Rio Tinto (RIO) Risk Factors

Our interest rate management policy is generally to borrow and invest at floating interest rates. The approach to floating rate borrowing is based upon; i) the lower cost of borrowing historically observed from maintaining a floating rate exposure and ii) the historical correlation between interest rates and commodity prices. In certain circumstances, we may elect to maintain a higher proportion of fixed-rate funding. Hedging strategy We enter into interest rate swaps to hedge the interest rate exposure from our fixed rate borrowings, and review these positions on a regular basis. The tenor of the interest rate swaps is sometimes shorter than the tenor of the bond which means, we remain exposed to long term fixed rate funding. In 2020 we entered into US$1.5 billion of interest rate swaps with a tenor of five years to hedge the Alcan bonds which had been historically held at fixed rates. In 2021, we issued a 30-year US$1.25 billion bond which was swapped to floating rates for a tenor of seven years. As interest rate swaps mature, new medium dated swaps are generally transacted to maintain this floating rate exposure. The economic characteristics of the interest rate swaps are shown in the table below. The interest rates swaps transacted in 2020 and 2021, were designated into fair value hedge relationships with the respective tranches of debt. For the fair value movements, in relation to all of our fair value hedged items and instruments, refer to note 8. At 31 December 2021, US$6.0 billion (2020: US$5.9 billion) US dollar notional fixed-rate US dollar borrowings continue to be swapped to floating US dollar rates and €417 million (2020: €417 million) euro notional fixed-rate borrowings continue to be fully swapped to floating US dollar interest rates at an effective exchange rate of 1.3105. These swaps are designated in fair value hedge relationships. Since 2012, we have also held cross-currency interest rate swaps to convert the principal and annual fixed interest coupons of the Rio Tinto Finance plc £500 million Sterling Bond to a US dollar notional with fixed US dollar annual interest coupons. We applied cash flow hedge accounting to this relationship to limit our US dollar cash flow exposure on the principal and interest payments. The hedge was fully effective in the 2021 and 2020 financial years as the notional amount, maturity, payment and reset dates match. 20212020 Nominal amount of the bond Nominal amount of the hedging instrumentMaturity Effective exchange rate Loss in fair value of the hedged item US$m Gain in fair value of the hedging instrument US$m Gain in fair value of the hedged item US$m Loss in fair value of the hedging instrument US$m £500 million US$807 million November 2029 1.6132 (1) 1 7 (7) In 2019, we swapped the resulting fixed US dollar annual interest coupon payments to floating rates. Fair value hedge accounting has been applied to this relationship in addition to the pre-existing cash flow hedge. The effective interest rates of our borrowings, impacted by swaps, are summarised below. All nominal values are fully hedged unless otherwise stated: Borrowings in a hedge relationship Nominal value 2021 US$m Nominal value 2020 US$m Weighted average interest rate after swaps Swap maturity Carrying value 2021 US$m Carrying value 2020 US$m Rio Tinto Finance plc Euro Bonds 2.875% due 20245465463 month LIBOR +1.64%2024 497 555 Rio Tinto Finance (USA) Limited Bonds 3.75% 2025(a)—1,2003 month LIBOR +1.39%2025 — 1,299 Rio Tinto Finance (USA) Limited Bonds 7.125% 20287507503 month LIBOR +3.27%2028 934 1,005 Alcan Inc. Debentures 7.25% due 20281001003 month LIBOR +5.43%2024 105 109 Rio Tinto Finance plc Sterling Bonds 4.0% due 20298078073 month LIBOR +2.65%2024 682 717 Alcan Inc. Debentures 7.25% due 2031(b)4004003 month LIBOR +5.72%2025 420 438 Alcan Inc. Global Notes 6.125% due 2033(b)7507503 month LIBOR +5.67%2025 722 744 Alcan Inc. Global Notes 5.75% due 2035(b)3003003 month LIBOR +5.18%2025 283 292 Rio Tinto Finance (USA) Limited Bonds 5.2% 20401,1501,1503 month LIBOR +3.79%2022 1,156 1,173 Rio Tinto Finance (USA) plc Bonds 4.75% 20425005003 month LIBOR +3.42%2023 495 501 Rio Tinto Finance (USA) plc Bonds 4.125% 20427507503 month LIBOR +2.83%2023 735 743 Rio Tinto Finance (USA) Limited Bonds 2.75% 2051(a)1,250—6 month SOFR + 1.57%2028 1,225 — (a)On 28 October 2021, the Group issued US$1.25 billion of 30-year fixed rate debt with a coupon of 2.75%. On settlement of the bond, we entered into interest rate swaps to convert the interest payable on these bonds from fixed to floating rates rate for the next seven years. The bond and the