Reval.com: Accounting for Cross-Currency Interest Rate Swaps–A New Approach to Avoid P&L Volatility

The following is an excellent article from the Reval.com website titled “Accounting for Cross-Currency Interest Rate Swaps–A New Approach to Avoid P&L Volatility” and I quote:

“Accounting for Cross Currency Interest Rate Swaps – A New Approach to Avoid P&L Volatility”

Since the financial crisis, many organisations have experienced significant P&L volatility on their cross currency interest rate swaps through movements in currency basis. This is in spite of the hedges being perfectly matched to the underlying exposure and the application of best case hedge accounting techniques. Recently, a new technique for applying hedge accounting to these instruments has emerged which has significantly reduced the ineffectiveness flowing through to the bottom line.

As companies seek out cheap funding in the US, we are also seeing more cross currency swaps being dealt to lock in the currency and at times interest rate risk. In instances where an organisation looks to swap to floating rates locally, the accounting has been problematic because the principal and benchmark elements must be represented in a Fair Value hedge, not a Cash Flow hedge. In a Fair Value hedge relationship, the hedging instrument (cross currency swap) must be valued with currency basis applied whereas the hedged item (US denominated debt) does not – any movement in currency basis therefore causes P&L volatility.

In the days before the GFC, currency basis represented a small element of a valuation with little volatility. Post crisis, we have seen significant swings in currency basis by over 50 basis points or more at times which can cause havoc to a treasurer’s P&L on what is ‘suppose’ to be a perfect hedge. This has caused frustration for many corporations who know that economically they are hedged yet their financial statements do not reflect it.

Some auditors and advisors are now working with their clients to create a new way of designating hedge relationships that better reflect the economic hedging reality. In this manner of designation, all of the movements in currency basis are effectively maintained within Other Comprehensive Income. The only impact to P&L may be a small amount of ineffectiveness arising on the first coupon of the swap’s floating leg – a much better result for corporate.

Why the change of heart? Clearly the recent volatility has made this a higher priority for treasurers and CFO’s and they have encouraged their stakeholders to consider alternative approaches here. However, I think there is also an emerging pragmatic trend in hedge accounting under IFRS. More and more, auditors are looking to align the accounting results with the economic hedging situation and each company’s risk management policy. We see this now at the highest levels, where the IASB’s tentative decisions around IFRS 9 include aligning hedge accounting outcomes consistent with your risk management policy.

This is all good news for those who have suffered the whims of currency basis through their profit and loss. On a bigger scale, it is also very encouraging development for other aspects around hedge accounting, particularly when we get our first look at Phase 3 of IFRS 9 – for many, it can’t come soon enough.”

(NO WONDER SEN BERNIE SANDERS BECAME SO POPULAR IN THE DEMOCRATIC PRESIDENTIAL PRIMARY RACE WHEN HE KEPT REPEATING BREAK UP THE FIVE BIG UNREGULATED INVESTMENT BANKS, AS WELL AS REGULATING WALL STREET. READ THE BOOK “THE DEVIL’S DERIVATIVES: THE UNTOLD STORY OF THE SLICK TRADERS AND HAPLESS REGULATORS WHO ALMOST BLEW UP WALL STREET . . . AND ARE READY TO DO IT AGAIN” BY NICHOLAS DUNBAR.

LaVern Isely, Progressive, overtaxed, Independent middle Class Taxpayer and Public Citizen Member and USAF Veteran

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About tim074

I'm a retired dairy farmer that was a member of the National Farmer's Organization (NFO). Before going farming, I spent 4 years in the United States Air Force where I saved up enough money to get my down payment to go farming. I also enjoy writing and reading biographies and I write about myself as well as articles and excerpts I find interesting. I'm specifically interested in finances, particularly in the banking industry because if it wasn't for help from my local Community Bank, I never could have started farming which I was successful at. So, I'm real interested in the Small Business Administration and I know they are the ones creating jobs. I have been a member of Common Cause and am now a member of Public Citizen as well as AARP. I have, in the past, written over 150 articles on the Obama Blog (my.barackobama.com) and I'd like to tie these two sites together. I'm also on Twitter, MySpace and Facebook and find these outlets terrifically interesting particularly what many of these people did concerning the uprising in the Arab world. I believe this is a smaller world than we think it is and my goal is to try to bring people together to live in peace because management needs labor like labor needs management. Up to now, that hasn't been so easy to find.
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