Net investment hedging ineffectiveness

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DJP
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Joined: 26 Jun 2020, 15:57

Net investment hedging ineffectiveness

Post by DJP »

Hello all,

Wondering if you have experience with net investment hedges, namely with cases where the net investment is reduced to an amount below the designated hedged amount due to losses on the net investment. In order to determine ineffectiveness in those cases I guess you need to build a new hypothetical derivative for the new (reduced) notional amount and check the cumulative fair value change since the very beginning of the hedge (as if that hypothetical derivative had always been your hedged item). Would you agree? Thanks
pub_acco
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Re: Net investment hedging ineffectiveness

Post by pub_acco »

Though I have no experience facing such a situation, it's counterintuitive to me to check the fair value change since the beginning of the hedge, rather than that since a portion of the hedge became ineffective. I think the fair value changes that had been effective should stay in Accumulated OCI until the relevant foreign operation is disposed of. In this way, you will only need to recalculate the ineffectiveness portion of fair value changes since the hedging relationship became over-hedging.
DJP
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Re: Net investment hedging ineffectiveness

Post by DJP »

Ok, I can follow and understand the argument. Makes sense.

Now, could you see this as a change in the risk management objective, in which case the hedge relationship would have to be terminated, or simply an overhedge where ineffectiveness will have to be booked going forward?
pub_acco
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Re: Net investment hedging ineffectiveness

Post by pub_acco »

I think it depends. If the designated hedge amount is 1,000 and the reduced net investment is 990, then we can argue it's a continuing over-hedge relationship. But if the reduced net investment is say 10, it should be no longer possible to insist an economic relationship.
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