Notes to the financial statements

Classification of financial assets as at 31 March 2008

Financial assets can be reconciled to the balance sheet as follows:

Prepayments and certain items included within other receivables are not defined as financial assets under IAS39.

Assets classified as fair value through the income statement in accordance with the accounting policy in note 2(g) have been analysed in the table above as held for trading, hedging instruments and designated as fair value.

As at 31 March 2009 and 31 March 2008, the fair values of financial liabilities, with the exception of long-term borrowings, are not materially different from their book values.

Classification of financial liabilities as at 31 March 2009

Classification of financial liabilities as at 31 March 2008

Financial liabilities can be reconciled to the balance sheet as follows:

Taxes payable, deferred income and certain provisions are not classified as financial liabilities under IAS39.

(b) Credit risk

The Group is exposed to credit risk in the event of non-performance by counterparties in respect of its agency, matched principal, exchange trades and corporate treasury operations.

The risk in respect of the agency business is limited to the collection of agency commission and is controlled by the establishment and monitoring of credit limits for individual clients. The exposure to credit loss is limited to the carrying value of the receivable. Concentration is limited since the customer base is both large and unrelated. No significant concentrations of risk existed at any time during the year.

The matched principal business involves the Group acting as a counterparty on trades which may involve one or more financial instruments and/or counterparties. The Group manages its credit risk in respect of these transactions by having policies and procedures in place to ensure that the risks inherent in all trades are matched and that appropriate credit limits have been set and are monitored at entity, parent and country level to restrict the exposure to potential loss, transacting on a delivery versus payment basis and settling the majority of trades through a central counterparty.

The credit risk on cash and cash equivalents and derivative financial instruments is limited by the Group’s policy of requiring its corporate treasury transactions to be undertaken with financial institutions which have been approved by the group risk committee and which are investment grade rated or better by one or more recognised credit rating agencies. There were no significant concentrations of risk at the year end.

Trade receivables (matched principal trade receivables, deposits paid for securities borrowed and other trade receivables) consist of a large number of customers. The Group does not have any significant credit risk exposure to any single counterparty. The Group’s counterparty risk does not exceed 15% of Group capital at any time.

At least 90% of the Group’s counterparty risk is with institutions which have an external credit rating of investment grade or better (BBB-). The remaining counterparties are closely monitored and have strict trading limits.

The maximum exposure to credit risk for the Group is represented by the total fair value of the financial assets plus other off-balance sheet items as disclosed below:

The Group holds cash deposits from a number of counterparties to guarantee their trading lines with the Group. As at 31 March 2009 this amounted to £26m (2008 – £6m). The Group’s cash balance includes £60m which is collateral placed with exchanges and other bodies to facilitate the Group’s trading activities.

Collateral pledged and received as a result of the stock lending business is disclosed in trade and other receivables and trade and other payables (notes 18 and 19).

(c) Liquidity risk management

Through the finance committee, the board regularly reviews the liquidity demands of the Group and each of its principal subsidiaries with the objective of ensuring that each has access to appropriate forms of liquidity to meet their forecast regulatory, commercial and settlement requirements and that the Group in totality has sufficient headroom to provide constant access, even in periods of market turmoil, to an appropriate level of cash, other forms of marketable securities and committed funding lines to enable it to finance its ongoing operations, proposed acquisitions and other reasonable unanticipated events on cost-effective and attractive terms.

At 31 March 2009, the Group had gross debt of £559m (2008 – £443m) and cash and cash equivalents of £433m (2008 – £384m). Approximately £360m of the Group’s cash balance is employed by the Group’s trading subsidiaries to meet local regulatory, commercial, settlement and short-term working capital requirements, up £100m on 2008 as a result of acquiring the Link business in the UK, North America and Asia, and the impact of weaker sterling on the translation of the balances.

The Group invests its cash balances in a range of instruments including money market deposits, AAA liquidity funds and government bonds with the objective of optimising the return, while having regard to security, liquidity and counterparty risk. With the exception of small, local cash management balances, surplus cash is invested with strong investment grade institutions which have an equivalent credit rating of A or better. Counterparty limits applied are reviewed by the finance and group risk committees and, during the recent financial market turmoil, a number of changes have been made to reduce exposure to institutions perceived by the Group as higher risk.

Although the Group does not undertake proprietary trading, it is subject to the margin requirements of the clearing houses or exchanges used to settle certain client trades. The most significant margin requirements arise in North America where, as part of its brokerage business, it provides clearing services to clients and is required to deposit margin with the FICC and NSCC. During the last three quarters of 2008, these deposits averaged $54m peaking at $156m in September when Lehman Brothers failed but, as a result of management’s actions to increase the number of trades capable of being netted together with changes to the margin formulae introduced by the FICC in November 2008, have fallen to $38m in the first quarter of 2009. The deposits are met through a combination of internal cash resources and the $94m swingline facility (note 21). The Group has no other material margin requirements on a routine basis.

