IFRS 9 Financial instruments

Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity (share), or a contractual right to receive or deliver cash (bond).

Property development (intercompany) finance

Interest bearing term loan – Senior interest-bearing bank term debt


Parent C operates in the UK real estate sector and purchases land for development into residential units for public sale. Each potential development proposal is supported by a detailed business case which includes a due diligence report in respect of the expected Gross Development Costs (GDC) as well as an independent third party valuation of the Gross Development Value (GDV) of the completed site both of which are undertaken in order to secure bank financing. Management assesses each proposal in accordance with a number of key investment criteria, including for example, the minimum yield required on each development.

Once the proposal has been approved by Management, a new … Read more

Objective of hedge accounting

Every entity is exposed to business risks from its daily operations. Many of those risks have an impact on the cash flows or the value of assets and liabilities, and therefore, ultimately affect profit or loss. In order to manage these risk exposures, companies often enter into derivative contracts (or, less commonly, other financial instruments) to hedge them. Hedging can, therefore, be seen as a risk management activity in order to change an entity’s risk profile.

Applying the normal IFRS accounting requirements to those risk management activities can then result in accounting mismatches when the gains or losses on a hedging instrument are not recognised in the same period(s) and/or in the same place in the financial statements Read more

Hedged items – General requirements

The general requirements of what qualifies as an eligible hedged item are unchanged compared to IAS 39. A hedged item can be:


All of above can either be a single item or a group of items, provided the specific requirements for a group of items are met (see ‘Groups of items‘).

Only assets, liabilities, firm commitments and forecast transactions with an external party qualify for hedge accounting. As an exception, a hedge of the foreign currency risk of an intragroup monetary item qualifies for hedge accounting if that foreign currency risk affects consolidated profit or Read more

Hedges of exposures affecting OCI

Hedges of exposures affecting other comprehensive income

Only hedges of exposures that could affect profit or loss qualify for hedge accounting. The sole exception to this rule is when an entity is hedging an investment in equity instruments for which it has elected to present changes in fair value in OCI, as permitted by IFRS 9. Using that election, gains or losses on the equity investments will never be recognised in profit or loss.

For such a hedge, the fair value change of the hedging instrument is recognised in OCI. Ineffectiveness is also recognised in OCI. On sale of the investment, gains or losses accumulated in OCI are not reclassified to profit or loss.

Consequently, the same also Read more

Risk components – General requirements

Instead of hedging the total changes in fair values or cash flows, risk managers often enter into derivatives to only hedge specific risk components. Managing a specific risk component reflects that hedging all risks is often not economical and hence not desirable, or not possible (because of a lack of suitable hedging instruments).

However, under IAS 39, a non-financial item can only be designated as the hedged item for its foreign currency risk or all its risks in their entirety. There is no such restriction for financial items, therefore creating an inconsistency in hedge accounting for risks of financial and non-financial items. This results in many risk management activities, in particular those of non-financial services entities, not qualifying for Read more

Contractually specified risk components

Purchase or sales agreements sometimes contain clauses that link the contract price via a specified formula to a benchmark price of a commodity. Examples of contractually specified risk components are each of the price links and indexations in the contracts below:

  • Price of natural gas contractually linked in part to a gas oil benchmark price and in part to a fuel oil benchmark price
  • Price of electricity contractually linked in part to a coal benchmark price and in part to transmission charges that include an inflation indexation
  • Price of wires contractually linked in part to a copper benchmark price and in part to a variable tolling charge reflecting energy costs
  • Price of coffee contractually linked in part to a benchmark
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Non-contractually specified risk components

Not all contracts define the various pricing elements and, therefore, specify risk components. In fact, most risk components of financial and non-financial items are not to be contractually specified. While it is certainly easier to determine that a risk component is separately identifiable and reliably measurable if it is specified in the contract, IFRS 9 is clear that there is no need for a component to be contractually specified in order to be eligible for hedge accounting. The assessment of whether a risk component qualifies for hedge accounting (i.e., whether it is separately identifiable and reliably measurable) has to be made ‘within the context of the particular market structure to which the risk or risks relate and in Read more

Inflation as a risk component

Under IAS 39, inflation cannot be designated as a hedged risk component for financial instruments, unless the inflation risk component is contractually specified. For non-financial instruments, inflation risk cannot be designated under IAS 39 as a risk component at all.

For financial instruments, IFRS 9 introduces a rebuttable presumption that, unless contractually specified, inflation is not separately identifiable and reliably measurable. This means that there are limited cases under which it is possible to identify a risk component for inflation and designate that inflation component in a hedging relationship. Similar to other non-contractually specified risk components, the analysis would have to be based on the particular circumstances in the respective market, which is, in this case, the debt market.Read more

The ‘sub-LIBOR issue’

Some financial institutions are able to raise funding at interest rates that are below a benchmark interest rate (e.g., LIBOR minus 15 basis points (bps)). In such a scenario, the entity may wish to remove the variability in future cash flows caused by movements in LIBOR benchmark interest rates. However, IFRS 9, like IAS 39, does not allow the designation of a ‘full’ LIBOR risk component (i.e., LIBOR flat), as a component cannot be more than the total cash flows of the entire item. This is often referred to as the ‘sub-LIBOR issue’.

The reason for this restriction is that a contractual interest rate cannot normally be less than zero. Hence, for a borrowing at, say, LIBOR minus 15bps, if Read more

Components of a nominal amount


A component of a nominal amount is a specified part of the amount of an item. This could be a proportion of an entire item (such as, 60 of a fixed rate loan of EUR100 million) or a layer component (for example, the bottom EUR60 million of a EUR100 million fixed rate loan).

Nominal components are frequently used in risk management activities in practice. Examples include:

  • Part of a monetary transaction volume, e.g., the first USD1 million cash flows from sales to customers in a given period
  • Part of a physical volume, e.g., the 50 tonnes bottom layer of coal inventory in a particular location
  • A part of a physical or other transaction volume, e.g., the sale of the
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