Credit risk is defined as the probability of a trading partner of the Group’s failing to meet its obligations on time, or to meet such obligations at all. The credit risk resulting from a third party’s inability to perform its obligations under a financial instruments contract is generally limited to the amounts, if any, by which the third party’s liabilities exceed the Group’s liabilities. As a rule, the Group concludes transactions in financial instruments with a number of creditworthy entities. Key criteria applied by the Group in the selection of counterparties include their financial standing as confirmed by rating agencies, as well as their market shares and reputation.

The PGNiG Group is exposed to credit risk in connection with its:

• cash deposits,
• tradde receivables,
• loans and other financial assets and hedging transactions,
• financial guarantees provided.

Cash and cash equivalents

The Group identifies, measures and minimises its credit exposure to individual banks with which it places its funds. The credit exposure was reduced through the diversification of the portfolio of counterparties (mainly banks) with which the Group companies place their funds. The Parent has also concluded Framework Agreements with all its relationship banks, stipulating detailed terms for the execution and settlement of financial transactions between the parties.

The Group measures the related credit risk by regularly reviewing the banks’ financial standing, as reflected in ratings assigned by rating agencies such as Fitch, Standards & Poor’s and Moody’s.

In 2014, the Group invested its long-term cash surplus of significant value in highly liquid, credit risk-free instruments, in particular treasury bills and bonds.

Trade and other receivables

Material credit risk (in value terms) is related to receivables, mainly receivables under sales of gas fuel, as well as electricity and related products, including carbon credits, and certificates of origin for electricity.

Transactions made at the Polish Power Exchange do not generate any exposure to credit risk, as the system of guaranteed settlements through the agency of the Commodity Exchange Clearing House provides each member with assurance that their trades will be securely settled in the event of the insolvency of any market participants. In order to minimise the risk of uncollectible receivables arising in connection with sale transactions executed outside of the PPE, uniform rules designed to secure trade receivables are in place and must be observed when concluding general supply contracts.

Prior to the conclusion of a sale contract of significant value, the financial standing of the potential customer is reviewed in order to assess the customer’s creditworthiness. This assessment serves as the basis for determining the form of security required in connection with the contract.

Balances of receivables from customers are monitored on an ongoing basis, in line with the Group’s policy. If payment is not received within the contractual deadline, appropriate steps are taken, in line with the Group’s debt collection procedures.

Loans and other financial assets

Exposure to credit risk under loans advanced arises in connection with loans advanced by the Parent to the PGNiG Group companies: subsidiaries not accounted for with the full method, associates and joint ventures. Loans to those entities are advanced in line with an internal procedure containing detailed rules governing the conclusion and monitoring of loan agreements, thus minimising the Group’s exposure to credit risk under such agreements. Loans are advanced only if the borrower meets a number of conditions and provides appropriate security.

Positive value of derivative financial istruments

The exposure to credit risk under financial derivatives is equal to the net carrying amount of the positive valuation of the derivative (at fair value). As in the case of cash deposits, transactions in financial derivatives are executed with most reputable banks with high credit ratings. The Group companies have also concluded either Framework Agreements or ISDA Agreements with each of their relationship banks, stipulating detailed terms of service and limits of maximum exposure arising from the fair value of derivatives.

The Group believes that all these measures protect it from any material credit-risk-related losses.

Guarantees issued

The Group’s credit risk exposure under provided guarantees is substantially limited to the risk of default by the banks that, acting on the Group’s instructions, issued guarantees to other external entities. However, the banks on which the Group relies for the provision of guarantees are reputable institutions with high ratings; therefore, both the probability of their default and the associated credit risk are insignificant. As in the case of the risk related to cash deposits, the credit risk under provided guarantees is measured by regularly reviewing the financial standing of the banks issuing the guarantees.

Market risk is defined as the probability that the Group’s financial performance or economic value will be adversely affected by changes in the financial and commodity markets.

The main objective of the market risk management is to identify, measure, monitor and mitigate key sources of the risk, including:

• foreign exchange risk,
• interest rate risk,
• commodity risk (e.g. gas fuel, crude oil, energy and related products).

Currency risk

Currency risk is defined as the probability that the Group’s financial performance will be adversely affected by changes in the price of one currency against another.

The hedging measures implemented by the Group are mainly intended to provide protection against the currency risk accompanying payments settled in foreign currencies (mainly payments for gas fuel supplies). To hedge its trade payables, the Group uses call options, option strategies and forward transactions.

Interest rate risk

Interest rate risk is defined as the probability that the Group’s financial performance will be adversely affected by changes in interest rates.

The Group is exposed to interest rate risk primarily in connection with its financial liabilities.

The Parent measures its market risk (including the currency and interest rate risks) by monitoring VaR (value at risk). VaR means that the maximum loss arising from a change in the market (fair) value will not exceed that value over the next n business days, given a specified probability level (e.g. 99%). VaR is estimated using the variance-covariance method.

Commodity price risk

Commodity price risk is defined as the probability that the Group’s financial performance will be adversely affected by changes in commodity prices.

