32. Financial risk management

In the course of its business activities the Group is exposed to the following main financial risks:

• market risks:
  • risk of changes in metal prices,
  • risk of changes in foreign exchange rates,
  • risk of changes in interest rates,
  • price risk related to investments in debt instruments,
  • price risk related to investments in shares of listed companies,
  • credit risk,
• liquidity risk.

The Group continuously identifies and measures financial risk, and also takes actions aimed at minimising its impact on the financial situation. Understanding these threats arising from exposure to risk and having an appropriate organisational structure and procedures enable better realisation of its tasks.

The Parent Entity manages identified financial risks in a conscious and responsible manner on the basis of the approved Market Risk Management Policy, Financial Liquidity Management Policy and Credit Risk Management Policy. The process of financial risk management in the Parent Entity is supported by the work of the Market Risk Committee and the Credit Risk Committee.

In March 2014, a new Market Risk Management Policy in the KGHM Polska Miedź S.A. Group was approved, and KGHM INTERNATIONAL LTD. representatives were added to the composition of the Market Risk Committee. These changes were aimed at setting principles and procedures with respect to market risk management in selected mining companies of the Group (including KGHM INTERNATIONAL LTD.). The Policy concerns exposure to the following market risks: volatility in metals prices, volatility in exchange rates, volatility in interest rates and volatility in prices of commodities other than metals.

Liquidity risk management in the Parent Entity is based on the Financial Liquidity Management Policy approved by the Management Board. In KGHM INTERNATIONAL LTD. the liquidity risk management principles are described in the Investment Policy. These documents describe the financial liquidity management process while taking into account the specific character of the Group companies, indicating best practise procedures and instruments. The Parent Entity supervises the process of managing liquidity and acquiring external financing in the Group.

32.1 Market risk

The market risk to which the Group is exposed is understood as the possible negative impact on the Group’s results, resulting from changes in the market prices of commodities, exchange rates and interest rates, as well as the prices of debt instruments and the share prices of listed companies.

32.1.1 Principles of market risk management

In market risk management (especially commodity and currency risk) of greatest significance and impact on the results of the KGHM Polska Miedź S.A. Group is the scale and profile of activities of the Parent Entity and of mining companies of the KGHM INTERNATIONAL LTD. Group.

The Parent Entity actively manages the market risk to which it is exposed, while taking into account that its activities and decisions should be considered in context of the whole KGHM Polska Miedź S.A. Group’s global exposure to market risk.

In accordance with the adopted policy, the goals of the market risk management process are as follows:

• to limit fluctuations in financial result,
• to increase the probability of meeting budget assumptions,
• to decrease the probability of losing financial liquidity,
• to maintain a healthy financial condition; and
• o support the process of strategic decision making related to investment activity, including sources of financing.

All the market risk management objectives should be considered as a whole, and their realisation is determined mainly by the internal situation of the Group and market conditions.

The goals of market risk management at the Group level are achieved through their realisation in individual mining companies of the Group, with the coordination of these activities at the Parent Entity’s level, in which key tasks were centralised. These tasks are related to the process of market risk management (such as coordination of the identification of sources of exposure to market risk, proposing hedging strategies, contacting financial institutions in order to sign, confirm and settle derivatives transactions, and calculating measurements to fair value).

The primary technique for market risk management is the use of hedging strategies involving derivatives.
Apart from this, natural hedging is also used.

Taking into account the potential scale of their impact on the Group’s results, the market risk factors were divided into groups. The risk is managed by applying different approaches to separate, identified exposure groups.

The first group of factors with the greatest influence on the Group’s total exposure to market risk consists of: the copper price, silver price and USD/PLN exchange rate. The Parent Entity applies a strategic approach to this group, aimed at systematically building up a hedging position comprising production and revenues from sales for subsequent periods while taking into account the long-term cyclical nature of different markets.
A hedging position may be restructured before it expires.

The second group, which comprises risk factors such as the prices of other metals and merchandise, other exchange rates and interest rate levels is tactically managed - which means taking advantage of favourable market conditions.

The Parent Entity considers the following factors when selecting hedging strategies or restructuring hedging positions: current and forecasted market conditions, the internal situation of the Entity and the effective level and cost of hedging.

The Parent Entity applies an integrated approach to managing the market risk to which it is exposed.

This means a comprehensive approach to market risk, and not to each element individually. An example is the hedging transactions on the currency market, which are closely related to contracts entered into on the metals market. The hedging of metals sales prices determines the probability of achieving specified revenues from sales in USD, which represent a hedged position for the strategy on the currency market.

The Parent Entity enters into derivatives transactions only if it has the ability to assess their value internally, using standard pricing models appropriate for a particular type of derivative, and which can be traded without significant loss of value with a counterparty other than the one with whom the transaction was initially entered into. In evaluating the market value of a given instrument, the Parent Entity makes use of information obtained from leading information services, banks, and brokers.

The Group’s Market Risk Management Policy permits the use of the following types of instruments:

• swaps,
• forwards and futures,
• options; and
• structures combining the above instruments.

