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, China, Singapore 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

Maturity of liabilities and cash outflows

 

 

 

 

 

 

 

In € millions

 

Less than 1 year

 

Between 1 and 5 years

 

Over
5 years

 

 

 

 

 

 

 

At December 31, 2014

 

 

 

 

 

 

Borrowings

 

805

 

1,210

 

1,275

Interest on borrowings

 

103

 

228

 

93

Finance lease liabilities

 

6

 

17

 

25

Trade and other payables

 

3,362

 

 

 

 

 

 

 

 

 

Fx contracts (hedges)

 

 

 

 

 

 

Outflow

 

2,196

 

 

Inflow

 

(2,188)

 

 

 

 

 

 

 

 

 

Other derivatives

 

 

 

 

 

 

Outflow

 

14

 

10

 

Inflow

 

 

(4)

 

Total

 

4,298

 

1,461

 

1,393

 

 

 

 

 

 

 

At December 31, 2015

 

 

 

 

 

 

Borrowings

 

425

 

845

 

1,275

Interest on borrowings

 

71

 

186

 

65

Finance lease liabilities

 

5

 

18

 

23

Trade and other payables

 

3,408

 

 

 

 

 

 

 

 

 

Fx contracts (hedges)

 

 

 

 

 

 

Outflow

 

2,630

 

 

Inflow

 

(2,641)

 

 

 

 

 

 

 

 

 

Other derivatives

 

 

 

 

 

 

Outflow

 

28

 

27

 

Inflow

 

(2)

 

 

Total

 

3,924

 

1,076

 

1,363

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 2015, we had €1.4 billion available as cash and cash equivalents (2014: €1.7 billion), see Note 16. In addition, we have a €1.8 billion multi-currency revolving credit facility, which was amended and extended in 2015 by two additional years to 2020. This facility does not contain financial covenants or acceleration provisions that are based on adverse changes in ratings or on material adverse change. At year-end 2015 and 2014, this facility had not been drawn. We have US dollar and euro commercial paper programs in place, which can 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 2015 and 2014. The table above shows our cash outflows per maturity group. The amounts disclosed in the table are the contractual undiscounted cash flows.

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

At year-end 2015, the credit risk on consolidated level was €4.3 billion (2014: €4.7 billion) for cash, loans, trade and other receivables. Our credit risk is well spread among both global and local counterparties. Our largest counterparty risk amounted to €249 million at year-end 2015 (2014: €194 million).

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

 

2014

 

2014

 

2015

 

2015

US dollar

 

289

 

649

 

211

 

324

Pound sterling

 

212

 

103

 

554

 

66

Swedish krona

 

350

 

45

 

304

 

53

Chinese yuan

 

67

 

90

 

19

 

171

Other

 

355

 

385

 

562

 

705

Total

 

1,273

 

1,272

 

1,650

 

1,319

Investments in foreign subsidiaries, associates and joint ventures

Net investment hedge accounting was applied on hedges of pound sterling net investments in foreign operations which were hedged by a £250 million bond. During 2015 this hedge relationship was de-designated; until de-designation the hedge was fully effective. During 2015 net investment hedge accounting was applied to hedges of Chinese yuan net investments in foreign operations. During 2015 this hedge was fully effective. No net investment hedging is applied on pound sterling hedges and Chinese yuan hedges at year-end 2015.

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. The fair value of the contracts outstanding at year-end 2015 amounted to a loss of €20 million, net of tax, recorded in equity (year-end 2014: a loss of €8 million, net of tax), which are expected to affect profit within the next three years. All contracts qualified as effective for hedge accounting. In order to hedge the oil price risk, we have entered into oil/gas swap contracts. At the end of 2015, the contracts outstanding have a fair value of €2 million gain, net of tax on those contracts. The fair value of the contracts at the year-end 2014 was a €3 million gain, 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 Nasdaq commodities, based on expected use of electricity over the period 2016–2020. 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 €22 million loss net of tax, recorded in equity (year-end 2014: a loss of €11 million, net of tax), which are expected to affect profit within the next five years. All hedges were effective in 2015 and 2014.

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. Fixed rate debt maturing within one year is treated as floating rate debt. The fixed/floating rate of our outstanding bonds shifted from 79 percent fixed at year-end 2014 to 86 percent fixed at year-end 2015. During 2015, we have not used any interest rate derivatives.

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 & Poor’s. 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. In March 2015, a bond of €621 million matured.

