Tackling FX Earnings Risk New York Cash Exchange 2017

Transcription

1 Tackling FX Earnings Risk New York Cash Exchange 217 May

2 Today s Speakers Zeeshan Naqvi is Senior VP and Assistant Treasurer of Moody's Corporation since August 215. In this role, He is responsible for Funding, Financial Risk Management, Hedging & Trading, Capital Planning, Bank/Rating Agency Relationships and Pension Management. Previously, Zeeshan worked at General Electric Capital Corporation for 11 years in variety of roles in Debt Capital Markets and Treasury, both in U.S. and United Kingdom. In these roles, He helped fund GECC and GE Company balance sheets via corporate bonds, securitizations, structured secured and bank markets. He also helped GE clients obtain financing in Bank, ABL and Securitization markets. Prior to that, He was on Corporate Audit Staff at GE Company. Amanda Breslin, CFA, CTP is an Executive Director at Chatham Financial, leading the Corporate Treasury Advisory group, advising corporate clients on risk management strategy, analysis, and execution with respect to interest rate, currency exchange rate, and commodities exposures. During her tenure at Chatham, Amanda has developed broad hedging experience advising corporate clients on complex FX hedging strategies, and advising real estate clients on issues pertaining to REIT structures and in navigating the process of collateral substitutions. Prior to joining Chatham, Amanda was an officer in the Army serving in both Germany and Afghanistan. Amanda received her MBA from The Wharton School at the University of Pennsylvania and a Masters in International Relations from the University of Oklahoma. She also holds a BS in Business Administration from Cal Poly, San Luis Obispo. 22

3 About Moody s 33

4 About Chatham Strategic Risk Assessment Chatham helps clients assess their risk profile & capital structure at a strategic level Our holistic view into 1,8 companies best practices gives us a uniquely broad perspective Hedging Strategy & Execution Chatham helps clients structure & execute nearly $4 billion of hedges annually across 1+ banks Hedge Accounting Chatham Simplifies Complexity Valuation & CVA/DVA Chatham is widely recognized for its valuation expertise (including ASC 82 & IFRS 13) We sit on the valuation experts group assisting the IASB on the development of educational guidance for IFRS 13, Fair Value Measurement Legal (ISDA) We negotiate around 2, ISDA related documents annually, more than any other firm representing derivatives end-users Regulatory Compliance Chatham works with major accounting firms, the FASB, and the IASB on hedge accounting issues (ASC 815 & IFRS 9) Six former FASB staff members are part of our large and highly trusted accounting practice Supported by Chatham s robust technology platform: Chatham is on the forefront of regulatory changes, having worked with regulators, legislators, and companies across hundreds of meetings and expending 2,+ hours on behalf of end-users 44

5 Disclaimer 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 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. 55

6 Today s Agenda 1 Forecast Risk 2 Hedging Impact 3 Hedging Solutions 4 Case Study 66

7 Who Are Your Stakeholders? What are Your Metrics? Are you in compliance with DF? EMIR? How much risk do we have? How are we performing as a business unit? Is our pricing competitive? Are covenants and ratios in order? How volatile are my returns? How can we minimize our P&L impact? Regulators Board Subsidiaries Lenders Investors External Stakeholders Executive Management Internal Stakeholders Treasury Risks should be tackled early, holistically, collaboratively, and regularly 77

8 Metrics that Matter Economic Value Added or internally defined metric Hedge accounting is not usually a priority EBITDA or EBIT Hedge accounting is often applied Free cash flow or EBITDA Hedge accounting feasibility may be considered Earnings Per Share Hedge accounting is usually a priority Transaction Risk Reduction Percentage Economic Risk Reduction Percentage Fixed Risk/Cost Threshold Program Cost Forward Point Cost More Universal Metrics Ratio Debt covenants Cash Management Dividends 88

9 Today s Agenda 1 Forecast Risk 2 Hedging Impact 3 Hedging Solutions 4 Case Study 99

10 Transaction Risk Profiles Parent Sub Sub Sub Sub Transaction Transaction Transaction Transaction ❶ Transaction and Translation 3 different currencies in the transaction and translation process ❷ Translation Only No FX risk evident from the sub s perspective ❸ Transaction Only Parent and Sub have the same functional currency, but transaction currency is different ❹ Phantom Pass-Through Parent and Sub may have completely different views of whether there is FX risk or not 1

11 Sample Fact Pattern Parent? Revenue Expense 11 11

12 Company Overviews Parent Parent Functional Functional Sub Sub Functional Functional Revenue Expense Revenue Expense Company A Functional Company B Local Functional 12

