19 Financial Instruments

The following table shows financial assets and liabilities by measurement categories and classes. Liabilities from finance leases and derivatives that qualify for hedge accounting are also shown even though they do not belong to any of the IFRS 9 measurement categories. WACKER has not pledged any financial assets as security.

The fair value of financial instruments measured at amortized cost is determined by means of discounting, taking into account market-participant interest rates that are adequate to the inherent risk and correspond to the relevant maturity. The fair value of current items in the statement of financial position is seen as equivalent to their carrying amounts as the differences are immaterial.

Trade receivables, other loans and fixed-term deposits as well as cash and cash equivalents are recognized at amortized cost. 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 loans corresponds to their present value and results from the present value of the expected future cash flows. Discounting is carried out on the basis of the interest rates valid on the reporting date.

Investments in exchange-traded fixed-interest securities are recognized at fair value through other comprehensive income (FVOCI). Certain securities (funds) and investments in equity instruments are classified as fair value through profit or loss (FVPL). The investments in equity instruments are also recognized at fair value, the best approximation of which is their historical cost, as no observable prices on active markets are available.

The carrying amounts of trade payables and other financial liabilities correspond to their fair values. The fair values of financial liabilities constitute the present value of the expected future cash flows. Discounting is carried out on the basis of the interest rates valid on the reporting date. All other financial liabilities are valued at cost as no observable prices are available for them.

The following table shows the net gains and losses from financial instruments.

The net result of the category “financial assets measured at amortized cost” primarily comprised: net losses / gains from foreign currency translation; interest income from financial assets, fixed-term deposits and demand deposits; and loss allowances.

The “financial assets (FVOCI)” category comprises interest income and other changes in fixed-interest securities.

The gains and losses from changes in the fair value of foreign-exchange, interest-rate and commodity derivatives that do not fulfill the requirements of IAS 39 for hedge accounting are posted in the category “Assets / liabilities measured at fair value through profit or loss.” This item also reflects changes in value from the remeasurement of hedging transactions as part of fair value hedge accounting. It also contains distributions stemming from investments in equity instruments and funds.

The interest income from financial assets that are not recognized at fair value through profit or loss amounted to €8.0 million, compared with the prior-year figure of €7.5 million. This income mainly comprised interest on bank deposits, fixed-term deposits and loans.

The interest expense from financial liabilities that are not recognized at fair value through profit or loss amounted to €21.2 million, versus €38.3 million in the prior year. These interest expenses are mainly attributable to financial liabilities.

The net losses in the category “Financial liabilities measured at amortized cost” primarily comprise interest expenses on bank liabilities and other financial liabilities, as well as net losses / gains from foreign currency translation.

Impairments of financial assets measured at fair value through other comprehensive income (FVOCI) amounted to €0.02 million.

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.

The derecognition of financial assets measured at cost did not result in any material gains or losses.

The financial assets and liabilities measured at fair value in the financial statements were allocated to one of three categories in accordance with the fair value hierarchy described in IFRS 13. Allocation to these categories reveals which of the fair values reported were settled through market transactions and the extent to which the measurement was based on models in the absence of observable market transactions.

The following are the levels of the hierarchy.

Level 1

Financial instruments measured using quoted prices in active markets, the fair value of which can be derived directly from prices in active liquid markets and for which the financial instrument observable in the market is representative of the financial instrument being measured. These include fixed-interest securities and a mutual fund, both of which are traded in liquid markets.

Level 2

Financial instruments measured using valuation methods based on observable market data, the fair value of which can be determined using similar financial instruments traded in active markets or using valuation methods all of whose parameters are observable. These include hedging and non-hedging derivative financial instruments, loans and financial liabilities.

Level 3

Financial instruments measured using valuation methods not based on observable parameters, the fair value of which cannot be determined using observable market data and which require the application of different valuation methods. The financial instruments belonging to this category have a value component that is not market-observable and has a major impact on fair value. These include over-the-counter derivatives and unquoted equity instruments.

