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  • Welcome to the Deloitte Financial Reporting Update, our webcast series for important issues

  • and developments related to accounting frameworks. Today, we present the new IFRS 9 hedging model.

  • My name is Steve Aubin and I am an Advisory Partner in the Calgary office. I will be your

  • host for today’s webcast and I will be joined by others from the Canadian practice. A couple

  • of items before I tell you about the agenda and introduce our speakers. In the lower right-hand

  • corner of the screen are the webcast links, which include the link to download and print

  • out today’s slides, links to the webcast assistance, the links to the Deloitte updates

  • of upcoming sessions as well as the links to the archive sessions. If you have a pop-up

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  • or participate in our polling questions. For those of you who know of colleagues who could

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  • the same way that you just did and they will be able to view the archived webcast within

  • 48 hours after this event. So, please feel free to invite your colleagues to take advantage

  • of this feature afterwards. In addition, although you are on a listening mode only, you can

  • ask questions to our presenters during the session in the box at the bottom of the screen

  • and click submit. We will do our best to respond to your questions and comments during the

  • presentation. We also have interactive polling questions that will appear throughout the

  • webcast on your screen. Again, we invite you to participate by simply answering these questions

  • on your screen. A summary of the results will be provided on the screen shortly afterwards.

  • Now, let me introduce our speakers and discuss the agenda. First, you will hear from Kerry

  • Danyluk, who will provide us with an overview of the new standard and some additional information

  • on eligible hedging and hedged items under the standard. After Kerry, Kiran Khun-Khun

  • will update us on the hedge effectiveness requirements of the new standard as well as

  • the accounting and disclosure of consideration. She will finish with some important matters

  • to consider on transition and finally, we will conclude the session with a brief Q&A

  • session. You can read the bios of our presenters and access the agenda and technical support

  • in the navigation areas on your screen. Please keep in mind that it is a lot of material

  • for a 90-minute webcast, so we will need to keep the discussion at a fairly high level.

  • As I mentioned earlier, if timing permits, we will conclude with a question and answer

  • period. I would like to remind our viewers that our comments on this webcast are our

  • own views and do not constitute official interpretive accounting guidance from Deloitte. Indeed

  • as you know before taking any actions on any of these issues, it is always a good idea

  • to check with a qualified advisor. Before we kick it off, let us start with our

  • first polling question. We are going to ask everyone on the line to participate in this

  • webcast with our first polling question and please note that your response will remain

  • anonymous. Here is the first question: Are you considering early adopting IFRS 9

  • to take advantage of the new hedging standards? a. Yes

  • b. Probably not c. Maybe

  • While we are waiting for the results of the polling question, I would like to remind you

  • that today’s webcast maybe counted towards your continuing professional education. If

  • you stay with us for the whole webcast, you can credit yourself with one and a half hours

  • towards your annual total. This applies to those in public practice and those working

  • in industry. We do not issue certificates for the webcast, but your email registration

  • and confirmation can form part of your documentation in support of your attendance.

  • Let us look at the results of the first question.

  • We have about 5% of the people, 6% that are considering it and 65% probably not. I would

  • say that is probably consistent with the discussion I had with a lot of companies out there over

  • the last six months. Having said that a lot of people are starting to consider the benefits

  • and the advantages, we have to keep in mind that this is a fairly new standard that just

  • came out in December and I truly think that people are just starting to really understand

  • the benefits. Now, I would like to welcome our first speaker

  • for today’s webcast, Kerry Danyluk. Kerry Danyluk is a Partner in Deloitte’s National

  • office in Toronto. She specializes in a number of areas of IFRS, ASPE and not-for-profit

  • accounting. She has worked with entities in a number of sectors of IFRS implementation

  • and complex accounting issues including Crown corporations, financial services and public

  • utilities. So Kerry, I will now turn it over to you.

  • Thanks Steve. Before we get into meat I guess of the hedging standard, I just wanted to

  • give a little overview about IFRS 9. As you all know, I am sure, IFRS 9 in the hedging

  • instalment that we are going to be talking about today is part of a larger project and

  • so, all these pieces of IFRS 9 have been in development for a number of years and we got

  • a little schematic on the slide here of sort of all the various pieces and where we sit

  • with them. There are currently a number of parts of IFRS 9 that are available for early

  • adoption and today we are going to focus our comments on the general hedge accounting standard,

  • which was just released late last year and this is the latest instalment in the IFRS

  • 9 story I guess. In terms of other pieces of the standard, we expect the new impairment

  • standard to be finalized later this year and macro hedging is still at a much earlier phase.

  • It is still at sort of the discussion paper phase. We currently expect that all the pieces

  • of IFRS 9 will be mandatory for fiscal years starting on or after January 1, 2018. If you

  • have been following the project, you probably will remember that there was a thought at

  • one point that parts of IFRS 9 would be mandatory as early as 2013. So, we have really seen

  • a fair bit of slippage, I guess probably due just to the overall complexity and controversy

  • of this project. So as I mentioned, there are various parts of IFRS 9 that are available

  • for early adoption and as we will see on the next slide, there is a bit of complexity in

  • the order to which these parts may be adopted. The first piece of IFRS 9 to be released related

  • to classification and measurement of financial assets. This part of the standard sets out

  • the parameters for measuring financial assets at cost or fair value. There are currently

  • some proposed changes to the standard out for comment right now, but we do have an existing

  • version of the standard. We expect resolution of the exposure process later this year. So,

  • there may be some more changes to the classification and measurement of financial assets to come.

  • In the meantime, the current version of IFRS 9 on classification and measurement of financial

  • assets is available now for early adoption and this part of the standard could actually

  • be adopted by itself and in fact a number of companies have adopted this standard, not

  • financial institutions because the regulated ones have not been allowed to by the regulators,

  • but we have seen companies in other industries who have early adopted parts of IFRS 9.

  • The next thing we got was guidance on classification and measurement of financial liabilities in

  • 2010. This part of the standard can also be early adopted, but must be adopted with classification

  • and measurement of financial assets. If for some reason you wanted to adopt the financial

  • liabilities part of the standard, you would also adopt the financial assets part that

  • came out in 2009. In 2013, there was a more limited amendment that was released that deals

  • with re-measurement gains and losses related to a company’s own credit risk when financial

  • liabilities are recorded at fair value to profit and loss. This standard requires that

  • gains and losses related to changes in own credit risk should be recorded in other comprehensive

  • income and not profit and loss. This part of the standard, just to make it

  • even more confusing, can actually be adopted all by itself without any of the other pieces.

