SGN Annual Report 2015 by Tayburn

Leading the way in energy delivery Annual Report and Accounts 2015

Overview 01 Our business at a glance Strategic report 04 Chief Executive’s statement 14 Key performance indicators 16 Financial review 20 Principal risks and uncertainties 22 Corporate responsibility Directors’ report 24 Chairman’s statement 26 Board of Directors 28 Statement of Directors’ responsibilities 29 Directors’ report 31 Corporate governance statement 34 Carbon report Accounts 35 Independent auditor’s report 36 Consolidated profit and loss account 37 Consolidated statement of total recognised gains and losses 38 Balance sheets 39 Consolidated cash flow statement 40 Reconciliation of net cash flow to movement in net debt 41 Notes to the financial statements

SGN is ten

Our business at a glance Financial and operational highlights

98.7%

Gas escapes attendance within an hour in 2014/15

£369m

Network investment in 2014/15

External awards for innovative technologies

£4.9bn

Regulated Asset Value as at 31 March 2015

£1,100m Turnover in 2014/15

Colleagues from our Solent depot in Portsmouth.

SGN was formed on 1 June 2005, after the sale of four of the eight gas distribution networks. A few of the many highlights 2005 Company formed on 1 June with a Regulated Asset Value of £2.9bn.

SGN Annual Report and Accounts 2015

Our business at a glance (continued) SGN is the UK’s second largest gas distribution network company – comprises two networks across Scotland and southern England.

Assets

74,000km of gas mains and services, storage and pressure reduction stations – to transport shippers’ gas

Customers

5.8 million customers: Southern 4 million, Scotland 1.8 million plus five Scottish Independent Undertakings (SIUs)

Our values underpin everything we do Safety first We take responsibility for our own safety and the safety of those around us Driving performance Efficiency, innovation and continuous improvement will help us deliver excellence and achieve commercial success

2007 This year saw the formation of SGN metering. We now own, operate and maintain some 282,000 meters.

2009 Completion of the £40m Farningham to Hadlow 22km pipeline securing gas supplies in the south-east of England.

Area

40% of the UK land mass

RAV

£4.9bn – 29% of UK RAV

People

3,753 direct employees and around 2,000 contractors

Putting people at the heart We always work together, talk honestly and treat people with respect Looking after customers By listening to our customers, understanding their needs and keeping our promises we can deliver an excellent service that people trust Sustaining our world We maximise our effect on local communities and minimise our impact on the world

2010 World-record breaking 3.8km direction drill, installing two new gas pipelines to the Isle of Wight from the mainland, drilled and inserted under the sea bed.

2012 Opening of the largest commercial biogas plant in the UK by HRH the Prince of Wales at Poundbury, Dorset.

Aberdeen

Our operations throughout the UK Our Scotland network distributes gas across all of Scotland to 75% of households, including remote areas through the Scottish Independent Undertakings (SIU) at Stornoway, Wick, Thurso, Oban and Campbeltown.

Edinburgh Glasgow

In Northern Ireland we have been granted the licence to bring natural gas to eight towns in the west, constructing high, intermediate and low pressure pipelines and mains. We are also contracted to maintain the gas transmission system and maintain the assets for the gas pipeline connection between Northern Ireland and Scotland.

Belfast

Our Southern network stretches from Milton Keynes in the north, to Dover in the east and Lyme Regis in the west, including London boroughs to the south of the River Thames, distributing gas to around 90% of households.

London

Southampton Oxford

2013 Core & Vac technology starting to roll-out, revolutionising gas mains repairs.

2014 Opening of Portsdown Hill biogas injection plant, allowing biogas to be injected from remote locations.

2015 Gas to the West project commences in Northern Ireland with a ÂŁ250m investment.

SGN Annual Report and Accounts 2015

Chief Executive’s statement Our primary role operating two of the UK’s largest gas networks is to protect people and property. In the ten years we have been formed, I take pride that safety has been our number one priority and we remain dedicated to keeping our customers safe and warm by leading the way in energy delivery. Our efforts are focussed on driving continuous improvements through innovation, excellence in customer service, and developing our people, while pushing the boundaries on decarbonising our product and championing the green gas agenda.

Our business: delivering gas

We operate a safe and reliable network of mains and services delivering gas to 5.8 million customers connected to our networks, providing heat to some 25% of UK homes, using gas.

John Morea, Chief Executive Officer

‘ I’m proud to have played a part in what we’ve achieved over the last ten years and would like to pay tribute to the hard work, commitment and professionalism of all our people.’

Combined our networks comprise 74,000km of gas pipeline, ranging from high pressure transmission lines serving major cities and counties, down to low pressure networks serving rural communities. We also have 3,100km of gas transmission system, constructed of high grade steel and operating at very high pressure. Our distribution system is a mix of materials from the increasing population of modern polyethylene plastic pipes we use today, to the cast iron pipes installed in the last century.

A selection of our awards

Engineer of the year

Gas Industry Innovation Award

Winner for Customer Quality and Reliability

Innovator of the year

Construction and Engineering Winner

Occupational Health and Safety

Environmental Award

Excellence in Streetworks

How we add value through our business model RIIO Price Control We operate under a price control set by Ofgem. It’s an eight year price control which commenced in April 2013 and is designed to provide the incentives to encourage Gas Network Companies to efficiently meet the challenges ahead and provide value to all stakeholders.

Key inputs Human

Our people are at the core of what we do and we have over 3,700 highly skilled and flexible employees.

Operational excellence and efficiency We strive to uphold high levels of safety, reliability and customer service. We have ongoing programmes to drive efficient decisions.

Asset investment

Decisions around asset investment are made carefully to ensure both short-term and long-term impacts are considered.

Added value Network

£3.5bn network investment since inception.

We have committed under RIIO to deliver value to our stakeholders:

Pipeline

Safety

Financial

Reliability

8,535km pipeline replaced since inception. We have significant financial strength and good access to capital as and when required.

Innovation

We continually ensure we are at the forefront of new ideas and technology to work more efficiently.

Reduce risk of incidents (Emergency Standard 97%). Reduce interruptions and faults.

Customer

Maintain highest standards of customer service.

Social

Connect 20,000 fuel poor customers.

Environment

Reduce leakage of gas from our network.

Shareholder value

Revenue streams Regulated revenue

Non-regulated revenue

Revenue under the price control includes:

During the year we invested £16.4m in the creation of biomethane projects.

£1,044m £14m • Return on RAV • Depreciation • Efficient costs Earned from the two distribution networks:

• Provide returns to our stakeholders by efficient performance against allowances. • Strong performance under our incentive schemes. • Unregulated margins in sustainable areas that complement our corporate goals.

Through investment in areas such as biomethane, we are developing a sustainable unregulated business.

• Southern £716m • Scotland £328m

Our business model serves 5.8 million customers with 21 depots across Scotland and southern England, covering one third of Great Britain’s land mass. RAV at £4.9bn accounts for 29% of the UK RAV.

SGN Annual Report and Accounts 2015

Innovating with biomethane

‘ A highly innovative approach to advance green gas injection into the UK’s gas networks.’ Alan Midwinter

SGN Biomethane Project Manager (Gas Industry Engineer of the Year 2015)

Chief Executive’s statement (continued) Location: Portsdown Hill, Portsmouth Initial injection capacity: 4,000scmh (standard cubic metres per hour) Opened: August 2014

Prior to the development of this current project, the site was part of our network where gas pressures are reduced before entering the network. This innovative project has seen the development of an on-site gas terminal which can accept compressed gas delivered by road tanker from various sources, such as biomethane projects. Portsdown Hill now has five gas terminals which open up the market to numerous developers by reducing network injection costs and allowing gas producers who are far from the network to inject their ‘green’ gas into the grid. With its high flow rate, costly and carbon-heavy propane does not have to be added to the injected gas.

Strategic contribution

Non-regulated business growth As well as representing a huge innovation for the UK gas industry, it has also helped us towards our strategic goals of increasing the environmental sustainability of the gas network as well as helping to deliver non-regulated profits.

Gas networks’ regulation

Gas network companies are subject to economic regulation through Price Control Reviews set by industry regulator Ofgem. The current eight year price control (RIIO) commenced in April 2013 and runs through until March 2021. Revenues are earned through charges levied on network users, to cover costs and earn a return on the regulated assets of both network companies. Ofgem also has incentives in the price control to encourage greater efficiency, innovation and delivery of an enhanced standard of service for customers. In the first two years of RIIO we have performed well against the outputs set by the regulator, including those for innovation, customer satisfaction and stakeholder engagement.

Emergency: exceeding targets

We have both a desire and obligation through our operating licence to protect people and property. This includes the essential standard of attending uncontrolled gas escapes within one hour of notification at least 97% of the time. In 2014/15 we achieved 98.67%, exceeding Ofgem’s important target, which we have done every year since our formation. A key to this success is our advance contingency planning, which includes well-established processes to ensure quick and effective mobilisation of our resources.

Upgrading our network

Continually improving our network matters. In the last financial year we invested £369m on mains replacement and capital works to maintain, refurbish and replace our pipe network, ensuring a safe, warm and secure future for all our customers. In the ten years since our formation, we have consistently delivered the approved iron mains decommissioning length, as required by the Health and Safety Executive (HSE), for both of our network areas. During the year we replaced 1,042km of metallic pipe with polyethylene plastic pipe and since

SGN Annual Report and Accounts 2015

Chief Executive’s statement (continued) 2005, we have replaced some 8,535km of metallic gas mains. We now have replacement plastic gas mains in around 65% of our southern region network and around 72% across Scotland. This new plastic pipe not only improves the security and reliability of our network but reduces gas escape and associated repair work. Most importantly, through our investment we have reduced the risk of gas explosion by over 60% from pre-2005 levels.

Connecting people with gas

In 2014/15 we connected over 22,000 new meter points to our two gas networks with our on-line quoting system, which produces over 1,000 quotes a month. We combine social action and environmental awareness with the connection of fuel poor customers to our networks. The fuel poor network extension scheme was introduced by Ofgem to provide gas connections at a discounted price to vulnerable customers, helping alleviate fuel poverty. In 2014/15 we made 4,957 such fuel poor connections bringing our total to over 25,000 since 2009.

Delivering excellence in safety

Our approach has always been to engage our people at every level in a positive and productive way, encouraging ownership, authority and accountability. Our internal safety initiative ‘Raising the Standard’ will look to take our safety performance to new levels, ensuring we continue to keep the public and our people safe and secure. Our safety first value has two clear goals: • Deliver excellence in safety and operational performance. • Ensure no-one is harmed in the course of our work. We aim to embed safety behaviours in everything we do. During 2014/15 we held a number of ‘Raising the Standard’ mini-safety conferences throughout our company where teams developed improvement plans which are being implemented through local safety forums.

Locations: Galashiels and Worthing Date: March/April Legacy: training for local agencies to recognise instances of fuel poverty

Mains replacement – Galashiels We were carrying out a high profile mains replacement project in the centre of the Scottish borders town of Galashiels. Here we opened a pop-up energy café to provide information on our project and offer five days of energy efficiency advice working in partnership with Energy Action Scotland (EAS), Home Energy Scotland, Scottish Borders Council and Citizens Advice. Network extension – Worthing Here a network extension scheme took place in an area of multiple deprivation. We engaged with the local community to highlight the benefits of a fuel-poor connection and also provided energy efficiency advice from Communities Matter.

Strategic contribution

Maximising the benefits of stakeholder engagement As part of our strategy review our stakeholders said they wanted us to continue to focus on affordable warmth for our existing gas customers as well as supporting those in off-gas grid communities in fuel poverty. We piloted pop-up energy cafes with partner organisations in Brighton, Worthing, and the Scottish borders to support our activities.

Engaging with the community

‘ We’re delighted to be working in partnership with experts from Energy Action Scotland and Communities Matter to provide energy advice for the local community.’ Robbie Stevenson

SGN Social Strategy Manager

SGN Annual Report and Accounts 2015

Chief Executiveâ&#x20AC;&#x2122;s statement (continued) We have also developed an enhanced performance management process where all our operations managers have a daily conversation with each member of their team. Weekly performance discussions are held, enabling managers and their teams to collaborate in developing safety solutions and exploring best practices.

Stakeholder engagement

Underpinning our business plan is our stakeholder engagement strategy. During the year we were awarded ÂŁ2m under the Ofgem RIIO incentive for stakeholder engagement, recognising our positive approach to this activity.

of a mix of components which must comply with national regulations. Since the announcement National Grid was to close its Avonmouth Liquified Natural Gas (LNG) plant, we have been developing an enduring solution to maintain energy supplies for our mainland SIUs.

With backing from Europe, existing UK and Scottish Governments this project will help increase the future sustainability of the gas distribution networks, driving the development of hydrogen technologies and complementing our greening the gas strategy.

All alternative supply options were evaluated in terms of cost and ability to meet the timescale and we concluded an alternative LNG was the only solution to meet the timeline and ensure continuity of supply.

Opening up the gas market

Gas to the West

Through a variety of views expressed at these sessions, we believe we have a clear mandate to continue investing in the long-term safety and reliability of our gas distribution network.

In February 2015, with our partner Mutual Energy, we were awarded conveyance licences for the Northern Ireland Gas to the West project. This investment of around ÂŁ250m will involve the construction of 205km of high and intermediate pressure pipeline and 500km of gas mains and services, bringing natural gas to around 40,000 customers in eight towns in the west of Northern Ireland. Construction is planned to commence during 2015 and continue into 2017, with the first connections planned towards the end of 2016 and first revenue earned in 2017.

Scottish Independent Undertakings (SIUs)

Biomethane and unconventional gas

We held a number of engagement sessions with external stakeholders, covering a diverse range of our activities, including fuel poverty seminars which helped shape strategy.

In late 2014 National Grid announced its intention to close the LNG Avonmouth plant in 2016 (two years early), which meant we had to seek an exemption to the Gas Safety Management Regulations from the Health and Safety Executive (HSE) to enable us to use imported LNG during the intervening period for our SIUs. The gas we use in GB is made up

We continue to be highly innovative in this field, recently opening our biomethane injection site at Portsdown Hill, bringing gas from locations across the south and helping us meet our target of 250,000 customers on green gas by 2021. We are also a partner in the Aberdeen hydrogen bus project, led by Aberdeen City Council.

Our on-going and innovative project in Oban, funded by Ofgem is looking to establish a wider envelope of gas quality which can be used in GB gas networks. The project progressed well during the year with the successful completion of stage one involving visiting a number of homes. We are now into stage two where we will visit all 1,100 gas customers to test three different mixtures of bottled LNG on their home appliances. Initial indications are positive and if the overall project is successful, it could lead to more secure, affordable gas supplies for the whole country. Because the gas we use in GB is made up of a mix of components which must comply with national regulations, gas from places other than the North Sea currently have to be processed to change composition, simply adding cost to end bill. We believe our project will show that gasses already being used successfully in other European countries will be perfectly safe to use in GB.

Making innovation happen

Essential works from emergency repairs to planned network upgrades can cause disruption to road users and local communities alike. To speed-up our works, we have been

Photos on left:

Rebranding out street works materials with new SGN signage is starting to roll-out across all our sites. New tablets are being rolled-out to our field teams to improve service and efficiency.

developing a number of innovative techniques along with partners. These include our award-winning CISBOT system, a robotic technology offering a step change in the methods used to repair and prolong the life of our ageing cast iron network. Working with US-based ULC Robotics we have now developed a new cast iron joint sealing robot known as Large CISBOT. This can repair cast iron pipes through a small excavation using single box truck, greatly reducing excavation and inconvenience to the public. We have further developed our Core & Vac technology to enhance no-dig techniques and increase the safety benefits, minimising excavation size and reducing the likelihood of an electricity cable strike. We now operate with 600mm, 450mm and 300mm cores depending on circumstances. During the year we invested £1m in the next generation of mains insertion cameras. Used to locate joints up to 100m along the inside of the gas main, these allow our teams to effect faster repairs while minimising excavation.

Customer service a priority

Through increased training and customer satisfaction workshops we have reduced complaints during the year by 11% compared with the previous year. This is an overall reduction of 61% since 2009/10. In addition our customer satisfaction scores are at an all time high, ensuring we are well placed for the customer service incentives which operate under the RIIO price control incentive.