To provide protection against unexpected events, the Group has traditionally maintained minimum core liquidity, in the form of cash and undrawn debt facilities, of £75m 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 £150m in May 2008 through the addition of a £75m revolving credit facility (note 21). The headroom remained undrawn throughout the year. At 31 March 2009, the Group had committed headroom under its core credit facilities of £336m (2008 – £192m).

The Group is currently financed from a mix of bank facilities and subordinated loan notes. Over time, the Group plans to diversify its sources of finance into the public and private debt markets.

The table below shows the maturity profile of the Group’s financial liabilities based on the contractual amount payable on the date of repayment:

Maturity of financial liabilities as at 31 March 2009

Maturity of financial liabilities as at 31 March 2008

The total financial liabilities payable is higher than the amount recognised in trade and other payables as the gross amounts payable have been disclosed, rather than the net present value used in determining trade and other payables.

(d) Currency risk

The Group presents its consolidated financial statements in sterling and conducts business in a number of other currencies principally the dollar and euro. Consequently the Group is exposed to foreign exchange risk due to exchange rate movements which affect the Group’s transactional revenues and the translation of the earnings and net assets of its non-sterling operations.

(i) Transactional exposures

The Group’s policy is for subsidiaries with sterling functional currency to hedge their two main transactional exposures, which are the dollar and the euro, through a combination of forward FX contracts and options for up to two years forward. A maximum of 100% of the forecast exposure is hedged for the first 12 months, 75% for the following six months and 25% thereafter. The Group’s other transactional exposures are continually monitored and, where deemed appropriate, hedged for a period of 12 months forward.

The Group aims to achieve hedge accounting wherever possible with any gain or loss on the hedge recognised in equity to the extent it is highly effective and recycled to the income statement at the same time as the underlying hedged transaction affects the income statement. Any ineffectiveness is taken to the income statement in accordance with IAS39. Where hedge accounting is not achieved all fair value gains or losses are immediately recognised in the income statement.

The Group has contracts in place, designated as cash flow hedges under IAS39 where appropriate, covering approximately 85% of its forecast dollar transactional exposure for the year to 31 March 2010 at $1.64 and 25% of its forecast exposure for the year ended 31 March 2011 at $1.51. Approximately 95% of the Group’s euro exposure has been hedged for the year to 31 March 2010 at €1.27 and 34% of its exposure to 31 March 2011 at €1.16.

An analysis of the Group’s hedging instruments is given below.

(ii) Balance sheet translational exposures

The Group is exposed to balance sheet translational exposures at the local entity level where the local balance sheet may contain monetary assets or liabilities denominated in a currency other than the entity’s functional currency. It is the Group’s policy to hedge up to 100% of these exposures in individual entities using a mix of foreign currency swaps and forward FX contracts and these are designated as fair value hedges under IAS39 where appropriate.

Balance sheet translational exposures also arise on consolidation on the retranslation of the balance sheet of non-sterling operations into sterling, the Group’s presentational currency. The only significant exposure is to the dollar. These exposures are viewed as short term in nature and hedging could expose the Group to significant net cash flows and therefore the Group’s policy is not to actively hedge these exposures. However, in order to mitigate this exposure the Group has designated the subordinated loan notes as a hedging instrument against the underlying exposure. Any gains or losses on revaluation are recognised directly in equity to offset the revaluation of the net investment. As at 31 March 2009 this exposure was $0.8bn (2008 – $1.3bn) including intangible assets arising on consolidation, but before $0.2bn of hedging (2008 – $0.3bn).

During the year ended 31 March 2009, with respect to sterling, the dollar appreciated by 28% and the euro appreciated by 14%. In accordance with IAS21 “The Effects of Changes in Foreign Exchange Rates”, the resulting translational exchange difference is included within the £221m exchange gain taken directly to reserves, as disclosed in the consolidated statement of recognised income and expense.

(iii) Earnings translation exposures

The Group does not hedge the translation of those profits or losses earned by its non-sterling operations.

The table below shows the anticipated impact on the Group’s 2010 results of a 10 cent movement in the dollar and euro in terms of transactional and translational exposure before any 2009/10 hedging activity.

The principal exchange rates which affect the Group, expressed in currency per £, are shown below:

Derivative financial instruments

It is the Group’s policy to hedge a proportion of its transactional dollar and euro exposures with forward FX contracts. Where these are designated and documented as hedging instruments in the context of IAS39 and are demonstrated to be effective, mark to market gains and losses are recognised directly in equity and transferred to the income statement on recognition of the underlying item being hedged.

No amounts (2008 – £nil) were recognised in the income statement in the year as a result of ineffective hedges.

The fair value of financial instruments traded in active markets is based on quoted market prices on the balance sheet date.

