Derivative Financial Instruments and Hedge Activities

The Company recognizes all derivative financial instruments as either assets or liabilities at fair value on the balance sheet. The accounting for changes in the fair value of a derivative depends on the use of the instrument. To the extent that a derivative is effective as a hedge of an exposure to future changes in cash flows, the change in fair value of the instrument is deferred in accumulated other comprehensive (loss) income (“AOCI”). Any portion considered to be ineffective is reported in earnings immediately, including changes in value related to credit risk. To the extent that a derivative is effective as a hedge of an exposure to future changes in fair value, the change in the derivative’s fair value is offset in the condensed consolidated statement of income by the change in fair value of the item being hedged. To the extent that a derivative or a financial instrument is effective as a hedge of a net investment in a foreign operation, the change in the derivative’s fair value is deferred as an unrealized currency translation adjustment in AOCI.

PPG’s policies do not permit speculative use of derivative financial instruments. PPG uses forward currency and option contracts as hedges against its exposure to variability in exchange rates on short-term intercompany transactions, unrecognized firm sales commitments and cash flows denominated in foreign currencies. PPG uses foreign denominated debt and cross currency swap contracts to hedge net investments in foreign operations. PPG also uses an equity forward arrangement to hedge the Company’s exposure to changes in the fair value of PPG stock that is to be contributed to the asbestos settlement trust as discussed in Note 20, “Commitments and Contingent Liabilities.”

Interest rate swaps are used from time to time to manage the Company’s exposure to changing interest rates as such rate changes affect the fair value of fixed rate borrowings. No interest rate swaps were outstanding in the three-month periods ended March 31, 2013 and 2012. Forward starting swaps were used in the first quarter 2012 to lock-in a fixed interest rate, to which was added a corporate spread, related to future long-term debt refinancings. PPG also used derivative instruments to manage its exposure to fluctuating natural gas prices through the use of natural gas swap contracts in the first quarter of 2012.

PPG enters into derivative financial instruments with high credit quality counterparties and diversifies its positions among such counterparties in order to reduce its exposure to credit losses. The Company did not realize a credit loss on derivatives during the three month periods ended March 31, 2013 or 2012.

PPG centrally manages certain of its foreign currency transaction risks to minimize the volatility in cash flows caused by currency fluctuations. Decisions on whether to use derivative financial instruments to hedge the net transaction exposures related to all regions of the world are made based on the amount of those exposures by currency and, in certain situations, an assessment of the near-term outlook for certain currencies. This net hedging strategy does not qualify for hedge accounting; therefore, the change in the fair value of these instruments is recorded in "Other charges" in the accompanying condensed consolidated statement of income in the period of change. As of March 31, 2013 and December 31, 2012, the fair value of these contracts was an asset of $0.4 million and an asset of less than $0.1 million, respectively.

PPG designates forward currency contracts as hedges against the Company’s exposure to variability in exchange rates on short-term intercompany borrowings and transactions denominated in foreign currencies. To the extent effective, changes in the fair value of these instruments are deferred in AOCI and subsequently reclassified to "Other charges" in the accompanying condensed consolidated statement of income as foreign exchange gains and losses are recognized on the related intercompany transactions. The portion of the change in fair value considered to be ineffective is recognized immediately in "Other charges" in the accompanying condensed consolidated statement of income. All amounts related to these instruments deferred in AOCI as of March 31, 2013 will be reclassified to earnings within the next twelve months. As of March 31, 2013 and December 31, 2012, the fair value of these instruments was a liability of $8 million and $1 million, respectively.

PPG designates forward currency contracts as hedges against the Company’s exposure to future changes in fair value related to certain firm sales commitments denominated in foreign currencies. These contracts are designated as fair value hedges. As such, they are reported at fair value in the Company’s condensed consolidated balance sheet, with changes in the fair value of these contracts and that of the related firm sales commitments reported in net sales. As of March 31, 2013, these contracts converted $41 million to the South Korean won over the 18 month period ending September 30, 2014. As of December 31, 2012, these contracts converted $56 million to the South Korean won over the 21 month period ending September 30, 2014. As of March 31, 2013 and December 31, 2012, the fair value of the contracts was an asset of $1 million and a net asset of $3 million, respectively.