13 Timeline First Quarter Financial Statements Q1 Q2 Q3 Q4 Forecasted Financials Forecasted Financials Forecasted Financials Forecasted Financials 13

14 Budgeted Financials First Quarter Financial Statements Company A Subsidiary Company B Consolidated Subsidiary Consolidated Income Statement Revenue Expenses Net Income EPS (22 shares) Budgeted Spot Transaction Total Assets Liabilities Retained Earnings CTA Total Liabilities and.32 Budgeted Average Translation Balance Sheet Assets 71 1,1 1,1 1,1 1, ,1 1, ,1 1, ,

15 Budgeted Financials First Quarter Financial Statements Company A Subsidiary Company B Consolidated Subsidiary Consolidated Income Statement Revenue Expenses Net Income EPS (22 shares) Forecasted Spot Balance Sheet Assets Total Assets Liabilities Retained Earnings CTA Total Liabilities and 1,1 1,1 1,1 1, ,1 1, ,1 1, ,1 Historic Spot 15 15

16 Budgeted Financials First Quarter Financial Statements Company A Company B Subsidiary Consolidated Subsidiary Consolidated Income Statement Revenue Expenses Net Income EPS (22 shares) Balance Sheet Assets 1,1 1, ,1 Total Assets 1,1 1,1 1,1 Liabilities Retained Earnings CTA Total Liabilities and 1,1 1,1 1,1 16

17 Timeline First Quarter Financial Statements Q1 Q2 Q3 Q4 Actual Financials Forecasted Financials Forecasted Financials Forecasted Financials Forecasted 1.5 Actual Average :.95 17

18 Actual Financials First Quarter Financial Statements Company A Subsidiary Company B Consolidated Subsidiary Consolidated Income Statement Revenue Expenses.. Net Income EPS (22 shares). Materialized Spot Transaction Balance Sheet Assets Total Assets Liabilities Retained Earnings CTA Total Liabilities and

19 Actual Financials First Quarter Financial Statements Company A Subsidiary Company B Consolidated Subsidiary Consolidated Income Statement Revenue Expenses.. Net Income EPS (22 shares) Balance Sheet Assets Total Assets Liabilities Retained Earnings CTA Total Liabilities and. Reduced Net Income

20 Actual Financials First Quarter Financial Statements Company A Subsidiary Company B Consolidated Subsidiary Consolidated Income Statement Revenue Expenses.. Net Income EPS (22 shares). Materialized Spot Translation Balance Sheet Assets Total Assets Liabilities Retained Earnings CTA Total Liabilities and

21 Actual Financials First Quarter Financial Statements Company A Subsidiary Company B Consolidated Subsidiary Consolidated Income Statement Revenue Expenses.. Net Income EPS (22 shares). Materialized Spot Translation Balance Sheet Assets Total Assets Liabilities Retained Earnings CTA Total Liabilities and Translation Impact 21 21

22 Actual Financials First Quarter Financial Statements Company A Company B Subsidiary Consolidated Subsidiary Consolidated Income Statement Revenue Expenses Net Income EPS (22 shares)... Balance Sheet Assets Total Assets Liabilities Retained Earnings CTA -91 Total Liabilities and 22

23 Today s Agenda 1 Forecast Risk 2 Hedging Impact 3 Hedging Solutions 4 Case Study 23

24 Timeline First Quarter Financial Statements Q1 Q2 Q3 Q4 Forecasted Financials Forecasted Financials Forecasted Financials Forecasted Financials Q1 Cash Flow Hedge Sell m, Buy Q2 Cash Flow Hedge Sell 63m, Buy Q3 Cash Flow Hedge Sell 6m, Buy Q4 Cash Flow Hedge Sell 57m, Buy Hedging 1% of forecasted net revenue 24

25 Hedging at Company A Hedge Accounting Qualification Hedge Accounting Criteria Party to the derivative Transaction currency functional currency Parent Functional ($) Parent Sub Functional ($) Sub m Revenue Revenue Expense Counterparty Sell m Buy 25

26 Cash Flow Hedging Company A Program Details and Requirements A cash flow hedging program allows you to hedge transaction risk. When hedge accounting is applied, only the undesignated portion of the hedge is recognized and flows through the P&L. The remaining portion is placed in equity, until designated revenue is recognized in future periods. Budget Budget Equiv. Revenue Expenses Net Income 71 Q1 71 Hedge notional * rates = Hedge Impact * (1.1 ) = 6.5 Revenue Expenses Deriv. Gain Net Income 71 Q2-Q4 Hedge 198 Initial OCI ,18

