Items eligible for designation in the current net open risk position (Agenda Paper 4A)

The IASB introduced the concept of current net open risk position (CNOP) in November 2021 as the net open interest rate risk exposure (by time bucket) derived from the combination of an entity’s assets and liabilities (including core demand deposits) and eligible future transactions over the period the entity is managing such risk. In other words, this is the ‘organic’ interest rate risk exposure from the entity’s underlying positions before considering any derivatives.

In the July 2022 project plan, the staff included the consideration of items that would be eligible for inclusion in the CNOP as one of the areas requiring further analysis in the dynamic risk management (DRM) model. More specifically, the staff listed:

• Own equity (such as, equity reserves and equity instruments with characteristics of debt)
• Financial assets classified as fair value through other comprehensive income (FVOCI items)
• Other financial assets that are classified as fair value through profit or loss (FVPL) as a result of not having contractual cash flows that are solely payments of principal and interest

In its November 2022 meeting, the IASB discussed the inclusion of own equity in the CNOP and concluded it is not necessary to achieve the objectives of the DRM model, and therefore, equity is not eligible for designation in the CNOP.

At this meeting, the staff analysed whether financial assets measured at FVOCI or FVPL are eligible for inclusion in the CNOP.

Based on the analysis, the staff considered that although including FVOCI financial assets in the CNOP would not achieve an offsetting position in the statement of financial position, the DRM adjustment would nevertheless achieve the dual objectives of the DRM model, i.e. provide an offset when the net interest income and/or economic value inherent in the underlying items is realised (when it affects profit or loss). Therefore, the staff concluded that the DRM adjustment does faithfully represent the underlying economic phenomenon and as a result FVOCI items should be eligible for designation in the CNOP.

The staff also believed that financial assets measured at FVPL should not be eligible to be designated in the CNOP because the general accounting requirements already achieve faithful representation of both the economic value and earnings perspective. This is because the protection/benefit provided by the derivative is recognised in the same period as the change in value of the underlying item in profit and loss.

Staff recommendation

The staff recommended that financial assets measured at FVOCI are eligible for designation in the CNOP, while financial assets measured at FVPL are not be eligible for designation in CNOP.

IASB discussion

IASB members largely agreed with the staff recommendation. The main discussion revolved around what the DRM model was trying to achieve. This was triggered by an IASB member struggling with the economic value perspective. In his view, the DRM model does not add anything to economic value, it merely depicts the economics better in the accounting. The Chair agreed and said that DRM is only protecting the net asset value (NAV), to which the IASB member replied that it does not even that. The Chair conceded that it protects the NAV from an accounting perspective. The IASB member agreed but said that this has nothing to do with the economic value. The staff confirmed that DRM was only about eliminating the accounting mismatch and agreed to revisit the drafting with regard to economic value. The Chair said that it is important to include the risk manager perspective as well, as they would usually not be familiar with the accounting standards. Therefore, referring to accounting mismatches only would not reach the risk managers. The staff agreed to add an example that is addressed to risk managers but the IASB needs to be careful not to tell banks what is good or bad risk management. The DRM model just tries to solve the accounting problem that arises. An IASB member added that it would be good to illustrate debits and credits to make the guidance more accessible.

One IASB member asked why a previous tentative decision by the IASB precludes a net partial remaining exposure to be eligible for DRM. The staff replied that this decision would have to be revisited in light of other decisions made.

IASB decision

All IASB members agreed with the staff recommendation.

Performance assessment and unexpected changes (Agenda Paper 4B)

The IASB’s objective of developing the DRM model is to better reflect an entity’s interest rate risk management strategy and activities in its financial statements. As a result, an entity’s CNOP is determined on the basis of its risk management strategy (subject to the qualifying criteria for items included), reflecting the expected rather than contractual cash flows.

Since these expected cash flows are based on the entity’s internal models and include, for example, modelling of prepayments or core demand deposits, there could be unexpected changes in the actual cash flows or the entity’s expectations could change due to unexpected events.

To ensure the DRM model provides information that is relevant and a faithful representation of the economic substance of an entity’s DRM activities in the financial statements, a retrospective assessment of the success and performance of these activities are needed. This will ensure the robustness of the DRM model and maintain the required discipline when applying any hedge accounting or risk mitigation model.

The purpose of this paper was to analyse how unexpected changes could be reflected in the assessment and measurement of performance in the DRM model.

As a result of the analysis, the staff considered that the retrospective assessment against the entity’s target profile would not provide useful information to the users of the financial statements and applying such mechanics could even confuse or mislead users in some circumstances.

Staff recommendation

The staff recommended not requiring the retrospective assessment against an entity’s target profile, and only keep the retrospective assessment to check whether the entity has mitigated interest rate risk during the assessment period when applying the DRM model.

To address the challenge that the DRM model may not capture the full effects of unexpected changes (since the retrospective assessment would only consider the effects for the DRM period under assessment), the staff recommended the introduction of another retrospective assessment based on the entity’s capacity to realise the expected benefits.

IASB discussion

IASB members largely supported the staff recommendation, particularly with not requiring a retrospective assessment against the target profile.

There was some discussion as to how often the ‘capacity test’ would be applied. The staff said that it should be required once per reporting period, but if entities have the ability to do it more often, that would be beneficial to the information. However, the result should not change based on how often the test is performed. It should also not depict how successful the entity was in managing risk but represent the economics as closely as possible.

One IASB member asked for an illustrative example of the capacity test. The staff replied that they can provide an example but would be reluctant to prescribe a method of calculation. There was also the suggestion to produce webcasts, slides and pictorial representations of the model to make it more accessible to preparers. The staff agreed to prepare such material.

IASB decision

All IASB members supported the staff recommendation.