1. Capital Management

The Group’s objectives in managing capital are to safeguard its ability to operate as a going concern by maintaining sufficient liquidity so that it can continue to provide returns for shareholders, and to maintain a capital structure commensurate to targeting a strong investment grade corporate credit rating (Standard & Poor’s), to minimise the cost of capital and to provide credit transparency to trading and lending counterparties. The Group’s overall capital management strategy remains unchanged from 2018.

The capital structure of the Group consists of net debt (borrowings as detailed in Note 15 offset by cash and cash equivalents) and equity (comprising issued capital, reserves, and retained earnings). The Group’s capital structure is reviewed annually by the Board Audit and Compliance Committee which considers the Group’s expected operating cash flows, capital expenditure plans, maturity profile of debt facilities, dividend policy and the ability to access funding from banks and other sources.

The Group monitors its capital management objectives by continuously assessing several benchmarks related to debt, cash flows and financial performance.

2. Financial Risk Management

_{*The prior period financial information has been restated, as described in Note 2 of the Financial Statements.}

The Group’s Treasury and Portfolio management functions provide services to the business to monitor and manage risks relating to NEM outcomes, commodity prices, foreign exchange and interest rates movement, liquidity and credit exposure as they arise in the normal course of operations of the Group.

Risk exposures are assessed and monitored using a variety of methods including stress modelling and ongoing surveillance, with regular risk reporting to both Management and Board risk committees. The Group uses derivative instruments, physical hedges such as generation capacity, and strict liquidity management to mitigate the exposures while aiming to optimise risk-adjusted financial returns within policies approved by the Board of Directors.

Policy compliance is monitored by a segregated compliance management process and reviewed by the Board on a regular basis.

The Group holds and issues financial instruments as an integral part of conducting its revenue generating and financing activities including:

• Funding: to finance the Group’s operating activities. The principal types of instruments include revolving bank loans and bank guarantees;
• Operating: the Group’s day to day business activities generate financial instruments such as cash, trade and other receivables and payables; and
• Risk management: to reduce the risks to financial performance that would arise if all generation was subject to spot market outcomes. The Group transacts electricity swaps and options to notionally contract a portion of its generation capacity. Interest rate and foreign exchange contracts are transacted to manage cash flow risks associated with financing with floating rate debt instruments, purchasing in foreign currencies, and energy procurement activities.

Key financial risks from utilising the aforementioned financial instruments are explained further in the following sections:

(i) market risk (including electricity and commodity price risk, foreign exchange and interest rate risk)

(ii) liquidity risk

(iii) credit risk

The Group’s overall financial risk management strategy remains unchanged from 2018.

(i) Market risk

Electricity and commodity price risk

Fluctuations in electricity and commodity prices will impact the Group’s results and cash flows. To manage price risks associated with electricity generation, and sales of electricity and gas to retail customers the Group has established a risk framework that consists of policies on the overall limits of exposure across spot and energy derivatives markets, delegations and transaction limits for trading activity.

The Group utilises a range of energy derivative instruments to manage electricity price risk, both in futures and over-the-counter markets. These derivative instruments are classified into swaps (vanilla swaps, load-following swaps and capped swaps) and options (caps, standard options and average rate options). Some over-the-counter caps and related derivative products include features providing the counterparty with the ability to nominate different strike prices and notional megawatt (MW) volumes (within limits) for different contract periods. Snowy Hydro manages the risk associated with variably nominated contracts by utilising standby, fast-start generation capacity.

The table below sets out the fair value of energy and commodity derivatives at reporting date.

Of the total energy and commodity derivatives, $133.2 million (2018: $78.7 million) of the asset and $61.4 million (2018: $41.5 million) of the liability is expected to mature within 12 months, and $19.1 million (2018: $29.3 million) of the asset and $109.0 million (2018: $98.1 million) of the liability is expected to mature beyond 12 months.

Energy derivatives - economic hedge

The Group uses energy derivative instruments to economically hedge electricity price risks within the risk management framework. The economic hedges do not meet the requirements of hedge accounting set out in AASB 9 Financial Instruments. Therefore these instruments are categorised as held for trading and changes in fair valuation are recognised immediately as Change in fair value of financial instruments in the Consolidated statement of profit or loss.

Energy and Commodity Price Sensitivity Analysis

The table below sets out the impact of changes of prices on profit and loss and equity based solely on the Group’s exposures at the reporting date (holding all other variables constant and without any mitigating actions that management might take should the price changes occur). A 20% price change has been applied to flat, peak and off-peak electricity swaps, a 40% price change has been applied to electricity options. These changes are based on the volatility of historical prices of the relevant instruments.

^{_{*2018 sensitivity analysis was based on 25% price change on peak electricity swaps . Snowy assess the reasonableness of the sensitivity scenario at reporting time to reflect the most up-to-date market environment. and determined 20% is more appropriate for 2019.}}

Foreign exchange risk

The Group operates wholly within Australia and contracts with suppliers in Australian dollars or other currencies.

