IFRS 9 Qualifying For Hedge Accounting |

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:Hedged items - General requirements

  • A recognised asset or liability Hedged items4 – General requirements 
  • An unrecognised firm commitment Hedged items – 4General requirements 
  • A highly probable forecast transaction Hedged items – Gene4ral requirements 

Or Hedged items4 – General requir4ements Hedged items – General requirements Hedged items – Ge4neral requirements

  • A net investment in a foreign operation Hedged items – G4eneral requirements Hedged items – Gen4eral requirements

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 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). Risk components – General requirements

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 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 which the 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. Inflation as a risk component

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 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