The Group’s approach to the management of financial risks together with sensitivity analyses is set out below.
The Group holds financial instruments for two principal purposes: to finance its operations and to manage the interest rate and currency risks arising from its operations and its sources of finance. The Group finances its operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer term loans from banks and capital markets. The Group borrows principally in US dollars and sterling, at both floating and fixed rates of interest, using derivative financial instruments (‘derivatives’), where appropriate, to generate the desired effective currency profile and interest rate basis. The derivatives used for this purpose are principally rate swaps, rate caps and collars, currency rate swaps and forward foreign exchange contracts. The main risks arising from the Group’s financial instruments are interest rate risk, liquidity and refinancing risk, counterparty risk and foreign currency risk. These risks are managed by the chief financial officer under policies approved by the board, which are summarised below. All the treasury policies remained unchanged throughout 2010, except for a revision to the Group’s bank counterparty limits.
The audit committee receives reports on the Group’s treasury activities, policies and procedures. The treasury department is not a profit centre and its activities are subject to regular internal audit.
The Group’s exposure to interest rate fluctuations on its borrowings is managed by borrowing on a fixed rate basis and by entering into rate swaps, rate caps and forward rate agreements. The Group’s policy objective has continued to be to set a target proportion of its forecast borrowings (taken at the year end, with cash netted against floating rate debt and before certain adjustments for IAS 39 ‘Financial Instruments: Recognition and Measurement’) to be hedged (i.e. fixed or capped at the year end) over the next four years, subject to a maximum of 65% and a minimum that starts at 40% and falls by 10% at each year end. At the end of 2010 the fixed to floating hedging ratio, on the above basis, was approximately 136%. This above-policy level reflects the receipt of the proceeds from the divestment of Interactive Data in 2010, combined with strong cash collections, resulting in lower than typical net debt and hence a higher hedging ratio. Our policy does not require us to cancel derivative contracts and we expect to return to compliance with this policy during 2011. A simultaneous 1% change on 1 January 2011 in the Group’s variable interest rates in US dollar and sterling, taking into account forecast seasonal debt, would have a £2m effect on profit before tax.
The policy described in the section above creates a group of derivatives, under which the Group is a payer of fixed rates and a receiver of floating rates. The Group also aims to avoid undue exposure to a single interest rate setting. Reflecting this objective, the Group has predominantly swapped its fixed rate bond issues to floating rate at their launch. This creates a second group of derivatives, under which the Group is a receiver of fixed rates and a payer of floating rates. The Group’s accounting objective in its use of interest rate derivatives is to minimise the impact on the income statement of changes in the mark-to-market value of its derivative portfolio as a whole. It uses duration calculations to estimate the sensitivity of the derivatives to movements in market rates. The Group also identifies which derivatives are eligible for fair value hedge accounting (which reduces sharply the income statement impact of changes in the market value of a derivative). The Group then balances the total portfolio between hedge-accounted and pooled segments, so that the expected movement on the pooled segment is minimal.
The Group’s objective is to secure continuity of funding at a reasonable cost. To do this it seeks to arrange committed funding for a variety of maturities from a diversity of sources. The Group’s policy objective has been that the weighted average maturity of its core gross borrowings (treating short-term advances as having the final maturity of the facilities available to refinance them) should be between three and ten years. At the end of 2010 the average maturity of gross borrowings was 4.4 years (2009: 5.1 years) of which bonds represented 96% (2009: 96%) of these borrowings.
The Group believes that ready access to different funding markets also helps to reduce its liquidity risk, and that published credit ratings and published financial policies improve such access. All of the Group’s credit ratings remained unchanged during the year. The long-term ratings are Baa1 from Moody’s and BBB+ from Standard & Poor’s, and the short-term ratings are P2 and A2 respectively. The Group’s policy is to strive to maintain a rating of Baa1/BBB+ over the long term. The Group will also continue to use internally a range of ratios to monitor and manage its finances. These include interest cover, net debt to operating profit and cash flow to debt measures. The Group also maintains undrawn committed borrowing facilities. At the end of 2010 the committed facilities amounted to £1,118m and their weighted average maturity was 4.9 years.
The following tables analyse the Group’s sources of funding and the impact of derivatives on the Group’s debt instruments.
