Entries for February 2011

IASB and FASB Convergence

The International Accounting Standards Board and its U.S. counterpart the Financial Accounting Standards Board have been talking about compatible standards for years.  As companies increasingly become global entities, disparate accounting standards complicate things for both corporations and investors. As it currently stands, a U.S. subsidiary of a foreign corporation is essentially running two sets of financial disclosures, one according to U.S. GAAP (Generally Accepted Accounting Principles) and one according to IFRS (International Financial Reporting Standards). The benefits of applying a single standard should be obvious in terms of cost and clarity. Both boards recognize this, and since 2002 they’ve been engaged in a dialog to bring the two standards together.

 Less talk more action

Let’s fast forward a bit to 2004. The FASB and the IASB issue a Memorandum of Understanding (MoU), and it is apparent that the two organizations are taking this commitment seriously.  The MoU not only reiterates the need for a single standard, but also cites specific convergence topics as well as expected timeframes. The hope is that it will all come together by the end of 2011. In fact the G-20 (Group of Twenty nations) has recently turned the heat up for a 2011 project completion. The G-20 hopes that a single standard will revitalize global economies. (We could sure use a little boost here.)

Ok, so this is no cakewalk, and there has been bickering along the way, particularly with respect to the issues related to the recent economic crisis. That alone sparked a highly charged dialog on how to cope with toxic assets. At times it seemed almost as if the process was destined to stall. When the IASB issued an exposure draft in December of 2010 on hedge accounting, the document posed a very different approach to hedge accounting than that offered by FASB’s May 2010 exposure draft. So just when it looked like we would achieve confluence, a whole new batch of differences was introduced.  I presume that many hoped that the IASB would offer proposals more in line with those of the FASB. I can also presume that many were ecstatic that the proposals were not.

 Some of the Key Differences

 

IASB

FASB

Both financial and non-financial instruments may be used as hedging instruments, with the exception of certain written options.

Non-derivative financial instruments may not be used for hedging purposes unless they are used for foreign exchange or net investment risk.

In hedges where an option’s intrinsic value is the designated hedging instrument, the initial time value may be amortized over the time period related to the hedge.

In hedges where an option’s intrinsic value is the designated hedging instrument, the initial time value is immediately recognized in earnings.

Component risks are allowed to be hedged.

The hedging of component risks is not allowed.

Aggregated exposures (a combination of an exposure and a derivative) may be designated as a hedged item.

Not allowed.

To qualify for hedge accounting, a hedging relationship is required to both (a) meet the objective of the hedge effectiveness assessment (that is, to ensure that the hedging relationship will produce an unbiased result and minimize expected hedge ineffectiveness) and (b) be expected to achieve other-than-accidental offsetting.

To qualify for hedge accounting, current U.S. GAAP requires that the hedging relationship be expected to be highly effective in achieving offsetting of the changes in fair values or cash flows.

Under proposed U.S. GAAP, the “highly effective” requirement would be changed to “reasonably effective.”

After inception of a hedge, an entity must reassess hedge effectiveness on a prospective basis in an ongoing manner. A retrospective assessment is not required for qualification purposes. The proposed guidance does not specify whether an entity would perform a qualitative or quantitative analysis when determining whether a hedging relationship meets the hedge effectiveness requirements.

Proposed U.S. GAAP would require that, after inception, an entity assess hedge effectiveness after inception of a hedge on a prospective basis and retrospective basis only if changes in circumstances suggest that the hedging relationship may no longer be reasonably effective

An entity may adjust an existing hedging relationship (referred to as “rebalancing”) and account for the revised hedging relationship as a continuation of the existing hedge rather than as a discontinuation when any of the following occur:

a. A hedged item changes.

b. A hedging instrument changes.

c. The expectation of hedge effectiveness changes.

d. Any combination of the above.

The part of the hedging relationship that remains after the rebalancing would be reported as a continuing hedge, with the part that is no longer hedged after rebalancing reported as a discontinued hedge.

Under proposed U.S. GAAP, an entity may modify the hedging instrument by adding a derivative to an existing hedging relationship that would not offset fully the existing hedging derivative and would not reduce the effectiveness of the hedging relationship. That modification would not result in the termination of the hedging relationship.

