IFRS 7 paras 20, 21A-24F, certain disclosures, income statement, hedge fair values and gains and losses on hedges

Daimler AG – Annual report – 31 December 2018

Industry: automotive

1. Significant accounting policies (extract)
Application of IFRS 9 Financial Instruments. Daimler applies IFRS 9 initially for reporting periods beginning on and after January 1, 2018. Initial application is made retrospectively. In accordance with the transition requirements, Daimler chose to present prior periods in accordance with IAS 39. As an exception, the transition for recognition of fair-value changes of certain non-designated components of derivatives through other comprehensive income is to be applied retrospectively to the comparative figures.

32. Financial instruments (extract)
Net gains or losses
Table F.82 shows the net gains/losses on financial instruments included in the Consolidated Statement of Income (excluding derivative financial instruments used in hedge accounting) at December 31, 2018 according to IFRS 9.

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, among others the fair value change of our equity interest in Aston Martin Lagonda Global Holdings plc.

Net gains/losses on other financial assets and liabilities recognized at fair value through profit or loss primarily comprise gains and losses attributable to changes in their fair values.

Net gains/losses on equity instruments measured at fair value through other comprehensive income primarily comprise dividend payments.

Net gains/losses on other financial assets measured 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 primarily comprise impairment losses (including reversals of impairment losses) of €407 million that are charged to cost of sales, selling expenses and other financial income/expense, net. Foreign currency gains and losses are also included. On the other hand impairment losses (excluding reversals of impairment losses) amounted to €630 million at December 31, 2017 according to IAS 39.

Net gains/losses on financial liabilities measured at (amortized) cost primarily comprise the effects of currency translation.

Table F.83 shows the net gains/losses on financial instruments included in the Consolidated Statement of Income (excluding derivative financial instruments used in hedge accounting) at December 31, 2017 according to IAS 39.

Total interest income and total interest expense
Total interest income and total interest expense for financial assets or financial liabilities that are not measured at fair value through profit or loss at December 31, 2018 according to IFRS 9 are shown in table F.84.

Total interest income and total interest expense for financial assets or financial liabilities that were not measured at fair value through profit or loss amounted €4,572 million and €2,415 million respectively at December 31, 2017 according to IAS 39.

See Note 1 for qualitative descriptions of accounting for and presentation of financial instruments (including derivative financial instruments).

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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. These are mainly interest rate risks, currency risks and commodity price risks, which were defined as risk categories according to IFRS 9. For these hedging purposes, the Group mainly uses currency forward transactions, cross currency interest rate swaps, interest rate swaps, options and commodity forwards.

Table F.85 shows the amounts for the transactions designated as hedging instruments at December 31, 2018 according to IFRS 9.

Table F.86 shows the fair values of hedging instruments at December 31, 2017 according to IAS 39.

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 at December 31, 2018 according to IFRS 9 are included in table F.87.

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The amounts relating to hedge ineffectiveness for items designated as fair value hedges at December 31, 2018 according to IFRS 9 are shown in table F.88.

Net gains and losses on these hedging instruments and the changes in the value of the underlying transactions at December 31, 2017 according to IAS 39 are shown in table F.89.

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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 non-derivative financial instruments.

The amounts related to items designated as cash flow hedges and as hedges of net investments in foreign operations at December 31, 2018 according to IFRS 9 are shown in table F.90.

The gains and losses on items designated as cash flow hedges at December 31, 2018 according to IFRS 9 as well as the amounts relating to hedge ineffectiveness are included in table F.91.

Net profit at December 31, 2017 according to IAS 39 includes net losses (before income taxes) of €11 million attributable to the ineffectiveness of derivative financial instruments entered into for hedging purposes (hedge ineffectiveness).

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Table F.92 shows the reconciliation of the reserves for derivative instruments in 2018 according to IFRS 9.

The reserves for derivative instruments include reserves for hedge costs of minus €11 million at December 31, 2018 (minus €34 million at January 1, 2018).

