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G. Our financial risk management

As a result of its operation, the Group is exposed to a number of financial risks. This section sets out the nature of the financial risks, their quantification and management.

Financial risk management objectives
The Group’s risk management policy is to identify, assess and manage risks which are likely to adversely affect the Group’s financial performance, continued growth and ability to continue as a going concern. In terms of financial risk management, the Group takes a risk-averse approach as it seeks to minimise risk, provided it is cost effective to do so.

The Group’s principal financial instruments are outlined in the following table. The main risks arising from the Group’s financial instruments are market risks (interest rate risk, foreign currency risk), liquidity risk and credit risk.

Financial assets and liabilities
All the financial assets and liabilities below are carried at amortised cost except for derivative financial assets which are measured at fair value.

NBN Co Group

30 June 2019

30 June 2018

$m

$m

Financial assets

Cash and cash equivalents

520

593

Interest receivable

1

1

Trade and other receivables

357

225

Derivative financial asset

8

3

Carrying amount of financial assets

886

822

Financial liabilities

Trade and other payables

2,756

2,364

Other financial liabilities

8,553

7,198

Borrowings

13,053

5,531

Carrying amount of financial liabilities

24,362

15,093

Net income and expenses from financial assets and liabilities
The net income and expenses earned from financial assets and liabilities for the year ended 30 June 2019 was a net expense of $991 million (2018: net expense of $578 million).

Foreign currency risk management
Foreign currency risk refers to the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in foreign exchange rates. The Group is exposed to foreign currency risk due to fluctuations in foreign exchange rates for certain transactions. The Group operates US dollar (USD) and Euro (EUR) foreign currency denominated bank accounts.

As at 30 June 2019, the carrying amount of monetary liabilities denominated in foreign currencies and notional cash outflows as expressed in Australian dollars was as follows:

NBN Co Group

30 June 2019

30 June 2018

USD

EUR

USD

EUR

$m

$m

$m

$m

Foreign exchange risk

Trade payables

31

1

48

4

Current foreign exchange risk

31

1

48

4

Forward exchange contracts

Buy foreign currency (cash flow hedges)

101

-

85

-

Forward exchange contract risk

101

-

85

-

The Group has entered into forward exchange contracts to hedge its exposure to currency risk in relation to highly probable forecast transactions which are denominated in foreign currency. In order to protect against exchange rate movements, the Group has entered into forward exchange contracts to purchase US dollars. All forward exchange contracts are designated as hedging items in the cash flow hedges. The Group’s strategy is to hedge any material foreign currency exposure committed by contract to at least 80 per cent of the highly probably forecast purchase.

The Group has not entered into foreign currency positions that are not supported by underlying purchasing transactions that are certain or highly probable as to timing, quantum and currency.

Derivatives and hedging activities
Recognition and measurement

Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured to their fair value at the end of each reporting period. The accounting for subsequent changes in fair value depends on whether the derivative is designated as a hedging instrument and if so, the nature of the item being hedged. The Group only has derivatives which are designated as cash flow hedges, being hedges of a particular risk associated with cash flows of recognised assets and liabilities and highly probable forecast transactions.

The Group documents at the inception of the hedging transaction the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at hedge inception and on an ongoing basis, as to whether the derivatives used in hedging transactions have been, and will continue to be effective, in offsetting changes in cash flows of hedged items.

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income and accumulated in reserves in equity. The ineffective portion is recognised immediately in profit or loss within other income or other expenses.

Amounts accumulated in equity are reclassified to profit or loss in the periods when the hedged item affects profit or loss. When the hedged forecast transaction results in the recognition of a non-financial asset, the gains and losses previously deferred in equity are reclassified from equity and included in the initial measurement of the cost of the asset.

When a hedging instrument expires or is sold or terminated, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in profit or loss. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately reclassified to profit or loss, where applicable.

Sensitivity analysis of monetary liabilities denominated in foreign currencies and derivatives
The possible fluctuations in foreign exchange rates would not have a material impact on the measurement of monetary liabilities denominated in foreign currencies and profit or loss for the current and prior periods. In addition, possible fluctuations in exchange rates would not have a material impact on the measurement of derivatives and equity for the year.

Interest rate risk management
The Group is exposed to interest rate risk due to changes in market interest rates associated with interest-bearing cash and cash equivalents. Interest on financial instruments classified as floating rate is repriced at intervals of less than one year. Interest on financial instruments classified as fixed rate is fixed until maturity of the instrument. The Group’s exposure to interest rate risks and the weighted average effective interest rates of interest-bearing financial assets is set out below:

NBN Co Group

Carrying amount

Weighted average effective interest rate

Note

$m

%

At 30 June 2019

Cash and cash equivalents

C1

520

1.82%

At 30 June 2018

Cash and cash equivalents

C1

593

1.94%

Cash flow sensitivity analysis
Given the nature and quantum of interest-bearing instruments, any possible movements in interest rates would have an immaterial impact on profit or loss. The interest rate applicable to the loan facility with the Commonwealth of Australia is fixed for the term of the facility.

