Accounting for macro hedging – Financial institutions, particularly retail banks, have as a core business, the collection of funds by depositors that are subsequently invested as loans to customers. This typically includes instruments such as current and savings accounts, deposits and borrowings, loans and mortgages that are usually accounted for at amortised cost. The difference between interest received and interest paid on these instruments (i.e., the net interest margin) is a main source of profitability.
A bank’s net interest margin is exposed to changes in interest rates, a risk most banks (economically) hedge by entering into derivatives (mainly interest rate swaps). Applying the hedge accounting requirements (as defined in IAS 39 or IFRS 9) to such hedging strategies on an individual item-by-item basis can be difficult as a result of the characteristics of the underlying financial assets and liabilities:
- Prepayment options are common features of many fixed rate loans to customers. Customers exercise these options for many reasons, such as when they move house, and so not necessarily in response to interest rate movements. Their behaviour can be predicted much better on a portfolio basis rather than an item-by-item basis.
- As a result of the sheer number of financial instruments involved, banks typically apply their hedging strategies on a macro (or portfolio) basis, with the number of individual instruments in the hedged portfolio constantly churning.
Although IAS 39 can be applied to macro hedging situations, and guidance exists for portfolio fair value and cash flow hedge accounting for interest rate risk, entities do not always use hedge accounting in those situations. This is because not all sources of interest rate risk qualify for hedge accounting, use of IAS 39 can be operationally complex and cash flow hedge solutions result in volatility of other comprehensive income.
Some European banks have, instead, made use of the European Union’s carve out of certain sections of the IAS 39 hedge accounting rules.
Instead of developing particular hedge accounting requirements in IFRS 9 that are specifically tailored to macro hedging strategies, the IASB is seeking to create a separate accounting model for macro hedging situations that would be based on an entity’s risk management activities. The accounting for macro hedging was originally part of the IASB’s project to replace IAS 39 with IFRS 9. However, the IASB realised that developing the new accounting model would take time and probably be a different concept from hedge accounting.
In May 2012, the Board therefore decided to decouple the part of the project that is related to accounting for macro hedging from IFRS 9, allowing more time to develop an accounting model without affecting the timeline for the completion of the other elements of IFRS 9.
Although mainly focused on financial institutions, the accounting model for macro hedging might also be beneficial for some corporate entities applying macro-type hedging strategies.
Applying hedge accounting for macro hedging strategies under IFRS 9
Because of its pending project on an accounting model specifically tailored to macro hedging situations (see above), the IASB created a scope exception from the IFRS 9 hedging accounting requirements that allows entities to use the specific fair value hedge accounting for portfolio hedges of interest rate risk, as defined in IAS 39, until the project is finalised and becomes effective. However, the implementation guidance accompanying IAS 39 also contains specific illustrations of the implementation of cash flow hedge accounting when financial institutions manage interest rate risk on a net basis.
The IASB decided not to carry forward implementation guidance on hedge accounting to IFRS 9. As a result, many financial institutions were concerned that they would not be able to continue with their existing macro cash flow hedging strategies under IFRS 9. The IASB clarified that not carrying forward the implementation guidance was without prejudice (i.e., it did not mean that the IASB had rejected that guidance and so had not intended to imply that entities cannot apply macro cash flow hedge accounting under IFRS 9).
Nonetheless, the IASB also decided to give entities an accounting policy choice until the project on accounting for macro hedging is completed. Entities may:
- Apply the new hedge accounting requirements as set out in IFRS 9, in full Accounting for macro hedging
- Apply the new hedge accounting requirements as set out in IFRS 9 to all hedges except fair value hedges of the interest rate exposure of a portfolio of financial assets or financial liabilities; in that case an entity must also apply the paragraphs that were added to IAS 39 when that particular type of hedge was introduced (IAS 39 81A, IAS 39 89A and IAS 39 AG114-AG132) i.e., an entity must apply all the hedge accounting requirements of IAS 39 (e.g., the 80%-125% bright line effectiveness test) including the paragraphs that specifically address fair value hedges of the interest rate exposure of a portfolio of financial assets or financial liabilities)
Or Accounting for macro hedging
- Continue to apply hedge accounting as set out in IAS 39, to all hedges Accounting for macro hedging
Accounting for macro hedging
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