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Note 24: Financial risk management


Financial risk management framework

Our activities expose us to a variety of financial risks: market risk (including: currency risk, fair value interest rate risk and price risk), credit risk and liquidity risk. These risks are inherent to the way we operate as a multinational with a large number of locally operating subsidiaries. Our overall risk management program seeks to identify, assess, and – if necessary – mitigate these financial risks in order to minimize potential adverse effects on our financial performance. Our risk mitigating activities include the use of derivative financial instruments to hedge certain risk exposures. The Board of Management is ultimately responsible for risk management. Day-to-day risk management activities are carried out by a central treasury department in line with clearly identified and formalized corporate policies and in line with the Treasury Statute. The treasury department identifies, evaluates and hedges financial risks at corporate level, and monitors compliance with the corporate policies approved by the Board of Management, except for commodity risks, which are subject to identification, evaluation and hedging at business unit level rather than at corporate level.

We have a Corporate Finance & Treasury Committee in place that advises on financial policies and risk management. The businesses play an important role in identifying financial risk factors within the boundaries set in the corporate policies. We have treasury hubs located in Brazil, Asia and the United States that are primarily responsible for local cash management and short-term financing. The Treasury Statute does not allow for extensive treasury operations to be executed at subsidiary level directly with external parties. It is corporate policy that derivatives are entered into through the treasury department.

The treasury department is responsible for internal controls over treasury operations and for reporting to the Board of Management on company-wide exposures on a number of financial risks. This includes information regarding liquidity, foreign exchange, interest rate, capital and credit risk.

Foreign exchange risk management

Trade and financing transactions

Our subsidiaries operate in a large number of countries. They have clients and suppliers in many countries, many of whom are outside of their functional currency environment. This creates currency exposure which is partly netted out on consolidation by the treasury department.

The purpose of our foreign currency hedging activities is to protect us from the risk that the functional currency net cash flows resulting from trade or financing transactions are adversely affected by changes in exchange rates. Our policy is to hedge our transactional foreign exchange rate exposures above predefined thresholds from recognized assets and liabilities. Cash flow hedge accounting is applied by exception. Derivative transactions with external parties are bound by overnight limits per currency.

In general, forward exchange contracts that we enter into have a maturity of less than one year. When necessary, forward exchange contracts are rolled over at maturity. Currency derivatives are not used for speculative purposes.

Hedged notional amounts at year-end

 

 

 

 

 

 

 

 

 

 

 

Buy

 

Sell

 

Buy

 

Sell

In € millions

 

2010

 

2010

 

2011

 

2011

US dollar

 

214

 

977

 

619

 

1,062

Pound sterling

 

659

 

158

 

222

 

501

Swedish krona

 

390

 

51

 

306

 

6

Other

 

304

 

302

 

445

 

334

Total

 

1,567

 

1,488

 

1,592

 

1,903

Sensitivity analysis

We perform foreign currency sensitivity analysis by applying an adjustment to the spot rates prevailing at year-end. This adjustment is based on observed changes in the exchange rate in the past and management expectation for possible future movements. We then apply the expected volatility to revalue all monetary assets and liabilities (including derivative financial instruments) in a currency other than the functional currency of the subsidiary in its balance sheet at year-end.

At year-end 2011, if the euro had weakened/strengthened by 10 percent against the US dollar with all other variables held constant, post-tax profit for the year would have been €nil million (2010: €2 million) lower/higher. At year-end 2011, if the euro had weakened/strengthened by 10 percent against the pound sterling with all other variables held constant, post-tax profit for the year would have been €1 million higher/lower (2010: €3 million lower/higher). For 2010 and 2011 the sensitivity on equity is for both USD and GBP nil.

Translation risk related to investments in foreign subsidiaries associates
and joint ventures

We have subsidiaries with a functional currency other than the euro. Therefore our consolidated financial statements are exposed to translation risk related to equity, intercompany loans of a permanent nature and earnings of foreign subsidiaries and investment in associates and joint ventures. In principle, we do not use financial instruments to hedge this risk.

