Note 8 Derivatives
Derivatives are measured at fair value. As at year-end 2014, derivatives held for trading included a credit default swap (CDS) in current liabilities, forming part of the investments in financial assets.
The credit default swap derivative instrument has been part of two cross-border lease contracts since 2005. The CDS is a product which insures the credit risk on an underlying portfolio made up of almost 100 reference bonds. The instrument has a maturity of 10 years (maturing on 22 June 2015), Alliander’s maximum risk exposure was $171 million. An impairment loss on the CDS was recognised in 2008 and, in view of the then prospects for the product, it was decided at the time to recognise a provision in respect of the maximum risk exposure of $171 million. The greater part of this provision came from the fair value of the CDS (which was negative), the remainder being made up of an additional provision up to the amount of the maximum risk – see note . This approach was maintained up to year-end 2013, based on the expected risks.
In December 2014, the fair value of the CDS was $18 million (€15 million) and the additional provision amounted to $153 million (€127 million) on the basis of this methodology. As at year-end 2014, the remaining term to maturity of the CDS was only six months and the management of Alliander concluded at the time that the default risk among the companies in the CDS portfolio (between then and the expiration date of the instrument) had diminished to such an extent that the maximum risk relating to the entire product was no longer expected to materialise. Under the criteria stipulated in IAS 37, this meant that the entire amount of the provision of $153 million (€127 million) in 2014 should be released to income and set against operating expenses.
The fair value based on an external valuation in December 2014 amounted to $18 million (€15 million). However , Alliander’s management took the view that this fair value did not sufficiently reflect the remaining risks attendant upon the product. Based on an internal risk analysis, a valuation of $75 million (€62 million) as at year-end 2014 was arrived at. The difference, of $57 million (€47 million), was recognised in operating expenses in 2014. The net effect is that with respect to the CDS in 2014 a release of €80 million was recognised and set against the operating expenses.
The CDS matured on 23 June 2015, with the simultaneous expiry of all the risks attendant on this instrument. The carrying amount of the CDS, of €66 million, was released to the income statement for 2015 and set against operating expenses on the same date.
Finance was raised in 2015 under the Euro Commercial Paper Programme, denominated in foreign currency. In order to eliminate currency risks, the foreign currency was immediately converted into euros by means of foreign exchange swaps. The carrying amount of this short-term derivative as at year-end 2015 amounted to €0.3 million (2014: €2 million). The current liabilities as at year-end 2014, amounting to €18 million, related to three FX swaps hedging the currency risk on the current portion of the available-for-sale financial assets.