Discussion at the September 2009 IASB Meeting
The Board considered possible approaches to hedge accounting during this session. FASB Board members and staff joined the debate via video link.
The staff presented a wide range of possibilities for the future of hedge accounting ranging from its complete elimination to retaining and amending the current conditions and criteria. The staff recommended replacing fair value hedge accounting by permitting recognition outside profit or loss of gains and losses on financial instruments designated as hedge instruments (an approach similar to cash flow hedge accounting). The staff further proposed some simplification of current cash flow hedge accounting model. A majority of the Board agreed with this basic approach. Several Board members focussed on the need for further simplification of the hedge accounting requirements and development of a single set of hedge accounting rules.
Nonetheless, some Board members were concerned with some detailed issues as well as interaction of the project with the Classification and Measurement phase of the financial instruments project.
One Board member was concerned with the proposed approach as he believed that it would create more questions and issues than it would solve. He was particularly concerned with evaluating the effectiveness of hedge accounting.
Several Board members were concerned by the lack of convergence with FASB. The FASB clarified that it had not yet considered (either publicly or privately) the hedge accounting standards. The FASB and several IASB Board members seemed to be particularly concerned with the application of fair value hedge accounting to financial instruments measured at amortised cost due to the application of business model. For them the intuitive argument would be to prohibit the usage of fair value hedge accounting for such instruments. The staff replied that that interaction must be fully analysed and would be addressed by both Boards at a later stage.
The Board generally agreed that initially general requirements for hedge accounting had to be developed and agreed (in the form of an ED) and, based on the adopted approach and public consultation, application for portfolio hedging should be developed.
The Board agreed that portfolio hedge accounting was a very complicated area that would need to be assessed at a later stage and would require significant time to be completed.
The Board continued with discussion on hedge accounting for net investments in a foreign operation. Most of the Board agreed that this issue should not be addressed at this stage as the issue did not relate as much to hedge accounting as to IAS 21 requirements. Nonetheless, some Board members stressed the need for a single hedge accounting model. The Board agreed that it would address this issue at a later stage, when basic model of hedge accounting was agreed.
One Board member suggested that definition of hedging instrument should be based on cash flow characteristics. The staff will investigate how to fit this suggestion into the model.
Discussion at the Special IASB Meeting 6 October 2009
Application of cash flow hedge accounting mechanics to fair value hedges
The Board considered the application of the Board's September 2009 decision to replace fair value hedge accounting with a mechanism that permitted recognition outside profit or loss of gains and losses on financial instruments designated as hedging instruments – that is, applying the mechanics of cash flow hedge accounting also to fair value hedges. The major implication would be the application of the so-called 'lower-of test' to fair value hedges. The 'lower-of test', currently applied to cash flow hedges only, ensures that only ineffectiveness due to excess cash flows on the hedging instrument (that is, the derivative) is recognised in profit or loss.
The Board members disagreed with the extension of the 'lower-of test' to fair value hedges. The Board was concerned that it was inconsistent with the nature of fair value hedging, could lead to changes in eligibility of portions, could have unintended consequences in the area of deliberately under-hedging, and in effect would lead to a situation that there would be no ineffectiveness in fair value hedges as such. A FASB member clarified that in the FASB approach to hedge accounting (given the recent discussions over the issue) the 'lower of test' would not be applied to fair value hedges.
After a short debate the Board decided by a bare majority (8 votes) to retain the 'lower-of test' for cash flow hedges only. A third of the Board members abstained in this vote.
Discussion at the Special IASB Meeting 16 October 2009
Eligibility of financial instruments managed on a contractual cash flow basis in a fair value hedge
The Board discussed whether in principle any items measured at amortised cost still qualified as hedged items for fair value hedge accounting.
The Board agreed that hedge accounting for fair value hedges for instruments that are managed on a contractual cash flow basis did not contradict this classification condition, and said there are situations where such hedge accounting was appropriate. One Board member noted that financial institutions used fair value hedges to lock in their margin and thus to stabilise the yield. In his opinion that would not contradict the classification condition.
On the other hand, several Board members remained unconvinced, as they feared that hedge accounting for fair value hedges in such situations might lead to structuring opportunities and would represent create a synthetic yield as opposed to contractual yield that was the basis of the classification condition.
Discussion at the December 2009 IASB Meeting
Summary of outreach activities [Educational Session]
The Boards considered the feedback received on the hedge accounting from the recent outreach activities undertaken by both Boards. The overriding consensus from constituents was that the Boards should consider a principle-based approach for hedge accounting that would lead to simplification of the hedge accounting requirements.
