Financial Risk Management Policy

Financial Risk Management Policy

Luxottica operates a risk management policy designed to enable all Group companies to manage risk using clearly defined principles. Luxottica Group’s board of directors is responsible for approving this policy and defines:

• delegation of responsibility and authority;
• risk management activities and organization;
• principles for organizing risk and financial risk management activities, and
• principles for risk management reporting and control.

Luxottica’s financial risks are related to financial assets and liabilities denominated in local and foreign currencies (interest rate risk), to incomes and expenses denominated in currencies other than the functional currency (foreign currency risk) and to loss deriving from the inability of counterpart to meet its commitment (counterparty risk)

Interest rate risk arises from the close connection between the value of assets and liabilities and prevailing interest rates. In particular, it stems from:

1. the uncertainty of cash flows related to the Group’s assets and liabilities structure caused by changes in interest rates, which affect variable rate assets and liabilities;
2. the variability of the market value of the Group’s assets and liabilities caused by changes in market interest rates, which affect fixed rate assets and liabilities.

The interest rate risk of assets and liabilities can be categorized as follows:

• flow risk, referring to the sensitivity of interest amounts to changes in interest rates; flow risk is covered by cash flow hedge instruments;
• price risk, referring to the sensitivity of the market value of assets and liabilities to changes in the level of market interest rates; price risk is covered by fair value hedge instruments.

As a consequence, the objective of interest rate risk management is to reduce the uncertainty of the Group’s net interest result. This is achieved by reducing the volatility of interest impact on the Group’s income statement and controlling the fluctuation of the net debt market value.
To achieve this objective, the whole Group’s interest rate risk exposure, in terms of notional amounts, must be organized as a mix of fixed interest rates and floating interest rates, where neither of the two should be lower than 25% or higher than 75%.

Foreign currency risk is defined as follows:

1. the uncertainty of the value of net income, cash flows related to the Group’s firm commitment and forecasted transactions created by changes in currency rates;
2. the variability of the market value of foreign-currency-denominated assets and liabilities due to changes in currency rates.

The objective of foreign currency risk management is to help the Group minimize uncertainty and achieve the business objectives set by Group Planning, e.g. by minimizing the impact on the income statement of the random effects of currency rate changes.
The Group’s foreign currency position is subject to three types of risk: transaction risk, translation risk and competitive risk. Such risks are managed separately because of their different natures and effects on the Group’s income statement and balance sheet.

• Transaction risk is defined as the effect arising from the difference in foreign currency rates at the time of pricing or stipulating a contract and that of realization of a transaction. Transaction risk is defined in relation to the base currency of a company.
• Translation risk is defined as the sum of the effects of changes in foreign currency rates on the consolidated income statement and balance sheet of the Group. As the foreign Group companies’ income statements and balance sheets are translated into the Group’s functional currency using market rates, the values of the Group’s consolidated net income, assets, debt and equity change. In addition to the absolute amounts, balance sheet ratios like gearing and equity ratio may also change if the proportions between net income, assets, debt and net equity in the various currencies differ.
• Competitive risk refers to the Group’s foreign currency rate sensitivity in comparison to its competitors, i.e. to the long term effects of currency rate changes on the Group’s competitive position a given market.

Counterparty Risk is defined as follows: the inability of the counterpart to meet its commitment that can materialise through default or through a change in a counterparty’s creditworthiness affecting the market value of investments or derivates instruments.

As a consequence, the objective of Counterparty Risk is to minimize possibility to incur in losses deriving from investements or derivates portofolio due to counterparty’s default. To avoid this risk counterparty relation should meet certain objective credit rating.