F.29. Hedge accounting

F.29.1. Fair value hedge

F.29.1.1. Foreign currency risk hedging
Starting 1 October 2008, hedge accounting is applied by the Group to foreign currency risks (FX risk). The Group applies fair value hedge.

The functional currency of the Group and the currency of its liabilities is CZK. However, in the investment portfolios, there are also instruments denominated in foreign currencies. According to the Group’s general policy, all these instruments are dynamically hedged into CZK via FX derivatives.

Foreign currency hedging is in place for all foreign currency investments, i.e. bonds, investment fund units, equities, etc. in order to fully hedge the implied FX risk. The process is in place which guarantees the high efficiency of the hedging.

The FX difference on all financial assets and derivatives, except for equities classified in the available-for-sale portfolio, are reported in profit or loss according to IAS 39. FX revaluation on AFS equities is within the hedge accounting reported in profit or loss either as other income – gains on foreign currency or other expenses – losses on foreign currency.

Hedged items
Hedge accounting is applied to financial assets – defined as all non-derivative financial assets denominated or exposed in foreign currencies (i.e. all bonds, equities, investment fund units, term deposits and current bank accounts denominated in EUR, USD and other currencies) except for:
a) financial assets backing unit-linked products;
b) other particular exclusions predefined by the investment management strategy.

Hedged items include financial assets classified in the available-for-sale category, fair value through profit or loss, other investments and cash and cash equivalents. The hedged items do not include financial liabilities.

Hedging instruments
Hedging instruments are defined as all FX derivatives except for options and starting from 1.10.2015 also selected financial liabilities in foreign currency (such as sell-buy transactions).

Instruments according to this definition can be clearly identified at any time. As at 31 December, hedged items and hedging instruments were as follows:

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Assessment of hedging effectiveness and possible adjustment of dynamic hedging strategy is performed by the Group on a monthly basis. In every month of 2015 and 2014 Group’s hedging was according to IFRS and internal rules governing the hedge accounting evaluated as effective.

F.29.1.2. Interest rate risk hedging
Starting 1 July 2011 the hedge accounting has been applied to derivatives hedging an interest rate exposure of interest-bearing financial assets. The Group uses fair value hedging.

The Group has implemented a risk management strategy for interest rate risk. The objective of the investment and hedging strategy is to manage the overall interest rate risk position on a continuous basis. The Group achieves this objective by a dynamic strategy.

Change in the fair value of interest rated derivatives and FVTPL interest-bearing financial assets is reported in the profit or loss account according to IAS 39. Change in the fair value of AFS interest-bearing financial assets attributable to the interest rate risk is within the hedge accounting reported in the profit or loss account either as other income from financial instruments and other investments or other expenses for financial instruments and other investments.

Hedged items
The Group designates as the hedged item a group of fixed income instruments. Hedged items include financial assets classified in the available-for-sale category and fair value to profit or loss category. The hedged items do not include financial liabilities.

Hedging instruments
Hedging instruments are defined as a group of interest rate derivatives. The derivatives are designated as hedging instruments in its entirety.

Assets and derivatives according to this definition can be clearly identified at any time. As at 31 December hedged items and hedging instruments were as follows:

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Assessment of hedging effectiveness and possible adjustment of dynamic hedging strategy is performed by the Group on a monthly basis. In every month of 2015 and 2014 Group’s hedging was according to IFRS and internal rules governing the hedge accounting evaluated as effective.

F.29.2. Cash flow hedge

F.29.2.1. Foreign currency risk hedging
Starting 1 June 2010, a cash-flow hedge has been applied by the Group to foreign currency risks (FX risk). The hedge accounting is applied selectively for individual subsidiaries; as at 31 December 2015 the cash-flow hedge has been applied by 3 real estate companies – City Empiria, Solitaire and Pařížská 26 (further referred as to “the Companies” in this section).

As a result of their real estate rent operations, most of the transactions in the Companies are denominated in foreign currencies. In terms of the Group’s overall currency risk management strategy, these companies minimise their exposure to changes in the cash flows from the rental contracts by entering into loans denominated in foreign currencies.

In 2015 the hedging relation between hedged and hedging item of City Empiria was terminated. The hedging reseve will be gradually released in the following years based on the development of cash flows of the former hedged instrument.

Hedged items
The hedged items are expected payments (cash inflows) in EUR from lease contracts concluded in EUR. During the validity period of current existing rental contracts the cash inflows are constituted by payments related to these contracts. As the Companies intend to continue entering into lease contracts denominated in EUR, the expected future lease contracts that will be entered into after the existing contracts have expired are also presented as a hedged item. The future lease payments are modelled over the depreciation period of the building.

Hedging instrument
The Companies hedge the receivables by foreign currency loans received and used for construction and operation of the real estate owned by the Companies. The loan is being prolonged. In the case that the loan is not prolonged, the Companies expect to get a new loan in the same currency that will be used to repay the current loan. This assumption is based on the fact that rental contracts denominated in EUR will be a sufficient guarantee for receiving a new loan in EUR.

Prospective effectiveness test:

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The retrospective effectiveness is measured as the ratio of payments that are expected by the model to be obtained and rent income that is actually obtained. The Companies have to obtain at least the expected amount of rent payments in order for the hedging to be effective.

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F.29.2.2. Interest rate risk hedging
Starting 17 October 2011, cash-flow hedge had been applied by the Group to the interest rate risk (IR risk). The hedge accounting had been applied only by Group subsidiary City Empiria (further referred as to “the Company” in this section).

The Company hedges itself against the interest rate risk by entering into interest rate swap, to pay interest at a fixed interest rate and to receive interest at a variable interest rate. The Company hedges interest payments from the loan (commencing interest period starting 17 October 2011 until 30 September 2015) with interest rate of 3M EURIBOR. The Company does not hedge the margin over this interest rate, because it is not the subject to interest rate risk.

Hedging instrument
The Company entered into the interest rate swap, which the Company designates as hedging instrument as at 17 October 2011.

Hedged items
The hedged items are interest payments resulting from the loan drawn.

The measurement of the retrospective hedge effectiveness is based on comparison of the cumulative changes in the fair value of the hedging instrument and cumulative changes in the fair value of the hypothetical derivative instrument that represents the hedged item.

The hedging relation between hedged and hedging items was terminated in 2015 and the hedging reseve was fully released during 2015.

Results of hedging effectiveness in 2014 were following:

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