The Group’s net debt position is set out below:
| All figures in £ millions | 2010 | 2009 |
|---|---|---|
| Cash and cash equivalents | 1,736 | 750 |
| Marketable securities | 12 | 63 |
| Derivative financial instruments | 134 | 103 |
| Bank loans, overdrafts and loan notes | (73) | (70) |
| Bonds | (2,226) | (1,923) |
| Finance lease liabilities | (13) | (15) |
| Net debt | (430) | (1,092) |
The split of net debt between fixed and floating rate, stated after the impact of rate derivatives, is as follows:
| All figures in £ millions | 2010 | 2009 |
|---|---|---|
| Fixed rate | 577 | 772 |
| Floating rate | (147) | 320 |
| Total | 430 | 1,092 |
Gross borrowings, after the impact of cross-currency rate derivatives, analysed by currency are as follows:
| All figures in £ millions | 2010 | 2009 |
|---|---|---|
| US dollar | 1,954 | 1,656 |
| Sterling | 333 | 330 |
| Other | 25 | 22 |
| Total | 2,312 | 2,008 |
As at 31 December 2010 the exposure of the borrowings of the Group to interest rate changes when the borrowings re-price is as follows:
| All figures in £ millions | Less than one year | One to five years | More than five years | Total |
|---|---|---|---|---|
| Re-pricing profile of borrowings | 403 | 1,084 | 825 | 2,312 |
| Effect of rate derivatives | 1,264 | (529) | (735) | – |
| Total | 1,667 | 555 | 90 | 2,312 |
The maturity of contracted cash flows associated with the Group’s financial liabilities are as follows:
| All figures in £ millions | 2010 | |||
|---|---|---|---|---|
| USD | GBP | Other | Total | |
| Not later than one year | 571 | 117 | 160 | 848 |
| Later than one year and not later than five years | 767 | 399 | 32 | 1,198 |
| Later than five years | 792 | – | – | 792 |
| Total | 2,130 | 516 | 192 | 2,838 |
| Analysed as: | ||||
| Bonds | 1,938 | 710 | – | 2,648 |
| Rate derivatives – inflows | (364) | (297) | – | (661) |
| Rate derivatives – outflows | 340 | 7 | 34 | 381 |
| Trade creditors | 216 | 96 | 158 | 470 |
| Total | 2,130 | 516 | 192 | 2,838 |
| All figures in £ millions | 2009 | |||
|---|---|---|---|---|
| USD | GBP | Other | Total | |
| Not later than one year | 265 | 110 | 151 | 526 |
| Later than one year and not later than five years | 878 | 313 | 30 | 1,221 |
| Later than five years | 739 | 106 | – | 845 |
| Total | 1,882 | 529 | 181 | 2,592 |
| Analysed as: | ||||
| Bonds | 1,692 | 745 | – | 2,437 |
| Rate derivatives – inflows | (386) | (313) | – | (699) |
| Rate derivatives – outflows | 353 | 8 | 32 | 393 |
| Trade creditors | 223 | 89 | 149 | 461 |
| Total | 1,882 | 529 | 181 | 2,592 |
All cash flow projections shown above are on an undiscounted basis. Any cash flows based on a floating rate are calculated using interest rates as set at the date of the last rate reset. Where this is not possible, floating rates are based on interest rates prevailing at 31 December in the relevant year. All derivative amounts are shown gross, although the Group net settles these amounts wherever possible.
Any amounts drawn under revolving credit facilities and commercial paper are assumed to mature at the maturity date of the relevant facility, with interest calculated as payable in each calendar year up to and including the date of maturity of the facility.
Counterparty credit limits, which take published credit rating and other factors into account, are set to cover our total aggregate exposure to a single financial institution. The limits applicable to published credit ratings bands are approved by the chief financial officer within guidelines approved by the board. Exposures and limits applicable to each financial institution are reviewed on a regular basis.
Although the Group is based in the UK, it has its most significant investment in overseas operations. The most significant currency for the Group is the US dollar. The Group’s policy on routine transactional conversions between currencies (for example, the collection of receivables, and the settlement of payables or interest) remains that these should be transacted at the relevant spot exchange rate. The majority of the Group’s operations are domestic within their country of operation. No unremitted profits are hedged with foreign exchange contracts, as the company judges it inappropriate to hedge non-cash flow translational exposure with cash flow instruments. However, the Group does seek to create a natural hedge of this exposure through its policy of aligning approximately the currency composition of its core net borrowings (after the impact of cross currency rate derivatives) with its forecast operating profit before depreciation and amortisation. This policy aims to soften the impact of changes in foreign exchange rates on consolidated interest cover and earnings. The policy above applies only to currencies that account for more than 15% of Group operating profit before depreciation and amortisation, which currently is only the US dollar. The Group still borrows small amounts in other currencies, typically for seasonal working capital needs. Our policy does not require existing currency debt to be terminated to match declines in that currency’s share of Group operating profit before depreciation and amortisation. In addition, currencies that account for less than 15% of Group operating profit before depreciation and amortisation can be included in the above hedging process at the request of the chief financial officer.
