Derivative financial instruments and hedge accounting

12 Months Ended

Dec. 31, 2023

Statement [line items]

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:

					2023							2022
All figures in £ millions	Gross notional amounts		Assets		Liabilities			Gross notional amounts		Assets		Liabilities
Interest rate derivatives – in a fair value hedge relationship		174		–		(5	)		177		–		(11	)
Interest rate derivatives – not in a hedge relationship		356		14		(1	)		260		19		–
Cross-currency rate derivatives – in a hedge relationship		352		26		(31	)		83		34		(43	)
Cross-currency rate derivatives – not in a hedge relationship		87		–		(1	)		–		–		–
FX derivatives – in a hedge relationship		420		7		–			355		1		(9	)
FX derivatives – not in a hedge relationship		526		1		(5	)		573		5		(2	)
Total		1,915		48		(43	)		1,448		59		(65	)
Analysed as expiring:
In less than one year		1,047		16		(5	)		1,028		16		(11	)
Later than one year and not later than five years		868		32		(38	)		420		43		(54	)
Total		1,915		48		(43	)		1,448		59		(65	)

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 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	£157m	3.402%
				USD Libor
€19m	1.375%	GBPUSD: 1.206	£16m	+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. £157m 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 2023, the Group held FX outrights with a notional of $280m at an average rate of GBP:USD rate of 1.25.

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. In 2022, for USD exposures the Group transitioned its RCF from USD LIBOR to SOFR. 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 GBP:EUR 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:

							2023
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		(6	)		5			174
Derivative financial instruments for currency risk		26			(7	)		174

							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

 

The amounts at the reporting date relating to items designated as hedge items were as follows:

										2023
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		(169	)		6		5		1		Finance  costs
Currency risk
Financial liabilities – borrowings		(169	)		n/a		5		–		n/a

												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

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. The hedged risk is the risk of changes in the currency spot rate (eg GBP:USD) that will result in changes in the value of the Group’s net investment in its overseas subsidiaries when translated into GBP. The hedged items are a portion of the Group’s assets which are denominated in USD. The hedging instruments are debt and derivative financial instruments, including cross-currency swaps, FX forwards and FX collars, which mitigates an exposure to the effect of a weakening USD on the hedged item against GBP. It is expected that the change in value of each of these items will mirror 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 is significantly greater than the proposed net investment programme.

The amounts related to items designated as hedging instruments were as follows:

										2023
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		(24	)		26		599		26		–
Financial liabilities – borrowings		–			–		–		–		–

													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	)		–

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 2023 was £nil (2022: £1m). During the year £nil (2022: £2m) of hedging gains were recycled to the profit and loss.

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:

						2023									2022
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		26		(14	)		12				30		(17	)		13
Counterparties in a liability position		22		(29	)		(7	)			29		(48	)		(19	)
Total as presented in the balance sheet		48		(43	)		5				59		(65	)		(6	)

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’.