Note 27: Financial risk management

Financial risk management framework

Our activities expose us to a variety of financial risks: liquidity risk, credit risk and market risk (including foreign exchange risk, interest rate risk and capital 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, hedging and monitoring in the businesses. We have treasury hubs located in Brazil and China that are primarily responsible for regional cash management and short-term financing. We do not allow extensive treasury operations at subsidiary level directly with external parties.

Maturity of liabilities and cash outflows

In € millions

Less than 1 year

Between 1 and 5 years

Over 5 years

 

 

 

 

At December 31, 2020

 

 

 

Borrowings

33

1,259

1,274

Interest on borrowings

64

152

54

Lease liabilities

86

180

58

Trade and other payables

2,572

 

 

 

 

FX contracts (hedges)

 

 

 

Outflow

1,570

Inflow

(1,572)

Total

2,753

1,591

1,386

 

 

 

 

At December 31, 2021

 

 

 

Borrowings

1,469

1,006

776

Interest on borrowings

60

134

40

Lease liabilities

87

165

47

Trade and other payables

2,921

 

 

 

 

FX contracts (hedges)

 

 

 

Outflow

2,819

Inflow

(2,806)

Total

4,550

1,305

863

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 2021, we had €1.2 billion available as cash and cash equivalents (2020: €1.6 billion) and €58 million available as short-term investments (2020: €250 million), refer to Note 21.

In addition, we have a multi-currency revolving credit facility of €1.3 billion which was extended in 2021 to 2026. This facility does not contain financial covenants or acceleration provisions that are based on adverse changes in ratings or on other material adverse changes. At year-end 2021 and 2020, 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 €1.3 billion multi-currency revolving credit facility is not used. We had €371 million commercial paper outstanding at year end 2021 (2020: €nil) against an average negative interest rate of 0.5%. At year-end 2021, we had a €300 million short-term bank loan outstanding (2020: €nil) against a negative interest rate of 0.6%. Both facilities have a maturity of less than a year. Neither of these facilities contains financial covenants. The table on maturity of liabilities and cash outflows in this Note 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, deposits with financial institutions, money market funds, trade receivables and derivative financial instruments with a positive fair value. 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, short-term investments and transactions involving derivative financial instruments are entered into with counterparties that have sound credit ratings and a 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, refer to Note 17. Additionally, trade receivables and financial assets measured at amortized cost are subject to the expected credit loss impairment model either using the general or the simplified approach. For more information on the applied impairment approaches per financial asset type, refer to Note 1.

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

At year-end 2021, the credit risk on consolidated level was €3.9 billion (2020: €4.2 billion) for cash and cash equivalents, short-term investments, loans, trade and other receivables. Our credit risk is well spread among both global and local counterparties. Our largest counterparty risk amounted to €301 million at year-end 2021 (2020: €450 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 are partly netted out on group level. 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. Hedge accounting is generally not applied for foreign currency hedging activities, except for certain specific forecast transactions. In 2021, we applied cash flow hedge accounting on a COP 1.600 billion hedge of the foreign currency risk related to the intended acquisition of Grupo Orbis. The fair value of the hedge at year-end 2021 was €19 million negative and the spot result related to this hedge was recognized in other and accumulated in the cash flow hedge reserve. The hedge will mature mid-March 2022. During 2021, the hedge was fully effective.

In general, our forward exchange contracts have a maturity of less than one year. When necessary, forward exchange contracts are rolled over at maturity.

Hedged notional amounts at year-end

 

Buy

Sell

Buy

Sell

In € millions

2020

2020

2021

2021

US dollar

174

379

263

413

Pound sterling

485

31

601

45

Chinese yuan

31

179

145

Colombian peso

1

2

348

1

Other*

204

491

391

745

Total

895

903

1,782

1,349

*

No individually significant position is included in ‘Other’, the amounts per currency are highly disaggregated.

Currency derivatives are not used for speculative purposes.

Investments in foreign subsidiaries, associates and joint ventures

During 2021 and 2020, net investment hedge accounting was applied on hedges of certain net investments in foreign operations, which were partly hedged. The main net investments included were related to Brazilian real, Chinese yuan, Indonesian rupiah and Vietnamese dong (2020: Chinese yuan and Vietnamese dong), which were hedged with forward exchange contracts for the same currencies. The spot results related to these hedges were recognized in other comprehensive income and accumulated in the cumulative translation reserves. At year-end 2021, hedges of net investments Chinese yuan were outstanding, which were not material to the financial statements. During 2021 and 2020, these hedges were fully effective.

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. We treat fixed rate debt maturing within one year as floating rate debt for debt portfolio purposes. At the end of 2021, the fixed/floating ratio of our outstanding bonds was 70 percent fixed as we have one outstanding bond maturing within one year (2020: 100 percent fixed). During 2021 and 2020, we have not used any interest rate derivatives.

IBOR reform refers to the global reform of interest rate benchmarks, which includes the replacement of some interbank offered rates (IBOR) with alternative benchmark rates. Our long-term borrowings have fixed interest rates and we currently do not have any interest related hedging instruments. Fallback language has been added to our contracts while preparing for the transition to new rates. Based on this and following an internal assessment of the impact of the IBOR reform, we conclude that the interest rate benchmark reform does not have a material impact on the company’s financial statements.

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 an adequate financial strategy, with the objective to retain a strong investment grade credit rating as assigned by the rating agencies Moody’s and Standard & Poor’s. The capital structure can be altered, among others, by adjusting the amounts of dividends paid to shareholders, return of capital to capital providers, or issuance of new debt or shares. Consistent with other companies in the industry, we monitor capital headroom based on the /, for which we have set a target range of 1 to 2. The ratio was 1.6 in 2021 (2020: 0.8). EBITDA is the sum of , depreciation and amortization; for 2021 amounting to €1,469 million (2020: €1,324 million). Net debt is calculated as the total of long and short-term borrowings less cash and cash equivalents and short-term investments; for 2021 amounting to €2,340 million (2020: €1,034 million).