Photos on right:

Our teams taking part in the Barnardo’s cycle ride raised £8,000. Engineers working on a gas incident in Poole get a personal thank you from a customer.

Outstanding training

Team manager coaching and development programmes have now been rolled-out within our operational depots both north and south and have been well received. We continue to recognise the issues of an aging workforce and in 2014/15 had 3,000 applicants for our apprenticeship courses. Currently we have 147 trainees on our apprenticeship programme with an additional 24 new graduates and trainees this year. External recognition of the value of our programme came with a place among the finalists in the National apprenticeship awards.

Giving back to communities

The industry fuel poor network extension scheme is currently under regulatory review. In our response to the consultation, we are urging Ofgem to ensure any new criteria target the worst affected fuel poor households. We anticipate a final outcome on the consultation by mid-2015. Through our Community Action Programme (CAP), our employees receive a paid day-off each year for direct involvement in valuable community work. The scheme benefitted many good causes with 1,267 of our people taking part. During 2014/15 we achieved £516,874 equivalent community investment. In addition we gave £49,760 in matched funding, supporting our employees in their fund-raising endeavours and offering matched-funding up to £500 for each charity.

Pop-up energy cafés As part of our strategy reviewed last year our stakeholders told us they wanted us to continue to focus on affordable warmth for our existing gas customers as well as supporting those in off-gas grid communities who are in fuel poverty. Designed to support aspects of our work and community activities, we piloted pop-up energy cafes with partner organisations in Brighton, Worthing, and the Scottish borders. Barnardo’s During the year we reached our £25,000 target set for children’s charity Barnardo’s, our chosen company charity of the year. This was achieved by company-wide efforts, including a UK-wide cycle event which alone raised £8,000. RVS Through a partnership with the Royal Voluntary Service (RVS), we supported its Winter Wellness campaign, targeting older and vulnerable people with 65,000 Winter Wellness leaflets. Our employees also helped out at ‘Winter Wellness’ information events across the UK. Outward Bound Trust Through our developing partnership with the Outward Bound Trust, we sponsored 96 students in three schools in Southwark, Portsmouth and Glasgow to attend a programme with eight of our employee ambassadors. Participating employees had an opportunity to help the trust in its objective to deliver a better future for disadvantaged young people,

SGN Annual Report and Accounts 2015

A gas pipeline for Northern Ireland Gas to the west natural gas pipeline routing

Key Existing gas transmission system Potential Gas to the West HP system Potential Gas to the West IP system Strabane connection In Londonderry and Portadown we’ll be connecting to the existing gas transmission system

‘ I congratulate Mutual Energy and SGN on being awarded the licenses to bring gas to the west of Northern Ireland. Natural gas provides an affordable, cleaner and convenient form of energy and this is a further vote of confidence in the natural gas industry and a welcome new investment in our energy infrastructure.’

Jenny Pyper

Chief Executive of the Northern Ireland Utility Regulator

Chief Executive’s statement (continued) Location: Northern Ireland Investment: £250m Duration: 2015-2018

Our £250m Gas to the West project is a partnership with Northern Ireland based Mutual Energy to build a new gas pipeline in the west of Northern Ireland making natural gas available for the first time to eight towns and 40,000 homes and businesses. In a winning joint-bid with Mutual Energy in August 2014, the Northern Ireland Regulator granted us the Low Pressure licence and Mutual Energy the High Pressure licence. We have now set up SGN Natural Gas and under this banner will install, own and maintain 128km of Intermediate Pressure pipeline and 500km of Medium and Low Pressure network. Mutual Energy will own and operate 76km of High Pressure pipeline, which we will build and provide maintenance services.

Strategic contribution Unregulated revenue

Investing in new projects outside our traditional operational areas such as the Gas to the West project in Northern Ireland will add value and bring new opportunities to our company, helping us maximise our income from other sources.

initiating positive change and a sense of achievement through guidance and encouragement. London Road Safety We combined with the London Road Safety Campaign to give a helping hand to the safety of London school children by providing road safety officers with 33,000 reflective safety shiners. The reflectors were to raise safety awareness and to help children to be seen as they walked to and from school.

Awarding innovation and success

We won three awards at the 2014 Utility Week Stars Awards, held to celebrate the best of individuals and teams from across the utilities sector. In the Utility Industry Achievement Awards we collected the award for excellence in streetworks, which specifically recognised our robotics programme. In the gas industry awards we won an award for excellence in Customer Service Being recognised for our safety credentials matters to us. Here we achieved two more gold awards in the 2014 RoSPA occupational Health and Safety Awards. The RoSPA gold acknowledges companies for achieving high levels of performance, demonstrating well developed occupational health and safety management systems and culture. In individual awards, our Project Manager Sam Wilson won the Innovator of the Year Award 2014 from the Innovation Institute; Tracey McIntyre our Head of Operations (Replacement) won the Construction and Engineering section for the Women of Achievement Awards 2014; and our Company Secretary and Solicitor Nicola Shand won a bronze award in the In-house Lawyer of the Year category in the UK-wide Lawyer of the Year Awards 2014.

SGN Annual Report and Accounts 2015

Key performance indicators We measure our success in achieving our objectives through the use of quantitative assessments and, where these are less relevant, through the use of qualitative assessments. Our principal key performance indicators (KPIs), which are used to assess whether principal operating objectives have been achieved, are set out below:

Financial KPI

Performance and strategic objective

Operating profit

Operating profit is the profit before financing charges and taxation. It includes controllable operating costs and is a key profit related measure of performance. The operating profit increase is due to a combination of prior year income recoveries and the timing of allowances set at the commencement of the price control.

2015 Actual

£372.5m

2014

£359.1m

Additions to tangible fixed assets include new distribution mains and storage, new connections to existing mains, new governors and meters, and new investment in IT, land & buildings, vehicles & plant.

2015 Actual

Replacement expenditure is charged to the profit and loss account as incurred under UK GAAP. It represents the cost of renewing sections of gas network with modern polyethylene pipes to improve future safety and reliability. The sections replaced include mains and smaller diameter service pipes, which connect customers to mains. In total 1,042km of pipes were replaced in the year.

2015 Actual

£223.2m

2014

£222.7m

The Group’s net debt to Regulatory Asset Value (‘RAV’) ratio. RAV is defined as Ofgem Regulatory Asset Value of both networks plus adjustments relating to the sharing of out/under performance against allowances. Debt for the purposes of the Debt to RAV ratio excludes shareholders’ loans and liabilities arising from derivative financial instruments, and is net of cash. The percentages stated are as at 31 March.

2015 Actual

72.3%

2014

72.2%

2013

71.7%

Capital expenditure

Replacement expenditure

Debt to RAV ratio

Data

2013

£225.3m

2014 2013

2013

£145.8m £99.0m £145.0m

£253.0m

Operational KPI

Performance and strategic objective

Data

Employee lost time incidents

This is defined as the number of incidents per 100,000 hours worked that result in employees taking time off work. This is one of the key operational metrics that is monitored on a consistent basis. Safety is one of our core company values and is monitored closely by the Board.

2015 Actual

Customer satisfaction: planned interruptions

Results from customer satisfaction surveys (10 = very satisfied) are based on reports obtained for the nine month period ended 31 December 2014. Planned interruptions on our replacement, capital or routine maintenance works are where timing can be predicted and the customer has been notified in advance.

2015 Actual

Customer satisfaction: unplanned interruptions

Results from customer satisfaction surveys (10 = very satisfied) are based on reports obtained for the nine month period ended 31 December 2014. Unplanned interruptions arise through leakage or other emergencies.

2015 Actual

9.2

2014

9.1

2013

9.1

Escapes attendance

This represents the proportion of uncontrolled gas escapes attended within one hour (target 97%). Uncontrolled gas escapes are defined as those where the smell of gas persists and where the gas supply is still â&#x20AC;&#x2DC;onâ&#x20AC;&#x2122; at the time the customer calls. We responded to over 140,000 uncontrolled and almost 80,000 controlled gas escapes during the year ending 31 March 2015.

2015 Actual

Customer complaint volume reduction

Year-on-year our complaints reduce and since 2009/10 we have reduced them by 61%. Complaint means any expression of dissatisfaction related to any areas of our operation.

2015 Actual

Business carbon footprint %

This measures direct (scope 1) and indirect (scope 2) emissions percentage decrease, which are under our own control. From a baseline of 2013 we have had two reportable years. Scope 3 emission definitions and inclusion are currently under discussion with Ofgem and are excluded from this measure.

2015 Actual

2014

0.04

0.01

2013

0.08

8.6

2014

8.6

2013

8.3

98.7%

2014

98.7%

2013

98.4%

2014 2013

2014

11% 26% 27%

6.4 5.9

SGN Annual Report and Accounts 2015

Financial review We have set out below our financial review for the year ended 31 March 2015. The results for the period are reported under UK GAAP including FRS 25, 26 and FRS 29. The comparative figures presented are for the year ended 31 March 2014, as reported in the audited financial statements, unless otherwise stated.

We have continued to build on our progress from last year, sustaining our performance, and investing in the network for the future. The reorganisation of some of our business operations has helped us achieve this, along with our focus on planning and innovation. We have successfully secured further financing during the year that has strengthened our position in advance of some long term debt maturities. This included issuing a £350m 10 year bond, securing a further £400m of funding from the European Investment Bank, and extending our Revolving Credit Facility agreement to July 2019, increasing the limit from £280m to £350m. We describe the year in more detail below including our key financial policies.

Financial performance

The increase in operating profit to £372.5m (2014: £359.1m) was primarily driven by movements in turnover and operational savings. The movement in turnover was due to the timing of allowances set out at the start of the price control period, and growth in our unregulated revenue base. Actual expenditure was lower than our regulatory allowances due to a continued focus on efficiency.

Network investment

Investment in the distribution network is a key priority to maintain safety and integrity of our distribution system. The total network investment in replacement and capital expenditure was £369.0m (2014: £321.7m). The Regulatory Asset Value increased by 0.7% in the year from £4.88bn to £4.92bn.

Key financial highlights

Turnover

2015 £m

2014 £m

2013 £m

1,099.9

1,096.8 359.1 249.1 112.0

965.3

222.7 99.0

253.0

3,535.6 4,882.0

3,430.6

Operating profit

372.5

Net finance costs

235.0

Profit/(loss) for the financial year

102.5

Replacement expenditure

223.2

Capital expenditure

145.8

Long term debt*

3,419.1

Regulated Asset Value

4,917.0

225.3 237.9 (20.7)

145.0

4,783.0

*excludes shareholder loans

Regulated Asset Value (RAV) and Total Network Investment (TNI) TNI (£m)

RAV (£bn) 5.00

1000

4.50

900

4.00

800

3.50

700

3.00

600

2.50

500

2.00

400

1.50

300

1.00

200

0.50

100 0

0.00 2009

2010

RAV (£bn)

2011

TNI (£m)

2012

2013

2014

2015

Replacement expenditure We renew our iron pipes with modern polyethylene pipes to improve the safety of the existing network. Replacement expenditure, primarily of iron pipes, increased marginally to £223.2m (2014: £222.7m). During the year we replaced 1,042km of metallic pipe (2014: 1,088km). Since the start of the programme in 2002, we have replaced 8,535km, contributing to a safer network. Capital expenditure Total capital expenditure increased to £145.8m compared with prior year (2014: £99.0m) due to increased expenditure on local transmission systems, investment in our IT infrastructure and vehicle fleet. Capital expenditure is incurred to ensure the networks continue to operate at optimum pressures and sufficient storage capacity is available to meet instances of peak demand. New connections or increases in capacity to the networks also necessitate capital expenditure.

Treasury policies and capital structure

Financing consists of a mixture of equity, loans from shareholders and long-term debt. Investment expenditure and operations are mainly financed by long-term bonds and bank borrowings. Our funding and liquidity are managed within a framework of policies and guidelines authorised by the Board of Directors. Further details are set out in the Directors’ Report on page 29.

Long-term debt maturity profile 0-2 years

3-5 years

6-10 years

11-20 years

over 21 years 0

100

200

Floating rate

300

400

500

Fixed rate

As a matter of policy, a minimum of 75% of debt excluding shareholders’ loans is maintained at either fixed rates of interest or index-linked. This policy is kept under review from time to time. Interest rate swaps are used where necessary, to achieve the desired profile. We manage the maturities of debt and facilities to ensure no significant refinancing is required in any one period, thereby giving us access to competitively priced debt. In addition, the debt interest outflows are managed to ensure a competitive interest risk profile to allow us to meet our financing objective of at least 75% fixed rate or index linked interest.

600

700

800

900

1000 1100

1200

Index linked

At 31 March 2015, net debt (before issue costs), excluding shareholders’ loans and liabilities arising from derivative financial instruments, amounted to £3,555.2m (2014: £3,522.9m) and the debt to RAV ratio was 72.3% (2014: 72.2%). Of the total long-term borrowings at 31 March 2015, excluding shareholders’ loans and after taking into account the effect of interest rate swaps, 87.8% were at either fixed rates of interest or were index-linked (2014: 85.5%). The net interest costs for the year were £235.0m (2014: £249.1m). The net mark to market loss for the year ended 31 March 2015 was £4.8m, compared with a loss of £13.8m in 2014. Accretion charges on index linked bonds were lower at £20.3m (2014: £28.5m).

SGN Annual Report and Accounts 2015

Financial review (continued)

During the year we successfully issued a £350m 10 year bond with a fixed rate coupon of 2.5% strengthening our position in advance of debt maturities.

At 31 March 2015, there was a net derivative liability of £45.3m before tax on the balance sheet (2014: £27.9m). Appropriate interest rate swap contracts are used to achieve the target interest risk profile. FRS 26 requires these swaps to be valued at ‘fair value’, which is calculated using market based interest rate information at the year end. No new derivative contracts were entered into during the year. In line with the gearing objectives, we believe in maintaining a strong balance sheet and an investment grade credit rating. The credit ratings of our two network companies as at 31 March 2015 were: • ‘Baa1’ with stable outlook (Moody’s); • ‘BBB+’ with stable outlook (Fitch ratings); and • ‘BBB’ with stable outlook (Standard & Poors).

Liquidity and cash flows

Liquidity is maintained through a mixture of long-term borrowings and short-term liquid funds to ensure there are sufficient funds available for our current and planned operations. Committed facilities are in place in order to provide funding for future capital and replacement expenditure, as well as to provide sufficient available facilities to meet our seasonal working capital requirements.

Movement in long-term debt (£m) 3,600

3,535.6

-445.8

3,500 +381.1

3,400

+23.2

3,419.1

Other

2015 long-term debt

3,300 3,200 -75.0

3,100 3,000 2,900 2,800 2,700 2,600 2,500 2,400 2014 long-term debt

Transfer to short-term debt

Revolving credit facilities

During the year we successfully issued a £350m 10 year bond with a fixed rate coupon of 2.5% strengthening our position in advance of debt maturities. Additionally we secured a further £400m of European Investment Bank funding which will finance our investment programme; £35m was drawn down on this facility at the year end. As at 31 March 2015, the undrawn amount of the revolving credit facility was £350.0m (2014: £205.0m). The revolving credit facility was amended and extended during the year. The limit is now £350.0m (2014: £280.0m) and it has a five year term ending in July 2019.

New debt issued

Net cash inflow from operating activities for the year amounted to £500.2m (2014: £401.0m). The net cash outflow from returns on investments and servicing of finance increased slightly from the prior year to £201.1m (2014: £197.1m). Net investment cash outflow for the year was £115.7m (2014: £78.0m), the increase being due to network and support infrastructure investment. After taking into account movements in short-term deposits and financing items, cash increased by £8.8m in the year (2014: decrease of £1.2m). During the year we paid dividends of £150.0m (2014: £165.0m).

We have continued to build on our progress from last year, sustaining our performance, and investing in the network for the future.

Pension commitments

A significant proportion of our employees are members of the Scotia Gas Networks Pension Scheme which provides final salary defined benefits for members. In accordance with FRS 17 (Retirement Benefits), our balance sheet accounts for any pension asset or liability. The net pension liability as at 31 March 2015 was £47.6m (2014: £55.9m). Following the valuation carried out by the scheme’s actuary as at 31 March 2012, annual special pension contributions remain at £23.5m annually until 31 March 2025 to repair the deficit in the defined benefit pension scheme. Employer normal contributions remain at 37.3%.