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 2015 at year-end amounted to 0.58 (2014: 0.45). Funds from operations are based on net cash from operating activities after tax, 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 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 post-retirement benefit obligations and lease commitments.

Fair value of financial instruments and IAS 39 categories

Loans, 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, 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)

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

 

 

 

 

 

 

 

 

 

 

 

 

 

2014 year-end

 

 

 

 

 

 

 

 

 

 

 

 

Other financial non-current assets

 

797

 

529

 

268

 

 

268

 

289

Trade and other receivables

 

2,743

 

227

 

2,499

 

16

 

2,515

 

2,515

Cash and cash equivalents

 

1,732

 

 

 

1,732

 

1,732

 

1,732

Total financial assets

 

5,272

 

756

 

2,767

 

1,748

 

4,515

 

4,536

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term borrowings

 

2,527

 

 

2,527

 

 

2,527

 

2,775

Short-term borrowings

 

811

 

 

811

 

 

811

 

819

Trade and other payables

 

3,407

 

1,215

 

2,149

 

45

 

2,194

 

2,191

Total financial liabilities

 

6,745

 

1,215

 

5,487

 

45

 

5,532

 

5,785

 

 

 

 

 

 

 

 

 

 

 

 

 

2015 year-end

 

 

 

 

 

 

 

 

 

 

 

 

Other financial non-current assets

 

903

 

666

 

237

 

 

237

 

255

Trade and other receivables

 

2,741

 

217

 

2,500

 

24

 

2,524

 

2,524

Cash and cash equivalents

 

1,365

 

 

 

1,365

 

1,365

 

1,365

Total financial assets

 

5,009

 

883

 

2,737

 

1,389

 

4,126

 

4,144

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term borrowings

 

2,161

 

 

2,161

 

 

2,161

 

2,336

Short-term borrowings

 

430

 

 

430

 

 

430

 

436

Trade and other payables

 

3,473

 

1,271

 

2,137

 

65

 

2,202

 

2,202

Total financial liabilities

 

6,064

 

1,271

 

4,728

 

65

 

4,793

 

4,974

Level 1 fair valuation methods were used for bonds issued (€2.5 billion), of which €2.2 billion of the long-term borrowings and €0.3 billion of the short-term borrowings. All other fair values were determined using level 2 fair valuation methods, except for €110 million level 3 (discounted cash flow) fair valuation.

Master netting agreements

We enter into derivative transactions under International Swaps and Derivatives Association (ISDA) master netting agreements. In general, under such agreements the amounts owed by each counterparty on a single day in respect of transactions outstanding in the same currency may be aggregated into a single net amount that is payable by one party to the other. In certain circumstances – e.g. when a credit event such as a default occurs – all outstanding transactions under the agreement may be terminated, the termination value is assessed and a net amount is payable in settlement of the transactions.

We have evaluated the potential effect of netting agreements including the potential effect of rights of set-off. We did not offset any amounts regarding derivative transactions, but we did offset bank balances for immaterial amounts.

Sensitivities on financial instruments at year-end 2015

 

 

 

 

 

Sensitivity object

 

Sensitivity

 

Hypothetical impact

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: €2 million (2014: profit €7 million). Equity: €nil (2014: €nil)

 

 

 

 

 

A 10 percent strengthening of the euro versus the Pound sterling

 

Profit: €2 million (2014: profit €3 million). Equity: €nil (2014: €nil)

 

 

 

 

 

A 10 percent strengthening of the euro versus Swedish krona

 

Profit: €nil million (2014: profit €2 million). Equity: €nil (2014: €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 (€3 per MWh) as compared with the market prices (up/down)

 

Equity: €11 million (2014: €16 million)
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 (€2 per MWh) as compared with market prices (up/down)

 

Equity: €6 million (2014: €7 million)
We apply cash flow hedge accounting to the fair value changes of electricity futures

 

 

 

 

 

Oil price Specialty Chemicals Netherlands and Denmark:
A 10 percent change in price of oil (€3 per barrel) as compared with market prices (up/down)

 

Profit/(loss): €1 million (2014: €3 million)
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: €4 million (2014 profit: €nil million)

 

 

 

 

 

A 100 basis points increase of
US LIBOR interest rates

 

Profit: €1 million (2014 loss: €2 million)

 

 

 

 

 

A 100 basis points increase of
GBP LIBOR interest rates

 

Loss: €2 million (2014 profit: €1 million)