FINANCIAL INSTRUMENTS

In its normal operations, Linde is exposed to market risks relating to fluctuations in interest rates, foreign currency exchange rates, energy costs and to a lesser extent precious metal prices. The objective of financial risk management at Linde is to minimize the negative impact of such fluctuations on the company’s earnings and cash flows. To manage these risks, among other strategies, Linde routinely enters into various derivative financial instruments (“derivatives”) including interest-rate swap and treasury rate lock agreements, currency-swap agreements, forward contracts, currency options, and commodity-swap agreements. These instruments are not entered into for trading purposes and Linde only uses commonly traded and non-leveraged instruments.

There are three types of derivatives that the company enters into: (i) those relating to fair-value exposures, (ii) those relating to cash-flow exposures, and (iii) those relating to foreign currency net investment exposures. Fair-value exposures relate to changes in the fair value of recognized assets or liabilities, primarily financial assets and financial liabilities, and firm commitments. Cash-flow exposures relate to the variability of future cash flows associated with recognized assets or liabilities, or forecasted transactions for which no underlying exposure is yet reported in the consolidated balance sheet. Net investment exposures relate to the impact of foreign currency exchange rate changes on the carrying value of net assets denominated in foreign currencies.

When a derivative is executed and hedge accounting is appropriate, it is designated as either a fair-value hedge, cash-flow hedge, or a net investment hedge. Currently, Linde designates the majority of interest-rate and treasury-rate locks as hedges for accounting purposes; however, currency contracts are generally not designated as hedges for accounting purposes unless they are related to forecasted transactions. Whether designated as hedges for accounting purposes or not, all derivatives are linked to an appropriate underlying exposure. On an ongoing basis, the company assesses the hedge effectiveness of all derivatives designated as hedges for accounting purposes to determine if they continue to be highly effective in offsetting changes in fair values or cash flows of the underlying hedged items. If it is determined that the hedge is not highly effective, then hedge accounting will be discontinued prospectively.

Counterparties to Linde’s derivatives are major banking institutions with credit ratings of investment grade or better. As of year-end, Linde AG had existing Credit Support Annexes ("CSAs") in place with their principal counterparties to minimize potential default risk and to mitigate counterparty risk. Under the CSAs, the fair values of derivatives for the purpose of interest rate and currency management are collateralized with cash on a regular basis. As of December 31, 2018, the impact of such collateral posting arrangements on the fair value of derivatives was insignificant. Management believes the risk of incurring losses on derivative contracts related to credit risk is remote and any resulting losses would be immaterial.

The following table is a summary of the notional amount and gross fair values of derivatives outstanding at December 31, 2018 and 2017 for consolidated subsidiaries:



					Fair Value
(Millions of dollars)	Notional Amounts				Assets (a)				Liabilities (a)
December 31,	2018		2017		2018		2017		2018		2017
Derivatives Not Designated as Hedging Instruments:
Currency contracts:
Balance sheet items	$	6,357	$	2,693	$	24	$	16	$	42	$	16
Forecasted transactions	945		—		15		—		17		—
Interest rate/Cross-currency interest rate swaps	2,110		—		112		—		40		—
Commodity contracts	—		—		27		—		9		—
Derivatives Designated as Hedging Instruments:
Currency contracts:
Balance sheet items	$	—	$	38	$	—	$	—	$	—	$	2
Forecasted transactions	158		4		2		1		3		—
Interest rate contracts:
Interest rate swaps	2,164		475		13		—		10		—
Total Hedges	$	2,322	$	517	$	15	$	1	$	13	$	2
Total Derivatives	$	11,734	$	3,210	$	193	$	17	$	121	$	18

(a) Current assets of $67 million are recorded in prepaid and other current assets; long-term assets of $126 million are recorded in other long-term assets; current liabilities of $78 million are recorded in other current liabilities; and long-term liabilities of $43 million are recorded in other long-term liabilities.

Balance Sheet Items

Foreign currency contracts related to balance sheet items consist of forward contracts entered into to manage the exposure to fluctuations in foreign-currency exchange rates on recorded balance sheet assets and liabilities denominated in currencies other than the functional currency of the related operating unit. Certain forward currency contracts are entered into to protect underlying monetary assets and liabilities denominated in foreign currencies from foreign exchange risk and are not designated as hedging instruments. For balance sheet items that are not designated as hedging instruments, the fair value adjustments on these contracts are offset by the fair value adjustments recorded on the underlying monetary assets and liabilities.

