As a corporate group that operates internationally and due to its presence in the capital market, Merck is exposed to various financial risks and opportunities. Above all, these are liquidity and counterparty risks, market opportunities and risks, risks of fluctuations in the market values of operational tangible and intangible assets, as well as risks and opportunities from pension obligations.
Risk and opportunity management in relation to the use of financial instruments
In the area of financial risks and opportunities, Merck uses an active management strategy to reduce the effects of fluctuations in exchange and interest rates. The management of financial risks and opportunities by using derivatives in particular is regulated by extensive guidelines. Speculation is prohibited. Derivative transactions are subject to constant risk controls. A strict separation of functions between trading, settlement and control functions is ensured.
Liquidity risks
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. Furthermore, Merck has a multi-currency revolving credit facility of € 2 billion with a term of five years and two extension options of one year each that, above and beyond the Group’s positive operating cash flow, ensures continuing solvency if any liquidity bottlenecks occur. 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 addition, in fiscal 2009 Merck set up a debt issuance program that forms the contractual basis for the issue of bonds. In 2013, the volume of this program was increased from € 10 billion to € 15 billion. The liquidity risk is rated as unlikely overall.
Counterparty risks
Counterparty risks arise from the potential default by a partner in connection with financial investments, loans and financing commitments on the one hand and receivables in operating business on the other.
As for counterparty risks from financial transactions, Merck reviews all positions relating to trading partners and their credit ratings on a daily basis. Merck manages financial risks of default by diversifying its financial positions and thereby by the active management of its trading partners. Significant financial transactions involving credit risk are entered into with banks and industrial companies that have a good credit rating. Moreover, Merck’s large banking syndicate – the multi-currency revolving credit facility of € 2 billion was syndicated by 19 banks – reduces possible losses in the event of default.
The solvency and operational development of trading partners is regularly reviewed as part of the management of operational counterparty risks. Sovereign risks are also analyzed; this focuses in particular on Italy, Spain, Greece, and Portugal. The volume of receivables of each customer is capped in line with their credit ratings. Risk-mitigating measures, such as credit insurance, are utilized as appropriate. Nevertheless, defaults by isolated trading partners, even those with outstanding credit ratings, cannot be entirely ruled out, although rated as unlikely (further information can be found in “Credit risks” under “Management of financial risks” in the notes to the consolidated financial statements). Counterparty risk is classified as a medium risk overall.
Market opportunities and risks
As a result of its international business activities and global corporate structure, Merck is exposed to risks and opportunities from fluctuations in exchange rates. These result from financial transactions, operating receivables and liabilities, forecast future cash flows from sales and costs in foreign currency. Merck uses derivatives to manage and reduce the above risks and opportunities. The exchange rates for transactions already recognized, such as operating receivables and liabilities in foreign currency, are essentially hedged. In certain cases, the exchange rate for forecast sales and future costs in foreign currency are hedged up to 36 months in advance (further information can be found in “Derivative financial instruments” in the notes to the consolidated financial statements).
Future refinancing and cash investments are exposed to the risks and opportunities of interest rate fluctuations. These are also managed and reduced using derivatives. Currency risks are rated as possible and after hedging are classed as a medium risk; interest rate risks are considered unlikely and are classed as a low risk.
Risks of impairment on balance sheet items
The carrying amounts of individual balance sheet items are subject to the risk of changing market and business conditions and thus to changes in fair values as well. If required, impairment losses can result in significant non-cash reductions in earnings and affect the accounting 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 as a result of the acquisitions of Serono SA in 2007 and the Millipore Corporation in 2010, and the associated purchase price allocation (further information can be found under “Intangible assets” in the notes to the consolidated financial statements). All relevant risks were assessed during the preparation of the consolidated financial statements and taken into account accordingly. Merck rates risks beyond this as low.
Risk and opportunities from pension obligations
Merck has commitments in connection with pension obligations. The present value of defined benefit obligations can be significantly increased or reduced by changes in the relevant valuation parameters, e.g. the interest rate or future salary increases. Pension obligations are regularly assessed as part of annual actuarial reports. Some of these obligations are covered by the pension provisions reported in the balance sheet, while other obligations are externally funded (further information can be found under “Provisions for pensions and other post-employment benefits” in the notes to the consolidated financial statements). To the extent that 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 affect the fair value of plan assets and thus result in further additions to pension provisions. By contrast, rising returns increase the value of plan assets, thereby resulting in excess cover of plan liabilities. Merck increases the opportunities of fluctuations in the market value of plan assets on the one hand and reduces the risks on the other by using a diversified investment strategy. The risk of pension liabilities is considered possible and is classed as a medium risk.
Assessments by independent rating agencies
The capital market uses the assessments published by rating agencies to help lenders to assess the risks of a financial instrument. Merck is currently rated by Standard & Poor’s and Moody’s, and its ratings from these agencies rose in 2013 to the best level in the history of the Merck Group: While Standard & Poor’s issued a long-term rating of A with a stable outlook, Moody’s issued it an A3 rating with a stable outlook. In line with market procedures, Merck’s financing conditions are closely tied to its rating. The better a rating, the more favorably Merck can generally raise funds on the capital market or from banks.
Overview of rating development:
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