Annual report and accounts 2012

Financial instruments

OAO Severstal and Subsidiaries
Notes to the Consolidated Financial Statements
30. Financial instruments

for the years ended December 31, 2012, 2011 and 2010
(Amounts expressed in thousands of US dollars, except as otherwise stated)

The Group’s risk management policies are established to identify and analyze the risks faced by the Group, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Group’s activities.

The Group’s Board of Directors oversees how management monitors compliance with the Group’s risk management policies and procedures and reviews the adequacy of the risk management framework in relation to the risks faced by the Group.

Exposure to credit, liquidity, interest rate and currency risk arises in the normal course of the Group's business. The Severstal Resources segment of the Group has not used derivative financial instruments to reduce exposure to fluctuations in foreign exchange rates and interest rates. The use in the Severstal Russian Steel and Severstal International segments of derivatives to hedge their interest rates, commodity inputs and foreign exchange rate exposures were not material to these consolidated financial statements.

Management believes that the fair value of its financial assets and liabilities approximates their carrying amounts except for the following borrowings:

 December 31, 2012
 Market valueBook valueDifference
Ruble bonds 2013492,087493,865(1,778)
Eurobonds 2013569,632543,55226,080
Eurobonds 2014409,234375,00034,234
Eurobonds 2016535,780500,00035,780
Eurobonds 20171,096,9001,000,00096,900
Convertible bonds 2017480,268475,0005,268
Eurobonds 2022759,608750,0009,608
Severstal Columbus bonds553,875525,00028,875
 4,897,3844,662,417234,967
 December 31, 2011
 Market valueBook valueDifference
Ruble bonds 2012464,404465,895(1,491)
Ruble bonds 2013476,471465,89510,576
Eurobonds 2013581,503543,55237,951
Eurobonds 2014399,578375,00024,578
Eurobonds 2016468,240500,000(31,760)
Eurobonds 2017943,9101,000,000(56,090)
Severstal Columbus bonds547,313525,00022,313
 3,881,4193,875,3426,077
 December 31, 2010
 Market valueBook valueDifference
Ruble bonds 2012516,834492,17624,658
Ruble bonds 2013514,160492,17621,984
Eurobonds 2013605,044543,55261,492
Eurobonds 2014418,361375,00043,361
Eurobonds 2017988,1251,000,000(11,875)
Severstal Columbus bonds561,425525,00036,425
 3,603,9493,427,904176,045

The above amounts exclude accrued interest. The market value of the Group’s Eurobonds was determined based on London Stock Exchange quotations. The market value of the Group’s Ruble bonds was determined based on MICEX.

Credit risk

The maximum exposure to credit risk is represented by the carrying amount of each financial asset in the statement of financial position and guarantees (Note 31e). The Group has developed policies and procedures for the management of credit exposures, including the establishment of credit committees that actively monitors credit risk.

The maximum exposure to credit risk for financial instruments, including accounts receivable from related parties, was:

 December 31,
 201220112010
Cash and cash equivalents1,726,2751,863,5382,012,662
Loans and receivables1,180,7331,465,5791,138,656
Derivative financial assets34,808--
Held-to-maturity securities and deposits27,9086,91328,052
Available-for-sale financial assets39,84032,363155,477
Held-for-trading securities304,09318,350
Restricted financial assets32,97022,638103,027
 3,042,5643,395,1243,456,224

The maximum exposure to credit risk for trade receivables, including trade receivables from related parties by geographic region, was:

 December 31,
 201220112010
Russian Federation600,511549,392432,626
North America258,131332,720228,910
Europe177,984216,797202,661
The Middle East9,92579,0883,787
China and Central Asia4,14524,62535,973
Central and South America3,72218,3526,121
South-East Asia71232,12926,457
Africa543537,311
 1,055,1841,253,138973,846

The maximum exposure to credit risk for trade receivables, including trade receivables from related parties by type of customer, was:

 December 31,
 201220112010
Industrial consumers804,000751,943757,760
Wholesale customers177,709412,155122,215
Retail customers13,62918,21959,769
Other customers59,84670,82134,102
 1,055,1841,253,138973,846

The Group holds bank and other guarantees provided as collateral for financial assets. Amount of collateral held does not fully cover Group’s exposure to credit risk.

