Notes to the financial statements

20. Risks arising from financial instruments

Risk management

Treasury related risks

The board approves treasury policies and the treasury function manages the day-to-day operations. The board delegates certain responsibilities to the treasury committee. The treasury committee, which is chaired by the Finance Director, is empowered to take decisions within that delegated authority. Treasury activities and compliance with the treasury policies are reported to the board on a regular basis and are subject to periodic independent reviews and audits, both internal and external. Treasury policies are designed to manage the main financial risks faced by the Group in relation to funding, investment and hedging. These policies ensure that the borrowings and investments are with high quality counterparties; are limited to specific instruments; the exposure to any one counterparty or type of instrument is controlled; and the Group’s exposure to interest rate and exchange rate movements is maintained within set limits.

The treasury function enters into derivative transactions principally interest rate swaps, currency swaps and forward currency contracts. The purpose of these transactions is to manage the interest rate and currency risks arising from the Group’s underlying business operations. No transactions of a speculative nature are undertaken and written options may only be used when matched by purchased options.

Amounts receivable from customers

Risk management policies in respect of amounts receivable from customers are discussed in the credit risk section.

Interest rate risk

The Group has an exposure to interest rate risk arising on changes in interest rates in each of its countries of operation and therefore seeks to limit this net exposure. This is achieved by the use of derivative instruments such as interest rate swaps to hedge a proportion of borrowings over a certain time period, usually four years.

Interest costs are a relatively low proportion of the Group’s revenue (5.3% in 2008), and therefore the risk of a material variance arising from a change in interest rates is low. If interest rates across all markets increased by 200 basis points this would have the following impact:

This sensitivity analysis is based on the following assumptions:

• the change in the market interest rate occurs in all countries where the Group has borrowings and / or derivative financial instruments;
• where financial liabilities are subject to fixed interest rates or have their interest rate fixed by hedging instruments it is assumed that there is no impact from a change in interest rates; and
• changes in market interest rate affect the fair value of derivative financial instruments designated as hedging instruments.

Currency risk

The Group is subject to three types of currency risk; net asset exposure, cash flow exposure and profit and loss exposure.

Net asset exposure

The majority of the Group’s net assets are denominated in currencies other than sterling. The consolidated balance sheet is reported in sterling and this means that there is a risk that a fluctuation in foreign exchange rates will have a material impact on the net assets of the Group. The Group aims to minimise the value of net assets denominated in each foreign currency by funding overseas receivables by borrowings in local currency. Currently, the capital markets in Romania are not operating effectively with the result that the receivables in this market are partly funded in equity from the Parent Company which is denominated in sterling.

Cash flow exposure

The Group is subject to currency risk in respect of future cash flows which are denominated in foreign currency. The policy of the Group is to hedge a large proportion of this currency risk in respect of cash flows which are expected to arise in the following 12 months. Where forward foreign exchange contracts have been entered into, they are designated as cash flow hedges on specific future transactions.

Profit and loss exposure

As with net assets, the majority of the Group’s profit is denominated in currencies other than sterling but translated into sterling for reporting purposes. The result for the period is translated into sterling at the average exchange rate. A risk therefore arises that a fluctuation in the exchange rates in the countries in which the Group operates will have a material impact on the consolidated result for the period. The Group reduces the exposure to this risk by economically hedging a proportion of the budgeted profits which results in a currency variance in the trading result being partly offset by a gain or loss on the relevant foreign exchange contract.

The following sensitivity analysis demonstrates the impact on equity of a 5% strengthening or weakening of sterling against all exchange rates for the countries in which the Group operates.

This sensitivity analysis is based on the following assumptions:

• there is a 5% strengthening / weakening of sterling against all currencies the Group operates in (Polish zloty, Czech crown, Slovak crown, Hungarian forint, Mexican peso, Romanian leu and Russian rouble); and
• there is no impact on the profit or loss reserve or equity arising from those items which are naturally hedged (where the currency asset is exactly equal to the currency liability).

Credit risk

The Group is subject to credit risk in respect of the amounts receivable from customers and the cash and cash equivalents held on deposit with banks.

Amounts receivable from customers

The risk of material unexpected credit losses in respect of amounts receivable from customers is low as the Group lends small amounts over short-term periods to a large and diverse group of customers across the countries in which the Group operates. This risk is minimised by the use of credit scoring techniques which are designed to ensure we only lend to those customers who can afford the repayments. The amount lent to each customer and the repayment period agreed are dependent upon the risk category the customer is assigned to as part of the scoring process. The level of expected future losses is reviewed by management on a weekly basis by geographical segment in order to ensure that appropriate action can be taken if losses differ from management expectations.

