Rebalancing to achieve hedge effectiveness

What do you mean by rebalancing and how does it help achieve hedge effectiveness?

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.

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.

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.

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.

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