Notes 16-20
- 16 Financial risk management objectives and policies
- 17 Financial instruments
- 18 Trade and other payables
- 19 Provisions for liabilities and charges
- 20 Statement of changes in equity
16 FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES
The Group’s principal financial instruments, other than derivatives, comprise bank overdrafts, loans, current and non-current investments, cash and short term deposits. The main purpose of these financial instruments is to manage the Group’s funding and liquidity requirements. The Group has other financial assets and liabilities such as trade receivables and trade payables, which arise directly from its operations.
The principal financial risks to which the Group is exposed are those of interest rate, liquidity, foreign currency and credit. Each of these are managed in accordance with Board-approved policies. These policies are set out below.
The Group uses foreign currency borrowings, foreign currency forwards and options, interest rate swaps and forward rate agreements for the purpose of hedging its foreign currency and interest rate risks. The Group may designate certain financial instruments as either fair value hedges or net investment hedges in accordance with IAS 39. Key controls, applied to transactions in derivative financial instruments, are to use only instruments where good market liquidity exists, to revalue all financial instruments regularly using current market rates and to sell options only to offset previously purchased options. The Group does not use derivative financial instruments for speculative purposes.
The debt-financed acquisition of MedImmune during the year resulted in a change to the financial risks faced by the Group, specifically exposure to liquidity risk. The Group initially funded the acquisition through drawing on a $15bn 364 day loan facility, which was re-financed with short-term US commercial paper. The majority of the commercial paper was subsequently re-financed into longer-term debt through capital market issuances. The initial $15bn 364 day loan facility was gradually reduced throughout the year and then finally replaced by a series of new bilateral agreements making up in total $1.8bn of 364 day facilities, expiring on 24 October 2008 but with a 12 month term-out option, and $3.35bn of five year facilities. The Board approved the financing and risk management policy and parameters in July and delegated the execution, within these approved parameters, to the Chief Executive Officer, supported by a Treasury Committee. The Treasury Committee included the Group Financial Controller, Group Treasurer and Company Secretary.
Liquidity risk
The Group manages liquidity risk by maintaining access to a number of sources of funding, which are sufficient to meet anticipated funding requirements. Specifically, the Group uses US commercial paper, bank facilities and cash resources to manage short-term liquidity and manages long-term liquidity by raising funds through the capital markets.
In addition to cash balances (comprising fixed deposits, cash and cash equivalents less overdrafts) of $5,787m, the Group has committed bank facilities of $5.15bn, a $15bn US Commercial Paper Programme, a $5bn Euro Medium Term Note (EMTN) Programme and an uncapped SEC-registered shelf debt programme available to manage liquidity. As at 31 December 2007, the Group has issued $2,889m under the EMTN programme, $7,664m under the SEC-registered shelf, $323m under a previous SEC-registered programme and has $4,112m of commercial paper outstanding. The committed facilities were undrawn as at 31 December 2007.
The Board reviews the Group’s ongoing liquidity risks annually as part of the planning process. The Board considers short-term requirements against available sources of funding taking into account cash flow. In addition, this year the Board reviewed liquidity requirements as part of its consideration of the acquisition of MedImmune, and, at the January 2008 meeting, assessed the impact of the likely payments under the Merck termination agreement in March 2008.
Market risk
Interest rate risk
Prior to the debt-financed acquisition of MedImmune, the Group’s policy was to match the interest rate exposure on the Group’s gross debt balance with that arising on the surplus cash position using interest rate swaps. With the move to a net debt position and the subsequent re-financing of short-term debt, a significant portion of the new debt has been held at fixed rates of interest. The balance remains in floating rates, including $1.5bn of the new fixed rate debt swapped to floating, which is achieved through the underlying basis of the funding or through the use of interest rate swaps. The portion of fixed rate debt was approved by the Board and any variation requires Board approval.
The majority of the Group’s cash balances are held with third party fund managers who return a target yield referenced to seven day US dollar LIBID. In addition to interest rate swaps, the Group uses forward rate agreements to manage any short-term timing difference between the swapped debt interest expense and cash interest income.
Foreign currency risk
Translational exposure
The US dollar is the Group’s most significant currency. As a consequence, the Group results are presented in US dollars and exposures are managed against US dollars accordingly. Approximately 54% of Group external sales in 2007 were denominated in currencies other than the US dollar, while a significant proportion of manufacturing and R&D costs were denominated in sterling and Swedish krona. Surplus cash generated by business units is substantially converted to, and held centrally in US dollars. As a result, operating profit and total cash flow in US dollars will be affected by movements in exchange rates.
This currency exposure is managed centrally based on forecast cash flows for the currencies of Swedish krona, sterling, euro, Australian dollar, Canadian dollar and Japanese yen. The impact of movements in exchange rates is mitigated significantly by the correlations which exist between the major currencies to which the Group is exposed and the US dollar, and, accordingly, we will hedge only if there is a significant change or anticipated change in our risk position. Monitoring of currency exposures and correlations is undertaken on a regular basis and hedging is subject to pre-execution approval.
The Group will hold debt in non-US dollar currencies where there is an underlying net investment in the same currency. As at 31 December 2007, 4.6% of interest bearing loans and borrowings were denominated in sterling and 14.5% of interest bearing loans and borrowings were denominated in euros.
Transactional exposure
The transaction exposures that arise from non-local currency sales and purchases by subsidiaries are, where practicable, fully hedged economically using forward foreign exchange contracts.
Credit risk
The Group is exposed to credit risk on financial assets, such as cash balances (including fixed deposits and cash and cash equivalents), derivative instruments, trade and other receivables. The Group is also exposed in its net asset position to its own credit risk in respect of the 2023 debentures and 2014 bonds which are accounted for as fair value through profit and loss.
Trade and other receivables
Trade receivable exposures are managed locally in the operating units where they arise and credit limits set as deemed appropriate for the customer. The Group is exposed to customers ranging from government backed agencies and large private wholesalers to privately owned pharmacies, and the underlying local economic and sovereign risks vary throughout the world. Where appropriate, the Group endeavours to minimise risks by the use of trade finance instruments such as letters of credit and insurance.
The Group establishes an allowance for impairment that represents its estimate of incurred losses in respect of specific trade and other receivables where it is deemed that a receivable may not be recoverable. When the debt is deemed irrecoverable, the allowance account is written off against the underlying receivable.
Other financial assets
Exposure to financial counterparty credit risk is controlled by the treasury team centrally in establishing and monitoring counterparty limits. Centrally managed funds are invested entirely with counterparties whose credit rating is ‘A’ or better. External fund managers, who manage $4,368m of the Group’s cash, are rated AAA by Standard & Poor’s. There were no other significant concentrations of credit risk at the balance sheet date. All financial derivatives are transacted with commercial banks, in line with standard market practice and are not backed with cash collateral. The maximum exposure to credit risk is represented by the carrying amount of each financial asset, including derivative financial instruments recorded, in the balance sheet.
