IFRS 9 Chapter 6 Hedge Accounting Overview of revised proposal · PDF fileChapter 6 Hedge...

Deloitte Touche Tohmatsu Jaiyos Audit Co., Ltd.March 2013

IFRS 9Chapter 6 Hedge AccountingOverview of revised proposal

© 2013 Deloitte Touche Tohmatsu Jaiyos Co. Ltd

Agenda

• IFRS 9 Project : Current status• Hedge accounting : Background• Hedge accounting : Project status• Summary of changes in general hedge accounting

1 General Hedge Accounting | Overview of revised proposal


IFRS 9 Project : Current status


Phase 1:

Classification and

measurement

• Original publication

IFRS 9 Financial Instruments was published in November 2009 and contained requirements for financial assets. Requirements for financial liabilities were added to IFRS 9 in October 2010. Most of the requirements for financial liabilities were carried forward unchanged from IAS 39. However, some changes were made to the fair value option for financial liabilities to address the issue of own credit risk.

In December 2011, the Board amended IFRS 9 to require application for annual periods beginning on or after 1 January 2015 and to not require the restatement of comparative-period financial statements upon initial application.

• Limited amendments to IFRS 9

On 15 November 2011, the Board decided to consider making limited modifications to IFRS 9, and on 28 November 2012 the IASB issued an Exposure Draft Classification and Measurement: Limited Amendments to IFRS 9 (Proposed amendments to IFRS 9 (2010)).


IFRS 9 Project : Current status (Cont’d)


Phase 2:

Impairment methodology

• The supplementary document Financial Instruments: Impairment was published in January 2011. The comment period closed on 1 April 2011 and re-deliberations are on-going.

Phase 3:

Hedge accounting

• On 7 September 2012 the IASB posted to its website a draft of the forthcoming general hedge accounting requirements that will be added to IFRS 9 Financial Instruments.


Hedge AccountingBackground

• This project forms part of the IASB's comprehensive project on financial instruments.

• The existing hedge accounting requirements in IAS 39 are complex and not reflective of an entity’s risk management activities, nor to what extent those activities are successful in meeting the entity's risk management objectives. Many also find the requirements in IAS 39 excessively rule-based, resulting in arbitrary outcomes.

• The project involves a comprehensive review of hedge accounting requirements, to establish a more objective-based approach to hedge accounting and align it with an entity's risk management processes.

• This project is split into two phases: general hedge accounting and macro hedge accounting.



Hedge AccountingProject Status

General Hedge Accounting:• The exposure draft ED/2010/13 Hedge Accounting was published on

December 9, 2010.• The ‘review draft’ of hedge accounting section of IFRS 9 was published

on September 7, 2012, dealing with general hedge accounting requirements following its re-deliberations of the ED.• The purpose of issuing a draft was to provide constituents with an

opportunity to familiarise themselves with the proposals, which would represent a significant change to the current hedge accounting approach under IAS 39.

• The finalised requirements are expected to be issued in the second quarter of 2013 and effective on January 1, 2015.



Hedge AccountingProject Status

Macro Hedge Accounting:• This phase of the project considers risk management that assesses risk

exposures on a continuous basis and at a portfolio level. Risk management strategies tend to have a time horizon (e.g. two years) over which an exposure is hedged. Consequently, as time passes new exposures are continuously added to the hedged portfolio and other exposures are removed from it.

• The IASB has begun in-depth deliberations on macro hedge accounting and a discussion paper is expected in the first or second quarter of 2013



Reasons of changes

1. Have the complex rules made it difficult to apply hedge accounting and alsodifficult to explain the results of applying hedge accounting in the context to theentity’s business and its risk management activities.

2. To align accounting more closely with risk management and to provide usefulinformation about the purpose and effect of hedging instruments. It alsoproposed requirements for:

(a) what financial instruments qualify for designation as hedging instruments;

(b) what items (existing or expected) qualify for designation as hedged items;

(c) an objective-based hedge effectiveness assessment;

(d) how an entity should account for a hedging relationship (fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation as defined in IAS 21 The Effects of Changes in Foreign Exchange Rates); and

(e) hedge accounting presentation and disclosures.



Unchanged from IAS 39

• Applying hedge accounting remains a choice

• Terminology from IAS 39 is retained in many cases (hedged items, hedging instruments, fair value hedges, cash flow hedges, hedge ineffectiveness etc.).

• The mechanics of fair value, cash flow and net investment hedge accounting have not been changed.

• With the exception of hedge ineffectiveness related to hedges of equity investments designated as at fair value through other comprehensive income, all hedge ineffectiveness is recognized in profit or loss.

• The method for determining how much ineffectiveness to recognize for cash flow hedges is unchanged.

• General prohibition on hedge accounting with written options is retained.



