Within the framework of its financial risk management policies, the Company has defined the following elements of risk as fundamental to the health of its future cash flows and liquidity:
To manage such risks, priority is given to making use of natural hedging methods. In situations where this approach proves insufficient or impractical, recourse is made to financial risk hedging in derivative markets through the employment of strategies developed to protect the Company against potential risks arising from possible movements in commodity prices and/or in currency-exchange and interest rates. The effectiveness of existing strategies developed to hedge against such financial risks is constantly monitored by the Turkish Airlines Treasury and Risk Management Commission, such that alterations and improvements may be effected to account for changes in market conditions.
Cash flow risk is defined as the potential for medium- and long-term movements (incoming and outgoing) in the Company’s portfolio investments and/or cash positions to prevent the Company from achieving its business objectives. Financial transactions in the aviation industry tend to be of a much longer term nature than in many other lines of business. Consequently, having a sound cash management policy is one of the Company’s prime issues of concern.
To enable the Company to most effectively manage its medium- and long-term liquidity and financial risks, EUR, USD, and TL cash flow projections are made and updated monthly. For these projections, the Company’s exchange rate and fuel price forecasts for the period ahead are reconsidered and revised monthly so as to ensure that the information on which projections are based is both current and reliable. The results of cash flow projections are presented to the Turkish Airlines Treasury and Risk Management Commission, thereby providing it with essential information on which to base the Company’s investment and financing decisions. Each month’s actual performance figures are also compared and contrasted with the projections, and the results of these studies analyzed.
The Company makes use of swap- and option-based derivative instruments to mitigate the impact of fuel price movements on its aviation fuel costs, and to ensure that such costs are at least kept within predetermined limits where they cannot actually be anchored. In order to shield both its profitability and cash flows against volatility that may arise from fuel market movements, changes and potential future prices of past crude oil and jet fuel, as well as price correlations and their own price volatilities are taken into consideration for analytical purposes. Turkish Airlines, with contractual amounts corresponding to around 50% of its annualized jet-fuel consumption figures as projected for the next twenty-four months, and using various instruments for determined price ranges, through swaps written on crude oil and band derivative instruments with four barriers are used to gradually prevent financial risks. When market prices exceed pre-determined levels and there is an expectation that these price levels will not be in force for long, related transactions are put hold by the Company.
Effective as of 1 January 2012, the aviation industry was included within the scope of the European Union Emission Trading Scheme (EU-ETS). As a result of this inclusion, Turkish Airlines (like all other airlines flying in or out of European airports) is required to comply with EU ETS regulations.
Under this emission trading scheme, airlines must buy Carbon Credits in the market in situations where they exceed the maximum carbon emission limit prescribed by the authorities to which they are responsible. According to this, Turkish Airlines has developed hedging strategies to protect itself against financial risks that might arise from its having to purchase such credits. The plan is to make use of derivative instruments as a means of mitigating this risk.
Within this scope, and as one that executes EUA, EUAA, ERU and CER transactions, the Company has obtained certificates to be used within certain periods in 2012 and 2013.
Under the heading of interest rate risk management activities, the Company keeps regular track of possible changes in its costs arising from interest rate movements by monitoring and analyzing the FX markets, managing its debt structure, and determining its sensitivity to interest rate movements based on analyses of the weighted average terms of its debt exposure. In order to better manage interest rate risk, the Company engages in hedging with the aim of locking the interest rates on part of its debt portfolio for the duration of loans where possible, or at least of ensuring that interest rates remain within a predetermined band where not.
At the same time, the Company manages the interest rate risk arising as a result of the yield-focused assessments of its cash holdings in order to optimize the relationship between maturities and returns. Priority is given to cash flow planning. And while seeking to maximize return potential, yield projections are developed by making use of market data regarding the possible course that interest rates may be taking in order to generate the best returns in the near future.
Exchange rate risk is defined as the potential for changes taking place in the Company’s cash flows and revenues on account of movements in exchange rates. The Company secures a substantial volume of its earnings in Euros, but also incurs significant expenditure in US dollars and Turkish liras. Such a revenue and expenditure structure exposes the Company to serious risk arising from relative movements in these currencies’ exchange rates, which have been quite volatile of late, and are likely to remain so going forward.
Turkish Airlines’ exchange rate risk management activities focus on reducing the impact of exchange rate volatility by ensuring that the relative currency mixes of its income and expenditure items are reasonably proximate. To this end, the particular currency (or currency mix) on the basis of which a contract is to be signed is determined in such a way as to balance the Company’s ingoing and outgoing revenue streams and avoid the emergence of situations that are disadvantageous to it. Hedging is the primary method of recourse in managing the Company’s exchange rate risk exposure. In addition to the aforementioned measures, derivative instruments may also be deployed to manage exchange rate risks in situations where hedging is insufficient or impractical.
Furthermore, while the bulk of its exchange rate risk exposure stems from relative movements in EUR, USD, and TL rates, Turkish Airlines also has sizeable earnings and expenditures denominated in other foreign currencies. These positions are also managed through hedging and/or derivative contracts as circumstances warrant, in order to minimize the Company’s exposure to such risks.
In order to limit the impact of the ongoing global economic on Turkish Airlines, the nature of whose business requires it to interact with many domestic and international financial institutions across a broad range of commercial spheres, a variety of measures are taken to deal with its exposure to the risk of default by one or more of the counterparties with which it has dealings. Accordingly, the Company adheres to an approach that involves abiding by equally-applicable, objective criteria for each counterparty with which there is a deposit or derivative relationship. The underlying aim is to reduce counterparty risk on a long-term basis. The Company enters into agreements with financial institutions to cover the risks arising from derivative contracts.
When entering into deposit and derivative agreements, attention is given to the credit risk ratings assigned to financial institutions by international rating agencies. Wherever possible, the Company avoids dealing with any financial institution whose rating is below a predetermined threshold. In the case of those financial institutions that surpass the threshold, the Company assigns limits based on risk levels determined according to a specified credit risk assessment methodology, and works with them on that basis. The credit ratings of financial institutions with which the Company has dealings, and their assigned limits, are also reviewed periodically. Should it be ascertained that a financial institution’s credit rating has deteriorated, or where credit default spreads (CDS) increase, transactions with the related organization are closely scrutinized. And should the credit rating fall below specified limits, the Company keeps a much closer watch on its dealings with that concern, and may even unilaterally sever its relationships if need be.
To manage the credit risk to which it may be exposed through the use of derivative instruments, the Company enters into framework agreements with domestic financial institutions, into ISDA (International Swaps and Derivatives Association) agreements with foreign financial institutions, and into other agreements and conventions as may be deemed necessary. Issues specifically related to credit risk management are governed by a separate CSA (credit support annex) agreement. Based on such agreements, credit risk is reduced through offsets that take place at regular intervals.