Cash and cash equivalents

The Group only deposits cash with highly rated banks and sets strict limits in respect of the amount to be held on deposit with any one institution.

No collateral or credit enhancements are held in respect of any financial assets. The maximum exposure to credit risk is as follows:

The above table represents a worst case scenario of the credit risk that the Group is exposed to at the year end. An analysis of the amounts receivable from customers by geographical segment is presented in note 14 and of the cash and cash equivalents in note 15. Derivative financial instruments and trade and other debtors have not been presented by geographical segment as they are not considered significant.

Cash and cash equivalents, derivative financial instruments and trade and other debtors are neither past due nor impaired. Credit quality of these assets is good and the cash and cash equivalents are spread over a number of banks, each of which meets the criteria set out in our treasury policies which are explained further in the principal risks section of this report, to ensure the risk of loss is minimised.

Amounts receivable from customers are stated at amortised cost and calculated in accordance with the Group’s accounting policies. Those amounts receivable from customers that are neither past due nor impaired represent loans where no customer payments have been missed and there is therefore no evidence to suggest that the credit quality is anything other than adequate.

The Group’s accounting policy in respect of amounts receivable from customers requires that as soon as a customer misses any portion of a contractual payment the account is reviewed for impairment and the receivable is reduced to reflect the revised expected future cash flows. The result of this is that any loan which is past due (where a payment has been missed) will attract a deduction for impairment. Therefore amounts receivable from customers include no amounts that are past due but not impaired.

An analysis of the amounts receivable from customers that are individually determined to be impaired by geographical segment is set out below:

This analysis includes all loans that have been subject to impairment. The impairment charge is based on the average expected loss for each arrears stage of customer receivables and this average expected loss is applied to the entire arrears stage. This results in a significant proportion of the amounts receivable from customers attracting an impairment charge. For each market the amount by which an asset is impaired depends on the type of product, the recent payment performance and the number of weeks since the loan was issued. There will therefore be a large amount of receivables which are classed as impaired but where the carrying value is still a large proportion of the contractual amount recoverable. Annualised impairment as a percentage of revenue, which excludes the impact of provision releases, for each geographical market is shown below:

The carrying value of amounts receivable from customers that would have been impaired had their terms not been renegotiated is £nil (2007: £nil).

Liquidity risk

The Group is subject to the risk that it will not have sufficient borrowing facilities to fund its existing business and its future plans for growth. The short-term nature of the Group’s business means that the majority of amounts receivable from customers are receivable within 12 months with an average period to maturity of less than six months. The risk of not having sufficient liquid resources is therefore low. The treasury policy adopted by the Group serves to reduce this risk further by aiming to have (i) a diversity of funding sources across the banks which the Group uses and across the countries in which the Group operates; (ii) a balanced maturity profile of debt finance to mitigate refinancing risk; and (iii) committed facilities in excess of the forecast borrowing requirements. At 31 December 2008 the Group’s committed borrowing facilities had an average period to maturity of 2.3 years (2007: 2.2 years). As shown in note 18 total undrawn facilities as at 31 December 2008 were £229.5m (2007: £180.4m).

In note 18 a maturity analysis of the gross borrowing included in the balance sheet is presented. A maturity analysis of bank borrowings and overdrafts outstanding at the balance sheet date by contractual cash flow, including expected interest payments, is shown below:

The above analysis includes the contractual cash flow for borrowings and the total amount of interest payable over the life of the loan. Where borrowings are subject to a floating interest rate an estimate of interest payable is taken.

The following analysis shows the gross undiscounted contractual cash flows in respect of interest rate swap derivative liabilities and foreign currency contract derivative assets and liabilities which are all designated as cash flow hedges:

The outflow in respect of derivative liabilities occuring in later than one year will be broadly offset by inflows from derivative assets.

A maturity analysis of the Group’s receivables and borrowing facilities as at 31 December 2008 is presented below:

This demonstrates the short-term nature of the amounts receivable from customers which contrasts with the long-term nature of the Group’s committed funding facilities.

Capital risk

The Group is subject to the risk that its capital structure will not be sufficient to support the growth of the business. The Group is not required to hold regulatory capital.

The Group aims to maintain appropriate capital to ensure that it has a strong balance sheet but at the same time is providing a good return on capital to its shareholders. The Group’s long-term aim is to ensure that the capital structure results in an optimal ratio of debt and equity finance.

Capital is monitored by considering the ratio of equity to receivables and the gearing ratio (borrowings to equity). The capital of the Group and these ratios are shown below:

Equity as a percentage of receivables was above the internal minimum requirement set by the Group.

Gearing, which is equal to borrowings divided by net assets, at a ratio of 1.7 times (2007: 1.8 times), is well within covenant limits.

Previous note | Next note

Back to top