TREASURY POLICY: - GROUP FOREIGN EXCHANGE RISK MANAGEMENT – SEPTEMBER 2013
Executive Summary
1. The Group is exposed to foreign exchange (FX) risk i.e. the risk of changes in exchange rates
affecting the translation of its results, net assets and cash flows reported in sterling. This risk can
be categorised into:
 Long term economic or strategic FX risks which can affect shareholder value if the sterling
value of the Group’s expected future cash flows changes as a result of movements in
exchange rates. This would apply for example to the Group’s future profit/cash flow
streams from Australia and the US which could be worth less in sterling as a result of long
term exchange rate movements.
 Short term transaction FX risks which arises when committed or expected cash flow
transactions denominated in foreign currencies are translated into sterling e.g. foreign
currency receipts and payments in the Online business and transactions funding or defunding overseas operations from/into sterling. The risk exposure here is short term in
that the value of these transactions in sterling could be higher or lower than budgeted
due to exchange rate movements prior to settlement of the transaction.
 Accounting related translation risk which causes volatility in the Group’s consolidated
income statement and balance sheet reported in sterling as a result of currency
movements. This arises from:
 Businesses operating with a sterling functional currency but which have monetary
assets and liabilities denominated in foreign currencies that are re-translated at
period end rates giving rise to exchange gains/losses e.g. WH Online which
operates across a number of currencies.
 Overseas businesses operating with a functional currency other than sterling the
accounts of which are translated into sterling for consolidation into the Group’s
results e.g. the Group’s operations in Australia, USA, Israel, Philippines and
Bulgaria.
2. Given the risk orientation of our review, we are more concerned about the downside risk from FX
movements than the potential for upside gain from favourable movements. The Group’s FX risk
management objectives are therefore to protect against an adverse material impact on Group EPS
and on the Group’s debt covenant metrics.
3. It is not possible to avoid long term strategic FX risk as the Board has implicitly decided to accept
such economic risk by expanding the Group’s business and operations internationally. Treasury
hedging activity can only delay the impact (e.g. through the use of cross currency swaps).
However, our assessment at this time is that the Group’s current strategic FX exposures are
unlikely to have a material impact on the Group’s EPS or debt covenant metrics over the course
of the next year.
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4. Transaction risk affects the value of the Group’s cash flows in sterling. Given the amount of the
Group’s net foreign currency transaction exposures our assessment is that the Group as a whole
is not exposed to FX transaction risks that are likely to have a material impact on the Group’s EPS
or debt covenant metrics. Cash flow transaction exposures may, however, be considered
significant at the operating unit level.
5. Translation exposures arise as a result of accounting requirements and do not represent realised
gains and losses. As they do not represent cash flow exposures they should not affect shareholder
value and can therefore in theory be ignored. In practice this may not be the case as the
accounting treatment will affect the Group’s EPS and debt covenant metrics which are calculated
in sterling.
6. This risk management policy recommends the following approach:
 Strategic FX risk - accept the FX risk resulting from long term strategic economic exposures
as these cannot be avoided permanently given the Group’s decision to operate
internationally. Short to medium term hedging of such exposures should be considered
when foreign currency profits contribute c. 20% of Group profits (currently less than 10%).
The standard FX risk management response would be to match the currency profile of the
Group’s borrowings to the currency profile of its profits. This technique is known as net
investment hedging.
 Transaction FX risks – such shorter term exposures should be considered for hedging if
they have the potential to result in a realised cash loss of £3m (c. 1% of Group EBIT) over
the course of a year. A similar threshold (1% of divisional EBIT) should be considered at
the subsidiary level. Transaction exposures below these thresholds may be considered for
hedging on a case by case basis depending on a cost benefit analysis of hedging the
transaction versus not hedging it. The objective of hedging transaction exposures is to
ensure the achieved FX rate for the transaction at settlement is not materially worse than
the expected or budgeted FX rate for the transaction.
 Translation FX risks - these have to be accepted as they arise from accounting
requirements. They should be monitored for any potential impact on Group EPS or debt
covenants. Net investment hedging as described above will provide some protection at
the net profit/EPS level and for debt covenant measures but will not prevent FX
accounting related volatility affecting the Group’s reported sterling revenues and
operating profits.
