annual report and accounts 2016', SGN, 2016

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SGN Annual Report and Accounts 2016

Delivering on our customer promise Annual Report and Accounts 2016

SGN is the UK’s second largest gas distribution network company, operating across Scotland and southern England Overview 01 2016 Financial and operational highlights 02 How we keep the gas flowing Strategic Report 04 Chief Executive’s report 18 Key performance indicators 20 Financial review 24 Principal risks and uncertainties 26 Corporate responsibility Directors’ Report 32 Chairman’s statement 34 Board of Directors 36 Statement of Directors’ responsibilities 37 Directors’ report 39 Corporate Governance statement 42 Carbon report Accounts 43 Independent auditor’s report 44 Consolidated profit and loss account 45 Consolidated statement of comprehensive income 46 Balance sheets 47 Consolidated statement of changes in equity 48 Company statement of changes in equity 49 Consolidated cash flow statement 50 Notes to the financial statements

| Overview | Strategic Report | Directors' Report | Accounts |

01

2016 Financial and operational highlights

98.5% Gas escapes attendance within an hour in 2015/16

£

11

m

360

External awards for innovative technologies in 2015/16

Network investment in 2015/16

£

bn

5.0

Regulated Asset Value as at 31 March 2016

£

m

1,080

Turnover in 2015/16

02

SGN Annual Report and Accounts 2016

How we keep the gas flowing

24hr emergency response

Over 5.9 million customers

Keeping you safe

Safe and efficient streetworks

74,000km of pipes

Connecting the network Scotland and southern England

c. 22,000 new connections a year

Always improving Upgrading our pipes

Volunteering and fundraising

Engaging the community

Investing in new technology

Looking to the future Securing future gas supplies Using new fuel sources such as biomethane

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

Putting people at the heart We always work together, talk honestly and treat people with respect

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03

Our vision Dedicated to keeping our customers safe and warm by leading the way in energy delivery Our commitment • We go out of our way to exceed customer expectations • We’re innovating for a safe, secure and sustainable future for our network Involving you We engage with our stakeholders at the right time in the right way to help us deliver a better service Aberdeen

Operations throughout the UK

Edinburgh

Glasgow

Meeting expectations

Belfast

We meet our customers' expectations by exceeding our commitments under RII0

+ We meet our stakeholders' expectations by focusing on our 2016/17 priorities:

• • • • •

Keeping energy affordable Improving our service Keeping the gas flowing safely Sustaining our future Supporting our communities

Oxford London

Southampton

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

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SGN Annual Report and Accounts 2016

Chief Executive’s report

Our business Gas provides around 80% of the UK’s total energy demand at peak times and is the main source of energy for 85% of households. Whatever the weather, we transport your gas through our robust network of pipelines and services every single day, direct to homes and businesses. We’ve developed into one of the country's leading utility companies since we formed ten years ago. We manage two of the UK’s eight gas distribution networks putting natural and green gas through 74,000km of gas mains and services. In doing so, we deliver heat and energy to 5.9 million homes and businesses, touching the lives of some 14 million people. This is across our two distinct network areas which include the most densely populated areas of south London and the remotest parts of Scotland and the Hebrides. We invest time and energy in our highly professional and flexible workforce to ensure they are engaged and proud to work for us, the communities, and the customers we serve. We’ve taken innovation to a whole new level by developing new technologies, procedures and practices which often become award-winning. We lead by example but believe that collaboration and sharing is also vital. We share our knowledge and demonstrate new procedures on a continuous basis. Our ‘can-do’ approach delivers goals which inspire and benefit us, our customers, and the gas industry overall.

Gas networks regulation The current eight year regulatory price control known as RIIO-GD1, is an incentive based framework set by Ofgem which started in April 2013. In the first three years of RIIO we have performed well against both the outputs and incentives which have been set to deliver greater efficiency, innovation, stakeholder engagement and an enhanced standard of service for our customers. In addition, the charges levied on network users will fall in real terms between now and 2021. This stable regulatory regime is also crucial for the delivery of the £1.9bn investment required in our gas networks between now and 2021, when the current price control period will end. Images above from top

Emergency and upgrading our network Last year we replaced 960km of old iron pipe with new polyethylene gas mains as part of our iron mains replacement programme. We are also proud to operate the gas emergency service and during the year carried out some 50,000 repairs from 220,000 calls from the public. We attended over 98.51% of callouts within the hour, exceeding our licence condition target of 97%. As you might expect, as our mains replacement programme continues apace we are starting to see a reduction in our emergency workloads.

> Keeping our customers well-informed is important to them and something we take pride in doing well. > Core & Vac innovative technology helps reduce disruption and greatly improves efficiency.

Our awards Gaining external recognition for our industry-leading innovations, our project work and the endeavours of our people is important to us. The full list of awards is available on our website.

Engineer of the year Leadership award Innovation project award

Female leadership in gas safety management

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As an integral part of the UK’s energy industry, our primary role is to protect people and property. We do this by ensuring the safety of our people and our customers is at the heart of everything we do.

Safety first Safety is paramount. Whether it’s the safety of the general public, our customers, our own people or our contractors, we put great importance in continuing to build our strong 'safety first' culture to ensure zero accidents occur. We hold regular safety conferences for our employees, and have started bespoke safety conferences for our contractors with the aim of bringing their safety focus in-line with our own.

John Morea Chief Executive Officer

Further to this, we are also committed to increasing awareness of the dangers posed by Carbon Monoxide (CO) – a colourless, odourless and tasteless gas. Many are simply unaware of the serious, and sometimes fatal consequences of CO poisoning. We’re working with communities, partner organisations and governments to continue to raise public awareness of the silent killer and lobby for change to ensure no-one is harmed through accidental CO poisoning. The focus of our work has been on groups identified as most at risk: young children, students, those in private rented accommodation and the elderly.

Innovation of the year – CISBOT and Robotics

Gold award – core and vac technology

Innovator of the year

Innovator award Apprentice of the year

05

06

SGN Annual Report and Accounts 2016

How we add value through our business model 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

Revenue streams

Added value for all our stakeholders

Human

£

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

Our people are at the core of what we do and we have over 3,800 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.

Network £3.9bn network investment since inception.

Pipeline 9,495km pipeline replaced since inception.

Financial 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.

m

1,080

Safety

Regulated revenue Revenue under the price control includes: • Return on RAV • Depreciation • Efficient costs • Incentive income Earned from the two distribution networks: • Southern £716m • Scotland £318m

Non-regulated revenue During the year we invested £8.1m in the creation of biomethane projects. Through investment in areas such as biomethane, we are developing a sustainable unregulated business.

Reduce risk of incidents (Emergency Standard 97%).

Reliability Reduce interruptions and faults.

Customer Emergency response and highest standards of customer service.

Social • Connecting fuel poor customers. • Engaging with local communities.

Environment • Reduce leakage of gas from our network. • Delivering sustainable energy sources.

Shareholder value • 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.

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Innovating for the future Innovation on the ground We understand how our essential works, ranging from emergency repairs to planned network upgrades, can cause disruption to road users and local communities alike. To minimise disruption when carrying out our essential streetworks, we’ve developed award-winning Robotics programmes and Core & Vac techniques, which completely change the way we repair and prolong the life of our cast iron gas network. Working with US-based partner ULC Robotics, we have developed a cast iron joint sealing robot known as CISBOT. This can repair cast iron pipes from the rear of a single box truck through only a small excavation, greatly reducing the inconvenience to the public.

Images above from top

> CISBOT in operation in Edinburgh’s George Street. > Safety first with documented risk assessments and safety discussions on all our works. > First ever tanker containing LNG from Zeebrugge arriving in Oban.

CISBOT is now fully implemented, and our follow up Ofgem NIC (Network Innovation Competition) funded robotics project has been delivered on time and on budget. Developing our robotics programme further, in November 2015 we successfully launched: • The CIRRIS XI™ Inspection Robot – a ground breaking robotic system which uses two specialised sensors to internally assess the condition of metallic gas mains and collect previously unobtainable critical integrity data. • The CIRRIS XR™ Repair Robot – this repairs and prevents future gas leaks by injecting sealant into mechanical, lead-jute joints or internal seals of cast iron gas mains. Additionally, our Core & Vac keyhole excavation technique allows us to significantly reduce the size of excavation necessary to gain access to our pipes, reducing the likelihood of an electricity cable strike and speeding up the whole emergency repair process.

07

The future of gas We continue to be an active supporter of the biomethane industry which is producing green gas for the overall benefit of the UK’s energy market. There are now 22 projects injecting biomethane into our network. 46% of energy consumed in the UK is used for heating, and this accounts for one third of greenhouse gas emissions. To meet the government’s target of reducing emissions by 80% by 2050, we recognise the need to support innovations that help get greener gas flowing through our network. Our target is to supply 250,000 homes with green gas by 2021. We are supplying 133,000 homes already, and we welcome the extension of funding for the crucial RHI support mechanism beyond April 2016. In the development of biomethane in the UK we were: • First in biomethane injection • First in network entry and measurement units • First for a commercial biomethane plant • First in European deployment of a commercial biomethane membrane plant • First to integrate CO 2 capture technology into a biomethane clean up plant (carbon negative) • First to introduce a gas-blending and compressed biomethane/gas injection facility in Europe Hydrogen is an emerging green energy source which we believe could be transported through our existing distribution network. Current legislation only allows for the blending of 0.1% hydrogen with natural gas within the network. However, we are pleased to see continuing support for research and development around hydrogen. This crucial work could help overcome issues ranging from production and transportation to end use.

08

SGN Annual Report and Accounts 2016

Managing energy content through our network Real-Time Networks Ofgem has approved our £8m Real-Time Networks project, our most ambitious innovation to date. We’ll be trialling sophisticated sensors across a section of our gas network to measure pressure, flow, quality and temperature of both conventional and unconventional gases.

‘This project has the potential to revolutionise the way we manage gas networks in the future for the ultimate benefit of our customers.’ Gus McIntosh Innovation and New Technology Manager

Strategic contribution How does this activity contribute to our strategic ambition? It provides a better understanding and management of customer demand and its impact on energy forecasting. How do we measure our performance in this area? We have a series of technical stage gates to monitor progress plus regularly report to the regulator on eight identified SDRCs (Successful Delivery Reward Criteria).

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09

Image above

Janet MacCuish Image left

Scott Macgregor

10

SGN Annual Report and Accounts 2016

Chief Executive’s report continued

We believe support for biomethane and certain other forms of nonconventional gas must continue to help deliver the large volumes of renewable heat necessary to meet the 2020 targets. In the longer term, we believe there is a significant opportunity for the Government to look beyond the widespread electrification of heat, and consider instead a low carbon transition that is more closely aligned to its priorities in delivering secure and affordable energy to customers. An approach which utilises the UK’s existing gas infrastructure will enable customers to benefit from the uniquely flexible system already in place to meet peak heating needs. Opening up the gas market Our innovative ‘opening up the gas market’ project in the Scottish west coast town of Oban is looking to establish that current UK gas regulations can be safely changed to allow a wider envelope of gases to be transported through the nation’s gas networks and delivered into the home. Achieving this would see a reduced need for expensive processing of gas from further afield than the North Sea to comply with national regulations and would in turn lead to more secure, and importantly more affordable gas supplies for UK customers. At 08:05 on 6 July 2015 UK gas history was made when the first load of Zeebrugge LNG (Liquefied Natural Gas) was injected into the Oban network as stage three of our Oban project. We are now trialling the new gas for a twelve month period, during which time we’ll be conducting appliance testing in around 200 homes to demonstrate acceptable performance of the units while using the new gas. When complete, the project’s findings will be shared to inform a potential nationwide roll-out of gases already being used safely in other European countries.

Real-Time Networks As new forms of green gas are injected into the domestic network, the UK’s gas networks will need to measure the content of the gas in the grid, rather than just the traditional flow and volume. Gas network infrastructure will therefore need to employ new technology and become more flexible. With this in mind we are now embarking on our latest and probably most ambitious innovation project, Real Time Networks, which will meet the requirement for a more intelligent and flexible gas network. We are carrying out a £8m Ofgem sponsored innovation project, which is looking at how new technology can deliver this increased level of flexibility. By installing sensing technology in a representative part of our network in Kent we will be able to measure variables, including flow, pressure, temperature and gas quality, as well as enabling greater volumes of renewable gas in the network. We believe this project could revolutionise the way we manage gas networks in the future, again for the benefit of customers. Smart meter introduction Although we’re not rolling out smart meters ourselves, working closely with suppliers and network companies will be crucial to the success of the programme, to ensure the best experience and outcome for customers. We are committed to this process and continue to work closely with suppliers, government, Ofgem and other stakeholders to better understand supplier roll-out plans and clarify procedures to ensure an effective and coordinated response when network related issues arise from smart meter installations.

Engaging with our stakeholders We continue to underpin our business with our strategy for stakeholder engagement. Last year we were awarded £2.5m through Ofgem’s incentive scheme for stakeholder engagement as we took on a proactive approach to all our stakeholder relations. We value the views of our stakeholders and through hosting stakeholder events, as well as listening to and engaging with our external stakeholder panel, we believe we have a balanced and positive approach to interacting with all of them. As well as embracing innovation and new technology, we are working hard to improve the planning and coordination of our roadworks with local authorities and other utilities to reduce the impact of our work. We are also engaging with stakeholder groups such as the London Collaboration Forum whose priorities include reducing disruption on the roads and improving the efficiency of the street work activity of all relevant parties. The introduction of a major project impact assessment tool will also ensure consistency in the way we engage and communicate with communities and stakeholders. Sustainability Back in 2013 we introduced our sustainability programme ‘Greenplan’. It contains five goals with nine underpinning targets and is designed to reduce our environmental impact. Currently we are meeting seven of our nine targets with an eighth showing an improvement over the previous year. By the end of the third year of Greenplan we have reduced natural gas emissions by more than 10%, energy consumption by 37%, and we now send well under 1% of our total spoil and depot/office waste to landfill. Greenplan performances are validated by our regular Carbon Trust audit and ISO14001 accreditations.

