A substantial portion of Reuters revenue is committed under one- and two-year contracts and approximately 80% is denominated in non-sterling currencies. Reuters also has significant costs denominated in foreign currencies with a different mix from revenue. Reuters profits are, therefore, exposed to currency fluctuations. The approximate proportion of operating profit excluding goodwill amortisation and currency gains attributable to each key currency group was as follows:

Operating profit by currency

	1998	1997
Continental Europe
– euro currencies	80%	74%
– other	19%	16%
US dollar	54%	55%
Japanese yen	13%	14%
Sterling
– depreciation	(59%)	(52%)
– other	(22%)	(23%)
Other	15%	16%
Total	100%	100%

Sterling costs exceeded sterling revenues due to the level of UK-based marketing, development, operational and central management costs, and depreciation which, with the exceptions of Instinet and TIBCO, is largely accounted for in sterling once an asset has been acquired.

In broad terms using the 1998 mix of profits, the impact of an additional unilateral 1% strengthening of sterling would have been a reduction of approximately £9 million in 1998 operating profits before hedging (1997: £9 million).

Sterling strengthened significantly over 1997 and the first nine months of 1998, although it weakened in the last quarter of 1998. As a result, 1997 and 1998 operating profits were adversely affected.

The risk that sterling might strengthen against foreign currencies is hedged within parameters laid down by the Board. The priority in treasury policy is to reduce the risk of earnings volatility to acceptable levels while allowing a degree of flexibility to take advantage of market movements.

The main principles underlying currency hedging policies are as follows:

• Committed hedging cannot exceed the underlying cash flow exposure;
• Options may only be written against an underlying exposure;
• Levels of cover for currency hedging cannot exceed 90% of underlying exposure for the first 12 months and 70% for the following 12 months.

The company has adopted value at risk (VAR) analysis as a means of quantifying the potential impact of exchange rate volatility on reported earnings. VAR is a measure of the potential loss on a portfolio within a specified time horizon, at a specified confidence interval. Loss is defined, in this instance, as the diminution in value of rolling 12 month forecast group profits denominated in sterling. Due to the approximations used in determining VAR, the theory provides order of magnitude estimates only but these are useful for comparison purposes.

Reuters estimates that there is currently a 5% chance that profits forecast for the coming 12 months will deteriorate by more than £70 million as a result of currency fluctuations before hedging and £37 million after taking into account hedging at 31 December 1998 (1997: £74 million before hedging and £42 million after hedging). These figures represent the value at risk and are illustrated graphically opposite.

During 1998 the average value at risk before hedging on forecast profits for the coming 12 months varied between £55 million and £76 million and averaged £64 million (1997: £72 million) and after hedging varied between £30 million and £43 million, averaging £35 million (1997: £36 million).

The gains on currency hedging activities for the three years to December 1998 and the fair value of the unrecognised (losses)/gains on the hedging book at the end of 1998 are summarised below:

Currency hedging gains/(losses)

(£m)	1998	1997	1996
Recognised gains in the year	45	56	5
Unrecognised (losses)/gains at 31 December	(6)	39	39

The unrecognised (losses)/gains are based on fair values at the end of each year and include certain realised items which have been deferred because they relate to future periods.

Recognised currency hedging gains were lower in 1998 compared with 1997 due to the relative strength of sterling when hedging for 1998 was undertaken. Of the currency gains recognised in 1998, £43 million related to contracts in place at the end of 1997. Unrecognised losses of £6 million at 31 December 1998 compare with unrecognised gains of £39 million at 31 December 1997. The fall reflects the strength of sterling during most of 1998, when the majority of cover was arranged, and the impact of sterling’s subsequent weakness at the end of 1998.

Of the unrecognised currency hedging loss at 31 December 1998, £3 million relates to 1999 (31 December 1997 – £36 million gain related to 1998).

Net cash flows are mainly converted into sterling and either applied to reduce debt or invested in money market instruments with financial institutions holding strong credit ratings. The use of sterling instruments avoids any currency exposure. Interest rates are hedged using a mix of financial instruments which commence and mature at various dates through to April 2000. The maturity of investments and debt are matched to minimise interest rate risk.

In broad terms, using the average net funds position, adjusted on a proforma basis for the return of capital to shareholders as if it had taken place at the beginning of the year, a 1% increase in global interest rates would have reduced proforma profit before tax in 1998 by approximately £1 million (1997: £3 million) excluding the impact of hedging.