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12 Derivative Assets and Liabilities

The Group is exposed to fluctuations in freight rates, bunker prices, interest rates and currency exchange rates. The Group manages these exposures by way of:

Amongst the derivative assets and liabilities held by the Group, the fair values of forward foreign exchange contracts, interest rate swap contracts and bunker swap contracts are quoted by dealers at the balance sheet date.

Derivative assets and liabilities have been analysed by valuation method. Please refer to Note 11 (Fair value levels) for the definitions of different levels. Our derivative assets and liabilities are Level 2 financial instruments.

US$'000 2016
Total
2015
Total
Derivative assets    
Derivative assets that do not qualify for hedge accounting
      Bunker swap contracts (a)
3,800 -
Total 3,800 -
Less: non-current portion of
      Bunker swap contracts (a)
(969) -
Non-current portion (969) -
Current portion 2,831 -
Derivative liabilities    
Cash flow hedges

       Forward foreign exchange contracts (b)
21,506 22,314
      Interest rate swap contracts (c(i)) 788 2,831
Derivative liabilities that do not qualify for hedge accounting

      Bunker swap contracts (a)
5,456 23,674
      Interest rate swap contracts (c(ii)) 9 1,633
Total 27,759 50,452
Less: non-current portion of

      Forward foreign exchange contracts (b)
(21,506) (22,314)
      Interest rate swap contracts (c(i)) (788) (1,811)
      Interest rate swap contracts (c(ii)) - (1,633)
      Bunker swap contracts (a) (2,566) (8,039)
Non-current portion (24,860) (33,797)
Current portion 2,899 16,655

(a) Bunker swap contracts

The Group enters into bunker swap contracts to manage the fluctuations in bunker prices in connection with the Group’s cargo contract commitments.

Bunker swap contracts that do not qualify for hedge accounting

At 31 December 2016, the Group had outstanding bunker swap contracts to buy approximately 124,170 (2015: 114,950) metric tonnes of bunkers. These contracts expire through December 2021 (2015: December 2021).

With all other variables held constant, if the average forward bunker rate on the bunker swap contracts held by the Group at the balance sheet date had been 10% higher/lower, the Group’s profit after tax and equity would increase/decrease by approximately US$4.0 million (2015: US$2.5 million). Future movements in bunker price will be reflected in the eventual operating results derived from the vessels, which is expected to offset such increase/ decrease of the Group’s profit after tax and equity in future periods.

(b) Forward foreign exchange contracts

The functional currency of most of the Group’s operating companies is United States Dollar ("USD") as the majority of our transactions are denominated in this currency. Historically, a major part of our exchange rate fluctuations risk arose from the purchase of vessels denominated in non-USD currency. However this risk has significantly reduced as most of our vessel purchases are denominated in USD.

Forward foreign exchange contracts that qualify for hedge accounting as cash flow hedges

At 31 December 2016, the outstanding forward foreign exchange contracts held by the Group mainly consist of contracts with banks to buy Danish Kroner (“DKK”) of approximately DKK 835.2 million (2015: DKK 982.4 million) and simultaneously sell approximately US$149.8 million (2015: US$176.7 million), which expire through August 2023. The Group has long-term bank borrowings denominated in DKK with maturity in August 2023. To hedge against the potential fluctuations in foreign exchange, the Group entered into these forward foreign exchange contracts with terms that match the repayment schedules of such longterm bank borrowings. These forward foreign exchange contracts qualify for hedge accounting as cash flow hedges.

(c) Interest rate swap contracts

Certain secured borrowings are subject to floating interest rates, which can be volatile, but the Group manages these exposures by way of entering into interest rate swap contracts.

With all other variables held constant, if the average interest rate on net debt balance (2015: net cash balance) (after excluding borrowings subject to fixed interest rates) subject to floating interest rates, which includes cash and deposits net of unhedged secured loans, held by the Group at the balance sheet date had been 50 basis point higher/lower, the Group’s profit after tax and equity would decrease/increase by approximately US$0.1 million (2015: US$1.1 million increase/decrease).

