27 – Supplementary Information on Financial Instruments

27.1 Accounting policies

Financial instruments

Financial assets and financial liabilities are recognized in the consolidated balance sheet when the BASF Group becomes a party to a financial instrument. Financial assets are derecognized when BASF no longer has a contractual right to the cash flows from the financial asset or when the financial asset is transferred together with all material risks and rewards of ownership and BASF does not have control of the financial asset after it has been transferred. For example, receivables are derecognized when they are definitively found to be uncollectible. Financial liabilities are derecognized when the contractual obligations expire, are discharged or cancelled. Regular-way purchases and sales of financial instruments are accounted for using the settlement date; in precious metals trading, the trade date is used.

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. If pricing on an active market is available, for example in the form of exchange prices, these are used as the basis for the measurement. Otherwise, the measurement is based on either internal measurement models using current market parameters or external measurements, for example, from banks. These internal measurements predominantly use the net present value method and option pricing models. These models incorporate, for example, expected future cash flows as well as discount factors adjusted for term and, potentially, risk. Depending on the availability of market parameters, BASF assigns financial instruments’ market values one of the three levels of the fair value hierarchy pursuant to IFRS 13. Reassignment to a different level during a fiscal year is only carried out if the availability of observable market parameters for identical or similar items changes.

Except for financial assets measured at fair value through profit or loss, IFRS 9 requires the recognition of impairments for expected credit losses, independent of the existence of any actual default events and individual impairments if evidence of a permanent need for impairment exists. If this evidence no longer exists, the impairment is reversed in the statement of income up to the carrying amount of the asset had the default event not occurred. Impairments are generally recognized in separate accounts.

The classification and measurement of financial assets is based on the one hand on the cash flow condition (the “solely payments of principle and interest” criterion), that is, the contractual cash flow characteristics of an individual financial asset. On the other hand, it also depends on the business model used for managing financial asset portfolios. Based on these two criteria, BASF uses the following measurement categories for financial assets:

• Financial assets at fair value through profit or loss include all financial assets whose cash flows are not solely payments of principal and interest in accordance with the cash flow condition established in IFRS 9. At BASF, derivatives, for example, are allocated to this measurement category. In general, BASF does not exercise the fair value option in IFRS 9, which permits the allocation of financial instruments not to be measured at fair value through profit or loss on the basis of the cash flow condition or the business model criterion to the above category under certain circumstances.
• Financial assets measured at amortized cost include all assets with contractual terms that give rise to cash flows on specific dates, provided that these cash flows are solely payments of principal and interest on the principal amount outstanding in accordance with the cash flow condition in IFRS 9, to the extent that the asset is held with the intention of collecting the expected contractual cash flows over its term. At BASF, this measurement category includes trade accounts receivable, as well as receivables reported under other receivables and miscellaneous assets and certain securities.
  Initial measurement of these assets is generally at fair value, which usually corresponds to the transaction price at the time of acquisition. Subsequent measurement effects are recognized in income using the effective interest method.
  Impairments are recognized for expected credit losses in both initial and subsequent measurement, even before the occurrence of any default event. If the counterparty is considered as having defaulted, individual impairments are generally recognized for the financial assets measured at amortized cost. In addition, an impairment must be recognized when the contractual conditions that form the basis for the receivable are changed through renegotiation in such a way that the present value of the future cash flows decreases.
  The extent of expected credit losses is determined based on the credit risk of a financial asset, as well as any changes to this credit risk: If the credit risk of a financial asset has increased significantly since initial recognition, expected credit losses are generally recognized over the lifetime of the asset. If, however, the credit risk has not increased significantly in this period, impairments are generally only recognized as 12-month expected credit losses. By contrast, under the simplified approach for determining expected credit losses permitted by IFRS 9, impairments for receivables such as lease receivables and trade accounts receivable always cover the lifetime expected credit losses of the receivable concerned.
  At BASF, the credit risk of a financial asset is assessed using both internal information and external rating information on the respective counterparty. A significant increase in the counterparty’s credit risk is assumed if its rating is lowered by a certain number of notches. The significance of the increase in the credit risk is not reviewed for trade accounts receivable or lease receivables. Furthermore, it is generally assumed that the credit risk for a counterparty with a high credit rating will not have increased significantly.
  Regional and, in certain circumstances, industry-specific factors and expectations are taken into account when assessing the extent of impairment as part of the calculation of expected credit losses and individual impairments. In addition, BASF uses internal and external ratings and the assessments of debt collection agencies and credit insurers, when available. Individual impairments are also based on experience relating to customer solvency and customer-specific risks. Factors such as credit insurance, which covers a portion of receivables measured at amortized cost, are likewise considered when calculating impairments. Bank guarantees and letters of credit are used to an immaterial extent. Expected credit losses and individual impairments are only calculated for those receivables that are not covered by insurance or other collateral. Impairments on receivables whose insurance includes a deductible are not recognized in excess of the amount of the deductible.
  A decrease in impairment due, for example, to a reduction in the credit risk of a counterparty or an objective event occurring after the impairment is recorded in profit or loss. Reversals of impairments may not exceed amortized cost, less any expected future credit losses.
• Financial assets at fair value through other comprehensive income include all assets with contractual terms that give rise to cash flows on specified dates that are solely payments of principal and interest on the principal amount outstanding, in accordance with the cash flow condition in IFRS 9. Furthermore, the assets in this measurement category may not just be held with the intention of collecting the expected contractual cash flows over their term, but also generating cash flows from their sale. At BASF, certain securities that are classified as debt instruments are allocated to this category. BASF does not exercise the option to subsequently measure equity instruments through other comprehensive income.
  Assets measured at fair value through other comprehensive income are initially measured at fair value, which usually corresponds to the nominal value of the securities allocated to this category at the time of acquisition. Subsequent measurement is likewise at fair value. Changes in the fair value are recognized in other comprehensive income and reclassified to the statement of income when the asset is disposed of.
  Impairments on financial assets measured at fair value through other comprehensive income are calculated in the same way as impairments on financial assets measured at amortized cost and recognized in profit or loss.

