IFRS Newsletter: Financial Instruments, Issue 43, November 2017

14 Pages·2017·1.05 MB·English

Issue 43, November 2017
Financial instruments
IFRS Newsletter
“We support the
IASB’s plan to
The future of financial
explore a model
for dynamic risk
management along instruments accounting
the lines of cash fow
hT is edition o f IFRS Newsletter: Financial Instruments highlights
hedge accounting.” the IAs’BS discussions in oN vember 2017.
– hC ris pS all
KPMG’s global IFRS Highlights
fnancial instruments leader Dynamic risk management
hT e oB ard agreed that the accounting model of r dynamic ris k management RD( M )
should improve transparency, address the capacity issue and provide a simple and
reliable perof rmance metric hw ile ree� cting the u� id nature o f RD M.
hT e sta f f presented tow accounting approaches hw ere derivatives are used to align
the asset prol� e iw th the target prol� e and recommended the approach based on
cash o� w hedge mechanics.
hT e oB ard did not maek any decisions, but directed the sta f f to concentrate their
eof f rt on uf rther developing the model based on cash o� w hedge mechanics and
begin involving preparers and users o f n� ancial statements in their discussions at
an early stage. hT e netx steps ow uld be of r the sta f f to of rmulate a detailed proej ct
plan beof re the IA BS proceed to technical discussions.
Contents
Dynamic risk management 2
KPMG contacts 11
Acknowledgements 11
Keeping in touch 12
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Dynamic risk management
The story so far…
Although current IFR S – specic� ally, IA S 93 Financial Instruments: Recognition and
Measurement and IFR S 9 Financial Instruments – provides models of r macro hedge
accounting, these contain restrictions that limit companies ’ ability to ree� ct some
RD M activities. Moreover, some o f these models deal specic� ally iw th interest rate
ris k management, rather than other types o f ris.k Without an accounting model
that ree� cts the broader use o f RD M activities, some have asserted that it can be
dic�f ult to af ithuf lly represent these activities in n� ancial statements.
In April 201,4 the IA BS published its discussion paper DP/2014/1 Accounting for
Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging
t( he April 201 4 PD .) hT e April 201 4 PD outlined one possible approach to macro
hedge accounting – the portof lio revaluation approach P( RA ) – under hw ich
companies ’ managed epx osures ow uld be identie� d and revalued of r changes in
the managed ris.k As the proej ct involves uf ndamental accounting uq estions and
is not simply a modic� ation o f current hedge accounting models, the IA BS did not
proceed straight to issuing an epx osure dratf .)DE( uO r publication New on the
Horizon: Accounting for dynamic risk management activities provides a detailed
analysis o f the proposals.
Respondents to the April 201 4 PD broadly supported the macro hedging proej ct,
although several acnk olw edged that aligning n� ancial reporting and RD M activities
ow uld be challenging. eD spite this general support, many respondents ef lt that the
obej ctives ew re unclear, and dief f rent staek holder groups disagreed on hw at those
obej ctives should be.
hT e oB ard decided that the proej ct ow uld remain as a research proej ct, instead o f
being transef rred to the IAs’BS standards agenda, and that a second PD ow uld be
published beof re issuing an .DE Furthermore, the oB ard decided to ek ep open the
possibility o f moving directly to an DE i f a solution emerges that addresses the
disclosure, recognition and measurement issues. In March 2017, of lloiw ng uf rther
research carried out, the oB ard reopened its discussions on the proej ct iw th the
r� st o f a series o f education sessions.
Key points covered by education session
March 2017 � Proej ct approach, stages and netx steps.
� Indication by the sta f f that the of cus areas of r the proej ct
ow uld include RD M activities undertaek n to stabilise the net
interest margin IN( M ) and core deposit modelling.
May 2017 � hW y and ho w RD M activities are undertaek n to stabilise IN M.
� oH w derivatives are used to transof rm portof lios hw en
stabilising IN M.
� IN M reconciliations.
June 2017 � vE ents that result in changes to the RD M portof lio, including:
- ho w ne w originations impact managements’ target prol� e
of r the rep- ricing o f loan portof lios;
- ho w RD M reacts to changes in the RD M portof lio ; and
- inof rmation relevant to n� ancial reporting.
September � Prepayment ris k and aw ys to manage it.
2017
� eH dge accounting and capacity.
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Dynamic risk management
What’s the issue?
In oN vember 2017, the sta:f f
� epx lained the obej ctives o f the proposed accounting model of r RD M;
� identie� d tow approaches to the accounting of r af ir value changes o f derivatives
that are successuf l in aligning the asset prol� e iw th the target prol� e, based
on current accounting of r cash o� w hedges and af ir value hedges, and
recommended the approach based on cash o� w hedge mechanics ; and
� highlighted the ek y considerations reuq ired to develop the proposed model.