As of January 1, 2012, PPG had nine U.S. dollar to euro cross currency swap contracts with a total notional amount of $1.16 billion, of which $600 million were to settle on March 15, 2013 and $560 million were to settle on March 15, 2018. In June 2012, $600 million of swaps, with a settlement date of March 15, 2013, were settled with PPG receiving $1 million in cash. On settlement of the remaining outstanding contracts, PPG will receive $560 million U.S. dollars and pay euros to the counterparties to the contracts. During the term of these contracts, PPG will receive semiannual payments in March and September of each year based on U.S. dollar, long-term fixed interest rates, and PPG will make annual payments in March of each year to the counterparties based on euro, long-term fixed interest rates. The Company designated all of the cross currency swaps as hedges of its net investment in certain European businesses and, as a result, the mark to market fair value adjustments of the swaps outstanding have been and will be recorded as a component of AOCI, and the cash flow impact of these swaps has been and will be classified as investing activities in the condensed consolidated statement of cash flows. As of March 31, 2013 and December 31, 2012, the fair value of these contracts was a net liability of $45 million and $95 million, respectively.

As of March 31, 2013 and December 31, 2012, PPG designated €300 million euro-denominated borrowings as a hedge of a portion of PPG’s net investment in the Company’s European operations. As a result, the change in book value from adjusting these foreign denominated borrowings to current spot rates was deferred in AOCI.

As of March 31, 2013 and December 31, 2012 the Company had accumulated pretax unrealized translation gains in AOCI of $49 million and $9 million, respectively, which related to both the euro-denominated borrowings and the cross currency swaps that have been designated as hedges of net investments.

Deferrals in AOCI related to hedges of the Company’s net investments in European operations would be reclassified and recognized in earnings upon a substantial liquidation, sale or partial sale of such investments or upon impairment of all or a portion of such investments.

The Company manages its interest rate risk by balancing its exposure to fixed and variable rates while attempting to minimize its interest costs. Generally, the Company maintains variable interest rate debt at a level of approximately 25 percent to 50 percent of total borrowings. PPG principally manages its fixed and variable interest rate risk by retiring and issuing debt from time to time and through the use of interest rate swaps. During the year ended December 31, 2012, PPG settled all outstanding interest rate swaps, which had converted $445 million of fixed rate debt to variable rate debt, and received $29 million from such settlements. When outstanding, the swaps were designated as fair value hedges. As such, they were carried at fair value. Changes in the fair value of these swaps and that of the related debt were recorded in "Interest expense" in the accompanying condensed consolidated statement of income.

The Company entered into forward starting swaps in 2009 and in the second quarter of 2010 to effectively lock-in a fixed interest rate for future debt refinancings with an anticipated term of 10 years based on the ten year swap rate, to which was added a corporate spread. The notional amount of the swaps outstanding totaled $400 million, which were settled on July 30, 2012, resulting in a cash payment of $121 million. To the extent that the swaps were effective, changes in the fair values of the swap contracts were deferred in AOCI. The portion of the change in fair value considered to be ineffective was recognized immediately in Other charges in the accompanying condensed consolidated statement of income. As of March 31, 2013, the amount deferred in AOCI was $113 million. This balance will be amortized to interest expense over the remaining term of the ten-year debt that was issued on July 31, 2012.

Derivative instruments have been used to manage the Company's exposure to fluctuating natural gas prices through the use of natural gas swap contracts. There were no natural gas swap contracts outstanding as of March 31, 2013 as the price of natural gas has declined for the past four years and is not expected to be as volatile over the next 12 to 18 months as continued development of shale oil and gas reserves will maintain downward pressure on the price of natural gas. In addition, the separation and merger of the former commodity chemicals business (see Note 5) reduces PPG's annual natural gas usage by approximately 70 percent. To the extent that these instruments were effective in hedging PPG’s exposure to price changes, changes in the fair values of the hedge contracts were deferred in AOCI and reclassified to "Cost of sales, exclusive of depreciation and amortization" as the natural gas was purchased. The amount of ineffectiveness was reported in "Other charges" in the accompanying condensed consolidated statement of income immediately. There was no balance in AOCI as of March 31, 2013 or December 31, 2012 related to the contracts.

PPG entered into a one-year renewable equity forward arrangement with a bank in 2003 in order to mitigate the impact on PPG earnings of changes in the fair value of 1,388,889 shares of PPG stock that are to be contributed to the asbestos settlement trust as discussed in Note 20, “Commitments and Contingent Liabilities.” This instrument, which has been renewed, is recorded at fair value as an asset or liability and changes in the fair value of this instrument are reflected in the "Asbestos settlement – net" caption of the accompanying condensed consolidated statement of income. The total principal amount payable for these shares is $62 million. PPG will pay to the bank interest based on the principal amount and the bank will pay to PPG an amount equal to the dividends paid on these shares during the period this instrument is outstanding. The difference between the principal amount and any amounts related to unpaid interest or dividends and the current market price for these shares, adjusted for credit risk, represents the fair value of the instrument as well as the amount that PPG would pay or receive if the bank chose to net settle the instrument. Alternatively, the bank may, at its option, require PPG to purchase the shares covered by the arrangement at the principal amount adjusted for unpaid interest and dividends as of the date of settlement. As of March 31, 2013 and December 31, 2012, the fair value of this contract was an asset of $129 million and $130 million, respectively.

