IFRS 9 Financial Instruments

Part IV: Hedging

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Components of the hedge accounting model

Presentation and Disclosure

Groups and net positions

Discontinuation and rebalancing

Accounting for qualifying hedging

relationships

Qualifying criteria

Hedged items

Hedging instruments

Objective

Hedge accounting(IFRS 9, Chapter 6)

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Objective of hedge accounting

Risk management objective:

Seeks to link risk management and financial reporting

Accounting objective

Represents in the financial

statements the effect of risk management

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Hedging instruments 5

Only contracts with external parties can be designated as hedging instruments© IFRS Foundation

Instruments that may be designated as a hedging

instrument

Derivatives at FVTPL except some written options unless designated as an offset to a purchased option

Non-derivatives at FVTPL except financial liability at FVTPL for which change in FV attributable to credit risk is presented in OCI

Foreign currency risk component of non-derivatives

A qualifying instrument must be designated in its entirety

as a hedging instrument. The only exceptions

permitted are:

Intrinsic value of an option

Spot element of a forward contract

A proportion of entire hedging instrument, eg 50% of nominal

amount

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Option

Time value

Transaction- related hedged item, eg hedge of a forecast transaction

Other comprehensive

income(accumulated in a

separate component of equity)

Time-period related hedged item, eg hedge of an inventory over period of

time

Other comprehensive

income(accumulated in a

separate component of equity)

Intrinsic valueDesignate as

hedging instrument

Accounting: time value of options

Subsequent measurement - detailed rules apply

or

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Forward contract

Forward element

Transaction- related hedged item, eg hedge of a forecast transaction

Other comprehensive

income(accumulated in a

separate component of equity)

Time-period related hedged item, eg hedge of an inventory over period of

time

Other comprehensive

income(accumulated in a

separate component of equity)

Spot elementDesignate as

hedging instrument

Accounting: forward element of forward contracts

Subsequent measurement - detailed rules apply

or

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Qualifying itemsHedged items

• The following are allowed as hedged items (can be a single item or a group of items):

– A recognised asset or liability– An unrecognised firm commitment– A forecast transaction (must be highly probable)– A net investment in a foreign operation

• The hedge item must be reliably measurable• Only assets, liabilities, firm commitments or highly probable forecast

transactions with external parties can be designated as hedged items

– Exception: foreign currency risk of an intragroup monetary item, ie forecast sales or purchases of inventories between members of the same group if there is an outward sale of the inventory to a party external to the group

Hedged items

Designation of hedged item

Entire item Component

Risk component(Separately identifiable and

reliably measurable)

Nominal component or selected contractual

cash flows

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An entity may hedge a risk component of a non-financial item

A component comprises less than the entire

fair value change or cash flow

variability of an item

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Hedged itemGroup of itemsA group of items (including a group of items that constitute a net position) is an

eligible hedged item only if:

it consists of items (including components of

items) that are, individually, eligible

hedged items;

the items in the group are managed together on a

group basis for risk management purposes;

in the case of a cash flow hedge of a group of items whose variabilities in cash flows are not expected to be approximately proportional to the overall variability in cash flows of the group so that offsetting risk positions arise: - it is a hedge of foreign currency risk; and- the designation of that net position specifies the reporting period in which the forecast transactions are expected to affect profit or loss, as well as their nature and volume.

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Hedged items Designating a component of an overall group of items

Two types of components can be designated as the hedged item: a component that is a proportion of an entire item (ie 50% of the contractual cash flows of a loan) or a layer component

A layer component of an overall group of items is eligible for hedge accounting – conditions:

• separately identifiable and reliably measurable;• risk management objective = hedge a layer component;• items in the overall group from which the layer are identified are exposed to

the same hedged risk;• for a hedge of existing items an entity can identify and track the overall group

of items from which the hedged layer is defined; and• any items in the group that contain prepayment options meet the requirements

for components of a nominal amount

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Hedged itemsHedges of a group of items- nil net positions

What are nil net positions?

