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Results of EFRAG field-test on the IASB's general hedge accounting review draft

Jan 21, 2013

The European Financial Reporting Advisory Group (EFRAG) has publicly released a letter it has sent to the International Accounting Standards Board (IASB) commenting on the IASB's review draft of the forthcoming hedge accounting chapter of IFRS 9 'Financial Instruments'. The letter outlines the findings from a field-test of the review draft conducted by EFRAG involving 44 companies across various industry sectors.

The IASB published the review draft in September 2012 in order to enable constituents to familiarise themselves with the document and to detect potential inconsistencies (fatal flaw review).

The EFRAG letter follows on from an analysis of the review draft by the IFRS Committee of the Accounting Standards Committee of Germany (ASCG).  The field testing and was conducted in conjunction with the ASCG, together with the UK Financial Reporting Council (UK FRC, which also endorsed the ASCG analysis), Autorité des Normes Comptables (ANC) and Organismo Italiano di Contabilità (OIC).

The letter includes the following high-level themes:

  • Confirmation of important improvements to the hedge accounting model, such as improvements to hedge effectiveness testing, designation of risk components as eligible hedged items, and the ability to rebalance hedge relationships
  • Continuing complexity in the general hedge accounting model "because of the number of exceptions, restrictions and options"
  • Concerns about the readability of hedge accounting standard as a standalone document due to cross references to the existing requirements of IFRS 9 and the macro hedge accounting requirements in IAS 39 Financial Instruments: Recognition and Measurement
  • Implications of the review draft on current macro hedging practices, including possible unexpected changes to macro hedge accounting.

In addition, the letter contains appendices outlining fatal flaws, implementation difficulties, requests for additional guidance, and input into the IASB's effect analysis.  Some highlights from this analysis include:

Fatal flaws

  • Hedged items: aggregated exposures and net positions - clarification that a net position could consist of several risks that on a net basis amount to a nil position
  • Hedge ratio and effectiveness - rewording of additional guidance to address "tensions existing between economic hedges and hedge accounting", potential cross-cutting issues between the general and macro hedge accounting projects, and the interaction of the hedge ratio and its potential rebalancing

Implementation difficulties

  • Treatment of basis risk in cross currency interest rate swaps - whether synthetic cross currency swaps can be used to measure hedge effectiveness, and recommendations that basis spreads should be treated in the same way as the time value of options or forward points
  • Time value and forward points - the requirements are considered operationally complex, and recommendations that the change in fair value of basis risk should be recognised in other comprehensive income (OCI) to more closely align with risk management strategies
  • Own use exception - interaction with net agreements and net positions covering both recognised and unrecognised contracts

Requests for additional guidance

  • Hedge ratio and rebalancing - additional guidance to address concerns that the application of the rebalancing concept is not entirely clear and that insufficient guidance is provided for non-finance sectors
  • Eligible hedged items - clarifying whether non-financial items could qualify as hedged items, and whether foreign currency risk on highly probable transactions involving non-controlling interests can be designation as hedged items
  • Open and closed portfolios - which requirements can be applied to closed portfolios
  • Other - including eligible hedging instruments, presentation of forward points, and various other matters.

Effects analysis

  • The document outlines a number of areas where EFRAG believes the field testing reveals that the objective of reflecting the result of an entity's risk management activities is not fully achieved.  Matters are noted in relation to credit risk, sub-LIBOR, open and closed portfolios, the treatment of foreign currency risk compared to other risk components and disclosures.

Refer to the full report for the complete listing of matters raised.  Click for EFRAG press release (link to EFRAG website).