NOTE F35 Financial instruments and financial risk management

The following table presents the financial instruments by category, split by current and non-current assets and liabilities.

F35.A. Overview of financial instruments

The following table gives an overview of the carrying amount of all financial instruments by category as defined by IFRS 9 Financial Instruments.

The category “Held for trading” only contains derivative financial instruments that are used for management of foreign currency risk, interest rate risk, utility and CO₂ emission rights price risks, index and Solvay share price. Contracts which have been documented as hedging instruments (hedge accounting under IFRS 9 Financial Instruments) or which meet the exemption criteria for own use are not included in the category “Held for trading”. Equity instruments measured at fair value through OCI pertain to Solvay’s New Business Development (NBD) activity: the Group has built a Corporate Venturing portfolio which is made of direct investments in start-up companies and of investments in venture capital funds. If the Group does not have significant influence or joint control, the investments are measured at fair value according to the valuation guidelines published by the European Private Equity and Venture Capital Association, and impacts are recognized in other comprehensive income.

F35.B. Fair value of financial instruments

Valuation techniques and assumptions used for measuring fair value

The fair values of other financial assets and financial liabilities are determined in accordance with generally accepted pricing models based on discounted cash flow analysis.

Fair value of financial instruments measured at amortized cost

The carrying amounts of current financial assets and liabilities are estimated to reasonably approximate their fair values, such in light of short terms to maturity.

Financial instruments measured at fair value in the consolidated statement of financial position

The table “Financial instruments measured at fair value in the consolidated statement of financial position” provides an analysis of financial instruments that, subsequent to their initial recognition, are measured at fair value, grouped into Levels 1 to 3 based on the degree to which the fair value is observable. Financial instruments, classified as held for trading and as hedging instruments in cash flow hedges are mainly grouped into Levels 1 and 2. They are fair valued based on forward pricing and swap models using present value calculations. The models incorporate various inputs including foreign exchange spot and interests rates of the respective currencies, currency basis spreads between the respective currencies, interest rate curves and forward rate curves of the underlying commodity. The equity instrument measured at fair value through OCI fall within Level 3, and are measured based on a discounted cash flow approach.

In accordance with the Group internal rules, the responsibility for measuring the fair value level resides with (a) the Treasury department for the non-utility derivative financial instruments, and the non-derivative financial liabilities, (b) the Sustainable Development and Energy department for the utility derivative financial instruments and (c) the Finance department for non-derivative financial assets.

Financial instruments measured at fair value in the consolidated statement of financial position

Movements of the period

Reconciliation of level 3 fair value measurements of financial assets and liabilities

Income and expenses of financial instruments recognized in the consolidated income statement and in other comprehensive income

F35.C. Capital management

See 2 Capital, shares and shareholders in respect of capital in the Corporate governance statement chapter of this report.

The Group manages its funding structure with the objective of safeguarding its ability to continue as a going concern, optimizing the return for shareholders, maintaining an investment-grade rating, and minimizing the cost of debt.

The capital structure of the Group consists of equity (including perpetual hybrid bonds (see note F31 Equity) and of net debt (see note F36 Net indebtedness). Perpetual hybrid bonds are nevertheless considered as debt in the Group’s Underlying metrics.

Besides the statutory minimum equity funding requirements that apply to the Company’s subsidiaries in the different countries, Solvay is not subject to any additional legal capital requirements.

The Treasury department reviews the capital structure on an ongoing basis under the authority and the supervision of the Chief Financial Officer. As appropriate, the Legal department is involved to ensure compliance with legal and contractual requirements.

F35.D. Financial risk management

The Group is exposed to market risks from movements in foreign exchange rates, interest rates and other market prices (utility prices, CO₂ emission rights prices and equity prices). The Group’s senior management oversees the management of these risks and is supported by the Treasury department (non-commodity risks) and Solvay Sustainable Development and Energy department that advise on financial risks and the appropriate financial risk governance framework for the Group. Both departments provide assurance to the Group’s senior management that the Group’s financial risk activities are governed by appropriate policies and procedures and that financial risks are identified, measured and managed in accordance with the Group’s policies and risk objectives. The Solvay Group uses derivative financial instruments to hedge clearly identified foreign exchange, interest rate, index, utility price and CO₂ emission rights price risks (hedging instruments). All derivative activities for risk management purposes are carried out by specialist teams that have the appropriate skills, experience and supervision. However, the required criteria to apply hedge accounting are not met in all cases.

Furthermore, the Group is also exposed to liquidity risks and credit risks.

The majority of derivative hedging instruments held by the Group mature in less than one year.

Foreign currency risks

The Group is a multi-specialty chemical company with operations worldwide, and hence undertakes transactions denominated in foreign currencies. As a consequence, the Group is exposed to exchange rate fluctuations. In 2019, the Group was mainly exposed to US dollar, Chinese yuan, Brazilian real, Mexican peso and Japanese yen.

