Risk report

BASF Risk management's goal is to identify and evaluate risks as early as possible, limit business losses by taking suitable measures and avoid risks that pose a threat to the company’s continued existence. Moreover we use risk and opportunity assessments as a strategic planning instrument.

Organization, responsibilities and tools

Regular risk analyses are conducted by BASF's Chief Compliance Officer and the following units:

Corporate Controlling
Environment, Health & Safety
Finance
Global Procurement & Logistics
Human Resources
Legal, Taxes & Insurance
Strategic Planning & Controlling

Specific risks pertaining to operating divisions and units are continually registered, evaluated and monitored centrally. The Board of Executive Directors regularly receives reports on the risk situation of the BASF Group. We continually monitor certain risk areas with the help of performance data and indicators, and reports are immediately submitted if pre-defined risk thresholds are reached. The Board of Executive Directors is informed by means of monthly reports on the current and expected development of the business as well as the risks and opportunities. Strategic opportunities and risks are assessed as part of the regularly monitored product and regional strategies and weighed up against one another.

Our risk management process is continually being further developed. In 2007, we installed a new IT system for the quantitative recording and aggregation of opportunities and risks. In addition we are developing a new method of detailed analysis of opportunities and risks regarding the volatility of raw materials prices that takes the value adding chains of the BASF-Verbund into account.

Corporate Audit continually examines the functioning and effectiveness of our risk management systems as well as its continual development and its integration into business processes. The auditing of system for early risk recognition forms a part of the audit.

Internal Control

Corporate Audit acts on behalf of the Board of Executive Directors and operates throughout all divisions of the BASF Group. It audits:

the adherence to directives, guidelines, approval limits and anti-trust regulations;
safeguarding of assets and the attainment of an appropriate rate of return on invested capital;
the organization and its processes in terms of efficiency, effectiveness and compliance;
the functionality and reliability of the risk management system; and
the reliability of reporting

The general principles of risk avoidance, such as the segregation of duties and dual control, form the basic foundation of internal control. In addition, we have introduced guidelines for currency hedging, financial investments and the use of derivative financial instruments to hedge against price and market risks or as an alternative to original financial instruments.

In 2007, we continued to use the system introduced in accordance with the Sarbanes-Oxley Act to assess our internal controls for financial reporting purposes and further improved efficiency. The effectiveness of the control system is confirmed by management's self-assessment. We will continue to assess the internal controls for financial reporting after the delisting of BASF from the NYSE and the deregistration from the American Securities and Exchange Commission.

Risk controlling

The Strategic Planning and Controlling and Finance divisions are responsible for centralized risk controlling. They regularly inform the Board of Executive Directors.

Corporate systems

The Strategic Planning & Controlling division ensures that the risk management standards are implemented and further develops methods and tools. The division is responsible for worldwide communication with the operating units, corporate divisions, competence centers as well as the regional divisions and coordinates the identification of all significant risks for BASF throughout the company and systematically evaluates them according to uniform standards.

Fourteen operating divisions bear responsibility for the business operations of the BASF Group. It therefore follows that operational risk management is focused in these units. We have also established decentralized risk controlling units in the competence centers and regional divisions that work closely with the centralized units.

Financial risks

We monitor and control financial risks in the Treasury department of the Corporate Center or through appropriately authorized Group companies. Detailed guidelines and procedures exist for dealing with financial risks. Among other things, they provide for separate trading and processing functions.

Currency, interest rate and price risks: These risks are hedged using derivative instruments.

Risks from commodity positions: In connection with the catalysts business, BASF holds large positions in base and precious metals whose value is exposed to market price volatility. These positions can also encompass derivatives. They are only entered into within fixed limits and exposure constraints and are subject to constant monitoring.

Liquidity risks: We promptly recognize any risks from cash flow fluctuations using our liquidity planning system. We ensure a balanced debt repayment profile through the issuing of long-term bonds and thus reduce our refinancing risks. We have ready access to sufficient liquid funds in view of our good credit ratings, the ongoing commercial paper program and committed credit lines from banks.

Credit risk and default risk: We limit country-specific risks through internal country ratings, which are continually updated to reflect changing environment conditions. We use export credit insurance and investment guarantees as the main tools to limit specific country-related risks.

We lessen credit risks for our financial investments by engaging in transactions only with business partners and banks with good credit ratings and by adhering to fixed limits. Monetary transactions are also conducted through such banks. We reduce the risk of default on receivables by continually monitoring the creditworthiness and payment behavior of customers and by setting appropriate credit limits. Risks are also limited through the use of credit insurance and bank guarantees.

Pension obligations: We predominantly finance company pension obligations externally through separate pension assets. In addition to the pension plans of our Group companies in North America, this applies particularly to BASF Pensionskasse VVaG and the BASF Pensionstreuhand e.V. in Germany. We address the risk of pension plan underfunding due to market volatility of plan assets by aligning the investment strategy in terms of return and risk optimization to the structure of the pension obligations. Furthermore, we are reducing this risk by increasingly offering employees defined contribution schemes.

