This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to the International Accounting Standards Board in January 2008:
Dear Sir,
Exposure Draft of Proposed Amendments to IAS 39 Financial Instruments: Recognition and Measurement
Exposures Qualifying for Hedge Accounting
We are pleased to have the opportunity to comment on the above Exposure Draft issued by the International Accounting Standards Board (IASB), on behalf of BDO International1.
Overall, we support the proposals in the Exposure Draft as we believe that they will bring much needed clarity to the issues raised. While we would be more in favour of a principles based approach to the identification of what can be designated as the hedged item in an IAS 39 compliant hedging relationship, we agree that this approach is unlikely to be feasible in the context of the structured, rules based approach of IAS 39.
We note that the scope of the amendments is restricted to cover financial items only. As discussed in our response to the specific questions below, we believe that certain of the proposals may have an effect (or implied effect) on hedging arrangements involving non financial items. We would therefore encourage the IASB to consider, and issue for comment, proposals to clarify which exposures for non financial items might qualify for hedge accounting.
Our specific responses to your questions are set out below.
Question 1 – Specifying the qualifying risks
The proposed amendments restrict the risks qualifying for designation as hedged risks to those identified in paragraph 80Y.
Do you agree with the proposal to restrict the risks that qualify for designation as hedged risks? If not, why? Are there any other risks that should be included in the list and why?
We agree that restrictions should be placed around the risks that qualify for designation as hedged risks. However, we believe that the list as drafted is incomplete.
Some entities invest in equity securities which are not denominated in the investing entity’s functional currency, meaning that they are exposed to both foreign exchange and equity price risk. The effect of paragraph 80Y appears to be that the entity would be able to hedge either all risks or foreign currency risk, but not equity price risk. We therefore suggest that equity price risk should be added to paragraph 80Y.
Paragraph 80Y(d) proposes that prepayment risk can be designated as the hedged item in a qualifying hedging relationship. While we agree with this proposal, we note that this could result in the designation of a non separable written option (e.g. a prepayment option in a fixed rate loan advanced by a bank). This would appear to conflict with the guidance set out in IAS 39 AG94 and IAS 39 IG F.2.1 which prohibit the designation of a written option unless it is designated as an offset to a purchased option. We suggest that the IASB clarifies the guidance to eliminate this apparent inconsistency.
Question 2 – Specifying when an entity can designate a portion of the cash flows of a financial instrument as a hedged item
The proposed amendments specify when an entity can designate a portion of the cash flows of a financial instrument as a hedged item.
Do you agree with the proposal to specify when an entity can designate a portion of the cash flows of a financial instrument as a hedged item? If you do not agree, why?
Are there any other situations in which an entity should be permitted to designate a portion of the cash flows of a financial instrument as a hedged item? If so, which situations and why?
We agree in principle with the proposals. However, we believe that further consideration may be appropriate, in particular of the consequences of the proposed amendments on hedge accounting for non financial items.
While we acknowledge that the scope of the proposals extends to cover financial items only, the drafting of the proposals may have a significant effect on hedging arrangements involving non financial items, as the proposals in paragraph 80Z imply that percentages and one sided risks are always viewed as being portions. We note that IAS 39.82 restricts the designation of non financial items due to difficulties in, for example, ‘……isolating and measuring the appropriate portion of cash flows…….’. The effect of paragraph 80Z might be viewed as prohibiting the designation of percentages and one sided risks arising from non financial items, which we believe would be inappropriate.
We agree with the proposed guidance in paragraph AG99E dealing with hedging using options. However, there are other circumstances where hedging instruments might contain cash flows arising from time value that do not exist in the hedged item (eg where a forward exchange contract is used to hedge the net investment in a foreign subsidiary). It would be helpful for the IASB to take the opportunity to clarify the approach which should be followed.
Although paragraph 80Z refers only to cash flow hedging relationships, we can see no reason why it should not equally be applied to fair value hedging relationships. We suggest that the references within the paragraph are expanded to refer to both cash flow and fair value hedges. This would avoid potential for conflict between paragraph 80Z and IAS 39.81, which explicitly permits hedge accounting for a proportion or percentage of fair value.
Question 3 – Effect of the proposed amendments on existing practice
The aim of the proposed amendments is to clarify the Board’s original intentions regarding what can be designated as a hedged item and in that way to prevent divergence in practice from arising.
Would the proposed amendments result in a significant change to existing practice? If so, what would those changes be?
We do not believe that the proposals would result in a significant change to existing practice, other than for those entities which might have included the time value of an option in a hedging relationship, where the time value does not exist in the hedged item.
Question 4 – Transition
The proposed changes would be required to be applied retrospectively.
Is the requirement to apply the proposed changes retrospectively appropriate? If not, what do you propose and why?
We do not agree that the proposed changes should be applied retrospectively. Instead, we consider that any hedging relationships which do not qualify for hedge accounting under the new guidance should be dedesignated at the point at which the amendments are adopted and redesignated (if desired and if permitted) in a new hedging relationship.
This approach would be consistent with that previously adopted following changes to hedging requirements. It would also be consistent with the approach which was adopted following changes to the fair value option, where financial assets and liabilities which no longer qualified to be measured at fair value through profit or loss were not retrospectively restated, instead being redesignated at the date on which the revised requirements were adopted.
Should you wish to discuss our comments further, please contact:
Helen Thomson, ph: +32 (0)2 778 01 30, or
Andrew Buchanan, ph: +44 (0)20 7893 3300.
Yours faithfully,
BDO Global Coordination B.V.
1BDO International is a world wide network of public accounting firms, called BDO Member Firms, serving international clients. Each BDO Member Firm is an independent legal entity in its own country.
The network is coordinated by BDO Global Coordination B.V., incorporated in the Netherlands, with an office in Brussels, Belgium, where the Global Coordination Office is located.
Exposure Draft, Comments due 11 January 2008: