Management Policies

4. Financial risk management policies

Financial risk management is an integral part of the management of the Group’s operations. Risk management is carried out centrally using policies defined by the General Finance and Strategic Planning Department. Such policies define the categories of risk and specify the procedures and operating limits for each type of transaction and/or instrument. In accordance with these policies, the Group uses derivative contracts in relation to underlying financial assets or liabilities or future transactions. Financial risk management is centralized at the Sector Treasury Units which have the task of evaluating the risks and putting into place the relative hedges under the coordination of Group Treasury. The Sector Treasury Units act directly in the market on behalf of the Operating Units and, where it cannot operate directly because of external restrictions, coordinates with the Local Treasury Unit.

Types of financial risks

Foreign exchange risk

The Group operates internationally and is exposed to foreign exchange risk. This risk is managed by the Sector Treasury Units and coordinated by Group Treasury. The Operating Units are responsible for gathering all the information inherent to the positions subject to foreign exchange risk which are managed by forward contracts negotiated with the Sector Treasury Units. The positions subject to exchange risk are mainly represented by sales and purchases invoices.

The Sector Treasury Units are responsible for evaluating and managing the net position for every currency, consistent with policies and restrictions, by negotiating derivative contracts on the market, generally forward contracts.

As a result, a change in exchange rates will not generate any significant effects on the income statement.

Forward contracts between the Operating Units and the Sector Treasury Units as well as those among the Sector Treasury Units and the market are not designated as hedging instruments as defined by IAS 39 although they are in place for the purpose of managing risks.

Currency translation risk

The Group holds controlling investments in companies which prepare their financial statements in currencies other than the euro, which is the reference currency of the Group. This exposes the Group to risk from currency translations since fluctuations in the exchange rates of certain foreign currencies against the consolidation currency (euro) can cause changes in the amount of consolidated equity.

The principal exposures to currency translation risk are monitored but it is not the Group’s policy to hedge this exposure.

About 73 percent (about 80 percent at December 31, 2006) of total consolidated equity at December 31, 2007 is expressed in euro. The most important currencies for the Group other than the euro are the Brazilian Real at 11 percent (7 percent at December 31, 2006) and the Turkish Lira at 6 percent (5 percent at December 31, 2006).

The effect on total consolidated equity resulting from a hypothetical increase or decrease in the value of the above currencies against the euro – all other conditions being equal, is as follows:

(in thousands of Euros)

10% increase in value

10% decrease in value

12/31/2007

12/31/2006

12/31/2007

12/31/2006

Brazilian real

45,744

37,656

(37,427)

(30,809)

Turkish lira

27,333

25,667

(22,364)

(21,000)

Total effect on consolidated equity

73,077

63,323

(59,791)

(51,809)

Interest rate risk

The Group’s policy is to tend to maintain a correct balance between fixed-rate debt and floating-rate debt with the aim being to have fixed-rate debt at about 70 percent of total financial debt.

The Group manages the risk of an increase in floating-rate debt interest rates by compensation with floating-rate receivables and by the use of derivative contracts. The designation of such derivatives as hedging instruments under IAS 39 is decided case by case and authorized by the General Finance and Strategic Planning Department and the General Operations department.

The effects on the results for the year and directly on total equity resulting from an increase or decrease of 0.50 percent in the level of interest rates of all the currencies to which the Group is exposed – all other conditions being equal, are the following:

(in thousands of Euros)

0.50% increase

0.50% decrease

12/31/2007

12/31/2006

12/31/2007

12/31/2006

Effect on the result for the year:

- companies consolidated line-by-line

39

(3,441)

1,276

3,843

- companies accounting for using the equity method

7,052

5,177

670

1,260

Total effect on the result for the year

7,091

1,736

1,946

5,103

Direct effect on equity:

- companies consolidated line-by-line

836

1,086

(838)

(648)

- companies accounting for using the equity method

8,924

20,847

(9,169)

(21,810)

Total direct effect on equity

9,760

21,933

(10,007)

(22,458)

The direct impact on equity is connected with the change in fair value of cash flow hedge derivatives.

Price risk associated with financial assets

The Group is exposed to price risk to the extent of the volatility of financial assets such as listed and unlisted equity shares and bonds, listed real estate investment funds and unlisted closed-end real estate investment funds for an amount equal to about 12 percent of total consolidated assets at December 31, 2007; the change in fair value of these financial assets is recognized in equity or in the income statement in accordance with IAS 39.

