The IASB's project on macro hedge accounting considers risk management that assesses risk exposures on a continuous basis and at a portfolio level (i.e. dynamic portfolio hedging). This type of risk management strategy tends to have a time horizon over which exposures are hedged. Consequently, as time passes new exposures are continuously added to the hedged portfolio and other exposures are removed from it.
This area of accounting is complex and currently only accommodated to a limited extent in IAS 39 Financial Instruments: Recognition and Measurement, which includes a macro fair value hedging model for interest rate risk. The IASB's objective is to consider an alternative macro hedging model that will ultimately replace the macro fair value model in IAS 39 and have wider applicability to other risks.
Given the complexities involved, and the difficulties in proposing a single model in an exposure draft, the IASB decided to single accounting for macro hedging out from the project on general hedge accounting and to issue a discussion paper as the first due process document to consider a range of alternatives. This provides an opportunity for constituents to provide the IASB with feedback on those alternatives and give guidance on how to proceed.
Summary of the main proposal
The discussion paper entitled Accounting for Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging puts forward a 'revaluation approach', which is a simple concept of adjusting the measurement of the portfolio of exposures for changes in the hedged risk. The corresponding gain or loss is recorded in profit or loss to provide a natural offset against derivatives, measured at fair value through profit or loss, used to hedge those risks.
The objective of the model is to be less operationally burdensome than applying general hedge accounting to dynamic portfolios and be more reflective of an entity's dynamic risk management resulting in more meaningful and transparent financial reporting. The model is not a full fair value model, i.e. the risk exposures are only revalued for changes in the hedged interest rate risk and not for other risks, such as credit risk. Therefore, the normal accounting of income and expenses applies for the effect of other risks, for example the accrual of the credit margin charged on customer loans would be accrued in interest income as usual.
Consider a bank that has portfolios of financial assets (e.g. loans) and liabilities (e.g. customer deposits) and hedges the resulting interest rate risk position between those assets and liabilities using interest rate swaps. The model would result in the managed portfolio being remeasured for interest rate risk (with no assessment of hedge effectiveness required). The derivatives used for hedging the interest rate risk would be accounted for at fair value through profit or loss. The net impact in profit or loss shows the bank's remaining open risk position, after hedging with respect to interest rate risk. The revaluation model would be an overlay adjustment to the normal accounting under IFRS 9. Hence the usual recognition and measurement of assets and liabilities would be applied first before a revaluation adjustment is applied.
Complexities and questions
A portfolio revaluation model would address many of the accounting issues encountered with hedge accounting. The single model could also, if appropriately developed, represent an alternative for presenting hedging activities in the financial statements in addition to existing fair value and cash flow hedging, resulting in a more faithful reflection of portfolio risk management activities. However, complexities arise from determining which exposures to include in the revaluation and how to measure and present the revaluation.
Therefore, the discussion paper seeks feedback on a range of different aspects of the model:
- Should any forecast transactions be recognised and measured on balance sheet?
- Should the whole portfolio exposed to the hedged risk be revalued or just the part that is hedged?
- Can only the bottom layer of a portfolio be remeasured?
- Should demand deposits, pipeline transactions and equity model book be eligible for hedge accounting?
- Can internal derivatives be used?
- What are the various presentation and disclosure alternatives?
- What practical expedients are necessary to make the model operational, for example, can internal transfer pricing be used?
These questions and more are debated in the paper and the IASB is seeking feedback to understand whether the model proposed would provide useful information and be operational. The comment period ends on 17 October 2014.
On 29 April 2014, the IASB will hold two live webcasts introducing the Discussion Paper. Please click to register on the IASB's website for the 10am slot or the 2pm slot (both London time).