3.1 – Financial risk factors

The Group’s activities expose it to a variety of financial risks: market risk (including foreign exchange risk, interest rate risk and price risk), credit risk, liquidity risk, counterparty risk, (re-)financing and funding risk, and also settlement risk. The Group’s overall risk management program focuses on the unpredictability of financial markets and seeks to reduce potential adverse effects on the Group’s financial performance at reasonable hedging costs. The Group uses derivative financial instruments, non-derivative financial instruments and operating strategies to hedge certain risks.

Financial risk management is carried out by the central treasury department (Corporate Treasury) under policies approved by the Executive Committee and the Board of Directors. Corporate Treasury identifies, evaluates and hedges financial risks in close cooperation with the Group’s operating units and functions. Written principles for the management of overall foreign exchange risk, credit risk for the use of derivative financial instruments, non-derivative financial instruments and investing excess liquidity (counterparty risk) are in place.

3.1.1 – Market risk

3.1.1.1 – Foreign exchange risk

• Exposure to foreign exchange risk: The Group operates internationally and is exposed to foreign exchange risks arising from various currency exposures, primarily with respect to the euro and the US-dollar and to some extent the currencies of emerging countries. Foreign exchange risks arise from future commercial transactions, recognized assets and liabilities and net investments in foreign operations, when they are denominated in a currency that is not the respective subsidiary’s functional currency.
• Foreign exchange risk management: To manage the foreign exchange risk arising from future commercial transactions and recognized assets and liabilities, entities in the Group use spot transactions, FX forward contracts, FX options and FX swaps according to the Group’s foreign exchange risk policy. Corporate Treasury is responsible, in close coordination with the Group’s operating units, for managing the net position in each foreign currency and for putting in place the appropriate hedging actions.
  
  The Group’s foreign exchange risk management policy is to selectively hedge net transaction exposures in major foreign currencies.
  
  Currency exposures arising from the net assets of the Group’s foreign operations are managed primarily through borrowings denominated in the relevant foreign currency.
  
  Detailed information regarding foreign exchange management is provided in note 29.
• Foreign exchange risk sensitivity: The estimated percentage change of the following foreign exchange rates used in this calculation is based on the historical foreign exchange rate volatility for a term of 360 days.
  
  At 31 December 2017, if the euro had strengthened/weakened by 5% (2016: 6%) against the Swiss franc with all other variables held constant, pre-tax profit for the year would have been CHF 7 million higher/lower (2016: CHF 26 million higher/lower), mainly as a result of foreign exchange gains/losses on translation of the euro-denominated financing, cash and cash equivalents, intragroup financing and third-party trade receivables and payables. Equity would have been CHF 42 million lower/higher (2016: CHF 42 million lower/higher), arising mainly from foreign exchange gains/losses on translation of the euro-denominated hedging instruments.
  
  At 31 December 2017, if the US-dollar had strengthened/weakened by 7% (2016: 8%) against the Swiss franc with all other variables held constant, pre-tax profit for the year would have been CHF 27 million higher/lower (2016: CHF 32 million higher/lower) mainly as a result of foreign exchange gains/losses on translation of US-dollar denominated cash and cash equivalents, intragroup financing and trade receivables. Equity would have been CHF 19 million lower/higher (2016: CHF 24 million lower/higher), arising mainly from foreign exchange gains/ losses on the translation of the USD-denominated hedging instruments.

3.1.1.2 – Interest rate risk

• Exposure to interest rate risk: Financial debt issued at variable rates and cash and cash equivalents expose the Group to cashflow interest rate risk; the net exposure as per 31 December 2017 was not significant. Financial debt issued at fixed rates does not expose the Group to fair value interest rate risk because it is recorded at amortized costs. At the end of 2017 and 2016, 100% of the net financial debt was at fixed rates.
• Interest rate risk management: It is the Group’s policy to manage the costs of interest using fixed and variable rate debt and interest-related derivatives. Corporate Treasury monitors the net debt fix-to-float mix on an ongoing basis.
• Interest rate risk sensitivity: To calculate the impact of a potential interest rate shift on profit and loss, a weighted average interest rate change was determined, based on the terms of the financial debt issued at variable rates, fix-term deposits and the movements of the corresponding interest rates (interest rates comparison between end of 2017 and end of 2016). At 31 December 2017, if the euro interest rates on net current financial debt issued at variable interest rates had been 9 basis points higher/lower with all other variables held constant, pre-tax profit for the year would have been below CHF 0.1 million higher/lower (2016: CHF 0.8 million higher/lower for a euro interest rate shift of 19 basis points).

3.1.2 – Other price risks

With regard to the financial statements as per 31 December 2017 and 2016, the Group was not exposed to other price risks in the sense of IFRS 7, Financial Instruments: Disclosures.

3.1.2.1 – Credit risk

• Exposures to credit risk: Credit risk arises from deposits of cash and cash equivalents, from entering into derivative financial instruments and from deposits with banks and financial institutions, as well as from credit exposures to wholesale and retail customers, including outstanding receivables and committed transactions with suppliers. Customer credit risk exposure is triggered by customer default risk and country risk. As per 31 December 2017, the Group had a diversified portfolio with more than 32 000 active credit accounts (2016: more than 30 000), with no significant concentration neither due to size of customers nor due to country risk.
• Credit risk management: Clariant has a Group credit risk policy in place to ensure that sales are made to customers only after an appropriate credit risk rating and credit line allocation process. Procedures are standardized within a customer credit risk policy and supported by the IT system with respective credit management tools. Credit lines are partially backed by credit risk insurance.

