Currency Hedging Procedure

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The currency hedging procedure shown below is a regimented process for properly creating a hedge that will be acceptable for hedge accounting under Generally Accepted Accounting Principles, while also reducing or eliminating risk for the hedged transaction.

Set Up Hedging Transaction (Assistant Treasurer)

Ensure that the counterparty’s credit rating equals or exceeds the company’s minimum credit rating policy standard. Notify the treasurer if the counterparty exhibits a declining credit rating over the past two years.
Calculate the level of hedging effectiveness of the proposed transaction, and document the calculation.
Have the treasurer review and approve the transaction.
Enter into the hedging transaction.
Document the hedge, as required under hedge accounting standards. This includes documenting the relationship between the hedging instrument and liability, as well as the hedging strategy, risk management objectives, and how the effectiveness of the transaction shall be measured.
Have the treasurer review and approve the hedge documentation.

Confirm the Hedge (Treasury Clerk)

Immediately upon notification of the deal, confirm it with the counterparty, either by e-mail, orally, or by written notification. The confirmation should include all key terms of the deal, including the date of the transaction, the name and location of the counterparty, the rate, amount, currency, type and side of the deal, all relevant action dates, and the standard terms convention being used. Note: for transactions with short settlement periods, do not wait for the counterparty’s confirmation – send out your own confirmation instead.
If the confirmation sent by the counterparty contains incorrect information, then immediately call them back with correction information, and request a new version of the confirmation.
If the confirmation review process reveals an error that results in an open risk for either party, immediately close out the position.
Assemble the hedge contract, documentation, and confirmation into a package, and create a copy for distribution to the legal department. Retain the original documents.

Review the Contract Legality (Legal Staff)

Review the contract for completeness, and verify that the counterparty’s signatory is authorized to approve such contracts.
Approve the contract if acceptable, and forward to the assistant controller. If not, return it to the treasurer with attached notes regarding problem areas. If there are problems, then retain a copy of the package, and follow up with the treasurer periodically regarding resolution of the indicated issues.

Account for the Hedge (Assistant Controller)

Determine the extent of hedge effectiveness, based on the ranges set forth in the corporate hedge effectiveness policy.
On an ongoing basis, charge to comprehensive income that portion of the hedge that is considered effective, for any gains or losses resulting from marking to market. At the same time, charge to earnings that portion of the hedge that is considered ineffective as a result of marking to market.
On a monthly basis, evaluate the non-recoverability of hedge losses, and shift these losses from other comprehensive income to earnings.
On a monthly basis, evaluate if it has become probable that any forecasted cash flow transactions will not take place, and shift the associated gains or losses from other comprehensive income to earnings.

Reconcile the Hedge (Assistant Controller)

Match the internal account balances for the hedge to the statement received from the exchange or the over-the-counter counterparty. Report the reason for any significant differences to the treasurer and controller.
If the hedge is completed and settlement has occurred, reconcile the payment received or issued to internal records, and adjust for any differences.
If the reason for a reconciliation problem is not clear, or if the cause results in a variance of at least $_____, notify the treasurer and controller immediately.

Report on the Results of the Hedge (Assistant Controller)

Calculate the percentage of hedging achieved by the transaction and report this amount to the treasurer and controller.
Calculate the speed of confirmation matching, and the types of problems found during the reconciliation process, and report these metrics as key performance indicators to the treasurer and controller.