This article was written by Malcolm Finn for Bloomberg Brief. It appeared first on the Bloomberg Terminal. Malcolm Finn is the global financial controller at Costa, part of the U.K.-based Whitbread Group. He joined Costa in November 2015. The implementation of IFRS 9 will require companies to look at the structure of their organizations, he argues, a move which will allow them to take full advantage of hedging opportunities offered under the new accounting standard.
A long time in the making, the new international accounting standard IFRS 9 is now expected to be endorsed by the European Union later this year.
IFRS 9 overhauls rules established under IAS 39 and intends to be a more principles-based standard. The biggest change will be organizational and strategic as the structural fog of IAS 39 is cleared and thoughts can turn to reducing operational complexity and making the best use of the hedging opportunities presented in IFRS 9.
As the standard becomes a reality, the relevant knowledge and human assets must be redeployed in creative ways wherever they sit within the organization. As we move to fewer artificial constraints and a closer alignment with risk management, IFRS 9 presents an opportunity to review current hedging strategies.
The new success factors will be speed, flexibility, integration and innovation.
Costa is in the food and beverage business headquartered in the U.K. It roasts its own coffee, operates a store estate and a global supply network to serve customers. Like many organizations there are exposures to the pricing of agricultural products, freight and energy to name but a few.
Organizations determine their risk policies and governance depending on risk appetite, risk tolerances, liquidity and balancing unknown market volatility. The production, network and distribution costs as well as the price of soft commodities (in Costa’s case, these are the coffee beans, milk, sugar — to customer taste — and even the cups) must be managed to the point of delivery.
The focus has moved from the artificial rules of IAS 39 to a closer alignment with risk management. Organizations will need to think widely and cross-functionally to get the best understanding of their economic exposures.
Under the IAS 39 regime, certain derivative instruments may be selected on the basis that they work favorably from an accounting perspective, rather than optimal risk management. Organisations may have previously avoided entering into derivatives for managing risk components of non-financial items as hedge accounting under IAS 39 was not available to them.
IFRS 9 presents an opportunity to hedge commodity risk more efficiently. Technical and structural features that allow for this include:
Proxy hedging: Where there is correlation and relation to the same type of risk being managed.
Components: The variability in the commodity price can be a separately identified component of the contract price under IFRS 9. Hedging of components is not permissible under IAS 39.
Aggregated exposures: The combined commodity price risk and foreign currency risk can be approached efficiently and allows hedge accounting to be achieved more easily.
Moving from a discrete and esoteric treatment to a wider and holistic accounting treatment of economic hedging requires an intellectual and organizational shift to fully realise opportunities. This may have wider implications:
More supplier collaboration in contracting: Commodity contracts and hedging (financial) contracts will no longer be considered in isolation — with procurement and treasury working closer together. The price risk either resides with the supplier (fixed price) or the organization and taking on more risk may not be a bad thing if it can be managed more efficiently. There is clearly a balanced approach of profitable purchasing to cover demands, the market, credit, delivery, and FX risks; managing those risks and the accounting volatility. Open book contract relationships will shift negotiation dynamics.
More cost effective structures and cost efficiencies: Commodity prices can be anti-correlated with each other or exposures from other asset classes and assessing aggregate risk analytically often results in less hedging transactions. Further, entering into certain accounting hedges to offset the impact caused by economic hedges may be lessened.
Reduced volatility: Under the widened eligibility of IFRS 9, hedge accounting optimization of the risk from the aggregate of exposures and derivatives can be considered.
There will be new disclosures required by IFRS 9 to “tell the story” and there is opportunity to link these to the strategic narrative and business model disclosures — how organizations create and preserve value.
In a competitive environment where business as usual is unusual, organizations should continuously appraise their business models and any disclosures should be updated to reflect changes in business models.
Risk management strategy is becoming an organizational construct rather than just sitting in a single functional area – and leading organizations will have an integrated approach to commodity risk management in its widest sense. Leading organizations will create a boundary-less organizational culture — operating differently internally and externally.