  • So if you had something under IAS 39, a financial liability, that you were classifying, carrying

  • at fair value through profit and loss, so maybe it was a liability that had a complex

  • embedded derivative or something like that and you opted to mark it to fair value, then

  • you could adopt this part of the standard that talks about what to do with gains and

  • losses on the fair value re-measurement. Also in 2013, and this is the subject what we are

  • going to talk about today, we got the amendments related to hedge accounting. If the hedge

  • accounting standards are early adopted, then what you must do is adopt all the other pieces

  • of IFRS 9 that came before, so you need to adopt all those at the same time. If you do

  • decide to adopt the hedge accounting rules, just recognize that, that means that other

  • things need to happen as well such as making sure to classify your financial assets and

  • liabilities under the new standard. On the next slide, we just thought we should

  • point out some of the things that have not changed from IAS 39, so applying hedge accounting

  • remains a choice. The main objective behind the new IFRS 9 changes on hedge accounting

  • was to allow the accounting to more closely reflect risk management strategies and also

  • simplification was an objective as well. There were a lot of concerns that hedge accounting

  • was very complicated and did not reflect the way people actually are or the way the companies

  • are actually hedging their risks. So really trying to deal with both of those things in

  • the new standard and I guess it remains to be seen how well they have achieved that as

  • we get through our implementation of this new standard. Let us just look at that. There

  • are a number of things about IFRS 9 that are not changing. They did want to make it simpler

  • and more closely match up with risk management strategies, but they did leave some certain

  • principles in place. First of all, hedge accounting is still a

  • choice. What that means is if you are doing hedging, economic hedging I will say where

  • you are not applying hedge accounting, you do not need to and there is nothing in IFRS

  • 9 that would say that you would need to apply hedge accounting. You could continue with

  • economic hedges and not seek hedge accounting and in fact, really the only way to trigger

  • your hedge accounting is to comply with all the pieces of IFRS 9 including designation

  • and documentation, which is another feature of hedge accounting that we are quite familiar

  • with from IAS 39 that the hedges must be designated at inception of the hedge relationship and

  • there is documentation requirements that need to be met. Also there is no change under IFRS

  • 9 in the kinds of hedges for accounting purposes. If you are familiar with hedge accounting

  • now, you will know that there are fair value hedges, cash flow hedges, and hedges of net

  • investment in a foreign currency entity. There is no change in the basic types of hedges

  • and really a lot of similarities are pretty much the same in the mechanics of how those

  • different hedges would be accounted for. This next slide presents a good, more complete

  • overview, of the new hedge accounting standard and highlights some of the areas of difference

  • that we will go through in more detail through the presentation. As under IAS 39 just to

  • get some of the terminology down, we will refer to hedging instruments, what kinds of

  • things can you use to hedge an exposure, as well as hedged items, so these are the exposures

  • that are eligible for hedge accounting. These two elements work together to form the hedging

  • strategy for designation and documentation and accounting purposes. There have been some

  • changes in what can be a hedging instrument as well as changes in what are eligible hedged

  • items. We are going to go through these in a bit more detail shortly and then Kiran is

  • going to talk about in more detail about the effectiveness assessment process. This is

  • another area where hopefully the standard has become a little bit more user-friendly

  • and somewhat more judgement based than what we have seen in the past and then as well

  • Kiran is going to touch on the disclosure requirements, which have been increased in

  • the new standard. First on to eligible hedging items. This first

  • slide sort of presents, so on here we are going to focus you in on what you can now

  • consider to be hedging instruments under IFRS 9 and there are a couple of areas of difference

  • that we are going to touch on. Under IAS 39, non-derivatives could be used as hedging instruments

  • only related to hedging foreign currency risk. For example you could use US dollar debt to

  • hedge a net investment in a US dollar foreign operation, so that is an example of using

  • something that is not a derivative, being the debt, to hedge an exposure, but now this

  • has been broadened out a bit more under IFRS 9 as we will see. Let us look at an example.

  • An example, as the slides says, it is now possible to use non-derivatives in more cases

  • to hedge exposures and one of the examples that is given is a financial instrument measured

  • at fair value through profit and loss could now be a hedging instrument. What would be

  • an example of that? There is a company that has a highly probable forecast gold purchase

  • and so they know that they have got this exposure to the price of gold, what could they use

  • to hedge that? Under this new feature of IFRS 9, they could, in fact go out and purchase

  • units of a gold fund that holds physical gold and those would be a financial instrument

  • because it is units of a fund and those units also under IFRS 9, would be carried at fair

  • value through profit and loss and that could be a hedge, you could consider those units,

  • that investment, as a hedge of the highly probable gold purchase.

  • Then on the right hand side of the slide, we are touching on the new guidance on using

  • options and forwards as hedging instruments. It is a somewhat more complicated discussion,

  • which we will go through, but it does kind of open the door and make the accounting a

  • little bit more friendly in that area. Let us move right on to that then, on the next

  • slide. Let us consider options for a moment, as under IAS 39, an option that you purchased

  • would be recorded at fair value under IFRS 9. The fair value of an option consists of

  • the intrinsic value and time value. Intrinsic value of course, as a little bit of a review

  • here of some of the terminology, is the difference between the fair value of the underlying option

  • and the strike price. If the instrument is an option to buy stock, then the intrinsic

  • value is the difference between the option exercise price and the fair value of the actual

  • stock that you could buy. Then there is also time value and time value includes volatility

  • and can be somewhat volatile in your P&L. Under IAS 39, companies doing hedge accounting

  • for strategies involving options would often exclude the time value from the hedging relationship

  • because that would give you better effectiveness in your hedge relationship, but it meant that

  • the volatile time value element needed to be included in the profit and loss. So what

  • have they done under IAS 9? For option-based hedging strategies, there will be the ability

  • to exclude the time value from the hedging relationship. We have that already, so what

  • is different? In the case of IFRS 9, a portion of the time value would be deferred in OCI.

  • How much time value gets deferred in OCI depends on how perfectly matched the terms of the

  • option are to the hedged exposure. This is referred to in the standard as the aligned

  • time value, which gets deferred in OCI. If the terms of the option are not a perfect

  • match, then some portion of the time value may have to be recorded in profit and loss

  • and this is what I am calling the residual on my slide, so that falls to the P&L. The

  • time value deferred in other comprehensive income would be recycled to profit and loss

  • in a way that depends on whether the hedged exposure is transaction-based or time-based,

  • so there is some different guidance depending on the kind of hedge that you are dealing

  • with. An example of a transaction-based exposure would be the purchase of an inventory let

  • us say like a commodity or something and your hedging price risk and time-based exposure

  • maybe seen in the interest rate hedging strategy.  

  • So what about forwards? Well here they take a similar approach and let us look at the

  • value of a forward. The value of a forward contract includes a forward element, which

  • is the difference between the forward price and the spot price of the underlying. Under

  • IFRS 9, it will now be possible to exclude the forward element from the hedging strategy

  • similar to what we went through in options and either recorded immediately in P&L or

  • defer in OCI. We have a choice here to put it to the P&L or to the other comprehensive

  • income, whereas under the option discussion it was only to other comprehensive income

  • if you decided to exclude the time value from the hedging relationship. So you deferred

  • in OCI and again that is to the extent that the terms of the forward match the hedged

  • exposure. Again, we have this idea of aligned forward element and being deferred in OCI

  • and then recycled back into the profit and loss and then the residual would go to P&L.

  • In IFRS 9, just to summarize, the option, time value and the forward element are referred

  • to as the cost of hedging and under IAS 39, these elements would have been a potential

  • source and effectiveness is included in the hedging strategy. If you exclude them under

  • IAS 39, then they would have fallen straight to P&L. IFRS 9 is kind of giving a little

  • bit of a better of both worlds in the sense that these costs can be excluded from the

  • hedging strategy probably increasing its effectiveness by giving some ability to defer some of that

  • volatility into other comprehensive income, so less volatility in the P&L.

  • Let us move on, that is a discussion sort of, of the hedging instruments and some of

  • the things that have changed on that front and let us move on to eligible hedged items.

