Outlining Hedge Accounting for FX Option – Group Ledger IFRS (2RW)

The Hedge Management and Hedge Accounting process helps you to mitigate profit and loss volatility from the use of derivatives.

Currently the scope item supports IFRS 9 and covers Cash Flow Hedge using European Style FX Option as Hedging Instruments.

The functionality helps you to automate labor-intensive processes, such as calculating net open exposure amount, creating hedging relationship for hedge item and hedge instrument, determining the key figures calculation (NPV, Intrinsic Value, Time Value, CCBS, CVA/DVA), performing the valuation of FX transactions, checking classification, processing balance sheet crossover, dealing with the de-designation, and generating posting journal reports.

The main process flows covered by the Hedge Accounting for FX Option supporting IFRS 9 include the definition of hedging areas based on the hedging policy. The scope item supports the upload and release of forecast and planning data as well as the determination of net open exposure to make hedging decisions.

You will be able to execute FX transactions and to prepare and release designation. Further functionality includes the determination of Net Present Value, executing valuation, and classification at period end plus the de-designation and reclassification at contract close and the accompanying postings.

The Treasury department is responsible for executing a given hedging policy for hedging the risk of forecast cashflows in foreign currencies of future periods. The forecast itself is represented as exposures in the Hedge Management Cockpit. A snapshot is taken for the forecast exposures from Exposure Management. Based on the snapshot, the net open exposure amount, risk currency and period are detailed in the Hedge Management Cockpit. Based on rules of the hedging policy, the net open exposures are reduced by trading financial instruments such as a FX option.

In case of expected inflows of a risk currency, the resulting exposure shall be closed by a FX option whose underlying spot transaction sells the inflow currency and buys the local currency of the company code; where there are of expected outflows of risky currency, a FX option is traded whose underlying spot transaction buys the outflow currency and sells the local currency.

With the creation of the FX option contract, the financial transaction is automatically designated into a hedging relationship as a hedging instrument together with the exposure item of the Hedge Management Cockpit as the hedged item. The matching exposure item is determined based on characteristics of the hedging instrument, for example, hedging classification, foreign currency of underlying FX Spot Transaction, exercise of FX option. At the same time, the hypothetical derivative is created and all necessary mathematical evaluations necessary for the measurement of effectiveness are performed and stored.

At period end, the determination of NPVs, including the decomposition of market values for the hedging instrument and the hypothetical derivative is performed, and the key date valuation of the FX option transactions is executed. Meanwhile, the measurement and postings of the Hedging Reserve (OCI I), Cost of Hedging Reserve (OCI II) and ineffectiveness are executed on the exposure subitem level. The period end close can be executed using two different procedures: valuation and classification with reset or without reset.

At the balance sheet recognition date, the reclassification flows are automatically created; depending on the rule that was set in the hedging area definition, the reclassification flows are posted immediately or at the exposure subitem end date.

At the expiry date of the FX option transaction, the FX option can be exercised or expired. The cumulated hedging reserve and cost of hedging reserve amounts are classified as frozen. At the end date of the exposure subitem, the cumulated hedging reserve and cost of hedging reserve amounts are to be reclassified to profit or loss as a reclassification adjustment.

This section can be executed using the following product type as hedging instrument: 76A: OTC Currency Option.

Use the Define Hedging Area app to create a new hedging area for your company.

The hedging area is an entity that represents a section of hedging policy of the company. The creation of a hedging area is a necessary requirement to start the process of hedge management and hedge accounting. It is the central steering entity that contains all relevant settings for this process. It is fully versioned and certain changes are only allowed in a new version or a new hedging area.

A company can have multiple hedging areas for hedge accounting according to its hedging policy. However, a hedge accounting relevant hedging classification can only be assigned to one hedging area for hedge accounting, therefore creating additional hedging areas requires you to define additional hedging classifications.

The Number of Periods and Period Length fields define the time buckets that will be shown in the hedge management cockpit for exposure and hedging instrument data.

The Absolute Time Pattern flag allows definition of fixed periods. The number of periods in this case starts with the valid from date of the hedging area version. In case of a relative time pattern, the number of periods starts with the key date of the hedge management cockpit.

The hedging area controls which data (exposures and hedges) is shown and how they are presented in the Hedge Management Cockpit.

Hedge Accounting I and Hedge Accounting II control how designation works.

