20 Financial Instruments

Primary Financial Instruments

The carrying amounts of the held-to-maturity securities correspond to their fair values. If no prices from an active market are currently available and if the fair value cannot be determined reliably, the securities are valued at cost. This category includes current and noncurrent fixed-interest securities which are measured at amortized cost in accordance with the effective interest method.

The loans and receivables reported include trade receivables and other loans. Their carrying amounts correspond to their fair values. The present value of the loans corresponds to their cash value and constitutes the cash values of the cash flows expected in the future. Discounting is carried out on the basis of the interest rates valid on the reporting date. Available-for-sale financial assets include cash and cash equivalents, fund shares aimed at securing phased-early-retirement commitments, receivables from investment grants, and other financial receivables. The fair values of the fund shares correspond to their stock market prices on the reporting date. Cash and cash equivalents in foreign currency are valued at the conversion rate prevailing on the reporting date. Other financial assets are valued at cost, as no observable prices on active markets are available. The carrying amounts of the financial liabilities, trade payables, and other liabilities correspond to their fair values. The fair values of financial liabilities constitute the cash value of the cash flows expected in the future. Discounting is carried out on the basis of the interest rates valid on the reporting date. All other liabilities are valued at cost as no observable prices for them are available.

The interest expenses contain €14.5 million (2009: €12.8 million) from financial liabilities recognized at amortized cost. No profit was generated by the reversal of those financial instruments. Loans and receivables or financial liabilities at amortized cost in a foreign currency produced a net profit of €114.7 million (2009: €80.3 million) and a net loss of €-97.6 million (2009: €-79.3 million). These are posted under other operating income and expenses. Net profits from financial instruments that are held to maturity resulted in the amount of €1.1 million. This mainly involved interest income from noncurrent and current corporate bonds that are posted under securities. Exchange-rate effects did not arise. Net profits from available-for-sale financial instruments also originate from investment income. In addition, other operating income and expenses include €10.9 million (2009: €2.6 million) from the currency translation of cash and cash equivalents. Neither in the year under review nor in the previous year were there any reclassifications of financial assets between those recognized at amortized cost and those recognized at market value or vice versa.

Financial Risks

In the normal course of its business, WACKER is exposed to credit, liquidity, and market risks from financial instruments. The aim of financial risk management is to limit risks from operating business and the resultant financing requirements by using certain derivative and non-derivative hedging instruments.

The risks connected with the procurement, financing and selling of WACKER’s products and services are described in detail in the management report. WACKER counters financial risks via its implemented risk management system, which is monitored by the Supervisory Board. The principles follow the aim of identifying, analyzing, coordinating, monitoring and communicating risks in a timely manner. The Executive Board receives regular analyses on the extent of those risks. The analyses focus on market risks, in particular on the potential impact of raw-material-price risks, foreign-currency exchange risks, and interest-rate risks on EBITDA and net interest income.

Credit Risk (Default Risk)

In terms of financial instruments, the Group is exposed to a default risk should a contractual party fail to fulfill their commitments. This risk is, therefore, at a maximum in the amount of the respective financial instrument’s positive fair value. To limit the risk of default, transactions are conducted only within defined limits and with partners of very high credit standing. To make efficient risk management possible, the market risks within the Group are controlled centrally. The conclusion and handling of transactions comply with internal guidelines and undergo monitoring procedures that take account of the separation of duties. As for operations, outstanding receivables and default risks are continually monitored and hedged against via trade credit insurance. Receivables for major customers are not so high as to pose an extraordinary concentration of risks. Default risks are covered by impairments.

Liquidity Risk

A liquidity risk means that a company may not be able to meet its existing or future financial obligations due to inadequate funds. To ensure uninterrupted solvency and financial flexibility, the Group holds long-term credit lines and liquid funds based on multiyear financial planning and continuous monthly liquidity planning.

To limit this risk, WACKER keeps liquid reserves in the form of current investments and credit lines. Furthermore, WACKER has concluded agreements with a number of banks for long-term syndicated loans and bilateral loans. The aggregate volume of these loans is significantly higher than the planned financial liabilities.

Market Risk

Market risks refer to the risk that fair values or future cash flows of a primary or derivative financial instrument fluctuate due to changing risk factors.

Foreign Exchange Risk

The evaluation of the currency-exposure risk potential to hedging via derivative financial instruments is based on the major foreign-currency income and expenditure. The greatest risk is posed by the US dollar, whose income is taken to mean all sales invoiced in US dollars, while all US-dollar purchasing as well as site costs incurred in US dollars are reported under US-dollar expenditure. The evaluation of potential risks includes not only the direct US-dollar income and expenditure, but also the indirect US-dollar impact of WACKER’s main raw materials (methanol and natural gas). At the same time, indirect €-denominated sales are deducted from currency exposure. The US dollar is the exclusive relevant risk variable for the sensitivity analysis in accordance with IFRS 7, since the largest share of foreign-currency cash flows is in US dollars. Increases in the euro exchange rate against the Singapore dollar, Chinese renminbi and Japanese yen, in contrast, have a minor impact. In determining sensitivity, we simulate a 10-percent US-dollar devaluation against the euro, which would have had an EBITDA effect of
€-62 million as per December 31, 2010 and €-37 million as per December 31, 2009. The effect from cash-flow-hedge designated items would have increased equity before income taxes by €81.2 million. The Group’s USD currency exposure amounted to €677 million as per December 31, 2010 (2009: €409 million).