The following measurement categories are used for financial liabilities:

• Financial liabilities measured at amortized cost generally include all financial liabilities, provided these do not represent derivatives. They are generally measured at fair value at the time of initial recognition, which usually corresponds to the value of the consideration received. Subsequent measurement is recognized in profit or loss at amortized cost using the effective interest method. At BASF, for example, bonds and liabilities to banks reported under financial indebtedness are measured at amortized cost.
• Financial liabilities at fair value through profit or loss contain derivative financial liabilities. These are likewise measured at the value of the consideration received as the fair value of the liability on the date of initial recognition. Fair value is also applied as a measurement basis for these liabilities in subsequent measurement. The option to subsequently measure financial liabilities at fair value is not exercised. Derivative financial instruments can be embedded within other contracts, creating a hybrid financial instrument. If IFRS requires separation, the embedded derivative is accounted for separately from its host contract and measured at fair value. If IFRS 9 does not provide for separation, the hybrid instrument is accounted for at fair value in its entirety.

Financial guarantees of the BASF Group are contracts that require compensation payments to be made to the guarantee holder if a debtor fails to make payment when due under the terms of a transaction entered into with the holder of the guarantee. Financial guarantees issued by BASF are measured at fair value upon initial recognition. In subsequent periods, these financial guarantees are carried at the higher of amortized cost or the best estimate of the present obligation as of the reporting date.

In cash flow hedges, future cash flows and the related income and expenses are hedged against the risk of changes in fair value. To this end, future underlying transactions and the corresponding hedging instruments are designated to a cash flow hedge accounting relationship for accounting purposes. The effective portion of the change in fair value of the hedging instrument, which often meets the definition of a derivative, and the cost of hedging are recognized directly in equity under other comprehensive income over the term of the hedge, taking deferred taxes into account. The ineffective portion is recognized immediately in the income statement. In the case of future transactions that lead to recognition of a nonfinancial asset or a nonfinancial liability, the cumulative fair value changes of the hedge in equity are generally charged against the cost of the hedged item on its initial recognition. For hedges based on financial assets, financial liabilities or future transactions, cumulative fair value changes of the hedges are transferred from equity to the income statement in the reporting period in which the hedged item is recognized in the income statement. The maturity of the hedging instrument is aligned with the effective date of the future transaction.

