Why are we doing this project?
The IASB learnt from banks and other entities that addressing situations in which entities use a dynamic risk management strategy was important. Dynamic risk management of open portfolios introduces a level of complexity that becomes difficult to address when using the current hedge accounting requirements.
One of the objectives of the IASB is to align, as far as possible, accounting with an entity’s dynamic risk management activities. The work on this project to date has been focused on obtaining an understanding of the dynamic risk management activities that are commonly undertaken by banks when they are dynamically managing interest rate risk arising from open portfolios. The work has also considered whether such practices could be usefully included within an accounting approach. However, the intention of the IASB is not to restrict the application of the Discussion Paper only to interest rate risk.
What is the approach being explored in the Discussion Paper?
The Discussion Paper (DP) outlines a possible approach to accounting for an entity’s dynamic risk management activities. The approach is the portfolio revaluation approach (PRA). In the PRA, the exposures managed in open portfolio(s) would be identified and revalued for changes in the managed risk with any gains or losses being recognised in profit or loss. Any derivatives used to mitigate the managed risk would be measured at fair value through profit or loss. The net effect would then be reflected in profit or loss. The PRA aims to provide useful information about entities’ dynamic risk management activities in their financial statements, to better reflect economic volatility in profit or loss and reduce operational complexity.
Who would be affected by the preliminary views in the Discussion Paper?
The preliminary views in the DP are potentially relevant to all entities that manage risks in open portfolios on a dynamic basis. This is because the intention of the IASB is to understand whether the development of an accounting approach for dynamic risk management activities, which would accommodate the management of different types of risks, is necessary.
Nevertheless, the DP includes a comprehensive overview of dynamic interest rate risk management in the banking sector, because it is a well-known and documented dynamic risk management activity.
How is this linked with the general hedge accounting in requirements in IAS 39 and IFRS 9?
The Accounting for Dynamic Risk Management project was initially part of IFRS 9 Phase III: hedge accounting. The IASB realised that the development of a thorough new accounting approach for dynamic risk management would take time and this conflicted with the time line for IFRS 9. Consequently, in May 2012 the IASB decided to separate the two projects, allowing it to continue the finalisations of IFRS 9 as planned while developing an accounting approach for dynamic risk management as a separate project.