Hedge accounting, as a balance sheet option, offers the possibility of also reporting economic hedging strategies on the balance sheet. This can significantly reduce distortions on the income statement or in equity resulting from different valuation approaches (accounting mismatches), e.g. between continuing acquisition costs, recognized hedges and hedging instruments recognized at fair value. In order to stabilize earnings/equity on the balance sheet, underlying transactions and hedges are combined to form hedging relationships in accordance with IAS 39, IFRS 9 or US GAAP or to form valuation units in accordance with the Commercial Code (HGB) or the Accounting Law Modernization Act (BilMoG) and the compensating changes in value are reported accordingly. However, the exercising of the option is accompanied by numerous requirements for documentation, valuation, accounting, disclosure in the Notes to the Financial Statements, systems and processes and, last but not least, internal reporting.
Defining a Hedge Accounting Strategy
In order to achieve the desired long-term effects, a first essential step is to define the company- and transaction-specific objectives of hedge accounting as part of a hedging strategy. The next step is to examine how this strategy can be implemented in terms of content and what tools should be used. In addition, it should be determined how the achievement of the goal will be measured in relation to the definition of the goal. For this purpose, a reconciliation between the economic and balance sheet results should be regularly integrated into the hedge process, so the systematic differences will be determined and provide the basis for ongoing analysis and optimization. Various issues are relevant to the design of a customized hedge accounting approach:
- Relevant accounting guidance: IAS 39, IFRS 9, US GAAP, German Commercial Code (HGB) or German Accounting Law Modernization Act (BilMoG)
- Types of risk: Interest rate risks, currency risks, interest-currency risks, commodity risks
- Type of risk protection: fair value hedge, cash flow hedge, hedge of a net investment
- Composition of hedging relationships: micro, macro, portfolio hedge
Evaluation and Effectiveness Testing – External Reporting and Internal Reporting
For the effectiveness test, in particular, as well as for the determination, separation and reporting of individual results in external and internal reporting, it is necessary to clarify methodological issues, which, depending on the relevant accounting guidance, may be critical to the sustainable achievement of goals. Typical focal points include:
- Effectiveness measurement: critical terms match, sensitivity analysis, regression analysis, VaR comparison, dollar offset methods, variance reduction method, etc.
- Valuation, e.g. with regard to the use of a multi-curve setup (multi-curve)
- Value metrics and valuation components: hedge fair value, hedge amortized cost, pull-to-par effects, amortization amounts, etc.
- Preparation of quantitative and qualitative disclosures in the Notes to the Financial Statements
- Reconciliation between balance sheet and economic result
- Harmonization of economic controlling and balance sheet reporting
Accounting in Accordance with IFRS 9
The special option granted by the IASB in IFRS 9 to retain the provisions of IAS 39 until the publication of a new macro hedge accounting approach means that some new issues arise, such as how the IAS 39 approach can be brought into line with the new accounting and disclosure requirements of IFRS 9. The transition to an IFRS 9 hedge accounting approach is also challenging due to the large number of open questions and unclear definitions, but also offers new, additional possibilities. Typical focal points are as follows:
- Special option to retain IAS 39 rules for hedge accounting
- Analysis, design and adaptation of existing hedge accounting solutions to the requirements of IFRS 9
- Introduction of Hedge Accounting Approaches in Accordance with IFRS 9
- Design of the balance sheet reporting and development of appropriate booking concepts
- Harmonization of Commercial Code (HGB) and IFRS Reporting
System Selection and System Introduction for Hedge Accounting
The extensive bandwidth and complex technical and methodological challenges in particular result in some very special requirements for customized system implementation. Against this backdrop, it is advisable to pursue an intensive analysis and transparent comparison of the performance spectrum of the various system solutions in advance in order to ensure an efficient and sufficiently flexible reporting of the hedge strategy pursued. Typical issues include:
- Requirement analysis, technical design and testing of the required software solution
- Analysis, design and adaptation of the specialist architecture, processing methods and reporting
FAS AG as an Experienced Partner for your Hedge Accounting Issues
FAS AG has many years of experience as a specialist consultant for overall bank management in numerous projects relating to the subject of hedge accounting in accordance with IFRS, the Commercial Code (HGB) or US GAAP. From the technical design and software selection to the system-technical implementation, we attach great importance to the systematic employment of solutions that correspond to the respective requirements.
If you are interested or have any questions, please contact us.