Linde also enters into forward currency contracts, which are designated as hedging instruments, to limit the cash flow exposure on certain foreign-currency denominated intercompany loans. The fair value adjustments on these contracts are recorded to AOCI, with the effective portion immediately reclassified to earnings to offset the fair value adjustments on the underlying debt instrument.

Forecasted Transactions

Foreign currency contracts related to forecasted transactions consist of forward contracts entered into to manage the exposure to fluctuations in foreign-currency exchange rates on (1) forecasted purchases of capital-related equipment and services, (2) forecasted sales, or (3) other forecasted cash flows denominated in currencies other than the functional currency of the related operating units. For forecasted transactions that are designated as cash flow hedges, fair value adjustments are recorded to AOCI with deferred amounts reclassified to earnings over the same time period as the income statement impact of the associated purchase. For forecasted transactions that do not qualify for cash flow hedging relationships, fair value adjustments are recorded directly to earnings.

Interest Rate/Cross-Currency Interest Rate Swaps

Cross-currency interest rate swaps are entered into to limit the foreign currency risk of future principal and interest cash flows associated with intercompany loans, and to a more limited extent bonds, denominated in non-functional currencies. The fair value adjustments on the cross-currency swaps are recorded to earnings, where they are offset by fair value adjustments on the underlying intercompany loan or bond.

Commodity Contracts

Commodity contracts are entered into to manage the exposure to fluctuations in commodity prices, which arise in the normal course of business from its procurement transactions. To reduce the extent of this risk, Linde enters into a limited number of electricity, natural gas, and propane gas derivatives. As of December 31, 2018 these commodity contracts were not designated as cash flow hedges. Therefore, the fair value adjustments on these contracts are recorded to earnings and are eventually offset by the income statement impact of the underlying commodity purchase.

Net investment hedges

In 2014, Praxair designated the €600 million 1.50% Euro-denominated notes due 2020 and the €500 million ($568 million as of December 31, 2018) 1.625% Euro-denominated notes due 2025, as a hedge of the net investment position in its European operations. In 2016, Praxair designated an incremental €550 million ($628 million as of December 31, 2018) 1.20% Euro-denominated notes due 2024 as an additional hedge of the net investment position in its European operations.

On October 31, 2018 Praxair and Linde AG combined their respective businesses through an all-stock transaction and became subsidiaries of the company. In December 2018, as a condition of the merger, Praxair completed the sale of the majority of its European operations to Taiyo Nippon Sanso Corporation. This significantly reduced the net investment position in Praxair's European operations. During the same month Praxair also repaid the €600 million 1.50% Euro-denominated notes due 2020, which significantly reduced the debt balance designated as a hedge. In response to the above transactions, Praxair de-designated €965 million of its Euro-denominated notes. At December 31, 2017 Praxair had de-designated €200 million of its Euro-denominated notes in response to the U.S. government-enacted Tax Cuts and Jobs Act and associated decrease in the tax rate.

These Euro-denominated debt instruments reduce the company's exposure to changes in the currency exchange rate on investments in foreign subsidiaries with Euro functional currencies. Since hedge inception, exchange rate movements have reduced long-term debt by $202 million (long-term debt decreased by $105 million during the year ended December 31, 2018), with the offsetting gain shown within the cumulative translation component of AOCI in the consolidated balance sheets and the consolidated statements of comprehensive income.

Interest Rate Swaps

Linde uses interest rate swaps to hedge the exposure to changes in the fair value of financial assets and financial liabilities as a result of interest rate changes. These interest rate swaps effectively convert fixed-rate interest exposures to variable rates; fair value adjustments are recognized in earnings along with an equally offsetting charge/benefit to earnings for the changes in the fair value of the underlying financial asset or financial liability. The following table summarizes the outstanding interest rate swaps for Linde as of December 31, 2018:



	2018					2017
(Millions of dollars)	US$ Derivative Notional		Change in Fair Value (b)			US$ Derivative Notional		Change in Fair Value
Underlying debt instrument:
1.00% Euro denominated notes due 2028	$	516	$	8		$	—	$	—
1.25% Notes due 2018 (a)	—		—			475		—
0.250% Euro denominated notes due 2022	344		2			—		—
2.00% Euro denominated notes due 2023	287		2			—		—
3.875% Euro denominated notes due 2021	287		1			—		—
5.875% GBP denominated notes due 2023	254		1			—		—
1.75% Euro denominated notes due 2019	229		(1		)	—		—
1.75% Euro denominated notes due 2020	132		—			—		—
1.875% Euro denominated notes due 2024	115		1			—		—
	$	2,164	$	14		$	475	$	—

________________________

(a) At December 31, 2017, Praxair had one outstanding interest rate swap agreement with a $475 million notional amount related to the $475 million 1.25% notes maturing in November 2018. The increase in the fair value of this note was less than $1 million. In November 2018 the notes were repaid and the associated fixed-to-variable interest rate swap was settled.

