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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2022-02-23 compared with 2021-02-11 · 55 added, 64 removed, 7 unchanged (94% of the section changed)

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the normal course of business, we actively manage our exposure to various market risks by entering into various supplier-based and market-based hedging transactions, authorized under established risk management policies that place clear controls on these activities.

Our objective in managing these exposures is to decrease the volatility of our earnings and cash flows due to changes in underlying rates and costs.

The counterparties to our market-based transactions are generally highly rated institutions.

We perform assessments of their credit risk regularly.

In the normal course of our global operations, we are exposed to market risks associated with foreign currency exchange fluctuations, volatile interest rates and commodity price risks.

To manage our exposure to these market risks, we enter into certain supplier-based and market-based hedging transactions.

Such transactions are allowed under our risk management policy and are monitored closely with clear controls around the activities.

Our market-based transactions include a variety of derivative financial instruments, none of which are used for trading or speculative purposes.

The counterparties to these market-based transactions are generally highly rated institutions.

Our objective is to manage our exposures and to decrease the volatility of our earnings and cash flows as a result of changes in underlying rates and costs.

Interest Rate Risk

We are exposed to volatility in interest rates with regard to current and future debt offerings.

Primary exposures include U.S.

Department of Treasury rates, Canadian government rates and LIBOR.

To mitigate this exposure as it pertains to future debt offerings and to achieve our desired fixed-to-floating rate debt profile, we may enter into interest rate swaps from time to time.

We are exposed to volatility in interest rates with regard to our current and future debt offerings.

Specifically, we are exposed to U.S.

Department of Treasury rates, Canadian government rates and LIBOR, or any such LIBOR alternative like SONIA, SOFR or EURIBOR, for example.

We may from time to time enter into interest rate swaps on our current debt obligations as our hedging strategy is to achieve our desired fixed-to-floating rate debt profile such that we manage the volatility in earnings as well as the cost of funding our operations.

Further, we may enter into forward starting interest rate swaps to manage our exposure to the volatility of interest rates associated with future interest payments on a forecasted debt issuance.

See Part II - Item 8.

Financial Statements and Supplementary Data, Note 11.

"Debt" for the maturity dates of our outstanding debt instruments.

The following table presents our fixed rate debt and forward starting interest rate swaps as well as the impact of an absolute 1% adverse change in interest rates on their respective fair values.

Notional amounts and fair values are presented in USD based on the applicable exchange rate as of December 31, 2021 and December 31, 2020, respectively.

Notional amounts Fair Value Asset/(Liability) Effect of 1% Adverse Change

Ta b l e of C o n t e n t s

(in millions) As of December 31, 2021 As of December 31, 2020 As of December 31, 2021 As of December 31, 2020 As of December 31, 2021 As of December 31, 2020

USD denominated fixed rate debt $ 5,400.0 $ 6,400.0 $ (5,952.7) $ (7,211.4) $ (200.0) $ (213.2)

Foreign currency denominated fixed rate debt $ 1,701.0 $ 1,763.1 $ (1,763.1) $ (1,861.3) $ (10.5) $ (6.5)

Forward starting interest rate swaps $ 1,500.0 $ 1,500.0 $ (170.8) $ (221.5) $ (160.5) $ (177.1)

Foreign Exchange Risk

Foreign currency fluctuations affect our net investments in foreign subsidiaries and foreign currency-denominated cash flows.

We manage our foreign currency exposures through foreign currency forward contracts and foreign-denominated debt.

We may also enter into cross currency swaps from time to time.

Foreign currency exchange risk is inherent in our operations primarily due to operating results that are denominated in currencies other than the USD.

We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to foreign currency fluctuations.

Our financial risk management policy is intended to offset a portion of the potentially unfavorable impact of exchange rates on our earnings and cash flows.

Changes in foreign currency exchange rates affect the translation of local currency balances of foreign subsidiaries, transaction gains and losses associated with intercompany loans with foreign subsidiaries, royalty agreements and transactions denominated in currencies other than the USD, and their related cash flows, specifically related to the purchase of production inputs and imports, as well as our foreign currency-denominated debt.

See Part II - Ite m , 8.

