Annual Report 2012 - IOI Group

42. FINANCIAL INSTRUMENTS (Continued)42.1 Foreign currency risk (Continued)42.1.1 Risk management approach (Continued)ii.Transactional obligations or rights denominated in foreign currencyBackgroundThe majority of the Group’s transactional currency risk arises from its foreign currency based forward sales andpurchases of commodity items, contracted by its subsidiaries along the palm value chain. These forwardcommodity contracts for “own use” purposes are non-financial instruments and are generally not recognisedin the Statements of Financial Position. However, these non-financial forward contracts denominated in foreigncurrency are exposed to economic risk due to currency fluctuations. Certain product-streams underlying theforward contracts are net-cash settled or have contract provisions for net-cash settlement, and these areaccounted by the Group as financial instruments with fair valuation impact to its financial statements.Regardless of “own use” or fair value through profit or loss, these forward contracts on fulfilment at maturitywill result in book receivables or payables in foreign currency.Hedging methodIntra-day transactions or forward contracts in foreign currencies are first netted based on matchingcharacteristics. The net exposure is then hedged off with vanilla foreign exchange forwards.In general, currency exposure from foreign investments and borrowings is managed centrally at the Group HQ level,whilst currency exposure arising from transactions or contractual obligations is managed at the respective entity orbusiness unit’s level. The Group adopts a uniform Foreign Currency Risk Management Policy and Guide, which setsout the authority and limits for inception of foreign currency derivatives; types of approved foreign currencyderivatives; acceptable hedging practices and methods; and over-sight structure and controls. Below are extracts ofkey policies:(a)(b)(c)(d)(e)(f)Speculative positioning on foreign currency is prohibited;Net currency exposure on trade transactions and forward contracts are to be hedged in full on back-to-backbasis. Hedging on portfolio basis (or macro-hedging) comprising of unmatched mixed maturity and amount isdisallowed;Inception of foreign currency derivatives as hedging instrument against forecast trade transactions in foreigncurrency is disallowed;Hedging with foreign currency futures on traded exchanges is generally disallowed;Inception of over-the-counter structures derivatives for hedging purposes are confined to HQ and eachcontract is subject to executive management’s approval; andSubsidiaries inception of foreign currency derivative for hedging purposes are confined to vanilla foreigncurrency forwards and plain European style foreign currency options.The Group’s entire currency exposure (as hedge items) and corresponding foreign currency derivative hedginginstruments are mark-to-market and fair valued once a month primarily for operational hedge effectiveness testingand for executive management reporting and oversight. Weekly long-short positions on foreign currencies andforeign currency derivatives are also produced for timely control and intervention.Annual Report 2012IOI CORPORATION BERHAD 215