flows representing the aggregated exposure and associated discount rates, while holding
the previously calibrated blended fixed rate on the synthetic aggregated exposure
constant, similar to a hypothetical derivative (see 7.4.4.A below). The sum of the
resulting present values of cash flows, i.e. the present value of the overall synthetic
aggregated exposure (which previously was calibrated to be nil as at designation),
represents the present value of the cash flow variability of the aggregated exposure
which is used for measurement of ineffectiveness. [IFRS 9.IE134].
This is illustrated in the diagram below. The grey field represents the output from this
calculation which is the current present value of the cash flow variability of the
aggregated exposure.
PV synthetic
PV of the CF
PV CCIRS
PV of FX liability +
aggregated
variability of
receive fix in FC
+
=
pay fix in FC
exposure
the aggregated
pay variable in LC
receive fix in LC
exposure
PV of cash flows representing the aggregated exposure
Ineffectiveness is then determined by comparing the change in calculated present value
of the cash flow variability of the aggregated exposure and the fair value of the hedging
instrument, (i.e. the local currency IRS). The normal ongoing cash flow hedge
accounting treatment is applied to the change in fair value of the hedging instrument
(see 7.2 below). The accounting for the first level relationship in Example 49.23 above
continues unaffected by the second level relationship.
Example 49.24: Floating rate loan in a foreign currency – fair value hedge of an
aggregated exposure
This fact pattern is based on Example 18 in the implementation guidance. [IFRS 9.IE138-147]. An entity has a
floating rate borrowing denominated in a foreign currency (FC) and is therefore exposed to foreign exchange
risk and cash flow risk due to changes in interest rates. The entity decides to swap the borrowing into a
functional currency (LC) fixed rate borrowing using a cross currency interest rate swap (CCIRS). The CCIRS
is designated as the hedging instrument in a cash flow hedge (first-level relationship). By doing so, the entity
has eliminated both the foreign exchange risk and the cash flow risk due to changes in interest rates. However,
it is now exposed to a fair value risk resulting from changes in the functional currency interest rate curve.
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Later, the entity decides to hedge this fair value risk and enters into an interest rate swap (IRS) that receives
fixed rate and pays floating rate interest in its functional currency. By doing so, the entity is hedging the
aggregated exposure, which is the combination of the original exposure and the CCIRS. The IRS is designated
as the hedging instrument in a fair value hedge (second-level relationship). [IFRS 9.IE139(b)]. The diagram
below illustrates the two hedging relationships.
1st level relationship
Floating rate
FC
borrowing in
FC
LC
Interest rate
swap
Cross currency
FC
interest rate
swap
LC
2nd level relationship
The concept of economically hedging aggregated exposures as such is straightforward.
However, the accounting for such relationships includes some complexity. As for any
hedge accounting relationship, there is a need to calculate the cumulative change in
present value of the aggregated exposure, in order to measure ineffectiveness in the
second level hedge relationship. Paragraph IE144 in the IFRS 9 implementation
guidance provides some direction as to how this should be achieved: similar to
Example 49.23 above, this can be calculated as the change in present value of the gross
cash flows from the instruments making up the aggregated exposures. However, in this
example there is no requirement to create a synthetic blended fixed leg, as the
aggregated exposure itself is essentially fixed – it is simply the change in present value
of the aggregated exposure cash flows.
An additional complexity in Example 49.24 above, is that it is a cash flow hedge in the
first-level relationship that is then designated as the hedged item in a fair value hedge.
This means that the cross-currency interest rate swap is both a hedging instrument (first
level cash flow hedge relationship) and part of a hedged item (second level fair value
relationship) at the same time. Accordingly, its fair value changes are initially recognised
in other comprehensive income (OCI) through the first level cash flow hedge
accounting, but at the same time, should also offset the fair value changes in profit or
loss of the hedging IRS in the second-level fair value relationship. This requires a
reclassification of the amounts recognised in OCI to profit or loss (to the extent they
relate to the second-level relationship) to achieve the offset in the second-level fair
value hedge relationship. Consequently, applying fair value hedge accounting to a cross
currency interest rate swap designated as the hedged item as part of an aggregated
exposure affects where the hedging gains or losses from the first level cash flow hedge
relationship are recognised (i.e. reclassification from the cash flow hedge reserve to
profit or loss. [IFRS 9.IE143].
