Opportunity and Risk Report

Opportunity and Risk Status

In this section, we report on material, reportable risks pursuant to German Accounting Standard No. 20. These include all high and medium financial and nonfinancial risks that are at least significant in terms of potential impact, while taking into account established mitigation measures (net risk). They encompass risks falling within the black outline in the rating matrix. In addition, we report on relevant risks that, from a financial point of view, may not be sufficiently or meaningfully quantifiable, if at all. We also report on the principal opportunities identified in the course of our opportunity management.

Comparable risks existing in different segments of the company are bundled where applicable. The order in which the risks are listed does not imply any order of importance. We also describe opportunities and risks of a segment-specific nature where relevant.

According to our understanding, risks relating to the aspects outlined in the CSR Directive Implementation Act that would have to be reported separately would have to have at least a “severe” potential impact and their likelihood of occurrence would have to be classified as “very likely.” We did not identify any such risks in 2018.

The following table provides an overview of the individual risk categories together with risk classes and the affected segments. The categorization of risks was adjusted in 2018. This was partly due to the Monsanto acquisition and the resulting shift in alignment of our business model toward the agriculture business. Furthermore, we leveraged the experiences we gained from the classification introduced in 2017 to optimize our Risk Universe. This process is merely a reclassification among the risk categories, without disregarding any risks. Risks previously assessed under “external risks” have primarily been reallocated as follows: risks in the category “Business markets” have been assigned to the categories “Market developments” or “Sales, marketing and distribution”; risks in the category “Political, social and macroeconomic environment” have been allocated to “Regulatory changes” or “Social and macroeconomic trends”; and risks in the “Natural disasters and crises” category have been included in the “Supply of products” or “Security” categories. Risks in the “External network and partnerships” category have been transferred to “Supply of products,” “Marketing, sales and distribution” or “External partner compliance.”

Overview of Material Risk Areas

Risk category

 

Risk class

 

Affected segment(s) or Group1

PH: Pharmaceuticals; CS: Crop Science; CH: Consumer Health

1

Listed are those segments that have identified material risks. Other segments may also be affected to a lesser extent. The Group has been indicated where material risks have been reported by corporate functions.

2

Risk class: medium

3

The primary developments with respect to legal risks compared with the Annual Report 2017 (Chapter “Related Parties”) are outlined in the “Legal Risks” section of the Notes (Chapter „Legal Risks“) to the Consolidated Financial Statements of the Bayer Group.

Strategic risks

 

 

 

 

Social and macroeconomic trends

 

High

 

CS

Market developments

 

Medium

 

CH, CS

Regulatory changes

 

Medium

 

PH, CS, Group

Business strategy

 

Medium

 

PH, CS, Group

Operational risks

 

 

 

 

Research and development

 

High

 

PH, CS2

Supply of products (procurement, production, logistics)

 

Medium

 

PH, CS

Marketing, sales and distribution

 

Medium

 

PH

Human resources

 

Medium

 

Group

Information technology

 

High

 

Group

Finance and tax

 

Medium

 

Group

Safety, quality and compliance risks

 

 

 

 

External partner compliance

 

Medium

 

Group

Health, safety and environment

 

Medium

 

Group

Intellectual property

 

Medium

 

PH

Legal / compliance3

 

See Chapter “Legal / compliance”

 

Group

Product safety and stewardship

 

High

 

PH2, CS

Quality and regulatory requirements

 

Medium

 

PH, CS, Group

Security

 

Medium

 

Group

Social and macroeconomic trends

Changes in political, social and macroeconomic factors such as economic growth, life expectancy, population size and consumer behavior as well as societal trends, political crises and instability result in opportunities for us, but are also associated with risks.

The growing world population and the resulting higher demand for food offer further opportunities for our Crop Science segment. Partially changing consumer behavior is driving an increase in demand for food products of animal origin. Agricultural productivity therefore needs to increase in view of declining per-capita acreages, the challenges presented by climate change, and increasing resistance. We therefore expect demand for high-quality seeds and crop protection products to rise.

