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24. Financial risk management and derivative financial assets/liabilities

The Group is exposed in varying degrees to a variety of financial instrument related risks. The Board has approved and monitors the risk management processes, inclusive of documented treasury policies, counterparty limits, controlling and reporting structures. The risk management processes of the Group's independently listed subsidiaries are in line with the Group's own policy.

The types of risk exposure, the way in which such exposure is managed and quantification of the level of exposure in the balance sheet at year end is provided as follows (subcategorised into credit risk, liquidity risk and market risk).

Credit risk

The Group's principal financial assets are bank balances and cash, trade and other receivables and investments. The Group's maximum exposure to credit risk is as follows:

US$ million 2008 2007
Cash and cash equivalents 2,771 3,129
Trade and other receivables 2,797 3,591
Financial asset investments 1,108 938
Other financial assets (derivatives) 376 535
Other guarantees and loan facilities 239 12
  7,291 8,205

The Group limits exposure to credit risk on liquid funds and derivative financial instruments through adherence to a policy of:

  • Where possible acceptable minimum counterparty credit ratings assigned by international credit-rating agencies (including long term ratings of A- (Standard & Poor's), A3 (Moody's) or A- (Fitch) or better).
  • Daily counterparty settlement limits (which are not to exceed three times the credit limit for an individual bank).
  • Exposure diversification (the aggregate group exposure to key relationship counterparties cannot exceed 5% of the counterparty's shareholders equity).

Given the diverse nature of the Group's operations (both in relation to commodity markets and geographically), together with insurance cover (including letters of credit from financial institutions), it does not have significant concentration of credit risk in respect of trade receivables, with exposure spread over a large number of customers.

An allowance for impairment for trade receivables is made where there is an identified loss event, which based on previous experience, is evidence of a reduction in the recoverability of the cash flows. Detail of the credit quality of trade receivables and the associated provision for impairment is disclosed in note 20.

Liquidity risk

The Group ensures that there are sufficient committed loan facilities (including refinancing, where necessary) in order to meet short term business requirements, after taking into account cash flows from operations and its holding of cash and cash equivalents, as well as any group distribution restrictions that exist.

Non-wholly owned subsidiaries, where possible, will maintain their own financing and funding requirements. In most cases the financing will be non-recourse to the Group. In addition, certain projects are financed by means of limited recourse project finance, if appropriate.

The expected undiscounted cash flows of the Group's financial liabilities (including associated derivatives), by remaining contractual maturity, based on conditions existing at the balance sheet date are as follows:

      Within 1 year     1-2 years

US$ million
Fixed
interest
Floating
interest
Capital
repayment
Fixed
interest
Floating
interest
Capital
repayment
31 December 2008
Non-derivative financial liabilities (191) (405) (11,385) (179) (245) (732)
Net settled derivatives 156 (94) 8 164 (101) (53)
  (35) (499) (11,377) (15) (346) (785)

31 December 2007
           
Non-derivative financial liabilities (144) (188) (9,643) (87) (95) (440)
Gross settled derivatives    
Receive leg 7
Pay leg (1)
Net settled derivatives 102 (118) 291 52 (53) (9)
  (42) (306) (9,346) (35) (148) (449)

      2-5 years     +5 years

US$ million
Fixed
interest
Floating
interest
Capital
repayment
Fixed
interest
Floating
interest
Capital
repayment
31 December 2008
Non-derivative financial liabilities (472) (422) (4,348) (345) (114) (2,412)
Net settled derivatives 443 (304) 9 345 (195) (400)
  (29) (726) (4,339) (309) (2,812)

31 December 2007            
Non-derivative financial liabilities (177) (220) (1,158) (47) (171) (776)
Gross settled derivatives  
Receive leg
Pay leg
Net settled derivatives 130 (133) 112 35 (35)
  (47) (353) (1,046) (12) (206) (776)

The Group had the following undrawn committed borrowing facilities at 31 December:

US$ million 2008 2007
Expiry date    
Within one year(1) 2,994 2,877
Greater than one year, less than two years 5 322
Greater than two years, less than five years 3,081 3,865
Greater than five years 25
  6,105 7,064
(1)
Includes undrawn rand facilities equivalent to $1 billion in respect of a series of facilities with 364 day maturities which roll automatically on a daily basis, unless notice is served.

In addition, the Group has dedicated, committed financing facilities for Minas-Rio and Barro Alto totalling $1.6 billion, subject to certain disbursement conditions.