Financial instruments: Hedge accounting 4017
As explained in the illustrative examples in the implementation guidance, the
application of hedge accounting to an aggregated exposure gets even more complicated
when basis risk is involved in one of the hedging relationships, in particular if basis risk
is present in the first-level relationship. This is shown in Example 49.25 below.
Example 49.25: Hedge of a commodity price risk as an aggregated exposure in a
cash flow hedge of foreign currency risk
This fact pattern is based on Example 16 in the implementation guidance. [IFRS 9.IE116-127]. Entity A, with
functional currency LC, enters into a coffee benchmark price forward contract to hedge its highly probable
coffee purchases in foreign currency (FC) in five years. The coffee price that Entity A expects to pay for
its coffee purchases is different from the benchmark price. This differential could be because of differences
in one or a combination of factors such as the type of coffee, the location or delivery arrangements.
Entity A designates the benchmark forward contract and the highly probably forecast transaction as a cash
flow hedge (the first level relationship). The entity designates the entire price risk and not only the
benchmark risk as it was not able to separately identify a benchmark component in the hedged item
(see 2.2.3 above). Accordingly basis risk exists in the first level relationship. The entity is still exposed to
foreign currency risk.
One year later, the entity hedges the foreign currency risk by entering into a foreign exchange forward
contract. The entity designates the aggregated exposure in the first level relationship and the foreign exchange
forward contract as a cash flow hedge (the second level relationship). [IFRS 9.IE119(b)]. The diagram below
illustrates the two hedging relationships.
1st level relationship
Coffee
FC
purchase
Foreign
FC
exchange
forward
contract
LC
Coffee
FC
benchmark
price forward
2nd level relationship
Illustrative example 16 in the implementation guidance of IFRS 9 demonstrates the
accounting effort required in order to achieve hedge accounting for the aggregated
exposure. First, the entity calculates the change in fair value of the hedged item and
hedging instrument in the first level cash flow hedge relationship in foreign currency
and translates them into local currency, using spot rates. Using these local currency
equivalents, the entity calculates the ineffectiveness in the first level hedging
relationship in the usual way. Second, the entity calculates the change in fair value of
the aggregated exposure and the hedging instrument in the second-level cash flow
hedge relationship in local currency. This results in the second level ineffectiveness.
The existence of basis risk within the first level relationship complicates the
measurement of ineffectiveness in the second level relationship described above.
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The aggregated exposure is a combination of the foreign currency cash flows
expected from the highly probable coffee purchases and the gain or loss on the
commodity hedging contract. If the first level relationship was a ‘perfect hedge’, the
resultant foreign currency cash flow to be hedged in the second level relationship
would be known. However, as commodity basis risk exists in the first level
relationship, the hedged amount of foreign currency in the second level relationship
will vary, as the basis spread between the price of the forecast coffee purchases and
the underlying coffee price in the hedging contract varies. The hedging instrument in
the second level relationship is just a foreign exchange forward contract, and so its
fair value changes are insensitive to commodity basis risk. Accordingly, additional
ineffectiveness may arise in the second level relationship, due to the commodity basis
risk that exists in the first level relationship. [IFRS 9.IE119(b)].
For example, at inception of the second level relationship, an entity might have
expected a hedged aggregated cash flow of FC 990 based on the price achieved in the
commodity hedging contract and the level of basis risk that then existed. However, at
the date when the entity calculates the ineffectiveness, the expected aggregated cash
flow might be FC 1,000 due to changes in the commodity basis risk in the first level
relationship. The expected aggregated hedged cash flow is calculated as follows:
Designated volume of hedged coffee purchases × prevailing forward coffee price for actual coffee purchases
Plus
Change in market value of designated hedging coffee benchmark forward contracts
If the expected hedged cash flow has changed since inception of the second level
relationship, an entity would need to measure effectiveness as if the current expected
hedged cash flow from the aggregated exposure was always the expectation at inception
(i.e. FC 1,000 in the example given above). [IFRS 9.IE122, IE123]. As is usual for cash flow
hedges (see 7.2 below), ineffectiveness to be reported in the profit or loss is the change
in fair value of the actual hedging instrument less the effective portion taken to OCI.
Specifically, for the second level relationship in this scenario the effective portion taken
to OCI would be calculated as the lower of the following amounts: [IFRS 9.6.5.11(a)]
Change in fair value of the current expected hedged cash flows as if they had existed since inception.
