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Note 22: 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. We centrally identify, evaluate and hedge financial risks , and monitor compliance with the corporate policies approved by the Board of Management, except for commodity risks, which are subject to identification, evaluation and hedging in the businesses. We have treasury hubs located in Brazil, Asia and the US that are primarily responsible for regional cash management and short-term financing. We do not allow for extensive treasury operations at subsidiary level directly with external parties

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 2012, we had €1.8 billion available as cash and cash equivalents (2011: €1.6 billion), see Note 12. In addition, we have a €1.8 billion multi-currency revolving credit facility originally expiring in 2016. In 2012 the maturity of €1.7 billion of this facility has been extended with an additional year to 2017. At year-end 2012 and 2011, this facility had not been drawn. We have US dollar and euro commercial paper programs in place, which can only be used to the extent that the equivalent portion of the €1.8 billion multi-currency revolving credit facility is not used. We had no commercial paper outstanding at year-end 2012 and 2011. 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 one year

 

Between one and five years

 

Over five years

 

 

 

 

 

 

 

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

 

3,369

 

 

 

 

 

 

 

 

 

Fx contracts (hedges)

 

 

 

 

 

 

Outflow

 

2,676

 

 

Inflow

 

(2,687)

 

 

 

 

 

 

 

 

 

Other derivatives

 

 

 

 

 

 

Outflow

 

19

 

14

 

Inflow

 

(11)

 

 

Total

 

4,038

 

2,618

 

877

 

 

 

 

 

 

 

At December 31, 2012

 

 

 

 

 

 

Borrowings

 

656

 

1,794

 

1,548

Interest on borrowings

 

211

 

332

 

121

Finance lease liabilities

 

6

 

17

 

29

Trade and other payables

 

3,242

 

 

 

 

 

 

 

 

 

Fx contracts (hedges)

 

 

 

 

 

 

Outflow

 

2,380

 

 

Inflow

 

(2,417)

 

 

 

 

 

 

 

 

 

Other derivatives

 

 

 

 

 

 

Outflow

 

12

 

14

 

Inflow

 

 

 

Total

 

4,090

 

2,157

 

1,698

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 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 financial 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. We set limits per counterparty for the different types of financial instruments we use. We closely monitor the acceptable financial 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. The credit risk from trade receivables is measured and analyzed at a local operating entity level, mainly by means of ageing analysis, see Note 11.

Generally, the maximum exposure to credit risk is represented by the carrying value of financial assets in the balance sheet.

At year-end 2012, the credit risk on consolidated level was €4.5 billion (2011: €4.6 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 €230 million at year-end 2012.

Foreign exchange risk management

Trade and financing transactions

We operate in a large number of countries, where we have clients and suppliers, many of whom are outside of the local functional currency environment. This creates currency exposure which is partly netted out on consolidation.

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

 

2011

 

2011

 

2012

 

2012

US dollar

 

619

 

1,062

 

273

 

616

Pound sterling

 

222

 

501

 

68

 

541

Swedish krona

 

306

 

6

 

275

 

58

Other

 

445

 

334

 

273

 

517

Total

 

1,592

 

1,903

 

889

 

1,732

Investments in foreign subsidiaries, associates and joint ventures

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 2012 the hedge was fully effective.

In 2011 and 2012 we applied cash flow hedge accounting of CNY793 million for an acquisition of which CNY242 million was still outstanding at the end of 2012. There was no material gain/loss in 2012 on the effective hedges (2011: €11 million gain). An amount of €8 million has been recognized as consideration paid in Note 2. In the cash flow hedge reserve the remaining 2011 gain of €3 million was recorded, which will be included in the consideration paid in 2013 and 2014.

The foreign exchange and interest rate risks related to divestments amounting to $201 million and CAD190 million were hedged using forward contracts and cash flow hedge accounting was applied. The gain on the effective hedges amounted to €5 million of which €2 million relates to a divestment completed in 2012 which is included in the net cash flow in Note 2. The remaining €3 million gain in the cash flow hedge reserve will be included in the net cash flow on divestments in 2013.

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 Chlor Alkali activity in the Netherlands mitigates price risks related to electricity by concluding electricity futures to gradually cover the expected use over future periods. We apply cash flow hedge accounting to these futures. All contracts qualified as effective for hedge accounting. The fair value of the contracts outstanding at year-end 2012 amounted to a loss of €10 million, net of tax (year-end 2011: a loss of €7 million, net of tax). In the cash flow hedge reserve a loss of €10 million net of tax was recorded (year-end 2011: a loss of €11 million net of tax), which is expected to affect profit within the next three years.

In order to hedge the oil price risk, we have entered into oil/gas swap contracts. At the end of 2012, the fair value of these contracts amounted to a loss of €4 million net of tax (year-end 2011: €3 million loss net of tax). We did 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 2013 – 2017. 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 €10 million loss net of tax in equity (2011: €9 million net deferred loss), which are expected to affect operational cost within the next five years. All hedges were effective in 2012 and 2011.