The model should Objectives of the proposed model
hT e obej ctives o f developing a ne w model are to improve inof rmation provided
improve transparency,
about ris k management and, more specic� ally, to af ithuf lly represent the impact
address the capacity
o f a bans’k RD M activities on its n� ancial statements.o T achieve this aim, the sta f f
issue, refect the believe that the model should of cus on the of lloiw ng areas.
fuid nature of DRM � Transparency: oC nveying ho w RD M actions iw ll aef f ct the bans’k economic
and provide a useful resources is relevant to economic decision maik ng. Financial statement users
understand that the dief f rence betew en cash ino� sw i( nterest income ) and cash
performance metric.
outo� sw i( nterest epx ense ) is a ek y value driver of r bansk but also recognise the
dief f rent rep- ricing sensitivities o f cash ino� sw and outo� sw .r T ansparency on
the bans’k approach to managing rep- ricing o f those cash o� sw iw ll help users
assess the ek y value driver and enhance comparability among its peer group and
over time.
� Capacity: Under current IFR,S an entity could only apply hedge accounting
i f certain criteria are met. nE tities that are uf nded by demand deposits could
not designate those deposits as hedged items because they are not epx osed
to variability in cash o� sw or changes in af ir value arising rf om marek t interest
rate changes. hT is results in bansk not having suc�f ient gross cash ino� sw and
outo� sw against hw ich derivatives may be designated. hT e proposed model
should address this capacity issue.
� Fluid nature: As ne w epx osures are originated and eix sting epx osures mature,
the composition o f a bans’k assets changes and RD M actions may be reuq ired
to stabilise net interest margin IN( M.) hT ese actions result in rf euq ent changes in
the designation o f hedging relationships – because current IFR S reuq ires onet- o-
one designation betew en eligible hedged items and hedging instruments – and
otf en reuq ire the amortisation o f the associated cash o� w or af ir value hedge
accounting aduj stments. hT e processes reuq ired are comple,x costly and prone
to error, and the proposed model should address these operational challenges.
� Performance measurement: uC rrent perof rmance measures provide
some inof rmation about eef f ctiveness, but they are designed to ree� ct the
perof rmance o f onet- oo- ne relationships and are coloured by the af ct that certain
instruments – e.g. demand deposits – are not eligible hedged items under
current IFR.S hT ereof re, the proposed model should provide a simple and reliable
perof rmance metric that shosw hw ether management succeed in transof rming
the asset prol� e as desired.
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KPMG insight
Capacity issue
In practice, many entities try to address the capacity issue using p‘ royx
hedges,’ hw ich do not eax ctly represent but are d‘ irectionally consistent ’ iw th
the actual ris k management approach. pxE anding the scope o f uq aliyf ing
hedged items ow uld allo w ris k management activities to be better ree� cted in
the n� ancial statements in such cases.
In uE rope, companies that of llo w the UE carveo- ut version o f IA S 93 may
already be treating demand deposits as hedged items in macro af ir value
hedge relationships and may aw nt to continue to do so.
Proposed approaches
The staff made the
Folloiw ng the oB ards’ decision in May 201,5 the sta f f have prioritised the RD M o f
case for a model
interest rate ris k in developing the outline o f the model. hT e proposed model also
based on cash fow
assumes that the entity uses derivatives RD( M derivative instruments ) to transof rm
hedge mechanics. its asset prol� e to its target prol� e. hT e sta f f have considered the of lloiw ng tow
accounting approaches, based on the alternatives of r designating an interest rate
hedging relationship under current IFR.S
� Cash fow hedge mechanics: of r the cash o� w variability arising rf om eligible
o� atingr- ate assets and liabilities that rep- rice based on marek t interest rates.
� Fair value hedge mechanics: of r eligible ex� dr- ate assets and liabilities.
hT e of lloiw ng terms used in the proposed RD M model are analogous to those in
the IFR S 9 hedge accounting model.
Proposed DRM model IFRS 9 hedge accounting
Asset profle – i.e. all eix sting n� ancial assets eH dged item
measured at amortised cost plus highly probable
of recast transactions e( .g. reinvestments o f
maturing assets that result in uf ture n� ancial
assets that iw ll also be measured at amortised
cost.)
Target profle – i.e. the desired prol� e o f Ris k management obej ctive
cash o� sw arising rf om the items above as
determined by management to stabilise IN M.