Dividend policy

Our policy is to distribute to shareholders any available surplus funds, after taking into account the cash requirements needed to continue to invest in the business and our level of gearing.

Counterparty credit risk

The Group transacts with banks for the provision of interest rate and currency hedging transactions. The Group takes reasonable steps to maintain a minimum credit rating requirement as set out in its hedging policy; however, it recognises that at times the market conditions for banks can be unusually tight.

At the year end there was £23.4m (2014: £23.8m) receivable and £169.4m (2014: £167.9m) payable relating to financial instruments with bank counterparties.

Accounting policies

Our accounting policies are set out in note 1 to the financial statements. These accounting policies have been applied consistently during the year and in the preceding year and, as previously highlighted in this report, operating profit is stated after writing off replacement expenditure during the year.

Chris Brook Chief Financial Officer 24 July 2015

SGN Annual Report and Accounts 2015

Principal risks and uncertainties An essential facet of responsible and prudent corporate governance is that risk must be understood, communicated and managed effectively. The Board achieves this by demonstrating strong and visible leadership, setting the maximum tolerable risk for the company and ensuring full engagement and involvement of people throughout the organisation. The principal risks and uncertainties identified are as follows:

Description and impact of risk

Mitigation

Risk priority in 2014/15

Health and safety Failures in the design or implementation of our health and safety management system may result in unsafe behaviour and working practices resulting in injuries or fatalities involving staff, contractors or members of the public; asset damage or loss; and prosecution under relevant legislation.

Safety is the first of our core company values. The Safety, Health and Environmental Advisory Committee of the Board is responsible for ensuring our safety, health and environmental policy is adhered to.

No change

We have experienced regulation, finance and legal teams that manage and engage with all levels of Ofgem and Government. Regulatory returns are submitted following rigorous reviews and are approved by external audit and the Board.

No change

We have policy and public affairs specialists who engage openly and constructively with legislators, officials and other policy makers on all aspects of energy and related environment policy.

Increased priority Uncertainty in the political arena and possible changes in government policy.

Our gas control centre oversees a process of asset integrity and risk based management. Regular emergency exercises and testing are conducted at key sites. Capital spending and maintenance programmes are maintained and the Risk Committee and Engineering and Safety Committee provide oversight and guidance.

No change

Regulatory compliance Failure to comply with regulatory requirements could result in prosecution; damage to our reputation; and financial penalties.

Regulatory and legislative change Regulatory, legislative or political reform could have an adverse impact on our business model.

Asset management systems Failures in the design or implementation of our asset management systems including health, physical security and integrity may result in a major incident leading to loss of life; adverse impact on the environment; loss of assets; prosecution under relevant legislation; and failure to meet our licence conditions.

Description and impact of risk

Mitigation

Risk priority in 2014/15

Data protection and cyber security Failures in the design or implementation of IT security systems could result in unauthorised access to our IT systems; unauthorised or fraudulent disclosure of sensitive information; and vulnerability to external cyber attack.

We have a managed information security programme across all our activities to ensure resilient business operations.

No change

Funding strategy papers are regularly presented to the Board. There is regular dialogue with banks and credit rating agencies and key metrics are built into the business planning process. Detailed financial policies are continually monitored, as set out further on page 16.

No change

There are periodic formal valuations of pension schemes and contributions supported by continual monitoring of scheme investments and valuations.

Increased priority Low inflation/ deflation impact.

We have a comprehensive workforce planning and recruitment programme to ensure optimum resource management, including safety, HR, IT and finance.

No change

Business continuity plans are in place throughout the company and are reviewed continually. Regular test exercises are undertaken. We are also listed under the utilities fuel scheme as part of the national emergency fuel plan.

No change

Effective stakeholder engagement and continued cost savings and efficiency improvements. Also, we publish our own distribution prices.

Increased priority Heightened media activity on energy prices and continued political focus.

Funding strategy Inability to finance our functions due to deterioration in the economic climate; lack of availability of finance; external events; and failure to meet regulatory targets.

Pension liabilities/financial performance Liabilities increase due to market conditions or demographic changes or when investments underperform.

Recruitment and retention of a competent workforce The design or implementation of our policies, procedures and reward structures may result in difficulty recruiting and retaining sufficient competent people to carry out our operations safely, efficiently and in compliance with all regulatory obligations and shareholder expectations.

Crisis management Failure in the design or implementation of crisis management systems may result in an inability to deal with a major crisis; reputational damage; and regulatory enforcement action.

Energy affordability and delivery Risk that rising energy prices to customers will result in an increase in the number of households defined as being in fuel poverty; political pressure on energy suppliers; and hostile media attention.

SGN Annual Report and Accounts 2015

Corporate responsibility Corporate Responsibility remains high on our agenda being an integral part of our core values: • To keep our customers warm and secure by delivering gas safely, reliably and efficiently • To minimise our effect on the environment and have a positive impact on local communities • To create an inclusive and engaged workforce proud to work and do their best for SGN We aim to build partnerships with local communities, councils, charity, organisations and suppliers to identify vulnerable customers and better meet their needs. For this we have developed existing relationships with a number of organisations supporting vulnerable customers including Royal Voluntary Service (RVS), Age UK London, Macmillan Cancer Care Support and the Blue Lamp Trust. We are also proud to have joined Age Action Alliance. We are also identifying initiatives with other gas network companies to tackle the issue of fuel poverty collaboratively including innovative projects to support off-gas grid households. During the year we reviewed our fuel poverty strategy to include district heating and park homes, holding two ‘Help to Heat’ seminars with key stakeholders to review and inform this strategy. Providing support for district heating schemes and park homes is also a key deliverable of this strategy. We have committed through our community strategy to maximise our effect on the local communities affected by our works. We do this through volunteering in our employee Community Action Programme, understanding community needs and lending our skills to build practical community interaction opportunities and support.

Gregor Alexander Chairman 24 July 2015

Community investment: £516,800 Annual Community investment target: £500,000 Investment per employee: £140

Showing our support to charitable fund-raising activities and local causes which matter most to our people has resulted in a good year, maximising our effect on local communities and minimising our impact on the world. Our corporate community investment using an accredited benchmarking model has revealed our total community investment for this year was £516,800 (2013/14: £265,100). This includes cash donations, resources and where we have influenced others to support charities or campaigns. We use this model to ensure we are consistent in how we show our community investment and can benchmark it against previous years. Through this we also benchmark ourselves against other companies, share experiences, best practices and new ideas. This year’s achievement exceeded expectations, doubling our total community investment from the previous year.

Strategic contribution Making a real difference in our communities

We maximise our effect on local communities and we minimise our impact on the world. We look for the best in any situation and every interaction is an opportunity for us to demonstrate what we can achieve.

Community benchmarking

‘ We show our support through charity fundraising activities and local causes which matter most to our employees.’ Pamela Goee

SGN Head of Community

SGN Annual Report and Accounts 2015

Chairman’s statement Now in the second of the eight year RIIO regulatory price control, the year has again been a challenging one for the energy industry. There continues to be regulatory and political scrutiny for not just the energy suppliers but also the network operators such as ourselves. Against this backdrop, I am pleased to say we have continued to work hard to deliver a safer and increasingly secure gas supply to the UK, offering a quality of service for all our customers as well as exceptional value for money.

Gregor Alexander, Chairman

‘ The Board has a clear vision of what it wants our company to look like by the end of the current price control running up to 2021.’

Help to Heat We’re supporting low income and vulnerable people in fuel poverty by offering discounted connections to our gas network through our Help to Heat scheme. We are targeting 20,000 connections by 2021.

The Board has a clear vision of what it wants our company to look like by the end of the current price control running up to 2021. Our company strategy outlines what we want to achieve and sets out our priorities of working together to ultimately ensure gas remains a vital part of the UK energy solution beyond 2021. We remain confident gas has a long-term future and believe by implementing our strategy with purpose, passion and principle we can secure an exciting future for our company.

Climate Change Select Committee

In February the Energy and Climate Change Select Committee published a report following its intense inquiry into energy network costs across the UK’s electricity and gas transmission and distribution networks. We welcomed the debate this inquiry brought to energy networks and were pleased to see it highlighted the widespread support for robust and rigorous regulation of the

networks, recognising the importance of stability and market confidence in keeping cost to customers as low as possible. It demonstrated we have in the UK one of the most reliable energy networks in the world, providing customers with some of the lowest costs in Europe. Outputs and performance for customers will continue to improve into the next decade while the networks component of their bill will stay broadly flat or even fall. The cost of Britain’s networks has fallen by around 17% in real terms since privatisation while investment of almost £80bn has secured safer, more reliable and more efficient infrastructure. Our continued investment in replacing and maintaining our existing infrastructure and assets, while at the same time ensuring our networks adapt to meet the challenges of a low carbon economy, are vital to the UK’s energy future.

Focus on priorities

Our priorities in the coming year are to focus on and meet our financial and operational targets, and respond to changes in any government policy resulting from the 2015 General Election. They include maximising the efficiency of our regulated activities to drive cost savings back to our customers, tackling fuel poverty through our ‘Help to Heat’ strategy and developing relationships with powerful stakeholders to influence energy

policy change, in particular any which affects the gas industry. We will continue to actively support the green gas agenda by working towards supplying 250,000 homes with biomethane by 2021 and at the same time will look to investigate the development of heat networks and the increasing emerging alternative sources of gas such as synthetic and hydrogen. Innovation remains key to our success and as well as seeking-out new technologies to advance our industry, we will continue using newly-developed innovative technologies, such as robotics and Core & Vac, to maintain our network efficiently. Our key priorities now stretch right across our business as we aim to deliver excellent levels of safety and operational performance. We also want to meet our regulatory outputs and maximise incentives, while continuing to deliver value for all our stakeholders and deliver a strong financial performance, producing an acceptable shareholder return.

Committed to safety

Safety is and will remain our number one reason for being. The safety of our customers, our own people and the general public is paramount and something in which we all take responsibility. Gas is a basic need for the majority of UK households providing warmth and security of supply in the most harsh of winter conditions to domestic customers. It also provides a vital

Robotics This world-leading project allows extensive work to be carried out on the gas network without disrupting road works. New robotic technologies operate inside the live gas main. These can remotely repair leaking joints and support the pipe fracture risk management inspection process in larger pipes.

resource for industrial and commercial outlets which depend on a reliable service to keep their businesses running. We are proud to be seen as leaders in the UK gas industry, serving our current and future domestic, commercial and industrial customers alike and providing a safe and secure gas supply through the commitment and expertise of our highly trained and professional workforce.

Gregor Alexander Chairman 24 July 2015

SGN Annual Report and Accounts 2015

Board of Directors Executive Directors

Gregor Alexander

Natalie Flageul

Neil Fleming

Gregor joined the Board at its inception and was appointed the Chairman of SGN in July 2011. He is Finance Director of SSE plc and previously worked with the accountancy firm Arthur Andersen. He is a member of the Audit Committee.

Natalie joined the Board in September 2011. She is Director of Metering at SSE plc and over the past five years has overseen the transformation to nationwide coverage in preparation for Smart Meter deployment. She is a member of the Safety, Health and Environmental Advisory Committee.

Neil joined the Board in March 2015 and is a Senior Principal in Teachers’ Infrastructure Group. He is active in the regulated utilities and transportation sectors in Europe. Neil is a member of the Safety, Health and Environmental Advisory Committee.

Robert McDonald

John McManus

James McPhillimy

Robert joined the Board in July 2006. He is Managing Director, Corporate and Business Services at SSE plc and has previously worked with the industry’s regulatory body. Robert is a member of the Audit Committee.

John joined the board in March 2012. He is Senior Advisor to OMERS Private Markets and Borealis leadership team in infrastructure asset management, assessment of investment opportunities, relationship development and mentorship. John is a member of the People and Reward Committee.

James joined the Board at its inception. He is Managing Director, Enterprise at SSE plc. James is Chairman of the Safety, Health and Environmental Advisory Committee and a member of the People and Reward Committee.

Sebastien Sherman

Olivia Steedman

Sebastien joined the Board in March 2007. Sebastien is Executive Vice President and Senior Managing Director, Borealis responsible for the Borealis’ Americas infrastructure business. He is Chairman of the Audit Committee and a member of the Safety, Health and Environmental Advisory Committee.

Olivia joined the Board in July 2008. She is Vice President, Value Creation and Analytics for Teachers’ Infrastructure portfolio. Olivia is the Chair of the People and Reward Committee and a member of the Audit Committee.

Chairman

Director

Non-executive Directors

Senior management team

Paul Jeffery

John Morea

Paul joined the Board in January 2014 as an independent non-executive Director. Previously he ran the European Power, Utility and Infrastructure Investment Banking Sector team for Barclays. Paul is also a non-executive Director of UK Power Networks and Saeta Yield S.A.

John joined the Company in May 2005 from SSE plc. He has over 20 years experience within the utilities industry. John is a companion of the Institute of Gas Engineers and Managers, a member of the Institute of Engineering and Technology and holds an MBA.

Graham Juggins

Chris Brook

Graham joined the Board as an independent non-executive Director in January 2014. He is an electrical engineer and has 38 years of experience in the energy and construction industries holding senior posts, which include Director of Human Resources at SSE plc.

Chris joined the Company in September 2008. Chris was previously Finance Director of United Utilities Water, the regulated water business, before joining the Company. Chris is a Chartered Accountant having trained and qualified with Touche Ross.

Director

Chief Executive Officer

Chief Financial Officer

John Morea and Chris Brook are the senior managers who attend Board meetings.

Registered office St Lawrence House Station Approach Horley, Surrey RH6 9HJ Registered auditor Deloitte LLP Chartered Accountants and Statutory Auditor, London Registered number 04958135

Nicola Shand

Company Secretary Nicola joined the Board as Company Secretary in July 2011. Nicola is Company Secretary and Solicitor of the Company and is responsible to the Board for compliance with Board procedures and for advising and keeping the Board up-to-date on all corporate governance developments.

SGN Annual Report and Accounts 2015

Statement of Directors’ responsibilities The Directors are responsible for preparing the annual report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare the financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the Directors are required to: • Select suitable accounting policies and then apply them consistently; • Make judgements and accounting estimates that are reasonable and prudent; and • State whether applicable UK Accounting Standards have been followed. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time, the financial position of the Company and to enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. The Directors confirm to the best of their knowledge that: • The financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole as at 31 March 2015; and • The Strategic and Directors’ reports include a fair and true view of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of its principal risks and uncertainties. Signed on behalf of the Board of Directors of Scotia Gas Networks Limited:

Gregor Alexander Chairman 24 July 2015

Directors’ report The Directors present their report and the audited consolidated financial statements for the year ended 31 March 2015. The financial statements consolidate the financial statements of the Company and its subsidiary undertakings (together the ‘Group’).

Principal activities

The Company is a holding company which does not trade. The subsidiary undertakings principally affecting the profits or net assets of the Group in the year are listed in note 13 to the financial statements. The Group’s principal activity is the development, administration, maintenance and safe operation of the Southern and Scotland regional gas distribution systems and the supply of associated transportation, connection and metering services. It will continue these activities for the foreseeable future.

Directors

The Directors of the Company who served during the year ended 31 March 2015, are listed below: Gregor Alexander (Chairman) Robert McDonald James McPhillimy Sebastien Sherman Olivia Steedman Natalie Flageul John McManus Juzar Pirbhai (resigned 29 July 2014) Neil Fleming (appointed 24 March 2015) Graham Juggins Paul Jeffery

Directors’ insurance and indemnities

The Directors of the Company have the benefit of the indemnity provisions in the Company’s Articles of Association. The Directors have been granted a qualifying third party indemnity provision which was in force throughout the year. In addition,

the Company has purchased and maintained throughout the year directors’ and officers’ liability insurance in respect of itself, the Group, the Directors and other senior executives of the Group.

Strategic report

The review of business for the year, including an analysis using key performance indicators, together with a description of the principal risks and uncertainties facing the Group are set out in the Strategic Report on pages 4 to 23.