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 94 percent fixed at year-end 2011 to 88 percent fixed at year-end 2012. During 2012, 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 €13 million was amortized to the statement of income in 2012 on the interest line.

The effective interest rate (excluding hedge results) over 2012 was 5.63 percent (2011: 6.60 percent). Combined with the amortization of interest rate swaps closed out in 2011, the effective interest rate was 5.24 percent (2011: 6.22 percent).

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 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 other companies 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 2012 at year-end amounted to 0.30 (2011: 0.34). 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 2012, a bond was issued with a nominal value of €750 million maturing in 2022 at a coupon rate of 2.625 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.

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 and electricity 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)

Level 1 fair valuation methods were used for €3.6 billion of the long-term borrowings and €0.5 billion of the short-term borrowings. All other fair values were determined using level 2 fair valuation methods.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

2011 year-end

 

 

 

 

 

 

 

 

 

 

 

 

Other financial non-current assets

 

1,187

 

860

 

327

 

 

327

 

338

Trade and other receivables

 

2,937

 

277

 

2,632

 

28

 

2,660

 

2,660

Cash and cash equivalents

 

1,635

 

 

 

1,635

 

1,635

 

1,635

Total financial assets

 

5,759

 

1,137

 

2,959

 

1,663

 

4,622

 

4,633

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term borrowings

 

3,035

 

 

3,035

 

 

3,035

 

3,341

Short-term borrowings

 

494

 

 

494

 

 

494

 

496

Trade and other payables

 

3,369

 

1,217

 

2,130

 

22

 

2,152

 

2,152

Total financial liabilities

 

6,898

 

1,217

 

5,659

 

22

 

5,681

 

5,989

 

 

 

 

 

 

 

 

 

 

 

 

 

2012 year-end

 

 

 

 

 

 

 

 

 

 

 

 

Other financial non-current assets

 

1,748

 

1,428

 

320

 

 

320

 

335

Trade and other receivables

 

2,698

 

244

 

2,438

 

16

 

2,454

 

2,454

Cash and cash equivalents

 

1,752

 

 

 

1,752

 

1,752

 

1,752

Total financial assets

 

6,198

 

1,672

 

2,758

 

1,768

 

4,526

 

4,541

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term borrowings

 

3,388

 

 

3,388

 

 

3,388

 

3,713

Short-term borrowings

 

662

 

 

662

 

 

662

 

678

Trade and other payables

 

3,242

 

1,240

 

1,990

 

12

 

2,002

 

2,002

Total financial liabilities

 

7,292

 

1,240

 

6,040

 

12

 

6,052

 

6,393

Sensitivities

 

 

 

 

 

Sensitivity object

 

Sensitivity, measured at year-end 2012

 

Hypothetical impact, net of tax

Foreign currencies:

 

 

 

 

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 possible 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.

 

A 10 percent strengthening of the euro versus US dollar

 

Profit: €4 million (2011: €nil)
Equity: €nil (2011: €nil)

 

 

 

 

 

A 10 percent strengthening of the euro versus the pound sterling

 

Profit: €5 million (2011: €1 million)
Equity: €nil (2011: €nil)

   

 

   

Net investment hedge accounting is applied to GBP250 million, which results in a sensitivity on equity of nil.

 

 

 

 

 

Commodity prices:

 

 

 

 

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.

 

Electricity price Specialty Chemicals Netherlands:

 

 

 

A 10 percent change in the forward price of electricity (€5 per MWh) as compared with the market prices (up/down)

 

Equity: €10 million. (2011 €11 million). (up/down)

   

We apply cash flow hedge accounting to the fair value changes of electricity futures).

 

Electricity price Specialty Chemicals Sweden and Finland:

 

 

 

A 10 percent change in the forward price on the Nord Pool exchange electricity (€3.76 per MWh) as compared with the market prices (up/down)

 

Equity: €10 million. (2011 €7 million). (down/up)

   

We apply cash flow hedge accounting to the fair value changes of electricity futures).

 

Oil price Specialty Chemicals Netherlands:

 

 

 

A 10 percent change in price of oil (€8 per barrel) as compared with market prices (up/down)

 

Profit: €8 million (2011: €6 million. (down/up)

   

Over the full term of the (partially long-term) contracts, net impact on profit will be €nil.

 

 

 

 

 

Interest rates:

 

 

 

 

We perform interest rate sensitivity analysis by applying an adjustment to the interest rate curve prevailing at year-end.
This adjustment is based on observed changes in the interest rate in the past and management expectation for possible future movements. We then apply the expected possible volatility to revalue all interest bearing assets and liabilities.

 

A 100 basis points increase of EURIBOR interest rates

 

Profit: €6 million (2011: €2 million).

 

 

 

 

 

A 100 basis points increase of US LIBOR interest rates

 

Loss: €4 million (2011: €1 million).

 

 

 

 

 

A 100 basis points increase of GBP LIBOR interest rates

 

Loss: €nil million (2011: €2 million).

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