6 Risk management safe in the digital age

6 Risk management safe in the digital age – Following the maturation and success of bitcoin futures introduced by Chicago Mercantile Exchange’s (“CME”) Group in December 2017 and in response to growing customer demand for additional regulated bitcoin derivative products, CME is launching Options on Bitcoin futures on January 13, 2020.

The value of options on Bitcoin futures is based on the regulated CME CF Bitcoin Reference Rate (BRR) and settles into actively traded Bitcoin futures. Read the FAQ on CME’s Bitcoin options. Watch the videos to learn more on how CME’s Bitcoin contracts work and how they can be used. 6 Risk management safe in the digital age

The bitcoin futures are cash-settled and based on a once-a-day reference rate of the U.S. dollar price of Bitcoin. For CME futures, amounts are based on the CME CF Bitcoin 6 Risk management safe in the digital ageReference Rate (“BRR”), which aggregates bitcoin trading activity across four bitcoin exchanges (Bitstamp, GDAX, itBit and Kraken), while the new CBOE contract is based on a single auction price from a different bitcoin exchange (Gemini) on the final settlement date. 6 Risk management safe in the digital age

Bitcoin is a cryptocurrency, or an open-sourced software based payment system, that was introduced in 2009. Bitcoin is based on a peer-to-peer payment system and unlike physical currencies, such as the United States dollar (“USD”), it is not a fiat currency that derives its value from government regulation or law.

The value of Bitcoin in relation to fiat currencies has historically been subject to significant volatility, with a high of $19,205.11 USD and a low of $801.98 USD in 20171.

As more entities accept Bitcoin as a form of payment for goods and services provided, and hold Bitcoin, either for their proprietary accounts or for their customers, those entities face an increasing risk due to price fluctuations in the value of the Bitcoin compared to fiat currencies, Bitcoin futures may help mitigate certain risk exposures related to Bitcoin.

Hedge accounting under IFRS 9

Provided Bitcoin futures meet the definition of a derivative, under IFRS 9 they would be recognized at fair value, with subsequent changes in fair value through earnings.

Holders of crypto-assets need to consider carefully whether the terms and conditions of their crypto-assets give rise to a contract. In the absence of a contract, a crypto-asset is not a financial instrument. 6 Risk management safe in the digital age

IFRS 9 allows for all or a portion of a derivative to be used as a hedging instrument, and how an entity may apply the hedge accounting rules to a hedging relationship involving Bitcoin futures generally depends on the nature of the risk being hedged. 6 Risk management safe in the digital age

For example, if an entity has an exposure to market price fluctuations related to a holding of Bitcoin recorded as an asset on the balance sheet, then a fair value hedge may be appropriate. Alternatively, if an entity has an exposure to market price fluctuations as a result of future forecasted purchases or sales of Bitcoin, the entity may enter into a cash flow hedge.

Clearly understanding the risk exposure an entity desires to hedge is the critical first step in applying hedge accounting treatment. Here the considerations for both fair value and cash flow hedges are discussed. 6 Risk management safe in the digital age

Something else -   Disclosure financial assets and liabilities

Fair Value Hedge Accounting

A fair value exposure exists when changes in market prices can change the fair value of an existing asset, liability, firm commitment or a homogenous group of each of these and that change in fair value could potentially impact earnings. Examples include a fixed interest rate asset or liability, inventory on hand, or a fixed price firm commitment that meets the definition in IFRS 9.

The risks that can be hedged for a financial asset, liability or firm commitment are benchmark interest rates, creditworthiness, foreign currency or a combination thereof, including the overall change in fair value. If an entity is hedging a non-financial asset, liability, or firm commitment, the risk being hedged should be the overall chCrypto currencyange in fair value. As a result, entities’ determination of the nature of Bitcoin may impact the risk exposures eligible for hedge accounting treatment. 6 Risk management safe in the digital age

An entity may designate a derivative instrument as a fair value hedge of an exposure to changes in the fair value of the hedged item attributable to the risk being hedged. When a fair value hedge is highly effective and meets all of the hedging criteria of IFRS 9, both the changes in the fair value of the hedging instrument and the changes in the fair value of the hedged item (attributable to the risk being hedged) are recorded in earnings. 6 Risk management safe in the digital age

For Bitcoin, an entity may conclude all changes in fair value of the hedged item are being hedged. Effectiveness for a fair value hedge is the extent to which the changes in the fair value of the hedging instrument offset the changes in the fair value of the hedged item based on the risk being hedged. 6 Risk management safe in the digital age

Subsequently measuring an asset or liability at fair value with changes in fair value recorded currently in earnings would obviate fair value hedge accounting treatment. That is, because both the hedge item and hedging instrument would both be fair valued at each reporting date, changes would offset in earnings each period, provided the Bitcoin future is an effective economic hedge of the asset or liability. 6 Risk management safe in the digital age

Cash Flow Hedge Accounting

A cash flow exposure exists when an entity may be exposed to variability in the cash flows of a recognized asset or liability, or of a forecasted transaction, that is attributable to a particular risk. Examples include forecasted cash flows related to revenue denominated in a foreign currency, forecasted cash outflows related to the payments made on variable rate debt issued by an entity, or forecasted variable cash flows on the purchase of goods or services whose value is derived from an observable market (e.g., the purchase or sale of a commodity).

An entity may designate a derivative instrument as a cash flow hedge of an exposure to the variability in the expected cash flows of a recognized asset or liability, or of a forecasted transaction.

