Liquidity and treasury management
Treasury policy
Funding and treasury risk management for National Grid is carried out by the Treasury function under policies and guidelines approved by the Finance Committee of the Board. The Finance Committee has authority delegated from the Board, and is responsible for the regular review and monitoring of treasury activity and for the approval of specific transactions, the authority for which may be further delegated.
The primary objective of the Treasury function is to manage the funding and liquidity requirements of National Grid. A secondary objective is to manage the associated financial risks (in the form of interest rate risk and foreign exchange risk) to within acceptable boundaries. Further details of the management of funding and liquidity and the main risks arising from our financing activities are set out below, as are the policies for managing these risks including the use of financial derivatives, which are agreed and reviewed by the Board and the Finance Committee.
The Treasury function is not operated as a profit centre. Debt and treasury positions are managed in a non speculative manner, such that all transactions in financial instruments or products are matched to an underlying current or anticipated business requirement.
Contracts and derivatives entered into in respect of gas and electricity commodities are used in support of the businesses’ operational requirements and the policy regarding their use is explained here.
Current condition of the financial markets
During 2008/09 there has been a deterioration in the world economic situation. In particular, we have seen a crisis in the banking system, the failure or near failure of individual banks and increased restrictions on lending across the capital and money markets. This has been accompanied by a significant widening in credit spreads. However, with our low risk business model and cash flows that are largely stable over a period of years, we have been able to continue to access the markets and during 2008/09 have issued £4.9 billion of long-term debt. In addition, we have issued £2.9 billion of commercial paper and drawn down £943 million of uncommitted bank lines for short-term liquidity purposes, with £871 million of this still outstanding as at 31 March 2009, and remain confident of our ability to access the public debt markets going forward. Our effective interest rate has decreased from around 6.3% in 2007/08 to around 5.7% in 2008/09.
Cash flow and cash flow forecasting
Cash flows from our operations are largely stable over a period of years. Our electricity and gas transmission and distribution operations in the UK and US are subject to multi-year rate agreements with regulators. In the UK we have largely stable annual operating cash flows. However, in the US our operating cash flows are dependent on the price of gas and electricity and the timing of customer payments, and the regulatory mechanisms for recovering costs from customers can result in very significant cash flow swings from year to year. Significant changes in volumes in the US, for example as a consequence of weather conditions, can affect cash inflows in particular, with abnormally mild or extreme weather driving volumes down or up respectively.
Our capital investment programme is financed through a combination of internal cash flows and borrowings. During the year we incurred £3.2 billion of expenditure on capital investment, with a similar level of investment planned each year until 2012.
Our reported cash flows arising in the US are exposed to movements in the US dollar exchange rate, although our foreign exchange risk management policy aims to limit this exposure. Further detail is provided under the foreign exchange risk management section.
Both short- and long-term cash flow forecasts are produced regularly to assist the Treasury function in identifying short-term liquidity and long-term funding requirements, and we are undertaking a project to enhance our cash flow forecasting processes. Cash flow forecasts, supplemented by a financial headroom analysis, are supplied to the Finance Committee of the Board regularly to assess funding adequacy for at least a 12 month period.
As part of our regulatory arrangements, our operations are subject to a number of restrictions on the way we can operate. These include regulatory ‘ring-fences’ that require us to maintain adequate financial resources within certain parts of our operating businesses and restrict our ability to make dividend payments, lend cash or levy charges between certain subsidiary companies. Our assessment of National Grid’s liquidity takes into account these restrictions.
