Market risk

As part of its operations, the Enel Group is exposed to a variety of market risks, notably the risk of changes in interest rates, exchange rates and commodity prices.

As part of the governance of risk management, market risks are governed through specific policies set at both the Group level and at the level of individual divisions/countries, with special Risk Committees responsible for strategic policy-making and oversight. The governance arrangements for risk management provide for a system of operational limits defined by individual risk type, which are monitored periodically by the Risk Management units.

The nature of the financial risks to which the Group is exposed is such that changes in interest rates can cause an increase in net financial expense or adverse changes in the value of assets/liabilities measured at fair value.

The Group is also exposed to the risk that changes in the exchange rates between the euro and the main foreign currencies could have an adverse impact on the value in euro of performance and financial aggregates denominated in foreign currencies, such as costs, revenues, assets and liabilities, as well as the consolidation values of equity investments denominated in currencies other than the euro (translation risk).

As with interest rates, changes in exchange rates can cause variations in the value of financial assets and liabilities measured at fair value.

The Group’s policies for managing financial risks provide for the stabilization of the effects of changes in interest rates and exchange rates with the exclusion of translation risk. This objective is achieved both at the source of the risk, through the strategic diversification of the nature of financial assets and liabilities, and by modifying the risk profile of exposures with derivatives entered into on over-the-counter markets.

The risk of fluctuations in commodity prices is generated by the volatility of those prices and existing structural correlations. The combination of these factors creates uncertainty about the margin on transactions in fuels and energy. The variability of prices can also impact the industrial and commercial strategies of the Group.

In order to minimize the effects of such fluctuations and stabilize margins, strategies such as advance sourcing and hedging with derivatives are defined and planned in accordance with the Group’s policies and the operational limits specified under risk governance arrangements. The Group also engages in proprietary trading activities, aimed at monitoring the energy commodity markets used by the Group.

The strategies for hedging the price risk arising from trading in commodities can be implemented by Group companies through financial instruments that eliminate market risk by sterilizing the variable components of prices. To make the process more efficient, Enel has centralized the hedging of commodity price risk using financial instruments with a specialized organizational unit that primarily operates through contracts for difference and swaps, and turns to the derivatives market to hedge the net balance of the exposures.

During 2013, EMIR (European Market Infrastructure Regulation 648/2012 of the European Parliament) came into force. It is intended to regulate the OTC derivatives market in order to contain the systemic and counterparty risk typical of the market within sustainable limits, increasing the transparency of trading and reducing the scope for market abuse.

To this end, the EMIR framework introduces an operational model for the management of the entire life cycle of OTC derivatives, involving both financial and non-financial counterparties. Among the main innovations, it provides for the standardization of contracts, the obligation to use a clearing system involving a central or bilateral counterparty, and requirements to report to authorized entities at the European level (trade repositories).

In 2013, the Enel Group, as non-financial counterparty, undertook a number of initiatives to ensure compliance with the EMIR regulatory framework.

In particular, in the more specific area of risk management governance, the Group has begun monitoring the size of the OTC derivatives portfolio in relation to the threshold values set by regulators for the activation of the clearing obligations. During 2013, no overshoot of those threshold values was detected.

We report below the scale of transactions in derivative instruments outstanding at December 31, 2013, indicating the fair value and notional amount for each class of instrument.

The fair value of a derivative contract is determined using the official prices for instruments traded on regulated markets. The fair value of instruments not listed on a regulated market is determined using valuation methods appropriate for each type of financial instrument and market data as of the close of the period (such as interest rates, exchange rates, volatility), discounting expected future cash flows on the basis of the market yield curve at the balance-sheet date and translating amounts in currencies other than the euro using year-end exchange rates provided by the European Central Bank.

For contracts involving commodities, the measurement is conducted using prices for the same instruments on both regulated and unregulated markets.

In accordance with the new international accounting standards, the Group includes a measurement of credit risk, both of the counterparty (Credit Valuation Adjustment or CVA) and its own (Debit Valuation Adjustment or DVA), in order to adjust the fair value of financial instruments for the corresponding amount of counterparty risk.

More specifically, the Group measures CVA/DVA using a Potential Future Exposure valuation technique for the net exposure of the position and subsequently allocating the adjustment to the individual financial instruments that make up the overall portfolio. All of the inputs used in this technique are observable on the market.

Changes in the assumptions made in estimating the input date could have an impact on the fair value recognized for those instruments.

