DCSIMG
24 Financial instruments and risks - Annual Report 2015 - DSM

24 Financial instruments and risks

Policies on financial risks

General

The main financial risks faced by DSM relate to liquidity risk and market risk (comprising interest rate risk, currency risk, price risk and credit risk). DSM’s financial policy is aimed at minimizing the effects of fluctuations in currency-exchange and interest rates on its results in the short term and following market rates in the long term. DSM uses financial derivatives to manage financial risks relating to business operations and does not enter into speculative derivative positions. DSM does not hold financial instruments with embedded derivatives. DSM's financial policy, including policies and processes for managing capital, is discussed more extensively in Financial and reporting policy of the Report by the Managing Board.

Liquidity risk

DSM has two committed credit facilities: one facility of €500 million issued in 2011 and maturing in September 2018 and one facility issued in 2013 of €500 million and maturing in April 2020. In 2013, the second extension option for the 2011 facility was executed to extend the final maturity by another year, which was accepted by all banks but one, i.e. the facility amount in the last year will be €445 million. In 2015, the second extension option for the 2013 facility was executed to extend the final maturity by another year, which was accepted by all banks but one. However the bank that did not accept was replaced by a bank that did accept the extension for the full amount and the full period, i.e. the amount of the facility remained €500 million. Together, the facilities amount to a total of €1,000 million (2014: €1,000 million).

Furthermore, DSM has a commercial paper program amounting to €1,500 million (2014: €1,500 million). The company will use the commercial-paper program to a total of not more than €1,000 million (2014: €1,000 million). The agreements for the committed credit facilities have neither financial covenants nor material adverse changes clauses. At year-end 2015, no loans have been taken up under the committed credit facilities. DSM has no derivative contracts to manage currency risk or interest rate risk outstanding under which margin calls by the counterparty would be permitted.

Floating-rate and fixed-rate borrowings and short-term monetary liabilities analyzed by maturity are summarized in the following table. Borrowings excluding credit institutions are shown after taking into account related interest rate derivatives in designated hedging relationships. DSM manages financial liabilities and related derivative contracts on the basis of the remaining contractual maturities of these instruments. The remaining maturities presented in the following table provide an overview of the timing of the cash flows related to these instruments. Financial assets are not linked to financial liabilities in order to meet cash outflows on these liabilities.

Table 1: Borrowings and short-term monetary liabilities by maturity

Borrowings and short-term monetary liabilities by maturity
2014
Fixed-rate
borrowings
Floating-rate
borrowings
Short-term
monetary liabilities
Subtotal
Interest payments
Cash at redemption1
Total cash out
               
Within 1 year
626
15
2,417
3,058
87
3
3,148
Within 1 to 2 years
11
32
-
43
65
-
108
Within 2 to 3 years
747
47
-
794
55
3
852
Within 3 to 4 years
-
3
-
3
25
-
28
Within 4 to 5 years
300
-
-
300
24
-
324
After 5 years
497
-
-
497
84
3
584
               
Total
2,181
97
2,417
4,695
340
9
5,044
               
               
2015
             
Within 1 year
1
21
2,073
2,095
69
-
2,164
Within 1 to 2 years
751
7
-
758
68
2
828
Within 2 to 3 years
1
3
-
4
29
-
33
Within 3 to 4 years
300
-
-
300
29
-
329
Within 4 to 5 years
2
-
-
2
24
-
26
After 5 years
1,493
-
-
1,493
872
7
1,587
               
Total
2,548
31
2,073
4,652
306
9
4,967
1 Difference between nominal redemption and amortized costs
2 Cumulative interest payment in remaining years

The exposure of the financial derivatives to liquidity risk is as follows. The amounts are gross and undiscounted.

Table 2

 
2016
2017
2018
2019
2020
Total
             
Inflow
1,382
1,058
42
55
42
2,579
Outflow
(1,418)
(1,177)
(49)
(62)
(43)
(2,749)
Interest rate risk

DSM’s interest rate risk policy is aimed at minimizing the interest rate risks associated with the financing of the company and thus at the same time optimizing the net interest costs. This policy translates into a certain desired profile of fixed-interest and floating-interest positions, including cash and cash equivalents, with the floating-interest position in principle not exceeding 60% of net debt.

On 31 December 2015, DSM had no outstanding fixed-floating interest rate swaps other than the pre-hedges for refinancing in 2017 (see note 20).

The following analysis of the sensitivity of borrowings and related financial derivatives to interest rate movements assumes an instantaneous 1% change in interest rates for all currencies and maturities from their level on 31 December 2015, with all other variables held constant. A 1% reduction in interest rates would result in a €4 million pre-tax loss in the income statement on the basis of the composition of financial instruments on 31 December 2015 as floating-rate borrowings are more than compensated for by floating-rate assets (mainly cash). The opposite applies in the case of a 1% increase in interest rates. The sensitivity of the fair value of financial instruments on 31 December 2015 to changes in interest rates is set out in the following table.

