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Deloitte is supportive of the International Accounting Standards Board (IASB) in the development of an approach to account for dynamic risk management activities; however, Deloitte does not support the Portfolio Revaluation Approach as stated in the discussion paper because it will (1) conflict with the accounting principles in the conceptual framework, (2) require risk management activities to be defined in order to determine what is in or out of the revaluation model, and (3) not build on the classification, measurement and general hedge accounting concepts already established in IFRS 9. In addition, Deloitte believes that a portfolio hedging solution should be examined for insurers and other non-financial entities.
Deloitte also believes that an approach that combines existing thinking in IFRS 9 with the ability to behaviouralise cash flows on a portfolio basis (including core deposits) and allowing bottom layers to be designated has the potential to be more relevant than the existing portfolio fair value hedge accounting model in IAS 39.
The EBA understands that the objective of the proposed Portfolio Revaluation Approach ‘PRA’ (as defined in the DP) needs to be further clarified. In fact, the two proposed approaches included in the DP have different objectives: to reflect the entity’s net open position with respect to a particular risk managed (the dynamic risk management approach) or to reflect the entity’s hedging activity for such a net position (the risk mitigation approach).
Between the two proposed approaches, the EBA sees greater merits in the risk mitigation approach as it seems to be more consistent with an entity’s risk management strategy. The EBA is concerned that the dynamic risk management approach does not reflect the actual hedging activities of an entity. This approach could lead to significant volatility in profit or loss resulting from the revaluation of dynamically managed portfolios (including the revaluation of credit intermediation activities) regardless of the extent to which these portfolios are hedged. This would also be inconsistent with the principles underlying IFRS 9.
However, the EBA believes that under the risk mitigation approach, there are certain challenges that need to be addressed. More specifically, the macro hedging model should include a) sufficient guidance and safeguards (including sound eligibility criteria and appropriate documentation of the bank’s risk management policies) to ensure robust and consistent application of the PRA, while ensuring the comparability and verifiability of the financial information and b) adequate disclosure requirements, to enable users of financial statements to understand a bank’s risk management activities and their impact on the financial statements.
The objective of risk management is to preserve future interest margins in an originate and hold to collect cash flow business model, as is correctly recognised under IFRS 9. However, under the current hedge accounting framework of IAS 39 and IFRS 9, achieving hedge accounting for open portfolios is difficult and some very important exposures are excluded from hedge accounting even though they are included in actual risk management. The EBF considers it a major step forward that the discussion paper considered the following items as hedgeable items:
The EBF proposes the following alternative approaches for the Board’s consideration to address the issues relating to hedge accounting for open portfolios under the current hedge accounting requirements of IAS 39:
In FEE's view, the proposed model once the conceptual and practical challenges are overcome, would likely provide a clear solution to the issues which caused the existing “EU carve out” to the IAS 39 requirements.
FEE believes that a model that focuses on the risk mitigation is an appropriate model to consider in the context of macro hedging.
FEE shares the concerns of the insurance industry that the macro hedging project should be aligned with the work that is done in the entire “financial sector” standards (and not only focusing on IFRS 9 and the banking sector).
Related link: IASB discusion paper