Background
In developing a new model the IASB comprehensively reviewed the hedge accounting requirements of IAS 39. IAS 39 had long been criticised as being too rules-based and viewed by many as unnecessarily preventing hedge accounting from being applied in reasonable circumstances. This has led to more volatility in profit or loss from risk management activities.
In overhauling the hedge accounting requirements, the IASB chose to deal with portfolio (or “macro”) hedge accounting of open portfolios separately from general hedge accounting. The idea behind this was to first set the principles of a general hedge accounting model before considering how this might apply for a macro hedging.
In December 2010, the IASB published the Exposure Draft ED/2010/13 Hedge Accounting (the 'ED') proposing a new general hedge accounting model. That ED contained an objective to align hedge accounting more closely with risk management. To meet this objective the ED proposed to increase the scope of eligible hedged items and hedging instruments. It proposed an objective-based hedge effectiveness assessment starkly different to IAS 39’s 80-125 per cent hedge effectiveness threshold. To accompany these changes to eligibility and qualification, it also proposed changes to the mechanics of cash flow and fair value hedge accounting, as well as revised hedge accounting presentation and disclosure requirements.
The ED was well received in many respects since it addressed many concerns relating to hedge accounting restrictions in IAS 39. The IASB also received feedback on areas where the proposed new requirements were not well understood, overly complex or contained restrictions on the application of hedge accounting that constituents did not agree with. This resulted in changes that were included in the IASB’s review draft of its proposals that were posted on the IASB's website in September 2012.
The IASB received comments on its review draft which lead to further changes, the most significant of which introduced an accounting policy choice under IFRS 9 to continue to apply the hedge accounting requirements of IAS 39. This policy choice was introduced to alleviate concerns that the proposed general hedge accounting model could not accommodate macro cash flow hedging of interest rate risk in the same way as IAS 39. Also since the macro hedge accounting project is not yet complete, some preparers did not want to change their hedge accounting processes twice (ie once to accommodate the general hedge accounting model and then again to accommodate the macro hedge accounting model).
Summary of key requirements
Increased eligibility of hedged items
IFRS 9 increases the scope of hedged items eligible for hedge accounting. For example:
- Risk components of non-financial items may be designated provided they are separately identifiable and reliably measurable
- Derivatives may be included as part of the hedged item
- Groups and net positions may be designated hedged items
Increased eligibility of hedging instruments
The new model allows financial instruments at fair value through profit or loss to be designated as hedging instruments. It also introduces a new way to account for the change in time value of an option when the intrinsic value is designated, resulting in less volatility in profit or loss. The alternative accounting treatment for forward points and currency basis (when excluded from the designated hedge) can also result in less volatility in profit or loss.
New hedge effectiveness requirements
A fundamental difference to the IAS 39 hedge accounting model is the lack of the 80-125 per cent bright line threshold for effective hedges and the requirement to perform retrospective hedge effectiveness testing. Under the IFRS 9 model, it is necessary for there to be an economic relationship between the hedged item and hedging instrument, with no quantitative threshold. This will allow flexibility in how an economic relationship is demonstrated and for qualifying hedges actual hedge ineffectiveness will be reported.
Increased hedge accounting disclosures
The trade off to increased hedge accounting possibilities is increased disclosures about an entity’s risk management strategy, cash flows from hedging activities and the impact of hedge accounting on the financial statements.
Alternatives to hedge accounting
As part of developing the new model, the IASB introduced some alternatives to hedge accounting as a means to reflect risk management activities in the financial statements. For example:
- IFRS 9 includes an option to designate a credit exposure as measured at fair value through profit or loss if the credit risk is managed using a credit derivative
- IAS 39, as amended for application with IFRS 9, includes an option to designate at fair value through profit or loss “own use contracts” if doing so eliminates or significantly reduces an accounting mismatch
Policy options to continue applying hedge accounting under IAS 39
The newly developed general hedge accounting model does not deal with the accounting for hedges of open portfolios (portfolio/macro hedge accounting). To alleviate concerns of preparers having to change their policies twice within a relatively short period of time, the IASB introduced two policy options in the final version of the hedge accounting chapter of IFRS 9:
- Those entities that currently apply the requirements in IAS 39.81A (the application of fair value hedge accounting to portfolio hedges of interest rate risk) may continue doing so under the new requirements. In that case, the requirements in IFRS 9 would apply to hedges in general, whereas portfolio hedges would continue to be accounted for according to IAS 39.
- Additionally, entities would be given an accounting policy choice to account for all hedges under either IAS 39 or IFRS 9. That option would be all inclusive, i.e. entities could not pick and choose (e.g., entities wishes to continue applying IAS 39 would have to continue testing effectiveness in the narrow 80-125 per cent corridor, could not benefit from the increased eligibility of hedge items and hedging instruments, etc.).
Effective date and transition
The IFRS 9 amendment to introduce the new hedge accounting model removed the mandatory effective date for IFRS 9 which will be set once the standard is complete with a new impairment model and finalisation of any limited amendments to classification and measurement, both of which are due to be finalised in 2014. The standard is available for early adoption (subject to local endorsement requirements), but if an entity elects to apply it it must apply all of the requirements in the standard at the same time. On transition the hedge accounting requirements are generally applied prospectively with some limited retrospective application.
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