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Financial instruments – Hedge accounting

Date recorded:

Eligibility of equity investments at fair value through other comprehensive income as hedged items

The hedge accounting exposure draft prohibited designating financial instruments carried at fair value through other comprehensive income (FVTOCI) as eligible hedged items because the risk exposure being managed did not impact profit or loss as the gains and losses recognised in OCI are never recycled to profit or loss. Several comment letter respondents raised this issue requesting the board to also permit these items as eligible hedged items. They asserted that while these equity investments may not impact profit or loss, they are often times hedged in a similar manner to other financial investments at fair value through profit and loss. In particular, they noted hedging these investments for foreign exchange risk and the hedging of equity price risk.

The Board considered whether to retain the prohibition in the exposure draft or to allow designation of equity investments as eligible hedged items, and if so, how to deal with the ineffectiveness that results from the hedging relationship.

The Board was quite divided on the issue. Certain Board members were vehemently opposed to allowing hedge accounting for these investments as they believed it could encourage further use of this designation category under IFRS 9. The Board's intention with creating this category was only for strategic investments, but because of difficulty in defining the term strategic appropriately left it available to items not held for trading.

Some of these Board members suggested that IFRS 9 be reopened in order to properly narrow the scope of the FVTOCI designation. Others felt that the FVTOCI category was an exception and now they were being asked to create another exception to resolve issues around the initial exception. One IASB member mentioned he would be open to consideration of allowing investments at FVTOCI as hedged items if the dividends on those investments were also recognised in OCI rather than in profit or loss. The IASB Chair mentioned he would be open to permitting a one-time election at initial recognition of the hedge accounting provisions to move items previously designated at FVTOCI to fair value through profit or loss in order to achieve hedge accounting.

However, other Board members empathised with the concerns raised by constituents and felt the accounting should portray the risk management activities. Ultimately, the Board tentatively decided in a narrow vote (8-7) to permit equity investments designated at FVTOCI as eligible hedged items. The Board also agreed that any ineffectiveness resulting from the hedging relationship to be recognised in OCI.

Based on the vote of the Board, one IASB member requested that IFRS 9 be reconsidered in an attempt to narrow the definition of investments eligible for designation at FVTOCI.

Once the decision to permit investments designated at FVTOCI as eligible hedged items was made, the Board then had to consider whether to limit the scope expansion just to this item or whether to expand the scope of hedge accountings to all risk exposure that impact profit or loss or other comprehensive income. The other primary component of OCI where entities will utilise economic hedging relates to defined benefit obligations. The Board had hesitations over expanding the scope of hedge accounting to all items impacting comprehensive income and tentatively decided to limit eligible hedged items to only those equity investments designated at FVTOCI.

Correction list for hyphenation

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