To hedge or not to hedge has always been a vexing question for corporate treasurers, but recently it’s got more difficult still. The imminent arrival of accounting standard IAS 309 in Europe, together with the recently introduced FA 133 across the Atlantic, is forcing treasurers to demonstrate that hedges relate to real underlying exposures, be they currency, interest rate or commodity.
That’s chipping into the volume of derivatives bought by corporate customers; little surprise, then, that investment banks are fighting back. In January JPMorgan launched HEAT (Hedge Effectiveness Analysis Toolkit), an analytical and software package aimed at helping companies pass “hedge effectiveness tests.”
These tests track movements of a hedged item and those of the hedging vehicle—and whether they offset each other so that any overall change to the package is negligible. If a derivative can be shown to iron out risk in this way, the hedged liability or asset can be marked to market, which smooths out reported earnings volatility for a company.
Nina Littler, head of Northern European derivatives marketing at JPMorgan in London, says that using HEAT will enable companies to deploy derivatives on economic grounds, rather than be skewed by accounting guidelines.
The bank argues that the new accounting regulations may mean that some companies are dissuaded from using more complex derivatives to manage their underlying risk exposures. A company’s actual business interests may be sidelined by concerns over how it should keep its books.
HEAT guides treasurers in choosing an appropriate methodology and addresses when hedge accounting treatment may be undesirable. Users can evaluate the assessment of a hedging relationship, assess the likelihood of hedge accounting treatment being accepted and calculate the impact on earnings if hedge accounting is not obtained. That’s likely to make it easier for treasurers to step back into the world of complex derivatives.