Several hedging classifications can be defined to the same hedging area. A hedging classification that is hedge accounting relevant can only be assigned to exactly one hedging area. The hedging classification is a mandatory entry for a hedging instrument if it shall be designated automatically. Hedging Relationship Scenario and Hedge Accounting Rule are entities that are defined by SAP.

• Hedging Relationship Scenario: describes a specific use case of a Hedging Relationship.

• Hedge Accounting Rule: how the amounts of Hedging Reserve and Cost of Hedging Reserve are calculated.

Eight hedging classifications are pre-defined for IFRS 9 Cash Flow Hedge of FX risk by using FX Options (includes plain vanilla FX option, zero/low cost collar FX option).

The hedge classification should be always bundled with a related hedging profile when maintaining the tab Hedge Accounting II of a Hedging Area.

The enhancement for the new type of reclassification depends on the company code and distinguishes the reclassification of hedging reserve and cost of hedging reserve amounts which were classified for the hedging relationship up to and equal to the balance sheet recognition date.

Balance Sheet Recognition ID: 3

The classification result between the designation date and balance sheet recognition date is frozen until the Deviant Reclassification Date = Due Date of Hedging Instrument + DIO (Days Inventory Outstanding) - Payment Term.

You can use the Process Raw Exposures app to manually create, change, release, and delete raw exposures.

Each time you save a raw exposure, a new version is created. Version 000 is always the current version of the raw exposure. In display mode, you can switch between the different versions of the raw exposures.

If you select a line item on the Line Item Data tab, the system displays the related sub raw exposures at the bottom of the screen. You can view the flows created for each sub raw exposure in the Display Exposure Position Flows app.

On the Line Item Data tab, choose a due date that is in the future and that fits the definition of the reporting time pattern in the hedging area. Enter the amount and currency (use "-" for outgoing amounts) to the line item. Besides manually keying in a raw exposure, you can also import raw exposures from a spreadsheet.

Use the Take Snapshot app to take a snapshot of the exposure data belonging to a specific hedging area.

For the subsequent process of hedge management and hedge accounting, it is mandatory to rely on fully versioned data. This ensures that at all times an auditor can check which data served as the basis for a hedging decision. Taking a snapshot will "link" the raw exposures to a hedging area. The link is exclusive, meaning one exposure can be linked only to one hedging area.

A snapshot can be used only for hedge management purposes or for both hedge management and hedge accounting purpose (Day Reference should be selected).

The selected incoming or outgoing exposures and the exposure items are saved on the database, and can be reviewed in the Hedge Management Cockpit app .

You can review key figures in the Hedge Management Cockpit app by using predefined layout 1R_ALL_CH. These are incoming exposures and outgoing exposures. Furthermore, you will find the net exposure, net hedges, hedged rate and the hedge quota [%].

Different standard layouts are provided. Alternatively, you can define your own layouts.

Drill-down to a more detailed level is possible.

When creating a FX option transaction, you can set attributes for the forward transaction in order to determine the exposure item of the relevant exposure snapshot (of a valid hedging area version).

These include, for example, the company code, valuation area, currency or the Buy/Sell indicator.

After entering the hedging classification, the Hedge Accounting indicator is set.

When saving the deal, the automated designation is triggered in case an appropriate exposure item can be determined from the snapshot.

Navigation to the hedging relationships is available with the designation after the deal is saved.

For the automated designation, use the Manage Hedging Relationships app.

With the automated designation, different entities are created automatically to enable hedge accounting processing for exposure items. These are hedging relationship, hedged item and hedging instrument.

The hedging relationship status is initially Planned Designation. After releasing designation via the Release Hedging Business Transactions app, the status will become Designation.

The automated designation of a FX transaction into a hedging relationship is prevented if the calculated balance sheet recognition date is earlier than or on the same date as the designation date (contract date), and the portion of the FX transaction is processed as freestanding position.

In the Process Hedge Requests app, a released dedesignation request can be withdrawn.

A withdrawn dedesignation request cannot be released again.

If the dedesignation business transaction has been released (which means the next step, Process Dedesignation for Hedging Business Transaction, has been executed), the dedesignation request cannot be withdrawn unless you reverse the release of the dedesignation business transaction via the Reverse Release of Hedging Business Transactions app.

