Opportunity and Risk Report Opportunity and Risk Status As material reportable risks pursuant to German Accounting Standard No. 20, all high and medium – or at least significant in terms of potential impact – financial and nonfinancial risks, within the black outline in the rating matrix in Chapter “Group-wide Opportunity and Risk Management System” are reported as follows. By contrast, according to the system applied in the previous year, all risks with a total potential impact of €500 million were taken into account. In addition, we report relevant risks that from a financial point of view may not be sufficiently or meaningfully quantifiable, if at all. The risks reported in this section are described in detail and include the measures established to mitigate them (net risk). 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. The risk management processes were further developed compared with the previous year and the assessment method changed as described above. For this reason, a year-on-year comparison of risks is only possible to a limited extent and is therefore not illustrated here. Wherever relevant, we also describe segment-specific peculiarities of opportunities and risks. 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 “highly likely”. We did not identify any such risks in 2017. The following table provides an overview of the individual risk categories together with risk classes and the segments that are affected. The opportunities and risks resulting from the planned acquisition of Monsanto are described in detail in the following chapter. Overview of Material Risk Areas Risk category Risk class Affected segment(s) or Group1 Strategic risks External network and partnerships Medium PH, Group Operational performance risks Intellectual property Medium PH, CS Research and development High PH, CS2 Market supply Medium CS Personnel Medium Group Information technology Medium Group Finance, accounting and tax Medium Group Safety, quality and compliance risks Product safety Medium PH, CS Health, safety and environment Medium Group Quality and regulatory requirements High CS, PH2 Legal compliance See Chapter “Legal compliance” External risks Business markets Medium PH, CS, CH Political, social and macroeconomic environment Medium CS Natural disasters and crises Medium PH, Group 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 External network and partnerships We collaborate with partners along the value chain of our products. Suboptimum performance by collaboration partners may affect the development, manufacture or marketing of our products and services and adversely impact our business. 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. Furthermore, some materials, particularly in our Pharmaceuticals segment, are provided by only a very limited number of suppliers. Production could be disrupted by delays in delivery. Price adjustments may also occur that could have a negative impact on our margin. We counter these risks by establishing alternative suppliers, concluding long-term agreements, expanding inventories or producing raw materials ourselves. Strategic Material Review Committees (SMRCs) regularly examine and assess the supplier risks. From the perspective of the Group as a whole, there is a risk that our corporate values, ethical requirements, compliance and sustainability are not adequately accounted for by our external network and our partners. We counter this risk through an evaluation process, a code of conduct for suppliers, and supplier evaluations and audits. Intellectual property The Bayer Group, now as in the past, 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. Research and development We believe that our innovation strength holds opportunities both for the continued development of our brands and for the expansion of the research pipeline in all of our businesses. 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 in the long term. Despite all our efforts, we cannot assure 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 achieve and retain planned approval / registration or commercial success. Among other factors, this may result from the failure to meet technical, capacity- and time-related requirements or the inability to meet trial objectives in product development. 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. The Bayer Group seeks to counter this risk by way of holistic portfolio management in order to estimate the probability of success and prioritize its development projects. Market supply Despite all precautions, operations at our sites may be disrupted by fires, power failures, cyber attacks or supply disruptions. This also applies to external partners. If we are unable to meet demand for our products, 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 based on the respective corporate policy has been implemented at all our production sites as a mandatory component of our HSEQ schließen HSEQ stands for health, safety, environment and quality. management. Personnel 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, an inadequate and nontransparent company culture and strategy, as well as the resulting objectives and demands placed on employees, could lead to declining motivation and unsatisfactory performance and have a negative impact on Bayer’s attractiveness as an employer. Based on our analysis of future requirements, we design appropriate employee recruitment and development measures. In addition, the alignment of our company culture toward diversity schließen Diversity designates the variation within the workforce in terms of gender, origin, nationality, age, religion, sexual orientation and physical capability. 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, enabling us to constantly motivate our employees. Information technology Business and production processes and the internal and external communications of the Bayer Group are dependent on global IT systems. The confidentiality of internal and external data is of fundamental importance to Bayer in this connection. A loss of data confidentiality, integrity or authenticity, for example due to (cyber) attacks, could lead to manipulation and / or the uncontrolled outflow of data and know-how. Measures undertaken to counter this risk include the high-intensity testing of new technologies to be deployed and the implementation of projects to keep technical security standards up to date and proactively examine new threats (e.g. Information Security@Bayer, Cyber Security Initiative, User Awareness). In addition, the existing IT infrastructure is protected against unwanted access through security measures by the Corporate Cyber Defense Center. Finance, accounting, tax Liquidity risk Liquidity risks reflect the possible inability of the Bayer Group to meet current or future payment obligations. The liquidity risk is 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 whose amount is regularly reviewed and adjusted. Credit facilities also exist with banks, including, in particular, an undrawn €3.5 billion syndicated revolving credit facility with a current maturity of 2020. 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. Some of these receivables are collateralized, and the collateral is used according to local conditions. These include credit insurances and guarantees. 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 Group 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 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 and interest-rate risks are explained 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 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 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 and equity (other comprehensive income) as of December 31, 2017, by €346 million (December 31, 2016: €380 million). Of this amount, €155 million is related to the U.S. dollar (USD), €66 million to the Chinese renminbi (CNY), €44 million to the Japanese yen (JPY) and €40 million to the Canadian dollar (CAD). 