Financial instruments — Macro hedge accounting (IASB only)
The IASB continued its discussion on development of an accounting model for macro hedging activities on the basis of the ‘11 steps’ that the Board initially discussed at its November 2011 meeting. Similar to previous meetings, this meeting was an education session where no tentative decisions were made.
At this meeting, the Board discussed two topics:
- Could unrecognised hedged items included in a portfolio for interest rate risk management be included in the accounting revaluation portfolio?
- How should changes in hedging derivatives from floating legs and credit risk be treated within the macro hedging model (steps 8 and 9)?
Treatment of unrecognised items
The staff presented the Board with an agenda paper discussing how interest rate risk exposures arising from unrecognised items could be integrated into the macro hedging model. The paper split these items into items that already exist, but that are not recognised for accounting purposes, such as loan commitments, and items that have yet to be executed, known as pipeline trades. Although under normal circumstances, the groups are economically similar, the key distinction between the two groups is the lack of a legal obligation to lend at a given rate for pipeline trades.
For loan commitments, the solution proposed by the staff was consistent with that for firm commitments under the general hedging model.
For pipeline trades, the staff analysis was more complex and highlighted the tension between the Conceptual Framework and risk management practices in this area. The inclusion of such items conflicts with the Conceptual Framework as it would result in the recognition of gains and losses on forecast transactions, considers fair value risk arising from economic compulsion rather than contractual arrangements and leads to the recognition of items that could be considered akin to “internally generated goodwill”. However, were pipeline trades to be excluded from the macro hedging model, derivatives entered in to hedge the associated risk would either generate profit and loss (P&L) volatility or banks would seek alternative accounting solutions that would be unreflective of their risk management practices.
Some Board members felt strongly that the inclusion of pipeline trades in a revaluation model was not appropriate given the conflict with the Conceptual Framework. Others considered this to be an artificial solution and felt that as the Conceptual Framework is being considered in parallel with the macro hedging project, the inclusion of pipeline trades should not be ruled out on this basis. One Board member felt that inclusion of such items on a probability-weighted basis was consistent with the treatment of other items within an open portfolio. The similarity to considerations around behaviour relating to demand deposits was also discussed. The Board made no tentative decisions on this topic.
Credit risk and floating leg considerations
The staff presented the Board with an agenda paper explaining that as a consequence of measuring hedging derivatives at fair value through profit or loss (FVTPL) in accordance with IFRS 13 Fair Value Measurement, fair value changes resulting from credit risk and any floating legs will be reflected in the profit or loss account. The paper explained that risk managers consider floating rate funding together with their fixed rate assets and liabilities, and therefore a potential solution to the P&L volatility arising from the floating leg of the hedging derivatives is to allow the inclusion of floating rate instruments in the revaluation portfolio where portfolio hedging activity is still undertaken. The staff analysis then went on to state that by contrast, banks manage credit risk from derivatives separately to interest rate risk, and so no corresponding solution was proposed. The Board made no tentative decisions on this topic.