Many constituents asked for simplification of the rules relating to designation of hedge accounting items, testing of effectiveness, and eligibility of hedge accounting as well as clearer alignment of risk management practices to the hedge accounting guidance. On the other hand, some of the FASB constituents from the user community preferred eliminating cash flow hedging instead of using its mechanics for current fair value hedging (solution preferred by the IASB and its constituents).
The Boards discussed the high level principles of hedge accounting and its alignment with risk management practices. Some Board members felt that such approach might lead to increase earnings management and thus would not support it. Others would prefer if that approach was complemented by comprehensive disclosures that would show the primary statements without the effects of hedge accounting.
This was an educational session, no decisions were made.
The Boards also provided a brief update from the recent strategic meeting on the updated plan for the financial instruments project. The Boards agreed to deliberate hedge accounting as well as classification and measurement of financial liabilities jointly in January and February 2010. For this purpose the Boards will meet twice a month in January and February 2010. Following deliberation phase, the FASB will expose its comprehensive model for comments. At the same time, the IASB will expose the remaining parts of its model. Both Boards plan to provide a joint description of differences between the models and align questions asked to constituents.
Discussion at the January 2010 Joint IASB-FASB Meeting
Timetable for Hedge Accounting Discussions
The Boards discussed which issues related to hedge accounting should be addressed as part of the Financial Instruments project.
The Boards noted that according to the project plan, both Boards pledged to publish a comprehensive ED on Financial Instruments in March 2010. Nonetheless, based on the discussions with the project team, any comprehensive review of hedge accounting would not be finished before end of May 2010 at the earliest.
The Boards therefore discussed possibilities of delaying the hedge accounting part of the project or addressing only a narrow set of issues related to hedge accounting.
Most of the Board members were concerned that the Board promised a comprehensive review of hedge accounting and anything less than a full comprehensive review would be criticised as unsatisfactory by constituents.
Moreover, some Board members believed that this time provided a unique opportunity for review of hedge accounting that might not be repeated for many years.
Consequently, the Boards decided to tackle the hedge accounting in its entirety, but to divide the hedge accounting part of the Financial Instrument project into two phases.
The Boards agreed to include in the FASB comprehensive ED to be published in March (as well as corresponding IASB ED) the parts of the hedge accounting that directly relate to the classification and measurement of financial assets and liabilities (that would most probably include the overall model for the fair value and cash flow hedging, effectiveness consideration as well as bifurcation by risk). On the other hand, issues related to non-financial items as well as portfolio hedging would be addressed in the second phase of the project. The IASB tentatively discussed that the second phase should be completed by June 2011.
The Boards would discuss at the next meeting the precise timetable of deliberations. The staff noted that special sessions would be necessary for completing the proposed timetable.
Discussion at the January 2010 IASB Meeting
The objective of hedge accounting
The Board discussed the objective of hedge accounting. Some Board members expressed their concerns that this issue was being discussed at a separate meeting and not at the joint meeting. In their view, this approach would not lead to perception of joint project. The staff responded that the FASB was not prepared to discuss this issue at the joint meeting earlier this week, and the staff believed that a kind of educational session was required to start the discussion given the ambitious project plan. The FASB would have held a separate educational session. Finally, the objective of hedge accounting would be deliberated jointly at one of the following joint meetings.
The Board decided that this would be an educational session. As a consequence, no decisions were taken.
The Board considered two possible objectives of hedge accounting:
- to provide a link between entity's risk management and its financial reporting, or
- to mitigate the recognition and measurement anomalies between the accounting for hedged items and to manage the timing of the recognition of gains or losses on derivative hedging instruments used to mitigate cash flow risk.
In general, the Board members expressed divergent opinions on this subject. They perceived the first objective as being too broad and thought that it needed to be scaled down, whereas on the other hand, the second objective seemed to be too narrow. Even though the Board members agreed that the objective of hedge accounting should be defined at a high level and should be further limited by additional principles, many members of the Board believed that the first objective was defined too broadly.
Some Board members believed that the first (broad) objective did not capture sufficiently the difference between hedging activities (economic hedging) and hedge accounting. Moreover, they believed that the objective should focus on financial risks, as risk management might address a variety of risks that could not be captured in the financial statements.
Other Board members believed that objective of hedge accounting should tie more closely with risk mitigation. They expressed their view that currently proposed first objective was more appropriate for comprehensive risk disclosures project rather than for hedge accounting.
In further discussion on application/illustration of this objective, the Board tentatively agreed that a possibility to designate risk components should be retained if the risk component was separately identifiable and measurable for the purposes of determining the hedge ineffectiveness. The Board nonetheless asked the staff to consider how operational would these criteria be.
