Comments from ACCA to the International Accounting Standards Board (IASB)
17 October 2014
We are generally supportive of the proposed approach in the Discussion Paper (DP). Closer alignment of hedge accounting with the risk management is desirable in terms of macro-hedging as it has been for the general hedging model in IFRS9. However this approach will give significant flexibility to the management of the entity and it remains important that speculative positions need to be distinguished from risk mitigation.
Q1. Need for an accounting approach for dynamic risk management (DRM).
We agree there is a need. The current hedging model does not correspond well to the risk management approach of many banks. It is important that accounting tries to represent the economic substance of transactions.
The issue has created a particular problem in Europe leading to the ‘carve out’ from IAS39 that is currently needed for a restricted number of banks. A new macro-hedging model should hopefully remove the need for this.
Q2. Current difficulties in representing DRM in entities’ financial statements
We agree that the main issues have been identified and that the Portfolio Revaluation Approach (PRA) proposed would generally address those.
Q3. Description of DRM
We agree that the description of DRM seems right.
Q4. Pipeline transactions, EMB and behaviouralisation
(a) Pipeline transactions
Arguably including pipeline transactions would revalue items that do not otherwise exist in accounting terms. We accept the constructive obligation analogy to an extent, though we think this may be less applicable when dealing with contracts not yet entered into. From a practical point of view pipeline transactions are used in DRM and that is an argument for including them.
Overall we think the managed portfolio can include pipeline transactions, subject to their being clearly defined, better distinguished from forecast ones and the net presentation adopted (see Q18).
(b) Equity model book (EMB)
We consider an EMB should not be included. Treating equity as debt for these purposes arguably departs from the definitions used elsewhere in the balance sheet and which derive from the conceptual framework.
(c) Behaviouralisation
Yes we support the portfolio incorporating behaviouralisation. The economic substance of the situation is that a proportion of core demand deposits will be a source of longer term finance and that prepayments of loans by customers will probably be restricted to levels that are capable of being estimated.
Q5. Prepayment risk
The effects of risk management activities through options should in principle be allowed in the accounting model.
Q6. Recognition of changes in customer behaviour
As with other changes in estimates these should be recognised in profit for the period when the change becomes evident.
Q7. Bottom layers and proportions of managed exposures
It is desirable for the hedge accounting to follow as closely as possible the risk management. So if in a particular entity the DRM is based on either of these approaches the PRA should reflect this. However this model is to deal with open portfolios and net positions, so the allocation implied in layers or proportions is going against that and should not be required.
Q8. Risk limits
In our view risk limits should not be reflected in the PRA.
Q9. Core demand deposits
(a) Core demand deposits should be included in the managed portfolio on a behaviouralised basis, if that reflects the entity’s DRM approach. See also our answer to Q4(c) above.
(b) Guidance will be needed on determining the basis of behaviouralisation. This is judgemental and behaviour can be expected to vary according to different prevailing interest rate and stages in the economic cycle.
Q10. Sub-benchmark rate managed risk instruments
(a) We support Approach 3 as this looks to be the most practical approach.
(b) The PRA needs to reflect only those elements which are managed and so features that are not in the DRM may be excluded.
Q11. Revaluation of the managed exposures
(a) The revaluation approach set out looks reasonable.
(b) the funding rate seems the right one when the DRM objective is managing the interest income against the funding
Q12. Transfer pricing transactions
(a) Transfer pricing transactions is likely to be a suitable basis for the revaluation as this is a well-established and documented activity.
(b) The market funding index looks to be the most appropriate
(c) There are concerns about using an entity’s internal rates in the revaluation of the portfolio. Firstly because ALMs are sometimes operated as a profit centre, the internal rates may reflect other objectives such as liquidity factors and not be good proxies for market rates. Secondly the use of internal rates inevitably raises issues about the comparability with other banks. We would like to see the rates used for revaluation to be firmly related to market rates (including benchmark rates with fixed margins) so this is in line with the fair value principles of IFRS.
Q13. Selection of funding index
The PRA model applied should be allowed as far as possible to reflect the risk management of the entity. The selection of the funding index or indices should incorporate that.
Q14. Pricing index
See our concerns above in response to Q12.
Q15. Scope of application of PRA
We support the identification and mitigation approach. Financial statements are in part to reflect management’s accountability (stewardship) then arguably the mitigation requirement should be included when determining the scope of PRA. We accept that this could however leave the hedge accounting more
· open to manipulation
· operationally complex
Q16. Mandatory or optional application of the PRA
The application of the PRA should be optional. Making it mandatory would increase definitional problems especially with a mitigation scope requirement (see Q15). Macro-hedging by remaining optional would stay in line with the general hedge accounting model of IFRS9.
Q18. Presentation alternatives
(a) Statement of financial position
We prefer the single net line item. This seems to reflect better the net position nature of DRM. Also the PRA raises some conceptual difficulties in recognising items which may not meet the framework definitions of assets or liabilities and may incorporate some items on measurement bases that are also not fully in line with the framework. A single net line item would be the most suitable for including such items.
(b) Statement of comprehensive income
The actual net interest income presentation seems preferable as this achieves most transparency about the effect of DRM.
Q19. Presentation of internal derivatives
Though their effect will most often be eliminated on consolidation, we are not convinced that internal derivatives should be reflected in financial statements. In our view effective hedging must involve externalising risk in order for it to be mitigated. Internal derivatives may offer unnecessary scope for the manipulation of the results by management.
Q20. Disclosures
The four identified themes seem a reasonable approach.
Q21. Scope of disclosures
The disclosures should be on the same scope basis as the PRA – i.e risk identification and mitigation (see Q15).
Q22. Date of inclusion of exposures in a managed portfolio
Given the open portfolio concept it would seem unreasonable to insist that inclusion or otherwise in the portfolio must be determined on the date of first recognition of the instrument.
Q23. Removal of exposures
Likewise with removal of exposures from portfolios should be allowed in line with the risk management approach. The effect of any such removal should be in profit or loss.
Q24. DRM of foreign currency instruments
It should be possible in principle to do so.
Q25. Application of PRA to other risks
We do note significant differences in the application to interest rate risks and other risks. The IASB should proceed for now with the established need in relation to interest rates.
Q26. PRA through OCI
This approach should be considered further by IASB as part of its general approach to the distinction between items of profit or loss from OCI.
We are not sure however that the resulting complexity of a division of an item between profit and loss and other comprehensive income is going to be very helpful to users unless there is a clear principle to distinguish them.
Also we view PRA as most akin to fair value hedging under the general hedging model and so would not expect the accounting to be very different.