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Crisis Forces Consideration of Unwinding Cash-Flow Hedges

By May 7, 2020 No Comments

The COVID-19 crisis has reduced exposures to a point where for many companies those hedges may not be needed anymore. Time to unwind?

If you’re planning on unwinding a cash-flow hedge, there are many things to think about before you do. Determining when and why to unwind, as well as how to view the transaction’s cost benefits, and what counterparty to use, are just a few of the factors to consider. This was the topic of discussion among NeuGroup FX Managers’ Peer Group 1 and 2 members in a recent virtual “office hour” meeting, which led to some interesting takeaways.

  • The “No Choice” camp. With hedge accounting being a big driver for most members, keeping hedges on the books when exposures are materially reduced – as they unarguably have for many sectors in the COVID-19 crisis – is not an option as you’ll be over-hedged. For some companies, the lost sales in the crisis might be made up for in a later quarter, but for travel and service business, it is unlikely the rebound will make up for all of it.
  • Monetizing in-the-money hedges. If hedge accounting is a driver to unwind hedges that are in the money, the extra liquidity is welcome, nevertheless. But ITM hedges are also an opportunity to access additional liquidity, even if the hedges are still “good.” By unwinding them – cashing in – you get the extra cash immediately and if needed, you can enter into a new set of hedges for the remaining exposure at prevailing market rates.
  • Do you need to take the P/L right away? Talk to your hedge accounting people to see whether the gains/losses on the hedges are material enough to require that they be recognized in the current quarter or if they can be released in the quarter they otherwise would have occurred.
  • Do you need to sell the hedge? And if so, to the same counterparty? Not necessarily. If you don’t feel the pricing offered is attractive enough from the original counterparty, you can bid it out competitively if your trading processes permit. Or, you can dedesignate the hedge and enter into an offsetting cash-flow hedge for the “over-hedged” part for a neutral outcome.
  • Can you offset it on the balance hedge side instead? None of the members on the call said they could. In one case it was because of systems that prevented a cash-flow hedge to be “transferred” to the balance-sheet program. So instead, the cash-flow hedge needs to be dedesignated and an offsetting hedge to be put in place the same day.
  • How much extra work is it? Unwinding cross-currency interest rate swaps and other complex or multi-tranche derivatives can mean a lot of extra trading and processing work for the treasury team. That is less likely for relatively simple FX derivatives, most of which can likely be pushed through the regular trading process but will probably incur some more “manual” (spreadsheet) valuation calculations. This should take care of most of the push back from the treasury operations and accounting side.
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Ted Howard

Author Ted Howard

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