5.5 DERIVATIVE FINANCIAL INSTRUMENTS AT FAIR VALUE

a) Breakdown by type of derivative, changes, expiry dates and main features

The table below includes a detail of the fair values of the derivatives arranged at 31 December 2017 and 2016, as well as the maturities of the notional amounts to which the derivatives relate (maturities of notional amounts are shown as positive figures and already-arranged future increases are presented as negative amounts):

The cash flows composing the fair value of the derivatives mature as follows:

Following is a description of the main types of derivatives and of the most significant changes therein in 2017:

Toll Road Division derivatives

Interest rate swaps, Toll Roads

In order to hedge the interest rate risk in toll road infrastructure projects, the concession holders have arranged interest rate hedges on the projects’ debt, establishing a fixed or increasing interest rate for a total notional amount of EUR 883 million at 31 December 2017. Overall, the fair value of these hedges increased from EUR -399 million at 31 December 2016 to EUR -357 million at 31 December 2017.

In general, since these derivatives are considered to be effective, the changes in their fair value are recognised in reserves, with an impact of EUR 42 million (EUR 31 million attributable to the Parent, after tax and non-controlling interests).

The changes in settlements and accruals gave rise to an impact on the financial result of EUR -45 million and of EUR -46 million in cash.

Index-linked swaps, Toll Roads

This item relates exclusively to Autema, which in 2008 arranged an index linked swap to hedge income variability, by means of which an annual CPI of 2.50% was fixed. This hedge, which was considered effective, had an impact of EUR -5 million on reserves (EUR -3 million after tax attributable to the Parent).

Corporate derivatives

Interest rate swaps, Corporate

In relation to the bond issues launched in 2013, the Group arranged interest rate derivatives for a notional amount of EUR 250 million expiring in 2021. Since they convert a portion of the fixed interest rate on the bonds into a floating interest rate, these derivatives constitute a partial fair value economic hedge of the aforementioned bond issues and they all qualify for hedge accounting. The fair value impact of these bonds on the financial result amounted to EUR 0.4 million.

Cross-currency swaps, Corporate

In September 2016 Ferrovial arranged cross-currency swaps to hedge a drawdown of borrowings in US dollars (see Note 5.2.2). The notional amount of these instruments is USD 279 million (EUR 232 million) and they expire in 2019. The changes in value thereof are recognised in reserves (EUR 0.1 million in 2017), for the interest rate component, and Result on exchange differences, for the foreign currency hedge component (EUR -32 million in 2017).

Equity swaps

Ferrovial has arranged equity swaps in order to hedge against the possible impact on equity resulting from the exercise of the share-based remuneration schemes granted to its employees.

The modus operandi of these equity swap contracts is as follows:

• The calculation base is a given number of Ferrovial shares and a reference price, which is normally the market price of the share on the grant date.
• For the duration of the contract, Ferrovial pays interest equivalent to a given interest rate (EURIBOR plus a spread, to be applied to the result of multiplying the number of shares by the exercise price) and receives remuneration equal to the dividends corresponding to those shares.
• When the swap expires, if the share price has increased, Ferrovial will receive the difference between the market price and the reference price. If the share price has fallen, Ferrovial will pay the difference to the bank.

At 2017 year-end, these derivatives had a notional amount equivalent to 2.7 million shares, which, based on the exercise price of the equity swaps (the price at which they must be settled with the banks), represented a total notional amount of EUR 50 million.

Exchange rate derivatives, Corporate

These derivatives relate to Corporate hedges of foreign currency risk, the main aim of which is to protect against the volatility of future cash flows in foreign currencies (basically the pound sterling, the Australian dollar, the US dollar, and the Canadian dollar). Their notional value amounted to EUR 2,335 million at 31 December 2017, of which EUR 976 million relate to the Canadian dollar, EUR 552 million relate to the US dollar, EUR 596 million to the Australian dollar, EUR 190 million to the pound sterling and EUR 21 million to the New Zealand dollar. They expire at short term. The changes in their value are recognised as translation differences and amounted to EUR 77 million in 2017 (for effective derivatives). Options, which are not classified as accounting hedges, are recognised in financial results at fair value and in 2017 represented an expense of EUR -16 million.