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We also look to reduce our environmental impact through innovative technology. For example, our pioneering gas preheat system has delivered a thermal efficiency of 85%, a first in pipeline preheating. This resulted in a 30%-40% reduction in fuel use and CO2 emissions, compared with traditional water bath heaters. Our new £2.8m ‘iCore’ technology project is where we’re developing new ways of replacing gas mains and services through keyhole technology to use in conjunction with our pioneering flow-stop solution and Core & Vac excavation technique. These all offer more efficient and environmentally friendly methods of gas mains replacement.

Our strategic priorities

Customer service is a priority Our aim is to deliver industryleading customer service and satisfaction through the implementation of our Customer Experience strategy. This includes developing account managers, a new customer feedback app and live chat direct with our customer service centre.

We're focused on delivering affordable energy to customers. We provide a 10/10 service and support to households in fuel poverty while reducing the impact we have on customer bills.

During the year we performed well in Ofgem’s measure of customer satisfaction scores and we continue to improve our customer experience year-on-year. We reached number one gas network company for Emergency/Repair and hold the highest company Emergency/Repair scores on record. We also hold the title for mains replacement customer satisfaction. We’ve continued to reduce our customer complaints by 35% since 2012/2013 through increased customer satisfaction training and customer experience workshops for our front-line people.

Keeping the gas flowing safely

However, despite these good results we will not become complacent in any aspect of customer service and we realise there is still work to do in providing the world-class service our customers deserve.

11

Our vision for the future is to keep our customers safe and warm by leading the way in energy delivery. This means delivering over and above our basic commitments under the RIIO price control. Our priorities detail what we’ll focus on this year to support our development as a responsible, efficient and sustainable organisation. We consult with customers and stakeholders throughout the year to make sure that these priorities reflect their needs and expectations.

Keeping energy affordable

Improving our service Customers and stakeholders are central to what we do. We’re continuously improving to deliver industry-leading service every time.

We’re making sure our customers receive a safe, secure and reliable supply.

Sustaining our future We believe gas has a role to play in a low-carbon economy. We’re investing in our people and network to support a sustainable future.

Supporting our communities We're a local company with 27 depots across Scotland and the south of England. We want to contribute to and play an active part in the communities where we work.

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SGN Annual Report and Accounts 2016

A new age in engineering Robotics We've internally sealed around 10km of gas mains since launching our initial robotics technology CISBOT in 2014 and in November 2015 we successfully launched and field-tested our breakthrough CIRRIS™ Robotic Systems.

‘We’re on-track to progress the design development with the green light from Ofgem to invest a further £1.4m.’ Gus McIntosh Innovation and New Technology Manager

Strategic contribution How does this activity contribute to our strategic ambition? This pioneering technology will allow us to extend the life of large diameter cast iron pipeline infrastructure while reducing traffic congestion, overall excavation footprint, inspection time and general inconvenience to customers. How do we measure our performance in this area? We have a series of technical stage gates to monitor progress plus regular reports to the regulator on eight identified SDRCs (Successful Delivery Reward Criteria).

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13

14

SGN Annual Report and Accounts 2016

Chief Executive’s report continued

Focusing on safeguarding our most vulnerable customers has been a priority during the year. We believe in acting responsibly and agree with our stakeholders who tell us we need to provide our most vulnerable customers additional services to address their specific issues. Over the past year we launched five well-researched initiatives which will have a positive daily impact on our customers and could potentially save lives: 1. Care Commission accredited dementia awareness training which gives our operatives the ability to understand and recognise vulnerability and be knowledgeable enough to provide support. 2. Customer careline a Freephone referral service to encourage vulnerable customers to register on the Priority Services Register (PSR). 3. Locking cooker valve addressing vulnerability of customers with dementia in their own homes. We’re trialling a charitable project to fit lockable gas cooker valves to prevent explosions and fires, and reassure families and carers. 4. Gas safety in the home we’ve developed a QCV training module for frontline care workers and our own engineers on recognising unsafe gas situations that could seriously affect our vulnerable customers. 5. Vulnerable customer training a new initiative to give our employees knowledge and tools to help vulnerable customers further. These initiatives are in-line with our overall goal of being a leader and not a follower in what we do, showing our customers and stakeholders that we genuinely care about their well-being. Fuel poor connections Some 4.5 million of UK households (17%) are currently in fuel poverty (10% in England, 35% in Scotland) and those without gas heating are more likely to be fuel poor.

We recognise the important role we have to play in combating fuel poverty by providing free or discounted gas connections to our network. Since 2009 we have provided over 28,000 fuel poor connections. During the last year we connected 21,833 new customers to our network, 3,846 of which were fuel poor households as part of our Help to Heat scheme. We see this as important work and therefore welcomed the decision by Ofgem to extend our eight year target for the connection of fuel poor householders in both our network areas. Ofgem has now endorsed a 37% increase to our fuel poor connections target for RIIO-GD1 from 20,000 to 27,497. In November 2015, we sponsored the Energy Action Scotland Annual Conference. This conference provided a platform for us to engage with politicians, local authorities, housing associations and third sector organisations to highlight not only our Help to Heat strategy, but also what we are doing to safeguard vulnerable customers. As a direct result, we have been invited to join the Scottish Government’s Fuel Poverty Forum which monitors the implementation of the Scottish Government energy efficiency schemes, advises ministers on further action required, and liaises with the Fuel Poverty Advisory Group for England. Gas to the West Work commenced during the year on building the new pipelines which will take natural gas for the first time to eight towns in the west of Northern Ireland. Traditionally these towns have been dependent on oil and coal, among other solid fuels, to heat their homes. The completed project will see up to 40,000 new customers able to connect to natural gas for the first time, helping to address fuel poverty as well as offering a lower carbon fuel for heating purposes. This major infrastructure project in Northern Ireland will also greatly benefit the

Images above from top

> Looking after our vulnerable customers is a key priority for us. > Innovative use of flood defence barriers to protect our equipment.

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local economy and industry, providing a competitive and secure energy supply, while bolstering the region’s attractiveness for investors and securing employment. Giving back to communities As a responsible company, we know it’s important to support the communities where we work. Our stakeholders have also said they want us to utilise our core skills in the community work we undertake. For the year 2015/16 we achieved an overall community investment of £506,099 (exceeding our target of £500,000 and equating to £130 per employee). We measure our community investment using the accredited London Benchmarking Group (LBG) model. Our total included £52,461 in matched funding, supporting our employees in their own fund-raising endeavours, and offering up to £500 in like-forlike donations for individual’s charities or good causes. Through our Community Action Programme (CAP), all our employees can take a paid day-off each year for direct involvement in valuable community work. Over a third (1,710) of them were involved in charitable activities and in doing so were able to contribute positively to their local communities. This also offers our people good teambuilding opportunities which they embrace. Just one example of helping a worthy community cause came from a referral from one of our partners Energy Action Scotland. As part of our focus on fuel poverty and helping to make life better for low income and vulnerable households, we donated a week of some of our engineers’ time to install central heating into the head office of the Glasgow Old People’s Welfare Association. Now their employees and clients have a warm and comfortable environment in which to work.

Our new campaigns: 1. Working with London Road Safety Council we supplied 33,000 nine-year-old children with 'safety shiners' – reflective keychains that ensure the children are seen when walking home from school. 2. We supported the Royal Voluntary Service’s (RVS) national ‘Get ready for winter’ campaign, providing essential information to 65,000 people. 3. Through the Outward Bound Trust we sponsored 189 year-nine students in Portsmouth, Southwark, Orpington and Glasgow. 16 of our employees volunteered to mentor these groups, to initiate positive change and a sense of achievement through guidance and encouragement. 4. 389 employees are completing our online Quality Care Commission approved dementia awareness training to inform them more about the disease and how to better communicate with those affected. Gas holder dismantlement Despite being a feature of the British landscape for decade upon decade, gas holders have now come to the end of their useful life; advances in our innovative network technology have made them redundant. We have now commenced a gas holder dismantling programme with the target to remove some 55 in our operational areas by 2021. We’ve put stakeholder engagement at the heart of this programme ensuring the work takes account of each community’s requirements. Keeping the water out Over the last couple of years we’ve all seen just how damaging water can be for homes and businesses. If water gets into our network it disrupts customers’ supplies and this takes time to remedy. One innovation we’ve introduced to counter this threat is an investment in a Geo-design gold-class flood defence barrier system to protect our key equipment in high risk areas.

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Outstanding training With around 3,900 highly skilled and flexible employees, our people make a significant economic contribution in the areas in which we operate. We recognise that, with an ageing workforce like many companies across the energy industry, we need to address and mitigate the impacts of a future skills gap which will occur when a large number of experienced employees retire in the coming years. To help address this we currently have 147 trainees on our apprenticeship programme, which received a staggering 3,000 applicants last year. Along with an additional 24 new graduates we also have coaching and development programmes in place to ensure we have the right people, with the right skills to deliver our future business needs. During the year we worked with our partner ‘Develop Training’ to deliver a training programme called MaTE (Managing a Technical Environment). Using a combination of theory and innovative real-play scenarios, 189 of our team managers have gained an understanding of key management techniques and their practical application in the workplace. These new skills are positively contributing to the dramatic fall in complaints we are seeing.

John Morea Chief Executive Officer 21 July 2016

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SGN Annual Report and Accounts 2016

Leading the way in apprentice recruitment Apprentices Since 2008 we’ve recruited 279 apprentices across a range of engineering disciplines and this year added 25 more. We gained a ‘Highly Commended’ at the National Apprenticeship Awards (England) plus won a coveted place on the 2015 list of Top 100 Apprenticeship Employers.

‘This year’s Top 100 was hugely competitive with even more leading employers developing world class apprenticeship programmes.’ Nick Boles MP Skills Minister

Strategic contribution How does this activity contribute to our strategic ambition? Being involved in the Government’s new trailblazer campaign plus our Head of Competence Development, Neil Snell chairing the Gas Network Skills Forum puts us at the forefront of apprentice recruitment. How do we measure our performance in this area? Of the apprentices we have employed in recent years we have a retention rate of 97%.

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17

Image above

Mitch Kerby Image left

John Whittle and Kelvin Bovell

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SGN Annual Report and Accounts 2016

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, indicating the value provided to shareholders and customers. 2015 and 2014 operating profit are restated under FRS 102.

2016 Actual

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 and buildings, vehicles and plant.

2016 Actual

Capital expenditure

Replacement expenditure

Debt to RAV ratio

Data £511.7m

2015

£548.7m

2014

£534.1m

£135.6m

2015 2014

£145.8m £99.0m

Replacement expenditure is capitalised under FRS 102. (For details, please refer to Note 28: Explanation of transition to FRS 102). 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 960km of pipes were replaced in the year.

2016 Actual

£223.9m

2015

£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.

2016 Actual

72.2%

2015

72.3%

2014

72.2%

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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.

2016 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 2015. Planned interruptions on our replacement, capital or routine maintenance works are where timing can be predicted and the customer has been notified in advance.

2016 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 2015. Unplanned interruptions arise through leakage or other emergencies.

2016 Actual

9.4

2015

9.2

2014

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 ‘on’ at the time the customer calls. We responded to over 140,000 uncontrolled and over 80,000 controlled gas escapes during the year ending 31 March 2016.

2016 Actual

Customer complaint volume reduction

This represents the year-on-year reduction in complaints expressed as a percentage. Complaint means any expression of dissatisfaction related to any areas of our operation.

2016 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 three reportable years.

2016 Actual

2015

0.06 0.04

2014 0.01

8.8

2015

8.6

2014

8.6

98.5%

2015

98.7%

2014

98.7%

39%

2015 11% 2014

2015 2014

26%

7.6 6.4 5.9

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SGN Annual Report and Accounts 2016

Financial review

There has been a solid financial performance this year, derived primarily from efficiencies we have embedded in our business. These efficiencies are shared through a regulatory mechanism, providing value for shareholders and customers.

Capital expenditure

£223.9m £223.2m

£534.1m

£222.7m

2016

Cash generated from operations

2014

£511.7m

2015

£500.0m 2015

2016

2014

2016

2015

£1,096.8m

Replacement expenditure

£548.7m

2014 2014

£1,089.1m

Regulated Asset Value

£135.6m £653.5m

£4,882.0m

2014

£4,917.0m

£609.5m

2015

2014

2015

2016

£99.0m

£5,026.0m

£712.6m

2016

£145.8m

2014

Investment and safety Our overriding objective is to ensure safety is at the heart of everything we do. The RIIO price control sets operational outputs for removing risk from the network, and the primary method for achieving this is replacing old iron mains with modern polyethylene pipes. Innovative techniques, such as CISBOT, allow gas mains to be substantially renewed, without replacing the pipe. We look for the most effective method of removing risk, but we never compromise on the safety and integrity of our distribution network.

Operating profit

£1,079.7m

2016

This is the first year we have adopted the new UK accounting framework, FRS 102. (For details please refer to Note 28: Explanation of transition to FRS 102). The key impact of this change is that our replacement expenditure is now capitalised rather than expensed in the profit and loss. As a result, our net assets and profits have significantly increased due to this accounting change. We have restated all comparatives in this annual report, allowing an assessment of the underlying change in performance and position by the reader, and in the following commentary.