(e) Interest rate risk

The Group has an exposure to fluctuations in interest rates on both its cash positions and borrowings which it manages through a combination of sterling and dollar debt drawn on fixed and floating rate terms. The Group’s objective is to minimise interest cost and the impact of interest volatility on the Group’s income statement. In addition to debt, the Group’s treasury policies also permit the use of derivatives including interest rate swaps, interest rate options, forward rate agreements and cross currency swaps to meet these objectives.

At 31 March 2009, the Group had £115m of cash and £425m of floating rate debt denominated in sterling, £235m of cash and £135m of fixed rate debt denominated in dollars (or currencies closely related to the dollar) and £83m of cash denominated in other currencies. A 100 basis-point parallel movement in sterling LIBOR and LIBID rates would impact profit after tax and equity by £3m with a similar movement in dollar rates impacting profit after tax and equity by £2m. In the event that LIBOR and LIBID rates diverge, each 100 basis-point movement in sterling and dollar rates will impact profit after tax and equity by £2m and £2m respectively.

The table below gives an indication of the interest rate profile of the financial assets of the Group:

Fixed interest rate financial assets comprise investments in certificates of deposit, treasury bills and corporate bonds and had an effective interest rate of 4% for the year ended 31 March 2009 (2008 – 3%) for a weighted average period of one year.

Floating rate financial assets bear interest based on relevant national LIBID or equivalents with maturity of less than one year.

The table below gives an indication of the interest rate profile of the financial liabilities of the Group:

The details of the interest rate bearing financial liabilities are disclosed in note 21.

(f) Market price risk

The Group’s exposure to market price risk mainly arises through counterparties to matched principal and exchange traded transactions failing to fulfil their obligations or through trade mismatches and other errors. The Group is also exposed to market price risk in respect of its available-for-sale investments.

In matched principal transactions, the Group acts as an intermediary by serving as counterparty for identified buyers and sellers in matching, in whole or in part, reciprocal back-to-back trades. In order to facilitate customer transactions and provide liquidity, however, the Group may participate in certain marketplaces by posting quotations. On occasion, the act of posting quotations in pursuit of customer orders can result in the Group becoming principal to unmatched trades.

In exchange traded transactions, the Group executes the trade as principal and then novates the contract to its client. A failure by the client to accept the trade would result in the Group becoming exposed to market price risk.

The risk the Group faces in these situations is restricted to short-term price movements in the underlying instrument temporarily held by the Group and movements in FX rates. Any such market price risk arising is identified, monitored and reported to senior management on a daily basis and to the group risk committee. Policies and procedures are in place to reduce the likelihood of such trade mismatches and, in the event that they arise, the Group’s policy is to liquidate or hedge and liquidate these principal positions as soon as reasonably practicable.

The Group has limited exposure to market price risk on its available-for-sale financial assets as the majority of the Group’s equity investments are not listed. The Group estimates that its sensitivity to movements in market price is immaterial.

Company

The Company’s approach to risk is governed by the overall Group policies on risk and the limited activities of the Company limit its exposure to risk.

(a) Financial assets and liabilities

All of the Company’s financial assets are classified as loans and receivables and the financial liabilities as held at amortised cost. The fair value of these assets and liabilities is not materially different from their book values.

(b) Credit risk

The Company is exposed to credit risk in the event of non-performance by counterparties. This risk is considered minimal as all counterparties are Group companies and the risk of non-payment is viewed as low.

(c) Liquidity risk management

The Company seeks to ensure that it has constant access to an appropriate level of cash and funding to enable it to fund its ongoing operations, proposed acquisitions and other reasonable unanticipated events on cost effective and attractive terms.

If the Company has any cash, it is loaned intra-group for further investment.

All of the Company’s financial liabilities are payable within one month, with the exception of subordinated loans of £140m, which have a maturity of more than five years. All of the Company’ s counterparties are Group companies.

(d) Currency risk

(i) Transactional exposures

The Company has an immaterial exposure to transactional exposure.

(ii) Balance sheet translational exposures

The Company is exposed to balance sheet translational exposures where the balance sheet contains assets or liabilities denominated in a currency other than sterling. While it is the Group’s policy to hedge up to 100% of these exposures at Group level, at Company level these exposures can affect the Company’s profit after tax.

The Company has net financial liabilities of £14m (2008 – £41m) denominated in dollars.

The Company estimates that a 10 cent movement in the dollar exchange rate would result in a translational impact of £0.5m on the profit after tax of the Company.

(e) Interest rate risk

The Company is no longer exposed to interest rate movements as a result of the cash and debt formerly held by the Company being simplified or novated to a subsidiary company. It is estimated that the impact of a 100 basis-point movement in interest rates would have no effect on the profit after tax of the Company.

As at 31 March 2009 the Company’s financial assets are all non-interest bearing (2008 restated (note 1(a)) £317m non-interest bearing and £5m at fixed interest rates).

The table below gives an indication of the interest rate profile of the financial liabilities of the Company:

(f) Market price risk

The Company is not exposed to market price risk as it holds no listed investments.