Fin ancial Stateme nts and Supplementary Data , Note 1.

"Basis of Prese ntation and Summary of Significant Accounting Policies " for our accounting policy over the accounting for translation adjustments and foreign currency transactions.

Approximately $3.0 billion, or 30%, of our net sales was denominated in functional currencies other than the USD for the year ended December 31, 2021.

As a result, fluctuations in foreign currency exchange rates other than the USD, particularly the CAD and the GBP, may have a material impact on our reported results.

For the year ended December 31, 2021, net sales denominated in CAD and GBP was approximately $1.3 billion and $1.0 billion, respectively.

We manage our foreign currency exposures through foreign currency forward contracts and net investment hedges.

Our EUR foreign-denominated debt is a net investment hedge against our investment in our Europe business in order to hedge a portion of the foreign currency translational impacts.

The changes in fair value of the net investment hedge due to the fluctuations in the spot rate is recorded to AOCI.

Our foreign currency forward contracts manage our exposure related to certain royalty agreements, the purchase of production inputs and imports that are denominated in currencies other than the functional entity's local currency and other foreign currency exchange exposure.

From time to time, we may enter into cross currency swaps.

We settled the cross currency swaps associated with the $1.0 billion notes when they were repaid on July 15, 2021 and had no cross currency swaps outstanding as of December 31, 2021.

The following table includes details of our foreign currency forwards used to hedge our foreign exchange rate risk as well as the impact of a hypothetical 10% adverse change in the related foreign currency exchange rates on the fair value of the foreign currency forwards.

Notional amounts and fair values are presented in USD based on the applicable exchange rate as of December 31, 2021 and December 31, 2020.

The majority of our outstanding foreign currency forwards will mature in fiscal 2022.

Notional amounts Fair Value

Asset/(Liability) Effect of 10% Adverse Change

(in millions) As of December 31, 2021 As of December 31, 2020 As of December 31, 2021 As of December 31, 2020 As of December 31, 2021 As of December 31, 2020

Foreign currency denominated fixed rate debt $ 1,701.0 $ 1,763.1 $ (1,763.1) $ (1,861.3) $ (171.9) $ (190.4)

Foreign currency Forwards $ 170.8 $ 181.2 $ (1.5) $ (4.9) $ (19.0) $ (20.5)

Ta b l e of C o n t e n t s

Commodity Price Risk

We use commodities in the production and distribution of our products.

To manage the related price risk for these costs, we utilize market-based derivatives and long-term supplier-based contracts.

Our primary objective when entering into these transactions is to achieve price certainty for commodities used in our supply chain.

We manage our exposures through a combination of purchase orders, long-term supply contracts and over-the-counter financial instruments.

Equity Price Risk

We currently hold warrants allowing us the option to purchase common shares of HEXO Corp.

("HEXO"), our Truss LP ("Truss") joint venture partner in Canada.

These warrants are subject to equity price risk, representative of the potential future loss of value that would result from a decline in the market price of HEXO's underlying common shares.

Details of market-risk sensitive debt, derivative and other financial instruments are included in the table below.

Notional amounts and fair values are presented in USD based on the applicable exchange rate as of December 31, 2020.

See Part II—Item 8 Financial Statements and Supplementary Data, Note 11, "Debt" and Note 16, "Derivative Instruments and Hedging Activities" for further discussion.

Notional amounts by expected maturity date December 31,

2021 2022 2023 2024 2025 Thereafter Total Fair value

(In millions)

Long-term debt:

CAD 500 million 2.84% notes due 2023 $ — $ — $ 392.9 $ — $ — $ — $ 392.9 $ (414.9)

CAD 500 million 3.44% notes due 2026 $ — $ — $ — $ — $ — $ 392.9 $ 392.9 $ (432.6)

$1.0 billion 2.10% notes due 2021 $ 1,000.0 $ — $ — $ — $ — $ — $ 1,000.0 $ (1,017.9)

$500 million 3.5% notes due 2022 $ — $ 500.0 $ — $ — $ — $ — $ 500.0 $ (524.0)

