What Is FX Hedging Policy For Intercompany Flows?

FX hedging policy for intercompany flows defines exposure thresholds, approved instruments (forwards, swaps, options), hedge ratios, netting rules, and documentation requirements ensuring systematic currency risk management while maintaining hedge accounting eligibility.

Policy Framework Components

Exposure Identification

1. Transaction exposure - Payables/receivables
2. Translation exposure - Financial statements
3. Economic exposure - Competitive position
4. Net investment - Foreign subsidiaries
5. Contingent exposure - Forecast transactions

Materiality Thresholds

Hedging Triggers:
- Single exposure >$500K equivalent
- Monthly aggregate >$2M per currency
- Quarterly forecast >$5M net exposure
- Annual budget FX impact >5% EBITDA

Intercompany Netting Rules

Multilateral Netting Structure

Netting Cycle

1. Monthly submission deadline (5th business day)
2. Validation period (2 days)
3. Rate determination (month-end spot)
4. Settlement date (15th of month)
5. Dispute resolution process

Approved Hedging Instruments

Forward Contracts

• Use case - Known amounts and dates
• Hedge ratio - 50-100% of exposure
• Tenor limit - Up to 24 months
• Documentation - ISDA agreement required
• Accounting - Cash flow or fair value hedge

Currency Swaps

Cross-Currency Swap Structure:
Principal Exchange → Periodic Interest → Final Exchange
     (Inception)      (Quarterly)        (Maturity)

FX Options

• Vanilla options - Downside protection
• Collars - Zero-cost structures
• Participating forwards - Partial upside
• Barriers - Cost reduction strategies
• Authority limits - Board approval >$10M

Hedge Accounting Requirements

Documentation Standards

1. Risk management objective statement
2. Hedging relationship designation
3. Effectiveness testing methodology
4. Ineffectiveness measurement approach
5. Discontinuation triggers defined

Effectiveness Testing

Operational Controls

Segregation of Duties

Front Office          Middle Office         Back Office
(Execution)          (Risk/Compliance)     (Settlement)
     ↓                     ↓                    ↓
Trade Entry          Confirmation          Payment
Pricing              Valuation            Accounting
Strategy             Reporting            Reconciliation

Authorization Matrix

• <$1M - Treasury analyst
• $1-5M - Treasury manager
• $5-20M - CFO/Treasurer
• >$20M - Board committee
• Speculation - Prohibited

Performance Measurement

Key Metrics

1. Hedge ratio - Hedged/total exposure
2. Cost of hedging - Premium/fees as % of notional
3. Effectiveness ratio - Actual vs expected offset
4. Value at Risk - 95% confidence interval
5. Earnings volatility - Reduction achieved

Reporting Requirements

Monthly Dashboard:
├── Open exposures by currency
├── Hedge positions mark-to-market
├── Effectiveness test results
├── Policy compliance status
└── Forward-looking exposure forecast

Compliance Framework

Regulatory Considerations

• Dodd-Frank - Swap reporting requirements
• EMIR - European reporting
• MiFID II - Best execution
• SOX - Internal controls
• IFRS 9/ASC 815 - Accounting standards

Audit Requirements

1. Quarterly review of hedge effectiveness
2. Annual policy review and update
3. External audit of hedge accounting
4. Derivative valuations independent verification
5. Counterparty credit assessment

Technology Integration

Treasury Management System (TMS)

• Exposure aggregation from ERP
• Deal capture and confirmation
• Mark-to-market valuations
• Hedge accounting calculations
• Regulatory reporting automation

Risk Analytics

def calculate_var(exposures, correlations, confidence=0.95):
    portfolio_variance = exposures.T @ correlations @ exposures
    var = norm.ppf(confidence) * sqrt(portfolio_variance)
    return var

A comprehensive FX hedging policy for intercompany flows ensures consistent risk management across the organization, maintains hedge accounting eligibility, and provides clear governance while optimizing the cost-benefit trade-off of hedging activities.