23 DERIVATIVE ASSETS AND LIABILITIES.


The Group’s activities expose it to the financial risks of changes in foreign exchange rates and interest rates. The Group uses derivatives such as foreign exchange forward contracts and interest rate swap contracts to hedge these exposures. The Group uses hedge accounting, provided the prescribed criteria in IAS 39 are met, to recognise the offsetting effects of changes in the fair value or cash flow of the derivative instrument and the hedged item. The Group’s principal uses of hedge accounting are to:

(i) recognise in shareholders’ equity the changes in the fair value of derivatives designated as hedges of a net investment in a foreign operation. Any cumulative gains and/or losses are recognised in the income statement on disposal of the foreign operation;
(ii) defer in equity the changes in the fair value of derivatives designated as the hedge of a future cash flow attributable to a recognised asset or liability, a highly probable forecast transaction, or a firm commitment until the period in which the future transaction affects profit or loss or is no longer expected to occur; and
(iii) hedge the fair value movements in loans due to interest rate and exchange rate fluctuations. Any gain or loss from remeasuring the hedging instrument at fair value is recognised immediately in the income statement. Any gain or loss on the hedged item attributable to the hedged risk is adjusted against the carrying amount of the hedged item and recognised in the income statement.

The relationship between the hedging instrument and the hedged item, together with the risk management objective and strategy for undertaking the hedge transaction, are documented at the inception of the transaction. The effectiveness of the hedge is documented and monitored on an ongoing basis. Hedge accounting is only applied for highly effective hedges (between 80% and 125% effectiveness) with any ineffective portion of the gain or loss recognised in the income statement, within other expenses, in the current period.

Certain derivative instruments do not qualify for hedge accounting. Changes in the fair value of any derivative instruments which do not qualify for hedge accounting are recognised immediately in the income statement.

Where the risks and characteristics of derivatives embedded in other contracts are not closely related to those of the host contract and the whole contract is not carried at fair value, the derivative is separated from that host contract and measured at fair value, with fair value movements reflected within investment return, unless the embedded derivative itself meets the definition of an insurance contract.

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Contract/
notional
amount 2011
£m

Fair values

Contract/
notional
amount 2010
£m

Fair values

 

Assets
2011
£m

Liabilities1
2011
£m

Assets
2010
£m

Liabilities1
2010
£m

1.

Derivative liabilities are reported in the balance sheet within Payables and other financial liabilities (Note 37).

Shareholder derivatives:

 

 

 

 

 

 

Interest rate contracts – fair value hedges

600

123

600

91

Interest rate contracts – held for trading

3,040

50

207

1,804

36

125

Forward foreign exchange contracts – net investment hedges

884

9

887

15

1

Forward foreign exchange contracts – held for trading

578

118

11

752

130

4

Equity/index derivatives – held for trading

107

10

(79)

12

1

Credit derivatives – held for trading

185

7

3

89

4

4

Total shareholder derivatives

 

308

230

 

288

135

Non profit non-unit linked derivatives:

 

 

 

 

 

 

Interest rate contracts – held for trading

27,702

2,750

2,910

23,805

940

1,041

Forward foreign exchange contracts – held for trading

88

71

78

60

Equity/index derivatives – held for trading

97

169

112

296

Currency swap contracts – held for trading

3,539

65

Inflation swap contracts – held for trading

6,402

83

211

6,218

81

163

Credit derivatives – held for trading

1,333

17

198

1,343

30

178

Other derivatives – held for trading

994

14

996

13

Total non profit non-unit linked derivatives

 

3,107

3,469

 

1,425

1,455

With-profits derivatives:

 

 

 

 

 

 

Interest rate contracts – held for trading

1,426

110

102

1,531

51

57

Forward foreign exchange contracts – held for trading

18

7

4

11

Equity/index derivatives – held for trading

622

39

4

472

28

16

Other derivatives – held for trading

1

1

1

Total with-profits derivatives

 

167

113

 

84

84

Unit linked derivatives:

 

 

 

 

 

 

Interest rate contracts – held for trading

22,542

2,692

1,141

24,390

909

543

Forward foreign exchange contracts – held for trading

190

205

200

389

Credit derivatives – held for trading

(774)

7

16

(1,979)

5

12

Equity/index derivatives – held for trading

4,219

207

739

3,952

907

898

Other derivatives – held for trading

5

8

1

Inflation rate contracts – held for trading

5,827

78

207

7,781

195

253

Total unit linked derivatives

 

3,174

2,308

 

2,217

2,095

Total derivative assets and liabilities

 

6,756

6,120

 

4,014

3,769

The notional amounts of some derivative instruments provide a basis for comparison with instruments recognised on the balance sheet. However, these amounts do not necessarily indicate the amounts of future cash flows involved or the current fair value of the instruments and, therefore, do not indicate the Group’s exposure to credit or price risks.

The contractual undiscounted cash flows in relation to non-unit linked derivatives have the following maturity profile. Unit linked derivatives have not been included as shareholders are not directly exposed to liquidity risks.