DRM derivative instrument eH dging instrument
Performance assessment ef fE ctiveness reuq irements
hT e tow approaches presented are summarised belo.w
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Approach 1: Cash fow hedge mechanics
I f the RD M derivative instruments are successuf l in aligning the asset prol� e iw th
the target prol� e, then changes in the af ir value o f the eef f ctive portion o f the RD M
derivative instruments ow uld be deef rred in other comprehensive income ICO( .)
hT e amount deef rred ow uld be reclassie� d to prot� or loss in the periods( ) during
hw ich the hedged cash o� sw arising rf om the asset prol� e aef f ct prot� or loss,
so that the interest income recognised in prot� or loss ow uld be aligned iw th the
target prol� e.
Advantages Challenges
� A model that leverages cash o� w � hW ile the sta f f recognised the
hedge mechanics has a strong rationale behind the l‘ oew r o ’ f
conceptual basis, considering test, they acnk olw edged that it
that RD M entails understanding ow uld pose a challenge to provide
and managing ho w and hw en a a complete picture o f perof rmance
change in marek t af ctors iw ll aef f ct and ow uld reuq ire uf rther
cash ino� sw i( nterest income ) consideration hw en determining
and outo� sw i( nterest epx ense.) the perof rmance obej ctive o f the
oC mment letters on the April 201 4 model.
PD also indicate that bansk usually
� hT e sta f f recognised tow concerns
manage interest rate ris k on a
about the balance recognised in
cash o� w basis rather than a af ir
ICO , namely hw at inof rmation it
value basis.
purports to represent and ho w it
� hT is model prevents the revaluation should be reclassie� d to prot� or
o f of recast transactions of r the loss. hT is is eax cerbated by the
hedged ris k rf om being recognised u� id nature o f RD M activities. hT e
in the statement o f n� ancial sta f f acnk olw edged that specic�
position. hT is is also the reason guidance ow uld be reuq ired in
of r having the l‘ oew r o ’ f test in this regard.
current IFR S – i.e. aduj sting the
cash o� w hedge reserve to the
loew r o f the cumulative gain or
loss on the hedging instrument or
the cumulative gain or loss on the
hedged item.
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Approach 2: Fair value hedge mechanics
Under a af ir value hedge model, the hedged item is remeasured of r af ir value
changes attributable to the hedged ris.k I f the hedge is uf lly eef f ctive, then these
changes are osf f et by af ir value changes o f the hedging instrument, resulting in no
net eef f ct on the statement o f prot� or loss and ICO .
Unliek a af ir value hedge, the obej ctive o f RD M is not to eliminate the af ir value
ris k rf om the asset prol� e but to transof rm the asset prol� e using RD M derivative
instruments in order to attain the af ir value ris k inherent in the target prol� e. In
other ow rds, the RD M derivative instruments are successuf l in aligning the asset
prol� e iw th the target prol� e i f the af ir value changes o f the asset prol� e A( ) plus
the af ir value changes o f the RD M derivative instruments )B( euq al the af ir value
changes o f the target prol� e .)C(
As in a af ir value hedge, an entity recognises in prot� or loss any af ir value changes
o f the asset prol� e A( ) as ew ll as any af ir value changes o f the RD M derivative
instruments .)B( o T af ithuf lly represent that RD M activities are successuf l, it also
recognises in prot� or loss an osf f etting amount that represents any changes in the
af ir value o f the target prol� e attributable to the hedged ris k ,)C( resulting in no net
eef f ct on prot� or loss i( .e. A + B – C = 0.) o T achieve this, the entity also recognises
the cumulative af ir value changes o f the asset prol� e )B( and the target prol� e )C( in
the statement o f n� ancial position and amortise them to prot� or loss in a manner
that aligns interest income iw th the target prol� e.
Advantages Challenges
� hT e entity ow uld eliminate any � hT e entity ow uld recognise changes
measurement mismatch rf om the in the af ir value o f the target prol� e
statement o f n� ancial position as attributable to the hedged ris k in
ew ll as the statement o f prot� or the statement o f n� ancial position,
loss and also not have volatility in even though it ow uld not meet the
ICO compared to Approach 1. den� ition o f an asset or a liability in
the oC nceptual Frameow r.k
� hT ere is a clear lin k betew en
perof rmance and the RD M � iS milarly, af ir value changes o f
obej ctive because any residual af ir any highly probable of recast
value ris k arising rf om misaligned transactions in the asset prol� e
asset and target prol� es ow uld be ow uld not meet the den� ition o f
automatically recognised in prot� an asset or a liability. It ow uld be
or loss. inappropriate to account of r a hedge
o f of recast transactions as a af ir
value hedge because the entity
ow uld recognise an asset or a
liability beof re it becomes a party to
the contract and treat transactions
in hw ich there is no af ir value
epx osure as i f there ew re one.
