Note 29 – Financial Risk Management Audited

29.1 Overall Risk Management Policy

 

Lonza is exposed in particular to credit and liquidity risk as well as to risks from movements in foreign currency exchange rates, interest rates and market prices that affect its assets, liabilities, and forecasted transactions. Lonza’s overall risk management policy aims to limit these risks through operational and finance activities.

The Board of Directors has overall responsibility for the establishment and oversight of Lonza’s risk management framework. Financial risk management is carried out by a central treasury department (Group Treasury). Group Treasury is responsible for implementing the policy, and identifies, evaluates and hedges financial risks in close cooperation with Lonza’s business units. Group Treasury also has the sole responsibility for carrying out foreign exchange transactions and executing financial derivative transactions with third parties.

Lonza’s risk management policies are established to identify and analyze the risks faced by Lonza, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and Lonza’s activities.

Lonza Audit Committee oversees how management monitors compliance with Lonza’s risk management policies and procedures and reviews the adequacy of the risk management framework in relation to the risks faced by Lonza. Lonza Audit Committee is assisted in its oversight role by Internal Audit (Lonza Audit Services). Internal Audit undertakes both regular and ad hoc reviews of risk management controls and procedures, the results of which are reported to the Audit Committee.

29.2 Credit Risk

 

Credit risk is the risk of financial loss to Lonza if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and mainly arises from Lonza’s receivables from customers.

Accounts Receivables 

 

Lonza’s exposure to credit risk is influenced mainly by the individual characteristics of each customer. Risk control assesses the credit quality of the customer, taking into account its financial position, past experience and other factors. In monitoring customer credit risk, customers are grouped according to their credit characteristics, including geographic location, industry, and existence of previous financial difficulties.

Purchase limits are established for each customer, which are reviewed regularly. For customers domiciled in specific countries with high risk, Lonza has credit risk insurance covering the maximum exposure.

The maximum credit risk is equal to the carrying amount of the respective assets. There are no commitments that could increase this exposure to more than the carrying amounts. In general, Lonza does not require collateral in respect of trade and other receivables, but uses credit insurance for country risk where appropriate.

Lonza establishes an allowance for impairment that represents its estimate of incurred losses in respect of trade and other receivables. The allowance is based only on the specific loss component that relates to individually significant exposures. There is no collective impairment recognized

Financial Instruments and Cash Deposits


Credit risk from balances with banks and financial institutions is managed by the Group's treasury department. Counterparty credit ratings are reviewed regularly. The carrying amount of financial assets represents the maximum credit exposure. The maximum exposure to credit risk at the reporting date was as follows:

 

million CHF 2017 2016
     

Loans and receivables

   
Trade receivables, net 825 612
Other receivables 67 73
Current advances 0 1
Non-current loans and advances 5 1
Cash and cash equivalents 479 274
Total loans and receivables 1,376 961
     

Financial assets at fair value

   
Financial assets at fair value through profit or loss – held for trading:    
– Currency-related instruments1 5 12
– Interest-related instruments1 3 0
Total financial assets at fair value through profit or loss – held for trading 8 12

Financial assets at fair value through profit or loss - designated:
   
Contingent consideration from sale of business 40 0
Total financial assets at fair value through profit or loss - designated 40 0
     
Financial assets effective for hedge accounting purposes:    
Commodity-related instruments1 4 4
Total financial assets effective for hedge accounting purposes 4 4
     
Total financial assets at fair value 52 16
     
Total 1,428 977

29.3 Liquidity Risk

 

Liquidity risk is the risk that Lonza will not be able to meet its financial obligations as they fall due. Lonza’s approach to managing liquidity is to ensure that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to Lonza’s reputation. Group Treasury maintains flexibility in funding also using bilateral and syndicated credit lines. Lonza has concluded the following lines of credit: Committed credit lines of CHF 1,056 million (CHF 325 million used as of 31 December 2017), which are committed for up to five years and uncommitted credit lines of CHF 140 million (CHF 0 used as of 31 December 2017).

