Complete your hedge accounting documentation or your hedges may no longer comply!
There are only a few weeks to go until the holiday season. Before the festivities and parties start in earnest, there are a couple of important actions you need to take – particularly if you’re intending to hedge account in 2018.
Why? Because if financial institutions and corporates don’t have the relevant documentation in place before 1 January 2018, hedge accounting may not be possible – even if you have previously been hedge accounting under IAS 39.
This is an easy problem to fix, here’s how.
Firstly, you need to decide whether you want to take advantage of the new hedging rules under IFRS 9 or whether you want to carry on hedge accounting under IAS 39, which you are permitted to do until the IASB has completed its project on accounting for dynamic risk management.
For corporates, there are significant attractions in hedge accounting under IFRS 9 and more opportunities – for example, to do commodities hedging. You’ll be able to hedge account for a specific non-financial component of a larger contract, such as the crude oil component of a jet fuel contract, resulting in a more effective hedge.
For banks and financial institutions, meanwhile, there is less incentive to move away from IAS 39. Most banks I’ve been talking to intend to stay with it, in a spirit of “if it’s not broken, don’t fix it.”
The key point is that, whatever you decide to do – even if you decide to apply IAS 39 – you have to actively elect to do so. You can’t do nothing and expect the benefits of hedge accounting to be handed to you.
So, before the New Year, you must document your hedge accounting intentions – i.e. to apply IFRS 9 or IAS 39. This documentation would normally be formally approved by your usual policy governance processes, such as in a Board minute or by the technical accounting committee.
If you plan to apply the new IFRS 9 rules, you will first need to update old hedge documentation that might not comply with the new rules – even if you aren’t taking advantage of any of the new permissions in IFRS 9. For example, compliant IFRS 9 hedge documentation should identify the expected sources of ineffectiveness – does your IAS 39 hedge documentation do that? If you don’t do this, you might be unable to apply hedge accounting to your hedging arrangements until your documentation is complete and compliant.
If you are taking advantage of the new permissions, there are additional decisions to make. For example, if you plan to use of a cost of hedging reserve technique to defer currency basis or forward points, will you do this retrospectively or prospectively?
Beyond that, there is a whole range of decisions that need to be made across classification and measurement, impairment, transition and hedging that are related to the date of application, as we have summarised in this checklist (PDF 199 KB).
Whilst not all decisions have to be made before the date of application, I’m encouraging all of my clients to make decisions sooner rather than later.
IAS 8 is clear that hindsight should not be used when applying a new accounting policy to a prior period. Consistent with that principle, if decisions are made after the date of initial application, it may not be possible to demonstrate that they have been made solely using information available on that date.
For example, equity investments should be classified as either fair value through P&L or fair value (irreversibly) through other comprehensive income. Suppose you hold equities that halve in value before you make this accounting choice on 1 March 2018. How are you going to be sure, and convince others, that your decision to put those equities as fair value through OCI was based only on the facts and circumstances on 1 January 2018?
It could lead to lengthy wrangles and debates. Much better to make those decisions at the earliest opportunity and have them documented by the date of application if possible, in tune with the spirit of the new standard.
Colin provides technical accounting advice to financial institutions and corporates globally on the application of IFRS 9.