29. Management of financial risks and financial instruments

Financial income and expenses

The table below contains a breakdown of financial income and expenses. Capitalised construction interest is interest charges incurred during the construction phase of large investment projects.

The increase in total financial expenses is mainly attributable to a loss of 9 million euros from the recalculation of the financial lease obligation with respect to office building The Base. The recalculation was triggered by the decision in 2018 to opt for contractual early repayment in 2019. At early repayment a penalty interest is due, which is recognised at the expense of 2018. This loss was partly offset by an increase in capitalised construction interest.

Exchange differences on loans to associates concern the Redeemable Preference Shares (RPS) of Brisbane Airport Corporation Holdings Ltd held by Schiphol Group. The terms and conditions require repayment of the nominal value to the shareholders within a period of ten years and therefore the shares are not considered to be part of the net investment in the associate. Consequently, exchange differences should be accounted for in the income statement rather than in the exchange differences reserve. The currency risk relating to this long-term receivable is hedged by annual forward transactions which hedge the Australian dollar position against the euro. The hedge transactions are recognised as a cash flow hedge while the associated exchange differences are recognised in the reserve for hedging transactions. The other exchange differences are recognised in the income statement.

Financial risk factors

Due to the nature of its activities, Schiphol Group faces a variety of risks including market risk, counterparty risk and liquidity risk. The financial risk management programme (which is part of Schiphol Group’s overall risk management programme) focuses on the unpredictability of the financial markets and on minimising any adverse effects this may have on Schiphol Group’s financial results.

Schiphol Group uses derivative financial instruments to hedge certain risks. Financial risk management is carried out by the central treasury department (Corporate Treasury) and is part of approved Management Board policy. In addition to drawing up written guidelines for financial risk management, the Management Board determines the policy for specific key areas such as currency risk, interest-rate risk, credit risk, the use of derivative and non-derivative financial instruments, and the investment of temporary liquidity surpluses. The contracts relating to derivative financial instruments are shown in the table below.

Market risk

Market risk comprises three types of risk: currency risk, price risk and interest-rate risk. 

Currency risk

Currency risk arises if future business transactions, assets and liabilities recognised in the balance sheet and net investments in activities outside the euro zone are expressed in a currency other than Schiphol Group’s functional currency, which is the euro. Schiphol Group operates internationally and faces currency risks on several currency positions, in particular in Japanese yen (borrowings) and US and Australian dollars (net investments in activities outside the euro zone and non-current receivables).

Schiphol Group manages the currency risk on borrowings by using forward and swap contracts. The financial risk management policy is that virtually 100% of the expected cash flows are hedged. As at 31 December 2018, 6.0% of group financing had been drawn in foreign currency (one loan with a carrying amount of 158.7 million euros (JPY 20 billion nominal value)) compared with 6.8% of total borrowings (one loan with a carrying amount of 147.6 million euros and a nominal amount of JPY 20 billion) a year earlier. In accordance with the policy, this position is fully hedged by means of currency swaps. Movements in the exchange rate will not affect the results relating to these borrowings. The effect on equity is temporary (only for the duration of the hedging transaction) and amounts to 8.3 million euros positive in 2018 (after deferred tax).

Schiphol Group has a number of strategic investments in activities outside the euro zone; of these, the net investments recognised in the balance sheet under ‘associates’ and 'contract-related assets' are affected by a translation risk. In accordance with the policy, the currency position relating to Schiphol Group’s net investments in activities outside the euro zone, totalling 162 million euros as at 31 December 2018 (160 million euros as at 31 December 2017), is not hedged. As translation differences on these positions are recognised as part of the translation reserves, they do not directly impact the results. In 2018 the negative effect on equity amounts to 5.9 million euros, leading to a decline of the translation reserve from 5.9 million euros as per 31 December 2017 to zero as per 31 December 2018.

The Redeemable Preference Shares which Schiphol Group owns in Brisbane Airport Corporation Holdings Ltd. are reported as part of the 'loans to associates'. The currency risk related to this loan including any accrued dividends, with a carrying amount of 56.1 million euros as per 31 December 2018 (75.9 million euros as per 31 December 2017), is hedged by means of forward exchange transactions. Consequently, movements in the exchange rate will have only a minor effect on the results relating to this receivable.

Schiphol Group’s risk (counterparty risk) in respect of the cross-currency swap is mitigated by a cash collateral agreement with JPMorgan, which results in a maximum net position for both parties that depends on the parties’ credit ratings. If the credit rating of either party is reduced, the maximum net position for that party will also decrease. Under the cash collateral agreement, the difference between the market value of the swap and the applicable maximum net position is paid weekly through the bank.