Turnover

2015

We successfully issued a £250m ten year bond in the latter part of the year, reflecting our continued good standing in the debt capital markets. Along with our undrawn revolving credit facility and European Investment Bank facility, this leaves us in a strong liquidity position.

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The key financial performance indicators relating to this objective are the regulated asset value (RAV), and total network investment. The total network investment in replacement and capital expenditure was £359.5m (2015: £369.0m). All our operational outputs required under the price control are being met as a result of this investment, and we have maintained the highest standards of safety. Replacement expenditure, primarily of iron pipes, increased marginally to £223.9m (2015: £223.2m). During the year we replaced 960km of metallic pipe (2015: 1,042km). Other capital expenditure excluding replacement decreased to £135.6m (2015: £145.8m) due to timing related reductions on IT infrastructure and vehicle fleet expenditure. The RAV increased by 2.2% in the year from £4.92bn to £5.03bn. RAV is defined as the Ofgem regulatory asset value of both networks plus adjustments relating to the sharing of out/under performance against allowances. Efficiency and performance In delivering the overall business strategy, we have an objective to maximise our efficiency with a focus on innovation. The RIIO price control provides an effective framework to deliver value to both our shareholders and customers through a regulatory sharing mechanism. The key financial performance indicators we use to assess our progress on this objective are operating profit and cash generated from operations.

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

RAV (£bn) 5.00

1,000

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

0.00

0 2010 RAV (£bn)

2011

2012

2013

2014

2015

2016

TNI (£m)

There was a decrease in operating profit to £511.7m (2015: £548.7m). The fall in turnover was due to the timing of allowances set out at the start of the price control period, and the sharing of efficiencies with customers. The sharing is based on a two year time lag, and these efficiencies relate mainly to performance in 2013/14. Operational expenditure was lower than our regulatory allowances due to a continued focus on efficiency; these costs were higher than the prior year due to inflation and higher depreciation arising from further capital investment. Cash generated from operations has decreased to £653.5m (2015: £712.6m); the movements noted above in operating profits filter through

to cash flow, together with an increase in working capital. Treasury and financial management In line with our broader strategy, we aim for the same high standards of safety in our financial management, as we do in our operational activities. Our objective is to maintain safe levels of debt finance and liquidity. Net debt and interest Financing consists of a mixture of equity, loans from shareholders and long-term debt. The vast majority (95%) of our regulated revenue is based on capacity provided by our network, and the stable cash inflows provide a suitable foundation for debt

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SGN Annual Report and Accounts 2016

Financial review continued

Movement in operating profit (£m) 550

548.7

540

+12.0

530

-7.0 -22

520

-13.9 511.7 510

-6.1

500

490 Operating profit at 31 Mar 2015 (FRS 102)

Customer sharing

Incentive income

SIU recovery

financing. We have a robust financial risk management process, which we employ to ensure that appropriate mitigations are in place. A key financial performance indicator is the debt to RAV ratio. At 31 March 2016, net debt (before issue costs), excluding shareholders’ loans and liabilities arising from derivative financial instruments, amounted to £3,632.3m (2015: £3,555.2m) and the debt to RAV ratio was 72.2% (2015: 72.3%). 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. Interest rate swaps are used where

Dep'n and amort'n

Other

Operating profit at 31 Mar 2016

necessary, to achieve the desired profile. Of the total long-term borrowings at 31 March 2016, excluding shareholders’ loans and after taking into account the effect of interest rate swaps, 86.5% were at either fixed rates of interest or were index-linked (2015: 87.8%). Interest rate cover is another key performance indicator which is closely monitored. We exclude shareholder loan interest and at 31 March 2016, our interest coverage ratio was a 4.8x (2015: 5.1x). Net interest costs reduced along with operating profit, largely due to lower accretion charges on index linked bonds of £9.1m (2015: £20.3m).

Our prudent policy of using index linked RPI bonds to provide a natural hedge against our RPI linked revenues has proven highly effective. Liquidity 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. We manage the maturities of debt and facilities to ensure no significant

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refinancing is required in any one period, thereby giving us access to competitively priced debt. During the latter part of the year, we successfully issued a £250m 10 year bond with a fixed rate coupon of 3.25% in advance of a bond maturing in the following financial year. At 31 March 2016 the undrawn amount of our European Investment Bank loan facility was £160.0m, after draw downs of £205.0m were made during the year. These amounts are used to fund our investment programme. As at 31 March 2016, the undrawn amount of the revolving credit facility was £350.0m (2015: £350.0m). This facility has a five year term ending in July 2019. In conclusion, our undrawn facilities and pre-funding have resulted in a very healthy liquidity position. Financial instruments Appropriate interest rate swap contracts are used to achieve the target interest risk profile. FRS 102 requires these swaps to be valued at ‘fair value’, which is calculated using market based interest rate information at the year end. We take reasonable steps to maintain a minimum credit rating requirement as set out in our hedging policy; however, we recognise that at times the market conditions for banks can be unusually tight.

No new derivative contracts were entered into during the year. At 31 March 2016 there was £16.2m (2015: £22.1m) receivable and £137.4m (2015: £155.7m) payable relating to financial instruments with bank counterparties. Credit rating agencies 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 2016 were: • ‘Baa1’ with stable outlook (Moody’s); • ‘BBB+’ with stable outlook (Fitch ratings); and • ‘BBB’ with positive outlook (Standard & Poors). 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 102, our balance sheet accounts for any pension asset or liability. The net pension asset as at 31 March 2016 was £51.3m (2015: £59.5m liability).

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Following the valuation carried out by the scheme’s actuary as at 31 March 2015, 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%. Dividends 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. During the year we paid dividends of £160.0m (2015: £150.0m).

Chris Brook Chief Financial Officer 21 July 2016

24

SGN Annual Report and Accounts 2016

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

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 employees, contractors or members of the public, asset damage or loss and prosecution under relevant legislation.

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

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

 Risk priority in 2014/15

– No change

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

 Risk priority in 2014/15 – No change

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

We have a proactive public affairs campaign with relevant stakeholders to highlight the long-term value of the networks. Ofgem’s decision not to undertake a mid-point review is a positive point for our business model.  Risk priority in 2014/15 – Continued priority Uncertainty in the political arena and possible changes in government policy is ongoing.

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.

We have a comprehensive asset management system, and are accredited with the internationally recognised IS055000. There is a strong framework of engineering governance and risk management to ensure all assets have a strategic plan through their lifecycle and are tracked and managed by the Engineering and Safety Committee.

 Risk priority in 2014/15 – No change

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Description and impact of risk

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.

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.

Mitigation

We have a managed information security programme across all our activities to ensure resilient business operations. We conduct regular internal and external penetration and vulnerability tests of our network with government approved security partners to review our security posture.

 Risk priority in 2014/15

Liabilities increase due to market conditions or demographic changes or when investments underperform.

– No change

The funding position, including gearing and future cash requirements, is continually reviewed and managed with regular updates to the Board. There is frequent dialogue with banks and credit rating agencies to assess the impacts of any economic changes. Key metrics are built into the business planning process to manage future funding.

 Risk priority in 2014/15

Pension liabilities/ financial performance

25

– No change

There is a strategy to manage the risk including inflation and interest hedging as well as asset de-risking strategies, which are linked to overall scheme funding levels. This is supported by periodic formal valuations of pension schemes and contributions with continual monitoring of the scheme.

– No change No change due to continued low inflation.

 Risk priority in 2014/15

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.

We have a comprehensive workforce planning and recruitment programme to ensure optimum resource management, including safety, HR, IT and finance. This programme is reviewed regularly at executive level. We also keep abreast of general economic and industry developments to ensure we identify and respond to issues.

 Risk priority in 2014/15

Business continuity plans are in place throughout the company and are reviewed continually with regular test exercises at critical site operations. We also work with local and national government on broader resilience arrangements such as the national emergency fuel plan.

 Risk priority in 2014/15

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.

– No change

– No change

Effective stakeholder engagement and continued cost savings and efficiency improvements. Also, we publish our own distribution prices. Prevailing wholesale prices have modestly eased retail pricing. Ongoing work with stakeholders to seek an expanded DECC funding scheme to support local authorities in offering boiler replacement grants.

– Continued priority Media focus on energy prices and continued political attention.

 Risk priority in 2014/15

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SGN Annual Report and Accounts 2016

Corporate responsibility

We want to empower our employees to connect with the communities we serve, helping them prosper by developing charity partnerships and fundraising on a local level. Focusing on four areas – vulnerable customers, 4-18 year-old children, young adults and the general community – we’ve directly involved colleagues in building positive relationships which feel good and improve our corporate responsibility position.

Our community strategy targets an annual community investment of £500,000. Last year our community investment in the financial year ended 31 March 2016 was £506,099 with 1,710 employees getting involved in volunteering activities equating to 10,602 hours of company time. The appetite for mentoring grows every year; 44 employees were directly involved in helping 1,922 children build confidence, independence, and new skills through our close partnerships with Girlguiding UK, the Outward Bound Trust and local schools in the communities we serve. • The Outward Bound Trust – our partnership with the trust goes from strength to strength and our activities are outlined as a case study on the following pages. • We sponsored the Royal Voluntary Service’s ‘Winter Wellness’ campaign, and helped produce a free leaflet called ‘Get ready for winter’, full of advice about how to keep safe, warm and in touch over the colder months to encourage older people to stay both physically and emotionally well whatever the weather. The leaflet reached over 100,000 older people. Royal Voluntary Service volunteers provide support to help older people live independently in their own homes. Paying regular visits to older people in their community, either to deliver meals, to have a chat, or accompany them on outings, Royal Voluntary Service

volunteers make sure older people have the help they need to get through the winter months. • We’ve been working with the Blue Lamp Trust. The trust has been established to promote and enhance community safety (particularly vulnerable people) in Hampshire and is supported by Hampshire Constabulary and Hampshire Fire and Rescue Service. We provided 2,500 CO alarms free of charge for the homes of elderly or vulnerable people. • Our partnership with Girlguiding UK is opening up opportunities for women by encouraging them to pursue careers in science, technology, engineering and mathematics. 10 employees helped mentor 672 14-21 year-old girls in this area last year. With over a third of women in the UK involved in Girlguiding now or in the past, this is a great opportunity to improve the representation of women in male dominated industries. For the past three years we've been spreading safety messages with their help. Our campaigns to raise awareness about carbon monoxide and energy safety encourage young women to share the message in their community. Through the partnership we’re also providing a great resource to support the girls in achieving part of the existing Guides' Active Response Badge. Called 'Walk on the Safe Side', this badge support

resource is packed full of helpful information and fun activities and will help Guides show they take safety seriously and can be trusted to look after themselves and others. The information and activities will help guides understand gas and carbon monoxide safety as well as other utilities like electricity and water, and will help them achieve their Active Response Badge. • We’re working with ‘Solutions for the Planet’ and Tarmac in southern England to deliver a professional, flexible community-engagement programme with the aim of encouraging more young people to explore opportunities and careers in science, technology, engineering and mathematics. Through the programme our mentors will be working with six schools in Newham and Kent, engaging with approximately 1,200 students to generate and implement sustainable business solutions addressing key sustainability challenges. These big ideas, developed by communities for communities, are designed to improve society’s quality of life, the economy and the environment. The focus subjects are water, waste and energy and the aim is to encourage young people to: • • • •

Say something Do something Change something Make something better

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27

‘Our community strategy targets an annual community investment of £500,000’ Pamela Goee Head of Community

Pupils are encouraged to enter their ideas into a competition with the final being held and judged at the Palace of Westminster. Ideas from previous entries have been developed further and successfully implemented.

• Through Kit for Kids, employees can apply for sports equipment and clothing for local teams they coach or support. We had 34 funding applications last year and donated £16,042.

• This year we're continuing our support for the Scottish Charity awards by sponsoring the Cracking Campaign award. Campaigning is at the heart of Scotland’s charity sector – transforming attitudes, raising funds, changing laws and raising awareness of important issues – so the judges will be looking for unique ideas, effectiveness and impact from the submitted campaigns. The Scottish Council for Voluntary Organisations (SCVO) hosted the final on 9 June.

• Safety centres – We support the Risk Factory in Edinburgh, LV Streetwise in Poole and Hazard Alley in Milton Keynes with resources which help them promote gas safety and carbon monoxide awareness in the community.

• Our Into Action scheme allows employees who raise money for UK-based registered charities to apply through the company for matched funds or time in relation to these activities. Last year we processed 120 applications and donated £52,462 as part of this scheme. Images above from top

Working with our partners: > RVS winter wellness campaign > Outward Bound Trust > Girlguiding UK > Our Into Action scheme – Kit for kids

Our Community Action Programme (CAP) gives employees the chance to spend a day volunteering for local community or charitable causes; giving something back to the communities they work in. It also helps to foster an understanding within our workforce of the benefits of volunteering and raise awareness of community issues.

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SGN Annual Report and Accounts 2016

Partnering for mutual benefit Outward Bound Trust Our ongoing partnership with the Outward Bound Trust allows us to build deeper relationships with the participating schools, encourage greater interest in STEM subjects and involve more of our people as mentors. In 2015 we donated £50,000 to the trust to enable 189 disengaged young people to take part in a five-day course.

‘Our alliance with SGN has developed into a partnership that’s having a positive impact on young people and their own employees.’ Kerry Childs Corporate Partnerships Manager, The Outward Bound Trust

Strategic contribution How does this activity contribute to our strategic ambition? Our strategic objectives includes a company community investment target of £500,000 each year of which this is a core component. How do we measure our performance in this area? Through the London Benchmarking Group (LBG) we measure our annual community investment contribution. In addition being an Outward Bound mentor is recorded on our employees' core competency training records.