Table 3: Sensitivity of fair value to change in interest rate

Sensitivity of fair value to change in interest rate
 
2015
2014
 
Carrying
amount
Fair value
Sensitivity of fair value
to change in interest of:
Carrying
amount
Fair value
Sensitivity of fair value
to change in interest of:
     
+1%
(1%)
   
+1%
(1%)
                 
Current investments
9
9
-
-
6
6
-
-
Cash and cash equivalents
665
665
-
-
669
669
-
-
Short-term borrowings
(253)
(253)
1
(1)
(1,143)
(1,166)
6
(6)
Long-term borrowings
(2,557)
(2,750)
102
(109)
(1,637)
(1,842)
87
(94)
Interest rate swaps (fixed to floating and pre-hedges)
(1)
(1)
31
(31)
(109)
(109)
52
(58)
Currency risk

It is DSM’s policy to hedge 100% of the currency risks resulting from sales and purchases at the moment of recognition of the trade receivables and trade payables. In addition, operating companies may – under strict conditions – opt for hedging currency risks from firm commitments and forecasted transactions. The currencies giving rise to these risks are primarily USD, GBP and JPY. The risks arising from currency exposures are regularly reviewed and hedged when appropriate. DSM uses average-rate currency forward contracts, currency forward contracts, spot contracts, and average-rate currency options to hedge the exposure to fluctuations in foreign exchange rates. At year-end, these instruments had remaining maturities of less than one year.

To hedge intercompany loans, receivables and payables denominated in currencies other than the functional currency of the subsidiaries, DSM uses currency swaps or forward contracts. Hedge accounting is applied for instruments related to some larger internal loans with a total notional amount of €825 million. On 31 December 2015, the notional amount of the currency forward contracts was €2,541 million (2014: €3,781 million).

In 2015, DSM hedged USD 650 million (2014: USD 684 million) of its projected net cash flow in USD in 2016, of which USD 175 million against EUR and USD 475 million against CHF by means of average-rate currency forward contracts at an average exchange rate of USD 1.12 per euro and CHF 0.94 per US dollar, respectively, for the four quarters of 2016. In 2015, DSM also hedged JPY 5,450 million (2014: JPY 5,100 million) of its projected net cash flow in JPY in 2016, of which JPY 4,000 million against CHF and JPY 1,450 million against EUR by means of average-rate currency forward contracts at an average exchange rate of JPY 129 per Swiss franc and JPY 136 per euro, respectively, for the four quarters of 2016. DSM also continued the hedge of projected GBP cash obligations against CHF: GBP 50 million at an average exchange rate of CHF 1.45 per British pound. These hedges have fixed the exchange rate for part of the USD and JPY receipts and GBP payments in 2016. Cash flow hedge accounting is applied for these hedges. As a result of similar hedges concluded in 2014 for the year 2015, in 2015 €40 million negative (2014: €11 million positive) was recognized in the operating income of the segments involved in accordance with the realization of the expected cash flows. There was no material ineffectiveness in relation to these hedges.

The currency risk associated with the translation of DSM's net investment in entities denominated in currencies other than the euro was partially hedged at year-end 2015. CHF-denominated net assets have been partially hedged by currency swaps (2015: CHF 370 million; 2014: CHF 994 million). There was no material ineffectiveness in relation to these hedges.

The following analysis of the sensitivity of net borrowings and derivative financial instruments to currency movements against the euro assumes a 10% change in all foreign currency rates against the euro from their level on 31 December, with all other variables held constant. A +10% change indicates a strengthening of the foreign currencies against the euro. A -10% change represents a weakening of the foreign currencies against the euro.

Table 4: Sensitivity of fair value to change in exchange rate

Sensitivity of fair value to change in exchange rate
 
2015
2014
 
Carrying
amount
Fair value
Sensitivity of fair value to
change in all exchange
rates of:
Carrying
amount
Fair value
Sensitivity of fair value to
change in all exchange
rates of:
     
+10%
(10%)
   
+10%
(10%)
                 
Current investments
9
9
1
(1)
6
6
1
(1)
Cash and cash equivalents
665
665
54
(54)
669
669
53
(53)
Short-term borrowings
(253)
(253)
(10)
10
(1,143)
(1,166)
(25)
25
Long-term borrowings
(2,557)
(2,750)
(1)
1
(1,637)
(1,842)
(9)
9
Interest rate swaps
(1)
(1)
-
-
(109)
(109)
-
-
Cross currency swaps
(110)
(110)
(112)
112
(49)
(49)
(101)
101
Currency forward contracts
-
-
(19)
19
(36)
(36)
(136)
136
Cross currency swaps related to net investments in foreign entities1
(47)
(47)
(38)
38
(87)
(87)
(89)
89
Average-rate forwards used for economic hedging2
(27)
(27)
(19)
19
(34)
(34)
(20)
20
1 Fair-value change reported in Translation reserve
2 Fair-value change reported in Hedging reserve

