Don’t shoot the messenger

We are only a week or so past 30 June (a common balance date for many Hedgebook clients) and already we are fielding questions/comments regarding the big movements in the mark-to-market valuations of our clients’ portfolios. The questions have nothing to do with the accuracy of the valuations but mostly around, “why has this happened?” Many of the big movements relate to our clients that hedge their interest rate risk via interest rate swaps.

It is no surprise given the sharp downward movements we have seen in the New Zealand and Australian yield curves over the last few months (see charts). A 1% move on a 5 year $5 million swap will result in a $250,000 move in the mark-to-market. Depending on the size of your swap portfolio, and the tenor of the swaps, the moves can be material.

NZD swap movements

AUD swap movements

An interest rate swap is a valuable hedging tool which helps companies manage their interest rate risk. Many companies have treasury policies which force them to have a proportion of fixed and floating interest rate risk which helps with certainty of interest cost as well as smoothing sharp interest rate movements, both up and down. However, there is also a requirement to mark-to-market swaps, and for many to post these changes to their profit and loss account. Some companies negate this profit and loss volatility by hedge accounting, but many don’t which often requires some explanation to senior management, directors and investors.

For publicly listed companies the impact, both real and perceived, of large movements in financial instrument valuations is even more critical. The requirement for continuous disclosure means that a large move in these valuations may require the issue of a profit warning, as we have recently seen from Team Talk, the telecommunications company. Team Talk’s shares dropped 6.3% on the back of the hit taken by a revaluation of interest rate swaps. The company noted that the change in the value of the interest rate swap portfolio was due to “wholesale interest rates falling significantly in the period”.

Equally we have a number of private companies and local governments who have been concerned at the change in their valuations and how they are going to be explained further up the tree. Having constant visibility over these changes will at least forearm any difficult conversations, as opposed to relying on the bank’s month end valuations.

Whilst Hedgebook won’t help improve mark-to-market valuations, it does assist with companies keeping abreast of changes in the value of swap portfolios on any given day. This is pretty much a “must have” for publicly listed companies that have the responsibility of continuous disclosure but forewarned is forearmed and many others are also seeing the benefit of having access to mark-to-market valuations at any time.

Digital disruption in the Treasury Management System space

There is a digital revolution going on in the treasury management system space, not that you would necessarily know.  For many there is still a stark choice – over-priced, over-complex and over-engineered treasury systems or good old Excel spreadsheets. But the world is changing and as with all things technology, it is happening at a rapid pace.

Globally, larger organisations are well catered for as far as treasury management systems are concerned, and in fact it is a crowded and mature market. The PwC Global Treasury Survey of 2014 showed that 80% of those companies surveyed were using some type of treasury management system. However, as with big ERP systems, the issue for the providers of large, expensive treasury systems is how to offer a cost-effective alternative to the massive SME market without detrimentally affecting their existing market. The challenge is to offer a slimmed down treasury management system without compromising the huge premium that they currently charge.

So where is the competition for these large, expensive systems coming from? The answer is the cloud app revolution which is sweeping the world. Platforms are being developed that aggregate a whole bunch of cloud apps, both financial and non-financial. The really clever bit is the integration of these different apps and bringing it all together through a variety of widgets and dashboards to give a complete, and often unique, view of a company’s position. It’s like a Fitbit for business.

Not only are these cloud app aggregators bringing leading edge technology to the SME market but they are doing so for small monthly fees. The apps cross the spectrum of business tools such as accounting systems, CRMs, social media tools and now treasury management systems. All of this for a few hundred dollars a month.

In the on-line accounting world, Xero is leading the charge in the digital disruption revolution with its New Zealand developed, $50 per month product. Treasury systems will need to follow suit with a much cheaper solution.

By leveraging cloud technology, treasury systems can be implemented for costs palatable to the underserviced SME market. There is an enormous amount of importers and exporters hedging their foreign cashflows with forward exchange contracts and possibly FX options. These companies probably aren’t hedge accounting, even if they are reporting under IFRS, but the impact of exchange rate movements is vitally important to their bottom line.

