CFM62780 | Foreign exchange: matching under the Disregard Regulations: higher of accounts and net asset value

Matching the liability or derivative: periods of account beginning on or after 1 January 2008

It should be remembered that the objective of determining the net asset value underlying a shareholding is to find out to what extent liabilities or derivative contracts, which hedge that shareholding, are matched. In many cases the question can be answered straightforwardly without having to arrive at a precise figure for the underlying net asset value.

Suppose, for example, a company acquires a US subsidiary for $20 million, funding the purchase by a $20 million loan. The shares are shown in the company’s accounts at cost, $20 million. Because the matched amount is the higher of accounts value or net asset value, it does not matter if the value of the net assets underlying the shares is less than $20 million: the liability of $20 million is fully matched. It will remain fully matched if, subsequently, the underlying net asset value rises above $20 million.

In practical terms, it will only be necessary for a company (which has elected for net asset value matching) to monitor closely the net asset value underlying a shareholding if

• the company is hedging an amount that exceeds the book value of the shares, and

• the company is over-hedged, or is likely to become so.

Thus, in the above example, suppose that the company later decides to increase its hedge by borrowing a further $5 million. The net asset value underlying the shares is, at the time, $30 million. The total liability of $25 million is, again, fully matched. Unless it changes its hedging strategy, the company need only assure itself at each review date (CFM62790) that the net asset value has not dropped below $25 million.

If, however, the net asset value were only $22 million, so that the company’s dollar borrowing was only partially matched, it would need to determine the extent of matching for each review period, and make a separate computation for each period of the exchange gain or loss on the liability that is disregarded.