Financial Risk Management

Asset and Liability Management

One of the main functions of ALCO is asset and liability management. CITIC Pacific’s investments in different businesses are financed by a mixture of long-term debt, short-term debt and equity including perpetual capital securities. CITIC Pacific manages its capital structure to finance its overall operations and growth by using different sources of funds. The type of funding is targeted to match the characteristics of our underlying business.

Debt and Leverage

Debt

As at 31 December 2013, total outstanding debt of CITIC Pacific Limited and its subsidiaries amounted to HK$121,144 million. Total debt increased by HK$4.2 billion in 2013. Facilities totalling HK$34.5 billion were established or renewed during the period (HK$18.9 billion by CITIC Pacific Limited and HK$15.6 billion by its subsidiaries). The new facilities included US$500 million notes due in 2020 and HK$500 million notes due in 2018 issued under a medium-term note programme, and RMB500 million notes due in 2016 under another mediumterm note programme in mainland China. Net debt increased by HK$1.9 billion from the end of 2012 to the end of 2013.

Total debt and net debt of CITIC Pacific Limited and its subsidiaries are as follows:

Debt raised in the name of legal entities within each business segment is:

The maturity profile of the debt outstanding as at 31 December 2013 is as follows:

Total outstanding debt by maturity

Total outstanding debt by type

CITIC Pacific’s non-consolidated businesses are classified as joint ventures or associated companies. Under Hong Kong generally accepted accounting standards, they are not consolidated in CITIC Pacific’s financial statements but recorded in the consolidated balance sheet as CITIC Pacific’s share of their net assets. The debts arranged by the joint ventures and associated companies are without recourse to their shareholders. None of these debts are guaranteed by CITIC Pacific Limited or its subsidiaries. Certain of CITIC Pacific’s associates such as Hong Kong Resort Company Ltd, which develops property projects in Discovery Bay, are 100% financed by their shareholders and do not have any external borrowings.

The following table shows the net debt/cash position of joint ventures and associated companies by business sector as at 31 December 2013:

Leverage

As at 31 December 2013, net debt was HK$86.1 billion, and total ordinary shareholders’ funds and perpetual capital securities were HK$101.8 billion. Net debt divided by total capital is the measure of our balance sheet leverage. This ratio was 46% at the end of 2013. The drop from 50% in 2012 is mainly due to increase in ordinary shareholders’ funds and the issuance of US$1 billion of perpetual capital securities in 2013.

Leverage

Leverage

Liquidity Risk Management

Liquidity risk is in essence managed alongside ALM. The objective of liquidity risk management is to ensure that CITIC Pacific always has sufficient cash to meet its liabilities and has the flexibility to respond to opportunities by making sure that undrawn committed facilities are available to meet future funding and working capital requirements.

CITIC Pacific’s liquidity management procedures involve regularly projecting cash flows in major currencies and considering the level of liquid assets and new financings necessary to meet these cash flow requirements. Every month, cash flow projections for three years are reviewed and revised by business units and ALCO, and financing actions are taken accordingly.

As at the end of 2013, CITIC Pacific maintained borrowing relationships with over 40 major financial institutions based in Hong Kong, mainland China, Taiwan and other countries. In addition, CITIC Pacific has established cooperative agreements with major banks in mainland China under which CITIC Pacific can apply for credit facilities for projects in mainland China. The banks’ approval is required on a project-by-project basis.

CITIC Pacific actively seeks to diversify its funding sources so as not to be reliant on any one market. Our policy is to diversify the sources of funding as much as possible through the increasing use of the capital market to supplement bank borrowings and to maintain a mix of staggered maturities to minimise refinancing risk.

The following sub-sections reflect CITIC Pacific’s ALM and liquidity positions in various aspects:

Available Sources of Finance

CITIC Pacific aims at maintaining the cash balance and undrawn committed banking facilities at a reasonable level to cover the debt repayments in the upcoming year as well as to support the on-going business development of CITIC Pacific. The cash and deposits balance together with the undrawn committed banking facilities as at 31 December 2013 was HK$48.1 billion.

In addition to the cash and deposits balance of HK$35.1 billion as at 31 December 2013, CITIC Pacific had available loan and trade facilities of HK$26.7 billion, of which HK$13 billion was undrawn committed banking facilities. Loans can be drawn under these committed facilities before the contractual expiry dates.

