Submission to the IASB - Reducing Complexity in Reporting Financial Instruments

22 September 2008

Sir David Tweedie
Chairman
International Accounting Standards Board
30 Cannon Street
London EC 4M 6XH
UNITED KINGDOM

Dear Sir David

Reducing Complexity in Reporting Financial Instruments

The Group of 100 (G100) is an organisation of chief financial officers from Australia’s largest business enterprises with a purpose of advancing Australia’s financial competitiveness. The G100 is pleased to provide comments on the Discussion Paper ‘Reducing Complexity in Reporting Financial Instruments’.

Overall, the G100 supports the IASB’s objective of reducing complexity in accounting for financial instruments and supports transparency of financial information. However, we are concerned that the IASB is dealing with aspects of accounting for financial instruments, including measurement, in advance of important work being undertaken on other IASB projects. For example, there is a risk that decisions on the appropriate measurement bases for financial assets and liabilities will pre-empt the outcomes of the current Conceptual Framework project. We do not believe that the measurement of financial instruments should be determined in isolation from such projects.

We note the increasing emphasis by standard-setters on the use of fair value. While fair value may conceptually be an appropriate measurement model, we have significant concerns about how changes in fair value should be presented in an entity’s income statement, and how they marry with the entity’s performance measurement objectives. Our position is that fair value will be an appropriate measurement model when, and only when, entities use fair value for risk management purposes and efficient and active markets exist for all financial instruments. Furthermore, users of financial instruments must find fair value as the most relevant measure in order for it to be meaningful.

The Discussion Paper acknowledges many concerns which need to be addressed prior to full implementation of a fair value measurement model, such as artificial stability and volatility, difficulty in estimating fair value and the presentation of gains and losses which may never be realised. These are significant issues and their resolution is a necessary condition to the adoption of fair value as a long-term solution.

Our responses to specific questions follow:

Question 1
Do current requirements for reporting financial instruments, derivative instruments and similar items require significant change to meet the concerns of preparers and their auditors and the needs of users of financial statements? If not, how should the IASB respond to assertions that the current requirements are too complex?

Financial instruments may have multiple, fundamentally different purposes. Some instruments are entered into for short term gain, others to receive contractual cash flows over their life and others for risk management purposes. The current mixed measurement model reflects these differences. While the current requirements are complex, any measurement model must take into account the varying nature and purpose of financial instruments. A full fair value approach to measuring financial instruments (with fair value movements taken through the profit and loss account) in our view would not appropriately reflect the performance impact relating to the intended use of all instruments. A fair value approach with allowable exceptions (opt outs) would in practice differ little from a mixed measurement model. We need to accept complexity as a reality.

It is our position that the existing measurement requirements, while in some aspects complex, are bedded down and implemented within the financial community. Further changes, motivated by a need for improvement, will necessitate modifications of systems, increase costs and create potential confusion for users and preparers of financial statements while providing little relief to the complexity issues for the reasons discussed above. The more fundamental concerns from our perspective relate to improving the existing standards to address practical issues and specific problem areas such as hedge accounting and the incurred loss model for impairment measurement.

The G100 believes that the requirements need to be aligned with the IASB’s principles-based approach to standard setting rather than the current rules-based requirements that govern accounting for financial instruments.

We believe that the current project should aim to be an interim measure focused on resolving specific problem areas (such as cross currency swaps) many of which are not addressed in the DP. These are identified in responses to questions below.

Question 2
(a) Should the IASB consider intermediate approaches to address complexity arising from measurement and hedge accounting? Why or why not? If you believe that the IASB should not make any intermediate changes, please answer questions 5 and 6, and the questions set out in Section 3.

Yes. Intermediate steps are necessary but it is important to acknowledge that complexity is a reality when dealing with and reporting on financial instruments. Intermediate steps must address the fundamental and practical issues faced by entities when applying the current requirements. Issues relating to hedge accounting give rise to significant problems in implementation and monitoring and are inconsistent with good business practice. The current hedge accounting requirements also induce behaviour and outcomes which are driven by achieving a particular accounting result, rather than being aligned with prudent risk management policies, practices and the underlying economics of transactions and business operations.

(b) Do you agree with the criteria set out in paragraph 2.2? If not, what criteria would you use and why?

