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 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 is conducted by simulating a 10% appreciation of the respective functional currency against the other currencies. The effect on BASF’s income before income taxes would have been minus €373 million as of December 31, 2018, and minus €252 million as of December 31, 2017. The effect from the items designated under hedge accounting would have increased shareholders’ equity before income taxes by €33 million as of December 31, 2018 (2017: increase of €46 million). This only refers to transactions in U.S. dollars. The foreign currency risk exposure amounted to €3,185 million as of December 31, 2018, and €1,976 million as of December 31, 2017.

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. These 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 €4.802 million as of December 31, 2018 (2017: minus €986 million). 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, and raised income before income taxes by €4 million as of December 31, 2017. The effect from the items designated under hedge accounting would have increased shareholders’ equity before income taxes by €5 million as of December 31, 2018 (2017: increase of €9 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 risks from the volatility of raw materials prices. These are primarily options and swaps on crude oil, oil products and natural gas.
• In the discontinued business, margin risks 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 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 metals.
• 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.

In connection with carbon emissions trading, various types of carbon 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. There were no deals outstanding as of December 31, 2018, or as of December 31, 2017.

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 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 sufficient liquid funds from the 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 negative fair values and therefore represent a liability. Derivatives with positive fair values are assets and are therefore not taken into account.

Trade accounts payable are generally interest-free and due within one year. As a result, 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, 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 financial assets and financial liabilities” shows the extent to which financial assets and financial liabilities were offset in the balance sheet, as well as potential effects from the offsetting of instruments 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 2018 and 2017 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 gains and losses from instruments that are not designated as hedging instruments in acordance with IFRS 9.

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 using derivative instruments as necessary in accordance with a centrally determined strategy. Hedging is only employed for existing items 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 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 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 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 options correspond to the characteristics of the hedged item. These hedges are not presented using cash flow hedge accounting in BASF’s 2018 or 2017 financial statements.

Cash flow hedge accounting continues to be used to a minor extent for natural gas purchases exposed to commodity price risks, meaning that gains and losses from hedging instruments are initially recognized in equity. Commodity price-based options serve as hedging instruments, for which contract terms are adjusted to reflect the risks of the hedged item. Gains and losses from hedging instruments are included in cost of sales in the fiscal year in 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 2018, effective changes in the fair value of hedging instruments of €5 million (2017: €200,000) were recognized in the equity of the shareholders of BASF SE. In 2018, effective changes in the fair value of hedging instruments of €4 million were derecognized from the equity attributable to shareholders of BASF SE and recognized in other operating income (2017: €300,000). Ineffective parts required to be accounted for did not arise. In 2017, minus €100,000 was recognized as the ineffective part of value changes of the hedging instruments in other operating expenses. 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 matured. 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, increasing equity.

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 hedging rate is $1.1563 per euro. The impact on earnings from the hedged transactions will occur in 2019. In 2018, the effective change in the values of the hedges was €8 million (2017: €71 million), which was recognized in the equity of the shareholders of BASF SE. A total of €31 million (2017: €44 million) was derecognized accordingly from the equity attributable to shareholders of BASF SE and was recognized in income from foreign currency and hedging transactions. The hedges were entirely effective. The decrease in the options’ time value component arising in the amount of €33 million in 2018 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 €36 million.

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 largely correspond to the contractual elements of the hedged item. The bond and the interest rate swaps were designated in a hedging relationship. The effective changes in the fair value recognized in BASF SE shareholders’ equity amounted to €4 million in 2018 (2017: €6 million). Ineffective parts required to be accounted for did not arise.

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, because the private placement exposes BASF to a currency risk. The hedging interest rate was 4.13%; and the hedging foreign exchange rate was $1.3589 per euro. This hedge was designated as a cash flow hedge. Recognition of ineffective portions in profit or loss was not required. In 2018, changes in fair value of €42 million were recognized in shareholders’ equity (2017: minus €125 million). In 2018, €49 million was derecognized from other comprehensive income and recorded as income in the financial result (2017: expense of €144 million in financial result).