In the following cases, we apply net investment hedge accounting. Net investment hedge accounting is applied on hedges of pound sterling net investments in foreign operations which were hedged by a £250 million bond. In 2011, the hedge was fully effective.

During 2011, $780 million of net investments in foreign operations held by a pound sterling subsidiary were refinanced from the euro holding company and the related net investment hedge matured.

In 2011, we applied cash flow hedge accounting for a number of acquisitions. Amounts totaling Hong Kong dollar 1.6 billion and CNY 793 million were hedged with forward contracts. The gain on the effective hedges amounted to €20 million of which €9 million relates to acquisitions completed in 2011 and is included in the amount recognized as consideration paid in Note 2. In the cash flow hedge reserve a gain of €11 million was recorded.

Price risk management

Commodity price risk management

We use commodities, gas and electricity in our production processes and we are particularly sensitive to energy price movements.

Our Specialty Chemicals companies in the US hedge the price risk on natural gas through buying natural gas futures on the New York Mercantile Exchange. At year-end 2011, the notional amounts of these futures are 2 million dekatherms, spread over all 12 months of 2012 (2010: 1.3 million dekatherms, spread over all 12 months of 2010). The total fair value of these futures is an asset of €5 million at year-end (2010: an asset of €5 million). No hedge accounting is applied to the changes of the fair value of these contracts.

To hedge the price risks related to energy supply in the Netherlands, we operate one power plant in joint venture with Essent/RWE in Delfzijl of 520 MW. AkzoNobel power plants are located in Hengelo (80 MW), Rotterdam (20 MW) and Mariager, Denmark (20 MW). The power plants transform natural gas into steam and electricity. The steam is used in our production facilities and excess electricity is sold on the market. The price for natural gas in our purchase contracts is hedged by means of forwards. To cover the price risk of the excess electricity sold on the market, electricity futures to sell electricity are concluded. We do not apply hedge accounting to the changes of the fair value of these futures. At the end of 2011, on balance no gas (purchase) forwards or electricity (selling) futures were outstanding.

Our Chlor Alkali activity in the Netherlands used to mitigate price risks related to electricity by concluding normal purchase contracts for electricity to be supplied in future periods. As of May 2011, this policy was changed. Going forward electricity futures are concluded to gradually cover the expected use over future periods. As a consequence of this change, the already outstanding normal purchase contracts going forward no longer qualified for the “own use” exemption in IAS 39. Their recognition at fair value resulted in a gain of €4 million, net of tax. Going forward we apply cash flow hedge accounting to these contracts and the newly concluded futures in order to mitigate the accounting mismatch that would otherwise occur. All contracts qualified as effective for hedge accounting. The fair value of the contracts outstanding at year-end 2011 amounted to a loss of €7 million, net of tax. In the cash flow hedge reserve a loss of €11 million, net of tax, was recorded. The amounts deferred in equity at year-end are expected to affect operational cost within the next three years. In order to hedge the oil price risk included in certain sales contracts, we have entered into oil/gas swap contracts. At the end of 2011, the fair value of these contracts amounted to a loss of €3 million net of tax (year-end 2010: €2 million loss net of tax). We did not apply hedge accounting to the changes of the fair values of these contracts. Income volatility caused by energy prices of the unit in Denmark is being hedged by electricity price swaps. At the end of 2011, we had no electricity swaps outstanding for our activities in Denmark (fair value of the contracts at year-end 2010: €1 million gain, net of taxes). We do not apply hedge accounting to the changes of the fair values of these contracts.

To hedge the price risk of electricity that is used for the Specialty Chemicals plants in Sweden and Finland, we entered into future contracts on the power exchange Nord Pool Spot, based on expected use of electricity over the period 2012 – 2014. We apply cash flow hedge accounting to these contracts in order to mitigate the accounting mismatch that would otherwise occur. The effective part of the fair value of these contracts amounted to a €9 million loss net of deferred taxes in equity (2010: €29 million net deferred gain). In 2011, nothing was recorded in cost of goods sold due to ineffectiveness (2010: € nil loss). The amounts deferred in equity at year-end are expected to affect operational cost within the next three years.

