BT 2010 Annual Report Download - page 140

FINANCIAL STATEMENTS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
138 BT GROUP PLC ANNUAL REPORT & FORM 20-F
Hedging strategy
In order to manage the group’s interest rate mix 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 uses a combination of these derivatives to primarily 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 2010 are detailed in the Hedging activities and Other
derivatives sections below.
At 31 March 2010 the group’s fixed floating interest rate profile, after hedging, on gross debt was 91:9 (2009: 87:13).
Sensitivities
The group is exposed to volatility in the income statement and shareholders’ equity arising from changes in interest rates. To demonstrate
this volatility, management have concluded that a 100 basis point increase (2009: 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 2010, a 100 basis point increase (2009 and 2008: 100
basis point increase) in Sterling interest rates would decrease the group’s annual net finance expense by approximately £17m (2009: £5m,
2008: £5m).
The group’s main exposure to interest rate volatility within shareholders’ equity, as defined in IFRS 7, arises from fair value movements
on derivatives held in the cash flow reserve. The derivatives have an underlying interest rate 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 (2009 and 2008: 100 basis point increase) in interest rates in each of the currencies would impact
equity, before tax, as detailed below:
2010 2009 2008
£m £m £m
Charge Charge Charge
At 31 March (credit) (credit) (credit)
Sterling interest rates 496 550 470
US Dollar interest rates (392) (538) (347)
Euro interest rates (134) (149) (90)
The impact as a result of a 100 basis point decrease in interest rates would have broadly the same impact in the opposite direction.
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 February 2010 S&P downgraded BT’s credit rating to BBB–. Prior to this in March 2009, Moody’s and S&P
downgraded BT’s credit rating to Baa2 and BBB, respectively. Based on the total debt of £4.4bn outstanding on these instruments at
31 March 2010, the group’s finance expense would increase/decrease by approximately £9m in the year ending 31 March 2011 if BT’s
credit rating were to be downgraded/upgraded respectively by one credit rating category by both agencies below a long-term debt rating
of Baa2/BBB–.
In addition, the group’s €600m 2014 bond issued in June 2009 would attract an additional 1.25 percentage points for a downgrade by
one credit rating category by both Moody’s and S&P below Baa3/BBB–, respectively. This would result in an additional finance expense of
£5m in the year ending 31 March 2011.
Foreign exchange risk management
Management policy
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’s 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 treasury operation whilst long-term foreign exchange management decisions require 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.
32. Financial instruments and risk management continued