Furthermore, the increase in quality of life and life expectancy is leading to a heightened focus on the medical care needs of elderly patients. To take advantage of the opportunities arising from the growing demand for innovative health care products to treat age-related diseases, Bayer’s Pharmaceuticals segment is concentrating its research and development activities on relevant therapeutic areas, among other measures.

In the Crop Science segment, seasonal and macroeconomic factors in particular can unfavorably impact our business. Our markets are cyclical and are shaped by economic developments and factors including fluctuating weather conditions and pest pressure. We address these influences through our globally diversified business, flexible supply chain and comprehensive monitoring activities.

Modern agricultural methods, such as the application of certain classes of crop protection products and the use of genetic engineering, are regularly the subject of intense public debate and can negatively impact our reputation. The increased risk of an increasingly negative public debate that is not primarily based on science may lead to legislative and regulatory decisions that significantly limit the use of our products or even result in voluntary or mandated product withdrawals. We are engaged in constant dialogue with interest groups and regulators to promote a scientifically founded, rational and responsible discussion and decision-making process.

We are committed to responsible corporate governance. Our aim is to generate not just economic, but also ecological and societal benefits. Through our commitment to the U.N. Global Compact and the Responsible Care™ initiative, for instance, we underline our mission as a company that acts in a sustainable manner.

Market developments

In the Crop Science segment, we could face increased competition in the seed and crop protection industry. Consolidation processes as well as aggressive marketing and pricing strategies – not only for generic products – could negatively impact our profitability. In addition, increasing digitalization in the agriculture sector, such as the growing use of robotics, could lead to the rise of new players. We are addressing this development by realigning our business models, engaging in scientific and commercial partnerships, and utilizing our own R&D capabilities.

The risk of existing business models undergoing rapid change as a result of digitalization and new digital products is also present in the Consumer Health segment. Digitalization is a key factor in gaining a competitive advantage. If we fail to adequately integrate this development into our existing business models, we could lose customers and market share. We monitor the market very closely, and devise strategies and measures to address developments in our business models.

Regulatory changes

Our business activity is subject to extensive regulations that may change. For example, further restrictions could be imposed on the sale and use of various crop protection products, or the pricing of pharmaceutical products could be more strictly regulated. Residues of agrochemical products in the environment could also be subject to more stringent regulation. In addition, decisions could also affect agricultural imports from other parts of the world and therefore our business in those regions. Moreover, regulatory changes may generally give rise to uncertainty regarding our future patent protection. They can also lead to higher product development costs and times or even necessitate adjustments to our product portfolio, which may in turn negatively impact our reputation.

We counter these risks by monitoring changes in regulatory requirements, as we look to ensure they are adequately addressed within the company. Moreover, we respond to the changing situation through in-house research and development capacities, acquisitions and collaborations and we align our product portfolio to reflect anticipated changes.

Business strategy

As a globally operating, innovation-oriented and diversified company, we are exposed to various strategic risks. Where it appears strategically advantageous, we look to supplement our organic growth through measures such as acquisitions and / or inlicensing.

Such strategic measures may give rise to greater challenges at our Pharmaceuticals segment in connection with the inlicensing and / or the acquisition of new products required to achieve the inorganic growth targeted, in part due to the increasing difficulty in identifying suitable candidates on economically acceptable conditions.

In connection with the increasing digitalization of farming, our Crop Science segment faces the challenge of developing – and successfully marketing – optimal products and tools. Our activities in this area are bundled in our subsidiary, The Climate Corporation. Where necessary, they are supplemented by strategic partnerships with leading IT companies.

We counter these risks by aligning our organization and our processes with existing challenges that arise in areas including the identification and implementation of inlicensing opportunities and project oversight.

Research and development

Across our businesses, we see opportunities both in the continued development of our brands and in the expansion of our research pipeline as a result of our innovation strength.

In the Pharmaceuticals segment, opportunities result from digitalization and associated new research and development methods that save time and increase development effectiveness. We also rely on networking, both within the company and with external partners, to boost our innovation strength. This stimulates the development of new products. Technological advances in pharmaceutical product development are likewise influenced by digitalization, which can also present a risk for us if we are not in a position to shape this development.