No derivative instrument initially designated as a hedge instrument was undesignated or discontinued as a hedging instrument during the three month periods ended March 31, 2013 or 2012. Nor were any amounts deferred in AOCI reclassified to earnings during these periods related to hedges of anticipated transactions that were no longer expected to occur.

All of the outstanding derivative instruments are subject to accelerated settlement in the event of PPG’s failure to meet its debt obligations or payment obligations under the terms of the instruments’ contractual provisions. In addition, should the Company be acquired and its payment obligations under the derivative instruments’ contractual arrangements not be assumed by the acquirer, or should PPG enter into bankruptcy, receivership or reorganization proceedings, the instruments would also be subject to accelerated settlement.

For the first three months of 2013, "Other comprehensive income" included a pretax net gain due to cash flow hedge derivatives of $3 million ($1 million, net of tax). This net gain was comprised of realized losses of $6 million and unrealized losses of $3 million. The realized losses related to foreign currency contracts and the amortization of a portion of the balance deferred related to forward starting swaps. The unrealized losses related to the change in fair value of the foreign currency contracts.

For the first three months of 2012, "Other comprehensive income" included a pretax net gain due to cash flow hedge derivatives of $10 million ($6 million, net of tax). This net gain was comprised of realized losses of $4 million and unrealized gains of $6 million. The realized losses related to the settlement during the period of natural gas contracts, interest rate swaps owned by RS Cogen (Refer to Note 10, “Investments” for a discussion regarding this equity method investment), offset in part by realized gains on settlement of foreign currency contracts. The unrealized gains related to the change in fair value of forward starting swaps and foreign currency contracts, partially offset by unrealized losses related to the change in fair value of natural gas contracts and interest rate swaps owned by RS Cogen.

Refer to Note 3, “Fair Value Measurement,” for additional disclosures related to the Company’s derivative instruments outstanding as of March 31, 2013 and December 31, 2012.

The following table provides details for the three month period ended March 31, 2013 related to fair value, cash flow and net investment hedges by type of derivative and financial instrument. All amounts are pretax:



(Millions) Hedge Type	Gain (Loss) Deferred in OCI			Gain (Loss) Recognized
(Millions) Hedge Type	Gain (Loss) Deferred in OCI			Amount			Caption
Fair Value
Interest rate swaps	Not applicable			$	4		Interest expense
Foreign currency contracts (a)	Not applicable			—			Sales
Equity forward arrangements (a)	Not applicable			(1		)	Asbestos - net
Total Fair Value				$	3
Cash Flow
Forward starting swaps	—			(3		)	Interest expense
Foreign currency contracts (b)	(3		)	(3		)	Other charges
Total Cash Flow	$	(3	)	$	(6	)
Net Investment
Cross currency swaps (c)	$	28		$	—
Foreign denominated debt	11			Not applicable
Total Net Investment	$	39
Non-Hedge
Foreign currency contracts	Not applicable			$	—		Other charges
Total Non-Hedge				$	—


(a)	The ineffective portion related to each of these items was not greater than $0.1 million of income.


(b)	The ineffective portion related to this item was $2 million of expense.


(c)	The ineffective portion related to this item was $1 million of expense.

The following tables provide details for the three month period ended March 31, 2012 related to fair value, cash flow and net investment hedges by type of financial instrument. All amounts are pretax:



(Millions) Hedge Type	Gain (Loss) Deferred in OCI			Gain (Loss) Recognized
(Millions) Hedge Type	Gain (Loss) Deferred in OCI			Amount			Caption
Fair Value
Interest rate swaps (a)	Not applicable			$	2		Interest expense
Foreign currency contracts (a)	Not applicable			—			Sales
Equity forward arrangements (a)	Not applicable			18			Asbestos - net
Total Fair Value				$	20
Cash Flow
Natural gas swaps (a)	$	(4	)	$	(6	)	Cost of sales
Interest rate swaps of an equity method investee	—			—			Other earnings
Forward starting swaps (c)	8			—
Foreign currency contracts (b)	2			2			Other charges
Total Cash Flow	$	6		$	(4	)
Net Investment
Cross currency swaps (d)	$	(39	)	$	—
Foreign denominated debt	(12		)	Not applicable
Total Net Investment	$	(51	)
Non-Hedge
Foreign currency contracts	Not applicable			$	—		Other charges
Total Non-Hedge				$	—


(a)	The ineffective portion related to each of these items was not greater than $0.1 million of income or expense.


(b)	The ineffective portion related to this item was $3 million of income.


(c)	The ineffective portion related to this item was less than $0.6 million of income.


(d)	The ineffective portion related to this item was $0.4 million of expense.