The Handbook of Corporate Financial Risk Management (2nd Edition)
First published:
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Translation or Transaction: Netting Currency Risks
Foreword
Introduction
Theory and Practice of Corporate Risk Management
Theory and Practice of Optimal Capital Structure
Introduction to Funding and Capital Structure
How to Obtain a Credit Rating
Refinancing Risk and Optimal Debt Maturity
Optimal Cash Position
Optimal Leverage
Introduction to Interest Rate and Inflation Risks
How to Develop an Interest Rate Risk Management Policy
How to Improve Your Fixed-Floating Mix and Duration
Interest Rates: The Most Efficient Hedging Product
Do You Need Inflation-linked Debt?
Prehedging Interest Rate Risk
Pension Fund Asset and Liability Management
Introduction to Currency Risk
How to Develop Currency Risk Management Policy
Translation or Transaction: Netting Currency Risks
Early Warning Signals
How to Hedge High Carry Currencies
Currency Risk on Covenants
Optimal Currency Composition of Debt 1: Protect Book Value
Optimal Currency Composition of Debt 2: Protect Leverage
Cyclicality of Currencies and Use of Options to Manage Credit Utilisation
Managing the Depegging Risk
Currency Risk in Luxury Goods
Introduction to Credit Risk
Counterparty Risk Methodology
Counterparty Risk Protection
Optimal Deposit Composition
Prehedging Credit Risk
xVA Optimisation
Introduction to M&A-related Risks
Risk Management for M&A
Deal-contingent Hedging
Introduction to Commodity Risk
Managing Commodity-linked Revenues and Currency Risk
Managing Commodity-linked Costs and Currency Risk
Commodity Input and Resulting Currency Risk
Offsetting Carbon Emissions
Introduction to Equity Risk
Hedging Dilution Risk
Hedging Deferred Compensation
Stake-building
This chapter is one of the most important in this book since it impacts almost all companies with foreign currency exposures. We will therefore summarise the conclusions twice: once at the very start, and then again after going through our case study. Companies are often in a situation whereby they wish to hedge the translation risk on EBITDA arising from the consolidation of foreign subsidiaries; however, under IFRS, a group typically cannot apply hedge accounting to such hedges because the earnings being hedged are usually denominated in the functional currency of the foreign subsidiary where they arise. On the other hand, IFRS allows hedge accounting for transaction exposures, specifically for transactions not in the functional currency of the entity (eg, non-functional currency payables and receivables, including intercompany exposures).
The most common questions from companies are: does hedging the transaction risk reduce our translation risk and, if not, is there a better way to hedge the translation risk? Faced with this conflict between what the company really wants to do, which is to hedge translation risk on EBITDA, and what the company is permitted to do under the
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