7. Financial risk management
(a) Financial risk factors
The Group’s activities expose it to a variety of financial risks. These are market risk, including foreign exchange risk and interest rate risk, credit risk, and liquidity risk. These risks are unchanged from those reported in the 2021 Annual Report. The numeric disclosures in respect of financial risks are included within later notes to the financial statements, to provide a more transparent link between financial risks and results.
Financial risks represent part of the Group’s risks in relation to its strategy and business objectives. There is a full discussion of the most significant risks in the Risk management section of this Annual Report. The Group’s financial risk management focuses on the unpredictability of financial markets and seeks to minimise potentially adverse effects on the Group’s financial performance. The Group seeks to reduce its exposure to financial risks and uses derivative financial instruments to hedge certain risk exposures. Such derivative financial instruments are also used to manage the Group’s borrowings so that amounts are held in currencies broadly in the same proportion as the Group’s main earnings. However, the Group does not, nor does it currently intend to, borrow in the Brazilian real or the Colombian peso.
The Group also ensures surplus funds are prudently managed and controlled.
Foreign exchange risk
The Group is exposed to foreign exchange risk from future commercial transactions, recognised assets and liabilities and investments in, and loans between, Group undertakings with different functional currencies. The Group manages such risk, primarily within undertakings whose functional currencies are the US dollar, by:
- entering into forward foreign exchange contracts in the relevant currencies in respect of investments in entities with functional currencies other than the US dollar, whose net assets are exposed to foreign exchange translation risk;
- swapping the proceeds of certain bonds issued in pounds sterling and euros into US dollars;
- managing the liquidity of Group undertakings in the functional currency of those undertakings by using an in-house banking structure and hedging any remaining foreign currency exposures with forward foreign exchange contracts;
- denominating internal loans in relevant currencies, to match the currencies of assets and liabilities in entities with different functional currencies; and
- using forward foreign exchange contracts to hedge certain future commercial transactions.
The principal transaction exposures are to the pound sterling and the euro. An indication of the sensitivity to foreign exchange risk is given in note 10.
Interest rate risk
The Group’s interest rate risk arises principally from components of its Net debt that are at variable rates.
The Group has a policy of normally maintaining between 50% and 100% of Net funding at rates that are fixed for more than six months. The Group manages its interest rate exposure by:
- using fixed and floating rate borrowings, interest rate swaps and cross-currency interest rate swaps to adjust the balance between the two; and
- mixing the duration of borrowings and interest rate swaps to smooth the impact of interest rate fluctuations.
Managing interest rate benchmark reform and associated risks
A fundamental reform of interest rate benchmarks is taking place globally, involving the replacement of many London interbank offered rates (LIBOR). Historically our main floating rate borrowings and derivatives have been indexed to pound sterling and US dollar LIBOR. During FY22, we have amended our revolving credit facilities and other financial instruments, so that once these reforms are completed, sterling pound exposures will be indexed to Sterling Overnight Index Average (SONIA) rate, and US dollar exposures to the Secured Overnight Financing Rate (SOFR).
The Tax and Treasury Committee monitors and manages the Group’s transition to alternative rates. The Committee evaluates the extent to which contracts reference IBOR cash flows and whether such contracts will need to be amended as a result of IBOR reform.
Derivatives
The Group has transacted cross-currency swaps, interest rate swaps and equity swaps for risk management purposes. As at 31 March 2021, these swaps had floating legs that were indexed to either sterling LIBOR or US dollar LIBOR. During the year ended 31 March 2022 the Group modified derivatives indexed to sterling LIBOR to reference SONIA. In respect of US dollar LIBOR exposures, the Group has signed up to the ISDA protocol that introduces fallback clauses into all such instruments. These clauses automatically switch the instrument from referencing US dollar LIBOR to SOFR as and when US dollar LIBOR ceases. The Group expects the impact of the reform to be immaterial on these instruments.
Hedge accounting
The Group’s hedging instruments documented in hedge accounting relationships at 31 March 2022 are indexed to US dollar LIBOR. As already noted, these instruments have fallback clauses which automatically switch the instruments from referencing US dollar LIBOR to SOFR as and when US dollar LIBOR ceases. As there is still uncertainty about when these instruments will switch to SOFR, the Group is applying the Phase 1 amendments to IFRS 9 to its hedge accounting relationships. The Group expects the impact of the reform to be immaterial on these instruments.
