Due to the nature of its business, the Group is exposed to a variety of risks, notably market risks, credit risk, liquidity risk, industrial and environmental risks and regulatory risk. In order to mitigate its exposure to these risks, the Group conducts specific analysis, measurement, monitoring and management activities, as described in this section. See also the “Reference scenario” section for an analysis of the factors that represent some of the underlying bases for these risks.
Risks connected with market liberalization and regulatory developments
The energy markets in which the Group operates are currently undergoing gradual liberalization, which is being implemented using different approaches and timetables from country to country.
As a result of these processes, the Group is exposed to increasing competition from new entrants and the development of organized markets.
The business risks generated by the natural participation of the Group in such markets have been addressed by integrating along the value chain, with a greater drive for technological innovation, diversification and geographical expansion. More specifically, the initiatives taken have increased the customer base in the free market, with the aim of integrating downstream into final markets, optimizing the generation mix, improving the competitiveness of plants through cost leadership, seeking out new high-potential markets and developing renewable energy resources with appropriate investment plans in a variety of countries.
The Group often operates in regulated markets or regulated regimes, and changes in the rules governing operations in such markets and regimes, and the associated instructions and requirements with which the Group must comply, can impact our operations and performance.
In order to mitigate the risks that such factors can engender, Enel has forged closer relationships with local government and regulatory bodies, adopting a transparent, collaborative and proactive approach in tackling and eliminating sources of instability in regulatory arrangements.
Risks connected with CO2 emissions
In addition to being one of the factors with the largest potential impact on Group operations, emissions of carbon dioxide (CO2) are also one of the greatest challenges the Group is facing in safeguarding the environment.
EU legislation governing the emissions trading scheme imposes costs for the electricity industry. In order to mitigate the risk factors associated with CO2 regulations, the Group
monitors the development and implementation of EU and Italian legislation, diversifies its generation mix towards the use of low-carbon technologies and resources, with a focus on renewables and nuclear power, develops strategies to acquire allowances at competitive prices and, above all, enhances the environmental performance of its generation plants, increasing their energy efficiency.
As part of its operations, Enel is exposed to a variety of market risks, notably the risk of changes in interest rates, exchange rates and commodity prices.
The financial risk governance arrangements adopted by the Group establish specific internal committees responsible for policy setting and supervision of risk management, as well as specific policies at the Group and individual Region/Country/global business line levels that establish the roles and responsibilities for risk management, monitoring and control processes, ensuring compliance with the principle of organizational separation of units responsible for operations and those in charge of managing risk.
The financial risk governance system also defines a system of operating limits at the Group and individual Region/Country/global business line levels for the various types of risk, which are monitored periodically by risk management units. To maintain market risk within the limits set out in the Group’s risk management policies, Enel uses derivatives obtained in the market.
Risks connected with commodity prices and supply continuity
Given the nature of its business, Enel is exposed to changes in the prices of fuel and electricity, which can have a significant impact on its results.
To mitigate this exposure, the Group has developed a strategy of stabilizing margins by contracting for supplies of fuel and the delivery of electricity to end users or wholesalers in advance.
The Group has also implemented a formal procedure that provides for the measurement of the residual commodity risk, the specification of a ceiling for maximum acceptable risk and the implementation of a hedging strategy using derivatives on regulated or over-the-counter markets. For a more detailed examination of commodity risk management and the outstanding derivatives portfolio, please see note 41 of the consolidated financial statements. In order to limit the risk of interruptions in fuel supplies, the Group has diversified fuel sources, using suppliers from different geographical areas.
The Group is exposed to the risk that changes in the exchange rates between the euro and the main other currencies could give rise to adverse changes in the euro value of performance and financial aggregates denominated in foreign currencies, given the Group’s geographical diversification and the access to international markets connected with the issue of debt instruments and transactions in commodities. Accordingly, the exposure to exchange risk, which is mainly denominated in US dollars, is attributable to:
- cash flows in respect of the purchase or sale of fuel or electricity;
- cash flows in respect of investments in foreign currency, dividends from foreign subsidiaries or the purchase or sale of equity investments;
- financial liabilities assumed by the holding company or the individual subsidiaries denominated in currencies other than the currency of account or functional currency of the company holding the liability;
- financial assets/liabilities measured at fair value. The consolidated financial statements are also exposed to the exchange risk associated with the consolidation values of equity investments denominated in currencies other than the euro (translation risk). The policy for managing exchange risk is designed to ensure the systematic hedging of exposures, with the exclusion of translation risk, through operational processes that ensure the implementation of appropriate hedging strategies, which typically involve the use of financial derivatives on over-the-counter markets.
