Hedge effectiveness requirements
Rebalancing is permitted for the purpose of maintaining the hedge ratio to comply with the hedge effectiveness requirements. Changes to designate quantities of a hedged item or hedging instrument for a different purpose do not constitute rebalancing.
Continuation of hedging relationship
Rebalancing is accounted for as continuation of the hedge relationship.
In other words, when rebalancing occurs, the existing hedge accounting is not discontinued, but instead the hedge ineffectiveness of the hedging relationship is determined and recognised immediately before adjusting the hedging relationship.
When the hedge ratio is adjusted, the changes in the hedging relationship between the hedging instrument and the hedged item arising from the underlying or other risk variables are taken care of by the entity. In other words, rebalancing allows the continuation of a hedging relationship whether the hedging instrument and the hedged item changes in a way that can be compensated for by adjusting the hedged ratio.
Rebalancing should not create hedge ineffectiveness
Sometimes it may so happen that the changes in the fair value of the hedged instrument and the fair value of the hedged item cannot be synchronised by adjusting the hedge ratio. An entity analysis the source of the hedge effectiveness that is expected to occur during the tenure of hedging relationship and should examine whether the changes in the extent of offset are:
- fluctuations around the hedging ratio continues to appropriately reflect the relationship between the hedging instrument and the hedged item; or
- an indication that the hedge ratio no longer appropriately reflects such hedging relationship. The entity should ensure that the hedging relationship does not reflect an imbalance between the weightage of the hedged item and the hedging instrument so as to create hedge ineffectiveness.
Fluctuations not requiring rebalancing
Certain fluctuations around a constant hedge ratio resulting in hedge ineffectiveness cannot be reduced by adjusting the hedge ratio in response to each and every outcome. In such situations, the entity should evaluate the hedge ineffectiveness to be treated appropriately. In such a situation, rebalancing may not be required.
Fluctuations requiring rebalancing
If the current hedge ratio results in increasing hedge ineffectiveness and if after proper evaluation it is observed that the hedge ineffectiveness can be reduced by adjusting the hedge ratio, then the entity should consider adjusting the hedge ratio. But rebalancing the hedge ineffectiveness of the hedging relationship should be determined and recognised immediately before adjusting the hedging relationship.
Rebalancing hedging relationship and changes to hedge ratio
As mentioned earlier rebalancing refers to the adjustments made to the designated quantities of the hedged item or the hedging instrument of an already existing hedging relationship for the purpose of maintaining a hedge ratio that complies with the hedge effectiveness requirements. Changes to designated quantities of a hedged item or of a hedging instrument for a different purpose do not constitute rebalancing for the purpose of this Standard.