Financial risk management is carried out by a central treasury department under policies approved and delegated by the Board of Directors.
The main financial risks faced by the Group relate to fluctuations in interest and foreign exchange rates, the risk of default by counterparties to financial transactions and the availability of funds to meet business needs. The management of these risks is set out below.
Interest Rate Risk
The Group’s policy is to fix interest rates for the year on a minimum of 50% and maximum of 70% of actual and projected debt interest costs of the Group excluding Tesco Bank. At the year end, the percentage of interest-bearing debt at fixed rates was 88% (2015: 79%). The remaining balance of debt is in floating rate form. The average rate of interest paid on an historical cost basis this year, excluding joint ventures and associates, was 3.94% (2015: 4.09%). During 2016 and 2015, net debt was managed using derivative instruments to hedge interest rate risk.
Credit risk arises from cash and cash equivalents, trade and other receivables, customer deposits, financial instruments and deposits with banks and financial institutions.
The Group holds positions with an approved list of investment grade rated counterparties and monitors the exposure, credit rating, outlook and credit default swap levels of these counterparties on a regular basis. The net counterparty exposure under derivative contracts is £1.3bn (2015: £1.4bn). The Group considers its maximum credit risk to be £18.7bn (2015: £14.7bn) being the Group’s total financial assets.
The Group finances its operations by a combination of retained profits, disposals of assets, debt capital market issues, commercial paper, bank borrowings and leases. The policy is to smooth the debt maturity profile, to arrange funding ahead of requirements and to maintain sufficient undrawn committed bank facilities and to maintain access to capital markets so that maturing debt may be refinanced as it falls due.
Liquidity risk is managed by short-term and long-term cash flow forecasts.
The Group has committed facility agreements for £5.0bn (2015: £5.1bn), consisting of a revolving credit facility and bilateral lines as alternate sources of liquidity, which mature between 2017 and 2021.
The Group has a European Medium Term Note programme of £15.0bn, of which £7.4bn was in issue at 27 February 2016 (2015: £7.4bn), plus a Euro Commercial Paper programme of £2.0bn, £nil of which was in issue at 27 February 2016 (2015: £0.5bn), and a US Commercial Paper programme of $4.0bn, £nil of which was in issue at 27 February 2016 (2015: £0.7bn).
Foreign Exchange Risk
The Group is exposed to foreign exchange risk principally via:
- transactional exposure that arises from the cost of future purchases of goods for resale, where those purchases are denominated in a currency other than the functional currency of the purchasing company. Transactional currency exposures that could significantly impact the Group Income Statement are hedged. These exposures are hedged via forward foreign currency contracts or purchased currency options, which are designated as cash flow hedges. At the year-end, forward foreign currency transactions, designated as cash flow hedges, equivalent to £1.4bn were outstanding (2015: £2.2bn). The notional and fair value of these contracts is shown in Note 21 of the Annual Report;
- net investment exposure arises from changes in the value of net investments denominated in currencies other than Pounds Sterling. The Group hedges a part of its investments in its international subsidiaries via foreign currency derivatives and borrowings in matching currencies, which are formally designated as net investment hedges. During the year, currency movements increased the net value, after the effects of hedging, of the Group’s overseas assets by £168m (last year increase by £5m). The Group also ensures that each subsidiary is appropriately hedged in respect of its non-functional currency assets; and
- loans to non-UK subsidiaries. These are hedged via foreign currency derivatives and borrowings in matching currencies. These are not formally designated as hedges as gains and losses on hedges and hedged loans will naturally offset.