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Derivative financial instruments and hedge accounting
 12 Months Ended
Dec. 31, 2022
Text block [abstract]  
Derivative financial instruments and hedge accounting
16. Derivative financial instruments and hedge accounting
The Group’s approach to the management of financial risks is set out in note 19. The Group’s outstanding derivative financial instruments are as follows:
 
               
                  
2022
                          
2021
  
               
All figures in £ millions
   
Gross
notional
amounts
     
Assets
     
Liabilities
    
 
    
Gross notional
amounts
     
Assets
     
Liabilities
  
               
Interest rate derivatives – in a fair value hedge relationship
   
 
177
 
   
 
–
 
   
 
(11
) 
          
 
168
 
   
 
5
 
   
 
–
 
               
Interest rate derivatives – not in a hedge relationship
   
 
260
 
   
 
19
 
   
 
–
 
          
 
217
 
   
 
–
 
   
 
(9
) 
               
Cross-currency rate derivatives – in a hedge relationship
   
 
83
 
   
 
34
 
   
 
(43
) 
          
 
331
 
   
 
24
 
   
 
(21
) 
               
FX derivatives – in a hedge relationship
   
 
355
 
   
 
1
 
   
 
(9
) 
          
 
237
 
   
 
3
 
   
 
(1
) 
               
FX derivatives – not in a hedge relationship
   
 
573
 
   
 
5
 
   
 
(2
) 
  
 
 
 
  
 
193
 
   
 
–
 
   
 
(3
) 
               
Total
   
 
1,448
 
   
 
59
 
   
 
(65
) 
  
 
 
 
  
 
1,146
 
   
 
32
 
   
 
(34
) 
               
Analysed as expiring:
                                                             
               
In less than one year
   
 
        1,028
 
   
 
             16
 
   
 
             (11
) 
          
 
           393
 
   
 
               2
 
   
 
             (4
) 
               
Later than one year and not later than five years
   
 
420
 
   
 
43
 
   
 
(54
) 
          
 
679
 
   
 
30
 
   
 
(26
) 
               
Later than five years
   
 
–
 
   
 
–
 
   
 
–
 
  
 
 
 
  
 
74
 
   
 
–
 
   
 
(4
) 
               
Total
   
 
1,448
 
   
 
59
 
   
 
(65
) 
  
 
 
 
  
 
1,146
 
   
 
32
 
   
 
(34
) 
The Group’s treasury policies only allow derivatives to be traded where the objective is risk mitigation. These are then designated for hedge accounting using the following criteria:
 
—
Where interest rate and cross-currency interest rate swaps are used to convert fixed rate debt to floating and we expect to receive inflows equal to the fixed rate debt interest, these are classified as fair value hedges
 
—
Where derivatives are used to create a future foreign currency exposure to provide protection against currency movements affecting the foreign currency movements of an overseas investment, these are designated as a net investment hedge
 
—
All other derivatives are not designated in a hedge relationship.
The Group’s fixed rate GBP debt is held as fixed rate instruments at amortised cost.
The Group uses a combination of interest rate and cross currency swaps to convert its
€
300m EUR debt.
 
