2020 Universal registration document and annual financial report - BNP PARIBAS 443

5risks and CaPital adequaCy Pillar 3

5

Market risk

In this low and stable rate environment, early repayments and rate renegotiations remained low in Domestic Markets. The savings structure continues to be distorted in favour of low-interest funding sources, whose investment horizons are regularly reviewed.

Structural foreign exchange risk [Audited]

Currency hedges are contracted by the ALM Treasury in relation to the Group s investments in foreign currencies and its future foreign currency revenues. Each hedging relationship is formally documented at inception. The documentation describes the hedging strategy, identifies the hedged item and the hedging instrument, and the nature of the hedged risk and describes the methodology used to test the expected (prospective) and actual (retrospective) effectiveness of the hedge.

A hedging relationship is applied and documented for investments in subsidiaries and branches financed by foreign currency loans so as to record movements in exchange rates symmetrically and avoid impacts on the profit and loss account. These instruments are designated as net investment hedges. The amount of these loans stood at EUR 15 billion at 31 December 2020, compared with EUR 18 billion at 31 December 2019. The changes in value related to exchange differences recognised directly in equity with respect to these hedges was +EUR 907 million in 2020, compared with EUR 745 million at 31 December 2019.

During the 2020 financial year, no net investment hedging relationships were disqualified. The amount recorded in the profit and loss account for 2020 with respect to the ineffective portion of hedges of net investments is immaterial.

Hedging of financial instruments recognised in the balance sheet (Fair Value Hedge)

Fair value hedges of interest rate risks relate either to identified fixed- rate assets or liabilities, or to portfolios of fixed-rate assets or liabilities. Derivatives are contracted to reduce the exposure of the fair value of these instruments to changes in interest rates.

Individual assets hedging consists mainly of securities classified as Financial assets at amortised cost or Financial assets at fair value through equity ; individual liabilities hedging consists mainly of fixed income securities issued by the Group.

Hedges of portfolios of financial assets and liabilities, constructed by currency, relate to:

■ fixed-rate loans (property loans, equipment loans, consumer credit and export loans);

■ fixed-rate deposits (mainly demand deposits and funds deposited under home savings contracts).

To identify the hedged amount, the residual balance of the hedged item is split into maturity bands, and a separate amount is designated for each band. The maturity split is determined on the basis of the contractual terms of the transactions and historical observations of customer behaviour (early redemption assumptions and estimated default rates).

Demand deposits, which do not bear interest at contractual rates, are qualified as fixed-rate medium-term financial liabilities. Consequently, the value of these liabilities is sensitive to changes in interest rates. Estimates of future cash outflows are based on historical analyses.

For each hedging relationship, expected hedge effectiveness is measured by ensuring that for each maturity band, the fair value of the hedged items is greater than the fair value of the designated hedging instruments.

Actual effectiveness is assessed on an ex-post basis by ensuring that the monthly change in the fair value of hedged items since the start of the month does not indicate any over-hedging.

Cash Flow Hedge

In terms of interest rate risk, the Group uses derivative instruments to hedge fluctuations in income and expenses arising on floating-rate assets and liabilities. Highly probable forecast transactions are also hedged. Hedged items are split into maturity bands by currency and benchmark interest rate. After factoring in early redemption assumptions and estimated default rates, the Group uses derivatives to hedge some or all of the risk exposure generated by these floating-rate instruments.

In terms of foreign exchange risk, the Group hedges against variability in components of consolidated net income. In particular, the Group may hedge future revenue flows (especially interest income and fees) derived from operations carried out by its main subsidiaries and/or branches in a currency other than their functional currencies. As in the case of interest rate hedges, the effectiveness of these hedging relationships is documented and assessed on the basis of forecast maturity bands.

The table below concerns the scope of BNP Paribas SA s medium- and long-term transactions and shows the amount of hedged future cash flows (split by forecast date of realisation), which constitute the majority of the Group s transactions.

➤ TABLE 91: HEDGED CASH FLOWS [Audited]

Period to realisation In millions of euros

31 December 2020 31 December 2019

Less than 1 year

1 to 5 years

More than 5 years Total

Less than 1 year

1 to 5 years

More than 5 years Total

Hedged cash flows 291 883 331 1,505 537 1,787 943 3,267

In 2020, no cash flow hedges were declassified on the grounds that achieving these future earnings would no longer be highly probable.