Quantifying Currency Basis and Applying Hedge Accounting for Cross Currency Swaps under IFRS 9

Chatham Financial White Papers – February 2017


Cross currency (xccy) swaps are financial instruments often used by multinational companies to manage various combinations of currency risks and interest rate risks faced by their global businesses. A xccy swap most typically would be used to hedge fixed or floating rate debt issued in a foreign currency, as it involves the exchange of principal and interest payments in one currency for principal and interest payments of another currency. Economically, xccy swaps synthetically convert foreign debt to local debt, which can be beneficial when borrowing in foreign capital markets is more attractive than issuing local debt. Xccy swaps can also help mitigate mismatches between revenues and debt obligations by allowing the debt obligations to be serviced in the same currency as revenue receipts.
Xccy swaps exhibit substantial volatility in their fair values as a result of changes in spot FX rates and interest rate differentials of the different currencies during their terms. A less well-known contributor to this volatility is the “cross currency basis” or simply “currency basis,” which is a premium charged by market participants for funding in one currency relative to another currency over a period of time. Given that xccy swaps are classified as “derivatives” under IFRS, they must be measured at fair value and recorded on the balance sheet with changes in their fair values potentially being recorded in P&L. Fortunately, companies applying IFRS can elect to apply hedge accounting under IAS 39 – Financial Instruments: Recognition and Measurement for qualifying xccy swaps, which matches gains and losses on the derivative with the gains and losses of the exposures being hedged (i.e. the underlying debt), thereby minimising the potential P&L volatility from xccy swaps.


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