The table below analyzes the Group’s financial liabilities and derivative financial liabilities in relevant maturity groupings, based on the remaining period at the balance sheet date to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows, including interest payments. Balances due within 12 months are equal to their carrying balances, as the impact of discounting is not significant.

Year ended 31 December 2017
million CHF
Carrying amount Contractual cash flows1 Between 0
and 6 months
Between 7
and 12 months
Between 1
and 2 years
Between 2
and 3 years
Between 3
and 5 years
Over
5 years
                 
Straight bond (2011–2018) 140 144 0 144 0 0 0 0
Straight bond (2012–2018) 200 204 0 204 0 0 0 0
Straight bond (2012–2022) 105 121 0 3 3 3 112 0
Straight bond (2013–2019) 299 311 5 0 306 0 0 0
Straight bond (2015–2020) 150 153 0 1 1 151 0 0
Straight bond (2015–2023) 175 188 0 2 2 2 4 178
Straight bond (2016–2021) 249 251 0 0 0 0 251 0
Straight bond (2017–2021) 125 126 0 0 0 0 126 0
Straight bond (2017–2024) 110 116 0 1 1 1 2 111
Syndicated loan (2017–2022) 223 242 1 1 2 2 236 0
German private placement 1,108 1,234 8 15 23 23 565 600
Term loans 993 1,088 12 12 24 519 521 0
Other debt due to banks and financial institutions 119 119 119 0 0 0 0 0
Other debt due to others 238 305 58 3 5 38 30 171
Finance lease liabilities 12 16 1 1 1 1 3 9
Total debt 4,246 4,618 204 387 368 740 1,850 1,069
Trade payables 400 400 400 0 0 0 0 0
Other current liabilities2 605 605 605 0 0 0 0 0
Total financial liabilities 5,251 5,623 1,209 387 368 740 1,850 1,069
 
Year ended 31 December 2016
million CHF
Carrying amount Contractual cash flows1 Between 0
and 6 months
Between 7
and 12 months
Between 1
and 2 years
Between 2
and 3 years
Between 3
and 5 years
Over
5 years
                 
Straight bond (2011–2018) 139 149 0 4 145 0 0 0
Straight bond (2012–2018) 200 208 0 4 204 0 0 0
Straight bond (2012–2020) 105 124 0 3 3 3 6 109
Straight bond (2013–2019) 299 316 5 0 5 306 0 0
Straight bond (2015–2020) 150 154 0 1 1 1 151 0
Straight bond (2015–2023) 175 190 0 2 2 2 4 180
Straight bond (2016–2021) 249 252 0 0 0 0 252 0
Syndicated loan (2011–2018) 99 100 0 0 100 0 0 0
German private placement 49 50 0 45 0 5 0 0
Other debt due to banks and financial institutions 68 68 68 0 0 0 0 0
Other debt due to others 321 361 22 169 3 3 40 124
Finance lease liabilities 6 11 0 0 0 1 2 8
Total debt 1,860 1,983 95 228 463 321 455 421
Trade payables 284 284 284 0 0 0 0 0
Other current liabilities2 570 570 570 0 0 0 0 0
Contigent consideration 18 18 11 0 7 0 0 0
Total financial liabilities 2,732 2,855 960 228 470 321 455 421

29.4 Market Risk

 

Market risk is the risk that changes in market prices will affect Lonza’s income or the value of its holdings of financial instruments. Lonza is exposed to market risk from changes in currency exchange and interest rates and commodities. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimizing the return on risk. Lonza has established a treasury policy of which the objective is to reduce the volatility relating to these exposures. Lonza enters into various derivative transactions based on Lonza’s treasury policy that establishes guidelines in areas such as counterparty exposure and hedging practices. Counterparties to agreements are major international financial institutions with at least investment grade rating. Positions are monitored using techniques such as market value and sensitivity analyses. All such transactions are carried out within the guidelines set by the Audit Committee.

