presentation currency owns a subsidiary with the pound sterling as its
functional currency, monetary items held by the subsidiary that are
denominated in sterling do not give rise to any currency risk in the
consolidated financial statements of the parent.
(ii) Interest rate risk, the risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market interest rates.
It is explained that interest rate risk arises on interest-bearing financial
instruments recognised in the statement of financial position (e.g. debt
instruments acquired or issued) and on some financial instruments not
recognised in the statement of financial position (e.g. some loan
commitments). [IFRS 7.B22].
Financial
instruments:
Presentation and disclosure 4193
(iii) Other price risk, the risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices (other than those
arising from interest rate risk or currency risk), whether those changes are
caused by factors specific to the individual financial instrument or its issuer, or
factors affecting all similar financial instruments traded in the market.
Other price risk arises on financial instruments because of changes in, for
example, commodity prices, equity prices, prepayment risk (i.e. the risk that
one party to a financial asset will incur a financial loss because the other party
repays earlier or later than expected), and residual value risk (e.g. a lessor of
motor cars that writes residual value guarantees is exposed to residual value
risk). [IFRS 7.B25, IG32].
Two examples of financial instruments that give rise to equity price risk are a
holding of equities in another entity, and an investment in a trust, which in
turn holds investments in equity instruments. Other examples include
forward contracts and options to buy or sell specified quantities of an equity
instrument and swaps that are indexed to equity prices. The fair values of
such financial instruments are affected by changes in the market price of the
underlying equity instruments. [IFRS 7.B26].
The specified disclosures can be provided either in the financial statements or may be
incorporated by cross-reference from the financial statements to some other statement
that is available to users of the financial statements on the same terms and at the same
time, such as a management commentary or risk report (preparation of which might be
required by a regulatory authority). Without the information incorporated by cross-
reference, the financial statements are incomplete. [IFRS 7.B6, BC46].
Consistent with the approach outlined at 3 above, it is emphasised that the extent of
these disclosures will depend on the extent of an entity’s exposure to risks arising from
financial instruments. [IFRS 7.BC41]. Therefore, entities with many financial instruments
and related risks should provide more disclosure and those with few financial
instruments and related risks may provide less extensive disclosure. [IFRS 7.BC40(b)].
The IASB recognised that entities view and manage risk in different ways and that some
entities undertake limited management of risks. Therefore, disclosures based on how
risk is managed are unlikely to be comparable between entities and, for some entities,
would convey little or no information about the risks assumed. Accordingly, whilst at a
high level the disclosures are approached from the perspective of information provided
to management (see 5.2 below), certain minimum disclosures about risk exposures are
specified to provide a common and relatively easy to implement benchmark across
different entities. Obviously, those entities with more developed risk management
systems would provide more detailed information. [IFRS 7.BC42].
It is explained in the basis for conclusions that the implementation guidance, which
illustrates how an entity might apply IFRS 7, is consistent with the disclosure requirements
for banks developed by the Basel Committee (known as Pillar 3), so that banks can prepare,
and users receive, a single co-ordinated set of disclosures about financial risk. [IFRS 7.BC41].
The standard was originally written before the financial crisis and there have been a number
4194 Chapter 50
of subsequent initiatives to improve the reporting of risk by financial institutions, both from
a regulatory and a financial reporting perspective, for example as set out at 9 below.
In developing the standard, the IASB considered various arguments that risk disclosures
should not be included within the financial statements (even by cross-reference). For
example, concerns were expressed that the information would be difficult and costly to
audit and that it did not meet the criteria of comparability, faithful representation and
completeness because it is subjective, forward-looking and based on management’s
judgement. It was also suggested that the subjectivity involved in the sensitivity analyses
could undermine the credibility of the fair values recognised in the financial statements.
However, the IASB was not persuaded and these arguments were rejected.
[IFRS 7.BC43, BC44, BC45, BC46].
5.1 Qualitative
disclosures
For each type of risk arising from financial instruments, an entity is required to disclose:
[IFRS 7.33(a), (b)]
(a) the exposures to risk and how they arise; and
(b) its objectives, policies and processes for managing the risk and the methods used
to measure the risk.
Any changes in either (a) or (b) above compared to the previous period, together with
the reasons for the change, should be disclosed. These changes may result from changes
in exposure to risk or the way those exposures are managed. [IFRS 7.33(c), IG17].
