Renault is a French vehicle manufacturer producing cars, vans, buses, tractors, and trucks. The group is well known for its motor racing (through Renault Sport department), revolutionary designs (for example: Vel Satis, Avantime, Megane) and concepts (namely the Espace, the first monospace to be developed).
Renault distributes its vehicles through primary networks (dealers, branches belonging to the Renault group's business distribution unit, approved repairers) and secondary distribution network (subdealsers).
For a decade, Renault's growth strategy is mainly based on internationalization (outside Europe). Indeed, even if it is the leader on the European market, it needs to conquer the American and, all above, the Asiatic markets. That's why the group is present in "risky" countries such as Chile, Turkey...
Besides, Renault holds 20,74 % of the capital of AB Volvo (Sweden), 44,3 % of Nissan (Japan), and 99 % of Dassia (Romania). Renault also created Renault Samsung Motors (South Korea) after buying Samsung Motors' operational assets, and has partnerships with local companies in Russia (Avtoframos), China (Dongfeng), Iran (Idro), Columbia (SOFASA) and Italia (Fiat).
Concerning cash management, Renault's Corporate treasury department has developed two entities specialized in the centralization of cash flows (Société Financière et Foncière) and capital market trading after intra-Group netting (forex, fixed-income securities, short-term investments through Renault Finance).
Different types of risk that Renault has been exposed to
Renault is exposed to different risks which can have consequences on its financial performances. These risks can be divided in five different types :
operational
financial
legal
bank customer
dispute
Let's present and discuss them. The tools developed to manage the most important risks - operational and financial - will be developed in question 3, whereas legal, dispute and bank customer risks will quickly be presented beneath.
Operational risks
Operational risks are various, and can be related to factors such as geographical areas, product quality, suppliers, production, environment, IT, and distribution. These risks form an increasing part of risks Renault has to deal with.
2.1.1. Geographical risks
Renault operates in different geographical areas and sells its cars in countries such as South Korea, Brazil, Argentina, Turkey, Chile, Russia, Iran... and plans to increase its sales outside Europe by 10 points in 1999, to reach 40 %.
Such countries are considered as "risky" insofar as their GDP, economy and regime are unstable. Moreover, they bear payment collection problems, labor unrest, sharp fluctuations in interest and exchange rates and foreign exchange controls.
2.1.2. Product quality risks
The automotive industry needs to improve its technologies, that's why it develops automated systems in which men have less and less responsibilities. Because of this trend, incidents can occur quickly if you don't pay attention to mechanisms and equipments, important to the driver safety.
2.1.3. Supplier risks
This risk relates to the quality of the products purchased from the suppliers, all the more as purchases account is an important portion of vehicle production costs.
2.1.4. Production risks
These types of risks concern Renault's interdependent production sites and their impact related to issues such as personal health and safety, property security and pollution.
2.1.5. Environmental risks
Renault is concerned by several types of environmental risks. Indeed, it must pay attention to the impact of the company's activities on employees and local inhabitants. Moreover, malfunctions caused by accidents (fire, natural disasters, chemical spillage...) in Renault's plants might pollute soil and groundwater.
2.1.6. IT risks
IT risks are related to the good functioning of the IT network. Indeed, datas must be protected (confidentiality and integrity) and the network should not be interrupted, since most of the group's functions rely on the software tools and technical infrastructure connecting its sites.
2.1.7. Distribution risks
Depending on the type of distribution channel, Renault is exposed to different risks in addition of the risk of non-payment by customers. On the one hand, at commercial import subsidiaries, sales and marketing resources can be used in appropriate goals. Indeed, Renault does not control all the promotion process.
On the other hand, in Renault's own distribution subsidiaries, quality norms and procedures might not be applied correctly, and conveying a bad image of the Renault group.
Finally, Renault must pay attention to the financial situation of dealership networks.
Renault has to be cautious and has to pay attention to various operational risks. Nevertheless, they are not the only risks concerning Renault.
Financial risks
Most of the markets Renault is dealing in are volatile. That's why the company has to ensure good financial conditions while it is making transactions. The main risks resulting from these volatile markets are foreign exchange risks, interest rate risks, counterparty risks, liquidity risks, and commodity risks.
2.2.1. Foreign exchange risk
Renault is exposed to the foreign exchange risk since it sells cars and trucks all around the world. This risk has consequences on five major areas: operating margin, financial results, share in the net income of associated companies, shareholders' equity, and net financial debt.
2.2.1.1. Operating margin
They vary because of exchange rate fluctuations. Renault calculated that without hedges, a 1 % appreciation of the €euro against all other currencies would generate a loss of €30 million.
In 2006, Renault mainly worked (outside Europe) with the pound sterling and the Korean won. Renault estimated that a 1 % appreciation of the €euro against sterling without hedging would have a negative impact of €16 million on operation margin.
