Treasury is tasked with raising finance for the Group, managing the financial risks arising from underlying operations and managing the Group’s cash resources. All these activities are carried out under defined policies, procedures and limits.
The Board reviews and agrees the overall treasury policies and procedures, delegating appropriate authority to the Finance Director, the Treasury function and the Boards of the central finance companies. The policies include a set of financing principles including the monitoring of credit ratings, interest cover and liquidity. These provide a framework within which the Group’s capital base is managed and, in particular, the policies on dividends and share buy-back are decided. The Finance Director chairs the Boards of the major central finance companies. Any significant departure from agreed policies is subject to the prior approval of the Board.
Clear parameters have been established, including levels of authority, on the type and use of financial instruments to manage the financial risks facing the Group. Such instruments are only used if they relate to an underlying exposure; speculative transactions are expressly forbidden under the Group’s treasury policy. The Group’s treasury position is monitored by the Group Treasury Committee, which meets regularly throughout the year and is chaired by the Finance Director. Regular reports are provided to senior management, and treasury operations are subject to periodic independent reviews and audits, both internal and external.
One of the principal responsibilities of Treasury is to manage the financial risk arising from the Group’s underlying operations. Specifically, Treasury manages, within an overall policy framework, the Group’s exposure to funding and liquidity, interest rate, foreign exchange and counterparty risks. Derivative contracts are only entered into to facilitate the management of these risks.
During 2006, the Group issued three bonds (€525 million maturing in 2010, €600 million maturing in 2014 and £325 million maturing in 2016) and the proceeds were used to refinance maturing bond issues. In 2007, €800 million of €1.7 billion bonds with a maturity of February 2009 were replaced by €1 billion bonds with a maturity of 2017. In March 2007, the Group’s central banking facility of £1.75 billion was extended on existing terms under a one year extension option, with final maturity dates between March 2011 and March 2012, and remains undrawn as at 31 December 2007.
It is the policy of the Group to maximise financial flexibility and minimise refinancing risk by issuing debt with a range of maturities, generally matching the projected cash flows of the Group and obtaining this financing from a wide range of providers. The Group has a target average centrally managed debt maturity of 5 years with no more than 20 per cent of centrally managed debt maturing in a single year. As at 31 December 2007, the average centrally managed debt maturity was 5.4 years and the highest proportion of centrally managed debt maturing in a single year was under 17 per cent.
The Group utilises cash pooling and zero balancing bank account structures in addition to inter-company loans and borrowings to ensure that there is the maximum mobilisation of cash within the Group. The amount of debt issued by the Group is determined by forecasting the net debt requirement after the mobilisation of cash.
The Group continues to target investment-grade credit ratings; as at 31 December 2007 the ratings from Moody’s and S&P were Baa1/BBB+ (2006: Baa1/BBB+). The strength of the ratings has underpinned the debt issuance during 2006 and 2007 and, despite the impact of the turbulence in financial markets, the Group is confident of its ability to successfully access the debt capital markets.
Subsidiary companies are funded by share capital and retained earnings, loans from the central finance companies on commercial terms, or through local borrowings by the subsidiaries in appropriate currencies. All contractual borrowing covenants have been met and none of them are expected to inhibit the Group’s operations or funding plans.
There were a number of changes in the Group in 2007 and 2006 as described under exceptional items, while developments since 31 December 2007 are described in note 31.
In addition, on 31 May 2006, the Group’s associate, Reynolds American, completed the acquisition of Conwood, the second largest manufacturer of smokeless tobacco products in the US, for US$3.5 billion. The acquisition was funded principally with debt, and the fair value of assets acquired and liabilities assumed was US$4.1 billion and US$0.6 billion respectively.
From August 2006, the Group purchased minority interests in its subsidiary in Chile for a cost of £91 million, raising the Group shareholding from 70.4 per cent to 96.6 per cent. In the year ended 31 December 2006, the goodwill arising on this transaction was £80 million and the minority interests in Group equity were reduced by £11 million.
Share buy-back programme
The Group initiated an on-market share buy-back programme at the end of February 2003. During the year to 31 December 2007, 45 million shares were bought back at a cost of £750 million (2006: 35 million shares at a cost of £500 million). This brought the total of the share buy-back programme to 291 million shares at a cost of £2,942 million and an average share price of £10.11.
From 1 January 2005, the Group has reported under International Financial Reporting Standards (IFRS) and, generally, the move to IFRS has made the reporting of performance more complex.
As regards 2007, the changes in IFRS have not had a material impact on the Group’s results. The main change in 2007 was the implementation of IFRS7 on disclosures for financial instruments. This did not affect the measurement of the Group’s results but has required some changes and additions to the financial statements in describing the financial instruments we have in our business. However, the next few years are likely to see more changes in our financial statements following the relatively small changes in 2006 and 2007.