NEW ZEALAND GAZETTE, No. 25

29 FEBRUARY 2012

Notes to and Forming Part of the Financial Statements
For the year ended 30 June 2011

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 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. Powerco also utilises cross currency interest swaps to hedge against the variations in interest costs and fair value of the US dollar prefund placement debt.

Derivative instruments are initially recognised at fair value on the contract date and subsequently measured at their fair value at 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) 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 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.

(ii) Fair value hedges

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

(iii) Derivatives that do not qualify for hedge accounting

• Certain derivative instruments are undertaken 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 profit or loss component of the Statement of Comprehensive Income.

The fair value of financial derivatives and fixed rate debt are determined by reference to the market quoted rates input into valuation models.

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

The Division holds the following financial instruments:

Derivatives in a hedge relationship:

1. Interest rate swaps (fair value hedge):
   

• The Division receives a New Zealand fixed interest rate and pays New Zealand dollar floating interest rates. These qualify for hedge accounting as fair value hedges and are entered into to hedge underlying obligations.

| | 31,525 | 53,089 | (1,811) | 2,039 |

2. US cross currency interest rate swaps

• The Division receives a US dollar fixed interest rate and pays New Zealand dollar floating interest rates. The hedge is a fair value hedge and hedges the movements in currency and interest rate that would affect interest payments and final repayment at maturity. These were entered into to terms to match the underlying obligation.

| | 81,844 | 62,501 | (11,639) | (1,301) |

3. US cross currency interest rate swaps (combination fair value and cash flow hedge)

• The Division receives a US dollar floating rate and pays New Zealand dollar floating interest rates. For hedge accounting purposes, this is split into a fair value and cash flow hedge. The cash flow hedge hedges the changes in the fair value of the debt due to prospective changes in US interest rates. The fair value hedge hedges the changes in the value of the currency, basis swap and credit margins. The cross currency swap hedges interest payments and the final repayments at maturity. These were entered into to terms to match the underlying obligations.

| | 85,343 | - | (5,486) | - |

4. Interest rate swaps (non-hedge relationship)

| | 291,079 | 262,310 | (13,865) | (13,595) |

5. Interest rate collars

| | 10,508 | 10,620 | (224) | (505) |

6. Foreign exchange contracts

| | 345 | - | (12) | - |

| | 430,444 | 388,530 | (23,045) | (13,360) |

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

2. US cross currency interest rate swaps
   The Division receives a US dollar fixed interest rate and pays New Zealand dollar floating interest rates. The hedge is a fair value hedge and hedges the movements in currency and interest rate that would affect interest payments and final repayment at maturity.

3. US cross currency interest rate swaps
   The Division enters into these swaps where it receives a US dollar floating rate and pays New Zealand dollar floating interest rates. For hedge accounting purposes, this is split into a fair value and cash flow hedge. The cash flow hedge hedges the changes in the fair value of the debt due to prospective changes in US interest rates. The fair value hedge hedges the changes in the value of the currency, basis swap, and credit margins. These cross currency swap hedges interest payments and final repayments at maturity.

4. Interest rate swaps
   The Division enters into New Zealand dollar floating interest rate exposures to New Zealand dollar fixed debt. These swaps are used mostly to modify the interest rate profile in accordance with the Treasury Policy and are on matched terms. Hedge accounting is not applied to these swaps.