$2.0 billion 3.0% notes due 2026 $ — $ — $ — $ — $ — $ 2,000.0 $ 2,000.0 $ (2,206.4)

$1.1 billion 5.0% notes due 2042 $ — $ — $ — $ — $ — $ 1,100.0 $ 1,100.0 $ (1,376.0)

$1.8 billion 4.2% notes due 2046 $ — $ — $ — $ — $ — $ 1,800.0 $ 1,800.0 $ (2,087.1)

EUR 800 million 1.25% notes due 2024 $ — $ — $ — $ 977.3 $ — $ — $ 977.3 $ (1,013.8)

Foreign currency management:

Forwards $ 116.9 $ 56.3 $ 8.0 $ — $ — $ — $ 181.2 $ (4.9)

Cross currency swaps $ 400.0 $ — $ — $ — $ — $ — $ 400.0 $ (26.5)

Interest rate management:

Forward starting interest rate swaps $ 250.0 $ 250.0 $ — $ — $ — $ 1,000.0 $ 1,500.0 $ (221.5)

Commodity pricing management:

We are exposed to the volatility in commodity prices as we use commodities in the production and distribution of our products.

We specifically hedge our exposure to fluctuations in the price of natural gas, aluminum, barley and wheat.

We utilize market-based derivatives and long-term supplier-based contracts, specifically a combination of purchase orders, long-term supply contracts and over-the-counter financial instruments to mitigate our commodity price risk by establishing price certainty for commodities that are used in our supply chain.

The following table includes details of our commodity swaps and options used to hedge commodity price risk as well as the impact of a hypothetical 10% adverse change in the related commodity prices on the fair value of the derivatives.

Notional amounts and fair values are presented in USD based on the applicable exchange rate as of December 31, 2021 and December 31, 2020.

Approximately 62% of commodity swaps mature in 2022, 33% mature in 2023, and 5% mature in 2024 and thereafter.

Notional amounts Fair Value Asset/(Liability) Effect of 10% Adverse Change

(in millions) As of December 31, 2021 As of December 31, 2020 As of December 31, 2021 As of December 31, 2020 As of December 31, 2021 As of December 31, 2020

Swaps $ 722.1 $ 918.9 $ 300.8 $ 65.2 $ (95.7) $ (96.0)

Options $ 68.2 $ 16.8 $ 0.1 $ — $ — $ —

We hold warrants providing us with the ability to purchase 2.9 million common shares of HEXO, our Truss joint venture partner, at a strike price of CAD 24.00 per share, which expire on October 4, 2021.

The fair value of our warrant asset at December 31, 2020 was $0.3 million.

See Note 16, "Derivative Instruments and Hedging Activities" for further details.

Sensitivity Analysis

Our market sensitive derivative and other financial instruments, as defined by the SEC, are debt, foreign currency forward contracts, commodity swaps, commodity options, cross currency swaps, forward starting interest rate swaps and warrants.

We monitor foreign exchange risk, interest rate risk, commodity risk, equity price risk and related derivatives using a sensitivity analysis.

The following table presents the results of the sensitivity analysis, which reflects the impact of a hypothetical 10% adverse change in each of these risks to our derivative and debt portfolio, with the exception of interest rate risk to our forward starting interest rate swaps in which we have applied an absolute 1% adverse change to the respective instrument's interest rate:

December 31, 2020 December 31, 2019

(In millions)

Estimated fair value volatility

Foreign currency risk:

Forwards $ (20.5) $ (25.8)

Foreign currency denominated debt $ (190.4) $ (194.2)

Cross currency swaps $ (43.0) $ (89.2)

Interest rate risk:

$ (219.7) $ (255.4)

Forward starting interest rate swaps $ (177.1) $ (150.4)

Commodity price risk:

Commodity swaps $ (96.0) $ (52.9)

Commodity options $ — $ —

Equity price risk:

Warrants $ (0.1) $ (0.6)

The volatility of the applicable rates and prices are dependent on many factors that cannot be forecast with reliable accuracy.

Therefore, actual changes in fair values could differ materially from the results presented in the table above.

Ta b l e of C o n t e n t s

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7A. Quantitative and Qualitative Disclosures About Market Risk