The majority of the Board also expressed a preliminary view that consistent principles should be applied for eligibility of risk components for financial and non-financial items.
The Board will continue its discussion at the following Board meeting.
Discussion at the 2 February 2010 Special IASB-FASB Joint Meeting
The Boards considered the objective of hedge accounting. The Board members expressed a variety of preferences. Some Board members supported the objective proposed by the staff as a compromise between the two views discussed at the January meeting; others were concerned that the objective was very ambiguous as it represented the combination of the two. Consequently, the Boards agreed not to develop an objective of the hedge accounting for the time being and to re-discuss the question when the initial decisions on more detailed level were made.
The Boards continued their discussion with the designation of risk components ('bifurcation by risk'). The IASB in principle agreed that bifurcation-by-risk should be permitted on the basis of proper identification and measurement of risk components. Some IASB members were concerned whether a principle based on identification and measurement of risk components could be operational, but they supported it from a conceptual point of view as a basis for exploring the approach.
The FASB members engaged in a long discussion that reflected the FASB members' opinions on the FASB ED: Accounting for Hedging Activities. Some FASB members argued against permitting bifurcation-by-risk. They believed that their model of financial instruments accounting based on fair value would accommodate some of the hedge accounting issues. Other FASB members disagreed. Finally both Boards agreed in principle to explore the bifurcation-by-risk accounting considering both models of accounting for financial instruments (IFRS 9 and the FASB proposals respectively).
The Boards also initially agreed that they would first consider the financial items related bifurcation-by-risk before proceeding to explore the application to non-financial items. From the discussion it seemed that the issue of basis risk was more important for the IASB than for the FASB.
Discussion at the February 2010 Joint IASB-FASB Meeting
Hedged items: Approach for determining what risk components are eligible for designation
The Boards discussed, primarily in the IASB context, possible conditions for bifurcation-by-risk. The discussion was a follow-up to the 2 February 2010 Discussion in which some IASB members expressed their concerns that the broad approach to risk components designation might lead to what would be a free choice in componentisation of item and could lead to situation that designation of a component would automatically result in accounting relationship being 100% effective.
The staff paper provided an analysis of the current requirements of IAS 39 with the emphasis on the criteria for eligibility of risk components to be designated as hedged items being separately identifiable and reliably measurable.
Based on application of the IAS 39 criteria to a set of risk components may or may not be explicitly specified in the contract, the staff concluded that IAS 39 criteria do not lead to a free choice of how to split an item into components and do not automatically lead to 100% effectiveness of hedging relationship. Nonetheless, the staff concluded that current requirements of IAS 39 are problematic as they are rule-based and internally inconsistent.
Following this discussion the Board agreed to explore a new criterion for the purpose of determining eligible hedged components. The staff will present such analysis at a future Board meeting.
In the following discussion about possible criteria, one Board member expressed his concerns whether, in case of non-contractually specified risk components, would the risk component be separately identifiable within the entire hedged items. He argued that application of IAS 39 in some of these cases do not result from the fact that the risk component was separately identifiable, but rather from the fact that IAS 39 allows it to be a hedged item. He expressed his concerns about interdependence of risk components in many of the cases.
Another IASB member reinforced this view, by expressing his doubt whether this proposed approach would be operational. He also expressed his view that hedge accounting as such is an exception to the classification and measurement principles of financial instruments. Therefore, in his view, it would be difficult to formulate a broad principle underpinning hedge accounting, and some rules would be necessary.
The staff responded that it was not their intention to formulate the principle behind hedge accounting but rather a principle-based approach for designation of risk components that, in their view, should be possible.
Another Board member supported the broad direction the staff had taken. He asked the staff whether, based on the preliminary analysis, the new criteria for designation of risk components would be broader or narrower in comparison with current requirements of IAS 39. The staff responded that the answer would depend on the usefulness of the information provided to the users of financial statements.
One FASB member noted that the criteria need to be fleshed out before it was possible to determine how operational would the guidance be.
The staff noted that more attention should be focused on the reliably measurable criterion, rather than separately identifiable criterion.
One IASB member stated an example of an AA rated fixed rate instrument. He noted that in the past the benchmark interest rate decreased by 50 basis points whereas the AA rate increased by 100 basis points. He asked the staff to apply any criteria to the example and assess whether the benchmark interest rate was eligible for risk component designation.
The discussion continued by focusing on the FASB approach to bifurcation-by-risk for financial instruments within the remits of the overall FASB model for financial instruments.
