25. Financial risk management and derivative financial assets/liabilities

The Group is exposed in varying degrees to a variety of financial instrument related risks. The Board has approved and monitors the risk management processes, inclusive of documented treasury policies, counterparty limits, controlling and reporting structures. The risk management processes of the Group's independently listed subsidiaries are in line with the Group's own policy.

The types of risk exposure, the way in which such exposure is managed and quantification of the level of exposure in the balance sheet at year end is provided as follows (subcategorised into credit risk, liquidity risk and market risk).

Credit risk

The Group's principal financial assets are bank balances and cash, trade and other receivables and investments. The Group's credit risk is primarily attributable to its trade receivables however it also arises on liquid funds and derivative financial instruments. The Group's maximum exposure to credit risk at 31 December 2007 is $8,205 million (2006: $8,937 million).

The Group limits exposure to credit risk on liquid funds and derivative financial instruments through adherence to a policy of:

  • Acceptable minimum counterparty credit ratings assigned by international credit-rating agencies (including long term ratings of A- (Standard & Poor's), A3 (Moody's) or A- (Fitch) or better).
  • Daily counterparty settlement limits (which are not to exceed three times the credit limit for an individual bank).
  • Exposure diversification (the aggregate group exposure to key relationship counterparties can not exceed 5% of the counterparty's shareholders' equity).

Given the diverse nature of the Group's operations (both in relation to commodity markets and geographically) it does not have significant concentration of credit risk in respect of trade receivables, with exposure spread over a large number of customers.

An allowance for impairment for trade receivables is made where there is an identified loss event, which based on previous experience, is evidence of a reduction in the recoverability of the cash flows. Detail of the credit quality of trade receivables and the associated provision for impairment is disclosed in note 21.

Liquidity risk

The Group ensures that there are sufficient committed loan facilities in order to meet short term business requirements, after taking into account cash flows from operations and its holding of cash and cash equivalents, as well as any group distribution restrictions that exist.

Non-wholly owned subsidiaries in general will arrange and maintain their own financing and funding requirements. In most cases the financing will be non-recourse to the Group. In addition, certain projects are financed by means of limited recourse project finance, if appropriate.

The expected undiscounted cash flow of the Group's financial liabilities (including associated derivatives), by remaining contractual maturity, at the balance sheet date is as follows:

  Within 1 year 1-2 years
US$ million Fixed interest Floating interest Capital repayment Fixed interest Floating interest Capital repayment
31 December 2007
Non-derivative financial liabilities (144) (188) (9,643) (87) (95) (440)
Gross settled derivatives            
Receive leg 7
Pay leg (1)
Net settled derivatives 102 (118) 291 52 (53) (9)
  (42) (306) (9,346) (35) (148) (449)
31 December 2006
Non-derivative financial liabilities (145) (170) (6,962) (142) (112) (1,655)
Gross settled derivatives            
Receive leg 4
Pay leg (6)
Net settled derivatives 120 (147) (6) 120 (118) 145
  (25) (317) (6,970) (22) (230) (1,510)
  2-5 years +5 years
US$ million Fixed interest Floating interest Capital repayment Fixed interest Floating interest Capital repayment
31 December 2007
Non-derivative financial liabilities (177) (220) (1,158) (47) (171) (776)
Gross settled derivatives            
Receive leg
Pay leg
Net settled derivatives 130 (133) 112 35 (35)
  (47) (353) (1,046) (12) (206) (776)
31 December 2006
Non-derivative financial liabilities (225) (167) (1,809) (117) (51) (858)
Gross settled derivatives            
Receive leg
Pay leg
Net settled derivatives 171 (177) 78 68 (66)
  (54) (344) (1,731) (49) (117) (858)

The Group had the following undrawn committed borrowing facilities at 31 December:

US$ million 2007 2006
Expiry date    
In one year or less 2,877 3,345
In more than one year but not more than two years 322 80
In more than two years but not more than five years 3,865 2,408
In more than five years 119
  7,064 5,952

In addition, the Group had the following Commercial Paper programmes:

  • A $2 billion Canadian Commercial Paper Programme on which total drawings of $805 million were made at 31 December 2007 (2006: nil).
  • A $2 billion European Commercial Paper Programme established in October 2004. Drawings of $1,090 million were made at 31 December 2007 (2006: $10 million).

Subsequent to year end the Group also secured access to a $10 billion borrowing facility.

