Hedge accounting proposals aim for clarity on risk management activities

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London, 7 September 2012 – The International Accounting Standards Board (IASB) today released a draft final standard with revised proposals on hedge accounting that will allow many entities better to reflect their risk management activities in the financial statements. The proposals are designed to provide a stronger link between an organization’s risk management activities, the rationale for hedging, and the impact on the financial statements.

Tony Clifford, EY’s Global IFRS Financial Instruments Leader, says: “We welcome the IASB’s new proposals for a hedge accounting model because they are more principle-based, less complex, more linked to an entity’s risk management activities, and can be consistently applied in all industry sectors. The current hedge accounting model includes complex rules, some arbitrary limits, and onerous hedge effectiveness testing that often result in an entity not being able to apply hedge accounting to its economic hedging relationships.”

Clifford comments: “We expect that the most significant benefit of the proposals will be for non-financial services entities. These entities typically enter into contracts to buy or sell non-financial items that contain various risk components, such as, foreign exchange risk, commodity price risk and basis risk. Hedge accounting will now be permitted for individual risk components of non-financial items, provided the entity can separately identify and reliably measure the risk component that is actually hedged. One example commonly used is the hedge of the crude oil component of a jet fuel purchase.”

Many financial institutions are waiting for the IASB to develop a separate proposal on so called “portfolio” or “macro hedging,” that is expected to be issued as a separate standard in 2014. Some of the existing macro hedge accounting provisions have been carried forward into this final draft standard, but banks will need to review it carefully to ensure that when applying IFRS 9 they can continue with their existing hedge accounting policies until the macro hedging project is completed. But banks will benefit from the new standard. Clifford adds: It should reduce the operational burden of hedge accounting and provides more flexibility.”

The draft can be accessed on the website of the IASB for a period of 90 days. Clifford concludes: “Given the changes proposed by the IASB, we encourage organizations to analyze the review draft in detail to understand the impact the new hedge accounting model would have on their hedging activities and to identify any difficulties in applying it.”

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