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Dynamic risk management

Date recorded:

Agenda Paper 4: Proposed project plan

The Visiting Fellow reminded the Board that they had recently discussed the high-level feedback received on the Discussion Paper (DP) on Accounting for Dynamic Risk Management (DRM). The agenda paper proposed a project plan. The Visiting Fellow conceded that the project was challenging as there were conflicting views amongst different stakeholders.

Preparers had proposed to address the current challenges of applying hedge accounting that aimed to manage volatility in profit or loss arising from accounting mismatches. They had suggested that the Board considered the flexibility to apply fair value or cash flow hedge accounting, the Portfolio Revaluation Approach (PRA) and the fair value option at the same time. They had also proposed to accept behaviouralisation (i.e., DRM is based on the expected cash flow profile rather than on the contractual lives of the exposures) in the model.

Users had generally supported the project and the PRA concept. In their view, financial reporting and DRM would be better aligned in the proposed model as it allowed for an analysis of net interest income by the profit source, derivatives by their use and hedged vs. unhedged items. Users had expressed concerns that an optionality of DRM would result in a lack of comparability.

Securities and prudential regulators had disagreed with the accounting model for DRM expanding the application of fair value or quasi fair value measurement. They supported a solution emphasising the need of discipline, safeguards and disclosures.

The staff proposed to consider disclosures first, before addressing recognition and measurement requirements. This was based on the fact that both users and preparers had expressed a need for information on DRM activities. Furthermore, decisions on recognition and measurement could then be built on the information needs with a greater degree of certainty concerning transparency. This approach would also give the IASB flexibility and the methodology to try and explore how best to address the diversity in views. The Visiting Fellow clarified that the staff did not recommend a disclosures only approach, neither did they propose a two-phased approach (i.e., disclosures in phase one and recognition and measurement in phase two).

Furthermore, the staff proposed to prioritise dynamic interest rate risk management. Based on the comment letters, proxy hedge accounting was a less urgent issue for non-interest rate risks. They also showed that the area of ‘other risks’ was not a priority for constituents.

Finally, the staff proposed to constitute an Expert Advisory Panel at a later stage in the project to assist the IASB in its deliberations.

One Board member agreed that the identification of user needs would have to be the first step in the project. The Technical Director said that this was consistent with the ‘disclosures first’ approach. The Chairman welcomed this approach. He said if the Board started deliberating recognition and measurement first, it would become contentious immediately.

Another Board member was concerned that the ‘disclosures first’ approach could be misunderstood. She said instead it should be firstly determined which information package should be provided. She agreed with leaving the composition of the Expert Advisory Panel open until a later stage.

One Board member noted that the paper did not explain why the IASB had decided to be very industry-specific in this project. He said that an explanation should be communicated.

A fellow Board member said that it was sensible to wait until IFRS 9 was fully applied. It would be worth seeing whether the “corporate” hedge accounting model in IFRS 9 caused issues in practice that could have relevance for the “banking” hedge accounting model. He warned the Board to be cautious with the expansion of quasi fair value.

One Board member asked whether the “disclosures first” approach would give a holistic view of DRM or whether it would be focused on risk mitigation. The Technical Director said that it was likely that the staff would pursue the holistic approach. The Board member said that existing disclosure requirements (also in local GAAPs) should be examined for the project.

A Board member said that a disclosure on the application of the PRA could be very useful, albeit not his favourite approach. The disclosure could present all assets and liabilities that were subject to DRM together with the revaluation adjustment to arrive at fair value and a second column that presented the unhedged amount.

A fellow Board member said that information needs should be easy to determine. The challenge would be finding measures of performance that reflected the business.

One Board member suggested considering the non-GAAP measures banks currently provided to reflect their DRM activities.

When called to vote, all Board members agreed with the staff recommendations.

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