Using the Calculate Net Present Values app - with CVA and DVA, you can calculate NPVs for transactions with positions in parallel valuation areas. The net present values are calculated by the price calculator and are saved in the NPV table. These values can then be applied in parallel valuation.

You can also calculate the net present values including credit and debit value adjustments for individual financial transactions.

From an integration point of view, the results of the calculation are stored in the NPV table at the level of the financial transactions, and you can display the results using the Enter Net Present Values app.

The hedge accounting key figures are calculated as 100 percent of FX transaction and hypothetical derivative. Components of hedge accounting relevant key figures are Spot, Forward, CCBS and others.

You use the Run Valuation app to perform a key date valuation for the selected valuation-area-dependent treasury positions.

After setting the selection criteria and valuation parameters, the system evaluates the selected positions and posts the corresponding valuation flows.

When you perform a key date valuation, the system sets an internal block to prevent operational business transactions that affect position amounts from being created before the valuation key date when the valuation has not been reversed previously.

The key date valuation can be executed at period end with reset or without reset. The selected procedure determines how the valuation is executed.

The classification of FX transactions that are designated into one or several hedging relationships is executed using the Run Classification app at period end.

With the execution of classification, the designated exposure subitem positions of the hedging relationship are selected and relevant classification amounts are calculated according to settings of the hedge accounting rule.

At the balance sheet recognition date, you run the Release Hedging Business Transactions app. The app performs, for example, the calculation and saving of NPV of FX transaction, the calculation and saving of NPV component values for FX transaction and hypothetical derivative. The posting of key date valuation of the designated portion of the FX transaction with actual NPV values is also possible, as is the posting of classification of the selected hedging relationship with actual NPV component values.

The Release Hedging Business Transactions app also updates the amounts of reclassification update types and fixes scheduled reclassification update types.

Two options are provided for the reclassification of balance sheet crossover. They are maintained in the Balance Sheet Recognition field in sub-area Designation Splitting on the Hedge Accounting I tab of the hedging area:

• 1 - Immediate Reclassification at Balance Sheet Recognition Date.

• 2 - Reclassification at the End Date of the Exposure Subitem: the classification result between Designation Date and Balance Sheet Recognition Date is frozen until end date of the Exposure Subitem.

This step is only necessary when you do balance sheet crossover. That means you gave value 1 or 2 for the Balance Sheet Recognition field in sub-area Designation Splitting on the Hedge Accounting I tab of the hedging area, and you can see the Bal.Sheet Rec.Date on the Hedging Relationship Detail tab of the hedging relationship as described in step Automatic Designation (Planned).

At the maturity date (expiry date) of the FX option transaction, you also run the Release Hedging Business Transactions app. At this point the system performs the calculation and saving of NPV of the FX transaction and the calculation and saving of NPV component values for FX transaction and hypothetical derivative.

The transfer of position amounts from designated to free-standing subposition or the amount update of reclassification update types is executed by the app at the maturity date.

The reclassification of the hedging reserve and cost of hedging reserve position amounts is executed at the end date of the exposure subitem within the derived business transaction framework: the Post Derived Business Transactions app for the fixation and posting of derived business transactions selects the exposure subitem position flows to be reclassified.

Postings are created for reclassification of hedging reserve and cost of hedging reserve position amounts; P/L ineffective position amounts are fixed only.

This step creates postings only when the relevant split ID on tab Hedge Accounting I of the hedging area uses the following parameters for the field Balance Sheet Recognition:

• 0 or blank – None. The accumulated hedging reserve and cost of hedging reserve between designation date and de-designation date are reclassified at the end date of exposure subitem.

• 2 – Reclassification at the end date of the exposure subitem. The accumulated hedging reserve and cost of hedging reserve between designation date and balance sheet recognition date are reclassified at the end date of exposure subitem.

If 1 (immediate reclassification at balance sheet recognition date) is given for the Balance Sheet Recognition field, reclassification has been done at the balance sheet recognition date by using the Release Hedging Business Transactions app.

The figure explains the effectiveness of a Hedging Relationship.

To prove the effectiveness of a hedging relationship, a prospective effectiveness test is performed at the time of designation. If this test fails, the hedging relationship is not effective and therefore must not be designated. To this end, the total NPV and market value components are calculated at designation date using various alternative market data (representing different possible future market date constellations). This could be artificial market data or historical market data. For each alternative market data the change in the values of the designated components is compared between the hedging instruments and the hypothetical derivative. The change in the values for all alternative market data is finally the basis for the linear regression which should in case of an ideal hedge result in a slope close to minus 1.