Supply risks

The availability and price volatility of feedstock especially of oil products and precious metals, pose a special risk for BASF. Therefore in 2007, we implemented a method with which we can capture the opportunities and risks arising out of raw materials price volatility with regard to the value adding chains of the BASF-Verbund and consequently take any appropriate actions. We reduce our risks through the diversification of our portfolio from the oil and gas business all the way through to our high value products. Our global purchasing activities, long-term supply contracts and a diversification of our suppliers, as well as optimized procedures for the purchase of additional quantities of raw materials on spot markets make an important contribution to risk minimization. We minimize remaining cost risks through commodity derivatives. We address the risks from changes in the market for raw materials in the mid- and long term by developing new technologies.

Market risks

In addition to the risks arising from the development of the overall economy, fluctuations in demand in key customer segments as well as competition in sales markets by nature present further risks. We reduce these risks through operative measures such as working in close collaboration with our customers and developing tailored system solutions as well as through strategic measures such as geographic diversification, the continuous development of innovative products and systems and active portfolio management. Diversification of our portfolio and the continuous focus on businesses resistant to cyclicality take center stage. The latter is reflected for example in the acquisitions in the areas of catalysts and construction chemicals. Further examples of our continuous measures for portfolio optimization are the asset swap with Gazprom and the planned sale of parts of our styrenics business.

Economic cycle risks

Economic risks are presenting themselves in the form of continued high oil prices as well as increasing foreign currency instability in the global markets. On the production side we counter foreign currency risks through our local production sites. However on the market side we face risks through our key customer industries. The problems on the U.S. real estate and financial markets had a negative effect on the housing market and private consumption. There is the risk that the credit crisis may deteriorate into a longer crisis of confidence. An increase in the interest rates on loans has an impact on our customers’ interest-rate sensitive industries such as the construction, automotive and capital goods industries. It is hard to estimate the magnitude of the global impact that an intensifying US financial crisis will have, it can however be considerable. In addition, an aggravation of geopolitical tensions and the destabilization of currently politically stable systems pose risks.

Regulatory risks

As of June 1, 2007, a new European chemicals directive REACH setting forth terms for the registration, evaluation and authorization of chemicals came into effect. With its networked structure and extensive product portfolio, BASF is one of the companies most heavily affected. BASF is aware of the demands and therefore started preparing for REACH several years ago. We will register approximately 2,500 substances under the terms of REACH. We expect annual costs of around €50 million until completion of its implementation in 2018. Despite good preparation and planning we and our European customers face disadvantages due to the cost intensive test and registration procedures of REACH in comparison to our non- European competitors.

Within the framework of E.U. emissions trading the BASF Group was allocated allowances for 2007. Affected plants at our European sites were allocated allowances for approximately 7 million metric tons of carbon dioxide (CO²). For the second trading period from 2008 until 2012, a number of chemical plants will also be included in the Europe-wide trading system. Moreover increased pressure from the E.U. commission could give rise to stringent guidelines for further reductions which may mean additional costs for BASF.

The application procedure for the allocation of emission certificates for the second trading period is currently in process. A decision has not yet been reached by the authorities.

Other significant risks

Research and Development: Because of the high degree of complexity and uncertainty involved in chemical and biological research, there is a risk that projects might be discontinued or that developed products will not receive approval for marketing. We lessen this risk through our global Know-how Verbund, our collaboration with our partners and customers as well as our innovation process whereby efficiency, chances of success and general conditions of research projects are continuously reviewed.

Risks arising from acquisition and investment decisions: The implementation of acquisitions and capital investment decisions bring with them complex risks, therefore implementation and follow-up are subject to specified processes. The risk assessment for the businesses acquired in 2006 was integrated in the BASF risk management process with the focus being placed in each case on business-relevant risk areas.

Exploration risk: The search for new oil and gas reserves is dependent on geological conditions. We lessen such risks by means of a balanced exploration portfolio.

IT risks: To reduce possible risks, BASF has an integrated, Group-wide-standardized IT infrastructure and applications, back-up systems, replicated databases, viruses and access protection, and encoding systems. Risk management results from Group-wide regulations for organization and application as well as an internal control system based on this.

Patent risks: The Global Intellectual Property department of BASF SE, together with the appropriate units of the U.S.-based BASF Corporation and BASF Coatings, Munster, Germany monitors all the intellectual property rights of BASF. At the same time, we aim to avoid patent and licensing disputes as far as possible through our extensive clearance research.

Prospective candidates for specialist and management positions: Demographic change and international competition for highly qualified specialist and management positions are new challenges for human resources. To meet these demands, we have initiated regional projects to analyze local employment markets and to plan for mid- to long-term recruiting.

Corporate Security: BASF's Corporate Security department, through its Group-wide network, works in close cooperation with local security authorities to develop measures to protect BASF from worldwide security risks.

Legal risks: We limit risks from potential wrongdoing or legal infringements by using compliance programs, and centralized contract management. ///