Notes to the Consolidated Financial Statements of the Covestro Group – Notes to the Statement of Financial Position

24. Financial Instruments

24.1  Financial Instruments by Category

The following tables show the carrying amounts and fair values of the individual financial assets and liabilities in accordance with IFRS 9 (Financial Instruments):

The fair values of financial instruments are determined and reported in accordance with IFRS 13 (Fair Value Measurement) on the basis of the fair value hierarchy described below:

Level 1 covers fair values determined on the basis of quoted, unadjusted prices that exist in active markets.

Level 2 comprises fair values determined on the basis of parameters that are observable in an active market.

Level 3 applies to fair values determined using parameters whose input factors are not based on observable market data.

Because of the generally short maturities of cash and cash equivalents, loans and bank deposits, trade accounts receivable and payable, and other financial assets and liabilities, their carrying amounts do not significantly differ from the fair values.

The fair values of noncurrent receivables under lease agreements are calculated on the basis of interest curves observable in the market. Additionally, a discount for cash flows that are very far in the future is applied as an unobservable factor.

The following table shows the assignment of the financial instruments to the three-level fair value hierarchy:

Reallocation between the different levels of the fair value hierarchy takes place at the end of the reporting period in which the change occurred. During the fiscal year, no financial instruments were reallocated to a different level of the fair value hierarchy.

• See note 3 “Accounting policies” for detailed information on the calculation of the fair value of financial instruments and their assignment to the fair value hierarchy.

The table below shows the changes in Level 3 financial instruments:

The gains and losses from Level 3 financial assets and liabilities are reported as follows:

• Gains and losses from embedded derivatives recognized in profit or loss are reported in other operating expenses or income
• Gains and losses from contingent purchase price receivables from divestments and debt instruments recognized in profit or loss are reported in other financial result
• Gains and losses from other financial investments are reported in other comprehensive income from equity instruments

Covestro acts as a start-up investor as part of the Covestro Venture Capital (COVeC) approach newly developed in fiscal 2020. Investments associated with COVeC activities are recognized either as debt instruments at fair value through profit and loss or as other financial investments at fair value directly in equity, depending on the contractual design.

Other financial investments are recognized at fair value directly in equity because they are held for the long term for strategic reasons. Other financial investments amount to €22 million (previous year: €24 million), of which €18 million (previous year: €18 million) was attributable to Hydrogenious LOHC Technologies GmbH, Erlangen (Germany), and €3 million (previous year: €3 million) to Hi-Bis GmbH, Bitterfeld-Wolfen (Germany). In fiscal 2023, the Covestro Group received dividends of €1 million (previous year: €2 million) from other financial investments, of which €1 million (previous year: €1 million) was attributable to Hi-Bis GmbH.

As part of efforts to improve supplier relationships, a small number of Covestro’s suppliers participate in prefinancing programs in which an external financial intermediary pays the invoice underlying the current trade payables to the supplier before it is due in each case. Such scenarios could, in particular, lead to a change in the presentation of the original liability in the consolidated financial statements if the nature, function, and risk of the liability subject to the financing program differs from other trade payables. In the case of the current programs, however, the underlying conditions do not result in any changes to the presentation in the consolidated financial statements. For this reason, the corresponding amounts continue to be reported under trade accounts payable. As of the reporting date, only a minor share of outstanding trade accounts payable is attributable to such financing programs.

The classification of income, expenses, gains, and losses from financial instruments by measurement category in accordance with IFRS 9 is shown in the table below:

24.2  Financial Risk Management and Information on Derivatives

Capital Management

The main purpose of financial management is to ensure solvency at all times, continuously optimize capital costs, and reduce the risks of financing measures. Financial management for the Covestro Group is performed centrally by Covestro AG.

Capital management pursues a prudent debt management strategy, drawing on a balanced financing portfolio, which is based primarily on bonds, Schuldschein loans, commercial papers, syndicated credit facilities, and bilateral loan agreements.

Covestro intends to maintain financing structures and financial ratios that support a solid investment-grade rating in the future. As in fiscal 2022, Covestro AG currently holds a Baa2 investment-grade rating with a stable outlook from the rating agency Moody’s Investors Service, London (United Kingdom).

For its capital management, Covestro uses, among other tools, debt ratios published by recognized rating agencies, such as gross financial debt including provisions for pensions (adjusted gross financial debt) in relation to EBITDA as well as cash flow figures in relation to net financial debt including provisions for pensions.

• For information on the composition of gross financial debt and net financial debt, see the explanations in the Group Management Report on “Net Financial Debt.”
• See also the explanations in the Group Management Report on “Financial Management.”

Credit Risk

Credit risk is the risk of a loss for the Covestro Group when a counterparty is unable to meet its payment obligations arising from a financial instrument as contractually stipulated. Payment obligations to the Covestro Group primarily comprise trade accounts receivable, debt instruments, other financial assets, and contract assets.

The carrying amount of the financial assets and the contract assets represents the maximum credit risk exposure.

The impairment loss for financial assets and contract assets recognized during the year resulted almost exclusively from impairment losses on trade accounts receivable. Net impairment losses amounted to €3 million (previous year: €9 million) in the reporting year.

Trade Accounts Receivable and Contract Assets

The following table presents the gross carrying amounts and the expected losses for trade accounts receivable and contract assets:

The accumulated impairment losses amounted to €30 million (previous year: €30 million) for those customers that the Covestro Group considers credit impaired on the basis of this assessment. The corresponding gross carrying amount was €30 million (previous year: €31 million). Indicators for customers being credit impaired include significant financial difficulties of the customer and a breach of contract such as default or delinquency. Determining that a customer is credit impaired does not occur automatically when payments are overdue for more than 90 days but is instead always based on the individual assessment conducted by Credit Management.