Results and dividends

The consolidated profit and loss account is set out on page 36 and is reviewed on pages 16 to 19. The Group paid interim dividends of £150.0m (2014: £165.0m). The Directors do not recommend the payment of any final dividend for the year (2014: £nil).

Financial risk management

The Group’s funding, liquidity and exposure to interest rate, foreign exchange and credit risks are managed within a framework of policies and guidelines authorised by the Board of Directors.

Interest rate risk

The Group has interest bearing liabilities and as a matter of policy a minimum of 75% of debt, excluding shareholder loans, are maintained at either fixed rates of interest or index-linked. The Group uses interest rate swaps, where necessary, in order to achieve the desired profile.

Liquidity risk

The Group maintains a mixture of long-term funding and short-term liquid funds in order to ensure that

there are sufficient funds available for the Group’s current and planned operations.

Foreign exchange risk

All of the Group’s borrowings are currently denominated in Sterling, so there is no foreign exchange risk. However, in accordance with its policy, should the Group decide to raise finance in currency other than Sterling, cross currency swaps would be used to fully hedge the borrowings into Sterling.

Credit risk

The Company transacts with banks for the provision of interest rate and currency hedging transactions. The Company takes reasonable steps to maintain a minimum credit rating requirement as set out in its hedging policy; however, it recognises that at times the market conditions for banks can be unusually tight. In respect of short-term cash management, counterparties are subject to review and approval according to defined criteria. Trade receivables predominantly relate to transportation income from gas shippers. Credit risk arising from the Group’s regulated business is managed in accordance with industry standards as set out by the Unified Network Code. The Group contracts with shippers having investment grade ratings only, or where suitable collateral or cash prepayments are made.

Pricing risk

The Group’s gas transportation charges are subject to price control formulae set within the regulatory regime. The Group’s maximum allowed revenue in a given price

SGN Annual Report and Accounts 2015

Directors’ report (continued)

The Group places considerable value on the involvement of its employees and has continued to keep them informed on matters affecting them and on the various factors affecting the Group.

period is dependent upon a number of factors that are not known in advance and therefore the maximum allowed annual revenue is not known until the end of the relevant period. However, transportation tariffs are set on a prospective basis, so actual revenue received or receivable in any one year may differ from the maximum allowed revenue. Where revenues received or receivable differ from the maximum allowed annual revenue, adjustments are made to future prices to reflect this over or under recovery.

Employees

The Group places considerable value on the involvement of its employees and has continued to keep them informed on matters affecting them and on the various factors affecting the Group. Participation by employees generally is encouraged through team meetings, briefings, an internal magazine and an intranet site. The Chief Executive Officer and other senior executives regularly communicate with employees through these channels and employee representatives are consulted regularly on a wide-range of matters affecting their current and future interests. Applications for employment by disabled persons are always fully considered, bearing in mind the aptitudes of the applicant concerned. In the event of members of staff becoming disabled, every effort is made to ensure their employment within the Group continues and that appropriate training and development is arranged. It is the policy of the Group that the training, career development and promotion of

disabled persons should, as far as possible, be identical to that of other employees.

Going concern

The Group’s financial position, cash flows, liquidity position and borrowing facilities together with the factors likely to affect its future performance and the Group’s principal risks and uncertainties are set out in the Strategic Report on pages 4 to 23. The Group’s financial risk management objectives and risk exposures are set out above. As stated in the Strategic Report the Group operates the regulated gas distribution networks in south of England and Scotland. The revenue of the Group is regulated by Ofgem through established price control mechanisms based on the distribution network capacity. The Group has considerable financial resources together with committed financing facilities as discussed in note 16 to finance the current and future operations. The shareholder loans were refinanced after the year end, with further details in notes 27 and 28. The Group’s forecasts and projections, taking into account reasonably possible changes in trading performance, show that the Group should be able to operate within the level of its current facilities. As a consequence, the Directors believe the Group is well placed to manage its business risks successfully. After making enquiries, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the

foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the annual report and accounts.

Auditor

Each of the Directors at the date of this report confirms that: 1) So far as the Director is aware, there is no relevant audit information of which the Company’s auditor is unaware; and 2) The Director has taken all the steps that they ought to have taken as a Director to make themselves aware of any relevant audit information and to establish the Company’s auditor is aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 418 of the Companies Act 2006. Deloitte LLP has expressed their willingness to continue in office as auditor and a resolution to reappoint them will be proposed at the forthcoming Annual General Meeting of the Company. By Order of the Board.

Nicola Shand Company Secretary 24 July 2015

Corporate governance statement The Board of Directors is the principal decision making forum for the Company and is committed to the highest standards of corporate governance. The Board believes that strong governance improves the performance of the Group and enhances shareholder value. This report sets out the key governance principles and practices of the Company and of the Group.

The Company, being unlisted, is not subject to the UK Financial Reporting Council’s UK Corporate Governance Code1 (the ‘Governance Code’) and the Board of Directors does not believe that all of the guidance set out in the Governance Code is applicable to the Company. However, for the purposes of this statement, the Directors have applied the Governance Code insofar as they believe it to be applicable.

Board of Directors

The Board of Directors is comprised entirely of non-executive Directors and is the principal decision-making forum for the Company. Directors are nominated to the Board in accordance with the terms of the Shareholders’ and Governance Agreement. The Board is collectively responsible to the Company’s shareholders for the long term success of the Group and for its overall strategic direction, its values and its governance. It provides the leadership necessary for the Group to meet its business objectives whilst ensuring that a sound system of internal control and risk management is in place. The powers and the duties of the Directors are determined by legislation and by the Company’s Articles of Association. The Board has also adopted a formal schedule of matters detailing key aspects of the Company’s affairs reserved to it for decision. This schedule is reviewed regularly. Furthermore, the Board has established three

standing committees and one non standing committee with specific responsibilities to ensure focused and effective leadership. Details of the committees are set out below. The Board meets regularly and has held six meetings during the year.

Board constitution and appointments

The Board of Directors consists of seven non-executive Directors in addition to the non-executive Chairman. The Board of Directors is the same for the Company and each company within the Group, except for Scotland Gas Networks plc and Southern Gas Networks plc, which consists of two additional independent non-executive Directors. Each of the non-executive Directors are chosen for their diversity of skills and experience. The non-executive Directors: scrutinise, measure and review the performance of management; constructively challenge and assist in the development of strategy; review the Group financial information and ensure systems of internal control and risk management are appropriate and effective. Biographical details for each of the Directors are set out on pages 26 to 27.

Chairman

Gregor Alexander was re-appointed as Chairman on 24 July 2014 for a further three year period.

he UK Corporate Governance Code was issued in May 2010 (replacing the Combined Code on Corporate T Governance), applies to financial years beginning on or after 29 June 2010 and is available on the Financial Reporting Council’s website (www.frc.org.uk).

Chief Executive Officer and Chief Financial Officer

Below the Board, executive responsibility rests with John Morea, Chief Executive Officer (CEO) and Chris Brook, Chief Financial Officer (CFO). The CEO and CFO are each employed by the Group and are not Directors of the Company. They are supported by an executive committee which meets on a monthly basis and is responsible for managing the day-to-day operations of the Group. Biographical details for the CEO and CFO are set out on page 27.

Timeliness and quality of Board information

The Board has sought to ensure that Directors are properly briefed on issues arising at Board meetings by establishing procedures for distributing Board papers one week in advance of meetings; considering the adequacy of the information provided before making decisions; adjourning meetings or deferring decisions when Directors have concerns about the information available to them and making the Company Secretary responsible to the Board for the timeliness and quality of information. All Directors have access to the advice and services of the Company Secretary.

Conflicts of interest

With effect from 1 October 2008, the Companies Act 2006 has

SGN Annual Report and Accounts 2015

Corporate governance statement (continued)

introduced a statutory duty on Directors to avoid conflicts of interest. During the year, the Company Secretary reviewed all of the Directors’ reported actual and potential conflicts of interest and the Board then considered and recorded each Director’s reported actual and potential conflicts of interest. The Board has put into place a procedure to consider any future actual or potential conflicts of interest that the Directors may have and will review the position regularly.

Board Committees

In order to provide effective and focused leadership, the Board has established three standing committees and one non standing committee with specific responsibilities. These are the Audit Committee, the Safety, Health and Environmental Advisory Committee, the People and Reward Committee (standing) and the Finance Committee (non standing). Each Committee’s performance, constitution and terms of reference are reviewed annually to ensure that they are operating effectively. The Company Secretary acts as secretary for each committee and further details are set out below.

Attendance at Board and Board Committee meetings

The attendance of the Board of Directors and the Board committees during the year is as set out in the table on page 33.

Audit Committee

The current members of the Audit Committee are Sebastien Sherman (Committee Chairman), Graham Laughland (appointed in 2009 as independent member of the audit committee), Gregor Alexander, Robert McDonald and Olivia Steedman. Natalie Flageul also regularly attends the Audit Committee. The principal responsibilities of the Audit Committee are as follows: • Ensuring that the Company’s financial reports represent an accurate, clear and balanced assessment of the Company’s position and prospects;

• Ensuring the economy, efficiency and effectiveness of the Company’s operations and internal controls, the reliability and integrity of information and accounting systems and the implementation of established policies and procedures; • Monitoring and reviewing the Company’s internal audit function; and • Maintaining a close relationship with the Company’s external auditor and reviewing the effectiveness of the external audit process. As part of its activities, the Audit Committee also reviews and approves key regulatory filings prior to their issue to Ofgem. The Chairman of the Audit Committee reports to the Board of Directors following each committee meeting on the main areas and subjects the Committee has reviewed such as risk management, internal control, internal audit reports and any issues arising from its review of the financial statements.

reduce or otherwise control personal and process related data; • Reviewing and monitoring the safety, health and environmental compliance and assurance plan (and liaising with the internal auditor in relation thereto); • Setting health and safety and environmental targets to improve the Group’s performance; • Monitoring health and safety and environmental performance against planned targets and identified key improvement areas by means of appropriate leading and lagging key performance indicators; and • Encouraging greater awareness of the importance of health, safety and the environment and higher achievement in performance in these areas. The Chairman of the Safety, Health and Advisory Committee reports to the Board of Directors following each committee meeting on the main areas and subjects the Committee has reviewed. Three meetings were held during the year.

People and Reward Committee

The Board considers that the membership of the Audit Committee as a whole has sufficient recent and relevant financial experience to discharge its functions. The Committee met three times during the year.

The current members of the People and Reward Committee are Olivia Steedman (Committee Chair), John McManus and James McPhillimy. Gregor Alexander also regularly attends the People and Reward Committee.

Safety, Health and Environmental Advisory Committee

The principal responsibilities of the People and Reward Committee are as follows:

The current members of the Safety, Health and Environmental Advisory Committee are James McPhillimy (Committee Chairman), Natalie Flageul, Neil Fleming, Sebastien Sherman, John Morea (Chief Executive Officer) and Gary Barnes (Director of Corporate Services). The principal responsibilities of the Safety, Health and Environmental Advisory Committee are as follows: • Ensuring that the health and safety policy statement and environmental policy statement remain fit for purpose and are being adhered to; • Reviewing and monitoring the safety, health and environmental strategy and action plan, which shall be designed to eliminate,

• To determine and agree with the Board of Directors the Group’s framework or broad policy for executive and senior management remuneration. The Committee has delegated authority for setting the remuneration of the CEO, CFO and their direct reports; and • To review the ongoing appropriateness and relevance of the remuneration policy. The Chair of the People and Reward Committee reports to the Board of Directors following each committee meeting on the remuneration matters which the Committee has reviewed. Three meetings were held during the year.

Finance Committee

The Directors continue to review the Board’s performance and that of its three Committees and individual Directors on an annual basis.

The current members of the Finance Committee are Olivia Steedman, Gregor Alexander and Sebastien Sherman.

Internal Controls in relation to the Company’s financial reporting process

The principal responsibility of the Finance Committee is to authorise specific transactions of the Group, where it has been provided delegated authority by the Board of Directors to do so.

The Board of Directors is ultimately responsible for the Group’s internal control systems and risk management. The Group’s system of internal control and embedded risk management, which has been in place throughout the year, helps to safeguard the assets and is designed to manage, rather than eliminate, material risks to the achievement of the business objectives. The Board recognises that these systems can provide only reasonable, and not absolute, assurance against material misstatement or loss.

The members of the Finance Committee report to the Board of Directors following each Committee meeting on the matters which the Committee has reviewed. Five meetings were held during the year.

Board and Committee Performance Evaluations

During the year, the Board has undertaken a comprehensive evaluation of its own performance and that of its three standing Committees and individual Directors. This was conducted internally using detailed questionnaires which the Chairman then discussed with each Director and the Company Secretary. The Board has considered and discussed the outcomes of the evaluations and is satisfied that it is operating well and focused on the correct strategic issues.

Accordingly, the Directors have regard to what controls, in their judgement, are appropriate to the business, to the materiality of the risks inherent in the business and to relative costs and benefits of implementing specific controls. Internal control is maintained through an organisation structure with clearly defined responsibilities,

authority levels and lines of reporting, the appointment of suitably qualified staff in specialised business areas and continuing investment in high quality information systems. These methods of control are subject to periodic review as to their implementation and continued suitability. There were no changes in the Company’s internal controls over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Internal audit

The Board of Directors has established the scope of the internal audit function which is responsible for reviewing the effectiveness of the Group’s systems of internal control and reports to the Audit Committee of the Board. The internal audit manager reports to the Audit Committee on the audit programme, progress against the programme and any follow-up actions on a bi-monthly basis.

Meeting attendance Board meetings Attended

Audit Committee meetings

Possible Attended

People and Reward Committee meetings

Possible Attended

Safety, Health and Environmental Committee meetings

Possible Attended

Finance Committee meetings

Possible Attended

Possible

Gregor Alexander***

–

Juzar Pirbhai*

–

Natalie Flageul***

–

Robert McDonald

–

James McPhillimy

–

John McManus

–

Olivia Steedman***

Sebastien Sherman

–

Paul Jeffery

n/a

Graham Juggins***

n/a

Neil Fleming**

–

n/a

Graham Laughland

* Juzar Pirbhai resigned on 29 July 2014. ** Neil Fleming was appointed on 24 March 2015. *** During the course of their respective appointments as Directors of the Board, Natalie Flageul was invited to attend meetings of the Audit Committee, Gregor Alexander was invited to attend meetings of the People and Reward Committee, Olivia Steedman was invited to attend meetings of the Safety, Health and Environmental Committee and Graham Juggins was invited to attend meetings of the Audit, People and Rewards and Safety, Health and Environmental Committees.

SGN Annual Report and Accounts 2015

Carbon report Introduction

Our environmental and sustainability policy, which sits at the head of our environmental management system commits us to protecting our world and operating our business in a sustainable and responsible manner. Environmental considerations form a fundamental part of every business decision and we will always consider and mitigate the impact of our activities on the environment. To help achieve the aims set out in our policy, which is annually reviewed and approved by our board of directors, we have developed and implemented an eight year environmental strategy called ‘Greenplan’.

RIIO annual environmental measures

Non Shrinkage BCF

Shrinkage is responsible for the largest single element of our overall business carbon footprint (BCF). As such our first Greenplan goal targets reducing natural gas emissions by 12% between 2013 and 2017. We expect to have achieved the required 6% reduction during the first 2 years by: • Mains replacement programme; • Gas holder removal; • P MAC pressure optimisation; • Use of CISBOT; and • Deployment of Predictive Analytics.

We currently project a 4.4% reduction in our BCF Scope 1 and 2 emissions, over which we have direct control, for 2014-15 compared to the first RIIO reporting year. Scope 1 transport reductions have been achieved through: • Our commercial vehicles replacement programme of replacing older high polluting vehicles with lower weight more efficient ones; • CO2 capping our car fleet; and • Expanding the use of video and telecom facilities. Scope 2 electricity emissions reductions arise as a result of:

Greenplan has five goals underpinned by nine targets, which are reported on monthly to our executive committee. Each of the goals is ‘owned’ by a director who is responsible for action plans designed to deliver the targeted improvements. Seven of the nine targets will meet their 2014-15 goals and work is being undertaken on the remaining to enhance performance during 2015-16.

• Decommissioning or removing gas holders; • Improving the way we manage our building portfolio; and • Introducing local energy improvement initiatives.