The instruments applied may be, therefore, either of standardised parameters (publicly traded instruments) or non-standardised parameters (over-the-counter instruments). Primarily applied are cash flow hedging instruments meeting the requirements for effectiveness as understood in hedge accounting. The effectiveness of the financial hedging instruments applied by the Parent Entity in the reporting period is continually monitored and assessed (details in Note 2.2.8.6 Accounting policy – Hedge accounting).

The Parent Entity quantifies the Group’s market risk exposure using a consistent and comprehensive measure.

Market risk management in the Group is supported by simulations (such as scenario analysis, stress-tests, backtests) and calculated risk measures. The risk measures being used are mainly based on mathematical and statistical modelling, which uses historical and current market data concerning risk factors and takes into consideration the current exposure to market risk.

One of the measures used as an auxiliary tool in making decisions in the market risk management in the Parent Entity is EaR - Earnings at Risk. This measure indicates the lowest possible level of profit for the period for a selected level of confidence (for example, with 95% confidence the profit for the period for a given year will be not lower than…). The EaR methodology enables the calculation of profit incorporating the impact of changes in market prices of copper, silver and foreign exchange rates in the context of budgeted results. For the KGHM INTERNATIONAL LTD. Group and the JV Sierra Gorda S.C.M EBITDA-at risk is calculated.

Due to the risk of unexpected production cutbacks (for example because of force majeure) or failure to achieve planned foreign currency revenues, as well as purchases of metals contained in purchased copper-bearing materials, limits were set with respect to commitment in derivatives.

For the Parent Entity, limits on the commodity and currency markets are:

• up to 85% of planned, monthly sales volume of copper, silver and gold from own concentrates¹
• up to 85% of planned, monthly revenues from the sale of products from own concentrates in USD²
  
• or up to 85% of the monthly, contracted net currency cash flows in case of other currencies.

With respect to the risk of changes in interest rates, the Parent Entity has set a limit of commitment in derivatives of up to 100% of the debt’s nominal value in every interest period, as stipulated in the signed agreements.³

For selected mining companies in the Group, limits were set for using derivatives on the copper and currency markets at the same levels as those functioning in the Parent Entity, while with respect to transactions on the nickel, silver and gold markets the limits were set as up to 60% of planned, monthly sales volume of these metals from own concentrates.

These limits are in respect of both hedging transactions as well as the instruments financing these transactions.

The maximum time horizon within which the Group decides to limit market risk is set in accordance with the technical and economic planning process and amounts to 5 years, whereas in terms of interest rate risk,
the time horizon reaches up to the maturity date of the long-term financial liabilities of the Group.

[1] While: for copper and silver - up to 50% with respect to instruments which are obligations of the Parent Entity (for financing the hedging strategy) and up to 85% with respect to instruments representing the rights of the Parent Entity.
[2] For purposes of setting the limit, expenses for servicing the debt denominated in USD decrease the nominal amount of
exposure to be hedged.
[3] Separately for every currency.

32.1.2 Commodity risk

The Parent Entity is exposed to the risk of changes in market prices of the metals it sells: copper, silver, gold and lead. The KGHM INTERNATIONAL LTD. Group is exposed to the risk of changes in the market prices of copper, gold, nickel, molybdenum, platinum and palladium.

In the Parent Entity and the KGHM INTERNATIONAL LTD. Group the price formulas used in physical delivery contracts are mainly based on average monthly quotations from the London Metal Exchange (LME) for copper and other common metals and from the London Bullion Market (LBM) for precious metals. As part of the trading policy, the Parent Entity and KGHM INTERNATIONAL LTD. set the price base for physical delivery contracts as the average price of the appropriate future month. There are also other formulas in the Group for setting metals sales prices.

The permanent and direct link between sales proceeds and metals prices, without similar relationships on the expenditures side, results in a strategic exposure. In turn, operating exposure is a result of possible mismatches in the pricing of physical contracts with respect to the Group’s benchmark profile, in particular in terms of the reference prices and the quotation periods.

On the metals market, the Group has a so-called long position, which means it has higher sales than purchases. The analysis of the Group’s exposure to market risk should be performed on a net basis, i.e. by deducting the volume of metals’ contained in materials purchased from external sources, from the volume of sales.

Exposure of the Group to commodity risk is presented below⁴:

[4] Tonnage relates to amounts of payable metal in sold and purchased products. 

Exposure to the risk of changes in other metal prices was not included in the table because of its lower significance.

Sensitivity of the Group’s financial instruments to the risk of changes in copper and silver prices at the end of the reporting period is presented in Note 32.1.7 Sensitivity analysis of the Group to commodity and currency risk.

32.1.3 Currency risk

Regarding the risk of changes in foreign exchange rates, the KGHM Polska Miedź S.A. Group identifies the following types of exposures:

• the transaction exposure concerning volatility of cash flows in the base currency;
• the balance sheet exposure concerning volatility of selected items in consolidated statements of financial position in the base currency (functional currency); and

the net investment exposure concerning volatility of consolidated equity in the Group’s base currency (presentation currency).

