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(35) Financial instruments

Primary financial instruments are reflected in the statement of financial position. In compliance with IAS 39, asset instruments are categorized as “loans and receivables,” “held at fair value through profit or loss,” “held to maturity” or “available for sale” and, accordingly, recognized at cost or fair value. Liability instruments that are neither held for trading nor constitute derivatives are carried at amortized cost.

Risks and risk management

The global alignment of the LANXESS Group exposes its business operations, earnings and cash flows to a variety of market risks. Material financial risks to the Group as a whole, such as currency, interest rate, credit, liquidity and commodity price risks, are managed centrally.

These risks could impair the earnings and financial position of the LANXESS Group. The various risk categories and the risk management system for the LANXESS Group are outlined below.

The principles of risk management are defined by the Board of Management. At the regular strategy meetings of the Financial Risk Committee, which are chaired by the Chief Financial Officer, reports on the outcome of financial risk management and on current risks levels are presented and any further action is decided upon. Simulations are performed to assess the impact of market trends. The implementation of the Financial Risk Committee’s decisions and ongoing risk management are undertaken centrally by the Group Function Treasury. The aim of financial risk management is to identify and evaluate risks and to manage and limit their effects as appropriate.

Currency risks
Since the LANXESS Group undertakes transactions in numerous currencies, it is exposed to the risk of fluctuations in the relative value of these currencies, particularly the U.S. dollar, against the euro.

Currency risks from potential declines in the value of financial instruments due to exchange rate fluctuations (transaction risks) arise mainly when receivables and payables are denominated in a currency other than the company’s local currency.

Currency risks relating to operating activities are systematically monitored and analyzed. While the risks relating to changes in the value of receivables and payables denominated in foreign currencies are fully hedged, the scope of hedging for currency risks relating to forecast transactions is subject to regular review. A substantial proportion of contractual and foreseeable currency risks are hedged using derivative financial instruments. Changes in the fair values of these instruments are recognized in the financial result or, in the case of cash flow hedges, in other comprehensive income. Realized income/expense from the effective portion of cash flow hedges are recognized in other operating income/expenses.

Currency risks arising on financial transactions, including interest, are generally fully hedged through forward exchange contracts.

Since the LANXESS Group concludes derivative contracts for the greater part of its currency risks, it believes that, in the short term, a rise or fall in the euro against other major currencies would have no material impact on future cash flows. In the long term, however, these exchange rate fluctuations could adversely affect future cash flows should the LANXESS Group not be in a position to absorb them, for example, through the pricing of its products in the respective local currencies.

If the exchange rate for the euro had been 5% higher against all other currencies on the reporting date, this would have had a €20 million (2011: €19 million) effect, mainly on other comprehensive income, which would have improved accordingly. This effect mainly relates to the U.S. dollar. A correspondingly lower rate for the euro would have had basically the opposite effect.

Many companies in the LANXESS Group are based outside the eurozone. Since the Group prepares its consolidated financial statements in euros, the annual financial statements of these subsidiaries are translated into euros for consolidation purposes. Changes in the average exchange rate of a currency from one period to the next can materially affect the translation of both sales and earnings reported in this currency (translation risk).

Unlike transaction risk, translation risk has no impact on Group cash flows in the local currency.

The LANXESS Group has material assets, liabilities and businesses outside the eurozone that report in local currencies. The related long-term currency risk is estimated and evaluated on a regular basis. In view of the risks involved in such cases, however, foreign currency hedging transactions are only concluded if consideration is being given to withdrawing from a particular business and it is intended to repatriate the funds released by the withdrawal. The effects of exchange rate fluctuations on the translation of net positions into euros are reflected in other comprehensive income.

Interest rate risks
Fluctuations in market interest rates can cause fluctuations in the overall return on a financial instrument. Interest rate risk affects both financial assets and financial liabilities.

