Cover note (Agenda Paper 4)

In this session, the IASB discussed three agenda papers. Agenda Paper 4A provided an update on the DRM project only and did not ask for decisions from the IASB. IASB members were asked whether they agree with the staff recommendations on Agenda Papers 4B and 4C.

This paper was not discussed.

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

This paper provided an update on the DRM project based on the proposed project plan the IASB discussed in July 2022.

This paper was not discussed.

Designation of hedged exposures in the current net open risk position (Agenda Paper 4B)

This paper discussed two eligibility criteria defined as part of the core DRM model: The first is that items which are already designated in a hedging relationship are not eligible for designation in the current net open position (CNOP) and the second is that financial assets and financial liabilities must be denominated in the same currency to be eligible for designation in the CNOP.

On feedback received from stakeholders during outreaches, many participants said it is common for them to raise funding or originate loans in currencies other than their functional currency, and as a result they are likely to be exposed to foreign currency risk as well as interest rate risk from these portfolios. In many cases, they would economically manage the foreign currency risk using cross-currency swaps first, and then manage the interest rate risk in their functional currency holistically and dynamically together with other financial assets and financial liabilities denominated in their functional currency. Some IASB members asked the staff to explore the possibility of designating financial assets or financial liabilities in the DRM model after such assets or liabilities have been designated in a general hedging relationship.

Staff recommendation

The staff considered that the requirement to allocate underlying financial assets and financial liabilities denominated in different currencies into separate DRM models continues to be relevant. However, the staff recommended that an entity is permitted to include hedged exposures (i.e. the combination of the underlying exposures as the hedged items and the derivatives as the hedging instruments that are designated in an existing hedge accounting relationship) for the purpose of determining the CNOP in the DRM model.

IASB discussion

IASB members were overall supportive to the staff recommendations. One IASB member raised a question about the implications of designating aggregated exposure in the DRM model in terms of disclosure requirements. The staff acknowledged that the disclosure requirements are a topic that they should look into. Another IASB member raised a concern about the risk of the de-designation being used to achieve an accounting outcome rather than to reflect the risk management strategy. The staff clarified that the de-designation should be consistent with the risk management strategy.

IASB decision

12 of the 14 IASB members agreed that:

• The requirement for underlying financial assets and financial liabilities denominated in different currencies to be allocated to separate DRM models continues to be necessary
• An entity is permitted to include hedged exposures in a current net open risk position if doing so is consistent with the entity’s risk management strategy. In the DRM model, ‘hedged exposures’ refers to the combination of the hedged items and the hedging instruments that are designated in a hedge accounting relationship when applying IFRS 9

Designated derivatives (Paper 4C)

This paper discussed the designation of non-linear derivatives in the DRM model and the designation of off-market derivatives in the DRM model.

Designation of non-linear derivatives in the DRM model

Background

At the June 2018 meeting, the IASB tentatively decided that options would be considered in the second phase of the model depending on the feedback from stakeholders. Some stakeholders said that in some circumstances they may have to use non-linear derivatives (such as interest rate options with non-linear cash flows), particularly when the underlying positions contain non-linear cash flows or there is significant uncertainty about the expected cash flows from their underlying positions. Some preparers suggested that using an option-based risk management strategy is arguably more effective in mitigating the interest rate risks than relying on expected cash flows. They are of the view that the DRM model should be able to faithfully reflect the effect of using these non-linear derivatives.

Staff recommendation

The staff acknowledged that using non-linear derivatives might be inherently more complicated than using linear derivates. However, considering the objective of the DRM model, the staff recommended that non-linear derivatives, except for net written options, are eligible as designated derivatives when their use is consistent with an entity’s risk management strategy and faithfully represents the entity’s risk management activities.      

Designation of off-market derivatives in the DRM model

Background

Some stakeholders raised concerns that designation of off-market derivatives may cause further complications under the DRM model, given the complexities around determining the accrual profile of a derivative that has a non-zero fair value at the date of designation compared to the accrual profile of a derivative that has a zero fair value at the date of designation. Additionally, the potential impact of early termination of derivative contracts or derivatives trade compression (i.e. a process of reducing gross notional of a derivative portfolio by replacing multiple off-setting derivate contracts with fewer derivative contracts of the same net risk) would also need to be considered.

Staff recommendation

The staff recommended that off-market derivatives are eligible as designated derivatives in the DRM model, provided such a designation is in line with the entity’s risk management strategy and faithfully represents the entity’s risk management activities, and that only fair value changes of the designated derivatives after the date of the designation are considered as part of the measurement of the DRM adjustment.

IASB discussion

IASB members were overall supportive of the staff recommendations relating to both designation of non-linear derivatives and off-market derivatives into the DRM model.

IASB decision

13 of the 14 IASB members agreed that non-linear derivatives, except for net written options, would be eligible to be designated derivatives when their use is consistent with an entity’s risk management strategy.

All IASB members agreed that off-market derivatives would be eligible to be designated derivatives when their use is consistent with an entity’s risk management strategy. However, only the fair value changes that arise after the date of initial designation are considered when measuring the DRM adjustment.