"It's more difficult to get hedge accounting for exotic derivatives than vanilla," said Botha. "Either we come up with tailored solutions that comply with the IAS39 standards, or people live with the resultant earnings volatility. Some people believe the standard may discourage them from using exotics."
Corporate clients wanting to use any type of derivative instrument to hedge under IAS39 must first prove that there is an identifiable underlying exposure that needs to be hedged. Once the hedge has been designated, the client must test its effectiveness based on historical pricing levels and forward-looking simulation levels.
"After you've entered the trade you then have to re-check and re-assess whether this effectiveness still holds, and you do that every time you have to report your financials to the investor community," said Lutfey Siddiqi, global head of structuring at Barclays Capital in London.
This represents a new challenge to banks, since the structurers' role has expanded. However, although this proves more work for forex structurers and sales dealers, it could also work in banks' favour as a key area where they can differentiate themselves from their rivals. "We make suggestions about the likely accounting treatment of our proposed structures. We also provide arguments that may be made to allow particular derivatives to qualify for hedge accounting when at first glance they may not look like they are hedge compliant," said Siddiqi. "There are proprietary models that we have and other banks are also looking into it."
The week on Risk.net, November 25-December 1, 2016Receive this by email