SVB Online · PDF fileSVB Online Seminar Foreign Exchange Hedging & FAS 133 (ASC 815): What...
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SVB Online Seminar Foreign Exchange Hedging & FAS 133 (ASC 815): What You Must Know November 9, 2010
Transcript of SVB Online · PDF fileSVB Online Seminar Foreign Exchange Hedging & FAS 133 (ASC 815): What...
SVB Online SeminarForeign Exchange Hedging & FAS 133 (ASC 815): What You Must KnowNovember 9, 2010
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Today’s Speakers
• Silicon Valley Banko Paul Jennings, Senior International Advisor
o Drew Devine, International Advisor
• Ernst & Youngo Robert Royall, Partner
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Agenda
• Client Feedbacko Thoughts on international expansion
• Market Updateo Hedging in today’s volatile market environment
• Strategy Overviewo Four common hedging tools
• Hedge Accountingo Understanding and applying FAS 133
International Expansion and Today’s Market
Paul JenningsSenior AdvisorGlobal Financial Services GroupSilicon Valley Bank
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Client Feedback
• International presence criticalo Growing sales and collaborations in new marketso International investment and research
• Pressure from customers and business partners to price in local currencyo Pricing in USD does not eliminate FX risk- it is transferred to your counterpartyo Eliminate hidden costs and allowances for market volatility
• Need to manage risk and maintain profit marginso When is the right time to look at a hedging strategy?o What products should I use to manage the risk?
• Reluctance to tackle the perceived complexities of accounting requirements
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Market Update
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• FX markets are volatile
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Market Update
• Successful hedging strategieso Consistent
o Flexible
o Simple
Four Common Hedging Tools
Drew DevineInternational AdvisorSilicon Valley Bank
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Strategy Overview
• Clients value simplicity, flexibility and transparency
• Four fundamental hedging strategieso Forward or Window Forward Contract
o Vanilla Option
o Participating Forward
o Zero-Cost Collar
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Strategy Overview
• Forward or Window Forwardo Key Features: Certainty and timing flexibility
• 100% protection at pre-determined rate• No participation in favorable market moves• No upfront premium
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• Pricing Parameterso Hedger Buys Euro 1 m/Sells USDo Maturity Date: 02/01/2011o Reference Spot: 1.3900o Protection Rate: 1.3875
1,250,000
1,300,000
1,350,000
1,400,000
1,450,000
1,500,000
1.27751.32751.38751.4675
EUR/USD Spot Rate
USD Cost of Purchasing EUR 1,000,000
USD Cost Fixed at $1,387,500
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Strategy Overview
• Vanilla Optiono Key Features: Certainty, unlimited participation, no obligation to execute
• 100% protection at pre-determined rate• Unlimited upside• Upfront premium required
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• Pricing Parameterso Hedger Buys Euro 1 m/Sells USDo Maturity Date: 02/01/2011o Strategy: Buy Euro Call Optiono Reference Spot: 1.3900o Protection Rate: 1.3875o Premium: $38,000
1,300,000
1,320,000
1,340,000
1,360,000
1,380,000
1,400,000
1.33001.38751.4400
EUR/USD Spot Rate
USD Cost of Purchasing EUR 1,000,000
USD Cost Fixed above 1.3875
Execute at more favorable Spot Rate
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Strategy Overview
• Participating Forwardo Key Features: Certainty and partial participation in favorable market moves
• 100% protection at pre-determined rate• Participation in favorable market movements (typically structured as 50% participation)• No upfront premium
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• Pricing Parameterso Hedger Buys Euro 1 m/Sells USDo Maturity Date: 02/01/2011 o Reference Spot: 1.3900o Protection Rate: 1.4150o Participation Level: 50%
1,375,000
1,385,000
1,395,000
1,405,000
1,415,000
1.36001.41501.5000
EUR/USD Spot Rate
USD Cost of Purchasing EUR 1,000,000
USD Cost Fixed above 1.4150
Hedger Participates in 50% of the favorable market move
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Strategy Overview
• Zero-Cost Collaro Key Features: Certainty and complete participation to pre-determined maximum rate
• 100% protection at pre-determined rate• Participation in favorable market movements up to pre-determined maximum rate• No upfront premium
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• Pricing Parameterso Hedger Buys Euro 1 m/Sells USDo Maturity Date: 02/01/2011o Reference Spot: 1.3900o Protection Rate: 1.4600o Maximum Rate: 1.3150
1,300,000
1,350,000
1,400,000
1,450,000
1,500,000
1.30501.31501.46001.4750
EUR/USD Spot Rate
USD Cost of Purchasing EUR 1,000,000
USD Cost Fixed above 1.4600
Execute at Spot rate
Participation Capped at 1.3150
Foreign Exchange Hedging and ASC 815 (formerly FAS 133)
Robert Royall, Ernst & YoungPartner, Financial Accounting Advisory Services
9 November 2010
Presenter
Presentation Notes
For information on applying this template onto existing presentations, refer to the notes on slide 2 of this presentation. The Input area of the Beam can be customized to reflect the content of the�presentation. The Input area is an AutoShape with a picture fill. To change this, ensure you have the image you wish to use (ideally a .jpg or a .png file) in an accessible folder. The image should have a ratio of 1:1 to ensure it does not appear distorted. Acceptable images for importing into the Input area of the Beam are the three approved graphics (lines), and black and white photography or illustrations which follow the principles laid out on The Branding Zone. Color images should never be imported into this area. To create a thank you slide with a picture in the Input area of the Beam, duplicate this master slide and create a new master slide. If using the graphic on the title slide the same should be used on the thank you slide. If using a picture in the Input area of the Beam in the title slide, the same or different but related picture can be used on the thank you slide. Customize the Input area of the Beam as described below. Click on the View tab from the menu bar and select Master>Slide Master Right-click on the Input graphic and select Format AutoShape From the Fill menu, under the Color and Lines tab, click on the drop-down arrow next to Color and select the Fill Effects menu From the Picture tab, click on Select Picture. Navigate to the folder containing the image you wish to insert in the Input area. Highlight the image and tick the Lock picture aspect ratio box. Click on OK. You can now preview the image before continuing. If you are happy with how it looks, click Ok to continue. Otherwise, repeat the process until you are happy with your selected image To exit from Master View, click on View>Normal. The change you made to the Input graphic should now be visible on the title slide