7. In order to facilitate the practical execution and control over FX risk management activity across
the Group this policy recommends:
 All FX hedging must be undertaken at Group level unless otherwise agreed by the Group
Finance Director/Group Treasurer. Subsidiaries are not permitted to undertake FX
hedging without Group Head Office agreement.
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 FX hedging must not be undertaken for speculative purposes but only to hedge real or
potential exposures.
 The instruments to be used for FX hedging should be approved by the Group Treasurer
and/or Group Finance Director but may include the standard FX hedging products such as
FX forwards, FX options, FX swaps and cross currency swaps
 Hedging of FX exposures above £50m notional value or equivalent in foreign currency
require PLC Board approval
 Authority is delegated to the Group Finance Director to approve FX hedging in line with
this policy upto a notional principal value of £50m
 Authority is delegated to the Group Treasurer to approve FX hedging in line with this
policy upto a notional principal value of £25m
 Hedging of FX exposures at subsidiary level also requires the agreement of the relevant
divisional unit Finance Director.
Risk Identification
We have identified the following strategic, transaction and translation risk exposures across the
Group.
Long term strategic FX risks arising from: (i) the Group’s overseas operations in Australia, USA, Israel,
Philippines and Bulgaria and (ii) foreign currency profits/losses in the Online business
Transaction risks arising from foreign currency cash flows that need to be translated into another
currency. The most significant such cash flows are: (i) foreign currency denominated receipts and
payments in WH Online that need to be translated to/from sterling and (ii) cash flows in connection
with the funding/de-funding of overseas operations from sterling to local currency or vice versa.
Transaction risks may also arise from other material ad hoc transactions e.g. foreign currency
payments funded from sterling required for overseas acquisitions e.g. WH US and Tom Waterhouse in
Australia.
Translation exposures in respect of:
 WH Online that has monetary assets and liabilities denominated in foreign currencies e.g.
foreign currency cash balances. Exchange gains/losses on these are reported as
income/expenses in the profit and loss account.
 Overseas operations that maintain their local accounts in foreign currency (i.e. WH Australia,
WH US, WH Israel, WH Philippines and WH Bulgaria) which are translated into sterling for the
purposes of the Group consolidated accounts. Any exchange gains and losses on translation
are reported within other comprehensive income/reserves in the Group consolidated
accounts.
Strategic FX Risk
Strategic FX risk refers to the long term economic FX risk the business has chosen to accept by
operating internationally and doing business in foreign currencies. Ultimately such FX risk cannot be
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eliminated or hedged permanently although it may be possible to manage it over the short term. The
Group is exposed to two sources of strategic long term FX risk: (i) that arising from overseas operations
and (ii) WH Online profit streams earned in foreign currencies.
Overseas Operations
We have evaluated the Group’s annual exposure to economic FX risk from overseas operations by
estimating the potential financial impact on Group profits from a 10% and a 25% adverse change in
exchange rates over the course of a year – shown in the table below.
Approximate quantum of annual
economic exposure
Sterling impact of 10% adverse
change in exchange rate
Sterling impact of 25% adverse change
in exchange rate
WH
Australia
WH US
WH Israel
WH
Philippines
WH
Bulgaria
Total
Forecast
operating
profits of c.
AUD 40m
(£23.5m)
Forecast
operating
profits of
c. USD 7m
(£4.5m)
Operating
profit of
c. ILS 10m
(£1.8m)
Operating
profit of c.
PHP 37m
(£0.5m)
Operating
profit of c.
BGN 0.2m
(£0.1m)
(£2.0m)
(£0.4m)
(£0.2m)
(<£0.1m)
(<£0.1m)
(£2.7m)
(£4.7m)
(£0.9m)
(£0.4m)
(£0.1m)
(<£0.1m)
(£6.1m)
The table shows that the total cost of a 10% adverse movement in exchange rates across the Group is
only £2.7m and a 25% adverse movement is £6.1m. This is equivalent to a 0.3p (1%) and 0.7p (2%)
respectively reduction in forecast 2013 EPS. This level of exposure is not considered to be material.