Unrealized pre-tax gains/losses on the measurement of derivatives, which are recognized in other comprehensive income, amounted to €2,525 million at December 31, 2017 according to IAS 39.

Table F.93 provides an overview of the reclassifications of pre-tax gains/losses from equity to the Consolidated Statement of Income in 2017 according to IAS 39.

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The maturities of the interest rate hedges and cross currency interest rate hedges as well as of the commodity hedges 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 F.94 at December 31, 2018 according to IFRS 9 and in table F.95 at December 31, 2017 according to IAS 39.

At December 31, 2018, Daimler utilized derivative instruments with a maximum maturity of 34 months (2017: 39 months) as hedges for currency risks arising from future transactions.

Nominal values of derivative financial instruments
Table F.94 and table F.95 show the nominal values of derivative financial instruments at December 31, 2018 according to IFRS 9 and at December 31, 2017 according to IAS 39 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 at December 31, 2018 according to IFRS 9 are included in table F.96.

Hedging 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 mostly do not classify for hedge accounting.

Even if derivative financial instruments do not or no longer qualify for hedge accounting, these instruments are still hedging financial risks from the operating business. A hedging instrument is terminated when the hedged item 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.

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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 and interest rates. In addition, the Group is exposed to market risks in terms of commodity price risk associated with its business operations, which the Group hedges for certain metals partially through derivative financial instruments. 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 results of the Group and its segments. The Group calculates its overall 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. Starting in 2019, exposure to currency risks will be determined for each segment. The hedging strategy is specified at the Group level and uniformly implemented in the segments. Decisions regarding the management of market risks resulting from fluctuations in foreign exchange rates, interest rates (asset-/liability management) and commodity prices are regularly made by the relevant Daimler risk management committees. Exposures are the basis of the hedging strategies and are updated regularly.

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.

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 the value at risk by 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%.

Oriented towards the risk management standards of the international banking industry, Daimler maintains its financial controlling unit independent of operating Corporate Treasury and with a separate reporting line.

Exchange rate risk
Transaction risk and currency risk management. The global nature of Daimler’s businesses exposes cash flows and earnings 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 generating the revenue are incurred (transaction risk). When the revenue is converted into the currency in which the costs 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 the Mercedes-Benz Cars segment, which generates a major portion of its revenue in foreign currencies and incurs manufacturing costs primarily in euros. The Daimler Trucks segment is also subject to transaction risk, but to a lesser extent because of its global production network. The Mercedes-Benz Vans and Daimler Buses segments are also directly exposed to transaction risk, but also only to a minor degree compared to the Mercedes-Benz Cars segment. In addition, the Group is indirectly exposed to transaction risk from its equity-method investments.

The Group’s currency exposure is reduced by natural hedging to the extent that currency exposures of the operating businesses of individual segments offset each other partially at Group level, thereby reducing overall currency exposure. 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 operating business (future transactions), Daimler continually assesses its exposure to exchange rate risks and hedges a portion of those risks by using derivative financial instruments. Daimler’s Foreign Exchange Committee (FXCo) manages the Group’s exchange rate risk and its hedging transactions through currency derivatives. The FXCo consists of representatives of the relevant segments and central functions. The Corporate Treasury department aggregates foreign currency exposures from Daimler’s subsidiaries and operative units and implements the FXCo’s decisions concerning foreign currency hedging through transactions with international financial institutions. Any over-hedge caused by changes in exposure is generally reversed by taking suitable measures without delay.

Risk Controlling regularly informs the Board of Management of the actions taken by Corporate Treasury based on the FXCo’s decisions.

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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 FXCo 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 2018, foreign exchange management showed an unhedged position in the automotive business for the underlying forecasted cash flows in US dollars in calendar year 2019 of 29%, for the underlying forecasted cash flows in Chinese renminbi in calendar year 2019 of 30%, as
well as for the underlying forecasted cash flows in British pounds in calendar year 2019 of 33%.

