Hedge Accounting TEXPO2015
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Transcript of Hedge Accounting TEXPO2015
Sanjay Thoppil
Solution Consultant, Reval
April 21, 2015
Hedge Accounting for Effective Risk Management
Agenda
o Introduction to Hedge Accountingo Benefits of Hedge Accountingo Framework for Implementing a Program
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What is Hedge Accounting?
o “Special accounting treatment that alters the normal accounting for one or more components of a hedge so that counterbalancing changes in the fair values of hedged items and hedging instruments, from the date the hedge is established, are not included in earnings in different periods.” (formerly SFAS 133, par 320)
Basic Treatment
o “An entity shall recognize all of its derivative instruments in its statement of financial position as either assets or liabilities depending on the rights or obligations under the contracts. All derivative instruments shall be measured at fair value.” (formerly SFAS 133, par 17)
Hedge Accounting
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Introduction
CFHedge
Derivative?Yes
MtM
No
Accrual
FVHedge
Definition of a Derivative:Characteristics of a derivative ASC 815-10-15
(formerly SFAS 133, par 6)83(a) Underlying83(a) Notional amount83(b) No (or minimal) initial net investment83(c) Net settlement
Basic Accounting Treatment:Derivatives are recorded at FMV, with changes in FMV recognized currently in earnings
Hedge Types:• Cash flow hedges are recorded at FMV with
effective changes in FMV deferred in OCI
• Fair value hedges are recorded at FMV with offsetting gains and losses on the hedged item recognized currently in earnings
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Major Provisions of Hedge Accounting
o Documentation– Risk Management Strategy and Objective– Nature of the Hedged Risk– Hedging Instrument Identified– Hedged Item Defined– Effectiveness Assessments and Ineffectiveness Measurement
o Effectiveness Assessments– Regression, Dollar Offset, Critical Terms, Shortcut
o Ineffectiveness Measurement– Lesser of the cumulative change
o Disclosures
Agenda
o Introduction to Hedge Accountingo Benefits of Hedge Accountingo Framework for Implementing a Program
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Benefits of Hedge Accounting
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Cash Flow Hedge
Trade Date Settlement
Hedge
Hedged Item
Fair Value Hedge
Trade Date Settlement
Hedge
Hedged Item
Recognize in Earnings
Recognize in Earnings
Changes in derivative value are deferred to OCI until the hedged item impacts the income statement.
Changes in the hedged item value are booked to earnings at the same time as when the derivative changes.
Benefit 1: Alignment of Derivative and Hedged Item Impacts on Income Statement
Benefits of Hedge Accounting
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Benefit 2: P&L Volatility Reduction
Forecast SalesLo
ss/G
ain
FX rate at fcst date
FX Rate
FX Forward Net Acctg Impact
No Hedge Accounting Lo
ss/G
ain
FX Fwd Rate
FX Rate
Loss
/Gai
n
FX Fwd Rate
FX Rate
Loss
/Gai
n
FX rate at fcst date
FX RateWith Hedge Accounting Lo
ss/G
ain
FX Fwd Rate
FX Rate
Loss
/Gai
n
FX Fwd Rate
FX Rate
Cash Flow Hedge
Benefits of Hedge Accounting
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Benefit 3: Improved Economic Hedging Performance
Transaction Timeline:
Txn Event
t0 t1
Quote Order
t2
Sale/ Revenue Recognized
t3
Cash Received
Rates Planning Acctg1 Acctg2
Hedge Type Cash Flow Fair Value Balance Sheet
Objective: Minimize the difference between the hedge rate and planning rate
Potential P&L Impact
Economic Risk Accounting + Economic Risk
Benefits of Hedge Accounting
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Other benefits of implementing a hedge accounting programo Improved insight into underlying business exposures
– Companies are forced to analyze, measure and monitor business transactions on an ongoing basis
o Process controllership– Companies are required to have proper processes and controls
Agenda
o Introduction to Hedge Accountingo Benefits of Hedge Accountingo Framework for Implementing a Program
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Risk Management Framework
Hedge Accounting Lifecycle
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Risk Identification
Risk Appetite
Business Goals and Objectives
Assessment and Strategy
DefinitionExecution Reporting
Roles and Responsibilities
Policies and Procedures Technology
Hedge Accounting Lifecycle
High Level Derivative Lifecycle
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Reporting
Designation Maintenance Termination
• Policy definition
• Exposure tracking
• Trade execution
• Hedge documentation
• Prospective and retrospective effectiveness testing
• Valuations
• Measurement
• Documentation of hedge termination
• OCI management
Implementation Framework
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o Policy definition:– Types of exposures, policy for hedging, operational controls– Embed key HA language into policy and refer trade to this
o Exposure tracking:– Need repository to store exposure information (date, amount,
revision history, actuals etc.)o Trade execution:
– Consider hedge accounting structure when executing trades (e.g. are internal derivatives needed)
Designation Maintenance Termination
Implementation Framework
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Designation Maintenance Termination
FX Hedges Eligible for HA? Type
Unrecognized firm commitment with an unrelated party Yes Fair Value
Foreign currency denominated asset or liability Yes Fair Value
Non-financial asset (e.g.,inventory or a fixed asset) Yes Fair Value
Firm commitment to purchase a nonfinancial asset Yes Fair Value
forecasted purchase or sale of a foreign currency-denominated financial asset with a third party
Yes Cash Flow
Forecasted intercompany purchase or sale of a foreign currency denominated financial asset
Yes Cash Flow
Receipt or payment of interest on a foreign currency denominated debt instrument
Yes Cash Flow
Forecasted intercompany dividend No
Hedge of a forecast/firm commitment to purchase a foreign equity method Investment or business combination