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 improved or diminished other comprehensive income by €353 million. 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 based on our net floating-rate receivables and payables position at year end 2017, 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, 2017, would have raised our interest expense for the year ended December 31, 2017, by €13 million (December 31, 2016: €31 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 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. We counter the resulting risks by continuously identifying and evaluating the tax framework. Product safety Bayer evaluates the potential health and environmental risks of a product along the entire value chain. 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. We counter these risks through our organizational and operational structure in the areas of pharmaceutical and crop protection product safety and testing. In addition, Crop Science has a comprehensive stewardship program in place. Health, safety and environment We attach great importance not only to product safety but also to protecting our employees and the environment. Misconduct and noncompliance with these requirements may result in personal injury, property, reputation and environmental damage, loss of production, business interruptions and / or liability for compensation payments. With our principles, standards and measures, we ensure that our requirements are adequately communicated, understood and optimally implemented. Quality and regulatory requirements In almost every country where we operate, our business activity is subject to extensive regulations, standards, requirements and inspections. Due to growing public and regulatory expectations, we continue to anticipate considerably more stringent regulatory requirements; for example for 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. The presence of traces of unwanted genetically modified organisms in agricultural products and / or foodstuffs cannot be entirely excluded. Potential infringements of current or changing 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. Changed requirements can also lead to higher product development costs and times as well as a necessary adjustment in the product portfolio. We counter these risks through binding principles and standards, and implemented control mechanisms. Changes in regulatory requirements are monitored to ensure their implementation. Quality requirements are defined and implemented in global quality management systems. Legal 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, anticorruption law, patent law, tax law, data protection 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 hamper our commercial success. Bayer has established a global compliance management system to ensure the observance of laws and regulations. Business market There is a risk that our growth and market share could be impeded by increasing global cost pressure on health care systems, as well as price regulations. Government price controls, in part due to global cost pressure on health care systems, could reduce earnings from our pharmaceutical products and may occasionally make the market launch of a new product unprofitable. Furthermore, our growth and the development of our market share could be negatively affected by innovative and aggressive (pricing) policies by competitors, including generic competitors. We expect the current extent of regulatory controls and pricing pressure to persist or increase. We are responding to this trend by expanding in-house research and development capacities and through acquisitions and collaborations. The current global consolidation process in the seeds and crop protection is also altering our future competitive environment. We also see a risk in the Crop Science segment that digitalization could fundamentally change markets for seeds and crop protection products, and have an impact on value creation and access to markets and customers. Should we be unable to profit from or counteract these developments through suitable initiatives, this could lead to a loss of customers, market share or business value and necessitate higher subsequent investments. We are countering this risk in part through our Digital Farming Initiative, in which we utilize findings from the analysis and interpretation of agricultural data, and through selected further acquisitions and broadly based scientific and commercial partnerships. The risk of existing business models being disrupted by digitalization or 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 or market share. In the context of initiatives, we monitor the market very closely and develop strategies to illustrate developments in our business models. Political, social and macroeconomic environment 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. Modern agricultural methods, the application of certain classes of crop protection products and the use of genetic engineering are repeatedly the subject of intense public debate. This political opinion-forming may yield legislative and regulatory decisions that significantly limit the use of our products or even result in voluntary or mandated product withdrawals. In addition, decisions could also affect agricultural imports from other parts of the world and therefore our business in those regions. To mitigate such risks, we are closely monitoring the regulatory and legislative decision-making processes and developing our product portfolio with a view to the anticipated changes. We are also engaged in a constant dialogue with interest groups and regulators to promote a scientifically founded, rational and responsible discussion and decision-making process. The opportunities for our agricultural businesses arise from global population growth and the increasing demand for food. In addition, consumer behavior in some regions is shifting toward higher 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 pesticide resistance. We expect the demand for high-quality seed and crop protection products to rise in light of the need to produce sufficient food and animal feed to meet the growing demand in spite of limited acreages. In response, Crop Science is developing processes to more effectively protect plants against climatic and environmental influences and raise crop yields, for example. The increase in quality of life and life expectancy is leading to a heightened focus on the medical care needs of elderly patients. Our concentration on certain partly age-related diseases such as cancer or chronic cardiovascular disorders harbors opportunities for us. In response to 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. Natural disasters and crises Our business activities could be affected by natural disasters, pandemics and epidemics, terrorist activities or comparable critical events. For example, some of our production sites are located in regions that could be affected by natural disasters such as flooding or earthquakes. Such events could cause stoppages at production plants or other disruptions, or result in personal injury and damage to our reputation, as well as lead to declines in sales and / or margins and necessitate the reconstruction of damaged infrastructure. We address these risks through our local crisis organizations, which, among other things, provide response plans. We have implemented early warning systems, ensure continuous reporting and carry out regular crisis simulation exercises. In addition, we have established global safety communities, and the Business Continuity Management department within the Group Risk Management function assesses such risks and defines appropriate measures together with the responsible specialist units.