SMEs require the ability to record, report and value their transactions but just as importantly they want access to tools to help them make better hedging decisions. This is not too different from larger companies except SMEs are mostly using plain vanilla instruments. For a small monthly fee SMEs can benefit from a treasury management system with basic functionality, which integrates perfectly with other cloud based apps. So as we have seen with cloud based accounting systems, the power that was once reserved for large organisations can be put in the hands of a much larger group for a fraction of the cost.

Whether the current treasury management system providers have a solution for the SME market remains to be seen. It maybe that they do not care for this part of the market, however there are parallels with the large and expensive ERP systems which have successfully moved into the mid-market space and are now looking at the next tier down. The conundrum for treasury management system providers will be that SMEs will desire the core functionality of a larger system but without the price tag. The digital revolution for treasury management systems may only be in its infancy but it is set to have major ramifications regardless of the size of organisation.

First published on Treasury Insider (www.treasuryinsider.com)

PwC treasury survey reveals over-reliance on spreadsheets

PwC’s recently released “New Zealand treasury management survey” (http://pwc.to/1DCSdse) threw up some interesting results, especially in relation to treasury management systems.

It may come as no surprise to many, including us at Hedgebook, that there is a significant number of corporates who are still relying on good old spreadsheets to manage their treasury risks. In fact a whopping 73% of those surveyed still use spreadsheets, with only 13% using any type of treasury management system.

PwC Treasury Survey

Admittedly the 73% is mainly concentrated in small to medium sized organisations, however, the relative risks are the same for these business as they are for larger ones. The key difference is smaller businesses cannot afford, nor justify, the $50k plus price tag associated with these complex systems.

Therefore, it is not surprising that one of the main reasons for the high proportion of spreadsheet usage is price. However, as PwC pointed out in their survey, with low cost, cloud based systems entering the market, the excuse of treasury systems being too expensive is fast disappearing. We would also argue that a lower cost system does not have to mean loss of functionality.

Again as PwC’s survey showed “executives want detailed information in a timely, up-to-date, reliable and relevant manner.” This is becoming increasingly difficult to achieve with spreadsheets, as reporting requirements become more focused on information to make better decisions, as opposed to information for information sake.

Hedgebook certainly fits the bill of a low cost solution, not only providing the ability to better record, report and value treasury risks but also providing unique analysis combining cashflows, hedging and current market rates to help make better hedging decisions.

It will be interesting to see these same survey results this time next year. – we may start to see a significant change.

Using Hedgebook to make smart fx hedging decisions

Has anyone told you lately that they know where the currency is going? Lots of people think they know if it is going up or down but the reality is that no one knows where it is going in the next 5 minutes, 5 days or 5 years. We might all be able to have an educated guess but that is all it is – a guess.

As a former risk manager I know how hard it is to advise corporates on the risks around fx management. I can remember going to a potential client and explaining to the owner of the business the importance of having a treasury policy and why you should follow it. We could add value in helping with the strategic decisions and the instruments to use but by the way we can’t pick the currency because no one really knows where it is going and we don’t try to. After listening to all this sage advice the owner turned to us and asked what use were we to him if we didn’t know where the currency was going? End of meeting.

It is true no one can pick where the currency is heading. What is important is:

  • Understanding the impact on your business when foreign exchange rates move.
  • Knowing the impact on budget rates or costing rates when foreign exchange rates move.
  • Knowing whether the business can afford to not cover i.e. if exchange rates go any further against you are you losing too much margin or indeed are you out of business.

Having the ability to compare the amount of foreign exchange hedging in place with the impact of exchange rate movements on the uncovered portion is vital information in making rational decisions in an irrational market.

Whilst we can’t pick currencies at Hedgebook (we are still working on that one) we can tell you the impact on your business if rates go up or down. We can tell you in dollars and cents what the impact will be  on unhedged foreign cashflows, what the exchange rate needs to be to achieve the budget or costing rate and what the value of existing hedges are.

