Net investment hedging: Why it is time for US corporates to revisit this strategy

This article was written by Animesh Jaiswal, Technical Accounting Specialist, and Brian Williamson, Corporate Treasury Workflow Specialist at Bloomberg.

Net investment hedges are becoming an increasingly popular strategy for corporate treasurers to minimize FX risk in foreign investments.

Currently, there are two major factors contributing to an increase in net investment hedging among US corporates: The interest rate environment and favorable changes to the amended hedge accounting guidelines.

The interest rate environment is a key factor for US based corporations executing net investment hedges. When analyzing and comparing interest rates globally, interest rates in the US are higher than in any other region. Europe, for example, has negative rates for tenors under 5 years and longer tenors are barely above 75bps. This rate differential makes net investment hedging very appealing, as seen in the following example.

If a US company with an investment in Europe is expecting a payoff in 10 years, net investment hedging would allow them to execute a Fix/Fix or Float/Float Cross-Currency swap. With the rate differential, US corporates can receive 200bps in USD while only paying 27bps in EUR. All settled cash flows would be booked to P&L as interest income. As a result of the positive spread between USD and EUR swap rate, the P&L will be a realized-gain the life of the swap.

In addition to positive rate differential for US corporates, favorable changes under the FASB’s new hedge accounting rules have also helped make net investment hedging more appealing. Previously, under ASC 815, fair market value (FMV) was broken into two components: the spot fair market value was booked to other comprehensive income (OCI) and the remaining fair market value was booked to earnings. This led to considerable volatility, as the remaining FMV could be positive or negative, and this uncertainty was a deterrent for companies considering executing a net investment hedge, who wanted to avoid any potential unrealized loss being booked to the income statement.

With the new hedge accounting rules, there have been significant changes to net investment hedging and how P&L is booked. Under ASU 2017-12, both fair market value components can be booked to OCI, reducing volatility associated with market movements and eliminating a major issue with net investment hedges under the old guidelines. The FASB’s new rules on booking forward points now allow companies to book forward points to any line item within OCI, providing additional flexibility from an accounting perspective.

Corporate treasuries can use the Bloomberg Terminal to analyze swap rates and price net investment hedges as they negotiate with their banks. Once the trade is complete, treasurers can create a relationship between the exposure and the hedge. Bloomberg’s treasury solution is able to run robust monthly or quarterly hedge accounting and reporting, providing accounting departments with the necessary data points to quickly and effectively book journal entries.