Navigating the hedge accounting landscape post IFRS9 and US GAAP ASC 815
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Ali Curi: Treasury ConversatION is an ION podcast where we discuss topics of importance with CFOs, group treasurers, and treasurers. Join us as we explore critical topics with industry leaders, product owners, and subject matter experts, providing insights and strategies tailored to the dynamic world of treasury management.

Jocelyn: This episode is brought to you by ION. ION offers treasury management products like Reval, which is a SaaS-based treasury risk and payment solution, supporting bank connectivity, market data, and more, all backed by award winning customer service. To learn more, visit us at iongroup.com/treasury or email us at treasury@iongroup.com. 

Ali Curi: Hi everyone, and welcome to Treasury ConversatION. I'm Ali Curi. On today's premiere Treasury episode, we'll explore how do corporate treasuries navigate the hedge accounting landscape post IFRS 9 and U. S. GAAP ASC 815 rollout. 

Sourabh Verma from ION Treasury will discuss how these new accounting standards impact hedge accounting and how they have reshaped hedging strategy and hedge accounting practices.

Whether you're a treasury professional, a financial analyst, or simply interested in the evolving world of corporate treasury and financial risk management, this episode is packed with insights you won't want to miss. 

Let's get started. 

Saurabh Verma, welcome to the podcast. 

Sourabh Verma: Thanks, Ali. It's a pleasure. How are you doing?

Ali Curi: I'm doing great. Sourabh, this is our premiere episode for ION Treasury. What can we expect to learn from you and future guests in our upcoming episodes? What are some topics we can look forward to? 

Sourabh Verma: Sure. So at ION, we are constantly working with our customers and partners to solve the problems that keep them awake at night. And with this podcast series, we want to share our original ideas with the treasury community as a whole, and listeners can actually expect to learn more about challenges, solutions, and best practice suggestions from the series. 

Ali Curi: Before we get to our conversation, let's learn a little bit more about you. Tell us about your background and what your current role and responsibilities are at ION.

Sourabh Verma: Sure, Ali. So I've been with ION for over 14 years now. I'm a subject matter expert on financial risk management and hedge accounting. And I've spent over 12 years in consulting. Throughout my 12 years in consulting, I've worked with over 50 treasury customers solving their treasury problems and providing best practice suggestions.

In my current role, I head product marketing for ION Treasury. And I also run Hedge Accounting Technical Task Force, which is a specialized service geared towards addressing complex challenges faced by our customers. What we do at Hedge Accounting Technical Task Force is we provide technical insights and best practice suggestions.

Ali Curi: That's great, Saurabh. Now, what can you tell our audience to set the stage for today's topic? 

Sourabh Verma: I'm sure our listeners are already exposed to economic hedging, as it's really a must to protect yourself against adverse market movements. But economic hedging may not help you when it comes to managing volatility in financial statements.

Maybe, let me explain with an example here. If you buy an FX Forward to hedge your forecasted currency exposure, which is expected to hit your book in six months, you've essentially locked an FX all-in rate, and as such your net cash flow is defined. Any future FX volatility is not going to change your net cash flow except maybe a systemic or counterparty credit risk event.

But did that help you to manage your volatility in P&L for the next six months? The answer is actually no. That's because your financial instrument needs to be mark-to-market every month, which exposes you to P&L volatility throughout the next six months. And if your company is listed on stock exchanges, that volatility can really influence your quarterly reporting.

That's where hedge accounting can help, because hedge accounting enhances the basis for recognizing gains and losses on your hedging instruments by simply matching the timing of their impact, combining it with the hedged items. 

Ali Curi: So that's really thought provoking Sourabh. So, as I understand it, it's really about matching the timing of hedged items and hedged instruments hitting your financial statements.

Will you explain the key changes introduced by IFRS 9 and how they differ from the predecessor IAS 39? 

Sourabh Verma: Sure, Ali. Let me first start with IFRS 9 and for the benefit of our listeners, let me clarify that IFRS 9 covers three main areas; classification and measurement of financial instruments, impairment of financial assets, and then finally, hedge accounting.

So for the purposes of this podcast, I will keep it restricted to key changes introduced for hedge accounting only. Number one change is, under previous standard, which was IAS 39, a hedge relationship was considered effective only if the offset with hedged item was within 80 to 125 range. IFRS 9 has actually relaxed this assessment test and instead the standard outlines the principles based criteria without any thresholds.