The type of information that might be disclosed to meet these requirements includes,
but is not limited to, a narrative description of: [IFRS 7.IG15]
• the entity’s exposures to risk and how they arose, which might include details of
exposures, both gross and net of risk transfer and other risk-mitigating transactions;
• the entity’s policies and processes for accepting, measuring, monitoring and
controlling risk, which might include:
• the structure and organisation of the entity’s risk management function(s),
including a discussion of independence and accountability;
• the scope and nature of the entity’s risk reporting or measurement systems;
• the entity’s policies for hedging or mitigating risk, including its policies and
procedures for taking collateral; and
• the entity’s processes for monitoring the continuing effectiveness of such
hedges or mitigating devices; and
• the entity’s policies and procedures for avoiding excessive concentrations of risk.
It is noted that information about the nature and extent of risks arising from financial
instruments is more useful if it highlights any relationship between financial instruments
that can affect the amount, timing or uncertainty of an entity’s future cash flows. The extent
to which a risk exposure is altered by such relationships might be apparent from other
required disclosures, but in some cases furt
her disclosures might be useful. [IFRS 7.IG16].
Financial
instruments:
Presentation and disclosure 4195
The following extract from the financial statements of Origin Energy shows the type of
disclosure that can be seen in practice.
Extract 50.2: Origin Energy Limited (2014)
Notes to the Financial Statements [extract]
24. Financial
Instruments
[extract]
(A) Financial
risk management
Financial risk factors
The consolidated entity’s activities expose it to a variety of financial risks: market risk (including foreign exchange
risk and price risk), credit risk, liquidity risk and interest rate risk. The consolidated entity’s overall risk management program focuses on the unpredictability of financial and commodity markets and seeks to manage potential adverse
effects of these on the consolidated entity’s financial performance. The consolidated entity uses a range of derivative
financial instruments to hedge these exposures.
Risk management is carried out under policies approved by the Board of Directors. Financial risks are identified,
evaluated and hedged in close co-operation with the consolidated entity’s operating units. The consolidated entity has
written policies covering specific areas, such as foreign exchange risk, interest rate risk, electricity price risk, oil price risk, credit risk, use of derivative financial instruments and non-derivative financial instruments, and the investment
of excess liquidity.
(i) Market
risk
Foreign exchange risk
The consolidated entity operates internationally and is exposed to foreign exchange risk arising from various currency
exposures, primarily with respect to the New Zealand dollar, US dollar and Euro. Foreign exchange risk arises from
future commercial transactions (including interest payments and principal debt repayments on long-term borrowings,
the sale of oil, the sale and purchase of LPG and the purchase of capital equipment), the recognition of assets and
liabilities (including foreign receivables and borrowings) and net investments in foreign operations.
To manage the foreign exchange risk arising from future commercial transactions, the consolidated entity uses
forward foreign exchange contracts. To manage the foreign exchange risk arising from the future principal and interest
payments required on foreign currency denominated long-term borrowings, the consolidated entity uses cross
currency interest rate swaps (both fixed to fixed and fixed to floating) which convert the foreign currency denominated
future principal and interest payments into the functional currency for the relevant entity for the full term of the
underlying borrowings. In certain circumstances borrowings are left in the foreign currencies, or hedged from one
foreign currency to another to match payments of interest and principal against expected future business cash flows
in that foreign currency.
External derivative contracts are designated at the consolidated entity level as hedges of foreign exchange risk on
specific assets, liabilities or future transactions on a gross basis.
The consolidated entity has certain investments in foreign operations whose net assets are exposed to foreign currency
translation risk. Currency exposure arising from the net assets of the consolidated entity’s foreign operations is
managed primarily through borrowings denominated in the relevant foreign currencies.
Price risk
The consolidated entity is exposed to price risk from the purchase and sale of electricity, oil, gas, environmental
scheme certificates and related commodities. To manage its price risks, the consolidated entity utilises a range of
financial and derivative instruments including fixed priced swaps, options, futures and fixed price forward
purchase contracts.
4196 Chapter 50
The consolidated entity’s risk management policy for commodity price risk is to hedge forecast future transactions. The
consolidated entity has a risk management policy framework that manages the exposure arising from its commodity-
based activities. The policy permits the active hedging of price and volume exposure arising from the retailing, generation and portfolio management activities, within prescribed risk capacity limits. The policy prescribes the maximum risk
exposures permissible over prescribed periods for each commodity within the portfolio, under defined worse case
scenarios. The full portfolio is subject to ongoing testing against these limits at prescribed intervals, and reported monthly.
