Hedge Accounting TEXPO2015

1. Sanjay Thoppil Solution Consultant, Reval April 21, 2015 Hedge Accounting for Effective Risk Management

2. Agenda o Introduction to Hedge Accounting o Benefits of Hedge Accounting o Framework for Implementing a Program 2

3. What is Hedge Accounting? o “Special accounting treatment that alters the normal accounting for one or more components of a hedge so that counterbalancing changes in the fair values of hedged items and hedging instruments, from the date the hedge is established, are not included in earnings in different periods.” (formerly SFAS 133, par 320) 3 Basic Treatment o “An entity shall recognize all of its derivative instruments in its statement of financial position as either assets or liabilities depending on the rights or obligations under the contracts. All derivative instruments shall be measured at fair value.” (formerly SFAS 133, par 17) Hedge Accounting

4. Introduction 4 CF Hedge Derivative? Yes MtM No Accrual FV Hedge Definition of a Derivative: Characteristics of a derivative ASC 815-10-15 (formerly SFAS 133, par 6) 83(a) Underlying 83(a) Notional amount 83(b) No (or minimal) initial net investment 83(c) Net settlement Basic Accounting Treatment: Derivatives are recorded at FMV, with changes in FMV recognized currently in earnings Hedge Types: • Cash flow hedges are recorded at FMV with effective changes in FMV deferred in OCI • Fair value hedges are recorded at FMV with offsetting gains and losses on the hedged item recognized currently in earnings

5. Major Provisions of Hedge Accounting 5 o Documentation – Risk Management Strategy and Objective – Nature of the Hedged Risk – Hedging Instrument Identified – Hedged Item Defined – Effectiveness Assessments and Ineffectiveness Measurement o Effectiveness Assessments – Regression, Dollar Offset, Critical Terms, Shortcut o Ineffectiveness Measurement – Lesser of the cumulative change o Disclosures

7. Benefits of Hedge Accounting 7 Cash Flow Hedge Trade Date Settlement Hedge Hedged Item Fair Value Hedge Trade Date Settlement Hedge Hedged Item Recognize in Earnings Recognize in Earnings Changes in derivative value are deferred to OCI until the hedged item impacts the income statement. Changes in the hedged item value are booked to earnings at the same time as when the derivative changes. Benefit 1: Alignment of Derivative and Hedged Item Impacts on Income Statement

8. Benefits of Hedge Accounting 8 Benefit 2: P&L Volatility Reduction Forecast Sales Loss/Gain FX rate at fcst date FX Rate FX Forward Net Acctg Impact No Hedge Accounting Loss/Gain FX Fwd Rate FX Rate Loss/Gain FX Fwd Rate FX Rate Loss/Gain FX rate at fcst date FX Rate With Hedge Accounting Loss/Gain FX Fwd Rate FX Rate Loss/Gain FX Fwd Rate FX Rate Cash Flow Hedge

9. Benefits of Hedge Accounting 9 Benefit 3: Improved Economic Hedging Performance Transaction Timeline: Txn Event t0 t1 Quote Order t2 Sale/ Revenue Recognized t3 Cash Received Rates Planning Acctg1 Acctg2 Hedge Type Cash Flow Fair Value Balance Sheet Objective: Minimize the difference between the hedge rate and planning rate Potential P&L Impact Economic Risk Accounting + Economic Risk

10. Benefits of Hedge Accounting 10 Other benefits of implementing a hedge accounting program o Improved insight into underlying business exposures – Companies are forced to analyze, measure and monitor business transactions on an ongoing basis o Process controllership – Companies are required to have proper processes and controls

12. Risk Management Framework Hedge Accounting Lifecycle 12 Risk Identification Risk Appetite Business Goals and Objectives Assessment and Strategy Definition Execution Reporting Roles and Responsibilities Policies and Procedures Technology

13. Hedge Accounting Lifecycle High Level Derivative Lifecycle 13 Reporting Designation Maintenance Termination • Policy definition • Exposure tracking • Trade execution • Hedge documentation • Prospective and retrospective effectiveness testing • Valuations • Measurement • Documentation of hedge termination • OCI management

14. Implementation Framework 14 o Policy definition: – Types of exposures, policy for hedging, operational controls – Embed key HA language into policy and refer trade to this o Exposure tracking: – Need repository to store exposure information (date, amount, revision history, actuals etc.) o Trade execution: – Consider hedge accounting structure when executing trades (e.g. are internal derivatives needed) Designation Maintenance Termination

15. Implementation Framework 15 Designation Maintenance Termination FX Hedges Eligible for HA? Type Unrecognized firm commitment with an unrelated party Yes Fair Value Foreign currency denominated asset or liability Yes Fair Value Non-financial asset (e.g.,inventory or a fixed asset) Yes Fair Value Firm commitment to purchase a nonfinancial asset Yes Fair Value forecasted purchase or sale of a foreign currency-denominated financial asset with a third party Yes Cash Flow Forecasted intercompany purchase or sale of a foreign currency denominated financial asset Yes Cash Flow Receipt or payment of interest on a foreign currency denominated debt instrument Yes Cash Flow Forecasted intercompany dividend No Hedge of a forecast/firm commitment to purchase a foreign equity method Investment or business combination No

