Hot Topics _rtyrtyrtyrty Risk Management Trends.pdf
JorgeZambranoNorabue
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Feb 25, 2025
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About This Presentation
5ryryrtyrtyrtyrtyrtyrty
Slide Content
Strategic Risk Management Solutions
Risk Management Conference
US Tax Reform
Hot Topics in Risk Management
Risk Management Conference
US Tax Reform
Hot Topics in Risk Management
“Bank of America Merrill Lynch” is the marketing name for the global banking and global markets businesses of Bank of AmericaCorporation. Lending, derivatives, and other commercial banking activities are
performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securitie s, strategic advisory, and other investment banking activities are performed globally
by investment banking affiliates of Bank of America Corporation (“Investment Banking Affiliates”), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional
Clearing Corp., which are both registered broker dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities.
Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured * May Lose Value * Are Not Bank Guaranteed.
These materials have been prepared by one or more subsidiaries of Bank of America Corporation for the client or potential clientto whom such materials are directly addressed and delivered (the “Company”) in
connection with an actual or potential mandate or engagement and may not be used or relied upon for any purpose other than asspecifically contemplated by a written agreement with us. These materials are
based on information provided by or on behalf of the Company and/or other potential transaction participants, from public sources or otherwise reviewed by us. We assume no responsibility for independent
investigation or verification of such information (including, without limitation, data from third party suppliers) and have relied on such information being complete and accurate in all material respects. To the extent
such information includes estimates and forecasts of future financial performance prepared by or reviewed with the managements of the Company and/or other potential transaction participants or obtained from
public sources, we have assumed that such estimates and forecasts have been reasonably prepared on bases reflecting the best cur rently available estimates and judgments of such managements (or, with respect to
estimates and forecasts obtained from public sources, represent reasonable estimates). No representation or warranty, express or implied, is made as to the accuracy or completeness of such information and
nothing contained herein is, or shall be relied upon as, a representation, whether as to the past, the present or the future.These materials were designed for use by specific persons familiar with the business and
affairs of the Company and are being furnished and should be considered only in connection with other information, oral or written, being provided by us in connection herewith. These materials are not intended to
provide the sole basis for evaluating, and should not be considered a recommendation with respect to, any transaction or other matter. These materials do not constitute an offer or solicitation to sell or purchase
any securities and are not a commitment by Bank of America Corporation or any of its affiliates to provide or arrange any financing for any transaction or to purchase any security in connection therewith. These
materials are for discussion purposes only and are subject to our review and assessment from a legal, compliance, accounting policy and risk perspective, as appropriate, following our discussion with the Company.
We assume no obligation to update or otherwise revise these materials. These materials have not been prepared with a view towar d public disclosure under applicable securities laws or otherwise, are intended for
the benefit and use of the Company, and may not be reproduced, disseminated, quoted or referred to, in whole or in part, withoutour prior written consent. These materials may not reflect information known to
other professionals in other business areas of Bank of America Corporation and its affiliates.
Bank of America Corporation and its affiliates (collectively, the “BAC Group”) comprise a full service securities firm and commercial bank engaged in securities, commodities and derivatives trading, foreign exchange
and other brokerage activities, and principal investing as well as providing investment, corporate and private banking, assetand investment management, financing and strategic advisory services and other
commercial services and products to a wide range of corporations, governments and individuals, domestically and offshore, from w hich conflicting interests or duties, or a perception thereof, may arise. In the
ordinary course of these activities, parts of the BAC Group at any time may invest on a principal basis or manage funds that inv est, make or hold long or short positions, finance positions or trade or otherwise effect
transactions, for their own accounts or the accounts of customers, in debt, equity or other securities or financial instruments (including derivatives, bank loans or other obligations) of the Company, potential
counterparties or any other company that may be involved in a transaction. Products and services that may be referenced in the accompanying materials may be provided through one or more affiliates of Bank of
America Corporation. We have adopted policies and guidelines designed to preserve the independence of our research analysts.The BAC Group prohibits employees from, directly or indirectly, offering a favorable
research rating or specific price target, or offering to change a rating or price target to a subject company as consideration o r inducement for the receipt of business or for compensation and the BAC Group prohibits
research analysts from being directly compensated for involvement in investment banking transactions. The views expressed hereinare the views solely of Global Corporate and Investment Banking, and no inference
should be made that the views expressed represent the view of the firm’s research department. We are required to obtain, verify and record certain information that identifies the Company, which information
includes the name and address of the Company and other information that will allow us to identify the Company in accordance, as applicable, with the USA Patriot Act (Title III of Pub. L. 107-56 (signed into law
October 26, 2001)) and such other laws, rules and regulations as applicable within and outside the United States.
We do not provide legal, compliance, tax or accounting advice. Accordingly, any statements contained herein as to tax matters were neither written nor intended by us to be used and cannot be used by any
taxpayer for the purpose of avoiding tax penalties that may be imposed on such taxpayer. If any person uses or refers to any such tax statement in promoting, marketing or recommending a partnership or other
entity, investment plan or arrangement to any taxpayer, then the statement expressed herein is being delivered to support thepromotion or marketing of the transaction or matter addressed and the recipient
should seek advice based on its particular circumstances from an independent tax advisor. Notwithstanding anything that may appear herein or in other materials to the contrary, the Company shall be permitted
to disclose the tax treatment and tax structure of a transaction (including any materials, opinions or analyses relating to such tax treatment or tax structure, but without disclosure of identifying information or,
except to the extent relating to such tax structure or tax treatment, any nonpublic commercial or financial information) on and after the earliest to occur of the date of (i) public announcement of discussions
relating to such transaction, (ii) public announcement of such transaction or (iii) execution of a definitive agreement (withorwithout conditions) to enter into such transaction; provided, however, that if such
transaction is not consummated for any reason, the provisions of this sentence shall cease to apply.Copyright 2016 Bank of America Corporation.
Confidential
Notice to Recipient
performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securitie s, strategic advisory, and other investment banking activities are performed globally
by investment banking affiliates of Bank of America Corporation (“Investment Banking Affiliates”), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional
Clearing Corp., which are both registered broker dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities.
Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured * May Lose Value * Are Not Bank Guaranteed.
These materials have been prepared by one or more subsidiaries of Bank of America Corporation for the client or potential clientto whom such materials are directly addressed and delivered (the “Company”) in
connection with an actual or potential mandate or engagement and may not be used or relied upon for any purpose other than asspecifically contemplated by a written agreement with us. These materials are
based on information provided by or on behalf of the Company and/or other potential transaction participants, from public sources or otherwise reviewed by us. We assume no responsibility for independent
investigation or verification of such information (including, without limitation, data from third party suppliers) and have relied on such information being complete and accurate in all material respects. To the extent
such information includes estimates and forecasts of future financial performance prepared by or reviewed with the managements of the Company and/or other potential transaction participants or obtained from
public sources, we have assumed that such estimates and forecasts have been reasonably prepared on bases reflecting the best cur rently available estimates and judgments of such managements (or, with respect to
estimates and forecasts obtained from public sources, represent reasonable estimates). No representation or warranty, express or implied, is made as to the accuracy or completeness of such information and
nothing contained herein is, or shall be relied upon as, a representation, whether as to the past, the present or the future.These materials were designed for use by specific persons familiar with the business and
affairs of the Company and are being furnished and should be considered only in connection with other information, oral or written, being provided by us in connection herewith. These materials are not intended to
provide the sole basis for evaluating, and should not be considered a recommendation with respect to, any transaction or other matter. These materials do not constitute an offer or solicitation to sell or purchase
any securities and are not a commitment by Bank of America Corporation or any of its affiliates to provide or arrange any financing for any transaction or to purchase any security in connection therewith. These
materials are for discussion purposes only and are subject to our review and assessment from a legal, compliance, accounting policy and risk perspective, as appropriate, following our discussion with the Company.
We assume no obligation to update or otherwise revise these materials. These materials have not been prepared with a view towar d public disclosure under applicable securities laws or otherwise, are intended for
the benefit and use of the Company, and may not be reproduced, disseminated, quoted or referred to, in whole or in part, withoutour prior written consent. These materials may not reflect information known to
other professionals in other business areas of Bank of America Corporation and its affiliates.
Bank of America Corporation and its affiliates (collectively, the “BAC Group”) comprise a full service securities firm and commercial bank engaged in securities, commodities and derivatives trading, foreign exchange
and other brokerage activities, and principal investing as well as providing investment, corporate and private banking, assetand investment management, financing and strategic advisory services and other
commercial services and products to a wide range of corporations, governments and individuals, domestically and offshore, from w hich conflicting interests or duties, or a perception thereof, may arise. In the
ordinary course of these activities, parts of the BAC Group at any time may invest on a principal basis or manage funds that inv est, make or hold long or short positions, finance positions or trade or otherwise effect
transactions, for their own accounts or the accounts of customers, in debt, equity or other securities or financial instruments (including derivatives, bank loans or other obligations) of the Company, potential
counterparties or any other company that may be involved in a transaction. Products and services that may be referenced in the accompanying materials may be provided through one or more affiliates of Bank of
America Corporation. We have adopted policies and guidelines designed to preserve the independence of our research analysts.The BAC Group prohibits employees from, directly or indirectly, offering a favorable
research rating or specific price target, or offering to change a rating or price target to a subject company as consideration o r inducement for the receipt of business or for compensation and the BAC Group prohibits
research analysts from being directly compensated for involvement in investment banking transactions. The views expressed hereinare the views solely of Global Corporate and Investment Banking, and no inference
should be made that the views expressed represent the view of the firm’s research department. We are required to obtain, verify and record certain information that identifies the Company, which information
includes the name and address of the Company and other information that will allow us to identify the Company in accordance, as applicable, with the USA Patriot Act (Title III of Pub. L. 107-56 (signed into law
October 26, 2001)) and such other laws, rules and regulations as applicable within and outside the United States.