General Hedge AccountingKey areas of change


Closer alignment of the hedge

accounting model with risk

management

New rules for discontinuing

hedging relationships

Increased eligibility of

hedged items


hedging instruments

A revocable fair value

option when hedging

particular credit risks

New qualification

and effectiveness requirements

New concept of rebalancing



Closer alignment of the hedge accounting model with risk management

• Proposed hedge accounting requirements seek to deliver a more principles-based standard that aligns hedge accounting more closely with risk management.

• The objective of hedge accounting is to represent the effect of an entity’s risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss.

• This approach aims to convey the context of hedging instruments for which hedge accounting is applied in order to allow insight into their purpose of effect.




management




hedged items


hedging instruments


option when hedging


New qualification





Increased eligibility of hedged items

• Inclusion non-financial items which provided the component is separately identifiable and reliably measurable.

• The risk component does not necessarily have to be contractually specified for it to be separately identifiable

• Example of exposures may be hedged items under the proposals

- Risk components of non-financial items and non-contractually specified inflation

- Net positions and layer components of items- Aggregated exposures (a combination of a non-derivative exposure

and a derivative)- Equity investments at fair value through other comprehensive income

(OCI)




management




hedged items


hedging instruments


option when hedging


New qualification





Increased eligibility of hedged items (cont’d)

Example of Risk components of non-financial items and non-contractually specified inflation

Hedging risk component

Under IAS 39 Under new requirements

Risk component

Risk component

Risk component

Non-financial hedged item

Hedging instrument

Risk component

Risk component

Risk component

Non-financial hedged item

Hedging instrument



management




hedged items


hedging instruments


option when hedging


New qualification






Hedged itemsWhich hedged items are eligible for designation?




management




hedged items


hedging instruments


option when hedging


New qualification




� �


Hedged Items (cont’)

Example of Aggregated exposure

An entity has a forecast purchase requirement of a commodity denominated in a foreign currency (FC). That entity may manage the commodity price risk (in FC) two years in advance by transacting a net settled forward contract that fixes the price at FC100 per unit. A year later, it may wish to hedge the foreign currency risk that arises on the combination of the forecast purchase and the commodity derivative.

Hedging relationship#1(CF hedge):

Exposure

Derivative #1

Forecast purchase (FC)

Forward purchase contract

Hedging relationship#2(CF hedge):

AggregateExposure

Derivative #2

Fixed FC exposure

FX forward contract



management




hedged items


hedging instruments


option when hedging


New qualification






Hedging “own use” contracts to buy or sell a non-financial item

• To mitigate the need for hedge accounting, new general hedge accounting extends the fair value option in IFRS 9 to contracts that meet the “own use” scope exception if doing so eliminates or significantly reduces an accounting mismatch.

Example• Commodity processors hedge the economic risk exposure of their purchase

and sale contracts of non-financial items along with commodity inventories and derivatives measured at fair value.




management




hedged items


hedging instruments


option when hedging


New qualification





Increased eligibility of hedging instruments

• Inclusion of non-derivative financial instruments measured at fair value through profit or loss.

• However, a non-derivative financial asset or non-derivative financial liability (not measured at fair value through profit or loss) may be designated as a hedging instrument only for a hedge of a foreign currency risk.

• Therefore, cash instruments may be hedging instruments in additional circumstances.




management




hedged items


hedging instruments


option when hedging


New qualification





Increased eligibility of hedging instruments

• A hedging instrument must be designated in its entirely in a hedging relationship. The only exceptions permitted are:

• separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the change in intrinsic value of an option

• separating the forward element and the spot element of a forward contract and designating as the hedging instrument only the change in the spot element of a forward contract

• for a hedge of foreign currency risk, the foreign currency risk component of a non-derivative financial asset or non-derivative financial liability may be designated as a hedging instrument provided that it is not an investment in an equity instrument for which an entity has elected to present changes in fair value to OCI

• proportion of the entire hedging instrument, such as 50 per cent of the nominal amount, may be designated as the hedging instrument in a hedging relationship (not changed from current IAS39).




management




hedged items


hedging instruments


option when hedging


New qualification





Accounting for hedging instruments

The time value of purchased options and the forward element of forward contracts may be deferred or amortized.• Undesignated time value of an option contract should be accounted for in profit

or loss on a cost basis rather than on a fair value basis. Hence results in less profit or loss volatility.

• Two step process (which in some ways is similar to the mechanics of cash flow hedge accounting).� a “transaction related” hedged item (e.g. a hedge of a forecast transaction); or� a “period related” hedged item (e.g. a hedge of an existing item, such as

inventory, over a period of time).• For “transaction related” hedged items the cumulative change in fair value

deferred in OCI is recognized in profit or loss at the same time as the hedged item.

• For “period related” hedge items the amount of the original time value of option that relates to the hedged item is amortized from equity to profit or loss on a rational basis over the time of the hedging relationship.



management




hedged items


hedging instruments


option when hedging


New qualification






Hedging instrumentsWhich hedging instruments are eligible for designation?