Market risk

This is the risk that financial instrument fair values will fluctuate owing to changes in market prices. The significant market risks to which the Group is exposed are foreign exchange risk, interest rate risk and commodity price risk. These are discussed further below:

Foreign exchange risk

As a global group, the Group is exposed to many currencies principally as a result of non-US dollar operating costs incurred by US dollar functional currency companies and to a lesser extent, from non-US dollar revenues. The Group’s policy is generally not to hedge such exposures as hedging is not deemed appropriate given the diversified nature of the Group though exceptions can be approved by the Board.

In addition, currency exposures exist in respect of non-US dollar approved capital expenditure projects. The Group’s policy is that such exposure can be hedged at management’s discretion, within certain pre-defined limits (otherwise Board approval is required).

The exposure of the Group’s financial assets and liabilities (excluding intra-group loan balances) to currency risk is as follows:

US$ million
Currency
Financial assets (excluding derivatives) Impact of currency derivatives(1) Derivative assets Total financial asset exposure to currency risk
At 31 December 2007
US$(2) 4,260 (99) 465 4,626
Rand 4,414 88 17 4,519
Sterling 839 839
Euro 301 301
Canadian $ 75 2 53 130
Australian $ 221 (3) 218
Other currencies 1,390 12 1,402
Total financial assets 11,500 535 12,035
 
At 31 December 2006
US$(2) 3,321 (53) 254 3,522
Rand 3,032 8 15 3,055
Sterling 1,079 (10) 1,069
Euro 1,058 (49) 4 1,013
Canadian $ 42 (3) 46 85
Australian $ 166 166
Other currencies 1,476 107 10 1,593
Total financial assets 10,174 329 10,503
US$ million
Currency
Financial liabilities (excluding derivatives) Impact of currency derivatives(1) Derivative liabilities Total financial liability exposure to currency risk
At 31 December 2007
US$ (3,261) (2,962) (560) (6,783)
Rand (3,879) (26) (3,905)
Sterling (1,325) 606 (719)
Euro (2,103) 1,886 (217)
Canadian $ (269) 226 (43)
Australian $ (406) (406)
Other currencies (879) 244 (635)
Total financial liabilities (12,122) (586) (12,708)
 
At 31 December 2006
US$ (1,835) (2,178) (508) (4,521)
Rand (3,571) 1 (10) (3,580)
Sterling (1,541) 620 (921)
Euro (2,713) 1,323 (2) (1,392)
Canadian $ (18) (18)
Australian $ (333) (333)
Other currencies (1,223) 234 (989)
Total financial liabilities (11,234) (520) (11,754)

(1) Where currency derivatives are held to manage financial instrument exposures the notional principal amount is ‘reallocated’ to reflect the remaining exposure to the Group.

(2) Of these US$ financial assets, $571 million (2006: $497 million) are subject to South African exchange controls.

Interest rate risk

Fluctuations in interest rates impact on the value of short term investments and financing activities, giving rise to interest rate risk. Exposure to interest rate risk is particularly with reference to changes in US dollar, rand, sterling and euro interest rates.

The Group policy is to borrow funds at floating rates of interest as this is considered to give somewhat of a natural hedge against commodity price movements, given the correlation to economic growth (and industrial activity) which in turn shows a high correlation with commodity price fluctuation. In certain circumstances, the Group uses interest rate swap and option contracts to manage its exposure to interest rate movements on a portion of its existing debt. Also strategic hedging using fixed rate debt may be undertaken from time to time if considered appropriate.

In respect of financial assets, the Group’s policy is to invest cash at floating rates of interest and cash reserves are to be maintained in short term investments (less than one year) in order to maintain liquidity, while achieving a satisfactory return for shareholders.

The exposure of the Group’s financial assets (excluding intra-group loan balances) to interest rate risk is as follows:

  Interest bearing financial assets Non-interest bearing financial assets
US$ million Floating rate financial assets Fixed rate financial assets Equity investments Other non- interest bearing financial assets Total
At 31 December 2007
Financial assets (excluding derivatives)(1) 3,013 864 3,842 3,781 11,500
Derivative assets 1 11 523 535
Financial asset exposure to interest rate risk 3,014 875 3,842 4,304 12,035
 
At 31 December 2006
Financial assets (excluding derivatives)(1) 3,220 459 1,170 5,325 10,174
Derivative assets 1 2 326 329
Financial asset exposure to interest rate risk 3,221 461 1,170 5,651 10,503

(1) At 31 December 2007 and 2006 no interest rate swaps were held in respect of financial asset exposures.

