Commentary by Citi offers further insight into the IASB’s new hedge accounting proposal.
The new IASB exposure draft is heading in the right direction. That’s according to Matthew Daniel and Hector Lugo of Citi’s Corporate Solutions Group FX team in their summary of the IASB’s exposure draft on hedge accounting released last week.
One important item the two point out is how the IASB seems to be departing from the prior standard setters’ view that hedge accounting should be made an increasingly limited exception to the norm of fair valuing all financial instruments. This is how they interpret the IASB’s stated objective to provide clearer reporting of risk management in financial statements.
“This is a vastly different approach than used previously by both the IASB and the FASB where hedge accounting was viewed as an exception to accounting principles. Previously, both Boards held the belief that hedge accounting should be strictly limited and was not the preferred accounting treatment for derivatives.”
However, they also note that the proposed guidance could result in more onerous requirements and introduce practical difficulties, in some cases (hopefully, where the risk management context is cloudy), as well as make applying hedge accounting easier (hopefully, where the risk management goals are clear cut) in others. The bottom line is that hedging will flourish, relatively speaking, if hedge accounting is not phased out as it arguably was to be under the prior trajectory of financial accounting.
Facing the realities of risk mitigation
Reading the “Basis for Conclusions” that accompanies the ED, the IASB tries to argue that it split the difference between allowing the hedging, or risk management context to drive financial reporting (allowing hedging to flourish) and mitigating the recognition and measurement anomalies, and timing differences, between accounting for hedges (often derivatives) and the items being hedged. This may well be splitting hairs from a practical point of view since risk mitigation often can be messy from the perspective of recognition and measurement, as well as timing (that’s why it’s a risk).
In the fair value accounting mindset, hedge accounting should ultimately become obsolete when the items being hedged all come under the fair value model like the derivatives (and other tools) used to hedge.
Unfortunately, not everything that management may seek to hedge fits nicely into the fair value measurement mold. Thus, standard setters are forced to choose the extent to which they want a square peg forced into a round hole—or seek to have financial reporting actually reflect what is intended from a risk management perspective. According to Messrs Daniel and Lugo, the IASB looks to be leaning toward the proper choice.