Furthermore, we cannot ensure that we will identify a sufficient number of research candidates and that all of the products we are currently developing or will develop in the future will obtain their planned approval / registration or achieve commercial success. This may result from the failure to meet technical, capacity- and time-related requirements or the inability to meet trial objectives in product development, among other factors. The performance of our research partners could also have a limiting impact in this respect. Delays or cost overruns might occur during product registration or launch. We seek to counter this risk through holistic portfolio management, by estimating the probability of success and prioritizing development projects.

In the Crop Science segment, we anticipate that by combining our innovation capacities and budgets, we can more effectively tackle the challenges faced in developing and introducing product solutions in agriculture, including longer and more costly development cycles or stricter regulatory requirements. In the medium to long term, we plan to leverage the strengths of the combined R&D platform to deliver pioneering technologies faster.

The development of resistance represents both a risk and a continuous driver of innovation in the Crop Science segment. Developing resistance to both crop protection products and special traits is a natural process that we routinely monitor so that, where necessary, industry-wide measures can be initiated to halt the spread of resistance. In addition, we actively update our product portfolio based on anti-resistance strategies and combat factors that facilitate resistance in farming through programs focused on the optimal application of our products (integrated weed and pest management).

Supply of products (procurement, production, logistics)

Despite all precautions, operations at our sites may be disrupted by earthquakes, fires, power outages or disruptions at our suppliers, for example. Certain materials, particularly in our Pharmaceuticals segment, are offered by only a small number of suppliers. Possible price adjustments can also have a negative impact on our margin. We counter these risks by establishing relationships with alternative suppliers, concluding long-term agreements, expanding inventories or producing raw materials ourselves. Strategic Material Review Committees regularly examine and assess the supplier risks. Furthermore, some of our production sites are located in regions that can be affected by natural disasters, such as flooding or earthquakes. These risks can lead to production disruptions or stoppages, result in personal injury and damage to our reputation, lead to declines in sales and / or margins, and necessitate the reconstruction of damaged infrastructure. If we are unable to meet demand for our products, sales may undergo a structural decline.

We address this risk for certain products by building up safety stocks and by distributing production among multiple sites, for example. Furthermore, an emergency response system based on the respective corporate policy has been implemented at all our production sites as a mandatory component of our HSEQ stands for health, safety, environment and quality. (health, safety, environment and quality) management.

Marketing, sales and distribution

New product launches present particular challenges for our marketing and distribution organization since assumptions about aspects such as the market and market circumstances may not materialize as anticipated. As a result, product launch concepts – including those related to clinical trials – and the planning or implementation of the distribution strategy could turn out to be inefficient or inadequate in terms of scheduling. We address these risks with a forward-looking analysis of possible scenarios and the development of suitable strategies for projects such as planned product launches.

In some countries, the marketing rights for certain pharmaceutical products are held by third parties. Inadequate performance by these marketing 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.

Human resources

Skilled and dedicated employees are essential for the company’s success. Difficulties in recruiting, hiring, retaining and further developing specialized employees could have significant adverse consequences for the company’s future development. Furthermore, organizational changes that are not implemented adequately or transparently can lead to declining motivation. Based on our analysis of future requirements, we counter these risks by designing appropriate employee recruitment and development measures. In addition, the alignment of our company culture toward diversity and employee needs enables us to tap the full potential of the employment market. Furthermore, deliberate and transparent change management forms an integral part of our human resources management and supports our efforts to constantly motivate our employees.

Information technology

Our business and production processes and our internal and external communications are dependent on global IT systems. The confidentiality of internal and external data is of fundamental importance to us in this connection. The risk of a breach of data confidentiality, integrity or authenticity, for example due to (cyber) attacks, has increased as a result of the general security situation. This could lead to the manipulation and / or the uncontrolled outflow of data and knowledge, and to reputational damage. Our business and / or production processes could also be temporarily disrupted by (cyber) attacks. The measures we undertake to counter these risks include vigorously testing technologies before they are deployed and implementing projects to keep technical security standards up to date and proactively examine new threats. In addition, the existing IT infrastructure is protected against unauthorized access thanks to security measures implemented by the Corporate Cyber Defense Center.

