Annual Report and Accounts 2008
30 Financial risk management objectives and policies
Financial risk factors and management
The Group's multinational operations and significant debt financing expose it to a variety of financial risks, the most material of which are the effects of changes in foreign currency exchange rates, interest rates and changes in fuel prices. The Group has in place a risk management programme that seeks to limit the adverse effects of these risks on the financial performance of the Group by using financial instruments including borrowings, forward exchange contracts, fuel price and interest rate swaps.
The Board of Directors have delegated to a sub-committee, the Treasury committee, the responsibility for implementing the risk management policies laid down by the Board. The policies are implemented by the central treasury department that receives regular reports from all the operating companies to enable prompt identification of financial risks so that appropriate actions may be taken. The treasury department has a policy and procedures manual that sets out specific guidelines to manage foreign currency exchange risk, interest rate risk and credit risk including the use of financial instruments.
Foreign currency
The Group has major operations in the US, Canada, Spain and residual assets in Australia and as a result is exposed to foreign exchange risks on translation of net assets and on earnings denominated in foreign currency. The Group finances overseas investments mainly through the use of foreign currency borrowings to hedge the net asset investment and from time to time enters into foreign exchange forward contracts. During the year, the Group closed out all foreign currency borrowings and foreign exchange forward contracts except for a €540.0m Euro facility and a cross-currency swap of $85.0m. The swap contract term runs for a period up to 2.5 years. At the end of the year, the Group's policy is to hedge 0% to 50% its foreign currency denominated net assets (2007: 50% and 100%). At 31 December 2008, 14% (2007: 81%) of the Group's exposure to US dollar assets were hedged, nil% (2007: 71%) of the exposure to Canadian dollar assets, nil% (2007: nil%) of the exposure to Australian dollar assets and 39% (2007: 97%) of the exposure to euro assets.
The table below demonstrates the sensitivity of the Group's financial instruments to a reasonably possible change in foreign currency exchange rates, with all other variables held constant. This would affect the Group's profit before tax and translation reserve. The effect on the translation reserve represents the movement in the translated value of the foreign currency denominated loans and change in fair value of forward contracts. These movements would be offset by an opposite movement in the translated value of the Group's overseas net investments.
| 2008 | 2007 | ||||||
|---|---|---|---|---|---|---|---|
| As at 31 December | Strengthening / (weakening) in currency |
Effect on profit before tax £m |
Effect on translation reserve £m |
Effect on profit before tax £m |
Effect on translation reserve £m |
||
| US dollar | 10% | – | (5.3) | – | (19.9) | ||
| Euro | 10% | – | (46.9) | – | (87.2) | ||
| Canadian dollar | 10% | – | – | – | (8.8) | ||
| Australian dollar | 10% | – | – | – | – | ||
| US dollar | (10)% | – | 5.3 | – | 19.9 | ||
| Euro | (10)% | – | 46.9 | – | 87.2 | ||
| Canadian dollar | (10)% | – | – | – | 8.8 | ||
| Australian dollar | (10)% | – | – | – | – |
Interest rate risk
The Group is exposed to interest rate risk on both interest-bearing assets and interest-bearing liabilities. It is the Group's policy to maintain an appropriate balance between fixed and floating interest rates on borrowings in order to provide certainty as to the level of interest expense in the short term and to reduce the year on year impact of interest rate fluctuations over the medium term. Interest on the Group's floating interest rate debt is based on LIBOR or EURIBOR and, to achieve the above objectives, the Group has entered into a series of interest rate swaps that have the effect of converting floating rate debt to fixed rate debt. The net effect of these transactions was that as at 31 December 2008 the Group was hedged against interest rate movements on £525.6m (2007: £731.5m) of gross debt for an average of 2.5 (2007: 3.0) years.
The table below demonstrates the sensitivity of the Group's financial instruments to a reasonably possible change in interest rates, with all other variables held constant, on the Group's profit before tax and on the Group's hedging reserve. The effect on profit before tax arises through movements in interest on floating rate financial instruments. The effect on the hedging reserve represents the movement in the fair value of the Group's interest rate swaps which are accounted for as hedging instruments under IAS 39.
The sensitivity analysis covers all floating rate financial instruments, including the interest rate swaps.
| 2008 | 2007 | ||||||
|---|---|---|---|---|---|---|---|
| As at 31 December | Increase /(decrease) in basispoints |
Effect on profit before tax £m |
Effect on hedging reserve £m |
Effect on profit before tax £m |
Effect on hedging reserve £m |
||
| Sterling | 100 | (5.6) | – | 1.0 | – | ||
| US dollars | 50 | 0.5 | – | (0.2) | 0.6 | ||
| Euro | 75 | (0.2) | 8.2 | (1.9) | 9.5 | ||
| Sterling | (100) | 5.6 | – | (1.0) | – | ||
| US dollars | (50) | (0.5) | – | 0.2 | (0.6) | ||
| Euro | (75) | 0.2 | (8.2) | 1.9 | (9.5) |
Commodity prices
The Group is exposed to commodity price risk as a result of fuel usage. It is the Group's policy to hedge this exposure in order to provide certainty as to the level of costs in the short term and to reduce the year on year impact of price fluctuations over the medium term. This is achieved by entering into fuel swaps and purchase contracts which are expected to be highly effective. As at 31 December 2008, the Group had hedged approximately 100% of its 2009 expected usage and 23.4% of its expected usage in 2010 and 2011.
