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Accounting for macro hedging

Date recorded:

The IASB continued to discuss different aspects of the revaluation approach for accounting for macro hedging activities to be published in a forthcoming discussion paper on the topic.  No questions were asked of the Board. The purpose of the session was to discuss the following two issues:

  1. Income and balance sheet presentation: Where should the necessary accounting adjustments from application of the portfolio revaluation approach be presented in the financial statements?
  2. Portfolios included in the revaluation model: How should portfolios be selected for inclusion in the revaluation model?

Income and balance sheet presentation

The discussions so far have predominantly focussed on the net impact on profit or loss and the balance sheet from the revaluation adjustment for managed exposures.  In this session the Board considered the “geography” of the necessary adjustments considering what would present the most useful information and at the same time be practical.  This discussion was in the context where the objective of risk managers within a bank is to manage net interest margin.

The Board considered two approaches for income statement presentation as follows:

Stable net interest income approach

Under this approach net interest income is recognised on the assumption that this objective has been achieved. Revaluation profit or loss would then provide information on how good the bank has been at achieving that objective, for both realised and future net interest margin.

To apply this approach all changes to the revaluation adjustment would be taken to a new single profit or loss line item outside of net interest income. From this line, the managed accrued interest would be reclassified to net interest revenue or expense to reflect the stable rate.

Actual net interest income approach

Under this approach there would be no change to existing interest revenue and interest expense presentation. However, a new line would be introduced within net interest income, presented on the face of the income statement, called “net interest income from risk management activities”. Net accruals from all risk management instruments would be reported within this new interest line.  A profit or loss line item for the effect of dynamic interest rate risk management would also be presented reflecting any mismatches in anticipated future net interest income.

During the discussion the Board questioned whether the stable net interest approach would be relevant and useful for users.  The Staff noted that from the limited outreach undertaken so far there was a preference for the actual net interest margin approach. A number of a Board members agreed that both alternatives should be presented in the discussion paper, although those that commented said they would also prefer the stable net interest approach. In response to a question raised it was noted that although the two income approaches were being considered in the context of macro hedging of interest rate risk, the question could equally apply to hedges of non-financial risks by non-financial entities.

The Board considered three balance sheet presentation alternatives as follows:

Line-by-line balance sheet gross up

Under this approach individual exposures included in the managed portfolio would be adjusted on balance sheet to include the associated revaluation adjustment. Where eligible exposures do not meet the criteria to be recognised as assets or liabilities (e.g. equity model book or pipeline trades) the presentation of the revaluation adjustment would require further consideration with OCI being a possible alternative.

Separate lines for aggregate gross adjustments to assets and liabilities

Under this approach revaluation adjustments for all assets would be reported in a single asset revaluation line in the balance sheet and likewise a single liability revaluation line for liabilities. Again, adjustments to eligible exposures not meeting the criteria for recognition as assets or liabilities would have to be considered with a single net adjustment to OCI being a possible alternative.

Single net balance sheet line item

Under this approach the net revaluation adjustment for the whole managed portfolio would be presented in a single line in the balance sheet.

During the discussion many of the Board members preferred the gross aggregate approach with two expressing a preference for a net approach as they believed it provided a better reflection of the actual risk management approach and the potential difficulty in separating out a net amount. A number of Board members asked about disclosures and explained that the gross information would be useful and hence could see a rational for it to be at least disclosed. 

Portfolios included in the revaluation model

In Board discussions so far, the question of what the model should be applied to has not been explicitly covered. The Staff noted that in the limited outreach conducted so far there has been significant interest in what portfolios should be included in the revaluation model.

In this session the Board considered whether the approach should apply to all portfolios managed for interest rate risk, or to a selection of discrete portfolios and in either case whether the whole managed amount should be revalued or only the managed amount that is hedged (i.e. excluding open positions).

The Board considered the pros and cons of the different approaches. It was noted that to apply the model to the managed amount of all portfolios would be the most transparent and would provide information on risk management activities including information on the positions that have intentionally been left open. This approach would be less about reducing profit or loss volatility necessarily which is a key objective of hedge accounting, but more about presenting useful and transparent information about macro hedging activities. This approach would also avoid a patchwork of hedge accounting which can make it difficult for readers to understand the results.

It was noted by the staff that a revaluation model that tried to accommodate risk limits by allowing varying proportions of the managed amount being revalued would not be operational as it would result in tracking and amortisation issues.  These are the very issues and complexities that exist in the current model that the Staff is seeking to avoid by considering a revaluation model. The Staff explained that they would look to explain this point in the discussion paper.

The Board also considered whether the revaluation approach for macro hedging should be optional or mandatory. It was highlighted that the revaluation approach could give rise to more profit or loss volatility than current application of hedge accounting.  Hence if entities are given a choice between applying hedge accounting an applying the revaluation approach they may opt for hedge accounting. Also, if entities may apply the model only to selected portfolios, this could lead to the revaluation approach only applying to those cases where hedge accounting is difficult to apply or not permitted (e.g. apply the revaluation model only to a portfolio of demand deposits and apply the hedge accounting model to other items).

One Board member asked about how this model would interact with macro-cash flow hedge accounting under the general model. The Staff explained that this would depend on the choices made available to preparers. For example, if the revaluation approach was optional and could be applied to selected portfolios, then preparers could choose between the two models and apply macro cash flow hedge accounting to some exposures and the revaluation approach to other portfolios.

Another Board member requested the Staff to include some content about how to define a portfolio for the purposes of applying the revaluation model to it.

One Board member asked that the Staff make clear in the discussion paper that the objective of the revaluation model would be to make the accounting for macro hedging activities more transparent and not to reduce profit or loss volatility.

In a final question, the Staff were asked if there were any remaining issues to discuss before the discussion paper could be drafted.  It was explained that there may be one further issue to be brought to the Board before discussions are complete for the purpose of issuing a discussion paper.

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