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| 35.
Financial instruments and risk management |
The
group holds or issues financial instruments mainly to
finance its operations; 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 debtors and trade creditors
– arise directly from the group’s operations.
The group finances its operations primarily by a mixture
of issued share capital, retained profits, long-term loans
and, increasingly over the years ended 31 March 2000 and
2001, short-term loans, principally by issuing commercial
paper and medium-term notes. The group borrows in the
major long-term debt markets in major currencies and significant
new long-term debt was taken on in the year ended 31 March
2001. Typically, but not exclusively, the bond markets
provide the most cost-effective means of long-term borrowing.
The group uses derivative financial instruments primarily
to manage its exposure to market risks from changes in
interest and foreign exchange rates. The derivatives used
for this purpose are principally interest rate swaps,
gilt locks, currency swaps and forward currency contracts.
The types of financial instrument used for investment
of short-term funds are prescribed in group treasury policies
with limits on the exposure to any one organisation. Short-term
investing in financial instruments is undertaken on behalf
of the group by external substantial fund managers who
are limited to dealing in debt instruments and certain
defined derivative instruments and are given strict guidelines
on credit, diversification and maturity profiles.
During the year ended 31 March 2001, net debt increased
from £8.7 billion to £27.9 billion mainly as a result
of the group making acquisitions of businesses and third-generation
mobile licences. This increase in debt has been funded
primarily by the issuance of long-term debt together with
use of the group’s medium-term note programme. As
a result of this, together with the group’s interest
rate swap activity, the borrowing profile has changed
during the year from one mainly at floating rates to one
with a fixed: floating rate ratio of approximately 70:30.
This change is in line with the group’s intention
to limit the group’s exposure to interest rate increases
given the substantial size of the group’s debt portfolio.
During the second quarter of the year ended 31 March 2001,
it was not practical for the group to issue longer-term
debt in the global capital markets. The group therefore
pre-hedged its desired fixed rate profile by transacting
£9.3 billion of interest rate swaps with maturities ranging
from five to 30 years at a weighted average fixed interest
payable rate of 6.2%.
During the year ended 31 March 2000, net debt increased
from £953 million to £8,700 million primarily as a result
of the group making acquisitions of businesses and interests
in joint ventures and associates. This increase in debt
was primarily funded under the group’s commercial
paper programmes. As a result, the group’s borrowing
profile changed during that year from one at fixed rates
to one mainly at floating rates.
The group uses financial instruments to hedge some of
its currency exposures arising from its non-UK assets,
liabilities and forward purchase commitments. The group
also hedges some of its interest liabilities. The financial
instruments used comprise borrowings in foreign currencies,
forward foreign currency exchange contracts, gilt locks
and interest and currency swaps.
There has been no change in the nature of the group’s
risk profile between 31 March 2001 and the date of these
financial statements.
The risk profile of the group is likely to change following
the completion of the rights issued announced on 10 May
2001, and the proceeds due to be received on the planned
disposals of the investments in Japan and elsewhere which
have been announced to date (see note
29). In May 2001, Moody’s downgraded BT’s
credit rating to Baa1, which will increase BT’s
annual interest charge by £32 million.
The notional amounts of derivatives summarised below do
not necessarily represent amounts exchanged by the parties
and, thus, are not necessarily a measure of the exposure
of the group through its use of derivatives. The amounts
exchanged are calculated on the notional amounts and other
terms of the derivatives which relate to interest and
exchange rates.
(a) Interest
rate risk management
The group has entered into interest rate swap agreements
with banks and other institutions to vary the amounts
and periods for which interest rates on borrowings are
fixed. Under interest rate swaps, the group agrees with
other parties to exchange, at specified intervals, the
differences between fixed rate and floating rate interest
amounts calculated by reference to an agreed notional
principal amount. Under gilt locks, forward sales of UK
government long-dated treasury stock were entered into
for periods of up to one year. This hedge effectively
fixed in the interest on part of the group’s then
future borrowings, all of which have now been taken on.
