27 – Supplementary information on financial instruments

27.1 Financial risks

Market risks

Foreign currency risks: Changes in exchange rates could lead to losses in the value of financial instruments and adverse changes in future cash flows from planned transactions. Foreign currency risks from financial instruments result from the translation at the closing rate of financial receivables, loans, securities, cash and financial liabilities into the functional currency of the respective Group company. Foreign currency contracts in a variety of currencies are used to hedge foreign exchange risks from nonderivative financial instruments and planned transactions.

The foreign currency risk exposure corresponds to the net amount of the nominal volume of the primary and the derivative financial instruments which are exposed to currency risks. In addition, planned purchase and sales transactions of the respective following year are included, if they fall under the currency risk management system. Long and short positions in the same currency are offset against each other.

The sensitivity analysis is conducted by simulating a 10% appreciation of the respective functional currency against the other currencies. The effect on BASF’s income before taxes and minority interests would have been minus €252 million as of December 31, 2017, and minus €300 million as of December 31, 2016. The effect from the items designated under hedge accounting would have increased the equity of the shareholders of BASF SE before income taxes by €46 million as of December 31, 2017 (2016: increase of €24 million). This only refers to transactions in U.S. dollars. The foreign currency risk exposure amounted to €1,976 million as of December 31, 2017 and €2,113 million as of December 31, 2016.

Due to the use of options to hedge currency risks, the sensitivity analysis is not a linear function of the assumed changes in exchange rates.

Interest rate risks: Interest rate risks result from changes in prevailing market interest rates, which can cause a change in the fair value of fixed-rate instruments, and changes in the interest payments of variable-rate instruments. To hedge these risks, interest rate swaps and combined interest rate and currency derivatives are used. While these risks are relevant to the financing activities of BASF, they are not of material significance for BASF’s operating activities.

The variable interest exposure, which also includes fixed rate bonds set to mature in the following year, amounted to minus €986 million as of December 31, 2017 (2016: minus €2,447 million). An increase in all relevant interest rates by one percentage point would have raised income before taxes and minority interests by €4 million as of December 31, 2017, and raised income before taxes and minority interests by €1 million as of December 31, 2016. The effect from the items designated under hedge accounting would have increased the equity of the shareholders of BASF SE before income taxes by €9 million as of December 31, 2017 (2016: increase of €16 million).

Commodity price risks: Some of BASF’s divisions are exposed to strong fluctuations in raw materials prices. These result primarily from raw materials (for example naphtha, propylene, benzene, lauric oils, cyclohexane, methanol, natural gas, butadiene, LPG condensate and ammonia) as well as from precious metals. BASF takes the following measures to reduce price risks associated with the purchase of raw materials:

• BASF uses commodity derivatives to hedge the risks from the volatility of raw materials prices. These are primarily options and swaps on crude oil, oil products and natural gas.
• In the Oil & Gas segment, risks to margins arise in volatile markets when purchase and sales contracts are priced differently. Corresponding oil and gas derivatives are used to hedge these risks.
• The Catalysts division enters into both short-term and long-term purchase contracts with precious metal producers. It also buys precious metals on spot markets from a variety of business partners. The price risk from precious metals purchased to be sold on to third parties, or for use in the production of catalysts, is hedged using derivative instruments. This is mainly done using forward contracts which are settled by either entering into offsetting contracts or by delivering the precious metals.
• In the Crop Protection division, the sales prices of products are sometimes coupled to the price of certain agricultural commodities. To hedge the resulting risks, derivatives on agricultural commodities are concluded.

In addition, BASF holds limited unhedged precious metal and oil product positions, which can also include derivatives, for trading on its own account. The value of these positions is exposed to market price volatility and is subject to constant monitoring.

In connection with CO₂ emissions trading, various types of CO₂ certificates are purchased and sold using forward contracts. The goal of these transactions is to benefit from market price differences. These deals are settled by physical delivery. As of December 31, 2017 and as of December 31, 2016, there were no deals outstanding.

