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 target fixing a minimum of 50%–70% of interest costs for senior unsecured debt of the Group excluding Tesco Bank. At 24 February 2018, the percentage of interest-bearing debt at fixed rates was 90% (2017: 88%). The weighted average rate of interest paid on senior unsecured debt this financial year, excluding joint ventures and associates, was 4.26% (2017: 4.08%).
The Group has RPI linked debt where the principal is indexed to increases in the RPI. RPI debt is treated as floating rate debt. The Group also has LPI linked debt, where the principal is indexed to RPI, with an annual maximum increase of 5% and a minimum of 0%. LPI debt is treated as fixed rate debt. RPI linked debt and LPI linked debt are hedged for the effects of inflation until maturity.
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 £0.9bn (2017: £1.3bn). The Group considers its maximum credit risk to be £19.6bn (2017: £20.1bn) 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 maintain a prudent level of cash together with sufficient committed bank facilities to meet liquidity needs as they arise. The Group retains 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 undrawn committed facilities totalling £4.3bn (2017: £4.4bn), consisting of a syndicated revolving credit facility and bilateral facilities, which mature between 2019 and 2021.
The Group has a £15.0bn Euro Medium Term Note programme, of which £5.3bn was in issue at 24 February 2018 (2017: £6.8bn), plus £0.6bn equivalent of USD denominated notes issued under 144A documentation (2017: £1.7bn).
The following is an analysis of the undiscounted contractual cash flows payable under financial liabilities and derivatives taking into account contractual terms that provide the counterparty a choice of when (the earliest date) an amount is repaid by the Group. The potential cash outflow of £18.6bn is considered acceptable as it is offset by financial assets of £19.6bn (2017: £18.4bn offset by financial assets of £20.1bn). The undiscounted cash flows will differ from both the carrying values and fair values. Floating rate interest is estimated using the prevailing rate at the balance sheet date. Cash flows in foreign currencies are translated using spot rates at the balance sheet date. For index-linked liabilities, inflation is estimated at 3% for the life of the liability (2017: 3%).
The Group is exposed to foreign exchange risk principally via:
- transactional exposure that arises from the cost of future purchases of goods, 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 24February 2018, forward foreign currency transactions, designated as cash flow hedges, equivalent to £2.2bn were outstanding (2017: £2.1bn).
- 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 financial year, currency movements increased the net value, after the effects of hedging, of the Group’s overseas assets by £318m (2017: increase by £751m). 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.