Foreign Exchange Risk

 

The Group operates across the world and is exposed to movements in foreign currencies affecting the Group financial result and the value of Group equity. Foreign exchange risk arises because the amount of local currency paid or received for transactions denominated in foreign currencies may vary due to changes in exchange rates ("transaction exposures") and because the foreign currency denominated financial statements of the Group’s foreign subsidiaries may vary upon consolidation into the Swiss-franc-denominated Group Financial Statements ("translation exposures"). Foreign exchange risks arise primarily on transactions that are denominated in USD, EUR and GBP.

In managing its exposure regarding the fluctuation in foreign currency exchange rates, Lonza has entered into a variety of currency swaps and forward contracts. These agreements generally include the exchange of one currency against another currency at a future date. Lonza adopts a policy of considering hedging for all the committed contractual exposure. The planned exposure is hedged within certain ranges. Hedge ratios are determined by the risk committee and depend on market expectation, risk bearing ability and risk appetite.

The table below shows the impact on post-tax profit if at 31 December a currency had strengthened (+) or weakened (–) versus the Swiss franc, with all other variables held constant as a result of the currency exposures outlined in the tables below:

  Sensitivity Post-tax profit Other comprehensive income
million CHF                  
      2017   2016   2017   2016
    + + + +
USD + / – 10% 1261.5 1(261.5) 0.2 (0.2) 0.0 0.0 36.0 (36.0)
EUR + / – 10% (39.0) 39.0 (4.0) 4.0 0.0 0.0 (2.7) 2.7
GBP + / – 10% 2.9 (2.9) 1.3 (1.3) 0.0 0.0 0.0 0.0


 

The summary quantitative data relating to the Group's exposure to currency risks as reported to the management of the Group is as follows:

Year ended 31 December 2017              
million CHF USD GBP EUR SGD DKK Other Total
               
Non-current financial assets 0 0 42 0 0 0 42
Trade receivables, net 120 37 53 2 3 1 216
Other receivables, prepaid expenses and accrued income 2 12 12 1 0 2 29
Current advances and financial assets 5 0 0 0 0 0 5
Cash and cash equivalents 146 5 27 1 0 2 181
Non-current debt (770) 0 (1,344) 0 0 0 (2,114)
Other non-current liabilities (2) 0 0 (4) 0 0 (6)
Other current liabilities (56) 0 (17) (10) 0 (3) (86)
Trade payables (26) (2) (36) (13) 0 (4) (81)
Group internal loans 13,703 0 743 0 0 0 4,447
Gross balance sheet exposure 3,122 52 (520) (23) 3 (2) 2,633
               
Currency-related instruments 29 (17) 50 0 0 0 62
               
Net exposure 3,151 35 (470) (23) 3 (2) 2,695

 

Year ended 31 December 2016              
million CHF USD GBP EUR SGD DKK Other Total
               
Trade receivables, net 113 25 59 2 2 1 202
Other receivables, prepaid expenses and accrued income 0 8 14 2 0 0 24
Current advances and financial assets 5 0 0 0 0 0 5
Cash and cash equivalents 63 4 18 3 0 5 93
Non-current debt (25) 0 0 0 0 0 (25)
Other non-current liabilities 0 0 0 (3) 0 0 (3)
Other current liabilities (73) (21) (30) (7) 0 (1) (132)
Trade payables (19) (1) (33) (8) 0 (1) (62)
Current debt 0 0 (37) 0 0 0 (37)
Gross balance sheet exposure 64 15 (9) (11) 2 4 65
               
Currency-related instruments (61) 1 (40) 0 0 0 (100)
               
Net exposure 3 16 (49) (11) 2 4 (35)

 

The following exchange rates were applied during the year:

Balance Sheet Year-End Rates

    2017 2016
EU Euro 1.1683 1.0734
USA Dollar 0.9758 1.0189
Great Britain Pound sterling 1.3178 1.2520
Singapore Singapore dollar 0.7305 0.7042
China Renminbi 0.1499 0.1467

 

Income Statement Year-Average Rates

    2017 2016
EU Euro 1.1119 1.0901
USA Dollar 0.9846 0.9852
Great Britain Pound sterling 1.2686 1.3348
Singapore Singapore dollar 0.7132 0.7136
China Renminbi 0.1458 0.1483

 

Interest Rate

 

Risk arises from movements in interest rates which could affect the Group financial result or the value of Group equity. Changes in interest rates may cause variations in interest income and expense. In addition, they may affect the market value of certain financial assets, liabilities and hedging instruments. The primary objective of the Group’s interest rate management is to protect the net interest result.