By holding commodity derivatives and precious metal trading positions, BASF is exposed to price risks. The valuation of commodity derivatives and precious metal trading positions at fair value means that adverse changes in market prices could negatively affect the earnings and equity of BASF.

BASF performs value-at-risk analyses for all commodity derivatives and precious metals trading positions. Using the value-at-risk analysis, we continually quantify market risk and forecast the maximum possible loss within a given confidence interval over a defined period. The value-at-risk calculation is based on a confidence interval of 95% and a holding period of one day. The value-at-risk calculation for precious metals is based on a confidence interval of 99%. BASF uses the variance-covariance approach.

BASF uses value at risk as a supplement to other risk management tools. Besides value at risk, BASF SEts volume-based limits as well as exposure and stop-loss limits.

The exposure corresponds to the net amount of all long and short positions of the respective commodity category.

Default and credit risk

Default and credit risks arise when counterparties do not fulfill their contractual obligations. BASF regularly analyzes the creditworthiness of each significant debtor and grants credit limits on the basis of this analysis. Due to the global activities and diversified customer structure of the BASF Group, there is no significant concentration of default risk. The carrying amount of all receivables, loans and interest-bearing securities plus the nominal value of other financial obligations subject to default risk represents the maximum default risk for BASF.

Liquidity risks

BASF promptly recognizes any risks from cash flow fluctuations as part of the liquidity planning. BASF has ready access to sufficient liquid funds from our ongoing commercial paper program and confirmed lines of credit from banks.

27.2 Maturity analysis

The interest and principal payments as well as other payments for derivative financial instruments are relevant for the presentation of the maturities of the contractual cash flows from financial liabilities. Future cash flows are not discounted here.

Derivatives are included using their net cash flows, provided they have a negative fair value and therefore represent a liability. Derivatives with positive fair values are assets and are therefore not considered.

Trade accounts payable are generally interest-free and due within one year. Therefore, the carrying amount of trade accounts payable equals the sum of future cash flows.

27.3 Classes and categories of financial instruments

For trade accounts receivable, other receivables and miscellaneous assets, loans, cash and cash equivalents, as well as trade accounts payable and other liabilities, the carrying amount approximates the fair value. Shareholdings which are not traded on an active market and whose fair value could not be reliably determined are recognized at amortized cost and are reported under other financial assets.

The fair value of financial indebtedness is determined on the basis of interbank interest rates. The difference between carrying amounts and fair values results primarily from changes in market interest rates.

The table “Offsetting of financial assets and financial liabilities” shows the extent to which financial assets and financial liabilities are offset in the balance sheet, as well as potential effects from the offsetting of instruments subject to a legally enforceable global netting agreement or similar agreement. For positive fair values of combined interest and cross-currency swaps, the respective counterparties provided cash collaterals in corresponding amounts to the outstanding fair values.

Deviations from the derivatives with positive fair values and derivatives with negative fair values reported in other receivables and other liabilities at the end of 2017 and 2016 arose from derivatives not subject to any netting agreements as well as from embedded derivatives and are therefore not included in the table above.

Net gains and losses from financial instruments comprise the results of valuations, the amortization of discounts, the recognition and reversal of impairments, results from the translation of foreign currencies as well as interest, dividends and all other effects on the earnings resulting from financial instruments. The line item financial instruments at fair value through profit or loss contains only those gains and losses from instruments which are not designated as hedging instruments as defined by IAS 39. Net gains or net losses from available-for-sale financial assets contain income and expenses from write-downs/reversals of write-downs, interest, dividends and the reclassification of valuation effects from equity on the sale of the securities and shareholdings.

The decrease in net losses from financial liabilities measured at amortized cost primarily arose from the currency translation of financing-related liabilities denominated in foreign currencies, which resulted in a higher translation gain in 2017 than in the previous year. There was also a decline in the net loss for financial instruments measured at fair value through profit or loss. This development is primarily due to realized and unrealized results from derivatives to hedge foreign currency transactions. Countering this was a higher net loss from loans and receivables largely attributable to the foreign currency translation of receivables.