For fair value hedges, the gain or loss on the hedging instrument and hedged item (excluding the ineffective portion) would be recognized in other comprehensive income.

For fair value hedges, the gain or loss on the hedging instrument and hedged item (for changes in the hedged risk) are presented in profit or loss.

For fair value hedges, fair value changes attributable to the hedged risk would be presented as a separate line item in the statement of financial position. That separate line item should be presented next to the line item that includes the hedged asset or liability.

For fair value hedges, the carrying amount of the hedged item is adjusted for the change in its fair value attributable to the hedged risk.

Finding Middle Ground

 While it’s too early to break into a chorus of “What a Wonderful World”, progress is being made. This month, the FASB issued a discussion paper on hedge accounting that actually included the IASB’s exposure draft.  This could be an indication that the FASB may be leaning towards IASB’s proposals. At least that’s the way it looks. Both organizations are keen to simplify the hedge accounting rules, so I view the FASB’s issuance of this document as a positive step towards a single standard.

As things stand today, multi-national corporations need to constantly look to multiple sources for guidance on every accounting and disclosure issue. This is an important issue. Adhering to a mixed set of standards for global entities benefits no one – neither corporations nor investors.

 The comment deadline for the IASB’s exposure draft for hedge accounting is March 9, 2011, while the comment period for FASB’s discussion paper ends April 25, 2011.

 

As the annual International Petroleum (IP) Week gets underway for the second day, the city is buzzing with busy bees. Commodity management teams specializing in energy and beyond are striding through London trying to meet their heavy schedules from breakfast meetings to cocktail parties and other events in between exchanging ideas, experiences and views. As these conversations flow they carry with them an obvious focus of having a beneficial impact on the bottom line and sustaining healthy relationships, but there is always enough room for sidebar conversation about news.

One topic that has prevailed this year is the recent media attention to the registration of oil traders such as Rosneft, Russia’s largest oil producer, and Bashneft, another large refiner and oil producer, joining recent arrival of TNK-BP and placing Switzerland ahead of UK in its share of global volume of physical energy traded.  In some conversations this topic has likely upgraded into an experience that counterparts have shared as a benefit to the bottom lines of both companies and traders, whereas some conversations steered towards which quaint alpine town in Switzerland can host a future event of such magnitude and the effect its surrounding slopes can project.

As the seemingly well read Financial Times article published on  Feb 7th named ‘Swiss receive inflow of Russian Oil traders’ cited, the Geneva Trading and Shipping Association claims the Swiss city handles about 75 percent of Russia’s oil exports. With Russia moving ahead as the largest oil producer and these new registrations, Geneva, according to oil executives, has now overtaken London for the 1st European position as an oil trading hub. As the article also states, this is a story in the making with early birds such as Gunvor, Lukoil, Trafigura, Mercuria, Vitol SA, Sempra, Koch,  and Socar playing their part. Upon a closer look, Switzerland it seems has built up a vault of such impressive headlines as far as managing commodities is concerned.

Geneva also boasts being the number one world trading hub for physical trade of grains and oil seeds, with 1/3 of the global volume traded in these commodities and 75% of European and CIS volumes thanks to majors like Cargill, Bunge, and Louis Dreyfus. For sugar, again Geneva shares the first place in Europe with London with each hub managing 1/3 of the global sugar trade. The city of Zug plays the historical hub for Coffee and it enables Switzerland to claim 1/2 of the global volume being traded out of its boundaries.

Along with commodity trading Switzerland is also host to a group of large Consumer Product companies such as Nestle, Kraft and Unilever.  As commodities bear their burdens of volatility these companies are getting more sophisticated in hedging their commodity exposure and adding more fuel to the Swiss based physical market activity. While the consumer products companies have traditionally hedged their exposure to soft commodities such as grains, oil seeds, sugar, coffee etc., current hedging strategies for these companies sketch a larger share in energy markets than expected. Energy based hedges are becoming more prevalent as consumer product conglomerates look at their exposure in areas such as ingredients, packaging materials, energy consumption and so forth while adding further substance to correlations the market can accommodate.