Today’s fx risk management isn’t about picking exchange rates but about giving businesses greater visibility over its foreign exchange position. This allows for smarter foreign exchange hedging decisions using all available information. Sometimes the information isn’t what you want to hear but at least you don’t need to hope that things go your way. You can avoid the knee jerk decision – and chuck out the crystal ball.

Hedge accounting has never been easier

It seems like a lifetime ago since hedge accounting was first introduced, nearly ten years ago now. My how auditors loved it. How complicated could they make it? Very, ,was the answer. How about insisting on regression testing for simple foreign exchange forward contracts or forcing options to be split between time and intrinsic value? No doubt the fees were good for a while but after a decade of hedge accounting the bleeding obvious is that it isn’t, and shouldn’t be, that hard.

Because auditors did over complicate the process the perception was that to hedge account was a time consuming and difficult process to follow and so unless there were very good reasons for doing so many shied away from it. The reality is obviously somewhat different.

Hedge accounting can be simple if you are using plain vanilla instruments and follow some simple, good treasury practices.

We will look at the FX Forwards, FX Options and Interest Rate Swaps to show that anyone can hedge account if they want and it doesn’t need to be difficult or time consuming.

FX Forwards

Let’s take the most simple and commonly used financial instrument, FX Forwards. To achieve hedge accounting you need to match off your expected cashflow or exposure with the FX Forward you have used to hedge this. Given that one of the underlying reasons for hedge accounting is to recognise the difference between hedging and speculating it makes sense that you can identify a cashflow that matches your hedge. More simply than that, assuming you haven’t hedged more than you expect to buy or sell in the foreign currency, the cashflow can be matched exactly against the FX Forward.

Under the standard currently, you need to do a quantitative test to prove the effectiveness of the hedge, ie ensure that the hedge falls between 80% and 125% effectiveness. In practical terms all you need to do is value the FX Forward, which can be easily done through Hedgebook, and then value the cashflow that is allocated against the hedge. To value the cashflow, you create a hypothetical FX Forward which matches the same attributes as the original FX Forward, ie is an exact match. So by valuing the original FX Forward you also have the value of the hypothetical and lo and behold by comparing one to the other the hedge relationship is 100% effective.

If you need to pre-deliver or extend the FX Forward then, as long as this is within a reasonable period (45 days either way is generally accepted) this won’t affect the effectiveness of the hedge.

This method can be used for both the retrospective and prospective methodology.

FX Options

The process is the same for FX Options as it is for FX Forwards in terms of matching the hedge (ie the option) with the cashflow. Again there is only the requirement to value the underlying FX Option and replicate this with the cashflow by creating a hypothetical deal which exactly reflects the details of the original option. As with the FX Forward you then just compare the value of the underlying hedge with the value of the hypothetical option and again it will be 100% effective.

Those sneaky auditors have managed to complicate things by interpreting the current standard as requiring to split out the intrinsic value of the option from the time value. Again Hedgebook can do this calculation automatically which takes the pain away from trying to calculate this rather complex computation. The value of the time value will need to be posted to the Profit and Loss account.

Interest Rate Swaps

Interest rate swaps can be treated largely the same as FX Forwards and options in as much as you need to match the hedge against the exposure. In this case this means matching the swap against the underlying borrowing or investment. Again good treasury management should dictate that the reason you have taken out a swap is to match against the same details of the debt or the investment, in terms of amount and rate set dates.

Assuming that this match is occurring it is again a matter of valuing the swap and creating a hypothetical, in this case of the debt or investment but mirroring the details of the swap. Again this would mean that the relationship is 100%, assuming the hedge matches the exposure.

If there is a difference between the rate set dates and the rollover of the debt or investment then the hypothetical swap can reflect these changes and this means that the two valuations are slightly different but hopefully still well within the 80% to 125% relationship.

