Risk Management

Under New Accounting Standard, CFOs Could Change Hedging Strategies

Will finance chiefs come under more pressure to adopt hedge accounting — even though it remains entirely optional under the new standard?
Andrew SawersSeptember 12, 2012

A new international financial reporting standard (IFRS) on hedge accounting could prompt finance chiefs to change their companies’ hedging strategies under a more accommodating, principles-based regime that requires less testing.

The International Accounting Standards Board (IASB) has been pondering hedge accounting for several years in an effort to find a way to replace the unloved standard IAS 39: so unloved that it’s not part of the package of accounting standards endorsed by the European Commission for listed companies. The standard has made it tough to employ hedge accounting, which can be favorable to companies in certain circumstances.

In a recent podcast, Kush Patel, director in Deloitte’s U.K. IFRS Centre of Excellence, summarized the impact of the new rules: “More hedge-accounting opportunities, less profit and loss volatility — so as you’d expect, this has been well received.”

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Under IAS 39, he said, “we saw a lot of companies change the way they manage risk: we saw them reduce the amount of complex, structured derivatives that were being used to hedge and they went for more vanilla instruments that could [qualify for] hedge accounting more easily. Now that IFRS 9 will remove some of these restrictions, I think it’s fair to say risk management could change.”

Andrew Vials, a technical-accounting partner at KPMG, said in a statement, “A company will be able to reflect in its financial statements an outcome that is more consistent with how management assesses and mitigates risks for key inputs into its core business.”

Will CFOs come under more pressure to adopt hedge accounting — even though it remains entirely optional under the new standard? “If hedge accounting becomes easier, there may be more emphasis on them to achieve hedge accounting — so although it’s voluntary, there is an element that they may feel more compelled to do hedge accounting” says Andrew Spooner, lead global IFRS financial-instruments partner at Deloitte.

The final draft of the new hedge-accounting rules was published on September 7 and will be incorporated into the existing IFRS 9 Financial Instruments at the end of the year. The IASB says it’s not seeking comments on this final draft, but is making it available “for information purposes” to allow people to familiarize themselves with it. The new rules will take effect from January 1, 2015, but companies will be allowed to adopt them sooner if they wish.

Spooner and Patel note three main areas in which the new rules are different from the old:

Changes to the instruments that qualify. It’s now easier, for example, to use option contracts without increasing income-statement volatility.

Changes in hedged items. It may not be possible, for example, for a company to hedge the particular type of coffee beans a food company buys. But it could hedge a benchmark coffee price, because it is closely related to the item it would like to hedge. Another change for the better: companies in the euro zone that want to hedge dollar purchases of oil can now more easily hedge the dollar price of the oil, then later hedge the foreign-exchange exposure without the oil-price hedge being deemed ineffective. There are also more favorable rules for hedging against credit risk and inflation.

Changes to the hedge-effectiveness requirements. Under IAS 39, a company could use hedge accounting only if a hedge is “highly effective,” meaning it must be capable of offsetting the risk by a range of 80%–125%. But the 80–125 test has been scrapped to be replaced by a principle-based test that is based on economic relationship: “You have to prove that there is a relationship between the thing you are hedging and the thing you are using,” says Patel. Having gotten rid of the quantitative threshold, there are “more opportunities for companies to reduce the amount of testing they do,” he says. “It’s a welcome change.”

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.


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