23 Financial instruments and risks

Policies on financial risks

General

As an international company, DSM is exposed to financial risks in the normal course of business. A major objective of our group policy is to minimize the impact of market, liquidity and credit risk on the value of the company and its profitability. In order to achieve this, a systematic financial and risk management system has been established. For the purpose of securing compliance with the risk management policies, an internal control framework has been implemented, and the controls are monitored and tested periodically.

The derivatives contracts used by DSM are entered into exclusively in connection with the corresponding underlying transaction (hedged item) relating to normal operating business. The instruments used are customary products, such as currency swaps, cross-currency interest rate swaps, collars, forward exchange contracts and interest rate swaps.

An important element of DSM’s financial policy and capital management is the allocation of cash flow. DSM primarily allocates cash flow to investments aimed at strengthening its business positions and securing the dividend payment to its shareholders. The remaining cash flow is further used for acquisitions and partnerships that strengthen DSM’s competences and market positions. The net debt to equity ratio (gearing) is 25.6 (2019: 12.7), see also Note 25 Net debt.

Liquidity risk

Liquidity risk is the financial risk that an entity does not have and/or cannot access enough liquid cash and/or assets to meet its obligations. This can happen if the entity’s credit rating falls, or when it experiences sudden unexpected cash outflows or an unexpected drop in cash inflows, or some other event that causes counterparties to avoid trading with or lending to the entity. Additionally, an entity can be indirectly exposed to market liquidity risk, if the financial markets on which it depends are subject to loss of liquidity.

The primary objective of liquidity management is to optimize the corporate cash position, among other things, by securing availability of sufficient liquidity for execution of payments by DSM entities, at the right time and the right place.

At 31 December 2020, DSM had cash and cash equivalents of €871 million (2019: €800 million).

At the end of 2020, DSM had eight committed credit facilities amounting to €1.5 billion. The agreement for the committed credit facility has neither financial covenants nor material adverse changes clauses. The €1.0 billion committed credit facility concluded in 2018 and maturing on 28 May 2025 links the interest rate to DSM’s greenhouse gas (GHG) emission reduction. The new committed credit facilities (€0.5 billion) concluded in 2020, with a maximum tenor of 2 years, do not link the interest rate to DSM’s greenhouse gas (GHG) emission reduction. At year-end 2020, no loans had been taken up under the committed credit facilities.

Furthermore, DSM has a commercial paper program amounting to €2.0 billion (2019: €1.5 billion). The company will use the commercial paper program to a total of not more than €1.0 billion (2019: €1.0 billion). At 31 December 2020, €0 million had been issued as commercial paper (2019: €0 million). Due to COVID-19, in the first half of 2020, DSM issued commercial paper to the value of €0.5 billion.

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 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.

The following table reflects the exposure of the derivatives to liquidity risk. It contains the cash flows from derivatives with positive fair values and from derivatives with negative fair values to have a complete overview of the derivatives related cash flows. The amounts are gross and undiscounted.

Market risk

Market risk can be subdivided into interest rate risk, currency risk and price risk.

Interest rate risk

Interest rate risk is the risk that adverse movements of interest rates lead to high costs on interest-bearing debt or assets, which negatively impact the company’s capability to honor its commitments. 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 not exceeding 60% of net debt.

At 31 December 2020, there was a CNY 180 million credit facility held by DSM Inner Mongolia Rainbow, based on floating rate SHIBOR (2019: CNY 255 million). There were no outstanding fixed-floating interest rate swaps (end of 2019 none).

The following analysis of the sensitivity of borrowings, assets and related derivatives to interest rate movements assumes an instantaneous 1% change in interest rates for all maturities from their level on 31 December 2020, with all other variables held constant. A 1% reduction in interest rates would result in a €6 million pre-tax loss in the income statement and equity on the basis of the composition of financial instruments on 31 December 2020, 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 financial instruments with a floating interest rate on 31 December 2020 to changes in interest rates is set out in the following table.

For more information regarding fixed or floating interest, see Note 19 Borrowings.

Currency risk

Currency risk is the risk that adverse movements of foreign currencies negatively impact the results of operations and the financial condition of the company, for example due to losses on assets or liabilities in foreign currencies. It is DSM’s policy to hedge 100% of the currency risks resulting from sales and purchases at the moment of recognition of the receivables and payables. This is realized by transferring at spot rates the respective exposures to the group, which are, consequently (on a netted basis), hedged externally.

In addition, operating companies may — under strict conditions — opt for hedging currency risks from firm commitments and forecast transactions. The currencies giving rise to these risks are primarily USD, CHF and JPY. The risks arising from currency exposures are regularly reviewed and hedged when appropriate. DSM uses currency forward contracts, spot contracts, and average-rate currency forwards and options to hedge the exposure to fluctuations in foreign exchange rates. At year-end, these instruments had remaining maturities of less than one year. For the hedging of currency risks from firm commitments and forecast transaction cash flows, hedge accounting is applied. Hedge accounting is not applied for hedges of recognized trade receivables and trade payables hedged with short-term derivatives.

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.

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 2020, 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.

Sensitivity changes on these positions will generally be recognized in profit or loss or in the translation reserve in equity, with the exception of the instruments for which cash flow hedge accounting or net-investment hedge accounting is applied.

In case of a strengthening or weakening of the euro against USD, CHF and CNY (being the key currencies), this would affect the translation of financial instruments denominated in these currencies taking into account the effect of hedge accounting and assuming all other variables being constant.

Price risk

Financial instruments that are subject to changes in stock exchange prices or indexes are subject to a price risk. At year-end 2020 investments in securities are subject to price risks.