We do not provide legal, compliance, tax or accounting advice. Accordingly, any statements contained herein as to tax matters were neither written nor intended by us to be used and cannot be used by any
taxpayer for the purpose of avoiding tax penalties that may be imposed on such taxpayer. If any person uses or refers to any such tax statement in promoting, marketing or recommending a partnership or other
entity, investment plan or arrangement to any taxpayer, then the statement expressed herein is being delivered to support thepromotion or marketing of the transaction or matter addressed and the recipient
should seek advice based on its particular circumstances from an independent tax advisor. Notwithstanding anything that may appear herein or in other materials to the contrary, the Company shall be permitted
to disclose the tax treatment and tax structure of a transaction (including any materials, opinions or analyses relating to such tax treatment or tax structure, but without disclosure of identifying information or,
except to the extent relating to such tax structure or tax treatment, any nonpublic commercial or financial information) on and after the earliest to occur of the date of (i) public announcement of discussions
relating to such transaction, (ii) public announcement of such transaction or (iii) execution of a definitive agreement (withorwithout conditions) to enter into such transaction; provided, however, that if such
transaction is not consummated for any reason, the provisions of this sentence shall cease to apply.Copyright 2016 Bank of America Corporation.
Confidential
Notice to Recipient
US Tax Reform
Question:
“So, can you talk about the moving parts of the Trump administration policies in terms of
any
tax cuts or the border adjustments
and whatever manufacturing
implications may be? And can you just say, is it a net positive or favorable, or not?”
Technology, January25 2017
Question:
And then secondly, I'm interested in your thoughts on the potential for an
international tax reformas part of an infrastructure bill. Obviously, you would
be huge beneficiaries of such a bill because of repatriation.
Can you give us your thoughts on the likelihood of that happening? We've had multiple
discussions over the years about tax reform which never happens. Maybe it'll happen this
time. Just curious to know what your Washington folks are saying. “
Healthcare, January24 2017
1
Tax Reform
Question:
““I was just hoping that you could frame how much total cash … at the end of
last year. I'm guessing you don't have your 10-Q out yet. And also, what
percentage of that was offshore? So we can better understand how much
you would plan to repatriate based upon current cash ex U.S. And maybe you can also speak
to the opportunity for borrowing ex U.S. in the event that
repatriationis allowed to bring back more than the cash
on your books.”
Pharmaceutical, April 2017
Question:
“Just quick clarification and I have a question. The clarification is just it would be helpful if
you gave a little more insight as to what you're expecting in terms of the range of
outcomes for the tax rate,both normalized rate and how much discrete
items could be in the year.”
Technology, January 192017
Question:
“Hey guys, good morning. So we're getting a lot of, obviously, questions around tax policy,
and we've gotten a lot of questions from investors on you guys have a relatively low tax
rate as it is, but there's some conversation we've had with investors that say it can go
substantially lower, something like almost like a zero to 5% type of range. I can't quite get
there just doing the high level math, so maybe if you could just give us some color on
how your tax guys are looking at what's out there from a
tax policy perspective?”
Industrial, January20 2017
Question:
“Okay.On Border Adjustability, the comments were helpful. I'm curious if
you did need to take a large price increase to offset any changes in taxes, could you clarify
if you think distributors and retailers would more just pass on the dollar profit impact of
any price increases from Constellation or do you think they might look to more to maintain
margins, not just offsetting the profit dollar impact?”
“Also, you've shown a willingness to price to offset costs historically in beer. Conceptually,
if a tax change was large in nature, would you be willing
to consider a mid- to high-single-digit price increase if
needed to offset taxes? Is that in the range of scenarios
you run when thinking about the tax changes that you
mentioned earlier?”
Consumer, January5 2017
Source: SeekingAlpha.com public earnings transcripts
2017 -Equity Analyst Questions
“So, can you talk about the moving parts of the Trump administration policies in terms of
any
tax cuts or the border adjustments
and whatever manufacturing
implications may be? And can you just say, is it a net positive or favorable, or not?”
Technology, January25 2017
Question:
And then secondly, I'm interested in your thoughts on the potential for an
international tax reformas part of an infrastructure bill. Obviously, you would
be huge beneficiaries of such a bill because of repatriation.
Can you give us your thoughts on the likelihood of that happening? We've had multiple
discussions over the years about tax reform which never happens. Maybe it'll happen this
time. Just curious to know what your Washington folks are saying. “
Healthcare, January24 2017
1
Tax Reform
Question:
““I was just hoping that you could frame how much total cash … at the end of
last year. I'm guessing you don't have your 10-Q out yet. And also, what
percentage of that was offshore? So we can better understand how much
you would plan to repatriate based upon current cash ex U.S. And maybe you can also speak
to the opportunity for borrowing ex U.S. in the event that
repatriationis allowed to bring back more than the cash
on your books.”
Pharmaceutical, April 2017
Question:
“Just quick clarification and I have a question. The clarification is just it would be helpful if
you gave a little more insight as to what you're expecting in terms of the range of
outcomes for the tax rate,both normalized rate and how much discrete
items could be in the year.”
Technology, January 192017
Question:
“Hey guys, good morning. So we're getting a lot of, obviously, questions around tax policy,
and we've gotten a lot of questions from investors on you guys have a relatively low tax
rate as it is, but there's some conversation we've had with investors that say it can go
substantially lower, something like almost like a zero to 5% type of range. I can't quite get
there just doing the high level math, so maybe if you could just give us some color on
how your tax guys are looking at what's out there from a
tax policy perspective?”
Industrial, January20 2017
Question:
“Okay.On Border Adjustability, the comments were helpful. I'm curious if
you did need to take a large price increase to offset any changes in taxes, could you clarify
if you think distributors and retailers would more just pass on the dollar profit impact of
any price increases from Constellation or do you think they might look to more to maintain
margins, not just offsetting the profit dollar impact?”
“Also, you've shown a willingness to price to offset costs historically in beer. Conceptually,
if a tax change was large in nature, would you be willing
to consider a mid- to high-single-digit price increase if
needed to offset taxes? Is that in the range of scenarios
you run when thinking about the tax changes that you
mentioned earlier?”
Consumer, January5 2017
Source: SeekingAlpha.com public earnings transcripts
2017 -Equity Analyst Questions
2
Highlights of Unified Tax Reform Framework
Reduce Corporate tax rate from 35% to 20%
Move to a territorial tax system
Border adjustability
Immediate expensing of business investments
Partial deductibility on net interest expense
Impose a one- time transition tax
International
Tax System
Eliminates corporate alternative minimum tax (AMT)
Exempts foreign profits when repatriated to the US
Calls for, but does not specify, rules to protect the U.S.
tax base from cross-border income shifting by taxing at a
global minimum rate foreign profits
Enacts a one-time mandatory transition tax on
accumulated overseas earnings
Illiquid foreign assets will be subject to a lower tax rate
than liquid foreign assets, but does not specify the
actual rates
Allows full expensing for new short-lived investments
(e.g. equipment and machinery) for at least five years
No details around long-lived capital investment (e.g.
buildings and structures)
Net interest deductibility on debt will be partially limited
for C corporations
No details about the treatment of interest paid by pass-
through business
Incentives
to Invest
2B
3B
More
Competitive
TaxRate
1A
2A
3A
Cap tax rate for pass-through business at 25%
Calls for, but does not specify, measures to prevent the
recharacterizationof personal income into business
income to prevent individuals from avoiding the top personal tax rate
1B
Highlights of Unified Tax Reform Framework
Reduce Corporate tax rate from 35% to 20%
Move to a territorial tax system
Border adjustability
Immediate expensing of business investments
Partial deductibility on net interest expense
Impose a one- time transition tax
International
Tax System
Eliminates corporate alternative minimum tax (AMT)
Exempts foreign profits when repatriated to the US
Calls for, but does not specify, rules to protect the U.S.
tax base from cross-border income shifting by taxing at a
global minimum rate foreign profits
Enacts a one-time mandatory transition tax on
accumulated overseas earnings
Illiquid foreign assets will be subject to a lower tax rate
than liquid foreign assets, but does not specify the
actual rates
Allows full expensing for new short-lived investments
(e.g. equipment and machinery) for at least five years
No details around long-lived capital investment (e.g.
buildings and structures)
Net interest deductibility on debt will be partially limited
for C corporations
No details about the treatment of interest paid by pass-
through business
Incentives
to Invest
2B
3B
More
Competitive
TaxRate
1A
2A
3A
Cap tax rate for pass-through business at 25%
Calls for, but does not specify, measures to prevent the
recharacterizationof personal income into business
income to prevent individuals from avoiding the top personal tax rate
1B
3
What Do U.S. Investors Expect?
Source: September US Credit Investor Survey
1%
8%
15%
15%
31%
38%
55%
73%
0% 10% 20% 30% 40% 50% 60% 70% 80%
Comprehensive tax reform
Corporate tax rate of 20% or lower
Elimination of (or phasing out) net interest deductibility for corporations
No tax reform
Lower corporate tax rate but greater than 25%
Corporate tax rate greater than 20% but less than or equal to 25%
Repatriation of overseas cash
Tax reform, but not comprehensive
What D o You Expect T o Have Been Announced By The End of 2018?
What Do U.S. Investors Expect?
Source: September US Credit Investor Survey
1%
8%
15%
15%
31%
38%
55%
73%
0% 10% 20% 30% 40% 50% 60% 70% 80%
Comprehensive tax reform
Corporate tax rate of 20% or lower
Elimination of (or phasing out) net interest deductibility for corporations
No tax reform
Lower corporate tax rate but greater than 25%
Corporate tax rate greater than 20% but less than or equal to 25%
Repatriation of overseas cash
Tax reform, but not comprehensive
What D o You Expect T o Have Been Announced By The End of 2018?