The following table shows the categories in the fair value hierarchy to which the financial assets and liabilities measured at fair value in the statement of financial position are allocated. The table also shows financial assets and liabilities measured at cost in the statement of financial position. Their fair values are given in the Notes:

WACKER regularly reviews whether its financial instruments are still allocated to the appropriate fair-value-hierarchy levels. As was the case in the previous year, no reclassifications were carried out within the fair value hierarchy in 2018.

In the period under review, WACKER measured only financial assets and liabilities at fair value. The market values were calculated using market information available on the reporting date and based on counterparties’ quoted prices or via appropriate valuation methodologies (discounted cash-flow or well-established actuarial methodologies, such as the par method).

Derivative financial instruments and financial assets (trading and held-to-collect and for sale) are recognized at fair value and are thus subject to a recurring fair value assessment.

The fair value of derivative financial instruments is calculated based on market data such as exchange rates or yield curves in accordance with market-specific valuation methodologies. The calculation of the fair value contains our own and the counterparty’s default risk, using maturity-matching and market-observable CDS values. The fair value of financial assets (trading and held-to-collect and for sale) can be derived from prices listed in active markets.

Loans and financial liabilities are measured at amortized cost. However, the fair values must be provided in the Notes.

The fair value of loans corresponds to the present value of expected future cash flows. Application of the discounted cash flow method using market interest rates means that the carrying amount of the loans corresponds to their fair value.

The fair value of financial liabilities is determined using the net present value method and is based on standard market interest rates.

WACKER measured equity instruments not held for trading in the amount of €11.3 million at fair value pursuant to IFRS 9 and reallocated these to Level 3 of the fair value hierarchy. The equity instruments concerned consist of small, regional investments in companies that operate infrastructure facilities. No fair value exists for these companies since no active market values are available. WACKER considers the historical cost of these equity instruments to be the best approximation of their fair value. No further information is available that would enable a model-based measurement. Due to the non-profit nature of these entities, the noncurrent assets they hold and that are utilized by WACKER represent the best input factor for measuring fair value. A percentage of these assets is reflected in the acquisition costs. WACKER reviews the carrying amounts of investments in equity instruments once a year to counter the risk of an impaired asset. WACKER had no intention of selling any of the shares reported as of December 31, 2018.

The unilateral call option (Level 3 of the fair value hierarchy) held by WACKER for the purchase of 1 percent of the shares in the subsidiary WACKER Asahikasei Silicones Co. Ltd., Japan was recognized at cost as of December 31, 2018. The amortized cost best reflects the option’s fair value.

No changes were made to the valuation methodology compared with the previous year.

Management of Financial Risks

In the normal course of business, WACKER is exposed to credit, liquidity, and market risks from financial instruments. The aim of financial risk management is to limit risks from operations 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 the risk management system it has in place. That system is monitored by the Supervisory Board The fundamental purpose of the risk management system is to identify, analyze, coordinate, monitor and communicate 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-exchange risks and interest-rate risks on EBITDA and the interest result.

Credit Risk (Risk of Default)

In terms of financial instruments, the Group is exposed to a default risk should a contractual party fail to fulfill its commitments. The maximum risk is therefore the amount of the respective financial instrument’s positive fair value. To limit the risk of default, particularly for investments of securities and cash, transactions are conducted only within defined limits and with partners of very high credit standing. To ensure risks are managed as efficiently as possible, the market risks within the Group are controlled centrally. The transactions are concluded and managed in compliance with internal credit-risk principles and are subject to monitoring procedures that take account of the separation of duties. As for operations, outstanding receivables and default risks are continually monitored and hedged with trade credit insurance, advance payments and bank guarantees. Customer credit ratings and limits are based on generally available information from rating agencies and internal documents. No collateral exists for financial instruments. Receivables from major customers are not high enough to represent an extraordinary concentration of risks. Default risks are accounted for by loss allowances and advance payments received are taken into account. For information on default risks, please refer to the Accounting and Valuation Principles and the Notes to the individual items of the statement of financial position.