The following table summarises CITIC Pacific’s cash and deposit balances by location and currency:

The following table summarises CITIC Pacific’s funding by type of bank facility:

The following table summarises the outstanding bank facilities of CITIC Pacific by location of lenders:

Guarantees

Subsidiaries and affiliates secure debt facilities to fund their investments, to the extent possible, without recourse to CITIC Pacific Limited. The major exception is for the iron ore mining project, which has not begun to generate cash flow. For this project, CITIC Pacific Limited provides guarantees for the performance obligations under construction or procurement contracts, interest rate hedging transactions, foreign exchange hedging transactions and a total outstanding of US$3.6 billion in debt facilities. Other guarantees mainly include those provided for ship financing, a Japanese Yen bond and trade facilities for two subsidiaries.

Pledged Assets

As at 31 December 2013, CITIC Pacific had a total of HK$76.4 billion of assets pledged for various facilities. Iron ore assets of HK$70.4 billion were pledged under its financing documents. Twelve ships with carrying value of HK$5.2 billion for transporting iron ore from the mine to steel plants in mainland China were pledged as security for the ships’ financing. In addition, assets of HK$0.8 billion were pledged to secure banking facilities, which mainly related to Dah Chong Hong’s mainland China and overseas business.

Financial Covenants

Over the years, CITIC Pacific Limited has developed a standard loan document, including covenants to facilitate the management of its loan portfolio and debt compliance. CITIC Pacific Limited monitors these covenants on a regular basis and has been in compliance with them and any others applicable to a particular facility. The standard financial covenants are generally as follows:

For the purpose of the above covenant limits, as defined in the relevant borrowing agreements:

“Consolidated Net Worth” means the aggregate of shareholders’ funds, goodwill from acquisitions and developments having been written off against reserves or the profit and loss account, convertible debt and subordinated debt (including perpetual debt).

“Consolidated Borrowing” means the aggregate of all consolidated indebtedness for borrowed money (includes indebtedness arising under acceptances and bills of exchange other than in respect of goods or services acquired in the ordinary course of business) and all contingent obligations in respect of indebtedness for borrowed money other than the aforesaid consolidated indebtedness for borrowed money.

“Negative Pledge” allows certain exceptions, including but not limited to any security over any asset acquired or developed, which security is created to finance or refinance the acquisition or development of such asset.

Standard & Poor’s changed CITIC Pacific’s rating from BB+ to BB with negative outlook in August 2013. In November 2013, Moody’s followed suit referencing the slower than expected progress of the Sino Iron Project.

Despite the above, the current ratings still reflect the agencies’ expectation that CITIC Pacific will continue to enjoy strong support from the CITIC Group as a strategically important subsidiary.

One of CITIC Pacific’s risk management objectives is to improve its credit profile. CITIC Pacific expects that its overall operating and financial profiles will improve gradually after the iron ore mine starts to generate cash flow. flow.

Capital Commitments and Contingent Liabilities

Details of CITIC Pacific’s capital commitments as at 31 December 2013 are listed under Note 36 to the financial statements.

Details of CITIC Pacific’s contingent liabilities as at 31 December 2013 are listed under Note 39 to the financial statements.

Treasury Risk Management

Treasury risk management essentially covers the following financial risks inherent in CITIC Pacific’s businesses:

  • Foreign eschange risk
  • Interest rate risk
  • Counterparty risk
  • Commodity risk

Financial derivatives may be used to assist in the management of the above risks. It is CITIC Pacific’s policy not to enter into derivative transactions for speculative purposes. The use of derivative instruments is currently restricted by ALCO to interest rate swaps, cross currency swaps and plain vanilla forward foreign exchange contracts. The use of structured derivatives and instruments or contracts that contain embedded options would require presentation to and the specific approval of ALCO. None were submitted for approval in 2013. From a risk management perspective, simple, cost-efficient and HKAS 39 hedge effective instruments are preferred. To the extent possible, gains and losses of the derivatives offset the losses and gains of the assets, liabilities or transactions being hedged both in economic terms and under accounting rules.