The notional amount of a derivative contract is the amount on which cash flows are exchanged. This amount can be expressed as a value or a quantity (for example tons, converted into euros by multiplying the notional amount by the agreed price). Amounts denominated in currencies other than the euro are converted into euros at the exchange rate provided by the European Central Bank.

The notional amounts of derivatives reported here do not necessarily represent amounts exchanged between the parties and therefore are not a measure of the Company’s credit risk exposure.

In conformity with the international accounting standards, financial assets and liabilities associated with derivative instruments are classified as:

  • cash flow hedge derivatives related to i) hedging the risk of changes in cash flows associated with long-term floatingrate borrowings; ii) hedging the exchange rate risk associated with long-term debt denominated in currencies other than the currency of account or the functional currency in which the company holding the financial liability operates; iii) hedging the exchange rate risk associated with the price of fuels priced in foreign currencies; iv) hedging the price risk associated with forecast sales of electricity at vari Enel Annual Report 2013 Consolidated financial statements able prices; and v) hedging the price risk associated with sales of coal and oil commodities;
  • fair value hedge derivatives, related to hedging the exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk;
  • trading derivatives associated with proprietary trading in commodities or hedging interest and exchange rate risk or commodity risk which it would be inappropriate to designate as cash flow hedges/fair value hedges or which do not meet the formal requirements of IAS 39.

Interest rate risk

The twin objectives of reducing the amount of debt subject to changes in interest rates and of containing borrowing costs are pursued with the use of a variety of derivatives contracts, notably interest rate swaps, interest rate options and swaptions. The term of such contracts does not exceed the maturity of the underlying financial liability, so that any change in the fair value and/or cash flows of such contracts is offset by a corresponding change in the fair value and/or cash flows of the underlying position.

Interest rate swaps normally provide for the periodic exchange of floating-rate interest flows for fixed-rate interest flows, both of which are calculated on the basis of the notional principal amount.

Interest rate options involve the exchange of interest differences calculated on a notional principal amount once certain thresholds (strike prices) are reached. These thresholds specify the effective maximum rate (cap) or the minimum rate (floor) on the debt as a result of the hedge. Hedging strategies can also make use of combinations of options (collars) that establish the minimum and maximum rates at the same time. In this case, the strike prices are normally set so that no premium is paid on the contract (zero cost collars).

Such contracts are normally used when the fixed interest rate that can be obtained in an interest rate swap is considered too high with respect to Enel’s expectations for future interest rate developments. In addition, interest rate options are also considered appropriate in periods of uncertainty about future interest rate developments, in order to benefit from any decreases in interest rates.

The following table reports the notional amount of interest rate derivatives at December 31, 2013 and December 31, 2012 broken down by type of contract:.

Millions of euroNotional amount
 2013 2012 
Interest rate swap  8,803  8,294 
Interest rate option  50  50 
Total 8,853  8,344 

The following table reports the notional amount and fair value of interest rate derivatives at December 31, 2013 and December 31, 2012, broken down by designation (IAS 39):

Millions of euro Notional amount Fair value  Fair value assets Fair value liabilities 
 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 
Cash flow hedge derivatives             
Interest rate swaps  6,878  6,433  (386)  (686)  40  (426)  (691) 
Fair value hedge derivatives             
Interest rate swaps  1,121  83  49  17  49  17  - -
Trading derivatives               
Interest rate swaps  804  1,778  (67)  (110)  (69)  (114) 
Interest rate options  50  50  (4)  (7)  - - (4)  (7) 
Total interest rate swaps  8,803  8,294  (404)  (779)  91  26  (495)  (805) 
Total interest rate options  50  50  (4)  (7)  - - (4)  (7) 
TOTAL INTEREST RATE DERIVATIVES  8,853  8,344  (408)  (786)  91  26  (499)  (812) 

The following table reports the cash flows expected in coming years from these financial derivatives:

Expected cash flows from interest rate derivatives

Millions of euroNotional amount
 at Dec. 31, 2013
2014 2015 2016 2017 2018 Beyond
CFH on interest rates
         
Positive fair value 40  (7)  (9)  (6)  (1)  72 
Negative fair value (426)  (173)  (104)  (57)  (40)  (28)  (117) 
FVH on interest rates          
Positive fair value 49  (3)  19  14  (2)  39 
Trading derivatives on interest rates          
Positive fair value - - - -
Negative fair value (73)  (21)  (9)  (7)  (6)  (5)  (39) 

The amount of floating-rate debt that is not hedged against interest rate risk is the main risk factor that could impact the income statement (raising borrowing costs) in the event of an increase in market interest rates.