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 not only long-term lines of credit at financial institutions with high credit ratings, but also liquid funds based on multiyear financial planning and rolling liquidity planning.

To limit liquidity risk, WACKER keeps liquid reserves in the form of current investments and unused lines of credit. WACKER has also 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 the note on Financial Liabilities.

Market Risk

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

Foreign-Exchange Risk

The potential currency exposure to be hedged with derivative financial instruments is determined on the basis of the company’s major foreign-currency income and expenditure. The greatest risk results from the US dollar. US-dollar income is taken to mean all sales invoiced in US dollars, while all purchases in US dollars as well as site costs incurred in US dollars are reported under US-dollar expenditure. The US dollar is the only 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. By comparison, increases in the euro exchange rate against the renminbi (CNY) and yen (JPY) have a minor impact. In determining sensitivity, we simulate a 10-percent US-dollar devaluation against the euro, taking as a starting point the exchange rate used in the forecast. Such a devaluation would have had an effect on EBITDA of €-52 million as of December 31, 2018 and of €-50 million as of December 31, 2017. The effect from cash-flow-hedge designated items would have increased equity before income taxes by €15.8 million (versus €22.2 million a year earlier). The Group’s currency exposure amounted to €516 million as of December 31, 2018 (versus €498 million).

Interest-Rate Risk

The interest-rate risk results mainly from financial liabilities and interest-bearing investments. The Executive Board determines the mix of fixed- and variable-interest financial debt. Interest rate derivatives are concluded as required, taking account of the given structure. Depending on whether the instrument in question 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. As financial liabilities and fixed-interest investments are measured at amortized cost, under IFRS 7 they are not subject to any interest-rate risk. Fixed-interest securities are recognized at fair value. Due to their short maturities, 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 thus included in the calculation of earnings-related sensitivity. Changes in the market interest rates of interest-rate derivatives affect the financial result, and are consequently included in any earnings-related sensitivity analysis. If the market interest rate on December 31, 2018 had been 100 base points lower (December 31, 2017: lower), the interest result would have been €1.2 million (€1.4 million) lower (lower).

Raw-Material Price Risk

In general, the company is faced with the risk that its supplies of raw materials may be inadequate and that potential increases in raw-material prices could threaten its results. These risks are covered by long-term contracts. Cash flow hedge accounting is used only to a minor degree for long-term energy needs in Norway. This item is recognized in profit or loss under the cost of goods sold.

Derivative Financial Instruments

Financial risks are also hedged using derivative financial instruments. The raw-material price risks that WACKER hedges against result principally from ongoing energy procurement. Electricity-supply prices are hedged via contracts for which the “own-use exemption” rules of IFRS 9 can generally be invoked. These contracts, which are concluded for the purpose 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 currency risks, it uses derivative financial instruments, in particular foreign-exchange forwards and swaps. Derivatives are used only if they are backed by positions, cash deposits and funding, or scheduled transactions arising from operations. The scheduled transactions also include anticipated, but not yet invoiced, sales in foreign currencies.

Foreign-exchange hedging is carried out, in particular, for the US dollar. Potential interest rate hedges are based on the maturities of the underlying transactions.

Operational foreign-exchange hedging relates to the receivables and liabilities already recognized, and generally covers time horizons of between two and three months. The time horizon for strategic hedging is between three and a maximum of fifteen 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 fair values refer to the repurchase values (redemption values) of the financial derivatives as of the reporting date and are calculated using recognized actuarial methods.

The derivatives are recognized at fair value, irrespective of their stated purpose. They are reported in the statement of financial position under other financial assets or other financial liabilities. Where permissible, cash flow hedge accounting is carried out for the strategic hedging of currency-exchange risks from future foreign-exchange positions. For further details, please refer to explanations in the Accounting and Valuation Principles. 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 interest result or other financial result.

