by François Masquelier, Head of Corporate Finance and Treasury, RTL Group, and Honorary Chairman, ATEL
This article describes the main key proposals made by the IASB in London for financial instruments hedge accounting. Is this third and last act of IAS 39 revamping a revolution or a simple reform of existing principles? Hedge accounting has always been a controversial topic. Are these new proposed measures acceptable for corporate treasurers? Sometimes, adjustments could be better than a complete reform of basic rules. The convergence with US GAAP should remain a critical issue for IASB in coming months.
Third and final part of IFRS 9
The corporate treasurers in Europe were impatiently waiting for the third part of IFRS 9 (www.iasb.org). Eventually, this lengthy tripartite process of IFRS 9 was as long as an elephant’s gestation. The IASB based in London has recently issued a third Exposure Draft (ED – released on 9 December 2010 for comments by 9 March 2011) on proposals to replace the hedge accounting requirements previously defined in the famous and controversial IAS 39 Financial Instruments Recognition & Measurement. Unquestionably no single treasurer could dare to pretend that IAS 39 is/was not highly complex and inaccurate on different items. It has long been an area of difficulties for both preparers (companies applying IFRS/IAS standards) and users (investors using these financial reports under IAS/IFRS). After G20 in London, IASB wanted more than ever to improve the information available for investors. This explains why it decided to revisit IAS 39 in depth. However, after this third part of the IFRS 9 Exposure Draft trilogy, it is doubtful whether the initial goal of completely revamping IAS 39 has been achieved. We could consider that IASB has proposed an interim consensual solution with amendments on existing rules, more than a comprehensive reform of financial instruments (hedge) accounting model.
In short, hedge accounting rules concern the reporting of derivative instruments used by a company to hedge its exposures to financial risks which could potentially affect its business. The general treatment of such derivative products is to measure it at fair value with changes being reported to gains and losses in the income statement,unless the hedge accounting exception applies. This exception is needed to faithfully represent the activity of a company which intends to protect and hedge a defined exposure. IASB has always considered the cost basis for derivatives would be inappropriate for measuring their (current) value.
Struggle to understand IAS 39 reporting
The criticisms of IAS 39 are related to its too prescriptive approach of what can and cannot qualify for hedge accounting.
For users,hedging and hedge accounting activities have always been an area of business in which they often struggle to understand what is going on and how to interpret a company’s financial risk strategy. These rules have frustrated many preparers too, as the requirements have not been linked with common risk management practices. Hedge accounting has often been impossible or very costly, even when hedging was economically rational as risk management strategy.It has not been helped by the restrictions by which IAS 39 arguably limited the practical ability of companies to report their risk management activities faithfully.These exceptions and restrictions explain why some companies have refused to apply hedge accounting, while providing users with supplementary non-IFRS disclosures (unaudited) to explain their hedging approaches and strategies. It results in confusion and a lack of the comparability which is essential for investors, both accounting boards and even G20 members.
Some complainers also claimed that the use of different methods of hedge accounting created additional confusion. It is true and fair to say that accounting rules often created artificial restrictions which may negatively affect the way a business was managed. The criticisms of IAS 39 are also related to its too prescriptive approach of what can and cannot qualify for hedge accounting, the distinction between cash flow hedge and fair value hedge and eventually the disclosures to users which are insufficient for understanding the risk management strategy of the company.The major idea of the IASB was to adopt a principle-based approach for aligning hedge accounting measures more closely to financial and non-financial risk exposures. IFRS 9 also proposes an enhanced presentation and new disclosure requirements for improving transparency (that at least is what IASB firmly believes).