An important aspect of the role of Treasurer and/or the CFO is to stay abreast of changes and updates made by the International Accounting Standards Board (IASB). The IASB have recently issued IFRS 9 Financial Instruments as a replacement to IAS 39 Financial Instruments – Recognition and Measurement.
The Treasurer and/or the CFO must take into account all 3 phases of IFRS 9 Financial Instruments:
- Classification & Measurement
- Hedge Accounting
The focus of this article is on phase 3 – Hedge Accounting.
Let’s firstly cover what the high-level changes to the Hedge Accounting framework are under IFRS 9:
- The standard is more principle based, easier to apply and less complex
- It better aligns the economic risk strategy to accounting
- It’s easier to achieve hedge effectiveness
- More risks management strategies now qualify for hedge accounting
For a more detailed breakdown of the changes please download yourFREE Checklist here on IFRS 9 Hedge Accounting which contains some key discussion points around the new standard and the changes from IAS 39.
Top 5 questions that CFO’s/Treasurers should be considering:
- Does the new standard change how we can manage market risks?Consideration should be given to reviewing the current risk management strategy and the financial instruments used to manage risks. IFRS 9 allows more risks to be managed whilst achieving hedge effectiveness meaning that there are opportunities to implement more dynamic hedging programs with structured option products as an example.
- Is the current financial performance of the company being distorted by ineffective hedges?
Achieving hedge effectiveness is made easier with IFRS 9 and specific risk components of hedged items can be designated which improves hedge effectiveness.
- Does my treasury function have the capability in terms of technical and system requirements to early adopt?
If advantages can be gained by early adoption then bottlenecks can be worked through with the use of technical experts and cost effective treasury management systems which can remove much of the administration burden, in particular the new hedge accounting disclosure requirements.
- What are my competitors’ doing?
The majority of early adopters so far have been in the commodity sector or companies with debt exposures outside Australia with particular attention to minimising ineffectiveness and P&L volatility.
- What could be the financial benefits of early adoption?
Financial benefits could include:
- Protecting the ‘value-drivers’ (e.g. volume, price) of the business by using more dynamic hedging strategies to reduce cash-flow or earnings volatility
- Minimise risk of breach of covenanted ratios so that sources of borrowing remain available and cost effective. The financial impact of not meeting the above obligations can be catastrophic to a business
- Potential to benefit from favourable uplifts in rates with the increase use of optionality that is permitted by the new standard
The above benefits should in turn increase shareholder value which is the overarching corporate goal. By reducing the impact to the business of fluctuations in market variables on the firm’s cash flows, the cost of capital can be reduced. Furthermore, investors and lenders will perceive the company to be lower risk and hence will require a lower rate of return.
Financial modelling and analysis can be done to quantify the hedged and unhedged impact on cash-flows and profitability, both prospectively and retrospectively. This information acts as a useful appendix for a business case justification! This type of analysis can be resource intensive therefore outsourcing this to financial risk specialists is sometimes the appropriate course of action.
Download your FREE Checklist here on IFRS 9 Hedge Accounting which contains some key discussion points around the new standard and the changes from IAS 39.
Kevin Mitchell, ‘Partner – Advisory Services’ at Rochford, the leading treasury advisory house in Australia advising on in excess of AU$20 billion in financial market risk.