Who Knows What in Risk and Hedging Transactions

Each role holds a piece the others lack. Business units know which exposures are real. Dealers know what the market will offer. Accountants know whether a hedge will qualify. Settlement staff know what actually moved. Trouble starts where these pieces fail to meet, usually around forecasts and hedge documentation.

The business units and the forecast

Sales and procurement teams know when a foreign currency contract is likely to slip, shrink or vanish. They hear it from customers and suppliers long before it reaches a system. Treasury rarely hears it at all until the forecast is revised, and by then the hedge is already on the books.

This matters more than most people expect. A hedge placed against a forecast that quietly dies becomes an open position. Nobody chose to speculate. The information simply stayed in a sales pipeline that treasury cannot see.

Business units also tend to round. They report the exposure they expect, not the range of outcomes. Treasury then hedges a single number as if it were certain.

The dealing desk

Dealers know the market. They know which banks price a given currency pair well, when liquidity thins out, and what a structure really costs once the spread is included. They also know which counterparties have spare credit line and which are close to their limit.

What dealers often lack is the accounting consequence of a trade. A dealer may restructure a hedge to get a better rate and unknowingly break the documented relationship that allowed hedge accounting. The economics improve while the reported earnings become volatile.

Risk and the policy owners

Whoever owns the hedging strategy knows the intent. They know why a ratio was set, which risks the board cares about, and which exceptions were granted informally. Interest rate policy and currency policy are often written by different people, and each knows its own reasoning best.

The gap here is between policy and practice. Strategy owners tend to assume the policy is being followed because no breach was reported. Breach reporting depends on someone noticing, and on limits being coded correctly in the treasury system.

Settlement and the back office

The back office sees what happened, not what was meant to happen. Confirmations, payments and margin calls all pass through it. Settlement staff are frequently the first to spot a trade booked with the wrong value date or a counterparty confirmation that does not match the deal ticket.

They seldom know the purpose of a trade. An unusual deal looks like an error to them, and a genuine error can look routine. When they query something, the answer depends on whether a dealer has time to reply.

Hedge accounting and the ledger

Accountants know the designation rules, the effectiveness tests and how each relationship must be documented at inception. They also know how the general ledger expects entries to arrive and which subledger balances must tie back to it.

They usually learn about a trade after it settles. If documentation was not prepared on the trade date, it cannot be created later without weakening the hedge's standing with auditors. Accountants also find out about cancelled forecasts last, often through a failed effectiveness test that forces a reclassification nobody planned for.

Reconciling the treasury system to the ledger brings these problems into view. Mismatches in fair value, missing designations and unexplained reclassifications tend to surface here. That is late, and the people who could explain them have moved on to new deals.

Where the gaps cause the most damage

The worst problems sit at handoffs. A forecast changes in a business unit and never reaches treasury. A dealer amends a trade and never tells accounting. A settlement exception gets fixed in the payment system but not in the treasury record, so the ledger and the subledger drift apart.

Counterparty exposure is a quieter risk. Dealers track credit lines by bank. Risk tracks total exposure by counterparty group. These views can disagree without anyone noticing until a bank is downgraded.

Interest rate hedges carry their own trap. Debt is often managed by a separate team that knows the refinancing plans. If a loan is repaid early, the swap protecting it may outlive the debt, and the people who manage the swap find out when the cash flows stop matching.

Questions to ask the people who run it

What is documented often differs from what is done. These questions tend to expose the difference:

• When a forecast exposure falls away, who tells treasury, and how quickly does the news actually arrive?
• Who prepares hedge documentation, and is it finished before the trade is executed or afterwards?
• When a dealer amends or rolls a trade, who is told, and is that step written down anywhere?
• Which limits are enforced by the system, and which depend on someone checking a spreadsheet?
• When settlement finds a mismatch, who decides whether it is an error, and how is the treasury record corrected?
• Which reconciliation breaks keep recurring, and why are they accepted?
• Are there informal exceptions to policy that everyone knows about but nobody has approved in writing?
• Who would notice first if a hedged loan were repaid ahead of plan?
• Which manual journal entries are posted to fix hedge accounting results, and who approves them?
• If the most experienced dealer left tomorrow, what knowledge would leave too?

The answers often show that the process holds together through a few individuals who carry context between teams. Any redesign should capture that context before it removes the people or the steps that hold it.

APQC's Process Classification Framework® (PCF) is an open standard developed by APQC, a nonprofit that promotes benchmarking and best practices worldwide. To download the full PCF or to view definitions and measures, please visit www.apqc.org/pcf.