Contracts in New Zealand dollars are not hedged as historically the New Zealand dollar has maintained a proportional relationship with the Australian dollar, and purchase and contract exposures are immaterial.

Where a purchase or contract is payable in another currency, the Group is exposed to the fluctuation of exchange rates. The Group’s Treasury policy is to hedge any aggregate (per contract) foreign exchange exposure which exceeds AUD $250,000 equivalent value.

In April 2019 the Company signed a contract as part of Snowy 2.0 project which has a component denominated in EURO. Accordingly the Company has entered into a series of forward foreign exchange agreements, with €434.0 million outstanding at 30 June 2019. The purpose of these contracts is to fix the Australian dollar cost of the equipment purchase over the life of the contract up to January 2026.

Foreign exchange contracts - cash flow hedge

The Group has entered into foreign exchange contracts to hedge the exchange rate risk arising from purchases or contracts that are denominated in foreign currencies, which are designated as cash flow hedges at inception and tested for effectiveness at each reporting date. The economic relationship between the hedged item and hedging instruments is established based on the currency, amount and timing of the respective cash flows. It is the Group’s policy to match the key terms of the foreign exchange contract with the underlying transaction and apply a hedge ratio of 1:1 on the base contract. The entire forward rate of the foreign exchange contracts is designated to hedge the base contract currency risk. As at year end, the underlying purchases are assessed to remain highly probable and the amount accumulated in equity will be reclassified to profit and loss or assets when the underlying transaction affects profit and loss or result in acquisition of non-financial assets.

In these hedge relationships, the main sources of ineffectiveness are:

• the effect of the counterparties’ and the Group’s own credit risk on the fair value of the foreign exchange contracts, which is not reflected in the change in the fair value of the hedged cash flows attributable to the change in exchange rates; and
• changes in the timing and notional amount of the hedge transactions.

The following tables provide an overview of the foreign exchange hedge in place for the reporting period, detailing hedge exposure at different maturity.

The amounts at the reporting date relating to items designated as hedged items for foreign currency risk were as follows:

The amounts relating to items designated as foreign exchange hedging instruments and hedge ineffectiveness were as follows:

^{*The Group did not have any forecast transactions for which cash flow hedge accounting was used in the previous period, but which is no longer expected to occur.}

Foreign exchange rate sensitivity analysis

The table below sets out the impact on profit and loss and equity, if the foreign exchange forward rate had been 6.45 percentage higher or lower, based on the foreign exchange forward curve applicable to the Group’s financial instruments denominated in a foreign currency at the reporting date. All other variables have been held constant.

The impact of any mitigating actions that management might take if the exchange rate change had occurred has not been taken into account.

Interest rate risk

The Group is exposed to interest rate risk from floating rate borrowings (excluding finance lease liabilities). The Group manages interest rate risk by fixing the interest rate for a portion of the borrowings with interest rate swaps. The Group adopts a policy of ensuring that between 50% and 90% of its forecast interest rate risk exposure is hedged at a fixed rate.

Interest rate swaps - cash flow hedge

The Group has entered into interest rate swaps to hedge the fluctuation of projected interest payments arising from floating rate borrowings, which are designated as cash flow hedges at inception and tested for effectiveness at each reporting date. The economic relationship between the hedged item and hedging instruments is established based on the reference interest rates, notional amount, repricing dates and maturity of the respective cash flows. It is the Group’s policy to match the key terms of the interest rate swaps and projected interest payments and apply a hedge ratio of 1:1. As at year end, the projected interest payments are assessed to remain highly probable and the amount accumulated in equity will be reclassified to profit and loss when the underlying transaction affects profit and loss.

In these hedge relationships, the main sources of ineffectiveness are:

• the effect of the counterparty’s and the Group’s own credit risk on the fair value of the swaps, which is not reflected in the change in the fair value of the hedged cash flows attributable to the change in interest rates; and
• differences in repricing dates between the interest rate swaps and the floating rate borrowings.
• changes in the timing and notional amount of the projected interest payments.

The Group had the following financial assets and liabilities exposed to floating interest rate risk as at 30 June 2019:

The following table summarises the interest rate hedges in place for the reporting period, detailing the notional principal hedge amounts outstanding, the average fixed rate, and the current fair value:

The amounts at the reporting date relating to items designated as hedged items for interest rate risk were as follows:

The amounts relating to items designated as hedging instruments and hedge ineffectiveness were as follows:

^{*The Group did not have any forecast transaction for which cash flow hedge accounting had been used in the previous period, but which is no longer expected to occur.}

Interest rate sensitivity analysis

The table below sets out the impact on profit and loss and equity, if interest rates had been 75 basis points higher or lower, based on the interest rate yield curve applicable to the Group’s interest bearing assets and liabilities at the reporting date. All other variables have been held constant.

The impact of any mitigating actions that management might take if the interest rate change had occurred has not been taken into account.

^{*2018 sensitivity analysis was based on 150 bps movement of the interest rate curve. Snowy assess the reasonableness of the sensitivity scenario at reporting time to reflect the most up-to-date market environment. and determined 75 bps is more appropriate for 2019.}

Cash flow hedge reconciliation

The following table provides a reconciliation by risk category of components of equity and analysis of OCI items, net of tax, resulting from cash flow hedge accounting.

