Treasury Today Country Profiles in association with Citi

IFRS 9: hedge accounting your way?

A die on a board game with red coloured pieces

In September, the International Accounting Standards Board (IASB) issued a draft for general hedge accounting requirements to be added to the tripartite IFRS 9 Financial Instruments package. But while the new proposals, which aim to establish a close alignment between companies risk management activities and their hedge accounting procedures, have been largely welcomed, several issues of contention remain.

Calls to reform IAS39, the existing standard that deals with the recognition and measurement of financial instruments began well before 2008. Yet in many ways it was the financial crisis that really became the catalyst for greater scrutiny of accounting standards. A lot of people were unhappy with IAS39 – it was viewed as unnecessarily complex, difficult to apply, and too open to interpretation. In addition, there was the problem of a lack of regulatory convergence. With companies reporting under different standards, the consequence was that figures being produced often looked very different, even if they had the same underlying portfolio.

So when the crisis erupted, IAS39 became the subject of much debate. The complexity of the existing standards along with difficulties presented by regional divergence had, some experts argued, been causal factors in the turmoil that was then gripping the markets.

These, in essence, became the two principal objectives that regulators had in mind when drawing up IFRS 9 – greater ‘understandability’, and greater comparability. But has the latest section of the tripartite regulatory changes, published last month, succeeded in meeting these purposes? And if these proposals are indeed implemented in a form close to the review draft, what will be the implications for corporate treasurers?

Jacqui Drew, Solution Consultant at Reval, believes that the new hedge accounting requirements are likely to have profound implications for treasury professionals – in particular those at companies with significant commodity exposures. The changes, she says, will bring significant benefits. Above all, it will allow more corporations to hedge account non-financial items as they will be permitted to hedge account for components of non-financial items provided the component is separately identifiable and reliably measureable.

But, she warns, there are concerns about certain aspects of the draft being raised by both banks and corporates.

“Judging from the views we’ve seen from our clients and from the conferences I’ve attended I think everyone feels very positive about the broad objectives of the regulations – in terms of the principle of risk management being aligned with accounting outcomes,” she says. “However, I think there are some concerns in more of the detail in other areas.”

Taking different routes

One of the areas causing some disquiet in the industry, according to Drew, is the divergence that has begun to manifest between the IASB and the US Financial Accounting Standards Board (FASB). The two bodies had worked jointly on classification and measurement section, and are currently collaborating on the impairment piece. However, the FASB has indicated that it has no intention of working together with the IASB on hedge accounting. Furthermore, there even remains some uncertainty surrounding the likelihood of an endorsement from the EU of the new standard. Authorities in Brussels, according to sources among the big four accountancy firms, are believed to be holding back until the standard has been completed before confirming their approval.

“The FASB has made it pretty clear that they are not going to be exposing the same things as the IASB are. So there is unlikely to be convergence on hedge accounting of financial instruments because the IASB have said that the review draft is likely to become the final standard unless feedback from stakeholders indicate that there are fatal flaws in the draft,” she says.

As Drew points out, this could undermine one of the original objectives of the accounting standards – comparability. “I think that it is a problem,” she says. “Larger multinational corporates are still going to have the issue of having dual ledger systems one for US GAAP and one for IFRS. So the original concern, that you don’t have comparability between companies, remains. And that is a concern – both from a system perspective and also from a financial statement user perspective.”

A fatal flaw?

It seems then that the convergence that everyone wished for is rather unlikely to materialise. Unless, that is, a fatal flaw is unearthed, and the draft is revised before implementation. But does Drew think that this is a likely possibility?

“There is one paragraph in the draft concerning currency basis risk which has been causing a lot of contention, predominantly with the banks,” she says, noting this is perhaps because they are the ones who best understand it and its implications. “But it will also have quite a material impact upon corporates too if it comes to fruition,” she adds.

The paragraph was a surprise to some as it did not feature in the exposure draft, nor did it come up in the due process subsequent to that. The concern centres on the implied consequences of being unable to include currency basis when using cross-currency interest rate swaps (CCIRS) as your hypothetical derivative. This, experts contend, appears to be inconsistent with the principle of risk management aligned with accounting outcomes. Corporations would, as a result, receive markedly different accounting treatment if they raised debt locally than if they did so offshore and performed a CCIRS, if the new standard were to be implemented in its current form.

“It is quite a concern because it is something that is in the review draft that hasn’t gone through due process. And it does appear to give contradictory results to parts of the standard,” says Drew.

Accordingly, there has been a considerable amount of lobbying taking place to get this standard changed before the final draft is issued. But Drew is unsure about whether the IASB will take these concerns into consideration when drawing up the final draft. “There is a lot of discussion taking place at the moment about this definition – about whether the hypothetical derivative described in terms of currency basis risk is appropriate,” she says. “I believe we will see some people push for that to be corrected, but it is difficult to know whether the IASB will take that on board.”

Time to prepare

Although there remains a small degree of uncertainty surrounding the way the standard approaches currency basis risk, Drew believes that the forthcoming implementation of IFRS 9 should prompt treasurers to assess what treasury management systems they use, and consider how well prepared their department is to cope with the changes. The first step, she says, would be to work out which of their current hedges would qualify under IFRS 9 and then performing a gap analysis to see where hedge accounting could be applied.

The next step should be to adopt specialist tools that can allow users to put in some dummy trades to see whether hedge accounting could be applied under the new rules, she adds.