Hedged item – Forecast Issue of FX debt

Q: Does IFRS 9 allow a highly probable forecast foreign currency debt issuance as being eligible as a hedged item in a cash flow hedge of foreign currency risk?

Considerations:

On 1 January 20X1, it is highly probable that company X (with EUR functional currency) will issue, on 1 July 20X1, USD 100 million of five–year, fixed–rate debt, with quarterly coupons. On 1 January 20X1, the EUR:USD spot and six–month forward exchange rates are 1:1. The proceeds from the issuance of the debt are needed to finance the expansion of the company’s production facilities in Europe. The company is concerned that the EUR:USD exchange rate will fluctuate, such that additional USD debt will need to be issued in order to lock in the desired EUR 100 million in proceeds, which in turn will affect the interest incurred on the foreign currency debt to be issued. Hedged item – Forecast Issue of FX debt

Therefore, on 1 January 20X1, company X enters into a six–month forward to buy EUR and sell USD at 1:1. This transaction is on market at zero cost, because the six–month forward rate is 1:1. Hedged item – Forecast Issue of FX debt

Is the variability in functional currency equivalent proceeds, expected to be received from the forecast issuance of debt denominated in a currency other than the reporting entity’s functional currency, eligible for designation as the hedged transaction in a cash flow hedge of foreign currency risk?

Consequential Explanation and Reasoning:

No. The hedged item (risk of changes in foreign exchange rates before the forecast issuance of foreign currency debt) does not affect profit or loss when the transaction is settled or in subsequent periods. In this situation, company X is concerned about foreign exchange spot movements between the hedge inception date and the debt issuance date, specifically the risk associated with converting the foreign currency denominated debt proceeds into its functional currency. While this represents a risk from an economic and cash flow perspective and will impact interest expense in future periods, the impact on future interest expense is not the risk being hedged. Hedged item – Forecast Issue of FX debt

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