Finance and tax

Liquidity risk

Liquidity risks are defined as the possible inability of the Bayer Group to meet current or future payment obligations. They are determined and managed by the Finance function as part of our same-day and medium-term liquidity planning. The Bayer Group holds sufficient liquidity to ensure the fulfillment of all planned payment obligations at maturity. For unbudgeted shortfalls in cash receipts or unexpected disbursements, furthermore, a reserve is maintained and its balance is regularly reviewed and adjusted. Credit facilities also exist with banks, including, in particular, an undrawn €4.5 billion syndicated revolving credit facility with a current maturity of 2023.

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 maximum default risk is reduced by existing collateral, especially our global credit insurance programs. To manage credit risks from trade receivables, the respective invoicing companies appoint credit managers who regularly analyze customers’ creditworthiness. We generally agree reservation of title 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 locally and submitted to the Finance function. Credit risks from financial transactions are managed centrally in the Finance function. To minimize risks, financial transactions are only conducted within predefined exposure limits and with banks and other partners that preferably have investment-grade ratings.

Opportunities and risks resulting from market price changes

Opportunities and risks resulting from fluctuating exchange and interest rates as well as commodity prices in the market are managed by the Finance function. Risks are avoided or mitigated through the use of derivative financial instruments. The type and level of currency, interest rate and commodity price risks are determined using sensitivity analyses as per IFRS 7 that are 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 are regularly reexamined and reflect our view of the changes in currency exchange and interest rates as well as commodity prices that are reasonably possible over a one-year period. Although they fall below the external reporting threshold under our ERM system, we report on interest rate and commodity price risks in this section due to the provisions of IFRS 7.

See also graphic “Risk Assessment Matrix” in Chapter “Group-wide Opportunity and Risk Management System” 

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 not in the functional currency. Receivables and payables in liquid currencies from operating activities and financial items are generally fully exchange-hedged through cross-currency interest rate swaps. Anticipated exposure from planned payment receipts and disbursements in the future is hedged through forward exchange contracts and currency options according to management guidelines.

Sensitivities were determined on the basis of a hypothetical scenario in which the euro appreciates or depreciates by 10% against all other currencies compared with the year-end exchange rates. In this scenario, the estimated hypothetical increase or decrease in cash flows from derivative and nonderivative financial instruments would have improved or diminished earnings as of December 31, 2018, by €12 million (December 31, 2017: €6 million). Derivatives used to hedge anticipated currency exposure that are designated for hedge accounting would have improved or diminished equity (other comprehensive income) by €358 million (December 31, 2017: €353 million). Currency effects on anticipated exposure are not taken into account. Of the amount impacting equity, €75 million is related to the Chinese renminbi (CNY), €53 million to the U.S. dollar (USD), €42 million to the Japanese yen (JPY) and €42 million to the Canadian dollar (CAD).

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 that is subject to regular review. Interest rate swaps are concluded to achieve the target structure for Bayer Group debt. A sensitivity analysis conducted on the basis of our net floating-rate receivables and payables position at year-end 2018, taking into account the interest rates relevant for our receivables and payables in all principal currencies, produced the following result: A hypothetical increase of one percentage point in these interest rates (assuming constant currency exchange rates) as of January 1, 2018, would have raised our interest expense for the year ended December 31, 2018, by €69 million (December 31, 2017: interest income of €13 million).

Commodity price opportunities and risks result for the Bayer Group from the volatility of raw material prices, which can lead to an increase in the price we pay for seeds and energy. The commodity price risk is reduced by the use of commodity price derivatives such as futures, which are mainly designated as hedge accounting.

A sensitivity analysis with a 10% change in commodity prices would have an effect of €30 million on equity.

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 of these effects may negatively impact the development of equity and / or earnings and / or may necessitate additional payments by our company. 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.

