NEW ZEALAND GAZETTE, No. 179

4 DECEMBER 2009

Note to 2nd Facing Part of the Financial Statements
For the year ended 30 June 2009

POWER

GAS DIVISION

4 DERIVATIVE FINANCIAL INSTRUMENTS

a) Financial Instruments

The Division enters into New Zealand dollar floating to fixed interest rate swap agreements to reduce the impact of changes in floating interest rates on its borrowings and thus reduce variability in cash flows. Fixed to floating instruments are entered into in order to hedge the changes in fair value of fixed rate New Zealand dollar debt. The Division also utilises cross currency interest rate swaps to hedge against the variations in interest costs and fair value of the US dollar private placement debt.

Derivative instruments are initially recognised at fair value on the contract date and subsequently measured at their fair value on each Balance Sheet date. The method of recognising the resulting gain or loss depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged. The Division designates certain derivatives as either (i) hedges of the fair value of recognised assets or liabilities or a firm commitment (fair value hedges); or (ii) hedges of the highly probable forecast transactions (cash flow hedges); or (iii) hedges of the foreign currency risk of a firm commitment (net investment hedges).

The Division documents, at the inception of the hedge transaction, the relationship between hedging instruments and hedged items, as well as its risk management objective and hedging strategy. The Division also documents its assessment, both at hedge inception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

(i) Cash flow hedges

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognised in equity. The gain or loss relating to the ineffective portion is recognised immediately in the Income Statement. Amounts accumulated in equity are transferred to the Income Statement in the same period in which the hedged item affects the Income Statement.

When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in the Income Statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the Income Statement.

(ii) Fair value hedges

Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the Income Statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk.

(iii) Derivatives that do not qualify for hedge accounting

Certain derivative instruments are under taken as hedges of economic exposures but do not qualify for hedge accounting. Changes in the fair value of any derivative instruments that do not qualify for hedge accounting are recognised immediately in the Income Statement.

The Division holds the following financial instruments:

1. Interest rate swaps
   The Division receives New Zealand dollar fixed interest rates and pays New Zealand dollar floating interest rates. These qualify for hedge accounting as fair value hedges and are entered into in terms matched to the underlying obligation.

2. US cross currency interest rate swaps
   The Division receives New Zealand dollar fixed interest and pays US dollar floating interest. The hedge is both a fair value hedge and hedges movements in currency that would affect interest payments and final repayment of principal, therefore entered into to match the underlying obligation.

3. Interest rate swaps
   The Division receives New Zealand dollar floating interest rates and pays New Zealand dollar fixed interest. The hedge is to fix the variable floating obligations efficiently as per the hedge policy and the treasury policy and is on matched terms. These are cash flow hedges.

4. Interest rate swaps
   The Division receives New Zealand dollar floating interest rates and pays New Zealand dollar fixed interest. The hedge is to fix the variable floating obligations efficiently as per the hedge policy and the treasury policy and is on matched terms, but not hedge accounted.