Financial risk management and derivative financial instruments

12 Months Ended

Dec. 31, 2021

Text Block [Abstract]

Financial risk management and derivative financial instruments

24. Financial risk management and derivative financial instruments

Overview

The Group is exposed to financial risks that arise in relation to underlying business activities. These risks include: market risk, liquidity risk, credit risk and capital risk. There are Board approved policies in place to manage these risks. Treasury activities to manage these risks may include money market funds, repurchase agreements, spot and forward foreign exchange instruments, currency swaps, interest rate swaps and forward rate agreements.

Market risk

Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises: foreign exchange risk and interest rate risk. Financial instruments affected by market risk include loans and other borrowings, cash and cash equivalents, debt and equity investments and derivatives.

Foreign exchange risk

The US dollar is the predominant currency of the Group’s revenue and cash flows. Movements in foreign exchange rates can affect the Group’s reported profit or loss, net liabilities and its interest cover. The most significant exposures of the Group are in currencies that are freely convertible. The Group’s reported debt has an exposure to borrowings held in sterling and euros. After the effect of currency swaps, the Group holds its bond debt in sterling which is the primary currency of shareholder returns. US dollars are also borrowed when required to reflect the predominant trading currency and act as a net investment hedge of US dollar denominated assets.

The Group transacted currency swaps at the same time as the €500m 2.125% 2027 and €500m 1.625% 2024 bonds were issued in November 2018 and October 2020 respectively in order to swap the bonds’ proceeds and interest flows into sterling (see page 189).

Interest rate risk

The Group is exposed to interest rate risk in relation to its fixed and floating rate borrowings. The Group’s policy requires a minimum of 50% fixed rate debt over the next 12 months. With the exception of overdrafts, 100% of borrowings were fixed rate debt at 31 December 2021 (2020: 100%).

Derivative financial instruments

Derivatives are recorded in the Group statement of financial position at fair value (see note 25) as follows:

Description	Hedge relationship	2021 $m			2020 $m
Put option	None		–			4
Currency swaps	Cash flow hedge		(62	)		(17	)
			(62	)		(13	)
Analysed as:
Non-current assets			–			5
Non-current liabilities			(62	)		(18	)
			(62	)		(13	)

The carrying amount of currency swaps of $62m liability (2020: $17m liability) comprises $67m loss (2020: $13m gain) relating to exchange movements on the underlying principal, included within net debt (see note 23), and $5m gain (2020: $30m loss) relating to other fair value movements.

Details of the credit risk on derivative financial instruments are included on page 191.

Cash flow hedges

Currency swaps have been transacted to swap the proceeds from the euro bonds to sterling as follows:

Date of designation	Pay leg	Interest rate	Receive leg	Interest rate	Maturity	Risk	Hedge type	Hedged item
November 2018	£436m	3.5%	€500m	2.125%	May 2027	Foreign exchange	Cash flow	€500m 2.125% bonds 2027
October 2020	£454m	2.7%	€500m	1.625%	October 2024	Foreign exchange	Cash flow	€500m 1.625% bonds 2024

There is an economic relationship between the hedged item and the hedging instrument as the critical terms are aligned, such that the hedge ratio is 1:1.

The change in the fair value of hedging instruments used to measure hedge ineffectiveness in the period mirrors that of the hypothetical derivative (hedged item) and was $40m loss (2020: $7m gain).

Hedge ineffectiveness arises where the cumulative change in the fair value of the swaps exceeds the change in fair value of the future cash flows of the bonds, and may be due to any opening fair value of the hedging instrument, or a change in the credit risk of the Group or counterparty. There was no ineffectiveness in 2021 or 2020.

Amounts recognised in the cash flow hedge reserves are analysed in note 29.

Net investment hedges

The Group designates the following as net investment hedges of its foreign operations, being the net assets of certain Group subsidiaries with a US dollar functional currency:

• Borrowings under the Syndicated and Bilateral Facilities; and

• Short-dated foreign exchange swaps.

The designated risk is the spot foreign exchange risk and interest on these financial instruments is taken through financial income or expense.

Short-dated foreign exchange swaps are used when needed to manage sterling surplus cash and reduce US dollar borrowings whilst maintaining operational flexibility. No short-dated foreign exchange swaps have been held since the first quarter of 2020.

There is an economic relationship between the hedged item and the hedging instrument as the net investment creates a foreign exchange risk that will match the foreign exchange risk on the US dollar borrowing. The Group has established a hedge ratio of 1:1 as the underlying risk of the hedging instrument is identical to the hedged risk component.

The change in value of hedging instruments recognised in the currency translation reserve through other comprehensive income was $nil (2020: $1m loss). There was no ineffectiveness recognised in the Group income statement during the current or prior year.

