Portfolio Hedge Accounting: continuing to grapple with IAS 39

The financial markets have their fair share of obscure and confusing concepts and jargon. The topic of portfolio macro hedge accounting is a good example. Essentially an accounting technique intended to eliminate volatility in financial statements, it is not an easy topic. But the basics can be illustrated by taking a simple example:

  • A bank has advanced a portfolio of fixed rate loans
  • A rise in interest rates is a risk to the bank: it will reduce the value of the loans
  • The bank protects against this interest rate risk by entering into an interest rate swap(s)
  • This swap is a deal the bank enters with a third party to eliminate the interest rate risk
  • The bank may or may not adopt the portfolio macro hedge accounting technique
  • If it does not its accounts will treat the swap(s) in a manner which results in an accounting gain or loss, despite being an economic hedge
  • By adopting the technique the bank mitigates this mismatch between accounting treatment and economic reality in its accounts

Many banks do adopt macro hedge accounting, but applying the current accounting standard (IAS 39) in this area is difficult: many issues are unclear or require interpretation. A 2014 initiative by the IASB to develop a new approach appears to have been quietly shelved. The market is therefore left grappling with the application of IAS 39 . One specific scenario which can arise in practice – the swap(s) in question are cancelled – throws up a variety of considerations. Different methodologies and approaches to this scenario will result in quite different outcomes, some unwelcome: extraordinary adjustments to accounts due to overstatements in previous accounts can even be required. Our ALMIS Hedge Accounting provides an efficient solution which avoids the pitfalls. For a more detailed article on the swap cancellation scenario click here.