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Dynamic Risk Management

Description

Background

The International Accounting Standards Board is working on a project to simplify and improve the usefulness of financial statements, by developing accounting requirements for hedging within the context of open portfolios that are more closely aligned with a company's risk management activities. The project addresses situations in which entities use a dynamic risk management strategy to manage their risks where the IFRS 9 hedge accounting guidance for individual items or closed portfolios is insufficient.

IASB Discussion Paper

On 17 April 2014, the IASB published its Discussion Paper, Accounting for Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging. Under this approach the risk-managed exposures would be revalued with respect to the managed risk (e.g. three month LIBOR) and the resulting revaluation adjustment would be recognised in the statement of financial position and the income statement. The revaluation adjustment and the fair value of the risk management instruments offset each other to the extent that the hedge is effective. Open risk positions would thus have a net impact on profit or loss, depending on the scope of the proposals.

EFRAG final comment letter

EFRAG issued its final comment letter on 30 October 2014. In that letter EFRAG highlighted the needs of different industries for a macro hedge accounting solution.

EFRAG rejected the alternatives proposed by the DP as remeasuring all portfolios that are dynamically managed was not considered decision-useful. In addition, such a solution would result in overriding the amortised cost measurement attribute. EFRAG asked the IASB to develop a hedge accounting solution with the aim of addressing the accounting mismatch between fair valued hedging derivatives and hedged items at amortised cost. In addition, macro hedging should remain consistent with IFRS 9.  Further a cash flow hedge model was advised to consider as banks manage their interest rate risk on a cash flow basis, not on a fair value basis. Finally, EFRAG noted an impact assessment is needed during further development of the approach.

Dynamic risk management - core model

EFRAG in co-operation with the IASB conducted outreach on the practical implications of the IASB's core model during Q4 2020 and Q1 2021. In Q2 2021 both organisations provided feedback on the outreach.

A summary of the high level-comments:  

  1. The core model would allow to represent risk management activities more faithfully than the current IAS 39 as issued, specifically for the direction taken on the designation of a net position and the expansion of eligible items (specifically core demand deposits).
  2. The use of a cash flow hedging mechanism (i.e., changes of FV of the hedging derivatives recognised in OCI) is causing concerns around IFRS equity volatility and specifically in CET1.
  3. The core model operates on the idea of a single desired outcome for risk management purposes, but banks operate within accepted risk ranges or limits.
  4. Many European participants referred to the key benefit of the carve-out, i.e., the introduction of a bottom layer and concerns around ineffectiveness. These are not part of the current core model.
  5. The transition requirements to be applied (not yet considered at this stage of the project) will have a key role in shaping the profit or loss profile going forward.

The IASB will discuss the feedback received and the Staff's proposals for changes to the core model up to Q1 2022 and will decide on the project direction after that.

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