33 Financial risk management and supplementary disclosures regarding financial instruments

­Swisscom is exposed to various financial risks resulting from its operating and financial activities. The most significant financial risks arise from changes in foreign exchange rates, interest rates as well as creditworthiness and the ability of counterparties to meet their payment obligations. A further risk arises from the ability to ensure adequate liquidity. Financial risk management is conducted in accordance with established guidelines with the aim of limiting potential adverse effects on the financial situation of Swisscom. These guidelines contain, in particular, risk limits for approved financial instruments and specify risk monitoring processes. Financial risk management, with the exception of the management of credit risks arising from business operations, is handled by the central Treasury Department. It identifies, evaluates and hedges financial risks in close cooperation with the Group’s operating units. The implemented risk management process also calls for routine reports on the development of financial risks.

Market price risks

Foreign exchange risks

­Swisscom is exposed to foreign exchange risks; these can impact the Group’s financial results and consolidated equity. Foreign exchange risks which have an impact on cash flows (transaction risks) are partially hedged by financial instruments and designated for hedge accounting. In addition, foreign exchange risks with an impact on equity (translation risks) are partially hedged through financial instruments and designated for hedge accounting. The aim of Swisscom’s foreign exchange risk management policy is to limit the volatility of planned cash flows. Forward currency contracts, currency options and currency swaps may be employed to hedge transaction risks. These hedging measures concern principally the USD and EUR. EUR-denominated financing is employed in order to hedge the translation risk of positions in EUR. As of the balance sheet date, Swisscom contracted financial liabilities totalling EUR 1,300 million (CHF 1,409 million) which were designated for hedge accounting for net investments in foreign shareholdings.

The currency risks and hedging contracts for foreign currencies as of 31 December 2015 are to be analysed as follows:

The currency risks and hedging contracts for foreign currencies as of 31 December 2014 are to be analysed as follows:

Foreign currency sensitivity analysis

The following sensitivity analysis shows the impact on the income statement should the EUR/CHF and USD/CHF exchange rates change in line with their implicit volatility over the next twelve months. This analysis assumes that all other variables, in particular the interest rate level, remain constant.

The volatility of the balance sheet positions and planned cash flows is partially offset by the volatility of the related hedging contracts.

Interest rate risks

Interest rate risks arise from fluctuations in interest rates which could have a negative impact on the financial position of Swisscom. Fluctuations in interest rates lead to changes in interest income and expense. Furthermore, they may impact the market value of certain financial assets, liabilities and hedging instruments. Swisscom actively manages interest rate risks. The main aim thereof is to limit the volatility of planned cash flows. Swisscom employs swaps to hedge its interest rate risk.

The structure of interest-bearing financial instruments at nominal values is as follows:

Interest rate sensitivity analysis

The following sensitivity analysis shows the effects on the income statement and equity if CHF interest rates move by 100 basis points. In computing sensitivity in equity, negative interest rates are excluded.

Credit risks

Credit risks from operating activities

­Swisscom is exposed to credit risks arising from its operating activities. Swisscom has no significant concentrations of credit risk. The Group has policies in place to ensure that products and ser­vices are only sold to creditworthy customers. Furthermore, outstanding receivables are continually monitored as part of its operating activities. Swisscom recognises credit risks through individual and general lump-sum allowances. In addition, the danger of risk concentrations is minimised by the large number of customers. Given that the financial assets as of the balance sheet date are neither impaired nor in default, there are no indications that the debtors will not be capable of meeting their payment obligations. Further information on financial assets is set out in Notes 17, 18 and 19.

Credit risks from financial transactions

­Swisscom is exposed to the risk of counterparty default through the use of derivative financial instruments and financial investments. Requirements to be met by counterparties are defined in guidelines governing derivative financial instruments and financial investments. Furthermore, individual limits by counterparty have been set. These limits and counterparty credit assessments are reviewed regularly. Swisscom signs netting agreements as issued by ISDA (International Swaps and Derivatives Association) with the respective counterparties in order to control the risk inherent in derivative transactions. The carrying amount of financial assets exposed to credit risk is to be analysed as follows:

The carrying amounts of cash and cash equivalents and other financial assets and the related Standard & Poor’s ratings of the counterparties are to be summarised as follows:

Liquidity risk

Prudent liquidity management includes the holding of adequate reserves of cash and cash equivalents and marketable securities as well as the provision of adequate financing. Swisscom has processes and policies in place that guarantee sufficient liquidity in order to settle current and future obligations. Swisscom has a confirmed line of credit of CHF 100 million maturing in 2016 from banks and a further confirmed line of credit of CHF 2,000 million from banks maturing in 2016. As of 31 December 2015, these lines of credit had not been drawn down, as in the prior year.