Environment and carbon reporting 2014/15 Tonnes of CO2

Annual Movement Decrease/(increase)

2013/14

Tonnes of CO2 per £1m turnover

Tonnes of CO2

Tonnes of CO2 per £1m turnover

Tonnes of CO2

Tonnes of CO2 per £1m turnover

Scope 1 Energy consumption (excluding electricity) Transport (direct commercial vehicles and business miles)

526

0.48

738

0.67

212

0.19

17,480

15.89

18,139

16.54

659

0.65

6,192

5.63

6,973

6.36

781

0.73

10,709 34,907 840,311 875,218

9.74 31.74 763.99 795.73

430 26,280 894,575 920,855

0.39 23.96 815.62 839.58

Scope 2 Electricity consumption Scope 3* Rail, air and ferry travel Total (excluding shrinkage) Shrinkage Total carbon emissions

(10,279) (8,627) 54,264 45,637

(9.35) (7.78) 51.63 43.85

*S cope 3 included here but is not in the annual BCF performance table until reporting period 2015/16 onwards. Data for contractor vehicles and PE pipe is not currently recorded as it is not yet a measurable requirement. Data for PE pipe is included in 2014/15 figures, but was not recorded in 2013/14 as it was not a measurable requirement by Ofgem. Data has not been independently verified

Independent auditor’s report to the members of Scotia Gas Networks Limited We have audited the financial statements of Scotia Gas Networks Limited for the year ended 31 March 2015 which comprise the consolidated profit and loss account, the consolidated statement of total recognised gains and losses, the consolidated and company balance sheets, the consolidated cash flow statement, the reconciliation of net cash flow to movement in net debt and the related notes 1 to 28. The financial reporting framework that has been applied in their preparation is applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of Directors and auditor As explained more fully in the Directors’ Responsibilities Statements, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practice Board’s Ethical Standards for Auditors.

Scope of the audit of financial statements An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Group’s and the parent company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the Directors; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material mistatements or inconsistencies we consider the implications for our report. Opinion In our opinion the financial statements: • Give a true and fair view of the state of the Group’s and the parent Company’s affairs as at 31 March 2015 and of the Group’s profit for the year then ended; • Have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; and • Have been prepared in accordance with the requirements of the Companies Act 2006.

Opinion on matters prescribed in the Companies Act 2006 In our opinion the information in the Strategic Report and the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion: • Adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or • The parent company financial statements are not in agreement with the accounting records and returns; or • Certain disclosures of Directors’ remuneration specified by law are not made; or • We have not received all the information and explanations we require for our audit.

Andrew Clark FCA (Senior Statutory Auditor) for and on behalf of Deloitte LLP Chartered Accountants and Statutory Auditor London, United Kingdom 24 July 2015

SGN Annual Report and Accounts 2015

Consolidated profit and loss account for the year ended 31 March 2015

Notes

2015 ÂŁm

2014 ÂŁm

Turnover Net operating costs

1, 2 3

1,099.9 (727.4)

1,096.8 (737.7)

Operating profit Income from fixed asset investments Interest receivable and similar income Interest payable and similar charges Profit on ordinary activities before taxation Tax (charge)/credit on profit on ordinary activities Profit for the financial year

3 13 6 7 4 8 20

372.5 0.9 0.7 (235.7) 138.4 (35.9) 102.5

359.1 0.9 0.9 (250.0) 110.9 1.1 112.0

The above results relate to continuing operations in both the current and previous year.

Consolidated statement of total recognised gains and losses for the year ended 31 March 2015

Notes

Profit for the financial year Cash flow hedges (net of deferred tax) Actuarial loss recognised on defined benefit pension scheme Movement on deferred tax relating to pension scheme Total recognised gains for the year

20 21 26 26

2015 ÂŁm

2014 ÂŁm

102.5 (11.8) (4.6) 0.9 87.0

112.0 14.3 (4.0) (4.2) 118.1

SGN Annual Report and Accounts 2015

Balance sheets as at 31 March 2015 Group 2015 £m

2014 £m

2015 £m

2014 £m

11 12 13

383.4 3,580.6 0.2 3,964.2

393.0 3,552.7 0.2 3,945.9

– – 2,028.4 2,028.4

137.2 318.1 7.0 462.3

127.5 24.6 – 152.1

– 318.1 – 318.1

– 24.6 – 24.6

Notes

Fixed assets Intangible assets – goodwill Tangible assets Investments Current assets Debtors Short term deposits Cash

Creditors: amounts falling due within one year Net current liabilities

Total assets less current liabilities Creditors: amounts falling due after more than one year Provisions for liabilities Deferred income Net (liabilities)/assets excluding pension liabilities Defined benefit pension liabilities Net (liabilities)/assets including pension liabilities Capital and reserves Called up share capital Hedge reserve Profit and loss account Shareholders’ (deficit)/funds

Company

16 18 12 26

19 20 20 21

(1,346.2) (883.9)

(296.4) (144.3)

(1,839.9) (1,521.8)

(800.5) (775.9)

3,080.3

3,801.6

506.6

1,252.5

(3,420.3) (351.7) (193.5) (885.2) (47.6) (932.8)

(4,071.4) (366.6) (177.5) (813.9) (55.9) (869.8)

– – – 506.6 – 506.6

(533.6) – – 718.9 – 718.9

200.0 (56.9) (1,075.9) (932.8)

200.0 (45.1) (1,024.7) (869.8)

200.0 – 306.6 506.6

200.0 – 518.9 718.9

The financial statements of Scotia Gas Networks Limited, registered number 04958135, were approved by the Board of Directors on 24 July 2015. Signed on behalf of the Board of Directors

Gregor Alexander Neil Fleming Director Director

Consolidated cash flow statement for the year ended 31 March 2015

Net cash inflow from operating activities

Notes

2015 £m

2014 £m

500.2

401.0

(202.3) 0.3 0.9 (201.1)

(198.1) 0.1 0.9 (197.1)

Returns on investments and servicing of finance Interest paid Interest received Dividends received from fixed asset investments Net cash outflow from returns on investments and servicing of finance Taxation Capital expenditure and financial investment Purchase of tangible fixed assets Sale of tangible fixed assets Customer contributions received Net cash outflow from capital expenditure and financial investment Equity dividends paid Net cash inflow/(outflow) before management of liquid resources and financing

8, 27

(15.0)

0.4

(147.6) 11.3 20.6 (115.7)

(99.0) 1.3 19.7 (78.0)

(150.0)

(165.0)

18.4

Management of liquid resources Increase in short-term deposits Net cash outflow from management of liquid resources

Financing Issue of debt (Repayment)/draw down of bank borrowings Payments in respect of financial instruments Net cash inflow from financing Increase/(decrease) in cash and bank overdrafts

23 23 23

(38.7)

(293.5) (293.5)

(11.1) (11.1)

381.1 (75.0) (22.2) 283.9 8.8

– 75.0 (26.4) 48.6 (1.2)

SGN Annual Report and Accounts 2015

Reconciliation of net cash flow to movement in net debt for the year ended 31 March 2015

Notes

Increase/(decrease) in cash and bank overdrafts Increase in short-term deposits Movement in borrowings Change in net debt resulting from cash flows Other non-cash changes Net debt at beginning of year Net debt at end of year

23 23 23

2015 ÂŁm

8.8 293.5 (283.9) 18.4 (43.4) (4,193.1) (4,218.1)

2014 ÂŁm

(1.2) 11.1 (48.6) (38.7) (30.1) (4,124.3) (4,193.1)

Notes to the financial statements for the year ended 31 March 2015 1. Principal accounting policies The financial statements have been prepared in accordance with applicable accounting standards in the United Kingdom and the Companies Act 2006. The financial statements of the Group present the results for the year ended 31 March 2015. The comparative period presented is the year ended 31 March 2014. A summary of the more significant Group accounting policies, which have been applied consistently in both years is as follows. Basis of preparation These financial statements have been prepared under the historical cost convention except that assets and liabilities were stated at fair value when acquired, certain derivative financial instruments are recorded at fair value, and certain fixed asset investments are recorded on a valuation basis. The financial statements have been prepared on the going concern basis as set out in the Directors’ report. Basis of consolidation The financial statements consolidate the financial statements of the Company and its subsidiary undertakings drawn up to 31 March each year. Subsidiaries are those entities controlled by the Group or the Company. Subsidiaries acquired are consolidated in the financial statements of the Group from the date that control commences until the date control ceases, using the acquisition method of accounting. Intra-Group balances and any unrealised gains and losses or income and expenses arising from intra-Group transactions, are eliminated in preparing the consolidated financial statements. Turnover Turnover is stated net of value added tax and is attributable to the continuing activity of transportation of natural gas and the provision of related services. Turnover includes an assessment of transportation services supplied to customers between the date of the last meter reading and the year end. Where revenues received or receivable differ from the amount permitted by regulatory agreements, adjustments will be made to future prices to reflect this over or under recovery. Replacement expenditure Replacement expenditure represents the cost of planned maintenance of gas mains and services assets by replacing or lining sections of pipe. This expenditure is principally undertaken to repair and maintain the safety of the network and is written off as incurred. Expenditure that enhances the performance of mains and services assets is treated as an addition to tangible fixed assets. Taxation Current tax, including UK corporation tax, is provided at amounts expected to be paid (or recovered) using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date. Deferred tax is recognised in respect of all timing differences that have originated but not reversed at the balance sheet date where transactions or events that result in an obligation to pay more or a right to pay less tax in the future have occurred at the balance sheet date, with the following exceptions: • Provision is made for gains on disposal of fixed assets that have been rolled over into replacement assets only where, at the balance sheet date, there is a commitment to dispose of the replacement assets with no likely subsequent rollover or available capital losses; Provision is made for gains on revalued fixed assets only where there is a commitment to dispose of the • revalued assets and the attributable gain can neither be rolled over nor eliminated by capital losses; and Deferred tax assets are recognised only to the extent that the Directors consider that it is more likely than • not that there will be suitable taxable profits from which the future reversal of the underlying timing difference can be deducted. Deferred tax is measured on an undiscounted basis.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

Intangible assets – goodwill Goodwill is capitalised and amortised on a straight-line basis to the profit and loss account over its expected useful life. Goodwill represents the excess of the fair value of the consideration paid for the acquisition of businesses over the fair value of the separable net assets acquired. The useful life of goodwill related to acquired businesses has been estimated to be 50 years. A review for impairment of goodwill is carried out at the end of each financial year. Impairment reviews comprise a comparison of the carrying amount of the goodwill with its recoverable amount (the higher of net realisable value and value in use). To the extent that the carrying amount exceeds the recoverable amount, the goodwill is impaired and an impairment loss is recognised in the profit and loss account. Fixed asset investments Except for the Company’s investment in shares of Southern Gas Networks plc and Scotland Gas Networks plc, fixed asset investments are stated at cost less a provision for any impairment in value. Costs of the investments include all costs directly related to the acquisition of the investments. Investments in the shares of distribution networks which include Southern Gas Networks plc and Scotland Gas Networks plc are stated at market value as at the date of their last valuation under the alternative valuation rules in the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008. Tangible fixed assets Tangible fixed assets are stated at cost less depreciation and any provision for impairment. The cost is the purchase cost of the asset, together with any directly attributable costs of acquisition. In respect of assets purchased as part of a business combination, the cost is the fair value of the assets acquired. The carrying values of tangible fixed assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Depreciation is provided on all tangible fixed assets other than freehold land, at rates calculated to write off the cost of each asset evenly over its expected useful life, as follows: Freehold buildings Leasehold buildings Plant and machinery: – Mains and services – Regulating equipment – Gas storage Motor vehicles and office equipment

Up to 50 years Over the shorter of lease term and 50 years 60 to 65 years 30 to 50 years 40 years 3 to 10 years

Site remediation costs are depreciated over the life of the asset. Grants and contributions Capital grants and customer contributions in respect of additions to fixed assets are treated as deferred income and released to the profit and loss account over the estimated useful lives of the related assets. Revenue grants and contributions are credited to the profit and loss account in the year to which they relate. Deferred income in respect of revenue grants and contributions is included within creditors: amounts falling due within one year. Finance leases Assets held under finance leases, which confer rights and obligations similar to those attached to owned assets, are capitalised as tangible fixed assets and are depreciated over the shorter of the lease terms and their useful lives. The capital elements of future lease payments are recorded as liabilities, while the interest elements are charged to the profit and loss account.

1. Principal accounting policies (continued) Operating leases Rentals under operating leases are charged on a straight-line basis over the lease term, even if the payments are not made on such a basis. Benefits received and receivable as an incentive to sign an operating lease are similarly spread on a straight-line basis over the lease term, except where the period to the review date on which the rent is first expected to be adjusted to the prevailing market rate is shorter than the full lease term, in which case the shorter period is used. Pensions Defined benefit pension scheme The amounts charged to the profit and loss account are the current service costs and gains and losses on settlements and curtailments. They are included within staff costs. Past service costs are recognised immediately in the profit and loss account if the benefits have vested. If the benefits have not vested immediately the costs are recognised over the period until vesting occurs. The interest cost and the expected return on the assets are shown as a net amount of other finance costs or credits within interest payable or receivable. Actuarial gains and losses are recognised immediately in the consolidated statement of total recognised gains and losses. The defined benefit scheme is funded, with the assets of the scheme held separately from those of the Group, in separate trustee administered funds. Pension scheme assets are measured at fair value and liabilities are measured on an actuarial basis using the projected unit method and discounted at a rate equivalent to the current rate of return on a high quality corporate bond of equivalent currency and term to the scheme liabilities. The actuarial valuations are obtained at least triennially and are updated at each balance sheet date. The resulting defined benefit asset or liability, net of the related deferred tax, is presented separately after other net assets on the face of the balance sheet. Any pension asset is recognised in the balance sheet to the extent that the benefits may be derived from the surplus in the form of reduced cash contributions in the future or cash refunds. Defined contribution pension schemes The Group also operates defined contribution pension schemes. The assets of the schemes are held separately from those of the Group in independently administered funds. The amounts charged to the profit and loss account represent the contributions payable to the schemes in the period. Differences between contributions payable in the year and contributions actually paid are shown as either accruals or prepayments in the balance sheet. Provisions A provision is recognised in the balance sheet when the Group has a present legal or constructive obligation as a result of a past event and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are discounted where the impact of discounting the expected future cash flows is material. Financial instruments The Group’s funding, liquidity and exposure to interest rate risks are managed within a framework of policies and guidelines authorised by the Board of Directors. In accordance with these policies financial derivative instruments are used to manage interest rate and currency exposure. Where appropriate these instruments are recorded at fair value and accounted for as described below. Effective interest method The effective interest method is a method of calculating the amortised cost of a financial asset and of allocating interest income over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts (including all fees paid or received that form an integral part of the effective interest rate, transaction costs and other premiums or discounts) through the expected life of the financial asset, or, where appropriate, a shorter period. Income and expense is recognised on an effective interest basis for debt instruments other than those financial assets designated as ‘at fair value through profit or loss’ (FVTPL).

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

Financial Assets Investments are recognised and derecognised on a trade date where the purchase or sale of an investment is under a contract whose terms require delivery of the investment within the timeframe established by the market concerned and are initially measured at fair value, plus transaction costs, except for those financial assets classified as FVTPL, which are initially measured at fair value. Financial assets at the balance sheet date are classified into the following specified categories: financial assets at FVTPL ‘held-to-maturity’ investments, ‘available-for-sale’ (AFS) financial assets and ‘loans and receivables’. The classification depends on the nature and purpose of the financial assets and is determined at the time of initial recognition. Impairment of financial assets Financial assets, other than those at FVTPL, are assessed for indicators of impairment at each balance sheet date. Financial assets are impaired where there is objective evidence that, as a result of one or more events that occurred after the initial recognition of the financial asset, the estimated future cash flows of the investment have been impacted. The carrying amount of the financial asset is reduced by the impairment loss directly for all financial assets with the exception of trade debtors. If in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, the previously recognised impairment loss is reversed through profit or loss to the extent that the carrying amount of the asset at the date the impairment is reversed does not exceed what the amortised cost would have been had the impairment not been recognised. Derecognition of financial assets The Group derecognises a financial asset only when the contractual rights to the cash flows from the asset expire, or when it transfers the financial asset and substantially all the risks and rewards of ownership of the asset to another entity. Trade debtors Trade debtors are initially recognised at fair value. The carrying amount is reduced through the use of an allowance account. Appropriate allowances for estimated irrecoverable amounts are recognised where the estimated cash flows are less than the carrying amount. Subsequent recoveries of amounts previously written off are credited against the allowance account. Changes in the carrying amount of the allowance account are recognised in profit or loss. Cash Cash comprises cash on hand and demand deposits, which are those deposits, which are repayable on demand and available within 24 hours (one day) without penalty. Financial liabilities Financial liabilities are classified as either financial liabilities ‘at FVTPL’ or ‘other financial liabilities’. Financial liabilities at FVTPL Financial liabilities are classified as at FVTPL where the financial liability is either held for trading or it is designated as at FVTPL. A financial liability is classified as held for trading if: • It has been incurred principally for the purpose of disposal in the near future; or It is a part of an identified portfolio of financial instruments that the Group manages together and has a recent • actual pattern of short-term profit-taking; or • It is a derivative that is not designated and effective as a hedging instrument.

