IBOR reform: Enhancement of SAP Treasury

IBOR reform: Enhancement of SAP Treasury

One of the key finance related challenges that most corporates currently face is the IBOR reform. How can SAP technology support organizations with the consequences of IBOR reform? In this article we outline the SAP enhancements relating to the IBOR reform, discuss how to implement these enhancements, and pinpoint specific areas of attention based on our most recent SAP projects on IBOR reform implementation.

SAP provides a roadmap to support interest rate benchmark reforms. SAP has developed a standard solution to support the daily compounding interest calculation with overnight risk-free rates, which have become the new interest rate benchmarks like for example for USD, GBP and CHF currencies. This standard solution has been included in different versions of SAP: from ECC EHP8 to most recent versions of S/4 HANA.

The SAP solution consists of a set of composite SAP notes that need to be installed. It is recommended to install the SAP notes as a part of the support pack. There are three core SAP composite notes to install:

  • 2939657 (common basis for TRM and CML)
  • 2932789 (RFR in TRM)
  • 2880124 (for CML)

Additional SAP notes and/or activation of business functions may be required, especially if implementation takes place in SAP ECC. The implementation of the SAP notes is the first and the core step, but SAP also requires an update of the configuration objects.

Transaction management

The following five points should be followed for transaction management:

1) Activation of the parallel condition of the cash flow calculation.

This activation is done on the level of a respective product type. The following product categories are supported:

  • Money market deals (product category 550 and 580)
  • Bonds (product category 040)
  • SWAP (product category 620)

SAP recommends the creation of the new product types. It is also possible to do the activation by extending the configuration of the existing product types without any issues. However, we would still recommend executing prove-of-concept prior to amending existing product types to ensure there is no regression effect or dumps in the specific SAP environment.

Activation of parallel conditions will enable the following enhancements in SAP:

  • New interest conditions (Compound interest calculation and Average compound interest calculation) with spread components that can be calculated linearly or compounded.
  • Updated interest cash flow calculation according to the new interest conditions (new FiMa).
  • Parallel interest conditions (spread is linear and maintained as separate flow in the deal).
  • New fields and functionalities in the deal maintenance (Weighting, Lookback, Lockout periods etc).

Please note that SAP may require extra business function activation to enable selection of cash flow calculation in SPRO (such as FIN_TRM_INS_LOCBR).

2) For the Interest rate swaps the below notes should be installed:

  • 2971185 (Risk-Free Rates for Interest Rate Swaps: Collective Note)
  • 2973302 – Business Function: Interest Rate Swap Enhancements (FIN_TRM_IR)

It is strongly recommended to install and run report ZSAP_FTR_IRSWAP_NOTES which will indicate if any SAP note or business function is missing or invalid.

3) Amendment of the field selection for the respective condition types.

With the changes there are more fields to be created, therefore field selection needs to be changed accordingly.

4) There are new fields to be created in the deals, therefore you should consider if changes are required in the field selection in Transaction manager.

5) In the case where mirror deals are configured, you should validate that the conditions (interest calculation type of nominal interest and date structure) in the mirror deals are properly mirrored. Activation of the business function FIN-TRM-MME may be required.

Yield Curve Framework

Creation of the new yield curves where the new grid points should represent the reference interest rates based on the overnight risk-free rates. IBOR reform might result in a need for a corporate to change methodology for mark-to-market calculations of the financial instruments. New discounting yield curves will be required for the net present value calculation of FX contracts and interest rate derivatives. New yield curves might also be required for projecting future cash flows for interest rate derivatives in the mark-to-market calculations.

Creation of new yield curves (and evaluation types) requires thorough attention and input from Treasury and Accounting teams and it should be signed off by the auditor. This configuration also requires good communication with market data providers in order to retrieve correct data for the additional data feed.

Market Risk Analyzer

Creation of the new evaluation types. This is required to enable cash flow discounting to be based on the new yield curves. It is not recommended to amend existing calculation types for the audit purposes.

Market data feed

New reference interest rates in SAP. It is essential to have the new set of risk-free-rates as well as IBOR fallback rates, adjusted or term rates received from your market data provider. The scope here fully depends on the existing active deals, your migration approach, and alignment with your financial counterparties.

Treasury Accounting

Changes in assignment of the update types for accrual/deferral. An additional grouping term is required to be added for the respective update types.

In case there is a business need to aggregate daily cash flows, changes to the flow types for the nominal interest are required. With compound interest calculation, SAP calculates and posts interest cash flows daily, while interest settlement occurs based on the terms of the deal. Hence, daily flows (e.g. 30 flows for a monthly settlements) need to be reconciled with a single settlement at the settlement date. This daily cash flow maintenance and reconciliation may lead to extra workload for the back office/accounting team. Therefore, businesses might prefer to aggregate (net) these daily cash flows. A new flow type and derivation rule may be configured to support this requirement. This would be an update of the existing accounting, which represents a potential regression impact.

SAP IHC interest conditions

Consider changes in the IHC interest conditions for debit/credit balances in case a variable reference interest rate based in RFR is applied. Please note that SAP IHC does not support compounding of the interest for the daily balancing.

Reports

We also recommend executing a round of regression testing of SAP TRM. The new functionality potentially can impact your reports’ variants and layouts, therefore potential regression updates are required. Please validate if the fields showing variable interest rates are properly populated with the data, especially the collective processing report for OTC interest rate instrument (TI92).

Custom functionality and SAP queries

It is important to review your bespoke functionalities in SAP, which are related to TRM, MRA, Market data feed etc. Additionally, it is worthwhile to validate your SAP queries for Treasury, especially the ones designed for month end purposes: NPVs, Accrual/Deferral calculation etc. Pay attention to table TRLIT_AD_TRANS and how the table is updated.

 

IBOR reform and Zanders

Zanders is closely following all IBOR reform related regulations and latest developments. We have also developed a proprietary methodology to support our clients in this regulatory transition, with several projects already successfully completed.

Given our expertise in treasury management, valuations and treasury technology, we are well equipped to support financial and nonfinancial organizations in the IBOR reform from both a functional and a technological perspective. We assist our clients throughout the entire project, from the impact assessment to roadmap definition, and finally the transition itself. Functional support could include definition of the new reference rates, definition of the new yield curves for discounting and projecting future cash flows, formulation of the business cutover plan, support in the new interest calculation methodologies and new market conventions, changing procedures and other many other activities.

To learn more about the IBOR reform, see our previously published insights:

In this article we do not cover the migration of existing deals and impact to hedge accounting, as this will be explained in a separate article. Should you have any questions or quires regarding SAP implementation of IBOR reform, please feel free to contact Aleksei Abakumov or +31 35 692 89 89.