UK GAAP Parent Company Financial Statements: Note 16
For the Year Ended 31 December 2007
16. Financial Instruments
The Company's activities expose it mainly to the financial risks of changes in foreign currency exchange rates and changes in interest rates. The Company's policy is to hedge these exposures as explained further below using primarily interest rate swaps.
Treasury policy
The Board sets the Company's treasury policy to ensure that it has adequate financial resources to develop the Company's businesses and to manage the currency and interest risks to which the Company is exposed. The Company mainly uses interest rate swap contracts to hedge these exposures. All external hedging is performed by the Treasury function. The Company does not use derivative financial instruments for speculative purposes. Where a derivative (in whole or in part) cannot be designated in an effective hedge relationship any gain or loss arising on the undesignated portion of the derivative is immediately recognised in the Profit and Loss Account. Those derivative financial instruments (or portions thereof) that are not designated in a hedge relationship are classified as held for trading. The Treasury function acts as a service centre operating under the clearly defined regulation of the Board. The Company monitors the distribution of its cash assets, borrowings and facilities so as to control exposure to the relative performance of any particular territory, currency or institution.
Funding and cash management
The Company primarily borrows at short-term variable rates under its multi-currency loan facilities. These borrowings are guaranteed by material subsidiary companies. In connection with the acquisition of Datamonitor plc, in July 2007 the Company arranged for a new five year loan agreement, becoming effective upon the acquisition of Datamonitor plc in July 2007 and comprised of two facilities:
- A - Term loans of GBP 394.74m, USD 840m and EUR 220m;
- B - Multi-currency revolving facilities of GBP 500m.
The previously existing loan facility was cancelled at the same time. In 2001, the Company raised USD 50m on the US private placement market. This facility was cancelled in August 2007.
Operationally, cash pooling arrangements have been organised in primarily GBP, EUR and USD to minimise interest payable on net overdrafts and/or maximise interest receivable on net surplus balances.
Cash flows
Historically and for the foreseeable future the Company has been and is expected to continue to be in a net borrowing position. The Company's policy is to fulfil its borrowing requirements by borrowing in the currencies in which it operates, principally GBP, USD and EUR; thereby providing a natural hedge against projected future surplus USD and EUR cash inflows as well as spreading the Company's interest rate profile across a number of currencies. In addition, GBP denominated borrowings serve to reduce the exposure of the debt to EBITDA banking covenant to movements in exchange rates in respect of currency denominated debt. Therefore the Company seeks to maintain GBP denominated borrowings in the range of 25% - 50% of total borrowings, including where necessary, the selling of USD and EUR for GBP on a regular basis.
In addition, if a significant foreign currency denominated future transaction or cash flow is projected, then the Company may utilise forward foreign exchange contracts to help hedge the associated risk.
Foreign currency risk
Allied to the Company's above policy on the hedging of surplus foreign currency cash inflows, the Company will usually seek to finance its cost of investment in its principal overseas subsidiaries by borrowing in those subsidiaries' functional currencies, primarily EUR and USD. This policy has the effect of protecting the Company's Consolidated Balance Sheet from movements in those currencies to the extent that the associated net assets exceed the net foreign currency borrowings.
Interest rate risk
The Company seeks to minimise its exposure to fluctuations in interest rates by using interest rate swaps as cash flow hedges to hedge up to 90% of forecast interest payments over a period of up to five years, based on forecast net debt levels by currency during that period. This policy provides a level of certainty of future interest costs by swapping floating costs to fixed interest payments which in turn assists the predictability of achieving interest-based loan covenants.
Contracts with nominal value of £935,207,000 (2006: £466,253,000) have fixed interest payments at an average rate of 4.98% (2006: 4.33%) for periods up until 30 April 2010 and have floating interest receipts at LIBOR plus 0%.
