Hedge Accounting Documentation under IFRS 9

What is the issue?

Under IFRS 9, similar to IAS 39, a hedge relationship only qualifies for hedge accounting if certain criteria are met, one of which is the formal designation and documentation of the hedge relationship at inception. IFRS 9 introduces certain changes to the documentation requirements, and additional considerations also arise from the differences between the IFRS 9 and IAS 39 hedge accounting models.

Which entities are affected?

As explained in the December 2017 edition of Business Edge, entities have a hedge accounting policy choice on transition to IFRS 9: continue to apply the hedge accounting requirements of IAS 39 or choose to apply the new IFRS 9 requirements. Only those entities that have chosen to apply IFRS 9 will be affected by changes to the documentation requirements. This applies equally to new and existing hedge relationships previously designated under IAS 39. Entities choosing not to apply IFRS 9 are required to continue applying the requirements of IAS 39 until such time as they apply IFRS 9 in a subsequent reporting period.

What has changed?

IFRS 9 Documentation Requirements	Comparison to IAS 39
Risk management strategy and objective	Same requirement but more significant under IFRS 9
Hedging instrument, hedged item, nature of the risk being hedged	Same requirement but more items eligible for hedge accounting
How the hedge effectiveness criteria are met (including analysing sources of hedge ineffectiveness and how the hedge ratio is determined)	Different hedge effectiveness criteria Additional requirements

The entity’s risk management strategy and risk management objective

While this was also a requirement under IAS 39, an entity’s risk management strategy and objectives are more significant under IFRS 9 because the aim of the new hedge accounting model is to reflect actual risk management activities. The standard distinguishes between:

The risk management strategy which is set at a high level and can involve several different hedging relationships
The risk management objective which reflects how that strategy is executed and is applied to a specific hedging relationship.

For example, an entity could have a risk management strategy to fix the interest rate on 40% of its debt and may execute this through a number of different hedge relationships. Each of those relationships will have their own risk management objective (eg to hedge a specific floating rate debt with a specific receive-floating pay-fixed interest rate swap).

Under IFRS 9, the risk management objective is important because discontinuation of the hedge relationship is required if the objective changes, but discontinuation is not permitted if the objective remains the same. This contrasts with IAS 39 which permitted voluntary discontinuation. Therefore, entities should ensure that their hedge accounting policies reflect their actual risk management activities.

The hedging instrument, the hedged item and the nature of the risk being hedged

The only additional consideration under IFRS 9 is that more items may qualify as eligible hedging instruments and eligible hedged items (see December 2017 edition of Business Edge).

How the hedge effectiveness criteria are met; including sources of hedge ineffectiveness and how hedge ratio is determined

While the requirement to assess whether a hedge relationship is effective is consistent with IAS 39, the hedge effectiveness criteria have been significantly changed under IFRS 9. Most notably, the 80%-125% effectiveness thresholds that were required both prospectively and retrospectively under IAS 39 have been removed (see May 2017 edition of Business Edge). Under IFRS 9, entities will need to assess whether the hedge relationship is effective based on the following three criteria, both at inception and prospectively:

Effectiveness Criteria	Explanation
Economic relationship exists	The values of the hedging instrument and hedged item are expected to move in the opposite directions
Credit risk does not dominate value changes	The values of the hedging instrument and/or the hedged item must not be dominated by credit risk rather than the hedged risk
Designated hedge ratio is consistent with risk management strategy	The designated hedge ratio is the relationship between the quantities of the hedging instrument and hedged item and should be consistent actual hedge ratio used for risk management purposes

IFRS 9 also requires that the hedge documentation should include:

An analysis of the sources of ineffectiveness, eg due to a mismatch in critical terms or due to credit risk
How the hedge ratio was determined, eg if an entity hedges 100% of a fixed rate debt of £10m with a receive-floating pay-fixed interest rate swap with a notional amount of £10m, the hedge ratio will be 100%.

Finally, hedge documentation may need to be updated during the life of the hedge relationship under IFRS 9. This could occur in cases where the hedge ratio is rebalanced (see May 2017 edition of Business Edge) or where the sources of ineffectiveness need to be updated.

Next steps

Entities should take the time to review and update their hedge accounting documentation for both new and existing hedge relationships to ensure that they reflect their actual risk management activities and meet the requirements of IFRS 9.

For help and advice on IFRS 9 please get in touch with your usual BDO contact or Dan Taylor.