1. Principal accounting policies (continued) A financial liability other than a financial liability held for trading may be designated as at FVTPL upon initial recognition if: • Such designation eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise; or • The financial liability forms part of a group of financial assets or financial liabilities or both, which is managed and its performance is evaluated on a fair value basis, in accordance with the Group’s documented risk management or investment strategy and information about the Group is provided internally on that basis; or It forms part of a contract containing one or more embedded derivatives and FRS 26 Financial Instruments: • Recognition and Measurement permits the entire combined contract (asset or liability) to be designated as at FVTPL. Financial liabilities at FVTPL are stated at fair value, with any resultant gain or loss recognised in profit or loss. The net gain or loss recognised in profit or loss incorporates any interest paid on the financial liability. Other financial liabilities Other financial liabilities, including borrowings, are initially measured at fair value, net of transaction costs. Other financial liabilities are subsequently measured at amortised cost using the effective interest method, with interest expense recognised on an effective yield basis. The effective interest method is a method of calculating the amortised cost of a financial liability and of allocating interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments through the expected life of the financial liability, or, where appropriate, a shorter period. De-recognition of financial liabilities The Group derecognises financial liabilities when, and only when, the Group’s obligations are discharged, cancelled or they expire. Derivative financial instruments and hedge accounting The Group uses interest rate swaps and foreign exchange forward contracts to hedge interest rate and foreign currency risk arising on debt instruments. On inception of the hedge relationship the Group documents the relationships between the hedged item and the hedging instrument along with the risk management objectives and its strategy for undertaking various transactions. Furthermore, at inception of the hedge and on an ongoing basis the Group documents whether the hedging relationship is highly effective. Changes in fair value of derivatives that are designated and are effective as hedges of future cash flows are recognised directly in equity within the hedge reserve. Changes in fair value of derivatives that are designated and are effective as fair value hedges are recognised in the profit and loss account but effectively offset changes in fair value of the hedged item. Changes in the fair value of derivatives that do not qualify for hedge accounting are recognised in the profit and loss account as they arise. Hedge accounting is discontinued when the hedge instrument expires or is terminated. Financial assets and financial liabilities are offset where they are settled net as a matter of practice and there is legal right to offset.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

2. Segmental reporting Turnover arises entirely in the United Kingdom and is attributable to the continuing activity of transportation of natural gas and the provision of related services, which the Directors consider a single class of business.

3. Operating profit and net operating costs

Turnover Distribution costs Profit on disposal of fixed assets Other operating income Total net operating costs Operating profit

2015 £m

2014 £m

1,099.9

1,096.8

(743.3) 11.3 4.6 (727.4) 372.5

(743.1) 1.3 4.1 (737.7) 359.1

Distribution costs include the costs of operating the distribution network together with depreciation, goodwill amortisation and replacement expenditure.

4. Profit on ordinary activities before taxation Group profit on ordinary activities before taxation is stated after charging/(crediting):

Auditor’s remuneration Goodwill amortisation Depreciation of owned assets Profit on disposal of fixed assets Replacement expenditure Rentals under operating leases – other assets

2015 £m

2014 £m

0.6 9.6 117.7 (11.3) 223.2 1.1

0.3 9.5 116.5 (1.3) 222.7 1.0

Auditor’s remuneration for the Group comprises £120,000 (2014: £120,000) in respect of statutory audit services, £81,000 (2014: £82,000) in respect of other services pursuant to legislation, £28,000 (2014: £28,000) in respect of other assurance services, £171,000 (2014: £nil) in respect of IT consultancy services, £158,000 (2014: £nil) in respect of tax services, £34,000 (2014: £nil) in respect of Corporate Finance services and £nil (2014: £32,000) in respect of other services. Auditor’s remuneration in respect of statutory audit services for the Company amounted to £12,000 (2014: £12,000). This forms part of the total auditor’s remuneration above. In addition to the above services, the Group’s auditor acted as auditor to the Scotia Gas Networks Pension Scheme and fees of £17,000 (2014: £16,000) have been charged by the auditor to the Group in respect of these services.

5. Employee information and Directors’ emoluments The Group had 3,753 full time equivalent employees as of 31 March 2015 (2014: 3,717). The average monthly number of full time equivalent employees during the year was 3,739 (2014: 3,712). The Directors received remuneration of £64,000 (2014: £16,000) for their services to the Group during the year. No retirement benefits are accruing in the year or in the prior year to any Directors under money purchase or defined benefit schemes, in respect of their services to the Group. Staff costs for the Group during the year are as follows:

Staff costs Wages and salaries Social security costs Pension costs

2015 £m

2014 £m

145.8 14.4 31.4 191.6

140.4 13.8 32.0 186.2

2015 £m

2014 £m

0.3

0.1

0.4 – 0.7

0.3 0.5 0.9

2015 £m

2014 £m

0.3 39.9 114.7 66.5 0.1 7.5 6.3 0.4 235.7

0.3 47.5 113.5 66.5 0.1 6.0 – 16.1 250.0

The Company had 8 employees as of 31 March 2015 (2014: 9).

6. Interest receivable and similar income

Interest receivable on short-term deposits Other finance income: Net pension credit (see note 26) Unwind of discounts in provisions

7. Interest payable and similar charges

Bank loans Index-linked bond interest Other interest payable on bonds Shareholders’ loan interest (see note 27) Finance leases and hire purchase contracts Other interest payable Unwind of discounts in provisions (see note 18) Movement on financial derivatives (see note 17)

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

8. Tax charge on profit on ordinary activities a) Analysis of the tax charge on profit on ordinary activities 2015 £m

2014 £m

Current tax Corporation tax at 21% (2014: 23%) Adjustment in respect of prior year Total current tax charge

(31.0) 0.4 (30.6)

(0.7) 0.4 (0.3)

Deferred tax Deferred tax (charge)/credit for the year Adjustments in respect of prior year Total deferred tax (charge)/credit for the year Total tax (charge)/credit on loss on ordinary activities

(5.4) 0.1 (5.3) (35.9)

2.2 (0.8) 1.4 1.1

2015 £m

2014 £m

138.4

110.9

(29.1)

(25.5)

0.2 2.2 2.2 – (6.2) 3.2 (3.5) 0.4 (30.6)

0.2 1.3 – 32.6 (6.7) 0.3 (2.9) 0.4 (0.3)

b) Factors affecting the current tax charge for the year

Profit on ordinary activities before tax Profit on ordinary activities multiplied by standard rate of corporation tax in the UK of 21% (2014: 23%) Effects of: Non taxable income Deferred tax on accelerated capital allowances Gain on disposal of land offset by tax losses Utilisation of losses brought forward Depreciation on non-qualifying assets Other short-term timing differences Expenses not deductible for tax purposes Adjustment in respect of prior year – proceeds from sale of tax losses Current tax charge

The main rate of corporation tax was reduced from 21% to 20% on 1 April 2015. This rate change was substantively enacted on 2 July 2013, and therefore deferred tax balances at 31 March 2014 were restarted accordingly. The effect of the rate change on deferred tax balances at 31 March 2015 is £nil (2014: £36.3m).

9. Loss of the Company for the financial year The Company’s loss for the year amounted to £62.3m (2014: Loss of £55.7m). In accordance with the exemption available under section 408 of the Companies Act 2006, no separate profit and loss account is presented in respect of the Company.

10. Dividends

Equity shares Interim dividends paid of 31.9115p (2014: 35.1026p)

2015 £m

2014 £m

150.0

165.0

11. Intangible fixed assets Group Goodwill £m

Cost At 1 April 2014 and at 31 March 2015 Accumulated amortisation At 1 April 2014 Charge for the year At 31 March 2015 Net book value At 31 March 2015 At 31 March 2014

477.6

84.6 9.6 94.2

383.4 393.0

The goodwill, which arose on the acquisitions of Scotland Gas Networks plc and Southern Gas Networks plc, is being amortised on a straight-line basis over 50 years. 50 years is the expected life of the network and is consistent with the long term outlook of the Regulator. A review for impairment of goodwill is carried out at the end of each financial year. No impairment loss has been recorded in either the current or the prior year.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

12. Tangible fixed assets Group Short leasehold properties £m

Freehold properties £m

Cost At 1 April 2014 Additions Disposals At 31 March 2015

0.7 – – 0.7

75.8 8.6 – 84.4

4,079.4 101.6 (3.2) 4,177.8

255.1 35.6 (0.5) 290.2

4,411.0 145.8 (3.7) 4,553.1

Depreciation At 1 April 2014 Charge for the year Disposals At 31 March 2015

0.1 – – 0.1

15.3 3.0 – 18.3

708.6 89.2 (3.0) 794.8

134.3 25.5 (0.5) 159.3

858.3 117.7 (3.5) 972.5

Net book value At 31 March 2015 At 31 March 2014

0.6 0.6

66.1 60.5

Plant and machinery £m

3,383.0 3,370.8

Motor vehicles and office equipment £m

130.9 120.8

Total £m

3,580.6 3,552.7

Within motor vehicles and office equipment are assets held under finance leases with a net book value of £2.7m (2014: £3.6m). The Company had no tangible fixed assets in either year. The Group has received customer contributions relating to plant and machinery. In accordance with the Group’s accounting policy the assets are capitalised within fixed assets and the contributions are recognised as deferred income in the balance sheet. The deferred income is released to the profit and loss account over the estimated lives of the related assets. The amount deferred under this policy was as follows: Deferred income Group

Customer contributions brought forward Customer contributions received in year Amortisation in year

The Company has no deferred income.

2015 £m

2014 £m

177.5 20.6 (4.6) 193.5

161.9 19.7 (4.1) 177.5

13. Fixed asset investments Cost or valuation and net book value Group £m

Company £m

–

2,028.4

0.2 0.2

– 2,028.4

Shares in Group undertakings At 1 April 2014 and at 31 March 2015 Other investments At 1 April 2014 and at 31 March 2015

The Company’s investments in Southern Gas Networks plc and Scotland Gas Networks plc were valued at 16 June 2012 by an independent firm of professional valuers. The revaluation was undertaken using a discounted cash flow technique. Other fixed asset investments Other fixed asset investments relate to the Group’s investments in Xoserve Limited, which provides transportation transactional services on behalf of all the major gas network transportation companies. The Group holds 23.1% (2014: 23.1%) of the ordinary shares of Xoserve Limited. During the year the Group received dividends of £0.9m (2014: £0.9m) in relation to this investment. Interests in Group undertakings Details of the principal subsidiary undertakings at the end of the year, which are directly wholly-owned by the Company, are as follows: Name of subsidiary

Description of shares held Country of registrationPrincipal activities

Southern Gas Networks plc

160,174,772 ordinary shares of £1 each

England & Wales

Scotland Gas Networks plc

49,392,787 ordinary shares of £1 each

Scotland

SGN Contracting Limited SGN Connections Limited SGN Commercial Services Limited SGN Natural Gas Limited

1 ordinary share of £1 England & Wales 1 ordinary share of £1 England & Wales 1 ordinary share of £1 England & Wales 1 ordinary share of £1 England & Wales

Development, administration, maintenance and operation of regional gas distribution system and supply of transportation services. Development, administration, maintenance and operation of regional gas distribution system and supply of transportation services. Supply of contracting services. Supply of gas connections services. Meter asset manager and supply of commercial services. Development, administration, maintenance and operation of regional gas distribution system and supply of transportation services.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

14. Debtors Group

Amounts falling due within one year Trade debtors Prepayments and accrued income Derivative financial instruments (see note 17)

Company

2015 £m

2014 £m

2015 £m

2014 £m

95.3 18.5 23.4 137.2

92.7 11.0 23.8 127.5

– – – –

Trade debtors are stated net of bad debt provisions of £0.3m (2014: £0.3m) and credit note provisions of £3.3m (2014: £4.2m).

15. Creditors: amounts falling due within one year Group

Bank loans and overdrafts £233m floating rate loan rate due 2015 £100m floating rate loan rate due 2015 £250m 2.013% index-linked due 2035 Shareholders’ loans (see note 27 and 28) Obligations under finance leases and hire purchase contracts Trade creditors Amounts owed to Group undertakings Other taxation and social security Other creditors Accrued interest Other accruals Deferred income Derivative financial instruments (see note 17)

Company

2015 £m

2014 £m

2015 £m

2014 £m

2.6 233.0 100.0 112.8 533.6 1.0 34.6 – 44.4 15.0 70.9 100.6 29.0 68.7 1,346.2

4.4 – – – – 0.9 17.3 – 32.3 11.2 69.2 88.4 21.0 51.7 296.4

– – – – 533.6 – – 1,283.5 0.2 – 22.6 – – – 1,839.9

– – – – – – – 777.8 0.2 – 22.5 – – – 800.5

The shareholder loans, which are subordinated, are redeemable at par on 31 May 2015, or may be redeemed at par by the Company by giving due notice. Interest accrues at a fixed rate of 12.5% per annum and the Company may, upon giving due notice, elect to pay some or all of the interest payable through the issuance of further loans to shareholders. On 21 May 2015 the Board approved the issue of shareholder loans amounting to £533.6m with a ten year tenor and a fixed interest rate of 8.6%. These new loans refinance the outstanding shareholder loans above, which matured on 31 May 2015. The amounts owed to Group undertakings represents loans amounting to £1,336.1m (2014: £849.3m), which incur interest at 0.5% (2014: 0.5%) and trading balances owed by Group companies of £82.6m (2014: £71.5m). Part of the £250m index-linked bond due in 2035 is payable in October 2015.

16. Creditors: amounts falling due after more than one year Group

Bonds: Fixed rate and index-linked: £165m 2.127% index-linked due 2022 £250m 2.013% index-linked due 2035 £150m 2.066% index-linked due 2025 £15m 2.580% index-linked due 2028 £125m 2.31% index-linked due 2039 £257m 4.75% fixed rate due 2017 £300m 5.125% fixed rate due 2018 £225m 4.875% fixed rate due 2034 £215m 4.875% fixed rate due 2020 £375m 4.875% fixed rate due 2029 £225m 6.38% fixed rate due 2040 £25m 3.12% fixed rate due 2018 £25m 3.25% fixed rate due 2018 £300m 4.875% fixed rate due 2023 £25m 3.634% fixed rate due 2020 £50m 3.765% fixed rate due 2020 £35m 2.407% fixed rate due 2025 £350m 2.500% fixed rate due 2025 Floating rates: £233m floating rate loan note due 2015 £100m floating rate loan note due 2015 £80m floating rate loan note due 2043 £75m floating rate loan note due 2018 £50m floating rate loan note due 2019 Total bonds Revolving credit facility drawn Shareholders’ loans (see note 27) Obligations under finance leases and hire purchase contracts

Company

2015 £m

2014 £m

2015 £m

2014 £m

223.1 225.1 202.8 18.3 149.0 256.6 299.0 224.5 214.6 373.8 223.7 25.0 25.0 297.9 25.0 50.0 35.0 346.1 3,214.5

217.9 330.0 198.0 17.9 147.2 256.4 298.8 224.5 214.5 373.6 223.5 25.0 25.0 297.7 25.0 50.0 – – 2,925.0

– – – – – – – – – – – – – – – – – – –

– – 79.6 75.0 50.0 204.6 3,419.1 – – 1.2 3,420.3

232.8 99.9 79.6 75.0 50.0 537.3 3,462.3 73.3 533.6 2.2 4,071.4

– – – – – – – – – – –

– – – – – – – – 533.6 – 533.6

The total revolving credit facility is £350.0m and expires in July 2019.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

Maturity of borrowings Group

Due within one year Between one and five years After five years

2015 £m

2014 £m

983.0 1,021.4 2,398.9 4,403.3

5.3 1,708.8 2,362.6 4,076.7

The Company’s borrowings all fall due on 31 May 2015. The above borrowings are unsecured and are stated after the deduction of unamortised issue costs of £15.4m (2014: £11.9m). These costs together with the interest expense are allocated to the profit and loss account over the term of the borrowings. Interest is calculated using the effective interest rate method. Certain interest costs in respect of index-linked bonds are not payable until the principal amount of the bond is repaid and are included within the carrying value of the borrowings stated above. The amount included in the carrying value of the borrowings at 31 March 2015 is £227.9m (2014: £207.6m). Included within one and five years above are obligations under finance leases amounting to £1.2m (2014: £2.2m).

