a) Financial risk management objectives and policies
The Group's financial risk management objective is to reduce the financial risks and exposures facing the business with respect to changes in interest and
foreign exchange rates, and to ensure constant access to sufficient liquidity. To achieve this the Group undertakes an active hedging policy, including the use of
derivatives (interest rate and foreign exchange swaps, options, forward rate agreements and caps and collars), which are entered into under policies approved
and monitored by a sub-committee of the Board, chaired by the Group Finance Director. These transactions are only undertaken to reduce exposures arising
from underlying commercial transactions and at no time are transactions undertaken for speculative reasons.
Foreign currency risk
The majority of the Group's business is transacted in euros, sterling, US dollars and Swiss francs. The principal commercial currency of the Group is the euro.
The Group seeks to manage currency exposure wherever possible.
In each country where the Group has a corporate operation, revenue generated and costs incurred are primarily denominated in the relevant local currency, so providing a natural currency hedge. In addition, intra-group trading transactions are netted and settled centrally. Any remaining material foreign currency transaction exposures are hedged as appropriate into either euro or sterling. Revenue recognised from licensees is primarily received in sterling.
With regard to translation exposures, the policy is to match where possible the average assets of the Group to the equivalent average liabilities in each major currency and thus minimise any impact to the Group. To the extent that this does not occur, both foreign currency borrowings and forward exchange contracts are used. Long-term US dollar borrowings undertaken to benefit from the liquidity of the US dollar denominated capital markets are swapped into euros.
Interest rate risk
The Group's interest rate risk arises from the Group's borrowings which, after foreign currency risk hedging, principally arises in euro and sterling. Borrowings
issued at variable rates expose the Group to cash flow interest rate risk whereas borrowings issued at fixed rates expose the Group to fair value interest rate risk.
To manage these risks, the Group is both financed through a combination of fixed and floating rate facilities and enters into various derivatives. The Group's policy is to ensure that the proportion of fixed rate debt to the annual average net debt (defined for this purpose to include the net book value of fleet under operating leases) for the next three years will be maintained in the range of 65% to 85%, 55% to 80%, and 45% to 75% respectively.
Liquidity risk
The seasonal nature of the business necessitates higher fleet levels in the summer months and hence proportionately higher debt requirements. Consequently,
the Group ensures that it has a core level of long-term funding in place, with maturities spread over a wide range of dates, supplemented by shorter-term and
committed revolving facilities to cover requirements through the year.
Capital risk management
The Group's objectives when managing capital are to safeguard the ability to continue as a going concern, provide shareholder returns and appropriate
benefits for stakeholders. The Group seeks to maintain an optimal debt and equity structure to minimise the overall cost of capital. To maintain or adjust the
capital structure, the Group may issue new shares or acquire/sell assets to adjust debt levels where appropriate.
The Group monitors the use of capital on the basis of return on capital employed (ROCE) and average fleet utilisation. The Group's ROCE is based on the underlying operating profit of the business plus the operating result of joint ventures and associates. Underlying operating profit is adjusted to reverse: any non-exceptional goodwill impairments; the interest cost of pension liabilities; and the expected return on pension assets. Capital employed is based on net assets with adjustment for: all debt and related interest balances; all derivative financial instruments; tax balances; pension deficits; and capitalised goodwill. An average capital employed figure is used in the ROCE calculation based on the reported balance sheet positions as at previous 31 December and 31 December in the current period. This definition of ROCE may not be comparable to other similarly titled measures used by other companies. Average fleet utilisation is calculated as the average period of time during which vehicles are on rent as a percentage of their holding period.
Other price risks
As part of the presentation of market risks, IFRS 7 requires disclosures on how hypothetical changes in risk variables affect the price of financial instruments.
Important risk variables include stock exchange prices or indexes. As at 31 December 2007, the Group did not hold any material investments to be classified
as available for sale.
Credit risk
The Group's principal financial assets comprise: non-current assets held for sale; other financial assets held for trading; derivative financial instrument assets;
trade and other receivables; and cash and short-term deposits which in aggregate represent the Group's maximum exposure to credit risk at each year end.
The Group is exposed to credit risk from its operating activities and certain financing activities. This risk is controlled from a treasury perspective by only entering into transactions involving financial instruments with authorised counter-parties of strong credit quality, and monitoring such positions regularly. Outstanding debts are continuously monitored at an operational level. Bad debt provisions are made against known credit risks.
The credit rating of vehicle manufacturers, the key suppliers, is monitored separately. With respect to certain vehicle manufacturers, the Group has a natural hedge to its exposure to credit risk as vehicle receivables (see Note 19) are ordinarily less than vehicle payables (see Note 21).
