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Note 24 Financial risk management
and financial instruments


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 (Corporate Treasury) in line with clearly identified and formalized corporate policies and in line with the Treasury Statute. Corporate Treasury identifies, evaluates and hedges financial risks at a 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 the CFO in respect of the financial policy and evaluates the scope and performance of liquidity, interest, credit and currency risk management.

The businesses play an important role in the process of identifying financial risk factors. Within the boundaries set in the corporate policies, the subsidiaries perform the appropriate risk management activities. We have treasury hubs which provide treasury services on behalf of Corporate Treasury to subsidiaries in their region. These treasury hubs are located in Brazil (São Paulo), Asia (Singapore/Shanghai) and the United States (Chicago) and 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 Corporate Treasury.

Corporate Treasury is responsible 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. In addition, Corporate Treasury is responsible for maintaining a robust set of internal controls over treasury operations. We use a well-known treasury management system to support our treasury activities.

Foreign exchange risk management

Trade and financing transactions

Our subsidiaries operate in a large number of countries, and as such have clients and suppliers in many countries. Many of these subsidiaries have clients and suppliers that are outside of their 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 eventual functional currency net cash flows resulting from trade or financing transactions are adversely affected by changes in exchange rates. Our policy defines that we hedge our transactional foreign exchange rate exposures above predefined thresholds from recognized assets and liabilities. Cash flow hedge accounting is applied by exception.

Corporate Treasury enters into derivative transactions with external parties and is bound by overnight limits per currency. Where hedging through Corporate Treasury is not feasible under local legislation, local hedging may take place.

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.

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. We have forward contracts to sell $780 million and buy £405 million, maturing in December 2011. This contract hedges the foreign currency risk on $780 million of net investments in foreign operations held by a pound sterling subsidiary. Net investment hedge accounting is also applied on hedges of pound sterling net investments in foreign operations which were hedged by a £250 million bond. In 2010, both of the hedges were fully effective.

In 2010, we applied cash flow hedge accounting for the acquisition of the acquired powder coatings activities. An amount of $130 million was hedged with forward contracts. The effective hedge realized a gain of €10 million which is included in the amount recognized in the statement of income in note 2.

The foreign exchange and interest rate risks on $800 million of the divestment of National Starch was hedged using forward contracts and cash flow hedge accounting was applied. A gain of €60 million was realized on the effective hedge and is included in the net cash inflow in note 7.

Foreign currency transaction risk

The table below presents a breakdown of the notional amounts of outstanding foreign currency contracts for entities with other functional currencies than the euro.

Hedged notional amounts at year-end

 

 

 

 

 

In € millions

Buy

Sell

Buy

Sell

 

 

 

 

 

 

2009

2009

2010

2010

US dollar

241

1,474

214

977

Pound sterling

848

144

659

158

Swedish krona

270

91

390

51

Other

296

252

304

302

Total

1,655

1,961

1,567

1,488

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 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.

At year-end 2010, 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 €2 million (2009: €6 million) lower/higher. At year-end 2010, 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 €3 million (2009: €1 million) lower/higher.

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 2010, the notional amounts of these futures are 1.3 million dekatherms, spread over all 12 months of 2011 (2009: 1.7 million dekatherms, spread over all 12 months of 2010). The total fair value change of these futures is € nil at year-end (2009: € nil). 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 a fixed or floating price. In order to hedge the price risk of natural gas in these contracts, we have partly entered into option contracts for the underlying oil price. In 2010 the fair value changes of these contracts amounted to a €2 million loss net of taxes (2009: €1 million loss). Income volatility caused by energy prices of the unit in Denmark has been hedged by an electricity price swap. The fair value changes of this contract amounted to a €1 million gain net of taxes (2009: € nil). We do not apply hedge accounting to the changes of the fair value of the hedge 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 2011 – 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 changes of these contracts amounted to a €29 million gain net of deferred taxes in equity (2009: €12 million net deferred loss). In 2010, nothing was recorded in cost of goods sold due to ineffectiveness (2009: € nil loss). The amounts deferred in equity at year-end are expected to affect operational cost within the next four 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 2010, if a parallel adjustment of the price curve of natural gas by €8,000 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 (2009: €2 million) higher/lower. This is due to the fair value changes of natural gas derivatives.

At year-end 2010, if the price of oil had weakened/strengthened by €7 per barrel (10 percent) as compared with the market prices prevailing at that date, with all other variables held constant, post-tax profit for 2010 would have been €2 million higher/lower (2009: € nil). Nevertheless over the full term of the (partially long-term) contracts, net impact on post-tax profit will be € nil.

