20 Financial Instruments

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 its 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 from 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.

The potential currency exposure to be hedged with derivative financial instruments is determined 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 euro-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 €-50 million as per December 31, 2011, and €-62 million as per December 31, 2010. The effect from cash-flow-hedge designated items would have increased equity before income taxes by €62.3 million (2010: €81.2 million). The Group’s currency exposure amounted to €549.7 million as per December 31, 2011 (2010: €677 million).

The interest rate risk results mainly from financial debt and interest-bearing investments. 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 €1.1 million (2010: €0.9 million) higher (lower).

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 €10.4 million (2010: €8.4 million) on EBITDA.

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, silver and palladium) that are used as catalysts or for other purposes in the production process, as well as ongoing energy procurement. In 2011, precious-metal-related risks were partially 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 contracts, 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 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 31 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 balance sheet date and are calculated using recognized actuarial methods.

The derivatives are recognized at their market values, irrespective of their stated purpose. They are reported in the statement of financial position under other assets 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 or loss. The changes in the fair values of the currency options are posted to the statement of income.

For strategic hedging purposes, graduated hedging ratios are used of between 25 and 60 percent in relation to the expected net exposure in US$ and JPY. In doing so, the expected net exposure for 2012 is some 60 percent hedged and the expected net exposure for 2013 around 50 percent hedged. Expected semiconductor-business net exposure for the first half of 2014 is about 25 percent hedged.

In the fiscal year, the accumulated income and expenses recorded directly under equity included an unrealized result amounting to €-30.4 million (before tax) (2010: €11.5 million). In the result for the period, no gains or losses from hedge accounting ineffectivities were recorded, as the hedging relationships were almost entirely effective.

In a small number of cases, there are embedded derivatives. These are generally measured at market values, or at amortized cost if market values cannot be derived. They, too, are reported under other assets or other liabilities, respectively.

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

The foreign exchange derivatives contain forward exchange contracts amounting to US$1,447.3 million, ¥8.2 billion and SG$305.2 million.

Other derivatives principally involve interest-rate swaps with a notional sum of €25.0 million (2010: €100.0 million) and electricity futures traded on the Norwegian market with a notional amount of €17.4 million (2010: €15.6 million). The electricity futures are used to limit the risk of rising spot-market prices for energy via structured price setting on the electricity market. The hedged amount represents 90 percent of the Holla, Norway, site’s future silicon-production power needs. The futures fall due after a maximum of one year.