Interest Rate Risk

The interest rate risk results mainly from financial debt and interest-bearing assets. Each year, the Executive Board determines the mixture of fixed and variable-interest net financial liabilities. Depending on the structure involved, interest rate derivatives are concluded as required. Depending on whether the instrument in question (financial liabilities, investments or interest rate derivatives) has a fixed or variable interest rate, the interest rate risks are measured on the basis of either market-value sensitivity or cash-flow sensitivity. Financial liabilities and fixed-interest investments are measured at amortized cost and are therefore, in accordance with IFRS 7, not subject to any interest-rate risk. Hedge accounting is not used for any of the interest rate derivatives. Changes in market interest rates have an impact on the net interest income generated by variable-interest financial instruments, and are, therefore, included in the calculation of earnings-related sensitivity. Changes in the market interest rates of interest rate derivatives affect the financial result, and are, therefore, included in any earnings-related sensitivity analysis. If current interest rates had been 100 base points higher (lower) on average, net interest income would have been €0.9 million (2009: €0.9 million) higher (lower).

Raw-Material-Price Risk

Potential combinations of factors in the natural gas or ethylene segments make it impossible to exclude the risk that the company’s supply of raw materials might be insufficient. Ethylene-related risks, however, will be reduced in the future by the EPS pipeline currently under construction in Germany. In general, potential increases in raw-material prices pose a risk to results. An increase of 1 percent would have a negative effect of €8.4 million (2009: €7.2 million) on EBITDA.

Derivative Financial Instruments

Financial risks are also hedged using derivative financial instruments. The raw-material-price risks that WACKER hedges against result principally from the precious metals (platinum, gold and palladium) that are used as catalysts or for other purposes in the production process, as well as ongoing energy procurement. In 2010, precious-metal-related risks were not hedged using derivative financial instruments. Electricity-supply price hedging takes place via contractual stipulations, for which IAS 39’s “own-use exemption” can essentially be used. These agreements, which are concluded for purposes of receiving or delivering non-financial goods according to WACKER’s own needs, are not recognized as derivatives, but rather as pending transactions.

In those cases where WACKER hedges against these currency risks, it uses derivative financial instruments, in particular currency option and forward exchange contracts, and foreign exchange swaps. Derivatives are used only if they are backed by positions, cash deposits and funding, or scheduled transactions arising from operations (underlying transactions). The scheduled transactions also include anticipated, but not yet invoiced sales in foreign currencies.

Foreign exchange hedging is carried out mainly for the US dollar, Japanese yen and Singapore dollar. In the case of foreign exchange hedging in the financing area, the maturities of the receivables and/or liabilities are taken into account. Interest rate hedging is carried out primarily for the euro, with the maturities of the underlying transactions being the most important factor.

Operational hedging in the foreign exchange area relates to the receivables and liabilities already recognized, and generally encompasses time horizons of between three and four months. The time horizon of strategic hedging is between four and a maximum of 33 months. The hedged cash flows influence the statement of income at the time when sales are realized. The cash inflows are usually recorded shortly afterward, depending on the payment deadline. As well as receivables from, and liabilities to, third parties, intercompany financial receivables and liabilities are hedged.

The market values refer to the maturity repurchase values (redemption values) of the financial derivatives as of the statement of financial position date. They are calculated on the basis of quoted prices or with the help of standard calculation methods. In the valuation of forward contracts and/or swaps, WACKER primarily applies the zero-coupon method and thus follows a consistent valuation methodology as in prior years. Due to potential interest-rate-market and currency-market distortions, values determined via the zero-coupon method may nevertheless differ from commercial values.

The derivatives are measured at their market values, irrespective of their stated purpose. They are reported in the statement of financial position under other assets and/or other liabilities. Where permissible, cash flow hedge accounting is applied for the strategic hedging of currency exchange risks from future foreign exchange positions. In such cases, the changes in the market values of foreign exchange contracts and the changes in the intrinsic values of currency options are recognized under equity with no effect on net income until the underlying transaction takes place, insofar as the hedge is effective. When future transactions are realized, the effects accumulated under equity are reversed through profit and loss. The changes in the current values of the currency options are posted to the statement of income.

In the fiscal year, the accumulated income and expenses recorded directly under equity included unrealized earnings amounting to €11.5 million (before tax) (2009: €31.7 million).

Derivative financial instruments of which the changes in market value are recognized in profit or loss led to a net result of €-23.3 million (2009: €-28.3 million). Of this amount, €7.1 million (2009: €15.0 million) is attributable to derivatives from hedge accounting. In the result for the period, no gains or losses from hedge accounting ineffectivities were recorded, as the hedging relationships were almost entirely effective. These are presented under other operating income and expenses.

In a small number of cases, there are embedded derivatives. These are generally measured at market values. If not derivable, they are measured at amortized cost. These, too, are reported under other assets or other liabilities, respectively. The variant of these that prevails at WACKER is such that normal supply and service relationships with suppliers and customers abroad were not concluded in the functional currency of one of the two contractual partners.

Depending on the nature of the underlying transaction, they are posted in the statement of income either under other operating result or, if financial liabilities are being hedged, under net interest income.