Interest rate risk
The Group is exposed to the risk that changes in interest rates could give rise to increases in net financial expense or adverse changes in the value of assets/liabilities measured at fair value.
The main source of exposure to interest rate risk is the variability of financial terms in the case of new debt or fluctuation in the interest flows associated with floating-rate debt. The risk management policy seeks to maintain the risk
profile established within the framework of the formal risk governance procedures of the Group, curbing funding costs over time and limiting the volatility of results. This goal is also pursued through the use of financial instruments on over-the-counter markets.
For more details, please see note 41 of the consolidated financial statements.
The Group’s commercial, commodity and financial operations expose it to credit risk, i.e. the possibility that an unexpected change in the creditworthiness of a counterparty could impact the creditor position, in terms of insolvency (default risk) or changes in its market value (spread risk).
Beginning in the last few years, with the instability and uncertainty of the financial markets and the global economic crisis, average payment times for trade receivables by counterparties have increased. In this general environment, in order to minimize credit risk, the credit risk management policy calls for the preliminary assessment of the creditworthiness of counterparties in the main portfolios and the use of risk mitigation techniques, such as the acquisition of secured or unsecured guarantees and, for financial and commodities transactions in particular, standard contractual frameworks.
In addition, the general Group policy provides for application of uniform criteria in all the main Regions/Countries/global business lines for monitoring and controlling credit risk in order to promptly identify any deterioration in credit quality and determine any mitigation actions to implement.
As regards credit risk in respect of commodities transactions, credit risk limits specified by the competent units of the Region/Country/global business line involved are applied.
As to credit risk in respect of financial transactions, including those involving derivatives, risk is minimized by selecting counterparties with high credit ratings from among leading Italian and international financial institutions, portfolio diversification, entering into margin agreements for the exchange of cash collateral, or the use of netting arrangements. In 2016, operating limits on credit risk approved by the Group Risk Committee were again applied and monitored, using an internal valuation system, at both the individual Region/Country/ global business line level and at the consolidated level.
As part of the management of credit risk, for a number of years the Group has carried out non-recourse assignments of receivables for specific segments of the commercial portfolio. Partly in view of the macroeconomic environment, as from 2011 the use of assignments was extended both geographically and to invoiced receivables and receivables to be invoiced of companies operating in other segments of the electricity industry than retail sales (such as, for example, receivables from generation activities, sales of electricity as part of energy management operations, the sale of green certificates or electricity transport services).
All of the above transactions are considered as non-recourse transactions for accounting purposes and therefore involved the full derecognition of the corresponding assigned assets from the balance sheet, as the risks and rewards associated with them have been transferred.
Liquidity risk is the risk that the Group, while solvent, would not be able to discharge its obligations in a timely manner or would only be able to do so on unfavorable terms owing to situations of tension or systemic crises (credit crunches, sovereign debt crises, etc.) or changes in the perception of Group riskiness by the market.
The Group’s risk management policies are designed to maintain a level of liquidity sufficient to meet its obligations over a specified time horizon without having recourse to additional sources of financing as well as to maintain a prudential liquidity buffer sufficient to meet unexpected obligations. In addition, in order to ensure that the Group can discharge its medium and long-term commitments, Enel pursues a borrowing strategy that provides for a diversified structure of financing sources to which it can turn and a balanced maturity profile.
Credit ratings, which are assigned by rating agencies, impact the possibility of a company to access the various sources of financing and the associated cost of that financing. Any reduction in the rating could limit access to the capital market and increase finance costs, with a negative impact on the performance and financial situation of the company.
