Financial review

During the year, net operating expenses increased by 28% to £1,240 million primarily as a result of the impact of exchange rates which increased costs by £95 million, acquisitions which had an annual impact of £94 million and investments in new initiatives totalling £44 million.

The efficient and effective management of the cost base is one of the key components of the Group’s operational strategy. During the year, the Group maintained its focus on costs and has taken advantage of a number of opportunities in both voice and electronic broking to reduce costs. The impact of these cost reductions is expected to result in annual cost savings of £38 million: costs were reduced this year by £15 million and in 2009/10 will be reduced by a further £23 million. Costs of £12 million have been incurred in securing these savings in the current year but we do not expect to incur further material costs for the savings anticipated in 2009/10.

Staff costs represent the largest single expense of the Group and are variable, in part, with performance in voice broking and, to a lesser extent, electronic broking. The investment in new business areas, which are initially less productive than established businesses, together with the impact of acquiring businesses in sectors with higher payout ratios have resulted in staff costs as a percentage of revenue rising from 56% to 59% and, while the Group continues to focus on reducing these costs, ongoing investment is likely to see these levels remain for the foreseeable future.

The Group estimates that approximately 50% of its cost base varies with revenue which is in line with the prior year.

The Group’s operating profit* margin for the year ended 31 March 2009 was 23%, down 2% on the prior year mainly as a result of lower margins reflecting the start up nature of new initiatives and the investment businesses, as well as integration costs associated with acquisitions.

The electronic division continued to perform strongly with revenue up 19% on the prior year and operating profit* margin maintained at 39% as strong post-trade performance offset flat electronic brokerage revenue.

The operating profit* margin of the voice business declined from 20% to 17% primarily as a result of the aforementioned investment in new initiatives with the slowdown in North American and Asia Pacific markets offset by a strong performance in EMEA. Through the combination of the implementation of the cost saving initiatives mentioned above and the anticipated benefit from new initiatives, we expect voice margins to improve on the current position over time. However, a combination of competitive pressures and the need for continued investment will limit our ability to significantly improve voice margins in the near term.

The Group has not recognised any exceptional items in the period, however integration and reorganisation costs of £17 million have been taken through operating profit*. The integration costs relate to the Link and Capital acquisitions, rationalisation of surplus property assets and the reorganisation costs required to deliver the annual cost savings referred to above.

During the prior year, the Group incurred net exceptional costs of £11 million, as discussed further in note 5 to the financial statements, and a related net tax credit of £4 million was also recognised in respect of these items.

Since adopting IFRS on 1 April 2004, the Group has accounted for acquisitions under IFRS3 at fair value and has created a number of additional assets, such as customer relationships, on consolidation. These assets have a finite life and generally have no base tax cost.

Following a review of the accounting treatment adopted for recent acquisitions, the Group has determined that additional deferred tax liabilities should have been recognised in respect of the temporary differences arising on certain intangible assets and as such has made a prior-year adjustment to recognise this. The consequence of recognising such deferred tax liabilities is to recognise goodwill of an equivalent amount. Further details of the prior-year adjustment, which has no impact on the Group’s cash flow, are contained in note 1(a) to the financial statements.

The overall objective continues to be to plan and manage the tax affairs of the Group efficiently within the various local tax jurisdictions of the world so as to achieve the lowest tax cash cost consistent with compliance with local tax regulations.

The Group’s effective tax rate, excluding amortisation and impairment of intangibles arising on consolidation and exceptional items, has reduced to 34% (2008 – 35%) primarily as a result of a higher percentage of the Group’s voice profit being generated in the UK where Corporation Tax rates have fallen from 30% to 28%.

A tax credit of £22 million (2008 – £16 million as restated) has been recognised in the income statement column entitled “amortisation and impairment of intangibles arising on consolidation” to reflect the impact on deferred tax of amortising intangible assets.

The Group’s tax charge is affected by the varying tax rates in different jurisdictions applied to taxable profits and the mix of those profits, by the rules impacting deductibility of certain costs, such as finance costs, and by the rules relating to double taxation relief. The Group continues to take a prudent approach to the management of its tax affairs and provisions are set to cover any tax exposures the Group may have.

We continue to believe that the most appropriate EPS measurement ratio for the Group is adjusted basic EPS, which better reflects the Group’s underlying cash earnings. Adjusted basic EPS excludes amortisation and impairment of intangibles arising on consolidation and exceptional items. The calculation of EPS is set out in note 12 to the financial statements.

