Marks and Spencer 2015 Annual Report Download - page 120

118
MARKS AND SPENCER GROUP PLC
FINANCIAL STATEMENTS
NOTES TO THE FINANCIAL STATEMENTS
CONTINUED
21 FINANCIAL INSTRUMENTS CONTINUED
Fair value hierarchy
The Group uses the following hierarchy for determining and disclosing the fair value of fi nancial instruments by valuation technique:
> Level 1: quoted (unadjusted) prices in active markets for identical assets and liabilities.
> Level 2: not traded in an active market but the fair values are based on quoted market prices or alternative pricing sources with reasonable
levels of price transparency. The Group’s Level 2 fi nancial instruments include interest rate and foreign exchange derivatives. Fair value is
calculated using discounted cash fl ow methodology, future cash fl ows are estimated based on forward exchange rates and interest rates
(from observable market curves) and contract rates, discounted at a rate that refl ects the credit risk of the various counterparties for
those with a long maturity.
> Level 3: techniques which use inputs which have a signifi cant e ect on the recorded fair value that are not based on observable market
data. The fair value of the embedded derivative is calculated using an option valuation model based on the present value of a 35-year
lease with annual lease payments increasing by Retail Price Index (RPI), capped and fl oored at 1.5% and 2.5% respectively and then
discounted back to the valuation date. The valuation is sensitive to changes in RPI.
At the end of the reporting period, the Group held the following fi nancial instruments at fair value:
2015 2014
Level 1
£m
Level 2
£m
Level 3
£m
Total
£m
Level 1
£m
Level 2
£m
Level 3
£m
Total
£m
Assets m easure d at f air value
Financial assets at fair value through
profi t and loss
– trading derivatives – 3.1 – 3.1 – 1.6 – 1.6
Derivatives used for hedging – 166.9 – 166.9 – 30.3 – 30.3
Embedded derivatives (see note 5) – – 23.7 23.7 – – 22.4 22.4
Short-term investments – 11.6 – 11.6 – 12.4 – 12.4
Liabilit i es mea sured a t fair value
Financial liabilities at fair value through
profi t and loss
– trading derivatives – (0.4) – (0.4) – (0.6) – (0.6)
Derivatives used for hedging – (27.3) – (27.3) – (126.3) – (126.3)
There were no transfers between Level 1 and Level 2 fair value measurements, and no transfers out of Level 3 fair value measurements in
the current or prior reporting period. In addition to the above, the Group has £3.0m (last year £3.0m) in unlisted equity securities measured
at cost.
The following table represents the changes in Level 3 instruments:
2015
£m
2014
£m
Opening balance 22.4 25.9
Gains and losses recognised in the income statement 1.3 (3.5)
Closing balance 23.7 22.4
The gains recognised in the income statement relate to the valuation of the embedded derivative in a lease contract. The fair value
movement of the embedded derivative of £1.3m gain (last year £3.5m loss) is treated as adjustment to reported profi t (see note 5).
Fair value of fi nancial instruments
With the exception of the Group’s fi xed rate bond debt and the Partnership liability to the Marks & Spencer UK Pension Scheme, there were
no material di erences between the carrying value of non-derivative fi nancial assets and fi nancial liabilities and their fair values as at the
balance sheet date.
The carrying value of the Group’s fi xed rate bond debt was £1,697.7m (last year £1,605.9m), the fair value of this debt was £1,883.6m (last year
£1,780.3m). The carrying value of the Partnership liability to the Marks & Spencer UK Pension scheme is £512.9m (last year £568.7m) and the
fair value of this liability is £501.3m (last year £555.7m).
Capital policy
The Group’s objectives when managing capital are to safeguard its ability to continue as a going concern in order to provide optimal returns
for shareholders and to maintain an e cient capital structure to reduce the cost of capital.
In doing so the Group’s strategy is to maintain a capital structure commensurate with an investment grade credit rating, to operate within a
net debt/EBITDA ratio of 2.0x-1.5x and to retain appropriate levels of liquidity headroom to ensure fi nancial stability and fl exibility. To achieve
this strategy the Group regularly monitors key credit metrics such as the gearing ratio, cash fl ow to net debt (see note 27) and fi xed charge
cover to maintain this position. In addition, the Group ensures a combination of appropriate committed short-term liquidity headroom
with a diverse and balanced long-term debt maturity profi le. As at the balance sheet date the Group’s average debt maturity profi le was
eight years (last year nine years). During the year the Group maintained an investment grade credit rating of Baa3 (stable) with Moody’s and
BBB- (stable) with Standard & Poor’s.
In order to maintain or realign the capital structure, the Group may adjust the number of dividends paid to shareholders, return capital to
shareholders, issue new shares or sell assets to reduce debt.