Daimler AG – Annual report – 31 December 2020
32. Financial instruments (extract)
Net gains or losses
Table D.74 shows the net gains/losses on financial instruments included in the Consolidated Statement of Income (excluding derivative financial instruments used in hedge accounting).
Net gains/losses on equity and debt instruments recognized at fair value through profit or loss primarily comprise gains and losses attributable to changes in the fair values of these instruments.
Net gains/losses on other financial assets and liabilities recognized at fair value through profit or loss comprise gains and losses attributable to changes in their fair values.
Net gains/losses on equity instruments recognized at fair value through other comprehensive income primarily comprise dividend payments.
Net gains/losses on other financial assets recognized at fair value through other comprehensive income are primarily attributable to the effects of currency translation.
Net gains/losses on financial assets measured at (amortized) cost (excluding the interest income/expense shown below) primarily comprise impairment losses (including reversals of impairment losses) of €824 million (2019: €551 million) that are charged to cost of sales, selling expenses and other financial income/expense, net. Foreign currency gains and losses are also included.
Net gains/losses on financial liabilities measured at (amortized) cost (excluding the interest income/expense shown below) primarily comprise the effects of currency translation.
Total interest income and total interest expense
Total interest income and total interest expense for financial assets or financial liabilities that are not recognized at fair value through profit or loss are shown in table D.75.
See Note 1 for qualitative descriptions of accounting for and presentation of financial instruments (including derivative financial instruments).
Information on derivative financial instruments
Use of derivatives
The Group uses derivative financial instruments exclusively for hedging financial risks that arise from its operating or financing activities or from its liquidity management. These are mainly interest rate risks, currency risks and commodity price risks, which have been defined as risk categories. For these hedging purposes, the Group mainly uses currency forward transactions, cross currency interest rate swaps, interest rate swaps, options and commodity forwards.
Table D.76 shows the amounts for the transactions designated as hedging instruments.
Fair value hedges
The Group uses fair value hedges primarily for hedging interest rate risks.
The amounts of the items hedged with fair value hedges are included in table D.77.
The amounts relating to hedge ineffectiveness for items designated as fair value edges are shown in table D.78.
Cash flow hedges and hedges of net investments in foreign operations
The Group uses cash flow hedges for hedging currency risks, interest rate risks and commodity price risks.
Daimler also partially hedges the foreign currency risk of selected investments with the application of derivative or nonderivative financial instruments.
The amounts related to items designated as cash flow hedges and as hedges of net investments in foreign operations are shown in table D.79.
The gains and losses on items designated as cash flow hedges as well as the amounts relating to hedge ineffectiveness are included in table D.80.
In 2020, cash flow hedges with a nominal volume of €4,325 million were de-designated because the cash flows secured with these instruments could no longer be classified as highly probable. The de-designation of these derivatives, which is largely attributable to the covid-19 pandemic, mainly relates to cash flows in US dollars, British pounds and Canadian dollars, and led to reclassification from the reserves for derivative financial instruments to revenue of €26 million (losses) and to cost of sales of €2 million (gains).
Table D.81 shows the reconciliation of the reserves for derivative instruments (excluding reserves for hedges of net investments in foreign operations).
The reserves for derivative instruments include reserves for hedge costs of minus €7 million (2019: €0 million).
At December 31, 2020, the balance of reserves for hedges of net investments in foreign operations amounted to €189 million (2019: €189 million).
The maturities of the derivative financial instruments generally correspond with those of the underlying transactions. The realization of the underlying transactions of the cash flow hedges is expected to correspond with the maturities of the hedging transactions shown in table D.82. At December 31, 2020, Daimler utilized derivative instruments with a maximum maturity of 38 months (2019: 48 months) as hedges for currency risks arising from future transactions.
Nominal values of derivative financial instruments
Table D.82 shows the nominal values of derivative financial instruments entered into for the purpose of hedging currency risks, interest rate risks and commodity price risks that arise from the Group’s operating and/or financing activities.
The average prices for derivative financial instruments classified by risk categories for the main risks are included in table D.83.