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Maturity profile of undiscounted cash flows

As at 31 December 2011

Fair
values
£m

Within
1 year
£m

1-5
years
£m

5-15
years
£m

15-25
years
£m

Over
25 years
£m

Total
£m

Cash inflows
Shareholder derivatives

 

 

 

 

 

 

 

Derivative assets

308

634

662

13

1,309

Derivative liabilities

(230)

1,253

10

6

3

1,272

Non profit non-unit linked derivatives

 

 

 

 

 

 

 

Derivative assets

3,107

3,518

1,715

3,720

4,454

5,646

19,053

Derivative liabilities

(3,469)

4,925

4,330

2,782

3,375

3,676

19,088

With-profits derivatives

 

 

 

 

 

 

 

Derivative assets

167

552

134

36

115

5

842

Derivative liabilities

(113)

360

30

20

58

2

470

Total

(230)

11,242

6,881

6,577

8,005

9,329

42,034

Cash outflows
Shareholder derivatives

 

 

 

 

 

 

 

Derivative assets

308

(570)

(441)

(1,011)

Derivative liabilities

(230)

(1,321)

(153)

(20)

(4)

(1)

(1,499)

Non profit non-unit linked derivatives

 

 

 

 

 

 

 

Derivative assets

3,107

(2,894)

(724)

(3,027)

(3,462)

(4,326)

(14,433)

Derivative liabilities

(3,469)

(5,393)

(5,775)

(3,839)

(4,265)

(3,841)

(23,113)

With-profits derivatives

 

 

 

 

 

 

 

Derivative assets

167

(512)

(38)

(30)

(83)

(4)

(667)

Derivative liabilities

(113)

(389)

(79)

(36)

(90)

(3)

(597)

Total

(230)

(11,079)

(7,210)

(6,952)

(7,904)

(8,175)

(41,320)

Net shareholder derivatives cash flows

 

(4)

78

(1)

(1)

(1)

71

Net non profit non-unit linked derivatives cash flows

 

156

(454)

(364)

102

1,155

595

Net with-profits derivatives cash flows

 

11

47

(10)

48

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Maturity profile of undiscounted cash flows

As at 31 December 2010

Fair
values
£m

Within
1 year
£m

1-5
years
£m

5-15
years
£m

15-25
years
£m

Over
25 years
£m

Total
£m

Cash inflows
Shareholder derivatives

 

 

 

 

 

 

 

Derivative assets

288

1,240

725

65

17

5

2,052

Derivative liabilities

(135)

389

21

13

423

Non profit non-unit linked derivatives

 

 

 

 

 

 

 

Derivative assets

1,425

5,518

1,680

4,293

3,169

5,095

19,755

Derivative liabilities

(1,455)

6,027

1,269

3,858

3,583

4,372

19,109

With-profits derivatives

 

 

 

 

 

 

 

Derivative assets

84

223

131

103

30

4

491

Derivative liabilities

(84)

797

66

131

52

8

1,054

Total

123

14,194

3,892

8,463

6,851

9,484

42,844

Cash outflows
Shareholder derivatives

 

 

 

 

 

 

 

Derivative assets

288

(1,173)

(452)

(19)

(14)

(4)

(1,662)

Derivative liabilities

(135)

(444)

(178)

(48)

(670)

Non profit non-unit linked derivatives

 

 

 

 

 

 

 

Derivative assets

1,425

(5,300)

(1,260)

(4,016)

(2,858)

(4,536)

(17,970)

Derivative liabilities

(1,455)

(6,327)

(1,948)

(3,970)

(3,665)

(3,944)

(19,854)

With-profits derivatives

 

 

 

 

 

 

 

Derivative assets

84

(202)

(75)

(99)

(27)

(4)

(407)

Derivative liabilities

(84)

(845)

(91)

(144)

(58)

(9)

(1,147)

Total

123

(14,291)

(4,004)

(8,296)

(6,622)

(8,497)

(41,710)

Net shareholder derivatives cash flows

 

12

116

11

3

1

143

Net non profit non-unit linked derivatives cash flows

 

(82)

(259)

165

229

987

1,040

Net with-profits derivatives cash flows

 

(27)

31

(9)

(3)

(1)

(9)

Cash inflows and outflows are presented on a net basis where the Group is required to settle net or has a legally enforceable right of offset and the intention is to settle on a net basis.

Future cash flows on the floating legs of interest rate and exchange derivatives are calculated using current spot rates, which may differ from the market expectation incorporated in the fair value.

Cash flows arising from implied events covered by credit derivatives are presented in the table above on an expected basis as cash flows within one year.

Forward foreign exchange contracts – net investment hedges

The Group hedges part of the foreign exchange translation exposure on its net investment in its overseas subsidiaries, using forward foreign exchange contracts. It recognises the portion of the gain or loss which is determined to be an effective hedge through reserves within shareholders’ equity, along with the gain or loss on translation of the foreign subsidiaries.

Interest rate swap contracts – fair value hedges

The Group uses interest rate swap contracts to hedge fixed rate loans in particular to hedge the movement in the fair value of a loan due to interest rates.

Fair value gains and losses arising from fair value hedging relationships are as follows:
Fair value gains of £31m arose on hedging instruments (2010: gains of £23m);
Fair value losses of £31m arose on the hedged item attributable to the hedged risk (2010: losses of £24m).

The total fair value gain on hedging instruments shown above excludes fair value gains arising from factors which are outside the designated hedging relationship of £nil (2010: £nil).

Derivative contracts – held for trading

The Group uses certain derivative contracts which are effective hedges of economic exposures in accordance with the Group’s risk management policy, but for various reasons are not designated within a formal hedge accounting relationship. Therefore, these contracts must be designated as held for trading, and gains and losses on these contracts are recognised immediately in the income statement.

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