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Financial risk
management
We issue or hold financial
instruments mainly to finance our 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 our operations and from
our sources of finance. In addition, various financial instruments,
for example trade receivables and trade payables, arise directly from
our operations.
We
have a centralised treasury operation whose primary role is to manage
liquidity, funding, investment and counterparty credit risk and the
group’s market risk exposures, including risk 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 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 such policies and procedures
and perform review processes to assess and manage financial risk exposures
arising from trading financial instruments.
Foreign
exchange risk management
A significant proportion
of our current revenue is invoiced in Sterling, and a significant
element of our operations and costs arise within the UK. Our overseas
operations generally trade and are funded in their local currency
which limits their exposure to foreign exchange volatility. Our foreign
currency borrowings, which totalled £6.6 billion at 31 March
2008, are used to finance our operations and have been predominantly
swapped into Sterling. Cross currency swaps and forward currency contracts
have been entered into to reduce the foreign currency exposure on
our operations and net assets. We also enter 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 of these policies, our exposure to foreign currency arises
mainly on the residual currency exposure on our non UK investments
in our subsidiaries and on any imbalances between the value of outgoing
and incoming international calls.
After
hedging, our exposure to foreign exchange volatility in the income
statement from a 10% strengthening in other currencies, based on the
composition of assets and liabilities at the balance sheet date, with
all other factors remaining constant would be insignificant in 2008
and 2007.
Interest
rate risk management
We have interest bearing
financial assets and financial liabilities which may expose us to
either interest cash flow or fair value volatility. Our policy, as
prescribed by the Board, is to ensure that at least 70% of net debt
is at fixed rates.
The
majority of our long-term borrowings have been, and are, subject to
Sterling fixed interest rates after applying the impact of hedging
instruments. We have entered into interest rate swap agreements with
commercial banks and other institutions to vary the amounts and period
for which interest rates are fixed. We had outstanding interest rate
swap agreements with notional principal amounts totalling £4.8
billion at 31 March 2008 compared with £5.1 billion at 31 March
2007.
The long-term debt instruments
which we 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 July 2006, S&P downgraded BT’s credit rating to BBB+ and
Moody’s currently apply a rating of Baa1 following a downgrade
in May 2001. Based on the total amount of debt of £4.5 billion
outstanding on these instruments at 31 March 2008, our annual finance
expense would increase by approximately £22 million if our credit
rating were to be downgraded by one credit rating category by both
agencies below a long-term debt rating of Baa1/BBB+. If our credit
rating with each of Moody’s and S&P were to be upgraded by
one credit rating category, our annual finance expense would be reduced
by approximately £22 million.
After
the impact of hedging, our main exposure to interest rate volatility
in the income statement arises from fair value movements on derivatives
not in hedging relationships and our variable rate borrowings and
investments which are largely influenced by Sterling interest rates.
Interest rate movements on 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 2008, a 100 basis point
increase in Sterling interest rates would decrease our annual net
finance expense by approximately £5 million (2007: £11 million
increase).
Credit risk
management
Our exposure to credit
risk arises mainly from our trading related receivables and from financial
assets transacted by the centralised treasury operation.
For
treasury related balances, the Board defined policy restricts the
exposure to any one counterparty and financial instrument by setting
credit limits based on the credit quality as defined by Moody’s
and S&P’s and defining the types of financial instruments
which may be transacted. The minimum credit ratings set are A-/A3
for long-term and A1/P1 for short-term investments with counterparties.
The centralised treasury operation continuously reviews the limits
applied to counterparties and will adjust the limit according to the
size 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 adjustments required, if any. Where
multiple transactions are undertaken with a single counterparty, or
group of related counterparties, we may enter into a netting arrangement
to reduce our exposure to credit risk. Currently, we make use of standard
International Swaps and Derivative Association (ISDA) documentation.
In addition, where possible we will seek a legal right of set off
and have the ability and
intention to settle net. We also seek collateral or other security
where it is considered necessary. During 2008, the centralised treasury
operation tightened the credit limits applied when investing with
counterparties and continued to monitor their credit quality in response
to market credit conditions.
Our
credit policy for trading related financial assets is applied and
managed by each of the lines of business to ensure compliance. The
policy requires that the creditworthiness and financial strength of
customers is assessed at inception and on an ongoing basis. Payment
terms are set in accordance with industry standards. We will also
enhance credit protection when appropriate by applying processes which
include netting and offsetting, considering the customer’s exposure
to the group and requesting securities such as deposits, guarantees
and letters of credit. In light of the adverse market credit conditions
we have taken action to ensure the impact on trading related financial
assets is minimised. The concentration of credit risk for trading
balances of the group is provided in note 15 which analyses outstanding
balances by line of business and reflects the nature of customers
in each segment.
Liquidity
risk management
We ensure our liquidity
is maintained by entering into short, medium and long-term financial
instruments to support operational and other funding requirements.
On an annual basis the Board reviews and approves the maximum long-term
funding of the group. Short and medium-term requirements are regularly
reviewed and managed by the centralised treasury operation within
the parameters set by the Board.
Our
liquidity and funding management process includes projecting cash
flows and considering the level of liquid assets in relation thereto,
monitoring balance sheet liquidity and maintaining a diverse range
of funding sources and back-up facilities. Liquid assets surplus to
immediate operating requirements of the group are generally invested
and managed by the centralised treasury function. Operating finance
requirements of group companies are met whenever possible from central
resources. We manage liquidity risk by maintaining adequate committed
borrowing facilities. Refinancing risk is managed by limiting the
amount of borrowing that matures within any specific period.
Despite
adverse market credit conditions in 2008, we proactively raised long-term
funds of £3.5 billion and short term funds of £0.4 billion.
A proportion of these borrowings were raised using our European Medium
Term Note programme and US Shelf registration. In addition, we utilised
part of our commercial paper programme which is supported by a committed
borrowing facility of up to £1.5 billion. The facility is available
for the period to January 2013. We had additional undrawn committed
borrowing facilities of £835 million of which £800 million
was agreed in 2008 (with a further £100 million agreed after
the balance sheet date), and is for a term of 364 days and has a one-year term
out. The remaining £35 million was renewed in 2008. These funding
related actions ensure we are in a strong position and able to fund
the Board approved projected business requirements beyond 2009.
Price risk
management
We have limited exposure
to equity securities price risk on investments that we hold.
Further
information on financial instruments is mainly discussed in notes
5,
9,
10,
15,
16,
17 and
33 to the consolidated financial statements.
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