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Hedge Accounting is Elective
► Regular accounting is fair value through earnings --- many companies are OK with this
► Cash flow hedge accounting defers change in fair value of the derivative to “Other Comprehensive Income”► Gain or loss on derivative is reclassified to earnings later when the
hedged transaction affects earnings
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Hedge Accounting Must Be Qualified For
► Criteria for the hedged transaction:► Hedged transaction must be probable of occurring► Hedged transaction must be specifically identified as a particular
cash flow or series of cash flows, with expected timing specified► Forecasted transaction cannot be a business combination
(acquisition of another company)► Operating unit that has the foreign currency exposure must be a
party to the hedging instrument (or another member of the consolidated group with the same functional currency as the operating unit).
► The hedged transaction is denominated in a currency other than the hedging unit’s functional currency
► Forecasted transaction cannot be a netting of an inflow and an outflow
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Hedge Accounting Must Be Qualified For
► Criteria for the derivative:► Must be highly effective in offsetting exposure to variability in
expected future cash flows that is attributable to the foreign currency risk (as defined relative to the operating unit’s functional currency) both at inception of the hedge and on an ongoing basis, reassessed at minimum every three months
► Cannot be a written option► Cannot be a collar that is asymmetrical (as evidenced by a receipt
of premium or a written option notional that exceeds a purchased option notional)
► Purchased options, forwards, and zero cost collars generally qualify
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Hedge Accounting Must Be Formally Documented
► Must be formally documented as a hedging instrument in a specific relationship with the hedged transaction:► Entity’s risk management objective and strategy for undertaking the
hedge, including specific identification of the nature of the risk being hedged (e.g., “risk of EUR fluctuation against USD for the first 5,000,000 EUR of sales in French market probable of occurring on February 1 or thereafter”)
► How the derivative’s effectiveness in hedging the FX element of the hedged transaction’s variability in cash flows will be assessed (Statistical approaches? Qualitative approaches?)
► How the ineffectiveness of the derivative will be measured:► Change in variable cash flows method ► Hypothetical derivative method (most common)► Change in fair value method
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Hedge Accounting Choices for Forwards
► Entity can choose whether to document its risk as locking in today’s spot exchange rate or tomorrow’s forward exchange rate
► Lock-in spot: spot rate/forward rate differential is expensed as ineffective portion of the hedge over the life of the forward as the spot and forward rate converge over time. ► Pro: Helpful strategy if timing of hedged transaction is somewhat
uncertain► Con: Additional volatility in earnings due to fluctuation of the changes
in the spot/forward difference► Lock-in forward: spot rate/forward rate differential is considered
part of the hedge and effective; the differential goes to OCI and is expensed when sales occur► Pro: Not a source of earnings volatility during the hedge► Con: If hedged cash flow doesnt occur on same date as forward
matures, there will be some ineffectiveness at maturity
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Hedge Accounting Choices for Purchased Options and Zero Cost Collars
► Entity can choose whether to formally document its assessment of hedge effectiveness as based on either:
► Changes in the option’s intrinsic value: changes in intrinsic value are recorded in OCI, while changes in time value are recorded in earnings► Pro: Helpful if desire is to “expense” the option premium in a separate
income statement line-item► Con: Cannot straight-line the expense; time value changes are
volatile and irregular► Changes in option’s entire fair value: all changes recorded in
OCI (“DIG Issue G20”)► Pro: Not a source of earnings volatility during the hedge► Con: Cost of the option (premium paid) is reflected in the line item of
the hedged transaction (for example, sales, expenditures, royalties)
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Purchased Options and Zero-Cost Collars—DIG Issue G20
► Hedge relationship may be considered perfectly effective if:► Critical terms of derivative completely match the related terms of the
hedged forecasted transaction (notional, variable that determines variability of cash flows, expected date of transaction)
► The strike price (or prices) of the derivative matches the specified level (or levels) beyond (or within) which the entity’s exposure is being hedged
► The derivative’s inflows (outflows) at its maturity date completely offset the change in the hedged transaction’s cash flows for the risk being hedged
► The derivative can be exercised only on a single date—its contractual maturity date (e.g., American-style options will not qualify)
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Participating Forwards—eligible for hedge accounting?