The maximum exposure to credit risk is represented by the balance sheet values of the original loans and receivables that are carried in the balance sheet, including derivatives with positive market values. Where derivatives are settled gross, International Swaps and Derivatives Association (ISDA) based agreements are applied which include close-out netting provisions which are effective if the counter-party defaults. At the reporting date there were no other significant global offsetting agreements that reduce credit risk, nor were there any significant financial guarantees for third-party obligations that increase this risk.
b) Fair value of derivative financial instruments
| 2007 | 2006 | |||||||||||
| Recognised fair values of derivative financial instruments | Assets | Liabilities | Net | Assets | Liabilities | Net | ||||||
| €m | €m | €m | €m | €m | €m | |||||||
| Hedging instruments: | ||||||||||||
| – forward foreign exchange contracts | – | (0.6) | (0.6) | 1.0 | (0.1) | 0.9 | ||||||
| Non-hedging instruments: | ||||||||||||
| – forward foreign exchange contracts | 2.2 | (0.3) | 1.9 | 0.5 | – | 0.5 | ||||||
| – forward foreign exchange options | 1.2 | – | 1.2 | 0.4 | – | 0.4 | ||||||
| Non-debt derivatives | 3.4 | (0.9) | 2.5 | 1.9 | (0.1) | 1.8 | ||||||
| Hedging instruments: | ||||||||||||
| – interest rate swaps | 4.6 | – | 4.6 | – | (0.6) | (0.6) | ||||||
| – cross currency interest rate swaps | – | (52.9) | (52.9) | – | (71.8) | (71.8) | ||||||
| Non-hedging instruments: | ||||||||||||
| – interest rate swaps | 0.1 | (0.1) | – | 1.4 | (1.1) | 0.3 | ||||||
| – forward rate agreements | – | (0.9) | (0.9) | – | – | – | ||||||
| – interest rate caps and collars | 0.3 | – | 0.3 | 1.2 | – | 1.2 | ||||||
| – embedded derivatives | 5.6 | – | 5.6 | 6.8 | – | 6.8 | ||||||
| Debt derivatives | 10.6 | (53.9) | (43.3) | 9.4 | (73.5) | (64.1) | ||||||
| 14.0 | (54.8) | (40.8) | 11.3 | (73.6) | (62.3) | |||||||
| Non-current portion: | ||||||||||||
| Hedging instruments: | ||||||||||||
| – interest rate swaps | 4.6 | – | 4.6 | – | (0.6) | (0.6) | ||||||
| – cross currency interest rate swaps | – | (52.9) | (52.9) | – | (41.7) | (41.7) | ||||||
| Non-hedging instruments: | ||||||||||||
| – embedded derivatives | 5.6 | – | 5.6 | 6.8 | – | 6.8 | ||||||
| Debt derivatives | 10.2 | (52.9) | (42.7) | 6.8 | (42.3) | (35.5) | ||||||
| Analysed as: | ||||||||||||
| Current assets/(liabilities) (due for settlement within one year) | 3.8 | (1.9) | 1.9 | 4.5 | (31.3) | (26.8) | ||||||
| Non-current assets/(liabilities) (due for settlement after more than one year) |
10.2 | (52.9) | (42.7) | 6.8 | (42.3) | (35.5) | ||||||
| 14.0 | (54.8) | (40.8) | 11.3 | (73.6) | (62.3) |
Non-hedging derivatives (excluding the embedded derivative) are classified as a current asset or liability. The full fair value of a hedging derivative is classified as a non-current asset or liability if the remaining maturity of the hedged item is more than 12 months, and as a current asset or liability if the remaining maturity of the hedged item is less than 12 months. Trading derivatives are classified as a current asset or liability. The embedded derivative is classified as a non-current asset consistent with the maturity of the borrowing in which it is embedded.
Fair values of the derivative financial instruments are determined using a number of methods and assumptions based on conditions at the balance sheet date as none are traded in an active market. The fair values of interest rate swaps, forward rate agreements and cross currency interest rate swaps is calculated as the present value of future estimated cash flows. The fair value of interest rate caps and collars are valued using option valuation techniques. The fair value of forward exchange contracts is determined using forward exchange market rates at the balance sheet date.
The fair value of the embedded derivative is calculated based on the difference in fair value of the underlying loan notes to the fair value of equivalent loan notes without a call option.
