Citibank 2013 Annual Report Download - page 283

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Key aspects of achieving ASC 815 hedge accounting are documentation
of hedging strategy and hedge effectiveness at the hedge inception and
substantiating hedge effectiveness on an ongoing basis. A derivative must
be highly effective in accomplishing the hedge objective of offsetting either
changes in the fair value or cash flows of the hedged item for the risk
being hedged. Any ineffectiveness in the hedge relationship is recognized
in current earnings. The assessment of effectiveness excludes changes in
the value of the hedged item that are unrelated to the risks being hedged.
Similarly, the assessment of effectiveness may exclude changes in the fair
value of a derivative related to time value that, if excluded, are recognized in
current earnings.
Fair Value Hedges
Hedging of benchmark interest rate risk
Citigroup hedges exposure to changes in the fair value of outstanding
fixed-rate issued debt and certificates of deposit. Depending on the risk
management objectives, these types of hedges are designated as either fair
value hedges of only the benchmark interest rate risk or fair value hedges
of both the benchmark interest rate and foreign exchange risk. The fixed
cash flows from those financing transactions are converted to benchmark
variable-rate cash flows by entering into, respectively, receive-fixed, pay-
variable interest rate swaps or receive-fixed in non-functional currency, pay
variable in functional currency swaps. These fair value hedge relationships
use either regression or dollar-offset ratio analysis to determine whether
the hedging relationships are highly effective at inception and on an
ongoing basis.
Citigroup also hedges exposure to changes in the fair value of fixed-
rate assets, including available-for-sale debt securities and loans. When
certain interest rates do not qualify as a benchmark interest rate, Citigroup
designates the risk being hedged as the risk of changes in overall fair value.
The hedging instruments used are receive-variable, pay-fixed interest rate
swaps. These fair value hedging relationships use either regression or dollar-
offset ratio analysis to determine whether the hedging relationships are
highly effective at inception and on an ongoing basis.
Hedging of foreign exchange risk
Citigroup hedges the change in fair value attributable to foreign-exchange
rate movements in available-for-sale securities that are denominated in
currencies other than the functional currency of the entity holding the
securities, which may be within or outside the U.S. The hedging instrument
employed is a forward foreign-exchange contract. In this type of hedge, the
change in fair value of the hedged available-for-sale security attributable
to the portion of foreign exchange risk hedged is reported in earnings and
not Accumulated other comprehensive income—a process that serves
to offset substantially the change in fair value of the forward contract that
is also reflected in earnings. Citigroup considers the premium associated
with forward contracts (differential between spot and contractual forward
rates) as the cost of hedging; this is excluded from the assessment of hedge
effectiveness and reflected directly in earnings. The dollar-offset method is
used to assess hedge effectiveness. Since that assessment is based on changes
in fair value attributable to changes in spot rates on both the available-for-
sale securities and the forward contracts for the portion of the relationship
hedged, the amount of hedge ineffectiveness is not significant.