Tax risks

Bayer AG and its subsidiaries operate worldwide and are thus subject to many different national tax laws and regulations. Bayer Group companies are regularly audited by the tax authorities in various countries. Amendments to tax laws and regulations, legal judgments and their interpretation by the tax authorities, and the findings of tax audits in these countries may result in higher tax expense and payments, thus also influencing the level of tax receivables, tax liabilities and deferred tax assets and liabilities. Significant acquisitions, divestments, restructuring programs and other reorganizational measures undertaken by Bayer could also have an impact. We counter the resulting risks by continuously identifying and evaluating the tax framework. The Bayer Group establishes provisions for taxes, based on estimates, for liabilities to the tax authorities of the respective countries that are uncertain as to their amount and the probability of their occurrence. It cannot be ruled out that these provisions are insufficient to cover all the risks.

External partner compliance

From the perspective of the Bayer Group as a whole, there is a risk that our partners, such as suppliers, do not give due attention to our corporate values and ethical, compliance and sustainability requirements. We counter this risk through an evaluation process, a code of conduct for suppliers, and supplier evaluations and audits. Until full integration is completed, Monsanto will continue to apply its existing processes for sustainability in procurement. The code of conduct for the acquired business, which mainly matches the content of Bayer’s code, remains in place for existing supplier relationships.

Health, safety and environment

We attach great importance not only to product safety but also to protecting our employees and the environment. Misconduct or noncompliance with legal requirements or Bayer Group standards may result in personal injury, property, reputational or environmental damage, loss of production, business interruptions and / or liability for compensation payments. Our principles, standards and measures ensure that our requirements are adequately communicated, understood and optimally implemented.

Intellectual property

The Bayer Group has a portfolio that largely consists of patent-protected products. 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. Generic manufacturers, in particular, attempt to contest patents prior to their expiration. We are currently involved in legal proceedings to enforce patent protection for our products. 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.

Legal / compliance

We are 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, anticorruption law, patent law, tax law, data protection and environmental protection. Investigations of possible legal or regulatory violations may result in the imposition of civil or criminal penalties – including substantial monetary fines – and / or other adverse financial consequences, harm our reputation and hamper our commercial success. We have established a global compliance management system to ensure the observance of laws and regulations. Monsanto had its own compliance management system prior to the start of the integration process. This system, which addresses largely the same risk areas as Bayer’s system, will remain in place until integration into Bayer’s compliance processes and systems has been completed.

Product safety and stewardship

Bayer evaluates the potential health and environmental risks of a product along the entire value chain. Despite extensive studies prior to approval or registration, products can be partially or completely withdrawn from the market due to the occurrence of unexpected side-effects of pharmaceutical products or other factors. Such a withdrawal may be voluntary or result from legal or regulatory measures. In the agriculture business particularly, there is an additional risk that our customers could use our products incorrectly. Furthermore, the presence of traces of unwanted genetically modified organisms in agricultural products and / or foodstuffs can have wide-ranging repercussions.

We counter these risks, which could give rise to liability claims and also negatively affect our reputation, through comprehensive measures in the areas of pharmaceutical and crop protection product safety and testing, including in particular a comprehensive stewardship program for genetic product integrity and quality with regard to seeds. These measures are based on globally defined principles and include analysis and monitoring measures, an alert system and training programs.

Quality and regulatory requirements

In almost every country where we operate, our business activity is subject to extensive regulations, standards, requirements and inspections, for example regarding clinical studies or production processes in the area of health or at Crop Science in the monitoring of genetically modified organisms, particularly at country level. Potential infringements of regulatory requirements may result in the imposition of civil or criminal penalties, including substantial monetary fines, a restriction on our freedom to operate, and / or other adverse financial consequences. They could also harm Bayer’s reputation and lead to declining sales and / or margins.

We counter these risks through binding principles, standards and the control mechanisms implemented. Quality requirements are defined and implemented in global quality management systems.

Security

Due to the general security situation, we see an increase in potential criminal activities targeting our employees, property or business activities. These include intellectual property theft, vandalism and sabotage. There is also the risk of crises such as an extended power outage that could cause disruptions to our information technology infrastructure and our production.

We counter these risks – which in addition to financial effects could negatively affect our reputation in some cases – through our local crisis organizations, which produce response plans and other measures. We have implemented early warning systems, ensure continuous reporting and carry out regular crisis simulation exercises. In addition, we have established a global safety community, and the Business Continuity Management unit within the Risk Management function assesses business continuity risks and defines appropriate measures together with the responsible specialist units.

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