18.3.2 Opportunities and Risks

As a global enterprise with a diversified portfolio, the Bayer Group is constantly exposed to a wide range of internal or external developments or events that could significantly impact the achievement of our financial and nonfinancial objectives.

This chapter outlines the opportunities and risks which are classified in our risk matrix as “medium” or “high.” Risks that occur in comparable forms in different parts of the company are described in general terms. The sequence in which the risks are listed does not imply any order of significance. The opportunities and risks described apply to all divisions unless otherwise indicated. Also outlined in the following are risks that are of high relevance for the company but may be impossible to quantify directly, accurately or in financial terms. The impact on the Bayer Group of risks attaching to the Covestro business is affected by the size of Bayer’s shareholding in that company.

Business environment

Ethical conduct is a matter of essential importance for society. Many stakeholders evaluate companies according to whether they conduct themselves not just “legally” but also “legitimately.” The Bayer Group is dedicated to sustainable development in all areas of its commercial activity. This voluntary commitment is reflected in our responsible Corporate governance comprises the long-term management and oversight of the company in accordance with the principles of responsibility and transparency. The German Corporate Governance Code sets out basic principles for the management and oversight of listed companies. , which is geared toward generating not only economic but also ecological and societal benefit.

In the Emerging Markets – particularly Asia and Latin America – we see growth opportunities, such as those arising out of increasing affluence and the associated rise in demand for pharmaceutical products. Bayer is therefore systematically expanding its business in these regions in particular.

At the same time, however, the risk exists that our growth could be impeded by increasing global cost pressure on health systems. Pharmaceutical products are subject to regulatory price controls and regulations in many markets, and government reimbursement systems often favor less expensive generic medicines over branded products. In addition, in some markets, major health care providers can exert substantial pressure on prices. Price controls and pricing pressure reduce earnings from our pharmaceutical products and may occasionally make the market launch of a new product unprofitable. As a result, it may be necessary to choose indirect marketing options in order to provide access to pharmaceuticals. We expect the current extent of regulatory controls and market pressures on pricing to persist or increase. Changes in the business conditions in our key markets are continuously monitored. Depending on the intensity of such price controls and the pressure on prices, it could be necessary to adjust our business model.

In some countries the marketing rights for certain pharmaceutical products are held by third parties. An inadequate performance by collaboration partners could adversely affect the development of our sales and costs. Therefore, we have established an Alliance Management unit to monitor the most important collaborations and provide relevant support to the operational functions.

Further opportunities and risks may arise if actual market developments vary from those we predict in Chapter 18.1 “Economic Outlook.” Where macroeconomic developments deviate from forecasts, this may either positively or negatively impact our sales and earnings expectations.

For Covestro, an economic downturn, changes in competitors’ behavior or the market entry of new competitors may lead to more intense competition and thus to overcapacities or increased pressure on prices.

Continuous analysis of the economic environment and of economic forecasts enables us to pursue the identified opportunities and to mitigate risks by adjusting our business strategy.

Innovation

We analyze global trends and develop innovative solutions to address them, thereby mastering the challenges and taking advantage of the opportunities they provide.

Increase in life expectancy

Certain diseases, such as cancer or chronic cardiovascular disorders, are on the rise as a consequence of higher life expectancy. In response to the growing demand for innovative health care products to treat age-related diseases, Bayer’s Pharmaceuticals Division is focusing its R&D activities on relevant therapeutic areas such as oncology and cardiology.

Shortage of arable land and increasing demand for food

The challenges associated with ensuring an adequate food supply worldwide continue to increase, driven by global population growth, the reduction in available arable land and the consequences of climate change. In addition, the anticipated increase in affluence in the emerging countries is boosting the demand for animal-based food products. We expect there to be an increasing need for high-value seed and crop protection products to allow sufficient food and animal feed to be produced to satisfy rising demand despite limited acreages. The Crop Science Division is therefore developing processes to more effectively protect plants against climate and environmental stresses and increase crop yields, for example.

Conserving natural resources and protecting the climate

The finite nature of certain natural resources and efforts to protect the climate are boosting the demand for innovative products and technologies that reduce resource consumption and lead to lower emissions. This trend is being reinforced by increasingly stringent regulatory requirements and growing consumer awareness for the need to use resources sustainably. In this context, Covestro is developing new materials that help to raise energy efficiency and reduce emissions. For example, polyurethane from Covestro is used in the construction industry for thermal insulation, giving a positive energy balance, while the company’s polycarbonate is used in the automotive industry to reduce vehicle weight.