Since the majority of financial liabilities were entered into at fixed interest rates, changes in interest rates in the coming years will only have a limited impact on the LANXESS Group. The available liquidity is invested in instruments with short-term fixed interest rates, so that the LANXESS Group benefits quickly from rising interest rates. A general change of one percentage point in interest rates as of December 31, 2012 would have altered Group net income by €3 million (2011: €3 million).

Credit risks
Credit risks arise from trade relationships with customers and dealings with banks and other financial partners, especially with regard to the investment business and financial-instrument transactions.

Customer risks are systematically identified, analyzed and managed, using both internal and external information sources. Customer portfolios may be insured against credit risks, especially where the risk profile is elevated.

The objective of receivables management at LANXESS is to collect all outstanding payments punctually and in full, and thus to minimize the risk of default. Continuous monitoring is computer-assisted based on the payment terms agreed with the customers. These are generally based on the customary payment terms for the business or country. Reminders are sent out at regular intervals if payments are overdue.

The maximum risk of default on receivables, cash and cash equivalents, and near-cash derivative and other financial assets is reflected by their carrying amounts in the statement of financial position.

Credit insurance has been concluded with a well-known European credit insurer to cover material credit risks relating to receivables from customers. After taking the deductible into account, these cover default risks, especially in Europe and North America, in the mid-double-digit millions of euros. The maximum credit risk is further reduced by letters of credit in favor of LANXESS. In certain cases, prepayment is agreed with the contracting partner.

In addition, LANXESS has a contractually agreed title to goods until the contracting partner has paid the full purchase price. The vast majority of receivables relate to customers with very high credit standing.

The creditworthiness of the counterparty is a key criterion in the financial policy and credit risk management of the LANXESS Group, especially in the selection of banks and financial partners for capital investments and transactions involving financial instruments. LANXESS therefore endeavors to undertake transactions with banks and other financial counterparties that have at least an investment grade rating. The derivatives and financial assets outstanding as of the closing date were almost all concluded with banks with an investment grade rating.

Credit risk management also includes global management of the counterparty risk relating to banks and financial partners. The LANXESS Group pays particular attention to risk diversification to prevent any cluster risks that could jeopardize its existence. Through master agreements, the market values of open trading positions can be netted if a partner becomes insolvent, thereby further reducing risks.

Liquidity risks
Liquidity risks arise from potential financial shortfalls and the resulting increase in refinancing costs. The aim of liquidity management in the LANXESS Group is to ensure that the Group has sufficient liquidity and committed credit facilities available at all times to enable it to meet its payment commitments, and to optimize the liquidity balance within the Group.

A new €1.25 billion syndicated credit facility was signed in December 2012 and was virtually unused at year end. It runs until February 2018 with two one-year renewal options. This credit facility represents early refinancing of a €1.4 billion syndicated credit facility which originally ran through November 2014. A further material credit line for €200 million with the European Investment Bank had not been drawn at year-end 2012. In addition to credit facilities, the Group has short-term liquidity reserves of €797 million (2011: €528 million) in the form of cash and cash equivalents and investment in highly liquid AAA-rated money market funds. Accordingly, the LANXESS Group has a liquidity position based on a broad range of financing instruments.

The following table shows the contractually agreed (undiscounted) cash flows for primary financial liabilities, the interest components thereof and derivative financial instruments:

Dec. 31, 2011
             
€ million 2012 2013 2014 2015 2016 > 2016
             
Bonds (436) (70) (570) (32) (232) (541)
of which interest (34) (70) (70) (32) (32) (41)
Liabilities to banks (167) (33) (40) (38) (37) (63)
of which interest (7) (6) (5) (4) (3) (2)
Trade payables (766)          
of which interest 0          
Liabilities under finance leases (14) (38) (9) (6) (6) (27)
of which interest (3) (3) (2) (2) (1) (5)
Other primary financial liabilities (62) (1) (3) (3) (2) (1)
of which interest (56) 0 0 0 0 0
Derivative liabilities            
Hedging instruments that qualify for hedge accounting            
Disbursements (447) (183)        
Receipts 417 173        
Other hedging instruments            
Disbursements (788) (2) (13) (18) (24)  
Receipts 777 2 11 17 23  
Derivative assets            
Hedging instruments that qualify for hedge accounting            
Disbursements (38) (2)        
Receipts 39 2        
Other hedging instruments            
Disbursements (364) 0 0 (6)    
Receipts 370 2 0 6    
 
