25.4. Interest rate risk

The interest rate risk is a risk that the fair value or future cash flows of the financial instrument will change due to interest rates changes. The Group has interest bearing financial liabilities consisting mainly of loans from related party and bank borrowings (see Notes 20 and 31.2).

The Group’s interest rate hedging strategy, limiting exposure to unfavourable movements of interest rates, is reviewed on a regular basis. The preferable split between fixed and floating rate debt is the result of the analysis indicating the impact of the potential interest rates evolution on the financial costs.

According to the hedging strategy, the Group uses interest rate swaps and cross currency interest rate swaps to hedge its interest rate risk. As a result of the hedge, the structure of the liabilities changes to the desired one, as liabilities based on the floating/fixed interest rates are effectively converted into fixed/floating obligations.

As at 31 December 2020 and 2019, the Group’s proportion between fixed/floating rate debt (after hedging activities) was 99/1% and 96/4%, respectively.

Hedge ineffectiveness may arise from designation of non-zero fair value derivatives in hedge relationships and a difference between the counterparty credit risk and the own credit risk.

The Group uses the sensitivity analysis described below to measure interest rate risk.

The table below provides the Group’s sensitivity analysis for interest rate risk (net of hedging activities) assuming a hypothetical increase/decrease in the interest rates by 1 p.p.:

(in PLN millions)

The sensitivity analysis presented above is based on the following principles:

• finance costs, net include the following items exposed to interest rate risk: a) interest cost on financial debt based on floating rate (after hedging), b) the change in the fair value of derivatives not designated as hedging instruments and classified as held for trading (see Note 23),
• other reserves include the change in the fair value of derivatives that is determined as effective cash flow hedge (see Note 23),
• as at 31 December 2020, the gross financial debt based on floating rate (after hedging) amounted to PLN 31 million (as at 31 December 2019, PLN 251 million).

Following the recommendations of the Financial Stability Board to reform some major interest rate benchmarks, the European Union issued Benchmarks Regulation setting out certain criteria and conditions for benchmark rates to ensure that they are reliable and robust. The Group‘s financial instruments based on IBORs consist mainly of loans from related party, interest rate swaps and cross currency interest rate swaps, which are based on EURIBOR and WIBOR. As both benchmarks are considered compliant with the Benchmark Regulation, the interest rate benchmark reform will not impact the Group’s financial statements.