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 defined in the Group Treasury Policy, any changes to which are approved by either the Board of Directors of the parent company or the President and CEO. The Group Treasury is responsible for Group Treasure Policy 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, the Swedish krona, the Polish zloty, the Danish krone and the Norwegian krone. 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 22.214.171.124 of the Financial Statements 2022.
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. The fair value changes of the derivates relating to milestone payments are recognised in either sales revenues or operating income and expenses.
Translation risk arises from the equity of subsidiaries outside the eurozone. At 31 December 2022, the equity in these subsidiaries totalled EUR 63.2 (2021: 63.2) 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) and equity at the reporting date is presented for the significant currencies in the table in Note 126.96.36.199 of the Financial Statements 2022. 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 the case the Group is not adapting 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 mainly fixed-price contracts or 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 2022, the Group’s interest-bearing liabilities totalled EUR 213.9 (2021: 108.4) million, which comprise of long-term loans and lease liabilities. Of the loans from credit institutions, 108.8 million euros are tied to the variable Euribor interest rate. The group's exposure to rising market interest rates is reduced by the fact that 104.9 (2021: 0.0) million euros of the group's cash assets on 31 December 2022 have been invested in short-term interest instruments.
The effect of the increase in the interest rate on the net interest expenses has been estimated with a sensitivity analysis, where it is assumed that the interest rate will rise in 2023 by one percentage point (1%) from the interest rates priced at the balance sheet date, other factors remaining the same. The effect on result before taxes would be EUR -0.6 (2021: 0.0) million. Lease liabilities are not taken into account in the calculation.
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 2022 is the total of financial assets less carrying amounts of derivatives in financial liabilities, which totalled EUR 513.8 (2021: 392.1) million (Note 6.1 of the Financial Statements 2022). 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 duration of money market investments is less than 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 73.0% of the trade receivables at 31 December 2022 (2021: 72.3%). The trade receivables are not considered to involve significant risk (Note 3.7 of the Financial Statements 2022). Credit losses for the period recognised through profit and loss were EUR 0.2 (2021: -0.0) million.
The Group seeks to maintain a good liquidity position in all conditions. This is ensured by cash flows from operating activities and cash and cash equivalents and other money market investments. In addition, 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 2022 were EUR 213.9 (2021: 108.4) million, which consisted of loans of 188.2 million euros taken from European Investment Bank (EIB), bank loans transferred to the Group in connection with the acquisition of Inovet's veterinary medicine business and lease contract liabilities. The average maturity for interest-bearing liabilities excluding lease liabilities is 4.7 years (2021: 4.2 years). At 31 December 2022, the Group’s cash and cash equivalents and money market investments, which decrease liquidity risk, totalled EUR 332.6 (2021: 216.7) 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 2022.
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 agreements. The tables presented in Note 6.2.4 of the Financial Statements 2022, show the levels of financial covenants specified in the terms of the loans and the corresponding values at 31 December 2022. Orion fulfilled these financial covenants on 31 December 2022.