30. Financial risk management

30.1 Accounting policy

(a) Non-derivative financial instruments

Loans and borrowings are initially recognised at fair value plus directly attributable transaction costs. After initial recognition they are measured at amortised cost, using the effective interest method.

(b) Foreign currencies

The individual financial statements of each Group entity are prepared in their functional currency, which is the currency of the primary economic environment in which that entity operates. For the purpose of the consolidated financial statements, the results and financial position of each entity are translated into pounds sterling, which is the presentational currency of the Group.

Reporting foreign currency transactions in functional currency

Transactions in currencies other than the entity's functional currency (foreign currencies) are initially recorded at the rates of exchange prevailing on the dates of the transactions. At each subsequent balance sheet date:

  1. Foreign currency monetary items are retranslated at the rates prevailing at the balance sheet date. Exchange differences arising on the settlement or retranslation of monetary items are recognised in the Group income statement; and
  2. Non-monetary items measured at historical cost in a foreign currency are not retranslated.

Translation from functional currency to presentational currency

When the functional currency of a Group entity is different from the Group's presentational currency (pounds sterling), its results and financial position are translated into the presentational currency as follows:

  1. Assets and liabilities are translated using exchange rates prevailing at the balance sheet date;
  2. Income and expense items are translated at average exchange rates for the year, except where the use of such average rates does not approximate the exchange rate at the date of a specific transaction, in which case the transaction rate is used; and
  3. All resulting exchange differences are recognised in other comprehensive income and presented in the translation reserve in equity and are reclassified to profit or loss in the period in which the foreign operation is disposed.

Net investment in foreign operations

Exchange differences arising on a monetary item that forms part of a reporting entity's net investment in a foreign operation are initially recognised in other comprehensive income and presented in the translation reserve in equity and reclassified to profit or loss on disposal of the net investment.

30.2 Financial risk factors

The Group's treasury department, acting in accordance with policies approved by the Board, is principally responsible for managing the financial risks faced by the Group. The Group's activities expose it to a variety of financial risks, the most significant of which are market risk and liquidity risk.

(a) Market risk

Market risk is the risk that either the fair values or the cash flows of the Group's financial instruments may fluctuate because of changes in market prices. The Group is principally exposed to market risk through fluctuations in exchange rates ("currency risk") and interest rates ("interest rate risk").

Currency risk

The Group is exposed to currency risk on its borrowings and financial assets (being cash and short-term deposits) that are denominated in currencies other than pounds sterling. The Group's general policy is proportionally to match the currency profile of its core borrowings with the currency profile of its earnings and net assets achieved, where necessary, by the use of forward foreign exchange contracts ("FX swaps"). The currency profile of the Group's borrowings and financial assets, reflecting the effect of the FX swaps, is shown in the table below.

20122011
Borrowings
before
FX swaps
£m
FX swaps
£m
Borrowings
after
FX swaps
£m
Financial
assets
£m
Net debt
£m
Borrowings
before
FX swaps
£m
FX swaps
£m
Borrowings
after
FX swaps
£m
Financial
assets
£m
Net debt
£m
Sterling176.451.1227.5(14.9)212.6151.3100.6251.9(44.4)207.5
United States dollar156.8(51.1)105.7(4.8)100.9287.0(176.0)111.0(13.3)97.7
Euro91.891.8(36.7)55.1111.8111.8(13.8)98.0
Chinese renminbi(20.8)(20.8)(43.5)(43.5)
Japanese yen0.80.8(2.2)(1.4)0.875.476.2(2.4)73.8
Other4.24.2(50.1)(45.9)5.45.4(70.7)(65.3)
Capitalised borrowing costs(5.2)(5.2)(5.2)(4.3)(4.3)(4.3)
As at 31 December424.8424.8(129.5)295.3552.0552.0(188.1)363.9

Based upon the currency profile shown in the table above, while not impacting reported profit, the change in net debt arising from a 10% strengthening of sterling would increase reported equity by £8.0m (2011: £14.6m) and a corresponding 10% weakening of sterling would reduce equity by £9.8m (2011: £17.8m).

