Cover note (Agenda Paper 4)

In this session, the IASB continued its deliberations on Discussion Paper DP/2014/1 Accounting for Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging.

This paper was not discussed.

Topic Summary of tentative decisions and glossary of defined terms (Agenda Paper 4A)

This paper provided an update on the Dynamic Risk Management (DRM) project based on the proposed project plan the IASB discussed in July 2022. It also summarised the tentative decisions taken by the IASB to date that are relevant to the refined DRM model, identified the areas that are still subject to the IASB’s deliberation based on the proposed project plan, and provided a glossary of defined terms.

This paper did not ask for a decision from the IASB and was not discussed.

Risk mitigation intention and the construction of the benchmark derivatives (Agenda Paper 4B)

In the July 2022 project plan update, the staff listed the risk mitigation intention (RMI) and the construction of the benchmark derivatives as areas where further clarification may be required. This is due to feedback from outreach participants on the core DRM model. These participants followed the development of the DRM model and as a result informally requested further clarification on certain aspects of the requirements after the refinements to the core DRM model were tentatively decided by the IASB in November 2021.

Specifically, these participants were unclear about how the RMI will be determined from one DRM assessment period to the next, how the designated derivatives which have been entered into with external counterparties would evidence the RMI, and how the benchmark derivatives are constructed, particularly with respect to the relevant input factors such as the notional, tenor, reset terms, benchmark interest rate etc., to ensure consistent application of the DRM model.

The purpose of this paper was to provide an analysis and clarifications on how the requirements to determine the RMI and the benchmark derivatives will be applied using the DRM model.

Staff recommendation

The staff recommended that the IASB require:

• The managed risk to be the interest rate risk an entity manages consistent with its risk management strategy and therefore the risk an entity’s risk limits are based on
• The benchmark derivative is calibrated to current market rates of the managed risk to achieve a fair value of zero using the RMI by repricing time period

In addition, the staff recommended confirming the following tentative decisions the IASB have already taken at previous meetings:

• The RMI is evidenced by the actual amount of interest rate risk by repricing time period transferred to a party external to the reporting entity (i.e. external to the group or individual entity that is being reported on)
• For the purposes of the prospective assessment, the repricing time periods of the available risk to mitigate are aligned with an entity’s risk management strategy

IASB discussion

IASB members discussed an example in the agenda paper where an entity may have a current net open risk position (CNOP) at the nine-year repricing period while there may be a very limited market for a nine-year interest rate swap (or such bespoke swap is much more expensive). As a result, the entity may choose to mitigate the nine-year risk using a ten-year swap, which is more commonly available in the market. IASB members agreed that in such cases the IASB should provide more flexibility in determining the RMI, for example to document that only the risk up to the nine-year point of the ten-year derivative should be considered when determining the RMI and building the benchmark derivative when applying the DRM model.

There was a question as to whether an entity can have more than one CNOP. The staff confirmed that there is one CNOP per DRM, so there could be several within the reporting entity.

IASB decision

All IASB members voted in favour of the staff recommendation.

Further considerations on the current net open risk position (Agenda Paper 4C)

To better reflect the effect of an entity’s risk management activities in the financial statements using the DRM model, the IASB tentatively decided in November 2021 to introduce the CNOP. This represents the net open interest rate risk position (by time bucket) derived from the combination of an entity’s financial assets and financial liabilities (including core demand deposits) and eligible future transactions over the period the entity is managing such risk.

The qualifying criteria for inclusion of financial assets and financial liabilities in the CNOP were tentatively agreed by the IASB in February 2018 and April 2018. The IASB also made some further tentative decisions in November 2022 and February 2023 about an entity’s own equity and financial assets measured at fair value through other comprehensive income (FVOCI) and financial assets measured at fair value through profit or loss (FVPL).

In summary, the current qualifying criteria for inclusion in the CNOP are:

• Financial assets are measured at amortised cost or FVOCI in accordance with IFRS 9
• Financial liabilities are measured at amortised cost in accordance with IFRS 9
• The effect of credit risk must not dominate the changes in expected future cash flows
• Future transactions are highly probable
• Future transactions must result in financial assets or financial liabilities that are classified as subsequently measured at amortised cost or financial assets measured at FVOCI in accordance with IFRS 9
• Items already designated in a hedge accounting relationship do not qualify for designation in the DRM model
• Qualifying items are managed on a portfolio basis for interest rate risk management purposes

In this paper, the staff focused on the qualifying criteria of whether future transactions are highly probable, and considered whether further refinement is necessary with respect to this requirement.

Staff recommendation

The staff recommended that the IASB:

• Require future transactions that are the reinvestment or refinancing of existing financial assets or financial liabilities at the prevailing market interest rate to be included in the CNOP when they are expected to occur
• Retain the requirement for all other future transactions to be highly probable to occur

IASB discussion

There was not much discussion on this paper. One IASB member highlighted that the IASB needs to be careful not to cross the line into the hedging requirements of IFRS 9 to avoid unintended consequences for the IFRS 9 hedging.

IASB decision

All IASB members voted in favour of the staff recommendation.