Floating rate financial assets consist mainly of cash and bank term deposits. Interest on floating rate assets is based on the relevant national inter-bank rates. Fixed rate financial assets consist mainly of financial asset investments and cash, and have a weighted average interest rate of 11% (2006: 7%) and are fixed for an average period of four years (2006: seven months). Equity investments are fully liquid and have no maturity period.

The exposure of the Group’s financial liabilities (excluding intra-group loan balances) to interest rate risk is as follows:

US$ million Floating rate financial liabilities Fixed rate financial liabilities Non-interest bearing financial liabilities Total
At 31 December 2007
Financial liabilities (excluding derivatives) (5,425) (2,822) (3,875) (12,122)
Impact of interest rate swaps(1) (2,336) 2,336
Derivative liabilities (45) (541) (586)
Financial liability exposure to interest rate risk (7,806) (486) (4,416) (12,708)
 
At 31 December 2006
Financial liabilities (excluding derivatives) (3,019) (3,168) (5,047) (11,234)
Impact of interest rate swaps(1) (2,402) 2,402
Derivative liabilities (40) (1) (479) (520)
Financial liability exposure to interest rate risk (5,461) (767) (5,526) (11,754)

(1) Where interest rate swaps are held to manage financial instrument exposures the notional principal amount is ‘reallocated’ to reflect the remaining exposure to the Group.

Interest on floating rate instruments is based on the relevant national inter-bank rates. Remaining fixed rate borrowings accrue interest at 8% (2006: 5%) and are at fixed rates for an average period of two years (2006: two years). Average maturity on non-interest bearing instruments is three months (2006: two months).

Commodity price risk

The Group’s earnings are exposed to movements in the prices of the commodities it produces. Commodity price risk can be reduced through the negotiation of long term contracts or through the use of financial derivatives.

In respect of the use of derivative instruments, the Group policy is generally not to hedge price risk, although some hedging may be undertaken for strategic reasons. In such cases, the Group uses forward, spot, deferred and option contracts to hedge the price risk.

The exposure of the Group’s financial assets and liabilities to commodity price risk is as follows:

  Commodity price linked Not linked to commodity price Total
US$ million Subject to price movements Fixed price(2)
At 31 December 2007
Total net financial instruments (excluding derivatives) 325 461 (1,408) (622)
Commodity derivatives (net) (480) (480)
Other derivatives not related to commodity (net) 429 429
Total financial instrument exposure to commodity risk (155) 461 (979) (673)
 
At 31 December 2006
Total net financial instruments (excluding derivatives) 248 521 (1,829) (1,060)
Impact of commodity derivatives(1) (9) 9
Commodity derivatives (net) (423) (1) (424)
Other derivatives not related to commodity (net) 233 233
Total financial instrument exposure to commodity risk (184) 529 (1,596) (1,251)

(1) Where commodity derivatives are held to manage financial instrument exposures the notional principal amount is ‘reallocated’ to reflect the remaining exposure to the Group.

(2) Includes financial instruments whose commodity prices are set annually or via contract negotiations.

Derivatives

In accordance with IAS 32 and IAS 39, the fair value of all derivatives are separately recorded on the balance sheet within other financial assets (derivatives) and other financial liabilities (derivatives). Derivatives that are designated as hedges are classified as current or non-current depending on the maturity of the derivative. Derivatives that are not designated as hedges are classified as current in accordance with IAS 1 even when their actual maturity is expected to be greater than one year.

The Group utilises derivative instruments to manage its market risk exposures as explained above. The Group does not use derivative financial instruments for speculative purposes, however it may choose not to designate certain derivatives as hedges. Such derivatives that are not hedge accounted are classified as non-hedges and fair value movements are recorded in the income statement.

The use of derivative instruments is subject to limits and the positions are regularly monitored and reported to senior management.

Embedded derivatives

Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives when their risks and characteristics are not closely related to those of their host contract and the host contract is not carried at fair value. Embedded derivatives may be designated as a hedge and are accounted for in accordance with the Group’s accounting policy set out in note 1.

Cash flow hedges

In certain cases the Group classifies its forward exchange and commodity price contracts hedging highly probable forecast transactions as cash flow hedges. Where this designation is done, changes in fair value are recognised in equity until the hedged transactions occur, at which time the respective gains or losses are transferred to the income statement (or hedged balance sheet item) in accordance with the Group’s accounting policy set out in note 1.