This principles based criteria looks at economic relationship, hedge ratio, and credit risk as three main factors. A consequence of this change is the ability to assess a hedge relationship qualitatively, which really simplifies the application of hedge accounting. However, do bear in mind that companies can still choose to assess quantitatively, if they do want that. 

Ali Curi: I do think that eliminating this 80 to 125 range would have really been appreciated by corporate treasuries, but let's cover the operational impact later. Let's continue with the key changes. 

Sourabh Verma: The second changes under previous standard currency basis element of a derivative could not be excluded from hedge effectiveness testing, and this either resulted in some noise or hedge ineffectiveness flowing into P&L. And sometimes it even led to failure of hedge effectiveness, which meant taking the entire derivative mark-to-market movement to profit and loss account. IFRS 9 has actually addressed this major issue by introducing a new accounting treatment for currency basis. And now you can actually apply cost of hedge treatment to currency basis by excluding it from hedge effectiveness, parking it in excluded component OCI under balance sheet.

And from there on amortizing it to P&L. Similarly, option time value and forward points can now be considered as cost of hedge, excluded from hedge effectiveness testing, parked in excluded component OCI account and amortized to P&L from there. How exactly these are amortized is further dependent on whether the hedged item is transaction based or time period based.

The third change is around how carrying amount of hedged item can be reclassified from OCI account to asset liability accounts and then from there to P&L account. The treatment really depends on the nature of underlying hedge transaction here. Finally, the fourth change, an entity can now designate aggregated exposures as hedged items.

So these aggregated exposures can be a combination of an exposure and a derivative. And this combination can also be across asset classes. To give an example here, companies now have the ability to combine commodity price risk and foreign currency risk as part of one hedge relationship. I think all these four changes now allow entities to better reflect its risk management activities in the financial statements.

Ali Curi: Great. Thank you for that. I particularly like the fact that it allows entities to better reflect its risk management activities. Are we there yet in terms of this alignment? Also, what about changes introduced by US GAAP ASC 815? 

Sourabh Verma: Still a long way to go, Ali, in terms of alignment. Future changes such as dynamic risk management accounting model are expected to bring in more parity. But let's see, with respect to ASC815, I would say changes introduced are very similar. IFRS 9 went live first, of course, followed by ASC815. So, rather than talking about changes introduced by ASC815, let me summarize the differences between both ASC815 and IFRS 9. And that would be quite relevant for our listeners who operate globally and comply with both the standards. 

In general, ASC 815 includes additional guidance and considerations to analyze, whereas IFRS 9 is more principles based. The result is that some instruments are reported differently on an entity's financial statement.

One key difference is around characteristics of a derivative, which may result in difference around classification of certain instruments. Then there is difference on how a hybrid instrument is evaluated. Also there is a difference in terms of accounting for hedge ineffectiveness of noise. Under AS815, if hedge relationship is deemed to be highly effective, the entire change in fair value of derivative is recognized in other comprehensive income or OCI.

Under IFRS 9 though, the change is split between effective portion and ineffective portion, which immediately goes to P&L. There are other technical differences such as partial term hedging for fair value hedges, which is only allowed under ASC 815 and not IFRS 9. ASC 815 further allows portfolio layered method and we're seeing a lot of interest from corporates on that.

Ali Curi: So, minor differences in treatment, but overall, the changes introduced are similar in nature. And how have the new standards under IFRS 9 and ASC 815 impacted the day-to-day operations of corporate treasuries? 

Sourabh Verma: I think more and more corporates have actually benefited from this in terms of day to day operations.

It's much more simple to apply hedge accounting now, particularly if you elect qualitative method for effectiveness assessment. Further, cost of hedge treatment has really improved the way organizations can reflect their risk management activities in their financial statements. So I think now the big question is not how to apply and manage hedge accounting.

The big question is how to apply cost of hedge treatment. How to calculate currency basis and forward points, how to amortize to P& L, and what methodology to consider in this area. 

Ali Curi: So now is the perfect time to ask this next question. From an operational standpoint, what are the biggest challenges that treasuries face when implementing new standards? And what can you share with us on how they overcome these challenges? 

Sourabh Verma: Sure, Ali. So let me continue from my previous answer. Methodology for calculating currency basis, forward points, and time value, as well as amortization, is not straightforward. Further, if you have aggregated exposures acting as hedged item, the whole structuring of hedge relationship, assessment, and measurement methodology is a bit challenging.