At 31 March 2001, the group had outstanding interest rate
swap agreements having a total notional principal amount
of £9,574 million (2000 – £2,073 million, including
gilt locks).
(b) Foreign
exchange risk management
Cross currency swaps and forward foreign exchange contracts
have been entered into to reduce the foreign currency
exposure on the group’s operations and the group’s
net assets. The group also enters into forward foreign
exchange contracts to hedge investments, interest expense
and purchase and sale commitments denominated in foreign
currencies (principally US dollars, the euro and the yen).
The remaining terms of the currency swaps are up to 30
years and the terms of currency forward exchange contracts
are typically less than one year. 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.
At 31 March 2001, the group had outstanding foreign currency
swap agreements and forward exchange contracts having
a total notional principal amount of £25,325 million (2000
– £11,948 million).
The fair values of forward foreign currency contracts
at 31 March 2001 were £4,388 million (2000 – £7,088
million) for purchases of currency and £601 million (2000
– £1,852 million) for sales of currency. These fair
values have been estimated by calculating their present
values using the market discount rates, appropriate to
the terms of the contracts, in effect at the balance sheet
dates.
At 31 March 2001, the group had deferred unrealised gains
of £13 million (2000 – £18 million) and losses of
£34 million (2000 – £43 million), based on dealer-quoted
prices, from hedging purchase and sale commitments, and
in addition had deferred realised net gains of £25 million
(2000 – £11 million). These are included in the
profit and loss account as part of the hedged purchase
or sale transaction when it is recognised, or as gains
or losses when a hedged transaction is no longer expected
to occur.
(c) Concentrations
of credit risk and credit exposures of financial instruments
The group considers that it is not exposed to major concentrations
of credit risk. The group, however, is exposed to credit-related
losses in the event of non-performance by counterparties
to financial instruments, but does not expect any counterparties
to fail to meet their obligations. The group limits the
amount of credit exposure to any one counterparty. The
group does not normally see the need to seek collateral
or other security.
The long-term debt instruments issued in December 2000
and February 2001 both contain covenants that if the group
credit rating is downgraded below A3 in the case of Moody’s
or below A minus in the case of S&P, additional interest
accrues from the next interest coupon period at the rate
of 0.25 percentage points for each ratings category adjustment
by each ratings agency. Based upon the total amount of
debt of £12,930 million outstanding on these instruments
at 31 March 2001, the group’s annual interest charge
would increase by £65 million if the group’s credit
rating was to fall by one credit rating category below
a long-term debt rating of A3/A minus.
(d) Fair
value of financial instruments
The following table shows the carrying amounts and fair
values of the group’s financial instruments at 31
March 2001 and 2000. The carrying amounts are included
in the group balance sheet under the indicated headings,
with the exception of derivative amounts, which are included
in debtors or other creditors or as part of net debt as
appropriate. The fair values of the financial instruments
are the amount at which the instruments could be exchanged
in a current transaction between willing parties, other
than in forced or liquidation sale. |
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| Non-derivatives: |
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Assets |
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Cash at bank and in hand |
412 |
253 |
|
412 |
253 |
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Short-term investments (a) |
2,557 |
2,051 |
|
2,562 |
2,052 |
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Fixed asset investments –
loans to joint ventures (b) |
737 |
1,073 |
|
737 |
1,073 |
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Liabilities |
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Short-term borrowings (c) |
10,220 |
5,121 |
|
10,219 |
5,121 |
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Long-term borrowings, excluding
finance leases (d) |
20,592 |
5,874 |
|
20,852 |
6,085 |
|
| Derivatives relating
to investments and borrowings (net) (e): |
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Assets |
259 |
44 |
|
– |
– |