Sensitivity analysis

We perform our commodity price risk sensitivity analysis by applying an adjustment to the forward rates prevailing at year-end. This adjustment is based on observed changes in commodity prices in the previous year and management expectations for possible future movements. We then apply the expected volatility to revalue all commodity-derivative financial instruments in the applicable commodity in our balance sheet at year-end. For the purpose of this sensitivity analysis, the change of the price of the commodity is not discounted to the net present value at balance sheet date.

At year-end 2011, if a parallel adjustment of the price curve of natural gas by €5,000 per 10,000 dekatherms up/down as compared with the market prices prevailing at that date had occurred, with all other variables held constant, post-tax profit would have been €1 million (2010: €1 million) higher/lower. This is due to the fair value changes of natural gas derivatives.

At year-end 2011, if the forward price of electricity had weakened/strengthened by €5 per MWh (10 percent) as compared with the market prices prevailing at that date, with all other variables held constant, equity would have been €11 million lower/higher, net of tax. This is due to the fair value changes of electricity futures which have been accounted for under cash flow hedge accounting.

At year-end 2011, if the price of oil had weakened/strengthened by €8 per barrel (10 percent) as compared with the market prices prevailing at that date, with all other variables held constant, post-tax profit for 2011 would have been €6 million (2010: €2 million) higher/lower. Nevertheless over the full term of the (partially long-term) contracts, net impact on post-tax profit will be € nil.

At year-end 2011, if the forward price of electricity on the Nord Pool exchange had weakened/strengthened by €3.99 per MWh (10 percent) as compared with the market prices prevailing at that date, with all other variables held constant, equity would have been €7 million (2010: €13 million) higher/lower, net of tax. This is due to the fair value changes of electricity futures which have been accounted for under cash flow hedge accounting.

Cash flow and fair value interest rate risk management

We are partly financed with debt in order to obtain more efficient leverage. Fixed rate debt results in fair value interest rate risk. Floating rate debt results in cash flow interest rate risk. The fixed/floating rate of our outstanding bonds shifted from 80 percent fixed at year-end 2010 to 94 percent fixed at year-end 2011. During 2011, no interest rate swap contracts were outstanding.

Fair value hedges closed out in previous years resulted in an adjustment to the carrying amount of a bond of which €12 million was amortized to the statement of income in 2011 on the interest line.

The effective interest rate (excluding hedge results) over 2011 was 6.60 percent (2010: 6.64 percent). Combined with the amortization of interest rate swaps closed out in 2010, the effective interest rate was 6.22 percent (2010: 6.14 percent).

Sensitivity analysis

At year-end 2011, if EURIBOR interest rates had been 100 basis points higher/lower with all other variables held constant, post-tax profit for the year would have been €2 million higher/lower (2010: €5 million higher/lower).

At year-end 2011, if US LIBOR interest rates had been 100 basis points higher/lower, with all other variables held constant, post-tax profit for the year would have been €1 million lower/higher (2010: €nil million lower/higher).

At year-end 2011, if GBP LIBOR interest rates had been 100 basis points higher/lower, with all other variables held constant, post-tax profit for the year would have been €2 million higher/lower (2010: €1 million higher/lower).

Liquidity risk management

The primary objective of liquidity management is to provide for sufficient cash and cash equivalents at all times and any place in the world to enable us to meet our payment obligations. We aim for a well-spread maturity schedule of our long-term borrowings and a strong liquidity position.

