Outlining Hedge Accounting for FX Swap – Group Ledger IFRS (2UF)

This 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 FX forwards (including NDF) as hedging instruments, and using FX Swap as to transfer hedging instruments from the original exposure period to a new exposure period if an overhedge situation occurs in the original exposure period.

The main process flows covered by the Hedge Accounting for FX Swap 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, execute valuation, and classification at period end plus the de-designation and reclassification at contract close and the according postings.

As a result you will be able to reduce manual operation, such as hedge relationship mapping, designation and classification and make better operational and strategic decisions using the comprehensive reporting and analysis tools.

This section covers the Hedge Management and Hedge Accounting process for forecast cashflows in foreign currencies according to a company's hedging policy, and the hedging instruments are FX forward contracts, and near and far legs in FX swap transactions.

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, 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 forward transaction. In case of expected inflows of a risk currency, the resulting exposure shall be closed by a FX forward that sells the inflow currency and buys the local currency of the company code; in case of expected outflows, a FX forward transaction is traded that buys the outflow currency and sells the local currency.

With the creating of the FX forward transaction, 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 hedged item. The matching exposure item is determined based on characteristics of the hedging instrument, for example, hedging classification, position currency of financial transaction, maturity of financial transaction. At the same time, the hypothetical derivative is created and all mathematical evaluations necessary for the measurement of ineffectiveness 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 forward 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.

With the transfer of forecast cashflow from one exposure period to another exposure period, an overhedge situation occurs for the original exposure period. A FX swap transaction is created based on the information of a swap request to transfer the hedging instrument from the original exposure period to the new exposure period. As a result, the overhedge situation is solved with a FX swap transaction which is processed in the following period end close.

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.

With the maturity of the FX forward transaction, 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.

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, so creating additional hedging areas requires you to define additional hedging classifications.

The number of periods and the period length 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. And in the 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 II controls 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 which 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.

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.

The middle office collects exposure data based on forecast cash flows in risk currencies from various sources, and consolidates the exposure data which should be ready to be entered SAP system as raw exposures. The exposure data should be aggregated in granularity which differentiates the company code, the risk currency and the period in which exposure will be due.

The creation and subsequent release of a raw exposure leads to the creation of a derived exposure position (automatic released).

Besides manually creating the raw exposure, you can also import raw exposures from spreadsheet.

Use the Take Snapshot app to take a snapshot of the exposure data belonging to 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 or for both hedge management and hedge accounting (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.

In this step you use the tile Create FX Spot/Forward, to create a FX forward transaction which is the original hedging instrument before occurrence of overhedge.

Saving the FX transaction with a hedge-accounting specific hedging classification initiates the hedge accounting processing according to the following parameters:

• According to the contract start date and hedging classification, a valid hedging area is determined.
• According to the differentiating criteria (currency, company code, and so on) of the hedging area and by means of the contract start and value date, the exposure item of the snapshot is determined.
• According to the settings of the designation splitting of the hedging area, one hedging relationship or multiple hedging relationships are created.

After the FX transaction is saved, the treasury specialist for the middle office can use the Hedge Management Cockpit app to check the net open exposure again.

In the Hedge Management Cockpit, the amounts of FX transactions will be reflected in corresponding cells for Key Figure Name Net Hedges and relevant company code, risk currency and period; Net Open Exposure should be reduced accordingly.