(ii) Liquidity risk

Liquidity risk is the risk that the Group will not be able to meet its obligations as they become due.

Short term liquidity risk predominantly arises through three sources: the potential for large margin calls on electricity futures contracts in the event of adverse movements in forward electricity prices; prudential calls from the electricity market operator (AEMO); and lastly the risk of settling large payouts on a contract or contracts where the Group’s generation fails to cover those contract positions.

The Group manages its liquidity risk by continuously monitoring forecast and actual cash flows and prudential exposures, matching the maturity profiles of financial assets and liabilities and maintaining committed stand-by facilities. The Group holds an Australian Financial Services Licence under which it must continuously monitor its forward liquidity ratios and the amount of surplus liquid funds. Any unremedied breach of these conditions would trigger a cessation of trading.

At the reporting date, the Group had committed, undrawn facilities of $663.0 million (30 June 2018: $389.0 million), as detailed in Note 15 Interest bearing liabilities and credit facilities.

The Group manages its market related liquidity risk by maintaining adequate reserves of generation capacity and high levels of plant reliability and availability which allows for the generation of spot income to match contracted outgoing commitments to various NEM counterparties.

The nature of the Group’s exposure to liquidity risk and its objectives and processes to manage this risk remain unchanged from the prior financial year.

The table below details the contractual maturity of the financial liabilities of the Group at the end of the reporting period. The amounts are based on the undiscounted cash flows of financial liabilities on the earliest date on which the Group could be required to pay. The table includes both interest and principal cash flows.

To the extent that interest flows are at floating rate, the undiscounted amount is derived from interest rate curves at the end of the reporting period. For derivative instruments that are required to be net settled, the amounts are based on the undiscounted net cash inflows and outflows; for derivative instruments that are required to be gross settled, the amounts are based on undiscounted gross cash inflows and outflows.

_{*The prior period financial information has been restated, as described in Note 2 of the Financial Statements.}

(iii) Credit risk

Credit risk is the risk that a counterparty will not fulfil its financial obligations under a contract or other arrangement that may cause a financial loss to the Group.

The Group’s exposure to credit risk is influenced mainly by the individual characteristics of each customer. Credit risk is managed under a Board approved policy which includes the use of credit limits allocated based on the overall financial and competitive strength of the counterparty.

Derivative contract counterparties are generally limited to high-credit-quality financial institutions and organisations operating in the NEM and financial markets. Credit assessment of the counterparty is carried out when the Group deals with it for the first time and reviewed when necessary, at least annually.

The concentration of credit risk arising from energy derivative trading is significant within a few counterparties at the end of the reporting period. The Group manages the concentration risk by continuously monitoring the credit exposure against the individual assigned credit limit and the Group’s aggregate limit. The Group also utilises International Swap and Derivative Association (ISDA) agreements to limit its exposure to credit risk through the netting of amounts receivable from and payable to its counterparties.

The carrying amounts of financial assets and contract assets represent the maximum credit exposure. The nature of the Group’s exposures to credit risk and its objectives and processes to manage this risk remain unchanged from the prior financial year.

Trade and other receivables consist of over 1.0 million residential, small and large commercial and industrial customers, in New South Wales, Victoria, South Australia and Queensland. Refer to Note 7 Trade Receivables for further information.

3. Fair Value of Financial Assets and Financial Liabilities

The following table presents the financial instruments that are measured and recognised at fair value on a recurring basis. Snowy Hydro classifies its financial instruments into the three levels prescribed under the accounting standards. The three levels in the hierarchy reflect the level of independent observable market data used in determining the fair values and are defined as follows:

There were no material transfers between levels during the period.

Management have assessed the carrying value of financial assets (excluding derivative financial assets) and financial liabilities (excluding derivative financial liabilities) is a reasonable approximation of fair value.

The following is a summary of the methods that are used to estimate the fair value of Snowy Hydro’s financial instruments:

4. Level 3 fair value measurement instruments

The following table presents the changes in level 3 instruments for the period ended 30 June 2019:

Gains and losses in profit or loss due to changes in fair value are included within ‘Changes in fair value of financial instruments’. All other gains and losses in profit or loss are shown in revenue.

Sensitivity analysis of level 3 instruments

The use of different methodologies or assumptions could lead to different measurements of fair value. For fair value measurements in Level 3, the sensitivity of the valuation to a 40% movement in the price curve for cap instruments, 20% movement in the price curve for peak swap capped instruments and 20% movement in the price curve for flat and off-peak swap capped and load following swap instruments would have the following effects:

^{*2018 sensitivity analysis was based on 25% price change on peak electricity swaps . Snowy assess the reasonableness of the sensitivity scenario at reporting time to reflect the most up-to-date market environment. and determined 20% is more appropriate for 2019}

The sensitivity measure is based on the historical analysis of movement in the annual cap prices over the historical period for short term broker market (less than 100MW and short duration up to 2 years) and applied to non-standard, long term large volume contracts.