G28 Supplementary information – financial risk management

Financial risk management

Through its comprehensive international operations, Sandvik is exposed to financial risks.

Group Treasury is the function responsible for managing most of the Group’s financial risks. The primary objectives of the function are to contribute to the creation of value by managing the financial risks to which the Group is exposed to during the ordinary course of business, and to optimize the Group’s financial net.

The Board of Directors is responsible for establishing the Group’s finance policy, which comprises guidelines, objectives, and limits for financial management within Group Treasury as well as the management of financial risks within the Group.

Group Treasury supports Group companies and its tasks are to support subsidiaries with loans, deposits, foreign exchange deals, and banking solutions, as well as to act as an advisor in financial matters. The function conducts internal banking operations and is based at the head office in Stockholm. It is also responsible for the Group’s bank account set-up.

In addition, Group Treasury conducts operations for payment advisory and trade finance, and is responsible for the Group’s global policy for granting credit to customers in conjunction with sales. The customer finance activity is carried out through the business area Sandvik Mining and Rock Technology through selected locations worldwide.

Finally, Group Treasury also manages the financial risks associated with the Group’s defined-benefit pension plans.

Only institutions with a solid financial position and solid credit ratings are accepted as Sandvik’s counterparties in financial transactions.

Currency risk – Transaction exposure

Risk

Transaction exposure occurs when sales and purchases are made in two different currencies which affect profit for the year.

Sandvik’s annual transaction exposure, meaning the Group’s net flow of currencies, after full offsetting of the counter-value in the exporting companies’ local currencies, and measured at the average exchange rate, amounted to SEK 16,189 million (20,266) in 2020. The most important currencies for one year of exposure are shown in the following diagram.

Exposure
Net flow in foreign currencies

Comments

Sandvik generally offers customers the possibility to pay in their own currencies through the global sales organization. As a result, the Group is continuously exposed to currency risks associated with account receivables denominated in foreign currency and with future sales to foreign customers. Since a large percentage of production is concentrated to a few countries, while sales occur in many countries, Sandvik is exposed to a large net inflow of foreign currencies.

In order to mitigate the currency risk, pricing is adjusted against both customers and suppliers in circumstances where Sandvik is affected negatively by currency movements. To further reduce exposure to foreign currencies, currencies received are used to pay for purchases in the same currency via a netting structure.

A certain portion of the anticipated net flow of sales and purchases is hedged through financial instruments and bank account balances in accordance with guidelines set in the Group’s finance policy. In addition, major project orders are currency hedged to protect the gross margin. Under the finance policy, the CFO has a mandate to hedge the annual transaction exposure. At year-end, the total hedged amount was SEK 1,754 million (2,136). The average duration for the hedged volume of foreign currency was 3 months (3). Unrealized gains from outstanding currency contracts for hedging of future net flows amounted to SEK 184 million (18) at year-end. This amount consists of SEK 135 million in gains related to contracts maturing in 2021 and SEK 49 million in gains related to contracts maturing in 2022 or later.

If all exchange rates for the exposure currencies were to change by 5 percent in an unfavourable direction, total operating profit over a 12-month period would change by approximately SEK –1,239 million (–1,360 ), assuming that the composition is the same as it was at year-end.

Currency risk – Translation exposure

Translation exposure occurs when assets and liabilities are denominated in different currencies.

Since the Swedish krona (SEK) is Sandvik’s base currency, a translation risk related to the valuation of the net assets in foreign subsidiaries and the profit/loss in foreign currency achieved during the period occurs. The net assets, which usually consist of the foreign subsidiaries’ shareholders equity, are translated to SEK at the rates applied at the balance sheet date. At December 31, the Group’s net assets in subsidiaries in local currencies amounted to SEK 54,187 million (58,021).

Exposure

Group’s external borrowing by currency

Net assets by foreign currency

Comments

To avoid translation risk in the balance sheets of subsidiaries, they are financed in their functional currency through the internal bank. External borrowing often takes place in a specific currency, as shown in the first diagram. The currency risk that arises in the internal bank as a result of this is managed using various derivatives to minimize the translation risk.

Sandvik has chosen not to hedge future profits in foreign subsidiaries. Net assets are also not hedged, but the differences that arise due to changes in exchange rates since the preceding quarter are recognized directly in other comprehensive income. The second diagram shows the distribution of net assets among various currencies.

If exchange rates were to change by 5 percent in an unfavorable direction the net effect on other comprehensive income would be approximately SEK –2,712 million (–2,904). This net effect primarily comprises translation exposure in equity.

Interest rate risk

Risk

Interest-rate risk is defined as the risk that changes in market interest rates will have on the Group’s net interest items. The impact on net interest items of a change in interest rates depends on the interest terms of assets and liabilities. Sandvik measures interest-rate risk as the change over the forthcoming 12 months given a 1 percentage point change in interest rates.

Interest-rate risk arises in two ways:

• The Company may have invested in interest-bearing assets, the value of which changes when the interest rate changes.
• The cost of the Company’s borrowing fluctuates when the general interest-rate situation changes.