Documentation

It is important that the relationship is properly documented. There are plenty of places where you can source the appropriate documentation, with Google being a good place to start. In most cases it is a matter of copying and pasting the specific details of the underlying hedge but the vast majority of the documentation won’t change from deal to deal. A bit of admin but not too hard or onerous.

Summary

Our experience, somewhat surprisingly, has been that more organisations are moving towards hedge accounting. Probably because many are realising that it doesn’t have to be that hard as hopefully we have demonstrated above. This has also been recognised as the introduction of IFRS9 in a few years’ time is simplifying some of the rules which should push more down this path as most would probably prefer not to have the volatility of financial instruments flowing through their Profit and Loss account if they can help it.

It should be noted that hedge accounting can be complex if you are using more exotic instruments or if you are leaning more towards speculation than hedging, however, if you are keeping it simple then it doesn’t need to be onerous. Sure you need to value the financial instruments but if you can do that pretty much you can hedge account. Hedgebook has a number of clients, including publicly listed companies, using this approach. So why don’t you give it a try it might not be the beast you once thought it was.

Demo HedgebookPro for Free

Hedgebook is pleased to announce the launch of the free demo version of its flagship product HedgebookPro.

Potential users now have the ability to try before they buy. Simply go to the HedgebookPro website (www.hedgebookpro.com) and click on the big red button (it’s hard to miss). Fill in your details and we will send an email link of your login details so you can have a decent gander at the full functionality of HedgebookPro.

If you like what you see we can set you up with your own account by emailing us at enquire@hedgebook.co.nz. It’s as simple as that.

Give it a try and join the legion of users accessing the most cost-effective little treasury system known to man.

Rakon Ltd takes HedgebookPro and Infoscan data

We are pleased to announce that Rakon Ltd has chosen HedgebookPro and Hedgebook’s market data service, Infoscan, to assist in managing their financial market exposures.

Rakon is a publicly listed technology company based in New Zealand with offices around the world. Rakon designs and manufactures world leading advanced frequency control and timing solutions with the main application being in telecommunications (base stations, fibre optics, small cells and network timing). Rakon was one of New Zealand’s first tech companies, being established in 1967.

Rakon required a cost effective treasury system to capture its foreign exchange and interest rate hedges whilst continuing to comply with hedge accounting. Furthermore, Rakon required oversight of the foreign exchange and interest rate markets in terms of live data, which they now access through Infoscan’s MarketFeed product. MarketFeed keeps key decision makers abreast with the fast moving global money markets.

Hedgebook was chosen for its simplicity and ease of use. Rakon’s Group Financial Controller Anand Rambhai said, “HedgebookPro ticked all the boxes for us in terms of achieving a robust framework to manage our financial instruments, including hedge accounting and CVA.”

We are delighted to welcome Anand and Rakon as new HedgebookPro users.

CVA is here to stay

Nine months ago we at Hedgebook engaged audit firms, banks and corporates to discuss Credit Value Adjustment (CVA) and Debit Value Adjustment (DVA) as the introduction of IFRS 13 loomed. The overwhelming response was one of ignorance and/or disinterest. Either they didn’t know about it or they didn’t want to know. On my recent business trip to Europe an audit firm in France recounted a story about a get together they had with their clients to explain the requirement for CVA. The whole room burst out laughing. Adjust the financial instrument valuations for my credit worthiness – you must be kidding.

In some ways this wasn’t surprising as IFRS 13 really only began to impact corporates for their 31 December 2013 annual results, even though their half year results should have included the adjustment. Now six months down the track and the requirement to adjust for credit worthiness can’t be ignored.

Whether we like it or not the valuation of financial instruments has become more complex as the regulators are now focusing more closely on this area. In fact when we talk about valuations for financial instruments the understanding is that it includes the credit adjustment under the new standard. CVA is part of this change in focus and is here to stay. The question for corporates therefore is how do I calculate these values accurately but in a simple and cost-effective way?

Although this isn’t new for the US it is new for the rest of the world and it appears that Australia and New Zealand are leading the charge. Europe has been pre-occupied with the new regulatory changes, especially the reporting requirements under EMIR and so it is only now that it has come on their radar.

