4.3.29Financial Instruments − Fair Values and Risk Management

This note presents information about the Company’s exposure to risk resulting from its use of financial instruments, the Company’s objectives, policies and processes for measuring and managing risk, and the Company’s management of capital. Further qualitative disclosures are included throughout these consolidated financial statements.

Accounting Classifications and Fair Values

The Company uses the following fair value hierarchy for financial instruments that are measured at fair value in the statement of financial position, which require disclosure of fair value measurements by level:

  • Quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1);
  • Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices) (Level 2);
  • Inputs for the asset or liability that are not based on observable market data (that is unobservable inputs) (Level 3).

The following table shows the carrying amounts and fair values of financial assets and financial liabilities, including their levels in the fair value hierarchy. It does not include fair value information for financial assets and financial liabilities not measured at fair value if the carrying amount is a reasonable approximation of fair value.

Accounting classification and fair values

31 December 2019

31 December 2018

Notes

Fair value level

Total book value

Total fair value

Total book value

Total fair value

Financial assets measured at amortized cost

Finance lease receivables

4.3.15

3

6,694

7,137

5,947

5,712

Loans to joint ventures and associates

4.3.16

3

55

49

234

220

Total

6,749

7,186

6,181

5,932

Financial liabilities measured at amortized cost

US$ project finance facilities drawn

4.3.24

2

4,829

4,861

4,348

4,351

Revolving credit facility/Bilateral credit facilities

4.3.24

2

(0)

(0)

(1)

(1)

Lease liabilities

3

173

173

189

184

Other debt

4.3.24

2

1

1

1

1

Total

5,003

5,035

4,537

4,535

Additional information

  • In the above table, the Company has disclosed the fair value of each class of financial assets and financial liabilities for which the book value is different than fair value in a way that permits the information to be compared with the carrying amounts.
  • There are financial assets and financial liabilities measured at fair value, namely the interest rate swaps and forward currency contracts which are classified at a Level 2 on the fair value hierarchy. Level 2 is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices). The carrying amount for these financial assets and liabilities approximates the fair value as at December 31, 2019.
  • The Company has not disclosed the fair values for financial instruments such as short-term trade receivables and payables, because their carrying amounts are a reasonable approximation of fair values as the impact of discounting is insignificant.
  • Classes of financial instruments that are not used are not disclosed.
  • No instruments were transferred between Level 1 and Level 2.
  • No instruments were transferred between Level 2 and Level 3.
  • None of the instruments of the Level 3 hierarchy are carried at fair value in the statement of financial position.
  • No financial instruments were subject to offsetting as of December 31, 2019 and December 31, 2018.

The effects of the foreign currency related hedging instruments on the Company’s financial position and performance including related information is included in the table below:

Effect of the foreign currency and interest swaps related hedging instruments

2019

2018

Foreign currency forwards

Carrying amount

(35)

(23)

Notional amount

(2,107)

(1,427)

Maturity date

11/18/2020

10/23/2019

Hedge ratio

100%

100%

Change in discounted spot value of outstanding hedging instruments since 1 January

(17)

(88)

Change in value hedged rate for the year (including forward points)

17

88

Interest rate swaps

Carrying amount

(159)

(36)

Notional amount

5,481

4,063

Maturity date

5/28/2028

9/11/2026

Hedge ratio

96%

95%

Change in discounted spot value of outstanding hedging instruments since 1 January

(123)

73

Change in value hedged rate for the year (including forward points)

123

(73)

Measurement of Fair Values

The following table shows the valuation techniques used in measuring Level 2 and Level 3 fair values, as well as the significant unobservable inputs used.

