Financial Instruments, Hedging Activities and Fair Value Measurements

Financial instruments include cash and cash equivalents, short-term investments, cash held in escrow, marketable equity securities, accounts receivable, company-owned life insurance, accounts payable, short-term and long-term debt instruments, and derivatives. The fair values of these financial instruments approximated their carrying values at March 31, 2018 and December 31, 2017, in the aggregate, except for long-term debt instruments.

Hedging Activities

The Company has exposure to market risk from changes in foreign currency exchange rates and interest rates. As a result, financial instruments, including derivatives, have been used to hedge these underlying economic exposures. Certain of these instruments qualify as cash flow, fair value and net investment hedges upon meeting the requisite criteria, including effectiveness of offsetting hedged or underlying exposures. In certain cases, PPG employs foreign currency contracts to economically hedge net foreign currency exposures, which do not qualify for hedge accounting. Accordingly, changes in the fair value of such derivatives are recognized in income from continuing operations in the period incurred.

PPG’s policies do not permit speculative use of derivative financial instruments. 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, 2018 and 2017.

All of PPG's outstanding derivative instruments are subject to accelerated settlement in the event of PPG’s failure to meet its debt 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.

There were no derivative instruments de-designated or discontinued as hedging instruments during the three month periods ended March 31, 2018 and 2017 and there were no gains or losses deferred in AOCI that were reclassified to income from continuing operations during the three month periods ended March 31, 2018 and 2017 related to hedges of anticipated transactions there were no longer expected to occur.

Fair Value Hedges

The Company manages its interest rate risk by balancing its exposure to fixed and variable rates while attempting to minimize its interest costs. PPG principally manages its fixed and variable interest rate risk by retiring and issuing debt from time to time and occasionally through the use of interest rate swaps. In February of 2018, PPG entered into interest rate swaps which converted $525 million of fixed rate debt to variable rate debt. The swaps are designated as fair value hedges. As such, these swaps are carried at fair value. Changes in the fair value of these swaps and that of the related debt are recorded in “Interest expense” in the accompanying consolidated statement of income. There were no interest rate swaps outstanding as of December 31, 2017. However, in prior years PPG settled interest rate swaps and received cash. The fair value adjustment of the debt at the time the interest rate swaps were settled continues to be amortized as a reduction to interest expense over the remaining term of the related debt, which matures in 2021. The amount being amortized to interest expense is insignificant.

As of March 31, 2018 and December 31, 2017, there were no outstanding foreign currency forward contracts designated as hedges against future changes in the fair value of certain firm sales commitments.

Cash Flow Hedges

PPG designates certain foreign currency forward contracts as cash flow hedges of the Company’s exposure to variability in exchange rates on intercompany and third party transactions denominated in foreign currencies.

Net Investment Hedges

PPG uses cross currency swaps and euro-denominated debt to hedge a portion of its net investment in its European operations.

In February 2018, PPG entered into U.S. dollar to euro cross currency swap contracts with a total notional amount of $575 million and designated these contracts as hedges of the Company's net investment in its European operations. During the term of these contracts, PPG will receive payments in U.S. dollars and make payments in euros to the counterparties. The Company also settled outstanding U.S. dollar to euro cross currency swap contracts with a total notional amount of $560 million. At settlement of the outstanding contracts, PPG received $560 million U.S. dollars and paid euros to the counterparties.

As of March 31, 2018 and December 31, 2017, PPG had designated €2.3 billion of euro-denominated borrowings as hedges of a portion of its net investment in the Company's European operations. The carrying value of these instruments as of March 31, 2018 and December 31, 2017 was $2.8 billion and $2.7 billion, respectively.

Gains/Losses Deferred in AOCI

As of March 31, 2018, the Company had accumulated pre-tax unrealized net foreign currency translation losses in AOCI related to the euro-denominated borrowings, foreign currency forward contracts and cross currency swaps of $77 million. As of December 31, 2017, the Company had accumulated pre-tax unrealized net foreign currency translation gains of $16 million.

