Mercedes-Benz Group AG – Annual report – 31 December 2021
33. Financial instruments (extract)
Net gains or losses
Table D.78 shows the net gains/losses on financial instruments included in the Consolidated Statement of Income for the continuing and discontinued operations (excluding derivative financial instruments used in hedge accounting).
Net gains/losses on equity and debt instruments recognised 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 recognised at fair value through profit or loss comprise gains and losses attributable to changes in their fair values.
Net gains/losses on equity instruments recognised at fair value through other comprehensive income primarily comprise dividend payments.
Net gains/losses on other financial assets recognised at fair value through other comprehensive income are primarily attributable to the effects of currency translation.
Net gains/losses on financial assets measured at (amortised) cost (excluding the interest income/expense shown below) primarily comprise impairment losses (including reversals of impairment losses) of minus €223 million (2020: minus €824 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 (amortised) 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 of the continuing and discontinued operations for financial assets or financial liabilities that are not recognised at fair value through profit or loss are shown in table D.79.
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 Mercedes-Benz 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.80 shows the amounts for the transactions designated as hedging instruments.
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.81.
The amounts relating to hedge ineffectiveness for items designated as fair-value hedges are shown in table D.82.
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.
The Group also partially hedges the foreign-currency risk of selected investments with the application of derivative or non-derivative 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.83.
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.84.
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.85 shows the reconciliation of the reserves for derivative instruments (excluding reserves for hedges of net investments in foreign operations).
At 31 December 2021, the balance of reserves for hedges of net investments in foreign operations amounted to €189 million (2020: €189 million).
The maturities of the derivative financial instruments generally correspond with those of the underlying transactions. The realisation of the underlying transactions of the cash-flow hedges is expected to correspond with the maturities of the hedging transactions shown in table D.86.
At 31 December 2021, the Mercedes-Benz Group utilised derivative instruments with a maximum maturity of 35 months (2020: 38 months) as hedges for currency risks arising from future transactions.
Nominal values of derivative financial instruments
Table D.86 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.87.
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 34 in the sub-item finance market risk.
34. Management of financial risks (extract)
The global nature of its businesses exposes the Mercedes-Benz Group 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.
The Mercedes-Benz Group manages market risks to minimise the impact of fluctuations in foreign exchange rates and interest rates 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 the Mercedes-Benz Group risk management committees. Net-exposures are the basis for the hedging strategies and are updated regularly.
The Mercedes-Benz Group usually counteracts the risk of short-term fluctuations in raw material prices by means of price escalation clauses in the supply contracts. To a lesser extent, derivative financial instruments are used to hedge precious metal purchases.
Certain existing benchmark interest rates including those of the London Interbank Offer Rate (for USD, GBP, CHF and JPY) were comprehensively and internationally reformed by the end of 2021. As a result, those interest rates were 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 for USD, for example, 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 EURIBOR as well as GBP, CHF and JPY LIBOR reform already implemented, the contractual adjustment of financial instruments with a corresponding interest rate risk reference was made by 31 December 2021. The material share of interest rate risk hedging relationships that is still affected by the benchmark reform is based on the USD currency.
The Mercedes-Benz Group expects the conversion of the outstanding reference rates of hedging instruments and their underlying transactions to be identical and without any material delay. The Mercedes-Benz Group continues to consider the economic relationship and thus the continuation of hedge accounting to be still existing as of 31 December 2021.
The nominal values of the affected derivative financial instruments that are included in hedge accounting can be found in table D.86. The nominal values, which are not designated in a hedging relationship, amount to €12 billion in 2021 for derivatives used to hedge interest rate risks (2020: €14 billion), €8 billion (2020: €5 billion) for derivatives used to hedge exchange rate risks and €17 million (2020: €0 million) for derivatives used to hedge commodity price risks.
The effect of the application of the new interest rates on the Consolidated Financial Statements is being reviewed on an ongoing basis. In order to conduct financial transactions based on the new indices, the Mercedes-Benz Group is preparing its IT-systems accordingly. Uncertainty still exists about future market standards with interest conventions for individual financial products (cash products and interest derivatives) that reference the new risk-free rates. Contracts that have not been converted are shown in table D.90.
As part of its risk management system, the Mercedes-Benz Group employs value-at-risk analyses. In performing these analyses, the Mercedes-Benz Group 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, the Mercedes-Benz Group 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, the Mercedes-Benz Group 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%.