The criteria seem reasonable. However, we do not necessarily agree with the objective that full fair value should be the long-term objective at this stage. Instead of this criterion, we propose the following additional criteria:

any approach must be based on a clear principles-based framework underlying the fundamentals of accounting for financial instruments; and
no significant increase in respect of volume and detail of disclosures, as entities, particularly those not engaged in financial intermediation disclosures, are already overburdened in this regard.

Question 3
Approach 1 is to amend the existing measurement requirements. How would you suggest existing measurement requirements should be amended? How are the suggestions consistent with the criteria for any proposed intermediate changes as set out in paragraph 2.2?

The proposed changes to eliminate certain categories of financial instruments such as held-to-maturity and/or eliminate tainting rules are sensible. However, such changes pose practical difficulties given that the existing requirements have been implemented and are operational. As such, they would represent a change which will likely be of marginal benefit compared to those which would result from improved hedging rules and modifications to the incurred loss impairment criteria.

Necessary improvements to the current hedge accounting requirements are outlined in detail under question 6 (d) below. In relation to impairment of financial assets, we believe that expected loss approaches, consistent with sound internal risk ratings and methodologies, provide a better reflection of the economics of the instruments and a better indication of management decisions and performance than the incurred loss methodology.

Expected loss is also consistent with how prudential supervisors regulate entities. While expected loss is a quasi-fair value approach and would typically be applied to an amortised cost financial asset, that “mixed-model” approach does not, in our view, undermine its utility to users of financial reports.

Question 4
Approach 2 is to replace the existing measurement requirements with a fair value measurement principle with some optional exceptions.

(a) What restrictions would you suggest on the instruments eligible to be measured at something other than fair value? How are your suggestions consistent with the criteria set out in paragraph 2.2?

The implication that restrictions are necessary is inconsistent with the notion of developing principles-based standards.

Until such time as the issues outlined above relating to the use of fair value have been appropriately addressed, we would expect that many non-traded financial instruments would require an amortised cost opt-out. Furthermore, given the need for financial performance to reflect the nature and purpose of the underlying instrument, we would also expect fair value movements on equity instruments which are not held for trading and certain hedging arrangements to be recognised in comprehensive income.

Therefore, we do not support the “fair value with optional exceptions” approach on the basis that through the use of the opt out, practically the result will be not dissimilar to the current mixed measurement model. It therefore would not satisfy criteria 4 in paragraph 2.2 (it would not be significant enough to justify the cost of implementation).

(b) How should instruments that are not measured at fair value be measured?

These instruments should be measured at amortised cost or measured at fair value with the fair value movements taken to comprehensive income

(c) When should impairment losses be recognized and how should the amount of impairment losses be measured?

As mentioned above, the G100 considers that an expected loss approach to impairment better reflects the economics of most financial instruments. In addition, if applied consistently with sound internal risk ratings and methodologies, it provides a better indication of management decisions and performance than the current incurred loss methodology. Expected loss is also consistent with the approach taken by prudential supervisors when regulating entities.

(d) Where should unrealized gains and losses be recognized on instruments measured at fair value? Why? How are your suggestions consistent with the criteria set out in paragraph 2.2?

We believe that the treatment of gains and losses on financial instruments should follow the nature and intended purpose of the instrument. For instance, where the instruments relate to the underlying business operations such as sale transactions in a foreign currency, the changes in fair value should be recognised through profit and loss. However, where the instruments relate to financing/funding activities the changes in fair value should be recognised as part of comprehensive income.

(e) Should reclassification be permitted? What types of reclassifications should be permitted and how should they be accounted for? How are your suggestions consistent with the criteria set out in paragraph 2.2?

Yes, where the reclassification reflects a change in the underlying nature/purpose of the instrument.

Question 5
Approach 3 sets out possible simplification of hedge accounting.

(a) Should hedge accounting be eliminated? Why or why not?

No. The G100 considers that the IASB should focus on developing solutions and accounting requirements which faithfully represent the underlying economics and substance of business transactions. Hedging is a legitimate business practice which is undertaken as a risk management activity to reduce the uncertainty relating to the anticipated outcome of business transactions. The act of eliminating hedge accounting would result in accounting standards becoming divorced from business practice and further contribute towards disaffection with the standard-setting process.

(b) Should fair value hedge accounting be replaced? Approach 3 sets out three possible approaches to replacing fair value hedge accounting.

Which method(s) should the IASB consider, and why?

We do not support the full fair value (with all fair value movements through profit and loss) methodology of measuring financial instruments. For this reason we are not seeking a replacement of hedge accounting but rather, as set out below, we believe that the practical issues associated with the current model need to be addressed. We consider that gains and losses on fair value hedging instruments should be recognized as part of comprehensive income and not included in operating earnings.

