Hedge Accounting Stay with IAS 39 Or Move to IFRS 9?

FINANCIAL SERVICES Hedge Accounting Stay with IAS 39 or move to IFRS 9?

5. Oktober 2015 Disclaimer

The following slides were prepared to be held in combination with spoken word. The slides standing alone might not give a comprehensive and correct picture of the topic. The slides were prepared with care and due diligence. However they are no basis for any business decision and FAS AG does not take any responsibility for potential mistakes and losses due to any information taken from the slides. The slides were prepared by FAS AG and shall not be used or copied for any business purpose without explicit permission by FAS AG

Background and historic development of hedge accounting under IFRS 9 Requirements for hedge accounting under IFRS 9 Implementation of hedge accounting under IFRS 9 Discussion

Reasons to overhaul hedge Objective accounting

The objective of hedge Stronger alignment of risk accounting is to represent in management and (hedge) the financial statements the accounting effect of an entity’s risk Too rule based IAS 39 management activities when rules they use financial instruments Development in risk to manage exposures arising management practice from particular risks and Insufficient disclosures those risks could affect profit or loss

Mai 21th 2014: May 30th 2012: Nov. 19th 2013: Decision to first Decision to ??th of ?? 20?? Completion of focus on decouple macro Standard on IFRS 9 phase III: disclosures and hedging from macro hedge hedge issue an new IFRS 9 and issue accounting accounting discussion paper in an own standard the future

Dec. 9th 2010: April 17th 2014: January 1st 2018: Exposure draft Discussion paper July 24th 2014: First time on hedge on accounting for IFRS 9 was application of IFRS accounting was macro hedging issued 9 – including new issued was issued hedge accounting?

Is the PRA overall rather appoved or Feedback by industry rejected? 50 37 19 17 16 18 25 10 9 4 0 25% 62% 13% approved rejected no answer

Question15 – On which part of the Feedback by region portfolio the PRA should be applied? 100 84 75 50 18 25 12 5 9 9% 64% 2% 25% 3 0 Comprehensive only risk mitigation other No answer Choice to apply IFRS 9 or to stay with IAS 39 (hedge accounting)

Apply IAS 39 hedge accounting rules for all types of hedges (micro/ macro, CFH/FVH) Apply general hedge accounting rules after macro hedge is established (no matter if macro hedge rules itself are applied) 1st of January 2018 Apply IFRS 9 hedge accounting rules on micro hedge relationships Apply IAS 39 for portfolio fair value hedges until new macro hedge standard is developed (then change to macro hedge) Agenda

Background and historic development of hedge accounting under IFRS 9 Requirements for hedge accounting under IFRS 9 Implementation of hedge accounting under IFRS 9 Discussion

Linked to risk management practice Rebalancing

Designation of non-derivatives Cost of hedging

IFRS 9 Combination of derivatives and non Discontinuation of hedge accounting derivatives as hedging items hedge

Designation of risk components of non accounting Domination of credit risk financial hedged items requirements Reversible fair value option for credit Designation of layers risk

Effectiveness assessment Designation of net positions

Fair value hedge Cash flow hedge XYZ Bank XYZ Bank XYZ Bank 5% loan 3M Euribor 10Y debt 10Y 3M Euribor 5% loan 3M Euribor 5% loan 10Y 10Y debt 10Y 4% fix vs 3M Euribor payer swap debt 10Y 4% fix vs 3M Euribor payer swap

4% fix vs 3M Euribor payer swap Generaly fair value Designation of net hedge is in line with derivatives with “matching” economic PV based view hedged items usually is not Risk management on in line with PV based risk portfolio level does not management and treasury differ between hedged Economic relationship between all three “In the case of cash flow item and hedging item positions hedge accounting, so- Economic micro positions called ‘proxy hedging’ is still (e.g. asset swaps) are in Risk management approach usually to an eligible way to de- line with risk swap any fix cash flows to 3M / 6M floating signate a hedged item in management Risk management only looks on the PV of accordance with IFRS 9 as total net cash flow long as the designation Net interest margin is 1% reflects risk management”

Actual treatment is unsure but on a general level it might be difficult to show a link between risk management and hedge accounting for the whole business – a combination between IAS 39 PFVH and IFRS 9 micro hedge might be necessary

Insignificant credit risk What is the relevant trigger The effect of credit risk means that for credit risk domination even if there is an economic Historic relationship between the hedging General possibility instrument and the hedged item, the Likely event level of offset might become erratic. Is there a link between This can result from a change in the impairment stages and credit credit risk of either the hedging risk domination? instrument or the hedged item that is When is credit domination of such a magnitude that the credit risk reached? dominates the value changes that Significant credit risk Changing signs in result from the economic relationship. total FV changes A level of magnitude that gives rise to Full Offsetting FV dominance is one that would result in changes the loss (or gain) from credit risk Significant counter frustrating the effect of changes in the effect underlyings on the value of the Transfer from hedging instrument or the hedged impairment stage item, even if those changes were 2 to 3? significant. Total FV changes hedging item Total FV changes hedged item FV changes hedged item due to hedged risk FV changes hedged item due to credit risk FV changes hedging item due to hedged risk FV changes hedging item due to credit risk Actual implementation of domination of credit risk is open but it can be assumed that for most hedge relationships this should not reduce the applicability of IFRS 9

Transaction related hedged item (e.g. purchase of a bond) Recognition in OCI until transaction occurs Reguatory Under IFRS 9 the following Recognition in P/L when transaction affects treatment is components might be excluded P/L resp. recognition in initial acquisition cost from designation: open time value of options 50 Net FV hedging Forward elements of forward instrument 0 contracts 1 2 3 4 5 6 7 FV hedged item FX basis spreads of financial -50 instruments AC cost of hedging -100 Cost of hedging Instead of recognition in profit or componente loss the change in those -150 components might (for options has to) be recorded depending Time period related hedged item (e.g. hedge of Definition of on the hedged item FX risk of an existing bond) rational basis Recognition in OCI Amortization of initial amount into P/L on is missing rational basis

Recognition of changes of cost of hedging in P/L and rational amortization reduces P/L volatility and increases effectivity – regulatory treatment is still open

Linked to risk management practice Rebalancing

Designation of non-derivatives Cost of hedging

IFRS 9 Combination of derivatives and non Discontinuation of hedge accounting derivatives as hedging items hedge

Designation of risk components of non accounting Domination of credit risk financial hedged items requirements Reversible fair value option for credit Designation of layers risk

Effectiveness assessment Designation of net positions

Background and historic development of hedge accounting under IFRS 9 Requirements for hedge accounting under IFRS 9 Implementation of hedge accounting under IFRS 9 Discussion

Objective

Alternatives to Internal hedge Hedged items accounting deals

Full Disclosure Presentation Hedge Hedging of and disclosure Accounting instruments economic hedging

Groups and Effectiveness net positions assessment Dynamic risk Dicontinuation and manage- rebalancing ment

Cost of implementation (processes, tools, etc.) to move to IFRS 9 IAS 39 adoption on new categorization will also require adjustments of current process General policies, workarounds and methods under IAS 39 can generally be kept Unsureness about praxis development and definition of terms and actual requirements (also chance to shape praxis requirements) Not sure what choices and hedges may be revoked on first time application of macro hedging Schedule for macro hedge development is unclear (DP later than 6 month) Agenda

Background and historic development of hedge accounting under IFRS 9 Requirements for hedge accounting under IFRS 9 Implementation of hedge accounting under IFRS 9 Discussion