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Posted in: Thoughts on Commodity Management   |   Tagged IP Week

TheStreet took a look at the effect of rising commodity prices on ten food companies.  The companies reviewed were Hershey, Kraft Foods, McDonald's, Starbucks, Kellogg, Sara Lee, Panera Bread, J.M. Smucker, PepsiCo, Chipotle Mexican Grill (read the article).

I have 3 take-aways from the article:

1. This is a long-term issue

“Food inflation – from corn and cocoa to sugar and wheat -  is an increasingly important global issue and unlikely to go away anytime soon.”“The growing middle class in China and India where demand for beef and vegetable-based proteins grew disproportionately to demand for grain-based diets. Converting soft commodities like corn and wheat into protein -- think cows and poultry -- is inefficient, costly and time-consuming. ” 

I’ll add that it’s not just a growing middle class issue but also one of absolute growth in population.  The world added roughly 211,000 mouths to feed yesterday and will continue to do so every day for the foreseeable future.  And lastly, biofuels could become an important element of the equation.  Sugar is used for ethanol, palm oil is used for biodiesel and the U.S. uses roughly 25% of its corn for ethanol.  There is a brewing food vs. fuel debate on the horizon.  

2. Commodity costs will put tremendous pressure on margins in 2011

It’s a common theme echoed across food and beverage companies that rising commodity prices are affecting bottom lines and not all costs can be passed on to consumers through higher prices. 

“Hershey cautioned its margins would continue to be pressured since passing on all the higher ingredient costs to consumers could hurt its sales.”

“Kellogg cautioned this month its margins would remain under pressure as a still-weak economy will lead it to carry some of the higher costs since raising prices could dissuade already-choosy consumers.”

“Kraft Foods said higher input costs led its operating income margin to fall 240 basis points year-over-year.”

“Higher food costs led Sara Lee to miss fiscal-second quarter earnings expectations. It said commodity costs increased by $127 million last quarter, and by $219 in the first half of its fiscal year, partially offset by $123 million in higher prices during the first two quarters, resulting in a net unfavorable commodity cost impact of $96 million.”

“In its fiscal-second quarter earnings report in November, Smucker said escalating commodity costs will continue to present challenges. Its U.S. retail oils and baking segment saw profit decline 10% in the period as costs rose for milk, sugar, and soybean oil.” 

3. Commodity costs have become a CEO/CFO Issue

"McDonald's, Chief Financial Officer, Peter Bensen said it would raise prices where it makes sense but would carry some of the higher costs itself, rather than passing it all on to consumers, many of whom patronize McDonald's for its everyday low-cost food offerings.”

“Kraft Foods, CEO, Irene Rosenfeld said looking ahead, we expect the operating environment to remain challenging, with significant input cost inflation and persistent consumer weakness in many markets."

“PepsiCo, CEO Indra Nooyi,  said high levels of commodity cost inflation will weigh on PepsiCo's results this year.”

“PepsiCo, CFO Hugh F. Johnston,  said he expects PepsiCo's commodity costs to rise between 8% and 9.5% in 2011.”

"Chipotle Mexican Grill, CFO, Jack Hartung said we expect continued inflationary pressure on many of our ingredients, especially chicken, beef and avocados, during the year."

Are you prepared for the sweeping regulatory changes brought on by the Financial Reform Bill? The new financial reform law is not isolated to just banks and will dramatically alter the landscape of energy and commodity trading and hedging.

Triple Point recently hosted a webinar on the Dodd-Frank Act and what you can do now to prepare for the new regulatory requirements.  In case you missed you live webinar, here is a link to download the webinar and view at your convenience.

In this webinar, Michel Zadoroznyj, Vice President of Product Center, Treasury and Regulatory Compliance Division at Triple Point, discussed how the Dodd-Frank Act will impact the future of energy trading, who will be affected by the new rules and the implementation timeline.  Additionally, all attendees learned 8 steps to ensure you have the IT and reporting infrastructure in place to handle new rules on position limits, central clearing, margining and more.

To hear the 8 Steps to Prepare for the Dodd-Frank and learn more about the sweeping regulatory changes, download the webinar below.