Total amounts of unreformed contracts, including those with an appropriate fallback clause
The Group monitors the progress of transition from IBORs to new benchmark interest rates by reviewing the value of contracts that have yet to transition to an alternative benchmark interest rate and the value of contracts that include an appropriate fallback clause. The Group considers that a contract is not yet transitioned to an alternative benchmark rate when interest under the contract is indexed to a benchmark rate that is still subject to IBOR reform, even if it includes a fallback clause that deals with the cessation of the existing IBOR (referred to as an ‘unreformed contract’). The following table shows the value of unreformed contracts and those with appropriate fallback clauses. Derivatives are shown at their notional amounts.
| 2022 | 2021 | ||||||||||
| Sterling LIBOR | US dollar LIBOR | Sterling LIBOR | US dollar LIBOR | ||||||||
| Value of unreformed contracts US$m | Amount with appropriate fallback clause US$m | Value of unreformed contracts US$m | Amount with appropriate fallback clause US$m | Value of unreformed contracts US$m | Amount with appropriate fallback clause US$m | Value of unreformed contracts US$m | Amount with appropriate fallback clause US$m | ||||
| Derivatives | |||||||||||
| Cross-currency swaps | — | — | 1,413 | 1,413 | — | — | 1,413 | — | |||
| Interest rate swaps | — | — | 1,700 | 1,700 | 964 | — | 1,800 | — | |||
| Equity swaps | — | — | — | — | 22 | — | — | — | |||
Further information in respect of the Group’s net finance costs for the year and an indication of the sensitivity to interest rate risk is given in note 15.
Credit risk
In the case of derivative financial instruments, deposits, contract assets and trade receivables, the Group is exposed to credit risk from the non-performance of contractual agreements by the contracted party.
Credit risk is managed by:
- only entering into contracts for derivative financial instruments and deposits with banks and financial institutions with strong credit ratings, within limits set for each organisation; and
- closely controlling dealing activity and regularly monitoring counterparty positions.
The credit risk on derivative financial instruments utilised and deposits held by the Group is therefore not considered to be significant. The Group does not anticipate that any losses will arise from non-performance by its chosen counterparties. Further information on the Group’s derivative financial instruments at the balance sheet dates is given in note 30 and that in respect of amounts recognised in the Group income statement is given in note 15. Further information on the Group’s cash and cash equivalents at the balance sheet dates is given in note 25.
To minimise credit risk for trade receivables, the Group has implemented policies that require appropriate credit checks on potential clients before granting credit. The maximum credit risk in respect of such financial assets is their carrying value. Further information in respect of the Group’s trade receivables is given in note 24.
Debt investments
All of the Group’s debt investments at amortised cost and FVOCI are considered to have low credit risk; the loss allowance is therefore limited to 12 months’ expected losses. Management considers ‘low credit risk’ for listed bonds to be an investment-grade credit rating with at least one major rating agency. Other instruments are considered to be low credit risk when they have a low risk of default and the issuer has a high capacity to meet its contractual cash flow obligations in the near term.
Financial assets at FVPL
The Group is also exposed to credit risk in relation to debt investments that are measured at FVPL. The maximum exposure at the balance sheet date is the carrying amount of these investments.
Liquidity risk
The Group manages liquidity risk by:
- issuing long-maturity bonds and notes;
- entering into long-term committed bank borrowing facilities, to ensure the Group has sufficient funds available for operations and planned growth;
- spreading the maturity dates of its debt; and
- monitoring rolling cash flow forecasts, to ensure the Group has adequate, unutilised committed bank borrowing facilities.
Details of such facilities are given in note 27. A maturity analysis of contractual undiscounted future cash flows for financial liabilities is provided in note 32.
(b) Capital risk management
The Group’s definition and management of capital focuses on capital employed:
- The Group’s capital employed is reported in the net assets summary table set out in the Financial review and analysed by segment in note 9(a)(iii).
- As part of its internal reporting processes, the Group monitors capital employed by operating segment.
The Group’s objectives in managing capital are to:
- safeguard its ability to continue as a going concern, in order to provide returns for shareholders and benefits for other stakeholders; and
- maintain an optimal capital structure and cost of capital.
The Group’s policy is to have:
- a prudent but efficient balance sheet; and
- a target leverage ratio of 2.0 to 2.5 times Benchmark EBITDA, consistent with the intention to retain strong investment-grade credit ratings.
To maintain or adjust its capital structure, the Group may:
- adjust the amount of dividends paid to shareholders;
- return capital to shareholders;
- issue or purchase our own shares; or
- sell assets to reduce Net debt.
Dividend policy
The Group has a progressive dividend policy which aims to increase the dividend over time broadly in line with the underlying growth in Benchmark EPS. This aligns shareholder returns with the underlying profitability of the Group. In determining the level of dividend in any one year, in accordance with the policy, the Board also considers a number of other factors, including the outlook for the Group, the opportunities for organic investment, the opportunities to make acquisitions and disposals, the cash flow generated by the Group, and the level of dividend cover. Further detail on the distributable reserves of the Company can be found in note L to the Company financial statements.