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IFRS 9: Financial Instruments

Exposure draft and Comment letters [Dec 2010]


 Groups and net positions

(paragraphs 34�39, B70�B82, BC156�BC182)


The hedge accounting rules in IAS 39 were designed, primarily, from a single instrument view point. From that perspective a typical hedging relationship would involve a single hedging instrument (eg an interest rate swap) hedging a single item (eg a loan).

IAS 39 does allow multiple items to be hedged together as a group. However, it imposes restrictions that significantly limit the types of groups that are eligible hedged items (see paragraphs 83 and 84 of IAS 39).

What is the problem?

The types of groups that are eligible as hedged items under IAS 39 are generally those that would still qualify for hedge accounting if they were separated and designated as hedged items in multiple hedging relationships. In other words, the ability to hedge groups under IAS 39 could be described as a practical expedient as it can avoid the need to designate and monitor many individual hedges.

However, when entities hedge groups of exposures together it is often not possible to split the hedging instrument(s) and hedged items into individual hedging relationships that qualify for hedge accounting.

A typical example of this is where an entity hedges a group of items that is a net position using a single hedging instrument. The purpose of this would be to make use of the natural risk offset within the group of items. For example, consider an entity that hedges foreign currency risk on a net basis. It has a foreign currency sale of FC100 and purchase of FC(80), which are both eligible hedged items. It hedges the net exposure using a single forward foreign exchange contract (FEC) for FC(20). In this example it is not possible to split the forward contract into two, and designate it with the sale and the purchase in two separate hedging relationships. This can result in one of the following three unfavourable alternatives:

(a) Apply hedge accounting with the forward to something that is eligible

Given the scenario above, hedge accounting could be applied between FC20 of the sale and the FEC. However, unless the sale and the purchase are recorded in the same period, net profit or loss would be distorted, because the purchase would appear unhedged in the period it affects profit or loss.

(b) Not apply hedge accounting

In some cases the derivative used as a hedging instrument may not match any of the individual exposures in the group (eg settlement dates could be significantly different). In this case an entity cannot apply hedge accounting.

(c) Change the risk management strategy and undertake the hedge in a manner that achieves the desired hedge accounting result.

The volatility that can arise from not applying hedge accounting can in some cases be so significant that it changes the manner in which an entity hedges its risk. Using the example above, this can cause an entity to enter into two partially offsetting gross forward contracts to match the amount and timing of the hedged items (eg one forward for FC(100) and one forward for FC80). This would allow an entity to apply hedge accounting on a gross basis and present both transactions as hedged. 

What are the proposals?

In an effort to address the issues above, the Board proposes new criteria for multiple items to be hedged together as a group. The revised criteria will allow more groups to be eligible as a hedged item. In particular, it allows some net positions to be eligible hedged items.

A group of multiple items would be eligible for hedge accounting if:

(a) it consists of items (including components of items) that individually are eligible hedged items;

(b) the items in the group are managed together on a group basis for risk management purposes; and

(c) for the purpose of cash flow hedge accounting only, any offsetting cash flows in the group of hedged items, exposed to the hedged risk, affect profit or loss in the same and only in that reporting period. 

Using the same example from above, the foreign currency sale and purchase could be hedged together in a fair value hedge if they were firm commitments.
However, if they were forecast transactions they would only be eligible for cash flow hedge accounting if they affect profit or loss in the same reporting period. For a more detailed description of the reason behind this restriction for cash flow hedges, along with a more detailed example, see paragraphs BC168-BC173.

Another common example of net position hedging is seen in the financial industry where banks hedge interest rate risk on a net basis. These proposals would allow such entities to designate both assets and liabilities in a single, net position, hedging relationship (of the same type, eg cash flow hedge or fair value hedge).

