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Deloitte comment letter on FRED 51 'Draft amendments to FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland — Hedge Accounting'.

Published on: 17 Feb 2014

We have published our comment letter on the Financial Reporting Council’s (FRC’s) Financial Reporting Exposure Draft (FRED) 51 ‘'Draft amendments to FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland — Hedge Accounting'.  We are supportive of the aims of FRED 51 but highlight a number of areas which we consider require amending before a finalised standard is published. 

The amendments propose to replace the restrictive hedge accounting requirements in FRS 102 with a set of hedge accounting principles based on the IFRS 9 Financial Instruments hedge accounting model.  Current FRS 102 requirements are narrow and do not permit hedge accounting in a number of common hedging scenarios leading to volatility in profit or loss when hedging instruments are transacted to reduce rather than increase risk.  In addition to broadening the eligibility criteria, FRED 51 also proposes to remove the requirement that an entity must expect the hedging instrument to be highly effective in offsetting the hedged risk in order to apply hedge accounting.  Instead, FRED 51 would require there to be “an economic relationship between the hedged item and the hedging instrument”.  

Our key concerns are around the measurement of hedge ineffectiveness and transition.  We comment: 

We believe the measurement of hedge ineffectiveness will be a major difficulty in the practical application of hedge accounting for simple entities and that this complexity has been underestimated.  We suggest the FRC may wish to consider allowing a ‘short cut’ method that would allow a sub-group of common hedge relationships to be accounted for as if they were 100 per-cent effective. 

We believe the proposed transitional requirements are unclear and open to various interpretations.  More generally, we have concerns about the timing of designation of hedge relationships on transition.  We accept that a pragmatic solution is needed to overcome the problem that the hedge accounting requirements will be finalised after the effective date of FRS 102, but as drafted, the proposals could be read as allowing complete flexibility as to the timing of documenting hedge relationships in the period up to the issue of the first financial statements that include these amendments.  We consider some discipline should be introduced to reduce the risk that hedges are designated with the benefit of hindsight. Further, because entities will transition from different GAAPs with different eligibility and documentation requirements we believe that the transitional provisions should differ. 

In addition to the above comments we also highlight that more detailed guidance is needed for where items are grouped together for risk management purposes and also in relation to which risk components can qualify as hedged items. 

Further comments and a full response to all questions raised in the invitation to comment are contained within the full comment letter which can be downloaded below.


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