Exposure

If market rates were to rise by 1 percentage point across all terms, in relation to loans for which the interest rate will be reset during the coming year, interest costs would be impacted by SEK –29 million (–36).

An interest-rate sensitivity analysis of interest-rate swap agreements valid at year-end, and to which hedge accounting was applied, shows that other comprehensive income would change by SEK 34 million (50) as a result of a 1 percentage point shift in the interest-rate curve.

Comments

The Group’s interest-rate risk arises mainly in connection with borrowing. Interest-rate swap agreements are sometimes used to achieve the desired fixed-interest term. The Group CFO has a mandate to vary the average fixed-interest term of the Group’s debt portfolio, provided that it does not exceed 60 months. The average fixed-interest term on Sandvik’s borrowing was 46 months (49) at year-end, with consideration given to interest-rate swap agreements entered into.

In line with the Group’s finance policy, internal lending to foreign subsidiaries is hedged with currency derivatives. Consequently, there is an interest-rate effect in currency derivatives of 1.1 percent between the currencies the Group borrows and the currencies the Group lends. The Group’s average interest expense, including other loans and effects of various derivatives, was 4.7 percent (4.4).

Hedge accounting is applied when an effective link exists between hedged loans and interest-rate swaps. Accordingly, changed market interest rates could also impact other comprehensive income, since the Group has interest-rate swap agreements that are 100 percent effective and with a notional amount of SEK 1,500 million, to which it applies cash-flow hedging. This means that changes in the market values of these swaps are recognized directly in other comprehensive income instead of in profit for the year. A presentation of all interest-rate swap agreements entered into, and information regarding their duration, can be found at the end of this note.

Sandvik’s loan conditions do not currently entail financial covenants linked to key figures. Only under exceptional circumstances are assets pledged in connection with the raising of loans. Such pledging is disclosed in note G27.

In the event that Sandvik has surplus liquidity, it is placed in bank deposits or in short-term money market instruments (durations of up to 90 days), which means that the interest-rate risk (the risk of a change in value) is low.

Liquidity and refinancing risk

Risk

Liquidity and refinancing risk is defined as the risk that financing possibilities will be limited when loans are to be refinanced, and that payment commitments cannot be met as a result of insufficient liquidity.

Exposure

Maturity profile for borrowing and liquid assets
Nominal amount

Comments

According to the finance policy, the Group’s capital employed excluding cash and cash equivalents should be financed on a long-term basis. At year-end, the Group’s capital employed, excluding cash and cash equivalents, was SEK 68,040 million and long-term financing, including share capital, pension liabilities, long-term tax liabilities, long-term provisions and the guaranteed long-term credit facility, amounted to SEK 96,540 million. The short-term liquidity reserve, comprising committed credit facilities and accessible cash and cash equivalents was SEK 28,667 million. This reserve should at a minimum correspond to loans that mature for payment over the next six months and two weeks operating expenses, calculated to SEK 5,518 million.

Sandvik has a revolving credit facility totaling SEK 9,000 million maturing in 2023. The facility was unutilized at year-end.

The aim of Sandvik’s financing strategy is to achieve a well-balanced maturity profile for liabilities to thereby reduce the refinancing risk. The share of long-term loans in relation to total borrowing was 76 percent at year-end 2020 compared with 87 percent one year earlier. The maturity structure for the Group’s financial liabilities and derivatives is presented further down in this note.

At year-end, Standard & Poor’s, the international credit rating agency, had assigned an A–credit rating to Sandvik’s long-term borrowing and A–2 for its short-term borrowing. For a continuous update on Sandvik’s credit rating, please visit home.sandvik.

Credit risk

Risk

The Group’s commercial and financial transactions give rise to credit risk in relation to Sandvik’s counterparties. Credit risk or counterparty risk is defined as the risk for losses if the counterparty does not fulfill its commitments.

The credit risk to which Sandvik is exposed to can be divided into three categories:

• Financial credit risk
• Credit risk in trade receivables
• Credit risk in customer financing

Exposure

Comments

Sandvik has entered into agreements with the banks that are most important to the Company, covering such matters as the right to offset assets and liabilities that arise from financial derivative transactions, so-called ISDA agreements. This means that the Company’s counterparty exposure to the financial sector is limited to the unrealized net gains that arise in derivative agreements, and investments and bank balances. At December 31, the value of these amounted to SEK 24,169 million (17,396).

Sandvik companies are generally exposed to credit risk associated with outstanding trade receivables from ongoing sales. The credit risk is spread over a large number of customers in the business areas, and the 2020 consolidated credit losses were limited despite challenging circumstances on several of Sandvik’s market segments. To mitigate increasing credit risk, focus on the area sharpened and additional credit control tools were introduced. Sandvik’s credit losses, defined as the total of receivables written off and change in bad debt reserve, amounted to SEK –150 million (–24), equivalent to 0.2 percent of sales. The gross value of trade receivables was SEK 13,016 million (15,535) at December 31. Total impairment of these was SEK –647 million (–657). An age analysis of trade receivables at December 31, is presented in note G19.