Most of the transactions for which the effects from the measurement of the hedging instrument and the underlying transaction to a large extent offset each other in the Consolidated Statement of Income do not classify for hedge accounting.
Even if derivative financial instruments do not or no longer qualify for hedge accounting, these instruments still serve to hedge financial risks from business operations. A hedging instrument is terminated when the hedged transaction no longer exists or is no longer expected to occur. Explanations of the hedging of exchange rate risks, interest rate risks and commodity price risks can be found in Note 33 in the sub-item finance market risk.
33. Management of financial risks (extract)
Finance market risks
The global nature of its businesses exposes Daimler to significant market risks resulting from fluctuations in foreign currency exchange rates, interest rates and commodity prices. The Group is also exposed to equity price risk in connection with its investments in listed companies.
Daimler manages market risks to minimize the impact of fluctuations in foreign exchange rates, interest rates and commodity prices on the earnings of the Group and its segments. The Group calculates its overall net-exposure to these market risks to provide the basis for hedging decisions, which include the selection of hedging instruments and the determination of hedging volumes and the corresponding periods. The hedging strategy is specified at Group level and uniformly implemented in the segments. Decisions regarding the management of market risks from foreign exchange rates and commodities, as well as asset-/liability management (interest rates), are regularly made by the relevant Daimler risk management committees. Net-exposures are the basis for the hedging strategies and are updated regularly.
Certain existing benchmark interest rates including those of the London Interbank Offer Rate (for USD, GBP, CHF and JPY ) will be comprehensively and internationally reformed by the end of 2021. As a result, those interest rates will be gradually abolished and replaced with alternative risk-free reference rates. Alternative interest rates are being developed on a national level in the context of the respective legal systems and currencies; they can therefore vary with regard to their structure, methodology and period of publication.
Despite market uncertainty, the existing benchmark interest rates are still applied as reference rates in financial markets and have an impact on the valuation of financial transactions. This also applies for financial instruments in hedging relationships with a maturity beyond the end of 2021. With EU RIBOR reform already implemented, the material share of interest rate risk hedging relationships affected by the benchmark reform is based on the currencies USD and GBP.
Daimler expects the conversion of reference rates of hedging instruments and their underlying transactions to be identical and without material delay in time. Daimler continues to consider the economic relationship and thus the continuation of hedge accounting to be still existing as of December 31, 2020.
The nominal values of the affected derivative financial instruments can be found in table D.82.
The effect of the application of the new interest rates on the Consolidated Financial Statements is currently being reviewed. In order to conduct financial transactions based on the new indices, Daimler is preparing its IT -systems accordingly. Uncertainty still exists about future market standards with interest conventions for individual financial products (cash products and also interest derivatives) that reference the new risk-free rates.
As part of its risk management system, Daimler employs value-at-risk analyses. In performing these analyses, Daimler quantifies its market risk due to changes in foreign currency exchange rates and interest rates and certain commodity prices on a regular basis by predicting the potential loss over a target time horizon (holding period) and confidence level.
The value-at-risk calculations employed:
- express potential losses in fair values, and
- assume a 99% confidence level and a holding period of five days.
At the Group level, Daimler calculates the value at risk for exchange rate and interest rate risk according to the variance-covariance approach. The value-at-risk calculation method for commodity hedging instruments is based on a Monte Carlo simulation.
When calculating value at risk using the variance-covariance approach, Daimler first computes the current market value of the Group’s financial instruments portfolio. Then the sensitivity of the portfolio value to changes in the relevant market risk factors, such as particular foreign currency exchange rates or interest rates of specific maturities, is quantified. Based on volatilities and correlations of these market risk factors, which are obtained from the RiskMetrics™ dataset, a statistical distribution of potential changes in the portfolio value at the end of the holding period is computed. The loss which is reached or exceeded with a probability of only 1% can be derived from this calculation and represents the value at risk.
