BT 2009 Annual Report Download - page 132

ADDITIONAL INFORMATION FINANCIAL STATEMENTS REPORT OF THE DIRECTORS BUSINESS AND FINANCIAL REVIEWS OVERVIEW
FINANCIAL STATEMENTS CONSOLIDATED FINANCIAL STATEMENTS – NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
130 BT GROUP PLC ANNUAL REPORT & FORM 20-F
33. Financial instruments and risk management
The group issues or holds financial instruments mainly to finance its operations; to finance corporate transactions such as dividends, share
buy backs and acquisitions; for the temporary investment of short-term funds; and to manage the currency and interest rate risks arising
from its operations and from its sources of finance. In addition, various financial instruments, for example trade receivables and trade
payables, arise directly from the group’s operations.
The group finances its operations primarily by a mixture of issued share capital, retained profits, deferred taxation, long-term and
short-term borrowing, mainly using commercial paper supported by committed borrowing facilities. The group borrows in the major long-
term bond markets in major currencies and typically, but not exclusively, these markets provide the most cost-effective means of
long-term borrowing. The group uses derivative financial instruments primarily to manage its exposure to changes in interest and foreign
exchange rates against these borrowings. The derivatives used for this purpose are principally interest rate swaps, cross currency swaps and
forward currency contracts. The group also uses financial instruments to hedge some of its currency exposures arising from funding its
overseas operations, acquisitions, overseas assets, liabilities and forward purchase commitments. The financial instruments used comprise
forward currency contracts. The group does not hold or issue derivative financial instruments for trading purposes. All transactions in
derivative financial instruments are undertaken to manage the risks arising from underlying business activities.
The group has a centralised treasury operation whose primary role is to manage liquidity, funding, investments and counterparty credit
risk arising with financial institutions. The centralised treasury operation also manages the group’s market risk exposures, including risks
arising from volatility in currency and interest rates. The centralised treasury operation acts as a central bank to members of the group
providing central deposit taking, funding and foreign exchange management services. Funding and deposit taking is usually provided in
the functional currency of the relevant entity. The centralised treasury operation is not a profit centre and the objective is to manage risk at
optimum cost.
The Board sets the policy for the group’s centralised treasury operation and its activities are subject to a set of controls commensurate
with the magnitude of the borrowings and investments and group wide exposures under its management. The Board has delegated its
authority to operate these polices to a series of panels that are responsible for the management of key treasury risks and operations.
Appointment to and removal from the key panels requires approval from two of the Chairman, the Chief Executive or the Group Finance
Director. The key policies defined by the Board are highlighted in each of the sections below.
The financial risk management of exposures arising from trading related financial instruments, primarily trade receivables and trade
payables, is through a series of policies and procedures set at a group and line of business level. Line of business management apply these
policies and procedures and perform review processes to assess and manage financial risk exposures arising from these financial
instruments.
There has been no change in the nature of the group’s risk profile between 31 March 2009 and the date of these financial statements.
Interest rate risk management
The group has interest bearing financial assets and financial liabilities which may expose the group to either cash flow or fair value
volatility. The group’s policy, as prescribed by the Board, is to ensure that at least 70% of net debt is at fixed rates. Short-term interest rate
management is delegated to the centralised treasury operation whilst long-term interest rate management decisions requires further
approval from the Group Finance Director, Director Treasury, Tax and Risk Management or the Treasurer who have been delegated such
authority by the Board.
In order to manage this profile, the group has entered into swap agreements with commercial banks and other institutions to vary the
amounts and periods for which interest rates on borrowings are fixed. Under cross currency swaps, the group agrees with other parties to
exchange, at specified intervals, US dollar and Euro fixed rates into either fixed or floating Sterling interest amounts calculated by
reference to an agreed notional principal amount. Under Sterling interest rate swaps, the group agrees with other parties to exchange, at
specified intervals, the differences between fixed rate and floating rate Sterling interest amounts calculated by reference to an agreed
notional principal amount. The group primarily uses a combination of these derivatives to fix its interest rates.
The majority of the group’s long-term borrowings have been, and are, subject to fixed Sterling interest rates after applying the impact of
hedging instruments. Outstanding currency and interest rate swaps at 31 March 2009 are detailed in the ‘Hedging activities’ and ‘Other
derivatives’ sections below.
At 31 March 2009, the group’s fixed:floating interest rate profile, after hedging, on net debt was 99:1 (2008: 100:0).
The group is exposed to income statement and shareholders’ equity volatility arising from changes in interest rates. To demonstrate this
volatility, management have concluded that a 100 basis point increase (2008: 100 basis point increase) in interest rates and parallel shift
in yield curves across Sterling, US dollar and Euro currencies is a reasonable benchmark for performing a sensitivity analysis. All
adjustments to interest rates for the impacted financial instruments are assumed to take effect from the respective balance sheet date.
After the impact of hedging, the group’s main exposure to interest rate volatility in the income statement arises from fair value
movements on derivatives not in hedging relationships and on variable rate borrowings and investments which are largely influenced by
Sterling interest rates. Trade payables, trade receivables and other financial instruments do not present a material exposure to interest rate
volatility. With all other factors remaining constant and based on the composition of net debt at 31 March 2009, a 100 basis point
increase (2008: 100 basis point increase) in Sterling interest rates would decrease the group’s annual net finance expense by
approximately £5m (2008: £5m).
FINANCIAL STATEMENTS