The FASB staff recommended the application of the current bifurcation-by-risk model in the ASC Topic 815 if the FASB retains the tentative classification and measurement model for financial instruments. Further, the staff recommended that if the FASB increases the amortized cost category to allow more financial instruments to be measured at amortized cost, the FASB should utilize bifurcation-by-risk guidance similar to that proposed in FASB ED Accounting for Hedging Activities, issued in June 2008, to determine if the relationship qualified for hedge accounting.
The FASB agreed with this staff recommendation. The FASB also agreed that the reasonable effective threshold for hedge effectiveness (also proposed in June 2008 FASB ED) should be carried forward into the new guidance, thereby allowing more hedging relationship to qualify for hedge accounting. The FASB members noted that given the FASB tentative model, the current US GAAP model is the least onerous. However, they noted that any drift to amortized cost category beyond own debt would mean that a more fundamental change was required.
The Boards discussed both models and concluded that it is very difficult to further specify the hedge accounting models until the classification and measurement guidance is finalised (the cut between the fair value and amortised cost). The differences between both models are based mainly on the fact that the FASB and IASB classification and measurement models are different, thus leading to different requirements for hedge accounting.
The FASB briefly discussed any need for fair value hedge accounting in the context of financial instruments held for the contractual cash flows. The Board members noted that it is more a synthetic accounting rather than a hedge accounting, that is, its purpose is in many cases to lock-in a cash flow in case of mismatch of fixed-rate financial assets financed by variable-rate financial liabilities (such as in the context of a financial institution).
The Boards summarised that the FASB hedge accounting model would portray all the risk in the financial statements whereas the IASB model consistently with the amortised cost notion would not portray all the risks in the financial statements. One IASB member noted that a paradoxical implication of the FASB model in the IASB context would be that financial instruments measured at amortised cost subject to hedge accounting rules would also portray effects of non-hedged risks in the profit and loss (fair value) whereas reporting entities not applying hedge accounting rules would not.
The FASB disagreed as they believed that their model provided a consistent measurement attribute and any inefficiency in the profit or loss portray the actual financial risks and their management by the reporting entity.
The IASB members noted that the IASB had previously decided to apply the cash flow hedge mechanics also to fair value hedges that would provide a consistent measurement attribute.
Finally, both Boards noted that the different position on hedge accounting is reflection of the differences of the classification and measurement models. Nonetheless, both Boards expressed their willingness to explore a set of criteria for designation of risk components and discuss them at one of the following Board meetings.
Discussion at the Special 3 March 2010 IASB Meeting
Eligible hedged items: derivatives as hedged items
The Board discussed whether derivatives should be eligible as hedged items. The staff argued that many entities are economically required to enter into transactions that result in commodity price risk, interest rate risk, and foreign exchange risk, and they manage these risks independently of each other.
Most Board members agreed with the idea that hedge accounting should reflect the management of the risk of the underlying (including a derivative) as modified by another derivative, if that is an entity's strategy used for managing different risks. Nonetheless, many Board members were concerned that the proposed wording was too general and could allow general designation of derivatives as hedged items. Those Board members noted that although such designation would have no net effect on profit or loss, because all derivatives should be measured at fair value through profit or loss, it might decrease clarity and increase opportunity for structuring.
The staff responded that even now there are some exceptions to the general prohibition of designating derivatives as hedged items (a purchased option is eligible to be designated as a hedged item if it hedged by a written option). Moreover, some special types of derivatives might not qualify for measurement at fair value through profit or loss – for example, some embedded derivatives that are not separated from the host contract that is measured at amortised cost or contracts that are measured at fair value in their entirety as they did not fulfil the own-use exemptions.
Some Board members suggested that the wording should be tightened to reflect the concerns expressed above. Finally, the Board agreed with the general principles presented but agreed to define the eligibility more narrowly and to provide more examples.
Eligible hedged items: components of nominal amounts
The Board briefly discussed and agreed with the designation of components of nominal amounts as hedged items. Those requirements would reflect the current IAS 39 requirements.
Some Board members were concerned with clarity and suggested:
- clarification of the terms 'portion' and 'proportion', and
- inclusion of examples of nominal amounts in terms of monetary and physical metrics.
Some Board members discussed a broader issue related to proportions and their eligibility in connection with timing of the forecast transactions. The staff clarified that those issues would be addressed at a later stage as part of the effectiveness criterion debate.
Eligible hedged items: one-sided risk components
The Board agreed to carry forward the IAS 39 requirements that permit the designation of one-sided risk components as hedged items.
One Board member asked the staff whether they considered changing the prohibition to use written options as hedging instruments. The staff replied that this discussion should not imply any such change and should be limited to eligible hedged items. Moreover, they noted that they would discuss option strategies at a future meeting.
| 
Print