The Group also had a $2 billion European Commercial Paper Programme established in October 2004. Drawings of $304 million were made at 31 December 2008 (2007: $1,090 million). The Group also had a Rand 20 billion South African Medium Term Note Programme, established in November 2007, on which total drawings of Rand 7,273 million ($782 million) (2007: nil) were made at 31 December 2008. Of this drawing Rand 7,074 million ($761 million) was issued as commercial paper.

Market risk

This is the risk that financial instrument fair values will fluctuate owing to changes in market prices. The significant market risks to which the Group is exposed are foreign exchange risk, interest rate risk and commodity price risk.

Foreign exchange risk

As a global business, the Group is exposed to many currencies principally as a result of non-US dollar operating costs incurred by US dollar functional currency companies and to a lesser extent, from non-US dollar revenues. The Group's policy is generally not to hedge such exposures as hedging is not deemed appropriate given the diversified nature of the Group though exceptions can be approved by the Board.

In addition, currency exposures exist in respect of non-US dollar approved capital expenditure projects. The Group's policy is that such exposure can be hedged at management's discretion, within certain pre-defined limits (or with Board approval).

The exposure of the Group's financial assets and liabilities (excluding intra-group loan balances) to currency risk is as follows:




US$ million
Financial
assets
(excluding
derivatives)

Impact of
currency
derivatives(1)


Derivative
assets
Total financial
assets –
exposure to
currency risk
At 31 December 2008
US$(2) 3,118 (108) 252 3,262
Rand 3,895 82 71 4,048
Sterling 547 (2) 545
Euro 136 136
Australian dollar 290 (4) 286
Other currencies 870 32 53 955
Total financial assets 8,856 376 9,232

At 31 December 2007
       
US$(2) 4,260 (99) 465 4,626
Rand 4,414 88 17 4,519
Sterling 839 839
Euro 301 301
Australian dollar 221 (3) 218
Other currencies 1,465 14 53 1,532
Total financial assets 11,500 535 12,035



US$ million
Financial
liabilities
(excluding
derivatives)

Impact of
currency
derivatives(1)


Derivative
liabilities
Total financial
liabilities –
exposure to
currency risk
At 31 December 2008        
US$ (7,854) (3,130) (1,056) (12,040)
Rand (5,289) (15) (2) (5,306)
Sterling (1,628) 1,141 (487)
Euro (1,821) 1,697 (124)
Australian dollar (528) (528)
Other currencies (1,953) 307 (439) (2,085)
Total financial liabilities (19,073) (1,497) (20,570)

At 31 December 2007
       
US$ (3,261) (2,962) (560) (6,783)
Rand (3,879) (26) (3,905)
Sterling (1,325) 606 (719)
Euro (2,103) 1,886 (217)
Australian dollar (406) (406)
Other currencies (1,148) 470 (678)
Total financial liabilities (12,122) (586) (12,708)
(1)
Where currency derivatives are held to manage financial instrument exposures the notional principal amount is ‘reallocated' to reflect the remaining exposure to the Group.
(2)
Of these US$ financial assets, $97 million (2007: $571 million) are subject to South African exchange controls and will be converted to rand within the next six months.

Interest rate risk

Fluctuations in interest rates impact on the value of short term investments and financing activities, giving rise to interest rate risk. Exposure to interest rate risk is particularly with reference to changes in US and South African interest rates. Exposure to Brazilian interest rates is expected to increase in the near term.

The Group policy is to borrow funds at floating rates of interest as this is considered to give somewhat of a natural hedge against commodity price movements, given the correlation to economic growth (and industrial activity) which in turn shows a high correlation with commodity price fluctuation. In certain circumstances, the Group uses interest rate swap and option contracts to manage its exposure to interest rate movements on a portion of its existing debt. Also strategic hedging using fixed rate debt may be undertaken from time to time if considered appropriate.

In respect of financial assets, the Group's policy is to invest cash at floating rates of interest and cash reserves are to be maintained in short term investments (less than one year) in order to maintain liquidity, while achieving a satisfactory return for shareholders.