  • On this first slide, the top row is showing all the things that are eligible hedged items

  • now under IAS 39. IFRS 9 is going to include all of these and adds the items that you see

  • on the bottom row. We will talk about each of these in the coming slides. The non-qualifying

  • items are listed at the bottom of the slide. These would also not have qualified under

  • IAS 39. For example, an entity cannot hedge any of its equity instruments, so it is issued

  • equity. Also hedge accounting cannot be achieved related to firm commitments to acquire a business,

  • so if you have an upcoming business combination. Equity-method investments also cannot be hedged

  • or at least you could economically hedge some of these things, but you would not be achieving

  • hedge accounting. This is probably one of the areas that is of interest to a number

  • of people looking at whether or not they would really adopt IFRS 9 and this deals with risk

  • components of non-financial items. Let us look at an example about what this could mean.

  • This sort of hedging strategy, hedging a risk component, starts with a consideration of

  • whether there is a risk component that is separately identifiable and reliably measurable.

  • Is there something in there that is a separate risk that you can identify and reliably measure

  • and hedge? If you have that, then it is possible that you could develop a hedge accounting

  • strategy that achieves a hedge of just that risk component. So that was not possible under

  • IAS 39 in the past except for in the case of just foreign currency hedging. Here now

  • we are able to look at different elements of risk and possibly create hedging strategies

  • that would achieve hedge accounting. So this example, the coffee example on the slide is

  • actually we developed it straight from one that appears in IFRS 9. We have entity B and

  • they are buying Arabica coffee for their own use and for delivery. They need it for their

  • business. In order to mitigate the risk of price changes, B enters into exchange traded

  • futures contracts for what is referred to as the benchmark quality of coffee, so that

  • is the standard futures contract that is trading on the futures exchange. It is not the Arabica

  • that B purchases for its use, but a different quality of coffee for which the exchange traded

  • futures maybe obtained. These contracts go out 15 months into the next harvest year.

  • B has entered into coffee contracts to purchase the Arabica coffee for delivery from the current

  • harvest, so they have secured basically their supply with these contracts. The contracts

  • include a pricing formula, which includes the price of the benchmark quality coffee.

  • You can see on the slide, it says the purchase

  • price basically, as specified in the contract, includes an element that reflects, at any

  • point in time when they take delivery of their coffee, part of the price would be related

  • to the coffee benchmark quality price per the futures exchange and then the quality

  • premium. So the difference between today’s price for that benchmark quality coffee compared

  • to the Arabica coffee, which is a different quality, that we are actually buying plus

  • transportation charges because they need to actually get the coffee to where they need

  • it. So we got this pricing formula within the contracts.

  • Beyond the current harvest, there are no contracts yet. So B does not really have any secured.

  • They do not have a contractually determined pricing formula yet for beyond the current

  • harvest, but they do have a highly probable future purchases for Arabica for the foreseeable

  • future that is part of their business, they need that coffee and they know that, that

  • will continue. The question that is asked on the slide is to what extent B can hedge

  • on a risk components basis? Let us look at the next slide, which outlines some of B’s

  • considerations. First of all, for the purchases during the current harvest, B has Arabica

  • supply contracts that include a pricing formula. In that formula, the price of the benchmark

  • quality coffee is separately identifiable risk component and B considers it to be reliably

  • measurable. This is kind of their conclusion on this question. Therefore, they conclude

  • that they can use the purchased coffee futures to hedge the risk component in the Arabica

  • contracts and that risk component is the price of benchmark quality coffee. What about the

  • period beyond the current harvest? And so remember they have no contracts right now.

  • They do not really know what those contracts for the purchases of Arabica, say into next

  • year, are going to be. However, they do have their highly probable purchases, so that is

  • potentially an exposure that would meet the condition of being a highly probable purchase,

  • which would be the same kind of threshold that we would have seen under IAS 39 in terms

  • of probability. Since there is no contract, B needs to analyze the market structure and

  • pricing to determine if the price of the benchmark quality coffee is separately identifiable

  • and reliably measurable risk component. Based on their experience with the market and how

  • their contracts for Arabica are eventually priced, B concludes that the price of the

  • benchmark coffee is separately identifiable and reliably measurable and so concludes that

  • this is a risk component that can also be hedged with the coffee futures.

  • Under IAS 39, just to reiterate, the benchmark quality price could not have been hedged by

  • itself and this hedging strategy would have been very unlikely to achieve hedge accounting

  • or this sort of hedging strategy where you are just hedging a component. So that is just

  • a little summary of how we can consider the door is opened up a little bit more in terms

  • of hedging risk components. In terms of what does this mean, we now think of hedge accounting

  • being available for many more risk management strategies and non-financial risks potentially.

  • As noted on the slide, any kind of risk management strategies that you are currently involved

  • in using derivatives related to agricultural products, energy, precious metals, basically

  • commodities, as I said, that is one of the places where if people are thinking of really

  • adopting IFRS 9 may be because they have these kinds of purchases and hedging strategies

  • or they would like to do that sort of thing and get hedge accounting. The next I am going

  • to talk about is a little bit different, but there are some changes in IFRS 9 as well.

  • It may be possible now to combine an exposure and a derivate to create an aggregated exposure,

  • for which hedge accounting maybe achievable. Let us look at an example on the next slide.

  • Consider entity A, which has the Canadian dollar as functional currency. A enters into

  • Canadian dollar floating rate loan and then enters into a pay US dollar floating and receive

  • Canadian dollar floating cross currency interest rate swap. This swap or payer of instruments

  • that we can see on the slide, the Canadian dollar floating rate loan and the US dollar

  • interest rate swap, you would not achieve hedge accounting for that because we are not

  • offsetting a risk, we are actually creating one, in fact, economically we have changed

  • the Canadian dollar floating rate loan to be almost as if it is an US dollar exposure.

  • Effectively, what we have done is created a US dollar floating rate exposure as I said

  • and under IFRS 9, this exposure can be hedged by another derivative and the hedging relationship

  • would be eligible for hedge accounting, so you would not have been able to do this under

  • IAS 39. This is another area to think whether: is there anything in your risk management

  • strategies and so on where something like this would be attractive since it is now possible

  • under IFRS 9 to get hedge accounting in these kinds of situations.

  • The next thing I want to talk about is groups and net positions. This is a potentially complex

  • area, but another one where we can see some more avenues opening up to apply hedge accounting.

  • The ability to get hedge accounting would require that the items be managed together

  • on a group or a net basis, beyond that there are other parameters impacted by whether or

  • not it is a net position that you are looking at or a group or whether it relates to foreign

  • currency exposure. It does get into a fair bit of complexity in the standard and I guess

  • the other thing to point out about reading the standard is there is the front part of

  • the standard, IFRS 9 itself, and then it refers you oftentimes into appendix B, which is where

  • a lot of the guidance actually sits. So, do not forget about that appendix B when you

  • are looking at IFRS 9, that is where a lot of the examples and in some cases, whatever

  • guidance there is, appears in appendix B. Let us look at an example, just one of many

  • possibilities as it comes to group and net positions. Consider a Canadian dollar functional

  • currency entity with highly probable forecasted transactions consisting of purchases in three

  • monthstime of $300,000 US dollars and sales of $500,000 US dollars. Basically, they

  • have a line of business where they are selling into the US and they have some US expenses

  • as well. One of the conditions for hedge accounting

  • on a group basis is that the items be individually eligible for hedge accounting. What does this

  • mean? In our case, because it is future forecasted transactions, we think about: Are they highly

  • probable? Would they individually meet the conditions for hedge accounting? Could I have

  • hedged them on their own? Here we are told in the facts of the case that these purchases

  • and revenue are highly probable of occurring so that condition would be met. We are also