(e.g. based on a hedged cash flow of FC 1,000)
And
Change in fair value of the actual hedging instrument
(e.g. based on original assumption of hedged flow of FC 990)
For hedge effectiveness measurement purposes, not only is the change in fair value of
the hedged cash flows affected by variations in the second level relationship hedged
risk, but also by ineffectiveness in the first level relationship. This second driver of fair
value change can be seen in the example above as, although the hedging instrument has
a notional of FC 990, the hedged cash flow is updated to FC 1,000, to reflect
ineffectiveness in the first level relationship. This is likely to result in incremental
ineffectiveness in the second level relationship.
The illustrative example in the standard demonstrates that to reduce the basis risk the
entity may chose a hedge ratio other than 1:1 for the first level relationship (see 6.4.3 below).
Financial instruments: Hedge accounting 4019
In the example the entity selects the volume of foreign exchange forward contract for the
hedging instrument in the second level relationship based on the implied coffee forward
price at the time the first level relationship was designated. This assumes the entity’s
original long term expectations of the basis spread have not changed since the coffee
forward was transacted, which may not always be the case. Alternatively when identifying
the optimal volume of the hedging instrument, an entity may conclude that the appropriate
basis spread is the prevailing basis spread at the time of designation of the second level
relationship. However, of course, the actual basis spread the entity will suffer is unknown.
Another layer of complexity would be added if the entity subsequently needed to
rebalance the hedge relationship because of changes in the expected basis. The
example, however, does not include this. Although the accounting for the second
level relationship may be complex, the accounting for the first level hedge
relationship in this example would continue to be unaffected by the existence of the
second level relationship.
The definition of an aggregated exposure also includes a forecast transaction of an
aggregated exposure. [IFRS 9.6.3.4]. An example, where this might be helpful, is when pre-
hedging the interest rate risk in a forecast foreign currency debt issue:
Example 49.26: Aggregated exposure – interest rate pre-hedge of forecast foreign
currency debt issue
Assume it is highly probable that an entity will issue fixed rate foreign currency debt in six months’ time. It
is also highly probable that on issue the entity will transact a CCIRS, converting the debt to functional
currency variable rate. The combination of the forecast foreign currency fixed rate debt issuance and the
forecast transaction of the CCIRS is economically a forecast functional currency variable rate debt issuance.
The entity wishes to hedge itself against increases in the variable functional currency interest rate between
today and the issue of the debt in six months as well as the term of the debt. Therefore, the entity enters into
a forward starting pay fixed/receive variable functional currency IRS. The entity designates the IRS as a
hedging instrument in a cash flow hedge of the forecast aggregated exposure.
In this example the first level relationship does not exist yet, as both the hedged item
(fixed rate foreign currency debt) and the hedging instrument (CCIRS) are forecast
> transactions. Hedge accounting for the ‘second level hedge relationship’ of the forecast
aggregated exposure is still permitted though, on the condition that when the aggregated
exposure occurs and is no longer forecast, it would be eligible as a hedged item.
[IFRS 9.6.3.4].
As an aggregated exposure is a combination of an exposure and a derivative, the
aggregated exposure is often a hedging relationship itself (the first-level relationship). In
order for the aggregated exposure to qualify for hedge accounting, IFRS 9 only requires
that the first-level relationship could qualify for hedge accounting and not that hedge
accounting is actually applied. However, applying hedge accounting to the aggregated
exposure gets even more complex when hedge accounting is not applied to the first-
level relationship, and the entity is also unlikely to achieve its desired accounting result.
[IFRS 9.BC6.167]. Therefore, in many cases we expect entities to apply hedge accounting
to the first-level relationship, even if not required.
However, just because an entity enters into an additional derivative transaction that
relates to an existing hedging relationship it does not mean that this relationship
qualifies as an aggregated exposure. This is demonstrated by the following example.
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Example 49.27: Cash flow hedging of an exposure that includes a net investment
in a foreign operation
Parent A with functional currency Australian dollars (AUD) has a US dollar (USD) net investment exposure.
It transacts a pay floating USD receive floating AUD cross currency interest rate swap (CCIRS) and
designates it in a hedge of a net investment in a foreign operation (see 5.3 below). By doing so, the group is
exposed to cash flow variability due to the floating rate exposure in AUD and USD. Parent A also enters into
a pay floating/receive fixed AUD interest rate swap (IRS) to eliminate cash flow variability from changes in
AUD interest rate risk, and wishes to designate this derivative as the hedging instrument item in a cash flow
hedge for the aggregated exposure including the net investment in a foreign operation.
While there is an economic relationship between the net investment exposure and the CCIRS for foreign exchange
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 795