As at 31 December 2018, the maximum net position of both parties amounted to 10 million euros (10 million euros as at 31 December 2017) while the market value of the swap was approximately 40.6 million euros positive (17.5 million euros as at 31 December 2017) at Schiphol Group. As at 31 December 2018, Schiphol Group had a liability of 30.9 million euros to JPMorgan (8.4 million euros as at 31 December 2017). If the EUR/JPY exchange rate decreases by 10%, Schiphol Group will receive 28.6 million euros from JPMorgan. If the exchange rate rises by 10%, Schiphol Group is required to deposit 23.3 million euros of collateral.

The interest rates shown against the various currency, interest-rate and cross-currency swaps are the fixed rates at which interest is payable to the counterparty, for which interest at the variable (or fixed) rate that Schiphol Group in turn has to pay on the loans concerned is receivable from the counterparty.

Price risk

Price risk is the risk of fluctuations in the value of assets and liabilities as a result of changes in market prices. Schiphol Group is affected mainly by the price risk on property investments which it recognises at fair value. This fair value is influenced by supply and demand and movements in interest rates and the rate of inflation, which is the basis for the Net Initial Yield. An average increase of 10% in the net initial yield (NIY) on offices and commercial buildings demanded by property investors would reduce the value of those properties by a total of approximately 136 million euros. A 10% decrease in the NIY would increase the value by approximately 165 million euros. Under the accounting policy, in that situation profitability before tax would fall by the same amount.

Schiphol Group purchases electricity and gas for its own use by Aviation on forward contracts.

Interest-rate risk

Interest-rate risk is divided into a fair value interest-rate risk and a cash flow interest-rate risk.

Fair value interest-rate risk is the risk of fluctuations in the value of a financial instrument as a result of movements in the market interest rate. Schiphol Group has no significant financial assets that attract a cash flow interest-rate risk but is affected by fair value interest-rate risk on its fixed-interest borrowings. If market interest rates fell by an average of 0.5%, this would lead to an increase of 36 million euros (1.3%) in the fair value of borrowings. An average increase of 0.5% in market interest rates would lead to a fall of 34 million euros (1.2%) in the fair value of borrowings. Schiphol Group’s policy is to draw at least 50% of borrowings at fixed interest rates, if necessary by using derivatives. As at 31 December 2018, 100% of borrowings were fixed-interest, excluding subsidiaries and associates (31 December 2017: 100%).

The cash flow interest-rate risk is the risk of fluctuations in the future cash flows of a financial instrument as a result of movements in market interest rates. Except for cash and cash equivalents, Schiphol Group has no significant financial assets that attract a cash flow interest-rate risk. If the average interest paid on deposits had been 0.5% higher during 2018 (and had therefore been -0.8%), the interest expense relating to deposits would have been 0.9 million euros higher (2017: 0.8 million euros).

In addition, Schiphol Group runs a cash flow interest-rate risk in respect of group financing at a variable interest rate. This position is limited by Schiphol Group’s policy of not drawing more than 50% of the funds borrowed at a variable interest rate (and at least 50% at a fixed interest rate), if necessary by using derivatives. As at 31 December 2018, the figure for variable-interest borrowings was 0% (31 December 2017: 0%).

Credit risk

Credit risk is the risk that one party to a financial instrument fails to fulfil its obligations, causing the other party to suffer a financial loss. Schiphol Group’s counterparties in derivative financial instruments and liquidities transactions are restricted to financial institutions with high creditworthiness (a minimum S&P credit rating of A) and the net position for each counterparty may not exceed 150.0 million euros. The maximum net position as at 31 December 2018 was 150.0 million euros (150.0 million euros as at 31 December 2017).

At 31 December 2018, trade receivables amounted to 125.0 million euros (31 December 2017: 120.3 million euros), after a provision for expected credit losses of 3 million euros (31 December 2017: 4 million euros) and including 4 million euros in security deposits received (31 December 2017: 2 million euros). Expected credit losses are measured based upon all possible situations and developments that may lead to default of the debtor during the expected total lifetime of the receivable. This is primarily derived from a provisions matrix based on historical data on credit losses per business area

Additionally, the measurement of credit losses is based on information accessible without undue costs and effort about current developments and expectations with regard to the market and significant trading relationships. The provision covers 100% of the receivables owed by debtors that are in bankruptcy or have applied for a suspension of payments, as well as receivables older than one year.

Parties using services from Schiphol Group are first assessed for creditworthiness. Depending on the outcome of this assessment, they may be required to provide security in the form of a bank guarantee or deposit to limit the credit risk. As at 31 December 2018, Schiphol Group holds 67.3 million euros in bank guarantees and security deposits (31 December 2017: 48.4 million euros). Koninklijke Luchtvaartmaatschappij N.V. (KLM) has an individual balance in excess of 10.0 million euros.