27 Actual Financials First Quarter Financial Statements Company A (Without Hedges) Subsidiary Income Statement Base Revenue Consolidated Company A (With Hedges & Accounting) Subsidiary Consolidated Total Revenue Expenses Net Income Gain From Derivative EPS (22 shares) Recognized Hedge Impact Balance Sheet Base Assets Cash From Derivative Derivative asset Total Assets Liabilities OCI Retained Earnings CTA Total Liabilities and , , , ,

28 Actual Financials First Quarter Financial Statements Company A (Without Hedges) Subsidiary Income Statement Base Revenue Consolidated Company A (With Hedges & Accounting) Subsidiary Consolidated Total Revenue Expenses Net Income , , , ,118 Gain From Derivative EPS (22 shares) Balance Sheet Base Assets Cash From Derivative Derivative asset Total Assets Liabilities OCI Retained Earnings CTA Total Liabilities and Unrecognized Hedge Impact 28 28

29 Actual Financials First Quarter Financial Statements Company A (Without Hedges) Company A (With Hedges & Accounting) Subsidiary Consolidated Subsidiary Consolidated Income Statement Base Revenue Gain From Derivative Total Revenue Expenses Net Income EPS (22 shares) Balance Sheet Base Assets Cash From Derivative Derivative asset Total Assets 1,118 1,118 Liabilities OCI Retained Earnings CTA Total Liabilities and 1,118 1,118

30 Cash Flow Hedging Company B Program Details and Requirements In order to qualify for hedge accounting, the targeted transaction currency must not match the functional currency of the subsidiary. In the company B scenario, while risk exists at the parent, the subsidiary is not exposed to any transactional risk. ($) Parent Hedge Accounting Criteria Party to the derivative Transaction currency functional currency ( ) Sub Counterparty 3

31 Cash Flow Hedging Company B Program Details and Requirements Company B can still hedge the exposure, but does not qualify for hedge accounting. This results in the full impact of the year s worth of hedges flowing through P&L Budget Budget Equiv. Revenue Expenses Net Income 71 Q1 71 Q2-Q4 Hedge 198 Net Hedges Hedge notional * rates = Hedge Impact 245 * (1.1 ) = 24 Revenue Expenses Deriv. Gain Net Income 89 31

32 Actual Financials First Quarter Financial Statements Company B (Without Hedges) Income Statement Total Revenue Expenses Income Other Income Net Income Subsidiary Consolidated - EPS (22 shares) Balance Sheet Base Assets Cash From Derivative Derivative asset Total Assets Liabilities Retained Earnings CTA Total Liabilities and Company B (With Hedges, No Accounting) Subsidiary Consolidated Fully recognized Hedge Impact , ,

33 Actual Financials First Quarter Financial Statements Company B (Without Hedges) Income Statement Total Revenue Expenses Income Other Income Net Income Subsidiary Consolidated - EPS (22 shares) Balance Sheet Base Assets Cash From Derivative Derivative asset Total Assets Liabilities Retained Earnings CTA Total Liabilities and Company B (With Hedges, No Accounting) Subsidiary Consolidated , ,24 Entire Hedge Is Realized 33 33

34 Actual Financials First Quarter Financial Statements Company B (Without Hedges) Income Statement Total Revenue Expenses Income Other Income Net Income Subsidiary Consolidated - EPS (22 shares) Balance Sheet Base Assets Cash From Derivative Derivative asset Total Assets Liabilities Retained Earnings CTA Total Liabilities and Company B (With Hedges, No Accounting) Subsidiary Consolidated , ,24 EPS (22 shares)

35 Today s Agenda 1 Forecast Risk 2 Hedging Impact 3 Hedging Solutions 4 Case Study Indirect Accounting Designation Alternatives Adjusted Earnings Change Functional Currency 35

36 Hedging Solution #1 Indirect Accounting Designation Company B does not qualify for hedge accounting as currently shown Hedge Accounting Criteria Party to the derivative Transaction currency functional currency Parent Functional ($) Parent Sub Functional ( ) Sub m Revenue Revenue Expense Counterparty Sell m Buy 36

37 Hedging Solution #1 Indirect Accounting Designation expenses could potentially qualify for Hedge Accounting of the same economic hedge Hedge Accounting Criteria Party to the derivative Transaction currency functional currency Parent Functional ($) Parent Sub ( ) Sub $9m Expenses Functional Revenue Expense Expense Counterparty Sell m Buy 37