• Hedged items among themselves fully offset the risk that is managed on a group basis.

Designating nil net positions in a hedging relationship that does not include a hedging instrument – conditions: • The hedge is part of a rolling net risk hedging strategy;• Hedged net position changes in size over the life of the rolling net risk

hedging strategy and the entity uses eligible hedging instruments to hedge the net risk;

• When net position is not nil and it is hedged with eligible hedging instruments; and

• not applying hedge accounting position would give rise to inconsistent accounting outcomes

Hedged items: aggregated exposures 13

First hedging relationship

Hedging instrument

eg futures contract

Hedged item eg forecast purchase

Second hedging relationship

Hedged item includes the entire first

hedging relationship

Hedging instrument

eg FX forward contract

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Effectivenessassessment

Measuring hedge ineffectiveness

Aggregate exposure → a combination of an exposure that would qualify as a hedged item

Consider combined effect of items

14Example:* aggregated exposures• An entity may hedge a given quantity of highly probable coffee

purchases in 15 months’ time against price risk (based on US dollars) using a 15-month futures contract for coffee.

• The highly probable coffee purchases and the futures contract for coffee in combination can be viewed as a 15-month fixed-amount US dollar foreign currency risk exposure for risk management purposes (ie like any fixed-amount US dollar cash outflow in 15 months’ time).

© IFRS Foundation* Refer to paragraph B6.3.3 of IFRS 9 Financial Instruments

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Qualifying criteria

Qualifying criteria for hedge accounting

Only eligible hedging instruments and

hedged items

Formal designation and documentation

Meets the hedge effectiveness requirements

Economic relationship between the hedged item and the hedging

instrument exists

Effect of credit risk does not dominate the

value changes

Hedge ratio results from the quantity of

hedged item and hedging used to hedge

Hedge accounting is elective

All 3 criteria to be met

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Hedge documentation

Risk management objective and strategy

Identification of the hedging instrument

The related hedge item

The nature of the risk being hedged

How the entity will assess whether the hedging relationship meet the hedge effectiveness requirements

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Hedge effectiveness requirements 17

Credit risk doesnot dominate

value changes ofthe economicrelationship

Economic relationshipbetween the hedged item and hedging instrument

Hedge ratio should be the same as that used for risk management

If a hedging relationship ceases to meet the hedge effectiveness requirement relating to the hedge ratio but the risk management objective for that designated hedging relationship remains the same → adjust the hedge ratio of the hedging relationship so that it meets the qualifying criteria again (‘rebalancing’)

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Hedge effectiveness

Hedge effectiveness

Extent to which changes in the fair value or the

cash flows of the hedging instrument

offset changes in the fair value or the cash

flows of the hedged item

Hedge ineffectiveness

Extent to which the changes in the fair value or the cash flows of the hedging instrument are greater or less than those on the hedged

item

Assess hedge effectiveness requirements at the inception of the hedging relationship, and on an ongoing basis (ie at a minimum, at each reporting date or upon a significant change in the circumstances, whichever comes first)

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Categories of hedges

• Hedge of the exposure to changes in FV of a recognised asset or liability or an unrecognised firm commitment, or a component of any such item, that is attributable to a particular risk and could affect profit or loss.

• Example: hedge of exposure to changes in the fair value of a fixed-rate debt instrument arising from changes in interest rates.

Fair value hedge

• Hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all, or a component of, a recognised asset or liability (such as all or some future interest payments on variable-rate debt) or a highly probable forecast transaction, and could affect profit or loss.

• Example: the use of a swap to change floating rate debt (whether measured at amortised cost or fair value) to fixed-rate debt (ie a hedge of a future transaction in which the future cash flows being hedged are the future interest payments).

Cash flow hedge

• As defined in IAS 21 The Effects of Changes in Foreign Exchange Rates (amount of the reporting entity’s interest in the net assets of that operation)

Hedge of a net

investment in a

foreign operation

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Hedge accountingFair value hedge (FVH):

• the gain or loss on the hedging instrument shall be recognised in profit or loss

• the hedging gain or loss on the hedged item shall adjust the carrying amount of the hedged item (if applicable) and be recognised in profit or loss

• Exception: equity instruments at FVOCI: effective & ineffective portion → OCI

Cash flow hedge (CFH):

• the separate component of equity associated with the hedged item (cash flow hedge reserve) is adjusted to the lower of the following (in absolute amounts):

• (i) the cumulative gain or loss on the hedging instrument from inception of the hedge; and

• (ii) the cumulative change in fair value (present value) of the hedged item (ie the present value of the cumulative change in the hedged expected future cash flows) from inception of the hedge.

• the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge shall be recognised in OCI.

• any remaining gain or loss on the hedging instrument is hedge ineffectiveness that shall be recognised in profit or loss.

Hedges of a net investment in a foreign operation - treated similarly to CFH

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Modifying hedging relationship: rebalancing

Discontinue hedge relationship

Does the hedged ratio continue to reflect the expected relationship

between hedged item and hedging instrument?

Rebalance the hedging relationship

Is the risk management objective still the same?

Continue hedge relationship

Yes

Yes Yes

No

No

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If a hedging relationship is rebalanced, the adjustment to

the hedge ratio can be effected in different ways:

the weighting of the hedged item can be increased (which at the same time reduces the

weighting of the hedging instrument) by:

increasing the volume of the hedged item; or

decreasing the volume of the hedging instrument.

the weighting of the hedging instrument can be increased

(which at the same time reduces the weighting of the

hedged item) by:

increasing the volume of the hedging instrument;

or

decreasing the volume of the hedged item.

Changes in volume → quantities that are part of the hedging relationship

Modifying hedging relationship: mechanics of rebalancing

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Discontinuing hedge accounting

- Discontinue hedge accounting prospectively- Partial discontinuation possible

Discontinue hedge accounting if: Hedging relationship ceases to

meet qualifying criteriaie hedging instrument expires or is sold, terminated or exercised

Estimates and other judgements

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Main judgements and estimates in applying IFRS 9

Hedge accounting • Whether the hedge accounting

documentation provides sufficient evidence to support the link between the hedging relationship and the entity’s risk management objective.

• Whether the hedging relationship meets the hedge effectiveness requirements.

• Assessing hedge effectiveness and determining hedge ineffectiveness.

• When a hedging relationship is rebalanced.

• Determining when to discontinue hedge accounting.© IFRS Foundation

DisclosuresHedge accounting

disclosures

Risk management

strategy

Amount, timing and uncertainty

of future cash flows

Effects of hedge

accounting on the

primary financial

statements

Specific disclosures for dynamic strategies and credit

risk hedging

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Disclosure requirements → refer to IFRS 7 Financial Instruments: Disclosures paragraphs 21B-24F

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27Project does not address macro hedging

• The IASB is simultaneously working on a specific project to consider accounting for macro hedges (Discussion Paper published).

IFRS 9 hedge

accounting

IAS 39 hedge

accounting

Accounting policy choice

For now entities can choose to keep using IAS 39 hedge accounting

Even if IFRS 9 is applied, the specific portfolio hedge accounting requirements in IAS 39 can still be used.

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• Prospective transition with limited exceptions– Retrospective application

o Required for time value of options o Permitted for accounting for forward elements (if elected, applies to all such

hedging relationships) – On initial recognition

o Allowed to consider the moment IAS 39 ceases to apply and the moment from which the new model applies as one point in time

o For rebalancing, the starting point will be the hedge ratio used under IAS 39 (any gains or losses will be recognised in profit or loss)

– Hedging relationships that qualified under IAS 39 and qualify under the new model will be treated as continuing hedging relationships

Effective date and transitionAnnual periods beginning on or after 1 January 2018

(early application of completed (whole) version permitted)