A 10% exchange rate movement over the course of a year is not uncommon but a 25% movement
would be unusual for developed market (although not emerging market) currencies. Having said this,
the GBP/AUD exchange rate is expected to move against the Group by about 25% from the beginning
to the end of 2013 so it is not impossible.
WH Online Foreign Currency Profits
WH Online conducts business in a number of different currencies and over time expects to earn profits
in these different currencies which expose the Group to FX risk when these profit streams are valued
in sterling. It is not possible to hedge the long term (i.e. over a period of years) strategic exposure to
these foreign currency profit streams cost effectively.
Currently WH Online foreign currency profits are not material so the Group and the Online division do
not have a significant FX exposure. The main Online foreign currency revenue streams are in Euros (c.
€75m annually) and US Dollars (c. $20m annually). In practice nearly all of these Euro and US Dollar
currency receipts are expended in settlement of Euro and US denominated marketing and other
expenses leaving the Group with a small net exposure. WH Online profits in other foreign currencies
are also immaterial at this stage.
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Transaction Risk
Transaction risk is short term FX risk which arises from committed or potential transactions that
involve the conversion of one currency into another. If the exchange rate moves between when the
transaction is entered into/contemplated and when it is settled the sterling value of cash flow could
be adversely affected resulting in a realised loss of value for the Group. The aim of transaction FX risk
management is to ensure the actual exchange rate applied to the transaction on settlement is not
materially worse than the expected or budgeted rate when the transaction was entered into.
Risk management theory suggests all such transaction exposures should be hedged otherwise the
Group is technically speculating on exchange rate movements between when the transaction is
entered into and when it settles. However, as hedging has a cost in practice it should only be
undertaken when the cost/benefit analysis stacks up.
Over the long run there should be no benefit in hedging. Derivatives price in the current market
expectations of future exchange rates plus a margin for the bank selling the derivative. As the future
is uncertain there will be as much a chance of a gain as a loss by hedging, as future exchange rates
may be better or worse than the current market expectations built into the FX hedge. This should
average out over time and there should be no net financial benefit to hedging over the long term.
Hedging transaction exposures can be useful, however, if:
 One has a different view on the future path of exchange rates to the market view at the time the
derivative is entered into and wishes to lock into this view. Generally we do not have the
expertise to form a view different to the market consensus.
 The impact of an adverse change in FX rates is so significant that we wish to protect against this
eventuality occurring. Our assessment is that at Group level FX transaction exposures are not
material enough to justify extensive use of hedging as a matter of course. At divisional level
hedging of transaction exposures may be warranted.
This policy recommends that cash flow transaction exposures should be considered for hedging when
they have the potential to result in a loss of value of £3m (c. 1% of Group EBIT). A similar percentage
test should be applied at the divisional unit level.
The major cash flows transaction exposures across the Group are:
1. In WH Online – net foreign currency receipts that need to be translated into sterling. As noted
above the Online’s expected net foreign currency receipts are not considered material as the
main Euro and US Dollar foreign currency revenue streams are matched against almost
equivalent Euro and US denominated marketing and other expenses leaving the Group with a
small net exposure. We therefore do not propose hedging this exposure at this time, although
we will keep the net cash flows under review and consider hedging if deemed appropriate to
do so by the Online Finance Director and Group Treasurer.
Revenue receipts in other currencies not required to meet currency liabilities are translated
into sterling periodically through the year. Therefore although not technically hedged we
achieve an average rate on translation into sterling across the course of the year. Given the
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relatively small size of these profit streams in a Group and Online context and the difficulty in
accurately forecasting such foreign currency net receipts we believe this is an appropriate and
acceptable approach to managing this exposure.