The transaction exposure to currency risk results from contracts generating cash flows, the amounts of which in the base (functional) currency depend on the future exchange rates of the foreign currencies versus the base currency. Cash flows exposed to currency risk may possess the following characteristics:

• denomination in the foreign currency – cash flows are settled in the foreign currencies other the functional currency; and
• indexation in the foreign currency – cash flows may be settled in the base currency, but the price (i.e. of a metal) is settled in a different foreign currency⁵
  

The key source of exposure to currency risk in the business operations of the Parent Entity are the revenues from sales of products (metals prices, processing and producer margins).

The source of balance sheet exposure to currency risk are items in the consolidated statement of financial position denominated in foreign currencies, which under the existing accounting regulations must be,
upon settlement or periodic valuation, converted by applying the current exchange rate of the foreign currencies versus the base (functional) currency. Changes in the carrying amounts of such items between valuation dates result in the volatility of profit/loss for the period.

The balance sheet exposure includes in particular:

• trade receivables and payables related to purchases and sales denominated in foreign currencies;
• financial debt liabilities in foreign currencies; and
• cash and cash equivalents in foreign currencies.

In 2014, a financing agreement was signed with the European Investment Bank for the amount of PLN 2 000 million and with instalment repayment dates of up to 12 years from the date the instalment was drawn (details in note 32.3.1 Financial liquidity management). In accordance with the loan amortisation schedule, the first instalment in the amount of USD 300 million was designated to hedge revenues from sales against the risk of changes in foreign exchange rates during the period from October 2017 to October 2026. The hedged position is comprised of a series of highly probable, planned revenues from sales transactions of products denominated in USD, in particular the first volume of revenues from sales (to the amount of designated capital rate) generated during a given calendar month. The hedging position is a part of the loan’s capital rate, which was designated to be included in the hedge accounting. As a result of hedge accounting, the exchange differences due to loans drawn will be recognised in the revaluation reserve from measurement of cash flow hedging instruments until the hedged revenues are recognised in the statement of profit or loss if they will meet the criteria of effectiveness.

[5] It is widely accepted on commodity markets that physical delivery contracts of metals are settled in USD or indexed in USD.

32.1.4 Interest rate risk

Interest rate risk is the possibility of the negative impact on the Group’s results due to interest rate changes. The Group was exposed to this risk due to loans granted, investing free cash and borrowing.

As at 31 December 2014 the balances of positions exposed to interest rate risk and therefore changes in interest income and interest costs were as follows:

• cash: PLN 475 million⁶; and
• bank loans: PLN 1 925 million⁷.

As at 31 December 2014 the balances of positions exposed to interest rate risk due to a change in measurement of a financial instrument with a fixed interest rate were as follows:

• receivables due to loans granted by the KGHM INTERNATIONAL LTD. Group to finance a joint venture in Chile: PLN 6 231 million (i.e. USD 1 777 million)⁸
• payables due to senior notes issued by KGHM INTERNATIONAL LTD.: PLN 1 775 million (nominal value of senior notes: USD 494 million, while the fair value after the final accounting at cost amounted to USD 506 million)⁹ and
• liabilidies due to loans: PLN 1 066 million, including the loan received by the Parent Entity which was granted by the European Investment Bank in the amount of PLN 1 058 million (i.e. USD 302 million);¹⁰

As at 31 December 2014, the Group held liabilities due to bank and other loans in the amount of 2 992 million, whose currency and aging structure, including interest, are presented in the table below.

Liabilities due to bank loans and a loan granted by the European Investment Bank as at 31 December 2014

[6]  As at 31 December 2013: PLN 864 million.
[7] As at 31 December 2013: PLN 1 348 million.
[8] As at 31 December 2013: PLN 3 378 million.
[9] As at 31 December 2013: PLN 1 522 million. 
[10] As at 31 December 2013: PLN 8 million.

32.1.5 Commodity, currency and interest risk management – derivatives

In order to reduce the market risk related to changes in commodity prices and in foreign exchange rates the Parent Entity, KGHM INTERNATIONAL LTD. and some other domestic companies of the Group make use of derivatives. However, only the Parent Entity applies hedging strategies, as understood by hedge accounting.

Taking into account the exposure to market risk, the most significant impact on the Group’s results is from the activities of the Parent Entity and KGHM INTERNATIONAL LTD.

Commodity, currency and interest risk management in the Parent Entity

The notional amount of copper price hedging strategies settled in 2014 represented approx. 15% (in 2013: 23%) of the total¹¹ sales of this metal by the Parent Entity. Revenues from sales of silver were not hedged by derivatives in 2014 (in 2013, approximately 9% of total revenues from sales of silver were hedged). In case of the currency market, hedged revenues from sales represented approx. 26% (in 2013: 18%) of total revenues from metals sales achieved by the Parent Entity.

In 2014 the Parent Entity implemented a copper price hedging strategy with a total volume of 11 thousand tonnes and a time horizon falling from August 2014 to June 2015. Put options were purchased (Asian options).

In 2014 the Parent Entity did not implement any hedging transactions for the silver market.

