Reval recently asked corporations that apply IFRS across the globe their opinion on the latest IFRS 9 Review Draft. In particular, Reval wanted to know how they felt about the controversial treatment of hypothetical derivatives embodied in Paragraph B6.5.5. This paragraph currently outlines how hypothetical derivatives, and by implication the exposures themselves, cannot include elements that only exist in the hedging instrument, not the hedged item. Practically, the most obvious impact of such guidance is in forward foreign exchange rates which include a currency basis component, particularly for longer duration periods beyond one year.

The survey found that nearly 40% of respondents were not even aware of this specific guidance as it was never exposed during the consultation process the IASB conducted in compiling IFRS 9. In fact, it only came to light when the Review Draft was issued in September 2012, and even then, it was buried deep in the Application Guidance, not in the main body of the standard. It is not surprising, then, that so many of our respondents were taken aback when learning of how this would impact their financial results.

The most obvious impact of this guidance would be to an organization’s currency hedging programme. We wanted to get a sense of how significant this issue would be, so we asked respondents to quantify the impact of Paragraph B6.5.5. The results were stunning – over a third saw this impacting between 75 and 100 percent of their current hedging programme, and more than half of respondents saw an impact of 50 percent or more of their hedging programme. This implies that the change will have far reaching consequences for organisations, even if many of them were not yet aware that such guidance even exists.

When questioned further on what should happen prior to the final standard being issued, over 90% wanted the guidance either removed or amended. I think these results are indicative of what happens when you issue new guidance that has a significant impact to most organisations’ hedging programmes, with seemingly no due diligence on testing the issue with your constituency. We have already heard cases of organisations delaying their adoption timeline of IFRS 9as a result of this paragraph.

Fortunately, the IASB meeting on Friday 14th December mentioned the feedback the IASB received around this issue – in fact, it was IASB Chairman Hans Hoogervorst who indicated that he had reviewed the comment letters personally. The IASB Staff suggested that they will present three alternatives for the treatment of hypothetical derivatives in the IASB’s next meeting in late January. This is clearly a great result; the IASB has heard the concern of the 90 percent! However, it does mean that we will not see a standard issued by the beginning of 2013 as the IASB indicated back in September. They do expect to outline the plan for issuing the standard in their January meeting, so hopefully the delay will not be too long. I think most of us would take a delay of a couple of months if it means fixing this fatal flaw to a more palatable outcome.