4
US Dollar Index (DXY)Repatriation Flows
Stronger USD as aResult of Deemed Repatriation
Available Funds to be Repatriated
USD Could Strengthen as a Result of Deemed Repatriation
At the end of 2016, accumulated amount of undistributed foreign earnings of U.S. Corporates had reached $3.5 trillion (including $2 trillion
in cash), representing the potential amount of dividends to be repatriated
–We estimate companies hold 20-40% of these foreign earnings in local currencies, which could potentially be converted to USD
In 2005, as a result of HIA, companies repatriated $300 billion of foreign earnings (of which we estimate approximately 33% was held in non-
USD assets)
The only year from 2002 –2008 in which the USD rallied was in 2005, during the first HIA, which resulted in a 12.8% appreciation
Source: Bureau of Economic AnalysisSource: Bureau of Economic Analysis Source: Bloomberg, BAML
US Dollar Index (DXY)Repatriation Flows
Stronger USD as aResult of Deemed Repatriation
Available Funds to be Repatriated
USD Could Strengthen as a Result of Deemed Repatriation
At the end of 2016, accumulated amount of undistributed foreign earnings of U.S. Corporates had reached $3.5 trillion (including $2 trillion
in cash), representing the potential amount of dividends to be repatriated
–We estimate companies hold 20-40% of these foreign earnings in local currencies, which could potentially be converted to USD
In 2005, as a result of HIA, companies repatriated $300 billion of foreign earnings (of which we estimate approximately 33% was held in non-
USD assets)
The only year from 2002 –2008 in which the USD rallied was in 2005, during the first HIA, which resulted in a 12.8% appreciation
Source: Bureau of Economic AnalysisSource: Bureau of Economic Analysis Source: Bloomberg, BAML
5
U.S. Corporates’ Repatriation Structure During HIA1
Dividend Repatriations by Region During HIA Dividend Repatriations by Country During HIA
Source: IRS
US Multinationals Repatriated Around $300bn in 2005 as a Result of HIA
Source: IRS
U.S. Corporates’ Repatriation Structure During HIA1
Dividend Repatriations by Region During HIA Dividend Repatriations by Country During HIA
Source: IRS
US Multinationals Repatriated Around $300bn in 2005 as a Result of HIA
Source: IRS
6
Overseas Cash Held By U.S. Corporates
Source: BofAMerrill Lynch Global Research, BofA2017 Risk Management Survey Source: BofAMerrill Lynch Global Research, BofA2017 Risk Management Survey
55% of respondents have over 40% of the company’s cash held overseas
Of the companies who have cash overseas, 50% have indicated that only 20% or less of their cash overseas is held in USD
% of Your Overall Cash Held Overseas % of Your Overseas Cash Held in USD
Overseas Cash Held By U.S. Corporates
Source: BofAMerrill Lynch Global Research, BofA2017 Risk Management Survey Source: BofAMerrill Lynch Global Research, BofA2017 Risk Management Survey
55% of respondents have over 40% of the company’s cash held overseas
Of the companies who have cash overseas, 50% have indicated that only 20% or less of their cash overseas is held in USD
% of Your Overall Cash Held Overseas % of Your Overseas Cash Held in USD
7
How Do U.S. Corporates Think About Repatriation?
Source: BofAMerrill Lynch Global Research, BofA2017 Risk Management SurveySource: BofAMerrill Lynch Global Research, BofA2017 Risk Management Survey
If tax legislation were to occur that allowed foreign earnings to be repatriated at an advantageous tax rates, 61% of respondent s have cash
that they would repatriate
Companies have indicated many uses for repatriated cash in the event of a tax reform. The most common uses are to pay down debt (65%),
share repurchase (46%) and M&A (42%)
Would You Bring Money Back If Foreign Earnings Can
Be Repatriated at Advantageous Tax Rate?
Use of the Proceeds of Repatriated Earnings
How Do U.S. Corporates Think About Repatriation?
Source: BofAMerrill Lynch Global Research, BofA2017 Risk Management SurveySource: BofAMerrill Lynch Global Research, BofA2017 Risk Management Survey
If tax legislation were to occur that allowed foreign earnings to be repatriated at an advantageous tax rates, 61% of respondent s have cash
that they would repatriate
Companies have indicated many uses for repatriated cash in the event of a tax reform. The most common uses are to pay down debt (65%),
share repurchase (46%) and M&A (42%)
Would You Bring Money Back If Foreign Earnings Can
Be Repatriated at Advantageous Tax Rate?
Use of the Proceeds of Repatriated Earnings
8
What Do We Expect U.S. Corporates To Do This Time?
Some overseas cash held in local currency
is currently earning negative rates (e.g.
Europe, Japan) or significantly lower
interest rates than what they could be
earning in USD
Companies may not want to bear the FX
risk of holding their overseas cash in local
currency if they have the opportunity to
repatriate and convert it to USD
1
2
U.S. corporates may have an incentive
to repatriate as soon as practical
their overseas cash held in local
currency, similar to what we saw in
2005, for the following reasons:
Differences
HIA 1.0 Unified Tax Reform
Fundamental
Basics
A Tax Holiday A Tax System Change
Temporary Permanent
Short timeframe to
repatriate foreign
earnings at an reduced
tax rate
One-time mandatory transition tax on
undistributed foreign
earnings. No timeframe
to repatriate foreign
earnings
Exempts foreign profits
when repatriated to the US going forward
Use of
Proceeds
Required to have a
“domestic
reinvestment plan” for
the repatriated earnings
No specific requirement
What Do We Expect U.S. Corporates To Do This Time?
Some overseas cash held in local currency
is currently earning negative rates (e.g.
Europe, Japan) or significantly lower
interest rates than what they could be
earning in USD
Companies may not want to bear the FX
risk of holding their overseas cash in local
currency if they have the opportunity to
repatriate and convert it to USD
1
2
U.S. corporates may have an incentive
to repatriate as soon as practical
their overseas cash held in local
currency, similar to what we saw in
2005, for the following reasons:
Differences
HIA 1.0 Unified Tax Reform
Fundamental
Basics
A Tax Holiday A Tax System Change
Temporary Permanent
Short timeframe to
repatriate foreign
earnings at an reduced
tax rate
One-time mandatory transition tax on
undistributed foreign
earnings. No timeframe
to repatriate foreign
earnings
Exempts foreign profits
when repatriated to the US going forward
Use of
Proceeds
Required to have a
“domestic
reinvestment plan” for
the repatriated earnings
No specific requirement
9
Borrowing At Foreign Subsidiary For Repatriation
Alternative 1:
Repatriate Only Cash Sitting Overseas
Alternative 2:
Repatriate Total Offshore Retained Earnings
Balance Sheet of European Subsidiary
Assets (€mm) Liabilities (€mm)
Current Assets Current Liabilities
Cash €100 A/P €20
A/R €50 Long-term Liabilities
Inventory €100 Debt €80
Long-term Assets Equity
Property €200 Retained Earnings€300
Equipment €50 Other Equity €100
Total Assets €500 Total Liabilities€500
Assets (€mm) Liabilities (€mm)
Current Assets Current Liabilities
Cash €100 A/P €20
A/R €50 Long-term Liabilities
Inventory €100 Debt €80
Long-term Assets Equity
Property €200 Retained Earnings€300
Equipment €50 Other Equity €100
Total Assets €500 Total Liabilities€500
Balance Sheet of European Subsidiary
1US parent repatriates €100mm cash back 1European entity borrows €200mm, the difference
between retained earnings and cash
2US parent can repatriate the entire €300mm
retained earnings back to the U.S. to maximize the
tax benefit
Borrowing At Foreign Subsidiary For Repatriation
Alternative 1:
Repatriate Only Cash Sitting Overseas
Alternative 2:
Repatriate Total Offshore Retained Earnings
Balance Sheet of European Subsidiary
Assets (€mm) Liabilities (€mm)
Current Assets Current Liabilities
Cash €100 A/P €20
A/R €50 Long-term Liabilities
Inventory €100 Debt €80
Long-term Assets Equity
Property €200 Retained Earnings€300
Equipment €50 Other Equity €100
Total Assets €500 Total Liabilities€500
Assets (€mm) Liabilities (€mm)
Current Assets Current Liabilities
Cash €100 A/P €20
A/R €50 Long-term Liabilities
Inventory €100 Debt €80
Long-term Assets Equity
Property €200 Retained Earnings€300
Equipment €50 Other Equity €100
Total Assets €500 Total Liabilities€500
Balance Sheet of European Subsidiary
1US parent repatriates €100mm cash back 1European entity borrows €200mm, the difference
between retained earnings and cash
2US parent can repatriate the entire €300mm
retained earnings back to the U.S. to maximize the
tax benefit
Bank of America Merrill Lynchvs. ACT / Barclays Risk Management Survey Results Comparison
European multinationals tend to be more active in net investment and earnings translation hedges than U.S. multinationalsgiven they regularly
repatriate foreign earnings back to the parent since they operate in territorial tax systems
10
Risk Management Consideration –Territorial Tax
16%
48%
18%
36%
BAML ACT / Barclays
Net Investment Hedges Earnings Translation
North America
79%
Europe
12%
Asia Pacific
8%
Latin America
1%
BAML
North America
9%
Europe
79%
Asia Pacific
12%
ACT / Barclays
Survey Participants by Location
FX Exposures Being HedgedWorldwide vs. Territorial Tax Systems, By Country
European multinationals tend to be more active in net investment and earnings translation hedges than U.S. multinationalsgiven they regularly
repatriate foreign earnings back to the parent since they operate in territorial tax systems
10
Risk Management Consideration –Territorial Tax
16%
48%
18%
36%
BAML ACT / Barclays
Net Investment Hedges Earnings Translation
North America
79%
Europe
12%
Asia Pacific
8%
Latin America
1%
BAML
North America
9%
Europe
79%
Asia Pacific
12%
ACT / Barclays
Survey Participants by Location
FX Exposures Being HedgedWorldwide vs. Territorial Tax Systems, By Country
Deemed Repatriation –Net Investment Hedges
11
1
2
3
4
5
6
7
8
9
Determine amount and currency composition of undistributed
foreign earnings
Determine amount and currency composition of overseas cash
Understand legal entity structure and functional currency of each entity
Determine net investment capacity
Calculate unhedgednet investment capacity
Determine potential repatriation amount by currency
If repatriations in foreign currency, verify if net investment hedges are approved by the company’s risk mgmt policy
If applicable, decide method to assess hedge effectiveness for net investment hedges (spot or forward method)
Determine hedge tenor and hedging instrument of net investment hedge
−Net investment capacity: total equity in foreign subsidiary + intercompany loans designated as long-term in nature
−If applicable, deduct any net investment hedges from total net investment capacity
−Decide whether to borrow at the foreign subsidiary to maximize repatriation amount
Net investment hedges are commonly used to:
–Protect the USD value of non- USD cash held
overseas plus
–Any retained earnings that would be repatriated
by borrowing at the local level
Net Investment Hedges To Protect Dividends
Planning for Potential “Deemed Repatriation”
Accounting for Net Investment Hedges
11
1
2
3
4
5
6
7
8
9
Determine amount and currency composition of undistributed
foreign earnings
Determine amount and currency composition of overseas cash
Understand legal entity structure and functional currency of each entity
Determine net investment capacity
Calculate unhedgednet investment capacity
Determine potential repatriation amount by currency
If repatriations in foreign currency, verify if net investment hedges are approved by the company’s risk mgmt policy
If applicable, decide method to assess hedge effectiveness for net investment hedges (spot or forward method)
Determine hedge tenor and hedging instrument of net investment hedge
−Net investment capacity: total equity in foreign subsidiary + intercompany loans designated as long-term in nature
−If applicable, deduct any net investment hedges from total net investment capacity
−Decide whether to borrow at the foreign subsidiary to maximize repatriation amount
Net investment hedges are commonly used to:
–Protect the USD value of non- USD cash held
overseas plus
–Any retained earnings that would be repatriated
by borrowing at the local level
Net Investment Hedges To Protect Dividends
Planning for Potential “Deemed Repatriation”
Accounting for Net Investment Hedges
12
Potential Market Implications
Tax Reform Could Impact All Markets
Economy expanding / return to growth
Drive further corporate investment, increase employment rate and
consumer spending
Increase in inflation expectations and asset prices. Fed more likely to
hike Fed Funds rate
Reduce the
corporate tax rate
As of 2016, accumulated amount of undistributed foreign earnings of
U.S. Corporateshad reached $3.5 trillion (including $2 trillion cash),
representing the potential amount of dividends to be repatriated
Historically, a $1 increase in repatriations equated to a ~$1 additional
payout to shareholders
(1)
Repatriations could also lead to domestic investments, liability
management, share repurchases, dividends and M&A
Move to a territorial
tax system - >
repatriations
Companies may pursue borrowing in foreign jurisdictions at
subsidiary levels, especially where rates are low or negative (e.g.,
Europe, Japan, U.K.)