The following table summarizes the location within the financial statements and amount of gains (losses) related to derivative financial instruments activity for the three months ended March 31, 2018 and 2017. All dollar amounts are shown on a pre-tax basis.



	March 31, 2018						March 31, 2017
($ in millions)	Loss Deferred in OCI			Gain (Loss) Recognized			Loss Deferred in OCI			Gain Recognized		Caption In Condensed Consolidated Statement of Income
Not Designated as Hedging Instruments:
Foreign currency forward contracts⁽¹⁾				$4								Other charges
Fair Value
Interest rate swaps⁽²⁾				1						—		Interest expense
Cash Flow
Foreign currency forward contracts		($6	)	(3		)		($15	)		$4	Other charges and Cost of Sales
Total Cash Flow		($6	)		$2			($15	)		$4
Net Investment
Cross currency swaps		($26	)		$1			($4	)			Interest expense
Foreign denominated debt	(68		)				(38		)
Total Net Investment		($94	)		$1			($42	)


(1)	For the period ended, March 31, 2018, the amounts excluded from effectiveness testing recognized in earnings based on an amortized approach was expense of $1 million, with a deferred loss balance of $1 million remaining in accumulated other comprehensive income as of March 31, 2018.


(2)	Interest rate swaps lowered interest expense by $6 million. The change in the fair value of long-term debt increased interest expense by $5 million.

Fair Value Measurements

The Company follows a fair value measurement hierarchy to measure its assets and liabilities. As of March 31, 2018 and December 31, 2017, the assets and liabilities measured at fair value on a recurring basis were cash equivalents, equity securities and derivatives. In addition, the Company measures its pension plan assets at fair value (see Note 13, "Employee Benefit Plans" under Item 8 in the 2017 Form 10-K/A for further details). The Company's financial assets and liabilities are measured using inputs from the following three levels:

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access at the measurement date. Level 1 inputs are considered to be the most reliable evidence of fair value as they are based on unadjusted quoted market prices from various financial information service providers and securities exchanges.

Level 2 inputs are directly or indirectly observable prices that are not quoted on active exchanges, which include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived principally from or corroborated by observable market data by correlation or other means. The fair values of the derivative instruments reflect the instruments' contractual terms, including the period to maturity, and uses observable market-based inputs, including forward curves.

Level 3 inputs are unobservable inputs employed for measuring the fair value of assets or liabilities. The Company does not have any recurring financial assets or liabilities that are recorded in its consolidated balance sheets as of March 31, 2018 and December 31, 2017 that are classified as Level 3 inputs.

Assets and liabilities reported at fair value on a recurring basis:



	March 31, 2018						December 31, 2017
($ in millions)	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Assets:
Other current assets:
Marketable equity securities		$4		$—		$—		$4		$—		$—
Foreign currency forward contracts ^(a)	—		—		—		—		4		—
Foreign currency forward contracts^(b)	—		12		—		—		2		—
Cross currency swaps	—		—		—		—		2		—
Investments:
Marketable equity securities	78		—		—		79		—		—
Other assets
Interest rate swaps ^(c)	—		5		—		—		—		—
Liabilities:
Accounts payable and accrued liabilities:
Foreign currency forward contracts ^(a)	—		3		—		—		1		—
Foreign currency forward contracts^(b)	—		28		—		—		22		—
Other liabilities	—				—		—		—		—
Cross currency swaps^(d)			11



(a) Cash flow hedges	(c) Fair value hedges
(b) Derivatives not designated as hedging instruments	(d) Net investment hedges

Long-Term Debt



($ in millions)	March 31, 2018 ^(a)		December 31, 2017 ^(b)
Long-term debt - carrying value		$5,187		$4,123
Long-term debt - fair value		$5,385		$4,341

(a) Excluding capital lease obligations of $16 million and short term borrowings of $15 million as of March 31, 2018.

(b) Excluding capital lease obligations of $15 million and short term borrowings of $8 million as of December 31, 2017.

The fair values of the debt instruments were based on discounted cash flows and interest rates then currently available to the Company for instruments of the same remaining maturities and were measured using level 2 inputs.