Are there any other methods not discussed that should be considered by the IASB? If so, what are they and how are they consistent with the criteria set out in paragraph 2.2? If you suggest changing measurement requirements under approach 1 or approach 2, please ensure your comments are consistent with your suggested approach to changing measurement requirements.

Refer comments in the next section.

Question 6
Section 2 also discusses how the existing hedge accounting models might be simplified. At present, there are several restrictions in the existing hedge accounting models to maintain discipline over when a hedging relationship can qualify for hedge accounting and how the application of the hedge accounting models affects earnings. This section also explains why those restrictions are required.

(a) What suggestions would you make to the IASB regarding how the existing hedge accounting models could be simplified?

The current requirements relating to hedge accounting is a rules-based accounting solution to the challenge of recognising the effects of an entity’s risk management practices in financial statements. The G100 considers that the IASB should ultimately adopt an approach which is consistent with the “management approach” to hedge accounting. This would mean that if hedging transactions are consistent with the company’s mandate and the risk management policies, hedge accounting should be permitted. As such, there should not be a need to specify detailed accounting rules relating to the designation of hedges and their effectiveness. As an anti-avoidance measure there may need to be requirements in place that ensure an entity has a documented policy and that this policy outlines formal requirements for designation and ongoing assessment of effectiveness. This constitutes good risk management practices and should underpin all hedging activities that an entity undertakes.

(b) Would your suggestions include restrictions that exist today? If not, why are those restrictions unnecessary?

No. The restrictions, specifically those relating to designation and effectiveness, are an impediment to entities undertaking hedging activities. Additional restrictions in an accounting standard would be unnecessary as companies would set their own designation and effectiveness requirements in their formal hedging policy.

(c) Existing hedge accounting requirements could be simplified if partial hedges were not permitted. Should partial hedges be permitted and, if so why? Please also explain why you believe the benefits of allowing partial hedges justify the complexity?

Yes. We do not believe that allowing partial hedges would result in significant complexity as the complexity arises from accounting rules rather than the features of partial hedging. The G100 considers that if an entity enters a partial hedge, (in line with its formal risk management strategy) that hedge should be treated as a hedge for accounting purposes. Entities have protocols and practices, including monitoring activities, as part of their management strategy and if a hedge transaction is within the risk management policies of the entity, the accounting should reflect the status of those activities. For example, an entity may enter a partial hedge because this is the most effective outcome it can achieve in the circumstances. In doing so, the entity has made the judgment that the transaction is consistent with maximising the outcome for shareholders. To prevent hedge accounting for such transactions may impede management undertaking value adding or value preserving transactions.

(d) What other comments or suggestions do you have with regard to how hedge accounting might be simplified while maintaining discipline over when a hedging relationship can qualify for hedge accounting and how the application of the hedge accounting models affects earnings?

As mentioned previously, there are many practical issues with the current requirements for hedge accounting. A list of these items has been provided below and further details in respect of three issues are included in Attachment A. (These issues were raised in the G100/FRC Workshop with IASB members on 11 August 2008). We reiterate that hedge accounting should ultimately enable the financial information of an entity to reflect its underlying business performance. All methods of hedging should be allowed as they reflect normal risk mitigation courses of action that an organisation may legitimately take. Accounting requirements should not drive decision making, accounting should reflect decision making, regardless of the complexity.

Since we believe that the IASB should focus on an interim measure that addresses problems arising from applying the existing Standard the issues which give rise to the most difficulty and complexity and which should be addressed include the following:

permitting the segregation of the fair value of a derivative at inception so that re-designation can occur and still meet hedge effectiveness criteria;
permitting specific identification of the hedged risk in respect of commodity hedges;
permitting deferral of the time value of purchased options;
permitting designation of physical contracts at ‘fair value through the profit and loss’ in a trading environment;
permitting hedging of foreign subsidiary income streams;
modifying of the definition of ‘firm commitment’ so as to not require a fixed volume and fixed price;

• permitting changes to the local currency interest rate profile of foreign debt which is hedged with a cross currency swap without forcing a de-designation of the initial cross currency interest rate swap; and
• the terms routinely denominated/commonly used must both be clearly defined as they currently interpreted differently.

Question 7
Do you have any other intermediate approaches for the IASB to consider other than those set out in Section 2? If so, what are they and why should the IASB consider them?

