Financial risks
For this risk category, the likelihood of occurrence is classified as medium (previous year: high) and the potential extent of damage is classified as medium (previous year: medium).
The most significant risks from the QRP arise mainly from the deterioration offinancing opportunities.
Strategies for hedging financial risks and the resulting risks arising from financial instruments
In the course of our business activities, financial risks may arise from changes in interest rates, exchange rates, raw material prices, or share and fund prices – but also from unforeseeable events such as a sudden outbreak of geopolitical tensions and conflicts or the intensification of existing ones. We continuously monitor these financial and liquidity risks and mitigate them using non-derivative and derivative financial instruments. These give rise to counterparty risks, which we limit using our counterparty risk management.
Interest rate risk refers to potential losses that could arise as a result of changes in market interest rates. It occurs because of interest rate mismatches between asset and liability items in a portfolio or on the balance sheet. We hedge interest rate risk – where appropriate in combination with currency risk – and risks arising from fluctuations in the value of financial instruments by means of interest rate swaps, cross-currency interest rate swaps and other interest rate contracts with generally matching amounts and maturities. However, variable interest rate positions exist as a result of the issuance of a floating rate bond in the Automotive Division in 2024 which was not matched with a derivative to eliminate the interest rate risk. The principle of matching amounts and maturities applies to financing arrangements within the Volkswagen Group in the Automotive Division. In the Financial Services Division, the risk of changes in the interest rate is managed on the basis of limits using interest rate derivatives as part of the defined risk strategy.
Foreign currency risk is reduced in particular through natural hedging, i.e. by adapting our production capacity at our locations around the world, establishing new production facilities in the most important currency regions and also procuring a large percentage of components locally. We hedge the residual exchange rate risk using hedging instruments. These mainly comprise currency forwards and currency options. We use these transactions to limit the exchange rate risk associated with forecasted cash flows from operating activities, intragroup financing and liquidity positions in currencies other than the respective functional currency, for example as a result of restrictions on capital movements. The currency forwards and currency options can have a term of up to ten years. We use these to hedge our principal foreign currency risks, mostly against the euro and primarily in Australian dollars, Brazilian real, Canadian dollars, Chinese renminbi, Czech koruna, Hong Kong dollars, Hungarian forints, Indian rupees, Japanese yen, Mexican pesos, Norwegian kroner, Polish zloty, pounds sterling, Singapore dollars, South African rand, South Korean won, Swedish kronor, Swiss francs, Taiwan dollars and US dollars.
The hedging of commodity prices entails risks relating to the availability of raw materials and price trends. We continuously analyze potential risks arising from changes in commodity and energy prices in the market so that immediate action can be taken whenever these arise. We limit these risks particularly by entering into forward transactions and swaps. We have used appropriate contracts to hedge some of our requirements for commodities such as aluminum, copper and lead over a period of up to six years. We have also entered into price hedges for cobalt and lithium with maximum terms of less than three years. In the case of nickel, the strategic hedging horizon is up to ten years, although existing hedges focus particularly on the next six years. Appropriate contracts have also been put in place to hedge prices of electricity and gas deliveries.
The precious metals platinum, palladium and rhodium have shorter hedging periods, generally amounting to a maximum of up to three years. For selected commodities, this may also involve increases in physical inventories. We have also entered into transactions for emission allowances to hedge the prices of a portion of the CO2 emissions generated beyond the free allocations as part of the European Union Emissions Trading System (EU ETS) over the coming years.
Special funds, in which we invest surplus liquidity, entail equity price risks and fund price risks in particular. We reduce these risks through the diversified investment of funds and through minimum values set out in the respective investment guidelines. In addition, exchange rates are hedged when market conditions are appropriate.
Channeling excess liquidity into investments and entering into derivatives contracts gives rise to counterparty risk. Partial or complete failure by a counterparty to perform its obligation to pay interest and repay principal, for example, would have a negative impact on the Volkswagen Group’s earnings and liquidity. We counter this risk through our counterparty risk management, which we describe in more detail in the section entitled “Principles and Goals of Financial Management” in the “Results of Operations, Financial Position and Net Assets” chapter. The financial instruments held for hedging purposes give rise to counterparty risks, and also to balance sheet risks, which we limit using hedge accounting.
By diversifying when selecting business partners, we work to limit the impact of a default and keep the Volkswagen Group solvent at all times, even in the event of a default by individual counterparties.
In addition, financial instruments used in risk hedging strategies may result in losses if the hedging exchange rates are less favorable than the rates achievable on the market at the maturity of the financial instrument.
Our hedging policy, the hedging rules, the default and liquidity risks, and the quantification of the hedging transactions mentioned, risks that arise in connection with trade receivables, and risks arising from financial services are explained in the notes to the consolidated financial statements. We also disclose information on market risk within the meaning of IFRS 7 in the notes.
Liquidity risk
Volkswagen is reliant on its ability to adequately cover its financing needs. There is a potential liquidity risk that we will be unable to cover existing capital requirements by raising funds or unable to finance the Group on reasonable terms, which in turn can have a substantially negative impact on Volkswagen’s business position, earnings, financial position and net assets.