Hedging instruments
The effectiveness of hedging relationships is tested by means of statistical methods using either regression analysis (for forward foreign exchange contracts
and cross currency interest rate swaps), or the closest offset method (for interest rate swaps). This involves defining the performance of the hedged item as
the independent variable and the performance of the hedging item as the dependent variable. A hedging relationship is classified as effective when the value
of the hedging item moves between 0.8% and 1.25% for each 1.0% movement in the hedged item. All hedging relationships, having been tested using
statistical methods, were effective at the reporting date.
Forward foreign exchange contracts
Forward foreign exchange contracts as at 31 December 2007 with notional values of US$4.1 million (2006: US$3.5 million) and South African Rand 58.0 million
(2006: South African Rand 23.6 million) were used to hedge expected foreign currency income of US$4.1 million (2006: US$3.5 million) and South African
Rand 58.0 million (2006: South African Rand 23.6 million) into sterling of £6.0 million (2006: £3.6 million). Forward foreign exchange contracts as at
31 December 2007 with notional values of US$nil (2006: US$16.1 million), Hungarian Forint 1,160.0 million (2006: Hungarian Forint 1,042.0 million) and
Sterling £2.9 million (2006: £nil) were used to hedge expected foreign currency income of US$nil (2006: US$16.1 million) and expected foreign currency
payments of Hungarian Forint 1,160.0 million (2006: Hungarian Forint 1,042.0 million) and Sterling £2.9 million (2006: £nil) into euro of €nil (2006:
€12.7 million), €4.6 million (2006: €3.8 million) and €4.1 million (2006: €nil) respectively.
These forward exchange contracts and corresponding foreign currency receipts will mature within 12 months of each year end. Movements in the fair value of these forward foreign exchange contracts are recognised as cash flow hedges in the hedging reserve within equity. These amounts are then transferred to the Income Statement when the amounts are received at various dates between one and 12 months after the year end. There was no material ineffectiveness of these hedges recorded as at the balance sheet date.
Interest rate swaps
Interest rate swaps of aggregate notional principal amounts of €200.0 million (2006: €200.0 million) with average fixed interest payable of 4.03% were used
to hedge variable quarterly interest payments arising under the Senior Floating Rate Notes due 2013. The aim of the hedge relationship is to transform the
variable interest borrowing into a fixed interest borrowing, and result in cash flow hedges of €(4.5) million (2006: €0.4 million). Credit risks do not form part of
the hedge. There was no material ineffectiveness of these hedges recorded as at the balance sheet date.
Cross currency interest rate swaps
Cross currency interest rate swaps of aggregate notional principal amounts of US$288.0 million (2006: US$390.0 million) were used to hedge the Group's
US$ denominated loan notes (see Note 25).
Fair value hedge adjustments of €(8.0) million (2006: €0.7 million) arise from the hedging of the principal value of the exposures to euro denominated liabilities. Equivalent (but opposite) fair value differences have been recognised on the hedging cross currency interest rate swaps for the same underlying risk. Of this adjustment, €nil (2006: €0.7 million) relates to hedged items due for settlement within one year and €(8.0) million (2006: €nil) relates to hedged items due for settlement after one year. Cash flow hedges of €9.0 million (2006: €7.5 million) arise from the conversion of the semi-annual US$ denominated interest payments to euro denominated interest payments. Amounts recognised within equity are released to the Income Statement when the underlying fixed interest payments occur at various dates between the year end and 2014. There was no ineffectiveness of these hedges recorded at the balance sheet date.
Non-hedging instruments
In certain circumstances, transactions to reduce economic exposure do not qualify for hedge accounting.
Forward foreign exchange contracts
Forward foreign exchange contracts as at 31 December 2007 were in place to convert the following foreign currency notional amounts into Sterling balances
totalling £140.3 million (2006: £28.0 million); Swiss Francs 50.7 million (2006: Swiss Francs 51.1 million); Singapore Dollar 5.4 million (2006: Singapore
Dollar 1.6 million); Hungarian Forint 229.8 million (2006: Hungarian Forint nil); US$1.5million (2006: US$5.0 million); and €228.6 million (2006: €71.1 million).
Forward foreign exchange options
Forward foreign exchange option contracts as at 31 December 2007 were in place to convert expected foreign currency income of: US$nil
(2006: US$0.2 million) into sterling of £nil (2006: £0.1 million); and US$35.3 million (2006: US$9.4 million) into €24.9 million (2006: €7.4 million).
These option contracts will mature within 12 months of each year end.
