Financial Risk Management enabled by IFRS 9

Financial Risk Management enabled by IFRS 9

In November 2012, almost a year after releasing the long-awaited exposure draft (ED) on hedge accounting, the IASB (International Accounting Standards Board) issued a review draft (RD) of the standard on general hedge accounting.

The central theme of the proposed new hedge accounting standard is the emphasis on the required link between hedge accounting and an organization´s risk management strategy and objectives. The application of hedge accounting will be increasingly driven by the risk management policy, instead of the other way around. The interplay is especially important for the effectiveness testing and potential discontinuation of hedge relationships.  Even more so than under IAS 39, it will be important for corporates to clearly define their risk management strategy and objectives. Therefore, Zanders sees the introduction of the IFRS 9 standard as an excellent opportunity for corporates to revisit their financial risk management strategy and objectives.

Opportunities

Opportunities exist for both corporates that already apply hedge accounting today and those that do not yet apply hedge accounting. With the increased flexibility on qualifying hedged items and hedging instruments, many entities will be better able to reflect economic risk management objectives in their hedge accounting. IFRS 9 can become an important driver for changes in risk management. The new standard will make it possible to identify and designate specific risk components of non-financial items as hedged items. Many commercial agreements are essentially variable price contracts with indexation based on market observable prices or rates, i.e. crude oil, metals, inflation, interest, etc. To the extent that these ‘risk components’ are ‘separately identifiable and reliably measurable’, they potentially qualify as hedged items. This will accommodate hedge accounting for many corporates exposed to commodity price risks. Other changes potentially impacting the risk management strategy and objectives include improvements to apply hedge accounting for hedging strategies involving options and the possibility to include derivatives in a hedge relationship in combination with a non-financial exposure.

Zanders expects these changes to drive corporate (commodity) hedging activity in the years after introduction of IFRS 9. For corporate treasury this once again offers an opportunity to emphasize its position as the strategic business partner for risk management. Corporate treasury should take a leading role in the identification and measurement of risk components in non-financial items. Furthermore, corporate treasury, together with the business, should formulate risk management policies and procedures while ensuring alignment with hedge accounting to avoid undesired P&L volatility. Those corporates that have not applied hedge accounting so far because they considered the implementation too complex or operationally challenging should reconsider. Hedge accounting will certainly become simpler to implement and operate, especially with regards to effectiveness testing and the ‘maintenance’ of the hedge relationship over its life cycle.

Conclusion

The new hedge accounting rules are expected to represent an entity’s risk management activities more closely. The introduction of IFRS 9 is an excellent motivation for corporates to ‘dust off’ and review old risk management policies and seek the required alignment between risk management and the application of hedge accounting. However, the implementation of IFRS 9 will not be without its challenges. Zanders stands ready to assist its clients with risk identification and advanced risk management techniques to help corporates preparing for the transition to IFRS 9. The new standard is expected to be mandatory as of 1 January 2015, but earlier application is permitted.

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