Expect to see less debt-financed M&A and more deleveraging
activity
Impact to company’s capital structure
Immediate capital
investments expense /
Partially eliminate of net
interest deductibility
Stronger
USD
Higher US
Rates
Higher US
Equities
__________________
1)BofAMLGlobal Economic Research as of January 20, 2017. Following the Homeland Investment Act (HIA) in 2004, research found that a $1 increase in repatriations was associated with almost a $1 payout to shareholders.
Tighter Credit
Spreads
Potential Market Implications
Tax Reform Could Impact All Markets
Economy expanding / return to growth
Drive further corporate investment, increase employment rate and
consumer spending
Increase in inflation expectations and asset prices. Fed more likely to
hike Fed Funds rate
Reduce the
corporate tax rate
As of 2016, accumulated amount of undistributed foreign earnings of
U.S. Corporateshad reached $3.5 trillion (including $2 trillion cash),
representing the potential amount of dividends to be repatriated
Historically, a $1 increase in repatriations equated to a ~$1 additional
payout to shareholders
(1)
Repatriations could also lead to domestic investments, liability
management, share repurchases, dividends and M&A
Move to a territorial
tax system - >
repatriations
Companies may pursue borrowing in foreign jurisdictions at
subsidiary levels, especially where rates are low or negative (e.g.,
Europe, Japan, U.K.)
Expect to see less debt-financed M&A and more deleveraging
activity
Impact to company’s capital structure
Immediate capital
investments expense /
Partially eliminate of net
interest deductibility
Stronger
USD
Higher US
Rates
Higher US
Equities
__________________
1)BofAMLGlobal Economic Research as of January 20, 2017. Following the Homeland Investment Act (HIA) in 2004, research found that a $1 increase in repatriations was associated with almost a $1 payout to shareholders.
Tighter Credit
Spreads
Risk Management Checklist–Planning for Tax Reform
13
Stronger USD Considerations
Review risk management policies
Extend hedge tenor
Increase hedge ratio
Earnings translation hedges
Net Investment hedges
High carry currency hedges
Higher US Rates Considerations
Liability management
Increased borrowing at subs
Swaps to fixed for heavily floating clients
Swaps to fixed to realize higher interest
cost upfront while still deductible
Swaps to floating for clients looking for
immediate savings
Hedge restructure to pay higher interest
now instead of later
13
Stronger USD Considerations
Review risk management policies
Extend hedge tenor
Increase hedge ratio
Earnings translation hedges
Net Investment hedges
High carry currency hedges
Higher US Rates Considerations
Liability management
Increased borrowing at subs
Swaps to fixed for heavily floating clients
Swaps to fixed to realize higher interest
cost upfront while still deductible
Swaps to floating for clients looking for
immediate savings
Hedge restructure to pay higher interest
now instead of later
US Tax Reform -Appendix
One-Time Transition (“Deemed Repatriation”) Tax
14
Methodologyto Calculate the One-Time Transition Tax (e.g. 10%)
Expected to be Similar to the 5.25% Rate under HIA
†
Under HIA, U.S.Corporations were permitted a one-time deduction of 85% of their extraordinary dividends received
–Allowing the 85% deduction lowered the effective tax rate on repatriated dividends from 35% to 5.25% [15% of taxable
dividends x 35%]
–Taxes were still due on the remaining 15% of repatriations, but firms continued to receive tax credits for foreign income
taxes paid on these earnings
Example under HIA:
U.S. multinational earned $100 abroad and paid $20 in foreign taxes
–85% of the foreign earnings exempt from U.S. repatriation taxes
–15% or $15 were subject to U.S. taxes but including foreign tax credits
–Tax Burden under HIA: $15 x (35% - 20%) = $2.25
–Tax Burden without HIA: $100 x (35% -20%) = $15
Expected Deductions under the One-TimeTransitionTax:
8.75% rate: 75% deduction on the cash portion of the undistributed foreign earnings
3.50% rate: 90% deduction on the non-cash portion of the undistributed foreign earnings
†H.R.4520 -American Jobs Creation Act of 2004, 108
th
Congress
14
Methodologyto Calculate the One-Time Transition Tax (e.g. 10%)
Expected to be Similar to the 5.25% Rate under HIA
†
Under HIA, U.S.Corporations were permitted a one-time deduction of 85% of their extraordinary dividends received
–Allowing the 85% deduction lowered the effective tax rate on repatriated dividends from 35% to 5.25% [15% of taxable
dividends x 35%]
–Taxes were still due on the remaining 15% of repatriations, but firms continued to receive tax credits for foreign income
taxes paid on these earnings
Example under HIA:
U.S. multinational earned $100 abroad and paid $20 in foreign taxes
–85% of the foreign earnings exempt from U.S. repatriation taxes
–15% or $15 were subject to U.S. taxes but including foreign tax credits
–Tax Burden under HIA: $15 x (35% - 20%) = $2.25
–Tax Burden without HIA: $100 x (35% -20%) = $15
Expected Deductions under the One-TimeTransitionTax:
8.75% rate: 75% deduction on the cash portion of the undistributed foreign earnings
3.50% rate: 90% deduction on the non-cash portion of the undistributed foreign earnings
†H.R.4520 -American Jobs Creation Act of 2004, 108
th
Congress
How did capital deployment change? Where did the cash come from?
HIA Uses Return of Capital
Net Repo
of Debt
+
Net
Acquisitions
+ CapEx +Dividends+
Net Share
Repo
+ Other
(2 )
=
$35.5 $11.4 $9.0 ($1.0) $7.8 ($2.8) $1.9 $26.4 $7.8 ($18.6)
15.9
(0.9) (0.4) (2.6) 0.2 (2.1) 1.5 (4.3) (5.4) (1.1)
14.5
(2.4) 11.7 1.7 (0.1) 12.1 (0.1) 22.9 12.4 (10.5)
10.7
(6.9) 16.9 1.7 4.4 2.8 (0.4) 18.5 11.2 (7.3)
9.5
(20.3) 0.7 (0.7) 1.8 15.9 1.0 (1.5) 2.3 3.8
9.4
(1.8) 15.7 (0.4) (0.9) (2.9) (0.1) 9.6 3.2 (6.4)
9.0
7.8 (0.8) (0.3) 0.1 (0.5) (0.5) 5.8 (0.6) (6.4)
8.0
4.7 2.7 (1.3) 0.9 (0.1) (0.3) 6.6 2.5 (4.1)
7.7
(1.2) 1.2 0.2 0.0 3.9 (1.8) 2.4 2.7 0.3
7.4
(0.3) 2.0 2.1 2.3 1.9 (0.3) 7.6 4.9 (2.8)
Total $127.5 ($9.9)+ $58.8 + ($0.5)+ $16.6 + $28.1 + $0.8 = $93.9
= $41.0- ($53.0)
Net Change in
Capital
Deployed
Change in
Cash
Generated
Change in
Balance Sheet
Cash
-
Company
Headline
Repatriated
Cash
=
15
Analyzing How Companies Used Capital During HIA
(1)
Ten Largest Repatriations Under HIA
In the three years following HIA, the ten companies that repatriated the largest amount of funds generally
increased capital deployment towards acquisitions and shareholder return programs
____________________
Sources: Factset, Bloomberg, and company filings.
(1)Analysis reflects the change in cumulative capital allocation between 2002-2004 (pre-HIA) and 2005- 2007 (post- HIA).
(2)Includes effect of exchange rates on cash, and other investing and financing activities.
(3)Represents change in operating cash flow.
(4)Includes changes in cash & cash equivalents and investments.