Level 2 and level 3 instruments

Level 3 instruments

Type

Valuation technique

Significant unobservable inputs

Inter-relationship between significant unobservable inputs and fair value measurement

Financial instrument measured at fair value

Interest rate swaps

Income approach −
Present value technique

Not applicable

Not applicable

Forward currency contracts

Income approach −
Present value technique

Not applicable

Not applicable

Financial instrument not measured at fair value

Loans to joint ventures and associates

Income approach −
Present value technique

  • Forecast revenues
  • Risk-adjusted discount rate (3%-7%)

The estimated fair value would increase (decrease) if:

  • the revenue was higher (lower)
  • the risk-adjusted discount rate was lower (higher)

Finance lease receivables

Income approach −
Present value technique

  • Forecast revenues
  • Risk-adjusted discount rate (3%-8%)

The estimated fair value would increase (decrease) if:

  • the revenue was higher (lower)
  • the risk-adjusted discount rate was lower (higher)

Loans and borrowings

Income approach −
Present value technique

Not applicable

Not applicable

Other long term debt

Income approach −
Present value technique

Not applicable

Not applicable

Derivative Assets and Liabilities Designated as Cash Flow Hedges

The following table indicates the period in which the cash flows associated with the cash flow hedges are expected to occur and the carrying amounts of the related hedging instruments. The amounts disclosed in the table are the contractual undiscounted cash flows. The future interest cash flows for interest rate swaps are estimated using the forward rates as at the reporting date.

Cash flows

Carrying amount

Less than
1 year

Between
1 and 5 years

More than
5 years

Total

31 December 2019

Interest rate swaps

(159)

(20)

(204)

54

(170)

Forward currency contracts

(35)

(28)

(34)

-

(62)

31 December 2018

Interest rate swaps

(36)

(4)

(32)

(5)

(40)

Forward currency contracts

(23)

(30)

(14)

-

(44)

The following table indicates the period in which the cash flows hedges are expected to impact profit or loss and the carrying amounts of the related hedging instruments.

Expected profit or loss impact

Carrying amount

Less than
1 year

Between
1 and 5 years

More than
5 years

Total

31 December 2019

Interest rate swaps

(159)

(20)

(204)

54

(170)

Forward currency contracts

(35)

(28)

(34)

-

(62)

31 December 2018

Interest rate swaps

(36)

(4)

(32)

(5)

(40)

Forward currency contracts

(23)

(30)

(14)

-

(44)

Interest rate swaps

Gains and losses recognized in the hedging reserve in equity on interest rate swap contracts will be continuously released to the income statement until the final repayment of the hedged items (please refer to note 4.3.23 Equity Attributable to Shareholders).

Forward currency contracts

Gains and losses recognized in the hedging reserve on forward currency contracts are recognized in the income statement in the period or periods during which the hedged transaction affects the income statement. This is mainly within twelve months from the statement of financial position date unless the gain or loss is included in the initial amount recognized in the carrying amount of fixed assets, in which case recognition is over the lifetime of the asset. If the gain or loss is included in the initial amount recognized in the carrying amount of the cost incurred on construction contracts then the recognition is over time.

Loss allowance on financial assets and construction work-in-progress

The movement of loss allowance during the year 2019 is summarized as follows:

Finance lease receivable

Construction work-in-progress

Trade receivables

Other financial assets

2019

2018

2019

2018

2019

2018

2019

2018

Closing disclosed 31 December 2017 under IAS 39

(0)

-

(0)

-

(7)

(1)

(99)

(114)

Amounts restated through opening retained earnings

(0)

(0)

(0)

(0)

(4)

(0)

Opening loss allowance as at 1 January

(0)

(0)

(1)

(0)

(7)

(5)

(99)

(114)

Increase in loss allowance recognized in profit or loss during the year

(0)

(0)

(0)

(0)

(1)

(2)

(0)

Receivables written off during the year as uncollectible

Unused amount reversed

0

1

4

-

-

15

At 31 December

(0)

(0)

(0)

(0)

(4)

(7)

(99)

(99)

Financial Risk Management

The Company’s activities expose it to a variety of financial risks, market risks (including currency risk, interest rate risk and commodity risk), credit risk and liquidity risk. The Company’s overall risk management program focuses on the unpredictability of financial markets and seeks to minimize potential adverse effects on the Company’s financial performance. The Company uses derivative financial instruments to hedge certain risk exposures. The Company buys and sells derivatives in the ordinary course of business and also incurs financial liabilities in order to manage market risks. All such transactions are carried out within the guidelines set in the Company policy. Generally the Company seeks to apply hedge accounting in order to manage volatility in the income statement and statement of comprehensive income. The purpose is to manage the interest rate and currency risk arising from the Company’s operations and its sources of finance. Derivatives are only used to hedge closely correlated underlying business transactions.