Credit risk

Credit risk is the risk that a (commercial or financial) counterparty may not be able to honor a financial commitment according to the contractual agreement with DSM. The company manages the credit risk to which it is exposed by applying credit limits per institution and by dealing exclusively with institutions that have a high credit rating.

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

For all financial assets measured at amortized cost and fair value through other comprehensive income, the estimation of the loss allowance for doubtful accounts receivable is based on an expected credit loss (ECL) model.

For trade receivables, DSM uses an allowance matrix to measure the lifetime ECL for trade receivables. The loss rates depend among other things on the specified aging categories and are based on historical write-off percentages, taking market developments into account.

For other financial assets, DSM applies an ECL model that reflects the size and significance of DSM’s exposure to credit loss. The ECL is based on the allocation of a credit risk grade which is based on data that is determined to be predictive of the risk of loss (including but not limited to external ratings, audited financial statements, management accounts and cash flow projections and available press information about customers) and applying experienced credit judgement. Credit risk grades are defined using qualitative and quantitative factors that are indicative of the risk of default and are aligned to external credit rating definitions from Moody’s.

Risk of default is herewith considered as the risk of bankruptcy, or any legal impediment to the timely payment of either interest and/or principal, as well as missed or delayed disbursement of either interest and/or principal.

The loss allowance on non-current financial assets that has been taken into consideration at the end of 2020 was €5 million.

With regard to treasury activities (for example cash, cash equivalents and derivatives held with banks or financial institutions) 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 management. Appropriate allowances are made for any credit risks that have been identified in line with the expected credit loss policy.

The development of the outstanding receivables per aging category is as follows.

The table below provides information about the credit risk exposure per aging category and the ECL for trade accounts receivable of €28 million at 31 December 2020 (31 December 2019: €17 million), see Note 13 Current receivables.

The changes in the expected credit loss for trade accounts receivable are as follows.

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. DSM has International Swaps and Derivatives Association (ISDA) agreements in place with its financial counterparties that allow for the netting of exposures in case of a default of either party. 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 arrangements, Note 11 Other financial assets, Note 13 Current receivables, Note 14 Current investments, Note 15 Cash and cash equivalents and Note 23 Financial instruments and risks.

DSM’s policy is to grant corporate guarantees for credit support of subsidiaries and associates, to get access to credit facilities which are necessary for their operating working capital needs and which cannot be funded by the corporate cash pools and/or for bank guarantees needed for local governmental requirements. Information on guarantees is presented in Note 22 Contingent liabilities and other financial obligations.

Hedge accounting

DSM uses derivative financial instruments to manage financial risks relating to business operations and does not enter into speculative derivative positions. The purpose of cash flow hedges is to minimize the risk of volatility of future cash flows. These may result from a recognized asset or liability or a forecast transaction that is considered highly probable (firm commitment). The hedge ratio is dependent on the risk analysis related to the specific cash flow, and can vary from 50% to 100%. Changes in fair value as a result of changes in interest (for cash flows hedges) or as a result of changes in exchange rate (for firm commitment hedges) are recognized in Other comprehensive income (Hedging reserve), and ineffectiveness (mainly as a result of changes in timing of the hedged transactions) will be recognized in the income statement. As soon as the forecast transaction is realized (the underlying hedged item materializes), the amount recognized in the Other comprehensive income will be reclassified to the income statement. In case the hedged future transaction is a non-financial asset or liability, the gain or loss recognized in Other comprehensive income will be included in the cost of acquisition of the asset or liability.

The purpose of a hedge of a net investment is to reduce the foreign currency translation risk of an investment in a company whose functional currency is not the euro. Changes in fair value are recognized in Other comprehensive income (Translation reserve), and ineffectiveness will be recognized in the income statement. The amount recognized in the Other comprehensive income will be reclassified to the income statement, upon divestment of the respective foreign subsidiary.

The purpose of a fair value hedge is to hedge the fair value of assets or liabilities reflected on the balance sheet. Changes of fair value in hedging instruments, as well as hedged items, will be recognized in the income statement.

Cash flow hedges

In 2020, DSM hedged USD 575 million (2019: USD 712 million) of its 2021 projected net cash flow in USD against the EUR by means of average-rate currency forward contracts at an average exchange rate of USD 1.14 per EUR for the four quarters of 2021. Each quarter, the relevant hedges for that quarter will be settled and recognized in the income statement. In 2020, DSM also hedged JPY 7,213 million (2019: JPY 7,453 million) of its 2021 projected net cash flow in JPY against the EUR by means of average-rate currency forward contracts at an average exchange rate of JPY 122 per EUR for the four quarters of 2021. DSM also hedged the projected CHF obligations against the EUR, namely CHF 361 million (2019: CHF 304 million) at an average exchange rate of CHF 1.07 per EUR. These hedges have fixed the exchange rate for part of the USD and JPY receipts and CHF payments in 2021. Cash flow hedge accounting is applied for these hedges. As a result of similar hedges concluded in 2019 for the year 2020, €3 million positive (2019: €43 million negative) was recognized in the 2020 operating profit of the segments involved in accordance with the realization of the expected cash flows. There was no ineffectiveness in relation to these hedges.

Net investment hedges

The partial hedging of the currency risk associated with the translation of DSM’s CHF-denominated investments was continued for an amount of CHF 135 million (2019: CHF 100 million). There was no material ineffectiveness in relation to these hedges.

For movements in Hedging or Translation reserve, see also Note 16 Equity.

Fair value of financial instruments

The following methods and assumptions were used to determine the fair value of financial instruments: cash, current investments, current receivables, current borrowings (excluding current portion of long-term instruments) and other current liabilities are stated at carrying amount, which approximates fair value in view of the short maturity of these instruments. The fair value of 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. 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:

• 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 following table shows the carrying amounts and fair values of financial assets and financial liabilities, including their levels in the fair value hierarchy.

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