Lonza’s policy is to manage interest cost using a mix of fixed and variable rate debt. Group policy is to maintain at least 50% of its borrowings in fixed-rate instruments. In order to manage this mix in a cost-efficient manner, Lonza enters into interest rate swaps and cross-currency interest rate swaps to exchange at specified intervals, the difference between fixed and variable interest amounts calculated by reference to a corresponding notional principal amount. Lonza adopts a policy of having one-third of the debt on a short-term basis and two-thirds of the debt on a long-term basis. The mix between floating and fixed rates depends on the market view of Lonza.

Lonza’s exposure to interest rate risk was as follows:

million CHF 2017 2016
Net debt (see note 15) 3,762 1,584
Net debt at fixed interest rates 1 (2,396) (1,374)
     
Interest risk exposure 1,366 210


If the interest rates had increased /decreased by 1% in 2017, with all other variables held constant, post-tax profit would have been CHF 11.3 million lower / higher (2016: CHF 1.7 million lower / higher).

Commodity Price Risk 

 

Lonza needs liquefied petroleum gas (LPG) as raw material for a cracker in Visp. Butane, naphtha or propane can be used as feedstock for the cracker. The raw material ultimately used depends on its availability and specifications. The annual demand is approximately 110,000 metric tons. In order to minimize the risk of higher raw material prices, Lonza hedges the commodity price risk via swaps. At 31 December 2017, if the propane / naphtha price had weakened / strengthened by 10%, with all other variables held constant, other comprehensive income would have been CHF 2 million lower / higher (2016: CHF 2 million lower / higher).

29.5 Overview of Derivative Financial Instruments

 

The following table shows the contract or underlying principal amounts and fair values of derivative financial instruments by type of contract at 31 December 2017 and 2016. Contract or underlying principal amounts indicate the volume of business outstanding at the balance sheet date and do not represent amounts at risk. The fair values are determined by using the difference of the prices fixed in the outstanding derivative contracts from the actual market conditions which would have been applied at the year-end if we had to recover these trades.

Financial Instruments at Fair Value Through Profit or Loss – Held for Trading

million CHF Contract or underlying principal amount Positive fair values Negative fair values Total net fair values
  2017 2016 2017 2016 2017 2016 2017 2016

Currency-related instruments

               
– Forward foreign exchange rate contracts 40 111 0 0 0 (4) 0 (4)
– Currency swaps 734 597 5 5 (7) (21) (2) (16)
– FX Options 1 0 1,426 0 7 0 (9) 0 (2)
Total currency-related instruments 774 2,134 5 12 (7) (34) (2) (22)
                 

Interest-related instruments

               
– Cross-currency interest rate swaps 407 444 3 0 (13) (35) (10) (35)
                 
Total interest-related instruments 407 444 3 0 (13) (35) (10) (35)
                 
Total financial instruments at fair value through profit or loss – held for trading 1,181 2,578 8 12 (20) (69) (12) (57)

Financial Instruments Effective for Hedge-Accounting Purposes

million CHF Contract or underlying principal amount Positive fair values Negative fair values Total net fair values
  2017 2016 2017 2016 2017 2016 2017 2016

Currency-related instruments

               
– Forward foreign exchange rate contracts 2 0 481 0 0 0 (6) 0 (6)
– Deal-contingent forward foreign exchange rate contracts 3 0 611 0 0 0 (12) 0 (12)
Total currency-related instruments 0 1,092 0 0 0 (18) 0 (18)
                 

Commodity-related instruments

               
– Naphtha swap 5 5 2 1 0 0 2 1
– Propane swap 9 12 2 3 0 0 2 3
Total commodity-related instruments 14 17 4 4 0 0 4 4
                 
Total financial instruments effective for hedge-accounting purposes 14 1,109 4 4 0 (18) 4 (14)

Offsetting of Financial Asset and Financial Liabilities

 

The Group enters into derivative transactions under International Swaps and Derivatives Association (ISDA) master netting agreements with the respective counterparties in order to mitigate counterparty risk. Under such agreements the amounts owed by each counterparty on a single day in respect of all transactions outstanding in the same currency are aggregated into a single net amount that is payable by one party to the other. The ISDA agreements do not meet the criteria for offsetting in the balance sheet as the Group does not have a currently enforceable right to offset recognized amounts, because the right to offset is only enforceable on the occurrence of future events, such as a default or other credit events.

