Financial Opportunities and Risks
Detailed guidelines and procedures exist for dealing with financial risks. Among other things, they provide for the segregation of financial instrument trading and back office functions.
As a part of risk management, activities in countries with transfer restrictions are continuously monitored. This includes, for example, regular analysis of the macroeconomic and legal environment, shareholders’ equity and the business models of the operating units. The chief aim is the management of counterparty, transfer and currency risks for the BASF Group.
Exchange rate volatility
Our competitiveness on global markets is influenced by fluctuations in exchange rates. For BASF’s sales, opportunities and risks arise in particular when the U.S. dollar exchange rate fluctuates. A full-year appreciation of the U.S. dollar against the euro by $0.01, which could result from a macroeconomic slowdown, would increase the BASF Group’s EBIT by around €30 million, assuming other conditions remain the same. On the production side, we counter exchange rate risks by producing in the respective currency zones.
Financial currency risks result from the translation of receivables, liabilities and other monetary items in accordance with IAS 21 at the closing rate into the functional currency of the respective Group company. In addition, we incorporate planned purchase and sales transactions in foreign currencies into our financial foreign currency risk management. These risks are hedged using derivative instruments, if necessary.
Interest rate risks
Interest rate risks result from potential changes in prevailing market interest rates. These can cause a change in the fair value of fixed-rate instruments and fluctuations in the interest payments for variable-rate financial instruments, which would positively or negatively affect earnings. To hedge these risks, interest rate swaps and combined interest rate and currency derivatives are used in individual cases.
In addition to market interest rates, BASF’s financing costs are determined by the credit risk premiums to be paid. These are mainly influenced by our credit rating and the market conditions at the time of issue. In the short to medium term, BASF is largely protected from the possible effects on its interest result thanks to the balanced maturity profile of its financial indebtedness.
Risks from metal and raw materials trading
In the catalysts business, BASF employs commodity derivatives for precious metals and trades precious metals on behalf of third parties and on its own account. Appropriate commodity derivatives are also traded to optimize BASF’s supply of refinery products, gas and other petrochemical raw materials. To address specific risks associated with these non-operating trades, we set and continuously monitor limits with regard to the type and volume of the deals concluded.
Risks from fluctuating cash flows are recognized in a timely manner as part of our liquidity planning. We have access to extensive liquidity at any time thanks to our good ratings, our unrestricted access to the commercial paper market and committed bank credit lines. In the short to medium term, BASF is largely protected against potential refinancing risks by the balanced maturity profile of its financial indebtedness as well as through diversification in various financial markets.
Risk of asset losses
We limit country-specific risks with measures based on internally determined country ratings, which are continuously updated to reflect changing environment conditions. We selectively use investment guarantees to limit specific country-related risks. We lower credit risks for our financial investments by engaging in transactions only with banks with good credit ratings and by adhering to fixed limits. Creditworthiness is continuously monitored and the limits are adjusted accordingly. We reduce the risk of default on receivables by continuously monitoring the creditworthiness and payment behavior of our customers and by setting appropriate credit limits. Risks are also limited through the use of credit insurance and individual hedging strategies, such as guarantees. Due to the global activities and diversified customer structure of the BASF Group, there are no major concentrations of credit default risk.
Asset impairment risk arises if the assumed interest rate in an impairment test increases, the predicted cash flows decline, or investment projects are suspended. Following the impairments recognized in the third quarter of 2020, we currently consider the risk of further impairment for assets such as property, plant and equipment, goodwill, technologies and trademarks to be immaterial. The same applies to investments accounted for using the equity method, with the exception of Wintershall Dea, which was remeasured at fair value in 2019. As the value of the shareholding is dependent on expected oil and gas price developments, impairments of the shareholding and of the assets held by the company are possible.
Long-term incentive program for senior executives
Since 2020, BASF has offered its leaders the opportunity to participate in a long-term incentive program (LTI program) in the form or a performance share plan. The LTI plan incentivizes the achievement of strategic growth, profitability and sustainability targets and takes into account the development of the BASF share price and the dividend. The need for provisions for this program varies according to assumptions on the degree of strategic target achievement, the development of the BASF share price and the dividend. This leads to a corresponding increase or decrease in personnel costs.
Until 2020, BASF offered leaders the opportunity to participate in a share price-based compensation program. The need for provisions for this program varies according to the development of the BASF share price and the MSCI World Chemicals Index; this leads to a corresponding increase or decrease in personnel costs.
Risks from pension obligations
Most employees are granted company pension benefits from either defined contribution or defined benefit plans. We predominantly finance company pension obligations externally through separate plan assets. This particularly includes BASF Pensionskasse VVaG and BASF Pensionstreuhand e.V. in Germany, in addition to the large pension plans of our Group companies in North America, the United Kingdom and Switzerland. To address the risk of underfunding due to market-related fluctuations in plan assets, we have investment strategies that align return and risk optimization to the structure of the pension obligations. Stress scenarios are also simulated regularly by means of portfolio analyses. An adjustment to the interest rates used in discounting pension obligations leads immediately to changes in equity. To limit the risks of changing financial market conditions as well as demographic developments, employees have, for a number of years now, been almost exclusively offered defined contribution plans for future years of service. Some of these contribution plans include minimum interest guarantees. If the pension fund cannot generate this, it must be provided by the employer. A permanent continuation of the low interest rate environment could make it necessary to recognize pension obligations and plan assets for these plans as well.