5.4 MANAGEMENT OF FINANCIAL RISKS AND CAPITAL

The Group’s activities are exposed to changes in the financial variables affecting their accounts, particularly interest rate, foreign currency, credit, liquidity and equity risk. The policies adopted by the Group in managing these risks are explained in detail in the directors’ report.

Following are specific data on the Group’s exposure to each of these risks and an analysis of the sensitivity to a change in the various variables, together with a brief description of the management of each risk.

In addition, in view of the economic and political importance of the UK’s decision to leave withdraw from the European Union (Brexit), this Note includes a separate in-depth analysis of the impact it has had for Ferrovial with respect to the various financial risks and how these risks are being managed.

a. Exposure to interest rate risk

Ferrovial’s businesses are subject to changes in the economic cycles and interest rate risk management takes this into consideration, modelling interest rate settings against financial instrument liquidity management. When interest rates are low, the Group seeks to fix future levels at non-infrastructure project level, although such hedging can affect liquidity in the event of cancellation. At infrastructure project level, the banks and rating agencies require a higher percentage of fixed-rate debt. These strategies are achieved by issuing fixed-rate debt or by arranging hedging financial derivatives, a detail of which is provided in Note 5.5, Derivative financial instruments at fair value. The aim of these hedges is to optimise the finance costs borne by the Group.

The accompanying table shows a breakdown of the Group’s debt, indicating the percentage of the debt that is considered to be hedged (either by a fixed rate or by derivatives).

Also, it must be borne in mind that the results relating to companies accounted for using the equity method include the results corresponding to the 25% ownership interest in HAH and the ownership interest of 43.23% in 407 ETR. As indicated in Note 3.5, the two companies have a significant volume of debt, of which 93% (HAH) and 100% (407 ETR) is hedged against interest rate risk.

Based on the foregoing, at the fully consolidated companies, a linear increase of 100 basis points in the market yield curves at 31 December 2017 would increase the finance costs in the statement of profit or loss by an estimated EUR 6 million, of which EUR 3 million relate to infrastructure projects and EUR 4 million to non-infrastructure project companies, with a net impact on the profit of Ferrovial of EUR -5 million.

It is also necessary to take into account changes in the fair value of the financial derivatives arranged, which are indicated in Note 5.5.

As regards these interest rate hedging instruments, a linear increase of 100 basis points in the market yield curves at 31 December 2017 would, in the case of the effective hedges, have a net positive impact of EUR 205 million on the equity attributable to the Parent (EUR 111 million at companies accounted for using the equity method, EUR 94 million at fully consolidated companies).

b. Exposure to foreign currency risk

Ferrovial monitors regularly the planned net exposure per currency for the coming years both for dividends receivable, investments in new projects and possible divestments.

Ferrovial establishes its hedging strategy by analysing past changes in both short- and long-term exchanges rates, establishing monitoring mechanisms such as future projections and long-term equilibrium exchange rates. These hedges are established by using foreign currency deposits or arranging derivatives (see Note 11 for more details).

The following tables show, by type of currency, the values of assets, liabilities, non-controlling interests and equity attributable to the Parent at December 2017, adjusted by the aforementioned currency forwards corresponding to each currency:

Note 1.4 contains a detail of the changes in the year in the closing exchange rates. As a result of these changes, the impact of translation differences on equity at 31 December 2017 was EUR -318 million for the Parent and EUR -60 million for non-controlling interests. Of the aforementioned EUR -318 million, EUR -124 million correspond to changes in the Canadian dollar, EUR -49 million to changes in the pound sterling, EUR -84 million to changes in the US dollar and EUR -61 million to changes in other currencies.

After analysing the sensitivity to changes in exchange rates, Ferrovial has estimated that a possible 10% appreciation of the euro at year-end against the main currencies in which the Group has investments would give rise to a change in the Parent’s equity of EUR 416 million, of which 43% would relate to the effect of the pound sterling and 39% to that of the Canadian dollar. This fluctuation in the value of the euro would give rise to a change in total assets of EUR 1,638 million, of which 45% would relate to the investments in US dollars, 22% to the investments in pounds sterling and 19% to the investments in Canadian dollars.

Also, the detail of the net profit attributable to the Parent by type of currency for 2017 and 2016 is as follows:

Note 1.4 contains a detail of the changes in the average exchange rates for the year. In this regard, the impact of a 10% appreciation of the euro against the other currencies on the statement of profit or loss would have amounted to EUR -32 million.

c. Exposure to credit and counterparty risk

The Group’s main financial assets exposed to credit risk or counterparty risk are as follows:

Ferrovial actively monitors its risk exposure to its various counterparties:

• Banks: Ferrovial constantly analyses changes in the short- and long-term public ratings issued by the three main agencies (S&P, Fitch and Moody’s) of each bank to which it has exposure. The internal regulations for the management of surpluses govern maximum investment limits with each counterparty using objective criteria: these regulations establish minimum rating requirements to be able to invest cash surpluses and establishes certain limits on such investments based on the rating of each bank. Also, the Financial Risk department monitors the evolution of various counterparties and proposes the appropriate corrective and preventive measures in each particular case.
• Geographical areas: Ferrovial monitors the evolution of the (geographical) markets in which it has a presence, and in its target markets. The Financial Risk department proposes potential actions for occasions when changes in specific geographical areas/markets are expected.
• Customers: Ferrovial analyses and monitors its customers’ credit risk, and the Group has a uniform methodology for assigning credit ratings to customers.

d. Exposure to liquidity risk

The Group has established the mechanisms necessary to preserve the level of liquidity that reflect the cash generation and need projections, in relation to both short-term collections and payments and obligations to be met at long term.