In the first quarter of 2014 however, favourable market conditions in the currency market were taken advantage of (strengthening of the PLN versus the USD) and there was a restructuring of the hedging position for the period from April to December 2014 through repurchasing seagull and collar options which were implemented in the fourth quarter of 2011 and the second quarter of 2012 for a total notional amount of USD 540 million. The closure of the position and un-designation of the hedging transactions was reflected in revenues from sales in 2014 in the amount of PLN 204 million. Simultaneously put options were purchased, with a strike exchange rate of USD/PLN 2.85, hedging revenues from sales in the same periods (in the second quarter and the second half of 2014) and for the same notional amount (in total: USD 540 million). In addition, in the first quarter of 2014 the hedging position for 2015 was restructured by reselling purchased put options with a strike exchange rate of USD/PLN 3.40 from the collar structure, which was implemented in the second quarter of 2012 for a notional amount of USD 360 million. Simultaneously put options were purchased with an exchange rate of USD/PLN 2.70 for the same notional amount (USD 360 million) and for the same period (2015). The closure of the position and un-designation of the hedging transactions was reflected in the revaluation reserve from the measurement of financial instruments in the amount of PLN 93 million, which will increase revenues from sales for 2015. In case of a significant strengthening of the Polish currency, revenues from sales will still be hedged for the same notional amount as they were before restructuring.

In the third and fourth quarters of 2014, planned revenues from sales for the total notional amount of USD 1 710 million and a time horizon falling in the period from October 2014 to December 2017 were additionally hedged
(of which USD 90 million concerned hedging the revenues from sales for the fourth quarter of 2014).
The Parent Entity made use of put options (European options) and collar option strategies.

As at 31 December 2014, the Parent Entity remained hedged for a portion of copper sales planned for 2015 (48 thousand tonnes). The Parent Entity does not hold any open hedging transactions on the silver market. As at 31 December 2014, with respect to revenues from sales (currency market), the Parent Entity held a hedging position for the planned revenues from sales of metals in the amount of USD 2 220 million, including: USD 960 million in 2015, USD 720 million in 2016 and USD 540 million in 2017.

[11] Relates to the sales of products from own concentrates or from purchased copper-bearing materials.

Condensed table of open transactions in derivatives of the Parent Entity¹²

[12] With the classification by type of assets hedged and type of instruments used as at 31 December 2014;  hedged notional/volume in the presented periods is allocated monthly, on a systematic basis

COPPER MARKET

Currency Market

With respect to currency risk management whose source is borrowing, the Parent Entity uses natural hedging by borrowing in currencies in which it has revenues. All liabilities which comprised the balance of bank loans
as at 31 December 2014 were drawn in USD, and following their translation to PLN they amounted to PLN 2 108 million.

The Parent Entity did not use derivatives to hedge against the interest rate risk, both in the current and comparable reporting periods. However, taking into consideration that the holding of financial liabilities denominated in USD, based on LIBOR, exposes the Parent Entity to the risk of higher interest rates, in the third quarter of 2014 the Management Board decided to take advantage of the opportunity to draw loans from the European Investment bank based on a fixed interest rate.

Commodity and currency risk management in selected mining companies and in KGHM INTERNATIONAL LTD.

Due to the fact that a portion of the expenditures on the Sierra Gorda project were incurred in the Chilean peso, KGHM INTERNATIONAL LTD. in January 2014 purchased put options with a strike exchange rate of USD/CLP 525 for the notional amount of USD 200 million for the first quarter of 2014. The purpose of entering into derivatives transactions was to limit the risk of a strengthening of the Chilean peso versus the USD.

These options expired unrealised.

Taking into account the estimated cost exposure in Canadian dollars, KGHM INTERNATIONAL LTD. in August 2014 implemented a strategy in currency derivatives (USD/CAD) for the period from August to December 2014 and for the total notional amount of USD 62.5 million). Asian put options were purchased.

As at 31 December 2014, KGHM INTERNATIONAL LTD. did not hold open derivatives on commodity or currency markets.

32.1.6. Impact of derivatives on the Group’s financial statement

The impact of derivatives on the profit or loss in the current and comparable periods is presented in the table below.

Impact of derivatives on the revaluation reserve from measurement of cash flow hedging instruments is presented in the table below.¹⁵

The fair value of derivatives of the Group and receivables/liabilities due to unsettled derivatives are presented in the table below.¹⁶

[17] Settlement date falls on 5 January 2015.
[18] Settlement date falls on 3 January 2014.

The remaining information on derivatives was presented in note 12: Derivatives and in note 31: Financial instruments.

[15] Concerns the open derivatives on the copper market and the currency market (USD/PLN). The amount of PLN 330 million as at 31 December 2014 and presented in the revaluation reserve from measurement of cash flow hedging instruments does not include the negative amount of PLN 17 million which was recognised due to the exchange differences on the tranche of the loan granted by the European Investment Bank, designated as a cash flow hedging instrument.
[16] Including embedded derivatives.