(i) Interest rate swap contracts that qualify for hedge accounting as cash flow hedges

Effective date Notional amount Swap details Expiry
For 2016 & 2015:
30 December 2013
     & 21 January 2014
US$178 million on
amortising basis
USD 3-month LIBOR swapped to a fixed rate of
approximately 1.9% to 2.1 % per annum
Contracts expire through
December 2021
For 2015:
2 January 2007 US$20 million USD 6-month LIBOR swapped to a fixed rate of
approximately 5.6% per annum
Contracts expired
in December 2016
31 March 2009 US$20 million USD 3-month LIBOR swapped to a fixed rate of
approximately 3.0% per annum
Contracts expired
in March 2016

(ii) Interest rate swap contracts that do not qualify for hedge accounting

Starting on 2 January 2007, a notional amount of US$40 million has the USD 6-month LIBOR swapped to a fixed rate of approximately 5.0% per annum so long as the USD 6-month LIBOR remains below the agreed cap strike level of 6.0%. This fixed rate switches to a discounted floating rate (discount is approximately 1.0%) for the 6-month fixing period when the prevailing USD 6-month LIBOR is above 6.0% and reverts back to the fixed rate should the USD 6-month LIBOR subsequently drop below 6.0%. This contract expired in January 2017.

(d) Analysis of derivative income and expense

During the year ended 31 December 2016, the Group recognised net derivative income of US$7.1 million, as follows:

The application of HKAS 39 “Financial Instruments: Recognition and Measurement” has the effect of shifting to the current year the estimated results of the derivative contracts that expire in future periods. On 31 December 2016 this created a net unrealised non-cash income of US$23.6 million (2015: US$8.8 million). The cash flows of these contracts will occur in future reporting years.

Accounting policy

Financial assets at fair value through profit or loss

Financial assets at fair value through profit or loss are financial assets held for trading. A financial asset is classified in this category if acquired principally for the purpose of selling in the short term. Derivatives are classified as held for trading unless they are designated as hedges. Derivatives are classified as current and noncurrent assets according to their respective settlement dates.

Financial assets at fair value through profit or loss are initially recognised at fair value, and transaction costs are expensed in the income statement, and are subsequently remeasured at their fair values. Gains and losses arising from changes in the fair values are included in the other income or other expenses in the period in which they arise.

Dividend income from financial assets at fair value through profit or loss is recognised in the income statement as part of other income when the Group’s right to receive payments is established.

In the cash flow statement, financial assets held for trading are presented within “operating activities” as part of changes in working capital.

Derivative financial instruments and hedging activities

The method of recognising the resulting gain or loss arising from changes in fair value for derivative financial instruments depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged. The Group designates certain derivatives as cash flow hedges.

The Group documents at the inception of the transaction the relationship between the hedging instruments and the hedged items, as well as its risk management objectives and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at the hedge inception and on an ongoing basis, of whether the derivatives that are used in the hedging transactions are highly effective in offsetting the changes in fair values or cash flows of the hedged items.

The full fair value of a hedging derivative is classified as a non-current asset or liability when the remaining maturity of the hedged item is more than twelve months after the balance sheet date. A trading derivative is classified as a current asset or liability.

(i) Cash flow hedges

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognised in other comprehensive income. The gain or loss relating to the ineffective portion is recognised immediately in the income statement within other income and expenses.

Amounts accumulated in equity are recycled in the income statement in the periods when the hedged item affects profit or loss. However, when the forecast transaction that is hedged results in the recognition of a non-financial asset or a liability, the gains and losses previously deferred in equity are transferred from equity and included in the initial measurement of the cost of the asset or liability. The deferred amounts are ultimately recognised in depreciation in the case of property, plant and equipment.

When a hedging instrument expires or is sold, 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 recycled when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was recorded in equity is immediately transferred to the income statement.

(ii) Derivatives not qualifying for hedge accounting

Derivative instruments that do not qualify for hedge accounting are accounted for as financial assets and liabilities at fair value through profit or loss. Changes in the fair value of these derivative instruments are recognised immediately in the income statement.

Bunker swap contracts and forward freight agreements do not qualify for hedge accounting mainly because the contract periods, which are in calendar months, do not coincide with the periods of the physical contracts. The terms of one of the interest rate swap contracts also did not qualify for hedge accounting.

Offsetting financial instruments

Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis or realise the asset and settle the liability simultaneously. The legally enforceable right must not be contingent on future events and must be enforceable in the normal course of business and in the event of default, insolvency or bankruptcy of the company or the counterparty.


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