Financial instruments – Hedge accounting - Comment letter summary

Date recorded:

Comment letter summary

The comment period on the hedge accounting exposure draft closed on 9 March 2011. During the comment period, the IASB members and staff conducted extensive outreach activities across the globe with various constituents. During this meeting, the staff provided the Board with an update on the outreach activities and a summary of the comment letters received as of 9 March 2011. This was an education session only and no decisions were made.

The outreach activities were held on six continents with 145 separate meetings involving over 2,500 participants. Those participants included preparers (including treasurers and risk managers), auditors, regulators, users and national standard setters.


Almost all constituents support the proposed objective of hedge accounting to better align the hedge accounting requirements and an entity's risk management activities. However, many feel the objective should not be limited to items impacting profit or loss but also extend to those items impacting other comprehensive income. Additionally, some commented that the term 'risk management' is not defined which could result to divergence in practice or, as some viewed it, as another test to achieve hedge accounting. Some comment letter respondents did not support the proposed objective as they believe the only purpose for hedge accounting is to eliminate an accounting anomaly.

Eligible Hedging Instruments

Almost all respondents support the eligibility of non-derivative financial assets and financial liabilities measured at fair value through profit or loss as hedging instruments. The outreach activities identified that in certain jurisdictions (specifically parts of Asia) the use of derivatives is restricted by regulators; the expansion of permitting non-derivatives as hedging instruments is particularly supported by these constituents.

Eligible Hedged Items

Most of the participants/respondents are supportive of the exposure draft's proposals related to aggregated exposures (permitting an eligible hedged item and derivative to be combined and designated as a hedged item). However, many asked for additional clarification and guidance including information on (1) how the hedge accounting mechanics should be applied for complex hedges, (2) how hedge effectiveness should be assessed, and (3) how hedge ineffectiveness should be measured.

Almost all participants/respondents strongly support the proposal to extend the ability to designate risk components for non-financial items as well as financial items. However, many requested additional guidance for non-contractually specified risk components as there were concerns over the potential for divergence in practice. Additionally, many participants had concerns over the restriction of entities not being able to designate an inflation component in a financial item. Similar concerns were raised by financial institutions about the Boards not addressing the hedging of credit risk.

Most participants/respondents support the exposure draft's proposals to allow designation of a layer component for fair value hedges. Most participants (particularly financial institutions) would like the proposal to also extend to prepayable items where the prepayment option's fair value is affected by changes in the hedged risk. Many would also like to see the prepayment option issue addressed as part of the deliberations on macro hedging. Many comment letter respondents requested the Board clarify whether the designation of a top-layer approach for an open population of items would be permitted (IAS 39 specifically mentions the population cannot be identified while the exposure draft was silent).

Many participants/respondents raised concerns with the exposure draft's prohibition of cash flow components being larger than the cash flows of the entire item ('the sub-libor issue'). Constituents noted that this issue did not apply only to financial institutions with the the sub-libor issue but also to non-financial institutions where negative spreads (or discounts) occur in contracts due to differences in quality between the hedged item and the benchmark.

Hedge Effectiveness

Almost all participants/respondents are supportive of the removal of the 80-125% effectiveness threshold and the retrospective effectiveness test requirement and replacing with a more principles-based approach. Some of the participants/respondents requested more stringent guidance for qualifying for hedge accounting including some who suggested the use of the FASB's proposal of a 'reasonably effective' threshold. However, other respondents expressed concern that the proposed approach implies a higher threshold than the existing 80-125% requirement (interpreting the 'unbiased' term to assume 100% effectiveness). Some others had concern over the requirement to minimise ineffectiveness also implies that a 'perfect' derivative must be utilised rather than the most economical derivative which meets management's risk management objective.

Rebalancing/Discontinuing the Hedging Relationship

Participants/respondents had mixed views on the requirement to rebalance the hedging relationship when the hedging relationship fails to meet the objective but the risk management objective is unchanged. Most support a rebalancing notion and believe it may address current practice issues under IAS 39. However, many requested additional guidance on those events that would be considered to require rebalancing and those events that would not. Some also believe that mandatory rebalancing could also be onerous on computer systems.

Many participants/respondents had concerns or requested additional clarification on the exposure draft's proposal that did not permit voluntary discontinuance of hedge accounting. Many felt that voluntary discontinuance is important for dynamic hedging strategies and questioned what level of risk management strategy should be considered in determining if discontinuance was appropriate - the hedging relationship level or some higher level (e.g., portfolio basis). Some also felt that as applying hedge accounting is options, discontinuing hedge accounting should also be optional.

Presentation and Disclosure

There are also mixed views by participants/respondents over the exposure draft's proposals for presentation of fair value hedges (where the hedged item is adjusted in a separate line item in the statement of financial position and effectiveness recognised in other comprehensive income while ineffectiveness recognised in profit or loss). While some welcome the proposals, others have concerns over the statement of financial position becoming 'cluttered' with the additional of separate valuation line items and questioned whether the valuation line item met the definition of an asset or liability. Many respondents also have concerns with expanding the use of other comprehensive income prior to the Board addressing the overall purpose of other comprehensive income. Also mentioned as a concern were operational complexities over tracking additional amounts in other comprehensive income. Most respondents agreed with the proposal not to allow linked presentation although constituents in Korea were particularly supportive allowing linked presentation.

Most participants/respondents agreed with the objective of the proposed disclosure requirements but have concerns with some of the proposed disclosures. Those concerns primarily focused on the requirement to disclose forward looking information and commercially sensitive information (such as locking into specific hedged rates in future periods). Participants/respondents mentioned that the requirement to disclose such information may impact the decision of whether to apply hedge accounting.

Time Value of Options

Most participants/respondents are supportive of the proposals regarding accounting for the time value of options. Some commented that the proposals would add complexity and preferred a single approach for all options or proposed alternative models.

Groups of Items

Respondents were generally supportive of the proposals regarding hedging groups of items, but many view this topic as part of the macro hedging discussions and therefore reserved comment until those proposals are finalised.

Contracts for non-financial items that can be settled in cash as a derivative

Most participants/respondents generally supported the proposal but some requested additional clarification such as whether the proposal would affect contracts which cannot be settled net in cash. Also, some requested the proposal to be extended to risk management strategies which are not managed to be close to zero. Some respondents had concerns over the requirement aspect of the proposal and preferred an option approach instead, similar to that in US GAAP.

Effective Date and Transition

Most participants/respondents agreed with the prospective application requirements. However, certain jurisdictions (Australia and New Zealand) requested retrospective application be permitted for the provision on time value of options as applying on a prospective basis would not capture the previous changes in fair value in other comprehensive income. Some respondents also requested early application of only the hedge accounting provisions (without early adopting other aspects of IFRS 9) for non-financial items.

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