Reducing the impact of forecast errors
- June 25, 2020
SummaryForecasts for many companies have significantly changed, therefore impacting both FX and commodity hedging programs, and the accounting for these programs.
As COVID-19 continues to wreak havoc on the global economy, many companies must confront the impending effects to their forecasted revenue targets. The missed earnings and subsequent impacts pose challenges for many businesses. However, if your company applies hedge accounting through the critical terms match (CTM) method, you could face more pronounced consequences.
CTM risks in a volatile market
When your organization applies CTM, you need to assert that you’ll have a quantity of hedged transactions that is greater than or equal to the notional of the hedging instrument, and that the timing will align. For most companies hedging less than the full amount of expected revenues in a normal market environment, this is not a problem. In uncertain times like this, however, where sales could fall dramatically or be delayed, your organization could fail to achieve sufficient sales for the amount you have hedged. This means you could lose hedge accounting and may need to take amounts in OCI to the P&L, compounding the pain you already feel from the economy.
The exposure-window approach
Thankfully, another approach allows more flexibility for missed forecasts: applying a long-haul method with exposure windows. By writing hedge designation memos in such a way to allow a three- or six-month window for the exposure to materialize, you can get additional flexibility for uncertain times like these. Applying this methodology in the current markets could give you time to make up for those lost sales in the coming months before they impact your hedging relationship.
Chatham recently worked with a large retailer who had inconsistent forecasting. By helping them switch from CTM to long-haul regressions with a window, the company was able to achieve hedge accounting despite their regional forecasting challenges.
Making a seamless transition
The regression method with exposure windows is more complex to apply than CTM but offers many benefits that make it worthwhile for most companies. Chatham offers a suite of technology tools and a team of expert accountants that can help your organization make a seamless transition from CTM to regressions.
Chatham Financial corporate treasury advisory
Chatham Financial partners with corporate treasury teams to develop and execute financial risk management strategies that align with your organization’s objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.
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Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.20-0097
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