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30

SGN Annual Report and Accounts 2016

Community Action Programme (CAP) 322 colleagues took part in our CAP month in June, with the coveted CAP trophy and £500 for their chosen charity going to the team judged by colleagues to have organised the most worthwhile overall project.

CAP trophy winners West Kent Depot were crowned the winners for their inspiring renovation project at Brooklands primary school for pupils with severe and complex needs. 19 volunteers from the depot worked hard tidying up the sensory garden, building new flowerbeds and mending the cracks and holes in the play area path. They also repaired and painted sheds, benches and playground furniture with bright colours to stimulate the children’s imagination. The project was especially poignant for Simon Patient, West Kent depot Engineering Manager as his daughter is a pupil at the school. He said: “The progress Rhian has made over the past two years is nothing short of amazing. I’m so grateful to the company for giving us the chance to improve the old facilities and build new ones for the children through CAP.” Connections Administrator Adam Jempson added: “It was a humbling experience and made me realise how things in everyday life can be taken for granted. The kids were so happy and inspiring as they tackled their difficulties head on at a very young age. Anyone who gets the chance to take part in CAP should do so. It’s something you’ll never forget and is incredibly rewarding.” These are a couple of the other projects shortlisted for the trophy: Five Sisters zoo 30 hardworking volunteers from our Edinburgh office spent time at the Five Sisters zoo in West

Lothian to help build a lion enclosure. The zoo is home to over 160 different species of mammals, birds and reptiles including four ex-circus lions rescued by the zoo. The team played a valuable role in preparing the lions’ new home, clearing land and preparing the heavyweight posts for the new enclosure. The zoo owners, Brian and Shirley Curran really appreciated all the hard work. Brian said: “Everyone put in so much effort. The work you did would have cost us about £1,500 which is a huge amount for the charity. We can’t thank you all enough.” Dundee Christmas toy and gift appeal A team of 11 Dundee depot colleagues spent their CAP day wrapping presents for delivery to 500 disadvantaged children in December as part of Dundee City Council’s Christmas Toy and Gift Appeal. The council’s social work department, in partnership with the charity Help for Kids provides Christmas presents for children and young people, aiming to make sure every child in Dundee wakes up to a gift from Santa. Presents donated by colleagues in the Dundee depot were added to the existing mountain of toys. Dundee City Council’s Programme Manager Kiley West, said: “This year we’ve been inundated with kind donations to our Christmas Toy Appeal, and without the support of SGN volunteers we would have struggled to get the gifts wrapped and distributed in time for Christmas.”

Images above from top

Our people getting involved in community schemes: > Brooklands school > Five Sisters zoo > Dundee Christmas appeal

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31

‘Our approach to hiring and promoting talent must bring alternative points of view and innovation to the company.’ Kirsty Richardson Head of Employee Engagement and Change

Inclusion and diversity ‘Our aim is to build a culture where who you are, and the skills you bring are valued, creating diversity of thinking and delivering differentiation for our company.’ By definition, diversity is the way people differ; inclusion is making the mix work; encouraging, developing and supporting differences. Last year our start point was recognising the need to instill a sense of community and integration rather than separate out identities, so it’s become I&D for us rather than D&I, and we’ve made it a business priority. The energy sector is facing many challenges but from an employment perspective it’s the lack of diversity, retirement crisis and the skills shortage that we need to address now. 47% of our industry’s workforce will leave or retire by 2023 so the talent pool to hire from is changing. This is an exciting opportunity for us, and our approach to hiring and promoting talent must allow employees to bring alternative points of view and innovation to our company.

Employee Engagement We’re now in our eighth year of employee engagement surveys and our employee engagement index (EEI) has leveled off at a high of 81%. Improvements made as a result of feedback over the past year include: • Modernising communications to reach our younger audience through vlogs and yammer • Celebrating our 10th anniversary and generating pride in our company • Improving the experience of all new starts with a video and booklet to make sure they know our real story • Finishing our rebrand project so our identity is consistent and modern • Putting 750 managers and leaders through core behaviour training • Developing an aspiring manager and engineer programme with mentor support to grow our future talent But we don’t want to become complacent or rely solely on our EEI scores, so we’ve reinvigorated our engagement approach for 2016. This includes: • Implementing new indices for effective management, inclusion and diversity, leadership and communications analysis • Refreshing our engagement reports and developing an engagement action planning toolkit

• Using more modern communication channels such as video to champion engagement and reach more people • Creating an employee engagement steering group with a cross representation of colleagues to involve more people in action planning and get to the root of any issues raised • Running ‘Let’s chat’ engagement events at varying locations so we reach many colleagues across different functions

Gregor Alexander Chairman 21 July 2016

32

SGN Annual Report and Accounts 2016

Chairman’s statement

‘We are committed to ensuring the government’s updated strategy on heat recognises the importance of the existing distribution networks.’ Gregor Alexander Chairman

A decade on from formation, we’ve truly come of age. Today we’re leading the way on innovative projects which are changing the shape of the gas industry and at the same time are at the forefront of customer service, customer communications and engagement, with the development of our networks now reaching across the Irish Sea. With consistent and dynamic leadership from our CEO since 2008, a supportive and committed group of shareholders with us from the beginning, committed employees and a world-class safety record, it gives us credibility as a leading player in energy networks. As a regulated business the RIIO framework introduced by Ofgem which runs from 2013 to 2021 drives our business to constantly innovate and deliver ever increasing value for money for our customers. In the first three years of RIIO we have performed very well against outputs and incentives to deliver greater efficiency, innovation, stakeholder engagement, and an enhanced standard of service for our customers. This all contributes to a position where, over the course of the price control to 2021, our network charges will fall in real terms. Gas is the fuel of choice for UK customers and meets the heating needs of 85% of homes. While the way heat is provided will change as the UK transitions to a low carbon economy, we believe gas will continue to have a key role beyond 2050, in particular in meeting peaks in demand. We are committed to ensuring the government’s updated strategy on heat recognises the importance of the existing distribution networks and the key role they can play in decarbonising heat at minimal cost and disruption to our customers. As the gas network is largely underground, it is also highly resilient. Our network is over 99.9% reliable, with unplanned outages expected once every 40 years.

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This level of reliability is important in meeting the heating needs of vulnerable customers, particularly during winters where the UK experiences severe storms and interruptions to power supplies can occur. Gas also provides an affordable way for people to heat their homes. Heating your home by gas is around three times cheaper than using electricity and saves customers over £400 a year compared with alternatives. Future heat solutions which make the most of existing infrastructure will reduce cost, as well as minimising disruption to communities and businesses from new developments. Through the Iron Mains Replacement Programme (IMRP), it is envisaged that the majority of our low-pressure distribution network will be made up of polyethylene by 2030. This will mean new, safe, reliable and above all flexible assets in place which can benefit customers for years to come.

SGN Ownership structure SGN has three supportive shareholders in place since the company formation in 2005. As well as the holding company they oversee the two operating companies in Scotland and southern England.

Shareholders

SSE (50%)

OTPP (25%)

SSE is a FTSE 100 company and one of the largest energy companies in the UK with market capitalisation of c £15bn

Ontario Teachers’ Pension Plan Board (OTPP) has net assets of $171.4bn

Gregor Alexander Chairman 21 July 2016

Borealis Infrastructure (Europe) (25%) Borealis is indirectly wholly owned by OMERS Administration Corporation which has over c $77bn in net investment assets

Holding company

Replacing ageing metallic pipes continues to be the biggest contributor to reducing energy losses through the gas distribution network, totalling over 90% of the total reduction in emissions each year. Replacing the old iron mains also greatly reduces the residual risk of explosion. This means the network we are building at the start of this century will be fit-for-purpose in the next. Finally, through consistent financial performance we ensure stability, demonstrating to worldwide investors why they should have confidence in investing in the UK utility industry generally.

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Scotia Gas Networks Ltd

Operating companies

Scotland Gas Networks plc

Southern Gas Networks plc

Public Bonds

Unregulated operating companies

34

SGN Annual Report and Accounts 2016

Board of Directors

Gregor Alexander

Natalie Flageul

Neil Fleming

Chairman

Director

Director

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 Audit Committee.

Robert McDonald

John McManus

James McPhillimy

Director

Director

Director

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.

Andrew Jonathon Mark Taylor Alejandro López Delgado Director

Director

Jo joined the Board in May 2016. He is Regional Managing Director in Teachers' Infrastructure Group EMEA, overseeing the full cycle of origination, analysis, execution, value creation and eventual realisation of private investments in EMEA. Jo is the Chairman of the People and Reward Committee and a member of the Safety, Health and Environmental Advisory Committee.

Alejandro joined the board in November 2015. He is a director at Borealis Infrastructure where he is responsible for the origination, acquisition and management of infrastructure investments with a focus in Europe. He is a member of the Safety, Health and Environmental Advisory Committee.

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

Statutory Independent Non-executive Directors

Senior management team

Paul Jeffery

John Morea

Director

Chief Executive Officer

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 30 years experience in the energy 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

Director

Chief Financial Officer

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, including a previous role as 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.

Registered office St Lawrence House Station Approach Horley, Surrey RH6 9HJ

Nicola Shand

Registered auditor Deloitte LLP Chartered Accountants and Statutory Auditor, London Registered number 04958135

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.

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SGN Annual Report and Accounts 2016

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) including FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland". Under company law the Directors must not approve the financial statements unless they are satisfied 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; • State whether applicable UK Accounting Standards have been followed; and • Prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business. 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 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 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 2016; 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 21 July 2016

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37

Directors’ report

The Directors present their report and the audited consolidated financial statements for the year ended 31 March 2016. 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 14 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 2016 and up to date of signing, are listed below: Gregor Alexander (Chairman) Robert McDonald James McPhillimy Sebastien Sherman  (resigned 24 November 2015) Alejandro López Delgado  (appointed 24 November 2015) Olivia Steedman  (resigned 26 May 2016) Natalie Flageul John McManus Neil Fleming Graham Juggins Paul Jeffery Andrew Jonathon Mark Taylor  (appointed 26 May 2016) 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.

at either fixed rates of interest or index-linked. The Group uses interest rate swaps, where necessary, in order to achieve the desired profile.

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 31.

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.

Results and dividends The consolidated profit and loss account is set out on page 44 and is reviewed on pages 20 to 23. The Group paid interim dividends of £160.0m (2014: £150.0m). The Directors do not recommend the payment of any final dividend for the year (2015: £nil). There are no subsequent events to report. 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

Liquidity risk The Group maintains a mixture of long-term funding and short-term liquid funds in order to ensure there are sufficient funds available for the Group’s current and planned operations.

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.

38

SGN Annual Report and Accounts 2016

Directors’ report continued

The Group contracts with shippers having investment grade ratings only, or where suitable collateral or cash prepayments are made.

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

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 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.

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 31. The Group’s financial risk management objectives and risk exposures are set out above.

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.

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 17 to finance the current and future operations. The shareholder loans were refinanced during the year.

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

The Group’s forecasts and projections, taking into account reasonably possible changes in trading performance, show 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 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 its willingness to continue in office as auditor and a resolution to reappoint Deloitte LLP will be proposed at the forthcoming Annual General Meeting of the Company. By Order of the Board.

Nicola Shand Company Secretary 21 July 2016

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39

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 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, not having listed equity shares, is not subject to the UK Financial Reporting Council’s UK Corporate Governance Code 1 (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 while ensuring 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. Furthermore, the Board has established three standing committees and one non-standing committee with specific

1

responsibilities to ensure focused and effective leadership. Details of the committees are set out below. The Board meets regularly and has held seven 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 34 to 35. Chairman Gregor Alexander was re-appointed as Chairman on 24 July 2014 for a further three year period.

The UK Corporate Governance Code was issued in May 2010 (replacing the Combined Code on Corporate 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 35. Timeliness and quality of Board information The Board has sought to ensure that Directors are properly briefed on issues arising at Board meetings. This is done 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 introduced a statutory duty on Directors to avoid conflicts

40

SGN Annual Report and Accounts 2016

Corporate Governance statement continued

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 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 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 41.

• 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. The Board considers 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 principal responsibilities of the Audit Committee are as follows:

Safety, Health and Environmental Advisory Committee The current members of the Safety, Health and Environmental Advisory Committee are James McPhillimy (Committee Chairman), Natalie Flageul, Neil Fleming, Alejandro Lopez Delgado, 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 the Company’s financial reports represent an accurate, clear and balanced assessment of the Company’s position and prospects;

• Ensuring the health and safety policy statement and environmental policy statement remain fit for purpose and are being adhered to;

Audit Committee The current members of the Audit Committee are John McManus (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.

• Reviewing and monitoring the safety, health and environmental strategy and action plan, which shall be designed to eliminate, 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. Two meetings were held during the year. People and Reward Committee The current members of the People and Reward Committee are Andrew Jonathon Mark Taylor (Committee Chairman), John McManus and James McPhillimy. Gregor Alexander also regularly attends the People and Reward Committee. The principal responsibilities of the People and Reward Committee are as follows: • 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.

41

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

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 current members of the Finance Committee are Olivia Steedman, Gregor Alexander and Alejandro Lopez Delgado. 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 members of the Finance Committee report to the Board of Directors following each Committee meeting on the matters which the Committee has reviewed. Three 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

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.

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

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.