(3) (4)
HIA Uses Return of Capital
Net Repo
of Debt
+
Net
Acquisitions
+ CapEx +Dividends+
Net Share
Repo
+ Other
(2 )
=
$35.5 $11.4 $9.0 ($1.0) $7.8 ($2.8) $1.9 $26.4 $7.8 ($18.6)
15.9
(0.9) (0.4) (2.6) 0.2 (2.1) 1.5 (4.3) (5.4) (1.1)
14.5
(2.4) 11.7 1.7 (0.1) 12.1 (0.1) 22.9 12.4 (10.5)
10.7
(6.9) 16.9 1.7 4.4 2.8 (0.4) 18.5 11.2 (7.3)
9.5
(20.3) 0.7 (0.7) 1.8 15.9 1.0 (1.5) 2.3 3.8
9.4
(1.8) 15.7 (0.4) (0.9) (2.9) (0.1) 9.6 3.2 (6.4)
9.0
7.8 (0.8) (0.3) 0.1 (0.5) (0.5) 5.8 (0.6) (6.4)
8.0
4.7 2.7 (1.3) 0.9 (0.1) (0.3) 6.6 2.5 (4.1)
7.7
(1.2) 1.2 0.2 0.0 3.9 (1.8) 2.4 2.7 0.3
7.4
(0.3) 2.0 2.1 2.3 1.9 (0.3) 7.6 4.9 (2.8)
Total $127.5 ($9.9)+ $58.8 + ($0.5)+ $16.6 + $28.1 + $0.8 = $93.9
= $41.0- ($53.0)
Net Change in
Capital
Deployed
Change in
Cash
Generated
Change in
Balance Sheet
Cash
-
Company
Headline
Repatriated
Cash
=
15
Analyzing How Companies Used Capital During HIA
(1)
Ten Largest Repatriations Under HIA
In the three years following HIA, the ten companies that repatriated the largest amount of funds generally
increased capital deployment towards acquisitions and shareholder return programs
____________________
Sources: Factset, Bloomberg, and company filings.
(1)Analysis reflects the change in cumulative capital allocation between 2002-2004 (pre-HIA) and 2005- 2007 (post- HIA).
(2)Includes effect of exchange rates on cash, and other investing and financing activities.
(3)Represents change in operating cash flow.
(4)Includes changes in cash & cash equivalents and investments.
(3) (4)
Risk Management Trends
16
Hedging with Options
Extending Hedge Tenor and Increasing HedgeRatio
Evaluating Proposed Changes to Hedge Accounting
2
3
4
Hedging Emerging Market Currencies
5
Tax Reform –Planningfor Repatriations and a Territorial Tax System
Trends Corporate FX Risk Management
Rules-basedHedging for Emerging Markets
Evaluating Risk on a Portfolio Basis
6
7
1
Synthetic Local Currency Funding
8
Hedging with Options
Extending Hedge Tenor and Increasing HedgeRatio
Evaluating Proposed Changes to Hedge Accounting
2
3
4
Hedging Emerging Market Currencies
5
Tax Reform –Planningfor Repatriations and a Territorial Tax System
Trends Corporate FX Risk Management
Rules-basedHedging for Emerging Markets
Evaluating Risk on a Portfolio Basis
6
7
1
Synthetic Local Currency Funding
8
17
2. Hedging with Options
Historical 1-Year Implied Volatilities Since Jan 2017
Implied Volatilities Have Decreased Significantly Since the Beginning of the Year
Implied volatility has decreased since the beginning of the year for several reasons:
–Given the political environment in the US, Europe and the rest of the world and the uncertainty of the potential outcomes (e.g. tax reform
Brexit, etc.), institutional investors have been staying on the side lines
–The lack of trading activity has impacted realized volatility, which has decreased considerably in the last couple of months
–The reduction in realized volatility has brought down implied volatilities
Corporations with option hedging programs have been taking advantage of the current low volatility environment to place addition al hedges
and extend tenor
2. Hedging with Options
Historical 1-Year Implied Volatilities Since Jan 2017
Implied Volatilities Have Decreased Significantly Since the Beginning of the Year
Implied volatility has decreased since the beginning of the year for several reasons:
–Given the political environment in the US, Europe and the rest of the world and the uncertainty of the potential outcomes (e.g. tax reform
Brexit, etc.), institutional investors have been staying on the side lines
–The lack of trading activity has impacted realized volatility, which has decreased considerably in the last couple of months
–The reduction in realized volatility has brought down implied volatilities
Corporations with option hedging programs have been taking advantage of the current low volatility environment to place addition al hedges
and extend tenor
18
Guidance Given on Restructuring
PPL Guidance Given on Restructuring
2. Hedging with Options
“…we took the remaining 2016 in-the-money hedges and executed restrikes, moving that value to 2018. This lowered our 2016
earnings by about $0.06. …this significantly reduces the effect a decline in the exchange rate could have on future earnings.”
“..we also have the opportunity to utilize up to $0.05 of our 2017 hedge gains to further reduce our exposure to foreign currency in
2019”
PPL Response to Declining FX Rate
Source: PPL Company Presentation 12 Oct 2016
Leveraged strong year-to-date earnings
Executed 6 cents of 2016 restrikes, moving hedge value to 2018
Average hedge rate now 1.38 for 76% of 2018 earnings
Ability to utilize upside in 2018 to execute restrikes in 2019
Identified up to 5 cents in 2017 earnings to provide for additional restrikes
Approach: hedge earningstranslation and restructure gains to decrease volatility in FX Rates for 2018
Guidance Given on Restructuring
PPL Guidance Given on Restructuring
2. Hedging with Options
“…we took the remaining 2016 in-the-money hedges and executed restrikes, moving that value to 2018. This lowered our 2016
earnings by about $0.06. …this significantly reduces the effect a decline in the exchange rate could have on future earnings.”
“..we also have the opportunity to utilize up to $0.05 of our 2017 hedge gains to further reduce our exposure to foreign currency in
2019”
PPL Response to Declining FX Rate
Source: PPL Company Presentation 12 Oct 2016
Leveraged strong year-to-date earnings
Executed 6 cents of 2016 restrikes, moving hedge value to 2018
Average hedge rate now 1.38 for 76% of 2018 earnings
Ability to utilize upside in 2018 to execute restrikes in 2019
Identified up to 5 cents in 2017 earnings to provide for additional restrikes
Approach: hedge earningstranslation and restructure gains to decrease volatility in FX Rates for 2018
19
[Replace with
Horizontal (2x1) size chart
or other object]
FX Hedging Status as of Oct 10, 2016
[Replace with
Horizontal (2x1) size chart
or other object]
FX Hedging Status as of August 8, 2016
PPL -Changes to Effective Hedge Rates & Notional
2. Hedging with Options
GBP Foreign Currency 2016 2017 2018
Percentage Hedged 87% 95% 50%
Hedged Rate (GBP / USD) 1.60 1.32 1.30
(1)
Budgeted Rate on Open Position 1.30 1.30 1.30
(1)
2018hedges are a combination of average- rate forwards and zero -cost collars.
Average hedge rates based on the average forward rate and the average floor in the
collars.
GBP Foreign Currency 2016 2017 2018
Percentage Hedged 87% 95% 76%
Hedged Rate (GBP / USD) 1.32 1.32 1.38
(1)
Budgeted Rate on Open Position 1.30 1.30 1.30
(1)
2018hedges are a combination of average- rate forwards and zero -cost collars.
Average hedge rates based on the average forward rate and the average floor in the
collars.
Source: PPL Company Presentations and 10-k
[Replace with
Horizontal (2x1) size chart
or other object]
FX Hedging Status as of Oct 10, 2016
[Replace with
Horizontal (2x1) size chart
or other object]
FX Hedging Status as of August 8, 2016
PPL -Changes to Effective Hedge Rates & Notional
2. Hedging with Options
GBP Foreign Currency 2016 2017 2018
Percentage Hedged 87% 95% 50%
Hedged Rate (GBP / USD) 1.60 1.32 1.30
(1)
Budgeted Rate on Open Position 1.30 1.30 1.30
(1)
2018hedges are a combination of average- rate forwards and zero -cost collars.
Average hedge rates based on the average forward rate and the average floor in the
collars.
GBP Foreign Currency 2016 2017 2018
Percentage Hedged 87% 95% 76%
Hedged Rate (GBP / USD) 1.32 1.32 1.38
(1)
Budgeted Rate on Open Position 1.30 1.30 1.30
(1)
2018hedges are a combination of average- rate forwards and zero -cost collars.
Average hedge rates based on the average forward rate and the average floor in the
collars.
Source: PPL Company Presentations and 10-k
20
Extending Tenor Is Attractive Given Positive Forward Points
3. Increasing Hedge Ratio and Tenor
For some currency pairs, increasing tenor has become very attractive
Long-term forward points as a percent of spot are close to all- time highs for some currencies
Current EURUSD forward points are
close to all- time highs
–1Y: 2.1% (98
th
percentile)
–2Y: 4.4% (97
th
percentile)
–3Y: 6.6% (96
th
percentile)
–4Y: 8.8% (96
th
percentile)
EUR Forward Points as a % of Spot
(6%)
(4%)
(2%)
0%
2%
4%
6%
8%
10%
12%
Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16
1Y 2Y 3Y 4Y
Extending Tenor Is Attractive Given Positive Forward Points
3. Increasing Hedge Ratio and Tenor
For some currency pairs, increasing tenor has become very attractive
Long-term forward points as a percent of spot are close to all- time highs for some currencies
Current EURUSD forward points are
close to all- time highs
–1Y: 2.1% (98
th
percentile)
–2Y: 4.4% (97
th
percentile)
–3Y: 6.6% (96
th
percentile)
–4Y: 8.8% (96
th
percentile)
EUR Forward Points as a % of Spot
(6%)
(4%)
(2%)
0%
2%
4%
6%
8%
10%
12%
Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16
1Y 2Y 3Y 4Y
21
Extending Tenor Helps Reduce Year-over-Year Volatility
3. Increasing Hedge Ratio and Tenor
Some companies experienced significant year- over-year changes in their hedge rate as a result of the rapid USD appreciation in the last
couple of years
–These companies had hedging programs with tenors of 12-month or under
–They also experienced margin compression given they were not able to adjust prices to fully offset the adverse currency movements
As a result, some companies increased their hedging tenors from 12 months to 18 to 24 months out using a layered approach
0.80
0.90
1.00
1.10
1.20
1.30
1.40
1.50
1.60
Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Unhedged 12M Layered24M Layered36M Layered
Backtesting Results of Hedging EURUSD Year-over-Year Volatility
10.5%
10.7%
8.3%
6.4%
5.0%
Unhedged
12M Static
12M Layered
24M Layered
36M Layered
Extending Tenor Helps Reduce Year-over-Year Volatility
3. Increasing Hedge Ratio and Tenor
Some companies experienced significant year- over-year changes in their hedge rate as a result of the rapid USD appreciation in the last
couple of years
–These companies had hedging programs with tenors of 12-month or under
–They also experienced margin compression given they were not able to adjust prices to fully offset the adverse currency movements
As a result, some companies increased their hedging tenors from 12 months to 18 to 24 months out using a layered approach
0.80
0.90
1.00
1.10
1.20
1.30
1.40
1.50
1.60
Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Unhedged 12M Layered24M Layered36M Layered
Backtesting Results of Hedging EURUSD Year-over-Year Volatility
10.5%
10.7%
8.3%
6.4%
5.0%
Unhedged
12M Static
12M Layered
24M Layered
36M Layered
22
Selected Disclosures
Beginning in the second quarter of 2014, 3M began extending the maximum length of time over
which it hedges its exposure to the variability in future cash flows of the forecasted transactions from
a previous term of 12 months to a longer term of 24 months, with certain currencies being extended
further to 36 months starting in the first quarter of 2015.
