by François Masquelier, Head of Corporate Finance and Treasury, RTL Group, and Honorary Chairman of the European Association of Corporate Treasurers
IFRS 13 ‘Fair Value Measurement’ came into effect from January 2013. It requires us to take into account counterparty and credit risk, part of non-performance risk, in the revaluation of financial hedging instruments. Some important questions need to be addressed, such as: How do we calculate this risk? What reports will have to be provided and disclosed? And finally how to simulate the potential impacts on the income statement? If we think only about IFRS 9 we are forgetting this other standard applicable now.
IFRS 13, the one we forgot?
Through focusing on the future IFRS 9 (which will not become effective until January 2015), we might almost forget IFRS 13 coming into force, and one of its major impacts on treasurers (yet another one). Treasurers sometimes focus on certain problems, such as OTC derivatives and the risk of being required to post cash as collateral, to the point of forgetting others. They are so obsessed with certain measures that they see as unfair (rightly) that they forget the mandatory aspect of reporting to ESMA via trade repositories. This latter measure nevertheless comes into force as of 2013. It seems to us that we should first focus on current priorities and ensure we can fulfil our obligations as soon as they come into force. IFRS 13 is now on our list of reports to be provided, to comply with all the new accounting regulations and standards. This accounting standard demands a minimum of thought to assess the scope of information to be provided, how to produce it and extract it from the computer systems and finally to understand the potential impact on the company’s balance sheet and income statement. IFRS 13 was published in November 2006 (that long ago). It is largely inspired by its US cousin SFAS 157 in the measurement principles that it adopts.
Dealing in financial instruments
When we deal in OTC type financial instruments for hedging purposes, for example, in IFRS we have to revalue them at every accounting period close. But what is the ‘fair’ value of such an instrument? The ‘fair value’ is the financial and mathematical value calculated by the difference between the NPV (Net Present Value) of the instrument and the NPV of a perceived identical and opposite contract that cancels it out. In short it is the difference between the first instrument and the instrument that needs to be traded to unwind the deal, discounted to present value. Any Treasury Management System (TMS) worthy of the name should do that with no problem. However, this ‘fair’ value – estimated on the basis of market data (mark-to-market) – does not take account of counterparty risk or counterparty default. If the counterparty defaults you will not receive delivery of the currency or commodity or interest rate that was the subject of the original deal. The idea was therefore additionally to incorporate the concept of the risk of default of the other contracting party. This risk was not taken into account when revaluing the financial instrument portfolio. For 12 years (for the IAS 39 pioneers), treasurers have been revaluing their financial instruments in a partial and ultimately incomplete manner. IFRS 13 is intended to put that right. ‘Risk-free’ interest rates or yield curves are taken as the basis for assessing whether the present value of the instrument is positive (an asset) or negative (a liability). To this value we would therefore apply a CVA (Credit Value Adjustment), depressing the instrument’s value for counterparty risk and conversely we would reduce (because it is negative) the negative value of a liability to recognise and record our own credit risk (Debit Value Adjustment).