The Executive Committee for Liquidity and Foreign Currency approves risk limits, authorized financial instruments, and hedging methods and horizons. Risk management is the responsibility of Group Treasury. The Group Board of Management is informed of the current risk situation on a regular basis.
Our business activities entail financial risks that may arise from changes in interest rates, exchange rates, commodity prices and fund prices. We manage these risks by employing primary and derivative financial instruments. Internal limits are set on the volume of business per counterparty, when entering into financial transactions, in order to limit the default risk by means of diversification. In setting these limits, various rating criteria are taken into account, including the ratings awarded by independent agencies and the equity base of potential counterparties. Interest rates and currencies are mainly managed centrally by Group Treasury. The Group hedges interest rate risk and risks arising from fluctuations in the value of financial instruments by means of interest rate swaps, cross-currency swaps and other interest rate contracts with matching amounts and maturity dates. This also applies to financing arrangements within the Volkswagen Group.
Foreign currency risk is reduced primarily through natural hedging, i.e. by flexibly adapting our production capacity at our locations around the world and establishing new production facilities in the most important currency regions, currently for instance in India, Russia and the USA. We hedge the residual foreign currency risk using hedging instruments. These include currency forwards, currency options and cross-currency swaps. We use these transactions to limit the currency risk associated with forecasted cash flows from operating activities and intra-Group financing in currencies other than the respective functional currency. These contracts may have a term of up to five years. They are primarily used to hedge the euro against the US dollar, sterling, the Mexican peso, the Russian rouble, the Swedish krone, the Czech koruna, the Swiss franc and the Japanese yen. These eight currencies are responsible for most of the foreign currency risk from forecasted cash flows. The purchasing of raw materials gives rise to risks relating to availability and price trends. We limit these risks mainly by entering into forward transactions. We have used appropriate contracts to hedge some of our requirements for commodities such as aluminum, copper, platinum, rhodium and palladium over a period of up to five years. We added additional hedging transactions in 2008, such as for CO2 certificates and coal prices.
We ensure that the Company is solvent at all times by providing sufficient liquidity reserves, access to confirmed credit lines and by our tried-and-tested money market and capital market programs.
We cover the capital requirements of the growing financial services business mainly through borrowings at matching maturities raised in the national and international financial markets. Refinancing costs have risen significantly since the beginning of the financial crisis. However, in view of the broadly diversified structure of our refinancing sources, we continued to be able to raise sufficient liquidity in the various markets. For example, despite the difficult market environment, Volkswagen Bank GmbH succeeded in placing the “Driver VI” ABS transaction with a volume of €1.0 billion in October 2008.
Credit lines from banks are generally only ever used within the Group to cover short-term working capital requirements. Projects are financed by, among other things, loans provided at favorable interest rates by development banks such as the European Investment Bank or the European Bank for Reconstruction and Development (EBRD), but also by national development banks, such as Kreditanstalt für Wiederaufbau (KfW) or the Brazilian National Economic and Social Development Bank (BNDES). This extensive range of options means that any liquidity risk to the Volkswagen Group is extremely low. In addition, Volkswagen Financial Services AG and Volkswagen Bank GmbH have each applied to the Sonderfonds Finanzmarktstabilisierung (SoFFin – German Financial Market Stabilization Fund) for a guarantee facility to refinance their financial services business.
A rating downgrade could adversely affect the terms attached to the Volkswagen Group’s borrowings. However, both the ratings for Volkswagen AG and for Volkswagen Financial Services AG are as stable as ever. The long- and short-term ratings given to Volkswagen Bank GmbH by both Standard & Poor’s and Moody’s Investors Service remain one notch higher than those for Volkswagen AG and Volkswagen Financial Services AG. Moody’s Investors Service raised the outlook for the long-term ratings of Volkswagen AG and Volkswagen Financial Services AG in 2008 from “stable” to “positive”, thus giving credit to the further improvement in the Volkswagen Group’s key financial figures and business prospects. The outlook for Volkswagen Bank GmbH’s rating set by Moody’s Investors Service continues to be “stable”. In view of the economic developments expected in 2009, Standard & Poor’s lowered the outlook for the bank to “negative”. For the current ratings of Volkswagen AG, Volkswagen Financial Services AG and Volkswagen Bank GmbH, plus information on our new issues in the capital market in fiscal year 2008, please see the chapter of this Report.
The Treasury department of Volkswagen Financial Services AG safeguards the liquidity of the Financial Services Division as well as managing credit, default and market risks. Risk Controlling is responsible for measuring, analyzing and monitoring market risk positions.
In the we explain our hedging policy, the hedging rules and default and liquidity risks, quantify the hedging transactions mentioned. Additionally, we outline the market risk within the meaning of IFRS 7.
Residual value risk in the financial services business
In the financial services business, we agree in selected cases to buy back selected vehicles at a residual value that is fixed at inception of the contract in order to realize market opportunities. We evaluate these lease contracts at regular intervals. We take the necessary precautions in the event of potential risks.
Management of the residual value risk is based on a defined feedback loop ensuring the full assessment, monitoring, management and communication of risks. The process design ensures not only professional management of residual risks but also that we systematically improve and enhance our handling of residual value risks.
As part of our risk management, we use residual value forecasts to regularly assess the appropriateness of the provisions for risks and the potential for residual value risk. In so doing, we compare the contractually agreed residual values with the fair values obtainable. These are produced from data from external providers and our own marketing data. We do not take account of the upside in residual market values when making provisions for risks.