Included within year end net debt, the net borrowings/(cash) in the hedging currencies above (taking into account the effect of cross currency swaps) were: US dollar £683m, sterling £179m and South African rand £9m.
The Group uses both currency denominated debt and derivative instruments to implement the above policy. Its intention is that gains/losses on the derivatives and debt offset the losses/gains on the foreign currency assets and income. Each quarter the value of hedging instruments is monitored against the assets in the relevant currency and, where practical, a decision is made whether to treat the debt or derivative as a net investment hedge (permitting foreign exchange movements on it to be taken to reserves) for the purposes of IAS 39.
The following table provides an analysis of those financial instruments that are measured subsequent to initial recognition at fair value, grouped into levels 1 to 3, based on the degree to which the fair value is observable:
Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities;
Level 2 fair value measurements are those derived from inputs, other than quoted prices included within level 1, that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices); and
Level 3 fair value measurements are those derived from valuation techniques that include inputs for the asset or liability that are not based on observable market data (unobservable inputs).
| All figures in £ millions | 2010 | 2009 | ||||||
|---|---|---|---|---|---|---|---|---|
| Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | |
| Financial assets at fair value | ||||||||
| Derivative financial assets | – | 140 | – | 140 | – | 112 | – | 112 |
| Marketable securities | – | 12 | – | 12 | – | 63 | – | 63 |
| Available for sale financial assets | ||||||||
| Investments in unlisted securities | – | – | 58 | 58 | – | – | 62 | 62 |
| Financial liabilities at fair value | ||||||||
| Derivative financial liabilities | – | (6) | – | (6) | – | (9) | – | (9) |
| Other financial liabilities – put option over non-controlling interest | – | – | (25) | (25) | – | – | (23) | (23) |
| Total | – | 146 | 33 | 179 | – | 166 | 39 | 205 |
The following table analyses the movements in level 3 fair value measurements:
| All figures in £ millions | 2010 | |
|---|---|---|
| Investments in unlisted securities | Other financial liabilities | |
| At beginning of year | 62 | (23) |
| Exchange differences | 1 | – |
| Additions | 7 | (2) |
| Disposals | (12) | – |
| At end of year | 58 | (25) |
The fair value of the investments in unlisted securities is determined by reference to the financial performance of the underlying asset and amounts realised on the sale of similar assets. The fair value of other financial liabilities represents the present value of the estimated future liability.
As at 31 December 2010 the sensitivity of the carrying value of the Group’s financial instruments to fluctuations in interest rates and exchange rates is as follows:
| All figures in £ millions | Carrying value | Impact of 1% increase in interest rates | Impact of 1% decrease in interest rates | Impact of 10% strengthening in sterling | Impact of 10% weakening in sterling |
|---|---|---|---|---|---|
| Investments in unlisted securities | 58 | – | – | (2) | 3 |
| Cash and cash equivalents | 1,736 | – | – | (140) | 171 |
| Marketable securities | 12 | – | – | – | – |
| Derivative financial instruments | 134 | (62) | 67 | 11 | (14) |
| Bonds | (2,226) | 59 | (64) | 142 | (174) |
| Other borrowings | (86) | – | – | 8 | (9) |
| Put option over non-controlling interest | (25) | – | – | 2 | (3) |
| Other net financial assets | 556 | – | – | (42) | 51 |
| Total financial instruments | 159 | (3) | 3 | (21) | 25 |
The table shows the sensitivities of the fair values of each class of financial instruments to an isolated change in either interest rates or foreign exchange rates. The class ‘Other net financial assets’ comprises trade assets less trade liabilities.
The sensitivities of derivative instruments are calculated using established estimation techniques such as discounted cash flow and option valuation models. Where modelling an interest rate decrease of 1% led to negative interest rates, these points on the yield curve were adjusted to 0%. A large proportion of the movements shown above would impact equity rather than the income statement, depending on the location and functional currency of the entity in which they arise and the availability of net investment hedge treatment. The changes in valuations are estimates of the impact of changes in market variables and are not a prediction of future events or anticipated gains or losses.