Brazil Leveraged Names Overview Annex: Derivatives accounting and the upcoming IPCA swap revaluation

A double-click on specific aspects of derivatives and hedge accounting

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Derivatives make up a very relevant portion of almost any Brazilian company, much more than in other countries, even for industries that are not too exposed to direct foreign exchange risks.

The problem with derivatives is that their accounting treatment can take many forms, and that companies have a lot of leeway in determining how much to disclose and where. Further, the gap between accrual and cash accounting in derivatives can span years of operations. This can generate a situation where derivatives add a lot of confusion to both operations and financing, complicating the task of projecting the future.

This premier annex discusses how hedge accounting works under IFRS and under BRGAAP, both for rates and foreign liabilities, how companies might decide to account for these factors, and how we can try to dissect the true cost of financing for heavily hedged companies.

As a bonus, many companies have hedged IPCA (inflation) against the CDI (reference rate). These swaps have been terrible for the past two years, generating significant non-cash accrual losses on mark-to-market. I analyze how this might revert in the future, potentially boosting accrual net income for some companies.

Index

• The four main types of derivatives

• Derivative accounting options

  • Fair value of derivatives

  • Hedge vs non hedge accounting

  • Cash flow vs fair value hedge accounting

• The upcoming IPCA swap revaluation