As a result there is no interest rate risk associated with the facility.

Credit risk exposure
Credit risk refers to the risk that a counterparty will default on its contractual obligations, resulting in financial loss to the Group. Counterparty exposure is measured as the total value of the exposures to all obligations of any single legal or economic entity (e.g. a group of companies).

Credit risk is managed on a group basis. Credit risk arises from cash and cash equivalents and the net favourable position of derivative financial instruments, as well as credit exposures to Retail Service Providers.

The Group’s maximum exposure to credit risk at the end of the reporting period is the carrying amount of the financial assets as recorded in the Statement of financial position.

The credit quality of financial assets can be assessed by reference to external credit ratings (if available) or to historical information about counterparty default rates.

NBN Co Group

30 June 2019

30 June 2018

$m

$m

Trade receivables

Counterparties with an external credit rating

AAA

1

1

A1

-

29

A2

188

97

A3

-

1

Counterparties without an external credit rating1

Group 1

5

5

Group 2

88

66

Group 3

22

13

Total

304

212

Cash at bank and short-term bank deposits

AA-

520

593

Total

520

593

Derivative financial (liabilities)/assets

AA-

8

3

Total

8

3

`1 Group 1 - new customers (less than 6 months).

Group 2 - existing customers (more than 6 months) with no defaults in the past.

Group 3 - existing customers (more than 6 months) with defaults in the past, subsequently remediated.

The Group did not have any material receivables that were past due or impaired at 30 June 2019 (2018: nil).

Liquidity risk
Liquidity risk refers to the risk of encountering difficulties in meeting obligations associated with financial liabilities. Liquidity risk management is associated with ensuring sufficient funds are available to meet financial commitments in a timely manner and planning for unforeseen events which may curtail cash flows and cause pressure on liquidity. The Group measures and manages liquidity risk by forecasting liquidity and funding requirements for the next four years as a minimum, which is reviewed annually by the Board as part of the Corporate Plan. In addition, the Group prepares and reviews a rolling monthly cash forecast.

The Group’s financial liabilities are trade and other payables, finance lease liabilities, and borrowings.

The following table illustrates the maturities for financial assets and liabilities:

NBN Co Group

Within 1 year

1 to 5 years

Greater than 5 years

Total contractual cash flows

Carrying amount (assets)/ liabilities

$m

$m

$m

$m

$m

At 30 June 2019

Non-derivatives

Trade and other payables

2,751

5

-

2,756

2,756

Borrowings

517

15,121

-

15,638

13,053

Finance lease liabilities

985

3,297

18,708

22,990

8,553

Total

4,253

18,423

18,708

41,384

24,362

Derivatives

Gross settled (forward foreign exchange contracts - cash flow hedges)

- inflow

86

23

-

109

-

- outflow

(80)

(21)

-

(101)

(8)

Total

6

2

-

8

(8)

At 30 June 2018

Non-derivatives

Trade and other payables

2,361

3

-

2,364

2,364

Finance lease liabilities

787

2,719

16,062

19,568

7,198

Borrowings

219

5,969

-

6,188

5,531

Total

3,367

8,691

16,062

28,120

15,093

Derivatives

Gross settled (forward foreign exchange contracts - cash flow hedges)

- inflow

43

45

-

88

- outflow

(41)

(44)

-

(85)

(3)

Total

2

1

-

3

(3)

Fair value measurement of financial instruments
The Group uses the following fair value hierarchy for determining and disclosing the fair value of financial instruments.

Level 1: quoted (unadjusted) prices in active markets for identical assets or liabilities.

Level 2: inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices).

Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs).

Fair value of derivative assets and liabilities
The Group’s derivative financial assets and liabilities are the only assets and liabilities carried at fair value in the Statement of financial position. The fair value of these instruments is determined using valuation techniques with observable market data, categorised as Level 2.

The fair value of derivatives used for hedging is determined using forward exchange rates at the reporting dates.

There has been no transfer between hierarchy levels during the year.

Fair value of other financial instruments
In line with accounting standards, the Group has a number of financial instruments which are not measured at fair value in the Statement of financial position. Their carrying amounts are materially consistent with their fair value as at the reporting date, with the exception of finance lease liabilities. A remeasurement of finance leases under fair value would likely include known contingent rental payments that are dependent upon an index or rate, which are excluded from minimum lease payments under AASB 117. Including the CPI component into the measurement of the lease liability would result in an uplift in the value of the lease liability held at 30 June 2019 of approximately $500 million.

Under the new lease accounting standard (AASB 16) these contingent rental payments will be included in the measurement of the lease liability as reported in the Statement of financial position. See pages 156 to 157 for further details of the adoption impact of AASB 16 on the Group.