2. The cost of funding WH Online overseas cost centre operations in Israel, Philippines and
Bulgaria. Online does not generate matching revenues in the local functional currencies of
these operations so has to purchase the required currency using other currencies (either
sterling, Euros or US Dollars). This creates a cash flow currency risk exposure.
a. Israel - Currently the annual cost of funding this operation is ILS 83m (£15.2m). A 10%
adverse exchange rate movement increases the sterling equivalent cost by £1.5m and
a 25% adverse exchange rate movement increases the sterling equivalent cost by
£4.9m. This magnitude of transaction risk exposure is considered significant at
divisional level and therefore the cash flow cost of the Israeli operation is hedged on
a rolling 3 months to 9 months forward basis to ensure the actual cost is not materially
worse than the budgeted cost in sterling.
b. Philippines – The annual cost of funding this operation is PHP 468m (£7.8M). A 10%
adverse exchange rate movement would increase this cost by £0.8m and a 25%
adverse FX movement by £2.6m. This exposure is not currently hedged but will be
monitored and hedged if thought appropriate by the Online Finance Director and
Group Treasurer.
c. Bulgaria – The annual cost of this operation is BGN 10m (£4.4m). A 10% adverse
exchange rate movement will cost £0.5m and a 25% adverse movement £1.5m. There
is a commercial hedge in place for this exposure in that the Bulgarian Lev is pegged to
the Euro and so the cost is funded from matching Euro receipts. This matching of Euro
costs with Euro receipts effectively hedges the FX cash flow risk.
3. De-funding of overseas profit centres i.e. WH Australia and WH US. For efficient Group
treasury management we intend to repatriate profits and surplus cash generated in WH
Australia and WH US back to the Group centre in the UK in order to service and pay down
central debt and fund dividends. As these operations’ functional currency is Australian Dollars
and US Dollars respectively this will create a FX exposure when these cash flows are translated
into sterling.
a. WH Australia – Over the course of the next year this business is currently forecast to
generate around c. A$40m (£23.5m) in operating profits. Assuming a 10% adverse
exchange rate movement this would reduce the sterling value of this cash flow by
£2.1m and a 25% adverse movement would reduce it by £4.7m. This is a significant
enough exposure to warrant hedging. However, given the uncertainty around the near
term profit performance of the Australian business and the uncertainty around the
cash requirement to fund working capital and investment plans in Australia we
currently lack clarity over the timing of the repatriation of any profits. In light of this
uncertainty of timing and amount of the cash flow we do not propose hedging this
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exposure in the short term. We will keep this under review and will consider hedging
any material individual cash flows repatriating profits from the Australian business if
deemed appropriate to do so by the Group Finance Director and Group Treasurer.
This will be reviewed again before half year 2014.
b. WH US – This operation is currently expected to generate around $7m (£4.5m)
annually. A 10% adverse exchange rate movement would reduce the sterling value of
this cash flow by £0.4m and a 25% adverse exchange rate movement would reduce it
by £0.9m. In practice the level of exposure is lower than this because most of the cash
profit generated must be retained in the US to fund capital expenditure or seasonal
increases in gaming reserve requirements. Hence this level of exposure is not currently
material enough to warrant hedging. But as with the Australian business individual
cash flows may be hedged in line with this policy if deemed appropriate to do so by
the Group Finance Director and Group Treasurer.
c. Although we hope over overseas operations will be profitable and generate surplus
cash for repatriation back to the UK there may be requirements to fund these
businesses with additional capital e.g. for working capital, capital expenditure or
acquisitions. For example since acquisition the US business has required
approximately $10m of additional funding for working capital, capital expenditure and
to meet regulatory gaming reserve requirements. We have funded the required cash
flow from the Group’s existing US dollar cash resources which has therefore not
resulted in any FX exposure for the Group. Going forward we will adopt a similar
approach to the hedging the FX cash flow exposures on funding and de-funding
transactions as outlined above.
4. Occasionally the Group enters into other material foreign cash flow transactions that give rise
to an FX cash flow exposure e.g. acquisition of WH US (US Dollars) and acquisition of Tom
Waterhouse (Australian Dollars) both of which were largely met by purchasing the required
foreign currency from the Group’s sterling cash resources. Such transactions will be assessed
for hedging on a case by case basis in line with the principles laid out in this policy – i.e.
potential to cause a loss in value equivalent to £3m or 1% of Group operating profit. In respect
of both of the US and Tom Waterhouse acquisitions the Board took the decision not to hedge
the exposure – mainly due to the cost of hedging.
