The International Accounting Standards Board (IASB) is considering an exposure draft, which proposes limited period exceptions from IFRS 9 and IAS 39 in relation to the requirements of hedge accounting. This could affect the accounting of hedges of interest rate risk.
A recent review of some major interest rate benchmarks by the Financial Stability Board (FSB), including interbank offer rates (IBORs), has led to reform which is replacing these existing benchmarks with alternative interest rates. There is uncertainty about when the existing interest rate benchmarks will be replaced and what the new interest rate will be.
IFRS 9 and IAS 39 both require forward looking analysis within the conditions for hedge accounting. The contractual cashflows of hedged items and hedging instruments based on existing interest rate benchmarks will change when such benchmarks are replaced with alternative interest rate benchmarks. Uncertainty about the timing and amount of cash flows could affect an entity’s ability to meet the current requirements of IFRS 9 and IAS 39. As a result, entities could be required to discontinue hedge accounting or be prevented from making new designations for hedging relationships.
The exposure draft proposes mandatory exceptions from specific requirements for hedge accounting. Entities would apply those requirements to hedges of interest rate risk assuming that the interest rate benchmark on which the cash flows of the hedged item and hedging instrument are based is unaltered by the reforms. Such an assumption is to be made when determining:
- whether a forecast transaction is highly probable;
- whether there is an economic relationship between the hedged item and the hedging instrument when applying IFRS 9;
- whether the hedge is expected to be highly effective in achieving offset when applying IAS 39;
- whether hedged cash flows are no longer expected to occur; and
- whether a non-contractually specified benchmark component of interest rate risk is separately identifiable (the component exception).
These exceptions will not apply to hedging relationships affected by interest rate benchmarks that are not subject to replacement as a result of the FSB’s recommendations.
The proposals included in the exposure draft only address pre-replacement issues, ie the financial reporting issues in the period before the replacement of an existing interest benchmark. As the conditions and details of replacement benchmarks are yet to be finalised, any post-replacement issues will be subsequently considered, and appropriate action taken by the IASB.
The amendments would have an effective date of periods beginning or after 1 January 2020, with early application permitted. They would apply retrospectively but would not allow reinstatement of previously discontinued hedge accounting. Other than the component exception, it is also proposed that the exceptions would cease to apply on the earlier of:
- when the uncertainty arising from the interest rate benchmark reform with respect to the amount and timing of cash flows is no longer present;
- when the hedging relationship is discontinued; or
- when the entire accumulated cash flow hedge reserve is reclassified to the profit or loss.
If you require any further information, please contact Lee Marshall.