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

Meeting attendance Board meetings

Audit Committee meetings

People and Reward Committee meetings

Safety, Health and Environmental Committee meetings

Finance Committee meetings

Attended Possible Attended Possible Attended Possible Attended Possible Attended Possible

Gregor Alexander

7

7

3

3









1

1

Alejandro Lopez Delgado*

2

2









1

1

1

1

Natalie Flageul

6

7

















Robert McDonald

5

7

3

3













James McPhillimy

6

7





3

3

2

2





John McManus

6

7

1

1

3

3

2

2





Olivia Steedman****

7

7

3

3

3

3









Sebastien Sherman**

4

5

2

2







1





Paul Jeffery

6

7





2

2

2

2





Graham Juggins***

6

7





3

3

2

2





Neil Fleming Graham Laughland

6

7









2

2

1

1

n/a†

n/a

2

3

n/a

n/a

n/a

n/a

n/a

n/a

* Alejandro Lopez Delgado was appointed on 24 November 2015. ** Sebastien Sherman resigned on 24 November 2015. *** Graham Juggins attended People and Reward Committee meetings and Safety, Health and Environmental Committee meetings as observer. **** On 26 May 2016, the membership of each of the board committees has changed to take account of the appointment of Andrew Jonathan Mark Taylor, who replaced Olivia Steedman. † Graham Laughland is not a member of those committees.

42

SGN Annual Report and Accounts 2016

Carbon report

Introduction Our environmental and sustainability policy, which sits at the head of our environmental management system (EMS) 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. The benefits derived from our main environmental impacts reduction strategy – Greenplan – have allowed us to deliver and demonstrate significant carbon reduction and other environmental improvements. Greenplan’s five goals are underpinned by nine targets, which are reported monthly to our executive committee and reviewed individually with directors who each own a specific goal. Despite the fact that targets have become even more demanding in year three, we have been able to meet seven out of nine of them. The Reducing Carbon Emissions (from Transport) goal has slipped to just over 1% behind target but shows an improvement over the previous year.

RIIO annual environmental measures The Energy Savings and Opportunities Scheme report (ESOS) reinforced what we were already aware of which is 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 this four year target by the end of year three. Reductions have accrued during the last three years as a result of: • Mains replacement programme; • Decommissioning or removal of all of our main gas holders; • P MAC pressure optimisation; • Use of CISBOT; and • Deployment of Predictive Analytics. Non-shrinkage BCF We have reduced our BCF Scope 1 and 2 emissions, over which we have direct control, for 2015/16 compared with the previous RIIO reporting year by 7.73% and 18.74% since 2012/13. Scope 1 transport reductions have been achieved through:

• Our ongoing commercial vehicles replacement programme of replacing older high polluting vehicles with more efficient ones; • Capping our car fleet CO2 and incentives designed to encourage selection of low carbon emitting vehicles; • Tom Tom vehicle driving behaviour reporting technology; and • Maximising the use of video and telecom facilities. Scope 2 – electricity emissions reductions arise as a result of: • Decommissioning or removing gas holders; • Identifying sites for which we have been incorrectly paying for energy; • Implementing building portfolio improvements to lighting and air conditioning systems etc; and • Campaigns designed to improve energy consumption behaviour. Scope 3 – Indirect emissions: These have increased year-on-year as we have added the emissions associated with production of our PE and fittings in year two and this year we have included carbon emissions generated by our replacement contractors vehicle movements.

Business carbon footprint

Scope 1 Energy consumption (excluding electricity) Transport (direct commercial vehicles and business miles) Scope 2 Electricity consumption Scope 3 Rail, air and ferry travel and PE total (excluding shrinkage) Total (excluding shrinkage) Shrinkage Total carbon emissions Data has not been independently verified

Annual movement tonnes of CO2

Annual movement tonnes of CO2 per £1m turnover

2015/16 tonnes of CO2

Tonnes of CO2 per £1m turnover

2014/15 tonnes of CO2

Tonnes of CO2 per £1m turnover

652

0.60

526

0.48

(126)

(0.12)

16,752

15.35

17,480

15.89

728

0.54

4,495

4.16

6,192

5.63

1,697

1.47

9,557

8.85

10,709

9.74

1,152

0.89

31,456 819,851 851,307

28.96 759.33 788.29

34,907 840,311 875,218

31.74 763.99 795.73

3,451 20,460 23,911

2.78 4.66 7.44

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43

Independent auditor’s report to the members of Scotia Gas Networks Limited We have audited the group financial statements of Scotia Gas Networks Limited for the year ended 31 March 2016 which comprise the consolidated profit and loss account, the consolidated statement of comprehensive income, the consolidated and company balance sheets, consolidated and company statement of changes in equity, the consolidated cash flow statement and the related notes 1 to 29. 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), including FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland". 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 2016 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 21 July 2016

44

SGN Annual Report and Accounts 2016

Consolidated profit and loss account for the year ended 31 March 2016

Notes

2016 £m

2015 As restated £m

Turnover Net operating costs

1, 3 4

1,079.7 (568.0)

1,089.1 (540.4)

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

4 14 7 8 5 9 22

511.7 1.0 0.4 (212.8) 300.3 31.3 331.6

548.7 0.9 0.3 (239.0) 310.9 (65.0) 245.9

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

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45

Consolidated statement of comprehensive income for the year ended 31 March 2016

Profit for the financial year Cash flow hedges: – Gains arising on cash flow hedges Remeasurement on net pension asset/liability Deferred tax movement relating to components of other comprehensive income: – Cashflow hedges – Pension asset/liability Other comprehensive income for the year Total comprehensive income

Notes

2016 £m

2015 As restated £m

22

331.6

245.9

21 26

5.5 101.2

21

(1.9) (21.7) 83.1 414.7

– (2.1) (7.2) 0.6 (8.7) 237.2

46

SGN Annual Report and Accounts 2016

Balance sheets as at 31 March 2016 Group 2016 £m

2016 £m

2015 As restated £m

12 13 14

448.7 5,706.9 0.2 6,155.8

461.7 5,514.0 0.2 5,975.9

– – 2,028.4 2,028.4

– – 2,028.4 2,028.4

15

135.5 260.4 3.5 399.4

135.9 318.1 7.0 461.0

– 260.4 – 260.4

– 318.1 – 318.1

16

(615.7) (216.3)

(1,340.1) (879.1)

Notes

Fixed assets Intangible assets Tangible assets Investments

Current assets Debtors Short term deposits Cash at bank and in hand

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 assets excluding pension asset/liability Defined benefit pension asset/(liability) Net assets including pension asset/liability Capital and reserves Called up share capital Hedging reserve Profit and loss account Shareholders’ funds

Company

2015 As restated £m

17 19 13 26

20 21 21 22

(1,445.7) (1,185.3)

(1,840.0) (1,521.9)

5,939.5

5,096.8

843.1

506.5

(4,242.6) (842.1) (317.5) 537.3 51.3 588.6

(3,514.2) (902.0) (287.2) 393.4 (59.5) 333.9

(533.6) – – 309.5 – 309.5

– – – 506.5 – 506.5

200.0 (44.8) 433.4 588.6

200.0 (48.4) 182.3 333.9

200.0 – 109.5 309.5

200.0 – 306.5 506.5

The financial statements of Scotia Gas Networks Limited, registered number 04958135, were approved by the Board of Directors and authorised for issue on 21 July 2016. Signed on behalf of the Board of Directors

Gregor Alexander Director

John McManus Director

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47

Consolidated statement of changes in equity as at 31 March 2016

Notes

Group: At 31 March 2014 as previously stated Changes on transition to FRS 102 At 1 April 2014 as restated Profit for the financial year Remeasurement of net defined benefit pension asset/liability Deferred tax movements relating to items of other comprehensive income: – Cash flow hedges – Pension liability Total comprehensive income Dividends paid At 31 March 2015 as restated Profit for the financial year Cash flow hedges Remeasurement of net defined benefit pension asset/liability Deferred tax movements relating to items of other comprehensive income: – Cash flow hedges – Pension liability Total comprehensive income Dividends paid At 31 March 2016

28

Called up share capital £m

200.0 – 200.0

Hedge Reserve £m

(45.1) 3.9 (41.2)









–  – – – 200.0

(7.2) –  (7.2) – (48.4)

Profit & loss account £m

(1,024.7) 1,112.6 87.9 245.9

Total £m

(869.8) 1,116.5 246.7 245.9

(2.1)

(2.1)

– 0.6 244.4 (150.0) 182.3

(7.2) 0.6 237.2 (150.0) 333.9

– –

– 5.5

331.6 –

331.6 5.5





101.2

101.2

– (21.7) 411.1 (160.0) 433.4

(1.9) (21.7) 414.7 (160.0) 588.6

–  – – – 200.0

(1.9) –  3.6 (44.8)

48

SGN Annual Report and Accounts 2016

Company statement of changes in equity as at 31 March 2016 Called up share capital £m

Hedge Reserve £m

200.0 – 200.0

– – –

518.9 (0.1) 518.8

718.9 (0.1) 718.8

Profit for the financial year Total comprehensive income Dividends paid At 31 March 2015 as restated

– – – 200.0

– – – –

(62.3) (62.3) (150.0) 306.5

(62.3) (62.3) (150.0) 506.5

Profit for the financial year Total comprehensive income Dividends paid At 31 March 2016

– – – 200.0

– – – –

(37.0) (37.0) (160.0) 109.5

(37.0) (37.0) (160.0) 309.5

Notes

Profit & loss account £m

Total £m

Company: At 31 March 2014 as previously stated Changes on transition to FRS 102 At 1 April 2014 as restated

28

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49

Consolidated cash flow statement for the year ended 31 March 2016

Notes

Cash flows from operating activities Cash generated by operations Taxation Net cash inflow from operating activities

2015 As restated £m

653.5 (40.8) 612.7

712.6 (15.0) 697.6

1.0 0.4 (358.7) 15.6 37.0 (304.7)

0.9 0.3 (370.8) 11.3 31.4 (326.9)

(198.0) 452.3 (160.0) (445.8) (16.4) 57.7 (310.2)

(202.3) 381.1 (150.0) (75.0) (22.2) (293.5) (361.9)

Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents at beginning of the year Cash and cash equivalents at the end of the year

(2.2) 4.4 2.2

8.8 (4.4) 4.4

Reconciliation to cash at bank and in hand: Cash at bank and in hand Bank overdraft Cash and cash equivalents

3.5 (1.3) 2.2

7.0 (2.6) 4.4

Cash flows from investing activities Dividends received from fixed asset investments Interest received Purchase of tangible fixed assets Sale of tangible fixed assets Customer contributions received Net cash outflow from investing activities Cash flows from financing activities Interest paid Issue of debt Dividend paid Repayment of borrowings Payments in respect of financial instruments Decrease/(increase) in short term deposits Net cash outflow from financing activities

23

2016 £m

13

11

50

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 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 2016. The comparative period presented is the year ended 31 March 2015. A summary of the more significant Group accounting policies, which have been applied consistently in both years is as follows. General information and basis of preparation Scotia Gas Networks Limited is a company incorporated in the United Kingdom under the Companies Act 2006. The address of the registered office is St. Lawrence House, Station Approach, Horley, Surrey RH6 9HJ. The company and its subsidiary undertakings together form the “Group” for which consolidated financial statements are drawn up. The Group’s principal activity is the development, administration, maintenance and operation of the Southern and Scotland gas distribution systems, the supply of gas transportation services and other gas related services. The financial statements have been prepared under the historical cost convention, modified to include certain items at fair value, and in accordance with Financial Reporting Standard 102 – 'The Financial Reporting Standard applicable in the United Kingdom and Republic of Ireland' (FRS 102) issued by the Financial Reporting Council. There were no material departures from that standard. The comparative financial information was restated for material adjustments on adoption of FRS 102 in the current year. For more information see note 28. The functional currency of Scotia Gas Networks Limited and its subsidiary undertakings is considered to be pounds sterling because that is the currency of the primary economic environment in which the Company and its subsidiary undertakings operate. 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. Going concern After reviewing the Group's forecasts and projections, the directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Thus they continue to adopt the going concern basis of accounting in preparing the annual financial statements. Intangible assets – goodwill Goodwill arising on the acquisition of businesses, representing any excess of the fair value of the consideration given over the fair value of the identifiable assets and liabilities acquired, is capitalised and written off on a straight line basis over its useful economic life, which is estimated to be 50 years. Provision is made for any impairment, and it is tested on an annual basis at each balance sheet date. Intangible assets – software Software assets are included at cost, net of depreciation and any provision for impairment. Amortisation is provided in equal annual instalments over a period of 3 to 10 years, which is their estimated useful economic life.

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51

Tangible fixed assets Tangible fixed assets are stated at cost, net of depreciation and any provision for impairment. Depreciation is provided on all tangible fixed assets, other than investment properties and freehold land, at rates calculated to write off the cost or valuation, less estimated residual value, of each asset on a straight-line basis over its expected useful life, as follows: Freehold buildings: Leasehold land and 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 55 to 65 years 30 to 50 years 40 years 3 to 10 years

Site remediation costs are depreciated over the life of the asset. Replacement expenditure is capitalised and useful life is based on the range within mains and services above. Residual value represents the estimated amount which would currently be obtained from disposal of an asset, after deducting estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. Fixed asset investments 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. Impairment of non-financial assets Assets, other than those measured at fair value, are assessed for indicators of impairment at each balance sheet date. If there is objective evidence of impairment, an impairment loss is recognised in profit or loss as described below. An asset is impaired where there is objective evidence that, as a result of one or more events that occurred after initial recognition, the estimated recoverable value of the asset has been reduced. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use. The recoverable amount of goodwill is derived from measurement of the present value of the future cash flows of the business. Any impairment loss is allocated first to the goodwill, and then to other assets on a pro-rata basis. The company considers there to be two separate CGUs for the purpose of goodwill impairment: Southern and Scotland Gas Networks Limited. Where indicators exist for a decrease in impairment loss, the prior impairment loss is tested to determine reversal. An impairment loss is reversed on an individual impaired asset to the extent that the revised recoverable value does not lead to a revised carrying amount higher than the carrying value had no impairment been recognised. Where a reversal of impairment occurs, the reversal is applied to the assets (other than goodwill) on a pro-rata basis. Goodwill impairment is not reversed. Taxation Current tax, including UK corporation tax and foreign 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 tax in the future or a right to pay less tax in the future have occurred at the balance sheet date. Timing differences are differences between the Group's taxable profits and its results as stated in the financial statements that arises from the inclusion of gains and losses in tax assessments in periods different from those in which they are recognised in the financial statements. Unrelieved tax losses and other deferred tax assets are recognised only to the extent that, on the basis of all available evidence, it can be regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying timing differences can be deducted.