Spot trading in Europe’s flagship emissions trading scheme (EU ETS) recently ground to a halt, following the theft of 2m Allowances from the Austrian, Czech and Greek National Registries. Valued at around €30m, this theft is the latest in the series of embarrasments for the European Union, following on from a theft of 1.6m Allowances from the Romanian Registry last year. It appears that the thieves managed to acquires the Account passwords of legitimate users and effect transfers to Accounts of their own choosing.  To make matters worse, the EC was aware of an imminent hacking threat, but didn’t order a lockdown of the Registry system before the theft. The EC maintains that Registry security is a matter for individual Member States. That’s technically true, but a little like failing to tell your neighbour he’s left his front door open, and he promptly gets burgled.

There is little doubt that the missing Allowances will be recovered, as each has a unique ID number and no Allowance ever actually leaves the Registry system. The whole Registry system is now on the lookout for the missing IDs, and many have already been found, but at the time of writing, 1m Allowances were still missing from the latest heist.  However, with 27 EU Registries currently operating, plus numerous others which support EU Allowance transfers, the thieves have had plenty of opportunities to cover their escape through a myriad of transfers.  Point Carbon, the leading industry publication on emissions trading, have spoken to a number of Registry officials, and got quotes like :

“We’ve heard the EUAs went to (an account in) Poland, then to Estonia, then to Liechtenstein, and the latest is they have left Liechtenstein, but we have no idea where they went after that.”

This sorry episode calls in to question the security protocols governing the operation of the Registries. For those of us involved in the EU ETS since its inception, the recent spate of thefts is remarkable not because they occurred, but because they did not occur much earlier and on a bigger scale, and the EU only has itself to blame.

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Credit departments manage billions of dollars of capital and provide a system of checks and balances on company risk, but are chronically under funded and lack regulatory support to provide proper oversight.  In the rush to make a quick buck, organizations often fail to invest the time and energy they should to constantly re-evaluate the strength of their policies and procedures and ultimately conduct business in a way that ensures long-term prudence and prosperity.  Even with recent financial reform regulatory actions under the Dodd-Frank act, no person, department or governmental compliance effort can totally prevent all errors, misrepresentations, or deceptions. It is essential that organizations have their own enterprise credit risk management policies in place to provide transparency and to help ensure compliance. This market perspective presents a number of timely approaches for potential improvements to the regulation and administration of credit risk management issues.

Automated Collateralization / Margining

The International Swaps and Derivatives Association, Inc. (ISDA) recently conducted its 2010 ISDA Margin Survey.  Over the last ten years, the number of executed collateral agreements has grown from 12,000 to over  170,000, with the estimated amount of collateral in circulation growing from $200 billion to over $3.2 trillion, and 83% are bilateral.  Much of the tracking and application of collateral (and its expiration) is still conducted in spreadsheets, with the potential for manual error and/or incorrect calculation.  This can lead to the belief that credit reserves are adequate when they’re not, or increased trading that is not supported by accurate and enforceable risk-mitigation provisions.  Automation and audit-ability of the recording, maintenance, and calculation of collateral and margining is critical to meet the growing demand.  Under Dodd-Frank, evolving requirements for minimums, timeliness, and collateral type will likely increase.  Investments in this area support the business and help to avoid the next company going down because it couldn’t meet liquidity demands.

Credit Rating Agency Independence

Similar to auditing, paying a company to review your own business and provide a rating can represent a potential conflict of interest.  And yet, critical decisions on billions of dollars of investments and contingent collateral requirements are based on those same ratings.  If you look to the consumer sector, where credit bureaus like TransUnion, Equifax, and Experian provide FICO credit scores, revenue comes from the requestor of the score—individuals do not pay for their own evaluation.  Even with the 2006 Credit Rating Agency Reform Act and the SEC implementation in 2007 of the Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organization, NRSRO’s still rely on an “issuer-pays” business model.  These ratings are too important to take a chance-- a subscription-based model would provide significant independence.  Recent reforms mandated by the Dodd-Frank act (Title IX, Subtitle C) look to address the oversight and regulation of rating agencies, but it is still unclear how far and deep the changes will go.  Market leading organizations will pay close attention and provide comments to the rule making process to ensure reform delivers comprehensive, sustained results.

Continue Reading »

Add clothing retailers and manufacturers to the list, along with Consumer Packaged (CP) companies and Industrial Manufacturers, of organizations that are having operating margins squeezed by rising and volatile raw material prices. 

