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Note 31: Financial risk management objectives and policies

The Group is exposed to a variety of financial risks: market risk (including foreign currency risk, interest rate risk and fuel price risk), credit risk, capital risk and liquidity risk. The Group’s overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Group’s financial performance.

Group treasury carries out financial risk management under governance approved by the Board. Group treasury identifies, evaluates and hedges financial risks. The Board provides written principles for overall risk management, as well as written policies covering specific areas, such as foreign exchange risk, interest rate risk, credit risk, capital risk and the use of derivative financial instruments and investment of excess liquidity.

a  Fuel price risk

The Group is exposed to fuel price risk. The Group’s fuel price risk management strategy aims to provide the airline with protection against sudden and significant increases in oil prices while ensuring that the airline is not competitively disadvantaged in a serious way in the event of a substantial fall in the price of fuel.

In meeting these objectives, the fuel risk management programme allows for the judicious use of a number of derivatives available on the over-the-counter (OTC) markets with approved counterparties and within approved limits.

The following table demonstrates the sensitivity of financial instruments to a reasonably possible change in fuel prices, with all other variables held constant, on (loss)/profit before tax and equity:

Group   Company
2009   2008   2009   2008
Increase/
(decrease) in fuel price
per cent
Effect on loss before tax
£ million
Effect on equity
£ million
  Increase/
(decrease) in fuel price
per cent
Effect on profit before tax
£ million
Effect on equity
£ million
  Increase/
(decrease) in fuel price
per cent
Effect on loss before tax
£ million
Effect on equity
£ million
  Increase/
(decrease) in fuel price
per cent
Effect on profit before tax
£ million
Effect on equity
£ million
30 15 301   10 14 166   30 15 301   10 14 166
(30) (4) (337)   (10) (11) (163)   (30) (4) (337)   (10) (11) (163)

b  Foreign currency risk

The Group is exposed to currency risk on revenue, purchases and borrowings that are denominated in a currency other than sterling. The currencies in which these transactions are primarily denominated are euro, US dollar and Japanese yen. The Group generates a surplus in most currencies in which it does business. The US dollar can be an exception as capital expenditure, debt repayments and fuel payments denominated in US dollars can create a deficit.

The Group can experience adverse or beneficial effects arising from foreign exchange rate movements. The Group seeks to reduce foreign exchange exposures arising from transactions in various currencies through a policy of matching, as far as possible, receipts and payments in each individual currency. Surpluses of convertible currencies are sold, either spot or forward, for US dollars or sterling.

The Group has substantial liabilities denominated in euro, US dollars and Japanese yen.

The Group utilises its euro, US dollar and Japanese yen debt repayments as a hedge of future euro, US dollar and Japanese yen revenues.

Forward foreign exchange contracts and currency options are used to cover near-term future revenues and operating payments in a variety of currencies.

The following table demonstrates the sensitivity of financial instruments to a reasonably possible change in the euro, US dollar and Japanese yen exchange rates, with all other variables held constant, on (loss)/profit before tax and equity.

Group Strengthening/
(weakening) in euro rate
per cent
Effect on (loss)
/profit before tax
£ million
Effect on equity
£ million
Strengthening/
(weakening) in US dollar rate
per cent
Effect on (loss)/
profit before tax
£ million
Effect on equity
£ million
Strengthening/
(weakening) in Japanese yen rate
per cent
Effect on (loss)/profit before tax
£ million
Effect on equity
£ million
2009 20 (7) (33) 20 (52) (162) 20 (8) (138)
  (20) 6 32 (20) 52 162 (20) 8 138
2008 10 (2) (26) 10 (4) (42) 10 (7) (57)
  (10) 2 22 (10) 3 32 (10) 5 47

Company
                 
2009 20 (7) (33) 20 (52) (162) 20 (8) (138)
  (20) 6 32 (20) 52 162 (20) 8 138
2008 10 (2) (26) 10 (6) (42) 10 (7) (57)
  (10) 2 22 (10) 5 32 (10) 5 47

c  Interest rate risk

The Group is exposed to changes in interest rates on floating debt and cash deposits.

