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The introduction of IFRS 13 in January 2013 was, in part, recognition of the mispricing of market credit risk that had resulted in the near collapse of financial markets in 2008. IFRS 13 requires “fair value” to include a credit adjustment for financial instruments such as FX forwards, FX options and interest rate swaps representing the credit worthiness of each counterparty to the transaction. It makes sense to adjust valuations by a credit component. IFRS 13 bases fair value on an “exit price” of the security i.e. the price at which you can go to the bank and close out an existing transaction. Whether you are buying or selling a financial instrument the bank will naturally add a margin so it is counter-intuitive to mark-to-market a position without a credit component.

What has been most surprising about the introduction of IFRS 13 has been the lack of engagement by auditors to champion the credit adjustment component of valuations. Often lack of materiality is cited as the reason for not asking companies to provide the credit adjustment when put in context of other risks within the business, but how can the adjustment be deemed non-material if the calculation is never done?

Given the deterioration of credit conditions over the last few months it will be interesting to see if auditors continue to stand-by the “non-material” argument or whether there is a move towards compliance of the IFRS 13 accounting standard.

Aussie Bank Big 4 CDS 3 -year

At Hedgebook we do not dispute that the credit adjustment adds little value to a business and is another thing to ensure year-end financial reporting is dragged on, however, we have made it easy and low-cost to achieve. The CVA module within the HedgebookPro app allows the user to create credit curves, assign them appropriately to the relevant instruments and produce a report to satisfy audit requirements.

For a demo of Hedgebook’s CVA/DVA functionality, register your interest here.

 

Just like Kathmandu, who recently became a Hedgebook client, we are pleased to announce the signing of another iconic New Zealand brand, Skellerup.

Many people know Skellerup as being the leading producer of gumboots, however, there is much more to Skellerup; the Group designs and manufactures a variety of Agri and Industrial polymer products for dairy, infrastructure, plumbing, water, automotive, marine, waste, gas and mining applications.

Skellerup was founded by George Skellerup in 1910 and has grown to employ almost 800 people in New Zealand, Australia, the United Kingdom, Italy, USA and China. As a listed company on the NZX, Skellerup is focused on the compliance reporting aspects that Hedgebook brings to its foreign exchange and interest rate derivatives. However, as Graham Leaming, CFO noted, “Hedgebook also gives Skellerup good visibility of its fx risks across multiple entities and multiple currencies”.

Hedgebook is pleased to welcome Skellerup as a client.

There can be no greater affirmation of the global movement towards digitalisation than the world’s biggest firms putting their considerable resources to work. The launch of PwC’s Next platform gives small and mid-sized businesses access to the tools to grow quicker, work smarter and level the playing field against the big boys. Hedgebook will be available on the Next platform alongside a growing number of other smart and leading edge apps.

http://www.pwc.co.nz/media-centre/news-releases/pwc-working-with-xero-and-spotlight-reporting-to-create-innovative-cloud-solution/

We often encounter a common misconception among SME importers and exporters that the FX hedging market is the domain of the “big boys”. SME importers and exporters often believe that the use of financial instruments such as FX forwards and options are for “large” foreign currency costs and/or sales receipts. However, the definition of “large” is obviously subjective; the more crucial consideration is one of materiality. If the importer or exporter has the luxury of being a price maker and can pass through the impact of foreign currency movements to the customer/supplier then there is less necessity to hedge. Many businesses are not fortunate enough to be in this situation. Rather, adverse movements in foreign exchange rates have a direct impact on margins and profits. So how much foreign currency exposure warrants hedging through derivatives and what are the administrative costs of doing so? As a rule of thumb if the company has on average >$50,000 of monthly FX exposures then there is merit in taking a more active approach to managing the risk, as opposed to passively transacting at the prevailing spot rate on the day. Of course this needs to be put into context of total revenue.

Having determined that the FX exposure warrants hedging, there are further important considerations of an FX hedging programme:

  1. Does the company have the knowledge base to transact and manage FX derivatives? There may be a certain level of education required before committing the company to financial obligations. There are many resources available to aid the understanding of the common financial instruments available for hedging purposes. On-line resources are plentiful. Banks and brokers are always available for training sessions, too. This is mutually beneficial. Banks and brokers make money from the FX transactions, whilst the company is put in a better position to manage and mitigate FX exposures.
  2. Does the company have the systems and processes to transact and manage FX derivatives? Derivatives such as FX forwards and options require recording, reporting and valuing. Until relatively recently many companies were reliant on spreadsheets and bank valuations to manage FX derivatives as systems were prohibitively expensive. With the advent of cloud based systems, SME companies have access to systems at a fraction of the cost of more traditional solutions. Systems allow better management of derivatives, give better visibility over exposures, in turn increasing confidence to enter hedging. Systems allow more time to be spent on strategic decision making.

So the hurdle to entering FX hedging is not so much one of quantum, but more about having the skill set and systems to adequately manage a portfolio of derivatives. There is a wealth of resources available to help transition a company into a hedging programme and take the volatility out of profit outcomes.

For a closer look at the fundamentals of FX hedging download our Dollars & Sense eBook.

In the very early days of Hedgebook, the software was developed solely as a derivative valuation tool. Over time, additional functionality was introduced to include a suite of reports. The reporting supports both the day-to-day administration of the treasury function such as cashflow and accrued interest reports from an interest rate management perspective, as well as strategic/decision making tools.

In the latest release of the software we have focused on enhancing the debt module. A significant number of the Hedgebook client base has debt of one kind or another. The debt is a combination of short and long term instruments e.g. term borrowing, commercial paper, floating rate notes and fixed rate bonds. For corporate clients the bank is the main source of funding

For Councils there is also the LGFA (Local Government Funding Agency). The LGFA can lend to New Zealand Local Government on a fixed or floating rate basis across the yield curve. Historically funding from the LGFA has been for longer dated maturities but has recently introduced a short term funding facility, too. Says LGFA’s CEO Mark Butcher, “It is encouraging to see tools like Hedgebook developed for the Local Government borrowing community. With over $5.5 billion currently outstanding to Councils across New Zealand, the LGFA draws confidence that these liabilities can be managed with a degree of sophistication.”

It is important for Hedgebook to cater to the wide and varied funding sources available to the corporate and Local Government sectors, therefore, the HedgebookPro system has been expanded to accommodate the majority of debt instruments available through financial markets to Hedgebook users. In doing so, Hedgebook is further reducing the need for companies/Councils to rely on external spreadsheets for managing treasury matters.

As well as adding a level of general risk management rigour around the capture and reporting of debt, the software’s latest module will provide functionality that cannot be achieved through spreadsheets. For example, automatically rate-setting floating rate instruments against the underlying BKBM reference rate and applying the appropriate credit margins which in turn flows through to the cashflow and interest accrual reports.

Hedgebook will continue to be developed in a practical and useful manner and remain easy to use. Oh, did we mention it’s cheap low cost? Why not get in touch for a demo?

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