The figures, Effectiveness Using Linear Regression by Market Data and Effectiveness Using Linear Regression by Market Data II, show the effectiveness calculation using linear regression based on changes of the designated market value components caused by alternative market data.

First, define a number of market data scenarios (using the Manage Market Data Set app). A single market data scenario contains self-contained market data, either an artificial one or loaded from historical market data. Use version dependency of the market data set to exchange assigned market data scenarios.

Maintain a simple Date Determination Rule to define a list of historical dates relative to the evaluation date (designation date) used for market data selection. There is no need to maintain market data scenarios using transaction TV21 containing historical market data.

On the Hedge Accounting II tab, the market data set can be assigned along with the hedging profile to a combination of company code, valuation area and hedging classification. During the creation of a hedging relationship the market data set is included in the generated test plan.

On the Effectiveness Test tab, in the Test Plan area, you see the generated test plan. It contains the market data set derived from the hedging area settings. The first record is the basis for the prospective effectiveness test (PET) performed at designation.

The selection screen is not affected by the PET. The system will automatically perform the PET for hedging relationships which fulfill the following conditions: A business transaction of type designation or swap transfer is performed. In the settings of the hedging profile the PET is enabled (see the corresponding customizing figures). A test plan has been generated containing a record for the designation (swap transfer) date and a market data set.

The figure shows the result of the effectiveness test.

Select the Manage Your Solution app in order to navigate to the Configuration screen.

The Configure Your Solution task will give you the possibility to maintain certain processes.

The hedging classification is an entity that is used in hedge management and accounting.

If the hedging classification is active for hedge accounting, this information is relevant for the automated designation process. Using the data from the financial transaction including the hedging classification the system can identify the relevant hedging area version and the relevant exposure item so the hedged item, hedging instrument, hedging relationship and the planned designation flows can be created according to your settings for the hedging area.

This process helps you to mitigate profit and loss volatility from the use of derivatives.

Currently, the scope item supports local GAAP and covers Cash Flow Hedge using European Style FX Option as hedging instruments.

The functionality helps you to automate labor-intensive processes, such as calculating net open exposure amount, creating hedging relationship for hedge item and hedge instrument, determining the key figures calculation (NPV, Intrinsic Value, Time Value), performing the valuation of FX transaction, checking classification, dealing with the dedesignation, and generating posting journal reports.

You use the valuation function to evaluate the positions of FX transactions based on the previously calculated NPVs, and transfer results to financial accounting. All together you will be enabled to make better operational and strategic decisions using the comprehensive reporting and analysis tools of SAP S/4HANA Cloud.

The key process flows that are covered within this scope item range from the definition of the hedging area based on hedging policy to the upload and release of forecast and planning data.

The scope item helps you to determine the net open exposure in order to make hedging decision. From here execute FX transactions, prepare the designation of those and finally prepare and release designation, determine NPV, execute valuation and classification at period end.

Use the interactive graphic to learn more about the purpose of the FX Option for Local GAAP.

Use the Define Hedging Area app to create a new hedging area for your company. 

The hedging area is an entity that represents a section of hedging policy of the company. The creation of a Hedging Area is a necessary requirement to start the process of Hedge Management and Hedge Accounting. It is the central steering entity that contains all relevant settings for this process. It is fully versioned and certain changes are only allowed in a new version or a new hedging area.​

A company can have multiple Hedging Areas for Hedge Accounting according to its hedging policy. However, a hedge accounting relevant Hedging Classification can only be assigned to one Hedging Area for Hedge Accounting, therefore creating additional Hedging Area means the necessity of defining additional Hedging Classifications. 

The Hedging Area controls how data is presented in Hedge Management Cockpit and also how snapshots for exposure data are taken.

For Hedge Accounting Processing the Risk Free Currency is set to Local Currency.

The Reporting Time Pattern defines the number of periods and the period length of the time buckets that will be shown in the Hedge Management Cockpit for exposure and hedging instrument data.

The Target Quota defines key figure determination in the Hedge Management Cockpit.

Within the definition of the hedging area you can set filters for exposures and filters for hedges.