17. Financial instruments The Group’s funding, liquidity and exposure to interest rate, foreign currency exchange and credit risks are managed within a framework of policies and guidelines authorised by the Board of Directors. In accordance with these policies and in accordance with covenants set out as part of the prospectus issued by the Company for the medium term note programme, financial derivatives are used to manage financial exposures. The Treasury function is responsible for managing banking and liquidity requirements of the Group, risk management relating to interest rate and foreign exchange exposures and for managing the credit risk relating to banking counterparties with which it transacts. The function’s operations are governed by policies determined by the Board.

17. Financial instruments (continued) Categories of financial instruments The categories of financial assets and liabilities held by the Group were as follows: Book Value

Financial assets held at amortised cost Trade debtors(1) Short term deposits(1) Cash Financial assets at fair value Derivative financial instruments through the profit and loss account Available for sale financial assets(1) Total financial assets

2015 £m

2014 £m

95.3 318.1 7.0 420.4

92.7 24.6 – 117.3

23.4

23.8

0.2 444.0

0.2 141.3

(1) The carrying amount of financial assets approximates to their fair value.

Book Value

Financial liabilities held at amortised cost Trade creditors Accrued interest Other accruals Bank loans and overdrafts Finance lease liabilities Bonds Shareholder loans Financial liabilities at fair value Bonds Derivative financial instruments in designated hedging relationships Onerous contract swaps Total financial liabilities

2015 £m

2014 £m

34.6 70.9 100.6 2.6 2.2 3,864.9 533.6 4,609.4

17.3 69.2 88.3 4.4 3.1 3,462.3 533.6 4,178.2

– 68.7 100.7 169.4 4,778.8

– 51.7 116.2 167.9 4,346.1

The carrying amount of financial liabilities approximates to their fair value except for bonds and shareholder loans, the fair value of which is disclosed on the next page. The following table provides an analysis of financial instruments that are measured subsequent to initial recognition at fair value, grouped into Levels 1 to 3 based on the degree to which the fair value is observable: • Level 1: Valued using unadjusted quoted prices in active markets for identified financial instruments; • Level 2: Valued using techniques based significantly on observable market data. Instruments in this category are valued using valuation techniques where all of the inputs that have a significant impact on the valuation are directly or indirectly based on observable market data; • Level 3: Instruments in this category have been valued using a valuation technique where at least one input (which has a significant input on the financial instruments’ valuation) is not based on observable market data. Where inputs can be observed from market data with not undue cost and effort, the observed input is used. Otherwise management determines a reasonable estimate for the input.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

An analysis of financial assets and liabilities that are recorded at fair value at 31 March 2015 is as follows: 2015

Financial assets At fair value through profit and loss – other financial assets (derivatives)

Financial liabilities At fair value through profit and loss – other financial liabilities (onerous contract swaps) Derivatives used for hedging

Level 1 £m

Level 2 £m

Level 3 £m

Total £m

– –

23.4 23.4

– –

23.4 23.4

– – –

100.7 68.7 169.4

– – –

100.7 68.7 169.4

2014

Financial assets At fair value through profit and loss – other financial assets (derivatives)

Financial liabilities At fair value through profit and loss – other financial liabilities (onerous contract swaps) Derivatives used for hedging

Level 1 £m

Level 2 £m

Level 3 £m

Total £m

– –

23.8 23.8

– –

23.8 23.8

– – –

116.2 51.7 167.9

– – –

116.2 51.7 167.9

Onerous contract swaps In 2005 the Group entered into interest rate swap contracts to fix the Group’s interest cost relating to (floating rate) bridging loans which were in place at the time. In October 2005, permanent long-term capital markets debt was issued to replace floating rate bridging loans. At that point these swaps became obsolete and consequently matching swaps were transacted (under which the Group received fixed rate interest) to close out the position. The crystallised loss was recognised in the profit and loss and a discounted provision equal to the market value of the matched swaps was established under onerous contract provision (see note 18). At 31 March 2015 the provision for onerous contract swap loss was £100.7m (2014: £116.2m). Fair values The Group’s financial instruments recorded at amortised cost are shown below together with their fair values: 31 March 2015

Bonds Shareholder loans

31 March 2014

Book Value £m

Fair Value £m

Book Value £m

Fair Value £m

3,864.9 533.6 4,398.5

3,337.6 533.6 3,871.2

3,462.3 533.6 3,995.9

3,810.6 599.9 4,410.5

Fair values of bonds and shareholder loans have been determined by reference to closing quoted market values where available or otherwise by discounting future cash flows at their market interest rate. The carrying value of all other financial assets and liabilities approximates to their book value.

17. Financial instruments (continued) Risks Exposure to counterparty credit risk, interest rate risk, currency risk and liquidity risk arise in the normal course of business. The extent of any exposures and the policies implemented to manage them are set out below: Credit risk Credit risk is the risk that a counterparty will default on its obligation resulting in financial loss to the Company. The maximum exposure to credit risk is the carrying value of financial assets as follows:

Net trade receivables Financial derivative assets Short term deposits Cash

2015 £m

2014 £m

95.3 23.4 318.1 7.0 443.8

92.7 23.8 24.6 – 141.1

Counterparty credit risks arising from financial derivatives are managed through the maintenance of financial limits, subject to a minimum credit rating of ‘A’ or equivalent allocated by a recognised major ratings group. In respect of short-term cash management, counterparties are subject to review and approval according to defined criteria. The Group conducted a review of counterparty credit risk and concluded that no adjustment was required to reflect the net credit risk in arriving at the fair value of financial instruments stated in the balance sheet. At 31 March 2015 the Group was holding collateral with a fair value of £3.8m (2014: £3.8m). Trade debtors predominantly relate to transportation income from gas shippers. Credit risk arising from the Group’s regulated business is managed in accordance with industry standards as set out by the Unified Network Code. The Group contracts with shippers having investment grade ratings only, or where suitable collateral or cash prepayments are made. Trade debtors from non-transportation income relates to consumers and businesses in relation to works for alterations, diversions, meters or damage repairs. In 2014/15 non-transportation debtors were 11.7% (2013/14: 12.3%) of net trade debtors. An impairment allowance has been set aside according to the Group’s impairment policy. The largest transportation debtor is £26.7m (2014: £28.0m). There is no material credit exposure to any one customer. The ageing of trade debtors net of impairment allowance was:

Not past due Past due 0-30 days Past due 31-90 days Past due over 90 days

2015 £m

2014 £m

95.3 – – – 95.3

92.7 – – – 92.7

2015 £m

2014 £m

The movement in the allowance for impairment of trade debtors was:

Balance at 1 April Decrease in allowance for impairment Balance at 31 March In addition there are credit note provisions against trade debtors of £3.3m (2014: £4.2m).

0.3 – 0.3

0.4 (0.1) 0.3

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

The increase in allowance for impairment of £0.1m is in respect of debtors 30 days past. None of the trade debtors that are past due or impaired have had their terms renegotiated. The maximum exposure to credit risk at the reporting date is the fair value of each class of debtors mentioned above. At the end of each reporting period a review of the provision for bad and doubtful debts is performed taking into account the age, status and risk of recovery for each debtor. Liquidity risk Liquidity risk, the risk that the Group will have insufficient funds to meet liabilities as they fall due, is managed through an appropriate liquidity risk framework for the management of the Group’s short, medium and long-term funding and liquidity requirements. The Group manages liquidity risk by maintaining adequate reserves, banking facilities and reserve borrowing facilities by continuously monitoring forecast and actual cash flows and matching the maturity profiles of financial assets and liabilities. The contractual maturity of the Group’s financial assets and liabilities are shown in the following tables. The amounts shown are gross cash inflows/(outflows) with the exception of financial derivatives settled on a net basis where the amounts represent undiscounted net cash flows. When the amount payable is not fixed, the amount disclosed is determined by reference to relevant conditions existing at the reporting date. 2015 0-6 months 6-12 months £m £m

Financial liabilities loans and borrowings Bank overdrafts Shareholder loans Bonds Finance lease liabilities Derivative financial liabilities Hedging interest rate swaps Onerous contract swaps Other financial liabilities Trade and other creditors Total financial liabilities

1-2 years £m

2-5 years £m

– – – – (863.1) (3,366.4) (0.8) – (863.9) (3,366.4)

(2.6) (567.0) (286.3) (0.5) (856.4)

– – (284.5) (0.5) (285.0)

– – (378.9) (0.7) (379.6)

(6.3) (8.2) (14.5)

5.9 (8.2) (2.3)

2.3 (12.9) (10.6)

(34.6) (905.5)

– (287.3)

– (390.2)

> 5 years £m

Contractual Interest/ cash flows discounting £m £m

Carrying value £m

(2.6) (567.0) (5,179.2) (2.5) (5,751.3)

– 33.4 1,314.3 0.3 1,348.0

(2.6) (533.6) (3,864.9) (2.2) (4,403.3)

(87.2) (105.9) (193.1)

41.9 5.2 47.1

(45.3) (100.7) (146.0)

– – (34.6) (904.7) (3,491.3) (5,979.0)

– 1,395.1

(34.6) (4,583.9)

(2.1) (38.7) (40.8)

(87.0) (37.9) (124.9)

The Group expects to meets its obligations from cash balances, operating cash flows and re-financing.

17. Financial instruments (continued) The corresponding amounts for 2014 were as follows: 2014 0-6 months 6-12 months £m £m

(4.4) (33.4) (47.4) (0.5) (85.7)

– (33.4) (78.0) (0.5) (111.9)

(9.2) (10.0) (19.2)

3.2 (10.0) (6.8)

(17.3) (122.2)

1-2 years £m

2-5 years £m

– – (566.9) – (458.2) (1,080.2) (1.0) (1.6) (1,026.1) (1,081.8)

(3.1) (16.3) (19.4)

– – (118.7) (1,045.5)

> 5 years £m

Contractual Interest/ cash flows discounting £m £m

– 100.1 1,953.2 0.5 2,053.8

(4.4) (533.6) (3,462.3) (3.1) (4,003.4)

(93.6) (120.9) (214.5)

65.7 4.7 70.4

(27.9) (116.2) (144.1)

– – (17.3) (1,120.5) (3,882.1) (6,289.0)

– 2,124.2

(17.3) (4,164.8)

7.2 (45.9) (38.7)

– (4.4) – (633.7) (3,751.7) (5,415.5) – (3.6) (3,751.7) (6,057.2)

Carrying value £m

(91.7) (38.7) (130.4)

Currency risk The Group generally transacts in sterling denominated currency with the exception of certain material purchases and bond financing. The Group enters into cross currency swap agreements from time to time with the effect of converting contractual commitments denominated in foreign currencies into sterling obligations. At 31 March 2015 the Group had minimal foreign currency exposure in relation to purchase contract commitments, or bond financing. Inflation risk The Group’s index-linked borrowings and interest liabilities are exposed to a risk of change in the carrying value due to changes in the UK Retail Price Index (‘RPI’). This form of liability is a good match to the Group’s regulated asset value which is also index-linked to RPI due to the pricing mechanism imposed by the regulator. The turnover capacity charges are also linked to RPI. By matching liabilities and assets, index-linked debt hedges the exposure to changes in RPI and delivers cash flow benefit. The compensation for the inflation risk is recorded as payable on the balance sheet with the principal, as opposed to a cash payment. The following table shows the illustrative effect on the profit and loss account that would result from a 1% movement in RPI before the effects of tax.

Impact on profit and loss Index-linked bonds accretion Transportation income Total

2015 £m

2014 £m

8.6 (10.2) (1.6)

8.6 (10.3) (1.7)

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

Interest rate risk The Group limits the impact of interest rate risk by implementing a policy of a minimum of 75% of borrowing being either at fixed or index-linked, excluding borrowing from shareholders. Derivative financial instruments are transacted to hedge risk in accordance with this policy. The impact of a change in interest rates on financial derivatives is dependent on whether their designation is fair value through the profit or loss, or if designated as cash flow hedges then the impact will be through equity. The following table represents the annualised impact (net of deferred tax) of 100 basis point change in shortterm interest rates at the reporting date in relation to equity and profit and loss account. The analysis assumes that all other variables remain constant.

Impact on profit and loss account Floating rate instruments Fixed to floating swaps Impact on equity Floating to fixed swaps

2015 £m

2014 £m

(7.1) (2.7) (9.8)

3.6

Cash flow hedges Cash flow hedges comprise floating to fixed interest rate swaps of future interest payments relating to existing bonds. Receipts and payments for the swaps and the underlying bonds are exactly matched and in accordance with FRS 26 any gain or loss that is deferred to equity is recognised in profit or loss over the period that the floating rate interest payments impact on profit. In September 2012 the Company issued a £300m 12 year fixed rate bond. Prior to the bond issue, from July to August 2012 the Company entered into six floating to fixed rate 10 year swaps of £25m each, to hedge the fixed interest rates prevalent in the market. After the issue of fixed rate bonds, the floating to fixed rate swaps were cancelled and a loss of £8.2m was recognised. The swaps were entered into to hedge future interest outflows on the bond and therefore were effective hedging instruments. In accordance with the requirements of FRS 26 (Financial Instruments Recognition and Measurement) the loss arising on settlement of the swaps has been recorded in equity. The loss will be recycled to profit and loss account over 10 years. As at 31 March 2015 the unamortised hedge loss balance in equity was £6.9m. The movement before deferred tax taken to equity in respect of cash flow hedges in the year was a £15.0m loss (2014: £20.3m gain). The hedge reserve movement is expected to unwind in profit or loss over the life of the swaps. The notional principal amount of the outstanding cashflow hedges at 31 March 2015 was £363.0m (2014: £363.0m). At 31 March 2015 the fixed interest rates vary from 4.5% to 6.3% and floating rates 2.1%, Libor plus 100bp (2014: 2.3% Libor plus 129bp).

17. Financial instruments (continued) Fair value hedges The Group has no fair value hedges at 31 March 2015. Movement in derivatives included in profit and loss account The net movement included within interest in the profit and loss account for financial derivatives is as follows:

Net fair value gain/(loss) Net amounts paid Net movement in financial derivatives

2015 £m

2014 £m

1.9 (2.3) (0.4)

(9.6) (6.5) (16.1)

In addition the movement on onerous swap contracts in the period was a loss of £4.4m (2014: gain of £2.3m) included in discount unwind within interest payable.