Funding and liquidity management
We maintain a number of medium-term note and commercial paper programmes in both the UK and the US companies to facilitate long- and short-term debt issuance into the capital and money markets. National Grid plc also has an SEC-registered debt shelf in place to facilitate long-term debt issuance specifically into the US capital markets. The table below shows the programmes that we had as at 31 March 2009, together with the level of utilisation of each:
| Programme | Amount | Status |
|---|---|---|
| National Grid plc | ||
| US commercial paper programme | $3.0 billion | Unutilised |
| US SEC-registered debt shelf |
Unlimited |
$1.0 billion issued |
| Euro commercial paper programme | $1.5 billion |
£743 million (equivalent) issued |
| National Grid Electricity Transmission plc | ||
| US commercial paper programme | $1.0 billion | Unutilised |
| Euro commercial paper programme | $1.0 billion |
€30 million issued |
| National Grid plc and National Grid Electricity Transmission plc | ||
| Euro medium-term note programme |
€15.0 billion |
€9.3 billion issued |
| National Grid Gas plc | ||
| US commercial paper programme | $2.5 billion | Unutilised |
| Euro commercial paper programme | $1.25 billion | Unutilised |
| Euro medium-term note programme |
€10.0 billion |
€6.1 billion issued |
| National Grid USA | ||
| US commercial paper programme | $2.0 billion | Unutilised |
| Euro medium-term note programme | €4.0 billion |
€0.1 billion issued |
| KeySpan Corporation | ||
| US commercial paper programme | $1.5 billion | Unutilised |
In addition, we have both committed and uncommitted bank borrowing facilities that are available for general corporate purposes to support our liquidity requirements. The vast majority of our committed borrowing facilities are used to provide back up to our commercial paper programmes. To date these have never been drawn and there is currently no intention to draw them in the future.
During the year, the $1.5 billion short-term committed facility within National Grid plc expired and was renewed at a reduced level and now stands at $850 million. This was due to a number of reasons, including the economic situation affecting the banking industry, the merger of some banks within our relationship group, and the desire of certain banks to rebalance their commitments to us away from undrawn committed lines of credit in favour of drawn loans.
At 31 March 2009, we had the following undrawn committed and uncommitted facilities, providing liquidity support to the group.
| Facility | Amount |
|---|---|
| National Grid plc | |
| Short-term committed facilities | $850 million |
| National Grid Gas plc | |
| Long-term committed facilities | £755 million |
| National Grid Electricity Transmission plc | |
| Long-term committed facilities | £425 million |
| National Grid’s US subsidiaries | |
| Committed facilities | $1,730 million |
| National Grid plc and certain subsidiaries | |
| Uncommitted borrowing facilities | £528 million |
The short-term committed facilities within National Grid plc include an option to extend these facilities for a further 364 days.
Note 35 to the consolidated financial statements shows the maturity profile of undrawn committed borrowing facilities in sterling at 31 March 2009.
To facilitate debt issuance into the capital and money markets, many of the companies within National Grid maintain credit ratings. At 31 March 2009, the long-term senior unsecured debt and short-term debt credit ratings respectively provided by Moody’s, Standard & Poor’s and Fitch were as follows:
| Facility | Moody’s | S&P | Fitch |
|---|---|---|---|
| National Grid plc | Baa1/P2 | BBB+/A2 | BBB+/F2 |
| National Grid Holdings One plc | – | BBB+/A2 | – |
| National Grid Electricity Transmission plc | A3/P2 | A-/A2 | A/F2 |
| National Grid Gas plc | A3/P2 | A-/A2 | A/F2 |
| National Grid Gas Holdings Ltd | A3 | A-* | A |
| National Grid USA | A3/P2 | BBB+/A2 | – |
| Niagara Mohawk Power Corp. | A3 | A-/A2 | – |
| Massachusetts Electric Co. | A3^/P2 | A-/A2 | – |
| New England Power Co. | A3/P2 | A-/A2 | – |
| The Narragansett Electric Co. | A3^ | A-*/A2 | – |
| KeySpan Corporation | Baa1/P2 | A-/A2 | A- |
| The Brooklyn Union Gas Company | – | A | A+ |
| KeySpan Gas East Corporation | A3 | A | A |
| Boston Gas Company | Baa1 | A- | – |
| Colonial Gas Company | A3 | A-* | – |
| National Grid Generation LLC | Baa1^ | A-* | – |
- *
- Corporate credit rating
- ^
- Issuer rating
Standard & Poor’s and Fitch have current outlooks of stable on all National Grid companies. Moody’s have a current outlook of negative on all National Grid companies which we expect to be resolved during the summer of 2009.
