Foreign exchange risk
Valmet operates globally and is exposed to foreign exchange risk in several currencies, although the geographical diversity of operations decreases the significance of any individual currency. Substantial proportion of Valmet’s net sales and costs are generated in euros (EUR), US dollars (USD), Swedish kronas (SEK) and Chinese yuans (CNY).
Foreign exchange transaction exposure arises when a subsidiary has commercial or financial transactions and payments in another currency than its own functional currency and when related cash inflow and outflow amounts are not equal or concurrent.
In accordance with Valmet's treasury policy, subsidiaries are required to hedge in full the foreign currency exposures on Consolidated Statement of Financial Position and other firm commitments. Cash flows denominated in a currency other than the functional currency of the subsidiary are hedged with internal forward exchange contracts with Treasury for periods, which do not usually exceed two years. Subsidiaries also carry out hedging directly with the banks in countries, where the regulation does not allow corporate internal cross-border contracts. Treasury monitors the net position of each currency and decides to what extent a currency position is to be closed. Treasury is responsible for entering into external forward transactions corresponding to the internal forwards whenever a subsidiary applies hedge accounting. Valmet’s treasury policy defines upper limits on the open currency exposures managed by Treasury; limits have been calculated on the basis of their potential profit or loss impact. To manage the foreign currency exposure Treasury may use forward exchange contracts and foreign exchange options.
Valmet is exposed to foreign currency risk arising from both on- and off-balance sheet items. The foreign currency exposure is composed of all assets and liabilities denominated in foreign currencies and their counter values in local currencies. Calculation includes external and internal short- and long-term sales and purchase contracts, projected cash flows for unrecognized firm commitments and financial items, net of respective hedges. The table below illustrates the Group’s outstanding foreign currency risk at the end of the reporting period:
This Group level currency exposure is the basis for the sensitivity analysis of foreign exchange risk. Assuming euro to appreciate or depreciate 10 percent against all other currencies, the impact on cash flows, net of taxes, would be:
The sensitivity analysis as required by IFRS 7, includes financial instruments, such as trade and other receivables, trade and other payables, interest-bearing liabilities, deposits, cash and cash equivalents and derivative financial instruments.
The table below presents the effects, net of taxes, of a +/- 10 percent change in EUR against all other currencies:
Changes in fair value of derivative contracts that qualify for cash flow hedge accounting are recorded in equity. The effect in profit or loss is the change in fair value for all other financial instruments exposed to foreign exchange risk.
The nominal and fair values of the outstanding forward exchange contracts are presented in Financial Statements 2019 Note 10.
Translation or equity exposure
Foreign exchange translation exposure arises when the equity, goodwill and fair value step up of a subsidiary is denominated in currency other than the functional currency of the parent company. As at December 31, 2019 the total non-EUR denominated equity, goodwill and fair value step up of the subsidiaries were EUR 408 million (EUR 310 million). The major translation exposures were in 2019 EUR 130 million in USD and EUR 97 million in CNY, and respectively in 2018 EUR 97 million in CNY and EUR 73 million in SEK. Valmet is currently not hedging any equity exposure.