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Financial instruments — Macro hedge accounting

Date recorded:

The Board continued its discussions on development of a macro hedge accounting model.  At the November 2011 Board meeting, the staff introduced the following steps in considering the valuation of the risk position in a macro hedge accounting model:

  • Step 1: Full fair value measurement
  • Step 2: Fair value attributable to interest rate risk
  • Step 3: Net interest margin as risk management objective
  • Step 4: Portfolio as unit of account
  • Step 5: Open portfolios to be included
  • Step 6: Applying repricing risk for periods rather than days
  • Step 7: Multi-dimensional risk objectives
  • Step 8: Valuation of floating rate instruments
  • Step 9: Counterparty risk of hedging instruments
  • Step 10: Internal derivatives
  • Step 11: Risk limits.

The agenda papers prepared by the staff and presented to the Boards during this meeting focused on steps one to three using the example of hedging interest rate risk.  The staff summarised the approaches for each of the three steps being discussed.

For step 1 (eg, full fair value measurement), the staff believes it provides transparency in respect of the ‘fictitious’ sales price of the hedged item and the offsetting hedging effect. The mismatch recognised in profit or loss represents the unhedged portion of the ‘fictitious’ sales price. Additional disclosures would be needed on the measurement of those fair values.

For step 2 (eg, fair value measurement attributable to the hedged risk), the staff believes it provides transparency in respect of the ‘fictitious’ sales prices but limited to the interest rate risk element. The mismatch recognised in profit or loss represents the unhedged portion of this risk.  Additional disclosures would be needed to explain the selection of the benchmark interest rate and how the value is determined.

For step 3 (eg, measurement addressing the margin hedge objective), the staff believes it provides transparency in respect of the margin risk associationed with a fixed rate instrument (eg, a negative valuation indicates a negative impact on the future net interest margin when not compensated or hedged). The mismatch recognised in profit or loss represents to what extent the margin risks are hedged. Addtional disclosures would be needed to explain the selection of the benchmark interest rate and the determination of the margin.

The Board’s discussion was dominated by four Board members with a couple of other Board members acknowledging they needed to better understand the issues involved.

A few Board members criticised the staff’s use of the term ‘fictitious’ sales price in the papers as they felt it implies that fair value information is irrelevant. The Board members emphasised that both cash flow and fair value information was relevant in the scenarios described in the agenda papers. The Board members also requested more analysis of user perspectives as they felt the papers were written from a preparer point of view. They also questioned the relevance of the examples as being ‘perfect scenarios’ and not addressing open portfolios or prepayment considerations.

The Board made no decisions during this session.  The staff indicated it would continue bringing additional steps to the Board at future meetings.  One Board member questioned whether July 2012 was a realistic time frame for an exposure draft and warned against trying to rush through the process.

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