Christmas cheer for corporate hedgers

The third phase of IFRS 9 will help companies better reflect their hedging activities on their financial statements.
Blaik Wilson, solutions consultant at Reval, and vice-chairman of its hedge accounting technical taskforce
Blaik Wilson, solutions consultant at Reval, and vice-chairman of its hedge accounting technical taskforce

It’s been a long time coming, but corporations may have felt the warm glow of an early Christmas this month. The unlikely source of this Yuletide cheer is the International Accounting Standards Board’s (IASB) latest IFRS 9 exposure draft, which addresses the rather involved issue of hedge accounting.

IFRS, or international financial reporting standards, are a principle-based financial reporting framework promoted by the IASB, the independent body responsible for establishing a global framework of accounting standards. As proposed, the third phase of IFRS 9, which was issued on December 9 and will become effective from January 1, 2013, will have a dramatic impact on the financial statements of any company which hedges risk. The existing rules, IAS 39 Financial Instruments: Recognition and Measurement (IAS 39), and which IFRS 9 will replace, are widely regarded to have inadequately reflected hedge accounting on financial statements.

“Accounting and hedging is a very broad and dynamic landscape, and current standard IAS 39 applies a rules-based approach rather than putting in place a principle which can apply to all scenarios,” said Blaik Wilson, solutions consultant at Reval and vice-chairman of its hedge accounting technical taskforce (HATT). Under IAS 39, it is very difficult for entities to fully reflect their risk management activities in their financial statements. Under this third phase of IFRS 9 (the first two phases having addressed the measurement and impairment of financial assets), firms will at last be able to far more accurately align accounting with risk management policies.

“What that means is that if you are hedging a particular risk in a portfolio and the hedge performs as you expected, the accounting will reflect those outcomes. In reality, that means you will experience less profit and loss (P&L) volatility through your income statement as a result of your hedging activities than you do currently under IAS 39,” said Wilson. “That may sound obvious, but it’s not necessarily the way it works at the moment.”

Since the global financial crisis, many firms have experienced increased P&L volatility on their cross-currency interest rate swaps. This is despite matching their hedges to the underlying exposures using any and all available hedge accounting techniques. Under IFRS 9, this inconsistency will be reduced. “The new rules should be welcomed by companies,” said Wilson. “If you have less P&L volatility over time, studies show that shareholders pay a stability premium.  So if the new hedge accounting guidance results in less P&L volatility, companies could see greater value for their shareholders.”  

Naturally this will come as big news to investors looking to better understand an entity’s risk management activities, but without having to resort to other sources. Investors typically find themselves having to look elsewhere for a company risk assessment right now, typically resorting to non-international financial reporting standard-based statements.

IFRS 9 and implications for CFOs

This latest regulation may be just one of around 40 accounting standards under IFRS alone, but the implications should not be underestimated.

CFOs should welcome the new standards, though they would need to conduct an impact analysis and ask themselves a number of questions. What will the impact be on their P&L volatility under the new rules? Since IFRS 9 considers derivatives to be hedged items, and presumably will result in more hedging scenarios qualifying for hedge accounting, under what circumstances will they be able to apply hedge accounting? Additionally, as accounting outcomes are set to be more certain and better reflect hedging strategies, should firms prepare to hedge more?

There is however a catch, in the form of the Financial Accounting Standards Board (FASB), the US equivalent of the global IASB. Despite having consulted extensively with each other since the global finance crisis with a view to eventually converging the two sets of accounting standards, as it stands IFRS 9 represents a divergence from both current and proposed US accounting standards.

“This is part of our concern. When two bodies have met on a regular basis since the global financial crisis to converge accounting standards, how can it be that they are issuing new accounting standards that are so different from each other?” asked Wilson. It should be noted, however, that FASB will monitor feedback on the new IFRS 9 exposure draft, and appears open-minded with regard to adopting its recommendations, he noted. In the meantime, however, converging the two sets of accounting rules will be that much tougher.

Nevertheless, corporations should view IFRS 9 as very much a positive development. “We’ve had five to 10 years operating under the old rules and I’ve see the frustration that corporations have experienced under the current rules, and some of the nonsensical results they create,” said Wilson. “In as much as we are going to see accounting aligned with risk management that can only be a good thing -- and the Big 4 accounting firms that I’ve spoken to feel the same way.”

¬ Haymarket Media Limited. All rights reserved.
Share our publication on social media
Share our publication on social media