� As in Approach 1, i f a RD M
derivative instrument is settled to
maintain alignment, then the entity
ow uld have to establish ho w to
amortise the related cumulative
af ir value changes o f the asset and
target prol� es to prot� or loss.
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Staff recommendation
hT e sta f f supported Approach 1 because a model based on cash o� w hedge
mechanics ow uld better ree� ct the nature o f RD M activities – i.e. to transof rm the
asset prol� e such that the entitys’ cash ino� sw ow uld react to changes in marek t
af ctors based on the target prol� e. Furthermore, hw ile the sta f f acnk olw edged the
challenge to provide a complete picture o f perof rmance given the reuq irements
o f the l‘ oew r o ’ f test, it ow uld be conceptually uq estionable to recognise the af ir
value changes o f the target prol� e as ew ll as of recast transactions under the
alternative approach.
Board comments
In light o f the arguments set out by the sta,f f the oB ard preef rred Approach 1 – on
the basis that it ow uld be less comple x and easier to epx lain than the alternative
approach as ew ll as broadly consistent iw th the principles in IFR S 9 and the
oC nceptual Frameow r.k Accordingly, the oB ard directed the sta f f to develop an
accounting model by taik ng Approach 1 as a starting point, instead o f developing
tow competing models concurrently. Furthermore, the oB ard asek d the sta f f to
of cus their initial eof f rts on identiyf ing and taclk ing issues that are both dic�f ult to
address and uf ndamental to developing the model.
hT e oB ard noted that many preparers might be concerned about operational
compleix ties and unaw rranted volatility in ICO under Approach 1. hT e oB ard
thereof re suggested that the sta f f start involving preparers and users o f n� ancial
statements around the ow rld early to understand their epx ectations and concerns.
nO e oB ard member also suggested that the sta f f consider seeik ng comments
rf om prudential regulators as they develop the model.
The staff identifed Key considerations
hT e sta f f identie� d the of lloiw ng critical areas that need to be considered uf rther in
key areas that require
developing the proposed model.
further consideration.
Key considerations Board comments
Asset profle
� Defnition and eligibility criteria: Leveraging hT e oB ard agreed that the
eix sting concepts and den� itions in IFR S 9 iw ll s‘ cope ’ o f the asset prol� e
ensure consistency. ow uld reuq ire uf rther
consideration.
� Initial designation of eligible items.
� De-designation of items: For eax mple,
it may be appropriate to remove rf om the
asset prol� e assets that have become
crediti- mpaired – i.e. the eef f ct o f credit ris k
dominates changes in its af ir value – and
of recast transactions that are no longer highly
probable. Additional consideration is reuq ired
about ho w these ded- esignations interact
iw th perof rmance, recycling or amortisation o f
accumulated changes in af ir value.
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Key considerations Board comments
Target profle
� Defnition and eligibility criteria: oT eS veral oB ard members
determine an achievable target prol� e, entities ew re concerned that limiting
should consider uf nding characteristics – e.g. ho w a specic� entity ow uld
hw ether n� ancial liabilities are interestb- earing den� e its target prol� e – e.g.
and have a specic� repayment schedule, delineating RD M activities
hw ether demand deposits are rates- ensitive, by a threshold – might be
and the entitys’ approach and strategy arbitrary and might not
regarding deposits that are nons- ensitive iw th ree� ct the nature o f the
an inden� ite lief . entitys’ RD M activities.
� How the target profle is consistent with nO e oB ard member also
risk management: hT e target prol� e should noted that, hw ile current
not ree� ct trading strategies. hT e sta f f IFR S generally dealt iw th
iw ll consider restrictions that can ecx lude accounting of r individual
trading strategies rf om the target prol� e assets and liabilities, under
– e.g. establishing a relationship betew en the proposed model the
the siez s o f the asset and target prol� es, target prol� e – i.e. a desired
and setting a ceiling on the siez o f the RD M prol� e o f cash o� sw that is
derivative instruments. not an asset or a liability –
ow uld dictate ho w and hw en
� How performance is affected by changes in
amounts recognised in ICO
the target profle – e.g. as a result o f changes
ow uld be reclassie� d to prot�
in regulation.
or loss. hT e sta f f should uj stiyf
this deviation rf om eix sting
� Interaction between equity and the target
accounting principles.
profle hw ere bansk treat euq ity as a source
o f uf nding.
