20 Financial Instruments

The following table shows a presentation of financial assets and liabilities by measurement categories and classes. Also presented are liabilities from finance leases and derivatives for which hedge accounting is used, even though they do not belong to any of the IAS 39 measurement categories.

The fair value of financial instruments measured at amortized cost is determined based on discounting, taking into account customary market interest rates that are adequate to the specific risk and correspond to the relevant maturity. For reasons of immateriality, the carrying amount of current balance-sheet items is the same as their fair value.

The loans and receivables reported include trade receivables and other loans, as well as cash and cash equivalents. Cash and cash equivalents in foreign currency are measured at the conversion rate prevailing on the reporting date. Their carrying amounts correspond to their fair values. The fair value of the loans corresponds to their present value and represents the present value of expected future cash flows. Discounting is carried out on the basis of the interest rates valid on the reporting date.

The held-to-maturity securities category includes current fixed-interest securities which are measured at amortized cost in accordance with the effective interest method.

Available-for-sale financial assets include securities, fund shares aimed at securing phased-early-retirement commitments, and investments in joint ventures and associates. The fair values of the fund shares correspond to their stock market prices on the reporting date. Investments in joint ventures and associates are measured at cost, as no observable prices on active markets are available.

The carrying amounts of 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 following table shows the net profits and losses from financial instruments, broken down by measurement category. The impacts on earnings due to finance leases and derivatives for which hedge accounting is used are not shown in the table because they do not belong to any of the IAS 39 measurement categories.

The net result of the category “Loans and receivables” was primarily due to net losses/profits from exchange-rate effects, interest income from demand deposits, and valuation allowances.

The category “Available-for-sale financial assets” includes interest income from fixed-interest securities.

The profits and losses from changes in the fair value of foreign-currency exchange rates, interest rates and commodity derivatives that do not fulfill the requirements of IAS 39 for hedge accounting are posted in the category “Derivatives for which hedge accounting is not used.”

The interest income from financial assets which are not recognized at fair value through profit and loss amounts to €13.5 million (2011: €16.3 million). This interest income mainly stems from demand deposits and loans as well as from held-to-maturity securities.

The interest expenses from financial liabilities which are not recognized at fair value through profit and loss total €37.4 million (2011: €23.6 million). These interest expenses are mainly due to financial liabilities.

The category “Held-to-maturity assets” mainly comprises interest income from noncurrent and current corporate bonds that are posted under securities.

The net losses in the category “Financial liabilities recognized at amortized cost” primarily consist of interest expenses from bank liabilities.

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 assets and liabilities that are measured at fair value must be allocated to one of the three levels of the fair value hierarchy. The hierarchical levels distinguish between the input data being used to determine fair value, and the extent to which they are observable in a market.

The following are the levels of the hierarchy:

Level 1:
quoted prices in active markets for identical assets or liabilities

Level 2:
directly or indirectly observable input data that are not quoted prices according to Level 1

Level 3:
unobservable market data

The financial assets and liabilities are allocated to the three levels of the measurement hierarchy as follows:

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 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.

For information on the maturity analysis for non-derivative financial liabilities, please refer to Note 15.

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 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 €-56 million as per December 31, 2012 and €-50 million as per December 31, 2011. The effect from cash-flow-hedge designated items would have increased equity before income taxes by €36.4 million (2011: €62.3 million). The Group’s currency exposure amounted to €564.0 million as per December 31, 2012 (2011: €549.7 million).

Interest Rate Risk

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. Available-for-sale securities are recognized at fair value. Due to their short terms, they are not subject to a significant risk of changes in interest rates. 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 the eporting date, net interest income would have been €2.9 million (2011: €0.4 million) lower (higher). The net financial liabilities at the end of the fiscal year do not correspond to the average net debt in the year under review.

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. In general, potential increases in raw-material prices pose a risk to results.

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, silver and palladium) that are used as catalysts or for other purposes in the production process, as well as ongoing energy procurement. 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 24 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-option contracts not subject to cash flow hedge accounting are recognized in profit or loss. 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 or other financial result.

For strategic hedging purposes, graduated hedging ratios of between 25 and 50 percent are used in relation to the expected net exposure in US$. The expected net exposure for 2013 is about 50 percent hedged, with the expected semiconductor-business net exposure for 2014 being around 30 percent hedged. The hedging ratio for operational hedging is some 85 percent.

In the 2012 fiscal year, the accumulated income and expenses recorded directly under equity included an unrealized (pre-tax) result of €7.9 million (2011: €-30.4 million). In the result for the period, no gains or losses from hedge accounting ineffectiveness were recorded, as the hedging relationships were almost entirely effective.

The purpose of fair value hedges is to hedge against changes in the fair value of financial assets and liabilities that come about because of fluctuations in the value of currencies (foreign currency swap). If the hedge is effective, the carrying amount of the corresponding underlying transaction is amended to reflect the changes in the fair values of the hedged risks. At the end of 2012, WACKER recognized an expense of €-11.6 million (2011: €0.0 million), from the valuation of the hedging instrument, under fair value hedges. At the same time, income of €11.2 million (2011: €0.0 million) was realized on the underlying transaction. According to the underlying transaction, the change in the fair value is recognized in the financial result.

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.

In the course of selling share of a minor investment, WACKER granted the buyer a call option for the companys remaining stake. That option must be exercised in 2013.

The foreign exchange derivatives mainly contain forward exchange contracts amounting to US$1,206.2 million, ¥17.2 billion and SG$295.1 million (2011: US$1,447.3 million, ¥8.2 billion and SG$305.2 million).

Other derivatives involve interest-rate swaps with a notional sum of €25.0 million (2011: €25.0 million) and electricity futures traded on the Norwegian market with a notional amount of €20.2 million (2011: €17.4 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. Derivatives with terms until 2015 were concluded.