The table below demonstrates the sensitivity of the Group's financial instruments to a reasonably possible change in fuel prices, with all other variables held constant, on the Group's profit before tax and on the Group's hedging reserve.
The sensitivity analysis includes all fuel price swaps. The effect on the hedging reserve arises through movements on the fair value of the Group's fuel price swaps.
| 2008 | 2007 | ||||||
|---|---|---|---|---|---|---|---|
| As at 31 December | Increase /(Decrease)in price |
Effect on profit before tax £m |
Effect on hedging reserve £m |
Effect on profit before tax £m |
Effect on hedging reserve £m |
||
| Sterling denominated ULSD | 20% | – | 7.2 | – | 5.5 | ||
| US dollar denominated gasoil | 20% | – | 5.6 | – | 2.2 | ||
| Euro denominated ULSD | 20% | – | 3.2 | – | 6.2 | ||
| Sterling denominated ULSD | (20%) | – | (7.2) | – | (5.5) | ||
| US dollar denominated gasoil | (20%) | – | (5.6) | – | (2.2) | ||
| Euro denominated ULSD | (20%) | – | (3.2) | – | (6.2) |
Credit risk
The maximum credit risk exposure of the Group is the gross carrying value of each of its financial assets. This risk is mitigated by a number of factors. The majority of the Group's receivables are public (or quasi-public) bodies, both national (DfT Rail and Network Rail in the UK) and local (school boards in North America, municipal authorities in Spain and Morocco, Transport for London and Centro in the UK). The Group does not consider these counterparties to pose a significant credit risk. Outside of this the Group does not consider it has significant concentrations of credit risk. The Group has implemented policies that require appropriate credit checks on potential customers before sales commence.
The counterparties for financial assets other than investments and trade receivables are subject to pre-approval by the Treasury Committee and such approval is limited to financial institutions with an A rating or better. The amount of exposure to any individual counterparty is subject to a limit, which is reassessed annually by the Treasury Committee.
The only element of the Group's financial assets which are not impaired but are past due are certain trade receivable items. An ageing of the assets which are past due is included below.
| Of which: not impaired and past due in the following periods | |||||||
|---|---|---|---|---|---|---|---|
| Carrying amount £m |
Of which:neither impaired nor past due £m |
Less than 30 days £m |
Between 30 and 60 days £m |
Between 61 and 90 days £m |
Over 90 days £m |
||
| Trade receivables at 31 December 2008 | 215.9 | 129.7 | 26.3 | 23.0 | 14.5 | 22.4 | |
| Trade receivables at 31 December 2007 | 163.8 | 94.5 | 15.3 | 19.2 | 9.0 | 25.8 | |
Liquidity risk
The Group actively maintains a mixture of long term and short term committed facilities that are designed to ensure the Group has sufficient available funds to meet current and forecast financial requirements as cost effectively as possible. As at 31 December 2008 the Group had committed borrowing facilities of £1,363.8m (2007: £1,167.5m) of which £143.8m (2007: £199.4m) were undrawn. The Group's primary bank facilities expire in September 2009 with an option to extend to September 2010 at the Group's discretion and June 2011 and the lease facilities at various times in line with their terms.
The table below summarises the maturity profile of the Group's financial liabilities at 31 December 2008 and 2007 based on the contractual undiscounted payments.
| Year ended 31 December 2008 | On demand £m |
Less than 1 year £m |
1–5 years £m |
> 5 years £m |
Total £m |
|---|---|---|---|---|---|
| Loan notes | 0.8 | – | – | – | 0.8 |
| Bank loans | – | 52.3 | 1,182.0 | 0.8 | 1,235.1 |
| Finance lease obligations | – | 57.8 | 63.3 | 29.3 | 150.4 |
| Other debt payable | – | 0.3 | 0.8 | – | 1.1 |
| Net Interest rate swaps | – | 8.9 | 11.5 | – | 20.4 |
| Fuel price swaps | – | 49.7 | 32.1 | – | 81.8 |
| Foreign exchange forward contracts | – | 15.9 | 14.9 | – | 30.8 |
| Trade and other payables | – | 439.2 | 14.7 | – | 453.9 |
| ICRRL onerous contract obligation | – | 8.6 | 15.7 | – | 24.3 |
| 0.8 | 632.7 | 1,335.0 | 30.1 | 1,998.6 |
| Year ended 31 December 2007 | On demand £m |
Less than 1 year £m |
1–5 years £m |
> 5 years £m |
Total £m |
|---|---|---|---|---|---|
| Loan notes | 0.8 | – | – | – | 0.8 |
| Bank loans | – | 421.5 | 619.8 | – | 1,041.3 |
| Finance lease obligations | – | 37.5 | 68.3 | 34.9 | 140.7 |
| Net interest rate swaps | – | 2.4 | 5.6 | – | 8.0 |
| Foreign exchange forward contracts | – | 14.2 | – | – | 14.2 |
| Trade and other payables | – | 464.4 | 0.8 | – | 465.2 |
| ICRRL onerous contract obligation | – | 8.4 | 24.4 | – | 32.8 |
| 0.8 | 948.4 | 718.9 | 34.9 | 1,703.0 |