Polaris assesses commodity risk and implements a new commodity hedging program

Polaris, a global leader in power sports vehicle manufacturing, operates off-road, on-road, and marine business units. With $8.6 billion in annual revenue and more than 16,000 employees worldwide, Polaris employs a global network of dealer partners to distribute its vehicles to outdoor enthusiasts across the globe.

To better manage commodity risk, especially given the extreme volatility in the diesel, aluminum, and steel markets, Polaris implemented a commodity hedging program. Polaris partnered with Chatham to analyze and assess its commodity risk, develop a strategic plan to mitigate this risk and implement a hedging program that accomplished leadership’s economic and accounting objectives in an efficient and effective way.

Aligning on program objectives

Working with stakeholders across the organization, the Polaris Treasury team determined its risk management objective was to reduce risk while minimizing program costs. Gaining alignment required reconciling multiple, sometimes conflicting, perspectives given that procurement wished to reduce input costs, treasury prioritized managing financial uncertainty, accounting focused on minimizing volatility on the financial statements, and senior leadership cared most about the overall financial results.

Understanding and quantifying the economic risk

With a defined objective in mind, Polaris turned to gaining a better understanding of the sources and potential magnitude of its commodities exposure. With support from procurement, the treasury team compiled commodity volumes and expenditures to identify its largest potential exposures, including steel, aluminum, and diesel — commodities required for manufacturing Polaris’ power sports vehicles. Treasury Manager, Matt Koller said, “We utilized Chatham to help show us what the risk could be based on our spend and look at various standard deviation market movements to create different cones of possible or probable outcomes.”

Based on these findings, the Polaris Treasury team identified a level of risk that it was comfortable holding. Given elevated prices and heightened volatility in most of the commodity markets, the team identified several commodities that exceeded this level and warranted moving to the next phase of assessing the potential impact of a hedging program.

Treasury shared its analysis and recommendations with stakeholders across the organization, from the broader treasury group to the treasurer, the CFO, and then to the executives on the sourcing side. Koller said, “As a cross-functional hedging program, teams from across Polaris were engaged to provide input and review, all working together cohesively toward a common goal.”

Determining the hedging strategy

Polaris worked with Chatham to evaluate a variety of hedging strategies and identify which provided the best balance of achieving its risk management objectives while minimizing the operational costs.

Implementing the accounting strategy

Polaris considered it critical that the program qualify for hedge accounting to align its financial reporting with the program’s economic results. To qualify for hedge accounting under the current guidance (ASU 2017-12), an organization hedging non-financial items is no longer required to hedge the entire price risk; they can identify just the component of that risk specified within the contract. However, to be able to use this guidance, Polaris had to first evaluate whether the relevant contracts met the definition of a derivative. This entailed:

• There is an underlying, and one or more notional amounts and/or payment provisions.
• There is little or no initial net investment.
• Net settlement is permitted or required.

If derivative qualifications are met, a company would have to take an additional step and apply the normal purchase, normal sale scope exception to the contract, before it could take advantage of the contractually specified component guidance.

Executing the program

With the economic and accounting strategies in place, Polaris then partnered with Chatham to identify strong commodity hedge counterparties within their facility. Polaris was able to execute its trades and partnered with Chatham for all middle- and back-office activities. Chatham also provided program visibility and analytics to the Polaris team through the ChathamDirect technology platform.

Ongoing hedge accounting

As the Polaris team implemented its commodities hedging strategy, they found that maintaining hedge accounting required them to work closely with the sourcing and sourcing finance teams to gain a more detailed understanding of the inventory turnover or the timing of when the hedged exposures impacted the P&L, so they could align these with the release of gains and losses from OCI to the balance sheet. Polaris leveraged Chatham’s hedge accounting support to determine the appropriate journal entries, track the holds in OCI, and determine the appropriate timing for the release from OCI to the P&L.

Managing ongoing operations

Supported by the Chatham team and the ChathamDirect platform, Polaris continues to assess ongoing program effectiveness from both an accounting and economic perspective. Polaris also partners with Chatham in managing its interest rate and foreign currency risk management programs.