At December 31, 2013, 9% of net long-term financial debt was floating rate (17% at December 31, 2012). Taking account of cash flow hedges of interest rates considered effective pursuant to the IFRS-EU, net financial debt was more than 6% overhedged at December 31, 2013 (97% hedged at December 31, 2012). Including interest rate derivatives treated as hedges for management purposes but ineligible for hedge accounting, net financial debt was more than 6% overhedged (99% hedged at December 31, 2012).

If interest rates had been 25 basis points higher at December 31, 2013, all other variables being equal, shareholders’ equity would have been €68.8 million higher (€79.4 million at December 31, 2012) as a result of the increase in the fair value of CFH derivatives on interest rates. Conversely, if interest rates had been 25 basis point lower at that date, all other variables being equal, shareholders’ equity would have been €68.8 million lower (€79.4 million at December 31, 2012) as a result of the decrease in the fair value of CFH derivatives on interest rates.

An equivalent increase (decrease) in interest rates, all other variables being equal, would have a negative (positive) impact on the income statement in terms of higher (lower) interest expense on the portion of debt not hedged against interest rate risk of about €35 million.

Exchange rate risk

Exchange rate risk is mainly generated with the following transaction categories:

  • debt denominated in currencies other than the currency of account or the functional currency entered into by the holding company or the individual subsidiaries;
  • cash flows in respect of the purchase or sale of fuel or electricity on international markets;
  • cash flows in respect of investments in foreign currency, dividends from unconsolidated foreign companies or the purchase or sale of equity investments.

In order to minimize this risk, the Group normally uses a variety of over-the-counter (OTC) derivatives such as currency forwards, cross currency interest rate swaps and currency options. The term of such contracts does not exceed the maturity of the underlying financial liability, so that any change in the fair value and/or cash flows of such contracts is offset by a corresponding change in the fair value and/or cash flows of the underlying position.

Cross currency interest rate swaps are used to transform a longterm fixed- or floating-rate liability in foreign currency into an equivalent fixed- or floating-rate liability in euros. In addition to having notionals denominated in different currencies, these instruments differ from interest rate swaps in that they provide both for the periodic exchange of cash flows and the final exchange of principal.

Currency forwards are contracts in which the counterparties agree to exchange principal amounts denominated in different currencies at a specified future date and exchange rate (the strike). Such contracts may call for the actual exchange of the two amounts (deliverable forwards) or payment of the difference between the strike exchange rate and the prevailing exchange rate at maturity (non-deliverable forwards). In the latter case, the strike rate and/or the spot rate may be determined as averages of the official fixings of the European Central Bank.

Currency options involve the purchase (or sale) of the right to exchange, at an agreed future date, two principal amounts denominated in different currencies on specified terms (the contractual exchange rate represents the option strike price); such contracts may call for the actual exchange of the two amounts (deliverable) or payment of the difference between the strike exchange rate and the prevailing exchange rate at maturity (nondeliverable). In the latter case, the strike rate and/or the spot rate may be determined as averages of the official fixings of the European Central Bank.

The following table reports the notional amount of transactions outstanding at December 31, 2013 and December 31, 2012, broken down by type of hedged item:

Millions of euroNotional amount
 2013 2012 
Cross currency interest rate swaps (CCIRSs) hedging debt denominated in currencies
other than the euro
14,263  13,892 
Currency forwards hedging exchange rate risk on commodities 4,253  6,250 
Currency forwards hedging future cash flows in currencies other than euro 1,906  1,348 
Currency swaps hedging commercial paper 246  232 
Currency forwards hedging credit lines 201  201 
Other currency forward 423  -
Total 21,292  21,923 

More specifically, these include:

  • CCIRSs with a notional amount of €14,263 million to hedge the exchange rate risk on debt denominated in currencies other than the euro (€13,892 million at December 31, 2012);
  • currency forwards with a total notional amount of €6,159 million used to hedge the exchange rate risk associated with purchases of fuel, imported electricity and expected cash flows in currencies other than the euro (€7,598 million at December 31, 2012);
  • currency swaps with a total notional amount of €246 million used to hedge the exchange rate risk associated with redemptions of commercial paper issued in currencies other than the euro (€232 million at December 31, 2012);
  • currency forwards with a total notional amount of €201 million used to hedge the exchange rate risk associated with credit lines in currencies other than the euro (€201 million at December 31, 2012).

