In the United Kingdom Financial Reporting Standard (FRS) 13, which came into force for March 1999 yearends,
requires narrative and numerical disclosure of all financial instruments held or issued, in order to provide
information about their impact on the firm’s risk profile. We use this information to examine the interest rate
and currency profile of financial liabilities and assets. We find that UK firms on average have a greater
proportion of assets and liabilities tied to floating rates of interest and that they tend to match the interest rate profile of assets and liabilities. Although sterling liabilities on average represent over half of total liabilities, for firms holding sterling and non-sterling debt the US dollar was the dominant currency. We also find a relationship between the level of foreign operations and foreign debt. Since the foreign debt profile is disclosed
after the effect of derivatives, this result suggests that cross-currency swaps are used for hedging

Clark, E.

Judge, A.

English

Middlesex University Research Repository

Finance Letters, 2003, 1, 57-60ISSN 1740-6242 © 2003 Global EcoFinance™ All rights reserved. 57Risk Management Disclosure Practices of UK Non-financialFirms after FRS 13Ephraim Clark and Amrit Judge*Middlesex University, UKAbstractIn the United Kingdom Financial Reporting Standard (FRS) 13, which came into force for March 1999 year-ends, requires narrative and numerical disclosure of all financial instruments held or issued, in order to provideinformation about their impact on the firm’s risk profile. We use this information to examine the interest rateand currency profile of financial liabilities and assets. We find that UK firms on average have a greaterproportion of assets and liabilities tied to floating rates of interest and that they tend to match the interest rateprofile of assets and liabilities. Although sterling liabilities on average represent over half of total liabilities, forfirms holding sterling and non-sterling debt the US dollar was the dominant currency. We also find arelationship between the level of foreign operations and foreign debt. Since the foreign debt profile is disclosedafter the effect of derivatives, this result suggests that cross-currency swaps are used for hedging.Key words: Corporate Hedging, Derivatives, Foreign Currency DebtJEL classification: G321. INTRODUCTIONIn March 1999 Financial Reporting Standard (FRS) 13 – “Derivatives and Other Financial Instruments:Disclosures” came into force. FRS 13 requires narrative and numerical disclosure in annual reports of allfinancial instruments held or issued. In particular firms must specify the currency in which liabilities and assetsare held, and show separately those liabilities and assets at fixed interest rates and those at floating interest rates.This information is disclosed after the effect of financial derivatives. The objective is to provide information onthe firm’s financial risk profile. This paper collects this information from the annual reports of 100 UK non-financial firms for the period March 1999 to December 1999 and analyses it in terms of the fixed floatinginterest rate mix and the foreign currency debt mix. This breakdown is important for distinguishing betweenfirms that use financial derivatives for hedging and those that use them for speculation. For example, if a firm isusing currency or interest rate derivatives, then a currency mismatch between assets and liabilities or an interestrate mismatch between assets and liabilities implies speculation rather than hedging and, thus, higher risk.2. INTEREST RATE PROFILE OF FINANCIAL LIABILITIES AND ASSETSAcross the sample an average of 44.8 per cent of total debt is fixed, 52.4 per cent is at floating rates ofinterest and around 3 per cent is non-interest bearing. Therefore, firms, on average, have a higher proportion offloating rate liabilities than fixed rate.Where the currency breakdown on fixed rate liabilities is concerned, fixed rate liabilities were held mostfrequently in Sterling, the US dollar and the Euro. Sterling liabilities were fixed on average for 6.94 years, USdollar liabilities for 4.75 years, and Euro liabilities for 3.18 years. The interest rate profile of financial assets isslightly different to that of liabilities. Whereas floating rates accounted for only 52.4 percent of liabilities, 79 percent of financial assets earned floating rate interest.                                                       * Corresponding author. Email: A.judge@mdx.ac.ukClark and Judge 58At first glance it seems that there might be a speculative exposure due to a mismatch between floatingassets and liabilities. However, for matching to be successful it is not necessary that the proportion of floatingrate financial liabilities equal the proportion of floating rate financial assets. Successful matching takes placewhen, the amount of floating rate financial liabilities is equal to the amount of floating rate financial assets. Forexample, consider a firm that has total debt amounting to £100m with £10m or 10% of this debt at floating ratesof interest. This firm holds £10m worth of financial assets, all at floating rates of interest. Although, in thisexample the proportions of floating rate debt and assets are not equal the actual amounts are equal.Relevant data on floating rate financial assets and liabilities was available for 81 firms. Of these, 22 firmshad more floating rate financial assets than floating rate liabilities, which means that floating rate liabilities werefully hedged. A further 14 firms hedged between 71 and 100 per cent of their floating rate liabilities, and 7 firmshedged between 51 and 70 per cent. Therefore, of the 81 firms with available data, more than half hedged over50 per cent of their floating rate financial liabilities with floating rate financial assets.Industry Analysis of Fixed-Floating Interest Rate MixTable 1 presents the average proportion of fixed rate debt for firms by industry and the level of gearing forthe firm with the lowest and highest proportion of fixed rate debt in each industry. The table ranks industries bythe average proportion of fixed rate debt and shows that there is a great deal of variation in the fixed-floatingdebt mix across industries. A comparison of gearing levels within an industry reveals that in 15 out of 27industry sectors the level of gearing for the firm with the highest proportion of fixed rate debt is greater than thatfor the firm with the lowest proportion of fixed rate debt. This finding suggests that the level of gearing ispotentially one of the factors that influence a firm’s fixed-floating debt profile.An industry analysis of the length of time fixed rates are fixed generates results that are very similar tothose above, which examine the fixed-floating debt mix across industries. We find that firms with the highestproportion of fixed rate debt also tend to fix the interest rates on this debt for the longest period of time. Forexample, firms in the property sector not only have on average the highest proportion of fixed rate debt but theyalso fix this debt for the longest number of years.3. FOREIGN CURRENCY PROFILE OF FINANCIAL LIABILITIESThe currency profile of financial liabilities provides details of the currencies in which liabilities are held andthe amounts of fixed and floating rate liabilities held in each currency. The amount of debt held in each currencyis disclosed after the effect of interest rate and currency derivatives. Our analysis shows that liabilities were heldmost frequently in Sterling followed by the US dollar, the Euro and the Australian dollar.Ninety firms held liabilities in Sterling and on average, these liabilities represented 54.2 per cent of totalliabilities for these firms. Sixty-eight firms held liabilities in US dollars and on average these dollar liabilitiesmade up 42.6 per cent of the total for these firms. The average proportion of Euro liabilities held by firms was24.8 per cent. For firms holding both Sterling and US dollar liabilities the average proportion of US dollarliabilities exceeded the average proportion of Sterling liabilities. Furthermore, 54.1 per cent (33 firms) of thesefirms had a higher proportion of US dollar financial liabilities than Sterling liabilities.1  For firms that possessSterling, US dollar and Euro financial liabilities, the US dollar is by far the most dominant currency with onaverage 43.26 per cent of financial liabilities held in US dollars. Furthermore, 65.6 per cent (21 firms) of thesefirms had a higher proportion of US dollar financial liabilities than Sterling liabilities.Where a company has extensive overseas investments, it may borrow in foreign currencies to protect thebalance sheet. In order to examine the relationship between level of foreign debt (non-sterling financialliabilities) and the level of foreign operations we divide the sample of 100 