The Monte Carlo simulation uses random numbers to generate possible changes in market risk factors consistent with current market volatilities. The changes in market risk factors allow the calculation of a possible change in the portfolio value over the holding period. Running multiple iterations of this simulation leads to a distribution of portfolio value changes. The value at risk can be determined based on this distribution as the portfolio value loss which is reached or exceeded with a probability of 1%.
Exchange rate risk
Transaction risk and currency risk management. The global nature of Daimler’s businesses exposes cash flows to risks arising from fluctuations in exchange rates. These risks primarily relate to fluctuations between the euro and the US dollar, the Chinese renminbi, the British pound and other currencies such as currencies of growth markets. In the operating vehicle business, the Group’s exchange rate risk primarily arises when revenue is generated in a currency that is different from the currency in which the costs of revenue are incurred, it may be inadequate to cover the costs if the value of the currency in which the revenue is generated declined in the interim relative to the value of the currency in which the costs were incurred. This risk exposure primarily affects Mercedes-Benz Cars & Vans, which generates a major portion of its revenue in foreign currencies and incurs manufacturing costs primarily in euros. Daimler Trucks & Buses is also exposed to transaction risks, but only to a minor degree because of its global production network and the overall lower foreign currency volume. The exposures of these segments serve as a basis for analyzing exchange rate risks at Group level. In addition, the Group is indirectly exposed to transaction risk from its equity-method investments.
The Group’s overall currency exposure is reduced by natural hedging, which consists of the currency exposures of the business operations of different entities and segments partially offsetting each other at Group level. These natural hedges eliminate the need for hedging to the extent of the matched exposures. To provide an additional natural hedge against any remaining transaction risk exposure, Daimler generally strives to increase cash outflows in the same currencies in which the Group has a net excess inflow.
In order to mitigate the impact of currency exchange rate fluctuations for the business operations (future transactions), Daimler continually assesses its exposure to exchange rate risks and hedges a portion of those risks by using derivative financial instruments. A committee manages the Group’s exchange rate risk and its hedging transactions through currency derivatives. The committee consists of representatives of the relevant segments and central functions. The Corporate Treasury department aggregates foreign currency exposures from Daimler’s subsidiaries and operational units and implements the committee’s decisions concerning foreign currency hedging through transactions with international financial institutions. For reporting purposes and accounting for hedge relationships,
those hedges are allocated to Mercedes-Benz Cars & Vans and Daimler Trucks & Buses. Suitable measures are generally taken without delay to eliminate any over-hedging at Group level regarding hedging transactions caused by changes in exposure. In the case of over hedges at the level of Mercedes-Benz Cars & Vans or Daimler Trucks & Buses, designated hedging relations are reviewed with respect to any requirements to discontinue hedge accounting.
The Group’s targeted hedge ratios for forecasted operating cash flows in foreign currency are indicated by a reference model. On the one hand, the hedging horizon is naturally limited by uncertainty related to cash flows that lie far in the future; on the other hand, it may also be limited by the fact that appropriate currency contracts are not available. This reference model aims to limit risks for the Group from unfavorable movements in exchange rates while preserving some flexibility to participate in favorable developments. Based on this reference model and depending on the market outlook, the committee determines the hedging horizon, which usually varies from one to five years, as well as the average hedge ratios. Reflecting the character of the underlying risks, the hedge ratios decrease with increasing maturities. At year-end 2020, foreign exchange management showed an unhedged position in the automotive business in calendar year 2021 for the underlying forecasted cash flows in US dollars of 44%, for the underlying forecasted cash flows in Chinese renminbi of 52% and for the underlying forecasted cash flows in British pounds of 48%.
To cover foreign currency exposure risks of the vehicle business operations forward foreign exchange contracts and currency options are primarily used. Daimler’s guidelines call for a mixture of these instruments depending on the assessment of market conditions. Value at risk is used to measure the exchange rate risk inherent in these derivative financial instruments.