To mitigate its foreign currency risk, the Group has defined a hedging policy that is essentially based on the principles of financing its activities in local currency and hedges the transactional exchange risk at the time of invoicing (risk which is certain). The Group constantly monitors its activities in foreign currencies and hedges, where appropriate, the exchange rate exposures on expected cash flows (risk which is highly probable).

Exchange rate exposures are managed within approved policy parameters utilizing forward foreign exchange contracts or, when appropriate, other derivatives like currency options.

In the course of 2019 the EUR/USD exchange rate moved from 1.1455 at the start of January to 1.1231 at the end of December. In the course of 2018 the EUR/USD exchange rate moved from 1.1995 at the start of January to 1.1455 at the end of December.

Based on the USD contribution to the Group’s EBITDA, as of Dec 31st 2019, a fluctuation of (0.10) to the US$/€ exchange rate, would generate about € 125 million (€ 120 million for 2018) variation to the EBITDA. 2/3 of this variation is at conversion level and 1/3 at transaction level the latter being mostly hedged.

At the end of 2019, a strengthening of the US dollar vs EUR would increase the net debt by approximately € 100 million per 0.10 US$/€ fluctuation. Conversely, a weakening of the US dollar vs EUR would decrease the net debt by approximately € 84 million per 0.10 US$/€ fluctuation.

At the end of 2018, a strengthening of the US dollar vs EUR would increase the net debt by approximately € 129 million per 0.10 US$/€ fluctuation. Conversely, a weakening of the US dollar vs EUR would decrease the net debt by approximately € 108 million per 0.10 US$/€ fluctuation.

The Group’s currency risk can be split into two categories: translation and transactional risk.

Translation risk

The translation exchange risk is the risk affecting the Group’s consolidated financial statements related to investees operating in a currency other than the EUR (the Group’s presentation currency).

During 2019 and 2018, the Group did not hedge the currency risk of foreign operations.

Transactional risk

The transactional risk is the exchange risk linked to a specific transaction, such as a Group entity buying or selling in a currency other than its functional currency.

To the largest extent possible, the Group manages the transactional risk on receivables and borrowings centrally and locally when centralization is not possible.

The choice of borrowing currency depends mainly on the opportunities offered by the various markets. This means that the selected currency is not necessarily that of the country in which the funds will be invested. Nonetheless, operating entities are financed essentially in their functional currencies.

In emerging countries it is not always possible to borrow in local currency, either because funds are not available in local financial markets, or because the financial conditions are too onerous. In such a situation the Group has to borrow in a different currency. Nonetheless the Group considers opportunities to refinance its borrowings in emerging countries with local currency debt.

Derivatives are initially recognized at fair value at the date a derivative contract is entered into and are classified into the two categories described below:

Held for trading

The transactional risk is managed either by spot or forward contracts. Unless documented as hedging instruments (see above), derivative financial instruments are classified as held for trading.

In 2019 the net notional amount is a short position of € (169) million compared to the long position of 2018. This evolution is mainly explained by a modification of the debt currency mix (see note F36 Net Indebtedness), an increased foreign exchange hedging activity in China and internal restructuring optimization activity.

The following table details the notional amounts of the Group’s derivatives contracts outstanding at the end of the period:

Cash flow hedge

The Group uses derivatives to hedge identified foreign exchange rate risks. It documents those as hedging instruments unless it hedges a recognized financial asset or liability when generally no cash flow hedge relationship is documented. Most hedges are transaction related.

At the end of 2019 for future exposure, the Group had mainly hedged forecast sales (short position) in a nominal amount of US$ 713 million (€ 635 million) and JP¥ 9,206 million (€ 76 million). All cash flow hedges that exist at the end of December 2019 will be settled within the next 12 months, and will impact profit or loss during that period.

The following table details the notional amounts of Solvay’s derivatives contracts outstanding at the end of the period:

Notional amounts net

At the end of 2019, around € 4.3 billion of the Group’s gross debt was at fixed-rate, including mainly:

• Senior EUR Bonds for a total of € 1,850 million maturing in 2022, 2027 and 2029 (carrying amount of € 1,837 million);
• Remaining part (US$ 196 million) of the US$ Senior Bonds 2023 of US$ 400 million (carrying amount of € 169 million);
• Remaining part (US$ 163 million) of the US$ Senior Bonds 2025 of US$ 250 million (carrying amount of € 143 million);
• Senior US$ Bonds for a total of US$ 800 million (carrying amount of € 709 million);
• Belgian Treasury notes (commercial papers) for a total of € 700 million maturing within the year (carrying amount of € 700 million);
• IFRS 16 lease liability for a total of € 470 million (carrying amount of € 470 million).