3. Increasing Hedge Ratio and Tenor
____________________
Source: Company filings
Cash Flow
Hedges
Earnings
Hedges
Beginning in the second quarter of 2013 and continuing throughout 2015, Corning entered into a
series of zero cost average rate collars and average rate forwards to hedge the translation impact of
Japanese yen on Corning's projected 2015, 2016 and 2017 net income.
Additionally, in January 2016, Corning extended its foreign exchange hedging program to hedge a
significant portion of its projected yen exposure for the period 2018 through 2022.
Selected Disclosures
Beginning in the second quarter of 2014, 3M began extending the maximum length of time over
which it hedges its exposure to the variability in future cash flows of the forecasted transactions from
a previous term of 12 months to a longer term of 24 months, with certain currencies being extended
further to 36 months starting in the first quarter of 2015.
3. Increasing Hedge Ratio and Tenor
____________________
Source: Company filings
Cash Flow
Hedges
Earnings
Hedges
Beginning in the second quarter of 2013 and continuing throughout 2015, Corning entered into a
series of zero cost average rate collars and average rate forwards to hedge the translation impact of
Japanese yen on Corning's projected 2015, 2016 and 2017 net income.
Additionally, in January 2016, Corning extended its foreign exchange hedging program to hedge a
significant portion of its projected yen exposure for the period 2018 through 2022.
23
4. Proposed Changes to Hedge Accounting
US GAAP
Requires the entire change in fair value of a hedging instrument to be presented in the same income
statement line as the hedged item.
For users of options where the time value cost of the option has been excluded from the hedge
relationship, the impact from the change in the option’s time value will now be presented “above the
line” rather than “below the line”
Negative
Game changer
Positive
Game changers
Permits entities to hedge contractually specified components in cash flow hedges of
forecasted purchases and sales of nonfinancial items (e.g. commodity risks)
Permits entities to hedge contractually specified interest rates in cash flow hedges of interest
rate risk of a variable-rate financial instrument
Permits partial term fair value hedges of interest rate risk (swap debt to floating interest rate)
Spot/Forward election for net investment hedging is no longer a one- time irrevocable election
Impact from excluded components would be amortized to earnings
Much simpler hedge effectiveness requirements
Eliminates measurement of hedge ineffectiveness
On Aug 28
th
, 2017, the Financial Accounting Standards Board (FASB) released its long-awaited update
to hedge accounting standards, Hedge Accounting Standards Update (ASU) 2017-12
Mandatory effective date beginning January 2019 => early adoption will be permitted in any quarterly
or annual period
Timing and
Adoption
4. Proposed Changes to Hedge Accounting
US GAAP
Requires the entire change in fair value of a hedging instrument to be presented in the same income
statement line as the hedged item.
For users of options where the time value cost of the option has been excluded from the hedge
relationship, the impact from the change in the option’s time value will now be presented “above the
line” rather than “below the line”
Negative
Game changer
Positive
Game changers
Permits entities to hedge contractually specified components in cash flow hedges of
forecasted purchases and sales of nonfinancial items (e.g. commodity risks)
Permits entities to hedge contractually specified interest rates in cash flow hedges of interest
rate risk of a variable-rate financial instrument
Permits partial term fair value hedges of interest rate risk (swap debt to floating interest rate)
Spot/Forward election for net investment hedging is no longer a one- time irrevocable election
Impact from excluded components would be amortized to earnings
Much simpler hedge effectiveness requirements
Eliminates measurement of hedge ineffectiveness
On Aug 28
th
, 2017, the Financial Accounting Standards Board (FASB) released its long-awaited update
to hedge accounting standards, Hedge Accounting Standards Update (ASU) 2017-12
Mandatory effective date beginning January 2019 => early adoption will be permitted in any quarterly
or annual period
Timing and
Adoption
24
4. Proposed Changes to Hedge Accounting
IFRS 9
Hedge ineffectiveness measurement is still required
The cross currency basis is an inherent source of ineffectiveness
The spot method cannot be applied on an undiscounted basis
Negative
Game changer
Positive
Game changers
Permits entities to hedge commodity risks provided that such risks are separately identifiable
and reliably measured
Hedge effectiveness calculations are largely relaxed. Requirements for hedge effectiveness
now largely rely on an “economic relationship” rather than 80%/125% bright line testing
Improved treatment for costs of hedging, particularly regarding the time value of options
Interest rate differentials on cross currency swaps can be amortized through P&L for net
investment hedges
The final standard (IFRS 9) was issued in July 2014. The mandatory adoption date for most countries is January 1, 2018.
While the IASB continues work on its macro hedging project, the hedge accounting aspects of IAS 39 may still be used
Timing and
Adoption
4. Proposed Changes to Hedge Accounting
IFRS 9
Hedge ineffectiveness measurement is still required
The cross currency basis is an inherent source of ineffectiveness
The spot method cannot be applied on an undiscounted basis
Negative
Game changer
Positive
Game changers
Permits entities to hedge commodity risks provided that such risks are separately identifiable
and reliably measured
Hedge effectiveness calculations are largely relaxed. Requirements for hedge effectiveness
now largely rely on an “economic relationship” rather than 80%/125% bright line testing
Improved treatment for costs of hedging, particularly regarding the time value of options
Interest rate differentials on cross currency swaps can be amortized through P&L for net
investment hedges
The final standard (IFRS 9) was issued in July 2014. The mandatory adoption date for most countries is January 1, 2018.
While the IASB continues work on its macro hedging project, the hedge accounting aspects of IAS 39 may still be used
Timing and
Adoption
25
4. Proposed Changes to Hedge Accounting
US GAAP IFRS
Changes to IFRS and GAAP
No ineffectiveness for effective hedges
Partial term fair value hedging allowed
De minimis allowance –relaxation of timing
mismatches
Amortization of interest savings with cross currency
swaps under net investment hedging Time value can now be deferred or amortized
Relaxed effectiveness testing
Ineffectiveness must be measured
Amortization of interest savings with cross currency
swaps
More commodity exposures will qualify
Amortization for hedge costs (includes forward points & options)
4. Proposed Changes to Hedge Accounting
US GAAP IFRS
Changes to IFRS and GAAP
No ineffectiveness for effective hedges
Partial term fair value hedging allowed
De minimis allowance –relaxation of timing
mismatches
Amortization of interest savings with cross currency
swaps under net investment hedging Time value can now be deferred or amortized
Relaxed effectiveness testing
Ineffectiveness must be measured
Amortization of interest savings with cross currency
swaps
More commodity exposures will qualify
Amortization for hedge costs (includes forward points & options)
26
4. Proposed Changes to Hedge Accounting
Updating Policies and Considerations for IFRS 9
Risk Management Objectives
Risk Management Process
Risk Management Infrastructure
Policies
And
Procedures
1.
2.
3.
4.
Roles
and
Responsibilities
Control
Activities
Technology
Example Holistic Risk Management Policy
Table of Contents
SectionI……………………. …………….......… ........Objectives
SectionII…………Exposure IdentificationandDefinition
SectionIII……………………. ………..FXHedgingFramework
SectionIV…….…………CommodityHedgingFramework
SectionV……….………InterestRateHedgingFramework
SectionVI………………. ……..CounterpartyRequirements
SectionVII………………………………………… Documentation
SectionVIII…………………………..… .SegregationofDuties
4. Proposed Changes to Hedge Accounting
Updating Policies and Considerations for IFRS 9
Risk Management Objectives
Risk Management Process
Risk Management Infrastructure
Policies
And
Procedures
1.
2.
3.
4.
Roles
and
Responsibilities
Control
Activities
Technology
Example Holistic Risk Management Policy
Table of Contents
SectionI……………………. …………….......… ........Objectives
SectionII…………Exposure IdentificationandDefinition
SectionIII……………………. ………..FXHedgingFramework
SectionIV…….…………CommodityHedgingFramework
SectionV……….………InterestRateHedgingFramework
SectionVI………………. ……..CounterpartyRequirements
SectionVII………………………………………… Documentation
SectionVIII…………………………..… .SegregationofDuties
27
Most Emerging Market Currencies Don’t Depreciate More Than the Forward Points on Average
5. Hedging Emerging Market Currencies
The graph shows the relationship, over the past 10 years, between average 1-year
–Currency % appreciation/(depreciation) vs.
–Forward points cost
Over the past 10 years, BRL has on average
–Depreciated only a bit over 2%
–Cost over 7% in forward points to hedge
Source: Bloomberg, BofAML
Average 1yr Forward Points
(prior 10 years, % of USD)
Average 1yr Currency Appreciation/(Depreciation)
(prior 10 years, % of USD)
EM currencies are not likely to
depreciate more than the forward
points on average; thus the negative
carry will just be a net cost
Most Emerging Market Currencies Don’t Depreciate More Than the Forward Points on Average
5. Hedging Emerging Market Currencies
The graph shows the relationship, over the past 10 years, between average 1-year
–Currency % appreciation/(depreciation) vs.