Interest and foreign exchange risk sensitivities

The following table shows the impact of a general strengthening in the US dollar against sterling and euro on the Group’s profit or loss before tax and net liabilities, and the impact of a rise in US dollar, euro and sterling interest rates on the Group’s profit or loss before tax. The impact of the strengthening in the euro against sterling on net liabilities is also shown, as this impacts the fair value of the currency swaps.

		2021 $m		2020 $m		2019 $m
Increase/(decrease) in profit before tax
Sterling: US dollar exchange rate	5¢ fall		7.0		5.9		4.0
Euro: US dollar exchange rate	5¢ fall		0.2		0.3		(2.6	)
US dollar interest rates	1% increase		7.1		2.2		(1.6	)
Sterling interest rates	1% increase		5.2		12.9		0.6
Decrease in net liabilities
Sterling: US dollar exchange rate	5¢ fall		29.1		30.2		39.9
Euro: US dollar exchange rate	5¢ fall		49.7		50.6		24.1
Sterling: euro exchange rate	5¢ fall		67.4		68.2		33.0

In 2021 and 2020, interest rate sensitivity relates to cash balances and would only be realised to the extent deposit rates increase by 1%.

Interest rate sensitivities include the impact of hedging and are calculated based on the year-end net debt position.

Liquidity risk

Group policy ensures sufficient liquidity is maintained to meet all foreseeable medium-term cash requirements and provide headroom against unforeseen obligations.

Cash and cash equivalents are held in short-term deposits, repurchase agreements, and cash funds which allow daily withdrawals of cash. Most of the Group’s funds are held in the UK or US, although $77m (2020: $44m) is held in countries where repatriation is restricted (see note 19).

Medium and long-term borrowing requirements are met through committed bank facilities and bonds as detailed in note 22. Short-term borrowing requirements may be met from drawings under uncommitted overdrafts and facilities.

The Syndicated and Bilateral Facilities contain two financial covenants: interest cover and a leverage ratio. Covenants are monitored on a ‘frozen GAAP’ basis excluding the impact of IFRS 16 ‘Leases’ and are tested at half year and full year on a trailing 12-month basis.

The interest cover covenant requires a ratio of Covenant EBITDA:Covenant interest payable above 3.5:1 and the leverage ratio requires Covenant net debt: Covenant EBITDA of below 3.5:1. Covenant EBITDA is calculated (on a frozen GAAP basis) as operating profit before exceptional items, depreciation and amortisation and System Fund revenues and expenses.

These covenants were waived from 30 June 2020 through 31 December 2021 and have been relaxed for test dates in 2022. A temporary minimum liquidity covenant of $400m is tested at each test date up to and including 31 December 2022. For covenant purposes, liquidity is defined as unrestricted cash and cash equivalents (net of bank overdrafts) plus undrawn facilities with a remaining term of at least six months.

	2019 and prior		30 June     2020 to 31 December 2021		30 June 2022		31     December 2022		30 June 2023
Amended covenant test levels for Syndicated and Bilateral Facilities
Leverage		<3.5x		waived		<7.5x		<6.5x		<3.5x
Interest cover		>3.5x		waived		>1.5x		>2.0x		>3.5x
Liquidity		n/a		$400m		$400m		$400m		n/a

The measures used in the covenant tests are calculated on a frozen GAAP basis and do not align to the values reported by the Group as Non-GAAP measures:

	2021		2020		2019
Covenant EBITDA ($m)		601		272		897
Covenant net debt ($m)		1,801		2,375		2,241
Covenant interest payable ($m)		133		111		99
Leverage		3.00		8.73		2.50
Interest cover		4.52		2.45		9.06
Liquidity ($m)		2,655		2,925		n/a

The interest margin payable on the Syndicated and Bilateral Facilities is linked to the leverage ratio and can vary between USD LIBOR + 0.90% and USD LIBOR + 2.75%.

The following are the undiscounted contractual cash flows of financial liabilities, including interest payments. Liabilities relating to the Group’s deferred compensation plan are excluded; their settlement is funded entirely by the realisation of the related deferred compensation plan investments and no net cash flow arises.