The Group’s exposure to commodity price risk arises mainly in connection with its contracts for gas fuel deliveries, and sales contracts entered into through the process of daily bidding and sale of the fuel at the PPE. It stems from the volatility of the prices of gas and oil products quoted on global markets. Under some of the contracts for gas fuel deliveries, the pricing formula relies on a weighted average of prices from previous months, which mitigates the volatility risk.

Commodity price risk is also related to trading in electricity, certificates of origin and carbon credits. Electricity trading is conducted on regulated exchange markets in Poland and abroad, but the Group also enters into transactions outside of the regulated markets, under framework agreements. The Group actively manages its exposure to commodity price risk using the implemented VaR measures. VaR is measured and VaR limits are set and actively monitored to limit the potential losses related to the exposure to commodity price risk assumed by the Company.

In addition, under the Energy Law an application for tariff adjustment may be filed if, within a quarter, the purchase cost of gas rises by more than 5%. In 2014, the Group closely monitored and hedged the risk. To hedge against the commodity price risk, the Group used Asian call options settled as European options, risk reversal option strategies, commodity swaps, as well as futures and forwards.

The main objective of liquidity risk management is to monitor and plan the Company’s liquidity on a continuous basis. Liquidity is monitored through at least 12-month projections of future cash flows, which are updated once a month. PGNiG reviews the actual cash flows against projections at regular intervals – an exercise that comprises an analysis of unmet cash-flow targets, as well as the related causes and effects.

The liquidity risk should not be equated exclusively with the risk of the loss of liquidity by the Group. An equally serious threat is that of having excess structural liquidity, which could adversely affect the Group’s profitability.

The Group monitors and plans its liquidity levels on a continuous basis. As part of its strategy to hedge against liquidity risk, as at 31 December 2014 the Group had in place the following debt security issuance programmes:

• Under the Note Issuance Programme Agreement executed by PGNiG on 10 June 2010, the Parent may issue discount or coupon notes maturing in one to twelve months, for an aggregate amount of up to PLN 7bn. The Agreement was executed with eight banks (Bank Pekao SA, ING Bank Śląski SA, PKOBP SA, Bank Handlowy w Warszawie SA, Societe Generale SA, BNP Paribas SA Branch in Poland, BRE Bank SA – currently mBank SA, and Bank Zachodni WBK SA), and its term expires on 31 July 2020. As at 31 December 2014, no debt was outstanding under the Agreement.
• On 25 August 2011 PGNiG and PGNiG Finance AB executed documentation for a Euro Medium Term Notes Programme with Societe Generale SA, BNP Paribas SA and Unicredit Bank AG, pursuant to which PGNiG Finance AB may issue notes with maturities of up to ten years, up to the aggregate amount of EUR 1.2bn. The first tranche of PGNiG Finance AB securities under the Programme, comprising EUR 500m five-year Euronotes, was issued on 10 February 2012. As at 31 December 2014, nominal debt outstanding under the Euronotes was PLN 2,131m (converted at the mid-rate quoted by the National Bank of Poland for 31 December 2014).
• On 22 May 2012 PGNiG executed a PLN 4.5bn Note Programme Agreement with Bank Pekao SA and ING Bank Śląski SA. On 30 July 2012 the issued five-year notes were floated on the Catalyst market, a multilateral trading facility operated by BondSpot. In 2014 no notes were issued. As at 31 December 2014, nominal debt outstanding under the Programme was PLN 2.5bn.
• On 2 October 2014 PGNiG executed a Note Programme Agreement for up to PLN 1bn with Bank Gospodarstwa Krajowego. In 2014 no notes were issued under the Programme.
• On 4 July 2012 PGNiG Termika SA executed a Note Programme with the following banks: ING Bank Śląski SA, PKO Bank Polski SA, Nordea Bank Polska SA and Bank Zachodni WBK SA. On 1 November 2014 two of the underwriters for the issue, PKO BP and Nordea Bank, merged. Under the Programme, PGNiG Termika SA may issue coupon or discount notes up to PLN 1.5bn. In accordance with the annexes, the Programme is to expire on 29 December 2019, though it may be extended for two years, i.e. until 29 December 2021. As at 31 December 2014, PGNiG TERMIKA S.A.’s nominal debt under notes in issue was PLN 190m.

Any surplus cash is invested, mainly in treasury securities, or deposited with reputable banks.

The liquidity risk at the Parent is significantly mitigated through the ‘PGNiG Liquidity Management Procedure’. Implemented across the Company’s organisational units, the procedure offers a systematised set of measures designed to ensure proper liquidity management through: settlement of payments, preparation of cash-flow projections, optimum management of free cash flows, securing and restructuring of financing for day-to-day operations and investment projects, protection against the risk of temporary liquidity loss due to unforeseen disruptions, and appropriate servicing of credit agreements.

The liquidity risk is measured on the basis of ongoing, detailed monitoring of cash flows, taking into account the probable timing of specific flows, as well as the planned net cash position.

In the current and comparative periods, the Group met its liabilities under borrowings in a timely manner. Further, there were no breaches of material provisions of any of its borrowing agreements that would trigger accelerated repayment.

The Group has not identified any other material financial risks inherent in its day-to-day operations.