firms into two groups, those with theproportion of foreign debt less than or equal to the median level of 52.9 per cent and those higher than themedian level. We examine whether there is a significant difference in the level of foreign operations betweenthese two groups by using two proxies for the level of foreign operations, foreign sales by origin divided by totalsales and the foreign tax ratio, defined as the ratio of foreign tax to total tax. The results in Table 2 show thatfirms with higher levels of foreign debt have statistically significant higher levels of foreign operations. Thisfinding is consistent with the notion that firms use foreign debt to hedge the foreign exchange exposure arisingfrom foreign operations.                                                       1 A further 3 firms had US dollar financial liabilities but no Sterling financial liabilities.Clark and Judge 59Table 1. Proportion of Fixed Rate Debt by Industry and Gearing Levels by Industry for Firms withLowest and Highest Proportion of Fixed Rate DebtIndustry No. offirmsAverage % of fixed ratedebt in industryGearing for firm withlowest % of fixed debtGearing for firm withhighest % of fixed debtProperty 4 71.9 40 22Electricity Production & Distribution 6 69.8 33 8Broadcasting & Satellite TV 2 66.2 18 1Telecommunication 6 62.8 0 24Tobacco 3 59.5 36 3Water 3 57.0 18 15Medical Equipment 2 56.1 15 31Airlines & Airports 2 55.4 3 22Hotels & Leisure Facilities 4 53.8 0 20Oil 3 51.5 21 1Food Retailing 4 50.1 21 0Pharmaceuticals 2 49.4 1 34Breweries, Pubs & Restaurants 4 48.5 17 38Business Support 3 45.6 12 1Chemicals 3 45.5 5 24Engineering, Defence, Aerospace 6 43.7 3 31Publishing & Printing 8 42.2 4 24Software 2 42.0 0 16Rail, Road & Freight 3 38.2 12 0Building Materials & Merchants 5 36.3 0 1Retailers, Multiple Department Stores 4 30.8 68 5Media Agencies 2 29.8 4 6Gas Distribution 2 25.5 5 6Mining 2 25.1 9 15Electronic Equipment 3 23.9 0 19Food Processors 2 22.8 9 0Computer Services 3 8.9 64 5Paper Manufacture 1 NADistillers & Vintners 1 NAHousehold Products 1 NADistributing Industrial Components 1 NARetailers, Soft Goods 1 NARetailers, Hardlines 1 NAShipping & Ports 1 NATOTAL 100Table 2. Differences in the Mean Level of Foreign Operations between Firms with High and Low Levelsof Foreign DebtForeign debt > median Foreign debt   medianLevel of Foreign Operations No. Mean % No. Mean %Mean %Difference t -statistic p-valueForeign sales by origin – 1998 44 60.21 36 27.48 32.74 5.46 0.000Foreign sales by origin – 1999 45 61.23 36 28.58 32.65 5.58 0.000Foreign tax ratio – 1998 49 54.73 48 16.98 37.76 6.62 0.000Foreign tax ratio – 1999 48 36.98 46 17.07 19.91 2.47 0.016Clark and Judge 604. SUMMARY AND CONCLUSIONSThis paper has presented the initial results from an analysis of FRS13 disclosures in the annual reports of100 UK non-financial firms for the period March 1999 to December 1999. We find that liabilities and assets aremainly held in Sterling, the US dollar and the Euro. We also find that in the case of both financial liabilities andassets firms on average have a greater proportion of liabilities and assets tied to floating rate indices than tofixed rates of interest.We find evidence of attempts made by firms to match the interest rate profile of liabilities and assets. Thissuggests that the level of financial assets might be one of the factors that influence a firm’s fixed floating debtmix. Our analysis shows that sterling liabilities were on average equal to over half of total liabilities. However,for firms holding sterling and non-sterling debt the US dollar was the dominant currency in which debt washeld. We also find evidence in support of a relationship between the level of foreign operations and the level offoreign debt. This is consistent with the argument that firms use foreign currency debt for the purposes ofhedging the exposure arising from foreign currency assets. Since the foreign currency debt mix is disclosed afterthe effect of derivatives this finding also implies that cross currency swaps are on average being used forhedging purposes.REFERENCESAccounting Standards Board (1998) FRS 13 - Derivatives and other Financial Instruments: Disclosures.

Risk management disclosure practices of UK non-financial firms after FRS13.

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Risk management disclosure practices of UK non-financial firms after FRS13.

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