The tables below show the net unhedged monetary assets and liabilities of Group companies that are not denominated in their functional currency and which could give rise to exchange gains and losses in the Group income statement.

Net unhedged monetary assets/(liabilities)
Sterling
£m
US dollar
£m
Euro
£m
Renminbi
£m
Other
£m
Total
£m
Functional currency
Sterling5.0(16.9)1.4(10.5)
United States dollar1.0(0.1)0.9
Euro(0.6)1.30.31.0
Chinese renminbi3.7(0.6)3.1
Other(1.4)(2.8)13.32.77.419.2
As at 31 December 2012(2.0)7.2(3.2)2.79.013.7
Net unhedged monetary assets/(liabilities)
Sterling
£m
US dollar
£m
Euro
£m
Renminbi
£m
Other
£m
Total
£m
Functional currency
Sterling1.01.50.42.9
United States dollar0.30.57.17.9
Euro(0.4)1.10.41.1
Chinese renminbi5.3(0.9)4.4
Other(1.3)26.210.210.04.649.7
As at 31 December 2011(1.4)33.611.310.012.566.0

Interest rate risk

The Group's interest rate risk principally arises in relation to its borrowings. Where borrowings are held at floating rates of interest, fluctuations in interest rates expose the Group to variability in the cash flows associated with its interest payments and where borrowings are held at fixed rates of interest, fluctuations in interest rates expose the Group to changes in the fair value of its borrowings. The Group's policy is to maintain a mix of fixed and floating rate borrowings, within certain parameters agreed from time to time by the Board, in order to optimise interest cost and reduce volatility in reported earnings.

As at 31 December 2012, the Group had $250.0m (£153.8m) of US Private Placement Loan Notes outstanding, which carry a fixed rate of interest, representing just over a third of the Group's total borrowings outstanding at that date. The interest rate profile of the Group's borrowings and net debt is detailed in the tables below.

Financial liabilities (gross borrowings)Financial
assets
£m
Net debt
£m
Fixed rate
£m
Floating
rate
£m
Total
£m
Sterling176.4176.4(14.9)161.5
United States dollar153.83.0156.8(4.8)152.0
Euro91.891.8(36.7)55.1
Chinese renminbi(20.8)(20.8)
Japanese yen0.80.8(2.2)(1.4)
Other4.24.2(50.1)(45.9)
Capitalised borrowing costs(1.2)(4.0)(5.2)(5.2)
As at 31 December 2012152.6272.2424.8(129.5)295.3
Financial liabilities (gross borrowings)Financial
assets
£m
Net debt
£m
Fixed rate
£m
Interest
rate swaps
£m
Notional
fixed rate
debt
£m
Floating
rate
£m
Total
£m
Sterling74.074.077.3151.3(44.4)106.9
United States dollar283.7283.73.3287.0(13.3)273.7
Euro111.8111.8(13.8)98.0
Chinese renminbi(43.5)(43.5)
Japanese yen0.80.8(2.4)(1.6)
Other5.45.4(70.7)(65.3)
Capitalised borrowing costs(0.7)(0.7)(3.6)(4.3)(4.3)
As at 31 December 2011283.074.0357.0195.0552.0(188.1)363.9

The floating rate financial liabilities shown in the tables above bear interest at the inter-bank offered rate of the appropriate currency, plus a margin. The fixed rate financial liabilities of £152.6m (2011: £357.0m) have a weighted average interest rate of 4.7% (2011: 5.4%) and a weighted average period for which the rate is fixed of 6.6 years (2011: 3.7 years). The financial assets attract floating rate interest at the inter-bank offered rate of the appropriate currency, less a margin.