Derivatives Cash instruments

Generally eligible for designation, except in these cases :

• Internal derivatives

• Derivatives embedded in financial assets (the financial asset in its entity may be an eligible hedging instrument)

• Written options

Measured at fair value through profit and loss

Measured at amortised cost

Always eligible for designation

Only eligible for designation for

foreign currency risk hedges

Financial Instruments



management




hedged items


hedging instruments


option when hedging


New qualification





A revocable fair value option when hedging particular credit risks

• Permits an entity to elect FVTPL accounting for credit exposures (such as loans, bonds and loan commitments) when it is hedged with a credit derivative and certain conditions are met (e.g. matching the name and security of the financial instrument delivered under the credit derivative with that of the hedged credit exposure). This would permit:� Electing FVTPL at initial recognition or subsequently (if elected

subsequently, the difference between the then carrying amount and fair value is recognized immediately in profit or loss); and

� Making that election for a component of nominal amounts (instead of the entire nominal amount).




management




hedged items


hedging instruments


option when hedging


New qualification





New qualification and effectiveness requirements

• More principles-based qualifying criteria, avoiding any specific offset thresholds (80%-125%) that could be inconsistent with risk management approaches.

• Hedge qualification will be based on qualitative, forward-looking hedge effectiveness assessments, rather than an arbitrary bright line.

• The new effectiveness requirements:� There should be an economic relationship between the hedging instrument

and the hedge item� The effect of credit risk should not dominate the value changes that result

from that economic relationship; and� The hedge ratio should reflect the actual quantity of hedging instrument

used to hedge the actual quantity of hedged item (provided this does not deliberately attempt to achieve an inappropriate accounting outcome).




management




hedged items


hedging instruments


option when hedging


New qualification





Hedge EffectivenessSimplification of existing rules

22

• No “bright line” threshold for hedge effectiveness

• The characteristics of each hedging relationship determine whether a qualitative assessment of hedge effectiveness is sufficient or if a quantitative analysis is needed

• Forward looking assessment of hedge effectiveness (at the time of designation and at each reporting date)

• A retrospective assessment of hedge effectiveness is no longer necessary in all cases, but ineffectiveness have to be measured and immediately recognized in profit or loss

80%

125%

General Hedge Accounting | Overview of revised proposal



management




hedged items


hedging instruments


option when hedging


New qualification





Fair value hedge – IAS 39 vs IFRS 9

23

(Y axis) : % change in fair value (FV) of hedging instrument recognised in profit or loss net of any fair value hedge adjustments on hedge items in a fair value(X axis) : -∆FV of hedged item / ∆FV of hedging instrument as %




management




hedged items


hedging instruments


option when hedging


New qualification




Y

X


Cash Flow Hedge – IAS 39 vs IFRS 9

24

(Y axis) : % change in fair value (FV) of hedging instrument recognised in profit or loss net of any fair value hedge adjustments on hedge items in a fair value(X axis) : -∆FV of hedged item / ∆FV of hedging instrument as %




management




hedged items


hedging instruments


option when hedging


New qualification





New concept of rebalancing hedging relationships

• Allows certain changes to the hedge relationship after inception as part of a continuing hedging relationship without forcing discontinuation for the entire hedging relationship

ExampleConsider an entity that hedges an exposure to foreign currency A using acurrency derivative that references foreign currency B. Currencies A and B arepegged. If the pegged exchange rate between currencies A and B changes to anew band or rate the hedge might be adjusted for risk management purposes tore-align the quantities of the hedging instrument needed to hedge the exposure.




management




hedged items


hedging instruments


option when hedging


New qualification





New concept of New rules for discontinuing hedging relationships

• No longer permit an entity to voluntarily discontinue hedge accounting when the underlying risk management objective for the hedging relationship has not changed.

• When entity choose to apply hedge accounting, that accounting cannot be discontinued until the risk management objective for the hedging relationship has changed or the “hedging instrument expired or is sold, terminated, or exercised.” or the hedging relationship is otherwise no longer eligible.




management




hedged items


hedging instruments


option when hedging


New qualification




© 2013 Deloitte Touche Tohmatsu Jaiyos Co. Ltd27 General Hedge Accounting | Overview of revised proposal

Cancellation of hedge accountingProcess visualisation



management




hedged items


hedging instruments


option when hedging


New qualification





Increased disclosures


Risk management strategy

• Disclosures on hedging risk components• How economic relationship determined• How hedge ratio determined

Effect on cash flows

• Quantitative information about hedging instruments • Sources of hedge ineffectiveness by risk

Effect on financial statements

• Quantitative disclosures of amounts arising from hedge accounting (including line item location)

• Examples: hedge ineffectiveness; amounts deferred in OCI; amounts reclassified from OCI; amounts related to time value of options and forward points of forwards

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