The Group is exposed to fluctuations in freight rates, bunker prices, interest rates and currency exchange rates. The Group manages these exposures using the derivatives summarised below together with their respective fair value levels.
| Derivatives | Fair value levels |
| Interest rate swap contracts | Level 2 |
| Forward foreign exchange contracts | Level 2 |
| Bunker swap contracts | Level 2 |
| Forward freight agreements | Level 1 |
The fair values of interest rate swap contracts, forward foreign exchange contracts and bunker swap contracts are quoted by dealers at the balance sheet date. The forward freight agreements are traded through a clearing house and its fair value is determined using forward freight rates at the balance sheet date.
| 31 December 2018 | 31 December 2017 | |||
| US$'000 | Assets | Liabilities | Assets | Liabilities |
| Non-current portion | ||||
| Cash flow hedges | ||||
| Interest rate swap contracts (a) | 1,055 | (563) | 432 | - |
| Forward foreign exchange contracts (b) | 21 | (7,948) | - | (4,706) |
| Derivative assets that do not qualify for hedge accounting | ||||
| Bunker swap contracts (c) | 669 | (1,401) | 801 | (1,084) |
| Non-current portion - total | 1,745 | (9,912) | 1,233 | (5,790) |
| Current portions | ||||
| Derivative liabilities that do not qualify for hedge accounting | ||||
| Bunker swap contracts (c) | 214 | (7,374) | 4,834 | (748) |
| Forward freight agreements (d) | - | - | - | (24) |
| Current portion - total | 214 | (7,374) | 4,834 | (772) |
| Total | 1,959 | (17,286) | 6,067 | (6,562) |
(a) Interest rate swap contracts
All our interest rate swap contracts qualify for hedge accounting as cash flow hedges
Certain secured borrowings are subject to floating interest rates, which can be volatile, but the Group manages these exposures by way of entering into interest rate swap contracts.
| Effective date | Notional amount | Swap details | Expiry |
| 2018 | |||
| December 2018 | US$40 million on amortising basis | USD 6-month LIBOR swapped to a fixed rate of approximately 3.0% per annum | Contract expires in June 2025 |
| December 2018 | US$5 million on bullet basis | USD 3-month LIBOR swapped to a fixed rate of approximately 2.9% per annum | Contract expires in June 2025 |
| * June 2018 | US$69 million on amortising basis | USD 3-month LIBOR swapped to a fixed rate of approximately 2.0% per annum | Contract expires in December 2020 |
| 2018 & 2017 December 2013 February 2017 | US$48 million on amortising basis US$9 million on amortising basis | USD 3-month LIBOR swapped to a fixed rate of approximately 2.1% per annum USD 1-month LIBOR swapped to a fixed rate of approximately 1.8% per annum | Contract expires in December 2021 Contract expires in January 2022 |
| 2017 * January 2014 | US$130 million on amortising basis | USD 3-month LIBOR swapped to a fixed rate of approximately 1.9% per annum | Contract restructured in June 2018 |
| * The US$130 million interest rate swap contract was restructured in June 2018 (with respective notional amount US$69 million). | |||
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Sensitivity analysis:
With all other variables held constant, if the average interest rate on the net debt balance as at 31 December 2018 (after excluding borrowings subject to fixed interest rates) subject to floating interest rates, which includes cash and deposits net of unhedged secured loans, held by the Group at the balance sheet date had been 50 basis point higher/lower, the Group’s profit after tax and equity would decrease/increase by approximately US$0.4 million (2017: US$0.4 million).
(b) Forward foreign exchange contracts
All our forward foreign exchange contracts qualify for hedge accounting as cash flow hedges
The functional currency of most of the Group’s operating companies is United States Dollar (“USD”) as the majority of our transactions are denominated in this currency.
At 31 December 2018, the outstanding forward foreign exchange contracts held by the Group mainly consist of contracts with banks to buy Danish Kroner (“DKK”) of approximately DKK 554.4 million (2017: DKK 692.6 million) and simultaneously sell approximately US$99.0 million (2017: US$123.9 million), which expire through August 2023. The Group has long-term bank borrowings denominated in DKK with maturity in August 2023. To hedge against the potential fluctuations in foreign exchange, the Group entered into these forward foreign exchange contracts with terms that match the repayment schedules of such long-term bank borrowings.
(c) Bunker swap contracts
None of our bunker swap contracts qualify for hedge accounting
The Group enters into bunker swap contracts for fuel oil and marine gas oil to mainly manage the fluctuations in bunker prices in connection with the Group’s cargo contract commitments. We have also used bunker swap contracts to lock in the prevailing future fuel price spread between low and high sulphur fuel for a portion of the estimated fuel consumption on some Supramax vessels that will be fitted with scrubbers. Future movements in bunker price will be reflected in the eventual operating results derived from the vessels, which is expected to offset such increase/decrease of the Group’s profit after tax and equity in future periods.