16. Implementation Framework 16 Designation Maintenance Termination Documentation Requirement Details Hedge Type Cash Flow, Fair Value or Net Investment Hedge Objective and strategy Need to define what the risk of the hedged item is along with the mitigation strategy Risk Changes in FX, interest flows attributable to the benchmark rate, price Assessment of Effectiveness Company expects that both at inception and on an ongoing basis the relationship will be highly effective… Methods: 1) critical terms/shortcut, 2) dollar offset, 3) regression Hedged Item Need to be specific as to what the exposure is Hedge Instrument Need to refer to the specific derivative Timing Designation must be made contemporaneously

17. Implementation Framework 17 o Prospective/Retrospective Effectiveness Testing – Must be performed at least quarterly – Optimal method is regression – Specific guidance for options, forward contracts – Impact of basis on commodities o Valuations – Source of market data – Confidence in pricing models o Measurement – Book to ledger after adjusting for excluded components, ineffectiveness, lesser of the cumulative change – Result is set of GL bookings Designation Maintenance Termination

18. Implementation Framework 18 o Cash Flow Hedges: – Regular Termination (e.g. at expiry of hedge contract) • Amounts in OCI are reclassified from OCI to income statement in same period as which the hedged item impacts the income statement – Irregular Termination (e.g. failed effectiveness) • Cumulative gain/loss on the derivative is discharged immediately from OCI to P&L – Management Decision (e.g. de-designation prior to maturity) • Amounts in OCI are reclassified from OCI to income statement in same period as which the hedged item impacts the income statement o Fair Value Hedges: – Cease adjusting the carrying value of the asset/liability/firm commitment – An adjustment to the carrying value of hedged item is accounted for in the same manner as the hedged instrument itself (e.g. adjustment to inventory is held until the inventory is sold) Designation Maintenance Termination

19. Implementation Framework 19 Other Considerations o Advanced FAS topics – DIG Issues – Treasury Center/Netting – Intercompany Transactions – Commodities – Cross Currency Swaps o FAS 157 – De-minimus testing – Credit adjusted values (at contract or on a net basis) Designation Maintenance Termination

20. The Power of SaaS TRM 20 CASH MANAGEMENT • Bank statement retrieval • Bank account management • Cash positioning and reconciliation • Payments and Payment Factory • In-house banking and Pooling • Multi-lateral Netting • Forecast and Liquidity Planning • Debt & Investments Management • Intercompany Loans • Limit Monitoring • Accounting • Performance Evaluation and Reporting LIQUIDITY MANAGEMENT ACCOUNTING AND COMPLIANCE RISK MANAGEMENT • Integrated Market Data • Exposure Quantification / Management • Multi-Asset Class Derivative Valuation including IR, structured rates, FX, energy, agriculture, metal, equity, credit) • Credit adjusted valuations • Hedging Strategy • Back Office and Accounting • Strategy Evaluation and Performance Measurement • Compliance with ASC 815(FAS 133 and FAS 161), ASC 820(FAS 157), IAS 39, IFRS 7, IFRS 9, and IFRS 13 • EMIR and Dodd-Frank Reporting • Inventory & Activity Reporting • General Ledger • Audit Controls

21. 21 Questions? Sanjay Thoppil Solution Consultant Reval Sanjay.thoppil@reval.com 646.376.4095 21 Visit us in the Exhibit Hall at Booth #616

22. Role of Commodity Risk Management Within Treasury 22

23. Commodity Risk Operating Models Basic Manager Silo risk manager Proprietary trader Portfolio risk manager • Risks ignored or addressed inconsistently through the organization • Exposures inaccurately identified • Material risks managed centrally • Focus on policy compliance with timely and cost effective execution • Supports organization's objectives • Manages entire portfolio incorporating asset correlations • Specialist risk managers Value Add • Trades for profit using value add strategies optimizing key drivers • Alignment of risk management and organization strategy • Organization has competitive edge on the market • Specialized proprietary traders Business Alignment Typically only specialized oil, gas, mining and electricity trading companies Typical corporate commodity risk manager 23

24. • Ongoing volatility • Systems and data infrastructure • Skilled staff • Hedge accounting • EMIR Transformation Objectives o Ultimately deliver greater shareholder value through: – Commodity risk management in line with risk appetite – Greater visibility and certainty of exposures – Enhanced control environment – Holistic management of company financial risks • Business case • Budget • Governance • Controls • Efficiency • Change • Business unit buy in External ChallengesInternal Challenges 24

25. Corporate Commodity Risk o Procurement manages relationship with supplier, both supply chain risk and price risk o Forces supplier to manage commodity price risk o Supplier will add a pricing premium for the service o Corporates may have better negotiation leverage than supplier o Supplier may not be any better at understanding and managing price risk 25

26. Corporate Commodity Risk o Decouples commodity supply risk from price risk. o Supplier and procurement focuses on delivery logistics. o Treasury generally maintains risk management knowledge and resources. They are better equipped to manage price risk. o Allows treasury to select hedge horizon and adjust hedge coverage at their will. o Treasury may have historically focused on FX and IR risk and will need to develop commodity expertise. o Creates increased accounting demands for tracking hedges. 26