Interest rate swaps
The notional principal amount of outstanding interest rate swap contracts not qualifying for hedge accounting as at the year end was €50.0 million
(2006: €50.0 million) and £30.0 million (2006: £40.0 million) with fixed interest rates payable between 4.4% and 5.9%, and €nil (2006: €60.0 million)
with interest payable at EURIBOR + 1.7%. The notional principal amounts of outstanding interest rate caps and collars as at the year end was €100.0 million
(2006: €100.0 million).
In addition, in 2007 the Group had in place forward start interest rate swaps with aggregate notional principals of €100.0 million which commence in 2008 and will run for one year and convert the prevailing floating interest rate to an average fixed rate of 6.0%.
Forward rate agreements
In 2007 the Group had outstanding forward rate agreements with aggregate notional principals of €1,250.0 million (2006: €nil) covering various three month
periods during 2008 and 2009. These convert the prevailing floating interest rate to an average fixed rate of 6.1%.
Embedded derivatives
The €250.0 million Senior Floating Rate Notes due 2013 include a call option permitting the Group to repay the notes with effect from 31 July 2008. Under
the option, the notes may be redeemed at the following redemption prices (expressed as a percentage of principal amounts) if repaid during the 12 month
period beginning on 31 July 2008: 102%; beginning on 31 July 2009: 101%; 31 July 2010 and thereafter: 100%. In accordance with IAS 39, this option is
separately recognised from underlying Senior Floating Rate Notes as an embedded derivative.
c) Risk and sensitivity analysis
Foreign currency risk
The following table details the sensitivities of the Group's total profit after tax from continuing operations, translation reserve, and cash flow hedge reserve, to a
hypothetical 10% strengthening of the euro against sterling, US$ and Swiss francs. These sensitivities are calculated by reference to the currency profile of the
Group's balance sheet as at each year end, with all other variables kept constant. Sensitivities to a 10% strengthening of the euro has been selected given the
current level of exchange rates, exchange rate volatility observed on a historic basis and market expectations for future movements. Similar but opposite
sensitivities would arise upon a 10% weakening of the euro against sterling, US$ and Swiss francs:
| Profit after tax | Translation reserve | Hedging reserve | ||||||||||
| (Profit)/loss | 2007 | 2006 | 2007 | 2006 | 2007 | 2006 | ||||||
| €m | €m | €m | €m | €m | €m | |||||||
| Euro/sterling | 2.9 | 2.1 | 6.8 | 3.9 | 0.2 | – | ||||||
| Euro/US$ | 0.9 | 1.4 | – | – | (0.5) | (1.2) | ||||||
| Euro/Swiss francs | (1.8) | (1.8) | 2.0 | 2.0 | – | – | ||||||
Profit after tax sensitivities primarily arise from the revaluation of non-hedging derivatives comprising forward foreign contracts where the Group has not applied hedge accounting. The sensitivities thereby primarily impact amounts excluded from underlying, rather than the Group's underlying profit after tax. Translation reserve sensitivities effectively arise from the retranslation of the net assets of head office and trading operations in the UK, and trading operations in Switzerland, from sterling and Swiss francs respectively, into euro. Hedging reserve sensitivities to sterling balances arise from the hedging of forward foreign exchange contracts, whilst the US$ sensitivities arise from both forward foreign exchange contracts and cross currency interest rate swaps.
Interest rate risk
To manage interest rate risk the Group is financed through a combination of fixed and floating rate facilities and enters into various interest rate derivatives.
The following table details the sensitivities of the Group's profit after tax from continuing operations, translation reserve, and cash flow hedge reserve, to a
hypothetical 1% increase in interest rates. These sensitivities are calculated by reference to the interest rate profile of the Group's balance sheet as at each
year end, with all other variables kept constant. Sensitivities to a 1% increase in interest rates have been selected given the current level of market interest
rates, interest rate volatility observed on a historic basis and market expectations for future movements. Similar but opposite sensitivities would arise upon a
1% reduction in interest rates. The interest rate sensitivities are calculated based on the following:
a) Changes in the market interest rates of non-derivative financial instruments with fixed interest rates only affect income if these are recognised at their fair value.
