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37. Risks connected with financial instruments

The Group manages risks related to financial instruments, which include market risk (currency risk, interest rate risk, aircraft fuel price risk and capital management risk), credit risk and liquidity risk.

Liquidity risk

The Group is exposed to liquidity risk, i.e. the risk that the Group will not be able to meet its financial obligations as they fall due. The Group’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 stressed financial conditions, without incurring unacceptable losses or risking damage to the Group’s reputation. The Group utilises a detailed budgeting and cash forecasting process to ensure its liquidity is maintained at appropriate level.

The following are the Group’s financial liabilities (excluding derivative financial instruments) as at 31 December 2013 and 31 December 2012 broken down by contractual maturities (based on the remaining period from the reporting date to the contractual settlement date). The amounts in the table are contractual undiscounted cash flows (including future interest payments) as at respective reporting dates:

Maturity dates of derivative financial instruments are disclosed in Note 24.

As at 31 December 2013, the Group was able to attract USD 495.8 million of cash (31 December 2012: USD 959.6 million) available under lines of credit granted to the Group by various lending institutions.

Currency risk

The Group is exposed to currency risk in relation to revenue as well as purchases and borrowings that are denominated in a currency other than rouble. The currencies in which these transactions are primarily denominated are Euro and US Dollar.

The Groups analyses the exchange rate trends on a regular basis. In November and December 2012 as well as in August, September and December 2013, the Group entered into agreements with a number of Russian banks to hedge the risk of negative changes in the exchange rates (Note 24).

The Group’s exposure to foreign currency risk was as follows based on notional amounts of financial instruments:

The Group also expects that payments of Euro 2.3 million, Euro 2.3 million, Euro 2.3 million, Euro 2.3 million and Euro 126.4 million related to the cross-currency interest rate swap with a fixed interest rate disclosed in Note 24, will be made in March and September 2014, March and September 2015 and March 2016, respectively.

A 20% strengthening or weakening of listed below currencies versus rouble as at 31 December 2013 and 31 December 2012, respectively, would have increased/ (decreased) profit after tax by the amounts shown below. This analysis assumes that all other variables, in particular interest rates, remain constant. The effect on the Group’s equity would be the same as that on the Group’s profit after tax relating to this profit.

Interest rate risk

The Group is exposed to the effects of fluctuations in the prevailing levels of market interest rates on its financial results and cash flows. Changes in interest rates impact primarily change in cost of borrowings (fixed interest rate borrowings) or future cash flows (variable interest rate borrowings). At the time of raising new borrowings as well as finance lease management uses judgment to decide whether it believes that a fixed or variable interest rate would be more favourable to the Group over the expected period until maturity.

As at 31 December 2013 and 31 December 2012, the interest rate profiles of the Group’s interest-bearing financial instruments were:

During the year some of the Group’s loans bore variable interest rates (Note 29 and Note 30). If the variable interest rates on loans in 2013 were 20% higher or lower than the actual interest rates for the year, with all other variables held constant, interest expense would not have changed significantly (2012: would not have changed significantly).

The interest expense under finance lease agreements primarily accrues at variable interest rates. A sizeable part of finance lease liabilities (USD 367.2 million as at 31 December 2013 and USD 445.9 as at 31 December 2012) is a subject to an interest rate swap with a fixed interest rate (Note 24). If in 2013 those rates were 20% higher or lower than what they actually were, with all other variables held constant, interest expense on finance leases for the year would not have been materially different (2012: would not have been materially different).

Aircraft fuel price risk

The results of the Group’s operations can be significantly impacted by changes in the price of aircraft fuel. In September and October 2012 as well as September 2013, the Group entered into agreements with a number of Russian banks to hedge a portion of its fuel costs from potential future price increases. In accordance with the terms of each agreement the Group will be compensated by the bank for the excess between the actual aircraft fuel price and the ceiling price specified in the agreement, whilst the Group has agreed to compensate the bank the shortfall between the actual prices and the floor price specified in the agreement (Note 24).

Capital management risk

The Group manages its capital to ensure its ability to continue as a going concern while maximizing the return to the Company’s shareholders through the optimisation of the Group’s debt to equity ratio.

The Group monitors its capital in comparison with rivals in the airline industry on the basis of the following ratios:

• net debt to total capital,
• total debt to EBITDA, and
• net debt to EBITDA.

Total debt consists of short-term and long-term borrowings (including the current portion), finance lease liabilities, custom duties payable on imported leased aircraft and defined benefit pension obligation.

Net debt is defined as total debt less cash, cash equivalents and short-term financial investments.

Total capital consists of equity attributable to the Company’s shareholders and net debt.

EBITDA is calculated as operating profit before depreciation, amortization and custom duties expenses.

The ratios are as follows:

There were no changes in the Group’s approach to capital management in 2013 and 2012.

Neither the Group nor any of its subsidiaries are subject to externally imposed capital requirements, except for minimal share capital according to the legislation.

Credit risk

Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Group’s cash and cash equivalents, financial receivables and investments in securities.

The Group conducts transactions with the following major types of counterparties:

• The Group has credit risk associated with travel agents and industry organisations. A significant share of the Group’s sales is made via travel agencies. Due to the fact that receivables from travel agents are diversified the overall credit risk related to travel agencies is assessed by management as low.
• Receivables from other airlines are carried out through the IATA clearing house. Regular settlements ensure that the exposure to credit risk is mitigated to the greatest extent possible.
• Aircraft suppliers require that security deposits are paid by the Group in relation to the future aircraft deliveries. The Group mitigates this credit risk by performing background checks on suppliers. Only well-known and reputable companies are contracted with.
• The Group limits its exposure to credit risk associated with investments in securities by only investing in liquid securities with a high credit rating. Management actively monitors its investing performance and given that the Group only has invested in securities with high credit ratings, management does not expect any counterparty to fail to meet its obligations.

The maximum exposure to the credit risk net of impairment provision is set out in the table below:

Analysis by credit quality of financial receivables is as follows:

Credit risk concentration

As at 31 December 2013 a large portion of the cash as well as long-term financial investments of the Group was placed in two banks (as at 31 December 2012: two banks) and invested in one company (as at 31 December 2012: one company), respectively, which causes the credit risk concentration for the Group.