Overall, EFRAG agrees with the direction of the proposals in the ED. In particular, EFRAG agrees with the direction of the proposed objective to reflect, in the financial reporting, the extent and effects of an entity’s risk management activities. EFRAG believes that this approach has the benefit of being consistent with the role of the business model in the classification of financial instruments. In EFRAG’s view, the hedge accounting model proposed in the ED provides a number of significant improvements that will make hedge accounting more accessible, including the following:

• The proposals remove a number of the restrictions to hedge accounting in IAS 39 Financial Instruments: Recognition and Measurement. In EFRAG’s view, there are important improvements such as the removal of the 80 to 125 per cent bright line for assessing and measuring hedge effectiveness, the possibility of designating derivatives, risk components and net positions as hedged items, and the possibility of applying hedge accounting to components of non-financial items.

• The proposals introduce the notion of ‘rebalancing’ hedging relationships and should enable an entity to reflect changes that occur in the hedge ratio without discontinuing and restarting the hedge relationship.

• The proposed hedging model requires the application of more judgement than IAS 39.  Therefore EFRAG believes that the disclosure objectives are appropriate, but has certain concerns about their prescriptive nature.

The most significant areas of concern are as follows:

EFRAG believes that entities may have valid risk management activities in place that might not be represented under the proposed hedge accounting model, either because the economic hedging relationship does not meet the qualifying criteria for the application of hedge accounting, or because the strategy is neither strictly a fair value hedge nor a cash flow hedge.

A number of issues that could create an inconsistency with risk management practices, and which require further consideration, are the eligibility of instruments at amortised cost as hedging instruments, non-contractually specified inflation risk as a hedged item, credit risk as a risk component, hedging of risks not affecting profit or loss and a benchmark component in hedging a debt instrument with a negative indexation to the benchmark (the sub-LIBOR issue).

The proposals introduce new concepts and definitions that are not well understood by constituents, which create considerable uncertainty around the operationality of the new model.  To address these concerns, the IASB should consider clarifying the drafting of the key concepts, making the redrafted proposals publicly available to constituents for comments, and testing the operationality of the proposals in practice.

Given the importance of macro hedging, EFRAG believes that the IASB should not finalise a standard on the general hedge accounting model before developing a model for macro hedging.

EFRAG believes that the IASB will need to consider the various phases of the IAS 39 replacement as a whole before finalising the resulting standards.

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