As such, all financial instruments with fixed interest rates that are carried at amortised cost are not subject to interest rate risk as defined in IFRS 7.
b) Changes in the market interest rate of financial instruments that were designated as hedging instruments in a cash flow hedge to hedge payment fluctuations
resulting from interest rate movements, affect the cash flow hedge reserve in shareholder's equity and are therefore taken into consideration in the equity related
sensitivity calculations.
c) Changes in market interest rates affect the interest income or expense of non-derivative variable interest financial instruments. As a consequence, they are included
in the calculation of income related sensitivities, other than where the interest payments are designated as part of a cash flow hedge against interest rate risk.
d) Changes in the market interest rate of interest rate derivatives (interest rate swaps, forward rate agreements, caps and collars) that are not part of a hedging
relationship as set out in IAS 39, affect other financial income or expense (net gain/loss from remeasurement of the financial fair value) and are therefore taken into
consideration in the income related sensitivity calculations.
e) Currency derivatives are not exposed to interest rate risks and therefore do not affect the interest rate sensitivities.
| Profit after tax | Translation reserve | Hedging reserve | ||||||||||
| 2007 | 2006 | 2007 | 2006 | 2007 | 2006 | |||||||
| €m | €m | €m | €m | €m | €m | |||||||
| Loss arising from 1% increase in interest rates (post tax) | 3.1 | 1.9 | – | – | 7.3 | 7.9 | ||||||
The decrease in total profit after tax partly arises due to the revaluation of non-hedging derivatives. The decrease in underlying profit after tax to a 1% increase in market interest rates is €1.7 million (2006: €1.1 million). Given the seasonality of the Group's debt, the Group's average net debt is ordinarily higher than the Group's year end net debt. If the market interest rates applied to the Group's average net debt in the year had been 1% higher, underlying profit after tax would have been lower by €2.2 million (2006: €1.7 million).
Liquidity risk
The following is an analysis of the contractual undiscounted cash flows payable under financial liabilities together with derivative financial instrument assets
and liabilities at the balance sheet date:
| Due within one year | Due between one and two years | Due between two and five years | Due after five years | Total | ||||||
| At 31 December 2007 | €m | €m | €m | €m | €m | |||||
| Non-derivative financial liabilities | ||||||||||
| Borrowings | (31.0) | – | (372.2) | (319.4) | (722.6) | |||||
| Interest payments on borrowings | (52.3) | (47.1) | (105.9) | (19.9) | (225.2) | |||||
| Trade and other payables (including Finance cost creditors) (see Note 21) | (670.3) | – | – | – | (670.3) | |||||
| Obligations under finance leases | (273.7) | (0.7) | – | – | (274.4) | |||||
| Interest payments on finance leases | (7.3) | – | – | – | (7.3) | |||||
| Deferred consideration | (0.3) | (0.3) | (1.0) | (29.0) | (30.6) | |||||
| Derivative financial instrument assets and liabilities – gross settled | ||||||||||
| Derivative contracts – receipts | 204.6 | 12.4 | 154.9 | 75.7 | 447.6 | |||||
| Derivative contracts – payments | (212.3) | (14.9) | (196.4) | (91.1) | (514.7) | |||||
| Derivative financial instrument assets and liabilities – net settled | ||||||||||
| Derivative contracts – receipts | 1.1 | 1.1 | 3.3 | 0.8 | 6.3 | |||||
| Derivative contracts – payments | (1.2) | – | – | – | (1.2) | |||||
| (1,042.7) | (49.5) | (517.3) | (382.9) | (1,992.4) |
| Due within one year | Due between one and two years | Due between two and five years | Due after five years | Total | ||||||
| At 31 December 2006 | €m | €m | €m | €m | €m | |||||
| Non-derivative financial liabilities | ||||||||||
| Borrowings | (231.7) | – | (127.0) | (432.5) | (791.2) | |||||
| Interest payments on borrowings | (54.7) | (39.2) | (109.5) | (44.3) | (247.7) | |||||
| Trade and other payables (including Finance cost creditors) (see Note 21) | (672.6) | – | – | – | (672.6) | |||||
| Obligations under finance leases | (292.1) | (2.1) | – | – | (294.2) | |||||
| Interest payments on finance leases | (5.8) | – | – | – | (5.8) | |||||
| Deferred consideration | (0.3) | (0.3) | (1.0) | (31.4) | (33.0) | |||||
| Derivative financial instrument assets and liabilities – gross settled | ||||||||||
| Derivative contracts – receipts | 194.4 | 13.8 | 162.9 | 103.0 | 474.1 | |||||
| Derivative contracts – payments | (225.3) | (14.9) | (189.1) | (113.2) | (542.5) | |||||
| Derivative financial instrument assets and liabilities – net settled | ||||||||||
| Derivative contracts – receipts | 0.1 | 0.1 | 0.4 | 0.2 | 0.8 | |||||
| Derivative contracts – payments | (1.1) | – | – | – | (1.1) | |||||
| (1,289.1) | (42.6) | (263.3) | (518.2) | (2,113.2) |