2.2.1.2. Financial results
Foreign exchange risk can have a huge impact on financial results.
2.2.1.3. Impact on share in the net income of associated companies
Without hedging, according to Volvo's and Nissan's financial contributions to Renault in 2006, a 1 % appreciation of the €euro :
against the Japanese yen would have lessened Nissan's contribution to Renault's income by €19 millions
against the Swedish krona would have lessened Volvo's contribution to Renault's income by €4 million
2.2.1.4. Impact on shareholders' equity and net financial debt.
Equity investments in other currencies than €euro are not usually hedged, but are adjusted.
However, a portion of Renault's financial debt is denominated in Yen (see point 3.2.1.4) in order to cover a part of the investment in Nissan. Indeed, a 1 % increase in the €euro against the Yen would generate a €49 million reduction in the net financial debt.
2.2.2. Interest rate risk
Interest rate risk can be estimated according to debt and financial investments, at fixed or variable rate.
2.2.3. Counterparty risk
Counterparty risk occurs when one of Renault's financial partners cannot meet its commitments, causing losses or prejudices to Renault.
Renault is exposed to counterparty risk in its financial market and banking transactions, in its management of foreign exchange and interest rate risk, and in the management of its payment flows.
2.2.4. Liquidity risk
Renault must be careful and always have enough financial resources both to finance the day-to-day running of the business and the investments required for future expansion, but also to face any extraordinary events.
2.2.5. Commodity risk
The commodity risk is related to important fluctuations in the raw material prices. Renault commodity risks mainly concern the purchase of copper, aluminum and platinum.
Customer risk
Customer risk is the risk of non-payment by customers. Before selling the car to customers who need loans, Renault has to assess risks concerning their solvency.
Legal risk
Sometimes the group uses patents held by other parties. Therefore, Renault has to negotiate licensing agreements with them. On the contrary, Renault also grants patents to third parties.
In order to assess this risk, Renault has developed scoring systems, monitoring by customer type (consumer, corporate and network) and comprehensive and individual dispute management.
Nevertheless, the group could be affected by recommendations for amending Directive 98/71 on the legal protection of designs and models. Indeed, these recommendations aim at abolishing the protection of spare parts under design and model law. If the amended version of the Directive were adopted, there would be a negative impact on Renault's earnings.
2.5. Other risks
2.5.1. Off-balance sheet commitments
The off-balance sheet commitments refer to the guarantees and endorsements granted by Renault in its business, as well as saving plans in Argentina. However, no off-balance sheet commitments have an important impact on the group.
2.5.2. Risks linked to pension commitments
Renault is present in countries where - most of the time - pension systems are publicly run. These pension commitments consist primarily of retirement compensation, and are only sensitive to changes in the labor factors and interest rates, which aren't very volatile in the countries where Renault operates.
2.5.3. Tax and customer risk
Renault can be inspected in the countries where it runs its business, and tax arrears can be demanded. Valid demands for tax arrears are booked (provisions) whereas disputed demands are taken into account on a case-by-case basis.
Dispute risks
Renault is involved in various legal proceedings linked to the use of its products. Nevertheless, none of them is considered as "dangerous" for Renault, insofar as they won't affect its assets, financial position, activities or earnings.
According to the presentation of Renault's business model (cf question 1), the most important risks Renault has to face are the operational and financial risks.
Let's analyze these two types of risks in question 3.
Analysis of the tools adopted in risk management by your company
Renault has developed risk management, which aims at anticipating and controlling the risks arising from its activities and international development. As a consequence, the group has to analyze the operational and financial risks, and to decide on action plans to avoid risks.
3.1. Operational risks
3.1.1. Geographical risks
In order to minimize geographical risks related to Renault's international growth outside Europe, the group has diversified its risks by being present both in risky/non risky countries. This classification is made according to the Coface, the export credit insurance agency. Thus, the industrial risks while developing outside Europe were taken into account in the growth strategy.
Moreover, in order to hedge its financial flows from commercial activities in emerging countries, Renault uses two main instruments: bank guarantees (Standby Letters of Credit from leading bank) and short-term export credit guarantees (global/commercial/political cover from Coface).
In order to improve its geographical management risk, Renault has developed tools taking into account country risk premium, short-term liquidity risk, and intra-group financial flows.
3.1.1.1. Country risk premium
Geographical risks are taken into account by demanding a higher rate of return for every new investment project in a country considered as "risky". The risk premium added to the standard rate of return is determined by the financial market and macroeconomic indicators.
3.1.1.2. Short-term liquidity risk
By monitoring liquidity risk, Renault can adjust its subsidiaries financing policy according to the situation in each country, and the financial datas.
