Novartis AG – Annual report – 31 December 2021
29. Financial instruments – additional disclosures (extract)
Credit risks arise from the possibility that customers may not be able to settle their obligations as agreed. To manage this risk, the Group periodically assesses country and customer credit risk, assigns individual credit limits, and takes actions to mitigate credit risk where appropriate.
The provisions for expected credit losses for customers are based on a forward-looking expected credit loss, which includes possible default events on the trade receivables over the entire holding period of the trade receivables.
In measuring the expected credit losses, trade receivables are grouped based on shared credit risk characteristics (such as private versus public receivables) and days past due. In determining the expected credit loss rates, the Group considers current and forward-looking macroeconomic factors that may affect the ability of the customers to settle the receivables, and historical loss rates for each category of customers.
The Group’s largest customer accounted for approximately 17% of net sales, and the second largest and third largest customers accounted for 11% and 6% of net sales, respectively (2020: 17%, 11% and 6%, respectively; 2019: 18%, 13% and 8%, respectively).
The highest amounts of trade receivables outstanding were for these same three customers and amounted to 16%, 12% and 7%, respectively, of the Group’s trade receivables at December 31, 2021 (2020: 14%, 12% and 6%, respectively). There is no other significant concentration of customer credit risk.
Counterparty risk encompasses issuer risk on marketable securities and money market instruments; credit risk on cash, time deposits and derivatives; as well as settlement risk for different instruments. Issuer risk is reduced by only buying securities that are at least A- rated. Counterparty credit risk and settlement risk are reduced by a policy of entering into transactions with counterparties (banks or financial institutions) that feature a strong credit rating. Exposure to these risks is closely monitored and kept within predetermined parameters. The limits are regularly assessed and determined based upon credit analysis, including financial statement and capital adequacy ratio reviews. In addition, reverse repurchasing agreements are contracted, and Novartis has entered into credit support agreements with various banks for derivative transactions. To further reduce the settlement risk, the Group has implemented a multi-currency system, Continuous Linked Settlement (CLS), providing multilateral netting (payment-versus-payment settlement) of cash flows from foreign exchange transactions.
The Group’s cash and cash equivalents include short-term highly rated government-backed debt securities, with an original maturity of three months or less, for approximately 16% (2020: nil) as well as cash and cash equivalents held with major regulated financial institutions; the three largest ones hold approximately 9.7%, 9.7% and 7.6%, respectively (2020: 14.1%, 12.6% and 9.7%, respectively).
The Group does not expect any losses from non-performance by these counterparties and does not have any significant grouping of exposures to financial sector or country risk.