In principle, the Automotive Division and Financial Services Division refinance themselves independently of one another. However, they are subject to very similar refinancing risks. In the Automotive Division, the Company’s solvency is primarily safeguarded through retained, non-distributed earnings, by drawing down on credit lines and by issuing financial instruments on the money and capital markets. The capital requirements of the financial services business are covered mainly by raising funds in the national and international financial markets, among other things through securitizations of receivables and the issuance of unsecured bonds, as well as through customer deposits from the direct banking business.
One of the ways in which Volkswagen finances its investments is with loans provided by national development banks such as Kreditanstalt für Wiederaufbau (KfW) or Banco Nacional de Desenvolvimento Econômico e Social (BNDES), or by supranational development banks.
In addition to committed credit lines, uncommitted credit lines from commercial banks supplement our broadly diversified refinancing structure.
Financing opportunities can be hindered by worsening financial and general market conditions (also resulting from a sudden outbreak of geopolitical tensions and conflicts or an intensification of existing ones) and by a worsening credit profile and outlook or a downgrade or withdrawal of the credit rating. The increasing relevance of ESG ratings to investors is also of growing significance in this context. In such cases, there is a risk of a fall in demand from market participants for securities issued by Volkswagen, which may additionally have a detrimental effect on the interest rates payable and restrict access to the capital market.
Risks and opportunities in the financial services business
While carrying out our financial services activities, we are primarily exposed to credit risks and residual value risks along with our dependence on the Group’s vehicle business.
Credit risk is defined as the danger of a financial loss resultingfrom defaults incustomer transactions These are caused by the default of the borrower or lessee. The default is caused by the borrower’s or lessee’s insolvency or unwillingness to pay. In other words, the counterparty does not make the agreed interest payments or repayments of principal on time or does not pay the full amounts.
The aim of a systematic credit risk monitoring system is to identify potential borrower or lessee insolvencies at an early stage, anticipate possible losses by recognizing appropriate allowances and, if possible, initiate corrective action in respect of a potential default. If, for example, an economic downturn leads to a higher number of insolvencies or greater unwillingness of borrowers or lessees to make payments, higher loss allowances and amortization expenses must be recognized.
Credit checks on borrowers are the primary basis for lending decisions. Rating or scoring systems are used that provide the relevant departments with an objective basis for reaching a decision on a loan or a lease.
An opportunity from credit risks may arise if the losses from the lending and leasing business are lower than the previously expected losses and the corresponding risk provision recognized on this basis. Particularly in countries where higher risk provision is needed due to the uncertain economic situation, the realized losses may be lower than the expected losses if the economy stabilizes and borrowers’ credit ratings improve as a result.
Credit risks are monitored and managed on the basis of defined guidelines and processes. All lending is monitored in relation to the financial circumstances of the borrower or lessee, contractual obligations, conditions stipulated by both outside parties and the company itself and defined in the credit approval process, available collateral and adherence to any limits granted. As such, commitments are managed according to the degree of risk involved (standard, intensified and problem loan management). Credit risk is also managed by means of approval or reporting limits and defining loan approval authority. Such limits and authority are specified separately for each individual branch and subsidiary.
Residual value risk arises from the fact that the predicted market value for an asset leased or financed could turn out to be lower on remarketing at the end of the contract than the residual value calculated when the contract was concluded, or that the sales revenue realized could be less than the carrying amount of the vehicle in the event that the contract is ended prematurely as a result of legal contract termination options being exercised. On the other hand, there is a possibility that remarketing could generate proceeds greater than the calculated residual value or carrying amount.
Referring to the bearer of residual value risk, a distinction is made between direct and indirect residual value risks. A direct residual value risk means that our financial services companies directly bear this risk. An indirect residual value risk arises if the residual value risk has been transferred to a third party (such as a dealer) on the basis of a contractual agreement. In such cases, there is a counterparty default risk in respect of the bearer of the residual value risk. If the bearer of the residual value risk defaults, the indirect residual value risk passes back to our financial services company and becomes a direct residual value risk. In other words, our financial services company re-assumes responsibility for remarketing the vehicles.
Management of the residual value risk is based on a defined control cycle, which ensures that risks are fully assessed, monitored, responded to and communicated. This process structure enables us to manage residual risks professionally and also to systematically improve and enhance the way we handle residual value risks.
As part of risk management procedures, the adequacy of the provision for risk and the potential residual value risk are regularly reviewed in respect of direct residual value risk. The preparation of the risk management report includes a review of adequacy in which the level of existing direct residual value risk is compared against the level of the provisions recognized for risks. Based on the resulting potential residual value risk, various measures are initiated as part of an active risk management approach to limit this risk. With regard to new business, the residual value recommendation must take into account current market circumstances and factors that might have an influence in future.
You can find more information on risks in the financial services business in the 2024 annual reports of Volkswagen Financial Services AG and Volkswagen Bank GmbH as well as Volkswagen Financial Services Overseas AG.