Financial Risk Management

The main financial risks include:

If these risks materialize, the financial impacts can be significant. It is important, therefore, to understand, identify, and limit these risks, particularly through hedging instruments. Effective management of these risks allows the Group to protect its financial health and stability and have better visibility of current and future income and expenses. Moreover, under certain conditions, the application of hedge accounting under IFRS and US GAAP ("Cash Flow Hedge - CFH," "Fair Value Hedge - FVH," "Net Investment Hedge - NIH") allows hedging instruments to significantly reduce P&L (profit and loss) volatility, which is generally a key element, if not one of the objectives, of the Chief Financial Officer.

Interest rate risk is associated with a potentially unfavorable change in interest rates, for example, on debt. If the debt is at a variable interest rate and rates increase over time, the interest expense will rise. One of the most common hedging instruments is an interest rate swap, which, for example, allows fixing the interest rate on debt.

Foreign exchange risk is linked to a potentially unfavorable change in exchange rates, for example, on a supplier invoice. For instance, if a supplier invoices 100 USD payable in 60 days to an entity whose functional currency is EUR (and whose revenues are in EUR), then the entity faces a foreign exchange risk. Suppose that at the invoice issuance date, 100 USD = 90 EUR. On the payment date, 100 USD could be worth 80 EUR (favorable change) or 95 EUR (unfavorable change). One of the most common hedging instruments is a currency forward, which allows buying one currency against the sale of another at a predetermined exchange rate and date. In the example above, the client would buy 100 USD in 60 days (against x EUR, at a predetermined exchange rate). The swap points (or term points) associated with FX forwards, considered by some as a hedging cost, represent the difference in interest rates between the two exchanged currencies.

It is noteworthy that intragroup loans between entities with different functional currencies generate exchange impacts that may not cancel out in consolidation, especially when the loan currency corresponds to the functional currency of one of the two entities.

Counterparty risk is related to the possibility that a counterparty may not fulfill its commitments, especially in the event of bankruptcy. This risk is measured, notably, by the ratings given by rating agencies (the most well-known are Standard & Poor’s, Fitch, Moody’s) and by CDS (Credit Default Swap, representing a kind of insurance premium against a counterparty default). Diversification of counterparties, consideration of their ratings and/or CDS, and financial analysis help limit this risk.

Liquidity risk is associated with the ability to buy or sell an asset quickly and at a fair price. The liquidity of investments should match cash flow forecasts to meet expected and unexpected (to a certain extent) of cash needs. For example, money market funds, which are highly stable, have a daily net asset value: investors can sell some or all of their shares the next day at a known or almost known price. On the other hand, if an investor has invested in a time deposit with a 32-day notice for early withdrawal, then the liquidity is 32 days: the investor must wait this duration to access the placed funds.

Policies should be implemented to ensure adherence to regulatory requirements and internal controls.