Hedge Of A Net Position – FAQ | IFRS

Hedge of a net position

Q: When can an entity make use of a hedge of a net position?

Considerations: Hedge of a net position
A EUR-functional currency entity has a sales department that sells certain items in USD. At the same time, the purchasing department buys certain products in USD. Each department is unaware of the other’s activities, but both want to hedge their forecast USD sales and purchases respectively. Assume that the sales department has USD 100,000 of sales in six months’ time, so it enters into a forward contract with the entity’s central treasury department (that is a separate entity within the same group). Hedge of a net position

The purchasing department has highly probable forecast purchases of USD 90,000, also in six months’ time, and it also enters into an internal derivative with the central treasury department. Both the sales and purchasing departments view their derivative as a hedging instrument, but the group cannot apply hedge accounting, because the derivative is internal to the group and so it is eliminated on consolidation. Hedge of a net position Hedge of a net position

Hedge of a net positionHowever, in order to hedge the group’s exposure, the treasury department enters into a forward with a bank for USD 10,000. By doing this, the group is economically hedged. However, under IAS 39, it was not possible to designate the net position of USD 10,000 (comprised of USD 100,000 sales and USD 90,000 purchases) as a hedged item. Instead, the group had to designate USD 10,000 out of the USD 100,000 of future sales as the hedged item. This did not reflect the entity’s risk management strategy and is not how the entity tracked the appropriateness of the economic hedge relationship. Hedge of a net position

Under IFRS 9 can the group designate the net position of USD10,000 as the hedged item?

Consequential Explanation and Reasoning: Hedge of a net position
Yes. Under IFRS 9, a net position that incorporates offsetting positions can be designated as a hedged item, provided all items included in the group are individually eligible as hedged items and the items in the group are managed together on a group basis for risk management purposes. This means that the group can now apply hedge accounting to a net position comprised of sales of USD 100,000 and purchases of USD 90,000 with a USD 10,000 derivative, which mirrors the entity’s risk management.

However, the hedging gains and losses on recycling must be presented as a separate line item in P&L (separate from the hedged items). An entity cannot present the post–hedging results of its commercial activities for the individual line items affected. [IFRS 9 B6.6.15-16].

Hedging an overall net position Hedge of a net position

Under IFRS 9, an entity can designate an overall net position as the hedged item, provided it is managed as a net position for risk management purposes. However, it must designate the gross amounts within the net position, and not a non-specific abstract amount. [IFRS 9 B6.6.1 and B6.6.4]. To illustrate what is meant by a net position, consider the following example.

Case — hedge of a net position

An entity with a euro functional currency has a sales department that sells certain items in USD. At the same time, the purchasing department buys certain products in USD. Each department is unaware of the other’s activities, but both want to hedge their forecast USD sales and purchases respectively. Assume that the sales department has highly probable forecast sales of USD 100 in six months’ time, so it enters into forward contract with the entity’s central treasury department. The purchasing department has highly probable forecast purchases of USD90, also in six months’ time, and it enters into an internal derivative with the central treasury department. Both sales and purchasing departments view their derivative as a hedging instrument, but they cannot apply hedge accounting because the derivative is internal, and so is eliminated on consolidation. Hedge of a net position

However, in order to hedge the entity’s net exposure, the treasury department enters into a forward contract with a bank for USD 10. By doing this, the entity is economically hedged. Under IFRS 9, a net position that incorporates offsetting positions can be designated as a hedged item, provided all items included in the group are individually eligible as hedged items and the items in the group are managed together on a group basis for risk management purposes. This means that the entity can apply hedge accounting to a net position comprised of sales of USD 100 and purchases of USD 90 with a USD 10 derivative, which mirrors the entity’s risk management strategy. Hedge of a net position

Treasury involvement

Treasurers commonly group similar risk exposures and hedge only the net position externally, as in the example above. However, although IFRS 9 permits hedges of a net position, it requires the presentation of the gains and losses on recycling as a separate line item in P&L (separate from the hedged items), and so it does not allow an entity to present the post-hedging results of its commercial activities for the individual line items affected (that is, sales and cost of sales in the above example). [IFRS 9 6.6.4, B6.6.13 to B6.6.16].

Cash flow hedges of a group of items

For cash flow hedges of a group of items that are expected to affect P&L in different reporting periods, there are also additional qualifying criteria:

  • Only hedges of foreign currency risk are allowed. Hedge of a net position
  • The items within the net position must be specified in such a way that the pattern of how they will affect P&L is set out as part of the initial hedge designation and documentation (this should include at least the reporting period, nature and volume). [IFRS 9 6.6.1(c)]

Presentation hedging gains and losses

Hedging gains and losses on hedges of net positions must be presented in a separate line item in the statement of P&L and OCI. For cash flow hedges of a group of items with no offsetting risk position, the presentation of gains and losses should be apportioned to the line items affected by the hedged items. [IFRS 9 B6.6.14 to B6.6.15]. Hedge of a net position

Hedging of net nil positions

In addition to groups of items and net positions, net nil positions (that is, where hedged items among themselves fully offset the risk that is managed on a group basis) are allowed to be designated in a hedging relationship that does not include a hedging instrument, provided that all the following criteria are met: Hedge of a net position

  • the hedge is part of a rolling net risk hedging strategy (that is, the entity routinely hedges new positions of the same type);
  • the hedged net position changes in size over the life, and the entity uses eligible hedging instruments to hedge the net risk;
  • hedge accounting is normally applied to such net positions; and
  • not applying hedge accounting to the net nil position would give rise to inconsistent accounting outcomes.

Net nil positions are expected to be rare in practice. [IFRS 9 6.6.6] Hedge of a net position

Designate some of the underlying gross items

IFRS 9 also allows an entity to designate some of the underlying gross items as the hedged item equal in amount to the net position. This was a common strategy under IAS 39 (the predecessor standard to IFRS 9). For example, an entity (C functional currency) with a firm commitment to make a purchase in a foreign currency of FC 100 and a firm commitment to make a sale in the foreign currency of FC 90 can hedge the net amount of FC 10 by acquiring a derivative and designating it as a hedging instrument associated with FC 10 of the firm purchase commitment of FC 100. Similarly, an entity with C 100 of fixed rate assets and C 90 of fixed rate liabilities with terms of a similar nature could hedge the net C 10 exposure by designating C 10 of those assets as the hedged item.

See also: The IFRS Foundation

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