You cannot rely on Excel to manage this. You need to have robust systems such as a treasury management system and other systems, which can do these calculations, relying on well established and tested mathematical models. What I generally recommend to our customers at ION Treasury, and as part of our Hedge Accounting Technical Taskforce engagements, start with a solid foundation by having a clearly defined hedging policy and hedge accounting policy, which can be developed with the help of experts and your auditors.

These policy documents should really capture the hedging strategy and hedge accounting strategy from target hedge ratio and trade execution to hedge designation and effectiveness testing. Then comes the question of finding the right tools that enable you to define an effective workflow. All process steps, along with technical ability to generate these numbers accurately in compliance with the standards.

Jocelyn: This episode is brought to you by ION. At ION, our Hedge Accounting Technical Task Force, or HATT, gives customers access to a dedicated international think tank of experts in financial risk management and hedge accounting. HATT helps you stay ahead of the curve with the latest regulatory changes and offers specialized advisory services.

To learn more, visit us at iongroup.com/treasury or email us at treasury@iongroup.com. 

Ali Curi: Sourabh, let's talk about IBOR a minute. Did the IBOR transition have any impact on hedge accounting application? 

Sourabh Verma: It did. We worked extensively with our clients to RFR index trades, and they did not need to discontinue their hedge relationships if certain requirements were met.

I would say re-papering did cause a lot of confusion on what would classify as a major update to trade terms, and it really differed on a case by case basis. But mostly our clients were able to continue their hedge relationships by updating the trades. This of course brought in some issues around continuation of hedge effectiveness history, but it was easily managed. At this point, I don't see a lot of differences in terms of how RFR trades are being managed versus how IBOR trades are managed within hedge accounting space, except of course, how interest accruals and NPV is calculated for RFR trades. 

Ali Curi: Right. And looking ahead, can you share with our listeners, what new regulatory changes to expect in the hedge accounting space?

Sourabh Verma: Sure. Currently, a new dynamic risk management accounting model is an exposure draft stage. It's headed by ISB, and it's due to come out sometime in 2025. That's a big one, but it may not go live before 2028. So we still have a bit of a time on that. In first phase, it will impact banks and financial institutions, and in second phase, corporates.

The objective of this new accounting model is to better reflect an entity's interest rate risk management strategy and activities in its financial statements. The proposed framework is quite interesting from my perspective, and it seeks to replace existing macro hedge accounting model within IFRS 9.

Ali Curi: Yeah, that is interesting. Now tell us more about the role of technological solutions in managing compliance with IFRS 9 and ASC 815. Automation is important, so how does integrating a treasury management system and an enterprise resource system benefit accounting and hedge accounting processes? 

Sourabh Verma: Well, most ARPs do offer valuation and hedge accounting capabilities, but they do not have advanced or specialized functionality or workflow to manage the hedge accounting processes.

Particularly, quantitative hedge effectiveness testing and cost of hedge treatment are two areas where I think specialized systems are really important. That's where the role of a TMS with this advanced functionality becomes important. Many of our clients use our TMSs to manage their derivative portfolio, mark-to-market, apply hedge accounting, generate ledger, and export their data to their ERP seamlessly.

This essentially takes care of accuracy, compliance, and integration angle very well. 

Ali Curi: Sourabh, what is the one big thing you hope listeners would take away from this episode? 

Sourabh Verma: That hedge accounting is much simpler now, and it's more aligned to risk management practices. But with knowledge of certain important points, well-defined hedge accounting policy and automation, I think the entire process can pretty much run on autopilot with minimal intervention from Treasury users.

Ali Curi: And now, Sourabh, I'm going to deviate a little bit and have a career advice question for you. What is the one or two things you wish you had implemented earlier in your career? 

Sourabh Verma: Though I did implement this early on in my career, but of course, earlier the better. That is, look at the big picture. Your role may require you to focus on one area.

Or develop expertise in one domain, but never lose sight of big picture. Ask questions, ask yourself, how do my actions help or influence the big picture? And that will allow you to take smarter and effective decisions, I think. 

Ali Curi: Sourabh Verma, thank you for joining us today and for sharing your insights. I look forward to our next episode.

Sourabh Verma: Thanks Ali. 

Ali Curi: And that's our episode for today. You can follow ION Treasury on X and on LinkedIn. Thank you for joining us.