Fundtech white paper sheds light on how receivables hubs capture embedded derivatives noise.
With a rather sharp turn the almost decade-long dollar-weakening cycle reversed in 2014, which has had negative effects on USD-reporting multinationals (see related stories here and here). One of those effects has been seen in derivatives. During a series of NeuGroup peer group discussions in March, some members said they were dealing with increasing mark-to-market valuation “noise” from embedded derivatives.
Embedded derivatives arise when contracts have currency clauses or the contract currency is not the functional currency of either party to a transaction. Accounting standards (ASC 815 and IAS 39) require that embedded derivatives be accounted for separately from the sales contract they are tied to. In quiet markets, their valuations don’t change much but they can rapidly cross materiality thresholds – and show up in earnings – as a result of the stronger dollar and more volatility in the FX markets. That’s also when the auditors start scrutinizing your ability to account for them.
The contract is signed – do you know where your embedded derivatives are?
Companies that don’t have a good handle on what situations cause embedded derivatives to arise and a process for capturing them early in the order-to-cash process, often end up chasing embeddeds when they need to be valued and accounted for on a one-off basis, late in the game, causing extra work and an incomplete picture of the associated exposure. This problem is made worse by the not uncommon situation of multiple ERPs across a large enterprise.
On the other hand, by establishing a centralized hub for automated receivables, companies can “gain 100 percent real-time visibility into embedded derivatives at the beginning of the order-to-cash process – resulting in comprehensive and accurate ASC 815 reporting as well as real-time reporting on all accounts receivable,” according to a white paper, Tackling the Challenge of Embedded Derivatives: How Receivables Automation Enables Earlier Identification and Reduces the Risk of Improper Accounting Treatment, published this week by Fundtech, a provider of financial technology to banks and corporations.
Fundtech makes a potent case for the benefits to be gained from implementing a centralized hub to capture embeddeds, above and beyond the process and automation benefits that may prompt such an implementation in the first place. “The message is clear,” Fundtech says in its white paper. “The recent strengthening of the dollar has thrown the spotlight onto the issue of embedded derivatives, which most companies have by and large ignored for the past few years.”