Dec. 31, 2012
             
€ million 2013 2014 2015 2016 2017 > 2017
             
Bonds (42) (593) (115) (252) (41) (1,343)
of which interest (42) (93) (55) (52) (41) (143)
Liabilities to banks (80) (46) (38) (37) (41) (22)
of which interest (5) (5) (4) (3) (2) 0
Trade payables (795)          
of which interest 0          
Liabilities under finance leases (38) (10) (7) (7) (5) (25)
of which interest (3) (2) (2) (2) (1) (4)
Other primary financial liabilities (57) (3) (3) (2) 0 (2)
of which interest (54) 0 0 0 0 0
Derivative liabilities            
Hedging instruments that qualify for hedge accounting            
Disbursements (170) (20)        
Receipts 162 19        
Other hedging instruments            
Disbursements (260) (13) (19) (25) (9)  
Receipts 257 12 17 23 8  
Derivative assets            
Hedging instruments that qualify for hedge accounting            
Disbursements (331) (172)        
Receipts 343 180        
Other hedging instruments            
Disbursements (952) (5) (27)      
Receipts 967 5 28      
 

The contractually agreed payments for other primary financial liabilities due within one year from the reporting date contain accrued interest of €52 million (2011: €53 million) relating mainly to the bonds.

Raw material price risks
The LANXESS Group is exposed to changes in the market prices of commodities used for its business operations. Increases in energy and raw material procurement costs are generally passed on to customers. Where such increases cannot be passed on in their entirety, the related risks are systematically monitored, evaluated and controlled as part of the financial risk management system. The aim is to achieve a deliberate and controlled reduction in the volatility of cash flows and thus the volatility of the company’s economic value by making systematic use of derivatives. Where cash flow hedges qualify for hedge accounting, changes in their fair values are recognized in other comprehensive income until the hedged transaction is realized.

If all raw material prices had been 10% higher or lower on the closing date, the changes in the fair values of the respective hedging instruments would have increased or decreased other comprehensive income by €0 million (2011: €2 million).

Carrying amounts, measurement and fair value of financial instruments

The table shows the carrying amounts of the individual classes of financial assets and liabilities and their fair values. The basis of measurement is also shown:

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Dec. 31, 2011
                 
€ million IAS 39 measurement category Carrying amount Dec. 31, 2011 Measurement according to IAS 39 Measurement according to IAS 17 Fair value Dec. 31, 2011
  Amortized cost Acquisition cost Fair value (other comprehensive income) Fair value (profit or loss)
                 
Financial assets                
Trade receivables LaR 1,146 1,146         1,146
Receivables under finance leases 6         6 6
Other financial receivables LaR 41 41         41
Cash and cash equivalents LaR 178 178         178
Available-for-sale financial assets                
Near-cash assets AfS 350     350     350
Other available-for-sale financial assets AfS 81   8 73     73
Derivative assets                
Hedging instruments that qualify for hedge accounting 1     1     1
Other hedging instruments FAHfT 15       15   15
                 
Financial liabilities                
Bonds FLAC (1,593) (1,593)         (1,700)
Liabilities to banks FLAC (350) (350)         (350)
Trade payables FLAC (766) (766)         (766)
Liabilities under finance leases (84)         (84) (84)
Other primary financial liabilities FLAC (71) (71)         (71)
Derivative liabilities                
Hedging instruments that qualify for hedge accounting (38)     (38)     (38)
Other hedging instruments FLHfT (15)       (15)   (15)
 

