2018 Registration document and annual fi nancial report - BNP PARIBAS 413

5RISKS AND CAPITAL ADEQUACY PILLAR 3

5

Market risk

In this context of low but stable rates, early redemptions and rate renegotiations remained stable, close to the minimum levels (whether in France, Belgium or Italy). The savings structure remains distorted in favour of non-interest bearing current accounts. Consequently, the outlook for current account investments is regularly reviewed in order to anticipate the potential consequences of an increase in short-term rates.

Structural foreign exchange risk

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, identifi es 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 fi nanced by foreign currency loans so as to record movements in exchange rates symmetrically and avoid impacts on the profi t and loss account. These instruments are designated as net investment hedges. The amount of these loans stood at EUR 22 billion at 31 December 2018. The changes in value related to exchange differences recognised directly in equity with respect to these hedges was -EUR 599 million in 2018.

During the 2018 fi nancial year, no net investment hedging relationships were disqualifi ed. The amount recorded in the profi t and loss account for 2018 with respect to the ineffective portion of hedges of net investments is immaterial.

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

Fair value hedges of interest rate risks relate either to identifi ed fi xed- rate assets or liabilities, or to portfolios of fi xed-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 classifi ed as as Financial assets at amortised cost or Financial assets at fair value through equity ; individual liabilities hedging consists mainly of fi xed income securities issued by the Group.

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

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

■ fi xed-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 qualifi ed as fi xed-rate medium-term fi nancial liabilities. Consequently, the value of these liabilities is sensitive to changes in interest rates. Estimates of future cash outfl ows 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 fl uctuations in income and expenses arising on fl oating-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 fl oating-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 fl ows (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 fl ows (split by forecast date of realisation), which constitute the majority of the Group s transactions.

➤ TABLE 84 : HEDGED CASH FLOWS [Audited]

Period to realisation In millions of euros

31 December 2018 31 December 2017

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 fl ows 604 1,729 1,339 3,673 427 1,285 1,029 2,740

In 2018, no cash fl ow hedges were declassifi ed on the grounds that achieving these future earnings was no longer be highly probable.