–Forward points cost
Over the past 10 years, BRL has on average
–Depreciated only a bit over 2%
–Cost over 7% in forward points to hedge
Source: Bloomberg, BofAML
Average 1yr Forward Points
(prior 10 years, % of USD)
Average 1yr Currency Appreciation/(Depreciation)
(prior 10 years, % of USD)
EM currencies are not likely to
depreciate more than the forward
points on average; thus the negative
carry will just be a net cost
28
Hedging Tenor and Hedging Instrument Are Critical When Hedging EM Currencies
5. Hedging Emerging Market Currencies
Forwards transacted with negative carry are more likely to suffer cash losses
The performance of options over forwards when paying away the forward points may be one of the most compelling arguments to justify the
use of options over forwards
Extending hedging tenor with forwards when earnings the forward points has proven to be beneficial as the currencies don’t depreciate by
more than the forward points on average
Source: Bloomberg, BofAML
Paying Away Forward Points:
Options Outperformed Fwds; Tenor Limited to <1Y
Earning Forward Points:
Longer Dated FwdsOutperformed Shorter Dated Fwds
Hedging Tenor and Hedging Instrument Are Critical When Hedging EM Currencies
5. Hedging Emerging Market Currencies
Forwards transacted with negative carry are more likely to suffer cash losses
The performance of options over forwards when paying away the forward points may be one of the most compelling arguments to justify the
use of options over forwards
Extending hedging tenor with forwards when earnings the forward points has proven to be beneficial as the currencies don’t depreciate by
more than the forward points on average
Source: Bloomberg, BofAML
Paying Away Forward Points:
Options Outperformed Fwds; Tenor Limited to <1Y
Earning Forward Points:
Longer Dated FwdsOutperformed Shorter Dated Fwds
29
Rules-Based Hedging for Emerging Market Currencies
6. Rules-Based Hedging for EM Currencies
Since high carry currencies, on average, don’t tend to depreciate by the forward points, hedging with forward contracts on a systematic basis
tend to generate losses
Ideally, company will only hedge using forward contracts when the currency is expected to depreciate by more than the forwardpoints
Volatility increases as the currency depreciates for most emerging market currencies
–When volatility is elevated compared to historical standards, the currency depreciation might have already occurred
–Hence, hedging with forward contracts may generate derivative losses as the currency may not depreciate by the forward points
Some companies use a rules-based approach to hedging EM currencies, allowing them to deviate from their standard approach to improve
risk management and profitability
Source: Bloomberg, BofAML
USDBRL USDBRL
Rules-Based Hedging for Emerging Market Currencies
6. Rules-Based Hedging for EM Currencies
Since high carry currencies, on average, don’t tend to depreciate by the forward points, hedging with forward contracts on a systematic basis
tend to generate losses
Ideally, company will only hedge using forward contracts when the currency is expected to depreciate by more than the forwardpoints
Volatility increases as the currency depreciates for most emerging market currencies
–When volatility is elevated compared to historical standards, the currency depreciation might have already occurred
–Hence, hedging with forward contracts may generate derivative losses as the currency may not depreciate by the forward points
Some companies use a rules-based approach to hedging EM currencies, allowing them to deviate from their standard approach to improve
risk management and profitability
Source: Bloomberg, BofAML
USDBRL USDBRL
($5.0)
($4.0)
($3.0)
($2.0)
($1.0)
$0.0
$1.0
$2.0
$3.0
Oct
-
08
Oct
-
09
Oct
-
10
Oct
-
11
Oct
-
12
Oct
-
13
Oct
-
14
Oct
-
15
Oct
-
16
in $ Millions
Monthly FX Gains / Losses at Maturity Based on a 1-Year
Rolling Hedging Strategies
Based on a Long IDR 100 Billion Per Month vs. USD
1Y Forwards 1Y ATMF 1Y Rules-Based
Oct-08Oct-09Oct-10Oct-11Oct-12Oct-13Oct-14Oct-15Nov-16
Periods When Rule Indicated to Hedge for USDIDR
Hedge
No
Hedge
($40)
($30)
($20)
($10)
$0
$10
$20
$30
$40
Oct
-
08
Oct
-
09
Oct
-
10
Oct
-
11
Oct
-
12
Oct
-
13
Oct
-
14
Oct
-
15
Oct
-
16
in $ Millions
Cumulative FX Gains / Losses at Maturity Based on a 1-Year
Rolling Hedging Strategies
Based on a Long IDR 100 Billion Per Month vs. USD
1Y Forwards 1Y ATMF 1Y Rules-Based
30
6. Rules-Based Hedging for EM Currencies
Backtest: Monthly Performance (USDIDR) Backtest: Cumulative Performance (USDIDR)
1Y ATMFImplied VolatilityBelow8-Year
Average of 1Y ATMF Implied Volatility
Hedge with 1- Year
Forwards
1Y ATMFImplied VolatilityAbove8-Year
Average of 1Y ATMF Implied Volatility
No Hedge
Volatility Signal Frequency Volatility Signal Was Triggered (USDIDR)
($4.0)
($3.0)
($2.0)
($1.0)
$0.0
$1.0
$2.0
$3.0
Oct
-
08
Oct
-
09
Oct
-
10
Oct
-
11
Oct
-
12
Oct
-
13
Oct
-
14
Oct
-
15
Oct
-
16
in $ Millions
Monthly FX Gains / Losses at Maturity Based on a 1-Year
Rolling Hedging Strategies
Based on a Long IDR 100 Billion Per Month vs. USD
1Y Forwards 1Y ATMF 1Y Rules-Based
Oct-08Oct-09Oct-10Oct-11Oct-12Oct-13Oct-14Oct-15Nov-16
Periods When Rule Indicated to Hedge for USDIDR
Hedge
No
Hedge
($40)
($30)
($20)
($10)
$0
$10
$20
$30
$40
Oct
-
08
Oct
-
09
Oct
-
10
Oct
-
11
Oct
-
12
Oct
-
13
Oct
-
14
Oct
-
15
Oct
-
16
in $ Millions
Cumulative FX Gains / Losses at Maturity Based on a 1-Year
Rolling Hedging Strategies
Based on a Long IDR 100 Billion Per Month vs. USD
1Y Forwards 1Y ATMF 1Y Rules-Based
30
6. Rules-Based Hedging for EM Currencies
Backtest: Monthly Performance (USDIDR) Backtest: Cumulative Performance (USDIDR)
1Y ATMFImplied VolatilityBelow8-Year
Average of 1Y ATMF Implied Volatility
Hedge with 1- Year
Forwards
1Y ATMFImplied VolatilityAbove8-Year
Average of 1Y ATMF Implied Volatility
No Hedge
Volatility Signal Frequency Volatility Signal Was Triggered (USDIDR)
31
How Our Clients Quantify Risk – Survey Results
7. Risk Quantification on a Portfolio Basis
Considerations
Notional of
Exposures
Value-at-Risk of
IndividualExposure
Value-at-Riskon
Portfolio Basis
Size of Exposure
Volatility of Exchange Rate
Correlation Benefits
Quantifies if Hedging Increases Risk
Source: BofAML Global Research Risk Management Survey
How Our Clients Quantify Risk – Survey Results
7. Risk Quantification on a Portfolio Basis
Considerations
Notional of
Exposures
Value-at-Risk of
IndividualExposure
Value-at-Riskon
Portfolio Basis
Size of Exposure
Volatility of Exchange Rate
Correlation Benefits
Quantifies if Hedging Increases Risk
Source: BofAML Global Research Risk Management Survey
32
BMW
7. Risk Quantification on a Portfolio Basis
Identify
Exposure
Consider any hedges
Quantify Net Risk Set Risk Tolerance
Quantifying Forecasted Risk
The starting point for analyzing currency
risk with this model is the identification of
forecast foreign currency transactions or
“exposures”. Calculate Risk
The potential negative impact on earnings is computed for each currency for the following financial year on the basis of current market prices and exposures to a confidence level of 95% and a holding period of up to one year
Calculate Net Exposure
In the next stage, these exposures are compared to all hedges that are in place. The net cash flow surplus represents an uncovered risk position.
Determine Materiality
The risk level is approximated in the case of risks measured on the basis of “value at risk” and “cash flow at risk” models. These approximations flow into the assessment of the significance of the risks
Source: BMW Annual Report 2016
BMW
7. Risk Quantification on a Portfolio Basis
Identify
Exposure
Consider any hedges
Quantify Net Risk Set Risk Tolerance
Quantifying Forecasted Risk
The starting point for analyzing currency
risk with this model is the identification of
forecast foreign currency transactions or
“exposures”. Calculate Risk
The potential negative impact on earnings is computed for each currency for the following financial year on the basis of current market prices and exposures to a confidence level of 95% and a holding period of up to one year
Calculate Net Exposure
In the next stage, these exposures are compared to all hedges that are in place. The net cash flow surplus represents an uncovered risk position.
