Q: Does IFRS 9 allow a highly probable forecast foreign currency debt issuance as eligible as a hedged item in a cash flow hedge of interest rate risk if the currency of issuance is not yet known?
Considerations: Hedging of a highly probable debt issuance
At 1 January 200X, entity A, whose functional currency is the Euro, intends to issue a variable interest rate debt in six months’ time in order to finance future activities. Depending on the market conditions existing at 1 July 200X, entity A will decide whether the debt is issued in Euros or in US dollars. If the debt is issued in US dollars, then at the debt issuance date (1 July 200X) entity A will enter into a cross-currency swap in order to convert the US dollar exposure on the debt to a Euro exposure.
Management wants to hedge its exposure to variable interest rates. On 1 January 200X, it contracts a forward-starting interest rate swap (that is, an interest rate swap that will start on 1 July 200X) which is denominated in Euros.
Consequential Explanation and Reasoning: Hedging of a highly probable debt issuance
Yes. Under IFRS 9, an aggregated exposure that is a combination of a forecast transaction that could qualify as a hedged item and a derivative can be designated as a hedged item, provided that the aggregated exposure is highly probable and, once it has occurred and is therefore no longer forecast, it is eligible as a hedged item.
As a result, the proposed designation is acceptable, provided that it is in line with entity A’s risk management strategy and objectives. In the illustration, the designated hedged item would be the highly probable variable interest payments in Euros (entity A’s functional currency), arising either from the Euro debt or the aggregated exposure (US dollar debt swapped into Euros by using the cross-currency swap).