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The term financial risk encompasses liquidity, market and credit risks. These can arise from transactions in the course of operating activities and from the hedging of those transactions, from decisions on funding and from changes in the value of financial items in the balance sheet.
We systematically control financial risks by establishing a mandatory risk policy guideline. This sets out clearly the type of financial instruments that may be used, the limits for individual transactions and a list of participating banks. To manage credit risk, we rely mainly on the credit ratings of our partners and we limit the extent and duration of any financial transactions to be concluded accordingly. We perform regular reviews to ensure proper compliance with all the limits set.
A key principle which must be observed throughout the risk management process is that of functional separation between the front, middle and back offices. This means that there is a strict personal and organizational separation between the completion of a commercial transaction and its processing and verification. We use a professional treasury (Glossary) management system to implement and measure our transactions. The operations in the Treasury department are subject to regular reviews by our internal and external auditors, generally once a year.
The basic risk strategies for interest, currency and liquidity management are determined by the Treasury Committee under the overall control of the Finance Director, which meets at least once a month.
We make financing and hedging decisions on the basis of our financial and liquidity forecasts, which include all the main business units in the Group. Our multi-currency rolling 15-month forecast is embedded in our financial reporting system, which is also used for accounting and financial control purposes, ensuring a consistent basis for the figures provided.
Business and financing activities which are not in the local currency inevitably lead to foreign currency cash flows. The Group guideline states that the individual business units must monitor the resulting risks themselves and agree appropriate hedging transactions with the Group treasury department, provided that no country-specific restrictions or other reasons not to hedge (Glossary) apply. Specific risks are grouped together by currency and the resulting net position (Glossary) per currency for Linde Group is hedged according to the risk strategies of the Treasury committee. Forward exchange deals, currency swaps (Glossary) and simple currency options are all used here. Translation risks are not hedged.
In the Gas and Engineering business segment, we also use financial instruments to hedge against exposure to changes in the price of electricity. In our project business in the Linde Engineering division, foreign currency risks are reduced as much as possible by natural hedges, for example by purchasing supplies and services in the currency of the contract. Any foreign currency amounts exceeding these figures are immediately hedged fully when they arise.
Interest rate risks arising from the different periods to maturity of borrowings on the capital market are centrally managed by Linde. Here, we use simple interest rate derivatives (Glossary) such as interest rate and currency swaps as well as interest rate options. At December 31, 2004, about one-third of the Group’s funding was at variable rates.
