IFRS 9: Financial instruments—hedge accounting

the IASB continued its redeliberations on the exposure draft Hedge Accounting (the ED) and discussed the accounting for options as hedging instruments, rebalancing of a hedging relationship and voluntary discontinuation of hedge accounting.  

Accounting for time value of options
The Board discussed whether the time value of an option should always be expensed over the life of an option instead of applying the accounting as proposed in the ED. The Board noted that such an accounting treatment would not provide an outcome that aligns with the view of the time value paid as a cost of hedging as it can result in recognising an expense in periods that are unrelated to how the hedged exposure affects profit or loss. The Board also discussed whether the proposals could be simplified by removing the differentiation between transaction related and time period related hedged items. The Board noted that doing so would be inconsistent with other IFRSs and treat unlike situations as alike, hence impairing comparability. The Board also discussed the concerns of some respondents about whether it is appropriate to defer the time value of options for transaction related hedged items. The Board noted that the time value paid is not an asset itself but is an ancillary cost that is capitalised as part of the measurement of the asset acquired or liability assumed-consistent with how other IFRSs treat ancillary costs. The Board also noted that the ED also includes an impairment test to ensure that amounts that are not expected to be recoverable are not deferred. The Board tentatively confirmed the accounting outcomes for the accounting for time value of options as proposed in the ED (ie that to the accounting would depend on the nature of the hedged item). The votes were 13 in favour, 1 against, 1 absent. The Board also discussed whether further application guidance and clarification should be provided in the final requirements. The Board tentatively decided to expand the application guidance in the ED. The votes were 14 in favour, 0 against, 1 absent. The Board also considered whether paraphrasing the requirements as a single general principle would clarfy the accounting for transaction and time period related hedged items. The Board noted that a principle that was suggested by the feedback received would not accurately reflect the accounting for hedges of firm commitments so tentatively decided not to use that principle but rather to provide further explanation in the basis for conclusions. The votes were 14 in favour, 0 against,1 absent. The Board considered whether it should provide an accounting choice to account for the time value of options either as: * proposed in the ED; or * in accordance with the treatment in IAS 39 Financial Instruments: Recognition and Measurement today. The Board noted that the treatment in IAS 39 today characterises the time value of an option as a trading gain or loss. This is not a faithful representation of the time value, which is a cost of hedging (the 'insurance premium' view). The Board noted that introducing an accounting choice would impair the comparability of financial statements. As a result, the Board tentatively decided to not introduce an accounting choice. The votes were 13 in favour, 1 against, 1 absent.
 
Designating combinations of options as the hedging instrument 

The Board discussed the restriction on designating a standalone written option in combination with a purchased option as a hedging instrument and noted that instead of entering into one collar contract, entities often enter into two separate option contracts that in effect achieve the economic outcome of a collar contract. Under the ED and IAS 39, the collar contract is eligible as a hedging instrument if it does not result in a net written option. However, designating two or more instruments in combination as the hedging instrument is not allowed if one of them is a written or a net written option. The Board tentatively decided to amend the requirements such that a combination of a written and a purchased option (regardless of whether the hedging instrument arises from one or several different contracts) can be jointly designated as the hedging instrument provided that the combination is not a net written option. The Board noted that whether a combination of a written and a purchased option is a net written option would require considering the same aspects as the evaluation of whether a collar constitutes a net written option. The votes were 13 in favour,1 against,1 absent
 
