BT 2009 Annual Report Download - page 133

ADDITIONAL INFORMATION FINANCIAL STATEMENTS REPORT OF THE DIRECTORS BUSINESS AND FINANCIAL REVIEWS OVERVIEW
FINANCIAL STATEMENTS CONSOLIDATED FINANCIAL STATEMENTS – NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
131BT GROUP PLC ANNUAL REPORT & FORM 20-F
FINANCIAL STATEMENTS
The group’s main IFRS 7 defined exposure to interest rate volatility within shareholders’ equity arises from fair value movements on derivatives
held in the cash flow reserve. The derivatives have an underlying interest exposure to Sterling, Euro and US dollar rates. With all other factors
remaining constant and based on the composition of derivatives included in the cash flow reserve at the balance sheet date, a 100 basis point
increase (2008: 100 basis point increase) in interest rates in each of the currencies would impact equity, pre tax, as follows:
2009 2008
£m £m
Charge Charge
(credit) (credit)
Sterling interest rates 550 470
US dollar interest rates (538) (347)
Euro interest rates (149) (91)
The long-term debt instruments which the group issued in December 2000 and February 2001 both contained covenants providing that if
the BT Group credit rating were downgraded below A3 in the case of Moody’s or below A– in the case of Standard & Poor’s (S&P),
additional interest would accrue from the next coupon period at a rate of 0.25 percentage points for each ratings category adjustment by
each ratings agency. In March 2009, both Moody’s and S&P downgraded BT’s credit rating to Baa2 and BBB, respectively. Prior to this
financial year, S&P downgraded BT’s credit rating to BBB plus in July 2006 and Moody’s downgraded BT’s credit rating to Baa1 in May
2001. Based on the total debt of £5.8bn outstanding on these instruments at 31 March 2009, BT’s annual finance expense would increase
by approximately £28m if BT’s credit rating were to be downgraded by one credit rating category by both agencies below a long-term
debt rating of Baa2/BBB. If BT’s credit rating with each of Moody’s and S&P were to be upgraded by one credit rating category the annual
finance expense would be reduced by approximately £28m.
Foreign exchange risk management
The purpose of the group’s foreign currency hedging activities is to protect the group from the risk that the eventual net inflows and net
outflows will be adversely affected by changes in exchange rates. The Board policy for foreign exchange risk management defines the
types of transactions which should normally be covered, including significant operational, funding and currency interest exposures, and
the period over which cover should extend for the different types of transactions. Short-term foreign exchange management is delegated
to the centralised treasury operation whilst long-term foreign exchange 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. The
policy delegates authority to the Director Treasury, Tax and Risk Management to take positions of up to £100m and for the Group Finance
Director to take positions of up to £1bn.
A significant proportion of the group’s current revenue is invoiced in Sterling, and a significant element of its operations and costs arise
within the UK. The group’s overseas operations generally trade and are funded in their functional currency which limits their exposure to
foreign exchange volatility. The group’s foreign currency borrowings, which totalled £9.9bn at 31 March 2009 (2008: £6.6bn), are used to
finance its operations and have been predominantly swapped into Sterling using cross currency swaps. The group also enters into forward
currency contracts to hedge foreign currency investments, interest expense, capital purchases and purchase and sale commitments on a
selective basis. The commitments hedged are principally US dollar and Euro denominated. As a result, the group’s exposure to foreign
currency arises mainly on its non-UK subsidiary investments and on residual currency trading flows.
After hedging, with all other factors remaining constant and based on the composition of assets and liabilities at the balance sheet date,
the group’s exposure to foreign exchange volatility in the income statement from a 10% strengthening in Sterling against other currencies
would result in a credit of approximately £20m in 2009 (2008: approximately £20m).
The group’s main exposure to foreign exchange volatility within shareholders equity (excluding translation exposures) arises from fair
value movements on derivatives held in the cash flow reserve. The majority of foreign exchange fluctuations in the cash flow reserve are
recycled immediately to the income statement to match the hedged item and therefore the group’s exposure to foreign exchange
fluctuations in equity would be insignificant in both 2009 and 2008.
Outstanding cross currency swaps at 31 March 2009 are detailed in the ‘Hedging activities’ and ‘Other derivatives’ sections below.
Credit risk management
The group’s exposure to credit risk arises from financial assets transacted by the centralised treasury operation (primarily derivatives,
investments, cash and cash equivalents) and from its trading related receivables. For treasury related balances, the Board defined policy
restricts exposure to any one counterparty by setting credit limits based on the credit quality as defined by Moody’s and Standard and Poor’s
and by defining the types of financial instruments which may be transacted. The minimum credit ratings permitted with counterparties are
A3/A– for long-term and P1/A1 for short-term investments. The centralised treasury operation continuously reviews the limits applied to
counterparties and will adjust the limit according to the nature and credit standing of the counterparty up to the maximum allowable limit set
by the Board. Management review significant utilisations on a regular basis to determine the adjustments required, if any, and actively
manage any exposures which may arise. Where multiple transactions are undertaken with a single counterparty, or group of related
counterparties, the group may enter into netting arrangements to reduce the group’s exposure to credit risk. Currently the group makes use of
standard International Swaps and Derivative Association (ISDA) documentation. In addition, where possible the group will seek a combination
of a legal right of set off and net settlement. The group also seeks collateral or other security where it is considered necessary. During the 2009
financial year, the centralised treasury operation tightened the credit limits applied when investing with counterparties in response to market
conditions and continued to monitor their credit quality and actively managed any exposures which arose.
33. Financial instruments and risk management continued