16 (a) Maturity Profile of Company Financial Assets and Liabilities
Financial liabilities
| Less than 1 year £'000 |
1-2 years £'000 |
2-5 years £'000 |
More than 5 years £'000 |
2007 Total £'000 |
Less than 1 year £'000 |
1-2 years £'000 |
2-5 years £'000 |
More than 5 years £'000 |
2006 Total £'000 |
|
|---|---|---|---|---|---|---|---|---|---|---|
| Current | ||||||||||
| Overdraft | - | - | - | - | - | 34 | - | - | - | 34 |
| Bank loans | 48,423 | - | - | - | 48,423 | 96,790 | - | - | - | 96,790 |
| Total current | 48,423 | - | - | - | 48,423 | 96,824 | - | - | - | 96,824 |
| Non-current | ||||||||||
| Bank loans | - | 96,845 | 1,104,016 | - | 1,200,861 | - | 96,343 | 558,498 | - | 654,841 |
| Derivative financial liabilities | - | 2,472 | 10,670 | - | 13,142 | |||||
| Total non-current | - | 99,317 | 1,114,686 | - | 1,214,003 | - | 96,343 | 558,498 | - | 654,841 |
| Total | 48,423 | 99,317 | 1,114,686 | - | 1,262,426 | 96,824 | 96,343 | 558,498 | - | 751,665 |
The Company had the following committed undrawn borrowing facilities at 31 December:
| Expiry date | 2007 £'000 |
2006 £'000 |
|---|---|---|
| In one year or less | - | - |
| In more than one year but not more than two years | - | - |
| In more than two years | 217,179 | 129,053 |
| 217,179 | 129,053 |
Financial assets
| Less than 1 year £'000 |
1-2 years £'000 |
2-5 years £'000 |
More than 5 years £'000 |
2007 Total £'000 |
Less than 1 year £'000 |
1-2 years £'000 |
2-5 years £'000 |
More than 5 years £'000 |
2006 Total £'000 |
|
|---|---|---|---|---|---|---|---|---|---|---|
| Current | ||||||||||
| Cash and cash equivalents | 1,266 | - | - | - | 1,266 | 2 | - | - | - | 2 |
| Derivative financial instruments | 790 | - | - | - | 790 | 1,357 | - | - | - | 1,357 |
| Total current | 2,056 | - | - | - | 2,056 | 1,359 | - | - | - | 1,359 |
| Non-current | ||||||||||
| Other financial investments (Note 4) | - | - | - | 257 | 257 | - | - | - | 1,131 | 1,131 |
| Derivative financial instruments | - | 423 | 1,567 | - | 1,990 | - | 1,488 | 4,851 | - | 6,339 |
| Total non-current | - | 423 | 1,567 | 257 | 2,247 | - | 1,488 | 4,851 | 1,131 | 7,470 |
| Total | 2,056 | 423 | 1,567 | 257 | 4,303 | 1,359 | 1,488 | 4,851 | 1,131 | 8,829 |
16 (b) Interest Rate Profile
The following interest rate and currency profile of the Company's financial liabilities and assets is after taking into account any interest rate and cross currency swaps entered into by the Company.
Financial liabilities
| Fixed rate £'000 |
Floating rate £'000 |
Non-interest bearing £'000 |
2007 Total £'000 |
Fixed rate £'000 |
Floating rate £'000 |
Non-interest bearing £'000 |
2006 Total £'000 |
|
|---|---|---|---|---|---|---|---|---|
| Gross Borrowings | ||||||||
| GBP | 357,000 | 154,905 | - | 511,905 | 187,000 | 154,228 | - | 341,228 |
| USD | 424,067 | 109,260 | - | 533,327 | 252,409 | 76,331 | - | 328,740 |
| EUR | 154,140 | 49,912 | - | 204,052 | 26,844 | 46,277 | - | 73,121 |
| Other worldwide currencies | - | - | - | - | - | 8,576 | - | 8,576 |
| 935,207 | 314,077 | - | 1,249,284 | 466,253 | 285,412 | - | 751,665 | |
| Derivative financial liabilities |
||||||||
| GBP | 5,630 | - | - | 5,630 | - | - | - | - |
| USD | 7,367 | - | - | 7,367 | - | - | - | - |
| EUR | 145 | - | - | 145 | - | - | - | - |
| Other worldwide currencies | - | - | - | - | - | - | - | - |
| 13,142 | - | - | 13,142 | - | - | - | - |
The Company draws down on its borrowing facilities at floating rates of interest. A portion of those are then swapped to fixed rates in line with the treasury policy. The first portion of these swaps end within twelve months £99,703,000 (2006: £130,108,000), the second portion ends in a period greater than one year but less than two years £321,776,000 (2006: £100,451,000) and the final portion ends between two and five years £513,729,000 (2006: £228,984,000).