Refer Question 6

Question 8
To reduce today’s measurement-related problems Section 3 suggests that the long-term solution is to use a single method to measure all types of financial instruments within the scope of a standard for financial instruments.

Do you believe that using a single method to measure all types of financial instruments within the scope of a standard for financial instruments is appropriate? Why or why not? If you do not believe that all types of financial instruments should be measured using only one method in the long term, is there another approach to address measurement-related problems in the long term? If so, what is it?

While the advantages of a single model to measure financial instruments are acknowledged and conceptually a single measurement model may be most appropriate in the long term, we cannot support a full fair value methodology unless issues relating to how changes are reflected in the performance statement, measurement issues and the concerns outlined throughout this paper are resolved. Furthermore, we strongly believe that the measurement of financial instruments in the long-term should not be part of the current project. Rather, long-term issues should first be addressed as part of the conceptual framework project dealing with measurement.

Question 9
Part A of Section 3 suggests that fair value seems to be the only measurement attribute that is appropriate for all types of financial instruments within the scope of a standard for financial instruments.

(a) Do you believe that fair value is the only measurement attribute that is appropriate for all types of financial instruments within the scope of a standard for financial instruments?

However, amortised cost (or fair value with movements recognised in comprehensive income) is more appropriate in certain circumstances, depending on the nature and purpose of the instrument. Refer to comments in questions 1 and 4 above.

(b) If not, what measurement attribute other than fair value is appropriate for all types of financial instruments within the scope of a standard for financial instruments? Why do you think that measurement attribute is appropriate for all types of financial instruments within the scope of a standard for financial instruments? Does that measurement attribute reduce today’s measurement-related complexity and provide users with information that is necessary to assess the cash flow prospects for all types of financial instruments?

Refer to comments in question 1 and 4 above. Since financial instruments have a vast number of uses and characteristics the specification of a single measurement is not appropriate.

Question 10
Part B of Section 3 sets out concerns about fair value measurements of financial instruments. Are there are significant concerns about fair value measurement of financial instruments other than those identified in Section 3? If so, what are they and why are they matters for concern?

Yes. The concerns identified are significant. Other concerns relate to risk management and the perspective of the users of financial instruments. Entities must be using fair value to manage their business if it is to be considered the most relevant measurement model and this is currently not the case for a large portion of financial instruments. Furthermore, users must find fair value information meaningful and useful for their decision making in order to justify the preparation and presentation of fair value financial information. Finally, in order for fair value to be the most appropriate measurement model, efficient markets must exist for financial instruments to be measured effectively, reliably and consistently.

Question 11
Part C of Section 3 identifies four issues that the IASB needs to resolve before proposing fair value measurement as a general requirement for all types of financial instruments within the scope of a standard for financial instruments.

(a) Are there other issues that you believe the IASB should address before proposing a general fair value measurement requirement for financial instruments? If so, what are they? How should the IASB address them?

Part C adequately identifies the issues that require resolution.

(b) Are there any issues identified in part C of Section 3 that do not have to be resolved before proposing a general fair value measurement requirement? If so, what are they and why do they not need to be resolved before proposing fair value as a general measurement requirement?

No, all issues require appropriate resolution.

Question 12
Do you have any other comments for the IASB on how it could improve and simplify the accounting for financial instruments?

The G100 supports improvements to the current mixed measurement model in the areas of hedging and impairment. We believe that any other interim solution is likely to cause more change and instability in the financial reporting environment with little added value to preparers and users.

Yours sincerely

Tony Reeves
National President

Practical Examples on Hedging Issues — Attachment A

Key issues in AASB 139 include:

the treatment of options as a hedge instrument;
inconsistency between the hedge accounting treatment of financial exposures and non-financial exposures; and
interpretation that leads to a bias toward ‘opportunity cost’ accounting rather than accounting for actual transactions.