Adjusted EPS increased by 9% to 34.1p. The Group’s basic EPS increased from 26.4p (restated) to 27.6p.

Subject to shareholder approval, a final dividend of 12.35p is proposed. This compares to 11.95p in the prior year and, when taken in conjunction with the interim dividend of 4.7p per share, results in a full-year dividend of 17.05p, up 9% on the prior year.

Dividend cover at two times adjusted basic EPS is consistent with the past two years and reflects the board’s desire to balance distributions to shareholders against the wider capital demands of the Group.

In order to give shareholders greater flexibility and the opportunity to elect to receive new ordinary shares in ICAP, we will be seeking authority at the annual general meeting to introduce a scrip dividend scheme. The scrip dividend scheme gives shareholders the opportunity to elect to receive a share alternative to any cash dividend declared by the Company including this year’s final dividend.

Interim dividends are calculated as 30% of the previous year’s full-year dividend. This approach will continue for the 2009/10 financial year.

The Group’s consolidated cash flow statement is set out in the financial statements.

The table below demonstrates the strong cash generative nature of the Group’s business, where free cash flow once again exceeded the Group’s post-tax profit.

Free cash flow increased from £232 million to £296 million of which £106 million was distributed to shareholders via dividends and £77 million utilised to finance a combination of small bolt-on acquisitions and deferred consideration arising from previous acquisitions, principally Reset.

While the Group’s low risk business model does not involve it in taking proprietary risk positions, its trading subsidiaries are required to hold cash balances of approximately £360 million to meet a combination of local regulatory capital rules, clearing house deposits and other commercial requirements including margin calls which arise through the provision in certain markets of clearing services to brokerage clients. These local cash balances have increased by £100 million since 2008 primarily as a result of the impact of weaker sterling on the translation of the balances and the acquisition of the Link business in the UK, North America and Asia.

Net assets increased by £284 million during the year and, as at 31 March 2009, were £1,140 million, primarily as a result of the effect of FX and retained profit.

Intangible assets arising on consolidation

The Group accounts for those assets and liabilities which arise on acquisition at fair value and recognises goodwill and other intangibles assets on consolidation. At 31 March 2009, intangible assets arising on consolidation stood at £1,404 million, up £445 million on the prior year as a result of the amortisation charge related to those assets with a finite useful life, such as customer relationships, being more than offset by the assets arising on the acquisition of Link and revaluation of dollar denominated assets, principally EBS and Reset.

The Group is required to consider the carrying value of these assets on an annual basis against their value in use and, if appropriate, to impair the carrying value. Details of the approach adopted to review the assets are set out in note 14 to the financial statements and resulted in a further £7 million impairment to the carrying value of First Brokers (2008 – £8 million).

Matched principal gross-up

Certain Group companies are involved as a matched principal in the process of broking securities between third parties. Such trades are complete only when both sides of the deal are settled and so the Group is exposed to risk in the event that one side of the transaction remains unsettled. Substantially all the transactions settle within a short period of time and, as such, the settlement risk is considered to be minimal.

All amounts due to and payable by counterparties in respect of matched principal business are shown gross, except where a legally enforceable netting agreement exists and the asset and liability are either settled net or simultaneously. At 31 March 2009 matched principal business resulted in the balance sheet being grossed up by £30.4 billion.

Contingent deferred consideration

A number of the Group’s recent acquisitions have been structured to include an element of deferred consideration which is contingent on the business performance. These arrangements take a variety of forms and may involve part of the purchase consideration being deferred and linked to future performance or the vendors retaining a minority interest which they may have the right to put and ICAP call after a pre-agreed period.

Overall, the objective of these arrangements is to reduce the risk inherent in acquiring smaller owner-managed businesses and to align the vendors, many of whom remain with ICAP, to both integrate and develop the business further. At 31 March 2009, the present value of these obligations was £46 million down £4 million on 2008 principally as a result of payments made to acquire Reset.

Further details of these arrangements are set out in note 13 of the financial statements.

Net debt and cash

At 31 March 2009, the Group had net debt of £126 million up £67 million on the prior year as a result of the borrowings to finance the acquisition of Link being partially offset by strong cash generation in the year. Further details of the Group’s net debt, cash and cash equivalent and borrowings are set out in notes 32(c), 32(b) and 21 respectively of the financial statements.