  • told that the exposure is managed on a net basis. This is another requirement and this

  • is something that would have to be sort of observable and would be a question of fact,

  • are you actually managing this exposure on a net basis. If you can say yes to that and

  • you met the highly probable conditions, then potentially it is possible that you could,

  • as this company has done, take a foreign currency forward for the net, being the $200,000 maturing

  • in three monthstime, and use that to hedge the net position. And that is the question:

  • Can we make that work? On the next slide, we see the answer is yes, for managing the

  • risk on a net basis, we were given that in the facts of the case. So, you have to think

  • about what that would mean and how you would demonstrate that in your particular circumstances

  • and as well as I mentioned individually, they are all highly probable transactions and so

  • they would potentially be eligible for hedging in the way described using this $200,000 US

  • dollar forward, which represents basically the net exposure. When you do this, then the

  • fair value of the change that the entire population designated as hedged items is taken into account

  • on a gross basis in assessing effectiveness. Fair value gains and losses on the hedging

  • derivative so the $200,000 forward is recycled from equity when each of the US dollar sales

  • and purchases hits income, obviously you have to find a reasonable rationale way to allocate

  • those gains and losses as the hedge transactions occurred. With that Steve, I think I am done.

  • Thank you very much Kerry. Let us move on to our next polling question. Our second polling

  • question for today’s webcast is:  

  • Which of the new features of IFRS 9 hedging are of most interest to you and your company

  • for future hedge accounting? a. Ability to achieve hedge accounting for

  • hedges of risk component b. Changes related to accounting for the cost

  • of hedging when hedging with options or futures c. Ability to have an aggregated exposure

  • as a hedged item d. Ability to achieve hedge accounting for

  • hedges of a group or net position e. Some or all of the above

  • f. Not sure yet Kerry, while we are waiting for the audience

  • to answer the question, I would like to ask you one question. Currently, there is an IASB

  • project that relates to hedging in dynamic risk management strategies. What is the difference

  • between that project and hedge accounting standard that we are talking about today?

  • Steve, it is a good question, that project is one that people also call it sometimes

  • the macro hedging project, that’s what it has been called. I think it seems to have

  • gotten a fancier name lately and those are really the more complex hedging strategies

  • often used probably more so by financial institutions where what they have is dynamic portfolio

  • where the exposures are sort of constantly changing and so the hedging strategy itself,

  • like as the title suggests, needs to be much more dynamic. What that project is looking

  • at is: how could the hedge accounting principles apply in such situations? And I think you

  • can see that, that is a more complicated series of questions and maybe a more specialized

  • area of hedge accounting. They did not want to slowdown the process of getting some new

  • hedge accounting guidance out for the more general hedging strategies and what they did

  • was a couple of years ago was they decoupled these projects and said ok we are going to

  • go with a more simple, general hedge accounting project and were going to take more time

  • on the macro hedging and that is where they are at the discussion paper stage right now,

  • so that is even actually before we even have an exposure draft, where they are still kind

  • of in their fact finding and developing their positions mode, so that is basically a little

  • bit of an overview of the difference between those two projects. It sounds like that project

  • really would align the hedge accounting a little bit more with the risk management policy

  • of a lot of companies. I guess that is the hope especially for those like financial institutions

  • with those very complex strategies. Good, so let us go back to our polling question.

  • I see the results here. I think all of the above are 35% and not sure yet 40%. I am not

  • surprised with some or all of the above because from my experience in working with some companies

  • adopting the new standard and be reminded that I have focused much more with companies

  • that deal with commodities, but the ability to hedge the risk components has been a huge

  • factor on those companies early adopting especially in a commodity world and the other thing as

  • well that was a huge benefit for some of the companies was really the ability to defer

  • the time value of the options in OCI and we saw that very relevant to the oil and gas

  • industry given that in this industry a lot of companies will use costless collars to

  • go and hedge their exposure, so that would be consistent with the results here.

  • Now, I would like to welcome our next speaker, Kiran Khun-Khun. Kiran Khun-Khun is a Partner

  • in the Accounting Advisory Group in Toronto with over 15 years of experience with Deloitte.

  • As the Accounting Advisory Group is part of a National and worldwide practice, Kiran is

  • involved in complex accounting across various number of topics with a specialty in the area

  • of financial instruments, hedging and valuation. So Kiran, I welcome and I turn it over to

  • you.  

  • Thank you Steve. What I will be doing today, I am just going to be picking up from Kerry

  • and spending the next session going through hedge effectiveness, that has been an area

  • of significant change in IFRS 9, going through the accounting disclosure along with transition

  • impacts and questions to think about in determining whether early adoption makes sense to you,

  • why, who is doing it, what are folks thinking about. So let us kick it off with hedge effectiveness.

  • So you will see on your screen, you have it right there, you have got the requirements

  • that must be met to demonstrate hedge effectiveness. So from the left to the right:

  • 1. There must be an economic relationship between the hedged item and the hedging item.

  • 2. The risk you are trying to manage and the derivative product that you are using to manage

  • that risk. 3. The effect of credit risk cannot dominate

  • the relationship and the hedge ratio must be established.

  • So, three parameters, I will talk to each in turn. Because hedge ratio is the last item

  • to the right on your screen, because the hedge ratio is the newer concept in this hedge effectiveness

  • test, I will be spending a couple slides diving deeper into what that means. From an economic

  • relationship perspective that means that generally the fair values of the item or the risks that

  • you are trying to manage, must move in the opposite direction as the derivative that

  • you have taken out to manage that risk. What that has done, as Kerry mentioned, is it has

  • opened the doors to be able to hedge variables that are economically related to each other.

  • From a commodity perspective, you may have a Brent-based derivative from an oil pricing

  • perspective that is being used to economically manage the price risk of a WTI, which is a

  • different index for oil, a WTI forecasted sale for example. Under old GAAP, it was very

  • difficult to be able to establish hedge accounting in that scenario. Under this test, all that

  • would need to be done is that one would need to establish that an economic relationship

  • does exist between the WTI price risk and the Brent price risk.

  • Credit risk, this one is sort of a concept tossed in just to make sure that as the fair

  • values move between the item you are trying to manage the risk of and the related derivative

  • product that there are no other movements that are frustrating the relationship. From

  • a derivative valuation perspective, there is a piece of the derivative fair value that

  • we term in accounting the credit valuation adjustment. That credit valuation adjustment

  • or that reflection of the credit quality of the counterparty to the contract cannot frustrate,

  • significantly impact the movement in fair value of the derivative such that it stops

  • from doing a good job at providing the economic offset with a risk it has been identified

  • to or transacted to hedge. Hedge ratio, this concept essentially says

  • you can only put into the hedge relationship the quantity of the derivative that you have

  • transacted from a risk management perspective to offset the risk exposure you would like

  • to hedge. It is very important. This is a new concept. There is documentation required

  • to establish what the hedge ratio is for each hedge relationship and what it does is it

  • guides on a go forward basis, what to do if there is an imbalance in the hedge relationship.

  • I will get back to that and talk to that in a bit more detail. The main benefit or the

  • biggest benefit from this revised hedge effectiveness requirement, we got the three pillars laid

  • across your screen, if I focus on the economic relationship, because we are establishing

  • an economic relationship between the item we are hedging and the derivative we have

  • transacted, there is no mandatory 80-125 rule. You will see that there is nothing on this

  • slide across the top part of the screen that says that the hedge relationship quantitatively

  • needs to be between the traditional 80-125 range, so that has been dropped. The test

  • can be qualitative or quantitative. The standard does not prescribe what type of test to do

  • in either scenario and the additional benefit is that retrospective testing has been dropped

  • as well.  

