28. DERIVATIVE FINANCIAL INSTRUMENTS

This item includes the fair value of derivative financial instruments outstanding at December 31, 2011. They are broken down as follows:

(in thousands of euro)

12/31/2011 12/31/2010
CURRENT ASSETS CURRENT LIABILITIES CURRENT ASSETS CURRENT LIABILITIES
HEDGE ACCOUNTING NOT ADOPTED
Foreign currency derivatives
- commercial transactions
46,161 (45,036) 32,538 (37,086)
Foreign currency derivatives
- included in net financial position
16,120 (6,138) 915 (4,810)
Interest rate derivatives - (621) - -
HEDGE ACCOUNTING ADOPTED
- cash flow hedge:
Foreign currency derivatives
- commercial transactions
- - 1,706 -
Interest rate derivatives - (42,288) - (28,018)
Other derivatives - (9,829) - -
- fair value hedge
Interest rate derivatives
- included in net financial position
4,142 - - -
Other derivatives 3,923   - -
  70,346 (103,912) 35,159 (69,914)
- Total derivatives included in net financial position 20,262 (6,138) 915 (4,810)

 

Derivative financial instruments for which hedge accounting has not been adopted

The value of foreign currency derivatives corresponds to the fair value of forward currency purchases/ sales outstanding at the closing date of the period. These involve hedges of Group commercial and financial transactions for which hedge accounting was not adopted. The fair value is determined by using the forward exchange rate at the reporting date.

The value of interest rate derivatives, recognised under current liabilities for euro 621 thousand, corresponds to the fair value measurement of “plain vanilla” interest rate swaps made on a notional amount of euro 375 million maturing in February 2012, initially made to hedge against the rise in interest rates associated with the syndicated revolving variable rate credit facility of euro 675 million stipulated in February 2007 by Pirelli Tyre S.p.A. and PIRELLI International Limited and in anticipation of new variable rate financing having similar characteristics to replace the syndicated credit line on maturity, for which hedge accounting was adopted.

Following issuance of the fixed rate bond for euro 500 million in February 2011 and simultaneous reimbursement of the utilised portion of the aforementioned syndicated credit facility for euro 380 million, on February 28, 2011, hedge accounting was interrupted for all existing derivatives insofar as the conditions envisaged in IAS 39 no longer existed. At December 31, 2010 the fair value of these derivatives was a negative euro 6,340 thousand and was included in the value of cash flow hedge interest rate derivatives (totalling euro 28,018 thousand). Beginning on the date when hedge accounting was interrupted, the positive change in fair value, euro 3,474 thousand, was recognised in the income statement. The cash flow hedge reserve accumulated at the date that hedge accounting was interrupted, amounting to a negative euro 4,095 thousand, was frozen and transferred to the income statement in the period when the future transaction impacts the income statement. The total amount reclassified in the income statement for the period was a negative 3,587 thousand.

Derivative financial instruments for which hedge acounting has ben adopted

Cash flow hedge

The value of interest rate derivatives, recognised under current liabilities for euro 42,288 thousand, consists mainly of:

  • euro 613 thousand for the fair value measurement of four “plain vanilla” interest rate swaps on a notional amount of euro 100 million, which envisage the payment of an average fixed interest rate of 1.338% on a quarterly basis and collection of a variable 3-month Euribor interest rate on a quarterly basis with the same frequency of payment of the coupon on the financing. These derivatives were made to hedge against a rise in interest rates on a euro 100 million loan at a variable 3-month Euribor rate with a spread of 0.328% granted by the European Investment Bank (EIB) in favour of Pirelli Tyre S.p.A. for research and development projects. Euro 613 thousand was recognised in equity for the period;
  • euro 41,567 thousand for the fair value measurement of 12 “plain vanilla” interest rate swaps on a notional amount of euro 575 million forward start beginning February 2012 and maturing February 2015, which envisage the payment of an average fixed interest rate of 3.384% per annum and collection of a variable 1-month Euribor interest rate on a monthly basis. These derivatives had initially been made to hedge against the rise in interest rates associated with the variable rate revolving syndicated credit facility of euro 675 million subscribed in February 2007 by Pirelli Tyre S.p.A. and Pirelli International Limited or in anticipation of new variable rate financing with similar characteristics replacing the syndicated credit facility on maturity, for which hedge accounting had been adopted. At December 31, 2010, the fair value of these derivatives was a negative euro 21,768 thousand. Following issuance of the fixed rate bond for euro 500 million in February 2011 and simultaneous reimbursement of the utilised portion of the aforementioned syndicated credit facility for euro 380 million, on February 28, 2011, hedge accounting was interrupted for all existing derivatives insofar as the conditions envisaged in IAS 39 no longer existed.
    On July 1, 2011 hedge accounting was resumed for these derivatives on the basis of the new variable rate payables included in the 2011-2014 three-year plan.
    The change in fair value between the date that hedge accounting was interrupted and the date it was resumed – negative euro 2,341 thousand – was charged to the income statement. The cash flow hedge reserve accumulated at the date when hedge accounting was interrupted, amounting to a negative euro 14,291 thousand, was frozen and transferred to the income statement beginning February 2012 until February 2015, i.e. the period when the future transaction will impact the income statement. The amount recognised in equity during the period for the effective part was negative euro 24,646 thousand, while the portion recognised in the income statement for the ineffective part was a negative euro 288 thousand.

The value of other derivatives (current liabilities of euro 9,829 thousand) reflects the fair value of purchased natural rubber futures contracts. The purpose of this hedge, made beginning in May 2011, is to limit exposure to the economic effects resulting from a change in natural rubber prices, and consequently stabilise the cost of future supplies on a limited portion of the total requirements forecast in the period May 2011 – June 2012. The net amount that was recognised in equity during the period was a negative euro 13,791 thousand, of which euro 18,130 thousand for losses recognised in the period and euro 4,339 thousand for reclassification in the income statement, as an adjustment to natural rubber purchases, to losses previously recognised in equity and related to purchases made during the year.

Fair value hedge 

The value of interest rate derivatives (current assets for euro 4,142 thousand) corresponds to the fair value of 5 interest rate swaps on a notional amount of euro 125 million, made to hedge the risk of changes in the fair value of a portion of the fixed rate bond issued by Pirelli & C. S.p.A. in February 2011 for euro 500 million (see note 25 “Borrowings from banks and other financial institutions”). These derivatives envisage the collection of a fixed rate of 5.125% per annum with the same frequency of payment as the coupon on the bond, which also pays interest at a rate of 5.125%, and payment of a variable 6-month Euribor rate with an average spread of 2.38%. Fair value hedge accounting was adopted for these derivative financial instruments, according to which the positive change in fair value of the derivative instrument is recognised in the income statement and is offset by a loss on the bond attributable to the risk hedged for the same amount, recognised in the income statement under financial expenses and that adjusted the carrying amount of the bond (“basis adjustment”).

The value of other derivatives (current assets for euro 3,923 thousand) reflects the fair value of the put option held by Pirelli & C. S.p.A. on the shares of Advanced Digital Broadcast Holdings S.A., classified as availablefor- sale financial assets, to hedge against the risk of a fall in the market value of the shares held. Fair value hedge accounting was adopted for these derivative financial instruments, whereby the positive change in the fair value of the derivative instrument (euro 3,923 thousand) is recognised in the income statement and offsets the negative fair value of the available-for-sale financial assets (euro 3,917 thousand) recognised in the income statement for the portion attributable to the hedged risk. Also see note 35.3 “Losses from equity investments.”