BT 2009 Annual Report Download - page 47

ADDITIONAL INFORMATION FINANCIAL STATEMENTS REPORT OF THE DIRECTORS BUSINESS AND FINANCIAL REVIEWS OVERVIEW
BUSINESS AND FINANCIAL REVIEWS
45BT GROUP PLC ANNUAL REPORT & FORM 20-F
BUSINESS AND FINANCIAL REVIEWS FINANCIAL REVIEW
tax rates from the UK. In 2009, we have paid cash tax in excess of
our income statement charge. We expect to obtain a refund of the
cash tax paid in relation to the 2009 liability in the near future.
It is expected that the cash tax paid will increase in the medium
term, despite the introduction of enhanced capital allowances in the
current financial year.
The effective corporation tax rate on profits before specific items
is expected to increase from (4.2)%, the rate applicable to 2009.
The 2009 rate reflects the tax credit arising on the BT Global
Services contract and financial review charges of £1.6bn (see page
10) recorded in the year. However, we believe that the future years’
tax effective rate will remain below the statutory rate of 28%.
Financial 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 sources of finance. In
addition, various financial instruments, for example trade
receivables and trade payables, arise directly from the group’s
operations.
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 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 policies 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 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.
Foreign exchange risk management
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, 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.
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.
The majority of the group’s long-term borrowings have been,
and are, subject to Sterling fixed interest rates after applying the
impact of hedging instruments. The group has entered into interest
rate swap agreements with commercial banks and other institutions
to vary the amounts and period for which interest rates are fixed.
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 minus in the case of
Standard & Poor’s (S&P), additional interest would accrue from the
next interest coupon period at the 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+ in July 2006 and Moody’s
downgraded BT’s credit rating to Baa1 in May 2001. Based on the
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.
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 in Sterling interest rates
would decrease the group’s annual net finance expense by
approximately £5m.