Hedge accounting in multi-curve logic
DZ BANK AG is a leading institution of the Cooperative Financial Network (Genossenschaftliche FinanzGruppe) and the central bank for more than 900 cooperative banks, which hold the majority of its shares. In addition, DZ BANK AG operates as a commercial bank and has a holding function for the affiliated companies of the DZ BANK Group. With their comprehensive range of financial services, the group jointly supports cooperative banks (Volksbanken & Raiffeisenbanken) in the areas private customer business, corporate client business, capital markets business and transaction banking.
Background and project assignment
Because of its strong impact on the P&L, hedge accounting is particularly relevant for the stabilization of the financial result. DZ BANK AG uses portfolio fair value hedges to hedge interest risks. The hedged transactions are assets and liabilities of the categories LaR, AfS and OLi in different currencies. With zeb.control, zeb offers a proven software solution for mapping the extensive requirements that apply for hedge accounting. Since 2006, this software solution has been used at DZ BANK AG for portfolio fair value hedge accounting. Since then, the valuation of the interest rate swaps used has changed, triggered by the financial crisis. From the new requirements, the necessity has arisen to extend the valuation methods for total bank management — and especially for hedge accounting — to multi-curve valuation.
A pre-study, which analyzed the impact of the multi-curve valuation and included an initial coordination with the auditor, marked the beginning of the project with zeb. This was followed by a phase of intense work evolving around the conceptual design and trial calculations. As a result of these, important decisions for the valuation and effectiveness tests could be confirmed. The hedged item should be valued by use of the benchmark curve of the hedging transaction. The analyses revealed that with some regularity, hedges would fail the effectiveness test if a different valuation curve was chosen and if the dollar offset method was applied. However, with the choice of the right valuation curve and the application of the regression analysis, the risk was next to zero. The concept of separating effects of changes in interest rates and pull-to-par effects could be maintained in the multi-curve context. In the case of the chosen procedure, the occurring P&L incongruities do not exceed an acceptable level. No further optimizations for enhanced effectiveness were undertaken in order to keep the procedure simple and comprehensible. As a consequence, the coordination with the auditor was also successful. He rated the proposed solution as a great example for integrating multi-curve logic into hedge accounting. Moreover, thanks to a regular coordination routine, it was possible to reach a consensus with other users concerning the multi-curve procedure and its implementation in zeb.control. In addition, an adjustment of the data supply was planned for the subsequent technical implementation. So far, the hedge accounting of DZ BANK AG had been conducted on the basis of supplied cash flows in order to ensure the closest possible proximity to the valuation in the trading systems. On this basis, a multi-curve valuation would only have been possible as a rough approximation and with a limited range of applications (e.g. no historical regression analysis, no simulations for the future, etc.). Consequently, a two-stage approach was agreed upon: The determination of the new fair value and transaction parameter-based interfaces became the key part of the technical implementation. Once this was documented and coordinated in detail, both sides worked on the implementation of the software and the data supply with full commitment. After the summer break, both parts could be put together and the test stage for the hedge accounting based on the transaction parameter interface could be concluded successfully within a short period of time. Once the final parameter optimizations based on real data had been made, the software successfully went into productive operation. As far as the software is concerned, the interface for the fair value supply has also been completed and is ready for use, depending on the experiences made with the transaction parameter supply.
- 1. Short-term: supply of transaction parameters in order to make multi-curve hedge accounting possible
- 2. Medium-term: shifting parts of the calculation to the feeder system
In the total bank management context, the valuation methods for hedge accounting could be adapted and optimized for the new market circumstances resulting from the financial crisis. Thus, the adaptation of the zeb.control hedge.engine for multi-curve valuation also contributed to the stabilization and transparency of the financial result for bank management purposes. This way, DZ BANK AG was the first bank to undertake a full changeover of the total bank management to multi-curve valuation. From the point of view of the parties involved, one key success factor for this project was the willingness to address the manifold requirements and possible solutions of this complex topic in detail right at the start, while also ensuring that the project was conducted strictly according to schedule with clear decision-making processes at all times.