18. Provisions for liabilities Group Onerous financial instruments Environmental £m £m

At 1 April 2014 Arising during the year Utilised during the year Net movement in deferred tax Amortisation of discount At 31 March 2015

116.2 – (19.9) – 4.4 100.7

34.2 (1.8) – – 1.9 34.3

Other Deferred tax provisions £m £m

211.7 – – (1.0) – 210.7

4.5 2.1 (0.6) – – 6.0

Total £m

366.6 0.3 (20.5) (1.0) 6.3 351.7

Onerous financial instruments The onerous financial instruments provision relates to interest rate swap contracts which the Group holds (see note 17). The provision recorded at each balance sheet date represents the aggregate fair value of the swap contracts held. The provision will be utilised as cash settlement payments are made over the life of the swaps over the next ten years. Environmental The environmental provision represents the Directors’ best estimate of environmental restoration costs, where the Group has a legal obligation to restore sites at the balance sheet date. The provision has been discounted and is stated at the present value of the estimated expenditure to settle the obligation. This provision is expected to be utilised over the next sixteen years.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

Deferred tax The net movement on the deferred tax provision has arisen mainly as a result of the movement on cash flow hedges during the year, offset by other movements in the year of which £2.2m is recorded as a charge to the profit and loss account and £3.2m is recorded as a credit to the statement of total recognised gains and losses. The Company has no provisions in either year. Deferred tax recognised in the financial statements (excluding deferred tax recognised in respect of pension liabilities – see note 26) is as follows: Group 2015 £m

(232.2) 13.7 7.8 (210.7)

Accelerated capital allowances Deferred tax on cash flow hedges Other timing differences

Company 2014 £m

(230.0) 10.3 8.0 (211.7)

2015 £m

2014 £m

– – – –

The movement in provision for deferred tax is as follows: Group 2015 £m

(211.7) (2.2) 3.2 (210.7)

At 1 April (Charged)/credited to profit and loss account Credited/(charged) to statement of recognised gains and losses At 31 March

2014 £m

(207.5) 1.8 (6.0) (211.7)

The Group has unrecognised deferred tax assets on £236.8m (2014: £275.1m) of unutilised tax losses. Deferred tax assets have been recognised in respect of tax losses to the extent that it is considered probable that these assets will be recovered. The Company has not recognised deferred tax assets on £269.3m (2014: £271.8m) of unutilised tax losses. In accordance with FRS 19 (‘Deferred tax’), deferred tax has been measured based upon a corporation tax rate of 20% (2014: 20%), being the tax rate substantively enacted at the balance sheet date. Other provisions This represents a provision for other legal and constructive obligations held by the Group. This provision is expected to be utilised over the next thirty five years.

19. Share capital 31 March 2015 Number

Allotted, called up and fully paid shares ‘A’ ordinary shares of 42.55p (2014: 42.55p) each ‘B’ ordinary shares of 42.55p (2014: 42.55p) each ‘C’ ordinary shares of 42.55p (2014: 42.55p) each Total

235,025,002 117,512,501 117,512,501 470,050,004

The ‘A’, ‘B’ and ‘C’ ordinary shares rank pari passu in all respects.

31 March 2014 Value (£m)

100.0 50.0 50.0 200.0

Number

235,025,002 117,512,501 117,512,501 470,050,004

Value (£m)

100.0 50.0 50.0 200.0

20. Reserves Hedge reserve Group £m

At 1 April 2014 Profit/(loss) for the financial year Dividends paid on equity shares (see note 10) Movement on cash flow hedges Deferred tax on cash flow hedges Actuarial loss on defined benefit pension scheme (net of related tax) At 31 March 2015

Profit and loss account

Company £m

Group £m

Company £m

(45.1) – – (15.0) 3.2

– – – – –

(1,024.7) 102.5 (150.0) – –

518.9 (62.3) (150.0) – –

– (56.9)

–

(3.7) (1,075.9)

– 306.6

21. Reconciliation of movements in Group shareholders’ deficit 2015 £m

Profit for the financial year Dividend paid on equity shares (see note 10) Cash flow hedges (net of deferred tax) Actuarial loss on defined benefit pension scheme (net of related tax) Movement in shareholders’ deficit Opening shareholders’ deficit Closing shareholders’ deficit

102.5 (150.0) (11.8) (3.7) (63.0) (869.8) (932.8)

2014 £m

112.0 (165.0) 14.3 (8.2) (46.9) (822.9) (869.8)

22. Cash flow from operating activities Reconciliation of operating profit to net cash inflow from operating activities: 2015 £m

Continuing operations Operating profit Depreciation charge Goodwill amortisation Amortisation of deferred income Profit on disposal of fixed assets Increase in debtors Increase/(decrease) in creditors Movement in provisions Total net cash inflow from operating activities

372.5 118.0 9.6 (4.6) (11.3) (7.0) 23.6 (0.6) 500.2

2014 £m

359.1 116.5 9.5 (4.1) (1.3) (44.0) (33.5) (1.2) 401.0

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

23. Analysis of net debt Cash flow £m

Non-cash changes £m

31 March 2015 £m

(4.4)

8.8

–

4.4

(51.7)

–

1 April 2014 £m

(Bank overdraft)/cash Debt due within one year: – Financial instruments Debt due after more than one year: – Bonds – Bank loans – Shareholders’ loans Onerous financial instruments Other financial instruments Short term deposits

(3,462.3) (73.3) (533.6) (116.2) 23.8 24.6 (4,193.1)

(381.1) 75.0 – 19.9 2.3 293.5 18.4

(17.0)

(68.7)

(17.6) (1.7) – (4.4) (2.7) – (43.4)

(3,861.0) – (533.6) (100.7) 23.4 318.1 (4,218.1)

Short term deposits comprise short-term highly liquid investments with a maturity of three months or less. Non-cash changes noted above represent fair value movements on financial instruments (see note 17) and interest incurred on index-linked bonds during the year which has not been paid and has been included within the carrying value of amounts borrowed.

24. Operating lease commitments The Group has lease agreements for which the payments extend over a number of years. Other

Annual commitments under non-cancellable operating leases expiring: Within one year Within two to five years After five years

Land and buildings

2015 £m

2014 £m

2015 £m

2014 £m

– 0.8 – 0.8

– 0.5 – 0.5

– – 0.5 0.5

The Company has no operating lease commitments in either year.

25. Capital commitments Capital projects contracted for by the Group but not provided in the financial statements amounted to £17.3m at 31 March 2015 (2014: £15.1m). The Company has no capital commitments at 31 March 2015 (2014: £nil).

26. Pension commitments A significant proportion of the Group’s employees are members of the Scotia Gas Networks Pension Scheme (‘the Scheme’). The Scheme provides final salary defined benefits for employees who joined the Lattice Group Scheme prior to 31 March 2002. A defined contribution section was added to the Lattice Group Scheme from 1 April 2002 for employees joining the Lattice Group Scheme from that date. Employees of the Group who were previously members of the Lattice Group Scheme transferred to the Scotia Gas Networks Pension Scheme on 1 December 2005. a) Defined benefit scheme The Scheme is operated by the Group and is funded with assets held in separate trustee administered funds. It is subject to independent valuations at least every three years, on the basis of which the qualified actuary determines the rate of employers’ contribution, which, together with the specified contributions payable by the employees and proceeds from the scheme’s assets, are expected to be sufficient to fund the benefits payable under the scheme. The latest full actuarial valuation was carried out as at 31 March 2012. In accordance with FRS 17, a limited actuarial review has been carried out by Hymans Robertson at 31 March 2015 using the projected unit method. The following financial assumptions have been used: As at 31 March Discount rate Inflation assumption Rate of increase of salaries Rate of increase of pensions payment

2015

2014

2013

2012

3.3% 3.2% 3.9% 3.2%

4.3% p.a. 3.6% p.a. 4.6% p.a. 3.6% p.a.

4.1% p.a. 3.2% p.a. 4.7% p.a. 3.2% p.a.

4.6% p.a. 3.2% p.a. 4.7% p.a. 3.2% p.a.

The discount rate is based on the return of high quality corporate bonds. The assumptions relating to longevity underlying the pension liabilities reflect the characteristics of the Scheme membership (‘VitaCurves’) for base mortality with an allowance for further improvements in life expectancy in line with the medium cohort adjustments subject to a 1.5% p.a. underpin in the longevity assumption. The assumed life expectancy in years for a member once they reach age 65 is as follows: As at 31 March 2015

Member currently aged 65 Member currently aged 45

2014

2013

Male

Female

Male

Female

Male

Female

25 28

26 28

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

The fair value of the assets in the scheme, the present value of the liabilities in the scheme and the expected rate of return were: As at 31 March 2015 Long term rate of return expected

Equities Government bonds Corporate bonds Property Cash Total market value of assets Actuarial value of liabilities Deficit in scheme Related deferred tax asset Net pension liability

2014 Long term rate of Value return £m expected

2013

2012

Long term rate of Value return £m expected

2011 Long term rate of Value return £m expected

Value £m

5.7%

240.1

6.5%

197.6

6.7%

192.5

7.0%

258.3

7.8%

279.5

2.3%

339.1

3.5%

262.6

3.0%

223.6

3.3%

166.2

4.3%

99.2

3.3% 3.9% 2.6%

360.4 51.2 23.6

4.3% 4.8% 3.7%

317.5 45.6 9.2

4.1% 4.7% 1.1%

318.5 41.7 5.8

4.6% 5.0% 1.9%

166.2 40.3 8.2

5.5% 5.3% 1.5%

134.3 36.3 9.9

1,014.4

832.5

782.1

639.2

559.2

(1,073.9) (59.5)

(902.4) (69.9)

(862.9) (80.8)

(749.2) (110.0)

(624.7) (65.5)

11.9

14.0

18.7

26.5

17.2

(47.6)

(55.9)

(62.1)

(83.5)

(48.3)

The expected return on scheme assets represents the expected return of each major class of assets in which the scheme invests. Expected yield on fixed interest instruments is based on gross redemption yields at the balance sheet date. Expected return on equity interests reflect real rates of return experienced in the relevant markets. Movement in fair value of scheme assets 2015 £m

At 1 April Expected return on scheme assets Contributions from scheme members Contributions from the Company Actuarial gains/(losses) Benefits paid As at 31 March

832.5 38.8 1.5 42.6 118.3 (19.3) 1,014.4

2014 £m

782.1 35.3 1.6 43.7 (13.2) (17.0) 832.5

26. Pension commitments (continued) Movement in fair value of scheme liabilities 2015 £m

At 1 April Service cost Interest cost Contributions from scheme members Actuarial (losses)/gains Benefits paid At 31 March

(902.4) (28.0) (38.4) (1.5) (122.9) 19.3 (1,073.9)

2014 £m

(862.9) (29.1) (35.0) (1.6) 9.2 17.0 (902.4)

The Group’s contribution rate during the year was 37.3% of pensionable earnings. Additionally, the Group made special pension contributions to repair the deficit amounting to £23.5m. The expected contributions to be made in the year to 31 March 2016 are 37.3% of pensionable salary. The actual gain on scheme assets was £157.1m (2014: £22.1m). The cumulative amount of actuarial losses recognised in the statement of total recognised gains and losses since the adoption of FRS 17 is £135.9m (2014: £131.3m). Analysis of the amounts recognised in the profit and loss account

Amount charged to operating profit: Current service cost Analysis of the amount credited to finance income: Expected return on pension scheme assets Interest on pension scheme liabilities Net finance credit (see note 6) Net charge to the profit and loss account

2015 £m

2014 £m

(28.0)

(29.1)

38.8 (38.4) 0.4 (27.6)

35.3 (35.0) 0.3 (28.8)

Analysis of the amount recognised in the statement of total recognised gains and losses (STRGL) 2015 £m

Actuarial gains/(losses) on scheme assets Actuarial (losses)/gains on obligations Deferred tax Actuarial losses recognised in the STRGL

118.3 (122.9) 0.9 (3.7)

2014 £m

(13.2) 9.2 (4.2) (8.2)

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

History of experience gains and losses 2015

Fair value of plan assets Present value of defined benefit obligation Deficit Experience adjustments on scheme assets – Percentage of scheme assets at year end Experience adjustments on scheme liabilities – Percentage of the present value of scheme liabilities at year end Total actuarial (losses)/gains on obligation – Percentage of the present value of scheme liabilities at year end

£1,014.4m (£1,073.9m) (£59.5m) £118.3m 11.7% £22.0m

2014

£832.5m (£902.4m) (£69.9m) (£13.2m) (1.6%) £12.2m

2013

2012

2011

£782.1m (£862.9m) (£80.8m) £74.7m 9.6% £44.6m

£639.2m (£749.2m) (£110.0m) £6.5m 1.0% £13.0m

£559.2m (£624.7m) (£65.5m) (£3.3m) (0.6%) £15.6m

2.0% (£122.9m)

1.4% £9.2m

5.2% (£64.6m)

1.7% (£75.6m)

2.5% £45.7m

(11.4%)

1.0%

(7.5%)

(10.1%)

7.3%

2015 £m

2014 £m

2013 £m

(69.9)

(80.8)

(110.0)

(65.5)

(149.5)

(28.0) 42.6 0.4 (4.6) (59.5)

(29.1) 43.7 0.3 (4.0) (69.9)

(24.6) 44.2 (0.5) 10.1 (80.8)

(21.6) 44.3 1.9 (69.1) (110.0)

(22.7) 64.4 (0.1) 42.4 (65.5)

2015 £m

2014 £m

3.3

2.9

Movement in deficit during the year

Deficit in scheme at start of year Movement in year: – Current service costs – Contributions – Other finance income/(expense) – Actuarial (loss)/gain Deficit in scheme at end of year

2012 £m

2011 £m

b) Defined contribution schemes The amounts recognised in the profit and loss account are as follows:

Amount charged in respect of defined contribution schemes

27. Related parties The Company is owned by a consortium consisting of Scottish and Southern Energy plc (50%), OTPPB Investments (UK) Limited (25%), which is owned by Ontario Teachers’ Pension Plan Board and Borealis Infrastructure Europe (UK) Limited (25%), which is indirectly wholly-owned by OMERS Administration Corporation. It is the opinion of the Directors that the Group and Company have no single controlling party as the Company is controlled jointly by the consortium. Transactions with shareholders Amounts owed to shareholders and loans from shareholders are set out below: Group

Shareholders’ loans: SSE plc Borealis (Luxembourg) SCA(1) Ontario Teachers’ Pension Plan Board Interest owed to shareholders: SSE plc Borealis (Luxembourg) SCA(1) Ontario Teachers’ Pension Plan Board Other amounts owed to shareholders: SSE plc

2015 £m

2014 £m

266.8 133.4 133.4 533.6

11.2 5.6 5.6 22.4

15.7

(1) Borealis (Luxembourg) SCA is an affiliate of Borealis Infrastructure Europe (UK) Limited.

The aggregate interest expense charged to the profit and loss account in respect of shareholders’ loans was £66.5m (2014: £66.5m). Interest accrues on the shareholders’ loans at a fixed rate of 12.5% per annum and is payable semi-annually in arrears on 30 November and 31 May each year. The Company may, upon giving due notice, elect to pay some or all of the interest payable through the issuance of further loans to its shareholders.

SGN Annual Report and Accounts 2015

Notes to the financial statements for the year ended 31 March 2015

(continued)

27. Related parties (continued) Other than interest charges relating to shareholder loans, the following transactions took place during the year between the Group and the SSE plc group of companies (SSE).

Sales of goods and services Purchase of goods and services Sale of tax losses

2015 £m

2014 £m

166.4 (49.0) 0.2

175.0 (58.7) 0.4

Sales of goods and services to SSE primarily represent gas transportation services. At 31 March 2015 an amount of £0.4m (2014: £0.3m) was owed by SSE in relation to these services and is included within trade debtors. SSE provides services to the Group in the form of a management services agreement for corporate services. The Group also purchases certain items such as consumables stock, shrinkage gas and public liability insurance from SSE. Included within purchases of goods and services are direct costs in relation to tangible fixed asset and acquisitions projects incurred by SSE which have been recharged to the Group and capitalised. These costs amounted to £2.0m (2014: £3.1m). During the year, the Group surrendered gross tax losses of £28.4m to SSE (2014: £30.4m) relating to the year ended 31 March 2013 for an aggregate cash consideration of £0.2m (2014: £0.4m).

28. Subsequent events On 21 May 2015 the Board approved the issue of shareholder loans amounting to £533.6m with a ten year tenor and a fixed interest rate of 8.6%. These new loans refinance the shareholder loans outstanding at 31 March 2015 detailed in note 27, which matured on 31 May 2015.

Designed and produced by Tayburn

SGN St Lawrence House Station Approach Horley, Surrey RH6 9HJ Customer Service enquiries Freephone 0800 912 1700 www.sgn.co.uk

If you smell gas or are worried about gas safety you can call the National Gas Emergency Number on 0800 111 999 Carbon Monoxide (CO) can kill. For more information: www.co-bealarmed.co.uk