Every cash flow hedge program begins with the best intentions: Reducing the impact FX, interest rate or commodity volatility has on anticipated revenues and expenses.
Over time, however, it’s easy to forget that the program is designed to reduce the company’s economic exposure. Instead, it’s common for hedgers to dedicate more and more focus to accounting exposures as the months and quarters roll on.
Why? For one, accounting exposures are highly visible – far more than economic ones. If a transaction is hedgeable, it stands out like a sore thumb in statements and documentation. And if it’s hedgeable, it should be hedged, correct?
Not always. In fact, in some cases, hedging a transaction for which special hedge accounting is available can actually be a negative. Imagine, for instance, a U.S.-based company anticipates a USD transaction in Germany. There’s no economic exposure there. But it is an accounting exposure to your Euro-functional subsidiary – and a highly visible one, at that. It can be hedged, but whether it should be is another issue. Doing so might actually exacerbate your exposure to Euro volatility.
Understanding why this is so requires a return to the basics of your cash flow hedging strategy. What are you actually trying to accomplish? What do you care about? And how can you help ensure your hedge program delivers the results you expect?
Cash flow hedging, ultimately, is about economic exposure. Special hedge accounting treatment is a tool to achieve this end, but that’s all it is. It’s not the goal, and it’s not the strategy. It’s a tool – a means to a greater end.
This fall, take some time to take a look at your hedge program. Remember why it’s there, and examine the tactics you’re using to achieve your goals. At the very least, you’ll gain valuable information on where you stand, and where you’re going. By going back to basics, you might uncover some intensely valuable insights and opportunities that will serve you well in 2017 – and beyond.