The following table reports the notional amount and fair value of exchange rate derivatives at December 31, 2013 and December 31, 2012, broken down by designation (IAS 39):

Millions of euro Notional amount Fair value  Fair value assets Fair value liabilities 
at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012
Cash flow hedge derivatives:             
- currency forwards  2,989  3,458  (91)  (83)  (95)  (87) 
- CCIRSs  14,258  13,631  (1,551)  (847)  435  927  (1,986)  (1,774) 
Fair value hedge derivatives:             
- CCIRSs  261  (2)  18  - 23  (2)  (5) 
Trading derivatives:               
- currency forwards  4,040  4,573  12  35  46  74  (34)  (39) 
Total forwards  7,029  8,031  (79)  (48)  50  78  (129)  (126) 
Total CCIRS  14,263  13,892  (1,553)  (829)  435  950  (1,988)  (1,779) 
TOTAL EXCHANGE RATE DERIVATIVES  21,292  21,923  (1,632)  (877)  485  1,028  (2,117)  (1,905) 

The following table reports the cash flows expected in coming years from these financial derivatives:

Expected cash flows from exchange rate derivatives

Millions of euroFair valueDistribution of expected cash flows
 at Dec. 31, 2013
2014 2015 2016 2017 2018 Beyond
CFH on exchange rates          
Positive fair value 439  164  70  52  48  32  275 
Negative fair value (2.081)  (346)  (71)  (186)  (32)  (47)  (313) 
FVH on exchange rates          
Negative fair value (2)  (1)  (1)  - - - -
Trading derivatives on exchange rates          
Positive fair value 46  35 - - - - -
Negative fair value (34)  (35) - - - - -

An analysis of the Group’s debt shows that 31% of mediumand long-term debt (29% at December 31, 2012) is denominated in currencies other than the euro. Taking account of exchange rate hedges and the portion of debt denominated in the currency of account or the functional currency of the Group company holding the debt position, the proportion of unhedged debt decreases to 1% (2% at December 31, 2012), a proportion that is felt would not have a significant impact on the Group’s earnings in the event of a change in market exchange rates.

At December 31, 2013, assuming a 10% appreciation of the euro against the foreign currencies involved, all other variables being equal, shareholders’ equity would have been €1,539 million lower (€1,689 million at December 31, 2012), as a result of the decrease in the fair value of CFH derivatives on exchange rates. Conversely, assuming a 10% depreciation of the euro against the foreign currencies involved, all other variables being equal, shareholders’ equity would have been €1,881 million higher (€2,064 million at December 31, 2012) as a result of the increase in the fair value of CFH derivatives on exchange rates.

Commodity risk

The exposure to the risk of changes in commodity prices is associated with the purchase of fuel for power plants and the purchase and sale of gas under indexed contracts as well as the purchase and sale of electricity at variable prices (indexed bilateral contracts and sales on the electricity spot market).

The exposures on indexed contracts are quantified by breaking down the contracts that generate exposure into the underlying risk factors.

As regards electricity sold by the Group, Enel uses fixed-price contracts in the form of bilateral physical contracts and financial contracts (e.g. contracts for differences, VPP contracts, etc.) in which differences are paid to the counterparty if the market electricity price exceeds the strike price and to Enel in the opposite case.

The residual exposure in respect of the sale of energy on the spot market not hedged with such contracts is quantified and managed on the basis of an estimation of developments in generation costs. The residual positions thus determined are aggregated on the basis of uniform risk factors that can be hedged in the market. Various types of derivatives are used to reduce the exposure to fluctuations in energy commodity prices (mainly forwards, swaps, commodity options, futures and contracts for differences). Enel also engages in proprietary trading in order to maintain a presence in the Group’s reference energy commodity markets. These operations consist in taking on exposures in energy commodities (oil products, gas, coal, CO2 certificates and electricity in the main European countries), using financial derivatives and physical contracts traded on regulated and over-thecounter markets, exploiting profit opportunities through arbitrage transactions carried out on the basis of expected market developments.

The commodity risk management processes established at the Group level are designed to constantly monitor developments in risk over time and to determine whether the risk levels, as observed for specific analytical dimensions (for example, geographical areas, organizational structures, business lines, etc.), comply with the thresholds consistent with the risk appetite established by top management. These operations are conducted within the framework of formal governance rules that establish strict risk limits. Compliance with the limits is verified by units that are independent of those undertaking the transactions. Positions are monitored monthly, assessing the Profit at Risk, in the case of industrial portfolios, and daily, calculating Value at Risk, in the case of the trading book.