Something else -   Disclosure requirements IFRS 4 and IFRS 17

When a cash flow hedge is highly effective and meets all of the hedge accounting criteria of IFRS 9, changes in the fair value of the hedging instrument are recorded in other comprehensive income and released into earnings in the period in which the variability from the forecasted transaction is also recorded in earnings.

Effectiveness for a cash flow hedge is the extent to which changes of the cash flows in thInputs to valuation techniquese hedging instrument are expected to offset the changes of variability in the expected cash flows of the hedged item. 6 Risk management safe in the digital age

When an entity subsequently remeasures Bitcoin holdings at fair value, cash flow hedge accounting is not permissible. Instead, the changes in fair value of the Bitcoin future and the Bitcoin holdings would offset in earnings in the period the changes are recorded. 6 Risk management safe in the digital age

Hedge Effectiveness

IFRS 9 permits application of hedge accounting to only certain eligible hedging instruments and hedged items. In addition, formal designation and documentation of the hedging relationship at the beginning of the relationship and an assessment of effectiveness are required.

IFRS 9 requires an economic relationship between the hedged item and the hedging instrument, which is a less restrictive test compared to the previous guidelines under IAS 39.

  • Nature and timing of effectiveness assessments – IFRS 9 requires initial and ongoing assessments of the hedging effectiveness. 6 Risk management safe in the digital age
  • Recognition of ineffectiveness – IFRS 9 requires measurement and recognition of ineffectiveness in a hedging relationship even though the hedge meets the effectiveness criteria. An entity is permitted to exclude certain components from the assessment of effectiveness and separately account for them, which may improve hedge effectiveness.
  • Amounts permitted to be excluded from the assessment of effectiveness – IFRS 9 permits an entity to exclude certain components of the change in the fair value of a hedging instrument from the assessment of effectiveness. 6 Risk management safe in the digital age
  • For fair value hedges, any difference between the change in the fair value of the hedging instrument and that of the designated hedged component is ineffectiveness which must be transferred from OCI. 6 Risk management safe in the digital age
  • For cash flow hedges, the ‘lower of’ test will continue to apply. There will be no ineffectiveness for under-hedges, i.e., where the cumulative change in fair value of the hedging instrument is less than the cumulative change in fair value of the hedged item. If the cumulative change in the hedging instrument exceeds the change in the hedged item (sometimes referred to as an ‘over-hedge’), ineffectiveness will be recognised.  6 Risk management safe in the digital age
    If the cumulative change in the hedging instrument is less than the change in the hedged item (sometimes referred to as an ‘under-hedge’), no ineffectiveness will be recognised. This is different from a fair value hedge, in which ineffectiveness is recognised on both over – and under-hedges. 6 Risk management safe in the digital age

Eligible hedged items

Here are some elements to potentially use as an eligible hedged item. 6 RisCrypto currenciesk management safe in the digital age

  • Components of non-financial items – Under IFRS 9, an entity is permitted to hedge a component of a non-financial item.
  • Hedges of groups of items – IFRS 9 permits an entity to hedge groups of items. In particular, IFRS 9 permits hedging groups of offsetting exposures.
  • Hedging pools of prepayable financial assets – IFRS 9 permits an entity to hedge layers of items, provided that certain criteria are met. An example are interest rate fair value hedges of layers of prepayable financial assets not expected to be prepaid during the hedge period. 6 Risk management safe in the digital age
  • Aggregated exposures – IFRS 9 permits an entity to combine a derivative and non-derivative exposure together and to designate them together as the hedged item in a hedging relationship.
  • Partial term hedging – IFRS 9 permits partial-term hedging of a financial instrument. 6 Risk management safe in the digital age
  • Variable-rate financial assets and liabilities – IFRS 9 permits designation of the contractually specified interest rate as the hedged risk in a cash flow hedge of interest rate risk of a variable-rate financial instrument. Under IFRS 9, the interest rate does not need to be contractually specified; it only needs to be separately identifiable and reliably measurable. However, IFRS 9 does not permit the designated interest rate component to exceed the contractual cash flows. 6 Risk management safe in the digital age
  • Fixed-rate financial assets and liabilities – IFRS 9 permits the designation of the entire contractual cash flows or a component of the contractual cash flows in a fair value hedge of interest rate risk of a fixed-rate financial instrument. 6 Risk management safe in the digital age
  • Hedging more than one risk – IFRS 9 provides significant flexibility with respect to utilising a single hedging instrument to hedge more than one risk in two or more hedged items. This allows entities to adopt new and sometimes more complex strategies to achieve hedge accounting while managing certain risks under IFRS.
  • Business combinations – IFRS 9 permits hedging foreign currency risk in a business combination. 6 Risk management safe in the digital age

Eligible hedging instruments

The following instruments can potentially achieve eligibility as hedging instruments. 6 Risk management safe in the digital age

  • Eligible hedging instruments – Non-derivatives– IFRS 9 permits a large scale of non-derivatives to be designated as hedging instruments in certain cases. Non-derivative financial instruments are most commonly used as hedges in hedge relationships involving foreign currency risk.
  • Location of hedging instrument – IFRS 9 permits a parent company to hedge exposures of an indirect subsidiary regardless of the functional currency of intervening entities within the organisational structure. 6 Risk management safe in the digital age

6 Risk management safe in the digital age

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Something else -   Presentation Hedges of groups of items

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