         
    Receive    
Notional
   
    Receive    
coupon
  
FX rate
   
    Notional    
   
  Pay coupon  
         
€
100m
   
1.375%
  
GBPEUR:
1.1295
   
  £87m
   
3.51%  
         
€
181m
   
1.375%
  
GBPUSD:
1.206
   
£160m
   
3.402%  
         
  
€
19m
   
1.375%
  
GBPUSD:
1.206
   
  £23m
   
USD Libor  
+1.36%  
To create the synthetic debt positions outlined above the Group converts
€
100m to £87m at a rate of 3.51% this is not in a hedge relationship. The remaining
€
200m of its EUR fixed debt is swapped to EUR floating debt via interest rate swap contracts that are in a designated fair value hedge. The EUR floating debt is then converted to GBP floating debt via cross-currency swap contracts that are in a designated fair value hedge. The GBP floating debt is then converted to USD floating debt through cross-currency swap contracts that are in a designated net investment hedging relationship. £160m of the EUR debt is finally converted to USD fixed debt via interest rate swap contracts that are not in a hedge relationship.
Additionally, the Group uses FX derivatives including forwards, collars, cross-currency swaps and swaptions to create synthetic USD debt as a hedge of its USD assets and to achieve reasonable certainty of USD currency conversion rates, in line with the Group’s FX hedging policy. As at 31 December 2022 the Group held FX outrights with a notional of $378m at an average rate of GBP:USD rate of 1.24.
The Group’s portfolio of derivatives is diversified by maturity, counterparty and type. Natural offsets between transactions within the portfolio and the designation of certain derivatives as hedges significantly reduce the risk of income statement volatility. The sensitivity of the portfolio to changes in market rates is set out in note 19.
In 2021, the Group transitioned GBP exposures from GBP LIBOR to SONIA. During the year, for USD exposures the Group transitioned its RCF from USD LIBOR to SOFR, it plans to move other exposures including derivatives in the near future. The Group’s risk management strategy has not changed as a result of IBOR Reform and it is considered to be immaterial to the financial statements.
Fair value hedges
The Group uses interest rate swaps and cross-currency swaps as fair value hedges of the Group’s euro issued debt.
Interest rate exposure arises from movements in the fair value of the Group’s euro debt attributable to movements in euro interest rates. The hedged risk is the change in the euro bonds fair value attributable to interest rate movements. The hedged items are the Group’s euro bonds which are issued at a fixed rate. The hedging instruments are fixed to floating euro interest rate swaps where the Group receives fixed interest payments and pays three-month Euribor.
As the critical terms of the interest rate swaps match the bonds, there is an expectation that the value of the hedging instrument and the value of the hedged item will move equally in the opposite direction as a result of movements in the zero coupon Euribor curve. Potential sources of hedge ineffectiveness would be material changes in the credit risk of swap counterparties or a reduction or modification in the hedge item.
A foreign currency exposure arises from foreign exchange fluctuations on translation of the Group’s euro debt into GBP. The hedged risk is the risk of changes in the GBPEUR spot rate that will result in changes in the value of the euro debt when translated into GBP. The hedged items are a portion of the Group’s euro bonds. The hedging instruments are floating to floating cross currency swaps which mitigates an exposure to the effect of euro strengthening against GBP within the hedge item.
As the critical terms of the cross-currency swap match the bonds, there is an expectation that the value of the hedging instrument and the value of the hedged item move in the opposite direction as a result of movements in the EUR:GBP exchange rate. Potential sources of hedge ineffectiveness are a reduction or modification in the hedged item or a material change in the credit risk of swap counterparties.
The Group held the following instruments to hedge exposures to changes in interest rates and foreign currency risk associated with borrowings:
 
       
                  
2022  
  
       
All figures in £ millions
   
Carrying amount of
      hedging instruments
    
  Change in fair value of
hedging instrument
used to determine
hedge ineffectiveness
    
Nominal amounts of  
    hedging instruments  
  
       
Derivative financial instruments for interest rate risk
   
 
(11
) 
  
 
(16
) 
  
 
177  
 
       
Derivative financial instruments for currency risk
   
 
33
 
  
 
9
 
  
 
266  
 
 
       
                   
2021  
  
       
All figures in £ millions
   
Carrying amount of
      hedging instruments
     
  Change in fair value of
hedging instrument
used to determine
hedge ineffectiveness
    
Nominal amounts of  
    hedging instruments  
  
       
Derivative financial instruments for interest rate risk
   
 
5
 
   
 
(5
) 
  
 
168  
 
       
Derivative financial instruments for currency risk
   
 
24
 
   
 
(20
) 
  
 
168  
 
The amounts at the reporting date relating to items designated as hedge items were as follows:
 
           
                                 
2022  
  
           
All figures in £ millions
   
    Carrying amount of
hedged items
    
Accumulated amount of
fair value hedge
adjustments on the
hedged item included in
the carrying amount
     
Change in fair value of
hedged item used to
determine hedge
ineffectiveness
    
Hedge
            ineffectiveness
    
Line item in profit or  
loss that includes hedge  
ineffectiveness  
  
           
Interest rate risk
                                          
           
Financial liabilities – borrowings
   
 
(167
) 
  
 
11
 
   
 
15
 
  
 
(1
) 
  
 
Finance costs  
 
           
Currency risk
                                          
           
Financial liabilities – borrowings
   
 
(167
) 
  
 
n/a
 
   
 
(14
) 
  
 
–
 
  
 
n/a  
 
 
           
                                  
2021  
  
           
All figures in £ millions
   
    Carrying amount of
hedged items
    
Accumulated amount of
fair value hedge
adjustments on
the hedged item
included in the carrying
amount
    
Change in fair value of   
hedged item used to   
determine hedge   
ineffectiveness   
     
Hedge
            ineffectiveness
     
Line item in profit or  
loss that includes hedge  
ineffectiveness  
  
           
Interest rate risk
                                           
           
Financial liabilities – borrowings
   
 
(173
) 
  
 
(4
) 
  
 
5   
 
   
 