The contractual maturities of financial liabilities including estimated interest payments as of 31 December 2015 are as follows:

The contractual maturities of financial liabilities including estimated interest payments as of 31 December 2014 are as follows:

Estimation of fair values

The carrying amounts of trade receivables and payables as well as other receivables and payables are a reasonable estimate of their fair value because of their short-term maturities. The carrying amounts of cash and cash equivalents and current loans receivable correspond to the fair values. The fair value of available-for-sale financial investments is based on quoted stock exchange prices or equates to their purchase cost. The fair values of other non-current financial assets are computed on the basis of the maturing future payments, discounted at market interest rates. The fair value of non-publicly traded interest-bearing financial liabilities is estimated on the basis of the maturing future payments discounted at market interest rates. The fair value of publicly traded interest-bearing financial assets and liabilities is based upon stock exchange quotations as at the balance sheet date. The fair value of finance lease obligations is estimated on the basis of the maturing future payments, discounted at market interest rates. The fair value of publicly-traded investments held for sale is based on quoted stock exchange prices as of the balance sheet date. Interest rate swaps and currency swaps are discounted at market interest rates. Foreign currency forward contracts and foreign currency swaps are valued by reference to foreign exchange forward rates as of the balance sheet date.

Fair value hierarchy

The fair value hierarchy encompasses the following three levels:

• Level 1: stock exchange quoted prices in active markets for identical assets or liabilities;
• Level 2: other factors which are observable on markets for assets and liabilities, either directly or indirectly;
• Level 3: factors that are not based on observable market data.

Asset/liability valuation categories and fair value of financial instruments

The carrying amounts and fair values of financial assets and financial liabilities with their corresponding valuation categories are summarised in the following table. Not reflected therein are cash and cash equivalents, trade receivables and payables as well as miscellaneous receivables and payables whose carrying amount corresponds to a reasonable estimation of their fair value.

In addition, as of 31 December 2015, there were available-for-sale financial assets with a carrying amount of CHF 37 million (prior year: CHF 27 million) which are valued at acquisition cost.

Level 3 financial instruments developed as follows in 2014 and 2015:

The level-3 assets consist of investments in various investment funds and individual companies. The fair value was calculated by using a valuation model. In 2014 and 2015, there were no reclassifi­cations between the various levels.

Asset/liability valuation categories and results of financial instruments

The results for each asset/liability valuation category are to be analysed as follows:

In addition, in 2015, valuation allowances for trade and other receivables amounting to CHF 81 million (prior year: CHF 87 million) were recorded under other operating expenses.

Derivative financial instruments

At 31 December 2014 and 2015, the following derivative financial instruments were recorded:

Fair value hedges

In 2015, Swisscom entered into interest rate swaps to hedge the interest rate risk of interest-bearing financing amounting to CHF 225 million. These interest rate swaps had positive fair values of CHF 1 million as at 31 December 2015. Furthermore, in 2015, Swisscom had concluded currency swaps totalling EUR 700 million to hedge the foreign currency and interest rate risks of interest-bearing financing in EUR. As at 31 December 2015, these currency swaps had positive fair values of CHF 11 million and negative fair values of CHF 3 million. In the prior year, Swisscom reported no instruments designated as fair value hedges for hedge-accounting purposes.

Cash flow hedges

Swisscom entered into interest rate swaps with final maturities in 2016 in order to hedge interest rate risks of CHF 350 million of the variable CHF-denominated interest-bearing private placements. These hedges were designated as cash flow hedges for hedge-accounting purposes. As of 31 December 2015, these interest rate swaps were recorded with a negative fair value of CHF 5 million (prior year: CHF 9 million). CHF 6 million was recognised in the hedging reserve within consolidated equity for these hedging instruments (prior year: CHF 10 million). In 2009, interest rate swaps designated for hedge accounting for the premature hedging of the interest rate risk for the intended issuance of debenture loans totalling CHF 300 million were closed out. The effective share of CHF 7 million was left in the other reserves as part of equity. It is being released to interest expense over the hedged duration of debenture bonds issued in 2009. As of 31 December 2015, a negative amount of CHF 1 million (prior year: CHF 2 million) is recognised in the hedging reserve as part of consolidated equity.