Of course CVA and DVA are not new. The banks have been adjusting for credit for a number of years but in the corporate space it is new and many have tried to over complicate the calculation. Monte-Carlo simulations might be appropriate for companies that have cross currency swaps or more exotic option hedging strategies but the vast majority of corporates globally are using vanilla products – fx forwards, options and interest rate swaps. For these instruments a simple methodology to calculate CVA is not just acceptable but also appropriate.

It appears that common sense is already coming to the fore with the current exposure method gaining common acceptance, where the discount curve is flexed to adjust for the credit worthiness of both parties. Although a more simplified method it is still not straightforward, requiring two valuations and an adjustment of the yield curves for credit margin. Not something the banks will be providing and so therefore there is the requirement to source this from someone who specialises in financial market valuations. It doesn’t need to be expensive though and there are low cost solutions available.

Given the numbers are mostly small there is a natural reluctance to pay very much for what are in some cases reasonably immaterial numbers. However the audit firms are insisting on its inclusion and rightly so – it is a requirement under the accounting standards and the materiality or immateriality needs to be proven. Of course credit conditions are benign at the moment but as we know this can change quickly and it won’t take much to make the credit adjustment more material.

New European Hedgebook distributor

We are pleased to announce the appointment of Konzept1 as our distributor of HedgebookPro in Germany and Austria.

Konzept1 markets third party software and is headed by Jorg Leuker. Jorg has previously been a user of HedgebookPro and was so impressed with the system he wanted his company to be able to distribute the product.

Jorg explained that “with the increasing reporting and compliance requirements HedgebookPro, with its simple and intuitive interface, fulfils a need in the German market”.

We look forward to working with Jorg and Konzept1.

FX management and a good night’s sleep

How hard is it really to manage your foreign exchange positions? Often we over think it and probably over-complicate things at the same time. Sure if you are a large corporate with many and varied risks it isn’t easy but for most it can be pretty straightforward. You are either an importer or an exporter. Maybe you can offset some receipts or payments or maybe you can’t but generally you should be looking at managing your net position. That would be a good start to simplifying things.

Next, no matter how big you are you should have a treasury policy that tells you what instruments you can use, who you can deal with and any parameters you need to keep within e.g. Minimum and maximum hedging levels. Generally you should be able to deal with fx forwards and vanilla options. Of course many corporates will only do options if they don’t have to write a cheque, so probably it’s only fx forwards and zero-cost collars.

Ideally you would have two banks to deal with to keep some competitive tension and online dealing platforms are more common now so you don’t even need to ring up the bank to do the deal. You might want to for some advice or to remind the dealer that you are available for the rugby next week. What’s important with currencies though is the medium term trend, not what is going to happen in the next 24 hours.

You should have some parameters to keep within that reflect your business risks and competitive situation. Despite what some may tell you no-one knows where the currencies are going so it makes sense to carry minimum amounts of cover just in case you, your advisor or bank is wrong. Budget rates and costing rates are important to keep front of mind. No one will thank you for protecting the budget rate but everyone will point the finger if you don’t.

We live in an age of information overload so don’t get bogged down on too much detail. Everyone will have a different story on where the currency is going and why. Form your own view on the basis of your own business. If you are unprofitable at a certain level then make sure you have as much cover as possible if it gets close to those key rates. If you know your competitor is covering everything on a short term basis you might need to reflect this in your own policy.

It is also really important to keep an accurate record of your positions and hedges. Not just for yourself to make the right decisions but also to easily report where you are to senior management. For whatever reason everyone seems to have a view on where the currency is going and happy to tell you when you get it wrong. Having good controls and recording mechanisms in this area will give others in the organisation confidence in the way you are managing a sensitive part of the business. They might just ask a few less questions too!

I am not saying currency hedging is easy, far from it, but it shouldn’t keep you up at night either if you follow some basic guidelines and principles.