Hedge Accounting (Agenda Paper 14A)

This paper focused on the potential hedge accounting issues that could arise as a result of interest rate benchmark (IBOR) reform.

At its October 2019 meeting, the Board tentatively decided to provide a practical expedient allowing entities to apply IFRS 9:B5.4.5 (i.e. no derecognition) to account for modifications to the interest rate benchmark on which a financial instrument’s contractual cash flows are based, that are:

• a) required as a direct consequence of IBOR reform; and
• b) done on an economically equivalent basis.

In this meeting, the staff asked the Board whether they agree with the following recommendations:

1. In summary, when the contractual cash flows of a financial instrument are renegotiated or otherwise modified, the accounting outcomes resulting from the application of current IFRS 9 requirements and the Board’s tentative decisions from its October 2019 meeting may differ depending on whether the modification:
   • a. results in derecognition
   • b. does not result in derecognition but is not directly due to the reform
   • c. is directly due to the reform.
   For a. and b. the staff recommend not amending the current requirements in IFRS 9 and IAS 39 to determine whether a hedging relationship should be discontinued.
2. For a modification that is due directly to the reform, IFRS 9 and IAS 39 should be amended to clarify that changes to the hedge documentation (such as redefining the hedged risk or the description of the hedging instrument/hedged item to make reference to the benchmark rate) does not result in discontinuation of hedge accounting. In addition, applying IAS 39, if the method to determine hedge effectiveness is amended due to IBOR reform, this would not result in discontinuation of hedge accounting.
   
   

   Board discussion and voting – points 1 and 2

   The Vice-Chair asked the staff to clarify the scope of the relief and what modifications would qualify in the final drafting of the amendment.  The drafting of this relief confirms that if you make the modification from IBOR to a risk free rate today, you would have to de-designate your hedge. It was noted that the staff should think about a helpful way to allow those making these changes earlier to be able to apply this relief (i.e. allow retrospective application). The staff confirmed this is something they will think about.

   Another Board member wanted to clarify a point discussed in the previous Board meeting: if the modification was not economically equivalent, but the economically equivalent portion was removed and the remaining portion was assessed to be substantially modified, then it needs to be clear that the whole item should be derecognised.  For the purpose of assessing the modification, the amendment would allow the portions to be separated even if they are not contractually specified. However, the whole item needs to be derecognised if one part is substantially modified. The Board member wanted to clarify whether this would be the same for hedge accounting. The staff confirmed that other modifications made to the hedge documentation would need to be assessed to see if they would cause the hedge to be discontinued and if they did, then the whole hedging relationship would need to be discontinued.

   All Board members voted in favour of points 1 and 2 of the staff’s recommendation.
   

3. Once the hedged risk in a fair value hedge has been amended or the derivative/hypothetical derivative in the hedge relationship has been amended due to IBOR reform, no exceptions should be provided from existing IFRS 9/IAS 39 requirements to measure and recognise valuation adjustments/ineffectiveness.
   
   

   Board discussion and voting – point 3

   A board member asked about situations when a hedge fails the effectiveness assessment. Staff confirmed that this will be discussed at a later session.

   13:1 Board members voted in favour of point 3 of the staff’s recommendation.
   
   
4. IFRS 9 and IAS 39 should be amended, so that when items within a designated group of items are amended for modifications due to the IBOR reform, entities are required to:
   • a. amend the hedge documentation to define the hedged items by way of two subgroups within the designated group of items, one referencing the original interest rate benchmark and the other the alternative benchmark rate;
   • b. perform the proportionality test (i.e. the test that the change in fair value attributable to the hedged risk for each individual item in the group is expected to be approximately proportional to the overall change in fair value attributable to the hedged risk of the group of items) separately for each subgroup of items designated in the hedging relationship;
   • c. treat the hedge designation as a single hedging relationship and allow entities to amend the hypothetical derivative to reflect the combination of the subgroups of items; and
   • d. for a group of items designated under IAS 39 only, entities could treat IBOR and its alternative benchmark rate as if they would share similar risk characteristics.
5. Regarding IAS 39 fair value hedge accounting for a portfolio hedge of interest rate risk, IAS 39 should be amended so that, when entities change the hedged risk in the hedged documentation due to IBOR reform, it is assumed that all items included in the portfolio of financial assets or financial liabilities share the risk being hedged.
   
   

   Board discussion and voting – points 4 and 5

   One board member asked if the benchmark rate, instead of being a single risk free rate, was several different new risk free rates and one of the new hedge designations fails, would all of the hedges fail. The staff responded by saying that there is only one hedged risk but agreed to investigate this point further. 

   All Board members voted in favour of points 4 and 5 of the staff’s recommendation.