swaps are in a fair value hedge relationship. The proceeds of the new issuance were used to fund the early redemption and extinguishment of the company’s US$1.20 billion 3.75% bonds due to mature in June 2025. (b)In 2020 we entered into new swaps to convert the interest payable in relation to these bonds from fixed to floating rates. The fair value of interest rate and cross currency interest rate swaps at 31 December 2021 was US$139 million (2020: US$388 million) asset and US$240 million (2020: US$140 million) liability, respectively. These are included within “Other financial assets” and “Other financial liabilities” in the balance sheet. The main sources of ineffectiveness of the fair value hedges include changes in the timing of the cash flows of the hedging instrument compared to the underlying hedged item, and changes in the credit risk of parties to the hedging relationships. Refer to note 8 for the changes in fair value of the bonds and the swaps as well as the ineffectiveness recognised in the period. Refer to note 1 “New standards Issued not yet effective” for the impacts of IBOR reform. Taking into account the interest and currency interest rate swaps, at 31 December 2021, US$11.6 billion (2020: US$11.7 billion) of our adjusted gross borrowings were at floating rates. This has resulted in a floating to fixed debt ratio of 85% floating to 15% fixed (2020: 86% floating to 14% fixed). Our weighted average debt maturity was approximately 11 years (2020: nine years) based on current interest rates and the carrying value of gross borrowings at the year end. Sensitivities Based on our floating rate financial instruments outstanding at 31 December 2021, the effect on our net earnings of a 100 basis point increase in US dollar LIBOR or SOFR (where applicable) interest rates, with all other variables held constant, would be an income of US$13 million (2020: expense of US$7 million), reflecting the net cash position in 2021 compared to a net debt position in prior year. We have an exposure to interest rate volatility within shareholders’ equity arising from fair value movements on derivatives in the cash flow hedge reserve. These derivatives have an underlying exposure to sterling and US dollars. With all factors remaining constant, and based on the composition of derivatives impacting the cash flow reserve at 31 December 2021, the sensitivity of a 100 basis point increase in interest rates in each of the currencies in isolation would impact equity, before tax, by a charge of US$55 million (2020: US$68 million charge) for sterling and a credit of US$65 million (2020: US$78 million credit) for US dollars. A 100 basis point decrease would have broadly the same impact in the opposite direction. B Derivative financial instruments In the table below we summarise our derivatives, including embedded derivatives, as at 31 December. Total fair value 20212020 Asset US$m Liability US$m Asset US$m Liability US$m Derivatives designated as hedges Interest rate swaps(a) 139 (34) 386 (1) Cross-currency interest rate swaps(b) — (206) 2 (139) Aluminium embedded derivatives(c) — (125) 66 (20) Currency forward contracts — — 7 — Total derivatives designated as hedges 139 (365) 461 (160) Derivatives not designated as hedges Currency forward contracts and swaps 1 (39) 63 (1) Aluminium embedded derivatives(c) 53 (121) 80 — Other embedded derivatives 39 (1) 28 (16) Other commodity contracts(d) 40 (92) 33 (7) Total derivatives not designated as hedges 133 (253) 204 (24) Total derivative instruments 272 (618) 665 (184) Analysed by maturity: Less than 1 year 62 (225) 134 (23) Between 1 and 5 years 60 (211) 330 (14) More than 5 years 150 (182) 201 (147) Total 272 (618) 665 (184) Total net derivative instruments (346) 481 Reconciliation to balance sheetNote 2021 US$m 2020 US$m Non-current assets19 210 531 Current assets19 62 134 Current liabilities21 (225) (23) Non-current liabilities21 (393) (161) Total net derivative instruments (346) 481 (a)The interest rate swaps are used to convert certain fixed rate borrowings to a floating rate. (b)The cross-currency interest rate swaps are used to convert non-US dollar denominated borrowings to either fixed or floating US dollar borrowings. (c)Aluminium embedded derivatives (forward contracts and options) are contained within certain aluminium smelter electricity purchase contracts. These contracts reduce our margin exposure to movements in the aluminium price. (d)Other commodity derivatives mainly relate to forward contracts which we have entered into to swap some of our fixed priced product sales to prevailing market prices at the point of revenue recognition. None of these derivatives is in a hedge relationship. C Fair values The following table shows the carrying amounts and fair values of our borrowings including those which are not carried at an amount which approximates their fair value at 31 December 2021 and 31 December 2020. The fair values of our cash equivalents, loans to equity accounted units and other financial liabilities approximate their carrying values because of their short maturity, or because they carry floating rates of interest. 