Financial instruments - Hedge accounting: Macro hedge accounting
The staff presented the Board with two agenda papers on the topic of macro-hedging. The first paper discussed alternatives for developing a business oriented macro-hedging model, continuing with the scenario of hedging interest rate risk as discussed in previous Board discussions. The second paper discussed use of non-GAAP information in the financial reporting of hedging activities.
The staff asked the Board to consider both the areas of the financial statements primarily affected by interest rate risk management and what should be the effect of risk management activities on those financial statement areas.
Alternatives for developing a business oriented macro-hedging model
The staff introduced two possibilities for accounting for hedging instruments under a macro hedging model.
The first alternative was titled the 'accrual accounting concept' under which the hedging instrument is accounted for on an accrual basis (either on an amortised cost or full deferral of all fair value changes) consistent with the hedged risk.
The second alternative was titled the 'valuation concept' under which the hedged risk position would be valued to offset the measurement of the hedging instrument.
The staff noted that one of the limitations of the accrual accounting concept is that when the hedging instrument does not perfectly offset the hedged risk the resulting mismatch would not be visible while under the valuation concept would reflect the imperfect offset to be reflected as valuation elements providing increased transparency. Other reasons the staff presented for supporting the valuation concept included 1) that financial institutions commonly identify interest rate risk on the basis of fixed rate financial instruments using present value based methods and 2) it is in line with long standing treatment under IFRSs that derivatives are accounted for at FVTPL.
Based on the staff view that the valuation concept was preferential to the accrual accounting concept, the staff went on to detail two possible approaches for the valuation concept.
The first approach is a 'separate valuation concept' that changes the measurement for elements of the risk position and allows accounting mismatches to be overcome that otherwise arise due to the fair value measurement of the hedging instruments.
The second approach is a 'coverage concept' where the risk position is valued to determine the portion of the fair value change of the hedging instruments that are covered by an offsetting effect and therefore not recognised in profit or loss.
In considering the valuation of the risk position, the staff identified the following eleven steps that would be need to be considered:
- Full fair value measurement
- Fair value attributable to interest rate risk
- Net interest margin as risk management objective
- Portfolio as unit of account
- Open portfolios to be included
- Applying repricing risk for periods rather than days
- Multi-dimensional risk objectives
- Valuation of floating rate instruments
- Counterparty risk of hedging instruments
- Internal derivatives
- Risk limits
The Board expressed their general preference for further development of a valuation concept and the changing of hedged risk position over an accrual accounting concept and changing the measurement of the hedging instrument. One Board member felt that if macro hedging were going to be permitted then the full fair value of the instrument being hedged should be presented on the balance sheet. Another Board member expressed concern with a variety of issues in the staff analysis including the fact that the entire premise of the macro hedging was anchored to risk management yet risk management was not defined. He also thought it was fundamental the unit of account be addressed in the model. Another Board member requested the staff present the Board with numerical examples at a future board meeting as it would help to illustrate the topics being discussed. Another Board member requested the staff to better understand financial statement users' expectations with regard to macro hedging as that would also be an important consideration. Another Board member questioned, if the Board were able to agree on a macro hedge accounting model, whether it would be required or optional.
The Board made no decisions during this session, the staff will continue its work in developing a macro hedge accounting model under the valuation approach.