Filters for Exposures

• At least one filter has to be defined to have exposure data available in the Hedge Management Cockpit.
• Entries in the attributes of the filter specify the selection criteria for data of the Exposure Source System (that is, Exposure Management 2.0)
• Data from several filters is merged according to the definitions in the differentiation criteria

Filters for Hedges

• At least one filter has to be defined to have Hedging Instrument data available in the Hedge Management Cockpit.
• Entries in the attributes of the filter specify the selection criteria for the source system of Hedging Instruments (that is, Transaction Manager for FX Forward and FX Options)
• Data from several filters is merged according to the definitions in the differentiation criteria

The definition of the hedging area consists of several steps in the SAP S/4HANA Cloud system. The definition of the tabs Hedge Accounting I and Hedge Accounting II is of importance to the overall process.

The following are defined in the Hedge Accounting I tab:

• Designation Level:
• Per Company Code and Valuation Area it is defined at which level it shall be designated.
• The activation of splitting opens another table which influences the attributes of the Hedging Relationships (for example, due date of hypothetical derivative, OCI reclassification date, off/on balance crossover).
• Designation Activation:
• Hedge Accounting can be activated per Company Code, Valuation Area and Currency. If activated the automated designation process is switched on.

In the Hedge Accounting II tab the following are defined:

• The Designation Type controls how instruments are treated during designation.
• The Hedging Profile is a central customizing entity of Hedge Accounting for Positions which holds information about how to process Hedging Relationships.
• With the creation of a hedging relationship the Market Data Set is included in the generated test plan and defines what market data is used for effectiveness testing.

Use the Take Snapshot app to take a snapshot of the exposure data belonging to a specific hedging area.​

For the subsequent process of Hedge Management and Hedge Accounting, it is mandatory to rely on fully versioned data. This ensures that at all times an auditor can check which data served as the basis for a hedging decision. Taking a snapshot will link the Raw exposures to a Hedging Area. The link is exclusive, meaning one exposure can be linked only to one hedging area.​

A snapshot can be used only for Hedge Management purpose or for both Hedge Management and Hedge Accounting purpose (Day Reference should be selected)​.

The selected incoming or outgoing exposures and the exposure items are saved on the database, and can be reviewed in Hedge Management Cockpit app.

Subsequently, use the Create FX Spot / Forward Fiori app to create your needed financial transactions. Use the General Valuation Class 45 - Derivatives Cash Flow Hedge and the Hedging Classification YFC24 - FX Risk, CFH, Vanilla.

Use the Release Hedging Business Transaction Fiori app to perform the designation for your FX Forward transaction. The status of your Hedging Relationship in Manage Hedging Relationship app will change from 05 - Designation planned to 03 - Designated.

Check the Hedge Accounting Key Figures and the Market Value Decomposition using the Calculate Net Present Value - with CVA and DVA app.

From an integration point of view, the results of the calculation are stored in the NPV table at the level of the financial transactions, and you can display the results using the Enter Net Present Values app.

You use the Run Valuation app to perform a key date valuation for the selected valuation area dependent treasury positions.

After setting the selection criteria and valuation parameters the system values the selected positions and posts the corresponding valuation flows.

When you perform a key date valuation, the system sets an internal block to prevent operational business transactions that affect position amounts from being created before the valuation key date when the valuation has not been reversed previously.

If you use the Run Classification app the following Hedge Accounting postings are performed:

• Postings are done on Exposure Subitem level for the designated portion of the FX Transaction based on calculated key figures at period end
• Hedging Reserve according to actual value
• Cost of Hedging Reserve according to actual value
• Amortization of forward points
• P/L ineffective
• The Financial Accounting Document Header is populated with Hedging Relationship, Exposure Item and Exposure Subitem

At maturity, you can either exercise or expire the FX option by following the steps in 1X1.

From the Process FX Options Collective Processing Report app you can decide to exercise the option and the payment request processing is started in the background.

It is also possible to create FX Spot Contract with a subsequent posting of realized profit and loss.

From the Process FX Options Collective Processing app you also have the option to change or expire.

When you dedesignate the Hedging relationship, SAP S/4HANA Cloud will calculate the following Hedge accounting data with the latest market data value:

• Hedging Reserve according to actual value

• Cost of Hedging Reserve according to actual value

• Amortization of premium

• P/Lineffective