The hedged position of the operating vehicle businesses is influenced by the amount of derivative currency contracts held. The derivative financial instruments used to cover foreign currency exposure are primarily forward foreign exchange contracts and currency options. 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 F.99 shows the period-end, high, low and average value at risk figures of the exchange rate risk for the 2018 and 2017 portfolios of derivative financial instruments, which were entered into primarily in connection with the operative vehicle businesses. 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. See also table F.94 at December 31, 2018 according to IFRS 9 and table F.95 at December 31, 2017 according to IAS 39 for the nominal volumes on the balance sheet date of derivative currency instruments entered into to hedge the currency risk from forecasted transactions.

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. In the case of options for currency hedging, the option premium is 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. 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 is not reflected in the change of the hedged currency risk.
– Changes in the timing of the hedged transactions.

In the course of focusing on the divisional perspective the designation of hedge relationships primarily for foreign currency risk from future vehicle sales will be subject to a further differentiation by Mercedes-Benz Cars/Mercedes-Benz Vans as well as Daimler Trucks/Daimler Buses starting with 2019. Until year-end 2018, the designation of these hedge relationships for a specific currency and maturity has no further differentiation in respect of the entire volume of expected vehicle sales by segments. Accordingly, as of January 1, 2019, the documentation required under IFRS with regards to this further differentiation of expected cash flows (i.e. the risk management objectives) will also be revised for the major part of the already designated hedge relationships for foreign currency risk although there is no change in the overall Group risk management strategy. This results in a formal discontinuation of existing hedge relationships as described in the methods applied in preparation of the financial statements and immediate redesignation of new hedge relationships according to the revised differentiation. The accumulated hedging gains/losses in equity as of December 31, 2018, subject to redesignation remain in the other reserves for derivative financial instruments because the hedged future cash flows are still expected to occur. Daimler does not expect any material impacts on the Group’s profitability, liquidity and capital resources or financial position.

In 2018, the development of the value at risk from foreign currency hedging was mainly driven by decreases in foreign currency rate volatilities and hedge volumes.

The Group’s investments in liquid assets or refinancing activities generally are not allowed to result in currency risk. 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 principally offset each other, these financial instruments are not included in the value at risk calculation presented.

Effects of currency translation. 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 its day-to-day operations. A substantial volume of interest rate sensitive assets and liabilities results from the leasing and sales financing business operated by the Daimler Financial Services segment. The Daimler Financial Services 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, the Group does not match funding in terms of maturities in order to take advantage of market opportunities. As a result, Daimler is exposed to risks due to changes in interest rates.

An asset/liability committee consisting of members of the Daimler Financial Services segment and the Corporate Treasury department manages the interest rate risk relating to Daimler’s leasing and financing activities by setting targets for the interest rate risk position. The Treasury Risk Management department and the local Daimler Financial Services companies are jointly responsible for achieving these targets. As separate functions, the Treasury Controlling and the Daimler Financial Services 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. Daimler coordinates the funding activities of the automotive and financial services businesses at the Group level.

Table F.99 shows the period-end, high, low and average value at risk figures of the interest rate risk for the 2018 and 2017 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. In this respect, the table shows the interest rate risk regarding the unhedged position of interest rate sensitive financial instruments. The average values have been computed on an end-of-quarter basis.

In the course of 2018, changes on the value at risk of interest rate sensitive financial instruments were 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 pro rata 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 mitigated with the use of derivative financial instruments.

For precious metals, central commodity management shows an unhedged position of 39% of the forecasted commodity purchases at year-end 2018 for calendar year 2019. The corresponding figure at year-end 2017 was 38% for calendar year 2018.

Table F.99 shows the period-end, high, low and average value at risk figures of the commodity price risk for the 2018 and 2017 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 F.94 at December 31, 2018 according to IFRS 9 and table F.95 at December 31, 2017 according to IAS 39 for the nominal values of derivative commodity price hedges at the balance sheet date.

In 2018, the value at risk of commodity derivatives was close to the previous year’s level due to offsetting developments of volatilities and hedge volume.

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 of the Group.

 

 

 

 

 

 

 

 

 

 

 

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