Performance assessment and disclosures
� When the asset and target profles are eS veral oB ard members
misaligned, what information should noted that the proposed
be portrayed through recognition and model assumed peref ct
measurement and what would be better alignment betew en the asset
captured by disclosure: As RD M activities and target prol� es, but did
are of cused on using RD M derivative not consider cases hw ere
instruments to align the asset prol� e iw th the RD M obej ctive is not to
the target prol� e, any event that results in uf lly align but to bring the
the target prol� e not being achieved should asset prol� e closer to the
in general be ree� cted in perof rmance. target prol� e. pS eciyf ing ho w
oS me events may reuq ire an aduj stment to measure perof rmance in
to prot� or loss hw ile others may trigger such cases – i.e. determining
specic� disclosures in addition to recognition the etx ent to hw ich the RD M
and measurement. obej ctive is achieved – ow uld
be critical.
hT e oB ard also believed that
bansk might be reluctant to
provide etx ensive disclosures
about the target prol� e
because they might contain
proprietary inof rmation.
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Key considerations Board comments
Criteria for designating a relationship
� Designation criteria that ensure consistent hT e oB ard agreed that uf rther
application and allo w entities to clearly identiyf consideration ow uld be
hw ich derivatives have been used of r RD M needed to determine hw at
and are thereof re subej ct to the proposed should be included in the
model, hw ich may include: of rmal documentation, given
that the relationships under
- the asset prol� e consisting o f eligible
the proposed model ow uld
items and the target prol� e meeting the
be designated on an open
uq aliyf ing criteria;
portof lio basis rather than
- f ormal designation and documentation o f onet- oo- ne.
the relationship and the RD M obej ctive and
strategy at inception o f the relationship ;
and
- the relationship meeting the perf ormance
assessment criteria.
� Whether applying the model is optional or
mandatory.
� When discontinuation is permitted
or required and how it interacts with
performance, recycling or amortisation.
The Board supported What did the IASB decide?
hT e oB ard did not maek any decisions, but directed the sta f f to concentrate their
a model based on
eof f rts on uf rther developing the model based on cash o� w hedge mechanics. hT e
cash fow hedge
sta f f should also begin involving preparers and users o f n� ancial statements in their
mechanics. discussions at an early stage.
Next steps
hT e sta f f iw ll present a detailed proej ct plan to the oB ard at a uf ture meeting to
enable it to proceed to technical discussions.
KPMG insight
Target profle
Under the proposed model, amounts recognised in ICO ow uld be reclassie� d
to prot� or loss in a manner that aligns interest income iw th the target
prol� e. In other ow rds, the interest income recognised in prot� or loss ow uld
be primarily based on the desired prol� e o f cash o� sw as determined by
management rf om time to time.
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eB cause the target prol� e is chosen by management, it may be important
of r an entity to provide disclosures not only to epx lain hw at the target prol� e
is but also to enable users to identiyf the ek y drivers o f any changes to the
target prol� e and the entitys’ ris k management strategies. hT e IA BS iw ll have
to consider ho w much disclosure is necessary to achieve the transparency
obej ctive o f the proposed model and hw ether there are commercial concerns
that ow uld be a uj stia� ble barrier to disclosing inof rmation about RD M.
Fair value changes in OCI and ineffectiveness
Although the proposed model ow uld lead to volatility in ICO , volatility in ICO
is already present of r entities that currently use p‘ royx hedges ’ by identiyf ing
alternative eligible hedged items – e.g. rep- ricing assets – to hw ich cash o� w
hedge accounting is applied.
A crucial decision in developing the model iw ll be to determine to hw at etx ent
af ir value changes o f the RD M derivative instruments should be deef rred in
ICO . Under current IFR,S of r cash o� w hedges ineef f ctiveness is recognised
in prot� or loss only hw en the cumulative af ir value changes o f the hedging
instrument ecx eed the cumulative changes in the present value o f the
epx ected cash o� sw rf om the hedged item attributable to the hedged ris.k
Applying this to the proposed model, i f the RD M derivative instruments bring
closer, but do not uf lly align, the asset prol� e to the target prol� e, then the
entity ow uld alaw ys recognise all af ir value changes o f the RD M derivative
instruments in ICO , regardless o f hw ether the RD M obej ctive has been
achieved. An alternative method to measure ineef f ctiveness might be to
represent ho w successuf l management are in meeting their RD M obej ctive.
Another issue concerns reclassiyf ing amounts recognised in ICO to prot�
or loss, hw ich iw ll be comple x because o f the continuous changes in RD M
relationships. For eax mple, ho w amounts in ICO should be reclassie� d to prot�
or loss hw en a RD M derivative instrument is no longer reuq ired of r alignment
and ho w changes in the target prol� e should aef f ct recycling iw ll need to
be addressed.
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