52

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 1. Principal accounting policies (continued) Deferred tax is measured using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date that are expected to apply to the reversal of the timing difference. Where items recognised in other comprehensive income or equity are chargeable to or deductible for tax purposes, the resulting current or deferred tax expense or income is presented in the same component of comprehensive income or equity as the transaction or other event that resulted in the tax expense or income. Current tax assets and liabilities are offset only when there is a legally enforceable right to set off the amounts and the Group intends either to settle on a net basis or to realise the asset and settle the liability simultaneously. Deferred tax assets and liabilities are offset only if: a) the Group has a legally enforceable right to set off current tax assets against current tax liabilities; and b) the deferred tax assets and deferred tax liabilities relate to income taxes levied by the same taxation authority on either the same taxable entity or different taxable entities which intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered. 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 is recognised to the extent that there is a right to consideration and is recorded at the value of the consideration due. 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. Employee benefits Defined benefit pension scheme For defined benefit schemes the amounts charged to operating profit are the costs arising from employee services rendered during the period and the cost of plan introductions, benefit changes, settlements and curtailments. They are included as part of staff costs. The net interest cost on the net defined benefit liability is charged to profit or loss and included within finance costs. Remeasurement comprising actuarial gains and losses and the return on scheme assets (excluding amounts included in net interest on the net defined benefit liability) are recognised immediately in other comprehensive income. Defined benefit schemes are 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 credit method. The actuarial valuations are obtained at least triennially and are updated at each balance sheet date. Defined contribution pension scheme For defined contribution schemes the amount charged to the profit and loss account in respect of pension costs and other retirement benefits is the contributions payable in the year. Differences between contributions payable in the year and contributions actually paid are shown as either accruals or prepayments in the balance sheet. Foreign currency Transactions in foreign currencies are recorded at the rate of exchange at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are reported at the rates of exchange prevailing at that date. Other exchange differences are recognised in profit or loss in the period in which they arise except for exchange differences on transactions entered into to hedge certain foreign currency risks and exchange differences arising on gains or losses on non-monetary items which are recognised in other comprehensive income.

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Leases Finance leases Assets held under finance leases, hire purchase contracts and other similar arrangements, which confer rights and obligations similar to those attached to owned assets, are capitalised as tangible fixed assets at the fair value of the leased asset (or, if lower, the present value of the minimum lease payments as determined at the inception of the lease) and are depreciated over the shorter of the lease terms and their useful lives. The capital elements of future lease obligations are recorded as liabilities, while the interest elements are charged to the profit and loss account over the period of the leases to produce a constant periodic rate of interest on the remaining balance of the liability. 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. Borrowing costs capitalised Borrowing costs which are directly attributable to the construction of qualifying tangible fixed assets are capitalised as part of the cost of those assets. Qualifying tangible fixed assets are considered to be those of significant size or complexity, which typically are under construction for in excess of one year and/or where project costs exceed a pre-determined threshold. The commencement of capitalisation begins when both finance costs and expenditures for the asset are being incurred and activities that are necessary to get the asset ready for use are in progress. Capitalisation ceases when substantially all the activities that are necessary to get the asset ready for use are complete. Borrowing costs are not capitalised in respect of construction projects which do not meet the defined thresholds or relate to replacement expenditure. Grants and contributions Customer contributions for connections to the network and for replacement expenditure diversions are capital grants. National Insurance Contributions (NIC) grants are considered revenue grants. Capital grants 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 both revenue grants and contributions is included separately on the face of the balance sheet due their materiality. Other deferred income items which are not considered as material are shown separately in note 16. 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 FRS 102 sections 11 and 12 give an accounting policy choice for financial instruments. The Group has chosen to apply the recognition and measurement provisions of IAS 39 (as adopted for use in the EU) and the disclosure requirements of FRS 102 in respect of financial instruments. Financial assets and financial liabilities are recognised when the Group becomes a party to the contractual provisions of the instrument. Financial liabilities and equity instruments are classified according to the substance of the contractual arrangements entered into. An equity instrument is any contract that evidences a residual interest in the assets of the Group after deducting all of its liabilities. 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.

54

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 1. Principal accounting policies (continued) 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). 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 For financial assets carried at amortised cost, the amount of an impairment is the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the financial asset’s original effective interest rate. For financial assets carried at cost less impairment, the impairment loss is the difference between the asset’s carrying amount and the best estimate of the amount that would be received for the asset if it were to be sold at the reporting date. The carrying amount of the financial asset is reduced by the impairment loss directly for all financial assets with the exception of trade debtors. Where indicators exist for a decrease in impairment loss, and the decrease can be related objectively to an event occurring after the impairment was recognised, the prior impairment loss is tested to determine reversal. An impairment loss is reversed on an individual impaired financial asset to the extent that the revised recoverable value does not lead to a revised carrying amount higher than the carrying value had no impairment 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 provision. Appropriate provision 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 provision account. Changes in the carrying amount of the provision 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.

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55

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. 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 IAS 39 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. The ineffective portion of the hedge is recognised through the profit and loss account. 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. 2. Critical accounting judgements and key sources of estimation uncertainty In the application of the Group's accounting policies, which are described in note 1, the directors are required to make judgements, estimates and assumptions about the carrying amounts of assets and liabilities that are not readily apparent from other sources. The estimates and associated assumptions are based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods.

56

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 2. Critical accounting judgements and key sources of estimation uncertainty (continued) Key source of estimation uncertainty a. Impairment of goodwill – determining whether goodwill is impaired requires an estimation of the value in use of the business. The value in use calculation requires the entity to estimate the future cash flows expected to arise and a suitable discount rate in order to calculate present value. The carrying amount of goodwill at 31 March 2016 was £373.8m. Following an impairment review, it was concluded that the recoverable amount exceeds the carrying value. b. Componentisation of replacement expenditure – Capitalised replacement expenditure is allocated to mains and services components with a range of useful economic lives between 55 and 65 years. On transition to FRS 102, all replacement expenditure incurred since 2005 has been assessed and allocated on an appropriate and relevant basis where replacement projects have involved multiple activities, judgement has been exercised to determine the appropriate accounts. c. Useful lives of assets and residual value – in assessing the estimate of economic useful lives and residual value, consideration is given to the economic life of the gas industry. The depreciation policy is set out in note 1. d. Retirement benefit schemes – the assumptions used in accounting for the defined benefit pension scheme are based on estimates and are subject to uncertainties. These assumptions are set out in note 26 and include: the discount rate on scheme liabilities, mortality rates, pension increases, salary increases and inflation. The Group takes advice from independent actuaries on the appropriateness of these assumptions. e. Losses on disposal of iron mains – losses on disposal of iron mains as a result of replacement activity can be subject to some estimation of the allocation of the original cost. f. Valuation of financial instruments – where financial instruments are recognised at fair value there are uncertainties in forward yield curves used in discounted cash flow calculations g. Environmental provision – in assessing the degree of contamination at the various sites an element of estimation is required. The discount rate is also a source of estimation. See note 19. h. Revenue recognition – 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. 3. 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. 4. Operating profit and net operating costs 2016 £m

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

1,079.7 (583.5) 8.8 6.7 (568.0) 511.7

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

2015 As restated £m

1,089.1 (550.9) 4.4 6.1 (540.4) 548.7

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5. Profit on ordinary activities before taxation Group profit on ordinary activities before taxation is stated after charging/(crediting): 2016 £m

Auditor’s remuneration Amortisation of goodwill Amortisation of intangible assets Depreciation of tangible fixed assets Amortisation of customer contributions Gain on disposal of fixed assets Rental under operating leases – other assets

2015 As restated £m

0.6 9.6 11.7 133.4 (6.1) (4.4) 1.1

1.1 9.6 17.2 146.1 (6.7) (8.8) 0.6

Auditor’s remuneration for the Group comprises £109,000 (2015: £120,000) in respect of statutory audit services, £82,000 (2015: £81,000) in respect of other services pursuant to legislation, £31,000 (2015: £28,000) in respect of other assurance services, £712,000 (2015: £171,000) in respect of IT consultancy services, £33,000 (2015: £158,000) in respect of tax services, £nil (2015: £34,000) in respect of Corporate Finance services and £136,000 (2015: £nil) in respect of other services. Auditor’s remuneration in respect of statutory audit services for the Company amounted to £12,000 (2015: £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 (2015: £17,000) have been charged by the auditor to the Group in respect of these services. 6. Employee information and Directors’ emoluments The Group had 3,865 full time equivalent employees as of 31 March 2016 (2015: 3,753). The average monthly number of full time equivalent employees during the year was 3,809 (2015: 3,739). The Directors received remuneration of £32,000 (2015: £64,000) 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

2016 £m

2015 As restated £m

150.5 15.2 35.0 200.7

145.8 14.4 31.4 191.6

2016 £m

2015 As restated £m

0.4

0.3

The Company had eight employees as of 31 March 2016 (2015: eight). 7. Interest receivable and similar income

Interest receivable on short-term deposits

58

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 8. Interest payable and similar charges

Bank loans Net defined benefit pension charge (see note 26) 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 Movement on financial derivatives (see note 18)

2016 £m

2015 As restated £m

0.2 1.2 27.9 121.8 49.3 – 1.8 2.1 8.5 212.8

0.3 2.1 39.9 114.7 66.5 0.1 7.5 3.1 4.8 239.0

2016 £m

2015 As restated £m

9. Tax credit on profit on ordinary activities a) Analysis of the tax (credit)/charge on profit on ordinary activities

Current tax UK corporation tax on profits for the period Adjustment in respect of previous periods Total current tax charge Deferred tax Origination and reversal of timing differences Effect of change in tax rate Adjustments in respect of previous periods Total deferred tax (credit)/charge Total tax (credit)/charge on profit on ordinary activities

55.5 (0.6) 54.9

30.9 (0.3) 30.6

4.6 (91.3) 0.5 (86.2) (31.3)

35.9 – (1.5) 34.4 65.0

b) Factors affecting the total tax (credit)/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 20% (2015: 21%) Effects of: Expenses not deductible for tax purposes Depreciation of non qualifying assets Fixed asset disposal – non qualifying Non taxable income Adjustment in respect of prior periods Effect of change in tax rate on deferred tax balance Total tax (credit)/charge on profit on ordinary activities

2016 £m

2015 As restated £m

300.3

310.9

60.1

65.3

2.5 0.5 (2.8) (0.2) (0.1) (91.3) (31.3)

3.5 0.4 (2.2) (0.2) (1.8) – 65.0

59

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The standard rate of tax applied to reported profit on ordinary activities is 20% (2015: 21%). Legislation was introduced in Finance (No 2) Act 2015 to reduce the main rate of corporation tax from 20% to 19% from 1 April 2017 and to 18% from 1 April 2020. As these changes have been substantively enacted at the balance sheet date deferred tax has been calculated accordingly. This has had the effect of reducing the group's deferred tax liability at 31 March 2016 by £88.8m. The total effect of £88.8m (credit) is made up of tax effect through profit and loss account of £91.3m (credit) and through reserves of £2.5m (debit). A further change to reduce the main rate of corporation tax to 17% from 1 April 2020 has been announced, but has not been substantively enacted at the balance sheet date. The effect of this change estimated to be £44.4m has not therefore been brought into account in calculating the group's deferred tax liability. There is no expiry date on timing differences, unused tax losses or tax credits. 10. Loss of the Company for the financial year The Company’s loss for the year amounted to £37.0m (2015: Loss of £62.3m). 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. 11. Dividends

Equity shares Interim dividends paid of 34.0389p (2015: 31.9115p)

2016 £m

2015 As restated £m

160.0

150.0

Software £m

Total £m

12. Intangible fixed assets Goodwill £m

Group Cost At 31 March 2015 Additions Disposals At 31 March 2016

477.6 – – 477.6

165.8 13.8 (19.4) 160.2

643.4 13.8 (19.4) 637.8

Amortisation At 31 March 2015 Charge for the year Disposals At 31 March 2016

94.2 9.6 – 103.8

87.5 17.2 (19.4) 85.3

181.7 26.8 (19.4) 189.1

Net book value At 31 March 2016 At 31 March 2015

373.8 383.4

74.9 78.3

448.7 461.7

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.

60

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 13. Tangible fixed assets

Group Cost At 1 April 2015 Additions Disposals At 31 March 2016

Short leasehold properties £m

Freehold properties £m

Plant and machinery £m

Motor vehicles and office equipment £m

Total £m

0.7 – – 0.7

84.4 9.6 (0.2) 93.8

6,145.6 323.8 (10.8) 6,458.6

290.2 12.3 (1.6) 300.9

6,520.9 345.7 (12.6) 6,854.0

Depreciation At 1 April 2015 Charge for the year Disposals At 31 March 2016

0.1 – – 0.1

18.3 3.8 (0.2) 21.9

829.2 127.9 (4.0) 953.1

159.3 14.4 (1.7) 172.0

1,006.9 146.1 (5.9) 1,147.1

Net book value At 31 March 2016 At 31 March 2015

0.6 0.6

71.9 66.1

128.9 130.9

5,706.9 5,514.0

5,505.5 5,316.4

Within motor vehicles and office equipment are assets held under finance leases with a net book value of £1.9m (2015: £2.7m). 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 connections contributions are from customers being connected to the network and replacement contributions are related to the diversion of gas mains. 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:

Group Deferred income Customer contributions brought forward Customer contributions received in year Amortisation in year

The Company has no deferred income.

