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Managing Financial Risk during Market Turbulence

An Interview with Wayne Read, Partner, Financial Risk Management, KPMG

What risk management and hedge accounting issues do you see CFOs and treasurers facing in the current climate?

In Australia, as in many other parts of the world, one of the most challenging issues for CFOs and treasurers is coming to terms with the implications of ineffectiveness in hedge relationships, when IAS 39’s fair value measurement rules are contributing to income statement volatility.

Many long term commodity, foreign exchange and interest rate hedges were designated for accounting purposes when financial market conditions were benign. Invariably, hedge designation practices were designed with administrative convenience in mind due to system constraints. These hedges are now being impacted, with the effects of market illiquidity, basis and counterparty credit risks compromising hedge effectiveness, sometimes with dire consequences.

The recent market turmoil has provided a salient reminder to CFOs of the importance of understanding the economics of hedging relationships, the fair value measurement process and designing effectiveness tests that accommodate a variety of adverse market conditions.

In assisting companies to document their hedge relationships, we focus on the “what if” scenarios, including the impact of market changes on the valuation of the instrument, basis risks and cash flow modelling assumptions. IAS 39 is a prescriptive standard, but it does provide mechanisms to accommodate less than perfect hedge