To enhance our innovation strength, we attach special importance to networking and cooperation both within and outside of our company. One example is interdisciplinary research at the interface between human, animal and plant health, which is being driven forward by our Life Sciences Field of activities comprising particularly health care and agriculture; at Bayer this refers to the activities of the Pharmaceuticals, Consumer Health and Crop Science divisions and the Animal Health business unit. Fund. This enables us to achieve research synergies and investigate new mechanisms of action that in the long term may provide new impetus to product development. Our strategy also encompasses research projects with outside partners from science and industry that give us access to complementary technologies and external innovation potential.

For further information, see Chapter 4 “Research, Development, Innovation” and Chapter 2 “Strategies of the Segments.”

Despite all our efforts, we cannot assure that all of the products we are currently developing or will develop in the future will achieve planned approval / registration or commercial success. For example, a drug candidate may fail to meet trial endpoints. The Bayer Group pursues a holistic portfolio management strategy in order to estimate the probability of success and prioritize its development projects. Furthermore, the expectations of the public and the regulatory authorities with regard to the safety and efficacy of chemical and pharmaceutical products are constantly rising. Against this background, we continue to anticipate increasing regulatory requirements for clinical or (eco)toxicological studies, for example. This increases product development costs and the time it takes to obtain registration or marketing approval. Special projects are set up to coordinate and ensure the successful implementation of new regulations.

Acquisitions

Where it appears strategically advantageous, we supplement our organic growth by acquiring companies or parts of companies. Failure to successfully integrate a newly acquired business or unexpectedly high integration costs could jeopardize the achievement of qualitative or quantitative targets and adversely impact earnings. Teams of experts therefore manage both the due diligence process and the subsequent integration of acquired companies. Due diligence includes reviewing risk-relevant factors such as compliance with applicable environmental regulations and occupational health and safety standards at production sites.

Patent protection

Patents protect our intellectual property. When our products are successfully commercialized, some of the profits can be used to continue investing in research and development. Due to the long period of time between the patent application and the market launch of a product, Bayer generally only has a few years in which to earn an adequate return on its investment in research and development. This makes effective and reliable patent protection all the more important.

Most of our products, primarily in the Life Sciences, are covered by patents. Generic manufacturers, in particular, attempt to contest patents prior to their expiration. Sometimes a generic version of a product may even be launched “at risk” prior to the issuance of a final patent decision. We are currently involved in legal proceedings to enforce patent protection for our products. Details of the risks arising from these proceedings are given in Note [32] to the consolidated financial statements. When a patent defense is unsuccessful, or if one of our patents expires, our prices are likely to come under pressure because of increased competition from generic products entering the market. Legal action by third parties for alleged infringement of patent or proprietary rights by Bayer may impede or even halt the development or manufacturing of certain products or require us to pay monetary damages or royalties to third parties. Our patents department regularly reviews the patent situation in collaboration with the respective operating units and monitors for potential patent infringements so that legal action can be taken if necessary.

Products and product stewardship

Bayer systematically and continuously evaluates the potential health and environmental risks of a product along the entire value chain – from research and development, production, commercialization and use by the customer to disposal.

Despite extensive studies prior to approval or registration, it is possible that products could be partially or completely withdrawn from the market due to the occurrence of unexpected side effects or other factors. Such a withdrawal may be voluntary or result from legal or regulatory measures. Furthermore, the presence of traces of unwanted genetically modified organisms in agricultural products and / or foodstuffs cannot be entirely excluded. Potential payments of damages in connection with the above risks may have a substantial negative impact on our earnings.

Our Life Science businesses counter these risks through a holistic organizational structure and process organization in the areas of pharmaceutical and crop protection product safety and testing. In addition, a comprehensive product stewardship program is in place in the Crop Science Division. For further information, see Chapter 8 “Product Stewardship.”

Another risk we face is that of illegal trading of counterfeit medicines and crop protection products by criminal third parties. In most cases, the composition and / or the quality of counterfeit products do not correspond to those of the original products. In addition, the fact that no local regulatory authority is involved in assuring the quality of the manufacturing or distribution process precludes any official product recall. Products originating from illegal third-party manufacturing not only endanger patients, users, animals and the environment, but also jeopardize the good reputation of our company and products and undermine our competitive position.