The Company’s principal financial instruments, other than derivatives, comprise trade debtors and creditors, bank loans and overdrafts, cash and cash equivalents (including short-term deposits) and financial guarantees. The main purpose of these financial instruments is to finance the Company’s operations. Trade debtors and creditors result directly from the business operations of the Company.

Financial risk management is carried out by a central treasury department under policies approved by the Management Board. Treasury identifies, evaluates and hedges financial risks in close co-operation with the subsidiaries and the Chief Financial Officer (CFO) during the quarterly Asset and Liability Committee. The Management Board provides written principles for overall risk management, as well as written policies covering specific areas, such as foreign exchange risk, interest rate risk, credit risk, use of derivative financial instruments and non-derivative financial instruments, and investment of excess liquidity. It is, and has been throughout the year under review, the Company’s policy that no speculation in financial instruments shall be undertaken. The main risks arising from the Company’s financial instruments are market risk, liquidity risk and credit risk.

Market risk

Market risk is the risk that changes in market prices, such as foreign exchange rates and interest rates, will affect the Company’s income or the value of its holding of financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimizing the return on risk.

Foreign exchange risk

The Company operates internationally and is exposed to foreign exchange risk arising from transactional currency exposures, primarily with respect to the euro, Singapore dollar, and Brazilian real. The exposure arises from sales or purchases in currencies other than the Company’s functional currency. The Company uses forward currency contracts to eliminate the currency exposure once the Company has entered into a firm commitment of a project contract.

For foreign currency risk, the principle terms of the forward currency contract (notional and settlement date) and the future expense or revenue (notional and expected cash flow date) are identical. The Company has established a hedge ratio of 1:1 for all its hedging relationships.

The main Company’s exposure to foreign currency risk is as follows based on notional amounts:

Foreign exchange risk (summary)

31 December 2019

31 December 2018

in millions of local currency

EUR

SGD

BRL

EUR

SGD

BRL

Fixed assets

83

-

516

81

-

388

Current assets

89

1

868

89

2

1,009

Long-term liabilities

(48)

-

(235)

(51)

-

-

Current liabilities

(105)

(20)

(1,169)

(93)

(12)

(1,415)

Gross balance sheet exposure

18

(19)

(21)

26

(10)

(19)

Estimated forecast sales

65

-

-

110

-

-

Estimated forecast purchases

(1,175)

(276)

(888)

(937)

(171)

(734)

Gross exposure

(1,092)

(295)

(909)

(801)

(181)

(753)

Forward exchange contracts

1,086

293

1,111

795

179

811

Net exposure

(6)

(1)

202

(6)

(2)

58

The increase of the BRL exposure during 2019 was mainly driven by the recapitalization of the Brazilian operations entities and the Company's new estimated forecast purchases increased compared to the year 2018.

The estimated forecast purchases relate to project expenditure and overhead expenses for up to three years. The main currency exposures of overhead expenses are hedged at 100% for the coming year, between 66% and 100% for the year after, and between 33% and 100% for the subsequent year depending on internal review of the foreign exchange market conditions.

Foreign exchange risk (exchange rates applied)

2019

2018

2019

2018

Average rate

Closing rate

EUR 1

1.1195

1.1810

1.1234

1.1450

SGD 1

0.7330

0.7414

0.7434

0.7344

BRL 1

0.2540

0.2753

0.2488

0.2577

The sensitivity on equity and the income statement resulting from a change of ten percent of the US dollar’s value against the following currencies at December 31 would have increased (decreased) profit or loss and equity by the amounts shown below. This analysis assumes that all other variables, in particular interest rates, remain constant. The analysis is performed on the same basis as for 2018.

Foreign exchange risk (sensitivity)

Profit or loss

Equity

10 percent increase

10 percent decrease

10 percent increase

10 percent decrease

31 December 2019

EUR

1

(1)

(125)

125

SGD

0

(0)

(21)

21

BRL

0

(0)

(27)

(27)

31 December 2018

EUR

1

(1)

(95)

95

SGD

0

(0)

(13)

13

BRL

(0)

0

(20)

20

As set out above, by managing foreign currency risk the Company aims to reduce the impact of short-term market price fluctuations on the Company’s earnings. Over the long-term however, permanent changes in foreign currency rates would have an impact on consolidated earnings.