At year-end 2010, if the forward price of electricity on the Nord Pool exchange had weakened/strengthened by €5,66 per MWh (10 percent) as compared with the market prices prevailing at that date, with all other variables held constant, equity would have been €13 million (2009: €8 million) higher/lower. 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 85 percent fixed at year-end 2009 to 80 percent fixed at year-end 2010.

We have entered into a number of interest rate swap contracts. A total of $500 million fixed rate liabilities with an interest rate of 5.625 percent were swapped with a three-month floating rate US dollar Libor plus an average of 1.1056 percent liabilities maturing in 2013. We classified these interest rate swaps as fair value hedges and recorded them at fair value until the derivatives were closed out in Q3 2010.

Fair value hedge accounting was applied to the above-mentioned interest rate swaps and fixed rate bond until close out date. During 2010, an amount of €16 million has been accounted for in the statement of income for fair value changes of the interest rate swaps and an amount of €15 million has been accounted for in the statement of income as an adjustment to the carrying amount of the hedged bond for fair value changes attributable to the hedged risk. The fully effective hedge relationship was discontinued following the close out of the interest rate swaps. Adjustments to the carrying amount of the hedged financial instrument have been amortized to profit and loss (interest).

The effective interest rate (excluding hedge results) over 2010 was 6.64 percent. Combined with the hedge result (interest rate swaps), the effective interest rate was 6.14 percent.

Sensitivity analysis

At year-end 2010, 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 €5 million higher/lower (2009: €6 million higher/lower).

At year-end 2010, 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 €nil million higher/lower (2009: €3 million lower/higher) .

At year-end 2010, 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 €1 million higher/lower (2009: €2 million higher/lower).

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. In the Treasury Statute limits are set per counterparty for the different types of financial instruments the company uses. We closely monitor the acceptable counterparty credit ratings and credit limits and revise where required in line with the market circumstances. We have no reason to 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 2010, the credit risk on consolidated level was €6.0 billion (2009: €5.0 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 €299 million at year-end 2010. 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.

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 2010, we had €2.7 billion available as cash and cash equivalents (2009: €1.9 billion), see note 15. In addition, we have a €1.5 billion multi-currency revolving credit facility expiring in 2013. Both at year-end 2010 and 2009, this facility had not been drawn. We have a commercial paper program in the US, which at both year-end 2010 and 2009 had a maximum of $1.0 billion and a euro commercial paper program, which at both year-end 2010 and 2009 ad a maximum of €1.5 billion. At December 31, 2010 and 2009, the commercial paper programs were not used. The commercial paper programs can only be used to the extent that the equivalent portion of the revolving credit facility is not used.

The below 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, 2009:

 

 

 

Borrowings

381

2,163

1,313

Interest on borrowings

236

771

93

Finance lease liabilities

3

11

Trade and other payables

2,866

Forward foreign exchange contracts (hedges):

 

 

 

– Outflow

2,372

569

– Inflow

(2,068)

(477)

Interest rate swaps:

 

 

 

– Outflow

12

47

– Inflow

(20)

(68)

Other derivatives:

 

 

 

– Outflow

103

26

– Inflow

(28)

(18)

Total

3,857

3,024

1,406

 

 

 

 

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

Forward foreign exchange contracts (hedges):

 

 

 

– Outflow

2,350

– Inflow

(2,267)

Other derivatives:

 

 

 

– Outflow

1

– Inflow

44

Total

4,577

3,213

334

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. The credit rating at year-end 2010 was Baa1/BBB+ (year-end 2009: Baa1/BBB+ with a negative outlook). 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 on the basis of funds from operations in relation to our net borrowings level (FFO/NB-ratio). The FFO/NB-ratio for 2010 at year-end amounted to 0.49 (2009: 0.23). 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.

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, 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

 

 

 

 

 

 

 

2009 year-end:

 

 

 

 

 

 

Other financial non-current assets

815

414

374

27

401

416

Trade and other receivables

2,564

246

2,290

28

2,318

2,318

Cash and cash equivalents

2,128

2,128

2,128

2,128

Total financial assets

5,507

660

2,664

2,183

4,847

4,862

 

 

 

 

 

 

 

Long-term borrowings

3,488

3,488

3,488

3,848

Short-term borrowings

384

384

384

384

Trade and other payables

2,866

1,231

1,523

112

1,635

1,635

Total financial liabilities

6,738

1,231

5,395

112

5,507

5,867

 

 

 

 

 

 

 

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

We have not applied the fair value option allowed under IFRS and reported certain energy purchasing contracts as held for trading. 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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