When fair value hedge accounting is used, the asset or liability recognized is hedged against the risk of a change in fair value. The hedging instruments used, which often take the form of a derivative, are measured at fair value and changes in fair value are recognized in the statement of income. The carrying amounts of the assets or liabilities designated as the underlying transaction are also measured at fair value through the statement of income.

27.2 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 various 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 that 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 as of December 31, 2019, was conducted by simulating a 5% and 10% appreciation of the respective functional currency against the other currencies. A 5% appreciation of the respective functional currency would have reduced BASF’s income before income taxes by €187 million as of December 31, 2019. A 10% appreciation of the respective functional currency would have resulted in an effect on BASF’s income in the amount of minus €356 million. The sensitivity analysis as of December 31, 2018, was conducted using a 10% appreciation of the respective functional currency. It resulted in an effect of minus €373 million as of December 31, 2018. The effect from the items designated under hedge accounting would have increased shareholders’ equity before income taxes by €19 million applying a 5% increase to the functional currency and by €40 million applying a 10% increase to the functional currency as of December 31, 2019 (2018: increase of €33 million applying a 10% increase to the functional currency). This only refers to transactions in U.S. dollars. The foreign currency risk exposure amounted to €3,014 million as of December 31, 2019, and €3,185 million as of December 31, 2018.

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 arise from changes in prevailing market interest rates, which can lead to changes in the fair value of fixed-rate instruments and in interest payments for variable-rate instruments. Interest rate swaps and combined interest rate and currency derivatives are used to hedge these risks. The derivatives are presented in Note 27.5. Interest rate risks are relevant to BASF’s financing activities but are not of material significance for BASF’s operating activities.

The variable interest risk exposure, which also includes fixed rate bonds maturing in the following year, amounted to minus €1,414 million as of December 31, 2019 (2018: minus €4,802 million). An increase in all relevant interest rates by one half of a percentage point would have lowered income before income taxes by €3 million as of December 31, 2019. An increase in all relevant interest rates by one percentage point would have lowered income before income taxes by €6 million as of December 31, 2019. An increase in all relevant interest rates by one percentage point would have lowered income before income taxes by €43 million as of December 31, 2018. If the relevant interest rates had changed by one half of a percentage point, the before-tax effect from items designated under hedge accounting would have been an immaterial increase in shareholders’ equity as of December 31, 2019 (increase of €1 million applying a 1% change in interest rates). An increase of one percentage point in relevant interest rates in 2018 would have increased shareholders’ equity by €5 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, benzene, natural gas, LPG condensate) 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 risks from the volatility of raw materials prices. These are primarily options on crude oil, oil products and natural gas.
• 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 various 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 performed using forward contracts, which are settled by either entering into offsetting contracts or by delivering the precious metal.
• In the Agricultural Solutions division, the sales prices of products are sometimes pegged 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.

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 enables continual quantification of market risk and forecasting of 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 in conjunction with 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 customers and debtors do not fulfill their contractual obligations. BASF regularly analyzes the creditworthiness of the counterparties 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 financial obligations stemming from contingent liabilities not to be recognized represents the maximum default risk for BASF.

Liquidity risks

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

27.3 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 negative fair values and therefore represent a liability. Derivatives with positive fair values are assets and are therefore not taken into account.

27.4 Classes and categories of financial instruments

For trade accounts receivable, other receivables and miscellaneous assets, cash and cash equivalents, as well as trade accounts payable and other liabilities, the carrying amount approximates the fair value.

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 derivative assets and liabilities” shows the extent to which assets and liabilities were offset in the balance sheet, as well as potential effects from the offsetting of derivatives subject to a legally enforceable global netting agreement (primarily in the form of an ISDA agreement) or similar agreement. For positive fair values of combined interest rate and currency swaps, the respective counterparties provided cash collaterals in an amount comparable 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 2019 and 2018 arose from derivatives not subject to any netting agreements as well as from embedded derivatives. These are therefore not included in the table above.

In addition to the offsetting of derivatives presented in the table above, trade accounts receivable were offset against advance payments received on orders that were subject to specific netting agreements with customers, which were included in current other liabilities in 2019. As a result, both balance sheet items were reduced by €647 million. This results in a net amount for trade accounts receivable of €9,093 million (gross amount before offsetting: €9,740 million). The resulting net amount for advance payments on orders is €537 million (gross amount before offsetting: €1,184 million). In 2018, neither trade accounts receivable nor advance payments received were netted.

