How banks and other financial institutions account for dynamic risk management activities in their financial statements is being retooled as the International Accounting Standards Board investigates new rules regarding macro hedging.

The IASB, the body which oversees the International Financial Reporting Standards, released last week a discussion paper on accounting for macro hedging. The goal is to come up with new rules that will “better reflect” the realities of macro hedging. According to IASB, many banks and other institutions manage interest rate risks and other risks dynamically on a portfolio basis, instead of on an individual contract basis. Because those risks and how they are managed change over time, that continuous process is difficult to account for under the current reporting rules, the IASB said.

The IASB has been working to replace the current accounting rules, IAS 39 Financial Instruments, with an updated standard known as IFRS 9 Financial Instruments, an initiative triggered by the financial collapse. In order to tackle the complex issue and seek input from a greater number of constituents, the IASB split off the rules dealing with macro hedging as a separate project.

“Current requirements make it difficult to faithfully represent dynamic risk management in entities' financial statements and can increase operational complexity,” IASB Chairman Hans Hoogervorst said in a statement. “This Discussion Paper sets out preliminary views on an accounting approach that better reflects the economics of dynamic risk management as compared to the current accounting requirements. Users of financial statements will also benefit from presentation that shows how dynamic risk management has affected an entity's profit or loss.”

Andrew Spooner, financial instruments lead partner at Deloitte, told AccountancyAge that if approved as proposed, the new approach would “fundamentally change banks' accounting for lending and deposits.”

“The discussion paper purposely asks more questions than the IASB has answers for,” Spooner told the publication. “It is the start of what will be a long journey to solve the ongoing debate as to how to best account for banks' macro hedging of interest rates.”

The possible approach put forward in the discussion paper is known as the portfolio revaluation approach (PRA). The IASB said the proposal calls for:

·         Exposures that are risk-managed using macro hedging would be revalued for changes in managed risk through profit or loss.

·         Fair value changes arising from risk management instruments like derivatives also would be recognized in profit or loss.

·         The success of an entity's macro hedging would be captured by the net effect of the above measurements in profit or loss.

·         Fair valuation of risk exposures that are managed with macro hedging would not be required.

·         Entities would be subject to more comprehensive disclosure requirements regarding macro hedging activities.

The discussion paper is available for comment until 17 October. The IASB also plans to do outreach to solicit more feedback on the issue.

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