Table D.86 shows the period-end, high, low and average value-at-risk figures of the exchange rate risk for the 2020 and 2019 portfolios of derivative financial instruments, which were entered into primarily in connection with the vehicle business operations. Average exposure has been computed on an end-of-quarter basis. The offsetting transactions underlying the derivative financial instruments are not included in the following value-at-risk presentation, since they primarily comprise forecasted cash-flows. See also table D.82.
Hedge accounting. When designating derivative financial instruments, a hedge ratio of 1 is applied. In addition, the respective volume, interest curves and currency of the hedge and the underlying transaction as well as maturity dates are matched. The Group ensures an economic relationship between the underlying transaction and the hedging transaction by ensuring consistency of currency, volume and maturity. Option premiums and – since mid-2020 for newly designated hedge relationships – also forward components are not designated into the hedge relationship, but the hedging costs are deferred in other comprehensive income and recognized in profit or loss at the due date of the underlying transaction or recognized as adjustment of acquisition cost of non-financial assets. The effectiveness of the hedge is assessed at the beginning and during the economic relationship. Possible sources of ineffectiveness of the hedge relationship are:
- Effects of the credit risk on the fair value of the used derivative instrument which are not reflected in the change of the hedged currency risk.
- Changes in the timing of the hedged transactions.
In the context of focusing on the divisional perspective, the designation of hedge relationships for foreign currency risk existing from the Group perspective from expected future cash flows from business operations, primarily from vehicle sales, have been assigned to Mercedes-Benz Cars & Vans and to Daimler Trucks & Buses starting with 2019. Accordingly, the documentation required under IFRS with regard to this further differentiation of expected cash flows (i.e. the risk management objectives) has been revised for a large proportion of the already designated hedge relationships for foreign currency risk, although there has been no change in the overall Group risk management strategy for foreign currency risk. Pursuant to the described methods applied in preparation of the financial statements, this results in the formal discontinuation and immediate redesignation of existing hedge relationships according to the revised differentiation. Further information can be found in table D.79. There were no material effects on earnings in 2020 and 2019.
In 2020, the development of the value at risk from foreign currency hedging was mainly driven by a sharp increase in foreign currency rate volatilities in the first quarter and subsequently by a gradual decrease.
The Group’s investments in liquid assets or refinancing activities are generally selected so that possible currency risks are minimized. Transaction risks arising from liquid assets or payables in foreign currencies that result from the Group’s investment or refinancing on money and capital markets are generally hedged against currency risks at the time of investing or refinancing in accordance with Daimler’s internal guidelines. The Group uses appropriate derivative financial instruments (e.g. cross-currency interest rate swaps) to hedge against currency risk.
Since currency risks arising from the Group’s investment or refinancing in foreign currencies and the respective hedging transactions generally offset each other, these financial instruments are not included in the value-at-risk calculation presented.
Effects of currency translation risk. For purposes of Daimler’s Consolidated Financial Statements, the income and expenses and the assets and liabilities of subsidiaries located outside the euro zone are converted into euros. Therefore, period-to-period changes in average exchange rates may cause translation effects that have a significant impact on, for example, revenue, segment results (EBIT ) and assets and liabilities of the Group. Unlike exchange rate transaction risk, exchange rate translation risk does not necessarily affect future cash flows. The Group’s equity position reflects changes in book values caused by exchange rates. In general, Daimler does not hedge against exchange rate translation risk.
Interest rate risk
Daimler uses a variety of interest rate sensitive financial instruments to manage the liquidity needs of the Group. A substantial volume of interest rate sensitive assets and liabilities results from the leasing and sales financing business operated by the Daimler Mobility segment. The Daimler Mobility companies enter into transactions with customers that primarily result in fixed-rate receivables. Daimler’s general policy is to match funding in terms of maturities and interest rates wherever economically feasible. However, for a limited portion of the receivables portfolio in selected and developed markets, Daimler Mobility does not match funding in terms of maturities in order to take advantage of market opportunities. As a result, the Daimler Group is exposed to risks due to changes in interest rates.