Interest on floating rate liabilities is based on the relevant national inter-bank rates.
Financial assets
| Fixed rate £'000 |
Floating rate £'000 |
Non-interest bearing £'000 |
2007 Total £'000 |
Fixed rate £'000 |
Floating rate £'000 |
Non- interest bearing £'000 |
2006 Total £'000 |
|
|---|---|---|---|---|---|---|---|---|
| non-derivative financial assets | ||||||||
| GBP | - | 1,266 | 257 | 1,523 | - | 2 | 1,131 | 1,133 |
| USD | - | - | - | - | - | - | - | - |
| EUR | - | - | - | - | - | - | - | - |
| Other worldwide currencies | - | - | - | - | - | - | - | - |
| - | 1,266 | 257 | 1,523 | - | 2 | 1,131 | 1,133 | |
| Derivative financial assets | ||||||||
| GBP | 1,886 | - | - | 1,886 | 2,600 | - | - | 2,600 |
| USD | 394 | - | - | 394 | 5,043 | - | - | 5,043 |
| EUR | 500 | - | - | 500 | 53 | - | - | 53 |
| Other worldwidecurrencies | - | - | - | - | - | - | - | - |
| 2,780 | - | - | 2,780 | 7,696 | - | - | 7,696 |
Interest on floating rate bank deposits is based on the relevant national inter-bank rate and may be fixed in advance for up to one month. There were no fixed rate deposits as at 31 December 2007 or 2006.
The interest rate profile of fixed rate financial liabilities and the weighted average maturity period (in years) of interest-free financial liabilities are analysed below:
| 2007 | 2006 | |||
|---|---|---|---|---|
| Weighted average effective interest rate % |
Weighted average for period for which the rate is fixed | Weighted average effective interest rate % |
Weighted average for period for which the rate is fixed | |
| GBP | 5.8 | 2.5 | 4.8 | 2.5 |
| USD | 4.8 | 2.4 | 4.2 | 1.8 |
| EUR | 4.4 | 2.6 | 3.6 | 0.8 |
16 (c) Fair Values of Financial Assets and Liabilities
The fair value is defined as the amount at which a financial instrument could be exchanged in an arm's length transaction between informed and willing parties and is calculated by reference to market rates discounted to current value. The fair value of these financial instruments was:
Primary financial instruments held or issued to finance the Company's operations
| 2007 | 2006 | |||
|---|---|---|---|---|
| Book value £'000 |
Estimated fair value £'000 |
Book value £'000 |
Estimated fair value £'000 |
|
| Bank loans and overdrafts (including current portion of long-term borrowings) | (48,423) | (48,423) | (96,824) | (96,824) |
| Long-term borrowings | (1,200,861) | (1,200,861) | (654,841) | (655,494) |
| Cash deposits | 1,266 | 1,266 | 2 | 2 |
| Other financial assets | 257 | 257 | 1,131 | 1,131 |
| Net derivative financial instruments | (10,362) | (10,362) | 7,696 | 7,696 |
The carrying value of primary financial instruments approximates to fair value due to the short maturity of the instruments or because they bear interest at rates approximate to the market. The fair value of the other financial assets is calculated based on the quoted market price, excluding any transaction costs.
Derivative financial instruments held to manage the interest rate profile
| 2007 | 2006 | |||
|---|---|---|---|---|
| Carrying amount £'000 |
Estimated fair value £'000 |
Carrying amount £'000 |
Estimated fair value £'000 |
|
| Net interest rate swaps (Note 16(b)) | (10,362) | (10,362) | 7,696 | 7,696 |
Fair values are determined by calculating the expected cash flows under the terms of each specific contract, discounted back to their present value. The expected cash flows are determined by modelling cash flows using appropriate financial market pricing models. Discounting is achieved through constructing discount curves derived from the market price of the most appropriate observable interest rate products such as deposits and interest rate futures and swaps. The carrying amount of the interest rate swaps comprise £(3,745,000) (2006: £2,600,000) in GBP, £(6,972,000) (2006: £5,043,000) in USD, £355,000 (2006: £53,000) in EUR and £nil (2006: £(nil)) in other worldwide currencies.