Hedge accounting

Date recorded:

Hedge effectiveness assessment

Feedback provided during the Board's outreach activities and comments received from the hedge accounting exposure draft identified that constituents were very supportive of the removal of the 80-125% brightline threshold and the required quantitative retrospective hedge effectiveness test. Additionally, most supported the introduction of a qualitative hedge effectiveness assessment to qualify for hedge accounting. However, constituents had some concerns with the exposure drafts' objective based hedge effectiveness assessment proposals.

The staff's analysis attributed some of that concern to the introduction of new terms and concepts that constituents were not previously familiar with. However, the staff also acknowledged that some of the proposals were being misinterpreted or had unintended consequences. For example, some constituents felt that the proposed requirement that a hedging relationship produce an unbiased result' that minimises expected ineffectiveness' would require entities to find the perfect' derivative rather than a derivative that is most economical and which meets the risk management objective (i.e., effectively replacing the 80-125% effectiveness threshold with a 100% hedge effectiveness requirement). Some respondents also noted that the effectiveness test requirement that no expectation that changes in the value of the hedging instrument will systematically either exceed or be less than the change in value of the hedged item' could be problematic for late hedges' when the hedging relationship is entered into at a point after inception of the derivative hedging instrument such that it has an inherent fair value other than nil.

To address the concerns over misunderstanding, lack of clarity and potential unintended consequences, the staff recommended supplementing the term other than accidental offsetting' by clarifying that a hedging relationship would have to meet the following two criteria: (1) that there is an economic relationship between the hedged item and the hedging instrument, and (2) the effect of credit risk does not dominate the value changes that result from the economic relationship (i.e., the effect of the changes in the underlying). The staff also recommended replacing the guidance in the exposure draft on unbiased hedge', minimising hedge ineffectiveness', and the entity has no expectation that changes in the value of the hedging instrument will systematically either exceed or be less than the changes in value of the hedged item such that they would produce a biased result'. Instead, the guidance would be replaced by adding criteria that an entity's designation of the hedging relationship shall be based on (1) the quantity of hedged item that it actually hedges, and (2) the quantity of the hedging instrument that it actually uses to hedge that quantity of hedged item. Additionally, guidance would be included that an entity shall not designate a hedging relationship such that it reflects a deliberate mismatch between the weightings of the hedged item and the hedging instrument that would create hedge ineffectiveness in order to achieve an inappropriate accounting outcome.

The Board began its discussion by clarifying that this discussion on hedge effectiveness was solely in the context of getting into hedge accounting and not in the context of measuring hedge ineffectiveness. The Board was generally supportive of the staff's recommendations although there were several comments made on drafting suggestions. Some Board members preferred the usage of anchor' or umbrella' terms (such as other than accidental offsetting' and unbiased result') feeling that principles based standards require usage of such terms and that overly describing the concepts will only result in additional requests for clarification. However, other Board members felt that adding additional clarity was necessary to ensure the effectiveness criteria were applied as intended by the Board.

The Board had a discussion on whether the revised criteria as recommended by the staff represented a loosening or tightening of 1) the current requirement under IAS 39 and 2) the proposals in the exposure draft. Some Board members felt that the revised criteria represented a tightening of the criteria over both the 80-125% threshold and the exposure draft proposals. Other Board members had concerns over expressing the revised criteria as tightening the requirements in IAS 39 because they felt the current requirements were overly punitive. The staff suggested that the revised criteria could not fairly be compared to the current IAS 39 requirements as looser' or tighter' because of the arbitrary results that sometimes occur with the 80-125% threshold. However, the staff acknowledged that the revised criteria should help to tighten the requirements over those in the exposure draft and help to address the concerns of those who interpreted the proposals as allowing inappropriate hedging relationships to qualify for hedge accounting.

Ultimately, the Board supported the staff recommendation subject to wording modification the Board will provide to the staff on the revised hedge effectiveness criteria.

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