The IASB’s proposed guidance gives hedgers more flexibility to manage risk without forgoing hedge accounting.
The long-awaited IASB Exposure Draft (ED) on hedge accounting was released today for comment through March 9, 2011. A quick read reveals that risk managers will find much more to like in the IASB’s new take on hedge accounting than that of the FASB’s.
Like the FASB in the US, the IASB’s overhaul of hedge accounting is part of a project to revise guidance on financial instruments accounting, or IAS 39 in the IASB’s case with hedge accounting. Unlike the FASB, however, the IASB seems to have been much more receptive to the concept that hedge accounting fit the risk management objectives of those seeking to apply it. Though reading the accompanying Basis for Conclusions document (a useful read), the IASB has either split the difference between principles-based accounting and risk management context well or, as a dissenting board member put it, “inappropriately proposes to expand the use of hedge accounting to accommodate any risk management activity.”
Per the majority IASB opinion, the objective of hedge accounting “is to represent in the financial statements the effect of an entity’s risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss.” This implies also that the accounting take into account the context of the instruments used in hedging “in order to allow insight into their purpose and effect.”
In seeking to adhere to this, the IASB’s proposed guidance would allow hedgers to avoid some of the adverse practical consequences found in the FASB’s proposed hedge accounting changes. For example, the IASB proposal provides for:
- An even narrower designation of components of risk being hedged, including one-sided risk designation and layers or percentages of the nominal value of components, which will prove particularly useful with commodity hedges.
- “Rebalancing” hedges that remain in line with risk management objectives, documented upon designation of a hedge, so that the revised hedging relationship can be accounted for as a continuation of the existing hedge (a novel work around to accommodate the common de-designation/re-designation practice). Even rollover or replacement strategies would not result in a discontinuation of a hedge, under this concept, so long as they were consistent with the documented risk management approach.
- Hedging of a group of items, including the net position of the group, the same as hedging an item individually (in this way allowing, for example, a treasury center to hedge the net position of the intercompany hedge contracts with affiliates and get hedge accounting though the intercompany contracts of the affiliates would not, consistent with IAS 39).
- Derivatives being allowed as hedged items or even a combination of an exposure and a derivative. This, along with grouping of items, allows for a wider range of hedging strategies, including with collars and basket structures.
It will be interesting to see what if any of the added flexibility in the IASB proposed guidance might find its way back into that of the FASB. Meanwhile, commentators who said that convergence was dead upon the arrival of FASB ED will find further evidence of divergence here.