Sandvik offers short- and long-term customer financing through its own Financial Services companies and in partnership with financial institutions and banks. At year-end, the value of outstanding credits referring to finance leases amounts to SEK 3,725 million (3,615), of which SEK –114 million (–88) was reserved for doubtful receivables.

In addition to the traditional financing of equipment, Sandvik also offers short-lease machinery. At year-end, the net carrying amount of this short-lease machinery was SEK 202 million (447).

Raw materials price risk

Risk

Sandvik’s financial risks related to raw materials are primarily concentrated to nickel and electricity. The price risks associated with these are partially hedged through the signing of financial contracts. A change in the electricity price of SEK 0.1 per kWh is estimated to affect Sandvik’s operating profit by plus or minus SEK 80 million (85) on an annual basis, based on the prevailing conditions at year-end 2020.

Exposure

When Sandvik Materials Technology obtains a customer order containing a fixed price for nickel, molybdenum or copper, the prices of these materials are hedged by signing financial contracts. This means that Sandvik’s operating profit is not impacted by movements in the price of these raw materials, relating to the aforementioned orders at a fixed price.

The Group applies a hedging strategy in order to minimize the metal price risk in connection with transactions conducted at a variable metal price. The measurement of inventory is not affected by hedging.

Changes in metal prices affect the profit and loss statement as a consequence of the lead time between the purchase of raw material and delivery of the finished product. The effect can be estimated through the rules regarding valuation of inventory. The net effect is presented in the “Development in business areas” section.

For Sandvik’s large production units in Sweden and Finland, the electricity price is continuously hedged through derivatives. Electricity consumption at these units normally totals around 800 GWh. The hedging horizon at year-end was about 22 months’ (18) expected consumption.

Comments

Net total consumption of nickel amounted to about 14,300 metric tons during the year.

At year-end, the volume of hedged nickel inventory was 643 metric tons (2,184). The market value of commodity derivatives entered into was SEK 10 million (–33).

The volume of electricity hedged with derivatives was 1,405 GWh (1,239) at year-end. The market value of these derivative contracts amounted to SEK –11 million (14).

For a more detailed breakdown of the quarterly effects on cash flow of the transactions that have been recognized in the hedge reserve, see the table at the end of this note.

Pension commitments

Risk

Sandvik has comprehensive pension obligations in the countries in which it operates. The pension solutions and funding requirements vary depending on legislation and local agreements. The largest funded pension plans are found in the US, UK, Finland, Sweden, Germany, and Canada. Three main risks are associated with Sandvik’s pension obligations; interest rate fluctuations, capital market volatility, and changes in life expectancy.

Exposure

The Group-funded pension liability has an average duration of 18.4 years. The average duration of the Group’s interest-bearing assets in the pension portfolio is 16.7 years. The allocation to interest-bearing assets is 51 percent of the pension portfolio. Due to the asset allocation and differences in duration between the interest-bearing assets and the liability, Sandvik is exposed to interest rate fluctuations, both when discounting the liability but also as market values change in the bond portfolio. If the average discount rate falls by –50 basis points the pension liability would increase by SEK 3,218 million.

25 percent of the pension portfolio is invested in equities. A 20 percent movement in the equity portfolio would result in a change in market value of SEK 1,180 million. If the life expectancy assumptions increase by one year, the pension liability would rise by 3.3 percent which corresponds to SEK 1,393 million. The calculated total loss potential for one year (pension risk), based on stress tests, is on aggregate SEK 4,325 million.

Development of pension liability and assets

Comments

In 2020, the pension assets totalled SEK 24,827 million (24,788) and the corresponding pension liability amounted to SEK 31,320 million (29,899), which is equal to a funding level of 79 percent (83). The return on Sandvik’s pension assets was 10.8 percent during the year (14.0). In addition, Sandvik has unfunded pension commitments of SEK 1,733 million (1,946).

The pension plans are governed through Sandvik’s Pension Supervisory Board (PSB). PSB is responsible for implementing policies and directives, approving new plans or material changes and closure of existing plans. The pension plans and governance are further described in note G22.

The Group’s financial instruments measured at fair value in the balance sheet

Financial assets and liabilities are not offset in the balance sheet. Derivative contracts are subject to framework agreements governing offsetting, and the carrying amounts of assets not offset in the balance sheet amounted to SEK 417 million. The carrying amount of corresponding liabilities was SEK –472 million. No collateral has been received or pledged. In the event of a default by a derivative counterparty, assets and liabilities for a total value of SEK 177 million would be offset in accordance with the framework agreement governing offsetting.

Calculation at fair value of the Group’s non-current borrowings would increase the total carrying amount by SEK 2,075 million (2,276). When measuring interest-bearing liabilities, the company’s Swedish and European bond loans have been remeasured using observable market prices for identical securities to value the Group’s marketable debt instruments. Other non-current debt has been remeasured in accordance with the principles described below. For short-term loans and deposits, no remeasurement was carried out, given that the carrying amount is considered to represent a good approximation of the fair value due to the short duration.

Net result per valuation category

The Company’s financial liabilities amounted to SEK 25,677 million (29,316) at year-end.