An asset/liability committee consisting of members of the Daimler Mobility, Mercedes-Benz Cars & Vans and Daimler Trucks & Buses segments and the Corporate Treasury department manages the interest rate risk by setting targets for the interest rate risk position. The Treasury Risk Management department and the local Daimler companies are jointly responsible for achieving these targets. As separate functions, the Treasury Controlling and the Daimler Mobility Controlling & Reporting department monitors target achievement on a monthly basis. In order to achieve the targeted interest rate risk positions in terms of maturities and interest rate fixing periods, Daimler also uses derivative financial instruments such as interest rate swaps. Daimler assesses its interest rate risk position by comparing assets and liabilities for corresponding maturities, including the impact of the relevant derivative financial instruments.
Derivative financial instruments are also used in conjunction with the refinancing related to the automotive segments and liquidity management. Daimler steers the funding activities of the automotive and financial services businesses at the Group level.
Table D.86 shows the period-end, high, low and average value-at-risk figures of the interest rate risk for the 2020 and 2019 portfolios of interest rate sensitive financial instruments and derivative financial instruments of the Group, including the financial instruments of the leasing and sales financing business. Lease liabilities are not included in the value at risk of the interest rate risk. These leasing liabilities have a fixed interest rate and changes in interest rates therefore have no effect on the Group’s net profit. The average values have been computed on an end-of-quarter basis.
During the year, the change in the value at risk of interest rate sensitive financial instruments was primarily determined by the development of interest rate volatilities.
Hedge accounting. When designating derivative financial instruments, a hedge ratio of 1 is generally applied. The respective volumes, interest curves and currencies of the hedged item and the hedging instrument as well as maturity dates are matched. In the case of combined derivative financial instruments for interest currency hedges, the cross-currency basis spread is not designated into the hedge relationship, but deferred as a hedging cost in other comprehensive income and recognized in profit or loss over the hedge term. The Group ensures an economic relationship between the underlying transaction and the hedging instrument by ensuring consistency of interest rates, maturity terms and nominal amounts. The effectiveness of the hedge is assessed at the beginning and during the economic relationship using the hypothetical derivative method. Possible sources of ineffectiveness of the hedge relationship are:
- Effects of the credit risk on the fair value of the derivative instrument in use which are not reflected in the change in the hedged interest rate risk.
- Changes in the parameters of the underlying hedged transactions.
Commodity price risk
Daimler is exposed to the risk of changes in commodity prices in connection with procuring raw materials and manufacturing supplies used in production. A small portion of the raw material price risk, primarily relating to forecasted procurement of certain metals, is hedged with the use of derivative financial instruments.
For precious metals, central commodity management shows an unhedged position of 80% of the forecasted commodity purchases at year-end 2020 for calendar year 2021. The corresponding figure at year-end 2019 was 55% for calendar year 2020.
Table D.86 shows the period-end, high, low and average value-at-risk figures for the 2020 and 2019 portfolio of derivative financial instruments used to hedge raw material price risk. Average exposure has been computed on an end-of-quarter basis. The transactions underlying the derivative financial instruments are not included in the value-at-risk presentation. See also table D.82.
In 2020, the development of the value at risk from commodity hedging was driven in the first quarter by an increase in volatilities and hedging volume. Subsequently, volatilities as well as the hedging volume decreased gradually and so did the value at risk.
Hedge accounting. When designating currency derivative financial instruments, Daimler generally applies a hedge ratio of 1. The respective volumes and parameters relevant for the valuation of the hedged item and the hedging instrument as well as maturity dates are matched. The Group ensures an economic relationship between the hedged item and the hedging instrument by ensuring consistency of volumes, parameters relevant for valuation and maturity terms. Effectiveness is assessed at initial designation and during the hedge term. Possible sources of ineffectiveness of the hedge relationship are:
- Effects of the credit risk on the fair value of the derivative instrument in use which are not reflected in the change in the hedged commodity price risk.
- Changes in the timing of the hedged transactions.
Equity price risk
Daimler predominantly holds investments in shares of companies which are classified as long-term investments, some of which are accounted for using the equity method, such as BAIC Motor. These investments are not included in a market risk assessment by the Group.