Hedge accounting under IAS 39 Financial Instruments: Recognition and Measurement is often criticized as being complex and rules-based, thus, ultimately not reflecting an entity’s risk management activities.
Consequently, the objective of IFRS 9 is to reflect the effect of an entity’s risk management activities in the financial statements. This includes replacing some of the arbitrary rules by more principle-based requirements and allowing more Hedging instruments and hedged items to qualify for hedge accounting. Overall, this should result in more risk management strategies qualifying for hedge Accounting.
Following are the significant improvements incorporated in the new standard:
• Expansion of the range of eligible hedged items to include the hedging of aggregated and net exposures, and the hedging of risk components and layers;
• Permitting designation of non-financial instruments that are accounted for at fair value through profit or loss (FVPL) as a hedging instrument for risk components ;
• Removal of the “80% -- 125%” bright line threshold in effectiveness assessment and requiring such assessment to be done only prospectively on an ongoing basis, as a minimum at each reporting date;
• Rebalancing hedge ratio if it turns out that the hedged item and hedging instrument do not move in relation to each other as expected;
• Prohibition of de-designation of a hedging relationship as long as the risk management remains unchanged and all other qualifying criteria are met; and
• Exclusion of costs of hedging such as the time value of an option, the forward element of a forward contract and any foreign currency basis spread, from the designation of a financial instrument as the hedging instrument.
These significant changes really provide a closer link between how management conducts its risk management activities in hedging its exposures, and how the effects of these activities are reflected in its financial reporting. It abolishes the previous rules-based approach on when and how an entity may avail of “hedge accounting” as a means of communicating the results of its hedging activities. Furthermore, the changes introduced include providing more useful information which would help investors and users of financial statements better understand the risk management activities of the entity and the effect of hedging activities on future cash flows.