The net gains and losses from financial instruments shown in the following table 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 gains and losses from instruments that are not designated as hedging instruments in accordance with IFRS 9.

27.5 Derivative financial instruments and hedge accounting

The use of derivative financial instruments

BASF is exposed to foreign currency, interest rate and commodity price risks during the normal course of business. These risks are hedged using derivative instruments as necessary in accordance with a centrally determined strategy. Hedging is only employed for existing underlying transactions from the product business, cash investments and financing as well as for planned sales, raw material purchases and capital measures. The risks from the hedged items and the derivatives are continually 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 that 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

BASF is exposed to commodity price risks in the context of procuring naphtha. Some of the planned purchases of naphtha are hedged using swaps and options on oil and oil products. The main contractual elements of these items are aligned with the characteristics of the hedged item. Cash flow hedge accounting was employed for a portion of these hedging relationships in 2019. These transactions were not presented using cash flow hedge accounting in 2018. Cash flows from designated hedging instruments and hedged transactions occur in the following year and are also recognized in profit or loss for that year.

Furthermore, cash flow hedge accounting is employed to a minor extent for procuring natural gas, which is likewise exposed to commodity price risks. Commodity price-based options serve as hedging instruments, for which contract terms are defined to reflect the risks of the hedged item. Cash flows from the hedging transaction and hedged item are generally recognized in profit or loss for the following year.

The change in the options’ time value is separately recognized in equity and recognized in profit or loss in the year during which the hedged items mature. In 2019, a decrease in fair value of minus €3 million was recognized in equity attributable to shareholders of BASF SE, and €2 million was derecognized, reducing earnings. In 2018, a decrease in fair value of minus €2 million was recognized in equity attributable to shareholders of BASF SE, and €1 million was derecognized, reducing earnings.

BASF’s planned soy bean procurement is also exposed to commodity price risks. These commodity price risks are hedged with soy bean futures. The contractual conditions for these hedging transactions correspond to the respective hedged item, and some are designated as cash flow hedging relationships. Cash flows from these futures and the hedged expected future transactions are generally recognized in profit or loss for the following year.

BASF is exposed to foreign currency risks due to planned sales in U.S. dollars. To some extent, cash flow hedge accounting is applied using currency options. The average hedging rate in 2019 was $1.1105 per euro and in 2018 $1.1563 per euro. The impact on earnings from designated transactions in 2019 will be recognized in the following year. The decrease in the options’ time value component arising in the amount of €38 million in 2019 was recognized separately in equity as the cost of hedging and resulted in a reduction in equity. The reclassification of the accumulated changes in the time value of options to profit or loss due to the maturity of hedged items had a countering effect in the amount of €35 million. In 2018, minus €33 million was recognized separately in equity as a change in the options’ time value component, and €36 million was reclassified to profit or loss.

The interest rate risk of the variable-rate bonds issued by BASF SE in 2013 was hedged using interest rate swaps, which converted the bonds into fixed-interest rate bonds with a rate of 1.45%. The key terms of the interest rate swap contracts used as hedging instruments generally correspond to the contractual elements of the hedged item. The bond and the interest rate swaps were designated as hedge accounting.

Furthermore, BASF SE’s fixed-rate U.S. private placement of $1.25 billion, issued in 2013, was converted to euros using cross-currency swaps, as the private placement exposes BASF to a combined interest/currency risk. The hedged interest rate was 4.13% in the fiscal years 2019 and 2018. The hedged foreign exchange rate in both years was $1.3589 per euro. This hedge was designated as a cash flow hedge.

The effects of the hedging relationships on the balance sheet, the cash flow hedge reserve, hedged nominal value and ineffectiveness to be determined are presented in the following tables by fiscal year.

The occurrence of all forecasted transactions was considered to be highly probably at all times during fiscal years 2018 and 2019. Amounts accumulated in the cash flow hedge reserve for commodity price risks are derecognized against the carrying amount of acquired assets once the hedged transaction occurs. Thus, an immediate reclassification of the amounts recognized in the cash flow hedge reserve to profit or loss does not occur in these cases.