Hedge Accounting for Effective Risk Management

Transcription

1 Hedge Accounting for Effective Risk Management Tracey Ferguson Knight Director, Solution Consulting May 29, 2014

2 Agenda o Introduction to Hedge Accounting o Benefits of Hedge Accounting o Framework for Implementing a Program 2

3 What is Hedge Accounting? 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 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) 3

4 Introduction No Accrual Derivative? FV Hedge MtM Yes CF Hedge Definition of a Derivative: Characteristics of a derivative ASC (formerly SFAS 133, par 6) 83(a) Underlying 83(a) Notional amount 83(b) No (or minimal) initial net investment 83(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 4

5 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 5

6 Agenda o Introduction to Hedge Accounting o Benefits of Hedge Accounting o Framework for Implementing a Program 6

7 Benefits of Hedge Accounting Benefit 1: Alignment of Derivative and Hedged Item Impacts on Income Statement Cash Flow Hedge Hedge Hedged Item Trade Date Recognize in Earnings Settlement Changes in derivative value are deferred to OCI until the hedged item impacts the income statement. Fair Value Hedge Recognize in Earnings Trade Date Settlement Hedge Hedged Item Changes in the hedged item value are booked to earnings at the same time as when the derivative changes. 7

8 Loss/Gain Loss/Gain Loss/Gain Loss/Gain Loss/Gain Loss/Gain Benefits of Hedge Accounting Benefit 2: P&L Volatility Reduction Cash Flow Hedge Forecast Sales FX Forward Net Acctg Impact No Hedge Accounting FX Rate FX Rate FX Rate FX rate at fcst date FX Fwd Rate FX Fwd Rate With Hedge Accounting FX Rate FX Rate FX Rate FX rate at fcst date FX Fwd Rate FX Fwd Rate 8

9 Benefits of Hedge Accounting Benefit 3: Improved Economic Hedging Performance Transaction Timeline: Txn Event Quote Order Sale/ Revenue Recognized Cash Received t0 t1 t2 t3 Rates Planning Acctg1 Acctg2 Potential P&L Impact Economic Risk Accounting + Economic Risk Hedge Type Cash Flow Fair Value Balance Sheet Objective: Minimize the difference between the hedge rate and planning rate 9

10 Benefits of Hedge Accounting Other benefits of implementing a hedge accounting program o 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 10

11 Agenda o Introduction to Hedge Accounting o Benefits of Hedge Accounting o Framework for Implementing a Program 11

12 Hedge Accounting Lifecycle Risk Management Framework Business Goals and Objectives Risk Appetite Risk Identification Assessment and Strategy Definition Execution Reporting Roles and Responsibilities Policies and Procedures Technology 12

13 High Level Derivative Lifecycle Hedge Accounting Lifecycle Designation Maintenance Termination Reporting Policy definition Exposure tracking Trade execution Hedge documentation Prospective and retrospective effectiveness testing Valuations Measurement Documentation of hedge termination OCI management 13

14 Implementation Framework Designation Maintenance Termination 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) 14

15 Implementation Framework 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 Forecasted intercompany purchase or sale of a foreign currency denominated financial asset Receipt or payment of interest on a foreign currency denominated debt instrument Forecasted intercompany dividend Yes Yes Yes No Cash Flow Cash Flow Cash Flow Hedge of a forecast/firm commitment to purchase a foreign equity method Investment or business combination No 15

16 Implementation Framework Designation Maintenance Termination Documentation Requirement Hedge Type Objective and strategy Risk Assessment of Effectiveness Hedged Item Hedge Instrument Timing Details Cash Flow, Fair Value or Net Investment Hedge Need to define what the risk of the hedged item is along with the mitigation strategy Changes in FX, interest flows attributable to the benchmark rate, price 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 Need to be specific as to what the exposure is Need to refer to the specific derivative Designation must be made contemporaneously 16

17 Implementation Framework Designation Maintenance Termination 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 17

18 Implementation Framework Designation Maintenance Termination o 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 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 item itself (e.g. adjustment to inventory is held until the inventory is sold) 18

19 Implementation Framework Designation Maintenance Termination Other Considerations o 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) 19

20 The Reval Solution How We Help o Reval helps optimize our clients global treasury operations across: Cash Management Liquidity Management Financial Risk Management Hedge Accounting & Compliance o Fully scalable solution o World-wide coverage and support o Over 500 global clients 20

21 Q&A Tracey Ferguson Knight Director, Solution Consulting Reval