Financial Instruments

6 Months Ended

Jun. 30, 2021

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Financial Instruments

Financial instruments

A. Fair values of financial instruments

The Company categorizes its financial assets and liabilities measured at fair value into a three-level hierarchy established by GAAP that prioritizes those inputs to valuation techniques used to measure fair value based on the degree to which they are observable. The three levels of the fair value hierarchy are as follows: Level 1 inputs are quoted prices in active markets for identical assets and liabilities; Level 2 inputs, other than quoted prices included within Level 1, are observable for the asset or liability either directly or indirectly; and Level 3 inputs are not observable in the market.

For non-exchange traded derivatives classified as Level 2, the Company uses standard valuation techniques to calculate fair value. Primary inputs to these techniques include observable market prices (interest, FX, and commodity) and volatility, depending on the type of derivative and nature of the underlying risk. The Company uses inputs and data used by willing market participants when valuing derivatives and considers its own credit default swap spread as well as those of its counterparties in its determination of fair value. All derivatives are classified as Level 2.

The Company’s short-term financial instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and short-term borrowings including commercial paper. The carrying values of short-term financial instruments all approximate their fair values.

The carrying value of the Company’s debt and finance lease liabilities does not approximate their fair value. Their estimated fair value has been determined based on market information, where available, or by discounting future payments of principal and interest at estimated interest rates expected to be available to the Company at period end. All measurements are classified as Level 2. The Company’s debt and finance lease liabilities, including current maturities, with a carrying value of $8,722 million at June 30, 2021 (December 31, 2020 - $8,951 million), had a fair value of $10,756 million (December 31, 2020 - $11,597 million).

B. Financial risk management

FX management

Net investment hedge

The effect of the Company's net investment hedge for the three and six months ended June 30, 2021 was an unrealized FX gain of $86 million and $162 million, respectively (three and six months ended June 30, 2020 - unrealized FX gain of $264 million and unrealized FX loss of $291 million, respectively) recognized in “Other comprehensive income”.

FX forward contracts

During the first six months of 2021, the Company entered into various FX forward contracts totalling a notional U.S. $1.0 billion to fix the FX rate and lock-in a portion of the amount of Canadian dollars it may borrow to finance the U.S. dollar-denominated cash portion of the total consideration that would have been payable pursuant to the Merger Agreement with KCS. The changes in fair value on the FX forward contracts were recorded in "Other expense (income)" on the Company's Interim Consolidated Statements of Income, with the offsetting unrealized losses included in "Accounts payable and accrued liabilities" on the Company's Interim Consolidated Balance Sheets. For the three and six months ended June 30, 2021, the change in fair value of the FX forward contracts was a loss of $17 million.

Interest rate management

Forward starting swaps

During the first six months of 2021, the Company entered into forward starting floating-to-fixed interest rate swap agreements ("forward starting swaps") with terms of up to 30 years, totalling a notional U.S. $2.4 billion to fix the benchmark rate on cash flows associated with highly probable forecasted issuances of long-term notes.

On May 21, 2021, the Merger Agreement with KCS was terminated which resulted in the Company ceasing hedge accounting for the U.S. $2.4 billion of forward starting swaps. However, as the debt issuances are still reasonably possible to occur, fair value changes prior to this determination remain in “Accumulated other comprehensive loss”, net of tax, until the notes are issued. Subsequent to the notes issuance, amounts in “Accumulated other comprehensive loss” will be reclassified to “Net interest expense”. If debts are not issued, a loss of up to $73 million in “Accumulated other comprehensive loss” would be immediately reclassified to “Other expense (income)”. Fair value changes subsequent to May 21, 2021 were recorded within “Other expense (income)" on the Company’s Interim Consolidated Statements of Income.

As at June 30, 2021, the unrealized fair value loss derived from the forward starting swaps of $220 million was included in "Accounts payable and accrued liabilities" on the Company’s Interim Consolidated Balance Sheets. The offsetting $73 million and $147 million were reflected in "Other comprehensive income" on the Company’s Interim Consolidated Statements of Comprehensive Income and “Other expense (income)” on the Company’s Interim Consolidated Statements of Income for the six months ended June 30, 2021, respectively. Changes in fair value of the forward starting swaps for the three and six months ended June 30, 2021 was a loss of $240 million and $220 million, respectively.

Bond locks

During the first six months of 2021, the Company entered into seven-year interest rate bond locks totalling a notional $600 million to fix the benchmark rate on cash flows associated with a highly probable forecasted issuance of long-term notes.

On May 21, 2021, the Merger Agreement with KCS was terminated which resulted in the Company ceasing hedge accounting for the $600 million of bond locks. However, as the debt issuances are still reasonably possible to occur, fair value changes prior to this determination remain in “Accumulated other comprehensive loss”, net of tax, until the notes are issued. Subsequent to the notes issuance, amounts in “Accumulated other comprehensive loss” will be reclassified to “Net interest expense”. If debts are not issued, up to $2 million in “Accumulated other comprehensive loss” would be immediately reclassified to “Other expense (income)”. Fair value changes subsequent to May 21, 2021 were recorded within “Other expense (income)" on the Company’s Interim Consolidated Statements of Income.

As at June 30, 2021, the unrealized fair value loss derived from the bond locks of $5 million was included in "Accounts payable and accrued liabilities" on the Company’s Interim Consolidated Balance Sheets. The offsetting $2 million and $3 million were reflected in "Other comprehensive income" on the Company’s Interim Consolidated Statements of Comprehensive Income and “Other expense (income)” on the Company’s Interim Consolidated Statements of Income for the six months ended June 30, 2021, respectively. Changes in fair value of the bond locks for the three and six months ended June 30, 2021 was a loss of $7 million and $5 million, respectively.