Financial instruments – Hedge accounting
The staff presented the Board with three agenda papers related to the macro hedge accounting project. The first paper provided an example of a common interest rate risk management strategy used by financial institutions. The staff clarified that while the example was focused on a particular industry (financial services) and a particular risk (interest rate) that this was being used as a starting point for discussions and should not be interpreted as simply a solution for one industry or one type of risk.
The second paper highlighted conceptual differences between the risk management approach described in the example and the current hedge accounting requirements, namely 1) the focus on the stabilisation of net interest margin and 2) the focus on the portfolio as unit of account.
The third paper discussed potential alternatives for an accounting solution to address the conceptual differences between risk management and current hedge accounting requirements. The four alternatives presented by the staff are as follows:
- Alternative 1 – Accept a risk management approach including risk management policies;
- Alternative 2 – Accept a risk management approach but restrict entity specific risk management policies;
- Alternative 3 – Deny a risk management approach but provide accounting policy choices instead to bridge the gap; or
- Alternative 4 – Definitely deny a risk management approach.
The IASB Chair began discussions by asking the staff if the financial statements of those entities looking for a macro hedge accounting model are currently distorted. The staff responded that it would depend on the perspective taken. Many of these firms have methods to designate and de-designate multiple micro hedging strategies as a proxy for macro hedging since macro hedge accounting is not an available solution. However, these strategies are cumbersome and don't accurately portray the risk management process so many of these entities will provide 'non-GAAP' measures to provide investors information as if macro hedge accounting were permitted.
One IASB member asked the inverse of the IASB Chair's question, that being if applying macro hedge accounting could cause distortion of financial statements. He acknowledged the challenge of reflecting the risk management activities but felt that appropriate safeguards have been put in place for a purpose. He noted that to truly understand if macro hedging minimises risk one would have to assess that at the enterprise level.
The IASB Chair asked the staff why entities could not just apply the fair value option to eliminate the accounting mismatch that exists. The staff noted in the example in the paper of hedging interest rate risk to lock in net interest margin, electing the fair value option would expose the entity to other changes in fair value such as credit risk. Additionally, the staff noted that IFRS 9 had introduced the business model criteria so that entities whose business model is to hold financial assets to collect contractual cash flows would measure those assets at amortised cost. So sending a message to those entities to simply elect fair value option to address the macro hedge accounting issue would be a contradictory message.
Another Board member acknowledged the issue caused by the inability to apply hedge accounting on a macro basis and mentioned his knowledge of the banking industry struggling with this for some time. But he noted that during the outreach activities on the general hedge accounting model he was made aware of how many other entities (utilities, commodities, etc.) were also impacted with this limitation. However, he also agreed with the other Board member who warned about needing appropriate safeguards, saying the Board needed to fully understand the ramifications and be comfortable that a macro hedge accounting approach would provide better and more transparent financial reporting.
Another IASB member raised the question of whether a macro hedge accounting model could be auditable and also highlighted the issues companies may have in establishing appropriate internal controls over financial reporting.
One Board member mentioned that it may be helpful to see what companies are currently doing now with respect to 'non-GAAP' measures and how they are determining the hedge accounting impacts at a macro level. The IASB staff said they could provide the Board with information but given that they are 'non-GAAP' the level of consistency between entities may fluctuate.
The IASB Chair concluded this session by asking the staff to further explore Alternative 1 (accepting a risk management approach including risk management policies) and Alternative 2 (accepting a risk management approach but restricting entity specific risk management policies). He suggested that the Board needs to get a better understanding of the issues and that a future education session to review 'non-GAAP' measures currently being used in practice would be beneficial.