(ii)
Credit risk
The consolidated entity manages its exposure to credit risk via credit risk management policies which allocate credit limits based on the overall financial and competitive strength of the counterparty. Publicly available credit information from
recognised providers is utilised for this purpose where available. Credit policies cover exposures generated from the sale of products and the use of derivative instruments. Derivative counterparties are limited to high-credit-quality financial institutions and other organisations in the relevant industry. The consolidated entity has Board approved policies that limit the amount of credit exposure to each financial institution and derivate counterparty. The consolidated entity also utilises International Swaps and Derivative Association (ISDA) agreements with all derivative counterparties in order to limit
exposure to credit risk through the netting of amounts receivable from and amounts payable to individual counterparties.
The carrying amounts of financial assets recognised in the statement of financial position, and disclosed in more detail
in notes 6, 7 and 19 best represents the consolidated entity’s maximum exposure to credit risk at the reporting date.
In respect of those financial assets and the credit risk embodied within them, the consolidated entity holds no
significant collateral as security and there are no other significant credit enhancements in respect of these assets. The credit quality of all financial assets that are neither past due nor impaired is constantly monitored in order to identify any potential adverse changes in the credit quality. There are no significant financial assets that have had renegotiated terms that would otherwise, without that renegotiation, have been past due or impaired.
The consolidated entity has provided certain funding to Australia Pacific LNG by way of subscription up to an amount
of $3.75 billion for mandatorily redeemable cumulative preference shares (MRCPS) issued by Australia Pacific LNG.
Each holder of the ordinary shares of Australia Pacific LNG also holds MRCPS in an equivalent proportion to its share
in the ordinary equity of the joint venture entity. The MRCPS attract a market-based fixed dividend, reflective of the
assessed credit risk of Australia Pacific LNG, have a mandatory redemption date of 31 December 2022 and accordingly
are recorded in “other non-current financial assets”. The carrying value of the loan at 30 June 2014, as disclosed in note 7, reflects the consolidated entity’s view that the shares will be fully redeemed for their full issue price prior to 31 December 2022 from the cash flows generated from Australia Pacific LNG’s export operations. There are no conditions existing at
the reporting date which indicate that Australia Pacific LNG will be unable to repay the full carrying value. Accordingly, the loan is valued at amortised cost, and reflects the cash provided to Australia Pacific LNG.
(iii) Liquidity
risk
Prudent liquidity risk management implies maintaining sufficient cash and marketable securities, the availability of funding through an ade
quate amount of committed credit facilities and the ability to close out market positions. Due to the dynamic nature of the underlying businesses, the consolidated entity aims to maintain flexibility in funding by keeping committed credit lines available. Certain of the consolidated entity’s interest-bearing liability obligations are subject to change in control provisions under the agreements with third-party lenders. As at 30 June 2014 those provisions were not triggered.
(iv)
Interest rate risk (cash flow and fair value)
The consolidated entity’s income and operating cash flows are substantially independent of changes in market interest
rates. The consolidated entity’s interest rate risk arises from long-term borrowings. Borrowings issued at variable
rates expose the consolidated entity to cash flow interest rate risk. Borrowings issued at fixed rates expose the
consolidated entity to fair value interest rate risk. The consolidated entity’s risk management policy is to manage
interest rate exposures using Profit at Risk and Value at Risk methodologies using 95 per cent statistical confidence
levels. Exposure limits are set to ensure that the consolidated entity is not exposed to excess risk from interest rate
volatility. The consolidated entity manages its cash flow interest rate risk by using floating-to-fixed interest rate
swaps. Such interest rate swaps have the economic effect of converting borrowings from floating rates to fixed rates.
Financial
instruments:
Presentation and disclosure 4197
Origin Energy applied IAS 39 in these financial statements but the disclosure
requirements noted above are unchanged under IFRS 9. However, the measurement of
certain financial instruments might have been different under the new standard.
5.2 Quantitative
disclosures
For each type of risk arising from financial instruments (see 5 above), entities are required
to disclose summary quantitative data about their exposure to that risk at the reporting
date. It should be based on the information provided internally to key management
personnel of the entity as defined in IAS 24 – Related Party Disclosures (see Chapter 35
at 2.2.1.D), for example the board of directors or chief executive officer. [IFRS 7.34(a)].
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 831