(b) In connection with the merger, Linde AG's assets and liabilities were measured at estimated fair value as of October 31, 2018.

Terminated Treasury Rate Locks

The following table summarizes the unrecognized gains (losses) related to terminated treasury rate lock contracts:



					Unrecognized Gain / (Loss) (a)
(Millions of dollars)	Year Terminated	Original Gain / (Loss)			12/31/2018			12/31/2017
Treasury Rate Locks
Underlying debt instrument:
$500 million 2.20% fixed-rate notes that mature in 2022 (b)	2012	$	(2	)	$	—		$	(1	)
$500 million 3.00% fixed-rate notes that mature in 2021 (b)	2011	(11		)	(3		)	(4		)
$600 million 4.50% fixed-rate notes that mature in 2019 (b,c)	2009	16			—			3
Total – pre-tax					$	(3	)	$	(2	)
Less: income taxes					1			1
After- tax amounts					$	(2	)	$	(1	)

________________________

(a)

The unrecognized gains / (losses) for the treasury rate locks are shown in accumulated other comprehensive income ("AOCI") and are being recognized on a straight line basis to interest expense – net over the term of the underlying debt agreements. Refer to the table below summarizing the impact of the company’s consolidated statements of income and AOCI for current period gain (loss) recognition.


(b)	The notional amount of the treasury rate lock contracts are equal to the underlying debt instrument with the exception of the treasury rate lock contract entered into to hedge the $600 million 4.50% fixed-rate notes that mature in 2019. The notional amount of this contract was $500 million.


(c)	In December 2018, Linde repaid $600 million of 4.50% notes that mature in 2019. The unrecognized gain on the associated treasury rate lock was reclassified from other comprehensive income to interest expense.

Impact of derivative instruments on earnings and AOCI

The following table summarizes the impact of the company's derivatives not designated as hedging instruments on the consolidated statements of income:



(Millions of dollars)	Amount of Pre-Tax Gain (Loss) Recognized in Earnings *
December 31,	2018			2017		2016
Derivatives Not Designated as Hedging Instruments
Currency contracts:
Balance sheet items:
Debt-related	$	(118	)	$	121	$	21
Other balance sheet items	3			—		4
Total	$	(115	)	$	121	$	25

* The gains (losses) on balance sheet items are offset by gains (losses) recorded on the underlying hedged assets and liabilities. Accordingly, the gains (losses) for the derivatives and the underlying hedged assets and liabilities related to debt items are recorded in the consolidated statements of income as interest expense-net. The gains (losses) on other balance sheet items are recorded in the consolidated statements of income as other income (expenses)-net.

The following table summarizes the impact of the company's derivatives designated as hedging instruments that impact AOCI:



(Millions of dollars)	Amount of Gain (Loss) Recognized in AOCI								Amount of Gain (Loss) Reclassified from AOCI to the Consolidated Statement of Income
December 31,	2018		2017			2016			2018			2017		2016
Derivatives Designated as Hedging Instruments**
Currency contracts:
Net investment hedge	$	—	$	—		$	(4	)	$	—		$	—	$	—
Forecasted transactions	—		1			—			—			—		—
Balance sheet items	—		(1		)	1			—			—		—
Interest rate contracts:
Treasury rate locks	—		—			—			(1		)	—		(1		)
Total – Pre tax	$	—	$	—		$	(3	)	$	(1	)	$	—	$	(1	)
Less: income taxes	—		—			—			—			—		1
Total - Net of Taxes	$	—	$	—		$	(3	)	$	(1	)	$	—	$	—

** The gains (losses) on net investment hedges are recorded as a component of AOCI within foreign currency translation adjustments in the consolidated balance sheets and consolidated statements of comprehensive income. The gains (losses) on forecasted purchases, balance sheet items, and treasury rate locks are recorded as a component of AOCI within derivative instruments in the consolidated balance sheets and the consolidated statements of comprehensive income. There was no ineffectiveness for these instruments during 2018 or 2017. The gains (losses) on net investment hedges are reclassified to earnings only when the related currency translation adjustments are required to be reclassified, usually upon sale or liquidation of the investment. The gains (losses) for interest rate contracts are reclassified to earnings as interest expense –net on a straight-line basis over the remaining maturity of the underlying debt. Net losses of less than $1 million are expected to be reclassified to earnings during 2019.