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Note 30: 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, 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 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 profit before tax and equity:

Group   Company
2010   2009   2010   2009
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 profit 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 profit before tax
million
Effect on equity
million
30 4 432 30 15 301 30 4 432 30 15 301
(30) (11) (420)   (30) (4) (337) (30) (11) (420)   (30) (4) (337)

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 US dollar, euro and Japanese yen (yen). The Group generates a surplus in most currencies in which it does business. The US dollar is an exception as capital expenditure, debt repayments and fuel payments denominated in US dollars normally 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 pounds sterling.

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

The Group utilises its US dollar, euro and yen debt repayments as a hedge of future US dollar, euro and 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 US dollar, euro and yen exchange rates, with all other variables held constant, on (loss)/profit before tax and equity.

Group Strengthening/
(weakening) in US dollar rate
per cent
Effect on profit before tax
million
Effect on equity
million
Strengthening/
(weakening) in euro rate
per cent
Effect on profit before tax
million
Effect on equity
million
Strengthening/
(weakening) in yen rate
per cent
Effect on profit before tax
million
Effect on equity
million
2010 20 5 (185) 20 1 (38) 20 (19) (104)
  (20) (5) 184 (20) (1) 38 (20) 19 104
2009 20 (52) (162) 20 (7) (33) 20 (8) (138)
  (20) 52 162 (20) 6 32 (20) 8 138

Company
                 
2010 20 (185) 20 (38) 20 (19) (104)
  (20) 184 (20) 38 (20) 19 104
2009 20 (52) (162) 20 (7) (33) 20 (8) (138)
  (20) 52 162 (20) 6 32 (20) 8 138

c  Interest rate risk

The Group is exposed to changes in interest rates on floating rate debt and cash deposits. Had there been a change in interest rates, either an increase of 100 basis points or a decrease of 50 basis points, there would have been a £nil impact on shareholders’ equity (2009: £nil) and a £nil impact on the Group and Company current year income statement. In the prior year, as a result of higher Group net debt, an increase in interest rates of 100 basis points would have had an unfavourable impact on the Group income statement of £2 million. A decrease in interest rates of 50 basis points would have had a favourable impact on the Group income statement of £1 million.

In the prior year, cash deposits were primarily held in a subsidiary entity. As a result, an increase in interest rates of 100 basis points would have had an unfavourable impact on the Company income statement of £10 million, a decrease in interest rates of 50 basis points would have had a favourable impact on the Company income statement of £5 million.

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 31.

The Group does not hold any collateral to mitigate this exposure. Credit risks arising from acting as guarantor are disclosed in note 36.

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 31 March 2010 assigned by Moody’s and Standard and Poor’s respectively were B1 and BB-. The Moody’s rating was reduced from Ba3 in March 2010 and the Company is on credit watch for a further downgrade. 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 31 March 2010 the Group and Company had unused overdraft facilities of £10 million (2009: £20 million) and €nil (2009: €4 million (£4 million)).

The Group and Company held undrawn uncommitted money market lines of £25 million as at 31 March 2010 (2009: £25 million).

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

  2010
Million Currency £ equivalent
US dollar facility expiring June 2013 $912 602
US dollar facility expiring September 2016 $966 638
US dollar facility expiring October 2010 $114 75
US dollar facility expiring October 2016 $509 336
US dollar facility expiring December 2010 $98 65
US dollar facility expiring June 2012 $750 495
Japanese yen facility expiring January 2011 ¥24,281 172
  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

The table below analyses the Group’s financial assets and liabilities into relevant maturity groupings based on the remaining period at the balance sheet 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
2010
Cash and cash equivalents 786 786
Other current interest-bearing deposits 833 95 928
Trade receivables 499 499
Interest-bearing loans and borrowings:
Finance lease and hire purchase obligations (286) (182) (201) (708) (1,618) (2,995)
Fixed rate borrowings (47) (36) (83) (485) (455) (1,106)
Floating rate borrowings (49) (71) (113) (317) (174) (724)
Trade and other payables (1,219) (1,219)
Derivative financial instruments:
Cross currency swaps (1) (2) (2) (5)
Forward currency contracts 17 4 21
Fuel derivatives 24 20 27 71
Forward currency contracts (3)         (3)
At 31 March 555 (170) (371) (1,512) (2,249) (3,747)
  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 31 March (434) (250) (697) (1,005) (2,257) (4,643)
  Company
£ million Within
6 months
6-12
months
1-2 years 2-5 years More than
5 years
Total
2010
Cash and cash equivalents 756 756
Other current interest-bearing deposits 813 95 908
Trade receivables 486 486
Interest-bearing loans and borrowings:
Finance lease and hire purchase obligations (301) (188) (222) (780) (1,732) (3,223)
Fixed rate borrowings (40) (40) (81) (477) (1,057) (1,695)
Floating rate borrowings (49) (68) (109) (303) (150) (679)
Trade and other payables (3,904) (3,904)
Derivative financial instruments:
Cross currency swaps (1) (2) (2) (5)
Forward currency contracts 17 4 21
Fuel derivatives 24 20 27 71
Forward currency contracts (3) (1)       (4)
At 31 March (2,201) (178) (386) (1,562) (2,941) (7,268)
  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 31 March (2,945) (480) (713) (1,055) (2,998) (8,191)

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 24 for details of the calculation of net debt. Total capital is defined as the total of capital, reserves, non-controlling interests and net debt.

The gearing ratios at 31 March were as follows:

  Group
£ million (except ratios) 2010 2009
Capital reserves 1,913 1,646
Add non-controlling interests 200 200
Total equity 2,113 1,846
Net debt (a) 2,288 2,382
Total capital (b) 4,401 4,228
Gearing ratio (a)/(b) 52.0 56.3

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