Rebalancing 

The Board discussed two main issues arising from the feedback on the proposals: * whether rebalancing should be mandatory or voluntary, and what the frequency of rebalancing is, and * what the scope of the rebalancing provisions is. Mandatory versus voluntary rebalancing The Board noted that the notion of rebalancing was introduced as a complement of the new hedge effectiveness assessment, mainly to address the requirements for the hedge ratio after designation of the hedging relationship. Therefore, the Board considered that rebalancing should be aligned with its tentative decision on the hedge effectiveness assessment because the purpose of rebalancing is to maintain compliance with the hedge effectiveness over the life of the hedging relationship following designation. The Board noted that an entity should therefore rebalance a hedging relationship if the hedge ratio used for risk management purposes changes or if rebalancing was required to prevent the hedge ratio resulting in an imbalance that would create hedge ineffectiveness in order to achieve an outcome that is inconsistent with the purpose of hedge accounting. In effect that means that if for risk management purposes an entity adjusts the hedge ratio in response to changes in the economic relationship between the hedged item and the hedging instrument the hedging relationship will automatically be adjusted accordingly (provided that it would not result in an imbalance). Hence, the Board noted that the notion of 'proactive' rebalancing would hence be obsolete Scope of Rebalancing The feedback on the ED also requested clarification of the scope of the term 'rebalancing'. There was a general request for clarifying the interaction between rebalancing and risk management. Another request was for clarification of whether rebalancing is used in a narrow sense in order to maintain a hedge ratio that complies with the hedge effectiveness assessment or whether it also includes other changes to the quantities of the hedged item and hedging instrument (ie changes unrelated to a response to a change in the economic relationship between the hedged item and the hedging instrument). Tentative Decisions As a result, the Board tentatively decided to align the notion of rebalancing with the Board's tentative decision on the hedge effectiveness assessment as follows: * After the start of a hedging relationship an entity would rebalance that hedging relationship for hedge accounting purposes when it adjusts the quantities of the hedging instrument or the hedged item in response to changes in circumstances that affect the hedge ratio of that hedging relationship (ie the 'hedge ratio is adjusted for risk management purposes'). However, the hedging relationship for hedge accounting purposes would have to use a different hedge ratio than for risk management purposes if: * the hedge ratio that would reflect an imbalance that would create hedge ineffectiveness in order to achieve an accounting outcome that is inconsistent with the purpose of hedge accounting; or * for risk management purposes, an entity would retain a hedge ratio that in new circumstances would reflect an imbalance that would create hedge ineffectiveness in order to achieve an outcome that is inconsistent with the purpose of hedge accounting (ie an entity must not create an imbalance by omitting to adjust the hedge ratio). * The notion of proactive rebalancing is eliminated (because it has become obsolete). * The final requirements would clarify that rebalancing covers only adjustments to the quantities of the hedged item or the hedging instrument for the purpose of maintaining a hedge ratio that complies with the requirements of the hedge effectiveness assessment. The votes were 14 in favour, 0 against, 1 absent.  





Voluntary discontinuation  

The Board considered the feedback and noted that there were mixed views. While some commentators argued that voluntary discontinuation should be allowed given that hedge accounting is optional, others agreed with the proposals but asked the Board to clarify the interaction with the risk management objective and strategy. As a result the Board discussed two main issues: * Whether voluntary discontinuation should be permitted; and * The clarification of the interaction between the proposed requirements for discontinuing hedge accounting and the risk management objective and strategy.  

Voluntary discontinuation 

The Board noted that the concerns of the commentators in relation to this issue are mainly a disagreement in principle based on the view that if starting hedge accounting by designating a hedging relationship is voluntary then discontinuation of hedge accounting should also be voluntary. However, the Board considered that if an entity chooses to apply hedge accounting it aims to represent in the financial statements the effect of pursuing a particular risk management strategy by using that kind of accounting. The Board noted that the ability to voluntarily discontinue hedge accounting would undermine the aspect of consistency over time in accounting for that type of hedging relationship. The Board also noted that the ability to discontinue hedge accounting when an entity still qualifies for hedge accounting and continues to pursue its original risk management objective would result in a misalignment with risk management and hence be inconsistent with the overall objective of the new hedge accounting model. Clarification of the interaction between the proposed discontinuation requirements and the risk management objective and strategy. The Board noted that some of the feedback indicated that the references to the risk management strategy and the risk management objective were not sufficiently clear, particularly their relationship with each other and at what level these notions would apply. The Board also noted that the concerns resulted from two scenarios: * hedge accounting approaches that are a surrogate of dynamic hedging; and * hedging relationships that a specific stage turn into a natural hedge. The Board concluded that the risk management strategy is the highest level at which an entity determines how it manages its risk while the risk management objective for a hedging relationship relates to how the particular hedging instrument designated is used to hedge a particular exposure (ie the risk management objective applies at the hedging relationship level). This means that even if the risk management strategy remains the same, a particular risk management objective might change for a previously designated hedging relationship. 
 
The Board tentatively decided: *

to add guidance showing how the risk management objective and the risk management strategy relate to each other using examples contrasting these two notions; and * to confirm the proposals in the ED and hence prohibit voluntary discontinuation of hedge accounting when the risk management objective remains the same and all the other qualifying criteria are still met.