We invest surplus funds on the money markets, usually in the form of short-term fixed deposits and placements with money market funds that are invested in highly liquid instruments of high credit quality. Investment of surplus funds is subject to our counterparty risk management policy, and we continue to believe that our cash management and counterparty risk management policies provide appropriate liquidity and credit risk management in light of the current crisis in the financial markets. Details relating to cash, short-term investments and other financial assets at 31 March 2009 are shown in notes 15 and 20 to the consolidated financial statements.
We believe that maturing amounts in respect of contractual obligations as shown in Commitments and contingencies in note 29 to the consolidated financial statements can be met from existing cash and investments, operating cash flows and other financings that we reasonably expect to be able to secure in the future, together with the use of committed facilities if required.
Use of derivative financial instruments
As part of our business operations, including our treasury activities, we are exposed to risks arising from fluctuations in interest rates and exchange rates. We use financial instruments, including derivative financial instruments, to manage exposures of this type. Our policy is not to use derivative financial instruments for trading purposes. Derivative positions are managed in a non speculative manner, such that all transactions in derivative financial instruments are matched to an underlying current or anticipated business requirement.
More details on derivative financial instruments are provided in note 17 to the consolidated financial statements.
Refinancing risk management
The Board controls refinancing risk mainly by limiting the amount of debt maturities (both principal and interest) arising on borrowings in any financial year.
Note 21 to the consolidated financial statements sets out the contractual maturities of our borrowings over the next 5 years together with the total contracted borrowings, which mature over a period of 50 years. This shows that, at 31 March 2009, we have £3.3 billion of debt (including £1.8 billion of bonds, pre-derivatives) maturing in 2009/10, and no more than £2.6 billion of debt maturing in each of the next four financial years. We expect to be able to refinance this debt through the capital and money markets, as we have done during the year to 31 March 2009.
Interest rate risk management
Our interest rate exposure arising from borrowings and deposits is managed by the use of fixed-rate and floating-rate debt and derivative financial instruments, including interest rate swaps, swaptions and forward rate agreements. Our interest rate risk management policy is to seek to minimise total financing costs (being interest costs and changes in the market value of debt) subject to constraints so that, even with an extreme movement in interest rates, neither the interest cost nor the total financing cost is expected to exceed pre-set limits with a high degree of certainty.
Within these constraints, we actively manage our interest rate risk, with over 50% of our debt exposed to floating or index-linked interest rates in the longer term. In 2009/10 we expect our financing costs to benefit from lower inflation and interest rates, some of which have already been locked in using short-term interest rate derivatives.
Some of the bonds in issue from NGET plc and NGG plc are index-linked, that is their cost is linked to changes in the UK retail price index (RPI). We believe that these bonds provide a good hedge for revenues and our regulatory asset values that are also RPI linked under our price control formulae in the UK.
The performance of the Treasury function in interest rate risk management is measured by comparing the actual total financing costs of its debt portfolio with those of a passively-managed benchmark portfolio with a constant ratio of fixed-rate to floating-rate debt, to identify the impact of actively managing National Grid’s interest rate risk. This is monitored regularly by the Finance Committee.
The chart below shows the interest rate profile of our net debt before derivatives.
Interest rate profile pre-derivatives at 31 March 2009
%
The following charts show the impact, as at 31 March 2009, of derivatives on our net debt for 2009/10 and for future years. The 2009/10 position reflects the use of derivatives, including forward rate agreements, to lock in interest rates in the short term. The future years’ position excludes derivatives that mature within the next year.
Interest rate profile post-derivatives at 31 March 2009
%
More information on the interest rate profile of our debt is included in note 33 to the consolidated financial statements.