  • So we end up having a day one test like we have always done at inception of each new

  • hedge relationship performed. So that is our day 1 inception test, it is our look forward

  • effectiveness assessment and then an ongoing minimum quarterly basis we are doing a continual

  • look for the prospective test. So that is a new piece of testing requirement with an

  • IFRS 9. One of the key takeaways that I have been seeing from clients early adopting is

  • keeping in mind that even though a test maybe qualitative, even though it may not be as

  • robust quantitatively as it would have been under IAS 39 because of that 80-125 rule,

  • the amount of noise in a relationship is still required to be measured, so that ineffectiveness

  • still is required to be quantified because we are still doing financial reporting, we

  • still need to identify for cash flow hedges how much is able to go into OCI for example.

  • On to the next slide, I do want to spend some of our discussion just talking about what

  • factors to consider when we are deciding whether a qualitative or a quantitative test makes

  • sense for a hedge accounting relationship. I had a lot of people say Kiran that 80-125

  • rule is gone, we can view qualitative testing, this is great, we can simplify our math, we

  • no longer have to do regressions, does that make sense to you, do you agree. In the spectrum

  • of looking or to helping to determine whether a qualitative or quantitative test makes sense,

  • I think it really gets back into being able to support whether an economic relationship

  • exists. And to that point, you have to really be able to be comfortable that as the derivative

  • changes in fair value that it will economically offset the change in risk that you are trying

  • to hedge. Now, this can be met qualitatively, for example, if your critical terms, meaning

  • the key terms in your derivative that influence its cash flows and then therefore influence

  • its fair value, if those key terms and conditions are perfectly without exception mirrored in

  • the risks that are trying to be hedged. For example, if you have got a floating rate liability

  • Canadian dollars, it is based on three months bankersacceptance and matures December

  • 31, let us say 2014 and we go out and trade a derivative today that is receive float three

  • months bankersacceptance, pay fixed, it also matures on December 31, 2014, its payment

  • dates, its reset dates match perfectly with the debt. There is the opportunity to say

  • what qualitatively I can get there, I can demonstrate qualitatively that there is an

  • economic offset between my derivative and my debt because the terms that influence fair

  • value changes match perfectly. Once you move away from that scenario in terms

  • of perhaps there is a mismatch, perhaps the derivative is not three months bankers

  • acceptance, receive three months bankersacceptance, maybe it has received one month’s

  • bankersacceptance for example, perhaps the payment dates are not aligned. Once these

  • move away from the critical terms being perfectly aligned, there is an increased level of uncertainty

  • in being able to say that there is an economic relationship between the derivative and the

  • hedge item without having to crunch some numbers. So, this slide is illustrating as you move

  • from the critical terms matching exactly and all the way up to significant mismatches,

  • you are starting to get into a quantitative world and then how much a quantitative world

  • is necessary really depends on how different the key terms are between the derivative and

  • the hedged item. We talked about effectiveness, let us talk

  • more about the hedge ratio concept. These ones are quite interesting. It was really

  • introduced to simplify the world of discontinuing hedge relationships. Under IAS 39 when we

  • have a situation where the hedged item changes, the derivative notional changes, hedge effectiveness

  • falls out of 80-125 parameter, those three scenarios call for an automatic de-designation

  • under IAS 39.  

  • One of the criticisms of IAS 39 is and was that when you have these de-designations,

  • it creates a complex accounting environment simply because you need to be able to track

  • or keep track of all the discrete hedge accounting adjustments you have made and be able to pull

  • that into P&L when appropriate throughout the life or the original life of the hedge

  • relationship. Because of that cumbersome type of accounting and the folks saying that they

  • want to simplify hedge accounting, this concept of hedge ratios was identified. What hedge

  • ratios are meant to illustrate is based on the risk management objective of a particular

  • hedge relationship once the derivative notional has been put into relationship and once the

  • corresponding risk has been put into the relationship, as long as that economic relationship exists

  • in the beginning, if that economic relationship is altered throughout the life of the hedge

  • relationship, there is the opportunity to rebalance or readjust how much of the derivative

  • is contained in the relationship and/or how much of the item that is being hedged is contained

  • in the relationship. This concept does not apply to the scenarios

  • where, for example, I forecasted I would have revenues of a million on December 15, 2014

  • and I end up having revenues of zero on December 31, 2014 or end up having 50% of the revenues

  • I thought I would have on December 31, 2014. In those scenarios, you would get into the

  • de-designation world because the hedge item does not exist. The rebalancing accommodation

  • or concept would not help those scenarios because there has been no change in economic

  • price relationship between the derivative and the hedge exposure. An example, the standard

  • does talk about and illustrate this concept is if for example you had a foreign currency

  • exposure in currency A and took out a derivative that was pegged to A via foreign currency

  • B, so you got an environment where the exchange rate is pegged to different currencies. Once

  • you have established that economic relationship at the beginning, you have documented it.

  • If something was to happen during the hedge relationship maybe the overseeing committee

  • who sets the time bands, the pegged rate, changed or adjusted that pegged relationship,

  • in those situations because an economic relationship between two variables foreign currency A and

  • B that was established at inception has now changed, this is the way to adjust the amount

  • of the foreign currency A and foreign currency B in the relationship without triggering an

  • automatic de-designation. Because you can rebalance both scenarios, you are allowed

  • to continue hedge accounting. You just need to be able to update your hedge documentation

  • and then continue forward, but like I mentioned it is not meant to accommodate or to facilitate

  • the continuation of hedged relationship where there has been a change in the fair values

  • of the derivative and the hedged item that have nothing to do with an economic relationship,

  • one example of that would be credit valuation adjustments.

  • Just to illustrate the concept of rebalancing or hedge ratios first actually before we get

  • into rebalancing, an illustration on rebalancing, what I wanted to do is identify or walk through

  • three scenarios that can occur that we do see in practice, walk through each of those

  • three scenarios and then talk through what the hedge ratio would be in each of those

  • scenarios. We have example 1, where we have got an entity producing fridges and they need

  • to purchase copper in order to facilitate the production of those fridges. They forecasted

  • that they will purchase a 1,000 tonnes of copper in three months. To do so based on

  • the risk management objective, they are going to be entering into 800 tonnes of copper forecasted

  • forward purchases via a forward contract so that would be a derivative because they would

  • cash settle on that forward contract. The risk management objective is to manage the

  • price risk of 80% of their forecasted copper purchases. Based on this relationship, entity

  • X would establish that its hedge ratio is 800 tonnes for the derivative hedging 80%

  • of the 1,000 forecasted copper purchases, so that would be established at day one in

  • the hedge documentation and that would be the hedge ratio for this relationship.

  • Example 2, we have got entity Y, they have

  • got forecasted foreign currency revenues USD and they are projecting it is going to be

  • 97 million dollars. Based on the risk management objective and the market sizing, the lots

  • that can be purchased for forward contracts, they can only purchase one, in this example

  • 100 million USD forward contract. Because the risk management objective is to purchase

  • 100 million, they also have a constraint to purchase, they are only able to purchase 100

  • million based on the lot sizes they are from a hedge ratio perspective putting in the 100

  • million of USD forward contract in full in a hedge relationship for the 97 million USD

  • forecasted FX revenue. Example 3 is a common one and I did want to

  • highlight this one. In this example, we have an entity that has fixed rate loans. It has

  • got a nominal principal amount of 200 million Canadian. They would like to be able to manage

  • the risk of their interest rate risk, fair value hedge of their fixed rate loan by entering

  • into, from a risk management perspective, a hedge of 100 million via a derivative, an

  • interest rate swap. They established that they would like to hedge 50% of their interest

  • rate risk exposure arising from their 200 million Canadian debt. The entity has run

  • some numbers and perhaps the credit valuation adjustment on the derivative is a bit high.