The part of long-term borrowings that is due within one year is presented under short-term borrowings. Short-term borrowings include the €750 million bond maturing in 2022.

Fair value of financial instruments and IFRS 9 categories

In the table “Fair value per financial instrument category” insight is provided in the recognition of the respective financial instruments per IFRS 9 category. The total carrying value is based on the accounting principles as outlined in Note 1. Financial instruments are recognized at fair value and subsequently recognized either at fair value or at amortized cost, using the effective interest method. The financial instruments accounted for at fair value through profit or loss are derivative financial instruments and securities included in financial non-current assets, cash and cash equivalents and short-term investments. The remaining financial instruments are accounted for at amortized cost.

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 instrument category

 

 

 

Carrying value per IFRS 9 category

 

 

In € millions

Carrying amount

Out of scope of IFRS 71

Measured at amortized cost

Measured at fair value through profit or loss

Total carrying value

Fair value of items measured at amortized cost

 

 

 

 

 

 

 

2020 year-end

 

 

 

 

 

 

Financial non-current assets

1,951

1,669

202

80

282

237

Trade and other receivables

1,994

121

1,863

10

1,873

1,863

Short-term investments

250

250

250

Cash and cash equivalents

1,606

1,606

1,606

Total financial assets

5,801

1,790

2,065

1,946

4,011

2,100

 

 

 

 

 

 

 

Long-term borrowings

2,771

2,771

2,771

2,995

Short-term borrowings

119

119

119

119

Trade and other payables

2,580

451

2,121

8

2,129

2,121

Total financial liabilities

5,470

451

5,011

8

5,019

5,235

 

 

 

 

 

 

 

2021 year-end

 

 

 

 

 

 

Financial non-current assets2

2,076

1,766

302

8

310

330

Trade and other receivables3

2,339

182

2,089

68

2,157

2,089

Short-term investments

58

58

58

Cash and cash equivalents

1,152

1,152

1,152

Total financial assets

5,625

1,948

2,391

1,286

3,677

2,419

 

 

 

 

 

 

 

Long-term borrowings

1,994

1,994

1,994

2,114

Short-term borrowings

1,556

1,556

1,556

1,570

Trade and other payables4

2,948

455

2,466

27

2,493

2,466

Total financial liabilities

6,498

455

6,016

27

6,043

6,150

1

Mainly includes pension assets (refer to Note 15), (non) income tax related receivables (refer to Note 17), payables to employees and (non) income taxes payables (refer to Note 22).

2

€302 million relates to loans and receivables (refer to Note 15), €8 million relates to other than financial instruments (refer to Note 15)

3

€2,089 million relates to the remainder of trade and other receivables (refer to Note 17), €68 million relates to FX contracts and the current portion of the escrow account for the Akzo Nobel (CPS) Pension Scheme in the UK

4

€2,466 million relates to the remainder of trade and other payables (refer to Note 22), €27 million relates to FX contracts

For the purpose of determining the fair value per financial instrument category, shown in the column ‘fair value’, the following valuation methods were used:

A level 1 valuation method was used to estimate the fair value of the bonds issued included in our long-term and short-term borrowings. The estimate is 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.

A level 2 valuation method was used to determine the fair value of marketable securities included in cash and cash equivalents and short-term investments by obtaining the market price at reporting date. The fair value of foreign currency contracts and swap contracts was determined by level 2 valuation techniques using market observable input (such as foreign currency interest rates based on Reuters) and by obtaining quotes from dealers and brokers. A level 2 valuation method was used to determine the fair value of time deposits included in cash and cash equivalents and short-term investments using the market interest rate. The carrying amounts of cash and banks, trade receivables less allowance for impairment, other short-term borrowings and other current liabilities approximate fair value due to the short maturity period of those instruments and were determined using level 2 fair value methods. A level 3 fair valuation method (discounted cash flow) was used for the subordinated loan granted to the Pension Fund APF in the Netherlands, resulting in a fair value of €116 million.

Sensitivities on financial instruments at year-end 2021

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 the balance sheet at year-end.

A 10% (2020: 10%) strengthening of the euro versus US dollar

Profit €6 million (2020: profit €8 million); Other comprehensive income, profit €1 million (2020: €nil)

A 10% (2020: 10%) strengthening of the euro versus the pound sterling

Profit €1 million (2020: €nil)

A 10% (2020: 10%) strengthening of the euro versus Chinese yuan

€nil (2020: loss €1 million). Other comprehensive income, profit €2 million (2020: €nil)

A 10% (2020: 10%) strengthening of the euro versus Colombian peso

€nil (2020: €nil). Other comprehensive income, loss €35 million (2020: €nil)

Interest rate:

 

 

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 EUR interest rates

Loss: €11 million (2020: profit €8 million)

A 100 basis points increase of USD interest rates

Profit: €nil million (2020: profit €1 million)

A 100 basis points increase of GBP interest rates

Profit: €1 million (2020: profit €1 million)

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 effect of rights of set-off and concluded the impact is immaterial. We did not offset any amounts regarding derivative transactions.

Comprehensive income

The change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with shareholders in their capacity as shareholders.

Leverage ratio

Calculated as net debt divided by EBITDA, which is calculated as the total of the last 12 months.

Net debt

Defined as long-term borrowings plus short-term borrowings less cash, cash equivalents and short-term investments.

EBITDA

Operating income excluding depreciation and amortization.

Operating income

Operating income is defined in accordance with IFRS and includes the relevant identified items. Adjusted operating income excludes identified items.