At 31 December 2018, the Group had outstanding bunker swap contracts as follows:
| Contract Type | Fuel Type | Quantity (tons) | Average deal price (US$) | Expiry through |
| 2018 | ||||
| Buy | Fuel oil | 135,228 | 352 | December 2022 |
| Buy | Marine gas oil | 10,511 | 591 | December 2021 |
| Sell | Marine gas oil | 27,480 | 566 | December 2022 |
| 2017 | ||||
| Buy | Fuel oil | 119,607 | 327 | December 2021 |
| Buy | Marine gas oil | 11,095 | 544 | December 2021 |
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Sensitivity analysis:
With all other variables held constant, if the average forward fuel oil rate on the bunker swap contracts held by the Group at the balance sheet date had been 10% higher/lower, the Group’s profit after tax would increase/decrease by approximately US$4.0 million (2017: US$4.3 million). With all other variables held constant, if the average forward marine gas oil rate on the bunker swap contracts held by the Group at the balance sheet date had been 10% higher/lower, the Group’s profit after tax would decrease/ increase by approximately US$1.2 million (2017: US$0.6 million).
(d) Forward freight agreements
None of our forward freight agreements qualify for hedge accounting
The Group enters into forward freight agreements as a method of managing its exposure to both its physical tonnage and cargo commitments with regard to its Handysize and Supramax vessels. Future movements in charter rates will be reflected in the eventual operating revenue derived from the vessels, which would offset such decrease/increase of the Group’s profit after tax and equity.
At 31 December 2018, the Group had no outstanding forward freight agreements. At 31 December 2017, the Group had outstanding forward freight agreements as follows:
| Contract Type | Index | Quantity (days) | Contract daily price (US$) | Expiry through |
| 2017 | ||||
| Sell | BHSI1 | 180 | 8,500 | December 2018 |
| "BHSI" stands for"Baltic Handysize Index". | ||||
Accounting policy
Financial assets at fair value through profit or loss
Financial assets at fair value through profit or loss are financial assets held for trading. A financial asset is classified in this category if acquired principally for the purpose of selling in the short term. Derivatives are classified as held for trading unless they are designated as hedges. Derivatives are classified as current and non-current assets according to their respective settlement dates.
Financial assets at fair value through profit or loss are initially recognised at fair value, and transaction costs are expensed in the income statement, and are subsequently remeasured at their fair values. Gains and losses arising from changes in the fair values are included in the other income or other expenses in the period in which they arise.
Dividend income from financial assets at fair value through profit or loss is recognised in the income statement as part of other income when the Group’s right to receive payments is established.
In the cash flow statement, financial assets held for trading are presented within “operating activities” as part of changes in working capital.
Derivative financial instruments and hedging activities
The method of recognising the resulting gain or loss arising from changes in fair value for derivative financial instruments depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged. The Group designates certain derivatives as cash flow hedges.
The Group documents at the inception of the transaction the relationship between the hedging instruments and the hedged items, as well as its risk management objectives and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at the hedge inception and on an ongoing basis, of whether the derivatives that are used in the hedging transactions are highly effective in offsetting the changes in fair values or cash flows of the hedged items.
The full fair value of a hedging derivative is classified as a non-current asset or liability when the remaining maturity of the hedged item is more than twelve months after the balance sheet date.
(i) Cash flow hedges
The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognised in other comprehensive income. The gain or loss relating to the ineffective portion is recognised immediately in the income statement within other income and expenses.
Amounts accumulated in equity are recycled in the income statement in the periods when the hedged item affects profit or loss. However, when the forecast transaction that is hedged results in the recognition of a non-financial asset or a liability, the gains and losses previously deferred in equity are transferred from equity and included in the initial measurement of the cost of the asset or liability. The deferred amounts are ultimately recognised in depreciation in the case of property, plant and equipment.
When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recycled when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was recorded in equity is immediately transferred to the income statement.
(ii) Derivatives not qualifying for hedge accounting
Derivative instruments that do not qualify for hedge accounting are accounted for as financial assets and liabilities at fair value through profit or loss. Changes in the fair value of these derivative instruments are recognised immediately in the income statement.
Bunker swap contracts and forward freight agreements do not qualify for hedge accounting mainly because the contract periods, which are in calendar months, do not coincide with the periods of the physical contracts.
Offsetting financial instruments
Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis or realise the asset and settle the liability simultaneously. The legally enforceable right must not be contingent on future events and must be enforceable in the normal course of business and in the event of default, insolvency or bankruptcy of the company or the counterparty.