Wake-up Europe, Time to Quick-Start IFRS 9 Initiatives

EU Endorses IFRS 9

The wait is over. Finally, the European Commission endorsed IFRS 9: Financial Instruments on 22 November 2016, and companies in the EU have a lot of catching up to do. The replacement of IAS 39 will become effective for financial years beginning on or after 1 January 2018.

Since the final version of IFRS 9 was issued in 2014, many companies in Australia, Canada, Japan, Switzerland, South Africa and India have early adopted IFRS 9 to take advantage of the simpler, principal-based standard that enables companies to better align hedge accounting and risk management. Now, companies in the EU can kick-off their own IFRS 9 initiatives.

New Hedging Strategies for Companies Reporting Under IFRS 9

Over the last 12-18 months, many companies – both early-adopters and companies preparing for IFRS 9 – have started reviewing how they are hedging their exposures. A recent Reval survey shows that 70% of corporates are considering to or have already entered into new hedging strategies as a result of IFRS 9. Here are some of these changes that are enabling new hedging strategies:

  • Increase in Commodity Hedging

Under IFRS 9, corporations have the ability to hedge the component risk of non-financial items. Previously under IAS 39, finance professionals were required to either hedge for FX risk only or for all risks, resulting in many hedges not qualifying for hedge accounting, causing significant P&L volatility. Sometimes, even if the hedges qualified, they would still experience volatility. With IFRS 9, however, corporates can now designate just a component of the risk of a non-financial item, for example the aluminium in an aluminium can or the rubber in a rubber tire. Because of this principal, IFRS 9 is promoting commodity hedging and, in many cases, bringing procurement hedging under treasury’s remit.

  • Different Treatment for Options

Under the new rules, hedging costs are also treated differently. Costs of hedging can be posted to equity rather than P&L. Previously under IAS 39, companies were required to record movements in the time value of options in P&L, whereas now they are permitted to initially post these movements to a separate component of equity (Other Comprehensive Income) and release them to P&L at a later point in time. This is resulting in less P&L volatility. We are seeing option usage gain in popularity for hedging purposes.

  • Economics Driving the Accounting, Not Vice Versa

The new standard also removes the 80%-125% “bright-line” rule for hedge effectiveness. For some hedging strategies that have previously failed the effectiveness test due to small misalignments between the hedge and the underlying exposure, IFRS 9 presents an opportunity to re-examine whether hedge accounting can be applied now. IFRS 9 permits new hedge items to be designated in hedge relationships, components of financial and non-financial items to be designated and derivatives to be designated as hedged items. All of these create new opportunities for corporates to revise their hedging strategies.

IFRS 9’s principle-based approach better aligns hedge accounting with a company’s risk management strategy, which brings new opportunities and instruments to companies hedging risk. That said, the transition to reporting under IFRS 9 will not necessarily be quick and easy.

How to Implement IFRS 9

Procurement, treasury, finance, accounting, internal and external auditors need to work closely together when planning their company’s transition to IFRS 9. On the backend, corporations need to review the technologies that can help them best automate hedge accounting and compliance reporting. Calculating aligned time value, currency basis, amortisation of forward points, rebalancing and setting up hedge relationships with derivatives as hedged items, all require sophisticated, analytical, valuation and hedge accounting engines.

In 2015, Reval was the first global SaaS provider for Treasury and Risk Management to offer comprehensive IFRS 9 capabilities. In conjunction with the Big Four and clients that have early adopted the standard, Reval’s Hedge Accounting Technical Taskforce (HATT) continues to lead the ongoing development of IFRS 9 hedge accounting functionality.

 

Read our white paper to find out how to quick-start your IFRS 9 implementation project.