For strategic hedging purposes, the aim is to achieve a hedging ratio of some 50 percent in relation to the expected net exposure in US dollars. The expected net exposure for 2019 is about 45 percent hedged. The average hedging ratio for operational hedging in US dollars is around 50 percent.

In 2018, the accumulated income and expenses recorded directly in equity included a pre-tax result from cash flow hedges amounting to €-12.8 million (versus €17.4 million in the prior year), of which €0.8 million concerned closed cash flow hedges. During 2018, €0.5 million was reclassified to the statement of income, after €1.1 million in the prior year. WACKER determines the effectiveness of the economic relationship between the hedged underlying transaction and the hedging instrument based on maturities, currencies and nominal amounts, with the hedge ratio between the hedging instrument and underlying transaction always being 100 percent in hedge accounting. WACKER uses the hypothetical derivative method to monitor whether the designated derivatives effectively hedge the cash flows of underlying transactions. The credit risk of counterparties and changes in the timing of the highly probable future transactions hedged represent possible sources of ineffectiveness. In the result for the period, no gains or losses from ineffective hedge accounting were recorded, as the hedging relationships were almost entirely effective and the changes in value of hedging instruments were thus almost contrary to those of the underlying transactions. The following table shows the effects on the Group’s earnings and net assets of the strategic hedging of currency risks from future foreign-currency positions:

The purpose of fair value hedges is to hedge against changes in the fair value of financial assets and liabilities due to exchange-rate risk (foreign-exchange swaps). If the hedge is effective, the carrying amount of the corresponding underlying transaction is amended to reflect the changes in the fair value of the hedged risks. In fiscal 2018, WACKER recognized an expense of €25.8 million from the realization and measurement of the hedging instruments under fair value hedges (versus income of €59.7 million in the prior year). At the same time, income of €18.0 million was realized on the underlying transactions (versus an expense of €-71.7 million a year earlier). Both amounts were recognized in the financial result. The differences result from the US dollar-euro interest rate component of the hedges. The interest rate component has no influence on the effectiveness of the fair value hedge. The fair value hedge no longer existed as of December 31, 2018.

The foreign exchange derivatives mainly comprise forwards and swaps amounting to US$493.0 million, ¥1,400 million, CNY 75.0 million (versus US$392.0 million, ¥400.0 million and €619.0 million a year earlier). Derivatives with market values of €-10.3 million are due in 2019.

The interest rate derivatives comprise an interest rate swap for a nominal amount of €60.0 million that transforms the fixed interest rate of a loan into a variable interest rate. The swap expires in January 2023 and has the same maturity as the loan installment.

Other derivatives involve electricity futures traded on the Norwegian market for a nominal amount of €12.9 million (€16.7 million in the prior year). 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 up to 90 percent of the Holla (Norway) site’s future silicon-production power needs not covered by long-term supply contracts. The futures have maturities of between one and three years. Derivatives with maturities until 2021 were concluded. The average hedging rate was €25.3/MWh (€25.3/MWh in the prior year).

The following table contains information on the netting of financial assets and liabilities in the consolidated statement of financial position.

In addition to the financial instruments complying with the provisions on netting pursuant to IAS 32, the table also includes those financial instruments that are subject to netting agreements or master netting agreements but may not be netted pursuant to IAS 32.

As a part of its strategic hedging activities, WACKER closes out forward-exchange contracts prior to maturity by means of offsetting transactions. The strategic forward-exchange contract and the corresponding offsetting forward-exchange transaction are recognized as a net amount in accordance with IAS 32 criteria. In addition, general offsetting agreements, which apply only in cases of insolvency, have been concluded with a number of banks.

The net amount shows the amount of financial assets or liabilities that, despite netting and global netting agreements, is not received or must be paid in the event of insolvency.