Impairment losses

The aging of trade receivables, including trade receivables from related parties, was:

 December 31,
 201220112010
 GrossImpairmentGrossImpairmentGrossImpairment
Not past due887,464(47,569)1,116,018(49,251)887,212(17,795)
Past due less than 30 days173,504(1,672)118,613(487)55,913(179)
Past due 31-90 days36,335(1,641)39,223(92)18,566(162)
Past due 91-180 days4,658(577)10,605(1,073)12,410(1,139)
Past due 181-365 days2,997(2,631)10,799(1,724)25,479(10,948)
More than one year55,271(50,955)47,839(37,332)41,516(37,027)
 1,160,229(105,045)1,343,097(89,959)1,041,096(67,250)

The impairment allowance at December 31, 2012 included the impairment allowance in respect of trade receivables from related parties for the total amount of US$ 50.1 million (December 31, 2011: US$ 31.9 million; December 31, 2010: US$ 3.4 million).

The movement in allowance for impairment in respect of trade receivables, including trade receivables from related parties, during the years was as follows:

 Year ended December 31,
 201220112010
Opening balance(89,959)(67,250)(85,649)
Impairment loss recognized(45,653)(58,445)(64,920)
Impairment loss reversed34,66127,23464,584
Reclassified to assets held for sale-6,47416,288
Foreign exchange differences(4,094)2,0282,447
Closing balance(105,045)(89,959)(67,250)

The allowance account in respect of trade receivables, including trade receivables from related parties, is used to record impairment losses unless the Group is satisfied that no recovery of the amount owing is possible; at that point the amount is considered irrecoverable and is written off against the financial asset directly.

The allowance for doubtful debts contains primarily individually impaired trade receivables from debtors placed under liquidation or companies which are in breach of contract terms.

At December 31, 2012 the Group recognized an impairment allowance in respect of deposit in the amount of US$ nil (December 31, 2011: US$ nil; December 31, 2010: US$ 134.0 million) (Note 6).

Concentration of credit risk

2012

The Group has a concentration of cash and short-term bank deposits with OAO Bank VTB, OAO Metcombank, AB Russia and OAO Sberbank Russia that at December 31, 2012 represented US$ 428.5 million, US$ 290.3 million, US$ 271.6 million and US$ 254.9 million, respectively.

2011

The Group has a concentration of cash and short-term bank deposits with AB Russia, OAO Bank VTB, OAO Metcombank and ОАО Gazprombank that at December 31, 2011 represented US$ 373.8 million, US$ 335.7 million, US$ 259.0 million and US$ 326.5 million, respectively.

2010

The Group has a concentration of cash and short-term bank deposits with AB Russia, OAO Bank VTB, OAO Sberbank Russia and OAO Metcombank that at December 31, 2010 represented US$ 322.8 million, US$ 393.5 million, US$ 300.0 million and US$ 168.2 million, respectively.

The Group has a concentration of available-for-sale financial assets with Detour Gold Corporation that at December 31, 2010 represented US$ 90.6 million.

Liquidity risk

The Group manages liquidity risk with the objective of ensuring that funds will be available at all times to honor all cash flow obligations as they become due by preparing an annual budgets, by continuously monitoring forecast and actual cash flows and matching the maturity profiles of financial assets and liabilities.

The following are the contractual maturities of financial liabilities, including estimated interest payments and excluding the impact of netting agreements:

      December 31, 2012
 Carrying amountContractual cash flowsless than 1 year1-2 years2-5 yearsMore than 5 years
Non-derivative
financial liabilities
      
Debt finance5,709,540(7,209,143)(1,623,905)(888,299)(3,166,531)(1,530,408)
Lease liabilities3,611(3,611)(1,878)(27)(1,706)-
Trade and other payables1,284,405(1,287,610)(1,248,073)(35,444)(4,093)-
Derivative
financial liabilities
11,532(13,487)(11,899)(1,588)--
 7,009,088(8,513,851)(2,885,755)(925,358)(3,172,330)(1,530,408)
      December 31, 2011
 Carrying amountContractual cash flowsless than 1 year1-2 years2-5 yearsMore than 5 years
Non-derivative
financial liabilities
      