The following table sets out the carrying value of derivative financial instruments and the amounts that are subject to master netting agreements.

million CHF Assets Liabilities
  2017 2016 2017 2016
         
Forward foreign exchange rate contracts 0 0 0 (22)
Currency swaps 5 5 (7) (21)
FX Options 0 7 0 (9)
Cross-currency interest rate swaps 3 0 (13) (35)
Commodity-related instruments 4 4 0 0
Carrying value of derivative financial instruments 12 16 (20) (87)
Derivatives subject to master netting agreements (5) (9) 5 9
Collateral arrangements 1 0 0 0 0
Net amount 7 7 (15) (78)

 Financial Instruments by Type / Currency

million CHF 2017 2016
     
Forward foreign exchange rate contracts, currency swaps and FX options    
USD 1 552 3,089
EUR 128 67
GBP 26 44
SGD 10 12
CAD 10 0
JPY 5 6
DKK 3 4
CZK 34 2
ILS 3 0
AUD 1 1
NZD 2 1
Total 774 3,226
Commodity swap 14 17
Cross-currency interest rate swap 407 444
Total financial instruments 1,195 3,687


Positive fair values of derivatives are included as part of “Other receivables, prepaid expenses and accrued income”. Negative fair values of derivatives are included as part of “Other current liabilities”.

Hedge accounting was applied to cash flow hedges on highly probable payments in foreign currencies and for raw materials (butane / naphtha / propane).

29.6 Financial Instruments Carried at Fair Value

 

The Group applied the following hierarchy for determining and disclosing the fair value of financial instruments by valuation technique:

  • Level 1: quoted (unadjusted) prices 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 or indirectly.
  • Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs).

 

million CHF 2017 2016
  Level 1 Level 2 Level 3 Total fair
value
Level 1 Level 2 Level 3 Total fair
value

Assets

               
Derivative financial instruments 0 12 0 12 0 16 0 16
Contingent consideration related to sale of business 0 0 40 40 0 0 0 0
                 

Liabilities

               
Derivative financial instruments 0 (20) 0 (20) 0 (87) 0 (87)
Contingent consideration 0 0 0 0 0 0 (18) (18)
                 
Net assets and liabilities measured at fair value 0 (8) 40 32 0 (71) (18) (89)

 

In 2017 there were no transfers between Level 1 and Level 2 fair value measurements.

Details of the determination of Level 3 fair value measurements are set out below.

Contingent consideration arrangements related to sale of business

million CHF 2017 2016
     
At 1 January 0 0
Arising from sale of business 37 0
Currency translation effects 3 0
At 31 December 40 0


The agreement to sell the Peptides business (see note 4.2) includes a contingent consideration arrangement under which Lonza will receive a defined percentage of the net sales of the disposed business for the financial years 2017 – 2021 (estimated to be CHF 40 million at year-end 2017 exchange rates). Lonza’s estimate of the net present value of these future payments is reflected as a receivable in the consolidated balances sheet as of 31 December 2017.

Contingent consideration arrangements

million CHF 2017 2016
     
At 1 January 18 0
Arising from business combinations 0 18
Used for settlements (11) 0
Gains and losses included in the income statement (7) 0
At 31 December 0 18

 

Lonza is party to certain contingent consideration arrangements arising from business combinations. The fair values are determined considering the expected payments. The expected payments are determined by considering the possible scenarios of forecast gross profit and sales, which are the most significant unobservable inputs. The estimated fair value would increase if the forecast gross profits and sales were higher. At 31 December 2017 the total potential payments under contingent consideration arrangements could be up to CHF 19 million (2016: CHF 30 million), primarily related to the InterHealth Nutraceuticals Inc acquisition. Based on InterHealth's 2017 performance no payment will be required and the contingent consideration liability has been adjusted accordingly.

