KRM, IAS 39, and FAS 133
Recent developments in financial accounting standards are bringing
accounting standards and the mark-to-market orientation of risk
management into much closer alignment. International Accounting Standard
39 ("IAS39") and the U.S. Financial Accounting Standard 133 ("FAS133")
both require financial institutions and corporations to clearly
demonstrate the effectiveness of hedging strategies. Without this proof
of effectiveness, hedging institutions will not be able to align the
hedging gains or losses with the declaration of interest income on the
assets being hedged.
In order to meet the standards of IAS39 (a term
we use generically to refer to its implementation around the world), a
hedging institution has to be able to accomplish a number of critical
tasks:
- Mark to market capability on traditional financial assets
is necessary as of the present date, over any series of dates in the
past, at any specific date in the future, and at various dates in the
future as part of a simulation of hedging effectiveness.
- Cash flow generation on traditional financial assets,
recognizing that much of the cash flow on financial assets is random
due to features like floating rate interest payments, prepayment and
default
- Mark to market capability on sophisticated derivatives
transactions used as hedging instruments, as of the present date, over
any series of dates in the past, at any specific date in the future,
and at various dates in the future as part of a simulation of hedging
effectiveness
- Cash flow generation on sophisticated derivatives,
recognizing that much of the cash flow on the derivatives is subject
to change based on market conditions on the payment dates
- Linear regression linking the market values and cash
flow generated by both the traditional financial assets and the
hedging derivatives. This regression is used to statistically prove
the effectiveness of the hedge on either a mark value or cash flow
basis
Kamakura Risk Manager, the industry-leading enterprise wide risk
management system from Kamakura Corporation, has had these features for
more than seven years. The mark to market capabilities stem from KRM's
critical role as a market risk system in major institutions around the
world. Historical simulation of hedging effectiveness is a special case
of the three types of value at risk analysis in KRM. Forward looking
simulation of cash flows and market values is a key feature of KRM-ni,
Kamakura's monte carlo simulation engine, and KRM-cr, Kamakura's credit
module which incorporates the potential default of each counterparty.
Linear regression has been embedded in KRM since 1996 as part of
Kamakura's non-maturity deposit analysis.
As a result, Kamakura Risk Manager has all of the analytical
capabilities necessary to meet the requirements of IAS39.
Kamakura's risk management and accounting experts work with clients
to show
- How to use KRM's data tables to link specific financial
assets and other transactions being hedged to specific
derivatives transactions being used to hedge. KRM's table
structure provides for a unique hedge identifier for this purpose with
proper security
- How to perform IAS-compliant linear regressions on KRM
simulation output to establish hedging effectiveness
- How to create reports specific to that institution's
requirements to report key data for appropriate accounting entries
and hedge documentation.
For detailed information please refer to our frequently asked
questions (FAQ's) 440kb
PDF.
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