Connections £m

193.5 20.0 (5.0) 208.5

Replacement £m

93.7 17.0 (1.7) 109.0

Total 2016 £m

287.2 37.0 (6.7) 317.5

Total 2015 As restated £m

261.9 31.4 (6.1) 287.2

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61

14. Fixed asset investments Cost or valuation and net book value Shares in Group undertakings At 1 April 2015 and at 31 March 2016 Other investments At 1 April 2015 and at 31 March 2016

Group £m

Company £m



2,028.4

0.2 0.2

– 2,028.4

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 23.02% (2015: 23.02%) of the ordinary shares of Xoserve Limited. During the year the Group received dividends of £1.0m (2015: £0.9m) in relation to this investment. Interests in Group undertakings Details of the 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 registration

Principal 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

1 ordinary share of £1 1 ordinary share of £1 1 ordinary share of £1

England & Wales England & Wales England & Wales

SGN Natural Gas Limited

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.

The registered address of Scotland Gas Networks plc is Axis House, 5 Lonehead Drive, Newbridge, Edinburgh, Scotland, EH28 8TG. The registered address of all other subsidiaries above is St Lawrence House, Station Approach, Horley, Surrey, RH6 9HJ.

62

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 15. Debtors Group

Amounts falling due within one year Trade debtors Prepayments and accrued income Derivative financial instruments (see note 18)

Company

2016 £m

2015 As restated £m

2016 £m

2015 As restated £m

93.1 26.2 16.2 135.5

95.3 18.5 22.1 135.9

– – – –

– – – –

16. Creditors: amounts falling due within one year Group

Bank loans and overdrafts £233m floating rate loan matured in 2015 £100m floating rate loan matured in 2015 £250m 2.013% index-linked due 2035 £257m 4.75% fixed rate loan due 2017 Shareholders’ loans (see note 27) 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 18) Derivative financial liabilities – mirror swaps

Company

2016 £m

2015 As restated £m

2016 £m

2015 As restated £m

1.3 – – – 256.8 – 1.0 25.0 – 60.6 26.2 61.9 101.3 27.8 53.8 – 615.7

2.6 233.0 100.0 112.8 – 533.6 1.0 34.6 – 44.4 15.8 70.9 100.6 29.0 58.3 3.5 1,340.1

– – – – – – – – 1,430.1 0.2 – 15.4 – – – – 1,445.7

– – – – – 533.6 – – 1,283.5 0.2 – 22.7 – – – – 1,840.0

The amounts owed to Group undertakings represents loans amounting to £1,535.1m (2015: £1,366.1m), which incur interest at 0.5% (2015: 0.5%) and trading balances owed by Group companies of £89.3m (2015: £82.6m). Part of the £250m index-linked bond due in 2035 was paid in October 2015.

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63

17. 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 £250m 3.25% fixed rate due 2027 £300m 5.125% fixed rate due 2018 £257m 4.75% fixed rate due 2017 £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: £80m floating rate loan note due 2043 £75m floating rate loan note due 2018 £125m floating rate loan note due 2025 £80m floating rate loan note due 2026 £50m floating rate loan note due 2019 Total bonds Shareholders’ loans (see note 27) Derivative financial liabilities – Mirror swaps (see note 17) Obligations under finance leases and hire purchase contracts

Company

2016 £m

2015 As restated £m

2016 £m

2015 As restated £m

225.6 227.6 205.1 18.5 150.9 247.3 299.3 – 224.5 214.7 373.9 223.7 25.0 25.0 298.0 25.0 50.0 35.0 346.4 3,215.5

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

– – – – – – – – – – – – – – – – – – – –

– – – – – – – – – – – – – – – – – – – –

79.6 75.0 125.0 80.0 50.0 409.6 3,625.1 533.6 83.6 0.3 4,242.6

79.6 75.0 – – 50.0 204.6 3,419.1 – 93.9 1.2 3,514.2

– – – – – – – 533.6 – – 533.6

– – – – – – – – – – –

The total revolving credit facility is £350.0m and expires in July 2019. The facility was undrawn at 31 March 2016. The shareholder loans, which are subordinated, are redeemable at par on 31 May 2025. 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% (2015: 12.5%). These new loans refinance the outstanding shareholder loans, which matured on 31 May 2015. 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.

64

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 17. Creditors: amounts falling due after more than one year (continued) Maturity of borrowings Group

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

2016 £m

2015 As restated £m

259.1 799.3 3,359.7 4,418.1

983.0 1,021.4 2,398.9 4,403.3

The Company’s borrowings all fall due on 31 May 2025. The above borrowings are unsecured and are stated after the deduction of unamortised issue costs of £14.1m (2015: £15.4m). 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 2016 is £237.0m (2015: £227.9m). Included within one and five years above are obligations under finance leases amounting to £0.3m (2015: £1.2m). 18. 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.

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65

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

2016 £m

2015 As restated £m

93.1 260.4 3.5 357.0

95.3 318.1 7.0 420.4

16.2

22.1

0.2 373.4

0.2 442.7

(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 Derivative financial instruments in designated hedging relationships Financial derivatives – mirror swaps Total financial liabilities

2016 £m

2015 As restated £m

25.0 61.9 101.3 1.3 1.3 3,882.1 533.6 4,606.5

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

53.8 83.6 137.4 4,743.9

58.3 97.4 155.7 4,765.1

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.

66

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 18. Financial instruments (continued) An analysis of financial assets and liabilities that are recorded at fair value at 31 March 2016 is as follows: 2016

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

– –

16.2 16.2

– –

16.2 16.2

– – –

83.6 53.8 137.4

– – –

83.6 53.8 137.4

Level 1 £m

Level 2 £m

Level 3 £m

Total £m

– –

22.1 22.1

– –

22.1 22.1

– – –

97.4 58.3 155.7

– – –

97.4 58.3 155.7

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

Mirror 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 balance equal to the market value of the matched swaps was established within creditors. At 31 March 2016 the mirror swap loss was £83.6m (2015: £97.4m). Fair values The Group’s financial instruments recorded at amortised cost are shown below together with their fair values: 31 March 2016

Bonds Shareholder loans

31 March 2015 As restated

Book Value £m

Fair Value £m

Book Value £m

Fair Value £m

3,882.1 533.6 4,415.7

4,606.8 507.4 5,114.2

3,864.9 533.6 4,398.5

4,725.4 533.6 5,259.0

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.

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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

2016 £m

2015 As restated £m

93.1 16.2 260.4 3.5 373.2

95.3 22.1 318.1 7.0 442.5

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 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 2016 the Group was holding collateral with a fair value of £12.1m (2015: £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 2015/16 non-transportation debtors were 14.5% (2014/15: 11.7%) of net trade debtors. An impairment allowance has been set aside according to the Group’s impairment policy. The largest transportation debtor is £26.5m (2015: £26.7m). There is no material credit exposure to any one customer. The ageing of trade debtors net of impairment allowance is:

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

2016 £m

2015 As restated £m

93.1 – – – 93.1

95.3 – – – 95.3

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SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 18. Financial instruments (continued) 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. 2016 0-6 months £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

6-12 months £m

1-2 years £m

(1.3) (22.9) (28.5) (0.5) (53.2)

– (22.9) (370.0) (0.5) (393.4)

– (45.9) (129.7) (0.3) (175.9)

(3.3) (6.5) (9.8)

8.3 (6.5) 1.8

0.6 (12.9) (12.3)

(25.0) (88.0)

– (391.6)

– (188.2)

2-5 years £m

> 5 Contractual Interest/ years cash flows discounting £m £m £m

– – (137.7) (694.2) (1,117.3) (4,040.6) (0.3) – (1,255.3) (4,734.8)

Carrying value £m

(1.3) (923.6) (5,686.1) (1.6) (6,612.6)

– 390.0 1,804.0 0.3 2,194.3

(1.3) (533.6) (3,882.1) (1.3) (4,418.3)

(83.1) (28.3) (111.4)

(85.2) (89.6) (174.8)

47.6 6.0 53.6

(37.6) (83.6) (121.2)

– – (1,298.4) (4,846.2)

(25.0) (6,812.4)

– 2,247.9

(25.0) (4,564.5)

(7.7) (35.4) (43.1)

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

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69

The corresponding amounts for 2015 were as follows: 2015 (as restated)

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

0-6 months £m

6-12 months £m

(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)

(2.1) (38.7) (40.8)

(34.6) (905.5)

– (287.3)

– (390.2)

– (904.7)

> 5 Contractual Interest/ years cash flows discounting £m £m £m

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

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)

51.0 8.5 59.5

(36.2) (97.4) (133.6)

– (34.6) (3,491.3) (5,979.0)

– 1,407.5

(34.6) (4,571.5)

(87.0) (37.9) (124.9)

The Group expects to meet its obligations from cash balances, operating cash flows and re-financing. 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 2016 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.

70

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 18. Financial instruments (continued) 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. 2016 £m

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

2015 As restated £m

8.6 (10.2) (1.6)

9.3 (10.1) (0.8)

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 profit and 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 short-term interest rates at the reporting date in relation to equity and profit and loss account. The analysis assumes that all other variables remain constant. 2016 £m

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

2015 As restated £m

(4.1) (2.7) (6.8)

(7.1) (2.7) (9.8)

0.8

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 IAS 39 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 IAS 39 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 2016 the unamortised hedge loss balance in equity was £4.5m. The movement before deferred tax taken to equity in respect of cash flow hedges in the year was a £5.5m gain (2015: £nil). 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 2016 was £80.0m (2015: £363.0m). At 31 March 2016 the fixed interest rate is 6.3% and floating rate 1.6%, Libor plus 100bp.

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Fair value hedges The Group has no fair value hedges at 31 March 2016. 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: 2016 £m

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

(2.7) (3.2) (5.9)

2015 As restated £m

1.9 (2.3) (0.4)

In addition the movement on onerous swap contracts in the period was a loss of £2.6m (2015: loss of £4.4m) included in discount unwind within interest payable. 19. Provisions for liabilities Environmental £m

Group At 1 April 2015 Arising during the year Utilised during the year Net movement in deferred tax Amortisation of discount At 31 March 2016

34.3 (0.2) – – 1.9 36.0

Deferred tax £m

861.7 – – (62.5) – 799.2

Other provisions £m

6.0 1.3 (0.6) – 0.2 6.9

Total £m

902.0 1.1 (0.6) (62.5) 2.1 842.1

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 fifteen years.

72

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 19. Provisions for liabilities (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 £86.2m is recorded as a credit to the profit and loss account and £23.7m is recorded as a charge 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 2016 £m

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

(803.2) 9.6 3.6 (9.2) (799.2)

Company

2015 As restated £m

(887.5) 11.6 2.3 11.9 (861.7)

2016 £m

2015 As restated £m

– – –

– – –





The movement in provision for deferred tax is as follows: Group 2016 £m

At 1 April Credited to profit and loss account Charged to other comprehensive income At 31 March

(861.7) 86.2 (23.7) (799.2)

2015 As restated £m

(829.8) (34.3) 2.4 (861.7)

The group has unrecognised deferred tax assets in respect of unutilised tax losses of £209.5m (2015: £236.8m). 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 on £209.5m (2015: £233.7m) of unutilised tax losses. Deferred tax has been measured based upon corporation tax rates substantively enacted at the balance sheet date (information regarding rates of corporation tax can be found in note 9 to the accounts). 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 four years.

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20. Share capital 31 March 2015

31 March 2016

Allotted, called up and fully paid shares ‘A’ ordinary shares of 42.55p (2015: 42.55p) each ‘B’ ordinary shares of 42.55p (2015: 42.55p) each ‘C’ ordinary shares of 42.55p (2015: 42.55p) each Total

Number

Value £m

Number

Value £m

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

100.0 50.0 50.0 200.0

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

100.0 50.0 50.0 200.0

The ‘A’, ‘B’ and ‘C’ ordinary shares rank pari passu in all respects. 21. Reserves Profit and loss account

Hedge reserve Group £m

At 1 April 2015 Profit/(loss) for the financial year Dividends paid on equity shares (see note 11) 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 2016

Company £m

Group £m

Company £m

(48.4) – – 5.5 (1.9)

– – – – –

182.3 331.6 (160.0) – –

306.5 (37.0) (160.0) – –

– (44.8)

– –

79.5 433.4

– 109.5

2016 £m

2015 As restated £m

22. Reconciliation of movements in Group shareholders’ funds

Profit for the financial year Dividend paid on equity shares (see note 11) Cash flow hedges (net of deferred tax) Actuarial loss on defined benefit pension scheme (net of related tax) Movement in shareholders’ funds Opening shareholders’ funds Closing shareholders’ funds

331.6 (160.0) 3.6 79.5 254.7 333.9 588.6

245.9 (150.0) (7.2) (1.5) 87.2 246.7 333.9

74

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 23. Cash flow from operating activities Reconciliation of operating profit to cash generated by operations: 2016 £m

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 Cash generated by operations

2015 As restated £m

548.7 148.8 9.6 (6.1) (4.4) (7.0) 23.6 (0.6) 712.6

511.7 163.3 9.6 (6.7) (8.8) (6.3) (8.7) (0.6) 653.5

24. Operating lease commitments Total future minimum lease payments under non-cancellable operating leases are as follows: Other

Within one year Within two to five years After five years

Land and buildings

2016 £m

2015 As restated £m

2016 £m

2015 As restated £m

0.6 0.3 – 0.9

0.8 0.7 – 1.5

0.7 2.1 12.3 15.1

– 2.7 13.2 15.9

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 £30.0m at 31 March 2016 (2015: £17.3m). The Company has no capital commitments at 31 March 2016 (2015: £nil).