  • There could be some differences between for example the terms of the derivative or the

  • terms of the debt and what they would like to do to minimize the differences and better

  • the hedge effectiveness results, they would like to put in the 100 million interest rate

  • swap into a hedge with 105 million CAD exposure on their debt side. IFRS 9 would only permit

  • designation of a 100 million of the fixed rate loans even though entities that would

  • like to put 105 million of the CAD loan into the relationship to prevent it from doing

  • so because from a risk management perspective the derivative was only transacted to hedge

  • 50% of the risk exposure. This is one hedge ratio example where I do tend to see some

  • adjustments as we are going through into IFRS 9. Once we have established that rebalancing

  • makes sense, the next step is how do we do the balancing act (if you will). This slide

  • just illustrates for us that once we have noticed or identified that the hedge ratio

  • needs adjustment and, which in my mind is a bigger interpretive area, when is the hedge

  • ratio adjustment appropriate, how it is done is quite simple, you simply would either adjust

  • the quantum of the hedged item or the quantum of the hedging instrument in the relationship

  • depending on where the economic relationship has moved and what is necessary to reset the

  • relationship. When that is done, it is documented and any P&L impacts from that rebalancing

  • are taken immediately to the income statement. Moving on to the next slide into the de-designation

  • / discontinuation world, just to round out the hedge ratio discussion, again, if hedge

  • ratio rebalancing is appropriate for hedge relationship, it does not trigger a de designation

  • / discontinuation. What does trigger can be discontinuation / de-designation is on your

  • screen it is of the three middle green items. The middle one is consistent to IAS 39, if

  • the derivative has been terminated, sold, the relationship stops and no longer continues.

  • The top criteria and the bottom criteria are new under IFRS 9 and it is really getting

  • back into the purpose for transacting the derivative. Has the risk management objective

  • changed? If it has not changed, then you will continue hedge accounting for the relationship.

  • If the risk management objective has changed for that particular hedge accounting relationship,

  • then it actually triggers an automatic de designation even if you have perfect hedge

  • effectiveness test results. If there has been a change in the risk management objective,

  • there is no spectrum of how much of a change will trigger a de designation, any change

  • in the objective will trigger de-designation for the hedge relationship. Also, the bottom

  • condition, if there is no longer an economic relationship or if the credit risk dominates,

  • so you will notice that these are the two conditions to establish hedge effectiveness.

  • If either these two items no longer are met, no longer an economic relationship, credit

  • risk now dominates, then there is an automatic discontinuation. You will see again that hedge

  • ratio is not on here, so if there has been a change to the hedge ratio, the hedge relationship

  • will continue. There is not an automatic de-designation. The one item I do want to make particular

  • note of which some folks were not happy with is you are not allowed to voluntarily stop

  • hedge accounting under IFRS 9. There is no ability to do that. We can under IAS 39, that

  • ability was removed under IFRS 9 simply again going back to the observations at the accounting

  • for discontinuation of hedge relationships was too cumbersome under IAS 39.

  • We have summed up to this point, effectiveness testing, the hedge ratio, what decisions will

  • help us or what thought process will help guide whether we do a qualitative or quantitative

  • test. I want to spend the next part of the session talking through accounting disclosure

  • and transition. The good news is that the accounting, fair value hedge accounting, cash

  • flow hedge accounting, the mechanics of the accounting are untouched, not altered by IFRS

  • 9. Kerry did talk about the accounting for time value of options and the time value associated

  • with forwards, that is the area that has changed from a hedge accounting perspective, but the

  • traditional concepts around the use of OCI for cash flow hedges and doing adjustment

  • to the hedged item in fair value hedges has not changed, that remains consistent.

  • From a disclosure perspective, significant increased disclosure. In my mind, it is slotted

  • into three different buckets: Why are you doing hedge accounting? (That is the risk

  • management strategy - what is it all about?) What is the effect on cash flows? and How

  • is it impacting our financial statements? You will see the center actually does have

  • a template that they have identified on how to organize the information. From a tracking

  • perspective, I think this will be the area where folks will just need to step back because

  • all the information actually is meant to be recorded in a note or cross referencing amongst

  • notes just to provide or use the ability for readers to understand the hedge accounting

  • activities of an entity. I think there will be time to spend sitting back and reflecting

  • on where all the information is contained in the notes of financial statements and just

  • organizing the information in a clear way to facilitate compliance with IFRS 9 requirements.

  • From an illustrative perspective, as I mentioned, IFRS 9 has some examples provided on how one

  • must present the information for the derivatives and it is a tabular format and answers the

  • question of: How have you reflected your derivative hedging activity in your financial statements?

  • So, there is the organization by the type of hedge, cash flow, fair value, type of derivative,

  • terms of the derivative, and what line items on the financial statements are these items

  • impacting. Similarly on the other side, the hedged item side, there is similar tabular

  • disclosure, where we will have identified by hedge relationships cash flow and/or fair

  • value, for example, the types of items and hedges in each bucket, what the carrying amounts

  • are, the balance sheet adjustments, so that a reader can easily identify the numerical

  • amount of the hedged items, what it relates to and where to find it in the financial statements

  • as well. From a transition perspective, IFRS 9 is a

  • prospective standard and this slide just captures the impacts of existing hedge strategies on

  • adoption. Where we have a hedge relationship, the first bucket on the top of your screen,

  • which was compliant with IAS 39 and it continues to sit well within IFRS 9. IFRS 9 would permit

  • the continuation of the hedge relationship, it would just reset the hedge ratio as applicable

  • and that hedge ratio would establish the starting point for the continuous movement from IAS

  • 39 to IFRS 9 from a hedging perspective. If you had IFRS 9 compliant hedge documentation

  • already in place, there is the opportunity to have that seamless movement through. For

  • relationships where IAS 39, the qualifying criteria was not met under IAS 39, so hedge

  • accounting was not pursued. IFRS 9, as long as the qualifying criteria for hedge accounting

  • is met, you are moving forward from a prospective scenario and in rare cases you may have situations

  • where you have had established hedge relationship under IAS 39 does not comply, the qualifying

  • criteria are not met under IFRS 9 and then there would be a mandatory discontinuation

  • of that hedge relationship and this category is expected to be rare.

  • So, prospective accounting there, there is a concept of retrospective adjustment and

  • it is isolated and only applies to the two elements that Kerry had talked about in her

  • presentation and that is the time value of the options and forward points as it relates

  • to forward contracts, for example, for time value of options this is a mandatory retrospective

  • application. If you have hedge relationship, you use options, you excluded the time value

  • from those relationships under IAS 39, then the accounting to use OCI for the time value

  • is pushed back based on the population existing at the earliest opening balance sheet date

  • and for the forward contract that retroactive pushback is optional and if it is selected

  • it is done for all hedging relationships for which the forward points were excluded.