Financial instruments contain an element of risk that the counterparty may be unable to either issue securities or to fulfill the settlement terms of a contract. Clariant therefore – whenever possible – only cooperates with counterparties or issuers that are at least rated »BB« when it comes to entering into deposits with such counterparties. The cumulative exposure to these counterparties is constantly monitored by Corporate Treasury. There is no expectation of a material loss due to counterparty risk.

The Group maintains a large cash pooling structure with a leading European bank, over which most European subsidiaries execute their cash transactions denominated in euro. As a result of this cash pool the Group at certain times has substantial current financial assets and at other times substantial current financial liabilities.

In view of the bank being rated »A-« (2016: A+) by the most important rating agencies, Clariant does not consider this to pose any particular counterparty risk.

At the balance sheet date 72% (2016: 75%) of the total cash and cash equivalents and short-term deposits were held with five (2016: five) banks, each with a position between CHF 37 million and CHF 224 million (2016: between CHF 74 million and CHF 494 million). All of these banks are rated »A-« (2016: »A« ) and better.

The table below shows in percentage of total cash and cash equivalents the share deposited with each of the three major counterparties at the balance sheet date (excluding the bank managing the euro cash pool):

3.1.3 – Liquidity risk

• Liquidity risk management: Cash flow forecasting is performed in the subsidiaries of the Group and in aggregate by Corporate Treasury. Corporate Treasury monitors the forecasts of the Group’s liquidity requirements to ensure it has sufficient cash to meet its operational needs while maintaining sufficient headroom on its undrawn borrowing facilities. At all times the Group aims to meet the requirements set by the covenants of any of its borrowing facilities. Corporate Management therefore takes into consideration the Group’s debt financing plans and financing options.

Cash which is not needed in the operating activities of the Group is invested in short-term money market deposits or marketable securities, if an interest income higher than the one on a regular bank deposit can be achieved. At 31 December 2017, the Group held money market funds of CHF 154 million (2016: CHF 627 million), thereof CHF 47 million with an initial tenor of more than 90 days (2016: CHF 277 million).

The following table analyzes the maturity profile of the Group’s financial liabilities. The amounts disclosed are the contractual undiscounted cash flows and therefore do not reconcile with the financial liabilities presented in the consolidated balance sheets.

The Group covers its liabilities out of generated operating cash flow, liquidity reserves in form of cash and cash equivalents including money market deposits (31 December 2017: CHF 748 million vs. 31 December 2016: CHF 1 320 million), out of uncommitted open cash pool limits and bank credit lines (31 December 2017: CHF 107 million vs. 31 December 2016: CHF 132 million), as well as out of additional uncommitted net working capital facilities and through issuance of capital market instruments.

On 16 December 2016, Clariant Ltd signed an agreement for a new CHF 500 million five-year multi-currency revolving credit facility (RCF) with two one-year extension options. The RCF is structured as a club deal with ten key relationship banks with equal stakes and contains an accordion option for an increase up to CHF 600 million. The RCF is structured as a »back-stop« facility for rating purposes to maintain Clariant’s liquidity headroom. It contains customary covenants such as negative pledge, cross default, ownership change and restriction on disposals, mergers and subsidiary debt. The Group is required to maintain one financial covenant (debt leverage) that is tested at the end of each financial half year. The RCF was extended one more year until 16 December 2022.

3.2 – Fair value measurement

IFRS 13, Fair Value Measurement, requires the disclosure of fair value measurements for financial instruments that are measured at fair value in the balance sheets in accordance with the fair value measurement hierarchy.

The fair value hierarchies are defined as follows:

• Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.
• Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (that is, derived from prices).
• Level 3: Inputs for the asset or liability that are not based on observable market data (that is, unobservable inputs).

3.2.1 – Valuation methods

As per 31 December 2017, the open derivative financial instruments held were valued using the following valuation methods:

Forward exchange rate contracts: The valuation of forward exchange rate contracts are based on the discounted cash flow model, using observable inputs such as interest curves and spot rates.

Exchange rate options: FX options are valued based on a Black-Scholes model, using major observable inputs such as volatility and exercise prices.

The financial instruments measured at fair value through profit or loss were all classified as Level 2 (see note 29). There were no transfers between the levels in 2017 and 2016.

3.3 – Capital risk management

The Group’s objectives when managing capital are to safeguard the ability to continue as a going concern in order to provide returns for the shareholders and benefits for other stakeholders and to maintain a capital structure suitable to optimize the cost of capital. This includes aspects of the credit rating.

In order to maintain or adjust the capital structure, the Group may adjust the amount of payouts to the shareholders, return capital to the shareholders, issue new shares, or sell assets to reduce debt.

The Group monitors capital on the basis of invested capital as part of the return on invested capital concept. Invested capital is calculated as the sum of total equity as reported in the consolidated balance sheets plus current and non-current financial liabilities as reported in the consolidated balance sheets plus estimated liabilities from operating leases, plus estimated cash needed for operating purposes, less cash and cash equivalents and short-term deposits not needed for operating purposes.

Invested capital for the Group was as follows on 31 December 2017 and 2016 respectively:

At the end of 2017, Clariant considers the invested capital to be adequate.