32.1.7 Sensitivity analysis of the Group to commodity and currency risk

Sensitivity analysis for significant types of market risk to which the Group is exposed presents the estimated impact of potential changes in individual risk factors (at the end of the reporting period) on profit or loss and on other comprehensive income. Possible changes in prices and exchange rates have been presented in percentage terms to the prices and exchange rates used to measure financial instruments to fair value at the end of the reporting period¹⁹:

Potential metal price and exchange changes

Currency structure of financial instruments exposed to market risk

SENSITIVITY ANALYSIS OF THE GROUP TO CURRENCY RISK as at 31 December 2014

SENSITIVITY ANALYSIS OF THE GROUP TO CURRENCY RISK AS AT 31 December 2013²¹

[21] Risk of changes in GBP/PLN exchange rate, included in the consolidated financial statements for the year 2013, was excluded from the analysis due to its small significance.

SENSITIVITY ANALYSIS TO COMMODITY RISK as at 31 December 2014

SENSITIVITY ANALYSIS TO COMMODITY RISK as at 31 December 2013

32.1.8 Price risk related to investments in debt instruments

As at 31 December 2014, the Group held Treasury bonds in the amount of PLN 61 million, i.e. USD 17 million (as at 31 December 2013: PLN 69 million). This amount is represented by environmental bonds denominated in USD under the mine closure assets of KGHM INTERNATIONAL LTD. which were issued by the United States government. Change in value was described in note 11.

Group’s investments in debt instruments are slightly exposed to price risk.

32.1.9 Price risk related to the purchase of shares of listed companies

Price risk related to the shares of listed companies held by the Group is understood as the change in their fair value due to changes in their quoted share prices.

Due to investments in listed companies the Group is exposed to the risk of significant changes in accumulated other comprehensive income due to changes in the share prices of these companies, resulting from current macroeconomic conditions. In case of an increase in the fair value of the shares versus cost or when the value of the shares decreases versus cost by at least 20%, the Group is exposed to the risk of changes in profit or loss.

As at 31 December 2014, the carrying amount of shares of companies which are held by the Group and are listed on the Warsaw Stock Exchange and on the TSX Ventures Exchange was PLN 978 million.

Sensitivity analysis of listed companies shares to price changes as at 31 December 2014

32.2 Credit risk

Credit risk is defined as the risk that the Group’s counterparties will not be able to meet their contractual obligations. Credit risk is related to three main areas:

• the creditworthiness of the customers with whom physical sale transactions are undertaken,
• the creditworthiness of the financial institutions (banks/brokers) with whom, or through whom, hedging transactions are undertaken, as well as those in which free cash and cash equivalents are deposited, 
• the financial standing of companies - borrowers.

In particular, the Group is exposed to credit risk due to:

• cash and cash equivalents and deposits,
• derivatives,
• trade receivables,
• loans granted, 
• debt instruments,
• guarantees granted.

32.2.1 Credit risk related to cash and cash equivalents and bank deposits

The Group allocates periodically free cash and cash equivalents in accordance with the requirements to maintain financial liquidity and limit risk and in order to protect capital and maximise interest income.

All entities with which deposit transactions are entered into by the Group operate in the financial sector. Analysis of exposure to this type of risk, conducted as at 31 December 2015 for the amount of PLN 451 million, which represents 95% of the Group’s cash, has proven that these are solely banks with the highest²², medium-high²³ and medium²⁴ credit ratings, an appropriate level of equity and a strong, stable market position. In the Parent Entity and KGHM INTERNATIONAL LTD. credit risk in this regard is continuously monitored through the on-going review of the financial standing and by maintaining an appropriately low level of concentration in individual financial institutions.

The following table presents the level of concentration respectively:

• as at 31 December 2014 of 95%; and
• as at 31 December 2013 of 94%.

of the periodically free cash and cash equivalents, showing the assessed creditworthiness of the financial institutions²⁵.

As at 31 December 2014 the maximum exposure of the Group to a single bank in respect of deposited cash and cash equivalents amounted to 20% (as at 31 December 2013: 22%).

[22] By highest rating is meant a rating from AAA to AA- as determined by Standard & Poor’s and Fitch, and from Aaa to Aa3 as determined by Moody’s.
[23] By medium-high rating is meant a rating from A+ to A- as determined by Standard & Poor’s and Fitch, and from A1 to A3 as determined by Moody’s.
[24] By medium rating is meant a rating from BBB+ to BBB- as determined by Standard & Poor’s and Fitch, and from Baa1 to Baa3 as determined by Moody’s.
[25] Weighed by amount of cash and cash equivalents.

32.2.2 Credit risk related to derivative transactions

All entities with which the Group enters into derivative transactions operate in the financial sector.

The following table presents the structure of ratings of the financial institutions with whom the Group engaged in derivatives transactions, representing an exposure to credit risk²⁶.

Taking into consideration the fair value of open derivative transactions entered into by the Group and unsettled derivatives, the maximum single entity share of the amount exposed to credit risk arising from these transactions as at 31 December 2014 amounted to 44% (as at 31 December 2013: 22%).

Due to diversification of risk in terms both of the nature of individual entities and of their geographical location, as well as to cooperation with highly-rated and medium-high-rated financial institutions, the Group is not materially exposed to credit risk arising from derivative transactions entered into.

In order to reduce cash flows as well as credit risk, the Parent Entity carries out net settlement (based on framework agreements entered into with its counterparties) to the level of the positive balance of fair value measurement of transactions in derivatives with a given counterparty.