27.4 Derivative instruments and hedge accounting

The use of derivative instruments

BASF is exposed to foreign-currency, interest-rate and commodity-price risks during the normal course of business. These risks are hedged through a centrally determined strategy employing derivative instruments. Hedging is only employed for underlying items from the operating business, cash investments, and financing as well as for planned sales, raw material purchases and capital measures. The risks from the underlying transactions and the derivatives are constantly monitored. Where derivatives have a positive market value, BASF is exposed to credit risks from derivative transactions in the event of nonperformance of the other party. To minimize the default risk on derivatives with positive market values, transactions are exclusively conducted with creditworthy banks and partners and are subject to predefined credit limits.

To ensure effective risk management, risk positions are centralized at BASF SE and certain Group companies. The contracting and execution of derivative financial instruments for hedging purposes are conducted according to internal guidelines, and subject to strict control mechanisms.

The fair values of derivative financial instruments are calculated using valuation models which use input parameters observable on the market. Exceptions to this are some commodity derivatives, whose valuation is based directly on market prices.

Cash flow hedge accounting

Some of the planned purchases of naphtha are hedged using swaps and options on oil and oil products. For the reporting of these hedges in the Consolidated Financial Statements of the BASF Group, no hedge accounting was applied in 2017 and in 2016.

Cash flow hedge accounting continues to be used to a minor extent for natural gas purchases, so that gains and losses from hedging instruments are initially recognized in equity. Gains and losses from hedging instruments are included in cost of sales at the point in time at which the hedged item is recognized in profit or loss.

The planned transactions and their effect on earnings occur in the year following the balance sheet date. In 2017, effective changes in the fair value of hedging instruments of €200,000 (2016: €1 million) were recognized in the equity of the shareholders of BASF SE. In 2017, effective changes in the fair value of hedging instruments of €300,000 were derecognized from the equity of shareholders of BASF SE and recognized in other operating income (2016: €1 million). The ineffective part in the change in value of the hedge amounted to minus €100,000 in 2017 and minus €1 million in 2016. These amounts were reported in the income statement in other operating expenses.

BASF also uses cash flow hedge accounting for some foreign currency derivatives to hedge planned sales denominated in U.S. dollars. The impact on earnings from the underlying transactions occurs in 2018. In 2017, the effective change in values of the hedges was €71 million (2016: €9 million), which was recognized in the equity of the shareholders of BASF SE. A total of €44 million (2016: €11 million) was derecognized from the equity of shareholders of BASF SE and was recognized in income from foreign currency and hedging transactions. The hedges were entirely effective.

To hedge foreign currency risk which existed for a part of the U.S. dollar-denominated purchase price for the acquisition of Chemetall, BASF used options and foreign currency forward contracts in the previous year. These were designated as hedging instruments and led to effective changes in the amount of €97 million, which was recognized in the equity of the shareholders of BASF SE. Upon completion of the transaction in December 2016, this amount was derecognized from the equity of the shareholders of BASF SE reducing the purchase price accordingly and along with that the resulting goodwill arising from the transaction. The ineffective part of the fair value changes of the hedging instruments amounted to minus €10 million and was recognized in other operating expenses.

The interest rate risk of the floating rate notes issued by BASF SE in 2013 was hedged using interest rate swaps. The bond and the interest rate swaps were designated in a hedging relationship. The effective changes in the fair value of the hedging instruments amounting to €6 million were recognized in equity of the shareholders of BASF SE in 2017. In the previous year, the variable interest bond issued in 2014 and expired in 2017 was also hedged by interest rate swaps. The effective changes in the fair value recognized in equity of the shareholders of BASF SE amounted to €6 million in 2016. There were no ineffective parts in either year.

Furthermore, BASF SE’s fixed-rate U.S. private placement of $1.25 billion, issued in 2013, was converted into euros using currency swaps. This hedge was designated as a cash flow hedge. The hedge was entirely effective. In 2017, this resulted in changes in fair value of minus €125 million, which were recognized in the equity of the shareholders of BASF SE (2016: minus €33 million). In 2017, €144 million was derecognized from other comprehensive income and recorded as an expense in the financial result (2016: €38 million income in financial result).