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How will IFRS 9 change hedge accounting for corporates?

Seven out of 10 finance teams say that they have or will implement new hedging strategies as a result of IFRS 9, which will replace IAS 39 Financial Instruments, according to a recent Reval survey.

Implications for corporates

The new financial reporting standard was endorsed by the European Commission in November 2016, so corporates in Europe are now starting to adjust their hedging strategies to comply by the January 2018 implementation date. IFRS 9 affects the classification, measurement, impairment and hedge accounting of financial instruments. CTMfile has already covered the implications for non-financial corporates, which are summarised as follows:

  • introduction of fair value through other comprehensive income (FVTOCI), for debt instruments;
  • FVTOCI replaces the available-for-sale (AFS) classification under IAS 39;
  • IFRS 9 introduces a new expected loss impairment model which replaces IAS 39’s incurred loss model;
  • the loan loss allowance is recognised on initial recognition and measured as either a 12-month expected loss allowance or a lifetime expected loss allowance;
  • an earlier trigger for recognising impairment losses means entities will have to establish appropriate systems and processes for identifying when there has been a significant increase in credit risk; and
  • corporates will have to use data not previously required under IAS 39, for example in the calculation of loss allowances measured on a probability-weighted basis.

Streamlining hedge accounting

So how will things really change for corporates? IFRS 9 enables hedges that previously didn't qualify for hedge accounting. Hedging a commodity risk, for example, may also cause fair value movements that didn't qualify for hedge accounting under IAS 39, which can cause significant P&L volatility, according to Reval. IFRS 9 allows corporates to hedge a component of the risk (ie, just the commodity, rather than other fair value movements, which can be posted to equity).

IFRS 9 enables hedgers to treat the cost of hedging as a separate component of equity. Reval states: “As costs of hedging include time value of options – as well as currency basis and forward points – options can now come back into the toolbox of the risk manager. Among early adopters, we have already seen a significant increase in the use of options as hedging instruments.”

Reviewing your company's risk management processes in order to adjust for IFRS 9 also gives companies an opportunity to redesign their risk approach. Reval states: “Best practice risk management includes the use of Cash Flow at Risk (CFaR) to assess correlations among exposures in multiple asset classes and detailed analytics to understand risk drivers better. Both help risk managers to avoid over-hedging, significantly decreasing hedging cost and limiting counterparty risk.”

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