The exposure of the Group's financial assets (excluding intra-group loan balances) to interest rate risk is as follows:


Interest bearing
financial assets
Non-interest bearing
financial assets

US$ million Floating
rate
Fixed
rate(1)
Equity
investments
Other non-
interest
bearing
Total
At 31 December 2008
Financial assets (excluding derivatives)(2) 3,098 464 2,180 3,114 8,856
Derivative assets 196 180 376
Financial asset exposure to interest rate risk 3,294 464 2,180 3,294 9,232

At 31 December 2007
         
Financial assets (excluding derivatives)(2) 3,013 864 3,842 3,781 11,500
Derivative assets 1 11 523 535
Financial asset exposure to interest rate risk 3,014 875 3,842 4,304 12,035
(1)
Includes $360 million (2007: $476 million) of preference shares in a BEE entity.
(2)
At 31 December 2008 and 2007 no interest rate swaps were held in respect of financial asset exposures.

Floating rate financial assets consist mainly of cash and bank term deposits. Interest on floating rate assets is based on the relevant national inter-bank rates. Fixed rate financial assets consist mainly of financial asset investments and cash, and have a weighted average interest rate of 13.5% (2007: 11%) and are fixed for an average period of four years (2007: four years). Equity investments are fully liquid and have no maturity period.

The exposure of the Group's financial liabilities (excluding intra-group loan balances) to interest rate risk is as follows:


Interest bearing
financial liabilities
Non-interest
bearing
financial
liabilities


US$ million
Floating
rate
Fixed
rate
Total
At 31 December 2008
Financial liabilities (excluding derivatives) (10,461) (3,459) (5,153) (19,073)
Impact of interest rate swaps(1) (2,829) 2,829
Derivative liabilities (1,497) (1,497)
Financial liability exposure to interest rate risk (13,290) (630) (6,650) (20,570)

At 31 December 2007
       
Financial liabilities (excluding derivatives) (5,425) (2,822) (3,875) (12,122)
Impact of interest rate swaps(1) (2,336) 2,336
Derivative liabilities (45) (541) (586)
Financial liability exposure to interest rate risk (7,806) (486) (4,416) (12,708)
(1)
 Where interest rate swaps are held to manage financial liability exposures the notional principal amount is 'reallocated' to reflect the  remaining exposure to the Group.

Interest on floating rate instruments is based on the relevant national inter-bank rates. Remaining fixed rate borrowings accrue interest at 8% (2007: 8%) and are at fixed rates for an average period of two years (2007: two years). Average maturity on non-interest bearing instruments is 17 months (2007: seven months).

Commodity price risk

The Group's earnings are exposed to movements in the prices of the commodities it produces.

The Group policy is generally not to hedge price risk, although some hedging may be undertaken for strategic reasons. In such cases, the Group uses forward, deferred and option contracts to hedge the price risk.

Certain of the Group's sales and purchases are provisionally priced and as a result are susceptible to future price movements. The exposure of the Group's financial assets and liabilities to commodity price risk is as follows:

  Commodity price linked Not linked
to
commodity
price
 


US$ million
Subject to
price
movements
Fixed
price(1)
Total
At 31 December 2008
Total net financial instruments (excluding derivatives) (291) 183 (10,109) (10,217)
Commodity derivatives (net)(2) (318) (318)
Other derivatives not related to commodity (net) (803) (803)
Total financial instrument exposure to commodity risk (609) 183 (10,912) (11,338)

At 31 December 2007
       
Total net financial instruments
(excluding derivatives)
325 461 (1,408) (622)
Commodity derivatives (net)(2) (480) (480)
Other derivatives not related to
commodity (net)
429 429
Total financial instrument exposure to commodity risk (155) 461 (979) (673)

(1) Includes financial instruments whose commodity prices are set annually or via contract negotiation.

(2) Includes $249 million (2007: $124 million) derivative embedded in a long term power contract.

Derivatives

In accordance with IAS 32 and IAS 39, the fair value of all derivatives are separately recorded on the balance sheet within other financial assets (derivatives) and other financial liabilities (derivatives). Derivatives that are designated as hedges are classified as current or non-current depending on the maturity of the derivative. Derivatives that are not designated as hedges are classified as current in accordance with IAS 1 even when their actual maturity is expected to be greater than one year.

The Group utilises derivative instruments to manage its market risk exposures as explained above. The Group does not use derivative financial instruments for speculative purposes, however it may choose not to designate certain derivatives as hedges. Such derivatives that are not hedge accounted are classified as ‘non-hedges' and fair value movements are recorded in the income statement.

The use of derivative instruments is subject to limits and the positions are regularly monitored and reported to senior management.