The following table provides more details on the provision for bad debt and ageing analysis:

Liquidity risk

Liquidity risk is the risk that Schiphol Group will have difficulty in raising the funding required to honour its commitments in the short term. Careful liquidity risk management means that Schiphol Group maintains sufficient liquid resources and has access to sufficient funding in the form of promised (and preferably committed) credit facilities and the EMTN programme. The financing policy is also aimed at reducing the refinancing risk. See note 23. Borrowings for further information on available facilities. In connection with liquidity risk, Corporate Treasury manages the cash pool through which several of the subsidiaries’ bank balances are managed and netted for optimum balance management.

All the items below are shown in the amounts at which they are recognised in the balance sheet and with a remaining maturity based on the date of redemption or settlement agreed with the counterparty. Schiphol Group’s policy is that no more than 25% of liabilities may have a term of less than one year. As at 31 December 2018, this figure was 14.0% (31 December 2017: 8.4%).

The remaining terms of the net liabilities relating to financial instruments and the composition of the expected cash flows are as follows:

Financial instruments can be classified as follows, according to the measurement policy applied:

• ¹ If a financial instrument is not measured at fair value, the level of fair hierarchy used to the determine the fair value disclosure is disclosed.

• ¹ If a financial instrument is not measured at fair value, the level of fair hierarchy used to the determine the fair value disclosure is disclosed.

The fair values are recalculated at the end of each reporting period. Depending on the input used, the established fair value falls into one of the following levels:

• Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities;
• Level 2: Quoted prices for similar assets and liabilities in active markets or information based on or supported by observable market inputs;
• Level 3: Unobservable inputs used to determine the fair value of an asset or liability.

At 31 December 2018, out of the 9 EMTN contracts outstanding per balance sheet date, 5 contracts were transferred from Level 2 to Level 1 since the fair value can be determined based upon quoted prices in active markets. There were no transfers from Level 1 to Level 2 in 2018. Level 2 measurements are determined using various methods and assumptions based on market conditions on the reporting date. The fair value of these financial instruments is determined on the basis of the present value of the projected future cash flows converted into euros at the relevant exchange rates and the market interest rate applicable to Schiphol Group on the reporting date.

The only item with a fair value in Level 3 is a profit sharing loan based on fair values of a specific real estate portfolio. The cash flows are determined on the basis of the expected value on the expiration date. The expected value is based on the valuation of investment property by external appraisers. For more information, see note 11. Investment property. Due to the positive movement in the fair values of the specific real estate portfolio, the profit sharing loan shows a similar move in the opposite direction.

The nominal value is assumed to approximate the fair value of loans to associates, trade receivables, cash and cash equivalents and trade payables.

Capital management

Schiphol Group’s long-term capital strategy and dividend policy are geared towards improving shareholder value, facilitating sustainable long-term growth and preserving an appropriate financial structure and sound creditworthiness. With its current shareholder base (public-sector shareholders), Schiphol Group only has access to the debt market and maintains a continued focus on further optimising its capital structure and cost of capital.

Schiphol Group uses certain financial ratios, including cash flow-based metrics, to capture the dynamics of capital structure, dividend policy and cash flow generation and monitors its capital structure in line with credit rating agencies and comparable best practises. In this context, key financial ratios employed include:

• Funds From Operations (FFO)/Total Debt: the FFO divided by the total debt.
• Leverage: interest-bearing debt divided by equity plus the interest-bearing debt.
• Funds From Operations (FFO) Interest Cover: the FFO plus interest charges divided by the interest charges.

Funds From Operations

‘Funds From Operations’ is calculated specifically for the purpose of determining the financial ratios and differs from the cash flow from operations calculated in the consolidated cash flow statement in accordance with the reporting policies, in the Consolidated statement of cash flow for the year ended 31 December 2018. FFO is the cash flow from operating activities adjusted for operating capital. In 2018 FFO increased from 467 million euros to 491 million euros.

For capital management purposes, debt consists of non-current and current liabilities as shown under ‘Total debt’. For capital management purposes, equity is equal to equity in the consolidated balance sheet. At 31 December 2018, equity was 4,117 million euros (31 December 2017: 3,978 million euros).

The FFO/total debt ratio and leverage at 31 December were as follows:

The FFO interest coverage ratio is calculated by dividing the FFO plus the interest charges relating to borrowings and lease liabilities, amounting to 88.1 million euros in 2018 (78.7 million euros in 2017), by those interest charges. The FFO interest coverage ratio for 2018 was 6.6x (compared with 6.9x for 2017). The ratios as at 31 December 2018 are consistent with Schiphol Group’s policy of maintaining at least a single A credit rating (S&P).