HKAS 39 - Financial Instruments - Recognition and Measurement (Condensed)

1. Introduction & Scope

Background

HKAS 39 has been largely replaced by HKFRS 9. However, HKAS 39 remains effective for hedge accounting because HKFRS 9 permits an entity to choose to apply either the hedge accounting requirements of HKFRS 9 or continue to apply those in HKAS 39.

Scope (Paragraph 2)

This Standard shall be applied by all entities to all financial instruments within the scope of HKFRS 9 if, and to the extent that:

• HKFRS 9 permits the hedge accounting requirements of this Standard to be applied; and
• The financial instrument is part of a hedging relationship that qualifies for hedge accounting in accordance with this Standard.

2. Definitions

Terms Defined in Other Standards (Paragraph 8)

Definitions Relating to Hedge Accounting (Paragraph 9)

• Firm commitment: A binding agreement for the exchange of a specified quantity of resources at a specified price on a specified future date or dates.
• Forecast transaction: An uncommitted but anticipated future transaction.
• Hedging instrument: A designated derivative or (for a hedge of the risk of changes in foreign currency exchange rates only) a designated non-derivative financial asset or non-derivative financial liability whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item.
• Hedged item: An asset, liability, firm commitment, highly probable forecast transaction or net investment in a foreign operation that exposes the entity to risk and is designated as being hedged.
• Hedge effectiveness: The degree to which changes in the fair value or cash flows of the hedged item that are attributable to a hedged risk are offset by changes in the fair value or cash flows of the hedging instrument.

3. Hedging Instruments

Qualifying Instruments (Paragraphs 72-73)

General Rule: This Standard does not restrict the circumstances in which a derivative may be designated as a hedging instrument, provided the conditions in paragraph 88 are met.

External Party Requirement: Only instruments that involve a party external to the reporting entity can be designated as hedging instruments. Intragroup transactions are eliminated on consolidation and therefore do not qualify for hedge accounting in consolidated financial statements. However, they may qualify in individual or separate financial statements.

Designation of Hedging Instruments (Paragraphs 74-77)

General Rule: A hedging relationship is designated for a hedging instrument in its entirety. There is normally a single fair value measure for a hedging instrument.

Permitted Exceptions:

• Separating the intrinsic value and time value of an option contract and designating only the change in intrinsic value as the hedging instrument.
• Separating the interest element and the spot price of a forward contract.

Proportion Designation: A proportion of the entire hedging instrument (e.g., 50% of the notional amount) may be designated. However, a hedging relationship may not be designated for only a portion of the time period during which a hedging instrument remains outstanding.

Multiple Risks: A single hedging instrument may be designated as a hedge of more than one type of risk provided that the risks hedged can be identified clearly, the effectiveness of the hedge can be demonstrated, and it is possible to ensure specific designation of the hedging instrument and different risk positions.

4. Hedged Items

Qualifying Items (Paragraphs 78-80)

A hedged item can be:

• A recognised asset or liability
• An unrecognised firm commitment
• A highly probable forecast transaction
• A net investment in a foreign operation

Group Designation: A group of items with similar risk characteristics may be designated as hedged items.

External Party Requirement: Only items that involve a party external to the entity can be designated as hedged items.

Designation of Financial Items as Hedged Items (Paragraphs 81-81A)

Portion Hedging: If the hedged item is a financial asset or financial liability, it may be a hedged item with respect to the risks associated with only a portion of its cash flows or fair value provided that effectiveness can be measured.

Portfolio Hedge of Interest Rate Risk: In a fair value hedge of the interest rate exposure of a portfolio of financial assets or financial liabilities, the portion hedged may be designated in terms of an amount of a currency rather than as individual assets (or liabilities). Designation of a net amount including assets and liabilities is not permitted.

Designation of Non-Financial Items as Hedged Items (Paragraph 82)

If the hedged item is a non-financial asset or non-financial liability, it shall be designated as a hedged item:

• For foreign currency risks; or
• In its entirety for all risks

This restriction exists because of the difficulty of isolating and measuring the appropriate portion of the cash flows or fair value changes attributable to specific risks other than foreign currency risks.

5. Hedge Accounting - Types & Conditions

Types of Hedging Relationships (Paragraphs 85-87)

Conditions for Hedge Accounting (Paragraph 88)

A hedging relationship qualifies for hedge accounting if, and only if, all of the following conditions are met:

1. Formal Designation and Documentation: At inception, there is formal designation and documentation of the hedging relationship, risk management objective, hedging instrument, hedged item, nature of risk, and effectiveness assessment method.
2. Expected High Effectiveness: The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk.
3. Highly Probable Forecast Transaction (for cash flow hedges): A forecast transaction that is the subject of the hedge must be highly probable and must present an exposure to variations in cash flows that could ultimately affect profit or loss.
4. Reliable Measurement: The effectiveness of the hedge can be reliably measured.
5. Ongoing Assessment: The hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designated.