Listed equity shares and listed real estate investment funds, which change in fair value is recognized in equity, represent 77 percent of total financial assets subject to price risk. A change of 1 percent in these listed securities, all other conditions being equal, would cause a change of Euros 8,233 thousand (Euros 8,985 thousand at December 31, 2006) in the equity of the Group.

Financial assets, which change in fair value is recognized through profit and loss, refer to unlisted closed-end real estate investment funds and fair value is arrived by reference to a basket of similarly listed securities. A change in the reference index relating to listed closed-end real estate funds of 1 percent, all other conditions being equal, would cause an impact on the result for the year of Euros 319 thousand (at December 31, 2006 there were no financial assets at fair value through profit or loss).

Credit risk

Credit risk represents the Group’s exposure to potential losses due to the non-fulfillment of obligations undertaken by commercial and financial counterparts.

In order to limit this risk with commercial counterparts, the Group has put into place procedures to assess the potential and financial creditworthiness of the customer in order to monitor flows of estimated proceeds and for recovery actions.

The aim of these procedures is to define the customer credit limits which, if exceeded, will activate the rule causing supplies to be blocked.

In some cases the client is asked to furnish guarantees; these will mainly be bank guarantees provided by high-credit standing banks or personal guarantees. Mortgages are requested less frequently.

Another tool used to manage commercial credit risk are insurance policies taken out to forestall the risk of non-payment through a meticulous selection of the customer portfolio made together with the insurance company, which undertakes to guarantee compensation in the case of insolvency.

As for financial counterparts, for the management of temporary excess resources or for the negotiation of derivatives, the Group only uses high-credit worthy counterparts.

Receivables for shareholder loans are evaluated together with the stakes invested in the associate or joint venture.

The carrying amount of junior notes and non-performing loans is adjusted each time there is a change in the estimate of discounted cash flows expected and, in the case of impairment, is directly reduced without recognition in any provision account, except for limited positions where specific provision accounts have been set up. In some cases the customers are asked to furnish guarantees; these are mainly bank guarantees provided by high-credit standing banks, personal guarantees or mortgages.

Impairment losses on receivables are calculated on the basis of the risk of non-fulfillment by the counterpart determined by considering the information available on solvency of the counterpart and historical experience. The carrying amount of receivables is indirectly reduced through recognition in a provision account.

Single significant positions, for which there is an objective condition of partial or total uncollectibility are written down individually. The amount of the impairment loss takes into account the estimate of future recoverable flows and the relative date of collection, recovery costs and expenses and any fair value of the guarantees.

The positions which are not written down individually are included in groups with similar characteristics from the standpoint of credit risk and written down on a collective basis according to a percentage that increases as the overdue period increases. The collective impairment procedure also applies to receivables not yet due.

The impairment percentages are determined on the basis of historical experience and statistical data.

The Group does not have significant concentrations of credit risk.

Liquidity risk

Liquidity risk represents the risk that available financial resources will not be sufficient to meet financial and commercial obligations within the prescribed time and due dates. The main instruments used by the Group to manage liquidity risk are three-year and annual financial plans and treasury plans that enable the Group to fully and correctly recognize and measure incoming and outgoing monetary flows. Variances between the plans and the actual figures are constantly analyzed.

Prudent liquidity risk management implies maintaining sufficient cash and/or short-term securities that can be readily converted into cash, the availability of funding through an adequate amount of committed credit facilities and/or the ability to close out market positions. Due to the dynamic nature of the businesses in which it operates, the Group aims to maintain flexibility in funding by keeping committed credit lines available.

In order to optimize the management of financial resources and thus the liquidity risk, the Group has implemented a centralized system for managing collection and payment flows while respecting the different local currency and tax laws. The negotiation and management of bank transactions is conducted centrally so that short-term and medium-term financial requirements are assured of coverage at the lowest cost possible. Even the funding of medium/long-term resources on the capital market is optimized by using centralized management.

At December 31, 2007, in addition to liquidity of Euros 2,057,682 thousand, the Group also has unused committed credit lines of Euros 2,672,000 thousand (Euros 1,791,000 thousand at December 31, 2006).