Bayer actively assists authorities’ efforts to combat product counterfeiting by adopting preventive measures and prosecuting offenders.

Procurement and production

To ensure the sustainability of our activities along the entire value chain, Bayer has introduced a Supplier Code of Conduct. This sets forth our sustainability principles, explains what we expect from our partners and requires them to observe our standards in areas including environmental protection and occupational safety. A further essential element is the respect of human rights. This means, for example, that no form of child labor may be employed. Violations of the Code may harm our company’s reputation. Through supplier assessments and audits, we verify whether our partners along the supply chain actually implement and comply with our Code of Conduct (see Chapter 7 “Procurement, Production, Logistics and Distribution”).

Despite its modern facilities and optimized manufacturing processes, Bayer requires significant quantities of energy and petrochemical feedstocks for the production of chemicals. Procurement prices for energy and raw materials may fluctuate significantly. This can provide opportunities but may also put our product margins at risk when oil prices are low, for example. Experience has shown that higher production costs cannot always be passed on to our customers through price adjustments. This applies especially to Covestro.

We attach great importance not only to product safety but also to protecting our employees and the environment. Risks associated with the manufacturing, filling, storage or shipping of products are mitigated by means of integrated quality, health, environmental protection and safety management. The materialization of such risks may result in personal injury, property and environmental damage, loss of production, business interruptions and / or liability for compensation payments.

Operations at our sites may be disrupted by natural disasters, fires or explosions, sabotage or supply shortages for our principal raw materials or intermediates. Disruption may also result from possible regulatory or legislative changes in the respective countries. The complexity of multistage manufacturing processes for active ingredients or biotechnology products strengthens the potential for disruption and may limit product availability. If we are unable to meet demand, sales may undergo a structural decline. We counter this risk by distributing production for certain products among multiple sites or by building up safety stocks. Furthermore, an emergency response system has been implemented for all our production sites as a mandatory component of our HSEQ stands for health, safety, environment and quality. management. It is aimed at protecting employees, neighbors, the environment and production facilities from the risks described. The Group Regulation “Safety and Crisis Management” forms the basis for this.

Increased ecological awareness creates opportunities for Covestro in two ways. On the one hand, the development of innovative materials for our customers (see Chapter 4 “Research, Development, Innovation”) opens up market potential. On the other hand, if we succeed in increasing the energy efficiency of our own production processes, we can mitigate environmental impacts and achieve cost savings at the same time. By developing new production technologies and applying internationally recognized energy management systems, we aim to help meet increasing environmental requirements, further reduce emissions and waste, and increase energy efficiency. In this way we not only contribute to sustainable climate protection and the conservation of natural resources, but also achieve cost and competitive advantages.

Employees

Skilled and dedicated employees are essential for the company’s success. There is keen competition among companies for highly qualified personnel, particularly in countries with full employment and in the emerging economies of Asia and Latin America. If we are unable to recruit a sufficient number of employees in these countries and retain them within Bayer, this could have significant adverse consequences for the company’s future development.

Based on our analysis of future requirements, we design appropriate employee recruitment and development measures. These include extensive employer marketing activities, such as our employer branding campaign, aimed at convincing our target groups of the advantages of working for Bayer. Competitive compensation containing performance-related components as well as an extensive range of training and development opportunities are among the essential elements of our human resources policies, which are based on the principles enshrined in our Human Rights Position, our corporate values and our (Corporate) compliance comprises the observance of statutory and company regulations on lawful and responsible conduct. Policy. In addition, our focus on Diversity designates the variation within the workforce in terms of gender, origin, nationality, age, religion and physical capability. enables us to tap the full potential of the employment market. In times of considerable strategic and organizational transition at Bayer, deliberate and transparent change management forms an integral part of our human resources management, enabling us to motivate our employees for the long term and alleviate uncertainties.

For more information, see Chapter 6 “Employees.”

Information technology

Business and production processes and the internal and external communications of the Bayer Group are increasingly dependent on global IT systems.

A significant technical disruption or failure of IT systems could severely impair our business and production processes. Technical precautions such as data recovery and continuity plans are defined and continuously evolved in close cooperation with our internal IT organization.