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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 102, 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

2016

2015

2014

2013

3.6% 3.1% 2.9% 3.1%

3.3% p.a. 3.2% p.a. 3.9% p.a. 3.2% p.a.

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.

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: 2015

2016

As at 31 March Members currently aged 65 Members currently aged 45

2014

Male

Female

Male

Female

Male

Female

24 27

25 28

25 28

25 28

25 28

25 28

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SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 26. Pension commitments (continued) The fair value of the assets in the scheme and the present value of the liabilities in the scheme were: As at 31 March 2016 £m

Equities Government bonds (2) Corporate bonds Property Cash Total market value of assets Actuarial value of liabilities Surplus/(deficit) in scheme

241.7 347.2 389.9 55.0 8.2 1,042.0 (990.7) 51.3

2015 As restated £m

240.1 339.1 360.4 51.2 23.6 1,014.4 (1,073.9) (59.5)

To reduce the risk of volatility in the Scheme’s funding level, a liability driven investment (LDI) strategy forms part of the assets employed within the investment strategy of the Scheme. The net investment in LDI at 31 March 2016 was £209 million, which represents £534 million of assets less £325 million of liabilities. The LDI strategy provides c38% interest rate protection and c55% inflation protection, with respect to the pension scheme liabilities of c£1.4bn (valued using a UK government bond yield curve). The Scheme assets which provide this interest rate and inflation protection are managed by BlackRock and Goldman Sachs and include a variety of instruments, e.g. UK government bonds (gilts), interest rate swaps, inflation swaps, gilt repos and corporate bonds. (2) Including LDI repurchase agreement liabilities

Movement in fair value of scheme assets 2016 £m

At 1 April Interest income Contributions from scheme members Contributions from the Group Actuarial (losses)/gains Benefits paid As at 31 March

1,014.4 33.3 1.3 41.7 (23.1) (25.6) 1,042.0

2015 As restated £m

832.5 38.8 1.5 42.6 118.3 (19.3) 1,014.4

Movement in fair value of scheme liabilities 2016 £m

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

(1,073.9) (30.3) (0.6) (34.5) (1.3) 124.3 25.6 (990.7)

2015 As restated £m

(902.4) (27.6) (0.4) (38.4) (1.5) (122.9) 19.3 (1,073.9)

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.

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The actual gain on scheme assets was £10.2m (2015: £157.1m). The cumulative amount of actuarial losses recognised in the statement of total recognised gains and losses since the adoption of FRS 17 is £34.7m (2015: £135.9m). Analysis of the amounts recognised in the profit and loss account 2016 £m

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

2015 As restated £m

(30.3) (0.6)

(27.6) (0.4)

33.3 (34.5) (1.2) (32.1)

36.3 (38.4) (2.1) (30.1)

Analysis of the amount recognised in other comprehensive income 2016 £m

Actuarial (losses)/gains on scheme assets Actuarial gains/(losses) on obligations Gain/(loss) recognised in other comprehensive income

(23.1) 124.3 101.2

2015 As restated £m

120.8 (122.9) (2.1)

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

Amount charged in respect of defined contribution schemes

2016 £m

2015 £m

4.0

3.3

78

SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 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 2465817 Ontario Limited 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 SGN Holdings BV(1) 2465817 Ontario Limited(2) Interest owed to shareholders: SSE plc Borealis SGN Holdings BV(1) 2465817 Ontario Limited(2) Other amounts owed to shareholders: SSE plc

2016 £m

2015 £m

266.8 133.4 133.4 533.6

266.8 133.4 133.4 533.6

7.7 3.9 3.9 15.5

11.2 5.6 5.6 22.4

15.2

15.7

(1) Borealis SGN Holdings BV is an affiliate of Borealis Infrastructure Europe (UK) Limited. (2) 2465817 Ontario Limited is wholly owned by OTPPB.

The aggregate interest expense charged to the profit and loss account in respect of shareholders’ loans was £49.3m (2015: £66.5m). Interest accrues on the shareholders’ loans at a fixed rate of 8.6% from 31 May 2015 (prior to this date, interest accrues 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. 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

2016 £m

2015 £m

155.8 (46.4) 0.1

166.4 (49.0) 0.2

Sales of goods and services to SSE primarily represent gas transportation services. At 31 March 2016 an amount of £0.4m (2015: £0.4m) 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 £nil (2015: £2.0m). During the year, the Group surrendered tax losses of £18.6m to SSE (2015: £28.4m) relating to the year ended 31 March 2014 for an aggregate cash consideration of £0.1m (2015: £0.2m).

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28. Explanation of transition to FRS 102 This is the first year the Group has presented its financial statements under Financial Reporting Standard 102 (FRS 102) issued by the Financial Reporting Council. The following disclosures are required in the year of transition. The last financial statements under previous UK GAAP were for the year ended 31 March 2015 and the date of transition to FRS 102 was therefore 1 April 2014. As a consequence of adopting FRS 102, a number of accounting policies have changed to comply with that standard. As previously stated at 31 March 2015 £m

Effect of transition at 31 March 2015 £m

FRS 102 as restated at 31 March 2015 £m

a b

383.4 3,580.6 0.2 3,964.2

78.2 1,933.5 – 2,011.7

461.6 5,514.1 0.2 5,975.9

c

137.2 318.1 7.0 462.3 (1,346.2) (883.9) 3,080.3

(1.3) – – (1.3) 6.1 4.8 2,016.5

135.9 318.1 7.0 461.0 (1,340.1) (879.1) 5,096.8

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

(93.9) (550.3) (93.7) 1,278.6 (11.9) 1,266.7

(3,514.2) (902.0) (287.2) 393.4 (59.5) 333.9

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

– 8.5 1,258.2 1,266.7

Notes

Reconciliation of equity at 31 March 2015: Fixed assets Intangible assets 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

d

Creditors: amounts falling due after more than one year Provision for liabilities Deferred income Net (liabilities)/assets excluding pension liabilities Defined benefit pension liabilities Net (liabilities)/assets including pension liabilities

e f g h

Capital and reserves Called up share capital Hedge reserve Profit and loss account Shareholders' (deficit)/funds Reconciliation of profit for the year ended 31 March 2015: Turnover Net operating costs 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 on profit on ordinary activities Profit for the financial year

i j

k l m

1,099.9 (727.4) 372.5 0.9 0.7 (235.7) 138.4 (35.9) 102.5

(10.8) 187.0 176.2 – (0.4) (3.3) 172.5 (29.1) 143.4

200.0 (48.4) 182.3 333.9

1,089.1 (540.4) 548.7 0.9 0.3 (239.0) 310.9 (65.0) 245.9

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SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 28. Explanation of transition to FRS 102 (continued) Note to the reconciliation of equity and to the reconciliation of profit or loss for the year ended 31 March 2015 Tangible fixed assets – Replacement expenditure The accounting policy upon transition is to capitalise the expenditure within mains and services as a tangible fixed asset, stated at cost, and depreciated in accordance with the policy described in note 1. When the project involves decommissioning the original asset, a disposal is recognised. Previously under UK GAAP, all replacement expenditure was expensed in the profit and loss account as incurred. On transition to FRS 102, the financial statements have been restated to consider capitalisation and subsequent depreciation of replacement expenditure with retrospective effect from the inception of the Company in 2005. Where replacement expenditure has resulted in the disposals of legacy property, plant and equipment, these assets are now accounted for as disposals. Grants and contributions Under FRS 102, revenue grants continue to be recognised as a credit within turnover in the year to which they relate. Contributions towards replacement expenditure will continue to be treated consistently with the related expenditure. As detailed above, replacement expenditure is now capitalised and depreciated, and accordingly the related contributions are capitalised and deferred over their useful economic life of the replacement expenditure. Intangible assets – Software Under previous UK GAAP, software assets were classified as office equipment and presented as tangible fixed assets. Under FRS 102, software assets are viewed as separable from the associated hardware and are therefore intangible in nature. The accounting policy upon transition is to recognise software assets as intangible in the financial statements. The amortisation charge to the profit and loss account in relation to the software costs is £7.5m for the period. Short-term employee benefits – Holiday accrual Under previous UK GAAP, no accrual was recognised for holiday days earned but not taken by members of staff. Under FRS 102, there is a specific requirement to include an accrual for this short term employee benefit. The accounting policy upon transition is to recognise an accrual in relation to holiday days earned but not taken by members of staff. Post-employment benefits – Defined benefit plans Under previous UK GAAP, interest cost on the defined benefit obligations was calculated using the applicable discount rate and presented on the income statement as interest expense. The expected return on plan assets were presented in the income statement as interest income. Under FRS 102, net interest on the defined benefit liability (or asset) is to be represented in the income statement, calculated using the applicable discount rate. The difference between expected return on plan assets as previously calculated and the interest income on plan assets as calculated using the applicable discount rate is to be presented in the statement of other comprehensive income as a remeasurement on plan assets. The accounting policy upon transition is to recognise any difference between the expected return on plan assets as previously determined and the interest income on plan assets as calculated using the applicable discount rate in the statement of other comprehensive income as a remeasurement on plan assets. The net interest on the defined benefit liability (or asset) will continue to be represented in the income statement.

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Financial Instruments – Option to apply IAS 39 Under previous UK GAAP, the recognition and measurement provisions of FRS 26 (the recognition, measurement and hedge accounting requirements of the international standard IAS 39 Financial Instruments) were applied in full. Under FRS 102, the choice is available to apply the recognition and measurement provisions of IAS 39 Financial Instruments: Recognition and Measurement (as adopted for use in the EU). A credit risk adjustment has been recognised in relation to derivative assets and liabilities on transition to FRS 102. The accounting policy upon transition is to apply the recognition and measurement provisions of IAS 39, which is a continuation of the full application of FRS 26. Business combinations FRS 102 permits entities to retain accounting previously applied in respect of business combinations that were affected before the date of transition. No adjustment has accordingly been made in respect of historic acquisition accounting. 2015 £m

a) Intangible fixed assets Reclassification of software costs from tangible fixed assets (net book value) b) Tangible fixed assets Capitalisation of replacement expenditure (net book value) Disposals of legacy assets at net book value relating to replacement expenditure Reclassification of software costs from tangible fixed assets (net book value – note A) Net increase in tangible fixed assets c) Debtors Credit risk adjustment on derivative assets Net decrease in debtors

78.2

2,081.7 (70.0) (78.2) 1,933.5

(1.3) (1.3)

d) Creditors: amounts falling due within one year Reclassification of the mirror swaps from provisions Credit risk adjustment on derivative liabilities Holiday accrual for days earned and not taken by employees at year end Net decrease in creditors due within one year

3.5 (10.4) 0.8 (6.1)

e) Creditors: amounts falling due after one year Credit risk adjustment on derivative liabilities Reclassification of the mirror swaps from provisions Net increase in creditors due after one year

(3.3) 97.2 93.9

f) Provisions for liabilities Net deferred tax liability resulting from adjustments Deferred tax assets on deficit in defined benefit pension scheme Reclassification of the mirror swaps to creditors Net increase in provisions

662.9 (11.9) (100.7) 550.3

g) Deferred income Deferred income relating to replacement customer contributions

93.7

h) Defined benefit pension liabilities Deferred tax assets on deficit in defined benefit pension scheme

11.9

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SGN Annual Report and Accounts 2016

Notes to the financial statements for the year ended 31 March 2016 continued 2015 £m

i) Turnover Deferred income relating to replacement customer contributions j) Net operating costs Capitalisation of replacement expenditure previously expensed Depreciation of replacement expenditure Amortisation of replacement deferred income Loss on disposal arising from capitalisation of replacement expenditure Net reduction in operating costs

(10.8)

223.2 (30.8) 1.5 (6.9) 187.0

k) Interest receivable Restriction of pension investment income assumption to equal discount rate applied to liabilities

0.4

l) Interest payable Credit risk adjustment on interest payable Restriction of pension investment income assumption to equal discount rates Net increase in interest payable

1.2 2.1 3.3

m) Tax charge on profit on ordinary activities Deferred tax charge on capitalised replacement expenditure Current tax credit on replacement customer contributions Deferred tax credit on adjustment to pension income Deferred tax credit on remeasurement of financial instruments Deferred tax credit on unwind of fair value adjustment Net increase in tax charge on profit of ordinary activities n) Reconciliation of equity at 1 April 2014: Equity at 1 April 2014 reported under previous UK GAAP Capitalisation of replacement expenditure previously expensed Depreciation of replacement expenditure Deferred income relating to replacement customer contributions Amortisation of replacement deferred income Loss on disposal arising from capitalisation of replacement expenditure Reduction in depreciation charge as a result of disposed capital expenditure associated with replacement expenditure Movement in holiday accrual Corporation tax Credit risk adjustment Equity at 1 April 2014 reported under FRS 102 29. Subsequent events There are no subsequent events to report.

37.8 (1.8) (5.2) (0.2) (1.5) 29.1

(869.8) 2,014.2 (121.9) (89.7) 5.3 (78.4) 12.3 (0.8) (632.3) 7.8 246.7

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