In previous newsletters, we already drew attention to the current significance of exchange rate and commodity price developments. For example, copper prices have more than halved since their all-time high in 2011 of more than USD 10,000/tonne and experienced significant price jumps in the meantime. Similar developments were observed for other non-ferrous metals as well as many other commodities, such as oil and wheat. Apart from reliable exposure measurement and a coordinated hedging strategy, one of the questions that continuously arises is how individual hedging strategies should be presented in separate financial statements and other regulatory frameworks.
Some Treasury departments issue fixed exchange rate or price commitments for group companies for the optional request of quotas. Controlling such commitments should always be assessed also with a view to various issues that are not evident from the consolidated financial statements.
If there are fixed price or volume commitments for the future, which have to be physically retrieved, the foreign currencies involved usually are derivatives. On the other hand, commodity quotas are usually considered executory contracts, both in accordance with commercial law and IFRS. These pending transactions must be assessed in individual financial statements prepared according to German GAAP for contingent losses, and under IFRS in terms of provision for onerous contracts as defined by IAS 37.68. Specific measurement of such commitments differs under these two GAAPs.
However, in the case of fixed price or volume commitments, which can also be settled in cash, the instruments involved are always derivatives (IAS 39.9). This also applies when the retrievable amount has been determined, however the request itself is at the discretion of the party involved (optional).
Some Treasury departments make exchange rate or commodity price commitments to group companies, which apply until retracted and cannot be determined in terms of volume. These exchange rate or price commitments, while applicable, can be requested both as spot transactions and futures transactions. This means that individual requests of these commitments still apply, even if another group exchange rate has already been issued for new requests. Both under German GAAP and IFRS, the commitment itself is initially a contract provisionally ineffective or subject to condition precedent, which does not have to be recognised. However, as soon as a rate commitment is fixed for a future date in terms of price and volume, for example by a specific request (e.g. + USD 10 million; - EUR 8 million on 15 June next year), an internal derivative is formally created. In addition, they can also be requested as spot transactions. In such a case, no internal derivatives are created.
For such commitments, the next question is how and when Treasury can recharge the external derivatives required for the rate commitment to subsidiaries. This applies in particular when entities of various tax consolidation groups are affected or hedge accounting is to be used in line with IFRS separate financial statements (e.g. Dutch GAAP).
If the fair market value of existing external derivatives is not recharged until the end of the year for contractual reasons, an internal derivative not in line with the market is formally created. The forward rate for this internal derivative will most likely not be in line with the current market forward rate. The issue of such a derivative instrument may have to be recognised (in IFRS separate financial statements) as a deposit or withdrawal by the shareholder. A similar interpretation may be required for tax purposes, so that it may be necessary to recognise intangible assets at fair market value without a cost component.
On the other hand, external derivatives should be recharged to subsidiaries by creating internal derivatives before there is a fair market value for the internal derivatives (i.e. simultaneously with external derivatives). This issue is relevant primarily with regard to its interplay with the European Market Infrastructure Regulation (EMIR). According to this regulation, internal derivatives have to be reported to a trade repository within two working days. This means that internal derivatives cannot be created retroactively as at the monthly or year-end closing date, but a daily handling process is required.
Alternatively, profit contributions of external derivatives also do not have to be recharged to the relevant subsidiaries of the group. However, in that case, the company of the Treasury department concerned then does not usually have information about the hedged item for the purpose of separate financial statements External derivatives therefore have to be recognised without the use of hedges or hedge accounting.
The hedging strategy should be carefully analysed at regular intervals for its effects on the consolidated financial statements, but also on the separate financial statements, tax accounts and for other compliance issues (EMIR). This is the only way to ensure compliance with framework conditions and their proper use.
Source: KPMG Corporate Treasury News, Edition 50, December 2015
Author: Felix Wacker-Kijewski, Manager, firstname.lastname@example.org
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