The recent turbulence in global financial markets, while positively impacting the Group’s business, has resulted in an overall contraction in the number of lenders servicing the non-bank financial sectors, leading to borrowers struggling, even at significantly higher spreads, to diversify their sources of finance and to maintain or increase the quantum.

While not immune from this wider trend, through a combination of leveraging strong existing lender relationships and demonstrable resilience to wider market shocks, the Group has increased the quantum of its credit facilities and also extended the tenor.

In April 2008, the Group raised £150 million of new debt from The Royal Bank of Scotland through a 364-day term loan to finance the acquisition of Link and, in May 2008, entered into a £75 million 364-day revolving credit facility with Lloyds TSB Bank plc to provide incremental headroom. The tenor of both of these facilities was extended in late 2008 to January 2011 and June 2010 respectively, with the result that ICAP ended the financial year with its debt portfolio having an average maturity in excess of two years.

To provide protection against unexpected events the Group has traditionally maintained minimum core liquidity, in the form of cash and undrawn debt facilities, of £75 million, and while the Group has never accessed this liquidity pool, the combination of more volatile markets, increased uncertainty surrounding the impact of volatility on clearers’ margin requirements and tightening liquidity supply, prompted the Group to increase headroom to £150 million in May 2008 through the addition of a Lloyds TSB Bank plc facility. The headroom facility remained undrawn throughout the year. At 31 March 2009, the Group had committed headroom under its core credit facilities of £336 million (2008 – £192 million).

The Group’s strategy remains to diversify its sources of debt when market conditions improve and, through a combination of the launch of a Global Medium Term Note Programme and a European Commercial Paper Programme, investment grade ratings from Fitch Ratings Limited and Moody’s Investor Services Inc and a series of investor meetings, ICAP believes that it is well positioned to react quickly to market opportunities.

ICAP is an international business which provides brokerage, information and post-trade services in a wide range of products to professional counterparties. The business is subject to consolidated supervision by the FSA under the terms of the CRD.

In March 2007, ICAP obtained a waiver from the consolidated capital adequacy tests which have the effect of excluding goodwill from the capital computation and, in so doing, allows the Group to undertake acquisitions using debt rather than equity finance. The terms of the waiver, which runs until the end of March 2012, prohibits the Group from undertaking proprietary trading activities.

The Group’s Pillar 1 regulatory capital surplus calculated in accordance with the waiver is relatively stable and at the year end was in excess of £700 million. While higher levels of market volatility have resulted in increased demand for the Group’s brokerage and post-trade services, the fact that much of this incremental business has occurred in markets which operate on a name give-up basis or are cleared through a central counterparty has had limited impact on the Group’s capital resource requirement and, as such, absent a material acquisition or change in the basis of computation, existing capital resources are viewed as sufficient to both operate and grow the business.

During the past year the Group’s total cost base was £1,240 million of which approximately 76% was represented by staff, 8% information systems and communications and 16% other costs including premises, travel, entertainment and clearing.

The Group places reliance on a number of key suppliers to effectively carry out its business and has put in place procedures to ensure that purchasing decisions balance cost against other factors including service quality, global reach and resilience.

The success of ICAP’s voice brokerage business is reliant on its ability to attract and retain highly qualified staff. A number of legal arrangements including rolling contracts and non-compete arrangements are employed to mitigate the risk of key producers being lost to competitors.

Information systems and communications are key to the delivery of both voice and electronic products and in this area, the Group seeks to ensure that its systems have full redundancy and are capable of operation from business continuity sites.

The settlement of matched principal and exchange traded businesses requires access to clearing houses either directly or through third party providers of clearing and settlement services. In North America the Group is a member of the FICC and NSCC through which it clears US Treasury products, agency, mortgage and equity trades for its client base. In Europe and Asia Pacific, with the exception of base metal clearing on LCH. Clearnet Group Limited, the majority of the Group’s clearing activities are outsourced to a third party where ICAP seeks to partner with one of the leading clearing providers in each market.

As more fully described in note 21, the Group relies on a small number of international banks to provide it with access to liquidity, of which approximately 53% of its committed credit facilities is provided by The Royal Bank of Scotland and Lloyds Banking Group.

On 8 April 2009, the Group paid £14 million of deferred consideration to the former shareholders in Link and expects to make a final payment to be determined by the financial results of Link for the year ending 31 March 2010.

On 23 March 2009, the minority shareholder of Reset exercised its option to sell its 15% stake of the Reset business to the Group for a total consideration of up to $43 million of which $41 million was paid in April 2009.