21 April 2014

IASB/Cooper: Dynamic risk management - Accounting in an age of complexity

IFRS provides disclosures and comparability in recognition and measurement with the aim of helping investors better understand entities’ financial statements. Entities may also choose to provide supplementary information for especially complex transactions or exposures. Nevertheless, in some areas of reporting, even the best of intentions can leave investors struggling.

One of these is risk management—particularly, dynamic risk management. Many entities are exposed to market price movements that affect their profitability. For example, a bank’s net interest income is often the most significant contributor to profitability. However, net interest income is exposed to changes in interest rates. How well a bank manages this risk affects its profitability. Managing these risks on a continuous and dynamic basis is one of the key elements of financial risk management.

Dynamic management of interest rate risk is therefore a critical component of a bank’s ongoing risk management activities. Understanding that financial reporting needs to provide more clarity about these types of activities, the IASB has just published the Discussion Paper "Accounting for Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging" (the 'DP').

The DP explores the accounting aspects of dynamic risk management and discusses preliminary views on a new accounting approach that may improve financial reporting in this area. The particular focus of the DP is the management of interest rate risk by banks; however, it also applies to other dynamic risk management activities in other industries (for example, commodity price risk).

Developing a new approach does not mean that current accounting practices are necessarily failing investors. IFRS already includes a general hedge accounting model, which provides for the fair value and cash flow hedge accounting with which most investors will be familiar. The model has recently been improved through the new financial instruments Standard IFRS 9 Financial Instruments (IFRS 9). However, even the general hedge accounting approach has limitations in which risk management practices are more complex and the risks being hedged are more dynamic.

Full perspective

IFRS- Discussion Paper

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