Total impairment losses for trade accounts receivable and contract assets changed as follows:

The Covestro Group limits the credit risk exposure from trade accounts receivable by stipulating the shortest payment terms possible. In addition, the Covestro Group has a widely diversified customer portfolio. In order to avoid concentration of risk, customer limits are set, regularly monitored, and exceeded only in agreement with Credit Management.

Receivables of €17 million (previous year: €25 million) are secured mainly by letters of credit.

Debt Instruments

The Covestro Group generally pursues a conservative investment policy based on a strategy of maintaining liquidity and safeguarding value. Consequently, investments are limited to counterparties with investment-grade ratings, simple debt instruments, and short-term investment horizons. Credit risks, particularly concentration of risk with individual counterparties, are managed by means of a Group-wide limit system in conjunction with ongoing monitoring. Covestro also acts as a start-up investor as part of the Covestro Venture Capital (COVeC) approach newly developed in fiscal 2020. Investments associated with COVeC activities are recognized either as debt instruments at fair value through profit and loss or as other financial investments at fair value directly in equity, depending on the contractual design.

As in the previous year, Covestro did not undertake any material reclassifications of debt instruments between the levels of the general impairment model during the fiscal year. The Covestro Group held no collateral for debt instruments in fiscal 2023 or in the previous year.

Because of the low credit risk profile, the Covestro Group is not exposed to significant credit risk from debt instruments. For fiscal 2023 and for the previous year, the risk provision calculated using the general approach is immaterial both overall and for the individual stages.

Currency Risks

Currency opportunities for and risks to the Covestro Group result from changes in exchange rates and the related changes in the value of financial instruments (including receivables and payables) and future cash inflows and outflows denominated in foreign currencies. Material receivables and payables in liquid currencies from operating and financial activities are generally fully hedged through forward exchange contracts. A value-at-risk approach is used to manage foreign currency exposures arising from planned receivables and liabilities. As in the previous year, the planned foreign currency exposure was not hedged. It will be hedged using forward contracts if the foreign currency risk increases significantly. The extent of the currency risk is presented below by means of a sensitivity analysis.

The currency risk shown in the sensitivity analysis results from the following:

• The unsecured portion of receivables and payables in nonfunctional currencies
• Unsecured bank deposits and liabilities to banks in nonfunctional currencies
• Currency risks from embedded derivatives

Sensitivities were determined based on a hypothetical scenario in which the euro depreciates by 10% against all other currencies compared with the year-end exchange rates. Under this scenario, the estimated hypothetical gains recognized in profit or loss as of December 31, 2023, would have totaled €3.8 million (previous year: €6.2 million). The table below shows the distribution of these effects among the individual currencies:

A hypothetical scenario in which the euro appreciates by 10% against all other currencies compared with the year-end exchange rates would lead to losses recognized in profit or loss in approximately the same amount.

Liquidity Risk

Liquidity risk is the risk of not being able to meet existing or future payment obligations. The liquidity status of all material Group companies is continuously planned and monitored. Liquidity is secured via cash pooling agreements as well as internal and external financing. The syndicated, revolving credit facility of €2.5 billion, which is available through March 2027, particularly provides additional financial flexibility.

The liquidity risks to which the Covestro Group was exposed from its financial instruments can be divided into obligations for interest and repayment installments on financial liabilities, payment obligations arising from derivatives and loan commitments. The following tables show the maturity structure of the nondiscounted contractually agreed payments arising from these line items:

In addition to Covestro’s recognized nonderivative liabilities and derivative financial instruments, Covestro AG is obligated, under certain conditions, to grant initial funding loans to Bayer-Pensionskasse VVaG, Leverkusen (Germany), and Rheinische Pensionskasse VVaG, Leverkusen (Germany), which may lead to payments by Covestro AG in subsequent years. In the reporting year, Bayer-Pensionskasse VVaG repaid part of the loan drawn down in fiscal 2022 in the amount of €39 million, with the result that the obligation increased accordingly as of December 31, 2023, to €156 million (previous year: €117 million). This is reflected in the loan commitments shown in the table above.

• See note 28.1 “Related Companies.”

In this analysis, foreign currencies were translated at closing rates. Derivative financial instruments are reported as net amounts.

Interest Rate Risks

Interest rate opportunities and risks for the Covestro Group arise from changes in capital market interest rates, which could lead to changes in the fair value of fixed-rate financial instruments and in interest payments in the case of floating-rate instruments. To minimize adverse effects, interest rate risk is managed centrally based on an optimized debt maturity structure.

A sensitivity analysis based on our net floating-rate receivables and payables position at the end of fiscal 2023, taking into account the interest rates relevant to our receivables and payables in all principal currencies, produced the following result: A hypothetical increase in the interest rates by 100 basis points or one percentage point would (assuming currency exchange rates remain constant) result in an increase in interest expense of €6.3 million (previous year: €16.3 million). A corresponding hypothetical reduction in interest rates would lead to a decline in interest expenses by the same amount.

Raw Material Price Risks

The Covestro Group requires significant quantities of different forms of energy and petrochemical feedstocks for its production processes. Procurement prices for energy and raw materials may fluctuate significantly. Important raw materials are procured on the basis of long-term supply agreements and active supplier management to minimize substantial price fluctuations. During the past fiscal year, derivative financial instruments were not used to hedge raw material price risks.

Derivatives

As of the reporting date, the nominal volume of the forward exchange contracts used to hedge currency risk amounted to €2,415 million (previous year: €2,914 million). Other market risks are not hedged as of the reporting date.

Covestro has entered into master netting or similar agreements for derivative financial instruments. These take effect in particular in the event of the insolvency of one of the contractual partners involved. The derivative financial instruments covered by netting agreements from the perspective of the Covestro Group are presented in the table below: