Published: June 15, 2009
In this interview, we discuss with Patrick Boyer, Group Manager, Treasury Controllers Group how Microsoft has addressed some of the challenges of hedge accounting by implementing Reval®.
Since Microsoft was first founded in 1975, it has become one of the world’s most respected companies and recognised brands. The company is centred around five business segments across client and server solutions, internet tools, business services and entertainment, with nearly 96,000 employees across 107 countries. In 2008, Microsoft achieved revenues of $60.42bn, an increase of 18% on the previous year, and net income of $17.68bn, representing growth of 26% on 2007. With complex cash and risk management requirements, and a diverse, fast changing business, Microsoft Treasury has a strong commitment to effective, practical risk management to protect the needs of the business and its shareholders.
Microsoft has an experienced treasury team with substantial experience in cash and risk management. Due to the large volumes of cash which the company often holds, treasury’s investment policy and risk management strategy is quite conservative, with liquidity and security being the most important drivers.
Cash needs to be available when required by the business for activities such as acquisitions, and in particular, returning cash to shareholders, such as the special dividend and share buyback announced in 2004. Once we have ensured that a sufficient proportion of the cash portfolio is available to support our business needs, we may seek a higher return on the remainder, but this is not a primary objective and security of capital remains a priority.
Microsoft treasury has a strong commitment to effective, practical risk management to protect the needs of the business and its shareholders.
Absolutely - due to the breadth of our international activities, Microsoft has considerable exposure to FX risk. We bill and collect cash primarily in the G10 currencies, but we are exposed to other currencies too. Consequently, minimising the effects of FX rate fluctuations is paramount. We have a hedging programme in place which involves using FX options to layer in hedges against our cash flow forecasts over 2-3 years. We hedge only a portion of our risk and act with a high degree of caution, particularly as the accuracy of forecasting and associated hedging must be very accurate under FAS 133. Wherever possible, we take advantage of natural hedges between foreign currency revenues and costs, to minimise our external hedging activities.
In addition to external hedging, we also have intercompany exposures created at the business unit level, resulting from activities such as cash pooling in foreign currencies. Under FAS 52, we need to measure FX translation gains and losses against the business unit’s functional currency. This can create a range of exposures, and therefore intercompany hedging requirements.
We are informed of FX exposures by the businesses which send cash flow forecasts via the CFO. We then leverage this forecast information to create our hedging programme. The number of contracts is far too high to contemplate individual contract hedging, so we perform cash flow hedging at a macro level. [[[PAGE]]]
When we first started reporting under FAS 133, there were no technology solutions for performing effectiveness testing, so we used spreadsheets to manage hedge accounting. As time went on, it became clear that although solutions were emerging to help with hedge accounting, few were providing capabilities at the right level. In some respects, this was hardly surprising bearing in mind that companies interpret the standard in different ways; therefore, a software provider delivering solutions in this area needs to have considerable expertise and flexibility in the functionality that it delivers. Initially, we used Excel in our treasury, but later we started to use a treasury management system (TMS). In time, we outgrew this and moved to an ERP. Since an ERP is typically not equipped to provide the depth of capability required in a specialist department such as treasury, we ended up with a core system with various Excel bolt-ons for specific activities, including measuring hedge effectiveness.
Over time, particularly with increasing market volatility, our approach to risk management has become more granular, and our option structures more sophisticated. We knew that we needed a more robust system to accommodate our expanding and increasingly complex requirements. Following a brief search, we identified Reval as an industry leader in this space, initially recognising the value of the system’s hedge effectiveness testing engine.
Over time, particularly with increasing market volatility, our approach to risk management has become more granular, and our option structures more sophisticated.
As we looked further into the product, we recognised its potential, not only as a hedge accounting tool, but also as a trading platform for FX. Consequently, we decided to extend our use of the system across front, middle and back office, including deal capture, settlement and accounting. While the majority of Reval’s customers use the system for hedge accounting purposes, the way in which Reval was developing the system, expanding the solution to act as a full derivatives trading platform, was also consistent with our needs.
We started using Reval for live operations in February 2009, and it is now used by around 16 Microsoft employees. We initially started implementing the hedge effectiveness engine, but in July 2008, we decided to expand the scope of the project to include front and back office capabilities. In total, the project took around a year to complete. The system is effectively used as a sub system to our ERP, but standalone from it. This works well as part of Microsoft’s strategy to avoid bolt-on spreadsheets or manual workaround solutions. Instead, we have a combination of systems which provides the necessary functionality, but also brings a high degree of comfort to management with systematic and automated controls that comply with internal audit objectives and Sarbanes-Oxley requirements.
From a technology perspective, we will continue to adopt a combination of solutions to meet our needs.
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