It’s become crystal clear that the commodity bull market is negatively affecting the bottom line of all companies that produce, process, transport (energy costs) or sell a physical product.  The exception, of course, are the companies that own the raw material in the ground – now their bottom lines are being affected but not in a way that would make management or investors unhappy.

The rapid rise in cotton prices is causing major disruption for clothing retailers and manufacturers.  Cotton prices rose 91% in 2010 (see graph below); towards the end of last year, cotton surpassed its highest price in the 141-year history of the New York cotton exchange.  It’s a familiar refrain we’ve witnessed with energy and other commodities.  Supply has not grown fast enough to meet rising demand from China.  “World cotton production is unlikely to catch up with consumption for at least two years,” said Sharon Johnson, senior cotton analyst with the First Capital Group.

Source: Finviz

It’s created a tough choice for clothing retailers and manufacturers of whether to “eat margin” or try to pass along cost increases to consumers.  Remember we are coming off a tough couple of economic years for consumers and it’s unclear how much prices can rise before there is demand destruction.

A quick scan of the news says it all:

“Gap, Wal-Mart Clothing Costs Rise on ‘Terrifying’ Cotton Prices” - Bloomberg News, Nov 15, 2010

“H&M (3rd largest fashion retailer) Q4 Profit Drops 11 Pct Amid High Cotton Prices” – CBS News, Jan. 27, 2011

“It’s really a no-choice situation…Prices  have to come up” - Wesley R. Card, president and chief executive of the Jones Group, the company behind Anne Klein, Nine West and other brands discussing cotton prices

“Levi Strauss said their prices are expected to increase by spring 2011 due to the dramatic rise in the price of cotton around the world” – CBS San Francisco, January 18, 2011

And it’s not just rising prices but volatility that needs to be managed.  Textile manufacturers are reporting that cotton suppliers will no longer quote firm prices in advance for new collections.  “Some manufacturers aren’t taking orders for next year because of fluctuating cotton prices,” J.C. Penney Chief Executive Officer Myron Ullman said Nov. 12.

It appears the entire value chain, growers, producers, textile manufacturers and retailers don’t have the risk management processes and tools in place to manage rising and volatile raw material prices.

Beluga Shipping GmbH licensed Triple Point’s flagship chartering and vessel operations software to profitably manage all pre- and post-fixture activities of its heavy-lift transport operations.

Beluga Group provides a full range of customized transport solutions including shipping, chartering, and fleet management operations. Beluga Group is the worldwide leader in the heavy-lift shipping segment and operates a modern fleet of 72 multipurpose heavy-lift project carriers, equipped to lift a combinable load of up to 1400 tons. The company is based in the Hanseatic city of Bremen, Germany and serves targeted industry sectors including oil and gas, refining, petrochemicals, wind energy, and more.

“Triple Point’s shipping software enables Beluga Group to meet strict requirements for precise handling and transport of the largest, most complex cargoes anywhere in the world,” said Michael Lolk Larsen, managing director, chartering and vessel operations, Triple Point. “We are pleased to add Beluga to our expanding community of world-class shipping customers.”

Triple Point is successfully claiming market share with a diverse group of commodity houses, energy companies, industrial manufacturers, CP companies, and ship owners/operators that have selected Triple Point to manage the supply and distribution of commodities via ocean-going vessel, including: Maestro Shipping, Prime East, Berge Bulk, Ultrabulk, Beluga Shipping, Practica Shipping, United Arab Chemical Carriers (UACC), Atlas Shipping, Navios Maritime, U-Sea Bulk, Oldendorff, Isaphia, Petredec Services, SAB Miller, Hindustan Petroleum-Mittal Energy, Gunvor International B.V., Louis Dreyfus, Bunge, Glencore, Transgrain (Nidera), and Olam International.

Events

Procemin 10th International Mineral Processing Conference

October 15-18, 2013 | Chile

XXV Brazilian National Meeting of Mineral Treatment and Extractive Metallurgy (ENTMME)

October 20-24, 2013 | Brazil



Opinions expressed on this blog are those of its individual contributors, and do not necessarily reflect the views of Triple Point Technology, Inc.