20212020 Note Carrying value US$m Fair value US$m Carrying value US$m Fair value US$m Borrowings (including overdrafts)21 12,168 13,904 12,653 15,076 Total borrowings with a carrying value of US$7.3 billion (2020: US$7.6 billion) relate to listed bonds with a fair value of US$8.7 billion (2020: US$9.5 billion) and are categorized as level 1 in the fair value hierarchy. Borrowings with a carrying value of US$4.2 billion (2020: US$4.2 billion) relate to project finance drawn down by Oyu Tolgoi, with a fair value of US$4.4 billion (2020: US$4.7 billion) and are categorised as level 3 in the fair value hierarchy. We use different valuation inputs for the pre-and post-completion phases to reflect Rio Tinto’s completion support guarantee during the pre-completion phase. To measure the fair value of the project finance pre-completion our valuation input includes market yield over the pre-completion period, the variability of which we consider a reasonable indicator of fair value movements on amounts outstanding under the project finance facility. Post-completion, we estimate the fair value with reference to the annual interest rate on each tranche of the facility, and after considering factors that could indicate a change in the credit assessment of Oyu Tolgoi LLC as a counterparty to project finance. These factors include in-country risk relating to the Oyu Tolgoi project, and the assumed date of transition from pre-completion to post-completion. These valuation inputs are considered to be level 3. Transition from pre-completion to post-completion is determined by a set of tests for both completion of physical infrastructure and the ability to extract and process ore of defined grades over a defined period. Our remaining borrowings have a fair value measured by discounting estimated cash flows with an applicable market quoted yield, and are categorised as level 2 in the fair value hierarchy. C (a) Valuation hierarchy The tables below show the financial instruments by fair value measurement method in accordance with IFRS 13 at 31 December 2021 and 31 December 2020. Held at fair value At 31 December 2021Note Total US$m Level 1(a) US$m Level 2(b) US$m Level 3(c) US$m Held at amortised cost US$m Assets Cash and cash equivalents(d) 12,807 4,138 — — 8,669 Investments in equity shares and funds 117 64 — 53 — Other investments, including loans(e) 19 2,682 2,422 — 238 22 Trade and other financial receivables(f) 18 2,762 1 1,163 — 1,598 Derivatives (net) Forward contracts and option contracts: designated as hedges(g) (Section B) (125) — — (125) — Forward contracts and option contracts, not designated as hedges(g) (Section B) (120) — (131) 11 — Derivatives related to net debt(h) (Section B) (101) — (101) — — Liabilities Trade and other financial payables 24 (6,356) — (67) — (6,289) Total 11,666 6,625 864 177 4,000 Held at fair value At 31 December 2020Note Total US$m Level 1(a) US$m Level 2(b) US$m Level 3(c) US$m Held at amortised costs US$m Assets Cash and cash equivalents(d) 10,381 6,411 — — 3,970 Investments in equity shares and funds 75 35 — 40 — Other investments, including loans(e)19 2,899 2,563 — 198 138 Trade and other financial receivables(f) 18 3,286 5 1,802 — 1,479 Derivatives (net) Forward contracts and option contracts: designated as hedges(g) (Section B) 53 — 7 46 — Forward contracts and option contracts, not designated as hedges(g) (Section B) 180 — 69 111 — Derivatives related to net debt(h) (Section B) 248 — 248 — — Liabilities Trade and other financial payables 24 (5,847) — (30) — (5,817) Total 11,275 9,014 2,096 395 (230) (a)Valuation is based on unadjusted quoted prices in active markets for identical financial instruments. This category includes listed equity shares and other quoted funds. (b)Valuation is based on inputs that are observable for the financial instruments, which include quoted prices for similar instruments or identical instruments in markets which are not considered to be active, or inputs, either directly or indirectly based on observable market data. (c)Valuation is based on inputs that are not based on observable market data (unobservable inputs). (d)Cash and cash equivalents