Financial position
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 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.
Commodity derivatives entered into in respect of gas and electricity commodities are used in support of the operational requirements of the business and the policy regarding their use is explained in Commodity contracts.
Current condition of the financial markets
During 2009/10, there has been a partial recovery in the global economic situation, following the crisis in the banking system, the failure of individual banks and increased restrictions on lending across the capital and money markets in 2008/09. Credit spreads have narrowed significantly. With our low risk business model and cash flows that are largely stable over a period of years, we were able to access the markets during 2008/09 and have continued to do so in 2009/10, having issued £1,993 million of long-term debt into the capital markets. In addition, we have issued £119 million of commercial paper, all of which remained outstanding as at 31 March 2010. At 1 April 2009, we had drawn down £105 million of uncommitted bank lines for short-term liquidity purposes, all of which was repaid by 31 March 2010. We remain confident of our ability to access the public debt markets in the future. The cost of our new long-term debt has fallen over the last few years, decreasing from around 6.7% in 2007/08 to around 4.6% in 2009/10. This reflects the increase in credit spreads demanded by lenders more than offset by the fall in headline interest rates.
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 cash flows. However, in the US our short-term cash flows are dependent on the price of gas and electricity and the timing of customer payments. 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 abnormally mild or extreme weather or economic conditions affecting the level of demand, can affect cash inflows in particular. In addition, our cash flows arising in the US are exposed to movements in the 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 seek to enhance our cash flow forecasting processes on an ongoing basis. Cash flow forecasts, supplemented by a financial headroom analysis, are monitored 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 undertake transactions between certain subsidiary companies including paying dividends, lending cash and levying charges. 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 to facilitate long- and short-term debt issuance into the capital and money markets. National Grid plc also has a Securities and Exchange Commission registered debt shelf in place to facilitate long-term debt issuance specifically into the US capital markets. The table below shows the programmes we had as at 31 March 2010, 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 |
£94 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 |
€9.0 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 |
€5.7 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 |
At 31 March 2010, we had signed a £360 million index-linked loan agreement with the European Investment Bank, of which £60 million had been drawn. Since that date a further £180 million has been drawn, and the remaining £120 million will be drawn by 30 June 2010.
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 or other specific debt issuances. These have never been drawn and there is currently no intention to draw them in the future.
During the year, the $850 million short-term committed facility within National Grid plc expired and was renewed at a slightly reduced level and now stands at $810 million. National Grid USA is also a named borrower under this facility, which includes an option to draw down under the facility for a fixed term of up to 12 months.
The table below shows the bank facilities we had as at 31 March 2010. None of the committed facilities were drawn at any time during the year.
| Facility | Amount |
|---|---|
| National Grid plc and National Grid USA | |
| Short-term committed facilities | $810 million |
| National Grid plc | |
| Long-term committed facilities | £830 million |
| Long-term committed facilities | $280 million |
| National Grid Gas plc | |
| Long-term committed facilities | £700 million |
| National Grid Electricity Transmission plc | |
| Long-term committed facilities | £425 million |
| National Grid’s US subsidiaries | |
| Committed facilities | $530 million |
| National Grid plc and certain subsidiaries | |
| Uncommitted borrowing facilities | £528 million |
Note 34 to the consolidated financial statements shows the maturity profile of undrawn committed borrowing facilities in sterling at 31 March 2010.
To facilitate debt issuance into the capital and money markets, many of the companies within National Grid maintain credit ratings. At 31 March 2010, the long-term senior unsecured debt and short-term debt credit ratings respectively provided by Moody’s Investor Services, Standard & Poor’s and Fitch Ratings were as follows (all with outlooks of stable):
| 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 | A3 | 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
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. Details relating to cash, short-term investments and other financial assets at 31 March 2010 are shown in notes 14 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 28 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.
Following the Board resolving to offer a fully underwritten Rights Issue for approximately £3.2 billion, net of expenses, due to be announced on 20 May 2010, and assuming its successful completion, we are of the opinion that it will not be necessary to raise additional funding for working capital purposes in the 12 month period from the date of this Annual Report. However, in line with our normal treasury practice we may continue to access the markets in order to manage actively our debt portfolio, optimise our finance costs and manage our refinancing risk.
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.
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 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, with the total contracted borrowings maturing over 49 years. This shows that, at 31 March 2010, we have £2.8 billion of debt maturing in 2010/11, and no more than £2.1 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 2010.
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 preset limits with a high degree of certainty.
Some of the bonds in issue from NGET plc and NGG plc are inflation-linked, that is their cost is linked to changes in the UK retail price index (RPI). We believe that these bonds provide an appropriate 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 set ratios 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.
Figure 4 shows the interest rate profile of our net debt before derivatives.
Figure 5 shows the impact, as at 31 March 2010, of derivatives on our net debt for 2010/11 and for future years. The 2010/11 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.
Within the constraints of our interest rate risk management policy, and as approved by the Finance Committee, we actively manage our interest rate exposure and therefore the interest rate profile shown at 31 March 2010 will change over time.
In 2010/11, we expect our financing costs to continue to benefit from low short-term interest rates, some of which have already been locked in using short-term interest rate derivatives although we expect this to be offset by higher UK inflation affecting our index-linked debt.
More information on the interest rate profile of our debt is included in note 32 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 dollars. In relation to these risks, our objective is to maintain the ratio of dollar denominated financial liabilities to 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 dollars against the servicing of those liabilities.
We have a policy of managing our foreign exchange transaction risk by hedging contractually committed foreign exchange transactions occurring in currencies other than the 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 exposures on borrowings in currencies other than sterling and the 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/dollar, as shown in figure 6.
More details can be found in note 32 to the consolidated financial statements.
Counterparty risk management
Counterparty risk arises from the investment of surplus funds, from the use of derivative instruments including commodity contracts, and from commercial contracts entered into by the businesses. 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 credit rating agencies. National Grid’s exposure to individual counterparties is monitored daily and counterparty limits are regularly updated for changes in credit ratings. We have a central treasury department, which is responsible for managing the policy. Where business areas enter into contracts carrying credit risk, 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 in relation to that counterparty. When transacting interest rate and exchange rate derivatives, 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.
Further information on the management of counterparty risk is provided in note 32 to the consolidated financial statements.
Valuation and sensitivity analysis
We calculate the fair value of debt and financial derivatives by discounting all future cash flows by the market yield curve, at the balance sheet date, including the credit spread for debt, and, in the case of financial derivatives, 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, 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 32 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.
| 2009/10 | 2008/09 | |||
|---|---|---|---|---|
| Income statement £m | Other equity reserves £m | Income statement £m | Other equity reserves £m |
|
| UK retail price index ±0.50% | 17 | – | 17 | – |
| UK interest rates ±0.50% | 51 | 71 | 67 | 77 |
| US interest rates ±0.50% | 52 | 14 | 63 | 13 |
| US dollar exchange rate ±10% | 68 | 623 | 55 | 880 |