The following table illustrates the sensitivity of financial instruments on (loss)/profit before tax for the year to a reasonably possible change in interest rates, with effect from the beginning of the year. There was no impact on shareholders’ equity. These changes are considered to be reasonably possible based on observation of current market conditions. The calculations are based on financial instruments held at each balance sheet date. All other variables were held constant.

  2009
  Effect on loss before tax
£ million 100 basis points increase 50 basis points decrease
Group    
Variable rate instruments (2) 1
Company    
Variable rate instruments (10) 5
 
2008
  Effect on profit before tax
£ million 100 basis points increase 50 basis points decrease
Group    
Variable rate instruments 3 (3)
Company    
Variable rate instruments (3) 3

d  Credit risk

The Group is exposed to credit risk to the extent of non-performance by its counterparties in respect of financial assets receivable. However, the Group has policies and procedures in place to ensure credit risk is limited by placing credit limits on each counterparty. The Group continuously monitors counterparty credit limits and defaults of counterparties, incorporating this information into credit risk controls. Treasury activities which include placing money market deposits, fuel hedging and foreign currency transactions could lead to a concentration of different credit risks on the same counterparty. This risk is managed by the allocation of an overall exposure limit for the counterparty that is then allocated down to specific treasury activities for that party. Exposures at the activity level are monitored on a daily basis and the overall exposure limit for the counterparty is reviewed at least monthly in the light of available market information such as credit ratings and credit default swap levels. It is the Group’s policy that all counterparties who wish to trade on credit terms are subject to credit verification procedures.

The maximum exposure to credit risk is limited to the carrying value of each class of asset as summarised in note 32.

The Group does not hold any collateral to mitigate this exposure. Credit risks arising from acting as guarantor are disclosed in note 37.

e  Liquidity risk

Prudent liquidity risk management includes maintaining sufficient cash and interest-bearing deposits, the availability of funding from an adequate amount of credit facilities and the ability to close out market positions. Due to the dynamic nature of the underlying business, Group treasury maintains flexibility in funding by maintaining availability under committed credit lines.

The Company’s long-term corporate debt ratings at March 31, 2009, assigned by Moody’s and Standard & Poor’s respectively were Ba1 and BB+. The Moody’s rating was reduced from Baa3 in February 2009 and the Company is on credit watch for a further downgrade. The Standard & Poor’s rating was reduced to BB with a stable outlook in May 2009. The downgrades were due to adverse trading conditions. The downgrades have had no impact on debt covenants or liquidity since the Group has committed borrowing facilities through to 2016, and adequate cash reserves to meet operating requirements for the next 12 months.

At March 31, 2009, the Group and Company had unused overdraft facilities of £20 million (2008: £20 million) and €4 million (£4 million) (2008: €20 million (£16 million) respectively).

The Group and Company held undrawn uncommitted money market lines of £25 million as at March 31, 2009 (2008: £45 million).

The Group and Company had the following undrawn general and committed aircraft financing facilities:

  2009
million Currency £ equivalent
US dollar facility expiring June 2013 $1,301 911
US dollar facility expiring March 2014 $940 658
US dollar facility expiring June 2010 $228 160
US dollar facility expiring September 2016 $509 356
US dollar facility expiring December 2012 $270 189
US dollar facility expiring June 2012 $269 189
Japanese yen facility expiring January 2011 ¥68,085 485
 
2008
million Currency £ equivalent
US dollar facility expiring June 2010 $266 134
US dollar facility expiring June 2012 $115 58
US dollar facility expiring December 2015 $509 256
US dollar facility expiring March 2014 $940 472
US dollar facility expiring December 2012 $1,615 812
Japanese yen facility expiring January 2011 ¥75,000 381

The table below analyses the Group’s financial assets and liabilities into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows and include interest.