The risk limits for Enel’s proprietary trading are set in terms of Value-at-Risk over a 1-day time horizon and a confidence level of 95%; the sum of the limits for 2013 is equal to about €33 million.

The following table reports the notional amount and fair value of derivative contracts relating to commodities at December 31, 2013 and December 31, 2012.

Millions of euro Notional amount Fair value  Fair value assets Fair value liabilities 
 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 at Dec. 31, 2013 at Dec. 31, 2012 
Cash flow hedge derivatives:             
- derivatives on energy  2,024  1,847  (19)  19  16  23  (35)  (4) 
- derivatives on coal  1,250  1,507  (120)  (141)  - - (120)  (141) 
- derivatives on gas  1,413  585  (8)  (5)  - - (8)  (5) 
- other derivatives on commodities  90  - - - - -
Trading derivatives:               
- derivatives on energy  13,812  13,371  127  66  268  84  (141)  (18) 
- swaps on oil commodities  5,426  3,380  (44)  (66)  1,621  1,346  (1,665)  (1,412) 
- futures/options on oil commodities  3,357  4,661  30  173  80  (143)  (75) 
- derivatives on coal  1,442  1,724  (3)  69  84  (63)  (87) 
- embedded derivatives  659  126  (1)  (122)  - - (1)  (122) 
TOTAL COMMODITY DERIVATIVES  29,473  27,201  (23)  (247)  2,153  1,617  (2,176)  (1,864) 

Cash flow hedge derivatives refer to the physical positions in the underlying and, therefore, any negative (positive) change in the fair value of the derivative instrument corresponds to a positive (negative) change in the fair value of the underlying physical commodity, so that the impact on the income statement is equal to zero. The following table shows the fair value of the derivatives and the consequent impact on shareholders’ equity at December 31, 2013 (gross of taxes) that would have resulted, all other conditions being equal, in the event of a 10% increase or decrease in the prices of the commodities underlying the valuation model considered in the scenario at that date.

Millions of euro-10% Scenario +10% 
 at Dec. 31, 2013
Fair value of cash flow hedge derivatives on energy 121  (19)  (159) 
Fair value of cash flow hedge derivatives on coal (204)  (120)  (27) 
Fair value of cash flow hedge derivatives on gas (24)  (8) 
Fair value of cash flow hedge derivatives on other commodities

The following table shows the fair value of derivatives and the consequent impact on the income statement and shareholders’ equity at December 31, 2013 (gross of taxes), that would have resulted, all other conditions being equal, in the event of a 10% increase or decrease in the prices of the commodities underlying the valuation model considered in the scenario at that date.

Millions of euro-10% Scenario +10% 
 at Dec. 31, 2013
Fair value of trading derivatives on energy 19  127  244 
Fair value of trading derivatives on oil commodities (39)  (14)  25 
Fair value of trading derivatives on coal (18)  21 

Embedded derivatives relate to contracts for the purchase and sale of energy entered into by Slovenské elektrárne in Slovakia. The risk factors underlying the contracts are the price of electricity on the Slovakian market, the price of aluminum on the London Metal Exchange and the euro/ US dollar exchange rate. The market value at December 31, 2013 came to a negative €0.8 million, composed of:

  1. a. an embedded derivative on the euro/US dollar exchange rate whose fair value at December 31, 2013 was nil;
  2. b. a derivative on the price of gas whose fair value at December 31, 2013 was a negative €1 million.

The following tables show the fair value at December 31, 2013, as well as the value expected from a 10% increase or decrease in the underlying risk factors.

Fair value embedded derivative (a)

Millions of euroeuro/US dollar exchange rate
Decrease of 10% -
Scenario at Dec. 31, 2013 -
Increase of 10% -

Fair value embedded derivative (b)

Millions of euroAluminum price
Decrease of 10% (14) 
Scenario at Dec. 31, 2013 (1) 
Increase of 10% 12 

The following table reports the cash flows expected in subsequent years from these financial derivatives on commodities.

Millions of euroFair value Distribution of expected cash flows
 at Dec. 31, 20132014 2015 2016 2017 2018 Beyond
Cash flow hedge derivatives            
Positive fair value 22  10  - -
Negative fair value (163)  (156)  (6)  (1)  - - -
Trading derivatives
           
Positive fair value 2,131  2,192  (20)  (51)  10  - -
Negative fair value (2,013)  2,096  37  53  (7)  - -