Impact of Sarbanes-Oxley and IAS39 on Online Trading
Best practice has become a priority for institutional traders across the foreign exchange markets, and corporate treasurers are no exception. Some of the impetus for this is external – the recent proliferation of accounting and corporate governance standards, such as Sarbanes Oxley and IAS 39 has had an impact on areas ranging from financial reporting to IT systems. However, internal drivers are equally important. Compliance is about more than keeping the auditors happy. When implemented well, industry standards and best practice guidelines can deliver enhanced efficiency and even cost savings.
For corporate treasurers, best practice in foreign exchange trading encompasses a wide range of considerations, from regulatory compliance, through boosting efficiency with straight through processing, to achieving best execution. From conversations with our clients, we also know that many corporations include banking relationships in their internal definition of best practice. Recent research by Greenwich Associates has found that corporates, more than any other type of client, tended to link FX to the overall lending relationship with their banks. For these organizations, best practice must take into account the need to direct business towards valued liquidity providers. This is why anonymous foreign exchange models have struggled to establish a foothold with non-financial corporations, while relationship-based models such as FXall have taken off.
Undoubtedly, the aspect of best practice that has generated the most debate over the last few years has been the raft of corporate governance and accounting standards introduced to enhance transparency and internal control. Treasurers are just starting to feel the full impact of these regulations, which include corporate governance standard Sarbanes Oxley and accounting standard IAS 39. Both have had an impact on foreign exchange, creating new challenges for treasury departments. Fortunately for treasurers, implementing a few key changes to systems and processes can help them achieve compliance with both standards simultaneously.
Sarbanes Oxley, which requires companies to verify the adequacy of their internal financial controls, is causing headaches for countless corporate treasurers. According to a study by San Francisco-based research firm Glass Lewis, 282 companies with market capitalizations of more than $100 million have informed the Securities and Exchange Commission that they will be late in submitting their annual reports in 2005. More than half of them attributed this delay to the difficulty of documenting and testing key financial controls.
Automating foreign exchange trading has two main advantages. Firstly, straight-through processing reduces the number of controls by eliminating all unnecessary manual intervention. Secondly, electronic controls can be monitored and documented automatically, reducing both time and the risk of error.
How can treasurers make compliance easier? One answer is automating and integrating treasury processes such as foreign exchange trading. One illustration of how automation can make it easier to document and test key controls is the process of confirmation matching, one of the most important controls in the foreign exchange trade lifecycle. Organizations need timely and accurate confirmations in order to accurately monitor foreign exchange activities and their impact. Testing a manual confirmation matching process – one done by fax, for example – is far more expensive and time-consuming than testing a system that generates automated communications. Indeed, some commentators believe that manual confirmation matching is no longer sufficient under the Sarbanes Oxley regime. Companies need to implement automated confirmation matching, or risk non-compliance with Sarbanes Oxley. Automated confirmation matching for foreign exchange is now readily available through providers, which can automate the exchange of trade confirmations between clients and liquidity providers.
Sebastian di Paola, a partner in the corporate treasury solutions department at PriceWaterhouseCoopers in Brussels, and a highly regarded expert on Sarbanes Oxley, believes that in the long run automation is the best way forward: “Logically, Sarbanes Oxley has made it impossible to ignore the long-term cost benefit of automating and integrating treasury systems. Companies that stick to manual processes will find it increasingly costly due to the need to document and test key controls to the standards required by the new legislation. These incremental costs tend to skew the ROI assessment of process changes in favor of more automated solutions, which should be less costly to maintain in the long run.”
Under Sarbanes Oxley, senior executives are not only required to monitor the internal controls at their organization. They are also held responsible for verifying the effectiveness of the controls at any service provider that hosts or processes their financial data. This places an additional burden on corporate treasurers. However, this task can be made much simpler by choosing service companies who have received an American Institute of Certified Public Accountants (AICPA) Statement on Auditing Standards No. 70, more commonly known as SAS 70. FXall is proud to have achieved this internationally recognized report, which gives our clients valuable reassurance about the security of our controls.
A SAS 70 report is a rigorous independent assessment of a service provider’s controls, in which an independent auditor tests physical and logical security controls, network access and monitoring controls, and new customer setup and existing customer management controls. The SEC has stated that organizations can rely on SAS 70 as an acceptable method of documenting service companies’ controls – in other words, there is no need to undertake a separate assessment of the provider organization in order to comply with Sarbanes Oxley.
IAS 39 aims to increase transparency in the way that organizations use and report financial products. It requires that all financial instruments appear on the balance sheet, and that most instruments be valued at their current market price rather than their historic cost accounting. While this has been welcomed by many in the industry as a timely opportunity for corporations to revisit and evaluate their risk management policies, it has undoubtedly increased the workload for corporate treasurers. How will the new accounting standard impact the way companies trade foreign exchange, and how can treasury departments meet the challenges it creates?
Less internal netting, more external transactions – Under IAS 39, companies who want hedge accounting will no longer be able to net hedges on certain types of transactions, including forecasted transactions. It has been common for companies to net foreign exchange hedges internally, before trading the net amount externally with their banks. The requirements of IAS 39 make it likely that many will now want to hedge externally, on a gross basis, in order to secure more favorable accounting treatment. To do this without increasing operational risks, costs and processing times, it is essential for organizations to implement straight-through processing between internal and external systems.
Monitoring every transaction – Once hedges have been executed, they need to be documented and tagged against the particular transactions they are hedging. Once again, automation makes this process infinitely simpler. Electronic trading platforms automatically record every hedge.
Fair value accounting requires real-time market data – All companies, even those that do not opt for hedge accounting, are required under IAS 39 to record all their derivatives at current, rather than historical, value. This makes an unbiased source of pricing data essential for marking books to market.
Automation is essential for dynamic hedging strategies – It is reported that the operational challenges of IAS 39 have forced many companies to move to more static hedging strategies. Investing in a well-designed automated system, which makes it easier to move in and out of the market, restores to treasurers the flexibility to recalibrate hedges in response to changes in market conditions.
In conclusion, it is clear that automation can prove invaluable in helping corporate treasurers comply with accounting and corporate governance standards. Despite the initial investment required by this type of systems overhaul, automating foreign exchange trading and treasury management ultimately saves companies money by creating processes that are both more efficient and less expensive to run. Furthermore, by installing state-of-the-art systems now, companies can be confident that they are prepared for any further regulations or best practice guidelines that may be introduced in the future.