38 Earnings Impact vs. Hedging Tools Aligning risk mitigation objectives with accounting constraints Earnings Impact Hedging Tools Risk to COMPANY is captured by evaluating both transactional and translational risks against the (Unhedged Earnings at Risk of 99%) Hedge accounting capacity is limited to transactional risk, where exposures impact a particular line item at a specific entity (Hedged Earnings at Risk of 99%) Earnings impact stems from consolidation of non- exposures: Accounting capacity may be less than or greater than the economic risk to earnings A translation-oriented view captures risk to earnings Earnings at Risk is defined by the impact to earnings, but is mitigated through tools that achieve hedge accounting treatment A transaction-oriented approach to hedging aligns with sources of hedge accounting capacity 38

39 Hedging Solution #2 Alternatives - Net Investment Hedge Net Investment Hedge A net investment hedge is used to hedge future changes in currency exposure of an investment in a foreign operation The economic result may be achieved but the impact of the hedge remains in OCI until the entity is substantially liquidated. Local Debt Issuance Net Investment Hedge via Cross Currency Swap Periodic coupon settlements Reverse notional exchange + Final interest payment Synthetic debt mechanism to convert repatriated cash to 39

40 Hedging Solution #3 Adjusted Earnings Companies may use EBITDA metrics, and choose to adjust earnings to reflect the impact of FX gains/losses on financials Considerations Non-GAAP measure SEC and investor questions Who does it? Private equity firms Recent IPO s Companies may choose to apply hedge accounting to the extent they qualify, and adjust earnings for the non-qualifying hedged portion 4

41 Hedging Solution #3 Adjusted Earnings We do not elect hedge accounting for our current currency forward contract activity The change in the fair value of currency forward contracts is recognized directly in earnings, as a component of other income We expect this volatility to continue in future periods for contracts for which we do not apply hedge accounting. Our hedging objectives may be targeted at non-gaap financial metrics, which could result in increased volatility in our GAAP results - Annual filing by a publicly traded company 41

42 Hedging Solution #4 Change Functional Currency Pros: Simplifies hedge accounting treatment Simplifies ongoing financial reporting Cons: Administratively difficult to change May not align with desired tax treatment Once the functional currency for a foreign entity is determined, that determination shall be used consistently unless significant changes in economic facts and circumstances indicate clearly that the functional currency has changed. Previously issued financial statements shall not be restated for any change in the functional currency. Accounting Standards Codification The functional currency of a new subsidiary should be carefully considered when setting it up. Keep hedge accounting qualification criteria in mind when doing so. 42

43 Today s Agenda 1 Forecast Risk 2 Hedging Impact 3 Hedging Solutions 4 Case Study 43

44 FX Risk Tolerance Considerations Defining Risk Metrics and Mitigation Thresholds Considerations: Earnings impact relative to communicated levels How wide of an EPS target band is tolerable? Are margins wide enough to absorb some degree of risk? Whether stakeholders accept/desire a degree of global exposure How palatable is a negative EPS impact due to FX? Is there an expectation that favorable FX markets should be captured? Ability to service debt and other obligations Does FX volatility impact the ability to service obligations? Are cash settlements associated with a hedging program easily supported? Are any key liquidity or debt ratios impacted by FX fluctuations? Competitive landscape Do peers/competitors hedge? Are key competitors based in local markets? What degree of FX volatility can be priced into business model? Cost-Benefit trade-offs Evaluating risk reduction against accounting constraints, tax implications, cash management, and resource utilization Practical applications: Ranges used to set policy guardrails (hedge ratios, exposure as a percentage of net income or other metrics) Trigger levels identified to prompt further review or action Thresholds identified for total risk tolerance or individual risk contributors (BS, CF, NI, Cash) Limiting factors identified /monitored (accounting capacity, tax, cash) Best Practices: Dynamic programs that monitor and adapt to changing business needs Aligning policy, procedures, and systems to support risk management objectives Reducing and communicating the timeline from risk trigger to program implementation 44

45 Connecting with Chatham Kennett Square 235 Whitehorse Lane Kennett Square, PA Denver 79 S. Platte Canyon Road Littleton, CO 8128 United States London Burdett House, 4th Floor Buckingham Street London WC2N 6DU United Kingdom +44 () Krakow ul. Rakowicka 7, III p Kraków Poland +48 () Amanda Breslin, CFA, CTP Executive Director T: Singapore 2 Cross Street China Square Central #2-16/17 Singapore, Melbourne L8, 11 Collins Street Melbourne, Australia,