Transaction risk and currency risk management. The global nature of the Mercedes-Benz Group’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 serves as a basis for analysing 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, the Mercedes-Benz Group 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), the Mercedes-Benz Group 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 the Mercedes-Benz Group’s subsidiaries and operational units and implements the committee’s decisions concerning foreign currency hedging through transactions with international financial institutions. Suitable measures are generally taken without delay to eliminate any over-hedging regarding hedging transactions caused by changes in exposure. In the case of over hedges, 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 generally indicated by a step-by-step method. Depending on the nature of the underlying risks, the hedging rates decrease the further the expected cash flows are in the future. 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 step-by-step method aims to limit risks for the Group from unfavourable movements in exchange rates while preserving some flexibility to participate in favourable developments. Based on this step-by-step method 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 2021, foreign exchange management showed an unhedged position in the automotive business in calendar year 2022 for the underlying forecasted cash flows in US dollars of 45 %, for the underlying forecasted cash flows in Chinese renminbi of 31 % and for the underlying forecasted cash flows in British pounds of 13 %.
To cover foreign currency exposure risks of the vehicle business operations forward foreign exchange contracts and currency options are primarily used. The Mercedes-Benz Group’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.91 shows the period-end, high, low and average value-at-risk figures of the exchange rate risk for the 2021 and 2020 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.86.
Hedge accounting. When designating derivative financial instruments, a hedge ratio of 1 is applied. In addition, the respective volume 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 recognised in profit or loss at the due date of the underlying transaction or recognised 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. Further information can be found in table D.83. There were no material effects on earnings in 2021 and 2020.
In 2021, the development of the value at risk from foreign currency hedging was mainly driven by a strong increase in the volume of hedges in the second half of the year. Rising hedge volumes reflect the revenue increases after temporary decreases due to the pandemic. The calculation of the averages includes the derivative hedging transactions of the Daimler commercial vehicle business. The hedging volumes disposed of as part of the deconsolidation of the Daimler commercial vehicle business have no significant effect on the value at risk from foreign currency hedges.
The Group’s investments in liquid assets or refinancing activities are generally selected so that possible currency risks are minimised. 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 the Mercedes-Benz Group’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 Mercedes-Benz Group’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, the Mercedes-Benz Group does not hedge against exchange rate translation risk.
The Mercedes-Benz Group 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 Mercedes-Benz Mobility segment. The Mercedes-Benz Mobility companies enter into transactions with customers that primarily result in fixed-rate receivables. The Mercedes-Benz Group’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, Mercedes-Benz Mobility does not match funding in terms of maturities in order to take advantage of market opportunities. As a result, the Mercedes-Benz Group is exposed to risks due to changes in interest rates.
An asset/liability committee consisting of members of the Mercedes-Benz Mobility, Mercedes-Benz Cars & Vans 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 Mercedes-Benz Group companies are jointly responsible for achieving these targets. As separate functions, the Treasury Controlling and the Mercedes-Benz Mobility Controlling & Reporting department monitor 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, the Mercedes-Benz Group also uses derivative financial instruments such as interest rate swaps. The Mercedes-Benz Group 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. The Mercedes-Benz Group steers the funding activities of the automotive and financial services businesses at Group level.
Table D.91 shows the period-end, high, low and average value-at-risk figures of the interest rate risk for the 2021 and 2020 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.
In the course of 2021, changes in the value at risk of interest rate sensitive financial instruments were primarily determined by the development of interest rate volatilities. The calculation of the averages includes the exposures and the derivative hedging transactions of the Daimler commercial vehicle business. The hedging volumes disposed of as part of the deconsolidation of the Daimler commercial vehicle business have no significant effect on the value at risk of interest rate sensitive financial instruments.
Hedge accounting. When designating derivative financial instruments, a hedge ratio of 1 is generally applied. The respective volumes, interest curves, currencies and maturity dates are generally 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 recognised 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. In the case of hedging for ABS transactions of private placements, the risk of the market interest rate component is partly protected, which historically covers on average more than 70% of the change in value of the total interest rate. 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.
- No perfect match for individual parameters of the underlying hedged transactions and the hedging instruments used.
- Premiums on hedging instruments for hedging ABS transactions.
There were no material effects on earnings in the years 2021 and 2020.
The Mercedes-Benz Group is exposed to the risk of changes in commodity prices in connection with procuring raw materials and manufacturing supplies used in production. The Mercedes-Benz Group usually counteracts the risk of short-term fluctuations in raw-material prices by means of sliding-price clauses in the supply contracts. A small portion of the raw-material price risk relating to the forecasted procurement of precious metals is hedged with the use of derivative financial instruments. The Mercedes-Benz Group has decided to suspend these hedging strategies for precious metals until further notice and to phase out existing hedges.
Table D.91 shows the period-end, high, low and average value-at-risk figures for the 2021 and 2020 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.86.
In 2021, the decrease of the value at risk from commodity hedging was caused by a decrease in the hedging volume. The calculation of the averages includes the derivative hedging transactions of the Daimler commercial vehicle business. The hedging volumes disposed of as part of the deconsolidation of the Daimler commercial vehicle business have no significant effect on the value at risk from commodity hedging.
Hedge accounting. When designating currency derivative financial instruments, the Mercedes-Benz Group 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.
The Mercedes-Benz Group 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. This also includes the share in Daimler Truck Holding AG. These investments are not included in a market risk assessment by the Group.