Embedded derivatives

Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives when their risks and characteristics are not closely related to those of their host contract and the host contract is not carried at fair value. Embedded derivatives may be designated into hedge relationships and are accounted for in accordance with the Group's accounting policy set out in note 1.

Cash flow hedges

In certain cases the Group classifies its forward exchange and commodity price contracts hedging highly probable forecast transactions as cash flow hedges. Where this designation is documented, changes in fair value are recognised in equity until the hedged transactions occur, at which time the respective gains or losses are transferred to the income statement (or hedged balance sheet item) in accordance with the Group's accounting policy set out in note 1.

Fair value hedges

The majority of interest rate swaps (taken out to swap the Group's fixed rate borrowings to floating rate, in accordance with the treasury policy) have been designated as fair value hedges. The respective carrying values of the hedged debt are adjusted to reflect the fair value of the interest rate risk being hedged. Subsequent changes in the fair value of the hedged risk are offset against fair value changes in the interest rate swap and classified within financing costs in the income statement.

Non-hedges

The Group may choose not to designate certain derivatives as hedges, for example certain forward foreign currency contracts that provide a natural hedge of non-US dollar debt in the income statement or where the Group is economically hedged but IAS 39 hedge accounting cannot be achieved. Where derivatives have not been designated as hedges, fair value changes are recognised in the income statement in accordance with the Group's accounting policy set out in note 1 and are classified as financing or operating depending on the nature of the associated hedged risk.

The fair value of the Group's open derivative position at 31 December (excluding normal purchase and sale contracts held off balance sheet), recorded within other financial assets (derivatives) and other financial liabilities (derivatives) is as follows:

    2008    2007
US$ million Asset Liability Asset Liability
Current
Cash flow hedge(1)        
Forward foreign currency contracts 10 (75) 2
Forward commodity contracts (49) (304)
Other 11
Fair value hedge  
Forward foreign currency contracts 1 (12)
Interest rate swaps 140
Other 2
Non-hedge (‘Held for trading')(2)  
Forward foreign currency contracts 114 (529) 31 (25)
Cross currency swaps 40 (504) 404 (10)
Other 66 (279) 86 (150)
Total current derivatives 372 (1,436) 535 (501)

Non-current
       
Cash flow hedge(1)  
Forward foreign currency contracts (57)
Forward commodity contracts (4) (53)
Fair value hedge  
Interest rate swaps 4 (32)
Total non-current derivatives 4 (61) (85)
(1)
The timing of the expected cash flows associated with these hedges is as follows:
US$ million 2008 2007
Within one year (160) (289)
Greater than one year, less than two years (80) (61)
Greater than two years, less than five years (11)
Greater than five years
  (251) (350)
    
The periods when these hedges are expected to impact the income statement generally follow the cash flow profile with the exception of hedging associated with capital projects which is included in the capitalised asset value and depreciated over the life of the asset. There are no material capital expenditure related hedges included in the above.
(2)
$78 million (2007: $160 million) of derivative assets and $824 million (2007: $126 million) of derivative liabilities not designated as hedges and that are classified as current in accordance with IAS 1 are due to mature after more than one year.

These marked to market valuations are in no way predictive of the future value of the hedged position, nor of the future impact on the profit of the Group. The valuations represent the cost of buying all hedge contracts at year end, at market prices and rates available at the time.

Normal purchase and normal sale contracts

Commodity based contracts that meet the scope exemption in IAS 39 (in that they are settled through physical delivery of the Group's production or are used within the production process), are classified as normal purchase or sale contracts. In accordance with IAS 39 these contracts are not marked to market.

Capital risk management

The Group's objectives when managing capital are to safeguard the Group's ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and, with cognisance of forecast future market conditions and structuring, to maintain an optimal capital structure to reduce the cost of capital.

In order to manage the short and long term capital structure, the Group adjusts the amount of ordinary dividends paid to shareholders, returns capital to shareholders (via, for example, share buybacks and special dividends), arranges debt to fund new acquisitions and also may sell non-core assets to reduce debt.

The Group monitors capital on the basis of the ratio of net debt to total capital less investments in associates (gearing). Net debt is calculated as total borrowings less cash and cash equivalents and current financial asset investments (excluding derivatives which provide an economic hedge of debt and including the net debt of disposal groups). Total capital is calculated as 'Net assets' (as shown in the Consolidated balance sheet) excluding net debt. Gearing as at 31 December 2008 was 37.8% (2007: 20.0%). The increase during 2008 resulted primarily from acquisitions and capital expenditure, partially offset by strong operating cash flows and asset disposals.

