Published: June 15, 2009
Founded in 1950, Mitsubishi Corporation has become Japan’s largest general trading company with over 200 locations in 80 countries worldwide. Mitsubishi employs a multinational workforce of approximately 60,000 people across 500 group companies. The company operates in virtually every industry, including energy, metals, machinery, chemicals, food and general merchandise.
Originally, Mitsubishi Corporation Finance PLC (MCF) in London, was established as an investment company; however, from mid 2006, it became the treasury centre for Mitsubishi’s business units in Europe. MCF uses SunGard’s AvantGard Quantum for front office, back office and accounting, and Reval® for revaluation and prospective hedge effectiveness calculations, with the intention of using it also for retrospective testing in the future.
Mitsubishi Corporation Finance Plc (MCF) in London, was established as an investment company; however, from mid 2006, it became the treasury centre for Mitsubishi's business units in Europe.
MCF issues medium term notes (MTNs) at fixed rates in London, mainly in JPY to investors in Japan which creates both interest rate and foreign exchange risks. To manage funding requirements and the associated risks, the funds are swapped into EUR or USD as appropriate. The MTNs have been of a complex structure in the past; however, due to the recent difficult market conditions and acceleration in the deterioration of credit quality impacting on market liquidity, it has become increasingly difficult to find opportunities to secure funding in Japan at a reasonable cost. The continuing global dislocation in financial markets in 2008, resulting in lower investor confidence, has impacted on MCF, and we are issuing less complex structured debt. MCF has therefore resorted to sourcing new forms of financing including issuing debt in other currencies, whenever market opportunities present themselves, such as in AUD and NZD, and swapping into the currency for which financing is required; however, this can still be expensive.
Although MCF deals only with highly-rated commercial banks to mitigate counterparty risk as far as possible, counterparty risk has not been high on the issues list in the past; however, due to the recent turmoil in the markets, MCF has started to look at this more closely.
From an accounting perspective, this means taking into consideration Credit Value Adjustment (CVAs) which has a significant impact on hedge effectiveness. Our auditors now insist that we include credit value adjustments (CVAs) in our valuations where these are material, which can easily render a hedge ineffective and cause volatility in the income statement. Spreads on CVAs can be very wide – often 200bps or more and although a particular bank may have a lower spread, they may not be providing funding, causing liquidity issues for businesses. Hedging counterparty risk using credit default swaps (CDS) is expensive and as MCF only deals with highly rated commercial banks, CDS are not appropriate for MCF presently. [[[PAGE]]]
As a business, MCF is risk-averse and hedges both interest rate and foreign exchange risks. MCF’s debt issuance used to be relatively complex, including embedded derivatives. Today, vanilla debt issuance has become far more expensive, and complex debt even more so, due to the exceptional instability and volatility in the markets. Some of the debt issued in the past incorporated call options and these have been called as they have moved out of the money for the counterparty. Therefore, with opportunities for long term debt issuance drying up, trades have become more vanilla and with a shorter maturity.
From a hedge accounting perspective, an important requirement is accurate and reliable market data. With a large number of swaps and structured debt, it has been difficult to obtain accurate market valuations in the past. We have worked closely with Reval to develop a module for complex interest rate revaluations, which is now part of the core system. Initially, MCF outsourced market valuation and hedge effectiveness testing to Reval, due to lack of sufficient resources in-house. However, once this module became available, we brought the activities in-house so we are now able to obtain market values sooner and whenever required as opposed to relying on periodic valuations. We have short quarterly reporting deadlines to our parent company and therefore, it is very important for information to be available as quickly as possible to allow us time to prepare the financial reports and have adequate time to review them.
We have worked closely with Reval to develop a module for complex interest rate revaluations, which is now part of the core system.
Hedge accounting continues to bring challenges, and small changes in market valuations can result in losing hedge effectiveness, especially when the cum-dollar offset method is used. More assessment is required by auditors regarding prospective effectiveness testing and on market valuations. Reval incorporates prospective testing capabilities which we have used since December 2008 and we are currently finalising the testing of the module. This aspect of the system is potentially very helpful as it is also used by our auditors for this purpose, so they can review the valuations and prospective testing results quickly and efficiently.
In the future, MCF’s debt issuance will be market-driven and further impacted by credit rating downgrades of counterparties. MCF will continue to issue complex debt where favourable conditions exist, but in the short term the focus will be more on vanilla trades. A continued focus on simplicity and transparency of debt issuance should also make hedge accounting easier, except for the effects of CVA. However, our treasury technology, including Reval, has enhanced the process considerably with greater transparency of information and timely market valuations.
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