Debt finance5,976,098(7,265,954)(1,457,545)(1,769,545)(2,336,373)(1,702,491)
Lease liabilities7,933(7,933)(5,880)(238)-(1,815)
Trade and other payables1,318,534(1,322,204)(1,289,456)(10,024)(22,724)-
Derivative
financial liabilities
38,180(43,089)(15,286)(26,360)(1,443)-
 7,340,745(8,639,180)(2,768,167)(1,806,167)(2,360,540)(1,704,306)
 December 31, 2010
 Carrying amountContractual cash flowsless than 1 year1-2 years2-5 yearsMore than 5 years
Non-derivative
financial liabilities
      
Debt finance6,146,477(7,716,557)(1,784,457)(1,126,555)(2,619,640)(2,185,905)
Lease liabilities10,859(10,860)(7,966)(842)(952)(1,100)
Trade and other payables1,025,190(1,029,186)(1,002,788)(5,250)(17,646)(3,502)
Derivative
financial liabilities
22,286(28,445)(9,377)(4,642)(14,426)-
 7,204,812(8,785,048)(2,804,588)(1,137,289)(2,652,664)(2,190,507)

2012

At December 31, 2012, the Group has a concentration of bank financing with European Bank for Reconstruction and Development and Citibank N.A. of US$ 349.2 million and US$ 415.6 million, respectively.

2011

At December 31, 2011, the Group has a concentration of bank financing with Deutsche Bank AG and European Bank for Reconstruction and Development of US$ 560.0 million and US$ 473.0 million, respectively.

2010

At December 31, 2010, the Group has a concentration of bank financing with Deutsche Bank AG and European Bank for Reconstruction and Development of US$ 880.0 million and US$ 618.4 million, respectively.

Currency risk

Currency risk arises when a Group entity enters into transactions and balances not denominated in its functional currency. The Group has assets and liabilities denominated in several foreign currencies. Foreign currency risk arises when the actual or forecasted assets in a foreign currency are either greater or less than the liabilities in that currency.

The Group’s exposure to foreign currency risk was as follows based on notional amounts:

 December 31, 2012
 EuroUSDGBPRUBCADNOK
Held-to-maturity securities-24,621----
Loans and receivables154,8161,270,082-11,6593,6932,186
Cash and cash equivalents201,8951,156,546-44--
Derivative financial assets-34,808----
Debt finance(2,047,611)(4,135,921)-(21,559)(3,671)-
Trade and other payables(188,811)(156,424)(92)(126)-(4)
       
Net exposure(1,879,711)(1,806,288)(92)(9,982)222,182
 December 31, 2011
 EuroUSDGBPRUBCADNOK
Available-for-sale financial assets-14,349----
Loans and receivables824,8681,738,321245349,4061,833
Cash and cash equivalents184,146703,401-4,716--
Restricted financial assets1,001-----
Debt finance(703,474)(3,500,569)-(1,730)(49,366)-
Finance lease liabilities(26)-----
Trade and other payables(148,425)(224,059)(45)(5)--
Derivative financial liabilities-(12,048)----
Net exposure158,090(1,280,605)(21)3,034401,833
 December 31, 2010
 EuroUSDGBPRUBCHFCADKZTNOKOther
Available-for-sale financial assets-15,5826,920------
Held-to-maturity securities and deposits-----690---
Loans and receivables1,332,6241,527,20518,73633,520-67,32254,501-310
Cash and cash equivalents210,260944,596596223,311---2,686
Restricted financial assets14,08229,337-------
Debt finance(853,446)(3,680,171)(3,435)(660)-(120,504)-(83,169)(383)
Finance lease liabilities(236)(662)-------
Trade and other payables(192,984)(94,896)(175)(981)(52)(10)---
Derivative financial liabilities-(14,039)-------
Net exposure510,300(1,273,048)22,64231,9013,259(52,502)54,501(83,169)2,613

Sensitivity analysis

A 10 percent strengthening of the following currencies against the functional currency at December 31, 2012 would have increased/(decreased) profit and equity by the amounts shown below.

This analysis assumes that all other variables, in particular interest rates, remain constant and no translation difference into the presentation currency is included. The analysis is performed on the same basis for 2011 and 2010.

