E6. Derivatives and hedge accounting

AP Accounting principles

Accounting for derivatives used for hedging purposes

All derivatives are initially and continuously measured at fair value in the balance sheet. Gains and losses on remeasurement of derivatives used for hedging purposes are recognized as described below. When using hedge accounting, the relationship between the hedging instrument and the hedged item is documented. Assessment of the effectiveness of the hedge is also documented, both when the transaction is initially executed and on an ongoing basis. Hedge effectiveness is the extent to which the hedging instrument offsets changes in value in a hedged item’s fair value or cash flow. The ineffective portion is recognized directly in profit or loss.

Cash flow hedges

Gains and losses on remeasurement of derivatives intended for cash flow hedges are recognized in equity under other comprehensive income and reversed to profit or loss at the rate at which the hedged cash flow affects profit or loss. If a hedge relationship is interrupted and cash flow is still expected, the result is recognized in equity under other comprehensive income until the cash flow affects the result. If the hedge pertains to a balance sheet item, the result is transferred from equity to the asset or liability to which the hedge relates when the value of the asset or liability is determined for the first time. In cases in which the forecast cash flow that forms the basis of the hedging transaction is no longer assessed as probable, the cumulative gain or loss that is recognized in equity under other comprehensive income is transferred directly to profit or loss. Cash flow hedges relating to energy are recognized as energy costs, that is, cost of goods sold. Cash flow hedges related to transaction exposure are recognized in consolidated net sales and expenses.

Hedges of net investments in foreign operations

Gains and losses on remeasurement of derivatives intended to hedge Essity’s net investments in foreign operations are recognized in equity under other comprehensive income. The cumulative gain or loss in equity is recognized in profit or loss in the event of divestment of the foreign operation.

Fair value hedges

The gain or loss from remeasurement of a derivative relating to fair value hedges is recognized in profit or loss together with changes in fair value of the hedged asset or liability. For Essity, this means that non-current loans that are subject to hedge accounting are discounted without a credit spread to the market interest rate and meet inherent interest rate derivatives’ discounted cash flows at the same interest rate.

Economic hedges

When Essity conducts hedges and the transactions do not meet requirements for hedge accounting according to IFRS 9, changes in fair value of the hedging instrument are recognized directly in profit or loss.

Balance sheet

Essity uses financial derivatives to manage currency, interest rate and energy price risks. For a description of how Essity manages these risks, refer to the section on Risk and risk management. The table above shows the derivatives that impacted the Group’s balance sheet on December 31, 2019. For more information relating to derivatives in the balance sheet, see Note E1 Financial instruments by category and measurement level.

Income statement

Hedges pertaining to transaction exposure had an impact of SEK –16m (92; –106) on operating profit for the period. At year-end, the net market value amounted to SEK –17m (0; –9). Currency hedges increased the cost of non-current assets by SEK 14m (increased: 1; increased: 10). At year-end, the net market value amounted to SEK –3m (–1; 20). Energy derivatives had an impact of SEK –173m (396; 90) on operating profit for the period. Energy derivatives had an outstanding market value of SEK –282m (366; 225) at year-end. Derivatives impacted net interest items in an amount of SEK –381m (–362; –289). The net market value of outstanding interest rate derivatives amounted to SEK 545m (489; 413) at year-end. For further information relating to financial items, see Note E7 Financial income and expenses.

Sensitivity analysis

Essity has performed sensitivity analysis calculations on the financial instruments’ risk at December 31, 2019 using assumptions on market movements that are regarded as reasonably possible in one year’s time. If the Swedish krona had unilaterally weakened/strengthened by 5% against all currencies, outstanding financial hedges, trade payables and trade receivables would have decreased/increased profit for the period before tax by SEK 8m (7; 54).

If the Swedish krona had unilaterally weakened/strengthened by 5%, currency hedges relating to the cost of non-current assets would have increased/decreased equity by SEK 0m (0; 0). If energy prices had increased/decreased by 20%, outstanding financial hedges relating to natural gas and electricity, all other things being equal, would have decreased/increased energy costs for the period by SEK 174m (299; 214). In addition to the earnings impact, equity would have increased/decreased by SEK 90m (136; 120). However, the total energy cost for the Group would have been affected differently if the price risk related to supply contracts was taken into account.

Derivatives with hedge accounting

The various risk management strategies are presented in the Risks and risk management section. The derivatives to which hedge accounting is applied are presented below. Essity also continuously hedges the transaction exposure and energy price risks for the risks that are recognized in the balance sheet and income statement. Hedge accounting is not applied in respect of these risks. For currency derivatives, the revaluation from the risks meets derivatives in the financial positions. For energy derivatives, the result is recognized in profit or loss.

IFRS 9 provides the option of hedging risk components. In 2019, Essity did not utilize this option except for energy, where Essity in the Nordic region hedges the system price, which is a sub-component. The hedging ratio for the various risks for which hedge accounting is prepared is consistently 1:1.

Cash flow hedges

Cash flow hedges for currency risk are prepared for transaction exposure, large investments and energy price risks in connection with purchases of electricity and gas. For cash flow hedges, hedges are prepared whereby critical terms match the hedged item. For the cash flow hedges prepared, this means that the change in fair value of the hedging instruments and the change in the hedged item are very highly correlated. Any ineffectiveness could, for example, be due to the time or the amount of the forecast cash flow mismatching with the cash flow of the derivative. In 2019, SEK 0m (0; 0) was recognized in profit or loss as ineffectiveness concerning the cash flow hedges. Currency derivatives mature in April 2021, while energy derivatives mature in December 2021.

Hedging of net investments

Essity has hedged net investments in a number of selected legal entities in order to achieve the desired currency distribution of net debt relative to assets so that key figures that are important to the company’s credit rating can be protected in the long term. The result of hedging positions affected equity by a total of SEK –168m (–122; –1,968) during the year. This result is largely due to hedges of net investments in USD and EUR. In 2019, SEK 0m (0; 0) was recognized in profit or loss as ineffectiveness. The total market value of outstanding hedging transactions at the end of the period was SEK 124m (353; 170). In total at year-end, Essity hedged net investments outside Sweden amounting to SEK –11,550m. Essity’s total foreign net investments at year-end amounted to SEK 71,797m. Currency derivatives and loans in foreign currency are used to hedge net investments.

Fair value hedges

For fair value hedges, the hedges have the same nominal amount, maturity dates and fixed interest as the hedged item. Hedge ineffectiveness is attributable, for example, to the various discount curves for the hedging instrument and the hedged item. Hedge ineffectiveness per maturity date is presented in the table below. Ineffectiveness is recognized in financial items under Fair value hedges, unrealized. See Note E7 Financial income and expenses.

The results from hedging of net investments in foreign operations are recognized in the translation reserve, refer to Note E8 Equity. The results from fair value hedges are recognized directly in profit or loss.

Hedge reserve in equity

Currency derivatives relating to hedging of transaction exposure mature mainly during the first quarter of 2020. With unchanged exchange rates, profit after tax will be affected in an amount of SEK 0m (0; neg. 1). Currency derivatives relating to hedging of the cost of non-current assets have a maturity spread until April 2021. With unchanged exchange rates, the cost of non-current assets will increase by SEK 2m (increase by 1; decrease by 15) after tax. The derivatives intended to hedge energy costs in the Group mature during 2020 and 2021. With unchanged prices, the Group’s profit after tax will be affected negatively in an amount of SEK 204m (pos. 245; pos. 152).