CITIC Pacific has engaged Reval Inc. (“Reval”), a derivative risk management and hedge accounting solutions firm, to provide a system supported by consulting services to better monitor its derivatives portfolio and ensure compliance with the latest accounting standards. The valuations of the derivatives portfolio as at 31 December 2013 are in compliance with HKFRS 13, which is effective since 1 January 2013. The system provided by Reval has been upgraded to generate the valuations that were used in the compilation of this report. In addition, in December 2013 the group treasury department started to adopt the Treasury & Risk Management System called “Integrity”, offered by SunGard Data Systems Inc. (“SunGard”) to facilitate its operations and risk management of all treasury related activities. SunGard is one of the world’s leading software and technology services companies in this field.

Foreign Exchange Risk

CITIC Pacific has major operations in Hong Kong, mainland China and Australia whose functional currencies are Hong Kong dollar (“HKD”), Renminbi (“RMB”) and United States dollar (“USD”). Entities within CITIC Pacific are exposed to foreign exchange risk from future commercial transactions, net investments in foreign operations and net monetary assets and liabilities that are denominated in a currency that is not the entity’s functional currency. CITIC Pacific is subject to the risk of loss or profit due to changes in USD, RMB and Australian dollar (“AUD”) exchange rates. There are also exposures to the Japanese Yen (“JPY”) (from operations and assets related to DCH), Euro (“EUR”) (from equipment and product purchases) and other currencies. In 2013, Mercer Investment (HK) Limited (“Mercer”), an external consultancy firm, was appointed to conduct an FX diagnostic review exercise for CITIC Pacific Limited and its major subsidiaries. Whilst Mercer highlighted a few areas for improvement in terms of system, reporting and policy, it was noted in the report that major foreign exchange risks (e.g. AUD exposure in our Australian mining operation) for CITIC Pacific as a whole have been properly identified and managed.

CITIC Pacific’s material currency exposures arise from the following:

(1) USD denominated debt
(2) RMB denominated debt
(3) expenditure relating to its iron ore mining operations in Australia and steel operations in mainland China
(4) purchases of raw materials by steel operations in mainland China
(5) purchases of finished products for sale by DCH, and
(6) investment in mainland China and Australia

We strive to reduce currency exposures by matching assets with borrowings in the same currency to the extent possible. Our policy is to hedge transactions where value or time to execution will give rise to material currency exposure, provided that the cost of the hedging instrument is not prohibitively expensive in comparison to the underlying exposure. CITIC Pacific uses forward contracts and cross currency swaps to manage its foreign exchange risk. Hedging is only considered for firm commitments and highly probable forecast transactions.

The consolidated financial statement is presented in HKD, which is the CITIC Pacific group’s presentation currency and CITIC Pacific Limited’s functional and presentation currency. Translation exposures from the consolidation of subsidiaries whose functional currency is not HKD are not hedged using derivative instruments, as this is not a cash exposure.

US Dollar (USD) – Being CITIC Pacific’s main investment in businesses with functional currency denominated in USD, the iron ore business had USD gross assets of HK$85.3 billion as at 31 December 2013. Correspondingly, CITIC Pacific had HK$83.5 billion equivalent of US dollar debt, of which HK$46 billion equivalent was designated as a net investment hedge to minimise foreign currency exposure in the profit and loss account in the event of movements in the HKD/USD exchange rate.

Renminbi (RMB) – Businesses in mainland China had RMB gross assets of approximately HK$136 billion as at 31 December 2013, offset by debts and other liabilities of HK$47 billion. This gave CITIC Pacific an RMB net asset exposure of HK$89 billion as at 31 December 2013. Renminbi is currently not a freely convertible currency, and ”registered capital”, which usually accounts for at least one third of the total investment amount for projects in mainland China, may be required to be paid in foreign currency by foreign investors such as CITIC Pacific. This RMB investment risk is accepted by CITIC Pacific as a natural consequence of its strategy of investing in business related to the development of China.

Australian Dollar (AUD) – Our Australian mining operation’s functional currency is USD as the future revenues from its iron ore business are denominated in USD. However, a substantial portion of its developmental and operating expenditures are denominated in AUD. To manage the AUD exposure of the business, the Australian mining operation has adopted a policy to stabilise the effective exchange rate over time by entering into plain vanilla forward contracts to hedge part of its forecast future AUD expenditures up to one year ahead. As at 31 December 2013, the Australian mining operation had plain vanilla forward contracts with a notional amount of A$239 million outstanding with maturities up to November 2014.