3.1.1.3. Intra-group financial flows
A finance and invoicing system is used to centralize management of financial risks.
3.1.2. Product quality risks
The organization put in place by Renault aims at limiting the number of cars dangerous to use. The safety impact of incidents are assessed and Renault deals with the risk as quickly as possible (namely thanks to recall campaigns).
Moreover, to decrease these types of risks, Renault established a set of best practices, trains staff in general product safety, and improves its risk control practices.
3.1.3. Supplier risk
Purchases account is an important part of Renault's costs. As a consequence, purchasing terms and conditions - namely prices, delivery times and payment periods - must be carefully negotiated. Besides, the suppliers must have good financial performances.
In addition, the suppliers must comply with regulations and sustainable development obligations. That's why in 2004 the Purchasing Department created a sustainable development action plan which incorporates sustainable development criteria into purchasing processes, provides training on changes in processes based on sustainable development criteria, and investigates the position of suppliers with respect to Renault's sustainable development's requirements.
3.1.4. Industrial risk
Renault has a prevention policy which covers all its production plants and applies both to employees and property. Central experts establish measures for all Renault plants all around the world and keep risk analyses up to date. These experts are supported by local teams in each plant: they all received trainings in industrial risks. Finally, each year four different insurance companies check the application of prevention and protection rules.
3.1.5. Environment risk
Because of the legislation - and in order to preserve its image - Renault has to put a great emphasis on environmental risks. Therefore, Renault has defined methods and identified risks on all its plants. By this way, it is able to quantify impacts of these risks, and to organize their prevention.
More precisely, these measures cover environmental risks and their potential damage to people. Moreover, they deal with the rehabilitation of areas where soil was polluted because of the past activities, and finally, with environmental audits for purchase and sale agreements. As a consequence of these measures, Renault can understand properly the environmental issues of each plant, and identify sources of pollution both by type of pollutant and business activity.
3.1.6. IT risk
To ensure the continuity of the network and to protect datas, Renault has developed a special unit called "Quality and security department" (DQS) within the Information technologies and systems department. DQS is in charge of developing prevention programs including IT security standards and procedures, and collaboration on IT projects and developments. Furthermore, it has to establish a multi-year site supervision plan, and IT audits.
3.1.7. Distribution risk
Renault's distribution risk management takes into account the three levels at which it is exposed to risk: import subsidiaries, distribution subsidiaries, and dealership network.
Concerning import subsidiaries, measures have been taken in order to control costs and financial assistances paid. Moreover, auditors inspect the network in some countries to ensure that dealerships can substantiate the assistance received.
Distribution subsidiaries are internally controlled, on the basis of standards and procedures developed in the Internal Control Quality. The subsidiaries of all the countries in which Renault operates are controlled.
Concerning dealership networks, Renault either uses a rating system to prevent and limit the risk of default or outstanding accounts; or it sets up a credit monitoring system thanks to a Risk supervision committee (it depends on the countries).
In order to respond to operational risks, Renault has developed efficient solutions and measures. Moreover, the group uses an insurance for these types of risks. Indeed, high-impact low-probability risks are transferred to the insurance and reinsurance markets, whereas common risks are provisioned by Renault. Finally, Renault negotiates global insurance policies an overall cover.
3.2. Financial risks
Several departments at Renault are in charge of market risks management: Central cash management department, Renault Finance, and Société financière and foncière. Moreover, Sales financing manages hedges the risks related to the financing of the sales and inventories of the distribution networks.
Furthermore, financial risks are monitored on three levels: by operational staff and managers, by internal controllers (under the responsibility of each entity's CEO), by control bodies (Renault's Internal audit or external auditors). Besides, each level has its own monitoring, control and monthly reporting resources.
3.2.1. Exchange rate risk
It has impacts on operating margin, financial results, share in the net income of associated companies, shareholders' equity, and net financial debt.
3.2.1.1. Operating margin
Currency hedges must be authorized by the Finance Department or senior management. Once put in place, reports must be submitted to senior management on the results. The main hedge in 2006 covered net commercial cash flows in sterling and ended in December 2006.
3.2.1.2. Financial results
Investments by automobile subsidiaries are mainly financed through equity contributions, the other requirements being dealt in local currency by Renault. In order to avoid any exchange rate fluctuation and impact on the financial results, financial flows in foreign currencies must be hedged by Renault in the same currency.
However, when subsidiaries can't be refinanced by Renault, they have to use external funding sources. These external financings in non-local currency are followed by Renault. Moreover, when cash surpluses are reported in weak-currency countries, and are not centralized by Renault's headquarters, deposits are made in the local currency or in a stronger currency under the control the Renault's Finance department.
Thus, Renault's foreign-exchange risk exposures are avoided, and are included in a monthly report.