The confidentiality of internal and external data is of fundamental importance to us. A loss of data confidentiality, integrity or authenticity could lead to manipulation and / or the uncontrolled outflow of data and know-how. We have measures in place to counter this risk, including an authorization system.

Furthermore, a committee has been established to determine the fundamental strategy, architecture and safety measures for the Bayer Group. These measures are designed to provide optimum protection based on state-of-the-art technology.

Law and compliance

The Bayer Group is exposed to risks from legal disputes or proceedings to which we are currently a party or which could arise in the future, particularly in the areas of product liability, competition and antitrust law, patent law, tax law and environmental protection.

Investigations of possible legal or regulatory violations, such as potential infringements of antitrust law or certain marketing and / or distribution methods, may result in the imposition of civil or criminal penalties – including substantial monetary fines – and / or other adverse financial consequences, harm Bayer’s reputation and ultimately hamper our commercial success.

Bayer has established a global compliance management system to ensure the sustainable observance of laws and regulations (see Chapter 16.3 “Compliance”).

Legal proceedings currently considered to involve material risks are described in Note [32] to the consolidated financial statements.

Financial opportunities and risks

The Bayer Group has financial opportunities at its disposal in the form of the market prices it can command, and is exposed to financial risks in the form of liquidity, credit and market price risks, as well as risks resulting from pension obligations.

The following paragraphs provide details of these and other financial opportunities and risks and how they are managed.

The management of financial opportunities and risks takes place using established, documented processes. One component is financial planning, which serves as the basis for determining the liquidity risk and the future foreign currency and interest-rate risks and covers all Group companies that are relevant from a Cash flow Key indicator for assessing a company’s financial strength; in addition to gross cash flow, the statement of cash flows also reports the cash flow from operating activities (net cash flow), which shows the amount of funds available from operating activities for financing investments, repaying debts or distributing dividends. The cash flows from investing and financing activities are also reported. perspective. Financial planning comprises a planning horizon of 12 months and is regularly updated.

Further information is provided in Chapter 14.7 “Financial Management of the Group.”

Liquidity risk

Liquidity risks result from the possible inability of the Bayer Group to meet current or future payment obligations due to a lack of cash or cash equivalents. The liquidity risk is determined and managed by the Finance department as part of our same-day and medium-term liquidity planning.

Payment obligations from financial instruments are explained according to their maturity in Note [30.2] to the consolidated financial statements.

The Bayer Group holds sufficient liquidity to ensure the fulfillment of all planned payment obligations at maturity. In addition, a reserve is maintained for unbudgeted shortfalls in cash receipts or unexpected disbursements. The amount of this liquidity reserve is regularly reviewed and adjusted as necessary according to circumstances.

Liquid assets are held mainly in the form of overnight and term deposits. Credit facilities also exist with banks. These include, in particular, an undrawn €3.5 billion Syndicated credit facility Credit line agreed with a group of banks; generally used for extensive financing requirements, such as when making an acquisition, to increase available liquidity or as security for the issuance of debt instruments. The credit facility can be utilized and repaid flexibly, either in full or in portions, during its term. . Additionally, credit facilities totaling €2.7 billion are available to the Covestro Group.

Credit risks

Credit risks arise from the possibility that the value of receivables or other financial assets of the Bayer Group may be impaired because counterparties cannot meet their payment or other performance obligations. The Bayer Group does not conclude master netting arrangements with its customers for nonderivative financial instruments. Here, the total value of the financial assets represents the maximum credit risk exposure. In the case of derivatives, positive and negative market values may be netted under certain conditions.

To manage credit risks from trade receivables, the respective invoicing companies appoint credit managers who regularly analyze customers’ creditworthiness. Some of these receivables are collateralized, and the collateral is used according to local conditions. It includes credit insurance, advance payments, letters of credit and guarantees. Reservation of title is generally agreed with our customers. Credit limits are set for all customers. All credit limits for debtors where total exposure is €10 million or more are evaluated by local credit management and submitted to the Bayer Group’s Financial Risk Committee.

Credit risks from financial transactions are managed centrally in the finance department. To minimize risks, financial transactions are only conducted within predefined exposure limits and with banks and other partners that preferably have investment-grade ratings. All risk limits are based on methodical models. Adherence to the risk limits is continuously monitored.