The floating rate debts that are subject to interest rate swaps are discussed below.

The impact of interest rate volatility at the end of 2019 compared to 2018 is the following:

Other market risks

Utility and CO₂ price risks

The Group purchases a large portion of its coal, gas and electricity needs in Europe and the United States based on fluctuating liquid market indices. In order to reduce the cost volatility, the Group has developed a policy for exchanging variable price against fixed price through derivative financial instruments. Most of these hedging instruments can be documented as hedging instruments of the underlying purchase contracts. Utility purchase contracts at fixed price with a physical delivery for use in the Group’s operations are qualified as own use contracts (not derivatives) and constitute a natural hedge. Those have not been included in this note.

Similarly the Group’s exposure to CO₂ price is partially hedged by forward purchases of European Union Allowances (EUA). Forward purchases with physical delivery for use in the Group’s operations are qualified as own use contracts (not derivatives).

Finally some exposure to gas-electricity or coal-electricity spreads may arise from the production of electricity on Solvay sites (mostly from cogeneration units in Europe), which can be hedged by means of forward purchases and forward sales or optional schemes. In this case, cash flow hedge accounting is applied.

Financial hedging of utility and CO₂ emission rights price risks is managed centrally by Energy Services on behalf of the Group entities.

Energy Services also carries out trading transactions with respect to utility and CO₂, for which the residual price exposure is maintained close to zero.

The following tables detail the notional principal amounts and fair values of utility and CO₂ derivative financial instruments outstanding at the end of the reporting period:

Performance Share Units Plan (PSU) risk on Solvay share price

In order to neutralize the volatility of the Solvay share price which will impact the liability valuation relating to the PSUs (with related employer charges), the Group entered into equity swaps covering more than 90% of the risk. The liability of € 25 million recognized for 2018 and 2019 PSU plans corresponds to the best estimate of the amount due at maturity. Consequently, all hedge relationships exceeding this liability have been discontinued with an insignificant impact on the consolidated income statement.

Credit risk

See the Financial risk in the Management of risks section of this report for additional information on the credit risk management.

The Group continuously monitors the credit risk of important business partners.

The Group engages in transactions only with financial institutions with a good credit rating. The Group monitors and manages exposures to financial institutions within approved counterparty credit limits and credit risk parameters in order to mitigate the risk of default. For financial guarantees, see note F39 Contingent liabilities and financial guarantees.

The Group recognizes expected credit losses on all of its trade receivables: it applies the simplified approach and recognizes lifetime expected losses on all trade receivables, using a provision matrix in order to calculate the lifetime expected credit losses for trade receivables, using historical information on defaults adjusted for the forward looking information.

The Group classifies the customers and their related receivables in various rating classes, based on the risks’ grading attributed to the customers and on the ageing balance of receivables. As such, for all receivables overdue below 6 months, the Group considers percentages within a range between 0.005% and 4.365%, depending on the rating class. For all receivables overdue in excess of 6 months, the Group considers a rate of 50% or of 100%, depending on the rating class. The customer’s grading is reviewed annually for customers assessed as low risk profile, and every six months for customers assessed as higher risk profile.

There is no significant concentration of credit risk at Group level because the receivables’ credit risk is spread over a large number of customers and markets.

The ageing of trade receivables, financial instruments - operational, loans and other non-current assets is as follows:

Liquidity risk

See the Financial risk in the Management of risks section of this report for additional information on the liquidity risk management.

Liquidity risk relates to Solvay’s ability to service and refinance its debt (including notes issued) and to fund its operations.

This depends on its ability to generate cash from operations and not to over-pay for acquisitions.

The Finance Committee gives its opinion on the appropriate liquidity risk management for the Group’s short, medium and long term funding and liquidity management requirements.

The Group manages liquidity risk by maintaining adequate reserves, banking facilities and reserve borrowing facilities, by continuously monitoring forecast and actual cash flows, and by matching the maturity profiles of financial assets and liabilities.

The Group staggers the maturities of its financing sources over time in order to limit amounts to be refinanced each year.

The following tables detail the Group’s remaining contractual maturity for its financial liabilities with contractual repayment periods.

The tables have been prepared using the discounted cash flows of financial liabilities, based on the earliest date on which the Group can be required to pay.

The following tables present discounted amounts (carrying amounts):

The Group has access to the following instruments:

• An amount of € 700 million (compared to € 246 million at the end of 2018) was issued from the Belgian Treasury Bill program (out of € 1.5 billion available under the program). The US commercial paper program in an amount of US$ 500 million was unused at the end of 2019 as well as at the end of 2018. The two programs are covered by back-up credit lines;
• A € 2 billion syndicated credit facility maturing in 2024. Solvay has also secured bilateral credit lines (~ € 1,495 million). They were all unused at the end of 2019.