Based upon the interest rate profile of the Group's financial assets and liabilities shown in the tables above, a 1% increase in market interest rates would increase both the net finance costs charged in the Group income statement and the net interest paid in the Group statement of cash flows by £1.4m (2011: £0.1m) and a 1% reduction in market interest rates would decrease both the net finance costs charged in the Group income statement and the net interest paid in the Group statement of cash flows by £1.4m (2011: £0.1m). Similarly, a 1% increase in market interest rates would result in a decrease of £9.2m (2011: £10.9m) in the fair value of the Group's net debt and a 1% decrease in market interest rates would result in an increase of £9.8m (2011: £11.7m) in the fair value of the Group's net debt.

(b) Liquidity risk

Liquidity risk is the risk that the Group might have difficulties in meeting its financial obligations. The Group manages this risk by ensuring that it maintains sufficient levels of committed borrowing facilities and cash and cash equivalents to ensure that it can meet its operational cash flow requirements and any maturing financial liabilities, while at all times operating within its financial covenants. The level of operational headroom provided by the Group's committed borrowing facilities is reviewed at least annually as part of the Group's three year planning process. Where this process indicates a need for additional finance, this is normally addressed 12 to 18 months in advance by means of either additional committed bank facilities or raising finance in the capital markets.

As at 31 December 2012, the Group had committed borrowing facilities of £578.8m (2011: £883.7m), of which £157.7m (2011: £339.5m) were undrawn. These undrawn facilities are due to expire in April 2016. The Group's borrowing requirements are met by US Private Placement Loan Notes ("USPP") and a multi-currency committed syndicated bank facility of £425.0m (2011: £600.0m). The USPP facility was fully drawn as at 31 December 2012 and amounted to £153.8m ($250.0m), of which $110.0m is repayable in 2017 and $140.0m in 2020. The syndicated bank facility was renegotiated at the time of the Cookson demerger and the Vesuvius facility was reduced to a £425.0m revolving credit facility from the £600.0m in place at December 2011. The facility is repayable in April 2016.

The maturity analysis of the Group's gross borrowings is shown in the tables below.

Non-currentCurrentTotal
2012
£m
2011
£m
2012
£m
2011
£m
2012
£m
2011
£m
Loans and overdrafts421.3421.84.9130.4426.2552.2
Obligations under finance leases2.32.61.51.53.84.1
Capitalised borrowing costs(3.3)(3.1)(1.9)(1.2)(5.2)(4.3)
Total interest-bearing borrowings420.3421.34.5130.7424.8552.0
2012
£m
2011
£m
Interest-bearing borrowings repayable
On demand or within one year6.4131.9
In the second year1.21.4
In the third year0.80.9
In the fourth year267.60.4
In the fifth year67.7260.5
After five years86.3161.2
Capitalised borrowing costs(5.2)(4.3)
Total interest-bearing borrowings424.8552.0

Capitalised borrowing costs shown in the tables above, which have been recognised as a reduction in borrowings in the financial statements, amounted to £5.2m as at 31 December 2012 (31 December 2011: £4.3m), of which £1.2m (2011: £0.7m) related to the USPP and £4.0m (2011: £3.6m) related to the syndicated bank facility.

30.3 Capital management

The Group considers its capital to be equal to the sum of its total equity and net debt. It monitors its capital using a number of key performance indicators, including free cash flow, average working capital to sales ratios, net debt to EBITDA ratios and RONA (note 4). The Group's objectives when managing its capital are:

  • to ensure that the Group and all of its businesses are able to operate as going concerns and ensure that the Group operates within the financial covenants contained within its debt facilities;
  • to maximise shareholder value through maintaining an appropriate balance between the Group's equity and net debt;
  • to have available the necessary financial resources to allow the Group to invest in areas that may deliver acceptable future returns to investors; and
  • to maintain sufficient financial resources to mitigate against risks and unforeseen events.

The Group operated comfortably within the requirements of its debt covenants throughout the year and has substantial liquidity headroom within its committed debt facilities. Details of the Group's covenant compliance and committed debt facilities can be found in the Financial Review.