11 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.

(XLS:) Derivative assets and liabilities

 

Contract/
notional
amount
2012
£m

Fair values

Contract/
notional
amount
2011
£m

Fair values

 

Assets
2012
£m

Liabilities1
2012
£m

Assets
2011
£m

Liabilities1
2011
£m

1.

Derivative liabilities are reported in the balance sheet within Payables and other financial liabilities (Note 24).

Shareholder derivatives:

 

 

 

 

 

 

Interest rate contracts – fair value hedges

600

123

Interest rate contracts – held for trading

2,637

75

100

3,040

50

207

Forward foreign exchange contracts – net investment hedges

710

2

884

9

Forward foreign exchange contracts – held for trading

488

104

578

118

11

Equity/index derivatives – held for trading

(349)

6

1

107

10

Credit derivatives – held for trading

109

3

5

185

7

3

Total shareholder derivatives

 

190

106

 

308

230

Non profit non-unit linked derivatives:

 

 

 

 

 

 

Interest rate contracts – held for trading

26,461

2,621

2,539

27,702

2,750

2,910

Forward foreign exchange contracts – held for trading

90

24

88

71

Equity/index derivatives – held for trading

97

22

97

169

Currency swap contracts – held for trading

3,384

32

2

3,539

65

Inflation swap contracts – held for trading

6,256

132

393

6,402

83

211

Credit derivatives – held for trading

1,476

3

83

1,333

17

198

Other derivatives – held for trading

1,577

13

116

994

14

Total non profit non-unit linked derivatives

 

2,913

3,157

 

3,107

3,469

With-profits derivatives:

 

 

 

 

 

 

Interest rate contracts – held for trading

1,068

10

3

1,426

110

102

Forward foreign exchange contracts – held for trading

11

3

18

7

Equity/index derivatives – held for trading

(357)

25

6

622

39

4

Other derivatives – held for trading

1

1

Total with-profits derivatives

 

46

12

 

167

113

Unit linked derivatives:

 

 

 

 

 

 

Interest rate contracts – held for trading

23,282

2,812

1,185

22,542

2,692

1,141

Forward foreign exchange contracts – held for trading

428

126

190

205

Credit derivatives – held for trading

(682)

2

5

(774)

7

16

Equity/index derivatives – held for trading

3,133

27

659

4,219

207

739

Other derivatives – held for trading

28

5

Inflation rate contracts – held for trading

6,108

27

479

5,827

78

207

Total unit linked derivatives

 

3,296

2,454

 

3,174

2,308

Total derivative assets and liabilities

 

6,445

5,729

 

6,756

6,120

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.

(XLS:) Derivative assets and liabilities – maturity profile of undiscounted cash flows 2012

 

Fair
values
£m

Maturity profile of undiscounted cash flows

As at 31 December 2012

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

190

1,549

536

2,085

Derivative liabilities

(106)

155

5

2

162

Non profit non-unit linked derivatives

 

 

 

 

 

 

 

Derivative assets

2,913

9,296

2,703

4,281

4,171

4,665

25,116

Derivative liabilities

(3,157)

2,586

1,320

3,382

2,794

3,026

13,108

With-profits derivatives

 

 

 

 

 

 

 

Derivative assets

46

741

67

68

20

2

898

Derivative liabilities

(12)

437

6

14

10

467

Total

(126)

14,764

4,637

7,747

6,995

7,693

41,836

Cash outflows

 

 

 

 

 

 

 

Shareholder derivatives

 

 

 

 

 

 

 

Derivative assets

190

(1,514)

(415)

(1,929)

Derivative liabilities

(106)

(180)

(47)

(2)

(229)

Non profit non-unit linked derivatives

 

 

 

 

 

 

 

Derivative assets

2,913

(8,850)

(1,668)

(3,164)

(3,402)

(3,799)

(20,883)

Derivative liabilities

(3,157)

(3,021)

(2,803)

(4,291)

(3,339)

(3,273)

(16,727)

With-profits derivatives

 

 

 

 

 

 

 

Derivative assets

46

(715)

(29)

(85)

(27)

(3)

(859)

Derivative liabilities

(12)

(446)

(5)

(17)

(15)

(483)

Total

(126)

(14,726)

(4,967)

(7,559)

(6,783)

(7,075)

(41,110)

Net shareholder derivatives cash flows

 

10

79

89

Net non profit non-unit linked derivatives cash flows

 

11

(448)

208

224

619

614

Net with-profits derivatives cash flows

 

17

39

(20)

(12)

(1)

23

(XLS:) Derivative assets and liabilities – maturity profile of undiscounted cash flows 2011

 

Fair
values
£m

Maturity profile of undiscounted cash flows

As at 31 December 2011

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

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. All such contracts were terminated during 2012.

Fair value gains and losses arising from fair value hedging relationships are as follows:
Fair value losses of £7m arose on hedging instruments (2011: gains of £31m).
Fair value gains of £6m arose on the hedged item attributable to the hedged risk (2011: losses of £31m).

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 (2011: £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.