Financial instrument sensitivities

Financial instruments affected by market risk include borrowings, deposits, derivative financial instruments, trade receivables and trade payables. The following analysis, required by IFRS 7, is intended to illustrate the sensitivity of the Group's financial instruments (as at year end) to changes in commodity prices, exchange rates and interest rates.

The sensitivity analysis has been prepared on the basis that the components of net debt, the ratio of fixed to floating interest rates of the debt and derivatives portfolio and the proportion of financial instruments in foreign currencies are all constant and on the basis of the hedge designations in place at 31 December. In addition, the commodity price impact for provisionally priced contracts is based on the related trade receivables and trade payables at 31 December. As a consequence, this sensitivity analysis relates to the position as at 31 December.

The following assumptions were made in calculating the sensitivity analysis:

  • All income statement sensitivities also impact equity.
  • The majority of debt and other deposits are carried at amortised cost and therefore carrying value does not change as interest rates move.
  • No sensitivity is provided for interest accruals as these are based on pre-agreed interest rates and therefore are not susceptible to further rate changes.
  • Changes in the carrying value of derivatives (from movements in commodity prices and interest rates) designated as cash flow hedges are assumed to be recorded fully within equity on the grounds of materiality.
  • No sensitivity has been calculated on derivatives and related underlying instruments designated into fair value hedge relationships as these are assumed to materially offset one another.
  • All hedge relationships are assumed to be fully effective on the grounds of materiality.
  • Debt with a maturity below one year is floating rate, unless it is a long term fixed rate debt in its final year.
  • Translation of foreign subsidiaries and operations into the Group's presentation currency has been excluded from the sensitivity.

Using the above assumptions, the following tables show the illustrative effect on the income statement and equity that would result from reasonably possible changes in the relevant commodity price, foreign currency or interest rates:


US$ million
Income
statement
Equity
Commodity price sensitivities
2008
   
10% increase in the copper price 47 47
10% decrease in the copper price (47) (47)
10% increase in the platinum price (9) (9)
10% decrease in the platinum price 9 9
10% increase in the coal price (11)
10% decrease in the coal price 11
2007
10% increase in the copper price 89 66
5% decrease in the copper price (45) (33)
10% increase in the platinum price (8) (8)
15% decrease in the platinum price 13 13
5% increase in the coal price (15)
5% decrease in the coal price 15
Interest rate sensitivities
2008
   
25 bp increase in US interest rates (6) (6)
25 bp decrease in US interest rates 6 6
50 bp increase in South African interest rates (11) (10)
50 bp decrease in South African interest rates 11 10
2007
75 bp decrease in US interest rates
(2) (2)
50 bp decrease in South African interest rates 10 10
75 bp decrease in UK interest rates 5 5
Foreign currency sensitivities(1)
2008
   
+10% US$ to rand 45 42
-10% US$ to rand (46) (43)
+10% US$ to Australian dollar 20 19
-10% US$ to Australian dollar (20) (18)
+10% US$ to Brazilian real (125) (128)
-10% US$ to Brazilian real 176 180
+10% US$ to Chilean peso (25) (42)
-10% US$ to Chilean peso 30 51
2007
+5% US$ to rand 18 18
-5% US$ to rand (18) (17)
+5% US$ to Australian dollar (19) (19)
-5% US$ to Australian dollar 23 23
+5% US$ to Brazilian real (46) (46)
-5% US$ to Brazilian real 46 46
+5% US$ to Chilean peso 8 8
-5% US$ to Chilean peso (9) (9)
(1) +
represents strengthening of US dollar against the respective currency.

The above sensitivities are calculated with reference to a single moment in time and will change due to a number of factors including:

  • fluctuating trade receivable and trade payable balances;
  • derivative instruments and borrowings settled throughout the year;
  • fluctuating cash balances;
  • changes in currency mix; and
  • commercial paper with short term maturities, which is regularly replaced or settled.

As the sensitivities are limited to year end financial instrument balances they do not take account of the Group's sales and operating costs which are highly sensitive to changes in commodity prices and exchange rates. In addition, each of the sensitivities is calculated in isolation, while in reality commodity prices, foreign exchange rates and interest rates do not move independently.

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