The fair value of open derivatives of the Group, and receivables and payables due to unsettled derivatives by counterparty (financial institutions), are presented in the table below²⁷.

[26] Weighed by positive fair value of open and unsettled derivatives.
[27] Excluding embedded derivatives, which are included in the contracts with counterparties not being financial institutions. 
As at 31 December 2014 the fair value of embedded derivatives amounted to PLN 32 million, while as at 31 December 2013 PLN 16 million.

32.2.3 Credit risk related to trade and other financial receivables

Group companies have been cooperating for many years with a large number of customers, which affects the geographical diversification of trade and other receivables.

Geographical concentration of credit risk for trade receivables²⁸:

The Parent Entity limits its exposure to credit risk related to trade and other receivables by evaluating and monitoring the financial condition of its customers, setting credit limits and using debtor security.

An inseparable element of the credit risk management process realised by the Parent Entity is the on-going monitoring of receivables and the internal reporting system.

Buyer’s credit is only provided to proven, long-term customers, while sales of products to new customers are mostly based on prepayments or trade financing instruments which wholly transfer the credit risk to financial institutions. The Parent Entity has secured the majority of its receivables by promissory notes²⁹, frozen funds on bank accounts, registered pledges³⁰, bank guarantees, corporate guarantees, mortgages, letters of credit and documentary collection. Additionally, the majority of customers who hold buyer's credit on contracts have ownership rights confirmed by a date certain³¹.

To reduce the risk of insolvency by its customers, the Parent Entity has entered into a receivables insurance contract, which covers receivables from entities with buyer’s credit which have not provided strong collateral or have provided collateral which does not cover the total amount of the receivables. Taking into account the collateral held and the credit limits received from the insurance company, as at 31 December 2014 the Parent Entity had secured 95% of its trade receivables (as at 31 December 2013: 74%).

The concentration of credit risk in the Group is related to the terms of payment allowed to key clients. Consequently, as at 31 December 2014 the balance of receivables from the 7 largest clients, in terms of trade receivables at the end of the reporting period, represented 60% of the trade receivables balance (as at 31 December 2013: 49%). Despite the concentration of this type of risk, it is believed that due to the availability of historical data and the many years of experience cooperating with its clients, as well as to the hedging used, the level of credit risk is low.

The following Group companies have significant trade receivables: KGHM Polska Miedź S.A. PLN 1 379 million, the KGHM INTERNATIONAL LTD. Group PLN 283 million, CENTROZŁOM WROCŁAW S.A. PLN 70 million, NITROERG S.A. PLN 30 million, WPEC w Legnicy S.A. PLN 29 million, „MIEDZIOWE CENTRUM ZDROWIA” S.A. PLN 17 million, Uzdrowiska Kłodzkie S.A. – Grupa PGU PLN 13 million, WMN „ŁABĘDY” S.A. PLN 12 million, KGHM ZANAM Sp. z o.o. PLN 11 million, PHP „MERCUS” Sp. z o.o. PLN 10 million.

Individual Group companies operate in various economic sectors, such as transport, construction, commerce, industrial production and energy. As a consequence, in the case of most Group companies, in terms of sectors, there is no concentration of credit risk. KGHM INTERNATIONAL LTD. operates in the same economic sector as the Parent Entity. Despite operating in the same sector, these two companies are different both in terms of their portfolios of products as well as in terms of the geographic location and nature of their customers, and consequently this sector concentration of credit risk is considered to be acceptable.

The companies of the Group, with the exception of the Parent Entity, do not enter into framework agreements of a net settlement in order to reduce exposure to credit risk, although in situations where the given entity recognises both receivables and liabilities with the same client, in practice net settlement is applied, as long as both parties accept such settlement. Due to the extensive volatility in the level of net settlement on particular days ending reporting periods, it is difficult in practice to determine a representative amount of such compensation.

[28] Data concerning the receivables arising from sales of copper and silver was presented in the financial statements as at 31 December 2013.  The data was recalculated in order to include all trade receivables.
[29] In order to speed up any potential collection of receivables, a promissory note is usually accompanied by a notarial enforcement declaration.
[30] At the end of the reporting period, the Parent Entity held pledges on aggregate tangible assets or rights representing an organisational whole, whose elements (variable) are recognised in a customer’s trade accounts.
[31] A confirmed notarial clause which is applied in trade contracts means that rights to ownership of merchandise are transferred to the buyer only after payment is received despite physical delivery. Application of this clause is aimed solely at hedging credit risk and simplifying any eventual legal claims with regard to deliveries. The Parent Entity transfers the substantial risks and rewards of ownership, and therefore such transactions are treated as sales and accounted for as income.

32.2.4 Credit risk related to loans granted

As at 31 December 2014 the carrying amount of loans granted by the Group amounted to PLN 6 231 million, i.e. USD 1 777 million (as at 31 December 2013: PLN 3 378 million, i.e. USD 1 122 million).

This item is mainly represented by long term loans based on a fixed interest rate, granted by the KGHM INTERNATIONAL LTD. Group for the financing of the joint mining venture in Chile. Both the principal amount and interest are paid on demand, but not after 15 December 2014.