Opportunities and risks resulting from market price changes

Opportunities and risks resulting from changes in market currency and interest rates are managed by the central finance department. Risks are eliminated or mitigated through the use of derivative financial instruments. Further details on derivatives are given in Note [30.3] to the consolidated financial statements.

The type and level of currency and interest-rate risks are explained in the following paragraphs using sensitivity analyses based on hypothetical changes in risk variables (such as interest curves) to determine the potential effects of market price fluctuations on equity and earnings. The assumptions used in the sensitivity analyses reflect our view of the changes in currency exchange and interest rates that are reasonably possible over a one-year period. These assumptions are regularly reviewed.

Foreign currencies

Foreign currency opportunities and risks for the Bayer Group result from changes in exchange rates and the related changes in the value of financial instruments (including receivables and payables) and of anticipated payment receipts and disbursements in the functional currency.

Receivables and payables in liquid currencies from operating activities and financial items are generally fully exchange-hedged through forward exchange contracts and cross-currency interest-rate swaps.

Anticipated exposure from planned payment receipts and disbursement in the future is hedged according to the rules agreed between the Board of Management, the finance department and the operating units. Hedging takes place through forward exchange contracts and currency options.

Sensitivities were determined on the basis of a hypothetical adverse scenario in which the euro depreciates by 10% against all other currencies compared with the year-end exchange rates. In this scenario, the estimated hypothetical loss of Cash flow Key indicator for assessing a company’s financial strength; in addition to gross cash flow, the statement of cash flows also reports the cash flow from operating activities (net cash flow), which shows the amount of funds available from operating activities for financing investments, repaying debts or distributing dividends. The cash flows from investing and financing activities are also reported. from derivative and nonderivative financial instruments would have diminished earnings and equity (other comprehensive income) as of December 31, 2015 by €303 million (December 31, 2014: €295 million). Of this amount, €108 million is related to the U.S. dollar, €66 million to the Chinese renminbi, €41 million to the Japanese yen and €28 million to the Canadian dollar. Currency effects on anticipated exposure are not taken into account.

Derivatives used to hedge anticipated currency exposure that are designated for hedge accounting would have diminished other comprehensive income by €313 million.

Interest rates

Interest-rate opportunities and risks result for the Bayer Group through changes in capital market interest rates, which in turn could lead to changes in the fair value of fixed-rate financial instruments and changes in interest payments in the case of floating-rate instruments.

Interest-rate opportunities and risks are managed over a target duration established by management for Bayer Group debt. This target duration is subject to regular review. Interest-rate swaps are concluded to achieve the target structure for Bayer Group debt.

A sensitivity analysis based on our net floating-rate receivables and payables position at year end 2015, taking into account the interest rates relevant for our receivables and payables in all principal currencies, produced the following result: a hypothetical increase of 1 percentage point in these interest rates (assuming constant currency exchange rates) as of January 1, 2015 would have raised our interest expense for the year ended December 31, 2015 by €29 million (December 31, 2014: €53 million).

Financial risks associated with pension obligations

The Bayer Group has obligations to current and former employees related to pensions and other post-employment benefits. Changes in relevant measurement parameters such as interest rates, mortality and salary increase rates may raise the present value of our pension obligations. This may lead to increased costs for pension plans or diminish equity due to actuarial losses being recognized as other comprehensive income in the statement of comprehensive income. A large proportion of our pension and other post-employment benefit obligations is covered by plan assets including fixed-income securities, shares, real estate and other investments. Declining or even negative returns on these investments may adversely affect the future fair value of plan assets. Both these effects may negatively impact the development of equity and / or the company’s earnings and / or may necessitate additional payments by the company. Further details are given in Note [25] to the consolidated financial statements.

We address the risk of market-related fluctuations in the fair value of our plan assets through balanced strategic investment, and we constantly monitor investment risks in regard to our global pension obligations.

Overall assessment of opportunities and risks

The risks reported above do not endanger the company’s continued existence. Nor could we identify any risk interdependencies that could combine to endanger the company’s continued existence.

Risks rated as “medium” or “high” did not change significantly compared with the previous year.

Based on our product portfolio, our know-how and our innovation strength, we are convinced that we can take advantage of the opportunities resulting from our entrepreneurial activity and successfully master the challenges resulting from the risks stated above.