Translation Risk
Translation risk refers to the risk of changes to accounting values reported in the Group’s income
statement and balance sheet as a result of changing exchange rates. As this is an accounting exposure
rather than a real economic exposure it does not require hedging. However, it does need to be
monitored and managed because of the potential impact on Group financial metrics including EPS and
debt covenants reported/calculated in sterling.
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Translation risk arises from two sources: (i) companies that account in sterling but have monetary
assets and liabilities denominated in foreign currencies and (ii) overseas subsidiaries that maintain
their accounts in foreign currency that are translated into sterling for consolidation into the Group
accounts. Our assessment is that neither of these exposures is currently material in a Group or
divisional context.
Translation Risk Arising From Monetary Assets and Liabilities Denominated In Foreign Currencies
For businesses that operate with sterling as their functional currency but conduct business in other
currencies there is a translation risk in respect of foreign currency denominated monetary assets and
liabilities. For the Group this mainly applies to WH Online which accounts in sterling but operates
across a number of currencies so will have assets and liabilities denominated in these foreign
currencies, the most significant of which are foreign currency client liabilities and foreign currency
cash balances.
These balances are translated into sterling at the period end rate. Any changes in value due to
fluctuations in exchange rates from one period to the next are recorded as gains or losses in the profit
and loss account. These gains and losses occur as a result of accounting process and are unrealised
until the foreign currency monetary assets and liabilities are physically converted into sterling.
In practice the Group and WH Online does not run significant exposures in respect of these foreign
currency assets and liabilities:
1. A significant proportion of the foreign currency cash balances are held to match equivalent
and offsetting foreign currency client liabilities. This provides a natural hedge with FX gains
and losses on the currency client liabilities being offset by opposite gains/losses on the foreign
currency client cash balances resulting in no net FX exposure.
2. The Online business will also hold a certain amount of surplus funds in the various currencies
it transacts business in usually to fund day to day operational requirements. The largest
currency balances, other than sterling, will be in Euros and US Dollar. These are retained as
floats to settle future expenses denominated in these currencies. So whilst there may be an
accounting translation exposure in respect of these balances they are providing a cost
effective commercial hedge to future cash flow exposures.
Translation Risk Arising From Overseas Subsidiaries
The accounting for overseas subsidiaries whose accounts are in local currency results in exchange
gains/losses when these accounts are translated into sterling for incorporation into the Group’s
consolidated accounts. These exchange gains or losses are recorded in the statement of other
comprehensive income and taken to reserves and can affect the Group’s net asset value either
positively or negatively. As Group net asset value is not a KPI for the Group or its shareholders this
accounting volatility is deemed acceptable. Net investment hedging would serve to mitigate the net
asset accounting volatility.
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FX Risk Management Execution
In order to facilitate the practical execution and control over FX risk management activity across the
Group this policy recommends:
 All FX hedging must be undertaken at Group level unless otherwise agreed by the Group
Finance Director/Group Treasurer. Subsidiaries are not permitted to undertake FX
hedging without Group Head Office agreement.
 FX hedging must not be undertaken for speculative purposes but only to hedge real or
potential exposures.
 The instruments to be used for FX hedging should be approved by the Group Treasurer
and/or Group Finance Director but may include the standard FX hedging products such as
FX forwards, FX options, FX swaps and cross currency swaps
 Hedging of FX exposures above £50m notional value or equivalent in foreign currency
requires PLC Board approval
 Authority is delegated to the Group Finance Director to approve FX hedging in line with
this policy upto a notional principal value of £50m
 Authority is delegated to the Group Treasurer to approve FX hedging in line with this
policy upto a notional principal value of £25m
 Hedging of FX exposures at subsidiary level also requires the agreement of the relevant
divisional unit Finance Director.
Policy Approval
Board approval is requested for the FX risk management policy described above.
APPROVED BY THE BOARD OF WILLIAM HILL PLC ON 2ND OCTOBER 2013
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