Derivatives, Services Division

Cross-currency swaps, Broadspectrum

The cross-currency swaps arranged at 2016 year-end hedged mainly fluctuations in the fair value of the High Yield Bonds issued in US dollars by converting this debt into Australian dollars at floating rate. Since this debt was repurchased in May 2017, this derivative was derecognised, giving rise to a variation of EUR 82 million in 2017. In addition, there was a liability balance of another EUR 3 million at December 2016 hedging debt issues denominated in Chilean pesos, which were also derecognised in 2017.

b) Main effects on profit or loss and equity

The changes for accounting purposes in the main derivatives arranged by fully consolidated companies, detailing the fair values thereof at 31 December 2017 and 2016, and the impact on reserves, profit or loss and other statement of financial position items are as follows:

Derivatives are recognised at market value at the arrangement date and at fair value at subsequent dates. Changes in the value of these derivatives are recognised for accounting purposes as follows:

• The changes in the year in the fair value of the derivatives designated as cash flow hedges are recognised in reserves (column I).
• The changes in fair value of the derivatives that do not qualify for hedge accounting or that are considered to be held for speculative purposes are recognised as a fair value adjustment in Group profit or loss (column II) and are reflected separately in the statement of profit or loss.
• “Impact on Financial Result” (column III) reflects the impacts on the financial result due to financing arising from the interest flows accrued during the year.
• “Impact on Cash” (column IV) indicates net payments and collections during the year.
• The impact of the difference between closing translation differences at December 2017 and 2016 is also presented separately (column V).
• Lastly, “Other Impacts” shows the impacts on profit or loss from operations, financial result (exchange rate effect) or other effects not considered in the other columns (column VI).

c) Derivative measurement methods

All the Group’s derivative financial instruments and other financial instruments carried at fair value are included in LEVEL 2 of the fair value measurement hierarchy, since although they are not quoted on regulated markets, the inputs on which their fair values are based are observable, either directly or indirectly.

Although the fair value measurements are performed by the Company using an internally developed valuation tool based on best market practices, they are in any event compared with the valuations received from the counterparty banks on a monthly basis.

Equity swaps are measured as the difference between the market price of the share on the calculation date and the unit settlement (strike) price agreed at inception, multiplied by the number of shares under the contract.

The other instruments are measured by quantifying the net future cash inflows and outflows, discounted to present value, with the following specific features:

• Interest rate swaps: the future cash flows with floating reference rates are estimated by using current market projections at the measurement date for each currency and settlement frequency; and each flow is updated using the market zero-coupon rate that is appropriate for the settlement period and currency in question at the measurement date.
• Index-linked swaps: the future cash flows are estimated by projecting the future behaviour implicit in the market curves on the measurement date for each currency and settlement frequency, for both reference interest rates and reference inflation rates. As in the cases described above, the flows are discounted using the discount rates obtained at the measurement date for each flow settlement period and currency.
• Cross-currency swaps: the future cash flows with floating reference rates are estimated by using current market projections at the measurement date for each currency and settlement frequency; and each flow is updated using the market zero-coupon rate that is appropriate for the settlement period and currency in question at the measurement date, including the cross-currency basis spreads. The present value of the flows in a currency other than the measurement currency is translated at the spot exchange rate prevailing at the measurement date.
• Foreign currency derivatives: as a general rule, the future cash flows are estimated by using the exchange rates and market curves associated with each currency pair (forward points curve), and each flow is updated using the market zero-coupon rate that is appropriate for the settlement period and currency in question at the measurement date. For other more complex instruments (options, etc.), the valuation models appropriate for each instrument are employed, taking into consideration the necessary market data (volatilities, etc.).

Lastly, credit risk, which is included in the measurement of derivatives pursuant to IFRS 13, is estimated as follows:

• in order to calculate the adjustments associated with own and counterparty credit risk (CVAs/DVAs), Ferrovial applies a methodology based on calculating the future exposure of the various financial products using Monte Carlo simulations. To this potential exposure, a probability of default and a loss given default based on the parties’ business and credit quality are applied, as well as a discount factor based on the currency and applicable maturity at the measurement date.
• In order to calculate the probabilities of default of the Ferrovial Group companies, the Credit Risk Management department assesses the rating of the counterparty (company, project, etc.) using a proprietary, rating agency-based methodology. This rating is used to obtain market spread curves according to the currency and term in question (generic curves by rating level).
• In order to calculate the probabilities of default of the counterparties, the CDS curves of those companies are used, if available; otherwise, the CDS curves of a similar entity (proxy) or a generic spread curve (by rating level) are used.