Tax, Accounting & Legal

Get Ahead of the Game... Hedge Accounting is About to Get Easier The EU endorsement process for IFRS 9 was escalated and endorsement is expected in the second half of 2015. If this proceeds as expected, the earliest date of early adoption could be 1 January 2016 or even earlier.

Get Ahead of the Game... Hedge Accounting is About to Get Easier

Olga Cileckovaby Olga Cileckova, Director in the Corporate Treasury and Commodity team at PwC in London

The new hedge accounting rules – IFRS 9 – are highly welcome to the majority of corporate treasurers. They were finalised in 2013 with an effective date in 2018 and early adoption was allowed and exercised by some non-EU entities. However, early adoption was not open to EU entities as the standard was not endorsed by the EU; and the timeline for EU endorsement was unclear.

The great – and hot off the press - news is that the EU endorsement process was escalated and endorsement is expected in the second half of 2015. If this proceeds as expected, the earliest date of early adoption could be 1 January 2016 or even earlier. In any case, it’s very likely that entities will be allowed to early adopt IFRS 9 earlier than 2018 – as originally expected - and they should kick off the transition project now.

Should your entity early adopt IFRS 9?

The new rules are both easier to apply and more aligned with risk management. The accounting should no longer drive the economics.

Our experience with early adopters – mostly from Australia and Hong Kong - shows that entities with the following hedging strategies were mostly those who opted for early adoption:

  • Hedging of commodity exposures (such as hedging the aluminium price risk in an aluminium purchase contract) and other components of non-financial items (such as hedging the RPI component of RPI linked revenues)
  • Hedging with options
  • Hedging with currency forwards where the timing of the future cash flows is uncertain
  • Hedging of dynamic debt portfolio, such as overlaying – half way through its life - an existing synthetic sterling debt (e.g., euro debt swapped into sterling) with an interest rate swap
  • Entities struggling with hedge ineffectiveness on currency risk hedges of debt

What should you do now?

  • Lobby EFRAG (the European Financial Reporting Advisory group, which is tasked with providing an opinion to the European Committee as part of the endorsement process) to ensure the promised timetable is adhered to. Unfortunately, it is not uncommon for the EFRAG timetable to be subsequently revised, in particular if the standard is complex and there are conflicting views on the market. Currently, there are two main groups closely engaged in the endorsement process: the banks – who are in favour of the early endorsement – and the insurers – who are less so.
  • Assess whether early adoption would be beneficial to your entity
  • Do not underestimate the complexity and time demands of the transition project:

+ IFRS 9, if adopted early, must be adopted in its entirety. Although its other two parts – classification & measurement and impairment – are not expected to have significant impact on most corporates, they need to be covered within the transition
+ Changes to risk management policies might be needed to ensure they are a best fit for your entity and allow for the new hedging strategies and instruments
+ The new rules will require changes to systems, processes and training  
+ Changes to some executory contracts might be needed to ensure that, say,  the RPI element of -the RPI linked revenue is clearly identifiable and measurable; and
+ All hedge documentation must be updated

  • Understand impact on tax and distributable reserves
  • Make sure your treasury team plays a key role in the transition project. Although accountings change, the underlying IFRS 9 principle is for the accounting to reflect the economics and the risk management policies. As such, a close alignment of the treasury and accounting functions will be critical. If this is not the case, you might end up with undesired income statement volatility, with a risk of tax cash consequences and a negative impact on distributable reserves and key financial ratios.

Overall, IFRS 9 is good news and a move in the right direction. The long wait – the drafting of IFRS 9 was started in 2008 - should indeed  be worth it. However, the transition project is a more complex and time-demanding exercise than one might expect. As one of my clients said “There is more to it (the transition project) than I originally thought … but it pays off”.

Start with the transition now. Ask a treasury accounting expert to ensure you properly understand all angles in this complex jigsaw. Get ahead of the game.

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