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Liabilities |
– |
– |
|
350 |
100 |
|
| Derivative financial
instruments held or issued to hedge the current
exposure on expected future transactions (net): |
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Assets |
– |
– |
|
– |
– |
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Liabilities |
– |
– |
|
21 |
25 |
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| (a) |
The fair value of listed
short-term investments were estimated based on quoted
market prices for those investments. The carrying
amount of the other short-term deposits and investments
approximated to their fair values due to the short
maturity of the instruments held. |
| (b) |
The fair value of loans
to joint ventures approximated to carrying value
due to loans bearing commercial rates of interest. |
| (c) |
The fair value of short-term
borrowings approximated to carrying value due to
the short maturity of the instruments. |
| (d) |
The fair value of the
group’s bonds, debentures, notes and other
long-term borrowings has been estimated on the basis
of quoted market prices for the same or similar
issues with the same maturities where they existed,
and on calculations of the present value of future
cash flows using the appropriate discount rates
in effect at the balance sheet dates, where market
prices of similar issues did not exist. |
| (e) |
The fair value of the
group’s outstanding foreign currency and interest
rate swap agreements was estimated by calculating
the present value, using appropriate discount rates
in effect at the balance sheet dates, of affected
future cash flows translated, where appropriate,
into pounds sterling at the market rates in effect
at the balance sheet dates. |
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The
following information is provided in accordance with the
requirements of FRS 13 – “Derivatives and
other financial instruments: disclosures”. Except
for disclosures under currency exposures below, the financial
information excludes all of the group’s short-term
debtors and creditors.
Financial liabilities
After taking into account the various interest rate swaps
and forward foreign currency contracts entered into by
the group, the interest rate profile of the group’s
financial liabilities at 31 March was: |
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| Currency: |
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| Sterling |
13,501 |
10,528 |
357 |
24,386 |
|
2,429 |
6,686 |
376 |
9,491 |
|
| US dollar |
806 |
145 |
293 |
1,244 |
|
353 |
83 |
7 |
443 |
|
| Euro |
4,759 |
664 |
72 |
5,495 |
|
424 |
389 |
30 |
843 |
|
| Yen |
508 |
– |
– |
508 |
|
508 |
– |
1 |
509 |
|
| Other |
– |
– |
– |
– |
|
– |
111 |
4 |
115 |
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| Total |
19,574 |
11,337 |
722 |
31,633 |
|
3,714 |
7,269 |
418 |
11,401 |
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| For
the fixed rate financial liabilities, the average interest
rates and the average periods for which the rates are
fixed are: |
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| Currency: |
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| Sterling |
7.5 |
16 |
|
9.1 |
15 |
|
| US dollar |
8.5 |
7 |
|
8.7 |
8 |
|
| Euro |
6.3 |
6 |
|
5.8 |
8 |
|
| Yen |
1.2 |
4 |
|
1.2 |
4 |
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| Total |
7.1 |
13 |
|
7.6 |
12 |
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The
floating rate financial liabilities bear interest at rates
fixed in advance for periods ranging from one day to one
year by reference to LIBOR. The financial liabilities
on which no interest is paid are due to mature within
one year of the balance sheet date.
The maturity profile of financial liabilities is as given
in note 23.
Financial assets
After taking into account the various interest rate swaps
and forward foreign currency contracts entered into by
the group, the interest rate profile of the group’s
financial assets at 31 March was: |
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| Currency: |
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| Sterling |
56 |
2,935 |
306 |
3,297 |
|
395 |
2,869 |
265 |
3,529 |
|
| US dollar |
– |
293 |
– |
293 |
|
– |
31 |
– |
31 |
|
| Euro |
19 |
315 |
– |
334 |
|
– |
53 |
– |
53 |
|
| Other |
– |
27 |
– |
27 |
|
– |
29 |
– |
29 |
|
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| Total |
75 |
3,570 |
306 |
3,951 |
|
395 |
2,982 |
265 |
3,642 |
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The
sterling fixed rate financial assets yield interest at
a weighted average of 6.3% (2000 – 6.6%) for a weighted
average period of 30 months (2000 – 18 months).