Non-infrastructure project companies

At 31 December 2017, cash and cash equivalents amounted to EUR 4,137 million (2016: EUR 3,301 million). Also, at that date undrawn credit lines totalled EUR 1,641 million (2016: EUR 1,471 million).

Infrastructure projects

At 31 December 2017, cash and cash equivalents (including short-term restricted cash) amounted to EUR 463 million (2016: EUR 277 million). Also, at that date undrawn credit lines amounted to EUR 116 million (2016: EUR 430 million), which were arranged mainly to cover committed investment needs.

e. Exposure to equity risk

Ferrovial is also exposed to the risk relating to the fluctuation of its share price. This exposure arises specifically in equity swaps used to hedge against risks of appreciation of share-based remuneration schemes, the detail of which is shown in Note 5.5 to these consolidated financial statements.

Since these equity swaps are not classified as hedging derivatives, their market value has an impact on profit or loss and, accordingly, a EUR 1 increase/decrease in the Ferrovial share price would have a positive/negative impact of EUR 2 million on the net profit of Ferrovial.

f. Exposure to inflation risk

Most of the revenue from infrastructure projects is associated with prices tied directly to inflation. This is the case of the prices of both the toll road concession contracts and those of HAH, which are accounted for using the equity method. Therefore, a scenario of rising inflation would result in an increase the cash flow from assets of this nature. Also, the defined benefit pension plans in the UK have obligations tied to inflation, which are covered on an individualised basis, since they are not included in consolidation at Ferrovial.

Unlike the Company’s other assets, from the accounting standpoint the derivatives arranged at HAH the objective of which is to convert fixed-rate borrowings into index-linked debt are measured at fair value through profit or loss, since hitherto they have been considered to be ineffective derivatives. HAH is assessing whether or not to classify them as hedge accounting under the new standards (IFRS 9). The accounting impact to date is that an increase of 100 b.p. throughout the inflation curve would have an effect on the net profit attributable to Ferrovial (in proportion to its percentage of ownership) of EUR -162 million.

Also, in the case of the toll road concession operator Autema, there is a derivative tied to inflation that is deemed to qualify for hedge accounting, in which an increase of 100 b.p. throughout the inflation curve would have a negative effect on reserves of EUR -110 million.

g. Capital management

The Group aims to achieve a debt-equity ratio that makes it possible to optimise costs while safeguarding its capacity to continue managing its recurring activities and the capacity to continue to grow through new projects in order to create shareholder value.

Ferrovial’s objective with regard to financial debt is to maintain a low level of indebtedness, excluding infrastructure project debt, such that it can retain its investment grade credit rating. In order to achieve this target it has established a clear and adequate financial policy in which a relevant metric refers to a maximum ratio, for non-infrastructure projects, of net debt (gross debt less cash) to gross profit from operations plus dividends from projects of 2:1.

At 31 December 2017, the net cash position was positive (assets exceeded liabilities) and, therefore, the difference with respect to the maximum debt-equity ratio established is very significant. For the purpose of calculating this ratio, "net debt excluding infrastructure projects" is defined in Note 5.2 and "gross profit from operations plus dividends" is the profit from operations before impairment losses, disposals and depreciation and amortisation of the Group companies other than infrastructure concession operators, plus the dividends received from infrastructure projects.

h. Impact of Brexit on financial risks

This section includes an analysis of the impact that Brexit is having for Ferrovial with respect to financial risks and how these risks are being managed. The risk section of the directors’ report contains a comprehensive analysis of Brexit and how it may affect the Group’s various business areas.

Ferrovial’s UK exposure on the basis of the different financial and business variables is detailed in the following table.

Exchange rate

In 2017 and in the midst of the negotiations between the UK and the European Union, the pound sterling continued its trend of weakness against the euro, although to a much lesser extent than in 2016 when Brexit was announced. At 31 December 2017, the pound sterling had fallen by 4% compared with the year-ago exchange rate. In order to hedge its foreign currency risk, Ferrovial has arranged hedges with a notional amount of GBP 437 million, which approximately cover the dividends it expects to receive on its UK assets over the next three years.

Inflation and interest rates

The market has lowered its expectations with respect to the future RPI – Retail Price Index by an average of 0.20%, with a level of 3.3% and a lower actual rate, with interest rates remaining at similar levels.

Once again the market expectation is for current levels to be maintained, although a negative impact on Brexit would push inflation up and adversely affect the value of pension las obligations and the nominal interest rate, increasing the cost of financing.