5. Hedge Accounting - Effectiveness & Accounting

Assessing Hedge Effectiveness (AG105-AG113A)

Definition of Highly Effective (AG105): A hedge is regarded as highly effective only if both of the following conditions are met:

• Prospective Test: At inception and in subsequent periods, the hedge is expected to be highly effective.
• Retrospective Test: The actual results of the hedge are within a range of 80-125 per cent.

Fair Value Hedges (Paragraphs 89-94)

Accounting Treatment:

• Hedging Instrument: The gain or loss from remeasuring the hedging instrument at fair value shall be recognised in profit or loss.
• Hedged Item: The gain or loss on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognised in profit or loss.

Cash Flow Hedges (Paragraphs 95-101)

Accounting Treatment:

• Effective Portion: The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge shall be recognised in other comprehensive income (OCI).
• Ineffective Portion: The ineffective portion of the gain or loss on the hedging instrument shall be recognised in profit or loss.

Hedges of a Net Investment (Paragraph 102)

Hedges of a net investment in a foreign operation shall be accounted for similarly to cash flow hedges: the effective portion in OCI and the ineffective portion in profit or loss.

6. Interest Rate Benchmark Reform - Temporary Exceptions

Scope and Application (Paragraphs 102A-102C)

These paragraphs apply only to hedging relationships directly affected by interest rate benchmark reform. A hedging relationship is directly affected if the reform gives rise to uncertainties about:

• The interest rate benchmark designated as a hedged risk; and/or
• The timing or the amount of interest rate benchmark-based cash flows of the hedged item or of the hedging instrument.

Temporary Exceptions (Paragraphs 102D-102I)

• Highly Probable Requirement: An entity shall assume that the interest rate benchmark on which the hedged cash flows are based is not altered as a result of interest rate benchmark reform.
• Reclassification of Cumulative Gain/Loss: For the purpose of determining whether the forecast transaction is no longer expected to occur, an entity shall assume that the interest rate benchmark is not altered as a result of the reform.
• Effectiveness Assessment: An entity shall assume that the interest rate benchmark is not altered as a result of the reform. An entity is not required to discontinue a hedging relationship because the actual results do not meet the retrospective effectiveness requirements.

Phase 2 Amendments - Changes Required by Reform (Paragraphs 102P-102Z3)

As and when the temporary exceptions cease to apply, an entity shall amend the formal designation of the hedging relationship to reflect changes required by interest rate benchmark reform. Such an amendment constitutes neither the discontinuation of the hedging relationship nor the designation of a new hedging relationship.

7. Portfolio Hedge of Interest Rate Risk - Application Guidance (AG114-AG132)

7. Portfolio Hedge of Interest Rate Risk - Application Guidance

Procedures for Portfolio Fair Value Hedge (AG114)

For a fair value hedge of interest rate risk associated with a portfolio of financial assets or financial liabilities, an entity would meet the requirements of this Standard if it complies with the following procedures:

1. Identify Portfolio: Identify a portfolio of items whose interest rate risk it wishes to hedge. The portfolio may comprise only assets, only liabilities or both.
2. Analyse into Repricing Time Periods: Analyse the portfolio into repricing time periods based on expected, rather than contractual, repricing dates.
3. Determine Hedged Amount: Decide the amount to hedge. Designate as the hedged item an amount of assets or liabilities (but not a net amount) from the identified portfolio.
4. Designate Hedged Risk: Designate the interest rate risk being hedged (e.g., a benchmark interest rate such as LIBOR).
5. Designate Hedging Instruments: Designate one or more hedging instruments for each repricing time period.
6. Assess Effectiveness: Assess at inception and in subsequent periods whether the hedge is expected to be highly effective.
7. Measure Change in Fair Value of Hedged Item: Periodically measure the change in the fair value of the hedged item attributable to the hedged risk and recognise it in profit or loss and in a separate line item in the statement of financial position.
8. Measure Change in Fair Value of Hedging Instrument: Measure the change in fair value of the hedging instrument and recognise it in profit or loss.
9. Recognise Ineffectiveness: Any ineffectiveness will be recognised in profit or loss as the difference between the change in fair value of the hedged item and the hedging instrument.

Expected Repricing Dates (AG117)

The expected repricing date of an item is determined as the earlier of the dates when that item is expected to mature or to reprice to market rates.

Sources of Ineffectiveness (AG124)

Ineffectiveness may arise from:

• Actual repricing dates being different from those expected, or expected repricing dates being revised.
• Items in the hedged portfolio becoming impaired or being derecognised.
• Payment dates of the hedging instrument and the hedged item being different.
• Other causes (e.g., when some hedged items bear interest at a rate below the benchmark rate).