Treatment of Options as a Hedge Instrument

AASB 139.74 allows entities to choose between designating an option in its entirety as a hedging instrument or, separating the intrinsic value and time value and designating the change in intrinsic value as the hedging instrument.
In reality this is not a choice. An option in its entirety cannot pass the 80%-125% effectiveness criteria unless the hypothetical derivative is an option or risk weighted adjustment of the hedged item. Recent changes to AASB 139 have confirmed that neither of these alternatives is acceptable as the hypothetical derivative.
As a result the only way to get any hedge accounting for options is to ‘elect’ to designate the changes in the intrinsic value only as the hedged item.
The result of this designation is significant P&L volatility as a number of variables in the option value (i.e. not just the passing of time) change over the life of the derivative.
If an option is not exercised, the maximum P&L impact must equal the original premium paid.
Whilst cumulatively over the life of an option a mark-to-market approach to ‘time value’ will provide the same result, options that cross over reporting periods can result in gains and losses being booked that are well in excess of the original premium paid in any one reporting period.
This is highlighted in the following example of a zero cost collar. Even though no premium is paid on day 1, and cumulatively the P&L impact will be nil by the maturity of the collar should it not be exercised, inter-period volatility can be significant and will provide misleading information to the users of financial statements.
In effect, under AASB 139, the intrinsic value of the option receives accounting treatment on a ‘going concern’ basis whereas the ‘time value’ component is treated from a ‘liquidation’ perspective.

Options – Current Practice

The previous chart is a graphical representation of the potential time value movements that would be recognised in the P&L based on movements in the AUD/USD exchange rate on a zero cost collar.
The Strikes are at .8000 and .9000 and only the intrinsic component is designated in the hedge relationship. The non-intrinsic value increases as the forward price approaches the bought option and falls as it approaches the sold option, beyond the strikes it starts to move the other way again.
If the spot exchange rate from one month to the next month moves from 90 cents down to 85 cents, the change in non-intrinsic value of the options that will be taken to current period P&L is a gain of approximately $170 million. As the hedge instrument is a zero cost collar (there was no premium paid at inception (therefore no non-intrinsic value) and it will also expire with zero non-intrinsic value) this ‘gain’ of A$170m must reverse prior to the maturity date, ie there will be time value losses totalling A$170m recorded in a future period(s). Users of financial statements are not in a position reconcile this P&L volatility to the true cost or underlying economic benefits of the hedge relationship. Nothing would be taken to P&L under a forward exchange contract or if the company did not hedge the capex exposure however both of these approaches require a view be taken on future exchange rate movements and create risk for shareholders.

Options – Proposed Solutions

If AASB 139 is to provide the ‘choice’ of designating an option in its entirety as a hedge instrument it must be capable of passing the 80% to 125% hedge effectiveness criteria.
Current interpretation and recent changes to AASB 139, fail to provide any possibility of an option in its entirety being deemed within this effectiveness criteria.
The standard appears to recognise that an option is a valid tool used to hedge the risk of one-sided movements in a market variable. As such, a valid hypothetical derivative that can be used to test the effectiveness of an option in its entirety must be identified by the standard setters - the major accounting firms have been unable to do so.
Alternatively, the standard should be amended to remove the ‘choice’ between a designation that can never achieve hedge effectiveness and the designation of the intrinsic value only as the hedged item.

Financial Assets & Liabilities v Non-Financial Assets & Liabilities
AASB 139.81 allows a financial asset or liability to be a hedged item with respect to the risks associated with only a portion of its cash flows or fair values provided that effectiveness can be measured, eg a financial liability may include both interest rate and FX risk elements that can each be hedged separately.

AASB 139.82 does not allow the same level of flexibility for non-financial assets or liabilities because of an assumed difficulty of isolating and measuring the appropriate portion of the cash flow or fair value changes attributable to specific risks other than FX risks.
This is an inconsistent approach that assumes all non-financial risks can not be broken into component risk elements.
The result of this inconsistency is P&L volatility caused by a perceived basis risk that again distorts the underlying economics of the transaction.

Current Practice – Non-Financial Assets and Liabilities

Component hedging is sensible where forward markets are illiquid, eg Jet Fuel, and a physical relationship can be established between components of the non-financial risk and the non-financial risk in its entirety, eg Crude oil and Jet Fuel.
Current practice does not allow this an as such any derivative representing a component of the non-financial risk must be designated to the non-financial risk in its entirety, eg a Crude oil derivative must be designated as the hedge instrument against Jet fuel as the hedged item.

Jet Fuel derivatives with a maturity of greater than approx 6 months are not viable hedge instruments due to lack of liquidity, ie volumes and pricing are prohibitive. Hedging long term Jet fuel exposures using Jet fuel derivatives can destroy shareholder value.
Crude oil derivatives, eg WTI, are liquid for periods up to 3-4 years and are readily priced and transacted. The physical relationship between crude oil and refined products such as Jet fuel is indisputable.
The inability to designate components of non-financial assets and liabilities as hedged items results in basis risk being included in effectiveness testing and generating P&L volatility that fails to reflect the economic rationale and benefits of a component based approach to hedging of some non-financial assets and liabilities.

