In this transitional time for risk management, there have been several accounting distractions that may have detracted from the business and economic reasons for hedging. By providing a transparent trading section in their accounts and explanation of their hedging rationale, companies can keep their shareholders advised of the impact of the new accounting standards. This will help reduce share price volatility. Moody’s has also made observations about IFRS, stating mitigating factors to the expected increase in reported P&L volatility. It said: “Moody’s is looking through the reported financial statements in order to focus on the underlying financial reality and economic substance.”
The agency will also continue to place a strong emphasis on cashflow-based measures and metrics. Companies should consider hedging their interest rate exposures over a longer maturity as 30-year rates are at a historic and absolute low and offer an inverse cost of carry if swapping from LIBOR. Demand for long-term investments by pension funds, seeking to match the maturities of their liabilities to their assets, could explain the low rates of 30-year sterling swaps. Interest rates would have to fall considerably to have a negative effect on mark-to-market values. And if rates do fall, companies should be hedged with shorter-dated or floating positions. Most businesses have longer core debt requirements than their existing debt facilities. Long-dated IR hedging can spread the duration of IR risk hedging and reduce rehedging risks. Long-dated hedging should be a sensible proportion of overall hedging so that any expected volatility is on a scale that is within acceptable parameters of overall profit and loss.
