As a company that operates internationally and due to its presence in the capital market, Merck is exposed to various financial risks. These are primarily liquidity, default, and market-price risks; fluctuations in the valuation of pension obligations; and risks of changing fair values of tangible and intangible assets.
In order to ensure its continued existence, a company must be able to fulfill its commitments from operating and financial activities at all times. Merck therefore has a central Group-wide liquidity management process to reduce potential liquidity risks.
In addition, we have a € 2 billion syndicated multicurrency credit facility, which expires in 2014. This ensures Merck’s continuing solvency in case any liquidity bottlenecks occur despite the Group’s positive operating cash flow. As our loan agreements do not contain any financial covenants, these agreed lines of credit can be accessed even if Merck’s credit rating should deteriorate. In fiscal 2009, Merck set up a debt issuance program that forms the contractual basis for the issue of bonds. In 2010, the volume of this program was increased from € 5 billion to € 10 billion.
Default risks arise in connection with financial investments, loans and financing commitments as well as receivables in operating business. Due to the impact of the financial crisis in the eurozone, an increased default risk continues to exist. Merck has therefore reviewed all its positions with trading partners in the respective countries and has adjusted its default risks as necessary. Merck minimizes these risks by spreading its financial positions and by the associated active management of its trading partners. Significant financial transactions involving credit risk are only entered into with banks and industrial companies that have a good credit rating. In addition, Merck’s large banking syndicate – the existing credit line of € 2 billion was syndicated by 17 banks – reduces possible losses in the event of default. Nevertheless, the default of individual trading partners cannot be fundamentally excluded, even if they have an excellent credit rating.
Companies with international business operations in different currency and interest rate regions are inevitably exposed to currency and interest risks. Merck is also affected by these market price risks owing to its global group structure and the associated financial transactions, receivables and liabilities in operating business, as well as expected future cash flows from sales and costs in foreign currency. Merck therefore uses derivative financial instruments to minimize currency risks and financing costs caused by exchange rate or interest rate fluctuations. The exchange rate for financial transactions and for operating receivables and liabilities recognized in foreign currency is generally hedged. In certain cases, the company also hedges the exchange rate for anticipated sales and future costs recognized in foreign currency for a period of up to three years. (More information can be found in the Consolidated Financial Statements).
The values of individual items in the balance sheet are exposed to the risk of changing market and business circumstances and thus also to changes in fair values. The need for write-downs could significantly impact profit and lead to changes in balance sheet ratios. This applies in particular to the high level of intangible assets including goodwill, which have become significantly more important in the consolidated financial statements due to the acquisitions of Serono in 2007 and Millipore in 2010, as well as the related purchase price allocations. (More information can be found under Intangible assets).
Merck has commitments in connection with pension obligations. The present value of these obligations can be significantly influenced by changes in the relevant valuation parameters, e.g. the interest rate or death probabilities. Pension obligations are regularly evaluated by preparing annual actuarial valuations. Part of these obligations is covered by the pension provisions disclosed in the balance sheet, while the other obligations are externally funded. (More information can be found under Provisions for pensions and other post-employment benefits). As far as pension obligations are covered by plan assets consisting of interest-bearing securities, shares, real estate, and other financial assets, decreasing or negative returns on these assets can adversely impact the value of the plan assets and thus result in further additions to pension provisions. We reduce the risk of fluctuations in the fair value of plan assets by a diversified investment strategy.
Assessments by independent rating agencies
The capital market makes use of the assessments published by rating agencies in order to assist lenders in evaluating the risks of a financial instrument. Merck is currently rated by the agencies Standard & Poor’s and Moody’s, who raised their credit ratings for Merck in 2012. While Standard & Poor’s issued Merck an A-long-term credit rating with a stable outlook, Moody’s issued it a Baa1 rating with a stable outlook.