Also worth noting:

  • For an entity that applies hedge accounting on a net basis, any hedging instrument gains or losses recognised in profit or loss shall be presented in a separate line in the income statement. Also see the examples for hedge accounting mechanics.
For example,

Sales                                            X
Cost of sales                               (X)
Hedging gain/(loss)                       X/(X)
Gross profit                                  X

Interest income                             X
Interest expense                         (X)
Hedging (gain/loss)                       X/(X)
Net interest income/(expense)     X
  • An entity designating a net position in a hedging relationship must designate the gross items (including layers of items) that give rise to the net position.
For example, to hedge a net position of FC20 arising from foreign currency sales and purchases, an entity would be required to designate a gross amount of sales and purchases that give rise to the net position (eg sales of FC60 and purchases of FC40).
  • In order to allow entities to designate the hedged items in a manner that is consistent with their risk management, the exposure draft permits the designation of layers of items (eg a bottom layer). This also extends to layers of groups of items, provided the conditions are met (see paragraphs 36 and B77-B78). Under the proposals an entity can designate a hedged amount from an overall group of items instead of specifying amounts of specific items.
For example, consider an entity that has two (non-prepayable) fixed rate bond assets of CU50m principle each. It wants to hedge CU40m for interest rate risk. If it is consistent with its risk management objective, it may designate a bottom layer of CU40m from a defined group of the two bonds. As a result of this, up to CU60m of bonds could be sold without affecting the hedge relationship, because the hedged CU40m remains. [See paragraph 36 for the full requirements. Debt instruments with prepayment options were scoped out of these proposals as they will be considered as part of the Board�s deliberations of hedging portfolios of items.]
  • Further proposals for portfolio hedge accounting, including open portfolios and macro-hedge accounting for interest rate risk continue to be deliberated by the Board.  

Staff papers

As part of our due process, discussions of technical issues take place during public IASB meetings. For these meetings, the staff prepare technical papers on the specific technical topics. The Board then uses these papers as a basis for their proposals.

The papers that have been prepared for the Board to discuss hedge accounting disclosures are listed below. Click on the paper reference number to access the specific paper. Click on the related month to access the summary of decisions taken at that month�s IASB meeting. 


TopicPaper refMonth discussed
Cover paperAgenda paper 9May 2010
Eligible hedged items: groups of hedged itemsAgenda paper 9AMay 2010
Eligible hedged items: Net positionsAgenda paper 9BMay 2010
Eligible hedged items: Net positionsAgenda paper 9CMay 2010
Cover paperAgenda paper 6July 2010
Eligible hedged items: Net positions - forecast transactionsAgenda paper 6AJuly 2010
Eligible hedged items: groups and net positions - identifying the hedged items (the what issue)Agenda paper 6BJuly 2010
Eligibility of hedged items: net positions - identifying the hedged itemAgenda paper 6CJuly 2010
Identifying (as hedged item) part of a group of existing items as portion (layer)Agenda paper 524 Aug 2010
Group hedging - cover paperAgenda paper 14September 2010
Hedge accounting for groups of hedged items including net positionsAgenda paper 14ASeptember 2010
Cover paperAgenda paper 19October 2010
Illustrative examplesAgenda paper 19AOctober 2010
Eligible hedged items: groups and net positionsAgenda paper 19BOctober 2010  
Eligible hedged items: nil net positionsAgenda paper 19COctober 2010

How to get involved

The exposure draft specifically asks for your views on this (and other) topics.

Question 11 in the invitation to comment in the exposure draft asks:

Do you agree with the criteria for the eligibility of groups of items as a hedged item? Why or why not? If not, what changes do you recommend and why?

Question 12 in the invitation to comment in the exposure draft asks:

Do you agree that for a hedge of a group of items with offsetting risk positions that affect different line items in the statement of comprehensive income (eg in a net position hedge), any hedging instrument gains or losses recognised in profit or loss should be presented in a separate line from those affected by the hedged items? Why or why not? If not, what changes do you recommend and why?

You may choose to answer all the questions in the invitation to comment or only some of them and you are welcome to comment on any other matter that you think we should consider in finalising the proposals. Comment letters will be posted on our website.

We will carefully consider all feedback and will discuss responses to the proposals in public meetings. We plan to issue the new standard in mid-2011.