At year-end 2011, we had €1.6 billion available as cash and cash equivalents (2010: €2.7 billion), see Note 15. In addition, we have a €1.8 billion multi-currency revolving credit facility expiring in 2016. At year-end 2011 and 2010, this facility had not been drawn. We have a $1.0 billion commercial paper program and a €1.5 billion euro commercial paper program, which had no paper outstanding at year-end 2011 and 2010. The US commercial paper program has been renegotiated and reactivated in January 2012 and the maximum has been increased to $3 billion. The commercial paper programs can only be used to the extent that the equivalent portion of the revolving credit facility is not used.

The table analyzes our cash outflows per maturity group based on the remaining period at balance sheet date to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows.

Maturity of liabilities and cash outflows

 

 

 

 

 

 

 

In € millions

 

Less than 1 year

 

Between 1 and 5 years

 

Over 5 years

 

 

 

 

 

 

 

At December 31, 2010

 

 

 

 

 

 

Borrowings

 

905

 

2,531

 

322

Interest on borrowings

 

238

 

673

 

12

Finance lease liabilities

 

2

 

8

 

Trade and other payables

 

3,305

 

 

 

 

 

 

 

 

 

FX contracts (hedges)

 

 

 

 

 

 

Outflow

 

2,350

 

 

Inflow

 

(2,267)

 

 

 

 

 

 

 

 

 

Other derivatives

 

 

 

 

 

 

Outflow

 

 

1

 

Inflow

 

44

 

 

Total

 

4,577

 

3,213

 

334

 

 

 

 

 

 

 

At December 31, 2011

 

 

 

 

 

 

Borrowings

 

489

 

2,219

 

812

Interest on borrowings

 

178

 

382

 

64

Finance lease liabilities

 

5

 

3

 

1

Trade and other payables

 

3,349

 

 

 

 

 

 

 

 

 

FX contracts (hedges)

 

 

 

 

 

 

Outflow

 

2,676

 

 

Inflow

 

(2,687)

 

 

 

 

 

 

 

 

 

Other derivatives

 

 

 

 

 

 

Outflow

 

19

 

14

 

Inflow

 

(11)

 

 

Total

 

4,018

 

2,618

 

877

Credit risk management

Credit risk arises from financial assets such as cash and cash equivalents, derivative financial instruments with a positive fair value, deposits with banks and financial institutions, and trade receivables.

We have a credit risk management policy in place to limit credit losses due to non-performance of financial counterparties and customers. We monitor our exposure to credit risk on an ongoing basis at various levels. We only deal with counterparties that have a sufficiently high credit rating. Generally, we do not require collateral in respect of financial assets.

Investments in cash and cash equivalents and transactions involving derivative financial instruments are entered into with counterparties that have sound credit ratings and good reputation. Derivative transactions are concluded mostly with parties with whom we have contractual netting agreements and ISDA agreements in place. The Treasury Statute sets limits per counterparty for the different types of financial instruments we use. We closely monitor the acceptable counterparty credit ratings and credit limits and revise where required in line with the market circumstances. We do not expect non-performance by the counterparties for these financial instruments.

Due to our geographical spread and the diversity of our customers, we were not subject to any significant concentration of credit risks at balance sheet date. Generally, the maximum exposure to credit risk is represented by the carrying value of financial assets, including derivative financial instruments, in the balance sheet. At year-end 2011, the credit risk on consolidated level was €4.6 billion (2010: €6.0 billion) for long-term borrowings given, trade and other receivables and cash. Our credit risk is well spread amongst both global and local counterparties. Our largest counterparty risk amounted to €150 million at year-end 2011. The credit risk from trade receivables is measured and analyzed at a local operating entity level, mainly by means of ageing analysis, see note 14.

Capital risk management

Our objectives when managing capital are to safeguard our ability to satisfy our capital providers and to maintain a capital structure that optimizes our cost of capital. For this we maintain a conservative financial strategy, with the objective to remain a strong investment grade company as rated by the rating agencies Moody’s and Standard & Poors. The credit rating at year-end 2011 was Baa1/BBB+ (year-end 2010: Baa1/BBB+). The capital structure can be altered, among others, by adjusting the amount of dividends paid to shareholders, return capital to capital providers, or issue new debt or shares.

