Entities no longer need to perform a retrospective quantitative effectiveness assessment using the 80% – 125% bright lines. However, this does not mean that hedge accounting continues irrespective of how effective the hedge is. A prospective effectiveness assessment is still required, in a similar manner as at the inception of the hedging relationship (see ‘Designation‘) and on an ongoing basis, as a minimum at each reporting date. Subsequent assessment of effectiveness
Decision tree: Effectiveness assessment and rebalancing Subsequent assessment of effectiveness
An entity first has to assess whether the risk management objective for the hedging relationship has changed. A change in risk management objective is a matter of fact that triggers discontinuation. Discontinuation of hedging relationships is discussed in ‘Discontinuation‘. Subsequent assessment of effectiveness
An entity would also have to discontinue hedge accounting if it turns out that there is no longer an economic relationship. This makes sense as whether there is an economic relationship is a matter of fact that cannot be altered by adjusting the hedge ratio. The same is true for the impact of credit risk; if credit risk is now dominating the hedging relationship, then the entity has to discontinue hedge accounting.
But the hedge ratio may need to be adjusted if it turns out that the hedged item and hedging instrument do not move in relation to each other as expected. The entity has to assess whether it expects this to continue to be the case going forward. If so, the entity is likely to rebalance the hedge ratio to reflect the change in the relationship between the underlyings.
Currently, under IAS 39, when a hedge ratio is revised, entities have to discontinue the hedging relationship in its entirety and restart a new hedging relationship. For a cash flow hedge this is likely to lead to a degree of recognised ineffectiveness, as the hedging instrument will likely now have changed in fair value since it was originally designated (colloquially known as the ‘late hedge’ issue).
Rebalancing under IFRS 9 allows entities to refine their hedge ratio without discontinuation and so reducing this source of recorded ineffectiveness.