Practical guide on general hedge accounting Dec 2013

Practical guide retrospective basis, to demonstrate that actual results of the hedge are within a range of 80-125% effectiveness). This meant that many valid economic hedges failed because they were not close enough for hedge accounting purposes. As described above, IFRS 9 relaxes the requirements for hedge effectiveness, removing the 80-125% bright line. PwC insight: The elimination of the 80-125% bright line is a positive move by the Board and takes away a significant obstacle to hedge accounting for many risk management strategies. Under IAS 39, a hedge that was 81% effective would achieve hedge accounting, even though it was 19% ineffective (subject to the ‘lower of’ test for cash flow and net investment hedges, refer to section 2.2 above). On the other hand, a hedge that was 79% effective would not achieve hedge accounting and the full fair value movements of the derivative would be recorded in P&L without any offsetting of the hedged item (that is, the accounts would show 100% ineffectiveness). From a risk management perspective, the difference between 79% and 81% effectiveness is minimal, yet the IAS 39 accounting rules did not reflect this. So we expect that many preparers and users will welcome the removal of the 80-125% bright line. 3.3.6. Discounted cash flows for measuring hedge ineffectiveness Hedge accounting does not change the measurement of the hedging instrument, but only the location of where the change in its carrying amount is presented for cash flow and net investment hedges. Hedging instruments are subject to measurement at either fair value or amortised cost, both of which take into consideration the time value of money. In order to be consistent, IFRS 9 introduces the requirement to measure the hedged item also on a present value basis; therefore, subsequent changes would include the effect of the time value of money (for example, an undiscounted spot approach cannot be used in a foreign currency hedge). The objective of this requirement is to ensure the measurement of the effectiveness of the hedge relationship reflects the time value of money and any mismatches in timing between the hedged item and the hedging instrument are recognised as ineffectiveness. PwC insight: It is a common hedging strategy to hedge the foreign currency risk of foreign sales or purchases and to assess effectiveness on an undiscounted spot basis. This new IFRS 9 requirement to consider the time value of money could have a significant impact where the risk management strategy is to hedge the spot risk (that is, pure foreign currency risk without considering the forward points), because more entities will now need to keep track of the timing of the hedged transaction and measure ineffectiveness on a discounted basis, thus capturing the ineffectiveness that arises from a difference in expected timing between the hedged transaction and the derivative. 3.4. Discontinuation of hedge accounting Under IAS 39, an entity had a free choice to voluntarily discontinue hedge accounting by simply revoking the designation of the hedging relationship. Voluntary de-designation is now prohibited under IFRS 9. Under IFRS 9, an entity cannot de-designate and thereby discontinue a hedging relationship that:  Still meets the risk management objective; and  Continues to meet all other qualifying criteria (after taking into account any rebalancing, if applicable). For this purpose, it is necessary to understand the distinction between the notions of ‘risk management strategy’ and ‘risk management objective’. A risk management strategy is the highest level at which an entity determines how it manages risk; typically, it identifies the risks to which the entity is exposed and sets out how the entity responds to them. It is usually in place for a longer period and might include some flexibility to react to changes in circumstances. It is normally a General hedge accounting PwC  11

Practical guide on general hedge accounting Dec 2013 | Page 13