The maturities of financial liabilities at December 31, 2007 can be summarized as follows:

(in thousands of Euros)

within 1 year

between 1
and 2 years

between 2
and 5 years

beyond 5 years

Total

Trade payables

1,323,588

-

-

-

1,323,588

Other payables

1,394,673

2,058

17,504

3,738

1,417,973

Financial instruments

72,513

262

6,520

-

79,295

Borrowings from banks and other financial institutions

871,759

289,526

348,390

150,282

1,659,957

3,662,533

291,846

372,414

154,020

4,480,813

The maturities of financial liabilities at December 31, 2006 can be summarized as follows:

(in thousands of Euros)

within 1 year

between 1
and 2 years

between 2
and 5 years

beyond 5 years

Total

Trade payables

1,102,456

-

-

-

1,102,456

Other payables

536,902

118,549

12,992

1,339

669,782

Financial instruments

45,362

761

3,990

-

50,113

Borrowings from banks and other financial institutions

1,562,262

543,902

601,149

232,375

2,939,688

3,246,982

663,212

618,131

233,714

4,762,039

Additional information: financial asset and liability categories

The carrying amounts for every class of financial assets and liabilities identified in IAS 39 are reported as follows:

(in thousands of Euros)

Note

Carrying amount
at December 31, 2007

Carrying amount
at December 31, 2006

FINANCIAL ASSETS

Financial assets at fair value through profit or loss

- designated at the time of initial recognition

Other financial assets - non-current

11

31,910

-

- held for trading

Securities held for trading

17

114,039

119,174

Financial instruments - non-current

27

3,849

-

Financial instruments - current

27

56,116

27,486

Loans and receivables

Other receivables - non-current

14

672,894

705,828

Trade receivables - current

13

1,098,927

999,669

Other current receivables

14

241,475

356,205

Cash and cash equivalents

18

2,057,682

269,574

Available-for-sale financial assets

Other financial assets - non-current

11

926,362

1,006,898

Hedging financial instruments

Financial instruments - current

27

2,210

1,661

Total financial assets

5,205,464

3,486,495

FINANCIAL LIABILITIES

Financial liabilities at fair value through profit or loss

- held for trading

Financial instruments - non-current

27

6,782

4,751

Financial instruments - current

27

72,513

45,362

Financial liabilities measured at amortized cost

Borrowings from bank and other financial institutions - non-current

24

788,198

1,377,426

Other payables - non-current

26

23,300

132,880

Borrowings from bank and other financial institutions - current

24

871,759

1,562,262

Trade payables - current

25

1,323,588

1,102,456

Other payables - current

26

1,394,673

536,902

Total financial liabilities

4,480,813

4,762,039

5. Capital management policies

The objective of the Group is to maximize the return on net invested capital, maintaining the ability to operate over time and guaranteeing adequate returns for the shareholders and benefits for the other stakeholders with a sustainable financial structure.

In order to achieve these objectives, in addition to pursuing satisfactory economic results and generating cash flows, the Group can take action on the dividend policy and the configuration of the Company’s capital.

The main indicators used by the Group to manage capital are the following:

  1. Ratio between operating profit, including earnings (losses) from investments and average net invested capital: the indicator represents the capacity of the company’s results to remunerate net invested capital, this being understood as the sum of fixed assets and net working capital. The earnings (losses) of investments is included in the calculation as it is the main figure representing the performance of the Real Estate Sector. The objective of the Group is that this ratio should be higher than the average cost of capital (WACC).
  2. Gearing: this is calculated as the ratio between financial position and equity capital. It is an indicator of the sustainability of the debt to equity capital ratio, which takes into account the market situation and the trend of the cost of capital and debt at different times.
    Gearing at December 31, 2007 is affected by the impact of the sale of Olimpia S.p.A.. In fact, following the sale, a resolution was passed to voluntarily reduce share capital aimed at reimbursing the shareholders for a part of the financial resources obtained in addition to optimizing the balance sheet structure of the Company, particularly by changing the ratio between fixed assets and available reserves.
  3. R.O.E (Return on equity): this is calculated as the ratio between income for the year and average equity. It is an indicator representing the capacity of the Group to remunerate its shareholders. The objective is that the indicator should assume a value that is significantly higher than the rate of return on a risk-free investment, in relation to the nature of the Company’s businesses.

The amounts for the years 2007, 2006 and 2005 are as follows:

2007

2006

2005

1

Ratio of operating profit, including earnings (losses) from investments and average net capital

9.77%

15.93%

8.80%

2

Gearing

n/a *

0.42

0.21

3

R.O.E. (Return on Equity)

7.61%

(20.37%)

7.38%

* Not applicable as there is a net liquidity position