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07 February 2014

Will auditors enforce CVA compliance?

There is no doubt that CVA (credit value adjustment) and DVA (debit value adjustment) is rapidly becoming front of mind as corporations who have a 31 December balance date and outstanding financial instruments discover something else that needs to be calculated for inclusion in the annual accounts. The world has...

There is no doubt that CVA (credit value adjustment) and DVA (debit value adjustment) is rapidly becoming front of mind as corporations who have a 31 December balance date and outstanding financial instruments discover something else that needs to be calculated for inclusion in the annual accounts.

The world has changed from when a valuation was just something you took from the bank, plugged into the accounts and moved on. First it was sensitivity analysis on the outstanding instruments. What would the effect be if exchange rates moved up 10% or interest rates moved down 1%? Interesting, but not necessarily that important, especially as this analysis is only on the hedged position not on what isn’t hedged. If you have only hedged 20% of your expected future exposure because you are waiting for the exchange rate to move in your favour, then you will know the effect on 20% of your business, but not the other 80%. The sophisticated investor might look through this, most won’t.

Now we have something called CVA and DVA to consider when we value a financial instrument. What is the impact if my counterparty falls over, or if I fall over, on the value of my outstanding instruments? Interesting, however more relevant during and immediately after the GFC. Less so now and not straightforward to calculate, by any means. However, it is a requirement under the recently released IFRS 13, and not something your bank is going to provide.

How hard will the auditors push to have these numbers included is up for debate. Some of the numbers are immaterial. If you have short dated foreign exchange deals, the numbers are small; if you have long dated interest rate swaps the numbers are more material. Either way they are not something that can be calculated on the back of an envelope.

Hence the problem for CFOs and auditors. The standards have moved down a path whereby the fair value of a financial instrument is not straightforward anymore, nor easily obtained. The relevant purpose is debateable and already the cries of “enough already” can be heard by CFOs who have enough to worry about without debating the benefits or otherwise of the new standards. Likewise the audit dollar is getting squeezed at every turn in an environment where the audit itself is under more scrutiny and regulation.

CFOs may be quite justified to push back when it comes time to including CVA in their valuations, given the usefulness and materiality of the numbers. Whether the audit fraternity accept this or not is too early to tell – material or not you still need to calculate the numbers to decide on their materiality. Whatever the result it will be fascinating to see how this plays out and whether the standards come out on top or the tide of CFO pressure prevails.

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