 Year ended December 31,
 201220112010
Net profit   
Euro(154,348)12,72440,241
USD(143,282)(100,897)(98,234)
GBP(8)(2)1,684
CHF--294
CAD33(3,923)
RUB(902)2122,690
KZT--4,103
NOK143128(5,988)
Other--209

A 10 percent weakening of these currencies against the functional currency at December 31, 2012 would have had the equal but opposite effect to the amounts shown above, on the basis that all other variables remain constant.

Interest rate risk

Interest rates on the Group’s debt finance are either fixed or variable, at a fixed spread over LIBOR, EURIBOR and MOSPRIME for the duration of each contract. Changes in interest rates impact primarily loans and borrowings by changing either their fair value (fixed rate debt) or their future cash flows (variable rate debt). Management does not have a formal policy of determining how much of the Group’s exposure should be to fixed or variable rates. However, at the time of raising new loans or borrowings management uses its judgment to decide whether it believes that a fixed or variable rate would be more favorable to the Group over the expected period until maturity.

The Group’s interest-bearing financial instruments at variable rates were:

 December 31,
 201220112010
Variable rate instruments   
Financial assets44,21921,09131,386
Financial liabilities(978,008)(1,942,638)(2,279,275)
 (933,789)(1,921,547)(2,247,889)

Other Group's interest-bearing financial instruments are at fixed rate.

Fair value sensitivity analysis for fixed rate instruments

The Group does not account for any fixed rate financial assets and liabilities at fair value through profit or loss. Therefore a change in interest rates would not affect profit or loss.

Cash flow sensitivity analysis for variable rate instruments

A change of 100 basis points in interest rates would have increased/(decreased) profit and equity by the amounts shown below. This analysis assumes that all other variables, in particular foreign currency rates, remain constant. The analysis is performed on the same basis for 2011 and 2010.

 Net profit
 100 bp increase100 bp decrease
December 31, 2012  
Financial assets442(442)
Financial liabilities(8,897)8,897
Cash flow sensitivity (net)(8,455)8,455
December 31, 2011  
Financial assets28(28)
Financial liabilities(14,304)14,304
Cash flow sensitivity (net)(14,276)14,276
December 31, 2010  
Financial assets251(251)
Financial liabilities(18,234)18,234
Cash flow sensitivity (net)(17,983)17,983

Fair value hierarchy

The table below analyzes financial instruments carried at fair value, except financial instruments measured at amortized cost, by valuation method. The levels in the fair value hierarchy into which the fair value measurements are categorized were disclosed in accordance with IFRS.

 Level 1Level 2Level 3Total
Balance at 31 December 20126,07823,30633,76263,146
     
Available-for-sale financial assets6,078-33,76239,840
Held-for-trading securities-30-30
Derivative financial assets-34,808-34,808
Derivative financial liabilities-(11,532)-(11,532)
Balance at 31 December 20118,098(34,196)24,374(1,724)
     
Available-for-sale financial assets8,098-24,26532,363
Held-for-trading securities-3,9841094,093
Derivative financial liabilities-(38,180)-(38,180)
Balance at 31 December 2010120,863(4,051)34,729151,541
     
Available-for-sale financial assets120,748-34,729155,477
Held-for-trading securities11518,235-18,350
Derivative financial liabilities-(22,286)-(22,286)

The description of the levels is presented below:

Level 1 - quoted prices in active markets for identical assets or liabilities;
Level 2 - inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly;
Level 3 – inputs for the asset or liability that are not based on observable market data.

The following table shows a reconciliation from the beginning balances to the ending balances for fair value measurement in Level 3 of the fair value hierarchy:

 Available-for-sale financial assetsHeld-for-trading securities
Balance at 31 December 201233,762-
   
Issues of financial instruments8,450-
Other movements1,047(109)
Balance at 31 December 201124,265109
   
Gains recognized in other comprehensive income276-
Purchases of financial instruments-109
Sales of financial instruments(3,417)-
Issues of financial instruments415-
Transfers out of Level 3(6,942)-
Other movements(796)-
Balance at 31 December 201034,729-
   
Losses recognized in other comprehensive income(580)-
Purchases of financial instruments23,712-
Balance at 31 December 200911,597-