Rebalancing by changing the hedge ratio

Rebalancing is a new concept introduced by a major amendment to IFRS 9 during November 2013. Rebalancing means adjustments made to the quantities of the hedged item or the hedging instrument of an existing hedging relationship for the purpose of maintaining a hedge ratio that complies with the hedge effectiveness requirements.

Adjusting the hedge ratio enables an entity to respond to changes in the relationship between the hedging instrument and the hedged item that arise from their underlyings. Rebalancing allows the continuation of a hedging relationship in situations in which the relationship between the hedging instrument and the hedged item changes in a way that can be compensated for by adjusting the hedge ratio.

Rebalancing is not possible if the risk management objective for a hedging relationship has changed. Instead the hedge accounting for that hedging relationship should be discontinued.

To rebalance a hedging relationship the adjustment to the hedge ratio can be effected in different ways:

a)     The weighting of the hedged item can be increased (which at the same time reduces the weighting of the hedging instrument) by:

(i)    increasing the volume of the hedged item; or

(ii)   decreasing the volume of the hedging instrument.

b)    The weighting of the hedging instrument can be increased (which at the same time reduces the weighting of the hedged item) by:

(i)    increasing the volume of the hedging instrument; or

(ii)   decreasing the volume of the hedged item.

Why should the hedge ratio be changed?

Adjusting the hedge ratio allows an entity to respond to changes in the relationship between the hedging instrument and the hedged item that arise from their underlyings or risk variables. For example, a hedging relationship in which the hedging instrument and the hedged item have different but related underlyings changes in response to a change in the relationship between those two underlyings (for example, different but related reference indices, rates or prices). Hence, rebalancing allows the continuation of a hedging relationship in situations in which the relationship between the hedging instrument and the hedged item changes in a way that can be compensated for by adjusting the hedge ratio.

Changes in volume refer to the quantities that are part of the hedging relationship. Hence, decreases in volumes do not necessarily mean that the items or transactions no longer exist, or are no longer expected to occur, but that they are not part of the hedging relationship. For example, decreasing the volume of the hedging instrument can result in the entity retaining a derivative, but only part of it might remain a hedging instrument of the hedging relationship. This could occur if the rebalancing could be effected only by reducing the volume of the hedging instrument in the hedging relationship, but with the entity retaining the volume that is no longer needed. In that case, the undesignated part of the derivative would be accounted for at fair value through profit or loss (unless it was designated as a hedging instrument in a different hedging relationship).

Increasing the volume of hedged instrument

Adjusting the hedge ratio by increasing the volume of the hedged item does not affect how the changes in the fair value of the hedging instrument are measured. The measurement of the changes in the value of the hedged item related to the previously designated volume also remains unaffected. However, from the date of rebalancing, the changes in the value of the hedged item also include the change in the value of the additional volume of the hedged item. These changes are measured starting from, and by reference to, the date of rebalancing instead of the date on which the hedging relationship was designated.

Decreasing the volume of hedging instrument

Adjusting the hedge ratio by decreasing the volume of the hedging instrument does not affect how the changes in the value of the hedged item are measured. The measurement of the changes in the fair value of the hedging instrument related to the volume that continues to be designated also remains unaffected. However, from the date of rebalancing, the volume by which the hedging instrument was decreased is no longer part of the hedging relationship.

Increasing the volume of hedging instrument

Adjusting the hedge ratio by increasing the volume of the hedging instrument does not affect how the changes in the value of the hedged item are measured. The measurement of the changes in the fair value of the hedging instrument related to the previously designated volume also remains unaffected. However, from the date of rebalancing, the changes in the fair value of the hedging instrument also include the changes in the value of the additional volume of the hedging instrument. The changes are measured starting from, and by reference to, the date of rebalancing instead of the date on which the hedging relationship was designated.

Decreasing the volume of hedged instrument

Adjusting the hedge ratio by decreasing the volume of the hedged item does not affect how the changes in the fair value of the hedging instrument are measured. The measurement of the changes in the value of the hedged item related to the volume that continues to be designated also remains unaffected. However, from the date of rebalancing, the volume by which the hedged item was decreased is no longer part of the hedging relationship.

When rebalancing a hedging relationship, an entity shall update its analysis of the sources of hedge ineffectiveness that are expected to affect the hedging relationship during its (remaining) term. The documentation of the hedging relationship shall be updated accordingly.

EventWhat happens to
Hedged itemHedging instrument
Increase in the volume of hedged itemFair value changes from the date of rebalancing include the additional volume. Fair value changes of previously designated volume continue as such.Does not affect the fair value changes.
Decrease in the volume of hedging itemDoes not affect the fair value changes.Fair value changes from the date of rebalancing exclude the reduced volume. The decreased volume is no longer part of the hedging relationship and is measured at FVPL.
Increase in the volume of hedging itemDoes not affect the fair value changes.Fair value changes from the date of rebalancing include the additional volume. Fair value changes of previously designated volume continue as such.
Decrease in the volume of hedged itemFair value changes from the date of rebalancing exclude the reduced volume. The decreased volume is no longer part of the hedging relationship and is treated in the same way when a hedge accounting is discontinued.Does not affect the fair value changes.

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As per the new requirements, hedge accounting cannot be voluntarily discontinued. Hedge accounting can be discontinued only if the hedge effectiveness requirements are not met or that the hedging instrument is liquidated. Even when the hedge effectiveness requirements are not met, the entity should adjust the hedge ratio through the process of rebalancing and continue with hedge accounting so long as the hedging relationship continues to meet the risk management objectives of the enterprise.
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