Interest rate risk

The Company’s exposure to risk from changes in market interest rates relates primarily to the Company’s long-term debt obligations with a floating interest rate. In respect of controlling interest rate risk, the floating interest rates of long-term loans are hedged by fixed rate swaps for the entire maturity period. The revolving credit facility is intended for the fluctuating needs of construction financing and bears interest at floating rates, which is also swapped for fixed rates when exposure is significant.

For interest rate risk, the principle terms of the interest rate swap (notional amortization, rate-set periods) and the financing (repayment schedule, rate-set periods) are identical. The Company has established a hedge ratio of 1:1, as the hedging layer component matches the nominal amount of the interest rate swap for all its hedging relationships.

At the reporting date, the interest rate profile of the Company’s interest-bearing financial instruments (excluding transaction costs) was:

Interest rate risk (summary)

2019

2018

Fixed rate instruments

Financial assets

6,770

6,026

Financial liabilities

(448)

(544)

Total

6,322

5,482

Variable rate instruments

Financial assets

55

234

Financial liabilities

(4,382)

(3,898)

Financial liabilities (future)

(1,879)

(313)

Total

(6,206)

(3,977)

Interest rate risk (exposure)

2019

2018

Variable rate instruments

(6,206)

(3,977)

Less: Reimbursable items

565

-

Less: IRS contracts

5,481

4,063

Exposure

(160)

86

At December 31, 2019, it is estimated that a general increase of 100 basis points in interest rates would decrease the Company’s profit before tax for the year by approximately US$1 million (2018: increase of US$1 million) mainly related to residual exposure on un-hedged financial liabilities.

The sensitivity on equity and the income statement resulting from a change of 100 basis points in interest rates at the reporting date would have increased (decreased) equity and profit or loss by the amounts shown below. This analysis assumes that all other variables, in particular foreign currency rates, remain constant. The analysis is performed on the same basis as for 2018.

Interest rate risk (sensitivity)

Profit or loss

Equity

100 bp increase

100 bp decrease

100 bp increase

100 bp decrease

31 December 2019

Variable rate instruments

(1)

1

-

-

Interest rate swap

0

(0)

240

(240)

Sensitivity (net)

(1)

1

240

(240)

31 December 2018

Variable rate instruments

1

(1)

-

-

Interest rate swap

0

(0)

159

(171)

Sensitivity (net)

1

(1)

159

(171)

As set out above, the Company aims to reduce the impact of short-term market price fluctuations on the Company’s earnings. Over the long-term however, permanent changes in interest rates could have an impact on consolidated earnings.

Credit risk

Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Company’s other financial assets, trade and other receivables (including committed transactions), derivative financial instruments and cash and cash equivalents.

Credit risk

2019

2018

Rating

Assets

Liabilities

Assets

Liabilities

AA

-

(4)

1

(1)

AA-

21

(89)

15

(34)

A+

20

(147)

29

(79)

A

-

(1)

2

(1)

BBB

1

-

-

-

Non-investment grade

1

-

-

-

Derivative financial instruments

43

(241)

46

(116)

AAA

120

-

246

-

AA

27

-

106

-

AA-

183

-

202

-

A+

131

-

104

-

A

11

-

11

-

A-

0

-

2

-

Non-investment grade

34

-

47

-

Cash and cash equivalents and bank overdrafts

506

-

718

-

The Company maintains and reviews its policy on cash investments and limits per individual counterparty are set to:

  • BBB- to BBB+ rating: US$25 million or 10% of cash available.
  • A- to A+ rating: US$75 million or 20% of cash available.
  • AA- to AA+ rating: US$100 million or 20% of cash available.
  • Above AA+ rating: no limit.

As per December 31, 2019, cash investments above AA+ rating do not exceed US$100 million per individual counterparty.

Cash held in banks rated below A- is mainly related to the Company’s activities in Angola (US$24 million).