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Dec. 31, 2012
                 
€ million IAS 39 measurement category Carrying amount Dec. 31, 2012 Measurement according to IAS 39 Measurement according to IAS 17 Fair value Dec. 31, 2012
  Amortized cost Acquisition cost Fair value (other comprehensive income) Fair value (profit or loss)
                 
Financial assets                
Trade receivables LaR 1,117 1,117         1,117
Receivables under finance leases 4         4 4
Other financial receivables LaR 8 8         8
Cash and cash equivalents LaR 386 386         386
Available-for-sale financial assets                
Near-cash assets AfS 411     411     411
Other available-for-sale financial assets AfS 20   15 5     5
Derivative assets                
Hedging instruments that qualify for hedge accounting 21     21     21
Other hedging instruments FAHfT 23       23   23
                 
Financial liabilities                
Bonds FLAC (1,946) (1,946)         (2,128)
Liabilities to banks FLAC (245) (245)         (245)
Trade payables FLAC (795) (795)         (794)
Liabilities under finance leases (78)         (78) (78)
Other primary financial liabilities FLAC (65) (65)         (65)
Derivative liabilities                
Hedging instruments that qualify for hedge accounting (8)     (8)     (8)
Other hedging instruments FLHfT (6)       (6)   (6)
LaR Loans and Receivables
AfS Available-for-Sale Financial Assets
FAHfT Financial Assets Held for Trading
FLAC Financial Liabilities Measured at Amortized Cost
FLHfT Financial Liabilities Held for Trading
Carrying Amounts by IAS 39 Category
     
€ million Dec. 31, 2011 Dec. 31, 2012
     
Loans and receivables 1,365 1,511
Available-for-sale financial assets 431 431
Financial assets held for trading 15 23
  1,811 1,965
Financial liabilities measured at amortized cost (2,780) (3,051)
Financial liabilities held for trading (15) (6)
  (2,795) (3,057)
 

Fair value measurement

Fair value measurement is based on a hierarchy that reflects the significance of inputs in the valuation. This comprises three levels:

Level 1
Quoted prices (unadjusted) for identical assets or liabilities in active markets

Level 2
Inputs other than quoted prices used within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices)

Level 3
Inputs for the asset or liability that are not based on observable market data.

The classification of financial instruments using the fair value hierarchy is as follows:

Fair Value Measurement Levels
       
€ million Dec. 31, 2011
       
  Level 1 Level 2 Level 3
       
Available-for-sale financial assets      
Near-cash assets 350
Other available-for-sale financial assets 72 1
Derivative assets 16
Derivative liabilities (53)
 
Fair Value Measurement Levels
       
€ million Dec. 31, 2012
       
  Level 1 Level 2 Level 3
       
Available-for-sale financial assets      
Near-cash assets 411
Other available-for-sale financial assets 4 1
Derivative assets 44
Derivative liabilities (14)
 

Net result by category

The following table provides an overview of the net results based on the measurement categories defined in IAS 39:

Net Results by IAS 39 Category
     
€ million 2011 2012
     
Loans and receivables 14 4
Available-for-sale financial assets (10) (9)
Assets and liabilities held for trading 0 0
Financial liabilities measured at amortized cost (100) (96)
  (96) (101)
 

Net gains and losses principally comprise interest income and expense and remeasurement effects.

The net result for available-for-sale financial assets includes gains of €10 million (2011: losses of €7 million), which are reflected in other comprehensive income.

In addition, fees of €6 million were incurred in 2012 (2011: €8 million) in connection with financial instruments.

Collateralization of financial liabilities

Financial liabilities amounting to €4 million (2011: €15 million) were collateralized by mortgages or other property claims.

Mezzanine financing

Mezzanine instruments such as profit participation rights, convertible bonds or warrant bonds have not been issued. Information on the possible issuance of such instruments is given in Note [12].

Service

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