Credit risk related to the loan granted is dependent on the risk connected with mine project realisation, and is judged at the present moment to be moderate.

32.2.5 Credit risk related to investments in debt instruments

As at 31 December 2014, the Group held US government bonds in the amount PLN 61 million, i.e. USD 17 million (as at 31 December 2013 PLN 69 million, i.e. USD 23 million). These are environmental bonds denominated in USD representing the mine closure assets of KGHM INTERNATIONAL LTD.

These investments are slightly exposed to credit risk due to the guarantee of solvency of the issuer.

The investment policies of the Group restrict the possibility of purchasing this category of asset to investments in government securities and money market funds, depositing financial resources in money market instruments and in government securities whose time remaining to maturity does not exceed one year, or whose interest is set for a period of no longer than one year.

32.2.6 Other information related to credit risk

Aging analysis of financial assets overdue as at the end of the reporting period, for which no impairment loss has been recognised

Except for trade receivables and other financial receivables, no other classes of financial instruments were identified as overdue but not impaired at the end of the reporting period.

Changes in allowances for impairment of financial assets by asset classes are presented in the tables below:

Trade receivables (category: loans and financial receivables)

Other financial assets (category: loans and financial receivables)

Shares (category: available-for-sale financial assets)

32.3 Liquidity risk and management of capital

The management of capital in the Group aims at providing both relevant funding capabilities for business development and at securing relevant liquidity.

Contractual maturities for financial liabilities as at 31 December 2014

Contractual maturities for financial liabilities as at 31 December 2013

Financial liabilities arising from derivatives are calculated as their intrinsic values, excluding the effects of discounting.

32.3.1 Financial liquidity management

The management of financial liquidity in the Parent Entity is performed in accordance with the „Financial Liquidity Management Policy” approved by the Management Board. In KGHM INTERNATIONAL LTD. the financial liquidity management principles are described in the Investment Policy. These documents describe the process of managing the financial liquidity, including the specific character of the Group companies, indicating best practise procedures and instruments. The basic principles resulting from these documents are:

• investment of financial surpluses in liquid instruments;
• compliance with the limits for individual financial investment categories;
• compliance with the limits for the concentration of resources for financial institutions; and
• assuring the stable and effective financing of the Group’s activities.

The Group’s external financing is based on four pillars:

1. The unsecured, revolving syndicated credit facility in the amount of USD 2 500 million (PLN 8 768 million using the exchange rate as at 31 December 2014) with the maturity date falling on 11 July 2019 (and the option to extend it for another 2 years) acquired by the Parent Entity;
2. The investment loan granted to the Parent Entity by the European Investment Bank, in the amount of PLN 2 000 million and a 12-year financing period;
3. Short-term bank loans in the amount of over PLN 4 600 million, used to finance working capital and to support current liquidity in Group companies as well as investment bank loans drawn by Group companies to finance the continued advancement of their investment activities; and
4. The senior notes program of KGHM INTERNATIONAL LTD. up to the amount of USD 500 million.

The above-mentioned sources of financing fully satisfy the current, medium- and long-term liquidity needs of the Group.

In 2014, the Group made use of all sources of external financing available in the aforementioned pillars.

Unsecured revolving credit facility

On 11 July 2014, the Parent Entity signed an agreement for an unsecured, revolving syndicated credit facility in the amount of USD 2 500 million with a five-year tenor with the option of extending for another 2 years. The option of extending may be exercised at the request of the Parent Entity on the first and second anniversaries of signing the agreement.

The financial resources from the credit facility will be used in financing general corporate purposes, including expenditures related to the continued advancement of investment projects and for refinancing the debt of KGHM INTERNATIONAL LTD. in the amount of USD 700 million. Consolidating the Group’s external financing at the Parent Entity’s level is a key provision of the new financing strategy. The strategy will enable to attain significant saving on debt servicing costs and is in line with the best market practices for the financing of large, international groups. It will also allow for an increase in effectiveness of the liquidity management process, simplification of the external financing structure and to optimise the financial and non-financial covenants in the Group.

The Parent Entity expects to make gradual use of the loan. The flexible structure of the transaction gives the possibility of multiple borrowing and repaying of the loan instalments, depending on the current liquidity needs of the KGHM Polska Miedź S.A. Group. Interest on the credit facility is based on LIBOR plus a margin, depending on the net debt/EBITDA ratio. The credit facility agreement obliges the Group to comply with the financial covenant and non-financial covenants standard for this type of transaction. As at 31 December 2014 and during the reporting period there were no instances of violation of the covenants stipulated in the aforementioned agreement.

Investment loan from the European Investment Bank

On 1 August 2014, the Parent Entity signed an agreement for financing from the European Investment Bank for PLN 2 000 million with a maximum repayment period for the instalments drawn of 12 years from the drawing date.

The loan is available for a period of 22 months from the date of signing the agreement.

For each of these loan instalments the Parent Entity has the option of drawing a non-renewable instalment in PLN, EUR or USD, with either a fixed or variable interest rate of WIBOR, LIBOR or EURIBOR plus a margin.

The funds acquired through this loan will be used to finance investment projects of the Parent Entity, related to modernisation of metallurgy and development of the Żelazny Most tailings pond.