include money market funds which are treated as fair value through profit or loss (FVPL) under IFRS 9 with the fair value movements going into finance income. (e)Other investments, including loans, comprise: cash deposits in rehabilitation funds, government bonds, managed investment funds and royalty receivables. The royalty receivables are valued based on future expected output as well as forward commodity prices. (f)Trade receivables include provisionally priced invoices. The related revenue is initially based on forward market selling prices for the quotation periods stipulated in the contracts with changes between the provisional price and the final price recorded separately within “Other revenue”. The selling price can be measured reliably for the Group's products, as it operates in active and freely traded commodity markets. At 31 December 2021, US$1,114 million (31 December 2020: US$1,671 million) of provisionally priced receivables were recognised. (g)Level 3 derivatives consist of derivatives embedded in electricity purchase contracts linked to the LME with terms expiring between 2025 and 2036 (2020: 2025 and 2029). The embedded derivatives are measured using discounted cash flows and option model valuation techniques. (h)Interest rate and currency interest rate swaps are valued using applicable market quoted swap yield curves adjusted for relevant basis and credit default spreads. Currency interest rate swap valuations also use market quoted foreign exchange rates. A discounted cash flow approach is used to derive fair value from these inputs to the underlying cash flows. There were no material transfers between level 1 and level 2, or between level 2 and level 3 in the year ended 31 December 2021 or in the year ended 31 December 2020. C (b) Level 3 financial assets and financial liabilities The table below shows the summary of changes in the fair value of the Group's level 3 financial assets and financial liabilities. 2021 Level 3 financial assets and financial liabilities US$m 2020 Level 3 financial assets and financial liabilities US$m Opening balance 395 383 Currency translation adjustments (6) 16 Total realised gains/(losses) included in:– consolidated sales revenue 27 11 – net operating costs (50) (39) Total unrealised gains included in:– net operating costs 68 24 Total unrealised (losses)/gains transferred into other comprehensive income through cash flow hedges (212) 26 Additions to (financial liabilities)/assets (21) 1 Disposals/maturity of financial instruments (6) (27) Transfers (18) — Closing balance 177 395 Net gains for the year included in the income statement for assets and liabilities held at year end(a) 20 — (a)In 2020 gains and losses included in the income statement offset each other to the extent that the net result is less than US$1 million. Sensitivity analysis in respect of level 3 derivatives Forward contracts and options whose fair value is determined using unobservable inputs are calculated using appropriate discounted cash flow and option model valuation techniques. To value the long-term aluminium embedded derivatives, we use unobservable inputs when the term of the derivative extends beyond observable market prices. In 2021 and 2020, changing the level 3 inputs to reasonably possible alternative assumptions does not change the fair value significantly, taking into account the expected remaining term of contracts. The fair value of our level 3 aluminium embedded derivatives is US$146 million at 31 December 2021 (2020: US$126 million). We also have receivables, with a carrying value of US$136 million (2020: US$113 million), that relate to royalties arising from the sale of coal from our previously divested businesses. These are classified as “Other investments”, including loans within “Other financial assets”. The fair values are determined using level 3 unobservable inputs. This royalty receivable includes US$53 million from forecast production beyond 2030. This has not been adjusted for potential changes in production rates that could occur due to climate change targets impacting the operator. The main unobservable input is the long-term coal price used over the life of the royalty receivable. A 15% increase in the coal spot price would result in a US$63 million increase (2020: US$198 million increase) in the carrying value. A 15% decrease in the coal spot price would result in a US$53 million decrease (2020: US$46 million decrease) in the carrying value. We have used a 15% assumption to calculate our exposure as it represents the annual coal price movement that we deem to be reasonably probable (on an annual basis over the long run).