Liquidity risk is defined as the risk that the Group would encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset. The Group invests in relatively illiquid investments (mainly non-listed equity and loans). As a closed-ended investment vehicle there are no automatic redemption of capital rights. The Group manages liquidity risk by maintaining adequate cash reserves, banking facilities and reserve borrowing facilities and by continuously monitoring the forecast and actual cash flows. Cash flow forecasts assume full availability of underlying infrastructure to the public sector entities. Failure to maintain assets available for use or operating in accordance with pre-determined performance standards may entitle the public sector to stop (wholly or partially) paying the income that the Group has projected to receive.

The Directors review the underlying performance of each investment on a quarterly basis, allowing asset performance to be monitored. Contractual mechanisms also allow for significant pass-down of unavailability and performance risk to sub-contractors.

   13.       Financial Instruments continued 
   13.4      Fair value hierarchy

All financial instruments for which fair value is recognised or disclosed are categorised within the fair value hierarchy, described as follows, based on the lowest level input that is significant to the fair value measurement as a whole:

> Level 1 - Quoted market prices in an active market (that are unadjusted) for identical assets or liabilities

> Level 2 - Valuation techniques (for which the lowest level input that is significant to the fair value measurement is directly or indirectly observable)

> Level 3 - Valuation techniques (for which the lowest level input that is significant to the fair value measurement is unobservable)

During the period there were no transfers between Level 2 and Level 3 categories.

Level 1:

The Group has no financial instruments classified as level 1.

Level 2:

This category includes derivative financial instruments such as interest rate swaps, RPI Swaps and currency forward contracts. As at 31 December 2014, the Group's only derivative financial instruments were currency forward contracts amounting to an asset of GBP2.9 million (2013: asset of GBP3.7 million).

Financial instruments classified as Level 2 have been valued using models whose inputs are observable in an active market (spot exchange rates, yield curves, interest rate curves). Valuations based on observable inputs include financial instruments such as swaps and forward contracts which are valued using market standard pricing techniques where all the inputs to the market standard pricing models are observable.

Level 3:

This category consists of investments in equity and loan instruments in underlying unconsolidated subsidiary entities which are classified at fair value through profit or loss. At 31 December 2014, the fair value of financial instruments classified within Level 3 totalled GBP1,032.9 million (2013: GBP844.4 million).

Financial instruments are classified within Level 3 if their valuation incorporates significant inputs that are not based on observable market data (unobservable inputs). A valuation input is considered observable if it can be directly observed from transactions in an active market, or if there is compelling external evidence demonstrating an executable exit price.

Valuation process

Valuations are the responsibility of the Board of Directors. The valuation of unlisted equity and debt investments is performed on a quarterly(1) basis by the Investment Adviser and reviewed by the senior members of the Investment Adviser. The valuations are also subject to quality assurance procedures performed by the Investment Adviser. The Investment Adviser verifies the major inputs applied in the latest valuation by agreeing the information in the valuation computation to relevant project financial models and market information. In addition, the accuracy of the computation is tested. The latest valuation is also compared with the valuations in the preceding semi-annual and annual reporting periods. The senior members of the Investment Adviser consider the appropriateness of the valuation methods and inputs. On a quarterly basis, after the checks above have been performed, the Investment Adviser presents the valuation results to the Audit and Risk Committee. This includes a discussion of the major assumptions used in the valuations, with an emphasis on the more significant investments. Any changes in valuation methods and assumptions are discussed and agreed with the Group's Audit and Risk Committee for recommendation to the Board.

In addition, any investment acquisitions by the Group from related parties are also subject to an independent valuation provided to the Board.

(1) Indicative valuations performed at 31 March and 30 September where cashflows are updated for asset performance. Macroeconomic assumptions are updated at 30 June and 31 December.

Valuation methodology

The valuation methodologies used are primarily based on discounting the underlying investee entities future projected net cash flows at appropriate discount rates. Valuations are also reviewed against recent market transactions for similar assets in comparable markets observed by the Group or Investment Adviser and adjusted where appropriate.

   13.       Financial Instruments continued 
   13.4      Fair value hierarchy continued

Projected net future cash flows

Cash flow forecasts for each underlying investment are generated through detailed project specific financial models. Financial models forecast the project related cash flows for the full term of the underlying service concession. The cash flows included in the forecasts used to determine fair value are typically fixed under contracts however there are certain variable cash flows which are based on management estimation. These models also forecast the dividend, shareholder loan interest payments, capital repayments and senior debt repayments (where applicable) expected from the underlying investments. Key macroeconomic inputs and assumptions utilised in projecting the Group's net future cash flows include:

 
                                                        Europe 
                                         UK             Non UK            North America            Australia 
=========================  ================  =================  =======================  =================== 
 Inflation                            2.75%              2.00%                    2.00%                2.50% 
                                                      12.50% - 
 Long-term tax                       20.00%             34.00%          25.00% - 26.50%               30.00% 
 Foreign exchange rates                 N/A               1.23                     1.84                 2.03 
 Long-term deposit rates              3.50%              3.00%                    3.00%                4.50% 
=========================  ================  =================  =======================  ===================

Discount rate

The discount rate used for valuation of each investment is the aggregate of the following:

> yield on government bonds with an average life equivalent to the weighted average concession length of the Group, issued by the national government for the location of the asset ('government bond yield');

> a premium to reflect the inherent greater risk in investing in infrastructure assets over government bonds;

> a further premium to reflect the state of maturity of the asset with a larger premium applied to immature assets and/or assets in construction and/or to reflect any current asset specific or operational issues. Typically this risk premium will reduce over the life of any asset as an asset matures, its operating performance becomes more established, and the risks associated with its future cash flows decrease;

> a further adjustment reflective of market based transaction valuation evidence for similar assets.

Over the period, the weighted average government bond decreased by 0.67%. This was offset by a 0.43% increase in the weighted average project premium to reflect the transactions observed in the market and the decrease in risk premia relating to construction assets nearing or that have reached completion. Further details are provided within the Strategic Report (page 24).

 
                                31 December   31 December 
 Valuation Methodology                 2014          2013   Movement 
=============================  ============  ============  ========= 
 Weighted Average Government 
  Bond Rate                           2.79%         3.46%    (0.67%) 
 Weighted Average Project 
  Premium                             4.69%         4.26%      0.43% 
=============================  ============  ============  ========= 
 Weighted Average Discount 
  Rate                                7.48%         7.72%    (0.24%) 
=============================  ============  ============  ========= 
 
 Weighted Average Discount 
  Rate(1)                             7.90%         8.20%    (0.30%) 
=============================  ============  ============  =========
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