  Group
£ million Within 6 months 6-12 months 1-2 years 2-5 years More than 5 years Total
2009
Cash and cash equivalents 402         402
Other current interest-bearing deposits 740 248       988
Trade receivables 530         530
Interest-bearing loans and borrowings:            
Finance lease and hire purchase obligations (447) (240) (474) (689) (1,672) (3,522)
Fixed rate borrowings (31) (21) (51) (141) (425) (669)
Floating rate borrowings (20) (40) (60) (171) (156) (447)
Trade and other payables (1,374)         (1,374)
Derivative financial instruments:            
Cross currency swaps     (1) (2) (4) (7)
Forward currency contracts (13) (2) (3)     (18)
Fuel derivatives (252) (204) (111) (2)   (569)
Forward currency contracts 31 9 3     43
At March 31 (434) (250) (697) (1,005) (2,257) (4,643)
 
Group
£ million Within 6 months 6-12 months 1-2 years 2-5 years More than 5 years Total
2008
Cash and cash equivalents 683         683
Other current interest-bearing deposits 861 360       1,221
Trade receivables 586         586
Interest-bearing loans and borrowings:            
Finance lease and hire purchase obligations (169) (220) (523) (695) (1,268) (2,875)
Fixed rate borrowings (98) (21) (51) (150) (468) (788)
Floating rate borrowings (20) (37) (56) (143) (211) (467)
Trade and other payables (1,265)         (1,265)
Derivative financial instruments:            
Cross currency swaps       (1) (1) (2)
Forward currency contracts (15) (5) (1)     (21)
Fuel derivatives       (1)   (1)
Forward currency contracts 5 3       8
Fuel derivatives 151 82 50 1   284
At March 31 719 162 (581) (989) (1,948) (2,637)
 
Company
£ million Within 6 months 6-12 months 1-2 years 2-5 years More than 5 years Total
2009
Cash and cash equivalents 219         219
Other current interest-bearing deposits 20 24       44
Trade receivables 517         517
Interest-bearing loans and borrowings:            
Finance lease and hire purchase obligations (461) (246) (495) (757) (1,811) (3,770)
Fixed rate borrowings (25) (25) (50) (137) (1,058) (1,295)
Floating rate borrowings (20) (36) (56) (157) (125) (394)
Trade and other payables (2,961)         (2,961)
Derivative financial instruments:            
Cross currency swaps     (1) (2) (4) (7)
Forward currency contracts (13) (2) (3)     (18)
Fuel derivatives (252) (204) (111) (2)   (569)
Forward currency contracts 31 9 3     43
At March 31 (2,945) (480) (713) (1,055) (2,998) (8,191)
 
Company
£ million Within 6 months 6-12 months 1-2 years 2-5 years More than 5 years Total
2008
Cash and cash equivalents 433         433
Other current interest-bearing deposits 414         414
Trade receivables 574         574
Interest-bearing loans and borrowings:            
Finance lease and hire purchase obligations (182) (225) (543) (760) (1,431) (3,141)
Fixed rate borrowings (92) (24) (47) (138) (986) (1,287)
Floating rate borrowings (18) (33) (51) (126) (172) (400)
Trade and other payables (2,776)         (2,776)
Derivative financial instruments:            
Cross currency swaps       (1) (1) (2)
Forward currency contracts (15) (5) (1)     (21)
Fuel derivatives       (1)   (1)
Forward currency contracts 5 3       8
Fuel derivatives 151 82 50 1   284
At March 31 (1,506) (202) (592) (1,025) (2,590) (5,915)

f  Capital risk management

The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital.

Consistent with others in the industry, the Group monitors capital on the basis of the gearing ratio, net debt as a percentage of total capital. Net debt is defined as the total borrowings, finance leases and hire purchase liabilities, net interest-bearing deposits and cash and cash equivalents less overdrafts. See note 25 for details of the calculation of net debt. Total capital is defined as the total of capital, reserves, minority interests and net debt.

The gearing ratios at March 31, 2009 and 2008 were as follows:

  Group
£ million (except ratios) 2009 2008
Restated
Capital reserves 1,646 3,062
Add minority interests 200 200
Total equity 1,846 3,262
Net debt (a) 2,382 1,310
Total capital (b) 4,228 4,572
Gearing ratio (a)/(b) 56.3 28.7

The increase in the gearing ratio during 2009 resulted primarily from decreased equity due to adverse marked-to-market adjustments on fuel derivatives and foreign currency borrowings, as well as the operating loss reported. The gearing ratio was further impacted by increased borrowings relating to the delivery of nine Airbus A320s and one Boeing 777 aircraft. The carrying value of foreign currency borrowings has increased as a result of the weakening of sterling during 2009.

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