Discontinuation of hedge accounting
Only prospective discontinuation
Discontinuation of hedge accounting applies prospectively from the date on which the qualifying criteria are no longer met.
An entity shall not de-designate and thereby discontinue a hedging relationship that:
- still meets the risk management objective on the basis of which it qualified for hedge accounting (ie, the entity still pursues that risk management objective); and
- continues to meet all other qualifying criteria (after taking into account any rebalancing of the hedging relationship, if applicable).
The distinction between the entity’s risk management strategy and the risk management objectives is already discussed earlier. To recapitulate, the risk management strategy is established at the highest level at which an entity determines how it manages its risk as against the risk management objective which is applied at the level of a particular hedging relationship. Where a risk management objective changes in order to comply with the overall risk management strategy, the hedging relationship executed with a view to implement the risk management objective may have to be discontinued either fully or partially.
For example, an entity has a strategy of managing its interest rate exposure on debt funding that sets ranges for the overall entity for the mix between variable rate and fixed-rate funding. The strategy is to maintain between 20% and 40% of the debt at fixed rates. The entity decides from time to time how to execute this strategy (ie, where it positions itself within the 20% to 40% range for fixed-rate interest exposure) depending on the level of interest rates. If interest rates are low the entity fixes the interest for more debt than when interest rates are high.
In the above example, whenever the risk management objective undergoes a change to take advantage of the low interest rates, hedge accounting will be discontinued to that extent of change. However, the risk management strategy itself remains unaltered here.
Another example is where some exposures result from positions that frequently change, say, the interest rate risk of an open portfolio of debt instruments. The addition of new debt instruments and the derecognition of debt instruments continuously change that exposure (ie, it is different from simply running off a position that matures). This is a dynamic process in which both the exposure and the hedging instruments used to manage it do not remain the same for long. Consequently, an entity with such an exposure frequently adjusts the hedging instruments used to manage the interest rate risk as the exposure changes. The risk management strategy remains the same, but there is no risk management objective that continues for those previously designated hedging relationships, which as such no longer exist. In such a situation, the discontinuation of hedge accounting applies to the extent to which the risk management objective has changed.
How discontinuation affects hedging relationship
The discontinuation of hedge accounting can affect:
- a hedging relationship in its entirety; or
- a part of a hedging relationship (which means that hedge accounting continues for the remainder of the hedging relationship)
A hedging relationship is discontinued in its entirety when, as a whole, it ceases to meet the qualifying criteria. For example:
- the hedging relationship no longer meets the risk management objective on the basis of which it qualified for hedge accounting (ie, the entity no longer pursues that risk management objective);
- the hedging instrument or instruments have been sold or terminated (in relation to the entire volume that was part of the hedging relationship); or
- there is no longer an economic relationship between the hedged item and the hedging instrument or the effect of credit risk starts to dominate the value changes that result from that economic relationship.
Partial discontinuation
A part of a hedging relationship is discontinued (and hedge accounting continues for its remainder) when only a part of the hedging relationship ceases to meet the qualifying criteria.
For example:
- On rebalancing of the hedging relationship, the hedge ratio might be adjusted in such a way that some of the volume of the hedged item is no longer part of the hedging relationship; hence, hedge accounting is discontinued only for the volume of the hedged item that is no longer part of the hedging relationship; or
- When the occurrence of some of the volume of the hedged item that is (or is a component of) a forecast transaction is no longer highly probable, hedge accounting is discontinued only for the volume of the hedged item whose occurrence is no longer highly probable. However, if an entity has a history of having designated hedges of forecast transactions and having subsequently determined that the forecast transactions are no longer expected to occur, the entity’s ability to predict forecast transactions accurately is called into question when predicting similar forecast transactions. This affects the assessment of whether similar forecast transactions are highly probable and hence whether they are eligible as hedged items.
An entity can designate a new hedging relationship that involves the hedging instrument or hedged item of a previous hedging relationship for which hedge accounting was (in part or in its entirety) discontinued. This does not constitute a continuation of a hedging relationship but is a restart.