Japanese Yen (JPY) – CITIC Pacific issued a JPY8.1 billion bond in 2005. From an economic perspective, this JPY exposure is hedged through a cross currency swap into Hong Kong dollar floating rate payments. This swap does not qualify as an accounting hedge under the specific rules in HKAS 39, therefore changes in its fair value are reflected in the profit and loss account. The JPY bond is the only significant JPY exposure as at 31 December 2013.

The denomination of CITIC Pacific Limited and its subsidiaries’ total debt and cash and bank deposit balances by currency as at 31 December 2013 is summarised as follows:

Total outstanding debt by currency

Outstanding debt after conversion

Interest Rate Risk

CITIC Pacific’s interest rate risk arises primarily from debt. Borrowings at variable rates expose CITIC Pacific to cash flow interest rate risk, whilst borrowings at fixed rates economically expose CITIC Pacific to fair value interest rate risk. In the current low interest rate environment, CITIC Pacific manages the ratio of fixed/floating debt to achieve a balance between minimising our interest expense and protecting against large increases in interest rates.

This risk is managed by considering the whole portfolio of interest bearing assets and liabilities. The net desired position is then managed by borrowing fixed rate or through the use of interest rate swaps, which have the economic effect of converting floating rate borrowings into fixed rate borrowings.

The appropriate ratio of fixed/floating interest rate risk for CITIC Pacific is reviewed periodically. The level of fixed rate debt is decided after taking into consideration the potential impact of higher interest rates on profit, interest cover and cash flow cycles of CITIC Pacific’s business and investments.

As at 31 December 2013, CITIC Pacific’s floating to fixed interest rate derivative contracts had a notional amount of HK$24.9 billion. After hedging through interest rate swaps and the issuance of fixed rate debt, 56% of the borrowings of CITIC Pacific were linked to floating interest rates. In addition, CITIC Pacific has entered into HK$1.2 billion of forward starting swaps to lock in fixed rates for 3 years.

Fixed and floating interest rates as at 31 December 2013 and 31 December 2012

CITIC Pacific’s overall weighted all-in cost of borrowing (including interest paid or accrued, fees and hedging costs or profits from interest rate swaps contracts) for 2013 was approximately 4.5% compared with 4.3% for 2012.

Average borrowing costs

Counterparty Risk

CITIC Pacific keeps a large amount of cash deposits at financial institutions. To mitigate the risk of non-recovery of cash deposits or financial instrument gains, CITIC Pacific deals mostly with international financial institutions with a credit rating of A- (S&P) or A3 (Moody’s). Special authorisations are given by ALCO for mainland Chinese institutions, many of which do not have international credit ratings. In great majority of cases, a maximum deposit limit is set that does not exceed the amount borrowed from the same institution.

Deposits are safe, liquid, interest-bearing and consistent with treasury and business purpose needs. Management monitors market developments, reviews the list of approved counterparties and closely monitors their credit quality, and revises deposit limits on an on-going basis.

The group treasury department is responsible for allocating and monitoring the limits with the list of approved financial institutions. Management does not expect any losses from non-performance by our financial counterparties.

Commodity Risk

CITIC Pacific purchases and produces commodities across its various businesses; it has exposure to commodity price risks such as gas, coal and iron ore.

CITIC Pacific has entered into long-term supply contracts for certain inputs, such as gas for the Australian mining operations and coal for its power generation business to manage some of its raw material exposure. CITIC Pacific’s businesses such as the manufacture of iron ore for its special steel operations, the ownership of ships to manage freight costs and production of coal to its power generation business are also exposed to commodity price risks as a result of on-going changing demand in these markets. Whilst CITIC Pacific views that naturally offsetting are being achieved to a certain extent across its different business sectors, continual risk management review is being performed to ensure commodity risks are well understood within its business strategies.

Due to the delay in the commissioning of the production lines for the Australian mining operations, the projected delivery of natural gas under certain gas supply contracts for the mining operations has, in aggregate, exceeded the current needs of the project. To manage these contracts and to minimise any adverse financial implications, the iron ore operation has entered into commercial agreements to dispose and/or swap and/or bank a portion of the excess gas to other parties. CITIC Pacific will continue to evaluate and implement appropriate strategies to manage its gas portfolio in view of its requirements and market development.

CITIC Pacific has considered the use of financial instruments to hedge its commodity exposures. However many commodities cannot be hedged effectively because there is no effective forward market for the product or there is insufficient liquidity in those markets. As at 31 December 2013, CITIC Pacific did not have any exposure to commodity derivatives.

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