31 December 2021	Less than 1 year $m			Between 1 and 2 years $m			Between 2 and 5 years $m			More than 5 years $m			Total $m
Non-derivative financial liabilities:
Bank overdrafts		59			–			–			–			59
£173m 3.875% bonds 2022		241			–			–			–			241
€500m 1.625% bonds 2024		9			9			575			–			593
£300m 3.75% bonds 2025		15			15			435			–			465
£350m 2.125% bonds 2026		10			10			502			–			522
€500m 2.125% bonds 2027		12			12			36			578			638
£400m 3.375% bonds 2028		18			18			55			575			666
Lease liabilities		58			49			123			3,212			3,442
Trade and other payables (excluding deferred and contingent purchase consideration)		550			2			1			2			555
Deferred and contingent purchase consideration		–			–			52			42			94
Derivative financial liabilities:
Currency swaps hedging €500m 1.625% bonds 2024 outflows		16			16			628			–			660
Currency swaps hedging €500m 1.625% bonds 2024 inflows		(9	)		(9	)		(575	)		–			(593	)
Currency swaps hedging €500m 2.125% bonds 2027 outflows		21			21			62			598			702
Currency swaps hedging €500m 2.125% bonds 2027 inflows		(12	)		(12	)		(36	)		(578	)		(638	)

31 December 2020	Less than 1 year $m			Between 1 and 2 years $m			Between 2 and 5 years $m			More than 5 years $m			Total $m
Non-derivative financial liabilities:
Bank overdrafts		51			–			–			–			51
£173m 3.875% bonds 2022		9			245			–			–			254
€500m 1.625% bonds 2024		10			10			634			–			654
£300m 3.75% bonds 2025		15			15			456			–			486
£350m 2.125% bonds 2026		10			10			31			488			539
€500m 2.125% bonds 2027		13			13			39			640			705
£400m 3.375% bonds 2028		19			18			55			601			693
Commercial paper		819			–			–			–			819
Lease liabilities		57			55			136			3,257			3,505
Trade and other payables (excluding deferred and contingent purchase consideration)		416			2			1			1			420
Deferred and contingent purchase consideration		13			5			13			81			112
Derivative financial liabilities:
Currency swaps hedging €500m 1.625% bonds 2024 outflows		16			16			652			–			684
Currency swaps hedging €500m 1.625% bonds 2024 inflows		(10	)		(10	)		(634	)		–			(654	)
Currency swaps hedging €500m 2.125% bonds 2027 outflows		21			21			63			627			732
Currency swaps hedging €500m 2.125% bonds 2027 inflows		(13	)		(13	)		(39	)		(640	)		(705	)

Credit risk

Credit risk on cash and cash equivalents is minimised by operating a policy on the investment of surplus cash that generally restricts counterparties to those with a BBB- credit rating or better or those providing adequate security. The Group uses long-term credit ratings from Standard and Poor’s, Moody’s and Fitch Ratings as a basis for setting its counterparty limits.

In order to manage the Group’s credit risk exposure, the treasury function sets counterparty exposure limits using metrics including credit ratings, the relative placing of credit default swap pricings, tier 1 capital and share price volatility of the relevant counterparty.

Repurchase agreements are fully collateralised investments, with a maturity of three months or less. The Group accepts only government or supranational bonds where the lowest credit rating is AA- or better as collateral. In the event of default, ownership of these securities would revert to the Group. The securities held as collateral are to protect against default by the counterparty.

The Group’s exposure to credit risk arises from default of the counterparty, with the maximum exposure equal to the carrying amount of each financial asset, including derivative financial instruments. The expected credit loss on cash and cash equivalents is considered to be immaterial.

The table below analyses the Group’s short-term deposits, money market funds and repurchase agreement collateral classified as cash and cash equivalents by counterparty credit rating:

31 December 2021

AAA $m

AA $m

AA- $m

A+ $m

A $m

A- $m

Total $m

Short-term deposits

–

–

87

45

169

–

301

Money market funds

1,025

–

–

–

–

–

1,025

31 December 2020

AAA $m

AA $m

AA- $m

A+ $m

A $m

A- $m

Total $m

Short-term deposits

–

–

98

165

94

1

358

Money market funds

892

–

–

–

–

–

892

Repurchase agreement collateral

238

65

18

–

–

–

321

Capital risk management

The Group manages its capital to ensure that it will be able to continue as a going concern. The capital structure consists of net debt, issued share capital and reserves. The structure is managed with the objective of maintaining an investment grade credit rating, to provide ongoing returns to shareholders and to service debt obligations, whilst maintaining maximum operational flexibility. A key characteristic of IHG’s managed and franchised business model is that it is highly cash generative, with a high return on capital employed. Surplus cash is either reinvested in the business, used to repay debt or returned to shareholders.

The Group’s debt is monitored on the basis of a cash flow leverage ratio, being net debt divided by adjusted EBITDA. The Group has a stated aim of maintaining this ratio at 2.5x to 3.0x. The ratio at 31 December 2021 (which differs from the ratio as calculated on a frozen GAAP basis for covenant tests) was 2.98 (2020: 7.69).

The Group currently has a senior unsecured long-term credit rating of BBB- from Standard and Poor’s. In the event this rating was downgraded below BBB- there would be an additional step-up coupon of 1.25% payable on the bonds which would result in additional interest of approximately $35m per year.