No
Implementation Framework
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Designation Maintenance Termination
Documentation Requirement
Details
Hedge Type Cash Flow, Fair Value or Net Investment Hedge
Objective and strategy
Need to define what the risk of the hedged item is along with the mitigation strategy
Risk Changes in FX, interest flows attributable to the benchmark rate, price
Assessment of Effectiveness
Company expects that both at inception and on an ongoing basis the relationship will be highly effective…Methods: 1) critical terms/shortcut, 2) dollar offset, 3) regression
Hedged Item Need to be specific as to what the exposure is
Hedge Instrument Need to refer to the specific derivative
Timing Designation must be made contemporaneously
Implementation Framework
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o Prospective/Retrospective Effectiveness Testing– Must be performed at least quarterly– Optimal method is regression– Specific guidance for options, forward contracts– Impact of basis on commodities
o Valuations– Source of market data– Confidence in pricing models
o Measurement– Book to ledger after adjusting for excluded components, ineffectiveness,
lesser of the cumulative change– Result is set of GL bookings
Designation Maintenance Termination
Implementation Framework
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o Cash Flow Hedges:– Regular Termination (e.g. at expiry of hedge contract)
• Amounts in OCI are reclassified from OCI to income statement in same period as which the hedged item impacts the income statement
– Irregular Termination (e.g. failed effectiveness)• Cumulative gain/loss on the derivative is discharged immediately from OCI to P&L
– Management Decision (e.g. de-designation prior to maturity)• Amounts in OCI are reclassified from OCI to income statement in same period as which
the hedged item impacts the income statement
o Fair Value Hedges:– Cease adjusting the carrying value of the asset/liability/firm commitment– An adjustment to the carrying value of hedged item is accounted for in the same
manner as the hedged instrument itself (e.g. adjustment to inventory is held until the inventory is sold)
Designation Maintenance Termination
Implementation Framework
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Other Considerationso Advanced FAS topics
– DIG Issues– Treasury Center/Netting– Intercompany Transactions– Commodities– Cross Currency Swaps
o FAS 157– De-minimus testing– Credit adjusted values (at contract or on a net basis)
Designation Maintenance Termination
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The Power of SaaS TRM
CASH MANAGEMENT• Bank statement retrieval• Bank account management• Cash positioning and reconciliation• Payments and Payment Factory• In-house banking and Pooling• Multi-lateral Netting• Forecast and Liquidity Planning
• Debt & Investments Management• Intercompany Loans• Limit Monitoring
• Accounting
• Performance Evaluation and Reporting
LIQUIDITY MANAGEMENT
ACCOUNTING AND COMPLIANCE
RISK MANAGEMENT• Integrated Market Data• Exposure Quantification / Management• Multi-Asset Class Derivative Valuation
including IR, structured rates, FX, energy, agriculture, metal, equity, credit)
• Credit adjusted valuations• Hedging Strategy• Back Office and Accounting• Strategy Evaluation and Performance
Measurement
• Compliance with ASC 815(FAS 133 and FAS 161), ASC 820(FAS 157), IAS 39, IFRS 7, IFRS 9, and IFRS 13
• EMIR and Dodd-Frank Reporting
• Inventory & Activity Reporting• General Ledger• Audit Controls
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Questions?
Sanjay ThoppilSolution [email protected] 646.376.4095
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Visit us in the Exhibit Hall at Booth #616
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Role of Commodity Risk Management Within Treasury
Commodity Risk Operating Models
BasicManager
Silo risk manager
Proprietary trader
Portfolio risk manager
• Risks ignored or addressed inconsistently through the organization
• Exposures inaccurately identified
• Material risks managed centrally
• Focus on policy compliance with timely and cost effective execution
• Supports organization's objectives
• Manages entire portfolio incorporating asset correlations
• Specialist risk managers
Value Add
• Trades for profit using value add strategies optimizing key drivers
• Alignment of risk management and organization strategy
• Organization has competitive edge on the market
• Specialized proprietary traders
Business Alignment
Typically only specialized oil,
gas, mining and electricity trading
companies
Typical corporate commodity risk manager
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• Ongoing volatility• Systems and data
infrastructure• Skilled staff• Hedge accounting• EMIR
Transformation Objectives
o Ultimately deliver greater shareholder value through:– Commodity risk management in line with risk appetite– Greater visibility and certainty of exposures– Enhanced control environment– Holistic management of company financial risks
• Business case• Budget• Governance• Controls• Efficiency• Change• Business unit buy in
External ChallengesInternal Challenges
Corporate Commodity Risk
o Procurement manages relationship with supplier, both supply chain risk and price risk
o Forces supplier to manage commodity price risko Supplier will add a pricing premium for the serviceo Corporates may have better negotiation leverage than suppliero Supplier may not be any better at understanding and managing price
risk
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Corporate Commodity Risk
o Decouples commodity supply risk from price risk. o Supplier and procurement focuses on delivery logistics.o Treasury generally maintains risk management knowledge and resources.
They are better equipped to manage price risk. o Allows treasury to select hedge horizon and adjust hedge coverage at their
will.o Treasury may have historically focused on FX and IR risk and will need to
develop commodity expertise.o Creates increased accounting demands for tracking hedges.
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