3.2.1.3. Impact on share in the net income of associated companies
Renault must imperatively hedge its transactions to avoid risks of decreases in associated companies financial contribution. A slight change in the rate can have huge impacts in contributions (see point 2.2.1.3).
3.2.1.4. Impact on shareholders' equity and net financial debt.
Although equity investments in other currencies than €euro are usually not hedged, the Nissan investment was such a huge transaction that Nissan's shareholders' equity in Yen has been covered by a specific foreign exchange hedge, and reached Yen 780 billion in December 2006.
3.2.2. Interest rate risk
The interest rate management policy is based on the financing of long-term investments at fixed interest rates, whereas liquidity reserves are built at variable rate. For example, Nissan's shareholders' equity financing has been hedged in Yen at fixed rates for periods going from one month to seven years.
Renault's financial liabilities reached €9,582 million on December 2006. After using derivatives, €4,972 million were based on Yen (Yen 780 billion), either in yen-dominated paper or in synthetic debt (€euro loans swapped for Yen).
3.2.3. Counterparty risk
Renault coordinates the management of counterparty risk by using a rating system based on counterparties' long-term credit rating as well as the level of their shareholders' equity.
Furthermore, Renault has created a consolidated monthly reporting system which gathers all its counterparties, organized by credit rating. By this way, a detailed analysis according to compliance and with limits in the field of amount, term and type is given.
3.2.4. Liquidity risk
Renault mainly finances its activities thanks to the capital markets and long-term financial instruments, namely bond insurance and private placement. By this way, Renault always has a minimum level of cash reserves.
However, to diversify its sources of long-term financing, Renault has increased its presence in the Japanese bond market since 2001 by issuing bonds (five Samurai bonds).
Furthermore, its main sources of short-term financing are commercial papers.
3.2.5. Commodity risk
Renault's Purchasing department can hedge commodity risk thanks to financial instruments. However, only physical purchases needed by Renault's plants, and made by the Purchasing department and the Renault-Nissan Purchasing organization can be hedged.
All the hedging transactions are made by Renault Finance, which mainly watches the metals markets. Moreover, Renault Finance has extended this trading and monitoring activity to the Nissan's group.
Besides, these transactions are authorized by senior management, which limits the volumes, maturity, and prices. The hedge performances are then reviewed in monthly reports. Commodity hedge decisions are made by a steering committed with the CFO and the executive vice president purchasing.
Analysis of the effectiveness of use of the hedging techniques with the derivatives
Hedging techniques with the derivatives are used in the field of operational and financial risk management.
4.1. Derivatives and operational risk management
Concerning operational risks, derivatives are used for supplier risks. Nevertheless, even if hedging techniques are used for geographical risk, no derivatives could be used.
4.1.1. Supplier risk
Renault has to hedge its purchases since its purchases account is heavy. As a consequence, it is important to hedge its purchasing terms and conditions, such as prices, delivery times and payment periods.
Renault can use either futures or forwards contracts to hedge its purchases. However, futures contracts would be more appropriated for two main reasons. On the one hand, Renault's purchases are mainly metals, and futures contracts are available on such commodities. On the other hand, futures contracts are less expensive than forwards contracts, since they are standardized.
4.1.2. Geographical risk
Renault, because of its growth strategy, is present in countries considered as "risky" (especially emerging countries). As a consequence, Renault has to hedge its financial flows from commercial activities in emerging countries. It uses two instruments: bank guarantees such as standby letters of credit, and short-term export credit guarantees.
No derivatives could be used here since Renault doesn't seek to secure a future delivery of an asset at a pre-specified price.
4.2. Derivatives and financial risks
4.2.1. Foreign exchange risk
Renault needs to hedge its foreign exchange risk since it sells cars in different countries, some of them being outside Europe. The use of derivatives and currency hedges (foreign currency futures) are indispensable in order to preserve the operating margin, financial results, share in the net income of associated companies, shareholders' equity, and net financial debt.
4.2.2. Interest rate risk
Renault's liquidity reserves are built at variable rate, whose change can impact the amount of interests.
On the Japanese market (alliance with Nissan) Renault used swaps, but it also could have used hedging techniques such as fixed rate of interests, convertible loan stock, interest rate collar, or financial futures.
4.2.3. Commodity risk
The supplier risk (point 4.1.1) developed below can be assimilated to the commodity risk insofar as the main issue was to secure purchasing terms and conditions (prices, delivery times, payment periods). The main commodities Renault has to buy are copper, aluminum and platinum, whose price can sharply fluctuate. As a consequence, Renault can either use forwards or futures to hedge their purchase.
Sources
www.renault.com
Renault 2006 registration document
Wikipedia
"l'alliance de deux entreprises automobiles : Renault et Nissan" on www.oboulo.com