Foreign exchange risk management
The principal foreign exchange risk to which we are exposed is translation risk arising from assets and liabilities denominated in US dollars. In relation to these risks, our objective is to maintain the ratio of US dollar denominated financial liabilities to US dollar denominated gross assets between 85% and 95%, by using debt and foreign exchange derivatives, so as to provide an economic offset of our cash flows that arise in US dollars against the servicing of those liabilities. In addition, we maintain a small amount of euro denominated debt to provide a hedge against the translation risk arising from assets and liabilities denominated in euros relating to our BritNed investment.
We have a policy of managing our foreign exchange transaction risk by hedging contractually committed foreign exchange transactions occurring in currencies other than the US dollar over a prescribed minimum size. This covers a minimum of 75% of such transactions occurring in the next 6 months and a minimum of 50% of such transactions occurring between 6 and 12 months in the future. In addition, where foreign currency cash flow forecasts are uncertain and a judgement has to be made, our policy is to hedge a proportion of such cash flows based on the likelihood of them occurring, with the aim of hedging substantially all the cash flows without overhedging. Cover generally takes the form of forward sale or purchase of foreign currencies and must always relate to forecast underlying operational cash flows.
The result of this hedging activity is that National Grid’s cash flow has limited exposure to foreign currencies.
In addition, we are exposed to currency movements on borrowings in currencies other than sterling and the US dollar, principally the euro. This currency exposure is managed through the use of cross-currency swaps so that, post-derivatives, the currency profile of our debt is almost entirely sterling/US dollar.
The currency compositions of net debt before and after derivatives is shown in the chart below. More details can be found in note 33 to the consolidated financial statements.
Currency profile at 31 March 2009
£bn
Counterparty risk management
Counterparty risk arises within Treasury from the investment of surplus funds and from the use of derivative instruments, and outside Treasury from commercial contracts entered into by the businesses, including commodity contracts. The Finance Committee has agreed a policy for managing such risk. This policy sets limits as to the exposure that National Grid can have with any one counterparty, based on that counterparty’s credit rating from independent rating agencies. National Grid’s exposure to individual counterparties is monitored on a frequent basis and counterparty limits are regularly updated for changes in credit ratings. Treasury is responsible for managing the policy. Where contracts are entered into outside Treasury, part of the relevant counterparty limit can be allocated to the business area involved. This ensures that National Grid’s overall exposure is managed within the appropriate limit.
Where multiple transactions are entered into with a single counterparty, a master netting arrangement is usually put in place to reduce our exposure to credit risk of that counterparty. We use standard International Swap Dealers Association (ISDA) documentation, which provides for netting in respect of all transactions governed by a specific ISDA agreement with a counterparty, when transacting interest rate and exchange rate derivatives.
Further information on the management of counterparty risk is provided in note 33 to the consolidated financial statements.
Valuation and sensitivity analysis
We calculate the fair value of debt and derivative financial instruments by discounting all future cash flows by the market yield curve at the balance sheet date, and in the case of derivative financial instruments taking into account the credit quality of both parties. The market yield curve for each currency is obtained from external sources for interest and foreign exchange rates.
In the case of derivative instruments that include options (swaptions), the Black’s variation of the Black-Scholes model is used to calculate fair value.
For debt and derivative instruments held, we utilise a sensitivity analysis technique to evaluate the effect that changes in relevant rates or prices would have on the market value of such instruments.
As described in note 33 to the consolidated financial statements, movements in financial indices would have the following estimated impact on the financial statements as a consequence of changes in the value of financial instruments. This analysis does not take account of the change in value in our income stream or in the value of our US operations that certain of these financial instruments are being used to hedge.
| 2008/09 | 2007/08 | |||
|---|---|---|---|---|
| Income statement £m |
Other equity reserves £m |
Income statement £m |
Other equity reserves £m |
|
| UK retail price index ±0.50% | 17 | – | 16 | – |
| UK interest rates ±0.50% | 67 | 77 | 46 | 57 |
| US interest rates ±0.50% | 63 | 13 | 31 | 7 |
| US dollar exchange rate ±10% | 55 | 880 | 38 | 590 |