Proposed Solution: Non-Financial Assets & Liabilities

Basis risk should not impact effectiveness testing and be marked-to-market through the P&L where the appropriate portion of the cash flows or fair value changes attributable to specific risks can be isolated and measured.
A principles based approach, as applied to financial assets and liabilities, should be applied to non-financial assets and liabilities.
The standard should be amended such that if a component of risk can be separately identified, measured, and its effectiveness can be tested, it should receive hedge accounting in accordance with AASB 139 regardless of whether the underlying hedged item is a financial asset or liability or a non-financial asset or liability.

“Opportunity Cost’ Accounting

Current interpretation of AASB 139 requires an entity to ‘re-assess’ the effectiveness test and/or the ‘lessor of’ test should an underlying forecast transaction change, eg a delay in the manufacture of an asset to be purchased in foreign currency.

Current interpretation points to F.5.4 which contemplates the changes in the timing of the hedged item impact on effectiveness and therefore ineffectiveness. F.5.4 is seen to require the approach to measuring effectiveness of the hedged item to be recalibrated to reach a conclusion under AASB 139.96. Whilst a delay in timing would arguably seem more analogous to the situation contemplated in F 2.17 this is not the view adopted by the major accounting firms.

A recalibration of the hedge relationship, should a forecast cash flow be delayed, imports an element of hindsight into the accounting model, eg “had the entity entering the hedge known about the change in timing when it first entered a hedge relationship, it would have hedged differently”. The quantification of this opportunity cost is likely to cause ineffectiveness and result in P&L volatility.

Current Practice: ‘Opportunity Cost’ Accounting

For example:

A forecast capital expenditure of USD1 m in 2 years time is hedged at the beginning of the year 1 using a forward FX contract with terms matching the underlying forecast exposure.
After 9 months the manufacturer advises a delay of 6 months for the delivery of the hedged item. The hedge has been 100% effective for the first 9 months and all hedging gains and losses have been booked to the Hedge Reserve to be capitalised to the asset value on delivery.
Current interpretation requires a recalibration of the hedge relationship whereby the ‘lessor of’ test is to be recalculated comparing the change in fair value of the hedge instrument to the change in fair value of the new forecast exposure.
Whilst the forward exchange risk for the original underlying forecast cash flow has been 100% covered for the first 9 months of the hedge relationship (as contemplated by F 2.17), retrospectively changing the underlying exposure to reflect the new expected delivery date will impact previous effectiveness test results and ‘lessor of’ test results to the extent that forward points have moved over that 9 month period.
Adjusting an existing hedge relationship based on information not available at time of the original hedge designation appears inconsistent with the basic AASB 139 requirements for ‘point in time’ testing and measurement of derivatives and hedge relationships

Proposed Solution: ‘Opportunity Cost’ Accounting

A hedge relationship should be defined based on knowledge available at a point in time.
Should changes to timing of the underlying exposure occur, the original hedge relationship should be automatically de-designated as that change occurs and all effectiveness testing and ‘lesser of’ testing be carried out on information specific to the original relationship.
New timing assumptions should be incorporated into the new hedge relationship (if one is designated). All effectiveness testing and ‘lesser of’ testing going forward should be carried out using information specific the new relationship.
At no time should information/assumptions used in the latter relationship contaminate the analysis and historical accounting treatment of the original hedge relationship.

G100
9/2008

Practical Examples on Hedging Issues — Attachment A

Options – Current Practice

The previous chart is a graphical representation of the potential time value movements that would be recognised in the P&L based on movements in the AUD/USD exchange rate on a zero cost collar.

The Strikes are at .8000 and .9000 and only the intrinsic component is designated in the hedge relationship. The non-intrinsic value increases as the forward price approaches the bought option and falls as it approaches the sold option, beyond the strikes it starts to move the other way again.

Options – Proposed Solutions

If AASB 139 is to provide the ‘choice’ of designating an option in its entirety as a hedge instrument it must be capable of passing the 80% to 125% hedge effectiveness criteria.

Current interpretation and recent changes to AASB 139, fail to provide any possibility of an option in its entirety being deemed within this effectiveness criteria.

Alternatively, the standard should be amended to remove the ‘choice’ between a designation that can never achieve hedge effectiveness and the designation of the intrinsic value only as the hedged item.