Hedge Accounting Trends in Asia Pacific
by Nik Tandy, Head of GAAP Solutions, The Hongkong and Shanghai Banking Corporation
The importance of understanding and managing risk has escalated over the past two years, prompted by the global financial crisis. For companies headquartered in Asia Pacific – or with significant standalone financial operations there – this has created the dual challenges firstly of establishing an appropriate way of measuring and managing risk, and secondly of accounting for hedge transactions in accordance with the relevant accounting standard, particularly the hedge accounting requirements of IFRS, US GAAP or other local equivalents.
While in many respects, these issues are reflected globally, treasury functions in Asia Pacific have typically had fewer resources available, in terms of specialist treasury management systems, compared with those in Europe and the US, with the possible exception of Australia. The use of spreadsheets rather than specialist treasury management systems or modules of ERP systems is commonplace within the region, even amongst large corporates, and there is a heavy reliance on banks for valuation of financial instruments. This article looks at how the issue of identifying, monitoring and accounting for risk has developed in Asia Pacific and how this could change in the future.
Asia Pacific cannot be considered as a cohesive region in any respect, with significant variations in financial culture and complexity. The same applies to treasury and accounting practices. For example, many of our corporate clients are only now introducing IFRS and the related hedge accounting requirements of IAS 39 – for instance, those in countries such as India (which is adopting IFRS from April 2011) and Malaysia (which adopted the standards in 2010). Companies in these countries typically need support throughout this statutory reporting transition process, from risk identification through to hedging and accounting for hedges. At the other end of the spectrum are more accounting-savvy clients in countries such as Australia. These companies are generally looking for advice on the best way to structure and execute a transaction to minimise accounting risk and maintain hedge effectiveness, or need help in identifying, quantifying and minimising the residual risks.
Whatever our clients’ level of financial sophistication, our starting point is to understand their business fundamentals, risk appetite and exposures. We are then in a position to help them to understand how market movements could affect their earnings. Depending on market conditions, we highlight certain risks that clients should be looking to hedge, or opportunities that they may look to take advantage of. Based on this, we can then recommend specific hedging products or assist them in restructuring or unwinding existing hedge transactions. Particular attention is paid to the fine-tuning of hedging proposals and execution strategies, as small differences can have a significant impact on the accounting treatment.
As in any region, our corporate clients are very interested in their competitors’ approaches to hedging risk, as well as those of companies outside of their immediate peer group, which may face similar market risks to them. One of the advantages of working with a bank with the global reach and diverse client base of HSBC is our ability to share a wide range of experiences and identify trends in terms of approaches to risk and use of financial instruments, not only by sector or by country, but at a global level.
The decision to hedge
Given the volume of import and export activity in the region, FX risk has historically been a top priority for corporates across Asia Pacific, and treasurers have historically been prepared to take stronger views on market direction than their counterparts in Europe and North America. This often resulted in the use of more sophisticated financial instruments, including structured options.However, the financial crisis, a number of high profile derivative losses, and the resulting greater scrutiny of statutory accounting results have all contributed to a change of approach. Companies have extended their focus from pure market risk in terms of specific exposures towards holistic balance sheet analysis (i.e., analysing the overall risk of the company and taking a high level, strategic approach rather than a product-specific one), following similar approaches taken by their peers in Europe and the US.
This shift in focus has resulted in a growing need amongst corporates to identify and outline their accounting objectives as they increasingly consider factors that would not previously have featured as highly in hedge decisions. For example, many companies are now interested in the impact of hedge ineffectiveness, or how the use of certain structures might be more ‘risky’ from an accounting perspective. More than ever, corporates are aiming to quantify differences or to rank alternatives relative to each other based not only on economic objectives, but on less tangible parameters such as accounting volatility. To support our clients in achieving this, we have implemented Reval®, which has become instrumental in assisting in their pre-hedge analysis. The system provides a wide variety of independent historical data, valuations and ‘what if’ features, which allow us to model how an instrument would have performed over a period of time and to compare different structures on an equivalent basis. Significantly, Reval provides this information not only from a pure mark-to-market standpoint, but it also performs the necessary accounting adjustments to provide statutory P&L output. Different hedging strategies can therefore be compared and contrasted quickly and efficiently, with the analysis recognised by the auditing profession as being generated by a reliable independent provider.