As of 31 December 2015, derivative financial instruments included currency swaps of USD 268 million which serve to hedge future purchases of goods and services in the respective currencies. Prior year, currency swaps of USD 237 and forward currency contracts of EUR 199, were recorded for this purpose. The hedges were designated for hedge-accounting purposes. The hedges disclose a positive fair value of CHF 1 million (prior year: positive market value of CHF 6 million). A zero amount was recognised in the hedging reserve within consolidated equity for these designated hedging instruments (prior year: positive amount of CHF 5 million).

Other derivative financial instruments

In 2010 in order to hedge currency and interest rate risks arising in connection with EUR-denominated financing, interest rate swaps were entered into covering EUR 350 million with a duration of five years. These hedges matured in 2015. They were not designated for hedge accounting. Furthermore, derivative financial instruments as at 31 December 2015 include interest rate swaps covering CHF 200 million with maturities ending in 2040 with a negative market value of CHF 53 million (prior year: negative market value of CHF 40 million) which were not designated for hedge accounting. In addition, included in derivative financial instruments are foreign currency forward contracts and currency swaps for EUR and USD which serve to hedge future transactions in connection with Swisscom’s operating activities and which were not designated for hedge-accounting purposes.

Cross-border lease agreements

Between 1996 until 2002, Swisscom entered into various cross-border lease agreements, under the terms of which parts of its fixed line and mobile phone networks were sold or leased on a long-term basis and leased back. Swisscom defeased a significant part of the lease obligations through the acquisition of investment-grade financial investments. The financial assets were irrevocably deposited with a trust. In accordance with Interpretation SIC 27 “Evaluating the Substance of Transactions involving the Legal Form of a Lease”, these financial assets and liabilities in the same amount are netted and not recorded in the balance sheet. As of 31 December 2015, the financial liabilities and assets, including accrued interest, arising from cross-border lease agreements amounted to USD 69 million or CHF 69 million, respectively, which, in compliance with SIC 27, were not recognised in the balance sheet (prior year: USD 66 million or CHF 65 million).

Netting of financial instruments

­Swisscom enters into derivative transactions under International Swaps and Derivatives Association (ISDA) master netting agreements. Under such agreements, the amounts owed by each counterparty on a single day in respect of all transactions outstanding in the same currency are aggregated into a single net amount that is payable by one party or the other. The ISDA agreements do not meet the criteria for balance sheet netting as Swisscom has presently no legally enforceable right to offset the recognised amounts and such a right may only be applied to future occurrences such as a credit default or other credit events. In 2015, Swisscom recorded an amount of CHF 3 million for which such netting agreements existed. In the event of netting, derivative assets of CHF 14 million and derivative liabilities of CHF 61 million would be reduced to CHF 11 million and CHF 58 million, respectively. In the prior year, Swisscom recognised an amount of CHF 2 million for which such netting agreements existed. In the event of netting, the derivative assets in the prior year of CHF 11 million would be reduced to CHF 9 million and the derivative liabilities would be reduced from CHF 98 million to CHF 96 million.

Charges for international roaming between telecom enterprises are settled over a clearing centre. Receivables and payables arising from roaming charges between the contracting parties are netted and settled on a net basis. Those receivables and payables for which Swisscom has a legal right of offset are netted in Swisscom’s consolidated financial statements.

Management of equity resources

Managed capital is defined as equity including non-controlling interests. Swisscom seeks to maintain a robust equity basis. This basis enables it to guarantee the continuing existence of the company as a going concern and to offer investors an appropriate return in relation to the risks entered into. Furthermore, Swisscom maintains funds to enable investments to be made which will bring future benefits to customers as well as generate further returns for investors. The managed capital is monitored through the equity ratio which is the ratio of consolidated equity to total assets.

The following table illustrates the calculation of the equity ratio:

In its strategic targets, the Federal Council has ruled that Swisscom’s net indebtedness shall not exceed approximately 2.1 times the operating result before taxes, interest and depreciation and amortisation (EBITDA). Exceeding this limit temporarily is permitted. The net-debt-to-EBITDA ratio is as follows:

Net debt consists of total financial liabilities less cash and cash equivalents, current financial assets as well as non-current fixed interest-bearing financial investments.