  • So, aside from the numbers, the numerical transition, some things to think about on

  • transitioning from IAS 39 to IFRS 9, so planning for early adoption. If you are in a scenario

  • where you would like to make sure that you achieve hedge accounting for your current

  • strategies when you move into IFRS 9, so you want to be in that first column, the seamless

  • move through from a hedge accounting perspective. It is a good idea now to revisit your hedge

  • relationship, make sure that they comply with IFRS 9, if they do not, is there an opportunity

  • to be IFRS 9 compliant, plan for having documentation that would suit both standards that is possible.

  • So that is our strategy for dual designations having designations that are IAS 39 compliant

  • and IFRS 9 compliant currently as we move into IFRS. Demonstrating the economic relationships,

  • I think this will be really important where we are in the world of hedging risk components,

  • so being able to demonstrate an economic relationship does exist between two different variables.

  • Rebalancing: is it applicable to every situation? That is going to be the area where I think

  • it will apply to some scenarios and not others and likely in scenarios where you have had

  • to spend a lot of time thinking about the economic relationship and again managing interpretive

  • areas of IFRS 9. There is a lot of opportunity in IFRS 9 for increased hedging, which will

  • lead to questions as to how should the relationship you established, what should the testing look

  • like and how do I calculate my hypothetical derivative for example? We have talked to

  • this point on about the numbers. I do just want to highlight this from a documentation

  • requirement standard, IFRS 9 is still a documentation standard. So the documentation, the word that

  • you are used to still exists under IFRS 9. What I have done on this slide is just highlight

  • for you what has gone away and what has come on and that is in light blue. You will see

  • that there is not much that has gone away. We will need to strike the one little item

  • in your third bucket and that relates to performing and documenting the retroactive effectiveness

  • assessment. What has come on are the two items I have added in blue in your middle section

  • there and that is documenting the hedge ratio once it has been determined and also analyzing

  • the source of any hedge ineffectiveness, which is required under the standard.

  • So, knowing the adoption for fiscal years starting January 1, 2018, will occur for sure

  • when we do get there from a mandatory adoption perspective. Just some helpful hints to think

  • about as you are thinking through whether early adoption does make sense for you? As

  • I mentioned, there are more opportunities for hedging under IFRS 9, Kerry talked to

  • the fact that if IFRS 9 hedging is early adopted and must be adopted in conjunction with the

  • other pieces of the finalized standard of IFRS 9, so that something that keep in mind.

  • There is significant documentation from an IFRS 9 perspective, but again if you have

  • got strategies that are leveragable from what you have now that is something that can be

  • managed. Interpretive issues, whenever you are adopting any standard first there is always

  • the opportunity to have interpretive issues and be the one that is dealing with those

  • issues versus your peers who may be adopting the standard at the mandatory adoption date.

  • Going forward to the next slide, this is just

  • a slide we put together that is taking the lessons that we have been learning as we have

  • been moving with clients through their early adoption, from a strategy perspective and

  • an organization perspective, for what to think about in terms of next steps if you are thinking

  • about early adopting. Risk management documentation, understanding what exists, what strategies

  • are driving and transacting hedge relationships and derivatives is key, that is the basis

  • of IFRS 9 and there is a requirement to be able to link and document the linkage between

  • established hedge accounting relationships and related risk management objectives. The

  • dialogue between treasury and accounting is extremely important in this regard and that

  • just flows right through to the identification of the risk, and financial setup of the type

  • of quantitative effectiveness assessment that must be completed, any tag on effects from

  • a control process and communicating new hedging relationships and the results of those new

  • hedging relationships to management as well. So, from early adoption perspective, some

  • other things we have noticed (just from a driving force perspective), what has driven

  • some folks to move towards early adoption, the standard came out in November and these

  • are the reasons we have seen entities early adopt. Currently the hedge relationships from

  • a risk management objective perspective under IAS 39 are not achievable for hedge accounting,

  • but are so far for IFRS 9. Kerry talked about risk component hedging that is one of the

  • main areas where people have seen IFRS 9 to be of benefit. We have got significant amount

  • of commodity hedging, so we have an opportunity now to use the economic relationship guidance

  • under IFRS 9 to establish those derivatives and hedged items into relationships strictly

  • by the guidance on economic relationships for the hedge effectiveness assessments. Managing

  • FX risk on a natural group basis and as Steve had mentioned when we have got clients who

  • have options, costless collars, etc., they have seen that the standard is also beneficial

  • from early adoption perspective. Perfect Karen, thank you very much. I think

  • we can probably move on to the final polling question and then need to come back with a

  • few questions for you, but let us go with a polling question #3.

  • Thinking back to our first question about early adoption. Have you changed your mind?

  • So, since the beginning of this session here, have you changed your mind?

  • a. Yes. b. No.

  • c. You were planning to early adopt and still thinking, you will.

  • d. I thought we might be early adopting, but we are probably changing our mind.

  • e. I am not sure, I still need more information. So while the audience here is responding to

  • question, Kiran I would like to bring a question from the audience here for you. The question

  • is as follows. We apply cash flow hedging using the hypothetical

  • derivative method. Does that concept still exist under IFRS 9?

  • Yes. That is a really good question and it’s funny, I had a client and we were having a

  • conversation talking about using the qualitative assessment approach and it made sense for

  • their particular strategy. They were in line with the example I had where everything matched,

  • but they still needed to use a hypothetical derivative method to be able to quantify to

  • do the accounting. So, you could run into a scenario where perhaps you are not crunching

  • the numbers from a quantitative effectiveness assessment perspective any longer, but that

  • does not mean that we still do not need to quantify what that hypothetical derivative

  • looks like for accounting because there was still requirement to measure ineffectiveness.

  • Let us move on to the result here. I am just looking back at the answers. At the beginning

  • of the session 6% say that they will go for it. 65% states that they will not go for it.

  • So, it went down by almost 18 points here and we had earlier question of 29 of maybe.

  • It looks like the official information perhaps that we provide here give some good food for

  • thought. So, that is good. I guess what I want to do right now is that we will finish

  • formal portion of the webcast before we begin the question and answer period. We would appreciate

  • your feedback and kindly ask that you complete our survey. You should expect to see a pop-up

  • survey appearing on your screen shortly and this survey assists in our developments of

  • future webcasts. We take these surveys very seriously. So, please continue to send us

  • your suggestions and feel free to also let us know if we are doing something well. We

  • want to make sure we keep it up. If we do not, have that all that time to address your

  • question today, especially if the question is regarding specific fact patterns of your

  • organization. I would recommend that you discuss these questions with your Deloitte Partner

  • or Deloitte Contact so that they can help you resolve the questions or concerns you

  • may have. So, as I just finished the formal portion, I would like to go through the Q&A

  • and I am just going to pull out here the second question that came from the audience and so,

  • the question goes as follows and Kerry I think that would probably be a question for you.

  • Did you mention that adopting IFRS 9 is optional? Meaning that the choice to remain on IAS 39

  • is possible, but disclosures are mandatory regardless as of January 1, 2019?

  • That is a good question Steve, and it is complicated, so it is worth going back over that and clarifying.

