the Group's cash flow and results. At 31 December 2020, the Group’s interest-bearing liabilities totalled EUR 108.5 (2019: 10.0) million, from long-term loan and lease liabilities.
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 2020 is the total of financial assets less carrying amounts of derivatives in financial liabilities, which totalled EUR 454.3 (2019: 348.6) million (Note 6.1 of the Financial Statements 2020). The main risks relate to trade receivables, cash and cash equivalents, and money market investments.
The Group Treasury Policy defines the requirements for the creditworthiness of the financial institutions acting as counterparties to Group companies. Limits have been set for counterparties on the basis of creditworthiness and solidity, and they are regularly monitored and updated. The maximum length of money market investments is 12 months.
The Group Customer Credit Policy defines the basis for classifying customers and setting limits for them, and the ways through which the credit risk is managed. Payment performance and the financial situation of customers are monitored, and effective collection is regularly undertaken. Credit risk can be reduced by requiring advance payment as a payment term or a letter of credit or a bank guarantee to secure the payment or by using credit insurance. In the pharmaceutical industry, trade receivables are typically generated by distributors representing different geographical areas. In certain countries, the Group also sells directly to local hospitals. The 25 largest customers accounted for 73.9% of the trade receivables at 31 December 2020 (2019: 78.1%). The trade receivables are not considered to involve significant risk (Note 3.6 of the Financial Statements 2020). Credit losses for the period recognised through profit and loss were EUR 0.0 (2019: 0.0) million.
The Group seeks to maintain a good liquidity in all conditions. This is ensured by cash flows from operating activities and cash and cash equivalents and other money market investments. Also the Company has a EUR 100 million of binding undrawn bilateral credit limits that will mature in 2024. In addition to this, the Group has undrawn bank overdraft limits and a EUR 100 million unconfirmed commercial paper programme from which no commercial papers had been issued on the reporting date.
The Group's interest-bearing liabilities at 31 December 2020 were EUR 108.5 (2019: 10.0) million, consisting of a fixed-rate EUR 100 million loan from the EIB and lease liabilities. The average maturity for interest-bearing liabilities excluding lease liabilities is 5.2 years (2019: zero years). At 31 December 2020, the Group’s cash and cash equivalents and money market investments totalled EUR 294.4 (2019: 149.0) million. To ensure the Group’s liquidity, any surplus cash is invested mainly in short-term euro-denominated interest-bearing instruments with good creditworthiness. An investment-specific limit is determined for each investment.
Forecast undiscounted cash flows of financial liabilities, interest payments and derivatives are presented in the table in Note 6.2.3 of the Financial Statements 2020.
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 terms of credit limit agreements of the Company include covenants that specify that if the covenants are breached, the lender optionally has the right to demand early repayment of the loan. The key figures used in the calculation of covenants have been calculated in accordance with the calculation formulas in the loan agreement. The tables presented in Note 6.2.4 of the Financial Statements 2020, show the levels of financial covenants specified in the terms of the loans and the corresponding values at 31 December 2020.