In 2016, the ratings assigned to Enel by Standard & Poor’s, Moody’s and Fitch did not change. Accordingly, at the end of the year Enel’s rating was: (i) “BBB” for Standard & Poor’s with a stable outlook; (ii) “BBB+”, with a stable outlook for Fitch; and (iii) “Baa2”, with a stable outlook for Moody’s.
By now, more than 50% of the Enel Group's revenue is generated abroad. The substantial internationalization of the Group – which among other countries operates in Latin America, North America, Africa and Russia – requires Enel to consider and assess country risk, which consists of the macroeconomic, financial, regulatory, market, social and geopolitical risks whose manifestation could have an adverse impact on income or threaten corporate assets. In order to mitigate this type of risk, Enel has adopted a model for calculating country risk that makes it possible to monitor carefully the level of risk in the countries in which it is present. The outlook is improving in the developed countries, but the weakness of the emerging economies is slowing the growth of global trade – world trade indicators set new lows in 2016 – and squeezing the prices of raw materials. Oil prices fell below the low levels reached in the trough of the 2008-2009 crisis. Forecasts of global activity point to a modest acceleration this year and the next compared with 2016.
The increase in interest rates by the Fed in December, prompted by the improvement in the labor market and the main growth indicators, marked the beginning of a gradual end of the expansionary monetary policy stance in the United States, in contrast to the situation in Europe.
In the euro area, growth continues but remains fragile. The Eurosystem’s asset purchase program is proving effective in supporting economic activity as a whole, with effects that so far are in line with initial expectations. The weakening of external demand, stagnant consumption and the fragility of the banking system have contributed to the emergence of new downside risks for growth and inflation, which nevertheless showed positive signs in the 3rd Quarter of the year. In December, the ECB’s Governing Council confirmed that it would retain the expansionary measures, continuing its purchases of securities worth €80 billion per month until March 2017, before easing back to a monthly €60 billion in the remaining months of the year.
On the political level, Brexit referendum and the spread of anti-Europe movements, fueled in part by the difficulties Governments are facing in managing the issues of immigration and terrorism, have increased the risk of instability on the continent in the light of the elections and referendums scheduled for 2017 in France, Germany, Spain and the Netherlands.
Other uncertainties in the international environment concern the ability of the emerging economies to grow with commodity prices that have fallen over the past decade, the foreign policy of the new Trump administration in the US, and the ability of Chinese policy-makers to steer the expected transition to a service economy.
Industrial and environmental risks
Industrial and environmental risks are managed by the Global Generation business line using statistical modeling techniques, which assess risks in probabilistic and monetary terms for each plant/grid/project. In addition to typically industrial risk models (business interruption, operation and maintenance), Enel has development models to measure disaster risks linked to seismic events, a model for assessing fire risks and environmental models to assess the exposure of each plant to risks involving all possible segments of the environment, such as the air, water, land and underground. All of this is done with the objective of identifying the most critical areas and preparing appropriate instruments to safeguard the industrial value of plants.
Breakdowns or accidents that temporarily interrupt operations at Enel’s plants represent an additional risk associated with the Group’s business.
In addition, we also conducted exercises to assess risks associated with the operation of the distribution networks managed by the Infrastructure and Networks business line. In order to mitigate such risks, the Group adopts leading prevention and protection strategies, including preventive and predictive maintenance techniques and technology surveys to identify and control risks. In the environmental area, plants undergo certification under international standards (ISO 14001 and EMAS) and the use of environmental management systems to monitor potential sources of risk in order to identify any threats promptly.
Any residual industrial and environmental risk is managed using specific insurance policies to protect corporate assets and provide liability coverage in the event of harm caused to third parties by accidents, including pollution, that may occur during the production and distribution of electricity and gas.
With regard to nuclear power generation, Enel operates in Spain through Endesa. In relation to its nuclear activities, the Group is exposed to operational risk and may face additional costs because of, inter alia, accidents, safety violations, acts of terrorism, natural disasters, equipment malfunctions, malfunctions in the storage, movement, transport and treatment of nuclear substances and materials. In the countries where Enel has nuclear operations, specific laws based on international conventions require operators to obtain insurance coverage for liability for risks associated with the use and transport of nuclear fuel, with coverage ceilings and other terms and conditions set by law. Other mitigating measures have been taken in accordance with international best practice.