CFOs that hedged their interest rate exposures before the recent aggressive rise in global base rates are most likely holding interest rate swaps (IRS) that are now significantly In-The-Money (ITM), which will need to be recognised as an asset on their company balance sheet at year-end.
The interest rate swap has effectively locked in a fixed rate of interest the company will pay on their floating debt for the notional of the swap. For some, this will equate to tens of millions of net interest savings over the life of the swaps. The present-day value of these expected savings is what the current fair value of swap portfolio represents.
This EoFY auditors will be keen to assess whether you have considered the credit risk of non-performance of your counterparts to honour the contractual agreement of the swap. Accounting standard IFRS 13 – Faire Value Measurement requires that credit risk be factored into the measurement of your derivatives. In practice, this means reducing your asset value on the balance sheet for the credit risk of non-performance, with the other side going to profit or loss.
This adjustment is called a Credit Valuation Adjustment (CVA). Based on our experience, most CFOs will not have the time or resources to compute this adjustment correctly and in accordance with the standard, opening themselves up to potential audit issues and late changes to the numbers.
As a high-level guide, the spread between your counterparty’s corporate bonds that have been issued versus that of similar maturities on Government Bonds will give you a spread to a Risk-Free-Rate (RFR) which you can use then to build your curve to maturity of your swaps. Alternatively, you could use the spread on Credit Default Swaps (CDS) for each counterparty as a proxy for CVA curves. It’s a technical and time-consuming process, so many CFOs prefer to free up their time by outsourcing this task to an experienced treasury advisor.
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