Consistent with others in the industry, we monitor capital headroom on the basis of funds from operations in relation to our net borrowings level (FFO/NB-ratio). The FFO/NB-ratio for 2011 at year-end amounted to 0.34 (2010: 0.49). Funds from operations are based on net cash from operating activities, which is adjusted, among others, for the elimination of changes in working capital, additional payments for pensions and for the effects of the underfunding of pension and other post-retirement benefit obligations. Net borrowings is calculated as a total of long and short-term borrowings less cash and cash equivalents, adding an after-tax amount for the underfunding of pension and other post-retirement benefit obligations and lease commitments.

In 2011 we bought back bonds with nominal amounts of €175 million maturing in January 2014 and €353 million maturing in March 2015. A bond was issued with a nominal of €800 million maturing December 2018 at a coupon of 4 percent.

Fair value of financial instruments and IAS 39 categories

Loans and receivables and other liabilities are recognized at amortized cost, using the effective interest method. We estimated the fair value of our long-term borrowings based on the quoted market prices for the same or similar issues or on the current rates offered to us for debt with similar maturities.

The carrying amounts of cash and cash equivalents, trade receivables less allowance for impairment, short-term borrowings and other current liabilities approximate fair value due to the short maturity period of those instruments.

Fair value per financial instruments category

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying value per IAS 39 category

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In € millions

 

Carrying amount

 

Out of scope of IFRS 7

 

Loans and receivables/ other liabilities

 

At fair value through profit or loss

 

Total carrying value

 

Fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

2010 year-end

 

 

 

 

 

 

 

 

 

 

 

 

Other financial non-current assets

 

1,008

 

640

 

368

 

 

368

 

386

Trade and other receivables

 

2,788

 

257

 

2,497

 

34

 

2,531

 

2,531

Cash and cash equivalents

 

2,851

 

 

 

2,851

 

2,851

 

2,851

Total financial assets

 

6,647

 

897

 

2,865

 

2,885

 

5,750

 

5,768

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term borrowings

 

2,880

 

 

2,880

 

 

2,880

 

3,266

Short-term borrowings

 

907

 

 

907

 

 

907

 

914

Trade and other payables

 

3,305

 

1,361

 

1,807

 

137

 

1,944

 

1,944

Total financial liabilities

 

7,092

 

1,361

 

5,594

 

137

 

5,731

 

6,124

 

 

 

 

 

 

 

 

 

 

 

 

 

2011 year-end

 

 

 

 

 

 

 

 

 

 

 

 

Other financial non-current assets

 

1,187

 

860

 

327

 

 

327

 

338

Trade and other receivables

 

2,917

 

278

 

2,611

 

28

 

2,639

 

2,639

Cash and cash equivalents

 

1,635

 

 

 

1,635

 

1,635

 

1,635

Total financial assets

 

5,739

 

1,138

 

2,938

 

1,663

 

4,601

 

4,612

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term borrowings

 

3,035

 

 

3,035

 

 

3,035

 

3,341

Short-term borrowings

 

494

 

 

494

 

 

494

 

496

Trade and other payables

 

3,349

 

1,290

 

2,037

 

22

 

2,059

 

2,059

Total financial liabilities

 

6,878

 

1,290

 

5,566

 

22

 

5,588

 

5,896

The only financial instruments accounted for at fair value through profit or loss are derivative financial instruments and the short-term investments included in cash. The fair value of foreign currency contracts, swap contracts, forward rate agreements, oil contracts and gas futures was determined by valuation techniques using market observable input (such as foreign currency interest rates based on Reuters) and by obtaining quotes from dealers and brokers.

The following valuation methods for financial instruments carried at fair value through profit or loss are distinguished:

  • Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities
  • Level 2: inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices)
  • Level 3: inputs for the asset or liability that are not based on observable market data (unobservable).
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