Fair-value changes on these positions will generally be recognized in profit or loss, with the exception of the instruments for which cash flow hedge accounting or net-investment hedge accounting is applied. Cash flow hedge accounting is applied for the average-rate forwards and average-rate currency options used for economic hedging; the fair value changes of these derivatives are recognized in the Hedging reserve in equity until recognition of the related cash flows. Net-investment hedge accounting is applied for the cross-currency swaps used to protect net investments in foreign entities; the fair-value changes of these derivatives are recognized in the Translation reserve in equity until the net investment is disposed of, to the extent that the changes in fair value are caused by changes in currency-exchange rates.

Price risk

Financial instruments that are subject to changes in stock exchange prices or indexes are subject to a price risk. At year-end 2015, price risks related to investments in securities were limited.

Credit risk

DSM manages the credit risk to which it is exposed by applying credit limits per institution and by dealing exclusively with institutions having a high credit rating.

At the balance sheet date there were no significant concentrations of credit risk.

With regard to treasury activities it is ensured that financial transactions are only concluded with counterparties that have at least a Moody's credit rating of A3 for long-term instruments. At business group level, outstanding receivables are continuously monitored by the management of the operating companies. Appropriate allowances are made for any credit risks that have been identified (as listed in note 13). It is therefore unlikely that significant losses will arise in relation to receivables that have not been provided for.

The maximum exposure to credit risk is represented by the carrying amounts of financial assets that are recognized in the balance sheet, including derivative financial instruments. No significant agreements or financial instruments were available at the reporting date that would reduce the maximum exposure to credit risk. Information about financial assets is presented in note 10 Associates and joint ventures, note 11 Other financial assets, note 13 Current receivables, note 14 Current investments, note 15 Cash and cash equivalents and note 24 Financial instruments and risks.

Fair value of financial instruments

In the following table the carrying amounts and the estimated fair values of financial instruments are disclosed:

Table 5

 
31 December 2015
31 December 2014
 
Carrying amount
Fair value
Carrying amount
Fair value
Assets
       
Other participations
51
51
44
44
Other non-current receivables
113
113
45
45
Current receivables
1,556
1,556
1,769
1,769
Financial derivatives
47
47
47
47
Current investments
9
9
6
6
Cash and cash equivalents
665
665
669
669
         
Liabilities
       
Non-current borrowings
2,557
2,750
1,637
1,842
Other non-current liabilities
228
228
81
81
Current borrowings
253
253
1,143
1,166
Financial derivatives
232
232
362
362
Other current liabilities
1,842
1,842
1,915
1,915

The following methods and assumptions were used to determine the fair value of financial instruments: cash, current investments, current receivables, current borrowings and other current liabilities are stated at carrying amount, which approximates fair value in view of the short maturity of these instruments. The fair values of financial derivatives and long-term instruments are based on calculations, quoted market prices or quotes obtained from intermediaries.

The portfolio of derivatives consists of average-rate forward contracts that are valued against average foreign exchange forward rates obtained from Bloomberg and other derivatives that are valued using a discounted cash flow model, applicable market yield curves and foreign exchange spot rates. All inputs for the fair value calculations represent observable market data that are obtained from external sources that are deemed to be independent and reliable.

DSM uses the following hierarchy for determining the fair value of financial instruments measured at fair value:

  • Level 1: quoted prices in active markets for identical assets or liabilities
  • Level 2: other techniques for which all inputs that have a significant effect on the fair value are observable, either directly or indirectly
  • Level 3: techniques that use inputs that have a significant effect on the fair value that are not based on observable market data

The financial instruments that have a fair value that is different from the carrying amounts are classified as level 2 for both 2014 and 2015.

The following table shows the carrying amounts of the financial instruments recognized at fair value, broken down by type and purpose:

Table 6: Carrying amounts financial instruments at fair value

Carrying amounts financial instruments at fair value
 
Fair value hierarchy
Assets
Liabilities
Total
         
Interest rate swaps
Level 2
-
(109)
(109)
Currency swaps
Level 2
32
(168)
(136)
Total financial derivatives related to borrowings
 
32
(277)
(245)
         
Currency forward contracts
Level 2
15
(85)
(70)
Balance at 31 December 2014
 
47
(362)
(315)
         
         
Interest rate swaps
Level 2
-
(1)
(1)
Currency swaps
Level 2
2
(74)
(72)
Total financial derivatives related to borrowings
 
2
(75)
(73)
         
Currency forward contracts
Level 2
45
(157)
(112)
Balance at 31 December 2015
 
47
(232)
(185)

During the year there were no transfers between individual levels of the fair value hierarchy.