Disclosures Risk management strategy

Disclosures Risk management strategy – The risk management strategy has to be described by type of risk, and this description has to include how each risk arises and how, and to what extent, the risk is managed. This description must also include whether the entity hedges only a part of the risk exposure, such as a nominal component or selected contractual cash flows. To satisfy this requirement, an entity must disclose:Disclosures Risk management strategy

  • The hedging instruments and how they are used to hedge the risk exposure
  • Why the entity believes there is an economic relationship between the hedged item and the hedging instrument
  • How the hedge ratio is determined
  • The expected sources of ineffectiveness

When only a component of a risk exposure is hedged, an entity must also disclose how it determined the component and how the component relates to the item in its entirety. In our view, this would include a description of whether the risk component is contractually specified and if not how the entity determined that the non-contractually specified risk component is separately identifiable and reliably measurable. 

Disclosures Risk management strategy Disclosures Risk management strategy  Disclosures Risk management strategy

Disclosures Risk management strategy Disclosures Risk management strategy Disclosures Risk management strategy

Illustrative disclosure of risk management strategy for commodity price risk

Coffee price risk

Fluctuations in the coffee price are the main source of market risk for the Alpha Beta Coffee Group (the Group). The Group purchases Arabica coffee from various suppliers in South America. For this purpose, the Group enters into long-term contracts (for between 1 and 3 years) with its suppliers, in which the future coffee price is indexed to the USD Arabica benchmark coffee price, adjusted for transport cost that are indexed to diesel prices plus a quality coefficient that is reset annually for a crop period. In order to secure the volume of coffee needed, supply contracts are always entered into (or renewed) at least one year prior to harvest.

The Group forecasts the monthly volume of expected coffee purchases for a period of 18 months and manages the coffee price risk exposure on a 12-month rolling basis. For this purpose, the Group enters into futures contracts on the Arabica benchmark price and designates the futures contracts in cash flow hedges of the USD Arabica benchmark price risk component of its future coffee purchases. Some of those purchases are committed minimum volumes under the contracts and some purchases are highly probable forecast transactions (i.e., quantities in excess of the minimum purchases volumes and sometime for periods for which no contract has yet been entered into).

The underlying risk of the coffee futures contracts is identical to the hedged risk component (i.e., the USD Arabica benchmark price). Therefore, the Group has established a hedge ratio of 1:1 for all its hedging relationships. The USD Arabica benchmark price risk component is contractually specified in its purchase contracts, therefore, the Group considers the risk component to be separately identifiable and reliably measurable based on the price of coffee futures.

The Group does not hedge its exposure to the variability in the purchase price of coffee that results from the annual reset of the quality coefficient, because hedging that risk would require highly bespoke financial instruments that in the Group’s view are not economical.

The Group’s exposure to the variability in the purchase price of coffee that results from the diesel price indexation of the transport costs is integrated into its general risk management of logistics costs that aggregates exposures resulting from various logistics processes of the Group (Cross reference:see Section ‘XYZ’ of this report).

The Group determined the USD Arabica benchmark coffee price risk component that it designates as the hedged item on the basis of the pricing formula in the Group’s coffee supply contracts (see the above description). That benchmark component is the largest pricing element.

The quality coefficient depends on the particular crop in the region from which the Group sources its coffee, depending mainly on weather conditions that affect size and quality of the crop. Sometimes pest and plant diseases can have similar effects. Over the last 10 crop periods, the quality coefficient ranged between USD0.02 and USD0.27 per pound (lb). For the effect of the diesel price indexation, refer to the section ‘Logistics costs management’ in the Risk Management Report that is included in this Annual Report.

More information about how the Group manages its risk, including the extent to which the Group hedges, the hedging instruments used and sources of ineffectiveness, is provided in the Risk Management Report (see section ‘Commodity Price Risk Management’).

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The risk management strategy disclosures are an important cornerstone of the new hedge accounting model, as they provide the link between an entity’s risk management activities and how they affect the financial statements. The notes should also disclose the key judgements the entity has used in applying the new hedge accounting model (including those used to determine whether an economic relationship exists between the hedged item and the hedging instrument, how the hedge ratio was set and how risk components were identified, just to mention a few).

Disclosures have to be made by type of risk, rather than the type of hedging relationship (e.g., cash flow hedge or fair value hedge). This should enable users to follow the various disclosures by type of risk, resulting in a much better understanding of the hedging activities and their impact on the financial statements. Disclosures Risk management strategy

Checklist risk management disclosures

Items to discuss under risk management disclosures IN the notes to the (Consolidated) Financial Statements are (with a very small indicative text intro/explanation), based on an automotive industry group of companies:

  • General information on financial risks – As a result of its businesses and the global nature of its operations, the Group is exposed in particular to market risks from changes in foreign currency exchange rates and interest rates, while commodity price risks arise from procurement.
  • Credit riskCredit risk is the risk of economic loss arising from counterparty’s failure to repay or service debt in accordance with the contractual terms.
  • Liquid assets – Liquid assets comprising for example cash and cash equivalents, marketable debt securities and similar investments or any of these names depending on the content of such liquid assets Disclosures Risk management strategy
  • Receivables from financial services – The Group’s financing and leasing activities are primarily focused on supporting the sales of the Group’s automotive products
  • Trade receivables – Trade receivables are mostly receivables from worldwide sales activities of vehicles and spare parts
  • Derivative financial instruments – The Group uses derivative financial instruments exclusively for hedging financial risks that arise from its operational business or refinancing activities
  • Other receivables and financial assets – With respect to other receivables and financial assets included in other financial assets in 2018 and 2017, the Group is exposed to credit risk only to a small extent Disclosures Risk management strategy
  • Irrevocable loan commitments – The Group’s Financial Services segment in particular is exposed to credit risk from irrevocable loan commitments to retailers and end customers
  • Financial guarantees – Financial guarantees principally represent contractual arrangements. These guarantees generally provide that in the event of default or non-payment by the primary debtor, the Group will be required to settle such financial obligations
  • Liquidity risk – Liquidity risk comprises the risk that a company cannot meet its financial obligations in full
  • Country risk – Country risk is the risk of economic loss arising from changes of political, economic, legal or social conditions in the respective country, e.g. resulting from sovereign measures such as expropriation or interdiction of foreign currency transfers
  • Finance market risks – The global nature of its businesses exposes the Group to significant market risks resulting from fluctuations in foreign currency exchange rates and interest rates
  • Exchange rate riskDisclosures Risk management strategy
    • Transaction risk and currency risk management – The global nature of the Group’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
    • Effects of currency translation – For purposes of the 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
  • Interest rate risk – The Group uses a variety of interest rate sensitive financial instruments to manage the liquidity needs of its day-to-day operations
    • Hedge accounting – When designating derivative financial instruments, a hedge ratio of 1 is generally applied
  • Commodity price risk – The Group is exposed to the risk of changes in commodity prices in connection with procuring raw materials and manufacturing supplies used in production
    • Hedge accounting – When designating currency derivative financial instruments, Daimler generally applies a hedge ratio of 1
  • Equity price risk – The 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 Disclosures Risk management strategy

Disclosures Risk management strategy

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