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Hedge accounting in currency management under IFRS9

Hedge accounting in currency management under IFRS9

New opportunities or everything as it was?


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Accounting standard IFRS 9 for financial instruments, generally applicable since the beginning of 2018, is at present one of the most significant topics for Treasury and Accounting. Within the scope of IFRS 9, corporations are primarily focused on phase 1 "Classification & measurement" and phase 2 "Impairment". Owing to the fact that the standard does not currently include provisions for the accounting of macro hedges, application of phase 3 "Hedge accounting" pursuant to IFRS is not yet mandatory. Instead the standard provides for a transitional rule. This rule states that an entity can continue to apply the requirements of IAS 39 for hedge accounting when applying IFRS 9 for the first time. Nevertheless many entities, having conducted IFRS 9 projects, have decided to introduce the standard fully, that means including hedge accounting. In practice the issue for FX hedge accounting is increasingly to what extent new opportunities arise from the IFRS requirements or whether everything – aside from a few changes – remains as it was?

Should an entity decide to continue hedge accounting under IAS 39, everything will initially remain as it was. It is currently not yet clear when the transitional rule for hedge accounting will end and corresponding changes will be required. The principle nevertheless holds that when applying the new IFRS 9 requirements, these are to be applied in full. There is no option to carry out only a portion of hedge accounting according to IFRS 9 and the remaining portion according to IAS 39. The entity must opt for the new standard or the transitional rule according to IAS 39.

If hedge accounting is applied according to the new standard, then some changes will materialise from this. Among others, these include:

  • Greater integration of hedge accounting with the entity's risk management strategy
  • Elimination of fixed effectiveness limits
  • Elimination of voluntary de-designation
  • New requirements for prospective hedge effectiveness measurement
  • New requirements for the calculation of the ineffective portion. 

Specific consideration is also to be given to the new accounting treatment of forward points and currency basis spreads as well as the designation of aggregated net positions as hedged item (underlying transaction). 

Due to the mandatory consideration of currency basis spreads and the specific requirements for the forward component, effectiveness is measured more clearly on a source basis and presented in a more differentiated manner. Under IFRS 9 an entity has the option to separate forward and spot components of a forward transaction and to designate only the changes in value of the spot component as hedging instrument. Alternatively it is possible to separate the currency basis spreads of a financial instrument and to exclude it from the designation of this financial instrument as hedging instrument. Increased effectiveness of the hedge is assumed due to separation. In case of separation, cash flow hedges would result in recognition of two OCIs. OCI 1 “Hedge Reserve” is based on the designated portion of the hedge, while OCI 2 “Cost of Hedging” presents the change in the undesignated portion. When the underlying transaction occurs, both OCIs are reclassified. The date in this regard depends on whether the underlying transaction is over time or at a point in time. The challenge with this new option of presenting the different components rests on the one hand in the correct separation and recognition of the components as well as the correct attribution of credit risk adjustments to these components. 

The designation of aggregated net positions for foreign currency risks, such as netting foreign currency cash flows from budgeted receivables and liabilities, was not previously possible under IAS 39. Under IFRS 9 there is now the option to directly designate this risk. The benefit of designation of a net position is that the accounting presentation of hedges is closer to the actual risk management of an entity, which is often managed on a net basis. Nevertheless it shows that this approach is very complex in practice and is thus less in use. In addition to increased documentation effort, the designation of a net position under IFRS 9 leads to complex accounting logic, which is why entities frequently decide not to apply this accounting treatment. These entities thus retain the simple designation of gross positions analogous to the previous approach. 

Overall it is clear that the changes in IFRS 9 have markedly expanded the opportunities and options for the presentation of FX hedge accounting and that not everything remains as it was. Practice shows nevertheless that with the exception of mandatory changes, such as separation into hedging reserve and cost of hedging, everything remains as it was for entities and that still little use is made of the opportunities presented by IFRS 9. It is generally advisable, as already under IAS 39, to conduct a cost-benefit analysis in respect of implementing the new options of hedge accounting under IFRS 9 as various provisions are associated with corresponding challenges, but these may also have a positive effect. Furthermore it is important to establish the necessary technical conditions to keep effort for application at the lowest possible level while maximising the benefit. For this purpose closer (automated) integration between Treasury, Accounting and the overarching risk management strategy is imperative alongside a treasury management system which has appropriate access to market data.

Source: KPMG Corporate Treasury News, Edition 80, May 2018
Author: Stepan Plein, Senior Manager, Finance Advisory,

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