29.7 Carrying Amounts and Fair Values of Financial Instruments by Category

 

The carrying values less impairment provision of trade receivables are assumed to approximate to their fair values due to the short-term nature of trade receivables. The fair value of financial liabilities for disclosure purposes is estimated by discounting the future contractual cash flows at the current market interest rate that is available to the Group for similar financial instruments.

The fair value of interest rate swaps is calculated as the present value of the estimated future cash flows. The fair value of forward foreign exchange contracts is determined using quoted forward exchange rates at the balance sheet date.

The table below shows the carrying amounts and fair values of financial instruments by category.

Carrying Amounts and Fair Values of Financial Instruments by Category

million CHF Carrying amount Fair value
  31 12 2017 31 12 2016 31 12 2017 31 12 2016

Financial assets – available for sale

       
Other investments – available for sale – carried at cost 16 13 16 13
Total financial assets – available for sale 16 13 16 13
         

Loans and receivables

       
Trade receivables, net 825 612 825 612
Other receivables 67 73 67 73
Current advances 0 1 0 1
Non-current loans 5 1 5 1
Cash and cash equivalents 479 274 479 274
Total loans and receivables 1,376 961 1,376 961
         

Financial assets at fair value

       
Financial assets at fair value through profit or loss – held for trading:        
Currency-related instruments 5 12 5 12
Interest-related instruments 3 0 3 0
Total financial assets at fair value through profit or loss – held for trading 8 12 8 12

Financial assets at fair value through profit or loss - designated: 
       
Contingent consideration from sale of business 40 0 40 0
Total financial assets at fair value through profit or loss - designated 40 0 40 0
         

Financial assets effective for hedge accounting purposes

       
Commodity-related instruments 4 4 4 4
Total financial assets effective for hedge accounting purposes 4 4 4 4
Total financial assets at fair value 52 16 52 16
         

Financial liabilities at amortized cost

       
Debt:        
– Straight bonds 1 1,553 1,317 1,590 1,365
– Other debt 2,693 543 2,693 543
Current liabilities 595 465 595 465
Trade payables 400 284 400 284
Total financial liabilities at amortized cost 5,241 2,609 5,278 2,657
         

Financial liabilities at fair value

       
Financial liabilities at fair value through profit or loss – held for trading:        
Currency-related instruments 7 34 7 34
Interest-related instruments 13 35 13 35
Total financial liabilities at fair value through profit or loss – held for trading 20 69 20 69
         

Financial liabilities at fair value through profit or loss – designated

       
Contingent consideration 0 18 0 18
Total financial liabilities at fair value through profit or loss – designated 0 18 0 18
         

Financial liabilities effective for hedge accounting purposes

       
Currency-related instruments 0 18 0 18
Commodity-related instruments 0 0 0 0
Total financial liabilities effective for hedge accounting purposes 0 18 0 18
Total financial liabilities at fair value 20 105 20 105

29.8 Capital Management

 

The Board’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of the business. The Board of Directors monitors both the demographic spread of shareholders and the return on capital, which Lonza defines as total shareholders’ equity, excluding non-controlling interest, and the level of dividends to ordinary shareholders.

The Board seeks to maintain a balance between the higher returns that might be possible with higher levels of borrowing and the advantages and security afforded by a sound capital position. Lonza’s target is to achieve a return on invested capital of between 10% and 15%; in 2017, the return was 9.7% (2016: 12.7%). In comparison, the weighted average interest expense on interest-bearing borrowings (excluding liabilities with imputed interest) was 1.6% (2016: 1.6%).

From time to time, Lonza purchases its own shares on the market; the timing of these purchases depends on market prices. Primarily, the shares are intended to be used for issuing shares under Lonza’s share programs. Lonza does not have a defined share buy-back plan.

Neither Lonza Group Ltd nor any of its subsidiaries is subject to externally imposed capital requirements.