German Accounting Standards Committee publishes analysis of the IASB's review draft on hedge accounting, findings endorsed by UK FRC
The IFRS committee of the Accounting Standards Committee of Germany (ASCG) has analysed the IASB Review Draft 'Hedge Accounting' published in September 2012. The analysis was conducted in co-operation with the ASCG’s Financial Instruments Working Group. It revealed several issues that need further clarification or amendment. One of the findings suggests that the EU carve-out is likely to be imposed on IFRS 9 as well. The results of the analysis have been submitted to the IASB.
The IASB published the review draft on 7 September 2012 in order to enable constituents to familiarise themselves with the document, but also to detect potential inconsistencies (so-called fatal flaw review). This encouraged the IFRS committee to conduct a near-term analysis and to bring the results to the IASB's attention as well as making them publicly available on the ASCG's website. Among the results are four issues the IFRS committee considers to be major issues*:
Accounting for Credit Risk. The hedge accounting ED published in December 2012 prohibited hedge accounting for credit risk. However, as respondents to the ED commented that hedging credit risk is a common risk management strategy and, therefore, a solution was needed, the IASB now permits hedge accounting for credit risk using the fair value option in the review draft. As the now proposed method (using a modified fair value option) adds extra complexity, is inconsistent with the general requirements surrounding that option and does not lead to an answer that is conceptually superior, the ASCG can't see why entities should not be allowed to rely on the general fair value hedge accounting model instead of tweaking the fair value option. Hence, the ASCG argues that the IASB should discard its proposed alternative and make credit risk an eligible risk factor just as any other risk factor.
Accounting for Sub-LIBOR-hedges. Hedge accounting is not permitted for sub-LIBOR risk although this is a common risk management strategy applied by banks in practice. The ASCG does not believe that prohibiting hedge accounting for sub-LIBOR issues is consistent with the overall principle in the general hedge accounting model which is to better align hedge accounting with an entity’s risk management strategy. This is especially true in current times when entities seek to invest more in less risky and high quality financial instruments, esp. AAArated government bonds. Given that many entities are currently engaging in sub-LIBOR hedging, the EU has placed a carve-out on the respective requirements in IAS 39 which, should the prohibition survive in the final standard, is likely to be imposed on the relevant paragraph in IFRS 9, too. When the IASB started developing new requirements for hedge accounting, one of the expectations of the European constituents was that the IFRS 9 requirements would be capable of being applied without an EU carve-out. The ASGC does not believe that such an outcome would be necessary, if the IASB acknowledged that entities do hedge sub-LIBOR risks.
Effectiveness when hedging basis risks. The ASCG points out that there are situations where hedge accounting may lead to inappropriately presenting ineffectiveness. The example cited concerns FX hedges that include the "basis risk". They lead to recognising ineffectiveness that is not considered as such from an economic perspective.
Co-existence of hedge accounting requirements in IFRS 9 and IAS 39. The ASCG sees major conflicts between the new hedge accounting requirements to become part of IFRS 9 and those hedge accounting requirements of IAS 39 that will not be replaced yet. The ASCG wonders when and how those remaining paragraphs would apply. The examples cited concern inter alia the qualifying criteria and groups as hedged item. Would "old" (IAS 39) portfolio fair value hedges go with the "old" hedge accounting criteria and "new" (IFRS 9) hedges go with the "new" hedge accounting criteria? Furthermore the ASCG points out that the review draft does cover some macro hedging strategies (closed portfolio strategies) that are also covered by the IAS 39 requirements that will continue to exist. The ASCG concludes that this seems to offer an arbitrary accounting choice.
*) The summary of the issues is largely based on extracts from the ASCG's letter to the IASB.
In addition to the major issues identified in the ASCG's letter, several other issues are mentioned. Although not having the same impact as the major issues, the ASCG recommends that these other issues are also considered.
Please click for the full ASCG analysis of the IASB's review draft (link to ASCG website).
The ASCG findings were endorsed by the United Kingdom Financial Reporting Council (FRC) and published as a joint document to the FRC website on 22 November 2012. Please click for the ASCG/FRC joint document.