► Differing views have been expressed by auditors► Ernst & Young believes they are akin to purchased options and
can use “DIG Issue G20”-style documentation to permit all changes in fair value to be recorded in OCI
► Hedged risk should be described precisely to match the terms of the participating forward
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Questions?
Appendix
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Paul Jennings
Paul Jennings is a senior advisor with the Global Financial Services Group at Silicon Valley Bank. He has 10 years experience in foreign exchange and international cash management. Paul works with SVB clients on all aspects of their global banking needs.
Prior to SVB, Paul worked with Anglo Irish Bank in Boston where he led the Private Equity Treasury Group and developed strategy for FX sales in North America. Paul also established and led the Anglo Irish Bank U.S. deposit business.
Paul is a Board Member of the Boston Irish Business Association (BIBA) and the Environment and Energy Committee of the British American Business Council (BABCNE). Paul is a business graduate of the University of Ulster in Ireland.
Sr. Advisor, Global Financial Services GroupSilicon Valley Bank [email protected]
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Drew Devine
Drew Devine is a foreign exchange advisor for Silicon Valley Bank’s global financial services group, based in Boston, MA. He has eight years of experience in foreign exchange services, including trading and sales positions at State Street Bank and Investors Bank and Trust.
In his current role, Devine works with clients to manage and hedge the foreign exchange exposure that arises from doing business internationally. He is also a prolific writer and regular contributor to Silicon Valley Bank’s Investment Strategy Outlook newsletter.
He holds a masters of business administration degree from Boston University.
International AdvisorSilicon Valley [email protected]
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Rob Royall
Robert L. Royall is a member of Ernst & Young LLP's US Professional Practice Department in New York, focusing on accounting for derivatives, hedging activities, and financial instruments for the past thirteen years. Rob has followed the development and amendments of Statement 133 from its infancy as a FASB project, and now serves on the FASB's outside advisory body, the Derivatives Resource Group (formerly known as "the DIG"). In that role, Rob has been an active participant in the FASB comment process and in working with the SEC staff on registrant issues. For Ernst & Young, Rob is the firm's primary consultative resource on all accounting issues involving derivatives and hedging, and he is responsible for maintenance of all of the firm's extensive technical literature related to ASC Topic 815 (formerly Statement 133).
Rob also serves as one of the U.S. representatives on the firm's international Financial Instruments Working Group, which deliberates the accounting under International Financial Reporting Standards for emerging issues and instruments, making recommendations to the firm's IFRS Policy Committee.
Rob has been with Ernst & Young for over 25 years, working in the audit practice in the Houston office for the first 13 years, focusing on the financial services industry, including commercial banking, insurance, and asset management. When moving to the National office in 1997, Rob began working with clients in all industry sectors as they sought guidance on financial instruments issues.
Rob is an MBA graduate of Rice University's Jones Graduate School of Business (1984). Rob also received his BA from Rice University. Rob attained the designation of Chartered Financial Analyst in 1996 and is a member of the CFA Institute. Rob is a Certified Public Accountant in the states of Texas and New York.
Partner Financial Accounting Advisory ServicesErnst & YoungRobert. [email protected]
Presenter
Presentation Notes
It is possible to apply this template to exiting presentations. Have the latest presentation template open Click on the View tab and select Normal Delete all unwanted slides Click on the Insert tab from the menu bar and select Slides from Files Click on Browse. Navigate to the presentation you wish to update with the new template. Highlight the presentation and click Open Wait for the slides from the presentation to load and click on Insert All. Then click Close Check the inserted slides to ensure that the most appropriate master slide has been used on each slide To change the master applied to a slide select the slide you wish to apply a different master to then click on the Format tab from the menu bar and select Slide Design From the Used in This Presentation section choose the master you wish to apply to the slide and hover over it to reveal a drop-down arrow. Click on the arrow and select Apply to Selected Slides It is important to thoroughly check the presentation to ensure that no further formatting is needed.
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Disclosures
This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
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