  • So, for now, we have all the pieces of IFRS 9, some of which can be early adopted by themselves

  • as I went through that one slide, but if you wanted to adopt the IFRS 9 hedge accounting

  • now, you could and you would have to adopt all the standard that exists. Now, when I

  • say adopted now, I guess that is important as well too because you have to remember because

  • since it is a documentation standard, you cannot start hedge accounting before you have

  • the documentation, so you cannot start hedge accounting until you decided and put your

  • strategies in place and documented them. So in that sense, it is somewhat prospective,

  • so we can adopt it now and if you do not adopt it now then you would stay in IAS 39 for hedge

  • accounting, but by 2018 or whenever it is that the standard finally becomes mandatory,

  • you would have to adopt all of it. So, the new hedge accounting standard, all the related

  • disclosures, all the rest of IFRS 9, I guess the other point to make though is that you

  • do not have to ever actually do hedge accounting, you can do economic hedging without doing

  • hedge accounting - if that is part of what the question was asking, hedge accounting

  • is optional as you never have to do hedge accounting and that will still be true under

  • IFRS 9, but the whole standard must be adopted by January 1, 2018. Thanks for the clarification.

  • Kerry, let’s keep going with you here and let’s go with another question. Can you

  • confirm if the ineffective portion of the hedge still goes directly through the income

  • statement only, under IFRS 9? Yes. That is true and essentially it goes back to the idea

  • that a lot of the mechanics of actual hedge accounting have not changed. If there is ineffectiveness,

  • and as Kiran talked about, she emphasized that even though we are going to a more qualitative

  • way perhaps of being able to assess whether or not your hedge is effective, you still

  • need to measure (if it is not perfectively effective) ineffectiveness, and so we need

  • to know how much that is, especially for cash flow hedges because it will dictate how much

  • of the gains or losses on the hedging instrument to go other comprehensive income. So, effectively

  • the ineffective part of the hedge will still fall to P&L, generally speaking. I guess the

  • only exception would be if you are hedging an equity investment, so an investment in

  • a share, which under another part of IFRS 9, you might have said I am going to record

  • gains and losses on that equity investment through OCI. Then, in that case, it may be

  • a different answer, but generally speaking for most hedges, ineffectiveness would go

  • to P&L. Kiran, maybe one question for you here. In

  • the absence of credit risk being a factor in the determination of hedging, do we still

  • have to account for credit value adjustments? The answer is yes and that has not gone away,

  • so IFRS 9 does not touch the requirement that derivatives need to appropriately capture

  • all of its credit qualities, so adjustments to the swap curve, so that will continue untouched

  • under IFRS 9. I have another question on ineffectiveness

  • here. It goes back to slide #28, in the example #1 of slide 28, why is 80% designated as the

  • hedged item instead of 800 tons. I do not know if the operator can turn back to slide

  • 28, that might be helpful. So, I recall that illustration. So, the hedge documentation,

  • whenever we have a forecasted transaction and it is a sort of first dollars based, we

  • always say that it is first x% from the documentation perspective, just in case we require a notional

  • change. So, you could have 7,000 tonnes come in the door, you can have more than 1,000

  • tonnes, so the documentation should say the first 80% of 1,000, either way the documentation

  • could say the first 800 of the projected cash flows for the first 80% of the defined. So,

  • either way as long this is clear in the documentation then it would establish what one should expect

  • and that is really the guiding principle for identifying your hedged items because you

  • need to specifically identify that the hedge item has occurred in the quantity that you

  • say that it would. Perhaps let us go back with Kerry here for

  • one question. Kerry, does this standard mandates how to determine if the risk component is

  • separately identifiable and reliably measurable. If not, is there a suggested approach. Okay,

  • Steve thanks. So, the standard does not mandate that, in the example that we looked at, the

  • coffee example, it was clear in the contract, so that is a really good way to observe that

  • it is separately identifiable and then measurement maybe another issue. If you do not have that

  • and you do not have it specified in your contract like that, which I guess often we will not,

  • then you need to look at prior experience, i.e. can you observe a relationship between

  • that risk component and how the ultimate purchase price is determined and now we are getting

  • a little bit judgmental. But I think it will be based on the way the example went through

  • it which was looking at past experience, pricing conventions, so I guess in terms of guidance

  • and the standard, as I mentioned, a lot is in appendix B, there are some examples and

  • so you can kind of read those examples and really infer what an approach could be or

  • things that you could look at. The standard has a lot of areas of judgment in application

  • and not as many bright lines or hard and fast rules. And in some ways I think that is what

  • the Board was setting out to do, was to try and make it a more judgmental standard, but

  • in some ways it makes a little bit harder too because the exercise of judgment can often

  • be quite tricky I guess as we have seen with all sorts of areas of IFRS.

  • Thank you for that. Maybe one more Kerry I think for you here. It goes as follows: Regarding

  • options and forwards, you talk about being able to defer an amount related to the aligned

  • time value and aligned forward element in OCI. This concept sounds a bit like the old

  • shortcut or critical times match concept. Is that correct? Yeah. I think Steve that

  • is a good way to look at it. I remember back to when I was talking about options and forwards,

  • and the aligned time value or forward element, was the amount that you were able to defer

  • in the OCI and keep out of the P&L and what that was really getting at is how much time

  • value would be in the perfect hedging derivative, so if you did not have a perfect hedging derivative,

  • how much of your time value would relate to one that is perfect. So, in a sense it almost

  • makes us think again the hypothetical derivative type of approach that people have taken and

  • so it is very similar. It is kind of basically saying you could differ the amount that relates

  • to a hedge that would perfectly match your exposure, so in that sense it is kind of like

  • the critical terms match or even hypothetical derivative approach.

  • Let us go back to Kiran. Kiran are you still

  • there? I am. Good. Here is the question. Are there any numeric thresholds to meet the hedge

  • accounting and I am assuming the person is making reference to the 80% to 125% ratio

  • we were looking at in the past to qualify for hedge accounting.

  • No more numeric threshold; it’s not contained in IFRS 9. IAS 39 had a specific requirement,

  • embedded right in the standard that said you needed to meet that range and that is no longer

  • around in IFRS 9, so a bit more flexibility. So, that really goes back to the concepts

  • of economical range that you are talking earlier during the session.

  • Yes, that is most important. You really do need to understand economically the why, why

  • have you transacted this derivative to manage the risk and exposure, how do they economically

  • move together. We have had clients going back in time and understanding the economic relationship

  • especially when the derivative is priced off of a different risk exposure as compared to

  • the hedged item so that is a big basis on which the hedge effectiveness testing qualifying

  • criteria is based on. Maybe one last question here. It goes as follows.

  • Can my current hedge effectiveness assessment testing be retained? Good question. Hopefully,

  • for example some of my clients do regressions for their hedge effectiveness testing. If

  • that relationship is plain vanilla, for example, managing the interest rate risk, floating

  • rate debt, fixed rate debt, nothing fancy about it and you are using regression, there

  • is no reason that that regression testing cannot continue into IFRS 9. IFRS 9 does not

  • tell you what type of test to use, it does not tell you, you cannot do a quantitative

  • test, so that is actually something that think about in terms of the level of effort to go

  • through when you do have transactions and trying to support qualitative, it may just

  • be from a process control perspective, it may just make sense to continue what you are

  • doing for those particular hedge strategies, but it is an opportunity to revisit what you

  • are currently doing to see if you can better streamline, demystify or simplify the current

  • hedge testing that you are doing. That is great. So, I think that completes

  • our Q&A section here and I would like to thank our speakers, Kerry and Kiran. We really hope

  • that you found the webcast helpful and informative. If you want additional information, please

  • visit our website at www.deloitte.ca and to all the people viewing our webcast today,

  • thank you very much for joining us and this concludes our webcast on the new IFRS 9 hedging

  • model. Thank you very much.

Welcome to the Deloitte Financial Reporting Update, our webcast series for important issues

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