Fair value hedges

The majority of interest rate swaps (taken out to swap the Group’s fixed rate borrowings to floating rate, in accordance with the treasury policy) have been designated as fair value hedges. The respective carrying values of the hedged debt are adjusted to reflect the fair value of the interest rate risk being hedged. Subsequent changes in the fair value of the hedged risk are offset against fair value changes in the interest rate swap and classified within financing costs, in the income statement.

Non-hedges

The Group may choose not to designate certain derivatives as hedges, for example certain forward contracts that economically hedge forecast commodity transactions and relatively low value or short term derivative contracts where the potential mark to market exposure on the Group’s earnings is not considered material. Where derivatives have not been designated as hedges, fair value changes are recognised in the income statement in accordance with the Group’s accounting policy set out in note 1 and are classified as financing or operating depending on the nature of the associated hedged risk.

Cross currency swaps are also taken out to protect the Group’s non-US dollar debt against future currency movements. The respective carrying values of the hedged debt are translated at the closing exchange rate in accordance with the Group’s accounting policy and as such a natural hedge of the currency risk is achieved.

The fair value of the Group’s open derivative position at 31 December (excluding normal purchase and sale contracts held off-balance sheet), recorded within other financial assets (derivatives) and other financial liabilities (derivatives) is as follows:

  2007 2006
US$ million Asset Liability Asset Liability
Current
Cash flow hedge(1)
Forward foreign currency contracts 2 11 (2)
Forward commodity contracts(2) (304) 2 (162)
Other 11
Fair value hedge
Forward foreign currency contracts 1 (12) 1 (1)
Other 4 (1)
Non-hedge (‘Held for trading’)(3)
Forward foreign currency contracts 31 (25) 14 (2)
Cross currency swaps 404 (10) 242 (19)
Other 86 (150) 55 (29)
Total current derivatives 535 (501) 329 (216)
 
Non-current
Cash flow hedge(1)
Forward commodity contracts(2) (53) (140)
Other(4) (126)
Fair value hedge
Interest rate swaps (32) (38)
Total non-current derivatives (85) (304)

(1) The timing of the expected cash flows associated with these hedges is as follows:

US$ million 2007 2006
Within one year (289) (174)
Greater than one year, less than two years (61) (166)
Greater than two years, less than five years (62)
Greater than five years (181)
  (350) (583)

The periods when these hedges are expected to impact the income statement generally follow the cash flow profile with the exception of hedging associated with capital projects which is included in the capitalised asset value and depreciated over the life of the asset. There are no material capital expenditure related hedges included in the above

(2) Forward commodity contracts include forward copper derivatives taken out to hedge the future prices of sales from Anglo American Norte (formerly Mantos Blancos). The contracted forward price of 116 US cents/lb covers 3,338 tonnes per month for three years starting January 2006. At 31 December 2007 there is one year remaining on the contract which represents 41% of Anglo American Norte cathode sales over the same period.

(3) $160 million (2006: $289 million) of derivative assets and $126 million (2006: $36 million) of derivative liabilities not designated as hedges and that are classified as current in accordance with IAS 1 are due to mature after more than one year.

(4) Other cash flow hedges in 2006 includes a derivative instrument embedded in a long term purchase power agreement which was designated as a hedge against market risk exposures on sales. This relationship was de-designated at the commencement of 2007.

These marked to market valuations are in no way predictive of the future value of the hedged position, nor of the future impact on the profit of the Group. The valuations represent the cost of buying all hedge contracts at the time of valuation, at market prices and rates available at the time.

Normal purchase and normal sale contracts

Commodity based contracts that meet the requirements of IAS 39 in that they are settled through physical delivery of the Group’s production or are used within the production process are classified as normal purchase and normal sale contracts. In accordance with IAS 39 these contracts are not marked to market when they are settled through physical delivery.

Capital risk management

The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and, with cognisance of forecast future market conditions and structuring, to maintain an optimal capital structure to reduce the cost of capital.

In order to manage the short and long term capital structure, the Group adjusts the amount of ordinary dividends paid to shareholders, returns capital to shareholders (via, for example, share buybacks and special dividends), arranges debt to fund new acquisitions and also may sell non-core assets to reduce debt.

The Group monitors capital on the basis of the ratio of net debt to total capital. Net debt is calculated as total borrowings less cash and cash equivalents (excluding derivatives which provide an economic hedge of debt and including the net debt of disposal groups). Total capital is calculated as ‘Net assets’ (as shown in the ‘Consolidated balance sheet’) excluding net debt and investments in associates.

