Friday, May 16, 2008

"ICAI, cast the (AS-32) net wide"

Ok. After the goons make away with the loot, the police arrive. Reads like a climax of a celluloid potboiler? In a way, it is. I am referring to the ICAI’s late awakening to the realities of forex derivative exposures (AS-32) by companies. Here are my safety net guidelines I gave almost two months back. (Me pretty fast, you see :-)

Industry chambers oppose it because they say MTM losses are notional (obligations don’t crystallize until the contract matures or is canceled by the party exposed to it) so long as the positions are open and hence cannot account for it accurately. But they miss the point. Disclosure of MTM losses have only the effect of a provision and not that of a definite charge against profit. So even if those losses don’t crystallize (or it ends in a profit if the sentiment reverses) they can be written back and added to the revenue account as prior period profits (just like tax credits). The only downside is for a trader that sells out fearing dent in share prices over the short term. But then that is their risk reward, so no tears to shed.

But I worry another aspect. Exotic swaps that have a multi-currency structure (fixing the $/Re.rate on the basis of prevailing price of Japanese Yen or Swiss Franc) may not find takers in the event of a crisis. For such products, literally there is no market during such downturns. So MTM would mean bringing the value of the contract to absolute zero or having to make 100% provisioning. These structured products are often sold by foreign banks and the swaps are traded in overseas markets. Now my question is, would it be prudent to MTM the exposure on a cut-off date (say 31st March) or right from the date a party enters into a contract on a daily / weekly basis? Would they have to be accounted for in quarterly results as well?

ICAI will have to explain to avoid any factual distortions in financial presentations. By the way, does AS-32 cover these shenanigans too? I think they should.

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