Determine Materiality
The risk level is approximated in the case of risks measured on the basis of “value at risk” and “cash flow at risk” models. These approximations flow into the assessment of the significance of the risks
Source: BMW Annual Report 2016
33
BMW
7. Risk Quantification on a Portfolio Basis
Identify
Exposure
Consider any hedges
Quantify Net Risk Set Risk Tolerance
Source: BMW Annual Report 2016
BMW
7. Risk Quantification on a Portfolio Basis
Identify
Exposure
Consider any hedges
Quantify Net Risk Set Risk Tolerance
Source: BMW Annual Report 2016
-100
-80
-60
-40
-20
0
20
40
Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Basis Points
3m JPY LIBOR 3m EURIBOR 3m CHF LIBOR
34
8. Synthetic Local Currency Funding
Access Negative Rates otherwise Floored in Lending Agreements
Cross Currency Basis –A Benefit for Swapping to FX Debt from USD
-140
-120
-100
-80
-60
-40
-20
0
20
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Cross Currency Basis (bps)
USDJPY EURUSD USDCHF
-80
-60
-40
-20
0
20
40
Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Basis Points
3m JPY LIBOR 3m EURIBOR 3m CHF LIBOR
34
8. Synthetic Local Currency Funding
Access Negative Rates otherwise Floored in Lending Agreements
Cross Currency Basis –A Benefit for Swapping to FX Debt from USD
-140
-120
-100
-80
-60
-40
-20
0
20
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Cross Currency Basis (bps)
USDJPY EURUSD USDCHF
*Assumes credit spread of 125bps
**Assumes 5-year 3M LIBOR vs.3M EURIBOR cross currency swap. Excludes credit charges. Current 3M LIBOR 1.31722%; Current 3M EURIBOR -0.329%35
8. Synthetic Local Currency Funding
Given favorable dynamics in the cross currency basis and interest rate differentials, corporations are swapping USD to
lock in interest savings
2.57%
1.25%
0.49%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
USD Revolver Draw EUR Revolver Draw USD Swapped to EUR
Cost of Funds – Three Approaches
Currently, interest rates in Europe are negative and at historical
lows
Companies can borrow directly in EUR from their credit facility,
but most agreements have a 0% floor
–The chart on the right shows the effective cost of funding
therefore is simply the company’s credit spread
However, synthetic funding through Cross Currency Swap can
unlock the value of negative interest rates
In addition to not having a 0% floor, cross currency swaps
monetize a supply/demand imbalance for US dollars known as the
cross currency basis
–As demand for US dollar funding has increased, the cross
currency basis swap rate has fallen sharply and has become
strongly negative
–The elevated cross currency basis has created opportunities
for interest savings through synthetic funding and only exist
in derivative market
**Assumes 5-year 3M LIBOR vs.3M EURIBOR cross currency swap. Excludes credit charges. Current 3M LIBOR 1.31722%; Current 3M EURIBOR -0.329%35
8. Synthetic Local Currency Funding
Given favorable dynamics in the cross currency basis and interest rate differentials, corporations are swapping USD to
lock in interest savings
2.57%
1.25%
0.49%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
USD Revolver Draw EUR Revolver Draw USD Swapped to EUR
Cost of Funds – Three Approaches
Currently, interest rates in Europe are negative and at historical
lows
Companies can borrow directly in EUR from their credit facility,
but most agreements have a 0% floor
–The chart on the right shows the effective cost of funding
therefore is simply the company’s credit spread
However, synthetic funding through Cross Currency Swap can
unlock the value of negative interest rates
In addition to not having a 0% floor, cross currency swaps
monetize a supply/demand imbalance for US dollars known as the
cross currency basis
–As demand for US dollar funding has increased, the cross
currency basis swap rate has fallen sharply and has become
strongly negative
–The elevated cross currency basis has created opportunities
for interest savings through synthetic funding and only exist
in derivative market
36
Qualifying Instruments for NIH
8. Synthetic Local Currency Funding
Derivatives
Forwards
Cross currency swaps
Options and combinations of
options that are net purchased
Includes purchased call
spreads and zero costcollars
Nonderivatives
Foreign currency debt
Combination of a derivative and a cash instrument, for example:
USDdebt + EURUSD Cross
Currency swap to hedge European subsidiary
Written (Sold)Options
and Other Instruments
Written options and net written option combinations
Compound derivatives that incorporate multiple risks (e.g., fixed-to-float cross currency swap)
Intercompany derivatives without individual 3
rd
party offset
To be considered a net purchased option:
No net premium received
Based on same underlying FX
Same maturity date
Notional of purchased option component greater
thannotional of written option component
IAS 39.72, 77
IAS 39 Implementation Guidance F.1.3
Qualifying Instruments for NIH
8. Synthetic Local Currency Funding
Derivatives
Forwards
Cross currency swaps
Options and combinations of
options that are net purchased
Includes purchased call
spreads and zero costcollars
Nonderivatives
Foreign currency debt
Combination of a derivative and a cash instrument, for example:
USDdebt + EURUSD Cross
Currency swap to hedge European subsidiary
Written (Sold)Options
and Other Instruments
Written options and net written option combinations
Compound derivatives that incorporate multiple risks (e.g., fixed-to-float cross currency swap)
Intercompany derivatives without individual 3
rd
party offset
To be considered a net purchased option:
No net premium received
Based on same underlying FX
Same maturity date
Notional of purchased option component greater
thannotional of written option component
IAS 39.72, 77
IAS 39 Implementation Guidance F.1.3
Two Approaches
8. Synthetic Local Currency Funding
Parent Corp
$-functional
Parent Executes Cross Currency Swap
(Net Investment Hedge)
European Hold Co
€-Functional
Parent Loans USD
Subsidiary Hedges USD Loan
(Cash Flow Hedge)
Cross Currency
Swap
European Hold Co
€-Functional
Parent Corp
$-functionalLoans USD
to Subsidiary
$ Fixed €Fixed
€Fixed $ Fixed
Cross Currency
Swap
37
8. Synthetic Local Currency Funding
Parent Corp
$-functional
Parent Executes Cross Currency Swap
(Net Investment Hedge)
European Hold Co
€-Functional
Parent Loans USD
Subsidiary Hedges USD Loan
(Cash Flow Hedge)
Cross Currency
Swap
European Hold Co
€-Functional
Parent Corp
$-functionalLoans USD
to Subsidiary
$ Fixed €Fixed
€Fixed $ Fixed
Cross Currency
Swap
37
38
Selected Disclosures
“…in conjunction with the issuance of €281 of euro-denominated intercompany notes payable,
issued by certain of our Luxembourg subsidiaries (the "Luxembourg Intercompany Notes") and
payable to USD-functional Dana, Inc., we executed fixed- to-fixed cross-currency swaps with the
same critical terms as the Luxembourg Intercompany Notes. The risk management objective of
these swaps is to eliminate the variability in the functional-currency-equivalent cash flows due to
changes in the… euro / U.S. dollar exchange rates associated with the forecasted principal and
interest payments on the respective underlying instruments.”
“During March 2017, in conjunction with the planned April 2017 issuance of the $400 of U.S. dollar-
denominated April 2025 Notes by euro-functional Dana Financing Luxembourg S.àr.l., we executed
fixed-to-fixed cross currency swaps with the same critical terms as the April 2025 Notes to
eliminate the variability in the functional-currency-equivalent cash flows due to changes in the
U.S. dollar / euro exchange rates associated with the forecasted principal and interest payments.”
“During May 2016, in conjunction with the issuance of the $375 of U.S. dollar-denominated June
2026 Notes by euro-functional Dana Financing Luxembourg S.àr.l., we executed fixed-to -fixed
cross-currency swaps with the same critical terms as the June 2026 Notes to eliminate the
variability in the functional-currency-equivalent cash flowsdue to changes in the U.S. dollar / euro
exchange rates associated with the forecasted principal and interest payments.”
8. Synthetic Local Currency Funding
____________________
Source: Company filings
Cash Flow Hedge
Net Investment
Hedge
Selected Disclosures
“…in conjunction with the issuance of €281 of euro-denominated intercompany notes payable,
issued by certain of our Luxembourg subsidiaries (the "Luxembourg Intercompany Notes") and
payable to USD-functional Dana, Inc., we executed fixed- to-fixed cross-currency swaps with the
same critical terms as the Luxembourg Intercompany Notes. The risk management objective of
these swaps is to eliminate the variability in the functional-currency-equivalent cash flows due to
changes in the… euro / U.S. dollar exchange rates associated with the forecasted principal and
interest payments on the respective underlying instruments.”
“During March 2017, in conjunction with the planned April 2017 issuance of the $400 of U.S. dollar-
denominated April 2025 Notes by euro-functional Dana Financing Luxembourg S.àr.l., we executed
fixed-to-fixed cross currency swaps with the same critical terms as the April 2025 Notes to
eliminate the variability in the functional-currency-equivalent cash flows due to changes in the
U.S. dollar / euro exchange rates associated with the forecasted principal and interest payments.”
“During May 2016, in conjunction with the issuance of the $375 of U.S. dollar-denominated June
2026 Notes by euro-functional Dana Financing Luxembourg S.àr.l., we executed fixed-to -fixed
cross-currency swaps with the same critical terms as the June 2026 Notes to eliminate the
variability in the functional-currency-equivalent cash flowsdue to changes in the U.S. dollar / euro
exchange rates associated with the forecasted principal and interest payments.”
8. Synthetic Local Currency Funding
____________________
Source: Company filings
Cash Flow Hedge
Net Investment
Hedge
-50
-25
0
25
50
75
100
125
150
Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Basis Points
3m EURIBOR 3m USD Libor
39
8. Synthetic Local Currency Funding
LIBOR –EURIBOR Divergence
The Federal Reserve versus the ECB
Q4 ’17 Q1’18 Q2 ’18 Q3 ’18
3m EURIBOR -0.33% -0.33% -0.32% -0.30%
3m LIBOR 1.60% 1.85% 2.10% 2.40%
Source: BofAML Research, October 2017 World at a Glance
-25
0
25
50
75
100
125
150
Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Basis Points
3m EURIBOR 3m USD Libor
39
8. Synthetic Local Currency Funding
LIBOR –EURIBOR Divergence
The Federal Reserve versus the ECB
Q4 ’17 Q1’18 Q2 ’18 Q3 ’18
3m EURIBOR -0.33% -0.33% -0.32% -0.30%
3m LIBOR 1.60% 1.85% 2.10% 2.40%
Source: BofAML Research, October 2017 World at a Glance
8. Synthetic Local Currency Funding
Companies are reevaluating fixed / floating debt mixtures on an aggregate basis, with a bias for fixed rate
debt in risingrate jurisdictions and floating rate for low rate jurisdictions
50% Fixed
50% Floating
50% Fixed
50% Floating
USD Debt
EUR Debt
100% Fixed
0% Floating
0% Fixed
100% Floating
USD Debt
EUR Debt
40
Companies are reevaluating fixed / floating debt mixtures on an aggregate basis, with a bias for fixed rate
debt in risingrate jurisdictions and floating rate for low rate jurisdictions
50% Fixed
50% Floating
50% Fixed
50% Floating
USD Debt
EUR Debt
100% Fixed
0% Floating
0% Fixed
100% Floating
USD Debt
EUR Debt
40
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