–
 
   
 
n/a  
 
           
Currency risk
                   
 
 
 
                  
           
Financial liabilities – borrowings
   
 
(173
) 
  
 
n/a
 
  
 
20   
 
   
 
–
 
   
 
n/a  
 
Hedge of net investment in a foreign operation
A foreign currency exposure arises from the translation of the Group’s net investments in its subsidiaries which have USD and EUR functional currencies. The hedged risk is the risk of changes in the GBP:USD and GBP:EUR spot rates that will result in changes in the value of the Group’s net investment in its USD and EUR assets when translated into GBP. The hedged items are a portion of the Group’s assets which are denominated in USD and EUR. The hedging instruments are debt and derivative financial instruments, including cross-currency swaps, FX forwards (including
non-deliverable
forwards) and FX collars, which mitigates an exposure to the effect of a weakening USD or EUR on the hedged item against GBP.
It is expected that the change in value of each of these items will offset each other as there is a clear and direct economic relationship between the hedging instrument and the hedged item in the hedge relationship.
Hedge ineffectiveness would arise if the value of the hedged items fell below the value of the hedging instruments; however, this is unlikely as the value of the Group’s assets denominated in USD and EUR is significantly greater than the proposed net investment programme.
The amounts related to items designated as hedging instruments were as follows:
 
           
                                
2022  
  
           
All figures in £ millions
   
Carrying
amount of
hedging
    instruments
    
Change in
value of hedging
instrument used to
determine hedge
ineffectiveness
    
Nominal
amounts
of hedging
instruments
    
Hedging
gains/(losses)
recognised in
OCI
    
Hedge  
ineffectiveness  
recognised in  
profit or loss  
  
           
Derivative financial instruments
   
 
(50
) 
  
 
(31
) 
  
 
172
 
  
 
(31
) 
  
 
–  
 
           
Financial liabilities – borrowings
   
 
(89
) 
  
 
(5
) 
  
 
(88
) 
  
 
(5
) 
  
 
–  
 
 
           
                                
2021  
  
           
All figures in £ millions
   
Carrying
amount of
hedging
    instruments
    
Change in
value of hedging
instrument used to
determine hedge
ineffectiveness
    
Nominal
amounts
of hedging
instruments
    
Hedging
gains/(losses)
recognised in
OCI
    
Hedge  
ineffectiveness  
recognised in  
profit or loss  
  
           
Derivative financial instruments
   
 
(19
) 
  
 
(2
) 
  
 
(400
) 
  
 
(2
) 
  
 
–  
 
           
Financial liabilities – borrowings
   
 
(240
) 
  
 
4
 
  
 
(240
) 
  
 
4
 
  
 
–  
 
Included in the translation reserve is a cost of hedging reserve relating to the time value of FX collars which is not separately disclosed due to materiality. The value of that reserve will decrease over the life of the hedge transaction. The balance as at 1 January and 31 December 2022 was £1m. During the year £2m of hedging gains were recycled to the profit and loss on the discontinuance of the net investment hedge of our Italian business.
Offsetting arrangements with derivative counterparties
All of the Group’s derivative financial instruments are subject to enforceable netting arrangements with individual counterparties, allowing net settlement in the event of default of either party. Derivative financial assets and liabilities subject to offsetting arrangements are as follows:
 
               
                 
2022
    
 
                    
2021
  
               
All figures in £ millions
   
Gross
    derivative
assets
     
Gross
    derivative
liabilities
    
Net
    derivative
assets/
liabilities
            
Gross
derivative
assets
     
Gross
    derivative
liabilities
    
  Net derivative
assets/
liabilities
  
               
Counterparties in an asset position
   
 
30
 
   
 
(17
) 
  
 
13
 
           
 
17
 
   
 
(12
) 
  
 
5
 
               
Counterparties in a liability position
   
 
29
 
   
 
(48
) 
  
 
(19
) 
  
 
 
 
   
 
15
 
   
 
(22
) 
  
 
(7
) 
               
Total as presented in the balance sheet
   
 
59
 
   
 
(65
) 
  
 
(6
) 
  
 
 
 
   
 
32
 
   
 
(34
) 
  
 
(2
) 
Offset arrangements in respect of cash balances are described in note 17.
Counterparty exposure from all derivatives is managed, together with that from deposits and bank account balances, within credit limits that reflect published credit ratings and by reference to other market measures (e.g. market prices for credit default swaps) to ensure that there is no significant exposure to any one counterparty’s credit risk.
The Group has no material embedded derivatives that are required to be separately accounted for in accordance with IFRS 9 ‘Financial Instruments’.