Credit risk

Counterparties’ risks – clients

We have developed and implemented policies and procedures to manage credit risks, including credit committees’ approvals. A bank guarantee from the approved bank is normally required or credit insurance if credit terms are granted. The letters of credit may be used as well. After the credit committee’s approval, products may be sold to key customers under deferred payment conditions.

Counterparties’ risks – financial institutions

To diversify credit risks, we keep financial resources on deposit, in bank accounts and in the form of securities, in accordance with the limits set for financial institutions and holdings.

Mitigation

Our management monitors the financial institutions’ ratings and financials to minimise the potential negative impact of counterparty default.

Interest rate fluctuations

The financial crisis led to an inter-bank crisis of trust, so reducing the levels of inter-bank credits and the liquidity of the financial system. Simultaneously, increased volatility and uncertainty led to increased risk premiums included in the cost of external financing. Such factors may limit our access to external sources of financing and financial markets. In this respect we may be unable to refinance existing debt; this, in turn, may cause difficulties in financing our investments. The increased cost of financing may negatively affect our financial results and lead to lower profitability. Fluctuations of interest rates may affect the existing fair value of debt (in the case of fixed interest rates) or future cash flows (floating interest rates). Decision-making about external sources of financing involves analysis and choice between fixed and floating interest rates, favourability of conditions and terms of financing.

Interest rates, either fixed or floating, are normally linked to LIBOR or EURIBOR. We monitor the situation on capital markets continuously and take the measures necessary to be able to respond to changing market conditions. The level of debt financing at December 31, 2009 was US$7.23 billion. Hence, changes of interest rates may have significant impact on our financial results. We had a negative net position in respect of financial instruments with fixed rates at December 31, 2009, when financial liabilities with fixed rates exceeded assets with fixed rates by US$276.2 million. We had a negative net position on the financial instruments with floating interest rates at December 31, 2009, when financial liabilities exceeded assets with floating interest rates by US$3,741 million.

Mitigation

We monitor interest rates and market conditions, and align our position to prevailing market trends. We achieve flexibility by embedding float-to-fix conversion options in major financing agreements.

Exchange rate fluctuations

We may be affected by exchange rates risk if we acquire assets or liabilities nominated in currencies other than our functioning currency.

We engage in transactions and acquire assets and obligations in several currencies: Russian roubles, US dollars, euros, sterling, Swiss francs, Canadian dollars and others.

The Group has assets and liabilities denominated in several foreign currencies. Currency risk (or foreign exchange risk) arises on financial instruments that are denominated in a foreign currency, that is, in a currency other than the functioning currency in which they are measured. Currency risk does not arise from financial instruments that are non-monetary items or from financial instruments denominated in the functioning currency.

At December 31, 2009 our liabilities exceeded corresponding assets in US$ and euros, which is a measure of the significance of the Group’s currency risk:

US$ – US$2,899.0 million;

Euros – US$457.0 million.

Contrarily, in other currencies, the Group’s assets exceeded its liabilities as follows:

Swiss francs – US$6.8 million;

Pounds sterling – US$2.5 million;

Canadian dollars – US$2.2 million;

Other currencies – US$4.8 million.

The Group is ultimately exposed to the following exchange rate risks. The weakening Russian rouble may negatively affect our ability to serve our debt denominated in foreign currency. The strengthening Russian rouble may cause a decrease in the value of earnings denominated in foreign currency.

Mitigation

In case of adverse changes in exchange rates, we are expected to correct our net positions within the approved limits. The limits restrict the potential impact of fluctuations in exchange rates on the value of assets and liabilities being subject to such changes. Our obligations denominated in foreign currency are naturally hedged by cash inflows from exports denominated in the same currency. The Group entered into a number of cross-currency swap and forward contracts for the more effective management of these opposite cash streams.

Credit agreement provisions

Credit agreements signed by the Group include provisions triggering default in case of material adverse changes or covenant violations.

Mitigation

The Group monitors possible credit covenant violations on the basis of its business plan and requests that lenders amend such agreement provisions in advance, for preventing defaults and adverse impacts on its financial statements.