For trade debtors the credit quality of each customer is assessed, taking into account its financial position, past experience and other factors. Bank or parent company guarantees are negotiated with customers. Individual risk limits are set based on internal or external ratings in accordance with limits set by the Management Board. At the date of the financial statements, there are no customers that have an outstanding balance with a percentage over 10% of the total of trade and other receivables. Reference is made to note 4.3.19 Trade and Other Receivables for information on the distribution of the receivables by country and an analysis of the ageing of the receivables. Furthermore, limited recourse project financing removes a significant portion of the risk on long-term leases.

For other financial assets, the credit quality of each counterpart is assessed taking into account its credit agency rating.

Regarding loans to joint ventures and associates, the maximum exposure to credit risk is the carrying amount of these instruments. As the counterparties of these instruments are joint ventures, the Company has visibility over the expected cash flows and can monitor and manage credit risk that mainly arises from the joint venture’s final client.

Liquidity risk

Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and abnormal conditions, without incurring unacceptable losses or risking damage to the Company’s reputation.

Liquidity is monitored using rolling forecasts of the Company’s liquidity reserves on the basis of expected cash flows. Flexibility is secured by maintaining availability under committed credit lines.

The table below analyses the Company’s non-derivative financial liabilities, derivative financial liabilities and derivative financial assets into relevant maturity groupings based on the remaining period at the statement of financial position date to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows. The future interest cash flows for borrowings and derivative financial instruments are based on the LIBOR rates as at the reporting date.

Liquidity risk 2019

Note

Less than 1 year

Between 1 and 5 years

Over 5 years

Total

31 December 2019

Borrowings

766

3,043

1,944

5,753

Derivative financial liabilities

89

105

29

223

Derivative financial assets

(25)

(3)

-

(29)

Trade and other payables

4.3.27

911

-

-

911

Total

1,740

3,144

1,973

6,858

Liquidity risk 2018

Note

Less than 1 year

Between 1 and 5 years

Over 5 years

Total

31 December 2018

Borrowings

687

2,638

2,072

5,397

Derivative financial liabilities

88

34

7

128

Derivative financial assets

(38)

0

(0)

(38)

Trade and other payables

4.3.27

847

(0)

-

847

Total

1,583

2,672

2,079

6,334

Capital risk management

The Company’s objectives when managing capital are to safeguard the Company’s ability to continue as a going concern in order to provide returns for shareholders, benefits for other stakeholders and to maintain a capital structure which optimizes the Company’s cost of capital while at the same time, ensures diversification of sources of external funds.

SBM Offshore generally uses its corporate revolving credit facility (RCF, US$1 billion) to bridge financing requirements on projects under construction prior to putting a dedicated project finance facility in place. When a project finance facility is arranged and draw-downs have started, the RCF is repaid and a corporate guarantee from the Company is put in place for the construction period. When the project facility is drawn in full and the associated FPSO is producing, the corporate guarantee is relinquished and the project finance becomes non-recourse debt.

As per December 31, 2019, all the debt associated with operating FPSOs is non-recourse, with the exception of the FPSO Liza Destiny, where the Company is currently going through the process of releasing the corporate guarantee (the FPSO Liza Destiny is producing since late December 2019).

The Company has limited appetite to decrease the existing debt in its structure, as this would involve breakage cost, through winding down the hedges and it would decrease the Company’s return on equity. From time to time, it may decide to increase leverage on existing facilities in case of sufficient tenor, charter income and relatively low remaining debt balances.

Given the non-recourse nature of its debt, SBM Offshore monitors its capital risk based on the Lease Backlog Cover Ratio, which is also used by the bank consortium supporting the Company’s RCF. Generally, this ratio is calculated as the present value of the projected future net charter income, after deducting the project finance debt and interest payments, of a selected group of FPSO owning entities divided by the Company’s corporate debt level (see note 4.3.24 Borrowings and Lease Liabilities).

The gearing ratios at December 31, 2019 and 2018 were as follows:

Capital risk management

2019

2018

Total borrowings and lease liabilities

4,922

4,536

Less: net cash and cash equivalents

506

718

Net debt

4,416

3,818

Total equity

3,613

3,612

Total capital

8,029

7,430

Gearing ratio

55.0%

51.4%

Other risks

In respect of controlling political risk, the Company has a policy of thoroughly reviewing risks associated with contracts, whether Turnkey or long-term leases. Where political risk cover is deemed necessary and available in the market, insurance is obtained.