Following the introduction of the standard, the first financial statements have now been prepared in accordance with IFRS 9. This article summarizes the main findings from the application of hedge accounting in industrial corporations as to what extent the new or amended designation options have been applied or used.
With the publication of Regulation (EC) No. 2016/2067 of 22 November 2016, the IFRS 9 standard was adopted for use in Europe by the EU Commission. The date of the standard's initial application in the EU is in line with the IASB's guidance, making it mandatory to apply it as from 1 January 2018 In this context, phase 3 of IFRS 9 "Hedge Accounting" is a peculiarity. For a limited period of time, users have the option to continue recognizing their hedge accounting in accordance with the requirements of IAS 39. Applying the requirements of IFRS 9 will only become mandatory once the IASB has finalized its provisions on macro hedge accounting.
Compared to IAS 39, IFRS 9 offers more extensive designation options that should improve the presentation of financial risk management activities in the external accounting of industrial corporations (hedge accounting). Based on our real-world observations, this article outlines ways in which the following four designation options have become part of the accounting practices of industrial corporations.
- Net positions (group of items)
- Aggregated exposure
- Fair values of options
- Risk components
Net positions (group of items)
Under IFRS 9, the designation net risk position is possible under specific conditions. The option of designating a net position as the hedged item aligns accounting more closely with risk management at a large number of corporation, whereby the relevant risks are recorded centrally in Treasury and managed and hedged on a net basis. However, one key requirement is that the hedging of the net position is in line with the company's risk management strategy. An offsetting solely for accounting purposes is deemed insufficient. In addition, the designation of a net position requires the designation of the overall portfolio from which the net position results. In this regard, there are complications stemming from, among other things, the accounting treatment of the net position in terms of cash flow hedge accounting, as the corresponding OCI recycling is based on the profit or loss effect of each hedged item within the net position, which presents major practical implementation challenges for those preparing the financial statements. As a result, it is relatively rare to find designated net risk positions within the scope of hedge accounting under IFRS 9 in the accounting practice of industrial companies.
Despite derivatives primarily being used as hedging instruments, IFRS 9 now provides the option of including derivatives as hedged items in hedge accounting as part of an aggregated exposure. This means that the hedging of aggregated exposures, which consist of a "non-derivative" risk position and a derivative, is explicitly permitted. The condition for such a designation is that through combining an aggregated exposure and an additional hedging instrument a new hedging effect is achieved that is also actively being managed as such in risk management. For example, a fixed-rate liability denominated in a foreign currency with a maturity of ten years could be hedged by a CCIRS with the same maturity (resulting in a floating-rate liability denominated in the functional currency), and then hedged at a second level against the risk of fluctuating interest payments for the first two years by means of a (payer) interest rate swap. However, such or similar forms of aggregated hedging relationships have so far only rarely been used by industrial companies in real life. This may be partly because a change in hedging strategy in an industrial company is usually accompanied by the closing out and rebalancing of hedging transactions, and also because the automated recording of an aggregated risk position in hedge accounting on the system side poses a challenge for preparing the balance sheet.
Fair values of options
In addition, IFRS 9 introduced changes to the solution for recognizing the fair value (time value) of options designated as hedging instruments, which had previously been unsatisfactory for many users to date. Previously, both the designation of an option in its entirety and the designation of just its intrinsic value have resulted in fluctuations in the fair value being reflected in the income statement. The cumulative changes in the option's fair value may now be recognized in other comprehensive income as cost of hedging. Quantitative analyses show that the designation of options in hedge accounting has not changed significantly as a result of the new IFRS 9 regulations. Rather, the previous level was maintained.
While IAS-39 allowed much more flexibility in the hedging of financial items than in that of non-financial items (either exclusively designating all risks or only foreign currency risk), IFRS-9 stipulates uniform requirements for both financial and non-financial items. A risk component to be hedged must be separately identifiable and the change in value attributable to the hedged risk component be reliably measurable. By way of example, the IASB mentions the hedging of the gas oil component of a longterm natural gas supply contract. In this example, this is contractually defined and the hedged risk component can therefore be identified and measured separately. This example can be applied to other non-financial items, which should result in a leaner commodity price risk management. The market shows signs that this new option is being applied by the accounting departments at industrial companies. Our observations show that industrial companies use the specific designation option to avoid inefficiencies in hedging relationships and to apply hedge accounting effectively.
In conclusion and based on our findings we can say that the new designation options provided by IFRS 9 are used by companies only to a limited extent. While the designation of a net position, an aggregated exposure or the option to recognize changes in the fair value of options in OCI with no effect on profit or loss have led to only few changes in accounting practice, there has been an increase in hedge accounting relationships due to the use of component designation. On the whole, however, it is clear that the market is making only limited use of the innovations in the designation of hedge accounting relationships and has identified only a few of them as an advantage or simplification. This may also be the reason why a not insignificant number of companies continue applying hedge accounting in accordance with the requirements of IAS 39 instead of switching to IFRS 9.
Source: KPMG Corporate Treasury News, Edition 112, June 2021
Authors: Ralph Schilling, Partner, Finanz- und Treasury-Management, KPMG AG; Dr. Christoph Lippert, Senior Manager, Finanz- und Treasury Management, KPMG AG