The credit facility agreement obliges the Group to comply with the financial and non-financial covenants standard for this type of transaction. As at 31 December 2014 and during the reporting period there were no instances of violation of the covenants stipulated in the aforementioned agreement.

Bank loans

The Group has open lines of credit due to short- and long term bank loans agreements entered into. The funds available from these open lines of credit are available in the following currencies: PLN, USD and EUR, with the interest based on variable WIBOR, LIBOR, EURIBOR rates plus a margin. The funds acquired from the aforementioned credit agreements are used for financing the working capital and support the short-term financial liquidity management.

As at 31 December 2014, the Parent Entity had open lines of credit and an investment loan, whose balances were as follows:

Open lines of credit and loans drawn as at 31 December 2014 (millions)

All of the Parent Entity’s liabilities which comprised the balance of bank and other loans as at 31 December 2014 in the amount of PLN 2 108 million were drawn in USD.

As at 31 December 2014, the KGHM INTERNATIONAL LTD. Group held an open line of credit in the amount of USD 200 million (PLN 701 million), with a variable interest rate, set as the sum of the reference rate LIBOR and a margin depending on the ratio net debt/EBITDA. It was fully utilised at the end of the reporting period.

In order to finance the continued advancement of the investment activities which are aimed at restoration, modernisation or increasing the assets’ value, the Group’s companies utilise investment loans. A loan’s currency is PLN or EUR and their repayment is guaranteed by mortgages on assets, cessions of trading agreements or cession of rights arising from insurance policies.

Senior notes of KGHM INTERNATIONAL LTD.

KGHM INTERNATIONAL LTD. benefits from external financing in the form of issued long-term senior notes with a fixed interest rate and a maturity falling in 2019. As at 31 December 2014 the value of the senior notes amounted to PLN 1 775 million (nominal value of the senior notes: USD 494 million; fair value due to final accounting for the acquisition: USD 506 million). These notes, issued in 2011, give KGHM INTERNATIONAL LTD. the opportunity for early repurchase at their nominal price, plus a premium if repurchase is made prior to 15 June 2017.

The Parent Entity continues to add additional companies to the cash management service of the KGHM Polska Miedź S.A. Group (zero-balance cash pool).

In the first half of 2014, KGHM INTERNATIONAL LTD. among others joined the service. As at 31 December 2014, the total available limit under this service amounted to PLN 696 million. Funds available under this service bear an interest based on variable WIBOR and LIBOR, respectively for PLN and USD.

This service enables optimisation of costs and effective management of current cash liquidity in the KGHM Polska Miedź S.A. Group.

As at 31 December 2014, 29 companies and the Parent Entity, serving as the coordinator, participated in the cash pool. This function is based on establishing the conditions for functioning of the system, particularly including the principles of interest calculation and representation of the entire Group in relations with the bank with respect to services. The Parent Entity also acts as a participant of the cash pool system, in which it deposits its financial surpluses and, in case of need, benefits from financing.

Guarantees and letters of credit are important tools used in managing the financial liquidity of the KGHM Polska Miedź S.A. Group. Thanks to them, the Group does not need to engage cash and cash equivalents in order to secure its liabilities toward other entities.

As at 31 December 2014, the Group held contingent liabilities due to guarantees and letters of credit granted in the total amount of PLN 1 720 million.

The most significant of these are the following contingent liabilities of the Parent Entity aimed at:

• securing the proper performance of agreements entered into by the JV Sierra Gorda in the amount of PLN 823 million;
• securing the proper performance of future environmental liabilities of the Parent Entity in the amount of PLN 320 million, related to the obligation to restore terrain around the „Żelazny Most” tailings pond following the conclusion of its operations; and
• securing the Robinson mine’s restoration cost, in the amount of PLN 272 million.

32.3.2 Management of capital

The Group manages its capital in order to maintain the capacity to continue its operations, including the realisation of planned investments, in a manner enabling it to generate returns for the shareholders and benefit the other stakeholders.
In accordance with market practice, the Group companies monitor their capital, among others based on the equity ratio and the ratio of Net Debt/EBITDA. The equity ratio is calculated as the relation of net assets (equity less intangible assets) to total assets. The ratio of Net Debt/EBITDA is calculated as the relation of borrowings and finance lease liabilities minus free cash and short term investments with a maturity up to 1 year to EBITDA (operating profit plus depreciation/amortisation).

In the process of managing financial liquidity the Group makes use of financial ratios which play a supportive role in this process. To monitor the level of liquidity,a broad range of liquidity ratios is applied.

In order to maintain financial liquidity and the creditworthiness to acquire external financing at an optimum cost, the Group assumes that the equity ratio shall be maintained at a level of not less than 0.5, and the ratio of Net Debt/EBITDA at a level of up to 2.0.

In addition, the revolving, unsecured credit facility agreement and the loan agreement signed with the European Investment Bank oblige the Group to maintain its financial and non-financial covenants, standard for these types of transactions. As at 31 December 2014 and in the reporting period there were no instances of breaching the covenants stipulated in the aforementioned agreements.

The ratios for the Group are presented in the table below: