Note 26 Financial risk management

Most of Arjo’s operations are located outside Sweden. This situation entails that the Group is exposed to different types of financial risks that may cause fluctuations in net profit for the year, cash flow and shareholders’ equity due to changes in exchange rates and interest rates. In addition, the Group is exposed to refinancing and counterparty risks.

The primary role of Arjo Group Finance is to support business activities and to identify and in the best way manage the Group’s financial risks in line with the Board’s established finance policy. Arjo’s financial activities are centralized to benefit from economies of scale, to ensure good internal control and to facilitate monitoring of risk.

Currency risks

Currency risks comprise exchange-rate fluctuations, which have an impact on the Group’s earnings and shareholders’ equity. Currency exposure occurs in connection with payments in foreign currency (transaction exposure) and when translating foreign subsidiaries’ balance sheets and income statements into SEK (translation exposure).

Translation exposure – income statement

When translating the results of foreign Group companies into SEK, currency exposure occurs, which affects the Group’s earnings when exchange rates fluctuate.

Translation exposure – balance sheet

Currency exposure occurs when translating net assets of foreign Group companies into SEK, which can affect the Group’s other comprehensive income. Exposure is reduced by Arjo applying hedge accounting to loans in foreign currency (EUR and USD) and also to currency derivatives. The Group also has loans in EUR that are not used in hedge accounting. The currency risk in these loans is reduced through currency derivatives.

The table provides information on the loans and derivatives that are used for hedge accounting of net investments in foreign operations. The Group did not recognize any ineffectiveness in profit or loss for the year.

Transaction exposure

Payment flows as a result of sales income and cost of goods sold in foreign currencies cause currency exposure that affects Group earnings in the event of exchange-rate fluctuations. The Group’s payment flows in foreign currencies consist mainly of the income generated by export sales that take place via a UK company with GBP as its functional currency. The most important currencies against the GBP are presented in the table below. Based on Group companies forecast currency flows, Group Finance hedged the most important currency exposures in 2019 in line with finance policy. Hedging took place using currency forward contracts. The fair value of financial currency derivatives that meet cash-flow hedging requirements and are recognized in other comprehensive income. In 2019, the Group analyzed its hedging policy, which resulted in a change to the policy in the final quarter of the year. From times point in time, the Group manages only currency risk for transactions that have occurred and no longer forecast flows. All derivatives under the former policy expired in 2019. Accordingly, the Group no longer uses hedge accounting for derivatives related to transaction exposure.

The table below presents the derivatives not used in cash-flow hedging. The Group did not recognize any ineffectiveness in profit or loss for the year.

The table below outlines the effect on net profit for the year, translated to SEK, of currency fluctuations of ±5 percent in the most important transaction currencies. Net volumes comprise the current year’s volumes in each currency.

The table below presents the derivatives outstanding on the closing date.

Financing risk

Credit facilities and loans

Prior to the IPO in 2017, Arjo signed an agreement for external financing of a total of about EUR 600 M with a group of Nordic and international banks. In 2018, Arjo established a commercial paper program of SEK 4,000 M that was valid in 2019. At year-end 2019, SEK 3,576 M (2,763) had been issued. The carrying amount was SEK 3,573 M (2,761).

Arjo signed an agreement for two revolving credit facilities denominated in EUR with a bank syndicate and an international bank. The company also entered into an agreement regarding a bilateral loan facility denominated in USD with another international bank. Based on these agreements, Arjo believes that it has a highly diversified loan portfolio with a good maturity structure. Furthermore, Arjo has a well-composed group of both Nordic and international lenders. Arjo’s policy is that refinancing risks are managed by signing long-term committed credit agreements with a range of tenures. All loan facilities include the usual guarantees and commitments, and do not contain any restrictions on dividends. The credit facilities may mature for earlier payment in full or in part if certain events occur, including, but not limited to, non-payment of past due amounts, non-compliance with financial covenants, rounds of terminations of the Group’s other financing agreements (cross default) and the insolvency of Arjo or some of Arjo’s subsidiaries. Financial covenants comprise Debt Repayment Capacity (the Group’s net debt as a percentage of the Group’s EBITDA) and Interest Payment Capacity (the Group’s EBITDA as a percentage of the Group’s net interest expenses). Arjo meet these covenants during the fiscal year. Arjo continued its commercial paper program of SEK 4,000 M in 2019. Based on this commercial paper program, Arjo can finance its operations in SEK and EUR for three to 12 months. The option of financing based on the commercial paper program was used to repay other interest–bearing bank loans. Arjo’s unutilized revolving credit facilities serve as a back-up to the commercial paper program.

Interest-rate risk

Arjo is exposed to interest-rate risk, defined as the risk of changed market interest rates impacting the Group’s net interest.The aim of Arjo’s interest policy is to reduce the short and long-term effect of changed market interest rates on the income statement and to minimize interest expenses. Arjo has focused on minimizing interest expenses and works actively with commercial paper programs to this end. Interest-rate risk is assessed and monitored continuously during the year.

All external bank loans carried variable interest (3 month LIBOR and STIBOR) at December 31, 2019. Loans under the commercial paper program have a fixed interest rate for each maturity based on the market rate on the issue date. On each issue date, Arjo can chose between using the commercial paper program or making use of the Group’s financial agreements, depending on which alternative is the most advantageous. Based on Arjo’s interest-bearing liabilities at December 31, 2019, a momentary change in average interest rates of ±1 percentage point for the currencies represented in the Group’s interest-bearing liabilities would entail changed interest expenses of ±SEK 63 M on an annual basis, which would impact net profit and equity in the amount of SEK ± 50 M.

Credit and counterparty risks

Arjo’s financial transactions cause credit risks with regard to financial counterparties. Credit risks or counterparty risks constitute the risk of losses if the counterparties do not fully meet their commitments. The finance policy states that the credit risk must be limited through accepting only creditworthy counterparties and fixed limits. At December 31, 2019, the total counterparty exposure in derivative instruments was SEK -42 M (-70). Credit risks in outstanding derivatives are limited by the offset rules agreed with the respective counterparty. The Group has ISDA agreements for all of its significant counterparties for raising funds and trading in financial instruments. For the financial assets and liabilities that are subject to legally binding offset agreements or similar, each agreement between the Company and its counterparties permits the relevant financial assets and liabilities to be offset. The derivatives were recognized at gross amount in the balance sheet. The Group’s liquidity is placed in bank accounts with low credit risks by distributing between several banks with high credit ratings. Arjo has a bank consortium comprising eight different banks, whose credit ratings are between A- and AA-.

Reserve for expected credit losses

Arjo’s accounts receivable are current in nature and thus the risk-assessment horizon is short. Credit risk is limited by a diverse customer base with a high credit rating since a high percentage are public customers. A collective assessment is performed of the impairment requirement for accounts receivable with low credit risk. An individual assessment is carried out for customers with impaired credit risk.

Fair value disclosures pertaining to interest-­bearing loans and other financial instruments

Arjo’s long-term loans have floating interest rates and, accordingly, the fair value is assessed as corresponding to the carrying amounts. Arjo’s credit risk has not changed significantly since the agreement was signed. For other financial assets and liabilities, fair value is assessed as corresponding to the carrying amount due to the short expected term.

The fair value of currency forward contracts is established using prices of currency forwards on the closing date, with the resulting value discounted to the present value. All derivatives are classified under level 2 of the fair value hierarchy. The Group has a liability for an additional purchase consideration related to the acquisition of ReNu in the US, which is at level 3 of the fair value hierarchy. The change in the liability for the year is primarily related to exchange-rate fluctuations.

The table below presents the Group’s financial instruments by category.

The table below shows the Group’s contractual and undiscounted cash flows from the external financial liabilities on the closing date until the contractual date of maturity.