3 DECEMBER 2010

NEW ZEALAND GAZETTE, No. 165

4131

Notes to and Forming Part of the Financial Statements
For the year ended 30 June 2010

GAS DIVISION

4 OTHER FINANCIAL ASSETS AND LIABILITIES

Powerco enters into New Zealand dollar floating to fixed interest rate swap agreements to reduce the impact of changes in financing interest rates on its borrowings and thus reduce variability in cash flows. Fixed to floating treatments are entered into either under the changes in fair value or the cash flow New Zealand dollar debt. Powerco also utilises cross-currency interest rate swaps to hedge against the volatility inherent across two fair value or the US dollar breakeven statement settlement.

Derivative instruments are initially recognised at fair value on the contract date and subsequently measured at their fair value on each balance 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 Group designates certain derivatives as either: (i) hedges of highly probable forecast transactions (cash flow hedges); or (ii) hedges of the fair value of recognised assets or liabilities or a firm commitment (fair value hedges).

The Division documents, at the inception of the hedge, 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.

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 profit or loss component of the Statement of Comprehensive Income. Amounts accumulated in equity are transferred to the profit or loss component of the Statement of Comprehensive Income in the same period or periods in which the hedged item affects the profit or loss.

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 profit or loss. 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 profit or loss component of the Statement of Comprehensive Income.

Fair value hedges

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

(a) Derivatives that do not qualify for hedge accounting
Certain derivative instruments are undertaken as regards economic exposure and are not eligible for hedge accounting. Changes in the fair value of any derivative instruments that do not qualify for hedge accounting are recognised immediately in the profit or loss component of the Statement of Comprehensive Income.

The fair value of financial derivatives and hedge ratio debt are determined by reference to the market source inputs into input into valuation models.

All derivative instruments are carried in the Balance Sheet at their “fair value”. Movements in the hedging reserve are shown in other comprehensive income.

The Division holds the following financial instruments:

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

2. US cross currency interest rate swaps
   The Division receives US dollar fixed interest and pays New Zealand dollar floating interest. This hedge is an effective fair value hedge and hedges the movements in currency but would affect interest payments and final repayments at maturity, these were entered into at terms 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. This is not a hedge but used to fix the cashflow obligations efficiently as per the hedging policy and the treasury policy and is on matched terms. They do not hedge accounted.

4. Interest rate swaps
   The Division receives New Zealand dollar floating interest rates and pays New Zealand dollar fixed interest. The hedges are fair value hedging obligations efficiently as per the hedging policy and the treasury policy and is reflected in the profit and loss.