Financial Risks

The Group is exposed to financial risks. These are principally associated with foreign exchange rates, raising funds on the market, fluctuations in interest rates, the ability of customers to honour their obligations to the Group, and the price of financial assets held as investments. Financial risk management is an integral part of Group business management and is handled directly by headquarters in accordance with guidelines issued by the Finance Department on the basis of general risk management strategies defined by the Managerial Risk Committee.

Exchange rate risk

The varied geographical distribution of Pirelli production and commercial activities entails exposure to transaction and translation exchange rate risk:

-Transaction exchange rate risk is generated by the commercial and financial transactions executed in currencies other than the functional currency due to exchange rate fluctuations between the time when the commercial or financial relationship is established and when the transaction is completed (collection or payment). The aim of Group policy is to minimise the impact of transaction exchange rate risk related to volatility. For this reason, Group procedures envisage that the Operating Units be responsible for collecting all information related to assets and liabilities exposed to transaction exchange rate risk. Forward contracts are made to hedge this risk, with the Group Treasury whenever possible. The items subject to exchange rate risk are mainly represented by receivables and payables denominated in foreign currency. The Group Treasury is responsible for hedging the net position for each currency. In accordance with established guidelines and restrictions, it closes all risk positions by trading derivative hedging contracts on the market, which typically take the form of forward contracts.

- Currency translation risk: Pirelli owns controlling interests in companies that prepare their financial statements in currencies other than the euro, which is used to prepare the consolidated financial statements. This exposes the Group to currency translation risk, which is generated by the conversion into euro of the assets and liabilities of subsidiaries whose functional currency is not the euro. The principal exposures to currency translation risk are constantly monitored, but it is not currently deemed necessary to adopt specific policies to hedge this exposure.

Below are the ramifications (all other conditions being equal) on the consolidated equity of a hypothetical appreciation/depreciation of below-mentioned currencies against the euro (Currency translation risk):

Liquidity risk

In addition to the available portion of the euro 1.2 billion revolving credit facility due on November 30, 2015, of which euro 790 million were used at March 31, 2014, the Pirelli Group draws on the capital market by diversifying the products and maturities used to seize the best opportunities available from time to time. For example, in December 2012 a private placement was executed in several tranches on the United States market for a total of USD 150 million, and a Schuldschein (German law loan) was obtained, again in several tranches, for a total amount of euro 155 million. Moreover, the Board of Directors has approved setting up a paper platform for the issuance of bonds on the Euromarket, with its maximum amount being set at euro 2 billion. The maximum amount of bonds that may be issued under this program in 2013 was euro 1 billion, which can be used until March 31, 2015. The program aims at promptly seizing the best financing opportunities to provide continuous support for business growth in the face of volatile financial markets and possible restrictions on access to credit. The bonds may be placed exclusively with qualified investors.

Below is the Pirelli debt structure as of March 31,2014.

Interest rate risk

Fluctuations in interest rates impact the market value of Group financial assets and liabilities and net financial expenses. Group policy tends to keep the ratio of exposure to fixed rates and variable rates at around 70% fixed rate and 30% variable rate. To maintain this general ratio, the Group enters into derivative financial instrument contracts, typically interest rate swaps.

Below are the ramifications (all other conditions being equal) on the net profit (and directly on equity) of a change (increase/decrease of 0.50%) in the level of interest rates of all currencies to which the group is exposed.

Credit risk

Credit risk represents Group exposure to contingent losses resulting from default by commercial and financial counterparties. To limit commercial counterparty default risk, the Group has implemented procedures to evaluate its customers’ potential and financial solidity, monitor expected incoming cash flows and take credit recovery action if necessary. The aim of these procedures is to define customer credit limits. Further sales are suspended when those limits are exceeded. In certain cases customers are asked to provide guarantees. These mainly consist of standby letters of credit issued by parties with excellent credit or personal standing.

Less frequently, mortgage guarantees may be requested. Another tool used to manage commercial credit risk is the execution of insurance policies: beginning in January 2012, a two-year master agreement was made with a leading insurance company for worldwide coverage (the policy excludes Egypt, Venezuela and China) of the credit risk related mainly to sales in the replacement segment (with the acceptance rate in December 2013 running at about 79%).

The Group transacts only with financial counterparties having high credit ratings for the management of its temporary cash surpluses or trading of derivative instruments. Pirelli does not hold government bonds issued by any European country, and constantly monitors its net credit exposures to the banking system. Pirelli does not exhibit significant concentrations of credit risk.

Please refer to the paragraph “risks and uncertainties” of 2013 annual financial report for further details regarding financial risks and their management policies.

Last Revised: 20 Jun 2014