During 2007, the Group’s strategy, which was unchanged from 2006, was to maintain certain credit ratios consistent with long term credit ratings of A2 from Moody’s and A from Standard & Poor’s. Net debt to total capital as at 31 December 2007 was 20.0% (2006: 12.9%). The increase during 2007 resulted primarily from share buybacks and acquisitions, partially offset by strong operating cash flows and asset disposals.

Financial instrument sensitivities

Financial instruments affected by market risk include borrowings, deposits, derivative financial instruments and trade receivables and trade payables. The following analysis, required by IFRS 7, is intended to illustrate the sensitivity of the Group’s financial instruments (as at year end) to changes in market variables, being commodity prices, exchange rates and interest rates.

The sensitivity analysis has been prepared on the basis that the components of net debt, the ratio of fixed to floating interest rates of the debt and derivatives portfolio and the proportion of financial instruments in foreign currencies are all constant and on the basis of the hedge designations in place at 31 December. In addition, the commodity price impact for provisionally priced contracts is based on the amount of trade receivables and trade payables (and the make up thereof) at 31 December. As a consequence, this sensitivity analysis relates to the position as at 31 December.

The following assumptions were made in calculating the sensitivity analysis:

  • All income statement sensitivities also impact equity.
  • The majority of debt and other deposits are carried at amortised cost and therefore carrying value does not change as interest rates move.
  • No sensitivity is provided for accrued interest as accruals are based on pre-agreed interest rates and therefore are not susceptible to further rate movements.
  • Changes in the carrying value of derivatives (from movements in commodity prices and interest rates) designated as cash flow hedges are assumed to be recorded fully within equity on the grounds of materiality.
  • No sensitivity has been calculated on derivatives and related underlying instruments designated into fair value hedge relationships as these are assumed to materially offset one another.
  • All hedge relationships are assumed to be fully effective on the grounds of materiality.
  • Debt with a maturity below one year is floating rate, unless it is a long term fixed rate debt in its final year.
  • Translation of foreign subsidiaries and operations into the Group’s presentation currency have been excluded from the sensitivity.

Using the above assumptions, the following tables show the illustrative effect on the income statement and equity that would result from reasonably possible changes in the relevant commodity price, foreign currency or interest rates:

US$ million Income statement Equity
Commodity price sensitivities
2007
10% increase in the copper price 89 66
5% fall in the copper price (45) (33)
10% increase in the platinum price (8) (8)
15% fall in the platinum price 13 13
5% increase in the coal price (15)
5% fall in the coal price 15
2006
10% fall in the copper price (76) 24
10% increase in the platinum price (4) (4)
10% fall in the platinum price 4 4
Interest rate sensitivities
2007
75 bp fall in US interest rates (2) (2)
50 bp fall in South African interest rates 10 10
75 bp fall in UK interest rates 5 5
2006
25 bp increase in US interest rates 1 1
25 bp fall in US interest rates (1) (1)
50 bp increase in South African interest rates 21 21
50 bp fall in South African interest rates (21) (21)
Foreign currency sensitivities(1)
2007
+5% US$ to rand 18 18
-5% US$ to rand (18) (17)
+5% US$ to Australian dollar (19) (19)
-5% US$ to Australian dollar 23 23
+5% US$ to Brazilian real (46) (46)
-5% US$ to Brazilian real 46 46
+5% US$ to sterling (7) (7)
-5% US$ to sterling 8 8
+5% US$ to Chilean peso 8 8
-5% US$ to Chilean peso (9) (9)
2006
+10% US$ to rand 45 45
-5% US$ to rand (23) (21)
+10% US$ to Australian dollar 7 6
-5% US$ to Australian dollar (2) (3)
+10% US$ to Chilean peso 20 19
-5% US$ to Chilean peso (11) (11)

(1) + represents strengthening of US dollar against respective currency.

The above sensitivities are calculated with reference to a single moment in time and will change due to a number of factors including:

  • fluctuating trade receivable and trade payable balances;
  • derivative instruments and borrowings settled throughout the year;
  • fluctuating cash balances;
  • changes in currency mix; and
  • commercial paper with short term maturities, which is regularly replaced or settled.

As the sensitivities are limited to year end financial instrument balances they do not take account of the Group’s sales and operating costs which are highly sensitive to changes in commodity prices and exchange rates.