The risk management strategy has to be described by type of risk, and this description has to include how each risk arises and how, and to what extent, the risk is managed. This description must also include whether the entity hedges only a part of the risk exposure, such as a nominal component or selected contractual cash flows. To satisfy this requirement, an entity must disclose:
- The hedging instruments and how they are used to hedge the risk exposure
- Why the entity believes there is an economic relationship between the hedged item and the hedging instrument
- How the hedge ratio is determined
- The expected sources of ineffectiveness
When only a component of a risk exposure is hedged, an entity must also disclose how it determined the component and how the component relates to the item in its entirety. In our view, this would include a description of whether the risk component is contractually specified and if not how the entity determined that the non-contractually specified risk component is separately identifiable and reliably measurable.
Disclosures – Risk management strategy Disclosures – Risk management strategy Disclosures – Risk management strategy
The risk management strategy disclosures are an important cornerstone of the new hedge accounting model, as they provide the link between an entity’s risk management activities and how they affect the financial statements. The notes should also disclose the key judgements the entity has used in applying the new hedge accounting model (including those used to determine whether an economic relationship exists between the hedged item and the hedging instrument, how the hedge ratio was set and how risk components were identified, just to mention a few).
Disclosures have to be made by type of risk, rather than the type of hedging relationship (e.g., cash flow hedge or fair value hedge). This should enable users to follow the various disclosures by type of risk, resulting in a much better understanding of the hedging activities and their impact on the financial statements.