30 October 2019
The International Accounting Standards Board (IASB) has issued limited period exceptions from IFRS 9 and IAS 39 in relation to the requirements for hedge accounting.
The review of some major interest rate benchmarks by the Financial Stability Board (FSB), including interbank offer rates (IBORs), 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 benchmark will be.
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 or the interest rate benchmark designated as a hedged risk could affect an entity’s ability to meet the current requirements of IFRS 9 and IAS 39. Without the amendments to IFRS 9 and IAS 39, entities might be required to discontinue hedge accounting or be prevented from making new designations for hedging relationships while this uncertainty exists.
The amendments apply to periods beginning on or after 1 January 2020, with early application permitted. They apply retrospectively but only to hedging relationships and cash flow hedge reserves that exist at or after the start of the period of first application.
The limited period exceptions from specific requirements for hedge accounting are mandatory.
A key exception is that entities shall assume the interest rate benchmark on which the cash flows of the hedged item and hedging instrument are based is unaltered by the reforms 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; and
- whether hedged cash flows are still expected to occur when accounting for the discontinuation of a cash flow hedge of a highly probable forecast transaction.
- An entity is not required to discontinue hedge accounting if the retrospective hedge effectiveness testing in IAS 39 fails as a result of uncertainty over interest rate benchmarks.
- The assessment of whether a non-contractually specified benchmark component or portion of interest rate risk is separately identifiable is considered only at inception of the hedging relationship, or, where a dynamic process is applied to frequently changing hedging instruments and hedged items (macro hedging), only on initial designation of the hedging relationship.
- Rather than being restricted to hedges of interest rate risk only, the exceptions apply to all hedging relationships directly affected by interest rate benchmarks such as certain hedges of foreign currency risk.
IFRS 7 has also been amended and requires additional disclosures for hedging relationships directly affected by interest rate benchmark reform during the period when the limited period exceptions to IFRS 9 or IAS 39 are applied.
The exceptions cease to apply on the earlier of:
- when the uncertainty arising from the interest rate benchmark reform with respect to the hedged risk or amount and timing of cash flows is no longer present; and
- when the hedging relationship is discontinued; or
- when the entire accumulated cash flow hedge reserve is reclassified to the profit or loss.
Changes to IFRS 9 and IAS 39 set out how to apply these cessation requirements to groups of hedged items or combinations of hedging instruments.
The limited period exceptions only address the financial reporting issues in the period before the replacement of an existing interest benchmarks. 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.
If you require any further information, please contact Lee Marshall.