Recently the IASB issued its long-awaited exposure draft (ED) on its proposed changes to hedge accounting. This ED is the third and final phase to replace IAS 39, with the proposed changes aimed at simplifying the requirements to hedge account financial instruments.
It is anticipated that IFRS 9 will be required to be adopted prospectively on or after 1 January 2013 with early adoption permitted. To early adopt the new hedge accounting model, the first two stages of IFRS 9 (Classification and measurement and Impairment methodology) previously finalised must also be adopted together.
After a significant outreach programme, the proposed changes put more emphasis on the financial reporting being aligned to a company’s risk management objectives. These changes will have a significant impact on companies that already hedge account as well as companies that have elected not to hedge account, as the criteria under the current rules were considered too onerous given their economic hedging program.
What companies should begin thinking about prior to IFRS 9 being adopted?
First, companies should undertake a review of their current risk management and hedge accounting policies to highlight how the proposed changes will impact these policies given the new IFRS 9 requirement. The proposed rules can operate on three core levels:
1) Current hedge accounting practice – It is expected that existing hedge relationships will continue to qualify under IFRS 9 but the criteria to achieve hedge accounting would be significantly different compared to IAS 39 particularly with regards to effectiveness testing. How will this impact your hedge accounting processes? What would be the impact to the financial statements?
2) Scenarios not currently hedge accounted – Potentially, hedge accounting can be applied to scenarios under IFRS 9 that were not available (or easy) under IAS 39. Are there such scenarios in your current hedging programme? What would be the potential benefit to the bottom line in applying hedge accounting?
3) Hedging strategy – Given that IFRS 9 links accounting outcomes to economic outcomes, what changes (if any) would you apply to your hedging strategy? For instance, many avoided using instruments with optionality components, given the implied P&L volatility under IAS 39. In most circumstances, this P&L volatility would be avoided under IFRS 9 – would you consider expanding the use of option-based products given this change to accounting? For commodity hedgers, ineffectiveness due to basis risk can be significantly reduced – would you hedge more commodity exposures as a result?
The IASB will allow early adoption of all phases of IFRS 9 prospectively, so such an impact analysis will be vital in assessing your company’s strategy regarding early take up of this new guidance. Also, check in with your system providers to understand their plans for accommodating the new rules to meet your timelines.