The floating rate financial assets bear interest at rates
fixed in advance for periods up to one year by reference
to LIBOR.
Currency exposures
The table below shows the currency exposures of the group’s
net monetary assets (liabilities), in terms of those transactional
exposures that give rise to net currency gains and losses
recognised in the profit and loss account. Such exposures
comprise the monetary assets and monetary liabilities
of the group that are not denominated in the operating
(or “functional”) currency of the operating
unit involved, other than certain non-sterling borrowings
treated as hedges of net investments in non-UK operations.
At 31 March, these exposures were as follows:
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| Functional currency of group
operation: |
|
| Sterling |
– |
|
3 |
|
3 |
|
2 |
|
8 |
|
– |
|
13 |
|
117 |
|
29 |
|
159 |
|
| Euro |
1 |
|
(21 |
) |
– |
|
(5 |
) |
(25 |
) |
6 |
|
(1 |
) |
– |
|
– |
|
5 |
|
| Other |
– |
|
2 |
|
– |
|
– |
|
2 |
|
(10 |
) |
– |
|
– |
|
– |
|
(10 |
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| Total |
1 |
|
(16 |
) |
3 |
|
(3 |
) |
(15 |
) |
(4 |
) |
12 |
|
117 |
|
29 |
|
154 |
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The
amounts shown in the table above take into account the
effect of any currency swaps, forward contracts and other
derivatives entered into to manage those currency exposures.
At 31 March 2001, the group also held various forward
currency contracts that the group had taken out to hedge
expected future foreign currency purchases and sales.
Fair values of financial assets
held for trading |
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| Net gain included in profit
and loss account |
62 |
51 |
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| Fair value of financial assets
held for trading at 31 March |
530 |
980 |
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The
net gain was derived from government bonds, commercial
paper and similar debt instruments. The average fair value
of financial assets held during the year ended 31 March
2001 did not differ materially from the year end position.
Hedges
Gains and losses on instruments used for hedging are not
recognised until the exposure that is being hedged is
itself recognised. Unrecognised and deferred gains and
losses on instruments used for hedging and those recognised
in the years ended 31 March 2001 and 31 March 2000 are
as follows: |
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| Gains and losses: |
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recognised in the
year but arising in previous years (a) |
35 |
31 |
|
51 |
23 |
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unrecognised at
the balance sheet date |
323 |
952 |
|
23 |
193 |
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carried forward
in the year end balance sheet, pending recognition
in the profit and loss account (a) |
106 |
36 |
|
99 |
15 |
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expected to be recognised
in the following year: |
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unrecognised at balance sheet
date |
73 |
96 |
|
11 |
19 |
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carried forward in the year
end balance sheet pending, recognition in the profit
and loss account (a) |
27 |
7 |
|
24 |
12 |
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| (a) |
Excluding gains
and losses on hedges accounted for by adjusting
the carrying amount of a fixed asset. |
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Average
effective interest rates
The interest basis of interest rate swap agreements used,
the notional amounts, their average maturities and weighted
average interest rates are shown below: |
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Pay fixed interest and receive
variable interest |
Over
5 years |
8,674 |
5.3 |
6.5 |
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Pay variable interest and receive
fixed interest |
Under
5 years |
900 |
6.5 |
5.5 |
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The
rates of the variable rate portion of the swaps are based
on quoted rates. In calculating the average variable rates,
the latest rates agreed with the counterparty on each
swap have been used. Changes in interest rates will affect
the variable rate information disclosed above.
Unused committed lines of credit
Unused committed lines of credit for short-term financing
available at 31 March 2001 totalled approximately £16,750
million (2000 – £5,800 million), which was in support
of a commercial paper programme or other borrowings. These
lines of credit are available for up to one year.
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